Working Paper: CEPR ID: DP1115
Authors: Dani Rodrik
Abstract: This paper considers a simple model of economic transition to analyse the dynamics of preferences over economic policy. I consider an economy with two sectors: a high-productivity private sector, which initially employs a small share of the economy's work-force, and a low-productivity state sector, where the majority of the population is employed at the outset. In the early stages of the transition, the private sector expands at a rate that is lower than the rate at which the state sector is contracting, with the result that unemployment first rises and then falls. The government's policy consists of a subsidy to the state sector, which has the effect of slowing down the transition. The analysis focuses on the dynamic evolution of workers' preferences over the level of the subsidy. A worker in the private sector always prefers the lowest possible subsidy to the state sector. The same is true of an unemployed worker as well, as the subsidy only reduces the number of new jobs created without reducing the number of job seekers. But state-sector workers have ambiguous feelings over reform strategy and their preferences change over time. In particular, even if state-sector workers prefer shock therapy at the outset, they will always want to slow the reforms down at a later stage. The reason is that the probability of finding a higher-paying private-sector job declines as the transition unfolds.
Keywords: transition; political economy
JEL Codes: O72; J60; P20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government subsidy levels to the state sector (H19) | Slowing down the economic transition (P27) |
| Government subsidy levels to the state sector (H19) | Job creation in the private sector (J23) |
| Job creation in the private sector (J23) | Workers' preferences regarding economic reform (E69) |
| Workers' preferences regarding economic reform (E69) | Political support for reforms (E69) |
| Higher unemployment (J64) | Pressure to slow reforms (E69) |
| State-sector workers' preferences (J45) | Taxing the private sector to slow down reforms (H29) |