In Central and Eastern Europe, the transition towards market economies has been associated with high unemployment, creating the potential for social instability and threatening continued liberalization. Many workers who move from (former) state-owned firms are unemployed for a time before finding jobs in private firms. Short of maintaining an unacceptable status quo, high unemployment during transition may be inevitable. In Discussion Paper No. 1094, Research Fellow Larry Karp and Thierry Paul present a continuous time, infinite horizon model in which some workers leave the dying state sector and pass through the pool of unemployed workers in order to obtain better jobs in the growing private sector. There is congestion in the labour market, and in making their migration decisions, workers, who have rational expectations, fail to internalize the congestion cost. The private solution leads to excessive migration and unemployment, which justifies government intervention.

The authors' objective is to answer two questions. How important is the government's ability to commit to future actions? How does the answer to this depend on the nature of the labour migration process? Using numerical simulations, they find that the equilibrium tariff trajectories under both unlimited and infinitesimal commitment ability are qualitatively the same, and both cases involve gradual liberalization. Therefore, the inability to make commitments does not necessarily provide an argument against gradualism.

Labour Adjustment and Gradual Reform: Is Commitment Important
Larry Karp and Thierry Paul

Discussion Paper No. 1094, January 1995 (HR/IT)