introduce new tax instruments, especially in transition economies. In addition, structural adjustments require increasing expenditure for a social safety net, particularly in the transition period. In Eastern Europe, increased unemployment has increased expenditures for social security purposes under their relatively advanced safety net systems.

Second, price liberalization leads to an increase in input price as well as output price to existing enterprises. Because of generalized price distortions, it could lead to a fall in profits, thereby reducing output and then employment, particularly in the case of SOEs. Naturally, newly-established private enterprises can take an advantageous position. In fact, non-state enterprises, generally small- and medium-sized, labor-intensive industries, have shown far better performance than SOEs, in both Eastern Europe and Asia.

Third, monetary tightening implies higher interest rates and a credit crunch. This in turn frustrates financing needs not only for investment, but also for working capital, leading to output reduction. This type of stagflationary impact has been typical to developing economies under 'financial repression' and/or imperfect capital markets as pointed out by Taylor $ [1980] $ and Calvo and Coricelli $ [1992] $ . In the case where financial repression is so serious that households or domestic savers can hardly have a strong financial intermediary link with enterprises or domestic investors, enterprises themselves establish intra-firm networks of claims/liabilities. Then, these stabilization measures accelerate the piling-up of these claims, thereby undermining the managerial foundation of those enterprises and then their lending banks, which in turn would shake the stability of the financial system as a whole.

## 2 -3 Initial Conditions for Reform Program

Now, if we turn to the recent economic performance in transition economies, no one can deny the shocking contrast between Eastern Europe/the former Soviet Union and China/Vietnam. While Eastern Europe and Russia have suffered from consecutive negative economic growth and persistent inflation, China has realized double-digit growth with limited inflation and Vietnam has also attained fairly steady growth with successfully controlling inflation to date (see Chart 1-I-2, 1-I-3).

In the previous section we have seen the transmission mechanism through which the reform measures affect macroeconomic variables such as inflation, fiscal deficit, money supply, and employment. With this respect there is no difference between Eastern Europe and China and/or Vietnam. Then what could generate such contrasting results?

One probable reason would be a difference in initial conditions of the recent economic reforms $ ^{2} $ . Among various initial conditions, three aspects could be essential to produce this much contrast. They are 1) industrial structures, 2) macroeconomic situations and 3) pre-reform regimes.

## 2 -3-1 Industrial Structures

In Eastern Europe, the industrial sector was dominant, while agriculture was minor in terms of both output and employment. But the situation is the opposite in China and Vietnam (see Chart 1-I-4). Considering central planning would be more penetrating in industry than in agriculture, it is not hard to see that the above impact of reforms on output and employment