The Interaction and Sequencing of Policy Reforms*

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1 Fral Rsrv Bank of Mnnapols Rsarch Dpartmnt Staff Rport 521 May 2016 Th Intracton an Squncng of Polcy Rforms* Jos Asturas School of Forgn Srvc n Qatar, Gorgtown Unvrsy Swon Hur Unvrsy of Ptsburgh Tmothy J. Kho Unvrsy of Mnnsota, Fral Rsrv Bank of Mnnapols, an Natonal Burau of Economc Rsarch Km J. Ruhl Strn School of Busnss, Nw York Unvrsy ABSTRACT In what orr shoul a vlopng country aopt polcy rforms? Do som polcs complmnt ach othr? Do othrs substut for ach othr? To arss ths qustons, w vlop a twocountry ynamc gnral qulbrum mol wh ntry an x of frms that ar monopolstc comptors. Dstortons n th mol nclu barrrs to ntry of frms, barrrs to ntrnatonal tra, an barrrs to contract nforcmnt. W fn that a rform that rucs on of ths stortons has ffrnt ffcts pnng on th othr stortons prsnt. In partcular, rforms to tra barrrs an barrrs to th ntry of nw frms ar substuts, as ar rforms to contract nforcmnt an tra barrrs. In contrast, rforms to contract nforcmnt an th barrrs to ntry ar complmnts. Fnally, th optmal squncng of rforms rqurs rformng tra barrrs bfor contract nforcmnt. Kywors: Squncng rforms; Intracton of rforms; Tra barrrs; Entry barrrs; Contract nforcmnt JEL classfcaton: F13, F4, O11, O19, O24 *W ar gratful for hlpful commnts from Jan Imbs, Maro Crucn, an partcpants at th F St. Lous-JEDC- SCG-SNB-UnBrn Confrnc on Intrnatonal Economcs. Th vws xprss hrn ar thos of th authors an not ncssarly thos of th Fral Rsrv Bank of Mnnapols or th Fral Rsrv Systm.

2 1. Introucton Polcy makrs n vlopng conoms ar call upon to mak a w array of structural rforms. Th Intrnatonal Montary Fun, n s Artcl IV consultaton wh Brazl, for xampl, rcommns, among othr thngs, that Brazl lbralz tra, ovrhaul th tax systm, an rform th bankng sctor (Intrnatonal Montary Fun, 2015). Fac wh a multu of rforms, n what orr shoul a country aopt polcy rforms? If polcal wll lms th scop for rform, whch substs of rforms ar optmal? To arss ths qustons, w vlop a two-country ynamc gnral qulbrum mol wh ntry an x of frms, as n Hopnhayn (1992), that ar monopolstc comptors, as n Mlz (2003). Th mol nclus barrrs to th craton of nw frms, barrrs to ntrnatonal tra, an barrrs to contract nforcmnt, as n Kho an Lvn (1993) an Albuqurqu an Hopnhayn (2004). Although our mol s smpl, proucs rch frm ynamcs. In countrs wh mprfct contract nforcmnt, for xampl, som frms must borrow to bgn proucton, arn profs n th omstc markt to pay own thr bt, an thn accumulat assts to fnanc thr ntry nto th xport markt. In sp of ths rch mcro ynamcs, th mol has a balanc growth path that s asy to charactrz. W calbrat th mol to match svral faturs of th U.S. conomy, focusng on th sz strbuton of stablshmnts an th fracton of stablshmnts that xport. W also consr stort conoms that hav th sam prfrncs an tchnologs as th Un Stats, but ar on lowr balanc growth paths bcaus of on or mor polcy stortons that ncras th barrrs to frm ntry, ncras th barrrs to ntrnatonal tra, or wakn contract nforcmnt. Usng ths stort conoms, w nvstgat how th squncng of thr rforms rucng barrrs to frm craton, rucng barrrs to ntrnatonal tra, an strngthnng contract nforcmnt trmns th wlfar gan from rform. W focus on a worl wh two symmtrc countrs that coornat, for xampl, by mans of a fr tra agrmnt, to smultanously nact ntcal rforms. W paramtrz th thr rforms to ntry barrrs, tra barrrs, an contract nforcmnt so that ach rform nact sparatly woul prouc th sam ncras n balanc growth path output pr capa. W consr th sx possbl squncs of th thr rforms. In ach squnc, th scon rform follows th frst rform by four yars, an th thr rform follows th scon by four yars. W nclu ths lags to rflct polcal an amnstratv constrants. Our mol an mthoology 1

3 ar farly gnral. W focus on ths partcular st of smpl xprmnts to prov an llustraton of th sort of rsults that th mol s capabl of gnratng. How mportant s th squncng of rforms? To answr ths quston, w comput th wlfar ffrnc btwn th bst an worst rform squncs n trms of both th pr-yar ral ncom ncrmnt an th ncras n pro-on consumpton n th worst rform squnc that th houshol woul n to b nffrnt btwn th two squncs of rforms. Th houshol ns an xtra 4.9 prcnt of s pro-on consumpton n th worst squnc to b nffrnt btwn th worst an th bst squnc of rforms. In trms of th pr-yar ral ncom quvalnt, w fn th ffrnc btwn th worst an bst squnc of rforms amounts to a prptual ncras of 0.10 prcnt of ral ncom pr yar. To put that nto prspctv, rsarchrs n th busnss cycl lratur follow Lucas (1987) n fnng wlfar gans of ths orr of magnu whn thy consr prmanntly lmnatng busnss cycl varaton, whras w fn ths gans from mrly changng th orr n whch th sam thr rforms ar carr out. W fn that th bst squnc of rforms s to frst cras tra costs, thn to mprov contract nforcmnt, an, fnally, to cras th cost of frm craton. Ths rsult s rvn by th bhavor of frm ntry n th mol. Th ncras n compton from th lowr tra costs las to a strong slcton of frms n th conomy n whch th xpanson of ffcnt frms who choos to bcom xportrs crows out th ntry of lss ffcnt frms. Rforms to contract nforcmnt or ntry costs la to an ncras n frm ntry an ths ntry s bas towar nffcnt frms that woul not hav bn abl to ntr f tra costs ha bn lowr frst. By lbralzng ntrnatonal tra frst, w mpos th frm slcton arly, whch ssuas nffcnt frms from ntrng latr whn contract nforcmnt an frm ntry costs ar rform. Wh smlar rasonng, w fn that frst mprovng contract nforcmnt, thn crasng tra costs, an fnally crasng frm ntry costs s th worst squnc of rforms. Unr ths squnc, th rform to nforcmnt gnrats an ncras n frm craton. Many of ths nw frms woul not hav bn abl to ntr f tra costs ha bn rform frst. As monopolstc comptors, frms n our mol nvr choos to x proucton, but xognously ovr tm. Ths gnrats hystrss, as frms that hav ntr o not x, vn as thy bcom lss profabl. For smplcy, w hav abstract from a fx proucton cost, whch woul yl nognous frm x. If w nclu a fx proucton cost, but on that s smallr than th cost of cratng a frm, frms woul stll lay x, gnratng th sam typ of hystrss w hav n 2

