economics 216: the macroeconomics of development

Economics 216:The Macroeconomics of Development

Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.)Kwoh-Ting Li Professor of Economic Development

Department of EconomicsStanford University

Stanford, CA 94305-6072, U.S.A.

Spring 2000-2001

Email: [email protected]; WebPages: http://www.stanford.edu/~ljlau

Lecture 12Strategies for Transition

from a Planned to a Market Economy

Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.)Kwoh-Ting Li Professor of Economic Development

Department of EconomicsStanford University

Stanford, CA 94305-6072, U.S.A.

Spring 2000-2001

Email: [email protected]; WebPages: http://www.stanford.edu/~ljlau

Lawrence J. Lau, Stanford University

3

The Transition from a Centrally Planned Economy to a Market Economy The meaning of transition

Replacement of administrative allocation by market allocation Replacement of administered prices by market prices

Can a transition be achieved without creating losers?


4

A Centrally Planned Economy Enterprises and households are assigned rights to and

obligations for fixed quantities of commodities at fixed plan prices

The rights and obligations are enterprise- and household-specific

There are governmental sanctions for failure to fulfil the obligations under the plan


5

The Dual-Track ApproachAdopted in the Chinese Transition (1) The “Plan Track”--the pre-existing central plan remains

and its rights and obligations continue to be enforced by the government

The “Market Track”--all markets are instantaneously open, with prices determined by supply and demand

Producers are given autonomy and incentive to plan their production and participate in the market, provided obligations under the plan are fulfilled

Consumers are completely free to plan their consumption and participate in the market, given allocated consumption goods and fulfillment of labor obligations


6

The Dual-Track ApproachAdopted in the Chinese Transition (2) Planned profits and losses (taxes and subsidies) of

enterprises remain the same Differences between plan and market prices make feasible

lumpsum transfers Continued planned consumer goods deliveries enable the

maintenance of the pre-reform standard of living as a floor


7

The Political Economy of the Dual-Track Approach No one is worse off--“Reform without Losers” “Grandfathering” of “Vested Interests” Autonomy and incentive on the margin Creation of new, reform-oriented “Vested Interests” Minimizing opposition and maximizing support But: CAN IT BE EFFICIENT?


8

A Preview Theoretical Analysis--under what conditions can the

“Dual-Track” approach achieve both efficiency and Pareto-improvement simultaneously? Partial Equilibrium General Equilibrium

Empirical Evidence--the Chinese experience

Theoretical Analysis:Partial Equilibrium


10

Two Types of Market Liberalization Limited Market Liberalization (price PM and quantity

QM) Market resales of plan-allocated goods by either enterprises or

households are not permitted Market purchases by planned suppliers for fulfilling plan-

mandated delivery quotas (e.g. sub-contracting) are not permitted Full Market Liberalization (price PE and quantity QE)

Market resales and market purchases for redelivery are all allowed by a planned supplier or a rationed user, as long as the rights and obligations under the plan are all fulfilled

QP = plan quantity; PP1 = plan price (below PE); and PP2 = plan price (above PE)


11

Interpretation of the Plan-Allocated Delivery Quotas under Full Market Liberalization A put option on the part of the planned supplier to sell

fixed quantities at the plan price to the rationed users A call option on the part of the rationed user to buy fixed

quantities at the plan price from the planned suppliers Since both options are exercisable at the same fixed plan

price, at most one of the options can have positive value at market equilibrium

These options can be “bought and sold” in lieu of the physical deliveries


12

Assumptions of the Model A closed economy Feasibility of the original plan Continued enforcement of the plan track Profit and utility maximization by the economic agents Full liberalization of the market track


13

Two Cases QP, the plan quantity, is less than QE, the market

equilibrium quantity QP, the plan quantity, is greater than QE, the market

equilibrium quantity


14

Efficiency in Demand Rationing and Supply Planning Efficient demand rationing implies that the rationed goods

are allocated to the most deserving users, that is, those whose willingness to pay is the highest (marginal utility or marginal productivity is the highest)

