Economics and Politics of Alternative Institutional Reforms

49 Pages Posted: 20 Jan 2007 Last revised: 27 Jul 2010

See all articles by Francesco Caselli

Francesco Caselli

London School of Economics & Political Science (LSE) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Nicola Gennaioli

Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: January 2007

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

Caselli, Francesco and Gennaioli, Nicola, Economics and Politics of Alternative Institutional Reforms (January 2007). NBER Working Paper No. w12833. Available at SSRN: https://ssrn.com/abstract=958485

Francesco Caselli (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Nicola Gennaioli

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
25
Abstract Views
562
PlumX Metrics