Instructor: Vladimir Popov,

1 Carleton University Department of Economics Winter term 2009 ECONOMICS OF TRANSITION (Economics 3808) Instructor: Vladimir Popov, e-mail: vpopov@ccs.carleton.ca Classes: Wednesdays, 14:35-17:25, 502 SOUTHAM HALL Office hours: DT 1313 - Mondays, 14:30-15:30; Wednesdays 17:30-18:30 Prerequisite: ECON 1000 or FYSM 1003. The overall aim of this course is to understand the processes of transition from a socialist, centrally planned economy to a capitalist market-type economy, using the Russian economy as the primary example. Extensive comparisons will be made with the experience of other economies in transition. After surveying the economics of transition in the perspective of comparative economic systems, we shall look at Soviet economic history and at basic features of the Soviet centrally planned economy. We shall then examine current transition problems, such as macroeconomic stabilisation and industrial policy, privatisation strategy and experience, emerging banking and financial systems. The conventional wisdom (as summarised, for instance, in the World s Bank 1996 World Development Report From Plan to Market) suggests that differences in economic performance are associated mostly with "good and bad policies, in particular with the progress in liberalisation and macroeconomic stabilisation: countries that are more successful than others in introducing market reforms and bringing down inflation are believed to have better chances to limit the reduction of output and to quickly recover from the transformational recession. The devil, however, is in the details, which often do not fit into the generalisation and make the whole explanation look trivial. The final task of the course is to examine to what extent differences in economic performance in post-communist countries during transition are associated with: the initial level of economic development; the magnitude of initial distortions in industrial structure and trade patterns; chosen reform paths (shock therapy or gradual transition), speed of liberalisation; institutional capacities of the state; macroeconomic stabilisation (rates of inflation) and industrial policies (import substitution vs. export oriented growth); other factors. Components of the final grade: Mid-term test, in-class (40% of final grade) questions 1 to 35, problems 1-4 (approximately). Final exam (60% of final grade) all questions and problems. Answers that demonstrate the ability of critical thinking and understanding of the issues would be given higher marks than answers that reproduce word by word any existing text. 1

2 Please be aware that plagiarism is a serious offense and one that should be recognized and avoided. For further information regarding this subject, please see the Economics website or pick up a handout from the Department. Failure to write the final examination will result in a grade of ABS. In order to write a deferred exam students must contact the Registrar s Office. For Students with Disabilities: Students with disabilities needing academic accommodations are required to contact a coordinator at the Paul Menton Centre to complete the necessary letters of accommodation. The student must then make an appointment to discuss their needs with the instructor at least two weeks prior to the first class or ITV test. This is to ensure sufficient time is available to make the necessary accommodation arrangements. For Religious Observance: Students requesting academic accommodation on the basis of religious observance should make a formal, written request to their instructors for alternate dates and/or means of satisfying academic requirements. Such requests should be made during the first two weeks of class, or as soon as possible after the need for accommodation is known to exist, but no later than two weeks before the compulsory academic event. Accommodation is to be worked out directly and on an individual basis between the student and the instructor(s) involved. Instructors will make accommodations in a way that avoids academic disadvantage to the student. Students or instructors who have questions or want to confirm accommodation eligibility of a religious event or practice may refer to the Equity Services website for a list of holy days and Carleton s Academic Accommodation policies, or may contact