1. Transformation process in the Central and East European (CEE) countries. Classification of CEE countries
Lecture 2

2. Learning objective
The CEE countries before 1990 – central planned economy
Stages of transformation process in CEE countries
Economic and social costs of transformation
Privatisation in CEE
Classification of CEE countries

3. Market versus centrally planned economy
Market Economy
Centrally-planned Economy
Dominant position of private property
Market coordination (resources)
Prices are determined by market forces
High elasticity of economy (production is adjusted to the needs of customers
Hard budget constraint: the principle of self-financing, companies covers expenditure of their income, entrepreneurs bear the risk
Market forces competition fuel innovation
Dominant position of the state ownership
Bureaucratic coordination (resources)
Prices are mostly set by government
Low elasticity of the economy: central planning stiffens the functioning of the economy
Soft budget constraint: companies can count on steady supply of funds, state covers shortages and losses
Plans discourages entrepreneurs from innovative activities

4. The stages of transformation and development in CEE
Initial Stabilization and Reforms
Market Reforms
Recovery
2002– Boom
Crisis
2014 and Beyond

5. Centrally Planned Economy Main Characteristics
Lack of competition,
Lack of freedom,
Lack of equilibrium.

6. How did central planned economy manifest?
The nationalized economy (no private ownership),
The prohibition of entrepreneurship (except small-family business and farming in some countries),
Centrally planned economy,
Non-existent market, no competition,
Non-existent prices (centrally established), in result – not efficient allocation of resources),
The external relation under CMEA, (Council for Mutual Economic Assistance) - trading arrangement between Soviet bloc economies,
No floating exchange rate of currency
Most of the communist countries had big foriegn debt. On the end of 80’ they are not able to pay it.

7. CMEA (comecon)
(Council for Mutual Economic Assistance)  the pre-1990 trading arrangement between Soviet bloc economies, which was the Eastern Bloc's reply to the formation of the Organization for European Economic Co-operation in western Europe

8. The main goals of transformation
To liberalize the economy
To stabilize the economy
To restructure the economy
Legal and institutional reforms (support of all the changes)

9. Nobody knew how to transform
The Economist (March 24-30, 1990)
“Hundreds of books have been written on the transition from capitalism to communism but not the other way. There is no known recipe for unmaking an omelet.”
Quote

10. Liberalization the process of removing regulatory restriction in business, allowing most prices to be determined in free markets and lowering trade barriers that had shut off contact with the price structure of the world's market economies
Price liberalization (the end of shortage economy – Kornai)
Trade liberalization
Market entry liberalization

11. Stabilization
To curb the inflation, liberalize prices and eliminate the shortages on the market
To decrease national debt and make the budget deficit more balanced
To open the economy to domestic and foreign competition
Conflict, opossition beetwen some goals. How to curb the inflation and liberalize or deregulate the proces?

12. National Debt as % of GDP, Poland 1970-2016

13. Inflation, Poland

14. Restructuring the economy
Privatization
New Tax system (VAT, PIT, CIT)
Independence of National Bank

15. Privatization in CEE
All larger political parties in CEE countries on the beginning of transformation supported privatization.
The reasoning behind were somewhat different in individual countries.
Main reasons:
– to create domestic middle class,
- to establishe competition
- to increase efficiecy
- to finance budget deficit

16. Privatization methods
Direct sales,
Initial public offering (IPO),
Public tender,
Self privatization
Auction,
Coupon or voucher privatization,
The Management-Employee Buyout (MEBO) method,
Restitution,
National Investment Founds,
Special methods,

17. Direct sales
Conducted by founding organs or commissioned agencies on behalf of government (Treasury – Poland, State Property Agency – Hungary).
Goal – fast ownership changes of small and medium enterprises in good financial condition.
The main recipients – mainly employees of state enterprises.

18. IPO – Initial Public Offering
Two phases process.
1st phase – transformation the state enterprise to joint stock company or limited liability company. 100% of shares held by Treasury or special state agency.
2nd phase – sale of shares on domestic or foreign stock exchange.
In cases of strategic importance of some companies, the Treasure kept the control packet (golden share), to ensure the state influence on the decisions.

19. Public tender
The public invitation for the investors selected by the representative of the state.
The state specify: the minimum price of the share, minimum number of shares the investor shall buy, minimum investment pledge and social commitments,
The deadline for submission the offer,
Negotiation an selection the best offer,
Popular for privatization medium and large enterprises in Poland (banking sector, detergent, pharmaceutical, sugar companies).
Public tender – przetarg publiczny

20. Self Privatization (tricky privatization)
Merger of state and private enterprises and undervalue the state assets in the merger (Poland).
Transfer property and financial assets to the private association (Hungary).
In the initial phase of privatization, when the state conception did not exist, but some transition laws was already approved by parliament.

