Money, Incentives and Efficiency in the Hungarian Economic Reform

Joseph C. Brada, Istvan Dobozi

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781315491677
• Edition: 1
• Topic: Literatura
• Subtopic: Poesía

The essays in this volume document the serious shortcomings of the Hungarian economic reform, which in two decades has brought deteriorating economic performance, declining real wages, a fiscal deficit and severe inflationary pressures. It has proved unexpectedly difficult to substitute a regulated market economy for a centrally planned one. The authors of these essays argue that the problems stem from the incompleteness of the reforms and their compromise character. Today, as the Hungarians prepare to implement more radical measures, constraining the Communist party and rolling back state ownership, they do so under economically difficult conditions.

PART II

THE EFFICIENCY ALLOCATION OF RESOURCES—WHAT HAS REFORM ACHIEVED?

Estimates of the Output Loss from Allocative Inefficiency

A Comparison of Hungary and West Germany

ROBERT S. WHITESELL

Introduction

It is generally believed that, relative to a market economy, the Soviet-type economic system is detrimental to an efficient allocation of resources because of a lack of meaningful market prices, improper economic incentives, and the vertical nature of the planning mechanisms, which makes the coordination of horizontal input allocations difficult. On the other hand, it can be argued that the primary deficiency of the Soviet-type planning system is in its dynamic aspects, which present impediments to technological innovation, and that it should be rather good at static resource allocation because that is the problem the system is geared to solve. This can be countered with the argument that the distribution of resources is more dependent on political than on economic considerations. In Hungary, however, substantial reform of the Soviet-type system may have improved the performance of the allocative mechanism. Attempts have been made to make prices more responsive to market forces, and direct horizontal links among firms have been strengthened. Nevertheless, much disagreement about the effectiveness of these reforms exists.

This paper attempts to measure the efficiency of resource allocation in Hungary. Two questions are addressed. First, a quantitative comparison with West Germany tests the hypothesis that the Soviet-type economic system results in a less efficient allocation of resources than a market economic system. Second, an analysis of the trend in allocative efficiency over time is presented in order to test whether the allocation mechanism improved with the institution of the New Economic Mechanism in Hungary.

The next section explains the theoretical foundation for the calculated measures of inefficiency. Section three explains the method used in calculating the measure of inefficiency, and section four discusses the data. The results are discussed in section five, and section six is the conclusion.

Theoretical analysis

The theoretical model is based on the proposition that, whenever factor marginal rates of substitution (MRS) diverge, gains can be realized through a proper reallocation of resources across sectors. Several different methods can be applied in the calculation of these potential gains: (1) factor savings, producing the initial output vector with fewer factors of production; (2) single output augmenting, producing the initial amount of n-1 different outputs and more of an arbitrarily chosen nth output; and (3) proportional output augmenting, producing equiproportional increases of each output with the initial total factor endowment. It can easily be shown that methods (1) and (3) are equivalent.¹ Since method (1) is computationally simpler, method (3) is not employed and the estimation focuses on methods (1) and (2). Since the methodology has been discussed in detail elsewhere, it will be outlined only briefly here.²

In the factor savings method inputs are reallocated among sectors, such that factor marginal rates of substitution are equalized while holding sectoral outputs constant. Since inputs are inefficiently allocated when factor MRSs are unequal, this reallocation of inputs allows the same levels of output to be produced with fewer inputs. A problem with this method is that there are many possible ways to reduce inputs. It is necessary to choose a particular MRS that production in each sector must meet. This problem is solved by choosing the MRS which preserves the original global capitallabor ratio. Since inputs are being reduced proportionately, a simple proportional measure of the potential gain from efficiency is

(1)	$ProportionalFactorSavingsGain=\frac{\overline{L}}{L^{*}}-1=\frac{\overline{K}}{K^{*}}-1.$^3

This measure represents both the potential increase in output achievable through an efficient reallocation of resources and the loss in output from the inefficient allocation.

