Economic Transition in Eastern and Central Europe
Readings
CRAFTING MARKET Appel and Orenstein
ECONOMIES Orenstein
Gryzmala-Busse CH 4
Guiding Questions
What ideas shaped the post-transition economic systems of democratic ECE states?
How was neoliberalism implemented in ECE?
What challenges have arisen during economic transition?
What explains economic growth in the post-transition era?
Why were ECE states so committed to neoliberalism?
Transitioning from a Command Economy (Kornai 2000)
Two dominant economic models in the 20th century: socialist and capitalist.
Both have system-specific attributes that allow differentiation.
Framing of political power: In socialist economies, power is typically centralized within the state, often an autocratic Marxist-Leninist one-party system. Capitalist economies, conversely, disperse power through various actors, including private enterprises and democratic institutions.
Distribution of property rights: Socialist economies feature state or collective ownership of the means of production, whereas capitalist economies emphasize private property rights.
Coordination mechanisms (bureaucratic or market-based): Socialist economies rely on bureaucratic planning to coordinate economic activity, while capitalist economies depend on market mechanisms such as supply and demand.
Both have system-specific attributes that shape economies, societies, political systems, cultures, etc.
A socialist economy required an autocratic Marxist-Leninist one-party state to function. This political structure ensured the state's control over economic planning and resource allocation.
The fall of communism created a vacuum. The collapse of these regimes left a void in both the political and economic spheres, necessitating the rapid construction of new systems.
Transitioning from a Command Economy (Kornai 2000)
Once the region determined democracy would shape the political sphere, transitioning to capitalism was a foregone conclusion. The shift towards democracy in Eastern and Central Europe (ECE) was intrinsically linked with the adoption of capitalist economic models.
"Capitalism is a necessary condition for democracy" and is "faster at increasing production and labor productivity, and thereby the material welfare of human beings." This perspective framed capitalism as the optimal engine for economic growth and improved living standards.
Many forms of capitalism are consistent with democracy. While capitalism was seen as essential, the specific type of capitalist model could vary.
The big question was NOT whether to adopt a capitalist model, but which TYPE of capitalist model to adopt. The central debate revolved around the characteristics of the capitalist system to be implemented.
Two types of capitalist models typically associated with democratic states:
Liberal market economies (LMEs). These prioritize market mechanisms, minimal state intervention, and individual economic freedom.
Social market economies (SMEs). These emphasize social welfare, income equality, and a more significant role for the state in regulating the economy.
Comparing Economic Logics (McCormick 2010; Pontusson 2005; Crepaz 2017)
Liberal Market Economies (LMEs) - Anglo-Saxon Model
More comfortable with the role of the market in society. LMEs embrace the market as the primary mechanism for resource allocation and economic decision-making.
More risk-acceptant; more comfortable using credit. These economies encourage entrepreneurship and innovation, with a greater willingness to take on financial risk.
Limited state services reduce the need for high levels of taxation and regulation. The state provides a minimal level of social services, resulting in lower tax burdens and fewer regulations on businesses.
Increases market freedom but reduces resources for social welfare programs. This approach prioritizes economic efficiency and individual choice but may lead to greater income inequality.
Agnostic over social cohesion and income inequality. LMEs do not necessarily prioritize social cohesion or actively seek to reduce income inequality.
Support private sector in the provision of public services. Private companies are encouraged to deliver services such as healthcare and education.
Promotes competition in the provision of goods. Competition among firms is seen as essential for driving innovation and efficiency.
Absence of "non-market coordination (i.e., corporatism)" among business, government actors, and unions. LMEs typically lack strong corporatist structures that involve coordination between business, government, and labor unions.
Coordinated/Social Market Economies (CMEs/SMEs) - Rhenish Model
Less comfortable with the role of the market in society. CMEs view the market as requiring significant regulation and oversight to ensure social welfare.
More risk-averse; less comfortable using credit. These economies prioritize stability and security, with a more cautious approach to financial risk.
