Survey 99

41

44Economic Survey of Europe, 2000 No. 1

The Transition Economies43

CHAPTER 3

THE TRANSITION ECONOMIES

3.1Introduction

(i)Expectations and outcomes

Aggregate GDP in the ECE transition economies increased by some 2 per cent in 1999, the highest average annual rate of growth for the transition economies as a group during the first decade of their economic and political transformation. However, the average figure for 1999 masks an unusual degree of volatility during the year as well as considerable differences between the individual economies. Performance was very weak in the first half of the year, and especially the first quarter when more than half of the transition economies plunged into recession; in contrast, there was a marked recovery of output in most of these countries in the second part of the year.

The uneven pace of output growth in the transition economies was predominantly driven by external factors: the widespread recessionary pressures during the first half of the year which followed the sharp weakening of output during the second half of 1998 were largely the aftershocks of the global financial turmoil and the Russian crisis, coupled with the economic fallout from the Kosovo conflict; conversely, the upturn in west European import demand in the second half of 1999 was an important factor behind the recovery in eastern Europe as well while commodity exporters, especially in the CIS, benefited from generally rising demand and better prices for some commodities. The vulnerability of most of the transition economies to external disturbances is yet another sign both of their high dependence on their external markets and of the absence of efficient policy mechanisms to counterbalance negative developments from abroad.

The recent volatility of output as well as the generally high, although varying degree of susceptibility to external shocks led to large discrepancies between ex-ante expectations and actual outcomes in many transition economies in 1999 (table 3.1.1). These differences were greatest in the three Baltic economies where the actual GDP growth rates were several percentage points lower than the official forecasts. GDP growth was generally less than expected in most of eastern Europe but the dismal figure for the increase in their aggregate GDP (1.4 per cent) largely reflects the poor performance in south-eastern Europe which was weakened by the economic consequences of the Kosovo conflict; in contrast, the average rate of growth in the central European transition economies (3.1 per cent) remained almost unchanged from that in 1998 (3.2 per cent).

The growth of GDP in the Russian Federation in 1999 (3.2 per cent) was not only the highest achieved during the past decade but was also much higher than all the forecasts, including the official ones (table 3.1.1). As discussed below, in sections 3.2 and 3.3, it would be premature to draw general conclusions about Russias growth prospects on the basis of one years outcome, which reflects to a large extent a cyclical upturn after the output collapse of 1998. At the same time the performance in 1999 marks a notable departure from Russias past record in several important respects: apart from the notable recovery of output (especially in industry), total employment also increased for the first time in a decade and there were also signs of the steep decline of investment demand coming to an end.

The transition economies are still undergoing to varying degrees deep structural changes accompanied by large-scale reallocation of resources. The new corporate sector, now dominated by private actors (combining new private firms and privatized, former state owned enterprises), is already the main engine of growth in many transition economies, especially those which are the more advanced with reforms. Largely operating in accordance with the principles and norms of the market economy, and capable of facing competitive pressures, the new corporate sector serves at the same time as a shield that increases the overall resilience of the economy to external disturbances, provided it is supported by efficient policy mechanisms. But in many transition economies, the prolonged existence of an unrestructured sector of inefficient, large state owned firms continues to be a major handicap for the transition economies, which increases their vulnerability to external shocks. Moreover, the slow process of closing down (or downsizing) unviable firms is itself a persistent (albeit diminishing) source of transformational recession in those economies that are lagging behind in the reform process. In turbulent periods (such as that between mid-1998 and mid-1999) it may be difficult to differentiate between the cyclical and transformational components of recession; however, it seems plausible that the unrestructured part of the enterprise sector among other factors has amplified the negative repercussions of external shocks in some of the less advanced transition economies.

-100

-80

-60

-40

-20

0

20

40

60

1996

1997

1998

1999

Real lending rates b

Real deposit rates c

Bulgaria

151.7

-100

-80

-60

-40

-20

0

20

40

60

1996

1999

1998

1997

Croatia

-10

0

10

20

30

40

1996

1999

1998

1997

Czech Republic

-10

-5

0

5

10

15

20

1996

1999

1998

1997

Hungary

-10

-5

0

5

10

15

20

1996

1999

1998

1997

Poland

-10

-5

0

5

10

15

20

25

1996

1999

1998

1997

Romania

-100

-80

-60

-40

-20

0

20

40

60

1996

1999

1998

1997

Slovakia

-15

-10

-5

0

5

10

15

20

25

1996

1999

1998

1997

Slovenia

-10

-5

0

5

10

15

20

25

30

1996

1999

1998

1997

In 1999, the economic performance of three central European countries Hungary, Poland and Slovenia stands out against that in the rest of the transition economies: the negative impact of the external disturbance was notably weaker compared with other transition economies; on average GDP continued to grow steadily in all the three countries despite the unfavourable external conditions; and final domestic demand (both consumption and investment) remained buoyant (section 3.3). In addition, the situation in the labour markets also improved in Hungary and Slovenia (section 3.5). The growing maturity of economic performance in these countries is the most conspicuous indication of their progress in systemic transformation and of their capacity to pursue prudent macroeconomic policies during the course of transition: arguably, a critical mass of successfully implemented reforms is both the source of higher living standards of the population and a safeguard against external shocks.

However, progress in systemic transformation differs widely among countries and the majority of the ECE transition economies still have a long way to go before they reach an adequate level of maturity and resilience. Those economies less advanced in the reform process are still prone to severe crises due both to the accumulation of macroeconomic imbalances and their vulnerability to external shocks. Thus, for example, the collapse of the Russian rouble in August 1998 set in motion a domino-like series of currency cries in a number of CIS countries that instigated a wave of instability and a general upsurge of inflation.

In general, the increased turbulence of 1998-1999, which combined an external demand shock with unexpected fluctuations in world commodity prices, was a major challenge and test for economic policy in the transition economies. The sudden and sharp cyclical downturn in some of the transition economies was quite unexpected and policy makers were not always prepared with the right response at the right time. In particular, the failure to recognize and a reluctance to take into account the increasing downside risks associated with the abrupt demand shock led to delays in fiscal adjustment; when initiated, the fiscal policy response was not always adequate and was often implemented in an ad hoc manner (section 3.2(iii)). It is also possible to argue that there was some overreaction by monetary policy to externally induced deviations in the long-term trend of domestic prices, caused by the fluctuations in world commodity prices (section 3.2(ii)). However, given the inherent vulnerability and the immature institutional infrastructure of the transition economies, it is not at all clear even with the benefit of hindsight whether policy makers in these countries had at their disposal sufficient policy instruments to counter the negative disturbances. In the event, the ongoing process of economic restructuring and reallocation of resources, coupled with the inherent fragility of these economies, imply a high probability of frequent and painful macroeconomic adjustments (and this is still the case even in the more advanced reform countries), in the course of which various economic agents are burdened with unduly high shares of the adjustment costs (section 3.2(ii)).

The susceptibility of the transition