A Decade of Transition

IMF Managing Director Michel Vadim Khoubanov, Marko Skreb, Miroslav Hrncir, Camdessus greets Yegor Gaidar, National Bank of Croatian National Bank Czech National Bank former Prime Minister of Russia. Azerbaijan A Decade of Transition An Overview of the Achievements and Challenges To take stock of the accomplishments of the transition economies over the past 10 years and identify the challenges ahead, in February 1999 the IMF organized a conference for high-level officials from transition countries, academics, and staff members of international organizations. This article highlights the key issues dis- cussed at the conference, some of which are explored further in the articles that follow. S a I e h M . N s o u I i INCE the fall of the Berlin Wall nearly a decade ago, The record the former centrally planned economies of Central The record thus far was reviewed, with a focus on such issues S and Eastern Europe and the Baltics, Russia, and as disinflation, growth, public enterprise reform, budget con- other former Soviet Union countries have made straints, governance, capital flows, banking sector reform, the major strides in moving toward market-based economies. underground economy, and income inequality. (See box for Initially, this historic transformation was accompanied by a list of the presentations made at the conference.) considerable price and output instability. Stabilization pro- The economic literature on the transition process has grams supported by the IMF and the World Bank helped con- grappled with two critical questions on disinflation. First, tain this instability in many countries and bolstered the how rapid has disinflation been during transition? Second, momentum for structural reforms. Yet the challenges that what effect has disinflation had on output? In fact, Carlo remain are enormous, as demonstrated by the problems Cottarelli and Peter Doyle found that disinflation had been Albania, Bulgaria, and Romania encountered during 1996-97, achieved quite rapidly in many of the transition countries. and by the crisis that beset Russia in 1998. The median inflation rate in the Central and Eastern The tone of the IMF conference, "A Decade of Transition: European countries dropped from 84 percent in 1992 to Achievements and Challenges," was set by Michel Camdessus, about 9 percent in 1995. Disinflation was achieved even the IMF's Managing Director, in his opening remarks. He more rapidly in the Baltics, Russia, and other former Soviet pointed to the progress made, but cautioned that "we are Union countries, where the median inflation rate fell from clearly far from the end of the road.... Now, most countries 1,210 percent in 1992 to 60 percent in 1995. The two can turn to the much more difficult and time-consuming groups of countries converged to a median inflation rate of task of implementing second-generation reforms." He high- 11-12 percent by 1997. But the reduction in inflation, with a lighted one specific task for the future: "enforcing the rule few exceptions, has not been sustained, and inflation has of law and fostering a culture that respects and, indeed, resurged in some countries. welcomes a framework of law, regulation, and codes of Despite such rapid disinflation, no general evidence was good practice." found that disinflation had been a factor in depressing 2 Finance & Development /June 1999 Dariusz Rosati, Werner Riecke, Anvar Saidenov, Pietro Garibaldi, Jeromin Zettelmeyer, National Bank of Poland National Bank of Hungary Kazakh Investment Agency Ratna Sahay, and Nada Mora of IMF staff output. Four factors played a key role in limiting the impact sufficient condition to bring about a new liberal order. of disinflation on output: there was considerable political Privatization was often pursued without due attention being support for disinflation and price liberalization; stabilization given to whether the necessary supporting systems for pri- policies were introduced early; comprehensive fiscal consoli- vate enterprise were in place, to the length of time it would dation underpinned disinflation in a number of countries; take to put such systems in place, or to the likely conse- and the various monetary frameworks were appropriately quences of privatization in their absence. flexible. In fact, rather than depressing output, the resulting The difficulties and setbacks suffered by Russia during moderate- and low-inflation environment had, in due transition were examined by former Prime Minister Yegor course, a positive impact on growth. Gaidar, who argued that they were due to the inability to Nonetheless, virtually every country in the region experi- move effectively from a system of "soft" budget constraints enced a substantial decline in recorded output with the onset with "hard" administrative constraints to the decentralized of transition. According to Oleh Havrylyshyn and Thomas market system, which is characterized by hard budget con- Wolf, the initial output loss reflected the collapse of the straints with little administrative and political interference. In highly centralized and inefficient production and distribu- Russia today, however, both the budget and the administration network of the command economy, while there were tive constraints have become soft, he explained. Even when inevitable, long time lags in reallocating resources to more privatized, enterprises have not been subjected to hard budget efficient uses in a decentralized system. The differences in constraints owing to institutional weaknesses. Consequently, initial conditions and policies led to a much greater decline the opportunities for rent seeking—that is, unproductive at the beginning of transition in the Baltics, Russia, and other profit seeking—are in place, but incentives for enhancing effi- former Soviet Union countries than in the Central and ciency are not. To reduce corruption and enhance efficiency, Eastern European countries. But after about three years of market discipline under hard macroeconomic constraints is decline, output in most countries has been growing for sev- key. However, Gaidar emphasized, macroeconomic discipline eral years. There are a number of exceptions, however. has been absent in Russia, and the resulting lax fiscal and Albania, Bulgaria, and Romania began growing three to five monetary policies have proved unsustainable. years into the transition period but suffered reversals during The record of fiscal reforms in the 1990s has been mixed. 1996-97 because they failed to undertake some important According to Vito Tanzi's analysis, the East European and structural reforms. Kazakhstan, Moldova, Russia, Tajikistan, Baltic countries have, in general, made rapid progress while Turkmenistan, and Ukraine have registered little or no the other countries have been less successful as a group in growth after eight years of transition, for various reasons, establishing fiscal institutions and in controlling fiscal imbal- including civil conflict, the decline in world oil prices, weak ances. In the pre-transition economies, revenue sources gen- policies, and the spillover effects of Russia's crisis, which erated very high tax levels (at times up to 50 percent of GDP) itself reflects political uncertainties and an unfinished struc- without the need for a full-fledged tax administration, and tural reform agenda. tax liabilities tended to be vague ("soft") rather than well- By contrast, the experience of the East Asian transition defined obligations. The particular characteristics of the cen- countries—notably, China—is considerably different in trally planned economies made the collection of these taxes terms of growth and inflation. Sanjay Kalra, Torsten Slok, relatively simple. The impact of the transition on the tradi- and David Robinson observed that the stronger performance tional revenue system was dramatic: the information that the of the East Asian countries reflected not only more favorable plan had provided was eliminated; the number of potential initial conditions but also far-reaching reforms in a number taxpayers that tax administrators had to deal with increased of areas—agriculture, in particular—undertaken quite early sharply; and incomes and production were created in areas, in the process. such as financial markets, that had not existed under the pre- The reform of the public enterprise sector has often been vious system and that often involved foreigners. Because of patchy and inconsistent in the transition economies, accord- these changes, the old systems cannot simply be reformed. ing to Nicholas Stern, and, as a result, unprofitable enter- Rather, totally new tax systems, capable of operating in the prises have continued to operate. Furthermore, as John Nellis new environment, are needed. pointed out, too much was promised—in Russia and else- New tax systems, however, require not just new tax laws but where—of privatization. Some had viewed privatization as a also new fiscal institutions and new skills. Often the personnel, Finance & Development /June 1999 3 schooled in the old ways, are the main obstacle to change. The net inflows, while Russia was a net capital exporter. incentives for these individuals are to maintain the old system. Generally, capital inflows at the beginning of the transition The tax system has come to be seen as a tool that should do period consisted largely of exceptional financing, but their many things, including supporting failing enterprises, sustain- composition later shifted to favor foreign direct investment ing employment by allowing loss-making

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