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Modeling and Policy Impact Analysis
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An Impact of Privatization on
Economic Growth and Poverty:
A Theoretical Analysis
Khashchuluun Chuluundorj
Mongolia
A paper presented during the 4th PEP Research Network General Meeting,
June 13-17, 2005, Colombo, Sri Lanka.
An Impact of Privatization on Economic Growth and
Poverty: A theoretical analysis1
Final proposal
B.Altantsetseg, B.Ariun-Erdene, D.Bayarmaa, S.Dulbadrakh,
Ch.Khashchuluun, T.Oyunbaatar, B.Soyolmaa
School of Economic Studies, National University of Mongolia
E-mail: [email protected]
Tel: 976 99828046
Fax: 976-11-350994
November 29, 2004
Abstract
We propose a study of an impact of privatization on growth, income distribution and
poverty by applying a model, where agents with heterogeneous entrepreneurial
capabilities choose between being employed as workers or becoming managers of private
businesses in a spirit of Murphy, Schleifer, Vishny (1991) paper “Allocation of Talent:
Implication for growth”. New in this paper is that we explicitly derive equilibrium for the
planned economy and investigate impact of privatization on economy, which we
understand as allocation of previously state-owned capital to emerging class of
entrepreneurs and compare a resulting market economy with the centrally planned
economy. In a centrally planned economy all agents were employed as state factory
workers, while after transition to market economy most capable agents may choose to
become businessmen, who in turn are employing less capable agents. Capital markets
play an important role in smoothing the privatization shocks.
1
The final proposal submitted to the Poverty and Economic Policy (PEP) Research Network for possible
funding.
1
Table of contents
1. Introduction ............................................................................................................2
1.1. Related literature.................................................................................................3
2. Economic background............................................................................................4
2.1. Economic growth .................................................................................................4
2.2. Poverty .................................................................................................................5
2.3. Privatization.........................................................................................................6
2.4. Relationship between poverty and privatization ................................................9
3. The Model .............................................................................................................10
3.1. The centrally planned economy ........................................................................10
3.2. Market Economy ...............................................................................................12
4. Comparative analysis of centrally planned economy and market economy ......15
5. Policy relevance ....................................................................................................16
6. Policy simulations and implications.....................................................................18
Further planned work.................................................................................................18
References....................................................................................................................19
Studies on privatization in Mongolia in which the research team members
participated..........................................................................................................20
1. Introduction
We analyze the impact of privatization of publicly-owned assets, such as state companies
and other state-owned assets, on economic growth and poverty reduction. Main objective
of the paper is a creation of an economy-wide model to analyze a link between
privatization, growth and poverty and an exploration of the impacts of privatization
within the framework of the applied model. The economic model enables analysis both of
income and asset distribution effects of privatization.
Privatization of state-owned assets, even of those not directly related to production,
creates a possibility of new owners to use the privatized assets as collateral for obtaining
credit from banks or other financial institutions and use the loans for investment, which
in turn can considerably positively affect economic growth. Therefore, in our opinion,
the impact of privatization of state assets is not limited to a mere revival of financial
markets, as it is usually viewed (e.g. E. Sheshinski and L. Lopez-Calva, Privatization and
its Benefits: Theory and Evidence, 1998). The reason is that privatization can be seen as
a financial stimulus for increasing investment and its main role is a proper and smooth
redistribution of capital, which in many transition countries was allocated among all
citizens with the help of various voucher schemes.
The proposed study of this overlooked role of privatization in the economic growth thus
represents a very promising field, which links privatization of state assets to financial
markets and further through investment to economic growth. The impact of investment
on economic growth and poverty is further enriched by the behavior of agents who
received privatized assets: indeed, if they consumed it, the privatization will have only a
temporary positive effect on GDP through one-time increase in spending on
2
consumption, yet if they invested privatized assets, their decision can have lasting effect
on GDP through increased investment and higher growth rates. In the sample survey
“Impacts of privatization on income distribution and poverty” 2003, results have shown
that mass privatization had initially distributed wealth equally; however difference in the
knowledge about the use of the distributed wealth causes more unequal distribution of
asset and income.
