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DISORGANIZATION
Olivier Blanchard + Michael KMWvcf"
96-30
October, 1996
massachusetts
institute of
technology
50 memorial drive
Cambridge, mass. 02139
DISORGANIZATION
Olivier Blanchard » ^ctaxel Ktev*t
96-30
October, 1996
Disorganization
Michael Kremer
Olivier Blanchard
*
Department of Economics, MIT, Cambridge,
mer@mit.edu)
Greif,
.
02138. (blanchar@mit.edu) and (kre-
We thank Susan Athey, Abhijit Banerjee, Simon Commander, Bill Easterly, Avner
Dani Kaufmann, Gian-Maria
Andrei Shleifer
MA
*
for discussions
for research assistance.
Milesi-Ferreti,
and comments.
We
Wolfgang Pesendorfer,
Julio
Rotemberg and
thank Maciej Dudek and Andrei Sarychev
Michael Kremer thanks the Research Department of the International
Monetary Fund, where some of the
initial
work
for this
paper was conducted.
Disorganization
Abstract
Under
central planning,
many
firms relied
on a
single supplier for
inputs. Transition has led to decentralized bargaining
ers.
be
Under incomplete contracts
inefficient,
many
of their
between suppliers and buy-
or asymmetric information, such bargaining can
and the mechanisms that mitigate
this
problem
in the
West can only
play a limited role in transition. For example, the scope for long-term relations to
reduce opportunistic behavior
to disappear or
disorganization,
change most of
is
limited
existing firms are expected
their suppliers in the future.
and a sharp decrease
that disorganization has played a
than in Central Europe.
when many
in output.
The
more important
The
result has
been
empirical evidence suggests
role in the former Soviet
Union
Disorganization
Figures
1
and 2 show the evolution of official measures of GDP
The two
of the former Soviet Union, since 1989.
in the countries
figures give a striking picture,
that of an extremely large decline in output. In 10 out of the 15 countries,
for
1996
is
expected to stand at
The evolution
unreported
still
of these
activities.
official
less
than half its 1989
measures
GDP
level.
reflects in large part a shift to unofficial,
But studies which attempt to adjust
for unofficial activity
conclude that there has been a large decline in output. For example, a recent
study,
by Kaufmann and Kaliberda [1995], puts the actual decline in
GDP
from
1989 to 1994 for the set of countries of the former Soviet Union at 35%, compared
to a reported decline of about
50%. x
This large decline in output presents an obvious challenge
ory.
Given the myriad price and trade
for neo-classical the-
distortions present under the Soviet system,
these countries surely operated far inside their production frontier before transition.
With
the removal of these distortions, one would have expected
operate closer to the frontier, and thus output to increase.
expected that the development of new
tier out,
activities
would
And
them
to
one would have
production fron-
shift the
leading to further increases in output over time. This clearly
is
not what
has happened.
In this paper,
we explore one explanation
lieve has played
1.
an important
role.
for the decline of output,
The best word
to describe
it is
which we be-
disorganization.
Estimates for a number of other studies are given and discussed in European Bank for Recon-
struction and
Development [1996], Annex
11-1.
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Disorganization
goes as follows:
Its logic
•
Central planning was characterized by a complex set of highly specific relations
between
"specific"
if
firms. (Following
there
is
standard usage, we shall
call a relation
a joint surplus to the parties from dealing with
each
other rather than taking their next best alternative.) There were typically
fewer firms in each industry than in the West. 2 For
or
knew
firms
•
many
of only one supplier from which to buy. For
had
or
Specificity
knew
of only one buyer to
opens room
for bargaining.
complete contracts, the
whom
many
had
of their goods,
3
Under asymmetric information or
result of bargaining
set of highly specific relations
to sell.
inputs, firms
may be
can thus lead
to a
inefficient.
in-
A complex
poor aggegate outcome,
with large effects on total production.
•
Through various
institutions
and arrangements, economies develop ways of
limiting the adverse effects of specificity:
Under central planning,
the
main instrument was the coercive power of the
central planner to enforce production
In the West, for
some goods, there
eliminating specificity altogether.
verse effects of specificity
is
and delivery of goods.
are
And
many
alternative buyers
for other goods, the
2.
scope for ad-
between
firms.
Transition eliminated the central planner, and thus the main instrument
One
reason
is
that, in the
create incentives for entry of
3.
sellers,
reduced by arrangements ranging from vertical
integration, to contracts, to long-term relations
•
and
The buyer was
transition.
West, (non natural) monopolies and associated monopoly rents
new
firms.
There was no such mechanism under central planning.
often a centralized trade organization, which disappeared altogether during
Disorganization
used to limit the adverse effects of specificity under the previous regime.
But the mechanisms which
West could not operate
exist in the
right away.
New buyers and sellers cannot be created overnight. The role of contracts is
reduced when many firms are close to bankruptcy. At the same time, transition has created the anticipation that
change
many
suppliers, thus shortening horizons
state firms will disappear or
and the scope
for
long-term re-
lations to avoid the adverse effects of specificity.
•
The
result has
been the breakdown of many economic
between the republics of the former Soviet Union has
than seems consistent with
tion,
many
crucial workers/managers,
turing
it
and
and raw
who may have been
survival. Cannibalization of
fallen by far
more
materials. Firms lose
their only
machines
Trade
Despite price liberaliza-
efficient reallocation.
firms report shortages of inputs
relations.
is
hope
for restruc-
widespread, even
when
appears that machines would be more productive in their original use.
This general disorganization has played an important role in explaining the
decline in output.
Our paper
•
is
organized as follows:
In sections
1
to 3,
we show through
three examples
how specificity,
together
with either incompleteness of contracts or asymmetric information, can lead
to large output losses.
We
show how the
effects
depend both on the degree
of specificity in the relations between firms, and on the complexity of the
production process.
portunities
can lead
We show
also
how
to a collapse of
the emergence of
new
private op-
production in the state sector, and to a
sharp reduction in total output.
•
In section
4,
we argue
that the
mechanisms used
in the
West
to deal with
Disorganization
specificity take time to
transition.
that
it
makes a
In section
•
We
develop and have therefore played a limited role in
also discuss the policy implications of our theory,
—
limited
—case
and argue
for gradualism.
taking measures of reported "shortages" of inputs by firms as
5,
indicators of disorganization,
we show
that disorganization appears to have
played an important role in the former Soviet Union, but a more limited
one
in Central Europe.
