Transition path and EU enlargement in Central and Eastern Europe

1. Transition path and EU enlargement in Central and Eastern Europe Irene Monasterolo PhD candidate in Agricultural Economics and Statistics University of Bologna

2. Today we are going to.. • Analyze the main features of the transition process in Central and Eastern European Countries (CEEs) • Present and compare the main transition theories • Preliminarly assess the economic performance in transition • Introduce the characteristics of the 2004 and 2007 EU ‘East- enlargement’

3. List of abbreviations • EU: European Union • EC: European Commission • CEEs: Central and Eastern European Countries • WB: World Bank • IMF: International Monetary Found • EBRD: European BAnk for Reconstruction and Development • NIS: New Independent States • FSU: Former Soviet Union • WC: Washington Consensus

4. Transition of what? • Definition of transition: • ‘a movement, development, evolution from one form, stage or style, to another’. For CEEs transition is a process finalized.. • at the dismantling of (what remained) of the Soviet-led planned economy, and at the introduction of the market economy; • at the creation of democratic institutions allowing citizens’ political participation after years of one-Party state rule; • at the introduction of an independent judiciary system; • at the ri-creation of a civil society and related public movements, previously banned and repressed in the fight against dissent • By introducing capitalism in former socialist economies, the objective, one hopes, is to bring these countries, within an appropriate period of time, to levels of prosperity comparable to those of the most advanced industrialized countries (Roland 2000)

5. The transition panorama • Post-communist transition countries were characterized by similar macroeconomic disorders: GDP contraction, inflation and the emergence of unemployment. • Initial fall in GDP as a surprise but the experience of transition economies not easily explained by existing models for market economies. • “Trade implosion” (Transformational recession): break-up of the old system of coordination of production and exchange in absence of fundamental market institutions. • Different path of GDP/employment adjustments in CEEs/ NIS: • In NIS countries GDP and employment started a steady decline, with GDP falling a lot more. • In CEEs instead GDP and employment followed a U-shaped path, with elimination of labour hoarding clearly visible.

6. The three keywords • 3 initial conditions are important in understanding the trade-off between fast and slow reforms: economic structure, initial macroeconomic imbalance, and the dynamics of political change. • Liberalization: eliminating price controls (prices based on the demand/supply principle) and restrictions on foreign trade; currency convertibility; changing the general framework (property rights regime..) and more specific deregulating state controlled sectors. • Macroeconomic equilibrium: to block the public deficit and control inflation, introducing taxation, cuts in public expenditure, fight to burocratization and stop to soft budget constraint. • Institutional reforms:reforming existing institutions (privatizing state enterprises, reorganizing the state administration, new tax system) and creating new institutions (stock exchanges, investment and pension funds, unemployment offices).

7. The transition effect • Transition from central planning to a free market economy followed different paths and showed different results in CEEs/NIS/FSU Fig. 1 GDP variation in CEEs in comparison with the EU 15 Sources: own elaborations on data from EC 2003.

8. official unemployment was the consequence of different choices of public firms after the end of soft budget constraint • → choice between reduction in wages and in hours worked or a reduction in employment. • Great difference in aggregate time series on GDP, employment and wages pattern between CEEs (“quantity” adjustment) and NIS (“price” adjustment) - Fig.2 • Result: real wages in virtually “free fall” in NIS vs. some real wage rigidity in CEE Fig 2. Employment and output fall Source: Boeri, T. et al, 2002

9. Fig. 3 Real wages in CEEs/FSU (1989=100) Source: Boeri, T. et al, 2002

10. Fig. 4 Liberalization of prices and trade P1 price for consumers in pre-reform era P3 price for producers and consumers after price liberalization in this sector P5 pre-reform price for producers Q4 quantity produced and consumed after price liberalization Q5 quantity produced before the reform Q6: quantity demanded from consumers in pre-reform era

11. An optimal speed of transition? Two approaches • After the fall of the Berlin Wall in 1991, two main approaches to transition: big bang vs gradualist • Big Bang (Balcerowicz, 1993; Sachs, 1993): a rapid break with the past and as fast as possible macroeconomic stabilization, liberalization of domestic trade and prices, current account convertibility, privatization, creation of a social safety net, simultaneously to the legal framework for a market economy. • Gradualist (Svejnar, 1989; Roland 1991,1992): non-radical economic programs, defined as those in which stabilization, liberalization and restructuring are not launched simultaneously, or are implemented at a slower pace, or are even interrupted. • The first was supported by WB and IMF (Washington Consensus) and prevailed in most of the ex soviet satellites (CEEs and CIS). • Both positions underestimated the role institutions and culture play in the transformation process. Countries have proper cultural determinants and evolutionary paths (Lenger, 2008) → no “one size fits all” solution!

