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12 rozdział do ściągnięcia
Chapter 12
The internationalization of postsocialist economies (pp. 300-62)
12.1 Transition and globalization: the issue of coordination
International organizations are playing a major part in the attempt
to guide the transition endeavour on an international scale. Of
special significance have been the Bretton Woods institutions,
which have been involved in the transition since the beginning.
Other organizations, mainly the European Bank for Reconstruction
and Development, the European Union, the Organization for Economic
Cooperation and Development, and the World Trade Organization,
though their roles and attitudes to transition differ, have also
been important in the course of the transformation.
These organizations do not act exclusively on their own account.
They are also employed as a means of assisting in the transition
by developed market nations, especially the G-7 group, consisting
of the seven most advanced market economies: Canada, France, Germany,
Great Britain, Italy, Japan, and the United States. The West European
nations are engaged through the EBRD and the EU in overhauling
the Eastern European economies. These countries are all keen to
push the transition forward quickly toward free market systems,
but also to integrate the transition nations with the world economy
or, in the case of the 'eastbound' EU, to integrate leading transition
economies with the rest of Europe. It is thus no wonder that key
changes in these economies are occurring on terms influenced significantly
by the priorities of the advanced market countries.
Surprisingly, there has been little coordination among the postsocialist
nations as they implement structural and institutional change.
These nations have established no formal mechanism or framework
to serve as the focal point for the study and the exchange of
views on the transition and on development policy in Eastern Europe
and the former Soviet republics. And this is certainly not because
there is no perceived need for coordination. On the contrary;
it is truly desired within the countries, just as a similar mechanism
to coordinate policy responses would be welcome among the crisis-torn
Asian nations. Only ex post, since nobody has been able to control
the spread of the Asian contagion, has policy coordination been
proposed on a global scale through the IMF Interim Committee,
especially vis-a-vis capital flows and the performance of emerging
markets. This committee may eventually be upgraded and enhanced
through periodic meetings of the heads-of-state of the 24 participating
countries.
There are two reasons for the negligence. First, according to
the neoliberal bias and market fundamentalism, coordination at
the regional level is not at all necessary and would only interfere
with transition, which is proceeding firmly forward without it.
Liberalization and globalization will suffice. Moreover, any policy
coordinating institution would presumably resemble the defunct
Comecon.
This last is a particularly irrelevant argument since Comecon
was dissolved for good reasons, and transition policies ought
to be coordinated for another set of good reasons. In any case,
there should at least be a periodic conference of key policymakers
from those transition countries seeking closer cooperation and
policy guidance. This would only help enhance policy efficiency
and facilitate the exchange of experiences.
Second, it has been assumed that the coordinating role can be
handled adequately by the EBRD and the Bretton Woods institutions.
This assumption would be correct if three other conditions were
fulfilled. First, the interests of these organizations must correspond
closely to the interests of the transition economies. Second,
the transition economies must be able to influence the transition
policies of these organizations. Third, the transition economies
must be able to use these organizations to coordinate their own
efforts. None of these conditions has been met.
It would be naive to expect the rich nations not to take advantage
of the collapse of the socialist system. Their insistence that
the transition economies should quickly become open must be seen
as natural behaviour. The immediate liberalization of capital
and financial markets and the rapid privatization of state assets,
among other measures, are considered very suitable because they
promote not only transition as such, but Western interests, too.
As long as they are compatible with the interests of transition
economies, then such measures are fine. The problem is that this
is not always so.
The emerging middle and upper classes in the transition countries
have a strong interest in the success of the liberalization and
privatization processes. They support fast 'Westernization', but
they are not paying attention to the needs at the other end of
the social rainbow. They have too much to gain and so little time.
However, healthy Westernization in the positive sense of a well-performing
market economy and an active civic society is not feasible if
the expansion of the middle class and of its well-being is accompanied
by spreading poverty. Poverty is unfair. It also threatens political
stability. Anyway, under such circumstances the business climate
is not going to be favourable for domestic entrepreneurs or foreign
investors. Likewise, if income becomes too unequal and 'Westernization'
is seen by the new poor as a cause of their impoverishment, then
the atmosphere for foreign involvement in overhauling the postsocialist
economy is going to be stormy.
Nonetheless, that the new rich are in favour of foreign participation,
while the new poor are not, is not always true. It depends. Some
new rich are against the participation of foreigners, because
without it they can make better deals, for instance through insider
trading and connections with cronies who still have influential
positions in the state bureaucracy. Some new poor are in favour
of growing foreign involvement if only because they can at least
afford a little bit of the goods now so readily available without
queuing, though not yet available without cash.
A judicious policy would assure that a wide spectrum of the people
in transition societies are in favour of growing links with the
world economy. To accomplish this, a balance is needed between
sharing the costs and sharing the fruits of the transition not
only within the societies, but internationally as well. Foreign
capital and foreign governments, in sound accord with international
organizations, ought to prefer long-term investment and reasonable
technical assistance which facilitates transition and serves the
purpose of ongoing globalization. This approach works on behalf
of all the parties involved. It creates within transition societies,
if not support for the internationalization of the economy, then
at least a calm climate.
However, if the foreign partners are less interested in long-term
investment, the upgrading of industrial capacity, and the provision
of assistance in the process of labour redeployment and if they
are more interested in quick profits in trade, speculative investment,
and non-transparent privatization deals conducted with corrupt
local officials and the new rich, then a majority of people, including
some of the new middle class, will remain suspicious and resist
the more thoroughgoing involvement of foreign partners in 'their'
affairs.
It so happens that in the era of the global economy the transition
economies are already not exclusively 'theirs' anymore. The opening
up of these societies to myriad contacts with the outside world
is generating a cultural revolution. This is true even in the
more geopolitically remote former Soviet republics. Indeed, the
level of 'globalization' is no longer measured in terms of the
number of bottles of soft drinks drunk or the dimensions of the
market for hamburgers. Nor is it measured by the penetration of
the emerging and the developing market economies by industrial
machinery from everywhere else. The level of globalization can
be measured by the fact that the imported cars, home appliances,
and electronic gadgets are threatening trade balances, which have
swung from surpluses following early devaluation and stabilization
to deficits, especially in quickly growing economies. The level
of globalization can be measured by the fact that pension benefits
in developed market countries may now depend at least in part
on the rate of return from pension funds invested in postsocialist
emerging market countries. And the level of globalization can
be measured by the fact that sometimes a government in a transition
economy may have to increase the pension arrears owed by its own
social security system in order to service the mounting public
debt due to the interest it must pay on the bonds it has sold
to pension funds in developed market nations. Pensioners in Arizona
or Florida, like pensioners in Siberia, are blissfully unaware
of this, but the economists and policymakers ought to be aware
of it.
The way an economy opens up to links with the outside world matters
as much for the elites as it does for ordinary people. If the
inflow of foreign capital creates new well-paying jobs and if,
for some of the new income, one can buy more goods no matter who
the buyer, who the seller, and who the producer, then the opening
may be healthy. But if the shops are full of goods which have
been imported or are made by local firms owned by foreign capital
or foreign firms operating locally, and if only a few people can
afford the goods anyway, then the opening may not be so sensible,
including for the foreign investors.1
People in the West may be tempted sometimes to evaluate the efficiency
of a country's transition policies not according to GDP growth
or the satisfaction of the basic needs of the people, but by the
way the downtown streets look in the capital city.2 Quite often
they look pretty good because, unfortunately, the streets everywhere
else look pretty bad. Even respected journals publish elaborate
accounts of the presumed achievements of infant Russian capitalism
because there are now Western-style up-market shopping streets
(a sort of Fifth Avenue for Muscovites). However, it should be
made clear that the vast corruption and the salary and pension
arrears are not on display in the shop windows. Moreover, not
only the nice looking, pricey shops, but also the not so nice
daily lives of ordinary citizens shape the political environment
in which foreign participation in the transition process must
occur.
12.2 The role of international organizations
Their attempts to join the World Trade Organization, the Organization
for Economic Cooperation and Development, and the European Union
have special meaning for the leading transition nations. Of less
importance, though not negligible, especially in the aftermath
of the turmoil on global financial markets, is the cooperation
between the central banks of the transition countries and the
Bank for International Settlement, particularly in the areas of
banking sector supervision and transparent and prudent banking
regulations. This organization can play an even bigger role in
institution-building, especially in bank restructuring and consolidation.
Healthy banking systems are crucial for stabilization and capital
allocation.
The process of joining the World Trade Organization, or a desire
to do so, has accelerated trade liberalization in several nations.
It has also been used by the G-7 governments to push through systemic
and policy changes which have had an impact on international trade
and liberalization in some postsocialist countries. The discussions
of the WTO and the G-7 with China and Russia have been very influential
on the market transformations occurring in these two huge economies.
As usual, politics is also involved in these discussions. Thus,
non-economic factors, including the status of human and minority
rights, have been cited as reasons for the delay in China's membership
in the WTO, despite the enormous progress of China in economic
liberalization.
Participation in the WTO for all members, including transitional
economies, has obvious benefits. First, members have more secure
access to global markets. The process of removing trade tariffs
and non-tariff barriers enlarges the limits of these markets,
thereby enhancing the ability of all open economies to expand.
Second, since member nations must observe the international rules
of trade agreed within the WTO, they are more able to resist domestic
protectionist pressures. In the effort to prod through unpopular
domestic industrial and trade policy measures, it is sometimes
very useful to have the ready excuse of international obligations.
Third, member countries, even the relatively weaker ones, may
count on fair treatment in any trade disputes with fellow members
(Michalopoulos 1997). If, despite the free market ideology and
official political support for free trade, a weaker partner is
discriminated against or taken advantage of by a stronger one,
then WTO arbitrage can come to the rescue.
Fourth, WTO members possess greater credibility in the face of
international investors and can thus attract larger inflows of
badly needed foreign direct investments.
Membership negotiations with the Organization for Economic Cooperation
and Development in 1994-6 led to a great deal of acceleration
in liberalization in the Czech Republic, Hungary, and Poland,
especially the regulation of capital transfers and foreign investments.
The governments of these nations worked with the OECD Committee
on Capital Movements and International Transactions, which is
responsible for the implementation of and compliance with the
organization's Codes of Liberalization of Capital Movements and
Current Invisible Operations. The new members are going to adopt
these principles, which are legally binding instruments accepted
by OECD countries. Certain transitory reservations and exceptions
on specific items apply to new members, including those from Eastern
Europe, but there is an agreed commitment that these will be lifted
in due course (meaning that there will be tough and complex negotiations
before any 'lifting' occurs).
Progress toward the gradual liberalization of capital movements
and invisible transactions has been achieved in other nations,
too. Conscious of the OECD membership requirements, but essentially
on their own behalf, the Baltic States, Slovakia, and Slovenia
have taken steps to widen the scope of liberalization. An official
statement issued by Russia in September 1997 concerning a commitment
to apply for association (though this is impossible for the time
being) should also be considered through the prism of the readiness
to carry out economic liberalization in line with OECD regulations
and standards. While Russia's was a political gesture rather than
a formal bid for application, the Baltic States and Slovenia have
decided not to approach the OECD at this stage of transition.
Following the experience of the Czech Republic, Hungary, and Poland,
they are aware of the hard conditions which must be met before
accession is possible.
The most difficult transition issues negotiated with the OECD
by the Czech Republic, Hungary, and Poland have revolved around
the liberalization of capital flows and the regulation of foreign
direct investments. These are serious issues as far as OECD development
policy is concerned. Hence the OECD has insisted very firmly on
the need for rapid and far-reaching liberalization and deregulation.
