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Jaromír Šindel ECES The Puzzles of Central and Eastern Europe Transformation and Integration Discussion over the Puzzles of Transformation Process ECES, Prague ECES, Prague • Main factor influencing the Transformation Economic Policy – Impossible trinity (capital, interest and inflation differentials), foreign capital, interest groups, … • Transformation Puzzles - best solutions? – Gradual vs. rapid liberalization and deregulation, privatisation, transformation slowndown, law and transformation, monetary or exhchange rate based stabilization programmes, financial and bank crisis, foreign direct investment, structural changes, labor market, welfare state, … – BUT: Initial conditions, methods of solutions, differences in transition process, … The Puzzles of Central and Eastern Europe Transformation and Integration Topics Index of initial conditions (1989) and real economic growth (1993-1995) ECES, Prague Source: Žák (2004) The Puzzles of Central and Eastern Europe Transformation and Integration Initial Conditions The Puzzles of Central and Eastern Europe Transformation and Integration Index of Liberalization Accrued Index of liberalization (1989-1997) Source: Žák (2004) ECES, Prague Accrued = Cumulation of values from previous years. Maximum in 1997 is 9. Accrued Index of liberalization (1989-1997, horizontal axis) and real economic growth (1991-1997, vertical axis) ECES, Prague Source: Žák (2004) The Puzzles of Central and Eastern Europe Transformation and Integration Index of Liberalization Democracy, Legal system, Reforms and IDR in the CEECs, 1997 against 2001 ECES, Prague Source: Žák (2004) The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - IDR IDR in 1997 (horizontal axis, better on left side) and change of IDR in 1997-2001 (vertical axis, negative is better development) ECES, Prague Source: Žák (2004) The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - IDR Small privatization, Trade and Exchange rate, Large privatisation, Price liberalization, Banking sector and Interest, Restructuralization, Securities, Trade Competition ECES, Prague Source: Žák (2004) The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Indexes HDI in 1990 (horizontal axis, better on right side) and change of HDI in 1990-1999 (vertical axis, positive is better development) ECES, Prague Source: Žák (2004) The Puzzles of Central and Eastern Europe Transformation and Integration Human Development Index - HDI Nations in Transit, 1997 to 2005 Source: http://www.freedomhouse.org/…Country Report ECES, Prague Slovakia The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - NIT Nations in Transit, 1997 to 2005 Source: http://www.freedomhouse.org/…Country Report ECES, Prague Czech Republic The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - NIT Nations in Transit, 1997 to 2005 Source: http://www.freedomhouse.org/…Country Report ECES, Prague Hungary The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - NIT Nations in Transit, 1997 to 2005 Source: http://www.freedomhouse.org/…Country Report ECES, Prague Poland The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - NIT Nations in Transit, 1997 to 2005 Source: http://www.freedomhouse.org/…Country Report ECES, Prague Bulgaria The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - NIT Nations in Transit, 1997 to 2005 Source: http://www.freedomhouse.org/…Country Report ECES, Prague Romania The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - NIT Nations in Transit, 1997 to 2005 Source: http://www.freedomhouse.org/…Country Report ECES, Prague Belarus The Puzzles of Central and Eastern Europe Transformation and Integration Transformation Index - NIT • Main Characteristics ECES, Prague – the nationalized economy – the system of plans, centrally planned economy (Imperative planning x Indicative planning); 5-years plans – non-existent market – non-existent prices (no real prices with their information, allocation and motivating function), the distorted price system resulted in inefficient allocation of resources – the prohibition of entrepreneurship – the external relationships under CMEA – “soft market” – lack of competition, large uneconomical companies The Puzzles of Central and Eastern Europe Transformation and Integration Centrally Planned Economy • Requirements – 1. Liberalize the economy, – 2. Stabilize the economy, – 3. Restructuring the economy The Puzzles of Central and Eastern Europe Transformation and Integration Transition Process ECES, Prague 