Summary of WP/92/59
“The Output Decline in the Aftermath of Reform: The Cases of Bulgaria, Czechoslovakia, and Romania” by E.R. Borensztein. D.G. Demekas, and J.D. Ostry
This paper analyzes a number of issues surrounding the declines in economic activity experienced by three Eastern European countries --Bulgaria, the Czech and Slovak Federal Republic, and Romania--in the period since market-oriented reforms were initiated in these countries. As the review of developments in these three countries indicates, price and trade liberalization--including the dismantling of CMEA trade practices--should set in motion a series of changes that, over time, would be responsible for a radical transformation of their productive structures. This process of resource reallocation could easily generate a decline in aggregate output initially, especially if an expansion of activities that were profitable under the new relative price structure was delayed by significant adjustment costs and uncertainty.
Apart from these long-term, “structural” factors, output in the three countries under review has also been affected by more conventional macro-economic forces. The combination of large increases in domestic energy prices (as subsidies for energy use were reduced) and policies necessary to contain inflation in response to price liberalization created a contractionary situation for output owing to both supply-side and demand-side factors. This raises two empirical questions that may help to explain the declines in output in these three countries. First, to what extent did the fall in output for each country reflect structural change (a reallocation of resources across sectors) rather than a conventional recession? Second, to what extent have demand-side versus supply-side forces been dominant in generating the output decline? The paper uses simple econometric techniques to investigate these two questions. Regarding the first, the empirical findings are remarkably strong in pointing toward conventional macroeconomic factors as the main explanation for the output declines. Regarding the second, the findings are more mixed.