Política Económica

American Economic Association
Understanding Economic Policy Reform

Author(s): Dani Rodrik
Source: Journal of Economic Literature, Vol. 34, No. 1 (Mar., 1996), pp. 9-41
Published by: American Economic Association
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Journal of Economic Literature,
Vol. XXXIV (March 1996), pp. 9-41
UnderstandingEconomic Policy
Reform
By DANI RODRIK
Columbia University
This paper has benefited from the comments of Herschel Grossman, Anne Krueger, Gustav
Ranis,Jeffrey Sachs, John Williamson,and three referees.
I. Introduction ist "technical"uncertainty as to what the

appropriate solution is to the problems
at hand. Think of President Clinton's
T" HIS GOVERNMENT will be austere,
health care plan, for example, or of
uncompromising, and tinpopular if
global warming. Consequently, reforms
that is what is required to achieve eco-
nomic recovery," declared Mario Soares
will arouse opposition if they are viewed
in 1983 upon taking office as prime min-
as applying the wrong fix or if they are
perceived as being primarily redistribu-
ister of Portugal.1 This kind of talk is
tive (that is, zero-sum). What is remark-
music to the ears of economists. Reform
able about current fashions in economic
requires austere policies which respect
development policy (as applied to both
budget constraints. It also precludes
developing and transitional economies),
compromising with the narrow, special
interest groups that have been the bene-
however, is the extent of convergence
that has developed on the broad outlines
ficiaries of the deleterious policies of the
of what constitutes an appropriate eco-
past. Policy makers who have coura-
nomic strategy. This strategy emphasizes
geously taken on such interest groups
fiscal rectitude, competitive exchange
and pursued market-oriented policies
rates, free trade, privatization, undis-
are the heroes of the economics profes-
torted market prices, and limited inter-
sion (see Arnold C. Harberger 1993).
vention (save for encouraging exports,
That such policies should also be un-
education, and infrastructure). Faith in
popular (as Soares feared they would),
the desirability and efficacy of these
however, requires a lot more explaining.
policies unites the vast majority of pro-
What is the point of loudly proclaiming
fessional economists in the developed
reforms if these are not aimed at improv-
ing the well-being of a large majority of
world who are concerned with issues of
development.2
the population? And if that is their goal,
why should reforms be unpopular? 2 The convergence is not complete of course.
In many areas of policy, there may ex- But compared to two decades ago, the various
sides have moved substantially closer to each
other. One indicator of this is the recent book by
1 Quoted by Jose Maria Maravallin Luiz Carlos Bresser Pereira, Maravall, and Przeworski (1993),
Bresser Pereira, Maravall, and Adam Przeworski which advocates a "social democratic" approach.
(1993). The views exDressed in this book concede an inor-
9
10 Journal of Economic Literature, Vol. XXXIV (March 1996)
Hence economists are often torn be- we observe such instances of collective
tween two conflicting perspectives: on irrationality.
the one hand, good economic policy The events of the last decade have un-
should produce favorable outcomes and derscored the need to understand the
therefore should prove also to be good political-economy of policy making. One
politics; on the other hand, the imple- of the eventual consequences of the
mentation of good economic policy is global debt crisis that erupted in 1982
often viewed as requiring "strong" and was a wave of market-oriented economic
"autonomous" (not to say authoritarian) reforms, the likes of which have never
leadership. The experience of Chile, a been seen. The reforms were strongest
country which has perhaps gone further and most sustained in Latin America,
than any other in implementing liberal where countries like Bolivia, Mexico, Ar-
economic policies, provides a good exam- gentina, Peru, Colombia, and Brazil
ple. An essay on Chile's reform strategy joined Chile in orthodoxy. But this was
by Jose Pifiera (1994), an economist and very much a global phenomenon. "Stabi-
minister of labor and social security un- lization" and "structuraladjustment" be-
der General Pinochet, concludes: "[i]n came the primary preoccupation of gov-
the end, good policy is good politics" (p. ernment leaders in Asia and Africa as
231). The irony is that most of the re- well, even though the commitment to
forms the author glowingly discusses in economic orthodoxy varied across coun-
the preceding pages required the sus- tries and over time. These countries
pension of normal politics and as heavy a were in turn soon joined by the pre-
dose of authoritarianism as seen any- viously socialist economies of Eastern
where. Europe and the former Soviet Union.
Good economics does often turn out Economists who had cut their teeth in
to be good politics, but only eventually. Latin America's economic quagmires be-
Policies that work do become popular, came the advisors and analysts of these
but the time lag can be long enough for transitional economies. Even India, the
the relationship not to be exploitable by giant archetype of a closed, import-sub-
would-be reformers. In Chile's case, free stituting economy among developing
market policies (implemented after countries, embarked on a process of eco-
1973) were eventually resoundingly en- nomic liberalization in 1991 (see Jagdish
dorsed in the presidential elections of Bhagwati 1993 and Arvind Panagariya
1989 and have become the envy of Latin 1994).
America.3 Conversely, bad economics These reforms were encouraging to
can be popular, if only temporarily. economists and a vindication of sorts to
President Alan Garci a's popularity those among them who had long advo-
soared in Peru during his first two years cated market-oriented reforms. But they
in office (1985-86), thanks to expansion- in turn raise their own puzzles. Most
ary fiscal policies whose medium-term fundamental of all, why are so many gov-
unsustainability should have been obvi- ernments reforming now, after decades
ous to anyone with common sense (see of adherence to policies of an opposite
Ricardo Lago 1991). The puzzle is why kind? This question poses a particularly
important challenge to political econo-
dinate amount to the consensus view, and depart mists: an understanding of these coun-
from it in remarkably few details. I will discuss tries' experiences now requires a theory
this book in Section IV.
3 For a recent evaluation, see Barry Bosworth, that explains not only why seemingly dys-
Rudiger Dornbusch, and Ral Labn (1994). functional policies had been initially un-
Rodrik: Understanding Economic Policy Reform 11
dertaken and then maintained for so mist's perspective on the political econ-
long, but also why these policies were omy of policy reform. I begin by examin-
suddenly abandoned en masse during the ing the origins and analytical content of
1980s, often by the same politicians who the new orthodoxy in development policy
had been among their most ardent sup- (Section II). I will focus here on two is-
porters. Second, while the reforms were sues in particular which I feel remain
inspired at least in part by the East Asian in need of clarification. One of these
experience, they took place much more concerns the distinction between (a)
quickly and, in many areas, are going macroeconomic policies aimed at eco-
considerably beyond those undertaken in nomic stability, such as fiscal, monetary,
East Asia. This raises the question of and exchange rate policies, and (b) liber-
whether the new wave of reformers have alization policies aimed at structural re-
internalized the correct lessons from the form and growth, such as the removal of
East Asian experience. Finally, are there relative-price distortions and the reduc-
any helpful rules for reformers to follow tion of state intervention. It has become
in guiding their policies through compli- commonplace to conflate these two
cated political terrain? Can one hope to groups of policies, but for analytical pur-
develop a "how-to"manual for the refor- poses they are best kept apart. As we
mist politician? shall see, they also have different politi-
Puzzlement over such questions has cal-economy underpinnings. Moreover,
led to a large and growing literature. A maintaining the distinction reminds us
very short bibliography would include that the consensus on what constitutes
books by Merilee Grindle and John appropriate structural reform is based on
Thomas (1991), Robert Bates and Krue- much shakier theoretical and empirical
ger (1993), Krueger (1993), Przeworski grounds than is the consensus on the
(1991), Ranis and Syed Mahmood (1992), need for macroeconomic stability. The
Bresser Pereira, Maravall, and Przewor- second issue concerns the appropriate
ski (1993), Stephan Haggard and Robert lessons to be drawn from the experience
Kaufman (1992), Dornbusch and Se- of East Asian success stories. The new
bastian Edwards (1993), Haggard and orthodoxy has tended to draw a some-
Steven Webb (1994), Lance Taylor what biased picture that needs correc-
(1994), Williamson (1994), and Ian Little tion.
et al. (1993), not to mention countless Next, I will turn to the reforms of the
papers.4 As this partial list indicates, 1980s and 1990s. This experience has
both economists and political scientists opened an important window on the mo-
have devoted their attention to these is- tivations of politicians, as well as on the
sues, often together in coauthored or nature of interactions between the econ-
coedited works. Indeed, no other area of omy and the polity. As indicated above,
economics or political science that I can an important question is why so many
think of has spawned so much interdisci- countries have suddenly caught the re-
plinary work.5 form bug. The confluence of economic
In this essay, I will provide an econo- crisis with reform has led to the natural
4 One recent survey-Mariano Tommasi and
supposition that crisis is the instigator of
Andres Velasco 1995-which overlaps with this reform, a hypothesis that keeps reap-
one deserves special mention. pearing in the literature and yet is inade-
5 The literature on the economics of policy re-
quately analyzed. Section III discusses
form is of course even larger. For recent surveys,
see Vittorio Corbo and Stanley Fischer (1995) and this issue, as well as related questions
Rodrik (1995b). such as: what, if any, are the short-term
costs of reform? and does foreign aid parently successful example of Soviet
help or hamper reform? planning invited emulation. Moreover,
Finally, I will discuss some normative the economic ideas of the 1950s and
aspects related to the politics of policy early 1960s tended to dismiss the bene-
reform (Section IV). In particular, I will fits from trade and emphasized the need
analyze what kind of guidance, if any, for physical capital accumulation and in-
the literature provides to the reformist fant-industry promotion. As Krueger
politician regarding the appropriate puts it,
strategies for carrying out his program.
The focus here will be on the conflict [t]he underlying premises regarding markets
and governments implicit in these policy pre-
between top-down versus participatory scriptions are obvious: There was a strong
approaches. This discussion will take us emphasis on the primacy of market imperfec-
back to some of the deeper questions tions. Market failures were thought to be
about the collective rationality of politi- relatively strong, while it was assumed that
cal institutions and behavior. governments could correctly identify and per-
form economic functions. Virtually no atten-
tion was given to the possibility that there
II. The New Orthodoxy in Development might be government failure. (p. 49)
Thinking and Enduring Puzzles
And there was plenty of government
Once upon a time, there was some- failure. Not only did many infant indus-
thing called the Third World and we tries fail to mature, but many countries
thought we understood how it worked succumbed to stop-go cycles driven by
(or did not work). Countries of the Third excessive government spending. Krueger
World followed import-substitution poli- explains that in viewing the government
cies, so called because the overarching as a "benevolent social guardian" most
objective of economic policy was to de- economists had ignored a number of
velop domestic manufacturing capability important forces at work. Individuals
for goods previously imported. Such in the public sector were apt to follow
policies included import controls, over- their own selfish interests. They would
valued exchange rates, binding ceilings be lobbied by pressure groups aiming to
on interest rates, a heavy dose of public impose their own agenda on a largely
ownership, and pervasive price regula- docile majority. Policy interventions
tion. The political-economy counterpart would create rent-seeking incentives
of these policies was the predominance diverting entrepreneurs from productive
of urban over rural interests, and within activities. Finally, the informational
the' urban sector, an uneasy alliance of disadvantage of government bureaucra-
sorts between the protected industries cies over market participants would
and the bureaucrats administering the doom even the best-laid plans to ineffi-
protection. ciency.
Perhaps no other economist has done Meanwhile, four East Asian economies
as much as Anne Krueger in document- were making a mockery of the export
ing and popularizing the shortcomings of pessimism that had persuaded policy
import-substituting policies. As she makers elsewhere to follow an inward-
points out in her Ohlin Lectures (1993), oriented strategy. South Korea and Tai-
there was a multitude of reasons for the wan, in particular, were able to engineer
initial adoption of these policies. Newly a remarkable increase in their growth
independent governments had a strong rates, thanks to sharp jumps in their in-
desire for industrialization, and the ap- vestment and export efforts during the
TABLE1
COMPARATIVE
GRowTHEXPERIENCE
Per capita GDP, Per capita GDP, Per capita GDP

