Abstract

Jonathan Anderson, Daniel A. Citrin, Ashok K. Lahiri

Jonathan Anderson, Daniel A. Citrin, Ashok K. Lahiri

The poor and deteriorating growth performance of the economy of the U.S.S.R. from the mid-1970s to late 1980s was a major cause of its demise in 1991.1 The 15 states that emerged from the territory of the former Soviet Union launched their systemic transformations from central planning to markets with the primary objective of reversing this declining trend and improving the output performance of their economies. Since the dissolution of the U.S.S.R., however, recorded output has fallen significantly in all of these states. Following a decline for the region as a whole of roughly 10 percent in 1991, real GDP in these states dropped by about one third on average in 1992-93, with a further significant deterioration in 1994 (Table 1.3).

The extent of recorded output decline has varied substantially across countries. Through 1994, the largest cumulative declines were registered in both Armenia and Georgia, where output in that year was roughly one third or less of its 1990 level. In contrast, in Belarus, Estonia, Uzbekistan, and Turkmenistan, real GDP in 1994 was as much as 65 percent or more of the level prevailing in 1990. Given the poor state of statistical reporting in the former Soviet Union, these estimates of output decline should be interpreted with caution. While there is no doubt that output has fallen substantially, it is likely that the decrease has not been as large as indicated by the official figures. First, statistical reporting in the state sector has generally deteriorated in the transition period owing to administrative disorder. Second, growth rates may be biased downward by the fact that incentives to overstate production in the planned economy have, under liberalization, given way to strong incentives to report as little revenue as possible, or to avoid reporting altogether. Third, production in the newly emerging private or informal sectors—where most new production and growth has been occurring—is poorly captured by official statistics.2

This section discusses the major reasons that could account for both the overall decline in activity and the observed differences in output performance across countries and identifies policy implications and determinants of renewed growth. It contains a brief survey of the major factors that have been hypothesized to play a role in the observed output decline, presents basic evidence across countries and sectors, and suggests some possible conclusions. It also addresses the prospects for recovery, including some observations based on the recent experience in Eastern Europe.

Output Decline

The 15 countries can be placed into three broad categories in terms of output performance since 1990 (Table 1.3). A first group consists of Armenia, Azerbaijan, Georgia, Tajikistan, and Moldova. These countries have been involved in armed conflicts and in some cases were subject to economic blockades, and have had large declines in output. A second group, Uzbekistan and Turkmenistan, are those with a large share of natural resource exports relative to the size of their economies. These two countries have experienced relatively small output declines, as fairly stable demand and favorable price movements for these exports buoyed economic performance. A third group, the other eight countries, have recorded a wide range of output performance that is generally between that of the first two groups of countries.

Notwithstanding these differences, the underlying trend in output has been negative and subject to a common set of forces in all 15 countries. In that regard, a number of explanations have been put forward. These include (1) sectoral shifts and aggregate shocks directly related to systemic change from a planned economy to a market-based system open to world trade; (2) institutional and political problems arising from the disintegration of the Soviet Union; (3) the monopolistic structure of traditional industries; and (4) overly contractionary monetary and credit policies. In the following, we argue that the first two sets of explanations are broadly consistent with the cross-country aggregate and sectoral data for the region, whereas there is little support for the latter two.

Factors Related to Economic Transition

The changing role of the state and the liberalization of domestic and external sector policies are likely to have contributed to the decline in output in these transition economies in a number of ways.3

First, during transition, the reduction in government coordination of economic activity is not instantly and fully replaced by market coordination. The consequent disruptions in input supplies and availability of credit, and marketing difficulties for enterprises, have contributed to what has been termed the “transformational recession.”4 In this context, the lack of a legal infrastructure and financial institutions appropriate for a market economy has been a serious impediment to the operation of a market-based system.

