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18
Possible Future Directions for Economies In Transition

Anders Åslund

The post-communist world has now undergone up to 7 years of transition to a market economy. A great deal has been accomplished, but much has also failed. We can now begin to see how the societies of these countries are evolving. The purpose of this chapter is to try to envisage what sorts of economic models these countries are developing.

The focus of this chapter is the whole of Central and Eastern Europe and the New Independent States, with the exception of the former Yugoslavia, that is, 22 countries.1 Thus the scope of the discussion is those countries that previously had a Soviet type of economic and political system. The 22 countries had differing levels of economic development and varying economic structures, which means that the costs of transition were bound to vary, but the emphasis here is on common features.

The next section considers how the countries have fared in the transition to date, assessing what factors have really mattered and how far the various countries have progressed. This is followed by a discussion of why certain reform policies have worked better than others; the answer provided here is that rent seeking is the key. Next is an examination of the major threats faced by these countries today. The future direction of economic policy is dependent not only on the past, but also on current problems. To a considerable extent, the predominant concerns are the same in most countries, and the

1  

Poland, the Czech Republic, Slovakia, Hungary, Bulgaria, Romania, Albania, Estonia, Latvia, Lithuania, Belarus, Ukraine, Moldova, Russia, Georgia, Armenia, Azerbaijan, Kazakstan, the Kyrgyz Republic, Uzbekistan, Turkmenistan, and Tajikistan.



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Transforming Post-Communist Political Economies 18 Possible Future Directions for Economies In Transition Anders Åslund The post-communist world has now undergone up to 7 years of transition to a market economy. A great deal has been accomplished, but much has also failed. We can now begin to see how the societies of these countries are evolving. The purpose of this chapter is to try to envisage what sorts of economic models these countries are developing. The focus of this chapter is the whole of Central and Eastern Europe and the New Independent States, with the exception of the former Yugoslavia, that is, 22 countries.1 Thus the scope of the discussion is those countries that previously had a Soviet type of economic and political system. The 22 countries had differing levels of economic development and varying economic structures, which means that the costs of transition were bound to vary, but the emphasis here is on common features. The next section considers how the countries have fared in the transition to date, assessing what factors have really mattered and how far the various countries have progressed. This is followed by a discussion of why certain reform policies have worked better than others; the answer provided here is that rent seeking is the key. Next is an examination of the major threats faced by these countries today. The future direction of economic policy is dependent not only on the past, but also on current problems. To a considerable extent, the predominant concerns are the same in most countries, and the 1   Poland, the Czech Republic, Slovakia, Hungary, Bulgaria, Romania, Albania, Estonia, Latvia, Lithuania, Belarus, Ukraine, Moldova, Russia, Georgia, Armenia, Azerbaijan, Kazakstan, the Kyrgyz Republic, Uzbekistan, Turkmenistan, and Tajikistan.

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Transforming Post-Communist Political Economies pressure to resolve them is a driver of economic policy. These pressures are likely to push countries in similar directions. However, policy issues alone do not determine the course of reform. Another consideration is the political framework—what ideas are predominant, or what schools of thought compete on the policy-making stage, and what ideas and interests the politicians represent. Finally, the purpose of this chapter is to assess how these considerations affect the kinds of states the former communist countries are becoming and what future developments appear likely. Thus, the last section suggests four plausible future models, commenting on the probability of each and what factors may influence them positively or negatively. RESULTS OF ECONOMIC TRANSITION TO DATE The aim of post-communist economic transition can be described broadly as to build capitalism—to depoliticize the economy, to activate markets, and to institute private ownership of the means of production (Kornai, 1992:360365). An underlying belief supported by the new institutional economic history is that the economic institutions of capitalism can generate economic growth (North, 1981). A number of recent econometric studies covering a large number of countries support this view (Sachs and Warner, 1995; Gwartney et al., 1996). A number of the 22 countries of interest here appear already to have entered a period of sustained economic growth under a new economic system. As of 1995, 4 of the countries—Poland, Slovakia, Romania, and Albaniahad reached growth rates of 7 percent (Stockholm Institute of Eastern European Economies, 1997). Yet only Poland, having recorded several years of considerable growth, appears to have entered a stage of sustained growth. However, in most cases it takes a long time before substantial growth can be expected. What other criteria can be used to measure the attainment of capitalism? We have settled for a qualitative target—capitalism—and its attainment should be measured by qualities. Three obvious criteria are financial stabilization, liberalization, and private-sector development: financial stabilization means that money is stable enough to function as a reliable means of exchange, liberalization is necessary so that market allocation can substitute for vertical state commands, and a dominant private sector is required to render ownership apolitical and pluralist. Each of these three criteria can be quantified, and the question is at what point we can say that a market economy has been reached. In practice, the most obvious success indicator has been low inflation. The control of inflation and the return of economic growth are closely related. No post-communist country has restored growth without limiting inflation to 40 percent per annum or less, while all the countries that have contained