4 our mol wh only xognous frm x. Rform squncs that gnrat ntry of nffcnt frms n th bgnnng of th rform pro sal th conomy wh lss ffcnt strbutons of frms urng th transon, rucng th wlfar gan from rform. W shoul strss that th wlfar ffrncs w fn ar rvn solly by th squncng of th rforms. Rgarlss of th orr n whch th rforms ar mplmnt, all of th qulbra convrg to th sam balanc growth path. In ths papr, w also ask a rlat quston: How o rforms ntract wh ach othr? W summarz th ntracton of rforms by classfyng pars of rforms as hr substuts or complmnts. Two rforms ar substuts f, onc a country has nact on rform, th ncras n GDP from nactng th othr rform crass. Smlarly, two polcs ar complmnts f, onc a country has nact on rform, th ncras n GDP from nactng th othr rform ncrass. Ths analyss s ffrnt from th squncng quston scuss abov. In trmnng f two polcs ar substuts or complmnts, w ar comparng thr balanc growth path proprts; w o not nclu th transon followng rform. Computng how th chang n on polcy affcts th ffcacy of a chang n anothr polcy s akn to computng th cross-partal rvatv of output wh rspct to th two frctons. In ths way, our analyss hghlghts th ntracton of two polcy rforms on aggrgat output. W fn that rformng tra costs s a substut for rformng nforcmnt or rformng ntry costs, but rformng ntry costs an nforcmnt ar complmnts. Agan, ths rsult s rvn by th ncntvs for frm ntry an x. Lowrng tra barrrs ncrass compton from forgn frms, gnratng slcton that maks mor ffcult for lss ffcnt frms to ntr th omstc markt. Rformng nforcmnt or ntry barrrs, howvr, maks asr for ths lss-ffcnt frms to ntr. Ths two typs of rforms work aganst ach othr, so mplmntng on rform wll wakn th mpact of mplmntng th scon on. Snc both nforcmnt an ntry rform mak asr for frms to ntr th omstc markt, th two rforms ar complmntary. Th complmntary of nforcmnt rform an ntry cost rform mpls that, f polcy makrs ar constran to only mplmnt two rforms, thy shoul choos ths two an skp th rforms to ntrnatonal tra. Thr s a larg lratur on th squncng an ntracton of polcy rforms. Som of ths rsarch for xampl, Azz an Wscott (1997), Ewars (1990), an Martnll an Tommas (1997) focuss on lss vlop countrs, spcally thos n Latn Amrca. 3

5 Anothr part of ths lratur for xampl, Campos an Corcll (2002) focuss on th transon conoms n Eastrn Europ. Th collcton of paprs by Krugr (2000) combns rsarch on th two aras. Ths lratur s mostly concrn wh th tmng of capal account lbralzaton an th assocat cross-borr capal flows, typcally n a rprsntatvfrm framwork. Th capal account os not play a rol n our mol of two symmtrc countrs. Rathr, our focus s on th frm-lvl mplcatons of structural rform an th ways that frm ntry an x pn on th squncng of rforms. Nonthlss, our rsults ar rlvant for th bat n ths lratur. In comparng conomc growth n Mxco an Chna, for xampl, Kho an Mza (2011) conclu that Mxco woul hav xprnc bttr conomc prformanc subsqunt to s rap growth urng f ha opn to tra an forgn nvstmnt arly n ths pro. Our mol provs thortcal justfcaton an an ntuon for ths concluson: If a country s gong to vntually rform forgn tra an nvstmnt, s bttr to o ths arly n s nustralzaton procss so that th conomy has a composon of frms mor su to compton n ntrnatonal markts. Th structural rform lratur typcally consrs a partcular polcy storton n solaton. Closr to our stuy of polcy ntracton, howvr, s a growng lratur that analyzs th mpact of multpl frctons n htrognous frm mols. Bura, Kabosk, an Shn (2011) an Bah an Fang (2014) construct mols wh both fnancal frctons an frm ntry costs. Thy show that th largr ar ntry costs, th mor snsv ar frms to fnancal frctons. Thr work s rlat to our analyss of th complmntary of rformng ths two stortons, but thr focus s on th stay-stat ffrncs n aggrgat output an prouctvy an not th squncng of rforms or th transonal ynamcs from rform. A rcnt papr by Brgong, Loayza, an Pgullm (2015) constructs a mol wh ntry an x of htrognous, prfctly comptv frms an calbrats to th Un Stats an to 107 lss vlop countrs. Thy fn that rforms to ntry costs an rforms to x costs ar hghly complmntary an that rucng on typ of cost whout rucng th othr s lkly to b nffctv. Th mol of Brgong, Loayza, an Pgullm (2015) also focuss on balanc growth paths rathr than transon paths. Our mol s smpl an stylz. Th smplcy of our mol allows us to focus on a lm st of rsults for whch w can vlop ntuon. Our framwork coul b gnralz substantally, howvr, an ong so woul b worthwhl. W coul, for xampl, mol tra 4

6 costs as cbrg transportaton costs or tarffs rathr than as th fx tra costs n our mol, whch can b thought of as non-tarff tra barrrs. Whl w mol our two countrs as symmtrc, an w stuy symmtrc rforms, w coul nsta nclu mor than two countrs n our mol an w coul mol thm as asymmtrc. W suspct th most sgnfcant parturs from our rsults woul b gnrat by asymmtrc rforms. If a country unlatrally lowrs th costs of forgn ntry nto s markt, omstc houshols woul bnf from mor vars of forgn goos, for xampl, but unlatral tra lbralzaton woul gnrat an unfavorabl shft n th trms of tra that coul mak omstc houshols wors off. Although gnralzatons of our mol ar lkly to chang many of our rsults, w suspct that our most mportant rsult that any rform packag that nclus a tra rform shoul nclu arly n th squnc of rforms s robust. Any squnc of rforms that pushs th tra rform to latr n th squnc woul nuc frms to pay fx costs to ntr arly n th rform squnc vn though ths frms woul latr b too nffcnt to ntr. In Scton 2, w vlop a ynamc two-country gnral qulbrum mol wh thr polcy stortons. In Scton 3, w charactrz th balanc growth path of ths mol. In Scton 4, w us a calbrat vrson of th mol to quantatvly nvstgat th gans from varous rform squncs. In Scton 5, w conclu. 2. Mol In ths scton w vlop a two-country ynamc gnral qulbrum mol bas on Chany (2008) an Asturas t al. (2015). Thr s a rprsntatv houshol n ach country. Thr ar two typs of frms n th conomy: a rprsntatv fnal goo proucr an a contnuum of monopolstcally comptv ntrmat goos proucrs. Th ntrmat goo frms fac an ntry cost to oprat omstcally, a tra cost, an nognous borrowng constrants that ars from th lm nforcmnt of contracts Houshols Th rprsntatv houshol n country 1, 2 s now wh L uns of labor, whch nlastcally suppls to th ntrmat goos frms. Th problm of th houshol s s.t. max t0 t log C C 1 1 D B 5 P q B w L (1)

