Economics of Institutional Change

Central and Eastern Europe Revisited

Elodie Douarin, Tomasz Mickiewicz

• Publisher: Palgrave Macmillan
• Year: 2017
• ISBN:
  9783319654744
• Edition: 3
• Topic: Economics
• Subtopic: Political Economy
• Index: Economics

This book, a third edition, has been significantly expanded and updated. It revisits the process of institutional change: its characteristics, determinants and implications for economic performance. New chapters address the significance of Post-Communist transition, the differences and importance of initial conditions in institutional building, and, social norms, values, and happiness. Other chapters have been expanded to include, for example, a focus on the Washington consensus, commentary on the 2008 financial crisis, state capacity and corruption, andnew findings on redistribution and inequality.
With specific focus onCentral Europe, Eastern Europe and Central Asia, this revised editionexamines the process of development, and its interdependence with institutions.

© Tomasz Mickiewicz 2017

Elodie Douarin and Tomasz MickiewiczEconomics of Institutional ChangeStudies in Economic Transitionhttps://doi.org/10.1007/978-0-230-29128-7_1

Begin Abstract

1. Moving Away from the Command Economy in Central and Eastern Europe and the Former Soviet Union

Elodie Douarin¹ and Tomasz Mickiewicz²

(1)

School of Slavonic and East European Studies, University College London, London, UK

(2)

Aston Business School, Aston University, Birminghan, UK

Keywords

TransitionGrowthHappinessEastern EuropeRussia

End Abstract

Aims of the Chapter

• to present the key stylised facts relating to the experience of transition over the past thirty years
• to describe what we mean by the process of transition, signalling what are the key economic indicators of relevance
• to discuss transition as a process of institutional change
• to highlight some aspects of the impact of transition on individual wellbeing

1 Introduction

At the beginning of 1989, Europe was a different place. The continent was dominated by the largest country on earth, which no longer exists: the Union of Soviet Socialist Republics (USSR or Soviet Union ). It embraced an economic system labelled with different names; ‘command economy’ being one of the more accurate. Yet seventy years earlier, the USSR had replaced another huge empire, Tsarist Russia, which had collapsed in 1917 near the end of the First World War. Later, towards the end of the Second World War, in 1944–5, a Soviet command-type economic system was imposed on several European countries – Bulgaria , Czechoslovakia , the Eastern part of Germany, Estonia , Hungary , Latvia , Lithuania , Poland and Romania . ¹ Three other nations, Lithuania, Latvia and Estonia , were annexed by the USSR and declared Soviet Republics. The countries not incorporated into the USSR preserved varying degrees of autonomy, yet with the monopoly of political power guaranteed to local Communist parties and protected by the presence of Soviet military. Despite some early experience of economic growth, economic performance in the USSR soon slow-downed, and stagnation in the 1970s and 1980s led to growing discontent across the communist region.

By 1989, another large economy based on the Soviet model, China , had already experienced a decade of economic liberalisation which had resulted in strong economic growth (see e.g. Coase and Wang 2012). Thanks to good economic results, the Chinese political elite remained in power, mostly unchallenged. However, Soviet leaders failed to emulate the Chinese experience. Economic performance continued to deteriorate in the Soviet bloc and serious efforts at reforming the system only materialised in the late 1980s, when it proved too little and too late. This vast international economic and political system collapsed in 1989, a year that began with the official re-emergence of the independent ‘Solidarity’ trade union in Poland (led by an electrician from the Lenin Shipyards in Gdańsk, Lech Wałęsa), and ended with the spontaneous demolition of the Berlin Wall. The dictatorships across Central and Eastern Europe (CEE) were collapsing, either peacefully or violently and, unlike his predecessors, the Soviet leader Mikhail Gorbachev decided not to send tanks to help the locale communist parties stay in power. In fact, in some cases he actively supported local liberals against hard-liners. But Gorbachev’s aim was to reform the Soviet system, not to replace it; against his initial intentions, once the change gathered momentum the social and political dynamics of anti-Communist revolution turned out to be impossible to stop.

