When Does Limited Commitment Matter in a Production Economy?

We investigate the conditions under which the first-best allocation without commitment is sustainable in a production economy. While it is widely known in the literature that allowing capital accumulation creates a distortion, we find that it can help to sustain the first-best allocation. We also find that for a certain set of endowment economies in which the efficient allocation is not sustainable, the efficient allocation becomes sustainable once we introduce a production technology with very small returns to scale or any returns to scale higher than the threshold. In some cases, gains from efficient resource allocation between agents can be so large that they can compensate for the increase in the outside option that arises when capital moves from the less-productive to the more-productive agent