Tag: Transition

Moldova’s EU Integration and the Special Case of Transnistria

Posted on October 14, 2024 | Policy Brief

Flags of Moldova and the European Union at a diplomatic meeting, symbolizing Moldova's EU integration efforts.

In the shadow of Russia’s invasion of Ukraine, another East European country is actively working to secure its European future. After three years of negotiating cooperation agreements with the European Commission, Moldova finally obtained its EU candidate status and is now on track to join the EU as a member state. However, among many remaining obstacles on the path to full membership, one stands out as especially problematic: the region of Transnistria. The region, officially Pridnestrovian Moldovan Republic, is an internationally unrecognized country and is rather seen as a region with which Russia has “special relations”, including a military presence in the region since 1992. This policy brief provides an overview of the current state of the Transnistrian economy and its relationships with Moldova, the EU, and Russia, arguing that Transnistria’s economy is de facto already integrated into the Moldovan and EU economies. It also points to the key challenges to resolve for a successful integration of Moldova into the EU.

Moldova’s EU Integration: The Moldovan Economy on its Path to EU Accession

On December 14th, 2023, the European Council decided to open accession negotiations with Moldova, recognizing Moldova’s substantial progress when it comes to anti-corruption and de-oligarchisation reforms. The first intergovernmental conference was held on the 25th of June 2024, officially launching accession negotiations (European Council, 2024). On October 20th, 2024, Moldova will hold a referendum on enshrining Moldova’s EU ambitions in the constitution. However, several issues remain to be solved, for Moldova to enter the EU.

With a small and declining population of only about 2.5 million people and a GDP of 16.54 billion US dollars (2023), Moldova remains among the poorest countries in Eastern Europe. In 2023 the GDP per capita was 6600 US dollars in exchange rate terms (substantially higher if using PPP-adjusted measures; World Bank, 2024a). In the last decade, the largest share of its GDP, about 60 percent, stemmed from activities in the services sector, and about 20 and 10 percent from the industrial and agricultural sectors, respectively (Statista, 2024). Despite substantial economic growth in the last decade (3.3 percent on average between 2016 and 2021) and recent reforms (largely under the presidency of Maia Sandu), Moldova remains highly dependent on financial assistance from abroad and remittances, the latter contributing to about 15 – 35 percent of Moldova’s GDP in the last two decades (World Bank, 2024b).

The COVID-19 pandemic and refugee flows caused by Russia’s invasion of Ukraine have only intensified this dependence. Furthermore, these events excavated existing vulnerabilities in the Moldovan economy, such as high inflation and soaring energy and food prices, which depressed households’ disposable incomes and consumption, while war-related uncertainty contributed to weaker investment (World Bank, 2024c).

The Contested Region of Transnistria – Challenge for Moldova’s EU Integration

In addition to Moldova’s economic challenges, the country also faces a particular and unusual problem; it does not fully control its territory. The Transnistrian region in the North-West of the country (at the South-Western border of Ukraine) constitutes about 12 percent of Moldova’s territory. The region has a population of about 350 000 people, mostly Russian-speaking Moldovans, Russians, and Ukrainians.

Following the breakup of the Soviet Union, a movement for self-determination for the Pridnestrovian Moldavian Republic resulted in a self-declaration of its independence on the 2nd of September 1990. More specifically, the alleged suppression of the Russian language and threats of unification between Moldova and Romania were the main stated reasons for the Transnistrian movement for self-determination, which in turn led to the civil armed conflict in 1992 and a following ceasefire agreement (Government of Republic of Moldova, 1992). The main points of the agreement concern the stationing of Russia’s 14th Army in Transnistria, the establishment of a demilitarized security zone, and the removal of restrictions on the movement of people, goods, and services between Moldova and Transnistria. As of 1992, Transnistria is de-facto an entity under “Russia’s effective control” (Roșa, 2021).

Over the years, the interpretations of the conflict have become more controversial, ranging from the local elite’s perspectives to assertions of an entirely artificial conflict fueled by malign Russian influence (Tofilat and Parlicov, 2020).

Notably, the Moldovan government has never officially recognized Transnistria as an occupied territory (see Article 11 of the Moldovan constitution stating “The Republic of Moldova – a Neutral State (1) The Republic of Moldova proclaims its permanent neutrality.  (2) The Republic of Moldova shall not allow the dispersal of foreign military troops on its territory” (Constitute, 2024)).

Furthermore, the European Council’s official recognition of Transnistria as an “occupied territory” on March 15, 2022, underscores the EU’s stance on the matter and highlights Russia’s pivotal role in providing political, economic, and military support to Transnistria (PACE, 2022).

The Transnistrian Economy: Main Indicators and Weaknesses

Despite Russia’s central role in Transnistria, the region’s economy is, in practice, substantially integrated into the Moldovan and EU economies. This fact should be considered at various levels of decision-making when discussing Moldova’s EU accession.

As depicted in Figure 1, economic activity in Transnistria has been quite “stable” in the last decade. GDP per capita has remained around 2000 US dollars, 2,5 times lower than Moldova’s GDP per capita in 2021.

Figure 1. Moldovan and Transnistrian GDP per capita, in thousand USD

Source: Data from World Bank, 2024; Pridnestrovian Republican Bank, 2024a. Note: since 2022 the Pridnestrovian Republican Bank has suspended publishing official statistics on macroeconomic indicators.

However, one must be careful when estimating and interpreting Transnistrian economic indicators in dollar terms. The local currency is the Transnistrian ruble which is not recognized anywhere in the world except in Russia. Its real value is thus highly uncertain as there is no market for this currency. Moreover, only Russian banks are authorized to open accounts and conduct transactions in the currency, demonstrating yet another significant weakness for Transnistria as a potential independent state, particularly given the current global ban on most Russian banks. As such, the official exchange rate for US dollars should be taken with a grain of salt. At the same time, there are no alternative statistics as the Pridnestrovian Republican Bank is the only source for relevant data on Transnistria.

Another distinctive feature of Transnistria is the substantial reliance on remittances from abroad (see Figure 2). In 2021, remittances amounted to 143.7 million US dollars, constituting 15.5 percent of GDP in 2021 (if relying on the official exchange rate for US dollars, as published by the Pridnestrovian Republican Bank).

Figure 2. Remittances to/from Transnistria, in million USD

Source: Data from the Pridnestrovian Republican Bank (2024b). Note: CIS denotes the Commonwealth of Independent States and all other countries.

Figure 2 illustrates a notable trend of increasing dependency on remittances in recent years, particularly on remittances originating from CIS countries, chiefly Russia and Ukraine.

In terms of reliance on Russia, this dependency is not a concern when it comes to Transnistria’s exports. Foreign trade data from recent years indicates that the Transnistrian economy no longer relies on exports to Russia. As seen in Figure 3, the share of exports to Russia has been constantly declining since 2014 and amounted to merely 9.2 percent in 2021. At the same time, exports to the EU, Moldova and Ukraine collectively accounted for about 80 percent in 2021. The primary commodities driving Transnistrian exports were metal products, amounting to 337.3 million US dollars in 2021, followed by electricity supplies at 130.1 million US dollars. Additionally, food products and raw materials contributed 87.6 million US dollars to Transnistrian exports in the same period.

Figure 3. Transnistrian exports by destination countries, in percent

Source: Data from the Pridnestrovian Republican Bank Bulletins (2024c).

These figures highlight the significant integration of the Transnistrian economy into the European market and, to some extent, indicate the strong potential to further align in this direction.

The increase in Transnistria’s exports to the EU in recent years can be largely attributed to the implementation of mandatory registration of Transnistrian enterprises in Moldova in 2006 as a prerequisite for engaging in foreign economic activities (EUBAM, 2017). Consequently, Moldova has exercised full control over Transnistrian exports and partial control over its imports since 2006.

However, Transnistria remains reliant on Russia for its imports, particularly in the energy sector. In contrast to the export structure, Russia’s share in Transnistrian imports was significantly larger in 2021. About 45 percent of the imports originated from Russia in 2021, and mostly constituted of fuel and energy goods (447.0 million US dollars) and metal imports (254.3 million US dollars), quite typical for a transition economy.

Figure 4. Transnistrian imports by origin countries, in percent

Source: Data from the Pridnestrovian Republican Bank Bulletins (2024c).

Transnistria’s Energy Dependence on Russia

The biggest challenge for Transnistria, as well as for Moldova, is the large fuel and energy dependence on Russia, mostly in the form of natural gas.

For many years, gas has been supplied to Transnistria effectively for free, often in the form of a so-called “gas subsidy” (Roșa, 2021).  This gas flows through Transnistria to Moldova, effectively accumulating a gas debt. Typically, Gazprom supplies gas to Moldovagaz, which in turn distributes gas to Moldovan consumers and to Tiraspol-Transgaz in Transnistria. Tiraspol-Transgaz then resell the gas at subsidized tariffs to local Transnistrian households and businesses. This included providing gas to the Moldovan State Regional Power Station, also known as MGRES – the largest power plant in Moldova. MGRES, in turn, exports electricity, further highlighting the interconnectedness of energy distribution between the Transnistrian region and the rest of Moldova.

Figure 5. Export/import of fuel and energy products from/to Transnistria, in million USD

Source: Data from the Pridnestrovian Republican Bank Bulletins (2024c). Note: Data for 2017 and 2018 unavailable.

The revenue generated from energy exports to Moldova has been deposited into a so-called special gas account and subsequently channeled directly into the Transnistrian budget in the form of loans from Tiraspol-Transgaz. In this way the Transnistrian government has covered more than 30 percent of their total budgetary expenditures over the last ten-year period. This further points to Transnistria’s’ fiscal inefficiencies and highlights its precarious dependency on gas from the Russian Federation.

In the last few years there have however been repeated disruptions in the gas supply and continuous disputes about prices and how much Moldovagaz owes Gazprom. De jure Tiraspol-Transgaz operates as a subsidiary of Moldovagaz, but de facto its assets were effectively nationalized by the separatist authorities in Transnistria (Tofilat and Parlicov, 2020). These unclarities has led to multiple conflicts over who owes the built-up gas debt. Given the ownership structure the debt is often seen as “Moldovan debt to Russia” (see e.g., Miller, 2023), albeit created by Transnistrian authorities. According to Gazprom, the outstanding amount owed by Moldovagaz to Gazprom stood at approximately 8 billion USD at the end of 2019 (Gazprom, 2024). This corresponds to about 7 times of Transnistria’s GDP. The Moldavian assessment of the debt is about two orders of magnitude lower  (Gotev, 2023).

The disagreement on the debt amount was the official reason for the gas supply to be drastically reduced in October 2022. From December 2022 to March 2023, Russia’s Gazprom supplied gas only to Transnistria and it was not until March 2023 that supplies to the rest of Moldova were resumed. Since then, there have been shifts back and forth with Moldova mainly buying gas from Moldovan state-owned Energocom, which imports gas from suppliers other than Gazprom (Całus, 2023; Tanas, 2023). Understanding all turns and events is at times challenging due to lack of transparency in dealings.

