How History Matters in Post-Socialist Economies

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Though it has been suggested that The Beatles Rocked the Kremlin’ it was “Wind of Change” by Scorpions in the early 1991 that captured the minds of the new generation of Eastern Europe (EE) and the Former Soviet Union (FSU).

The promise of more open societies following Mikhail Gorbachev’s perestroika announcement set in motion powerful dynamics completely transforming the world. The Berlin Wall fell in 1989 and by the end of 1991 the Soviet Union disintegrated bringing down the entire socialist institutional edifice. Newly independent nation-states emerged across Europe, the Caucasus, and Central Asia. This new “wind” was that of hope, progressive stability and economic prosperity, or so it seemed at the time. And yet, “[f]or whom the wall fell?” as Branko Milanovic has recently inquired, is not as straightforward as might have been expected.

Despite the independence premium in national policy and in parallel with evidence suggesting recent strong economic growth the post-socialist economies are yet to achieve the ideals announced at the outset of market reforms. Ironically, the most unfortunate economic plan was the 1990s script of transition from planned economy to free market in the EE and FSU.

Economics first

Back in 1980 EE and FSU economies collectively represented up to 15 percent of the world’s economy, in gross domestic product (GDP) shares (Figure 1). By 2016, this same group barely claimed 6 percent of the global output share. The largest economy in the group, Russia, averaged 3 percent of the global share in 2016, with remainder going to the smaller FSU and EE economies.

Figure 1. Eastern Europe and Former Soviet economies’ relative to the global GDP, % shares.

Screenshot 2018-08-01 at 20.49.25.png      Source: author’s estimates based on The Conference Board’s Total Economy Database (original analysis is aggregated in Transition Economies)

Granted these are approximate estimates, subject to statistical revisions, and will change as global commodities trade and geopolitics play out, the decline from the socialist highs to the post-socialist lows of the group’s global economy ranking has been drastic. On a macro scale GDP levels across majority of countries would only rise back to the 1989 levels by late 1990. In many cases this would not occur until the mid-2000s (e.g. Armenia, Bulgaria, Croatia, Romania, and others). And as of 2017 measurements, for some countries such as Georgia, Moldova, Serbia and Montenegro, and Ukraine, broad GDP levels are yet to come back to pre-reform levels.

The macroeconomic trinity reforms of liberalization, privatization, and stabilization were the tangible triggers of the change. The choice was made to reform quickly, abruptly severing all ties from the socialist past. Poland’s Deputy Prime Minister, Leszek Balcerowicz offered most convincing motivation, exclaiming that Poland was “too poor to experiment.” The refrain would influence practically all EEFSU policy makers.

The adopted macroeconomic policy packages called for rapid dismantling of the existing economic (and political) system paving the way to the rise of private enterprise and competitive market institutions. The collapse of the socialist common market (Council for Mutual Economic Assistance or CMEA) led to a breakup of established supply lines across the region, most severely affecting the smaller FSU and those in Southeast Europe economies. At the same time, macroeconomic research analyzed the timing, sequence, and intensity of reforms (e.g. Fischer and Gelb, 1991). This turbulent economic policy whirlpool gave rise to the infamous “shock-therapy.” Social costs were deemed to be collaterally minor as opposed to a greater goal of economic prosperity (what an odd parallel to the goals of the socialist past).

The reality

There is hardly any need to re-tell the known story. Those EEFSU economies with significant dependence on the CMEA suffered the worst macroeconomic and social impacts in the early years of transition. While the early declines in industrial growth and productivity might have been expected, hardly anyone foresaw the massive economic and social degradation at the time.

Figure 2. Real 2000 and 2016 GDP per capita by country (1989=100)

Screenshot 2018-08-01 at 20.50.53.pngSource: author’s estimates based on The Conference Board’s Total Economy Database (original analysis is aggregated in Transition Economies)

Economic Survey of Europe estimates real gross industrial output collapsing between 1989 and 2004 up to 80.2 percent in Georgia, 74.2 percent in Albania, 52.8 in Kyrgyzstan, 45.6 in Romania, 35.6 in Bulgaria, 32.8 in Armenia, 28.7 in Russia, and similar ranges elsewhere. Despite the general negative trend, there were some notable exceptions. For example, Belarus, instead, saw an increase of 41.2 percent over the same period in its real industry growth, while most of the Eastern European economies, now members of the European Union, overcoming immediate losses induced by the breakup of legacy trade ties and under the stress of shock therapy, have posted steady growth starting in mid 1990s and up to now.