1960 1989 growth,
Country (1985 dollars) (1985 dollars) 1960-89 (%)
South Korea 883 6206 6.82
Taiwan 1359 8207 6.17
Ghana 873 815 -0.54
Senegal 1017 1082 0.16
Mozambique 1128 756 -2.29
Brazil 1745 4138 3.58
Mexico 2798 5163 2.36
Argentina 3294 3608 0.63
Source: Penn World Table 5.5 (1993).
mid-1960s. Table 1 summarizes this im- measures of resource transfers in order to

pressive performance in comparative promote growth artificially.
context. Recent work by Jong-Il Kim and And Krueger (1993, p. 30) writes:
Lawrence J. Lau (1992) and Alwyn
To be sure, the Korean economy has not
Young (1993, 1994) has shown that these been characterized and is not characterized
were miracles of accumulation rather by laissez-faire. But in contrast to the over-
than of productivity: the sharp increases controlled, overregulated, highly distorted
in physical and human capital as well as economies described above, the Korean econ-
in labor-force participation account for omy has been characterized by diminishing
intervention in most spheres of economic ac-
virtually all of the rise in output, and tivity, and the degree of distortion is consid-
consequently the East Asian tigers' per- erably smaller.
formance with respect to total factor
productivity (TFP) growth does not look Indeed, in both Korea and Taiwan,
outstanding. Of course, for accumulation there was an extensive set of reforms
to have taken place at such rates, the during the late 1950s and early 1960s, on
profitability of investment in the region which more later.
must have been very high, which needs So the new orthodoxy was built on two
explanation. mutually reinforcing pillars: one was the
What was the key to these economies' set of policies that had been tried by the
success? Among professional economists, import-substituting countries and had
there soon developed the view that the failed; the second was the set of success-
East Asian miracles could be attributed ful policies implemented by the East
to market-oriented policies and the re- Asian tigers. These two sets of policies
duced role of government intervention. bear close scrutiny, as they overlap to a
Hence, Ranis and Mahmood (1992, p. much greater extent than the orthodox
138) attribute the Taiwanese and South case likes to admit.
Korean successes to A. MacroeconomicDisequilibrium or
the willingnessof the governmentsin both Import-Substitution Policies?
countries-albeit somewhatless so in South
Korea-to allow growth to proceed along a In describing the experience of devel-
"natural"path and an aversionto use covert oping countries it has become common
to lump together a wide range of poli- rates are different. By definition, they
cies, as I too have done above, under the result in trade deficits that are unsus-
label of "import-substitution policies." tainably large, and therefore in balance-
For descriptive purposes, this makes per- of-payments crises (unless they are
fect sense. Except for a handful of coun- corrected quickly). Consequently, ex-
tries in East Asia, most developing coun- change rate misalignments are closely as-
tries did combine illiberal trade and sociated with economic instability and
price policies with (at least occasional) with the deterioration of economic per-
fiscal profligacy and overvalued exchange formance over the medium to long run.
rates. So there was a common syndrome, The confusion between these two types
which perhaps does deserve to go under of policies often reveals itself in empiri-
a single name. However, the practice has cal studies that uncover a negative rela-
also frequently led economic analysis tionship between measures of exchange-
astray and generated confusion. The rate distortion and economic growth, and
trouble is that failures were often misat- then attribute the effect to the lack of
tributed to microeconomic policies, openness in the sense of trade protec-
when their sources lay either with unsus- tion.7
tainable macroeconomic policies or bu- Similarly, consider subsidies to spe-
reaucratic and institutional shortcomings. cific industries versus large fiscal defi-
Consider for example two trade-re- cits. The former can be damaging if the
lated policies: import restrictions (e.g., targeted industries do not produce posi-
import quotas) and overvalued exchange tive externalities or if the subsidies lead
rates. These two have rather different to rent-seeking activities. But the dam-
implications for economic stability and age done by large, sustained budget defi-
long-run performance. The effect of im- cits is often much larger. An unsustain-
port restrictions is to repress trade (im- able deficit can be financed by foreign
ports as well as exports in the longer borrowing or by monetization, and in
run). While this is costly insofar as it en- either case a crisis is often not too far
genders some resource misallocation, it away.8 Usually, external sources are the
does not inherently generate economic first resort, and an inflation problem fol-
instability, nor does it necessarily reduce lows on the heels of a payments crisis.
long-term growth.6 Overvalued exchange The World Bank recently undertook a
large-scale research project on the con-
6 In traditional economic theory, trade restric-
sequences of public-sector deficits in de-
tions have level effects, but no growth effects.
That is, a 20 percent tariff may reduce real income veloping countries. The findings were
by, say, 0.5 percent of GDP (permanently), but it unequivocal: "Deficits . . . are unambigu-
will not affect the economy's long run growth rate. ously bad for growth."9 This distinc-
In the more recent endogenous growth literature,
trade restrictions may have growth effects, but
these growth effects can go either way depending 7 See for example the use made of David Dol-
on the model. For a small economy, the effect lar's (1992) "realexchange rate distortion"index in
tends to depend on whether the comparative- World Bank (1993).
advantage efTect pulls resources in or out of the 8 Of course, foreign borrowing or moderate
growth-sectors of the economy (those with techno- amounts of monetization (seignorage or inflation
logical externalities or learning-by-doing). Empiri- tax) need not be bad things. The focus here is on
cal work on growth has often claimed to discover a unsustainable levels of borrowing or seignorage.
negative relationshipbetween trade protection 9 William Easterly, Carlos Alfredo Rodrguez,
an growth. However, this literature is marred by and Klaus Schmidt-Hebbel (1994, p. 1). It is of
severe analytical and conceptual confusions, with course possible, as a referee pointed out, that a
macroeconomic policies often confused for trade deeper underlying cause (i.e., political instability)
restrictions and the endogeneity of trade policy is jointly responsible for both the deficits and low
not fully accounted for. growth.
TABLE 2
DETERMINANTSOF THE DEBT CRISIS, 1982
Failureto adjust
monetaryand fiscal Indexof relative-price
Largeexternalshock policy distortion
TroubledCounties
Argentina No Yes 0.3054
Brazil Yes Yes 0.2019
Chile Yes Yes 0.4460
CostaRica No Yes 0.2818
Cote d'lvoire Yes Yes 0.2438
Mexico No Yes n.a.
Morocco No Yes 0.2675
Nigeria No Yes 0.2306
UnweightedAverage 0.2824
ModeratelyTroubledCountries
Colombia No Yes 0.2744
Kenya Yes Yes 0.1218
Sri Lanka Yes No 0.8606
UntroubledCountries
Cameroon Yes No 0.2344
India No No 0.2620
Indonesia No No 0.4503
Korea Yes No 0.2128
Pakistan No No 0.3814
Thailand Yes No n.a.
Turkey No No n.a.
Source:Little et al. (1993), Table 4.4, except for the relative-pricedistortionindex which is taken from Easterly
(1993).The latterindexis the varianceof the log inputprices (relativeto U.S. prices)acrosscommodities,measured
in 1980. See Easterly(1993) for the methodof calculationand the justificationfor the index.
tion-between micro and macro-is lost ing country par excellence, managed to
in many studies that attribute balance- escape the debt crisis during the 1980s,
of-payments crises to activist industrial thanks to its tradition of conservative
policies (rather than the unwillingness or monetary and fiscal policies.10 At the
inability to balance budgets). other end of the spectrum, South Korea
The watershed event of the 1980s for experienced a payments crisis in 1979-
most developing countries, the general- 80, before the Latin American countries,
ized debt crisis that followed the Mexi- as a consequence of an ambitious invest-
can moratorium of August 1982, was a ment program running ahead of available
dramatic confirmation of the importance domestic savings. But the quick adoption
of prudent macroeconomic policies.
Looking below the surface, it was evi- 10 During the 1980s, however, a growing public-
dent that the crisis affected only those sector deficit began to endanger macroeconomic
balances. In 1990, the deficit reached 8.3 percent
countries that did not respect budget of GDP, culminating in a balance-of-payments cri-
constraints. India, the import-substitut- sis in 1991 (Panagariya1994, pp. 205-06).
of expenditure-reducing and expendi- most everything right on the micro-

