A UNIQUE SET OF URBAN PROBLEMS

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1 Executive Summary It has now been little more than a decade since events fundamentally changed the political, economic and social systems of the formerly socialist economies of Europe and Central Asia (ECA). The hope for a better life after the collapse of socialism has animated the peoples of this region to engage in changes of unprecedented magnitude. Great hardships have been endured by the citizens of the ECA region in the past ten years. Some of these countries have suffered civil unrest and war. All the countries in ECA have experienced economic shocks, which for some were very severe. The transition has made manifest the inefficiencies and waste of the socialist system. One of the side effects of this development has been a decade of declines in output for the region of the order of 4 percent per year. Of the 27 countries in the world that had output declines for the entire decade of the 1990s, 21 were in the ECA region. Poverty and deprivation have increased dramatically in this part of the world. Nevertheless, remarkable progress has also occurred in other spheres, and the structural changes that have taken place give reason to expect a better economic performance in the years ahead. Civil liberties and democracy are taking root in many of the ECA countries and new opportunities are being created and exploited as the region opens to the global economy. Several countries are preparing to join the European Union (EU) within the decade. In fact, during the past year, twenty-one of the ECA countries experienced increases in GDP, thus lifting the growth rate of the region to 1.7 percent. In about one-third of these countries, the foundations for lasting and equitable growth are quite robust as they enter the twenty-first century. For most ECA countries, however, the transition process remains fragile. Cities, and the policies that affect them, play a major role in building a market economy and in achieving stable and equitable growth. Three hundred million of the 450 million people who live in the ECA region reside in cities and towns. The lion s share of the region s GDP is produced in urban areas, but a very high proportion of the poor live in these same areas. Indeed, the vulnerability of city dwellers in ECA countries is not only pronounced, but also quite distinct from the situation of urban inhabitants in other parts of the world. In more than half of these countries, the urban poor account for the majority of those who live in poverty. This is in contrast to the situation globally, where less than 15 percent of the countries have a greater number of urban poor than rural poor. Furthermore, for the region as a whole, the urban poor are twice as numerous as the rural poor. Elsewhere in the world, this ratio is inverted; there are nearly three times as many rural poor as urban poor. The causes of poverty in urban areas in the region still need to be thoroughly examined because a better understanding is critical if the problem is to be successfully addressed. The paper argues that management and development of cities in transition economies deserve increased attention, both within the countries of the region and in the international community that seeks to support their development. Poverty reduction being the over-arching mission of the World Bank, it is imperative for us to focus on the dimensions of urban poverty in the transition economies. A UNIQUE SET OF URBAN PROBLEMS Coping with the effects of rapid urban growth is a major challenge for all developing countries, whether they have urbanized rapidly in the past two decades, or are in the process of rapid urbanization today. In most ECA 1

2 F r o m C o m m i s s a r s t o M a y o r s : C i t i e s i n t h e T r a n s i t i o n E c o n o m i e s countries, however, increased urbanization will not happen. In these countries, and particularly in the former Soviet Union, urbanization has for decades been driven by a forced industrialization policy, rather than being the productivity-led, spontaneous trend that characterizes economic development in most of the world. Indeed, it may be argued that many transition countries are over-urbanized. Furthermore, in many cases over-populated cities were designed to service economies which were both over-industrialized and under-provided with services. With 67 percent of the region s population living in cities, ECA is a close second behind Latin America as the most urbanized region among the Bank s borrowers. Russia, which has a per capita income of about one-tenth that of the United States, has the same level of urbanization 74 percent which increased from only 17 percent in the late 1920s. Clearly, the traditional relationship between income growth and urbanization applies neither in Russia, nor in many other countries of the region. The industrialization that socialist policies emphasized required increased urban populations of workers. These policies led to higher rates of industrialization and urbanization, but not to higher productivity or a significant services sector. Thus, with some exceptions, ECA countries today have achieved a level of urbanization similar to that which prevails in the Organisation for Economic Co-operation and Development (OECD) countries, but without the concomitant wealth that had been generated by higher productivity in those