This year marks the 25-year anniversary of the breakup of the Soviet Union and the beginning of a transition period, which for some countries remains far from completed. While several Central and Eastern European countries (CEEC) made substantial progress early on and have managed to maintain that momentum until today, the countries in the Commonwealth of Independent States (CIS) remain far from the ideal of a market economy, and also lag behind on most indicators of political, judicial and social progress. This policy brief reports on a discussion on the unfinished business of transition held during a full day conference at the Stockholm School of Economics on May 27, 2016. The event was organized jointly by the Stockholm Institute of Transition Economics (SITE) and the Swedish Ministry for Foreign Affairs, and was the sixth installment of SITE Development Day – a yearly development policy conference.
A region at a crossroads?
25 years have passed since the countries of the former Soviet Union embarked on a historic transition from communism to market economy and democracy. While all transition countries went through a turbulent initial period of high inflation and large output declines, the depth and length of these recessions varied widely across the region and have resulted in income differences that remain until today. Some explanations behind these varied results include initial conditions, external factors and geographic location, but also the speed and extent to which reforms were implemented early on were critical to outcomes. Countries that took on a rapid and bold reform process were rewarded with a faster recovery and income convergence, whereas countries that postponed reforms ended up with a much longer and deeper initial recession and have seen very little income convergence with Western Europe.
The prospect of EU membership is another factor that proved to be a powerful catalyst for reform and upgrading of institutional frameworks. The 10 countries that joined the EU are today, on average, performing better than the non-EU transition countries in basically any indicator of development including GDP per capita, life expectancy, political rights and civil liberties. Even if some of the non-EU countries initially had the political will to reform and started off on an ambitious transition path, the momentum was eventually lost. In Russia, the increasing oil prices of the 2000s brought enormous government revenues that enabled the country to grow without implementing further market reforms, and have effectively led to a situation of no political competition. Ukraine, on the other hand, has changed government 17 times in the past 25 years, and even if the parliament appears to be functioning, very few of the passed laws and suggested reforms have actually been implemented.
Evidently, economic transition takes time and was harder than many initially expected. In some areas of reform, such as liberalization of prices, trade and the exchange rate, progress could be achieved relatively fast. However, in other crucial areas of reform and institution building progress has been slower and more diverse. Private sector development is perhaps the area where the transition countries differ the most. Large-scale privatization remains to be completed in many countries in the CIS. In Belarus, even small-scale privatization has been slow. For the transition countries that were early with large-scale privatization, the current challenges of private sector development are different: As production moves closer to the world technology frontier, competition intensifies and innovation and human capital development become key to survival. These transformational pressures require strong institutions, and a business environment that rewards education and risk taking. It becomes even more important that financial sectors are functioning, that the education system delivers, property rights are protected, regulations are predictable and moderated, and that corruption and crime are under control. While the scale of these challenges differ widely across the region, the need for institutional reforms that reduce inefficiencies and increase returns on private investments and savings, are shared by many.
To increase economic growth and to converge towards Western Europe, the key challenges are to both increase productivity and factor input into production. This involves raising the employment rate, achieving higher labor productivity, and increasing the capital stock per capita. The region’s changing demography, due to lower fertility rates and rebounding life expectancy rates, will increase already high pressures on pension systems, healthcare spending and social assistance. Moreover, the capital stock per capita in a typical transition country is only about a third of that in Western Europe, with particularly wide gaps in terms of investment in infrastructure.
Unlocking human potential: gender in the region
Regardless of how well a country does on average, it also matters how these achievements are distributed among the population. A relatively underexplored aspect of transition is to which extent it has affected men and women differentially. Given the socialist system’s provision of universal access to education and healthcare, and great emphasis on labor market participation for both women and men, these countries rank fairly well in gender inequality indices compared to countries at similar levels of GDP outside the region when the transition process started. Nonetheless, these societies were and have remained predominantly patriarchal. During the last 25 years, most of these countries have only seen a small reduction in the gender wage gap, some even an increase. Several countries have seen increased gender segregation on the labor market, and have implemented “protective” laws that in reality are discriminatory as they for example prohibit women from working in certain occupations, or indirectly lock out mothers from the labor market.
