Political economy of public sector reform: Redistributive promises and transfers to special interests

Why is reform of the public sector so politically difficult? More generally, why is good economics not necessarily also good politics? An enduring question in political economy is why "efficiency-improving" economic policies are so often politically difficult to adopt. This paper asks specifically, how the presence of special interest groups on the one hand, and limited taxation capacity on the part of the state on the other, affects the sorts of redistributive policies that are necessary to win support for reform from potential losers of that reform. Voters recognize that the government, in compensating losers, has an incentive to misuse this redistributive mechanism to disproportionately steer compensation towards its supporters, or other special interest groups. Our analysis suggests that this is particularly damaging in countries with low state capacity, where popular support for the adoption of efficiency-enhancing reforms is likely to be the lowest in any case. We include some suggestive evidence for this. Looking at reforms in privatisation in 20 transition economies in Europe over the period 1994-99, we find evidence in favour of our basic result that economies with a higher state capacity have made greater progress in the implementation of public sector reforms. On the other hand, countries with a bigger special interest group in the form of a larger share of employment in the public sector have had more difficulty in bringing about reforms in the public sector. We find that political activism on the part of the workforce is also lower in countries with better state capacity.