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Does choice of transition model affect GDP per capita growth?

Written by E. Harrtell, H. Larsson

Paper category

Bachelor Thesis






Thesis: Market economy and its elements The origin of market economy has a long history, but today's characteristics are basically the same as those of one of its founders, Adam Smith, who wrote the world-famous "The Wealth of Nations" in 1776. This is the first time the term "invisible hand" was coined (Smith, 1910), implying no government intervention or other coercion. Therefore, it is a place where buyers and sellers meet and conduct transactions in accordance with regulations, laws, and rules supported by self-organizing behavior. In addition, it is also a natural place for transactions, property rights transfers and contract conclusions. (Hacker, Johnson and Carlson, 2004). This requires educated participants to have a basic understanding of the market and its characteristics, which are often lacking in transition countries. Building it is a time-consuming process, and failures in this area can cause high levels of damage. Therefore, it is important to have stable and regulated institutions to counteract possible causes of corruption (Marangos, 2005). Although institutional changes are slow, they have a powerful impact on a country’s economic performance and stability. This stage can also be referred to as the Achilles’ heel of transition economies, because institutional construction is the foundation of a market economy (Marangos, 2005). The importance of these systems becomes obvious when it comes to how national income must change when it shifts from a command economy to a market economy. In the command economy, state revenue mainly comes from state-owned enterprises (Åslund, 2002). When enterprises are privatized, the government loses the source of income it drew from the profits of old state-owned enterprises. Therefore, resources must be searched elsewhere, for example. Through tax agencies. In addition, a market economy is an economic system in which the production and distribution of goods and services are carried out through a free market mechanism. This is guided by the free price system, not by the state, in the command economy (Isachsen, Hamilton & Gylfason, 1994). A properly functioning market economy or system needs to be able to adapt to competition and pressure from the market. These pressures come from the supply and demand factors that determine prices (Hacker. et al, 2004), as shown in Figure 1 on the next page. In contrast, Figure 2 highlights the fundamental difference between the two systems, from which it can be seen that the command economy established the total output in period x. The predetermined production quantity S(q) determined by the country is fixed and has nothing to do with demand, thus causing market distortions (Isachsen et al., 1994). 2.2 CEEC EU membership and market economy Since most of the selected Central and Eastern European countries have now joined the EU, they have been asked to join the list of requirements. First, countries must obtain stable systems to ensure democracy and maintain an effective legal system. Second, all the characteristics of the operation of a market economy must be established so that countries can compete with other market forces in the EU. Finally, these countries must be able to strengthen all the obligations of membership, such as joining the Economic and Monetary Union (EMU). In order to achieve the implementation of a common currency, the inflation rate must be kept within an average of 2%. Until recently, high inflation rates have been an ongoing problem for all Central and Eastern European countries, but there are still some countries that have not achieved this goal. Nevertheless, almost all Central and Eastern European countries have achieved the EU's goal of 4.5% annual GDP growth, and the reference countries have encountered difficulties in achieving this goal. (El-Agraa, 2004) 3 Two transformation methods The main reason for supporting transformation is the eager desire to put Central and Eastern European countries on the path of sustainable economic growth. It is believed that the transfer of property rights from the state to private owners and the transformation of the distribution mechanism from the state to a free market will increase the savings rate and capital formation on the basis of obtaining allocation efficiency. (Kolodko, 1998) When privatizing the economy, there are many different ways and the decision-making is very complicated. The key is to decide whether the country should complete this process quickly as a single point of transformation for all economic sectors, which is advocated by the shock therapy spokesperson. The other option is to make the transition take time, so that every step is deeply implemented and matured into the economy, gradualism. However, in all command economies, researchers claim that there are different steps that affect GDP growth in their own way, so there are independent variables; privatization, degree of openness (Beyer, 2001), foreign direct investment (Johnson, 2005), and macroeconomics Forms of economic stability, such as inflation (Sachs, 1997a). From the author's empirical research by Jürgen Beyer (2001), you can find evidence that supports these different components with different weights and importance between the two systems. The countries in transition have all entered the transition stage, and their economic conditions are quite different. In addition, in the process of transformation, the situation of different countries is also different. According to Beyer (2001), this fact will affect the outcome of their transformation. As an alternative, he claimed that economic prerequisites and individual size are more important when estimating the success of a country’s transformation. Read Less