Furthermore, many of the obstacles experienced by small and medium-sized enterprises (SMEs) are more severe for women than for men. Female entrepreneurs in the Eastern Partnership (EaP) countries have less access to external financing, business training and affordable and qualified business support than their male counterparts. While the free trade agreements, DCFTAs, between the EU and Ukraine, Georgia, and Moldova, respectively, have the potential to bring long-term benefits especially for women, these will only be realized if the DCFTAs are fully implemented and gender inequalities are simultaneously addressed. Women constitute a large percentage of the employees in the areas that are the most likely to benefit from the DCFTAs, but stand the risk of being held back by societal attitudes and gender stereotypes. In order to better evaluate and study how these issues develop, gendered-segregated data need to be made available to academics, professionals and the general public.
Looking back 25 years, given the stakes involved, things could have gotten much worse. Even so, for the CIS countries progress has been uneven and disappointing and many of the countries are still struggling with the same challenges they faced in the 1990’s: weak institutions, slow productivity growth, corruption and state capture. Meanwhile, the current migration situation in Europe has revealed that even the institutional development towards democracy, free press and judicial independence in several of the CEEC countries cannot be taken for granted. The transition process is thus far from complete, and the lessons from the economics of transition literature are still highly relevant.
Participants at the conference
- Irina Alkhovka, Gender Perspectives.
- Bas Bakker, IMF.
- Torbjörn Becker, SITE.
- Erik Berglöf, Institute of Global Affairs, LSE.
- Kateryna Bornukova, Belarusian Research and Outreach Center.
- Anne Boschini, Stockholm University.
- Irina Denisova, New Economic School.
- Stefan Gullgren, Ministry for Foreign Affairs.
- Elsa Håstad, Sida.
- Eric Livny, International School of Economics.
- Michal Myck, Centre for Economic Analysis.
- Tymofiy Mylovanov, Kyiv School of Economics.
- Olena Nizalova, University of Kent.
- Heinz Sjögren, Swedish Chamber of Commerce for Russia and CIS.
- Andrea Spear, Independent consultant.
- Oscar Stenström, Ministry for Foreign Affairs.
- Natalya Volchkova, Centre for Economic and Financial Research.
Former socialist countries inherited factory-dominated cityscapes since planners made industrial location decisions in relative ignorance of land’s opportunity costs. Drawing on unique survey evidence and policy variation across territorial units within Russia, this brief discusses the relationship between land tenure reforms and land reallocation. The evidence points to land privatization as an important factor in the reallocation of land in Russian cities.
This brief discusses the role of external anchors or goals such as WTO accession, NATO and EU accession in Latvia’s development strategy since 1991. On the one hand the external goals ‘depoliticised’ many potentially contentious areas of Latvian life. On the other hand, some developments would not have happened or would not have happened as fast without the constraints imposed by the external goals. For example liberalisation of the citizenship laws was prompted by NATO accession and the balance was tipped when the rejection of Latvia from fast-track EU accession talks in December 1997 led Latvia to abandon its quota or ‘windows’ naturalisation system. Most recently, Eurozone accession was an externally defined exit strategy from the austerity episode induced by the economic and financial crisis. Today there are no big external goals left to guide policy making. Home grown problems such as inequality require home grown solutions. But even now an external dependency persists. For example a long needed reform of the financing model of higher education has had to wait for a World Bank report published in September 2014 for action to be taken.
On January 1st, 2015 Latvia assumed the Presidency of the European Union. This milestone represents a certain level of maturity of the Latvian state and offers an opportunity for reflection on some aspects of how politics and political economy have evolved in Latvia between 1991 and today.
After Latvia regained independence in 1991, it faced (at least) two political economy challenges: one was to disentangle the economy from the Soviet system in which it had been deeply integrated, and the second, perhaps more difficult challenge, was to create an independent nation state. At a formal level, the solution to the latter challenge appeared straightforward – assume continuity of the Latvian state. Effectively this meant reinstating the pre-war constitution, which was indeed done for the most part. Symbolically this continuity was signalled by, for example, calling the first post-Soviet parliamentary elections held in June 1993 the elections for the 5th Saeima (parliament). The elections for the 4th Saeima had taken place more than 60 years earlier in October 1931.
At a practical level the challenges were more complex – Latvia had had no practical experience of statehood for nearly fifty years and mistakes were made. For example, Latvia initially diplomatically recognised Taiwan rather than the Peoples Republic of China.
