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Energy Sector Reform in Eastern Europe Working Papers WP-EE-01 The End of ‘Transition’ - An Institutional Interpretation of Energy Sector Reform in Eastern Europe and the CIS Christian von Hirschhausen and Thomas Waelde Reprint from MOCT-MOST Economic Policy in Transitional Economies, Vol. 11, 93-110 (2000) Dresden University of Technology DREWAG-Chair for Energy Economics The End of ‘Transition’An Institutional Interpretation of Energy Sector Reform in Eastern Europe and the CIS by Christian von Hirschhausen* and Thomas W. Waelde** MOCT-MOST Economic Policy in Transitional Economies, Vol. 11, 93-110 (2000) * correspondence address: Dr. Christian von Hirschhausen, M.A. Department of International Economics DIW German Institute for Economic Research Königin-Luise-Str. 5 D-14195 Berlin (Germany) tel.: +49-30-89789-343 (-341) fax:: +49-30-89789-108 (-200) e-mail: [email protected] ** Professor Thomas Waelde Centre for Energy, Petroleum/Mineral Law & Policy University of Dundee Dundee, DD1 4HN, Scotland, UK e-mail: [email protected] The authors thank Bogumila Puchalska-Tych, Hella Engerer, Jürgen Bitzer, Eirik Svindland, Wolfram Schrettl, Petra Opitz, Uta Kreibich and Deborah Bowen for comments. Earlier versions of the paper were presented and discussed at the annual meeting of the Verein für Socialpolitik (Rostock, September 1998), the Workshop of the German Advisory Group to the Government of Ukraine (November 1997), and the European-Institute Saarbruecken (November 1996). The usual disclaimer applies. hirsch_moct_pdf.doc The End of ‘Transition’An Institutional Interpretation of Energy Sector Reform in Eastern Europe and the CIS This paper provides an empirical analysis of the growing institutional divergence of systemic transformation in the countries of Eastern Europe and the former Soviet Union. Based upon the institutional theory of economic and legal systemic change, we empirically analyse reforms in a sector where the transformation process proved to be particularly tough: the energy sector. We test to what extent reforms reflect the ideal types seen in Western contexts (e.g. Anglo-Saxon and French), and to what extent new models have emerged. By generalising the results from the energy sector, one key finding emerges: starting from similar reform projects, 'transition' in Eastern Europe has led to fundamentally different outcomes, of which we identify three ideal types: i) the reforming Central/Eastern European market economy; ii) the post-Soviet mixed economy; and iii) the Caspian state economy. Key words: transition, institutional economics, CIS, energy sector 1. Introduction The attempts to introduce the institutions of a capitalist market economy in Eastern Europe and the CIS raises questions about the relationship between formal elements of reform, which are identified as key in developed Western countries, and underlying institutional foundations that are neither visible nor well understood.1 Experience with copying institutional models has shown that they often work very differently in the host context than in the original home context. With regard to Eastern Europe and the former Soviet Union, it was expected that the transfer of the institutions of a market economy would take place in the early 1990s. This assumption led to the idea of alinear transition process, and to a long period of neglect to institutional differences in implementing reform. By the late 1990s, however, system transformation 1 Throughout this paper we will apply North’s concept of institutions as a socially defined constraint on individual behaviour. 2 has come to be viewed largely as a process of institutional change. Almost a decade after its beginnings, the transition debate has therefore arrived at a crossroads. Can the hypothesis of a ‘transition’ process throughout the region still be upheld ten years after its inception? This paper provides an empirical analysis of institutional aspects of systemic reform in Eastern Europe and the former Soviet Union. We observe that in the specific post-socialist context, similar approaches to economic reform lead to very different outcomes, depending upon the formal and informal institutions dominating in each country. The approaches to and outcomes of transition seem to be so different that little in common can be identified between, for example, truly reforming market economies and non-reforming countries. The paper is structured in the following way: section two briefly lays out the issue. In section three, we develop a methodology for the analysis of reform, by selecting a sector of particular importance in all post-socialist countries: the energy sector. We identify the two dominant ideal types of energy reform in the West, i.e. the Anglo-Saxon model and the French model. In section four, we review the point of departure, the conduct, and the results of reform of different transition countries. Section five attempts a generalisation of the results and identifies the specific institutional differences among different economic systems that have emerged in the wake of the post-socialist transition. Section six presents our conclusions. 2. The issue: is 'transition' still a useful concept? In the mainstream literature on systemic change in Eastern Europe, ‘transition’used to refer to the reshaping of socialist countries into some form of a market economy.2 It was assumed that transition is a unidirectional 2 The term ‘transition’ was in fact adopted from the Russian Revolution, when according to N. Bukharine ‘transition’ designated the movement from the capitalist to a communist society. Note that there is a difference in notion between the anglo-saxon term of ‘transition’ (Latin root: trans-ire), and ‘transformation’ (Latin root: trans-formare), which is more generally applied in the German tradition of Max Weber, the latter designating a more open process of active systemic change. However, this distinction is generally ignored in the current debate, and the two terms are often used synonymously. It is argued elsewhere that because of its definitory character, ‘transition’ was a misleading concept right from the beginning, as it defined an objective, whereas the way to get there remained unclear (Bomsel, 1995, Hirschhausen, 1996); the concept of ‘post-socialism’ seemed to be more adequate. 3 process with a pre-defined outcome assumed to be generally known and accepted (“market economy“). The early phase was dominated by a macroeconomic debate upon the optimal sequencing of reform steps (“gradualism-vs.-shock-therapy“, Funke, 1993). After the “transformation crisis“ (Schmieding, 1993), institutionally oriented and political economy oriented approaches enter the debate more frequently (Streit and Mummert, 1996). A distinction derived from political economy (Buchanan, 1975) was introduced between two layers of reform the building of an institutional infrastructure (“choice of rules“) and the day-to-day policymaking process (“choice within rules“). Recent empirical work indeed supports the idea that the success of any transition country depends much more on the institutional infrastructure than on short-term macroeconomic policies (Cornia and Popov, 1998, World Bank, 1996, 1997, EBRD, 1999). Econometric studies also tend to confirm a positive link between the development of institutional infrastructure and the development of the economy (Havrylyshyn, et al., 1999, Heybey and Murrell, 1997). However, not all countries were able or willing to proceed on a pre-defined reform path. Even with similar reform packages put in place, the institutional reforms proceeded quite differently thereafter, leading to diverging transition processes. This differentiation of transition processes has not gone unnoticed by most analysts. However, the implications thereof have been different. Some authors contend that Eastern European countries show only minor differences and consider ‘transition’ to be an ongoing process. Thus, Stiglitz (1999) contends that transition is far from over for those countries that have withstood market-oriented reforms thus far. Schrettl (1999) concludes that the ongoing reform process in Russia and other countries implies that "musing about the 'end of transition' may be a bit premature" (p. 1). On the other hand, several authors have started to classify different categories of transition countries, according to, for example, macroeconomic performance (Havrylyshyn et al., 1999), structural indicators (Meske, 1998), or simply the political process of EU-integration.3 Another line of research has turned the 3 The results of these classifications are not identical: thus, according to the macro-criterion, countries like Armenia and Georgia would join EU-accession countries like Poland in the group of ‘high growth’ countries. According to the structural statistics, the EU-accession countries emerge in Group I, whereas Bulgaria joins Russia, Belarus, and Ukraine in Group III. Clement, Jungfer et al. (1998) identify three different transformation stages on the move 4 transition debate into a more general debate on comparative economic systems (Nuti, 1999, Dallago, 1999). All in all, a consensus seems to be emerging that transition willnot lead to comparable outcomes. Should this be so, however, the very concept of ‘transition’ is put in question, and it would no longer make sense to compile and compare ‘transition’ indicators for Tadjikistan and Hungary, to give just one example.4 The question of the current state of transition goes beyond a mere issue of wording; it also touches upon concrete policies to be applied in these countries, for example, optimal methods of privatisation, the pace of price liberalisation, or the treatment of the inter-enterprise arrears issue. There is no easily applicable methodology to test the hypothesis of the end of transition. We therefore propose an inductive approach, observing the reform process in a sector that can be regarded as representative for the transition countries, the energy sector. 3. Ideal types of Western energy sector reform - models for transition countries? 3.1 The energy sector as a key to systemic change The energy sector plays a key role in accelerating or slowing down systemic change in any country, in particular in transition countries. This may be from a centrally planned economy to a ‘real’ market economy. Cornia and Popov (1998) insist on structural and institutional conditions that determine differences in output performance; they come up with four broad clusters of transitional economies, corresponding to highly different economic models which have vastly dissimilar potentials for growth. 4 The recent restructuring of two major journals of transition research is representative of this movement: The journal ‘Economics of Transition’ stated that “... in some important respects these <Central European countries undergoing transition towards a market economy, especially those on track for early accession to the EU> countries can be studied in the same terms as one would study the relatively developed countries of Western Europe. ... Other countries, especially in the CIS, are much further behind in their reforms...“ (Economics of Transition, vol. 7(1) p. i). The journal ‘Communist Economies & Economic Transformation’ has even dropped the ‘transformation’ aspect from its title, to become simply ‘Post-Communist Economies’, “because of a growing feeling that the major processes into which transformation has generally been divided - stabilisation, liberalisation and privatisation - have in substantial measure been completed“ (journal announcement, early 1999). 5 explained by the importance of this sector for the entire economy, its technical structure (which has long tended towards natural monopoly), its strategic aspects of supply security, and the high politicisation of the business. In the context of transition in Eastern Europe, the energy sector stands out as having been the most “socialist“ of all sectors, in the sense that it had to serve ideological, geopolitical, social, and other purposes before everything else, faithful to Lenin’s leitmotiv: “Communism = Soviet Rule + Electrification“. The energy industries were formed by well established, proud and cohesive social groups (Party; workers; management and technical staff; research institutions and their extensive staff). The industry was run as a large hierarchical organisation, dominated by the Communist Party. In the absence of hard budget constraints, economic criteria (such as costs, reserves and profits) were insignificant. The peculiar, multifunctional role of the energy sector in the socialist system can be highlighted by pointing to some specific organisational features: - location decisions were hardly ever based upon the availability of resources, but were politically determined. For instance, the energy industry in the Soviet Union was organised in a way to distribute activities equally among the Republics, with Russia holding on to the strategic parts. Thus, oil equipment industries were located in Azerbaijan, whereas the extractive regions were increasingly concentrated in Western Siberia; - transport was never considered to be a cost factor, but was accepted as a byproduct of the politically-determined production and consumption structure. Allocation decision therefore ignored transport costs, which - once priced at full costs in a market economy - would have made many operations uneconomic; - similarly, raw material extraction was not based on economic criteria, but purely on technical criteria. Thus, energy fuels (coal, oil, gas) were often produced through costly investment, which in a capitalist environment would not have been feasible;5 5 East Germany boasted the world's largest lignite industry, which literally collapsed after the introduction of hard budget constraints and international competition. Latvia's energy sector was largely dependent on peat, Estonia's on oil shale, neither of which has a future in an (environmentally concerned) market economy. Coal production in Russia, Ukraine and 6 - though country-specific aspects certainly existed, the hierarchical, Partydominated structure was found in all socialist countries in Eastern Europe and the Soviet Union, the latter exercising a model function for the others. Today, the energy sector in Eastern Europe and the CIS continues to be an important industry in terms of production and employment. In Russia, Ukraine, the Caspian countries and Poland it even plays a dominant role, sometimes for the better (Russian oil and gas exports), sometimes for the worse (regional conversion problems, environment). In general, the objective of energy sector reform in all transition countries was that non-monetary relations be replaced by monetised contractual relations, that the true costs be used for investment decisions, that companies operate under commercial - not political - budget constraints criteria, and that government and consumers (industrial, distribution companies and households) see energy supply as a product or service with a certain price. However, in this sector, systemic change can not be introduced by decree, but requires a minimum societal consensus on the degree of commercialisation, the distribution between public service obligation vs. private supply, and the resulting socio-economic effects, e.g. environment and employment. In the context of system transformation, the re-regulation of the energy sector is a particularly complex process requiring a fundamental reorganisation of the material and immaterial institutional framework. It is therefore particularly useful for analysing the 6 development and current state of reform in transition countries. Kazakstan were also pushed to unsustainable levels. An overview of the Soviet energy system and problems is provided by Jensen, Shabad and Wight (eds.) (1983), Soviet Natural Resources in the World Economy, Chicago, The University of Chicago Press, 6 Various modifications of Lenin’s leitmotiv exist already which highlight the role of energy in the transition process. Thus, Brock (1999), based on the experience of the Irkutsk region (Russia), equates transition with “improved revenue performance + electrificatiya“. From the point of view of a Baltic electric utility participating in the EU’s Trans-EuropeanNetwork programme to link Western and Eastern European power networks, the outcome of transition was characterised as follows: “Capitalism = Brussels Bureaucratic Power + European Interconnection“. 