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Transition Report 2013 Stuck in transition?

CH3 180sq

Facts at a glance

ALMOST
25
years after the start of the transition process, economic institutions in the transition region are, on average, still weaker than in other countries with comparable levels of income.

0.5 The correlation between measures of democracy and regulatory quality in a global sample of countries.

Cover 180sqV2

 

THE
3
-year period prior to accession saw a peak in terms of institutional improvements in EU accession countries.

OVER
33%
of Kyrgyz SMEs say that unofficial payments are required in everyday business.


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Economic institutions

Conclusion

Reform-oriented policy-makers can attempt to improve economic institutions by “just doing it”: by passing an anti-corruption law, by changing the management and accountability relationships of a customs agency, by abolishing licensing requirements, by giving more independence to a competition authority, and so on. However, when faced with systemic obstacles, such as low levels of democracy, political polarisation or market aversion, their efforts could be unsuccessful. They may well encounter opposition from government, parliament or vested interest groups, and even if they do manage to pass legislation, its implementation could be undermined by corrupt officials.

What options could be available to policy-makers who wish to promote good economic institutions and help to implement economic reforms? This section concludes by outlining possible answers to that question, building on the evidence presented earlier.

International integration

Unlike most other variables considered in the cross-country analysis, economic openness supports institutional quality and is achievable across a wide range of political systems. Such diverse countries as Azerbaijan, Estonia, Kazakhstan and the Slovak Republic have all, with at least some success, tied their development strategies to openness.

International integration may help institutions through several channels. The increased presence of international firms helps to disseminate international business practices and standards. It may also put pressure on national and local authorities to improve the quality of government services. Dual listing of company shares may contribute to improved corporate governance.

Such passive strategies for improving institutions through openness to trade and foreign direct investment can also be supplemented by more active policies.

First, even if a country does not have the option of joining the European Union, it may be possible to exploit international integration or external benchmarks to anchor reform. For instance, since 2008 Russia has sought to turn Moscow into a leading international financial centre. This has resulted in reforms within and beyond the financial sector that will help Russia regardless of whether its ambition is fully realised.

Compliance with the principles of the WTO or the Organisation for Economic Co‑operation and Development (OECD) in the course of accession to these organisations can help to anchor economic reforms. Unlike the European Union, membership of these organisations is not restricted by geography. Russia joined the WTO in 2012, having made important adjustments to its laws and regulations on issues such as the protection of intellectual property rights. Tajikistan joined in 2013, and Kazakhstan is in the process of concluding its accession negotiations. Russia has also been negotiating membership of the OECD.

Another useful external benchmark is the World Bank Doing Business report. This may even help countries with weak political systems. Belarus is one of the four countries that have improved their Doing Business ratings the most since 2005 (along with Georgia, FYR Macedonia and Kazakhstan). Russia has recently adopted a Doing Business target. Doing Business is often publicised as a relative ranking of countries, comparing economic policies and achievements with those of a peer group – which is known to play a role in shaping economic policies.1

Second, international integration can take the form of institutional integration, as in the case of the EU. There is evidence that the quality of economic institutions tends to converge within regional economic blocs with deeper integration. Countries with weaker institutions tend to catch up (albeit slowly) with those that have stronger institutions, particularly in areas such as regulatory quality.

In some cases institutional integration may help even when countries have similar levels of institutional quality – as in the case of the Eurasian Economic Union recently established by Belarus, Kazakhstan and Russia – if it involves the transfer of certain competencies to the supranational institutions of the union. This provides an opportunity to build institutions from scratch.2 The challenge is to make those supranational institutions stronger than the national institutions of the individual member countries.3

Lastly, international integration can facilitate the transfer of skills and ideas. Faced with severe skills shortages in a rapidly growing economy, Kazakhstan has adopted various policies to promote the overseas training of its workforce and to leverage the transfer of skills from multinational corporations operating in the country. In addition, as early as 1993, Kazakhstan launched its Bolashak scholarship programme, which is modelled on successful schemes in Singapore, Thailand and a number of other countries. This scholarship provides full funding for studies abroad to Kazakh students selected on a competitive basis. Recipients are obliged to return to Kazakhstan to work for a minimum of five years. Many of the returning scholars have taken up positions in government, state agencies and state-owned companies, strengthening the technical capacity of the civil service and helping to design and implement technocratic economic reforms.