Before starting,
Our
analysis
is
it
may be
useful to
do some product
differentiation.
based on standard ideas in microeconomics, from asymmetric in-
formation, to hold-up problems under incomplete contracts, to the breakdown
of cooperation in repeated games as the horizon shortens or as alternative opportunities arise.
4
The
potential importance of specificity for
has been emphasized recently by Caballero and
tion
is
Hammour
macroeconomics
[1996].
Our contribu-
to point to the potential importance of these problems in the context of
transition.
Our
analysis
Most explanations
tion.
form,
may
complements other explanations of the decline
and
for
new
start
from the need
private firms to emerge.
reflect efficient reorganization
capital, as firms try
4.
On
this last topic, see for
tion within households,
development.
for state firms to decline
Some
for
example). In contrast,
Newman
trans-
in information
look for the right jobs. (Atkeson
example Wells and Maher [1995]
and Banerjee and
and
argue that the output decline
and unmeasured investment
new techniques and workers
and Kehoe [1992], Shimer [1995]
in output in transi-
for
we see
the evidence
breakdowns of coopera-
[1993] for an example in the context of
Disorganization
as reflecting in large part inefficient disorganization.
reallocation with
some remaining
Other explanations combine
distortion, explaining the decline in output as
a second-best outcome. Perhaps the most widely accepted explanation argues
that efficient reallocation
would have implied a decrease
in real
wages of some
workers inconsistent with either actual wage determination or political concerns
about income distribution; as a result of these contraints, employment and output
have decreased
(see
Blanchard [1996]).
Soviet Union as showing that there
theories are related to ours.
The
We
more
is
first,
read the evidence from the former
at work,
namely disorganization. Two
developed by Murphy et
phasizes the adverse effects of partial price liberalization.
al.
[1992],
em-
The second, developed
by Shleifer and Vishny [1993], focuses on the role of corruption, and emphasizes
the adverse effects of rent extraction by government
the relations as
1
we go
officials.
out
along.
A chain of production
This and the next two sections develop three examples,
ing different
mechanisms through which
in output during transition.
•
We shall point
A good
is
The
first is
produced according
of production.
Each
firms
three aimed at captur-
can lead
also the simplest.
It
step of production
We
is
to a large decline
goes as follows:
to a Leontief technology
(A point of semantics here.
firm
specificities
all
and requires n
carried out by a different state
shall use "state" firms to
denote the
which existed under central planning and produced under the plan,
whether or not they have been privatized since the beginning of
We
steps
shall use "private" firms to
transition.
denote the firms which have been created
.
Disorganization
One
since transition.)
one unit of the
One may
leads, after the
n
steps, to
good. Intermediate goods have a value of zero.
final
price of the final
good
unit of the primary
good
is
The
normalized to one.
replace "production" by "distribution" here: an interpretation
with a Soviet Union flavor
is
good having
that of a
to travel
through n
provinces/republics, to go from the primary producer to the final distributor.
•
The
supplier of the primary good has
to
One can
a
c.
for the input equal
think of c as a private opportunity, perhaps the production of
much simpler good,
production; c
an alternative use
may
avoiding the division of labor implicit in the chain of
therefore be
much
lower than
1. (It is
straightforward to
introduce similar private opportunities for the intermediate producers along
the chain of production. But the point
is
made more simply by
ignoring this
possibility.)
Each buyer along the chain knows only the
•
central planning,
and
bargaining problems.
vice-versa.
We
The end
supplier
it
was paired with under
of central planning thus leaves
assume that there
is
Nash bargaining
at
n
each step
of production, with equal division of the surplus from the match.
The characterization of the solution is straightforward and is obtained by working
backward from the
last
The value
stage of production.
of the surplus in the last
bargaining problem, between the final producer and the next-to-last intermediate
producer
is
equal to
1
(by assumption, the
good
is
useless before the final stage)
Thus, the next-to-last intermediate producer receives
the
first
The
intermediate producer receives (l/2) n
surplus to be divided between the
plier of the
primary good
is
first
equal to (l/2)
(1/2).
Solving recursively,
.
intermediate producer and the supn
—
c. If
c
<
(l/2)
n
,
the surplus
is
Disorganization
positive
and production takes place along the chain.
If
>
instead c
(1/2)", the
primary producer prefers to take up his private opportunity. Thus, the appearance
of even mediocre private opportunities will lead to the collapse of production in
may be
the state sector: the decrease in total output
example (what matters here
is
as large as
— (l/2) n
1
in
our
not the absolute level of private opportunities,
but their level relative to opportunities in the state
sector.)
The more complex
the structure of production (the higher n), the smaller the private opportunities
needed
to trigger the collapse of the state sector.
Avoiding the adverse
effects of specificity in
a problem faced by firms in the
sufficiently specific that firms
one buyer.
We
West
complex structures of production
as well.
Even
can only get them from one
shall discuss in
The source
many goods
supplier, or sell
are
them
to
Section 4 below the mechanisms which alleviate
the adverse effects of specificity in the West, and
role in transition.
in the West,
is
why they have played
a limited
But a few points are worth making here already.
of the inefficiency and of the collapse of output in our example
a hold-up problem:
each intermediate producer must produce
its
is
intermediate
good before bargaining with the next producer along the chain. Once he has
produced the intermediate good and has no alternative use
value
The
is
for
it,
his reservation
equal to zero.
inefficiency
would therefore disappear
if all
the producers could sign an en-
forceable contract before production took place. In this case, production
take place so long as c was less than
ceive
1
—
specificity,
c of the output.
which gives
The source
rise to
1,
and the producers
of the problem
the bargaining problems,
is
as a
would
whole would
re-
thus the combination of
and incomplete
contracts.
8
Disorganization
The assumption of incomplete contracts seems quite
former Soviet Union.
ment
is
The
legal
system
reasonable in the case of the
in construction. Contract enforce-
is still
notoriously weak. Firms often have few valuable assets, making
punish them
for deviating
Another natural solution
it
hard to
from the contract.
is
vertical integration. In our
tegration (which effectively reduces the
from n to a smaller number)
,
number
example, even partial
of bargaining problems
alleviates the problem,
and
full vertical
in-
down
integra-
tion (where one decision-maker decides whether or not to produce) eliminates
it.