Second, price liberalization implies a large structural shift in production toward goods that were previously in “shortage,” and away from those of the traditionally favored industries. The asymmetric responses of sectors to relative price movements, with cutbacks in production taking place faster than corresponding increases, led to declines in aggregate output. In Russia, for example, high prices for fodder relative to that of animal products led nonprivate farms to significantly reduce herd sizes during 1992. On the other hand, in spite of large increases in the relative prices of energy products, output of crude oil in Russia fell by 15 percent in that year. There was little evidence of successful attempts to rapidly ameliorate the supply-side constraints such as the depletion of low-cost high-yield fields and the deterioration in the quality of existing wells to take advantage of higher prices. Furthermore, some of the benefits from radical price liberalization in improving the efficiency of resource allocation were postponed owing to the considerable uncertainty and confusion about relative prices at the early stages following liberalization. Adjustments in relative prices were protracted over a lengthy period, and the geographic dispersion of prices was large.5

Third, the shift of production away from traditionally favored sectors was reinforced by the reduction in direct or indirect government demand in a number of industrial and military sectors. For example, historically, the U.S.S.R. had extended sizable export credit to developing countries, mainly to finance arms exports. Arms exports and output of the military industrial complex were adversely affected by the sharp reduction in the provision of new export credits from the late 1980s.6 Output in this sector was also affected by a decline in domestic demand—for example, defense spending in Russia reportedly dropped from over 8 percent of GDP in 1991 to 5 1/2 percent of GDP in 1992, with sizable cuts in military procurements. As a result, the share of industrial output in defense-related industries oriented toward military purposes reportedly fell from 40 percent in 1991 to 30 percent in 1992.

In the short term, the decline of traditional sectors is likely to be more rapid than the growth of new sectors for several reasons. Investment in new sectors may be particularly slow to respond because of uncertainty regarding relative prices, property rights, legal infrastructure, and the general macroeconomic environment.7 In addition, even if investment in new activities takes off quickly, this may only translate slowly into new productive capacity because of the time required to build new plants and train labor. One would thus expect a net reduction in overall output during the transition period.

Fourth, the transition process has typically entailed modifying the tax and subsidy system—particularly trade taxes, variable profit taxes, and subsidies—to substantially reduce, if not eliminate, the large variations in net tax incidence that existed under central planning. This has implied potentially large increases in profitability for some sectors and large decreases for others, which may also have translated to lower aggregate output through an asymmetric growth response as described above.8 Such changes have been manifest not only across industries but across regions as well, as reflected in a marked decline in financial transfers to the poorer states. In the former U.S.S.R., some of the central Asian republics received grants from the union budget of 15 percent to 20 percent of their GDP. Transfers also took place through low prices for energy and raw materials, relative to world market standards. In 1992, while the transfers from the union budget ceased, following significant upward adjustments in energy prices, Russia continued to provide official financing to the Baltics and other states of the former Soviet Union equivalent to around 20 percent of these countries” combined GDP, and in some cases (Georgia, Tajikistan, Turkmenistan, and Uzbekistan) amounting to one third or more of estimated GDP.9 Official financing from Russia, however, was substantially reduced from 1993 onward. This exacerbated the output losses in these states by reducing their ability to pay for imported inputs.10

Finally, the liberalization of external transactions has had important sectoral and aggregate implications. Prices of tradable have moved toward world levels, notably for energy and other raw materials.11 According to one estimate, for the 14 states apart from Russia, this entailed a terms of trade deterioration of some 23 percent in 1992 followed by a further worsening of over 10 percent in 1993-94.12 At 1990 levels of trade, a 30 percent deterioration in the terms of trade is estimated to have had a 13 percent negative impact on GDP on average in the 14 states excluding Russia.13 On the other hand, the sharp decline in the volume of interrepublican trade prevented Russia from taking advantage of the terms of trade improvement.

At the same time, and especially for the countries in this region, traditional Council for Mutual Economic Assistance (CMEA) export markets have been lost. The abolition of CMEA and the revision of prices of raw materials, such as energy products, implied an estimated 40—45 percent improvement in the terms of trade with the other CMEA countries.14 However, CMEA trade volumes collapsed, preventing the Baltic countries, Russia, and other countries of the former Soviet Union from taking full advantage of this terms of trade improvement. Thus, for example, from around 60 percent of the U.S.S.R.”s total trade in the second half of the 1980s, the former CMEA’s share dropped to less than 20 percent of Russia’s trade with the area outside the Baltic states and other countries of the former Soviet Union in 1992. Finally, pent-up demand for foreign goods has led to substantial real depreciation as exchange markets were decontrolled. This, together with the removal of implicit import price subsidies, has resulted in rising imported input costs, lowering the viability of enterprises that depend heavily on these inputs.

