parties can carry out transactions at the prevailing equilibrium market price.
Key to our analysis is that private agents anticipate in the first period the implementation
of the dual track reform in the second. As a result, the equilibrium resource allocation in
the first period is determined not only by the original distortionary policy, but also by the
anticipated second period reform. Therefore, when evaluating dual track liberalization, we
need to consider its welfare implications over both periods. Specifically, we will compare
the equilibrium allocation under dual track liberalization to the status quo (i.e., the no
liberalization outcome). We say that the reform is efficiency-enhancing when it dominates
the status quo from the point of view of social welfare, i.e. the total (discounted) surplus
over the two periods is greater under the reform than under the status quo. Furthermore,
dual track liberalization achieves a Pareto improvement over the status quo if the total
(discounted) surplus of each private agent over the two periods is greater under dual track
than under the status quo.
3 The Second Period Resource Allocation
Our analysis of the second period equilibrium reproduces that of Lau, Qian, and Roland
(2000). To proceed, it is useful to distinguish between two sets of agents: those who have
transacted in the first period and those who have not. Previously active agents must carry
out their original transactions as required by the dual track liberalization mechanism. By
doing so, the dual track mechanism ensures that in the second period no one can be worse
off as compared to the status quo. As in Lau, Qian, and Roland (2000), we further assume
the dual track mechanism allows agents to carry out these transactions by taking advantage
of the existence of a market track without actually producing or using the commodity. For
instance, an employer can second his former employee (whom he is obliged to hire at the
union wage rate) to another employer at the market wage rate, instead of actually using him.
By granting previously active agents access to the market track, the dual track mechanism
enables them to arbitrage between the market price and the marginal cost (or marginal
willingness to pay) of the good/service they are obliged to provide (or entitled to consume).
For instance, by seconding his employee at the market wage rate, an employer avoids using
the first period, the same payment will be made in the second.