Transition Economies

There have been always different economics systems all over the world. Countries can be either free-market economies or command-planned economies. There are not pure free-market or command-planned economies in the world, only a few. These are just paradigms and most countries are mixed economies, economies with characteristics from the two extreme economic systems. The differences between the two economic systems are huge therefore if a country tried to transform itself from one system to another, some problems will be induced.

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An economic systems main function is to answer and solve the basic economic problem, resources in the world are scarce but wants are infinite. Resources will have to be allocated. Governments must figure out what to produce, how to produce it and for whom to produce. In an economic system there are different players each with a responsibility to the system. Each player’s function in a command- planned economy is different from a free-market’s one.

Eastern European countries became command economies in the late 1940’s and early 1950’s after a communist takeover of their governments. In the early 1990’s after communism fell, these economies started transforming themselves into market-orientated economies. This essay will try to analyze and evaluate the problems faced by ex command economies switching to a more free-market system. ) A command-planned economy is one, which the fundamental questions of what, how, and for whom to produce, are answered by the state; it’s the states main priority. Such systems were mainly found in Eastern Europe and all these went in a transition process after they saw their economic system was proving to be not that efficient in comparison with a more capitalistic economic system, the free-market system. Command systems are also to be found in China and other parts of East Asia, Cuba, and some African countries.

What caused the collapse of the command economic systems of Eastern Europe was a combination of political crisis and economic failure. Although the systems ended up in ruins, the command economic system did deliver some success. In 1950 the USSR’s GNP was 40% of the G7 average. By 1970 that figure had risen to 70% indicating that in the intervening 20 years growth had been much faster in the east than the west. However this picture changed in the middle 1970’s.

The Eastern Bloc could no longer compete effectively in the arms and space races, it was poorer than the west and only its rapid growth had enabled it to compete. The International Demonstration Effect gradually revealed to eastern citizens, despite efforts at censorship, that living standards were better in the west. Eastern European countries after realizing conditions were far better in the west than in the east they decided to transform their economies similar to ones in the West. This is called the Transition Process.

These numbers show the economic disaster that resulted from centrally planning economies. Of course, the human suffering, which this approach produced, is unimaginably worse than can ever be conveyed by statistics In command planned economies all people are suppose to work and act for the common good and not from self-interest. All their land and property is owned by the state and instructions are given on how to work on that land. Resources are all allocated through a planning process; the government must plan everything.

Planners perhaps may decide to limit prices so that goods are within the price range of all consumers. But low prices often result in excess demand since everyone can afford to buy now but there are shortages thus a queuing system is formed. In command planned economies there is need for competition. This need of competition leads to the production of poor quality of goods. Consumers will suffer since lack of competition will restrict choice since firms wont bother to produce a variety of goods to produce. There are many subsidies imposed on necessities such as food, which may lead to shortages and then queuing.

The lack in competition leads to another problem lack of investment since competition triggers investment. The jeopardy that if there is not improvement in a product or in the production process the competitors will take over your own share in the market, this triggers investment in new machines and labor. In the west, each product has different brands competing each other resulting to better quality products and there is not any type of queuing. A very common characteristic in command plan economies that causes problems is that there is no incentive to productivity.

There is very little individual incentive for enterprise and innovation. A firm that meets the targets the state put, its only reward will be an increase in the target, which might be almost impossible to achieve. In the west it is necessary to cut costs and raise output in order to compete, those who can achieve this is rewarded in the form of higher profits and wages. In the East success is measured as the achievement of a planning target. There is no incentive to produce better quality products since the producers don’t see a reason why, they just have to produce as many as the state told them to.

In Eastern Europe as Economies grow they become more complex, the more complex the economy the more difficult it is to plan the allocation of resources in an efficient way. Lack of incentive exists also not only for producers but for workers. There might be enormously heavy taxes on high incomes thus there is little point for individuals to work hard to get more money since its less likely they will lose their job nor lose income. In a market system, profits and losses signal success and failure and provide incentives to increase or decrease production.