1.1. Related literature
In recent theoretical literature, privatization is usually considered to have an impact on
economic growth from such microeconomic factors as an improvement of production
efficiency through better managerial incentives, layoffs and more flexible pricing, and
positive macroeconomic effects, such as improved taxation (Galal, et al. (1994, LaPorta
and Lopez-De-Silanes (1998, Smith, et.al. (1996), and also Barberis, et al. (1996), Earle,
et al. (1994) and Frydman, et al. (1997) for transition economies.) Galal, et al. (1994) and
Chisary, et al. (1997a) study privatization in the general equilibrium framework.
Demirguc and Levine (1994) and McLindon (1996) study the role of privatization in the
revival of the financial market. Yet, to our knowledge, there is not yet a theoretical
research, which explores privatization exactly in the way, which is proposed by our
research team.
Philippe Agion, Patrick Bolton (1997) and Ferreira (1997) assume that a high yield
“entrepreneurial” activity requires a fixed initial outlay of capital. In our case,
entrepreneurs choose their activity based on comparison of possible profit and wages.
Ferreira (1997) assumes that individuals possess some initial wealth and they differ in its
initial wealth allocations. In our model, we assume that people have different initial
human capital but are allocated equal wealth initially.
Ferreira (1997) makes an assumption that expected end-of-period income is higher in the
private sector than in the public sector. This is a very strong assumption. We do not
employ such a strong assumption but derive the wages in a centrally planned and market
economies separately from the modeling results and then compare these wages with each
other.
The structure of the paper is as follows. Chapter 2 is devoted to description of empirical
data and results of privatization process in Mongolia. We also show interrelated poverty
and income distribution results in Mongolia during the time when privatization took
place.
First, we analyze equilibrium under the centrally planned economy. Then we analyze the
economy after privatization of state-owned enterprises takes place and the new class of
entrepreneurs is being born. The third section is devoted to a comparative analysis of
various privatization schemes and the role of financial markets. The last section is
devoted to conclusions and comments.
3
2. Economic background
Before 1990, Mongolia had been in centrally planned economy and the rate of economic
growth varied from as much as 8.3% in 1981 to lower 4.2% by the end of 1980s. Since
the beginning of 1990s, the transition to the market economy in Mongolia has begun and
the economy collapsed at the beginning of the transition. During the depression, shortage
of goods, hyper inflation, unequal income distribution and poverty appeared as negative
consequences of the transition.
2.1. Economic growth
In the beginning of the transition, between 1990 and 1993, GDP dropped by more than 20
per cent. Since 1994, the economy has steadily recovered and ever since has positive
growth rates. But growth rates have not been stable and fluctuated sharply (Figure 1).
While 1980 and 1989, the economy grew on average 8.1% annually, between 1994 and
2004, growth rates have been 3.5% on average.
Figure 1
Economic growth, 1981-2003 (% )
1.
1
1.
1
4
2.
3
19
97
3.
5
3.
2
2.
3
19
95
3.
8
6
6.
3
4.
2
3.
4
5
5.
1
6.
2
6
5.
8
8.
3
8.
3
10
9.
4
15
20
03
20
01
19
99
-3
19
93
-2 1
.5 99
1
19
89
19
87
19
85
-5
19
83
19
81
0
.5
-9
-9
.2
-10
-15
4
2.2. Poverty
GDP per capita is shown in Figure 2. GDP per capita is an indicator which directly
connected to living standard of people and we can see that the population experienced a
sharp fall in living standards at the beginning of 1990s, when the transition to market
economy started.