countries. The exceptions lie primarily in Central Asia, which exhibit population distribution patterns that are more similar to those of developing countries in other regions. But, even in these countries, the service sector was suppressed and employment was dominated by large public enterprises. It follows from the above that urban policy issues in the ECA transition economies are quite different from those of the Bank s developing country clients and go well beyond the problems of managing largescale rural-urban migration. POVERTY IN CITIES Excessive urbanization, coupled with a sharp decline in industrial production associated with the closing of industrial enterprises, is the main factor behind the high incidence of urban poverty across ECA. Large-scale manufacturing collapsed at a much faster rate than small-scale, often service-sector related, firms emerged. The result has been increasing unemployment, under-employment and poverty. Urban poverty and economic decline are most pronounced in the FSU, where socialist industrialization policies were implemented longest and deepest, and therefore created the greatest distortions and inefficiencies. The loss of employment has meant outright deprivation for millions of citizens in the cities and towns of the FSU. In contrast, in Central Europe, where the effects of socialist policies were most attenuated, rural poverty exceeds urban poverty, but by a smaller margin than in developing countries. The experience of Central Europe seems to indicate that the effects of socialist policies were less severe. In addition, and perhaps more important, economic recovery in these countries has had a stronger influence on the reduction of urban poverty than of rural poverty because the effects of increased employment from new sources of growth favor the urban-based services sector. The post-war Balkan countries have roughly equal levels of rural and urban poverty. The conflicts that these countries have suffered have created migration into urban areas. These countries, including Albania, are the only in ECA that are currently urbanizing. The incidence of urban poverty is highest in secondary cities of the ECA region. The case of Tajikistan, a predominantly rural country, is an example of a country where poverty concentration is in medium-sized, secondary cities. In these ancillary, often highly industrialized urban areas, the incidence of poverty is about twice as high as it is in rural areas, while in the capital, Dushanbe, the level of poverty is lowest. Similar findings exist for several other countries. The secondary urban areas have often been most exposed to the effects of economic decline because the largest cities not only have received more domestic and foreign investment, but they also have had access to better services and supply by virtue of being in or nearer to decisionmaking centers. In addition, the secondary cities do not even have the advantage of producing their own food. Although a plot of land and the growing of subsistence food offers some relief to rural dwellers, such options are much more limited for the poor in urban areas. PRINCIPAL CONCERNS IN CITY MANAGEMENT What can the leadership of cities do to cope with the changed circumstances in urban areas? There are at least three systemic issues that urban policies in transition economies must address: (i) allocating resources efficiently embedded in the move from central planning to market pricing of production factors; (ii) managing social safety nets embedded in the transfer of responsibility for delivery of social services from state enterprises to local authorities; and (iii) building strong local institutions embedded in the changing role of local authorities from that of being responsible for executing central planning to that of being accountable to local citizens for management of municipal assets. 2

3 E x e c u t i v e S u m m a r y Resource Efficiency in Transition Cities: Socialist investment policies have shaped cities in ways that are highly inefficient from an economic perspective. Cities have developed according to detailed master-plans in which prices for land, capital, services, and labor did not play an important role in the determination of policy. The price of land, for example, which varies by more than 100-fold in market economies, was ignored or suppressed. Similarly, the service sector, which is so vital to urban economic growth, was suppressed and accordingly, accounted for a much smaller share of economic activity. Finally, investment policies often produced an existing stock of urban assets that was more than sufficient to accommodate the needs of these cities populations. However, a major portion of these assets has been poorly managed, resulting in low productivity and in waste of energy, water and space in prime locations. This misuse of resources will continue as long as economic and legal activities are impeded by weak or non-existent institutions. Unenforceable property rights, high legal costs, restitution claims, inappropriate zoning policies, continued production at money-losing state enterprises and environmentally damaged sites are among the key factors that impede a rapid shift in land use patterns and the emergence of an efficient, labor-intensive service sector. They are also the factors that prevent the sometimes large informal economies from coming afloat and contributing to the formal economy. These same