T C A Srinivasa-Raghavan: Why stitches are not put in time

OKONOMOS

Reform is delayed because it is profitable for everyone to wait even if the social cost of waiting is unaffordable.

There have been various explanations for why remedial action, whether by individuals, groups or countries, is usually delayed.

Individuals delay action because they hope the problem will go away. In groups, the delay happens because everyone thinks someone else will act first. But what about countries?

Alberto Alesina, Silvia Ardagna, and Francesco Trebbi, all from Harvard, decided to ask why countries delay reforms. We in India know the answer, of course, but it is always nice to get a stylised confirmation of your diagnosis.

The authors rely on what is called the "war of attrition" model in game theory. This is a model in which two or more opponents enter into a contest that can be ended at any time by any one of them.

The contest involves costs, so there is a positive incentive to drop out of it. However, the gains from outlasting your opponents are also huge, which means you may want to go on.

I will not go into the details but, essentially, what happens is that clever contestants choose to drop out precisely when the probability is almost one that the opponent will be indifferent between dropping out and remaining in the contest.

In other words, the cost of staying in is equal to the gains. Amazingly, this results in the weaker player winning. Remember the 2004 election?

Alesina and his colleagues have applied this insight to why reforms get delayed. They discuss only stabilisation-type reforms, however, not structural reforms. But I daresay the analysis would hold for the latter as well.

"The key assumption of this model is that the political conflict over what type of stabilisation to implement, in particular on the distribution of costs of the adjustment, leads to delays."

Reforms as we all know now impose costs on social groups, for instance, the middle class and LPG prices or farmers and fertiliser subsidies. The political contest consists of distributing these costs in some acceptable manner.

Consider a contest between political parties representing two groups. (In practice there are many more groups but the number of parties can remain two).

"Each group would like to charge to the other a large fraction of the additional taxes need to stabilise the budget. By assumption one of the groups has to pay more than half of the costs of stabilisation."

If each group has a veto, and neither is certain about the other's costs although it knows its own costs "" CPM and the unions, for instance "" there is no alternative but to wait to see which group is weaker, "i.e. it has the highest costs of waiting."

How long each group will wait depends on the marginal cost of waiting. If it is lower than the marginal benefit of waiting, it will.

"The game ends when for one of the groups the marginal benefit becomes less than the marginal cost, and this will occur sooner for the group with the higher cost of waiting. So in the end the weaker group (i.e. the one that suffers more from the delays) will concede."

This is fine but the problem is that delaying is "costly for society as a whole and it is Pareto inferior to immediate stabilisation." No one cares, however, because "it is individually rational for each of the two groups to wait."

This is what we are seeing in India with regard to reforms.

The authors also say that stabilisation programmes are more likely to occur when there is a crisis at the beginning of term of office of a new government. Far more importantly, "the role of external inducements like IMF programs has at best a weak effect, but problem of reverse causality are possible."

The authors have tested their theory for a large sample of countries. It seems to work.

Who Adjusts and When? On the Political Economy of Reforms, NBER Working Paper No. 12049, February 2006