Countries of the former Soviet bloc have been in transition from central economic planning for almost 10 years. The variety of outcomes across many dimensions—from degree of privatization to unemployment levels to speed of economic recovery—is of great interest to economists and policymakers looking to advise these countries early in the transition process.

The measured drop in output from prereform levels was dramatic in all of these countries. The lowest level of decline—on average, about 20 percent—was in the Czech Republic, Hungary, and Poland. By contrast the Baltics, Russia, and Ukraine have each seen output decline by more than 50 percent. Even taking into account problems with data collection and interpretation, there is a clear trend of dramatic decline in GDP in the initial stages of reform for these countries. Strikingly, in almost every case, GDP fell after prices and trade had been liberalized.

Both Blanchard and Kremer (1998) and Roland and Verdier (forthcoming, 1999) examine one explanation for the decline in output: a theory of disorganization. Blanchard and Kremer emphasize the cost of losing the coordinating function of central planning in the absence of institutional arrangements that ease transactions in market economies.

Central planning was characterized by a complex set of highly specific relations between firms, meaning that firms typically had one supplier for each input and one buyer for output. In a market economy, relationships like these lead to abuses by one or both parties, which would have adverse effects on overall production. Market economies eliminate such negative effects either by encouraging competition (many buyers and sellers eliminates specificity) or through the evolution of institutional arrangements such as contracts and vertical integration. Under central planning, the main instrument available to prevent the adverse effects of specificity was the coercive power of the central planner.

Transition of these economies has eliminated the central planner, but institutional arrangements common in the West have been slower to arise. As a result, a number of economic relations have broken down. Sectors with the most complex production processes have suffered the most dramatic output losses. Trade between former republics of the Soviet Union has collapsed, and many firms report shortages of inputs despite price liberalization. Blanchard and Kremer argue that this general "disorganization" has played an important role in explaining the output decline. Providing evidence for this theory, they show that output has fallen most in sectors with the most complex production processes, and that disorganization has played a more important role in the former Soviet Union than in Central Europe.