Central Eurasia: Making Markets

I.    The Fall of Communism

A.  Contributing factors

1.   Soviet economic growth slowdown.

2.   East-West normalization, changing attitudes.

3.   Rise/fall of world energy prices, causing instability.

4.   Rise of labor movement in Poland, encouraged by Polish Pope.

5.   Soviet involvement in Afghanistan, causing social problems.

6.   Death of Tito, instability in Yugoslavia.

7.   Technological lead of industrial West and Asian NICs.

8.   Gorbachev’s glasnost, political reform, end Brezhnev doctrine.

9.   Chernobyl disaster (1986) and Armenian earthquake (1988).

10. Yeltsin's attack on Party privilege.

11. Failed coup attempt (1991), dissolution of Soviet Union.

B.  Lessons

1.   Fall of communism was result of many trends and events.

2.   Few problems that contributed to the fall of communism were quickly resolved by its failure.

II.  The Starting Line

A.  Historical advantages: background in Austro-Hungarian empire.

B.  Private sector development: Poland, Yugoslavia, Hungary, Bulgaria.

C.  Dominance of large firms, esp in Czechoslovakia.

D.  Military spending highest in Bulgaria, USSR, and Poland.

E.   Low unemployment, except in Yugoslavia.

F.   Largest budget deficits in USSR, Albania, Poland, Romania.

G.  Highest monetary growth and inflation in Poland and Yugoslavia.

H.  Signs of repressed inflation, monetary overhang, in all except Hungary.

I.    External debt heavy in Yugoslavia, Hungary, Poland and Bulgaria; light in Romania, USSR, and Czechoslovakia.

J.   Currencies were most overvalued—according to black market exchange rate premium—in Soviet Union and Romania; least overvalued in Yugoslavia and Hungary.

III. Transition Tasks and Strategies

A.  Tasks:

1.   Macroeconomic stabilization

2.   Price liberalization

3.   Privatization

4.   Military conversion

5.   Anti-monopoly reform

6.   Labor market reform

7.   Banking reform

8.   Financial market reform

9.   Tax reform

10. Legal reform

11. Social welfare reform

12. Foreign exchange market reform

13. Foreign trade reform

14. Foreign investment reform
 

B.  Strategic Concept

1.   Government-managed transition versus laissez faire

2.   Guiding importance of political stability, foreign investment, IMF support, EU membership, or independence.

C.  Pace

1.   Arguments for shock therapy

a.   interdependence of market institutions

b.   preempt political opposition

c.   aggressive programs in Central Eurasia are generally associated with milder transformational recession (but both of these may reflect historical and initial conditions).

2.   Arguments for gradualism

a.   “first things first”—legal and social foundation

b.   key sectors first?  agriculture?

c.   careful preparation, avoid mistakes

d.   spread pain of adjustment

D.  Sequence–typically, (1) stabilization, (2) price liberalization, (3) small-scale privatization, monopoly regulation, tax reform, and foreign market reform, (4) large-scale privatization, military conversion, legal reform, development of securities markets.

IV. Money, Public Finance, and Prices

A.  First stage of financial adjustment—release of repressed inflation, mildest in Czech and Slovak republics and Hungary.

B.  Second stage of adjustment—inflation declined to still-high levels

1.   Inflation sustained by:

a.   state budget deficits caused by large subsidies to state enterprises, small contributions to the budget from those same enterprises, and poor enforcement of tax collections from the new private sector.

b.   subsidized central bank credits to unprofitable state enterprises.

c.   reorientation of production from plan to market.

d.   disruption of regional production and trade relations.

2.   During stage 2, inflation fought by:

a.   deficit reduction—reduce subsidies, strengthen tax collections.

b.   selling treasury securities to general public, rather than central bank.

c.   incomes policies—taxes on excessive wage increases, real wage agreements among government officials, employers, and union leaders.

d.   monetary anchors—fixed exchange rates—to impose additional discipline.

C.  Third stage of adjustment—inflation below 40 percent per year.

1.   Benefits are less certain, but include domestic and international confidence in currency and policy.

2.   Disadvantage—continued disinflation may reduce the flexibility of relative prices if some prices are inflexible downward.

V.  Privatization

A.  Objectives

1.   Raise efficiency.

2.   Obtain skills and capital.

3.   Reduce budget deficits.

4.   Pursue social justice. Return to pre-Communist owners? Highest bidder? Workers? Population?

5.   Simplicity and speed.


 

B.  Methods

1.   Differ for small and large privatizations.

2.   Distinction between managed and spontaneous privatizations.

3.   Options

a.   restitution

b.   equal-access voucher privatizations

c.   management-employee takeover

d.   auction

e.   strategic investors in a closed-bid tender offers.

f.    loans for shares auctions

C.  Results

1.   Most aggressive privatizations in East-Central Europe EU candidates. Least aggressive in Turkmenistan, Belarus, Uzbekistan, and Tajikistan.

2.   In Bulgaria, the Czech Republic, Hungary, and Poland, the share of subsidies in GDP declined from an average of 16 percent in 1989 to 3 percent in 1994.

3.   Impact on microeconomic efficiency is ambiguous. “Outside” sales seem to be more effective than “inside.”

Private Sector Share of GDP, 1989-2010

 

1989

1995

2000

2005

2010

Albania

5

60

75

75

75

Armenia

10

45

60

75

75

Azerbaijan

10

25

45

60

75

Belarus

5

15

20

25

30

Bosnia/Hrz

na

na

35

55

60

Bulgaria

10

50

70

75

75

Croatia

15

40

60

65

70

Czech Rep.

5

70

80

80

80

Estonia

10

65

75

80

80

Macedonia

15

40

55

65

70

Georgia

10

30

60

65

75

Hungary

5

60

80

80

80

Kazakhstan

5

25

60

65

65

Kirgiz Rep.

5

40

60

75

75

Latvia

10

55

65

70

70

Lithuania

10

65

70

75

75

Moldova

10

30

50

60

65

Mongolia

0

40

60

70

75

Montenegro

na

na

na

na

65

Poland

30

60

70

75

75

Romania

15

45

60

70

70

Russia

5

55

70

65

65

Serbia

na

na

na

na

60

Slovakia

5

60

80

80

80

Slovenia

10

50

65

65

70

Tajikistan

10

25

40

55

55

Turkmenistan

10

15

25

25

25

Ukraine

10

45

60

65

60

Uzbekistan

10

30

45

45

45

 
For other transition indicators, look here:
http://www.ebrd.com/what-we-do/economic-research-and-data/data.html  



VI. Banking and Finance

A.  Transition from physical output planning to financial decisionmaking.

B.  Transition from monobanking systems to two-level systems.

C.  Poor control of bank creation led to weak institutions.

D.  Creation of securities markets.  Small in most countries, except Czech Republic. Tainted by several high-profile instances of fraud.

E.   Financial systems distorted by nonpayments crises. Failure to pay suppliers, government, employees. In 1997, the share of barter in payments among all industrial enterprises in Russia reached more than 50 percent, and 40 percent of all taxes paid to the Russian federal government were nonmonetary.

VII.     UPDATE: Anders Aslund, "How Capitalism was Built."

GDP per Capita
Source: World Bank, World Development Indicators

Democracy and Corruption Graph
Source: Anders Aslund and Simeon Dyankov, The Great Rebirth: Lessons from the Victory of Capitalism over Communism.