Even short of vertical
integration, long-term relations
also alleviate the problem. If they are
may be
ing
it
willing to pay their supplier
more
likely that
engaged
2
in a long-term relation, producers
more than the
price
we derived above, mak-
production takes place in the chain. As we shall argue in
Section 4 however, the nature of transition
vertical integration
between producers can
and
for
is
such that
it
reduces the scope for
long-term relations to induce such behavior.
A state firm and its suppliers. I
In our second example, the source of inefficiency
is
not incomplete contracts but
asymmetric information:
•
•
A state firm needs n
inputs in order to produce.
the firm can produce
n
Each input
is
for his input,
If all
inputs are available,
units of output. Otherwise, output
is
equal to zero.
supplied by one supplier. Each supplier has an alternative use
with value
c,
distributed uniformly
the distribution function, so that F(0)
pendent across
suppliers.
=
on
and F(c)
[0,c].
=
1.
Let F(.) denote
Draws
are inde-
Disorganization
We
can again think of c
as a private sector alternative,
production or sale of the input to a foreign buyer.
known, but the
specific realization of each c
is
The
such as small scale
distribution of c
is
private information to each
can be thought of as indicating the degree of development of the
supplier, c
private sector,
which we assume
is
very low pre-transition, and increasing
over time thereafter.
The
•
state firm
maximizes expected
each supplier (given the symmetry
to
price
is
the same for
of
suppliers, production takes place in the state firm. Otherwise,
all
tion of c
and
all
all
suppliers). If the price
suppliers use their
and
n.
own
Given price
first
to profit
term
if
it
does
private opportunity.
private,
and
total
production as a func-
p,
expected
profit
is
=
is
given by:
(F(p))
n
(l-p)n
the probability that production takes place.
The second
is
equal
production takes place. Maximizing with respect to p yields the profit
maximizing
price:
p
the
exceeds the reservation prices
We must first solve for the profit-maximizing price set by the state
ir
The
built in the assumptions, the
p
We can now characterize expected state,
The
take-it or leave-it
price
not,
firm.
announces a
profit. It
firm never pays
maximum
=
min(c
,
—
—
n
+
-)
I
more than the maximum alternative opportunity,
alternative opportunity exceeds (n/(n
+
1)),
c.
But,
if
the firm does not
Disorganization
increase
its
10
price. Increasing the price
would increase the probability that pro-
duction takes place, but would decrease expected
Given
this price,
Y
expected state production,
Y =
s
,
is
,
is
,
(
equal
n
—
— -)
n + lc
1
nmin(l
Yp
Expected private production,
s
profit.
to:
n
)
equal to the probability that state production
does not take place, times the conditional expected sum of alternative opportu-
on
nities (conditional
at least
offered by the state firm)
.
one private alternative being
Yp can be written as:
n
nr
^ = ^(0,1-^1)
Expected
total
larger than the price
production
is
\
n+1
)
in turn equal to
Y = Y + Yp
s
The best way
to see
the behavior, for
what these equations imply
n '.==
4,
figure,
would be the outcome
to look at Figure 3,
it is
useful to
if the
for values of c
keep the
monopsonist was
efficient
fully
for inputs
(all
plots
three
ranging from 0.4 to 2.4.
benchmark in mind (which
informed about the alternative
opportunities of each supplier and thus was fully discriminating, or
markets
which
of expected state, private and total production
normalized by the number of inputs, n)
To interpret the
is
if
there were
which revealed these alternative opportunities). So long
as c
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Disorganization
was
1
than one, production would always take place in the state
less
increased above one,
would sometimes be
it
efficient
production would increase. Eventually, as c became very
would take place in the private
with
linearly
sector,
As
c
not to produce in the state
expected production in the state sector would decrease, but
sector:
sector.
total
expected
most production
large,
with expected total production increasing
c.
In contrast with the efficient outcome, increases in private opportunities lead
initially to
such a large decrease in state production that the net
decrease in total production. Total production starts declining
(n/(n
tion
+
still
1))
=
.8.
For c equal to
the efficient
is
divided by the
a production level of only 0.75.
that total production
is
It is
number
a
c exceeds
outcome would be that produc-
of inputs).
its
The
actual
(1
outcome
in
is
pre-transition level.
in the state sector increases the size of the decline in
We can think of n as an index of the complexity of the production process.
Figure 4 shows the effects of alternative values of n
The
is
not before c has reached a value of about 2.0
again equal to
Complexity of production
total
when
only takes place in the state firm, with total production equal to n
the figure, as output
output.
1,
effect
on the evolution of expected
production (again normalized by the number of inputs) as a function of
larger n, the higher the price that the state firm offers: for c large
so that the
minimum
condition does not bind, p
=
n/(n
+
1).
c.
enough
Thus, the higher
n, the higher the value of c required to trigger the collapse of the state sector.
But, also the higher n, the smaller the probability that production takes place
in the state firm for c
total
>
n/(n
+
1),
and thus the greater the
production as c increases. As n approaches
state firm
infinity,
initial
collapse of
the price offered by the
approaches one, and state production collapses as soon as c increases
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Disorganization
12
above one: the probability that
at least
greater than one goes to one. Thus, as
one supplier
will
n approaches
have a realization of c
infinity,
the path of state
production (normalized by the number of inputs) approaches one
c/2 (the expected value of private production) for c
1,
output
falls
by
fifty
>
1.
for c
<
and
1,
When c increases above
percent.
Putting our results in words: Pre-transition, suppliers have such poor alternative
opportunities that the state firm can offer a price at which there
alternative than to supply.
suppliers
now have more
As
transition starts,
is
no better
and alternatives improve, some
attractive opportunities.
They
start asking the firm for
more. Not knowing which suppliers are bluffing and which are not, the firm has no
choice other than to offer a given price and take the risk of not getting the inputs.
The
result is
an
initial
decrease in total production as opportunities improve.
Let us take two sets of issues at this point:
(1)
This example
is
closely related to the analysis by
effects of partial price liberalization. In their
held fixed while others are
left free
Murphy
et
al.
[1992] of the
model, the fact that some prices are
can also lead
to
an
inefficient diversion of
output from state to private firms (Young [1996] argues that a similar perverse
mechanism
is
relevant in China)
occur even under
section 5) in a
full
.