7 3.2 Two dominant ideal types of Western energy sector organisation: Anglo-Saxon and French7 There is no such thing as a clearly identifiable "best practice" which has been put into effect world-wide to organise and regulate the energy sector. Instead, different modes of governance have emerged, reflecting different national or regional institutional conditions. The Western market economies provide two polar cases of regulating the energy sector, mainly those parts requiring particular attention due to their natural monopoly characteristics: these are the Anglo-Saxon and the French approach: i) the Anglo-Saxon approach - as it is emerging under the impact of the Thatcher privatisation in Britain and now replicated in Australia, New Zealand, Canada, several US States and the Scandinavian countries - pursues a very direct approach to privatisation, corporatisation and competition. Wherever technically possible, it creates a series of independent companies at the level of power generation and power distribution, exposed to competition from each other and from newly emerging independent power producers. Transportation - where still necessarily a natural monopoly - is opened up by third-party access of competitors to electricity grids or gas pipelines which are owned either by private companies or by publicly owned companies exercising only a transportation function (for example, the UK National Grid Company). Under the influence of independent regulatory agencies, competition develops or is promoted by the regulators and sometimes by competition authorities. The logic of the Anglo-Saxon model leads to competition on the level of retail electricity and gas distribution as well as power generation and gas extraction and trading. While originally doubted by supporters of established structures, it can no longer be denied that this model works - that is, supplies energy to consumers reliably, and that it is accompanied by substantially lower energy costs, in particular for large consumers able to negotiate on their own. The Anglo -Saxon model provided the benchmark for the opening up of EU energy markets that, with the introduction of the 1997/98 gas and electricity directives has now started in earnest. As concerns non-network activities, mainly oil and coal, the Anglosaxon approach prescribes private ownership and minimal regulation; 7 This section is based on Waelde and von Hirschhausen, 1999. 8 ii) the French system, by contrast, relies largely on integrated monopolies, protected against competition from outside, operating with some forms of supervision/planning by the competent central government ministry. Energy is produced, transported and distributed by large, integrated organisations. Energy is available everywhere and under similar conditions. Until recently, the state played a dominant role in the oil and coal sectors as well. The economic shortcomings of the model are the absence of competition and, resulting from this, a lack of incentives for efficient production and distribution structures. While the disadvantages of this regulatory setting are evident to the economist, the survival of the model in France can be explained by two specific characteristics of the country’s economic institutions: the dominance of the “public service“ obligation and public service culture, and the lack of separation between management and politics. Both are rooted in French history: the first in the immediate post-war period, the second in the 8 century-old osmotic relationship between (state) firms and government. There is a societal consensus on this regulatory setting; most French energy consumers, apart from some large-scale industries, seem to be reasonably content with this state of affairs. 3.3 Unanimous choice of the Anglo-Saxon model in transition countries: an institutional interpretation Institutional reform often, and particularly so in the post-socialist situation, consists in identifying suitable models from abroad and then trying to emulate them effectively at home. The domestic model then emerges in the way a transplant takes root and evolves according to its own principles in its new context. At first sight, one would assume that the natural tendency of the transition economies would be to look towards the French model, at least for electricity and gas. This system appeared to be closest in terms of structure, organisation and attitude to the heritage of socialist energy sector organisation, that is, monopolies, largely protected against competition and outside influences. Emphasis on central planning and coordination, on largescale grands projets (including nuclear power), the concept of energy supply 8 See for example: Stoffaes, Christian, Services Publics - Question d’Avenir, Paris, Editions Odile Jacob, 1996. Even the European Court of Justice accepted the dominance of public service obligations in France, over, for example, jurisdiction on European integration (1997 decision). 9 as a public service that should be provided by a state entity - all these factors indicate areas of affinity which were likely to determine the selection of the French model. Most surprisingly, and contrary to what an evolutionary perspective might predict, the institutional reforms of transition countries’ energy sectors have been largely based, at least on paper, on the liberalAnglo-Saxon model. Reform concepts, brought into the political agenda mainly by foreign advisors, reflected the liberal, competition-oriented approach that had proven to be successful in the UK and the US. In a few cases, the policies proposed in most transition countries for restructuring the network industries (electricity and gas) included even more elements of competition than those of the Western European continent (e.g. Ukrainian and Russian power sector reform).9 The following section analyses the concrete outcomes of this reform approach. 4. Empirical test: case studies on the growing systemic diversity in Eastern Europe and the CIS 4.1 Different institutional layers To what extent has the formal selection of the Anglo-Saxon over the French and other models succeeded in transition countries? In order to test this question empirically, we develop a set of institutional indicators which are then applied to different country cases. The specificity of any country’s approach to and outcome of transition cannot be identified by comparing macroeconomic data, as the latter are affected by institutional change only indirectly and in the long term. Instead, we distinguish threeinstitutional layers to characterise transition in Eastern Europe: 9 There are different possible explanations for this choice: one is the original attraction of Anglo-Saxon economic thought for the young economists in the former planning organisations and the main economic research institutes in Moscow and the other capital cities. The second reason is the recognition that at this time, the Anglo-Saxon model appeared to be clearly superior to the mercantilist model embodied by France in terms of wealth generation, innovativeness in modern technologies and flexibility of economic response. The third line of explanation, taking the more classical approach of political economy, looks instead at the economic interests of elites: the surprising enthusiasm in favour of reform in almost all post-Soviet countries must have benefited those who were already in control of the energy industries. 