Throughout the course of 1998 governments, policy makers and analysts
have been struggling to keep up with and adjust to the consequences of the financial
crisis which started in South-East Asia in July 1997 and has since been extended and
amplified by prolonged recession in Japan and financial collapse in Russia. What was at
first diagnosed as a serious regional upset with few, or at least easily manageable,
implications for the rest of the world, has developed into a global and economic crisis
which is now affecting the prospects for real economic growth in all parts of the global
economy. Although the impact of the crisis varies considerably between individual
economies, there are no islands of immunity to the effects of global financial turmoil.
Although relative calm has returned to the financial markets since early October, and
hopes that a further deterioration in the world economy can be avoided have been
strengthened by interest rate cuts, especially in the United States, and by the explicit
recognition by the Group of Seven countries in late October of the risks of deflation and
global recession, the uncertainties and downside risks surrounding the outlook for 1999
remain considerable.
The optimistic forecasts of a year or so ago have been steadily and
significantly lowered during 1998 as it became clear that the crisis would be deeper and
longer than originally assumed. The IMF's forecasts for world economic growth in 1998 were
lowered from 4 3 per cent in October 1997 to 2 per cent in October 1998 and
its forecast for 1999 was cut from 3.7 per cent in May 1998 to 2.5 per cent in October;
the OECD's forecast for aggregate GDP growth in its member countries in 1998 and 1999 was
lowered from 2.9 and 2.6 per cent in December 1997 to 2.4 and 2.5 per cent, respectively,
in June 1998 - and in November these were reduced again, to 2.2 and 1.7 per cent; and the
Commission of the European Communities has lowered its forecast for the European Union in
1999 from an average 3.1 per cent in October 1997 to 2.4 per cent in October 1998. In the
last month or so official national forecasts have been revised downwards, not least in the
transition economies of eastern Europe where the adjustments largely reflect re-evaluation
of the prospects in western Europe.
The rapidly changing economic outlook underlines how difficult it is to
make reliable forecasts in turbulent times. The standard forecasting models, which have a
major influence on the stance of economic policy, have always had difficulties in
identifying turning points in the real economy, but these problems have been intensified
by important structural changes which have occurred in the world economy and which for the
most part are poorly reflected, if at all, in the structures of the models themselves. One
of the most important of these changes in the world economy has been the wholesale
liberalization of capital movements. At first only the advantages of such a process tended
to be emphasized: their capacity to channel global savings to where returns were highest
(for a given level of risk) and thus to promote growth and development where it was most
urgently needed. What has only been gradually realized in many policy-making circles,
often with some reluctance, is that unrestricted capital flows, particularly of short-term
capital, also have the capacity to provoke financial crises which, because they can be
quickly propagated in an interdependent world economy, can be highly disruptive of real
economic activity across the globe. At first, there was a tendency to blame the crises in
South-East Asia solely on internal weaknesses in these economies, such as poor regulatory
regimes, weak systems of corporate governance, and a general lack of transparency in their
financial and banking sectors. Similar charges have been made in the case of Russia. The
question is not whether such deficiencies exist - they probably do - or whether it is
beneficial to remove them - certainly it is - but whether they played a significant role
in causing the crisis. This is by no means clear: most of the institutional and economic
problems of these economies are well-known and of long-standing; it is inconceivable that
foreign investors, with highly-paid advisers and advanced information gathering resources
at their disposal, were not aware of them when placing their funds. Moreover, warnings
about the accumulation of foreign short-term liabilities to dangerous levels in South-East
Asia were being made a year before the crisis by the Bank for International Settlements.
Since the collapse in the United States of the LTCM hedge fund in
September there has been markedly less discussion of crony-capitalism, the lack of
transparency, and so on, in emerging markets as causes of the crisis. Instead, more
concern is being expressed about the inherent volatility of the global capital markets and
their susceptibility to herd behaviour, panics, and "fear-induced psychological"
responses (in the words of the Chairman of the United States Federal Reserve). This
concern is reflected in the emerging debate over proposals for a new
"architecture" for regulating the global economy and responding to crises and,
more narrowly, by increasing acceptance of the idea that, in certain circumstances, resort
to controls on short-term capital movements - or, where they are still in place, a more
cautious and gradual rate of liberalization - may be justified to preserve domestic
economic stability.
These developments also point to departures from the standard framework
of economic thinking, the "paradigm", that has shaped economic policy making in
the G-7 countries and many others for most of the past two decades. Included in that
framework was the view that financial factors have little or no effect on the underlying
performance of the real economy; instead, the "fundamentals" are assumed to be
determined essentially by the structure of the economy and so structural reform is the
only way to improve the underlying growth of the real economy and, for example, to achieve
lower rates of unemployment. The alternative view - which is not new but rather returning
to favour - is that the behaviour of financial markets can have very significant effects
on the real economy and its long-run performance. The volatility of financial markets and
its rapid transmission (contagion) through interdependent economies increases risk and
raises the cost of capital, thus depressing fixed investment and growth. Moreover, the
scope for individual governments to use macroeconomic policy to support objectives such as
higher growth and lower unemployment is severely curtailed by the threat of capital
outflows which tend to respond to a narrow range of short-term financial and monetary
indicators. Consequently, macroeconomic stances tend to be dominated by interest rate
policy which in turn has led to higher and more volatile short-term interest rates, which
again are damaging for fixed investment and for growth. Transition economies that might
wish to run a current account deficit over an extended period as part of a general
strategy of "catching-up" with western levels of GDP per head, may in fact have
to settle for medium-term growth rates below what are feasible if they are to avoid being
destabilized by volatile capital movements.(1) These
debates about macroeconomic policy and reform of the international monetary system are
particularly important because they introduce another element of uncertainty into the
present economic outlook, namely, over the intellectual framework which shapes the policy
responses to economic imbalances. The tensions thrown up by this questioning of the
prevailing paradigm are nowhere greater than in western Europe where the governments of
the largest economies in the European Union have declared their intention to give greater
priority to growth and the reduction of unemployment while the newly created and
independent European Central Bank (ECB) has only a single objective, namely, to keep
inflation at below 2 per cent.(2) The actual risk of a
serious conflict between EU governments and the ECB is likely to depend on whether the
present cyclical upturn can quickly regain the momentum it has lost during 1998.
The economic performance of the ECE member countries - that is, the
whole of Europe, Russia and the other members of the CIS, as well as North America - is
likely to vary considerably in any circumstances but this is particularly the case in 1998
despite the global nature of the financial and economic crisis. The impact of falling
demand for exports and of instability in financial markets will depend on a range of
factors including each country's position in the business cycle, whether the growth rate
is picking up or falling, the size of its trade with the countries directly affected by
crisis, its openness to global capital markets; and the exposure of its banking and
financial sectors to losses abroad.
