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THE ECONOMICS OF TRANSITION

THE ECONOMICS OF TRANSITION. Central and Eastern Europe ref: transtnplus332cbs march 2010. Objectives. By the end of this lecture students should: be aware of the characteristics of a transition economy and major macroeconomic trends

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THE ECONOMICS OF TRANSITION

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  1. THE ECONOMICS OF TRANSITION Central and Eastern Europe ref: transtnplus332cbs march 2010

  2. Objectives By the end of this lecture students should: • be aware of the characteristics of a transition economy and major macroeconomic trends • understand why western economic policies were not be directly applicable • be able to understand and explain why some Central European Economies (CEEs) were able to join the EU, while others were not

  3. BACKGROUND • Planned economy v market economy • Performance of transition economies • Macroeconomic stabilisation & Microeconomic (institutional) reforms • How economic theory explains ‘U’ shaped response to output • How relevant is western macroeconomics?

  4. TRANSITION(transformation) • Change from a centrally administered economy (CAE) to a market economy (ME) • Main issues considered here -see handout • property rights • domestic prices • domestic output & employment • financial institutions • budget revenue • Hard Budget Constraint (HBC) -Kornai ‘The Socialist System’

  5. INITIAL PERFORMANCE OF TRANSITION ECONOMIES • See handout with data • Progress in transition • inflation • output • unemployment • budget • Poland(1st 1/1/90),Romania, Russia

  6. STABILISATION POLICIES • Similar menu in countries. Choose speed and sequence • Initial fall output in all countries - bigger than expected • Macroeconomic stabilisation • Microeconomic (structural) reforms • For CREDIBILITY -simultaneous announcement

  7. (Macro) Stabilisation package • Price liberalisation -cornerstone of ME • Macroeconomic stabilisation • low inflation - Restrictive monetary policy • Incomes policy • Balance budget • Foreign trade liberalisation

  8. Structural measures:institutional reforms (micro) • Market environment • banking sector • financial sector • tax structure • commercial law • Privatisation • Others

  9. APPLICATION • Initial debate : • Shock therapy v gradualism • Sequencing • Debate late 1990s; why did output fall sharply? • See O Blanchard ch2 for relevant theory How do we achieve future sustainable growth? • Transformation traps (Portes, 1994) • overemphasis on macroeconomic policy • inadequate micro foundations • financial intermediation not developed

  10. Macroeconomic policies • Some argue tight macro policies lead to fall in output • Others (Blanchard, Begg); macro policies not the principal driving force • Sound macro fundamentals necessary but insufficient for stabilisation (Begg) • may be undermined by inadequate structural reform

  11. Example: monetary policy • A major transformation trap - not recognise key role of banks (Portes) • transition banks learning the market system (ab initio) - mistakes in lending • Eg1.Firms avoided HBC • undermines interest rate as instrument of monetary policy • Eg2.Composition of credit distorted • Eg3. Higher interest rates - - - increased loans ! • adverse selection problem

  12. LATE 1990s/ 2000s • 3 CEECs, (Poland, Czech, & Hungary), in particular strengthened the performance of market supporting institutions, • Successful transformation to market economies • GDP rose above pre-transition levels • Similarly for Baltic states & Slovenia • EU accession countries

  13. SE Europe & Russia - lagging • Some CAEs have still not reformed sufficiently to enter the EU • Divergent patterns of economic reform mirrored by political reform (EBRD 2003) • Thus, political reform & credibility are vital

  14. Post accession: consider benefits/costs to CEEs & EU • Include; • Budget • Competitive pressure on EU15 & EU global competitiveness • Anglo-Saxon / French /Nordic approaches in EU? • Opportunites and threats for EU15 • Agriculture • Structural funds • Migration • Voting & decision making

  15. FDI • Trade flows

  16. Credit Crunch & CEECs • EBRD Transition Reports - Good source

  17. CONCLUSION • The nature of CAEs & market economies varies significantly • This summary indicates that stabilisation policies were important, and a lack of structural reform was a major feature • Credibility of reforms important • Output initially fell further than expected, but did recover in CEECs

  18. Additional references • Refs for Fiscal & Monetary policy • Begg,’Monetary policy during transition; progress & pitfalls in Central & Eastern Europe,Oxford Review of Econ Policy,vol 13,no.2 ,1997 • Buding & Van Wijnbergen,’Fiscal policies in Eastern Europe’ as above • Papazoglu et al, ‘Potential trade effects of the 2004 enlargement’, World Economy 2006

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