Eastern Europe and the Former Soviet

UnionClass 2:

The Transition Period

Begins January 1, 1989

• Poland launches big bang stabilization program

• had been earlier attempts at reform but. . .

Dimensions of transformation under

wayFrom planned to market

economiesIntegration into global

economyPolitical territorial

fragmentation

Major issue re. market economy often ignoredWhat kind of a market

economy are these countries aiming for???Liberal market economy

(U.S. model)Welfare state (Western

European model)

Primary components of transition to a market

economyPrivatization

change in ownership structureMarketization

substitution of the price mechanism to bring supply and demand into balance and to allocate factors of production

Integration into global economy

Necessary to adjust internal prices and output structure to world market conditions

ProblemHow to expand exports???

Additional issue--social safety net problem

Old system relied on full employment labor market and distribution of benefits by enterprises

unemployment increases in transition and enterprises cannot act as benefactors and still compete

state lacks the funds to increase social welfare spending

-12

-10

-8

-6

-4

-2

0

1989* 1990 1991 1992 1993 1994

Fiscal balance(% of GDP)

0

200

400

600

800

1000

1200

1400

1600

1989* 1990 1991 1992 1993 1994

Averageinflation

50

60

70

80

90

100

110

1989* 1990 1991 1992 1993 1994

Real GDP(1989=100)

-20

-15

-10

-5

0

5

1989* 1990 1991 1992 1993 1994

Real GDPgrowth

Growth, Inflation and Fiscal Balance in Calendar Time: All Transition

Economies

What is responsible for the slump in

output???• Collapse of CMEA trade• Substantial industrial output

became uneconomic under the new market prices

• Tighter credit restrictions needed to control inflation made it difficult for even viable enterprises to get access to credit

Reservations

1. Growth, Inflation and Fiscal Balance in

Stabilization Time

-15

-10

-5

0

5

T-4 T-3 T-2 T-1 T T+1 T+2 T+3

Real GDP growth

40

50

60

70

80

90

100

110

T-4 T-3 T-2 T-1 T T+1 T+2 T+3

Real GDP(T-4=100)

0

200

400

600

800

1000

1200

1400

1600

T-4 T-3 T-2 T-1 T T+1 T+2 T+3

Averageinflation

-12

-10

-8

-6

-4

-2

0

T-4 T-3 T-2 T-1 T T+1 T+2 T+3

Fiscal balance (%of GDP)

Inflation-Growth correlation, average of

1992-94

Padma Desai’s perspective

• High vs. medium and low-speed reformers• High Speed reformers got an early start and

adopted more comprehensive reform– price decontrol– fiscal and monetary tightening to reduce inflation– convertibility of currency– trade liberalization– privatization

Findings

BUT

Implications???

• One perspective. Not a significant problem. Faster growth will eventually provide more employment

• Alternative perspective. The high unemployment rate may make it impossible, politically, to sustain an economic reform package before this can happen

2.Data problemsPrices at which goods were valued

before transition were significantly out of linequality of goods was typically very poor

Need to build new statistical services.Earlier systems set up to measure state

sector outputincreasing share of output is not recorded

(unofficial economy)incentives

How to estimate the size of the unofficial

economy???A macroelectric approachbased on observed correlations

between GDP and total electrical use.use trends in total electrical

consumption as a proxy for trends in the overall economy

subtract est. of change in official economy to estimate unofficial economy

The example of Ukraine

1989 1990 1991 1992 1993 1994Growth inelectricityconsumption

--- 1.0% -2.2% -6.2% -7.8% -11.7%

Est. GDP growthrate

--- 1.0% -2.2% -6.2% -7.8% -11.7%

Overall GDP index(1989-100)

100.00 101.0 98.8 92.7 85.4 75.4

Official GDP index(1989=88)

88.0 84.7 73.3 60.5 51.5 38.9

Unofficialeconomy index

12.0 16.3 25.5 32.2 34.0 36.6

Results for the region

0 20 40 60 80 100

Poland

Czech

Estonia

Kazakhsta

Lithuania

Georgia

Official GDPdecline

Overall GDPdecline

Recent Trends--variability

(World Bank web site)Polandby 1994 real GDP exceeds 1989GDP growth rate is 6.2%/year--

1994-97Hungary

1997 14.4% 1998 5.1%Czech. Rep.

1994 3% 1995 6%

1997 0.3% 1998 -2.3%

Latvia1995 -3.1% 1997

8.6%Russia 1998 -4.6%Ukraine1998 -1.7%

(ripple effect from Russia)Kazakhstan same problem.

Financial crisis--> fall in commodity prices-->falling GDP in 1998.