Learning Dynamics and Support for Economic Reforms: Why Good News Can Be Badby S. J. G. van Wijnbergen, T. Willems

The World Bank Economic Review


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Learning Dynamics and Support for Economic

Reforms: Why Good News Can Be Bad

Sweder J. G. van Wijnbergen and TimWillems*

Support for economic reforms has often shown puzzling dynamics: many reforms that began successfully lost public support. We show that learning dynamics can rationalize this paradox because the process of revealing reform outcomes is an example of sampling without replacement. We show that this concept challenges the conventional wisdom that one should begin by revealing reform winners. It may also lead to situations in which reforms that enjoy both ex ante and ex postmajority support will still not come to completion. We use our framework to explain why gradual reforms worked well in China (where successes in Special Economic Zones facilitated further reform), whereas this was much less the case for Latin American and Central and Eastern

European countries. JEL classification: D72, D83, P21

Why have gradual economic reforms worked out well for China, whereas this is much less the case for most Latin American and Central and Eastern European countries? How is it possible that so many of the reforms that began successfully while enjoying majority support subsequently lost this support, although there are also examples of reforms that did not begin well but nevertheless managed to maintain momentum among voters?

The most dramatic example of a reformist government that lost majority support in spite of strong economic performance is Slovakia in 2006. At that time, theWall Street Journal Europewrote,1 “Imagine you’re the leader of a country where economic growth is running at 6.3%, your government has been praised by theWorld Bank as the best market reformer in the world [and] unemployment has fallen to a record low of 10.6% from around 20% in just four years. [. . .] * Sweder van Wijnbergen is a professor at the Department of Economics, University of Amsterdam,

The Netherlands. He is also affiliated with the Tinbergen Institute. His e-mail address is s.j.g. vanwijnbergen@uva.nl. Tim Willems (corresponding author) is a research fellow at Nuffield College and the Department of Economics, University of Oxford, UK. He is also a member of the Centre for

Macroeconomics. His e-mail address is tim.willems@economics.ox.ac.uk. The authors thank the editor (Andrew Foster), two anonymous referees, Philippe Aghion, Bjo¨rn Bru¨gemann, Tom Cunningham, Allan

Drazen, Michal Horvath, Ruixue Jia, Matija Lozej, Torsten Persson, Dani Rodrik, Ge´rard Roland, and audiences at the EBRD and the 2013 SITE Conference in Stockholm for useful comments and discussions. 1. Robin Shepherd, “The Dzurinda Revolution”,Wall Street Journal Europe, June 12, 2006.

THE WORLD BANK ECONOMIC REVIEW, pp. 1–23 doi:10.1093/wber/lhu005 # The Author 2014. Published by Oxford University Press on behalf of the International Bank for

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With this record in mind, now consider that you face parliamentary elections this Saturday at which, unless the opinion polls change dramatically, you risk annihilation by a leftist opposition party with no experience of government and a policy agenda filled with populist rhetoric.

Welcome to the world of Mikula´sˇ Dzurinda, prime minister of Slovakia, who for the past eight years has led what can reasonably claim to have been the most successful neo-liberal government of the 21st century so far.”

Despite his impressive reform successes, Dzurinda lost the 2006 elections to

Robert Fico of the SMER party (a breakaway party from the successor to the original Communist Party of Slovakia), who reversed many of Dzurinda’s reforms.

With important reforms currently being implemented in many African and

Southern European states, it is important to understand why such puzzling reversals can occur. In this paper, we focus on the interaction between learning from reform outcomes and the dynamics of public support for gradual economic reforms.2

We believe that learning processes play a key role in determining support for reforms. So far, however, the literature has remained relatively silent on this issue. Although there are many informal discussions of learning from reform outcomes, formal treatments are scarce.3

Even if everyone gains from efficient reforms in the long run, there will almost inevitably be losers during the transitional phase (for example, certain generations or professions). The model we construct captures the fact that reforms typically generate reform winners and reform losers, but (as emphasized in the seminal paper by Fernandez and Rodrik (1991)) these winners and losers cannot always be identified in advance. That is, there is individual uncertainty, which causes the reform to have uncertain distributional consequences. As the reform progresses over time, voters update their beliefs about whether they will end up in the winners’ group or in the group of losers. Because the full version of our model not only features individual uncertainty but also allows for aggregate uncertainty (which implies that voters are unsure about the exact share of the population that will benefit from reform), this paper can be seen as augmenting the Fernandez-Rodrik setup with aggregate uncertainty and learning dynamics.

The fact that existing reform measures affect the distribution from which future sampling will occur plays a key role in our analysis. Specifically, the process of revealing reform outcomes is an example of sampling without replacement. This implies that the revelation of reform winners deteriorates the quality 2. With the possible exception of price decontrol, all reforms are gradual (as opposed to “big bang”), if only because of implementation delays. As noted, for example, by Gupta, Ham, and Svejnar (2008), even reforms that were supposed to be “big bang” (such as the Balcerowicz reforms in Poland) were not completed instantaneously, thereby giving voters an opportunity to update their beliefs about the effects of the reform. In this sense, all reforms are gradual, but some reforms are “more gradual” than others. 3. Some exceptions are van Wijnbergen (1992, where voters learn about the effects of price reform),