Front Matter

Front Matter

Author(s):
James Roaf, Ruben Atoyan, Bikas Joshi, and Krzysztof Krogulski
Published Date:
October 2014
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    © 2014 International Monetary Fund

    Cataloging-in-Publication Data

    25 years of transition : post-communist Europe and the IMF / James Roaf, Ruben Atoyan, Bikas Joshi, Krzysztof Krogulski and an IMF staff team. – Washington, D.C. : International Monetary Fund, 2014.

    p. ; cm. – (Regional economic issues special report)

    Includes bibliographical references.

    1. Former communist countries – Economic policy. 2. Former communist countries – Economic conditions. 3. International Monetary Fund. I. Roaf, James. II. Atoyan, Ruben (Ruben V.) III. Joshi, Bikas. IV. Krogulski, Krzysztof. V. International Monetary Fund. VI. Series: Regional economic issues special report.

    HC244.A15 2014

    ISSN: 2071-4157

    ISBN: 978-1-49830-563-1 (paper)

    ISBN: 978-1-49834-201-8 (web PDF)

    ISBN: 978-1-49833-218-7 (ePub)

    ISBN: 978-1-49835-212-3 (MobiPocket)

    The Regional Economic Issues (REI) is a series published to review developments in Central and Eastern Europe. The policy considerations in this REI Special Report are those of the IMF staff and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

    Publication orders may be placed online, by fax, or through the mail:

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    Approved by

    Aasim M. Husain

    Prepared by a staff team from the European Department led by James Roaf (Senior Resident Representative, CEE Regional Office, Warsaw), Ruben Atoyan, Bikas Joshi (Resident Representatives to Bosnia and Herzegovina and the Russian Federation respectively) and Krzysztof Krogulski (Warsaw Office); and including Armine Khachatryan, Daehaeng Kim, Guillermo Tolosa (Resident Representatives to Moldova, Serbia and Bulgaria/Romania respectively), Michael Gorbanyov, Ricardo Llaudes, Jesmin Rahman, Joanna Swirszcz (Washington DC), Irena Jankulov (Sarajevo Office), Desanka Nestorovic and Marko Paunovic (Belgrade Office). Additional contributions were made by Martin Gilman (Higher School of Economics, Moscow), Anne-Marie Gulde-Wolf (AFR, Washington DC), Nemanja Jovanovic, Christoph Klingen (Washington DC), Octavian Scerbatchi (Chisinau Office) and Robert Sierhej (Warsaw Office). The report was edited by James Roaf, with the invaluable assistance of Joanna Swirszcz. Helpful comments on earlier drafts by country teams, other IMF departments, and others outside the IMF, are gratefully acknowledged.

    25 Years of Transition: Post-Communist Europe and the IMF

    October 24, 2014

    Executive Summary

    The past 25 years have seen a dramatic transformation in Europe’s former communist countries, resulting in their reintegration into the global economy, and, in most cases, major improvements in living standards. But the task of building full market economies has been difficult and protracted. Liberalization of trade and prices came quickly, but institutional reforms—in areas such as governance, competition policy, labor markets, privatization and enterprise restructuring—often faced opposition from vested interests.

    The results of the first years of transition were uneven. All countries suffered high inflation and major recessions as prices were freed and old economic linkages broke down. But the scale of output losses and the time taken for growth to return and inflation to be brought under control varied widely. Initial conditions and external factors played a role, but policies were critical too. Countries that undertook more front-loaded and bold reforms were rewarded with faster recovery and income convergence. Others were more vulnerable to the crises that swept the region in the wake of the 1997 Asia crisis.

    In contrast to the turbulence of the first decade of transition, the early and mid-2000s saw uniformly strong growth. With macroeconomic stability established and key market-based frameworks largely in place, the region experienced large capital inflows, supported by a benign global environment and increasing confidence in rapid convergence with Western Europe—especially for those countries that joined the EU during this period. Widespread foreign bank ownership brought much-needed credibility and technical know-how, and facilitated the provision of financing to the region—indeed to excess, causing growth to become increasingly imbalanced. The resulting vulnerabilities were exposed when the global and euro zone crises struck at the end of the decade, hitting the region harder than any other.

    In the wake of these crises, countries embarked on significant consolidation, although some continue to struggle to restore competitiveness and fiscal sustainability against the backdrop of slow growth and lingering structural weaknesses. New analysis shows the effect of widening disparities within the region: the more advanced countries now have more in common with Western European economies than they do with some other former communist countries. But even in the better-performing economies, the pace of convergence has slowed substantially. And reform momentum has generally slowed over the years, with a risk of reversals emerging in a few countries.

    To revitalize the convergence process—and, for some countries, to reduce the risk of falling back into crisis—stronger commitment to market-based policies is needed. Two broad priorities stand out. First, a renewed focus on macroeconomic and financial stability in some countries, to rein in persistent deficits and increasing debt, and to address rising levels of bad loans in banks. Second, to raise the pace and depth of structural reforms in areas such as the business and investment climate, access to credit, public expenditure prioritization and tax administration, and labor markets.

    The influx of new member countries at the start of transition was a huge challenge to the IMF both operationally and intellectually. The IMF has been closely involved with the region ever since, providing a mix of policy advice, program lending and specialized training and technical support as country needs have evolved.

    Country coverage and codes

    The report covers the European transition economies up to Belarus, Moldova, Russia, and Ukraine among the former Soviet republics. The full set of transition countries is broader, including the Caucasus and Central Asian republics and even countries such as Mongolia and Vietnam. But in order to have reasonably consistent country groupings for analytic purposes, the report follows the division of countries used within the IMF’s internal organizational structure. And it does not cover the experience of former East Germany, which has naturally followed a different path than the other transition economies, and with which the IMF has only had indirect involvement via its surveillance of unified Germany.