The demand curve is the aggregation of the willingness to pay of the potential users

Efficient supply planning implies that the production is assigned to the most efficient producers, that is, those whose marginal costs are the lowest

The supply curve is the aggregation of the marginal costs of the potential producers


15

Efficient Rationed Demand andEfficient Planned Supply

Figure 1: Efficient Rationed Demand and Efficient Planned Supply

Quantity

Pri

ce A

B, H

D, I

C

C'

E

G

G'

F

QP Q

E

PE

PP1

PP2

Rationed Demand

Planned Supply

Total Demand

Total Supply


16

Inefficient Rationed Demand andEfficient Planned Supply

Figure 2: Inefficient Rationed Demand and Efficient Planned Supply

Quantity

Pri

ce A

B

D, I

C

C'

E

G

G'

F

QP

QE

PE

PP1

PP2

Rationed Demand

Planned Supply

Total Demand

Total Supply

H


17

Inefficient Rationed Demand and Efficient Planned Supply: Limited Market Liberalization

Figure 3: Residual Demand and Supply:Inefficient Rationed Demand and Efficient Planned Supply

Quantity

Pri

ce

QM

PM

Residual Demand

Residual Supply


18

QP + QM> QE:Over-Production under Limited Liberalization If PM<PE, then every potential user with a willingness to

pay greater than or equal to PE is an actual user There may be actual users whose willingness to pay is less

than PE Thus, QP + QM> QE If PM>PE, then every potential supplier with a marginal

cost less than or equal to PE is an actual supplier There may be actual suppliers whose marginal costs are

greater than PE Thus, QP + QM> QE


19

PM> PE under Efficient Planned Supply Under efficient planned supply, the actual total supply in

the economy will be produced by the suppliers with the lowest marginal costs

Thus, QP + QM> QE implies PM> PE


20

Efficient Rationed Demand andInefficient Planned Supply

Figure 4: Efficient Rationed Demand and Inefficient Planned Supply

Quantity

Pri

ce A

B, H

D

C

C'

E

G

G'

F

QP

QE

PE

PP1

PP2

Rationed Demand

Planned Supply

Total Demand

Total Supply

I


21

Efficient Rationed Demand and Inefficient Planned Supply: Limited Market Liberalization

Figure 5: Residual Demand and Supply:Efficient Rationed Demand and Inefficient Planned Supply

Quantity

Pri

ce

QM

PM

Residual Demand

Residual Supply


22







23

PM< PE under Efficient Rationed Demand Under efficient rationed demand, the actual total demand

in the economy will be used by the users with the highest willingness to pay

Thus, QP + QM> QE implies PM< PE


24

Inefficient Rationed Demand and Inefficient Planned Supply

Figure 6: Inefficient Rationed Demand and Inefficient Planned Supply

Quantity

Pri

ce A

B

D

C

C'

E

G

G'

F

QP

QE

PE

PP1

PP2

Rationed Demand

Planned Supply

Total Demand

Total Supply

I

H


25

Inefficient Rationed Demand and Inefficient Planned Supply: Limited Market Liberalization

Figure 7: Residual Demand and Supply:Inefficient Rationed Demand and Inefficient Planned Supply

Quantity

Pri

ce

QM

PM

Residual Demand

Residual Supply


26







27

Plan Quantity < Market Equilibrium Quantity Proposition 1: (1) The combined output of the plan and market tracks

under limited liberalization of the market track is greater than or equal to the fully liberalized market equilibrium quantity; and

(2) The market equilibrium price under limited liberalization is greater (respectively, less) than or equal to the market equilibrium price under full liberalization of the market track if planned supply (respectively, rationed demand) is efficient.


28

Plan Quantity < Market Equilibrium Quantity Proposition 2: Independently of the initial conditions concerning the plan

price and the degree of efficiency of rationed demand and planned supply:

(1) The dual-track approach with either limited or full liberalization of the market track is Pareto-improving; and

(2) The dual-track approach with full liberalization of the market track achieves full economic efficiency.