Currently, despite Gazprom’s debt claims, the entirety of Transnistria’s gas is still being provided by Russia. While this is a relatively “cheap” investment from the Russian perspective, its impact on Moldova is large, as highlighted by Tofilat and Parlicov (2020) “the bottomline costs for Russia with maintaining Transnistria as its main instrument of influence in Moldova was at most USD 1 billion—not too expensive for twenty-seven years of influence in a European country of 3 million people”.

Corruption in Transnistria – Who is the Real “Sheriff”?

Another obstacle hindering a resolution of the Transnistrian conflict is the near complete monopoly of political and economic power held by Transnistria’s former President Igor Smirnov (1991-2011), through his strong ties to the Sheriff corporation. The corporation, established in 1993 by two former members of Transnistria’s “special services” (Ilya Kazmaly and Victor Gushan), was enabled by Transnistria’s former president, Igor Smirnov. For instance, the Sheriff company was exempt from paying customs duties and was permitted to monopolize trade, oil, and telecommunications in Transnistria. In return, the company supported Smirnov’s party during his presidency. For more on the conflict between Transnistria’s power clans and their relationships with Russia, see Hedenskog and Roine (2009) and Wesolowsky (2021).

The Sheriff company encompasses supermarkets, gas stations, construction firms, hotels, a mobile phone network, bakeries, a distillery, and a mini media empire comprising radio and TV stations. Presently, the company is reported to exert control over approximately 60 percent of the region’s economy (Wesolowsky, 2021).

A straightforward illustration of Sheriff’s political influence is the establishment of the Sheriff football team. For the team, Victor Gushan constructed the Sheriff sports complex, the largest football stadium in Moldova, accommodating
12 746 spectators. This investment in sports infrastructure is notable, especially considering that the total population of Transnistria is only approximately 350 000, and that the region is fairy poor. A similar example concerns the allocation of a land plot of 6.4 hectares to the company “to expand the construction of sports complex for long-term use under a simplified privatization procedure” signed directly by the former president.

While these details may seem peripheral to broader problems, they illustrate how some vested interests in the Transnistrian region may not be keen to change towards a society based on the rule-of-law, increased transparency and a market-oriented economy.

Moldova’s Options for Resolving the Transnistrian Conflict in EU Integration

As Moldova grapples with both the consequences of the ongoing conflict in Ukraine and the prolonged “frozen” conflict with Transnistria, its economy remains vulnerable. With the recent attainment of EU candidate status, it’s essential for the Moldovan government to map out ways to solve the conflict despite strong interest from powerful political and economic groups in preserving the status quo.

While the perspectives of resolving the Transnistrian conflict obviously hinge on Russian troops withdrawing from the region, Moldova would also need to address a wide range of economic issues. The Transnistrian economy faces numerous critical structural challenges including a persistent negative foreign trade balance, an unsustainable banking system, and pervasive corruption. Notably, the dominant oligarchic entity, the Sheriff company, exercises monopolistic political and economic influence, striving to preserve the status quo for Transnistria. The obvious unviability of the local currency due to its artificial nature and a complete dependency on Russia’s banking system are additional challenges to be solved for Moldova to be able to integrate Transnistria properly into its economy. Therefore, introducing additional measures such as restricting access to remittances in Transnistria, and imposing personal sanctions on elite groups could help Moldova in establishing economic control over the region.

Furthermore, while the Transnistrian region de-facto has strong economic ties with the Moldovan and European markets in terms of exports, its heavy reliance on Russian gas imports remains a significant vulnerability.

When integrating Transnistria and severing its ties with Russia, Moldova would also need to resolve the issues arising from its reliance on the electricity produced at MGRES using subsidized Russian gas. Natural gas bought at market prices would make Moldovan electricity highly costly, presenting financial challenges to Moldova, and effectively destroying the competitive advantage and important source of revenue in the Transnistrian region. Moreover, alternative electricity routes to Moldova are yet to be completed (with an estimated cost of approximately 27 million EUR).

These and other issues need to be dealt with for a successful Moldovan transition into the EU. Although these challenges are highly important from a Moldovan point of view, and even more so from a Transnistrian perspective, it should be emphasized that these issues are, in economic terms, relatively small for the EU. Given that the EU has opened the way for Moldovan accession, it should be ready to step up financially to help Moldova solve these issues and stay on the membership path.

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.

The Long Shadow of Transition: The State of Democracy in Eastern Europe

Posted on November 25, 2019 | Policy Brief

Dark hill on the right side of the image with a shadow of a man holding his bicycle on the right side

In many parts of Eastern Europe, the transition towards stronger political institutions and democratic deepening has been slow and uneven. Weak political checks and balances, corruption and authoritarianism have threatened democracy, economic and social development and adversely impacted peace and stability in Europe at large. This policy brief summarizes the insights from Development Day 2019, a full-day conference organized by SITE at the Stockholm School of Economics on November 12th. The presentations were centred around the current political and business climate in the Eastern European region, throwing light on new developments in the past few years, strides towards and away from democracy, and the challenges as well as possible policy solutions emanating from those.

The State of Democracy in the Region

From a regional perspective, Eastern Europe has seen mixed democratic success over the years with hybrid systems that combine some elements of democracy and autocracy. Based on the V-Dem liberal democracy index, ten transition countries that have joined the EU saw rapid early progress after transition. In comparison, the democratic development in twelve nations of the FSU still outside of the EU has been largely stagnant.

In recent years, however, democracy in some of those EU countries, such as Bulgaria, the Czech Republic, Hungary, Poland and Romania have been in decline. Poland, one of the region’s top performers in terms of GDP growth and life expectancy, has experienced a sharp decline in democracy since 2015. Backlashes have often occurred after elections in which corruption and economic mismanagement have led to the downfall of incumbent governments and a general distrust of the political system. Together with low voter turnout, this created fertile ground for more autocratic forces to gain power helped by demand for strong leadership.

An example from Ukraine illustrated the role of media, both traditional and social, for policy-making. In some countries of the region, traditional media is strictly state-controlled with obvious concerns for democracy. This is less the case in Ukraine, where also social media plays an important role in forming political opinions. The concern is that, as elsewhere, opinions that gain traction on social media may not be impartial or well informed, affecting public perception about policy-making. A recent case showing the popular reaction to an attack on the former governor of the Central Bank suggests that those implementing important reforms may not get due credit when biased and partial information dominates the political discourse on social media.

Another case is the South Caucasian region: Armenia, Georgia and Azerbaijan. The political situation there has been characterized as a “government by day, government by night” dichotomy, implying that the real political power largely lies outside the official political institutions. In Georgia, the situation can be described as a competition between autocracy and democracy, with a feudalistic system in which powerful groups replace one another across time. As a result, trust in political institutions is low, as well as citizens’ political participation.

In the case of Azerbaijan, there is an elected presidency, but in reality, power has been passed on hereditarily, becoming a de facto patrimonial system. Lastly, in Armenia, the new government possesses democratic credentials, but the tensions with neighbouring Azerbaijan and Turkey have given increasing power to the military and important economic powers. Overall, democratisation in these countries has been hindered by a trend for powerful politicians to form parties around themselves and to retain power after the end of their mandates. Also, the historical focus on nation-building in these countries has led to a marked exclusion of minorities and a conflict of national identities.

The last country case in this part of the conference focused on the current political situation in Russia and on the likely outcomes after 2024. The social framework in Russia appears constellated by fears – a fear of a world war, of regime tightening and mass repressions, and of lawlessness – all of them on the rise. Similarly, the economy is suffering, in particular from low business activity, somewhat offset by a boost in social payments. Nonetheless, it was argued that it is not economic concerns, but rather political frustration, that has recently led citizens to take to the street. Despite this, survey data shows that trust in Putin is still over 60%, and that most people would vote for him again. However, survey data also points out that the most likely determinant of this trust is the lack of another reference figure, and that citizens are not averse to the idea of political change in itself. Lastly, Putin will most likely retain some political power after 2024, transiting “from father to grandfather of the nation”.

Voices from the civil society in the region also emphasized the importance of a free media and an active civil society to prevent the backsliding of democracy. With examples from Georgia and Ukraine, it was argued that maintaining the independence of the judiciary, as well as the public prosecutor’s office, can go a long way in building credibility both among citizens and the international community. The European Union can leverage the high trust and hopeful attitudes it benefits from in the region to push crucial reforms more strongly. For example, more than 70% of Georgians would vote for joining the EU if a referendum was held on the topic and the European Union is widely regarded as Georgia’s most important foreign supporter.

Weak Institutions and Business Development

The quality of political and legal institutions strongly affects the business environment, in particular with regards to the protection of property rights, rule of law, regulation and corruption. Research from the European Bank for Reconstruction and Development (EBRD) highlights that the governance gap between Eastern Europe and Central Asia and most advanced economies is still large, even though progress in this area has actually been faster than for other emerging economies since the mid-‘90s. This is measured through enterprise surveys as well as individual surveys. In Albania, for instance, a perception of lower corruption was linked to a decrease in the intention to emigrate equivalent to earning 400$ more per month. Another point concerned the complexity of measuring the business environment and the benefits of firm-level surveys asking firms directly about their own actual experience of regular enforcement. For example, in countries such as Poland, Latvia and Romania the actual experience of business regulation measured via the EBRD’s Business Environment Enterprise Performance Survey, is far worse than one would expect from the World Bank’s well known Doing Business rating.

From the perspective of Swedish firms, trade between Sweden and the region has remained rather flat in the past years, as the complexity and risks of these markets especially discourage SMEs. Business Sweden explained that Swedish firms considering an expansion in these markets are concerned with issues of exchange rate stability, and the institutional-driven presence of unfair competition and of excessive bureaucracy. Moreover, inadequate infrastructure and the presence of bribery and corruption make everyday business operations risky and costly. It was generally emphasized that countries have to create a safe investment environment by reducing corruption, establishing a clear and well enacted regulatory environment, having dependable courts and strengthening domestic resource mobilization. Swedish aid can play a part, but there is a need to develop new ways of delivering aid to make it more effective.

An interesting example is Belarus, that has seen more economic and political stability than most neighbours, but at the same time a lack of both economic and political reforms towards market economy and democracy. Gradually the preference towards private ownership, as opposed to public, has increased in recent years and the country has seen a rising share of the private sector, even without specific privatization reforms. Nonetheless, international businesses are still reluctant to invest due to high taxes, a lack of access to finance as well as to a qualified workforce, but most importantly due to the weak legal system. An exception has been China, and Belarus has looked at the One Belt One Road Initiative as a promising bridge to the EU. Scandals connected with the two main Chinese-invested projects have damped the enthusiasm recently, though.

The economic and political risks of extensively relying on badly diversified energy sources, as is the case with natural gas imports from Russia in many transition states were also discussed. It was shown how some countries such as Ukraine, Poland and Lithuania have improved their energy security by either benefitting from reverse-flow technology and the EU’s bargaining power or building their own LNG terminals to diversify supply sources. However, either of these, as well as other energy security improving solutions are likely to come with an economic cost, though, that not all countries in the region can afford.

