derive the following conclusion, which holds also for the case of binding demand:
Proposition 1 Suppose that the government status quo policy is price setting. Then antic-
ipated dual track liberalization is never Pareto improving. From the point of view of social
welfare, it is dominated by the status quo if
δ(Qe - Q1) ≤ Q1 - Qd1 . (1)
Proof. We only need to prove the efficiency result since we have already shown that an-
ticipated dual track liberalization does not lead to a Pareto improvement. Notice that the
efficiency loss in the first period is bounded below by (D-1(Q1) -S-1(Q1))(Q1 -Q1d), whereas
the efficiency gain in the second is bounded above by (D-1 (Q1) -S-1(Q1))(Qe -Q1). There-
fore, the dual track is not efficiency enhancing if δ(Qe - Q1) ≤ Q1 - Q1d. QED.
Proposition 1 states that, from a dynamic perspective, the anticipated removal of a price-
setting policy in a dual-track fashion is welfare-reducing rather than welfare enhancing if
condition (1) is satisfied.7
5.2 Dual Intervention
Our discussion so far has shown that dual track liberalization will not be both efficiency
enhancing and Pareto improving in a dynamic context if the status quo policy involves an
intervention on a single dimension. The appeal of dual track liberalization can be reestab-
lished however when in the status quo the original intervention involves instead both prices
and quantities.8 As an example of this situation consider a labor market where in the sta-
tus quo all employment contracts specify a union-set wage rate, and the domestic market is
closed to immigrant workers. A dual track liberalization will then result in current employees
7If there is a supply shortage, condition 1 is satisfied as long as the supply is linear. To see this, substituting
Pe = S-1 (Qe ) and P = S-1(Q1) into the equation P = S—(^^1 '/ δP , we get S-1(Q1) — S-1( Qd ) =
δ(S-1 (Qe) - S-1(Q1)), which reduces to Q1 - Q1d = δ(Qe - Q1), i.e., condition (1) when the supply is linear.
8This was the case in centrally planned economies like China or the former Soviet Union where almost all
product markets saw the planning authority determining output targets to specific production units, as well
as fixing their prices. Likewise, many developing countries used to follow import substitution development
strategies, involving the exclusion of foreign competitors on the one hand and the introduction of measures
such as distortionary taxes, subsidies, and price ceilings on the other.
10
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