Lecture 4' Dualtrack liberalization and its properties'

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Lecture 4. Dual-track liberalization and its
properties.
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1. Introduction.

• Price liberalization in China followed a
  dual-track.
• Plan track production and prices are frozen at
  defined preexisting level (last years plan)
• Market track liberalization at the margin for
  all goods with fully free transactions once the
  plan obligations are fulfilled. Producers are
  full residual claimants of market track.

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1. Introduction.

• Dual-track liberalization has particularly
  interesting properties as Eastern European
  countries did not implement it.
• Can theoretically achieve the same efficiency as
  full liberalization if secondary markets (resale)
  are allowed.
• Has interesting political economy property not to
  create losers but only winners (!)
• Prevents output fall that was associated to price
  liberalization.

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1. Introduction.

• Household responsibility system was first form of
  application of dual-track approach. A fixed
  quantity of grain was to be sold to the state
  procurement agency at planned prices, a certain
  quantity of inputs (mainly chemical fertilizers)
  at planned prices. Once these obligations
  fulfilled, farmers were free to produce, buy and
  sell what they wanted.
• Dual-track price liberalization introduced in all
  industry in 1984.
• For consumers, basic necessities assigned by
  rationing before 1979. After liberalization,
  coupon system still available until 1979.

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• State procurement remained stable over time
  despite the increase in total production
  (exception of 1983-1984 where market prices were
  below state prices).

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The dual-track under efficient supply and
rationing
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S
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D
Q
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A case of efficient supply and inefficient
rationing
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D
Q
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A case of efficient supply and inefficient
rationing
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A case of efficient supply and inefficient
rationing
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D
D
Q
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A case of efficient rationing but inefficient
supply
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s
D
D
Q
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A case of efficient rationing but inefficient
supply
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s
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D
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A case of efficient rationing but inefficient
supply
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• Consider the more general case where QP is not
  necessarily allocated between users with highest
  willingness to pay and producers with lowest
  marginal costs.
• Consider first the case of limited liberalization
  (without secondary market). Intuitively, if
  consumers with willingness to pay below PE were
  served under the plan, higher than efficient
  demand will drive the market price upward
  bringing in inefficient producers. If producers
  with marginal cost above PE served the plan,
  there are more efficient producers available
  competing at lower costs to serve residual
  demand. This will drive the price downward which
  will attract more demand.
• Inefficient rationing and inefficient supply
  under limited liberalization will not generally
  lead to efficiency because inefficient allocation
  of planning is not undone and distorts market
  allocation.

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• Under full liberalization, all inefficient trades
  of the plan can be undone. Those who receive
  planned goods and have willingness to pay lower
  than PE will benefit from reselling the goods at
  market price, thereby undoing the inefficient
  allocation. Similarly, producers with marginal
  costs higher than PE can benefit from not
  producing and purchasing the goods at market
  price thereby undoing the inefficient allocation.
  The rents accruing to those benefiting from these
  secondary transactions can seem morally unjust
  but they satisfy the Pareto criterion.

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Properties of dual track liberalization

• Dual track liberalization is a way to enforce
  efficient reform without creating losers.
• It has no special informational requirements (no
  new informational asymmetry problem to be solved)
• It does not require new institutions but uses the
  existing institutions of the plan.
• Can be seen as a transitional institution itself
  designed to disappear as the importance of the
  plan fades away.

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Dual track liberalization and the output fall.

• Models of the output fall (Blanchard and Kremer,
  1997, Roland and Verdier, 2000) emphasize a
  similar mechanism new trades from liberalization
  do not compensate disorganization related to
  breakdown of existing production chains.
• Dual track liberalization is an institutional
  means to prevent disorganization. Enterprises are
  given freedom to search for new business partners
  but cannot abandon their contractual obligations
  under the plan.

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Wider applications of dual-track liberalization.

• Outside the context of China or even transition,
  the same idea can be applied in other contexts.
• Pension reform
• Labor markets .
• North Korea?