Econ 372
Problem Set 5
Selected Answers

1.

2. East Germany had ready access to the whole social and economic infrastructure of West Germany. The West Germans offered their East German counterparts well-established legal and accounting standards, a stable financial system, a supply of entrepreneurs, access to global markets, extensive transportation and communication infrastructure, and a social safety net.

3. It was an efficiency versus equity tradeoff. Efficiency would have implied an exchange rate somewhere in the area of 5 Ostmarks per D-Mark (as judged by the black market rate and the pricing of East German goods on the world market). Such an exchange rate would have left many East Germans with much less purchasing power than West Germans. Hence, the call for 1 OM : 1 DM was a political move to appease the East German populace. The parity rate, however, severely overpriced East German labor and, therefore, contributed to rising unemployment during the transition period.

4.

5. This question is redundant. See #4 above.

6. The "J" curve is the notion that an economy's performance (as measured by GDP, for example) will get worse before it gets better during the transition period. The big questions are how deep the "J" is and how long will it be before the economy recovers. This may depend on whether a Big Bang (shock therapy) approach or a Gradualist approach to reform is taken.

7.

8.

9. While this question is very normative in many respects, you will certainly want to consider the reform experiences of Russia and China. In Russia, political reform generally preceded or was coincident with economic reform. In China, political reform has clearly taken a back seat to economic reform. In some respects, Chile's experience is more like China's than Russia's. In Chile, a military dictator launched a coup to overthrow a democratically elected socialist and then preceded to introduce market reforms. Chile's experience is unique in that the dictator eventually handed control back to the people after the reforms took hold (though the intervening years were filled with strong-arm tactics).

10.

11. Gorbachev moved too slowly and his reforms never fundamentally addressed the problems associated with the Soviet economic system. Of course, your answer will include many more details than this broad description.

12. Consider that soft budget constraints have not been totally eliminated. Thus, enterprises may still hold on to excess workers and expect the state to bail them out to cover their costs. Transition to a market economy requires that labor be re-allocated to more efficient uses. The transition, though, is likely to be painful for certain types of workers (consider your answer to #10 above) and such workers may resist the necessary changes.

13.