The EBRD and transition

The EBRD and transition

The EBRD’s new broader transition concept, which comes into effect in 2017, argues that a well-functioning market economy should be more than just a set of markets; it should be competitive, inclusive, well-governed, environmentally friendly, resilient and integrated.

Here Hans-Peter Lankes and Sergei Guriev explain how we design and evaluate our investments and technical assistance projects.

Why do we have a transition concept?

Because we need to know what our objectives are when we invest or provide advice. Article 1 of the Agreement Establishing the Bank (AEB) spelled out that “the purpose of the EBRD shall be to foster the transition towards open market-oriented economies and to promote private and entrepreneurial initiative”. This defined the purpose of the EBRD in terms unlike the charters of conventional development institutions. The EBRD was to foster a change in economic systems – i.e., the way economic decisions are made - rather than directly pursuing development outcomes. What exactly constituted a “market-oriented economy” was not specifically defined, and so developing a shared understanding of it was an important task early in the EBRD’s life.

What lay behind the way transition was formulated in 1997?

Though employed since 1994 for the qualitative assessment of projects, the transition concept was ‘formalised’ only in 1997 in a paper by the Chief Economist. It set out three dimensions for measuring transition impact. One was the creation, expansion and deepening of markets. The second was the establishment and strengthening of institutions, laws and policies that support the market (including private ownership). The third was the adoption of behaviour patterns and skills that have a market perspective.

The paper also set out the “transition impact checklist,” describing seven key areas of potential transition impact of projects within these three dimensions, now familiar to all our bankers. The checklist allowed the EBRD to assess the relative merits of a project.

How did the review process now reaching completion come about?

The 1997 transition concept was a pragmatic, effective response to the EBRD’s project selection challenge - robust but also accommodating evolution, while sticking with the systemic, means-oriented perspective that is at its heart. The aim of the review we are now completing was to bring what we have learned since 1997 formally into our definition of transition.

There has been a global evolution over the past quarter century in defining a successful market economy.That includes the importance we now attach to sustainable energy, the key role of governance and institutions which proved fragile in the 2008 crisis, and the growing understanding of the need for markets to provide opportunities for women and disadvantaged groups.

What is the outcome?

The 2016 concept refines the notion of transition formulated in 1997, when all of the EBRD’s countries of operations were emerging from communism and faced a similar set of challenges on their way to capitalism. Now the basic components of market economies are in place, our countries are more diverse—some never had command economies—and they need different sets of reforms. The 2016 concept puts the emphasis on the desirable qualities of market economies in our region, in a language that is more accessible and easier to communicate than the transition checklist.

Does the new transition concept represent the need for a new balance between market and state?

Yes, one of the key lessons of the past 25 years is that transition is not only about building markets, but also about redesigning the state. Modern markets rely on efficient state institutions. Market and state are not substitutes, they complement each other. Therefore in order to build a market economy we should not minimise the state; instead, we should improve the quality of both state and market institutions. This new “complements rather than substitutes” view has direct implications for the EBRD’s work – as we enhance our policy dialogue activities to complement our investments.

What changes with our new transition qualities?

By consensus, Article 1 remains at the heart of our mandate. But while the 1997 concept stressed the components or structure of a market economy, we are now shifting towards the desirable qualities of a market economy. This emphasis remains compatible with a focus on systemic change. But it also implies that fostering a market economy should not be separated from the intended outcomes.  The six qualities identified foster and support sustainable market economies, which continues to be our overarching aim.

Here we understand sustainability far broader than environmental sustainability only (although the latter obviously remains our priority). We have in mind sustainability of capitalist and democratic institutions mentioned in Article 1. During the twenty five years of transition we have seen many examples of transition setbacks. Whenever the benefits of the reforms were not shared broadly, transition was not perceived as fair by the majority of citizens so that reforms were stalled or reversed.

In order to avoid the risks of reversals, we need assure that our works contributes to building not just a competitive, but also a well-governed and inclusive market economy. Inclusion makes sure that reforms deliver to underprivileged groups (including – but not limited to – women and youth). Governance is crucial for rewarding talent and hard work rather than rent-seeking – and prevents creating crony capitalist institutions. Both governance and inclusion are vital for the continued popular support of the reforms.

The crisis of 2008 brought home clearly that our framework had underplayed the role of resilience of economies and societies. Banking panics, volatility of asset prices – as well as of food and energy prices – also undermine the support for market economy. This is why we believe that our work promoting resilience of financial systems, food security and energy security should be taken into account when we assess transition impact of our projects.

We also believe that markets economies must be integrated. Internal and cross-border connectivity and integration of markets promotes competitiveness and resilience; thus, integration could be considered as a tool to achieve other qualities. However, given the rising populist backlash against globalisation, we include integration as a separate quality of a sustainable economy as we want to indicate that for EBRD integration is especially important. 

The environmental considerations set out as part of the EBRD’s operations from the start have also come under closer scrutiny as the world moves to tackle green issues. Their link to our transition concept was not straightforward since they could not purely be measured by price signals. Projects that targeted effluent reduction, for instance, such as those aimed at improving water quality in the Baltic Sea, used to receive low transition impact score. When the climate change agenda gained traction and the EBRD launched its Sustainable Energy Initiative in 2006 the transition concept evolved too. The solution, agreed in 2009, was to define investments in sustainable energy and associated subsidies as process decisions that compensated for inadequate price signals. Now, we go further, explicitly adding environmental sustainability to the list of desirable qualities of the market economy.

Finally, there is the question of country specificity. Twenty-five years ago, all our countries of operation faced similar challenges. Now, some of them have almost closed the gap with the West, while other still have many economic and political transformations to complete. Also, while transition still has a clear direction, it may not have a single end-point, as highlighted by institutional diversity across advanced market economies. Finally, the EBRD has expanded into countries which have never had a command economy and therefore their transformation is to proceed along a very different path. Therefore the original one-size-fits-all approach to transition impact assessment does not work anymore. In order to apply the new transition concept, we need to run a “country diagnostic” in terms of the six qualities listed above and determine priorities – which may be different in each country.