Op-ed

Fifteen years after the fall of the Berlin Wall: Reform needed to sustain growth in ex-communist sphere

International Herald Tribune, 9 November 2004

by Willem Buiter

Today marks the fifteenth anniversary of the fall of the Berlin Wall – the symbolic beginning-of-the-end of communism in central, eastern and southern Europe, Russia and central Asia. Reaching the end-of-the-end will depend on commitment to continue reforming economies and political systems. Despite some remarkable successes, that commitment appears to be wavering in much of the region.

It is taking longer than predicted for the 27 countries in this region to make the full transition from centrally planned to market economies and from communist totalitarianism to open and democratic political systems. The countries that acceded to the European Union this year have made the most progress. This is partly due to the EU incentive and partly because they did not face the same task of nation-building as did some former Soviet republics and parts of the Balkans. Besides EU membership, drivers for reform have included the lure of membership in the World Trade Organisation, development of new economic sectors, booming exports and the emergence of a vibrant entrepreneurial class.

Since 1989 there has been marked progress in such key reform areas as price, trade and exchange rate liberalisation; privatisation; banking sector reform and improvements in the legal environment. For most of the region, which suffered greatly in the chaotic and precipitous economic decline of the first post-communist years, there has been steady economic growth since the mid-1990s. For four years running, growth has exceeded the world average.

But those achievements are not proving sufficiently motivating to keep all these countries focused on the often painful next steps that will see them complete their transition to a market economy.

The carrot of EU membership

According to the EBRD’s Transition Report 2004, published today, enthusiasm for further reform has waned even in the countries that have changed the most dramatically as part of the accession process. Market liberalisation and other reforms cleared the way for the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovenia and the Slovak Republic to join the EU in May. Their growth for this year is forecast at almost five per cent, up from 3.3 per cent in 2003.

But now that the EU prize is in hand, the drive for further reform in these eight states risks losing steam. This year they account for just three upgrades across nine reform indicators tracked in the Transition Report. Especially in the four largest countries there is weariness with reform, with fiscal prudence and with persistently high unemployment. But without continued reform the anticipated benefits of joining the EU will not be fully realised.

Surge in Balkans reform

Currently the most ardent reformers are those in the EU waiting room. Romania and Bulgaria hope to accede in 2007, and Croatia soon after. They account for 10 transition upgrades, a third of those awarded in our report this year. For example there has been a surge in large-scale privatisations, including Bulgaria’s national telecoms company and part of Romania’s Petrom oil and gas company, and Croatia has improved its bankruptcy legislation and company law and initiated judicial reform. The more distant prospect of EU membership for Serbia and Montenegro, Bosnia Herzegovina, Macedonia and Albania is helping to promote reform there as well.

Growth without reform in the CIS

With oil around $50/barrel and prices also soaring for metals and agricultural products, the commodity-based economies of the Commonwealth of Independent States are booming. Growth is forecast at 7.4 per cent for 2004. But since commodity booms are inevitably followed by commodity busts, it is crucial to save much of these temporary windfalls and to diversify resource-dependent economies.

Economic diversification depends on enhancing infrastructure and strengthening the business environment. Yet in the CIS only the Kyrgyz Republic made significant reform progress in 2004, earning three transition upgrades this year.

Russia, on the other hand, has seen a slowdown in the pace of reform and earns only a single transition upgrade, for infrastructure reform in the railways sector. While Russia has been a transition leader in recent years, high growth rates and buoyant government revenues, both driven by oil and gas prices, have lowered the authorities’ sense of urgency for reform. The Yukos affair has raised concerns about private property rights and the selective application of the rule of law. These concerns have not diminished portfolio and direct investment inflows into Russia. However Russians themselves continue to invest in foreign financial assets on a very large scale due to concerns about their country’s investment climate; in 2004 the net export of Russian savings is expected to equal about seven per cent of GDP.

Reform required to sustain growth

The prize of EU membership has propelled reform in candidate countries. But ultimately the incentive for reform is the same for all countries in the region. Sustainable growth that delivers widely-shared benefits is the only long-term means of reversing high unemployment and poverty and, in the case of some CIS countries, the decline in life expectancy.

Fifteen years since the fall of the wall is just half a human generation – not that long a time to achieve the sometimes wrenching changes required to rein in corruption and build well-functioning market economies and democratic political institutions. These goals can be pursued even where democracy has not yet found a firm footing. Realising them will require further stores of patience, strong leadership, a willingness to take on vested interests and the endurance and skills to survive periods of political unpopularity.

Willem Buiter is Chief Economist of the European Bank for Reconstruction and Development with responsibility for production of the annual Transition Report.