Introduction

The relationship between the government and the market, as two means of resource allocation, is one of the fundamental issues in national governance and is also a controversial academic issue. According to traditional economic theory, the market, as the “invisible hand”, can make the factors of production achieve optimal allocation and thus promote economic growth. For the relationship between institutions and economic growth, as North (1971) argued, an institutional arrangement that better achieves economic freedom is conducive to promoting long-term economic growth. Since the 1990s, many developing countries, such as the CIS, Eastern European countries, and China, have transitioned from a highly centralized planned economic management system to a market economy. The transitional institutional arrangements for advancing market-oriented reforms in these countries differ both from the former planned economy system and from the market economies in force in developed countries. The economic performance resulting from the economic transition also shows a large degree of variability. If the market is the most effective means of resource allocation, then why have the market-oriented reforms carried out by many transition countries failed to achieve the expected results? International experience shows that there are conditions for the market mechanism to play a role in resource allocation. There is no simple correspondence between an increase in the level of marketization and economic growth in a country. What exactly is the relationship between the level of marketization and economic growth? Does an increase in economic freedom have different effects on factors of production? The answers to these questions are highly practical, and these transition countries provide good research cases.

On the basis of existing research, this paper tries to make several innovative attempts in the following aspects:

First, the literature on the impact of market-oriented reforms on economic performance focuses more on the economic growth rate than on data on the level of economic growth. The Solow model suggests that economic growth rates converge in the long run, so it is more important to explain the differences in the level of economic growth data and to analyze the differences in the long-term performance of each country in a clearer way. From the perspective of developing countries, an increase in per capita output is the key to successfully leaping the “middle-income trap” into the ranks of high-income countries. Therefore, this paper uses GDP per capita data for market analysis to reflect the economic performance of market-oriented reforms, which better reflects the real needs of developing countries.

Second, there are few empirical studies on the economic performance of market-oriented reforms in countries with economies in transition, focusing on the cross-sectional data of a specific country and lacking cross-country panel data, which leads to a lack of generality and persuasiveness of the conclusions. In this paper, empirical tests are conducted through cross-country panel data to further enhance the persuasiveness of the research conclusions.

Finally, most empirical studies on the economic performance of market-oriented reforms focus on mixed-country data. Li & Xu (2006) and Paakkonen (2010) address transition countries with cross-sectional data, which are not panel data that can truly reflect the relationship between economic freedom and the economy. The so-called transition countries refer to countries that used to have a highly centralized system of planned economic management and are now converting to a market economy, usually including the countries formed after the dissolution of the Soviet Union and the countries of Eastern Europe, as well as China. In terms of the economic system, mode of operation, state functions, ownership structure, and social security system, transition countries are different from the original planned economy system and from the current market economy in Western countries. Therefore, this paper chooses countries with economies in transition since the 1990s as the research sample, which better reflects the differences in the economic performance of transitional institutional arrangements in the process of market-oriented reforms.

The remaining sections of this study are organized as follows. Section “Theoretical model and basic hypotheses” reviews the relevant literature and presents the theoretical model and research hypotheses of the study; section “Model construction, data sources and indicator estimation” describes the construction of the model, the data sources, and the estimation of the indicators; section “Empirical results” analyzes the results on the basis of empirical tests; and section “Conclusions” concludes the paper and offers suggestions.

Theoretical model and basic hypotheses

With respect to the relationship between economic freedom and economic growth, earlier studies focused on theoretical studies of this relationship, such as North (1971), who argued that incentives under a free economic system are conducive to long-term economic growth. With the introduction of the economic freedom index, Easton & Walker (1997), using economic freedom data and the Mankiw-Romer-Weil model as a benchmark, argued that economic freedom has a level effect on per capita income, but their study did not address the growth effectFootnote 1 of the economy. Nelson & Singh (1998) used economic freedom as a control variable to study the relationship between economic freedom, political freedom, and economic growth; analyzed it via parallel data from developing countries; and reported that economic freedom has a fairly positive effect on economic growth. Ail, Crain (2002) used the extreme value boundary analysis model (EAB model) to analyze the relationships among economic freedom, political freedom, and economic growth and concluded that the relationship between economic freedom and economic growth is also very positive. The relationship between economic freedom and economic growth is very “significant” (Lee et al., 2022). Economic freedom creates a favorable market environment to enhance the input and output capacity of factors of production, such as capital and labor, which directly promotes economic growth, as confirmed by many scholars (Doucouliagos & Ulubasoglu, 2006; Bordo et al., 2017; Demir & Razmi, 2021).