A Government Perspective

The main focus of this section was the Swedish government’s new inspiring foreign policy initiative, “Drive for Democracy”. Drawing from a definition of democracy by Kerstin Hesselgren, an early Swedish female parliamentarian, democracy enables countries to realize and utilize the forces of the individual and draw them into a life-giving, value-creating society. It was emphasized that the values of democracy are objectives by themselves (e.g. freedom of expression, respect for human rights) but also that democracy has important positive effects in other areas of human welfare. The Swedish government views democracy as the best foundation for a sustainable society, equality of opportunity and absence of gender or racial bias.

The “Drive for Democracy” specifically identifies Eastern Europe as one of the main frontiers between democracy and autocracy, and the Swedish government promotes human rights and stability through various bilateral programmes through the Swedish International Development Cooperation Agency, Sida, and multilateral initiatives within the EU, such as the Eastern Partnership. It was also emphasized that democracy is a continuous process that can always be improved, as indeed experienced by Sweden. Political rights were granted to women only in 1919 followed by convicts and prisoners in 1933 and to the Roma people only in 1950. Political and democratic rights are thus never once and for all given, and it is crucial that the dividends from democracy are carried forward to the younger generation.

Conclusion

In sum, the day illustrated clearly how democracy engages all segments of society, from the business sector to civil society, and the potential for but also challenges involved for democratic deepening in Eastern Europe. To get more information about the presentations during the day, please visit our website.

Participants at the Conference

  • PER OLSSON FRIDH, State Secretary, Ministry for Foreign Affairs.
  • ALEXANDER PLEKHANOV, Director for Transition Impact and Global Economics at EBRD.
  • TORBJÖRN BECKER, Director, SITE.
  • CHLOÉ LE COQ, Associate Professor, SITE and Professor of Economics, University of Paris II Panthéon-Assas.
  • THOMAS DE WAAL, Senior Fellow at Carnegie Endowment for International Peace.
  • NATALIIA SHAPOVAL, Vice President for Policy Research at Kyiv School of Economics.
  • ILONA SOLOGUB, Scientific Editor at VoxUkraine and Director for Policy Research at Kyiv School of Economics.
  • KETEVAN VASHAKIDZE, President at Europe Foundation, Georgia.
  • MARIA BISTER, Senior Policy Specialist, Sida.
  • HENRIK NORBERG, Deputy Director, Ministry for Foreign Affairs.
  • YLVA BERG, CEO and President, Business Sweden.
  • LARS ANELL, Ambassador and formerly Volvo’s Senior Vice President.
  • ERIK BERGLÖF, Professor in Practice and Director of the Institute of Global Affairs, London School of Economics and Political Science.
  • KATERYNA BORNUKOVA, Academic Director, BEROC, Minsk.
  • ANDREI KOLESNIKOV, Senior Fellow, Carnegie Moscow Center.

Liberal Democracy in Transition – The First 30 Years

Posted on October 28, 2019 | Policy Brief

20191027 Liberal Democracy in Transition FREE Network Policy Brief Image 07

This year marks 30 years since the first post-communist election in Poland and the fall of the Berlin Wall. Key events that started a dramatic transition process from totalitarian regimes towards liberal democracy in many countries. This brief presents stylized facts from this process together with some thoughts on how to get this process back on a positive track. In general, the transition countries that joined the EU are still far ahead of the other transition countries in terms of democratic development.

The recent decline in democratic indicators in some EU countries should be taken seriously as they involve reducing freedom of expression and removing constraints on the executive, but should also be discussed in light of the significant progress transition countries entering the EU have shown during the first 30 years of transition. The brief shows that changes in a democracy can happen fast and most often happen around elections, so getting voters engaged in the democratic process is crucially important. This requires politicians that engage the electorate and have an interest in preserving democratic institutions. An important question in the region is what the EU can do to promote this, given its overloaded political agenda. Perhaps it is time for a Greta for democracy to wake up the young and shake up the old.

This brief provides an overview of political developments in transition countries since the first post-communist elections in Poland and the fall of the Berlin Wall 30 years ago. It focuses on establishing stylized facts based on quantitative indices of democracy for a large set of transition countries rather than providing in-depth studies of a small number of countries. The aim of the brief is thus to find common patterns across countries that can inform today’s policy discussion on democracy in the region and inspire future studies of the forces driving democracy in individual transition countries.

The first issue to address is what data to use to establish stylized facts of democratic development in the region. By now, there are several interesting indicators that describe various aspects of democratic development, which are produced by different organizations, academic institutions and private data providers. In this brief, three commonly used and well-respected data providers will be compared in the initial section before we zoom in on more specific factors that make up one of these indices.

The big picture

The three indicators that we look at first are: political rights produced by Freedom House; polity 2 produced by the Polity IV project; and the liberal democracy index produced by the V-Dem project. Figures 1-3 show the unweighted average of these indicators for two groups of countries. The EU10 are the transition countries that became EU members in 2004 and 2007 and include Bulgaria, the Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Romania, Slovakia, and Slovenia. The second group, FSU12, are the 12 countries that came out of the Soviet Union minus the three Baltic countries in the EU10 group, so the FSU12 group consists of Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

Figure 1. Freedom House

Source: Freedom House and author’s calculations
Note: Scale inverted, 1 is best and 7 worst score

Figure 2. Polity IV project

Source: Polity IV project and author’s calculations
Note: Scale from -10 (fully autocratic) to 10 (fully democratic)

Figure 3. V-Dem

Source: V-Dem project and author’s calculations
Note: Scale from 0 to 1 where higher is more democratic

All three indicators convey the message that the democratic transformation in the EU10 group was very rapid in the early years of transition and the indicators have remained at high levels since the mid-90s only to show some decline in the most recent years for two of the three indicators. The FSU12 set of countries have made much less progress in terms of democratic development and remain far behind the EU10 countries in this regard. Overall, there is little evidence at the aggregate level that the democratic gap between the EU10 and FSU12 groups is closing. While the average EU10 country is more or less a full-fledged democracy, the average FSU12 country is at the lower end of the spectrum for all three democracy measures.

The average indicators in Figures 1-3 obviously hide some interesting developments in individual countries and in the following analysis, we will take a closer look at the liberal democracy index at the country level. We will then investigate what sub-indices contribute to changes in the aggregate index in the countries that have experienced significant declines in their liberal democracy scores.

For the first part of the analysis, it is useful to break down the democratic development in two phases. The first phase is from the onset of transition (1989, 1991 or 1993 depending on the specific country) to the time of the global financial crisis in 2009 and the second phase is from 2009 to 2018 (the last data point).

Figure 4. Liberal democracy, the first phase

Source: V-Dem project and author’s calculations

Figures 4 and 5 compare how the liberal democracy indicator changes from the first year of the period (measured on the horizontal axis) to the last year of the period (on the vertical axis). The smaller blue dots are the individual countries that make up the EU10 group while the red dots are the FSU12 countries. The 45-degree line indicates when there is no change between start and end years, while observations that lie below (above) the line indicate a deterioration (improvement) of the liberal democracy index in a specific country.

In the first phase of transition (Figure 4), all of the EU10 countries increased their liberal democracy scores and the average increase for the group was almost 0.5, going from 0.26 to 0.74. This was a result of many of the countries in the group making significant improvements without any countries deteriorating. The FSU12 group had a very different development with the average not changing at all since the few countries that improved (Georgia and Ukraine) were counterbalanced by a significant decline in Belarus and a more modest decline in Armenia.

Figure 5. Liberal democracy, the second phase

Source: V-Dem project and author’s calculations

The very rapid improvement in the liberal democracy index in the EU10 countries in the first phase of transition came to a halt and also reversed in several countries in the second phase of transition. Of course, as they had improved so much in the first period, there was less room for further positive developments, but the rapid decline in some of the countries was still negative news. However, it does point towards that reform momentum was very strong in the EU accession process, but once a country had entered the union, the pressure for liberal democratic reforms has faded.

Overall, the EU10 average fell by 0.1 from 2009 to 2018. This was a result of declining scores in several countries. The particularly large declines in this period have been seen in Hungary (-0.28), Poland (-0.27), Bulgaria (-0.14), the Czech Republic (-0.14), and Romania (-0.12). Again, the average FSU12 score did not change much, although Ukraine (-0.2) put its early success in reverse and lost as much in this period as it had gained earlier.

Country developments

Since much of the current discussion centers on how democracy is being under attack, the figures name the countries that have seen significant declines in the liberal democracy score in the first or second phase of transition. Figures 6 and 7 show the time-series of the liberal democracy index in the countries with significant drops at some stage of the transition process.

Figure 6. FSU12 decliners

Source: V-Dem project and author’s calculations

In many countries, the drop comes suddenly and sharply, with the first and most prominent example being Belarus. There, it only took three years to go from one of the highest ranked FSU12 countries to fall to one of the lowest liberal democracy scores. In Poland, Romania, Bulgaria and Armenia, the process was also very rapid and significant changes happened in 2-3 years.

Figure 7. EU10 decliners

Source: V-Dem project and author’s calculations

In the Czech Republic and Hungary, the period of decline was much longer and in the case of Hungary, the drop was the most significant in the EU10 group. Ukraine stands out as more of an exception with a roller-coaster development in its liberal democracy score that first took it up the list and then back down to where it started. For those familiar with politics in these countries, it is easy to identify the elections and change in government that have occurred at the times the index has started to fall in all of these countries. In other words, the democratic declines have not started with coups but followed election outcomes where in most cases the incumbent leaders have been replaced by a new person or party.

How democracy came under attack

We will now take a closer look at what has been behind the instances of decline in the aggregate index by investigating how the sub-indices have developed in these countries. The sub-indices that build up the liberal democracy index are: freedom of expression and alternative sources of information; freedom of association; share of population with suffrage; clean elections; elected officials; equality before the law and individual liberty; judicial constraints on the executive; and legislative constraints on the executive (the structure is a bit more complex with mid-level indices, see V-Dem 2019a).

Table 1 shows how these indicators have changed in the time period the liberal democracy indicator has fallen significantly (with shorter versions of the longer names listed above but in the same order). The heat map of decline indicated by the different colours is constructed such that positive changes are marked with green, smaller declines are without colour, declines greater that 0.1 but smaller than 0.2 are in yellow and larger declines in red. Note that the liberal democracy index is not an average of the sub-indices but based on a more sophisticated aggregation technique (see V-Dem 2019b). Therefore, the Czech Republic and Bulgaria can have a greater fall in top-level liberal democracy index that what is indicated by the sub-indices.

Table 1. Changes in liberal democracy indicators at times of democratic decline

Source: V-Dem project and author’s calculations

For the countries with the largest changes in the liberal democracy index, it is clear that both freedom of expression and alternative sources of information have come under attack together with reduced judicial and legislative constraints on the executive. Among the EU10 countries, Hungary and Poland stand out in terms of reducing freedom of expression, while Romania has seen most of the decline coming from reducing constraints on the executive. Not surprisingly, Belarus stands out in terms of the overall decline in liberal democracy coming from reducing both freedom of expression and constraints on the executive in the most significant way.

