The Role of Social Policy in the Promotion of Trade
Co-authored with Chris Bidner, University of New South Wales
Abstract:
Cooperation in the face of moral hazard is a critical factor in economic development. Existing research on institutional support for cooperation has primarily focused on the role of contract enforcement in limiting the incentives for cheating. In contrast, we focus on the need for a social safety net to permit extensive cooperation. Starting from a basic prisoner’s dilemma model, we introduce uncertainty in contracting institutions through a global games mechanism similar to that in Carlsson and van Damme (1993). Whereas under perfect information limiting exposure to risk reduces cooperation, the identical model with uncertainty generates the opposite result: limiting risk encourages cooperation in parallel with increased contract enforcement. The results support a growing literature showing that both contracting and social institutions are key factors in promoting economic growth.