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World market economies are comprised of two different types of markets. Those markets are free market economy and planned market economy. Free market economy is an economic system which resolves the basic economic problem through the market mechanism. Planned market economy is an economic system where the government, through a planning process allocates resources in society. Countries such as Russia and China whose markets are based on planned economy, have being experiencing problems such as the incentive offered buy the profit motive maybe replaced by personal ambition or a political ideal, and people have little to say in what is provided directly by the state and the purchasing shops is likely to be limited.(http://www.cato.org/pubs/joural/cj16n2-3.html). Therefore they have decided to change to a market economic system from a planned economic system. There are several conditions that have to be met to make a transition from a planned to a market economy. Those conditions are stabilisation privatisation and price liberalisation.
The first of the conditions for transition to a market economy is stabilisation. Stabilisation requires a flexible, functioning product and hard working labour markets to be able to have a successful transition. If the operation for the state enterprises are being subsidise by the government or there have been loan taking from national banks as happens in planned economies, from neither the enterprise nor the workers will have an incentive to decrease the wage or employees from the effect of the aggregate demand. Aggregate demand is the total of all demands or expenditures in the economy at any given price. Aggregate demands will fall if the consumption , investment, government spending or net exports decrease on the a constant level will lead to a fall. As in the diagram below shows how the aggregate demand curve is shifted to left from the effect it happens.
Fall in Aggregate Demand Curve
The failure of the transition process in creating the correct labour force which will lead to a collapse to any stabilisation program while having a tight fiscal and monetary policies being steadily undermined by increasing public subsidies and credit taxation to state enterprise. Fiscal policy is decisions about spending, taxes and borrowing of the government. Monetary policy is the attempt by government or a central bank to manipulate the money supply, the supply credit, interest rates or any other monetary variable to achieve the policy goal such as price stability.
Micro-economic stabilisation and with domestic price liberalisation comprises the main element of transition phase. The need for it rose back in end of socialism and from the implications for inflation where prices are liberalised . Inflation is the rate of change of average prices in an economy. In many planned economies the price was set to an extent not to clear the market. The tendency of former communist countries was to generate excess demand in the economy. Although prices were fixed which left all for the individuals markets with excess demand. Resulting from this illegal markets started to emerge. From this situation it lead to higher wages and excess demand which resulted in shortages in socialist countries. Besides that it was also happening from decrease in demand but no change in supply. Excess demand reflected the parallel market prices which generated large surpluses in the hand of consumers. Larger surpluses was in a form of cash in social systems, but in capitalist countries surpluses are based on investment, or other forms of savings. This causes enormous problems for the price liberalisation which transition. When price liberalised, consumers can buy goods they were not able to before. This will change the repressed inflation to an actual inflation. Therefore the need for stabilisation in transition has a higher rate. This is to prevent the increase in prices from being institutionalised in wages or hyper inflationary condition that would ultimately affect the other factors of transition.
Second condition for transition to market economy is privatisation. Privatisation have been an important element for the government policies. In Western Europe the rate of privatisation was nothing compared to what was happening in Eastern Europe. In command economies all of the firms which were transitioning were in the governments hand. Privatisation is owning nearly all of the factors of production within the economy that are owned mainly by private individuals or organisations. Government does not have the right to stop citizens form owning business. In the public share of national outputs in former socialist countries is not largely explained by any differences in the size of the private manufacturing o service sectors. This depends on the communist policy for agriculture, and size of the agricultural sector. If you look at the Polish communist they have never collectivised the agricultural sector, so mainly it stayes in private hands. This previous points show why privatisation is one of the important factors of reform or transition to market economy. If we compare UK, and Eastern Europe private ownership’s it shows that in UK a small number of very large natural monopolies and main issue came out was the result of the market structure and the firm of regulation would look like. Privatised firms will be more efficient in producing the good nearly the consumers wants, but in return prices substantially raise above marginal cost. Marginal cost is the cost of producing an extra unit of output. As it shows in the diagram below, Cn is the average and marginal cost curve of nationalised industry, whilst Cp is the cost curve of its privatised counterpart. The nationalised industry maybe induced to charge a price that reflects its costs, consumers will face a price of Pn and quantity Qn will be sold. The privatised industry will wish to maximise profits which requires choosing to produce Qp where marginal costs equals marginal revenue. But in the end the price that is being charged higher then in the nationalised industry, whilst costs are lower.
