A model of a socialist economy is presented, incorporating bargaining over wages and employment in the socialized sector and shortages that are reflected in the black market. The model is used to analyze the implications of liberalization policies, including trade liberalization, an administered price increase, and provisions allowing for increased direct foreign investment. The results suggest that reforms may have different effects under different trade regimes, that small price reforms may have perverse effects, and that foreign investment in a shortage economy may be immiserizing. [JEL P21, P31, P33]
The economic transformation currently being undertaken by many countries in Eastern Europe, and initiated in the former Soviet Union, is often portrayed as a “leap to the market” (see, for example, Sachs (1990)). It is widely recognized, however, that this metaphor exaggerates the speed with which a switch to a full-fledged market economy can be made—building new institutions simply takes time. In many countries, including Hungary, Poland, and Yugoslavia in the 1980s, and the former Soviet Union in the early 1990s, reforms have been undertaken gradually, while the basic structures of a socialist economy have been preserved. As a result, in the interim there has existed a situation of “neither plan nor market,” in which no central economic plan is implemented but in which the state continues nominally to own a substantial part of state enterprises. A reforming socialist economy may also have a substantial nonsocialized sector, consisting of industries that were never nationalized to begin with, newly established private firms, and, in some cases, privatized formerly state-owned enterprises.1 The aim of this paper is to develop a model of such a reforming socialist economy and to explore the consequences of market-oriented policies in the context of such an economy.
In a reforming socialist economy the employees often dominate the enterprises’ management through worker-led enterprise councils; workers in such labor-dominated enterprises thus implicitly have some property rights over the enterprise that employs them. Despite the absence (or irrelevance) of a central plan, the state frequently continues to influence enterprises’ wage, employment, and output decisions through a variety of other channels. The vagueness of property rights over the state enterprise, together with the soft budget constraints that arise from the state’s propensity to tax away exceptional profits while accommodating any losses through subsidies and easy credit, as well as the substantial domestic market power enjoyed by many state enterprises, implies that the enterprise’s wage and employment decisions may be the outcome of bargaining between the government and the enterprise’s employees over their shares of the enterprise’s earnings. In most socialist economies, moreover, the importance of this bargaining is enhanced by the fact that the state enterprises are the primary source of revenues for the state budget (Tanzi (1991) and Lane and Dinopoulos (1991)).2
A transitional socialist economy may also be characterized by shortages. The government may continue to exert an influence over prices, and price controls may be associated with shortages, queues, and black market activity. In many socialist economies, the shadow economy is highly developed, A convenient, and probably not unrealistic, assumption is that black market activity exhausts the rents associated with the controlled price (see, for example, Barzel (1974) and Lipton and Sachs (1990)).
In this paper a model that combines these features of a socialist economy is presented in Section I, and the equilibrium of the model is characterized in Section II. In Section III the model is used to analyze the consequences of price reform and trade liberalization. Section IV explores the implications of permitting an increase in foreign direct investment. Section V offers conclusions.
APPENDIX Consumer Choice and Shortages
In the model presented in Section I, it is assumed that all rents associated with the controlled price are dissipated, and that the price that is relevant from the standpoint of consumers is the black market price, Pb We also assume that all DUP activity associated with the controlled price is carried out by individuals who are not otherwise employed and who specialize in standing in the queues to purchase goods for resale in the black market. This assumption is in contrast to models such as those of Weitzman (1991) and Boycko (1991), in which queuing is done by the representative consumer, and in which no resale takes place; it is closer to the simple model presented in Lipton and Sachs (1990). In this appendix, we derive the circumstances under which there is specialization in queueing.
Consider the following simple framework, similar to Boycko (1991), in which the individual chooses the allocation of time and money. Individual i’s utility function is
where xi zi, and li denote the individual’s consumption of the two goods and leisure, respectively. The budget constraint is
indicating that wage income must equal the sum of expenditures in the official shops and in the black market (where the latter would be negative for a specialist arbitrageur).
The individual’s time constraint is
where hi denotes the individual’s hours of work in his or her place of employment (if any), li the hours of leisure, and t the time required to purchase one unit of the good; the total amount of time available is normalized to unity. This assumes, as in Boycko (1991) but unlike in Weitzman (1991), that purchasing each unit of the good requires a fixed waiting time, as with a “one to a customer” limit; this assumption is needed, because when resale is permitted, the first customer in line would otherwise buy the entire available stock.