What we will label the economic transformation, or the transition, followed. On the 12th of September 1989, Poland gained the first non-communist government for decades, with the office of Minister of Finance and Deputy Prime Minister responsible for economic reforms taken by one of the economic advisers of ‘Solidarity’, an academic from the Warsaw School of Economics, Leszek Balcerowicz; before him, other leading Polish economists refused the job as too difficult. Just three months later, on the 17th of December 1989, a package of economic reforms focusing on stabilisation and liberalisation was introduced in the Polish parliament, and implemented from the 1st of January 1990 (Balcerowicz 1992). The programme became a benchmark for other post-communist countries, which could learn from both the successes and the failures of one of the most fascinating experiments in economic history. More than that: events in the former Soviet bloc resonated in the whole developing world. A wave of economic liberalisation that swept across Latin America, Africa and Asia (starting with India) in the early 1990s was to a significant extent inspired by the collapse of the system that for much of the twentieth century served as an inspiration for models of technocratic and authoritarian development (Easterly 2013).

Reviewing what happened, it is difficult to overstate the extent of the changes that transformed the countries that underwent this transition away from command economy and (in some, but not all cases) from political authoritarianism. It is also difficult to exaggerate the ways in which the population was affected by these changes. In Chapter 2, we will present a stylised model of a centrally planned economy and contrast it with a functioning market economy, to explain the task reformers were setting out to perform. But first, we want to provide a stylised, bird’s eye, overview of what happened from 1989 onwards, presenting the evolution of key indicators, and highlighting common trends and areas of divergence across the region. This stylised descriptive overview is the object of this chapter. It sets the frame for the rest of the book: the issues to be explored and hopefully explained.

2 The Stylised Facts of Transition

Almost thirty years after the beginning of transition, the extent of the change represented by the collapse of central planning is still poorly understood, and academics still disagree on the key lessons to take away from this experience. Disagreement persists around our understanding of the evolution of the economies of the countries in transition over the past decades, and on the reasons behind these changes. Importantly, this disagreement makes it difficult to draw unanimously accepted policy implications.

At the same time, it is slightly less difficult to argue about the “key facts” of transition, i.e. key patterns of change that were observed across the region, and which characterise the experience of transition. Most observers would agree on the importance of a few “stylised facts” highlighted by Campos and Coricelli (2002) in a major critical review of the literature on the first decade of transition. We follow these authors, with a minor variation of the list of facts they initially highlighted. We will first focus on the five facts detailing the economic dimension of the transition process. ² Applying some slight rephrasing, these are as follows:

1. 1.
   Output fell initially
2. 2.
   Investment shrank
3. 3.
   Labour moved
4. 4.
   Trade reoriented
5. 5.
   Structure of production changed

Describing these five facts allows one to give a detailed picture of what happened in the region from the beginning of transition; it also allows highlighting differences across countries. We will proceed to detail the common trends and divergence observed across these five dimensions starting with the first several years of transition. We will add to Campos and Coricelli’s presentation by discussing the persistence, or otherwise, of these stylised facts beyond the initial period of transition (i.e. beyond the period covered by their own factual review), and by expanding this description using other related and relevant indicators.

3 Facts 1 to 5: Economic Restructuring

3.1 Fact 1: Output Fell

Output estimates for the period preceding transition are unreliable. Among other issues, production was often over-estimated, both in quantity and quality, leading to an upward bias in Gross Domestic Product (GDP) estimates (Aslund 2002). It is also widely believed that production had started declining well before the 1990s, with the economic slowdown beginning as early as the 1960s (Ericson 1991). This pre-transition experience implies that we need to treat the concept of “transitional recession” with caution: these economies were contracting even before transition started.

Moreover, GDP is a value concept; therefore pre- and post-transition production are not directly comparable in particular as some of the pre-transition production was not driven by social needs. In a rare effort to make that comparison, Hughes et al. (1994) illustrate the extent of structural adjustment needed in the early years of transition. Also producing tanks, ballistic nuclear missiles, and maintaining a massive apparatus of internal repression including political police, all feed into GDP measure. However, they do not necessarily represents “value-adding” activities. Taking Poland as an example, while GDP is thought to have fallen, there may not have been any substantial negative impact on private consumption (Sachs 1994). A focus on GDP may therefore be misplaced. It represents a bias persisting in much of the development and transition literature, where spotlight is on countries but not on real people’s wellbeing (Easterly 2013). Yet, it is also fair to say that focus on GDP is often driven by practicalities: the GDP data is often more readily available than data on private consumption.

With these caveats in mind, the existence of an economic recession that continued and typically deteriorated after 1989 across the region cannot be questioned and in some transition economies consumption and standards of living were significantly and negatively affected, along with the collapse in GDP. In their paper, Campos and Coricelli (20...