ture-switching policies enabled a swift economic front, but still face a deep cri-
recovery, after a five percent contraction sis if macro policies-in Mexico's case an
in 1980 (see Susan Collins and Won-Am overvalued exchange rate aggravated by
Park 1989). Before long, Korea's crisis pre-election credit expansion-are not
was forgotten. More broadly, there was managed well.
no correlation between the propensity to This distinction between microeco-
fall into crisis and the nature of micro- nomic distortions and macroeconomic
economic policies proper. As Table 2 instability is one that economists have long
dicates, the countries that experienced recognized. Yet it is also one that has
a debt crisis in 1982 were those that made little impression on the develop-
failed to adjust their monetary and fiscal ment profession. In an essay published
policies, and not those that had large mi- in 1975, for example, Carlos Diaz-Ale-
croeconomic distortions or were con- jandro (1975) faulted the Little-Sci-
fronted with particularly large external tovsky-Scott (1970) study mentioned
shocks. above for lumping
There is little question that the mi-
together all features of the import-substitu-
croeconomic distortions in themselves tion sydrome,such as importand other con-
were often costly. A series of team ef- trols,tariffs,overvaluedandpegged exchange
forts led by Little, Tibor Scitovsky, and rates,spectacularbalance-of-payments crises,
Maurice Scott (1970), Bela Balassa inflationarypressures, and stop-go cycles.
(1971), Bhagwati (1978), and Krueger Followinga "guiltby association"procedure,
they then tend to blame much of what is go-
(1978) had documented in detail the re- ing wrongin less developedcountrieson that
source-allocation costs of high protec- ill-defined syndrome.Unsophisticatedread-
tion. These studies used measures of ef- ers may indeed conclude that nearly every-
fective rates of protection (ERP) and thing gone wrongin those countriesis due to
domestic resource costs (DRC) to dem- thatwickedsyndrome.
Considera mentalexperiment.Whatwould
onstrate that the governments' price and have happenedif, say, Argentinaand Colom-
trade policies had led to the creation of bia had adoptedflexible exchangerates back
wildly inefficient industries, at times in 1945, while adopting also an across-the-
producing negative value-added at world board importtariff of 150 per cent ad valo-
prices! Moreover, the net incentive ef- rem? I suspect their record, at least on
growthand exports,would have been much
fects of these policies seemed hap- better. Theirharmfulstop-gopolicies maybe
hazard, judged by the variability of ERPs blamed to a large extent on exchange-rate
and DRCs across industries. More recent mismanagement. . . and on other short-run
work has shown that particular relative policies that could be analyticallyseparated
price distortions, those affecting capital from the long-run effects of protection.
(Diaz-Alejandro1975, pp. 115-16, emphasis
and intermediate goods, can be costly to in the original)
growth as well (Bradford De Long and
Lawrence Summers 1991; Easterly Elementary as these points may be,
1993). However, what eventually drove they were largely overlooked in the af-
many import-substituting countries to termath of the debt crisis. The consensus
ruin were not such microeconomic in- post mortem view held the whole com-
efficiencies, but macroeconomic imbal- plex of import-substitution policies re-
ances and the inability to correct them sponsible for what was essentially a crisis
with sufficient speed. Mexico's currrency of overspending exacerbated by the fick-
crisis in December 1994-January 1995 is leness of international capital markets. It
a poignant example of how one can get became commonplace to view the debt
TABLE3
THE 'WASHINGTON CONSENSUS"AND EAST ASIA
Elementsof the
WashingtonConsensus SouthKorea Taiwan
1. Fiscaldiscipline Yes,generally Yes
2. Redirectionof public Yes Yes
expenditureprioritiestowards
health,educationand
infrastructure
3. Taxreform,includingthe Yes,generally Yes
broadeningof the taxbase and
cuttingmarginaltaxrates
4. Unifiedand competitive Yes(exceptfor limitedtime Yes
exchangerates periods)
5. Securepropertyrights PresidentParkstartshis rule Yes
in 1961by imprisoning
leadingbusinessmenand
threateningconfiscationof
their assets.
6. Deregulation Limited Limited
7. Tradeliberalization Limiteduntilthe 1980s Limiteduntilthe 1980s
8. Privatization No. Governmentestablished No. Government
manypublic enterprises establishedmanypublic
during1950sand 1960s. enterprisesduring1950s
and 1960s
9. Eliminationof barriersto DFI heavilyrestricted DFI subjectto government
directforeigninvestment(DFI) control
10. Financialliberalization. Limiteduntilthe 1980s Limiteduntilthe 1980s
Source:Williamson(1994) for firstcolumn,and author'sevaluation.
crisis as the consequence of import-sub- lay, this produced dramatic results, espe-
stitution ("inward-oriented") policies." cially in Latin America.
The intellectual ground was therefore
cleared for the wholesale reform of pre- B. What Did the East Asian
vailing policies in Latin America, Africa, Governments Do Right?
and Asia. Orthodox economists who had
Ironically, many governments (notably
the ear of policy makers now had their
in Latin America) ended up implement-
chance to wipe the slate clean and
ing policies that went far beyond what
mount a frontal attack on the entire
the East Asian governments themselves
range of policies in use. After some de-
had adopted since the 1960s. As inti-
11This view was (and is) strongly held in the
mated above, many of the discredited
World Bank, which shaped development policy in policies had long been in use in South
many countries during the 1980s through its struc- Korea, Taiwan, and Singapore, and ap-
turaYadjustment loans. See for example the World parently to good effect. (Hong Kong's
Bank volume edited by Vinod Thomas et al.
(1991), and especially the essays by the editors policies have come closest to the laissez-
and by Ernest Stern. faire ideal, even though there is plenty of
intervention in the housing market.) To fered in the investment decisions of pri-

appreciate this point, it is useful to spell vate enterprises. And far from privatizing
out in somewhat greater detail the ele- public enterprises, both countries actu-
ments of the new orthodoxy, so we can ally increased their reliance on such en-
compare them to East Asian policies. terprises during the crucial decade of the
Fortunately, we have a useful list of 1960s.13 In short, where South Korea
policy desiderata compiled by William- and Taiwan followed the orthodox path
son, who has dubbed it the "Washington most closely was in maintaining conser-
consensus." Williamson originally com- vative fiscal policies and competitive
piled the list in 1990, and a summary is exchange rates; this accounts for their
included in Williamson (1994). In Wil- ability to avoid protracted periods of
liamson's words, "[t]he 'Washington con- macroeconomic instability, particularly
sensus' offers a description of what is in the crisis-ridden decade of the 1980s.
agreed about the set of measures that are In the area of microeconomic interven-
typically called for in the first stage of tions, however, their experience di-
policy reform. . . ." (p. 17).12 The list is verged from the orthodox path.
shown in Table 3, along with my own By contrast, it is striking how many
summary comments on the degree of Latin American countries have come
compliance exhibited by Taiwan and within reaching distance of completing
South Korea in each area of reform. the items on the "Washington consen-
How well did South Korea and Taiwan sus" in a period of no more than a few
do according to this list? Judging by the years during the 1980s. Mexico, Bolivia,
number of the prescriptions these coun- and Argentina, to cite some ofl the more
tries did or did not follow, we would distinguished examples, have undertaken
have to award South Korea a score of more trade and financial liberalization
about five (out of ten), and Taiwan about and privatization within five years than
six. Both countries managed fiscal expen- the East Asian countries have managed
ditures and revenues rather well, avoid- in three decades.
ing macroeconomic stop-go cycles and I will discuss the reforms of the 1980s
high inflation. They also consistently at greater length later. First we have to
maintained unified exchange rates (Tai- confront two puzzles that arise from the
wan since 1961 and Korea since 1964) contrasting experiences of the East Asian
and competitive parities for the most tigers and other developing countries
part. But the rest of the scorecard is less prior to the 1980s. How could the East
spectacular. Taiwan welcomed DFI, but Asian countries avoid the disasters that
Korea much less so. Korea repressed in- accompanied interventionist policies
terest rates and made heavy use of subsi- elsewhere? And why did most develop-
dized credit; Taiwan did not do so, but ing countries succumb so easily, and
did give priority to public enterprises in often periodically, to unsustainable fiscal
credit allocation. Neither country signifi- and exchange-rate policies? Neither of
cantly liberalized its import regime until the puzzles is handled very well in the
the 1980s. Both countries heavily inter- existing literature, although we do have a
number of useful leads.
12 Williamson is quick to say that there remains
a number of disagreements among economists on 13 Probably the two best known works on these
some of the narrower issues, for example the issues are Alice Amsden (1989) and Robert Wade
speed of trade liberalization or the need to elimi- (1990). Leroy Jones and Il Sakong (1980) and
nate indexation. See pages 17-18 for his list of Ching-yuan Lin (1973) are two older books which
disagreements. are extremely detailed and informative.
TABLE4
HUMAN CAPITALINDICATORSIN EAST ASIA: ACTUALVERSUSPREDICTED VALUES FOR THE EARLY1960s
Primaryenrollmentratio,1960 Secondaryenrollmentratio,1960 Literacyrate, 1960

