Privatization, Market Liberalization and Learning in Transition Economies

Privatization and market liberalization are widely considered to be complementary reforms in transition economies. This article challenges this view and the closely related " big bang " approach: when pursued too vigorously, privatization may impede the transition process following liberalization. Our result is based on an explicit model of market learning. Compared to a mature market, a market in transition is characterized by greater uncertainty regarding market conditions, including equilibrium prices and quantities. Economic actors must learn about these conditions through their participation in the market process. Less than full privatization is optimal if the costs of learning are sufficiently important. with BRS, the computer simulation environment in which the simulations were performed. The suggestions of Giancarlo Moschini, editor, and two anonymouns referees were very useful. This paper has benefitted from comments made by seminar participants at 1 Privatization and market liberalization are widely considered to be complementary reforms in transition economies. This article challenges this view and the closely related " big bang " approach to economic reform. Our analysis suggests that when pursued too vigorously, privatization may actually impede the transition process following market liberalization and reduce social welfare. Our result is based on an explicit model of the market learning process, which is an intrinsic component of any transition from a socialist economy—in which markets and market institutions are either nonexistent or highly distorted by government interventions—to a fully-functioning market economy. The theoretical literature to date on the transition in Central and Eastern Europe has ignored the need for individuals to simultaneously learn, through their participation in the market process, about the features of a market in transition and the effects of government-instituted reforms, e.g. Murrell. In what follows, we will argue that, insofar as it fails to take account of the learning process, the policy advice provided by Western experts to transition economies may be seriously flawed. An urgent task facing policymakers in a small transition economy is to identify those subsectors of the economy in which their country will have a comparative advantage. 1 Typically, very little information about the identity of these subsectors is provided by relative prices from the pre-transition era, since these were hugely distorted by production quotas, taxes and subsidies, and other nonmarket influences. So what economic policies will best facilitate the process of acquiring the necessary information? The standard economic advice proffered by Western economists has been to follow a …