29

Inefficient Rationed Demand and Inefficient Planned Supply:PlanQuantity>MarketQuantity

Figure 8: Inefficient Rationed Demand and Inefficient Planned Supply:The Case of Plan Quantity Greater Than Market Equilibrium Quantity

Quantity

Pri

ce A

B

D

E

G

G'

F

QP

QE

PE

PP1

PP2

Total Demand

Total Supply

I

H

C

C'

Planned Supply

Rationed Demand


30

Inefficient Rationed Demand and Inefficient Planned Supply:PlanQuantity>MarketQuantity

Figure 9: Residual Demand and Supply:The Case of Plan Quantity Greater Than Market Equilibrium Quantity

Quantity

Pri

ce

Residual Demand

Residual Supply

QM

PM


31

Efficient Rationed Demand and Efficient Plan-ned Supply: Plan Quantity>Market Quantity

Figure 10: Efficient Rationed Demand and Efficient Planned Supply:The Case of Plan Quantity Greater Than Market Equilibrium Quantity

Quantity

Pri

ce A

B, H

D, I

E

G

G'

F

QP

QE

PE

PP1

PP2

Total Demand

Total Supply

C

C'

Rationed Demand

Planned Supply


32

Plan Quantity > Market Equilibrium Quantity Proposition 3: Independently of the initial conditions concerning the plan

prices and the degree of efficiency of rationed demand and planned supply:

(1) The dual-track approach with limited or full liberalization is always Pareto-improving; and

(2) The dual-track approach with full liberalization achieves efficiency if the rights and obligations under the plan are enforced in terms of the rents.


33

Plan Quantity > Market Equilibrium Quantity: Efficiency Achieved through Payment of Rents If PP1 is less than PE, then all planned suppliers with marginal costs

above PE will have an incentive to pay off rationed users with willingness to pay below PE with a payment equal to PE-PP1 The potential loss to these planned suppliers from physical delivery exceeds

PE-PP1 The potential gain to these rationed users from accepting physical delivery is

less than PE-PP1 Thus, the planned suppliers with marginal cost above PE should try

to purchase the call options in the market at price PE-PP1; the rationed users with willingness to pay below PE should try to sell their call options in the market at price PE-PP1

Both groups are better off then if physical delivery is effected


34

Feasibility of the Original Plan (1) The production plan for each producer is feasible; (2) The consumption plan for each consumer is feasible; (3) Material balance holds for the economy as a whole; and (4) The consumption plan for each consumer is affordable

at the plan prices.


35

Continued Enforcement of the Plan Track No different from contract enforcement in a market

economy Focus of enforcement shifted from total physical

production to inter-enterprise deliveries Pre-existing rents can be protected without the

enforcement of physical deliveries Enforcement against consumers may be difficult Credibility of state enforcement is crucial


36

Full Market Liberalization is Necessary for Full Economic Efficiency Under the “Dual-Track” approach, full market

liberalization is necessary at the outset to assure both Pareto-improvement and efficiency

A sequential approach of implementing first limited market liberalization and then full market liberalization does not possess the Pareto-improvement property


37

Applicability to the Chinese Economy Feasibility of the original plan Credibility of continued enforcement “Contract responsibility system” Full market liberalization

Theoretical Analysis:General Equilibrium


39

The Model l goods m producers with production set Yi n consumers with consumption set Xj lth good is leisure; consumers have only leisure

endowment


40

The Status Quo a national production plan v = (v1, ..., vm) a national consumption plan c = (c1, ..., cn) q=(q1, ..., ql) the plan price An economy under central planning is characterized by (v,

c, q)


41

Feasibility of the Original Plan (i) The production plan for each producer is feasible (ii) The consumption plan for each consumer is feasible (iii) Material balance holds in the aggregate; and (iv) The consumption plan for each consumer is affordable

at the plan prices


42

The Big-Bang Strategy The central plan is abolished All markets are instantaneously open Producers are completely free to plan their production Consumers are completely free to plan their consumption


43

The Openness of All Markets Both the Big-Bang and the Dual-Track strategies require

that all markets are open for economic efficiency In particular, market resales of plan-allocated inputs and

consumption goods, and market purchases of outputs for re-delivery are allowed

There are two prices for each good, PP, the plan price and PE, the market price


44

Efficiency of a Dual-Track Equilibrium A Dual-Track Competitive Equilibrium is Efficient


45

Physical Implementability What happens if the equilibrium aggregate gross output is

less than the plan aggregate gross output for at least one good?

