Introducing the Market in a Shortage Economy : The Vertical Integration Issue

It is well known that in the traditional Soviet-type economies, there is a spontaneous tendency of enterprise and ministries to integrate vertically, as a response to the supply uncertainty typical of a chronic shortage economy. The main purpose of the paper is to analyze the link between the vertical integration issue and economic reform. It is argued that, in an institutional context with fixed prices, when there is shortage of inputs, enterprises consuming these inputs will generally not be able to agree on a rationing scheme, in the absence of vertical integration. This decisional vacuum entails the functional necessity of a central planner who will decide on the rationing scheme. It is shown that this result may help to highlight some of the key theoretical and empirical issues of economic reform. One of its main implications is that, in an economy where vertical integration is weak, the abolition of imperative planning can hardly be successful if shortages are not suppressed at the same time. On the other hand, it is much easier to abolish imperative planning if the economy is highly vertically integrated but, because vertical integration destroys the competitive nature of markets, the main goals of economic reform cannot be fulfilled unless additional structural changes are introduced in order to create a competitive environment