Most of the former socialist countries are proud of their free pricing system. In China the prices of more than 60 percent of all commodities are governed by the free market system, and in Vietnam the government controls only a limited number of goods. However, if many basic input materials are produced by state-owned enterprises, the ratio of commodities whose prices are effectively liberalized to total commodities is likely to be low. To provide incentives for the private sector to enter into new production, liberalization of the prices of the factors of production (raw materials, energy, basic intermediate goods, capital, labor, and so on) becomes urgent. Also the free mobility of the factors of production needs to be facilitated, consistent with their price liberalization.

(2) Distortion of the Relative Price Structure

Gradual price liberalization may create distortions in the relative price structure. The relative price structure, in turn, affects real income through the terms of trade. In Vietnam's transition, for example, most of the manufacturing sector's output prices remained under strict government control—because the products were made in state-owned enterprises. The prices of agricultural products, however, were liberalized at an early stage. As a result of the market function, therefore, the price increase of agricultural products exceeded the price increase of manufactured goods. In other words, the price of agricultural commodities rose relative to manufactured goods. For example, the ratio of the price of rice against the price of steel jumped from 0.17 in 1987 to 0.65 in 1991. This improvement in the terms of trade of the agricultural sector caused a relative increase of real income in that sector. Meanwhile, in the manufacturing sector (in other words, the state-owned sector), trade deteriorated, putting further burdens on the government to compensate the declining real income of workers in the state-owned sector. Thus, ironically, partial price liberalization sometimes creates the need for further subsidies from the government.

## 3 -5-2 Reform of State-Owned Enterprises

The most difficult task in the transitional period is that of reforming a huge number of state-owned enterprises. Most former socialist countries have been eager to introduce a privatization policy. Privatization has been seen as a panacea for such diverse problems as government budget deficits, low productivity, unemployment, poor capital formation and so on. However, experience shows that confusion has surrounded privatization in the following areas:

(i) main purpose of privatization-change of ownership or management reform, reduction of budget deficits; promotion of competition

(ii) how to finance privatization - domestic savings, foreign capital, new money supply, establishment of capital markets

(iii) social cost-unemployment, social safety net.

Looking at Central European privatizations, regarded as an example of the shock approach, we see that only small -scale privatizations -e.g. shops - have gone well. The progress of large-scale privatizations has been very slow. The Mongolian experiment with privatization also has been a failure: only ownership of the state-owned enterprises has changed-there has been no change in management, and no contribution to supply improvement.