Tag: shocks

Belarusian Business in Turbulent Times

Posted on October 23, 2023 | Policy Brief

20231023 Belarusian Business Challenges

In the past three years, the Belarusian private sector appears to have been caught between a hammer and an anvil, experiencing domestic repressions and de-liberalization as well as collateral damage from sanctions and a deterioration of the country’s image. This policy brief discusses the challenges that Belarusian businesses have been facing since the onset of the Covid-19 pandemic and argues that the private sector may be the last hope for sovereignty and transformation of the country.

The years that have passed since the onset of the Covid-19 pandemic and the subsequent economic shocks have significantly altered the entrepreneurial landscape in Belarus. This period has seen the emergence of private businesses’ social and political activation during the pandemic, as well as during the 2020 election campaign and post-election protests (Bornukova & Friedrich, 2021). Businesses have also had to adapt to reactionary government policies, cope with sanctions against Belarus and deal with issues related to the Russian invasion of Ukraine. In the face of these challenges, the reactions and responses from small and medium-sized businesses signals that the private sector still has the potential to remain a driving force for socio-economic development in Belarus – despite the current political forces in power.

Private Sector Development; Liberalization and Regulation

The liberalization of the business environment, which lasted more than a decade and ended in 2020, allowed the private sector (enterprises without any state ownership share) to become the most dynamic part of the economy (see Figure 1).

From 2012 through 2020, the share of the private sector in employment increased by 7.7 percentage points. Similarly, the contribution from the private sector to the export of goods and services, as well as to GDP, exceeded the contribution from state-owned commercial enterprises. Moreover, even in the absence of significant privatization and restructuring of state-owned enterprises, the private sector took over the “social” function as an “employer of last resort”, absorbing workers released from the public sector (including from fully and partly state-owned enterprises) (IPM Research Center, 2020).

In addition, the development of the private sector increased the diversification of Belarus’ foreign trade. Private companies in the IT sector, advanced instrument manufacturing, electronics, and other high-value-added industries shifted their focus to developed countries’ markets, which reduced the dependency on Russian resources and markets. This increased Belarus’ economic sovereignty and its resilience to political tensions and other external shocks. The year 2020 however marked the end of the liberalization of entrepreneurial activities, as private businesses and private capital started to be seen as a threat to the political system (Bornukova & Friedrich, 2021).

Figure 1. Contributions from the Belarusian private sector to main economic indicators.

Source: Own elaboration based on Chubrik (2021) and IPM Research Center (2020).

Although there are no uncontestable figures describing business’ attitudes and activities during the political crisis in 2020, several non-academic projects documented that 58 percent of people protesting the fraud elections in 2020 worked within the private business sector (Devby.io, 2020). Dozens of businesses also openly supported the anti-regime strikes (The Village Belarus, 2020). As a consequence, legislation and law enforcement have since been steadily tightened, the tax burden has increased, and the possibility for using simplified taxation and accounting systems by small-scale businesses, in particular for sole proprietors, have been substantially reduced.

Against this backdrop, the government has also suppressed the publication of detailed statistical data including those on entrepreneurial activity. Since 2020, the Belarusian Research and Outreach Center (BEROC)’s quarterly enterprise surveys have become the main source of information and analysis on the business development situation.

In general, BEROC’s surveys demonstrate that, despite a reduced safety cushion and the lack of substantial state support during the pandemic, Belarusian businesses had, by the end of 2021,  adapted to the shocks from the post-election crisis and harsh de-liberalization, by realizing  their ability to cope, and finding creative solutions in the turbulent environment (Marozau, Akulava and Panasevich, 2021). Before Russia’s aggression against Ukraine, Belarusian entrepreneurs’ optimism about overcoming external barriers – i.e., factors that are out of a firm’s control such as macroeconomic instability, etc. – was the highest since 2015. However, increased uncertainty forced Belarusian businesses to focus primarily on maintaining the achieved scale of activity, halting investments (Kastrychnicki Economic Forum (KEF) & BEROC, 2022).

