Economic Transition of Centrally Planned Economies to Liberal Market Economies Basic Facts Basic Facts Basic Mechanisms Basic Mechanisms Reallocation Reallocation Disorganization Disorganization Restructuring Restructuring Partial Analysis Partial Analysis Start of Transition and the Initial Adjustment of State Firms Start of Transition and the Initial Adjustment of State Firms Global Analysis Global Analysis The Benchmark Model The Benchmark Model

Basic Facts

Basic Mechanisms Reallocation Reallocation From Public to Private Sector = Privatization From Public to Private Sector = Privatization

Basic Mechanisms Disorganization Disorganization Collapse of CMEA (Council of Mutual Economic Aid = COMECON) Collapse of CMEA (Council of Mutual Economic Aid = COMECON) The role of time horizon The role of time horizon Firms experience shortages of material Firms experience shortages of material Long term relationships with suppliers had been broken Long term relationships with suppliers had been broken Macroeconomic Policies – problem of inflation Macroeconomic Policies – problem of inflation

Basic Mechanisms

CPI inflation

Basic Mechanisms Restructuring Restructuring Aim of restructuring is increase in productivity Aim of restructuring is increase in productivity Either decrease of employment or increase of output Either decrease of employment or increase of output Fears of unemployment slow down restructuring Fears of unemployment slow down restructuring

Basic Mechanisms Time on the horizontal ax

Basic Mechanisms Real development Specific situation of East Germany The role of social factors in Russia

Basic Mechanisms Restructuring and Privatization Restructuring and Privatization Barriers to Restructuring Barriers to Restructuring Opposition of Insiders Opposition of Insiders Lack of Capital Lack of Capital Privatization to Privatization to Insiders Insiders Outsiders Outsiders From Insider Ownership to Resale From Insider Ownership to Resale

Basic Mechanisms

Partial Analysis Start of transition Start of transition price liberalization + removal of subsidies price liberalization + removal of subsidies triggered triggered the collapse of state firms the collapse of state firms growth in the new private sector was insufficient to take up the slack growth in the new private sector was insufficient to take up the slack

Partial Analysis The Initial Adjustment of State Firms The Initial Adjustment of State Firms Situation Situation The Hardening of the Budget Constraint The Hardening of the Budget Constraint Reactions Reactions The Appropriation of profits The Appropriation of profits Delays in Payments of taxes and to Suppliers Delays in Payments of taxes and to Suppliers Bad Loans Bad Loans The Choice of Employment and Wages The Choice of Employment and Wages

Partial Analysis

Global Analysis The Benchmark Model The Benchmark Model Interactions among Interactions among Growth of the new private sector Growth of the new private sector Restructuring of the state firms Restructuring of the state firms Unemployment Unemployment Two Phases of Transition Two Phases of Transition 1st : High unemployment prevents restructuring, action comes from private sector growth only. 1st : High unemployment prevents restructuring, action comes from private sector growth only. 2nd : Economy proceeds along a balanced path, where private sector employment creation absorbs the employment losses from restructuring. Output grows as a result of both reallocation and restructuring and unemployment remains constant until transition has been achieved. 2nd : Economy proceeds along a balanced path, where private sector employment creation absorbs the employment losses from restructuring. Output grows as a result of both reallocation and restructuring and unemployment remains constant until transition has been achieved.

Global Analysis Assumptions of the benchmark model Assumptions of the benchmark model State and private sector State and private sector Pre-transition is no unemployment Pre-transition is no unemployment Just after the start of transformation (price liberalization, elimination of subsidies), employment in state firms decreases and unemployment is generated Just after the start of transformation (price liberalization, elimination of subsidies), employment in state firms decreases and unemployment is generated

Global Analysis Summary of the first half of the model Summary of the first half of the model Private employment creation depends on the profit rate. The profit rate depends in part on the wage. The wage is a decreasing function of unemployment. Thus, other things being equal, higher unemployment leads to higher private employment creation.

Global Analysis Summary of the second half of the model Summary of the second half of the model Restructuring of state firms implies both an increase in output and an increase in unemployment. The decision to restructure depends, among other things, on the state of the labor market: the higher the unemployment rate, the less likely restructuring is to take place.

Global Analysis Putting two halves together Putting two halves together If initial unemployment is below some critical value, then some restructuring takes place instantaneously until unemployment is equal to that critical value. Transition then takes place at the constant unemployment rate, with the flow of lay- offs from restructuring equal to the flow of hirings in the new private sector. If initial unemployment is below some critical value, then some restructuring takes place instantaneously until unemployment is equal to that critical value. Transition then takes place at the constant unemployment rate, with the flow of lay- offs from restructuring equal to the flow of hirings in the new private sector.

Global Analysis If initial unemployment is above some critical value, then there is no restructuring until private employment creation has decreased unemployment down to that critical level. At that point, the flow of restructuring starts and the economy follows a balanced transition path with constant unemployment. If initial unemployment is above some critical value, then there is no restructuring until private employment creation has decreased unemployment down to that critical level. At that point, the flow of restructuring starts and the economy follows a balanced transition path with constant unemployment.