Why Gradualism?

This article discusses why gradualism is an essential component of economic optimization.

I recently completed a class called Global Financial Crises and Institutions with Dr. Nils Bjorksten. The class was an economic history of financial crisis with an emphasis on the Post-WWII to contemporary period.

The final exam had a number of great essay-style questions. I will try to get the exam back and write about several of its good questions, but one I can recall from memory. You can also view my version of a “Cheat Sheet” we were allowed to prepare here.

The question asked to the effect of, “A policymaker is considering economic liberalization. What warnings and advice would you give this policymaker?”

Economic liberalization is the lessening of government regulations and restrictions in an economy. It includes deregulation, privatization, removing trade barriers, and so on. In the United States we generally associate these policies with fiscal conservatives and libertarians.

My answer was that I would give three warnings and two pieces of advice. To summarize my answer:

  1. I would warn that destabilization of the foreign exchange rate is a common problem for improper economic liberalization. This further results in price and trade instability.
  2. Public revenue problems and underwhelming growth also frequently result from improper liberalization.
  3. Many other problems can occur due to improper liberalization, although they are less common as a matter of history. These problems include hyperinflation, very high unemployment, socio-political discontent, and more.
  4. To minimize these issues I recommend the employ of two key strategic elements. First, consider the specific nation-state environment. The economic liberalization policies of your country should not look like the economic liberalization policies of other countries. It should be carefully tailored to the local environment, not boilerplate.
    1. In particular, pay attention to the local socio-political and market attitudes towards the reform. Expect the markets to behave emotionally and do not assume rationality in the short run.
  5. Secondly, take advantage of gradualism. This means the economic liberalization policies should be broken down into small, self-contained, comprehensible policies and addressed one step at a time over many years, not as part of a holistic package.
    1. Based on our experience with the Lost Decade of the LDC Crisis and the time it took for the post-soviet Transition Crisis to subside, it seems proper, gradual, economic liberalization takes between ten and twenty years.
    2. The problem with rapid economic liberalization is that it creates a economic shock, instability, and a mismatch between expectations or perceived value and reality within the economy.
    3. Gradualism minimizes this problem by allowing plenty of time for the market to learn as policies change in a slow, steady, anticipated way. It might be a good idea to specifically call for some public education of the policy changes you plan on implementing.
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