THE CHALLENGE OF CHANGING THE OLD MINDSET Ruslan Stefanov Coordinator of the Economic Program Center for the Study of Democracy, Sofia, Bulgaria

Transition: Launching into the unknown No one at the beginning of transition knew how it was going to play out New and unknown challenges of transforming state- run, highly centralized economies into free markets Transition has been both easy and hard Easy: In the 1980s, nobody believed that a systemic change in the Eastern bloc would come soon; few expected that 10 ex-communist countries would join the European Union (EU) Hard: Despite massive costs and long transition, former communist countries still lag behind the West Changing the old mindset is a very difficult issue

The legacy of post-communist mindset The lack of personal responsibility Expectation that the state will take care of everything The lack of choice No choice among consumer goods and services State-provided security (employment, etc.) Shattered values As communism collapsed, the old value system also crumbled Learning to make choices was a challenge Can the boat steer in a stormy sea without an anchor?

Differences within the region Transition has been easier in countries with traditions of market economy and industrialization prior to the communist takeover in the 1940s – e.g. Poland, Czech Republic, Hungary

Formal and informal institutions of democracy and market economy formal - informal formal + informal - formal - informal - formal + informal More centralized economies Southeastern Europe, former Soviet Union Less centralized economies Central Europe

Economic growth in the post-communist regions Source: IMF

Economic growth in Eastern Europe Source: IMF

Measuring the reform effort in post-communist countries Source: EBRD Simple average of all transition indicators of EBRD

Key reform steps Price liberalization Privatization Trade and capital liberalization Institution building Macroeconomic and microeconomic reforms The market and rule of law

Economic liberalization – letting the steam out The first step towards reducing imbalances and introducing price incentives for economic agents Liberalization requires prudent central bank policies and quick restructuring of the economy to escape excessive inflation and financial crises In Central and Eastern Europe, liberalization also brought the first voices of discontent, as democratic rules began to take hold in the region – The seeds of reform reversal were planted through this discontent While indispensable for inducing market reforms, liberalization also produced reverse reactions to market economy and democracy.

Privatization Two types of privatization: freedom of private enterprise vs. privatizing state-owned assets Privatization without having a private sector created the missing local stakeholder problem The “quick and ugly” privatization – was there a middle way in post- communist countries? The dangerous political economy of privatization: privatize profits, nationalize losses Privatization was indispensable for market reforms: it improved long-term economic performance and helped create pro-market attitudes. But serious shortcomings in how it was conducted gave rise to many abuses.

Macroeconomics vs. microeconomics Early-stage reforms focused on easier to implement macroeconomic, monetary, and fiscal stabilization programs (some failed already here) Mid-stage reforms encompassed tackling long-term fiscal challenges such as social security and healthcare Advanced reforms include microeconomic policies aimed at strengthening economic institutions: the rule of law, competitiveness, etc. Countries that failed to build a new mindset early faced problems with the microeconomic reforms later on Early reforms can be done under external pressure but sustainability requires internalizing values. The further down the reform road, the more a new mindset is needed.

Institution building: Markets and the rule of law Building market institutions and making them work takes longer and is much harder than liberalization and privatization While it is fairly easy to create a private sector through privatization, it is much more difficult to foster entrepreneurship In Russia or Southeast Europe, for instance, there is private economy but it is still largely controlled by the state or oligarchs connected to the state Having a private sector does not automatically mean having a competitive market economy.

Economic freedom and institutional performance: Central and Eastern Europe Source: Index of Economic Freedom, Heritage Foundation

Economic freedom and institutional performance: former USSR Source: Index of Economic Freedom, Heritage Foundation

The values of democracy and market economy Democracy and market economy are about values Freedom of choice, speech, and entrepreneurship is at the core of both democracies and markets It is easier to build the formal traits of democracy and market economy than to internalize the underlying values in a society It is much more difficult to build institutions that allow democracies and free markets to work Building democracy and free markets goes hand in hand and requires the presence of underlying values and institutions of good governance.

Lessons learned Having unclear distinctions and relationships between the public and private sector has been one of the key challenges in Central and Eastern European transition – In many countries, just formal elements of democracy and market economy were adopted with no in-depth institutional transformation Countries that introduced the deepest reforms in both formal and informal institutions have achieved the highest growth and prosperity – Although there are different paths toward greater social well- being, countries that reformed early and reformed deepest saw the most successful outcomes

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