More concretely, only a handful of countries reached the 1989 per capita income levels as of 2000 as can be inferred from Figure 2 contrasting GDP per capita levels of 2000 and 2016 to the pre-reforms, 1989, level. Interestingly, economies either strong European Union integration (or relying on other development transfers) have performed better. For some countries, Ukraine, Georgia, Tajikistan, etc., the 1989 income levels as of 2016 estimate still remained out of sight on per capita basis. Per capita numbers are adjusted for population changes. Considering large scale migration out of these countries, the macroeconomic landscape outside of the large central city becomes loses some of its gloss. What is not obvious in this contrast, often portrayed as the success of shock therapy, is the factor of initial economic conditions, in particular in some Eastern European countries.

For example, the Czech Republic, Hungary, and Poland would be the most industrialized in the group, as evidenced in monumental archival work by Wlodzimierz Brus in larger study by M.S. Kaser and E.A. Radice (1986). Post-World War II investments into heavy machinery and consumer products industries reached close to 50 percent (and in some places more) of the total, with remainder going to agriculture and services. Coupled with relatively loose controls (in contrast to FSU) over trade connections with Western Europe, industrial growth with newer technology set the EE countries on a more advantageous footing vis-à-vis their Soviet “peers.’ Furthermore, agricultural sector, despite nationalization attempts, in EE sustained significant private ownership, unlike in the FSU. Finally, majority of the EE economies were able to tap international capital markets, mustering some investment in upgrading their capital funds and technology, despite getting into debt and eventually opting for International Monetary Fund bailouts (e.g. Boughton, 2001).

As life expectancy dropped by mid 1990s, either due to retraction of state provided basic healthcare services, military conflicts, or under psychological stress of dealing with uncertainty of survival, unemployment skyrocketing as state-funded enterprises collapsed, and hyperinflation pushing societies in the Southeast Europe and parts of the FSU into barter transactions, income inequality and wealth inequality began to worsen as well. Desperate to flee from jobless growth conditions (a term used by the World Bank to describe situation of growth in the region without creating new jobs), military conflicts, migration, led by temporary labor migration, climbed to recent history highs, exacerbating population losses from Bulgaria, Moldova, to Armenia, and to Tajikistan. For some of these countries remittances, the small monetary transfers that migrants send back home to support their families, have become instrumental to every day survival, averaging up to 20 and more percent of annual GDP levels. These transfers continue to play an important financial supporting role across mostly rural communities in countries lacking institutional structures channeling remittances towards economic development initiatives (though some proposals suggest a migration development bank to serve the purpose).

Institutions will come along

Continuing with the concept of initial conditions there is a duality: economic base and less tangible institutional development.

As mentioned above, the economic footing of the region varied, more favorably for the industrialized EE economies and less so for the CMEA dependent FSU, other than the larger commodity exporters in the group. Tamás Vonyo (2017) offers new empirical evidence suggesting that by the early 1980s the declining investment in industrial and technological upgrades, much necessary for the competitiveness of the EE’s semi-open economies, largely caused the growing inefficiency of those economies preventing wide-scale adoption of labor augmenting techniques, in contrast to the early 1950s post-war rapid growth. A similar argument is found in an earlier study by Vladimir Popov (2007) finds the lack of financial and technological upgrade of the fundamental industrial capacity of the Soviet Union by by the early 1980s as a major critical factor worsening the subsequent 1990s recession. Both observations, could be argued to be in parallel with the Kondratieff cycles concept, which has recently resurfaced as a possible conceptual framework in the post 2008 crisis analytical and policy work.

Of course, the unexpected element in the 1990s reforms was the dominance of the evolutionary and transformative nature of institutional development. This leads to the other side of the mentioned duality. There is no lack of relevant research in the problem of institutional change (e.g., Acemoglu and Robinson, 2012; Rodrik, 2004). In the post-socialist context, the problem of the 1990s transition policies was standardization across macroeconomic and evolving institutional change, in absolute dissonance with country specifics.