Figure 2
2002
1.3
-0.3 2000
-1.9
1998
1.4
1.9
1.4
1.4
-1.8
-1.3
2.5
1.5
-0.4
5.1
2.5
4.5
1996
4.7
1994
1.3
6.0
1.6
-4.9
1992
-9.1
1.3
1.8
-13.9
2.6
1990
-5.2
GDP per capita growth rate
Population growth rate
Between 1990 and 1993, GDP per capita had fallen sharply and after that its growth rate
did not stabilize for long time. In particularly, growth rates in 2000 and 2001 were -0.3
and -0.4 respectively while it was 2.5 per cent in 2002. As of 2002, GDP per capita was
268 thousand MNT2 and it was lower by 15.8 per cent than that in 1989. In other words,
living standard of Mongolian hasn’t yet reached to the level of it in 1989.
Poverty level (% )
45
40
36.3 35.6
38.5 39.4
35
35.1 34.1
33.1 32.6
30
25
1995
20
1998
15
10
5
0
All Mongolia
Urban
Ulaanbaatar
Rural
Figure 3.
2
MNT is abbreviation for Mongolian national currency, Tugrug. The exchange rate is currently about 1200
MNT per 1 US dollar.
5
Poverty issue has appeared in Mongolia in 1990s. Before 1990, Mongolia had been in the
centrally planned economy and in this system, income distribution was relatively equal.
Poverty has become the one of most serious problems in Mongolia. According to “Living
standard measurement survey” 1995, 1998, one third of Mongolian population was poor.
Although poverty remained relatively stable, deepness of poverty has increased.
2.3. Privatization
Regarding the transition to the market economy, the privatization has become one of new
terms and main tools for the government to foster private business sector. In Mongolia,
three types of the privatization have run since 1990s.
•
First, livestock privatization took place in 1991-1992.
•
Second, small and medium enterprise privatization has continued to run since
1991.
•
Third, apartment privatization is continuing to take place since 1996.
Livestock and apartment privatizations had impact on particular groups of population or
people who worked before at state-owned and collective farms, or lived in state-owned
apartments. The small and medium enterprise privatization had involved all groups of
population. For example, in Mongolia every citizen was given blue and pink vouchers
worth 10 thousands MNT (in 1991 the official rate was about 15 MNT per 1 USD),
which total worth was equal to over 40 percent of the total state property according to
estimates made at that time.
Currently, a fourth major privatization of social sector and land is beginning. According
to the law of privatization of land, land is again distributed free of charge (excluding
small registration charges) to every household in Mongolia in a equal manner, similar to
vouchers.
The government’s policy aim for privatization was an increase in economic efficiency, to
the creation of favorable conditions for effective use and development of the property, a
reduction in poverty and inequality.
Rules of privatization in Mongolia:
In the beginning of privatization in Mongolia, residents of Mongolia had been granted
following rights:
o Buying freely by vouchers the privatized public assets (asset quantity should
equal value of the investment voucher)
o Workers could buy shares of own working factory by investment voucher and
at nominal prices
6
o When workers buy assets of industry which he/she works by an auction, they
can receive 10 per cent of sale revenue
o If individual had work by rent contract, then individual had an advantage in
purchasing assets.
Privatization in agriculture was meant to be different from other types of privatization
and the following rules in privatization of agriculture “negdel” (collective farms) had
been approved to employ. These rules were:
o Based on proposal of members in agriculture “negdel”, privatization of
agricultural “negdel” assets will take place
o The members will choose the method of privatization at their meeting
o Investment vouchers distributed to members of agricultural “negdel” are
backed by assets of “negdel”
o Government organizations will participate in privatization of agricultural
sector to assist in methodology of privatization and management of the
process
Reasons for this specific approach to privatization of agricultural sector was that
collective farms had assets of the cooperative members, so its privatization was rather
different.
Besides that, there were principles that people, who had given their assets to the
“negdel”, when they were first founded in 1950-60s, had supplied their labor to the
cooperative and were employed by the cooperative have an advantage in privatization of
property and, if they want, then farmers had rights to privatize up to 30 percent of assets
of agricultural “negdel” using vouchers.
