Dual Track Reforms: With and Without Losers

and the corresponding first period demand is given by

5 The Dynamic Welfare Implications of Dual Track
Reform

We are now ready to evaluate whether, from a dynamic perspective, anticipated dual track
liberalization is efficiency enhancing and Pareto improving as compared to the status quo.
As it turns out, the answer to this question depends on whether the original government
policy involves an intervention only in one or in multiple dimensions. Instead of providing
an exhaustive analysis of the various possible types of government intervention, we illus-
trate our arguments by means of three examples. First we consider a price setting policy,
and then a quantity restriction accompanied by price setting with and without involuntary
participation/exclusion.⁶

5.1 Single-Dimension Intervention: Price Setting

Suppose the government fixes the price at P in the first period, and assume that this policy
results in excessive demand (that is, the supply is binding). In this case, the second period
market price P ^e must be higher than P , as Figure 2 illustrates. In the first period, if
agents do not anticipate future policy changes, the quantity exchanged will be Q₁, so that
S^-1 (Q1) = P. When a dual track liberalization is instead expected, sellers have an incentive
to withhold their sales in the first period, in order to avoid being locked into a contract fixing
the low price P . At the same time, buyers have an additional incentive to transact in the first
period so as to lock up the low price P. This implies that the first period excessive demand
persists under the anticipated dual track liberalization. Let Q₁^d be the equilibrium quantity
transacted in the first period under the anticipated dual track liberalization. Following

⁶For a more complete analysis, see Che and Facchini (2004).

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