Download The Global Financial Crisis and Eastern Europe

Reflections on 20 years of
transition in Eastern Europe
Milica Uvalic
University of Perugia
Conference – Europe: 20 Years of Transition
Vienna, 15-17 September 2010
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Issues
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20 years of transition in post-communist countries in
Eastern Europe
1. The transition to a market economy
2. The model’s flaws 20 years later
3. Present challenges
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1. Transition in Eastern Europe
November 1989 (fall of Berlin Wall)
 Transition to a market economy and multiparty
democracy in Eastern Europe (EE)
 Unprecedented experiment: radical changes of
systemic features of EE economies creation of
capitalism by design!
 The typical transition model followed the main
prescriptions of the “Washington consensus” (based on
experience from Latin America in the 1980s)
 Liberalization, Stabilization, Privatization
[Peak of Reaganite and Thatcherite ideology]
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Transition in Eastern Europe
Transition required various measures in parallel
 (1) Macroeconomic stabilisation: liberalisation of
prices & foreign trade
 (2)Microeconomic reforms: rapid privatization,
microeconomic restructuring, reduction of
subsidies (“hard budget constraints”)
 (3)Institutional reforms: banking and financial
sector, creation of capital and labour markets,
radical fiscal reforms …
 Results? Reality very different from initial
expectations (generally too optimistic)
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Transition in Eastern Europe
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Transformational recession in early 1990s  Very severe and prolonged
recession, fall in GDP of 18-80%, even more of industrial production...
Economic recovery delayed, only in Poland and Slovenia in 1992-3...
Causes? Partly due to economic/trade disintegration (CMEA, USSR, CSSR,
Yugoslavia)  today 29 countries in the EE region (instead of 9)
Systemic vacuum: passage from a centralized administrative system to
new market institutions disorganization and “chaos”
But also wrong economic policies  the hyper-liberal model:
 Overshooting of stabilization programs: overly restrictive monetary &
fiscal policies
 Too rapid trade opening, frequently revoked and therefore premature
 Much faster capital liberalisation than in post-second World War
Europe
 Speedy privatization, without changes in corporate governance
 Non-progressive taxation of companies and households, as witnessed
by the widespread introduction of the “flat tax”
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Transition in Eastern Europe
We dispose of an ample literature on what happened in EE in the
1990s, but the assessments greatly differ…
Today, many EE considered “normal” capitalist economies (?)
 In the meantime, “good policies” have been applied also in
countries that were late reformers (e.g. the Balkans)
 Economic reforms: institutional convergence towards the
“ideal” model of a market economy (EBRD transition indicators)
 Many lessons not learnt from the experience gained in the
1990s prescriptions for the latecomers very similar to those
in the early 1990s
 Gradual integration with EU: trade, FDI, banking and finance
 2004 & 2007 EU enlargement: 10 EE countries, Balkans on their
way...
 Increasing FDI throughout the region after 2000, not only in
Central Eastern Europe (as in the 1990s)
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Foreign Direct Investment (2001-08)
40000
35000
Million US $
30000
25000
20000
15000
10000
5000
0
2001
2002
CEE & Baltics
2003
2004
2005
CIS
Western Balkans
2006
2007
2008
Bulgaria & Romania
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Transition in Eastern Europe
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Yet in many countries the “Washington consensus” has failed to fulfil
expectations of growth, development & increased welfare
Social costs of transition greatly underestimated: it was assumed that
social policy and the welfare state are a luxury that must be sacrificed for
the sake of transformation  many negative consequences
“Jobless growth”: emergence (and persistence) of very high
unemployment, particularly in the Balkans (40% - Macedonia, Kosovo)
Social differentiation, increasing poverty (esp. in Russia, CIS countries)
A particularly flexible labour market, with weak trade unions and scarce
diffusion of collective bargaining (with very few exceptions)
Inadequate systems of taxation (flat-tax rate)
High popular dissatisfaction: EBRD Life in Transition (2007): only 30% of
respondents from transition region, on average, consider their
households today are better off than before 1989
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Transition in Eastern Europe
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Institution building much slower than expected
Informal economy (and informal institutions) remain important
in many countries, rule of law still not in place, widespread
corruption, weak judiciary …
Slow catching up after the deep GDP fall in the early 1990s and
subsequent reversals in growth
Ten years later, only Poland and Slovenia had attained the
levels of GDP they enjoyed in 1989
By 2008, Poland had reached 178% of its 1989 GDP, Slovak
Republic 164%, Czech Republic 142%, Hungary 136% …
But Russia only 108%, and similarly the Balkans  by 2008,
three countries had still not reached their 1989 level of GDP
(Bosnia, Montenegro, Serbia)
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Real GDP growth in the Balkans, 19892008 (1989= 100)
180
Albania
160
140
120
Croatia
Macedonia
Montenegro
100
BiH
80
60
Serbia
40
20
0
1990
1991
Albania
1992
1993
1994
BiH
1995
1996
1997
Croatia
1998
1999
2000
Macedonia
2001
2002
2003
Serbia
2004
2005
2006
2007
2008
Montenegro
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2. The model’s flaws 20 years later
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In 2007-08, average GDP growth in the transition region was
still high, only in last quarter of 2008 was there a drastic
deterioration of main indicators
In late 2008, EE was severely effected by the global economic
crisis, hit by two external shocks:
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Financial sector: sharp reduction in foreign capital inflows (FDI,
remittances, foreign loans)
Real sector: reduced demand for exports on EU/global markets
Since early 2009, forecasts for 2009 have been changing
continuously, from positive to highly negative growth rates
(exc. Albania, Poland)
2010: Recovery on its way but not in all countries + growth
sluggish, 50-90% lower than in 2008
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Sl
ov
ak
R.