Our argument
price liberalization.
that the
The presence
same perverse
effects
of reported shortages (see
number of former republics a number of years after nearly complete
price liberalization suggests that there
liberalization.
is
The
quite different.
is
indeed more at work than partial price
implications of the two models for policy are also potentially
The Murphy
et
price liberalization. In our case,
al.
[1992] model implies the desirability of
even under
full
price liberalization, output
full
may
13
Disorganization
be lower during transition than
(2)
it
was under central planning.
We have assumed that the sellers had private information, and that the seller
set the price.
What is essential here is
that there be private information,
some bargaining power. Suppose
the uninformed party have
for
and
that
example that the
firm has private information about the value of final production, but that, now,
suppliers
tunities,
sum
make
price offers to the firm.
and choose the
Assume
that they have
maximize
price so as to
of the prices charged by suppliers
is
their
no private oppor-
expected revenue.
It is
probability increases in the
tion process, the
more
pliers.
likely
is
on output.
There
is
also easy to
state production to collapse,
show
that
that this
is
even in the absence
closely related to results
on the adverse
We have assumed that the price setters were sup-
But, absent the rule of law, they
to operate the firm.
It is
much and
that,
number of suppliers: the more complex the produc-
5
of private opportunities. This result
effects of corruption
positive.
is
show
straightforward to
in this case, the probability that suppliers collectively ask for too
production does not take place
the
higher than the actual value of final
production, production does not take place.
final
If
may be government officials selling permits
therefore a close parallel
between our argument that
decentralized bargaining between firms has led to a decline in output, and the ar-
gument made by
Shleifer
5.
More
for
example uniformly on
formally,
the prices set by
assume that
all
common
1/(71+1).
Now consider
other suppliers as
price
is
=
(n
political decentralization has
inputs are supplied, output
if all
[0, 1].
chooses a price equal to pi
that the
and Vishny [1993] that
—
equal to p
p_,-.
is
equal to ne, with
the problem facing supplier
Supplier
i
maximizes (1
—
(p_,-
n/(n
+
1),
Denote the sum of
+ Vi)l n
p_,)/2. In the symmetric equilibrium
=
i.
e distributed
p_,-
=
)
Pi< ar| d
(n
—
^ us
l)p,-,
so
and the state firm produces with probability
.
Disorganization
14
led to competition
among
rent extractors, with large adverse effects
3
A state firm and its suppliers. 11
The
third
example shows how
coordination
failures,
is
more natural
and complexity can combine
specificity
here,
is
again Leontief in n inputs. Because the interpreta-
we think of the n
The
suppliers as the
n
crucial workers in
between
the firm. But this
is
previous model
in the timing of decisions. In the previous model,
is
to create
and a collapse of output.
In this model, technology
tion
on output. 6
not essential.
essential difference
duction did not take place, suppliers could
still
this
if
and the
state pro-
take up their private opportunity.
Here, suppliers have to decide whether or not to take their private opportunity
before they
know whether production
is
taking place in the state firm. This dif-
ference in timing introduces problems of coordination between workers, which
we now examine.
The model
is
as follows:
A state firm needs n workers in order to produce efficiently. Assume that its
•
technology
is
Leontief in those workers (who are therefore the workers
are difficult to replace;
we can think of
who
the other workers as having been
solved out of the production function)
If all
workers
stay,
the firm produces n units of output, equivalently
output per worker.
6.
If
is
given by
unit of
one or more workers leave, the firm can hire replace-
Empirical evidence on the number and the
today
1
Kaufmann and Kaliberda
size
[1995].
of bribes needed to run a business in Ukraine
15
Disorganization
merits; replacements are
or
however
less productive. If the firm
more replacements, output per worker
Thus n measures
7 (which was
1.
the complexity of the production process.
implicitly put equal to zero in the first
measure of the
<
equal to 7
is
has to hire one
The parameter
example)
is
an inverse
specificity of existing workers.
Each worker has an alternative opportunity given by c, distributed uniformly
•
on
[0, c].
Draws
known, but the
are independent across workers.
specific realization of each c
The
distribution of c
private information.
is
is
We can
think of cas representing the opportunities open to the most qualified workers after transition,
from opening their
own
business, to working for foreign
consulting firms, and so on. 7
The wage
•
paid
is
equal for
workers
all
from the assumption
(this follows
that alternative opportunities are private information,
and the symmetry
in
production), and
is
equal to output per worker. This assumption simplifies
the analysis, and
is
reasonable in the case of
many former
state firms, but
the analysis would be qualitatively similar as long as wages increased with
other workers' participation.
Workers must decide whether
•
they
know
to take
the decisions of other workers,
the wage per worker in the state firm.
so that their decision
7.
An
is
is
If all
We
their private opportunity before
and thus the
level of
assume that they are
output and
risk neutral,
based on the expected wage.
alternative interpretation of this
ferent costs of effort.
worker
up
workers put
model
effort,
is
as a
model of
output per worker
shirking,
is
one.
If
where workers have
some do
dif-
not, output per
equal to 7 instead. Under that interpretation, one may interpret the model as applying
to all workers.
1
Disorganization
Thus,
wage,
tive,
16
workers decide to
if all
is
equal to one.
If
output per worker, and therefore the
stay,
one or more workers take up their private alterna-
some replacement workers must be
hired,
and output per worker and
the wage are equal to 7.
It is
form: Stay
c*,
problem facing each worker has the following
clear that the solution to the
if
c
less
is
than some threshold
c*,
otherwise leave. To characterize
think of the decision problem facing one worker.
his alternative opportunity,
Given
that,
he
will
by symmetry, the (n
to c*, the probability that they
receive
—
all
1)
Suppose he decides instead to
c.
n_1
+
(1
-
(F(c*))
stay
n-1
is
The
)7.
stay.
other workers also have a threshold equal
given by (F(c*))
per worker, and thus the wage he can expect to receive
to (F(c*))
he leaves and takes up
If
if
n_1
.
he
threshold level c*
Expected output
stays,
is
is
thus equal
such that he must
be indifferent between leaving or staying, so that:
n—
»
c*
=
7 + min(l,(-)
c
)(l- 7 )
(3-1)
Expected output per worker, and thus the expected wage, are given
io
8.
Note the
different
exponents
alternative opportunity
from what the n
of the
as
n
is
—
1
=
+ min(l,
in (3.1)
and
(3.2),
when choosing whether
other workers will do.
wage and depends on what
large.