However, with the economic transformation of former socialist countries in the early 1990s, an increasing number of scholars have begun to pay attention to the heterogeneous impact of the increase in the level of marketization on economic performance (Xu & Liao, 2014; Liu et al., 2023). To achieve the strategy of catching up, late-developing countries should explore the optimal level of marketization to achieve sustained economic growth according to their own national conditions (Bao & Zhou, 2020; Chen & Guo, 2020; Zhang, 2021). Sturm, De Haan (2001) considered the possible effects of data outliers, and after removing anomalies via the least squares median (LMS) method and then estimating them via the weighted squares method, the results revealed that the level of economic freedom does not contribute significantly to economic growth; thus, they concluded that the level of economic freedom has no growth effect. Paakkonen (2010) analyzed the data by using the average of the calendar year of each transition country as cross-sectional data and used the GMM method to find that the index of economic freedom as an aggregate indicator promotes economic growth, but the introduction of investment after the introduction of the degree of freedom variable has a negative effect.

The economic performance of market-oriented reforms in transition countries has also been studied in some depth by many scholars. Li (2007) reported that in the process of transplanting the Western market economy system in Russia in the early stage of transition, the formal system faced the strict constraints of the local informal system, which made the transplanted formal system dysfunctional and hindered economic development. In the 21st century, Russia adjusted its institutional arrangements and established a “controlled market economy” system for resource allocation, which has achieved remarkable results. Reinhart & Rogoff (2009) reported that financial crises are more likely to occur in countries that have implemented financial liberalization. In contrast, China’s economic transformation has been a great success with a low level of marketization, and McKinnon (1994) argues that the success of China’s economic transformation was due to the government’s control of prices, especially the government’s control of the capital market through the financial sector, which avoided the volatility caused by the liberalization of the financial sector. Huang & Wang (2011), also using China as a case study, not only confirmed McKinnon’s viewpoint but also further reported that China’s implementation of financially repressive policies in the early stage of economic transformation not only did not reduce the allocation efficiency of capital factors but also played a facilitating role. In the absence of market efficiency and distortion of factor prices, excessive liberalization of the factor market is not conducive to economic development. In reality, the implementation of a lower economic freedom index for China’s economic development has achieved very good results. Russia and Central Asian countries, which have similar economic freedom, have not achieved corresponding economic development. On the other hand, after experiencing difficulties at the early stage of reform, the economic development of Central and Eastern European countries with higher levels of economic freedom gradually moved to the ranks of high-income countries. Through the above studies and typical cases, it can be found that the market-oriented reforms in these transition countries have had heterogeneous impacts on economic performance. This leads to the hypothesis to be tested in this paper.

Hypothesis 1: An increased level of marketization does not contribute significantly to economic growth in transition countries.

The reason for this is that the conflict between formal and informal institutions in the process of economic transition can amplify market failure. Many studies and country experiences have also shown that the market can indeed allocate resources better and promote economic development to a certain extent. However, this positive impact is not simple and direct; rather, it is subject to the limitations of many factors in a country. For example, scholars such as Xu (2003) argue that market-based reforms implemented in transition countries during the transition process must consider the conflict between formal and informal systems. A country’s informal system is a code of conduct, including values and beliefs, customs, cultural traditions, morals and ethics, and ideology, that has been gradually formed by the people of the country in the course of long-term social interaction and has been accepted by society. Many countries in transition are strongly influenced by the informal system. In addition to the informal system, many other factors affect the functioning of the formal system, such as a country’s resource endowment and the external environment. The 26 transition countries analyzed in this paper differ greatly in their informal institutions, such as cultural traditions, customs and habits, or other resource endowments. Therefore, the same level of institutions will have different effects on different countries, and there is no single perfect institutional arrangement to solve the problems of all transition countries.

