Interest Groups, Stakeholders, and the Distribution …

1 Interest Groups, Stakeholders, and the Distribution of Benefits and Costs of Reform Jan Fidrmuc* and Abdul G. Noury** August 2003 Prepared for the GDN Global Research Project: Understanding Reform We grateful from comments and suggestions received from Gary McMahon, Jos Mar a Fanelli, the participants of the GDN Workshop on Understanding Reform in Cairo on January 16-17, 2003, and two anonymous referees. * ECARES, Universit Libre de Bruxelles; Center for European Integration Studies (ZEI), University of Bonn; CEPR, London; and WDI, University of Michigan. Address: ECARES, Universit Libre de Bruxelles, 50 Avenue Roosevelt, CP114, 1050 Brussels, Belgium.

2 Email: Phone: +32-2-650-4462, Fax: +32-2-650-3369. ** DULBEA and ECARES, Universit Libre de Bruxelles, e-mail: 21 Introduction Over the past two decades, a large number of developing and socialist countries have moved towards implementing wide ranging economic reforms aimed at introducing or strengthening economic freedom and replacing state interference with the market economy. Often, economic reforms were accompanied or followed by political liberalization as well. While this trend towards greater political and economic liberalism was particularly pronounced in Latin American and Central and Eastern Europe, a number of African and Middle Eastern countries followed suit during the 1990s.

3 The reforms bore fruit in many countries by delivering higher growth, low inflation, stable public finance and, ultimately, greater political and economic stability. Yet, reform programs that originally appeared as if they all followed similar blueprints (typically motivated by the so-called Washington Consensus) frequently delivered very diverse results. Thus, all too often, the reform was stalled or reversed, painful belt-tightening was not followed by the hoped-for rapid recovery but instead by prolonged muddling through, seemingly stable economies were plunged into disarray by currency and banking crises, and/or reformist governments were democratically voted out of the office only to be replaced by nationalist or populist politicians.

4 The term reform is generally used to refer to any substantial departure from previously pursued policies. A reform is efficiency enhancing if, in the long term, it increases social welfare by delivering greater price stability, sound government finances, higher economic growth and the like. A reform often requires a costly adjustment in the short to medium term and when its benefits finally arrive, they are usually not shared equally by all members of the society. Therefore, a reform results in winners and losers; even if the average member of the society is better off, there are some socio-economic groups who are worse off as a consequence of the reform.

5 Furthermore, the balance between the winners and losers may change over time, reflecting the realization of individual gains or losses as well as changes in uncertainty about the reform s outcomes. An efficiency-enhancing reform, if successful, should deliver substantial improvements in the long term. Yet, any change that brings about benefits to the society 3as a whole but has negative consequences for certain minority groups may face opposition by the latter. Often, the losers are sufficiently powerful (economically or politically) and organized to stage considerable opposition and may even succeed to slow down or stifle the change.

6 Resistance to reform and economic change is not a new phenomenon. In Western Europe, the industrial revolution was strongly opposed by guilds and workers alike, who saw mechanization of production as a threat to their power and, indeed, their very survival (see Mokyr, 1990; Landes, 1999). Innovation and technological progress in many respects resemble reform programs: they benefit the majority of citizens but certain minorities suffer from their introduction. Under certain conditions, both can be hindered or blocked by Interest groups. Yet, resistance to change is not an inevitable consequence of reform as the groups supporting and opposing the change can also find a way of sharing the benefits so that opposition is minimized.

7 Understanding the roles played by the various groups and the interactions between them therefore is a crucial step towards understanding why reform programs succeed or fail. In the following section, we review the theories of lobbying and Interest groups formulated in Economics and Political Science alike and discuss the available empirical evidence. Section 3 reviews the literature on political economy of reform in transition and developing countries. Section 4 presents a summary of key findings that can serve as guidance when studying individual country experiences with reforms and Section 5 offers a few conclusions. 2 Theories of Lobbying and Interest Groups Economists and political scientists alike have devoted much effort to the analysis of Interest groups.

8 The theoretical literature not only rationalizes their emergence but also provides a number of explanations of their activities and strategies. Empirical studies, on the other hand, have focused on identifying the various determinants of lobbying as well as explaining the impact of rent-seeking activities. Note that most theories and empirical studies that address lobbying and rent seeking, and their impact on economic policy-making, have been developed in the context of the United States. This however, does not mean that there are no studies devoted to other countries and in particular to developing 4countries. Krueger (1974) and Rama and Tabellini (1998) are examples of studies that analyze lobbying in the context of developing countries.

9 In this section, we analyze the motivations and the activities of groups to get organized in order to prevent the implementation of the reform or divert it from its originally intended purpose. To do that, we first address the question of why Interest groups try to influence policy-makers. Are they motivated by protecting economic rents or by avoiding the loss of political powers? Do other factors such as uncertainty play play a role in explaining Interest groups actions against reforms? After briefly analyzing the implications of uncertainty we focus on the activities of Interest groups and the type of activities and strategies they use to achieve their goals.

10 We also discuss the impact of lobbying on welfare. Are Interest groups always detrimental to economic welfare or may they play some positive roles as well? We end this section of the paper by briefly reviewing the empirical literature. Interest Groups and Stake Holders: Who Are They and How Do They Come About? For the purposes of our analysis, we understand Interest groups as collections of individuals who share a specific common Interest . Various Interest groups can overlap. For instance, the same individual can be an entrepreneur, a house owner and an avid golf player. Stake-holders then are members of an Interest group whose interests are affected by a particular decision.