7 C 0, no Ponz schms, B 0 gvn, whr, 1 0, s th scount factor, C s consumpton of th fnal goo, P s s prc, q 1 s th prc of a on-pro bon, 1 th wag rat, L s th nowmnt of labor, an B s th fac valu of on-pro bt purchas, w s D s th aggrgat vns pa by omstc frms thos frms that wr crat n country. W assum that thr s no borrowng an lnng across countrs, so th prc of bons can ffr across countrs Fnal goo proucrs Prfctly comptv fnal goo frms purchas ntrmat goos an assmbl thm to prouc th fnal goo. Th rprsntatv fnal goo frm n country solvs mn p ( ) y ( ) p ( ) y ( ) jt jt jt 1 jt jt s.t. y ( ) y ( ) Y, (2) whr p ( ) an y ( ) ar th prc an quanty of ntrmat goo ; s th st of ntrmat goos prouc for omstc consumpton n country ; p ( ) an y ( ) ar th prc an quanty of ntrmat goo ; an jt s th st of ntrmat goos prouc for xport n country j. Th lastcy of substuton btwn ntrmat goos s 1 (1 ) 1, an Y s ral aggrgat output. Solvng th fnal goo frm s problm yls th stanar man functon for th omstcally prouc goo from country, y ( ), an th mport goo from country j, y jt ( ). Th prc of th fnal goo, P, taks th stanar form. jt jt 2.3. Intrmat goos proucrs Thr s a contnuum of htrognous ntrmat goo frms. In ach pro, a masur of potntal ntrants arrvs wh margnal prouctvs, x, rawn from th strbuton F x. A potntal ntrant must hr uns of omstc labor f wll prouc for th omstc markt. 6

8 Th potntal ntrant who ntrs n tm t bgns proucton n t 1. Potntal ntrants who choos not to ntr cannot ntr n subsqunt pros. Intrmat goo proucrs may also choos to hr uns of forgn labor to prouc for th forgn markt. W rqur forgn labor for th tra cost bcaus w thnk of ths fx cost as bng partally trmn by th govrnmnt n th forgn country. If a frm chooss to ntr th xport markt n t, bgns to xport n t 1. Onc a frm has pa th fx cost to oprat omstcally or to xport, thr ar no furthr fx costs assocat wh hr actvy. Thus, a frm os not voluntarly x omstc proucton or cas xportng to th othr country. Frms wh probably vry pro. Th frm proucng goo, wh prouctvy x ( ), uss labor to prouc accorng to y ( ) x ( ) l ( ). Cononal on choosng to sll to th omstc markt, frm chooss s omstc prc to maxmz profs, y ( ) ( ) max p ( ) y ( ) w. (3) x ( ) Th soluton to ths prof-maxmzaton problm yls th stanar constant markup prcng, w p ( ) x ( ). (4) If th frm xports, solvs an analogous problm. Snc w assum that thr ar no transportaton costs or tarffs, th frm chargs th sam prc n th xport an omstc markts, p( ) p t( ). Notc that vry frm wh prouctvy x chooss th sam prc. In what follows, w no longr charactrz a goo by s nam but by th prouctvy x of th frm that proucs. Th fx costs that frms pay to ntr omstc an forgn markts must b pa bfor proucton taks plac. Ths mpls that frms must fnanc ths costs by ssung bt. Th amount of bt th frm can ssu, howvr, s lm by th strngth of contract nforcmnt n th conomy. W assum that th managr of th frm can abscon wh a fracton 1 of th valu of th frm n th cas of fault. W ntrprt ths possbly as th rsult of mprfct contract nforcmnt. 7

9 Th prc of rsk-fr bt s q 1. Whn a frm ssus bt, thr s a possbly that th frm wll xognously cas opratons an not rpay s bt. Ths xognous frm ath occurs 1 q wh probably. In qulbrum, th prc of th frm s bt wll b 1 rturn on frm bt matchs th rsk-fr rat, 1 1, so that th (5) q 1 q An xstng xportr, wh prouctvy x an xstng bt b, chooss nw holngs of bt, b, an vn paymnts,, to solv th ynamc programmng problm V (, b x) max q 1 V ( b, x) 1 1 s.t. V ( b, x) 1 V (0, x) (6) 1 ( x) ( x) 1 q b' b 0. Th frst constrant s th nforcmnt constrant, whch lms th amount of bt that th frm can ssu, whr, 1 0, govrns th gr of contract nforcmnt. If 1, thr s prfct contract nforcmnt; f 0, thr s no contract nforcmnt an borrowng s mpossbl. W rul out 0, snc frms n our mol rqur som borrowng for proucton to tak plac. Th scon constrant fns th vn paymnt. Th frm cannot choos ngatv vns, as ths woul crcumvnt th nforcmnt constrant. Bss choosng s bt lvl b, an xstng non-xportr chooss hr to contnu to prouc for only th omstc markt an pay vns vns. An xstng non-xportr solvs V 1 (, n n n n or to ntr th xport markt an pay ( b, x) max q V b x), q 1 V ( b, x) q 1 n n V (, b x) 1 V (0, x) n () x 1 b b 0 (7) q 1 ( x) 1 b bw 0. jt Notc that, f th frm chooss to bcom an xportr, th frm pays th fx cost ( w ) n th currnt pro, but os not xport untl th nxt pro. jt 8

10 2.4. Entry csons In ach pro, masur of potntal ntrants s born. Thr prouctvs ar rawn from a Parto strbuton, x F ( x) 1 t xg, x t x g, (8) whch has a man that grows at rat g 1. W mpos th stanar conon for ths sort of mol, (1 ) 0, whch s ncssary for th strbuton of profs to hav a fn man. Th contnual mprovmnt of th tchnologs avalabl to nw frms rvs long-run growth: Olr frms x an ar rplac by nw ntrants who ar, on avrag, mor prouctv. A potntal ntrant wh prouctvy x os not prouc at ag k 0 bcaus of th tmto-bul rqurmnt. Ths potntal ntrant borrows to pay th fx cost w only f two conons ar satsf. Frst, th valu of th frm must b posv f ntrs, an scon, thr must xst a bt path that satsfs th nforcmnt constrants n all subsqunt pros. Th frst conon s satsf f V n 1 w 1 q 1, x 0. (9) Notc that th frst trm n th valu functon s th bt of th frm n t 1 f slls only n th ˆ t omstc markt. W not x 0 as a potntal ntrant s mnmum prouctvy ncssary to ntr th omstc markt n t. Mor gnrally, x ˆ kt s th mnmum prouctvy of frms of ag k that oprat n t. Snc thr ar no fx costs to pay aftr ntry, frms only x th omstc markt xognously, an xˆ ˆ kt x, k 1, t 1 for all k 1. th fx cost Smlarly, a frm only sllng to th omstc markt, wh prouctvy x an bt b, pays w to ntr th xport markt only f th valu of th frm f ntrs th xport markt s gratr than th valu of th frm f rmans only srvng th omstc markt, V b w ( x ) b ( x ), x, (10) jt n 1, x V 1 1q 1 1q 1 9

11 an f thr xsts a bt path that satsfs th nforcmnt constrants n all subsqunt pros. Notc that th frst trm n th xportr valu functon n (10) s th bt n pro t 1 of th frm aftr pays th fx cost to ntr th xport markt. Fnally, a potntal ntrant wh prouctvy x borrows an pays both th fx cost w to ntr th omstc markt an th fx cost w to ntr th xport markt only f th valu jt of th frm f ntrs both markts s gratr than th valu of only ntrng th omstc markt, whch n turn s gratr than zro, V w w w,, x 0, (11) jt n 1 x V 1 1q 1 1q1 an f thr xsts a bt path that satsfs th nforcmnt constrants n th subsqunt pros. at ag 0 W not xˆ k t as th mnmum prouctvy of frms of ag k 0 who pay th tra cost ; a potntal ntrant s mnmum prouctvy ncssary to ntr both th omstc markt an th xport markt at ag zro s x ˆ 00t. In a country wh prfct nforcmnt, any frm that wll vr xport pays th xport fx cost at ag 0. As nforcmnt worsns, lss ffcnt xportrs tak longr to xport bcaus thy must cras thr bts to satsfy th nforcmnt constrant, an, consquntly, xˆ xˆ... xˆ, whr n ˆ nots th olst ag at whch a 00t 01t 0nˆ t frm who ntrs n tm t pays th tra cost. Fnally, fn x ˆ kt as th mnmum prouctvy of all xportng frms wh ag k 1. Th masur of xportng frms,, volvs accorng to 1 ( )(1 ) s th masur of nw xportrs, nˆ k 1 F ˆ 00 1 ˆ ˆ x F k x F k x whr t k 1 kt kkt. (12) Th frst trm on th rght-han s of (12) s th masur of nw ntrants who mmatly pay th tra cost to accss th xport markt, an th scon trm s th masur of xstng ag- k frms who pay th tra cost to accss th xport markt n t. Th masur of omstc frms,, volvs accorng to 1 ( )(1 ), whr t( 0t 1 F x ˆ ). s th mass of nw frms, 10

