Dr. Richard Connolly Centre for Russian and East European Studies ( r.connolly@bham.ac.uk )

1. MBA in Strategy and Procurement ManagementInternational Business EnvironmentSunday, 16th January 2010, 9.30 a.m. – 4.30 p.m.Political Risk in Transitional Economies: Russia and Emerging Europe Dr. Richard Connolly Centre for Russian and East European Studies (r.connolly@bham.ac.uk)

2. POLITICAL RISK IN TRANSITIONAL ECONOMIES: RUSSIA AND EMERGING EUROPE 9.30 – 9.45 Outline of the day – why is emerging Europe important? 9.45 – 10.30 Planned Economies in Theory and Practice 10.30 – 10.45 Break 10.45 – 12.30 Post-communist Transformation in Theory and Practice 12.30 – 13.30 Lunch 13.30 – 14.45 Emerging Europe today: the global financial-economic crisis, future challenges and political risks 14.45 – 1500 Break 15.00 – 16.15 Russia today: the global financial-economic crisis, future challenges and political risks 16.30 Close Agenda

3. POLITICAL RISK IN TRANSITIONAL ECONOMIES: RUSSIA AND EMERGING EUROPE Why should we care about emerging Europe? • Population: 400 million (5.7% of world population), more than Brazil (194 million, 2.7%) and the USA (307 million, 4.3%) • GDP (current US$): $2.9 trillion (5% of world), compared to Brazil (2.7%), India (2.2%) and China (8.5%) • GDP (PPP): $5.7 trillion (7.8%), compared to Brazil (2.7%), India (5%) and China (12.4%) • International trade: share of world exports is 9%, just behind China (9.6%), but ahead of Brazil (1.3%) and India (2%). For imports, share of world total is 8.6%, ahead of China (8.1%), Brazil (1.3%), India (2.4%) • In general, exceptionally open to international trade, foreign direct investment and capital flows. • Taken together, Goldman Sachs have argued that emerging Europe may represent the ‘fifth BRIC’, i.e., a region that promises to account for a large share of future economic growth and investment opportunities. • In recent years, consumption has grown rapidly, and is forecast to do so in the future as the region continues to converge with richer countries.

4. TRANSITIONAL ECONOMIES IN THEORY AND PRACTICE PART ONE: THE SOCIALIST PLANNED ECONOMIES IN THEORY AND PRACTICE

5. Transitional Economies in Theory and Practice The Socialist Planned Economies of the USSR and Eastern Europe Soviet Union – 1917 – end 1991 (Union of Soviet Socialist Republics), including Baltic States (Estonia, Latvia and Lithuania) incorporated in 1940 Central and Eastern Europe – 1945-89, including German Democratic Republic (East Germany). Yugoslavia – less rigidly planned, ‘workers self management’, broke with USSR in 1949 Albania – broke with USSR 1960, became closer to China until c.1978 Plus: Mongolia China – 1949 ........ Vietnam, Cambodia, Laos North Korea Cuba

6. Transitional Economies in Theory and Practice The planned economies of USSR and Eastern Europe - geography

7. Transitional Economies in Theory and Practice • Ideology (Marxism Leninism), Communist Party rule, nomenklatura • Predominant state ownership – variation across region • Hierarchical, bureaucratic coordination • Non-market resource allocation – the planning system, material balances, • investment • Employment planning, full employment plus underemployment • Administered prices • Financial system – passive money, dual circuits, state budget • State managed foreign trade, Council of Mutual Economic Assistance • Extensive growth model – factor mobilisation, not their more efficient use • Existence of an unofficial ‘second economy’, supplementing planned • official economy • Use of statistical concepts not comparable with international standards – • output measured in Net Material Product not GDP – bias towards • exaggeration of growth rate and understatement of rate of inflation. The Planned Economies – Principal Features

