When Does Limited Commitment Matter in a Production Economy?

Abstract

We investigate the conditions under which the first-best allocation without commitment is sustainable in a production economy. We find that allowing capital accumulation can help to sustain the first-best allocation, although it is known to create a distortion. For some production technologies, gains from efficient resource allocation between agents can be so large that it can compensate for the increase in the outside option that arises when capital moves to the more productive agent from the less productive agent.