Ownership and Incentives In a Transition Economy

The process of transition of reforming socialist economies to market economies has several alternative paths. Seven adjustment scenarios are evaluated: public ownership; employee management under absentee state ownership; entrepreneurship; diffuse private ownership; hands-on domestic private ownership; hands-on foreign ownership; and scrappage. Two phases are likely to characterize the Eastern European environment: an initial noisy phase, followed by a more mature phase. Two key features of the transition process are the unusually high level of uncertainty in the firms's environment and the non stationarity in its level. Five implications are developed: 1) stock markets will work poorly in the noisy phase; 2) most competition-oriented restructuring ought to take place before privatization; 3) the threat of capture of government decision making by interest groups is, during the transition period, more serious in Eastern Europe than in Western economies; 4) the main attraction of foreign aid for the transition process may not be expertise, but rather commitment and independence from interest groups; and 5) the stock market must be appropriately introduced at the beginning of the mature phase.