BOFIT Discussion Papers, Institute for Economies in Transition, Bank of Finland
No 11/2005:
On the Speed of Economic Reform: Tale of the Tortoise and the Hare
Bruno Merlevede ()
and Koen Schoors
Abstract: We analyse how the choice of reform speed and economic
growth affect one another. We estimate a system of three equations where
economic growth, economic reform and FDI are jointly determined. New
reforms affect economic growth negatively, whereas the level of past reform
leads to higher growth and attracts FDI. This means that the immediate
adjustment cost of new reforms is counterbalanced by a future increase in
FDI inflows and higher future growth through a higher level of past reform.
Reform reversals contribute to lower growth. We use the model to simulate
the impact of big bang reform and gradualist reform on economic growth.
This is only meaningful in the presence of reform reversals, which requires
aggregate uncertainty about the appropriate reform path. Using the
coefficients from the empirical model, we find that even relatively small
ex ante reversal probabilities suffice to tilt the balance in favour of
gradualism. The case for gradualism gains strength if policymakers are
short-sighted, but weakens if voters are myopic.
Keywords: policy reform; gradualism; big bang; FDI; economic growth; (follow links to similar papers)
JEL-Codes: O57; P21; P26; P27; (follow links to similar papers)
42 pages, September 5, 2005
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