factors have also left open opportunities for corruption of municipal officials. At the same time that space in urban centers was underutilized, socialist policies often required people to live at the periphery of cities. The location of residents on urban peripheries necessitated more extensive transportation facilities to enable mobility between home, work and school, as well as increased infrastructure to provide residents with such essential services as water, sewerage and access to social facilities. Local institutions are now challenged to provide these services with enhanced efficiency, to adjust supply through rehabilitation, to restructure and to reevaluate the pricing of services (most water systems, for example are over-designed and water waste is incredibly high), and to overhaul completely the legal and regulatory framework that governs municipal development, so that competitive markets and the supply of services can grow. To date, only a few cities have attempted to formulate a longerterm strategy that would enhance new sources of economic growth and would arrest the deterioration of urban service delivery and housing. In their new roles as managers of market-driven cities, however, local governments must facilitate the growth of new private-sector led employment opportunities. They must embrace the 20 to 30 percent of GDP in the underground economy so that it can be both more productive and less a source of corruption and rent-seeking. There is much that they can do to expand the availability of land, improve the functioning of real estate markets, and facilitate the establishment of private businesses by reducing regulatory roadblocks. In the long run, encouraging private sector development is almost certainly the most substantial contribution these officials can make to solving the difficulties of the transition to a market economy. Social Safety Net: Under socialist rules, employers, usually state-owned or socially owned (as in the former Yugoslavia) institutions, were responsible for providing a broad range of social services to their employees, ranging from vacation facilities to health services and clinics. With the closure or rationalization of these firms, this system has collapsed and many of these functions have been transferred to local authorities. Needless to say, local leadership cannot cope. They lack the resources, the skills and the authority to manage an effective social safety net. Given both the magnitude of the expenditures involved and the comparative advantages of different levels of government, the national government should most appropriately assume this fiscal responsibility. Local authorities principal role ought to be to implement policies in the most critical areas of health and education, concentrating on efficiency gains through local decision-making and administration. Overall policy, however, meaning the responsibility for funding, and setting of standards should be determined at the national level in order to ensure consistency and equity. Similarly, the national government should guide local authorities role in unemployment compensation. Local governments should assume, however, broader responsibility for public kindergartens, orphanages and similar functions. Institution Building: Cities need institutions that are stronger than those they inherited from socialism in order to be fully accountable in their new roles managing assets, creating conditions for new employment and achieving social development targets. Creating this capacity will take time and require guidance and in some cases technical assistance. Much of the institution building in cities will be determined by national policy. Yet, the success of structural reforms will ultimately be determined by local leaders willingness and ability to follow through on mandates. There is no single model that could serve in determining the framework to guide the complex process of local capacity building, which must also vary according to location. Such countries as Poland, Hungary, Estonia, Slovenia and Latvia, where economic reforms have progressed more rapidly, 3

4 F r o m C o m m i s s a r s t o M a y o r s : C i t i e s i n t h e T r a n s i t i o n E c o n o m i e s have stronger, more transparent local governments. All of these countries are oriented toward accession to the EU. At the other end of the spectrum are Ukraine and Central Asian countries, where decentralization and transfer of more decision making to local levels has been supported to a much lesser extent by national policy. There are, however, specific areas of policy that fall universally within the competence of local institutions. Among them is the regulation of real estate development and housing markets and the encouragement of a healthy business environment. Municipalities still own sizeable portions of urban land, from 30 percent in the central areas of Warsaw, to 75 percent to 80 percent or more in cities of the FSU countries, such as Samara and Pskov in the Russian Federation. Most of this land should be put on the market, so that private investors can establish small businesses and new service industries. Budapest, Prague and Warsaw have taken the lead among metropolitan cities in making these adjustments. Secondary cities are following (Poznan, Ostrow Wiekopolski, Wroclaw, Gdansk, Tatdbanya, Gyor). It is worth remembering that socialist law did not have the legal concept