Comprehensive Notes on Economic Systems and Transitions

Economic Shortages & Soft Budget Constraints

• Soft Budget Constraint (SBC):

  • Organizations face SBC when they can be bailed out by the government to cover deficits.
  • Bailouts are common for non-profit organizations (schools, hospitals) and sometimes in the financial sector ("too large to fail").
  • Fiscal, credit, and indirect (protectionism) methods are used.

• Micro-level effects of SBC:

  • Lower effort from organizations.
  • Lower sensitivity to prices.
  • Resources diverted to activities that improve relationships with bailout sources.

• Macro-level effects of SBC:

  • Inefficient allocation of resources, with inefficient companies using resources that could be used for expansion of output elsewhere.

• SBC as a Dynamic Commitment Problem:

  • The organization cannot commit itself not to extend further credit after initial support.
  • Example: China; profit contributions significantly deteriorate the operational dynamics of state-owned enterprises (SOEs), leading to larger subsequent government support.

• Dewatripont-Maskin Model of SBCs:

  • Degree of BC: o (probability to liquidate is 1-o).
    • Pure strategies: o = 1 (always refinances), o = 0 (always liquidates).
  • Projects have external effects (political issues, welfare).
  • The only equilibrium is one where managers submit poor projects, which are all funded and refinanced (o = 1).

• Shortages and SBC:

  • Governments have an incentive to keep prices low, aggravating shortages, which helps mitigate the effects of SBCs in a costly way.

• Ratchet Effect:

  • Good projects generate returns in both the first and second periods.
  • Managers with good projects must exert costly efforts to realize their second-period return.
  • Poor projects in the second period exceed the return from the second period of good projects.
  • Thus, poor projects may receive priority over good projects in second-period funding.

Reform Attempts Before 1989

• Problem: Public protest.

• Types of reforms:

  1. Small modification of the central planning mechanism.
     • Attempts to improve coordination within central planning.
     • Usually unsuccessful, potentially successful in Poland (modernization).
  2. Proposal of more complex changes.
     • If viewed as a threat: military intervention by the Soviets (Czechoslovakia).
     • If harmless: some reforms could be implemented (Hungary).

• USSR:

  • Similar troubles.
  • In a position as a commodity exporter.
  • Discussions about reforms, potentially creating real new capitalism.
  • Not admissible: private businesses could only be small-scale; large companies remained private.
  • Deeper reforms in the decision-making processes of the managers.

• Hungary:

  • 1956 protests were bloody.
  • Gradual steps towards reform frequently interrupted.
  • Kadar’s Goulash Communism.
  • Long-term orientation on raising material welfare (prevention of political instability), paternalistic welfare state.
  • Gradualistic economic reforms (influence of historical and institutional factors).
  • Less isolated from the West, relative freedom of economic thinking (e.g., J. Kornai).

• Reforms in Hungary:

  1. New Economic Mechanism.
  2. New system of pricing.
  3. Recentralization.
  4. New economic policies.
  5. 1983: financial liberation.

• Effects of Partial Reforms:

  • Reforms mostly failed (exception: Hungary).

• Problems:

  1. Shortages.
  2. Interception between private and state sectors.
  3. Integration issues.
  4. Centralized modernization is inefficient.

• Effects:

  1. Countries that attempted partial reforms suffered from macroeconomic disequilibria.
  2. Positives: understanding what doesn't lead to success by 1990.

Social Models in Europe

• Nordic Model: excels in innovation and social inclusion.

• European Social Model: the notion of a single European social model is largely irrelevant.

  • Implication: country-specific or model-specific approaches are necessary.

• Mediterranean Model:

  • Old-age pensions.
  • Employment protection.
  • Wage structure based on collective bargaining.
  • Countries: Greece, Italy, Spain.

• Nordic Model:

  • High levels of social protection.
  • Active policy instruments.
  • Strong labor unions.
  • Highly compressed wages.
  • Countries: Denmark, Sweden, Netherlands.

