63356
TRANSITION
YEARS:
REFLECTIONS ON
ECONOMIC
REFORM AND
SOCIAL CHANGE
IN EUROPE AND
CENTRAL ASIA
TRANSITION
YEARS:
REFLECTIONS ON
ECONOMIC
REFORM AND
SOCIAL CHANGE
IN EUROPE AND
CENTRAL ASIA
JOHANNES LINN
III THE WORLD BANK
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Contents
Foreword vii
Introduction IX
List of Abbreviations xv
PART 1 Regionwide Progress and World Bank Engagement
Chapter 1 The Transition in Europe and Central Asia:
Progress and World Bank Assistance (1996) 3
Chapter 2 Progress in Transition: Central and Eastern
Europe and the Former Soviet Union after
a Decade of Reform (2002) 23
PART 2 Country and Subregional Perspectives 33
Chapter 3 New Leadership, New Opportunities in the
Russian Federation (2000) 35
Chapter 4 Central Asia: Ten Years of Transition (2002) 45
Chapter 5 Economic and Social Dimensions of
Enlargement of the European Union (2000) 55
Chapter 6 Staying the Course in the Balkans (2002) 61
Chapter 7 Structural Reforms for Sustainable Growth in
Turkey (2000) 65
PART 3 Key Thematic Perspectives 69
Chapter 8 Good Governance and Transparency in
the Transition Economies (2001) 71
v
Contents
Chapter 9 Legal and Judicial Reform in the Transition
Economies of Europe and Central Asia (2001) 77
Chapter 10 Transition in Central and South East Europe
and the CIS: The Energy Dimension (2003) 83
Chapter 11 Transition in Central and South East Europe
and the CIS: The Social Dimension (2003) 89
Chapter 12 Progress and Challenges in Meeting
Environmental Goals in Europe
and Central Asia (2003) 95
PART 4 Beyond Europe and Central Asia 103
Chapter 13 A New Global Approach to Development (2002) 105
Chapter 14 Ensuring Peace, Alleviating Poverty, and
Protecting the Environment (2002) 111
Chapter 15 Postscript: The Economic Outlook for Eurasia:
From Transition to Sustained Growth
and Integration (2003) 115
vi
Foreword
The twentieth century saved one of its biggest surprises for its last decade:
the wholesale transformation of a group of countries tightly bound together
under one economic, political, and social model-the former Soviet Union
and the Council for Mutual Economic Assistance (CMEA)-into individ
ual states that embrace market principles, pluralism, and civil society par
ticipation in the process commonly known as transition.
The end of the Cold War was the trigger that allowed this transforma
tion to happen. But who would have thought that less than 15 years
after the Berlin Wall fell, in November 1989, a significant number of the
former CMEA countries would be ready to join an enlarged European
Union? Who would have thought that barely 10 years after the rather
chaotic disintegration of the former Soviet Union, the Russian Federa
tion would have reemerged as a vibrant economy and would be reestab
lishing itself as the second-largest exporter of oil in the world? Who
would have thought that in the early years of the twenty-first century we
would be able, for the first time in decades, to use the term "Eurasia"?
All of these monumental changes have occurred, many of them during
the tenure of Johannes Linn as Vice President of the World Bank's
Europe and Central Asia Region.
This compendium of selected speeches by Johannes eloquently illus
trates these transformations. Indeed, under Johannes' leadership, the
Europe and Central Asia Region positioned itself as an intellectual as
well as pragmatic leader in terms of contributing to the transition
debate. The topics range from a description of individual challenges fac
ing subregions and countries to a regionwide perspective. The speeches
provide Johannes' special insights into such issues as legal and judicial
reform and social concerns. They also demonstrate the relevance of les
sons learned in this process to the broader development debate. These
lessons come from the vantage point of one who was intimately
involved in the decisionmakers' struggles to face and ultimately manage
the unprecedented challenges of transition. The speeches transmit to
the reader a sense of increasing understanding and learning over time of
the true dimensions of those challenges: to overcome the shock resulting
from the unprecedented sudden disintegration of a common economic
space to the socioeconomic and political fabric and the lives of more
than 400 million people.
vii
Foreword
Starting from the earliest phases of transition and through the present,
the World Bank has aimed to improve the livelihoods of people in all
countries in the region. Johannes never ceased to advocate that no
country, however small, should be forgotten in the larger geopolitical
scheme. The Bank is working to help people in Europe and Central Asia
have a more optimistic outlook on life, to give them a fairer chance, and
to ensure that future generations benefit from sound environmental
practice and social and economic development.
The countries in the Europe and Central Asia Region can be proud of
their achievements, which, if sustained, will represent a success story
that all stakeholders in the development community would do well to
note. World Bank can also be proud of its contributions to the
region's success under Johannes' stewardship and that of the late
Wilfried Thalwitz before him.
Shigeo Katsu, World Bank Vice President for Europe and Central Asia
viii
Introduction
or a young Gennan born in 1945 and growing up in Bavaria in the
F two decades after World War II, the world was sharply divided into
East and West and North and South. In many ways, the East-West
divide was much closer, more threatening, and more worrisome than the
gap opening up between North and South in the wake of decoloniza
tion. The Iron Curtain and the Berlin Wall were visible and deadly bar
riers. The political maps showed little more than a great red expanse to
the east of Finland and the River Oder and to the southeast of Vienna,
with hardly a sign hinting at different countries or peoples or cultures.
This is how I grew up, in awe of the postwar division of the world,
unable to imagine that this division might ever end. As a teenager and
student 1visited and lived in West Berlin, once or twice crossing into
East Berlin to meet an East German pen pal. The impressions I took
away from these visits only reinforced the picture of a world divided,
with opportunity beckoning in the West and repression looming in the
East. Even Hungary and Poland were largely inaccessible and unknown
to us in the West in those years. Even less could we contemplate getting
to know the far reaches of the huge Soviet Empire, although we might
have read about the exploits of explorers who had traversed the moun
tains, steppes, and deserts of a mysterious and presumably long-gone
Central Asian world. My own, more timid explorations took me by car
from Germany to Greece, traversing Yugoslavia, then relatively open,
accessible, and unified. In contrast to East Germany, Yugoslavia gave the
young traveler from the West a glimpse--or as it turned out, a mirage
of what a less threatening, more humane form of socialism might have
to offer.
In the early 1970s I became much more aware of and troubled by the
challenges of development in the South and by the urgent need to
bridge the ever more glaring gap between the two hemispheres. Having
joined the World Bank as an economist in 1973, 1worked mostly in
Latin America, East Asia, and Southeast Asia and largely ignored the
internal tensions that were developing in the "red" area on the world's
map. I was not alone. Most of us who worked on development issues had
little interest, knowledge, or understanding of the communist system or
of the countries and peoples behind the Iron Curtain. During the 19805
only a few people in the World Bank worked on Yugoslavia and on the
ix
Transition Years
early, gradual reformers, Hungary and Poland. But then, in 1989, while I
served as an adviser to Stanley Fischer, then Chief Economist at the
World Bank, and as the signs of fundamental change in the East became
unmistakable, the Bank organized a conference on the incipient transi
tion in socialist countries. At this meeting we met for the first time with
experts on the communist economic system and gently explored what
might or might not be in store as systemic political and economic
change seemed to be in the offing. In early 1990 I visited a devastated
Poland for a conference organized by the World Bank jointly with a
young Polish economist, Leszlec Balcerovic. At about the same time I
visited Berlin, just as the Wall began to crumble, knocked down by the
many small hammers of people ecstatic to see the old divide disappear.
In October 1990 German unification was comp leted; by the end of 1991
the Soviet Union was no more.
In the subsequent years I watched with great interest the rapidly growing
engagement of the international community, including the World Bank,
in the countries that emerged from the now defunct former Soviet
empire. As the Bank's Vice President in charge of financial risk manage
ment and resource mobilization, I was excited and concerned about the
rapid expansion of our International Bank for Reconstruction and
Development (IBRD) loan exposure in its brand new members, as well
as about the need to raise new funds for the International Development
Association (IDA) with which to aid the poorer countries in the Europe
and Central Asia Region, as the new regional office became known.
From the sidelines I watched with admiration and fascination how the
first Vice President for the region, Wilfried Thalwitz, built up the Bank's
institutional and staff capacity virtually from scratch and almost
overnight, how he and his team plunged into the often very uncomfort
able and risky worlds of political chaos, deep economic recession, and
civil war that characterized many parts of the former Eastern Bloc in the
immediate aftermath of the collapse of the Soviet Empire and
Yugoslavia. I marveled at how they were able to establish trust with new
partners and a track record of sensible advice and prudent lending. In
the first five fiscal years (1991-95), the World Bank financed 163 proj
ects in the region, totaling $18.1 billion. During the same period, the
Bank made 14 loans to Turkey, for a total of$2 billion.