Po
la
nd
Se
rb
ia
Al
ba
Hu nia
ng
M
ac a ry
ed
on
i
Bo a
sn
ia
Es
to
Sl nia
ov
M
on enia
te
ne
gr
Li
o
th
ua
n
Bu ia
lg
ar
ia
Cr
oa
tia
La
t
Ro via
m
an
ia
Real GDP in 2010 (EBRD July 2010)
Real GDP growth forecasts, 2010
4,0
3,0
2,0
1,0
0,0
-1,0
-2,0
-3,0
-4,0
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The model’s flaws
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Eastern Europe among the most severely hit regions!
The global economic crisis revealed many structural
weaknesses of EE economies
Factors of vulnerability of EE countries
 Huge external imbalances, for years covered by
massive foreign capital inflows (foreign loans, FDI,
official assistance, workers’ remittances)
 High dependence on trade with EU (more than
many old EU member states) vulnerable to
deteriorating conditions in EU
 Banking and financial sector characteristics
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Current account deficits (Oct. 2008)
(% of GDP)
-39,6
Mo n ten eg ro
-24,4
B u lg aria
-18,6
S erb ia
-15,8
B o s n ia an d H erz eg o v in a
-15,1
L atv ia
-14,9
L ith u an ia
-14
F Y R Mac ed o n ia
-13,8
R o man ia
-10,8
E s to n ia
-10,5
A lb an ia
-10,1
C ro atia
-5,5
H u n g ary
-5,1
S lo v ak R
-4,7
S lo v en ia
-4,7 P o lan d
-2,2 C z ec h R
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
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Gross external debt (2008) (% of GDP)
L a tv ia
129.5
E s to n ia
111.3
S lo v e n ia
108
B u lg a ria
103.5
Hu n g a ry
94.2
C ro a tia
88.4
Mo n te n e g ro
77.2
L ith u a n ia
64.2
S e rb ia
62.7
F Y R Ma c e d o n ia
54.2
R o m a n ia
49.4
S lo v a k R
49.4
Uk ra in e
48.9
P o la n d
48.1
B iH
40.5
C z ec h R
37.7
R u s s ia
30.2
A lb a n ia
19.7
0
20
40
60
80
100
120
140
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The model’s flaws
Characteristics of the banking and financial system
 Privatization of banks in EE sales to foreign (EU) banks, 7598% of banking assets in EE are in foreign ownership (Slovenia
the only exception)
 Foreign banks lending policies of easy credit  credit boom,
increased lending to private sector, many loans in foreign
currency
 Credit boom was followed by credit crunch foreign banks
vulnerable to deteriorating conditions in home countries,
reduced credit to local clients
 2008-09: Depreciation of national currencies in EE causing
many credit defaults, increase in non-performing loans
 Liberalization of financial markets has also greatly stimulated
cross-border borrowing directly from banks abroad
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3. Present challenges
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Global 2008-09 crisis  a new course in developed
market economies: return to protectionism, state
intervention, expansionary fiscal policies, more
regulation
In EE: Which growth model for the future?
Transition-related economic reforms  hyper-liberal
model (fast trade opening, free capital inflows, weak
social protection...)
Should EE countries also return to more state
intervention, undoing what was done during the last 20
years?
Partly ...yes! More active government policies necessary
in several important areas
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Present challenges...
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Global crisis the fragility of EE economies due to the model of
credit-driven growth and resulting dependence on foreign capital
Global crisis  more general flaws of the transition strategy, since
many problems were becoming unsustainable
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Consumption much higher than production, financed by foreign savings &
investment (increasing trade and current account deficits)
High unemployment, limited restructuring, slow growth of new private
sector, mounting social problems
Inadequate structural changes, favouring the fast expansion of primarily
services [linked to]
Structure of FDI: frequently not in industry, but in services (banking,
telecommunications, real estate), therefore in non-tradables, not facilitating
industrial restructuring, export-led growth, East-West industrial integration
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Present challenges...
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Today: need to change the target model of the hyper-liberal
market economy
[In 2009, the best transition results (EBRD score 4) were attained in Estonia and Hungary, among
the most severely hit by the global crisis!]
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Changes in which direction? Further integration – certainly not
autarchy - but prudently
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Trade liberalization: not necessarily in all sectors (e.g. agriculture)
Financial liberalization: too fast, ought to be in line with development of
financial markets (as in Western Europe)
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Improve the quality of government institutions to enforce laws, collect
taxes, supervise the financial sector ...
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Introduce a levy on the financial sector? Probably justified, but
since most banks are foreign owned, there is no direct political
power to effectively negotiate a tax EU coordination is critical!
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Present challenges...
Industrial policy: to promote investment, encourage innovation, quality standards,
enhance competitiveness (in line with the current EU approach to industrial policy)
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Despite remaining privatization opportunities, EE cannot count much on FDI over
the coming years, need to rely much more on own resources
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More effective employment policy, more elements of the European Social Model
which was not seriously considered by the EE countries (not part of the
Acquis)so the model was “diluted” by the 2004/07 entry of New Member States
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How to strengthen trade unions and social dialogue? Many lessons from the old
EU member state
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Increasing labour flexibility (Germany, France, Italy) has led not to greater
international competitiveness, but to higher profit margins
Strong East-West interdependence: EE countries cannot solve current problems by
themselves, as they are strongly integrated with the EU/global economy!
 Necessitates coordinated action...
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