In terms of systemic change, broadly speaking, the Baltic states are farthest along in the transition, followed by the Kyrgyz Republic, Russia, Moldova, and Kazakstan. The other countries have made varied but generally less progress. Once country-specific factors, such as armed conflicts and relative importance of natural resource exports, are taken into account, the cross-country experience regarding aggregate output, investment, and trade appears to be broadly consistent with the above arguments that stress the relationship between output decline and systemic change.

Among the nine countries of the third group, the speed of output decline varied directly with the speed of systemic change during the first two years of transition. Indeed the output decline was almost twice as fast in the Baltics compared with Belarus and Ukraine in 1992 (Table 2.1 and Chart 1.2). The positive rewards in output from systemic change subsequently accrue with a lag, and thus, in the Baltic states, although greater declines in output were recorded at the beginning of the transition period, subsequently output stabilized or increased. Countries, such as Belarus and Ukraine, which were slow to both stabilize and undertake structural reforms, registered smaller declines early on, but the fall in output has recently accelerated, reflecting the progressive collapse of the traditional sectors and the lack of significant growth in new activities. Countries that liberalized relatively early but did not immediately stabilize (Russia and the Kyrgyz Republic) have recorded continued declines throughout the period. In these countries, continued quasi-fiscal support of unprofitable enterprises in the initial period may have slowed adjustment and thus postponed the decline in output compared with the Baltics, while relatively strong reform efforts led to larger initial output losses than for the slow reformers.

Table 2.1.

Real Gross Domestic Product1

(Average annual percentage change)

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Excludes Armenia, Azerbaijan, Georgia, Moldova, and Tajikistan because of armed conflicts, and Turkmenistan and Uzbekistan with large natural resource exports relative to the size of their domestic economy.

Moreover, it does not appear that countries that have delayed liberalization and stabilization measures have been able to reduce the magnitude of cumulative output decline. In fact, the opposite may have been true. Early Eastern European reformers, such as Poland, Hungary, and the Czech Republic, have recorded lower total declines in output than countries such as Bulgaria and Romania, which have had higher inflation and are still undertaking liberalization measures (Chart 2.1): the same is true when the Baltic states are compared with Russia and other countries of the former Soviet Union.

Chart 2.1.
Chart 2.1.

Eastern Europe, the Baltics, and Other Countries of the Former Soviet Union: Real Gross Domestic Product1

(1990 = 100)

Sources: World Economic Outlook database; and IMF staff estimates.Note: Eastern Europe I = the Czech Republic, Hungary, Poland: Eastern Europe II = Bulgaria, Romania.1Excluding Russia.

In the countries of the region, systemic reform promoted improvements in inventory management, and this in turn also had a dampening effect on output in the short run. Inventory levels were excessively high under the command system with its emphasis on forced growth, a production structure unadjusted to user requirements, and rates of interest administratively held at artificially low levels. There are problems of measuring inventories under high inflation in the countries of the region, but it appears that there were downward adjustments in the levels of inventories in the fast-reforming countries of the Baltics (Table 2.2).15 For example, in Estonia, stocks declined by more than 6 percent of GDP in 1992. Although the downward adjustment in the historically high level of inventories could be expected to contribute to improvements in the efficiency of resource allocation in the medium to longer run, its effect on aggregate output in the short run was unambiguously negative. Thus, in the three Baltic countries on average, stock decumulation is estimated to have contributed about 7 percentage points to the 11 percent decline in GDP in 1993. By contrast, stocks continued to be accumulated in slowly reforming countries, where enterprises were reluctant to adjust their work force and continued to produce and hoard goods for which demand had disappeared.

Table 2.2.

Gross Fixed Investment and Stockbuilding1

(Percent of GDP)

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The precision of these estimates is subject to considerable uncertainty because of valuation problems under high inflation.

The available data on investment are consistent with the view that the aggregate output decline has been exacerbated by sluggish investment in new sectors.16 Virtually every country has recorded large falls in real gross capital expenditure, both in levels and as a percentage of GDP (Tables 2.3 and 2.4).17 Moreover, these figures appear to mask an even more significant deterioration in fixed capital investment, because available data indicate a sharp increase of about 30 percentage points on average between 1990 and 1992 in the share of stockbuilding in gross capital expenditure in a number of countries.18 It should also be noted that substantial private capital flight has accompanied liberalization. From virtually zero in 1990 and 1991 for the U.S.S.R. as a whole, nonofficial capital outflows increased to an average of more than 9 percent of GDP for the region in 1992, before subsiding to 5 percent of GDP in 1993.19 This acceleration may reflect the same factors that explain low investment, namely, a lack of confidence in domestic policies and the risks implied by the political and economic transformation.

