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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.

Suggested Citation

  • Francesco Caselli & Nicola Gennaioli, 2007. "Economics and Politics of Alternative Institutional Reforms," CEP Discussion Papers dp0775, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp0775
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    References listed on IDEAS

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    Cited by:

    1. Wang, Yong, 2015. "A model of sequential reforms and economic convergence: The case of China," China Economic Review, Elsevier, vol. 32(C), pages 1-26.
    2. Madhav S, Aney & Maitreesh Ghatak & Massimo Morelli, 2011. "Can Market Failure Cause Political Failure?," STICERD - Economic Organisation and Public Policy Discussion Papers Series 029, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
    3. António Antunes & Tiago Cavalcanti & Anne Villamil, 2015. "The effects of credit subsidies on development," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 58(1), pages 1-30, January.
    4. Bonfiglioli, Alessandra, 2012. "Investor protection and income inequality: Risk sharing vs risk taking," Journal of Development Economics, Elsevier, vol. 99(1), pages 92-104.
    5. Jacopo Ponticelli & Leonardo S. Alencar, 2016. "Court Enforcement, Bank Loans, and Firm Investment: Evidence from a Bankruptcy Reform in Brazil," The Quarterly Journal of Economics, Oxford University Press, vol. 131(3), pages 1365-1413.
    6. 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, April.
    7. Gani Aldashev, 2009. "Legal institutions, political economy, and development," Oxford Review of Economic Policy, Oxford University Press, vol. 25(2), pages 257-270, Summer.
    8. Djankov, Simeon, 2008. "The Regulation of Entry: A Survey," CEPR Discussion Papers 7080, C.E.P.R. Discussion Papers.
    9. Kira Boerner & Christa Hainz, 2009. "The political economy of corruption and the role of economic opportunities," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 17(2), pages 213-240, April.
    10. Besley, Timothy J. & Ghatak, Maitreesh, 2009. "The de Soto Effect," CEPR Discussion Papers 7259, C.E.P.R. Discussion Papers.
    11. repec:eee:rujoec:v:2:y:2016:i:4:p:349-374 is not listed on IDEAS
    12. Ana Fernandes, 2008. "Endogenous Political Economy: On the Inevitability of Inefficiency under the Natural Resource Curse," Diskussionsschriften dp0802, Universitaet Bern, Departement Volkswirtschaft.
    13. Maria Rosaria Carillo & Vincenzo Lombardo & Alberto Zazzaro, 2013. "Family Firm Connections and Entrepreneurial Human Capital in the Process of Development," Mo.Fi.R. Working Papers 89, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
    14. Galiani, Sebastian & Torrens, Gustavo, 2014. "Autocracy, democracy and trade policy," Journal of International Economics, Elsevier, vol. 93(1), pages 173-193.
    15. Aney, Madhav S. & Ghatak, Maitreesh & Morelli, Massimo, 2016. "Credit market frictions and political failure," Journal of Monetary Economics, Elsevier, vol. 81(C), pages 48-64.

    More about this item

    Keywords

    financial economics; deregulation; meritocracy;

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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