Experiences with the monetary transmission mechanism in Poland

1
POST-COMMUNIST TRANSITION IN A COMPARATIVE
PERSPECTIVE
Leszek Balcerowicz
Public Expenditure Management Challenges in
ECA/PSRP Countries Warsaw, February 7th, 2005
2
I. Analitical scheme.
External developments (shocks)
(9)
(8)
(7)
(2)
Outcomes (performance)
Initial conditions
(10)
The institutional system
(6)
(3)
(4)
(1)
Other policies
Reforms
Policies
(5)
Socio-political developments
3

• II. Initial conditions in transition countries.
• Nature of the communist institutional system.

• A. The controls exerted by the communist state
  were exceptionally extensive
• private entrepreneurship was banned, which,
  together with the initial nationalizations,
  resulted in the monopoly of the state sector,
• state-owned enterprises were subject to central
  planning, which included output commands,
  rationing of inputs and foreign exchange, price
  controls and directed foreign trade,
• the range of financial assets available to
  enterprises and individuals was extremely
  limited, as a market-type financial system could
  not have coexisted with central planning,
• the setting up and functioning of non-economic
  organizations were also heavily controlled that
  is, civil society was suppressed and political
  opposition was banned,
• foreign travel was restricted,
• media were subject to formal censorship, direct
  party controls and personnel policy mass media
  were largely an instrument of communist state
  propaganda.

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• B. These extensive controls co-existed with an
  overgrown communist welfare state, which
  included
• relatively large transfers in kind (education,
  health),
• social protection delivered via state-owned
  enterprises (SOEs),
• artificially low prices for foodstuffs, energy
  and housing rents,
• social safety net, typical of some market
  economies, did not exist as the need for it was
  sharply limited through the curtailment of
  individuals opportunities and risks.

• C. The communist state was peculiar with respect
  to the provision of public goods.
• Defense expenditures were excessive and shaped
  by the imperial aspiration of the ruling elites.
• Law and order were kept at reasonable level,
  however, at the cost of practices typical of a
  police state.
• The legal framework and the juridical system
  criminalized private economic activity and
  independent political activity, and were ill
  suited to the market economy, rule of law and
  free society.

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In various other aspects the communist countries
differed from one another. However, when taken
together and compared to market economies,
especially the developing ones, they showed

• much higher ratio of general government
  expenditure to GDP,

General government expenditure, 1989 ( of GDP).
Source EBRD Transition Reports, OECD Economic
Outlook 73.
6
2. Human capital.
The communist countries achieved high enrollment
ratios.
Primary school enrollment, the ratio of total
enrollment to the population of age that
officially corresponds to the level of primary
education, 1990.
The value of this indicator exceeds 100 when
the number of primary school pupils is higher
than the total population of age that officially
corresponds to the level of primary education.
Source World Bank, World Development Indicators
2003.
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3. Macroeconomic imbalances.
The communist countries differed a lot with
respect to the
macroeconomic imbalances.
Inflation, 1989 ( of annual average).
Repressed inflation in 1987-1990.
difference between increase in real wages and
real GDP from 1987 to 1990
Source IMF World Economic Outlook, October 2000,
EBRD Transition Reports.
8
4. Foreign debt.
A few countries, i.e. Hungary, Poland, and
Bulgaria inherited a huge
debt burden from the communist times.
Foreign debt in the pre-transition year
(1989-1991), for non-transition countries 1989
( of GDP).
Source Orlowski L., Transition and Growth in
Post-Communist Countries, 2001, World Bank, World
Development Indicators, 2003.
9
5. Some performance variables.
Countries under communism lost a lot of distance
to Western European
economies.
Per-capita GDP (in 1990 international dollars) in
1950 and 1990 Poland vs. Spain, Hungary vs.
Austria.
Source Maddison A., The World Economy A
Millennial Perspective, OECD, Paris 2001.
10
The communist countries trailed with respect to
productivity.
Industry value added per worker, 1989
(Eurozone100)
Agriculture value added per worker, 1989
(Eurozone100)
Source World Bank, World Development Indicators
2003.
11
III. Some dozen years following the collapse of
communism, countries in the former Soviet bloc
achieved enormously
diverse outcomes in terms of

