The Interaction and Sequencing of Policy Reforms

In what order should a developing country adopt policy reforms? Do some policies complement each other? Do others substitute for each other? To address these questions, we develop a two-country dynamic general equilibrium model with entry and exit of firms that are monopolistic competitors. The model includes barriers to entry of new firms, barriers to international trade, and barriers to contract enforcement. We find that the same reform can have very different effects on other economic outcomes, depending on the types of distortions present. In our model, we find that reforms to trade barriers and barriers to the entry of new firms are substitutable, as are reforms to contract enforcement and trade barriers. In contrast, we find that reforms to contract enforcement and the barriers to entry are complementary. Finally, the optimal sequence of reforms requires reforming trade barriers before contract enforcement.