Act. Pred. Diff Act. Pred. Diff Act. Pred. Diff
Hong Kong 0.87 0.83 0.04 0.24 0.23 0.01 0.70 0.59 0.11
Indonesia 0.67 0.51 0.16 0.06 0.07 -0.01 0.39 0.25 0.15
Japan 1.03 0.92 0.11 0.74 0.29 0.45 0.98 0.70 0.28
Korea 0.94 0.57 0.37 0.27 0.10 0.17 0.71 0.31 0.40
Malaysia 0.96 0.68 0.28 0.19 0.15 0.04 0.53 0.43 0.10
Singapore 1.11 0.78 0.33 0.32 0.21 0.11 0.50 0.54 -0.04
Taiwan 0.96 0.62 0.34 0.28 0.12 0.15 0.54 0.36 0.18
Thailand 0.83 0.57 0.26 0.12 0.10 0.02 0.68 0.31 0.37
Source:Authors'calculations.
Note:Predictedvaluesof the indicatorsare obtainedfrom a cross-countryregressionrun on a 118-countrysample,
with per capitaGDP in 1960 and its squareused as independentvariables.Source of the data:Alan Heston and
RobertSummers(1988) and RobertBarroand HogerWolf(1989).
C. How Did East Asian Countries clearly something special about the abil-
Manage to Intervene without ity of the Taiwanese and South Korean
Inviting Rent Seeking? policy makers to discipline their private
sectors and their bureaucracies-an abil-
One major puzzle noted above had to
ity to which the label of "strong" or
do with the apparently successful pursuit
"hard"state is often attached. But where
of interventionist microeconomic poli-
this ability came from, and whether it
cies by South Korea and Taiwan. Why
can be replicated in other settings, re-
did trade protection, industrial policy,
mains a mystery.
and subsidized credit work in these
Authoritarianism may have had some-
countries when it failed most everywhere
thing to do with the East Asian gover-
else? There has been much debate about
nance style, but there are too many mis-
these questions, not the least about the
managed dictatorships around the world
degree of intervention itself. The extent
to take the hypothesis seriously. One
to which activist government policies en-
need only look at Sub-Saharan Africa.
abled these miracles of accumulation to
Krueger is clearly thinking of the East
take place is an issue that is not yet set-
Asian cases when she writes:
tled.14 From our present perspective, we
can ignore purely economic aspects and
narrow down the question to the follow- The adoption of the same economic policies
in response to the same (economic) circum-
ing: how were the East Asian govern-
stances will ... have different consequences
ments able to avoid the rent-seeking under a politically strong leadership of a gov-
activities that typically accompanied mi- ernment with a well functioning bureaucracy
croeconomic interventions? capable of carrying out the wishes of the
While we have some clues, the answer leadership than it will when a weak leader-
ship of a coalition attempts to do the same
is that we do not really know. There was
things in circumstances where bureaucrats
14 For two recent contrasting viewpoints, see believe that they can generate support for op-
World Bank (1993) and Albert Fishlow and others position to those policies . . . (Krueger 1993,
(1994). p. 9)
But we do not get much more help than exceptionally equal by cross-country
this acknowledgement that governments standards (Table 5). Equality may have
and bureaucracies differ. been conducive to better governance for
It is reasonable to suppose that at least at least three different reasons.
part of the explanation has to do with First, these governments did not gen-
with some of the special initial condi- erally have to contend with powerful in-
tions that the East Asian countries dustrial or landed interest groups: there-
shared prior to their economic take-off. fore, policy making and implementation
Two such conditions stand out. First, by could be insulated from pressure-group
the late 1950s the East Asian economies politics. Second, the absence of large-
had for the most part a much better edu- scale inequities meant that governments
cated labor force than would have been felt no immediate need to undertake re-
expected on the basis of their income distributive policies; they could concen-
levels (Table 4). This may have made it trate on expanding the pie instead. Note
easier to establish a competent bureau- that this point is analytically distinct
cracy (as well as enhancing the product- from the previous one. Even a govern-
ivity of interventions aimed at boosting ment which is completely insulated from
private investment, as argued in Rodrik lobbying groups would wish to redistrib-
1995a). Second, and perhaps more im- ute income as long as its objective func-
portantly, in all of them the distribution tion looks anything like a conventional
of income and wealth around 1960 was social welfare function. This redistribu-
TABLE5
DISTRIBUTIONALINDICATORSFOR EAST ASIAN AND COMPARATORCOUNTRIES,
AROUND 1960
GiniCoefficient GiniCoefficientfor
Country for Income,c. 1960 LandOwnership,c. 1960
EastAsia
Hong Kong 0.49 n.a.
Indonesia 0.33 n.a.
Japan 0.40 0.47
Korea 0.34 0.39
Malaysia 0.42 0.47
Taiwan 0.31 0.46
Singapore 0.40 n.a.
Thailand 0.41 0.46
UnweightedAverage 0.39 0.45
Others
Argentina 0.44 0.87
Brazil 0.53 0.85
Egypt 0.42 0.67
India 0.42 0.52
Kenya 0.64 0.69
Mexico 0.53 0.69
Philippines 0.45 0.53
Turkey 0.56 0.59
UnweightedAverage 0.50 0.68
Source:Rodrik(1994a)
tive motive figures more heavily the More equality usually (but not necessar-
worse the pre-tax distribution of re- ily) goes with a lower difference between
sources among the population.15 Third, median and average incomes. Conse-
and related to these, the fact that the quently, and assuming that redistributive
top political leadership was free to focus policies act as a tax on accumulation, so-
on economic goals meant that it could cieties with lower inequality will resort
supervise the bureaucracy closely and to less redistribution and grow faster.
make sure that the bureaucrats assisted The empirical literature to date has
rather than hindered private entrepre- not been successful in testing directly for
neurship. For bureaucracies are prone to the presumed political channel through
two problems that are fatal to economic which equality affects growth. Therefore
performance: they can be captured by the precise links between equality and
the interests they are supposed to regu- growth remain to be demonstrated
late, and they can create excessive red (Roberto Perotti 1992b). As the East
tape discouraging economic activity. In Asian cases suggest, it is at least plausi-
Korea and Taiwan, these problems were ble that governance plays some role in
avoided because the bureaucracies were this relationship. Nonetheless, this too is
very closely supervised by the top politi- an area in need of more research. We
cal leadership. need to understand better why broadly
These points have recently received similar policies can produce quite differ-
some indirect empirical support in a ent outcomes in different societies.
number of papers which have found a
D. The Political Economy of
positive relationship between equality
Macroeconomic Cycles
and subsequent economic growth. See in
particular Alesina and Rodrik (1994), The continued existence of some of
Persson and Tabellini (1994), George the policies that make up the "import
Clarke (1993), and Nancy Birdsall, David substitution" syndrome, despite mount-
Ross, and Richard Sabot (1994). In these ing evidence of their inefficiencies, can
papers, the initial level of income equal- be understood in distributional terms:
ity around 1960 is shown to be robustly such policies redistribute income or
and positively correlated with growth rents to favored groups in society. Their
over the next three decades, controlling beneficiaries-business and labor groups
for other initial conditions such as per protected from foreign and domestic
capita income and educational attain- competition-are naturally resistant to
ment. The theoretical models proposed their reform. But what is distinctive
by Alesina and Rodrik (1994) and Pers- about large-scale deficit spending and
son and Tabellini (1994) to explain this overvalued currencies is that these poli-
phenomenon rely on a political-economy cies are by their very nature temporary,
argument. When distributive policy is and the longer they are pursued the
sensitive to the preferences of the me- more drastic their eventual reversal must
dian voter, it can be shown that the equi- be. Groups that benefit during the up-
librium level of redistribution is increas- swing of the joyride have to suffer losses
ing in the gap between the median during the downswing. Labor, for exam-
voter's income and average income. ple, normally gains from expansionary
"populist" policies, but also ends up as
15The analytics backing up this statement can the greatest loser when the eventual cri-
be found in Aiherto Alesina and Rodrik (1994) and
Torsten Persson and Guido Tabellini (1994). The sis takes its toll on real wages and em-
result is explained later in the text. ployment. Businessmen benefit from
TABLE6
CONSEQUENCES OF POPULISM IN PERU
Average
1980-84 1985 1986 1987 1988 1989
Publicsectordeficit (%of GDP) 7.8 5.8 9.1 12.9 15.6 9.8
Currentaccountdeficit (%of GDP) 3.9 0.3 6.0 7.2 7.4 1.0
Real GDP growth -1.0 2.4 9.5 7.8 -8.8 -10.4
Realconsumptiongrowth -0.4 2.3 13.3 8.3 -11.5 -7.5
Inflation 87.0 158.3 62.9 114.5 1722.3 2775.3
Realwages (1979=100) 95 64 73 79 60 29
Source: Lago (1991, Table 9.4).
cheap imported inputs while the cur- prices, interest rates, and the exchange
rency overvaluation lasts, but they are rate. And consumption did boom for a
condemned to take a hit when the inevi- couple of years, raising output alongside
table devaluation takes place (or when a it (Table 6). According to Lago, "[p]rior
large black-market premium makes its to 1987, private-sector confidence in and
appearance). Therefore, short of attrib- support of the government's economic
uting myopia or irrationality to the main policy could only be described as being
political actors, it is hard to understand unanimous"(1991, p. 281). However, the
why such policies find support in the process was clearly unsustainable: the
first place.16 public-sector and current-account defi-
A fascinating case in point is the expe- cits both rose substantially and foreign
rience of Peru under President Garcia reserves were depleted. By late 1988, the
(1985-90). Facing a stagnant economy, economy had collapsed and prices were
the new Garcia administration launched near hyperinflation levels. Real wages,
a "heterodox program" in August 1985. which had increased until 1988, took a
The main thrust of the program was to sharp nose dive and in 1989 stood at a
boost consumption demand by increas- third of their 1987 level (Table 6). (For
ing real wages, subsidizing consumption, the full account, see Lago 1991.)
and creating public-works programs. The Peru's case may be extreme, but it is
government also instituted a freeze on by no means unique. Observers of the
16 Political scientists too often ignore this issue, developing world have long been fasci-
by treating all policies as benefiting some groups nated by the prevalence of such boom-
necessarily at the expense of others. Therefore the and-bust cycles. Ranis and Mahmood
presence or absence of reform is viewed in purely (1992) document how governments em-
partisan terms. This view is taken to its logical ex-
treme by Bates in his comment on Williamson's bark on unsustainable spending booms
(1994) introduction. He explains reform thus: during periods when resources are tem-
"Economic technocrats become powerful, and porarily plentiful (due either to improve-
thus reform becomes politically sustainable, when
they serve the interests of powerful groups: in- ments in the terms of trade or the avail-
dustries, sectors, or regions of the economy" (in ability of external finance), and then
Williamson 1994, p. 32). The fact is that reform- resist retrenchment when the inevitable
particularly in the macroeconomic area-often
benefits the politically influential groups that downturn arrives. What is the explana-
block it. tion for these cycles? The answers pro-
vided in the case-study literature, as in Because economists hate to give up on

Ranis and Mahmood, tend to be me- rationality (at least until they become
chanical. Ranis and Mahmood (1992, p. older-wiser?-and distinguished), it is
vi) summarize their conception of politi- not surprising that a small analytical lit-
cal economy thus: erature has developed around this set of
issues. Several recent papers have pro-
we accept the concept that the typical LDC
state is an instrument of the most powerful- posed formal models that generate po-
if often myopic-interest groups, the new in- litical outcomes that are inefficientfrom
dustrialist class, public or private. the standpoint of the politically powerful
groups themselves, even though these
The operative termnhere, for our pur- groups behave rationally and non-myopi-
poses, is "myopic." Ranis and Mahmood cally. The trick is usually performed by
do not offer an explanation for these pol- positing some kind of coordination prob-
icy cycles, save for suggesting short- lem among the contending actors. Some
sighted behavior. of these models focus on providing an
At least these authors are- explicit explanation for the adoption of unsus-
about their assumption of myopia. More tainable policies, while some focus on
commonly the attribution of myopia to the timing of reform (usually fiscal stabi-
policy makers and interest groups is im- lization). A few attempt to do both.
plicit. For example, Krueger (1993, p. In the near-classic of this field, Alesina
19) writes: and Allan Drazen (1991) show how a sta-
Regardless of the form of government-be- bilization can be delayed, at great cost to
nevolent guardian, predatory authoritarian or the parties involved, thanks to a "war of
bureaucratic, or factional-the political pro- attrition" between two groups, each of
cess typically demanded more resources than which is uncertain about the costs being
were available from tax revenues in the early
stages of growth.
incurred by the other group. It is indi-
vidually rational to wait in this model be-
She then lays out in great detail the cor- cause the group that caves in first is as-
rosive and cumulative long-run conse- sumed to bear a larger part of the
quences of deficit spending and fixed ex- post-stabilization tax burden. Each group
change rates. But she considers these has the incentive to wait and see if the
consequences as largely unanticipated by other group will throw in the towel first.
the relevant groups. Stabilization takes place only when one
But myopic behavior can take us only of the groups figures that it stands to
so far in understanding these policy cy- gain more from assuming the cost of sta-
cles. For one thing, the underlying eco- bilization than from waiting another in-
nomics is straightforward:it does not re- stant to see if its rival will do so instead.
quire a Ph.D. in economics to realize In other papers, Alesina and Tabellini
that spending money one does not have (1989), Sule Ozler and Tabellini (1991),
can result in unpleasant consequences.17 and Alex Cukierman, Edwards, and Ta-
For another, people ought to learn from bellini (1992) have shown how macro-
their mistakes. To take one-not alto- economic problems can arise from politi-
gether extreme-example, since the cal instability (i.e., expected turnover in
1950s Turkey has gone throughfour full governments) as well as polarization. In
boom-and-bust cycles, one per decade. these papers, governmental "myopia"
arises not from a war of attrition, but
17 Of course, that does not prevent some people
from trying it anyhow. But we'd like to think of from the realization by groups in power
this as the exception rather than the rule. that they may be replaced by future gov-
ernments with different ideological or oped by Velasco (1994), who considers a

redistributive preferences. model in which two organized groups
More recent papers by Lab-an and treat the state's resources as a common
Federico Sturzenegger (1994a and pool, and decide every period how much
1994b) generate results with the same to extract from the pool. For simplicity
flavor, by relying not on asymmetric in- and tractability, the choice is limited to
formation or uncertainty but on the dy- one of two options: One option is to ex-
namics of the flight from the domestic tract a "large" share, which leads to a
currency once inflation sets in. These pa- build-up of government debt and a re-
pers assume two contending social duction over time in the state's net
groups-the rich and the poor-which wealth. The other is to extract a "small"
prefer, at low levels of inflation, not to share, which leaves net government
submit themselves to a costly stabiliza- wealth unchanged. Velasco demonstrates
tion. The key dynamic is generated by the existence of a switching equilibrium
the presence of a "financial adaptation" in which the two groups demand large
technology (i.e., bank accounts in Mi- transfers until the public debt stock
ami), which is available only to the rich reaches a critical amount, after which
(at a fixed cost), and which leads to both they both switch to the more moderate
increased inflation and a greater burden strategy. The latter is a cooperative out-
on the poor over time. The main result is come maintained by trigger strategies,
that at some point the poor may there- and stands for the stabilization stage.
fore become willing to accept conditions The intuition is that once government
they would have earlier rejected. net wealth becomes very low (i.e., once
Guillermo Mondino, Sturzenegger, and the state's resources are sufficiently
Tommasi (1992) generalize this frame- plundered), the benefits of the defec-
work to generate the possibility of recur- tion strategy become low compared to
ring cycles of inflation and stabilization. its costs (which are modeled here as be-
In this model, two political groups inter- ing constant and independent of net
act strategically and demand transfers wealth).
from the government, with the transfers Finally, Perotti (1992a) builds a model
paid for by the inflation tax. In addition, with three groups-the poor, the middle
members of each of these groups have class, and the capitalists-to show how
access to financial adaptation, and they unsustainable policies can emerge as a
behave atomistically in deciding when to consequence of a "populist" alliance be-
indulge in it. Because 'the demand for tween the poor and the capitalists. Three
transfers is determined at the group key features lead to this result. First, it is
level while the flight from domestic cur- assumed that capitalists can insulate
rency is decided at the individual level, themselves from the costs of stabilization
socially suboptimal outcomes and cycles in the long run because capital is mobile
both become a possibility. Under low in- in the long run (and only in the long
flation it may be optimal for groups to run). Second, the poor are too poor to
demand high levels of transfers, which be taxed, so they do not bear any of
sets into motion rising levels of inflation the costs of stabilization. Third, the
through the flight from local currency. poor derive a positive externality from
In turn, at high levels of inflation, it may the profits made by capitalists at home.
be optimal for the groups to agree on a Now suppose that the economy is hit
stabilization. with a negative shock which makes long-
A variant along the same lines is devel- run capital flight the dominant strategy
for capitalists. Because domestic capital economic policy making.18 Similarly,