It is still very difficult to judge the likely, combined impact of the
Asian and Russian crises on the economies of the rest of the ECE region, in part of course
because the Russian default occurred in the second half of 1998 for which there are still
very few published data available. The negative trade effects have been increasingly felt
in the United States and western Europe during the year, especially in the former, and
these have in general been somewhat greater than expected. Nevertheless, on both sides of
the Atlantic growth has remained fairly strong in 1998 although its deceleration during
the year points to a significant slowdown in 1999, from 3.4 to 2 per cent in the United
States and from 2.8 to 2.2 per cent in both western Europe as a whole (21 countries) and
in the European Union. In the United States the negative effects of falling net exports
and reduced stockbuilding in 1998 were largely offset by the continued buoyancy of private
consumption and fixed investment. The latter are both expected to weaken in 1999. There is
still a risk of a sudden cut in consumer spending in the United States which has been
boosted by a drop in the household savings rate to virtually zero and by large-scale
borrowing supported by the increase in stock market wealth. An eventual sharp fall in
equity prices, combined with a weaker labour market, could lead to a much more pronounced
weakening of domestic demand than currently forecast.
In western Europe, the growth of industrial production was slowing down
in the first half of 1998 and capacity utilization rates started to fall, also affected by
the slowdown in export growth. Surveys of industrial and consumer confidence show them
both to have been weakening during the year with a particularly sharp deterioration of
industrial confidence in the autumn. Stock levels have also risen in recent months and
there is a generally more pessimistic assessment of order books and export prospects. It
should be emphasized that there are still large differences among the west European
countries in terms of growth rates and their relative position in the cycle. Nevertheless,
the two key economies as far as growth in 1999 is concerned are France and Germany, and in
both of these there is a clear weakening of the forces for cyclical recovery. Even with
the present outlook, of west European growth of 2.2 per cent in 1999, there is unlikely to
be any significant improvement in the average unemployment rate of around 10 per cent in
the EU or just over 11 per cent in the EMU area. A more severe slowdown will risk
reversing the small gains of the last few years and increasing the tensions, noted above,
among those responsible for macroeconomic policy.
At present there is no problem of inflation in the western market
economies. Despite the long period of sustained growth in the United States, the
year-on-year rate of increase in consumer prices is still running below 2 per cent and was
1.6 per cent in the third quarter. Inflation is similarly below 2 per cent in western
Europe, and in the EMU countries was under 1.5 per cent in the third quarter, with France
and Germany both under 1 per cent. It is difficult to see why there should be any
significant change in this low-inflationary environment. The inflationary expectations of
wage earners and producers have clearly changed since their experience of the high
inflation rates of the 1970s and 1980s, and there have been major changes in the world
economy which tend to reinforce those lower expectations. The removal of barriers to
international trade and capital movements, the privatization of state enterprises, the
breakup of national monopolies by technological change in industries such as
telecommunications, as well as new sources of supply in Asia, Latin America and eastern
Europe, have all contributed to a marked intensification of international competition. The
investment led expansions in the United States and Asia have contributed to global
overcapacity in many industries - as evidenced by the growing demands for protection by
western producers of steel, computer chips, automobiles, textiles, etc. - leading to
falling profitability and the increasing risk of falling prices. In addition, primary
commodity prices, including energy, are still falling or remain very weak and most
forecasters see little prospect of a rapid recovery in the next two to three years. Faced
with the prospect of a premature cyclical slowdown, it is hardly surprising that European
Union governments see unemployment as the major economic and social problem in Europe and
are planning to coordinate their economic and employment policies in order to stimulate
growth in the Union.(3)
Economic performance in the transition economies has continued to be
highly variegated and the shocks from Asia and Russia have also had a wide-ranging but
variable impact on individual economies. Most of the east European and Baltic economies
appeared by mid-year to have weathered the effects of the Asian crisis quite well with
relatively little contagion from the world financial markets. In the first half of 1998
economic growth was relatively strong with an average 3.5 per cent in eastern Europe
(rather better than 1997) and 7.1 per cent in the Baltic states (slightly less than in
1997). For 1998 as a whole, average rates of some 3 and 6 per cent respectively would seem
to be in sight, provided there are no serious setbacks in the second half. However, as in
western Europe, there seems to have been a slowing down of east European growth after the
first quarter. In the second quarter this already appears to have been due, at least in
part, to the situation in Russia. Although the importance of Russia in total east European
exports is now relatively small (mostly some 3 to 8 per cent) and total CIS is somewhat
larger (some 5 to 14 per cent), it is frequently concentrated in a few industries (such as
food and light industrial products) or in certain border areas where the impact of the
crisis on economic activity and employment is already significant. The impact on the
Baltic economies will be much greater since their exports to Russia and the CIS amount to
some 15 to 21 per cent and 23 to 43 per cent, respectively, of total exports. A number of
governments (the Baltic states, Hungary and Poland for example) are proposing to try to
preserve their trade with Russia and the CIS by resorting to alternative means of
settlement, such as barter, state-to-state sales, etc. The situation will almost certainly
have worsened in the third quarter and estimates for the year as a whole suggest that
exports to Russia could fall by an order of magnitude of some 20 to 25 per cent.
Although the influence of the Russian factor on eastern Europe is
perhaps rather more important than would appear from just a consideration of export
shares, the major concern of the east European and Baltic countries is with the prospects
for growth in western Europe, and particularly the European Union. Hungary now sells over
70 per cent of its exports to the EU; for the Czech Republic, Poland, Romania and Slovenia
the shares of the Union are close to two thirds, and for most of the other countries it is
around 50 per cent. Thus any setbacks to the growth of import demand in the EU could have
serious effects on the outlook for eastern Europe. Indeed, there already appears to have
been some slackening in the growth of east European exports to the western market
economies in the second quarter of 1998 which accelerated in the third quarter. In this
context it is very important to ensure that proposals to ship large amounts of food aid
from the EU and the United States to Russia this winter (see box 1.1.1 on humanitarian aid to Russia) are not implemented in such a way as to weaken further east
European and Baltic exports to Russia. From the point of view of maintaining economic
stability in the region, it might be more efficient for the EU to finance shipments from
east European and Baltic producers.(4)
In general, trade and current account balances have tended to
deteriorate in 1998, although the deficits of the Czech Republic and Poland fell more than
expected. In relation to GDP, current account deficits are very large in Slovakia,
Croatia, The former Yugoslav Republic of Macedonia and Lithuania (10 to just over 12 per
cent), over 7 per cent in Estonia and Latvia and for most of the other east European
economies they are in the range of 31/2-4 per cent. Apart from some of the south-east
European economies, most of the transition economies have been able so far to finance
these deficits without much difficulty.(5) The impact of
the Asian crisis on the flow of capital into eastern Europe seems so far to have been
relatively minor: the inflow of some $16.3 billion in the first half of 1998 was actually
larger than a year earlier (and larger than in the second half of 1997), and within this
total foreign direct investment accounted on average for just under 30 per cent. Foreign
capital inflows also held up in the Baltic states, with a slightly higher proportion of
FDI. However, most of the direct and indirect impact of the Russian crisis will only begin
to affect the current accounts in the second half of 1998 - when the data become available
they may very well show a deterioration. Moreover, whether current account deficits will
continue to be financed easily in 1999 is open to question. Since the Russian debt crisis
in August the costs of international finance rose sharply for all the transition economies
and although they have since fallen back from their levels in the immediate aftermath of
the crisis, they still remain higher than in 1997. Some transition economies have had
their credit ratings downgraded, which will add to the costs of borrowing, while others
with severe structural problems and continuing uncertainty over the direction of their
reforms will continue to have difficulty in accessing the foreign capital markets at all.