an Equity Services Advisor in the Equity Services Department for assistance. For Pregnancy: Pregnant students requiring academic accommodations are encouraged to contact an Equity Advisor in Equity Services to complete a letter of accommodation. The student must then make an appointment to discuss her needs with the instructor at least two weeks prior to the first academic event in which it is anticipated the accommodation will be required. THE REQUIRED READINGS FOR THE COURSE will be drawn from the following: Comparative Economic Systems by Paul Gregory and Robert Stuart, Houghton Mufflin Company, 5th edition, 1995; Russian and Soviet Economic Performance and Structure by Paul Gregory and Robert Stuart, Harper Collins College Publisher, 6th edition, 1994; The Turning Point: Revitalizing the Soviet Economy by Nikolai Shmelev and Vladimir Popov, Doubleday, 1989; Lavigne, MacMillan Press Ltd., Second Edition, 1999; EBRD Transition Report, 1997-2008 From Plan to Market. World Development Report. World Bank, 1996; Shock Therapy Versus Gradualism: The End of the Debate (Explaining the Magnitude of the Transformational Recession), Comparative Economic Studies, No. 1, Vol.42, Spring 2000, pp. 1-57, by Vladimir Popov, 2000; 2

3 Shock Therapy versus Gradualism Reconsidered: Lessons from Transition Economies after 15 Years of Reforms. Comparative Economic Studies, Vol. 49, Issue 1, March 2007, pp. 1-31, by Vladimir Popov, 2007. My papers can be found at my site: www.carleton.ca/~vpopov There are some useful course materials at: http://http-server.carleton.ca/~vpopov/courses.html =================================================== Week 1-2. Shock therapy versus gradualism. Transformational recession. Transition strategies and performance. Godoy, Sergio, Joseph Stiglitz. Growth, Initial Conditions, Law and Speed of Privatization in Transition Countries: 11 Years Later. 2004. (http://www2.gsb.columbia.edu/faculty/jstiglitz/download/website/growth_initial_conditions_law_and_speed.htm). Stiglitz, Joseph E. WHITHER REFORM? Ten Years of the Transition. WORLD BANK ANNUAL BANK CONFERENCE ON DEVELOPMENT ECONOMICS, 1999. Keynote Address, World Bank (http://www2.gsb.columbia.edu/faculty/jstiglitz/download/1999_4_wither_reform.pdf) Fischer, Stanley and Sahay, Ratna. Taking Stock. Finance & Development, September 2000, Volume 37, Number 3 (http://www.imf.org/external/pubs/ft/fandd/2000/09/fischer.htm). The full version is at (http://www.imf.org/external/pubs/ft/wp/2000/wp0030.pdf) IMF Working Paper WP/00/30. Åslund, Anders. Why Has Russia s Economic Transformation Been So Arduous? Paper prepared for the Annual World Bank Conference on Development Economics, Washington, D.C., April 28-30, 1999 (http://www.carnegieendowment.org/publications/index.cfm?fa=view&id=201) Popov, Vladimir. Shock Therapy Versus Gradualism: The End of the Debate (Explaining the Magnitude of the Transformational Recession), Comparative Economic Studies, No. 1, Vol.42, Spring 2000, pp. 1-57 (http://http-server.carleton.ca/~vpopov/documents/tr-rec-full.pdf) ; See also: G. A. Cornia, V. Popov. Structural and Institutional Factors in the Transition o the market Economy: An Overview. In: Transition and Institutions: The Experience of Late Reformers. Ed. By G. A. Cornia and V. Popov. Oxford University Press, 2001 (http://www.oup.co.uk/pdf/0-19-924218-6.pdf); Popov, V. Shock Therapy versus Gradualism Reconsidered: Lessons from Transition Economies after 15 Years of Reforms. - Comparative Economic Studies, Vol. 49, Issue 1, March 2007, pp. 1-31 (http://http-server.carleton.ca/~vpopov/documents/shock%20vs%20grad%20reconsidered%20-15%20years%20after%20- %20CES,%202007.pdf). Popov, V. Reform Strategies and Economic Performance of Russia s Regions. World 3

