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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 5: How Each Reform Promotes Growth

Transitions and Growth in Post-Soviet Europe

Patricia Dillon and Frank C. Wykoff


Each economic reform has unique effects on growth prospects. With growth models we can show how each reform changes behavior of optimizing agents or parameters on which their behavior depends. These changes in turn alter steady-state values of income, capital, consumption and utility. Price liberalization directly raises utility by improving the mix of consumer goods, but it reduces effective incomes of those who had benefited from low administered prices. Property privatization improves growth prospects by raising output per set of inputs and by fostering formation of both physical and human capital. Macroeconomic stabilization lowers the cost of the public sector by eliminating waste; lower military spending and fewer subsidies for inefficient state-owned enterprises leave more income for consumption and accumulation. Lower taxes and transfers help some people and hurt others, while improving incentives to produce. Industry deregulation reduces effective burdens on capital, which increases growth. Free trade improves the mix of goods, ameliorates local monopoly power, enhances competition, disciplines the authorities responsible for stabilization and fosters technology transfer. All of these reforms generate relative losers who will resist the reforms politically. THE ECONOMIC CHANNELS OF REFORM If citizens understand the relationship between market-oriented reforms and improved living standards, then voters are more likely to allow reformers to impose the necessary structural shocks on the body politic. In Chapter 3 we explained the theoretical benefits of each of the basic reforms needed for a market economy to thrive. In Chapter 4 we developed models to explain how private...

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