ERIK BERGLOF: EBRD cannot bank on stability – Transition is reversible

Advanced economies with established democracies very rarely become authoritarian. In post-Soviet space there are broadly two groups of countries: democratic market economies and economies with less developed markets and more authoritarian systems. We’ve always assumed that the process of political and economic transition moves in one direction: it is only a matter of time before democracy and markets take hold, and once established, there is no turning back. Unfortunately, it is becoming increasingly clear that transition can be reversed.

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The conventional wisdom is based on the belief that markets and democracy reinforce each other. The EBRD was established in this spirit, but in practice the bank never really directly pursued democratic reforms through its projects or acknowledged in its investments that a deterioration in political reforms could undermine markets. Now, a recent assessment by three leading economists, including its own incoming chief economist, suggests that the Bank could take a more active stance.

The evidence from Central and Eastern Europe shows that while market institutions took a long time to put into place, the essential features of the political systems were established in the early 1990s and have not changed much since. In two cases, Serbia and Montenegro, later democratisation (in 2000) had a positive impact on market reforms, but in others, Romania (1995) and Ukraine (2004), it did not. The only country where political institutions markedly deteriorated from an immature democracy in the 1990s, Belarus, subsequently saw little or no economic reform.

The intimate link between markets and democracy was also central to accession to the European Union. Political systems in candidate countries were evaluated according to the so-called Copenhagen criteria, which complemented the Maastricht economic criteria. These assessments helped cement the achievements of the early years and support further reforms. Once these countries became members, democratic and market institutions were not believed to be at risk.

Yet we now have several examples of reversals in both the economic and political spheres in Central Europe (and in other parts of post-Soviet space). Developments in Hungary have caught the most attention, but similar tendencies have been visible for several years in other Central European countries. Perhaps most surprisingly, Poland, previously the posterchild of democratic and economic transition, has now joined the group of countries proving that transition can be reversed.

Why have democracy and markets in Central Europe been less resilient than expected? The obvious explanation is that political and market institutions have not yet sufficiently taken root. Support for democracy and markets dropped significantly after the global financial crisis: the larger the fall in GDP, the larger the drop in support. In crisis Greece, which has suffered at least as much economically as Central Europe, popular support for democracy and markets has held up much better.

It is important to note that a transition that goes in reverse will not end up where it started i.e., in centrally planned dictatorships – like other social processes-- transition is not fully reversible. Instead, what we are observing are variations of what some supporters like to call “illiberal democracies”. These models differ in degree of authoritarianism, but share how they were established and function today.

How should the rest of Europe respond? A first insight is that outside intervention is very sensitive and can easily backfire. Some of the current rejection of the EU in Central Europe may in fact date back to the rather patronising and dragged-out process of accession with its tedious and uncompromising negotiations of the chapters of the acquis communautaires. In many cases, the Commission pitted candidate countries against each other or at least undermined coordination among them.

Most, if not all, cases of serious regression have occurred after countries joined – the EU’s leverage decreases drastically once a country is a member. The influence prior to joining depends on the perceived benefits of membership. These benefits might not be as large or at least not as obvious today as they were when the process of accession started in the early 1990s. The weakening of the “European offer” also hollows out what the EU can ask for from any new member.

The European Union should think very broadly about what instruments it could use to engage Central European political leaders in positive-sum negotiations to discourage transition backsliding. Protecting transition against reversal may be even more important than promoting transition in the first place – if people feel that their sacrifices have been in vain, their willingness to endure another round of reforms diminishes.

So what can the EBRD do? It is unlikely, through its projects, to be as successful in directly promoting political reforms as it has been in engendering economic reforms. But it could improve its tools for monitoring political institutions in its country assessments and more explicitly recognise links between political and economic institutions. For example, preventing transition reversal was an important consideration in evaluating individual projects during the global financial crisis; this methodology could be expanded.

More actively, the EBRD can actively help build state capacity and promote transparency, increasing resilience to anti-democratic tendencies. The Bank can and does engage in building end-user participation through its projects, particularly in municipal infrastructure. It can also avoid engaging in the public sector in countries that do not live up to the ideals expressed in the Bank’s charter, something which has not really been applied to late-stage transition countries. The Bank should also openly acknowledge reversals in both economic and political transition. As the EBRD reviewers say, the Bank’s “commitment to democratic values and institutions remains a distinctive rhetorical device for focusing its priorities.”

Erik Berglof is Professor and Director of the Institute of Global Affairs, London School of Economics and was chief economist of the EBRD 2006-2015