However, in the Baltic States and Slovenia there is some reluctance
to lift restrictions on the acquisition of real estate. Rightly
or wrongly, for a number of reasons, including political and sentimental
ones, they are wary of foreigners making a run on choice properties.
The same concern was raised rather loudly within Poland during
its negotiations with the OECD. In Slovenia one hears this fear
expressed in relation to Italians, and in the Baltic States it
arises toward Germans and Russians.3 There may be no solid economic
rationale for these reservations, but they must not be neglected
since they can easily shift from simple concerns into insurmountable
political challenges.
Another sticking point is the OECD insistence on transparent
regulations on bank secrecy. The OECD wants the transparency so
as to make price transferring more difficult to use as a means
of money laundering or of hiding otherwise taxable profits from
tax authorities.4 However, in transition countries and in many
other emerging markets there is strong opposition to such a step
from banks and financial organizations with influence in the media
and among political parties. To break down this opposition is
not easy, and a certain amount of political will must exist to
do so. In the case of Poland, if not for the significant pressure
from the OECD, the relevant amendments would not have been enacted.
Whenever the issue was brought up, there was an attempt to kill
it by hostile lobbying, while the central bank hemmed and hawed
rather than driving the reforms forward through all political
obstacles.
Some nations are not yet ready to accept the OECD requirements
regarding capital flows because they are afraid that liberalization
would lead to financial destabilization, thereby exposing the
economy to the risk of severe external shocks. They are right,
since liberalization in this area requires sound financial fundamentals
and a sophisticated institutional framework. In its negotiations
over this issue with the OECD, the Czech Republic was keen to
show a willingness to accept very liberal regulations in order
to prove its determination to go to the free market as speedily
as possible. However, quite soon, only a year and a half after
it joined the OECD, the country experienced a currency crisis
because it had not been sufficiently concerned about the medium-term
effects of the liberalization on current account sustainability
and currency fluctuations.
In contrast, Poland was able to negotiate a slightly more gradual
path toward the liberalization of capital flows, and this was
one reason it avoided a similar crisis. Actually, among new OECD
members - Mexico (since 1994), Hungary and the Czech Republic
(1995), Poland (1996), and the Republic of Korea (1997) - only
Poland has been able to sidestep an economic emergency linked
to the poor regulation of capital flows and weak banking supervision.
In some countries, the instant the confidence of investors in
the economy was shaken by unexpected events, a crisis erupted.
This proves only that liberalization and openness to international
capital movements can be positive if there is careful policymaking
and institution-building.
The series of crises among new members seems to have played a
part in the fact that the OECD now appears less eager to take
on fresh candidates. Another important cause is the spreading
concern about the future of an organization which includes nations
at such different levels of development as the United States and
Mexico, Japan and South Korea, or Germany and Poland. Even if
the liberal regulatory environments are becoming similar in these
countries thanks to OECD technical assistance and the leverage
it exercises, the development gap remains very large, and real
partnership and cooperation are not always so easy within the
OECD.
Some countries have found a good reason to join the OECD in the
fact that this represents a strong argument for acceptance in
the European Union. Naturally, it is possible to join the EU without
joining the OECD, as is likely to be the case of Estonia and Slovenia,
but this can be a slightly more difficult route. If Bulgaria,
Latvia, Lithuania, Romania, and Slovakia had joined the OECD before
1997-8, when the current list of applicants to the EU was determined,
then they would have had a better chance of being included on
this list. This is not because OECD membership necessarily carries
with it a deciding influence, but simply because the procedure
leading to OECD membership is an important additional catalyst
for certain major structural reforms and institutional changes.
In any case, for the Czech Republic, Hungary, and Poland, the
process of approaching the OECD was part of the process of approaching
the EU. The reforms implemented during that time facilitated the
course of the transition to the market economy, as well as of
integration with the EU.
12.3 The special mission of the IMF and the World Bank
Conditions are such in the postsocialist nations that the position
of certain international organizations is relatively stronger
there than it is elsewhere. This is so for many reasons, but especially
because of the rather weak penetration of private capital in this
area of the global economy. The transition nations are cash starved,
but the growth they are seeking needs plenty of capital. Foreign
governments are anxious to see the political and economic systems
change quickly in these nations, but they do not wish to become
entangled in complicated financial, legal, and technical difficulties.
This represents an ideal situation for international organizations
able to supply capital, expertise on market economy performance,
and an arena for the indirect involvement of foreign governments.
Hopefully, they will never consider a deserved dose of constructive
criticism always out of place, but for once it ought also to be
admitted that the contribution of these international organizations
has been significant and positive.
The governments of countries in transition have always turned
first for money and advice to the International Monetary Fund
and the World Bank.5 Quite soon they realize that from these two
they obtain less money than advice on the policies needed to generate
more money (and less advice) in due time. Though often they may
not apply the policies, the bargaining procedures and the lengthy
discussions are very useful in the process of learning by doing.
This alone has represented a unique investment in human capital.
Owing to the rapid rotation of government officials and higher
level civil servants and the fact that many of them have left
to work as executives in the private sector, the quality of the
state bureaucracy and of corporate governance throughout the economy
has been upgraded through the contacts with these organizations.
Likewise, the persuasion and insistence employed especially by
the IMF, but also by the World Bank, to push through certain policies
have been important. The arguments on the way structural adjustment
policies ought to be framed and implemented have been instructive,
and they have influenced policymaking.
Of course, the credit for the policy achievements, as well as
the blame for the policy failures, ought to be laid squarely at
the door of the governments and the policymakers, but it must
be acknowledged that, without the active and capable participation
of the Bretton Woods institutions, the transition to the market
economy would be more difficult. Despite many false starts, meaningful
steps toward a market economy have been taken in the transition
region, and, though late in coming, there is a chance for durable
growth. Because of the significant involvement of the IMF and
the World Bank, the systemic transition has made more overall
progress, and sustainable development has become more likely.
Nonetheless, membership in the IMF and the World Bank has not
helped the transition countries much in the regional coordination
of transition policies and development strategies. Initial discussions
between IMF staff and the fiscal and monetary authorities of these
nations - the ministries of finance and central banks - were typically
a sort of one-way street, without too much attention being given
by the former to the views of the latter. The participation of
the representatives of the transition economies in the 'constituencies'
of Bretton Woods institutions is designed in a way which limits
the opportunities for comprehensive coordination among the economic
policies of the transition countries, as well as among the policies
of these countries toward the organizations. Only China and Russia
have been able to afford to establish themselves as single-country
constituencies, so that their position is relatively stronger.6
As for the others, they have been dispersed among various groups,
which are sometimes organized so that the transition nations,
even if there is a number of them together, do not have much say
in the formulation of proposals, let alone the design of policies.
A group is usually led by an advanced market country, and the
other group members have only a minor influence on the policies
of the organization, including the policies toward them.
The most well composed constituency in terms of postsocialist
countries is the one led by Finland, since it is established on
a clearly regional basis. The other members are the Nordic advanced
market countries (Denmark, Iceland, Norway, and Sweden) and the
three Baltic States (Estonia, Latvia, and Lithuania, which are
transition countries). But for the remaining postsocialist economies,
there are no clear links between them and the leaders and other
members of their constituencies. For example, the constituency
led by Switzerland contains Poland and five former Soviet republics
(Azerbaijan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan).
The constituency led by Belgium includes three other market economies
(Austria, Luxembourg, and Turkey) and six transition nations (Belarus,
the Czech Republic, Hungary, Kazakhstan, Slovakia, and Slovenia).
The constituency led by the Netherlands consists of Cyprus and
Israel, as well as a number of transition economies (Armenia,
Bosnia-Herzegovina, Bulgaria, Croatia, Georgia, FYR Macedonia,
Moldova, Romania, and Ukraine).
It would be more reasonable and desirable to put transition countries
together according to geopolitical criteria so that neighbours
are not separated. What may have somehow made sense at the beginning
of the transition in 1990 is not necessarily a suitable solution
for the situation in 2000. So, why not establish at least one
strong and competent constituency, if not exclusively of transition
economies, then led by them?
Yet, the postsocialist countries must agree that it should be
this way, too. However, there is sometimes an atmosphere of competition
and even rivalry among them based upon the false assumption that
this is a better method to gain political and financial support.
But now more than ever there is a real need for sound policy coordination
among these nations.
In the absence of other appropriate institutional arrangements,
the creation of task force groups working within the international
financial organizations might be a good means to coordinate policies,
monitor developments, and funnel advice to transition countries.
If it is considered natural that the US executive director in
IMF can be called to appear before a Congressional hearing in
Washington on support for American interests and policies within
the IMF Board, why should it not be possible for Eastern European
and CIS governments to have an organizational means to express
their views in a coordinated way? If they are too small and too
weak to act separately within the Bretton Woods institutions,
this is all the more reason for them to seek to act together so
that they are neither so small, nor so weak.
The composition of the 24 constituencies in each of the Bretton
Woods institutions is determined on the basis of quotas in 'special
drawing rights' (that is, according to the value of contributions
to the institutions). Thus, an individual nation cannot join a
constituency as it pleases (unless, of course, it contributes
sufficiently to form a single-country constituency). However,
a constituency could still be led by a transition country, just
as less-developed countries now lead several existing constituencies.
For instance, Mozambique currently leads the constituency of 22
sub-Saharan countries, including much stronger and more developed
South Africa and Zimbabwe.7 Kuwait leads a constituency of countries
in the Middle East and North Africa.8 The Philippines heads up
a group of countries in South America and the Caribbean.9 Finally,
Bolivia leads a constituency composed of several Latin American
countries.10 In these last two cases, the constituency leadership
rotates, so that before the Philippines and Bolivia, the leaders
were Brazil and Argentina, respectively. Hence the architecture
of particular groups is not solely a matter of financial quotas,
but political preferences play a role as well, and there could
be a constituency led on a rotating basis by, for example, Estonia,
Hungary, or Poland, or by the Czech Republic, Kazakhstan, or Ukraine.
This would help in the formulation of regional policy and might
raise the efficiency of the responses the Bretton Woods institutions
address to these countries.
There are reasons for the current constituency structure. It
was more comfortable for the IMF and the World Bank to spread
the transition countries out among various constituency leaders.
Moreover, several serious attempts on the part of these organizations
to enhance the cooperation among the transition nations failed
because of the lack of interest of these nations, which appear
to share only the conviction that there is much more to be learned
from the experience of the developed and developing market economies
than from each other's failures and achievements.
The process of learning by doing has therefore occurred through
an intermediary, since the IMF and the World Bank have not been
able to provide sufficient institutional platforms for direct
contacts among experts and policymakers from transition countries.
Despite the flaws, however, knowledge and experience have been
acquired. Moreover, the process of learning by doing is taking
place within the Bretton Woods institutions, too, so that these
organizations are becoming the international financial intermediaries
of the transition, but also the international intermediaries of
transition knowledge.
Yet, before these institutions could absorb the lessons, the
questionable structural adjustment policies they had framed and
proposed were tending to worsen the situation in postsocialist
economies. Across Eastern Europe and the former Soviet republics,
the once distorted centrally planned economies were becoming 'Latinized',
so that the differences between them and distorted developing
market economies, mainly those of Latin America, were shrinking.
At the onset of the 1990s, these differences were substantial.
Now, these two groups of economies, so diverse in background,
are a little less distinct. The Russian economy of today recalls
not the Russian economy of the beginning of the decade, but the
Brazilian economy of the late 1980s. The two differed substantially
back then. This is no longer so. The same can be said of a number
of other 'Latin-transition' pairs, say, Chile and the Czech Republic,
Argentina and Poland, Uruguay and Latvia, or Nicaragua and Georgia.