10 i) the set of formal institutions which includes the legal framework and the technical prerequisites to operate and control markets, the monetisation of the economy (that is, money being used as the dominant means of transactions), and budget constraints on independently operating enterprises (for example, bankruptcy procedures, banking and financial sector regulation, social security). The introduction and functioning of the formal institutions can be observed and even quantified quite easily (for example, with the EBRD transition indicators); ii) the informal institutions which include the non-codified legal, economic and cultural conventions; the level of trust in economic transactions substituting for formal regulations; the comprehension and approval of market mechanisms by the population; the civil service culture with more or less explicitly defined incentive structures, the culture of political, professional and academic debate, and public control of this debate, as well as of the press and other mass-media. In the absence of clearly identifiable and quantifiable indicators, the evaluation of informal institutions depends largely upon subjective empirical observations made on site; iii) the societal consensus about the economic system which encompasses both the normative aspect (“what system should govern?“) and the positive aspect (“what system does in fact govern?“). It was certainly unrealistic to assume that all post-socialist countries would develop a consensus on the virtues of a capitalist market economy, and be able to implement changes rapidly. Instead, fundamental questions concerning systemic change were addressed controversially in transition countries, with some even decidingagainst the market economy. What is more, the societal understanding of core economic concepts may be very different in post-socialist countries than in established Western market economies (for example “contract“, “legislation“, “money“, “property“, “state“, “profit“). 4.2 The results of ten years of energy sector reform Energy sector restructuring was, in all transition countries, one of the most controversial and time-consuming of the reform processes. However, ten years after its inception, results are clearly emerging. Though most of these countries started out with similar approaches, that is, the Anglo-Saxon one, the results have differed among the Central and Eastern European transformation countries (CEECs) and CIS countries: in the advanced Central and Eastern European countries, governments were able to implement 11 coherent transformation strategies in order to overcome the socialist legacy. Energy companies were set up that operate according to established legal and economic criteria, and a certain separation between them and state governance structures was institutionalised. Some privatisation and corporatisation has taken place on the distribution level (gas and electricity) with a massive inflow of foreign direct investment. In contrast, the results in post-Soviet countries (the CIS countries emerging after the collapse of the Soviet Union) did not at all converge with those obtained in Central/Eastern Europe, the UK or the US. In the following case studies, we test to what extent this divergence is due to the specific institutional context prevalent in each country. In order to do so, we provide stylised evidence of the patterns of reform in different countries, distinguishing between the formal institutions, the informal 10 institutions, and the societal consensus on the regulatory system. 4.2.1 The Polish electricity reform: towards the gradual adaptation of an Anglo-Saxon model The reform of the Polish energy sector, in particular electricity, is a representative case for other advanced Central and Eastern European countries: not only was an Anglo-Saxon type of deregulation formally introduced; the entire system is indeed being gradually adapted to market mechanisms. Already in February 1990, only a few months after the introduction of the first non-socialist government in Eastern Europe, the Branch “Ministry of Energy and Lignite“ was dissolved. Whereas the 10 We simplify more complex structures; empirical evidence was collected by the authors between 1992-99, it is documented, along with other empirical details, in inter alia: Waelde, Thomas, Internationale Investitionen im Energiesektor der früheren Sowjetunion: Zwischen wirtschaftspolitischem und rechtlichem Anspruch und der chaotischen Wirklichkeit jenseits des Kommunismus, Europainstitut, Universitaet Saarbruecken, Publication Nr. 359, 1997; Waelde, Thomas, “The Russian Oil&Gas Industry and Foreign Investment“,OPEC-Bulletin, 25, July 1994; Hirschhausen, Christian von and Hella Engerer: Post-Soviet Gas Sector Restructuring in the CIS: A Political Economy Approach. Energy Policy, vol. 26, No. 15, 1113-1123, 1998; Hirschhausen, Christian von, and Hella Engerer, Energy in the Caspian Sea Region in the late 1990s: The End of the Boom,OPEC-Review, vol. 23, No. 4, 273-291, 1999. Furthermore Newberry (1994); Stern and Davis (1998); Petra Opitz, The PseudoLiberalisation of Russia's Power Sector: The Hidden Rationality of Transformation, Energy Policy, forthcoming; Kuba, Elzbieta, Die Umstrukturierung der polnischen Elektrizitätswirtschaft, Zeitschrift für Energiewirtschaft, No. 2, 1998: 110-122; Baltic Ring Study [http:\\www.BalticRing.com], 1998. 12 restructuring of the coal industry was somewhat delayed, mainly for social reasons, the power sector reform clearly moved towards liberalisation. Electricity production, transmission, and distribution were separated into independent units. Preparations began for the establishment of a wholesale market, which is to be further split into a spot market and a contract market. The following years were characterised by the gradual implementation of deregulation at a decentralised level. Technical and psychological obstacles to the marketisation of electricity had to be overcome. Though governments changed regularly, political support for deregulation remained strong. A proof of this was the gradual price liberalisation, in particular an inversion of the socialist price structures, where household prices had been heavily subsidised on the back of industry prices: between 1990 and 1999, the ratio of household over industry electricity prices in Poland was inverted, from 1:2.5 to 1.6:1. This corresponds to the normal ratio for EU or OECD countries.11 An external impetus to modernisation was provided in October 1995 by the synchronisation, that is, connection in alternating-current-mode, of Poland 12 (and other Eastern European countries) with the Western European grid. The reform culminated in the new Polish energy law of 1997, introducing the possibility of competition in the generation and electricity supply markets and the creation of an independent Energy Regulatory Office (ERO) for monitoring the system and reviewing price policies. In August 1998, the first long-term supply contract was struck between an independent power producer and a large industrial customer. The relative success of Polish energy reform depended upon a variety of formal and informal institutional changes. Early systemic transition had led to a separation between the state and the economic sphere that was not only accepted by the population but also actively pursued. The societal acceptance 11 See International Energy Agency (various issues): Energy Prices and Taxes; Paris. Stern and Davis (1998) remark correctly that the absolute price level in Poland and other Eastern European countries has not reached long-run marginal costs. Other Eastern European countries have also delayed price reform for some time; yet at the time of writing (October 1999), these are approaching economic levels. The ratio of household to industry prices is 1.3 in Hungary and 1.1 in the Czech Republic, it was 1.5, 1.4, and 1.1 in 1996 in Estonia, Lithuania and Latvia, respectively (IEA, op cit., Stern and Davis, 1998). 