will be abroad in the long run anyhow there is no room in these models for
and the burden of stabilization does not learning about the way the economy
fall on the poor, the latter's well-being functions: if it is people that learn rather
is maximized by expansionist policies than organizations, each generation will
that increase domestic profits in the repeat the mistakes of the previous
short run. Hence the poor and the capi- ones.19 Finally, and most fundamentally,
talists ally themselves against the middle these papers leave hanging a key ques-
class in pursuit of unsustainable policies tion: if distributional struggles are at the
that they know will be reversed eventu- heart of inefficient policy choices and
ally. macroeconomic policy cycles, why do
In these models, political agents or policy makers not design compensation
groups are assumed to be rational and schemes to neutralize political opposi-
forward-looking, with expectations that tion? In the Alesina-Drazen (1991)
are consistent with the properties of the model, for example, the distribution of
underlying model. Behavioral rules are the costs of stabilization is taken as ex-
derived from solving optimization prob- ogenous. This is unsatisfactory because
lems with well-defined objective func- the design of the stabilization package
tions. The political-economic outcome is can surely influence the distributional
derived as a Nash equilibrium in which impacts. I will return to the issue of
each individual or group is doing the compensation toward the end of the pa-
best it can given the actions of others. Of per.
course, none of these models is capable
of providing the full political-economic III. Crisis and Reform During the 1980s
story of the boom-and-bust cycles dis-
cussed above. But they each capture an The 1980s experienced two events of
aspect of the phenomenon, and perhaps lasting significance. First, much of the
more importantly, they confirm that we developing world became engulfed in a
can do better than resort to myopia or protracted debt crisis. Second, many
irrationality when explaining social phe- countries began to shed their import-
nomena. substitution policies and endorsed mar-
There are several directions in which ket-oriented ones. The reforms did not
this literature could be usefully ex- come immediately after the crisis (Table
tended. First, we now need theoretically 7). In fact, the typical pattern was for
informed case studies-or more formal governments to respond to crisis by
test-that attempt to discriminate among tightening their restrictions. Even Chile,
these alternative stories. Second, the which had already opened up during the
normative implications of these models 1970s under General Pinochet, initially
for policy and institutional design have chose to increase its (uniform) import
to be worked out. Third, there are sev- tariff when the crisis hit. But after some
eral relevant aspects of reality which delay, which differed across countries,
have yet to receive attention. For exam- countries in Latin America, Africa, and
ple, in many political organizations (par- Asia jumped on the bandwagon of re-
ties, unions, etc.) principal-agent prob- 18
John Pencavel has suggested that the policies
lems prevent the leadership from of the Mexican petroleum labor union at PEMEX
internalizing in full the interests of the can be explainei in such a framework.
19The relevance of these considerations was
rank-and-file. It is plausible that this suggested by Pencavel in his comments on this pa-
would be one source of inefficiency in per.
TABLE7
ANDINFLATION
TIMINGOFREFORMS
Annualized inflation rate

Stabilization Structural Reform prior to stabilization (%)
Boliva 1985 1985 23,455
Mexico 1987-88 1985-1988 159
Argentina 1991 1987-1991 1,344
Peru 1990 1990 12,378
Brazil 1994 1988-1990 2,103
India 1991 1991 16
form. Governments endorsed reform Bresser Pereira, "it was because the cri-
with varying degrees of enthusisasm. The sis in these countries was so deep that
most enthusisastic reformers by far were even the costs of sticking to populist
in Latin America, where the Chilean ex- policies became higher than the costs of
ample played a major role. (For more on adjustment" (1993, p. 57). According to
Latin America, see Edwards 1994.) The Krueger, economic reforms were under-
developing countries were followed after taken when "economic conditions dete-
1989 by the socialist countries of Eastern riorated sufficiently so that there
Europe and the former Soviet Union, emerged a political imperative for better
which embarked on their own transition economic performance" (1993, p. 109).
to market economies. Moreover, the idea is not limited to
developing countries. "The 'golden rule'
A. Does Crisis "Cause" Reform? of recent Spanish economic history,"
It is natural to suppose that crisis and writes Guillermo de la Dehesa "is: 'Only
reform were somehow related. Indeed, if when the level of reserves was suffi-
there is one single theme that runs ciently low and/or the current account
through the length of the political econ- balance was in large deficit have neces-
omy literature it is the idea that crisis is sary economic adjustment and structural
the instigator of reform. This theme reform measures been taken' . . ." (in
keeps reappearing in different guises. Williamson 1994, p. 137; footnote omit-
Ranis and Mahmood write that ted). Explaining why Australia undertook
fewer reforms than New Zealand, Max
resistance[to] vested interests can be over- Corden writes "[t]he reforms have been
come only when the systemhas no otherway less dramatic than New Zealand's be-
of avoidingthe requiredadjustment.In other
words, it has to be "up againstit," without cause things never got so bad: inflation
anyeasy alternativeby whichthe dayof reck- did not rise so high, and considerable
oningcan be delayed-either becausea coun- trade liberalization had taken place since
try's own resources or the resources made the 1950s" (in Williamson 1994, p. 112).
availablefromthe outside are consideredin- The idea that governments have to be
sufficientto keep the systemoperatingalong
the old rails.(1992,p. vi) up against the wall before they act may
be valid, but it is not entirely free of
"When populist leaders in Argentina, Bo- problems from an analytical standpoint.
livia, Venezuela, Peru, and Brazil First, note that there is a strong element
adopted nonpopulist policies," claims of tautology in the association of reform
with crisis. Reform naturally becomes an clined to believe that the burden of ad-
issue only when current policies are per- justment will be one-sided. This places
ceived to be not working. A crisis is just the East Asian countries in an advanta-
an extreme instance of policy failure. geous situation, once again, where crises
That policy reform should follow crisis, are concerned.
then, is no more surprising than smoke In addition, the emphasis on crisis has
following fire.20 Furthermore, the hy- in itself little predictive content as to
pothesis is virtually nonfalsifiable: if an what form the response will take. Latin
economy in crisis has not yet reformed, American countries eventually adjusted
the frequently proffered explanation is not only by balancing their fiscal ac-
that the crisis has not yet become "se- counts, but also by overhauling their
vere enough." Bresser Pereira, who was trade and industrial policies and under-
briefly Brazilian finance minister in taking privatization on a major scale. As I
1987, argues that the reason his fiscal have discussed above, these trade and in-
package was not supported by Presi- dustrial policies had little to do with in-
dent Sarney was that the crisis was not stigating the crisis, and consequently
yet perceived as serious (in Williamson their reform was not a logical necessity
1994, pp. 333-54). True, perhaps, but once decisive action was taken. In fact,
not very helpful for explanation or pre- some of the reforms in the area of trade
diction. What we surely need to under- liberalization almost surely complicated
stand is why South Korea's politicians the macroeconomic stabilization effort.22
are ready to change course at the slight- Therefore, the comprehensiveness of the
est hint of a crisis, while Brazil's will reforms that the Latin American coun-
bring their economy to the brink of hy- tries undertook still requires explanation.
perinflation several times before they Part of the explanation has to do with
tackle the problem. The political-econ- the advice that these governments re-
omy literature recognizes this issue, but ceived. As mentioned previously, many
is largely silent on it. professional economists themselves
Some helpful hints come from the ana- tended to lump together all "import sub-
lytical literature mentioned previously. stitution" policies and to hold them
Alesina and Drazen (1991) show in their equally responsible for the crisis. That
<'warof attrition" model that the lower was certainly the approach taken by the
the "degree of cohesion" in society, World Bank, the most important conduit
which they model as the expected asym- of economic ideas to developing-country
metry in the burden of stabilization, the policy makers.
greater the delay before a stabilization But how could these wide ranging
takes place.2' One can loosely interpret
this in the following terms. In societies 22That is so for several reasons. The reduction
where resources are evenly distributed, of tariffs resulted in losses in fiscal revenue. Fur-
and the government has a good distri- thermore, trade liberalization aggravated the ad-
verse effect of stabilization policies on aggregate
butional track record, groups are less in- demand and domestic output. Last but not least, it
created an important conflict in exchange-rate
20 Williamson and Haggard (in Williamson management: trade liberalization required a "com-
1994, p. 564) mention several cases where reform pensating" devaluation of the currency, which
was undertaken despite the absence of crisis (no- often could not be undertaken for fear of upset-
tably Australia,Colombia, and Portugal). ting fragile price expectations. The recent Mexi-
21 This is also possibly what Krueger has in can debacle could possibly have been avoided, or
mind when she argues that a "strong"government at least its impact minimized, if the authorities had
such as Korea's will react quickly to crisis, while a not removed controls on trade and capital flows so
"factional"one will delay (Krueger 1993, p. 126). enthusiastically.
trade and industrial policy reforms be ciated with this reform can be expressed
rendered palatable to the interest groups as 1/get, where j is the share of affected
that had been their beneficiary for so imports in domestic consumption and E
long? How were they persuaded to go is the absolute value of the import de-
along? Here again it is plausible that the mand elasticity. With reasonable values
atmosphere of crisis played a role. Crisis of t = 0.5, j = 0.2, and E = 2, the formula
enabled reformist governments to pack- yields a value of five for the PCBR.23
age fiscal reforms, which were absolutely That is, five pesos of income have to be
crucial for the return of price stability, reshuffled among groups in society to
with trade and industrial policy reforms, yield a single peso of efficiency gain!
which were viewed as desirable in the This is one way of capturing the political
longer run but were incidental to the im- difficulty of achieving microeconomic re-
mediate crisis. In other words, policy form in normal times.
makers acted as agenda setters: They Now suppose that the economy gets
presented domestic interests with a caught up in a deep macroeconomic cri-
package of both macroeconomic and mi- sis, recovery from which would provide
croeconomic reforms. Because high in- all-around gains. The idea here is that
flation and macroeconomic instability triple-digit inflation and the associated
hurt pretty much everyone across the instability hurt pretty much all groups in
board, influential interest groups felt society, although some may naturally
compelled to go along. They may have protect themselves better than others.
preferred to have only the macro- Suppose further that a reformist govern-
economic component of the package, but ment packages the stabilization program
that was not the choice that they con- needed to end the crisis with the price
fronted. reform discussed above. Let y stand for
The argument can be illustrated by us- the percentage increase in income that
ing a simple heuristic concept that we accrues to all groups in society as a result
may call the "political cost-benefit ratio" of the stabilization. We can think of y as
(PCBR, Rodrik 1994b). Assume that re- an index of the depth of the macro-
distributing income is politically costly, economic crisis. Under reasonable as-
and that this cost has to be traded off sumptions on the value of y (e.g., y =
against the efficiency benefits of reform. 0.10) the PCBR plummets to well below
Define the PCBR as the ratio of the total unity (from five previously). The point is
redistribution generated by reform to its that the opportunity to do something
efficiency benefits. This index answers that will benefit most everyone by a large
the question: how many pesos are re- margin-an opportunity that arises only
shuffled among different groups for when the economy is mismanaged terri-
every peso of efficiency benefit? The bly and falls into deep crisis-allows re-
PCBR takes values between zero and in- formist policy makers to sneak in, along-
finity. The higher the value of the index,
the more difficult reform is likely to 23 There are three groups that matter in this ex-
prove. ample, consumers of the importable, producers of
Price reforms (such as trade liberaliza- the importable and the rest of the economy as af-
fectedTby the government budget. Let the world
tion and removal of subsidies) tend to price of the importable be p*, the domestic price
generate a lot of redistribution relative p, and the quantities of consumption, production,
to their efficiency benefits. Consider the and imports c, q, and m, respectively. Consumers
gain -cdp, producers gain qdp, and the govern-
removal of an import tariff, t. To a first- ment budget changes by mdp + tp *dm. The effi-
order of approximation, the PCBR asso- ciency gain is tp*dm. See Rodrik (1994b).
side the stabilization, microeconomic, run, the consequences of reform actually