Table 2.3.

The Baltics, Russia, and Other Countries of the Former Soviet Union: Real Gross Capital Formation1

(1990 = 100)

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Sources: Data provided by country authorities; and IMF staff estimates.

Except where shown, figures include changes in stocks.

Figures shown are net of Stockbuilding.

Table 2.4.

The Baltics, Russia, and Other Countries of the Former Soviet Union; Gross Capital Formation1

(In percent of GDP)

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Sources: Data provided by country authorities; and IMF staff estimates.

Except where shown, figures include changes in stocks.

Figures are net of Stockbuilding.

With regard to the relationship between developments in trade and output, declines in exports to trading partners other than the Baltics, Russia, and other countries of the former Soviet Union (Table 2.5) appear to have been positively correlated with output declines across countries in 1991 (Chart 2.2), reflecting the loss of traditional CMEA export markets. Export trends in 1992 are much more difficult to interpret, in part because movements in export values may have been governed by relative price movements, and in part because of statistical breaks in the series. Nonetheless, from the data on export volumes, the relationship is clear: countries that suffered smaller output declines and those even beginning to recover (Estonia, Latvia, Lithuania, and the Kyrgyz Republic) are characterized by strong export volume growth. The strongest export performers over the period from 1992 to 1994 have been those economies that pursued a relatively rapid reform strategy (Estonia, the Kyrgyz Republic, and Lithuania)—which may have promoted a greater supply response—and Uzbekistan, whose favorable resource endowment facilitated transition to Western markets.20

Chart 2.2.
Chart 2.2.

The Baltics, Russia, and Other Countries of the Former Soviet Union, 1991: Decline in Rest-of-the-World Exports and Output

(In percent)

Sources: Data provided by country authorities: and IMF staff estimates.
Table 2.5.

The Baltics, Russia, and Other Countries of the Former Soviet Union: Value of Total Exports to the Rest of the World

(1990= 100)

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Sources: Data provided by country authorities; and IMF staff estimates.

The impact of systemic change in the countries of the region is evident in the differential pattern of output developments (measured by net material product (NMP)) across sectors (Table 2.6). The largest recorded declines have been in construction, transportation, communications, and retail trade.21 The relative weakness in construction activity has likely reflected the strong declines in investment demand discussed above. The declining shares of retail trade and transportation, on the other hand, appear to reflect disruptions due to the breakup of the Soviet Union, as well as widespread movement into private activity in these areas. NMP statistics do not report value added in other services sectors; in the Baltic states, which report sectoral breakdowns of GDP instead of NMP, activity in the services sector has fallen far less on average than that in other sectors. Indeed, differences in coverage may help explain variations in recorded output performance. In a number of countries in the region, GDP is calculated on the basis of NMP estimates, with a mark-up to account for services and other activities not contained in the latter indicator. If, however, the underlying performance of services and other areas is more buoyant than in basic industrial and agricultural sectors, GDP estimates based on NMP figures may overstate the decline in output. Thus, the Baltic states—and in particular Estonia—record somewhat lower GDP declines than other countries in the region, while value added in agriculture and industry (which make up the bulk of NMP estimates) has fallen by much more than in other states.

Table 2.6.

The Baltics, Russia, and Other Countries of the Former Soviet Union: Output by Sector, 19931

(1990 = 100)

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Sources: Data provided by country authorities; and IMF staff estimates.

Sectoral data are taken from NMP statistics, except for the Baltics, where the data come from GDP statistics.

Data are for 1992.

1991 = 100.

Refers to activities of officially registered enterprises only.

Factors Related to the Breakup of the Soviet Union

Output in these countries has also been adversely affected by disruptions associated with the dissolution of the Soviet Union.

The breakup of the U.S.S.R. into independent states contributed to a disruption of interstate commerce, which in turn is likely to have played a role in the output decline. Most states have been slow to establish full current account convertibility for external transactions, preferring initially to limit access to foreign exchange markets to official organizations, often at administratively determined exchange rates (the Baltic states, Russia, and the Kyrgyz Republic were among the earliest to liberalize current account transactions); this approach was reflected in the widespread preservation of quota and licensing arrangements for imports and exports.22

The lack of effective payments systems also played a role in hampering interstate, and in many cases also domestic, trade. Under the “ruble area” arrangements in 1992 and into 1993, interstate payments were forced to take place through centralized correspondent accounts, which often entailed delays in clearing of three months or more; because of disarray in exchange and financing arrangements, some payments were never carried out at all.23 This situation led in some cases to informal payments mechanisms (including reportedly large physical movements of cash between the Baltic countries, Russia, and other countries of the former Soviet Union), barter, or outright autarky, with corresponding output losses.

