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Economics and Politics of Alternative Institutional Reforms

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  • Francesco Caselli
  • Nicola Gennaioli

Abstract

We compare the economic consequences and political feasibility of reforms aimed at reducing barriers to entry (deregulation) and improving contractual enforcement (legal reform). Deregulation fosters entry, thereby increasing the number of firms (entrepreneurship) and the average quality of management (meritocracy). Legal reform also reduces financial constraints on entry, but in addition it facilitates transfers of control of incumbent firms, from untalented to talented managers. Since when incumbent firms are better run entry by new firms is less profitable, in general equilibrium legal reform may improve meritocracy at the expense of entrepreneurship. As a result, legal reform encounters less political opposition than deregulation, as it preserves incumbents' rents, while at the same time allowing the less efficient among them to transfer control and capture (part of) the resulting efficiency gains. Using this insight, we show that there may be dynamic complementarities in the reform path, whereby reformers can skillfully use legal reform in the short run to create a constituency supporting future deregulations. Generally speaking, our model suggests that "Coasian" reforms improving the scope of private contracting are likely to mobilize greater political support because -- rather than undermining the rents of incumbents -- they allow for an endogenous compensation of losers. Some preliminary empirical evidence supports the view that the market for control of incumbent firms plays an important role in an industry's response to legal reform.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12833.

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Date of creation: Jan 2007
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Publication status: published as Francesco Caselli & Nicola Gennaioli, 2008. "Economics and Politics of Alternative Institutional Reforms," The Quarterly Journal of Economics, MIT Press, vol. 123(3), pages 1197-1250, August.
Handle: RePEc:nbr:nberwo:12833

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Citations

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Cited by:
  1. Nicola Gennaioli & Alberto Martin & Stefano Rossi, 2014. "Sovereign Default, Domestic Banks, and Financial Institutions," Journal of Finance, American Finance Association, vol. 69(2), pages 819-866, 04.
  2. Sebastian Galiani & Gustavo Torrens, 2013. "Autocracy, Democracy and Trade Policy," NBER Working Papers 19321, National Bureau of Economic Research, Inc.
  3. Timothy Besley & Maitreesh Ghatak, 2009. "The de Soto effect," LSE Research Online Documents on Economics 25429, London School of Economics and Political Science, LSE Library.
  4. Gani Aldashev, 2009. "Legal institutions, political economy, and development," Oxford Review of Economic Policy, Oxford University Press, vol. 25(2), pages 257-270, Summer.
  5. Djankov, Simeon, 2008. "The Regulation of Entry: A Survey," CEPR Discussion Papers 7080, C.E.P.R. Discussion Papers.
  6. Maria Rosaria Carillo & Vincenzo Lombardo & Alberto Zazzaro, 2013. "Family connections and entrepreneurial human capital: The uncertain destiny of proprietary capitalism," Mo.Fi.R. Working Papers 89, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  7. Alessandra Bonfiglioli, 2010. "Investor Protection and Income Inequality: Risk Sharing vs Risk Taking," UFAE and IAE Working Papers 827.10, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  8. Ana Fernandes, 2008. "Endogenous Political Economy: On the Inevitability of Inefficiency under the Natural Resource Curse," Diskussionsschriften dp0802, Universitaet Bern, Departement Volkswirtschaft.

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