Emerging economies are ‘stuck in transition’

Erik Berglof, the EBRD’s Chief Economist, has delivered a speech at the ECB’s conference on “Emerging Market Economies as an engine of growth for the global economy: facts and challenges” in Frankfurt. Here is a summary of his remarks

Over the past two decades Eastern Europe has achieved a rapid convergence in income levels and significant institutional reform, but as this momentum has slowed many countries can now be described as “stuck in transition”.

The unique experience of transition in Emerging Europe provides a new perspective on the question of whether countries face a “middle income trap”. Many countries, particularly in Central and South-Eastern Europe have now reached income levels historically associated with growth slowdowns. They do not, however, share the characteristics that often accompanied such slowdowns in the past: their investment rates are not excessively high, their growth was not fuelled by undervalued exchange rates and, unlike other middle-income countries, they have not benefitted from a democratic dividend that is now exhausted. Moreover, it can be seen as encouraging that the East Asian countries that successfully avoided the “middle income trap” were, like Central European countries, small open economies.

Nevertheless, there are reasons to believe that even the most successful transition countries are in danger of getting “trapped”. Growth over the past decades was fuelled by very rapid improvements in productivity as Eastern Europe underwent a transformation from a capital-intensive economic structure to a more market-oriented model. Relative to their income levels, many countries have now eliminated this productivity-gap, and are unlikely to sustain the same pace of productivity growth in the future. Another defining feature of transition over the past twenty years has been the speed of reform. In some cases motivated by the prospect of EU-accession, countries across the Transition region made rapid progress towards creating the institutions required for markets to function. In recent years the reform process has stagnated, despite significant scope for further improvement. While this stagnation predated the global financial crisis in 08/09, the crisis may have compounded the problem by eroding popular support for market reform.

The diverse experiences of transition countries suggest that avoiding the “middle income trap” requires good political institutions. Across the region, the quality of economic institutions largely mirrors the quality of political institutions. In well-functioning democracies with strong legal frameworks, the transition process is less likely to be captured by particular interest groups and the threat of reform reversal is smaller. Improving political institutions may be a prerequisite for further economic reform in some countries and could ensure that they are not “stuck in transition”. Yet past experience suggests that political institutions are at best slow-moving and at worst structural. According to indices that attempt to measure institutional quality, the majority of transition countries have seen no significant change in political institutions since the early 1990s; an inertia that may be reflected in the more recent stagnation of economic reforms.

At the current level of institutions, the projected growth rates of transition economies are insufficient to ensure a rapid convergence of living standards with high income countries over the next twenty years. Decelerating productivity, combined with gradually aging populations, is likely to result in a slowdown of growth relative to the past decades. The danger of countries getting “trapped” could be averted by a reinvigoration of the reform process, however, this will require an understanding of what is feasible in light of existing political constraints.