7
all
fy
(n
—
)(l-7)
1) versus n.
to stay or not,
The expected wage
n workers
do.
in turn by:
J
(3-2)
Each worker knows
his
own
and thus the uncertainty comes
is
the unconditional expectation
The difference between
c*
and
w goes to
zero
7
Disorganization
The solution
of
c.
1
These three cases
equation
on the
(3.1)
vertical axis against c*
=
represented by a 45-degree
which
•
initially
is
5,
and 7
line.
convex, turning
The
=
right
flat at c*
workers decide to
stay,
depending on the value
which
The
axis.
The
figure
is
left-hand-side of the equation
hand
=
both sides of
plots
on the horizontal
.2.
For low alternative opportunities, there
initial
types,
are represented in Figure 5,
drawn assuming values of n
is
can be one of three
to equation (3.1)
side
is
represented by a curve
1.
is
only one equilibrium, in which
all
leading to a level of output per worker equal
to one.
In Figure 5, the only equilibrium corresponding to the case where c
at point
•
=
.3 is
A.
For intermediate alternative opportunities, there are two equilibria (the
equilibrium in-between
all
is
unstable using standard arguments) one in which
,
workers stay and output per worker
ers are likely to leave,
where
c*,
and
is
one, and one in which most work-
in turn expected output per worker, are
close to 7.
In Figure
c* is 1.
5, for
At
c equal to
A and B. At A,
the two equilibria are at points
B, c* (and the expected
probability that at least
•
.7,
one worker
wage from
will leave
For higher alternative opportunities
—
for c
(3.2))
is
is
very close to
.2:
the
very high.
>
1
—
there
is
a unique, low
activity, equilibrium.
In Figure 5, for c
=
1.1, the
only equilibrium
is
at point B,
the expected wage, are both equal to a value close to
state sector
We want
is
.2:
very unlikely.
to emphasize
two separate aspects of these
results:
where
c*,
and
production in the
lo
O
CD
O
>
CD
>
oo
d
O
CD
CO
*.
d
<->
*
CD
Z3
^_
-Q
^3-
d
Z5
CT
UJ
LO
CD
CNI
d
ZS
o
o
I
01
80
90
*D
V0
Z'O
O'O
18
Disorganization
(1)
is
The
first is
some
the existence, over
not due to private information. To see
an alternative opportunity equal
7 and
c,
to a
range, of multiple equilibria. This result
this,
note that even
known value
there are two equilibria, one in which
(the efficient
outcome) and one
,
in
which
all
c,
all
when workers have
then, for values of c between
workers stay in the state firm
workers take up their alternative
opportunity.
Is
one equilibrium more
likely to prevail?
The arguments here
the one hand, the equilibrium with high production
is
one of pure coordination, so
if
worker
ravel.
if
each worker believes that there
will irrationally refuse to participate,
As n becomes
large,
tionally refuse to participate
can lead
is
is
better for
some
all
of them.
probability that
On
the
some other
then the high-equilibrium can unwill irra-
to the rational collapse of output.
fact that
which require the contribution of many
is
The game
even a small probability that one worker
This aspect of the model captures the
suppliers) imply
Pareto superior.
On
the workers can talk beforehand, they should
be able to coordinate on the equilibria which
other hand,
is
are standard.
specific
complex coordination problems.
the potential presence of multiple equilibria.
complex production processes,
workers (or/and
many
specific
A reflection of these problems
The argument was
first
made by
Bryant [1983] in the context of Western Economies. But the prevalence of specific relations
(and
we
shall argue in the
next section, the lack of mechanisms
designed to handle such coordination problems) makes
tries in transition.
Some
firms
it
more relevant
may disappear simply because
for
coun-
they are expected
to,
either by their suppliers or their essential workers.
(2)
The second
aspect derives from the combination between private informa-
Disorganization
tion
19
and interactions between decisions given the timing of
decisions.
It is
the
rapid collapse of state output as soon as the probability that at least one private
wage under efficient production
alternative exceeds the
positive. For
example,
for the case
value of private opportunities
if
is
where
=
c
in the state firm
1.1 in Figure 5 (so that the
only equal to .55, compared to
workers stay) the probability that
1
becomes
expected
in the state firm
workers stay in the state firm
all initial
nearly equal to zero, and expected production per worker in the state firm
close to
.2,
collapses, note that as
chance that a worker
is
will leave.
soon as c
The wage
is
greater than one, there
is
a
that remaining workers can expect to
thus reduced in proportion to the probability that at least one worker
reduction in the expected wage prompts more workers to
will leave. In turn, this
leave,
very
a highly inefficient outcome.
To see why output
receive
is
is
and so on. The
effect of higher values of
between the workers' decisions. For example,
worker in the state firm
equal to .92
is
if
n— 2,
n
is
to magnify the interactions
for c
=
but
falls
1.01,
expected output per
to .21
when n=3.
9
This aspect of the model appears to capture a number of aspects of transition.
It
captures the idea that crucial managers
large payoffs from turning
stay around long enough.
9.
To see the
it
If
may
leave a firm, despite potentially
around, because they are not sure that others
we
will
return to an interpretation of the model with sup-
role of timing decisions, these results
can be compared to those which obtain when
workers decide whether or not to take their private opportunity after having observed the decisions of others. In that case, the probability that
(l/c)
n
,
and expected output per worker
expected output per worker
in
in the firm
the state firm
is
all
is
workers stay
equal to 7
equal to .98
if
in the state firm
+ (l/c)"(l — 7).
n=2, and
.97
if
n=3.
is
For c
equal to
=
1.01,
20
Disorganization
pliers rather
than workers, the model
is
consistent with anecdotal evidence that
suppliers are often very reluctant to supply state firms, because of the difficulties
of getting paid.
If
they are not paid on delivery but only
producing and selling
pliers
become
if
the firm succeeds in
production, then, just like workers in our example, sup-
its
residual claimants, (this raises the issue of
why
state firms
do not
pay their suppliers on delivery. More on this in the next section.) The probability
that
one of them
will
not supply leads
all
of them to be leary of supplying, leading
to collapse of the state firm.
4
Managing
specificity
We have shown through three examples how specificity and complexity may have
combined
to lead to a large decrease of output during transition.
