The Post-Communist Transition: Patterns and Prospects

• Author: Julian Exeter and Steven Fries
• Position: Senior Economist in the Office of the Chief Economist at the European Bank for Reconstruction and Development/Director of Policy Studies in the Office of the Chief Economist at the European Bank for Reconstruction and Development

Most formerly centrally planned economies have laid the foundations for a market economy. Their future development will depend on how they respond to the challenges of the next phase of transition: developing the public and private institutions-in particular, a strong financial sector-needed in a healthy market economy.

ALTHOUGH the transition from a command to a market economy began in the late 1980s in some Eastern European economies, political developments following the fall of the Berlin Wall in late 1989 and the breakup of the Soviet Union two years later sharply accelerated this process. The collapse of the previous economic systems and relationships, and the ensuing large-scale reorientation and reorganization of production initially sent output and trade into a steep decline and triggered rampant inflation. Since then, however, the countries of Central and Eastern Europe and the Baltics, Russia, and other countries of the former Soviet Union have made significant progress in transition and in stabilizing output and prices (see "Ten Years of Transition: A Progress Report" by Patrick Lenain, in this issue).

Transition has so far comprised two distinct phases. The first, which is largely complete in most (but not all) countries, consisted of the liberalization of markets and trade, privatization of state enterprises, and withdrawal of government from many activities. In the second phase, now under way in some countries, the key challenges are to develop the public and private institutions that underpin an effective market economy, to strengthen the state's capacity to raise revenues and provide the public services that are essential to a market economy, and to ensure that sound business practices become more firmly established. The response to these challenges will ultimately determine the extent of competition, quality of corporate governance, climate for investment, and prospects for longer-term growth. A major challenge faced by all these countries is the need to strengthen their financial sectors-the recent turmoil in East Asia provides a stark reminder of the danger of not doing so. And, for some transition economies, the process of economic reform and institutional change will be shaped by the prospect of accession to the European Union.

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Progress in transition

A few former Soviet Union countries have yet to meet the challenges of the first phase of transition-market liberalization and privatization (Chart 1). While particularly difficult legacies from the era of central planning may be partly responsible, the fact that some countries have made far less progress than others with which they share many common features (for example, Belarus and Russia) points to the influence of political factors. Moreover, how well the transition economies are functioning today and the paths their future development will follow are, to a great extent, a consequence of decisions they made in the early days of reform, especially with respect to the method of privatization, which can have a significant impact on corporate governance and enterprise restructuring over the longer term.

Monitoring the transition process

In 1991, the European Bank for Reconstruction and Development (EBRD), a multilateral financial institution headquartered in London, was established for the purpose of fostering the transition in Central and Eastern Europe and the former Soviet Union countries. To help it fulfill this mandate, the EBRD has monitored and analyzed the progress that these countries have made toward establishing market economies. Since 1994, it has published an annual Transition Report, which assesses the progress of member countries in all of the many complex dimensions of transition-including price and trade liberalization, competition policy and demonopolization...