ECONOMICS OF TRANSITION Lecture 2

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ECONOMICS OF TRANSITIONLecture 2

• 1. INSTITUTIONS IN TRANSITION
• 2. CURRENT MACROECONOMIC CONDITIONS AND FUTURE
  OUTLOOK

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INSTITUTIONAL CHANGE
GOAL
transition
SOCIALISM
CAPITALISM
Inherited economic problems and recession

• Key institutional characterisics (Pejovich,
  1995)
• Market coordination
• Private property
• Rule of law
• Small and supportive state
• Higer/high economic freedom
• Motivation and efficiency

• Key institutional characterisics
• Planning
• Absence of private property
• Low economic freedom
• Motivation and efficiency

HOW TO CHANGE INSTITUTIONS?
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INSTITUTIONAL CHANGE

• The reform strategy (Gomulka, 2000)
• macro stabilization (especially with regard to
  inflation, public finances and foreign debt)
• micro liberalization (especially with regard to
  prices, trade and entry)
• new market institutions (especially with regard
  to new commercial codes, property rights and the
  financial/capital markets sector)
• structural changes (especially privatization and
  international trade)
• safety nets (transfers and subsidies)
• external assistance (usually small and of limited
  impact)

• Which problem is solved?
• precondition for successful growth
• market coordination instead of planning
• establishing private property rights (efficiency)

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INSTITUTIONAL CHANGEFROM PLAN TO MARKET

• SOCIALISM
• Planning (role of market very very limited)
• Monopolies
• Limitation in foreign trade
• CAPITALISM
• Market
• Price liberalization
• Competition (regulation of monopoly) and free
  entry
• Trade liberalization

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INSTITUTIONAL CHANGEFROM PLAN TO MARKET - 1

• Increasing the role of markets
• Price liberalization
• Efficient allocation of resources
• Reduction of socially wasteful activity
• Hurts the less affluent
• Highly concenrated industrial structure becomes
  problematic
• Regulation of monopoly and free entry
• Soviet style planning led to high concetration,
  entry and exit decided by state, competition very
  low
• Importance of new market entrants and free
  imports
• Some demonopolization by reorganization of
  enterprises (Aeroflot)
• Role of trade
• For tradable goods trade liberalization an
  important check to domestic producers
• Dangers to domestic producers (quality, design,
  prices)

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INSTITUTIONAL CHANGEENTERPRISE REFORM - 1

• Enterprise under central planning
• Size of enterprises
• Objectives of management
• Marketing and sales effort
• Lack of export orientation
• Extent of vertical integration
• Provision of ancillary services
• Enterprise reform
• Corporitization
• Creating independent management
• Defining the goals of the enterprise
• Separating ancillary services from the productive
  enterprise
• Establishing realistic accounting system
• Providing incentives to management and workers
• Privatization

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INSTITUTIONAL CHANGEENTERPRISE REFORM - 2

• PRIVATIZATION
• Principles of privatization
• The tragedy of the commons
• Principal agent issues
• Restitution issues
• Holding the nations assest in trust
• Desirable characteristics of a privatization
  program
• Rapidity
• Improved enterprise governance
• Fairness
• Gaining the support of powerful interests
• Facilitating inflow of new capital, technology,
  management skills
• Sustaining and supporting the liberalization
  program

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INSTITUTIONAL CHANGEENTERPRISE REFORM - 3

• Techniques of privatization
• Restitution
• Small-scale mass privatization
• Sale to insiders
• Direct sale to outsiders
• Privatization through initial public offerings
• Voucher privatization
• Pros and cons of these methods?