Command economies are set to be similar to Marxist governments where income is equal. A lot of effort is taken by the state to guarantee a minimum standard of living. But, this is proved otherwise when those in power have used the planning system to their own gain. Some members of the society with power can acquire for themselves benefits that only most do not have. This maximization of utility is a problem for Eastern European countries, since it proves wrong that there is “equality” amongst them. In command planned economies there is wastage of resources due to the diversion or resources for planning purposes.

Resources were over committed; planners used more resources than were available creating shortages. In USSR Gosplan, the state planning organizations, needed to calculate 12 million prices a year, and plan the output of 24 million products. Although the economic information was not sufficient it still needed to employ 18 million people. Over-regulation and inflexibility exist in the Command-plan economies and that’s not surprising since a complex plan of this detail could not be easily accustomed to changing circumstances.

The coordination problem has been massive on Eastern European countries. There was no price mechanism to provide incentives to eliminate blockages as it’s done in a market economy. It’s difficult for planners to detect demand with accuracy unless they take account price signals. The UK tried this method of planning in the National Plan 1964-1970 and it collapsed after only two years because of rigidity. The USSR had to keep this sort of plan for 73 years. This large amount of planning surely leads to a lot of red tape and bureaucracy and confusion.

The government is full of bureaucrats that do not always come up with the best plans thus creating a chaotic situation. Their decisions are really important and determine the present state of their country and its well-being. Insufficient planning is a large problem for Eastern European countries. Black market is a product of the bad management and planning by the Eastern European government. Black market is created by a minimum price by the government to keep prices low, rationing, a queuing system and people that are willing to break the law to feed their thirst for some products.

Whenever wants are not satisfied these black markets appear and if you are capable of paying, someone will supply you with what you need. In some parts of Eastern Europe the black markets were fairly open dealings. People were sick of rationing, and needed certain goods their own government could not provide, thus they turned to criminal elements. The government fixes prices of all inputs and outputs, but these prices do not reflect the scarcity of the resources or product. The use of the price mechanism would be a better indicator for scarcity of recourses.

Externalities and environmental problems occur often in Eastern European countries. Planners are far more interested in securing output than in reducing damage to the environment. Environmental objectives are not written into plants thus causing inevitable damage to the environment. All these reasons have encouraged the leaders of Eastern European countries to use more the price mechanism to make their economies more similar to market economies thus eliminating some of the problems. ) Eastern European countries started making greater use of the price mechanism so they can start changing their economies to a west-like one. The price-mechanism is the one that decides how recourses will be allocated in a free-market economy. This huge “leap” from one system where all decisions were taken and made by the government through a planning process to a system where economic decisions were made by the market mechanism, aroused some problems and abnormalities to the eastern European countries.

Governments are using more positive economic policies including interventions to save local authorities. A major difficulty facing cities in Eastern Europe is the cost of subsidies to housing and utilities. For example real estate in Russia after the transition in general makes up major expenditure level for the local government in contrast with western cities as a major source of revenue. The transition revolutionized the finances and independence of Russian cities. Where a country tries to use the price mechanism, inequality between people increases.

There are people, which are better off than others in a higher level. When Romania went through the transition process the country started seeing some great technological changes, there was modernization, and the use of the Internet and mobile phones kept increasing. There were predictions for economic growth. Despite these changes there was still corruption and poor infrastructure. The courts were corrupted. A third of all Romanians live in poverty. The rural population lives off what they grow but the urban poor are worse off.

Even though wages have increased by the government, the government has no extra cash for the improvement of health care or education for the poor. People see the big new industries such as McDonalds just for the rich. The Price Mechanism answers the economic question for whom to produce. All consumers have to spend money, a proportion of their income to acquire goods and services. But those with a little income or not at all, they cannot receive the same benefits as others with higher income or standard of living. It’s clearly unfair.

