The Role of Time and Institutional Traps Chapters 6 and 7. Kristin Harris and Anders Hawes. The Role of Time. ♦♦Market System♦♦ А ) Brings a competitive equilibrium model into the economy Б ) Individual firms/households make their own decisions
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The Role of Time and Institutional TrapsChapters 6 and 7
Kristin Harris and Anders Hawes
А) Brings a competitive equilibrium model into the economy
Б) Individual firms/households make their own decisions
В) Firms know more about what they need for inputs and outputs in this system than a faraway ministry would
»Past influences present → obvious
» Future influences present → not so obvious (Example on page 87)
» Foreign goods now compete with domestic goods
» Prices now reflect costs, not policy
1992 Price Liberation in Russia
Inflation Soars, causing value of paper money to fall
Russia has an unformed, Inefficient Banking system
Barter System in Russia
Firms begin Barter Transactions (less expensive)
Barter Exchange spreads & becomes the norm through “Coordination Effect”
Over time, Companies learn to design elaborate `chains of Barter Exchanges
By this point, it is far too costly to ‘break out’ of the barter exchange system.
“Cultural Inertia” & uncertainty results in conservative pressure groups who resist monetary exchange.
A HYSTERESIS EFFECT IS NOW IN PROCESS
What am I paying taxes for?!!
I am going to stop paying taxes !!
Too inefficient to prevent people from stop paying taxes
India plans to overhaul tax systemBy Amy Kazmin in New Delhi Published: August 13 2009 05:11 | Last updated: August 13 2009 16:25
“India’s government is planning a big shake-up of its archaic tax system in a bid to curb widespread evasion as it confronts a sharply widening fiscal deficit amid expanding social welfare programs.
The plan, announced by PranabMukherjee, the finance minister, aims to foster greater compliance with tax laws by lowering key corporate and personal income tax rates, simplifying rules and eliminating exemptions blamed for eroding the tax base.
Corporate taxes on Indian companies will drop to 25 per cent from 30 per cent.
India has long struggled to increase its low tax-to-gross domestic product ratio, the legacy of punitive socialist era tax rates, which have encouraged widespread evasion.”
Inflationary stock empties companies bank accounts
No Bankruptcy laws or restructuring mechanisms in place
Modest tax rate reductions cannot help- Non-payers will continue to avoid taxation, and law-abiding taxpayers will pay less.
Buyer only makes partial payment to company
Cycle of Sadness !!
Supplier does not want to lose clients, so they continue to ship supplies.
Company only makes partial payment to supplier
Result Mutual Arrears blocks the application of bankruptcy laws
Large-scale economic reform can be carried out, but requires:
1)Preparation of the economy for transformation
2) Effective provisional institutions to guide the reforms
3)Proper rate and sequencing of the reforms
4)Consistent discretionary economic policy
And MOST important task of the reformative state is-
5) AVOID INSTITUTIONAL TRAPS!!
Privilege-generating rental income- limitation posed on the free flow of resources or the level of prices.
A margin was made between retail and wholesale and paid as rent to the state budget to be redistributed.
Most was stolen by high-ranking officials and shadow dealers
Limitations were lifted
Russia wasn’t prepared at that time for such a change, and their losses have been tremendous
Some regions continued to collect the rent and firms pocketed the money
1) Shock Therapy- as quickly as possible. The belief is that reforms are sililar to surgery and have to be carried out as quickly as possible to minimize suffering.
There are 3 key arguments for the gradualist viewpoint:
Government needs to acquire the funds to finance the transformation costs
When reforms are too rapid, it is extremely difficult or impossible to make adjustments or correct mistakes
Shock liberalization of prices inevitable leads to barter and arrears traps if there is no efficient banking system to avoid inordinate transactions costs
The end (With thunderous applause) !!!