When should market-supporting institutions be established?

Journal of Law, Economics, and Organization

Volumn 16, Issue 1, 2000, Pages 129-154

  Fleck, Robert K ^a  

^a MONTANA STATE UNIVERSITY   (United States)

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[No Author keywords available]

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EID: 0034409511     PISSN: 87566222     EISSN: None     Source Type: Journal    
DOI: 10.1093/jleo/16.1.129     Document Type: Article

References (68)

1. New businesses and private sector investment, represented in the model as the endeavors of stylized "entrepreneurs" have produced much, and perhaps most, of the economic gains from the transition to markets (e.g., Krueger, 1992; Tesche and Tohamy, 1994; Murrell, 1996).
2. The population is assumed to be sufficiently large that no generality is lost by using a continuous function to describe the share of the population in favor of maintaining the reform.
3. In practice, institutions can be corrupt or incompetent. Quite obviously, this can decrease efficiency, as can γ < 0. The model assumes that γ ≥ 0 to focus on the more interesting cases.
4. Figure 1 could easily be modified to reflect a supermajority rule. If, for example, changing the reform required a vote over 67%, then W(t) = 0.33 would indicate the time at which there would be enough winners to block legislation. A supermajority rule would be relevant if, for example, (1) private property rights could be guaranteed under a constitution and (2) the country had somehow established a credible commitment to requiring a supermajority to amend the constitution. Committing to a supermajority rule would neither eliminate the commitment difficulties encountered under democratic government nor change the nature of the analysis in this article.
5. redist does not exist, in which case losers would never prefer redistribution.
6. redist/∂r > 0. (Proof available from author.)
7. 2 nor any other time can be rationally scheduled for redistribution.
8. 1 = 5, entry begins at t = 10.4.
9. Numerical solutions are rounded.
10. This focuses the analysis on the cases in which group B potentially can be an obstacle to reform: (i) group B can be decisive in voting, (ii) majority rule among voters holds meaningfully, (iii) the commitment issue is not trivialized by assuming a rule allowing only "winners" (who will oppose redistribution) to vote, (iv) the higher expected private sector returns for members of group A gives them a potential reason to prevent group B from voting, and (v) the issue of credible commitment to nonvoters is not trivialized.
11. Obviously, even if democracy threatens property rights, it may not be undesirable. Individuals may value highly the democratic process itself. And, in practice, the alternatives to democracy have often produced disastrous policy.
12. redist (which is easy to show when T = 0).
13. A will reduce the value of redistribution.
14. This is not to suggest that redistributing wealth is necessarily undesirable, inefficient, or detrimental to transition. The model's key concern with redistribution is that insecure property rights can reduce incentives to create wealth. Note that efficiency-enhancing aspects of redistribution are consistent with all the theoretical findings in the model: efficiency-enhancing redistribution can be modeled as a market-supporting institution that may either enhance or derail growth, depending on commitment issues and timing. Furthermore, it is easy to see how, in practice, a policy of ending transfer payments might be so unpopular that it would doom majority support for reform. And, at least in principle, redistribution can be used to compensate losers, thereby building a constituency in favor of more efficient policy (e.g., Blanchard, 1996; Rodrik, 1996). On the relationship between redistribution and growth, see, for example, Alesina and Rodrik (1994).
15. There are several mechanisms through which tax enforcement institutions may improve efficiency (parallel to γ > 0 in the model). First, because widespread evasion greatly reduces the tax base, strengthening enforcement would allow marginal tax rates on reported income to be cut, without decreasing total tax revenue. This would generally be expected to reduce the deadweight loss of taxation, thereby improving efficiency. Second, weak enforcement may lead to inefficient revenue collection if governments resort, as they often have, to capricious seizures of wealth or to inflationary expansion of the money supply. Third, the inability to raise revenue may lead to an inefficiently low provision of public goods and of publicly provided goods that influence growth. For a discussion of models in which publicly provided goods influence economic growth, see Barro and Sala-i-Martin (1992). As should be obvious, this is not to say that increasing tax revenue will necessarily improve efficiency.
16. Kornai (1990) also argues that strict enforcement of tax laws may not be optimal for transition.
17. Olson (1982) also points out benefits from dismantling institutions. Naturally, rules against hiring or appointing former communists have caused controversy; for related scholarly work, see Frydman and Rapaczynski (1994) and Barberis et al. (1996).
18. In practice, of course, moral hazard matters when establishing or dismantling institutions. The model ignores such problems because it is trivial to show how incompetent agencies can decrease efficiency. Corrupt agencies have indeed hindered entrepreneurs, creating disincentives to invest (e.g., Goldberg, 1994). See also Shu (1992), Shleifer and Vishny (1994), and Mauro (1995).
19. b > 0. This generalization is straightforward because, when the first-best reform will not lead to immediate entry, there will never be any benefit to delay setting up the institution.
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