Fiscal Constraintson Market-Oriented Reform in a Socialist Economy

IMF Working Papers, August 1, 1991

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Develops a simple two-sector model of a socialist economy.
Government revenues required for servicing external debt are obtained from taxation of the socialized sector and from import taxes.
Wages and employment in the socialized sector are the outcome of Nash bargaining between the government and an import-competing labor-dominated state enterprise with domestic market power.
Examines the effects of:
- trade liberalization,
- demonopolization,
- technical improvements,
- limitations on labor’s bargaining power.
Considers the implications for privatization.
Concludes that some combination of tax reform and debt reduction may be a precondition for market-oriented reforms.

Two-sector framework distinguishing a socialized sector and an import-competing sector with state enterprises.
Government revenue sources explicitly modeled as:
- taxation of the socialized sector,
- import taxes.
Labor outcomes (wages and employment) modeled via Nash bargaining between:
- the government,
- an import-competing labor-dominated state enterprise with domestic market power.

Trade liberalization, demonopolization, technical improvements, and reduced labor bargaining power each have distinct effects on wages, employment, and government revenue within the model.
Because government debt-service requirements rely on revenues from the socialized sector and import taxes, reforms that reduce these revenue bases can constrain feasible market-oriented reforms.
Some combination of tax reform and debt reduction is identified as potentially necessary before undertaking market-oriented reforms.

Policy sequencing: tax reform and debt reduction may need to precede market-oriented reforms to avoid fiscal shortfalls that undermine reform objectives.
Privatization implications: model results are used to assess when privatization is likely to be feasible given fiscal constraints tied to debt servicing.
Trade policy trade-offs: trade liberalization can alter import-tax revenue, affecting the fiscal space for reforms.

Subject: Employment, International trade, Labor, Trade barriers, Trade liberalization, Wages
Keywords: Eastern Europe, Employment, enterprise council, enterprise manager, enterprise sector, enterprises vis-à-vis, firm's indifference curve, labor-managed firm, marginal revenue, monopoly rent, socialized enterprise, state enterprise, Trade barriers, Trade liberalization, Wages, WP

Content summarized from "Fiscal Constraintson Market-Oriented Reform in a Socialist Economy", IMF Working Papers 1991/075 (August 1, 1991).