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INSTITUTIONAL CHANGEFINANCIAL SECTOR REFORM

• From monobank system to a normal financial
  system
• The central bank
• Issues money and controls interest rates
• Acts and promulgator and enforcer of regulation
  to enhance stability and efficiency of the
  financial system
• Lender of last resort
• Monitoring the foreign exchange value of the
  currency
• Commercial and investment banks
• Effective in mobilizing savings and alocating
  investment capital among potential borrowers
• Problem of controlling the growth and behaviour
  of new financial intermediaries banking
  regulation
• The stock market
• Is it neccessary to establish a stock market
  ASAP?
• Process of maturation of stock markets
• Dormant stage
• Manipulation
• Speculation
• Consolidation or crash

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INSTITUTIONAL CHANGEINTERNATIONAL TRADE REFORM

• Socialist system
• Trade concern of state not firms
• Direction of trade, volume and prices subject to
  plan
• Trade bank
• Reform of trade system
• Elimination or moderation of tariffs (short run
  infant tariffs)
• Currency reform (from limited convertibility and
  multiple exchange rates to convertibility and a
  realistic exchange rate)
• Greater role of FDI

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INSTITUTIONAL CHANGESOCIAL SAFETY NETS

• Socialism
• Most important form of safety net is a guarantee
  of work
• Capitalism
• Closing down inefficient enterprises unemployed
• Social security nets
• The problem of premature welfare state

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INSTITUTIONAL CHANGEWAS IT SUCCESSFUL?

• Institutional transition indicators
• Business environment in transition economies and
  its importance for economic growth
• (all figures and data from Transtion report 2006
  presentation, http//www.ebrd.com/pubs/econo/6813p
  resent.pdf)

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BUSINESS ENVIRONMENT IN TRANSITION ECONOMIES
BEEPS STUDY

• Business environmet is improving. Firms were
  asked to evaluate, how problematic these aspects
  are to their operation and growth (1-no obstacle,
  4-major obstacle)

Source Transition Report 2006 presentation,
http//www.ebrd.com/pubs/econo/6813present.pdf
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BUSINESS ENVIRONMENT IN TRANSITION ECONOMIES
BEEPS STUDY - 3

• Time tax is smaller. Senior managers spend less
  time dealing with bureaucracy.

Source Transition Report 2006 presentation,
http//www.ebrd.com/pubs/econo/6813present.pdf
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BUSINESS ENVIRONMENT IN TRANSITION ECONOMIES
BEEPS STUDY - 4

• Bribe tax has come down.

Source Transition Report 2006 presentation,
http//www.ebrd.com/pubs/econo/6813present.pdf
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BUSINESS ENVIRONMENT IN TRANSITION ECONOMIES
BEEPS STUDY - 4

• But private sector pays more bribe tax.

Source Transition Report 2006 presentation,
http//www.ebrd.com/pubs/econo/6813present.pdf
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BUSINESS ENVIRONMENT IN TRANSITION ECONOMIES
BEEPS STUDY - 7

• State firms are least productive.

Source Transition Report 2006 presentation,
http//www.ebrd.com/pubs/econo/6813present.pdf
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BUSINESS ENVIRONMENT IN TRANSITION ECONOMIES
BEEPS STUDY - 8

• Competition is important factor of growth.

Source Transition Report 2006 presentation,
http//www.ebrd.com/pubs/econo/6813present.pdf
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• MACROECONOMIC PERFORMANCE AND FUTURE OUTLOOK
• Macroeconomic performance in past few years
• Financial crisis

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MACROECONOMIC PERFORMANCE

• Good growth performance. Danger of Dutch disease
  for some CIS economies.

Data Transition report, 2008
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MACROECONOMIC PERFORMACE

• Good economic results from the beginning of
  transition, on average GDP 13 higher than in
  1989, 51 in CEE, 11 in SEE and 2 in CIS.