• Anglo-Saxon Model:

  • Social assistance as a last resort.
  • Cash transfers for the working group.
  • Activation measures (benefits).
  • High incidence of low-pay employment.
  • Countries: Ireland, UK.

• Continental Model:

  • Insurance-based (old age, unemployment).
  • Strong unions.
  • Countries: France, Germany, Belgium.

• Labor markets in Europe:

  • Flexibility issues leading to unemployment.
  • Two solutions:
    1. Make labor markets more flexible.
    2. Make employees more complicated.

Transition Reforms in Central and Eastern Europe (CEE)

• Fall of communism was largely unexpected.

• Three Causes:

  1. Economic dissatisfaction.
  2. Political limitations.
  3. External factors (lack of support in satellite countries).

• Why didn't it happen in China too?

  • Stability and pragmatism.
  • Slow and gradual reforms.

• Economic Theory of Transition (Ex Ante):

  • No complete pre-established theory before the fall of the Berlin Wall.

• Macroeconomic Stabilization Proposals:

  • Big bang (speedy) reforms: Åslund, Berg, Sachs.
  • Gradualism: Roland, McMillan.
  • No single universal approach was chosen; policymakers inspired by role models and advice from abroad.
  • Institutional development lacked deep understanding of the reforms.

• Intellectual Climate in 1990:

  1. Domestic: Awareness of failure, need for decisive approach.
  2. International: Influence of Thatcher and Reagan, emphasis on liberalization, privatization, and deregulation.

• Conclusion: Decisions relied on a return to the market, rapid liberalization, and privatization.

  • Actual policies: gradual approach (Hungary) and shock therapy (Poland).

• Washington Consensus (Williamson, 1989):

  • Basic recommendations neglecting institutional reforms.
  • Emphasis on open economies.
  • Role of the consensus: inspiration.

• Main Points:

  • Fiscal discipline.
  • Reduction of expenditure.
  • Tax reform.
  • Interest rate liberalization.
  • Competitive exchange rate.
  • Trade liberalization.
  • Investment liberalization.
  • Privatization.
  • Deregulation.
  • Property rights.

• Reforms: Main Components:

  1. Stabilization.
  2. Liberalization.
  3. Privatization.
  • This means new institutions, new laws, agents who know the changes, and enforcement of compliance.

• China: Dual-track system (keeps central plan + some freedoms).

Price and Privatization

• Price Liberalization: Necessary for the introduction of market mechanisms.

  1. Simple: Likely to accelerate inflation.
     • Results in theory: positive.
     • Lipton and Sach: Welfare improves.
       • Increases level Q, average cost is queuing.
       • After price liberalization, a market price is clear.
       • Higher price, but still the same supply (and consumption) Q.
       • Costs of queuing disappear.
       • Utility increases to U = Q.
         *Reality: More complicated.
  2. Full.
  3. Partial: Reduces political cost.
     • China.
     • Overcomes constraints.

• Dual Track of China: Agriculture

  • Commune - free to do whatever they want to do
  • Retain profit
  • Commune had responsibilities: fulfillment of their taxes and quotas
  • Similar system, later in oil and industry

Stratagies and Managerial Motivations

• Startegic organic behavior: bottom up.

• strategic accelerated behavior: as fast as possible, techniques.

• China: not main engine of reform, later introduction.

• Constrains:

  1. Avoid extreme shocks.
  2. Political considerations.
  3. State of finances.
  4. Organization needed.
  5. Fiscal constraints - tax introductions.
  6. Stock flow - against the flow of annual savings.

• Restructuring:

  1. Defensive: Taking measures to reduce costs for immediate survival.
  2. Strategic: Motivation to enhance enterprise performance and requires good administration.

• Manager Motivation:

  1. Privatization to outsiders: Will the incumbent managers just wait for outcomes? Potentially leads to wild privatizations.
  2. Privatisation to insiders: Reduced motivation for spontaneous or wild methods.