1. Changes in the economic sphere in the direction of the capitalistic economic system; 2. Changes in the political field in the direction of democracy; 3. A complete transformation, parallel in all spheres (economy, political structure, political ideology, legal system, stratification of society); 4. Non-violent transformation; 5. Transformation under peaceful process; 6. Incredible speed The Puzzles of Central and Eastern Europe Transformation and Integration Kornai´ six characteristics of transformation process “The presence of all six characteristics together is unique in world history” ECES, Prague Source: Kornai, J., 2005. • Price liberalization – The end of Shortage Economy (Kornai) – price didn’t reflex supply and demand relationships – in Czech Republic • July 1990 – 10% increase due to foodstuffs prices, respectively the abolition of subsidies (negative turnover tax) • January 1990 – price deregulation – 85 % of GDP under price regulation in 1990 – in December 1991 only 6 % of GDP (rents, energy, water, health services, transportation and communication) ECES, Prague • Trade liberalization – in the later lecture The Puzzles of Central and Eastern Europe Transformation and Integration Transition Process – Liberalize the economy • Rapid ECES, Prague – Liberalize the economy • Quick response of market and private sector • Queues, uneconomic production and unwanted goods can be eliminated quickly – If macroeconomic and structural conditions are right – quick recovery – The macroeconomic discipline works – without low inflation no long-term growth • Don’t forget on microeconomic view – the Czech Case 19951997 – Essential structural reform – enterprises have to face budget constraints The Puzzles of Central and Eastern Europe Transformation and Integration Gradual vs. rapid liberalization and deregulation • Gradualism – Danger that old system impedes the working of new forces of the market economy – Gradual price liberalization also gradual deregulation creates new deformation in the price structure. This new deformation need new subsidy, so never ending story of government intervention in market economy The Puzzles of Central and Eastern Europe Transformation and Integration Gradual vs. rapid liberalization and deregulation • Flexibility – fiscal policy, exchange rate regime, … ECES, Prague • Restructuring the economy – – – – deetatization, the end of price controls, the end of production plans, the end of vertical relationships, … – New tax system and the independent central bank for the effective implementation of stabilization economic policy The Puzzles of Central and Eastern Europe Transformation and Integration Transition Process – Restructuring the economy ECES, Prague Other Ways and Solution - comparison Goal Better Corporate Governance Speed and Feasibility Better Access to Capital, Know-how and Experts Higher Government Revenue Greater Fairness Sale to foreigners + - + + - MBO / MEBO - + - - - Voucher privatization ? + ? - + Method ECES, Prague Source: World Bank, World Development Report: From Plan to Market, from Schejbal, J. (2002) The Puzzles of Central and Eastern Europe Transformation and Integration Privatisation The Puzzles of Central and Eastern Europe Transformation and Integration Privatisation ECES, Prague Source: Schejbal, J. (2002) • Demand side – Consumption – real wages decline (wage cushion with exchange rate cushion – important transition tools); increased savings by expectation of price liberalization with exchange rate devaluation and by uncertainty about future development. – Investment – expectation lead to savings; obscure ownership delayed investment programme; restructuralization didn’t start. – Government expenditures – changes in government; declined role of government in economy. – Export – foreign demand – brake up of CMEA; search of new markets. • Supply side shocks ECES, Prague – Price increase of imported goods – devaluation of currency; oil contract cancellation; – Price liberalization brought higher than expected supply shock – Government subsidy cancellation (rough budgetary limitations) – Managerial shock – new market environment The Puzzles of Central and Eastern Europe Transformation and Integration Reasons of Transformation Slowdown How to get new Law – different views • Law and finance theory – Choose the best institutional setting • Institutional convergence has its limits by existing PATH DEPENDENCY ECES, Prague • Impossible to achieve the best results in CEE countries due to the path dependency