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Stuck in transition?

By Sean L Hanley, on 20 December 2013

Economic reform in Eastern Europe and the former USSR is stagnating suggests the latest Transition Report from the European Bank for Reconstruction and Development (EBRD).  However, as debates at a joint EBRD/UCL-SSEES launch event highlight, the responses needed may not be straightforward, reports Randolph Bruno

The idea that some countries are Stuck in Transition – to take the title of the EBRD’s 2013 Transition Report – has resonated for some time in the literature. It is now it is time to take stock and ask whether transition is really over – at least for some countries.

The 2013 EBRD Transition report tries to address this by asking two main questions. Firstly, why has convergence slowed? The standard of living of the best performing countries in Eastern Europe is still around 60-70% of the average for rich Western European countries. Secondly, can economic institutions be improved if there are constraints on political reform– a question which could also be asked in a very similar fashion of Western European countries. As far as the first question is concerned, the data clearly shows an end to the productivity catch-up (moving closer to the EU average) observed at the turn of the millennium.

Why should this be the case? One possible answer is stalled political reform. The up-to- EBRD transition indicators in the Report show political reforms plateau-ing and this is worrying. The attitude of the citizens in transition states shifted in 2006-2010, basically dropping the consensus that the market economy is a good mechanism for allocating resources.

Reforms matter

However, the main element is the increase in the so called Total Factor Productivity – productivity derived from the increase in efficiency not accounted by factors of production such capital and labour. In other words, the injection of new capital or new labour has a very limited impact on productivity whereas new technology and innovation play a major role.

The EBRD downgrades of the top reformers’ rankings are concentrated in the EU countries and with the current policy convergence will slow. However, the other side of the coin is that if economic reforms are improved convergence will improve. On this point the EBRD Transition Report is very clear: keep going with reform –or re-start reform- and this can make a substantial difference. Still more worryingly, in some cases (for example in Belarus) reforms have been reversed.

The report also considers the relationship between the market system and democracy. The start of transition was a window of opportunity and in the early 1990s a real game changer. The potential for massive improvement in the lives of millions of people was echoed in the propaganda for the market reforms at the time. Here the report identifies a strong link: democracies -> reforms-> good institutional setting.  In turn countries able to implement more reforms will definitely achieve a higher level of democracy.

EBRD analysts have discovered an interesting perspective: the countries that were early reformers – that is, those that started to move into a market economy with some pro-reform political momentum – are much later on in the late 2010s those that achieved higher democracy. Early reforms stance is a very good predictor of democracy down the line. Furthermore, international integration (for example participation to EU) is associated with good institutions, both political (democracy) and economic (market reforms). Moreover, some countries exploited the critical junctures offered in the early period of transition, whereas others stalled in the transition process.

Do market reforms promote democracy? The Report is adamant that they do, but different elements have to be taken into account: geography and history, fractionalisation of society; natural resource endowment; economic openness and political systems: the interplay of these elements can foster or slow down reform. Moreover, there is no a pre-determined way to do this. Transplanting of institutions from one set of countries (e.g. the EU) does not automatically guarantee a success story.

Human capital and economic inclusion also matter.  As far as the former is concerned, the Report notes that the injection of new capital  in Eastern Europe and the FSU in the last 20 years suggests a renewed effort to train the population in order to use this new, more sophisticated) capital. The return on tertiary education is particularly high and this should be focus of government policy which needs especially reinforce the education system to limit the increasing brain drain.

 The report also tackles the issue of economic inclusion looking at inequality of opportunities with respect to wealth. It unpicks the differential impacts of location (living in rural areas give a clear disadvantage), parental education – which matters, particularly in Southern Eastern Europe (SEE) – and parental membership of the Communist Party (whose effects are still surprisingly felt).

 In sum, as the EBRD’s lead economist  Peter Sanfey noted at the launch,  reform and democracy remain key for economic converge of transition economies but a slowdown in reform is a reality and is especially marked in countries with large endowment of natural resources. In the current climate financial integration, transparency and accountability, economic inclusion are the new priorities for policymakers as improved economic institution, international integration and better education are drivers of prosperity.

The reality of divergence?

Questions can, however, be asked about the Transition Report’s assumptions. As former Serbian finance minister Božidar Delić suggested at the launch  event divergence in economic and political institutions is already a reality. An implicit convergence towards enlightened authoritarianism seems to be a growing phenomenon. Speaking at the same event Júlia Király, former deputy-governor of the National Bank of Hungary, warned against over rapid financial liberalisation in the region. Financial globalisation has hit hard some institutionally weak transition economies hard and controlling capital movements could reduce vulnerability and stop markets fluctuating excessively. Economic reforms, she suggested, might actually be weakly linked to economic convergence suggesting that the EBRD stance should be better tailored to individual countries.

Even a speaker such as Tomasz Mickiewicz of Aston Business School who agreed with the Report’s close linkage of reform and growth – and saw the transition countries’ key point of reference as lying firmly in Western Europe – stressed that that  it was important to allowing for local diversity rather than aiming to transplant institutions and questioned whether the Report should not now extend its scope to issues such as labour markets.

Randolph Bruno is Lecturer in Economics at UCL-SSEES. His research focuses on institutional economics and industrial organisation, with a focus on productivity and labour markets in Russia and CEE.

The EBRD’ Transition Report 2013 was discussed at a launch event on 26 November jointly convened by UCL-SSEES and the European Bank for Reconstruction and Development and hosted by the Representation of the European Commission in the UK in cooperation with the UCL European Institute .  

 A  full recording of the launch event can be viewed here.

Note: This article gives the views of the author(s), and not the position of the SSEES Research blog, nor of the School of Slavonic and East European Studies, nor of UCL. 

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