GABLER EDITION WISSENSCHAFT Wunner The Political Economy of Transition Norbert Wunner The Political Economy of Transition International trade, factor market imperfections, and structural adiust ment With a foreword by Prof. Albert Schweinberger, ph.D. Die Deutsche Bibliothek -ClP-Einheitsaufnahme Wunner, Norbert: The politicol economy of tronsition : internotional trade, factor morket imperfections, and structural adjustment / Norbert Wunner. With 0 foreword by Albert Schweinberger. -Wiesboden : Dt. Univ.-Verl. ; Wiesbaden : Gabler, 2000 (Gobler Edition Wissenschaft) lugl.: Konstonz, Univ., Diss., 1998 ISBN 978-3-8244-7242-0 ISBN 978-3-322-89642-1 (eBook) DOl 10.1007/978-3-322-89642-1 1. Aufloge September 2000 Aile Rechte vorbeholten © Betriebswirtschaftlicher Verlag Dr. Th. Gabler GmbH, Wiesbaden, und Deutscher Universitats-Verlag GmbH, Wiesbaden, 2000 lektorot: Brigitte Siegel/Julia Hinrichsen Der Gobler Verlag und der Deutsche Universitats-Verlog sind Unternehmen der Fochverlogsgruppe BerielsmannSpringer. Das Werk einschlieBlich aller seiner Teile ist urheberrechtlich geschUtzt. Jede Verwertung aul3erholb der engen Grenzen des Urheberrechtsgesetzes ist ohne lustimmung des Verlage~ unzulassig und strafbar. Das gilt insbeson dere fur Ver-vielfaltigungen, Ubersetzungen, Mikroverfilmungen und die Ein-speicherung und Verorbeitung in elektronischen Systemen. http://www.gabler.de http://www.duv.de Hi:ichste inhaltliche und technische Qualitat unserer Produkte ist unser liel. Bei der Produktion und Verbreitung unserer Werke wollen wir die Umwelt schonen. Dieses Buch ist deshalb ouf saure freiem und chlorfrei gebleichtem Popier gedruckt. Die EinschweiBfolie besteht aus Polyethylen und domit aus organischen Grundstoffen, die weder bei der Herstellung noch bei der Verbren nung Schodstoffe freisetzen. Die Wiedergabe von Gebrauchsnamen, Handelsnomen, Worenbezeichnungen usw. in diesem Werk berechtigt auch ohne besondere Kennzeichnung nicht zu der Annahme, doss solche Na men im Sinne der Warenzeichen- und Markenschutz-Gesetzgebung als frei zu betrochten waren und doher von jedermonn benulzl werden dUrften. To Simone Foreword Economists nowadays face two challenges of truly global dimension; on the one hand the division of the world into developed and developing countries and on the other the set of issues arising in the transition of former centrally planned to efficiently working market economies. International trade or more generally globalisation play a crucial role in this context. Dr. Wunner's thesis focuses on one key aspect of the transition from centrally planned to market economies: the restructuring of the economy and the special role played by for eign trade in this. Whilst there exists a fairly broad consensus on the targets of transition the impression conveyed by the received literature is that there is considerable debate on the path which the economy should follow to reach the targets. This is not surprising. The literature on transition economics is motivated by events and problems of the real world. There are no clear-cut theoretical benchmarks. Probably the most important contribution of Dr. Wunner's thesis is to have taken a significant step towards the integration of the extremely amorphous literature. The book discusses and evaluates a wide variety of approaches to the key issues of transi tion: macroeconomic stabilisation, privatisation, liberalisation and above all the thorny problems raised by the required restructuring of the economy. Economic policy issues playa pivotal role in the thesis. The author makes use not only of second best analysis and political economy models but also relates the former to the latter. This is one of the key aspects in which the thesis is truly innovative. Another fine contribution is the integration of issues of structural adjustment with the other key issues of transition mentioned above. The author highlights in his analysis of structural adjustment a number of institutional features in transition economies which impede the desirable reallocations of labour and capital. The thesis contains chapters which are easier to read and others which are technically more demanding. However a most valuable feature from the reader's point of view is that the thesis is very reader-friendly. There is no tendency to ride hobby horses or to sell preconceived ideas. There exists by now a huge literature on transition economics but to the best of my knowledge there is no book which combines such a comprehensive, integrated and well balanced treatment of the key issues of transition with a focus on problems of restructuring in the context of economic policy making. Albert G. Schweinberger Preface Ten years after the start of transition in Central and Eastern Europe, the experience in different countries is decidedly mixed. Some countries have made great strides towards the establishment of a free market economy and a democratic political system and are now facing the realistic prospect of soon joining the European Union. In others, democratic consolidation and market-oriented economic reforms still have a long way to go and it is far from obvious, if and when these countries will eventually catch up. But even in the case of the frontrunners of reform, the transition process has been by far more painful and protracted than was initially expected. Early predictions of a swift economic recovery and rapid democratic consolidation have clearly underestimated the complex nature of the transition from socialism. This transition involves many different dimensions, which are all inextricably linked and which cannot be tackled in isolation. Successful macroeconomic stabilisation hinges on simultaneous structural reforms, which prevent the continuation of soft budget constraints and the repeated bail-out of enterprises. On the other hand, economic restructuring requires at least some degree of macroeconomic stability in order for prices to give the right incentives for investment decisions. It has also become increasingly clear that successful economic reforms depend not only on progress with regard to stabilisation and liberalisation, but also on good political governance. Political reforms, including for instance the emergence of a civil society or a democratic party system, are thus important prerequisites for economic change, just as successful economic recovery may foster a climate that is conducive to democratic consolidation. It