IS THE TRANSITION ALREADY OVER IN THE FORMER SOVIET BLOC COUNTRIES? AN ATTEMPT AT A TAXONOMY OF POST-COMMUNIST ECONOMIES1
Dr Gennadi Kazakevitch
The concept of transition from one economic system to another implies identification of a starting point as well as a destination. In the case of economic transition in the former communist bloc countries, the starting point is known from those countries' historic experience. However, understanding of destination is based on knowledge about existing predominantly market systems, rather on previous historical experience at such a transition. By default, both reform strategists within the post-communist countries and foreign analysts prefer to think that the destination is a "perfect" system similar to the best performing industrialised market economies of Western Europe, Northern America, Japan or, perhaps, Australia.
In the euphoria of dramatic historical changes, it was easy to forget that the destination of post-communist transition to a market system can be different. The family of existent market economies includes various kinds of systems. The countries with very liberal market mechanisms have different levels of productivity and living standards. If the countries do not fell into the category of most liberal market systems, they have different proportions of public and private ownership, different principles of legislation and governmental regulation, different levels of performance, stability, prosperity and social welfare. Economic and political instability, considerable, but not always reasonable, governmental involvement in economic life and extensive corruption have been immanent features of some of them for decades or centuries. There were examples of rapid economic growth followed by drastic decline. From time to time, some of the market economies were engaged in more or less comprehensive and more or less successful economic reforms, which, however, did not affect the predominantly market substance of their systems. In additions, rapid and intensive reforms were followed by the periods of slow and gradual changes. On the other hand, the transitional economies themselves have already demonstrated considerable differences in the speed, sequence of and success in economic reforms, at list if the success is understood as attaining a "perfect-market-system" situation.
The question is whether the transition is continuing and whether the transitional economies (or some of them) are somewhere on their way to a desirable "perfect" market economic system. Alternatively, the transition is already over, and each of the former communist countries has transformed to a particular form of a market economy, analogous to one of the existing forms, more or less distant from the "perfect" one. In the letter a case, further transformation towards a "perfect" system can take more or less considerable time.
This paper represents an attempt at answering the above-mentioned question based on taxonomy of post-communist economies in association with other economic systems. Consideration is restricted to the former Soviet Bloc countries including former Soviet republics as well as the post-communist countries of Eastern and Central Europe. China and other countries still ruled by communist parties are not considered, though they are in the process of dramatic changes as well. The reason for that is that they themselves have not declared yet that they are in the process of "post-communist" transformation. The countries of what was former Yugoslavia are not considered because of insufficient information. In addition, East Germany is not considered separately from the rest of Germany, because, although the former socialist part of Germany is facing enormous economic and social problems, in terms of economic mechanism they have achieved the German and European Union standards through observing German federal laws and regulations.
The Freedom House Survey data 2 is used, but interpreted differently to how the authors of the survey used their data themselves. The detailed results of the Freedom House Survey contains qualitative data on 82 countries including the countries of the former communist bloc. The survey covers 90% of the World's population and 99% of the World's Gross Domestic Product. The expert data on each country is structured to unable ranking the countries based on a scalar indicator that the authors of the survey define as the level of economic freedom. The following categories are taken into account for ranking: freedom to hold property; freedom to earn a living; freedom to own a business; freedom to invest one's earnings; freedom to trade internationally; freedom from unreasonable government interference; and freedom to participate in the market economy. Based on a comprehensive analysis of the survey data, each category for each country is assigned a rank. The sum of the ranks for each country is interpreted as the level of economic freedom in the corresponding country. They also categorise the counties, according to the value of the level of economic freedom indicator, in three groups: free, partly free, mostly not free, and not free.
Meanwhile, the qualitative data, associated with each of the categories, allows much more than it was used by the authors for. It gives an opportunity to undertake a structured comparative analysis of economic systems, included in the survey, and to classify them using a multi-dimensional vector criterion rather than a scalar rank. Then, falling of a particular country into a particular groupparticular group (cluster) can be interpreted as closeness of that country, in terms of its socio-economic system, to other members of the corresponding group.
For the purposes of such an analysis, here the Freedom House Survey data is associated with the following characteristics of economic mechanisms.
This includes recognition by law and protection of private ownership law. In the case of "perfect" market system all types of transactions and activities with private property can be permitted by default. An owner have a right, protected by law, to decide how a particular property will be used, to receive income generated by its use, to transfer the property rights via gift or sale, and to keep an income from such a sale.
