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Output Patterns in Transition Economies. 1 Introduction The initial drop in output is a stylized fact of transition: Poland-15%, Hungary 18%, Czech-21%, Russia-40% 2. Patterns of Transition A transition-related recession is a common feature:

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1 Introduction

The initial drop in output is a stylized fact of transition:

Poland-15%, Hungary 18%, Czech-21%, Russia-40%

2. Patterns of Transition

A transition-related recession is a common feature:

Growth has resumed in most countries, but only in Central Europe has the recession been overcome in levels

Central European Economies have generally done better than FSU economies. Only in CEE has growth restored official GDP to its initial level

Among the rest of the FSU Uzbekistan and Belarus appear to be doing the best

Within CEE Bulgaria and Romania are the worst performers. Poland and Slovenia are the largest successes.

It appears that the shorter the faster the initial output fall the quicker the recovery

3. Measurement

Perhaps the output fall is overestimated

There are systemic reasons why official data overstate the fall in output, and particularly in industrial output, in these economies.

the statistical systems of socialist economies were census-based, and were designed to gather data from the state-owned sector.

After liberalization the most dynamic sectors of the economy are services and new private enterprises, and these types of establishments are hard for the authorities to keep track of.

The incentives to report output have changed dramatically since the demise of planning. Whereas enterprises formerly had incentives to overstate output to fulfill planned targets, they are now much more interested in understating production so as to reduce taxes.

Growth in the relative magnitude of the hidden economy could thus explain why the measured output drop is as large as it appears. Tax evasion is a strong incentive to hide income, and with the very high tax rates that enterprises faced they had a survival need to hide.

4. Factors for output decline

a) Supply shocks

Inflationary pressures

end of subsidies

Relative price changes

Hardening budget constraints

Increased shortages due to the decline of the planning system and resulting misallocation and distribution.

b) Demand shocks:

Demand shocks can be thought of in terms of stabilization. How much of the output decline is due to stabilization or transitional factors.

c) Market symbols (prices & information) were weak, thus leading to the collapse of many industries. Directives from planners ceased but mkt price signals slow to emerge

d) CMEA (Council for Mutual Econ Assistance) shocks—decline in trade within the bloc.

e) Decline in investment

f) Structural adjustment

Structural adjustment is the relative decline of the state sector and the expansion of services and the new private sector.

g) Failure to provide needed institutional changes

- development of corporate form of business organization and bank supervision

h) Disorganization

planners previously determined both suppliers and purchasers and, after the collapse of planning, enterprises found themselves both w/o secure, uncontested markets for their output. They also encountered difficulty getting raw materials that under the former system were at least nominally guaranteed. Transition has led to decentralized bargaining b/w suppliers and buyers.

Blanchard, O. and M. Kremer, "Disorganization."Quarterly Journal of Economics 112 (4) (Nov 1997)

Main idea—the collapse of planning institutions before market institutions are in place causes the output fall. Because production involves coordination of many different producers, the collapse of planning can lead to inefficient declines in output. If activity could be coordinated the output fall would not occur.


The output fall due to disorganization represents decrease in welfare

Because value adding activity do not occur. Productive activity is not taking place because resources are diverted.

Example: inefficient bargaining-due to the absence of contracts-causes raw materials to be exported when they could produce higher value if production chains are maintained.

Vertical chain of production







m—primary input (supplier of primary good)

x1… xn-1—intermediate inputs

y—final output (producer of final output)

A good is produced according to Leontief technology in which inputs always enter in fixed proportions to produce a unit of output (a zero elasticity of factor substitutes) and requires n steps of production.

Assumethat 1 unit of primary input leads after nsteps to 1 unit of final good (normalize the value of final good to 1). The value of the intermediate good is 0. The supplier of primary input has an alternative use, which is c (could be a private opportunity or selling it for a less fabricated use).

Transition leads to independence of the elements in the chain. What problems could arise?


each buyer along the chain knows only the suppliers it was paired under planning and vise versa. The end of planning leads to n bargaining problems. Now each unit must bargain for a supplier and a customer.

The value of surplus in the last stage between producer final good and last intermediate input producer is equal to 1.Therefore, the last intermediate producer gets ½, the next to the last gets ¼, the first intermediate producer gets (½)n. Since the 1st producer must purchase the primary input to produce, (½)n > c for a positive surplus. Therefore, the surplus at the first stage (½)n -c > 0.

If c > (½)n the primary producer will prefer to sell to someone else. If the primary producer defects, the output fall will be large as 1-(½)n.

The more complex the structure of production is (higher n) the smaller the private opportunities needed to trigger the state sector.

The collapse of output is due to a combination of 2 factors:

The improvement in private opportunity

Loss of centralized power of government

The more complex is the production process, the greater output fall.

If production is very specialized and highly disintegrated there is more opportunity for disorganization

Therefore more suppliers and openness of the economy would reduce the severity of this problem

The source of inefficiency and the collapse of output under decentralized bargaining:

Each intermediate producer must produce its intermediate good before bargaining with the next producer along the chain. Once he has produced the intermediate good and has no alternative use for it, his reservation value is 0. The inefficiency would therefore disappear if all the producers can sign an enforceable contract before production took place. In this case production would take place as long as c<1. the source of the problem is incomplete contracts

Factors to prevent output fall

Vertical integration

eliminates the bargaining problem b/n enterprises. The production chain as a whole is producing value added.

Long-term contracts

could prevent conflicts over splitting the surpluses.

Disorganization had less impact on output in Central Europe, and larger impact in the former Soviet Union.

i) The sequencing and speed of transition—fast reforms lead to sharper decline in output but faster recovery later.

5. Labor productivity

The initial impact of econ reform was lower labor productivity but increases with the greater freedom of the privatized businesses to get rid of the unproductive workers.

The faster reforms are implemented, the more sharply labor productivity initially declines but the more rapidly it returns to positive. First reformers like the Czech republic, Poland and Hungary saw productivity rising by 1992, while Russia and Central Asian Republics continue to experience productivity decline until at least 1996.