Cooperatives in Transition : The Pros and Cons of Free Enterprise in an Uncertain World

The big bang approach to policy-making in transition economies advocates immediate privatization coupled with market liberalization and other reform measures. In the countries of Central and Eastern Europe and the former Soviet Union privatization has proceeded far more slowly than anticipated or recommended. The disjunction between expectations and outcomes is usually cast in terms of cultural and ideological considerations. In this paper, we offer a purely economic explanation for the persistence of non-market-oriented organizational forms; the optimal degree of privatization for a market in transition depends on the level of uncertainty regarding market conditions, including free market equilibrium levels of prices and quantities and the breakdown of sectoral composition between private and cooperative producers. In the short run, there is a tradeoff associated with the degree of privatization: as the degree of privatization increases, the full information welfare level increases, but the welfare-reducing price and production volatility due to the need to learn about market conditions increases as well. In addition there is a short-run/long-run tradeoff: increased privatization lengthens the short run with its associated welfare-reducing uncertainty, but speeds the rate of convergence to the free market equilibrium levels of prices and production once the long run period is reached. Specifically, as the level of uncertainty increases, the optimal level of privatization decreases monotonically