But these exam-
ples raise a general issue. If anything, the production structure in the
more complex than
it is
in the East.
West
is
even
Why aren't problems arising from specificity
as severe in the West?
We
have already hinted
(1) First, in
buyers and
the West,
at
some of the answers:
many goods are
many sellers. And
traded in thick markets, markets with
while for
many intermediate
many
goods, firms deal with
only one supplier, there are likely to be other potential suppliers, and shifting
suppliers
may be
difficult
but not impossible.
For
many goods however,
just
not enough suppliers or buyers in the economy to start with;
thick markets cannot be created overnight. There are
new
firms
must
be created, a process which takes time. Opening the economy to foreign trade
21
Disorganization
increases the potential
number
of buyers
and
sellers
can
clearly help here. In-
deed, one of the arguments for imposing convertibility and low
in
1990 was indeed
monopoly power of domestic
to limit the
tariffs in
Poland
firms by increasing
competition, an argument closely related to ours (Sachs [1993]).
(2)
Second, there
is
more scope
handle problems created by speci-
for contracts to
ficity.
The
potential role of contracts in solving or alleviating problems of specificity
clearest in our
tracts before
first
example. In that model,
if
production takes place, then they
achieve an efficient outcome. Total output
is
producers can sign binding conavoid hold-up problems, and
will
not decline
will
when
private oppor-
tunities improve.
There
question however that the scope
is little
lems such as hold-ups
is
more limited
in the East.
Russian legal system have been pointed out by
del [1994]): Contract enforcement
is
weak
for contracts to alleviate
The
many
prob-
deficiencies of the current
(for
example Greif and Kan-
our example, producers have an
(in
incentive ex-post to renege and offer a lower price to their suppliers. Contract
enforcement
is
therefore crucial) Firms have few assets
.
thus less to lose from breaking a contract. This
last
which can be
seized,
and
aspect takes us to the next
point.
(3)
Most state
liquid assets,
The
on "cash" (more
firms in transition are short
and limited access
precisely
have limited
to credit.)
potential role of cash in reducing problems
in our third example. Consider the case
coming from specificity
where there are two
which existing workers stay and productivity
is
high,
and one
in
is
clearest
equilibria,
one
in
which they leave,
22
Disorganization
forcing the firm to hire less efficient replacements.
A commitment by the firm to
pay each existing worker a wage of one, independently of what the other workers
do, will lead
all
workers to
stay,
and
will sustain the efficient equilibrium, at
no
cost to the firm.
Thus, firms with "deep pockets" can alleviate some of the problems arising from
specificity.
10
But state firms in the former Soviet Union typically do not have
such deep pockets: wages
access to credit, and
many
typically exhaust
most of revenues, firms have limited
are close to bankruptcy.
have no easy way of convincing
Under
these conditions, they
workers to stay or their suppliers to supply.
their
This argument points to the role of foreign direct investment: foreign firms typically
have deep pockets. They can pay suppliers on delivery; they can credibly
promise to pay their workers even
if
things go wrong.
They can
therefore avoid
the problems of coordination faced by state firms.
(4)
While
state firms
were often more vertically integrated than in the West,
the type of vertical integration needed to alleviate problems of specificity during
transition
is
different from
what
it
was in the
past.
The reason to vertically integrate under central planning was the imperfect ability
of the central planner to enforce timely delivery of some inputs, leading firms to
protect themselves against such disruptions. Sachs [1993] gives the example of
an
industrial firm installing pigpens to raise pigs
and insure the delivery of food
to their workers in the face of food shortages.
The type of vertical integration needed in transition,
lO.See Holmstrom [1982] for a related point.
as well as later on,
is
likely to
23
Disorganization
be different.
It is
most needed for those inputs with a high degree of specificity, and
thus a large potential for serious bargaining problems. Pigpens are not the answer
anymore: markets in agricultural goods have eliminated the problem. But the
problem may now be a
planning but
is
now
which was easy
specific engine part,
available from only
one
to get
under central
firm, raising issues of specificity
and
bargaining.
Thus, the existing structure of vertical integration can only play a limited role in
And creating new
transition.
vertically integrated structures of
has sharp limits and takes time.
production interlock.
The arguments here
When suppliers have
integrates with the buyer? Second,
are standard. First, chains of
more than one
if vertical
time not in the determination of input prices, but
of the purchase price of firms.
If
n
—
1
which supplier
we saw become
now
of the firms in our
integrate, the remaining hold-out firm has
buyer,
integration is to be achieved through
the purchase of existing firms, the bargaining problems
this
production both
an incentive
to
relevant,
in the determination
first
example
hold out
vertically
for a large part
of the rents, and thus a high purchase price. Thus, no firm will want to be the
first
to be vertically integrated. This suggests
to proceed
through the development of new
the development of
(5) Fifth,
new
much
of vertical integration needs
activities within the firm. This, like
firms, takes time.
but we think most important, the very nature of (any) transition
that there
is
is
such
limited scope for long-term relations in solving problems arising from
specificity.
In stable economic regimes, such as under central planning in the Soviet
in the past or in
Union
Western market economies today, long-term relations can play
24
Disorganization
an important
role in reducing inefficiencies arising
from
specificity,
who decide
take for example our third model, and assume that workers
a private opportunity cannot
work
.
logical reasons (they
have
to
move
will use a
much
workers
will
The
and higher expected production
is
is still
low,
there and relies
then workers
will
c*, for
if
it is
up
the optimal
private opportu-
More
formally, they
deciding whether to
result will be a higher probability that
workers
overall.
In that context, the value of c* will depend crucially
firm
Then,
think twice about leaving.
higher threshold, a higher value of
take up a private opportunity.
stay,
state firm.
to take
either for techno-
to another city) or because
punishment from the point of view of the
nities are temporary,
may be
this,
(one can again
for the state firm in the future
replace "workers" by "suppliers" in what follows) This
lb see
on the same workers
on the
probability that the
in the future. If this probability
behave opportunistically, in a way close to that charac-
terized in the previous section. But by the nature of transition, this probability
indeed
likely to
disappear,
well as
and
many
be low in transition: Transition implies that
that,
even
if
they survive, they
will
have
to
many
is
state firms will
change operations
as
of their suppliers.
In a neo-classical benchmark,
if it
took time for new more productive firms to
were
arise following transition, state firms
would continue producing
replaced by new, more efficient firms.
