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Economics of Transition - Essay Example

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University of Edinburgh School Of Economics Economics of Transition How can rent-seeking activity by banks disrupt the process of hardening budget constraints in the transition economies? 27th March 2012 Table of Contents 1. Introduction 3 2. Soft and Hard Budget constraints 4 3…
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Economics of Transition
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Economics of Transition

Download file to see previous pages... This competition not only transformed the contours of politics in the twentieth century but also led to the creation of two parallel and competing economic systems. Transition can be defined as the race of transformation of centrally planned economies into free markets. Such a transformation can be seeing as occurring after the political events that decimated the Soviet Iron Curtain. Transition is characterized by liberalization, macro-economic stabilization, restructuring and privatization and legal and institutional reforms. Countries have employed disparate transition models owing to the distinct initial circumstances that prevailed at the time when transition process materialized. Moreover, transition circumstances can also be seen as the product of the country’s peculiar socio-economic realities. While some countries like China embraced a slow and steady economic transformation approach, others like Russia adopted an aggressive and speedy model. It was envisaged that a swift approach could be undertaken for the privatization of small corporate entities as well as liberalization of prices and macro-economic stabilization, without encountering much economic problems (International Monetary Fund, 2000, p.3). The significance of transition for these economies can be attributed to the fact that any immature measures for transition tend to lead to economic collapse. This was all the more clear for example in the Russian banking sector failure in the late nineties. This paper will analyse how rent-seeking activities of financial institutions can have a bearing on hardening budget constraints in the transitional process. 2. Soft and Hard Budget constraints It was Kornai who invented the term ‘soft budget constraint’ to elucidate economic behaviour of the communist economies. This concept is deemed as the focal point of the subject of transition from socialist to capitalist economies. The term itself is derived from microeconomic terminology to shed light on a pragmatic economic social syndrome. The necessity of implementing hard budget constraints is accentuated repeatedly in relation to transition of socialist economies. The disintegration of the banking sector of East Asian economies during the nineties era can be comprehended by studying soft budget constraints (Kornai et al., 2003, p.54). The soft budget hypothesis denotes a condition under which firms incurring losses are bailed out by banks. Banks can undertake this role in both, capitalist and socialist economies. However, its repercussions in socialism make it a potential problem since banks are compelled by the state to rescue loss-making entities, for safeguarding employment or pursing other aims. The entanglement of state and banking into one entity means that any failure on the part of the banks will reflect clearly in the finances of the state. Typical failure in these circumstances leads to massive cuts in social sector development. Under a soft budget constraint, capital is injected in the loss making firm by the banks to keep them afloat and in a position to pay taxes, therefore acting as a disincentive for privatization. Research on the issue practically proves by applying a model based on the local authorities, a bank and firm (Brandt et al., 2003, p.13). The bank managers’ propensity to lend loans to private firms rather than SOEs will escalate as ...Download file to see next pagesRead More
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