Download Economic Transition in the Western Regions of the Former Soviet

On October 29 and 30, representatives of the international community
gathered in Tokyo to decide on an important change in how support is provided
to the former Soviet Union (FSU). Until then, the process-launched at the
initiative of U.S. Secretary of State James A. Baker III at the Coordinating
Conference on Assistance to the New Independent States in January 1992coordinated and directed support to the former Soviet Union as a whole.
As a result of the Tokyo meeting, the international community now strives
to account for the special needs of each individual country that has emerged
from the USSR's dissolution, and directs its assistance accordingly. This is the
Country Consultative Group approach that the World Bank has been sponsoring
for numerous countries for a few decades now. Kazakhstan and Kyrghyzstan will
be the countries addressed in the first Consultative Group meetings for the FSU,
scheduled for mid-December 1992, followed by others in the first part of 1993.
This is a welcome change of approach for two reasons. First, the focus on
the FSU as a group was essentially a focus on Russia. To be sure, Russia's fate
is critical, given the size of the country, its natural resources, and-as a military
power-its potential role as a stabilizer or destabilizer for the region as well; and,
for these reasons, the level of attention focused on Russia must not diminish.
However, there are almost as many people living outside the Russian Federation
as within it. In 1990 the population of the Russian Federation stood at 148
million/ while that of all the other republics combined was higher than 141 million.
Many of the 14 other newly established states are well endowed with natural
resources-and several of these Soviet successor states have nuclear weapons
as well.
The second reason for welcoming this changed approach is that these are
different countries with specific needs that are not simple extrapolations of
Russia's own needs. The resource endowments of these countries, as well as
their industrial composition and human capital are varied-a year of independence
has driven this point home to the international community.
So, in line with this appropriate refocusing of the world's attention, it
behooves us to take a closer look at the individual countries in the FSU,
particularly in the western region. These countries-specifically Belarus, Ukraine,
Moldova, Armenia, and Georgia- deserve a closer examination for several
reasons. First, these particular countries are all considered part of Europe, and
they were all part of the Soviet Union from its inception except for parts of
Moldova and western Belarus and Ukraine. Together they constitute more than
75 million people and almost one million square kilometers. Second, they are
countries whose destiny should be significant for the rest of Europe. They have
served as important trading routes between East and West (Asia to Europe), as
well as between North and South (Europe to the Middle East). Historically, these
countries have also served as important corridors for numerous invasions across
the Eurasian continent. Third, in spite of their current problems, these are
countries that have a great potential for emerging early and strong from the
current economic chaos afflicting the FSU. Their success- probably more
attainable because, among other things, it is more affordable in terms of financial
aid-could help point the way to other FSU countries. In brief, the strength and
stability of these five countries can contribute greatly to the peace and the
welfare of the rest of Europe.
This article begins, then, with a selective look at some structural
dimensions of the economies of these countries, as well as their current
economic performance. It then takes a look at the ambitions, objectives, and
dilemmas they face. This, in turn, leads to a consideration of what these
countries have done about their economic transition and what could possibly be
the next steps in their reform programs.
I. Structural Dimensions of the Economies in the FSU's Western Region
Belarus, Ukraine, Moldova, Georgia and Armenia fall into the category of
middle-to-low-income countries. Their GNP per capita probably ranged between
a low $1,200 for Georgia to a high of $2,600 for Belarus in 1991. These numbers
are at best tentative given the difficulties of comparing the system of national
accounts used in the FSU with that commonly used in the rest of the world.
One important economic characteristic all five countries have in common
is that they are all energy poor. The exception here is Ukraine, with its vast
deposits of coal; though it still must import about 50 million tons of oil annually.