The dramatic reduction in the volume of interstate trade is shown in Table 2.7. 24 Countries with large output declines have typically also suffered from large reductions in interstate trade, the most extreme examples being Armenia, Georgia, and Tajikistan; indeed, the magnitude of decline in interstate trade has significantly exceeded that of output for virtually every country in the region.25

Table 2.7.

The Baltics, Russia, and Other Countries of the Former Soviet Union: Volume of Interstate Trade1

(1990= 100)

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Source: The World Bank.

In constant 1990 prices.

Given the faster decline in interstate trade relative to output, it is tempting to attribute the output decline in the region mainly to the breakup of the U.S.S.R. However, the decline in interstate trade should be seen in the context of the economic transition itself. The main factor determining the pattern of interstate trade during the U.S.S.R. era was the close specialization and integration of the republican economies developed for strategic and self-sufficiency considerations in a command regime. The reorientation of trade on the basis of economic cost and benefits was a fundamental component of the reform process in the countries of the region. For example, the sharp drop in trade with Russia and other countries of the former Soviet Union observed in the Baltics, in part, reflects the rapid redirection of their trade toward the West. Thus, while the breakup of the U.S.S.R. itself probably did contribute independently to the fall in interstate trade and the output decline in the 15 countries, much of the fall must be viewed as part and parcel of the process of systemic transformation.

Other Factors

Factors other than those related to the economic transition may have also played a role in the decline in output, particularly monopolistic market structures and contracting monetary and credit policies.

Monopolistic Market Structures

It has been argued, particularly in the initial years of transition, that the “monopolized” production structure in transition economies may have exacer-bated the output decline. Central planners favored large-scale production concentrated in a few enterprises. To capture monopoly rents, these enterprises may have lowered production and raised prices after liberalization. While a comprehensive review of the evidence is beyond the scope of this paper, it should be noted that empirical findings as to the concentration of industry have yielded mixed results. Recent studies, in particular, have contested the stylized characterization of a strongly monopolized production structure at the national level.26 In general, monopoly market power is unlikely to have played a significant role in the observed output declines, particularly since trade liberalization would have undermined the ability of firms lo exercise such power.

At the same time, the regional concentration of industry may have contributed to output declines. To the extent that there were disruptions to interstate trade, as discussed above, their impact on activity would have been exacerbated if viable industries were unable to trade in inputs and components.

Contractionary Monetary and Credit Policies

Some observers have asked whether the fall in output has been exacerbated by “unduly tight” credit policies, resulting in low levels of real liquidity, declining real working capital holdings of enterprises, and high real interest rates.27 The discussion has been motivated by the fact that real domestic money balances have generally been observed to fall in transition economies, and as discussed in Section III, this decline has been particularly large for a number of states in the region. The simultaneous decline in output and money stock in real terms (Table 2.8) has given the hypothesis of unduly tight credit and monetary policies a priori plausibility. This plausibility has been strengthened by a casual examination of a few country experiences. As of 1993, for example, Uzbekistan and Turkmenistan, which saw the lowest declines in output, also reported the highest levels of real balances. Armenia and Georgia, on the other hand, recorded by far the largest falls in both output and real money balances. However, even at the level of ordinary correlation the hypothesis fares rather poorly. For example, in the five countries of central Asia, between 1992 and 1993, a significant slowdown in the rate of decline in real money stock was not accompanied by a corresponding improvement in output performance (Table 2.9). Similarly, in the same five countries as well as in the three countries in the Caucasus, between 1993 and 1994, a marked acceleration in the rate of decline in real money stock has not been associated with a noticeable acceleration in the decline in real GDP.

Table 2.8.

The Baltics, Russia and Other Countries of the Former Soviet Union: Real Domestic Money Stock1

(1988 average = 100)

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Sources: Data provided by country authorities: and IMF staff estimates.

Annual average level of real balances.

Table 2.9.

Real Money Stock and GDP at Constant Prices

(Average annual percentage changes)

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All three countries were affected by armed conflicts.