Methods Used in CEE Countires Privatizations

• Based: traditional (direct sales) vs non-orthodox (vouchers)

• Set of Principles: (1 or few owners vs mass, insider vs outsider)

• Price: (Zero vs Positive)

• Problem: Typically mixed approach

• Bottom up vs Bottom down: (outsiders vs insiders)

• GDR objective: Social market economy like in the west, fast privatization

• Treuhand Anstalt: East German enterprises prior to full reunification, success but not without controversies

• Debate:

  1. Give away debated.
  2. Auctioning: preferred but criticized (Treuhand) - recommended for small things.
  3. Bargaining: preselected, solution to some of the issues, investors active in the same sector.

• Bottom line:

  • Positive features: real and experienced owners found.
  • Problems: too many goals, high losses (124%) dominance of the west

• Czechia: Vouchers

  • Distribution to citizens
  • Pride of czech reformers
  • 50%
  • Coupon book
  • People could decide if they want to invest or not

• Reasons:

  • Lack of domestic capital
  • Didnt want to rely only on foreign capital
  • Fast
  • Generate public support
  • Less demanding state

• Immediate Results: formal, investments became powerful, many shareholders

• Problems: real owners?, fragmented ownership, no new capital, still owned by banks
  *Economist point of view:

  1. Principal agent problem
  2. Soft budget constrains
     *Third wave: after vouchers

Russia's Privatization: Loans and Shares

• Deal: 1995 Russia: deficit, privatization vital

• Two-stage program:

  1. Before elections of shares of auction
  2. auctions rigid
     • 12 companies were eventually sold
     • only a view names involvedResult: only specific people gained smt
       • The winners of the auctions would have to fight punishing battles against the entrenched, Soviet-era managers, with their contacts in local law enforcement and sometimes organized crime.
         • (later further info)

  Mafiaeconomics

• business elites formed from these three groups

  • Former members of the official hierarchy (Party)
  • Former informal entrepreneurs
  • Former leaders of organized crime groups (OCG)

  It was indeed naive to think that democratic elections could transfer power and wealth "to the people" in a political setting where no mechanisms functioned according to formal rules
  *Lecture 10 Russias Privatization + Effects

• How to compare success with companies?

• price relative to size

• dealing with sample bias: basically omitted variable problem

• Reality of studies on empirical effects of privatization

• problem with instruments

• Summary of literature: overall observations

  • in depth firm level studies further suggest that consecrated private ownership has stronger positive effects on performance

  • Quality of post-privatization corporate governance matters a lot.

    • superior impacts of foreign ownership

    • differences between countries in location, privatization methods and speed of policy

• Privatization - lesson learned

  • forms of budget constrains matter
  • information asymmetry are not just theoretical issue
  • no sufficient owners but an environment that makes the real owners
  • foreign ownership provide leads in better results

Privatization in China & Elites

• Privatization in China

  • Privatization did not constitute the main engine of reforms

    • privatization can be seen as less attractive because of power/control distribution
    • Efficiency improvements: “retain the large, release the small”
    • Towns hip and village enterprises: referst to location. market oriented, controlled by local governments, fuzzy poverty rights

• Privatization:

  • introduced later

    • close to half of the SOEs had zero or negative equity
    • caused trouble (lock of incentives, social responsibility of companies)1. large scale privatizations
      • after 2003 ditch
      • renewed interest in 2014: motivation debts1. methods
        • buy outs
        • sales to outsiders
        • issue privatization
        • joint dentures leasing employee holdings

• 1997: year asia crisis: China Telecom had only recently come into existence, born of the combination of the assets of two southern-China-based telecoms that had been selected by Goldman Sachs and CICC in consultation with the Chinese government, whose Ministry of Posts and Telecommunications controlled the new firm. It was incorporated just seven weeks before the IPO (initial public offering)

• IPOs

  • became popular effect on efficiency1. china economic growth since the economic reforms

    • driven by reallocation of resources
    • small SOEs are more likely to exit or become privatized