21. Auction called pre-privatization
The sale of the state property on an auction.
Small enterprises
Popular on the beginning of the transformation process
Most popular in Czech Republic and Hungary.

22. Coupon or voucher privatization Mass privatization
The state assets were supposed to be handed over citizens, which could then be used to buy shares.
Czech Republic, Poland, Hungary (compensation for nationalized lands in 1950), Romania, Slovenia.
Not successful form – create corruption (Czech), unstable structure of ownership, devaluation of shares.

23. Management-Employee Buyout (MEBO) method
The transfer of shares to employees through giveaways or sales at low prices.
Special association for holding shares during the repayment period.
Repayment period 3-5 years.
Most popular in Romanian privatization.
Giveaway - wskazówka

24. Restitution
To give back to the original owner from whom it was taken during the nationalization
However it turnout to be very complicate to find the original owner, to established the proper value especially when the property has gone through significant changes.
In Czech Republic restitution claims were opened up in 1990 and moved about properties (houses, farms, small businesses) to the private hands.
In Hungary this form was applied to lands.
In Poland problem is not solved up to this time.
In other CEE countries it became more political matter.
Restitution – zwrot mienia

25. Privatization dominating and most efficient methods in CEE countries were: direct sales, management-employee buyout

26. Private Sector Share of GDP
Source: European Bank of Reconstruction and Development

27. Income from privatization

28. Transformation process in CEE countries
Two ways of transformation:
Big bang (shock therapy)
Slow and steady (gradual or evolutionary approach)

29. Shock Therapy
strategy that involves moving quickly to eliminate the old order and to replace it with new organizational and policy arrangements, i.e. markets; transition policies could be implemented rapidly.
all at once and painful
causes immediate, sharp economic collapse
get it over with before it can be undone
The window of opportunity for reform must be exploited
It was often thought that markets would naturally emerge from decentralization as the state exited from its former dominant role.
Poland, other Central European countries (Hungary, Czech, Slovenia, Slovakia) chose the big band strategy

30. Slow and steady transformation
Emphasizes complexity of organizations; process of learning and adaptation required.
This approach drew on the analogy of how markets and related organizational arrangements and policies emerged in Western industrialized economies, typically over extended periods of time.
spread out and less painful
avoids collapse, in principle
takes longer
The gradual approach believe that institutional change is path-dependent. Organizations are viewed as complex hierarchies within which participants pursue objectives while guided by incentives but subject to bounded rationality. “Bounded rationality” refers to the limits of information; the limits faced by decision makers and personal limitations (inadequate education).
Hierarchy is an architecture in which there are superiors and subordinates. To an economist the hierarchical structure of an organization implies the principal-agent problem.
Organizational change is sequential, path-dependent and evolutionary through a process of organizational learning and adaptation.

31. Slow or shock therapy?

32. Economic and social costs of transformation
Consumer Price Index
(Year 0 means the year of price liberalization)
P – Poland,
C – Czech R.,
S – Slovakia,
H – Hungary,
B – Bulgaria
1. Growing inflation – consequence of price liberalization.

33. Economic and social costs of transformation
Employment trends in the CEECs,
(1989=100)
2. Falling employment and growing unemployment rate

34. Economic and social costs of transformation
3. Recession of transformation – falling GDP growth rate
By the year 2000, only four countries managed to surpass the level of GDP in Poland % growth, Slovenia %,
Slovakia and Hungary %,
Czech Republic - has just reached the GDP level of 1990 in 2000,
Latvia has the poorest record with having in 2000 just 60% of its GDP level a decade earlier,
Lithuania and Bulgaria were in 2000 about 20% below its GDP of 1990 (80% of GDP level frim 1990).
The GDP Changes in Eastern Europe
Czech PL
Ukraina
Hungary

35. The Transition Recessions in Post-Communist Countries

36. Other economic and social costs of transformation
Growing dispersion of income
Brake up of CMEA; search of new markets
Growing structural unemployment

37. The Visegrad Group
The Visegrad Group – 15 February 1991, established by heads of Hungary, Poland and Czechoslovakia in Visegrad.
The initial goals were economic cooperation and mutual help for the promotion of the democracy and Euro-Atlantic integration.
One of the most important achievements of the Group was the establishment of CEFTA (the Central European Free Trade Agreement). This, together with the coordination in economic, technological, industrial and agrarian policies in the area, enhanced cooperation between its members, via the establishment of a pre-EU-like economic environment.
The Group also established the International Visegrad Fund in order to support scientific research and culture.