There was a presumption that newly independent Latvia should become a market economy but little consensus on how this should be achieved. This is in contrast to Estonia where a group of ‘young market economy Turks’ were able to implement a kind of zero option i.e. zero tariffs, fast privatisation, etc. In Latvia there were strong protectionist sentiments and the initial privatisation was a muddled process.
Advice and advisers were abundant in post-independence Latvia. In the early 1990s, Latvia was awash with international advisers: the IMF and the World Bank were both present, the Germans were advising on a constitution for the Bank of Latvia, the British were active in public administration reform, the Danish advised on research and higher education and so on. Advice was often conflicting with different advisers promoting their own visions of structures as models that Latvia should adopt e.g. on legal and education systems. Today, we see something akin to this in the Eastern Partnership countries such as Moldova and Ukraine.
There was a general sense of the desirability of a ‘return to Europe’ but no plan or strategy. Nevertheless, even without a conscious plan a strategy emerged – namely a strategy of external anchors.
The external goals or anchors that emerged included the following:
- World Trade Organisation, 1998
- NATO, 29 March 2004
- European Union, 1 May 2004
- Eurozone, 1 January 2014
The most important effect of the external anchors was that they ‘depoliticised’ many potentially contentious areas of Latvian life. This has been particularly important given the fragmentation that has historically dominated Latvian politics. Thus, in the interwar period, no less than 32 different political parties were represented in the Saeima. In the early post-Soviet parliaments, similar tendencies were observed with newly created parties being the winners in terms of the number of seats in the first four elections. The election of 2006 was the first in which the previously largest party returned as the largest party. Between the first post-Soviet election in 1993 and the 2014 election, there have been no less than 17 governments which mostly have been uneasy coalitions of 3 or 4 partners with divergent views and interests. In this context the benefit of external anchors is self-evident.
The external anchors each contributed in different ways: WTO accession contributed to modify the protectionist sentiments that were rife in the early years of independence. Rather curiously, Estonia, which adopted a radical free trade policy right from the first days of independence, had more difficulties in achieving their WTO membership than ‘protectionist’ Latvia. Estonia was obliged to implement additional economic regulations in order to conform to the rules of the WTO and the EU (to which it was committed to join as its WTO application proceeded), and as a consequence, Estonian WTO accession was delayed to 1999. The WTO accession process also gave Latvia’s fledgling Foreign Ministry invaluable experience of multi-lateral negotiation.
Apart from the obvious security benefit, NATO membership was conditional on the creation of the Latvian anti-corruption Bureau (KNAB) and on the liberalisation of citizenship legislation, the latter because NATO was concerned about the prospect of a member state with a large number of non-citizen residents.
EU accession represents the biggest and most significant anchor. The requirement of candidate countries to accept the EU acquis communautaire took huge swathes of economic and social legislation out of the political arena. While the economic criteria for accession presented few difficulties of principle for Latvia – most people were in favour of a market economy – the requirement of respect for and protection of minorities presented problems for many Latvian politicians and liberalisation of the citizenship law was resisted until after 1997 when the rejection of Latvia from fast-track EU accession talks in December 1997 prompted a rethinking of Latvia’s intransigent position on the quota or ‘windows system’.
It is hard to over-estimate the impact of EU accession on Latvia. What would Latvia be like today if it were not a member state of the EU? There are sufficient tendencies even now in Latvia to suggest we would observe something like a tax-haven, off-shore economy, probably with weak democratic institutions. EU accession has saved the Latvian people from something like such a fate.
Even later in Latvia’s largely self-inflicted financial and economic crisis of 2008-10 it was the ‘Holy Grail’ of accession to the Eurozone that politically anchored Latvia’s famous austerity programme.
What of today? The ‘big’ external anchors are used up, and Latvia today:
- Is the fourth poorest country in the EU with GDP per capita in 2013 at 67% of the EU average (only Croatia, Romania and Bulgaria are poorer);
- Is a particularly unequal society – Latvia has some of the worst poverty and inequality indicators in the EU;
- Has a shadow economy at 23.8% of GDP (data on 2013; Putniņš and Sauka (2014)); and
- Has an internationally uncompetitive higher education system.