On a more general level, the attack on democracy does differ between the countries, but in the cases where serious declines can be seen, the attack has been particularly focused on information aspects and constraints on the executive. At the same time, all countries let all people vote (suffrage always at 1) and let the one with the most votes get the job (elected officials).

Policy conclusions

This brief has provided some stylized facts on the first 30 years of liberal democracy in transition and some details on how democracy has come under attack in individual countries. It leaves open many questions that require further studies and some of these are indeed ongoing in this project and will be presented in future briefs and policy papers here.

Some observations have already been made here that can inform policy discussions on liberal democratic developments in the region. The first is that changes can happen very rapidly, both in terms of improvements but also in terms of dismantling important democratic institutions, including those that provide constraints on the executive or media that provides unbiased coverage before and after elections. What is also noteworthy is that these changes have almost always happened after an election where a new person or party has come to power, so the democratic system is used to introduce less democracy in this sense.

It is also interesting that in all of the countries, the most easily observed indicators of democracy such as suffrage and having the chief executive or legislature being appointed by elections are given the highest possible scores. In other words, even the most autocratic regime wants to look like a democracy; but as the old saying goes, “it is not who votes that is important, it is who counts”.

The regime changes at election times that have led to declining liberal democracy scores have also in many cases come as a result of the incumbents not doing a great job or voters not turning up to vote. It was enough for Lukashenko in Belarus to promise to deal with corruption and rampant inflation that was a result of the old guard’s mismanagement to turn Belarus into an autocracy. In Hungary, the change of regime came after the Socialist leader was caught on tape saying he had been lying to voters. While in Romania, only 39% voted in the 2016 election. And in Bulgaria, around half of the voters stayed at home in the presidential election the same year.

In sum, both incompetent and corrupt past leaders and disengaged or disillusioned voters are part of the decline in a liberal democracy that we have seen in recent years. It is clearly time for policy makers that are interested in preserving liberal democracy in the region and elsewhere to think hard about how democracy can be saved from illiberal democrats. Part of the answer clearly will have to do with how voters can be engaged in the democratic process and take part in elections. It also involves defending free independent media and the thinkers and doers that contribute to the liberal democracy that we cherish. The question is if the young generation will find a Greta for democracy that can kick-start a new transition to liberal democracy in the region and around the world.

For those readers that want to participate more actively in this discussion and have a chance to be in Stockholm on November 12, SITE is organizing a conference on this theme which is open to the public. For more information on the conference, please visit SITE’s website (see here).

References

  • Freedom house data downloaded on Oct 4, 2019, from https://freedomhouse.org/content/freedom-world-data-and-resources
  • Freedom house methodological note available at https://freedomhouse.org/report/methodology-freedom-world-2018
  • Polity IV project data downloaded on Oct 4, 2019, from http://www.systemicpeace.org/inscrdata.html
  • Polity IV project manual available at http://www.systemicpeace.org/inscr/p4manualv2018.pdf
  • V-Dem project data downloaded on Sept 24, 2019, from https://www.v-dem.net/en/data/data-version-9/
  • Coppedge, Michael, John Gerring, Carl Henrik Knutsen, Staffan I. Lindberg, Jan Teorell, David Altman, Michael Bernhard, M. Steven Fish, Adam Glynn, Allen Hicken, Anna Lührmann, Kyle L. Marquardt, Kelly McMann, Pamela Paxton, Daniel Pemstein, Brigitte Seim, Rachel Sigman, Svend-Erik Skaaning, Jeffrey Staton, Steven Wilson, Agnes Cornell, Lisa Gastaldi, Haakon Gjerløw, Nina Ilchenko, Joshua Krusell, Laura Maxwell, Valeriya Mechkova, Juraj Medzihorsky, Josefine Pernes, Johannes von Römer, Natalia Stepanova, Aksel Sundström, Eitan Tzelgov, Yi-ting Wang, Tore Wig, and Daniel Ziblatt. 2019a. “V-Dem [Country-Year/Country-Date] Dataset v9”, Varieties of Democracy (V-Dem)
  • Pemstein, Daniel, Kyle L. Marquardt, Eitan Tzelgov, Yi-ting Wang, Juraj Medzihorsky, Joshua Krusell, Farhad Miri, and Johannes von Römer. 2019b. “The V-Dem Measurement Model: Latent Variable Analysis for Cross-National and Cross-Temporal Expert-Coded Data”, V-Dem Working Paper No. 21. 4th edition. University of Gothenburg: Varieties of Democracy Institute.

Institutions and Comparative Advantage in Services Trade

Posted on June 3, 2019 | Policy Brief

High office buildings facing sky representing Institutions and Services Trade

Recent studies have highlighted the role of human capital and good economic institutions in establishing a comparative advantage in trade in complex institutions-intensive goods. We show that the effect of institutions on comparative advantage in services trade is quite different: in fact, countries with bad institutions rely significantly more on services exports. More specifically, as the quality of institutions deteriorates, information technology sector (ICT) services exports as a share of total ICT exports increase significantly and countries with worse institutions get a substantial comparative advantage in the provision of ICT services. This is especially applicable to transitional economies characterized by high, arguably exogenous, human capital at the level of most advanced countries.

Introduction

Recent research in international trade has demonstrated that institutions influence the determination of comparative advantage in the trade of goods. Countries with strong domestic institutions have a significant comparative advantage in producing complex, institutions-intensive goods while countries with weak institutions tend to specialize in less complex goods. Through this channel, weak institutions can hinder growth and development (Nunn and Trefler, 2014).

We argue that the role of institutions in services trade can differ significantly from the one in trade in goods. The intuition behind it is that services provision often relies less on institution-driven factors, such as public infrastructure, availability of large number of inputs, property rights and capital investments than the production of complex goods.

We show, in the case of the information technology sector (ICT), that countries with bad institutions rely significantly more on services exports even after controlling for human capital input requirements and availability. We focus on the ICT sector to isolate the differences in the role of institutions in determining comparative advantage in goods and services. Both ICT goods and services provision are equally intensive in human capital and thus present a good opportunity to study differences between goods and services provision.

Our study is motivated by high ICT services exports (e.g. software development) and low ICT goods exports (e.g. computers, phones, etc.) of transition countries which are known to have high human capital and low institutional indicators.

Institutions and ICT Services Exports

Figure illustrates the high human capital availability of transitions economies and weak domestic institutions relative to other countries. Specifically, we categorize countries into four groups: 23 most developed economies (e.g. USA, Canada, Japan and Western European economies); new members of the European Union (a group of 13 countries including Poland, Slovakia, and Baltic countries); transition economies group consists of 17 mostly post-Soviet countries including Russia, Ukraine, Belarus; the most numerous fourth group includes more than hundred other developing countries.

Figure 1. Institutions quality and schooling by country groups

1a

Source: Authors’ calculations, schooling data from Barro and Lee (2013)

1b

Source: Authors’ calculations, institutional indicators data from the World Bank World Governance Indicators

Figure 1a presents an average number of years of schooling, our measure of human capital, for each country group in 2000 and 2010 (the years are chosen based on data availability). The human capital is at a similar level in the most developed economies, EU-13 and transition economies, but significantly lower in other developing countries. Figure 1b illustrates the average institutional quality for each group in 2000 and 2010. Institutional quality for each country is calculated as an average of six indicators, distributed approximately from -2.5 to 2.5: control of corruption, government effectiveness, political stability, rule of law, regulatory quality, voice and accountability, with a lower value corresponding to worse institutional quality. In contrast to education, the average institutional quality of transition economies, although improving from 2000, remains on average lower than the institutional quality of other developing countries.

Consistent with the literature on institutions and comparative advantage in relationship and investment-intensive goods production, ICT goods export from transition economies is significantly lower than in other countries. In contrast, ICT services exports is at a higher level and faster growth in transition economies than in other countries.

Belarus presents a good motivating example. On the one hand, fundamental education in Belarus is at a level of the most advanced countries, which allows 21 universities in the country to educate about 7,000 graduates in IT industry in a year. On the other hand, ICT services exports in Belarus is thriving: over the last 10 years, the growth of ICT services is an eightfold increase (it was 150M USD in 2008 and 1.2B USD in 2017). Nowadays, Belarus is one of the world leaders in ICT services exports per capita. At the same time, ICT goods export is not growing even close to the level of ICT services exports. Over the same time period, it has grown only by about 30 percent: in 2008 ICT goods export was 105M USD, in 2016 – 140M USD (BELARUS.BY, 2019).

The importance of ICT services exports in transition economies is seen in Figure 2. The figure presents ICT services exports as a share of total exports of ICT goods and services. To obtain values for each country group, we average ICT services shares across countries within each group.

Figure 2. ICT services exports as share of total ICT exports

Source: Authors’ calculations, ICT services export data from Trademap, ICT goods export data from WDI

As Figure 2 shows, the average share of ICT services exports in transition economies is higher than the share of ICT services exports in all other groups of countries. Transition economies, characterized by high human capital and weak institutional quality, specialize in exports of services over goods in their ICT exports. This descriptive evidence suggests that abundant human capital, inherited from the USSR and arguably exogenous, shifts to services within the human capital intensive ICT sector when facing weak institutions.

Empirical panel analysis confirms the descriptive evidence. To test our hypothesis, we use the share of ICT services in total ICT exports as a dependent variable and we show that quality of institutions is a significant determinant. Our regressions show that the higher the quality of institutions is, the lower will the share of ICT services in total ICT exports be. Moreover, regression analysis allows us to quantify this dependence: as the quality of institutions increases by 1, which is approximately the difference between Belarus and Georgia (as can be seen in figure 3 below), the share of ICT goods in total ICT services increases by about 20%.

Institutions as a source of comparative advantage in services

To explore the role of institutions in the relative services provision within a sector further, we look at comparative advantage in exporting ICT services. We incorporate a measure similar to Relative Share measure used in Levchenko (2007) for the analysis of comparative advantage in goods export. The measure effectively compares the share of ICT services export for a given country with the world average. The index of revealed comparative advantage in ICT services over ICT goods is computed for country in the following way:

where  is share of ICT services exports in total ICT exports for country,  is the export of ICT services for all countries, and  is the total ICT export (goods plus services) for all countries.

We look at the revealed comparative advantage index across our group of transition economies in figure 3 and see that even within this group, there is a negative correlation between institutions quality and revealed comparative advantage in ICT services.

Figure 3. Revealed Comparative Advantage and Institutions Quality

Source: Authors’ calculations

Countries with high institutional quality, like Georgia, export relatively more goods compared to services. Countries with low institutional quality, like Ukraine and Belarus, have a comparative advantage in ICT services exports.

We hypothesize that the main mechanism responsible for this is as follows. Poor institutional quality, resulting in, for example, corruption and the impossibility to create binding contracts does not allow the countries to produce complex goods in the ICT industry, while the presence of high human capital in these countries allows them to produce ICT services that much less depend on corruption and contracting inefficiencies but are as intensive in human capital as ICT goods.