Turkmenistan requires additional explanation and
caution with data.
Data Transition report, 2008
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MACROECONOMIC PERFORMACE

• Rising inflation, inflation rose to double digits
  in 19 countries in 2008 (first half) compared to
  5 in 2007.
• Causes food and energy prices, labour markets,
  fiscal and monetary policy

Data Transition report, 2008
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MACROECONOMIC PERFORMACE

• Labour markets and core inflation. Transition
  report 2008 stresses the importance of
  unfavourable labour market developments for
  inflation high demand for labour (growth), low
  unemployment, wage pressures

Data Transition report, 2008, p.9
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PROGRESS IN TRANSITION
Data Transition report, 2008, p.
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PROGRESS IN TRANSITION

• Still much to do on 2nd and 3rd stage of reforms

Source Berglof, Presentation of 2008 TR,
http//www.ebrd.com/pubs/econo/tr08p.pdf
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PROGRESS IN TRANSITION

• Most progress in SEE, less in CIS, marginal in
  CEE
• Most progress in Belarus and Turkmenistan
  (virtual absence of progress earlier)
• Sectoral improvements
• Most apparent in financial sector
• Also infrastructure (telecommunications)
• Absence of progress in CEE
• EU accession impact
• 2nd and 3rd stage reforms still needed

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OUTLOOK AND THE IMPACT OF FINACIAL CRISIS

• Growth projections
• Financial crisis overview
• Paper work country insights

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FUTURE OUTLOOK

• After years of strong growth, now an uncertain
  future
• Growing intergration benefits, but also
  additional exposure to global imbalances
• Home imbalances

Figure Growth outlook, 2009 in comparison with
2007 and 2008 (2009 average projection, 2008
not final data)
Data Transition report, 2008
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FUTURE OUTLOOKKEY FACTS ON FINANCIAL CRISIS

• FINANCIAL CRISIS IN THE UNITED STATES
• Pre-crisis american economy
• Stable growth
• Low savings

Source Larson, M.D., How Federal Regulators,
Lenders, and Wall Street Created Americas
Housing Crisis. Nine proposals for a Long-Term
Recovery, http//www.weissgroupinc.com/whitepaper1
/Housing_white_paper.pdf
Source Reinsdord, M.B., Alternative measures of
personal saving , http//www.bea.gov/scb/pdf/2007/
0220February/0207_saving.pdf
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FUTURE OUTLOOKKEY FACTS ON FINANCIAL CRISIS

• Problems in the real-estate market

Source Larson, M.D., How Federal Regulators,
Lenders, and Wall Street Created Americas
Housing Crisis. Nine proposals for a Long-Term
Recovery, http//www.weissgroupinc.com/whitepaper1
/Housing_white_paper.pdf
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FUTURE OUTLOOKKEY FACTS ON FINANCIAL CRISIS
The growing problem connection between
real-estate markets, financial markets,
securitization
Source of graphs Kiff J., Mills P. (2007) Money
for Nothing and Checks for Free Recent
Developments in U.S. Subprime Mortgage Markets,
http//papers.ssrn.com/sol3/papers.cfm?abstract_id
1006316
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FUTURE OUTLOOKKEY FACTS ON FINANCIAL CRISIS

• The problem of securitization

The Economist, 20th September 2007
The Economist, 20th September 2007
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FUTURE OUTLOOKKEY FACTS ON FINANCIAL CRISIS

• Consequences
• Financial sector
• Bear Sterns
• Fannie Mae and Freddie Mac
• Lehman Brothers and many other
• Real sector
• Employment
• Investment
• growth
• Contagion
• E.g. Northern Rock
• Real impacts globally

Economist, 19th March 2008
Economist, 17th October 2007
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FUTURE OUTLOOKGlobal overview

• IMF forecast that the world economy would shrink
  by 1.3 in 2009, the first global fall in 60
  years. In January the fund predicted growth of
  0.5 (The Economist, 23rd April 2009)
• OECD GDP expected to fall significantly
  (Economist, Apr 2nd 2009)
• Outlook and forecasts
• China (growth rate fell to 6.1 in the year to
  the first quarter, less than half its pace in
  mid-2007, exports fell by 17, some expect 5
  growth)
• Poor (commodity prices, remittances, e.g. IMF
  Sub-saharan Africa instead of 6,7 3,3, might
  fall further)

Sources The Economist, 23rd April 2009