If the formal system does not interact well with the country’s resource endowment, a single step toward increasing the level of marketization will not produce a good business environment or sensible policy arrangements for the country. For example, Russia, with its sparsely populated resource endowment, has maintained a relatively small democratic tradition. As Russian President Dmitry Medvedev said in April 2010, “Democracy in Russia is only 20 years old. There was no democracy in the Soviet Union, and there was no democracy at all under the tsars. Therefore, our country is more than 1,000 years old in the traditional sense, but 20 years old in the democratic sense.” Under the influence of such a cultural background and traditional values, Russia practiced “shock therapy”, in which excessive liberalization of institutional arrangements led to disastrous consequences. In contrast, in the early stage of transition, China adopted a transitional institutional arrangement suitable for its own national conditions, especially in terms of the allocation of factors, and actively promoted the government’s management functions to maintain social stability and achieve great economic success. Therefore, the appropriate institutional arrangements for different countries in transition are not necessarily identical, and good results can be achieved only if they are compatible with their own national institutional and resource endowments.

In addition, nonmarket approaches can address market failures, but they may also lag behind the needs of economic development. As Stiglitz (1998) argues, due to information asymmetry in the market, the prices of commodities and factors of production do not correctly reflect the relevant information in a timely manner. Therefore, the market does not fully solve all problems, and there are failures. The transition of countries from the original traditional planned economy to a market economy does not necessarily entail the complete abandonment of nonmarket approaches; rather, the dynamics of the factor allocation approach at the boundary between the market and nonmarket need to be redefined. The positive impact of the market on the efficiency of the allocation of factors of production does not work out directly. It is also constrained by many other factors, such as the level of productivity development, cultural traditions, geographic location, and the external environment. However, at the same time, the consequences of carrying out market-oriented reforms with increased economic freedom can have different effects on factors of production in different areas. This is because different factors of production markets have different levels of development, the need for marketization is different, and the impact of marketization reforms on the economic performance of different factors of production is also different. As a result, this paper tests another theoretical hypothesis.

Hypothesis 2: An increase in the level of marketization has different effects on the economic performance of different factors of production.

In the early stages of economic transition, the role of nonmarket (government-regulated) methods in factor allocation declines sharply. The incomplete development of the market may create an “institutional vacuum” in the transition economies of these countries, which may, on the contrary, cause disruptions in the national economy. From the perspective of factor allocation, in the initial stage of economic development in transition countries, the incomplete development of the market and the conflict between the formal and informal systems magnified market failures, resulting in a decline rather than an increase in the efficiency of factor allocation. At this time, more nonmarket ways (government regulation, etc.) to participate in the allocation of factors can be corrected to a certain extent through market failure. Moreover, to meet the initial stage of economic development of the urgent need for industrialization and infrastructure construction, economic take-off can be accelerated. It is appropriate not to go overboard with the speed of market-oriented reforms at this time. With the development of the market, the market mechanism can better fulfill the function of factor allocation. Moreover, it is becoming increasingly more difficult for nonmarket methods (government regulation, etc.) to grasp the economic system of accurate information, increasing the cost of nonmarket methods of resource allocation. At this time, market reform is still at a slow pace, making the level of marketization lower than the needs of economic development and causing obstacles to the national economy. Therefore, this is the period in which targeted market-oriented reforms of factor markets should be carried out to increase the level of economic freedom in this area.

Model construction, data sources, and indicator estimation

Considering that many countries with planned economies began to carry out marketization reforms in the early 1990s, this provides us with a good research sample to study the economic performance of the dynamic adjustment of marketization levels. Therefore, this paper intends to test the above hypotheses by using data from 26 transition countriesFootnote 2 from 1995–2022 as a research sample.

