Abstract
On the speed of economic liberalization the neoclassical benchmark is Mussa. He shows that if the private costs of adjustment reflect the true social costs and agents correctly anticipate future expected returns, shock therapy maximizes growth even when mobility costs lead to a slow adjustment of resources. This paper studies the implications of introducing reference-dependent behavior in Mussa’s framework. I find that in this case gradualism is likely to maximize growth when liberalization involves a large enough loss to workers in the actual losing sectors. Empirical evidence from Eastern Europe’s transition is consistent with my arguments.
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