Public Finance and the Optimal Speed of Transition

28 Pages Posted: 3 Oct 2003

See all articles by Micael Castanheira

Micael Castanheira

Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES); Centre for Economic Policy Research (CEPR)

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Abstract

We develop a general equilibrium model that jointly considers the influence of capital accumulation constraints and of labour market frictions on the process of transition. We endogenize the economic and budgetary costs of different government policies and show that, early in transition, governments ought to subsidize state firms. Provided that intertemporal commitment is feasible, this policy limits the initial output fall, which relaxes capital accumulation constraints, accelerates transition, and increases welfare. Moreover, by resorting to indirect - instead of direct - taxes, governments can bring the path of transition closer to the first best. Yet, political pressures may induce a policy of suboptimal subsidization.

Suggested Citation

Castanheira, Micael, Public Finance and the Optimal Speed of Transition. Available at SSRN: https://ssrn.com/abstract=452771

Micael Castanheira (Contact Author)

Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES) ( email )

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Brussels, B-1050
Belgium
+32 2 650 4467 (Phone)
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Centre for Economic Policy Research (CEPR)

London
United Kingdom

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