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Creating Capitalism

Transitions and Growth in Post-Soviet Europe

Patricia Dillon and Frank C. Wykoff

Employing historical analysis and building on growth theory and modern political economy, Dillon and Wykoff explain Soviet disintegration and analyze efforts to create capitalism in newly independent states. They show how five fundamental economic reforms generate growth, and use an original model to test the connections between reforms, elections and economic performance. The authors examine the progress of six countries (Bulgaria, Czech Republic, Estonia, Hungary, Russia and Slovakia) in terms of each country’s history and its successful application of the five reforms. Anyone interested in how capitalism works and why pro-market reforms encounter resistance in spite of their potential for generating higher living standards will find this book essential reading.
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Chapter 4: Growth Models for Assessing Reforms

Transitions and Growth in Post-Soviet Europe

Patricia Dillon and Frank C. Wykoff


1 The social value of reforms is reflected in their influence on growth of income, consumption and utility (consumer satisfaction). Both neoclassical and endogenous growth models provide a number of specific channels for reforms to affect consumers and for subsequent policies to influence growth. These models focus attention on the need to accumulate physical capital. Such accumulation in turn requires saving. Growth models provide a number of insights as to how policies may enhance or retard growth. For reforms to succeed, they must assist in the process of reorienting resources into optimal new technologies embodied in new capital that requires in turn development of domestic human capital. The best solution to a growth model is called the optimal steady state, the best of the economy’s long-run equilibria. It is shown to consist of three conditions: the marginal decision rule of the optimizing forward-looking consumer, the marginal decision rule of the optimizing forward-looking producer, and the dynamic time path of capital. Growth models provide lessons for reformers; for example, savings must generate enough productive capital to hurdle replacement requirements, population growth and labor quality improvements for growth in living standards to be enjoyed. Social gains from capital formation may exceed the private returns on capital as a result of technological spillovers embodied in new capital. Free trade promotes growth by fostering adaptation of new technologies from advanced economies. Policies to encourage savings and forward-looking behavior and policies to foster new technologies and orientation of savings to productive...

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