In the fall of 1995, Wilfried Thalwitz informed the World Bank's Presi
dent, James D. Wolfensohn, that he wished to retire at year's end, after
three decades of extraordinarily dedicated service to the institution and
to its shareholders, clients, and partners. To my surprise, and consterna
tion, Mr. Wolfensohn asked me to take over. This was a daunting step
x
Introduction
for me, since I had been away from the Bank's operational work for
almost 10 years and did not know the region except from my limited
vantage point in the Bank's financial wing. However, I could not refuse
the offer to be part of the historical transition of the former "red area"
on the maps of my childhood and to do everything in my power to help
the countries of the region recover from what had been a traumatic eco
nomic and social shock and from the scars of their communist past. On
January 1, 1996, I became Vice-President for Europe and Central Asia,
beginning what was undoubtedly the most exciting part of my World
Bank career. In September 2003, after more than 30 years of service,
almost 8 of them in the Europe and Central Asia Region, I retired from
the Bank, grateful for the extraordinary opportunities I had had for so
many exciting years. By the end of fiscal year 2003, the World Bank had
opened offices in virtually every country in the region, employed more
than half of its 1,000 regional staff in country offices in the region
(rather than at Washington headquarters), had made more than $40 bil
lion in loans to the transition economies, and could with some satisfac
tion consider the progress that the region had made with its support,
even as much remained to be done to achieve the urgent goals and aspi
rations of its people.
This volume collects some of the speeches and addresses I gave between
1996 and 2003. They serve as a record of the World Bank's institutional
thinking during the period of the historic transition process in Europe
and Central Asia. These years, and hence the speeches, span a time of
many fateful events. The countries of Central Europe embarked firmly
and successfully on the path to accession in the European Union. The
Russian Federation and Ukraine reached the nadir of a deep recession
shortly after the traumatic 1998 financial crisis and began the long path
of recovery, which after the unexpectedly deep collapse has proven to be
unexpectedly rapid and sustained. The small, poor republics of the for
mer Soviet Union in the meantime were plagued by severe economic
and social problems, compounded by rapidly rising debt burdens and
serious problems of governance and regional strife. While most of these
countries are now recovering from their deep recession, their prospects
are at best clouded. In the Balkans 1996 marked the beginning of the
reconstruction of Bosnia and Herzegovina after a bloody civil war. This
was followed by the upheavals in Kosovo and the collapse of the old
regime in Serbia and Montenegro. Today, perhaps for the first time in
centuries, it appears that the Balkans are set for peaceful integration
with the rest of Europe. Finally, since 1996 Turkey went through a see
saw of political and financial crises and recoveries, and it experienced a
major earthquake as well as a war in its backyard. Yet Turkey now seems
xi
Transition Years
to have turned a corner, with increased domestic pohtical stabihty, far
reaching and sustained reforms, and an economic recovery, all of which
give hope that Turkey's aspirations for a prosperous future, ultimately as
a member of the EU, are indeed a real possibility.
Public speeches represent a somewhat curious and idiosyncratic combi
nation of institutional and personal reflection. Preparing such speeches
is a bit like tailoring a suit for oneself. Usually someone else does the
first cut and stitches together various bits and pieces of information and
insight into an early draft, which then requires varying degrees of repair,
unraveling and reassembly, additions and subtractions, and changes in
color or tone before the presenter feels comfortable with the length,
content, message, and style. But in the end, it's only once you're at the
podium that the real speech emerges, some more successful than others,
some well attuned to the needs of the audience, others missing their tar
get, some more spur of the moment and short-lived, others more in
depth and lasting in their messages.
In selecting the speeches for this volume, I tried to provide a broad rep
resentation of the ideas and experiences that motivated the World Bank
in its work. The speeches do not, of course, provide a complete history
or overview of all that the Bank did or had to say during this time. 1 The
volume starts with overviews of regional trends and outlook in 1996 and
2002. It then presents perspectives on individual country and sectoral
issues. It closes with a set of speeches addressing broader development
perspectives and a summary of the regional outlook as seen in mid-2004.
These speeches cannot do justice to the courage and perseverance of the
people of the region whom I served for almost eight years. While the
enjoyment of newly found political freedom was palpable, the economic
shock and human toll of the transition were severe. It is worth remem
bering that after two World Wars, the dissolution of the Soviet empire
and the resulting dramatic economic recession was the third great
upheaval that the countries of Central and Eastern Europe faced in a
century and its successful and peaceful outcome by no means foreor
dained. Fortunately, 15 years after the transition started a modicum of
economic prosperity is now returning to most parts of the former Soviet
1 Readers interested in the talking points for a more complete set of speeches delivered
during 1996-2003 can find them on the World Bank's Web site (www.worldbank.org/eca).
This Web site also contains many of the World Bank publications produced during the last
few years by the staff of the Europe and Central Asia Region.
xii
I nrroouction
world, and the prospects for continued recovery, peace, and even democ
racy are promising. I have deep admiration for the leaders and the peo
ple of the region who made this outcome possible.
I am very grateful for the contributions my many colleagues in the Bank,
especially in the Europe and Central Asia Region, have made to the
transition process. Without their initiative, inputs, and support, the
speeches and addresses collected in this volume could not have been
credibly prepared or delivered. I am indebted to my colleague and suc
cessor, Shigeo Katsu, for pushing forward with the idea of issuing this
volume and for his many years of dedication in his previous capacity as
Director of Operations in the region. Miriam Van Dyck provided invalu
able assistance for the production of the volume, strongly supported by
Nick van Praag. Our trusted and efficient editor, Barbara Karni, made
sure the talking points translated into what I hope is readable prose.
Finally, I wish to thank Priscilla Rachun Linn and our children, Joseph
and Natasha, for always cheerfully putting up with stress and deprivation
caused by their peripatetic husband and father during more than 30
years ofhfe with the World Bank.
xm
List of Abbreviations
CDF Comprehensive Development Framework
CIDA Canadian International Development Agency
CIS Commonwealth of Independent States
COMECON/ Council for Mutual Economic Assistance
CMEA
DFID British Department for International Development
EBRD European Bank for Reconstruction and Development
EU European Union
FDI foreign direct investment
FIAS Foreign Investment Advisory Service
GEF Global Environment Facility
GTZ Deutsche Gesellschaft fOr Technische Zusammenarbeit
HIPC Heavily Indebted Poor Countries
IDA International Development Association
IFC International Finance Corporation
MOOs Millennium Development Goals
MIGA Multilateral Investment Guarantee Agency
NGO nongovernmental organization
OSCE Organization for Security and Co-operation in Europe
PRSP Poverty Reduction Strategy Paper
USAID US. Agency for International Development
WHO World Health Organization
WTO World Trade Organization
xv
PART 1
Regionwide Progress and World Bank
Engagement
T he speeches in this section of the book--chapters 1 and 2-provide
snapshots of the region's progress and outlook, of the lessons of the
transition process to date, and of the World Bank's support for the
region. In 1996 the Bank was already stressing a number of key dimen
sions of the transition that critics do not usually associate with the
"Washington Consensus." These included social, poverty, and environ
mental dimensions; the need for institutional development; and the key
role of a supportive business climate. 2 It would be fair to say, however,
that the Bank as an institution-and I personally--ciid not adequately
address some important problems of transition in 1996, among them the
weaknesses of the privatization processes in many of the countries
(notably Russia's scandalous loans-for-shares program) and the scourge
of corruption. By 2002 the Bank had begun to focus on these issues,
along with a number of other lessons learned, as reflected in chapter 2.3
2. For an in-depth appraisal of the early transition experience, see World DevelDpment
Report 1996 (World Bank 1997).
3. Many of these issues are addressed in much greater detail in Transition: The First Ten
Years (World Bank 2002) and Anticorruption in Transition (World Bank 2000).
CHAPTER 1
The Transition in Europe and Central Asia:
Progress and World Bank Assistance
From a speech given in Tokyo, November 25, 1996
T ransition in Central and Eastern Europe and Central Asia is a vast
and complex topic with wide political, institutional, and economic
dimensions. The World Bank is trying to assist economic reform. What
is the Bank doing, why is it doing what it is doing, and how is it directly
and indirectly helping the private sector playa major role in the
process?
How Are the Countries of Central and Eastern Europe
and Central Asia Performing Today?
The countries of Central Europe and the Baltics have seen renewed
growth during the past three years (although Bulgaria is likely to suffer a
reversal in 1996). Belarus, the Russian Federation, and Ukraine are still
experiencing negative growth, however. In Russia we expect output to
bottom out at the end of 1996 and grow in 1997; Ukraine may also
begin to recover in 1997.
The overall picture would look better if the largely unrecorded private
and services sectors were included in the national accounts. The "pure"
private sector in the Russian Federation has now reached a third of
GDP. In addition, roughly another third of GNP is contributed by joint
ventures and firms with other forms of mixed ownership.
In Central Asia and the Caucasus, Armenia, Georgia, and the Kyrgyz
Republic are growing, and the recession appears to have ended every
where except in Azerbaijan and Tajikistan, which still suffer the conse
quences of conflict.
The assistance of Marcelo Selowsky, former Chief Economist for the Europe and Central
Asia Region of the World Bank and current Assistant Director of the IMF's Independent
Evaluation Office, in drafting this speech is gratefully acknowledged.
3
Transition Years
Overall, the severe recession in Eastern Europe and Central Asia shows
clear signs of abating; with reasonable policies, growth is likely to
resume in the near future in most, if not all, countries. Poland's signifi
cant recovery since 1992 shows what is possible.
Inflation has fallen more sharply in Central Europe and the Baltics than
in the non-Baltic republics of the former Soviet Union, except for a
sharp reversal in Bulgaria and, to a lesser extent, Romania. Throughout
the region, countries that have begun to recover have reduced inflation
below 30 percent a year, confirming the notion that stabilization is a
prerequisite for the resumption of growth.
