The debates about the economics of transition that were commonplace a decade ago have, for the most part, ended. Few now seriously dispute that macroeconomic stability, openness to trade, strong institutions and liberalised prices are necessary conditions for a successful shift from planned to market economies.
But almost two decades since the fall of the Berlin Wall gave way to one of the most important economic revolutions of the past century, alarm is growing over the extent to which the process has fallen short of what backers of the market economy initially envisaged.
“My biggest concern about transition is that there is a bifurcation between, on the one hand central and eastern Europe and the Baltics, which are moving towards democracy and market economy, and on the other hand much of the former Soviet Union that is becoming increasingly autocratic and corrupt,” former EBRD chief economist Willem Buiter tells Emerging Markets.
The worry is that transition has - in certain key respects - gone horribly askew, in particular across the Commonwealth of Independent States (CIS). “We’re seeing the spread of corrupt, crony and clan capitalism and to various degrees authoritarianism,” says Buiter, who returned to a teaching post at the London School of Economics in 2005 after five years as the bank’s top researcher.
The trouble, Buiter says, is that the countries most in need of deeper reforms, more growth and better public services tend also to have weakest institutions and so are most susceptible to corruption.
Joseph Stiglitz, a former World Bank chief economist and Nobel economic laureate, has also echoed this point. “The single most important factor is the failure to establish the rule of law and the institutional infrastructure for a market economy,” he tells Emerging Markets. What’s key, he says, is the quality of institutions and their interplay as well as the interrelations between state and the private sector. Independence, after all, had left many CIS countries without resource transfers, external markets, and many of the institutions necessary for running a modern economy.
But in parts of eastern Europe and much of the former Soviet Union, the primacy of justice is a widely overlooked principle, says Buiter. “The whole concept of government under the rule of law is a contradiction in terms. How is that even possible when governments in effect control the law?” he says. “The degree of institutional development or the availability of social capital to create functioning regimes is woeful.”
A joint EBRD-World Bank survey on the impact of transition shows that only 30% of people living in transition counties believe their lives are better now than since the end of communism. One of the report’s findings is that transition has eroded trust. “Across the region societal trust was stronger prior to 1989,” it says. Moreover, the vast majority of the survey’s 29,000 respondents said corruption is greater now than before market reform began.
Eastern challenge
The challenge posed by increasing corruption, lawlessness and mounting state control across the CIS is perhaps most acute for the EBRD, as the multilateral bank pulls out of central Europe and shifts eastwards. The bank, unlike its peers such as the World Bank, is specifically charged with promoting democracy, which puts it in direct conflict with some of its countries of operation.
“It’s going to be hugely difficult to reconcile its operations with its political mandate,” says Buiter. “Its democratic credentials are becoming more tarnished year by year. They will have to make their choices, lower the minimum standards of Article 1 compliance,“ he adds, referring to the Bank’s founding charter which commits it to “applying the principles of multiparty democracy, pluralism and market economics.”
Asked how the bank will deal with this challenge, EBRD president Jean Lemierre says the move east will mean more policy dialogue in certain countries. But he is adamant that the fact of rampant corruption, crony capitalism and state intervention are challenges that are being dealt with. “It is true that the ownership of the private sector in many countries is highly concentrated [in the hands of a few],” he tells Emerging Markets. “But it’s a fact. I don’t see what’s the big deal.”
“Compared with 10 years ago, I think what is happening now is more sustainable. In Russia, people accept that the state has got a role to play and that what was happening before [Putin] was very strange,” Lemierre says. Russia now accounts for 37% of the banks activity, up from 21% in 2005 and compared to 16% in post-accession Europe.
The former French civil servant acknowledges that Russia “has made various decisions” to the effect that “the economy would be better run by the state.” In this regards, he says, “one of the challenges for Russia is the efficiency of the public sector.” Making the state more effective to allow it to facilitate private-sector coordination is a keystone of transition economics and policy reform strategies.
