Chapter 3: Elements of Transition
The key aspects of transition are the replacement of physical planning by the price mechanism and of universal public ownership by enterprise reform. They are complementary because with market-determined prices but no enterprise reform, changes in relative prices are unlikely to induce an appropriate response, while with enterprise reform but artificial prices the enterprises will make sub-optimal decisions. Price reform is closely related to trade reform because for a small economy the appropriate opportunity cost prices will generally be world prices. Thus, removing barriers to trade will not only permit realization of gains from trade but, more importantly, will accelerate the adoption of the appropriate relative price structure. Trade reform requires current account convertibility and a unified exchange rate, and is related to capital mobility. Access to trade credit is necessary for smooth functioning of trade transactions, although there may be arguments in favour of controls on other international capital flows in order to forestall speculative attacks and other destabilizing capital movements. Enterprise reform is related to financial reform, because if enterprises are to respond to new opportunities they will need access to capital. All of this is likely to be tied to fiscal and monetary policy as the government loses its existing tax base, that is the state-owned enterprises, and yet still has to supply public services. Without a domestic capital market in which to borrow, the macroeconomic policy choice is often stark, between bringing the budget into balance or printing money; the latter leads to inflation, which hinders...
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