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Transforming Post-Communist Political Economies inflation have returned to growth within a year or so (Fischer et al., 1996). There is also a strong correlation between inflation and decline in output. In 1995, 13 of the countries still had inflation exceeding 40 percent per annum, although virtually all inflation rates were lower than in the preceding year (Åslund et al., 1996:236-237). In 1996, nearly all the countries got inflation down to below 40 percent per annum. The only exceptions were Bulgaria in Central Europe and Tajikistan and Turkmenistan in the New Independent States. In Belarus, on the other hand, inflation may explode again. There have been several such cases in which inflation has fallen temporarily to a low level and then increased. Examples are Russia and Ukraine in the summer of 1994. In those two cases, the temporary stabilization was based entirely on monetary policy and not on a sufficient reduction of the budget deficit. Sustained monetary stabilization needs to be based on fiscal adjustment as well. Only when the budget deficit has been limited so that what remains can be financed by noninflationary means has inflation been brought under permanent control (Fischer et al., 1996). The frightening case is Bulgaria. In 1993, its inflation had decreased to 64 percent, but it doubled the next year—to 122 percent. Inflation was again reduced to 33 percent in 1995, but as the budget deficit stayed at almost 7 percent of gross domestic product (GDP), the exchange rate collapsed in 1996. As a consequence, inflation surged again to 305 percent a year (Stockholm Institute of East European Economies, 1997:1), and the associated social cost is likely to be very high. The Bulgarian experience illustrates the danger of trying to do only what is absolutely necessary, effectively walking a tightrope on the verge of an abyss. The countries most successful in controlling inflation have not calculated how large a deficit they can finance. Instead, they have aimed at a balanced budget or a small budget surplus. Croatia had a budget surplus of 0.7 of GDP and a deflation rate of 3 percent in 1994; the Czech Republic has a steady surplus of 0-1 percent of GDP and had an inflation rate of 8 percent in 1995; Slovenia balances its budgets almost perfectly, although its inflation rate was 9 percent in 1995; and Estonia maintains a budget surplus of 0.5-1 percent of GDP, while it recorded an inflation rate of 29 percent in 1995 (Stockholm Institute of East European Economies, 1997). Presumably, some of these countries harbor hidden semifiscal budget deficits, but that is an additional argument for eliminating the official budget deficit. With the exception of Croatia, not a single post-communist country has managed to achieve what would be considered low inflation in the West. This illustrates both how difficult and how important it is to combat inflation. One reason for the lingering high inflation is the existence of hidden deficits, often bad debts taken over by the government. Another reason is that these countries started with extremely devalued currencies, and real revaluation often

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Transforming Post-Communist Political Economies takes the form of inflation. Substantial relative price adjustments are a third reason. In hindsight, common complaints that too much attention was being devoted to combatting inflation appear particularly misplaced (Nuti, 1992; Nuti and Portes, 1993; Portes, 1993). There is no room for fine-tuning in post-communist stabilization. Another important criterion for successful transition is deregulation. In theory, stabilization can take place without liberalization, but in the reality it has proved impossible in the post-communist countries because price regulation is usually connected with substantial subsidies that must be reduced if financial stabilization is to succeed. Today there are a number of competing liberalization indices, produced by the World Bank (1996:14), the European Bank for Reconstruction and Development (EBRD) (1995), the Heritage Foundation (Johnson and Sheehy, 1996), and the Fraser Institute (Gwartney et al., 1996). These indices try to compound various indicators of liberalization, such as foreign trade obstacles, price regulation, tax levels, freedom of enterprise, and quality of financial markets. The World Bank liberalization index shows a clear correlation between liberalization and financial stabilization (de Melo et al., 1996). In an international context, most of the post-communist countries do not rank very high on the rather varied liberalization indices. Unfortunately, the EBRD and the World Bank do not compare the transition countries with countries in other parts of the world, and the EBRD has not even elaborated a composite index. The Heritage index, which endeavors to reflect 1996, includes 140 countries. It puts the Czech Republic as no. 12, and Estonia as no. 26, but the next transition country on the list is Hungary at no. 57; Bulgaria and Russia are no. 100. The Fraser Institute ranks 103 countries for 19931995. Its earlier point of measurement puts the transition countries at a disadvantage, and the highest-ranking transition country is the Czech Republic at no. 51; Hungary is no. 85, while none of the post-Soviet states is included. We can somewhat arbitrarily choose one of the liberalization indices and define a market economy as a country that surpasses a certain level on that index. Examining how far different countries have advanced toward a market economy at various times, it appears reasonable to put the threshold at 0.5 on the World Bank's liberalization index. Thus, we say that any country that surpasses this level is sufficiently liberalized to qualify as a market economy. Almost all the post-communist countries had passed this test by 1996. The exceptions are rare—notably Turkmenistan, Tajikistan, Azerbaijan, and Belarus (de Melo et al., 1996). We could also use the qualification of an open economy according to the criteria defined by Sachs and Warner (1995), which they identify as the threshold to economic growth. Today those criteria would result in approximately the same four countries being excluded. Moreover, there is only one example of an outright backlash after significant liberalization, namely Ukraine in 1993, which at the time had not been highly liberal-