But as Russia integrates further with the global economy, “questions on corporate governance, transparency, predictability and communication are very crucial, more than they were before,” says Lemierre.
The EBRD, which made a record profit of $3.25 billion last year, has stepped up its commitments to Russia’s regions, where Lemierre says public institutions and the rule of law is still weak. About 75% of the 1.9 billion euros ($2.6 billion) of commitments made to Russia by the EBRD in 2006 were outside of Moscow and St Petersburg. The bank plans to expand its presence to all the federal districts in Russia in 2007.
As part of its renewed eastern focus, Lemierre points out that his bank has vowed to step up pressure on governments in Turkmenistan, Belarus and others. The bank suspended all public sector projects with Uzbekistan in 2005.
Nevertheless, Buiter argues that the institution’s deepening dependence on the region as a source of income will compromise its workings: “It was always a stretch but it will become increasingly hard. It’s a poisoned chalice.”
Capital adequacy
In Russia alone, in the seven years since president Vladimir Putin was first elected the stock market has risen 20-fold and the government has paid off virtually all of its foreign debts. In that time, Russian firms have raised tens of billions of dollars in international capital markets.
“Russia knows full well it depends on the [international] capital markets so it will play by the rules,” Hans Joerg Rudloff, chairman of Barclays Capital tells Emerging Markets.
Lemierre reckons this can only be a good thing. “We begin to see an increased interaction between the west and the region,” he says. “It has to do with energy but also capital flows.” The bank chief maintains that the flurry of IPOs in London by Russian and Kazakh banks and companies represents significant progress: “It does mean, and I think everyone acknowledges this, without any doubt progress on corporate governance and transparency of these companies,” he says.
But the investment boom in Russia, Kazakhstan and elsewhere in the CIS impacts negatively on the populations, says Buiter. “The only capital that goes in goes to oil. It has nothing to do with development, with society or with the population.”
The transition in Russia as well as eastern and southeastern Europe is far from over, but in the majority of the region’s 27 countries, with over 400 million inhabitants, the output and consumption levels remain lower than they were 18 years ago, Grzegorz Kolodko, a former Polish finance minister, points out.
The proportion of people “marginalized by social exclusion” in post-socialist transition economies has jumped significantly over the last 18 years, Kolodko says. The areas of poverty and destitution have also grown, and in some countries life expectancy has also dropped. Income disparities have increased almost universally across the region, sometimes sharply.
A World Bank study on Russia, for example, shows that the national incidence of poverty is close to 20%. The rural population has the highest rates of poverty (30.4%), while the urban population has a poverty rate of 15.7%.
The excluded middle
Kolodko, who is credited as an architect of post-socialist economic reforms in Poland, says that the main lesson of the Polish experience of economic transition is that neoliberalism – the orthodox, free-market economic policies advocated by Washington based multilaterals – has “failed significantly in eastern Europe and the former Soviet Union.”
“I think the lesson from almost 20 years is that this [process] is about much more than economics. The transformation to the market must be accompanied by a transformation to civil society,” Kolodko tells Emerging Markets. “Even if institutions have been nominally built up, without the right political culture they will collapse.”
Kolodko points out that transition failed Poland most profoundly in missing out the “social ingredient” from economic policy, with “negative implications for the quality of human capital.”
But there is still cause for encouragement. Although the World Bank/EBRD transition survey points to evidence of dreams unfulfilled, particularly among older respondents, it also gives some hope for the future: more young people believe that life is better than before, and many in their parents’ generation expressing hope for their children’s futures.
It’s a view shared by Kolodko, who argues it will take time – possibly several generations – for the full impact of transition to filter through. “You cannot expect change with this generation,” he says.
Lemierre agrees: “Transition is a long process, it’s not an easy process. At the time communism was falling we thought politics would be quicker to change than the economy. We have underestimated the time [it took] to change values, behavior and history.”