Model construction

To better test the impact of increased levels of marketization on the economic performance of transition countries, this paper uses a Cobb–Douglas production function with endogenous institutional variables, assuming that technological progress is Harrod-neutral:

$$Y={Af}(K,L,I\cdot \cdot \cdot \cdot \cdot \cdot )$$
(1)

in which \({A}\) is total factor productivity, \(K\) is the capital stock, \(L\) is the labor force, and \(I\) is institutional data, i.e., the level of marketization. Taking Eq. (1) in logarithmic form gives a linear production function:

$${\mathrm{ln}}\,Y={\beta }_{0}+{\beta }_{1}\,{{ln}}\,I+{\beta }_{2}\,{ln}\,X+\xi$$
(2)

in which \(Y\) denotes GDP per capita, \(I\) denotes the marketization level, \(X\) is another control variable, and \(\xi\) is the residual term.

In the following, the impact of the marketization level on economic performance is analyzed by establishing four models. In this paper, the theoretical hypotheses above are tested via regression through the following four models.

Model 1: relationship between GDP per capita and physical capital or the labor force;

Model 2: relationships between GDP per capita and physical capital, the labor force, and the level of marketization;

Model 3: relationship between GDP per capita and physical capital * level of marketization, and labor force;

Model 4: the relationship between GDP per capita and physical capital, labor force * level of marketization.

Data sources

The dependent variables in this paper are level indicators of economic development, namely, GDP per capita, which is denoted as pgdp. The aggregate GDP data for each country are real GDP in 2005 constant prices, in US dollars, from the World Bank’s WDI (World Development Indicators) online database. The labor force data are calculated by multiplying the number of workers involved in production per year by the price of labor. Data on the number of workers involved in production per year are obtained from the World Bank’s WDI Online database, whereas data on the price of labor are obtained from the “Hourly Compensation Costs of Manufacturing Workers” and “Annual Real Hours Worked per Capita” in the KILM 8th Edition database published by the International Labor Organization (ILO). The data are obtained by multiplying “annual real hours worked per capita”, adjusted to real prices in 2005 constant prices for the base period, in US dollars. Some missing data were obtained from the EuroSTAT database.

The level of marketization of the main independent variables is measured in this paper by the Index of Economic Freedom. The specific data indicators come from the Index of Economic Freedom (IEF), measured by the Heritage Foundation and the Wall Street Journal. The Index of Economic Freedom is a 50-item index that reflects economic freedom in ten areas: Trade Freedom, Business Freedom, Fiscal Freedom, Government Spending, Investment Freedom, Monetary Freedom, Property Rights, Financial Freedom, Freedom from Corruption, and the latter addition of Labor Freedom. With the addition of Labor Freedom, the index generally corresponds to a country’s level of marketization, and since 2007, the index has moved away from the old 1–5 scale to a percentage scale (0–100), which gives a homogeneous relationship between scores and ratings. After the scores of the indicators in each area are calculated, a simple average is used to produce a composite index for a given economy, with higher scores indicating greater economic freedom and vice versa.

Considering the reasonableness, authority, and data availability of the indicator setting, it is appropriate for this paper to adopt the Economic Freedom Index to measure the degree of marketization of countries. We continue to decompose the World Economic Freedom Index by introducing six indicators one by one, namely, trade freedom (\({tf}\)), commercial freedom (\({bf}\)), financial freedom (\({ff}\)), monetary freedom (\({mf}\)), government expenditure (\({gs}\)), and the degree of integrity (\({cf}\)), and set up Models 5–10 for analyses. Since the values of the indicators of financial freedom, investment freedom, and security of property rights are basically stable, and the data on the indicator of labor freedom only started to be counted in 2005, these indicators are ignored, and all the data are treated as logarithms.