Two groups of economies that were different at the end of the
1980s and the beginning of the 90s have become similar because
the Washington consensus erroneously thought that the transition
group required similar policy solutions. A shoulder-numbing shot
of good anti-distorted-developing-market-economy vaccine was given
to the wrong patient, and, in one of those ironies of nature,
the patient has acquired the symptoms of a well-distorted emerging
market economy. Indeed, why not compose a new IMF and World Bank
constituency from Latin American, Eastern European, and CIS nations?
The Bretton Woods institutions are normally perceived as lending
institutions. For obvious reasons, the lending is subject to 'conditionalities'
and is tied to numerous structural reforms. Therefore, what matters
is how much money is being lent, but also the conditions which
apply and the purposes of the reforms.
Whereas the IMF is concerned basically with financial fundamentals
such as sound fiscal stance, a balanced current account, a stable
currency, and low inflation, the focus of the World Bank is the
restructuring of industrial capacity, infrastructure upgrading,
and human capital investment. Thus, the IMF aims at stabilization,
while the World Bank aims at growth. Each is also involved in
structural reform and institution-building, the IMF being oriented
to equilibrium and financial stabilization, and the World Bank
to long-term development. For these reasons it may be a mistake
to put both institutions on the same footing or to speak their
names in the same breath, as one might say 'Marx and Engels'.
The financial support provided by the IMF to government budgets
and the current account balance and the lending supplied by the
World Bank for retraining and manpower redeployment, social security
reform, health care upgrading, hard infrastructure, and environmental
protection have been remarkably useful to the transition economies.
Throughout the region during the early transition, as well as
now in several countries with only limited access to private resources,
a bulk of the external financing has been provided by these two
organizations. Becoming active somewhat later, the EBRD has been
helpful, too. Bilateral assistance, though more important for
certain countries, has been relatively minor.
It should be remembered that the money comes in loans, not grants.
The money is supposed to be allocated efficiently to foster systemic
transition and socioeconomic development, but it takes the form
of credits which must be paid back and which bear interest. So,
the relationship is a business (and political) one, not charity.
The lending is always conducted through phased 'tranches' of
credit that are to be used for specific purposes which have been
agreed upon beforehand. The release of the tranches is usually
well publicized. The government authorities take care of the publicity
themselves. The conditions for the lending of the Bretton Woods
institutions are known to be tough. Of course, in the age of the
liberal global economy, a government capable of meeting tough
conditions is a good government. If the government is good, everyone
should know about it.
This mechanism also operates in another direction. The IMF performance
criteria, which are used to assess the fiscal and monetary profile
of an economy, are always linked to fiscal stance, the monetary
aggregates, and the external financial position. They are well
publicized, too, so that, similar to the situation with the credit
tranches, there is always much more public debate over meeting
or missing the criteria than the issue actually deserves. Often
it is difficult to satisfy the criteria, but a government can
nonetheless become exposed to strong pressure to succeed. If the
government does not succeed, it can still succumb to the temptation
to blame the criteria or the policies imposed by the 'outsiders'.
If subsequent tranches of stand-by credit are not urgently needed,
it may be better to take them anyway and try to meet the performance
criteria. This is so for three reasons. First, during the troublesome
period of structural adjustment the demand for external financing
is great, but if a transition economy has no access to private
capital markets it can acquire the financing only through the
IMF. Then, after achieving some progress in stabilization and
structural reform, the country may apply for a credit evaluation,
usually to the American rating agencies Moody's or S&P, or
the British agency IBCA. Only with a proper grading is there a
chance to approach international capital markets and try to borrow
at commercial rates through the Eurobond or global bond issues.
Thus, without a good relationship with the IMF, there is little
likelihood for a good relationship with capital markets.
Second, reaching an agreement with the IMF is a seal of approval
for prudent policies and thus opens up access to additional credits
from the World Bank, the EBRD, and private commercial banks. In
the early 1990s no postsocialist country could hope to acquire
a major foreign commercial bank lending without the endorsement
of its economic policies by the IMF. Even today, such a relationship
is understood to be necessary.
Third, the IMF performance evaluation is a strong point in favour
of or against a government's policies. If the evaluation is positive,
this strengthens the government's position and credibility in
dealing with other issues. If it is negative, the government's
standing is weakened. The effort to fulfil the performance criteria
is monitored by the IMF, the business community, and international
investors and financiers, but also by the political opposition
waiting in the wings. This can render policymaking even more difficult.
There is no doubt that the IMF and the World Bank had more say
with governments during the early transition. The paradox is that
they had much less of value to say at the time because of their
lack of experience with the unique problems of the postsocialist
nations. Later, though the Bretton Woods institutions gradually
came to learn more through their monitoring functions and to understand
which policy proposals had a better chance of working, their influence
began to decline, particularly in transition economies doing relatively
well. If structural reform has made sound progress, then the technical
advice and financing assistance of these institutions, though
still sought, are less critical.11
Economic recovery and growth encourage more inflows of foreign
private investment and commercial lending from the private sector.
As growth gains momentum, official lending begins to fall, and
private investment and credit begin to increase. Simultaneously,
the influence of private entities (investment banks, hedge funds,
rating agencies, consulting firms, research establishments) on
economic matters is expanding, while that of individual foreign
governments and international organizations is shrinking.
There can also be turnarounds the instant another severe crisis
occurs. The extent to which this is true can be gauged by the
shift in relative power between the private sector and official
institutions during the Asian crisis. While the crisis was caused
mainly by the private sector, it must now be solved mainly by
governments and international organizations. There has been a
similar, though opposite shift especially in the more successful
transition economies, where less and less is depending on governments
and more and more on the private sector.
Clearly, if a country is confronted by a deteriorating economy,
then the sway of the IMF and the World Bank becomes stronger.
Only then is the government obliged - like it or not - to seek
assistance; only then is it obliged to listen to the recommendations
of outsiders, and only then does it not consider blaming the outsiders
for intervening in its internal affairs. Thus, the Bretton Woods
institutions have a greater say (and, more importantly, a greater
power of decision), for example, in Russia than in China. In 1997-8
they were much more influential in Albania, Bulgaria, and Romania
than they were in Hungary, Poland, or Slovenia.
12.4 Integration in the world economy
The amount of its openness toward and the range of its integration
with the world economy have a significant impact on a country's
ability to expand. Likewise, the more integrated a country is
in the world economy, the more its development will follow the
overall trend in growth of the global economy. This may not always
be good news because of sluggish economic performance occurring
from time to time in other regions or among the most advanced
market nations. By the same token, because transition countries
are trying to catch up with the developed market economies, they
may end up growing at a faster rate than these economies, and,
owing to ongoing integration, this can favour sustained growth
in the global economy, too. Such a phenomenon may already be on
the near horizon, since the transition economies are still expanding
despite the East Asian contagion and the Japanese recession.
Integration with the world economy has fundamental implications
for a country's expansion in trade and capital absorption. Rising
exports and imports provide access to new markets, and foreign
competition fosters technological and managerial upgrading. The
greater openness also promotes the inflow of much-needed capital,
which must be attracted for the purpose of closing the gap between
the amount of domestic savings and the demand for new investments.
The call for fresh capital is so intense in the transition economies
that Eastern Europe alone will absorb at least another $150 billion
during the first decade of the 21st century. The bulk of this
inflow will be supplied by the private sector, and the relative
influence of international financial institutions will therefore
decline further. Substantial capital will be invested in the CIS
if economic reform and political stabilization endure.
The leading transition economies will also be able to integrate
rather rapidly with the world economy. Some Eastern European countries
will have the option of joining the European Union. Socioeconomic
development in the former Soviet republics in Central Asia could
be as remarkable as that of South Korea between the 1960s and
the 90s. Certain among these countries may eventually join ASEAN
or join together in a new association, and for all of them there
is the prospect of becoming members of the World Trade Organization
fairly soon.
Since the collapse of the Soviet system and the dismantling of
the Soviet Union and of Comecon, there has been much unravelling
of regional structures, but there have also been new - and sometimes
strange - forms of regional 'reintegration'. Four former Soviet
republics, Belarus, Kazakhstan, Kyrgyzstan, and Russia, have created
a 'common market'; these four countries belong to three different
constituencies in the IMF and the World Bank. A socioeconomic
union, with a commitment to eventual monetary unification, has
been established between Belarus and Russia (two different constituencies).
Georgia, Ukraine, Armenia, and Moldova have instituted the GUAM
group of countries (a single constituency). In Eastern Europe
the Central European Free Trade Agreement is active in the establishment
of smooth trade arrangements. Other new regional and subregional
organizations will certainly appear to facilitate growth, regional
economic integration, and international economic cooperation.
However, such efforts at integration among these nations are
not the real answer to the challenge of sound regionwide cooperation.
More important at the current stage of development is regional
policy coordination vis-a-vis other governments (which do coordinate
their policies), other regions, international relations, and the
global economy. There is no need for Central Europe to seek close
economic ties, lavish trade, and integration with emerging markets
in Central Asia, since these have more natural economic partners,
but there is a true need to coordinate transition and development
policies among all the emerging market countries.
In Denver in June 1997, Russia participated for the first time
in a summit of the G-7 group of the world's largest economies.
This exercise was repeated at the Birmingham summit in 1998. The
invitation to Russia to participate in the economic policymaking
deliberations has been forthcoming more because of political factors
than because of economic ones. In the not too distant future China
may also be invited to participate. However, all this is quite
artificial. As long as there was only the G-7, the 'who's who'
of the global economy was evident. Now, it is only a matter of
time and political opportunity before the G-7 becomes the 'G-9',
and the signals become jumbled. Neither Russia, the relative importance
of which in the global economy is declining rapidly, nor China,
which is enhancing its international economic standing day by
day, are suited to the G-7 formula. (The same is true of Brazil
and India.) They may be huge economies, but Russia and China are
definitely not developed, nor will they be for at least several
more decades. In fact, the old G-7 group is still quite alive;
it is merely trying out another method to manipulate the course
of the global economy according to its preferences and interests.
The participation of Russia has been only minor and will not be
sufficient to allow that country to influence global issues to
any very great extent.
There is a sort of pattern that transition nations follow in
becoming integrated in the world economy. They have first joined
the Bretton Woods institutions.12 Several of them, having proceeded
rapidly with trade liberalization, have then become members of
the World Trade Organization. Among the 134 members of the WTO
are Bulgaria, the Czech Republic, Hungary, Kyrgyzstan, Latvia,
Mongolia, Poland, Romania, Slovakia, and Slovenia (as well as
Cuba, which was a founder-member of the General Agreement on Tariffs
and Trade, the predecessor of the WTO).
Once more, countries which undertook precocious market reform
during the central planning period have had an advantage. Thus,
their previous participation in the General Agreement on Tariffs
and Trade has helped Hungary, Poland, and Slovenia to become members
of the WTO without much difficulty.
Even countries which are lagging behind in the transition are
finding their way to this institution. Among the 30 applicants
to the WTO in 1998 were Albania, Armenia, Belarus, China, Croatia,
Estonia, Georgia, Kazakhstan, Lithuania, Moldova, Russia, Ukraine,
Uzbekistan, Vietnam, and Yugoslavia. The membership of China and
Russia (and to a lesser extent Ukraine) is contingent on conditionalities
which are similar to those for the early postsocialist members.
Unlike the IMF and the World Bank, in which all postsocialist
members have been admitted unconditionally, the WTO imposes economic
and political conditions, such as further political liberalization
in the case of China or a solution to local conflicts in the case
of Croatia.
