Entrepreneurship and conflict generating product price changes

Why are vested interest groups and political economy activities much less significant in some countries than in others? We put forward the following hypothesis: because entrepreneurship is much more established in some countries than in others. In the former there exists a factor, say skilled labour which -in contrast to unskilled labour -is highly mobile between production and the setting up of firms. Making use of a model of a small open economy with one monopolistically competitive industry (good 2) and a variable elasticity of demand, we derive conditions under which an exogenous increase in the price of good 2 is conflict generating between the owners of unskilled and skilled labour in the short but Pareto improving in the long run. Generally speaking, output adjustments in good 2 at the intensive margin make for conflict generation; but the converse holds for adjustments at the extensive margin. By assumption all the rent in the short run equilibrium accrues only to the owners of skilled labour because they are also the owners of firms. Surprisingly, the price increase is more likely to imply a Pareto improvement in the long run if it has a strongly anticompetitive effect in the short run. The analysis and the results also highlight the importance of (a) the skilled labour intensity in the production of goods 1 and 2 relative to the skilled labour intensity of production and in the setting up of firms and (b) appropriately defined gross and net economy rates of return from the setting up of firms by the owners (skilled labour).