12 2.5. Equlbrum W focus on balanc growth paths an th transons btwn thm, but bfor fnng a balanc growth path, w frst fn an qulbrum. To o so, w n to prov, as nal conons, th masurs of omstc an xportng frms of all ags opratng n pro zro. To fn ths masurs, w n th mnmum prouctvs of opratng frms, x 1k 0, x 2k 0, xˆ, xˆ 1k0 2k0 0 an th strbutons of prouctvs from whch ths xstng frms wr rawn. Ths strbutons ar analogous to thos for frms born n pro zro an latr, ˆ ˆ x F, k( x) 1 k xg, x k x g, (13) for 1, 2 an k 1. Aonally, w n to spcfy th bon holngs of houshols, B 10 an B 20, an th bon holngs of frms, b ( ) 1k 0 x for x xˆ 1k 0, k 1 an b ( ) 2 0 x for x xˆ 2k0, k 1. W rqur that ths nal conons for bon holngs by houshols an bon holngs by frms ar consstnt, n that th sum of frm bon holngs s qual to houshol bon holngs. Dfnon: Gvn th nal conons, an qulbrum s squncs of wags; fnal goo prcs; bon prcs; aggrgat output, consumpton, vns, an bon holngs; ntry thrshols; masurs of nw ntrants; an prcs, allocatons, vns, an bt holngs for ntrmat goo frms such that: houshols an frms bhav optmally, ntry thrshols ar consstnt wh th masurs of frms n opraton, vns rcv by th houshol ar th sum of frm-lvl vns, labor markts clar, for 1, 2, k 1 L ( ) ( ) l 1 x F k x k xˆ kt k 1 l ( x) F ( ), k x (14) k1 xˆ jt j kt k bon markts clar, for 1, 2, an tra s balanc, k 1 ( ) ( ), (15) B b x F x 1 k 1 xˆ kt 1 k kt 11

13 1 k ( ) ( ) ( ) 1 k ( ) p x y x F ( ) ( ) k 1 k x p x y x F k 1 jt k x. (16) xˆ j kt xˆ jt jt jkt Appnx B contans th complt qulbrum fnon. 3. Balanc growth In ths scton, w fn a balanc growth path an charactrz th bhavor of s ky varabls. To mak our charactrzaton smpl, w assum that s low nough rlatv to so that, on th balanc growth path, th margnal ntrant nvr xports an only proucs for th omstc markt. W also assum that th lastcy of substuton btwn ntrmat goos s larg nough, 1 (1 ) 2, so that a frm s profs cras wh ag. Proposon 1: A balanc growth path s an qulbrum n whch, for th approprat nal conons, wags, output, consumpton, bon holngs, vns, an th ntry cutoffs grow at rat g 1; an prcs, labor allocatons, an masurs of xportng an non-xportng frms ar constant. A balanc growth path xsts. Proof: S Appnx C. Appnx B contans th complt balanc growth path fnon. On th balanc growth path, growth n th conomy s rvn by th contnual ntry of nw frms that ar, on avrag, mor prouctv than th prvous cohorts. Output, consumpton, an both componnts of ncom grow at th rat g 1, whch s th rat at whch th man of th prouctvy strbuton of potntal ntrants grows. Nxt, w charactrz th prouctvy cutoff for th margnal ntrant on th balanc growth path. Lmma 1. On any balanc growth path, th nforcmnt constrant of th margnal ntrant n tm t hols wh qualy only whn k 1, for all tk, 1 an x xˆ kt. Proof: S Appnx C. ˆ,0, 1, ˆ n b 1 0, ˆ t x V t n V 1 x 0t 0t 1 x 0 (17) n k. 1, tk( ), 1, 0, V b x x V x (18) n k t k 12

14 Notc that, although th nforcmnt constrant hols wh qualy for th margnal ntrant whn k 1, os not bn n th sns that storts th cson of ths margnal ntrant. Insta, th nforcmnt constrant bns n trmnng th margnal ntrant. If w loosn th nforcmnt constrant by ncrasng, frms wh lowr prouctvy ntr. Ths s an attractv fatur of th mol n trms of charactrzng balanc growth paths, an arss bcaus th costs of ntry ar fx. Ehr frms pay ths fx cost an ntr or thy o not. whr Usng (17), w can rv th xprsson for th cutoff prouctvy lvl, x ˆ 0t, xˆ w 1 w 0t 1 P Y P, (19). (20) k k 1 1 g k k 1 Th cutoff n (19) looks smlar to that n a statc mol xcpt that th ntry cost n that xprsson s rplac wh, whch w ntrprt as th ffctv ntry cost. Notc that changs n th nforcmnt constrant chang th ffctv ntry cost that frms fac. In th cas that approachs 0, thn margnal xportr. approachs nfny. W now charactrz th prouctvy cutoff for th Lmma 2. On any balanc growth path, th nforcmnt constrant of th margnal frm of ag k at tm t who pays th tra cost at ag 1. hr hols wh qualy only at ag 1: xˆ, xˆ k t 1 V t k 0, ˆ k t V b x, 1, tk1,, tk1 kt, 1, 1 (21) ( ), 1 0, V b x x V x, for all h 1, t, x xˆ (22) k t, h, tkh, h1, tkh, h, tkh 2. or s slack, n whch cas, 13

15 V ˆ ˆ b x w x, 1, tk kt, tk, tk kt ˆ, 1, tk1, xk t 1 q, k1 V b xˆ xˆ,. n, 1, tk kt kt ˆ, 1, tk1 xk t 1 q, k1 (23) Proof: S Appnx C. Th lmma says that, at som ags, th margnal xportr s trmn by th nforcmnt constrant, but at othr ags, s trmn by th conon that ntrng th xport markt s at last as profabl as not ntrng. Th nforcmnt constrant bns n th sns that storts th tmng of whn a frm bgns to xport. Cononal on xportng, though, os not stort th frm s csons. Usng (21), w can rv an xprsson for th constran margnal xportr s prouctvy, x ˆc k t, xˆ c kt 1, k 1 w, k 1 c 1 w (24) 1 P, ky, k P, k whr c w 1 1 m Y P1 m m m 1 m m g 1 g m1 m1 (25) w Y P an w 0 / w0, Y 0/ Y0, an P / P for j. Th cutoff n (24) looks smlar to j j j that n a statc mol for th mnmum prouctvy of an xportr, xcpt th fx cost s rplac by, whch w ntrprt as th ffctv tra cost. Changs n th nforcmnt paramtr n c (25) affct th ffctv tra cost ffrntly from th way thy o n th ffctv ntry cost n (20). As approachs zro, os not approach nfny, as c 14 os. Ths s bcaus frms can slf-fnanc, usng profs from th omstc markt to pay th fx cost to xport. Also, notc that c s crasng n ag, an thrfor xˆ s also crasng n ag. In othr wors, c lss ffcnt frms tak longr to xport. k t

