On the Dynamic Consistency of Reform and Compensation Schemes

To make reform possible, politically strong losers have to be bought out. Whether the losers are fully compensated upfront or given running compensation depends on their political influence after reform. We build a simple but general model to study dynamic consistency of compensation and political support for reform. We find that positive but decreasing compensation is required in every period up to the last period the losers have political influence. In that period it increases dramatically. If there are limited resources available to compensate the losers upfront, increasing the cost of reversing the reform may reduce the political feasibility of reform.