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Transforming Post-Communist Political Economies ized. With the exception of the four outliers, then, we might dare to suggest that sufficient liberalization to form a market economy has been undertaken, although this is only a tentative empirical conclusion. Yet even if much remains to be deregulated, the paradigm has changed to that of a market economy. We might also note that with regard to liberalization, the danger of going too far seems remote, while the risk of not going far enough is very high. The third criterion for the transition to capitalism is expansion of the private sector, whether through privatization or the opening of new private enterprises. These two approaches are often presented as alternatives, but in reality tend to be complementary. Moreover, private-sector development is generally greater in countries with more financial stablization and liberalization (Åslund et al., 1996:245-248). To develop the private sector takes longer than to undertake financial stabilization or liberalization. Unfortunately, statistics on ownership are of particularly poor quality. EBRD (1995:11) offers the most complete picture, but provides only estimates, which tend to be very conservative. No Western country has more than about 35 percent public employment or public share of GDP produced. Thus, the threshold for capitalism might be set at 65 percent. By 1996, all of the Central European countries, apart from Bulgaria and Romania, appear to have approached that level, and only the three Baltic states, Russia, and Kazakstan in the New Independent States. There is a remarkable correlation among the above three criteria for capitalism. Two countries—Tajikistan and Turkmenistan—have not met any of the criteria. Bulgaria and Belarus have met only the liberalization criterion, and Azerbaijan has achieved only financial stabilization. Ten countries—Poland, the Czech Republic, Slovakia, Hungary, Albania, Estonia, Latvia, Lithuania, Russia, and Kazakstan—have met all three criteria. The 7 remaining countries—Romania, Moldova, Ukraine, Armenia, Georgia, the Kyrgyz Republic, and Uzbekistan—have not achieved privatization. However, reforms have progressed in all 7 countries, with the possible exception of Uzbekistan, and several of them may have passed the threshold for privatization in 1996. Therefore, of the 22 countries, 5—Azerbaijan, Belarus, Bulgaria, Tajikistan, and Turkmenistan—are failures to date, and 17 countries seem to be achieving capitalism. Is it sufficient to examine only these three key criteria? Institutional development has sometimes been contrasted with them. The relationship is difficult to measure, but the attempts that have been made show a strong positive correlation between these three key criteria for the transition to capitalism and institutional development (de Melo et al., 1996). There has been widespread concern that the transition from communism to capitalism has been marked by considerable social hardships (see the chapters in Section IV of this volume). Initially, anticipated high social costs in the form of a sharp decline in output, leading to a drastically falling standard of

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Transforming Post-Communist Political Economies living and massive unemployment, were widely believed to argue against a rapid transition. A common argument was that a swift transition would lead to greater adjustment costs than would a more gradual transition, and would therefore lead to social or political upheaval that could derail the whole transition process (see also Nelson, in this volume). Many believed that the population would accept only a certain level of social costs and that this absolute limit must not be reached. A wide range of possible disasters was invoked, including starvation; social unrest because of excessive poverty, price increases, and income differentials; and labor unrest because of low wages and mass unemployment. Today we have the record, and it is very clear. In general, there is a distinct positive correlation: the more radical the reform—in terms of deregulation, stabilization, and privatization—the smaller the total decline in output. The differences in the decline in output are stunning. Officially, GDP in Poland fell by 18 percent as compared with 86 percent in Georgia (Åslund et al., 1996). Official statistics generally overstate the decline in output, but the real decline has been reassessed at 7 percent in Poland and about 50 percent in Georgia, which is still a stark contrast. Statistics for income differentiation exist for only a few countries, but there appears to be a sharp divide between Central Europe, with more radical reforms, and the New Independent States, with slower reforms. In Central Europe, the least radical reformer, Bulgaria, displays the greatest income differentiation in the region (World Bank, 1996:68-69). Previously, the Soviet Union had greater income differentials than Central Europe, but the differences were of much smaller magnitude. Unemployment is perplexing because there is no correlation between it and decline in output or the nature of reform. On the whole, unemployment is greater in Central Europe than in the New Independent States, but within Central Europe the radical Czech Republic maintains a very low unemployment rate of around 3 percent of GDP (Åslund et al., 1996:237-243; Stockholm Institute of East European Economies, 1997). Although social suffering has been great, it is remarkable that these widely expected problems did not result in social upheaval although ethnic strife has erupted in several countries. Today few remember that the EU sent food aid to Poland in the winter of 1989-1990 because of fears of starvation. The same fear was stronger in Russia in the winter of 1991-1992, but starvation did not occur. Communist governments had long argued that they could not raise consumer prices because of the danger of social unrest. When the Soviet government raised meat prices in 1962, it faced substantial riots, notably in Novorossiisk. The Polish government fell because of workers' unrest when it tried to raise food prices in December 1970, and it suffered serious unrest again in 1976 for the same reason. Yet none of the post-communist governments has experienced any serious popular unrest because of price liberaliza-