In cross-country comparisons, how to estimate the capital stock series data of each country is difficult, and the current more consistent practice is to use the “perpetual inventory method” for estimation, which is also adopted in this paper; the specific calculation method is as follows:

$${K}_{t}={K}_{t-1}(1-\delta )+{I}_{t}$$
(3)

in which \({I}_{t}\) is the amount of fixed capital formation in period t; δ is the depreciation rate, for the value of the depreciation rate, different scholars in the choice of different scholars, but now the more mainstream practice in economic research is to take a uniform 7 percent; and \({K}_{t}\) is the period t of the physical capital stock. The World Bank’s WDI Online database provides fixed capital formations in 2005 US dollars for each country for all years, and we also need to determine the physical capital stock in the base year. We identify 1995 as the base period, assume that the capital stock in this period is the accumulation of past investment, and assume that fixed asset investment follows a constant growth rate λ. This gives us \({I}_{t}={I}_{0}{e}^{\lambda t}\), with \({I}_{0}\) being the amount of investment in the initial period. The physical capital stock in the base period of 1995 can be calculated via the following equation:

$${K}_{1995}={\int }_{-\infty }^{1995}{I}_{t}{(1-\delta )}^{(1995-t)}dt={\int }_{-\infty }^{1995}{I}_{0}{e}^{\lambda t}{(1-\delta )}^{(1995-t)}dt$$
(4)

Calculating Eq. (4) also requires obtaining the values of \({I}_{0}\) and λ, which we find via the following linear regression:

$${ln}\,{I}_{t}={ln}\,{I}_{0}+\lambda t,t=1995,1996...2012$$
(5)

Taking the values of \({I}_{0}\) and λ, we can calculate the physical capital stock for the base period 1995. Using \({K}_{t}={K}_{t-1}(1-\delta )+{I}_{t}\), we can obtain the physical capital stock in 2005 dollars for each year.

Estimation of the optimal level of marketization

To further explore the complex relationship between the level of marketization and economic growth and to explore the potential threshold effect of economic freedom, the next step is to estimate the optimal level of marketization for each country. To test the impact of informal institutions on economic performance, this paper refers to the methodology of Rajan & Zingales (1998), Sethi & Kumar (2013), and Yu (2013), examines the OECD countries as a reference system of optimal institutional arrangements, and uses the economic liberalization indices of these countries as the explanatory variables through a counterfactual group feature to estimate the optimal level of marketization under the constraints of informal institutional factors. The selected influencing factors include lngdppercap (logarithm of GDP per capita), lnpopdens (logarithmic value of population density), lnpop (logarithm of population size), youthdep (age structure of the population), olddep (old-age dependency ratio), lat (geographical location of the country), and lawdum (cultural factors that are expressed in terms of legal origins). t represents time trends and is the difference between each year and 1995. Footnote 3Table 1 reports the descriptive statistics of the main variables.

Table 1 Descriptive statistics for the main variables.
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Table 2 reports the results of the estimation of the factors influencing a country’s optimal level of marketization. The paper adopts a regression approach with progressively increasing control variables to examine which factors influence the optimal marketization level. First, in column (1), the level of economic development is examined; in column (2), the influence of demographic factors, including population size and population density, is further examined; in column (3), the age structure of the population, such as the teenage dependency ratio and the old-age dependency ratio, is examined; and in column (4), a country’s legal origins and geographic location are controlled for. The final regression results show that each set of explanatory variables added separately is significantly correlated with the explanatory variables, indicating that the selected country characteristics have a significant effect on the change in the optimal level of marketization. The optimal level of marketization is estimated by regressing all explanatory variables simultaneously in column (5).

Table 2 Influencing factors of the optimal level of marketization.
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Empirical results

Stationary and cointegration tests

To examine whether the time series data changes are stationary, this paper uses two methods to perform a unit root test, namely, the LLC test and Fisher-ADF test. The results show that the variables are smooth after the first-order difference. The specific test results are shown in Table 3.

Table 3 Stationary test.
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This paper then uses the Kao test to carry out the cointegration test and finds that there is a cointegration relationship between the variables; the specific test results are shown in Table 4.

Table 4 Cointegration test.
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Relationship between economic freedom and per capita output

The results of the F-test show that the constant coefficient model without individual effects should be used to fit the sample. To avoid serial correlation in the model, this paper adopts the GLS method to test the effect of the marketization level on GDP per capita in transition countries, and the specific estimation results are shown in Tables 5 and 6.

