Putty-clay politics in transition economies

We build a bargaining-theoretic model of an important dilemma inherent in any major political economic transition process. While swiftly removing the old order is a necessary condition for a successful transition, it also leads to widespread social disruption that may threaten the viability of the reform process. This issue lies at the heart of much of the "big-bang/gradualism" debate in the literature. We argue that this dichotomy is overly simplistic. In particular, the debate, as it has been framed, has failed to capture the significance of interest group competition. Interest group competition matters precisely because the political environment during a transition is fluid and malleable and is thus open to manipulation by interests seeking to mold post-transition governance structures to best serve themselves. As different economic and political structures will give rise to different incentives within these interest groups, one might expect that transition strategies will differ across societies. We show this is the case with two interesting examples. First, we consider how transition strategies differ in open and closed economies. We are able to derive a number of strong results, the most striking of which identifies conditions under which closed economies outperform open economies in terms of social welfare. Our second set of experiments examines Krueger's (1993) "vicious and virtuous circles" theory of policy reform. We identify conditions under which societies with political systems that reward rent-seeking behavior enjoy higher social welfare than societies with political systems that reward productive behavior.