Yet, despite their relative dearth of indigenous energy sources, heavily
industrialized Belarus and Ukraine have a high energy intensity-double or more
that of the three other countries, but comparable with that found in countries with
high per capita incomes, such as the United States. At around 7,500, Ukraine's
energy consumption per capita in terms of kilograms of oil-equivalent compares
with that of the United States. Energy consumption in Belarus could be in the
order of 5,000, while that of the three other countries, at around 2,600, compares
with that of Italy or Spain.
High energy intensity and heavy dependence on imported oil make these
countries vulnerable to both oil price changes and supply disruptions. Moldova,
the most energy dependent of the five, imports 99 percent of its energy needs.
Supplies of oil and gas to Armenia have been interrupted because of the
blockade of the country. Georgia has also suffered from a shortfall in energy
supplies owing to the civil strife. Ukraine and Belarus traditionally obtained their
oil from Russia but now face cuts that are due mainly to Russia's pressing foreign
exchange needs.
All five economies are still highly integrated with those of the other
countries in the FSU. Their FSU trade shares are well in excess of 80 percent.
For all of them except Ukraine, other FSU countries account for more than
90 percent of their exports. All five countries are currently experiencing a
significant contraction of output that may range this year between 20 percent (in
Belarus) and 40 percent (in Armenia)-the latter being particularly affected by the
Nagorno-Karabakh conflict and by the economic blockade imposed by
Azerbaijan. Georgia and Moldova have also been affected by civil strife, and the
latter has suffered the effects of the most severe drought in the last 50 years that
is costing the country an additional $200 million in grain imports this year.
Finally, the state continues to play a large role in these five countries'
economic affairs. This is particularly so in Belarus but is much less pronounced in
Armenia. Budgeted fiscal revenues continue to be high, although the collapse of
recorded output has significantly eroded the tax base and actual revenue
collection. For example Armenia's share of revenue in GDP may be as low as 15
percent in 1992.
II. Ambitions, Objectives, and Dilemmas: Revolution and Confusion
Conflicting Ambitions
Conflicting ambitions on the part of both the citizens and the authorities in
these countries convey the impression that a full grasp of the implications of the
ongoing reform process is lacking. The ambition of the citizens is to enjoy the
standard of living seen in American movies and yet maintain the security of
employment and incomes that previous regimes provided. The ambition of the
authorities is to ride through the transition to democracy without having to worry
about their tenure in office being cut short by a newly enfranchised and, possibly,
angry electorate. There is an intrinsic inconsistency between the population's
desire of full employment and income security and the vagaries of market
capitalism as it roots out the structural inefficiencies stemming from decades of
central planning. The same type of inconsistency between desires and new
realities is apparent in the governmental sector as government officials grapple
with the democratic principle of accountability. The authorities now face the grim
reality that the democratic electoral process cannot ensure that governments
remain in power-although it has, however, its own surprises, as Romania and
Lithuania have demonstrated.
Uncertain Objectives
The declared objectives of the authorities are to establish democratic
independent states and private market economies. While hesitant steps in these
directions have been taken, the political and economic new orders have not yet
emerged-as might have been expected.
None of the five countries has completed the political revolution of
establishing a full-fledged democracy of the western type, although progress has
been made in this direction. Apart from a brief period of a couple of years in the
1920s for Georgia, Armenia, and Ukraine, none of the five countries has
experienced democracy in its recent history. Establishing a democratic culture
requires settling policy disputes through debate and compromise. It also requires
that governments become accountable and that they operate within a transparent
legal framework. Progress in all these areas is uneven.
While a flag, a military and a separate currency are often thought of as the
signs of independence, the latter requires a legal and regulatory framework as
well as a skilled bureaucracy. A striking feature of the five countries is the
weakness of their public administration. Finance ministries and central banks are
woefully ill-equipped to handle the complexities of fiscal and monetary policy of a
market economy; they need to be built up. At the government level, mechanisms
for coordinating public policy are weak or nonexistent. Domestic efforts in the
reform process are being concentrated on strengthening the public sector
management capabilities of the five countries, often with external expertise and
support.
