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Produced by the Office for the Chief Economist, EBRD.

© European Bank for Reconstruction and Development

20.11.13

TRANSITION REPORT 2013

Stuck in Transition?

1

Erik Berglof

Chief Economist

Transition Report 2013 Stuck in Transition?


20.11.13

Transition stuck, almost everywhere

2

Eco

no

mic

Tra

nsit

ion



20.11.13

Income converged, but will it continue?

3

Growth since 1990

Pe

r ca

pit

a I

nco

me

(lo

g)



20.11.13

Income converged, but will it continue?

4

Growth since 1990

Pe

r ca

pit

a I

nco

me

(lo

g)

Source: World Bank



20.11.13

Motivation: will convergence resume?

5

Gro

wth

Real GDP growth y-o-y, per cent:



20.11.13

This Transition Report in a nutshell

6

I. Reinvigorating growth requires more reform and better institutions.

II. Two sets of factors shape the quality of economic institutions:

1. Broad political institutions: democratisation

2. International integration, human capital and local political reform

III. Democratisation more likely with economic development and reform

Transition to market can spur (or at least stabilise) democratic

transition, which in turn spurs more reform.



20.11.13

Why convergence may slow

7

Everyone focuses on slower capital flows. But this a cyclical

phenomenon which will lose importance in the medium term.

Better reasons to worry about convergence are:

1. The end of productivity catch-up related to early transition

2. Stalled reforms, even in less advanced transition countries



20.11.13

Convergence driven by growth of total factor productivity

8

Gro

wth

19

93

-20

10

Total growth of real GDP (PPP) from 1993 to 2010:

Source: Penn World Tables 8.0



20.11.13

9 Source: Penn World Tables 8.0

Tota

l fa

cto

r p

rod

ucti

vit

y (l

og)

Income per capita (log)

… but this productivity catch-up may now be complete



20.11.13

Similar trajectories for groups of countries To

tal fa

cto

r p

rod

ucti

vit

y (l

og)

Income per capita (log)

Source: Penn World Tables 8.0



20.11.13

With current policies, convergence will slow…

11

Inco

me

as a

sh

are

of

EU

15

in

co

me

GDP per worker as a share of EU15 average, actual and projected:

Source: EBRD calculations



20.11.13

…unless reform efforts can be reinvigorated

12

Inco

me

as a

sh

are

of

EU

15

in

co

me

GDP per worker as a share of EU15 average, actual and projected:




20.11.13


13










20.11.13

Democracy is strongly correlated with reform

14

Eco

no

mic

Tra

nsit

ion

Level of democracy

2012 Polity2 score (x-axis) and average country-level transition indicator (y-axis):

Source: Polity IV database and EBRD

© European Bank for Reconstruction and Development 2010 |

www.ebrd.com

15

Even political institutions in 1992

predict economic institutions in 2011 “Initial” political institutions matter



20.11.13

Democratisation has propelled reform – but not always

16

Eco

no

mic

Tra

nsit

ion

Average of 6 country-level transition indicators:

Source: EBRD



20.11.13

Democratic reversal impedes reform

17

Eco

no

mic

Tra

nsit

ion

Average of 6 country-level transition indicators:

Source: EBRD



20.11.13

Improving economic institutions for given political system

18

i. International integration and external anchors

• Both trade and financial integration; EU effect

ii. “Feasible political reform”:

• Particularly at the local/regional level

iii. Exploiting political windows of opportunity

• Relatively small political improvements (1-2 points on Polity

scale) can open a window of opportunity for reform

iv. Improving human capital

• Improves institutional capacity in normal times; ability to

exploit critical junctures; spreads fruits of reform



20.11.13

International integration comes with good institutions

19

Exp

lan

ato

ry p

ow

er

Fin

an

cia

l Tr

ad

e

Factors explaining institutional quality difference between top and

bottom transition countries, using WGIs as measure of institutions :




20.11.13

Large variation in business environment at regional level

20

• e.g. corruption as a business obstacle in Russian regions.

