Reflections on 20 years of transition in Eastern Europe

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Reflections on 20 years of transition in Eastern
Europe

• Milica Uvalic
• University of Perugia
• Conference Europe 20 Years of Transition
• Vienna, 15-17 September 2010

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Issues

• 20 years of transition in post-communist
  countries in Eastern Europe
• 1. The transition to a market economy
• 2. The models flaws 20 years later
• 3. Present challenges

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1. Transition in Eastern Europe

• November 1989 (fall of Berlin Wall)
• ? Transition to a market economy and multiparty
  democracy in Eastern Europe (EE)
• Unprecedented experiment radical changes of
  systemic features of EE economies ?creation of
  capitalism by design!
• The typical transition model followed the main
  prescriptions of the Washington consensus
  (based on experience from Latin America in the
  1980s)
• ? Liberalization, Stabilization,
  Privatization
• Peak of Reaganite and Thatcherite ideology

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Transition in Eastern Europe

• Transition required various measures in parallel
• (1) Macroeconomic stabilisation liberalisation
  of prices foreign trade
• (2)Microeconomic reforms rapid privatization,
  microeconomic restructuring, reduction of
  subsidies (hard budget constraints)
• (3)Institutional reforms banking and financial
  sector, creation of capital and labour markets,
  radical fiscal reforms
• Results? Reality very different from initial
  expectations (generally too optimistic)

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Transition in Eastern Europe

• Transformational recession in early 1990s ? Very
  severe and prolonged recession, fall in GDP of
  18-80, even more of industrial production...
  Economic recovery delayed, only in Poland and
  Slovenia in 1992-3...
• Causes? Partly due to economic/trade
  disintegration (CMEA, USSR, CSSR, Yugoslavia) ?
  today 29 countries in the EE region (instead of
  9)
• Systemic vacuum passage from a centralized
  administrative system to new market institutions
  ?disorganization and chaos
• But also wrong economic policies ? the
  hyper-liberal model
• Overshooting of stabilization programs overly
  restrictive monetary fiscal policies
• Too rapid trade opening, frequently revoked and
  therefore premature
• Much faster capital liberalisation than in
  post-second World War Europe
• Speedy privatization, without changes in
  corporate governance
• Non-progressive taxation of companies and
  households, as witnessed by the widespread
  introduction of the flat tax

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Transition in Eastern Europe

• We dispose of an ample literature on what
  happened in EE in the 1990s, but the assessments
  greatly differ
• Today, many EE considered normal capitalist
  economies (?)
• In the meantime, good policies have been
  applied also in countries that were late
  reformers (e.g. the Balkans)
• Economic reforms institutional convergence
  towards the ideal model of a market economy
  (EBRD transition indicators)
• Many lessons not learnt from the experience
  gained in the 1990s ?prescriptions for the
  latecomers very similar to those in the early
  1990s
• Gradual integration with EU trade, FDI, banking
  and finance
• 2004 2007 EU enlargement 10 EE countries,
  Balkans on their way...
• Increasing FDI throughout the region after 2000,
  not only in Central Eastern Europe (as in the
  1990s)

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Foreign Direct Investment (2001-08)
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Transition in Eastern Europe

• Yet in many countries the Washington consensus
  has failed to fulfil expectations of growth,
  development increased welfare
• Social costs of transition greatly
  underestimated it was assumed that social policy
  and the welfare state are a luxury that must be
  sacrificed for the sake of transformation ? many
  negative consequences
• Jobless growth emergence (and persistence) of
  very high unemployment, particularly in the
  Balkans (40 - Macedonia, Kosovo)
• Social differentiation, increasing poverty (esp.
  in Russia, CIS countries)
• A particularly flexible labour market, with weak
  trade unions and scarce diffusion of collective
  bargaining (with very few exceptions)
• Inadequate systems of taxation (flat-tax rate)
• High popular dissatisfaction EBRD Life in
  Transition (2007) only 30 of respondents from
  transition region, on average, consider their
  households today are better off than before 1989

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Transition in Eastern Europe

• Institution building much slower than expected
• Informal economy (and informal institutions)
  remain important in many countries, rule of law
  still not in place, widespread corruption, weak
  judiciary
• Slow catching up after the deep GDP fall in the
  early 1990s and subsequent reversals in growth
• Ten years later, only Poland and Slovenia had
  attained the levels of GDP they enjoyed in 1989
• By 2008, Poland had reached 178 of its 1989 GDP,
  Slovak Republic 164, Czech Republic 142,
  Hungary 136
• But Russia only 108, and similarly the Balkans ?
  by 2008, three countries had still not reached
  their 1989 level of GDP (Bosnia, Montenegro,
  Serbia)

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Real GDP growth in the Balkans, 1989-2008 (1989
100)
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2. The models flaws 20 years later