16 Usng (23), w can rv th xprsson for th unconstran margnal xportr s u prouctvy xˆ, k t xˆ 1 1 u u 1 w, k 1 w, tk kt 1 P, k Y, k P, k (26) whr w u 1 1 m m Y P m 1 1 g m1 1 g. (27) In ths cas, x ˆu k t s ncrasng n ag. Ths s bcaus th longr a frm was to pay th tra cost, th mor profabl ns to b. In an conomy wh prfct contract nforcmnt, any xportr wll pay th tra cost at ag 0. In gnral, th margnal xportr prouctvy s c u xˆ max xˆ, x ˆ. kt kt kt To llustrat th ways that polcy stortons nflunc frm ynamcs, w plot th voluton of bt, profs, an vns of frms that srvc only th omstc markt an thos that o not mmatly bcom xportrs. As Fgur 1 shows, a frm that nvr xports taks on bt at ag zro. Th frm thn uss s profs n th subsqunt pros to pay off that bt. Upon payng off s bt, th frm ssus s profs as vns. Notc that th profably of th frm clns through tm. Ths s bcaus, as mor prouctv frms ntr, an xstng frm bcoms rlatvly unprouctv. Th bt, profs, an vns of a frm that os not mmatly xport, as sn n Fgur 2, looks smlar to th frm that nvr xports wh two notabl xcptons. Frst, an vntual xportr s mor prouctv an thus pays own s bt fastr. Scon, aftr payng own s bt, th frm os not ssu vns. Insta, th frm savs so that can pay th fx cost to ntr th xport markt. Aftr ntrng th xport markt, both th frm s profably an s bt lvl ncras. Nxt, th frm uss s profs to pay own ths aonal bt. Upon rtrng s bt, th xportng frm ssus s profs as vns. 15

17 Fgur 1: Dbt, profs, an vns of a omstc frm Fgur 2: Dbt, profs, an vns of an vntual xportr 4. Quantatv xrcss In ths scton, w us th mol to prform quantatv xrcss to trmn how th squncng of rforms affcts th wlfar gans from ths rforms. For smplcy, w mol two symmtrc countrs n whch L1 L2, 1 2, 1 2, 1 2, 1 2, x1 x2. W bgn by calbratng th mol to th U.S. conomy, whch tras wh a symmtrc conomy that rprsnts th rst of th worl. W xamn th ffcts of conuctng symmtrc rforms. In partcular, w nvstgat th ffcts of sx possbl rform squncs, wh ach rform occurrng vry four yars. Th frst rform s unxpct by th agnts, but th subsqunt rforms ar forsn. W focus on symmtrc countrs an symmtrc rforms only to kp our analyss smpl. W coul calbrat th mol to asymmtrc countrs, an w coul analyz th mpact of asymmtrc rforms Calbraton W choos paramtrs so that th mol s qulbrum matchs svral faturs of th U.S. conomy, focusng on th sz strbuton of stablshmnts an th numbr of stablshmnts that xport. W summarz th paramtrs n Tabl 1. 16

18 W normalz th labor nowmnt, L, to 1. W st th fx cost to oprat omstcally,, so that th mol matchs th avrag stablshmnt sz n th Un Stats of 16.0 mploys ( , U.S. Cnsus, Statstcs of U.S. Busnsss). W choos th tra cost,, so that th mol matchs th obsrv fracton of manufacturng plants that xport, 0.21 (Brnar t al., 2003). Th paramtr that govrns nforcmnt,, s st so that th mol matchs th bt-to-rvnu rato of frms ag lss than fv yars, 0.27 (2003, Survy of Small Busnss Fnancs). Th Survy of Small Busnss Fnancs survys frms wh lss than 500 mploys, whch account for most of th nw frms crat n th Un Stats. For xampl, n , prcnt of nw frms mploy lss than 500 workrs (U.S. Cnsus, Statstcs of U.S. Busnsss). Tabl 1: Calbrat paramtrs paramtr valu targt fx cost omstc fx cost tra 8.5 avrag U.S. stablshmnt sz: fracton of U.S. xportng stablshmnts: 0.21 nforcmnt 0.39 bt/rvnu of frms ag lss than fv yars: 0.27 Parto strbuton paramtr 4.03 stanar vaton of U.S. stablshmnt sz: 91.2 ath rat 0.10 U.S. stablshmnt ath rat: 10 prcnt pr yar scount factor 0.98 U.S. ral ntrst rat: 4 prcnt pr yar ntrant prouctvy growth g 1.02 U.S. output growth rat: 2 prcnt pr yar Th curvatur paramtr of th Parto strbuton,, s st so that th mol matchs th stanar vaton of th U.S. stablshmnt sz strbuton, whch avrags 91.2 workrs ( , Un Stats Cnsus, Statstcs of U.S. Busnsss). Th probably that th frm s,, s st so that th stablshmnt ath rat s 10 prcnt pr yar ( , U.S. Cnsus, Statstcs of U.S. Busnsss). Th scount factor,, s st to gnrat a ral ntrst rat of 4 prcnt pr yar (McGrattan an Prscott 2005). Fnally, w st th ntrant prouctvy growth factor, g, so that, n th balanc growth path, output pr capa grows at 2 prcnt pr yar th hstorcal U.S. avrag. 17

19 Thr ar thr paramtrs that w o not calbrat. W st th lastcy of substuton across goos, 1/(1 ), to 3. Ths lastcy of substuton s smlar to th stmats of Broa an Wnstn (2006), who fn that th man lastcy rangs btwn 2.7 an 2.9 across ffrnt spcfcatons. In our mol, as n Chany s (2008) mol, th rspons of output to a chang n prcs pns on th strbuton paramtr, not th utly paramtr. If, nsta of rlyng on Broa an Wnstn s stmats of 1/(1 ), w chos to us ata on markups to match th markup n our mol, 1/ 1, w woul calbrat a somwhat hghr valu of. W scuss ths furthr n Scton 4.7, whr w xplor th robustnss of our rsults to changs n paramtrs. W st th mass of potntal ntrants,, an th mnmum prouctvy lvl, x, to 1. Gvn our assumpton that frm prouctvs ar strbut accorng to a Parto strbuton, ths fnal two paramtr chocs ar whout loss of gnraly as long as th mass of potntal ntrants s larg nough an th mnmum prouctvy s low nough that th ntry cutoffs ar always strctly gratr than thy wr allow to ffr btwn countrs. t xg. Th paramtrs an x woul play mor mportant rols f 4.2. Cratng a bnchmark stort conomy Usng th calbrat mol, w crat a bnchmark stort (worl) conomy that has all thr stortons (hgh ntry costs, hgh tra costs, an poor nforcmnt of contracts). W us ths bnchmark stort conomy to stuy th optmal squnc of rforms. Th spr of th xrcs s that ths conomy has th sam tchnology an prfrncs as th Un Stats, but th conoms hav ffrnt lvls of stortons. Notc that, to kp th analyss smpl, both of th two countrs hav th sam stortons an unrgo th sam rforms. As a frst stp, w solv for th balanc growth path of thr conoms, ach of whch s stort by a sngl polcy. In th frst conomy, w ras ntry barrrs so that output rops by 3 prcnt, whch rqurs ncrasng from 8.5 to 9.9. In th scon stort conomy, w ras tra costs so that output rops by 3 prcnt, whch rqurs rasng from 39.8 to In th thr stort conomy, w lowr contract nforcmnt so that output rops by 3 prcnt, whch rqurs lowrng from 0.39 to Th stortons w hav mput abov ar comparabl, as ach of thm rsults n a cln n ncom of 3 prcnt n th balanc growth path. Th bnchmark stort conomy s th on 18

