CATO INSTITUTE

1
CATO INSTITUTE

• BOOK PRESENTATION
• SEPT. 25,2006
• OLEH HAVRYLYSHYN
• IMF CERES, University of Toronto

2
(No Transcript)
3
OUTLINE

• I. Expectations in 1989.
• II. Outcomes 15 yrs. later
• III. Why different outcomes ?(group 1 Liberal
  Democracies vs. group 2 Oligarch States)
  
• IV Prospects for completing transition in
  Captured States?
  
• V. Summing Up

4
I EXPECTATIONS AND DEBATES

• Euphoria and optimism generally, but social pain
  expected, some lose some win
  
• Fast or slow
• What to do first ? (sequence)
• How to mitigate adjustment costs,social pain

5
(No Transcript)
6
(No Transcript)
7
All of 1990s Years of IMF Programs
8
BIG-BANG vs. GRADUALISM DEBATE

• Gradual reforms allow time to create new
  industries and jobs as old eliminated, to reduce
  social pain most important recommendation put
  in place market institutions before
  liberalization of prices, markets
• Big-Bang needed to change incentives, close
  rent-seeking opportunities and lobbying by Red
  Directors, prevent opponents of reform to delay
  process for own interests

9
DEMOCRACY VS MARKET REFORM DEBATE

• Przeworski Market reforms cause pain.
  Democratic elections bring back renamed communist
  parties. Reforms reversed.
  
• Balcerowicz Early democratization gives
  historical opportunity to move from communism to
  liberalism of markets and polity.
  
• (Bunce calls this Dual Liberal Vision)

10
II OUTCOMES

• How to measure?
• Economic performance, democratic
  evolution,poverty and distribution,social
  indicators,regime typology, oligarch formation
  

11
Measuring Outcomes

• Progress to Market (EBRD-TPI)
• Economic Performance (GDP growth, inflation,
  FDI)
  
• Social well-being (UNDP-HDI poverty, literacy,
  health, etc)
  
• Degree of Democracy (contestable elections, media
  freedom)
  
• Rule of Law( judicial and administrative
  institutional quality corruption).
  
• Type of political regime (democratic, autocratic)

12
EBRD-TPI EXCELLENT PROXY

• TPI a synthetic measure by EBRD experts of degree
  of free-market economy
  
• 1.0 Central plan economy
• 4.3 Fully operational market
  economy
  
• TPI turns out to have strong statistical
  correlation with other outcome measures, e.g.
  
• TPI and democracy
• TPI and social well-being

13
EBRD Transition Progress Indicator 2004
14
Economic Recovery
15
Financial Stability
16
CUMULATIVE FDI PER CAPITA 1989-2003, U.S.(By
Subregion)
17
DEMOCRACY AND MARKET LIBERALIZATION
18
HUMAN DEVELOPMENT INDICATOR(UNDP Highest Value
Norway0.944 Lowest Value Sierra Leone0.275)
19
Outcome Regime-Types

• Liberal societies with capitalism for all, open
  markets (CE, BALT Bg Cr Romarginal)
  
• Still-undetermined polities (Some SEE) but
  progressing.
  
• Oligarch societies, with capitalism for the few
  non-competitive markets (most CISM)
  
• Unreformed polities, still very soviet-like
  (CISL)
  

20
Concentration of Forbes Billionaires
21
Preliminary Conclusions on Outcome

• Wide-divergence of outcomes regardless of
  measuring stick dumping communism and letting
  capitalism blossom not so automatic.
  
• In some countries real open markets with
  capitalism for all, in some non-competitive
  markets with capitalism for the few (oligarchs).
  
• Przeworski hypothesis not confirmed by facts
  market liberality and political liberality
  complements rather than trade-offs.
  
• Gradualist strategy for easing social costs or
  reforms not confirmed by outcomes on the
  contrary the more rapid reforms, the lower were
  social costs and the earlier they were overcome.

22
BIG-BANG vs. GRADUALISM EVIDENCE

• When countries properly classified, BB perform
  much better on all indicators even most
  surprisingly on social indicators
  
• Governments claiming pursuit of gradualist
  strategy delayed both liberalization and
  institutional development
  
• One could conclude self-acclaimed gradualist
  governments more interested in self interest than
  easing social pain

23
IIIWHY DIVERGENT OUTCOMES?

• Encyclopedic Approach 27 different stories for
  27 countries, each with unique combination of
  history, initial conditions, geographic-cultural
  distance to Europe etc.
• Problem cannot see the forest for the trees
• Political-Economy model three main causal
  factors broadly but not perfectly applicable to
  all countries
  
• how long reforms debated and delayed
• how powerful are vested interests
• how important was reform discipline of
  international club memberships (EU, IMF)

24
WHY DIFFERENT OUTCOMES THE NAVIGATION MODEL

• Uncharted waters Debate and delay cause slow and
  partial reforms, postpone adjustment
  