For some Eastern European countries, success in the attempt to
join the European Union is most important. Joining is a long and
difficult process, but certainly a most encouraging endeavour
in terms of the progress in economic and political transition
that can be achieved (Eatwell et al. 1997). The ambition to join
the EU undoubtedly arouses efforts to transform economic and political
systems.
By 1996, 10 transition countries - Bulgaria, the Czech Republic,
Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia,
and Slovenia - were associated with the EU (Tables 30 and 31).
The Czech Republic, Estonia, Hungary, Poland, and Slovenia started
negotiations for full membership in March 1998, and there is a
chance that they will join sometime after 2003. One may safely
assume that in due course there will be a follow-up for the remaining
associate countries, Bulgaria, Latvia, Lithuania, Romania, and
Slovakia. Considering its progress with systemic transition, Croatia
also deserves to be seen as a future member no less than, say,
Bulgaria or Romania.
In inviting the Czech Republic, Estonia, Hungary, Poland, and
Slovenia to discuss the terms of integration, the EU stressed
that the first round of candidates had been selected on the basis
of 'complete objective criteria. . . . The prerequisites for entry
include a functioning market economy, the existence of democratic
institutions and respect for ethnic minorities, the ability to
compete in the single market, and reasonable public administration'
(Barber 1997). Marketization matters, but democratization is important,
too. The eastbound enlargement of the EU is as much an economic
endeavour as it is a political venture.
In some cases, there are problems with certain aspects of the
introduction of a full-fledged civic society in the EU aspirants.
For instance, the treatment of the tiny gypsy minority in the
Czech Republic or the attitude toward the large Russian minority
in Estonia rubs the wrong way. However, the long process leading
to membership by all means contributes to better and faster resolutions
of these sorts of problems.
Among the other five nations associated with the EU, only Bulgaria
and Romania are lagging behind substantially in the prospects
for EU membership, especially with respect to marketization. Slovakia,
albeit taking a more radical path toward economic reform and usually
reckoned among the nations most advanced in transition (see Table
14), has been omitted from the first round of membership negotiations.
So have Latvia and Lithuania, both of which are ranked almost
as high as Estonia and Slovenia in terms of institutional transition
and GDP growth (see Tables 14 and 28).
One suspects that the selection process has also been inspired
by other political and geopolitical considerations which have
not been announced openly. The five countries invited to join
the EU share borders with members.13 Among the other postsocialist
nations, Slovakia has a common border with Austria, while three
Balkan states - Albania, Bulgaria, and FYR Macedonia - have short
borders with Greece (which, together with Portugal, is the poorest
EU member). In fact, though it is never admitted, the geopolitical
factor is of special consequence for the integration of part of
Eastern Europe with the European Union, and it has influenced
decisions taken by the European Commission on the shadings to
be used on the map of Europe should the EU negotiations and the
overall transition process be crowned with success. Thus, even
if, for example, Moldova were in better political and economic
shape than Estonia, it would not necessarily be invited to undertake
membership negotiations with the EU.
Meanwhile, many factors have motivated the decision to include
Estonia and Slovenia in the earliest wave of negotiations. Estonia
and Slovenia are very small countries, with populations of about
1.5 million and 2 million, respectively. It is easier to manage
the transition and integration of a small nation than to do so
for a large one, say, Romania, with almost 23 million inhabitants.
The small size and small population are important elements in
view of the EU budget, especially since it has already also been
determined (finally) that the common agriculture policy and the
EU regional aid policy must be reformed before eastbound enlargement
can proceed. Slovenia is the only republic of the former Yugoslavia
to be invited, and it was the smallest of them all, too. Likewise,
if it can fulfil the agreed conditions, Estonia will be the only
former Soviet republic with a chance to join the EU in the foreseeable
future. By including this country, the smallest among the former
Soviet republics, the EU cannot be accused of abandoning the Baltic
States to the Russian sphere of influence. Perhaps most significantly,
nonetheless, both these tiny countries are relatively well developed.
Estonia is the most developed among the former Soviet republics,
and Slovenia is the most developed of all postsocialist economies
The evaluation of GNP or GDP on a PPP basis varies for well-known
methodological reasons. Agenda 2000, presented in 1997 by Jacques
Santer, the president of the EU, to the European Parliament, shows
per capita GDP data for the associate countries that are different
from those in Table 32. For instance, the EBRD estimates the per
capita GDP of Poland in 1995 at $5,400, while the EU sees it closer
to 5,300 ecu (about $5,800-$5,900 at the time). Another evaluation
suggests that in 1997 per capita GDP was nearer to $7,000. This
seems more reliable, especially considering the growth of about
14 per cent in 1996-7 and the fluctuations in domestic prices
relative to international ones. After some tendency toward decline,
particularly in 1995, when it fell from above 2 down to about
1.8, the ratio of the official exchange rate over the PPP exchange
rate hovered in the range of 1.77 to 1.82 in 1996 and increased
again to 1.9 or so in 1997 (PlanEcon 1997c).14 This sort of problem
with the evaluation of GDP on a PPP basis also occurs for all
other countries.
Accomplishing the enlargement of the EU may be more difficult
than merely accommodating the first five applicants, despite the
likelihood that in future the other transition country aspirants
will be even better prepared for integration than was the first
round in 1998. There will always be questions about the effective
limits of eastbound EU expansion and about the point at which
adding members might become a disadvantage. So far, geopolitical
position (which does not depend on policy) and OECD membership
(which depends exclusively on wise reform and policy) have played
key roles in the integration process.
From the viewpoint of membership in international economic, trade,
and financial organizations, only three transition economies,
the Czech Republic, Hungary, and Poland, have been 'five star'
performers (Table 33). These countries belong to the Bretton Woods
institutions, the WTO, and the OECD, and soon also the North Atlantic
Treaty Organization. During the Madrid summit in the summer of
1997, official invitations were extended to the three nations
to join NATO in 1999. NATO membership has been much easier to
achieve than EU membership is going to be. The entry into NATO
can facilitate the process of the economic integration of these
three nations with the EU, as well as with the global economy,
inter alia through the positive impact on business confidence
and foreign direct investment.
The forthcoming integration with the European Union should be
seen as a partnership between the 15 old members and the five
new ones, which must make their institutions conform to the demands
of the EU and must also upgrade infrastructure and overhaul industries.
The whole endeavour is going to be quite costly and must be paid
for mainly from the pockets of taxpayers in the new member countries.15
Before this tax effort can bear fruit, it will cause tensions.
However, if these adjustments are not carried out at this stage
of transition and integration, the costs may be even higher in
the long run anyway.
Vietnam became a member of ASEAN in 1995, and Laos joined in
1997. Because of political turmoil in Cambodia in the summer of
1997, ASEAN has been forced to postpone a decision on that nation's
entry into the organization. Membership in ASEAN is important
for these countries, especially considering the wide development
gap between them and the more advanced members of the association.
The size of the gap depends on the yardstick used, but it is certainly
enormous. For example, if calculated in PPP dollars, the figure
for the GDP per capita for Vietnam is about four times higher
than it is if calculated according to the market exchange rate.
For Singapore, the PPP figure is lower by about 25 per cent. Thus,
the ratio of the income per head in Singapore and that in Vietnam
shrinks from a shocking 100:1 according to current nominal cross
exchange rates to a still immense 20:1 according to purchasing
power comparisons
The only way to close such a giant gap is by boosting the rates
of growth in the less-developed countries past the rates among
the richer nations. A significant means for accomplishing this
is increased regional integration, accompanied by trade liberalization,
freer capital flows, and the coordination of structural policies.
Despite the crisis of 1998-9, or because of it, ASEAN plans to
negotiate the Asian Free Trade Agreement and work on a programme
called 'vision for the year 2020'. No mere illusion that the free
market can solve all problems, the 'vision' is a very long-term
horizon for the coordination of development strategies at the
regional level. This is the sort of decisive approach which has
enhanced the ability of Asian economies to sustain high rates
of growth for so long. The recent profound crisis does not negate
this conclusion. These economies can hardly fail to rebound. Such
a vision is needed in Central Asia, Eastern Europe, and Russia,
too.
Will the process of the enlargement of ASEAN contribute to the
acceleration of market reform and ultimately the transition to
a full-fledged market in the socialist and postsocialist countries
of Indochina?16 In Vietnam price and trade liberalization, as
well as a regulatory environment favourable to capital markets
and foreign direct investment, have already been pushed forward
by the membership in ASEAN, which has therefore had a positive
effect on the pace of reform. If a country becomes a member before
the economy has been brought up to speed with the association's
standards, as was the case of Laos and Vietnam and probably is
going also to be the case of Cambodia, than gradual liberalization
must follow.
This is the advantage of joining early. (From this angle, it
is never too early.) The structural and institutional changes
are thus enforced by the membership, which has a strong influence
on the policies exercised by the country. The early membership
serves to help break down any ideological, political, or bureaucratic
resistance to the necessary reforms. Contrary to the WTO, which
requires that most reforms be carried out before a country is
admitted, ASEAN membership is not based on political and institutional
conditionality, but itself is understood as the cornerstone of
change. Once a nation is a member, there will always be the time
and the means to insist on reforms and adjustments.
Is the coming process of liberalization and regional integration
going to mean that growth will be more rapid in the less-developed
markets of ASEAN than it is in the developed ones? Despite the
1997-8 East Asian crisis and its impact on close neighbours, economic
growth rates among the new ASEAN members have not decelerated
significantly. In the long run the membership in ASEAN will also
promote economic stability. One may therefore anticipate that,
if there is continued cooperation and if the political dilemmas
in Cambodia are solved, then the Indochinese economies will grow
quickly. This will occur because these economies will become more
open to foreign investment and technology transfers, but also
because these processes will open up new markets for Cambodia,
Laos, and Vietnam. This combination of the greater absorption
of foreign capital and improved access to new markets will enable
these economies to allocate resources better and expand through
export-led growth.
12.5 The two faces of emerging markets
The markets in all postsocialist nations are 'emerging' in two
senses. First, these markets are in statu nascendi and can be
considered as 'emerging' because they are rooted in the centrally
planned economy and are gradually becoming part of the integrated
world market economy. This means that policymakers must be determined
to foster mature market behaviour and institutional arrangements
so that the market system can evolve in a healthy fashion.
Second, the postsocialist nations possess financial and capital
markets which are 'emerging' because they are opening up to the
world economy and thereby represent fresh investment opportunities
(Mobius 1996). These opportunities are being keenly taken up,
mainly by rich countries with extra savings which are not being
absorbed by domestic investment. The propensity to save and the
capacity for capital formation in these rich countries surpass
their current domestic investment needs. Some savings therefore
flow out in search of opportunities in other nations. Whereas
in mature markets the supply of capital exceeds the demand, in
emerging markets the demand for capital outstrips the supply.
Since capital tends to flow from places where it is abundant to
places where it is scarce, the spare capital is invested in emerging
markets, where there is a chance of obtaining unusually high profits
(and where the risks are also unusually high).
In 1997, the year before the crash, the shares traded on stock
markets in emerging market economies were worth a very significant
$2.7 trillion, or 14 per cent of the $19.3 trillion traded worldwide.
The stock markets in the more advanced transition countries -
the Czech Republic, Hungary, and Poland - had a higher turnover
than did the stock market in Russia, but this time first place
in the league of transforming countries was definitely held by
China. The stock market turnover in China represented about 230
per cent of that nation's market capitalization, which means that
the average share changed hands between two and three times. Along
with South Korea and Taiwan, China was therefore among the most
active emerging markets in 1997. In terms of activity, Poland
and Hungary, with turnover close to 80 per cent, were, respectively,
between the United States and Brazil and between Malaysia and
Greece. Russia was close to the bottom of the league, with turnover
at about 25 per cent of market capitalization, placing it between
Israel and South Africa.
