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Price Liberalization and Output Decline in Transition

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  • Saso Polanec

Abstract

In this paper, we attempt to fill the gap in theoretical explanations of a large output decline that took place in the early years of transition process. The prevalent explanations, commonly found under the title of disorganisation, are succesful in explaining output decline in countries of former Soviet Union, but less so for Central and Eastern European countries. The model we develop shares the cause of output decline with disorganisation - price liberalisation, however, the decline takes place only under a set of plausible assumptions: adjustment costs to labor mobility across economic sectors and large benefits to inactivity in a form of either government transfers or reservation wage earned in informal economy. Liberalisation of prices in a form of removal of distortionary taxes creates incentives for labor mobility from a declining sector to inactivity. The decline takes place only in a part of the economy, while the rest of the economy stagnates or slowly grows. Since the model does not have a closed-form solution, we analyze the equilibrium allocation using simulation methods. We also discuss the political economy of reforms and identify the conditions under which rational voters under majoritarian voting rule would support the price liberalisation.

Suggested Citation

  • Saso Polanec, 2004. "Price Liberalization and Output Decline in Transition," LICOS Discussion Papers 15304, LICOS - Centre for Institutions and Economic Performance, KU Leuven.
  • Handle: RePEc:lic:licosd:15304
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    File URL: http://www.econ.kuleuven.be/licos/publications/dp/dp153.pdf
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    References listed on IDEAS

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    1. Tito Boeri, "undated". "Optimal Speed of Transition 10 Years After," Working Papers 154, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    2. Blanchard, Olivier Jean & Froot, Kenneth A. & Sachs, Jeffrey D. (ed.), 1994. "The Transition in Eastern Europe, Volume 2," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226056623, July.
    3. Atkeson, Andrew & Kehoe, Patrick J, 1996. "Social Insurance and Transition," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(2), pages 377-401, May.
    4. Gérard Roland, 2004. "Transition and Economics: Politics, Markets, and Firms," MIT Press Books, The MIT Press, edition 1, volume 1, number 026268148x, January.
    5. Guillermo A. Calvo & Fabrizio Coricelli, 1993. "Output Collapse in Eastern Europe: The Role of Credit," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 32-52, March.
    6. Kornai Janos, 1994. "Transformational Recession: The Main Causes," Journal of Comparative Economics, Elsevier, vol. 19(1), pages 39-63, August.
    7. Tito Boeri & Katherine Terrell, 2002. "Institutional Determinants of Labor Reallocation in Transition," Journal of Economic Perspectives, American Economic Association, vol. 16(1), pages 51-76, Winter.
    8. Olivier Blanchard & Kenneth Froot & Jeffrey Sachs, 1994. "The Transition in Eastern Europe, Volume 2: Restructuring," NBER Books, National Bureau of Economic Research, Inc, number blan94-3, June.
    9. Gomulka, Stanislaw & Lane, John, 2001. "The Transformational Recession under a Resources Mobility Constraint," Journal of Comparative Economics, Elsevier, vol. 29(3), pages 403-416, September.
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    11. Dariusz K. Rosati, 1994. "Output decline during transition from plan to market: a reconsideration," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 2(4), pages 419-441, December.
    12. Olivier Jean Blanchard & Kenneth A. Froot & Jeffrey D. Sachs, 1994. "The Transition in Eastern Europe, Volume 1," NBER Books, National Bureau of Economic Research, Inc, number blan94-2, June.
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    More about this item

    Keywords

    liberalization; transition; recession; adjustment cost; government transfers; reservation wage; heterogeneity;

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure
    • J60 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - General
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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