PhD Course: Development Economics – Macro Aspects Chapter 2.

The Political Economy of Resistance to Reform

1. Status Quo Bias (Rodrik and Fernandez, 1991).

Consider the following:

The government runs a policy that is bad for efficiency/growth.
There exists a better policy.
Why does the government not switch to the better policy, i.e. why is there
resistance to beneficial reform?

Example: trade policy:

Historically tariffs have once been a convenient mean of collecting fiscal revenue.
Nowadays, the main purpose of tariffs is protection (of e.g. farmers) from import
competition.
It is one of the most inefficient means of income distribution (recall trade theory).
Everybody would be better off if income is redistributed directly or through taxes
and subsidies.
So why do we observe tariffs? Why isn’t there political reform to free trade?

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

Some immediate, seemingly obvious answers:

Reform always creates winners and losers. Maybe it is (for political reasons) not
possible to compensate the losers.
Myopia: people just do not see the possible efficiency and welfare gains from reform.
Foolishness: Voters would object to direct income transfers to a special group (e.g.
to farmers) but do not understand that tariffs are hidden income transfers and thus
tolerate them.

In any case: a question of political economy

in democracies: the decisive voter expects to lose from reform.
in autocracies: the ruling elite expects to lose from reform.

They could be
economic losers
political losers.

We consider 2 alternative explanations of resistance to beneficial reform based on

rationality...
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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

1. Idiosyncratic uncertainty (Fernandez and Rodrik, 1991): Explains resistance to reform

in democracy although a majority would be better off.

Simplest version:
Population consists of winners and losers from reform. Ex ante uncertainty:
I π pop. share of winners, i.e. probability to win.
I g present value of gain, ` present value of loss
No compensating payments possible (commitment problem)
With certainty: a majority votes in favor of reform if π > 1/2
With uncertainty: everybody is against reform if

πg + (1 − π)` < 0

Clou: this is possible although π > 1/2.

Now consider the opposite case:

πg + (1 − π)` > 0

i.e., in principle, everybody would be in favor of reform ex ante.

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

However, π < 1/2, i.e. a majority loses through reform.

If reversal costs < present value of loss through reform → an executed reform
would be always reversed.
Anticipating this, everybody is already against reform ex ante.

Conclusion:
Status quo bias against reform: A reform will take place only if

π > 1/2 and πg + (1 − π)` > 0

Problem with the simple model: idiosyncratic uncertainty eliminates those reforms
that would lead to a loss of social welfare (remember: π and 1 − π are pop. shares).
It cannot be used to explain persistent inefficient trade policy.

Extension:
2 groups with pop. shares λ > 1/2 and 1 − λ.
The smaller group will always gain g1 > 0 from reform.
The larger group suffers idiosyncratic uncertainty:

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

a fraction π of the larger group gains g2

the remaining fraction 1 − π loses `.
Note a possible interpretation within the Ricardo-Viner trade model.
With certainty the reform gets enacted iff
(1 − λ) + λπ > 1/2 (1)
i.e. if the median voter is a winner.

With uncertainty,
note that the median voter is member of the larger group.
Thus the reform passes iff
πg2 + (1 − π)` > 0. (2)

Observe:
Condition (2) is much stronger than (1).
Idiosyncratic uncertainty prevents a socially beneficial reform if
(1 − λ)g1 + λ [πg2 + (1 − π)`] > 0.
| {z }
<0

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

Of course, it is still possibility that a non-beneficial reform gets enacted without

uncertainty, i.e.
(1 − λ)g1 + λ [πg2 + (1 − π)`] < 0
and (1 − λ) + λπ > 1/2.
In other words, if “somehow” the reform was enacted it will not be reversed.

Problems:
1 Additional explanation needed for
I why people do not know their identity ex ante
I why compensation of losers is not possible.
2 Policymakers are elected by voters. Yet their policies are made under influence of
special interest groups (e.g. lobbying of farmer’s associations).
→ refinement of theory needed.

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

2. Political Losers.

So far: welfare enhancing reforms are blocked by economic losers.

Acemoglu and Robinson (2000): a theory why economic reforms are blocked by
political losers.
Application: pre-industrial Europe, LDC’s today.

Basic idea
Suppose a country is ruled by a political elite
I the monarch/president and his family/clan
I the aristrocracy/landlords
I the communist elite/nomenklatura
which is able to extract economic rents based on their political position.
An economic reform would reduce the probability of political survival.
A credible commitment to compensate for their economic loss after they have lost
political power is not possible.
→ High incentive to block the reform.