12. Characteristics and limits • Big bang: use the period after the breakdown of socialism – the window of opportunity – to quickly put in place the new liberal regime and prevent reforms from being reversed. • For unemployment and other social issues: introduction of social safety nets. “Giving compensating transfers to losers from reform to buy their acceptance is an obvious way to help in enacting a reform” (Roland 2002: 32). • compensation has to be very large because of the huge inefficiencies of the socialist economy. • Gradualist: to avoid excessive costs for the government budget; an excessive reduction in living standards as the start of the reforms; to allows trial-and-error and mid-course adjustment; it is politically more suitable; developing adequate institutions before liberalizing the economy (vs. WC). • “While a gradualist approach may cause lesser social tensions, a long period of moderate reforms entails the danger that both reformers and the population will ‘become tired of reforms’ as they do not seem to bring visible changes… and various anti-reform and other lobbies may mobilize their forces and may gradually strangle the reform process” (taken from Przeworski 1991/95).

13. Fig. 5 The ten commendments from the Washington Consensuns ..A specific set of ten economic policy prescriptions to constitute a "standard" reform package for transition countries

14. Assessing the success or the failure? • In the transition process a crucial role is played by initial economic conditions, determined by history, including macroeconomic (im)balances, economic structure, stock of physical and human capital, size of the economy, its geographical location, demographic structure, etc. Fig. 6 GDP variation used in assessing the transition performance • Pay attention: it is hard to compare pre-transition data because of the low accountability of the soviet period data (incentive to misreporting) and the different accounting system used (MNP vs. GDP; i.e. MNP didn’t inclued services)

15. Fig. 7 Transition Progress Indicator • The classification of the reform processes has been done arbitrary. TPI: country’s market-orientation on a scale from 1 to 4.5 (1: centrally planned regime/ 4.5 free market economy). TPI dimensions: price and trade liberalization, competition policy, governance, small and large scale privatization, liberalization of the banking and financial sectors. Countries in 6 groups: CEEs, the Baltic states, South-East Europe, members of the former Soviet Union with a moderate degree of reforms, and FSU members

16. Toward the EU membership: the final solution? • Eu eastern enlargement: ‘greatest’ for number of countries involves, and relevance of budget consequences. • + 10 Countries, 75 million people, EU average income decreases of circa 12.5%, population living in backward regions increases from 20% till 25%, doubling the hectares committed to agriculture and the labour force in that sector. • While the difference between average p.c. GDP in EU-15 and the level of Greece&Portugal was < 30%, with enlargement it double (average p.c. GDP in Latvia <60% thanEU-25 average) • Therefore, all the new members got into the ex Objective 1 area (now Convergence) for Countries with backward areas, whose GDP <75% of the EU average, getting the related structural, to which more than 2/3 of the financial endowment (more than 135 billion euro) was designated. • In Agenda 2000 are established the interventions supporting the cohesion policy in the former candidate Countries: cohesion fund and the structural funds which represent a disbursement, i.e for Hungary and for the other CEEs, equal to the 4% of GDP in the EU-25.

17. Fig. 8 Rural and Urban municipalities in EU-27 using OECD methodology, 2007 Source: European Commission, 2007

18. Fig. 9 GDP p.c. in EU-27, 2009

19. Overview on structural and cohesion funds • Structural Funds finance development programs endowed with an own balance and presented by the Government of the State interested in the eligibility for the financial assistance in a programming document covering several years. • This plan must be implemented by the interested Government just after the EC approval. • In the National Development Plan presented before the starting of the new programming period, interventions and structural funds are presented: national and regional authorities assisted by the EC with guidelines considering the specificity of every Country (problems and commitments under the Aquis Communitaire) • The outlined interventions realized by Operative Programs which identify the specific actions • Every OP is under the responsibility of a managing authority which cooperates with the Plan Unit, assuring the coherence among actions started, key objective and strategies highlighted. • Other programs also implemented with the financial assistance of the Structural Funds: INTERREG (trans-national cooperation) and EQUAL (establishment of partnerships against gender discrimination on the workplace). • Cohesion Fund: disbursements for infrastructural projects regarding environment protection (potable water, waste..) and transports (motorway, airports..). Important: the EU acts as a co-financer for the projects: the entitled Country has also to take part in the financing (with lower quotas).

20. (preliminar) Conclusions • Before the 2007 financial crisis (but also before the 1998 Russian stock exchange crisis), we could find some successful (in GDP terms) examples of a gradual approach and of a big-bang reform (Murrell 1995). • Focus on the interaction between formal and informal institutions provides explanation for why the adaptation of a “first best” reform approach cannot work → different countries have different “local conditions” which arise from slow-moving institutions (Roland 2004) That’s why reforms in a given country must be built ALSO according to its local conditions. • The same lesson can be so far learned 5 years from the EU Eastern enlargement: those programs and interventions succeeded, whose managing authorities and competent institutions were properly set, and where local development characteristics were taken into account in policy drafting. → transition process and EU enlargement share this same aspect: they fail where the ‘one fits all’ solution is applied

21. THANKS FOR YOUR ATTENTION!!!

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