Because of their more limited inequality and more comprehensive social welfare systems, many perceive average welfare to be higher in Scandinavian societies than in the United States. Why then does the United States not adopt Scandinavian-style institutions? …we 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.
We show that, 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, those with cuddly reward structures, though poorer, may have higher welfare than 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. We 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.
This is interesting beyond their [re]framing of inequality and technology frontiers in that they specifically mention entrepreneurs as crucial to the wealth/innovation creation process. The entrepreneur has too long been absent from discussions about development outside of specific circles and it is promising to see entrepreneurs as central to a model not explicitly designed to discuss entrepreneurship. They go on to suggest that investigating ‘institutional specialization’ is an important research direction as it may apply to other institutions like education and labor mobility. Such studies could potentially add insight into the ever difficult question of why there are higher concentrations of entrepreneurial activity and success in different areas.
Finally, the use of the word ‘cuddly’ in an academic paper is both ground-breaking and highly entertaining.
Hat tip to Chris Blattman.