Optimal Restructuring Under a Political Constraint: A General Equilibrium Approach

Vivek Dehejia ()

No 35, William Davidson Institute Working Papers Series from William Davidson Institute at the University of Michigan

Abstract: This paper considers the generalized second-best analytics of optimal restructuring under a political constraint, building on the modeling approach in Dehejia (1997). It is shown that the second-best optimum entails administering the terms of trade shock fully at the initiation of the reform, just as in shock therapy, but that this must be supplemented with interventions in domestic factor markets. The effects of these interventions are to speed up the exit of the politically affected factor, labour, and of retarding the exit of the other factor, capital, both of which serve to prop up the wages of workers in the declining sector and hence address the political constraint. The results are in the spirit of the neoclassical theory of distortions and welfare: the optimal intervention targets the affected margin directly, in consonance with the "targetting" principle of Bhagwati-Ramaswami-Johnson.

Keywords: general equilibrium; gradualism; political economy; second-best theory; shock therapy; structural adjustment; transitional economies (search for similar items in EconPapers)
JEL-codes: F11 F13 (search for similar items in EconPapers)
Pages: pages
Date: 1997-01-01
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Citations: View citations in EconPapers (1)

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Working Paper: Optimal Restructuring Under a Political Constraint: A General Equilibrium Approach (1997)
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