A unique feature of the small infant postsocialist stock markets
is the fact that they have provided remarkable profits to portfolio
investors even when output within the economies has been severely
contracting. These people may be considered to have taken greater
risks in order to reap greater profits, but from a macroeconomic
viewpoint there has simply been an outward transfer of part of
national income to the accounts of foreign investors. The profits
have not always been due to increased productivity resulting from
the investments, and often they have not been reinvested locally,
but have been quickly moved elsewhere.
A majority of transition economies have been able to attract
healthy inflows of foreign direct investment, and emerging financial
and capital markets generally facilitate capital formation and
allocation, thereby contributing to postsocialist recovery and
growth. However, in some countries the level of capital flight
has risen above that of foreign lending and investment, including
private capital inputs and the financial assistance of governments
and international organizations. This would not have been possible
had appropriate regulations been adopted. Instead there has been
deregulation and a renunciation of the tools available for controlling
cash flows. This occurred not because no one knew how to regulate
capital flows, but because of weak political commitment and the
lack of the courage necessary to carry out the reforms. No wonder
the markets in some of these economies have emerged in a very
awkward manner. In nations such as Albania and Russia for quite
some time the interests of informal institutions were preferred
over the needs of stabilization and national economic development,
and the emerging markets were used as instruments to favour these
interests.
Policies should therefore focus on guiding foreign capital inflows
into long-term, preferably direct investments. These sorts of
outlays encourage microeconomic restructuring and competitiveness
and thus contribute to recovery and growth, which help both the
foreign investors and the local recipients of the capital flows.
If this policy approach is not adopted, the liberalization of
financial and capital transfers may generate capital drainoff
instead of more capital injection.
The best example of this last scenario is the Russian economy,
which shrank in 1996 by 6 per cent, bringing GDP down to about
50 per cent of the pre-transition (1989) level. Simultaneously,
the rate of return in dollar terms on the Russian stock market
was 113 per cent. This trend continued through 1997. During that
year the drop in GDP did not bottom out, while the rate of return
was still a recklessly high 111 per cent. The gains available
in other emerging markets, including the leading transition economies,
were not so spectacular, but they were still large and in most
cases much greater than those accruing in advanced market countries
Then reality struck; the pendulum started to swing in the opposite
direction after the onset of the Asian crisis, and the investors
feeding off emerging markets worldwide began to panic. In the
first half of 1998 the index for the Moscow stock exchange fell
by 63.3 per cent, meaning that in dollar terms the value of shares
had plunged by nearly two-thirds in the space of six months. By
the end of the year the index had dropped by a staggering 96 per
cent. How extremely hectic the stock market was can be seen by
the drop of 18.2 per cent in just one week in June. Indeed, Russia's
has become a 'gambling casino' economy. Many investors, including
renowned foreign investment banks and hedge funds, have lost substantial
sums.
Nonetheless, the blame for Russia's stock market swoon ought
not to be directed at foreign investors and speculators, who were
not acting out of character, but at government macroeconomic mismanagement
and malfunctioning structural reform policies, mainly in privatization
and corporate governance (Kolodko 1998d).
For several years the government had been selling assets below
the market clearing price. Nonetheless, the increase in the stock
market index by around 450 per cent in just two years, 1996-7,
was irrational. Only to a certain extent was it due to a natural
catching-up process involving the search for and the reestablishment
of stable market value levels. The gap between the nominal prices
on the primary market and the real value and profitability of
the physical assets as expressed in the long run on the secondary
market was closing, but most of the great leap skywards on the
stock exchange was due to a bubble which was being pumped up by
constant speculation and even intentionally by some investors,
especially by insider traders. In turn, the bubble encouraged
senseless expectations about the capacity for further growth.
That the bubble would burst - that is, that the capitalization
of the stock market would bring the market back down to the level
it should have been at because of the performance of the real
economy - was inevitable. Whereas real output halved in six years,
it took only six months for the average value of stocks on the
capital market to plummet by half.
While those six months were very bullish on stock markets in
the advanced countries (the Dow Jones average on Wall Street rose
by 14.4 per cent, and the Morgan Stanley Capital International
index, which included the 23 most developed countries during that
period, increased by 17.4 per cent), it was a very bearish six
months for all but a few markets elsewhere. Over the same six-month
period, the loses varied from 56.9 per cent in Indonesia and 49.6
per cent in Venezuela to 6.2 per cent in Brazil and 0.9 per cent
in South Korea. On the major postsocialist markets, the loses
were from 8.6 per cent in Hungary to 1.7 per cent in the Czech
Republic. Only five of the 'smaller' markets registered positive
returns from investments on the stock exchange during the first
half of 1998: the three older markets of Greece (a gain of 50.9
per cent), Israel (5.2 per cent), and Portugal (39.5 per cent),
and the transforming markets of China (11 per cent, despite a
decline of 6.1 per cent in the last week of June) and Poland (9.6
per cent), the most stable and steadily growing emerging capital
market.
China and Poland demonstrate that relatively firm macroeconomic
fundamentals and well-designed structural adjustment policies
do make a difference. They show that it is possible for an emerging
market - whether in a reformed socialist economy or in an open
postsocialist economy - to avoid financial crisis if only liberalization,
stabilization, and institution-building are properly managed.
China and Poland can continue this sort of performance in the
future if the liberalization and deregulation of capital flows
remain subordinate to development strategies, not the other way
around.
In the case of Russia, the greed of portfolio investors for quick
profits - regardless of financial instability, growing inequality,
and spreading poverty - and the weak fundamentals, the inadequate
regulation, and the inconsistent policies of the government created
a bubble, which was readily burst by a market panic. The consequences
were certainly negative for the real economy, output, and living
standards. The only way to have avoided the bursting of the bubble
was to have avoided the bubble. But the only way to have done
that would have been to step on the toes of the financial interest
groups. In effect, the 'tycoons' have not wanted the government
to regulate capital flows and take care of adjustment properly,
also because for some time there has been a little bit of fog
surrounding the tycoons and the government. It is not surprising
that there was a bubble which could burst and a severe crisis
waiting to happen. In the meantime, there was an enormous redistribution
of stocks and capital flows nationally, as well as internationally.
Once more, the few became richer, and many became very poor.
The evaluation of the profits earned on emerging stock markets
depends on the time span examined. For instance, in 1996, although
the capitalization of stock markets in transition economies was
relatively quite low, the real rate of return on these markets
was more than seven times higher than the corresponding rate on
developed markets. However, the index of emerging stock markets,
including those in transition economies, compiled by the International
Finance Corporation fell by 15 per cent in dollar terms between
the end of 1993 and September 1997. Over the same period, the
capitalization of Wall Street, that is, the Dow Jones average,
more than doubled. Whereas from 1990 until September 1997 the
average annual rate of return on all emerging markets was a mere
3.5 per cent, Wall Street yielded around 13 per cent. The postsocialist
markets were more profitable until the bearish year of 1998.
The emerging capital markets have clearly been more profitable,
but more chaotic and unpredictable, too. To a certain extent,
this has been due to the advice coming from people in developed
market nations. For quite some time, nobody on Wall Street had
any sound understanding of how the Russian capital market ought
to be developed from scratch and what the regulatory environment
should be like. Still worse, the knowledge which has been applied
has been more useful for the exploitation rather than the protection
of the emerging markets. Even official aid designated for technical
assistance in carrying out privatization and the establishment
of capital markets has sometimes been redirected toward other,
less socially justifiable purposes (Blasi, Kroumova, and Kruse
1997, Wedel 1998b). According to USAID, the US government agency
which administers American foreign aid, some American advisors
to Russia's privatization programme 'used information gained from
their programme activities . . . to make further private investments
in the Russian securities market' (The Economist 1997h). Unfortunately,
insider trading, sometimes also involving foreigners, is quite
common in transition economies. However, because of the participation
of influential, well-connected investors with media contacts,
cases of conflicts of interest and the use of confidential information
for private gain have not received much public attention and the
notoriety and criticism they deserve.
The emerging markets and the postsocialist economies should not
be seen only as a field of action for financial speculation for
international investors. Yet, owing to the foreign capital inflows
they facilitate, these investors are important for transition
countries, all of which possess insufficient domestic savings
resources. Thus, a key to the development of these countries is
the ability to attract as much long-term foreign investment as
possible. In this respect, the situation in transition economies
is very dynamic, since foreign direct capital investments, unlike
the portfolio transactions, are expanding all the time.
12.6 Economic aid, direct investment, and foreign capital
At the onset of transition, the main source of foreign capital
was international organizations, especially the IMF, the World
Bank, and the EBRD. However, in the long run it will be the private
sector. Initially, aid provided by the governments of advanced
market countries also played a relatively larger role, though
not everywhere. The recipients of the highest relative amounts
of economic aid were Albania, Kyrgyzstan, and Poland. Relatively
high per capita assistance was also received by the Baltic States
The explanation for the preference for these countries is simple.
Except for Poland, these are all small economies. To provide aid
at $100 per head in Estonia in three years' time is about 35 times
less costly than to deliver the same level of aid to Ukraine.
Whereas aid worth about $33 per person per year over 1994-6 would
have amounted altogether to around $150 million for Estonia, in
Ukraine the same level of aid would have cost over $5 billion.
The aid of over $50 per person in Albania and Kyrgyzstan may seem
impressive in comparison to the meagre $2 or $3 for much bigger
Kazakhstan and Uzbekistan, but in fact the total aid sent to these
latter two dwarfs that received by the two former nations. Once
more we see that, in regard to transition, 'small is beautiful'.
It is cheaper to give many dollars to a few than to give a few
dollars to the many.
Poland is an exception. A significant debt reduction was the
reward to Poland for its pioneering role in the transition and
in overhauling the socialist system.18 If the postsocialist revolution
had started in Hungary, then the debt of that country might have
been lightened, while Poland would be choking under an unmanageable
debt burden for years. Yet, Poland happened to be the first to
start to turn the wheel of history.
Already in 1991 the Paris Club of official creditors took an
initial decision regarding the outstanding debt of Poland, but
the debt reduction scheme continued for several more years. The
second major cut was agreed with the creditors from the London
Club in 1994. In both cases the debt was pared by 50 per cent,
and the deal was contingent on the strict conditionality of further
progress with structural reform. Because this progress was achieved,
the debt was forgiven. In this sense, among all postsocialist
countries, Poland has obtained by far the largest amount of financial
assistance from the developed market nations.19
One might view this assistance to Poland not only as a reward,
but also, given the relative health of the emerging Polish market,
as a good investment. Likewise, in terms of the economic rationale
of the allocation of international aid among transition economies,
assistance has been mainly forthcoming for countries which are
more advanced in or at least committed to structural reform and
which exhibit a better record with reform. For several years now,
these countries have been enjoying stronger economic growth than
have other emerging markets. This is good not simply for the sake
of the nations receiving the assistance, but also for those providing
it, for this means that the climate is favourable for investors
from these nations. If, for example, assistance has been supplied
to support institution-building, then the new market organizations
which are established serve not only local businesses, but also
foreign investors.
This sort of give and take is well known from the experience
with technical and financial aid in the less-developed countries.