is these interdependencies between different reform elements, which have presented the greatest obstacle for political and economic reforms in Central and Eastern Europe and which are the main focus of this book. In the first part, the book gives a detailed overview of the main stylised facts of transition so far and disentangles at least some of the interdependencies facing economic and political reforms in former socialist countries. The second part then analyses one particular set of interdependencies - in the context of economic restructuring - in greater detail. It shows how factor market imperfections, both in the labour and in the capital market, and political economy factors impinge on the process of structural adjustment. While the integration of transition economies into the world economy presents great opportunities for these countries, the structural changes associated with trade liberalisa tion are severely hampered by ubiquitous market imperfections. Underdeveloped financial markets and only ill-functioning labour markets are at the heart of many of the problems x Preface encountered in the context of economic restructuring. At the same time, endemic rent seeking and tight political constraints for the viability of reforms prevent many of these imperfections from being tackled more effectively. In combination these factors thus delay not only the process of economic restructuring but protract the whole transition process. The analysis here therefore underlines the need for a comprehensive and well-balanced approach to political and economic reforms during transition. In both respects, emphasis should be given to the building of sound institutions and to the provision of good and effective governance, which adequately reflects the complex, multi-dimensional nature of transition and the political and economic realities in these countries. This book has been accepted as a doctoral thesis by the Faculty of Economics and Statistics at the University of Konstanz in July 1998. In writing this thesis, I have benefited greatly from comments and suggestions from many different sides. I would like to thank in particular my supervisor Albert Schweinberger for many inspiring discussions and for the enthusiasm and openness with which he supported the writing of this thesis. Special thanks are also due to Heinrich Ursprung and Arye Hillman who have provided extremely helpful advice and great encouragement throughout. Many friends and colleagues at the University of Konstanz have contributed to this book through numerous discussions and have made the writing of this thesis a very pleas ant and rewarding experience. I would like to thank especially Max Albert, Axel Behrens, Bodo Hilgers, Achim Korber and Jiirgen Meckl for their immeasurable support and for their help in clarifying many points. I have also received numerous useful comments from Rolf Bommer, Udo Broil, Jan Fidrmuc, Claus Knoth, Karl-Josef Koch, Martin Paldam, Christoph Pleitgen, Hartmut Pohl, Richard Portes, Gert Tingaard Svendsen, Xavier de Vanssay, and Ulrich Wacker. Financial assistance for this project by the Volkswagen-Foundation is gratefully ac knowledged. Above all I would like to thank my wife, Simone, for her continuous support and encouragement. Without her endless patience and understanding the completion of this book would not have been possible. Norbert Wunner Contents 1 Introduction 1 l.l Objective ........... . 2 1.2 Facets of transition ...... . 4 1.3 On the economics of transition. 5 1.4 Structure 6 I The economics of transition 9 2 Stylised facts 11 2.1 Legacies of central planning ......... . 11 2.1.1 General features of socialist economies 11 2.1.2 Foreign trade in socialist economies .. 17 2.1.3 The financial system in socialist economies 19 2.1.4 Reforming socialist economies 20 2.2 Transition policies and developments 21 2.2.1 Transition policies 22 2.2.2 Economic developments 26 3 Transition in Eastern Europe 35 3.1 Perspectives on transition . 36 3.2 Dimensions of Transition . . 40 3.2.1 Macroeconomic Stabilisation. 43 3.2.2 Privatisation. 48 3.2.3 Liberalisation ........ . 54 3.2.4 Restructuring ........ . 58 3.3 Summing Up: What is "Transition"? 62 4 Economic theory and transition 65 4.1 Walrasian general equilibrium theory and beyond 66 4.2 Second-best analysis: the role of distortions. 72 4.2.1 Basic assumptions ........ . 72 4.2.2 Implications for transition .... . 74 4.3 Political economy: the role of distribution. 76 XII Contents 4.3.1 Basic assumptions ..... . 76 4.3.2 Models of the political process 78 4.3.3 Implications for transition . . 83 4.4 Rents and distortions: a unified framework 84 II Economic restructuring, international trade and factor markets 87 5 Labour re-allocation 89 5.1 Structural change and factor re-allocation ........ 90 5.2 Labour adjustment and structural change. . . 94 5.2.1 Labour adjustment, unemployment and economic restructuring 94 5.2.2 Labour adjustment, unemployment and growth 100 5.2.3 State enterprises and economic restructuring . . 104 5.2.4 Political economy aspects of labour adjustment 106 5.3 Labour adjustment and the path of transition .. 108 5.3.1 The basic framework . . . . . . . . . . . . . . . 109 5.3.2 Economic transition without governmental interference 111 5.3.3 Economic transition and political support 112 5.3.4 Transition policies and the speed of restructuring 114 5.4 International trade and labour adjustment .... 120 5.4.1 A stylised model of economic restructuring 121 5.4.2 Effects of trade policy ....... . 126 5.4.3 Second-best trade policy . .. .. 128 5.5 The political economy of trade liberalisation . . . 129 5.5.1 The political process in transition economies 129 5.5.2 Trade policy in a static setting .... 131 5.5.3 Trade policy in a dynamic setting .. 133 5.5.4 Endogenous trade policy and welfare 135 6 Capital markets and transition 139 6.1 Financial markets in transition economies 140 6.1.1 Functions and problems of financial markets 140 6.1.2 Reforms of the financial sector .... 145 6.1.3 Financial markets and restructuring. . . . . 151 6.2 Capital markets and the transition process .. 152 6.2.1 Intersectoral capital mobility and price liberalisation 153 6.2.2 Capital accumulation and structural change 154 6.2.3 Credit availability and the collapse of output. 157 6.2.4 Risk diversification and structural change. 161 6.3 Imperfect capital markets 166 6.3.1 Missing markets. .... . . .. . .. 167