8. Transitional Economies in Theory and Practice Resource allocation • A system of five-year and annual plans • Plans drawn up as outcome of bargaining between state planning committee (in USSR, Gosplan), ministries, and enterprises • Material resources ‘planned’ using ‘material balances’ - for main products balances drawn up indicating sources of supply and uses. Supplies allocated to enterprises by a state supply agency. • Prices centrally determined, i.e. not set by market forces; use of average cost pricing, not marginal. Prices to a large extent arbitrary. • Enterprise performance assessed by fulfilment of a set of plan indicators • Bonuses for managers if principal success indicators fulfilled, or over fulfilled, in relation to the plan This hierarchical, bureaucratic, economic management system rife with ‘principal-agent’ problems, with substantial scope for opportunistic behaviour, including bargaining for soft plan targets, exaggerating plan fulfilment , ‘informal’ trading activities between enterprises, etc. Outcome – inefficiency, waste and, for centre, high ‘agency costs’

9. Transitional Economies in Theory and Practice The Socialist Economic System – according to Janos Kornai Hungarian economist, born 1928 Now retired, but in 1986-2002 spent half his time at Harvard University First major work: Overcentralisation in Economic Administration, 1957 (1959 in English);later, Anti Equilibrium, 1971

10. Transitional Economies in Theory and Practice Major work of Kornai – Economics of Shortage, 1980 Summary work of 1988 – The Socialist System

11. Transitional Economies in Theory and Practice Janos Kornai Soft Budget Constraints Budget constraints subject to bargaining: • Soft subsidies • Soft taxation • Soft administered prices • Soft credit terms Budget constraints most soft in priority sectors of the economy. Households experienced hard budget constraints.

12. Transitional Economies in Theory and Practice Janos Kornai With SBCs, the socialist economic system exhibited a number of characteristic phenomena: • Forced growth • Chronic, pervasive, shortage (and slack) • Labour shortage and full employment, coexisting with underemployment • Low labour discipline • ‘Investment hunger’ • No enterprise bankruptcy • Sellers’ market, no concern for quality except in military industry (cf US) • Repressed inflation • Queues, low quality, forced substitution, forced savings • Weak incentives for innovation • Low efficiency and productivity

13. Transitional Economies in Theory and Practice Janos Kornai The Socialist Economic System provides a comprehensive analysis of the classic socialist system – a ‘resource-constrained’ economy, and comparisons with the ‘demand-constrained’ capitalist system. CapitalismClassical socialism Market regime Buyers’ market Sellers’ market Dominant deviation from market equilibrium Surplus Shortage State of labour allocation Labour surplus Labour shortage

14. Janos Kornai Transitional Economies in Theory and Practice In Kornai’s view the socialist economic system had considerable systemic coherence and was highly resistant to any reforms that threatened it. In his view the ideological commitment to Marxism-Leninism was crucial, above all because of the central belief in the superiority of state ownership over private property. Although in practice, was it not a case of excessively powerful bureaucratic and industrial interests.

15. Transitional Economies in Theory and Practice • very high participation rates (but underemployment) • ‘over-industrialised’, with much heavy industry • underdeveloped service sector • often backward, socialised agriculture and relatively large agricultural • employment • trade-averse, especially USSR, although less so in CEE • in the case of USSR, a militarised economy Structural characteristics of planned economies • Performance • Growth – rapid in early years, then declined • Efficiency - low • Energy/material intensive – CEE dependent on subsidies from USSR • Innovation – poor, except in priority sectors, and in Czechoslovakia, GDR • Standards of living – low cf. West European market economies • Environment – a wasteful system, with much environmental degradation

16. Transitional Economies in Theory and Practice • Many attempts to reform the socialist economic system, but very limited success • USSR – reforms in 1965, 1979, and finally in 1985-91, under Mikhail Gorbachev • Most far reaching reforms in Hungary and Poland; limited reforms in • Czechoslovakia, Bulgaria, GDR, and Romania • Directions of reform: partial market reforms: decentralisation, enterprise rights • raised cf. ministries, reduced number of plan/success indicators, more indirect • influence of state, limited price reforms, limited changes in property rights, partial • external liberalisation. • However, as argued by Kornai and others, the socialist planning system had a high • degree of systemic coherence and any reform threatening it tended to be rejected or • diluted. • Far reaching reforms also threatened to challenge the political legitimacy of • communist rule. The planned economies – failed reforms and collapse

17. Transitional Economies in Theory and Practice • While region had performed badly in 1980s, change is initiated by Gorbachev • USSR – uskorenie, glasnost, perestroika: all initiated to stimulate CPSU into undertaking reform so that socialism could become more efficient and competitive. • In 1985, Gorbachev described the USSR as in a ‘pre-crisis’ situation; same could be said for much of CEE. • ‘New thinking’ designed to create more favourable external conditions so that reform could be undertaken more comfortably. • ‘Sinatra doctrine’ an attempt to relax imperial burden on USSR, but had unintended consequences. • Some countries exhibited appetite for reform (e.g., Poland, Hungary), but others staunchly resist change (Czechoslovakia, Romania, Bulgaria) • However, as argued by Kornai and others, the socialist planning system had a high • degree of systemic coherence and any reform threatening it tended to be rejected or • diluted. • Far reaching reforms also threatened to challenge the political legitimacy of • communist rule. The planned economies – collapse

18. Transitional Economies in Theory and Practice Unravelling and collapse, 1989-91 In 1989 – end of socialist system in Central and Eastern Europe In USSR - Gorbachev reforms – perestroika – mounting crisis, eventual collapse end 1991 – outcome, 15 independent countries. • Features at end of the system • Economic decline • Inflation – open and repressed • Budgetary crises • Macroeconomic disequilibrium • Balance of payments crises • Substantial external debts • Severely reduced living standards • Negative demographic trends • Growth of crime and corruption • ALL TO SHAPE TRAJECTORY OF TRANSITION

19. Socialism: concluding thoughts • The performance of the socialist economies declined after the 1970s. • There were clear systemic limitations inherent within the system, as described by Kornai. These prevented a move from extensive to intensive economic development. • Technological revolution of 1970s (and rising oil prices) exposed these flaws (Berend, 2008) • Nature of collapse varied across the region: some elite-led, some popular based, ‘from below’. • However, legacies of socialism would shape future economic and political developments. • While nearly all countries expressed desire to adopt democratic political institutions and create market economies, not all were able to do so, often because of structural impediments.

20. TRANSITIONAL ECONOMIES IN THEORY AND PRACTICE PART TWO: POST-COMMUNIST TRANSFORMATION – THEORY AND PRACTICE

21. Transitional Economies in Theory and Practice The task of transformation – in theory The ultimate goal: convergence with the West In early years – 1989 – c.mid-1990s, predominance of so-called ‘Washington consensus’ (a term coined by John Williamson, Institute of International Economics, Washington) in 1989): • Liberalisation and stabilisation according to standard methods of IMF (in particular, as adopted in Latin American countries) • Privatisation seen as essential for functioning markets and economic efficiency • Priority for deregulation, open trade, fiscal balance, low inflation • Belief that institutions arise as generated by market forces. Became known as ‘shock therapy’, ‘big bang’ approach, etc Influential advocates include Leszek Balcerowicz (Poland), Anders Aslund First adopted in Poland in 1990; influential in Russia, early 1992 (Gaidar government)

22. Transitional Economies in Theory and Practice • At this time task posed was ‘transition’ – from the planned economy to a liberal, free-market, economy – seen as relatively unproblematic process. • Standard agenda for transition: • Stabilisation: securing macroeconomic balance as quickly as possible • (removing inflationary pressure from economy) – monetary policy, fiscal policy • – new taxes, budget spending cuts, etc • Liberalisation: domestic and external – removing administrative constraints • to permit markets to function (including freeing most prices); foreign trade • liberalisation, customs duties, moves towards currency convertibility • Privatisation: changing property relations, ending dominance of state • Institution building: especially adoption of new laws appropriate to a market • economy – civil and commercial codes, company laws, labour codes, etc • Social support for those adversely affected by transition, including • unemployment benefit • Politics – hopefully, the development of a pluralistic, democratic, political order with a vibrant civil society and the rule of law.

