1. Jaromír Šindel ECES Discussion over the Puzzles of Transformation Process The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

2. Topics Main factor influencing the Transformation Economic Policy –Impossible trinity (capital, interest and inflation differentials), foreign capital, interest groups, … Transformation Puzzles - best solutions? –Gradual vs. rapid liberalization and deregulation, privatisation, transformation slowndown, law and transformation, monetary or exhchange rate based stabilization programmes, financial and bank crisis, foreign direct investment, structural changes, labor market, welfare state, … –BUT: Initial conditions, methods of solutions, differences in transition process, … The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

3. Initial Conditions Source: Žák (2004) Index of initial conditions (1989) and real economic growth (1993-1995) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

4. Index of Liberalization Source: Žák (2004) Accrued Index of liberalization (1989-1997) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Accrued = Cumulation of values from previous years. Maximum in 1997 is 9.

5. Index of Liberalization Source: Žák (2004) Accrued Index of liberalization (1989-1997, horizontal axis) and real economic growth (1991-1997, vertical axis) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

6. Transformation Index - IDR Source: Žák (2004) Democracy, Legal system, Reforms and IDR in the CEECs, 1997 against 2001 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

7. Transformation Index - IDR The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague IDR in 1997 (horizontal axis, better on left side) and change of IDR in 1997-2001 (vertical axis, negative is better development) Source: Žák (2004)

8. Transformation Indexes The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Small privatization, Trade and Exchange rate, Large privatisation, Price liberalization, Banking sector and Interest, Restructuralization, Securities, Trade Competition Source: Žák (2004)

9. Human Development Index - HDI The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague HDI in 1990 (horizontal axis, better on right side) and change of HDI in 1990-1999 (vertical axis, positive is better development) Source: Žák (2004)

10. Transformation Index - NIT Source: http://www.freedomhouse.org/…Country Report Nations in Transit, 1997 to 2005 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Slovakia

11. Transformation Index - NIT Source: http://www.freedomhouse.org/…Country Report Nations in Transit, 1997 to 2005 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Czech Republic

12. Transformation Index - NIT Source: http://www.freedomhouse.org/…Country Report Nations in Transit, 1997 to 2005 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Hungary

13. Transformation Index - NIT Source: http://www.freedomhouse.org/…Country Report Nations in Transit, 1997 to 2005 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Poland

14. Transformation Index - NIT Source: http://www.freedomhouse.org/…Country Report Nations in Transit, 1997 to 2005 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Bulgaria

15. Transformation Index - NIT Source: http://www.freedomhouse.org/…Country Report Nations in Transit, 1997 to 2005 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Romania

16. Transformation Index - NIT Source: http://www.freedomhouse.org/…Country Report Nations in Transit, 1997 to 2005 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Belarus

17. Centrally Planned Economy Main Characteristics –the nationalized economy –the system of plans, centrally planned economy (Imperative planning x Indicative planning); 5-years plans –non-existent market –non-existent prices (no real prices with their information, allocation and motivating function), the distorted price system resulted in inefficient allocation of resources –the prohibition of entrepreneurship –the external relationships under CMEA – “soft market” –lack of competition, large uneconomical companies The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

18. Transition Process Requirements –1. Liberalize the economy, –2. Stabilize the economy, –3. Restructuring the economy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

19. Kornai´ six characteristics of transformation process 1. Changes in the economic sphere in the direction of the capitalistic economic system; 2. Changes in the political field in the direction of democracy; 3. A complete transformation, parallel in all spheres (economy, political structure, political ideology, legal system, stratification of society); 4. Non-violent transformation; 5. Transformation under peaceful process; 6. Incredible speed “The presence of all six characteristics together is unique in world history” The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: Kornai, J., 2005.

20. Transition Process – Liberalize the economy Price liberalization –The end of Shortage Economy (Kornai) – price didn’t reflex supply and demand relationships –in Czech Republic July 1990 – 10% increase due to foodstuffs prices, respectively the abolition of subsidies (negative turnover tax) January 1990 – price deregulation – 85 % of GDP under price regulation in 1990 – in December 1991 only 6 % of GDP (rents, energy, water, health services, transportation and communication) Trade liberalization – in the later lecture The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

21. Gradual vs. rapid liberalization and deregulation Rapid –Liberalize the economy Quick response of market and private sector Queues, uneconomic production and unwanted goods can be eliminated quickly –If macroeconomic and structural conditions are right – quick recovery –The macroeconomic discipline works – without low inflation no long-term growth Don’t forget on microeconomic view – the Czech Case 1995- 1997 –Essential structural reform – enterprises have to face budget constraints The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