If a system is different from a perfect one, certain kind of restrictions on property use and/or transfers may be imposed beyond reasonable requirements of national security, safety standards or environment protection. Some types of property (such as land, mineral resources or infrastructure utilities) can be excluded from private ownership or some operations (such as sale of land or particular activities on the land) can be forbidden or restricted. Another problem with property right exists in the countries where the property rights legislation has been established but is not sufficiently enforced. Finally, the property rights may be non-existent, poorly developed or practically not enforced at all.
. The labour force of a particular country is either free to organise and join unions, or the unions are restricted or prohibited. In some cases, the unions are controlled by the state or the governing political party. The wages are either determined by market forces and are a subject of enterprise bargaining, or controlled by the state. The labourers are either free to change their occupation and/or an area of residence, or considerable legal, administrative or restrictions take place. On the another end of the spectre, such restrictions or closed shop arrangements are originated from unions. Another aspect of labour and industrial relation laws, which may or may not be enforced, is prohibition of elements of indentured servitude, bonded labour, or child labour.
. In a liberal market economic system, normally there are reasonably simple and easily observed rules of establishing and running businesses. The variety of restrictive regulations and mechanisms can include, however, unreasonably complex rules and bureaucratic procedures factually restricting or making difficult establishing new businesses. Other forms of restrictions can be different levels of price control for products and/or inputs, official administrative barriers to entry in particular industries or non-competitive governmental procurement.
. This characteristic is what international investors look at concerning investment climate in a particular country. Is there an independent central reserve bank or a comparable institution? Are interest rates, in general, or rates of return on investment, in particular, controlled by the government? Are international in and out transactions or holdings restricted of unreasonably administered? Are competitive mechanisms in the financial spheres? Are governmental bodies involved in credit allocation?
. This characteristic concerns with restrictive tariffs, export taxes, quotas, and other barriers to import and export. Alternatively, non-market control can prevail in the determination of directions and volumes of trade or exchange rates.
. This characteristic includes the equal rights of all subjects in a particular country to participate in a market economy as entrepreneurs, employees or investors. The legal rights can be, however, either enforced or abused by the governmental institutions. Those rights are more or less considerably restricted if the corruption is wide spread.
For most of above-mentioned characteristics, corresponding Economic Freedom House ranks vary from "3" to "0". For the last two characteristics the ranks are determined from "2" to "0".
Those characteristics form a vector criterion, which is applied to taxonomy of countries according to their predominant economic mechanisms. The method of hierarchical cluster analysis was used to classify the countries included in the survey according to this criterion. This procedure attempts to identify relatively homogeneous groups of cases (in this application the cases are actual countries) based on selected characteristics. A statistical algorithm is used, that starts with each case in a separate cluster and combines clusters until only the specified number of clusters is left and each of the cases belong to one or another cluster.
Attempts were made to obtain interpretable classifications based on from 5 to 10 cluster brackets. For the purpose of this study, the nine-cluster classification appeared to be the most interpretable. However, the following comments preceding the discussion of the obtained classification may help not to misinterpret the results.
Generally speaking, the order of clusters reflects the relative closeness of the countries, included in those clusters, to a "perfect" market system. However, it can or cannot be so with regard to two to three neighboring clusters. The neighboring clusters can be different in a limited number of characteristics and each of the characteristics can deviate to or from a "perfect" market system not always in the same direction.
Closeness of countries, in terms of the proposed taxonomy, does not always mean their closeness in terms of the level of economic or technological development, GDP per capita or other indicators of living standards. The only reason the countries are associated with each other is comparability of their economic mechanisms, at the time of the survey, in terms or the above-mentioned characteristics.
The ranking of the elements of economics systems by the Economic Freedom House is based on a comprehensive qualitative analysis of countries included in the survey. It is also based on structured criteria and in most cases seems to be pretty well justified. Nevertheless, some ranks can be understood as rather subjective opinion of researchers with regards to a particular information on a particular country. As a result, some countries appear in clusters that, intuitively they should not be in. In addition, the reforms continue, and what was true at the time of the survey sometimes is not true now. All those deficiencies, however, do not distort the overall picture significantly. No do they undermine the methodology or conclusions suggested in this article.
Keeping in mind all the above considerations, let us consider the former communist countries within the context of the suggested taxonomy of economic systems.
Cluster 1 includes the countries with developed market mechanisms. Belonging to this cluster could be considered as a desirable destination of post-communist countries in their transition, if it did not include the countries at different levels of productivity and living standards ranging from USA to Columbia and Ghana. Czech Republic, Poland and Estonia are the only post-communist countries, which, so far, have joined this family of "perfect market systems" 3.