23. Transitional Economies in Theory and Practice • However, from the outset alternative approaches were advocated to secure a more gradual transition, hopefully leading to less severe social costs: • Notably, work of Peter Murrell, University of Maryland: a gradualist view • based on an evolutionary, Austrian School (von Mises, Hayek, Schumpeter), • understanding of economic change. • Also, impact of alternative path of China – communist rule maintained, gradual • development of market sector and non-state businesses • ‘Heterodox’ economists (e.g., Reinert, Chang, Stiglitz) had criticised the application of the WC in practice (Latin America in 1980s and 1990s) for resulting in macroeconomic instability (due to openness to capital flows) and deindustrialization (as state withdrew from economy) • This view gained ground during the 1990s and the focus of discussion turned • increasingly to institutions, without attention to which, some saw successful transition as unlikely.

24. Transitional Economies in Theory and Practice Neo-institutionalism An influential trend of analysis arising from dissatisfaction with the orthodoxies of the ‘Washington consensus’ , even from within the international financial institutions themselves, e.g. Joseph Stiglitz, when chief economist of World Bank, 1997-2000. With rise of institutionalism, term ‘transition’ increasingly replaced by ‘transformation’. Growth of understanding that for markets to function effectively appropriate institutional arrangements are required, arrangements that may not emerge spontaneously from the impact of market forces alone. ‘Founding father’ of new institutionalism, Douglass C North (b.1920), Nobel Prize for Economics, 1993 • Major works: • Structure and Change in Economic History, 1981 • Institutions, Institutional Change and Economic Performance, 1990 • Understanding the Process of Economic Change,2005

25. Transitional Economies in Theory and Practice ”Institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction. In consequence they structure incentives in human exchange, whether political social or economic”. Institutions can be formal (e.g. law) or informal (custom and habit). They can be created from above or evolve. Organisations arise within a given institutional framework and structure human action in the achievement of certain goals. So, organizations (state, firms, other groups) operate within framework of rules or institutions (formal or informal). North stressed the importance of ‘fit’ between formal and informal rules – if formal rules were dissonant with interests of organizations and prevailing informal rules, how could transition be successful? North’s definition of institutions

26. Transitional Economies in Theory and Practice Neo-institutionalism and post communist transformation Institutionalist critique of Washington Consensus – Peter Murrell, Joseph Stiglitz, Martin Raiser, Gerard Roland (‘evolutionary-institutional’ alternative). An early work; O Blanchard and M Kremer, ‘Disorganization’, Quarterly Journal of Economics, 1997 (output decline and lack of effective governance). In words of Peter Boettke, evolution of thinking , from ‘getting the prices right’ to ‘getting the institutions right’, then to ‘getting the culture right’ (cultural factors influence institutions). In a sense, back to a Weberian understanding (or Pareto and other 19thc thinkers): interaction of political, social, legal, economic, and cultural variables to explain performance and behaviour of a social systems. Institutional approaches tended to emphasize ‘case specificity’ while WC associated with ‘one-size fits all approach’ Methodological problems with the latter? (i.e. use of averages, unrealistic and over simplistic assumptions)

27. Transitional Economies in Theory and Practice • Issues of institutional convergence and diversity • The historical evolution of institutions, path dependency • Can institutions be transplanted? If not, why not? • What causes institutional change? – market forces, government action, • external pressure (e.g. with FDI), social conflict….? • How quickly can institutions be changed? An optimal pace? • Counterproductive if too fast? • An influential normative approach – seeking to transfer best practice (especially international agencies during the 1990s and since) • But, a reaction: e.g., Dani Rodrik (Harvard) for ‘second-best’ institutions –’if you think best practice is the way to go in institutional reform, think again’. • How to measure institutional performance, best practice? • Debate continues, but ‘one-size fits all’ approaches increasingly discredited outside basic arguments (e.g., relative macroeconomic stability, and….?)