12 This was proof that Poland was able to fulfil the technical requirements and institutional standards of Western Europe, including security issues, quality control, communication procedures, and so on. 13 of the basic principles of a market economy even favoured the marketisation of such sensitive goods as energy. The decentralisation of this industry into 32 small production units (that is: power plants) also favours the emergence of competition. But the strongest incentive for institutional change may have been European integration, and the imperatives of prospective EU accession requiring adaptation to the now rapidly evolving EU energy law. Having opted for EU integration, Poland had an incentive to adhere to what was expected to become the dominant European model in any case. Ten years into transition, the Polish electricity sector has largely succeeded in its institutional reforms and has passed the point of no return. Thus, an irreversibility has 13 been established in the reform process on the way to a market economy. 4.2.2 The Russian gas sector reform: Anglo-Saxon model, post-Soviet reality The Russian gas sector reform is a case in which the government formally announced an Anglo-Saxon type of deregulation, but in reality reinforced the monopoly power and non-economic functioning of the industry. As early as 1993, the Russian government ‘liberalised’ the gas sector on paper. The philosophy of gas sector reform, as officially presented, corresponded to the model of introducing competition in a sector dominated by monopoly: it was to create transparency of legal and economic aspects, to establish levelplaying-field conditions for all enterprises, to reserve a limited role for the state (in the form of "golden shares"), and to introduce competition in production and - eventually - in distribution. The commitment to reform culminated in 1996, when Russia integrated gas sector deregulation in its Memorandum of Understanding with the IMF, an internationally binding document. However, the implementation of the program didnot lead to an Anglo-Saxon type of market competition. Instead, a variety of more or less governmentcontrolled organisations got involved in the process, the distribution of tasks 13 We do not imply that the Polish reform process was an optimal one, or that all problems have been resolved. Critical issues remain, such as privatisation and further price liberalisation. Similar pictures emerge in the power sectors of Hungary, the Czech Republic, Slovenia and Estonia. 14 and responsibilities being unclear.14 Worse, the position of Gazprom as the Russian gas monopolist has not been touched. Gazprom has resisted all efforts that have been made to break it up and to create competition: it controls over 95% of Russian gas production, owns the pipeline infrastructure, remains the only distribution company (through its regional affiliates), produces equipment for the sector and runs large social programs for its employees (education, housing, vacation, food supplies, etc.). The Russian Law on Regulation of Natural Monopolies (1995) and the creation of the Federal Energy Commission as a regulatory agency (1996) did not change the situation significantly. Rather than be split up into competing enterprises, Gazprom has become a “state within the state“, claiming an important role in Russian domestic and foreign policy (“What is good for Gazprom is good for Russia“). The discrepancy between the Anglo-Saxon model of gas sector reform and its application can be partly explained by four institutional factors: first, despite an initial attempt in 1992, there is no separation between the state (government, Parliament) and the gas industry.15 Second, the population does not regard the gas industry in an economic context; rather, the supply of gas 16 is still considered a “human right“ from which nobody can be excluded. Hence, Gazprom can claim to be obliged to deliver gas as a social service, which excludes the application of hard budget constraints on the company. Third, still benefiting from its aura of socialist times, the gas sector is considered to be one of the few stable elements in an unstable economic environment, which for a majority excludes any risky experiments. Fourth, fundamental issues of systemic change are still open in Russian society, 14 For example, licensing of upstream exploration and extraction is handled by the Ministry of Natural Resources (the former State Committee on Geology) based on the 1992/95 subsoil law. Such licensing coexists very uneasily with the 1996 Production-sharing law which vests the negotiation of production-sharing agreements for oil & gas in the Ministry of Fuel & Energy (Mintopenergo, the former all-Soviet Ministry of Energy. Parliament (the Duma) and the Parliamentary Committee on energy policy play a direct, but ambiguous role as well. 15 Former gas sector managers continue to occupy high political positions (up to Prime Minister) but have maintained capital participation in their former firms. Current management intervenes directly in political issues, be it at the local, national or international level. 16 Gas tariffs to households are still highly subsidised, they are only 30% of international levels. The gas payment ratio is still as low as 50-65%. 15 leading to a lack of support for market-oriented reforms at a decentralised 17 level, and a low time consistency of policy choices and regulatory reforms. 4.2.3 The Azeri oil sector reform: from socialism to state planning The newly established Republics in theCaspian region demonstrate a third type of outcome of energy sector reform. For example, Azerbaijan had been developed within the Soviet Union as a large producer of oil exploration, transport and refining equipment. Production of raw oil was carried out through the 1970s and 80s, although it was uneconomical when compared to international prices. Hence, the Azeri oil industry was hit hardest by the end of Soviet socialism. In the first stage of the country’s newly gained independence, the government pretended determination to liberalise the sector, to provide a transparent judicial framework, and to open it up to international investment.18 These promises then led to an international oil and gas investment rush towards the Caspian Sea. In sharp contrast to the formal lip service to a liberalised energy sector, the real development of the Azeri oil sector was characterised by continued efforts of state planning and a selective industrial and investment policy. Instead of restructuring the sector according to market economic principles as it had announced, the Azeri government drew up state plans for a variety of activities. A vast exploration program was designed, including specialised Western and Russian firms. Output was planned to be tripled by the year 2005. A diversified pipeline infrastructure was planned for oil exports. Finally, in order to increase domestic value-added, the plans included the construction of a new oil refinery. The concept of hard budget constraints is, as of today, unheard of. Once again, institutional factors may help to explain the divergence between the initial announcements and the real results. Azerbaijan has neither the institutional base for a capitalist market economy, nor the intention to 17 Similar experience can be reported from other energy branches (oil, electricity) in Russia, and from Ukraine, Belarus and Kazakstan. 18 Azerbaijan was one of the first countries of the former Soviet Union to adhere to the European Energy Charter. Thus it accepted, for example, general GATT rules, which oblige it to introduce and enforce laws addressing anti-competitive practices, and to treat the investments of an investor of another Contracting Party no less favourably than those of its own investors. 