policy reform, gradualism, big bang, FDI, economic growth, O57, P21, P26, P27, Bruno Merlevede, Koen Schoors
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.
Published in: Journal of Economic Policy Reform, Vol.10, No.1, 29-50, 2007. Print ISSN: 1384-1289.