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The Political Economy of Transition

Europe in Search of Itself

After more than ten years of transition, are the former countries of the “other Europe” on their way to integration into a new, reunified Old World? In economic terms, the answer is maybe.

While the countries that are currently candidates for European Union membership seem to be converging towards the living standards and production patterns of member States, it is unclear whether the other countries in transition (Southeast Europe, the CIS1) are on a course to escape being stuck in permanent under-development. Why such differences? The answer lies in different conditions at the outset and divergent reform policies.

Different initial conditions
The nine ex-communist countries gave birth to 20 countries in transition in Europe and eight in Asia2, and economic rehabilitation was slowed at the start by war, lack of a competent administration, inexperienced emerging political elites, corruption and other difficulties. In addition, the economic situation of these countries was already differentiated under communist rule; Hungary and Yugoslavia were more open to the outside world than were Romania or the Soviet Union. Levels of development varied; from Slovenia to Macedonia, or the Baltic countries to the central Asian republics, or from the former GDR to Albania, per capita GDP varied along the same scale as exists between Latin America and western Africa. Lastly, certain countries of the former Soviet Union inherited considerable mineral resources while other countries which had specialised in transformation of these resources suddenly found their sources cut off. These differences in initial conditions explain in part the disparity among trajectories of economic development since.

Contrasting policies of reform
Huge, historically unprecedented reforms were needed at the outset, and the policies adopted varied widely. The communist countries shared certain characteristics such as exacerbated protectionism, over-industrialisation, widespread shortages and an active black market, and low productivity in un-competitive State-owned enterprises. This dilapidated structure was held together only by a monolithic Party and by energy resources distributed by the Soviet Union to its trading partners.

So what happened when centralised power and protectionist walls both fell? The first political divide opened up between proponents of “shock therapy” and those who advocated gradualism. But why did the former approach work in Poland and fail in Russia? Why has the latter succeeded in Hungary and not in Romania? For all these countries the “shock” of de-controlled prices and foreign trade were inevitable in the same way that rigorous stabilisation policies were necessary as a “therapy” against inflation. But structural transformation is a long-term affair, a fact that the “Washington consensus3” could be criticised for ignoring when promulgating its trinity of themes for successful transition: liberalisation, stabilisation, and privatisation.

A second political debate arose between advocates of top-down privatisation and those convinced by the wisdom of bottom-up privatisation. The former were supported by the multilateral organisations and felt that the transfer of former State enterprises into the private sector ought to happen as quickly as possible and that this would be all that was needed to reinvigorate the industrial fabric. Their opponents felt that only the creation of new firms by genuine entrepreneurs could ensure the transformation of former communist economies into market economies, but that it would take too long. In retrospect, both ideas were wrong4. It is vital to encourage the creation and growth of small private enterprises as a sector capable of very fast growth. Knowing how to establish the rules of the game (legal institutions) in a way that encourages such behavior is what distinguishes successful transitions in some cases. Neglecting these rules, on the other hand, can keep “slow” countries stuck in underdevelopment. Applying the “acquis communautaire” - that is the legal framework which is binding in common for all EU member States – by candidate countries has been a move in the right direction.

Joining the euro, a third debate
The third great political debate of transition is whether or not to join Euroland. The growth boom ahead for transition countries, whose growth reservoir resembles Western economies in the decades after WWII, will trigger a permanent rise in productivity and salaries, which in turn will have an inflationary5 effect and make it difficult to hit monetary union targets. Should transition countries keep their currency and practice floating exchange rates, or should they adopt the euro and not worry about inflation ceilings, or should the European Central Bank establish a special monetary regime for Eastern Europe? This is one of the major economic challenges facing the reunification of Europe.




Gérard Duchêne
Director of ROSES
Centre de recherche sur l'économie de la transition et du développement
CNRS-Université Paris I

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