TRANSITION REPORT 2013 www.tr.ebrd.com Stuck in Transition? Erik Berglof Chief Economist Produced by the Office for the Chief Economist, EBRD. 1
Economic Transition Transition stuck, almost everywhere 2
Per capita Income (log) Income converged, but will it continue? Growth since 1990 3
Per capita Income (log) Income converged, but will it continue? Growth since 1990 Source: World Bank 4
Growth Motivation: will convergence resume? Real GDP growth y-o-y, per cent: 5
This Transition Report in a nutshell I. Reinvigorating growth requires more reform and better institutions. II. III. Two sets of factors shape the quality of economic institutions: 1. Broad political institutions: democratisation 2. International integration, human capital and local political reform 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. 6
Why convergence may slow 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 7
Growth 1993-2010 Convergence driven by growth of total factor productivity Total growth of real GDP (PPP) from 1993 to 2010: Source: Penn World Tables 8.0 8
Total factor productivity (log) but this productivity catch-up may now be complete Income per capita (log) Source: Penn World Tables 8.0 9
Total factor productivity (log) Similar trajectories for groups of countries Income per capita (log) Source: Penn World Tables 8.0
Income as a share of EU15 income With current policies, convergence will slow GDP per worker as a share of EU15 average, actual and projected: Source: EBRD calculations 11
Income as a share of EU15 income unless reform efforts can be reinvigorated GDP per worker as a share of EU15 average, actual and projected: Source: EBRD calculations 12
This Transition Report in a nutshell I. Reinvigorating growth requires more reform and better institutions. II. III. Two sets of factors shape the quality of economic institutions: 1. Broad political institutions: democratisation 2. International integration, human capital and local political reform 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. 13
Economic Transition Democracy is strongly correlated with reform 2012 Polity2 score (x-axis) and average country-level transition indicator (y-axis): Level of democracy Source: Polity IV database and EBRD 14
Even Initial political institutions political institutions 1992 matter predict economic institutions in 2011 2010 www.ebrd.com 15
Economic Transition Democratisation has propelled reform but not always Average of 6 country-level transition indicators: Source: EBRD 16
Economic Transition Democratic reversal impedes reform Average of 6 country-level transition indicators: Source: EBRD 17
Improving economic institutions for given political system 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 18
Explanatory power Trade Financial International integration comes with good institutions Factors explaining institutional quality difference between top and bottom transition countries, using WGIs as measure of institutions : Source: EBRD calculations 19
Large variation in business environment at regional level e.g. corruption as a business obstacle in Russian regions. Ranking of corruption relative to other obstacles to business 1st 3rd 5th 10th 2nd 4th 6th Source: Banking Environment and Enterprise Survey 2012 20
Level of democracy Windows of opportunity leading to better economic institutions: Slovak Republic and Georgia Quality of institutions Polity2 (left axis) and average worldwide governance indicator (right axis): Source: Polity IV database and World Bank 21
Level of democracy Quality of institutions Missed opportunities: Romania (1995), Ukraine (2004) Polity2 (left axis) and average worldwide governance indicator (right axis): Source: Polity IV database and World Bank 22
Factors shaping the success of windows of opportunity 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 23
This Transition Report in a nutshell I. Reinvigorating growth requires more reform and better institutions. II. III. Two sets of factors shape the quality of economic institutions: 1. Broad political institutions: democratisation 2. International integration, human capital and local political reform 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. 24
Economic reforms help democracy 1. Make societies richer and build constituencies for democratisation 2. Strengthen competition and weaken resisting special interests 25
Democracy in 2011 Early economic reforms help to predict democracy Average country-level transition indicator 1992 (x-axis) and Polity2 score 2011 (y-axis) : Economic reform levels in 1992 Note: relationship holds controlling for initial levels of democracy. 26 Source: Polity IV database and EBRD
Demand for democracy 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. 27
Human capital, institutions and reform: the links 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. 28
Quality of education Number of In transition region, tertiary education is the issue 29
Brain drain. but returns to education are also critical Better institutions improve returns to tertiary education Key to people acquiring education and to retaining them 30
The role of economic inclusion 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. 31
Inequality of opportunity influences political and economic perceptions Which is the most important factor to succeed in life in our country now? Average inequality of opportunity for people who answered: What is the main reason why there are some people in need in our country today? 32
Conclusion 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 33
Stuck in Transition how to get unstuck Foster trade and financial openness Promote local competition/accountability Invest in people and in institutions 34