and structural reforms which have sig- look pretty good. This shows up in a
nificant distributional implications and number of different areas. With regard
which would be difficult to implement to disinflation, most of the recent cases
under normal circumstances. of exchange-rate based stabilizations,
such as those in Israel (1985), Mexico
B. Does Reform Have Short-Term
(1987), and Argentina (1991), have been
Costs?
accompanied by consumption booms,
The proposition that some of the ma- rather than recessions.24 With regard to
jor structural reforms of the 1980s and broader structural adjustment policies,
1990s were adopted despite interest the best statistical evidence to date is
groups, rather than because of them, that such policies tend to significantly in-
naturally raises the question of the sus- crease, rather than decrease, growth of
tainability of the reforms. Here we face output within two or three years, even if
two other conventional wisdoms of the not immediately (Corbo and Patricio Ro-
political-economy literature: First, re- jas 1992).25 Even in Eastern Europe,
forms become sustainable when they where there is genuine reason to believe
generate "winners"with a stake in their that the transition may have short-term
continuation. Second, and this one is the costs, the evidence indicates that reform
downer, reforms tend to make things reduces rather then intensifies the short-
worse before they make them better. term costs. Output has fallen the least in
For a proposition that is startlingly countries like Poland and the Czech Re-
lacking in empirical support, the second public which have had the most exten-
piece of conventional wisdom is surpris- sive reforms, and the most in countries
ingly strongly held. It permeates practi- like the Ukraine which have had the
cally every discussion of the political least (Table 8). Furthermore, consump-
economy of reform. "The results of many tion statistics indicate that much of the
worthwhile reforms lie on a J-curve," measured contraction of GDP in transi-
writes Piniera,"they tend to make things tional economies is illusory. (For the
a good deal worse before they get bet- Polish case, see Andrew Berg 1993.)
ter" (1994, p. 227). Bresser Pereira, Ma- Of course, structural reforms (and pos-
ravall, and Przeworski (1993, p. 2) state sibly stabilization as well) may have
categorically: "the effect of economic re- sharp distributional consequences, as
form on growth must be negative in the discussed previously. But this is not a
short run." "A key political problem of matter of the short run versus the long
sustaining support for reform programs," run, as with the worries reflected in the
argues Joan Nelson "is the long delay in quotes above. Saying that reform is diffi-
reaping visible benefits for much of the
population." She continues: "Quite sim- 24 See for example Guillermo Calvo and Carlos
ply, in most cases there are not enough Vegh (1994). Dornbusch and Fischer (1993) argue
that it may be unavoidable to incur output costs
early winners to ensure the political sus- when disinflating from moderate inflation (40-80
tainability of the program . . ." (in Wil- percent per year, but their evidence on this is not
liamson 1994, p. 476-77). so clear cut.
25Corbo and Rojas use a control-group ap-
The facts do not support such pessi- proach and focus on the 1985-88 performance of
mism about long-delayed response. Once countries that received at least two Structural Ad-
one makes allowance for the likelihood justment Loans (SAL) from the World Bank start-
ing in 1985 or before. They find that adjustment
that the counterfactual-no reform- raised GDP growth rates by an average of two per-
produces even worse results in the short centage points.
TABLE8
REFORM IN ECONOMIES IN TRANSITION
Averageannualreal GDP
changeduringfirstthree Annualinflation,
yearsof transition(%)* 1994(%)
Countrieswith StrongReformPrograms
Poland -5.5 30
Czech Republic** -8.2 9
Hungary -6.2 19
Estonia -10.1 47
CountrieswithWeakReformPrograms
Russia -14.7 336
Ukraine -14.4 1000
Moldova -17.8 245
Source: CalculatedfromIMF (Oct. 1994,Table11).

* The first year of the reformprogramis taken to be 1990 for Poland and
Hungary,and 1991 for others.
** The figuresfor Czechoslovakiaare used for 1991 and 1992.
cult because some powerful groups will tural adjustment" lending as well as for
be inevitably made worse off-in the official bilateral credits. But the logic of
long run as well as the short run-is dis- this statement is not unassailable, even if
tinct from claiming that reform is diffi- the premise is accepted. The reason is
cult because the net benefits from the that external resources reduce the costs
reform come too late for politicians to both of reform and of doing nothing-
reap the gains. It is the latter that seems that is, avoiding reform. In addition,
empirically problematic. the prospect of aid can actually exacer-
None of this is to dismiss the obvious bate the delay in stabilization, by induc-
fact that reforms do arouse opposition, ing groups to postpone making sacrifices
and that the opposition often tends to be until aid actually materializes.26The ef-
strongest early on. The point is that we fect on reform is consequently ambigu-
cannot really attribute these phenomena ous.
to presumed (rather than demonstrated) One of the strongest proponents of
short-term costs of reform. Once irra- foreign aid has been Jeffrey Sachs, who
tionality and myopia are dismissed, the has served as a high-profile advisor to re-
political economy of reform turns out formist governments in Bolivia, Poland,
once again to contain more puzzles wait- and Russia among other places. In his
ing to be worked out. contribution to Williamson (1994) enti-
tled "Life in the Economic Emergency
C. Does Foreign Aid Help Reform?
Room," he complains that economists
If reform has short-term costs, as so tend to neglect the role played by for-
many believe, then foreign aid should eign assistance in most of the major post-
help reforms get launched (and sus- war reforms. He provides capsule histo-
tained) by alleviating these costs. This 26 This argument is worked out in Alessandra
indeed is the standard justification for Casella and Barry Eichengreen (1994), using the
the World Bank's and the IMF's "struc- Alesina-Drazen model.
ries of the economic reforms in postwar on the part of the borrowing govern-
Germany, Japan, Bolivia, Mexico, Chile, ments. But conditionality is no panacea,
Poland, Israel, and Turkey, stressing the as conditionality can last (at best) only as
critical contribution of aid in each case. long as net transfers are positive. In the
Sachs is explicit that a government com- end, sovereign governments are just that:
mitted to reform is needed before aid sovereign. There is a fairly large litera-
can do any good. But once such a gov- ture on conditionality and its effective-
ernment is in place, the international ness (see Manuel Guitian 1982; Paul
community should be forthcoming. What Mosley 1987; Jacques Polak 1991; and V.
aid can do, even if it is small in relation Thomas et al. 1991). Some emerging
to the country's problems "is help good conclusions are that conditionality is
governments to survive long enough to most effective when it focuses on a small
solve problems" (in Williamson 1994, p. range of quantifiable indicators and
512). when governments are already commit-
The problem is that aid can also help ted to the reforms. However, it may not
bad governments survive. For debating be easy to tell governments apart, and
purposes, one can cite at least as many even governments that are genuinely re-
cases as Sachs does to demonstrate an formist may be tempted by aid to deliver
association between plentiful aid and de- less than they promised.
layed reform.27As mentioned previously,
one of the themes of the book by Ranis IV. In Search of a Manualfor Reformist
and Mahmood (1992) is that the avail- Politicians
ability of external resources tends to pro-
mote irresponsible policies. Scarcity of All of which raise the question, "what's
resources, on the other hand, is good for a poor reformist politican to do?" Re-
reform. (Note the obvious parallel to the cently Williamson had the interesting
crisis hypothesis.) One of the pieces of idea of gathering a group of high-ranking
conventional wisdom about the Korean technocrats ("technopols" in William-
and Taiwanese reforms of the 1960s is son's jargon) to talk about their experi-
that these reforms took place in large ences, in the hope that some common
measure because U.S. aid, which had lessons may emerge. The resulting book
been plentiful during the 1950s, was (Williamson 1994) opens with a list of
coming to an end (see for example Ranis hypotheses drawn from the literature
and Mahmood 1992, p. 139). about what makes reform feasible and
Sachs would respond that donors must successful, and which contributors were
ensure the recipient governments will asked to examine from their own individ-
undertake the reforms before doling out ual perspective. I have reproduced the
the cash. More generally, aid must come list in Table 9. The list includes some
with a heavy dose of conditionality. This items that I have already discussed, as
is well recognized, and both the IMF well as many others.
and the World Bank make access to their In the end, however, Williamson is
resources conditional on good behavior forced to concede defeat. In his conclud-
ing chapter (written with Haggard), he
27 Some of Sachs' case histories can also be writes "there are no fully robust empiri-
challenged. It is true that aid played an important cal generalizations; in every case there is
role in the Turkish reforms of the early 1980s, but at least one partial counterexample.
it is also true that it delayed the fiscal day of reck-
oning, with ultimately debilitating consequences None of the 15 hypotheses investigated
for the Turkish economy. was either necessary or sufficient for
TABLE9
ABOUT
HYPOTHESES REFORM
1. Policyreformsemerge in responseto crisis

2. Strongexternalsupport(aid)is an importantconditionfor successfulreform
3. Authoritarianregimesare best at carryingout reform
4. Policyreformis a right-wing-program
5. Reformersenjoya "honeymoonperiod"of supportbefore oppositionbuildsup
6. Reformsare difficultto sustainunlessthe governmenthas a solidbase of legislativesupport
7. A governmentmaycompensatefor the lackof a strongbase of supportif the oppositionis weak and
fragmented
8. Socialconsensusis a powerfulfactorimpellingreform
9. Visionaryleadershipis important
10. A coherentandunitedeconomicteam is important
11. Successfulreformrequireseconomistsin positionsof politicalresponsibility
12. Successfulreformrequresa comprehensiveprogramcapableof rapidimplementation
13. Reformersshouldmasktheirintentionsto the generalpublic
14. Reformersshouldmakegood use of the media
15. Reformbecomes easierif the losersare compensated
16. can be enhancedby acceleratingthe emergenceof winners
Sustainability
Source:Williamson(1994)
successful reform" (p. 589).28 The propo- Count Sergei Witte, a prominent reformer
sitions that received strong support were under the czars, used to say that there were
two essential elements for radical reforms in
"the need for a strong political base, for Russia: absolute monarchy, because you need
visionary leadership, and for a coherent not pay attention to your critics if His Maj-
economic team." Disproved were the esty supported you, and speed, because
hypotheses that reform requires author- somebody might persuade the czar to change
itarian regimes or that it is an exclu- his mind before the reform could be made
irreversible. (pp. 435-36)
sively right wing enterprise. But the
volume itself is far from a failure. The Sachs cites approvingly the example of
exchanges among former politicians, Jacques Necker (the French finance
technocrats, economists, and political minister before the 1789 revolution) who
scientists that it contains make for fasci- maintained that flexibility or willingnesss to
nating reading. compromise, which might be harmless or
A fundamental fault line that divides even advantageous in other ministers, was an
the contributors to this literature is unforgivable failing in a finance minister!
the issue of how participatory reform Sachs goes on:
politics ought to be. Most economists
are on the side of speed, stealth, and If reformers want free prices, they should not
stand around and talk about it-they should
consequently of reform from above. do it, because everyone will be against free-
Vladimir Mau, a Russian economist, ing prices until it has been done, until it is an
writes: established fact. (pp. 509-10)
Sachs has plenty of first-hand experi-

