Successes and Failures in Catching-Up

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Successes and Failures in Catching-Up
Leszek Balcerowicz
Belgrade, 23 May 2005
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Presentation Agenda

1. Experience of transition countries.
2. Explaining the differences in outcomes.
3. Some lessons on the real convergence.

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• I. Experience of transition countries.
• Initial conditions in transition countries the
  nature of the communist institutional system.

• A. The controls exerted by the communist state
  were exceptionally extensive
• private entrepreneurship was banned, which,
  together with the initial nationalizations,
  resulted in a monopoly of the state sector
• state-owned enterprises were subject to central
  planning, which included output commands,
  rationing of inputs and foreign exchange, price
  controls and directed foreign trade
• the range of financial assets available to
  enterprises and individuals was extremely limited
  as a market-type financial system could not have
  coexisted with central planning
• the setting up and functioning of non-economic
  organizations were also heavily controlled that
  is, civil society was suppressed and political
  opposition was banned
• foreign travels were restricted,
• media were subject to formal censorship, direct
  party controls and personnel policy mass media
  were largely an instrument of communist state
  propaganda.

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• B. These extensive controls co-existed with an
  overgrown communist welfare state, which
  included
• relatively large transfers in kind (education,
  health),
• social protection delivered via state-owned
  enterprises (SOEs),
• artificially low prices for foodstuffs, energy
  and housing rents,
• social safety net, typical of some market
  economies, did not exist as the need for it was
  sharply limited through the curtailment of
  individuals opportunities and risks.

• C. The communist state was peculiar with respect
  to the provision of public goods.
• Defence expenditures were excessive and shaped
  by the imperial aspiration of the ruling elites.
• Law and order were kept at a reasonable level,
  however, at the cost of practices typical of a
  police state.
• The legal framework and the juridical system
  criminalized private economic activity and
  independent political activity, and were badly
  suited to the market economy, rule of law and
  free society.

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• Communist countries economies were different,
  but all of them were lagging behind market
  economies with a comparable GDP per capita level.

General government spending (as of GDP) Czech Rep. (64.5), Slovakia (64.5), Poland (48.8) Euro area (47.8), Korea (18.9)
Social welfare spending(as of GDP) Hungary (16), Estonia (9.9) Chile (7.1), Mexico (2.1)
Share of industry in GDP (in ) Slovakia (59), Bulgaria (59), Poland (53) Euro area (35), Mexico (29)
Share of agriculture in GDP (in ) Tajikistan (33), Uzbekistan (39), Poland (7.8), Czech Rep. (6.3) Mexico ( 8), Euro area (4)
Ecological inefficiency CO2 emission (in kg per 1 dollar of GDP) Uzbekistan (3.7), Kazakhstan (3.3), Poland (1.4), Czech Rep. (1.3) Mexico (1.1), Euro area (0.5)
Trade dependence to COMECOM (in of GDP) Lithuania, Belarus (41), Poland (8), Czech Rep. (6)
Data for post-communist countries refer to the
first year of their transition or the preceding
year, i.e. 1989 for Poland, Czech Republic,
Hungary, Slovakia and Bulgaria, 1990 for
Lithuania and Estonia, 1992 for Belarus,
Uzbekistan, Kazakhstan and Tajikistan. Data for
Euro zone, Mexico, Korea and Chile refer to the
year 1989.
Source EBRD Transition Reports, OECD Economic
Outlook 73.
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• A dozen or so years following the collapse of
  communism, countries in the former Soviet bloc
  achieved enormously diverse outcomes in terms of

• economic growth,

Real GDP, 2003 (1989100).
Source EBRD Transition Report, 2004.
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• reducing inflation,

Inflation, 2004 (annual average, ).
Source IMF, The World Economic Outlook Polish
Central Statistical Office.
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• There emerged huge differences in the efficiency
  of the
  economic system in respect of
• labour productivity,

Change in labour productivity in industry,
1992-2003 (1992100).
Source EBRD Transition Report 2004.
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• attracting Foreign Direct Investment,

Cumulative per-capita FDI inflow, 1989-2003,
(USD).
Cumulative FDI inflow, 1989-2003 (billion USD).
Source EBRD Transition Report, 2004 UNCTAD.
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• improving health indicators,

Infant mortality per 1000 life births, (1990,
2002).
Source World Bank, World Development Indicators
2004.
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Life expectancy at birth (1990, 2002).
Source World Bank, World Development Indicators
2003, EBRD Transition Reports.
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• income distribution.

Gini Coefficient of Income Per Capita, 1987-90
and 2000-01 (in ).
Source World Bank, Transition The First Ten
Years, 2002 World Development Report 2005
UNICEF, 2003.
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• ecological efficiency.

GDP unit of energy use, 1989 and 2001 (PPP per
kg of oil equivalent).
Source World Bank, World Development Indicators
2004.
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Some early transition countries are catching up
quickly with the ones that are already advanced
in reforms.
Armenia a case study.

• During past few years Armenia achieved good
  economic results.