28. Transitional Economies in Theory and Practice A new consensus? Today: a new consensus? Washington Consensus widely acknowledged as too limited; institutions do matter, but do not explain everything; now a more sceptical, less doctrinaire, approach to policy has become influential, e.g. work of Dani Rodrik, Harvard (One Economics, Many Recipes: Globalisation, Institutions and Economic Growth, 2007) William Easterly, New York University (White Man’s Burden: Why the West’s Efforts to Aid the Rest have Done so Much Ill and so Little Good, 2007) In part, the encounter of economists with the ex-communist economies, including the notable case of China, has helped to promote this new understanding.

29. Transitional Economies in Theory and Practice Privatisation A particularly contentious topic at the time because it dealt with ‘who got what’. As such, a highly politicized process. • Why privatise? • Ronald Coase: Most important is to assign property rights clearly and unambiguously – someone has property rights better than no-one. • Concern for value (present and future) of assets • Creation of a market for control • Existence of capital markets – shares, takeovers, mergers etc • Market evaluation of assets • More open market for managerial skills (cf nomenklatura) • May be less conducive to rent seeking • More credible hard budget constraints? • Privatisation increases the transaction costs of lobbying government for • support (Stiglitz) • Political goals: build a constituency for further reform.

30. Transitional Economies in Theory and Practice • Generation of social support for post-communist transformation • Creation of obstacle to communist restoration • De-politicisation of economy – rolling back the state (still a politicisation, surely?) • Decentralisation of economic power and property conducive to democracy • Who owns the assets prior to privatisation? Some political arguments in favour of privatisation – in theory • ‘Public’ ownership – all owned but in reality no-one • Contested property rights, especially in late communist period – state, • ministries, managers, workers, population at large? • Spontaneous privatisation • Restitution issues (especially in CEE and Baltics) • For clarity of rights prior to privatisation transfer assets to a State Property • Fund

31. Transitional Economies in Theory and Practice • Small scale businesses - sell, auction, transfer to employees • Large-scale businesses - ‘retail’ model (as in UK under Thatcher) – one off IPOs – problems of valuation, finding buyers with money, restructuring? But, in most cases considered too slow. • ‘Wholesale’ model • – give them away to employees, free • - give entitlements to own shares (vouchers) – free, for a charge? Who to – • employees only, whole population? • Potential dangers – may lead to predominance of ‘insider’ ownership, possibilities for corruption, future legal battles.... • Problems if process drags out • Problems if rushed • Which enterprises to be left in state hands? – public utilities, defence companies, other ‘strategic’ enterprises? • Land privatisation? How to privatise?

32. Transitional Economies in Theory and Practice • Insider or outsider ownership? • Restructuring? • Development of effective corporate governance • Market for shares – redistribution of property • Post-privatisation consolidation of ownership • Emergence of ‘oligarchs’ • Competition policy • Bankruptcy legislation After privatisation? • New business creation • Small and Medium Sized Enterprises (SMEs) • Ease of registration • Tax regime • Access to capital • Problem of state interference – national and local – opportunities for bribery

33. Transitional Economies in Theory and Practice Post-communist economic transformation - practice

34. Transitional Economies in Theory and Practice Outline: • How transition unfolded in practice: output, privatization, social consequences, political developments. • What explains patterns of economic performance? • What explains patterns of institutional development?

