Jan Svejnar November 2003

1. Commentary on Post-Communist Transition in a Comparative Perspective by Leszek Balcerowicz Jan Svejnar November 2003

2. Background • Insightful overview of the communist system • Key institutions • Extensive controls, overgrown welfare state, police state • Economic structure • Limited development of services • Varying dependence on COMECON • Varying development of infrastructure • Human capital • Varying health indicators, high enrollment ratios in schools • Macroeconomic imbalances • Open or repressed inflation, black market exchange rate • Large foreign debt in Bulgaria, Hungary, Poland

3. Background • Performance during communism • Low relative GDP per capita growth • Low value added per worker • Low energy productivity • Severe pollution of the environment

4. Performance during the Transition • Very diverse rates of GDP growth during 1989-2002 • Fastest growth in Central Europe • Only 5 economies have inflation over 10% by 2002 • Lowest in Central Europe, Baltics and Ukraine, Kyrgyz Rep. and Azerbaijan • High FDI per capita inflows in the EU accession countries plus Kazakhstan • Diverse developments in fiscal transition (government expenditure/GDP) – link to corruption? • Varied financial sector development

5. Performance during the Transition • Improving health indicators in many but not all transition economies • Rising infant mortality in Kazakhstan, Russia, Latvia, and Ukraine • Declining life expectancy in Russia, Ukraine and Central Asia • Income inequality rises modestly in Central Europe and more further east • Varying rates of change in labor productivity in industry (restructuring) • Most but not all countries have reduced CO2 emissions

6. Factors explaining the differences in outcomes • Initial conditions • External developments/shocks • Extent of market reforms • Nature of macroeconomic policies

7. Factors explaining outcomes • GDP growth is a positive function of • the scope of reforms (private sector share in GDP) • the EBRD liberalization index • Income inequality is negatively related to the EBRD liberalization index • Initial conditions have a minor effect (existing studies) • Economic reform => better health and environmental outcomes • Capital account liberalization not clearly related to the occurrence of financial crises • More democratic countries liberalize their economies faster and more

8. Assessment • A fine comparative analysis of an important topic • A major (unique) systemic experiment • Diverse initial conditions • Diverse policies • Diverse outcomes • Valuable analytical insights

9. Assessment • Methodological questions • Are the policy variables exogenous? => search for instruments => are the instruments (e.g., IMF deficit targets) uncorrelated with the error term in the GDP growth equation (e.g., Borensztein et al. 1999) • Is it possible that policy variables proxy for other variables? Geography (fixed effects)? • Results vary with indicators of performance • Problem of relying on indices • Overall, a very refreshing, crisp, comparative analysis

10. Real GDP Index, 1989-2003 (1989 Base Year) Source: William Davidson Institute based on the IMF World Economic Outlook April 2003, and Davidson Institute Forecasts

11. Extensions • Examine the role of policies at the micro-level, using information on firms and individuals over time (panel data) • Types of privatization and ownership • Foreign investment • Legal system and institutions • Development of commercial banks and stock markets • Unemployment and labor market institutions

12. Privatization and Ownership • What are the determinants of the forms and sequencing of privatization • Does some forms of privatization result in more effective corporate governance and improved economic performance than others? • What type of ownership improves economic performance? • Concentrated foreign ownership seems to have a strong positive effect on firm performance • Is privatization conducive to economic growth by spurring the development of market institutions (e.g., capital markets)?

13. Foreign Direct Investment (Net inflows per capita, in Million of US Dollars) Source: Davidson Institute calculations based on the World Bank World Development Indicators 2002 and on the EBRD Transition Report May 2003.

14. Entrepreneurs/Start-ups/De Novo Firms • A major engine of growth in transition? • Over one-half of workers moved from SOEs to de novo firms in Czech Republic and Estonia during the first five years of the transition (Jurajda and Terrell, 2002) • => Are new private firms more important in the long run than domestic privatized state-owned firms? • Debate as to what constrains SMEs the most • Access to and cost of capital (Pissarides et al., 2003) • Legal-institutional barriers; corruption (Johnson et al., 2002)

15. Unemployment Rate (Percent) Notes: For most countries data based on ILO methodology. Sources: Croatia, Poland, Slovenia, Bulgaria, Romania, Ukraine - ILO survey data; Davidson Institute Forecast for Czech Republic, Estonia, Hungary, Slovak Republic, Russia based on ILO survey data; USA - EIU

16. The Role of Banks • Often provided loans to poorly performing (large) firms • Bank financial problems often concealed in accounting data • => accumulation of non-performing loans • => financial crises; banks too big to fail • => significant fiscal implications (budget deficits) • Only privatization to foreign (western) banks appears to have stopped the soft budget lending practice in CEE • => restructuring (acquisition) of domestic firms • => banks still lend heavily to governments but increasingly also to SMEs and consumers

17. The Role of Stock Exchanges • Appeared in transition economies in the early 1990s • Some registered a rapid rise in the number of listed firms during (voucher) privatization • Recently the number of listed firms has been stagnating or declining • Few stocks are traded and the volume is thin • Question if the pension funds will provide sufficient demand for the stock markets to survive

18. Issues for the Future • Will other countries (CIS) follow the CEE example of relying (almost) exclusively on foreign banks? • Will a financial sector composed of foreign banks be (perceived of as) providing adequate services? • Will local stock markets survive/develop or a regional stock market appear? • Will large domestically-owned firms emerge/survive in the open transition economies? • Will the combination of FDI and local entrepreneurial talent result in fast and sustained growth in the CEE countries as they join EU?