It is easier to get foreign aid (or, shall we say, a 'foreign
indirect investment') to finance feasibility studies, privatization
schemes, stock exchanges, the training of banking personnel, or
the purchase of computer hardware manufactured in the aid-giving
country than it is to get foreign aid to finance poverty alleviation
programmes, job creation schemes, cultural institutions, the training
of hospital personnel, or the development of a local computer
industry. There are no relevant studies, but anecdotal evidence
suggests clearly that much more foreign aid has been channelled
into the development of the financial sector than into antipoverty
programmes. Assistance should therefore not be seen as charity,
but as an investment, often in human capital. In fact, this bias
can help the country absorbing the extra capital recover sooner
and grow more quickly, so that the country may be able to gather
independent resources to meet its needs in other areas, such as
poverty alleviation, at a later date.
Like commercial lending from international financial institutions,
the foreign aid is often conditional. The transfers of capital
are frequently subject to the implementation of certain specified
programmes or particular reforms. This sort of conditionality
is rigorously practised by the EU, which sometimes cancels planned
aid allocations because of it. For instance, over 34 million ecu
in grants to Poland under the PHARE initiative were rescinded
in 1998 because the government could not meet certain requirements.20
The fact that this kind of conditionality is tied to progress
in structural reform and institution-building partly explains
why nations which are further along in transition are able to
absorb more aid. It also shows why more aid tends to help transition
go forward more smoothly in these nations. Aid cannot be used
more efficiently in these nations than in lagging countries because
the former possess more effective institutions. Foreign aid has
a positive influence on economic policy, and, even if the amounts
are small, they can accelerate growth if they are mainly employed
for investments rather than for consumption (Blustein 1997).
Before the collapse of its economy in 1997, this was the case
of Albania, the most backward country in Europe. The politics
and economics of foreign aid had functioned in such a way that,
due to the progress it had achieved in stabilization and liberalization,
Albania was for a time the recipient of the most foreign aid both
as a share of GDP and on a per capita basis. Since then it has
continued to benefit from relatively important assistance despite
policy failures, mainly the mismanagement of institutional reform
in the financial sector and in capital markets. However, this
has been the exception which has proved the rule, since the significant
aid is now being provided for geopolitical reasons linked to the
fighting in the Balkans, religious-ethnic considerations, and
the Albanian immigrant problem in neighbouring countries. In the
case of the best performing small former Soviet republics of the
Baltic region and Central Asia, the link between aid and reform
is unmistakable: more aid is supplied to the countries more advanced
in institutional transition. And here, too, there is a positive
feedback loop between the level of foreign capital inflows, including
aid, and overall economic attainment.
It is a fortunate historical coincidence that the postsocialist
transition is occurring during a period of swelling savings in
developed market economies. With more than one and a half billion
people, the emerging markets in Europe and Asia represent a vast
potential arena for foreign investment and the expansion of market
capitalism. In a certain sense, they are fulfilling a function
for global capitalism that is similar to the one performed for
European capitalism by the New World after 1492. Likewise, even
in the early 1990s the postsocialist region seemed terra incognita
for the major investment banks and investment funds.
However, the foreign investors were quick to set up shop. The
investors are of various sorts, but the major sorts are the investment
banks and the aggressive hedge funds which are managing mutual
and pension funds. Unlike the postsocialist economies, which still
rely heavily on the old pay-as-you-go public pension systems,
in the advanced economies social security arrangements have evolved
mostly toward market-based, funded systems. According to InterSec
Corporation, a research company, the total value of the world's
pension assets grew by almost 60 per cent, from $5.4 trillion
to $8.5 trillion, between 1991 and 1996. It was being anticipated
that these assets would at least double over the next five years
and exceed $17 trillion in 2001, although this may be exaggerated
in light of the stock bubble in the developed market countries
(except Japan) in 1995-7 and the turmoil on capital markets worldwide
during 1998. During the second half of 1998 pension assets were
depreciating owing to the corrections on these markets. In any
case, because they represent so many additional investment opportunities
for these assets, the transition nations, together with other
emerging markets, have seemed like a newly discovered America.21
If there had been no capital in search of markets, the situation
would have been even more difficult for the transition countries.
As it is, the rapid changes taking place simultaneously in other
regions of the world - especially in Latin America and Asia, but
also in Africa - mean that the transition economies must compete
for foreign investment. The Washington-based Institute for International
Finance, a research group of private commercial and investment
banks, estimates that net private capital flows to major emerging
market economies dropped to $261 billion in 1997 from a record
high of $281 billion in 1996. This was mainly the result of a
contraction in the flow of investment into Asia by about $35 billion
(from $142 billion down to $107 billion) and a decline of about
10 per cent in Latin America, while the capital flows to economies
in transition continued to expand. In 1998 private capital flows
were still falling and, because of the Russian 'syndrome', were
beginning to affect negatively the postsocialist emerging markets,
too.
Nonetheless, the postsocialist nations are clearly capable of
competing for the attention of world capital markets. A new stage
in this competition was reached in 1998 owing to the crisis in
East Asia. As part of this competition, the postsocialist economies
are trying to become viewed as 'emerging markets' by foreign investors
and, moreover, to be referred to in this way. In 1995-6 Poland
was the only postsocialist economy to be included on the list
of the so-called 'Big Ten emerging markets' (Garten 1998).22 This
was a US government initiative to draw more American investors
and exporters toward these markets.
The portfolio investors turned out to be the most active, followed
by the direct investors, then the exporters, and only at the very
end the importers. A more healthy sequence for the transition
economies would have been the direct investors, followed by the
importers, and then the exporters, with the portfolio investors
bringing up the rear. Then growth would likely have been more
robust, the current account deficits smaller, and the cumulative
profits of foreign investors larger.
Transition economies have also started to compete among themselves
to gain the biggest possible piece of the pie. The heads-of-state
of transition countries eagerly attend vast numbers of conferences,
gatherings, and other events to push the advantages of their markets.
They entertain international bankers and fund managers and encourage
them to invest in their countries. Such meetings were first organized
mainly in relatively advanced Eastern European nations, but soon
other countries, including the bigger economies among the former
Soviet republics, also joined this 'club' of the emerging markets.
They were launching vast privatization programmes and issuing
Eurobonds and global bonds to finance their fiscal deficits. As
a consequence, not only their markets 'emerged', but also their
current account deficits, since the exports from these countries
to advanced market nations were not growing quickly enough, while
the portfolio investment flows in the opposite direction were
growing too quickly.
On a cumulative basis, foreign direct investments in the transition
economies of Eastern Europe and the CIS reached over $60 billion
between 1989 or 1990 and the end of 1997 and $90 billion to $100
billion by the end of 1998. Around two-thirds of this was absorbed
by Eastern Europe, and the other one-third by the CIS. This is
quite a small amount relative to the needs of these countries
and to the level of direct investment in other emerging markets.
Overall (not cumulative) foreign direct investments in 1996 totalled
$349 billion according to the United Nations Conference on Trade
and Development, but the share going to the transition economies
was estimated by the EBRD at only about $15 billion, a meagre
4 per cent of the total. Most went to developed market economies,
although the share received by developing nations, especially
those in Asia and including China and Vietnam, was rising.
China was the largest recipient of foreign direct investment
among emerging markets in terms of both flows and stock. It had
taken in $169 billion on a cumulative basis through 1996.23 In
1996 alone China received $42.3 billion, that is, about three
times more than Eastern Europe and the former Soviet republics
combined. However, since there are more than 1.2 billion Chinese,
this otherwise remarkable inflow adds up to only about $35 per
person, which was comparable to the per capita share for the transition
economies that year.
The following year (1997) the per capita average for the transition
countries was $43, of which $86 per head went to Eastern Europe
and $26 to the CIS. By the end of 1997 cumulative foreign direct
investments in China had exceeded $200 billion. Approximately
230,000 enterprises backed by foreign capital had received authorization
to operate in China, and 145,000 of them had started business.
Enterprises supported by foreign capital employed 17 million people
and accounted for more than 10 per cent of the industrial and
commercial taxes collected by fiscal authorities and for about
40 per cent of China's total exports.24 All these achievements
resulted from a steadily growing commitment, since foreign direct
investment, unlike portfolio flows, cannot pack up and go in the
aftermath of shocks or radical local policy shifts.
Yet, the amount of money being invested in particular countries
sometimes fluctuates significantly from year to year, since, for
example, a privatization programme in a single industry can alter
the picture substantially. The link between privatization and
the foreign direct investment absorbed is not always obvious.
Even if the overall pace of privatization is slow, significant
injections of foreign direct investment can be attracted if the
incentives to undertake new ventures and green field projects
are strong enough. Usually this sort of equation involves foreign
capital penetration in natural resources and large individual
investment projects in the energy sector. Big privatization schemes
in the banking sector, energy, and telecommunications have caused
particular economies to move up on the list of the recipients
of the most foreign direct investment. Thus, in 1997 Poland surpassed
Hungary in terms of the Eastern European nation receiving the
most cumulative foreign investment.
Among the former Soviet republics and the countries of Eastern
Europe, Russia is bound to lead in this respect eventually, considering
the enormous sums to be invested, for example, in the energy sector,
which has yet to be privatized. Although the investment per capita
is relatively small, only about $13 and $26 in 1996 and 1997,
respectively, Russia absorbed around $6 billion altogether during
that time. This is still less than the total investment in Poland
in 1997 alone ($6.6 billion), but almost three times as much as
that in Kazakhstan in 1996 and 1997, where average per capita
inflows were three times higher (about $73 and $76, respectively).25
In Eastern Europe at the end of 1997 the stock of foreign direct
investment per capita was highest in Hungary ($1,519), followed
by the Czech Republic ($726), and Estonia ($557). In Russia and
Ukraine, the biggest countries in terms of population, the per
capita stock was $66 and $41, respectively.
The best measure of relative foreign direct investment is not
the amount per capita, but the share of GDP. According to this
measure, Azerbaijan and China lead the way in Asia. It is believed
that in 1997 foreign direct investment in Azerbaijan represented
a remarkable 24.4 per cent of GDP (Table 38). In Eastern Europe,
the most was absorbed by Latvia (7.6 per cent) and, despite the
severe contraction there, Bulgaria (5.6 per cent). At the other
end of the scale were Uzbekistan (0.4 per cent) in Central Asia
and FYR Macedonia (0.5 per cent) in Eastern Europe.
Because of the generally positive outcomes produced by foreign
investment, the earlier fears and the reluctance of certain political
circles have waned. This shift in attitude is also due to the
changed environment, since a portion of the political class is
now tied to foreign capital, whether through the endeavours of
individual entrepreneurs, financial intermediaries, or direct
investors in green field projects or joint ventures. There has
been a significant change in public opinion, too. More and more
people are in favour of the absorption of foreign capital. Contrary
to what they were led to believe during the socialist era, they
generally experience these investments not only as harmless, but
also as the means for the supply of new products and services
and even as a chance for skill upgrading and eventually well-paying
jobs. Thus, they are coming to perceive these investments as beneficial
to overall economic performance at the workplace and to the standard
of living at home.
12.7 Openness, capital flows, and four policy dilemmas
Governments are still hesitant to open up all industries and
sectors to the unbridled penetration of foreign capital. This
is the case of the automobile industry in China, banks in the
Czech Republic, tourist services in Hungary, the energy sector
in Russia, land in Slovenia, and so on. There are many concerns,
depending on the time and the place and what segment of public
opinion and the political spectrum one has in mind. There are
also certain policy dilemmas with significant financial and economic
implications and important political, psychological, and moral
consequences. Four are worth particular note: the risk of dependent
capitalism, the instability of portfolio investments, the redistribution
of global wealth and income, and capital flight.
