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Reform, Lobbies and Welfare: A Common Agency Approach

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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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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  1. 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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  4. Gene M. Grossman & Elhanan Helpman, 1992. "Protection For Sale," NBER Working Papers 4149, National Bureau of Economic Research, Inc.
  5. 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.
  6. Gary S. Becker, 1984. "Public Policies, Pressure Groups, and Dead Weight Costs," University of Chicago - George G. Stigler Center for Study of Economy and State 35, Chicago - Center for Study of Economy and State.
  7. Mathias Dewatripont, 1992. "Economic Reform and Dynamic Political Constraints," ULB Institutional Repository 2013/175991, ULB -- Universite Libre de Bruxelles.
  8. Roland, Gérard, 1992. "The Political Economy of Transition in the Soviet Union," CEPR Discussion Papers 628, C.E.P.R. Discussion Papers.
  9. 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.
  10. Doyle, Christopher, 1993. "The Distributional Consequences of Russia's Transition," CEPR Discussion Papers 839, C.E.P.R. Discussion Papers.
  11. 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.
  12. Neary, J.P & Roberts, K.W.S, 1978. "The Theory of Household Behaviour under Rationing," The Warwick Economics Research Paper Series (TWERPS) 132, University of Warwick, Department of Economics.
  13. Gene Grossman & Elhanan Helpman, 1994. "Electoral Competition and Special Interest Politics," NBER Working Papers 4877, National Bureau of Economic Research, Inc.
  14. Portes, Richard, et al, 1987. "Macroeconomic Planning and Disequilibrium: Estimates for Poland, 1955-1980," Econometrica, Econometric Society, vol. 55(1), pages 19-41, January.
  15. Heady, Christopher & Smith, Stephen, 1995. "Tax and Benefit Reform in the Czech and Slovak Republics," CEPR Discussion Papers 1151, C.E.P.R. Discussion Papers.
  16. 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.
  17. Jarvis, Sarah & Pudney, Stephen, 1995. "Redistributive Policy in a Transition Economy: The Case of Hungary," CEPR Discussion Papers 1117, C.E.P.R. Discussion Papers.
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