20 that has all thr stortons. Snc w ar consrng th cas of symmtrc rforms, th sam paramtrs ar us for both omstc an forgn countrs Th ntracton of polcy rforms In ths scton, w stuy th ntracton among th thr polcs usng nformaton from th balanc growth path. In th nxt scton, w consr th transon paths from th rforms an th wlfar ffcts of th rform squncs. Tabl 2 rports th polcy paramtrs for ach balanc growth path along wh thr corrsponng ncom lvls. Th ncom lvls hav bn normalz to th bnchmark stort conomy for asr comparson. Notc that rformng tra costs nucs th largst balanc growth ncras n ncom whn startng from th bnchmark stort conomy, vn though all rforms ncras ncom by th sam amount whn thy ar th only storton prsnt, n whch cas ncom woul ncras from 100 to (= 100/0.97). Notc too that th balanc growth ncras n ncom of any all thr combnatons of two rforms s th sam. Ths s bcaus ach combnaton of rforms proucs a balanc growth path whr thr s only on storton prsnt an w hav calbrat th stortons so that all thr of ths paths a 3 prcnt blow th path wh no stortons, whr ral ncom s : = Tabl 2: Balanc growth path output gan from rform rforms Bnchmark (wh nw paramtrs) 19 / 1 0) Y L(bnchmark 0 no rforms Rforms to (wh nw paramtrs) nforcmnt ntry costs tra costs ntry costs an nforcmnt tra costs an nforcmnt ntry costs an tra costs all (Un Stats) Not: Paramtr changs ar n bol.

21 W catgorz polcy pars as bng hr complmnts or substuts. Two polcs ar substuts f, onc a country has nact on rform, th ncras n GDP from nactng th othr rform crass. Smlarly, two polcs ar complmnts f, onc a country has nact on rform, th ncras n GDP from nactng th othr rform ncrass. W can trmn whthr polcs ar substuts or complmnts usng th nformaton n Tabl 2. For xampl, suppos that w bgn wh all thr stortons prsnt. W fn that rucng tra costs an rucng ntry costs ar substuts. To arrv at ths concluson, w obsrv that rucng tra costs ncrass output by 3.77 prcnt (from to ). If th conomy alray ha lowr ntry costs, howvr, th sam ructon n tra costs ncrass output by only 3.26 prcnt (from to ). W summarz our fnngs n Tabl 3: Rforms that ruc tra costs ar substuts wh th othr rforms, but contract nforcmnt an ntry barrrs ar complmnts. Tabl 3: Intractons of rforms rform #1 rform #2 tra costs ntry costs substuts tra costs nforcmnt substuts nforcmnt ntry costs complmnts W can gan ntuon nto why polcs ar substuts or complmnts by analyzng how th numbr of vars avalabl to houshols changs n ach balanc growth path. To o so, w compos th chang n th total numbr of vars avalabl to houshols, whr V s th mass of vars avalabl to houshols, NE E E V D D F, (28) V V V V NE D s th mass of omstc non- E E xportrs, D s th mass of omstc xportrs, an F s th mass of forgn xportrs. Th rsults from ths composon ar rport n Tabl 4, whch has bn sort n scnng orr of th prcnt chang n total vars. W fn that rforms can la to vry ffrnt outcoms n th composon of frms n th conomy. Whn w ruc tra costs, w fn a small ncras n th total vars avalabl to houshols, 0.8 prcnt. Rucng tra 20

22 costs las to fwr nffcnt frms that xst to only srv th omstc markt, but ths ructon n omstc-ornt frms s offst by ncrass n omstc xportng frms an forgn xportrs. rform Tabl 4: Chang n vars from on rform total vars omstc non-xportrs prcnt chang omstc xportrs forgn xportrs nforcmnt ntry costs tra costs Nots: Columns rport th prcnt chang, from th nal balanc growth path to th nw balanc growth path, whn a sngl rform s mplmnt n th bnchmark mol. Th mol gnrats largr ncrass n th numbr of vars wh mprovmnts n contract nforcmnt (22.8 prcnt) an ructons n ntry costs (18.2 prcnt). Ths ncras n th numbr of vars coms from frms that only srv th omstc markt. Rformng contract nforcmnt or frm ntry costs has a small ngatv mpact on xport actvy. Notc that th numbr of xportng frms clns vn though rforms to contract nforcmnt bnf xportng frms by mprovng thr ably to borrow to pay th tra cost. Ths outcom s th rsult of two opposng forcs n th mol. Frst, aftr a rform, frms fn asr to ntr th xport markt, whch ncrass th numbr of xportrs. Ths can b sn by xamnng th ffctv tra cost that frms fac n (25): An ncras n las to a ructon n th ffctv tra cost. Scon, th gnral qulbrum ffcts from th surg of nw frms crows out xportng frms by ncrasng th ral wag. Th ncras n th ral wag omnats, an th numbr of xportng frms shrnks. In Appnx A, w rport th composon n (28) for an conomy mplmntng a scon an thr rform (Tabl 10 an Tabl 11). W consstntly fn that rforms to nforcmnt la to th largst ncras n th numbr of vars avalabl to houshols, follow by rforms to ntry costs. Furthrmor, s always th cas that rforms to nforcmnt an ntry costs, through gnral qulbrum ffcts, la to a crowng out of xportng frms. Th rsults n Tabl 4 hghlght th forcs that rv th ntractons of rforms. Rformng nforcmnt or ntry costs maks ntry asr for rlatvly nffcnt frms, ncrasng th 21

23 numbr of non-xportng frms. Tra lbralzaton, howvr, crass th numbr of nonxportng frms an transfrs rsourcs to xportng frms. Whn ths two typs of polcs ar mplmnt togthr, thy work aganst ach othr, rucng th ffctvnss of th scon rform. Rformng nforcmnt costs an ntry costs togthr combns two polcs that ncras th numbr of non-xportng frms, makng th scon rform mor ffctv. Rforms ar complmnts f thy push th strbuton of frms n th sam rcton; rforms ar substuts f thy push th strbuton n oppos rctons. That s, at last n ths xampl, rforms ar substuts not bcaus thy hav smlar ffcts on th conomy, but bcaus thy hav oppos ffcts. Th strbuton of frm typs n th conomy s rflct n th aggrgat prc nx. Rforms to nforcmnt or ntry costs la to mor frms, whch lowrs th prc nx. Rforms to tra costs la to an xpanson of low-prc frms, whch also lowrs th prc nx. In Tabl 5, w rport th prcntag chang n th prc nx along wh th omstc an mport prc nxs. As xpct, w s that all rforms la to ructons n th ovrall prc nx. Rforms to ntry costs or nforcmnt work through th omstc prc nx, whras rforms to tra costs work through th mport prc nx. Tabl 5: Chang n th prc nx from on rform prcnt chang rform prc nx omstc prc nx mport prc nx nforcmnt ntry costs tra costs Nots: Columns rport th prcnt chang, from th nal balanc growth path to th nw balanc growth path, whn a sngl rform s mplmnt n th bnchmark mol. Th bhavor of th prc nx allows us to s why rformng ntrnatonal tra las to th largst gan n balanc growth path output (Tabl 2), vn though th rform gnrats th smallst chang n th numbr of vars avalabl for consumpton (Tabl 4). Rforms to nforcmnt or ntry costs ncras th numbr of rlatvly low-prouctvy frms that can profably prouc for th omstc markt. Followng ths rforms, th omstc prc nx falls mostly. Ths cras n th prc nx s rvn mostly by th ncras n vars th 22

