ECONOMIC GROWTH AND INCOME REDISTRIBUTION IN A DIFFERENTIAL GAME BETWEEN THE GOVERNMENT AND THE PRIVATE SECTOR

Abstract

Development economists analyze distributional conflict on growth with a mechanistic view of policy making and discuss issues of fairness from the economists' point of view. Economic growth theorists ignore distributional issues and concern themselves with the production function and TFP growth. These gaps distort discussions and demonstrate the importance of understanding growth and distributional issues from a game-theoretic perspective. This exercise introduces dynamic (differential) game models to analyze the dynamic conflict of growth and distribution. A distinctive feature of these models is that issues of fairness are not analyzed from the economists' point of view. Instead, this exercise rigorously develops new and formal concept of fairness from the players' point of view. At least, in part, the gaps in the theoretical literature reflect the absence of an empirically relevant model which could exhibit the rigor and elegance of economic growth models. Past attempts at such a model were seriously undermined by the loose treatment of the time consistency problem in policy making. From an empirical perspective, these models also fail to explain why ideological differences matter less for some countries than others. The dynamic game models developed in this exercise fill these theoretical gaps. For analytical tractability, the exercise restricts itself to games with two players. Within this limitation, the models here deliver many important insights. The following conclusions highlight the models' capacity to address many important and outstanding issues in economic growth and development. The exercise clearly demonstrates that distributional conflict afflicts both developing and developed countries. In the Nash equilibrium, the economies in both developed and developing countries stagnate. However, developed countries are in better positions to pick up again. In contrast, developing countries may never pick up from their initial conditions and may be trapped indefinitely in poverty and low growth. While this is true for some developing countries, others seem to refute this hypothesis by sustaining high growth and exhibiting good distributional records for well over a quarter of a century. The link comes from the policy reactions to the Nash outcome.