Furthermore, declining real liquidity has not necessarily reflected tight credit policies. First, a good portion of the decline in real balances in 1992 reflects the elimination through price liberalization of the monetary “overhang” accumulated in previous years. Desired money holdings at the beginning of liberalization were much lower than observed levels; the real money stock in the U.S.S.R. was 35 percent higher in 1990 than it had been in 1988, despite the fact that output had already begun to fall.28 Second, the lines of causality between output and real balances run in both directions. Output could have fallen because of an ex ante decline in real liquidity; on the other hand, the demand for real balances is likely to have fallen as a result of the output decline.

Third, substantial declines in real money balances were reported both in countries that undertook monetary tightening and those that did not. In fact, the largest declines were in countries with very high rates of growth of money in nominal terms (e.g., Armenia and Georgia), while the only countries where real balances rose were those that successfully achieved monetary stabilization (i.e., the Baltic states), suggesting that declining real money balances were the result of loose, rather than tight, monetary and financial policies (Table 2.10).

Table 2.10.

Money and Prices

(Percent changes)

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All three countries were affected by armed conflicts.

Fourth, there has been little correlation across countries between the decline in output and the observed level of real interest rates (Chart 2.3); while high positive rates of return were associated with strong declines in output in Moldova, Russia, and Ukraine, the decline in output accelerated under strongly negative real rates in Georgia, Belarus, and Turkmenistan. In the Baltic states, moreover, high real interest rates were accompanied by relatively stable or even increasing output.29

Chart 2.3.
Chart 2.3.
Chart 2.3.

The Baltics, Russia, and Other Countries of the Former Soviet Union: Real Interest Ratesand Real GDP Growth, April 1992-July 1994

Source: IMF staff estimates.

Finally, there is little evidence in favor of the perceived trade-off between output growth and disinflation in the transition economies of the Baltics, Russia, and other countries of the former Soviet Union (Chart 1.1).30 Ukraine has experienced much higher inflation than Russia, while output declines in the two countries have been roughly of the same order of magnitude. Furthermore, growth has resumed in the three Baltic states, which have successfully brought inflation down.

Determinants of Future Growth

The above discussion suggests that several factors are likely to play an important role in determining future growth prospects:

(1)To the extent that the declines in output have been driven by the unavoidable transitional costs of systemic change, recovery in aggregate output will, of course, begin as soon as growth in new industries and services and in the private sector exceeds the decline in traditional industries and the state sector. In this sense, the speed of recovery will depend closely on the speed of sectoral adjustment and change. In particular, the factors governing the pace of investment in the new sectors will be crucial to the recovery of aggregate output. Ceteris paribus, we would thus expect recovery to be enhanced by stabilization, privatization, and improvements in the legal infrastructure as well as in financial intermediation.

(2) At the same time, to the extent that the decline in output is due to political disruptions (including interstate trade and payments problems) and macro-economic factors, there may be scope for recovery across all sectors, including the traditional sectors. The removal of trade restrictions and regularization of payments mechanisms will induce some revival in output, as will the end of conflicts and the renewal of economic ties in countries now at war.

Some Tentative Evidence from Central Europe and the Baltics

It is still early for there to be solid evidence on the resumption of growth in transition economies. The path of output in both central and eastern European transition economies and the Baltic economies has not been characterized by a strong rebound in production in traditional sectors; rather, initial declines have been followed by relative stabilization and finally by moderate growth after a lag of about a couple of years (Chart 2.1; see also Tables 2.3 and 2.11). In those countries that have achieved an output turnaround, growth rates have been on the order of 2 percent to 6 percent a year. Nevertheless, the following observations can be made.

Table 2.11.

Eastern European Countries in Transition: Selected Indicators

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Sources: Data provided by country authorities; and IMF staff estimates.

Reflects change in consumer prices.

First, a striking feature of the output performance of transition economies is that few countries have achieved a resumption of output growth without first bringing down inflation to low single-digit levels on a monthly basis. Among the five central European countries included here, all the three that have successfully stabilized—Poland. Hungary, and the Czech Republic—registered positive growth in 1994, with Poland experiencing sustained growth for three years in a row. The problem of relatively high inflation has persisted in Bulgaria, and output has continued to stagnate. Only Romania has experienced some growth while maintaining high inflation. Similarly, the only states in the territory of the former Soviet Union that resumed growing in 1994, the three Baltic countries, all have undergone successful stabilizations. On the other hand, it is also clear that stabilization is not sufficient for the resumption of growth, and that output recovery may take time even after inflation has been brought under control. For instance. Hungary and the Czech Republic experienced relatively low levels of inflation for about two years before the resumption of growth. Among the countries in the region of the former Soviet Union, Moldova and the Kyrgyz Republic may by now be considered as successful stabilizers, but as yet growth remains elusive.