Privatisation in UK(Costs and Benefits)
In transition to market economy nearly all of the firms have to be privatised. Once all the firms are privatised there will be competition and no more monopoly. The benefits of privatisation are ambiguous. In the diagram below it shows that privatised firm will operate in a competitive market, price reflects marginal cost and both price and cost are over in the privatised care.
Privatisation in Central & Eastern Europe
The development of private sector involves more then only privatisation of existing enterprises or firms. Lots of new firms will need to be created to fill the gaps in supply revealed by the price system.
To ensure the private sector and state firms, it must reminded that in many socialist countries private economic activities are extended beyond family groups in an illegal way. Therefore the private sectors can prosper it is necessary to ensure laws of contracts and bankruptcy.
Last condition for transition is price liberalisation. Prices in command economies were highly irrational and frequent complex. There was no such thing as market forces as many economist thought and were but concerned that the prices will reflect supply and demand. Then will function is guiding resource allocation. In planned economy it show many things that can go wrong in regulating prices. If you look at Soviet union, “The price of bread was so much below the price of on that it was cheaper for farmers to buy bread to feed their livestock then to buy animal feed, so exacerbating bread shortages”(Healy,1994,p.4). The cost of capital charged to firms was really low and sometimes it was zero which it lead to an extreme capital intensive production. There was inefficient use of energy that was caused by use of energy which was only factor of the worlds level. Different or low prices was the main cause of misallocation of resources in planned economy because “in practice the bulk of key inputs were allocated on a quantitative bases from one supplier to another without passing through market and without using of money as an intermediary to the transaction”(Healy, 1994, p.4). These kind of rationales ruled out the sensible investment planning and minimised the costs.
Price liberalisation is a pivotal element in transitioning to market economy because the new firms that are coming need sensible prices upon they can base their decisions. Several evidences show that price reforming is effected quickly. If it was preannounce on a slower speed expectations for future price changes lead to a wide speculation which takes the new fragile market system away from stabilisation. Many countries were subsidising rents and electricity prices for several years. After privatisation was becoming to have an impact on the profits, many stated to say there should be controls on the wages just to prevent coalition of workers and mangers from running down the enterprises by raising wages. To that or to put limit on it several economies used a tax based income policy to maintain the wages.
Another procedure is to be done in price liberalisation is liberalising the exchange rate and trade regime. Many small and open economies do that while in the transition. Exchange rates allows establishment of world prices for restructuring f production and investment. Imports also provide a competitive pressure in domestic markets which should be blocked during transition time period. It is to be blocked because “the highly imperfect market structures inherited for the planners”(healy,1994,p.4)
Making a transition from one market economy to another takes several year to finish. It takes several conditions to be met while transitioning to a free market economy from a planned economy. Stabilisation, privatisation and price liberalisation are the tree main condition to be met while transition. In the time period of the transition there are always some problems happen in an economy of the country. Such problems are fall in GDP and unemployment. If we look at Russia from 1991 to 1996, at this time it was transiting to a market economy. Its gross domestic product(GDP) kept going lower in the first year. Even though it started to rise after a year, but again it went down. It shows it takes long time for the economy to become stable. Unemployment of the country starts to rise, because many people or workers were not trained for jobs such as risk-taking while going privatised. It takes them several years of training to get to a point where they can work in the transition. This how unemployment rates increases at the beginning of the transition, but decreases at the end of the phase of transition. Every country will have problems while transitioning from a planned to a market economy, but at the end in the long term it was worth doing it.
Bibliography
1. “Economics Transformation in Central and Eastern Europe, Part 1”.By Saul Estrin. The Economic review, November 1994. P2-5.
2. “The Economics form Marx to the Market”. By Nigel Healy. Economic review, September 1996. P4-8.
3. Economics Third Ed., By Alain Anderton 2000.
4. “The lessons of China’s Transition to a Market Economy”. http://www.cato.org/pubs/jounal/cj16n2-3.html.
Word Count: 1771
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