A Quarter Century of Post-communist Transition

As of 9 November 2016, twenty-six years will have passed since the fall of the Berlin Wall, the event that is widely considered to mark the end of communism and the beginning of the transition to a democratic, market economy. Such a long time, with extensive data plus the experience of over twenty-five countries, facilitates a retrospective analysis and testing of the key competing hypotheses of how to go about transition.

Some caveats are in order concerning methodology and testing the major hypotheses on transition. In spite of the extensive availability of conventional statistics including institutional quality, a number of widely accepted criticisms of liberal reforms do not rely on this data. For example, many ^[1]

suggested that Russia succeeded in making early and rapid progress to the market because its private sector share of GDP was the same as Poland’s in 1996. This turns out to be very misleading; its actual economic performance lagged very far behind Poland’s. By 1996, the European Bank for Reconstruction and Development (EBRD) estimated Poland’s economy grew to 122 % of its 1989 GDP level. By 1996, Russia’s economy was still suffering significant output declines and had fallen to 57 % of its 1989 level. Privatization in Russia, in other words, did not automatically translate into a strong economic performance. To avoid similar misinterpretations, the analysis in this book has suggested the distinction between ‘inputs’ of transition (i.e. reform policies) and ‘outputs’ of transition (i.e. actual economic performance results). Numerous quantitative indicators for these are then used to check for the correlation between ‘inputs’ and ‘outputs’, testing of various hypotheses about the optimal transition strategy.

There are seven principal conclusions derived from a comprehensive view of this vast amount of quantitative information. The first is that with the exception of three countries (Belarus, Turkmenistan and Uzbekistan), all the nonAsian, post-communist, transition economies have moved a long way from centrally planned socialist regimes towards market-based, capitalist systems. The EBRD estimates annually how far reforms have progressed. The EBRD Transition Progress Index (TPI) in Fig. 3.1, measured on a scale of 1.0 to 4.3, demonstrates that most of the countries of the CEB have nearly reached full transition, and that with few exceptions FSU countries have gone along way, reaching values of 3.0 or more—a level the EBRD considers a functional albeit incomplete market economy.

The second conclusion concerns the sharp divergence between the early and the slower reformers. As seen in Fig. 3.1, while all ex-communist countries started from about the same position, by the mid-1990s the differences among them were huge and kept growing. The gap grew because countries that led from the start continued to move resolutely forward, while the gradualists—like the subject of this book, Ukraine—moved less quickly. Why was this so? Some experts emphasize the importance of closeness to Europe both geographically and culturally due to the much shorter period of communism. Others put a lot of weight on the incentives and pressures to achieve European Union (EU) membership. A third factor is central to the present story on Ukraine: in the FSU there was no

Fig. 3.1 EBRD Measure of Progress to Market

Fig. 3.2 Evolution of Liberalization and Institutions (Source: EBRD online dataset. EBRD data after 2010 does not provide the same detail)

comparable lustration of former communist ruling elites, and they found it in their personal financial interest to go slowly, ensuring they become the new capitalist ruling elite.

The third conclusion is that the basic pattern of which countries led the reform process and which lagged was set within the first four to five years. That it has stayed that way ever since is also clear in Fig. 3.1, though there is one significant exception: Georgia has been steadily catching up after the 2003 Rose Revolution.^[2] Because of their late start due to the Yugoslav wars, several of the former Yugoslavia states, despite their more market- oriented status at the beginning of the 1990s, were surpassed by the gradual reformers of the FSU. But once the wars stopped, the ex-Yugoslav countries moved faster in an effort to catch up to the transition leaders in the CEB.

Fourth, institutional development in all countries lagged behind economic liberalization (Fig. 3.2). However, no country has followed the recommendation of gradualist theory to put in place good institutions first before liberalization, though many leaders in the gradual and lagging countries explained the delays by saying that they must first develop good institutions. Thus, the leaders of both Belarus and Uzbekistan have frequently stated that their aim was a so-called social market economy, and that the first stage of this process involved development of conditions in which markets can function properly. Chapter 4 analyses similar arguments made by Ukraine’s leadership. From the late 1990s, some countries started to move a little faster in terms of institutional development, but those countries were not the gradualist reformers; on the contrary they were the very same countries that had moved earliest and most forcefully in terms of market liberalization. Some analyses like those of Roland (2014) and the EBRD (2013) worry that the lag on institutions undermines the first conclusion about CEB reaching completion of transition. Havrylyshyn et al. (2016) make two counterpoints to this concern. First, a slower pace of evolution of institutions is to be expected as the transition process nears its asymptotic end. Second, when compared to a pertinent benchmark group such as the highly successful Tiger countries of East Asia, the level of institutional development in the CEB is at least as high if not better.