Central Europe and the Baltics
The countries of Central Europe and the Baltics early on liberalized and
privatized part of their economies, especially small and medium-size
enterprises. They inherited market and legal institutions that have
helped the process, and they had smaller military industrial complexes
(for which demand collapsed). We may never be able to disentangle
what part of the superior growth performance of Central Europe and the
Baltics is due to better and earlier reform policies and what can be
attributed to initial conditions prevailing at the outset. What we do
know is that the quality of policies matters-and policies are under the
control of governments.
Will growth be sustainable? Will it be hampered by macroeconomic
threats, such as the reemergence of fiscal deficits and banking sector
emergencies? Throughout Central Europe and the Baltics, fiscal deficits
have been reduced. Public expenditures and revenues remain extremely
high as a percentage of GOP, however, averaging close to 50 percent.
This means that relatively small shocks on either the expenditure or the
revenue side could have a significant impact on the fiscal deficit. The
sudden need to recapitalize banks or compensate depositors for losses
caused by banking sector crises, an increase in public sector wages,
increased transfers to money-losing public enterprises as part of an
electoral cycle-any of these events could have a significant effect on the
deficit, which could lead to monetization of that deficit or crowding-out
of the private sector. Further progress in increasing the tax base while
reducing tax rates (especially the payroll tax), early resolution of banking
sector problems, and civil service and social transfer reforms are thus
critical to ensuring the sustainability of the macroeconomic situation and
the growth process.
4
The Transition in Europe and Central Asia: Progress and World Bank Assistance
The Russian Federation, Ukraine, and Belarus
The Russian Federation is going through a difficult macroeconomic
phase. Declining fiscal revenues have led to sharp expenditure cuts,
threatening the viability of the overall adjustment program. Provided
the government weathers this crisis, prospects that growth will resume
in 1997 are good. But markets must remain liberalized and the econ
omy open. Efforts to artificially jump-start noncompetitive industrial
sectors through trade protection or subsidized inputs and credit will
simply postpone the process. Social concerns should be addressed by
better targeting social assistance directly to households (particularly
poorer pensioners) rather than transferring funds to money-losing
enterprises to sustain output. Subsidies should be used to reach house
holds and the very poor, not enterprises.
In Ukraine reforms started two years later than in the Russian Federa
tion, and the country paid a price, in the form of a more severe cumula
tive output loss. After some hesitation in 1995, the reform program is
now proceeding on a broad front. Provided the authorities keep their
resolve, Ukraine could enter a growth path next year similar to that of
Poland in the 1990s.
Belarus has reversed its reform efforts. Prospects for an economic recov
ery there remain dim.
Central Asia
The Central Asian countries are generally poorer than the Central and
Eastern European countries, but four of them (Azerbaijan, Kazakhstan,
Turkmenistan, and to a lesser extent Uzbekistan) are endowed with
extensive oil and gas deposits that could bring considerable wealth to
their people. Development of these resources will require large invest
ments in pipelines and infrastructure, the financing of which will need
to come mostly from private external sources. A development path
based on oil and gas exports raises special policy challenges: how to cre
ate productive employment outside the capital-intensive energy sector
and how to manage large revenue inflows without overheating the econ
omy or indulging in wasteful showcase projects. Privatization, restructur
ing, and further liberalization of markets are necessary to enable other
sectors (agriculture, manufacturing, and financial and other services) to
grow and remain competitive in an environment of real exchange rate
apprecia tion.
5
Transition Years
The pattern of agricultural development in Kazakhstan, Turkmenistan,
and Uzbekistan presents a unique set of challenges, Concentration on
irrigation-intensive cotton monoculture has led to the diversion of two
large rivers and the drying up of the Aral Sea, Soil degradation, deterio
rating health conditions, and changes in the local climate are long-term
problems that will require attention and resources over several decades,
The Kyrgyz Republic and Tajikistan do not share their neighbors' rich
endowments of natural resources, While heavily dependent on agricul
ture, they face considerable hurdles to increasing agricultural exports,
including high transport costs,
Poverty throughout the Region
Poverty and income inequality have increased in all economies in transi
tion, The Central Asian countries inherited significant poverty from the
Soviet Union, About a third of the population in these countries is poor,
Slowing reforms is not the solution to poverty. Despite having delayed
the reform process, the share of poor households in Ukraine increased
from 12 percent to 25 percent between 1992 and 1994; in Azerbaijan
the share increased from one-third in 1989 to 60 percent in 1995, In the
Russian Federation the practice of using the inflation tax to finance sub
sidized enterprise credit to sustain production was not helpfuL In 1992
the inflation tax burden on households amounted to 12 percent of GDP.
That tax ended up subsidizing the financial sector and larger enterprises
(by providing credit at negative interest rates). Poorer households
those least able to avoid the inflation tax--ended up financing capital
flight,
The emerging evidence indicates that poverty in Central Europe is shal
low, with many poor households bunched around the poverty line. This
means that the recovery of growth may pull many households out of
poverty, In Poland a 5 percent real annual growth rate could reduce the
share of the poor from 14 percent of the population to 5 percent by the
end of the decade.
In Belarus, the Russian Federation, and Ukraine, a large segment of the
poor population will have to be assisted directly, The sharp erosion of
minimum pensions and the increase in unemployment in company town
areas call for more targeted approaches in public spending. Growth
alone will not be enough.
6
The Transition in Europe and Central Asia: Progress and World Bank Assistance
In Central Asia, poverty is both more widespread and more severe than
elsewhere in the region. For example, about one-fifth of an households
in Azerbaijan and one-third of all households in the Kyrgyz Republic
have expenditures that are 50 percent or more below the poverty line.
In other words, a large part of the population is not just poor but
severely impoverished. The level of cash benefits has plummeted, and
transfers play only a marginal role in maintaining living standards. Eco
nomic recovery remains the first priority, because without it there is
nothing to transfer to the poor. In Azerbaijan, Kazakhstan, and Turk
menistan, oil and other natural resource exports will lead the recovery,
but they will not create many employment opportunities. Accelerating
structural reforms in other sectors is therefore crucial to increase their
competitiveness and provide wage employment. Better targeting of cash
benefits is also important, but even then adequate minimum levels of
support will become possible only with economic recovery. In the
interim, health services must be improved and targeted more directly
at the major causes of death and disability.
What Is the World Bank Doing Today?
During the past five years, 23 transition economies--15 newly inde
pendent states of the former Soviet Union and eight Central and South
East European countries--have become members of the World Bank.
Cumulative lending commitments reached US$20 billion between fiscal
year 1991 and fiscal year 1996. Annual lending to the non-Baltic
republics of the former Soviet Union went from zero in 1992 to about
US$3 billion during the past two years. Thirteen field offices in the
region were established during that period. This has been a major effort.
While the volume of assistance is by itself significant, the key principle for
Bank involvement has been to improve the environment and the incen
tives to attract other financial flows, particularly private flows and foreign
direct investment. Thus World Bank lending and advice can be seen as
"seed interventions" for the medium- and long-run private flows that will
result from successful stabilization and reform programs. Eventuany, Bank
financing should be complemented and even replaced by private flows
and foreign equity. This is what we are observing today in some of the
most advanced countries in the reform process: the Czech Republic,
Estonia, Hungary, Poland, and Slovenia. The natural resources-rich coun
tries of Central Asia will, of course, attract foreign investments under
almost any condition, but even there a better environment is likely to
increase flows and improve the terms for the host country.
7
Transition Years
To achieve this objective, the Bank operates on two fronts. First, it
improves the environment and incentives for investment and business
activity; macroeconomic stability, price and trade liberalization, a credi
ble legal system, and progress in transferring assets from the public to the
private sector. Second, it provides resources to revamp public infrastruc
ture and offers credit to the emerging private sector, as it takes time for the
improved incentives to trigger a response from domestic and international
capital markets. These efforts need to be complemented by creation of a
dynamic and liquid financial sector able to intermediate such flows.
Key for the Bank is matching its assistance with the domestic policy
effort, which it must complement. If we are too slow or too late, we
unnecessarily increase the cost of reform. But if we are premature
lending too much and too early-we add to the debt burden without
improving a country's ability to repay. The Bank could thus help sustain
bad policies. To maximize complementarity between assistance and
policy efforts, we must adapt our instruments to the stage in which the
transition economies find themselves.
The Russian Federation: An Early Reformer at a Crossroads
Supporting the reform program in the Russian Federation has been one
of the Bank's major challenges. The uneven pace of reform across sec
tors, fluctuating progress in stabilization, frequent changes in counter
part ministries, constitutional uncertainties, the strong role of local gov
ernments, and other factors have made the task difficult. Starting from
zero, the Bank's cumulative lending during its first four years of opera
tions (1993-96) climbed to US$6.4 billion. Today, about 75 Bank pro
fessionals work exclusively on the Russian program. The Bank's basic
strategy has been to provide early support for the processes of stabiliza
tion, price liberalization, and privatization. It has worked closely with
the International Monetary Fund (the most recent Extended Fund Facil
ity Program was put together in close collaboration with the Bank). The
objective is to achieve a "high-quality" fiscal adjustment. The deficit
must be reduced, but it should be done so efficiently, equitably, and in a
sustainable manner. Deficit reduction cannot rely on running arrears in
contractual payments or on unsustainable cuts in social spending.