4 Development, May 2001(http://http-server.carleton.ca/~vpopov/documents/Regions_Apr2000.pdf). Kornai, Janos, Transformational Recession: The Main Causes. Journal of Comparative Economics, No. 1, 1994, pp. 39-63. World Development Report. From Plan to Market. World Bank, 1996, Ch. 1,2 Week 3. Transition economies in the framework of comparative economic systems. Market socialism. Types of planning (directive vs. indicative), SOFE Gregory, Paul and Stuart, Robert Comparative Economic Systems, Houghton Mufflin Company, 5th edition, 1995, Ch. 6,7 (6 th edition Ch. 6,7) Gregory, Paul and Stuart, Robert. Russian and Soviet Economic Performance and Structure, Harper Collins College Publisher, 6th edition, 1998, Ch. 1, 12, 13. Kornai, J. The Socialist System. The Political Economy of Communism. Princeton, NJ, 1992, Ch., 21. pp. 474-512. Lavigne, MacMillan Press Ltd., Second Edition, 1999, ch.6 (First edition Ch. 6) Week 4-5. Review of Soviet economic history War Communism, NEP, Command Economy, Industrialisation Debate. Soviet statistics. Gregory, Paul and Stuart, Robert Comparative Economic Systems by, Houghton Mufflin Company, 5th edition, 1995, Ch. 11, 12 (6 th edition Ch. 9, 13) Gregory, Paul and Stuart, Robert. Russian and Soviet Economic Performance and Structure by Harper Collins College Publisher, 6th edition, 1998, Ch. 2-5. Shmelev, Nikolai and Popov, Vladimir. The Turning Point: Revitalizing the Soviet Economy. Doubleday, 1989, Ch. 1-3. Lavigne, MacMillan Press Ltd., Second Edition, 1999, ch. 2 (First edition ch. 2). Week 6. CPEs: industrial organisation and structural inefficiencies. Gregory, Paul and Stuart, Robert Comparative Economic Systems by, Houghton Mufflin Company, 5th edition, 1995, Ch. 11, 12 (6 th edition ch. 9, 13) Gregory, Paul and Stuart, Robert. Russian and Soviet Economic Performance and Structure by Harper Collins College Publisher, 6th edition, 1998, Ch. 6-7, 9, 10-11. Shmelev, Nikolai and Popov, Vladimir. The Turning Point: Revitalizing the Soviet Economy. Doubleday, 1989, Ch. 4-7. Lavigne, MacMillan Press Ltd., Second Edition, 1999, ch. 1,3,4,5 (First edition ch. 1,3,4,5). 4

5 Week 7. Reading week Week 8. Review class. Mid-term exam. Week 9-10. Monetary overhang during Gorbachev reforms (1985-91). Macroeconomic stabilisation and currency crises in transition economies. IMF, World Bank, OECD, EBRD. A Study of the Soviet Economy, 1991, Vol. 1,2,3, Ch. III.1 - III.3. World Development Report. From Plan to Market. World Bank, 1996, Ch. 1,2, 6,7. Popov, V. The Rise and Fall of the Non-monetary Economy in Russia: Puzzles Multiply Faster Than Resolved. Review of D. Woodruff s book Money Unmade. Barter and the Fate of Russian Capitalism. Journal of Policy Analysis and Management, May 2001. Montes, Manuel and Popov, Vladimir. The Asian Crisis Turns Global. Institute of Southeast Asian Studies, Singapore, 1999. See also: Popov, Vladimir. Currency crises in Russia and other transition economies. - In: International Financial Governance under Stress. Global Structures versus National Imperatives. Edited by Geoffrey R. D. Underhill, Xiaoke Zhang, Cambridge University Press, 2003. Based on the presentation at the AEA meeting in Atlanta in 2001 (http://http-server.carleton.ca/~vpopov/documents/cc-atlanta-2001.pdf). Popov, V. Exchange Rate Policy After the Currency Crisis: Walking the Tightrope. PONARS Policy Memo No. 174, Nov. 2000 (http://http-server.carleton.ca/~vpopov/documents/exch- RATE_PONARS2001.pdf) Popov, V. Does Russia Need to Strengthen the Ruble? Accumulation of Foreign Exchange Reserves and Economic Growth. PONARS Policy Memo No. 306, Nov.2003 (http://httpserver.carleton.ca/~vpopov/documents/forex%20and%20growth%202003-ponars.pdf) EBRD Transition Report, 1997, Ch. 1,2,7; 1998, Ch. 1,2,3. Stiglitz, Joseph E. Capital Market Liberalization, Economic Growth, and Instability. World Development, Volume 28 (6) 2000, pp. 1075 1086. Rodrik, Dani. The Real Exchange Rate and Economic Growth. October 2008 (http://ksghome.harvard.edu/~drodrik/rer%20and%20growth.pdf). *Polterovich, V., V Popov. Accumulation of Foreign Exchange Reserves and Long Term Economic Growth. In: Slavic Eurasia s Integration into the World Economy. Ed. By S. Tabata and A. Iwashita. Slavic Research Center, Hokkaido University, Sapporo, 2004. Updated version, 2006 - http://http-server.carleton.ca/~vpopov/mainresearchpapers.html Week 11. Industrial restructuring, industrial policy. World Development Report. From Plan to Market. World Bank, 1996, Ch. 8. 5

