Note on Adjustment and the Specific Factor Model

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the state sector depends on the productivity differential. Here we are assumingthat productivity in the state sector is constant, but that productivityin the private sector depends on the rate of growth of the private sector.Notice that to close the model one needs to answer the third question; i.e.,Lwhat is the relation between · s Land · u? If there were no third state, thenL s L u·one could argue that L u = − L · s . This is unlikely to be the case, however.It assumes that there are no frictions in the adjustment process, an assumptioninconsistent with the poor market infrastructure inherited by transitioneconomies.Remark 4 A more plausible assumption would continue to assume thatis a function of the productivity differential, but assume that there is a thresholdthat β − α must exceed before the state sector will contract; i.e.,s=·LL sL−F [β( · u) − α − γ], whereγ is the threshold value, and where F 0 > 0, butL u ·Lwithout necessarily assuming thats< 0 for all positive productivity differentials.It may be the case, for example, that β>αis required for the stateL ssector to contract. This would follow if there are subsidies to the state sector,or if there is uncertainty about the duration of opportunities in the privatesector. This is especially the case if leaving the state sector is irreversible.Remark 5 We could also think of γ as an adjustment cost that must beLborne as the private sector expands; γ = γ( · p). The net beneÞt ofmovingL pLto the private sector is now β( · uL) − α − γ, rather than β( · u) − α as before.L u L uNotice that this adjustment cost is a sunk cost. This means that there is anoption value to waiting if returns are uncertain. Agents may wait to switchuntil they have more information about the prospects for returns.Remark 6 Absorption depends on entry. This may, in turn, depend on exitfrom the state sector to free resources for the private sector.Remark 7 Notice that this framework neglects any changes in the state sector.But we would expect that privatization may also affect the productivityof resources that remain in that sector. We could add another state, L x ,theex-state sector, with productivity α 0 ,whereα
Remark 8 The key to recovery is for job creation to exceed job destruction,i.e.,·L p ·L > − L sp L sIf this condition does not hold, then unemployment (or underemployment)will continue to grow.Remark 9 Absorption (or job creation) can be a function of tax rates. Ifunemployment gets too large, tax rates may rise, and this could cause slowerjob creation.Regarding the second question, there are a variety of reasons why structuraladjustment is costly. Privatization takes a signiÞcant period to beimplemented. The absence of property rights makes capital immobile in theearly stages of transition. An interesting example of this is the difficultyof leasing. More generally, the absence of market infrastructure makes theimmediate movement of resources from one sector to another too costly. Wewill talk about these various costs in a variety of ways as we proceed.11
Page 1: Note on Adjustment
Page 4 and 5: • the problem of course, is that
Page 6 and 7: In short-hand this can be thought o
Page 8 and 9: • the real wage decreasesNotice t

Note on Adjustment and the Specific Factor Model

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