Both the fiscal adjustment (which called for a significant reduction of
subsidies to the enterprise sector) and trade and price liberalization were
supported by two quick-disbursing operations providing noninflationary
financing for the budget. The gradual emergence of the private sector
8
The Transition in Europe and Central Asia: Progress and World Bank Assistance
was then supported by funding a strong technical assistance program to
create a modern banking sector with international standards and by
providing credit through these new banks. To avoid bottlenecks in infra
structure, the Bank has supported rehabilitation investments in the
transport sector. Loans to rehabilitate oil fields to maintain export levels
have also been important.
Today the Bank is focusing on supporting progress in two sectors where
reform has lagged behind: the social sectors and agriculture. Despite
spending of 6 percent of GOP on pensions and social transfers, the mini
mum pension today amounts to only 60 percent of the minimum subsis
tence level. Unemployment compensation payments cover only 15 per
cent of minimum subsistence. The Bank is in the process of working
with the government on a reform program that will better protect these
basic transfer payments, better target social assistance by focusing on
families with large numbers of children, and improve both the tax base
and the collection of contributions financing pensions and unemploy
ment benefits. Earnings-related pensions will have to be constrained by
the history of past contributions. The Bank expects to support this
process through a social sector adjustment operation. This effort is being
complemented by lending operations to provide some basic medical
equipment to hospitals and local community health centers.
The Bank has been less fortunate in engaging Russian counterparts in
speeding up agriculture sector reform, particularly land reform. Many of
the actions are under the direct control of regional governments. Local
and pilot-type interventions will be needed to accelerate this process.
Ukraine: Making Progress Despite a Late Start
Ukraine's reform program began in the second half of 1994, after
President Kuchma was elected. The fiscal deficit and monetary expan
sion were reduced, privatization was initiated, and most domestic prices
were freed. In addition to providing advice, the Bank supported the
process with a US$500 million balance of payments operation and a
large investment project to help rehabilitate and reform the energy
sector (Ukraine is a heavy gas and oil importer, with an energy import
bill of about 12 percent of GOP).
The reform process slowed in mid-1995, as state enterprises and the
Parliament started pressuring the government to reinstate credit and
budget subsidies to enterprises and the coal sector and to hold back the
9
Transition Years
privatization process. In response, the Bank had to withhold further
financial assistance.
The government took corrective fiscal and monetary measures in early
1996, and it is now taking structural reform actions on a broad front that
includes large- and small-scale privatization, including agro-processing
industries; elimination of restrictions on private traders in the agricul
tural sector and accelerated land reform; downsizing of the coal sector;
and development of an electricity market. Major public sector reforms
are being prepared. In response, the Bank's total commitments for fiscal
1997 may reach US$L5 billion-with disbursement conditional on
continued progress.
Belarus: Stagnation and Reversals
When Belarus became a member of the Bank, in 1993, the Bank pre
pared a significant program of assistance. It began with a quick-disburs
ing (balance of payments support) operation supporting the start of sta
bilization and economic liberalization. A resident mission was opened to
enhance our policy dialogue. Unfortunately, that was the end of the
process. Today, administrative controls have been reintroduced in the
foreign exchange market, the government has announced its intention
to reinstate direct controls over the decisionmaking process of the lead
ing commercial banks, and the privatization program has been halted.
As a consequence, the Bank is not preparing any new loans, although it
is trying to keep the policy dialogue alive (by conducting a seminar for
parliamentarians, for example). The Bank has brought in experts from
other countries to share the lessons learned from privatization. Through
economic missions, we are trying to better document current economic
events and help the government understand the implications of differ
ent policy options.
The Baltics and Central Europe: Much Progress,
But Challenges Remain
Although on average growth in the countries of Central Europe and
the Baltic is recovering and inflation declining, large variations in the
reform agenda remain on the structural side. Bulgaria has lagged in
privatization, restructuring and isolation of large money-losing enterprises,
and banking sector refonn, and the banking sector is threatening the over
all macroeconomic situation. The Slovak Republic's privatization program
10
The Transition in Europe and Central Asia: Progress and World Bank Assistance
still places restrictions on the entry of investors, jeopardizing the quality
of the governance of the newly privatized enterprises. Croatia still has
an unfinished agenda in restructuring state banks and privatizing large
loss-making state enterprises. Romania has just begun its privatization
program, but the authorities are still intervening in the foreign exchange
market, creating uncertainties for exporters and the emerging private
sector.
At the other extreme are the Czech Republic, Estonia, Hungaty, Poland,
and Slovenia, where the economies have become quite open and liberal
ized, privatization has had a more consistent record, and large private
sectors are emerging. The best evidence that the transition is progressing
is the large amount of foreign direct investment flowing to these coun
tries. Together the Czech Republic, Hungaty, and Poland are receiving
about US$2 billion a year in foreign direct investment-about as much
as the Russian Federation, a much larger countty with greater national
resources.
The Bank is adapting it~ instruments to particular situations. In Bulgaria
it is willing to provide assistance if the government takes the necessaty
steps, particularly in the enterprise and banking sector. Already, the
Bank is providing some US$30 million in quick-disbursing funds to help
the authorities deal with the social implications of the closure of some
major loss-makers. In Romania the Bank is supporting privatization
through a large adjustment operation. In Croatia it is preparing several
operations to support the resolution of problems in the banking sector
and state enterprises.
In the more advanced countries, the Bank is focusing on ensuring the
sustainability and efficiency of public finances and on facilitating private
sector participation in infrastructure investments and environmental
improvement. In Hungary, Latvia, and Poland it is actively supporting
the design of more sustainable pension systems, which would eventually
include a privately run, fully funded pillar. Loans are intended to help
defray the transitional cost of such reforms and to establish an efficient
regulatoty framework for private pension funds. The Bank is also sup
porting improvements in tax policy and administration to reduce
distortive payroll taxes and eliminate the unfair competitive advantages
generated by lax enforcement of tax legislation. Adjustment operations
to support such reforms are envisioned for Hungary and Latvia.
To encourage private sector participation in infrastructure, the Bank is
supporting the establishment of an energy regulatory agency in Poland
11
Transition Years
that provides dear rules for private provision of power services. It is also
actively designing a guarantee operation in support of Poland's motor
way program, in which significant private sector participation is
envisaged.
Bosnia: The Beginnings of Reconstruction and Hope
Donors have looked to the Bank for leadership in the reconstruction
effort in Bosnia and Herzegovina. In dose collaboration with the
European Union, the Bank designed a three-year emergency reconstruc
tion program of some US$5 billion. A broad coalition of donors, who
have pledged US$1.8 billion for the first year of the program, has been
mobilized.
The Bank's own efforts began more than a year ago and have accelerated
since the signing of the Dayton Accords. In April the Bank established a
field office in Sarajevo, which will help manage projects and provide
policy advice to the government. The field office will also chair overall
coordination of donor activities to ensure maximum development effec
tiveness. The International Finance Corporation (lFC) has begun work
in Bosnia to consider possible projects with the private sector.
More than 40 Bank staff work on Bosnia, implementing 13 ongoing
projects with Bank support ofUS$325 million and preparing an addi
tional 9 projects with Bank funding of about US$225 million, expected
to be approved over the next two years. These 22 projects will be cofi
nanced by more than US$l billion from other donors on concessional
terms. Rapid implementation is critical, and funds are expected to be
disbursed within two years for these emergency projects. The impact of
these investments is already visible on the ground and will become more
evident during the next few months.
Central Asia: Special ProgTams and Challenges
The unique challenges and potential of the Central Asian republics
have taken time to define and understand. In the interim, the Bank has
worked with the governments of these countries to help deal with
immediate problems following the dissolution of the Soviet Union.
These problems are similar to those faced by other former Soviet
republics, namely, the need to achieve macroeconomic stability and
begin the transition to a market economy.
12
The Transition in Europe and Central Asia: Progress and World Bank Assistance
Initially, the Bank made a quick-disbursing rehabilitation loan to each of
the Central Asian republics except Turkmenistan, which did not need
the balance of payments support provided by these operations. Each
country also received technical assistance loans to build institutional
capacity, in particular for the management of external assistance and
debt. The Bank later developed adjustment operations in line with each
government's willingness to move toward a market economy.
The pace of adjustment has varied considerably across countries. The
Kyrgyz Republic has been among the fastest reformers. Early on it
engaged in a far-reaching price liberalization and privatization program,
and it has begun to restructure its financial system. Kazakhstan has fol
lowed close behind, with privatization and financial reform programs
under way. Uzbekistan has now started its privatization program. War
and civil strife have delayed reform programs in Azerbaijan and
Tajikistan, but adjustment programs are now being prepared for both
countries. Turkmenistan has yet to begin this process.
The Bank and the International Development Association have com
mitted more than US$l. 7 billion in loans to the Central Asian republics
during the past four years. Most of these loans are for rehabilitation and
adjustment operations; some are for institurion building and investment
projects. A pipeline of investment projects has been developed, and
bank lending is turning to projects that will improve basic infrastructural
and social services.
The Bank's assistance strategy for Central Asia also emphasizes the
mobilization of foreign capitaL This is done in two ways: by chairing
consultative groups for official assistance and by chairing conferences
(through the IFC) for private investors. The Bank is also providing
advice on how to make the foreign investment regime more attractive to
private investors, something that is essential for developing the mineral
resources in Central Asia.
Emerging Common Themes
Throughour the transition economies common issues and policy chal
lenges have emerged. Many countries are facing the difficult challenge
of downsizing large, politically sensitive, money-losing enterprises. In
Poland, the Russian Federation, and Ukraine, the Bank is helping
governments find a socially acceptable way to downsize the coal sector.
A loan to Ukraine has been approved, and a loan to the Russian
13
Transition Years
Federation will be presented to the Bank's Board shortly. The objective
is to close unviable mines and to make those that remain more competi
tive and eventually privatize them. Bank lending operations will help
finance severance payments, retraining and job search assistance, and
the transfer of social services to local governments.
In response to the increase in poverty and the decline in health indica
tors, the Bank is accelerating its work to better target social assistance
and prevent the deterioration of basic health services. Much can be
done within current budget envelopes, by reallocating subsidies that cur
rently benefit enterprises and nonpoor households to the most vulnera
ble households. In many countries, people retire very early and receive
pensions while earning a salary. About 14 percent of the labor force in
Hungary and Poland receives disability pensions, suggesting that the
transfer system is being misused. The Bank is heavily involved in identi
fying reforms in the area of social transfers. It is trying its best in this
area, but reform is politically very difficult.
The Bank has been more successful in rehabilitating basic health ser
vices and addressing critical shortages of basic equipment for the emer
gency medical system. During the past two years, it has prepared such
projects for Albania, Bulgaria, Croatia, Estonia, the Kyrgyz Republic,
Macedonia, and the Russian Federation, and projects for Kazakhstan
and Turkmenistan are being prepared.
Throughout the Europe and Central Asia Region, the Bank is trying to
provide leadership by investing in environmental improvements and pro
moting regional environmental programs for countries facing common
problems. All of the Baltic states have benefited from Bank projects to
protect their shared Baltic Sea coast. The Bank is also playing a key role
in the Black Sea Environmental Program, which has developed an "urgent
investment portfolio" for Bulgaria, Georgia, the Russian Federation, and
Ukraine. Last year the Bank completed the Strategic Action Plan for the
Danube Basin, aimed at improving the quality of water in the basin and
reducing the negative impact of human activities on its ecosystem. It is
working closely with the European Commission in these activities.
In Central Asia a major program is under preparation for the endan
gered Aral Sea. The project involves the five states that share the sea's
coastline and donor countries, under the leadership of the Bank and the
United Nations. The program consists of country-specific as well as
multicountry projects to alleviate some of the immediate effects of this
ecological disaster on the population. The program will also finance
14
The Transition in Europe and Central Asia: Progress and World Bank Assistance
long-term efforts to stem further ecological degradation. The issues asso
ciated with this effort are extremely complex and involve water rights,
hydroelectric power generation, agricultural production, and environ
mental management. Defining viable development strategies that man
age these competing interests effectively is clearly one of the most chal
lenging tasks facing these governments and the Bank in Central Asia.
A unique feature of Eastern Europe and Central Asia is the extensive
network of pipelines and power lines carrying massive amounts of energy
across borders. Investment opportunities to expand that network are sig
nificant, given the substantial energy resources in some countries and
severe import dependence in others. These opportunities will become
more profitable as countries achieve sustained growth. The Bank could
play an important role in refereeing multicountry agreements, providing
technical advice, and providing catalytic financing or guarantees, partic
ularly if foreign direct investment is associated with such agreements.
For several Central European countries, accession to the European
Union (EU) has become the main objective of economic policies as well
as political strategies. Accession within the next decade will present sev
eral challenges. Per capita income differentials are much wider today
than they were when the poorer EU members (Greece, Portugal) joined.
Many important sectoral policies defined by the EU-in financial
markets, for instance-require the existence of laws, regulations, and
institutional arrangements that are still wanting in Central Europe.
Other EU directives and policies-in agriculture, labor markets, and
telecommunications, to name just a few areas-may not be suitable in
their present forms to the realities of some of the countries, which may
be more advanced in these areas than in Western Europe. The criteria
for macroeconomic convergence built around the Maastricht Treaty will
obviously require adaptation to the realities of the Central European
countries.
Numerous agreements and discussions will be necessary over many years
to make the accession a smooth and credible progress. Policymakers are
currently thinking about how to maximize the synergies between the
World Bank and the European Union in these matters, to the benefit of
the Central European countries. The strength of the Bank's assistance
lies in its intimate knowledge of the requirements for sustained private
sector~induced growth in these countries. It intends to capitalize on
these strengths and play the role of an "honest broker," offering advice
to both sides by sharing lessons and providing alternative approaches. A
mix of lending and policy advice will provide the basis for this strategy.
15
Transition Years
What Is the Bank Doing to Promote the Private Sector?
How do the Bank's activities in support of stabilization and overall struc
tural reform help the private sector? Are they too removed, indirect, or
general?
Improving the Business Environment
Interventions aimed at improving the business environment are crucial
in improving the overall environment for private sector activity and
ensuring the sustainability of that improvement. Overwhelming evi
dence from international experience shows that investment growth and
private sector activity are highly correlated with macroeconomic stabil
ity and a liberal and depoliticized functioning of markets-that is, a
climate that encourages private business.
This is precisely what the Bank is trying to achieve, by fostering action
on several fronts. First, the Bank is supporting the reduction in public
sector deficits through sustainable measures, such as modern tax reforms
that lower rates and enhance compliance, lower payroll taxes to
enhance employment, reduction of inefficient subsidies while protecting
the most vulnerable (key for the social sustainability of the reform
process), and the focusing of government expenditures on key infrastruc
ture needed to complement private sector investment.
Second, the Bank's work to support price liberalization and eliminate
price controls increases the predictability of future prices; trade reforms
further link these prices to world prices, making them even more pre
dictable and subject to less bureaucratic interventions. Price liberaliza
tion also reduces the room for bribery and corruption.
Third, privatization puts assets on the market, making them available to
small domestic entrepreneurs as well as larger foreign investors. Privati
zation takes control of firms away from line ministries, which in many
countries have been the main pressure groups for subsidized credit and
protection. It depoHticizes economic activities and markets.
Fourth, the Bank has helped strengthen the environment for foreign
investment, which will playa critical role in the future of the transition
economies. The Foreign Investment Advisory Service (FIAS), operated
jointly with the IFe, has conducted diagnostic assessments of the envi
ronment for foreign investment in a dozen countries and reviewed
16
The Transirion in Europe arul Central Asia: Progress arul World Bank Assistance
investment legislation throughout the region. As a result of this work,
"national treatment" in the ownership of assets and in licensing rights
has been eliminated from most legal codes, as have other restrictions on
business activity. In Latvia, for example, after a FIAS review of the legal
code, the government changed the investment law to include foreign
investment in intangibles (intellectual property and goodwill). There
are many such examples.
Providing Direct Support
The Bank has undertaken many actions to assist private sector develop
ment directly and ensure an enabling environment for foreign invest
ment. These actions include a wide variety of activities supporting
reforms in the financial and banking system, legal and institutional
reforms, the direct promotion of foreign investments through investor
conferences, and the development of new financial instruments to bene
fit private companies.
Supporting Financial Sector and Banking Reforms
Financial sector development lies at the core of the systemic transforma
tion process. Without active financial markets, economies in transition,
having abandoned central planning, have no alternative allocation
mechanisms. Developing such markets is crucial to channel resources
domestically and from abroad, including the Bank's own resources-to
the emerging private sector.
There is, however, a complication: dealing with banks alone could mean
that future lending would again be channeled to their traditional client
base: debt-burdened and loss-making state enterprises. Hence there is a
need to deal simultaneously with the banks and the enterprises that
account for the nonperforming loans of those banks.
Through adjustment operations (enterprise and financial adjustment
operations), the Bank has supported reforms to resolve the debt over
hang of debtor enterprises and the portfolio problems of state banks.
Both are needed to unfreeze bank lending (tied up in rolling over non
performing loans) so that credit can be redirected to the emerging pri
vate sector. The Bank has conducted such operations in Kazakhstan, the
Kyrgyz Republic, Poland, Romania, and Slovenia; it is currently prepar
ing operations for Croatia, Hungary, and Macedonia. An integral part of
17
Transition Years
these operations has been improving governance and bank supervision,
accounting, licensing, and regulations. Some recent projects support
outright privatization of state banks.
In many countries Bank support has been through intensive technical
assistance. In the Russian Federation, the Bank provided one of the largest
technical assistance loans ever made at the Bank. This US$200 million
project for financial institution development builds the capacity of 25
core private commercial banks, which will have to meet international
banking standards. In Poland a technical assistance project has success
fully twinned Polish and international banks. In Hungary the Bank is pro
cessing a banking supervision loan. At the governments' request, it has
also provided significant technical assistance and advice to Latvia and
Lithuania in dealing with their problems in the sector.
As progress is made in prudential regulation (and enforcement) and bank
capitalization, the Bank uses the emerging commercial banking sector to
intermediate credit to privatized enterprises and new private firms. It has
done so throughout Central Europe. In the Russian Federation it is inter
mediating credit through the small group of qualifying banks.
Supporting Legal and Institutional Refonns
Working with other donors, the Bank has been actively involved in
modernizing legal systems throughout the region. It helped draft new
laws for foreign investment and sector-specific legislation that led to
increased private sector participation in production and distribution in
the oil and gas, power, agriculture, banking, mining, manufacturing, and
transport sectors. Given the lack of legal precedence and rule of law, the
Bank has coupled legal advice with technical assistance to strengthen
the institutions that will enforce and regulate the new economic order.
In Poland and the Baltics, for example, the Bank conducted judicial
reviews and proposed improvements in the court system. In several
countries it has helped design strong bankruptcy laws and worked with
other donors to improve legal institutions.
