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Price Liberalization and Output Decline in Transition

  • Saso Polanec

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.

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Paper provided by LICOS - Centre for Institutions and Economic Performance, KU Leuven in its series LICOS Discussion Papers with number 15304.

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Length: 33 pages
Date of creation: 2004
Date of revision:
Handle: RePEc:lic:licosd:15304
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  1. 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.
  2. Andrew Atkeson & Patrick J. Kehoe, 1993. "Social Insurance and Transition," NBER Working Papers 4411, National Bureau of Economic Research, Inc.
  3. Tito Boeri, . "Optimal Speed of Transition 10 Years After," Working Papers 154, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  4. 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.
  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. Gérard Roland, 2004. "Transition and Economics: Politics, Markets, and Firms," MIT Press Books, The MIT Press, edition 1, volume 1, number 026268148x, June.
  7. 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.
  8. Tito Boeri & Katherine Terrell, 2001. "Institutional Determinants of Labor Reallocation in Transition," William Davidson Institute Working Papers Series 384, William Davidson Institute at the University of Michigan.
  9. 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.
  10. 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.
  11. Kornai Janos, 1994. "Transformational Recession: The Main Causes," Journal of Comparative Economics, Elsevier, vol. 19(1), pages 39-63, August.
  12. Blanchard, Olivier Jean & Froot, Kenneth A. & Sachs, Jeffrey D. (ed.), 1994. "The Transition in Eastern Europe, Volume 1," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226056609.
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