Mistakes in privatization
In the privatization of agricultural sector, there were:
o During privatization, there were few cases that only assets, such as livestock,
fence and so on, were privatized while other assets, such as funds and capital were
not privatized and were left to in companies, which emerged from the
cooperatives.
o In some cases, only current members of agricultural “negdel” privatized assets of
“negdel” and people who founded the “negdel”, but retired afterwards, did not
participate in the privatization.
In voucher privatizations, there were also some other cases of
o Widespread corruption, insider trading and other economic crime
o Underevaluation of the privatized assets
o Buying assets by initial price abusing advantagous rights of members
7
o Company’s assets were privatizated not in a way, designed by privatization
committees
o Some individuals resold the assets received from privatization at prices many
times exceeding initial privatized prices.
Obstacles in privatization
o In the framework of small privatization, one of problems was the asset evaluation.
Because the capital market had not developed and on the other hand, it was
impossible to calculate the future benefit of privatized asset given extreme
uncertainty of the economy, development of a methodology to evaluate privatized
assets was one of vital obstacles.
As of 2001, State Property Committee determined approximately 40 mistakes and
approved resolutions to correct the privatization process of assets worth 6.5 bln MNT.
Following results were made public by a survey, conducted by Dr. Nyamzagd about
privatization in Mongolia (because research methodology and calculation are unknown
here, direct application of these results directly is risky).
According to the survey, 37.3 per cent of residents of Mongolia had actively participated
in privatization. A small minority of population received dividents from privatized assets
and majority could not. Since it was connected with system of privatization, this shows
one of flaws inherent in voucher privatization (weak post-privatization control of new
owners).
After privatization, changes in live of organizations and residents /on average/ were
Positive
Negative
Normal
20-25 %
20-25%
50%
The next question was, after privatization, did assets reach their [real] owners?
Really reached
Reached
Reached or not reached
Away
Far away
15%
48%
16%
12%
9%
After small privatization, whether enough assets were distributed
Very enough
Enough
Neutral
Average
Below average
3-4%
8-10%
30-35%
30-33%
18-23%
8
Things received from privatization
Nothing
45-50%
Apartment
18-20%
Livestock
10-15%
Others /occupation, cars, equipment, tools, savings, company, Non governemt
organization ans so on/
Result of privatization:
Positive:
− Having property
40
− Having freedom
28
− Having minimum standard 22
− Having company
14
− Became rich
11
− receiving dividend
18
− found yourself
9
Negative:
Nothing
became dependent
no ways to live
becoming unemployer
becoming the poor
Neutral
was left out completely
26
14
9
33
27
23
8
Evaluation of privatization process:
− Honest
20-25%
− Dishonest
45-50%
Change in life:
− Improved
− Worse
− Normal
15%
38%
43%
2.4. Relationship between poverty and privatization3
Some researchers of our team studied previously the interrelationship between
privatization and poverty or equity in income distribution. The conclusions of their
research show the following results.
First, assets have been concentrated in hands of few people after privatization. We also
can say that the share of employees in the management board and in the total structure of
shareholders has dropped sharply in the period after the privatization. Therefore assets
and control of a company‘s assets have shifted from employees to administration and
outsiders after the privatization.
Second, of all privatized enterprises 25.6 percent were not operating after their
privatization at the time of our study. Of them 14.2 percent have stopped operations or
were disbanded. Another question in the study concerned is downsizing. Of privatized
enterprises, which operate at present, 50.8 percent reported downsizing after
3
This section was written from the result of empirical research “Interrelation between privatization and
poverty/ inequality”
9
privatization. When an enterprise stopped operation, it reduces its number of employee
severely. The privatization has great impact on unemployment through downsizing and
stopping operations of enterprises. Unemployment is very important factor for poverty.