• Model of state capitalism

  • despite consistency: lower productivity, chinas enterpsiees seem to exhibit higher profitThe unprecedented prosperity of SOEs is thus symptomatic of the incompleteness of market oriented reforms, distorting factor prices, impeding structural change, depressing GDP, and reducing public welfare

• Side effects:

Elites and Labor Markets

• Side effects from privatization

  • traditional elites: more or less remained in power, in some countries highjacked reforms, remained important even in countries which had attempted to reduce the risk of similar scenarios
  • Elites Hanley: focus on Poland and Czechia
    • original aim was to draw four random samples of elites in each country1. nomenklatura: who were in these kind of positions
      • . new political and cultural elite: random sample of individuals who were included in political and cultural decisions
        • old economic elites sample: random sample of old ceo of 500 firms randomly selected
          • new economic elite: random sample of ceo of newer firms --> his conclusions: The transition to democracy led has resulted in much higher rates of elite circulation among political as opposed to economic elites, allowing managers to dominate the privatization process once the collapse of state socialism occurred.
            • Trust in the date ?1. size of economy
              • manipulations (within the system, deliberate)
                • faking data can be difficult
                  • hiding date + faking is probably the approach

• North Korea follows a similar approach

Labor Market mobility

* gradual liberalization

    * remains unique and the mobility within the market are lower

Institutional Features of China & Superstitions

• Lecture 11 Chinese Economy and some traditional Topics

  • Institutional features: non democratic systems

    • state intervention: specific legal and judicial systems
    • historical and cultural heritage: and attempts to outroot some parts of this heritage in the past tendencies to rely on networks
      • mix of modern economy and traditional supersititions

• Superstitions in china

  • surged into doomsday industry

  • crystals, fortune telling and ai oracles relations between china and west

    • reversal in the late 200s

      • before: seen as rolemodel

      • reversal since financial crisis (especially with Trump)

        • china became trend stter and explorer
        • fastest adoption of modern technologies unclear boundaries between public and private

Chinese Political System, SOEs, POEs, Labour Markets with Hukou & Autocracy

• Chinese Political System

  • state has less control over SOE (state owned enterprises) and more control over POE (private owned enterprise)

  • capitalism can better be explained by capture of the state by ownership

  • unclear about party and state too the CCP

    • party and those of the state has become blurred and largely indistinguishable

      • control over the country full control over strategic sectors (financial systems, capital resources Party and Companies

        • SOEs: action plans, ensure that Party leadership and Party building are fully embodied and effectively strengthened during enterprise restructuring;

        • Private companies: company law, an organization of the Communist Party of China shall be established

          • result: privatisation created by concentrated ownership, connections with the state (partially privatizes)

          • state keeps significant control over private companies

            • trends: innovative and global competitive multinationals, irrational competition, with troubles still turns to market

• Labour Market:

  • before reforms: workers have assigned by gov
  • after gradual liberalization mobil within the market

• Hukou: household registration. ancient roots possiable excessive urbanization Original Rigid Version:

  • since 1980s gradual reforms decentralization, non hukou migration have been toarted and accepted, migrant population (floating population in china) effects of Hukou:

    • workers with different hukou face differnrs costs of living in cities and have different access to government provided public services and wlefare programs
    • negative impact of rural to urban migration, economic inefficiency , hukou discrimination

• Autocracy within Chinese Characteristics:

  1. supplemental compensations in china bureaucracy was pegged to financial performance

     • government granted partial autonomy to local authorities spend funds they earned

       • local gov generated and the more nontax revenue that party and state offices earned the more compensation they got
       • public employees took a cut of the revenue produced by their organizations (profit sharing)
       • a resultoriented culture in bureaucracy

Corruption in China, Typologies of Corruption & Guanxi in Detail

• Corruption and Motivation of public administration

  • supplemental compenation in china
  • what emerged was essentially a variant of private sharing1. a result oriented culture on the bureaucracy

• Typology of corruption:

  • non elites: petty theft and speed money(petty bribes)

  • elites: grand theft and access money (high stakes bribes)

    • non legal and illegal

• Guanxi Translation: relationship or connection network based on economic favours

  • friends and gifts

  • without friends you cannot do a thing

  • similar to blat (Guanxi and blat were similar practices which became ubiquitous during China’s and Russia’s communist eras - both helped to preserve the ideological tenets of state socialism by adapting them to reality

    • back door Adjective you means “oily” or “greasy,” and is sometimes applied to people who are especially adept at the art of guanxi • Guanxixue—the “art of guanxi”—involves the exchange of gifts, favors, and banquets; the cultivation of personal relationships and networks of mutual dependence; and the creation of obligation and indebtedness.

• matters everywhere

  • extend and type (extreme vs normal)

  • ability

  • role (cultures, quality)

  • historical experience why informal practises exist1. strategies to maintain or exploit formal rule

    • benign formal rules and informal norms - implications depend on the system

      • in everyday life: safety net, formalizes hierarchies, Blat vs Guanxi Blat: less clearer rules, less used term, based on criminal jargon Guanxi: clear traditions, social norms, based on kinship ethics.

        • values: repay favors, long term relationship nurtured, must help disadvantaged, illegal is more about shame and loss of face than guilt1. the gate: belings to the state, gatekeepers are in charge of the distribution now: china stays the same, Russia has changed

Why is China growing so Fast & Household responsibility

• Why is China growing so Fast?

  • traditional implications

    • hard work, high rate savings, education , orientation on the export market

      • barriers: strong role of state, soft budget constrains, allocative inefficiency 1. success is a product of own unique system
        • “The West constructed the road; China just followed it. That China walked faster does not mean that its institutions are superior. ”
          • Problem?
            • china is a unique case
            • high investment innovation1. allocation issues
      • other possibilities1. china started from a low base
        • just closing the gap2. restructuring and relocation of labour

  • relaocation of labour

1. demographic divided: large share of working age - yet declining4. effects of unification of internal market: used to be fragmented, missing infrastructure - similar to unifing internal market of the EU5. presence of strong external demand and liberation of trade: memeber since WTO 2001 (imbalances in trade from other major countries (USA) led to more demand tor Chinese products)

• Household responsibility system:

  • poor village contracting collectivly owned land: then became nation wide, agriculture: contarct collective land, and carry out production

• China - Why is China growing so fast?

Lecture 12 - China and Russia and India

• China:

• liberation of trade and external demand,plus timing - WTO member since 2001 - imbalances in trade from other major countries (USA) led to more demand for Chinese products

• technology

• political stability

• Trade issues: the world realized it has become dependent on China and visa versa - both sides try to reduce dependency emphasis on local and domestic demand - dual circulation - examples: li-ion batteries, wind turbines

China's Insides: The party and Factions & India's Trajectories.

• Inside tha party:

• Focus on Shihs Model, coexietence of: low inlation with chronic inefficiency1. techonological contol manages inflation. radical political interventions, chronic inefficiencies Explanation: technological factors and generalist factorsLeaders Preferences:

  • in China: idealist removed or transformed1. those who were unwilling to bend with the political wind were inevitably eliminated1. top leaders value the retention and expansion of power above all else, lack of creadiable formal institutions,

• bandwagining behaviour

• factions: objectives and competition1. personal network which seeks to expand power by allocating scares goods in political system1. the factions compete for ultimate control of the party.