Real change in good and services exports (in ).
Real GDP growth (annual rates, in ).
Consumer price index (in ).
Source EBRD Transition Report, 2004.
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• Armenia is an example of
  a
  post-communist country with a limited state.

Average general government spending (as of
GDP).
Tax revenues (as of GDP).
Average general government balance (as of GDP).
Source EBRD Transition Report 2004, IMF Country
Reports.
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• Reforms in Armenia led to an extension of
  economic freedom.

Economic Freedom Index (The lower the value of
the index and rank, the greater the extent of
economic freedom).
The index level is based on a composite index
calculated as an arithmetic average of the 10
sub-indices concerning (1) Trade, (2) Fiscal
Burden, (3) Government Intervention, (4) Monetary
Policy, (5) Foreign Investment, (6) Banking
Finance, (7) Wages/Prices, (8) Property Rights,
(9) Regulation, (10) Informal Market. The ranking
included about 150 countries.
Source Heritage Foundation.
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Lithuania a case study.

• During last few years Lithuania achieved very
  good economic results.

Real GDP growth (annual rates, in ).
Real change in exports of good and services (in
).
Consumer price index (in ).
Source EBRD Transition Report, 2004.
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• Lithuania managed to cut public expenditure and
  reduce fiscal deficit.

Tax revenues (as of GDP).
General government expenditutre (as of GDP).
General government balance (as of GDP).
Source Eurostat The European Commission, AMECO.
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• Reforms in Lithuania resulted in an increase in
  the extent of economic freedom.

Economic Freedom Index (The lower the value of
the index and rank, the wider the extent of
economic freedom).

• The index level is based on a composite index
  calculated as an arithmetic average of the 10
  subindices concerning (1) Trade, (2) Fiscal
  Burden, (3) Government Intervention, (4) Monetary
  Policy, (5) Foreign Investment, (6) Banking
  Finance, (7) Wages/Prices, (8) Property Rights,
  (9) Regulation, (10) Informal Market.
• The ranking included about 150 countries.

Source Heritage Foundation.
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Slovakia a case study.

• During last few years Slovakia achieved very
  good economic results.

Real GDP growth (annual rates, in ).
Real change in exports of good and services (in
).
Consumer price index (in ).
Source EBRD Transition Report, 2004.
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• Slovakia managed to limit the state.

Tax revenues (as of GDP).
General government expenditutre (as of GDP)
General government balance (as of GDP).
Sources Eurostat The European Commission, AMECO.
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• Reforms in Slovakia resulted in an increase in
  the extent of economic freedom.

Economic Freedom Index (The lower the value of
the index and rank, the wider the extent of
economic freedom).
The index level is based on a composite index
calculated as an arithmetic average of the 10
sub-indices concerning (1) Trade, (2) Fiscal
Burden, (3) Government Intervention, (4) Monetary
Policy, (5) Foreign Investment, (6) Banking
Finance, (7) Wages/Prices, (8) Property Rights,
(9) Regulation, (10) Informal Market. The ranking
included about 150 countries.
Source Heritage Foundation.
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• II. Explaining the differences in outcomes.
• Main factors explaining the differences in growth
  rates
• initial conditions,
• external developments (e.g. the Russian crisis)
  including
• - access to markets,
• location,
• extent of market reforms and the nature of
  macroeconomic policies.

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Countries which introduced reforms faster,
achieved better
economic results.
GDP level (1989100) and average value of EBRD
liberalization index (1991 2003).
Countries excluded from the regression due
to the questionable quality of statistical data.
The index level is the level of a composite index
calculated as an arithmetic average of the 8 EBRD
liberalization indices published in the EBRD
Transition Reports (index of price
liberalization, index of forex and trade
liberalization, index of small-scale
privatization, index of large-scale
privatization, index of enterprise reform, index
of competition policy, index of banking sector
reform, index of reform of non-banking financial
institutions).
EBRD Index value 1 (minimum) very little (or
no) progress since the fall of communism value
4.3 standards and performance typical of
advanced industrial economies. Source EBRD
Transition Reports.
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These findings are strongly supported by
substantial empirical literature reviewing
experiences of transition countries.
Berg, Borensztein, Sahay, Zettelmeyer, (1999) The role of initial conditions in explaining cross-sectional variation in growth is surprisingly minor in particular, the difference in performance between the CEE and the Baltics, Russia, and other countries of the former Soviet Union is mostly explained by differences in structural reforms (even at the beginning of transition), rather than initial conditions.
Fischer, Sahay, (2000) The experience accumulated in the past decade, whether viewed informally or with the help of data, charts, and regressions, provides support for the view that the most successful transition economies are those that have both stabilized and undertaken comprehensive reforms, and that more and faster reform is better than less and slower reform.
Havrylyshyn, van Rooden, (2000) () progress in achieving macroeconomic stabilization and implementing broad-based economic reforms remain the key determinants of growth in transition countries.
Havrylyshyn, Oleh, Wolf, Thomas (2001) Unfavorable initial conditions should not become an excuse for inaction.(...) First, their negative effects decline over time. Second, empirical studies clearly suggest that these effects can be compensated by modestly faster progress on reforms. Third, perhaps the main fact is indirect that is, unfavorable initial conditions result in less political will and capacity for reform, and less reform means less growth.
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Why better economic results go hand in hand with
better non-economic outcomes (health,
environment, etc.)?
Some crucial factors conducive to longer-term
economic growth are also conducive to ecological
improvement and to favorable health development,
e.g.
less waste
less environmental degradation and less damage to
health

• economic reforms

healthier foodstuffs become more available and
relatively cheaper

• stronger rule of law

ecological regulations are more strictly observed

• privatization (separation of companies from
  the state)

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Privatisation a broad definition approach.

