Transition to a Market Economy: Some First Principles

To work efficiently, a market system requires institutions such as private property, legal and accounting systems, and a monetary framework. These institutions need not be in place, but the structure should be agreed upon so that market participants can value assets. The paper concentrates on decisions about the choice of monetary arrangements, price and wage setting. Several countries in Eastern Europe have adopted fixed exchange rates and wage controls. The paper argues that the combination is generally inconsistent; only one relative price can be fixed. Attempts to fix wage rates and the exchange rate increases uncertainty and imposes an excess burden. The paper proposes fixed exchange rates for East European countries and development of a clearing union. In contrast to time phased programs of liberalization, the paper argues that structural changes should be announced and price, wage, budget, and monetary reforms should be made simultaneously.