Modelling reforms

In this section, we illustrate the effect of economic reforms on farms in transition countries. For tractability, the analysis is restricted to two stylized reforms, property rights reform and price reform.2 Although we look at how each reform would affect farm behaviour and performance separately, as will be seen in Chapter 4, in reality the two reforms often occurred simultaneously. Moreover, as the next chapter will discuss in great detail, the reforms were implemented differently in different countries. Therefore, we will first explain the impact of the two reforms separately and afterwards we will examine their effect when they are implemented simultaneously.

Using our modelling framework, it is easy to see that one of the most fundamental transition policies, price reform, can have large, but varying, effects in different transition nations. For example, in Country 1, price reform means that planners remove the implicit tax and the government-set input to output price ratio, w\/p\, falls as it moves to the market one, wm/pm. In Figure 3.1, this is represented as the move along the production frontier, f0(x), from point A to point C. Outputs and inputs rise due to these reforms. The farm managers remain on the Socialist production function in our simplified world because although price reform removes the price distortions, the farmers are still technically inefficient since there are no property rights reforms. In Country 2, the farm managers also respond to price reform. In this case, however, price liberalization reduces the input to output price ratio as subsidies are removed and the farm moves from point B to point C. Output and inputs both fall. Hence, price reform acts differently, depending on the initial conditions.

In the other transition policy shift, property rights reform, the farm manager is allowed to determine his or her own organization (e.g. they begin to work on a private farm, which is identical in all other respects to the original Socialist farm) and is given the rights to the residual income produced by the farm. As seen in Figure 3.1, increased effort shifts the production function from fo(-) to f(-). Without considering the effect of price liberalization, the reform has similar effects on producers in Country 1 and 2: in both countries output goes up, but the magnitude differs. In Country 1, the farm moves up from point A to point E. In the case of Country 2, the farm moves up from point B to point F.

Modelling the simultaneous implementation of both reforms allows one to identify which part of the effects is due to each reform and to gain insights about the complex relationship between observed outcomes and reforms, and what role initial conditions play in these effects. This can be seen in Figure 3.1. If both price reform and property rights reforms are implemented successfully, Countries 1 and 2, although starting at different points, both end up at point D. For example, Country 1 first moves from A to C in response to price reform and then from point C to D in response to property rights reform.3 In contrast, Country 2 first moves from A to C in response to price liberalization and, once at point C similarly to Country 1, from point C to D in response to property rights reform.

Using Figure 3.1, the analysis yields several conclusions. First, it immediately becomes clear that 'successful reform implementation' can have different effects on output depending on the initial conditions. In Country 1 output goes up: from q1 (point A) to qp+r (point D). In Country 1 the positive output effects from the property rights reform from qp (point C) to qp+r (point D) are reinforced by the positive output effect of the price reform from qo1 (point A) to qp (point C). However, in Country 2 output may decline: from qo2 (point B) to qp+r (point D). This is because in Country 1, with the initial subsidization of agriculture, the positive output effects from the property rights reform from qp (point C) to qp+r (point D) are more than offset by the negative output effect of the price reform from q2 (point B) to (point C).

Second, not only do the combined reform effects differ in terms of output between Countries 1 and 2, they also may differ in terms of productivity changes. This can be seen from Figure 3.2. To avoid cluttering the graphical illustration in Figure 3.1, we show the average productivity effects, q/x, which are represented by the slopes of the OA, OB, OC, OD, OE, and OF lines in Figure 3.2. It is clear that when both reforms are implemented successfully, i.e. when both countries are at point D, the changes in productivity are different. Country 1, moving from point A to D, witnesses a decline in its average productivity (illustrated by a pivot of the average productivity line from OA to OD). This is because the increase in average productivity from property rights reforms (from OA to OE) more than offsets the reduction in average productivity due to the q = f (x)

price reform from OA to OC (or from OE to OD depending on the sequencing of the reforms). Since the marginal product is less than the average product in Country 1, given the assumed form of our production function, price reform, which removes the tax and stimulates an output and input increase, actually decreases the average product in Country 1. In contrast, in Country 2 when moving from point B to D average productivity increases (illustrated by an aggregate pivot of the average productivity line from OB to OD). In Country 2 both reforms reinforce each other in terms of average productivity effects. Property rights reforms increase average productivity from OB to OF and price reform increases it further from OF to OD (or first from OB to OC and then from OC to OD if the sequencing of the reforms is the other way around).