Soon after abandoning their communist regimes and gaining independence from the Soviet rule or control, all three of them have adopted basic constitutional rights to hold property. There are no significant restrictions on selling or exchanging property, and individuals can structure their property holdings as they choose. At the same time they adopted legislation on and mechanisms of privatisation. Poland is rated lower, though, with regard to property rights due to sill existing considerable problems with protecting intellectual property rights and combating piracy. A lower rating of Estonia with regard to property rights is explained by unresolved problems with land ownership 4.
In all three countries both labour markets and labour rights have been established according to liberal market economy standards. Workers have got the right to form and join independent labour unions, and the regulation of wages has been eliminated. Entrepreneurship rights are observed through reasonable procedures of registration of businesses and elimination of most of price control. Meanwhile, prices for all or some of the following commodities, utilities and services are regulated: electricity, precious stones and metals, energy inputs, telecommunications and passenger transport.
Financial markets and investors' rights have been established and observed. There is no control of return on investments. Central banks with reserve functions have been established. However, at some stages a rather strict control of interest rates was introduces due to unresolved macroeconomic structural problems. There are now restrictive barriers to capital inflow or outflow excepting taxation on repatriated earnings. Non-tariff restriction on international trade have been considerably liberalised, though licensing of a limited number of exported and imported items still takes place. Equal opportunities of participation in market economy have been achieved in principle. However, controversial issues are discrimination of Roma (Gypsies) in Czech Republic as well as discrimination of Russian community in Estonia regarding employment, housing, and education due to Estonian-language requirements.
Cluster 2 includes countries with developed market mechanisms, though imposing relatively high (but not restrictive) barriers to international trade. Like the previous cluster, this one includes the countries ranging most developed to developing ones with various political systems. Another successfully reforming post-communist democracy, Hungary, is a part of this family. There are several reasons why Hungary appears to be associated with market economies where international trade is partially restricted. Hungary imposes a quota on the overall import of consumer goods. New trade regulations can be introduced without advanced notice. Some imported products require import licensing. There are restrictions on convertibility of the forint, and permission should be given by the authorities for taking out hard currency loans.
Cluster 3, including Lithuania, Bulgaria and Slovakia is characterised by a relatively lower profile, than in the previous two clusters, of private ownership mechanisms. They have high barriers to international trade and relatively low level of equal opportunities in the economic sphere.
In Bulgaria some products are either banned from export or are subject to strict licensing. Informal discrimination against Roma in employment and social benefits exists.
In Lithuania, the exchange rate is fixed by the government in consultation with the Bank of Lithuania. The reason why Lithuania is ranked lower in terms of equal opportunities in the economic sphere is widespread corruption and organised crime. Although the legislation is brought to the standards closed to European Union requirements, private business people complain about arbitrary high taxes, import restrictions and corrupt bureaucrats.
In Slovakia, all import is subject to licensing. Apart from complains of the Hungarian minority about informal abuse of their rights, equal opportunities in running businesses are also restricted through continuing subsidising , inefficient state companies.
Cluster 4 countries, including Latvia and Romania, are characterised by different levels, normally below the highest ones, of all indicators. They have a high to medium levels of labour and entrepreneurship rights and a relatively low level of equal opportunities in the economic sphere. In particular, there is evidence of discrimination of the Russian Minority in Latvia and Hungarian minority in Romania. However, they all have achieved a reasonable level of deregulation of the labour market and international trade.
Cluster 5 includes former Soviet republics: Kyrgyz Republic, Russia and Ukraine. They have various profiles of private ownership mechanisms. They have reasonable levels of entrepreneurship rights, low to medium level of barriers to international trade, though, relatively low level of labor rights and equal opportunities 5.
In all three countries Workers have the right to establish and join trade unions and to affiliate with international labour organisations. However, the successors to the Soviet-era All-Union Central Council of Trade Unions under different names have largely retained bot the majority of membership and the privileges and control mechanisms of the old official structures. Free interregional migration of labour force is still restricted either by the Soviet era legislation (Kyrgyz Republic), or by new regulations replacing old one (Russia), or by socio-economic reasons limiting the formation of adjustable regional labour markets (Ukraine).
Cluster 6, including Belarus, is characterised by a relatively low profile of all market mechanisms and medium constraints on international trade.
