Stuck In Transition: Eastern Europe Losing Traction?

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 |  Includes: ESR, GUR, VGK
by: QFinance

By Anthony Harrington

From its founding in 1991, the European Bank for Reconstruction and Development (EBRD) has had two objectives written into its charter, namely advancing democracy and helping to build robust economies in the nations in which it invests. This emphasis on advancing democracy is not just unusual, but unique in a financial institution like the EBRD. It gives the EBRD a particular perspective on things and it is not surprising that from this perspective, there is much that the EBRD finds in Eastern Europe to give it cause for concern.

It made its views on this matter very clear in its November 2013 annual Transitions report entitled: Stuck in Transition:

"Economic reform has stagnated in the transition region since the mid-2000s, even in countries that are still far from reaching the transition frontier. [...] Economic growth remains well below pre-crisis levels and many countries have turned their backs on the reforms that could put economic expansion back on track [...] Under current policies and institutions, productivity growth will likely remain modest over the next 10 years, around 2-4 per cent on average - and decline further in the following decade. At that rate, convergence with the living standards in western Europe would stall in some countries and slow to a crawl in many others."

If this scenario plays out, Eastern Europe's best hope will be that it continues to be used as a lower wage outsourcing center for advanced markets while the gray hand of the remnants of state socialism and authoritarianism continue to foster corruption and stagnation.

Exposure to the full play of market forces can be brutal but the ethos of competition in capitalist economies continually corrects mis-allocations of capital and resources. Weak firms are forced into liquidation and new jobs are created elsewhere. With crony capitalism a cosy circle of family owned banks and companies props up zombie companies long past the point where they would have failed in more market-orientated economies. Innovation and new entrants are frozen out or life is made difficult for them, stifling entrepreneurship. Companies favored by the state get lucrative contracts and deliver poor results while their owners, drawn from the ruling elites, turn into super rich oligarchs.

What the EBRD seeks to do, consistently, is to use its funding power to advance democratization and openness in industrial and political relations. As such, the EBRD is not shy of asking the big questions:

"Why do some countries succeed in building sustainable democracies and others not? What role does economic development play in the process? Does transition to a market-based economy led by the private sector strengthen the medium- and long-term prospects for democratic consolidation?"

This latter question, of course, can be asked of China at least as pertinently as of Eastern Europe. The answer there, the ruling communist elite would hope, would be a decisive "no." But that game is still in play and the next two decades in China are going to be very interesting.

The EBRD's report is fascinating on a number of levels, not least because of the subtlety and depth of its analysis. As it notes:

"Early transition histories (are) important because they sometimes gave rise to vested interests that became entrenched. Political polarization makes the success of reforms less predictable and reformers and civil servants more hesitant."

The report does not hesitate to draw potentially controversial conclusions. Take this example:

"Political systems with proportional representation seem to have worked better in the transition region than majoritarian electoral systems."

In the UK, this conclusion would be celebrated by the Liberal Party, which has long espoused proportional representation, and vigorously contested by both the Conservatives and Labor. However, the EBRD is not making a political argument but stating a fact as it sees it. Proportional representation has made the capture of the state by authoritarian figures and parties, playing on the anxieties stoked by the global financial collapse, more difficult.

It is important to realize that as well as being a commentator and analyst, the EBRD is an active player in all this, since it is a significant lender to the region. Under the joint action plan of the European Investment Bank, the World Bank Group and the EBRD, these three international financial institutions lent some 25 billion euros to central and south-eastern Europe as part of a two year program begun in 2012. So far, as events in Ukraine have demonstrated in spades, entrenched political and ethnic forces seem able to trump logical analysis and democratizing intentions in the region.

Nevertheless, funding power does play a role. Clearly, without the EU and the IMF's massive $17 billion loan, the Kiev transitional government would have been in a far worse plight than it currently is, and it is significant, of course, that the funding is going to Kiev, and not to the recently annexed Crimea, now part of Russia. The IMF doesn't pretend to be neutral any more than the EBRD does. Democracy is good, authoritarianism is bad. The interesting part is the EBRD's focus on trying to understand whether and how economic progress fosters democratic progress, and vice versa. This study is well worth reading twice over.