Foreword
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Faced with great uncertainty, the people of central and eastern Europe, the Baltic states and the Commonwealth of Independent States (CIS) showed great courage and resolve in their struggle to overcome the legacy left behind by the old regime. In the decade since the fall of the Berlin Wall, they have gained wide-ranging political and economic freedoms. Today, most goods and services are produced by the private sector and are exchanged in markets. Free and fair elections have been held in most countries, and political and civil liberties have begun to take root. However, the promise of good governance and economic prosperity remains unfulfilled in many countries. The experience has demonstrated that the process of transition from the command to the market economy is complex and long and that the upheavals and stress can be severe.
This Transition Report , a special issue within an annual series, takes stock of developments in transition over the past decade. While the countries of central Europe and the Baltic region have moved steadily towards the standards and performance of developed market economies, elsewhere the transition has been stunted by slow and uneven reforms and by persistent weaknesses in the institutions that support markets and private enterprise. The transition is not necessarily a steady march forward; there have been and will be setbacks and crises along the way. It has a long way to go, even in more advanced countries.
The EBRD seeks to foster the transition to an open marketoriented economy and to promote private and entrepreneurial initiative in all 26 of its countries of operations. It does this as a participant investor with a private sector focus. It works with its partners on projects that are financially sound and advance the transition, and that would be unlikely to emerge or to function well without its participation. For the EBRD to perform this task effectively, it needs to analyse and understand the complex process of transition and to share the Bank’s analyses with its partners, other investors and policy-makers in the region. The EBRD’s Transition Report take therefore an investment perspective on the transition. They focus on both the climate for investment and the contribution that investment shaped by market forces can make to the transition and to overall economic performance.
The analyses in this and previous Reports have consistently pointed to two broad patterns across the region. First, progress in market-oriented reform has been more rapid and sustained in the countries adjacent to the European Union, including central Europe and the Baltic states, than in countries further south and east. As was demonstrated by the repercussions from the crisis in Russia last year, countries such as Hungary and Poland showed impressive resilience in the face of heightened uncertainty over economic prospects in emerging markets. These economies have benefited from a sound investment climate and from policy stability fostered by the prospect of accession to the European Union. In south-eastern Europe and in the CIS, on the other hand, slower and more uneven reforms, combined with repercussions of the crisis in Russia and, more recently, the conflict in Kosovo, have created a more challenging environment for investment.
A second pattern that has emerged in the first decade of transition is an inherent imbalance in reforms, which is a characteristic even of more advanced transition economies. Some aspects of a market economy can and have been created quickly, in particular through market liberalisation and privatisation. However, developing the institutions and behaviour required for well-functioning markets and private enterprise takes much longer. The promotion of effective institutions, such as government structures, laws and regulations and the sound behaviour of governments, enterprises and financial institutions lies at the heart of the challenge of transition as it enters the next decade.
The structure of this Transition Report follows from its purpose: to understand the dynamic process of market reforms in transition economies and the key requirements for a successful transition. It focuses on the impact of initial conditions, early reform choices and the political process, all of which can have powerful consequences for the direction of future reforms and for aggregate economic performance (see Parts I and II). This analysis helps to identify the transition traps that have entangled reforms in some countries and the characteristics of countries that have pressed ahead steadily with reforms. Central to this analysis is an assessment of how reforms have reshaped the relationship between the state and enterprises. The analysis shows that the initial hope that liberalisation and privatisation would create the foundation for improved governance and would transform the relationship between the state and firms has not been fully realised. The impact of these reforms on the quality of governance depends strongly on the extent to which states are subject to "capture"– or undue influence– by private interests. The Report also breaks new ground in its detailed analysis of the factors for success at the level of individual enterprises, both existing ones and potential new firms (see Part III). The competitive process of market entry, innovation and growth at the enterprise level ultimately holds the key to a successful transition and rising living standards.
Part of the analysis of the Report presents the results of a major new Business Environment and Enterprise Performance Survey undertaken by the EBRD in collaboration with the World Bank. Covering over 3,000 enterprises in 20 transition economies, the survey asked senior managers about the characteristics of their firms, about the business environment in which their firms operate, and about their restructuring and growth performance.
While this Transition Report takes the form of a special issue, previous Reports have each had a special theme. These themes have developed a close analysis of the transition and the forces shaping its progress, together with an examination of the policies that foster the development of the institutions and behaviour that is required to support the functioning of markets and private enterprise. It is important, therefore, to consider the Reports as a series in which each edition, including this special issue, is not only complete in its own right but also inter-related and crossreferenced to previous editions.
The special themes of the previous Transition Reports have been:
1994– Institutional reform and economic openness;
1995– Fixed investment and enterprise development;
1996– Commercial infrastructure and contractual savings institutions;
1997– Enterprise performance and growth; and
1998– Financial sector in transition.
This year’s Transition Report draws from and builds on this previous work.
This Report argues that the way to improve governance and the investment climate is to strengthen simultaneously the capacity and the accountability of the state. This requires the promotion of domestic constituencies for reform with the power to break the grip that vested interests hold on the transition in many countries. The last decade has shown that liberalisation and privatisation alone are not enough to generate such constituencies. Political and economic competition is vital to pressure the government to provide essential public goods and to encourage firms to restructure and innovate rather than to rely primarily on state support. The process of competition is therefore central to the development of institutions that are able to support markets and private enterprise. Importantly, the Report argues that promoting the formation and growth of small and medium-sized enterprises (SMEs) and opening the market to foreign competition are core elements of an effective strategy for transition economies to reach their full potential.
The assessments and views expressed in this Transition Report are not necessarily those of the EBRD. The responsibility for them is taken by ourselves on behalf of the Office of the Chief Economist. While we have attempted to be as up to date as possible, the "cut-off" date for most of the information in the Report is September 1999.
Nicholas Stern
Chief Economist and Special Counsellor to the President
Ricardo Lago
Deputy Chief Economist
Steven Fries
Director of Policy Studies
8 October 1999
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