DP860 | The Design of Reform Packages Under Uncertainty

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We present a model of large-scale economic reforms, modelled on the transition process in Eastern Europe, with aggregate and individual uncertainty concerning the outcome of reforms. The government is assumed to choose the speed and sequencing of reforms. We compare `big bang' strategies with gradualist reform packages. We show that 1) gradualist reform packages may be easier to get started; 2) optimal sequencing of reforms should aim at creating constituencies for further reforms; and 3) gradualism may reduce <MI>ex post<D> reversibility of reforms through a strong investment response in cases where the option value of waiting generates a low investment response under `big bang'.