Op-ed

Don't Let Success Breed Complacency

The Wall Street Journal Europe, 25 November 2002

By Willem Buiter

For the second year in a row, the economies of Eastern Europe and the former Soviet Union are outperforming the European Union -- and indeed, on average, the rest of the world. Every one of the countries is growing. Most enjoy well-rooted macroeconomic stability. Many see their capital inflows increasing.

After a decade of often painful transition, the benefits of market reform couldn't be more clear. The EU candidate countries will be crowned for their efforts at next month's Copenhagen summit, when they are officially invited to join. In southeastern Europe and the former Soviet states too, political and regional stability, combined with sustained reforms, is drawing investors. Moscow has been the world's top-performing stock market for the past two years. Indeed transition laggards such as Yugoslavia, Albania and Bulgaria are starting to catch up with the frontrunners -- though the gap remains wide and indeed not all the frontrunners are performing to capacity.

But where these countries go from here is not so clear. It is evident that the region is not immune to global developments, and is slowing down. The question for both the accession countries and those outside is whether they can keep it up.

The reasons for emerging Europe's above-average growth -- and how it might be sustained -- are clear. Long-term investment, especially foreign direct investment, has flowed fastest where structural and institutional reforms are most advanced; that is, to the EU candidate countries, where structural and institutional reforms have been deepest. Price liberalization, privatization and macroeconomic stabilization alone are not sufficient to keep a country on the path to prosperity.

Nor do macroeconomic measures ensure that the growth process is inclusive, and that those who lose out in the reforms are properly protected and assisted. The approach to reform adopted in the process of EU accession has served the EU candidates well, and is now being embraced by southeastern Europe. In particular, the requirement to adopt the body of EU law and regulations, together with the need to boost the competitiveness of local companies as they enter the single European market, has helped sustain the drive to reduce bureaucracy, streamline taxation and improve access to infrastructure and finance.

Many countries in Central Europe and the Baltics now face serious fiscal policy challenges. Most of the accession candidates have levels of public spending that are significantly higher than those found in other emerging markets with comparable per-capita incomes. All the more reason for policymakers in the region to use expected improvements in the global and regional economy to achieve overdue reductions in the size of structural government budget deficits. The demographics -- already-grey populations aging further -- also point to the need for current spending restraint.

Without such changes, the improvements seen in countries such as Bulgaria and Romania, and in many CIS countries will not sustain appropriate levels of growth. In Russia, Kazakhstan and Ukraine, the strength of the recovery is fading as their exchange rates appreciate in real terms, crimping competitiveness. Oil and gas exporters remain vulnerable to volatile world prices.

How Russia in particular meets these challenges will have implications for the region as a whole. According to our transition indicators, among the 27 countries in our region, Russia achieved, after Yugoslavia, the most significant progress in economic reform during the past year. Spanning two continents, 11 time zones and a multitude of cultures and ethnic identities, the task for Russia remains formidable. There is an urgent need to diversify the economy away from excessive dependence on oil and gas, and to attract investment into manufacturing and services. At the same time, strengthening of the rule of law by promoting an impartial and effective judiciary, independent of the executive branch of government, must be a priority. So too with measures to enhance political competition independent media and human rights. Successful economic transition and political pluralism go hand-in-hand.

The prospects for the region have clearly brightened. But the current period of relatively resilient growth should not give rise to complacency. There are both pressing short-term challenges to be addressed, to maintain macroeconomic and financial stability in the face of a still-moribund global economy, and longer term challenges to build sound market institutions.

Mr. Buiter is chief economist of the European Bank for Reconstruction and Development.