In countries establishing modern national governments for the first time
(Albania and some of the former Soviet republics), the Bank has played
a more fundamental role. Through loan conditionality, projects have
addressed a variety of problems, including market control by state
monopolies, restrictions on market entry for new participants, and a myr
iad of licensing requirements that have impeded business development.
18
The Transition in Europe and Central Asia: Progre:;:; and World Bank A:;:;i:;r:ance
Another example of Bank support for institution building is the Bank's
work in support of the development of Russia's oil sector. The first Oil
Sector Rehabilitation Loan could not provide the billions of dollars
required to cover all rehabilitation needs, but it did establish a basis for
overhauling the sector. A second rehabilitation loan followed, as well
as policy advice on oil taxation reform, refinery strategy, and oil trans
port issues. Progress has been difficult, but the Bank has helped ease
administrative controls and sales allocations, and export duties have
been reduced. The Bank has also directly facilitated foreign investment
by bringing together private oil companies and federal and regional
authorities and assisting in their negotiations. An oil rehabilitation
project in Romania and a petroleum technical assistance project in
Kazakhstan have had similar effects, attracting foreign investment
through sector reforms and bringing private and state oil companies
and other authorities together.
Promoting Foreign Direct Investment: Conferences, Service Centers,
and Executive Training
FlAS supports foreign investment by helping governments establish
investment promotion agencies. In Croatia the Bank helped create an
investment promotion agency to attract investor interest after the war in
the former Yugoslavia. The agency was set up as a 50/50 nonprofit joint
venture between the government and several private companies. Several
other programs also actively try to present opportunities to foreign
investors. The Bank is working particularly hard in countries that have
had difficulty attracting investment for political and geographic reasons.
In 1994 the Bank began a program to present investment projects to for
eign investors in Central Asia. This program has identified more than
300 investment opportunities in countries such as Azerbaijan, the
Kyrgyz Republic, and Turkmenistan. More than 400 multinational cor
porations have sent representatives to investor conferences at which
country profiles, legal and regulatory reviews, and the menu of invest
ment possibilities have been presented. In addition, the Bank is helping
the governments of Azerbaijan and Ukraine set up investment service
centers, and other countries are interested in following suit. These
offices will act as one-stop shops to facilitate the approval of invest
ments. Investors will no longer have to go through several bureaucratic
steps to obtain licenses or permits or negotiate asset purchases only to
have a different government agency interfere later. The centers will also
have investment banking experts to help cut deals between foreign
investors and local enterprises.
19
Transition Years
Reducing Sovereign Risk through New Guarantee Instruments
Sovereign risk is a particular constraint early in a reform program, when
political and economic uncertainty is greatest and government commit
ment to economic liberalization is still untested. During this period,
investors and suppliers (both domestic and foreign) lack confidence that
the new, more liberal rules and regulations will remain in force during
the life of the investment or transaction. Sovereign risk is also particu
larly significant in large countries, such as the Russian Federation and
Ukraine, where local governments may interfere in ways that are incon
sistent with federal policies.
The guarantee is a relatively new instrument with which the Bank is
experimenting. It is intended to eliminate a class of sovereign risks
that may impede private commercial transactions and investments.
This guarantee facility requires governments to commit not to take
specific actions that negatively affect the contractual obligations of
business deals. If they do, they must compensate the guarantee hold
ers for any financial losses. Typically covered under these instruments
are risks such as retroactive taxes on imports and exports, revocation
of import or export licenses, and restrictions on foreign exchange
convertibility. The guarantees do not cover commercial or project
risk.
Since political risk guarantees offered by the governments do not yet
have credibility on international markets, the World Bank backstops
the facilities with its own guarantee. If the government fails to pay a
legitimate claim, the World Bank covers the obligation. The govern
ment must then reimburse the Bank for the liability on demand. The
Bank is experimenting with two types of guarantees: individual guaran
tees for specific deals between an investor and a local company and
umbrella guarantees that cover many lenders, foreign or domestic, and
local borrowers.
An example of an individual guarantee is the Sea Launch Project, a
joint venture between two international investors, a Ukrainian com
pany and a Russian company, designed to develop a sea-based launch
capability for commercial satellites. Two separate guarantees of US$100
million will be purchased, one for the Ukrainian entity, the other for the
Russian enterprise. These guarantees will protect the lenders against
debt service defaults caused by specific government interference with
the production or export of launch components and against political
force majeure.
20
The Transition in Europe and Central Asia; Progress and World Bank Assistance
An umbrella guarantee for US$30 million was approved last year in
Moldova and is being replicated in other countries in the region. Risk
coverage can be purchased for any legitimate loan to finance invest
ment or working capital in any sector. Foreign lenders (input suppliers,
commercial banks) establish a commercial contract with a local com
pany and apply to purchase a guarantee policy if they deem it neces
sary. Once a contract is satisfied, the guarantee is canceled and funds
are rolled over into new policies. In this way, the guarantee facility can
leverage the US$30 million value several times over its five-year
project life.
Providing Assistance through MIG A and 1FC
The Multilateral Investment Guarantee Agency (MIGA) provides guar
antees for foreign equity and leveraged investments against risks of
currency transfer, expropriation, and war or civil disturbances. These
guarantees usually have long terms (up to 20 years). MIGA has provided
guarantees for investments by foreign banks in Bulgaria and the Slovak
Republic and for investments made by foreign firms in the Czech
Republic, Kazakhstan, the Kyrgyz Republic, Poland, the Russian
Federation, and Uzbekistan. Almost all the transition economies are
members of or are in the process of joining MIGA.
IFC assistance in the region has several elements. IFC is helping create
modem financial systems, which are urgently needed to efficiently mobi
lize and allocate funds as well as manage the large volume of securities cre
ated by privatization. In the more advanced transition economies, IFC is
supporting large, private, locally owned companies. In the less advanced
countries, it is creating models to attract foreign investment. IFC is also
providing technical assistance in privatization and capital market develop
ment and facilitating private participation in infrastructure.
Some of IFC's new projects are quite novel. This year, for example, it
developed a US$60 million trade guarantee facility to stimulate intrare
gional trade. Jointly created with Raiffeisen Zentralbank Osterreich AG,
the project guarantees the use of bank documents in trade transactions.
Another IFC project that could have a significant long-term impact is
the model of land reform being launched in Ukraine. In a pilot project
stage, farms were privatized. Interest by farm communities surrounding
the project area has been strong, and the project should be expanded
nationally.
21
Transition Years
Closing Remarks
The Bank expects the economic recovery of Central Europe and the
Baltic countries to remain on track. But decisive actions will be required
on three fronts: further consolidation of public finances by reducing
governments' burden on the private sector and rationalizing social trans
fers, closures and liquidation in the banking sector, and downsizing and
eventual divestiture of large money-losing enterprises still in state hands.
The Russian Federation must stabilize its public finances, resume privati
zation, and further liberalize its energy and power sector, ensuring
increased production and competition. The social situation will not be
helped by jump-starting money-losing industries that have no future in
the medium term. A better policy is to promote restructuring and use
subsidies and transfers to help needy households directly. Ukraine is
making progress again, but everything will depend on the consensus that
can be reached between Parliament and the executive branch. Belarus
remains a problem. The resource-rich Central Asian countries must
avoid the temptation to rely solely on their prospects for energy exports.
Other sectors must be developed if productive employment is to be cre
ated, and this requires progress on a still large reform agenda.
The transition will be a lengthy process-lengthier than initially
expected, particularly for the New Independent States. Because of the
synergies between improved policies, capital flows, foreign direct invest
ment, and their impact on economic results, current disparities may
grow over time.
These disparities will require the World Bank to be highly flexible. In
countries advancing quickly and building bridges to external capital
markets, the Bank will accelerate the use of its guarantee power. In large
countries in which lack of consensus about reform and weak institutions
may delay progress, the Bank will have to experiment with pilot projects
of a local nature, from which it can learn, test the responsiveness of
institutions, and provide incentives for reform in other regions.
The Bank's role is catalytic; it cannot do its job alone. It needs partner
ships with donor countries from Europe and Japan and their bilateral
agencies through its joint consultative group process. It needs partner
ships with the European Bank for Reconstruction and Development, the
European Investment Bank, and the Asian Development Bank to
enhance investments and private sector participation. And it needs to
forge partnerships with the European and Japanese private sectors,
which are contributing capital and know-how to these countries today.
22
CHAPTER 2
Progress in Transition: Central and Eastern
Europe and the Former Soviet Union
after a Decade of Reform
From a speech given at the Center for Research on Economic
Development and Policy Reform, Stanford University, Stanford,
California, May 16, 2002
C lear differences have emerged between the countries of Central and
Eastern Europe and the Baltics on the one hand and those of the
non-Baltic former Soviet republics (the Commonwealth of Independent
States [CIS]) on the other. Central and Eastern Europe and the Baltics
experienced a brief and relatively mild downturn followed by steady
recovery to GOP levels above those of 1990, with some countries experi
encing very strong growth (GOP in Poland, for example, was 50 percent
higher in 2000 than it was in1990). These results are consistent with
the expectations of experts in the early 1990s on how a successful transi
tion process should work.