38. Towards EU
After years of isolation from the Western economic system, and after the distortions and deprivations of the communist system, most citizens just wanted to live in a normal country with a normal economy, and, given their history and geography, that vision was captured in the allure of reintegrating with Western Europe.
From the very beginning of transformation the main goals for all CEE countries was to become: a memeber of NATO; OECD, and finally EU.
The historic offer from the European Union to countries in the region provided a gravitational pull that helped policymakers justify and implement difficult reform steps.

39. CEE countries in NATO March 1999 – Czech Rep., Hungary, Poland;
March 2004 – Bulgaria, Estonia, Latvia,
Lithuania, Romania, Slovakia, Slovenia,
April Croatia

40. CEE countries in OECD
In 1989, the OECD started to assist countries in Central Europe (especially the Visegrád Group) to prepare market economy reforms. In 1990, the Centre for Co-operation with European Economies in Transition was established, and in 1991, the Program "Partners in Transition" was launched for the benefit of Czechoslovakia, Hungary, and Poland. This program also included a membership option for these countries. As a result of this, Czech Republic (1995), Poland and Hungary (1996), Slovakia (2000), Estonia and Slovenia (2010) as well as Latvia (2016) became members of the OECD.
Other CEE countries which are not the members, expressed the interest to joint.

41. Steps of EU integration History
1951: The European Coal and Steel Community is established by the six founding members
1957: The Treaty of Rome establishes European Economic Community and common market
1973: The Community expands to nine member states and develops its common policies
1979: The first direct elections to the European Parliament
1981: The first Mediterranean enlargement
1985: Schengen Agreement – open borders
1993: Completion of the single market
1993: The Treaty of Maastricht establishes the European Union
1995: The EU expands to 15 members
2002: Euro notes and coins are introduced
2004: Ten more countries join the Union
2007: Romania and Bulgaria became EU members
2013: Croatia became EU member

42. Membership conditions for CEE countries to join EU
European integration has always been a political and economic process that is open to all European countries prepared to sign up to the founding treaties and take on board the full body of EU law. According to Article 237 of the Treaty of Rome ‘any European state may apply to become a member of the Community.
Article F of the Maastricht Treaty adds that the member states shall have ‘systems of government […] founded on the principles of democracy’.

43. The ‘Copenhagen criteria’
In 1993, following requests from the former communist countries to join the Union, the European Council laid down three criteria they should fulfill so as to become members. By the time they join, new members must have:
Adherence - przestrzegać

44. Integration and enlargement of EU institutional framework to international business in Europe
Four freedoms of the EU single market freedom of movements
of people,
goods,
services, and
capital
- the single market – rules: mutual recognition – the principle that products recognized as legal in one country may be sold throughout the EU; harmonization of selected sectors – sectors in which EU has created common rules; subsidiary – the privilege to take the action by EU only if it is more effective than actions taken by local level (priority for decentralization).
the euro -Maastricht Criteria (annual budget deficit not exceeding 3% of GDP, public debt under 60% of GDP, inflation rates and long-term interest rates within 1.5% of the three EU countries with lowest rate and the exchange rate stability and the lowest long-term interest rates)

45. Integration and enlargement of EU, timeline
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
The beginning
of the transition
The Copenhagen Criteria
To set the political, economic
And legislative criteria that applicants need to fulfill
Negotiation
The launch of
Negotiations with
Luxemburg group
Entering EU
Association
Agreement
The signing of Europe
Agreements with Poland and
Hungary
Application for the EU Membership
Poland and Hungary apply for the EU membership
Accession Treaty
The signing of

46. EU Accession Referendums in Central & Eastern Europe, 2003
The graph summarizes the results of referendums in 8 post-communist countries – the new members that entered EU on the 1st May 2004.
The 2003 referendums were a huge victory for the European idea and the European integration project. Central and Eastern European citizenries expressed in this way their strong support for the idea of European integration.

47. The accession process
The entry negotiations are carried out between each candidate country and the European Commission which represents the EU.
Once these are concluded, the decision to allow a new country to join the EU must be taken unanimously by the existing member states meeting in the Council.
The European Parliament must give its assent through a positive vote by an absolute majority of its members.
All accession treaties must then be ratified by the member states and the candidate countries in accordance with each country’s own constitutional procedures.
During the years of negotiation, candidate countries receive EU aid so as to make it easier for them to catch up economically. For the enlargement of the 10 countries in 2004, this involved a package of €41 billion aimed mainly at funding structural projects to allow the newcomers to fulfill the obligations of membership.

48. Thank you !