    The following regional aggregates, country codes and flag markers are used in the report:

    Central and Eastern Europe (CEE) refers to the full set of countries listed above. CEB refers to CE5 plus the Baltics. SEE refers to SEE EU plus SEE xEU. Averages are unweighted unless stated.

    Structure and focus of the report

    This report sets out the main features of the transition in chronological chapters that alternate with chapters on the main thematic issues from a macroeconomic perspective. The final chapter examines whether it is still relevant to consider the transition economies as a group, and points to key policy challenges going forward.

    The main focus is on macroeconomic developments, this being the IMF’s principal area of operations and expertise. At the same time, the report tries to summarize progress at the micro level, recognizing that the transition to a market economy is at heart a transformation of legal and economic institutions, and of individual firms and households’ incentives and behaviors. In compressing the experience of more than 20 countries over 25 very eventful years, the report inevitably focuses on broad themes, and cannot do justice to the nuance and diversity of individual country narratives.

    The report highlights the IMF’s role during the transition. But the IMF was only one of a number of agencies that have supported these countries over the past 25 years. While the IMF took a lead role in the early phases of transition, for many countries the process of accession to the European Union (EU) has been the most important catalyst for reform in later phases, and European integration remains today a main driver of structural change. Other key players include the European Bank for Reconstruction and Development (EBRD), European Central Bank (ECB), European Investment Bank (EIB), and World Bank, as well as bilateral country donors and private and voluntary sector institutions. But whether from the IMF or others, the impact of external assistance pales in significance to domestically-driven reform and development—which is the principal subject of the report.

    The report was prepared by a team drawn mainly from the IMF’s offices in the region. The views presented are those of the authors.

    Foreword

    David Lipton, IMF First Deputy Managing Director

    Nearly a generation has passed since Central and Eastern Europe embarked on its historic transition from communism to capitalism and democracy. Many people both in the region and beyond have little or no memory of the old systems, nor the remarkable transformation path that brought the people and countries in the region to where they are today. So, the twenty-fifth anniversary of the launching of reform is a fitting time to remind ourselves what was done, recall the people who did it, and ponder the lessons learned. The IMF, which was called upon by incoming governments in the region for advice and financing, played an important supporting role in this transition, and thus we have a unique vantage point.

    Having myself been involved in the early days of reforms in Poland and a couple of other countries in the region, I have a personal perspective on what happened. Looking backward at history, as we must, there is often a temptation to conclude that what happened was natural, even inevitable. In the case of the transition in Central and Eastern Europe, that would be a mistake, and a mistake that diminishes the scope and scale of the accomplishment, and that obscures efforts to discern what worked and why. I know from my experience that looking forward during the inception of reforms, the prospects for transition were daunting. In fact at first, most observers thought the effort would not succeed.

    Economies were weighed down by state ownership and relative prices deliberately distorted to favor the buildup of heavy industry. Fiscal and monetary policies, which had aimed at supporting industrial growth rather than achieving macroeconomic balance, had produced chronic excess demand and widespread shortages of goods. By the end, that chronic excess demand had also led to unsustainable external debt and high or hyperinflation. Unfortunately, only a small number of economists or policymakers in these countries at the time had much education or experience that prepared them for the complex tasks ahead. In reality, neither modern macroeconomics, nor for that matter the history of the IMF itself, offered much guidance on such a novel transition. The IMF had helped countries overcome debt and inflation, but had no experience in designing and executing the sweeping changes needed to convert economies from the communist system to capitalism.

    So, how did it all succeed? I think four key factors played important roles.

    Great people. Courageous politicians and reformers stepped forward and took on the challenge of designing reforms and explaining their consequences to a wary public. Those reformers understood the historic nature of their task and boldly embraced the challenge of transition.

    Smart strategies. Reform strategies were developed to address the key imperatives of transition, the need to liberalize prices to reflect scarcity and facilitate resource allocation, stabilize finances to end chronic shortages and inflation, and privatize state companies and assets to begin a process of improved governance over companies and their capital. The countries that most fully addressed all three of these challenges made the quickest and most complete progress.

    Magnet Europe. After years of isolation from the Western economic system, and after the distortions and deprivations of the communist system, most citizens just wanted to live in a normal country with a normal economy, and, given their history and geography, that vision was captured in the allure of reintegrating with Western Europe. The historic offer from the European Union to countries in the region provided a gravitational pull that helped policymakers justify and implement difficult reform steps. As reform fatigue brought down governments and new ones took their place, the litmus test for any new policy was “will it lead us back to Europe?” a test that foreclosed much undesirable experimentation.

    External support. Debt and balance of payments pressures imposed harsh conditions on governments setting out to make structural reforms while coping with financial destabilization. Financing from the IMF, World Bank, EBRD and bilateral creditors, and in some key cases debt relief from official and commercial bank creditors, helped relieve those constraints. In time, support for privatization efforts, in particular of state owned commercial banks, helped smooth the way for improvements in resource mobilization and efficient resource allocation.

    Over the past quarter century, countries in the region have continued the transition, through elections, changes in governments, recessions, and more recently the global financial crisis. Some have upgraded laws, financial systems, and infrastructure sufficiently to become integral to powerful, emerging supply chains linked to advanced economies in the European Union. Others have more to do to complete their transitions, and create the prospects for convergence of living standards toward those in Western Europe. But even in the more successful countries, convergence is far from complete. At the outset of reforms, per capita GDP, on a purchasing power parity basis, in Poland was a third of that in Germany. Last year it was a little over a half. That is progress, but also a reminder that there is more to do.

    This volume provides a detailed assessment of twenty-five years of transition in Central and Eastern Europe. By assessing the past, we hope to recognize the remarkable accomplishments to date and contribute to the bright future that lies ahead.

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