The transition to a private market economy in these countries has hardly
begun; and while there are numerous requirements the leaders of these
countries must address for successful transitions, the most salient requirement is
lacking at this crucial point: a long-range vision of the future of these countries'
economies. Numerous reform programs have been written, and have at times
been approved by governments, as is the case in Ukraine. In some cases,
concrete reforms have been implemented. However, none of the countries
considered here has elaborated a vision of the private market economy it would
like to establish, nor have any provided a time frame for its implementation. Such
a vision is essential for the mobilization of domestic and international efforts
during the transition. As soon as this vision is articulated, it needs to be put in
place rapidly and its implementation must begin soon thereafter. The debate
between gradualism and shock therapy should not divert attention from the need
to develop objectives and to progress toward them at the pace that is most
appropriate to the countries' particular conditions.
Difficult Dilemmas
The five countries discussed here face two central dilemmas crucial to the
success of their transition: financial discipline and the introduction of a separate
currency.
The first dilemma, which is common to all economies in transition, is
making the difficult choice of whether to enforce financial discipline on
enterprises and face mass layoffs, or to allow for the continued financing of
enterprises' losses and experience soaring inflation. In a situation where
economies are already contracting, and where employment opportunities are
limited and social safety nets are not yet in place, it is difficult for governments to
withstand political pressures to keep enterprises open. This is the hard dilemma
of choosing between the Scylla of mass unemployment and social unrest and the
Charybdis of excessive credit expansion and inflation. The depreciation of the
Ukrainian coupon vis-a-vis the ruble is a reflection of the difficulty of maintaining
financial discipline. Without financial discipline, however, no stabilization and
structural adjustment can really take place.
The other dilemma is that of the ruble zone. Ukraine seems to have opted
for resolving this dilemma by its withdrawal from the ruble zone and its
introduction of its national currency, the hryvnia. There are several dimensions to
the issue of membership in the ruble zone that make it difficult for the authorities
to act decisively.
Arguments for remaining in the zone are as follows: the reduction of
transaction costs in trade as operators need not be concerned about exchange
rate fluctuations; the possibility that Russia may continue to supply energy
(principally oil) at subsidized prices, although it is unlikely that this will continue
much longer; Russia's financing of these countries' budget deficits; lack of
readiness to manage a separate currency; and geopolitical considerations that
affect, in particular, Moldova, Armenia, and Georgia.
A separate currency, on the other hand, would allow the country to: fully
control its monetary policy and collect seignorage on money issue, and use the
exchange rate as an additional policy instrument to adjust in case of external
shocks. In addition, skepticism about Russia's capacity to exert fiscal and
monetary restraint is supporting movements toward independent currencies. At
present, none of the five countries, except Ukraine, has made a decision to quit
the zone. All, however, are preparing themselves for such a decision, should the
alternative become unacceptable.
III. Experience with Reforms
The basic premise of the structural and sectoral reforms is that a growing
private sector, free to allocate resources and responding to market-based price
signals, will deliver increased productivity and hence growth, employment, and
incomes. Macroeconomic stabilization, free markets, enterprise reform-including
privatization, a market-oriented legal framework, and an affordable and effective
safety net-are all necessary ingredients for a business environment that leads to
efficient resource allocation and development.
To achieve the welfare promise of a private market economy, the
countries of the region have embarked on wide-ranging reform programs,
sometimes boldly, as in Armenia, but hesitantly in general. Without entering into
the elusive debates over gradualism versus shock therapy or over the ideal
sequencing of reforms, progress in these countries is reviewed briefly in the
following four critical areas for the success of the transition: macroeconomic
stabilization, privatization and private sector development, financial sector
reform, and social protection.
Macroeconomic stabilization
This aspect of the transition is presenting the authorities with a serious
challenge. Fiscal deficits are difficult to contain within the appropriate limits,
monetary policy may be conducted elsewhere perforce, and incomes policy is
difficult to enforce. However, macroeconomic stability is at the core of the
confidence building process that could underlie the development of private sector
activity. As such, it must be pursued with determination.
