Journal Issue
Working Paper Summaries (WP/93/1 - WP/93/54)

Summary of WP/93/16: “Economic Restructuring, Unemployment, and Growth in a Transition Economy”

International Monetary Fund
Published Date:
August 1993
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This paper develops a simple model of the process of reallocation of labor from the state to the private sector and examines several questions relating to the dynamics of the transition process. The transition economy is characterized by the asymmetric behavior and market power of labor in the two sectors. In the state sector, labor dominates the decision process of enterprises, while in the private sector employment and wage decisions are determined by profit-maximizing firms. It is assumed that firms in the private sector are concerned with worker effort and productivity, while these considerations play a minor role in the state sector. Worker effort in the private sector is endogenously determined by an efficiency-wage mechanism. In order to boost work force productivity, firms find it optimal to pay a premium over the market-clearing wage, resulting in unemployment.

The paper examines two alternative processes driving growth and restructuring: a neoclassical exogenous productivity growth model, where transition is inevitable; and an endogenous growth model, where human capital is acquired through learning by doing, and restructuring is endogenously determined. When growth and restructuring are exogenously determined, the paper shows that, in the initial stages of transition, as a natural consequence of the reallocation of labor that accompanies the restructuring of production, the economy will not only suffer a cost in terms of unemployment but this cost will rise over time. Only after a critical stage in the transition process is restructuring accompanied by a decline in unemployment. The paper demonstrates that, when growth is endogenously determined, the level of human capital in the private sector and the rate of unemployment determine whether or not restructuring of production toward the private sector eventually occurs. With low levels of human capital or skills specialized in the production of the private sector good, a relatively high rate of unemployment is necessary to place the economy on a self-sustaining path of restructuring of production toward the private sector.

The paper analyzes the way in which various shocks--such as changes in relative prices--and government policies affect the dynamic path of unemployment. The role of government policies differs significantly depending on whether growth is viewed as an exogenous or an endogenous process. When growth is exogenously determined, the speed of transition has no long-run impact, and restructuring is inevitable. Therefore, policies that reduce unemployment in the early stages of transition--for instance, through subsidies to the state sector--may reduce short-term costs without affecting the long-run equilibrium. By contrast, when growth is endogenous, policies that reduce unemployment may slow down the transition process and jeopardize restructuring and eventual convergence to long-run specialization in the private sector good.

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