• economic growth,

Real GDP, 2003 (1989100).
Source EBRD Transition Report 2004.
12

• combating inflation,

Inflation, 2004 (annual average, ).
Source IMF.
13

• attracting Foreign Direct Investment,

Cumulative per-capita FDI inflows, 1989-2003,
(US).
Cumulative FDI inflows, 1989-2003 (b US).
Data for 1989-2002
Source EBRD Transition Report 2004.
14

• improving the health indicators,

Infant mortality per 1000 life births, 1990 and
2002.
Source World Bank, World Development Indicators
2004.
15
Life expectancy at birth (1990, 2002).
Source World Bank, World Development Indicators
2003, EBRD Transition Reports.
16

• income distribution.

Gini Coefficient of Income Per Capita, 1987-90
and 2000-01 (in ).
Source World Bank, Transition The First Ten
Years, 2002 World Development Report 2005
UNICEF TransMONEE, 2003.
17

• ecological efficiency.

GDP unit of energy use, 1989 and 2001 (PPP per
kg of oil equivalent).
Source World Bank, World Development Indicators
2004.
18
CO2 emission, 1989 and 2000 (kg per 1995 US of
GDP).
Source World Bank, World Development Indicators
2004.
19

• IV. Explaining the differences in outcomes.
• Main factors explaining the differences in the
  growth rates
• initial conditions,
• external developments (e.g. the Russian crisis)
  including
• - access to markets,
• location,
• extent of market reforms and the nature of
  macroeconomic policies.

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Countries which introduced reforms faster,
achieved better
economic results.
GDP level (1989100) and average value of EBRD
liberalization index (1991 2003).
Countries excluded from the regression due
to the questionable quality of statistical data.
The index level is the level of a composite index
calculated as an arithmetic average of the 8 EBRD
liberalization indices published in the EBRD
Transition Reports (index of price
liberalization, index of forex and trade
liberalization, index of small-scale
privatization, index of large-scale
privatization, index of enterprise reform, index
of competition policy, index of banking sector
reform, index of reform of non-banking financial
institutions).
EBRD Index value 1 (minimum) very little (or
no) progress since the fall of communism value
4.3 standards and performance typical of
advanced industrial economies. Source EBRD
Transition Reports.
21
Countries which liberalized faster,
experienced smaller
increases in earnings inequality.
GINI coefficient (2000-2001) and average value of
EBRD liberalization index (1991 2003).
Source World Development Report 2005 EBRD
Transition Reports UNICEF TransMONEE 2003.
22
These findings are strongly supported by
substantial empirical literature reviewing
experiences of transition countries.
Berg, Borensztein, Sahay, Zettelmeyer, (1999) The role of initial conditions in explaining cross-sectional variation in growth is surprisingly minor in particular, the difference in performance between the CEE and the Baltics, Russia, and other countries of the former Soviet Union is mostly explained by differences in structural reforms (even at the beginning of transition), rather than initial conditions.
Fischer, Sahay, (2000) The experience accumulated in the past decade, whether viewed informally or with the help of data, charts, and regressions, provides support for the view that the most successful transition economies are those that have both stabilised and undertaken comprehensive reforms, and that more and faster reform is better than less and slower reform.
Havrylyshyn, van Rooden, (2000) () progress in achieving macroeconomic stabilization and implementing broad-based economic reforms remain the key determinants of growth in transition countries.
Havrylyshyn, Oleh, Wolf, Thomas 2001 Unfavourable initial conditions should not become an excuse for inaction.(...) First, their negative effects decline over time. Second, the empirical studies clearly suggest that these effects can be compensated by modestly faster progress on reforms. Third, perhaps the main fact is indirect that is, unfavourable initial conditions result in less political will and capacity for reform, and less reform means less growth.
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Why better economic results go hand in hand with
better non-economic outcomes (health,
environment, etc.)?
Some crucial factors conducive to longer-run
economic growth are also conducive to ecological
improvement and to favourable health development,
e.g.
less waste
less environmental degradation and less damage to
health

• economic reforms

healthier foodstuffs become more available and
relatively cheaper

• stronger rule of law

ecological regulations are more strictly observed

• privatization (separation of companies from
  the state)

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V. Some other observations on economic transition.
1. For the last 5 years some former USSR
countries have been developing faster than
Central European countries.
Real GDP in 2003 (1998100).
Source EBRD Transition Report 2004.
25
Armenia a case study.

