Working Paper No. 05-12

Does It Take a Tyrant to Carry Out a Good Reform?
Anna Rubinchik-Pessach and Ruqu Wang
December 2005

ABSTRACT

In this model a reform is a switch from one norm of behavior (equilibrium) to another and agents have to endure private costs of transition in case of a reform. An authority, which coordinates the transition, can enforce transfers across the agents and is capable of imposing punishments upon them. A transfer is limited, however, by an agent¡¯s payoff, and a punishment can not exceed an upper bound. Carrying out a good, Pareto improving, reform can be hindered by asymmetric information about the costs of transition, which are privately known to the agents and can not be verified by the authority. In this case execution of some good reforms is impossible without a credible threat of a punishment, even if Bayesian mechanisms can be used. Allowing for harsher punishments in that framework reduces to ¡®softening¡¯ individual rationality constraints, thus widening the range of feasible reforms. The flip-side of increasing the admissible punishment is making ¡®bad¡¯ reforms possible as well as lowering well-being of selected individuals. We, thus, formulate a trade-off between successful implementation of good reforms and severity of acceptable punishments.

JEL classification: D78, E61.
Keywords: reform, mechanism design, incentive compatibility

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