Second, where new growth has been observed in central and eastern Europe, the recovery has generally been accompanied by a rise in real gross capital formation (Table 2.11). The observed increases have typically been undramatic, but they may mask a more decisive recovery in fixed capital investment to the extent that the share of stockbuilding in recorded investment tends to fall with a reduction in inflation. Nevertheless, higher capital formation may be more a symptom of recovery and of improvement in the investment climate, rather than an explanation of output growth in the short run. That said, it would be a prerequisite for sustainable growth, and hence the transition, over the longer run. Apart from the problem of inadequate incentives, one of the major problems behind the economic decline in the last decade or so of the former socialist economies, including the U.S.S.R., was low productivity stemming in part from the obsolescence of capital and technology. While depreciation of the old capital stock inherited from the command regime may continue to dampen the effect of new investment on net capital formation in a statistical sense, technological progress embodied in the new investments—particularly in the emerging private sector—should provide one of the major growth stimuli to these transition economies. The pickup in gross capital formation seems to have not only begun in the leading countries of the region, namely, the Baltics, but also appears to have been more pronounced than in the central European countries (Tables 2.3 and 2.11).

Conclusions and Policy Implications

In addition to region-specific problems, such as trade disruptions and war, the output declines in the Baltics, Russia, and other states of the former Soviet Union appear to be primarily associated with structural changes and sectoral adjustments that accompany the transition to a market economy and as such are an inevitable part of the transition process. The evidence suggests that countries attempting a gradual strategy have not been able to reduce the cumulative output cost of transition; instead, the principal effect of such a strategy appears to be a delay in the resumption of growth.

Output recovery has so far almost always been preceded by stabilization, suggesting that controlling inflation is an important precondition for recovery. On the other hand, there have been lags between stabilization and the resumption of growth of up to two years.

These findings suggest that bold and rapid stabilization, liberalization, and reform measures are indeed conducive to a sustained recovery of economic activity. In particular, improvements in the legal infrastructure and the development of financial markets are likely to contribute to the new investments that are needed for growth over the longer term.

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1

See Easterly and Fischer (1993) for a description of the economic decline in the U.S.S.R.

2

See Berg and Sachs (1992) and Rajewski (1993) for Poland, and Gavrilenkov and Koen (1994) for Russia. Note that biases in output estimation may differ between countries, especially given the significant variations in the degree to which individual countries have been able to introduce new statistical standards; these variations may account for some of the differentiation in individual countries’ performance (see, in particular, the discussion on output movements in the Baltics, below).

3

A general discussion of the following issues in the context of Central Europe is provided in Berg (1994), Bruno (1992), Commander and Coricelli (1992) and Williamson (1993a and 1993b).

4

See Kornai (1994). According to the survey data for Hungary reported by Kornai, more than one fourth of the respondents considered the insufficient supply of raw materials and spare parts of domestic origin an impediment to production until early 1990. Financing problems were also mentioned as an impediment to production until early 1992 by more than half of the respondents.

5

For example, in Russia, the price of food relative to overall consumer prices rose by 12 percent during 1991, a further 16 percent in January 1992, fell somewhat during the next few months, and rose again from June onward and ended the year 25 percent above its December 1990 base. Similarly, prices sometimes varied by a factor of ten or more in state stores. See Koen and Phillips (1993) for a detailed analysis of price liberalization in Russia.

6

See Christensen (1994), pp. 5-6.

7

Indeed, the process of privatization in most states of the region has been delayed until long after the beginning of economic reforms (the Baltics and Russia are clear exceptions), particularly with regard to medium- and large-scale enterprises. Also, traditional forms of organization under the plan have generally not been replaced with a comprehensive set of commercial codes or court procedures for contract enforcement of claims (see Kornai (1994) for a discussion of these issues in the case of Hungary).

8

The traditional system of taxation and subsidization, and the changes in this system under transition, is described in Holzmann (1991), Kopits (1991), and IMF and others (1991).