Expanded state services to ensure income equality and job protection. The state provides a comprehensive array of social services, including unemployment benefits and healthcare, to promote income equality and job security.
Reduces market freedom and requires higher taxation. This approach limits individual economic freedom but provides a stronger social safety net.
Boosts social cohesion and communal values. CMEs place a high value on social cohesion and the well-being of the community.
Opposition to privatization in the provision of public services. Public services are generally provided by the state rather than private companies.
Presence of "non-market coordination (i.e., corporatism)" among business, government actors, and unions. CMEs feature strong corporatist structures that facilitate coordination between business, government, and labor unions.
The Washington Consensus (Orenstein 2013; Stokes 2012; Appel and Orenstein 2016)
Transition is an opportunity to "reform" the economy; a liberal market economy is seen as necessary. The shift from command economies was viewed as a chance to implement LME principles.
"Washington Consensus" greatly shaped this debate. This set of neoliberal policies advocated by international financial institutions heavily influenced the transition process.
Rapid privatization, removal of state business subsidies, enactment of austerity measures in social welfare spending, discontinuance of price controls, passage of balanced budgets, lowering taxes, open markets, etc. These policies aimed to create a market-oriented environment.
Would root out inefficient industries and reorganize state/society according to market principles. The expectation was that these reforms would eliminate inefficiencies and promote economic growth.
States first need to reform bureaucracy to implement reform. Effective implementation of these policies required a capable and efficient bureaucracy.
Bureaucracies implement executive decisions AND allow the state to function. Bureaucracies are essential for translating policy decisions into concrete actions and ensuring the smooth operation of the state.
Bureaucracies and State Exploitation (Gryzmala-Busse 2007)
The logic of bureaucracy is shaped by its occupants. The behavior and effectiveness of a bureaucracy depend on the individuals who staff it.
Bureaucracy in theory:
Hierarchical: Structured with clear lines of authority and responsibility.
"Rule-bound, impersonal and specialized, characterized by a division of labor, established routine, professionalism, and merit.": Ideally, bureaucracies operate based on established rules and procedures, with decisions made impartially and based on merit.
But in practice, it can vary:
Characterized by "political patronage, nepotism, and social networks where merit is not a criterion." In reality, bureaucracies can be subject to political influence, with appointments based on personal connections rather than qualifications.
Problematic, as bureaucrats possess "hidden information." Bureaucrats often have access to information that is not readily available to policymakers or the public, which can create opportunities for corruption or manipulation.
Bureaucracies and State Exploitation (Gryzmala-Busse 2007)
"[… ] the unregulated and unmonitored growth in the number of those employed in central state ministries, regulatory and tax agencies, social security administration and their territorial offices" is a key part in understanding transition in ECE. The expansion of state employment without adequate oversight contributed to state exploitation in Eastern and Central Europe.
Particularly relevant in crafting ECE economic transition. This issue was especially important during the economic transition in ECE countries.
"Discretionary expansion" of bureaucracy varies widely within the region. The extent to which bureaucracies expanded varied significantly across different countries in the region.
Crafting Bureaucracies (Gryzmala-Busse 2007)
First question: How do we staff the bureaucracy?
Some kept Soviet-era bureaucrats (e.g., Bulgaria): They know how to run a state; just ensure loyalty to new regime. This approach maintained continuity but required ensuring the loyalty of former officials.
Others purged old bureaucrats (e.g., Slovakia, Poland, and Hungary): Cannot ensure loyalty; provides opportunities for new appointments; often lacked expertise. This strategy aimed to create a clean break but often resulted in a loss of institutional knowledge.
NOTE: Purges do not always come during the initial transition (Example: Hungary in 2010). Purges could occur later in the transition process, not just at the beginning.
In either circumstance, governments must hire new bureaucrats, creating openings for state exploitation. Hiring new officials created opportunities for patronage and corruption.
Expansion of the Public Sector (Gryzmala-Busse 2007)
Examples of political parties looking to expand the public sector NOT to reward their electoral base, BUT to gain control over state resources for private use. Political parties sometimes expanded the public sector to gain access to state resources for their own benefit rather than to reward supporters.
Did not target specific electoral constituencies to build an electoral base (patronage/clientelism). These actions were not primarily aimed at building political support through patronage.
Did not see a rise in state employment in administering the welfare state (due to privatization). Privatization efforts meant that increased state employment was not primarily related to administering social welfare programs.
Expansion of the Public Sector (Gryzmala-Busse 2007)
Chief mechanisms to expand control over state resources include:
Hiring party allies to occupy positions within the government and/or creating new "quasi-state" entities controlled by allies. This involved placing political allies in government positions and establishing new organizations under their control.
Use allies to control oversight/implementation of regulatory policy. Allies were used to manipulate regulatory policy for private gain.
Relied on the creation of new quasi-state entities more than staffing existing positions within the state. Creating new entities was preferred over simply filling existing positions in the state bureaucracy.
Could impact oversight and/or redistribute patronage outside of the state. These actions could undermine oversight mechanisms and shift patronage networks.
Robust competition is associated with SMALLER levels of growth within "discretionary" bureaucratic offices (e.g., Hungary, Estonia, Slovenia, Lithuania, and Poland). Greater political competition tended to limit the expansion of discretionary bureaucratic offices.
States with weaker levels of competition are associated with HIGHER levels of state expansion (i.e., Czech Republic, Slovakia, Bulgaria, and Latvia). Weaker political competition was linked to greater expansion of state bureaucracies.
The Washington Consensus Redux (Orenstein 2013; Stokes 2012)
Second question: How to enact economic reform.
Elites knew unemployment and prices would rise and wages would fall. Policymakers were aware of the potential negative consequences of economic reforms.
BUT believed privatization would inject new investment into the system AND reward those who follow "market logic." They believed that privatization would attract investment and reward market-oriented behavior.
New production would increase consumption AND eventually decrease unemployment. The expectation was that increased production would lead to greater consumption and lower unemployment.
The Washington Consensus Redux (Orenstein 2013; Stokes 2012)
The debate was not over WHETHER to adopt neoliberal reforms, but how quickly. The main point of contention was the speed of implementing neoliberal reforms.
Two broad strategies identified: "shock therapy" and "gradualism."
"Shock therapy": a quick jump would create short-term dislocation but more growth in the medium to longer term (Strategy employed by Poland and the Baltic states). This involved rapid and comprehensive reforms aimed at quickly transitioning to a market economy.
Gradualism: states should ease into economic reform to provide the right social/political basis for economic transition (Strategy employed by Hungary). This approach favored a slower, more incremental approach to reform.
Consequences of Economic Reform (Orenstein 2013; Stokes 2012)
The recession was not as "short-lived" as promised: "Wip[ed] out between 15% and 75% of 1989 GDP." The economic downturn was more severe and prolonged than initially anticipated.
Reforms did not work as well as anticipated. The reforms did not produce the expected positive outcomes.
Privatization did not trigger a foreign capital boost; no new "Marshall Plan." Privatization failed to attract significant foreign investment.
Economic inequality exacerbated, and poverty levels increased. Economic disparities widened, and poverty rates rose.
No longer the citizens vs. party elites…shift to business entrepreneurs vs. labor. The primary conflict shifted from citizens against party elites to business owners against workers.
Business AND outgoing communists did VERY well. Both business elites and former communists benefited significantly from the transition.
Youth migration increased and strained state and society. Increased emigration of young people put pressure on state resources and social structures.
Infant mortality increased, and life expectancy decreased (now stabilized). Health indicators worsened during the transition, although they have since stabilized.
Neoliberalism and Reform (Orenstein 2013; Stokes 2012)
Four types of economies among the "EU-10":
Liberal market economies (Baltic neoliberalism). These economies embraced neoliberal policies.
