The inevitability of a fall in output in the early stages of transition to the market: Theoretical underpinnings

Abstract

THE STEEP FALL in industrial output in Poland and the even steeper one in East Germany at the start of the respective transition programmes came as a surprise to many analysts. It prompted a discussion on the 'costs of transition', giving the chance to criticise the 'big bang' (or 'shock therapy' or 'critical mass') approach of both residual believers in the old order and proponents of various allegedly painless formulae of gradual transition. Leaving aside the discussion itself, I shall concentrate here on the fall in output and its treatment as a cost of transition to the market. What is particularly puzzling is the near-complete neglect of the economic theory of the centrally planned (or centrally administered or Soviet-type) economy in discussion of the fall in output in the early stages of the transition period. I posit that both economic theory and empirical data supporting that theory clearly suggest exactly such an outcome after the start of the 'big bang'. I posit further that the fall in output can only to a certain extent be seen as a cost of transition, understood as a welfare loss. A major part of the fall in output has no impact on the welfare of the population. As the economic system changes, so does the behaviour of economic agents: firms and households. The change in behaviour inevitably induces a fall in output but the level of welfare remains unchanged. In this article, first, various sources of output loss are considered and their theoretical rationale is presented. Next, implications of output loss for welfare are presented in comparative economic systems' terms. Finally, policy implications are drawn.