For a better understanding of the relationship between institutions and comparative advantage determination, we run panel regressions analysing the probability of having a comparative advantage in ICT services in exports of ICT goods and services as a function of institutional quality. Following Balassa (1965), a country has a comparative advantage in ICT services if the share of services in overall ICT exports is higher than the world average, in other words, revealed comparative advantage index is greater than 1. We find that one unit increase in institutional quality reduces the probability of having a comparative advantage in services by about 25%, which means that a country with institutional quality similar to Georgia is about 25% less likely to have comparative advantage than a country with institutional quality similar to Belarus.

Conclusion

In this brief we have discussed the role of institutions in determining comparative advantage in services. Our study argues that, given high human capital, low quality institutions create comparative advantage in services provision. Since low quality institutions act as an implicit tax on the production of complex goods, rational agents reallocate most resources to the production of services that are less sensitive to the institutional quality, while still requiring high level of human capital. We showed that transition economies are characterized by low institutions quality and high human capital. At the same time, transition economies have the highest share of ICT services export in total ICT export. We also showed that institutions negatively affect comparative advantage in ICT services export. Our results suggest that services exports can be a novel development channel for countries with weak institutional, capital investments and infrastructure. Specialization in high-value added services exports provides opportunity for fostering high human capital.

References

  • Arshavskiy, Victor, Arevik Gnutzmann-Mkrtchyan and Aleh Mazol, 2019. “Institutions and Comparative Advantage in Service Trade”, Working paper
  • Balassa, B. (1965). Trade liberalisation and “revealed” comparative advantage 1. The Manchester School of Economics and Social Studies, 33(2), 99-123.
  • Barro, Robert J. and Jong Wha Lee, 2013. “A new data set of educational attainment in the world, 1950–2010”, Journal of Development Economics, vol. 104, pp 184-198
  • Levchenko, Andrei A., 2007. “Institutional Quality and International Trade”, Review of Economic Studies, vol. 74, pp 791-819.
  • Nunn, Nathan and Daniel Trefler, 2014. “Domestic Institutions as a Source of Comparative Advantage”, Handbook of International Economics, Volume 4, Chapter 5, pp 263-315.
  • BELARUS.BY, 2019. “ИТ в Беларуси”, it-belarus, accessed on May 19, 2019

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.

Unemployment in Transition and Its Long-Term Consequences

Posted on December 3, 2018 | Policy Brief

20181203 Unemployment in Transition Image 01

We examine the relationship between the experience of unemployment in the early years of the socio-economic transition in Poland and a number of wellbeing measures about two decades later. The analysis takes advantage of the rich content of data from the Survey of Health, Ageing and Retirement in Europe (SHARE) by matching retrospective information on labour market experiences with outcomes observed in the survey after year 2006. While there is a strong correlation between unemployment and general wellbeing measures such as life satisfaction, depression and subjective assessment of material conditions, the relationship cannot be interpreted as causal. On the other hand, we find that unemployment in the early years of the transition has strong, negative, long-term consequences for income and house ownership. The analysis sheds light on the implications of unemployment and on the nature of job losses in the follow-up of the Polish ‘shock-therapy’.

Introduction

Next year, the countries of Central and Eastern Europe will celebrate the 30th anniversary of the political breakthrough and the beginning of a major socio-economic transformation which followed. In the Polish case, the ‘shock therapy’ approach to the reform process implemented by the Mazowiecki government, though not without faults, has generally been viewed as the origin of the country’s economic success story. Afterwards, Poland experienced nearly three decades of uninterrupted economic growth and the Polish GDP returned to its pre-reform level already in 1995.

However, discussions of negative implications of the reform package still fuel the academic discourse as well as the political debate. While the majority of the population managed to avoid significant economic difficulties, many families experienced the painful hardship of the transition period in the form of job losses, poverty and exclusion. Given the scale of the socio-economic change, surprisingly little is known about the long-term consequences of individual experiences at that time. In particular, it is unclear if the negative outcomes observed many years after the reforms started can be causally linked to individual experiences in the early 1990s.

This lack of evidence is not unique for Poland and is largely due to unavailability of good individual-level data spanning the time before and after the collapse of communism. Since the transition cannot be lived through again, we shall never know how socio-economic conditions would have looked like under numerous alternative reform scenarios. However, as we show in a recent paper (Myck & Oczkowska, 2018), much can be learnt from the combination of contemporary and retrospective information on the nature of labour market histories during the transition and their relationship to outcomes recorded many years later.

The analysis presented in Myck and Oczkowska (2018) relies on the treatment of the systemic changes in the early 1990s as a major exogenous shock and on differentiating between reasons behind individual experiences of unemployment. We demonstrate that the observed strong correlation between unemployment in the initial years of the transition and a number of subjective wellbeing measures in later life is endogenous, and may reflect unobservable individual characteristics. It seems plausible to argue that these characteristics were the reasons behind the recorded job losses once the economy was liberalised and firms could fire their least productive employees.

Work histories in the SHARE dataset

The analysis is based on individual-level data from the Polish part of the Survey of Health, Ageing and Retirement in Europe (SHARE). SHARE is a multidisciplinary biennial panel survey focusing on individuals aged 50 years and over. Since the start of the project in year 2004 seven waves of data have been collected, and the survey was conducted in Poland in waves 2, 3, 4, 6 and 7. While the standard waves of the survey focus on contemporary conditions of respondents such as health, economic conditions, labour market activity and social networks, in wave 3 (the so-called SHARE-Life), participants were asked about their life histories including their family history, mobility and labour market experiences. The detailed labour market histories recorded in SHARE-Life allow us to identify transition-related job losses, which can be matched with current information on several measures of material conditions and wellbeing for the same individuals.

In Figure 1 we present labour market profiles since 1988 of those in the sample who were working prior to the start of the reform process.

Figure 1. Labour market status 1988 – 2008 conditional on working in 1988 in Poland

Source: Myck and Oczkowska, 2018.

The figure shows that along with rapidly increasing unemployment rates, the degree of inactivity of the Polish population grew substantially in the two decades following the transition. This data confirms that in the follow-up of the ‘shock-therapy’ reforms many individuals faced unemployment, while others, especially among older groups of employees, used several other labour market exit options, such as retirement or disability.

Analysing long-term consequences of economic shocks

To examine the role of unemployment experiences in the initial years of the transition for outcomes observed a few decades later, we use data from waves 2, 3 and 4 of the SHARE study. The analysis focuses on two groups of later-life outcomes – objective measures of material conditions such as household income, real assets and house ownership, and subjective indicators of wellbeing such as life satisfaction, depression or reporting difficulties in making ends meet.

We are able to control for an extensive set of individual characteristics which are usually unobservable to the researcher, through a complex set of background variables available in SHARE. These include respondents’ childhood conditions, parental background as well as health and labour market experience prior to 1988. With regard to the experience of unemployment we differentiate the instances of unemployment between the initial (1989-1991) and later (1992-1995) period of the transition to examine the potential differential implications of the rapid pace of the reforms in the early 1990s. Most importantly though, the data allows us to distinguish between different reasons behind job losses and we can separately examine the relationship with plant/office closures and other reasons for unemployment. Following other examples in the literature (Farber, 2011; Jacobson et al., 1993), we argue that plant closures can be treated as reasons for exogenous job separations. This in turn allows us on the one hand, to give a causal interpretation to the estimated coefficients, and on the other, to interpret those on other reasons for unemployment in the light of the causal relations.

Effects of unemployment experience on later-life outcomes

We find that experiencing unemployment due to plant/office closure between 1989 and 1991 is associated with almost a 30 percent lower level of household income and a lower probability of house ownership of about 10 percentage points (pp) some two decades afterwards. There is also a strong relationship between unemployment in the early years of the transition and wellbeing measures two decades later – individuals who experienced unemployment in the first three years of the transition have a 14 pp. higher likelihood of reporting great difficulties in making ends meet, a 10 pp. lower probability of  high life satisfaction and a 11 pp. higher likelihood of depression. However, since these relations do not hold for unemployment due to plant closures, they cannot be treated as causal. The results are therefore most likely driven by unobserved factors which simultaneously determine the lower level of outcomes two decades after the ‘shock-therapy’ reforms, and the likelihood of experiencing unemployment in the early 1990s.

Conclusion

In this policy brief we outline recent results on long-term implications of labour market developments in the early years of the economic transition in Poland. The analysis is based on a combination of contemporary and retrospective data from the SHARE survey, and focuses on the associations between the experience of unemployment in the initial years of the transition in Poland and a number of outcomes measured about two decades later. Using plant/office closures as exogenous sources of job separations during the early 1990s, we find a strong and statistically significant, negative, long-term effect on income and home ownership, which can be treated as causal.

We also find strong negative associations between unemployment for other reasons than plant / office closures and a number of subjective measures of wellbeing. This relationship however, does not hold for the exogenous reasons for job losses, which suggests an important role of unobservable factors that lead to unemployment and at the same time are responsible for the lower level of outcomes in later life. This is consistent with the labour market reality of central planning characterised by labour hoarding and maintaining employment regardless of workers’ productivity. When the economic reality changed in 1989, the least productive individuals were the first to be fired, and as our analysis shows, these are also the individuals with lower subjective levels of wellbeing two decades later. We confirm thus that those who lost their jobs in the early 1990s have lower measures of the subjective wellbeing outcomes, although the latter cannot be identified as specific consequences of unemployment in the first years of transition.

References

Acknowledgement

The authors gratefully acknowledge the support of the Polish National Science Centre through project no. 2015/17/B/HS4/01018. For the full list of acknowledgements see Myck and Oczkowska (2018).

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.

Revisiting Growth Patterns in Emerging Markets

Posted on October 15, 2018 | Policy Brief

20181014 Revisiting Growth Patterns Image 01

Recent studies document that emerging markets are rather similar in their growth patterns despite profound differences in starting conditions and productivity fundamentals. This challenges the common view on productivity as the main growth engine. The crucial role of the external environment for emerging markets emphasized by numerous studies adds to this doubt. I argue that productivity fundamentals still matter and remain the core driver of sustainable growth. However, external factors are crucial for understanding deviations from the trajectory of sustainable growth, i.e. episodes of growth accelerations/decelerations.

Challenges for Understanding Growth in Emerging Markets

As we enter the 4th decade of economic transition in Central and Eastern Europe (CEE), the causes and directions of causality of long-term growth in emerging markets might need to be reconsidered. Some recent studies emphasize that growth trajectories in emerging markets are pretty similar, i.e. average growth rates do not differ too much, while jumps and drops in growth rates are synchronous for the bulk of emerging economies (e.g. Fayad and Perelli, 2014). For instance, a decade ago the level of GDP per capita (in 2011 international $) in Macedonia was roughly 45% of that in the Slovak Republic, which likely reflected the productivity (measured through the Global Competitiveness Index) gap  between them. During the last decade, Macedonia has roughly closed this productivity gap. Growth theory would postulate that this should have transformed into faster output growth in Macedonia vs. Slovak Republic closing well-being gap. However, the two countries’ had throughout the decade roughly equal average output growth and the well-being gap today is still the same as it was ten years ago.