According to poverty studies, 60% of unemployed people are poor in Mongolia. (Poverty
situation in Mongolia, 2001) Therefore privatization has a considerable impact on
poverty. The real wage has decreased dramatically over the period of 1992-2002 and
change in relative wage is smaller.
Third, animals (livestock) was distributed to people who did not have nessesary skills for
herding animals in the countryside. Also there were widespread school drop-out among
school aged male children. Quality of animals dropped down due to poor organization
of breeding of animals. As households stated to live individually far from each other,
benefits of joint labor was lost and hosehold became more vulnerable for natural disasters
like zud. All of these things have been become rural people more vulnerable to poverty.
Given these empirical results, the research team tried to address the problem of
interrelation between privatization, income distribution and economic growth, using a
theoretical model.
3. The Model
We develop a closed economy model with heterogeneous agents each living for one
period. One good is produced using human capital4, capital and labor as inputs to the
constant returns to scale production function. The population is normalized to one.
Agents in the economy possess each one unit labor and are endowed with hi units of
human capital. The human capital is distributed from h (lowest managerial skill) to h
(highest managerial skill) over the population. For simplicity, we assume that aggregate
capital is equal to K and is constant and all produced goods are consumed. Similarly to
Murphy, Scheifer, Vishny (1991), in order to concentrate on distribution effects of
income, we assume throughout the paper that commodity price is fixed and we normalize
it as equal to 1.
3.1. The centrally planned economy
During the socialist era the government maintained a policy of equal income distribution,
trying to provide relatively equal living standards for population. The government
allocated great amount of resources to the social welfare sector. All enterprises were
owned by the state and there was no private property or private sector. At the beginning
of transition, wealth and income distribution was relatively equal, in other words, nobody
had private property.5 Therefore we model a centrally planned economy in the following
way.
4
In this paper human capital refers mainly to managerial skill, which is not equally distributed over the
population.
5
“Links between Privatization and Poverty/Inequality”, Economic Policy Research Association and School
of Economic Studies, NUM, sponsored by UNDP, 2003.
10
In the centrally planned economy, the State or the government is the only producer and
employer and all capital is owned by the State. All agents supply one unit labor and are
employed by the State6. The State pays wages to labor and also distributes its production
)
profit to the population. The State has its own human capital or managerial skill H
)
( h < H < h ), which reflects the available human capital possibilities in the economy and
cannot exceed or be lower than human capital of its population.
The production function of the State is:
)
)
y = H ! K " L# = H ! K "
(1)
)
where: H - is State-owned human capital, K is aggregate capital, L is total labor stock,
which is normalized to one and the production function coefficients are chosen such as
! + " + # = 1 . Thus, the production technology is a constant return to scale production
function. Further, w is a wage of labor7 and r is an interest rate. Let us assume that the
State maximizes its profit, ! . In this case, the State’s problem is:
max
)
# = H ! K " $ w $ rK
(2)
First order conditions for profit maximization problem are following:
)
MPL = # H ! K " = w
)
MPK = " H ! K " $1 = r
L:
K:
(3a )
(3b)
According to the first order conditions, income share of human capital, capital and labor
are given as in (4):
L:
K:
)
H:
w = !Y
rK = " Y
(4a )
(4b)
# s = $Y
(4c)
The State receives its reward as a manager, equal to ! s as in 4c . Furthermore, we assume
that the State pays wages to labor and also distributes its production profit to the
population in an equal way. Let’s formulate agent i’s income mi as a sum of wage and a
transfer payment, which the agent receives from the government and which is equal to a
share of profit and capital income of the State.
mi = w + (rK + ! s ) / L
(5)
6
Full employment is most important goal of the central planner.
Wage is determined by the central planner as to clear the labor demand and supply market, where labor
supply is equal to one.
7
11
Because of normalization of the population to 1 and the profit maximization conditions
the expression (5) is equal to GDP per capita, y.
mi =
y
=y
L
(6)
Agents receive equal income y in a centrally planned economy, since wages and statedistributed benefits are equal. Therefore, in the centrally planned economy asset and
income distribution is perfectly equal and GDP and GDP per capita is equal to y.