• Pirate raids Rent-seekers stronger where old
  elite survives, and even stronger if reforms are
  slow and partial
  
• Safe havens Progress steady, rent-seeking
  mitigated by efforts at global integration Most
  powerful beacon was EU membership

25
VICIOUS CIRCLE OF DELAYED REFORM AND OLIGARCHIC
DEVELOPMENT
26
State Capture Index, 1999
27
State Capture Higher the Longer Delay in
Stabilization
28
State Capture Lower the More Rapid Reforms
29
Regression Results State Capture 1999 determined
by (1) months to 5 Inflation and (2) TPI after
4 years
30
IV Prospects for Captured States

• BB v. GRAD Debate is history future, new debate
  is Transition Inevitable(TI) vs. Transition
  Frozen (TF)
  
• TI argument high degree of ownership eventually
  leads even oligarchs to seek security of property
  rights, (Coase Theorem in a market any demand,
  including for institutions, will generate a
  supply (Schleifer (1995) Aslund (1997) but
  different view later) (Buiter (2000)
  Yesterdays thief is the staunchest defender of
  property rights)
• TF counter argument as long as rents and
  privileges from non-transparent lobbying exceed
  value of equal property rights for all, oligarchs
  prefer status quo (Havrylyshyn (1995) Hellman
  (1998) Polischuk Savateev (2004) Sonin (2003)

31
State Capture Leads to Frozen Transition
32
CAPITALIST ELITES IN HISTORY

• Rent-seeking and Oligarch resistance to
  liberalism, not unique in Post-Communist
  Societies
  
• Elite Entrenchment Resistance to liberal
  markets (article by Morck et al,
  Journ.of.Econ.Lit., September 2005).
  
• Elite, or Incumbent Capitalist Lobbies against
  competition (e.g. Glass-Steagall Act.,1934, USA
  see Rajan and Zingales (2003) Saving Capitalism
  from Capitalists.
• Successful Rent-Seeking Rewarded by Shareholders
  Lee Iacocca of Chrysler and US quotas on
  Japanese automobiles.
  
• Post-Communist States, degree of state capture
  and short-time for oligarch creation very
  different and special in history. Not equivalent
  to US Robber Barons or Chaebol in Korea.

33
REDUCING POWER OF OLIGARCHS

• Create open environment for small business.
• Transparent and equal application of tax
  licensing, tender, other government actions.
  
• Very judicious use of
• re-privatization
• Colour Revolutions provide opportunity to apply
  measures, but do not guarantee reversal of state
  capture.

34
VSUMMING UP WHAT HAPPENED?

• Widely divergent outcomes, Central Europe and
  Baltics fully liberal societies, most CIS in
  frozen transition of oligarch regime.
  
• Fears that rigid reforms cause greater social
  pain unfounded this argument for gradual reforms
  used maliciously by opponents of reform who
  contributed to formation of oligarch regimes.
• No trade-off between democracy and market
  reforms where leaders and populace committed to
  dual liberal vision, the two reinforce each
  other.

35
SUMMING UP Why it happened?

• Where reforms debated and delayed too long,
  vested interests, high jacked transition and
  oligarch regimes resulted.
  
• EU membership a very powerful instrument for
  pursuing commitment to dual liberal vision.
  

36
SUMMING UP WHAT NEXT?

• Best antidote to oligarch power is a strong
  middle-class anchored by small business.
  
• Colour revolutions by the demos can affect
  oligarch power, but as always in history
  entrenched elites do not give up power easily.
  

37
APPENDIX
38
Table 4. Quality of Institutions in Transition
Economies 1997-98
39
Summary Outcome (cont.)

• Output recovery in all
• CE, Baltics, some in SEE, steady progress, strong
  FDI
  
• CISM growth surge (10) since 2000, slowed
  sharply 2005
  
• Even by official data. CE, BALTICS, SEE life
  much better
  
• Unofficial data, consumer choice life is better
  even in CISM (bananas expensive but always
  available)
  

40
Summary Outcome (cont.)

• Social impact
• Some social costs in CE, B, SEE, but most
  overcome
  
• Very unequal benefits in CIS, GDP poverty,
  social indicators still not fully recovered
  
• Very high unemployment remains in most countries

41
BIG-BANG vs. GRADUALISM EVIDENCE

• When countries properly classified, BB perform
  much better on all indicators even most
  surprisingly on social indicators
  
• Governments claiming pursuit of gradualist
  strategy delayed both liberalization and
  institutional development
  
• One could conclude self-acclaimed gradualist
  governments more interested in self interest than
  easing social pain

42
Transition Countries and Type of Reform Strategy
43
Transition Indicator Values by Year and Type
44
RENT-SEEKING TYPES HIGH AND LOW
45
EU OFFER AND REFORM DELAY