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Transforming Post-Communist Political Economies tion. One explanation is that price increases for a few staple goods, such as meat and bread, are easily perceived as directed against the working man to the benefit of the elite, and can thus give rise to strikes and riots. Wider price deregulation, however, is clearly a change of paradigm and a transition to another economic system, not just an act of redistribution. Moreover, the very drastic price deregulations underlined how serious the crisis was, and there was no obvious alternative. In most countries, the previous level of price subsidies was untenable, and the preceding shortages were truly unbearable. Labor unrest was another concern before the reforms. Many of the new post-communist governments were very worried about strikes over wages. Yet the region has in fact been characterized by a very low level of labor unrest, and wage pressure has been remarkably limited. A similar worry was that unemployment would skyrocket; there were forecasts that it would rise to half the labor force in a year or two. The rate of unemployment has risen, but on the whole has been lower in Eastern and Central Europe than in Western Europe, where it lingers at around 11 percent of the work force. This is the only respect in which the New Independent States has done better than Western Europe. In hindsight, it is obvious that the organization of labor remains very weak, and that the very limited degree of collective action would render significant strikes implausible, particularly in the short term. As workers have accepted massive reductions in real wages, employers have had little reason to lay them off, which is a major reason why unemployment has increased far less than output has decreased. However we look upon the transition process, the empirical result is that it is better to undertake all the main transformations in concert and as rapidly as possible. There are no economic or social arguments for proceeding slowly. This was indeed the argument of a broad economic prescription literature from the beginning (Kornai, 1990; Lipton and Sachs, 1990; Blanchard et al., 1991; Fischer and Gelb, 1991; Åslund, 1992), while much of the theoretical literature dealt with trade-offs between potential negative effects of radical reforms that never materialized and obvious positive effects. THE IMPORTANCE OF RENT SEEKING How can the above empirical results be explained logically? Why have the costs of slow reform been so high? How do inflation, regulations, and state ownership cause economic decline? Much of the discussion about post-communist transition has concerned structural adjustment costs and how they can be minimized. The problem with much of the theoretical literature on how to minimize adjustment costs is that it assumes a good government, working in the interest of the people. In practice, however, structural adjustment costs appear to be a secondary concern. Instead, the most serious social costs result from rent seeking by an elite that is exploiting the state for its own enrichment.

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Transforming Post-Communist Political Economies In a way, the state was privatized because so much of society was nationalized. To understand this drama, we need to identify the main means of rent seeking. I shall focus on Russia, because I possess the best knowledge about rent seeking there (Åslund, 1996). The fundamental method of rent seeking was arbitrage: to buy something cheaply at fixed state prices and sell it at a high free market price at home or abroad. The great bonanza of arbitrage was in 1991 and 1992, when raw materials, notably oil, gas, and metals, sometimes cost as little as 1 percent of the world market price. The trick was to have access to these commodities in Russia and to be able to sell them abroad at the world market price. Considering the domestic and world market prices and the volume of exports of these commodities, it is easy to conclude that total rents arising from the export of oil, gas, and metals amounted to about 30 percent of Russia's GDP in 1992.2 These rents went to state enterprise managers and commodity traders dealing in oil, gas, and metals; various middlemen; and corrupt officials. A second, similar source of rents was import subsidies. Multiple exchange rates allowed this kind of arbitrage. In 1992, an importer of essential foods paid only 1 percent of the official exchange rate, and no less than 15 percent of Russian GDP went to import subsidies that year (International Monetary Fund, 1993:132-133, 140). Import subsidies did not show up in the Russian budget, as they were financed with Western commodity credits off the budget. Yet the Russian state is responsible for servicing and paying back these debts. The import subsidies went to a small group of commodity traders in Moscow. A third form of rents was huge subsidized credits. When prices were liberalized in January 1992, money became scarce as the money supply did not rise as rapidly as prices. State enterprises urged the government and the Central Bank to replenish their working capital. Unfortunately, the government and the Central Bank accommodated them. As a result, from June to September 1992, the money supply increased by almost 30 percent a month. Worse, most of these credits were issued at highly subsidized interest rates, 10 or 25 percent per annum, while inflation was 2,500 percent a year. Thus, these credits were virtual gifts from the state to the receiving enterprises. The net credit expansion amounted to 33 percent of GDP in 1992, and the interest paid was less than one-tenth of that volume. Hence, the total volume of credit subsidies reached some 30 percent of GDP in 1992 (Granville, 1995:67). The subsidized credits were directed primarily to three kinds of enterprises: agrarian enterprises (primarily Roskhlebprodukt, the previous Ministry of Grain 2   Total Russian exports in 1992 amounted to $42 billion. Of these exports, 70 percent was subject to export quotas and licenses. The average domestic price was less than 10 percent of the world market price, and the export tariffs collected were just over $2 billion (Aven, 1994; Åslund, 1995).

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Transforming Post-Communist Political Economies Procurement, which continued to purchase grain and bread), energy enterprises, and enterprises in the northern regions of Russia. However, these credits were channeled through about ten commercial banks, the so-called court banks. They delayed the disbursements for a long time and meanwhile let the credits work for their own benefit. Subsidized credits were a major source of the enrichment of the commercial banks. Nomenklatura privatization of enterprises was a fourth source of rents, but surprisingly appears to have been much more limited than the others. In total, almost 17,000 large and medium-sized enterprises went through voucher privatization. In the spring of 1996, the total market capitalization of the 200 companies with the most-traded shares, which included Gazprom and the big oil companies, was about 7 percent of GDP (Government of the Russian Federation, 1996). Collectively the remaining companies that underwent voucher privatization were at most worth one-third of that amount. Moreover, surveys carried out by the World Bank showed that the initial ownership by managers was only 8 percent, though it rose rapidly to 18 percent in 1996 (Blasi et al., 1997). Even so, voucher privatization had given the managers only about 2 percent of GDP in total by the spring of 1996. There are many other forms of rent, such as ordinary monopoly rent, corruption, racketeering, and rents from municipal real estate. Real estate might generate substantial rents, but otherwise these forms of rent are likely to be less significant than those discussed above. Racketeering seems heavily focused on the retail sector, and total retail trade amounts to one-third of GDP. Ordinary protection fees extracted from retail traders by racketeers are 15-20 percent of total sales. However, many retailers in small localities and shielded shops do not pay protection money, and it would be surprising if retailers did not learn how to escape racketeers when they evade taxes so successfully. Therefore, a reasonable assumption is that protection fees average 10 percent of total retail trade, which would mean that annual revenues from racketeering in retail trade amount to 3 percent of GDP, a relatively small amount. Incredibly, we can conclude that gross rents amounted to about 80 percent of GDP in Russia in 1992. It is little wonder that people had a perception of lawlessness. Yet these are gross rents as compared with gross revenues of an enterprise, which can add up to several times the GDP. Net rents, corresponding to net value added, would be a far smaller share of GDP. A relatively small group has benefited enormously from the rent seeking that arose at the end of communism and the birth of capitalism in Russia. The sectors offering the greatest opportunities for rent seeking have been energy, agriculture, trade, and banking. The rents have been heavily concentrated among state enterprise managers and early commercial operators in trade and finance. In contrast with profits gained in a competitive market, these rents have been extracted as a result of privileged access awarded by the state