These and other problematic aspects of Latvian life and society are home grown and it is hard to imagine external anchors that can improve poverty or inequality, that can reduce the size of the shadow economy, or which can improve the quality of the Latvian higher education system.
Nevertheless, Latvian policy makers seem to be addicted to the external anchor concept and often find difficult to progress without it. The recent experience of reform of the financing of higher education illustrates. Latvia has historically had a funding mechanism for universities and other higher education institutions based entirely on student numbers. The lack of a link between funding and quality has resulted in a Latvian higher education system that is strong on enrolment but low on quality e.g. as measured by peer-reviewed publications. At some level this has been understood and there has been much talk of reform. Although various reports and evaluations have been published, there has been little progress on concrete reform until the Ministry of Education commissioned the World Bank in December 2013 to produce a report on funding models for Latvia. The final report was delivered in September 2014 and action has now been taken to adopt the World Bank recommended three-pillar model where the funding criteria will now include performance and innovation.
Of course, the new model will not solve all the problems of Latvian higher education – far from it – but it illustrates the pervasive nature of policy makers seeming dependency on external anchors.
- Putniņš, Tālis & Arnis Sauka (2014). “Shadow Economy Index for the Baltic Countries. 2009-2013,” The Centre for Sustainable Business at SSE Riga, May 2014.
For a long time Belarus considered privatization as a minor factor in influencing the economy’s development, competitiveness and effectiveness. The former economic model relied on concessional loans and donations from Russia and various international organizations. The 2011 financial crisis led to the breakdown of this model and forced the authorities to reconsider privatization. A draft of a new law on investment has been prepared, which is aimed at increasing foreign capital inflow to the country. However, it does not contain sufficient measures to significantly raise the investment attractiveness. In turn the lack of such attractiveness can have a very negative effect on the economy in the near future.
Belarus is right now facing a currency crisis primarily due to three factors:
- A growing deficit of trade and payment balances;
- The National Bank’s continuing Belarusian ruble emission partly because of pre-elective directive wages’ raise;
- A lack of foreign currency reserves required to keep the USD exchange rate at BYR 3100 level.
However, the key problem is a growing negative balance of payments, which in January-June 2011 amounted to USD (-1032.6) million against USD (-82.2) million in January-June 2010.
The Belarusian ruble devaluation, which occurred in May 2011, managed to improve the trade balance situation and gradually lead to export earnings growth. That in turn reduces the current account deficit, which amounted to USD (-1630.4) million in the second quarter of 2011 against USD (-3657.2) million in the first quarter 2011.
Negative foreign trade balance mostly forms negative balance of payments of the country, and problems with external payment capacity are likely to occur under conditions of trade deficit preservation. Moreover, taking into account that the main repayment share of external debt should be paid in 2012-2014 it is necessary to attract additional funding sources.
Table 1. External debt repayment scheme
For this to be feasible privatization as a major long-term capital raising instrument will be required for the following reasons:
- Belarus will not be able to borrow in the external markets in the near future. This is due to impossibility of attracting loans from international organizations as well as extreme expensiveness and inexpedience of sovereign debt securities placement in global stock markets.
- Before the 2011 crisis, public and private companies were able to attract bank and state financing programs’ sources for the financing of their activities. However, the unstable economic situation in the country has forced the authorities to cut the state programs’ funding (BYR 12 trillion instead of requested BYR 36 trillion, while BYR 22 trillion were spent in 2011) in order to prevent further inflation and to provide a budget surplus. Moreover, the economic crises resulted in a decline in domestic demand of the population and the corporate sector simultaneously, with reduced domestic savings levels as a consequence. During the first eleven months of 2011 savings dropped by 25% in USD terms in comparison to the corresponding period of the previous year. These occurrences in the economy make a search of a strategic partner through additional issue of shares or mergers with other agents the only source of financing attraction for state and private companies.
Speaking about the current situation, it should be noted that Belarus planned to get around USD 3 billion from privatization in 2011. 178 assets were to be sold according to the privatization plan. However, just around 38 assets were sold in 2011 and the country managed to gain around BYR 150 billion (USD 17.6 million) from that. Thus, the result cannot get positive evaluation right now.