3.2. Market Economy
Privatization is one of specific features of transition economies. Privatization has created
initial capital or start capital for engaging in private business. For example, in Mongolia
every citizen was given blue and pink vouchers worth 10 thousands MNT (in 1991 the
official rate was about 15 MNT per 1USD), which total worth was equal to over 40
percent of the total state property according to estimates made at that time. As we can
see, at the first stage of privatization everyone had an opportunity to own equal amount of
assets. However, people’s knowledge, skills, access to information related to economy,
business and capital markets were different, which led to the situation when some
increased their initial capital by hundreds times, while others were left with no capital. In
other words, although start-up conditions were equal regarding shares of distributed
capital, but start-up conditions regarding their knowledge of information on economy,
business and capital markets were unequal. For instance, we can assume that the
management of enterprises had more opportunities to access information on the
enterprise and further prospects of business in the given field than workers of the
enterprise. On the other hand, studies show that the enterprise workers had more
information than outsiders in general.8 That’s why the privatization process and the
market economy is modeled in our paper in the following way.
In the process of transition from the centrally planned economy to a market economy the
State privatizes all its capital. During the privatization agents receive equal amount of
capital k. The State withdraws from production so private entrepreneurs now are
responsible for production rather than the State, and economic growth can be derived
only from an increase in output of private sector. When agents become entrepreneurs,
they use their own human capital or managerial skill in their production activity, borrow
the capital for production at the market-determined rate r and hire labor at a marketdetermined rate of wage w.
Individuals now have two options: one is becoming an entrepreneur and one is becoming
a worker and supplying labor.
8
“Links between Privatization and Poverty/Inequality”, Economic Policy Research Association and School
of Economic Studies, NUM, sponsored by UNDP, 2003.
12
Agents, who choose to supply labor, earn income from two sources, namely from selling
labor at a wage rate w and renting privatized capital at a market rate r. On the other hand,
those agents, who choose to become an entrepreneur, earn income from employing their
human capital and also earn interest on its privatized capital. They are becoming
managers and owners of the private firms.
Ultimately, agents will compare income from these two options and will choose the one
which earns greater income.
Formally, let us show income from both options. By becoming a worker and supplying
labor, agent i will earn the following income.
mi = w + rk
(7)
If agent i choose to become an entrepreneur, she/he will produce goods using the constant
returns to scale production technology and her/his human capital or managerial skill:
yi = hi! ki" li#
(8)
The entrepreneur maximizes profit from the production:
max yi $ wli $ rki = hi! ki" li# $ wli $ rki
(9)
Where: ki -capital, li-labor, hi-agent i’s human capital. Entrepreneur’s profit maximizing
conditions define her/his factor demands. Labor demand of firm i:
#y
MPl = w = i
(8a )
li
!
% ! &" % # &
li = ' ( ' (
) r * ) w*
Capital demand of firm i
# yi
MPk = r =
ki
1$!
%# &"
ki = ' (
)r*
Entrepreneurs` income
physical capital.
1$ !
"
hi
(8b)
(9a )
!
% ! &"
(9b)
' ( hi
) w*
me consists of return to his human capital and return to his
e
mi = ! yi + rk
(12)
Agents compare income of these two options and choose the one with larger income. In
other words, agents choose to become an entrepreneur if and only if the following
condition holds.
mi " mi
e
#
w " ! yi
(13)
After replacing yi with production function and some manipulating, we get the following
inequality.
13
!
"
) w $ r %# $ w %#
hi & h = ' ( ' (
#)! * )" *
(14)
The agents will choose to become an entrepreneur if they have human capital endowment
)
)
equal to or higher than h . Therefore h is a threshold level of human capital endowment
for becoming a businessman.