• In 2007-08, average GDP growth in the transition
  region was still high, only in last quarter of
  2008 was there a drastic deterioration of main
  indicators
• In late 2008, EE was severely effected by the
  global economic crisis, hit by two external
  shocks
• Financial sector sharp reduction in foreign
  capital inflows (FDI, remittances, foreign loans)
• Real sector reduced demand for exports on
  EU/global markets
• Since early 2009, forecasts for 2009 have been
  changing continuously, from positive to highly
  negative growth rates (exc. Albania, Poland)
• 2010 Recovery on its way but not in all
  countries growth sluggish, 50-90 lower than in
  2008

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Real GDP in 2010 (EBRD July 2010)
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The models flaws

• Eastern Europe among the most severely hit
  regions!
• The global economic crisis revealed many
  structural weaknesses of EE economies
• Factors of vulnerability of EE countries
• Huge external imbalances, for years covered by
  massive foreign capital inflows (foreign loans,
  FDI, official assistance, workers remittances)
• High dependence on trade with EU (more than many
  old EU member states) ?vulnerable to
  deteriorating conditions in EU
• Banking and financial sector characteristics

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Current account deficits (Oct. 2008)( of GDP)
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Gross external debt (2008) ( of GDP)
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The models flaws

• Characteristics of the banking and financial
  system
• Privatization of banks in EE ?sales to foreign
  (EU) banks, 75-98 of banking assets in EE are in
  foreign ownership (Slovenia the only exception)
• Foreign banks lending policies of easy credit ?
  credit boom, increased lending to private sector,
  many loans in foreign currency
• Credit boom was followed by credit crunch
  ?foreign banks vulnerable to deteriorating
  conditions in home countries, reduced credit to
  local clients
• 2008-09 Depreciation of national currencies in
  EE causing many credit defaults, increase in
  non-performing loans
• Liberalization of financial markets has also
  greatly stimulated cross-border borrowing
  directly from banks abroad

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3. Present challenges

• Global 2008-09 crisis ? a new course in developed
  market economies return to protectionism, state
  intervention, expansionary fiscal policies, more
  regulation
• In EE Which growth model for the future?
• Transition-related economic reforms ?
  hyper-liberal model (fast trade opening, free
  capital inflows, weak social protection...)
• Should EE countries also return to more state
  intervention, undoing what was done during the
  last 20 years?
• Partly ...yes! More active government policies
  necessary in several important areas

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Present challenges...

• Global crisis? the fragility of EE economies due
  to the model of credit-driven growth and
  resulting dependence on foreign capital
• Global crisis ? more general flaws of the
  transition strategy, since many problems were
  becoming unsustainable
• Consumption much higher than production, financed
  by foreign savings investment (increasing trade
  and current account deficits)
• High unemployment, limited restructuring, slow
  growth of new private sector, mounting social
  problems
• Inadequate structural changes, favouring the fast
  expansion of primarily services linked to
• Structure of FDI frequently not in industry, but
  in services (banking, telecommunications, real
  estate), therefore in non-tradables, not
  facilitating industrial restructuring, export-led
  growth, East-West industrial integration

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Present challenges...

• Today need to change the target model of the
  hyper-liberal market economy
• In 2009, the best transition results (EBRD score
  4) were attained in Estonia and Hungary, among
  the most severely hit by the global crisis!
• Changes in which direction? Further integration
  certainly not autarchy - but prudently
• Trade liberalization not necessarily in all
  sectors (e.g. agriculture)
• Financial liberalization too fast, ought to be
  in line with development of financial markets (as
  in Western Europe)
• Improve the quality of government institutions to
  enforce laws, collect taxes, supervise the
  financial sector ...
• Introduce a levy on the financial sector?
  Probably justified, but since most banks are
  foreign owned, there is no direct political power
  to effectively negotiate a tax ?EU coordination
  is critical!

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Present challenges...

• Industrial policy to promote investment,
  encourage innovation, quality standards, enhance
  competitiveness (in line with the current EU
  approach to industrial policy)
• Despite remaining privatization opportunities, EE
  cannot count much on FDI over the coming years,
  need to rely much more on own resources
• More effective employment policy, more elements
  of the European Social Model which was not
  seriously considered by the EE countries (not
  part of the Acquis)?so the model was diluted by
  the 2004/07 entry of New Member States
• How to strengthen trade unions and social
  dialogue? Many lessons from the old EU member
  state
• Increasing labour flexibility (Germany, France,
  Italy) has led not to greater international
  competitiveness, but to higher profit margins
• Strong East-West interdependence EE countries
  cannot solve current problems by themselves, as
  they are strongly integrated with the EU/global
  economy!
• ? Necessitates coordinated action...