Dual Track Reforms: With and Without Losers

1 Introduction

Economic reforms are likely to create losers and too often the difficulties involved in iden-
tifying and compensating adversely affected individuals have made major policy changes
impossible. For this reason, the dual-track approach implemented in the Chinese economic
reforms should be of great interests to policy makers. As Lau, Qian, and Roland (2000)
have shown, this mechanism has the potential not only to obtain an efficient allocation
of resources, but more importantly to do so without creating losers. Some observers have
concluded that the “dual-track approach is perhaps the most important aspect of Chinese
reforms since it was, at the time, an innovative solution to the political constraints on the
direction and speed of reform”(International Finance Corporation (2000)). Indeed, dual
track-like reforms are being attempted in other economic environments. One interesting
example is represented by the recent reform of the Italian labor market, in which older work-
ers are kept under existing tenure contracts, while new personnel can be hired according
to temporary, short term arrangements. Similarly, the proposed overhaul of the US social
security system contains features of a dual-track mechanism in which current retirees are
promised unchanged benefits, while younger workers would be allowed to invest in personal
accounts.

There is, however, a critical institutional difference between centrally planned economies
and market economies. While in the former government control completely dictates almost
all economic decisions, in the latter government control is at best incomplete. That is,
despite government interventions, economic decisions by private agents continue to play a
role in determining the resource allocation. It is then natural to ask whether the welfare
implications of the dual-track mechanism are the same in these different environments.

The dual-track reform strategy can improve efficiency without creating losers because
it preserves all the existing rents throughout the reform process. However, in economies
where government control is incomplete, the anticipation of a policy change may well induce
rational agents to distort their pre-reform behaviors in order to maximize the very rents
that the dual-track mechanism tries to maintain.¹ This pre-reform distortion will instead

¹Given that the purpose of a dual-track mechanism is to ‘build consensus’ for a policy change, dual
track-like reforms carried out in countries with a democratic tradition have been the subject of vibrant
discussions. The recent debate on the reform of the social security system in the US is one obvious example.
Even in China, the question of whether the price reform should proceed in a dual track fashion has been the

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