The argument we have just developed sug-
gests that the
mere anticipation that more
efficient private firms will eventually
appear can lead to a reduction in productivity in the state firms.
plain
why
the pre-official transition period in the Soviet
ized by increasing disorganization
until they
It
may
also ex-
Union was character-
and decreasing output,
as the shortening of
horizons led to more opportunistic behavior on the part of firms. There
is
indeed
25
Disorganization
some evidence that the degree
to
which
state firms felt they
had
to satisfy the
plan decreased in the Soviet Union with the increased likelihood of reform in
the mid-1980s.
n
This line of argument may explain also some of the difference between the experiences of China and Eastern Europe during transition. China's lower level of
industrial
development, and
its
explicit policy of decentralizing industry to
small factories implies that problems of specificity were less in the
et
al.
[1996]).
control
meant
bargaining.
place (Qian
the ability of the Chinese government to maintain political
that centralized allocation was not fully replaced by decentralized
And
China's
commitment
may have lengthened
necessary,
relations
And
first
many
between firms and
firms in the face of
new
to
maintain state
firms, using subsidies if
horizons, allowing for a larger role of long-term
their suppliers,
and thus avoiding the collapse of state
private opportunities. This last point naturally takes us
to a discussion of the policy implications of our theory.
implications.
(6) Policy
Suppose that in a neo-classical benchmark
on
so far)
time.
,
absent subsidies,
many
state firms
The argument we have developed
specificity are
11. This
taken into account,
argument can
(i.e
this
absent the effects
we have focused
can be expected to disappear over
implies that, once the implications of
may
well lead to the
immediate collapse
also explain the opposition of industry to laws requiring firms to provide
workers advance notification of plant shut-downs and why some firms decide simply to pay their
workers severance pay rather than providing notice. Ellickson [1989] notes that at the time of the
collapse of the nineteenth century whaling industry, the
among whalers began
to
break down.
norms of cooperation that had evolved
26
Disorganization
of those firms. Shorter horizons
cally,
may lead
suppliers to
behave more opportunisti-
leading to the collapse of state production. By the same argument, a
mitment by the government
to subsidize state firms for
com-
some time may avoid
their
immediate collapse. 12
Should a government commit
and thus avoid a
to subsidizing state firms,
lapse of state production at the beginning of transition? This will
col-
depend on the
expected path of private opportunities, on the time path of c in our example.
efficient private firms (firms
in the state firms) are
with values of c equal to or greater than productivity
expected to develop quickly, then a commitment to main-
taining state firms for a long time
accept the
fall
is
in initial output, in
likely to
exchange
be overly
for
(if
enough
c
is
higher production soon
is
after. If
expected to take more
that state production dominates private production for a long time)
justified to
commit
immediate collapse
There are
to subsidize state firms for
in the face of
any point
in
the future.
A
some
we have not taken
is
the beginning.
is
a positive probability,
standard:
with certainty at some future point
into account
be
high enough probability will lead suppliers to increase the
government must be such that there
The argument
it
and avoid
as affecting the probability that the state firm will
threshold at which they take up their private opportunities. Technically, the
survives forever.
time,
,
mediocre private opportunities.
clearly other implications of subsidies
12.Think of subsidies by the government
alive at
better to
expected to be high enough to create problems of bargaining, but low
may then be
their
may be
costly. It
however, the development of an efficient private sector
time
If
if it
however
were known that
in time, things
commitment
of the
small, that the state firm
a firm
was going
to
disappear
would unravel, and the firm would collapse
at
27
Disorganization
here: subsidies
may reduce
to be financed,
firms.
And
the incentives of state firms to adjust. Subsidies have
and through the tax channel, slow the growth of new private
in the end, political
economy considerations may
conclusion that the only way to stop subsidies
is
to stop
well
them
still
lead to the
But our
at once.
theory provides at least one respectable argument in favor of gradualism.
the emergence of efficient private firms
is
the government to subsidize state firms for
ate collapse,
and avoid
likely to
When
be slow, a commitment by
some time may avoid
their
immedi-
a large inefficient decline in output at the beginning of
transition.
5
Empirical Evidence
As we went
along,
we attempt
to give
we gave anecdotal evidence
of disorganization. In this section,
more formal evidence about the
ganization, both over time
and across countries
relative
importance of disor-
in transition.
To do
so,
we
rely
on measures of reported shortages of raw materials and intermediate products by
firms.
Two remarks
What
firms
are in order here
mean when
also not clear
they report "shortages"
whether the breakdowns
ples should be called shortages.
in supply", while there are
are,
admittedly unclear.
which occur
breakdowns
shortages. Thus,
we
And
in our three
it is
exam-
however, no measures of "breakdowns
measures of reported shortages.
that firms facing
proxy
There
in supply
is
in supply as in
And
it
is
plausible
our examples would report them as
are reasonably confident that reported shortages are a decent
for disorganization.
28
Disorganization
We focus on shortages rather than some of the other implications of our examples
because most alternative theories of the output decline do not naturally predict
shortages.
13
There
one exception: shortages may
is
price liberalization, along the lines of
however, prices have
now been
Murphy
et
reflect the effects of partial
al.
[1992]. In most republics
mostly liberalized, so that partial price liberaliza-
tion probably plays a limited role in explaining shortages at this point.
We
14
read the available evidence as suggesting that disorganization has played a
limited role in the major Central
European countries, some
role in Russia
and
the Baltics, and a major role in the other republics.
(1)
in a
Since 1992/93, the
number
OECD has carried out a survey of firms in manufacturing
of Central European and Baltic countries, asking
limiting production in manufacturing.
come from roughly
The
important.
Table
1.
strength of these data
identical surveys. Unfortunately, they
period of transition, where disorganization
The evidence from
is
these surveys
them about
likely to
is
is
factors
that they
do not cover the early
have been
summarized
relatively
in table
more
1:
Percentage of firms experiencing shortages of materials.
13. Phenomena
such
Rutkowski [1996]
as
wage compression
in state firms
for Poland, Kollo [1996] for
compared
to private firms (for
example
Hungary), the collapse of inter-republican trade,
cannibalization of machines, "spontaneous privatization" and the carving up of firms, are also
consistent with our story.
