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Interview with Odling-Smee Healthy private sector, rule of law, accountability are key in transition to market economy

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2000
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IMFSurvey: The economies in the European II Department reflect a wide range of progress along the transition path. What accounts for these differences?

Odling-Smee: There certainly are big differences. At one extreme are the three Baltic countries—Estonia, Latvia, and Lithuania—which are all applying for membership in the European Union. At the other extreme are three countries that have not moved very far at all in the reform process—Belarus, Turkmenistan, and Uzbekistan. In between are nine countries in various stages of reform, including the big ones, Russia and Ukraine. The immediate reason for these differences is that the countries have made different policy choices. The fast reformers wanted to go in the direction of a market economy. The slow reformers wanted to stay fairly close to a planned economy and were reluctant to take some of the major steps needed to introduce market mechanisms throughout the economy. The ones in between have all started down the road toward a market economy but have not always been able to institute the needed changes quickly enough.

Of course, you can take the question further back: why did they make these different policy choices? One, obviously oversimplistic, but interesting, view is that the policy choice depends on proximity to western Europe. It’s not that simple, but there is obviously some basis for saying that the westernmost countries geographically were also those most aware of how to operate a market economy both from their own history and from their more significant contacts with western countries, even during Soviet times. The more eastern countries tended to be primarily within an isolated economic and political system and were therefore less able to see the benefits of moving quickly to a market economy.

The central European countries—Poland, Hungary, the Czech Republic, and Slovakia—have certainly moved faster because they felt closer to Europe. And now, of course, they feel the attraction of Europe; they want to do whatever is needed to get into the European Union.

IMFSurvey: How does the IMF take account of these differences?

Odling-Smee: We try to treat each country according to its merits, to take account of what it needs from the IMF, and to respond accordingly. So, for example, in the area of technical assistance, in countries that have not moved very far toward developing a sophisticated central bank, our monetary experts advise them on the more elementary features of central banking. In countries that have moved further along, the technical assistance would deal with the more sophisticated requirements of a central bank.

In finance, the three Baltic countries, which are the most advanced, are not short of money and are not borrowing from us. However, they value our policy advice, so they have precautionary Stand-By Arrangements, which enable them to interact with us on policy discussions but don’t involve their drawing any money. Farther east and south, the poorer countries in the Caucasus and central Asia do need the money, so our relationship is still a financial one. The types of reforms we discuss with them are less advanced than those we discuss with the Baltic countries.

IMFSurvey: What role should the private sector be playing in these transition economies?

Odling-Smee: This question is right at the heart of the transition process, because the transition process, in its essence, involves dismantling the old government-controlled economy and creating an environment within which the private sector can grow. The countries have reached different levels of achievement in this respect. The Baltic countries have created an environment in which the private sector is thriving. In Russia and Ukraine, progress has been made in creating a good environment for the informal sector and for small retailing businesses. Russia has also made some progress in privatizing medium- and large-scale enterprises, although these enterprises don’t always operate like truly private enterprises. They still have a rather close relationship with government. But in all countries except the Baltics, conditions are not very favorable for legitimate private sector activity, and the private sector is therefore not playing as large a role as it might have at this stage of the transition.

IMFSurvey: The transition process in some countries appears to have stalled. What caused this “partial reform,” and how can the process be restarted? What role can the IMF play?

Odling-Smee: In some stalled economies, attempts to create a more favorable environment for private enterprise are blocked by people who “got there first” and now want to prevent competition from newcomers. Countries at an intermediate stage between central planning and market economies have not yet developed the characteristics of a rule of law necessary for a market economy to work. The vested interests that got there first have managed to accumulate a lot of economic and political power, which they use to protect their own position, while the legitimate political authorities feel that they don’t have the power to overrule these interests, break up these groups, and introduce level playing fields into economic and commercial legislation and practice.

The situation is not all gloomy, however. Many small and medium-sized businesses are operating in a more competitive way and are able, through the political process, to have a positive influence on the legislative environment. I believe that, in the long run, such influence will be constructive, as it has been in most western countries.

The IMF, of course, is not able to go in and change this sort of situation overnight. We can probably have an influence only at the margin. But there are a number of things we can do. First, we can explain to people what is going on, especially people inside the country. Second, we can advise the government directly on policies that would produce a more liberal system with more competition and therefore more opportunities for satisfactory development of the private sector. Third, if we have financial relations with the countries, we can, through our conditionality, try to have an impact on the measures that reform-minded governments may wish to implement. In attempting to do so, however, we may meet with resistance from vested interests.

IMFSurvey: What are the main impediments to growth in the central Asian and Caucasus regions?

Odling-Smee: For the major oil and gas exporters—Azerbaijan, Kazakhstan, and Turkmenistan—growth in the energy sectors is reasonably assured. The big challenge is to avoid the “Dutch disease” and ensure that other sectors of the economy have the opportunity to develop. Armenia, Georgia, Tajikistan, and the Kyrgyz Republic are relatively poor, however. Here, the major challenge is to create the conditions in which the private sector can develop, to make private activity a more attractive proposition. The authorities in these countries tend to believe that nobody has any money or is willing to invest in them. That is really not true. Even in the poorest of the countries, there are people who have made quite a bit of money and would invest if circumstances were right. And there is also some interest from foreign investors. So those countries need to create opportunities for investment, which means liberalizing the system and strengthening the rule of law so that property rights are protected, and, above all, corruption is reduced.