The main reasons for the slow privatization process and weak foreign capital inflows are the following:
- The multiplicity of agencies responsible for privatization. There are too many responsible decision-makers, which potential buyers have to contact. In addition, it is not very clear which agency is responsible for this or that asset. The State Property Committee and the National Agency for Investments and Privatization (NAIP) supervise the state asset sales today. However, ministries and local authorities are also responsible for privatization plan accomplishment.
- Difference in asset valuation methods. Investors, while analyzing any investment project, tend to focus on the cash flows that the project will be able to generate and how soon the costs will be covered. The Belarusian side values the asset according to its’ book value, below which the price cannot fall. This often results in large price differences.
- Additional requirements. The presence of additional requirements is a common phenomenon, but only when the price negotiations are more flexible. But it distracts investors in case the requirements are followed by a fixed overestimated price.
- Lack of transparency. Periodically the deals are announced, which were closed not during the auctions or tenders but after the closed backroom negotiations. That also affects negatively investors’ opinion about the country
- High share of public sector. Private sector is mostly represented by small and medium businesses. Thus, the strategic investors’ interest in them is initially lower. Moreover, they are unable to invest by themselves due to a lack of resources.
In addition, the authorities and enterprise management demotivation in the privatization process, an undeveloped culture of IR and consulting services usage, and the fact that it is often non-controlling stakes that are put up for sale, are also obstacles in the process.
These are the main problems influencing the foreign capital inflow rates. Their solution and elimination should increase the economy’s investment rates as there is an interest in the country’s assets and it is high enough.
As was mentioned earlier, the sale price of an asset is estimated according to its’ book value in Belarusian rubles. The national currency devaluation, which occurred in May and October 2011, has significantly reduced assets’ real value in USD terms and therefore a sharp drop in prices occurred. Starting from March 2011, the national currency depreciated by 181%, and the fall in real value of assets on sale was comparable. The analysis of transactions, which were closed during the auctions held in 2011, showed that the companies acquired by the investor were generally highly undervalued even in the beginning of 2011.As a result of devaluation, the ratio of asset price to revenue (P/S) dropped by 1.67-1.8 times. OJSC “Zhlobinmebel” (P/S=0.3 January 2011, P/S=0.18 in June 2011), OJSC “Vitebskles” (P/S=0.37 – January 2011, P/S=0.2 – June 2011) .
On the other hand, in accordance with Presidential Decree #476, the revaluation of fixed assets should be done by January 1, 2012 and adjusted to PPI, which equaled to 82% in October, 2011. Such adjustment will still not be able to cover the depreciation resulting from the devaluation. Therefore, there will be a gap between the announced corrected asset price and its real value at least for another year.
Nowadays, the demand is formed by Belarusian export-oriented companies. Their products have become more competative in the markets as a result of devaluation and have caused some growth in earnings. Consequently, they are ready for vertical and horizontal integration with attractive companies operating in the local market in order to expand the production and increase their niche in the global markets.
As for foreign investors, macroeconomic stabilization is necessary in order to make them wanting to enter the Belarusian market. Moreover, foreign buyers are attracted by the strategic Belarusian companies rather than by the small and medium business. This is because they are then able to generate sufficient profit volumes even in the short-term period.
The privatization process will be much more active and intensive in the forthcoming 2012, in comparison to what we have seen during 2011. This is determined on the one hand by a great need in external capital and on the other hand by sufficiently favorable acquisition conditions. However, obviously the privatization process and plan should be reviewed and optimized.
It might be more efficient to put on sale, not just companies’ shares, but also controlling interest as it should increase buyer interest.
It is also possible to sell assets at a minimum fixed price (in case it has losses and no perspectives with current owner), or the authorities could reduce the amount of requirements which accompany the transaction.
Finally, it should be noted that the privatization of small companies will not generate sufficient amounts of foreign capital to the country. In order to achieve that goal, Belarus will have to sell some large strategic assets. It already sold the state’s controlling interest of OJSC “Beltransgaz” to OJSC “Gazprom” for USD 2.5 bln. As for other assets, it is most likely that these will be 51% of shares sale of OJSC “MTS”, 51% shares sale of OJSC “Naftan” in exchange of USD 1 billion syndicated loan issued by “Sberbank Russia” and EABR, as well as a merger of OJSC “MAZ” with Russia’s corporation “Russkie Mashiny” or OJSC “KAMAZ”.