IMF Working Papers

The paper discusses the case against a laissez faire approach to resource allocation and develops a model of supply bottlenecks. It argues that: (1) once budget constraints are hardened and credit markets begin to function appropriately, externalities associated with production bottlenecks and adjustment costs--other considerations aside--provide a case for subsidizing the costs of critical inputs for the state sector but not the new private sector; (2) the optimal subsidy declines as the private sector grows; and (3) the subsidy should be “financed” by taxing wage income in the state sector, which will strengthen incentives for workers to move.