Simultaneous physical delivery then becomes impossible Recycling through the market with (infinite) subdivisions

of the plan period provides a solution


46

Pareto-Superiority of a Dual-Track Equilibrium A Dual-Track Competitive Equilibrium is Pareto-

Improving, by construction


47

The Dual-Track Strategy Combines plan and market “Contract Responsibility” system Autonomy and incentive on the margin Efficiency achieved immediately Reliance on existing institutions and Information


48

Is Chinese Economic Reform Gradualist? No! Efficiency is instantaneously achieved as if under a

“Big Bang” reform Efficiency is achieved because both the prices and

quantities of goods allocated within the plan are fixed Chinese economic reform appears gradualist because the

population is protected from shock (pain)


49

The Importance of the Physical Implementability Constraint A “shortage” economy under the Plan implies that

equilibrium aggregate gross output is likely to exceed plan aggregate gross output

Economic growth is also likely to increase the equilibrium aggregate gross output through its effects on the intermediate and consumption demands over time


50

The Role of State Power Enforcement of contracts Credibility of the state, and expectations thereof, affect

enterprise (and household) behavior, and hence compliance with the State Plan (post reform)

Multiple equilibria (outcomes) possible, depending on credibility of the state


51

Desirable Features of the “Dual-Track” Approach: Pareto-Improvement The “Dual-Track” approach minimizes political opposition

to reform ex ante and maximizes political opposition to reversal of reform ex post


52

Desirable Features: Minimal Additional Informational and Institutional Requirements The “Dual-Track” approach utilizes the existing

information contained in the original plan and does not require new information for the implementation of the implicit compensatory scheme

The “Dual-Track” approach can be implemented by enforcing the original plan through existing institutions (e.g., the state planning commission). No new institutions (e.g., a national revenue service, or a social welfare agency) are necessary

The Chinese Experience


54

The Chinese Economy Today (1) East Asia is the fastest-growing region in the world over the past two

decades, the East Asian currency crisis of 1997-1998 notwithstanding China is the fastest growing country in East Asia—10% p.a. since

beginning of economic reform (1979) China survived the East Asian currency crisis relatively unscathed China is one of the very few socialist countries that have made a

successful economic transition from a centrally planned to a market economy--the rate of interest (the price of money) and the exchange rate are the only prices that are still administratively determined

The private (non-state) sector accounts for more than 60% of GDP in 2000

China is no longer a “shortage” economy--insufficient aggregate demand is a real possibility


55

The Chinese Economy Today (2)

1979 2000US$ (2000 prices)

Real GDP 176 bill. 1.08 trill.

Real GDP per capita 182860


56

The Chinese Economy Today (3)

U.S. ChinaUS$ (current prices)

2000 GDP 9.962 trill. 1.08 trill.

2000 GDP per capita 36,165 860


57

The Chinese Economic Reform(1979-the present) The Open Door

International Trade Foreign Direct Investment

Marketization Goods Market Labor Market Foreign Exchange Market Housing Market Capital Market


58

The Chinese Economic Reform(1979-the present) Devolution of Economic Decision-Making Power (The

Contract Responsibility System) Empowering Provincial and Local Governments Professional Management of Enterprises Autonomy and Incentive


59

The Chinese Economic Reform(1979-the present) Creation of New, Non-State-Owned Modes of

