The speed of transition revisited

Abstract

The speed of transition literature appears to have overlooked the fact that due to the dynamic nature of the economy the post-transition economic performance influences optimal behavior already during transition. We illustrate the implications of this neglect using the well-known model of Aghion and Blanchard (1994, Section 6.4). The correct solution differs in several respects from the "approximate" solution presented by Aghion and Blanchard. First, unemployment is increasing up to a certain endogenous point in time, when, second, the remaining state sector is closed down. This point in time can be defined as the end of transition. The correct solution is based on transforming the problem to a type of a dynamic optimization problem often encountered in resource economics: a scrap value problem with free terminal time.