6 Popov, Vladimir. Will Russia Achieve Fast Economic Growth? - Communist Economies and Economic Transformation, Vol. 10, No. 4, 1998, pp.421-49. Polterovich, V., V. Popov. Stages of Development, Economic Policies and New World Economic Order (co-authored with V. Polterovich). Paper presented at the Seventh Annual Global Development Conference in St. Petersburg, Russia. January 2006 (http://httpserver.carleton.ca/~vpopov/documents/newworldeconomicorder.pdf). EBRD Transition Report, 1997, Ch. 3-6. Dani Rodrik. WHAT S SO SPECIAL ABOUT CHINA S EXPORTS? Harvard University, Revised, January 2006 (http://ksghome.harvard.edu/~drodrik/chinaexports.pdf). Lavigne, MacMillan Press Ltd., Second Edition, 1999, ch. 9 (First edition ch. 9). Week 12. Privatisation strategy, financial system in transition. Popov, V. The Financial System in Russia as Compared to Other Transition Economies: The Anglo- American versus The German-Japanese Model - Comparative Economic Studies, No. 1, 1999. See: http://www.cbs.dk/centres/cees/network/pdf/popov.pdf. World Development Report. From Plan to Market. World Bank, 1996, Ch. 3, 6. EBRD Transition Report, 1998, Ch. 5-8. Lavigne, MacMillan Press Ltd., Second Edition, 1999, ch. 8 (First edition ch. 8). Week 13. Transition theory and growth of transition economies. Political economy of reforms. Campos, Nauro F. BACK TO THE FUTURE: THE GROWTH PROSPECTS OF TRANSITION ECONOMIES RECONSIDERED. Center for European Integration Studies, August 2000 (http://www.zei.de/download/zei_wp/b00-13.pdf). Popov, Vladimir. Shock Therapy Versus Gradualism: The End of the Debate (Explaining the Magnitude of the Transformational Recession), Comparative Economic Studies, No. 1, Vol.42, Spring 2000, pp. 1-57 (http://http-server.carleton.ca/~vpopov/documents/tr-rec-full.pdf) ; See also: G. A. Cornia, V. Popov. Structural and Institutional Factors in the Transition to the Market Economy: An Overview. In: Transition and Institutions: The Experience of Late Reformers. Ed. By G. A. Cornia and V. Popov. Oxford University Press, 2001 (http://www.oup.co.uk/pdf/0-19-924218-6.pdf); Popov, V. Shock Therapy versus Gradualism Reconsidered: Lessons from Transition Economies after 15 Years of Reforms. Comparative Economic Studies, Vol. 49, Issue 1, March 2007, pp. 1-31, (http://http-server.carleton.ca/~vpopov/documents/shock%20vs%20grad%20reconsidered%20-15%20years%20after%20- %20CES,%202007.pdf). 6

7 Popov, V. Reform Strategies and Economic Performance of Russia s Regions. World Development, May 2001(http://http-server.carleton.ca/~vpopov/documents/Regions_Apr2000.pdf). * Popov, V. RUSSIA REDUX? - New Left Review, No. 44, March-April 2007 (http://httpserver.carleton.ca/~vpopov/documents/nlr-april2007-popov-woods.pdf) *Popov, V. After 10 Years of Growth, the Russian Economy May Be Losing Steam. - Russian Analytical Digest, No. 48, October 17, 2008. (http://httpserver.carleton.ca/~vpopov/documents/russian_analytical_digest_48%5b1%5d-oct2008.pdf) EBRD Transition Report, 1999, Ch. 5, 6. M. Castanheira, M., Popov, V. Framework Paper on the Political Economy of Growth in Transition Countries. EERC, 2000. See: http://www.gdnet.org/pdf/425_casta-popov.pdf and http://http-server.carleton.ca/~vpopov/documents/polecongrowthcasta-popov.pdf Lavigne, MacMillan Press Ltd., Second Edition, 1999, ch. 10 (First edition ch. 10). Examples of questions and problems at the exams Two questions and one problem would be offered at mid-term and final exams. Each question is worth 40 points, a problem is worth 20 points. QUESTIONS 1. Define shock therapy and gradual transition. What are the principal components of these strategies? 2. Compare the most important features of the major models of transition (Chinese, Polish, Russian). 3. Describe reforms that should be carried out in order to transform a centrally planned economy into a market economy. 4. What is transformational recession? Why it occurs? 5. Why was there no transformational recession in China and Vietnam? 6. Why was the transformational recession in FSU countries deeper than in EE countries? 7. Why the transition to the market in the early 1920s (during NEP period) was not associated with the decline in output, whereas in the 1990s Russian economy went through a depression. 8. What is growing out of socialism? Explain costs and benefits of such a strategy. 9. Classify economic systems using as a criteria the magnitude and types of government economic intervention. 10. Explain the difference between macroeconomic stabilisation policy and industrial policy. 11. Classify market and non-market economic systems by types of property. 12. What is market socialism? 13. Discuss how the performance of coops and labour-managed firms differs from the performance of private companies in a market economy. 