Transcript The Economics of Transition: Central and Eastern Europe

THE ECONOMICS OF
TRANSITION
Central and Eastern Europe
ref: transtnplus332cbs
march 2010
Objectives
By the end of this lecture students should:
 be aware of the characteristics of a transition
economy and major macroeconomic trends
 understand why western economic policies were
not be directly applicable
 be able to understand and explain why some
Central European Economies (CEEs) were able
to join the EU, while others were not
BACKGROUND
Planned economy v market economy
 Performance of transition economies
 Macroeconomic stabilisation &
Microeconomic (institutional) reforms
 How economic theory explains ‘U’ shaped
response to output
 How relevant is western macroeconomics?

TRANSITION
(transformation)
Change from a centrally administered economy
(CAE) to a market economy (ME)
 Main issues considered here -see handout

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property rights
domestic prices
domestic output & employment
financial institutions
budget revenue
Hard Budget Constraint (HBC) -Kornai ‘The Socialist
System’
INITIAL PERFORMANCE OF
TRANSITION ECONOMIES
See handout with data
 Progress in transition
 inflation
 output
 unemployment
 budget
 Poland(1st 1/1/90),Romania, Russia

STABILISATION POLICIES
Similar menu in countries. Choose speed and
sequence
 Initial fall output in all countries - bigger than
expected
 Macroeconomic stabilisation
 Microeconomic (structural) reforms
 For CREDIBILITY -simultaneous
announcement

(Macro) Stabilisation package
Price liberalisation -cornerstone of ME
 Macroeconomic stabilisation

– low inflation - Restrictive monetary policy
– Incomes policy
– Balance budget

Foreign trade liberalisation
Structural measures:
institutional reforms (micro)
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Market environment
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banking sector
financial sector
tax structure
commercial law
Privatisation
 Others
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APPLICATION

Initial debate :

– Shock therapy v gradualism
– Sequencing
Debate late 1990s; why did output fall sharply?
– See O Blanchard ch2 for relevant theory
How do we achieve future sustainable growth?

Transformation traps (Portes, 1994)
– overemphasis on macroeconomic policy
– inadequate micro foundations
– financial intermediation not developed
Macroeconomic policies
Some argue tight macro policies lead to fall in
output
 Others (Blanchard, Begg); macro policies not
the principal driving force
 Sound macro fundamentals necessary but
insufficient for stabilisation (Begg)

– may be undermined by inadequate structural reform
Example: monetary policy

A major transformation trap - not recognise key
role of banks (Portes)
» transition banks learning the market system (ab initio) mistakes in lending

Eg1.Firms avoided HBC
– undermines interest rate as instrument of monetary
policy
Eg2.Composition of credit distorted
 Eg3. Higher interest rates - - - increased loans !

– adverse selection problem
LATE 1990s/ 2000s

3 CEECs, (Poland, Czech, & Hungary), in
particular strengthened the performance of
market supporting institutions,
– Successful transformation to market economies
– GDP rose above pre-transition levels
Similarly for Baltic states & Slovenia
 EU accession countries

SE Europe & Russia - lagging
 Some CAEs have still not reformed
sufficiently to enter the EU
 Divergent patterns of economic reform
mirrored by political reform (EBRD 2003)

– Thus, political reform & credibility are vital
Post accession: consider
benefits/costs to CEEs & EU

Include;
– Budget
– Competitive pressure on EU15 & EU global
competitiveness
» Anglo-Saxon / French /Nordic approaches in EU?
» Opportunites and threats for EU15
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Agriculture
Structural funds
Migration
Voting & decision making
– FDI
– Trade flows
Credit Crunch & CEECs
– EBRD Transition Reports - Good source
CONCLUSION
The nature of CAEs & market economies
varies significantly
 This summary indicates that stabilisation
policies were important, and a lack of
structural reform was a major feature
 Credibility of reforms important
 Output initially fell further than expected,
but did recover in CEECs
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Additional references
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Refs for Fiscal & Monetary policy
Begg,’Monetary policy during transition;
progress & pitfalls in Central & Eastern
Europe,Oxford Review of Econ Policy,vol
13,no.2 ,1997
Buding & Van Wijnbergen,’Fiscal policies in
Eastern Europe’ as above
Papazoglu et al, ‘Potential trade effects of the
2004 enlargement’, World Economy 2006