To what extent do the EBRD's Transition Indicators help in measuring this process?
There are many different views on transition, however this essay will focus on the transition of ex-Soviet economies which abandoned communism to implement more market based, capitalist, economies. Looking particularly at the cases of Belarus, Poland, and Russia I wish to identify why some economies have implemented transitional policies extremely well, while some have made very slow progress. I will examine the extent to which transition should be purely political or if it should incorporate institutional change and convergence. Finally I hope to assess the ability of the European Bank of Restoration and Development's (EBRD) transition indicators to measure the effectiveness of post-communist transition.
Economic transition is defined in many different ways, and is largely dependent on the value judgements of individual parties who determine the process for transition. The Washington Consensus, coined in 1989, set out a standard reform package for developing troubled countries, for example the International Monetary Fund (IMF) whose membership consists of 186 countries worldwide and defines countries as being in transition when their economies are changing from a centrally planned system to a system based on market principles (International Monetary Fund, 2000). This approach drew criticism from several economists, such as Nobel laureate Joseph Stiglitz who described the Consensus as a 'one size fits all' treatment of individual economies which is too simple and simply quick fixes without prioritising or watching for side effects (Challenging the Washington Consensus - An Interview with Lindsey Schoenfelder, 2003). Other approaches to transition include those of the Slavophiles, who heavily oppose Western influences and desire the Russian Empire to be developed upon values and institutions derived from its early history; and Islamists, who desire transition towards a pan-Islamic unification and the elimination of non-Muslim (particularly western) military, economic, political, social, and cultural influences in the Islamic world.
Economic transition to a market based economy requires political, cultural, social and legal transition. The sequence in which transition occurs as well as the speed of transition will have a large impact on the success of the process. For example, under a gradualism approach, transition from centrally planned to market based economy is achieved through small economic changes over time, which are strategically measured to diminish the effects of inflationary pressures and unemployment. Gradualism allows for transitional progress to be monitored and corrected along the way providing support for the reforms. On the other hand the big bang approach attempts to transform policies quickly in one go and is weakly supported economically. Under the big bang approach speed is of the essence during major reforms as it is believed only a short-term window of opportunity exists to adopt extreme policies. Supporters of the big bang approach argue that the optimal approach is to quickly push through tough policies and attempt to create irreversibility for these reforms before they can be opposed. Difficulties in ordering interdependent reforms lead to the big bang strategy of the 1990 Polish program and is clearly based on practical rather than economic criteria. Poland's experience during this time can be used to argue that big bang reforms lead to large output declines as Poland faced a decline in GDP of 20% after implementing liberalisation reforms. However alternatively looking at the gradual reforms by Russia it is clear that they do not give better results. Gros and Vandille, in 1997, used econometric analysis which shows no relationship between the speed of reform and the size of initial output decline but in fact the size of output decline seems to be determined mostly by the length of time the country spent under communism (Gros, et al., 1997). In order to discuss the transition steps implemented and how successfully they are measured by the EBRD's indicators, it is necessary to first look at the countries being studied.
Russia's 1905 revolution resulted in several reforms as well as the formation of parliament. Repeated defeats of the Russian army in the First World War led to rioting in the major cities of the Russian Empire and the eventual overthrow of the imperial household in 1917. Under Vladimir Lenin, a communist government seized power and formed the USSR. The rule of Joseph Stalin between 1928 and 1953 strengthened both Communist rule and Russian dominance of the Soviet Union at a cost of tens of millions of lives however in the following decades the Soviet economy and society stagnated. This was until leader Mikhail Gorbachev between 1985 and 1991 introduced openness and restructuring in an attempt to modernise Communism, but his initiatives unintentionally released forces that by December 1991 split the USSR into Russia and 14 other independent states. Russia has since shifted its post-Soviet democratic ambitions towards a centralised semi-authoritarian state managed by national elections, and a prudent management of Russia's large energy wealth. Russia experienced GDP growth of 7.8% in 2008 (The World Bank, 2010), driven largely by non-tradable services and domestic manufacturing, rather than exports. During the past decade, Russian poverty and unemployment has steadily declined with an expanding middle class whilst in macroeconomic terms Russia has run sequential balance of payments surpluses since 2000 and foreign exchange reserves have grown from $12 billion in 1999 to almost $600 billion in 2008. These positive trends began to reverse in the second half of 2008 due to investor concerns over the Russia-Georgia conflict, corporate governance issues, and the global credit crunch resulting in roughly a 70% fall in the Russian stock market. A 70% drop in the price of oil in mid 2008 further worsened imbalances in external accounts and the federal budget. President Medvedev immediately outlined a number of economic priorities for Russia including improving infrastructure, innovation, investment, and institutions; reducing the state's role in the economy; reforming the tax system and banking sector; developing one of the biggest financial centres in the world, combating corruption, and improving the judiciary. Russia should place its focus on further diversifying its economy, as energy and other raw materials still dominate Russian export earnings and federal budget receipts while corruption, exchange rate uncertainty and the global economic crisis continue to discourage domestic and foreign investors.