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Transforming Post-Communist Political Economies through corruption. The rents have been conditioned by state regulations that have effectively favored parts of the old elite. Privatization implied some rent seeking, but much less than is commonly believed. A variety of financial flows caused a much larger transfer of resources from the state to managers than did privatization. Even so, privatization tends to be criticized much more than do other forms of rent seeking. The explanation is probably that privatization is a very visible, relatively transparent process, and people tend to blame what they can see. Moreover, rent seeking implied that managers benefited far more from unproductive transactions and manipulations than from production or enterprise profits. The managers' focus on rent seeking implied that they cared little about output or the utilization of the factories they managed, and a natural consequence was that output fell sharply. Privatization, on the other hand, often led to new enterprise behavior, making managers focus on profits rather than rents. Hence, privatization often initiated the ouster of corrupt and inept managers and the beginning of enterprise restructuring. Privatization, then, was actually a way of limiting rent seeking. Ironically, it was technically easy to stop the main rent seeking. Export rents were abolished with the liberalization of exports and raw material prices, which occurred in many small steps in Russia. Import subsidies were eliminated by the government by the end of 1993 as the exchange rate was unified, and subsidized credits were abolished in late 1993. These four measures were all part of the radical reform agenda; they were undertaken in most of Central and Eastern Europe much earlier, but in the former Soviet Union, the reformers were too weak to impose their policies. In hindsight, it is obvious that this implied a great loss to society. Not only did much of the elite indulge in unproductive redistribution of wealth to their benefit at the cost of society at large, but they also neglected ordinary work, ranging from production to elementary government services. Hence, the greater the rent seeking, the more income differentials grew, and the more output fell. There was far less rent seeking in Central and Eastern Europe than in the NIS, and the degree of rent seeking can explain much of the difference in the results of post-communist transformation between these two regions. Central and Eastern Europe benefited from fewer economic distortions, more economic and legal norms, a better-functioning state, and a stronger civil society than existed the former Soviet Union, where the old elite had been and remained amazingly free of social controls. Rent seeking can also explain the strong correlation between the nature of economic reform and the political regime. Radical reform—defined as a certain degree of deregulation and a certain effort at financial stabilization measured ex post—was undertaken by five countries: Poland, Czechoslovakia, Albania, Estonia, and Latvia. All initially had liberal, nonsocialist governments. All the remaining socialist governments, on the other hand, under-

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Transforming Post-Communist Political Economies took gradual reforms, as did four of the nonsocialist governments. Hungary and Lithuania did so as well, because their regimes were more nationalist than liberal. Bulgaria and Russia attempted radical reforms, but their governments were too politically weak to be able to sustain these efforts for even a year. In short, the capable nonsocialist regimes opted for radical reform, while all the lingering socialist regimes preferred gradual reform. Typically, those states that have failed to transform have been ruled by former socialists. These regimes are not very democratic, and they have been ruled in ways that enrich and further entrench the old elite. This poses a danger not only to the successful formation of a market economy, but also to democracy. The case is most obvious in Belarus, which is surrounded by democracies and more reformist countries. WHAT ARE THE THREATS TODAY? As we explore what dangers the post-communist countries are likely to encounter in the future, four threats are apparent. First, nation building itself may fail, leading to general chaos. Second, a country may not accomplish elementary transition, but end up with persistent high inflation. Third, a country may not liberalize and privatize enough, or privatization may lead to excessive concentration so that it gets mired in corrupt, crony capitalism. Fourth, a country may become caught in the entitlement trap, with excessive taxes and social transfers. The worst case is the first—that the newly independent state fails in its nation building, and does not even establish basic law and order and elementary state institutions. The obvious example is Tajikistan, which has collapsed in every sense of the word. Georgia appeared to be as badly off, but it seems to be recovering, even if the peace there seems fragile. To date, only three countries—Bulgaria, Belarus, and Turkmenistan—seem really to have failed in their economic transition policies, as argued above. They continue to pursue irresponsible policies, leading to high inflation, continued regulation, and little privatization. In Bulgaria, the democrats lost power because of internal division after a short time in power, and their fragmentation facilitated the electoral victories of the old communists. A small group of former communists controls the big enterprises, which they run badly, causing losses. These losses are covered by state banks, which are controlled by roughly the same people who run the government, which recapitalizes the banks and runs a large budget deficit of about 7 percent of GDP in spite of a very larger foreign debt. Fortunately, the whole drama came to a head in 1996, as Bulgaria ran out of international finance; many of the banks collapsed when the government could no longer afford to refinance them. Ordinary citizens had little choice but to withdraw their bank deposits and exchange their leva for hard currency; the exchange rate of the leva collapsed,