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

Model:
2 goods:
I competitively produced corn, price = 1

I industrial good y , price p

citizens/consumers are endowed with m units of corn maximize utility (pop. size
normalized to 1):
1
u(x, y ) = x + y α
α
s.t. m = x + py → implying demand y = p −1/(1−α) .
y is produced by a monopolist with technology
1
y = A0 x cost function c(y ) = x = y
A0
the government may tax sales at rate τ .

Solving the monopoly pricing problem

1
max Π = (1 − τ )py − y
A0
provides the price
1
y α−1 = p =
(1 − τ )αA0
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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

Thus, sales are

py = y α = p −α/(1−α) = [(1 − τ )αA0 ]α/(1−α)
yielding profits:
1
Π = (1 − τ ) [(1 − τ )αA0 ]α/(1−α) − [(1 − τ )αA0 ]1/(1−α)
A0
α α α 1 1 1 −1
= (1 − τ ) 1−α +1 α 1−α A01−α − (1 − τ ) 1−α α 1−α A01−α
1 α
use 1−α
= 1−α
+ 1:
1 α
Π(A0 ) = (1 − α)(1 − τ ) 1−α (αA0 ) 1−α
Current Situation:
The political elite controls government and the monopolist.
There exists a potential rival monopolist who could produce industrial goods with
superior technology A1 > A0

y = A1 x ⇒ potential sales: py = [(1 − τ )αA1 ]α/(1−α)

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

Government collects lump sum tax on citizens T̄

Probability to stay in power is higher if the new technology is not introduced.
I if A1 is introduced: elite keeps control with prob. s.
I if A1 is not introduced: elite keeps control with prob. q.
I s≤q

What should the ruling elite do? → compare 4 cases.

A) The elite blocks entry (B) and keeps in power (P): :

collects taxes
collects the monopoly profit (and thus sets τ = 0)
Payoff: α
V (B, P) = T̄ + Π(A0 ) = T̄ + (1 − α) (αA0 ) 1−α (3)

B) It blocks entry and loses political power (NP):

it keeps the monopoly profits
V (B, NP) = Π(A0 ) (4)

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

C) It does not block entry (NB) and keeps in power:

it loses all profits (the superior competitor sells at a lower price)
it still keeps T̄
it can design τ to maximize sales tax revenue (τ py ).
max τ [(1 − τ )αA1 ]α/(1−α)
τ

FOC:  
α α α
(αA1 ) α/(1−α)
(1 − τ ) 1−α + τ · (1 − τ ) 1−α −1 · (−1) = 0
1−α
i.e.
α 1−τ α
(1 − τ ) − τ · =0 ⇒ = ⇒ τ ∗ = (1 − α)
1−α τ 1−α
Thus, payoff
h iα/(1−α)
V (NB, P) = T̄ + (1 − α) α2 A1 (5)

D) Finally, if the elite does not block entry and loses power:
it loses everything.
V (NB, NP) = 0. (6)

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

Cost of blocking entry: C . → Expected payoff for blocking:

V (B) = q · V (B, P) + (1 − q) · V (B, NP) − C .

Expected payoff for not-blocking:

V (NB) = s · V (NB, P) + (1 − s) · 0

Inserting (3)-(5) the elite compares both and blocks the superior technology iff
n α
o n α
o
q T̄ + (1 − α) (αA0 ) 1−α + (1 − q) (1 − α) (αA0 ) 1−α − C
 h iα/(1−α) 
2
> s T̄ + (1 − α) α A1

i.e. if the net gain from blocking

h iα/(1−α)
(q − s)T̄ + (1 − α) [αA0 ]α/(1−α) − s(1 − α) α2 A1 > C.

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 PhD Course: Development Economics – Macro Aspects Chapter 2. The Political Economy of Resistance to Reform

Observe:
The elite would never block if q = s = 1 and αA1 > A0 : i.e. if political survival is
certain and the new technology is sufficiently better than the old one.
In other words, economic losers would not block the new technology.
Blocking is caused by the threat to lose political power, i.e. by s < 1.

Observe: The likelihood of blocking is high if

high absolute threat to lose power (s ↓)
high relative prob. to stay in power when blocking ((q − s) ↑ )
high political rents from staying in power (T̄ ↑)
relatively high monopoly profits with old technology (A0 ↑)
relatively low monopoly profits with new technology A1 ↓).

Weil’s example: railroads in Russia. Attempt to block a switch

from agricultural production (run by landed aristocrats)
to industrial production (run by capitalists, the bourgeoisie).

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