What is a Transition Economy?

Mary McMahon
Mary McMahon

A transition economy is a national market undergoing a shift from a controlled, centralized economic system to a liberalized and open one. This term describes former communist nations transitioning towards democracy and a capitalist economic model. In the 1990s, a number of transition economies appeared with the collapse of the Soviet Union across Russia and Eastern Europe. There are some special concerns with such economies, as well as numerous opportunities for savvy investors and politicians.

Businessman giving a thumbs-up
Businessman giving a thumbs-up

Several features can be seen in a communist economy. The government owns the means of production, and a single party controls politics and the economy. Additionally, in these nations, the government uses centralized planning to make decisions about fiscal policy and the future of the nation's economy. When communist governments collapse, they are typically replaced by a multiparty system, loosening government control at all levels of life, and a series of legal reforms turn the nation's financial markets into a transition economy.

Typically, a transition economy experiences a spike in inflation after initial liberalization. The government may have to take measures to slow and stabilize inflation. National assets transfer to private ownership and the nation encourages the creation of a more free market. Private companies may arise, offering goods and services not previously available. Competition creates a more realistic market, as supply and demand push prices in various directions. In a transition economy, it is sometimes difficult for people to meet basic needs initially due to the inflation and the lagging pace of wage increases.

Politically, a transition economy is often of interest. Neighboring nations usually want to engage in trade and foreign companies may be interested in investment and trade opportunities. The government may have to exercise caution with the reforms it enacts to make sure the pace of reform does not move so quickly that the citizens of the country do not have time to adjust. Rapid liberalization can destabilize the country and in a nation where the government has just undergone a major transition, this can be dangerous.

A transition economy may be eligible for benefits from the international community like loans and other forms of support. International organizations and financial institutions provide assistance with the goal of helping the country gets its economy off the ground. Transitioning nations may also look to the policy reforms made by other former communist nations to get ideas for proceeding with the goal of avoiding pitfalls and traps other nations encounter along the way to liberalization.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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