16 establish one. The legal framework and the “rule of law“ are missing; litigations are solved individually on a case-by-case basis at the highest political level. After the breakup of the Soviet Union and the Communist Party, an autocratic governance structure took over in politics and business. Based upon moderate oil reserves but a strategic geopolitical situation, the elites adopted a lucrative rent-seeking approach.19 The consolidation of the national independence of young Azerbaijan goes hand in hand with personal short-term income maximisation of the few leading politicians and businessmen. In this context, the institutions of legal stability and economic efficiency matter little. Similar experience exists in other Caspian countries (Turkmenistan and Uzbekistan). The case studies highlight some of the reasons for the success or failure of energy sector reform. In the Polish case, conservative forces in the industry could be overcome by a wide political and societal consensus is favour of gradual reform. By contrast, in the two latter cases, resistance to energy sector reform and liberalisation has annihilated the initial reform impetus. Opposition of certain interest groups, difficulties to cut subsidies or hurt wellestablished industries otherwise, lack of public support and the general absence of a clearly-oriented reform path proved to be stronger. 5. Generalisation: Three stylised outcomes of systemic transformation Contrary to the initial idea of a smooth transition process based upon the implementation of the Anglo-Saxon competition-oriented approach, a variety of models of legal and economic reform have emerged in Eastern Europe and the CIS. The empirical evidence highlights the differences in outcomes of the transformation process among countries that had adopted similar reform approaches. The diversity of institutional settings in Western countries (e.g. the dichotomy between Anglo-Saxon and French regulation) is no longer conducive to understanding the specific outcomes of reform in post-socialist countries. The common characteristics of post-socialist systemic change have disappeared and new, different forms of economic systems are stabilising, creating a systemic irreversibility. This is what we call theend of transition. Though the case studies cannot reflect the complexities of the situation, they 19 For example, the management of the State Oil Corporation of the Republic of Azerbaijan (Socar) was confined to the President’s son himself. 17 do reveal some specifics of the reform process in each country or region. By way of generalisation, we contend that the lessons from the energy sector can be widely applied to the systemic change of most of the former transition countries. Using the classification of institutions developed above, and referring to the concrete case of the energy sector as an indicator for systemic change, three stylised outcomescan be identified: a) the reforming Central/Eastern European market economy has largely adopted the formal institutions of a market economy or has at least given a binding commitment to do so in the future. The upcoming accession to the European Union provides a stable framework for further reform. On the noncodified level, an adaptation of informal institutions can be observed, which, if not fully in favour of a market economy, nevertheless poses no major obstacles to the gradual introduction of a market culture in most spheres of public life. The societal consensus is an outright rejection of the socialist system and a binding commitment to a market economy. This consensus is stable and time-consistent. Countries representing this group are Poland, Hungary, and Estonia; b) the post-Soviet mixed economy is a blend of incoherently functioning elements of a market economy and straightforward state planning. It has made an initial, formal attempt to introduce market-oriented institutional reform, but was not able (or willing) to carry it out fully and bear the political and social consequences. Reforms have therefore been half-hearted and uncoordinated, dominated by the legacy of Soviet socialism (hence the notion of post-Sovietism). Though some formal institutions of a market economy were put into place (for example, privatisation procedures, legal framework, monetary policies, bankruptcy law), they have not developed any normative power at the level of execution (Welfens, 1998). On the informal level, there is widespread rejection of timid attempts to monetize and formalise civic relations (Stiglitz, 1999). The societal consensus in favour of a reformed economy is weak and unstable: an external shock, such as the financial turmoil subsequent to the August 1998 devaluation, can break the consensus and lead to a questioning of the entirety of institutional reform (examples: Russia, Ukraine, to a large extent also Belarus, though the latter also shows signs of the next group); c) the Caspian state economy has not even considered introducing marketoriented institutions, but has opted to use its newly-gained independence to transform Soviet socialism into an autocratic, clan-based regime based upon a 18 strong state involvement in the economy. The formal institutions of Soviet socialism have been abandoned, but they have not been replaced by market institutions. In the absence of an established legal framework, let alone the rule of law, decisions are made by leading politicians at their own discretion. Little is known about the informal institutions, though it is fair to assume that the absence of any experience of a capitalist economic culture and the traditionally undemocratic civil society provide little room for market-oriented developments. The societal consensus, if any, gives priority to the consolidation of the new-born Republic, with little consideration to economic efficiency. Instead, the transformation process seems to lead from socialism towards some form of rentier governance structure, similar to those of the Arab Oil Republics in the Gulf. Examples of the Caspian state-planned economy are Azerbaijan, Turkmenistan and Uzbekistan.20 Table 1 synthesises the main institutional characteristics of the three stylised outcomes of system transformation. Table 1: Institutional settings in the three stylised outcomes of system transformation ABOUT HERE 20 The Caspian approach may imply a less drastic macroeconomic shock, as occurred in Central and Eastern Europe and in the European CIS-countries. As Klugman (1998) shows for the case of Uzbekistan, the deliberately gradual and partial approach to reform led to the lowest output drop in any of the 26 transition countries. However, this gradual approach does not seem to be particularly conducive to long-term growth, either. Klugman (1998, p. 68) notes that “the government nonetheless remains extensively involved in the economy through state orders, ownership of the bulk of medium and large enterprises and regulations on the external sector, alongside significant centralisation of decision-making authority.“ The EBRD Transition Report (1999, p. 275) notes on infrastructure reform in Turkmenistan: "Reform of public utilities remains negligible. There has been no commercialisation of infrastructure. ... Price subsidies are substantial: households have free access to water and pay nominal sums for electricity and gas." This sounds familiar to tales of Soviet times. 