28As indicated in Table 9, there were actually
16 hypotheses, so the number 15 must be a mis- ence in Bolivia, Poland, Russia, and else-
print. where, so his views perhaps ought to
Rodrik: Understanding Economic Polict Reform 33
count for a lot more than those of Sachs' words have the advantage of
armchair economists. He is especially expressing forthrightly what a lot of
outspoken on the question of whether economists feel deep down but find
reformers should strive for a consensus politically incorrect to articulate. What
with affected groups.29 "Many partici- some may find striking in these state-
pants have suggested that reformers suc- ments is the lack of faith in the com-
ceed by constructing a 'social consensus' mon sense of ordinary people and in the
in favor of reforms," he writes. "This is efficacy of political institutions, espe-
mostly not the case. In deep crises, there cially in new democracies. That econo-
is simply no consensus to build upon, mists should hold to these views is not
only confusion, anxiety, and a cacophony without irony. After all, homo econ-
of conflicting opinions." He goes on to omicus is supposed to be rational and
relate how the Polish "big bang" was forward-looking, and to process all the
enormously controversial at the time, information that comes his way in the
and the desire to "return to Europe" did most efficient way. Sachs' homo politi-
not translate into agreement on specific cus is none of these things, or else is
policies. "Consensus on many specifics being held hostage to some grand co-
(e.g., currency convertibility, price de- ordination failure whose nature is un-
control, budgetary discipline) has come clear.3l
to Poland, but only after three years of This irony is seized upon by Przewor-
reform" (p. 505). In Sachs' view, it is at ski, who provides a serious challenge to
best a waste of time to seek a broad co- the economists' preference for reform
alition for reform because most people from above (in Bresser Pereira, Ma-
have no understanding of what is re- ravall, and Przeworski 1993). Focusing
quired: "While the history of market- on the Polish case, he faults the storm
based reforms has repeatedly shown that tactics favored by Sachs and others for
free markets, open trade, and an econ- both weakening democratic political in-
omy fueled by private ownership are stitutions and making errors in economic
enormously powerful in stimulating policy more likely. He and his two co-
rapid economic growth, the general authors (Bresser Pereira and Maravall)
public rarely knows it or believes it at summarize their argument in their con-
the start" (p. 506). Neither is the prob- cluding chapter thus:
lem limited to the person on the street: we find that subjecting the reform strategy
"Few Russians understand the source to the competitive interplay of political forces
of Russia's current inflation, least of all is superior on three essential grounds: It
the [former] governor of the central
bank . . ." (p. 507). The operational im-
plication of all this is that reform needs a that he favors authoritarian forms of government
strong and autonomous executive, unhin- over democracy. He believes, however, that demo-
cratically elected governments should have a fairly
dered by the search for consensus and free hand in between elections.
compromise.30 31 One reader objected to this paragraphin the
following terms: "The notion that the conventional
29 Of course, there are very few things that economist may be a better judge of economic pol-
Sachs is not outspoken about. His sharp critique of icy than the man on the street contains no more
IMF policy in Russia in his after-dinner speech at 'irony' than the notion that a physician may know
the Williamson conference drew a defensive re- better how to diagnose and cure my illness." Most
sponse from the IMF (printed in the Williamson of us, however,take our physician'sadvice.Were
volume), and (naturally)a rejoinder from Sachs. economists'adviceas well receivedby politicians,
30 In a personal communication, Sachs has clari- the puzzleson whichthis paperfocuseswouldbe
fied that -his views should not be taken to imply farless salient.
improves policy, it builds support for the a terrifying prospect for most Poles.32
continuation of reforms, and it helps con- The main shortcoming of the Bal-
solidate democratic institutions. We do not
see a trade-off between public discussion cerowicz plan, therefore, was its failure
and the soundness of economic plans. (p. to put in place adequate social protec-
210) tion to guard against the inevitable un-
employment that would result.33 Prze-
These points are underscored in Prze- worski argues that this was a "technical"
worski's interesting discussion of the Pol- mistake, but one that resulted from not
ish program. The program began with having listened to the people:
the famous "big bang" of January 1st, If the purposeof their architectswas to make
1990. Leszek Balcerowicz, a contributor reforms politically palatable, the blueprint
to the Williamson volume (and from was not well designed. But the reasontech-
whom more later), was its principal ar- nocratscommit'technical'errorsis that they
chitect and Sachs its principal foreign do not consult and concert with those who
are affected by their blueprints. There is
advisor. Przeworski grants that the near- somethingparadoxicalwhen believersin the
hyperinflation in which the Polish econ- informationalefficiency of decentralizedde-
omy found itself by the Fall of 1989 re- cisionsfear them most . . . The mainobstacle
quired some fast action. But he faults the to reformis people. (p. 185)
program for having had no social dimen-
sion: "I could find no references to 32 That the decline in popularity was related to
building a welfare state or extending so- rising unemployment is plausible enough, but the
cial protection in any formulation of the statistical analysis that Przeworski undertakes to
establish this relationship is unconvincing. The
reform program," he declares; "this was analysis consists of pairwise correlations between
a pure trickle-down model of reforms" poll results and actual economic outcomes. The
(p. 142). This may be bad enough for results of the exercise are unreliable for several
reasons: there are few observations (a maximumof
some, but the real clincher in Przewor- 20), there is obvious scope for omitted-variable
ski's argument is that the absence of so- bias, and a lot of the variables have strong time
cial policy ended up threatening the sus- trends leading to spurious correlations. The strong
negative correlation Przeworski obtains between
tainability of the economic reforms. To the program's popularity and unemployment is a
demonstrate this, he analyzes at length statistical reflection of the fact that the first of
the trend in public support for the Bal- these consistently went down, and the second up,
after January1990.
cerowicz program. He finds that until A more telling piece of evidence comes from
May 1990 public support was high and the experience of the Czech Republic (not dis-
steady, after which a significant decline cussed by Przeworski). Alone among reformist
governments, Vaclav Klaus' government has re-
in support occurred. Thereafter it re- tained much of its popularity. Not coincidentally,
mained steady again, until early 1991 the Czech Republic is also the only strongly re-
when "the diagnosis of the current situ- forming economy that has not (yet) experienced
high unemployment. An alternative argument for
ation, optimism, willingness to bear sac- the decline in the popularity of reforms is pro-
rifices, and support for the Balcerowicz vided in Rodrik (forthcoming), based on changes
program all began to decline again" in the preferences of state-sector workers over the
course of the transition.
(pp. 158-59). Eventually, of course, sup- 33 This point would be disputed by Balcerowicz
port would fall so low that the former and Sachs. According to Sachs (1994, p. 3): "Con-
Communists would return to power in trary to the impression of uncompromising laissez
faire and harsh social policies, Poland's social
the September 1993 parliamentary elec- spending has risen very sharply since the begin-
tions. ning of reforms. Total budgetary spending on so-
Przeworski attributes this slide in sup- cial programs (labor fund, pension fund, health
care) has risen from 10 percent of GNP in 1990 to
port primarily to the rise in unemploy- 21 percent of GNP in 1993, one of the highest
ment, which he argues convincingly was proportions in Europe."
Moreover, Przeworski and his col- of the program, including the emphasis
leagues believe that the top-down style on a "social safety net" (to use the Wash-
of these reforms tend to corrode nascent ington term), would not look out of place
democratic institutions: in a World Bank document. Przeworski
mentions the Hungarian case approv-
the autocraticpolicy style characteristicof ingly, and implies that the more gradual
Washington-style reformstends to undermine approach adopted there was prefer-
representative institutions, to personalize
politics, and to generate a climate in which able because it paid greater attention
politicsbecomesreducedto fixes, to a search to social issues. Yet, Hungarian unem-
for redemption.Even if neo-liberal reform ployment has risen nearly as high as the
packages make good economics, they are Polish one, and by 1994 most economists
likelyto generatevoodoopolitics.(pp. 9-10) would agree that the Polish economy had
turned the corner while Hungary was
Przeworski undertakes an interesting
still struggling. The cumulative output
analysis of the trend in public confidence
fall in Hungary has been larger, and
in various Polish institutions. He docu-
the recovery smaller, than in Poland
ments how confidence in representative
(see John Flemming 1995, Table 4). In
institutions like political parties, the gov-
any case, in 1994 former Communists
ernment, and the Sejm gradually eroded
were elected to power in Hungary as
while confidence in the army and the po-
well.
lice increased, to the point where "two
Perhaps an alternative model would
years after the transition to democracy, have been the "social pacts" approach,
Poland was a country in which the three
used most conspicuously by post-Franco
institutions in which people had the
governments in Spain. This experience is
most confidence were the army, the
described in Maravall's contribution to
church, and the police" (p. 173). He at-
the same volume (as well as by de la
tributes this to the "policy style" of the
Dehesa in the Wiliamson volume).
reforms-the introduction and continu-
The Moncloa pacts in Spain were an ef-
ation of a set of policies "by surprise and
fective device through which labor re-
independently of public opinion and of
ceived expanded rights in return for
representative organizations and institu-
wage moderation. But as Maravallmakes
tions"34(p. 175). To paraphrase Przewor-
clear, this experience is probably of
ski only slightly, economic reform is con-
little relevance to Eastern European
sequently too important to leave to
countries, because there was still sub-
economists.
stantial room for expanded government
The alternative to which Przeworski
in Southern Europe. Regarding the ex-
and his colleagues would subscribe is not
perience of Spain, Portugal, and Greece
entirely clear. In terms of actual policy
he writes:
content, their "social democratic" ap-
proach departs only mildly from the Bothpublicexpenditureas a whole and social
Washington consensus, in envisioning a expenditure in particular increased very
somewhat more active role for the gov- sharplyfrom the mid 1970s under the new
democratic regimes. Welfare systems and
ernment in industrial policy and in co- mechanismsfor income distributionwere ex-
ordinating private investment.35 The rest tended and reorganized.The role of the state
34"The televised spectacle of the government
ramming through the parliament a package of evidently, be expected to develop complex indus-
complicated legislation ... took its toll" (p. 176). trial policies or structural policies. After all, they
35To which Sachs would retort: "Governments aren't even carrying out their most fundamental
that have reached hyperinflation cannot self- task"(in Williamson 1994, p. 510).
in the provision of health, education, and accompli than it would have been to build re-
pensions was reinforced. Revenues from taxa- forms gradually in the face of strong populist
tion increased, and fiscal systems were made opposition in Parliament after the elections
more redistributive. (Bresser Pereira, Ma- of October 1991. (pp. 172-73)
ravall, and Przeworski 1993, p. 101)
One useful distinction in this debate,
As he later puts it, "public expenditures not often made, is between the initiation
could generally grow in spite of crisis" and consolidation of reform. Haggard ar-
(Bresser Pereira, Maravall, and Przewor- gues that the initiation of reform re-
ski 1993, p. 105). quires independence or autonomy for
Leszek Balcerowicz, the former dep- the executive, while consolidation of re-
uty prime minister after whom the Polish form necessitates "building of legislative
reform program was named, agrees with and interest-group bases of support" (in
Przeworski's facts, but not with the con- Williamson 1994, p. 468). This argument