Poland was overrun by Germany and the Soviet Union in World War II and became a Soviet satellite state following the war. Labour turmoil in 1980 led to the formation of the independent trade union, 'Solidarity', which by 1990 had swept to power in parliamentary elections and took the presidency as a political party. A big bang transitional approach during the early 1990s enabled the country to transform its economy into one of the most robust in Central Europe, however the remaining challenges of high unemployment, an underdeveloped infrastructure, a poor rural underclass, and inflation as high as 585.8% in 1990, shows this came at some cost (International Monetary Fund). Solidarity suffered a major defeat in the 2001 parliamentary elections when it failed to elect a single deputy to the lower house of Parliament, and the new leaders of the Solidarity Trade Union subsequently pledged to reduce the Trade Union's political role. Poland joined the EU in 2004 and today stands out as a success story among transition economies. In 2008 GDP grew an estimated 4.8% (The World Bank, 2010), resulting from rising private consumption, a jump in corporate investment, and EU funds inflows. Although GDP per capita is much below the EU average it remains similar to those of the three Baltic States, whilst unemployment, which remains above the EU average at 9.8% in 2008, is falling rapidly (Index Mundi, 2010). In 2008 inflation reached 4.2% (Index Mundi, 2010), more than the upper limit of the National Bank of Poland's target range, but has been falling due to global economic slowdown. The private sector is kept from performing up to its full potential by an inefficient commercial court system, a rigid labour code, bureaucratic red tape, and persistent low-level corruption. For the public sector rising demands to fund health care, education, and the state pension system present a challenge to the government's effort to hold the public sector budget deficit under 3.0% of GDP, a target which was achieved in 2007-08. The PO/PSL coalition government which came to power in November 2007 plans to further reduce the budget deficit with the aim of eventually adopting the euro by 2012 and have also announced intentions to pass business-friendly reforms, reduce public sector spending growth, lower taxes, and accelerate privatisation although state major reforms will be implemented slowly.
Belarus attained its independence in 1991, after seven decades of rule from the USSR, although today it retains close political and economic ties to Russia. Since the election of Aleksandr Lukashenko in July 1994, the country's first president has steadily consolidated his power through authoritarian means. However government restrictions on freedom of speech, control over the press, peaceful assembly, and religion remain in place. Belarus has seen little structural reform since 1995 when Lukashenko launched the country on the path of 'market socialism' by reemploying administrative controls over prices and exchange rates, and also increasing the state's influence over the management of private enterprises. Since 2005, the government has re-nationalised a number of private companies while businesses have been subject to pressure from authorities, for example, there have been arbitrary regulation changes, numerous thorough inspections, and arrests to "disruptive" businessmen. These restrictive economic policies have impacted on Belarus' ability to attract foreign investment yet GDP growth has been strong in recent years, reaching more than 10% in 2008 (The World Bank, 2010), despite the challenges of a centrally controlled economy with a high rate of inflation, estimated at 14.8% in 2008 (Index Mundi, 2010). Much of Belarus's growth can be attributed to the re-exporting of discounted oil and natural gas it receives from Russia, its largest trade partner. However trade between Russia decreased in recent years, largely due to Russia's introduction of a gradually increasing export duty on oil shipped to Belarus, and a requirement for duties on re-exported Russian oil be shared with Russia, e.g. in 2009, 85% was to go to Russia. Russia also increased Belarusian natural gas prices to $128/tcm in 2008, and plans to increase prices gradually to world levels by 2011. Whilst these growing pressures on the Belarus economy have been managed mostly by borrowing, some other policy measures including improving energy efficiency and diversifying exports have been introduced. It seems likely that the weakening trade partnership with Russia will result in a slowdown to economic growth in Belarus over the next few years.
