To Shock or Not to Shock? Economics and Political Economy of Large‐Scale Reforms

This paper studies the economics and political economy of optimal scale of reforms. The aim of the reform is to replace inefficient existing institutions by the more efficient new ones. The optimal scale of reform, in general, differs from a shock therapy that replaces the old institutions all at once. Furthermore, if agents in the economy are heterogeneous in terms of their subjective discount rates, the politically‐determined reform speed may be lower in a democracy than in an economy with a benevolent dictator.