Budget deficits in these countries will be large in 1992; they are likely to
exceed 10 percent of GDP and could be much higher in some cases. This
reflects a deterioration of revenue collection due to declines in production, poor
tax administration, and increasing demands on the budget to cushion various
groups from the fall in incomes. Wherever fiscal reform has introduced a value
added tax (VAT), generally at a rate of 28 percent, VAT revenues have also been
budgeted at 28 percent; this assumes perfect tax administration, an unheard-of
phenomenon. Also, the deterioration in real incomes has pulled down revenues
for pension and unemployment funds, while, at the same time, benefits are
maintained or increasing. In the same way, the subsidization of industrial lossmakers and the compensation of agriculture for the deterioration of its terms of
trade put pressure on budget outlays. In certain cases subsidies and transfers
may represent 75 percent of expenditures. An overhaul of the tax and budget
systems in these countries has yet to appear, although efforts are being made in
this area.
On the monetary front there is confusion. Often, another currency
circulates in tandem with the ruble, like the rubel in Belarus and/ until recently,
the coupon in Ukraine. Also, in all these countries the mechanism for expansion
of the money supply is not transparent. Central banks are facing up to
challenging new responsibilities but are, in the main, poorly equipped to deal with
them. However, they are currently developing their institutional capacity at a
rapid pace with the help of external support and technical assistance.
Even effective incomes policy would not save the day for these economies
under the prevailing circumstances. The lack of clarity in enterprise ownership is
undermining efforts at wage controls. Enterprises are often in a state of limbo
regarding ownership, leading their managers and workers to appropriate
revenues in the form of wage increases before it is too late. The pressure is
compounded by galloping inflation. Also, the good behavior of one country in this
region may actually penalize it. Restraining wage increases, for example, may be
a sign of competitiveness in other parts of the world, but here, in an overall
environment of scarcity, it leads to an outflow of cheaper goods to other countries
of the ruble zone.
Privatization and the emergence of new private firms
These areas have developed unevenly in the five countries. By now all of
them recognize private property rights while four have adopted enterprise
privatization laws. Land privatization appears more problematic in Belarus and
Ukraine than in the other three countries. In Armenia and Georgia, 90 percent
and 60 percent, respectively, of agricultural land is now in private hands. Land
reform has begun in Moldova, and in Ukraine family plots may represent up to
6.2 percent of arable land. Georgia has privatized its housing stock, while a
housing privatization law is in effect in Belarus as of 1 July 1992.
Enterprise privatization programs are being put in place in all five
countries though implementation is lagging behind. Small-scale privatization has
progressed the most in Armenia, Georgia, and Ukraine. A small but vibrant new
private sector is developing in both Armenia and Ukraine.
Financial Sector Reforms
In the financial sector, the creation of new banks is moving sometimes
ahead of the adoption of adequate legislation and prudential regulations, while
banking supervision is, at best, weak. The ownership structure of the capital of
most of the new banks is alarming. In most cases, these new banks are set up by
large state-owned enterprises to finance their own activities. This type of
arrangement, which prevailed notably in the former Yugoslavia, naturally leads to
insider lending and to uncontrolled credit expansion. In addition, it renders
difficult the enforcement of prudential regulations. While the ownership structure
of the new banks endangers their stability, that of many of the older banks is
already in jeopardy. Their portfolios are mostly composed of loans extended at
fixed nominal interest rates to firms experiencing the difficulties of the transition.
Inflation, if not defaults/ is rapidly eroding their assets. Finally interest rates-on
the order of 50, 80, or 100 percent-remain well below inflation, with a rate that
could well exceed 1,500 percent by the end of 1992. Though the legislative
pieces may be in place-an adequate banking law has recently been adopted in
Armenia-the sector is not yet positioned to fulfill its role of an efficient financial
intermediary supporting the development of private entrepreneurial activity.
