Looking back over the nearly 20 years since the fall of the Berlin Wall, it is clear to any of the 400 million people in the countries of Eastern Europe and the former Soviet Union that the transition from centrally planned to market economies has not been an easy ride.
Old trade patterns disintegrated overnight and over-subsidized state-owned enterprises that produced shoddy goods collapsed, while the people of the region lost what they thought were stable jobs and many fell into poverty. While the countries of Central Europe experienced a shallow recession, the CIS countries saw their average incomes fall to nearly a half of their 1990 levels by the time of the Russian financial crisis in 1998.
While the first decade after communism was rough, however, the past decade has been kinder to the region that stretches from Tallin and Tirana in the West to Vladivostok and Bishkek in the East. Today, only 10 years after the Russian financial crisis, the former Eastern Bloc is back on its feet - and for many countries in the region, the transition is over.
Today, average incomes in the CIS countries have risen above 1990 levels and some 50 million people in the region have been lifted out of poverty in the past decade alone. Merchandise exports and imports, which had collapsed with the fall of the Berlin Wall, the dissolution of the Soviet Union and the disintegration of Yugoslavia, expanded rapidly from just over 15 percent of GDP in 1994 to nearly 35 percent in 2006 in the region as a whole. Services, a low priority under central planning, emerged as a dynamic force in such sectors as telecommunications, transportation, energy, and banking, boosting services trade to nearly 7 percent of GDP.
Still, while the countries of Eastern Europe and the former Soviet Union have put the crisis of the 1990s largely behind them, they need to innovate more, include all their citizens in the development of their countries, and integrate with the broader global economy if growth is to be sustained, says a new World Bank report out this week in Brussels.
The past 20 years of transition have produced a clear division in the former Eastern Bloc, with some parts of the region moving faster than others. In the Western part of the region, the lure of accession to the EU has driven great gains among the new EU member countries. Fed by rising foreign investment, trade with Western neighbors has boomed and increased participation in global production networks such as those in automobiles and information technology has boosted the local economies. Key aspects of the business environment that shape the behavior of firms are now catching up or have caught up with those in the more developed market economies of Western Europe. This augurs well for their future prospects.
Further east, in the Commonwealth of Independent States (CIS), however, progress has not been as extensive. Trade with the outside world is in natural resources or goods that can be produced using unskilled labor, and the downsizing of loss-making state-owned enterprises is lagging behind. The business environment is improving there too but is not as yet supportive enough to deliver competition that can pressure firms to develop new products or reduce costs.
So how can the lagging parts of the former Eastern Bloc catch up with the faster-growing countries? The only viable route to lasting prosperity is improving productivity – the amount that the existing capital stock and workers produce in a period of time. And that is where innovation, inclusion and integration come in.
For its part, innovation is needed because boosting productivity requires firms either to innovate, developing knowledge new to the world, or to absorb knowledge generated elsewhere. Productivity growth is higher in firms when they face stronger pressure from domestic competitors to develop new products and markets, when they can access more developed financial sectors, and when rules and regulations are more predictable.
Meanwhile, the notion of “inclusion” is key. While incomes across the region have grown rapidly, jobs have not done so except for recently in the new member states of the European Union. Furthermore, labor force participation—the proportion of 15-64 year olds who belong to the labor force—is lower than in Western Europe. This is a waste of human resources that countries can ill afford, especially in a large number of these countries whose populations are aging rapidly. What is needed are lifelong education programs, and retirement ages for men and women need to be raised. And where fiscal considerations permit, payroll taxes that make hiring labor expensive for employers need to be cut.
Lastly, the countries in the region need to redouble their efforts at integrating with the global economy. While trade now accounts for 60 percent of GDP in the countries that joined the European Union in 2004, it pales at only 20 percent in the CIS countries. This calls for developing better trade facilitation and logistics in port efficiency, and undertaking customs reforms. And by lowering costs through liberalized banking, telecommunications, and transport services, this can make countries’ exports more competitive.
Only 10 years after the tumult of the Russian financial crisis, the transition is largely over for many in the former Eastern Bloc. But for many others, there is quite a way to go. We hope countries will redouble their efforts to innovate, include, and integrate, so that 10 years from today, the people of Eastern Europe and the former Soviet Union will be able to see transition as part of their distant history and look ahead to a brighter post-transition future.
The writers are, respectively, Vice-President and Chief Economist for the Europe and Central Asia Region of the World Bank.