1st 3rd 5th 10th

2nd 4th 6th

Ranking of corruption relative to other obstacles to business

Source: Banking Environment and

Enterprise Survey 2012



20.11.13

Windows of opportunity leading to better economic

institutions: Slovak Republic and Georgia

21

Le

vel o

f d

em

ocra

cy

Qu

ality

of

insti

tuti

on

s

Polity2 (left axis) and average worldwide governance indicator (right axis):

Source: Polity IV database and World Bank



20.11.13

Missed opportunities: Romania (1995), Ukraine (2004)

22

Le

vel o

f d

em

ocra

cy

Qu

ality

of

insti

tuti

on

s

Polity2 (left axis) and average worldwide governance indicator (right axis):

Source: Polity IV database and World Bank



20.11.13

Factors shaping the success of windows of opportunity

23

1. Early transition histories – where powerful vested interests

arose after the collapse of central planning, they impeded

reform.

2. Political Polarisation – restricted reformers’ ability to initiate

and sustain change.

3. Leaders’ priorities – in some countries foreign-educated

leaders backed reformist agendas and tackled corruption.

4. External anchors and support – the prospect of EU

membership spurred reform, as did foreign financial and

technical assistance



20.11.13


24










20.11.13

Economic reforms help democracy

25

1. Make societies richer and build constituencies for democratisation

2. Strengthen competition and weaken resisting special interests



20.11.13

Early economic reforms help to predict democracy …

26

De

mo

cra

cy

in 2

01

1

Economic reform levels in 1992

Note: relationship holds controlling for initial levels of democracy.

Average country-level transition indicator 1992 (x-axis) and Polity2 score 2011 (y-axis) :

Source: Polity IV database and EBRD



20.11.13

Demand for democracy

27

• Evidence from the EBRD/World Bank Life in Transition Survey (LiTS)

shows that support for democracy may be affected by:

• Employment – employees of government agencies or state-owned

entities less likely than private sector workers to support democracy

• Education – better educated people more likely to support

democracy (even if they work in the state sector)

• Upward mobility – people who believe themselves to be better off

than four years ago more likely to support democracy.



20.11.13

Human capital, institutions and reform: the links

28

• Links to institutions in normal times: from human capital to

institutional capacity; from institutional quality to returns to education

• Importance in critical junctures – recruitment of young, educated

Georgians contributed to success of institutional reform after 2003.

• Effect via economic inclusion – quality of education and availability of

opportunities for young people across countries.



20.11.13

In transition region, tertiary education is the issue…

29

Qu

ality

of

ed

uca

tio

n

Nu

mb

er

of



20.11.13

…. but returns to education are also critical

30

• Better institutions improve returns to tertiary education

• Key to people acquiring education and to retaining them

Bra

in d

rain



20.11.13

The role of economic inclusion

31

• Reforms sometime undermined by lack of inclusion: e.g. Egypt before

revolution; privatisation in Russia ... (Euro area today?)

• Inclusion correlated with, but not fully captured by, democracy and

measures of institutional quality (e.g. rule of law).

This report

1. Measure economic inclusion “bottom up” as inequality of

opportunity (based on Life in Transition Survey)

2. Measure “inclusion gaps” across countries “top down”: by rating

capacity of markets and institutions to create opportunities for

women, young, and across sub-national regions .



20.11.13

Inequality of opportunity influences political and

economic perceptions

32

Average inequality of opportunity for people who answered:

Which is the most important

factor to succeed in life in our

country now?

What is the main reason why

there are some people in need in

our country today?



20.11.13

Conclusion

33

1. Time is on the side of democracy and economic reform

2. But the process can be slow, and some factors – like natural

resource abundance – can hold it back

3. In the meantime, countries can:

• Foster international – trade and financial – integration

• Strengthen regional competition and local accountability

• Invest in human capital and institutions



20.11.13

Stuck in Transition – how to get unstuck

34

• Foster trade and financial openness

• Promote local competition/accountability

• Invest in people – and in institutions

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