It is by now evident to most observers that the successful economic transformation of the centrally planned economies will require major institutional reforms. To pursue policies associated with market economies, new institutions will need to replace existing ones. This process will require considerable time and effort, in particular, the reform of the financial sector and the creation of Western-style fiscal institutions. However desirable it might be to introduce reforms in a certain sequence, reality and the limited availability of certain skills will impose on the process a time sequence that may not necessarily be ideal. Eventually, however, these countries will achieve a kind of “social ecological balance” that will allow them to operate fully as market economies.
Because the subject of this paper is broad, it deals with major issues in broad strokes. It first discusses the very limited role that financial markets and fiscal institutions played under classical central planning. It also highlights the fragility of the traditional financial and fiscal establishment and explains why it could not survive the transition to a market economy. It then considers the main changes that must take place in financial institutions and investigates the role of commercial banks in mobilizing and allocating savings. The banks’ current problems, especially nonperforming loans, are addressed, and the fiscal implications of following a Chilean-style solution are detailed.
The paper then looks at the changes needed in fiscal institutions. This section briefly discusses the establishment of Western-style tax administrations, the main elements of the reform of the tax system, social security reform, the implementation of a modern budgetary system, and the reform of public expenditure, which will be conditioned by an almost inevitable fall in tax revenue. The paper cautions that simply transplanting Western institutions is likely to lead to disappointing results.
Finally, the paper calls attention to the many fiscal-monetary links that exist in these countries and to how difficult it is to pursue pure fiscal or pure monetary policies in isolation from each other. It explains that governments will be faced for some time with a choice between abandoning specific policy objectives and achieving them with relatively inefficient tools. Thus, fiscal objectives may have to be achieved with monetary instruments and monetary objectives with fiscal instruments.