10

The exact magnitude of the net impact of the cessation of transfers on these economies is hard to estimate without detailed information on the composition of imports precluded by the cessation of transfers, and import intensities of production in the various sectors.

11

See IMF (1994a) for an analysis of the magnitude of relative energy price increases in the Baltic countries, Russia, and other countries of the former Soviet Union. In their study of eastern European transition economies, Borensztein and Ostry (1993) find that rising energy prices were particularly important in explaining output decline. A more general discussion of movements in the terms of trade under liberalization is provided in Tarr (1994).

13

Trade intensities in 1990 estimated by Tarr (1994) have been used in this calculation.

14

Kornai (1994), Rodrik (1992), and Rosati (1993) discuss the effects of the dismantling of the CMEA in Eastern Europe; Christensen (1994) presents estimates of the loss in CMEA trade volume in Russia.

15

Direct evidence for structural change—including moves from large to small firms, state to private sector, and industry to services—and the consequent improvements in productivity and efficiency have to rely on micro-level disaggregated data. Thus, a comparison of the pace of structural change with the pace of reform is beyond the scope of this paper. There is evidence that a substantial share of recorded stockbuilding represents revaluation of existing stocks rather than the physical accumulation of inventories, leading to serious overestimation—particularly in periods of high inflation.

16

At the same time, as with production, investment activity in nontraditional sectors has likely been underrecorded in official statistics.

17

While a contraction in real investment expenditure has contributed to the decline in output, it is likely that—in line with the arguments made above—much of the contraction represented lower investment in unprofitable sectors.

18

Belarus, Moldova, Russia, Tajikistan, and Ukraine.

19

This measure is merely suggestive, since it includes “errors and omissions,” which can reflect both unrecorded current and capital transactions; moreover, private capital flows in individual countries varied strongly, from outflows of over 50 percent to in-flows of 40 percent.

20

Two exceptions are Armenia and Tajikistan. While Armenia maintained its exports by directing scarce energy supplies to industry and the production of exportables, Tajikistan’s performance was related to strong market conditions in aluminum and cotton.

21

Within the industrial and agricultural sectors, detailed production data also reveal substantial variations in output performance between product types (the coverage, however, is usually very spotty). Moreover, sectors that have seen strong increases in demand (financial services is one widely quoted example) tend to be outside the traditional state-owned sphere; thus, those areas with the best output performance and potential for new investment may not be captured in official statistics.

22

See IMF (1994b) for a detailed discussion.

23

IMF (1994a) provides a detailed description of payments developments.

24

Weights for interstate trade volume indices were calculated using 1990 relative prices; thus, the decline in interstate trade volume may be overstated due to the undervaluation of raw materials trade (which generally fell by less than other product categories).

25

Armed conflicts in Armenia, Georgia, and Tajikistan were a major reason for the large decline in trade in these states.

26

See, in particular, Brown, Ickes, and Ryterman (1994).

28

The subsequent decline in the real money stock beginning in 1992, however, decreased real holdings not only relative to 1990 but also to 1988 or even 1982 levels; thus, the decline was probably greater than could be explained by the “money overhang” alone (see Cottarelli and Blejer (1992) for estimates of the monetary overhang and forced saving in the Soviet Union). On the other hand, while there is no agreed theory as to whether the demand for real transactions balances (for a given level of output) should be higher or lower in a market economy compared with a planned regime, it is almost certain that the real demand for money as an asset fell substantially after 1991, as increased access to both foreign and nonmonetary domestic assets caused a shift out of domestic money balances—particularly as inflation accelerated through the end of 1992 and beyond.

29

Blanchard and Berg (1993) provide an additional argument; empirical evidence in Poland shows that inventories accumulated in the industries where output was declining; if output were falling owing to decreases in real credit, one would expect to see output declines in those industries where inventories were being run down.

30

See Koen and Marrese (1995) for a discussion of the econometric evidence for Russia.

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    Eastern Europe, the Baltics, and Other Countries of the Former Soviet Union: Real Gross Domestic Product1

    (1990 = 100)

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    The Baltics, Russia, and Other Countries of the Former Soviet Union, 1991: Decline in Rest-of-the-World Exports and Output

    (In percent)

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    The Baltics, Russia, and Other Countries of the Former Soviet Union: Real Interest Ratesand Real GDP Growth, April 1992-July 1994