ECONOMICS AND POLITICS OF ALTERNATIVE INSTITUTIONAL REFORMS

In a model with heterogeneity in managerial talent, we compare the economicand political consequences of reforms aimed at reducing fixed costs of entry (deregulation)and improving the efficiency of financial markets (financial reform). Theeffects of these reforms depend on the market where control rights over incumbentfirms are traded. In the absence of a market for control, both reforms increase thenumber and the average quality of firms, and are politically equivalent. When amarket for control exists, financial reform induces less entry than deregulation,and endogenously compensates incumbents, thereby encountering less politicalopposition from them. Using this result, we show that financial reform may beused in the short run to open the way for future deregulation. Our model shedslight on the privatization and reform experiences of formerly planned economiesas well as on the observed path of reforms in economies of the Organisation forEconomic Co-operation and Development.[...]