!hˆ
!hˆ
> 0,
>0
!w
!r
)
(h ! h )
Let us define a { a =
} as the share of entrepreneurs in the population (as the
(h ! h )
population is equal to 1, a is also the number of entrepreneurs).
!a
< 0 The higher the wage, the number of enterpreneurs will reduce because
!w
opprotunity cost of enterpreneurs will increase.
!a
< 0 The higher the interest rate, the number of enterpreneurs will reduce, because cost
!r
of output will become higher.
Thus 1-a is the labor supply. Wage is determined by labor market equilibrium condition:
a
1{! a =
labor sup ply
(15)
" l di
i
0
{
labor demand
Substituting li with entrepreneur i’s labor demand function and accounting for the
uniform distribution of human capital, we get the following expression:
!
1$ !
% ! &" % # & "
1{$ a = ' ( ' ( + (hi )di
r * ) w* 0
)144424443
labor sup ply
a
(16)
labor demand
From (14), the equilibrium wage can be expressed as:
w* = w (! , " , # , h , h, K )
(17)
One can see that wage increases with a number of entrepreneurs. ( wa > 0 ). There are two
reasons. First, labor demand increases with the number of entrepreneurs. Second, labor
supply decreases with entrepreneurs’ number as the population is constant.
The interest rate is defined by the capital market equilibrium condition:
14
a
K
{
(18)
! k di
=
i
asset sup ply
0
{
asset demand
Aggregate capital supply is assumed K. Substituting into (16) entrepreneur i’s capital
demand function, we get the following expression:
r* = r (! , " , # , h , h, K )
(19)
Let us find aggregate production. The aggregate production is an integral of all
entrepreneurs’ production.
a
!
a
"
$ ! %# $ " %#
Y = * y (i )di = * & ' & ' h(i )di
w) ( r )
0
0(
(20)
Note Hm as total human capital in the market economy e.t sum of total enterpreneurs’
a
capacity. H m = ! h(i )di
0
Substitute equilibruim wage and interest rate, and summarize:
!
$a
%
!
or Ym = H m K " (1 $ a )#
Ym = ' + h(i )di ( K " (1 & a )#
)0
*
Here, total output in the market economy depends on total factors in the economy and
technology. Technology is similar with technology of private industry.
4. Comparative analysis of centrally planned economy and
market economy
Comparing to total output in centrally planned economy, human capital increases and
labor force decreases. Depeding on these changes in factors and elasticity of output
regarding with factors (alpha, beta, gamma), it can be determined whether output in
market economy increases rather than that of centrally planned economy.
Following condition must be necessary to increase output in the market economy:
!
Hm
"
)
) # 1 $"
(1 % a ) > H " & H m > H '
(
) 1% a *
!
In accordance with this condition, human capital used in the market economy is
! /"
a $
#
times higher than human capital used in centrally planned economy. (This
%1 +
&
( 1' a )
ratio is less 3). Unless market economy utilizes more human capital, it cannot exceed in
terms of output the planned economy. Therefore, large number of private entrepreneurs is
vital for economic growth of the market economy.
15
Figure 4. Income distribution
Income distribution in centrally
planned economy
Income distribution in the market
economy
y
y
w+rK
w+rK
1
a
1
Asset distribution is perfectly equal in both economies. In centrally planned economy all
agents have no capital, while in a market economy agents receive equal k amount of
capital in the result of privatization.
Production in the centrally planned economy:
)
)
y = H ! K " L# = H ! K "
Production in the market economy:
a
y=
! y di
i
0
The model research will proceed in following directions:
o Comparison of production and factor incomes in the centrally planned economy
and the market economy.
o Analysis of income distribution using the Lorentz curve and Gini coefficient.
o Comparison of income distribution in the centrally planned economy and the
market economy.
5. Policy relevance
Now we study how the economic results change depending on mode of privatization
(distribution profile of capital) for given levels of human capital. The policy can be
16
expressed as a choice of various distribution methods of capital, that is various
privatization methods, which leads to different economic outcomes in terms of
macroeconomic growth, income distribution and individual income.
