Tue, Nov 11, 2014 - Page 9 News List

Tracing Central, Eastern Europe’s quarter-century transformation

By David Lipton

What a difference 25 years can make — In 1989, Central and Eastern Europe embarked upon a historic transformation, from authoritarian communism to democratic capitalism. With memories of the old system already beginning to fade, it seems fitting to look back at the region’s achievements, review the lessons learned and examine the challenges ahead.

It would be a mistake to assume that the success of the region’s transformation was inevitable. At the close of the Cold War, Central and Eastern Europe’s economies were burdened by pervasive state ownership and concentrated investments in heavy industry.

Fiscal and monetary policies had focused on boosting industrial growth, without regard to macroeconomic balance, resulting in chronically excessive demand and widespread shortages. To make matters worse, most of the region — Czechoslovakia being a notable exception — was plagued by unsustainable external debt and soaring inflation.

Meanwhile, few economists or policymakers had the background needed to tackle the complex tasks ahead. Such was the scale of the necessary transition that neither modern macroeconomics, nor the IMF’s nearly 50 years of experience offered much guidance. The challenges to be overcome were daunting and many thought it would be impossible.

Instead, four key ingredients contributed to successful transitions: First, courageous politicians and policymakers took on the challenge of designing crucial reforms and explaining their consequences to a public that was understandably wary. They understood the historic nature of the task and embraced the challenge.

Second, the reform strategies focused squarely on the essential: The liberalization of prices to reflect scarcity and facilitate the allocation of resources; stabilization of finances to end shortages and inflation; and privatization of state-owned companies and assets to improve corporate governance and performance. Countries that implemented these policies generally made the quickest and most complete progress.

Third, the allure of rejoining Europe after years of isolation, together with the EU’s commitment to enlargement, provided a gravitational pull — and a legislative template — that helped policymakers justify and implement difficult reforms. Unpopular laws sometimes brought down governments, but the ultimate litmus test for any new policy remained: “Will it lead us back to Europe?”

Finally, external support helped the region’s heavily indebted countries face the twin tasks of implementing structural reforms and coping with financial instability. Financing from the IMF, the World Bank, the European Bank for Reconstruction and Development and bilateral lenders, along with debt relief from official and commercial bank creditors, helped relieve the pressure. Technical assistance, capacity building and support for privatization — of banks, in particular — further smoothed the way.

Overall, the progress has been impressive. Several Central European countries have achieved per capita GDP levels (measured in terms of purchasing power parity) that place them on the lower rungs of the eurozone’s income ladder. Standards of living in the region have improved dramatically — even if full convergence with Western Europe is far from achieved.

Unsurprisingly, however, the picture is far from rosy everywhere. Some countries, especially in the Balkans and the Commonwealth of Independent States, are far from completing the transition and have gone through repeated cycles of hope and crisis.

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