DP1636 Transition and the Output Fall

Author(s): Gérard Roland, Thierry Verdier
Publication Date: May 1997
Keyword(s): Asset Specificity, Output Fall, Search, Transition
JEL(s): D21, D50, E30, E61, P41, P51
Programme Areas: International Macroeconomics, Transition Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1636

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.