Among the former Soviet Republics, Belarus is notorious for low profile of both human rights and progress in economic reforms. Although all forms of ownership have been permitted, private ownership of land is prohibited except for small household farming that was inherited form the Soviet times. The restriction on land ownership as well as private ownership in a number of industries considerably slows the process of privatisation and establishing new businesses. The privatisation of housing, although proclaimed on paper, has not been fully implemented. There is no a clear regulation on the registration of businesses, and bureaucratic restrictions prevail.
By law, workers are allowed to join unions and engage collective bargaining. However, there have been incidences of collective bargaining violation and unions suspension. The largest trade union was inherited from the Soviet era and still controls some of social functions. The government sets state sector wages. The privatised enterprises often set wages comparable with the government sector. Interest rates and long-term credit allocation are still under control of the central government. Import restrictions and restrictive export taxes limit the development of international trade. Exchange rates are controlled and the amount of currency that can be exchanged in one transaction is restricted. The National Bank of Belarus is dependent upon the Government and the Parliament. Overall, the government retains control over about 90% of GDP. Large state enterprises, most of which are state monopolies, are subsidised by the government.
Cluster 7 has a low profile of all market mechanisms and hard constraints on international trade.
Cluster 8 consists of just two counties. Like the countries of the Cluster 7, the systems included in this cluster are characterised by a relatively low profile of all market mechanisms. However, the labour rights at a higher level and there are hard constraints on investor's rights. Both Clusters 7 and 8 do no include former Soviet Bloc Countries.
Cluster 9 includes three former Soviet republics: Uzbekistan, Kazakhstan and Azerbaijian. It is characterised by hard governmental intervention in all or almost all components of market mechanisms 6. This includes: retaining of the major industrial sectors in public ownership; the Soviet type of trade unions; compulsory work of industrial workers and students in harvesting; retaining of the government's control on prices for basic consumer goods; restriction on purchasing foreign currency; direct control of the central bank by the government; licensing of export (with the exception of joint ventures); and retaining some elements of the Soviet stile planning system.
The considered classification may be used then to return to the question in the title of the paper: is the transition already over in the former Soviet bloc countries?
As it was mentioned earlier, from time to time all the countries, including the most developed and the most close to a "perfect" market mechanism ones, are engaged in more or less comprehensive and more or less rapid restructuring of their systems. Therefore, all of them can be considered as being at some stage of transition. The question is, therefore, if the specific kind of transition, namely the rapid escape from the Stalinist and post-Stalinist type of economic mechanism is over, and the former communist countries are now in the process of rather more prolong and gradual changes.
Looking at the clusters, the former Soviet Bloc Countries are associated with according to the suggested classification, it can be concluded that they have joined one of two types of families. One of them includes many or some examples of rather long economic histories of established market economic systems or they are developing nations (Clusters 1-6). Another one consists of only developing nations. (Cluster 9). In both cases, strong similarities can be found of the current state of economic systems in the former communist countries, on the one hand, and other members of clusters with more or less prolong experience of a gradual progress of reforms within an existing economic mechanism, on the other hand. Therefore, it is possible to conclude that the most dramatic short-run transformation in the former Soviet Bloc countries is over. Long term struggling for better economic systems is ahead.
Endnotes:
1 This is a revised version of a paper presented at International Conference on Communist and Post-Communist Societies, Melbourne University, 7-10 July 1998.
2 World Survey of Economic Freedom, 1995-1996. Freedom House, 1986.
3 If it is not stated otherwise, the following sources were used for characterising economic mechanism of different countries:
World Survey of Economic Freedom, 1995-1996. Freedom House, 1986 Country essays
Bureaucrats in Business: The Economics and Politics of Government Ownership. World Bank Policy Research Report. (Washington, DC: World Bank, 1995.)
Lambsdorff, Johann G. 1995 Corruption Index. (Berlin: Transparency International, 1995).
Shleifer, Andrei. Establishing Property Rights. (Washington, DC: The World Bank, 1995).
4 Republic of Estonia: Recent Economic Developments. Report No. 95/40. (Washington, DC: IMF, May 1995).
5 Brooks, Karen and Zvi Lerman. Land Reform and Farm Restructuring in Russia. World Bank Discussion Paper No. 233. (Washington, DC: World Bank, 1994). Webster, Leila. "Newly Privatized Enterprises: A Survey." In Ira W. Lieberman and John Nells, ed. Russia: Creating Private Enterprises and Efficient Markets. (Washington, DC: Private Sector Development, World Bank. 1994).
6 Kazakhstan: The Transition to a Market Economy. (Washington, DC: World Bank, 1993). Kygyzstan: The Transition to a Market Economy. (Washington, DC: World Bank: 1993).