Viability, Economic Transition and Reflections on Neo-classical Economics

Many transition policies, based on neoclassical economics, failed in Eastern Europe, Former Soviet Union, and China. The paper argues that the failure is due to the viability assumption of the neoclassical economics. The neoclassical economics implicitly assumes a firm to be able to earn a socially acceptable profit in an open, competitive market if the firm has a normal management. However, many firms in the socialist as well as transitional economies are not viable, that is, they will not be able to earn a socially acceptable profit in an open, competitive market even if they have normal management because they are in sectors in which the economies do not have comparative advantages. With the viability assumption, the policies, based on neoclassical economics, focus on issues related to property rights, corporate governance, government interventions and other issues related to firms’ management. However, many of those issues are in fact endogenous to the firms’ viability problem. Therefore, without addressing the firms’ viability issue, those policies fail to achieve its intended goals. Not only in the socialist and transition economies but also in developing countries many firms are not viable. The paper suggests to relaxing the viability assumption in the neoclassical economics when analyzing issues in socialist and transition economies, as well as in developing countries. 1 The paper was presented at workshops at the Graduate School of Chinese Academy of Social Sciences, the State Economic and Trade Commission’s Economic Research Center, the Unirule Institute’s summer courses on Neo-institutional Economics and Economic Transition, and the summer camp of CCER, Peking University. I thank all the participants in these workshops for their questions and comments. Comments are most welcome. Please send the correspondences to [email protected].