EC1111 Lecture 8 Outline · What is a Transition Economy? . The Process of Transition · Problems encountered under Transition · Welfare analysis under price liberalization · Conclusion The Economics of Transition Since the fall of the Berlin Wall in 1989, economists have been studying the process of transition from socialism to capitalism in the former centrally planned economies (e.g. former Soviet Union, China, Vietnam, Mongolia). . (Havrylyshyn and Wolf, F&D, 1999) -Transition implies: · liberalizing economic activity, prices, and market operations, along with reallocating resources to their most efficient use; · developing indirect, market-oriented instruments for macroeconomic stabilization; · achieving effective enterprise management and economic efficiency, usually through privatization; · imposing hard budget constraints, which provides incentives to improve efficiency; and establishing an institutional and legal framework to secure property rights, the rule of law, and transparent market-entry regulations. The term 'Transition economies' refer to countries which have moved, or are moving, from a primarily state-planned (command economy) to a market-based economic system · The Transition Economies are o The Former Soviet Union (FSU) states o Countries from Eastern and Central Europe closely allied with the Soviet Union, o Countries in Asia undergoing market transformations of various degrees, such as China, Mongolia and Vietnam. Market and Government What is a market? O Define a market o What is a market economy? o Does the government have a role in a market economy?
What is a market? · A market brings buyers and sellers together What is a market economy? · An economy where production and consumption occur through a free market system, with market determined prices o Prices adjust until demand and supply meet o Exchanges take place by means of prices only o Private ownership of assets o Market-supporting institutions (protection of property rights) Does the government have a role in a market economy? · No true free market exists - all markets have some government involvement o Even in the most 'liberal' markets, government do intervene (e.g., to prevent monopolies, provide public goods, etc.) Allocation under Central Planning · Central planning: main features o price system · The central planner decides the price at which producers sell their products and consumers buy. . Hence, prices are virtually fixed (and not changed very often). Disequilibrium (rationing or excess supply) Consequences? . The price fixed by the central planner was usually not the market equilibrium price ... o Price below mkt equilibrium price: rationing regime o Price above the mkt equilibrium price: excess supply regime · Shortages of consumption good, i.e. rationing, and queues were common in centrally planned economies. · Also, excess supply of low quality good was frequent Production under central planning · State owned firms (SOE) o The central planner was deciding on the type and scale of investment. o Typically, as big firms could be more easily managed in the plan, there was a bias toward big firms. o Often, the investment scale dictated by the plan was not optimal.
Incentives · Firm did not