Such observations seem to conflict with existing theoretical views. First, this is a challenge to the well-being convergence concept that results from growth theory. Moreover, if we measure growth in terms of the speed of closing the well-being gap with respect to the frontier (the US economy), one may argue even for divergence. For instance, Figure 1 presents a scatter-plot for a sample of emerging markets relating the initial conditions – well-being level in 1995 (GDP per capita  relative to one of the US economy) – and the average speed of well-being gap (vs. the US economy) closing throughout 1996-2017  (measured in p.p. of corresponding gap ).

Second, the evidence that productivity gains do not automatically trigger output growth challenges a common view that productivity is the major driver for sustainable growth.

Figure 1.Starting Conditions and Well-Being Gains

Source: Own computations based on data from World Development Indicators database (World Bank).

What are possible explanations for the observed similarity in growth rates of emerging markets?

A study by the IMF (2017) suggests a response: growth in emerging markets is similar and synchronous due to the external environment. This study emphasizes the crucial dependence of medium-term growth in developing countries on the following factors: growth of external demand in trade partners, financial conditions, and trade conditions. Moreover, it states that these factors are dominant in explaining the episodes of growth strengthening/weakening.

Does this explanation change the growth nexus for emerging markets? Can one state, that while external factors are crucial for growth and growth in developing countries is rather homogenous, the productivity gains are not so important anymore?

I would say no. First, for better understanding of growth patterns we must clearly compare the relative importance of productivity gains vs. external factors in affecting the growth schedule. Second, we must separate relatively short-term fluctuations in GDP growth from sustainable growth.

Detecting Relative Importance of Growth Drivers

To answer the question about the relative importance of productivity fundamentals and growth factors, I study a panel of 34 emerging market economies (EBRD sample netted from 3 countries for which the data is not available) for 11 years (2007-2017).

To evaluate the relative importance of productivity and external factors, I use a standard approach of running panel growth regressions with fixed effects. At the same time, I make a number of novelties in the research design.

First, for measures of productivity, I engage a unique database – Global Competitiveness Indicators by World Economic Forum (WEF). Although this database provides an insightful perspective on productivity fundamentals at the country level, it is rather seldom a ‘guest’ in economic research. From this database, I extract a number of individual indicators in order to detect which ones among them that have the strongest growth-enhancing effect. For an alternative specification, I use principal components of 9 individual indicators from this database as proxies for productivity gains.

Second, for external factors, I use an approach similar to the IMF (2017) and calculate variables representing external demand growth, trade conditions, and financial conditions (such as a measure of capital inflows) for each country. Moreover, in respect to external demand growth, I use different competing measures (based on either imports of GDP growth of trade partners) and choose the best one in each individual equation. By doing so, I allow this dimension of the external environment to be represented in each model to the largest possible extent.

Third, I depart from using output growth as the only measure of economic growth and response variable in growth regressions. I argue that for international comparison purposes it is worthwhile to consider also the speed of closing the gap towards the frontier (the US economy). On the one hand, this measure is strongly correlated with the traditional output growth rate. On the other hand, this measure, in a sense, nets out the growth rate of a country from global growth, thus capturing something more unique and peculiar just to individual countries’ gains in well-being. Furthermore, I argue that in the discussion about the factors behind growth, one should distinguish between relatively short and long term growth. Annual growth rates, especially at relatively short time horizon, are too dependent on fluctuations, which may be interpreted in terms of growth rate strengthening/weakening. However, to emphasize the property of growth sustainability, we should get rid of ‘unnecessary noise’. For this purpose, I also introduce a trend growth rate measured in a most simple way as the 5 year moving average (following the discussion in Coibion et al. (2017), show that the bulk of measures of ‘potential’ growth are not good enough to get rid of demand shocks and these measures are pretty close to simple moving average measures).

I apply this definition of trend growth both to ‘standard’ GDP growth rate and to the speed of closing the gap towards frontier. So, finally I have 4 response variables: ‘standard’ growth rate, the speed of closing the gap to frontier, and two corresponding measures of trend growth.

Sustainable Growth Mainly Depends on Productivity

Having short-term (annual) growth rate as response variable (either ‘standard’ or the one in terms of closing the gap) provides results close to those in IMF (2017). It may be interpreted in a way that the external environment is more important than productivity factors. If dividing all regressors into two broad groups of factors – external and productivity – the former is responsible for up to 70% of the growth effect, while the latter for about 30%. Among external environment factors, the most important one is financial conditions. Its relative importance is roughly 50% of the group of external factors’ total.

Among productivity fundamentals, an important contributor to short-term growth is the quality of the macroeconomic environment. According to the methodology of WEF (2017), this indicator encompasses the fiscal stance, savings-investment balance, the external position, inflation path, debt issues, etc.

When refocusing from short-term growth to the growth trend as a response variable, the relative importance of the factors behind growth changes. Productivity fundamentals in this case drive up to 80% of growth effect, while external factors are responsible for the remaining 20%. It is worth noting here that the proportion in favor of productivity factors is higher for the concept of closing the gap to frontier rather than for ‘standard’ trend growth rate. This evidence may be interpreted as additional justification for treating this measure of growth as ‘good’ at reflecting individual properties of a country in a global landscape.

Furthermore, the role of individual variables also changes. Among external factors, the most important role in driving sustainable growth belongs to trade conditions and external demand growth, while the role of financial conditions is either miserable or insignificant at most. Among productivity factors as drivers of trend growth, the quality of the macroeconomic environment seems to play a special role, as well as the efficiency of the goods market and the financial system.

Conclusions

The evidence showing rather similar and synchronous growth in emerging markets and recent evidence on the crucial importance of external factors for emerging markets should not lead us to incorrectly believe that productivity fundamentals do not matter anymore. Productivity fundamentals are still the core driver of sustainable growth. At the same time, we should keep in mind the important role of the external environment for emerging markets. However, changes in the external environment are more likely to generate relatively short-term growth rate fluctuations, while having a modest impact on the sustainable growth trajectory. Hence, a country aiming to secure sustainable growth should still first of all think about productivity fundamentals.

References

  • Coibion, O., Gorodnichenko, Y, Ulate, M. (2017). The Cyclical Sensitivity in Estimates of Potential Output, National Bureau of Economic Research, Working Paper No. 23580.
  • EBRD (2017). Transition Report 2017-2018, European Bank for Reconstruction and Development, London, UK.
  • Fayad, G., and Perelli, R. (2014). Growth Surprises and Synchronized Slowdown in Emerging Markets—An Empirical Investigation, IMF Working Paper, WP/14/173.
  • IMF (2017). Roads Less Traveled: Growth in Emerging Markets and Developing Economies in a Complicated External Environment, in IMF World Economic Outlook, April, 2017, pp. 65-120.
  • World Economic Forum (2017). The Global Competitiveness Report 2017-2018, Geneva: World Economic Forum.

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.

Poland’s Road to “High Income Country” Status: Lessons Learnt – Not Only for Other Countries

Posted on March 12, 2018 | Policy Brief

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In this brief we summarize and discuss results presented in a recent World Bank Report focused on Poland’s path from middle to high-income country status. In the period until 2015, Poland’s economic development distinguished itself by its stability and consistency of the implemented reform package, and its inclusive nature. Poland became classified as a high-income country after only 15 years from gaining a middle-income status. At the same time, income inequality remained stable and absolute poverty levels fell significantly. The World Bank Report offers lessons from and insights for Poland, which are discussed from the perspective of the policies implemented by the governments in the last two years.

Poland’s status in the World Bank nomenclature has recently been “upgraded” from being middle to high-income country. While this categorization is only a nominal change, it reflects the country’s economic development over the recent decades and is an important recognition of the success of a wide range of reforms implemented across a broad number of areas. Notably, Poland moved from the middle to high-income status in a period of less than 15 years.

In a book recently published by the World Bank, it is argued that the Polish experiences from the reform process can serve as valuable lessons for countries that are in the process of, or have just embarked upon major socio-economic reforms, as well as for those, who have fallen into the so-called middle-income trap and are looking for solutions to their stagnant economies. At the same time, in comparison to other established high-income countries, there are a number of insights that Poland’s policy makers ought to bear in mind in order to stay on course of the reform process and continued stable growth.

Looking at policies of the recent governments, however, one gets a strong impression that some important insights have been ignored. As rapid population aging looms over the horizon, the lack of necessary adjustments combined with the risks to stability of the political and economic environment might in the medium run have significant implications for Poland’s further development.

The big picture

The key feature of the Polish socio-economic policy approach, over the period covered by the World Bank analysis (i.e. up to 2015), was a unique consistency of a broad direction taken by subsequent administrations. This allowed the reform process to develop without major breaks or U-turns, which ensured the overall stability of the socio-economic environment and provided stable investment prospects. The World Bank highlights the key role of institutions, including rule of law, property rights, and democratic accountability of different levels of government. Basic market institutions, including the respect for rules on price and product regulations, corporate governance and market regulations, as well as foreign trade and investment, have played a crucial role. This framework allowed for continued improvement in the efficiency of resource allocation – including the allocation between sectors of the economy, as well as between and within enterprises.

Crucially, Poland prepared well and took full advantage of the integration with the European Union. The EU accession was first used as a common anchor for stability of the reform process, and after 2004, the European funds became an additional engine of growth. At the macro level, stability of the fiscal framework with limited deficits and public debt were combined with appropriate regulation and supervision of the financial sector, an independent central bank, and close links to global markets.

Shared prosperity

While the above points provided the basis for Poland’s economic development, the Report highlights another unique feature of Poland’s success, namely the degree to which the fruits of the process have been equally shared among different groups of society. The overall income inequality has remained relatively stable, with the Gini coefficient actually falling slightly between 2005 and 2014, from 0.351 to 0.343. Relative income poverty levels remained stable over this period (at about 20%), and the levels of absolute poverty fell significantly. For example, the proportion of the population living on less than $10 per day fell from 51.3% in 2005, to 29.6% in 2014. Growing incomes were primarily driven by increases in labor earnings, but employment growth – in particular among older age groups –also made a contribution. The government’s labor market policy also played a role with a rapid increase in the level of the national minimum wage (NMW), which grew by 65% in real terms between 2005 and 2015, i.e. almost twice as fast as the average wage. While there is evidence that the rapid growth in the NMW had negative effects on employment – in particular among temporary, young, and female workers, these have been relatively modest. Additionally, the tax and benefit policy has contributed to reduced inequality. It has been estimated that nearly half of the reduction in the Gini coefficient, over the period 2005–2014, resulted from reforms of the tax and benefit system (Myck and Najsztub, 2017).