Coordinated market economy (Slovenian corporatism). This economy relied on corporatist structures.
Dependent market economies (Visigrad). These economies were dependent on foreign investment.
Weak state (Eastern Balkans). These economies had weak state institutions.
In the early 2000s, it was believed that states that "went the furthest" on neoliberal reforms had better growth rates, but this was re-evaluated by mid-decade. Initial assessments suggested that more neoliberal states experienced faster growth, but this view was later revised.
More neoliberal states associated with:
Higher growth in the early 2000s.
More suffering during the credit crisis. Neoliberal states were more vulnerable during the global financial crisis.
The Consequences of Reform (Orenstein 2013; Stokes 2012)
Autocracies also engaged in reform (i.e., authoritarian development), typically tying economies to Russia. Authoritarian regimes also implemented economic reforms, often aligning their economies with Russia.
Democracies AND autocracies look similar. Both democracies and autocracies exhibited similar economic patterns.
Deep economic shocks in the 1990s are typical for economies undergoing structural transitions. Significant economic disruptions were common in economies undergoing structural changes.
Economic growth in the early 2000s. Many economies experienced economic growth in the early 2000s.
Economic contraction after the credit crisis. The global financial crisis led to economic contraction in many countries.
The Consequences of Reform (Orenstein 2013; Stokes 2012)
Begs questions about whether liberal democracy and economic reforms were "self-reinforcing." This raises questions about whether democracy and economic reforms mutually reinforce each other.
The rise of illiberalism. The rise of illiberal political movements presents a challenge to democratic consolidation.
Begs questions about the Washington Consensus: Was the pain necessary? Was the pain even productive? This prompts questions about the necessity and effectiveness of the Washington Consensus policies.
The Case for Authoritarianism? (Kornai 2000; Orenstein 2013; Stokes 2012)
Capitalism can co-exist within an authoritarian state if it permits private ownership + markets. Capitalism can function in an authoritarian context if private property and markets are allowed.
If we assume that autocrats are actually building a vibrant market-based economy, then authoritarian development can provide the economic reforms needed to promote growth without any "ballot box" instability. If authoritarian leaders genuinely aim to create a thriving market economy, authoritarian development can facilitate economic reforms without the risk of political instability.
Can reinforce growth in the short/medium term by limiting rent-seeking WITHOUT risking being voted out of office. Authoritarian regimes can promote short- to medium-term growth by curbing rent-seeking without fear of electoral consequences.
The question becomes whether a vibrant market-based economy is the actual goal (e.g., Singapore) or not (e.g., Belarus). The key question is whether the authoritarian regime's true goal is to build a market economy, as in Singapore, or not, as in Belarus.
The Case for Democracy (Kornai 2000; Orenstein 2013; Stokes 2012)
Value lies in "guaranteeing political freedoms and preventing tyranny." The value of democracy lies in protecting political freedoms and preventing authoritarian rule.
Where democracy is stable, it can reinforce growth. Stable democracies can promote economic growth.
Democracy is most stable in systems associated with the EU: Transparency and EU relations limit rent-seeking; EU members can experiment without backsliding (Baltics, Visigrad, Eastern Balkans). Democracy is most stable in countries associated with the EU due to transparency and the constraints imposed by EU membership.
Where democracy is unstable, it can undermine growth: Transition creates opportunities for state exploitation; elite contestation creates instability, undermining investment; reforms may be avoided for fear of vote loss (or coup) (Western Balkans, Moldova, Ukraine). Unstable democracies can undermine growth due to state exploitation, elite conflict, and political risks.
Why Adopt Neoliberalism? (Appel and Orenstein 2016; 2018)
"No region has embraced neoliberalism as enthusiastically and persistently as post-Communist Europe and Eurasia," despite a "host of political, cultural, and institutional obstacles" expected to thwart neoliberal reform efforts. Post-communist Europe and Eurasia embraced neoliberalism more enthusiastically than any other region, despite facing significant obstacles.
Expected economic and political pain would undermine implementation, yet neoliberal reforms persisted through governments of the left AND right. Despite the expected negative consequences, neoliberal reforms persisted under both left- and right-leaning governments.
Neoliberal policies will be enacted through the Great Recession and became MORE rather than LESS radical over time, "includ[ing] the flat tax, pension privatization, the slashing of corporate tax rates, extreme monetarism, and strong central bank independence." Neoliberal policies were implemented even during the Great Recession and became more radical over time.
Why Adopt Neoliberalism? (Appel and Orenstein 2016; 2018)
Persistence of neoliberalism in ECE from 1989-2008 WAS NOT a function of:
Citizen acquiescence: Protests and demonstrations were observed. The persistence of neoliberalism was not due to citizens' acceptance.
Europeanization: Governments enacted policies NOT required for EU accession. Governments implemented policies that were not required for EU membership.
Varieties of capitalism: ECE economies similar to each other (Low domestic savings, need for capital, desire to integrate into the global economy, "near hegemonic embrace of free market ideology"). ECE economies shared similar characteristics, such as low domestic savings and a desire to integrate into the global economy.
Why Adopt Neoliberalism? (Appel and Orenstein 2016; 2018)
Persistence of neoliberalism in ECE from 1989-2008 WAS a function of:
Competitive signaling: They needed to differentiate from other emerging economies; they were "Capital poor" and dependent on loans from the West + international institutions; hence an early adoption of the Washington Consensus. Countries in the region needed to differentiate themselves from other emerging economies and relied on loans from Western countries and international institutions.
Needed foreign direct investment, so they were competing against each other AND other developing regions, needing to get investor attention. They competed with each other and other developing regions for foreign direct investment.
Enacting more radical neoliberal reforms would "signal" the attractiveness of their business environment. Implementing more radical neoliberal reforms signaled the attractiveness of their business environment.
"Sudden stop" of capital inflows after the Great Recession kills neoliberalism. The "sudden stop" of capital inflows after the Great Recession undermined neoliberalism.
Dealing with Discontent? (Kornai 2000)
There remains a great deal of frustration throughout the region, often tied to decisions made during the transition era. Significant frustration persists in the region, often related to decisions made during the transition.
Transitioning economies may still be "backward" vis-à-vis capitalist economies. Transitioning economies may still lag behind established capitalist economies.
No quick "fix", but requires recognizing that this is not the fault of transition. There is no easy solution, but it is important to recognize that this is not necessarily due to the transition itself.
Transitioning economies and societies may need time to "solidify." Transitioning economies and societies may require time to consolidate their development.
Governments should be able to provide the resources/expertise to facilitate. Governments should provide resources and expertise to facilitate this process.
Dealing with Discontent? (Kornai 2000)
Capitalism (like socialism) has some inherent flaws (e.g., inequality). Capitalism, like socialism, has inherent flaws, such as inequality.
Citizens should press political elites for needed reforms to reduce inequality or push back against capitalism. Citizens should pressure political elites to implement reforms to address inequality or challenge capitalism.
Corruption can be a byproduct of capitalism and it must be rooted out, but it is also a byproduct of socialism. Corruption can result from both capitalism and socialism and must be addressed.
Evaluating Neoliberalism (Orenstein 2013)
Neoliberalism greatly shaped the post-transition era, but it's unclear whether it helped regional economies ("U-shaped recessions, social/economic displacement, corruption"). Neoliberalism significantly shaped the post-transition era, but its impact on regional economies is unclear.
Unclear if democratization promoted economic growth; growth was evident in democracies AND autocracies, and only "went together" in EU members. It is unclear whether democratization promoted economic growth, as growth was observed in both democracies and autocracies and was only consistently linked to EU membership.
Evaluating Neoliberalism (Orenstein 2013)
"Geopolitics, more than reform or democracy, …separate[s] the winners from the losers." Geopolitical factors, more than reform or democracy, determined which countries succeeded and which ones failed.
Ties to either the EU or Russia benefit the economy. Links to either the EU or Russia benefited economies.
The Eurozone crisis threatens EU health, creating challenges for consolidation. The Eurozone crisis poses a threat to the EU and creates challenges for consolidation.
The decline in oil prices weakens Russia, with ripple effects in Post-Soviet states. The decline in oil prices weakens Russia, with ripple effects in post-Soviet countries.
Was It Worth It? (Orenstein 2013; Stokes 2012)
Initially, citizens believed painful reforms were necessary. Initially, citizens believed that painful reforms were necessary.
After the global credit/eurozone crises, citizens are no longer giving governments "wide berth." After the global credit and Eurozone crises, citizens became less tolerant of government policies.
Economic fears exacerbate other tensions (e.g., immigration/asylum), reinforce pessimism AND promote populism. Economic anxieties exacerbate other tensions, reinforce pessimism, and promote populism.
Fears once again spiked in the aftermath of COVID-19. Fears were heightened again following the COVID-19 pandemic.
Was It Worth It? (Kornai 2000)
ECE citizens are understandably upset at the pace/direction of the transition. Citizens in Eastern and Central Europe are understandably upset about the pace and direction of the transition.
Researchers, pundits, opinion-makers, and politicians should know better than to demagogue the transition. Researchers, pundits, opinion-makers, and politicians should avoid demagoguing the transition.
Citizens AND governments need to make the case for democracy AND for capitalism. Both citizens and governments need to advocate for democracy and capitalism.
Conclusions: But What About Corruption? (Kostadinova and Spirova 2018)
Discussions of corruption as a function of how economic reforms were implemented remain ongoing. Discussions about corruption in relation to the implementation of economic reforms are ongoing.
Main definition: "the misuse of public office for private gain." The main definition of corruption is the misuse of public office for private gain.
Explanations for why corruption/state exploitation is more pervasive in some states over others varies:
Legacies of communism suggest political culture was impacted by Soviet domination, BUT discussions lack a causal mechanism explaining corruption. Legacies of communism suggest that political culture was affected by Soviet domination, but discussions lack a clear causal mechanism explaining corruption.
Institutional reform posits the need to create oversight institutions, BUT, even with oversight institutions created, the implementation of reforms is key. Institutional reform emphasizes the need for oversight institutions, but the implementation of reforms is crucial.
Market competition contends "market forces" reduce returns to corruption, BUT, liberalization appears to have opened up new opportunities. Market competition argues that market forces reduce corruption, but liberalization may have created new opportunities for it.
Conclusions: But What About Corruption? (Grzymala-Busse 2007; Kostadinova and Spirova 2018)
Independent bureaucracies take decades to form and stabilize. It takes decades for independent bureaucracies to form and stabilize.
Does robust competition AND/OR Europeanization provide the BEST opportunities for an independent bureaucracy? Do robust competition and Europeanization provide the best conditions for an independent bureaucracy?
Robust competition and Europeanization are the most cited explanations for state exploitation in ECE. Robust competition and Europeanization are the most common explanations for state exploitation in Eastern and Central Europe.
Robust competition suggests incentives to engage in exploitation are linked to party competition, BUT, if competition dissipates after transition, the impact weakens, AND if electorates are volatile, does competition actually help? Robust competition suggests that incentives for exploitation are linked to party competition, but if competition weakens or electorates are volatile, its impact may diminish.
If parties believe they’ll be voted out regardless of what they do in office, does robust competition impact incentives? If parties believe they will be voted out regardless of their actions, does robust competition affect their incentives?
Europeanization suggests EU accession conditionality can force states to combat exploitation, BUT, the EU is better at exerting leverage BEFORE accession as opposed to AFTER accession. Europeanization suggests that EU accession conditionality can force states to combat exploitation, but the EU has more leverage before accession than after.