14. Contrast administrative and indicative planning. 15. What is a CPE and Soviet-type economic system? What types of CPE's exist? 16. Describe the economic system in Russian agriculture after the Emancipation Act of 1861. 17. Discuss the most important economic reasons for the Russian revolutions of 1905-07, February 1917 and October 1917. 18. Describe War Communism. Was this type of economic system inevitable during the war? 19. Describe briefly the major features of NEP. 20. Describe the Scissors Crisis of 1923. Why did it occur? 21. How the trends in Russian (Soviet) economic growth differ according to Soviet official statistics and alternative estimates? 22. Why did Soviet official statistics underestimate the rate of price increases and overestimate the growth of output? 23. What are hedonic price indices? When they differ most from ordinary price indices? 24. What are the more reliable and the less reliable Soviet official statistical data. Explain. 25. What is index number relativity (Gerschenkron effect)? 26. What were the major views expressed in the Industrialisation Debate? 7

8 27. Discuss the transition to the command economy in the late 1920s-early 1930s. 28. What were the cost and benefits of the transition to a command economy? 29. Discuss the arguments of scholars justifying the transition to the command economy. 30. Compare the War Communism economy of 1918-20 and the command economy that emerged after collectivisation. 31. Why does central planning create disproportions? 32. What were the major structural inefficiencies of Soviet economy? What economic losses did they entail? 33. Discuss concentration and specialisation in Soviet economy. 34. Discuss energy intensity, material intensity and inventories in Soviet economy. 35. Why capital productivity was low and falling in the CPEs? 36. What is monetary overhang? How it could be measured? 37. What were the major options to deal with the monetary overhang in the late 1980s in the USSR? 38. What is exchange rate based stabilisation and money based stabilisation? Discuss advantages and disadvantages of both. 39. Why did efforts to bring down inflation fail in Russia in 1992-95? 40. Describe and explain the dynamics of non-payments and barter transactions in Russian economy in the 1990s. 41. Discuss cost-push and demand-pull factors in Russian inflation in the 1990s. 42. Why inflation was brought under control in the 1920s, whereas in the 1990s several attempts to ensure macroeconomic stabilisation failed? 43. Discuss different types of currency crises. 44. Discuss the statement: Russian currency crisis was caused by the outflow of capital due to the Asian contagion. 45. Discuss the statement: Russian currency crisis was caused by the expansionary financial policy - unsustainable government budget deficit. 46. Discuss the statement: Russian currency crises was caused by corruption and misuse of foreign credits and by the prodigality of the oligarchs. 47. Why actual (market) exchange rates in developing and transition economies is usually below PPP exchange rate? 48. What is capital flight? How the government should deal with the capital flight? Why? 49. What are twin liberalisations? Should this policy be followed or not? Why? 50. What is Dutch disease? Did Russian economy ever have it? Explain. 51. Why output after devaluations of 1997 in East Asian countries fell, whereas output in Russia and other CIS states after 1998 devaluation started to increase? 52. Discuss Russian currency crisis in the framework of Mundell-Fleming model (draw charts, if necessary). 53. Why China managed to avoid the currency crisis? 54. Discuss changes in the structure of GDP and industrial output in Russia. Why did they occur? 55. What is import substitution policy and export oriented growth? Explain. 56. Discuss distortions in interrepublican trade in the FSU. What were the consequences of these distortions. 57. How did Russian domestic resource prices compare to the prices of the world market in the 1990s? Why did they differ from the world prices and what were the consequences? 58. Discuss the statement: Marketization of the Russian economy, deregulation of foreign trade and introduction of the convertibility of the rouble resulted in the de-industrialisation of Russia. It undermined R&D and led to the technological degradation. 