IMFSurvey: Some observers have suggested political economy considerations may not have been given adequate weight in decisions about the pace and sequencing of reform. Are these considerations relevant?

Odling-Smee: The general view that the IMF has held throughout the transition process—that a comprehensive and rapid reform is the best approach—has been based largely on political economy rather than on more technical considerations. We expected at the beginning that there would be quite a lot of resistance to reforms. What led many, including in the IMF, to favor rapid reform was the belief that if the reforms were not instituted all at once, political opposition would quickly build up and would prevent the reforms from going much further. Experience has shown this to be correct.

What lessons of a political economy nature might we want to draw for the future? For many countries, there is an implicit, and in some cases, explicit bargain between the political leadership and the leaders of major economic groups to conduct economic policy in the interests of those groups and not try to create a more open, liberal, and competitive system that would allow more new businesses to start up, including through foreign investments. We need to think of ways of loosening that coalition, to make it easier for policymakers to move in a liberal direction.

IMFSurvey: Russia’s problems, including debt and widespread corruption, seem overwhelming. What has gone wrong with Russia’s reform programs, and what is the current thinking in the IMF on Russia’s prospects?

Odling-Smee: One can answer the question of what went wrong at various levels, starting from the fairly narrow perspective of the IMF. We have been very concerned about Russia’s fiscal difficulties, which at least up to last year came about largely because enterprises were not willing to pay the full amount of tax and the government didn’t have the authority to extract the tax from them. The result was a serious and persistent revenue shortfall. This failure of the government to collect taxes means that enterprises are not subject to hard budget constraints. In those circumstances, the market economy doesn’t work properly, and the transformation of the economy is impeded.

But I’d like to dwell a little more on the future because I think there are grounds for optimism, including the quality of the debate within Russia in the last 6 or 12 months about what is needed. I’ve been impressed with the consistent and clear message coming from the current Russian leadership—that they have to behave like a civilized country, which is a special expression used in Russia that means a law-based society and economy. Not only are they saying these things, but they know what kinds of laws they should have and what sanctions they should have in place for those who don’t obey the law. The chances are therefore higher than they have been that Russia will become more law abiding, including in the tax arena. The stronger economy in the last year or so is also making it easier to move in this direction.

IMFSurvey: In September 1999, the IMF suspended its $2.6 billion Extended Fund Facility (EFF) credit line to Ukraine after it failed to fulfill a number of conditions. What efforts are being made to restart the credit line? What obstructions remain?

Odling-Smee: Ukraine has been very slow to reform, and until late last year, we were rather disappointed in its performance and were continually encouraging it to speed up the reform process. At the time of the suspension of the EFF in September of last year, we made absolutely clear that after the presidential elections in November, the authorities should launch a major acceleration of structural reforms; otherwise, we would not be able to resume financial assistance. I am pleased that the authorities have made good progress on structural reforms this year, and I hope they can complete a structural reform package that would really signify a break with the past and would, when implemented, show that Ukraine was now joining the countries that are moving toward a market economy at a decent pace. If that is the case, I expect that the IMF would resume financing.

IMFSurvey: The IMF has had to contend with misreporting of data and misuse of its funds in some transition economies. How great an impediment is this?

Odling-Smee: The cases that have come to our attention and to the attention of the wider public have all been investigated up to now. No evidence has been found so far of any misappropriation of funds, in the sense of IMF money falling into the wrong hands. A different problem has caused us some difficulty, however—misreporting by the authorities of the status of some of their monetary and international reserves figures. Some of that misreporting has been due to administrative inexperience, especially in some of the poorer countries. In other cases, it seems to have been an attempt to avoid the implications of not being able to report figures that would qualify them for the next disbursement from the IMF. To put that in context, one has to understand that the governments in the countries in the European II Department are all operating new systems. There were no national governments in these countries, just the local regional offices of the relevant Soviet Union ministries. There is a long tradition of misleading the central ministries in Moscow; and the local governments have some-times regarded agreements they had with people from outside the country, including the IMF, as having similar characteristics. I think that this has changed and will continue to change over time—first, as the economic situation gets a little easier, so government officials don’t feel under quite the same pressure; and, second, as they develop a greater understanding of the importance of straightforward dealing with partners in other countries and even within their own country. The whole process of transition is producing a realization that honest dealing is the way to conduct all relations, including with government and with international organizations. So I think that we will see misreporting disappear and not be an issue in the future.

IMFSurvey: Do you see the venue for this year’s Annual Meetings—the Czech Republic—as symbolically significant for the other transition economies?

Odling-Smee: It is good that the meetings are in a transition economy. The IMF’s activities in transition economies over the past 10 years have been a very important part of our work. At the peak of our efforts, one-third of the IMF’s technical assistance was going into the former Soviet Union countries—more than that if you add the central and eastern European countries. That is an enormous effort by the IMF. It was very successful at the level of technical assistance, especially in developing central banks and in various aspects of fiscal work. Our financial activities were very successful in a number of countries, and in all countries we had a big impact on macroeconomic stabilization, both in explaining why and how it was important and in creating the financial and moral support necessary to bring it about. By holding the meetings in Prague, we are recognizing both the achievements of the countries in transition and the contribution of the IMF to those countries.

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