In contrast, the CIS countries experienced a sustained downturn, with
recovery beginning only after 1998. This transition recession was much
more severe than expected-and much more severe than the Great
Depression in the United States, during which GOP fell 27 percent in
four years. The transition recession of the 1990s resulted in a substantial
increase in inequality, a significant rise in poverty, and a sharp decline in
public expenditures on health and education to extremely low levels,
especially in the poor CIS countries. However, these trends may soon
change as a result of the very high growth the CIS countries experienced
between 1998 and 2000 (4.1 percent in 1999, 7.4 percent in 2000, and
an estimated 6.6 percent in 2001). The rates were among the highest in
The assistance of Marcelo Se lowsky, former Chief Economist for the Europe and C'.entral
Asia Region and current Assistant Director of the IMPs Independent Evaluation Office,
and Pradeep Mitra, former Director of the Poverty and Economic Management Sector
Unit of the Europe and Central Asia Region and current Chief Economist for Europe and
Central Asia, in drafting this speech is gratefully acknowledged.
23
Transition Years
the world-higher than rates in East Asia (excluding China) and South
Asia-and they occurred despite the global slowdown in 2001.
What accounts for the different experiences of the two groups of coun
tries? Let's look behind the numbers, at some of the key factors explain
ing the very different trends in the transition economies.
The Unprecedented Transition Challenge of the 1990s:
Three Transitions in One
All countries in the region faced three simultaneous transitions: an eco
nomic transition (the breakup of the highly integrated Council for
Mutual Economic Assistance [COMECON]), an institutional transition
(the transition from plan to market), and a political transition (the deep
political transition from dictatorship to democracy). But different coun
tries were affected by and able to cope with these transitions in different
ways.
The CIS was hit harder than Central and Eastern Europe and the Baltics
in all three respects. It had a rigidly specialized economy, and activities
were widely dispersed across the huge expanse of the former Soviet
Union. It had a large military-industrial complex, and heavy distortions
in energy and transport prices, which caused severe disruptions in trade
and transport after the breakup of the Soviet Union. It also relied more
heavily on central planning and had a much longer history of undemo
cratic institutions, a problem that was compounded by the need to set
up new national public institutions in the new republics.
The poor landlocked CIS countries were especially hard hit, because
they lost the subsidies they had received from the Soviet budget, as well
as access to trade, transport, secure water, and energy resources. War and
domestic conflict caused major disruptions, and many professionals emi
grated. The Russian financial crisis in 1998 caused currencies to plum
met, the nascent banking systems and capital markets to collapse, and,
in some cases, exports and remittances to decline sharply.
In contrast, Central European countries, which also faced initial losses
from the breakup of the COMECON, had easier access to world trade
and Western capital as well as the prospect of joining the European
Union (EU). They also had recent memories of democratic and market
institutions and had begun to develop some basic institutions of civil
society during the 1970s and 1980s.
24
Progress in Transition
The Western Balkan countries faced the breakup of Yugoslavia, regional
strife, and blockades, but many had stronger market-based economies,
easier access to European and world markets, and histories of stronger
political and civil society development than the CIS countries.
With the benefit of hindsight, the big surprise of the past 10 years is not
that Central and Eastern Europe and the Baltics did relatively well or
that the CIS countries took a worse tumble and are taking longer to
recover. The surprise is really that despite the extraordinary risks and
challenges it posed, the triple transition was largely peaceful and that
10 years later most countries show real signs of success on all three
dimensions.
The Role of Economic and Institutional Reforms
in the Transition Process
A key question in looking back~and forward-is what role economic
reforms played in meeting the transition challenge. Researchers at the
World Bank have examined three aspects of reform: the role of initial
conditions, the progress of economic reforms, and the politics of reforms.
Two important conclusions can be drawn from this work.
First, initial conditions mattered. Econometric analysis confirms that
initial conditions (as measured by repressed inflation, black market
exchange rates, the share of industry in GDP, and trade dependence on
other communist countries) made a difference, especially in the early
years. Countries that had experience with markets and with nationhood
performed better than countries that did not.
Second, economic reforms mattered, especially in the enterprise sector.
Market-oriented policy and institutional reforms not only speeded
economic recovery and promoted growth in the medium term, they also
mitigated the effects of the transition recession.
A key factor of success was the reform of the enterprise sector. In the
successful countries of Central and Eastern Europe and the Baltics, the
share of economic employment provided by new small and medium-size
enterprises grew rapidly in the 1990s, reaching more than 40 percent. In
the large CIS countries, that share stagnated at about 20 percent.
New small and medium-size enterprises tended to be more productive, to
hire more new workers, and to invest and export more than old (large)
25
Transition Years
enterprises. An important policy question is, then, what kind of reforms
spur the growth of new small and medium-size enterprises?
Key Aspects of Successful Enterprise Reform
Successful transformation requires that labor and capital be shifted from
old to new enterprises and that new investment be channeled to new
enterprises. The experience of successful reformers shows that the key
policy and institutional requirements for this transformation to occur are
imposing discipline on old (as well as new) enterprises and encouraging
new enterprises. What does this mean in practice?
Imposing Discipline on Enterprises
Disciplining enterprises implies a variety of policies. First, it means
imposing a hard budget constraint on enterprises and banks by passing
effective bankruptcy laws and eliminating tax exemptions, subsidies,
directed credits, and guarantees (implicit or explicit). Second, it means
improving institutions of corporate governance by strengthening minor
ity shareholder and creditor rights, developing accounting and auditing
standards, and tightening banking supervision. Third, it means encour
aging competition, through free entry, free trade, and effective competi
tion laws.
In order to exercise discipline without imposing excessive social or polit
ical costs, policymakers need to shift social assets (housing, clinics,
kindergartens) from enterprises to local governments. They need to
strengthen social safety nets (pensions, unemployment insurance, sever
ance pay, retraining) and target them toward the most vulnerable.
Encouraging New Enterprises
Encouraging new enterprises does not mean granting particular firms
and sectors special favors. It means liberalizing prices, entry, trade, and
investment; reforming the tax code (by eliminating tax exemptions and
reducing marginal tax rates, simplifying the tax regime for small busi
nesses, and strengthening rule-based tax administration); streamlining
business licensing, registration, and inspections; establishing secure
property and contract rights (by reforming the legal and judicial systems
and the land code); and improving the financial system (by closing weak
26
Progress in Transition
banks, privatizing banks to strategic investors, and permitting the entry
of new banks satisfying prudential norms).
Encouragement without discipline will not work; the two must go hand
in hand. Disciplining and encouraging firms requires an effective public
sector. Reforms of public administration, of the legal and judicial system,
and of the subnational government are thus essential elements in the
long-term reform process.
Privatizing Enterprises as Part uf a Strategy of Discipline
and Encouragement
Privatization occurred on an unprecedented scale and played an impor
tant role in the enterprise transformation process. In the early transition
years it was viewed as a way of getting around hard budget constraints,
promoting restructuring, and creating demand for stronger property
rights and institutions of corporate governance. It was also a way of
getting the state irreversibly out of enterprise management.
The best type of privatization was the sale of enterprises to strategic
investors through transparent methods--and these enterprises have
indeed performed best. Where this kind of sale was not possible, there
were no good alternatives. State ownership could have been continued,
without a political commitment to transparent privatization outcomes or
the institutional capacity to prevent asset stripping by incumbent man
agers. Alternatively, state enterprises could have been transferred to new
private owners, without the institution of effective corporate gover
nance that could protect minority shareholders from expropriation by
those owners. Whatever view is taken about the appropriateness of alter
native privatization strategies in the past, it is extremely important look
ing forward to clarify and strengthen the legal rights of minority share
holders and creditors and to develop the capacity to implement those
safeguards effectively.
The Politics of Reform
If it is so clear which reforms work, why have these reforms not been
implemented more widely and consistently? The answer lies at least
partly in the politics of reform. A simple model of the behavior of key
winners and losers from reform can help explain why transition reforms
went off track in some countries and not in others.
27
Transition Years
The winners of reform are the owners and employees of new small and
medium-size firms. These people incurred some initial adjustment costs
as they exited jobs in the state sector, but eventually they benefited from
the reforms. They include insiders and oligarchs, who gain greatly in the
early stages of reform, when liberalization and privatization provide
them with de facto control rights over state assets that can be converted
into de jure control and cash flow rights before discipline and encour
agement take hold.
The losers are employees of state-owned enterprises and government
bureaucrats, who go unpaid or find their real wages decline and who may
end up unemployed after old firms are restructured or liquidated. They
also include oligarchs and insiders after the initial stages of reform, as
additional reforms dissipate their rents.
Countries in which governments are hostage to a narrow set of private
interests or in which a large public bureaucracy has "captured" the state
can easily get sruck in a low-level equilibrium trap of partial reforms,
in which the economic weight and political influence of the losers
exceeds that of the winners. When this occurs, oligarchs and insiders
face strong incentives to block reforms that seek to increase competi
tion, strengthen corporate governance, and allow freer market entry.
The costs to politicians of serving a concentrated set of powerful private
interests rather than a broad but dispersed set of losers tend to be low.
As a result, the political calculus can easily lead to a deferral of further
reforms.
The evidence shows that there is a negative relation between state cap
ture and the investment climate. State capture is thus associated with
stalled reforms, a poor investment climate, and low growth of new, more
productive enterprises. The result is the absence of sustained economic
recovery.
How can countries prevent or break out of a partial reform equilibrium
and move toward more comprehensive reform? The lessons from the
successful transition economies suggest that dedicated reformers take the
following steps:
• Help give new businesses voice (through business associations, for
example).
