Reform reversals

Details

Convergence at risk

It is tempting to conclude from the analysis above that transition countries which are stable democracies – the new Member States of the European Union, for example – should have no problem completing their transition and developing market institutions in line with advanced market economies. However, there may be reasons for concern even for this group.

First, while there is a strong correlation between democratisation and economic reform in the transition region, Chart 1.6 shows that there is considerable variation in economic reform among full democracies (that is to say, countries with Polity2 scores of 8 or above). Transition indicator averages for these countries range from slightly above 3 to above 4 (close to the theoretical maximum of 4+). In the case of Serbia and Montenegro this may be due to the reform process starting late. In other cases the causes are not immediately clear.

Second, for the new members of the EU, the prospect of EU accession is no longer available as a driver of reform or an anchor against reform reversals. It is noteworthy that the region where reforms appear to have stagnated the least – in the sense that there continues to be an upward trend – is south-eastern Europe (see Chart 1.5a). This region mostly comprises countries which were either EU candidates or EU aspirants at the time in question. This is consistent with the notion that the goal of EU membership is a powerful driver of reform. However, this effect may weaken after accession countries pass specific membership hurdles, and it stops once countries become members. Indeed, Chapter 3 shows that the pace of reform peaked in the years preceding accession.

Lastly, the 2008-09 crisis – and perhaps also the period of slow growth and austerity since then – has prompted decline in public support for market reform and democracy, particularly in the more advanced countries (see Chart 1.10). This reversal was apparent in the EBRD/World Bank 2010 Life in Transition Survey (LiTS) and seemed to reflect the depth of the crisis, which was much worse for the EU countries than for those further east, as well as being worse than the crises of the 1990s. The proportion of survey respondents who stated that the crisis had affected their household “a great deal” or “a fair amount” was particularly high in EU countries such as Bulgaria, Hungary, Latvia and Romania. In addition, in many countries the crisis seems to have been blamed on the political and economic system in place at the time – democracy and free markets in the case of the EU countries.¹

This shift in sentiment appears to have had palpable effects on economic reform. While reforms have continued in some countries – in some cases, in the context of EU and IMF-supported programmes initiated during the crisis – there have been 11 downgrades in EBRD country-level transition indicators since 2010, six of which relate to the EU countries of Hungary, the Slovak Republic and Slovenia.² This compares with seven upgrades in EU countries – in Latvia, Lithuania, Poland, Romania and the Slovak Republic. Five of the six downgrades were in 2013 ‒ the first year since the collapse of communism in which downgrades have outnumbered upgrades across the entire transition region (see the “Progress in transition” section of this report for details). Most downgrades in EU countries are arguably related to policies reflecting the same anti-market sentiment that is detectable in the LiTS data.³

At the sector level, the overall picture is more hopeful. Based on a new set of sector-level EBRD transition indicators introduced in 2010 (see Chart 1.11) upgrades have continued to exceed downgrades by about two to one. However, it is remarkable that of the total of 25 downgrades relating to sector-level market structures or market-supporting institutions, the majority took place in EU countries, even though these make up less than one-third of the countries tracked by the Transition Report.⁴

The downgrades mainly reflect populist measures involving increases in government subsidies and/or state control in areas such as energy, transport and pensions. For example, Hungary was downgraded: (i) in 2010 for new legislation introducing price caps for electricity to households, (ii) in 2011 for the establishment of a National Transport Holding Company (which was expected to weaken competition), for an increase in subsidies in the transport sector and for a reversal in the pension system resulting in the virtual elimination of the private pillar, (iii) in 2012 for a significant decline in private investment in the electric power and natural resources sectors (which was attributable to a tax on energy groups and state interference with the regulator in the gas sector), and (iv) in 2013 for related reasons (see the “Progress in transition: structural reforms” section of this Transition Report for details).

Bulgaria and Romania were downgraded in 2012 for their failure to implement previous commitments to liberalise their energy sectors. There was then a further downgrade for Bulgaria following government intervention discouraging investment in renewable energy. In addition, Estonia has been downgraded in the urban transport sector in 2013 for offering travel without user charges to all residents of the capital, Tallinn.

To sum up, there are causes for concern regarding long-term growth in transition economies. Temporary sources of total 
factor productivity growth associated with initial transition steps are likely to have abated, and reforms had stagnated even before the crisis began. The long period of austerity since 2008 has led not only to more reform fatigue, but also to reform reversals. The next section considers the likely quantitative impact of these developments on growth and convergence in transition economies.

1. See EBRD (2011a and 2011b) and Grosjean et al. (2011). [back]
2. 
The remainder relate to Armenia, Belarus, Kazakhstan and Uzbekistan, and concern price and/or trade and exchange restrictions. [back]
3. 
The one exception is the Slovenian downgrade in 2012, which was in the area of competition policy. For a description of the 2013 downgrades, see the “Progress in transition: structural reforms” section of this Transition Report. Earlier downgrades in 2010 were a reaction to Hungary’s decision to introduce disproportionate levies on the banking system and a reaction to changes to the Slovak pension system which made the operating environment for private pensions more uncertain. [back]
4. Until 2011 the sector-level assessments covered 29 countries in Europe and Central Asia. As of 2013 they also cover Egypt, Jordan, Kosovo, Morocco and Tunisia. All of the new Member States of the EU are covered, with the exception of the Czech Republic, which “graduated” from EBRD operations at the end of 2007. [back]

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