not arise in centrally planned economies because of complete government control. For this
reason, to fully understand the impact of a dual-track mechanism in the context of a market
economy, we need to consider not only how the reform affects the resource allocation after it
has taken place, but also how the expectation of a future reform affects the allocation before
its introduction.
To this end we extend the analysis by Lau, Qian, and Roland (2000) in two ways. First,
while Lau, Qian, and Roland (2000) have implicitly assumed that in the status quo gov-
ernment fiat completely dictates both quantities produced and consumed as well as prices,
we allow the status quo intervention to be incomplete, in the sense that in the first period
either quantities or prices can be adjusted in response to the forthcoming reform.2 Second,
we move beyond their static framework by introducing a simple dynamic model involving
two periods, where a dual-track reform taking place in the second period is anticipated in
the first.
The basic question we address in this paper is whether, taking into account that the
reform will have effects on the allocations in both periods, the dual-track liberalization
continues to be both efficiency-enhancing and Pareto improving as compared to the status
quo. This is an important issue for a policy maker eager to introduce change with ‘no
pain’. In particular, if the anticipation effect results in the exacerbation of the status quo
distortions, then the policy maker will face a dilemma. Either he will be able to manipulate
the public’s expectations, so that the dual track reform will come as a ‘surprise’, or he will
need to look for devices allowing him to make his commitment not to use a dual track
reform credible. Our analysis therefore highlights some important caveats to the broader
applicability of the mechanism analyzed by Lau, Qian, and Roland (2000).
The remainder of the paper is organized as follows. In section 2, we set up the model,
while section 3 analyzes the second-period allocation and reproduces the central result of
Lau, Qian, and Roland (2000). We study how the first period allocation responds to the
anticipated reform in section 4. In section 5, we evaluate, from a dynamic perspective, the
sub ject of a lively debate both in the policy circle and among the general public. (See for instance ‘Peking
polls the masses on prices’ in the Financial Times, August 22 1985.)
2Our analysis differs from Murphy, Shleifer, and Vishny (1992). They show that in a static setting a dual
track reform may lead to an efficiency loss when the separation of the two tracks is not well enforced. We
take instead a dynamic perspective and the potential source of additional distortions is the intertemporal
arbitrage activities of the agents.