Optimism In Challenging Times

In general, the institutional environment for doing business in Belarus has deteriorated in recent years, both due to actions such as changes in tax legislation, price regulation and pressure on disloyal businesses, and due to negligence from the state, such as lack of significant support measures for private business, an outflow of businesses due to sanctions and an increasingly negative image of the country (KEF & BEROC, 2022). The Business Confidence Index (BCI, ranging from 0 – “extremely negative” to 100 – “extremely positive”), developed by BEROC and the Kastrychnicki Economic Forum based on OECD methodology, documented that at the end of 2020, the confidence level of business representatives regarding future developments was in the negative zone – arguably due to the political unrest and the Covid-19 pandemic. As firms accepted a new normality and adjusted their businesses, the BCI steadily grew before comfortably settling in the neutral zone at the end of 2021 (see Figure 2).

In March-April 2022, however, macroeconomic instability, disruption of supply chains, and shortages of raw materials and/or components following the Russian war on Ukraine became serious external barriers for Belarusian businesses. This lowered the BCI and businesses’ perception of their economic situation.

Quite surprisingly, the risks of doing business in Belarus in the second half of 2022, until early 2023, were estimated to be lower than in 2021 (see Figure 3). This may be explained by the fact that (for companies remaining in Belarus) many of the potential risks (inflation, exchange rate instability, sanctions, counter-sanctions, disruption of supply chains, tightening of price regulation, etc.) had already realized (BEROC, 2023).

Figure 2. Business Confidence Index and GDP growth rate, October 2020-March 2023.

Source: KEF & BEROC (2023) and the National Statistical Committee of the Republic of Belarus.

Figure 3. Risk perception by Belarusian Businesses.

Source: BEROC (2023).
Note: Risks were scored on a five-point scale, 1-5, where 1 denotes “very low” and 5 “very high”. Dotted lines denote the 95 percent confidence intervals.

The New Reality

The reaction from most Belarusian businesses to both pandemic- and war-related challenges has manifested in their search for new business models, an introduction of new products/services, and the entry into new export markets. Despite a bundle of powerful shocks to the economy stemming from the Russian war on Ukraine and related sanctions, some factors have dampened the anticipated drop in the economy: in particular, the increase in Russian support, export re-orientation to Russia and developing markets, alongside monetary stimuli, and interference with the activity of state-owned enterprises as well as artificial price controls (Kruk & Lvovskiy, 2022). As a result, the standard of living has remained at pre-war levels: in January-April 2023, real household disposable income and real salary grew by 1.6 percent and 3.8 percent respectively. With sanctions on Belarus being comparatively softer than those on Russian businesses, Belarusian businesses may have gained a comparative advantage and additional opportunities in both the domestic and Russian markets (BEROC, 2022). This caused optimism among entrepreneurs and in March 2023 – for the first time in the considered period – the composite BCI turned out to substantially exceed the neutral zone (see Figure 2). These positive spillovers are however likely to be bound in time – they will end both if the state of the Russian economy worsens (as this would reduce Russian support and decrease export revenues for Belarusian firms), and in the unlikely scenario that Russia’s current isolation is reduced. Whether Belarusian businesses will withstand the current protracted crisis depends on the ability of state authorities (current or new) to restore a constructive dialogue with the business community, return to the rule of law and create a business environment conducive to entrepreneurship.

According to business, the key factor needed to expand business activity is a reduction of external barriers (such as disruptions to supply chains, shortages of raw materials and/or components), rather than government support (e.g., financial, informational, etc.) (KEF & BEROC, 2022). Thus, “We do not need state support, but need the state not to worsen legal conditions for doing business” has become a motto of Belarusian entrepreneurs. Even in the context of war and political instability in the region, it allows looking at the prospects of the private sector in Belarus with some positive expectations.