24 nw ntrants charg rlatvly hgh prcs. Tra rform, n contrast to th othr two, gnrats a larg cras n th mport prc nx, whch las to th largst ovrall cln n th aggrgat prc nx an, thus, th gratst ncras n ral output among th thr rforms. Th cras n th mport prc nx coms from two sourcs. Frst, nw mport vars from abroa ncras th vars avalabl for consumpton. Scon, ths mport vars ar prouc by rlatvly hgh-prouctvy frms n th othr country, so th nw mport vars ar sol at low prcs. Ths scon ffct gnrats a strongr cras n th mport prc nx Evaluatng th wlfar gans from on rform As a nxt stp, w comput th transon path for th cas n whch on unxpct rform s mplmnt. In Sctons 4.5 an 4.6, w wll masur th wlfar gans n th cas n whch two an thr rforms ar mplmnt. Tabl 6 rports th wlfar gans from conuctng ach of th thr rforms n trms of th chang n prmannt ral ncom. W calculat prmannt ral ncom as C t1. (29) t1 xp 1 log Frst, w s that th wlfar ffrncs across rforms can b larg, amountng to 0.39 prcnt n trms of ral ncom. Scon, w fn that, although th rform to tra costs rsults n th hghst balanc growth path consumpton lvl (Tabl 2), s rformng ntry costs that rsults n th hghst wlfar gan onc w consr th transon ynamcs. Th ntuon bhn ths rsult can b sn n Fgur 3, whr w plot consumpton, trn by t g, followng th rform. Compar wh th ntry cost rform, w obsrv a largr cras n consumpton followng th tra cost rform, bcaus thr s a larg ncras n th numbr of frms that pay th fx tra cost. Ths nal rop n consumpton rsults n th rform to ntry costs bng mor bnfcal, vn though th tra cost rform vntually rsults n hghr consumpton. Fnally, w fn that, aftr rform, th conomy taks sgnfcant tm to rach th nw balanc growth path. For xampl, n th cas of tra rforms, taks th conomy 17 yars to b 0.1 prcnt away from th nw balanc growth path. 23

25 Tabl 6: Wlfar gans from on rform rform chang n ral ncom (prcnt) ntry costs 3.14 tra costs 3.11 nforcmnt 2.74 Nots: Ral ncom s comput accorng to (29). Th calculaton nclus th transon from th nal balanc growth path to th nw balanc growth path whn a sngl rform s mplmnt n th bnchmark mol. Fgur 3: Dtrn consumpton for on rform 4.5. Evaluatng th gans from conuctng two rforms Nxt, w valuat th gans from nactng two rforms. Th scon rform taks plac four yars aftr th frst. W mpos th four-yar lags to rflct polcal an amnstratv constrants n mplmntng rform. Th frst rform s unxpct, but, aftr th frst rform, agnts fors th scon rform. 24

26 Tabl 7: Wlfar gans from two rforms rform #1 rform #2 chang n ral ncom (prcnt) ntry costs nforcmnt 5.79 nforcmnt ntry costs 5.71 tra costs ntry costs 5.63 ntry costs tra costs 5.60 tra costs nforcmnt 5.56 nforcmnt tra costs 5.46 Nots: Ral ncom s comput accorng to (29). Th calculaton nclus th transon from th nal balanc growth path to th nw balanc growth path whn two rforms ar mplmnt n th bnchmark mol. Tabl 7 rports th wlfar gans, n scnng orr, from mplmntng ach possbl squnc of two rforms. W fn sgnfcant ffrncs n wlfar outcoms. Th ffrnc btwn th bst an worst rforms s 0.31 prcnt of ral ncom, quvalnt to 17.4 prcnt of frst pro consumpton. Th bst squnc of rforms frst lowrs ntry costs an thn mprovs contract nforcmnt. Th scon bst rform squnc s th sam par of rforms, but wh thr orr rvrs. Notc that, f only two rforms ar conuct, thn polcy makrs shoul avo ructons n tra costs. Ths s for two rasons. Frst, as can b sn n Fgur 4, tra cost rforms nuc a largr nal rop n consumpton compar wh othr rforms. Scon, tra rforms ar substuts for th othr rforms, whras rforms to ntry costs an contract nforcmnt ar complmnts. 25

27 Fgur 4: Dtrn consumpton for two rforms If tra costs ar to b rform, thn squncng plays an mportant rol: It s prfrabl to lowr tra costs bfor conuctng othr rforms. Ths ffrnc s most stark n th cas of rformng tra costs an thn nforcmnt. Th gans from ths squnc ar 0.09 prcnt hghr than from th squnc n whch w rform nforcmnt an thn tra costs. Ths s bcaus, f w rform ntry costs or nforcmnt frst, w ncras th numbr of rlatvly nffcnt nonxportng frms n th conomy. If w thn rform tra costs, th slcton nuc by th xportng cson wll mak ths nw frms obsolt. Th hystrss gnrat by th ntry cost mans that th conomy wll carry ths nffcnt frms for a numbr of pros bfor thy vntually off. Th optmal squncng of rforms mposs th slcton from rucng tra costs frst, so that th rform to nforcmnt or to ntry costs os not gnrat th ntry of soonto-b unwant frms Evaluatng th gans from conuctng thr rforms To trmn th optmal squnc of rform, w comput th qulbrum of th mol unr sx possbl squncs of thr rforms. As bfor, th frst rform s unxpct by agnts. Aftr th frst rform taks plac, th agnts fors rforms two an thr, whch tak plac four yars an ght yars aftr th nal rform. 26

28 In Tabl 8, w rport, n scnng orr, th wlfar gan from th sx possbl rform squncs. W fn that th ffrnc btwn th bst an worst squnc s 0.10 prcnt of ral ncom, whch s quvalnt to 4.9 prcnt of consumpton n pro on of th worst squnc. Snc ach squnc of rforms gnrats th sam balanc growth path, ths ncras n wlfar s solly th rsult of ffrncs n th transon paths that ars from th orrng of rforms. Tabl 8: Wlfar gans from thr rforms rform #1 rform #2 rform #3 chang n ral ncom (prcnt) tra costs nforcmnt ntry costs 8.04 tra costs ntry costs nforcmnt 8.03 ntry costs nforcmnt tra costs 8.02 ntry costs tra costs nforcmnt 8.01 nforcmnt ntry costs tra costs 7.94 nforcmnt tra costs ntry costs 7.93 Nots: Ral ncom s comput accorng to (29). Th calculaton nclus th transon from th nal balanc growth path to th nw balanc growth path whn thr rforms ar mplmnt n th bnchmark mol. Tabl 8 ncats that th bst rform squncs nvolv rucng tra costs frst, an th worst rform squncs nvolv mprovng nforcmnt frst. W also fn that mprovng nforcmnt bfor lowrng tra costs s a poor combnaton. It s strkng to not that n th bst an worst squncs, ntry cost rforms occur last: Th ffrnc s th orrng of rforms to tra costs an nforcmnt. Notc that, whn w compar th gans from th ffrnt squncng of th thr rforms n Tabl 8 wh th gans from ong only on rform n Tabl 6 an th gans from th ffrnt squncs of two rforms n Tabl 7, th ffrnc btwn th bst rform scnaro an th worst rform scnaro s smallr. Th largst ffrnc for ffrnt ways of orrng thr rforms s btwn frst rformng tra costs, thn nforcmnt, an fnally ntry costs, whch s th bst, an frst rformng nforcmnt, thn tra costs, an fnally ntry costs, whch s th worst. Th ffrnc s 0.10 prcnt of lftm ral ncom, quvalnt to 4.9 prcnt of pro-on consumpton n th worst squnc. In contrast, f w nact only on rform, th ffrnc btwn th bst rform, ntry costs, an th worst, nforcmnt, s 0.39 prcnt of lftm ral 27