• Privatisation of economy includes 3 processes
• entry privatisation,
• assets privatisation,
• transformational privatisation.
• Entry privatisation and assets privatisation are
  very important in the post communist economies
  but they cannot substitute transformational
  privatisation.
• The longer the delay in the privatisation of
  SOEs
• the greater the probability of its bankruptcy or
  liquidation,
• the lower the price if one manages to privatise
  at all.
• The performance of the privatised enterprises
  depends on the privatisation method.

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• Polish experience shows that enterprises
  privatised with the participation of foreign
  investors achieved the best results whereas
  employee partnerships achieved the worst results.

Productivity of privatised enterprises
(1993100).
Productivity is measured as revenues in real
terms to no. of employees. The survey is based on
the research of 837 enterprises (almost all
enterprises privatised till 1993 in each
category). Due to the cases of liquidations,
bankruptcies, acquisitions and so forth the
number varied in subsequent years and in 1999 it
declined to 807 companies. The number of
enterprises in the year 1993 (1999) in each
category group is as follows capital
privatisation 97 (95), capital privatisation
with foreign participation 67 (65), employees
partnerships 701 (675).
Source M. Baltowski (ed.), Przedsiebiorstwa
sprywatyzowane w gospodarce polskiej, PWN, Warsaw
2002.
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Average revenues of privatised enterprises(in
real terms, 1993100).
Dynamics of the number of profitable enterprises
(1993100).
The survey is based on the research of 837
enterprises (almost all enterprises privatised
till 1993 in each category). Due to the cases of
liquidations, bankruptcies, acquisitions and so
forth the number varied in subsequent years and
in 1999 it declined to 807 companies. The number
of enterprises in the year 1993 (1999) in each
category group is as follows capital
privatisation 97 (95), capital privatisation
with foreign participation 67 (65), employees
partnerships 701 (675).
Source M. Baltowski (ed.), Przedsiebiorstwa
sprywatyzowane w gospodarce polskiej, PWN, Warsaw
2002.
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III. Some lessons on the real convergence.

• Examples of failures to catch-up. Divergence is
  dominant.
• There are many examples of countries, which
  failed to catch-up with the most developed
  countries
• Entire non-Western world in 18th-19th century,
  until Meiji in Japan (1868)
• Almost all the African countries after WW II
• Latin America under the old economic model
  (until the late 1980s)
• All communist countries after WW II
• Most post-communist countries after 1990.

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GDP per capita in selected groups of countries
(Western Europe 100)
Source Own calculations based on Maddison A.,
The World Economy A Millennial Perspective, OECD,
Paris 2001.
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• Examples of successes in real convergence
• It is worth to mention the following are among
  the countries that
• were successful in catching up
• United States in the 19th century relative to
  the United Kingdom
• Scandinavia before the expansion of the Swedish
  model (until mid-20th century)
• Japan, since Meiji (1868) until the end of the
  1980s
• younger Asian Tigers (South Korea, Taiwan and
  Thailand) since 1973 until 1997
• China since the late 1970s
• Chile since 1984
• Ireland in the 1990s

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GDP per capita in selected countries (Western
Europe 100)
SourceOwn calculations based on Maddison A., The
World Economy A Millennial Perspective, OECD,
Paris 2001.
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REASONS FOR FAILURES OF CONVERGENCE
WARS
DOUBLE STATE FAILURE
STATISM (POPULISM)
FAILURE TO SUPPLY THE PUBLIC GOODS, LAW AND
ORDER, PROTECTION OF PROPERTY RIGHTS
OVEREXTENDED REGULATIONS THAT IMPAIR ECONOMIC
LIBERTIES AND FOSTER CORRUPTION AND SHADOW ECONOMY
MONOPOLISATION
UNSTABLE CURRENCY
UNSOUND FISCAL POLICY
PROTECTIONISM / CLOSED ECONOMY
LARGE DOSE OF STATE OWNERSHIP
HIGH BUDGETARY REDISTRIBUTION AND HIGH TAXES
SOCIAL TRAPS HINDERING EMPLOYMENT
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What lies behind sustained success in convergence
with the most developed countries?

• Rationally limited state, which gives rise to a
  free market economy within the rule of law (e.g.
  the United States).
• or a successful transition to such a system
  (reduction of public failures).
• Main features of the system conducive to economic
  growth
• 1. Large extent of economic liberties
• rule of law,
• private ownership,
• low barriers to free entrepreneurship.
• 2. Limited public spending
• low and simple taxes,
• sound public finance.
• Open economy giving rise to competition
• - stable currency.