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Reform, Lobbies and Welfare: A Common Agency Approach

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Policy makers make policy decisions, which affect the utility of private citizens. The traditional explanation for government intervention in the economy is the existence of market failure. Nevertheless, despite public policy interventions, the economy may fail to reach the efficient frontier. Hence, unless we suppose that efficient policies are not feasible (second and third best arguments), we need a theory of inefficient decisions by policy makers. Therefore the following questions arises: How do policy makers take policy decisions? What is their objective function? The objective of this paper is to verify if policy-makers' preferences for monetary transfers can generate inefficiency. We analyse a policy making process where the policy decisions are a reform and a compensating taxation. The main feature of the reform is that it creates gainers and losers. Redistributive taxation can be used to compensate losers. Formally, the relationship between the citizens and the policy maker is modeled as a common agency game, where the citizens, organized in lobby groups, are the principals and the policy maker is the agent. With the possibility for at most two lobbies, we find that one-lobby equilibrium is inefficient and the two-lobbies equilibrium is efficient. When we check for the Nash equilibrium we find that, non-lobby and one-lobby are not Nash equilibria and two-lobbies is a Nash equilibrium. Finally, the unique Nash equilibrium is robust to the introduction of a political constraint on tax parameters.

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Bibliographic Info

Paper provided by Department of Economics, Royal Holloway University of London in its series Royal Holloway, University of London: Discussion Papers in Economics with number 01/6.

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Length: 31 pages
Date of creation: Dec 2001
Date of revision: Dec 2001
Handle: RePEc:hol:holodi:0106

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Keywords: Reform; Lobbying; Redistribution; Economic Welfare;

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  1. Dixit, A. & Helpman, E., 1996. "Common Agency and Coordination: General Theory and Application to Tax Policy," Papers 179, Princeton, Woodrow Wilson School - Public and International Affairs.
  2. Branko Milanovic, 1999. "Explaining the increase in inequality during transition," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 7(2), pages 299-341, July.
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  8. Elias Dinopoulos & Timothy D. Lane, 1992. "Market Liberalization Policies in a Reforming Socialist Economy," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 465-494, September.
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  13. Doyle, Christopher, 1993. "The Distributional Consequences of Russia's Transition," CEPR Discussion Papers 839, C.E.P.R. Discussion Papers.
  14. repec:fth:coluec:625 is not listed on IDEAS
  15. Dewatripont, M & Roland, G, 1992. "Economic Reform and Dynamic Political Constraints," Review of Economic Studies, Wiley Blackwell, vol. 59(4), pages 703-30, October.
  16. Wyplosz, Charles, 1992. "After the Honeymoon: On the Economics and the Politics of Economic Transformation," CEPR Discussion Papers 734, C.E.P.R. Discussion Papers.
  17. Mathias Dewatripont & Gérard Roland, 1992. "The virtues of gradualism and legitimacy in the transition to a market economy," ULB Institutional Repository 2013/9587, ULB -- Universite Libre de Bruxelles.
  18. Fernandez, Raquel & Rodrik, Dani, 1991. "Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty," American Economic Review, American Economic Association, vol. 81(5), pages 1146-55, December.
  19. Andrei Shleifer & Robert Vishny, 1992. "Pervasive Shortages under Socialism," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 237-246, Summer.
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  21. van Wijnbergen, Sweder, 1991. "Intertemporal Speculation, Shortages and the Political Economy of Price Reform: A Case Against Gradualism," CEPR Discussion Papers 510, C.E.P.R. Discussion Papers.
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