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Transforming Post-Communist Political Economies and inflation increased. The government responded by price regulation, which led to food shortages. GDP fell sharply in 1996. Fortunately, popular protests have grown so strong that the government has been altered, and early parliamentary elections seem plausible. This is a good example of how democracy offers a new opportunity for radical market reform. The presidential election in Ukraine in July 1994 is another example. Belarus is ruled by a truly populist and authoritarian president who does not bother with economic laws, and his entourage makes money on illicit deals facilitated by economic chaos. Popular protests have been strong, but apparently not strong enough. Democracy effectively ended in Belarus in 1996 as a new authoritarian constitution was adopted, and the old parliament was reduced to presidential supporters. Similarly, Turkmenistan is run by the most totalitarian leader in any former communist state, who could not care less about economics. Naturally, a long period of economic mismanagement is bound to undermine the legitimacy of the regime, and the question is whether civil discontent will be strong enough to oust the flawed regime, or it will defend itself by nondemocratic means. Crony capitalism, however, seems to have become a far more common problem. All over the former communist world, extensive corruption prevails as the government retains control over large resources—enterprises and real estate—and the state remains highly interventionist and arbitrary. To any observer of the Russian economy, it is obvious that the market economy does not function very well there as yet. Prices and mark-ups remain high; regional price differentials remain sizeable; the number of registered private enterprises is very small and declining; although bank and interenterprise arrears have stagnated, wage arrears and tax arrears have mounted; and stock prices are very low in comparison with the asset values of the companies. Any foreigner is still overwhelmed by the degree of regulation. Russia continues to license virtually all economic activities, and in many cases multiple licensing is required because of various branch legislation. Russia is the promised land of inspectors of all kinds. Rather than imposing strict legislation, the state inspectors tend to require bribes. The situation appears to be similar all over the New Independent States, in sharp contrast with Central Europe. There is a real danger that several countries will remain mired for a long time in crony capitalism, so that even big capitalists will stay heavily dependent on the state. Several Latin American countries and India until the early 1990s are examples of such states, and their economies have not been very dynamic. The most apparent problem is that far too much property remains in public ownership. A related concern is that privatization will be directed to protégés of the regime to such an extent that private monopolies having a cozy relationship with a regulative state will evolve. This is also a concern for some countries that have done very well in terms of stabilization and liberalization. Such an economic policy could easily endanger democracy as well.

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Transforming Post-Communist Political Economies It may be noted that all the countries that are or might end up in the first three groups discussed above are those that pursued slow or gradual economic reform. Finally, the threat of excessive state intervention is balanced by another problem, which might be seen as a possible solution. The whole of the New Independent States is seeing a steady decline in state revenues of about 5 percent a year. Average state revenues as a share of GDP plummeted to 29 percent in 1993, and the share is continuing to decline (Citrin and Lahiri, 1995:78). In 1996, most members of the Commonwealth of Independent States collected no more than 20 percent of GDP in tax revenues, and no shift toward higher revenues is noticeable as yet. The states that collected most taxes were Ukraine, with 35 percent of official GDP, and Russia, with 31 percent. As little financing is available, and most governments are determined to keep inflation under control, they have no choice but to cut expenditures to limit the budget deficit. The liberal response to this problem is to cut tax rates while broadening the tax base, abolishing tax exemptions, demanding that all liable for taxation actually pay their taxes, and accepting that public revenues should not be more than 20-25 percent of GDP. This would imply a minimization of subsidies, which would reduce state intervention to a more tolerable level. Social transfers would have to be capped, and pension reform would be required, increasing the role of savings and private pensions. The statist approach is to try to collect taxes by whatever means available, reinforcing the arbitrariness of state powers. Yet the shortfall of tax revenues is so great that it is likely to have a primarily liberal impact. The leaders of the transition are facing the opposite problem. Their apparent threat is the entitlement trap (Sachs, 1995). The four Visegrad countries have public expenditures of around 50 percent of GDP. In particular, Hungary had public expenditures of as much as 62 percent of GDP in 1992 and 1993 (Banerjee et al., 1995:8). Worldwide, only Sweden and Denmark exceed this level. The dilemma is multiple. High public expenditures mean high taxes, but often a big budget deficit as well, which easily leads to an excessive debt burden, as is the case in Hungary. Large social transfers—23 percent of GDP in Hungary in 1993—weaken the incentives to work. The combined effect is that people work less productively than in a more liberal economy, and no economy with public expenditures as high as those of Hungary has been especially dynamic. By comparison, the economic lions in East Asia spend only a few percent of GDP on social transfers (Sachs, 1995). Countries in the New Independent States, however, are not very likely to fall into the entitlement trap because of their limited state revenues. Hence, the former Soviet republics have the possibility and challenge to opt for a much more liberal model than Central Europe has adopted. Estonia stands out as the country that has done so, but the Kyrgyz Republic, Moldova, Georgia, and Kazakstan seem to have embarked on a similar course.

