1-2 Worldwide Trend of the Transition to a Market Economy

The worldwide trend of the “transition to a market economy” in the former centrally planned economies since the late 1980s can be referred to as an historical event. Since 1986, Perestroika in the former USSR spread over Eastern Europe and caused major economic and political upheaval in the area in 1989. Market-oriented reforms were also observed in the planned economies of Asia, including China, Vietnam, Laos and other countries.

However, those economies actually started their “economic reform within the framework of centrally planned system” much earlier. Several attempts of “market socialism” were tried in Eastern Europe and USSR in the late 1960s, e.g. the “New Market Mechanism” in Hungary, as well as other attempts. Also, in Asia, China and Vietnam started their reforms in the late 1970s, with China’s Third Plenum of the 11th Party Congress in 1978 and Vietnamese “New Economic Policy” approved in 1979.

## 1 -2-1 Domestic Factors

The problems which urged them to reform their economies can be summarized into the following three points: (1) stagnation of production, (2) mismatch between demand and supply and (3) macroeconomic imbalances such as inflation, fiscal deficits and external imbalances.

These problems can be attributed to the two major defects of planned economies, namely (a) lack of profit incentives and (b) lack of the mechanism which secures efficient allocation of resources.

In the planned system, enterprises were required not to earn profit but to fulfil the planned norms, with all the necessary materials, labor forces and capital provided by the state. In addition, these enterprises did not face hard budget constraints, with easy access to direct or indirect subsidies. In such a no-incentive environment, we cannot expect rational behavior toward profit maximization or cost minimization by the enterprises.

Even if the enterprises acted with economic rationality, with the relative prices determined by the state --which did not reflect demand-supply conditions--, efficient resource allocation could not be expected.

Consequently, we can conclude that (a) lack of incentive brought about (1) stagnation of production, and (b) lack of market mechanism caused (2) the mismatch of demand-supply, and they finally resulted in (3) macroeconomic imbalances.

In the stage of the “reform within the framework of the planned system,” the main feature of the reform was (a) to give incentives to enterprises (or farmers) by establishing their autonomy regarding management or economic decisions. (b) introduction of market-based resource allocation, which includes price liberalization and the abolition of plan based resource allocation, was virtually neglected in this stage.

However, progress of the reform (a) inevitably causes pressure to implement the reform (b) from the enterprises sector. The Eastern European and Asian planned economies pursued different courses from this point.

In Eastern Europe, where the potential requirement of political democratization was strong, (b) introduction of a market could lead directly to a structural change of the political system since it weakens the justification of the dictatorship of the communist party.