Although there will be some exceptions, many transition economies are likely to face
increasing difficulties in financing current account deficits at their present levels,
which implies a tighter balance of payments constraint on their economic growth. Their
vulnerability to renewed turmoil in the world financial markets is also underlined by the
fact that the share of short-term capital in the financing of deficits rose sharply in the
first half of 1998, from 35 per cent in 1997 to 58 per cent.
Many governments are hoping that inflows of FDI will be maintained and
continue to provide an important source of current account financing. Although the inflow
was more or less maintained in the first half of 1998, it was mostly concentrated in
Poland and a small number of other transition economies: in Russia the inflow was
virtually halved. FDI is influenced by factors in its countries of origin - overall
profitability, the prospects for growth, etc. - as well as those in the host countries. A
major determinant of FDI in the transition economies in the last eight years has been the
pace and scale of privatization programmes. These have already fallen behind schedule in
many countries of south-east Europe and the CIS where the general environment for
investment has generally deteriorated; but where they are going ahead asset valuations
have been cut substantially, even for certain prime investments in countries with
relatively strong economies. Large investments, such as car plants, and those already in
the pipeline are unlikely to be curtailed, but smaller investments and those still on the
drawing board are likely to be delayed until the economic outlook becomes less uncertain.
On balance, an increase in FDI into the transition economies looks unlikely and instead
there may very well be a falling off in the rate of inflow seen in the last two years.
One of the more disturbing aspects of developments in central and
eastern Europe is the growing divide between the group of so-called leading reformers -
those where institutional and market reforms are well advanced, economic growth is
relatively high and sustained, and most of which are in the first wave of applicants for
EU membership - and a group, mainly in south-east Europe, where a coherent programme of
reforms has proved much more difficult to design and implement, which in turn has made it
more difficult to achieve an improved macroeconomic performance. In fact, data on recent
developments in this group of countries is often scarce or contradictory, or both. In
Bulgaria it is difficult to determine whether or not a recovery is underway from the slump
of 1997; in The former Yugoslav Republic of Macedonia the economy remains weak and will be
further affected by the tightening of policy in Yugoslavia; the Yugoslav economy is beset
by chronic external and fiscal deficits, with reduced prospects of financing, an
incoherent mix of macroeconomic policies, and by the reimposition of sanctions in the wake
of events in Kosovo, which have also made the government's finances even more precarious
than before; in Bosnia and Herzegovina a relatively high growth of output is reported, but
as this is essentially a partial recovery from the catastrophic levels to which it had
sunk as the result of armed conflict it indicates very little about the prospects for
sustained improvement. The statistical picture is at least clearer in Romania and it
points to a considerable deterioration in the economy in 1998. Domestic demand remains
very depressed, industrial output collapsed in the first half of the year, and GDP is
likely to fall by at least 4 per cent in 1998 as a whole. At the same time little progress
has been made in reducing the government's budget deficit.
The problems facing the south-eastern economies are complex and to some
extent interrelated. The regional economy has been destabilized by the breakup of the
former SFR of Yugoslavia and the wars in Croatia and Bosnia and Herzegovina, and
uncertainty has been maintained not least by the tension in Kosovo. Regional trading links
have been broken and there are now many barriers to their restoration, a factor which adds
to the discentives for significant FDI to enter the region. This group of countries
already finds it difficult to finance current account deficits and it is likely to become
more so for the reasons mentioned above. Many commentators are often tempted to blame the
lack of significant progress in these economies on a "lack of political will",
but this fails to take into account the very severe structural and institutional problems
they are facing. As in Russia, the scale of restructuring required, for example in
eliminating non-viable enterprises, is simply so large that the adjustment problems are
likely to generate widespread resistance and to paralyse policy making rather than
stimulate it. The situation is made all the more difficult by the lack of the appropriate
institutional structures required both to support the market economy and to handle the
social costs of economic change. All of these economies will require large amounts of
investment in order to restructure their economies and lay the basis for sustained growth,
and a great part of this will have to come from abroad. But the latter is unlikely to be
forthcoming without significant progress in institution building (for market-based
activity) and improved security in the region. As is suggested below in the case of
Russia, perhaps the only way out of such an impasse is to combine a detailed, coherent and
carefully sequenced programme of institutional reform and economic restructuring,
stretching over a period of, say, some 5-8 years, with a commitment of large-scale
financial and technical assistance from the G-7 countries and, especially, from the
European Union. Without substantial support from outside, the national authorities will
find it very difficult to create the "breathing space" and the political support
required to implement such a programme; but without a carefully designed programme and a
broad measure of popular domestic support, foreign assistance is unlikely to be
forthcoming. The symbiosis between the two elements implies that a strong political
initiative has to come from somewhere; given the fragile economic and social situation in
these countries, this will probably have to come from the leading economic powers in
western Europe out of an interest in overall regional stability.
The economies of the CIS have been subject, in varying degrees, to two
major shocks over the last year or so: the collapse in demand and prices for primary
commodity prices following the Asian crisis, and the repercussions of the Russian crisis
in August. Among the European members of the CIS, there had been hopes that, despite the
relatively fragile state of their economies, there would be some improvement in 1998 - a
return to growth in Ukraine and an improvement on the modest recovery in 1997 in the
Republic of Moldova. In both cases the combination of internal fragility and the
disruption of trade with Russia have disappointed those hopes - in both countries GDP is
likely to fall in 1998 as a whole and it is possible that the decline could continue into
1999 as well. In Belarus the official statistics give a deceptive picture of economic
recovery, but this is largely the result of an expansion of cheap credit and disregard for
increasing internal and external imbalances which, at some point, will require a major
correction. All three economies, however, have similar structural and institutional
problems to those in Russia and essentially the Russian crisis has simply brought them to
the fore rather than being the fundamental cause of the current deterioration.
The central Asian members of the CIS are predominantly primary
commodity exporters and, as such, have been seriously affected by the collapse in
commodity prices. In all five countries the value of their exports fell in the first half
of 1998, and by considerable amounts in Tajikistan and, especially, Turkmenistan. Apart
from falling demand for their exports, trade in the first half was also probably being
affected by payments difficulties in their trade with Russia. The impact of these external
shocks on domestic demand and output is difficult to judge as the limited data available
are not always consistent in the picture they present. For the first half of 1998 the
official statistics still show rates of growth of between 2 and 5 per cent, but the
outcomes for the year as a whole are likely to be significantly lower. Of all the CIS, the
three Caucasian economies appear to have suffered least from the Russian crisis. Growth
rates in the first half of the year were sustained, particularly in Azerbaijan where the
economy is benefiting from extensive investments in the oil and related industries.