Transparency and accountability at regional and local level

Reform-minded policy-makers in weak political systems may face a conundrum. On the one hand, economic reforms may be essential to improve the business environment and generate growth because they offer a channel for improving weak political institutions (see Chapter 2). On the other hand, the implementation of such reforms may be undermined precisely because political institutions are weak and impeded by vested interests.

Reform of political institutions at the local and regional level offers a potential solution to this dilemma. The local business environment is particularly important for small and medium-sized enterprises (SMEs) and varies considerably within countries (as described previously). Local political institutions are critical to the quality of this environment. And, unlike at the national level, reform of local or regional institutions – for example, forcing local authorities into greater transparency – may be easier to achieve politically.

Russia offers an example of the importance of local and regional institutions for the success of economic reform. Between 2001 and 2004 several new laws limited business inspections, exempted many activities from licensing requirements and introduced a notification-based system for firm registration, eliminating the need to wait for authorisation from various government agencies. While this resulted in improvements, these differed widely across regions. Subsequent surveys found that, in some regions, firms were in fact inspected more frequently than was legally permitted, licences were still necessary for activities that were no longer subject to them and authorisation was still required from various agencies for firms to start operations.

Such anomalies occurred in those regions that had less transparent
governance.4 This suggests that governance reforms aimed at greater transparency and accountability at the local level could be a crucial complement to business environment reform at the national level.

A key instrument in achieving more transparency is the media. Research suggests that independent media are a necessary safeguard against corruption, including at the local level. For example, there is evidence that the electoral effects of exposing corruption are stronger in places with local radio stations, and that the exposure of fraud improves corporate governance.5 There is also evidence that social media can exert an important disciplining influence, both in local authorities and in state companies.6 This suggests that social media may well become an important force supporting reform efforts in a wide range of political environments.

Political reform

In countries that are already democracies (even imperfect ones), there may be scope for top-down political reform. What kind of reform is needed will depend on the nature of the political problem. If the problem is unstable coalitions that give smaller parties, or the interest groups behind them, too much power, the answer may lie in a more presidential system or a less proportional electoral approach. Where there is a stalemate between two major groupings, with one blocking reform, there may be a need for wider proportional representation.

Estonia’s creation of a pluralistic political system is one successful example of a power shift from president to parliament. A proportional electoral system with a 5 per cent threshold for parties’ entry into parliament was implemented in the first few years of transition, preserving representation for minority parties. Also, the creation of a decentralised bargaining system between the state, employers and employees gave losers in the reform process a voice, without giving them the power to block the process entirely. Estonia’s parliamentary democracy therefore helped to unite the population behind the early reform programme.7

The Kyrgyz Republic offers another example. In June 2010 the country adopted a new constitution introducing a parliamentary form of government and imposing an unusual limit preventing any one party from holding more than 65 of the 120 seats in parliament. While it is too early to tell how this political change will affect economic institutions, it will surely contribute to preventing abuse of power by any president or any party, which could undermine economic reform.

Electoral reform is clearly not a panacea. Political polarisation may emerge even in representative political systems. While proportional representation prevents the concentration of power in a single political party, the survival of strong former communist factions may produce strongly polarised political systems regardless of the electoral arrangements in place. For example, although Bulgaria uses proportional representation, it is one of the most polarised transition countries, as the Bulgarian Socialist Party (the successor to the pre-1989 Communist Party) is usually strongly represented in parliament.

Furthermore, it may be very hard to pursue electoral reform from a polarised starting point. That said, as the Kyrgyz example demonstrates, opportunities may arise where the balance of support for reform shifts in a new direction. It may be possible to lock in that support if leaders treat that moment as an opportunity to overhaul both political and economic institutions.

 

  1. See Besley and Case (1995) for evidence from the United States. [back]
  2. See Tarr (2012). [back]
  3. See EBRD (2012b). [back]
  4. See Yakovlev and Zhuravskaya (2011 and 2012). [back]
  5. See Brunetti and Weder (2003), Ferraz and Finnan (2008) and Dyck et al. (2008). [back]
  6. See Qin (2013) and Enikolopov et al. (2013). [back]
  7. See Aslund and Dombrovskis (2011) for a comparison of Estonia and its Baltic neighbours. [back]

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