19 6. Concluding remarks The aim of this paper is to provide some insight into the status and the perspectives of the 'transition' process. We have confirmed that system transformation and economic reform in the countries of Central and Eastern Europe and the former Soviet Union was constrained by a specific set of institutions. Starting from similar reform philosophies and applying, at least formally, a similar set of Anglo-Saxon-inspired reforms, distinct reform paths have emerged. These can be at least partially explained by identifying the specifics of the three layers of the institutional context: formal institutions, informal institutions, and society’s search for a consensus regarding the economic system. The diversity of regulatory mechanisms, rather than disappearing in some kind of convergence toward an ideal type of transition, has in fact grown. Classifications of Western regulatory models cannot be applied to the specific context of post-socialist Eastern Europe. Based upon the analysis of what we consider to be a key sector of transition, energy, we identify three ideal types of transition outcomes: i) the reforming Central/Eastern European market economy; ii) the post-Soviet mixed economy; and iii) the Caspian state economy. The institutional approach also helps to explain why reforming Central and Eastern European countries have quite easily accommodated the transplanting of Western models, whereas post-Soviet and Caspian countries have shown unfavourable “immune reactions“ (Streit and Mummert, 1996, p. 12). Transition is over. If one accepts the idea that “transition“ in Eastern Europe was the attempt to introduce the institutions of a market economy to former socialist systems, and that this was a process common to all countries in the region, then this historical era can be considered as finished with the irreversible establishment of a variety of different systems. The similarities of systemic change have disappeared, and so has the research subject “transition“ (or: “transformation“). The “end of transition“ implies that common similar economic policies for or research on the economies of the region are no longer possible. The reforming Central/Eastern European market economies require the completion of reform, mainly in the area of corporate governance, including the banking and financial systems in some countries. In post-Soviet mixed economies, some fundamental structural and real institutional reform is required, which hinges upon the political and socioeconomic consensus. 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World Bank (1997), World Development Report 1997 - The State in a Changing World, Washington, D.C. 24 Table 1: Institutional settings in the three stylised outcomes of system transformation Legal framework Privatisation/ ownership change Budget constraints/ enterprisation FORMAL INSTITUTIONS Money i) Reforming Central/Eastern European market economies (e.g. Poland, Hungary, Estonia) Full revision of socialist legislation has been carried out and a legal basis for a market economy introduced, largely following the EU model; application sometimes still constrained by technical difficulties and political intervention; firm commitment to adhere to EU-standards (“acquis communautaire“) Largely completed; an important stock of enterprises remain stateowned (e.g. Poland: about 50% of all industrial enterprises), but they, too, are subject to budget discipline and capital constraints Budget constraints have solidified, bankruptcy law is in place and being applied: relatively large number of factory closures; enterprisation has been largely achieved, creating a host of new enterprises; abandoning of multifunctionality (production intertwined with social sphere) of industrial factories Introduced and accepted as the dominant agent of economic transactions; monetary policies are applied and effective ii) Post-Soviet mixedeconomies (e.g. Russia, Ukraine, Belarus) Formally, a vast body of new legislation has been adopted, a mixture of Western proposals and transformation of Soviet law; but: low level of knowledge and acceptance of new legislation; no normative power at the execution level; regionalisation of power makes application still more difficult iii) Caspian state economies (e.g. Azerbaijan, Turkmenistan, Uzbekistan) Absence of a culture of formal law; little reform of Soviet legislation, no legal basis for market economy established; strong informal component in problem solving; larger-scale and international litigation resolved on case-by-case basis through political compromise Large-scale privatisation, where introduced, is more advanced on paper than in reality; ownership is widely dispersed, except ofr the few lucrative companies; state retains controlling stakes in many enterprises; mysterious “autoprivatisation” of the few cash cows (e.g. Lukoil, Gazprom, United Energy System of Ukraine) Budget constraints weak; no factory closures; serious rise in interenterprise arrears; enterprisation is achieved in few former state combines only; multifunctionality remains strong, in particular in rural areas Very little privatisation in the “strategic“ sectors (e.g. energy), state holds controlling stakes; some personal enrichment through licensing procedures and in FDItransaction (Partially) convertible, 'real' money introduced, but domestic economies rely heavily on barter; uncontrolled explosion of inter-enterprise arrears; monetary policy with little effect on the real economy The newly introduced currencies have mainly a symbolic value (sign of an independent Republic); most economic transactions take place in USDollar or without money (barter); little for monetary policy No hard budget constraints applied, practically no enterprise closures; multifunctionality remains strong 1 FORMAL INSTITUTIONS (ctd.) INFORMAL INSTITUTIONS Banking system, financial markets Introduced and largely working; increasing importance of financial markets (in particular: stock market, foreign exchange); competition within the banking sector is intensifying; real interest rates are becoming “reasonable” (i.e. one-digit); investment financing of enterprises through banking system and financial markets is increasing Formally introduced, but: financial markets hardly work, a competitive banking system does not exist; high degree of concentration of a few banks; strong state impact remains, including regular attempts of renationalisation; collapse of investment is continuing; small investments are autofinanced from retained earnings Little institutionalisation of banking system and financial markets; important role of the state in allocating investments, no capitalist criteria in the choice of priority projects Role of the state More and more a “stateregulator”, with strong emulation of the EUmodel of economic regulation; active regional policies Active pursuit of vertical industrial policies, selective protectionist trade policies; post-Soviet type of state planning in many areas of the economy; no separation between state action and private business Comprehension and approval of market mechanisms Widespread comprehension and dominant (though not unconditional) approval of market mechanisms; collective memory of prewar national market economies and comparatively high living standards The institutional setting of the European Union (EU) is widely accepted and considered as a benchmark; this provides a stable framework for individual and collective expectations and a system of normative references Little acceptance of market mechanisms, no cultural or historical affinity; market economy is considered as private enrichment at the population’s detriment Autocratic, clan-based state structures dominate and control public life, including the economy; no separation between state and economic sphere possible; the state seen as responsible for targeted industrial and investment policy; no alternatives attempted or even discussed Rejection of capitalist market economy principles; private economic transactions are largely family-based Role of external institutional references Perception of unemployment Unemployment, at a level similar to EU-countries, is accepted as a result of separation between the economic sphere and the state; unemployment schemes, unemployment benefits and social security are put in place Reference to foreign institutional models is traditionally rejected, but with no alternative, and no domestic reference system emerging either; latent ex-post approval of many institutions of Soviet socialism (mainly: social benefits) The state refuses to accept responsibility for the social results of economic reform; official unemployment figures are kept artificially low (58%), whereas real underemployment is estimated in the range of 20-30% The only reference to outside institutions is negative, i.e. rejection of Soviet socialism; focus on consolidation of new-born