Finally, there is a nonnegativity condition on the amount the individual purchases in the official shops:
The first-order conditions for this problem give rise to the following results. First, there is the familiar result that
that is, the marginal rate of substitution between the two goods equals the black market price. This confirms the assumption in the main text of the paper that it is the black market price that is relevant for consumer demand. Next, there is a condition for time spent queueing:
where λ is the multiplier on condition (27); the Kuhn-Tucker conditions state that
Note also that one can define the black market wage (per unit of time) as the return per unit purchased and resold times the number of units that can be purchased per unit of time, or
that is, the black market wage equals the marginal rate of substitution between leisure and the numeraire good.
Another result follows directly from definition (31): if it is assumed that the average time required to purchase a unit of the good is equal to the total number of people queuing divided by the goods available—that is, t = Lb/x—then equation (10), the zero-profit condition for the black market, follows immediately.
that is, the additional consumption to be earned by participating in the black market is less than the marginal evaluation of the leisure that would be lost.
Now in equations (32) and (32’), both Φ1, and S2 will, in general, be different for households that are otherwise unemployed than for those employed in the productive sectors. First, employed workers generally have less leisure—li = 1 – hi—txci— where h’ > 0; for unemployed workers, li = 1 – txci. This implies that (if all workers are otherwise identical) Φ1 is higher for employed than for unemployed workers. In addition, the marginal utility of consumption of the numeraire good may be lower for employed workers (if the subutility function, S(x,z), is strictly concave), since they have higher incomes if wx,wz ≥ wb. We can write the marginal utility of the numeraire good as a function of the consumer’s wage and the black market price, S2 (w, Pb).
Then complete specialization in the DUP activity requires that
that is, the black market wage, which is equal to the marginal rate of substitution for leisure of individuals who specialize only in black market activity, must be less than the marginal rate of substitution of goods for leisure for workers employed in either of the two productive sectors.
If workers in the two productive sectors could voluntarily choose their hours of work for a given wage, condition (33) would become simply
Condition (34) may or may not be satisfied; the bargaining structure for wage determination in the socialized sector presented in Section I implies that wx > wb, provided that the enterprise has any bargaining power, but in the nonsocialized sector, wz = wb. In a previous version of this paper, however, a model of efficiency wages was presented, in which workers were paid more than their reservation wage in order to motivate greater effort, implying that wz > wb.
However, the assumption that workers can choose their hours of work for a given wage is not necessarily appropriate. In the nonsocialized sector an efficiency wage mechanism would imply a distortion in hours if the worker can choose hours voluntarily; some restriction on hours would be a feature of a cost-minimizing contract, a general feature of agency models as examined by Lazear (1980). Efficiency wage models imply economies of scale in deterring shirking, so there is a tendency for hours to be longer than would be implied by equality of the reservation wage with the marginal rate of substitution of leisure for consumption, Φ1>,/S2; this implies that condition (33) will generally be met for the non-socialized sector. In the socialized sector hours could be made an additional subject of bargaining between enterprise and government; an employment-oriented enterprise might engage in “feather-bedding,” reducing (effective) hours of work in return for higher employment, which would imply that the individual worker would be subject to restrictions on hours, possibly implying Φ1/S2 < wb—in effect, “forced leisure.” If that were the case, some workers in the socialized sector would participate in queues after (or during) normal working hours.22
It has been demonstrated that the assumption of complete specialization in queueing can be the result of optimal behavior by otherwise identical consumers who differ only in whether they happen to find employment in the socialized, or nonsocialized sector, or nowhere. It has also been argued, however, that the conditions for complete specialization may or may not be met, even if, as is assumed, wages in the two productive sectors exceed the income that can be earned in the black market. The possibility that workers in the socialized sector have “forced leisure” implies that some of them may participate in queues; this would be consistent with the observation that in socialist economies some (although not all) of the queueing is in fact done by people who are also employed elsewhere.23
In the main text of the paper it is assumed that complete specialization does occur. It is also assumed that hours of work are fixed in both productive sectors and in the black market (the latter being equivalent to assuming, not unrealistically, that the official shops are only open for a limited number of hours).
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)| false Portes, Richard, “The Theory and Measurement of Macroeconomic Disequilibrium in Centrally Planned Economies,”in Models of Disequilibrium and Shortage in Centrally Planned Economies, ed. by ( Christopher Davisand Wojciech Charemza London; New York: Chapman and Hall, Ltd., 1989).
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Elias Dinopoulos, who is an Associate Professor at the University of Florida, received his doctorate from Columbia University. He was a consultant in the Research Department when this paper was written.
Timothy D. Lane is an Economist in the Research Department. He received his doctorate from the University of Western Ontario.
The authors wish to thank John Beghin, Patrick Conway, Peter hard, Kent Osband, and other participants in seminars at the IMF, the World Bank, the University of Florida, the Southeastern International Economics Meetings, and the University of Cincinnati for helpful comments.