It is clear that human capital was one of the cornerstones of Poland’s success in recent years. Developments on the labor market, such as a rapid productivity growth, were facilitated by a well-educated labor force, which could respond and adjust to the changing conditions and requirements. In this regard, Poland’s advantage in comparison to many other low and middle-income countries has been the relatively high level of spending on public education and healthcare, not only since the start of the economic transformation in the 1990s, but also before that. Indicators, such as the infant mortality rate, were low in Poland already in the 1980s, and have since further improved (see Figure 1). For a long time, public spending on education has been at levels comparable to those in established high-income countries (see Figure 2). Additionally, a series of reforms to the education system since 1990, have resulted in improvements in the quality and coverage of education. This, in turn, has lead to a rapid improvement of scores in language, mathematics, and science in the PISA study (Programme for International Student Assessment), in which Polish students recently outperformed those from many other OECD countries (OECD 2014). Importantly, the improvements in the education results have been found across the socio-economic spectrum, which further stresses the inclusive character of the changes that have taken place.

Figure 1. Infant mortality rate (per 1,000 live births), 1980 and 2014

Notes: Countries grouped in the following manner: red – middle-income countries; blue – new high-income countries; green – established high-income countries. Horizontal lines represent group averages. Source: World Bank (2017), Figure 5.16, based on World Development Indicators.

Figure 2. Government expenditure on education, percent of GDP, 1990

Source: World Bank (2017), Figure 5.11, see notes to Figure 1.

Insights for Poland

“As economies enter the high-income group, weakness in economic institutions such as the rule of law, property rights, and the quality of governance become increasingly important to sustain convergence.”

World Bank (2017)

While the Polish reform experience, over the period examined in the World Bank Report, offers important lessons for other countries aspiring to the high-income status, the authors point out that Poland’s continued development needs to rely on further improvements in a number of key areas. The following policy areas have been highlighted in the Report:

  • Working on more inclusive political and economic institutions and enhancing the rule of law with the focus on the judiciary;
  • Adjustments to fiscal policy in particular to deal with the consequences of population aging;
  • Increasing the domestic level of savings to facilitate large investment needs;
  • Supporting innovation through more intense competition and high quality research education;
  • Improving social assistance programs and access to high quality health and education for low income groups;
  • Increasing the progressivity of the tax system to support inclusive growth;
  • Adjusting migration policies to bring in skills and innovative ideas and compensate for the country’s aging workforce.

“Sustaining Poland’s record of high, stable growth will require adjustments to fiscal policy (…). Government will need to create the fiscal space to deal with the increasing pressures coming from aging, the inevitable decline of EC structural funds for investment, and a more uncertain global context.”

World Bank (2017)

Lessons, insights and recent policies

While several of the Law and Justice majority governments’ policies since 2015 have been well in line with the World Bank recommendations, there have also been a number of questionable policy areas. One major concern seems to relate to the broad background of reforms of the judiciary, which have drawn significant criticism of the European Commission and other international institutions. Implications of such major changes for economic growth are uncertain but potentially very damaging.

Another long-term concern arises from the new pension age reform. From the socio-economic perspective, rapid ageing of the population is one of the main challenges facing the country. Between 2015 and 2030, the number of people aged 65+ will grow from 6.1 million to 8.6 million, i.e. by over 40%. This will put significant strains on the country’s public finances due to increasing public-pension expenditures and growing costs of health and long-term care. These pressures will only be exacerbated by the current government’s decision to lower the statutory retirement age to 60 for women and 65 for men, from the target uniform age of 67 legislated in the reform of 2012. Given the contributions-defined nature of the Polish pension system, this will result in significantly lower levels of pensions, especially among women, and a substantial drain on public finances resulting from lower levels of contributions and taxes.

The generous family benefits of the Family 500+ Program – implemented in 2016 and which cost about 1.3% of the GDP – have also been criticized on a number of grounds. They have undoubtedly changed the financial conditions of numerous families and limited the extent of child poverty. At the same time, they contribute to maintaining low levels of female labor-force participation and there is so far little indication that they have significantly changed Poland’s very low fertility rate. It seems that while the program may have positive long-term consequences resulting from reduced poverty, it is unlikely to shift the demographic dynamics.

Uncertainty also surrounds the consequences of a haphazard major education reform, which is another trademark policy of the Law and Justice party. The reform re-introduced the 8+4 system in place of the post-1999 three-level educational arrangement (6+3+3). The new system takes the number of years of general education back from 9 to 8 years, and instead extends by one year the length of secondary schooling. While the potential effects of such a change are difficult to foresee, the 8+4 system may be in particular disadvantageous to children from rural areas, who are most likely to continue their education in their rural primary schools for the two extra years.

A number of steps taken by the government since late 2015, and in particular those related to the redistributive policies implemented in the last two years, seem to be consistent with the World Bank insights. On the other hand, the approach towards the reforms of the judiciary, the general approach to the rule of law, and the reforms of education and pension regulations, quite clearly appear to ignore not only the insights, but also the lessons resulting from Poland’s own experience of the recent decades. Given the challenge of rapid aging in the Polish population, there seems to be much gained from taking them seriously if the current and future administrations want to ensure Poland’s continued inclusive growth and to secure its status as an established high-income country.

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This policy brief draws heavily on the World Bank (2017) Report: “Lessons from Poland, Insights for Poland: A sustainable and inclusive transition to high-income status” (co-authored by Michal Myck) and the accompanying Working Paper by Myck and Najsztub (2016). Views and opinions expressed in this brief are the sole responsibility of the author and are not endorsed by the World Bank or CenEA.

References

  • Myck, M., and M. Najsztub (2016) “Distributional Consequences of Tax and Benefit Policies in Poland: 2005–2014.” CenEA Microsimulation Report 02/16, Centre for Economic Analysis, Szczecin.
  • OECD (Organisation for Economic Co-operation and Development) (2014) PISA 2012 Results: What Students Know and Can Do—Student Performance in Mathematics, Reading and Science (Volume I: Revised edition, February 2014). Paris: OECD Publishing.
  • World Bank (2017) “Lessons from Poland, Insights for Poland: A sustainable and inclusive transition to high-income status”, The World Bank, Washington.

Stylized Facts from 25 Years of Growth in Transition

Posted on February 26, 2018 | Policy Brief

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This brief summarizes the growth experience of transition countries 25 years after the dissolution of the Soviet Union. We divide our sample into two main groups: the 10 transition countries in Eastern Europe and the Baltics that became EU members in 2004 and 2007 (EU10); and the 12 countries (ex Baltics) that emerge from the Soviet Union (FSU12). The growth experiences of these two groups have been distinctly different. The magnitude of the initial transition decline in output was much more severe in the FSU12 group. Despite growing almost 2 percentage points faster than the average EU10 for the following fifteen years, the FSU12 group is still further behind the EU10 group than they were at the beginning of transition. This illustrates how hard it is for countries to recover from large negative income shocks and thus the importance for countries to avoid such negative events. However, there are no signs of transition countries being stuck in a low or middle-income trap or that natural resource wealth leads to lower growth during this period.

2017 marked the 25-years anniversary after the dissolution of the Soviet Union and the beginning of the transition for the economies in the region. In a recent paper, we explore the growth experience of transition countries over these 25 years (Becker and Olofsgård, 2017). The paper has four main parts: an overview of the transition literature focusing on growth; a part that provides a detailed description of growth in transition; an analytical section that investigate if we can explain growth in transition countries with a standard growth model; and finally an exploration of whether institutional and other variables that have been highlighted in the transition literature (but are excluded from the basic growth model) are correlated with growth in transition countries. This brief summarizes the descriptive part of the paper, while the more analytical sections will be the topic of future briefs.

For most of the paper, we divide our sample into two main groups; the 10 transition countries in Eastern Europe and the Baltics that became EU members in 2004 and 2007 (EU10); and the 12 countries that emerged from the Soviet Union (FSU12). In addition, we include three transition countries that are not part of either group (Croatia, Albania and Macedonia – Other3) and we also divide the FSU12 group into the four countries that export significant amounts of fuel (FSUF) and the eight countries that do not (FSUNF). There are of course remaining differences within these groups, but this aggregate analysis allows us to see certain patterns in the transition process more clearly.

Initial output collapses

The focus in economics is often on how to generate higher growth and not about protecting against significant drops in output. There are some exceptions, including Becker and Mauro (2006) and Cerra and Saxena (2007), where the focus is on output losses and how countries recover after crises. For transition countries, a very important feature of the economic development process is exactly the initial drop in income and the time it has taken countries to recover from the initial phase of transition. Table 1 shows how much income fell in the different country groups and the time it took to get back to the pre-transition income level.

Table 1. Output drops and recoveries

Source: Becker and Olofsgård (2017)

The initial collapse in the FSU12 group was enormous, with income cut in half. The EU10 countries also had massive output losses, but “only” lost a quarter of their income on average. This took over a decade to recover from, while the path back to pre-transition income levels in the average FSU12 country was almost twice as long. There have been many papers written on the economic chaos that was part of the initial transition process, and explanations for this decline has been attributed to, e.g., misleading data, lack of functioning markets, shock therapy and poor economic and legal institutions in general. All of these factors have likely played important roles in the process, but regardless of the explanation, this was a very unfavorable time in terms of economic outcomes for hundreds of millions of people in these countries. Avoiding such costly drops in output should be a top priority for economic policy makers in any country at all times, not just in transition.

From collapse to growth

In most transition countries, the initial phase of decline in transition lasted several years, but eventually the negative growth rates turned positive (Figure 1). Again, we can see that the EU10 group had fewer years of declining incomes with growth resuming in 1993, while for the FSU12 group, growth in transition only started in 1996/7.

Figure 1. Bust-Boom countries

Source: Becker and Olofsgård (2017)

What is less visible in Figure 1 due to the wide scale needed to capture the initial output drops is that the FSU12 groups has shown significantly higher growth than the EU10 group in the last 15 years. Over the more recent period, the average FSU12 country has grown by close to 6 percent, while growth for the EU10 has been around 4 percent per annum (Table 2).

Table 2. Real GDP/cap growth

Source: Becker and Olofsgård (2017)

The faster growth in FSU12 countries is particularly pronounced among the fuel exporters, which were growing by one and a half percentage point faster than the non-fuel exporters between 2000 and 2015. But the table also shows that the very negative growth experience during the first ten years of transition is hard to erase and the EU10 countries have grown faster over the full 25-year period compared to the FSU12 countries. In terms of understanding the growth experience of the different country groups and time periods, it is clear that the sharp increase in international oil prices during the last 15 years of the period generated high growth in the fuel exporting countries in the FSU12 group. Interestingly though, also the non-fuel exporters grew faster than the EU10 in this time period. This is likely linked to spillovers from Russia to the other countries in the region, but could also be related to some recovering after the massive initial declines in output. Such macro and external factors are not always stressed in discussions of growth in transition countries, which more often focus on the pace of reforms or strength of institutions, but seem to be relevant at this aggregate level when comparing the initial and later phases of transition.