Although the future of commodity prices, especially for oil, is an
important element of the future outlook for the CIS economies, the most important single
factor still concerns the stability and longer-run development of the Russian economy.
After a brief interlude in 1997 the long-term decline in Russian output resumed in the
second quarter of 1998 and accelerated after the August devaluation of the rouble. The
crisis in Russia hangs over the discussion of the transition economies in much of this Survey and it is discussed at some length in the next chapter. Although the immediate cause of
the crisis in August was the government's chronic fiscal imbalance, the more fundamental
causes are to be found deeply rooted in the structure of the economy, in the institutional
environment, and in the political process. The argument made in this Survey is that
in this highly deficient structural and institutional environment, and given the limited
set of policy instruments available to the Russian government, a sustainable degree of
stabilization was not only impossible but that attempts to achieve it with standard policy
prescriptions led to perverse responses on the part of enterprises and banks which made
the situation even worse. Since, as noted above, there are also a number of other
transition economies which share several of the basic problems existing in Russia it is
important to try to draw some policy lessons from the Russian crisis in order to suggest
ways of preventing a similar transformation crisis emerging elsewhere.
The short-term prospects for the transition economies are both very
varied and very uncertain. The variation is between economies which are still struggling
to implement a coherent programme of reforms and get economic recovery underway - much of
south-east Europe, Russia and the European CIS - and those where reforms are well advanced
and economic growth is re-established. In the former group their prospects depend heavily
on combining a reform programme with increased assistance from abroad; while in the latter
they are more dependent on maintaining the growth of their exports to the European Union
and being able to finance their current account deficits at levels which do not constrain
their growth rates. The current official forecasts for eastern Europe and the Baltic
states imply average rates of GDP growth in 1999 of some 4 per cent and 6 per cent,
respectively, slightly better in fact than the average rates in 1998. But these forecasts
may be too optimistic about west European growth: east European exports (and industrial
output) appear to have been slowing down already in the third quarter of 1998 and if this
continues their economic growth in 1999 could be significantly weaker than currently
expected.
The fragility of the transition process in much of eastern Europe and
the European CIS, and the uncertain outlook for growth in the stronger economies, puts
considerable weight - and responsibility - on economic development and policies in the
European Union as the region's major economic power. The present outlook for western
Europe in 1999 - an average increase in GDP of some 21/4 per cent - is already causing
concern about the prospects for unemployment, and most of the uncertainty points to
downward rather than upward revisions to this forecast.(6) Adjusting policies to aim for higher rates of growth is therefore desirable not only for
western Europe but also for stability in the central and eastern parts of the region as
well. It is also vitally important for the authorities in the EU to resist pressures for
increased protection, especially under the guise of complaints against dumping, and to
avoid any other actions that might, inadvertently, damage the exports of the transition
economies.
1.2
Policy lessons from the Russian crisis
Over the past decade it has become commonplace to claim that Russian
reform was "at a crossroads" or a turning point.(7) Today, it is clear that Russia finds itself in a cul-de-sac.(8) There is very little point, therefore, in telling the country's policy makers to keep
going forward "on course", which is the standard advice from abroad. No matter
how blame is apportioned for the situation, the reality is that the course that has been
followed so far has led precisely to this unpromising point. A fundamental reappraisal is
necessary.
The 17 August announcement of the Russian government and central bank,
of an effective default and devaluation, was a declaration that a three-year strategy of
juggling an unsustainable fiscal position with a tight monetary policy and a stable
exchange rate regime had come to an unproductive end.(9) The instrument which had borne the main burden of this strategy, the continued placement
of rouble denominated Treasury bills (GKOs) of short maturity, had exhausted its capacity
for papering over the cracks. There was no longer any yield on this debt which could
persuade investors to roll over existing commitments. Higher, and apparently more
attractive returns, by increasing the dramatically rising cost of servicing the debt,
could only reinforce the conviction of potential investors, resident and non-resident,
that the situation was not sustainable, even in the very short run.
The Russian state's inability to rectify its major fiscal imbalance is
thus indisputably at the heart of its crisis. The contentious and unresolved issue,
however, is why the fiscal situation has proved so intractable. The most common answer
today is that, quite simply, political will was absent.(10) This, however, remains too superficial a diagnosis to be useful for policy. It needs to be
asked why Russian political will for fiscal discipline and structural reform has
been so much weaker than, for example, in Poland and Hungary. The analysis presented in
this, and earlier, Surveys, proposes a rather different answer: political will is
not determined exogenously but has been weak, largely because the initial conditions were
so daunting.(11)
This issue of the Survey argues, in chapter 2, that the Russian
fiscal dilemma was made progressively more, not less, acute by the policy mix adopted in
1995. All sides saw the initial narrowing of the fiscal gap through debt financing as a
measure to buy time for adjustment, but the conventional wisdom is now that this time was
simply wasted.(12) Whilst there is much to be criticized
in the conduct of Russian debt policy, this summary dismissal from abroad fails to
acknowledge the actual dynamics of the particular stabilization recipe, and its increasing
(not decreasing) pathological effects. The perverse incentives generated by macroeconomic
policy were, moreover, magnified by the deeply flawed privatization process.
Given the profoundly inappropriate character of so much of the Russian
institutional infrastructure for the new market environment, and the added operational
incapacity of the state itself,(13) disinflation turned
out to be a more easily achievable goal, given the operative policy levers actually
available to policy makers. The success in reducing inflation, in one key sense, was
unfortunate, in that it distracted much policy attention from other key problems. When
other, more difficult goals, in areas such as the reform of the social safety net, the
development of local government, or the creation of an anti-monopoly policy, proved
unattainable, ever lower inflation targets were effectively seen as some sort of
trade-off.
This set in train a series of interlocking, policy-induced pernicious
circles. The increasingly excessive emphasis on price stabilization necessitated
increasing monetary austerity. The commitment to what became, in effect (from July 1995)
an exchange rate anchor, involved a further policy commitment to high interest rates. To
help complete this particular vicious circle, the higher interest rates raised the cost of
debt service, and thus increased the fiscal burden. This process ruled out a return to
growth, and fixed investment has continued to fall throughout the entire period. Whilst
there is little doubt that there has been concealment of corporate profits, particularly
in light of the continued complex and arbitrary tax structures, corporate profits have
actually fallen. Enterprises and regions increasingly resort to barter, further extending
the demonetization of the economy. All this, of course, has continued to shrink the tax
base. In sum, the chosen policy has made even the fiscal problem worse.
The issue of non-payment of taxes by the important energy sector
further reveals the unusual character of the Russian fiscal dilemma. The popular
perception in the west that arrogant oil and gas barons were simply unwilling to pay the
taxes they owed needs some correction. In the complex Russian tangle of non-payment, the
government also came to demand effectively that energy be provided free of charge (that
is, with no disconnection for nonpayment) to a substantial proportion of users.