Social Protection Policy
Up until the present, an implicit objective of social protection policy in
these five countries has been to provide an adequate standard of living to all.
Planning, along with wage and price controls/ have allowed the authorities to
maintain an elaborate system of transfers, including pension benefits and various
forms of family allowances, to respond to the needs of practically every social
group. With the transition to a market economy, the erosion of the tax base, and
the acceleration of inflation, the prevailing system is clearly no longer affordable.
The strain could already be seen earlier in 1992 when budgets featured shares of
social expenditures as high as 45 percent of GDP. Reform in this area aims at
transforming an all-inclusive social safety net to one that targets the most
vulnerable. The policy is currently under review in all five countries, with initial
efforts focused on developing the information base necessary to design such a
targeting approach. Meanwhile, specific measures are being implemented, such
as the case in Moldova, where children's benefits are now means-tested.
IV. Next Steps for Successful Reform
There is no unique blueprint for reform that covers the sequence of steps
and timing these countries must follow in order to make a successful transition to
market economies. Initial conditions as reflected in the existing economic and
financial structure, the diversity of endowments in natural resources, historical
heritage and cultural characteristics should determine the timelines and
strategies of reform each country pursues even if final objectives may be similar.
Successful reform in its initial stages is likely to include the following actions:
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Provide the authorities with the means to implement their policies. This
would involve: arriving at a consensus on the objectives of reforms and
acquiring, say, a two-year mandate to pursue those objectives without
political haggling; set up the instruments of economic management
whether in terms of policy instruments, institutions, or access to the
required skills, and; establish the minimum legislative and regulatory
framework needed for the functioning of a private market economy-in
particular, property rights and the settlement of contracts.
Develop a three-to-four-year macroeconomic framework that takes into
account a possible initial deterioration-and subsequent improvement-in
both the budget and the current account of the balance of payments.
Fully liberalize the input and output markets of sectors where a rapid
supply response can be expected, and privatize them. These sectors would
most likely be agriculture, small-scale industries/ distribution, and
housing.
Develop a dual financial sector. Existing lending institutions would
continue to deal with their current clients exclusively while an explicit
program is developed to restructure and then privatize those banks and
their clients. New institutions would cater only to the emerging new
private sector firms under strict commercial rules and prudential
regulations.
Put in place a mechanism for the management of existing public ventures
for as long as they remain within the public sector. The state's ownership
rights should be exerted. A simple privatization program would be
developed for the medium and large ventures.
V. Conclusion
Belarus, Ukraine, Moldova, Georgia, and Armenia, like other countries of
the FSU, have embarked on a long journey toward a new world full of promise. It
will be a difficult journey. The citizens of these countries have a vague and
sometimes idealized notion of the destination, and the route to follow is mostly
uncharted. It is an adventure that must succeed. At stake is not only the welfare
of those involved-and they are a large part of humanity-but also peace and
stability in other areas of the world that might be dragged into the consequences
of economic collapse, social turmoil, and upheavals. The countries under
consideration need to maintain the course with determination. The international
community, in turn, world that might be dragged into the needs to match this
determination with consequences of economic collapse, its commitment to
support the voyage social turmoil, and upheavals. They have to make it
successful with patience, countries under consideration need to with
understanding.
Waflk Grais is division chief of country operations for Ukraine, Belarus. Georgia,
Moldova, and Armenia at the World Bank. He has written extensively on the subject of
economic transitions In the Former Soviet Union, Including his latest monograph,
Kazakhstan: The Challenge of Economic Development published by the World Bank. This
article is based on a lecture the author delivered at the Kennan Institute for Advanced
Russian Studies on November 3, 1992. This article reflects only the author's views.
Interpretations and conclusions are his own, and should not be attributed to the World
Bank, Its Board of Directors, Its management, or any of its member countries.