On the Feasibility of Institutional Reform

Abstract

This paper considers the role of information in executing the institutional reform. Each individual is assumed to be ex ante faced with the uncertainty about effects of institutional reform. We suppose that there are two kinds of uncertainty; uncertainty of type 1 which arises from the imcomplete information about structural parmeter (tax reform), and uncertainty of type 2 which arises from the change of economic enviornment in the future (financial reform) . In the case of tax reform (resp. financial reform), “information” means the data about structural parameter (resp. the government's commitment to take complementary measures) .
When the uncertainty about effects of institutional reform is small, if many individuals' welfare can be potentially improved by it, the common consent is easilly given to the institutional reform, and thus information plays no role in executing it. On the contrary, when the uncertainty about effects of institutional reform is great and the individuals are more risk averse, even if social welfare can be potentially improved, there may be the possibility that the proposal for reforming the present system is refused by a member of a community, because expected payoff under new system may be smaller than payoff under status quo for many individuals (i.e. V^h (0) < u^h for many h) . Then, the government is required to provide the information to the individuals to reduce the uncertainty and execute the institutional reform. The value of information is positive under some conditions (i.e. V^h (g) > V^h (0) ), but the institutional reform is not always realized by the provision of in-formation, and the feasibility of it depends on the quality (credibility) of information. Since, in the case of drastic reform, the uncertainty about the effects of it is seemed to be great, the information about structural parameter plays the important role in execut-ing “design” tax reform, and additional regulations are needed to stabilize new financial system, which is formulated with complete abolition of old regulations.