Hubert Gabrisch

Privatization and Competition

Chapter 4 addresses the relationship between ownership transformation and the establishment of competition. Competition is the driving force of an innovative market economy with private ownership. But privatization — the core of ownership transformation — is a necessary policy to generate a competitive private sector, but it is far from being sufficient. We discuss the problem of the ‘soft’ budget constraint, which prevails in CPEs with state-owned firms and which is a stubborn attendant of transition, when ownership transformation is conducted in a non-competitive way and a non-competitive environment. A taxonomy of privatization presents the various ways in which ownership transformation has been pursued. Finally the difficulties in creating a competitive environment are illustrated with an analysis of anti-trust policy in transition countries.

Emerging Labour Markets

Chapter 5 provides an overview on the impact of transition on labour markets. It starts with some indicators describing the liberalization of labour relations. It then directs the focus on to the unemployment problem during and, possibly after, transition. The chapter introduces a model that describes the conditions for an initial rise and later fall of unemployment due to an optimal speed of restructuring the state-owned sector: the model of the optimal speed of transition (OST). Two macroeconomic concepts are used to indirectly assess the relation between market rigidities and unemployment — the Beveridge curve and Okun’s law. Both concepts suggest that the present high unemployment in countries should no longer be understood as a transitional problem or a problem of too rigid markets. It is rather a matter of too little economic growth.

Country Case Studies

The treaty on the economic, currency, and social union with the Federal Republic of Germany (West Germany) of 1 July 1990 implanted the West German economic and social constitution almost instantly in the GDR. The economic union imposed the constitution that ruled the West German market economy including the common law of the European Union on a socialist CPE. The social union introduced the West German set of social entitlements to the GDR — the pension system, the unemployment benefits, the health system. The currency union made the D-Mark the legal tender in East Germany and regulated the conversion of the East German Mark. This import of West Germany formal institutions was more or less finished when the GDR acceded to the Federal Republic on 3 October 1990 and was transformed into the 5 new federal states of Germany. East Germany was included in the European Union, the Union’s first eastern enlargement.

Transition and EU Membership

Chapter 8 looks at the challenges for transformation concerning membership of the European Union. We concentrate on competition policy as the core of a competitive transformation and membership within the European Monetary Union (EMU) and its fiscal requirements. The chapter concludes with an exploration of fiscal transparency in the biggest new EU member country, Poland. We show that the EU law regarding competition policy has been implemented; the fulfilment of the Stability and Growth Pact (SGP), however, raises some concern, because the precondition of fiscal transparency cannot be taken for granted.

Opening towards the World

Chapter 6 distinguishes between the benefits of an open economy and the specific risks of opening the economy. A first challenge to transition policy is how to mitigate the shocks on production stemming from getting distorted price relations right after the removal of trade controls and selective protection. The chapter explains why, and how, output declines when opening leads to a massive adjustment of price relations via a higher price level as well as via changing the positive into the negative value added of industries. The chapter further discusses whether, and how, to use the exchange rate of the currency as a non-selective tool for protecting the economy. The chapter also illustrates that the exchange rate tool becomes more or less ineffective when the government lifts capital controls. The exchange rate depends on free capital flows, and undesired capital movements have their own impact on output via the exchange rate and the financial system.

Financial Institutions, Stability and Growth

Chapter 3 stresses the importance of well-functioning financial systems for economic development in a market economy. It is no exaggeration to claim that the transition countries had to build up their financial institutions from scratch. In the planned economy money had no economic function and had to be re-established in the process of transformation.

Two Competing Concepts of Transition

Chapter 2 presents two different intellectual concepts of transition. On the surface, these concepts were initially identified with the debate about ‘shock-therapy versus gradualism’. However, the differences were deeper and rooted in different schools of economic thought. Behind the shock approach we find the so-called ‘Washington Consensus’, which dominated economic policy in transition countries for many years. This approach is based on liberalization, privatization and stabilization as cornerstones of the transition to a market economy. The contributors to this approach shared a deep belief in flexible prices, market transactions, and a minimalist state. The approach is contrasted with the ‘evolutionary-institutionalist’ concept, which emphasizes the role of informal institutions such as behavior and mindsets as well as formal institutions such as the rule of law. This approach takes into account that institution building is a time-consuming process, in particular when some institutions such as those of the financial sector within the transition countries have to be created from scratch.

The Meaning and Measurement of Transition

Chapter 1 introduces the reader to the characteristics of economic transition. We explain transition as a fundamental change in institutions, and show that progress in transition has been made above all in changing formal institutions; the transformation of informal institutions, however, still lags behind. Corruption, little interpersonal trust and trust in public institutions cause high forgone gains in income generation, employment, and equity. We further evaluate the achievements of institutional changes in terms of sustainable and equitable economic development, and compare expected with actual results. We find that differences between the Chinese transition and transition in Russia and other CEE countries can be explained by country-specific institutional arrangements.

Rising Income Inequality

A relatively even distribution of income was one of the classic attributes of the socialist system. This changed dramatically during the period of transformation but stabilized in CEE to almost continental European levels. Not so in Russia, where inequality levels remained significant. Chapter 7 is structured as follows. We first summarize the standard explanation for rising inequality, which is a microeconomic approach in a partial analytical framework. Its application to transition economies is briefly presented. We then reflect on the macroeconomic issues related to the distribution of income: various approaches are discussed in this context. We then present an empirical analysis of the Czech Republic, Hungary, Poland, and Russia, organized in a sequence of general income development, personal income distribution, and functional income distribution plus transfers. The following section reconsiders the performance of each country, and gives hypothetical explanations. The conclusion reviews the countries into the context of convergence and divergence.