The Success and Failure of Reforms in Transition E

August1,2002TheSuccessandFailureofReformsinTransitionEconomiesStephenL.ParenteandJosé-VíctorRíos-Rull(FirstversionDecember2000)Abstract.ThispaperarguesthatRussia’sperformanceandChina’sperformanceundercapitalismhavediffereddramaticallybecausedifferentarrangementsgoverningthedeterminationofpricesandworkpracticesevolvedduringthetransitionprocess.InRussia,thearrangement,whichconferredmonopolyrightstoindustrygroupsleftoverfromsocialism,preventedtheadoptionofbettertechnology.InChina,thearrangementthatevolvedcontainednosuchmonopolyelements.Thekeyfactorindeterminingwhicharrangementevolvedwasthestrengthofindustryrelativetothecentralgovernmentatthestartofthetransition.Weputforthamodelthatimplementstheseideasandprovideevidenceinsupportofthistheory.Parente:DepartmentofEconomics,UniversityofIllinois,1206S.SixthStreet,Champaign,IL61820.Ríos-Rull:DepartmentofEconomics,UniversityofPennsylvania,3718LocustWalk,PhiladelphiaPA19104-6297.TheauthorsthankLeeAlston,JamesBang,DanielBerkowitz,JosephBerliner,AnitaChan,JiuhuaChe,TatyanaDubyokov,GuidoFreibel,BarryIckes,MartinSpechler,andRuiZhaofortheircomments.Theusualdisclaimerapplies.1IntroductionIn1985Russia’spercapitaGDPwas29.7percentoftheU.S.levelwhereasChina’swas6.7percent.Inthetimethathaspassed,bothRussiaandChinahavemovedtowardscapitalisticsystemswithgoodsandservicesallocatedthroughmarkets.Theirperformancesoverthistimehavediffereddramatically.In1998Russia’spercapitaGDPwas22.4percentofthatoftheU.S.levelwhereasChina’swas10.3percent.1WhyhascapitalismproventobeadisappointingexperienceforRussiabutnotChina?2Thispaperarguesthattwoverydifferentarrangementsgoverningthedeterminationofpricesandworkpracticesevolvedduringtheseeconomies’transitionstocapitalismonaccountofdifferencesininitialconditionsandintheauthorityofthecentralgovernment.InRussia,wherethecentralgovernmentwasweakrelativetoindustry,thearrangementthatevolvedconferredcertainrightstoindustrygroupsleftoverfromsocialism.Thisarrangement,whichismonopolisticinnature,preventedbettertechnologiesfrombeingadopted.InChina,incontrast,wherethecentralgovernmentwasstrongrelativetoindustry,thearrangementthatevolvedconferrednosuchrightstoindustrygroupsleftoverfromsocialism.Thisarrangement,whichiscompetitiveinnature,facilitatedtheadoptionofbettertechnologies.Ourargumentisbasedonthreecomponents.ThefirstcomponentisaquantitativetheoryofpercapitaoutputdifferentialsbetweentheUnitedStatesandRussiabasedonthetypeofarrangementusedineachcountrytoallocateresources.Thetheory,1ThedataarefromthePennWorldTables.Weassumethat1985percapitaGDPinRussiawasequaltothatoftheUSSRasawhole,whichclearlyundercutsthepointwewanttomake.Thelatestyearavailableis1998.2ThroughoutthispaperweassesstheperformanceofthetwocountriessolelyintermsoftheTFPthattheyhave,notinanyotherdimension.2whichisbasedonParenteandPrescott(1999),assumesthearrangementwascompetitiveinnatureintheUnitedStatesandmonopolisticinRussia.Thetheoryassumesequaleducationlevelsofthelaborforceaswellasequalaccesstounderlyingtechnologiesinthetwocountries,sothattheentiredifferenceinpercapitaoutputsisattributedtothedifferentarrangements.Thesametheory,whenappliedtoacountrylikeChinawithverylowinitialproductivity(dueperhapstoaveryloweducationofitslaborforce),indicatesthattheimplementationofthecompetitivearrangementcanproducealargeincreaseinpercapitaoutputinashortperiodoftime.InthecaseofChina,thetheorydoesnotassumethesamelevelofeducationorthesameaccesstotechnologyastheUnitedStates.Assuch,thetheorydoesnotpredictthatChinashouldbecurrentlyasrichastheUnitedStates.Thesecondcomponentisatheoryofthetransitioninwhicheitherthemonopolyarrangementorthecompetitivearrangementarises.Inparticular,wedocumentthattheevolutionofthemonopolyarrangementandsecularstagnationassociatedwithitcanbeunderstoodasthebadequilibriumoutcomeofaprisoner’sdilemmasituation.Eachindividualindustryalwayshastheincentivetoacquirethemonopolyrightbecausefactorearningsarehigherwhenitsindustryisamonopolycomparedtowhenitisperfectlycompetitive.Thisisthecaseregardlessofwhatoccursinotherindustries.Weshowthattheexistenceofacentralizedauthoritycapableofaffectingthebehaviorofagentsinspecificindustriesisacrucialstepinavoidingthebadequilibriumoftheprisoner’sdilemmaenvironment.ItisthisdifferentialpowerofthecentralgovernmentrelativetoindustrythatweseeasbeingprimarilyresponsibleforthedifferentialperformancesofRussiaandChina.3Thethirdcomponentconsistsofempiricalevidence.Inparticular,weprovidealargebodyofevidencethatsuggeststhatthemonopolyarrangementisprevalentinRussiabutnotinChina.Additionally,weprovideevidencethatindustriesinRussiahavebeenstrongrelativetothecentralgovernmenttoanextentunseeninChina.WeseethecombinationoftheinternallogicandquantitativeplausibilityofourtheorytogetherwiththeempiricalsupportasavirtueofourpaperrelativetoothersthatsimilarlyattributeRussia’sperformancetoindustryinsidergroupsthatblockedreform.DebandeandFriebel(1999),forexample,emphasizeimperfectinformationconcerningmanagerialabilityandincompletecontractstoexplainRussia’spooreconomicperformance.BlanchardandAghion(1