35. Transitional Economies in Theory and Practice Leading figures in post-communist economic transformation Jeffrey Sachs Anders Alsund Marek Dabrowski Peter Murrell (Harvard) (Sweden) (Poland) (USA) Leszek Balcerowicz YegorGaidar (Poland) (Russia) AnatoliiChubais (Russia) Václav Klaus (Czech Republic)

36. Transitional Economies in Theory and Practice Reform measures With varying speed and sequencing, most countries undertook a common set of measures: • Liberalisation – domestic: freeing most prices, allowing market forces to develop, freedom of trade and business • Liberalisation – external: reducing state control of foreign trade, adoption of tariff regimes, moves towards convertible currencies • Stabilisation: measures to bring economy into balance and reduce inflation – new monetary policy – moves toward positive real interest rates, new fiscal policy (including new taxes – VAT, profits tax, etc), new approach to budget and its role in the economy; spending cuts/changes • Privatisation: changing property relations – large and medium enterprises, SMEs, land, housing, etc • Institution building: new institutions for market economy • Social support: creation of at least basic social safety net, unemployment benefit system (as allowed by state of budget).

37. Transitional Economies in Theory and Practice • Output decline: • Chaos and uncertainty of transformation • Break down of supply links • Reduction of value subtracting output • But, problems of measurement – growth of new businesses and informal, • unregistered economic activity. • Inflation: • In some cases at very high rates (Ukraine, 1992-3, Russia, 1992-3, etc) • Persisted when stabilisation policies not pursued rigorously or consistently • Budget deficits: • Problems of reducing spending, especially social • Ineffective tax reforms and inadequate measures to collect taxes • Deliberate tax avoidance • Unemployment: • In some cases grew rapidly to rates of 15% or more (e.g. Poland) and • proved to be persistent Impact of measures in early years of transformation

38. Transitional Economies in Theory and Practice Privatisation in practice Basic methods of privatisation (medium and large enterprises) • sale to outside owners (‘retail’ privatisation) (primary method in Estonia, Bulgaria, Hungary) • mass privatisation – vouchers (free, or for payment; named, or anonymous) (primary method in Czech Republic, Russia, Latvia, Lithuania, Armenia, Georgia, Moldova, Kazakhstan, Kyrgyzstan) • management or employee buy outs (primary method in Poland, Slovakia, Romania, Ukraine, Tajikistan and Uzbekistan) • restitution (restoration to pre-communist owners) (in some Central, Eastern European and Baltic countries) In Russia, 1995, ‘loans for shares’ as a process chosen more for political expediency, i.e., ‘Eltsin’s 1996 presidential campaign against the then potent CPRF. In some countries very limited and slow privatisation, e.g. Belarus

39. Transitional Economies in Theory and Practice Private sector share of GDP, % Source: EBRD

40. Transitional Economies in Theory and Practice Social consequences of transformation To varying degrees in different countries with changes over time: • Unemployment • Widening of income and wealth differentials (new poor, ‘oligarchs’) • Development of social and health problems – homelessness, alcoholism, drug abuse, HIV-AIDS • Demographic consequences – reduced birth rates, increased death rates (although continuation of pre-existing trends) • Growth of crime and corruption But • New freedoms – consumption, travel, occupation, expression • New career opportunities Winners and losers of transformation • Winners – tend to be those with good education, young, urban, well connected(?) • Losers – tend to be those with poor education, older, rural

41. Transitional Economies in Theory and Practice Level real GDP in 2007 cf 1989 (1989 =100) Recovery and growth Source: EBRD

42. Transitional Economies in Theory and Practice GDP in CIS economies, 1991 - 2004

43. Transitional Economies in Theory and Practice • Average of scores for: • Large-scale privatisation • Small privatisation • Enterprise restructuring • Price liberalisation • Trade and foreign • exchange system • Competition policy • Banking reform Transition indicator scores – EBRD Average score, 2008

