Speed of adjustment and self-fulfilling failure of economic reform

An economic reform programme where inefficient public labour is laid off is considered. The immediate effect is a lowering of wages and increased prof itability in the private modem sector. Over time, as capital accumulates in the modem sector, wages and production increases. Big bang reform generate s a sharp transitory drop in wages while gradual reform gives a more modest decline. In the presence of a subsistence wage constraint popular resistan ce can cause the cancellation of big bang reform. Two arguments for gradual ism can in that case be made. First, a more gradual reform requires a less abrupt drop in the wage, and will, therefore be feasible. Second, the initi al wage drop will be stronger if a cancellation of reform is expected and, since cancellation is dependent on the severity of the initial wage drop, m ultiple equilibria occurs. The existence of multiple equilibria is dependen t on the speed of reform. Sufficiently gradual programmes have a unique suc cessful equilibrium. (C) 2001 Elsevier Science B.V. All rights reserved.