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POST-COMMUNIST TRANSITION IN A COMPARATIVE PERSPECTIVE Leszek Balcerowicz Public Expenditure Management Challenges in ECA/PSRP Countries Warsaw, February.

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Presentation on theme: "POST-COMMUNIST TRANSITION IN A COMPARATIVE PERSPECTIVE Leszek Balcerowicz Public Expenditure Management Challenges in ECA/PSRP Countries Warsaw, February."— Presentation transcript:

1 POST-COMMUNIST TRANSITION IN A COMPARATIVE PERSPECTIVE Leszek Balcerowicz Public Expenditure Management Challenges in ECA/PSRP Countries Warsaw, February 7th, 2005

2 2 I. Analitical scheme. External developments (shocks) Outcomes (performance) The institutional system Other policies Reforms Policies Initial conditions Socio-political developments (1) (2) (3)(4) (5) (7) (6) (10) (8) (9)

3 3 II. Initial conditions in transition countries. 1. 1.Nature of the communist institutional system. A. The controls exerted by the communist state were exceptionally extensive: private entrepreneurship was banned, which, together with the initial nationalizations, resulted in the monopoly of the state sector, state-owned enterprises were subject to central planning, which included output commands, rationing of inputs and foreign exchange, price controls and directed foreign trade, the range of financial assets available to enterprises and individuals was extremely limited, as a market-type financial system could not have coexisted with central planning, the setting up and functioning of non-economic organizations were also heavily controlled; that is, civil society was suppressed and political opposition was banned, foreign travel was restricted, media were subject to formal censorship, direct party controls and personnel policy – mass media were largely an instrument of communist state propaganda.

4 4 B. These extensive controls co-existed with an overgrown communist welfare state, which included: relatively large transfers in kind (education, health), social protection delivered via state-owned enterprises (SOEs), artificially low prices for foodstuffs, energy and housing rents, social safety net, typical of some market economies, did not exist as the need for it was sharply limited through the curtailment of individuals’ opportunities and risks. C. The communist state was peculiar with respect to the provision of public goods. Defense expenditures were excessive and shaped by the imperial aspiration of the ruling elites. Law and order were kept at reasonable level, however, at the cost of practices typical of a police state. The legal framework and the juridical system criminalized private economic activity and independent political activity, and were ill suited to the market economy, rule of law and free society.

5 5 In various other aspects the communist countries differed from one another. However, when taken together and compared to market economies, especially the developing ones, they showed: Source: EBRD Transition Reports, OECD Economic Outlook 73. General government expenditure, 1989 (% of GDP). much higher ratio of general government expenditure to GDP,

6 6 Primary school enrollment, the ratio of total enrollment to the population of age that officially corresponds to the level of primary education*, 1990. Source: World Bank, World Development Indicators 2003. The communist countries achieved high enrollment ratios. * The value of this indicator exceeds 100% when the number of primary school pupils is higher than the total population of age that officially corresponds to the level of primary education. 2. Human capital.

7 7 The communist countries differed a lot with respect to the macroeconomic imbalances. Source: IMF World Economic Outlook, October 2000, EBRD Transition Reports. Inflation, 1989 (% of annual average). “Repressed” inflation* in 1987-1990. * difference between increase in real wages and real GDP from 1987 to 1990 3. Macroeconomic imbalances.

8 8 A few countries, i.e. Hungary, Poland, and Bulgaria inherited a huge debt burden from the communist times. Foreign debt in the pre-transition year (1989-1991), for non-transition countries 1989 (% of GDP). Source: Orlowski L., Transition and Growth in Post-Communist Countries, 2001, World Bank, World Development Indicators, 2003. 4. Foreign debt.

9 9 Source: Maddison A., The World Economy A Millennial Perspective, OECD, Paris 2001. Countries under communism lost a lot of distance to Western European economies. Per-capita GDP (in 1990 international dollars) in 1950 and 1990: Poland vs. Spain, Hungary vs. Austria. 5. Some performance variables.