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Transforming Post-Communist Political Economies POLITICAL FRAMEWORK As noted earlier, policy issues have only a limited impact on the course of reform; the political framework is also of vital importance. Three aspects of the political framework appear particularly relevant: the economic paradigm, political forces, and the state of civil society. Economic thinking in the region has counterposed two paradigms. The first has been represented by those who have favored radical economic reforms; these have been largely trained economists. They have reflected the set of views that Williamson (1993) has labeled ''the Washington consensus." It implies limited fiscal deficits, strict monetary policies, price liberalization, deregulation of foreign trade, and privatization, and is being embraced by the International Monetary Fund (IMF), the World Bank, and the international community at large. A broad international consensus exists on the ways in which many of these problems should be approached, and these alternatives are clearly presented in a large literature. Reform economists and economic policymakers throughout the post-communist world have gained strength by drawing on this international consensus. Proponents of the opposing pardigm have comprised not old communist doctrinaires, but rather the managers' lobby. They did not advocate the old communist system, but they wanted the transition from the old to the new system to last a long time and to involve serious economic distortions that would allow them to maximize their rents. Hence, they favored subsidies from the government budget and subsidized credits to producers, arguing that output would fall otherwise. The size of the budget deficit and inflation were of no concern to them. They advocated domestic price regulation and export controls in order to generate export rents through arbitrage. Generally, they preferred a minimum of transparency to facilitate illicit deals. For instance, they suggested that production monopolies had to be controlled by the state; this led to far-reaching regulation of domestic trade, which in turn limited competition, as desired by the managers (Åslund, 1995). For a long time, the managers enjoyed widespread support from people ignorant of the dilemmas of post-communist transition. Reform communists and most social democrats thought it sounded right to slow down the transition process. The less was the economic understanding, the more successful were the managers in their advocacy of a slow transition. This is one reason why the managers in the former Soviet Union were able to get away with much more malpractice than in Central and Eastern Europe. Over time, however, the population has learned and no longer accepts spurious arguments. The interests of many managers have also shifted from rent seeking to profit seeking as they have learned their new businesses and no longer want to depend on bureaucrats. Furthermore, rents tend to dry up. The inflation tax, and thus the rents from high inflation, falls as people and enterprises reduce their real cash

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Transforming Post-Communist Political Economies balances and as the velocity of money rises; export rents decline with a real revaluation of the currency, bringing domestic prices closer to world market prices. Finally, weak reform policies tend to lead to serious economic crisis, and the only financing available for financial restructuring tends to be IMF money, which is provided only on the condition of sufficiently far-reaching reforms. The paradigm of the reform communists has therefore lost out, as it has proved utterly ineffective. Thus the international liberal consensus is making inroads throughout the region as time passes. There are certain countervailing forces, notably some protectionism in import policies, but such tendencies have thus far been limited. It is possible that a new ideological divide is opening up between Central and Eastern Europe and the New Independent States. Central and Eastern Europe has assumed many features characteristic of Western Europe—a similar degree of liberalization, state ownership, taxation, social transfers, and income differentiation. The region is increasingly characterized by a party spectrum resembling Western European political views, ranging from conservatives, to liberals and peasant parties, to social democrats, with the occasional hard nationalists. The New Independent States, on the other hand, is much less liberalized, is much more corrupt, has more differentiated incomes, and collects much less in taxes. The weakness of the state is much more apparent, and the whole situation is more akin to Latin America two decade ago than to Western Europe. Hence, political and economic thinking is also developing along different lines. The political center represented by social democrats is strikingly absent; one school of thought considers itself gosudarstvenniki ("statists"), while another is far more liberal than similar groupings in Europe. Which force wins out will to a considerable extent be determined by whether democracy or dictatorship prevails. Whenever dictatorship takes over, it is usual, though not inevitable, that a statist economic policy wins out, as such a policy can benefit people in power the most (Maravall, 1994). However, the strong correlation between political and economic regimes noted just after the demise of communism has been weakening with the passage of time. Some dictatorships, notably that in Kazakstan, have gone far in liberal economic reforms after substantial nomenklatura privatization, while Albania, an early radical reformer, appears to have given up democracy in 1996. Civil society seems to have been a vital factor in the formation of both political and economic systems, and it is likely to remain so. Poland provides an enlightening example. It possessed a far more extensive civil society than most other post-communist countries in the form of the Catholic Church, the private peasantry, and the Solidarity trade union. While all these groups were vigorously opposed to economic reform, they effectively made it succeed, as they blocked much of the rent seeking of Poland's managers. Hence, Putnam's (1993) argument that a strong civil society contributes to economic growth has

