Juan Carlos Carbajal | University of New South Wales

This paper examines the impact of inertia, understood as adjustment costs, on the implementation of market-oriented reform programs. I consider the problem of a benevolent planner (government) who can introduce efficiency-enhancing reforms to increase the rate of economic growth by inducing, via monetary compensations, reassignments of a scarce resource from low to high productivity households. Since productivity levels are private information, any reform program requires incentive transfers to be implemented. In my baseline scenario without inertia, I show that efficiency gains are sufficiently large, despite the asymmetry of information between households and government, to permit the implementation of market mechanisms with unanimous support from the population. Moreover, the market reform program is revenue neutral in its first year of implementation. In the presence of adjustment costs the government is required to increase compensation to new generations of households to allow for institutional changes associated with the expansion of markets. I show that, under some mild assumptions, the government prefers to introduce a transition reform program instead of a full market reform. In this transition program, households with intermediate productivity levels are kept in the inefficient, non-market system, while only high productivity households enter the market. 

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