Fifth, the CEB countries that led in market liberalization have also followed a consistent path to democratization. This is important because democratization (free multi-party elections, freedom of the press and individual liberty) and economic transformation are closely linked. As Fig. 3.3 shows, in sharp contrast to the CEB countries, the countries of the FSU, which did implement at least some moderate reform (FSUREF) implemented only partial democratization. Worse, from about 2000, most of the FSUREF members started to revert to authoritarianism. In the FSU cases, which lagged considerably on reforms (FSULAG), this lack of democratization was fairly explicit and extreme throughout. For the FSUREF, it was subtler, with a formal electoral process legally permitting many parties. In practice, democracy was so restricted by the incumbent government that it came to be labelled by political scientists as ‘managed democracy’. This failure to democratize and the excesses of the oligarchs led in many countries to popular resentment, demonstrations, and effective ‘colour revolutions’. A number of these colour revolutions initially

Fig. 3.3 Evolution of GDP per Capita by Transition Country Groups plus Poland and Ukraine (Source: World Bank, World Development Indicators. Note: Many comparative assessments use growth rate data in local currency. This understates performance as it misses the effect of productivity gains (Balassa-Samuelson effects). For this reason, this book uses current USD. Country groups: Central Europe (Croatia, Czech Republic, Hungary, Poland, Slovak Republic and Slovenia); Baltics (Estonia, Latvia and Lithuania); FSU9 (Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russia Federation, Tajikistan and Ukraine)

succeeded—at least to the extent of overthrowing the existing governments in Serbia (2000), Georgia (2003), Ukraine (2004), and Kyrgyz Republic (2005). However, only in Georgia did the colour revolution lead to real changes in the economic direction of the country. Ukraine too was relatively unique in the FSU group; while it lagged in reforms and economic performance like its neighbours, it avoided the trend to revert to autocracy. This is discussed in later chapters.

Sixth, transition in some countries has led to the rise of an oligarchic class, as implied by the Forbes billionaire data of Table 3.1: the number of billionaires relative to GDP—the last column of the table—is far higher in Russia and Ukraine than in established ‘capitalist’ economies but also higher than in advanced reformers like Poland. Transition experts broadly agree that it is a problem when a small group of very rich new

Table 3.1 Number and Frequency of Forbes Billionaires in Selected Countries

Source: Columns 1 and 2: Forbes 2006 'List of World Billionaires'; column 3: World Bank, World Development Indicators, 2005a, b; column 4: author's calculation = [col. 2/col. 4]. Values were done for 2006 to demonstrate that by this time the number of billionaires in countries like Russia and Ukraine was highly disproportionate to their GDP size. Later calculations have not changed that picture

capitalists use non-transparent means to influence policy and to protect their monopoly-like status impeding a truly open and competitive market economy. Lobbying and financial support for favoured political parties or entities is not unique to ex-communist countries, but the degree of dominance by the post-communist oligarchate goes far beyond the usual lobbying activities to determine the general philosophical direction of government, reform policies and geostrategic decisions.^[3] How this happens in Ukraine is the subject of Chap. 10. An important question is whether the extent of oligarchic power varies with the strategy of transition followed. There is a casual empiricist hypothesis that it does, that it is far greater in the countries that followed gradual and slow reforms, that the delays in liberalization allowed the beginning of oligarchic formation, and that slow reforms permitted their entrenchment.

The seventh and last conclusion is how ‘inputs’ and ‘outputs’ are positively correlated. The countries that went earliest and furthest in transition to market liberalization achieved the highest GDP per capita increases, and notably, the best results for social indicators: the least widening of income distribution; the lowest poverty ratio increases, and the best scores in the HDI. It should also be noted that non-GDP performance closely mirrored the GDP performance. Generally, as soon as the GDP recovery began, social deterioration stopped and since the early reformers were the first to experience a recovery, they also experienced the least social costs. They were also the first to enjoy the benefits of transition: higher income, an end to shortages, access to a wide variety of goods, and improved quality of goods.

There is little disagreement that the most important question facing ex-communist nations in 1989 was whether to opt for gradual or rapid reforms. If economic performance is the main measure of success, the data speaks loudly. Countries that moved early and rapidly on reforms have performed far better. Why? Aslund et al. (1996) provide a good answer: notwithstanding the mathematical sophistication and elegance of optimizing gradualist models, big-bang reforms worked better due to the political economy in ex-communist countries. As they correctly understood, the former communist elites for the most part accepted that a new capitalist regime was inevitable but wanted to retain their privileged or ruling status. Soon, they enriched themselves through corrupt privatization schemes. In a word, the gradualist model was too easily abused.

The evidence for this is only indicative in the strong visual similarity of the graphs showing the reforms gap between the leaders and the laggards (Fig. 3.1) and the same gap in performance of GDP and HDI (Figs. 3.3 and 3.4). But it is broadly consistent with earlier econometric studies of growth in transition. These are surveyed by three articles: Babetskii and Campos (2007), Campos and Coricelli (2002), and Havrylyshyn (2001). The studies do not necessarily agree on all aspects but point to the role of several different determinants of performance: liberalizing reforms, initial conditions, the EU anchor and institutional quality. That is to say, the countries that did best on growth were those that started earliest

Fig. 3.4 H uman Development Index for Selected Country Groups plus Poland and Ukraine (Source: United Nations Human Development Reports, online database)

and went furthest on market liberalizing reforms and institutional development. The simpler quantitative analysis of this chapter confirms that these earlier conclusions still hold after a quarter century. The chapter has not addressed some of the other factors, like initial conditions and the value of the EU anchor, but the discussion on Ukraine in the rest of the book will consider these in detail.

• [1] This section draws on Havrylyshyn et al. (2016).
• [2] The catch-up is less evident in the TPI value than in other indicators. By 2012, it had risen to thenineteenth position in the rankings of the Doing Business report, higher than any of the CEB.
• [3] Havrylyshyn (2006) discusses in detail the differences between Western billionaires and postSoviet oligarchs.