22. Gradual vs. rapid liberalization and deregulation Gradualism –Danger that old system impedes the working of new forces of the market economy –Gradual price liberalization also gradual deregulation creates new deformation in the price structure. This new deformation need new subsidy, so never ending story of government intervention in market economy Flexibility –fiscal policy, exchange rate regime, … The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

23. Transition Process – Restructuring the economy Restructuring the economy –deetatization, –the end of price controls, –the end of production plans, –the end of vertical relationships, … –New tax system and the independent central bank for the effective implementation of stabilization economic policy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

24. Privatisation The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: World Bank, World Development Report: From Plan to Market, from Schejbal, J. (2002) Other Ways and Solution - comparison Method Goal Better Corporate Governance Speed and Feasibility Better Access to Capital, Know-how and Experts Higher Government Revenue Greater Fairness Sale to foreigners +-++- MBO / MEBO -+--- Voucher privatization ?+?-+

25. Privatisation The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: Schejbal, J. (2002)

26. Reasons of Transformation Slowdown Demand side –Consumption – real wages decline (wage cushion with exchange rate cushion – important transition tools); increased savings by expectation of price liberalization with exchange rate devaluation and by uncertainty about future development. –Investment – expectation lead to savings; obscure ownership delayed investment programme; restructuralization didn’t start. –Government expenditures – changes in government; declined role of government in economy. –Export – foreign demand – brake up of CMEA; search of new markets. Supply side shocks –Price increase of imported goods – devaluation of currency; oil contract cancellation; –Price liberalization brought higher than expected supply shock –Government subsidy cancellation (rough budgetary limitations) –Managerial shock – new market environment The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

27. How to get new Law – different views Law and finance theory –Choose the best institutional setting Institutional convergence has its limits by existing PATH DEPENDENCY Impossible to achieve the best results in CEE countries due to the path dependency and the political economy The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Law and Transformation

28. Monetary or Exchange Rate Based Stabilization Programme Source: Frait, Komárek (1998) Alternative exchange rate scenarios The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

29. Exchange rate and transition The theoretical paths of the real exchange rate in transitional economies The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: Frait, Komárek (1998)

30. Following Generalisations about ER Path in Transition a) Significant nominal exchange rate depreciation - the exchange rate flexibility at the beginning of the 1990s - Slovenia, Hungary, Poland. b) fixed exchange rate - lower inflation (The Czech Republic, Slovakia, Estonia). c) A trend towards real appreciation can be found in all accession countries, even though with profound differences. The strongest one is confirmed in Estonia and significantly applies also to the Czech Republic, Poland and Slovakia. On the other hand, Hungary and Slovenia experienced only mild real appreciation. –Real appreciation in Czech R. (Inflation differential) x Poland (inflation caused by devaluation) d) convergence process - slow e) Since 1999 - switch from nominal exchange rate depreciation to nominal exchange rate stability or even appreciation The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: Frait, Komárek (1998)

31. Competitiveness and ER appreciation – how to cope with it? Improve image and export at a higher price Increase labour productivity at constant wages Pay lower wages at unchanged productivity Shift from domestic production to more import Shift production to another country Exert political pressure against appreciation The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

32. Financial and Bank Crisis Crisis Indicators –... –Interest rate´s behaviour during crisis 1994, 1997, 1998 –Russian Crisis Case studies in CEE countries –Hungary, Czech Republic, Estonia Banking sector The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

33. Foreign Direct Investment and C&EE Transformation consequences Privatisation Structural changes Integration consequences Better environment for foreign investment, better rating (OECD, NATO, EU, euro) Better growth The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

34. Effects of FDI? Source: Newton. Country Report. April 2001. www.newton.cz The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

35. Technological Levels of Manufacturing Production (constant prices, %) Source: Newton. Country Report, January 2002. www.newton.cz –low-tech group (DA food products, beverages and tobacco; DB textiles and textile products; DC leather and leather products) –medium/high-tech group (DK machinery and equipment; DL electrical and optical equipment; DM transport equipment) –resource- (and scale-) intensive group (DD wood and wood products; DF coke, refined petroleum products and nuclear fuel; DG chemicals, chemical products and man-made fibres; DI other non-metallic mineral products) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Structural Changes

36. Labour Market - Employment Source: UNECE. Economic Survey of Europe, 2000 No. 2/3. www.unece.org Employment trends in the CEECs, 1989-1999 (1989=100) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

37. Czech „unemployment miracle“ delayed restructuring, with a relatively small output drop and job destruction early retirement schemes to shrink the labor force low unemployment benefits and strict application of eligibility criteria The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: IMF 2004, K. Krajnyák and M. Sommer

38. Welfare State - Gini coefficient Source: Kornai, J., 2005. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague