DP1442 | The Optimal Speed of Transition: A General Equilibrium Analysis

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We present in this paper a bench-mark model for the optimal speed of transition from a state-owned to a private market economy, based on the consumption-savings decision in a closed economy. This bench-mark model abstracts from rigidities or frictions to focus on the macroeconomic conditions for accumulation of private capital and closure or restructuring of state-owned enterprises (SOEs). It is shown that an excess rate of closure of SOEs, compared to the welfare optimum, generates a substitution effect that accelerates the pace of transition, and an income effect, that slows down transition. When the latter effect dominates, too high a speed of closure of SOEs may result in suboptimally slow growth of the private sector. This will especially be the case if such a deviation occurs at an early stage of transition. Lastly, the model sheds some light on macroeconomic contraction in Central and Eastern Europe in the early phase of transition.