This inequality of wealth leads to a high percentage of crime as was seen in the former U.S.S.R. In sharp contrast to conditions before the transition, people now find themselves deprived of personal safety and security. The United Nations Development Program reported some terrifying results and details. There have been 9.7 million premature deaths in the countries of the former Soviet Union and Eastern Europe directly linked to the introduction of the “free market” during the last decade. Also in the report there have indications of high poverty rates, an escalation of in suicides and alcoholism, the return of previously-conquered diseases like tuberculosis and the rapid spread of new ones such as AIDS.

The ‘transition’ in most of the countries in the former Soviet bloc in Central and Eastern Europe in reality has been a Great Depression. On average, gross domestic product in Central and Eastern Europe in 1997 was nearly 12 percent lower in 1997 than in 1990. But in many countries the situation was much worse. In Latvia and Lithuania, for example, GDP was only 59 percent of the 1990 level.

Another problem that prompted several countries in Eastern Europe is that goods and services, which are judged to be essential, may not be provided on an adequate scale. The self-interest factor will cause people to be greedy, selfish and do not care about others, main aim will be to maximize profits and eliminate competition.

There have been privatizations at extremely low prices that allowed many enterprises to fall into the hands of local or foreign criminal elements, and the exploitation of political influence to secure advantageous licenses.

There has been an increase in the mortality rate. Between 1980 and 1995 in Russia, life expectancy for Russian men fell by four years, more than in any other country and today life expectancy for males in the Russian Federation is 58 years. By 1995 ten of the transition countries experienced a decline in population.

In almost all countries, the suicide rate for men is higher than the average for the European Union. In Hungary it is almost three times as high and in the Russian Federation, Latvia and Lithuania, more than three times greater.

The transition economies came with costs. There has been a huge deteriorating human security. Employment is no longer secure, nor, is incomes. Rich, get richer, poor get poorer. For many people income poverty has become a way of life. People’s residents are no longer stable; there have been mass migrations occurring within the countries in transition. There is not a secure privilege to a decent education, a healthy life or a sufficient nutrition. It depends whether u have the financial ability or not. These costs make up of what is called the free-markets social catastrophe.

It is inevitable that a transition from a command to a market economy will reduce output. A big problem that got triggered due to the transition process is that before the process government planners allocated factors of production between differing production units such as factories or farms. All the economic decisions were taken by the state. With the transition, the firm now has to buy its own inputs in order to produce its good or service to the market. With the price mechanism firms have to make their own decisions on how to produce, when to produce and what methods to use. Since many firms were caught by surprise from the transition process, they were not used to making these decisions or buying their own inputs. Therefore, this has lead to a significant decrease in output thus causing unemployment.

In the free market most land and capital is owned by the private sector. Moving from one type to another involved many assets to be sold to private individuals. A way to do that is for the state to give the company to the workers. This is not a very good deal because the worker in a factory, which produces goods for export to the West, will do far better than a worker whose factory is outdated. Also some with power like manager of very successful enterprises will use their influence to get the asset transferred into their name.

The governments of Eastern Europe required to privatize 100% of their economies. They faced several obstacles during this process. There was an absence of a capital market. There were no institution channel funds into industry. There was not an Entrepreneurial culture. For years the only methods of advancement had been through work for the state. Firms were no used of making profits thought business for them.

Privatizing can be dangerous since it can lead to a creation of a monopoly. A private monopoly in a market with no regulations can be more damaging to the community than a state monopoly.

The diagram shows how a profit maximizing monopoly can charge the high price p1, whilst supplying only a small quantity q1 of the product. An efficient state monopolist should be able to charge p2 and produce q2. This is marginal cost pricing. A state monopoly not trying to cover its own re-investment could charge p3, but it would require a subsidy to operate in this way in the long term.

The large falls in output had lead to extreme rises in unemployment. The movement to a market system had forced many factories and plants to close and workers were laid off. Some enterprises were forced to become more efficient especially now they competing in the economy against imports of the West or other firms. Firms to become more efficient they will try laying off some workers and making the remaining work harder and more productive.

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