The first dilemma is the risk of 'dependent capitalism'. How
are the governments of transition economies to hand over national
assets to foreigners without handing over the independence and
freedom of action of their countries, too? Postsocialist economies
are often short on resources, and vast privatization therefore
means that a significant portion of assets will be acquired by
foreign capital. Unlike the case in other economies, the middle
class and even the very wealthy often have no meaningful outward
foreign investments and do not usually possess property in other
countries. Thus, while people in other nations may come to own
a growing part of the economy's assets, nationals of the transition
country own little or nothing in the other nations. If the scales
tip too far, then the transition country may become subject to
a sort of 'dependent capitalism', with all the negative political
implications.
Vis-a-vis capital flows there is also a risk of asymmetry between
the usually stronger foreign partner who brings the capital and
the transition economy governments, industries, and domestic financial
intermediaries, which, being in need of cash, are usually the
weaker partners. Of course, the ideal policy response is to prefer
the formation of national capital, but this takes more time, and
an ever-growing share of extremely important activities is meanwhile
being oiled by foreign capital, which therefore is also working
on behalf of national welfare. However, predator foreign investors
may attempt to take control of certain industries by acquiring
assets - which the transition nation sells off for the purpose
of microeconomic restructuring and to sustain employment - and
then crushing any local competition by using the assets to introduce
to the domestic market the products they manufacture elsewhere.
The hedge funds aim at speculative profits. In a situation of
financial instability, they may therefore be very vigorous. By
allowing profits which are sufficiently high to maintain aggressive
competition, but not too high to permit a net transfer of national
wealth, governments must try to use the hedge funds on behalf
of financial stability.
International financial institutions work on behalf of global
financial stability and liquidity, but they must also take into
account the expectations and interests of the largest and strongest
economies. Less influential nations and their governments must
nonetheless try to employ these institutions to attract reasonable
amounts of long-term capital which is not too dear.
An indispensable part of any financial deal, conditionality is
a trump card in the possession of the supplier of the capital
and thus a means to guarantee the realization of his targets.
However, the recipient of the capital flow must stand tough in
the negotiations. The investor may have far-reaching preferences
such as tax holidays, fiscal allowances, or customs duties which
must be imposed on competitive imports, but the government must
not accept awkward concessions exposing consumers and other producers
to unfair competition and the state budget to unnecessarily low
revenues.
From this perspective, the government should favour foreign direct
investment because this type of capital inflow is subject to national
laws, as well as regulations and policies, albeit in a roundabout
way and only to a limited extent. Moreover, foreign direct investments
are usually long term and stable and can therefore enhance the
economy's growth potential by contributing to the restructuring
of industrial capacity, which in turn supports competitiveness.
Foreign direct investments are oriented not only toward the domestic
market. Indeed, often foreign direct investors are seeking to
take advantage of competitive local labour costs in order to produce
for export. This can foster export-led growth, which in the longer
run is beneficial for all concerned.
There is a strong and positive feedback loop between the scope
and pace of privatization and the amount of foreign capital investments
in a transition economy. It is true that the more rapidly state
assets have been privatized, the more cheaply they have been sold
off. However, this has also usually meant that a relatively larger
amount of foreign capital is quickly injected into the economy.
If the privatization programme is accompanied by steady progress
in institution-building and financial stabilization, then the
feedback loop can facilitate significant growth.
All in all, wise liberalization policies and the establishment
of effective institutions are more important for recovery and
growth than is privatization or foreign investment linked with
denationalization. Yet, if all these elements are at work at the
same time, then the risk of 'dependent capitalism' is greatly
reduced, and transition growth can be accelerated. Privatization
and liberalization encourage foreign investment. When supported
by maturing institutional arrangements, this process can boost
growth. The growth then secures increased domestic capital formation
and additional absorption of portfolio investments and foreign
direct investments. This stimulates more privatization and streamlines
liberalization. Growth which is high quality, that is, fast, durable,
and equitable, thereby gains momentum.
The existence of this interrelationship among liberalization,
privatization, foreign investment, and institution-building explains
why countries with relatively larger private sectors and relatively
greater absorption of foreign capital can show a lower rate of
growth (or higher rate of contraction) than countries with smaller
private sectors and relatively less foreign capital.
A simple comparison, for instance between the Czech Republic
and Slovenia in Eastern Europe or between Russia and Uzbekistan
in the CIS, supports this claim. In the Czech Republic in 1994-8
the average rate of GDP growth was below 3 per cent, while in
Slovenia it exceeded 4 per cent. In Russia during the same period
GDP was shrinking annually by an average 4.2 per cent, while in
Uzbekistan it was growing by an average 0.7 per cent. Yet, the
share of the private sector in the economy was greater in the
Czech Republic than it was in Slovenia, and it was greater in
Russia than it was in Uzbekistan. Likewise, the stock of per capita
foreign direct investment at the end of 1997 was higher by almost
half in the Czech Republic than it was in Slovenia ($726 and $538,
respectively), while it was over seven times higher in Russia
than it was in Uzbekistan ($66 and $9, respectively).
The second dilemma is the instability of portfolio investments.
This can persuade even the most liberal governments and policymakers
to be reluctant to permit foreign capital free access to all sectors.
The liquidity of portfolio investments is much greater than that
of direct investments. Portfolio investments are thus more 'easy
come, easy go'. It is prudent not to let them flow in too easily,
since later it may be very difficult, if not impossible, to prevent
them from doing damage by flowing out equally readily. Unlike
direct investments, which are tied to fixed assets, portfolio
investments, because of the liberal regulation of capital markets,
can be pulled out with shocking speed.
Furthermore, secondary capital deficits (financial 'holes' left
after the escape of capital which was invested and circulating
in the economy) impair performance much more than do primary capital
deficits (shortages of capital for planned investment and reform
projects). Secondary capital deficits lead to more underutilization
of existing capacity and thence to contraction in national income
and the spread of poverty. Primary capital deficits mean only
that industrial capacity cannot be raised. Therefore, they do
not necessarily generate a reduction in economic activity, which
is unavoidable in the case of the withdrawal of capital. In other
words, the economic consequences and policy implications of each
type of capital deficit are different. Portfolio capital may later
return and often does (though still later it may again be pulled
out). This is why portfolio capital investments represent a risk
in terms of continuity and stability in the process of capital
formation and hence the sustainability of growth. It was precisely
the sudden flight of portfolio capital that has turned this risk
into disaster in East Asia, where, instead of fresh foreign investment,
there was a massive foreign divestment.
Thus, policy should focus not only on attracting investment capital,
but also on keeping it in the country as long as possible. The
more reinvestment there is of speculative capital and the profits
earned from it, the more growth becomes stable and durable and
the more development becomes sustainable. Sound fundamentals,
attractive interest rate differentials, and a stable financial
and political climate can encourage speculative capital to become
long-term capital. So, transition countries should aim at constant
institutional improvements, circumspect structural policies, and
the consolidation of stabilization into stability. Then they will
earn the growing confidence of international partners, including
portfolio investors.
Of course, policy is handicapped in this endeavour. Owing to
the speculative nature of portfolio investments, they often fluctuate
and flow in and out in any case. The young postsocialist markets,
being more volatile and chaotic, are more vulnerable to such fluctuations.
Their financial and capital markets and other market institutions
are still emerging, and so they have relatively weaker fundamentals
and less effective regulations and cannot easily resist a capital
market panic (though even mature capital markets sometimes panic,
such as Wall Street in 1987).
If the investors panic, no official policy statement or significant
economic argument is going to calm them down immediately. Since
the market itself has no appropriate emergency mechanism, investors
will tend to follow the herd. If worse comes to worst, capital
will begin to flow out of the economy like water out of a sieve,
and neither the market, nor the government is going to be able
to plug the holes. Even the IMF (presumably nearer the angels)
will be helpless.
There was the 'tequila effect' of the Mexican crisis and then
the East Asian 'contagion', but there has not yet been a distinguishable
'vodka effect' from the turmoil on Russian markets, although there
have been negative repercussions in several transition countries.
In some nations, for instance in Poland, the government tried
to draw political advantage from the Russian crisis by blaming
it for the slowdown in growth, even though this was due to deliberate
government policy.26
Meanwhile, in Estonia in 1998 growth slipped by about 1.5 percentage
points in the aftermath of the events in Russia. Unfortunately,
in the era of globalization, it may happen that other countries,
even those with relatively healthy and mature fundamentals, institutions,
and policies, will not be entirely immune to a similar 'effect'.
All the more reason for transition economies to be attentive in
the liberalization of foreign capital flows. If it is possible
to launch a speculative attack on an exposed economy (and the
postsocialist nations definitely belong in this category), then
one will be launched, very much as wolves will attack sheep at
any opportunity.
Nonetheless, in seeking profits on volatile markets, hedge funds
and institutional investors also add liquidity to these markets,
and this tends to reduce unpredictability and lessen the chances
for speculation. Moreover, for the time being, there is a need
for these funds on both the supply side and the demand side. They
contribute to the development of world financial markets and to
the market fluctuations which are part of the global financial
and economic game.
Though the hedge funds will not be driven out of the market altogether
since they are too powerful and enjoy the strong support of influential
interest groups in the most advanced countries, at least the risk
they represent to market stability may diminish. Yet, this will
happen only if they are subjected to the sort of regulation applied
to investment banks. Despite the sense of urgency due to the world
financial crisis in 1998, a consensus has still not been reached
(in Washington, of course) on how the re-regulation ought to occur.
It has been claimed that 'The hedge funds legitimize the role
of the IMF in the eyes of its obstinate clientele. The hedge funds,
in turn, depend on the IMF as a clean-up brigade' (Götz-Richter
1997). Hedge funds and the globalization of financial markets
have certainly not lessened the role of the IMF. Indeed, they
have enhanced it, including in the transition economies. Private
financial intermediaries alone are clearly not capable of acting
as watchdogs over capital flows on emerging markets. There are
even cases in which these particular watchdogs have taken from
the pantry.
Greed and the desire for big profits are powerful among some
investors. If this causes problems, to shout at the market does
not accomplish anything, but to deal with it wisely can be helpful.
The governments of emerging market countries are looking increasingly
to international financial institutions, like the IMF and the
Bank for International Settlement, and to regional development
banks, such as the EBRD, the Asian Development Bank, and the Inter-American
Development Bank. Nations faced with the instability of capital
inflows and outflows rely on these organizations for assistance.
Besides sound fundamentals and wise policies, cooperation with
international financial organizations is the only remedy for the
attacks of speculators that is available to transition nations,
which must continue to open up to the global economy and accept
the impact on their markets of global capital transfers. In fact,
these organizations represent the market as much as they do governments,
and there is no way to bring governments and the market together
without their (official or secret) mediation. The influence of
these organizations can make the task of hostile speculators more
difficult.
Ironically, one outcome of transition has been an entirely unplanned
interdependence among the once centrally planned economies. What
is happening in Hungary or Poland depends to a certain extent
on what is happening in Russia or Ukraine, the core republics
of the former Soviet Union. The emerging capital markets are linked,
and the turmoil among the biggest former Soviet republics is generating
storm-clouds in other markets. Of course, this is at least as
true of Hungary or Poland as it is of Argentina or Brazil. Without
the worldwide coordination of policies toward financial and capital
markets that is promoted by international financial organizations,
a single country may be unable to resist market pressures, even
if the fundamentals and the policies are sound.