The problem
including efficient reorganization.
ization of
tion
on
that they are also consistent with other explanations,
The volume
machines or of firms may be
14. For a survey of progress
is
efficient,
of trade
may
well have been too high. Cannibal-
and so on.
price liberalization as of 1995, see
and Development [1996).
European Bank
for
Reconstruc-
,
29
Disorganization
min percent
max
percent
1996-1 value
Czech Republic 93-1 96-1
3
9
5
Hungary 92-1 96-1
6
11
5
Poland 93-3 96-1
3
6
5
Bulgaria 93-1 96-1
15
33
25
Romania 92-1 96-1
8
39
15
Latvia 93-1 96-1
21
32
21
Lithuania 93-3 96-1
13
43
17
Source:
OECD Short term indicators,
2/1996. Business survey annex.
In the three major Central European countries, shortages of materials have played
a very limited role since 1992-1993.
The numbers
are
tained from similar surveys of firms in Western Europe.
Blanchard [1994] show
that,
even
in
comparable
Numbers from Berg and
1990 in Poland (the
disruptions were not an important part of the story.
to those ob-
first
year of transition)
The proportion of firms citing
"supply and employment shortages" as a limiting factor in production was
62%
in
October 1989, 37% in January 1990 (the month of the "big bang"), but down
to
10% by
April 1990.
The evidence from
those Central European countries which are doing less well
suggests a larger role for disorganization. In Bulgaria and Romania, two of the
countries with the largest drop in output, supply shortages played an important
role
more than two years
the Baltic states.
after the
beginning of transition. The same
is
true of
30
Disorganization
(2)
Table 2 gives corresponding numbers for Russia, since 1991 (from a sample of
about 500 industrial firms, with a response rate of 30-40% over time).
Table 2. Proportion of firms in industry mentioning the following constraints as
limits to production. Russia,
1991-1995
Insufficient
Shortages of
Shortages of
Shortages of
Demand
Materials
Financial Resources
Labor
1991
4
82
18
28
1992
51
46
45
8
1993
41
23
62
6
1994
48
19
64
5
1995
47
22
64
8
;
Source: Russian Economic Barometer, 1996
The most
striking
number
is
the proportion of firms experiencing shortages of
materials in 1991. This however
is
(which took place in January 1992).
1992, and are
still
the
15
last
year before
success.
lost to full
directly to disorganization,
is
the
stoppages of production, by reason.
series are given in table 3.
would be interesting
pre-1991.
in
high by standards of market economies.
proportion of work time in firms
15. It
price liberalization
The numbers however remained high
Another piece of evidence, which speaks more
The time
full
The
to find
out how the proportion of firms experiencing shortages evolved
survey used above starts in 1991.
We have searched
for earlier ones, so far
without
Disorganization
31
Table 3. Percentage of working hours lost due to full stoppage ofproduction,
reasons for
Russia, 1992-1995.
it.
By reason
Percentage
of hours lost
Lack of demand
Lack of materials
Other
1992
10
59
40
1
1993
10
50
39
11
1994
18
53
35
13
1995
7
37
53
10
Source: Goskomstat Rossii, various issues. 1992
age over 4 quarters. 1994
of the
first
and
is
the average of May
is
August only. 1993
is
the aver-
and October. 1995 is the average
two quarters.
Lack of materials appears
to be the
main
factor in explaining
work stoppages
during the period 1992-1995.
(3)
Shortages of materials appear to play
still
a
more important
publics of the former Soviet Union. Table 4 gives
republic.
The numbers
role in the re-
some numbers
are from a survey of firms by the
ILO and
for the
Kyrgyz
are for 1993,
thus a year after price liberalization in the Kyrgyz republic, and one year after
the collapse of trade between the Kyrgyz republic and the other republics of the
former Soviet Union. (1993
a
month on average
trade,
and
this
—
.
is
High
may account
however a period of very high
inflation
for
is
inflation
—23%
typically associated with disruptions in
some of the shortages reported by
firms.)
32
Disorganization
Table
4-
Main business problems of firms
1993
in industry. Kyrgyz republic,
Shortages of materials
Low demand Other
factors
Food processing
57
13
30
Textiles
36
17
47
Non
26
32
42
Fabricated metals
31
22
47
Wood and
63
16
21
43
21
36
metallic minerals
paper
Other
Source: Windell et
These numbers
al.
[1995] Proportion of firms, in percent.
are in sharp contrast to those
for,
say Poland or Hungary. Short-
ages of materials seem to being playing a central role.
evidence from the other republics. So
far,
We are now collecting more
the evidence appears consistent with
that in Table 4.
The
shortages in Table 4 seem to reflect mainly internal disorganization, rather
than the collapse of trade between republics. The same survey gives
industry the proportion of materials coming from domestic
sources.
The
for
each
and non-domestic
correlation across sectors between the proportion of firms citing
shortages and the share of materials coming from non-domestic sources
is
roughly
equal to zero.
Can one
explain the differences between Central Europe and the former Soviet
Union? Our discussion suggests
may
well
have been higher
in
a
number of potential explanations.
many
of the republics of the Soviet
Specificities
Union than
in,
33
Disorganization
say,
Poland or the Czech Republic, leading to a larger collapse of both intra- and
inter-republican trade. Distance from the West,
and the scope
6
role.
These are however speculations
at this point.
Conclusions
Transition was conceptualized in a recent World
movement "From Plan
port [1996] as a
a
trade,
problems of specificity, may also have
for foreign firms to alleviate
played an important
and thus the volume of
more accurate,
stitutions to
if less
succinct,
Market and Market
title
to
Bank World Development Re-
Market."
If our
argument
is
right,
then
would have been "From Plan and Plan
Institutions." Transition
may cause
In-
the existing
organization of production to collapse, leading to a large decline in output until
new
institutions
The evidence
can be created.
suggests that disorganization has played a limited role in Central
Europe, a more important one in the Baltics and Russia, and an even more important
one
in the other Republics. Put
another way, disorganization appears to have
played a more important role in countries where the output decline has been the
largest.
While
political
economy and other considerations may
sion that the only
provides
way
some support
emergence of new
to stop subsidies
is
to stop
for gradualist policies in
efficient private firms
for subsidizing state firms for
some time
is
them
at once,
our analysis
dealing with state firms.
likely to
at the
well lead to the conclu-
be slow, there
may
beginning of transition.
If
the
be a case
34
Disorganization
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