Public Finance and Low Equilibria in Transition Economies; The Role of Institutions

Abstract

This paper develops two stylised models of the transitional economy that challenge to some extent, the conventional approach to policy-reforms. In the first model, the absence of market-oriented institutions is responsible for the occurrence of a non-cooperative equilibrium, where the amount of public services provided by the state is too low, which, in turn, adversely affects the global performance of the productive sector. In the second model, the government, which aims to maximise tax receipts, will choose a taxation level that pushes too many firms out of the market; hence the global supply falls below its optimal level. In both models, strain and disruptions specific to transitional systems lead to abnormal responses of the real sector to standard policy measures. Efficient economic policies should explicitly take into account the institutional deficit.