Externalities, Incentives, and Economic Reforms

Joshua Aizenman, Peter Isard

NBER Working Paper No. 3395
Issued in June 1990
NBER Program(s):   ITI   IFM

The paper emphasizes the role of institutions and incentives in the presence of externalities. An economy with multiple public decision makers is likely to experience "overspending," "undertaxing," "overborrowing," and "overinflation" unless effective institutions exist for overcoming coordination failure. External financing may weaken incentives for adjustment over the longer run unless assistance is made conditional on fundamental institutional reforms. The paper also analyses reforms that strengthen incentives to provide effort. Uncertainty regarding future taxes reduces present effort and the responsiveness of output to market signals. In addition, the paper addresses the adverse effects of bank insurance and soft budget constraints.

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Published: Bulletin of Economic Research, October 1993, pp. 305-315

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