Why good economic reforms could actually be bad news for ruling party…

There is large literature on political economy of reforms. Whether the ruling party wins on economics reforms? What kind of reforms? Should it highlight the reforms/growth or remain quiet? How should the reforms be sequenced? etc etc.

This paper is an addition to the literature giving contrary ideas. It is written by Sweder Van Wijnbergen of Universiteit van Amsterdam and Tim Willems of University of Oxford. They show why some reforms that begin well, lose public support. They say such reforms are like sampling without replacement..once out of the sampling bag they cannot go back into the bag. Overtime, people lose confidence and as a result lose out:

Support for economic reforms has often shown puzzling dynamics: many reforms that began successfully lost public support. This paper shows that learning dynamics can rationalize this paradox because the process of revealing reform outcomes is an example of sampling without replacement. This concept challenges the conventional wisdom that one should begin by revealing reform winners. It may also lead to situations in which reforms that enjoy both ex ante and ex post majority support will still not come to completion. The framework can be used to explain why gradual reforms worked well in China (where successes in Special Economic Zones facilitated further reform), whereas this was much less the case for Latin American and Central and Eastern European countries.

The paper begins with this interesting example:

The most dramatic example of a reformist government that lost majority support in spite of strong economic performance is Slovakia in 2006. At that time, the Wall Street Journal Europe wrote, “Imagine you’re the leader of a country where economic growth is running at 6.3%, your government has been praised by the World Bank as the best market reformer in the world [and] unemployment has fallen to a record low of 10.6% from around 20% in just four years. […]

With this record in mind, now consider that you face parliamentary elections this Saturday at which, unless the opinion polls change dramatically, you risk annihilation by a leftist opposition party with no experience of government and a policy agenda filled with populist rhetoric.

Welcome to the world of Mikuláš Dzurinda, prime minister of Slovakia, who for the past eight years has led what can reasonably claim to have been the most successful neo-liberal government of the 21st century so far.”Despite his impressive reform successes, Dzurinda lost the 2006 elections to Robert Fico of the SMER party (a breakaway party from the successor to the original Communist Party of Slovakia), who reversed many of Dzurinda’s reforms. 

With important reforms currently being implemented in many African and Southern European states, it is important to understand why such puzzling reversals can occur. In this paper, we focus on the interaction between learning from reform outcomes and the dynamics of public support for gradual economic reforms

So, what is the idea?

The fact that existing reform measures affect the distribution from which future sampling will occur plays a key role in our analysis. Specifically, the process of revealing reform outcomes is an example of sampling without replacement. This implies that the revelation of reform winners deteriorates the quality of the remaining pool, thereby making unreformed agents less eager to continue the reform process. We derive a condition under which these dynamics are so strong that they lead to the counterintuitive situation in which reform successes make the median voter begin opposing a reform he used to support. In these circumstances, the reforming government suddenly loses majority support although (or because) the reform is progressing in such a successful way. Consequently, even reforms that enjoy both ex ante and ex post majority support may not come to completion.

We emphasize that this phenomenon results from rational economic thinking and that it arises as soon as a reform is believed to generate losers whose identity is ex ante unknown – a feature that we see as being in accordance with many economic reforms in reality (see also Fernandez and Rodrik 1991). In addition, sampling without replacement continues to play a role when one adds aggregate uncertainty. In that setup, the revelation of winners may also lead to an upward revision of the expected aggregate number of reform beneficiaries (enhancing support for reform). However, we show that it is possible for this strategy to sow the seeds for its own destruction.

Although this learning mechanism applies to many reform types (such as land reform, the gradual abolition of subsidies/price controls, or the reduction in trade barriers), we often link it to privatization. Privatization is a good example of a reform in which learning dynamics may be important, and the choice between starting with “good” or “bad” companies arises consistently. Because the government is the incumbent owner of the firms that are to be privatized, it often has inside information on the profitability of these firms and on future policies that may benefit or harm them. This situation brings up the sequencing question for the government and the issue of learning for other agents (see, e.g., Roland 2000, chapter 2).

Policy implications:

Our results question the political feasibility of the so-called “sectoral gradualist” way of privatization. This strategy has been advocated, for example, by Kornai (1990) through his plea for the “case-by-case” approach, and it has been applied to many countries in Latin America and Central and Eastern Europe as well as to the UK during its liberalization phase. This strategy implies that one sector (or firm) is reformed after the other (cf. Berg and Blanchard (1994, 53, 63)). However, as we argue below, following such a gradual, sequential approach triggers the “sampling without replacement” effect presented previously.

This may explain why practitioners have experienced political difficulties with the case-by-case strategy. Lipton and Sachs (1990, 298) note that “in almost all countries where privatizations have been attempted, there have been major political obstacles to the case-by-case approach”. Boycko, Shleifer, and Vishny (1993, 148) state that reforms that proceed at a rather slow pace are likely to reach a deadlock. As we argue later in this paper, “spatial gradualism” (reforming one region after another, as China did by installing Special Economic Zones) can avoid the “sampling without replacement” problem. Thus, the mechanisms explored in this paper may help explain why gradual reform strategies have been more successful in China than in Latin America and Central and Eastern Europe.

Hmmm..

India did benefit from this approach in recent elections. The focus on Gujarat model and how it is a better reformed region, led people to vote for the CM who worked on the Guj Model..

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