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Eastern Europe outperforms world economy
Better business climate curbed by agriculture's backwater status, says EBRD Transition Report
Growth in central and eastern Europe and the Commonwealth of Independent States slowed in 2002 but continued to outpace the world economy, says the latest Transition Report, published today by the European Bank for Reconstruction and Development. Output in the region is set to expand by 3.5 per cent this year, and by 4 per cent in 2003, after growth of 4.2 per cent in 2001. This compares well with a world output growth forecast for 2002 of 1.7 per cent.
The region's resilience reflects the strength of its reforms and a markedly better business environment. Transition indicators in the latest Report point higher in most of the 27 countries in which the Bank operates, with FR Yugoslavia chalking up the most significant progress for the second consecutive year.
At the same time, a survey based on 6,000 face-to-face interviews with entrepreneurs in 26 countries reveals improvements in finance, infrastructure, taxation, corruption and crime. The Business Environment and Enterprise Performance Survey (BEEPS) - conducted jointly by the EBRD and World Bank - found that the business environment of the region as a whole improved by about 0.5 on a 1 to 4 scale.
The region's agriculture sector and rural economy, however, are acting as a drag on the business environment. In a special section, the Report acknowledges that rural areas remain a backwater in terms of reform, with stagnating living standards. An urban bias in policy-making, combined with vested interests, has held back necessary reforms.
In all, said Willem Buiter, the EBRD's Chief Economist, emerging Europe remains one of the bright spots in an otherwise generally gloomy world economy. Mr Buiter emphasised the strength of the region's reforms, but said greater fiscal consolidation and further improvements in the business environment will be required. A litmus test for reforms is the ability to attract foreign investment. While foreign direct investment (FDI) to the region is set to reach a record $31 billion in 2002, this amount remains small relative to the size of the region.
Macroeconomic performance and prospects by region
In central eastern Europe and the Baltic states (CEB), growth is expected to slow to 2.3 per cent in 2002, as these countries are most affected by the EU slowdown, and rise to 3.7 per cent in 2003. The Report notes that slow growth in Poland reflects the aftermath of conflicting stances of fiscal and monetary policy. Prospects for south-eastern Europe (SEE) remain favourable, reflecting greater political stability and sub-regional cooperation, and growth is projected at 3.6 per cent this year and 4.1 per cent next year. In the Commonwealth of Independent States (CIS), where growth is forecast at 4.4 per cent for 2002 and 4.0 per cent in 2003, countries that benefit from significant natural resources wealth continue to grow rapidly, although in the region's largest economy, Russia, growth is expected to ease to just below 4 per cent.
Over the medium term, the Report asserts, the EU candidates must continue to attract foreign investment and raise productivity, while carefully managing the fiscal and monetary challenges of accession and membership. In SEE, large fiscal and external imbalances continue to cause concern. For CIS countries, the recent period of growth assisted by competitive currencies and high oil prices may be ending, and greater economic diversification is needed. Improving the capabilities of the state and managing high levels of external debt will challenge several of the poorer CIS countries.
Progress in transition by region
The greatest reform strides in CEB, particularly in the financial sector, were in the Baltic region, the Slovak Republic and Slovenia. The nearing prospect of EU accession has provided these countries with a clear incentive. In SEE, benefiting from favourable political and economic developments, Bosnia and Herzegovina and FR Yugoslavia have made significant advances in reform over the past year.
The implementation of reforms in the CIS has also sustained some of the forward momentum of recent years. In Russia, significant progress was made in strengthening financial discipline and improving corporate governance standards. Preliminary steps have also recently been taken to reform the electric power and railway sectors. In other CIS countries, Azerbaijan, Belarus, Tajikistan and Ukraine have taken measures to liberalise their trade and foreign exchange systems and to privatise state-owned enterprises, but elsewhere there was a lack of major reform gains.
Business Environment and Enterprise Performance Survey
This survey asks local firms about their perceptions and experiences of the business environment. The results represent a significant improvement from the first BEEPS, reported in the 1999 Transition Report. This reflects not only better macroeconomic performance but also underlying improvements in governance. A key finding from the 2002 and 1999 BEEPS is the improvement in the business environment of the region as a whole, with the strongest improvements in some of the less advanced countries of SEE and the CIS.
Perceptions of the business environment improved the most in the areas of finance, infrastructure, taxation, corruption and crime. These gains were broadly uniform across the region, except finance and crime, where SEE and the CIS scored relatively strong gains. There was less improvement in the areas of business regulation and the judiciary. Part of the problem is that many states are still too weak to rein in their own officials or to enforce their own rules and laws.
The unevenness of the business environment for different types of firms - from small, newly established private firms to large state-owned enterprises - has also diminished. Therefore, as the gap between front-runner and laggard transition countries is starting to close, entrepreneurs and new businesses see greater opportunities to overcome the negative legacies of the socialist past.
Notwithstanding these improvements, the most serious business obstacles in 2002 remain finance, taxation and corruption. While fewer firms report paying bribes, and those that do pay less as a share of their annual sales revenue, more needs to be done to improve governance in the region. Infrastructure is seen as the least problematic area.
Agriculture and rural transition
The Report's special section finds that agricultural reform and rural issues have not featured prominently during the first decade of transition, and that the degree to which agricultural reform has taken place is related to the extent of democracy and held back by vested interests.
However, agricultural reform is only one of the factors that explain differences in agricultural performance. Equally important are the initial conditions at the beginning of transition, liberalisation and privatisation elsewhere in the economy, and the extent and method of land reform. Countries that adopted policies that distributed land to collectives experienced lower output and productivity growth, as did countries with a low share of farmland in individual hands. Since the beginning of the reform process, transition countries have experienced a major reorientation of their agricultural trade toward OECD countries. There have also been significant increases in agricultural trade deficits. This is partly due to high levels of agricultural protection in most OECD countries, but also to low agricultural productivity, which remains a major factor limiting exports. Restricted access to the markets of the main industrial nations is a continuing problem for exporters of agricultural commodities and processed agribusiness products.
The Report finds that rural areas lag behind urban areas in many respects. Poverty and unemployment are much more common among the 134 million rural people of the region, and the rural business environment is less investor-friendly. As a result, rural enterprises have experienced slower growth, lower investment and more patchy restructuring than urban firms. The Report sees the strengthening of market linkages as an effective way to increase the efficiency of farms and diversify the economic basis of rural areas. Improved links between rural firms and their clients and suppliers can help bring about enterprise reform, develop skills and provide working capital. Another crucial link is between rural firms and financial institutions. Transition countries are still in the process of reforming their rural banking sector and developing the legal and institutional framework that would allow banks to increase lending to the rural market.
The Transition Report 2002 provides a detailed assessment of progress in transition, combining both region-wide and country-by-country analysis of the reform process. It also provides an account of macroeconomic performance and looks at the region's prospects. The series of Transition Reports began in 1994 and provide a valuable record of the historic political and economic reforms in CEE and the CIS and their impact on economic performance.
Also available in French, German and Russian .
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