Figure (The World Bank, 2010)
The transition process is comprised of steps which dismantle old, and create new structures. Price liberalisation and external liberalisation usually come at the start of reforms, followed by more complicated reforms of establishing tradable property rights, and the role of governments in establishing stability and a fiscal system. The EBRD produced an index as a composite indicator of progress towards price liberalisation, trade and exchange regime liberalisation, private sector entry, and legal reforms (International Monetary Fund, 2000). For the EBRD indicators to be considered as good measurements of transition we must see how well they measure these different reforms.
Price liberalisation simply means that prices are determined by the market and is easy to implement as the government just has to stop fixing prices. Some people who know where to get scarce goods for low prices will become rich very quickly and the resultant income redistribution requirements often lead to political difficulties. Price reforms must be accompanied by trade freedom, because if trade is blocked then the goods that are produced will not reach those consumers who have the best use for them. This and the overnight elimination of queues are the only immediate efficiency gains from price liberalisation as industries need time to produce different products and to become efficient. Price reforms lead to a reorientation of consumption as consumers will reduce their consumption of goods with a low marginal utility and increase consumption of goods with a high marginal utility; this must make them better off.
Although price reforms and trade liberalisation go hand in hand, there is never full openness. Tariffs are important as they provide government revenue and this can help to ease the negative effects of transition such as loss of GDP. It also prevents the short term demand for imported goods rocketing above exports, helping to maintain the balance of trade. External liberalisation also includes liberalising the capital account to maintain macroeconomic stability and the state of the domestic financial market and altering the exchange rate regime in order to achieve monetary stability.
By looking at the different countries private sector share in GDP for 2009 in their structural change indicators I can analyse how privatisation has improved over the years and measure the property rights and financial market transition. Russia has 70% and Poland 75%, whilst Belarus is again the lowest with only 30% private sector share of GDP (European Bank for Reconstruction and Development, 2010). This again gives the impression that Russia and Poland have been highly successful at transition to a market based economy, while Belarus has not. The data provided in structural change indicators cannot give a complete account or precise measurement of progress in transition due to the innate difficulties of measuring structural and institutional change. However the transition development indicators created by the EBRD compensate for these difficulties and highlight qualitative or institutional developments in the areas of liberalisation and privatisation, the business environment and competition, infrastructure, the financial sector and social reform. The snapshots these indictors provide are extremely useful as they show the latest reform data and an assessment of how well, and in which areas, transition countries have progressed successfully (European Bank for Reconstruction and Development, 2010).
When I look at the EBRD's transition indicators for price liberalisation, it is clear the level of price reforms achieved by the three countries. Russia made no progress in reforms until 1992 although since 2000 have achieved a score of 4 which is defined as "Comprehensive price liberalisation; state procurement at non-market prices largely phased out; only a small number of administered prices remain" (Economic Bank of Reconstruction and Development, 2010). Poland since 1998 have scored 4.33, which at 4+ is the top measure in the indicator, and defined as "Standards and performance typical of advanced industrial economies: complete price liberalisation with no price control outside housing, transport and natural monopolies" (Economic Bank of Reconstruction and Development, 2010). Belarus has made the least headway with price liberalisation out of all the countries achieving an improved score of 3.00 in 2009 which according to the EBRD's methodology means "Significant progress on price liberalisation, but state procurement at non-market prices remains substantial" (Economic Bank of Reconstruction and Development, 2010). I believe the transition indicators are a good measure of this area of reform as they create an easy to understand scale that allows comparisons to be made between countries. The indicators help identify the countries progressing well through transition, and those not making much progress at all whilst showing which countries have implemented and managed their policy measures effectively, such as Poland, and which managed them less effectively, for example Belarus.
Economists have often overanalysed economic influences of transition by examining only economic factors and ignoring institutional transformations. Economic transition is also intimately related with key institutional transformations the process requires reconstruction of the institutions of democracy and governance, including the executive and legislative branches of government; a free press; new social values; openness to private organisations and to entrepreneurship; a network of regulators; and a new network of contractual relationships, both domestic and abroad. Successful institutions of capitalism are already present in advanced economies and consequently we tend to take them for granted when studying developing transitional economies where such institutions are absent.
The experience of transition has caused a shift in economic thinking towards that of the legal, social and political structure and also forced us to think about institutions in a dynamic way i.e. the role of momentum in shaping reforms and how institutions can then evolve, but also the maintenance of forward momentum and how a country can get unstuck from inefficient institutions (Roland, 2002). These issues are debated within political economics, and are crucial to understanding how successful capitalism can emerge.
