Globalization of capital markets is accompanied by an increase in information about the economic environment in developing economies. We explore the implications of this for policy choices of governments. Indeed, we demonstrate that the threat of capital flight can even generate perverse incentives that induce governments into enacting inefficient policies, especially over the earlier phase of globalization. Finally, we show that there exists a U shaped relationship between the degree of globalization and national welfare.
Welfare decreases over the earlier phase of globalization and increases during the later phase.
We use a representative democracy framework to examine this question, when there exists individual-specific uncertainty about the impact of economic reforms. We show that there exists a non-monotonicity in the relationship between the size of the reform and the likelihood of its adoption. Reforms that result in an overwhelming majority of winners and a minority of winners are adopted. We discuss the conditions which determine the credibility of government promises to compensate losers, and illustrate the analytics of our model by applying it to the dynamics of political support for the Balecerowicz Plan in Poland. We show that a majority of voters might turn against reforms that were originally supported by a majority, even when the reforms are proceeding successfully.