the system collapsed, the member economies were exposed to international trade based on competitive prices, which were totally different from those distorted prices. Also, the CMEA regime was a system of regional integration. Once it collapsed, it was revealed that the whole production location system based on distorted prices had to be reshuffled.

Second, no less important, the former CMEA economies had to confront the collapse of their economic system as a whole. Namely, their economic reform requires not just partial revisions, but revolutionary changes in their entire institutional arrangements. The reforms are to introduce a new ownership system based on private property rights, a new corporate system by privatization, a new banking system to replace the mono-bank system, and a new fiscal and social security system.

Of course, we have often observed in capitalist developing economies such as 'soft budget constraints' between governments and state enterprises and 'financial repression.' But at least we could say that those economies are based on private property rights and decentralized decision making processes. The difference between the 'capitalist' developing economies and the former socialist economies is not a matter of degree. Thus we must realize that there is 'a sea of difference' between the start and the goal of economic reforms in the case of the former socialist economies, which requires far more comprehensive reforms than in the other developing economies.

Another recent development and/or turmoil in policy thinking around transition economies is how to evaluate or reconcile contrasting economic performances in Eastern Europe and the former Soviet Union on one hand, and in China and Vietnam on the other (see McKinnon [1994] and Sachs and Woo [1994], for example). The present discussion proceeds toward the method of reform management, and the initial conditions of the reform. Before doing so, we are going to clarify the mechanism inherent to transition economies which creates a variety of economic responses in the process.

## 2 -2 Reform Process: Stabilization and Structural Reforms

At the start of economic reforms, typical problems are domestic inflation, fiscal deficit, external imbalance, pervasive price distortion and financial repression. Then, the prescription for stabilization should be fiscal restraint or reduced subsidies, domestic price liberalization, foreign exchange rate devaluation and monetary restraint. In Eastern Europe and the former Soviet Union, the result has been a disastrous combination of unexpected price inflation and output decline despite transitory improvement in the external balance.

## 2 -2-1 Inflation

The extent of price explosion due to price liberalization has been harsh, sometimes far beyond initial expectations, and this inflation has not subsided swiftly in Eastern Europe and Vietnam. In China, where price liberalization was undertaken at a slower pace, inflation was fairly high (as much as 20 percent), but not accelerated as much as in the others.

There are three possible reasons for this hyper-inflation. The first is, of course, excess liquidity. To the extent that pre-reform price distortions were serious, price liberalization would expose mismatching demand and supply in various aspects of economies. Excess demand, however, could not necessarily generate inflation without the support of excess