• During last few years Armenia achieved good
  economic results.

Real change in exports of good and services (in
).
Real GDP in 2003 (1996100).
Consumer price index (in ).
Source EBRD Transition Report 2004.
26

• Armenia is an example of a post-communist country
  with a limited state.

Average general government expenditures (as of
GDP).
Tax revenues (as GDP).
Average general government balance (as GDP).
Source EBRD Transition Report 2004, IMF Country
Reports.
27

• Reforms in Armenia resulted in an increase in the
  extent of economic freedom.

Economic Freedom Index (The lower the value of
the index and rank, the wider the extent of
economic freedom).

• The index level is based on a composite index
  calculated as an arithmetic average of the 10
  subindices concerning (1) Trade, (2) Fiscal
  Burden, (3) Government Intervention, (4) Monetary
  Policy, (5) Foreign Investment, (6) Banking
  Finance, (7) Wages/Prices, (8) Property Rights,
  (9) Regulation, (10) Informal Market.
• The ranking included about 150 countries.

Source Heritage Foundation.
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2. Price liberalization.
EBRD Index of price liberalization, 2004.
EBRD Index value 1 (minimum) very little (or
no) progress since the fall of communism value
4.3 standards and performance typical of
advanced industrial economies.
Source EBRD Transition Report 2004.
29
3. Strictly limited state with limited social
transfers and simple tax system.
Models of fiscal transition varied substantially
by country ranging from the Irish model to the
collapse-of-state model.
General government expenditure in 1989 and 2003
( of GDP).
Source EBRD Transition Reports, OECD Economic
Outlook 73.
30
4. Fast privatization.
Private sector share in GDP in 2004 (in ).
Source EBRD Transition Report 2004.
31
5. Banking sector open to foreign investors.
EBRD Index of banking sector reform, 2004.
EBRD Index value 1 (minimum) very little (or
no) progress since the fall of communism value
4.3 standards and performance typical of
advanced industrial economies.
Source EBRD Transition Report 2004.
32
Financial sector in the transition economies
developed at varied pace.In the majority of
these countries this sector is bank-dominated.
Domestic credit to private sector and market
capitalization of listed companies, 2002 ( of
GDP).
Source World Bank, World Development Indicators
2004.
33
The differences in these developments were
due to
the less different initial conditions and more
due to
the difference in the quality of general
(horizontal) and sectoral policies.

• GENERAL (HORIZONTAL) POLICIES
• FISCAL AND EXCHANGE RATE POLICIES
• ENFORCING THE RULE OF LAW
• LIBERALISATION.

ENTERPRISE SECTOR
INITIAL CONDITIONS
FINANCIAL SECTOR

• PRIVATISATION
• PRUDENTIAL REGULATION AND SUPERVISION
• PROTECTION OF CREDITORS AND MINORITY
  SHAREHOLDERS RIGHTS
• RESTRUCTURING OF BAD DEBT.

• PRIVATISATION
• SOFT OR HARD BUDGET CONSTRAINTS ON ENTERPRISES.

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It is too simplistic to assume that financial
crises in some transition economies were caused
by the liberalization of the capital flows.
Such crises did not occur in the countries with
the lowest number of capital transactions
controls.
Index of capital transactions controls, 1996.
Value of index is equal to the number of areas
of capital transactions controls covering 10
distinguished areas (1) capital market
securities, (2) money market instruments, (3)
collective investment securities, (4) derivatives
and other instruments, (5) commercial credit, (6)
financial credit, (7) guaranties, sureties, and
financial backup facilities, (8) direct
investment, (9) liquidation of direct investment,
(10) real estate transactions.
Source IMF, Exchange Arrangements and Exchange
Restrictions, 1997, 2003.
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6. More democratic countries liberalized their
economies faster and to a larger extent.
Non-democratic regimes have stuck to non-market
economic model.
Average value of the EBRD liberalization index
and average rating of political and civil
liberties (1991-2004).
Competitive democracies
Non-competitive political regimes
The index level is the level of a composite
index calculated as an arithmetic average of the
8 EBRD liberalisation indices published in the
EBRD Transition Reports.
Source Freedom House, EBRD Transition Reports.