10 10 The communist countries trailed with respect to productivity. Source: World Bank, World Development Indicators 2003. Agriculture value added per worker, 1989 (Eurozone=100) Industry value added per worker, 1989 (Eurozone=100)

11 11 Real GDP, 2003 (1989=100). Source: EBRD Transition Report 2004. III. Some dozen years following the collapse of communism, countries in the former Soviet bloc achieved enormously diverse outcomes in terms of: economic growth,

12 12 Inflation, 2004 (annual average, %). Source: IMF. combating inflation,

13 13 attracting Foreign Direct Investment, Source: EBRD Transition Report 2004. Cumulative FDI inflows, 1989-2003 (b US$). Cumulative per-capita FDI inflows, 1989-2003, (US$). * Data for 1989-2002

14 14 Infant mortality per 1000 life births, 1990 and 2002. Source: World Bank, World Development Indicators 2004. improving the health indicators,

15 15 Life expectancy at birth (1990, 2002). Source: World Bank, World Development Indicators 2003, EBRD Transition Reports.

16 16 Gini Coefficient of Income Per Capita, 1987-90 and 2000-01 (in %). Source: World Bank, Transition: The First Ten Years, 2002; World Development Report 2005; UNICEF TransMONEE, 2003. income distribution.

17 17 ecological efficiency. GDP unit of energy use, 1989 and 2001 (PPP $ per kg of oil equivalent). Source: World Bank, World Development Indicators 2004.

18 18 CO 2 emission, 1989 and 2000 (kg per 1995 US$ of GDP). Source: World Bank, World Development Indicators 2004.

19 19 IV. Explaining the differences in outcomes. Main factors explaining the differences in the growth rates: initial conditions, external developments (e.g. the Russian crisis) including: - access to markets, location, extent of market reforms and the nature of macroeconomic policies.

20 20 GDP level (1989=100) and average value of EBRD liberalization index (1991 – 2003). Countries which introduced reforms faster, achieved better economic results. Countries excluded from the regression due to the questionable quality of statistical data. The index level is the level of a composite index calculated as an arithmetic average of the 8 EBRD liberalization indices published in the EBRD Transition Reports (index of price liberalization, index of forex and trade liberalization, index of small-scale privatization, index of large-scale privatization, index of enterprise reform, index of competition policy, index of banking sector reform, index of reform of non- banking financial institutions). EBRD Index: value 1 (minimum) – very little (or no) progress since the fall of communism; value 4.3 – standards and performance typical of advanced industrial economies. Source: EBRD Transition Reports.

21 21 GINI coefficient (2000-2001) and average value of EBRD liberalization index (1991 – 2003). Source: World Development Report 2005; EBRD Transition Reports; UNICEF TransMONEE 2003. Countries which liberalized faster, experienced smaller increases in earnings inequality.

22 22 These findings are strongly supported by substantial empirical literature reviewing experiences of transition countries. Berg, Borensztein, Sahay, Zettelmeyer, (1999) ‘The role of initial conditions in explaining cross-sectional variation in growth is surprisingly minor; in particular, the difference in performance between the CEE and the Baltics, Russia, and other countries of the former Soviet Union is mostly explained by differences in structural reforms (even at the beginning of transition), rather than initial conditions.’ Fischer, Sahay, (2000) ‘The experience accumulated in the past decade, whether viewed informally or with the help of data, charts, and regressions, provides support for the view that the most successful transition economies are those that have both stabilised and undertaken comprehensive reforms, and that more and faster reform is better than less and slower reform.’ Havrylyshyn, van Rooden, (2000) ‘(…) progress in achieving macroeconomic stabilization and implementing broad-based economic reforms remain the key determinants of growth in transition countries.’ Havrylyshyn, Oleh, Wolf, Thomas [2001] ‘Unfavourable initial conditions should not become an excuse for inaction.(...) First, their negative effects decline over time. Second, the empirical studies clearly suggest that these effects can be compensated by modestly faster progress on reforms. Third, perhaps the main fact is indirect; that is, unfavourable initial conditions result in less political will and capacity for reform, and less reform means less growth.’

23 23 Why better economic results go hand in hand with better non-economic outcomes (health, environment, etc.)? Some crucial factors conducive to longer-run economic growth are also conducive to ecological improvement and to favourable health development, e.g. economic reforms less waste less environmental degradation and less damage to health healthier foodstuffs become more available and relatively cheaper privatization (separation of companies from the state) ecological regulations are more strictly observed stronger rule of law

24 24 1. For the last 5 years some former USSR countries have been developing faster than Central European countries. Real GDP in 2003 (1998=100). Source: EBRD Transition Report 2004. V. Some other observations on economic transition.

