The transition from a planned economy to a market economy involves a complex process of institutional, structural, and behavioral change. This article develops an index of economic liberalization and analyzes its interaction with growth and inflation, using data from twenty-six transition countries for 1989–94. The article reveals two paradoxes of transition. First, the attempt to maintain output by subsidizing enterprises results in larger declines in output than occur under a policy of reducing subsidies. Second, price liberalization results in lower inflation than occurs under a policy of continued price controls.

Strong common patterns exist among countries at similar stages of reform. The common legacy and the associated changes that result from initial disruptions in the socialist economic coordinating mechanisms and subsequent liberalization measures go a long way toward explaining the transition experience. Because strong interactions between liberalization and stabilization are likely, stabilization becomes a priority for the resumption of growth.

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