Essays on the economics of transition: Why is "big bang" implosive in output and explosive in prices, while controlled marginal reform isn't?

Abstract

This dissertation explores why "big bang" reform in Eastern Europe and the former Soviet Union (EEFSU) has led to output collapse while controlled reform in China has promoted growth. This dissertation presents a unified theory that attributes output collapse in EEFSU to price liberalization and decentralization, and China's growth to marginal marketization and intramarginal regulation. In the model economy, industries depend on each other for intermediate inputs. The inter-industry dependence in the presence of imperfect competition creates negative pecuniary externalities in that one industry's raising price or reducing output increases other industries' costs and reduces their demands. Under central planning, industries are fully integrated and the externalities internalized. With big bang, decentralized decision-making by the monopolistic and interdependent industries leads, in a Nash equilibrium, to reduced output, lower profits, and higher prices. Controlled reform in China, however, requires industries to fulfill planned output quotas at planned prices, while allowing them to sell above-the-quota output at market prices. The quotas reduce the effect of externalities since they force each enterprise to produce at least its planned output. Moreover, since additional sales do not lower planned prices on the quotas, industries have an incentive to produce beyond the quotas. This dissertation also studies the effectiveness of China's industrial reforms between 1980-89 using a panel data set of 769 state enterprises from 36 2-digit industries. I derive and apply a method that measures marginal products of factors, changes in total factor productivity (TFP), and improvements in factor allocation between enterprises by comparing actual changes in output to actual changes in inputs. Under this approach, the production functions can differ arbitrarily across firms. Market power in product markets and deviations from efficient allocation of factors are also permitted. The major findings are: (1) There were marked improvements in marginal productivity of factors between 1980-89. (2) Improvements in TFP and factor allocation accounted for 45 percent and 28 percent of output growth. (3) Over 80 percent of the improvements in TFP were attributable to increases in employees' financial incentives and to intensified market competition.