At the same time, factors such as political repressions, sanctions against Belarus, problems with logistics, and the refusal of business partners to work with Belarusian companies due to the Russian aggression towards Ukraine have forced many Belarusian businesses, especially in high-tech sectors, to relocate. While the scale and direction of Belarusian business emigration is still difficult to assess (Krasko & Daneyko, 2022), these processes devastate entrepreneurship capital in Belarus and jeopardize the prospect of entire sectors such as the IT sector. In addition, the popular opinion about the lack of business opportunities implies that, unless conditions improve in terms of state policy and public confidence in the future, the socio-economic effects (employment, value added, tax revenue, innovations) from entrepreneurial activity in Belarus will diminish (GEM-Belarus 2021/2022). With operations severely affected by external barriers and restrictive legislation, halted investments and limited, if any, commercial contacts with Western countries and individual businesses, Belarusian private enterprises can hardly be seen as a source of stability for the current regime.

Conclusion

To promote an increased role of the private sector in the Belarusian economy, and to ensure high-quality and sustainable growth of the same, two prerequisites are critically necessary.

Firstly, a resolution of the political crisis and a restoration of authorities’ and state institutions’ legitimacy will significantly increase the populations’ confidence in state policy on business and economics. The principle of rule of law must be recognized and public and private actors must be treated equally in all spheres. It is also necessary to ensure the stability of tax legislation and economic law and the mitigation of excessive state control of business activities. All the above would lower external barriers and create stimuli for long-term business investments that, in turn, would facilitate economic transformation.

Although the sanctions’ packages imposed on Belarus by most developed countries due to domestic repressions, and complicity in the aggression against Ukraine, were directed towards the public sector, the private business suffered substantial macroeconomic and reputational consequences in their wake. The refusal of many foreign partners (suppliers, customers, banks, transport companies etc.) to work with Belarusian businesses – regardless of their affiliation with the state and attitude towards Lukashenko’s regime as well as towards the war on Ukraine – also substantially undermine businesses’ potential and Western soft power in Belarus. Such refusal is often driven by the argument that, by paying taxes, private businesses in Belarus support the current regime, when they should instead undermine the regime by halting operations (and thus tax revenues). At the same time, with the complete liquidation of civil society organizations and the termination of international projects and initiatives, the Belarusian private business may serve as the last resort in the hope of achieving independent, decentralized, and autonomous decision-making – all cornerstones of modern democracy (Audretsch & Moog, 2022).

From this perspective, the preservation of the private sector in Belarus may be of decisive importance in the future political processes, necessary to take into account by policymakers and business elites alike in developed countries.

In addition, relocated Belarusian businesses can play an important role in transforming the country by developing social ties between entrepreneurs and civil society, by providing support when solving problems related to doing business outside of Belarus and by investing in the Belarusian economy in the future. In this regard, establishing non-partisan Belarusian business associations abroad creates preconditions for consolidation of the most active part of the Belarusian community and its involvement in the envisaged economic transformation of the country.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes. 

Shock “Therapy” the Market Way

Posted on September 5, 2011 | Policy Brief

Policy Brief Image with Tall Buildings Representing Transition, Market Economy and Shock Therapy

Twenty years after transition began and the merits of “shock therapy” were argued the most hotly, (former) transition countries are hard hit by global shocks originating in Western market economies. Although discussions now focus on troubles in Western developed countries, countries in Eastern Europe and the CIS were particularly hard hit in 2008/09. This should not come as a surprise given their pre-crisis vulnerabilities. As transition countries opened up to trade and capital flows—like other countries that want to reap the benefits of the global economy—they also became subject to the shocks that hit open economies. The very high current account deficits and/or reliance on commodity exports prior to the crisis exposed many countries in this region to two of the shocks that have been most costly to emerging markets and developing countries in the past, namely sudden stops in capital flows and terms of trade shocks. However, the lesson from the crisis should not be that opening up is bad in general, but that shock absorbers should be put in place to minimize the damage market-based “shock therapy” can do.