Republic rather than foreign models “Unemployment“ has no status and is not treated by economic policy; few attempts to cushion socioeconomic effects of unemployment, no labour market policies 2 SOCIETAL CONSENSUS Wide consensus on rejection of socialist experience, binding commitment to market economy; open public debates exist; consensus is stable and timeconsistent Weak consensus in favour of “some kind“ of reform, but absence of a constructive public debate on the pros and cons of different options; any consensus is likely to be unstable, external shocks can easily lead to a questioning of institutional reform (e.g the financial turmoil subsequent to the August 1998 devaluation) Some consensus on the consolidation of the newborn Republic, with hardly any debate on options for the future economic system; strategic orientations are decided autocratically, absence of public debate 3 Table 1: Institutional settings in the three stylised outcomes of system transformation Legal framework Privatisation/ ownership change Budget constraints/ enterprisation FORMAL INSTITUTIONS Money i) Reforming Central/Eastern European market economies (e.g. Poland, Hungary, Estonia) Full revision of socialist legislation has been carried out and a legal basis for a market economy introduced, largely following the EU model; application sometimes still constrained by technical difficulties and political intervention; firm commitment to adhere to EU-standards (“acquis communautaire“) Largely completed; an important stock of enterprises remain stateowned (e.g. Poland: about 50% of all industrial enterprises), but they, too, are subject to budget discipline and capital constraints Budget constraints have solidified, bankruptcy law is in place and being applied: relatively large number of factory closures; enterprisation has been largely achieved, creating a host of new enterprises; abandoning of multifunctionality (production intertwined with social sphere) of industrial factories Introduced and accepted as the dominant agent of economic transactions; monetary policies are applied and effective ii) Post-Soviet mixedeconomies (e.g. Russia, Ukraine, Belarus) Formally, a vast body of new legislation has been adopted, a mixture of Western proposals and transformation of Soviet law; but: low level of knowledge and acceptance of new legislation; no normative power at the execution level; regionalisation of power makes application still more difficult iii) Caspian state economies (e.g. Azerbaijan, Turkmenistan, Uzbekistan) Absence of a culture of formal law; little reform of Soviet legislation, no legal basis for market economy established; strong informal component in problem solving; larger-scale and international litigation resolved on case-by-case basis through political compromise Large-scale privatisation, where introduced, is more advanced on paper than in reality; ownership is widely dispersed, except ofr the few lucrative companies; state retains controlling stakes in many enterprises; mysterious “autoprivatisation” of the few cash cows (e.g. Lukoil, Gazprom, United Energy System of Ukraine) Budget constraints weak; no factory closures; serious rise in interenterprise arrears; enterprisation is achieved in few former state combines only; multifunctionality remains strong, in particular in rural areas Very little privatisation in the “strategic“ sectors (e.g. energy), state holds controlling stakes; some personal enrichment through licensing procedures and in FDItransaction (Partially) convertible, 'real' money introduced, but domestic economies rely heavily on barter; uncontrolled explosion of inter-enterprise arrears; monetary policy with little effect on the real economy The newly introduced currencies have mainly a symbolic value (sign of an independent Republic); most economic transactions take place in USDollar or without money (barter); little for monetary policy No hard budget constraints applied, practically no enterprise closures; multifunctionality remains strong 1 FORMAL INSTITUTIONS (ctd.) INFORMAL INSTITUTIONS Banking system, financial markets Introduced and largely working; increasing importance of financial markets (in particular: stock market, foreign exchange); competition within the banking sector is intensifying; real interest rates are becoming “reasonable” (i.e. one-digit); investment financing of enterprises through banking system and financial markets is increasing Formally introduced, but: financial markets hardly work, a competitive banking system does not exist; high degree of concentration of a few banks; strong state impact remains, including regular attempts of renationalisation; collapse of investment is continuing; small investments are autofinanced from retained earnings Little institutionalisation of banking system and financial markets; important role of the state in allocating investments, no capitalist criteria in the choice of priority projects Role of the state More and more a “stateregulator”, with strong emulation of the EUmodel of economic regulation; active regional policies Active pursuit of vertical industrial policies, selective protectionist trade policies; post-Soviet type of state planning in many areas of the economy; no separation between state action and private business Comprehension and approval of market mechanisms Widespread comprehension and dominant (though not unconditional) approval of market mechanisms; collective memory of prewar national market economies and comparatively high living standards The institutional setting of the European Union (EU) is widely accepted and considered as a benchmark; this provides a stable framework for individual and collective expectations and a system of normative references Little acceptance of market mechanisms, no cultural or historical affinity; market economy is considered as private enrichment at the population’s detriment Autocratic, clan-based state structures dominate and control public life, including the economy; no separation between state and economic sphere possible; the state seen as responsible for targeted industrial and investment policy; no alternatives attempted or even discussed Rejection of capitalist market economy principles; private economic transactions are largely family-based Role of external institutional references Perception of unemployment Unemployment, at a level similar to EU-countries, is accepted as a result of separation between the economic sphere and the state; unemployment schemes, unemployment benefits and social security are put in place Reference to foreign institutional models is traditionally rejected, but with no alternative, and no domestic reference system emerging either; latent ex-post approval of many institutions of Soviet socialism (mainly: social benefits) The state refuses to accept responsibility for the social results of economic reform; official unemployment figures are kept artificially low (58%), whereas real underemployment is estimated in the range of 20-30% The only reference to outside institutions is negative, i.e. rejection of Soviet socialism; focus on consolidation of new-born Republic rather than foreign models “Unemployment“ has no status and is not treated by economic policy; few attempts to cushion socioeconomic effects of unemployment, no labour market policies 2 SOCIETAL CONSENSUS Wide consensus on rejection of socialist experience, binding commitment to market economy; open public debates exist; consensus is stable and timeconsistent Weak consensus in favour of “some kind“ of reform, but absence of a constructive public debate on the pros and cons of different options; any consensus is likely to be unstable, external shocks can easily lead to a questioning of institutional reform (e.g the financial turmoil subsequent to the August 1998 devaluation) Some consensus on the consolidation of the newborn Republic, with hardly any debate on options for the future economic system; strategic orientations are decided autocratically, absence of public debate 3