25 25 During last few years Armenia achieved good economic results. Real GDP in 2003 (1996=100). Consumer price index (in %). Real change in exports of good and services (in %). Source: EBRD Transition Report 2004. Armenia – a case study.

26 26 Armenia is an example of a post-communist country with a limited state. Average general government expenditures (as % of GDP). Tax revenues (as % GDP). Average general government balance (as % GDP). Source: EBRD Transition Report 2004, IMF Country Reports.

27 27 Reforms in Armenia resulted in an increase in the extent of economic freedom. Economic Freedom Index* (The lower the value of the index and rank, the wider the extent of economic freedom). * The index level is based on a composite index calculated as an arithmetic average of the 10 subindices concerning: (1) Trade, (2) Fiscal Burden, (3) Government Intervention, (4) Monetary Policy, (5) Foreign Investment, (6) Banking Finance, (7) Wages/Prices, (8) Property Rights, (9) Regulation, (10) Informal Market. The ranking included about 150 countries. Source: Heritage Foundation.

28 28 2. Price liberalization. EBRD Index of price liberalization*, 2004. Source: EBRD Transition Report 2004. EBRD Index: value 1 (minimum) – very little (or no) progress since the fall of communism; value 4.3 – standards and performance typical of advanced industrial economies.

29 29 3. Strictly limited state with limited social transfers and simple tax system. Source: EBRD Transition Reports, OECD Economic Outlook 73. General government expenditure in 1989 and 2003 (% of GDP). Models of fiscal transition varied substantially by country ranging from the Irish model to the collapse-of-state model.

30 30 4. Fast privatization. Private sector share in GDP in 2004 (in %). Source: EBRD Transition Report 2004.

31 31 5. Banking sector open to foreign investors. EBRD Index of banking sector reform, 2004. Source: EBRD Transition Report 2004. EBRD Index: value 1 (minimum) – very little (or no) progress since the fall of communism; value 4.3 – standards and performance typical of advanced industrial economies.

32 32 Financial sector in the transition economies developed at varied pace. In the majority of these countries this sector is bank-dominated. Domestic credit to private sector and market capitalization of listed companies, 2002 (% of GDP). Source: World Bank, World Development Indicators 2004.

33 33 The differences in these developments were due to the less different initial conditions and more due to the difference in the quality of general (horizontal) and sectoral policies. GENERAL (HORIZONTAL) POLICIES: FISCAL AND EXCHANGE RATE POLICIES; ENFORCING THE RULE OF LAW; LIBERALISATION. FINANCIAL SECTOR ENTERPRISE SECTOR INITIAL CONDITIONS PRIVATISATION; PRUDENTIAL REGULATION AND SUPERVISION; PROTECTION OF CREDITORS’ AND MINORITY SHAREHOLDERS’ RIGHTS; RESTRUCTURING OF BAD DEBT. PRIVATISATION; SOFT OR HARD BUDGET CONSTRAINTS ON ENTERPRISES.

34 34 Such crises did not occur in the countries with the lowest number of capital transactions controls. Index of capital transactions controls*, 1996. It is too simplistic to assume that financial crises in some transition economies were caused by the liberalization of the capital flows. Source: IMF, Exchange Arrangements and Exchange Restrictions, 1997, 2003.. * Value of index is equal to the number of areas of capital transactions controls covering 10 distinguished areas: (1) capital market securities, (2) money market instruments, (3) collective investment securities, (4) derivatives and other instruments, (5) commercial credit, (6) financial credit, (7) guaranties, sureties, and financial backup facilities, (8) direct investment, (9) liquidation of direct investment, (10) real estate transactions.

35 35 6. More democratic countries liberalized their economies faster and to a larger extent. Non-democratic regimes have stuck to non-market economic model. Average value of the EBRD liberalization index and average rating of political and civil liberties (1991-2004). Source: Freedom House, EBRD Transition Reports. * The index level is the level of a composite index calculated as an arithmetic average of the 8 EBRD liberalisation indices published in the EBRD Transition Reports. Competitive democracies Non-competitive political regimes


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