29 ncom, quvalnt to 21.7 prcnt of pro-on consumpton wh th worst rform. Wh two rforms, th bst squnc s frst rformng ntry costs an thn nforcmnt, whch has lftm ral ncom 0.31 prcnt hghr than frst rformng nforcmnt an thn tra costs, quvalnt to 17.4 prcnt of pro-on consumpton n th worst squnc. It s asy to unrstan why th ffrncs n ral ncom across rforms ar largr th fwr rforms ar nact. In th cas of nactng only on rform, th thr rforms n Tabl 6 gnrat qulbra that convrg to thr ffrnt balanc growth paths wh ffrnt lvls of ral ncom, as sn n Tabl 2. In th cas of nactng only two rforms, th sx ffrnt rform squncs n Tabl 7 gnrat qulbra that convrg to thr ffrnt balanc growth paths. Evn though ths thr balanc growth paths all hav th sam lvl of ral ncom, as sn n Tabl 2, w s n Tabl 7 that th thr sts of two rform squncs that convrg to th sam balanc growth path ar group togthr n trms of ral ncom rankngs. In partcular, th two rform squncs that la to th balanc growth path wh rforms to ntry costs an nforcmnt hav hghr lvls of ral ncom than th four rform squncs that la to on of th two balanc growth paths that hav rforms to tra costs. Ths s bcaus n nhr of th rform squncs that o not nvolv rformng tra costs o th countrs n to pay th larg transon costs of bulng up a larg xport sctor. In Fgur 5 w plot th voluton of trn consumpton n th bst an worst rform squncs. Rforms tak plac n yars 1, 5, an 9. Frst, notc th p n consumpton that taks plac whn tra costs ar lowr. Ths s rvn by th ntry of nw xportrs, who vrt labor from proucton to pay th fx cost to ntr th xport markt. Ths p n consumpton s smallr n th cas of th bst rform squnc ( 9.4 vs prcnt). Scon, notc that, followng th rform n tra costs, consumpton n th worst rform squnc s consstntly blow that of th bst untl thy convrg to th sam balanc growth path. 28

30 Fgur 5: Dtrn consumpton for thr rforms As n th two-rform cas an for th sam rasons w fn that tra costs shoul b rform bfor ntry costs or nforcmnt. Dcrasng tra barrrs las to a strong slcton on prouctvy that maks harr for lss ffcnt frms to compt. In Fgur 6 an Fgur 7, w plot th mass of xportrs an th mass of non-xportrs n th bst an worst rform squncs. Each squnc of rforms wll vntually gnrat th sam strbuton of frms, but th transon paths can b qu ffrnt an la to larg an prsstnt ffrncs n th composon of frms n opraton. In th bst rform squnc, th mass of xportrs bgns to grow mmatly, an th nal cln n non-xportng frms s rvn mostly by th convrson of non-xportng frms to xportng frms. Convrtng non-xportng frms to xportng frms taks tm, as constran frms n to mprov thr balanc shts bfor thy ar abl to fnanc th tra costs. In yar 5, th mass of xportrs sharply ncrass, as th rform to contract nforcmnt ncrass th avalably of fnanc. Th cln n th mass of non-xportrs lvls off n yar 5 as nforcmnt rform lowrs th prouctvy thrshol for ntry nto th omstc markt. Whn ntry costs ar rform n yar 9, th mass of non-xportrs bgns to ncras as convrgs to s balanc growth path. In th worst rform squnc, th mprovmnt n nforcmnt las to an ncras n nonxportng frms. Ths nflow of nw frms ncrass th ral wag, whch has a slght ngatv ffct on th mass of xportrs. In yar 5, th tra costs ar rform. Ths rform gnrats an 29

31 ncras n xportrs an an ncras n th prouctvy lvl n to profably ntr th omstc markt. Snc rforms to nforcmnt alray occurr, th conomy ha alray ncras s stock of low prouctvy non-xportrs. Ths frm typs ar no longr profabl from th pont of vw of a nw ntrant, but th frms that ar alray n th markt wll rman untl thy xognously. Carryng ths nffcnt frms along th transon path crass th gans from ths squnc of rforms. Fgur 6: Mass of xportrs Fgur 7: Mass of non-xportrs 4.7. Ral ncom ynamcs In ths scton w scuss how ral ncom volvs ovr th transon. To o so, w construct a truncat ral ncom masur that consrs only th frst T pros of th transon. Ths masur s a mof vrson of (29), 1 xp 1 T t 1 log T C t 1. (30) Ths ral ncom masur allows us to stuy th short-trm pan assocat wh ach rform squnc. W consr th cass whn T 4, 8, an 12, whch corrspon to th thr pros aftr th mplmntaton of ach rform. In ths xrcs, w o not chang th way th mol s solv agnts ar stll forwar lookng. Tabl 9 rports th rsults for ach rform squnc. In th last row of th tabl, w also rport th mnmum T such that th gan from rform s posv for all t T. 30

32 rform #1 rform #2 rform #3 truncaton pro tra costs nforcmnt ntry costs Tabl 9: Truncat wlfar gans tra costs ntry costs nforcmnt ntry costs nforcmnt tra costs ntry costs tra costs nforcmnt chang n truncat ral ncom (prcnt) nforcmnt ntry costs tra costs nforcmnt tra costs ntry costs truncaton pro for whch gans from rform prmanntly xc Nots: Truncat ral ncom s comput accorng to (30). Th calculaton nclus th transon from th nal balanc growth path to th nw balanc growth path whn thr rforms ar mplmnt n th bnchmark mol. W fn vnc that thr ar tra-offs btwn short-trm losss, as masur by truncat ral ncom, an long-trm gans. Tak, for xampl, th two bst squncs, whch nvolv rformng tra costs frst. Ths rform squncs ar th ons that also nuc th largst ngatv truncat ral ncom whn T 4, snc rforms to tra costs nuc th largst nal cln n consumpton. W also fn that th bst rform squnc has th largst truncat ral ncom for all T 10, suggstng that th long-trm gan from choosng th optmal squnc omnats n as ltl as 10 yars. W fn that rformng ntry costs, nforcmnt, an thn tra costs nvr has a ngatv truncat ral ncom. Ths s bcaus rforms to ntry costs o not la to a p n consumpton. Furthrmor, rforms to tra costs ar unrtakn last, an th accumulat bnfs of th frst two rforms outwgh th corrsponng rop n consumpton Snsvy Snsvy analyss ncats that our man rsults ar robust to ffrnt paramtr spcfcatons. Spcfcally, th rsult that th bst rform squnc nvolvs rformng tra costs frst an that th worst rform squnc nvolvs rformng nforcmnt frst s robust to changs n th scount factor, th prouctvy growth rat g, th xognous ath rat of frms, an th 31