Ohio Wesleyan University Goran Skosples 17. Transition

Transition not a _______ of the existing system, but a _______________ of the current system with a new system involves virtually all aspects of the economy: micro-, macro-economics, property rights, legal institutions, trade, social safety net, financial sector,... vast differences among transition countries (@ 30) – similarities –

Commonalities Coordination via the _______ demand and supply not in equilibrium  ____________________ no institutions that could support the market (____________, ____________ _______________, ...) prices did not reflect scarcities entry into economic activity was controlled limited private property control of foreign trade 18

Dimensions of transition Microeconomic market creation and price liberalization property rights firm restructuring and privatization Macroeconomic stabilization budgetary finances financial sector reform 19

Output in transition countries

Output in transition countries Country Consecutive years output decline Cumulative output decline (%) Real GDP, 2000 (1990=100) Hungary 4 15 109 Poland 2 6 112 Romania 3 21 144 Armenia 63 67 Georgia 5 78 29 Russian Federation 7 40 64 Output decline during the Great Depression (1930-34) France 11 UK US 27

Why did output collapse? disintegration of the coordination structure increase in price of __________ decrease in trade within the “Soviet bloc” dissolution of the Council for Mutual Economic Assistance (CMEA) new goods from the west shadow economy accounting errors

Steps of transition Stabilization severe macroeconomic problems high inflation (hyperinflation) monetary overhang currency flight (usually DM and the US dollar) inflationary tax sharp decline in GDP ↓ @ 30% GDP in the US during the Great Depression reasons already mentioned 19

Steps of transition Price liberalization employment did not decrease as much as output? instead, productivity decreased, which allowed for a ________ decrease in employment than output Price liberalization problematic in the SR more beneficial in the LR hurts less affluent more danger that large firms will exercise their monopolistic power could be ________ or _____________________ ___________________ 19

Steps of transition Enterprise reform corporatization independent management defined goals of the enterprise removal of the social function from production firms accounting reform proper incentives privatization  transfer or ownership private ownership can utilize the resources more efficiently who gets the ownership? how is this to be done? who has enough capital? what should be the value? 19

Privatization Desirable characteristics rapidity improved governance fairness (equity) further investments (capital, technology, innovation, management skills) sustaining the overall stabilization and liberalization program revenue for the state

Privatization

Privatization Comparison Is privatization the same in transition economies as in established capitalist economies? _____ privatization vs. _________ privatization Can a product or service to be privatized be clearly identified? Is the legal infrastructure is established? Can contracts can be written, monitored, and enforced? Are markets and financial arrangements present? What is the value of the firm? Can outcomes can be assessed?

Steps of transition Financial sector reform monobank vs. two-tiered bank system monobank: credit granting + plan oversight two-tiered: commercial banks: channeling funds from savers to investors, risk evaluation, etc. central bank: controlling banks, the overall economy stock markets very _________ usually considered a consequence of development rather than a cause

Policy Effectiveness How effective can a central bank be in regulating the macroeconomy? the banking system is limited firms do not obtain much funds from banks ____________________ are not well established problems of policy objectives is magnified as compared to market economies (the economy is more fragile) _______________ and _________________

Steps of transition International trade previously determined by the plan, not individual firms transition liberalized trade, but protection tariffs and licensing were put in place currency reform  convertibility + access realistic exchange rate foreign direct investment (FDI) needs clear property rights, consistent tax laws, reparation of profits high inflow of FDI required sterilization policies

Steps of transition Social safety net during socialism, non-wage benefits provided through work unemployment hidden – actually existed, but people still employed inevitably, unemployment increases during transition  need to create a safety net guarantees some minimum standard of living prevents creation of an underclass prevents development of crime, prostitution... helps workers find the right job match __ levels of well being + __ inequality

Legal system property law contract law bankruptcy law use of property, transfer property, right of control contract law clear definitions of business party conducts and remedies consumer laws bankruptcy law anti-monopoly law intellectual property law etc.

Speed of transition Big push all at once and painful all prices liberalized at once rapid privatization change the system as fast as possible and so it cannot (before it can) be undone the Washington Consensus 10 “simple” policy prescriptions very controversial Poland, some other CEE countries

Speed of transition Gradualism it takes time to change institutions and laws realization that transition is complex sequencing and complementarities experimentation might be warranted could be reversed (political commitment issues) Hungary, China complementarities: elements of transition cannot be implemented in isolation

Initial conditions if rules/institutions are lacking, things are done according to tradition legacies of central planning trade patterns allocation of inputs/capital ownership of resources length of socialism  socialist culture socialism was present in Russia since 1917 and in Eastern and Central Europe since WWII level of development agriculture vs. industry per capita income