Dual Track Reforms: With and Without Losers

Dual Track Reforms:

With and Without Losers *

Jiahua Che

Hong Kong University of Science and Technology and William Davidson Institute

Giovanni Facchinit

University of Illinois at Urbana Champaign and University of Milan

November 28, 2005

Abstract

The dual track approach to market liberalization has been widely recognized as the
key to the success of the Chinese economic reform. In this paper we study the effec-
tiveness of this strategy in economic environments where the status quo government
control is incomplete. We show that in a dynamic context intertemporal arbitrage will
emerge, potentially resulting in efficiency losses and/or adverse distributional effects.
Only when the status quo involves both price and quantity interventions by the gov-
ernment can dual track liberalization maintain its appeal. Our analysis thus suggests
some caution as for the broader applicability of this reform mechanism.

JEL classification: H2, P2, F1

Keywords: Dual Track Liberalization, Intertemporal Arbitrage, Pareto Improving Re-
forms, China

*We would like to thank Dan Bernhardt, Hadi Esfahani, Earl Grinols, Eli Katz, Jan Svejnar, Bart
Taub, Cecilia Testa, Weiyin Zhang, Li-An Zhou and seminar participants at the ERWIT CEPR meeting in
Bern, the Midwest International Economics Meetings in Pittsburgh, SAET VI conference in Rhodes, Beijing
University, the University of Illinois and University of Leipzig for useful comments.

tCorresponding author: Department of Economics, University of Illinois at Urbana-Champaign, 484
Wohlers Hall MC-706, 1206 S. Sixth Street, Champaign, IL 61820, United States. Tel: (217) 265-0644, Fax:
(217)-244-6678. E-mail: [email protected]. Che can be contacted at Department of Economics, Hong Kong
University of Science and Technology, Clear Water Bay, Hong Kong. Email: [email protected]

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