Trade Liberalization, Privatization, and Restructuring Incentives

This paper presents a model describing the policy decision framework confronting governments seeking to effect transition of their economies from prior socialism to a free-market private-property economy. Fundamental elements of this transition are (i) change from the socialist trade regime under which domestic enterprises did not confront import competition (nor domestic competition for that matter), and (ii) privatization of the formerly socialist enterprises. We consider circumstances where governments have as an objective a liberal trade regime, sought because of the traditional efficiency case for an open economy — with the additional benefit, not present when the domestic market is competitive, from exposure of a sole domestic producer to discipline of import competition. The government that we model bases its policies on broadly consensual economic principles and policy advice. Government officials do not seek to take advantage of incumbency to provide policy favors in exchange for political support or personal remuneration, and the pursuit of efficiency objectives is not compromised by political competition that can lead to policies favoring domestic interest groups. Nonetheless, as we shall elaborate, the formulation of policy is subject to the need to maintain a minimum level of electoral support. A substantial literature motivated by real-world observation views policies as endogenous to the political process via the self-interest motives of policy makers.1