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Chapter 12. Transition: Theory,
Policy, and Practice
TRANSITION: THEORY
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The era following the collapse of the Soviet Union and other planned
socialist economic systems is one of transition.
Transition involves the replacement of one economic system by another.
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During the early discussions of transition, economists placed considerable
emphasis on issues of speed and sequencing.
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the replacement of the administrative command economy by the market.
dichotomy between rapid (“big bang”) approach/ the slower approach (“gradualist”)
Beyond the initial discussion of the speed and sequencing of transition, the
components of transition were typically classified in four major
dimensions.
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microeconomics of transition
macroeconomics of transition
international economic integration
safety net
legal infrastructure
TRANSITION: INITIAL CONDITIONS
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The administrative-command economy had created fundamental initial conditions
different than would have existed under market arrangements.
Transition laid bare enormous distortions in the structure of the transition
economies.
Initial conditions and transition policies developed and implemented during the
transition process itself are interrelated and have an impact upon the speed with
which the transition can proceed and the sequence of transition components.
The appropriate pace of transition varies from case to case, depending upon a
number of factors.
The farther an economy is from "normal“ market patterns of resource allocation,
the more difficult will be the process of adjustment under newly emerging
allocation arrangements and policies.
There are a great many possible indicators. Macroeconomic imbalances, structural
differences, and initial foreign trade postures matter in influencing the nature and
success of the transition process.
The Soviet case - a special set of circumstances unlike other transition economies
What?
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Schumpeter and more modem economists recognize that resources must
flow from the declining to the expanding industries for an economy to
grow, but they recognized that oftentimes resources are slow to withdraw
from declining industries because of resistance to change.
Schumpeter recognized that the uneven pace of expanding and contracting
industries and the difficulty of withdrawing resources from contracting
industries would lead to economic decline.
According to Schumpeter's analysis, the movement of output in such
circumstances would not be along an existing Production Possibilities
Frontier.
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Such as PPF, but a sharp movement to the interior of the PPF, such as from point A to
point C.
 Thus during the transition, the contraction of output in declining industries would be
greater than the expansion of expanding industries.
TRANSITION POLICIES: SPEED AND SEQUENCING
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Q: Should transition proceed quickly in the form of shock therapy, or should the
approach of gradualism be used?
First, there is a political argument for moving quickly.
Second, initial conditions may affect the issue of speed.
Third, the degree of distortions relative to market patterns may affect speed.
The problem of speed is interlinked with sequencing.
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For example, if the price-setting function of the state is to be eliminated, does it make sense to release
prices to be determined by market forces when those market forces do not exist?
Both the speed and the sequencing of transition are also tied closely to a much more
fundamental and complex issue-the nature of change.
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Neoclassical economic theory postulates that change emerges from the behavior of rational agents
who maximize known objectives with available information, resulting in the achievement of
equilibriums through time.
The evolutionary approach suggests that institutions emerge only slowly and sequentially in a pathdependent world from the behavior of agents with limited knowledge and foresight. In this world, the
emergence of new institutions is a slow and sequential process.
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Contemporary economic thought focuses on elements (microeconomic,
macroeconomic, foreign trade, and safety net, legal infrastructure) as
complementary in the transition process and seeks to determine the nature of an
optimal reform path.
This path can be characterized as encompassing the appropriate mix and intensity
of complementary transition components to achieve a specified transition objective
given existing conditions when the process of transition (change) is implemented.
The concept of transition implies the movement from one position on the PPF to
another.
The position to which the economic system is moving cannot be characterized
simply by observing the formality of a new set of institutions or policies.
 The economy must undergo restructuring.
With restructuring, when transition comes to an end, new institutions and policies
are in place, they are functioning, and they are influencing resource allocation.
Such an outcome is far more difficult to characterize than simply changing the
shareholding arrangements of an industrial enterprise.
The Microeconomics of Transition: Privatization
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The process of privatization in both developed and less developed economies focuses on
efficiency issues with new arrangements implemented through existing markets.
In transition economies, the issues much broader issues are usually termed mass privatization.
Then process of privatization, absent even basic market arrangements and accompanying
legal system, is complex and difficult involving a variety of issues different from those
encountered in market economies.
A variety of approaches for privatization
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restitution
small-scale privatization is frequently accomplished under local auspices through various means
(direct sale, auction and vouchers)
mass privatization that attempt to change equity arrangements on a large scale over a short period of
time, directed especially at the major enterprises.
Insider privatization, or sale of shares to workers or managers in the organizations.
The absence of domestic investment funds, institutions necessary for channeling such funds
into the purchase of equities, and traditional equity considerations has led to the use of
voucher privatization.
While privatization is fundamental to transition, privatization is just the beginning. After
ownership arrangements are changed, it is necessary to undergo restructuring.
MONETARY AND FISCAL ARRANGEMENTS
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One of the most difficult issues of transition is the immediate onset of
macroeconomic imbalance.
Creating macroeconomic institutions and policies is an inevitable element of
transition
There are two major components of the macroeconomy, namely, the banking
system and the state budgetary system.
Although the broader issues of an appropriate role for the state in transition
economies have sustained over time, it quickly became clear that the role of the
state in the newly emerging market economies would be reduced.
Revenues available to the state decreased much more rapidly than the willingness
of the population to give up long-held state benefits such as pensions, medical care,
and subsidized transportation . The usual response was a shift to new sources of
revenues, usually a “Western-style” taxation system.
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The essence of banking in the transition setting has been the replacement of the
socialist monobank system with a modem two-tier banking system consisting of a
central bank and monetary authority and a net of commercial banks serving the
needs of the economy through emerging financial markets.
The initial emergence of a large number of undercapitalized banks, the shallow and
nontransparent nature of financial markets has limited the effectiveness of the
emerging macroeconomic policy framework and allowed the financing of the
deficit through inappropriate and often inflationary mechanisms.
TRANSITION AND THE SAFETY NET
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As the economy of the Soviet Union collapsed, the "benefits package," whether it pertained to
child care, grade school education, higher education, medical care, or retirement benefits, was
provided by the state, typically through the state-enterprise employer. How would these
requirements be handled during transition?
First, during transition the social contract must change and the package of benefits will shrink.
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Second, the nature of the demands on the system will change.
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This shrinkage reflects both difficulties with the package that existed under the old order and the
inability of the new order to provide the necessary financial underpinning.
For example, while retirement, medical, and related requirements remain, a new set of demandsspecifically unemployment and related benefits-will emerge.
During transition it is essential to focus on four basic aspects of the safety net.
 First, needs must be identified.
 Second, it is essential to develop the infrastructure necessary to deliver services.
 Third, new sources of funding must be established.
 Fourth, the system must change from one of benefits that are available to all to one in
which benefits are delivered to those in need.