• it is less costly to remain in factions, but defection possible. they have clearly divergent prefrences over monetary policies

          *   protize short term factional gains lack of long term financial strategies Actors:
  

1. to pleaders - centers of power - enormous authority
2. senior cadres: official at the vices (minister, govenor, people), outsiders can provide resources to leaders - leaders useful in propaganda
3. beurocrats (ministers) - paralyze policies - represent central committee Forms
4. provincial leaders - preferences for the distribution of economic goods - objective: more capital - all this increase the chances of promotion as well as provides opportunites fro rent seeking - members: senior party members, senior cadres, senior provincial cadres
5. centreal beuraucrats - career and prestige depends on the control over policies - members: senior technocrats - senior cadres in state council - bank president

The 2,2,2 Model for Factions, Russia, Its Trajectory and India

• 2,2,2 Model:

• 2 types of factions: gerealist and technocratic; 2 strategies: financial decentralization, finiantial centralization; 2 outcomes Inflation cycle

1. gerealist dominate
2. devolution of financial discretion
3. inflation
4. dominance of technocrats
5. centralization of finances
6. price stability
7. back to 1 Implications:

• distribute money differently, negative effect between curre t and future inflation, short term positive realtionship between output and inflation, no true fix for this situation Li, Roland, Xie Model: corny capitalism(individuals become successful through personal relations hips to political leaders) + hierarchy + descison making process, inefficient economic institutions, local corruption, threatens social peace, central will maximise crisis control, even sacreficing economy Russia abisitious plans to state capitalism specific factors:

1. long periods under central planning - no traditions

2. influence of nationalism - huge territory

3. rise of oligarchic structure , weak insitutions (not good use of natural wealth)Features from 2005-2010

   1. market economy had a strong link to wealthy elite - weak insitutions, state capitalism, clash control between old elites, state capture
   2. interesting differences in the performance and functioning of companies - state controlled companies often face assets stripping and must participate in uniprfit deals
   3. energy sector is crucial - resource curse , corruption and dominated by state oil companies

Russia and India: State Control, Renationalization and Corruption

• Aslund:

• major trend under Putin has been the renationalisation of large private companies

• renationalisation started with the arrest of Mikhail, private assets have been seized with the unlawful assistance of law enforcement , the state sector has expanded implications: private sector peaked in 2003: 70% of GDP everer since has fallen, while russia claims it has not or it is back to 70% no analysis confirms this statement. Diffirent type of state capitalism unlike Brazila dn china, putin has not used currency to invest in new companies, no forced competition state companies throttle at any competition from the private sector, under putin, the kremlin has allowd just one ore two state firms to dominate nearly every industryImplication: specific state capitalism: the state enterprises have other purposes (political control, social mitigation, and personnel enrichment)Putins inner circle: Family Effects on the War economy?

1. overheating2. inflations3. structural changes4. transformation in external relations5. role of state rises

• India
  1947: independence, 2014 Modi becomes PM India under Modi: intertwines economic changes with modernization, corruption allegations , data manipulations
• Gautam Adani: one of the richest people in the world, markets aware of linkages: Modis first year in office
• Adanis group rose by 5.7 billion State capitalism strategic managment, compertaive capitalism, global political economy
• renewed state intervaention constraining the market, widerspreak infleunce of the state on the market

Governmental Threats, State Ownership and Statistm & Models Classifications

• Why is there such a focus on state capitalism?

• the rise of such countries, rise of variations and hybridsPrincipal components Analysis( PCA) liner combinations of the original variables that maximally explain the variance of all the variables three factors

  1. governmental threats (governments effectiveness, perception of gov bureaucracy, is the government a threat?)
  2. state ownership (how high loadings of state ownerships to GDPs are, based on ownership rights, how depended are firms on state
  3. statism (loadings of state subsidies to GDP and state compesition to GDP), how is the state involved in buissness transactions - source of funds? Resulting Classifications3. interventionist states - state ownership are low/mediumi 4. interventioniest entrepreneurial welfare states, all three factors aer high, max profit not welfare5.interventionist entrepreneurial states, state wondership/threat 6 .invetionare welfare stateslevel of welfare provided, government theat is also high, state ownership is medium

1. Market orientedlow levels of all thee factors8. welfare stateslow giv theat and state ownership; high statism9. entrepreneurial stateslow gov threat, stagmatis, high state ownership10 . entrepreneurial welfare stateslow government theat, high state ownership and high statism