Lessons of Transformation
Strong institutions make stable economic growth possible. It is not relevant in terms of the dynamics of economics which methods – whether authoritarian or democratic – are used to maintain these institutions
Picture by VE
Abrief look at statistics allows us to see a tremendous difference in the economic processes of the post-Soviet states. Which republics out of the former Soviet Union countries have been developing better for the last fifteen years after the collapse of the Soviet Union? The man in the street will most probably say that the most successful have been the Baltic republics and will certainly be mistaken. Estonia is indeed present on the list of economic pacesetters, but Latvia and Lithuania are not. But such countries as Armenia, Belarus, Kazakhstan and Uzbekistan - not usually seen as leaders in economic reforms - are not on that list. According to the EBRD’s data, last year resulted in their complete overcoming the decline of the 90’s, that is, they exceeded the GDP of the pre-crisis year of 1989 (see diagram 1). According to the data provided by the CIS Statistical Committee, if we take the year of 1991 as a reference point, then the pre-market output level in the post-Soviet space was overcome only by six out of fifteen former Soviet republics (Russia is overcoming this level only based on the last year’s results). At this point, the best accumulated economic dynamics is demonstrated by the countries which experienced a less economic decline (see diagram 2).
With regard to the share of investments in the GDP in 2000-2005, the same countries are in the lead: Estonia is close to Belorussia, and Latvia is close to Azerbaijan (see diagram 3).
Fifteen years ago at the beginning of economic transformation, the disputes were held mostly about the pace of reforms – between the “shock-therapists”, advocates of radical reforms and “gradualists”, the advocates of gradual reforms. The shock therapy advocates asserted that it is “impossible to close a gap in two jumps.” Social unrest – a period when old rules are no longer in place and the new ones have yet to be established - can be avoided if the economic system is changed quickly. The gradualists, objected to destroying the old institutions and abolishing the old rules of economic regulation before new institutions are created and new rules are enforced. They cautioned that an institutional vacuum might lead to a disastrous production decline.
The arguments about the connection between the tempo of liberalization and the economic growth overall may look convincing; however, the devil, as we know, is in details.
A careful glance at specific examples immediately reveals a number of discrepancies.
A comparison of the economic dynamics in the countries of the former USSR does not fit the hypothesis that more liberalization leads to less decline in production”. Indeed, of the Baltic republics, veritable leaders in liberalization, only Estonia demonstrates adequate results. The economic successes of Belarus, a country with oil and gas, and called the last dictatorship of Europe, defies conventional wisdom.
Uzbekistan has never fitted and does not fit either the limits of the notion of liberalization. Ten years ago the article of the IMF’s expert Jeromin Zettelmeyer “The Uzbek growth puzzle” affirmed that the economic growth in the country is maintained artificially, though direct and indirect subsidies. Ten years have passed and there has been no evident decline: the Uzbek economy has been steadily growing since 1996.
It would seem that there is no connection between liberalization and the health of the economy. As seen on diagram 4, with the exception of the Baltic republics, higher liberalization always matches lower production growth. The same seem to be true for the connection between indicators of privatization and economic activity: the growth rate leaders in the CIS (Uzbekistan and Belarus) have the lowest percent of the private sector as against GDP (less than 50%).
So, it would seem that liberalization works in the Baltic countries and does not in the CIS. Why so? A short answer would be that first, the initial conditions were very different. Second, the state institutions – already well-established- without which the market economy does not work had deteriorated less in countries with a rapid liberalization and democratization process (the Baltic countries). State institutions deteriorated less slowlyl in countries which already had a weak state and a slow pace of democratization (Belarus and Uzbekistan). However, in countries with a weak state which chose the path of rapid democratization and liberalization, state institutions collapsed. This was followed by a challenging and unending decline of the economy.
Based on the experience of all of the countries economies in transition, where reforms call for a structural transformation (re-distribution of resources), the pace of restructuring should not be more than the economy’s investment potential. These are the principle grounds for a gradual elimination of tariff and non-tariff barriers, subsidies, and other forms of state support for certain sectors. Incidentally, it took the European Economic Community and NAFTA five years to eliminate tariffs even though they were very low – only about 10% of the cost of imports.
The dynamics of state expenditures during the transition period turned out to be a more important factor for successful transformation rather than the speed of reforms from all points of view. It goes without saying that preserving a big state during the transition period cannot guarantee healthy production levels (other conditions including careful expenditure of state funds are necessary too).
And sudden cutting of state expenditures, in particular, for typical state purposes (which include healthcare, education, police and judicial system) will ensure the collapse of state institutions and deep production decline. accompanied by intensified social disparities and macro-economic populism.
This way, the history of ups and downs of the transition period does not look like a history of consistent (successful) and inconsistent (unsuccessful) reforms. The main plot of the “novel” entitled post-socialist transformation is ensuring the functioning of the state in some countries (very different in characteristics, ranging from Central Europe and Estonia to China, Uzbekistan and Belarus) and their seeing their collapse in other countries. At least, this is 90% a history of state failure and its establishments but not the market failure and insufficient liberalization.