Relative incomes in transition countries

Growth or the lack thereof is of importance in determining income levels, which is what we generally think is what influences welfare. The question is then what the growth processes we have analyzed imply for income levels in transition countries, and in particular, how the income levels in these countries compare with other countries.

Figure 2. Income relative to 15 old EU countries

Source: Becker and Olofsgård (2017)

The short story here is that the relative ranking of the different groups is largely unchanged from the start of transition until the end of 2015. The group of countries that eventually joined the EU has the highest income level while the non-fuel exporting FSU countries have the lowest. However, the leading group still only has around 60 percent of the income of the average “old” EU country while the average FSU12 country has half of that or around 30 percent of the income of the old EU countries. This puts the relatively high growth rates of the FSU12 group over the last 15 years in perspective; the road to reach old EU level incomes is long indeed. Also, within the FSU group, it is clear that there is a sharp dividing line between the fuel exporters and the rest. This is in stark contrast to the notion of a “natural resource curse” that is often blamed for poor growth in oil and mineral rich countries.

Growth traps in transition?

One issue that comes up with regards to both low and middle-income countries is if they are stuck at a certain level in the relative income rankings of the world. This is referred to as the low or middle-income trap and the question is if there are signs of transition countries being stuck in such traps.

Figure 3. Moving up the income ladder

Source: Becker and Olofsgård (2017)

Figure 3 shows how transition countries are classified into the World Banks income groups low income (1 in the Figures scale), lower middle income (2), higher middle income (3) and high income (4) groups.

It is clear that the FUS 12 group of countries was sliding down the scale initially, but since the beginning of the 2000’s, all of the transition countries have been climbing up the World Bank income ranking scale without any apparent signs of a low or middle-income trap.

Policy conclusions

There are of course country differences along all the dimensions discussed in this brief but grouping the transition countries together provides some interesting general observations of growth in transition. First of all, it is clear that it is very hard to fully recover from large drops in income. Even with the help of some extra growth following a crisis, it seems to take a long time for most countries to make up for lost ground. This suggests that policy makers in transition as well as other countries need to take measures to hedge the really bad outcomes and not only focus on how to generate an extra one percent of growth.

The other observation is that at the aggregate level, external factors and more mechanical macro boom-bust-boom type of growth factors may dominate what we generally think of as the long-run determinants of growth (such as institutions, education, and micro level reforms to make markets work better) over very long time spans. This does not mean that the focus on the more fundamental growth drivers should diminish, but it is important that reforms in these areas are complemented with a macroeconomic framework that reduces the risks of costly output collapses.

Finally, it is clear that the incomes generated by natural resources can produce growth at the macro level and that there is little evidence that transition countries should be stuck at any particular level in the global income rankings. Go transition countries!

References

  • Becker, T, and A. Olofsgård (2017), “From abnormal to normal—Two tales of growth from 25 years of transition”, SITE Working paper 43, September.
  • Becker, T., and P. Mauro, (2006). “Output Drops and the Shocks That Matter”. IMF Working Papers 06/172.
  • Cerra, V., and S.C. Saxena (2008). ”Growth Dynamics: The Myth of Economic Recovery”. American Economic Review, 98(1), 439–457.

Ethnic Networks in Ex-USSR

Posted on November 6, 2017 | Policy Brief

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Do ethnic networks facilitate international trade when formal institutions are weak? Using data collected by ethnologists on the share of ethnic groups across countries, this study assesses the effect of ethnic networks on bilateral trade across the sphere of the former Soviet Union. This region provides a perfect setting to test for this effect as both forced re-settlement of entire ethnic groups during the Stalin era and artificially drawn borders in Central Asia led to an exogenous ethnic composition within countries. While ethnic networks do not seem to have played a role in inter-republic trade during the Soviet Union, they did facilitate trade in the years following the collapse of the Soviet Union, a transitional period when formal institutions were weak. This effect, however, eroded steadily from the early 2000s.

Economists and historians alike study the role of ethnic networks in international trade. Some prominent examples are the Greek commercial diaspora of the Black Sea in the 19th century (Loannides and Minoglou, 2005), the Maghribi traders in 11th-century North Africa (Greif, 1993), or the overseas Chinese all around the world in the last decades (Rauch and Trindade, 2002). Such networks facilitate trade by building trust relationships, enforcing contractual agreements in weak legal environments, matching buyers with faraway sellers that speak different languages, and by exchanging information on arbitrage opportunities.

In “Ethnic Minorities and Trade: The Soviet Union as a Natural Experiment”, forthcoming in The World Economy, we study the Soviet Union (USSR) to assess the role of ethnic networks in international trade. We argue that ex-USSR countries are particularly well suited for such a study. Indeed, the ethnic diversity of ex-USSR countries is exogenous, partly due to the creation of artificial borders cutting through ethnic homelands, and partly due to forced relocations (deportations) during the Stalin era, which brought ethnic groups to various remote regions of the USSR. This exogeneity adds power to our empirical strategy.

Ethnic Networks in the USSR

We first build a measure of ethnic networks based on the size of common ethnic groups using ethnologists’ data from the Ethnic Power Relations Dataset on the resulting ethnic groups across ex-USSR countries (Vogt et al., 2015; Bormann et al., Forthcoming). It covers all ethnic groups in every country of the world from 1946 to 2013. While there is some yearly variation in the data, we focus on the cross-section average for the pre-1991 period as per our identification strategy based on exogenous distributions.

Figure 1 gives an overview of the spatial distribution of ethnic groups, such as Russian, Kazakh, or Uzbek.

Figure 1. Ethnic Groups in the USSR

Source: Authors’ own ArcGIS mapping based on the EPR-ED dataset.

Russians are ubiquitous across the Soviet sphere. Countries with the largest ethnic Russian populations are Kazakhstan, Estonia, Latvia and Moldova. At the same time, Russia is very diverse. Almost all of the 60 ex-USSR ethnic groups are present in Russia, and ethnic Russians account for only 62% of the population. Most countries are ethnically diverse. Kazakhstan for example is home to Russians as well as Germans, Tatars, Ukrainians, Uzbeks and Uighurs.

From the information on ethnic populations within each country, we create an ethnic network index as the sum of products of common ethnic groups as a share of the country’s population. Figure 2 presents a matrix overview of the ethnic network index among country pairs with darker shades corresponding to higher scores. Some high scoring country pairs are Russia—Kazakhstan, Ukraine—Russia, Uzbekistan—Tajikistan, Kyrgyzstan—Uzbekistan, Latvia—Kazakhstan, and Ukraine—Kazakhstan.

Figure 2. Ethnic Networks Index

Source: Authors’ estimates. The index is the sum of products of common ethnicities as a share of the country’s population.

Effect of Ethnic Networks on Bilateral Trade in the USSR

Next, we evaluate the impact of ethnic networks on aggregate trade between the countries of the former Soviet sphere. We use trade data from two sources. First, the data on internal trade between Soviet republics from 1987 to 1991 are from the input-output tables of each Soviet Union republic as compiled by the World Bank mission to the Commonwealth of Independent States (Belkindas and Ivanova, 1995). Second, the Post-1991 to 2009 trade data are from the Correlates of War Project (Barbieri et al., 2009, 2016), which offers the best coverage of the trade in the region.

We follow the migrant network and trade literature and estimate a standard log-linear gravity equation controlling for importer-year and exporter-year fixed effects (Anderson and van Wincoop, 2003).

Figure 3 presents the results on the effect of ethnic networks on trade over time. We observe that there is no effect in the period before the end of the USSR, a positive effect after the breakup of the Soviet Union, and an erosion of this effect from 2000s on (omitting Russia from the sample does not alter the results).

These results can be explained with the fact that in the Soviet Union ethnic ties did not matter as official production and trade were centrally planned by the State Planning Committee, Gosplan, and by State Supplies of the USSR, or Gossnab, which was in charge of allocating producer goods to enterprises. Free trade was forbidden. However, once the Soviet system collapsed and before countries could establish more formal trade ties, the first reaction and fallback option for many people was to reach out to their co-ethnics (in the 1990s) to substitute for the broken chains of the centrally planned trade (Gokmen, 2017). The other reason is that the institutional framework was at its weakest in this transitional period, and hence, reliance on informal institutions such as ethnic networks may have been especially strong (Greif, 1993). Once systematic and formal trade ties could be established, more and more traders no longer had to rely on their ethnic networks and this could explain the decline in the effect in the 2000s.

Figure 3. The Effect of Ethnic Networks on Trade over Time

Source: Authors’ estimates. Estimate of the effect of ethnic networks on bilateral trade in a gravity model controlling for distance, contiguity, and importer and exporter fixed effects.

Conclusion

This study shows that ethnic minorities played a role in shaping trade patterns across ex-USSR countries, but only in the early years following the collapse of the Soviet Union. Thus, we argue that reliance on informal institutions, such as ethnic networks, in forming trade relations is especially strong when the institutional framework is at its weakest in the transition period. This message may hold, not only for transition countries, but also for other developing countries with poor institutions.

References

  • Anderson, J. E. and E. van Wincoop, 2003. “Gravity with Gravitas: A Solution to the Border Puzzle,” American Economic Review, 93, 170-192.
  • Barbieri, K., M. G. Omar, and O. Keshk, 2016. “Correlates of War Project Trade Data Set Codebook, Version 4.0.”
  • Barbieri, K., M. G. Omar, O. Keshk, and B. Pollins, 2009. “TRADING DATA: Evaluating our Assumptions and Coding Rules,” Conflict Management and Peace Science, 26, 471-491.
  • Belkindas, M. and O. Ivanova, 1995. “Foreign Trade Statistics in the USSR and Successor States,” Tech. rep., The World Bank, Washington, DC.
  • Bormann, N. C., L. E. Cederman, and M. Vogt, Forthcoming. “Language, Religion, and Ethnic Civil War,” Journal of Conflict Resolution.
  • Gokmen, G., 2017. “Clash of civilizations and the impact of cultural differences on trade,” Journal of Development Economics, 127, 449-458.
  • Gokmen, Gunes; Elena Nickishina; and Pierre-Louis Vezina, forthcoming. “Ethnic Minorities and Trade: The Soviet Union as a Natural Experiment”, The World Economy.
  • Greif, A., 1993. “Contract enforceability and economic institutions in early trade: The Maghribi traders’ coalition”, The American Economic Review, 525-548.
  • Loannides, S.; and I. P. Minoglou, 2005. “Diaspora Entrepreneurship between History and Theory”, London: Palgrave Macmillan UK, 163-189.
  • Rauch, J. E. and V. Trindade, 2002. “Ethnic Chinese networks in international trade”, Review of Economics and Statistics, 84, 116-130.
  • Vogt, M., N. C. Bormann, S. Regger, L. E. Cederman, P. Hunziker, and L. Girardin, 2015. “Integrating Data on Ethnicity, Geography, and Conflict: The Ethnic Power Relations Dataset Family,” Journal of Conflict Resolution, 1327-1342.

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Traces of Transition: Unfinished Business 25 Years Down the Road?

Posted on June 13, 2016 | Policy Brief

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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.

Conclusion

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.