The EBRD and transition

Article 1 of the Agreement Establishing the Bank 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 – in the way economic decisions are made – rather than directly pursue development outcomes.

What exactly constituted transition towards an “open 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.

The EBRD’s transition concept argues that a well-functioning market economy should be more than just a set of markets; it should be competitive, inclusive, well governed, green, resilient and integrated.

Hans-Peter Lankes and Sergei Guriev, two of its authors, explained at the time of its launch how the transition concept has evolved and how it affects the way we design and evaluate our investments and technical assistance projects.

Use of the transition concept for the qualitative assessment of projects began in 1994, but it was "formalised" only in 1997 in a paper by Nick Stern, the Bank's then Chief Economist, and Hans Peter Lankes. 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.

The 1997 transition concept was a pragmatic, effective response to the EBRD’s project selection challenge – a robust but also accommodating evolution, while sticking with the systemic, means-oriented perspective that is at its heart. The aim of the review, completed in 2016, was to bring what we had 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 important shift to sustainability, 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.

The 2016 concept refined the notion of transition formulated in 1997, when all of the EBRD’s countries of operation were emerging from communism and faced a similar set of challenges on their way to capitalism. In 2016, the basic components of market economies were already in place, our countries of operation were more diverse – some had never had centrally planned economies – and they needed different sets of reforms. The 2016 concept put the emphasis on the desirable qualities of market economies in our regions, in language that was more accessible and easier to communicate than the transition checklist.

Yes, one of the key lessons of the past 30 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. 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.
 

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, in 2016 it shifted 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 transition qualities identified foster and support sustainable market economies, which continues to be the EBRD's overarching aim.

Here we understand sustainability in a far broader sense than environmental sustainability only (although that also remains a priority). We have in mind the sustainability of capitalist and democratic institutions mentioned in Article 1. During more than 30 years of transition, we have seen many examples of transition setbacks. Whenever the benefits of reforms were not shared broadly, transition was not perceived as fair by the majority of citizens and the reforms stalled or were reversed.

To avoid the risks of reversals, we need ensure that our work 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 the creation of crony capitalist institutions. Both governance and inclusion are vital for the continued popular support of 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 market economies must be integrated. Internal and cross-border connectivity and the integration of markets promote competitiveness and resilience; therefore, integration could be considered a tool to achieve other qualities. However, given populist backlashes against globalisation, we include integration as a separate quality of a sustainable economy as we want to indicate that for the 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, as 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 scores. 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. More than 30 years ago, all our countries of operation faced similar challenges. Now, as the EBRD expands its horizons even further, the challenges our economies face may differ vastly. 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 that have never had a centrally planned economy and therefore their transformation will proceed along a very different path. The original one-size-fits-all approach to transition impact assessment does not work anymore. 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.