clusions. There was no choice but to is echoed by Joan Nelson, who says that
move quickly on both the macro- it may be inevitable to be somewhat
economic and structural fronts, and pub- autocratic in the early stages of reform,
lic debate and deliberation would have but that in later stages one needs to
wasted valuable time: "[T]he estab- generate support and consensus (pp.
lishment of a social pact [as in Spain] in 472ff.).36 But what if the autocratic ap-
Poland in 1989 would simply have taken proach early on does irreparable damage
too much time during a crucial period." to confidence in democratic institutions,
Besides, as Przeworski claims it does?
[w]hat would be the purpose of such a pact It is difficult not to feel sympathy for
today? It could not afford to give compensa- Przeworski's yearning for a more demo-
tion, because that would conflict with the cratic style of reform. Yet my suspicion is
fiscal program; the real compensation had that most observers of the Polish reforms
consisted of the rapid elimination of short- would agree with Balcerowicz and Sachs
ages, which has been increasingly appreciated
as time has passed. (in Williamson 1994, p. that speed (and stealth) was of the es-
218) sence. While there have been some re-
versals in the reforms, even with these
Moreover, it would have allowed the op- reversals the Polish economy is in far
ponents of the program to dilute it. Like better shape today than it would have
Sachs, Balcerowicz has little confidence
in the political process in the short term, 36 Perhaps Mexico (prior to its most recent cri-
and complains that two election cam- sis) is a good example of the Haggard-Nelson
strategy. Jose Cordoba relates in detail the dra-
paigns in the first two years of the matic changes in Mexican economic policy follow-
program-presidential in 1990 and ing the 1982 crisis. An astounding turnaround in
parliamentary in 1991-made his job the fiscal stance (of 10 percentage points of GDP!)
was accomplished within two years, and in a fairly
extremely difficult. He sees the first few unilateral manner. But the government's sub-
months of a honeymoon period in early sequent approach was more participatory (or at
1990 as having provided an opportunity least, corporatist): "The Economic Solidarity Pact
[of 1987] clearly established that inflation could
to ram through as many reforms as not be reduced through government policies alone
quickly as possible. "[T]he period of but required a social dialogue and active support
Iextraordinary politics' was short-lived by labor, business, and peasant organizations.That
lesson profoundly impressed policymakers, and
and . . one should use it to introduce from then on much greater effort was made to
tough economic measures." Further: build consensus and promote the direct involve-
ment of those sectors in society that would be af-
[i]t was easier for the supporters of the mar- fected positively or negatively by the reforms" (in
ket-oriented reforms to defend them as fait Williamson 1994, p. 254).
been under a more gradual path. Bal- benefit a majority of the voters. We show
cerowicz is absolutely right that his re- that the answer is "yes." We also show
forms have created a new, largely irre- that political systems in general have a
versible reality that his successors dare bias toward the status quo even when the
not touch-a matter of importance when status quo is inefficient and individuals
these successors are former Commu- are risk neutral. The key to the argument
nists. is uncertainty of a particular kind: the
This fascinating debate takes us back identity of many of the gainers (as well
to the most fundamental issue in the po- as losers) from reform cannot be deter-
litical economy of policy reform, the one mined ex ante.
with which this essay opened: If the ob- To see how the argument works, con-
jective of reform is to make people bet- sider a democracy where a majority vote
ter off, why does reform have to be is needed before reform can be adopted.
shielded from the people? "[T]he sad Let the economy have 100 voters and
fact that good things-such as democ- suppose that the reform in question will
racy and market-oriented economic pol- increase the incomes of 51 individuals by
icy-do not always go together," as Hag- five zlotys each and decrease the in-
gard puts it (in Williamson 1994, p. 467), comes of the rest by one zloty each, leav-
suggests that there is a real puzzle here. ing a net gain of (5 x 51) - (1 x 49) = 206
Furthermore, if the problem with reform zlotys. In the absence of uncertainty,
is that powerful groups are hurt by it, the majority of the population would
why can't policy makers come up with vote in favor and the reform would be
compensation schemes that remove the adopted. Assume that all these conse-
hurdle? Myopia, to which many ob- quences of reform are common knowl-
servers ultimately resort, appears to me edge. Now suppose that while 49 indi-
to be as unsatisfactory an explanation viduals know for sure that they will gain,
here as in any area of conventional eco- the remaining 51 are in the dark as to
nomics. which among them will gain and which
As I pointed out above, the analytical will lose. However, because aggregate
literature has begun to address these consequences are common knowledge,
puzzles. I close this section by discussing individuals in the latter group know that
briefly two papers which are especially two of them will eventually benefit while
germane to the questions at hand. The 49 will lose out. (Such uncertainty may
first one (Raquel Fernandez and Rodrik arise, say, from incomplete information
1991) provides an answer to why reforms at the individual level about the skills
that will benefit most everyone may still needed to suceed in the post-reform en-
be rejected by a majority of the elector- vironment.) This renders individuals in
ate, and why compensation may not re- the second group identical ex ante, with
move distributional obstacles. The sec- an expected benefit from reform of [(5 x
ond (Mathias Dewatripont and Gerard 2) - (1 x 49)]/51 = - 0.76 zloty each.
Roland 1992) discusses optimal reform Hence the individuals in the uncertain
design under dynamic political con- group will reject reform, blocking its
straints, restricting feasible policies to adoption.
those that for example will be approved The bottom line is that uncertainty
by unanimity. about the consequences of reform at the
In Fernandez and Rodrik (1991) we level of the individual can prevent re-
ask whether a rational electorate would form, even when it is recognized that re-
ever reject a reform which is known to form will make a politically effective ma-
jority better off.37 Moreover, the same by partial reform, which generates less of
kind of argument explains why compen- a budgetary burden.
sation, or the promise thereof, is not al- Dewatripont and Roland show that a
ways an effective device to remove the dynamic version of this set-up produces
distributional obstacle to reform. In the an argument for gradualism. A partial re-
above example, ex ante losers know that form early on would induce only the
if reform is passed, there will be an ex highest-ability group to leave; next pe-
post majority in support of its continu- riod it becomes optimal to induce the
ation-even in the absence of compensa- next-highest group to leave; and so on, at
tion. Therefore, a promise to compen- much lower cost to the budget ulti-
sate losers ex post is not going to be mately. The government's assumed con-
credible. This kind of reasoning may ex- trol over the agenda of policies under
plain why many reforms that would have consideration allows it to dynamically re-
been popular ex post are passed up ex lax the political constraints. A somewhat
ante. It may also explain why reforms similar story, but using the Fernandez-
that are instituted by an authoritarianre- Rodrik (1991) model and based on the
gime against prevailing political senti- Chinese example, is provided by Shang-
ment survive the return of democracy Jin Wei (1992), who shows how a se-
(e.g., Pinochet's reforms in Chile). quence of reforms in different policy are-
Inspired more directly by the Eastern nas may be politically sustainable where
European context, Dewatripont and Ro- an economy-wide "big bang"would fail.
land (1992) analyze the case of an
agenda-setting government faced with V. Concluding Comments
the task of shrinking the size of the state
sector subject to political constraints. A political scientist or historian may
Some of their analysis focuses on the well find much of the economics litera-
case where a reform must be approved ture on the political economy of reform
by unanimity to be passed. Efficiency naive or simplistic. However, what is en-
calls for immediate shrinkage of the state couraging about this literature is that
sector (i.e., shock therapy), as product- economists are now doing their political-
ivity is much lower than in the private economy analysis explicitly, rather than
sector. But unanimity requires that state- implicitly as used to be the case. Most
sector workers who are forced to exit be economists have now come to the real-
compensated. Suppose that state-sector ization that good economic advice re-
workers are heterogeneous in terms of quires an understanding of the political
their earning power in the private sector economy of the situation. The result has
(to which they will be displaced) and been a remarkable degree of collabora-
that this information is private. The tion between economists and political
budgetary cost of shock therapy will be scientists, as well as more work on politi-
large, as all exiting workers will have to cal economy by younger economists.
be paid a common exit fee that is based Both of these are good news. The bad
on the income loss that would have been news is that the habit of attributing myo-
incurred by the least-capable worker. If, pia or irrationality to political actors-
in turn, raising fiscal revenue is distor- whether explicitly or, more often, implic-
tionary, shock therapy may be dominated itly-persists.
As this essay attests, there is by now a
37 The situation is worse when individuals are
risk averse. But the argument does not rely on risk wealth of case-study material on the ex-
aversion. periences with policy reform. This mate-
rial provides plenty to chew on for any- ment of Economic Activity During Transition to
the Market" in Eastern Europe in transition:
one interested in the interactions be- From recession to growth. Eds.: MARIO I. BLE-
tween economics and politics. The next JER ET AL. Washington, DC: World Bank, 1993,
step should be to integrate evidence pp. 39-63.
BHAGWATI, JAGDISH. Foreign trade regimes and
from these case studies more systemati- economic development. Vol. 11. Anatomy and
cally into the analytical work, and in turn consequences of exchange control regimes. Lex-
to use the analytical models as a spring- ington, MA: Ballinger, 1978.
. India's economy: The shackled giant. Ox-
board for more rigorous case studies. ford, Clarendon Press, 1993.
I close by highlighting one of the many BIRDSALL, NANCY; Ross, DAVID AND SABOT,
questions raised earlier as requiring RICHARD. "Inequality and Growth Reconsid-
ered." Unpub. paper, Feb. 1994.
more work. Because distributional issues BOSWORTH, BARRY P.; DORNBUSCH, RUDIGER
are at the heart of the literature dis- AND LABAN, RAUL, eds. The Chilean economy:
cussed here, we need more progress on Policy lessons and challenges. Washington, DC:
Brookings Institution, 1994.
understanding why institutions for com- BRESSER PEREIRA, LUIZ CARLOS; MARAVALL,
pensating losers from reform are not JOSEt MARIA AND PRZEWORSKI, ADAM. Eco-
more common. There are very few pa- nomic reforms in new democracies: A social-
democratic approach. Cambridge: Cambridge
pers where the difficulties of compensa- U. Press, 1993.
tion are made endogenous to the analyti- CALVO, GUILLERMO A. AND VEGH, CARLOS A.
cal framework.38 This makes the "Inflation Stabilization and Nominal Anchors,"
Contemp. Econ. Policy, Apr. 1994, 21(2), pp.
literature somewhat incomplete in its di- 35-45.
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Understanding Economic Policy Reform

I. Introduction ist "technical"uncertainty as to what the

Per capita GDP, Per capita GDP, Per capita GDP

Source: Penn World Table 5.5 (1993).

mid-1960s. Table 1 summarizes this im- measures of resource transfers in order to

of expenditure-reducing and expendi- most everything right on the micro-

Source:Williamson(1994) for firstcolumn,and author'sevaluation.

intervention in the housing market.) To fered in the investment decisions of pri-

Primaryenrollmentratio,1960 Secondaryenrollmentratio,1960 Literacyrate, 1960

Source: Lago (1991, Table 9.4).

vided in the case-study literature, as in Because economists hate to give up on

ernments with different ideological or oped by Velasco (1994), who considers a

for capitalists. Because domestic capital economic policy making.18 Similarly,

Annualized inflation rate

side the stabilization, microeconomic, run, the consequences of reform actually

Source: CalculatedfromIMF (Oct. 1994,Table11).

1. Policyreformsemerge in responseto crisis

Sachs has plenty of first-hand experi-

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