Markets versus governments

Daron Acemoglu, Mikhail Golosov, Aleh Tsyvinski

Research output: Contribution to journalArticlepeer-review

24 Scopus citations

Abstract

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.

Original languageEnglish (US)
Pages (from-to)159-189
Number of pages31
JournalJournal of Monetary Economics
Volume55
Issue number1
DOIs
StatePublished - Jan 2008

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Keywords

  • Governments
  • Markets
  • Mechanisms
  • Political economy
  • Risk sharing

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