This underscores an important aspect of the Russian situation, the
weight and potential significance of rents from its abundant natural resources for
resolving some of the dilemmas of development. Policy discussion on this has failed to
come to terms with any of the basic issues. Instead, as the unfortunate story told below
in chapter 5 of the lack of progress towards a viable framework for production sharing
agreements (PSAs) makes all too clear, measures which could have provided some first steps
forward have foundered as the delaying tactics of various interest groups, some of them
openly nationalist, have blocked progress, and increased the perception abroad that Russia
is a hostile and unreliable place for fixed investment.
In sum, the path taken in an attempt to restore fiscal balance in
Russia since 1995 has proved to be counterproductive and, in the end, has resulted in a
disastrous financial and political crisis. The new Russian government does not appear to
be in a position to service either its external or internal debt, and has not even been
able to make headway in resolving the issue of wage and pension arrears. Overwhelmed by
the scale and complexity of the problems it faces, its time horizon is inevitably very
short.
In this unpromising atmosphere, what sort of initiatives, from the
Russian authorities themselves and also from the G-7 or the European Union, could point to
a way forward? It is easy to be paralysed by the sheer scale of the problems, yet positive
first steps can lead to others, provided that there is an overall sense of direction. The
greatest source of disorientation, however, has come from the belief that economic
policies can be advocated in an institutional vacuum. A critical lesson which emerges yet
again from consideration of the Russian crisis is that active assistance in the creation
of appropriate institutions should never have been relegated to the rank of
"second-generation" transition issues.
(i) Institution building
From the very start of the transition, the Economic Survey of Europe(14) has emphasized the role of institutions, stressing
that a fundamental difference between the tasks of postwar European reconstruction in 1945
and the transformation of the former centrally planned economies lay in the fact that in
the devastated countries of western Europe there was, nonetheless, no need to construct
market economies de novo, create and demarcate property rights, nor even to
undertake to establish the idea of a civil society and the rule of law, although in some
cases these had been absent for a decade or so.
The implementation of any set of economic policies must perforce be
done through institutions, the state and its public administration. Arguably the most
serious consequence of the "policy overshooting" on transformation issues was
the exceptionally widespread and deliberate downgrading of the role of the state. Even for
something so mundane as the establishment of an effective fiscal administration, with a
reasonable degree of grudging respect from the population, there will be little progress
without the creation of a professional civil service, a functioning public administration,
and the development of broader societal attitudes regarding the legitimacy of the state
and of its right to levy taxes. It is evident that the gap which must be bridged in this
respect is substantially greater for the countries of the CIS than for most of the states
of central and eastern Europe.
Among the most damaging of the mistaken conclusions that were drawn
early on in the transition process, both by western advisers and by policy makers in
Moscow, was that the Russian state remained too strong.(15) The need to scale back inefficient spending, and to create room for private sector
consumption, is a necessary task for which a strong public administration is required; but
this is a quite different task from restructuring the state so that it is strong
enough and capable to perform the functions required to support a market economy. It is
often argued that the widespread corruption and criminalization of Russian economic life
derives from a state with too much power. This is almost certainly wrong. The development
of increasing corruption in the new Russia, and the history of other corrupt structures,
whether the original Mafia(16) or India's Income Tax
Department,(17) demonstrates that the most damaging of
corrupt and criminal structures arise to fill a void, an institutional hiatus in which the
state is weak, beginning with the functions of contract enforcement and dispute
arbitration, but swiftly taking on much more predatory and disruptive forms.
This is not to deny that excessive state regulation and bureaucracy
will create room for bribe-taking and obstruction of all kinds, inimical to the
development of an enterprise culture and stifling to small business. The particular
inheritance of the Soviet bureaucracy, which made rules as it pleased, magnifies this
problem. However, this sort of anti-Weberian bureaucratic structure presents a relatively
minor danger, in contrast to the way in which special interest groups have effectively
succeeded in privatizing many of the functions of the weak Russian state.(18)
There are many who think that combatting Russian corruption and
improving Russian public administration is a hopeless task and it does appear that these
are major stumbling blocks to progress. Yet, even in conditions of state weakness and a
public sense of a pervasive and hopeless corruption which undermines the legitimacy of
fiscal efforts, the development of an entrepreneurial culture, and the democratic process
itself, there are still many examples - from 19th century Britain to Sri Lanka in the
1970s, Hong Kong's Independent Commission Against Corruption in the late 1970s, and the
working of Singapore's Customs and Excise Department - which demonstrate that a successful
struggle against corruption can be conducted even when it seems that the local culture is
accommodating to it and the national leadership itself may be corrupt.(19)
The state performs a myriad of other functions which were forgotten in
the rush to the market.(20) The welfare effects of what
became known as "state desertion", the abdication of the state from carrying out
many of its responsibilities, have been more evident, but the coordinating and enabling
role of a well-functioning state is much more visible in its absence. The "anomic
reaction" in which it becomes the social norm to seek ways round laws, to connive
against authority, to trust no politician, varies in intensity across the region. In
Russia its deep roots and present justification have made it a major issue to be tackled,
if economic reform is to go forward.
The state, its courts, and its legal systems must also develop
appropriate structures but their development can be hampered not just by questions of
legitimacy but also by a sheer lack of resources. Such is the situation of much of the
Russian judiciary today. Again, the demonstration effect may be very powerful. Some
contracts, successfully enforced, send out one set of signals. Others, in which court
rulings are ignored and prove helpless to change the situation, create an entirely
different perception of whether or not a society is moving towards the rule of law. There
has been far more development of Russian legal structures than is often realized, but the
negative cases, understandably, have dominated the thinking of economic actors.
(ii) Political will in democracies
In the western disappointment at the present policy impasse in Russia,
there is often a surprising irritation expressed at the failure of the executive branch to
handle the rather unruly Duma and often recalcitrant regions.(21) The obstructionism of the Duma is not in doubt and, as the recent rejection of 10 highly
promising production sharing agreements shows, this divided and unpredictable body can be
a serious barrier to the creation of a more stable and predictable economic climate. But
it needs to be acknowledged that the composition of the Duma was determined by a free and
fair vote in December 1995; the lack of sensitivity of the political elites for the
expressed concerns of the population who have had to bear the social costs of the
transition has been inevitably reflected in such elections.
The reality which must be faced, however, is that a consensus for
far-reaching market reform has never been created in Russia in the way that it has in a
number of other countries.(22) The Baltic states also
faced enormous structural distortions in their economies, on a similar scale to those in
the European CIS and Romania. Their superior results to date do not simply derive from the
advantages of an institutional memory from the interwar period. There was an exceptional
consensus for reform, and a desire to reorient to the west, based on national political as
well as economic considerations. The three states were politically able and willing to
tolerate an immense fall in industrial output and GDP at the start of independence,
greater than that of all but the transition economies which suffered a war. Their ability
from that point to achieve fiscal balance, and an attractive climate for investment, was
certainly conditioned by these factors. "Political will" cannot be demanded of
governments or elites alone. In democratic conditions the willingness to sacrifice, even
during the period that Balcerowicz has christened "extraordinary politics", is
conditioned by far more than the desires, and even the persuasiveness and authority of the
political elite. There is, though, much learning which remains to be done, especially in
Russia, on how to achieve a democratic consensus and rally popular support for a programme
of reform.
