Journal Issue

Cato Institute event: Are we there yet? Åslund assesses progress of transition economies after a decade

International Monetary Fund. External Relations Dept.
Published Date:
January 2002
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The race to transform centrally planned economies into market economies has led, 10 years later, to one group of countries approaching the finish line, a second positioned about half-way down the track, and a third group barely off the starting blocks. According to Åslund, radical reformers in Central Europe and the Baltics have already built democratic and dynamic market economies and are knocking on the doors of the European Union. Among the gradual reformers—Bulgaria, Romania, Russia, and most former Soviet Republics—there has been uneven progress toward democracy and a market economy. Although these remain “rent-seeking economies,” their prospects may have improved in recent years. The nonreformers—notably Belarus, Turkmenistan, and Uzbekistan—have maintained firm dictatorships with state-controlled economies. The novel part of Åslund’s presentation dealt with his views on why the prospects for the gradual reformers may be rosier than generally believed.

Supply-siders relocate to Russia?

Economic growth over the past few years in many of the gradual reformers has come as a surprise to most economists. High oil prices, and a temporary boost to exports from the depreciation of the ruble following the 1998 crisis, are typically credited for the good economic performance of countries such as Russia in recent years. But another reason, Åslund suggested, may be that the gradual reformers have been moving from a system of “high taxes paid by a few to low taxes paid by many.”

During much of the transition process, Åslund said, high taxes—and the opportunities they offer for extortion—have suppressed honest entrepreneurs, while dishonest businessmen have benefited from large subsidies. This tended to depress growth, particularly in countries like Russia and Ukraine. But now, he observed, the tide has turned. The current fashion in the region is drastic tax reduction, along the lines of the supply-side revolution unleashed by Ronald Reagan in the United States in the 1980s.

The trendsetter in this regard was Estonia, which implemented a 26 percent flat rate of personal income tax in 1994. Latvia and Croatia also moved to a flat-tax system; then in April 2001, Russian President Vladimir Putin unveiled a 13 percent flat tax. Through much of the region, Åslund said, there has been a sharp reduction in the number of taxes; personal income taxes are now subject to flat rates of 10–20 percent; corporate-profit and payroll taxes have been lowered; and taxes for individual entrepreneurs are low and levied on a lump-sum basis. With lower tax rates, Åslund noted, tax revenues have actually risen and taxes are less likely to serve as a means of extortion.

Privatization better than its reputation?

Åslund also challenged conventional wisdom about the benefits to the gradualist reformers from privatization. It is a “pipe dream,” he argued, to think that privatization should occur only after sound (non-corrupt) institutions are in place. If that became a precondition, privatization would never take place; the real choice, he said, is “dirty privatization or none.” Åslund noted that mass privatization of the kind carried out by Russia had acquired a bad name because of the corruption associated with some of the deals and because it did not appear to have changed the incentives for managers and workers.

But the benefits of privatization do kick in after the share of the private sector in the economy reaches a threshold level of, say, 60 percent of GDP, according to Åslund. Before that point, with most of the public sector still up for grabs, people focus on rent seeking and deal making. But once the bulk of the economy is privatized, the incentives turn toward improving the quality of enterprises through a clearer definition of property rights, better corporate governance, and greater transparency in operations. Fischer agreed—to a point. Privatization, he said, had indeed conferred benefits in terms of increased economic growth, but some schemes—for example, the loans-for-shares scheme in Russia in 1995—had gone well beyond the pale in terms of corruption.

So why is capital still fleeing?

If the prospects of these gradual reformers are on the mend, why does capital continue to flee? In Russia, for instance, capital flight is generally estimated at about $20 billion a year. In sharp contrast, private capital returned quickly to the radical reformers once the direction of reforms was clearly established. In the Central European economies, net outflows of $15 per capita reversed to net inflows of $75 per capita a few years after the start of reforms. Likewise, in the Baltics, net outflows of $30 per capita turned into net inflows of $70 per capita once the reforms took hold.

If Russia is at a similar point of takeoff, why does capital flight persist? Åslund attributed continued capital flight to the absence of a strong banking system. “The Russian citizens’ bank is located outside Russia,” he said. Income was being generated in Russia as its prospects improved, but Russians were unwilling to trust their savings to domestic banks. Even the Bank of New York scandal, according to Åslund, was actually a case of “sensible Russians transferring their money holdings abroad.”

No U-turns on road to capitalism?

A decade after the fall of the Soviet Union, Åslund had no fears the gradual reformers would turn back to communism. Westerners, he said, are more worried about transition economies returning to central planning than are the people in these countries. Fischer agreed with this assessment, noting that an early study by Yale economist Robert Shiller showed that people in New York and Moscow had quite similar attitudes toward market economies. (Fischer alluded to the widely used quip that the similarity in attitudes may have arisen from the fact that many New Yorkers are socialists!)

EBRD structural reform index: the pace has varied considerably

Data: European Bank for Reconstruction and Development

Capital flight reversed in Central Europe and Baltics, but continues in Russia

(dollars per capita)

1Left bar is for 1990–92; right is for 1993–96.

2Left bar is for 1992–94; right is for 1995–98.

3Left bar is for 1994–98; right is for 1999–2000

Data: IMF, International Financial Statistics

Åslund and Fischer were also in accord that having a clear external goal helps focus the minds of reformers and the populace. For the radical reformers, the promise of accession to the European Union and the desire to be thought of as part of the West helped generate support for market-oriented reforms and democracy. IMF programs had also served this purpose to some extent by giving countries clear targets and a coherent framework within which to carry out reforms. It may be that, in the post–September 11 environment, Russia has moved more clearly into the Western sphere. This may, Fischer said, give its reform efforts added impetus.

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