Dynamic Processes of Social and Economic Interactions: On the Persistence of Inefficiencies

Abstract

An economy with a finite number of agents and a finite number of states is considered. An exogenous institutional rule prescribes what moves from one state to another are feasible to each coalition. At each time an agent is called to act with some exogenous probability, and he chooses a coalition, a feasible new state to move the economy to, and side-payments between the agents in the coalition. The setup can be applied to various dynamic processes of social and economic interactions such as legislative bargaining, coalition formation or exchange economies. Whenever agents are unable to write long-term contracts, but agents are otherwise unconstrained both in their ability to write arbitrary spot contracts and in their ability to collude, there can be long-run inefficiencies (with cycles or inefficient steady states). However, when agents are sufficiently patient, the initial state from which the process starts plays no role in the long-run. Moreover, when there exists an efficient state that is negative-externality-free (in the sense that a move away from that state does not hurt the agents whose consent is not required for the move), then the system must converge to this efficient state in the long-run. It is thus more important to design institutions guaranteeing the existence of an efficient-negative-externality-free state than to implement a fine initialization of the process.

Keywords: Dynamic games, externalities, efficiency, convergence, contracts

JEL Classification: C70, D50, D70