Abstract
In a planned economy, state monopoly ensures that economies of scale are exploited. However, state monopoly could not commit to reward its workers. Anticipating this, individuals will exert less effort. In a market economy, competition among firms ensures that higher effort from workers will be rewarded. However, competition means that economies of scale are not fully exploited. Per capita output growth is generated by continuous adoption of new technologies substituting labor for capital. Growth rate in a market economy is higher than that in a planned economy when the incentive to exert effort is relatively more important.
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Notes
Duranton and Haniotis (2004) compare economic performance for different economic systems. They study the tradeoff between the loss associated with risk-taking in a market economy and the informational problems in a planned economy. Different from this paper, economic growth is not studied in their model.
One well-known phenomenon in a planned economy is the soft-budget constraint problem (Dewatripont and Maskin 1995). Our emphasis of the role of competition in ensuring that workers are sufficiently compensated is similar to their argument that decentralization makes the liquidation of a bad project credible. The role of competition in the process of industrialization is discussed in Zhou (2009).
Our framework is highly stylized. In a market economy, imperfect competition is quite common. This will not change our result as long as the degree of monopoly in a planned economy is higher than that in a market economy. In a planned economy, monopoly pricing and rents would decrease the benefit of monopoly. This aspect does not contradict our model because this model accommodates the aspect that monopoly is costly. If we combine the cost from monopoly pricing with cost from low effort in this model, the analysis of this model still goes through.
This paper does not address the development of new technologies. We have also studied a model in which new technologies are developed by the R&D sector. The essential tradeoff between a market economy and a planned economy remains because which economy has a higher growth rate still depends on which economy has a higher supply of effective labor. However, there will be no closed-form solutions for the growth rates. Since incorporating a R&D sector complicates the presentation significantly without adding important insights, it is not pursued.
Here we assume that human capital does not accumulate over time. Introducing human capital accumulation will not change the essence of this model if the growth rate of human capital in a market economy is similar to that in a planned economy. One interpretation of the assumption of no human capital accumulation is that individuals of different periods are just different generations of a family. Different generations are linked as an individual cares about the utility of his offspring while human capital does not transfer between different generations.
Here a worker gets all surplus generated by him if there are two or more firms producing the same good. Alternatively, a worker’s share of the surplus can be specified to increase with the number of firms producing the same good. The tradeoff between a market and a planned economy will be similar under the alternative setup.
For an example of oligopolistic competition with free entry, see Lahiri and Ono (2004).
Here it is assumed that in an infinite horizon, the government in a planned economy could not establish a reputation that investment in human capital will be rewarded.
In a planned economy, the number of firms producing a good may be higher than one. This does not necessarily mean there is competition among these firms. The reason is that all firms may follow orders from the same government agency.
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I thank John M. Virgo and an anonymous referee for their valuable suggestions.
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Zhou, H. Economic Systems and Economic Growth. Atl Econ J 39, 217–229 (2011). https://doi.org/10.1007/s11293-011-9280-4
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DOI: https://doi.org/10.1007/s11293-011-9280-4