Table 5 Regression results on the relationship between the level of marketization and per capita output.
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Table 6 Regression results on the relationship between the marketization level decomposition indicator and per capita output.
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The regression results of the four models are reported separately in the columns of Table 5. The results show that, first, the increase in the level of marketization does not contribute significantly to the per capita output of the sample countries. After the introduction of the World Economic Freedom Index (WEFI), the indicator does not pass the significance test, suggesting that an increase in the level of marketization does not have a significant effect on the per capita output of transition countries. This phenomenon can be reflected in the real development of many countries, i.e., China’s economic freedom index is ranked after 100 among more than 180 countries in the world, and it is also ranked in the bottom four among the 26 transition countries we examined, but China’s economic growth achievements are remarkable. The economic levels of Central and Eastern Europe and the CIS countries, which have also implemented a higher index of economic freedom, also show large differences. Therefore, the impact of market-oriented reforms on economic performance is heterogeneous, and few countries are suitable for higher levels of marketization. Thus, Hypothesis 1 is tested. Table 5 also clearly shows that the inputs of both factors of production, capital and labor, have significant effects on economic growth.

Second, the contribution of capital and labor to the economic development of transition countries declined after the inclusion of the economic freedom index. We then introduce the economic freedom index into the capital and labor variables to examine the impact of the level of marketization on these two factors of production. Comparing columns (1) and (3), we find that capital still passes the significance test after the introduction of the economic freedom index, indicating that capital plays a key role in the economic development of the transition countries, but the degree of its contribution declines significantly, from the original 0.318 to 0.2164, a decrease of 31.95%. The same problem is reflected in the labor force, whose contribution to the economy after the introduction of the economic freedom index decreased from 0.6178 to 0.5687, a decrease of 8%. This shows that the increase in the level of marketization in transition countries has, on the contrary, weakened the role of the two factors of production, capital and labor, in economic growth.

Third, in terms of contributing to the economic development of transition countries, the contribution of labor exceeds that of capital. Therefore, labor is an important factor influencing the economic transformation of developing countries, and the effect of the marketization level on labor is also weaker than its effect on the capital market. With the above two articles, Hypothesis 2 is verified.

Next, to examine the impact of changes in the level of marketization on the economic performance of transition countries, we decompose the index of economic freedom, the results of which are shown in Table 6.

Table 6 clearly reflects the impact of the level of marketization on per capita output after decomposition. None of the indicators pass the significance test except for trade liberalization, which has a significant effect on economic growth. Although trade liberalization passes the significance test, the regression shows that too much excess trade freedom plays a negative role in the growth of the country’s economy, and that if trade freedom is increased by 1%, the output per capita decreases by 0.102%. This phenomenon occurs because:

First, not all developing countries engage in trade liberalization for economic development. Since the market development of many developing countries is not complete and there are still more serious distortions in the domestic production factor market, their production factors cannot be reallocated according to the occurrence of trade liberalization; instead, there is a separation of production and exchange due to the premature liberalization of trade, and the advantaged industries in trade do not receive timely replenishment of their production factors, while the disadvantaged industries are hit more seriously as a result. There is even unemployment and idle capital, which in turn restricts the development of the national economy.

Second, not all developing countries have the basic conditions to participate in trade liberalization. For example, the economic structure and development model of countries such as Central Asia and Russia have led to the fact that, in the process of trade liberalization, their exports are inevitably dominated by byproducts made from oil and gas and other raw materials. Under the influence of unfavorable fluctuations in international market conditions, the greater the degree of trade liberalization is, the more unfavorable it is for the development of the national economy.

Finally, the greater the degree of dependence on foreign trade is, the more vulnerable a country is to external market shocks. The product and factor markets of most developing countries are still in a weak position in the international market, and a higher degree of foreign trade dependence will make the national economies of transition countries more vulnerable to shocks in the international market. As the integration of the world economy is driven forward, the external trade dependence of transition countries is also increasing. For example, under China’s export-led development strategy, the degree of foreign trade dependence rose from 30 percent in 1990 to a maximum of 67 percent in 2006, then began to gradually decline and is still at a high level of approximately 50 percent. Russia’s dependence on foreign trade has remained above 50%, and its trade structure is relatively homogeneous. As a result, the national economies of these countries are overly dependent on external markets, and any economic crisis in international markets will have a negative effect on their economic growth.

