Transition Economies A brief analysis

The former Communist economies  Self sufficient – COMECON stayed non- reliant on western economies  Did not use price system to send ‘messages’ as we do in market economies  Invested large proportions of GDP in capital goods – wanted to succeed against ‘western’ alternatives  No property rights – everything central  Central Planning – input-output analysis

International Trade  75% of trade ‘internal’ – external trade mainly for essentials used to build industries  Seldom applied comparative advantage  5 year plans and each state exchanged within COMECON.  Price system not used. Trade credits given and could only be used with other COMECON members

Banking System  ALL State owned  Foreign Trade and Agriculture dealt with by separate banks  Independent Savings Bank – money was not transferable and so could NOT act as a medium of exchange

Problems?  Inefficiencies in collective ownership  Target ‘satisfied’ line manager  Quality not always apparent in targets  Bonuses not related to quality  Monopoly position – did they produce at lowest AC?  Shortages of basics but good supplies of capital equipment

Problems – 2?  Supply-side problems  Hidden unemployment  Suppressed inflation  Budget deficits  Lack of incentives  Smuggling  General tensions

Big changes  Price liberalisation – controls off, standards of living fell  All system had under priced and supplied = queues  End of subsidies – SOE’s did this in phases to avoid political unrest  Privatisation – the profit motive, redundancies, huge wealth for a few, lack of managers, some overseas investors used.

Big changes - 2  Trade liberalisation – end of State monopolies – currency convertibility? (FIXED)  Then resources could be allocated as per comparative advantage  End of tariffs, quotas and non-tariff barriers = level playing field but for who?  International currency now enters, imports also and law of contract enforced

Institutions needed?  Independent Central bank  Financial system – channel savings, encourage investment  Regulatory bodies to oversee financial sector  Market for bond selling  No ‘one model suits all’

Costs of transition?  Inflation – partly a ‘one-off’ jump but some monetary overhang allowed for extra purchases. Also wages allowed to rise faster than productivity.  GDP fell initially = plus increased unemployment.  Macro problems – recession = fall in government revenues, social protection down, budget deficit up, pressure on bond market. Printed lots of money!!

Conclusions - 1  Shock tactics seem to have worked better than gradualist approach  Those who controlled inflation became stronger quicker  Regulations had to be attractive to FDI. Then technology and skills transfer can take place. MULTIPLIER EFFECT.  Increases in labour productivity NOT fully rewarded

Conclusions - 2  Those who succeeded in channelling savings into investment grew faster  Geographic location helped. Those nearer to EU tended to adapt and grow more quickly. Also removal of Soviet troops slowed some – e.g. Estonia.  Transition monies from EU flowed as part of Agenda 200.  Will EU become a two-tier ‘club’?