A set of collected studies edited by Gareth Dale (2011) annotates the subsequent trajectories of the resulting non“pure”-market outcomes. More recently the institutional literature has seen new researchers calling for more country specific analysis in economic reform as opposed to over-simplified one-size-fits all approach of “bundles” or “types” to economic systems (e.g. Jackson and Deeg, 2008 and Vonnegut, 2010). More substantially, Yegor Gaidar—the architect of the 1990s economic transformation in Russia—offered a sober analysis in one of his last contributions (Gaidar, 2012), recognizing the socially disruptive nature of the 1990s institutional vacuum.

New institutions lacked foundational traditions and required a long time to evolve—this realization is at odds with the predominant reforms first views of the early transition era. Still, Gaidar’s argument appears to be consistent with North’s (1991) definition of institutions as “the rules of the game in a society. Here society at a given time is the outcome and the driver of an evolving web of accumulating institutional tendencies. This necessarily implies gradual institutional emergence and adaptation to the new social norms and business practices, as the dynamic self-regenerating process of economic development takes over.

An emerging new concept of “varieties of capitalism” (Lane, 2007; Hall and Thelen, 2009; Myant, 2016; Hall and Soskice, 2001) seems to be capturing researchers imagination. Complementing the debate, Puffer et al. (2015) discuss varieties of communism, suggesting the influence of an even more complex mix of individual and nuanced social motivations rather than an all-encompassing institutional change. The former approach may help explain better the diversity of post-socialist economic models. Certainly, the question of the final destination must be openly discussed.

And still, in a recent update to the World Economic Forum, Eshe Nelson raised much concern about sustainability of strong economic growth and progressive social change in the region. Strikingly, perhaps to some observers, the reference is in to the top EE performing economies. For example, the author draws attention to unsustainable government spending in Romania or rise of populist business people in Czech Republic elsewhere; often disconnect between policy intentions of Poland (e.g. judicial reform) and the European Union, and other examples. In fact, Ivan Berend, an authoritative name in the field of transition economies, voiced strong reservations in his 2009 book From the Soviet Bloc to the European Union over the haste to declare absolute victory [in “transition”], citing large population displacement and rising social pressures, often unintentionally masked by the rapid economic growth mainly dependent on the integration within EU’s supply chain. From Southeast Europe to Caucasus and Central Asia, the smaller is the country the stronger is the challenge of securing broader economic activity, attracting competitive foreign direct investment, avoiding underdevelopment, and sustaining social inclusion; all without falling into dependence on the earlier mentioned expatriate remittances feeding into consumption cycles or significant levels of debt pile-up.

Why is this important now?

Still, there can be no doubt, today post-socialist societies of Eastern Europe and the former Soviet Union live in a more open cultural, political, and economic environment. The civil, political, and economic freedoms enjoyed by the region’s citizens are unprecedented in the scope of the twentieth century (and perhaps even earlier) offering much hope for continued progress in economic and social development. However, analysis of the causes of the 1990s massive economic losses and degradation of the living standards must necessarily be connected with the dynamic history of the region.

In broader context, the market liberalization reforms were the signals triggering a more systemic disruption, in turn exacerbated by the disparities of the preexisting conditions of the socialist economic model of the time.

Perhaps one of the difficulties for a nation is to become content with its own history. This is less so about repeating history but more about ability to objectively settle the past discontents to seek pragmatic balance of the present. These challenges are visible across the post-socialist geography, from Central Europe to Caucasus and Central Asia.

As for the future, it is by definition bright, progressive, and prosperous, which seems to be a unifying end goal here (as it naturally should be, perhaps).

And so while the past remains debatable and difficult to accept, while the future is full of promise, the present remains important as ever.

History teaches that to move forward, much attention should be given to the complexity of country specifics, regional dynamics, and, unsurprisingly, history itself. This, perhaps, would be the most critical lesson one is to draw from the late 20th century massive transformation of the societies and economies of Eastern Europe and the Former Soviet Union as it is relevant to contemporary macroeconomic and institutional processes.

It is tempting to find salvation in a rapid action. Perhaps, under certain conditions it may even be the right approach. Yet, from a social dialectic a more evolutionary approach might be more prudent instead.

Just how the individual ‘transition economies’ interpret this lesson in their present conditions will no doubt shape their future.

Aleksandr V. Gevorkyan is Assistant Professor of Economics at St. John’s UniversityHe is also the author of Transition Economies: Transformation, Development, and Society in Eastern Europe and the Former Soviet Union

Transition Economies: Transformation, Development, and Society in Eastern Europe and the Former Soviet Union is available via Routledge for purchase as well as for editorial reviews and via Amazon.

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