Tthe main economic problem which may arise in transition economies

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Last updated: April 19, 2019

The Eastern European countries like The Soviet Union, Poland, Ukraine etc. were command economies throughout the 1940s and the 1950s; however during the 1990s these economies started transforming themselves into market-oriented economies.

These countries while they were in a process of transition were known as transition economies. This transition created a lot of problems for the people living in these nations and also for the government itself. The first immediate problem that the economy faced when it started the transition was a sharp fall in its GDP because of the reduction in the output.The average fall of all the countries was about 30%. For example the GDP of Albania was about 1. 0 in 1976-85; it fell to about -10.

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8 by 1991. This can be seen form Table 44. 1. Russia has seen its output fall to 53% of its 1989 level. The fall in the output was because of various reasons. Due to the transition now that there is no central planning the factories could produce whatever they wanted.

They started cutting back on investment because they did not want to take too many risks; this lead to reduced demands for the supplies.So the suppliers cut off workers, leading to large scale unemployment and this led to the reduced demand which had an impact on the decrease in the output of the country. The change in the economic system from planned to market also lead to large scale unemployment. One of the causes of this unemployment was that, during the transition many enterprises were forced out of business because of the lack of funds and demand to support them. Another reason was that some of the firms were forced to become efficient after the transition due to the competition from other firms and foreign enterprises.

The easiest way of becoming efficient for these firms was by laying-off workers and making the remaining the workforce work harder and more productively. All the countries in the transition process found unemployment as one of the heaviest costs they had to bear. The countries worst affected by the GDP fall have seen a rise in their informal sectors. For example it can be easily seen from table 44. 3 that in 1988 countries like Uzbekistan and Georgia had informal sectors that were greater than their formal sectors. This also affected the GDP because the revenue earned in the informal sector is not included in a country’s GDP.In a command economy the concept of rationing exists. But in a market economy rationing exists in a different way than that in a command economy.

In a free market goods and services are produced for those who can afford them. Rationing exists through price mechanism and only those who are in a position to buy the goods contribute to the demand. This is exactly what happened in the transition economies.

So even though there were no shortages in the goods anymore, there was a large scale increase of the costs of goods.For example from Table 4. 4 which was a Financial Times survey in Moscow the prices of mandarins increased from 1. 00 to about 10. 0 and the prices of veal increased form 2. 50 to 15. 00. The state prices of goods were about one fifth the free market prices of those same goods.

So no one could afford to buy even the daily necessities because their wages had remained the same even after the transition. This lead to a rapid decrease in demand. The firms were forced to increase the wages of the workers to accommodate the high prices of goods.

Since the firms themselves did not have enough money to meet the demands of the workers, the governments were forced to print more money. This lead to hyperinflation and further increased the problems of the country. For example according to Table 44. 3 we can see that the average consumer price in Bulgaria was 1 in 1976-1985 but in 1997 it rose up to about 1082. Thus we can understand the level of inflation that affected the country. Another problem during this transition was the unequal distribution of wealth. The rich politicians of the counties acquired all the wealth and the state assets.It led to a shift in the distribution of wealth.

Earlier in a command economy coal miners used to earn more than doctors. This was reversed once the economies shifted to form a market economy. This caused the wage inequalities to widen greatly and led to the formation of a new rich, working class with spending power. These were all some of the main problems that arose the transition process of the Eastern European economies. b) Using examples from the data provided, explain how the transition can be achieved as smoothly as possible.Different countries in Eastern Europe tried different methods in order to ensure a smooth transition. In a command economy, land, capital and all the other factors of production are owned by the state government where as in a free market economy they are owned by the private sector. So during the transition the governments could either decide to transfer or sell these assets to the private companies, industries or individuals.

The duty of the government was to ensure that these assets were equitably distributed among all the people in the country. In order to do so different countries used various methods.The state could just give the property and capital away to the people or the companies who were using them at that time.

For example if a firm was allotted a specific factory to produce the goods which the government told them to produce, they would now just own the factory. This was a very unequal way of allotting the goods and led to a lot of problems, because a factory with good quality modern machinery would be much better off than a factory where the machinery was old and needed to be replaced. This method also led to a lot of inequalities among the people.

The rich corrupt politicians in some countries seized all the state assets and increased the unequal distribution of wealth. The government could just sell all the state assets into a fund and give a share of this fund to all the citizens of that country. Then this fund would then try to sell the physical assets for money. Either this money could be distributed equally among the shareholders of the fund or the money could be used to invest the other assets of this fund. The citizens would all have equal number of shares of this fund and could either sell their shares or keep them in the hope of making more profit.This was a relatively fair model of transition from a command economy to a free-market system where every citizen got an equal share of the state’s income during the transition. This was the model that the Czech Republic used successfully in order to transform itself into a market economy. Another method that the state government could use in order to achieve a smooth transition was by selling it assets to the highest bidder and using the earnings in order to reduce the past government debt, reduce the taxes etc.

These assets could either be sold to individuals, producers or to a foreign country. For example East Germany had set up a company called Truehand to sell the state assets Between 1990 and 1995 Truehand was responsible in selling all the state assets. Some of them were sold to foreign companies and others to private firms. The speed of privatization differed in various countries because all of them wanted to redistribute the state assets in the best possible way.For example East Germany was completely privatized by 1995 while the Czech Republic and Hungary were privatized by the year 2000 and countries such as Ukraine and Belarus are still under the process of transformation.

The move from a command economy to a free market system led to a big shift in the distribution of wealth. Earlier a coal miner used to earn more than a doctor and now the roles were reversed to a great extent. Thus we can see that this transition created a lot of inequalities in the distribution of incomes and widened the gap between the rich and the poor classes even further.The extent to which these inequalities are prevalent depended on the social security safety net of the country and also the transfer payments the country offered. This is basically the income allotted by the government to people who are unemployed, ill or retirement pensions.

If the former command economies retain their social security safety net systems the inequalities will be relatively low but if they collapse the difference between the rich and poor will widen greatly increasing the problems in the country.For example West Germany has kept its social security safety net systems relatively intact. Another way that the government can prevent the inequalities within the society to escalate is by handling this privatization slowly like Poland did. In order to prevent large scale shut down of a number of its firms and factories like in East Germany it did not sell too many of its firms to Western countries and sold them within the country itself and was also very liberal in allowing the new firms to be set up and forced the state companies in maintain strict economic discipline.

Hence it is the private competition that has led to a large increase in the productivity of the state run firms. The state government can also try to fluctuate between the inflation and the printing of more money and can try to provide enough money in the economy to prevent the firms from shutting down and workers from suffering from their low wages with the increased prices. New tax reforms such as the introduction of VAT can also increase the government income so that the government can have a larger social security safety net system and transfer payments.In the long run even though this transition was quite problematic to all of the Eastern European countries it was no doubt necessary for them for two main reasons. One reason was that the main aim of a command economy was to give the people personal freedom and command economies actually tell people what to do.

The only way you can give people personal freedom is by giving them economic freedom. Another more important reason was the growth of inefficiencies within the countries. Often most of the products were unsatisfactory and only a few people could obtain them because of the long queues and the shortages.There were also long waiting lists for essential goods like housing and shops were often lacking the basic necessities like food for all the people. A lot of investment was wasted on things that people did not want. There was over employment of people and since the wages of the workers were minimal, a large informal sector started growing rapidly and a lot of workers looked at black markets as a second source of income. Inequality was widespread and this led to a growth in both absolute and relative poverty. This is why there was an urgent need in those countries to transform their economies into free-market systems.

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