Relationship between the level of marketization and resource allocation efficiency

On the basis of the estimation of the optimal level of marketization above, this paper uses the absolute value of the difference between a country’s economic freedom index and the estimated optimal level of marketization as the main independent variable, denoted as gap_abs. The OLS method is used to further verify whether economic freedom enhances the input‒output efficiency of capital and labor. Therefore, following Hsieh & Klenow (2009) and Dong et al. (2023), this paper constructs a cross-sectoral perfect competition model to estimate the allocation efficiency levels of the two factors of production, capital and labor. For the convenience of the subsequent empirical analysis, we denote the loss of potential TFP caused by marketization as the loss of resource allocation efficiency. Footnote 4The dependent variable for the empirical analysis is resource allocation efficiency, measured in this paper and denoted as misallocation. Other control variables include the geographic location of the country (lat), expressed in terms of the latitude at which the country’s capital is located. The abundance of labor resources (agedepen) is expressed as the share of the working-age population in the total population. The urbanization rate (urbanratio) is expressed as the proportion of the urban population to the total population. Economic openness (open) is expressed as the ratio of total trade to GDP. The size of government (govconsum) is expressed as government spending as a share of GDP. The inflation rate is denoted as inflation. Foreign direct investment (fdi) is expressed as a ratio of the amount of foreign direct investment to GDP. The population density (popdens) is expressed as the total number of people per square kilometer. The savings rate is denoted as savings.

Columns (1)–(3) of Table 7 report the results of the regressions on the factors affecting resource allocation efficiency. First, only the main explanatory variables are considered in column (1), and the regression results confirm that the deviation of a country’s economic freedom index from the optimal level of marketization clearly contributes to the loss of resource allocation efficiency and that there is a significant positive relationship between the two. Next, controlling for other explanatory variables in columns (2) and (3) and even controlling for the time factor still yields a significant positive relationship between institutional deviation and resource allocation distortion. Columns (4)–(6) of Table 7 examine the 25th, 50th, and 75th percentile cases, respectively, and the regression coefficients with positive signs indicate that deviations from a country’s index of economic freedom from the optimal level of marketization bring about a loss of efficiency in resource allocation but that this negative effect diminishes.

Table 7 Regression results of factors affecting resource allocation efficiency.
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The regression results show that regardless of whether the economic freedom index is ahead or lagging, the greater the deviation from the optimal marketization level under the constraints of noninstitutional factors is, the greater the TFP losses. Economies with higher resource allocation efficiency are basically in the stage of high economic development, and the factors affecting the optimal level of marketization are also in the process of accelerating changes, at which time market-oriented reforms, if not promoted in a timely manner, will result in a more serious loss of resource allocation efficiency.

Robustness test

The econometric analysis above is regressed via stepwise addition of explanatory variables, and the conclusions obtained are somewhat robust. To obtain more robust estimation results, this paper next groups the marketization level by overshooting and lagging and then separates regressions for testing. In addition, a robustness test is conducted by using abnormal sample removal.

First, countries with advanced and lagging levels of marketization are grouped. The above method uses a country’s economic freedom index and the absolute value of the difference between the optimal marketization level as an explanatory variable to examine the impact on the efficiency of resource allocation. Clearly, this method does not consider the difference between the impact of the marketization level ahead or lagging on the efficiency of resource allocation. This paper, according to the difference between a country’s economic freedom index and the optimal level of marketization, divides the sample into two subsamples to carry out the test. The positive sign represents the marketization level ahead group, and the negative sign represents the marketization level lagging group.

Second, abnormal samples were removed. Since resource allocation efficiency and the optimal marketization level are estimated through complex calculations, which may lead to outliers in the sample data and thus affect the conclusions of the empirical analysis, this paper considers clearing the outlier samples before conducting the regression to examine whether the analysis results are still robust. To do this, the average level of the absolute difference between the economic freedom index and the optimal marketization level in each country during the sample period is taken as the benchmark, and data above the 95% quartile level and below the 5% quartile level are regarded as outliers and removed. The resulting subsamples are tested again.