Shock Therapy and Transition

It is now twenty years since the failed 1991 coup that led to the breakup of the Soviet Union and started the transition from plan to market in (then) communist countries. A few years earlier, in 1989, the Stockholm Institute of East European Economies was set up at the Stockholm School of Economics. Its first director was Anders Åslund who was a strong proponent of shock therapy (see Åslund 1992). The basic idea was that a rapid transition from plan to market through changing institutions, privatizations and other liberal reforms would minimize the cost of transition. There are still different views on the merits of shock therapy as a reform strategy, but this brief will not address this debate.

In the wake of the academic debate of shock therapy, the broader research agenda was put under the heading “transition economics”, which became a new field in economics. This also lead Erik Berglöf, the new director of the Stockholm Institute of East European Economies, to change the institute’s name to the Stockholm Institute of Transition Economics, or SITE for short, the name we still use today. The economics of transition was also the title of the fifth Nobel symposium in Economics (Berglöf and Roland, 2007).

The use of the label “transition economics” may see a revival in the aftermath of the Arab spring. However, the economic issues that now face the (former) transition countries are much the same issues that emerging markets, developing countries and also advanced countries around the world grapple with. This is not least true when we look at what has happened in the current crisis.

Below this brief will argue that the shock therapy ex-communist countries were subject to in the early 90’s has been changed to the shock “therapy” open market economies around the world have been facing for a very long time. And just as there were heated debates on what the right therapy was then, the world is now debating what the “therapy” for the current shocks should be.

Output Drops Around the World

Significant drops in output have not only been observed in countries transitioning from plan to market but have occurred with regularity throughout modern history in countries around the world. The figure from Becker and Mauro (2006) shows the frequency of countries that entered into a major output loss event—defined as a cumulative loss of at least 5 percent of initial GDP in an event that last at least two years—during the 20th century. In the after-war period, a relative modest 5 to 10 percent of countries have entered into a period of significant output loss. However, in the great depression, almost half of the countries for which data is available entered into a period of significant loss of output.

Since the methodology used in Becker and Mauro follows countries until they return to pre-crisis levels of GDP, it is too early to provide a full account of what the number would be in the current crisis that started in 2008. Nevertheless, it is straightforward to compute how many countries have experienced output losses in 2008/09 (which is the first criteria to satisfy in the Becker and Mauro measure) and this number is close to fifty percent, on par with the great depression. This is not to say that the total output loss will be as high as in the great depression, but it clearly tells the story that this is the worst global crisis we have seen since then in terms of how many countries have been affected. The share of countries affected at the onset of this crisis varied greatly in different parts of the world and at different levels of development. The most surprising statistic from this crisis is that 90 percent of advanced economies experienced an output drop whereas “only” 40 percent of emerging market countries did. The regional differences between emerging markets are also striking; 85 percent of countries in Central and Eastern Europe (CEE) and more than half of CIS countries saw output decline, far above other regions.

Shocks 2.0

The Becker and Mauro paper also looks at the correlates of major output drops and focuses on a number of domestic and external macro, financial and political shocks as triggers of output collapses. A large dataset of shocks and output drops is used to compute the frequency of the different shocks; the likelihood that a particular shock leads to an output collapse (as defined above); and the output loss associated with such event. These numbers are then used to calculate how much different types of shocks have cost in terms of lost output for emerging markets and developing countries. The scale in the chart shows how much it would be worth in terms of GDP per annum to avoid a certain shock.


For emerging market countries, the worst shock has been sudden stops in capital flows that cost almost a percent of GDP per year. Unless countries have high levels of foreign exchange reserves, sudden stops in capital flows mean that (often large) current account deficits have to contract and even become surpluses quickly because there is no external financing available for a deficit. This, in turn, affects domestic production and demand and can have a serious effect on output. Add to this the financial uncertainty that is often associated with sudden stops and it makes it the number one shock to worry about for emerging market countries integrated in the global economy and financial markets.

