INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 1 Transition State ownership Market interventionnone total The economic transition of formally centrally planned economies has many aspects Let’s look at just 2 dimensions: market intervention and state ownership. Different economic systems can then be characterized in this matrix

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 2 Transition State ownership Market interventionnone total At one hypothetical extreme we have capitalism, without state ownership or market intervention At the other extreme communism with total state ownership and total government control. capitalismcommunism

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 3 Transition State ownership Market interventionnone total No country in the world fits in either extreme description. Even the USA has a public sector spending 30% of GDP Even North Korea and Cuba have private production and incentives. capitalismcommunism USA N. Korea Cuba

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 4 Transition State ownership Market interventionnone total Note that other hypothetical extremes are also possible. A country in transition is changing the mix of state ownership and market intervention in the medium run. From the same initial position many different paths are possible. capitalismcommunism USA N. Korea Cuba Welfare state capitalism Market socialism?

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 5 Transition State ownership Market interventionnone total Note also that privatisation is one-dimensional, while transition has more dimensions. If we would place Holland in this figure and characterize its path over the last 15 years it would look somewhat like this capitalismcommunism USA N. Korea Cuba Welfare state capitalism Market socialism? privatisation Holland

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 6 Transition, a second “J-curve” The multidimensional character of transition, the differences in initial positions, the differences in transition mix and speed of privatization and deregulation make it easy to understand why different countries have widely varying transition experiences. Transition involves a series of steps at the institutional, micro- economic and macroeconomic level. Inevitably, adjustment requires a reallocation of capital, services and labor between sectors of the economy, leading to an initial phase of decline in production. There are two strategies of reform: the “big bang” approach, achieving necessary steps of transition in a short period of time, leading to large initial declines of production (Poland is the prime example) the “gradual” approach, trying to systematically sequence the steps to be taken and minimize transition pain and output loss (successor states of the former Soviet Union).

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 7 Transition, a second “J-curve” Poland used the “big bang” strategy. It started to recover quite quickly; this strategy seems to have worked better than the gradual approach.

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 8 planned goods market goods Transition, the costs The transition process is estimated to lead to huge costs. Let’s look At these costs using a neoclassical framework and our knowledge of the construction of statistics. We draw a ppf for a transition country. On the axes we put “market goods” versus “planned good”. The economy produces a lot of planned goods at P 0 P0P0

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 9 planned goods market goods Transition, the costs P0P0 If the transition process is complete the economy will produce a new output mix, such as P 2. The transition process brings the economy from production point P 0 to P 2. P2P2 How long it takes, and how it evolves we cannot say; here we have drawn a possibility. Production point P 1 is reached after some time. P1P1

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 10 planned goods market goods Transition, the costs P0P0 P2P2 P1P1 How do we measure the loss in output resulting from the transition? Statisticians use the prices at P 0 to estimate the fall in production. Clearly, the estimated production loss at P 1 compared to P 0 is substantial.

INTERNATIONAL ECONOMICS: THEORY, APPLICATION, AND POLICY;  Charles van Marrewijk, 2006; 11 planned goods market goods Transition, the costs P0P0 P2P2 P1P1 Remember that the initial production point P 0 was not optimal. After the transition process is complete the production point P 2 should represent true preferences. Using P 2 prices there is no production loss at P 1 relative to P 0. Using preferences there is actually a welfare gain. The estimated loss is exaggerated.