Transition and the Output Fall

Abstract

We present a model to explain why in transition economies of Central and Eastern Europe an important output fall has been associated to price liberalization. Its key ingredients are search frictions and Williamsonian relation-specific investment implying that new investments are made only after having found a new long ten-n partner. When all firms search for new partners, output may fall because of three effects: a) disruption of previous production links, b) a fall in investment, C) capital depreciation due to the absence of replacement investment. We show that forms of gradual liberalization like the Chinese "dual-track" price liberalization may avoid or reduce the transitory output fall.