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Transforming Post-Communist Political Economies been borne out in the post-communist world, and the explanation is that civil society limits rent seeking. FOUR POST-COMMUNIST MODELS The outcomes of the post-communist transformation have varied greatly, and it is obvious that they were not predetermined. The orientation and quality of economic policymaking during these first few years is likely to remain of fundamental importance for all these countries for decades to come. At the outset of the post-communist transition, a large number of possible economic models were discussed. Today, the number has shrunk considerably. Only a few countries had sufficiently strong states to be able to opt for a more complex model. The Visegrad countries are adopting much of the Western European model, not least because they are preparing to enter the EU. Yet complexity is not entirely a good thing. These countries are also facing the danger of limited economic growth and the entitlement trap most clearly developed in Sweden as a result of taxes that are too high and social transfers that are too large. The entitlement trap is particularly evident in Hungary, but social transfers are of about the same size in Poland. Poland is frequently compared with post-war Italy—corrupt and messy, but highly dynamic. Most of the countries have undertaken substantial reforms, but these have not been at all as far-reaching as they should be. The result has not been collapse, but corruption and crony capitalism, as in the old protectionist and interventionist Latin American model. Most countries in the New Independent States fall into this category. It may be hoped that this state of affairs will not be permanent. As has been done by many Latin American countries, several of these former communist countries are likely to opt for a new liberal economic model with low taxes, limited social transfers, few regulations, an open economy, and far-reaching privatization. To date, Estonia has most clearly made such a choice, but several other countries appear to have started moving in this direction, including Latvia, Lithuania, Moldova, Georgia, the Kyrgyz Republic, and Kazakstan. This model is more reminiscent of the old U.S. model. More countries are likely to follow as they try to control their economic and social problems. There are also countries that have done little and who may ultimately fail not only as economic reformers, but even as states. They could end up in a terrible economic situation reminiscent of parts of Africa, without a functioning state or economy. Tajikistan is currently in such a condition. Because of the combination of excessive state intervention and poorly functioning governments and markets, neither an East Asian model nor a well-functioning Western European model appears to be a plausible option for these countries.

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Transforming Post-Communist Political Economies REFERENCES Åslund, A. 1992 Post-Communist Economic Revolutions: How Big a Bang? The Center for Strategic and International Studies. Washington, DC: Westview. 1995 How Russia Became a Market Economy. Washington, DC: The Brookings Institute. 1996 Reform vs. 'rent-seeking' in Russia's economic transformation. Transition (OMRI) , January 26:12-16. Åslund, A., P. Boone, and S. Johnson 1996 How to stabilize: lessons from post-communist countries. Brookings Papers on Economic Activity 26(1):217-313. Aven, P. 1994 Problems in foreign trade regulations in the Russian economic reform. Pp. 80-93 in Economic Transformation in Russia, Anders Åslund, ed. New York: St. Martin's. Banarjee, B., V. Koen, T. Krueger, M.S. Lutz, M. Marrese, and T.O. Saavalainen 1995 Road Maps of the Transition: The Baltics, the Czech Republic, Hungary, and Russia. IMF, Occasional Paper No. 127, Washington, DC. Blanchard, O.J., R. Dornbusch, P. Krugman, R. Layard, and L. Summers 1991 Reform in Eastern Europe. Cambridge, MA: MIT Press. Blasi, J. R., M. Kroumova, and D. Kruse 1997 Kremlin Capitalism: Privatizing the Russian Economy. Ithaca, NY: Cornell University Press. Citrin, D.A., and A.K. Lahiri, eds. 1995 Policy Experiences and Issues in the Baltics, Russia, and Other Countries of the New Independent States, IMF, Occasional Paper No. 133 , Washington, DC. de Melo, M., C. Denizer, and A. Gelb 1996 From Plan to Market: Patterns of Transition. Policy Research Working Paper No. 1564, World Bank, Washingon, DC. European Bank for Reconstruction and Development (EBRD) 1995 Transition Report 1995. London: EBRD. Fischer, S., and A. Gelb 1991 The process of socialist economic transformation. Journal of Economic Perspectives 5(4):91-105. Fischer, S., R. Sahay, and C.A. Vegh 1996 Stabilization and Growth in Transition Economies: The Early Experience. IMF Working Paper. March. Government of the Russian Federation 1996 Russian Economic Trends 5(1). London, Lawrence, KS: Whurr Publishers. Granville, B. 1995 The Success of Russian Economic Reforms. London The Royal Institute of International Affairs. Gwartney, J., R. Lawson, and W. Block 1996 Economic Freedom of the World: 1975-1995. Vancouver, BC: The Fraser Institute. International Monetary Fund 1993 Economic Review: Russian Federation. Washington, DC: IMF. Johnson, B.T., and T.P. Sheehy 1996 1996 Index of Economic Freedom. Washington, DC: Heritage Foundation. Kornai, J. 1990 The Road to a Free Economy. New York: Norton. 1992 The Socialist System: The Political Economy of Communism. Princeton, NJ: Princeton University Press.

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Transforming Post-Communist Political Economies Lipton, D., and J.D. Sachs 1990 Creating a market in Eastern Europe: The case of Poland. Brookings Papers on Economic Activity 20(1):75-147. North, D.C. 1981 Structure and Change in Economic History. New York: Norton. Nuti, D.M. 1992 How to contain economic inertia in the transitional economies. Transition 3(11): 1-3. Nuti, D.M., and R. Portes 1993 Central Europe: The way forward. Pp.1-20 in Economic Transformation in Central Europe. A Progress Report, Richard Portes, ed. London: Centre for Economic Policy Research. Portes, R. 1993 From central planning to a market economy. Pp. 16-52 in Making Markets, Shafiqul Islam and Michael Mandelbaum, eds. New York: Council on Foreign Relations. Sachs, J. 1995 Postcommunist parties and the politics of entitlements. Transition 6(3): 1-4. Sachs, J., and A. Warner 1995 Economic reform and the process of global integration. Brookings Papers on Economic Activity 25(1): 1-118. Stockholm Institute of East European Economies 1997 Key Economic Indicators 4(4) January 7. Williamson, J. 1993 Democracy and the "Washington Consensus." World Development 21(8): 1329-1336. World Bank 1996 World Development Report 1996: From Plan to Market. Oxford, England: Oxford University Press.