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Resource Allocation During the Transition to a Market Economy: Political Implications of Supply Bottlenecks and Adjustment Costs


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  • Joshua Aizenman
  • Peter Isard


This paper explains why a laissez-faire approach may fail to account for externalities in transforming economies, focusing on externalities associated with supply bottlenecks and adjustment costs. Bottlenecks tend to arise whenever input requirements are stochastic and the opportunity cost of holding inventories is high. They are likely to become prevalent in the state industrial sector once budget constraints are hardened and credit markets begin to function properly, since the creditworthiness of state enterprises is limited by outdated production technologies. The analysis recognizes that producers have incentives to form pooling arrangements, supported potentially by market mechanisms, for reallocating stocks of critical inputs. It is shown, however, that such arrangements do not eliminate the externalities, and that the externalities rise in a nonlinear manner with the opportunity cost of holding inventories. The analysis suggests that once budget constraints are hardened, the externalities associated with bottlenecks and adjustment costs provide a case for subsidizing the costs of critical inputs for the state industrial sector, but not for the new private sector. This subsidy declines as the private sectors grows.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4366.

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Date of creation: May 1993
Date of revision:
Publication status: published as The Economics of Transition, "Production Bottlenecks and Resource Allocation During the Transition to a Market Economy," Vol 3(3), pp. 321-331, 1995.
Handle: RePEc:nbr:nberwo:4366

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  1. Rodrik, Dani, 1992. "Making Sense of the Soviet Trade Shock in Eastern Europe: A Framework and Some Estimates," CEPR Discussion Papers, C.E.P.R. Discussion Papers 705, C.E.P.R. Discussion Papers.
  2. Stanley Fischer, 1992. "Stabilization and Economic Reform in Russia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(1), pages 77-126.
  3. Ethier, Wilfred J, 1982. "National and International Returns to Scale in the Modern Theory of International Trade," American Economic Review, American Economic Association, American Economic Association, vol. 72(3), pages 389-405, June.
  4. Michael Bruno, 1992. "Stabilization and Reform in Eastern Europe," IMF Working Papers 92/30, International Monetary Fund.
  5. Murphy, Kevin M & Shleifer, Andrei & Vishny, Robert W, 1992. "The Transition to a Market Economy: Pitfalls of Partial Reform," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 107(3), pages 889-906, August.
  6. Perotti, Enrico C., 1993. "Bank lending in transition economies," Journal of Banking & Finance, Elsevier, Elsevier, vol. 17(5), pages 1021-1032, September.
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