25 Years of Market Based Reforms in Ex-Communist Countries

from CATO Institute,

More than 25 years have passed since the fall of communism. That span of time provides researchers with an enormous amount of information about the transition experiences of nearly 30 countries. It also allows for a much fuller analysis of moves from authoritarianism and central planning to democracy and market economics than had been possible in the past.

Earlier reviews have generally agreed that different groups of countries followed different paths, with Central Europe and the Baltics (CEB) moving and staying ahead, while others lagged behind.

A socialist state is characterized by authoritarianism and one-party rule. National assets are almost entirely state-owned. There is a virtual prohibition on individual market activity (large-scale buying and selling is a criminal act labelled as “speculation” in the pejorative sense of the word) and the economy is run by central planners. Transition, therefore, means a change away from these characteristics. China, for example, moved extensively, but not fully, toward private ownership and market forces, while doing little in terms of democratization. At the other extreme are the CEB countries, which embraced both free markets and democracy. Russia, Ukraine, and others ended up somewhere in the middle — with partial democratization, considerable private ownership, and a very incomplete market competition.

The transition from socialism to the market economy produced a divide between those who advocated rapid, or “big-bang” reforms, and those who advocated a gradual approach. More than 25 years have passed since the fall of the Berlin Wall in 1989, providing ample empirical data to test those approaches. Evidence shows that early and rapid reformers by far outperformed gradual reformers, both on economic measures such as GDP per capita and on social indicators such as the United Nations Human Development Index. A key argument for gradualism was that too-rapid reforms would cause great social pain. In reality, rapid reformers experienced shorter recessions and recovered much earlier than gradual reformers. Indeed a much broader measure of well-being, the Human Development Index, points to the same conclusion: the social costs of transition in rapidly reforming countries were lower. Moreover, the advocates of gradualism argued that institutional development should precede market liberalization, thus increasing the latter’s effectiveness. In a strict sense, it is impossible to disprove this argument, for no post-communist country followed that sequence of events. In all post-communist countries, institutional development lagged considerably behind economic reforms. Waiting for institutional development before implementing economic reforms could easily have become a prescription for no reforms at all. However, after 25 years, rapid reformers ended up with better institutions than gradual reformers. This outcome is consistent with the hypothesis that political elites who were committed to economic liberalization were also committed to subsequent institutional development. Conversely, political elites that advocated gradual reforms often did so in order to extract maximum rents from the economy. One extreme consequence of gradualism was the formation of oligarchic classes. When it comes to the speed and depth of reforms, the relative position of countries has remained largely unchanged. Most countries that moved ahead early are still farthest ahead.

Are there lessons to be learned, perhaps, for Cuba, North Korea, or other countries that may begin the transition away from command economies in the future?

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