Economics and Politics of Alternative Institutional Reforms

Francesco Caselli () and Nicola Gennaioli ()

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: We compare the economic consequences and political feasibility of reforms aimed at reducingbarriers to entry (deregulation) and improving contractual enforcement (legal reform). Deregulationfosters entry, thereby increasing the number of firms (entrepreneurship) and the average quality ofmanagement (meritocracy). Legal reform also reduces financial constraints on entry, but in addition itfacilitates transfers of control of incumbent firms, from untalented to talented managers. Since whenincumbent firms are better run entry by new firms is less profitable, in general equilibrium legalreform may improve meritocracy at the expense of entrepreneurship. As a result, legal reformencounters less political opposition than deregulation, as it preserves incumbents' rents, while at thesame time allowing the less efficient among them to transfer control and capture (part of) the resultingefficiency gains. Using this insight, we show that there may be dynamic complementarities in thereform path, whereby reformers can skillfully use legal reform in the short run to create a constituencysupporting future deregulations. Generally speaking, our model suggests that "Coasian" reformsimproving 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 oflosers. Some preliminary empirical evidence supports the view that the market for control ofincumbent firms plays an important role in an industry's response to legal reform.

Keywords: financial economics; deregulation; meritocracy (search for similar items in EconPapers)
JEL-codes: G34 O11 O16 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dev, nep-ent, nep-pol and nep-reg
Date: Written
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Related works:
Working Paper: Economics and Politics of Alternative Institutional Reforms (2007)
Working Paper: Economics and Politics of Alternative Institutional Reforms (2007)
Journal Article: Economics and Politics of Alternative Institutional Reforms (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:cep:cepdps:dp0775

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