Social Planner's Solution Research Articles

Growth and the cycle: Creative destruction versus entrenchment

Newly estaboished firms often try to secure their market position by building up a base of loyal customers. While recessions may not destroy technological leadership, they may be harmful for such firm-customer relationships. Without such customer bases, these firms find themselves more vulnerable to attacks by competitors. We formulate this idea within an Aghion-Howitt-type model of creative destruction and discuss its implications for growth. In the context of this model, recessions might be good for growth since they weaken the incumbent firm's position and, thereby, stimulate research by outside firms. The model allows for the extreme case where the leading firm can be so entrenched that growth ceases, unless a recession shakes up its customer base. We find a one-to-one relationship between the average growth rate and the cyclical variability, a U-shaped relationship between the average speed of building up good customer relationships and the average growth rate, and a positive relationship between the arrival rate of recessions and average growth. It is finally shown that an appropriate stochastic tax program can implement the social planner's solution. In some cases, general-equilibrium effects may generate interesting results, conflicting with intuition from a partial-equilibrium approach: we show that, in some cases, a social planner might want to subsidize research in order to discourage it.

Economic instruments for emission abatement under appreciable technological indivisibilities

The paper explores the performance of decentralized incentives when abatement involves technological indivisibilities. Technologically, pollution abatement is often carried out as a discrete process, if pollution reduction involves relatively large-scale investments in emission abatement equipment.Consequently, the firm's response to decentralized economic incentives for pollution abatement is affected by the indivisible property of the technology. It can be shown that in such cases efficiency may not be realized. Installing an abatement device may entail “too much” or “too little” investment compared with the eficient solution. To partially remedy this problem, an incentive scheme which incorporates a fine (penalty) on pollution-induced damages is proposed in this paper. Essentially, as in the case of the command and control approach, the mechanism imposes a fine when firms do not meet an aggregate (e.g., a “bubble”) emission level. The fine is set as a proportion of the polluting firm's share of the total excess damage inflicted when the standard has been violated. The paper explores alternative outcomes under this scheme in the framework of a non-cooperative game. The outcomes under command and control (uniform percentage reductions), taxes, pollution permits and the fine scheme are illustrated with data from the haifa area in northern Israel. They are compared with the social planner solution in terms of efficiency (achieving a given standard at minimum cost) and the volume of transfer cost.