Dynamics of privatization under a subsistence constraint

Former Soviet-type economies were characterized by extensive state subsidies to workers that kept wages above the marginal product of labor. Privatization limits the state's ability to redistribute income. If worker earnings are to be above the politically motivated subsistence constraint, immediate complete privatization may be infeasible. We present a dynamic model of the transition in which low labor productivity combined with a subsistence constraint necessitate continued state ownership in order to preserve some wage subsidies. The model generates two alternative scenarios of the speediest feasible privatization. In one, full employment is maintained during most of the transition. In the other scenario, unemployment develops, Gradual privatization is characterized by an increasing share of private ownership in the economy and by capital accumulation, both of which lead to increasing labor productivity. Complete privatization occurs when the economy has accumulated a sufficient stock of capital so that the marginal product of labor rises above the subsistence constraint. The model supports important stylized facts of the transition to markets such as the decline of output accompanied by increasing unemployment. (C) 2001 Academic Press.