Organization for Production Agriculture--Abolition of communes; return to a system of

individual cultivators with fixed rents and taxes Industry--Emergence of “Township and Village” (T&V)

enterprises; (foreign) joint-venture, foreign and private enterprises


60

Economic Performance:Pre- and Post-Reform

1952-1979 1979-1998

Pre-Reform Reform

Real GDP 6.20 9.82

Real GDP/Capita 4.14 8.39

Real Gross Value of:

Agricultural Production 4.33 8.05

Light Industry 7.83 11.30

Heavy Industry 11.37 11.34

Real Personal Consumption 4.99 8.91

Real Consumption/Capita 2.96 7.51

Real Gross Fixed Capital Formation 11.43 11.10

Capital Stock 5.93 9.77

Employment 2.52 2.91

GDP Deflator 0.59 6.51

Retail Price Index 0.80 7.03

Exports (in current US Dollars) 10.98 14.66

Imports (in current US Dollars) 10.27 12.22

Average Annual Rates of Growth of Selected Economic Indicators (%)


61

Marketization:Domestic Prices The prices of all consumer goods and more than 99% of

the producer goods are determined in the market (with the exception of within plan outputs of coal, natural gas, and steel)

Only three agricultural commodities--grains, cotton, and tobacco--remain under the central plan

The price of low-grade grain is controlled (subsidized) The price of energy is at world market levels

The prices of oil and gasoline are freely determined in the market China has been taken off the “non-market economies” list

of the European Union (12/97)


62

Marketization:Foreign Exchange Unified exchange rate since 1/94 Interbank market in foreign exchange established 4/94 Current account convertibility since 12/96 Exporters permitted to retain 15% of foreign exchange

proceeds as of 10/97 However, full capital account convertibility unlikely in the

near future


63

The Growth of the Non-State Sector-Industry

Distribution of Gross Value of Industrial Production by Ownership1979

State-owned 78%

Collective22%

1999

Collective33%

State-owned 26%

Individual 17%

Other Types24%


64

The Growth of Industrial Output by Sector of Ownership

The Rate of Growth of Industrial Output by Sector of Ownership

0%

10%

20%

30%

40%

50%

60%

1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999

Total Industrial Output

State-Owned Enterprises

Non-State Owned Enterprises


65

The Growth of Industrial Output of the Non-State Sector

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994

Per

cent

age

Non-state Owned Enterprises

Township and Village Enterprises


66

The Growth of the Non-State Sector (2)-Retail

The Distribution of Retail Sales by Ownership1979Joint-Owned

0.0%Individual0.2%

Collective-Owned43.1% State-Owned

54.0%

Others2.6% 1998

Joint-Owned0.6%

Individual37.1%

Others25.2%

Collective-Owned16.6%

State-Owned20.7%


67

Efficient Utilization ofNew Resources New enterprises and new activities are responsible for the

phenomenal economic growth of China Little or no privatization of existing enterprises Little or no successful restructuring of existing enterprises


68

The Dual Tracks in the Grain Markets

Table 1. The Dual Tracks in the Grain Market (million tons)

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

State procurement at plan price

47.8 54.0 50.2 52.1 56.2 91.2 102.4 59.6 53.3 56.9 50.5

State procurement at market price

10.6 17.5 7.6 9.3 19.6 32.3 42.3 43.8

Domestic production

304.8 332.1 320.6 325.0 354.5 387.3 407.3 379.1 391.5 403.0 394.1

Plan procurement/Production

0.16 0.16 0.16 0.16 0.16 0.24 0.25 0.16 0.14 0.14 0.13


69

The Dual Tracksin Agricultural Goods Markets

Table 2. The Dual Tracks in Agricultural Goods Markets (% of output value)

1978 1985 1986 1987 1988 1989 1990

Transactions atplan prices

94.4 37.0 35.0 29.4 24.0 35.5 31.0

Transactions atmarket prices

5.6 63.0 65.0 70.6 76.0 64.5 69.0


70

The Dual Tracks in Industrial Goods Markets

Table 3. The Dual Tracks in Industrial Goods Markets(% of output value)

