The Impact of Simple Institutions in Experimental Economies with Poverty Traps

Abstract

The existence of multiple equilibria is one explanation for why some countries are rich while others are poor. This explanation also allows the possibility that changes in political and economic institutions might help poor countries jump from a bad economic equilibrium into a better one, permanently increasing their output and income. Experiments are a useful methodology to study the effect of institutions on economic growth. In this paper, we study a simple experimental economy in which agents produce output in each period and can allocate the output between consumption and investment (the experiment adds to the design of Lei and Noussair, 2002, 2003). Capital productivity is higher if total investment is above a threshold. The threshold externality generates two equilibria - a suboptimal poverty trap and an optimal rich country equilibrium - which differ by a factor of around three in the income they create. In baseline sessions, in which agents make independent decisions in a decentralized manner, the economies typically sink into the poverty trap and the optimal equilibrium is never reached. However, the ability to communicate before investing, or to vote on binding industrial policy proposals, improves average earnings. Communication enables agents to agree to restrain consumption to cross the capital threshold, and voting enables them to enforce such plans. Combining both of these simple institutions enables all of the economies to escape the poverty trap. This experimental environment constitutes a platform onto which more complex features can be added in a program of experimental growth economics.