of real estate. Developing this legal basis for transactions, and introducing the tools of efficient real estate management should be high on the agenda for institutional development in ECA cities. Excessively restrictive regulations on land use, particularly in high value city center locations, contribute to distorted prices for residential and commercial real estate, leaving opportunities for rent seeking by local officials. Similarly, lengthy and costly licensing procedures and exorbitant taxes squeeze new and potential entrepreneurs out of markets. Today, cities in ECA need the institutions that regulate zoning and actually support the establishment of new businesses and better housing because they rationalize land use. These cities also need stronger institutions to manage the provision of urban services to bring water, energy, sewerage, transportation, health, education and social services to residents in a more efficient and cost effective way. And, finally, these cities need the institutions that facilitate the growth of new businesses and help create employment, thereby preventing economic distress. All those local institutions that help enable better housing, more vibrant commercial activity, increased employment and more effective delivery of services create a healthy economic environment where the likelihood of poverty is greatly reduced. The management of these public and private assets and services cannot be governed effectively by city administrations unless these institutions, in turn, are supported and safeguarded by a set of laws that are consistently and equitably enforced. At times, this basic legal framework must be developed from a very thin base. PUTTING REFORMS IN CONTEXT Local authorities in all transition economies are clearly challenged by the necessity to adjust to market conditions and to expanded responsibilities associated with the process of decentralization. At the same time, they are often coping with high unemployment and economic distress. They know that the services they provide are under-priced and of poor or rapidly deteriorating quality. They know that higher charges cannot be easily afforded by many of their citizens, and as newly elected leaders, they are often reluctant to make unpopular decisions. They are very concerned about the creation of new employment opportunities, but they lack, in most cases, the tools and the experience to develop a longer-term strategic framework for city development. They are often keen to get greater private sector involvement in the responsibilities of service delivery, but they may have encountered difficulties in negotiating with potential investors or service providers. Indeed, they realize that they must involve the private sector to a much greater degree because they face extremely tight budgetary constraints. What, then, can they do? Poverty Alleviation and Intergovernmental Relations: First of all, the dimensions of urban poverty in the region need to be recognized. As discussed in Section II, urban poverty is a systemic by-product of the transition process. It is extensive, in many places it is still increasing, and it requires considerably greater attention. Indeed, without greater priority being given to protecting the urban poor from the effects of transition, it is likely that many urban policy reforms will be impeded by the prospects of high social, and therefore political, costs. Urban poverty is much more than a local government concern. Greater involvement of all levels of government, as well as the international community, is urgently needed to prevent the effects of the transition from hobbling the economic success of the ECA countries. In order to avoid the conditions that can perpetuate the decline of urban living standards, local authorities must find sustainable solutions jointly with national governments. Perhaps the highest priority is to rectify the many irregularities in the interaction between central and provincial layers of government. Many problems stem from poorly defined domains of responsibility at each level, and also from arbitrary, untimely resource transfers that result in a mismatch between resources and responsibilities. As these nations strive for greater democracy, voters have the right to know whom to hold accountable. Stable fiscal transfer 4

5 E x e c u t i v e S u m m a r y systems and greater local autonomy within an agreed legal framework are needed to facilitate local revenue generation, to encourage investment, and the growth of formal sector economic opportunities. Without these methods of achieving transparency and efficiency, sustainable and equitable growth cannot be attained. Maintaining the Capital Stock Prices and Subsidies: In most cities in the region, it is better maintenance, rather than expansion of the capital stock, that is needed. But for this maintenance to take place, financial discipline needs to be enforced. At present, the provision of infrastructure services in many cities faces major problems due to failure to collect payment on time. Often public sector users and public enterprises are the worst culprits. A change from the vicious circle of under-maintenance and lack of cost recovery is imperative to avoid service collapse. Improved financial discipline however, is not enough. Price increases, and sometimes large ones, are also needed. Such price increases are likely to have a major impact on the poor, those