To Each According to . . . ? Markets, Tournaments, and the Matching Problem with Borrowing Constraints.

We compare the performance of markets and tournaments as allocative mechanisms in an economy with borrowing constraints. The economy consists of a continuum of individuals who differ in their initial wealth and ability level. These must be assigned to a continuum of investment opportunities or inputs of different productivity. With perfect capital markets matching is efficient under both mechanisms. Markets, however, generate higher aggregate consumption because of the waste associated with the production of signals under tournaments. When borrowing constraints are present, tournaments dominate markets in terms of matching efficiency and, for sufficiently powerful signalling technologies, also in terms of aggregate consumption. Copyright 1999 by The Review of Economic Studies Limited.