and the political economy The Puzzles of Central and Eastern Europe Transformation and Integration Law and Transformation ECES, Prague Source: Frait, Komárek (1998) The Puzzles of Central and Eastern Europe Transformation and Integration Monetary or Exchange Rate Based Stabilization Programme Alternative exchange rate scenarios The theoretical paths of the real exchange rate in transitional economies ECES, Prague Source: Frait, Komárek (1998) The Puzzles of Central and Eastern Europe Transformation and Integration Exchange rate and transition ECES, Prague a) Significant nominal exchange rate depreciation - the exchange rate flexibility at the beginning of the 1990s Slovenia, Hungary, Poland. b) fixed exchange rate - lower inflation (The Czech Republic, Slovakia, Estonia). c) A trend towards real appreciation can be found in all accession countries, even though with profound differences. The strongest one is confirmed in Estonia and significantly applies also to the Czech Republic, Poland and Slovakia. On the other hand, Hungary and Slovenia experienced only mild real appreciation. – Real appreciation in Czech R. (Inflation differential) x Poland (inflation caused by devaluation) d) convergence process - slow e) Since 1999 - switch from nominal exchange rate depreciation to nominal exchange rate stability or even appreciation Source: Frait, Komárek (1998) The Puzzles of Central and Eastern Europe Transformation and Integration Following Generalisations about ER Path in Transition • Improve image and export at a higher price • Increase labour productivity at constant wages • Pay lower wages at unchanged productivity • Shift from domestic production to more import • Shift production to another country • Exert political pressure against appreciation The Puzzles of Central and Eastern Europe Transformation and Integration Competitiveness and ER appreciation – how to cope with it? ECES, Prague • Crisis Indicators – ... – Interest rate´s behaviour during crisis • 1994, 1997, 1998 – Russian Crisis • Case studies in CEE countries The Puzzles of Central and Eastern Europe Transformation and Integration Financial and Bank Crisis – Hungary, Czech Republic, Estonia ECES, Prague • Banking sector C&EE • Transformation consequences • Integration consequences • Privatisation • Structural changes • Better environment for foreign investment, better rating (OECD, NATO, EU, euro) • Better growth The Puzzles of Central and Eastern Europe Transformation and Integration Foreign Direct Investment and ECES, Prague ECES, Prague Source: Newton. Country Report. April 2001. www.newton.cz The Puzzles of Central and Eastern Europe Transformation and Integration Effects of FDI? Structural Changes The Puzzles of Central and Eastern Europe Transformation and Integration Technological Levels of Manufacturing Production (constant prices, %) –low-tech group (DA food products, beverages and tobacco; DB textiles and textile products; DC leather and leather products) –medium/high-tech group (DK machinery and equipment; DL electrical and optical equipment; DM transport –resource- (and scale-) intensive group (DD wood and wood products; DF coke, refined petroleum products and nuclear fuel; DG chemicals, chemical products and man-made fibres; DI other non-metallic mineral products) Source: Newton. Country Report, January 2002. www.newton.cz ECES, Prague equipment) Employment trends in the CEECs, 1989-1999 (1989=100) ECES, Prague Source: UNECE. Economic Survey of Europe, 2000 No. 2/3. www.unece.org The Puzzles of Central and Eastern Europe Transformation and Integration Labour Market - Employment • delayed restructuring, with a relatively small output drop and job destruction • early retirement schemes to shrink the labor force • low unemployment benefits and strict application of eligibility criteria The Puzzles of Central and Eastern Europe Transformation and Integration Czech „unemployment miracle“ Source: IMF 2004, K. Krajnyák and M. Sommer ECES, Prague Pre-transition Mid-transition Post-transition Percentage change from 1987-1989 1996-1997 2001-2002 pre- to post-transition Czech Republic 19.8 23.9 23.4 18 Estonia 28.0 36.1 39.3 40 Hungary 22.5 25.4 26.7 19 Latvia 26.0 32.6 35.8 38 Lithuania 26.3 30.9 35.7 36 Poland 27.5 33.4 35.3 28 Slovakia 19.4 24.9 26.7 38 Slovenia 21.0 24.0 24.4 16 CEE 8 23.8 28.9 30.9 29 EU 15 26.9 27.8 28.6 7 Country ECES, Prague Source: Kornai, J., 2005. The Puzzles of Central and Eastern Europe Transformation and Integration Welfare State - Gini coefficient