Less developed countries are in several cases dependent on concentrated commodity exports to generate foreign exchange. This makes this group of countries more vulnerable to terms-of-trade shocks. The estimates of how costly these shocks are range from around half a percent of GDP per year, as is shown in the chart, to around 2.5 percent of GDP if a more extensive sample including very long-lasting output events is used.

Other shocks like currency, political and debt crisis have also been associated with significant losses in output, but tend to occur less frequently, which makes the cost per year smaller.

The 2008/09 Crisis

As was mentioned previously, not enough time has passed since the start of the crisis in 2008 to use the methodology in Becker and Mauro to compute cumulative output losses since many countries are still below their pre-crisis GDP levels. However, projected losses can be computed by using the IMF’s World Economic Outlook forecasts of GDP growth rates. If we then rank the countries according to worst output performance, CEE and CIS countries dominate the “top-ten” list with seven entries. Latvia at the top of the list is projected to lose a cumulative 40 plus percent of pre-crisis GDP during the 11 years it is projected to take the country to return to the GDP level it enjoyed in 2007. The other Baltic countries, Ukraine and Armenia have also been hit particularly hard in this crisis. Russia and Romania are close behind three advanced countries that had to seek IMF and EU assistance to deal with the crisis; Ireland, Iceland and Greece.

The forecasts used for these calculations are constantly being revised and the ranking of countries based on actual outcomes will certainly look different years from now. We can only hope that the current forecasts are too pessimistic although right now many revisions go in the wrong direction.

Could we have predicted what countries were hit in this crisis based on history? Based on the Becker and Mauro (2006) paper: Yes and no. “No” regarding the fact that overall, many advanced countries were hit this time. The paper found that in the past, the frequency of output collapses have decreased with the income level of countries, contrary to what has been the case this time. “Yes” for the fact that CEE and CIS countries were hit significantly more that other emerging markets since they were particularly vulnerable to the sudden stops and terms-of-trade shocks that the paper showed often are associated with severe output losses.

The signs of vulnerability in CEE and CIS countries were easy to see, but warnings ignored; the Baltic countries and Romania had double-digit current account deficits that where to a large part financed by external debt. For example, current account deficits in Latvia passed 20 percent of GDP in some years, far beyond the 4-5 percent deficits some Asian countries had prior to the Asian crisis in 1997. Ukraine also had large current account deficits and concentrated (metal) exports on top of that, exposing the country to both sudden stops and terms-of-trade shocks.

Russia’s dependency on energy and mineral exports was also well known, with 80 percent of export revenues coming from this source. However, the pre-crisis boom in oil and mineral prices had made Russian policy makers think this was a strength and not a vulnerability. On top of that, the strong external position of the government and central bank obscured the external financial vulnerabilities that had built up in the private sector. With the sharp decline in oil prices in the crisis, Russia was hit both by a terms-of-trade shock and a sudden stop in capital flows to the private sector.

There were of course individual countries in other regions that were showing vulnerabilities and were hit in the crisis, but the countries in the CEE and CIS region stood out as particularly vulnerable to the shocks that hit emerging market and developing countries in the past. The IMF’s Global Financial Stability Report from October 2008 summarizes these vulnerabilities in its Table 1.5 on macro and financial indicators for emerging markets very well. The shaded boxes that indicate potential problems in the table completely dominated the picture for CEE and CIS countries whereas other regions looked significantly less vulnerable. In short, history told us what shocks matter and the vulnerability indicators clearly showed where the shocks would do most damage.

Therapy 2.0

What are the policy lessons from this? Countries will always be subject to different types of shocks, and the question is how these shocks can best be absorbed to minimize the economic costs. In other words, what is the “therapy” needed to deal with these shocks? A key challenge is to find the policies and tools that strike the right balance between crisis prevention and high sustainable growth. Isolation to protect against external shocks is certainly not the answer.

Early warning systems (EWS) that identify vulnerabilities ahead of time and give policy makers time to reduce these vulnerabilities and thus avoid crisis is of course what everyone dreams of. The IMF and others have worked on various EWS models since the Mexican and Asian crises with mixed success (see Berg, Borensztein and Pattillo, 2005). With this crisis, the G20 and other groups of policy makers have made new calls for developing EWS, at times seemingly unaware of past efforts and the limited success in this area.