A second strategy in measuring the gains from an efficient allocation is the single output augmenting approach, which involves generating the same output in all sectors except one, then allocating the savings of factors in the n-1 sectors to the nth output. The increase of output in that one sector is a measure of the gain from the proper reallocation of resources, or the loss from a misallocation. The measure of efficiency is straightforward:

(2)	$ProportionalSingleOutputGain=\frac{P_1{\overline{Y}}_1+P_2{\overline{Y}}^{*2}}{P_1{\overline{Y}}_1+P_2{\overline{Y}}_2}-1.$

Since the prices in which gains are measured are important in the single output augmenting approach, whereas the factor savings approach does not depend on prices, and since resources are allocated differently in the two methods, these measures will not be the same. The single output augmenting approach will also result in differing measures according to which output is expanded.

It is important to note that these are second best estimates of the true efficiency gain. The perfect estimate would entail finding a social welfare optimum. This cannot be done without knowing the output price vectors. Even if such information were available, the probability that price data represented socially optimal general equilibrium prices would be very low. The calculations are estimates of the potential gain in production from an improvement in allocative inefficiency, but no claim is made that they represent a movement toward a social welfare optimum.⁴

Econometric implementation

In order to estimate the production gain that could be achieved from an efficient reallocation of resources, aggregate production functions are estimated for various sectors of manufacturing for the period 1961–84. Several variants of the Cobb-Douglas production function are used.⁵ All production functions are estimated assuming constant returns to scale. The following forms of the Cobb-Douglas production function are estimated:

(3)	$\text{CDA}1:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{λ}}_{\text{i}}\text{t}+{\text{μ}}_{\text{i}}{\text{t}}^2+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{ε}}_{\text{i}},$

(4)	$\text{CD}1:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{λ}}_{\text{i}}\text{t}+{\text{μt}}^2+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{u}}_{\text{i}},$

(5)	$\text{CDA2}:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{λ}}_{\text{i}}\text{t}+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{ε}}_{\text{i}},$

(6)	$\text{CD2}:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{λ}}_{\text{i}}\text{t}+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{u}}_{\text{i}}$

(7)	$\text{CDA3}:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{μ}}_{\text{i}}{\text{t}}^2+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{ε}}_{\text{i}},$

(8)	$\text{CD3}:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{μ}}_{\text{i}}{\text{t}}^2+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{u}}_{\text{i}},$

(9)	$\text{CDA4}:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{ε}}_{\text{i}},$

(10)	$\text{CD4}:\ln {\text{y}}_{\text{i}}(\text{t})=1{\text{nγ}}_{\text{i}}+{\text{α}}_{\text{i}}{\mathrm{lnk}}_{\text{i}}(\text{t})+{\text{u}}_{\text{i}},$

where

i = sector i

y_i(t) = output-labor ratio in year t

k_i(t) = capital-labor ratio in year t

${\text{γ}}_{\text{i}}$ = an efficiency parameter

${\text{λ}}_{\text{i}}+2{\text{μ}}_{\text{i}}\text{t}$ = the rate of Hicks-neutral technical change

${\text{α}}_{\text{i}}$ = imputed output share of capital

$\text{1}-{\text{α}}_{\text{i}}$ = imputed output share of labor

u_i = an error term with zero mean and constant variance

${\text{ε}}_i=u_i^t+\text{ρ}i{\text{ε}}_i^{t-1}$, this assumes first order autocorrelated errors.

The functions are nested and a likelihood ratio procedure used to choose a best estimate for each sector in each country.⁶

The factor savings measure of efficiency gain is calculated, for each year, by searching for a MRS* that would produce the initial bundle of output...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Illustrations
• Editors and Contributors
• Economic Reform in Hungary An Overview and Assessment
• PART  I.  MONEY, BANKING, AND REGULATION IN THE HUNGARIAN REFORM
• PART II.  THE EFFICIENCY ALLOCATION OF RESOURCES—WHAT HAS REFORM ACHIEVED?