Shock Therapy versus Gradualism: 15 Years Later

Abstract

This paper starts by separating the transformational recession from the process of economic growth (recovery from the transformational recession) in 28 transition economies (including China, Vietnam and Mongolia). It is argued that the collapse of output during transition can be best explained as adverse supply shock caused mostly by two factors: change in relative prices after their deregulation due to distortions in industrial structure and trade patterns accumulated during the period of central planning; collapse of state institutions during transition period that worsened the investment climate. The speed of liberalization, to the extent it was endogenous, i.e. determined by political economy factors, had an adverse effect on performance as the 2SLS estimates suggest. In contrast, at the recovery stage the ongoing liberalization starts to affect growth positively, whereas the impact of pre-transition distortions disappears. Institutional capacity and reasonable macroeconomic policy, however, continue to be important prerequisites for successful performance.