Working Paper: CEPR ID: DP1636
Authors: Gerard Roland; Thierry Verdier
Abstract: This paper presents a model that explains why in the transition economies of Central and Eastern Europe an important output fall has been associated with price liberalization. Its key ingredients are search frictions and Williamsonian relation-specific investment implying that new investments are made only after a new long-term partner has been found. When all firms search for new partners, output may fall because of three effects: a) disruption of previous production links; b) a fall in investment; and c) capital depreciation due to the absence of replacement investment. We show that forms of gradual liberalization like the Chinese ?dual-track? price liberalization may avoid or reduce the transitory output fall.
Keywords: transition; output fall; asset specificity; search
JEL Codes: 021; 050; E30; E61; P41; P51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| price liberalization (P22) | output fall (E23) |
| disruption of previous production links (F12) | output fall (E23) |
| fall in investment (E22) | output fall (E23) |
| capital depreciation (D25) | output fall (E23) |
| price liberalization (P22) | disruption of previous production links (F12) |
| price liberalization (P22) | fall in investment (E22) |
| price liberalization (P22) | capital depreciation (D25) |