The limits to the power of even a very deeply committed central
government are presently being tested in Ukraine, where there is an essentially
oppositionist parliament (Rada), which has frequently defeated legislation which is an
important component of the programme agreed with the IMF.(23) The programme spelled out there, under the IMF's three-year $2.2 billion Extended Fund
Facility, which appears to incorporate a wider range of issues than earlier programmes,
will also be a testing ground of whether the bulk of the very broad range of institutional
reforms enumerated, 88 in all, can be carried through in such a time period.
(iii) Second-best solutions
After the default and devaluation in August, Russian policy makers must
work in a second-best world. Policy prescriptions on what not to do have been
freely given by foreign advisers, almost all of them deriving from a first-best world. It
is an appropriate time to consider once more the road to recovery adopted after the Second
World War in western Europe, which led to a remarkable two decades of rising prosperity.
The ruling orthodoxy of today is mistaken in its swift dismissal of the possibilities for
temporary, explicitly time-limited and well thought out controls which might form part of
a comprehensive programme to gain some breathing space, some time for governments to
implement appropriate policies.(24) Such a programme would
have to give high priority to the key institutional foundations of the market economy such
as an effective judicial and law enforcement system, the creation of a healthy commercial
banking system, and a coherent policy for changing the structure of incentives so as to
encourage entrepreneurship and fixed investment rather than rent-seeking and asset
stripping. The precise content of such a programme should be determined by the Russians
themselves who are best acquainted with the problems that have to be solved but it must
satisfy at least three key requirements: one, the length of the programme must reflect a
realistic appreciation of the time required to solve key problems; two, it must set out
the problems to be solved and the solutions proposed in a coherent way such that it can
provide a convincing case for official support from the G-7 and the international
financial institutions; and, three, it must also specify the conditions for lifting
temporary controls and restrictions in order to confirm the commitment of the authorities
to their temporary character and to increase transparency in making long-term strategic
decisions.
A well-articulated and coherent programme is required not only to
convince western governments that assistance will be effective but also to help restore
popular credibility among the Russian population in the possibility of success. Ad hoc
programmes which fail to tackle fundamental institutional problems and which put a premium
on speed rather than effectiveness are simply a recipe for another round of failures and
false starts. Unmoved by ideological purity, but with a constant pragmatic monitoring, the
postwar reconstruction of western Europe proceeded far more smoothly than could have been
hoped for in 1947. Russia today needs far more of this well-informed, professional
pragmatism in the design of policy.
The situation in Russia may appear to consist of an impossible tangle
of vicious circles. The tasks of transformation in Russia are, indeed, enormous and must
not be underestimated. Anatoly Chubais, inter alia, former Minister of
Privatization, asked in September what he thought had been his greatest mistake, replied:
"We must recognise that we did not fully understand the scale of the process which we
had undertaken. We thought there would be a very difficult three years, five years, eight
years. Now, unfortunately, it is clear that reform will take decades. ... It is now clear
that Russia does not need billions or tens of billions, but hundreds of billions of
dollars".(25)
This Survey, for nearly a decade, has made a similar assessment
of the scale of the Russian transformation effort, of the institutional changes required,
and, critically, of the necessary scale of investment. A more ambitious, longer-term,
transformation programme, drawn up in the country itself, and embarked upon in 1992,
would, in the end, have cost an order of magnitude less than the effort now required to
solve the problems confronting the country. Failure invariably raises the price of
subsequent efforts. The situation is now more perilous, the popular willingness to endure
the cost of reform is greatly reduced, and cynicism is rampant. Russia highlights the
risks and threats that were always inherent in the transformation process in their
sharpest possible form. But, despite all these major difficulties, the development of a
coherent strategy, along the lines suggested above, probably offers the best chance of
moving forward.
(iv) Broader implications
The Russian crisis has attracted considerable public attention
throughout the world not only because of its grave economic implications but also because
of the political weight of the Russian Federation. Given the size of the Russian economy
and its influence on the economic and political stability of neighbouring countries, the
course of the reform process in this country has been both a lasting preoccupation for
western policy makers and a focal point for numerous strategic business decisions. For a
wide range of international public opinion, the progress achieved in establishing a
democratic society and a fully-fledged market economy in Russia is a measure of the
success of the entire transformation process in the former communist block. The fact that
the August crisis occurred while Russia was implementing a reform programme supported by
the international financial institutions casts a shadow over the transition process in
general; moreover, it also raises doubts about the fundamental conception of the
transformation paradigm, particularly as applied in Russia.
At the same time it is worth noting that in strictly economic terms the
Russian crisis is by no means a unique event. In many aspects, the Russian crisis of 1998
is a repetition of the Bulgarian crisis in 1996, which combined a fiscal crisis with a
currency crash and a collapse of the banking system.(26) The more recent cases of economic distress in other transition economies (for example
Romania and some of the CIS countries, especially Ukraine and the Republic of Moldova)
have much in common with these crises and, indeed, contain the potential for further
escalation and aggravation. The 1997 exchange rate crisis in the Czech Republic
B although not so
acute and devastating B was also symptomatic of important, transformation-specific
economic weaknesses and was followed by a painful economic downturn.(27) Although similar sources of stress are present in most of the transition economies, their
relative importance varies, of course, as does the capacity of existing institutions to
handle crises when they appear. The Czech crisis was dealt with fairly rapidly but it is
nevertheless a warning of the risks of incipient fragility even among the more advanced
transition economies.
In what concerns the primary causes of these transformation crises, a
common feature is that their roots are deep-seated in the microeconomics of transition.
While the visible outcome of the crises has usually taken the form of major macroeconomic-cum-financial
disturbances, the latter have been not so much the consequences of erroneous macroeconomic
policy per se as the result of failure to make sufficient progress in important
microeconomic reforms. The principal microeconomic factors that have led to macroeconomic
distress during the transition are often related to the nascent status of the market
infrastructure and/or the inherited structural weaknesses of these economies: market
distortions and the malfunctioning of markets; perverse incentives and the perverse
behaviour of economic agents; weak or poorly functioning regulatory, judicial and other
state institutions; weakness and poor regulation of the banking system; and inherent
inefficiencies in the corporate sector of the economy. The lesson here is that without
microeconomic reforms macroeconomic stabilization is likely to be short-lived and may even
produce perverse effects; but without a reasonable degree of macroeconomic stability, the
micro-reforms may not be undertaken.