1. Suppose there is a privatization, which allows unequal distribution of assets
depending on, for example, level of education, level of human capital an
individual possesses, or depending on various factors, such as insider information
before the transition.
Suppose that if individual has the higher human capital, they receive more capital
1
from privatization. In this case, K = ! ki (hi )di . There is ki ! k j , i ! j . Income of
0
entrepreneurs is equal to ! yi + rki , while income of employees is equal to w + rki .
Agents, who have human capital endowment equal to or higher than human capital in
which these two incomes are equal to each other, becomes an enterpreneur.
Otherwise, they become an employee. If wage is equal to that of previous model, then
a share of enterpreneurs in population is also equal to the share of previous model.
Therefore, there is no change in demand for labor and wages are equal. On capital
market, because demand for and supply of capital are reduced each by equal
proportions, interest rate is unchanged. Here, only one different result from the
main model is an increase in income inequality.
2. In the this distribution mode, all employers have equal income, w + rk , while
now workers have different capital income rki regarding with holding different
capitals. The lower human capital, employees will receive less capital from
privatization and their income will become lower. This result will be shown
following figure.
mi
mi=y i+rki=w+rki
0
1
i
3. If agent with the lower human capital than the threshold human capital, holds
more capital ki , then in perfect capital market, this change could not affect
market equilibruim wage, interest rate and output. Only income distribution will
change. In particulrly, the line in above figure will break. Any distribution of
capital ki will change demand for and supply of capital in same proportion
because distribution policy could not have effect on total capital K in the market.
Therefore equilibruim interest rate will not change.
17
If asset market is perfect, then in spite of asset distribution, same wage,
interest rate and output will be determined. Asset distribution made by
privatization will affect only income distribution.
4. If asset market is not perfect, then distribution of capital or privatization policy
has important role in the economy. Depending on distribution of capital, wage,
interest rate and output will be different in each case.
1
For instance, when there is credit rationing, K ! " ki (hi )di . Also total output will be
0
lower than that of the model. Almost in all transition countries, asset market is not
perfect. Therefore privatization policy is important factor to challenge difficulty in
transition economy for example to alleviate the poverty.
6. Policy simulations and implications
Various privatization methods can be simulated using the abovementioned model and
calculating economic results of each of them. We can envision a method of privatization,
which inlcudes a government-controlled number of entrepreneurs, or number of
individuals, allowed to privatize assets. This kind of privatization may suit more
transition countries, where government retains strong control over capital markets and
asset distribution. The policy will determine the number of entrepreneurs, as well as
amount of assets, available for privatization, while preserving some kind of state-owned
assets. We can also imagine privatization, which employes vaucher schemes, but has
inherently different level of asset distribution, for example, depending on former insider
information.
We can determine various income distribution and poverty results related to each
privatization method and find advantages and disadvantages of these methods for
comparison.
Then the policy simulations can be estimated and we can calibrate the model, using real
data, derived from studies of privatization in Mongolia and elsewhere in transition
countries. In particular, we could establish whether the 3 privatizations which took place
in Mongolia, can be linked to later unequal distribution of income and rising poverty.
Further planned work
Plan of activities for the project period
1. Finalizing the model (8 months)
a. Completing the model
b. Creating a dynamic version of the model
c. To outline further research directions
2. Writing the final report (2 months)
a. Completion of the final report
18
b. Submission of the report to the PEP
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Studies on privatization in Mongolia in which the research team
members participated
1. “Links between Privatization and Poverty/Inequality”, Economic Policy
Research Association and School of Economic Studies, NUM, sponsored by
UNDP, 2003
2. “Urban poverty” Population Training Research Centre, sponsored by UNDP,
2003-2004
3. “Case studies of Social Sector Privatization”, Economic Policy Research
Association, BizMongolia research agent, and Finance Economics Institute,
sponsored by Open Forum, OSI, 2004
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