Per Jacobsson address: Tošovský reviews lessons learned from transition, indicates process is still incomplete

On September 24 at the Annual Meetings in Prague, Josef Tošovský, Governor of the Czech ‘National Bank, delivered the 2000 Per Jacobsson address, “Ten Years On: Some lessons from the Transition.” His remarks are summarized here; the full text is available on www.perjacobsson.org

Abstract

On September 24 at the Annual Meetings in Prague, Josef Tošovský, Governor of the Czech ‘National Bank, delivered the 2000 Per Jacobsson address, “Ten Years On: Some lessons from the Transition.” His remarks are summarized here; the full text is available on www.perjacobsson.org

Beginning with the premise that the transition process is still incomplete, Tošovský said that most of the failures and continuing difficulties that transition economies have encountered are rooted in the past—the legacy left by 40 years of central planning.

Ten years ago, Tošovský said, the transition economies of central and eastern Europe were mostly or completely nationalized. As a result of this near-total nationalization, a mass privatization program was needed to move quickly to a market economy. At the same time, these transitional economies needed to create an adequate institutional framework to support the newly emerging private sector. This second task, Tošovský noted, turned out to be far more demanding.

Distortions in the real economy

Among the legacies of the old regime were the “deformations and distortions” in the real economy, including the exclusive geographic orientation toward eastern markets, aggravated by a policy of economic self-sufficiency.

The true extent of the distortions inherent in centrally planned economies, as well as the true magnitude of implicit, hidden indebtedness, came to light only with the political changes that took place in 1989. According to Tošovský, the growth of internal debt was a major problem. To avoid social unrest, ruling communist parties sought to provide an acceptable living standard. But since the productive capacities of the communist economies were eroded by inherent inefficiencies, the only way to achieve a decent living standard was to mortgage the future—that is, by living on hidden debt. The consequences of this long-standing allocation of resources based on political priorities rather than profitability continued to haunt reformers during the 1990s, as massive amounts of bad loans began to surface.

Human factors also accounted for many of the transition problems, Tošovský suggested. For one thing, the structure of education and the mix of skills in a command economy do not match the needs of a market economy. In addition, living under socialism shaped people’s qualities, mentality, and morals into patterns inconsistent with the requirements of a market economy.

Finally, the newly democratic economies emerged into an environment of a rapidly moving globalization involving the widespread liberalization of goods and capital markets—in a word, competition.

Although all developing countries had to accept and adapt to these changes, the transition economies were at a particular disadvantage; their “delayed start” gave them much less time to adjust, and they were forced to proceed with integration into the global economy and international financial system quickly, regardless of the risks associated with such rapid integration.

Importance of market-friendly institutions

Many analysts agree, Tošovský said, that the current difficulties of some transition economies whose economies have unexpectedly lagged behind other stronger performers stem from their initial misunderstanding of the importance of institutions in a market economy.

One widespread and very damaging mistake, Tošovský observed, was the misconception that systemic measures—price and trade liberalization, a realistic exchange rate, and creation of market institutions—could be implemented “overnight” in the absence of the necessary supporting structural and institutional reforms. Such underestimation was common, for example, during privatization efforts that failed to establish the regulatory framework needed for a privatized economy to function smoothly.

Central bank independence. In general, transition economies formally embraced most of the elements of the European legal framework defining the position of central banks. But the principle of an independent central bank has not yet been fully accepted by the public, and especially by politicians, Tošovský noted. Central banks have often had the unpopular task of announcing bad news about mounting macroeconomic imbalances. In addition, they end up getting the brunt of the blame for slow growth, increasing unemployment, and social unrest when they attempt to tighten monetary policy to address the imbalances. This political pressure, Tošovský said, has been “a fact of life” for central banks in most of the transition economies in the region, but he had hopes that this “symptom of immaturity” would soon disappear as these countries became members of the European Union (EU).

Financial sector reform. Because it is the financial sector that undergoes the greatest changes in the course of an economic transition, the financial crises that hit virtually all transition economies were probably unavoidable, Tošovský observed. The transformation of a centrally planned financial sector to a market economy calls for a systemic overhaul requiring the development of a totally new infrastructure. The financial sectors of postcommunist countries still come in for a lot of criticism, he said, but it should not be forgotten that the task of creating from scratch a strong, efficient, globally competitive financial sector operating in an appropriate legal environment is a lot to expect in only 10 years.

Results and conclusions

Despite the highly unfavorable starting conditions, combined with several mistakes along the way, Tošovský said he considered the transformation of the Czech Republic and other countries at a similar stage of transition as successful, even if the traditional indicators, such as GDP, did not appear to support his conclusion. Radical economic transformation is precisely the kind of situation where calculated GDP is not necessarily the ideal indicator of a country’s social well-being and quality of life, he stressed. A lot of mistakes were made, but in his view the countries of central and eastern Europe that have made the most progress in adapting themselves to the conditions of a free market economy are incomparably better off than the countries that have postponed these reforms.

In the past 10 years, Tošovský observed, the pitiful economic conditions that prevailed in the closing days of socialism have become a distant memory, and the most advanced transition economies are serious candidates for EU membership. Their maturity is attested to by the extent to which they satisfy the Copenhagen criteria that—in addition to the political requirement that “the candidate state has achieved stability of institutions guaranteeing democracy, the rule of law, human rights, and respect for and protection of minorities”—emphasize the existence of “a functioning market economy as well as the capacity to cope with competitive pressure and market forces within the Union.”