Russia's experience has once again highlighted the daunting policy task
of restructuring and rehabilitating the corporate sector in many transition countries. The
lack of satisfactory progress in structural reforms in some transition economies,
especially in dealing with unviable enterprises, has often been due not so much to a lack
of understanding of the problems and an absence of political will to address them, but to
the very severe political and resource constraints stemming from the sheer magnitude of
the required restructuring effort. The existence of a large, critical mass of unviable
firms is a major stumbling block to the successful implementation of the whole
transformation policy agenda.
If Russia's painful experience was somewhat different from the crisis
episodes that occurred in other transition economies the reason probably lies in the fact
that it revealed the crucial importance of the interactions between transformation policy,
institutions and the incentives working for economic stability. It showed that, in the
absence of an adequate institutional framework, even an otherwise apparently coherent
macroeconomic policy mix (insofar as the continued support of the international financial
institutions was an indication of such coherence) may generate perverse incentives which,
in turn, may not only erode the efficiency of the policy process but may in fact
B due to their
distortive impact B be counterproductive for economic stability and growth in
the longer run. One of the important lessons of the Russian crisis is that deep
microeconomic restructuring and fundamental institutional reforms are not only essential
for the formation of a new market environment in the transition economies; they are also
crucial for macroeconomic stability as well.
Another policy lesson is that focusing solely on the observable
progress in macroeconomic stabilization may be deceptive
B in the sense of
sending wrong signals to the markets B and, as such, may be short-lived if not supported by
adequate progress in microeconomic reforms. Actually, in broader terms, this negative
outcome has policy implications as regards one of the concepts embodied in the mainstream
transformation paradigm, namely, that of the primacy of macroeconomic stabilization over
microeconomic and, in particular, institutional reforms. While reform programmes based on
this philosophy have been successful in some transition economies, the failures in other
countries which have apparently adhered to the same paradigm suggest that the latter may
not be universally appropriate. Indeed, as follows from the analysis in chapter 2.3(i)(a),
given the nature and depth of the structural weaknesses of the Russian economy, a
different policy mix, based on a more gradual disinflation but a more vigorous programme
of institutional reform, would have probably been more effective with respect to
macroeconomic stabilization in the long run. This experience also suggests the need to
reconsider (in some cases and on an individual basis) the balance of transformation policy
priorities as well as the sequencing of the reform process so that these are better suited
to the specificity of individual countries.
The main features of the Russian crisis are symptomatic of the dangers
of major disruptions in the transformation process which are still present
B in one way or
another and to a different degree B in most of the economies in transition. The risks of
encountering economic disturbance and incurring transition-specific damage are further
amplified in a situation of high volatility of international capital flows and strong
contagion between different economies. The noticeable fallout from the Russian crisis and
the effects of global turmoil on other transition economies indicate that even the more
advanced reform countries are not completely immune to setbacks. The more advanced
reformers, in turn, are and will be facing further challenges in trying to sustain and
strengthen the momentum of their recovery; if they are successful in doing so it will make
it easier to implement the major programme of policy reform required for their accession
to the EU. Considerable caution will thus continue to be needed in setting the future
transformation policy agenda in all of the countries with transition economies.
One of the recurring points of this chapter is the key importance of
the European Union in influencing not only the short- to medium-run economic outlook in
most of the ECE region but also its strategic direction, particularly in that part of the
continent where countries are still engaged in the transition to market economies, a
process which in many of them is putting considerable strain on their new democratic
institutions. The need to achieve rates of economic growth that will lower significantly
the prevailing high rates of unemployment in western Europe is obviously important for the
members of the Union itself; but it is also crucial for maintaining high rates of growth
in those central and east European countries where economic recovery is underway and which
are now heavily dependent on the Union as a trading partner. A premature slowdown of the
cyclical recovery in western Europe will encourage a resurgence of protectionist pressures
and complicate the process of EU enlargement, not least by increasing the resistance of
some of the existing members to the adjustments required by the admission of new members.
At the same time most central and east European countries, not only
those in the first wave of applications, want to be members of the Union and this
objective is shaping their political and economic strategies over the medium to long term,
depending on how close to EU membership they are judged to be. The EU itself can exert a
major influence on the expectational environment in all the transition economies, not only
those in the first wave of applications, by leaving no doubt as to either side's
commitment to the ultimate objective of membership, but at the same time encouraging the
adaptation of comprehensive and consistent strategies designed to enable the transition
economies to meet the requirements of the acquis in the shortest feasible time.(28)
There are also other transition economies, especially in the CIS, which
have either not expressed any intention to apply for EU membership or have no intention of
doing so. But to a large extent the requirements for entry into the EU are the same as
those for creating a well-functioning market economy. Whether or not a country wishes to
join the EU, if it wants a market economy it must build the necessary institutional
infrastructure for market-based activity, and that includes restructuring the state.
Reforming public administration and strengthening the state are essential requirements for
the EU applicants if they are to be able to carry out the requirements of the acquis
communautaire; but they are equally essential for any country that wishes to introduce
an efficient market economy. For those applying to join the EU, the requirements to be met
for membership effectively constitute a programme of reform and, more or less, a timetable
for completion; those countries for which membership is a longer term aim or not envisaged
at all will have to draw up their own programmes and timetables, although the contents of
both programmes will overlap to a large extent.
Much is being done in providing assistance to the transition economies,
especially to the EU candidates, but much is also lacking, especially in those other
countries where the reform process is lagging behind. The EU is focusing much help on the
former, but, as the major economic power in the region, it could be a much more active
partner of policy makers in the latter group in supporting their efforts to bring about
the economic and social transformation of their countries. The EU has the resources to
provide considerable help in actually designing more effective strategies to bring about
the degree of institution building and microeconomic reform which will eventually lay the
basis for more effective stabilization policies and for a sustained recovery of economic
growth. Achieving those objectives will not only ease the transition of those who want to
join the European Union but will also make a major contribution to increased security
throughout the entire European region.
1. On these issues see J. Eatwell and L. Taylor, "International
capital markets and the future of economic policy. A proposal for the creation of a world
financial authority", paper prepared for the project on International Capital Markets
and the Future of Economic Policy, funded by the Ford Foundation and available at
www.newschool.edu/cepa; and UN/ECE, "Catching up in a global economy: sustaining
growth in the transition economies", Economic Survey of Europe, 1998 No. 1,
pp. 9-10. See also J. Stiglitz, "More instruments and broader goals: moving towards
the post-Washington consensus", The 1998 WIDER Annual Lecture (Helsinki),
1998, as well as J. Stiglitz, "Towards a new paradigm for development: strategies,
policies, and processes", 1998 Prebisch Lecture, UNCTAD (Geneva), October
1998.
2. See below, chap. 2.2(ii).
3. It was agreed at the Council Meeting at Pörtschach (25 October
1998) that the 15 Finance Ministers would draw up such a plan to be discussed at the EU
Summit in Vienna in December. Among the various proposals aired in the press and informal
briefings are: the exclusion of public investment expenditure from the Maastricht budget
deficit rule; European infrastructure projects, particularly for transport; and calls for
lower interest rates.
