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Produced by the Office for the Chief Economist, EBRD.© European Bank for Reconstruction and Development20.11.13

TRANSITIONREPORT2013

Stuck inTransition?

1

Jeromin ZettelmeyerDeputy Chief Economist

STUCK IN TRANSITION?

Jeromin ZettelmeyerDeputy Chief Economist

Alan RoussoManaging Director, External Action and Political

Affairs

Presentation at the Higher School of Economics

12 December 2013

Transition Report 2013 Stuck in Transition?© European Bank for Reconstruction and Development20.11.13

Motivation: will convergence resume?

2

Real GDP growth y-o-y, per cent:


This Transition Report in a nutshell

3

Jeromin Zettelmeyer

Alan Rousso

I. Worries about permanently lower growth in the future compared to 1997-2005 are justified. Reinvigorating growth requires additional reform and better economic institutions.

II. Two sets of factors shape the quality of economic institutions:

1. Broad political institutions: democratisation

2. International integration, human capital and local political reform

III. Fortunately, democratisation itself becomes more likely as a result of economic development and market reform

Transition to market can spur (or at least stabilise) democratic transition, which in turn spurs more reform.


Why convergence may slow

4

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


Convergence driven by growth of total factor productivity

5

Total growth of real GDP (PPP) from 1993 to 2010:

Source: Penn World Tables 8.0


6Source: Penn World Tables 8.0

… but this productivity catch-up may now be complete


7

Average of 6 country-level transition indicators:

Source: EBRD

Reforms have stagnated since mid-2000s


With current policies, convergence will slow…

8

GDP per worker as a share of EU15 average, actual and projected:

Source: EBRD calculations


…unless reform efforts can be reinvigorated

9

GDP per worker as a share of EU15 average, actual and projected:



Democracy is strongly correlated with reform

11

2012 Polity2 score (x-axis) and average country-level transition indicator (y-axis):

Source: Polity IV database and EBRD


Democratic reversal impedes reform

12


Source: EBRD


Democratisation has propelled reform – but not always

13


Source: EBRD


Improving economic institutions for a given political system

14

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


What we mean by “economic institutions”

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• Worldwide Governance Indicators (survey based) • Doing Business “distance to the frontier” (laws and

regulations)• EBRD transition indicators (cumulative market reform)


International integration comes with good institutions

16

Factors explaining institutional quality difference between top and bottom transition countries, using WGIs as measure

of institutions :



Large variation in business environment at regional level

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• e.g. corruption as a business obstacle in Russian regions.

1st 3rd 5th 10th

2nd 4th 6th

Ranking of corruption relative to other obstacles to business

Source: Banking Environment and Enterprise Survey 2012


Windows of opportunity leading to better economic institutions: Slovak Republic and Georgia

18

Polity2 (left axis) and average worldwide governance indicator (right axis):

Source: Polity IV database and World Bank


Missed opportunities: Romania (1995), Ukraine (2004)

19

Polity2 (left axis) and average worldwide governance indicator (right axis):

Source: Polity IV database and World Bank


Factors shaping the success of windows of opportunity

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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


Political polarisation was an obstacle in Romania and Ukraine

21

Index of political polarisation. Average score 1990-2004.

Source: Frye 2010


In transition region, tertiary education is the issue…

22

Comparison of human capital in Advanced and Transition countries:

Source: EBRD calculations, National Science Foundation, WIPO


…. but returns to education are also critical

23

• Better institutions improve returns to tertiary education

• Key to people acquiring education and to retaining them

Bra

in d

rain

*

Source: EBRD calculations based on Artuc et al. (2013)

*Stock of high-skilled immigrants minus the stock of high-skilled emigrants abroad, as a percentage of high-skilled workers, 2000:


Since the end of the Cold War, democracy has resumed a secular upward trend

25Source: Polity IV dataset


What drives democracy?

26

• Modernisation (Lipset, 1959)

• Democratic beliefs and culture (Almond and Verba, 1965)

• Convergence of interests and equality (Dahl, 1971)

• Critical junctures (Acemoglu and Robinson, 2006)

• Immobility of assets and the creation of a ‘rentier state’ can impede progress towards democracy (Mahdavy, 1970)


Economic development and reforms help democracy

27

• Economic development – measured in terms of growth in per capita GDP, expansion of the middle class, industrialisation, urbanisation – has led to advances in democracy both globally and in the transition region (with diminishing returns).

• Reform can help democracy:

1. By making societies richer and building constituencies for democratic reform

2. By creating competition and weakening special interests opposed to democracy

3. By fostering growth of the private sector and small business


Early reforms help to predict democracy …

28Note: relationship holds controlling for initial levels of democracy.

Average country-level transition indicator 1992 (x-axis) and Polity2 score 2012 (y-axis) :

Source: Polity IV database and EBRD


…but natural resources may hold it back.

29

Not oil producing Oil-producing

Log per capita income 1992 (x-axis) and Polity 2 score 2012 (y-axis):

Source: Polity IV database and IFS


Demand for democracy

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• 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 are less likely than private sector workers to support democracy

Education – better educated people are 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 are more likely to support democracy.


Less democratic countries tend to have higher levelsof state employment

31Source: LiTS (2010) and Polity IV


The case of Russia

32

• Big Bang in 1991/92 (following years of gradual reform under Gorbachev).

• Experience in the 1990s (distorted reforms, corruption and state capture, inequality) eroded public support for democracy.

• Yet, Russia has grown significantly since the 1998 crash – roughly 4% p.a. between 1998 and 2012, GDP doubled, large middle class.

• Russia is less democratic than its level of economic development would predict. Why?

State-dominated middle class

Demographic distribution of pro-reform segments

Reliance on natural resource rents and side payments


Conclusion

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1. Time is on the side of democracy and 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 integration• Improve transparency and accountability at local

levels• Improve human capital

4. International community can help by:

• Promoting international integration (trade and financial)

• Supporting diversification

• Supporting education

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