For example, in Poland in the late 1980s the officially recognized private sector accounted for about 25 percent of total output; this is likely to be an underestimate, since it omits production in the “shadow economy” (Kalicki (1989)).
For instance, in Poland in 1989 taxes and dividends on socialized enterprises constituted 80 percent of the total revenues of the state budget, and transfers from financial institutions (also state owned), another 10 percent; only 5 percent of total revenues came from taxation of nonsocialized enterprises.
In practice, this assumption may not be realistic; many of the exports of Eastern European countries are produced by state enterprises. However, the alternative—to have the socialized sector exporting—would be less satisfactory, since it would imply that goods were being exported in the face of domestic shortages; this would require a more complex explanation (or an arbitrary assumption) to determine the level of exports. The alternative would be to disaggregate the socialized sector into exporting and import-competing subsectors, but that would make the model intractable.
This utility function has been used extensively in the literature to represent the objectives of labor unions; see McDonald and Solow (1981), Brander and Spencer (1988), Mezzetti and Dinopoulos (1991), Pemberton (1988), and Lane and Dinopoulos (1991), among others. The excess wage is defined in terms of the black market wage, because the latter represents the opportunity cost of labor.
Numerical subscripts denote derivatives of a function with respect to the relevant argument; for example
In order to see this property, consider the slope of an isotax curve, dwx/dLx = – [wx – PXF1(LX)]/LX, and the slope of an indifference curve, dwx/dLx = – y(wx – wb)/θ Lx. Equation (6a) represents the result of setting these two expressions equal to each other.
In an earlier version of the paper, available from the authors on request, we assumed that firms in the nonsocialized sector could pay efficiency wages—that is, elicit more effort from their workers by paying them more than their reservation wage (see. for example, Brecher (1992)). The results are qualitatively similar, but the efficiency wage framework implies that wages in the nonsocialized sector need not be lower than those in state enterprises.
If imports were restrained by a tariff instead, the difference between the black market and official price would depend only on the tariff; in that case, the amount of labor, Lb, would necessarily be a decreasing function of the reservation wage, wb. The difference between the two trade regimes is developed in the next section.
The possibility of nonuniqueness of equilibrium is explored further in an appendix, available from the authors on request
In a previous version, incorporating efficiency wages, the wages in the socialized and nonsocialized sectors could not be ranked.
Some Eastern European countries, notably Hungary, Yugoslavia, and Poland, undertook market liberalization measures during the 1970s and 1980s; these efforts were greatly intensified in the radical reform programs initiated in 1989 and 1990 (see, for example, Lane (1991) and Boote and Somogyi (1991)), and similar programs were pursued by other countries in the region. By early 1992, some states of the former Soviet Union had yet to decide whether, and at what pace, to undertake extensive market liberalization in order to alleviate shortages and provide the basis for a move toward a market economy.
The case of quotas is particularly relevant due to the prevalence of nontariff barriers in socialist economies, including not only formal quantitative restrictions but also the implicit restrictions that have historically been associated with the dominant role of government-owned foreign trade organizations and with the centralization of the distribution system. Tariffs have replaced such quantitative restrictions in the countries that have proceeded furthest with market-oriented reforms.
Notice that this property excludes the possibility of multiple equilibria, as discussed in an appendix available from the authors.
An example is the freeing of agricultural prices in Poland in August 1989.
An example is the Polish authorities’ decision to raise coal prices by 400 percent for industrial users (and 600 percent for households) in January 1990, which still left these prices below world levels.
Geometric analysis is inadequate for examining the effects of a change in Px, since the direction and magnitude of the shift in the Lx + Lb curve are ambiguous.
This result, and the possibility of multiple equilibria, is examined in an appendix, which is available from the authors on request.
It should be emphasized that this refers to a small change in prices; even if official prices are initially far below their market-clearing levels, full price adjustment in this model must reduce black market activity (to zero).
For instance, Tarr (1991) reports that in Poland in 1979, the black market price of color televisions was twice the official price, and the black market price of automobiles, three times the official price.
In practice, gradual price adjustment may also be vitiated by the effect of expectations, as anticipated price increases may create increased incentives for hoarding and thereby exacerbate the shortages. Such dynamic effects cannot, of course, be analyzed in our static model.
The analysis has assumed that an employed individual must stay at the workplace for the stipulated hours of work. Anecdotal evidence suggests that this is far from the case in many reforming socialist countries; on the contrary, many workers spend time during which they are ostensibly employed to work at other jobs and to stand in line for goods.
This also abstracts from the possibility of specialization within the family—that is, the possibility that some members of a family who are unemployed or work shorter hours may do more of the queueing. Anecdotal evidence suggests that this may be an important phenomenon.