4. On the issue of possible food shortages in Russia in the coming
winter, see the next section.
5. Some of the transition economies, however, with very large
deficits would eventually find it difficult to sustain them even in the absence of the
Asian and Russian shocks.
6. See chap. 2.2(ii) for a discussion of these risks.
7. See, for example, the IMF Managing Director's address,
"Russia's transformation efforts at a turning point", at a Conference of the
United States-Russian Business Council (Washington, D.C.), 29 May 1995 (internet website).
8. If anything, appreciation of this may be overstated in the west.
G. Somerville, "U.S. says time has run out for Russia reform", Reuters (Washington, D.C.), 9 November 1998, cites the United States Deputy Secretary of the
Treasury noting that "In August the government's time ran out" and that
"The new government of Prime Minister Primakov will have to make its way as it deals
with the problems which that failure has wrought".
9. An IMF stabilization programme was signed on 26 March 1995,
central bank of Russia independence began in April, and a target was set for the monetary
base; the exchange rate corridor regime was introduced in July 1995. A comprehensive
account of the entire period, with an emphasis on the policy dilemmas inherent in the
multiple targets, and the conflict with the fiscal stance, will be found in B. Granville,
"The problem of monetary stabilisation", in B. Granville and P. Oppenheimer
(eds.), Russia in the 1990s (Oxford University Press, 1998, forthcoming). Chap.
2.3(i)(a) below presents a detailed analysis of the entire sequence of events.
10. Thus, J. Odling-Smee, in "What went wrong in
Russia?", Central and East European Review, November 1998, p. 6, writes,
"In particular, there was insufficient agreement and will among the leadership of the
country - broadly defined - to impose the fiscal discipline needed to pursue successful
reforms".
11. A substantial and expanding body of literature has emerged
focusing, inter alia, on the question of the role of initial conditions versus
subsequent policies in determining transition economy success. Relying, as it does,
largely on cross-section or panel econometric evidence, it is subject to all the strengths
and weaknesses of such an approach. This question remains in serious dispute, and a number
of papers are now forthcoming. Perhaps the most serious difficulty would appear to lie in
the proper specification of initial conditions. As two examples, A. Aslund, P. Boone and
S. Johnson, "How to stabilize: lessons from post-communist countries", Brookings
Papers on Economic Activity, No. 1, 1996, pp. 217-213 stress the role of policy, while
M. De Melo, C. Denizer, A. Gelb and S. Tenev, "Circumstance and choice: the role of
initial conditions and policies in transition economies," World Bank, International
Finance Corporation, October 1997, whilst not denying the role of policies, call attention
also to the role of initial conditions and the determinants of policy.
12. Thus the Director of the IMF's Research Department said at a
forum in October that "it turned out in the end, really, to be, you know, giving the
key of the liquor cabinet to a drunk, and there was no way to discipline the resort to
borrowing and keep it within reasonable boundaries". IMF Economic Forum,
"Capital account liberalization: what's the best stance?" (Washington, D.C.), 2
October 1998, p. 28 (internet website).
13. See J. Sachs, "Russia's struggle with stabilization", Proceedings of the World Bank Annual Conference on Development Economics (Washington, D.C.), 1995, pp. 57-80, and A. Cheasty, "The realized net present value
of the Soviet Union", in V. Tanzi (ed.), Transition to Market, IMF
(Washington, D.C.), pp. 125-134, which calculates the dissolution value at -6 trillion
(1991) roubles.
14. Notably in UN/ECE, Economic Survey of Europe in 1989-1990, pp. 5-27. At the time, of course, the assertion (p. 21) that "the transformation of
centrally planned economies into decentralized market economies is a much more difficult
task than the reconversion of the west-European economies" and the warning that the
forthcoming stabilization programmes "will impose heavy burdens on the population in
the immediate future" (p. 5), was regarded as heterodox.
15. Thus, see J. Odling-Smee, op. cit.
16. F. Varese, "Is Sicily the future of Russia? Private
protection and the rise of the Russian Mafia", Archives Européenes de Sociologie,
No. 2, 1994.
17. O. Goswami, A. Sanyal and I. Gang, "Taxes, corruption and
bribes: a model of Indian public finance", in M. Roemer and C. Jones (eds.), Markets in Developing Countries: Parallel, Fragmented and Black (San Francisco, ICS
Press, 1991), pp. 201-213.
18. It should be noted that there are more pessimistic accounts of
the relationship between a deficiency of social capital and the nature of certain states
which bear consideration: R. Putnam's Making Democracy Work: Civic Traditions in Modern
Italy (Princeton, Princeton University Press, 1993), and P. Hanson, "What sort of
capitalism is developing in Russia?", Communist Economies and Economic
Transformation, Vol. 10, No. 2, 1998, pp. 27-42 are two examples.
19. R. Klitgaard, Controlling Corruption (Berkeley,
University of California Press, 1998). To these cases might be added the recent successes
of the mayor of New York, many of whose pragmatic measures seem applicable to Russian
conditions. Additional discussion on the importance of public administration is to be
found in J. Eatwell, M. Ellman, M. Karlsson, D. Nuti and J. Shapiro, Transformation and
Integration (London, IPPR, 1995), pp. 15-39. For a more critical view see P.
Stavrakis, "State-building in post-Soviet Russia. The Chicago boys and the decline of
administrative capacity", Kennan Institute Occasional Paper (Washington,
D.C.), 1993.
20. UNDP, The Shrinking State: Governance and Human Development
in Eastern Europe and the Commonwealth of Independent States (New York), July 1997.
21. Thus J. Odling-Smee, op. cit., complains that "Even
when government decisions were taken and supporting legislation passed, difficult measures
were still often not being implemented by regional governments. Municipalities often
wanted little more than to keep their local businesses afloat". Against this apparent
obtuseness, see R. Kozul-Wright and P. Rayment, "The institutional hiatus in
economies in transition and its policy consequences", Cambridge Journal of
Economics, Vol. 21, 1997, pp. 641-661, particularly 650-653.
22. On the necessity for this see UN/ECE, "Popular support for
the transition process", Economic Survey of Europe in 1992-1993, pp. 10-15.
23. Government of Ukraine, "Memorandum of economic policies
for July 1, 1998-June 30, 2001", 11 August 1998 (internet website).
24. M. Pani
ƒ, "Managing reforms in the east European countries:
lessons from the post-war experience of western Europe", UN/ECE, Discussion Papers,
Vol. 1, No. 3 (United Nations publication, Sales No. GV.E.92-0-1).
25. Reuters, 23 September 1998.
26. UN/ECE, Economic Survey of Europe in 1996-1997, pp.
75-84.
27. UN/ECE, Economic Survey of Europe, 1998 No. 1,
pp. 75-82.
28. On the need for a more strategic approach towards EU
enlargement see UN/ECE, "Enlarging the European Union to the transition
economies", Economic Bulletin for Europe, Vol. 48 (1996), pp. 7-18.