Much more economic progress has been made across the entire post-communist region of central and east Europe and the former Soviet Union than many thought possible when the Berlin wall was pulled down just over a decade ago.
There have been political setbacks and financial crises, hyperinflation and steep output declines. But these were to be expected especially in the early years, given the profound nature of the changes involved in moving to a market-based economy from a command system.
Under the command system the state owned virtually all commercial activity and output was determined by planners more or less regardless of cost, price or profit and without the kind of laws, rules and regulations, institutions and behaviour that are needed to enable a market system to function properly. No-one before in history has had to embark on such a transition. No text-book solutions existed.
The gains, though, are undeniable. Most countries now hold more or less free elections at which governments can be, and have been, changed. Most goods and services throughout the region are now produced by privately-owned firms and are traded in what is more or less a market-based system. However, progress is still uneven, not only across the region as a whole but in each country.
Poland, Hungary and Slovenia in central Europe, and Estonia in the Baltics, for example, fairly quickly reaped substantial benefits in terms of output growth, low inflation and policy stability as a result of their prompt and single-minded pursuit of often painful reforms. The Czech and Slovak republics,
Bulgaria, Croatia, Latvia and Lithuania have drawn the lesson of their own or others’ mistakes and are now in hot pursuit of the leaders. Recorded output in some countries is now higher or at least equal to the levels that the former communist regimes claimed (the qualification “recorded output” has to be made because so much activity still takes place in the grey or unrecorded economy).
Living standards in the more successful countries are now higher (in Slovenia, for example) than or at least broadly comparable with the levels of the poorer European Union countries. The steep fall in output that accompanied the collapse of communism almost everywhere was quickly reversed in Poland and Slovenia, and then in the Czech and Slovak republics, Hungary and the Baltic republics, followed by Armenia, Georgia and parts of central Asia.
Even Russia’s economy was showing unmistakable signs of recovery before the 1998 financial crisis struck and again more recently. Russia’s crisis was no help for most of its neighbours. The Kosovo war, the blocking of the Danube waterway and the earlier Yugoslav conflicts blighted recovery in the Balkans – though Slovenia and Croatia were quick to overcome the loss of markets to the south by switching their export efforts to EU countries.
But then in the mid-to late 1990s output and demand in EU countries and elsewhere in western Europe slowed down with the inevitable consequences for post-communist countries’ exports. Inflation was brought back under control by the mid 1990s in the Czech and Slovak republics and, most notably, Croatia, and since then in Poland, Hungary, Slovenia, Bulgaria, Albania, Macedonia, the Baltic states, Armenia, Azerbaijan and Georgia. External deficits remain widespread – save, most notably, in Russia whose current account has never fallen into the red but which suffers instead from serious capital flight as well as unpaid taxes.
In the more successful countries of central Europe and the Baltics, these deficits are fairly readily funded by substantial inflows of foreign investment or by international borrowings supported by investment grade credit ratings.
But even in these countries the transition is far from complete. As the European Bank for Reconstruction & Development (EBRD) is fond of pointing out, market, price and trade liberalisation and privatisation are not enough. The rule of law has to be re-established in its full panoply of market-based rules, regulations, courts and institutions equipped with fully trained staffs. The state itself has to be tamed and shrunk, with the elimination of subsidies, arbitrary interventions, bureaucratic thickets and scope for corruption.
As a recent joint EBRD/World Bank survey of the experience of more than 3000 firms in 20 transition countries concluded, the “quality of economic governance” varies widely across the region. The survey took account of many factors, including taxes, regulations, policy and exchange rate stability, inflation, the rule of law, crime and corruption. The key factor, though, was the extent to which the state is still subject to “capture” – that is, undue influence – by vested interests.
Complaints of state capture were highest in Azerbaijan, Ukraine, Moldova, Russia and Georgia among the former soviet republics while Bulgaria stood out among the former satellite countries. Complaints were least in Slovenia, Uzbekistan, and Armenia. At the same time, state-owned businesses have to be weaned of loss-making habits and restructured before or at least immediately after privatisation.
Privatisation should preferably be conducted so that corporate governance is improved and additional capital, management and skills brought in. Financial discipline has to be restored generally, which means not only abolishing subsidies but also establishing effective systems of bankruptcy laws and procedures.
Above all, perhaps, a thriving banking system, capital market and a full array of insurance companies, pension funds and other financial institutions capable of mobilising savings and acting as lenders or institutional investors has to be created. It is on this last point in particular that the transition still has a substantial way to go in all countries, even the most advanced.
The financial sector, and especially the provision of market-based banking and other financial services, remains relatively underdeveloped across the entire post-communist region. The ratios to GDP of both total bank deposits and total bank credit to the private sector are still well below the levels seen in western industrial countries, the only palpable exception on both scores being the Czech Republic.
The ratio to GDP of total stock market capitalisation, though growing especially in countries like Hungary, is also still relatively low, while securities market regulation still lags in extent or effectiveness across the whole region, save perhaps in Hungary and Poland. In sum, the banking habit has still to catch on in most countries.
Most remain largely cash-based societies – not surprising, perhaps, given their painful experience of high inflation in the early transition years and their still generally low average incomes. Stock market investment is an even rarer individual practice. Active institutional investment remains embryonic, even in countries which established privatisation investment funds. To cope with foreseeable demographic trends, state pay-as-you-go pension systems are being reformed in a growing number of countries reinforced by a supplementary structure of fully-funded mandatory and/or voluntary contributory pension funds.
Nevertheless, apart from a few exceptions, even large businesses in central and east Europe remain starved of access to both bank and equity finance, while for small and medium-sized firms external finance is simply unavailable – save in some cases by way of special EBRD or World Bank financed credit schemes.
True, banking and financial services are now substantially privatised – or rather the more readily saleable institutions no longer burdened by asset quality problems or other disadvantages that might deter strategic investors are now virtually all sold off. Most countries, and not only those hoping to join the EU, have opened their banking and other financial markets to foreign ownership.
Foreign bank entry has substantially strengthened local banking systems, as have the growing number of mergers among the region’s banks and the many closures brought about by financial failures and the steadily tightening framework of prudential banking regulations and supervision. As competition has increased following the arrival of foreign banks, so more and more of the region’s banks are redefining their strategic direction.
As Thomson Financial BankWatch recently pointed out, most banks aimed to be universal banks in the early years of the transition. The more go-ahead banks have since been refocusing their aims in the light of the cost of matching the competition and the growing sophistication of corporate and retail customers.
Retail banking is now growing apace in the more advanced countries of central Europe with the emphasis broadening out from deposit-taking to vehicle and other consumer loans, insurance, mutual funds and, in a few pioneering instances, housing finance – despite the widespread absence as yet of term loans and long-term funding.
The achievements in banking and finance, as well as more generally, have been substantial in the first decade of the post-communist transition, especially in central Europe and the Baltics, although less so in southern Europe and the former soviet republics.
Even so, a great deal of unfinished business remains to be tackled in the decade ahead, even in the 10 or so countries now actively negotiating their entry into the EU. The administrative capabilities of these countries, however, are being burdened by the pressure to take on the EU’s own huge and ever-growing accumulation of laws, rules and regulations (the acquis communitaire) – at a time when Brussels appears to be evincing increasing reluctance to take on the more painful implications of enlargement, such as in the area of the common agricultural policy.
But the EU’s own transition is another story.
