Effects of market liberalization

Few authors have attempted to quantify the gains from market liberalization. Part of the problem may be the short period of analyses, the inability of standard methodologies and measures or indicators of market liberalization to separate efficiency gains of market reform from overall gains in the reforming economy, and the breadth of the studies. For China, Wen (1993) found total factor productivity (TFP) growth had stopped in the post-1985 period, a trend he blames on the failure of the market liberalization stage of reform. There are two shortcomings of Wen's conclusions. First his analysis ends in 1990, a period that might be too early to have allowed the liberalization reforms to take effect. Second, he is only examining the net change in TFP and does not account for other factors that could be affecting productivity. Holding the effect of technology constant and using data up to 1995, Jin et al. (2002) find that TFP growth restarts in the 1990s, a finding that they claim could be linked to increased liberalization of the economy. Like Wen, however, they do not explicitly examine the improvements in efficiency that are associated with market development. Fan (1999) uses stochastic frontier production decomposition analysis to isolate the efficiency gains of Jiangsu provincial rice producers in the late reform era, a time when most of the property rights reforms had already been implemented and when market liberalization was just getting started. Fan finds that there have been only limited gains in allocative efficiency since 1984, a result that he suggests is due to the partial nature of China's market liberalization. Unfortunately, Fan does not explicitly model the interactions between property rights reform and market liberalization. Also, his study examines only one crop in one province, a fact that limits the generalization of his study, since it is possible that many of the gains from market liberalization may come from shifting among crops (and between cropping and non-cropping activities).

The only truly systematic attempts at trying to measure the returns to market liberalization in China are deBrauw, Huang, and Rozelle (2000, 2004). These papers develop measures of increased responsiveness and flexibility within a dynamic adjustment cost framework (as developed by Epstein 1981) to estimate the return to market liberalization reforms, holding the incentive reforms and other factors constant. The authors find that the behaviour of producers in China has been affected by market liberalization, but that the gains have been relatively small. Small gains in responsiveness (measured by price elasticities of factor demand for variable inputs—in this case, fertilizer) between the early and late reform periods are attributed to the gradual market liberalizing changes of the late 1980s. Farmers also have increased their speed of adjustment of quasi-fixed factors (which in the case of China's agriculture includes labour and sown area) to price changes (and other shifts in exogenous factors) between the early and late reform period. The magnitude of the gains in efficiency from increased responsiveness and flexibility in the late reform period, however, is substantially less in percentage terms (less than 1 per cent per year) than that from the incentive reforms in the early reform period (up to 7 per cent per year or about 40 per cent over the whole period). But, although the gains are small, they are still positive, and China's gradual market reform policy appears to have avoided the collapse that was experienced throughout CEE and CIS nations. Unfortunately, the results of the deBrauw paper cannot shed light on the interactions among property rights reform and market liberalization since it relies on the assumption that the time period of the reform identifies the effect of individual policies (that is, all of the property rights reforms were complete before 1984 and market liberalization did not begin until after 1985). The analysis also only examines the effect of market liberalization.

In contrast to the research in China that demonstrates the success of the gradual market liberalization measures, scholars have differing views outside Asia. Without much quantitative support, several authors have pointed to the negative impact of the early market policies on output and productivity in CEE and the CIS nations (Roland 2000; Wehrheim et al. 2000). Other studies explain how the emergence of market-supporting institutions has been crucial in the agricultural recovery and growth and improved access to input and output markets in several CEE countries, and that their absence hampered recovery in other, mainly CIS, transition countries (EBRD 2002; Swinnen 2002b; World Bank 2001).

Unfortunately, the only studies that try to quantitatively examine market liberalization effects use rough time period indicator variables. These studies provide some support for a J-shaped impact of radical market liberalization. For example, Macours and Swinnen (2000a), after holding constant property rights reform, farm restructuring, and other factors, measure the impact of the breakdown of exchange systems between farms and input suppliers and processing companies with a time period dummy variable for the first two years after major restructuring. They find that the breakdown of exchange has a negative effect on output and productivity in CEE. Evidence on subsequent recovery with the emergence of new institutions for contract enforcement in CEE is limited, but growing.

Transnational, systematic evidence of the impact of market liberalization is still missing. There have been a growing number of papers on single industries and small groups of firms in transition nations (Beckmann and Boger 2004; Gow and Swinnen 2001). These studies, often case study in nature, find strong positive effects on firm performance of the emergence of institutions that help in contract enforcement and the provision of credit and other inputs.11 For example, Gow, Streeter, and Swinnen (2000) for sugar and Dries and Swinnen (2004a, 2004b) for dairy, document how enterprises have used contracting to help producers gain access to inputs and sell their output in the absence of well-functioning wholesale markets.

Despite the appearance of these case studies, most of which tell a similar story, there is still relatively little systematic, econometric-based evidence of these dynamic market liberalization effects. Macours and Swinnen (2002), using a rough measure of the overall liberalization of the economy developed by de Melo and Gelb (1996), do find in their regression results explaining agricultural productivity in fifteen transition countries, that over the first five years of the reforms the coefficient on the indicator of market liberalization was significantly positively related with productivity growth. This positive correlation between the emergence of markets and productivity was found even after holding constant property rights reforms, farm restructuring, and prices. This conclusion is consistent with findings of Swinnen and Vranken (2004) who calculate farm-level efficiency indicators based on representative surveys in five CEE countries and show that, after the initial transition period, the average farm efficiency in the five countries is strongly positively correlated with the level of economic reforms and market liberalization as measured by EBRD and World Bank indicators.

In summary, the transition countries have taken vastly different roads in market liberalization. The empirical evidence suggests that there is not a single successful path in establishing a market economy. In several CEE countries a rapid and radical approach to full-scale market liberalization of the entire agro-food system contributed importantly to output declines in early transition, but within five years after the start of transition market institutions were emerging and after a decade robust productivity growth.

In contrast, the success of China's liberalization policies is due to an entirely different, much more gradual approach that ultimately contributed to positive productivity growth, while avoiding catastrophic disruption. In the short run, planning with all of its inefficiencies was retained for the nation's major agricultural commodities. Even though the maintenance of the system of planned procurement and supply in China almost certainly caused substantial allocative irrationalities during the interim (although these have never been measured), the benefit of such a strategy was that it did provide farmers with access to inputs and product outlets during the period of property rights reforms and farm restructuring and avoided the economic collapse experienced outside Asia (Rozelle 1996). With improved farm productivity (initially from other policies, such as HRS), the planning system actually increased farm incomes and allowed an increasing supply of food to urban consumers. In the longer run, China's market liberalization strategy depended on creating an environment that allowed new entrants. The gradual policies at the very least allowed space for traders to slowly develop networks and figure out ways to finance commodity trade (Watson 1994). In the longer run, as these traders began to take advantage of profitable trades, they attracted new traders and forced the state to commercialize the trading divisions of the grain bureaux in a way that is described more generally by McMillan and Naughton (1992). Ultimately, this competition forced policy makers to formally remove most of their market-restricting policies, mainly because they were not effective. The gradual deregulation of the input and output marketing also ultimately produced its own successes.

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