The third dilemma is related to the redistribution of global
wealth and income. Together with globalization, labour mobility,
advanced information networks, and wise government policies (often
guided by international organizations), the emerging markets may
be viewed as buffers for the richer part of the world against
the severe effects of sharp fluctuations in the business cycle
(Weber 1997). Policies designed by the rich countries from this
perspective may tend to ignore the impact of the global economy
on working and living conditions elsewhere, thereby 'instrumentalizing'
the transition economies. If transition economies are merely cushions
against the business cycle for the advanced market countries,
what does this say about the significance of the business cycles
in the transition economies? How much does it matter? Who cares?
The lack of a sound partnership might mean that, for example,
the Czech economy could be used as a backup for German business
whenever the German economy slows down, but that the German economy
would never be available to Czech business in a like circumstance.
If this sort of arrangement is a logical consequence of the relative
value of particular economies in international terms, then all
the more reason it should be an issue in international policy
discussions. This is yet another demonstration of the usefulness
of the leading international economic and financial organizations.
Without the support of these organizations, the transition economies
cannot be sufficiently protected from exploitation by other players,
be they hedge funds, investment banks, or foreign governments.
If the efforts of transition countries to establish a market
economy and achieve high-quality growth are only a means to boost
the well-being of people in other countries, then something is
wrong with the world system. The problem is more serious than
merely the success or failure of a raid by speculators on the
peso or baht, ringgit or koruna, forint or rouble. Emerging capital
markets, which the cash-poor economies wish to rely on as a stable
instrument for the absorption of foreign savings and for capital
formation, may be used by rich-country investors and governments
as vehicles to transfer assets and income to themselves from emerging
markets, including the transition nations. What starts out as
investments in the poorer countries by a richer one ends up as
capital divestment or asset stripping. As a result, income inequality
increases, but this time the global economy is the scene of the
'old rich' taking from the 'new poor'. This is a serious challenge
for international policy coordination.
The fourth dilemma is capital flight. Due to the denationalization
of state assets, capital liquidity is rising. If this is accompanied
by poor financial fundamentals and the flimsy regulation of capital
transfers, then capital flight may be facilitated. The money is
not always taken out of the economy because of a lack of prospects
for profitable local investments or because the prospects are
better elsewhere, but rather because of political and economic
instability and unpredictability and sometimes simply because
of the shadowy if not plain indecent way the assets have been
accumulated, including illegal activities in the parallel economy,
corruption, and organized crime.
Though it is impossible to gauge precisely the amounts of capital
that have been transferred out of transition economies, they have
certainly been large. Jacques de Larosiere, the former managing
director of the EBRD, claimed at the 1997 annual meeting of the
bank that, with respect to Russia and other former Soviet republics,
'In 1996 alone the outflow of capital from the region probably
exceeded the total invested by the EBRD since its creation' (Financial
Times 1997c).
The Russian case is an extreme one, if it is possible to believe
that $60 billion or $70 billion (The Economist 1997d) or even
(up to the end of 1998) as much as $150 to $180 billion has left
the country. These sums surpass the total foreign direct investment
in Eastern Europe and the CIS over 1990-7. While capital flight
and crossborder transfers have occurred elsewhere, too, they have
not been of the same orders of magnitude as in Russia. It may
be too much to believe (as an estimate of Deutsche Morgan Grenfell
suggests) that in 1996 alone the capital outflows reached about
$22 billion and therefore exceeded the amount of foreign direct
investment absorbed by a factor of 10, but it does seem possible
that the average level of capital flight has hovered around $12
billion annually since the onset of the transition.
If so much capital has been pulled out of Russia, one may ask
whether the rates of return on investment were too high. The answer
is that not all investors have acted the same. Some domestic investors,
though not ready to take the risks foreign investors have taken,
have kept their money in the country.27 Of course, often domestic
investors have simply lacked sufficient capital to bid for privatization
deals. Many have lost money through financial intermediaries,
including pyramid schemes, and this money has been transferred
abroad as someone else's profits anyway.
A significant portion of the outflowing capital has been illicit
money which could not be recirculated in the country without first
being laundered somewhere else. By the same token, a small fraction
of the foreign direct investment in Russia has been money in need
of 'washing'. Poor regulation and inadequate commitment to fight
money laundering make such activities possible. At least some
of the capital leaving the country certainly finds its way back
in, whether or not it left for laundering. A not negligible share
of the inflows of both portfolio and direct investments (especially
investments from the Cayman Islands, Cyprus, and Switzerland)
is believed to be returning capital (Robinson 1997). In the meantime,
the ownership of assets has changed, and privatization has continued.
The capital and market position of the financial intermediaries
who have transformed the capital from dirty domestic savings into
clean foreign investments has been transformed, too.
So, in Russia, ill-advised privatization and organized crime
have been the main sources of capital flight. Meanwhile, in Albania
financial pyramids have been directly responsible. On the input
side was a massive (and naive) investment of savings in these
fraudulent schemes. On the output side were the attempts to channel
the money abroad. Inadequate regulations and weak institutions,
as well as the inability if not unwillingness of the government
to put a stop to the course of events, allowed the pyramids to
grow so big that they were bound to collapse. Estimates of the
losses vary, but according to the most credible ones about one-third
of GDP was funneled out of the pyramids. Obviously, a great deal
of this money has flown out of the country. None of these financial
pathologies - not the Russian, not the Albanian, not any other
- would have been possible without the active participation of
third (foreign) parties.
It is very bad that such indecent methods of capital accumulation,
capital concentration, and capital transfer have been tolerated
by these countries, foreign governments, and international financial
circles, or at least that they have not been halted by appropriate
means in a timely way. International organizations, influential
media professionals, research entities, and advisors have not
reacted promptly even to diminish the losses once the problem
has become visible. In each case too little came too late (though
this is clearly not the view of those reaping the profits).
In a rather bizarre way, this financial hocus pocus has helped
postsocialist countries accelerate primary capital accumulation
and improve the links to global capital markets. The creation
of a new class of entrepreneurs has been catalysed; capital has
become more concentrated, and international ties have been established.
However, the negative political and psychological effects have
damaged the goodwill which is so important to the transition.
Some may believe that liberalization, privatization, and internationalization
have been accelerated, but institution-building, behavioural change,
and the development of market culture have been delayed. In the
end, this sort of redistribution of capital may have led to the
emergence of new 'capitalists' and the concentration of assets,
but it has also handicapped the formation of financial and human
capital. It should have been possible to achieve more of both.
- In the aftermath of the financial crisis and the currency
devaluation in Russia in 1998, the supply of consumer goods
and real household consumption deteriorated rapidly. This occurred
partly because a bulk of consumer goods were being imported
or were being produced locally using imported intermediate goods.
It is thought that prior to the crisis as much as 80% of the
consumer goods available in Moscow and more than 40% of the
consumer goods available in Russia had been imported.
- Asked to name the greatest achievement of the stabilization
programme in Poland in 1991, an advisor to the government answered
that one could now buy kiwi at fruit stands in Warsaw.
- Even Denmark maintains restrictions on the sale of land to
foreigners because of a fear that Germans would buy up much
of the available real estate.
- 'Price transferring' is the manipulation of price and cost
information through accounting tricks carried out on an international
level.
- In contrast, the European Bank for Reconstruction and Development,
for instance, mostly lends to the private sector or for projects
enhancing privatization.
- France, Germany, Great Britain, Japan, Saudi Arabia, and
the United States form the other single-country constituencies.
- The other 19 countries are Angola, Botswana, Burundi, Eritrea,
Ethiopia, the Gambia, Kenya, Lesotho, Liberia, Malawi, Namibia,
Nigeria, Seychelles, Sierra Leone, Sudan, Swaziland, Tanzania,
Uganda, and Zambia.
- Besides Kuwait, this constituency consists of Bahrain, Egypt,
Jordan, Lebanon, Libya, Maldives, Oman, Qatar, Syria, United
Arab Emirates, and Yemen.
- The constituency includes Brazil, Colombia, Dominican Republic,
Ecuador, Haiti, Suriname, and Trinidad and Tobago.
- In this constituency are also Argentina, Chile, Paraguay,
Peru, and Uruguay.
- One might call the technical advice 'soft' not only because
it is abstract, but also because it is always easier to give
advice ( 'tighten your belt', 'cut expenditure', 'withdraw subsidies',
'close state companies', 'fire superfluous workers') than it
is to apply it. In the same spirit, 'hard' (because tangible)
financial assistance is harder to come by. There is always an
excessive supply of easy advice and an insufficient supply of
hard financing, but this is especially true during early transition,
when the economy is weaker and more vulnerable.
- Some were already members of the IMF and the World Bank prior
to the transition, for example Romania since 1972 and Hungary
since 1982.
- Assuming - as the Estonians and Finns do - that the narrow
lane of water in the Gulf of Finland is equivalent to a border.
- An evaluation at the end of 1998 gave the GDP per capita
on a PPP basis at $5,033 for Estonia, $6,540 for Poland, $7,400
for Hungary, $10,521 for Slovenia, and $10,820 for the Czech
Republic (The Economist 1998d).
- Assistance for upgrading infrastructure is also being provided
by the European Investment Bank. This financial arm of the EU
has already supplied significant credits (over 3 billion ecu
by 1998) for infrastructure development in Central and Eastern
Europe.
- This question is even more relevant vis-a-vis Myanmar, which
joined ASEAN in 1997. Though poorer than Vietnam and not a transition
economy, Myanmar must take a similar road of political and economic
liberalization in order to achieve development.
- This does not include military assistance, which, though
'unproductive', appreciably increases the aid figures, particularly
for countries involved in local conflicts, such as Armenia,
Azerbaijan, Georgia, and Tajikistan.
- Contrary to what was being claimed at the time, the Gulf
War in 1990-1 helped the transition in a certain sense, at least
in Poland. The debt reduction for the benefit of Poland that
was agreed with Western governments in 1991 was catalysed by
the decision to cut by half the debt of Egypt. For strictly
political reasons, it was virtually impossible to forgive Egypt's
debt without doing the same for Poland, considering the crucial
role the latter had played in the overthrow of the socialist
system.
- Without this assistance, the prospects of Poland would not
have become so bright since 1993. An overwhelming burden of
unpayable debt - whether in Poland or Russia - renders successful
transition impossible. For this reason, much of the outstanding
debt of Russia should also be written off (Kolodko 1998e).
- PHARE was created in 1989 specifically as a way to furnish
financial and technical assistance to Hungary and Poland in
the reform process. Hence the acronym, which stands for 'Pologne
et Hongrie Action pour la Reforme Economique' ('Poland and Hungary:
Action for Economic Reform'). PHARE was eventually expanded,
and it is now being run in a majority of postsocialist countries.
- Hopefully, this time, there won't be so many Indians wiped
out.
- The other nine 'big' markets on the list are Argentina, ASEAN,
Brazil, China, India, Mexico, South Africa, South Korea, and
Turkey. Russia is noteworthy for being absent.
- The recipient of the next largest amount among the emerging
markets was Brazil, which had absorbed $108 billion through
1996.
- Based on data in Jie Fang Daily (Beijing), 8 September 1997.
- According to current account statistics, foreign direct investments
in Russia in 1997 were valued at $3.9 billion, which was the
highest inflow in any postsocialist country. Calculated on the
same basis, the absorption in Poland was $3 billion (see Table
37).
- The government mistakenly assumed that the economy was overheated
and - almost a year before the crash in Russia in August 1998
- decided to contain domestic demand. As a result the rate of
growth dropped from an average 6.3% in 1994-7 to 5.8% in 1998
and was expected to fall further, to around 5%, in 1999.
- Often such 'investors' have not invested all their money
or even put all of it to productive use. Most estimates place
the amount of hard currency 'under the mattress' in Russian
households at around $40 billion.
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