1978 1985 1990


100.0 64.0 44.6


0.0 36.0 55.4


71

The Dual Tracks in Retail Sales

Table 4. The Dual Tracks in Retail Sales (% of sales)

1978 1985 1986 1987 1988 1989 1990


97.0 47.0 35.0 33.7 28.9 31.3 30.0


3.0 53.0 65.0 66.3 71.1 69.7 70.0


72

The Dual Tracks in the Labor Market

Table 5. The Dual Tracks in Non-Farm Employment in the State and Non-state Sectors(million employees)

1978 1983 1985 1988 1989 1990 1991 1992 1993 1994

State 74.51 87.71 89.90 99.84 101.08 103.46 106.64 108.89 109.20 112.14

Permanent 74.51 87.14 86.58 89.76 89.18 89.74 90.75 88.31 85.24 83.61

Contract 0.00 0.57 3.32 10.08 11.90 13.72 15.89 20.58 23.96 28.53

Non-State 48.90 62.10 107.97 138.28 136.49 152.53 159.49 172.28 195.87 204.85

Urban 20.63 29.75 38.18 42.83 42.82 43.84 46.04 47.41 50.45 56.01

Rural 28.27 32.35 69.79 95.45 93.67 108.69 113.45 124.87 145.42 148.84

StatePermanent/Total

0.60 0.58 0.44 0.38 0.38 0.35 0.34 0.31 0.28 0.26


73

Examples from the Chinese Experience (1) The agricultural reform (2) The industrial reform (3) The dual-track price system in urban consumer

goods and services (4) The foreign exchange reform


74

Examples from the Chinese Experience (5) Growth of economic activities outside the “Plan” (6) Special economic zones and foreign direct

investment (7) The tax reforms (8) The rate of interest on household bank deposits


75

The Effect of Economic Growth Growing out of the “Plan” New resources from high saving rates of between 35 and

40% The rise of new enterprises


76

Phasing Out the Plan Track-Agriculture

Table 1. Phasing Out the Plan-Track: Agricultural Products (% of output value)

1978 1985 1986 1987 1988 1989 1990 1991 1992 1993

plan price 94.4 37.0 35.0 29.4 24.0 35.5 31.0 22.2 12.5 10.4

guide price 0.0 23.0 21.0 16.8 19.0 24.3 27.0 20.0 5.7 2.1

market price 5.6 40.0 43.7 53.8 57.0 40.4 42.0 57.8 81.8 87.5


77

Phasing Out the Plan Track-Industry

Table 3. Phasing Out the Plan-Track: Industrial Goods (% of output value)

1978 1985 1986 1987 1988 1989 1990 1991 1992 1993

planprice

100.0 64.0 60.0 44.6 36.0 18.7 13.8

guideprice

0.0 23.0 19.0 18.3 7.5 5.1

marketprice

0.0 13.0 40.0 36.4 45.7 73.8 81.1


78

Phasing Out the Plan Track-Retail

Table 5. Phasing Out the Plan-Track: Total Retail Sales (% of sales)

1978 1985 1986 1987 1988 1989 1990 1991 1992 1993planprice

97.0 47.0 35.0 33.7 28.9 31.3 30.0 20.9 5.9 4.8

guideprice

0.0 19.0 25.0 28.0 21.8 23.2 25.0 10.3 1.1 1.4

marketprice

3.0 34.0 40.0 38.3 49.3 45.5 45.0 68.8 93.0 93.8


79

Related Literature Byrd (1987, 1989) Murphy, Shleifer and Vishny (1992) McMillan and Naughton (1992) and Naughton (1995)


80

Conclusion:There Can Be Reform Without Losers! Reform is distinct from redistribution--new value is

created--a positive sum rather than a zero sum game Economic reforms without losers are possible--The “Dual-

Track” approach allows both economic efficiency and Pareto-improvement to be simultaneously attained

Efficiency and equity are compatible Feasibility of the original plan and credibility of state

enforcement are essential

economics 216: the macroeconomics of development

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