TY - JOUR
T1 - Markets versus governments
AU - Acemoglu, Daron
AU - Golosov, Mikhail
AU - Tsyvinski, Aleh
N1 - Funding Information:
This paper builds on and significantly extends Section 8 of our earlier working paper “Markets Versus Governments: Political Economy of Mechanisms” NBER Working Paper No. 12224, April 2006. We thank Georgy Egorov, Oleg Itskhoki, and Alp Simsek for excellent research assistance and Stefania Albanesi for comments. All three authors gratefully acknowledge financial support from the National Science Foundation.
Copyright:
Copyright 2008 Elsevier B.V., All rights reserved.
PY - 2008/1
Y1 - 2008/1
N2 - We provide a simple framework for comparing market allocations with government-regulated allocations. Governments can collect information about individuals' types and enforce transfers across individuals. Markets (without significant government intervention) have to rely on transactions that are ex post beneficial for individuals. Consequently, governments achieve better risk sharing and consumption smoothing than markets. However, politicians in charge of collective decisions can use the centralized information and the enforcement power of government for their own benefits. This leads to political economy distortions and rents for politicians, making government-operated allocation mechanisms potentially worse than markets. We provide conditions under which it is ex ante beneficial for the society to tolerate the political economy distortions in exchange for the improvement in risk sharing. For example, more effective controls on politicians or higher discount factors of politicians make governments more attractive relative to markets. Moreover, when markets cannot engage in self-enforcing risk-sharing arrangements and income effects are limited, greater risk aversion and greater uncertainty make governments more attractive relative to markets. Nevertheless, we also show theoretically and numerically that the effect of risk aversion on the desirability of markets may be non-monotonic. In particular, when markets can support self-enforcing risk-sharing arrangements, a high degree of risk aversion improves the extent of risk sharing in markets and makes governments less necessary. The same pattern may also arise because of "income effects" on labor supply. Consequently, the welfare gains of governments relative to markets may have an inverse U-shape as a function of the degree of risk aversion of individuals.
AB - We provide a simple framework for comparing market allocations with government-regulated allocations. Governments can collect information about individuals' types and enforce transfers across individuals. Markets (without significant government intervention) have to rely on transactions that are ex post beneficial for individuals. Consequently, governments achieve better risk sharing and consumption smoothing than markets. However, politicians in charge of collective decisions can use the centralized information and the enforcement power of government for their own benefits. This leads to political economy distortions and rents for politicians, making government-operated allocation mechanisms potentially worse than markets. We provide conditions under which it is ex ante beneficial for the society to tolerate the political economy distortions in exchange for the improvement in risk sharing. For example, more effective controls on politicians or higher discount factors of politicians make governments more attractive relative to markets. Moreover, when markets cannot engage in self-enforcing risk-sharing arrangements and income effects are limited, greater risk aversion and greater uncertainty make governments more attractive relative to markets. Nevertheless, we also show theoretically and numerically that the effect of risk aversion on the desirability of markets may be non-monotonic. In particular, when markets can support self-enforcing risk-sharing arrangements, a high degree of risk aversion improves the extent of risk sharing in markets and makes governments less necessary. The same pattern may also arise because of "income effects" on labor supply. Consequently, the welfare gains of governments relative to markets may have an inverse U-shape as a function of the degree of risk aversion of individuals.
KW - Governments
KW - Markets
KW - Mechanisms
KW - Political economy
KW - Risk sharing
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U2 - 10.1016/j.jmoneco.2007.12.003
DO - 10.1016/j.jmoneco.2007.12.003
M3 - Article
AN - SCOPUS:39549101000
SN - 0304-3932
VL - 55
SP - 159
EP - 189
JO - Journal of Monetary Economics
JF - Journal of Monetary Economics
IS - 1
ER -