Markets and Cooperation

Abstract:     
When isolated communities get in contact with more developed economic institutions an internal breakdown of cooperation typically occurs. Why do money and markets crowd out cooperative relations? I propose a new theoretical explanation of this phenomenon based on the interaction between players' aversion to intertemporal substitution, their ability to access goods and financial markets, and their ability to sustain cooperation. Real world agents are strongly averse to intertemporal substitution. This turns out to facilitate cooperation, since it reduces agents' evaluation of short-run gains from unilateral deviations relative to losses from punishments. The access to money and markets, therefore, makes cooperation harder to sustain by allowing agents to improve the intertemporal allocation of short-run gains from unilateral deviations; that is, by increasing agents' evaluation of direct gains from "cheating." By allowing for free intertemporal reallocation of payoffs, perfect financial markets always make cooperation harder. Financial markets' imperfections facilitate cooperation (and collusion) by opposing this effect.

JEL Classifications: C72, D51, O17

Working Paper Series