The specific test results are shown in Table 8.

Table 8 Results of the robustness test.
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Table 8 reports the results of the robustness test. Column (1) examines countries with backward marketization levels and shows that the requirement of a lower economic freedom index than the optimal marketization level in transition countries does not significantly affect resource allocation efficiency, whereas column (2) examines countries with forward marketization levels and shows that if a country’s economic freedom index exceeds the optimal marketization level, it can lead to significant TFP loss. After the abnormal samples in column (3) are removed, the test results hold, indicating that the previous results are more robust. Pushing the level of marketization too fast in transition countries does not significantly improve the efficiency of resource allocation, and a country’s economic freedom index can promote economic growth only if it matches the optimal level of marketization.

Conclusions

However, existing research has proven that the market is an effective way of allocating resources. Accelerating market-oriented reforms can break down market barriers, accelerate the flow of factors of production, and improve the efficiency of factor allocation. However, this study finds that in the process of marketization reforms in developing countries, the level of marketization has had a heterogeneous impact on the economic performance of different countries. For example, market-oriented reforms have not had the same effect on countries such as Central Asia and Russia as they have on countries in Central and Eastern Europe, whereas China, which has implemented a lower level of marketization, has achieved great economic success. However, in recent years, distortions in factor allocation have also emerged in China, and the deviation between the slow pace of reforms and the rapid pace of economic development has been a constraint on sustained economic growth.

To test the heterogeneous impact of marketization reforms on the economic development of transition countries, this paper uses the economic freedom index published by the Heritage Foundation to quantify the level of marketization and empirically analyses the relationship between the level of marketization and the level of the economy by using cross-country panel data of 26 transition countries for the period 1995–2022. The empirical results show that there is no significant relationship between the economic freedom index and the level of economic development, and even after the introduction of the economic freedom index, the contributions of capital and labor to economic growth decreased. The level of marketization has a positive effect on the efficiency of the allocation of production factors, but this effect is not simple and direct; it should depend on many aspects of a country. The reasons for this are as follows:

First, the conflict between formal and informal systems in developing countries in the process of promoting marketization may amplify market failure. In the 26 sample countries we examined, informal institutions such as cultural traditions, customs and habits, and other resource endowments vary greatly. As a result, the same formal institutions do not produce the same effects in different countries, and institutional arrangements that conflict with their own informal systems can magnify market failures, prevent markets from playing a better allocative role, and hinder economic development.

Second, nonmarket methods (government regulation, etc.) can solve the problem of market failure, but they may also lag behind the needs of economic development. In the initial stage of economic development, the incomplete development of the market and the market approach to resource allocation may not necessarily improve the efficiency of the allocation of factors, and at this time, more nonmarket approaches to the allocation of factors can be corrected to a certain extent through market failure. With the development of the market, the market mechanism can better play the role of factor allocation. At the same time, nonmarket methods (government regulation and control, etc.) want to grasp the economic system of accurate information more and more difficultly, increasing the cost of nonmarket methods of resource allocation. At this point, if the market-oriented reform is still at a slow pace, it will make the level of marketization lower than the needs of economic development and hinder economic growth.

Therefore, the informal system plays an important role in the process of promoting market-oriented reforms, paying attention to the important role of nonmarket ways of allocating factors in the process of transformation, and understanding that simply pursuing a higher level of marketization in the early stage of economic development will not necessarily promote economic growth but may instead impede it by reducing the contribution of capital and labor to economic development. Importantly, with the rapid development of the economy, the completeness of the market and the soundness of laws and regulations, it is possible that market-oriented reforms have lagged behind the needs of economic development and that the market can play an increasingly important role in accelerating the speed of market-oriented reforms in a timely manner to make institutional arrangements compatible with the needs of economic development. Therefore, in the long run, for the mode of economic transformation, whether radical or gradual, the ultimate goal is to achieve the economic system of a market economy; that is, in terms of institutional arrangements, countries ultimately converge, but only in the transitional stage of the system row, to achieve the appropriate system.