Post-Communist Europe And The IMF – 25 Years Of Transition (Iconographic Summary)

The past 25 years have seen a dramatic transformation in Europe’s former communist countries, resulting in their reintegration into the global economy. But the task of building full market economies has not been easy. Liberalization of trade and prices came quickly, but institutional reforms — in areas such as governance, competition policy, labor markets, privatization and enterprise restructuring — often faced opposition due to different conflicts of interest.

It appeared the results of the first years of transition were uneven. All countries suffered high inflation and major recessions. The scale of output losses and the time taken for growth to return and inflation to be brought under control varied widely.  Countries that undertook more aggressive reforms were rewarded with faster recovery. Those which took a more cautious approach, were more vulnerable to the crisis that affected the region in the late 1990s. In contrast to the tough first decade, the early and mid-2000s witnessed strong growth and the region experienced significant capital inflows.

Closer integration with the Western Europe resulting the ex-soviet block countries joining the European Union exposed some vulnerabilities when the global and euro zone crises struck at the end of the decade, hitting the region harder than any other.

In the mid – 1980s, few would have imagined the dramatic changes that were about to engulf Central and Eastern Europe. The speed of these changes was dramatically fast and by the end of 1991 the political landscape was unrecognizable from just three years earlier.

Rapid political changes have continued throughout the quarter-century since 1989. Most notable has been the reintegration with Western Europe. Partnerships with the EU strengthened through the 1990s, culminating with the accession of eight former socialist economies in 2004, followed by Bulgaria and Romania in 2007 and Croatia in 2013.

All the transition countries went through recessions with the initial economic dislocation and trade disruption stemming from the collapse of the Soviet-era Council for Mutual Economic Assistance (Comecon). The process was very painful. As mentioned already above, the countries that took bolder and more front-loaded reforms — notably in Central Europe and then the Baltics—were rewarded with a faster return to growth and stability, including avoiding the series of crises that hit the region in 1997 and 1998. Here are some charts presenting the transition economies GDP growth patterns as well as inflation and fiscal balances.

A critical element of the reform process has been to build a sound business environment in which firms can start, invest and expand. Creating these conditions requires drastic legal, administrative, and institutional reforms across a broad front.

At the start of the transition, these were not in place in any of the countries. Business activity was governed by:

central planning,

political decisions,

and often corruption.

25 years later, this is an area in which the transition countries differ the most from each other, with important implications for their future growth prospects.

In the World Bank survey of ease of doing business, they range from 17th place to 131st out of 189 countries worldwide.

The development of the financial sector has been important in strengthening conditions for business. Across the region, Western European banks made strategic investments to establish subsidiaries, to the extent that foreign bank ownership dominates most countries’ banking systems.

The social impact of the transition has been profound. In moving from a system of guaranteed employment to labor markets governed by supply and demand, and with the closure of unprofitable firms and industries, unemployment increased sharply at the start of transition.

The IMF has been closely involved with the transition process from the start. In fact, some of the countries had joined the IMF well before 1989, with the Fund providing financial and technical support to early reform steps in Hungary, Romania, and Yugoslavia in the 1980s. But it was after the collapse of communism in 1989 that the main expansion of the Fund’s membership and activities took place, with 25 new members from the ex-socialist bloc joining by the end of 1993.

Centrally planned economies had long experienced enormous price distortions, with prices detached from market forces. Trading was confined mostly among Comecon members, with limited trade with the rest of the world. The integration of these economies into the international monetary and trading systems urgently required liberalization of prices and establishment of currencies as units of exchange (which depreciated considerably in the initial phase).

Investment needs of the transition region were overwhelming, given underdeveloped infrastructure and dilapidated industrial capacity. Capital from Western Europe infused the region, playing a key role in development. Over the transition period, the region moved from relative isolation to become highly financially integrated with the rest of the world, particularly the EU.

The diverging pattern of capital flows also had a lasting impact on overall export and growth performance in the region.

The presence of foreign banks brought easy funding from abroad.

Despite the declines in regional average deficits of the transitional economies, fiscal vulnerabilities remain high in a number of countries. In 2014 deficits are set to remain above 4% of GDP in several countries, concentrated in the Western Balkans — some of which, along with Hungary, Slovenia and Ukraine, also have high public debt.

Demographic factors also pose major challenges to fiscal policy, as well as to growth strategies more generally. The working age share of the population is projected to embark on a secular decline from the middle of this decade on.

Overall progress of the transition economies is a fact, however there are clouds around the picture.

First, even after 25 years some countries have failed to make a decisive break with the past, or have seen former state command replaced with control by private interests. Such countries continue to struggle with low growth, high unemployment and uncompetitive industries, and risk getting left further and further behind.

Second, even in the well-performing economies, the pace of convergence has slowed dramatically in recent years. From 1995 to 2008 the region as a whole was catching up towards average EU incomes at a rate of about 1 percentage point a year, from around 35 percent to nearly to 50 percent. Since the crisis this rate has dropped sharply.

Source: 25 Years of Transition. Post-Communist Europe and the IMF