However, at the IMF the more formalized or mechanical EWS models are complemented with both bi-lateral and multilateral surveillance with the bulk of the findings made publicly available and communicated to relevant policy makers. These surveillance efforts contain much more information than more limited EWS models and also come with policy recommendation on how to deal with potential vulnerabilities.

There are of course limitations also with the surveillance by the IMF and other international and domestic organizations. First of all, they have to get it right and at the right time. This is far from trivial, not least because of our limited understanding of the links between the financial sector and the real economy. And even when the analysis gets it “right” in the sense of identifying vulnerabilities, it may take a long time before vulnerabilities translate into real problems and during this time, the analysis and recommended policies may seem misguided.

This is linked to the second major issue; to make relevant policy makers (politicians) listen to and take action on the advice. There is a reason Reinhart and Rogoff called their book “This time is different” since this is often the response to warnings from the IMF and others that suggest a party has been going on for too long and the punch bowl needs to be taken away.

Given the limitations of early warnings and surveillance more generally, there remains a strong need to reduce vulnerabilities in a systematic manner and develop tools to deal with the crises that were not prevented. This will require both domestic measures and a strong commitment to international cooperation. The latter part is of course extremely important right now in order to find appropriate solutions (read debt resolutions) to the problems cross-border banking and capital flows have created. It will also be key in setting up the rules for the future: what capital requirements should banks have; (how) should financial transactions or institutions be taxed; how can cross-border supervision be made more efficient; what type of crisis resolution mechanisms should be put in place both at the international and regional levels; etc, etc. Unless there is broad international agreement on these issues they will do little to address the weaknesses that were at the heart of this crisis.

On the domestic side, the usual IMF recommendation of creating a stable macroeconomic environment—with fiscal room to maneuver and a monetary policy that leads to stable prices—is always going to be part of a countries ability to absorb shocks. For countries that are integrated in international financial markets, exchange rate flexibility and a reasonable level of international reserves seem to be advisable. Jeanne and Rancière (2008) analyze optimal foreign exchange reserves for countries that are subject to sudden stops. Becker (1999) instead looked at accumulation of government assets as part of an optimal public debt and asset management strategy in a world with bailouts of the private sector which seems particularly relevant today.

The macro side should of course be combined with strong domestic supervision of the financial sector; structural policies that lead to sustainable growth in a competitive global environment; and strategies in commodity exporters to reduce the vulnerabilities associated with a narrow export base.

Although advanced countries get most of the attention in the international financial press today, emerging market and developing countries should not think that this is a new world were the shocks of the past do not matter to them. They do, so better get ready for “shock therapy” the market way while there still is time.

Bibliography

  • Becker, T., (1999), “Public debt management and bailouts”, IMF WP 99/103.
  • Becker, T. and P. Mauro, (2006), “Output drops and the shocks that matter”, IMF WP 06/172.
  • Berg, A., E. Borensztein, and C. Pattillo, (2005), “Assessing Early Warning Systems: How Have They Worked in Practice?”, IMF Staff Papers, 52:3, 462-502.
  • Berglöf, E. and G. Roland (2007), The economics of transition—The fifth Nobel symposium in economics, Stockholm Institute of Transition Economics (SITE) and Palgrave Macmillan.
  • IMF (2008), Global Financial Stability Report, “Financial stress and deleveraging”, October, Table 1.5 p.46.
  • Jeanne, O. and R. Rancière, (2008), “The optimal level of international reserves for emerging market countries: A new formula and some applications”, CEPR Discussion Papers 6723.
  • Reinhart, C. and K. Rogoff, (2009), “This time is different: eight centuries of financial folly”, Princeton University Press.
  • Åslund, A., (1992) “Post-Communist Economic Revolutions: How Big a Bang?”, Center for Strategic & International Studies, Washington D.C..

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.