59. Discuss the statement: In line with the theory of comparative advantages Russia should export mostly raw materials. 60. What are different models of privatisation? What transition economies followed particular models? 61. What are the advantages and disadvantages of different ways of privatising state enterprises? Explain. 62. What is Tobin s q? How did this ratio in transition economies compare to that in Western countries? Explain. 63. What are the major features of the institution-based and market-based financial system? In what countries particular system predominates? Why? 64. Discuss differences in the structure of assets and liabilities of Russian and Western banks. 65. Discuss advantages and disadvantages of Anglo-American and German-Japanese financial system with respect to transition economies. 66. Why growth accounting when applied to transition economies in the 1990s produces strange results? 67. Discuss how state institutions influence performance in transition economies. 68. Discuss advantages of backwardness in transition economies. 69. Discuss how the speed of liberalisation affected performance of transition economies in the 1990s. 70. Why economically rational reforms are sometimes not carried out in democracies? 71. Why the reduction of output and incomes did not lead to the reversal of reforms in transition economies? 8

9 72. Discuss macroeconomics of populism. Under what conditions governments resort to populist policies? PROBLEMS 1. If money supply increased by 40%, while output fell by 30% and money velocity did not change, what was the increase in prices? 2. In 1998 Russian GDP in current prices totalled 2700 billion roubles, whereas 1997 in current prices it was 2500 billion roubles. Prices (GDP deflator) grew in 1998 as compared to 1997 by 14%. How did the physical volume of GDP (in constant prices) changed in 1998 as compared to 1997? 3. In 1928 the USSR was producing 100 units of textiles and 50 units of machinery and that is all. The 1928 per unit prices of textiles and machinery were 1R and 2R respectively. In 1980 the USSR produced 200 units of textiles and 1000 units of machinery, whereas prices for textiles and machinery have risen to 10R and 10R respectively. By how much did output increase in 1928-80 in 1928 prices? In 1980 prices? Explain the difference. By how much did prices increase in 1928-80? 4. In 1985 GDP per capita in the USSR was 30% of the U.S. level. Investment and defence expenditure accounted for 50% of the Soviet GDP, but only for 25% of the American GDP. What was the per capita non-defence consumption (public and private) in the USSR as compared to the U.S.? 5. In the base period personal disposable income was equal to 200 bill R, personal consumer expenditure to 100 bill. R. Financial assets of the public (including cash) amounted to 400 bill R at the end of the base period, whereas monetary overhang (forced savings) was estimated at 200 bill. R. By how much prices would increase after they are deregulated in the current period, provided that there is no change either in the personal disposable income, or in consumer goods output, and that the public is willing to keep constant the real value of its consumer spending and financial assets? Y tc 6. Money demand function in Inflationland is: L =, where tc transaction costs of obtaining cash, π - 2π inflation rate, Y real income. What is the «optimal» inflation rate maximizing the revenues (as a % of GDP) from inflation tax? What would be the revenues (as a % of GDP) from inflation tax, if inflation runs at a rate of 100% a year and transaction costs are equal to 1% of GDP? 7. In 1997 Russia had a current account surplus of $4 bill. Russia was also a net exporter of capital: the outflow of capital was $2 bill. greater than the inflow. (a) Did the foreign exchange reserves increase or decrease? By how much? (b) If the government budget deficit in 1997 was equal to $30 bill. and domestic business and personal savings totalled $50 bill., what was the amount of privately financed investment? 8. The exchange rate of the rouble on July 1, 1998 was 6 R/$, the interest rate on dollar deposits was 10% a year, the interest rate on rouble deposits was 150% a year. What was the forward exchange rate expected by market participants for July 1, 1999? 9