Sunday, 2 September 2012

Cutthroat v. cuddly capitalism

Why, ask Daron Acemoglu, James A. Robinson and Thierry Verdier, can't we all be more like Scandinavians? They have a new working paper out on the question Can't We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World.

Acemoglu, Robinson and Verdier argue that many people perceive average welfare to be higher in Scandinavian societies than in the United States due to Scandinavian countries having more limited inequality and more comprehensive social welfare systems. This raises the question of Why doesn't the United States adopt Scandinavian-style institutions? Why isn't the U.S. more like the Scandinavians? More generally, in an interdependent world, would we expect all countries to adopt the same institutions? To provide theoretical answers to this question,  Acemoglu, Robinson and Verdier develop a simple model of economic growth in a world in which all countries benefit and potentially contribute to advances in the world technology frontier. A greater gap of incomes between successful and unsuccessful entrepreneurs (thus greater inequality) increases entrepreneurial effort and hence a country’s contribution to the world technology frontier. Under plausible assumptions, the world equilibrium is asymmetric: some countries will opt for a type of "cutthroat" capitalism that generates greater inequality and more innovation and will become the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and choose a more cuddly form of capitalism. Paradoxically, Acemoglu, Robinson and Verdier are able to show that those with cuddly reward structures, though poorer, may have higher welfare than the cutthroat capitalists; but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of capitalism. They also show that domestic constraints from social democratic parties or unions may be beneficial for a country because they prevent cutthroat capitalism domestically, instead inducing other countries to play this role.

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