who cannot afford an adequate consumption of services without some support by the state. The development of such markets must, therefore, be accompanied by a much better system of targeting subsidies for housing, electricity, heating, water and transportation. There is also a demand for further research to find better ways of fine-tuning price liberalization across sectors that achieve the objective of greater efficiency while protecting the most vulnerable sector of the population. When these implicit transfers exceed those on the most basic parts of social expenditures, better targeting mechanisms should be among the highest priorities of national and local policymakers. Although the initial political costs of stronger efforts at cost recovery and targeting of subsidies may be high, there is considerable evidence worldwide that the resistance to such change will diminish once the general public sees the benefits of efficient resource management coupled with sensible poverty alleviation measures. Social assessments almost always confirm that households are willing to pay higher prices for better quality services, even if it appears that they can barely afford to do so. The employment of private agents to help increase efficiency and quality of service supply is still only rarely used in ECA countries and is an area worthy of much more attention by local policymakers. Urban Finance: Finally, cities, like other investors in long-lived assets need access to finance, and a lively debate has emerged about access to financial markets to meet local investment requirements. In most ECA countries, however, reliance on debt finance for cities is not yet a realistic prospect. With few exceptions, domestic financial markets will take time to earn investor trust. They still lack the depth, and local authorities lack the creditworthiness to take advantage of financial products that traditionally provide long-term resources for municipal assets. In the nearterm, municipal development funds would be a more suitable alternative, particularly in countries that are just beginning to emerge from severe transition recessions. These municipal funds could contribute to the building of the institutions that, over the longer run, would improve cost recovery. Such mechanisms are likely to be needed until considerably more progress has been made on financial sector development and local government transparency and governance. A More Comprehensive Approach: Above all, a successful fight against the sharp increase of urban poverty in ECA can only produce lasting improvements if people can find new employment. A concern with urban poverty cannot be divorced from cities strategies for creating a business climate that attracts private sector resources into new productive investments. The vibrancy of the informal economy that has emerged from the old system is an important contribution to overall economic performance. However, and just as important, it is not as effective as a formal economy. Informal sector merchants and workers could be much more productive if the legal system made it possible for them to work in the formal sector. In order for this stronger legal basis for economic activity to take place, local authorities must better understand the demands and needs of the private sector, and they must create their own limited, but highly important functions in support of the private sector. It is essential that they put in place a clear and transparent regulatory framework that facilitates private sector activities at reasonable cost. An efficiently operating infrastructure system is an important prerequisite; access to land and clear, reliable property rights are other critical ones. Whatever actions may be appropriate in specific cases, there is little doubt that the systemic issues that the ECA Region faces in local development can only be resolved if a comprehensive view of urban management replaces the haphazard interventions of the past. Cities will increasingly need to be run by people who resemble successful managers of corporations, that is, leaders who can develop a business strategy for a city, assess the physical, human and financial resources needed to implement the strategy and mobilize the support of stakeholders to move ahead. WORLD BANK ASSISTANCE The challenge for cities in the ECA region will be to overcome the legacy of inefficient asset management and weak institutions that leads to high costs, a weaker private sector and therefore to larger public financing require- 5

6 F r o m C o m m i s s a r s t o M a y o r s : C i t i e s i n t h e T r a n s i t i o n E c o n o m i e s ments. The World Bank can help facilitate this reform. Traditionally, the Bank has addressed these urban issues by intervening at the sector level, be it in water, energy, transportation, housing, education or health. However, this approach, which can enhance the stock of physical assets and the performance of particular activities, often does not result in a cohesive city-wide or sub-regional development strategy. The Bank s new product, City Development Strategies (CDS), aims at filling this gap. The CDS is a comprehensive approach that takes into consideration the important role of better governance in the effective maintenance and utilization of capital stock, delivery of quality services, creation of incentives for business development and building of strong institutions. 6