44. Transitional Economies in Theory and Practice Relationship between economic growth and EBRD transition scores Is there any relationship? If not, what does this mean? Well, the top-left quadrant is empty, so reform certainly doesn’t do any harm

45. Transitional Economies in Theory and Practice Patterns of performance • As a rule, Central and East European countries have undertaken more far-reaching reforms and have shown strong economic growth. The southern countries –Bulgaria and Romania, which joined the EU later, have not performed as well, nor did they undertake reform as quickly. • Of the ex-USSR countries, the three Baltic economies have achieved the highest transition scores; overall, their performance has been similar to that of the CEE countries • Of the CIS countries, the most impressive growth has been shown by economies undertaking modest reforms – Turkmenistan (oil and gas), Azerbaijan (oil and gas), Belarus (subsidised by Russia). As a rule, the CIS countries have not undertaken reforms as far-reaching as those in the CEE/Baltic countries and rates of growth (with the exceptions indicated) have been lower.

46. Transitional Economies in Theory and Practice Patterns of performance – why? • The CEE countries and the Baltic states lived under communism for a shorter period than Russia and the other ex-Soviet countries. The planned economy was not so deeply institutionalised and attitudes were not so moulded by the experience of life under socialism. • The CEE and Baltic countries have also had more democratic political systems and stronger civil societies than Russia and other CIS states and this appears to have favoured successful market reforms. They are also less dependent on resource-based development than some CIS economies. • The CEE and Baltic countries from the outset had a realistic prospect of joining the EU and this focused the post-communist transformation process, providing an external ‘anchor’. • This prospect was not open to Russia/CIS countries, although ‘neighbourhood’ status has had some impact in Ukraine, Moldova and the Caucasus (Armenia, Azerbaijan, Georgia). • In Russia, the protracted accession process for WTO membership has played some role in focusing reforms, but this has diminished over time as accession has become increasingly illusive. Without WTO membership Russia cannot join the OECD, which also has potential as an external anchor. Russia is being considered for membership but prospects are now not good.

47. Transitional Economies in Theory and Practice Summary: patterns of performance – why? • Institutional reform most important, although not always decisive. • Other factors include: • Political stability - Frozen states (Belarus, some in Central Asia) performed well. • Initial conditions – the richer you were in 1989, the more likely you are to be rich in 2007. • Natural resource endowments – mineral rich countries have higher per capita income levels, especially 2000-2008. But negatively associated with institutional reform.

48. Transitional Economies in Theory and Practice Explaining institutional change in transition economies What is important: • Structural change (initial conditions, proximity to EU, FDI) – countries with more diverse economic structures have greater political competition. • Initial economic conditions – more sophisticated production structures in 1980s lead to greater sophistication later on. • Initial choice of institutions – countries that adopted parliamentary systems in early post-socialist period made greater reforms. But what ‘caused the cause’? Structure of economy? • All suggest path dependency is of paramount importance, lending weight to institutional explanations. This applies to cases of positive change, as well as negative – institutional ‘lock in’ occurs after early 1990s with few exceptions.

49. Transitional Economies in Theory and Practice SUMMARY: 1. Widespread desire – in early stages, at least – to create markets and democracies 2. Initial consensus was on Washington Consensus prescriptions. 3. As reforms stalled, recognition that reforms should be tailored to institutional environment. 4. Privatization, in particular, was a highly contentious and politicized process that was often subverted because of unfavourable institutional environment. 5. But to say that ‘good’ institutions in sense of WC caused growth is not entirely accurate; rather, formal institutions that match informal institutions is more important in explaining economic performance – so, appropriateness. 6. This is illustrated by patterns of performance. 7. Notwithstanding the above, positive WC institutional reform didn’t tend to cause any harm prior to 2008. 8. Drivers of institutional change appear to be structural-economic in nature – more structural change, more institutional change, and vice versa. 9. Politics – and any assessment of political risk – needs to appreciate close links with economic structure in emerging Europe.