Lecture 11. Assessment of Reforms

Lecture outline Basic macroeconomic indicators –GDP –Unemployment –Productivity –Investment –Inflation Impediments to growth in less successful economies Perceptions, measures of (un)happiness

Evolution of GDP U-shaped pattern from the beginning of transition Decline lasted from 2 to 4 years Decline ranged from 20% (Poland) to 60% (Ukraine) Causes: reporting incentives, reallocation of resources, disorganization, uncertainty about property rights, political situation

Productivity and employment Employment: decline and then stabilization Unemployment: almost mirror image of employment, but not completely (why not?) Why did labor participation rates decline? –Rates were too high in STE’s (a lot of wasted labor) –Usually decline in downturns (people get discouraged from looking for jobs) Productivity: U-shaped, but the initial drop is much smaller than for GDP

Investment Sharp decline (except in Poland and Slovakia) Reasons: –In order to have investment, you must have savings or resources (foreign or domestic) –Investment rates were too high in STE’s –Uncertainty –Much of investment would not be counted as such (retraining, establishing new networks, etc.)

Inflation High at the beginning of reforms, moderating later IMF and many western economists are too preoccupied with inflation (Russia had it under control right up to the 1998 financial crisis and default) Countries should fight causes of inflation not inflation as a symptom

Impediments to growth Slow enterprise restructuring Poor enforcement of property rights and contracts Corruption Economic and political uncertainty External debt

Indicators of well-being Life expectancy and infant mortality Contradictory data Life expectancy: dropped (esp. among males) but then recovered somewhat Reasons? Infant mortality in Russia has increased, but not as much as it did in the US Great Depression

Male Life Expectancy at Birth in ex-Communist countries, years, Years Lost Lost – Rec-d Russia Ukraine Belarus Estonia Latvia Lithuania Poland Czech no decline Slovakia no decline

Economies in transition and the current crisis The crisis affected Eastern and Central Europe (EE and CE) and former Soviet Union (FSU) more than other world regions 2009 drop in GDP was about 4% on average Countries that have performed worst in the crisis: former Soviet republics, except Russia (esp. Ukraine, Latvia, and Estonia) Countries that performed best: East European members of EU and Russia What are the reasons for the severity of the decline?

Nature of growth prior to the crisis Economies in transition benefited from market reform (liberalization, privatization, reform of institutions) EE economies, including Russia and Ukraine, had been growing at 7-8%/year prior to crisis However, problems were accumulating, particularly in

Problems of pre-crisis growth Many economies in transition experienced sharp increases in consumption and investment financed in large part by foreign capital Private entities (esp., banks) and individuals borrowed large amounts from foreign sources Foreign capital in-flows were particularly significant in countries that formally or informally pegged their currencies to the US$ or the Euro (Estonia, Latvia, Lithuania, Belarus, Russia, Ukraine, and Bulgaria)

The initial impact of the crisis When the crisis began, foreign capital fled to the safety of the main world currencies and credit froze up, making it difficult for the borrowers to roll over debt This and other factors generated significant pressure to devalue EE and CE currencies Cheaper currency helps exporters but banks had to pay back loans to foreign lenders in hard currency while their revenues were in depreciated domestic currencies

The initial impact of the crisis (cont.) Also, generally high levels of private debt (as well as public debt in Hungary and in Romania) combined with lower demand for goods and services meant that borrowers had difficulties repaying debt Demand could have been increased if currencies were sufficiently devalued, but governments were afraid to do that to avoid bankrupting the banks

Additional features of crisis in economies in transition Some countries (e.g., Russia) made significant spending commitments during the high growth years that contributed to budget deficits during the crisis However, these spending commitments might have helped maintain aggregate demand and were helpful as long as the country’s budget was in reasonable shape Little political turmoil despite hardships