Third, to what extent are these results general or do they depend on the specific shapes used in the graphs? The answer is in Table 3.1 which summarizes all the effects. Table 3.1 shows that all the partial effects which we have just discussed hold in general (see rows 1, 2, 4, and 5). For the aggregate

Table 3.1 Summary of effects of price liberalization and property rights reforms on output, inputs, and average product of farms in Socialist countries

Row

Country

Pricing policy environment during pre-

transition period

Reform scenario

Impacts

(2) Price liberalization

Axa

Average Product, A(q/x) b

1

1

Taxed

Yes

No

+

+

-

2

1

Taxed

No

Yes

+

+

+

3

1

Taxed

Yes

Yes

+

+

?c

4

2

Subsidized

Yes

No

-

-

+

5

2

Subsidized

No

Yes

+

+

+

6

2

Subsidized

Yes

Yes

?

?

+

c (?) means the sign is ambiguous.

c (?) means the sign is ambiguous.

effects (rows 3 and 6) this is not generally the case: the effect depends on whether the partial reform effects reinforce or mitigate each other. In those cases in which the reform effects reinforce each other, the aggregate effect is unambiguous and obviously the same as the partial reform effects. When the price reforms and property rights reforms have opposite effects, the net aggregate effect is ambiguous.

Fourth, property rights reforms and their associated rises in technical efficiency (rows 2 and 5) can have large and positive effects on farms in transition economies. Moreover, successful property rights reform, regardless of whether or not the country is being taxed or subsidized by pre-transition price policy, increases both output and productivity unambiguously. Assuming the property rights reforms are effective in raising technical efficiency (that is, assuming they are not offset by other disruptions that might come along with transition, a subject to which we return in the next section), in Country 1 the inputs and output of farmers rise when moving from point A to point E. The same is true for farmers in Country 2 (moving from point B to F). According to Figure 3.2, average product also rises when property rights are reformed in both Countries 1 and 2.

Fifth, the impact of price reform is more complex (rows 1 and 4). Successful price reform leads to rising allocative efficiency. However, the impact on output and average productivity depends on the pre-transition price policy. While in the case of successful property rights reform, whether a country is being taxed or subsidized by pricing policy, higher efficiencies will lead to higher inputs, output, and average product, it is not true in the case of successful price reform.

Sixth, because of the differences in the direction of some of the impacts, when two policies are implemented together, the net effects are sometimes ambiguous (Table 3.1, rows 3 and 6). For example, if Country 1 simultaneously implements price reform and property rights reform, according to our modelling framework, although input and output effects are unambiguous (they both rise), the same is not true for average product. It is unclear whether the rising average product associated with property rights reform is large enough to offset the falling average product associated with price reform. For example, if the price effect is large compared to the property rights reform effect, the net effect for Country 1 on aggregate productivity could be negative—unlike the situation in Figure 3.2. Inversely, in Country 2, the ambiguity of the effect of simultaneous price reform and property rights reform works in the opposite way. While average product unambiguously increases, the input and output effects are ambiguous. In Figure 3.1 the net impact of the combined reforms on output for Country 2 was negative, but this net effect depends on the shape of the production function and on the relative size of the technical inefficiencies and the subsidies. With different assumptions on these one could draw a situation where qp+r would be above, rather than below, qo2, implying a net increase in output for Country 2.

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