• Tax the rents of oligarchs and insiders and reallocate public spending
toward retraining workers, making severance payments (to facilitate
28
Progress in Transition
the exit of labor from old industries), and providing safety nets and
improved social services in communities hurt by downsizing.
• Work with the media and civil society to explain reforms to the public.
Low-level reform traps are more easily overcome when there is broad
based popular consensus on the goals of transition, as there was in the
Baltics, the Czech Republic, Hungaty, and Poland; when reform is tied
to an external goal (such as donor support for policy reform or accession
to the EU or the World Trade Organization); and when domestic leader
ship is strong and clearly committed to reform, as has recently been the
case in the Russian Federation under President Putin.
Prospects for the Region and the Role of the World Bank
Central and Eastern Europe and the Baltics have undergone far-reaching
structural transformation and are poised to join the EU-a key driver of
reform and a remarkable achievement. The World Bank has been associ
ated with this process since the early transition. The leading reformers
have now begun to "graduate" from the Bank. Of course, these countries
still face many challenges in terms of structural and social reform. These
challenges-not dissimilar to those facing Western Europe-include
removing structural rigidities in industty and agriculture, reducing high
unemployment, reforming unsustainable pension systems, and eliminat
ing pockets of poverty and exclusion. such as the Roma.
The countries of the Western Balkans face much improved prospects
since the change in the political situation in the former Yugoslavia.
Recovety and growth are under way, but many challenges remain. Bosnia
and Herzegovina, Kosovo, the former Yugoslav Republic of Macedonia,
and possibly Serbia and Montenegro still face major political risks. The
Western Balkans need continued reforms to improve the investment
dimate, increase the effectiveness of public administration, and increase
social services. Such reforms will bring more external support and oppor
tunities for integration with the rest of Europe. In support of the Stability
Pact, the World Bank, in partnership with the European Commission,
has coordinated donors, developed assistance programs in individual
countries, and supported regional initiatives in support of cooperation
and development in South East Europe.
In Kazakhstan, the Russian Federation, and Ukraine, transition has been
arduous and protracted, but reforms are now beginning to payoff, as
29
Transition Years
these economies recover and poverty declines. In the medium term, the
prospects for sustained recovery will depend on sustained implementa
tion of a stiLL substantial structural and institutional reform agenda.
These countries also face threats from the rising tide of HIVIAIDS and
tuberculosis, which need more urgent attention than they are receiving.
Through policy dialogue, lending, and technical assistance, the World
Bank has become a principal interlocutor with these countries on
structural reform. It helped forestall potentially serious policy reversals
after the 1998 crisis and continues to work with counterparts to
strengthen the reform program currently under implementation.
Prospects are most uncertain and worrisome in the lowest-income CIS
countries. These countries lack resources and access to markets, and
they suffer from poor governance, high levels of debt and poverty, and
the risk of conflict. Since September 11, these countries, especially
those in CentraL Asia, have become the center of internationaL atten
tion. Together with the other international financiaL institutions
involved in the region, the World Bank has launched a special initia
tive in support of the seven Low-income countries of the CIS (known as
the CIS-? Initiative). In the spirit of the Monterrey Summit consensus,
this program will help deepen domestic poLicy reform, promote subre
gional cooperation, and step up concessionaL finance and debt relief in
the seven poorest CIS countries, Armenia, Azerbaijan, Georgia, the
Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan.
Conclusions
Several key points emerge from this review of the transition process;
1. Ten years ago the countries in the region seemed to be facing similar
challenges, hopes, and uncertainties. Today one is struck by their
extraordinary diversity, by the progress that many have made in the
face of unfavorable odds, and by the generally good prospects for the
future.
2. The economic impact of the breakup of the Soviet Union substan
tially explains the dramatic income losses and rise in poverty in the
early years of the transition, especially in the poor CIS countries, and
the difficult recovery that the CIS countries have experienced rela
tive to other transition economies in the region. Differences in the
implementation of market reforms also explain different paths in the
subsequent recovery.
30
Progress in Transition
3. Development of new small and medium-size enterprises is critical to
restructuring the enterprise sector, a key factor in successful transi
tion. This restructuring is achieved by disciplining old and new
enterprises and encouraging new ones. Doing so requires an effective
public sector.
4. Political factors playa key role in explaining the differences in
progress with reform. Where special interests "capture" the state, a
low-level equilibrium of partial reforms often occurs, as those who
would lose from further reform (insiders, oligarchs, bureaucrats,
employees of state enterprises) block the interests of the more pro
ductive new enterprises, which stand to gain. Reform-minded
governments, with outside assistance where needed, can move the
reform agenda forward, as the government is doing today in the
Russian Federation.
5. The breakup of the Soviet Union and the subsequent transition
process have been very painful. Fortunately, the tide now appears to
have turned. Prospects for the region, while not uniform, are more
favorable than at any time in the recent past. Continued reforms-
improving the business dimate, making the public administration
more effective, providing better social services-are needed, however,
if the level of poverty and the deterioration in living standards that
occurred during the 1990s are to be reversed.
6. In light of the peaceful transition, the substantial progress with
reforms, and the current economic upturn in the region, the interna
tional community can be pleased by the outcome of the past 10 years
of transition, and it can be reasonably sanguine about the future of
the region. But continued international attention and suppott are
essential to consolidating progress in this critical part of the world
and to dealing with serious risks, especially in the Western Balkans
and in the poor CIS countries.
31
PART 2
Country and Sub,Regional Perspectives
T en years into the transition it had become very clear that what
initially had seemed like a homogenous group of new World Bank
clients turned out to be--or turned into--a very diverse set of borrow
ers. The next five chapters therefore present four speeches and an op-ed
piece prepared in 2000 and 2002 that capture the Bank's thinking on
some of the key country and subregional experiences.
Chapter 3 delineates the four main economic challenges for the new
Russian leadership in 2000: improved macroeconomic management,
structural reforms for greater competitiveness and growth, reform of
social policies and institutions, and public sector reform. Since 2000 the
Russian Federation has made great progress in the first area and some
progress in the second, but it still has a long way to go in the last two
areas, as President Putin stated after his recent re-election.
Chapter 4 is a speech I gave at a donor meeting for Central Asia in 2002
in which I highlighted the challenges facing this subregion, perhaps the
most troubled subregion in Eastern Europe and Central Asia. While
some countries have made some progress since, the fundamental chal
lenges of regional cooperation and promotion of systemic reforms in
governance and economic policies remain to be addressed, especially in
Turkmenistan and Uzbekistan.
Chapter 5 summarizes a speech given in 2000 that highlighted some of
the key economic and social reform tasks then facing the European
Union (EU) accession countries of Central Europe, especially reforms
regarding restructuring old industries and agriculture, creating employ
ment in the face of persistently high unemployment rates, providing
social protection and inclusion, and promoting human development.
These remain fundamental challenges today for these countries, even as
they are just entering the EU.
Chapter 6 is an op-ed piece published in 2002 in the International Herald
Tribune, in which my colleague Christiaan Poortman and I report on a
car trip from Croatia through Bosnia and Herzegovina, Montenegro, and
33
Transition Years
Kosovo to the southernmost tip of Albania. We were struck by the
extraordinary progress made in the Balkans since 1996 but also by the
need both for governments in this fragile subregion and the interna
tional community to stay the course. This exhortation remains as appo
site today as it was then.
But the reconstruction of "Stari Most," the historic bridge in the city of
Mostar, Bosnia & Herzegovina, has now been completed with the sup
port of the World Bank and other international donors. It is a symbol of
renewed hope for national and regional unity in the Balkans.
Chapter 7 presents a short speech given in 2000, at a time when Turkey
was facing a major financial crisis. The reforms it recommends have
since been substantially implemented, many of them with the help of
the World Bank and other international partners and friends of Turkey.
Fortunately, it looks as if the reforms are working and Turkey is set to
stay the course.
34
CHAPTER 3
New Leadership, New Opportunities
in the Russian Federation
From a speech given at the Fourth Annual U.S.-Russian
Investment Symposium, Harvard University, Cambridge,
Massachusetts, October 5, 2000
T he Russian Federation has chalked up an impressive macroeconomic
report card since the crisis of 1998, taking everyone by surprise.
Over the first half of this year, industrial output grew 10 percent and
investment picked up substantially. Current expectations are that GDP
will grow 5-7 percent this year, with the federal government recording
its first-ever post-transition fiscal surplus. Both output and the foreign
exchange reserves of the central bank are on track to eclipse their pre
crisis 1997 levels, and the fiscal situation has enjoyed a remarkable turn
around. Remarkably, the foreign exchange reserve build-up has occurred
without the matching increase in debt seen in 1997.
While good luck, in the shape of the oil and gas boom, has played a role,
so has good government policy. It is easy to forget that there were wide
spread fears in the aftermath of the August 1998 crisis that hyperinfla
tion and serious policy reversals would take over. To the contrary, one of
the most impressive accomplishments has been a sharp change in the
macroeconomic policy stance. The focus of macroeconomic manage
ment is now clearly on re-establishing control over Russia's public
finances and debt dynamics--the root cause of the 1998 crisis-and the
importance of keeping the real exchange rate at a level that helps both
the trade surplus and industrial recovery is now recognized.
Notwithstanding this good news, questions about sustainabiliry abound.
As Mr. Illarionov, adviser to President Putin, recently noted, growth is
slowing down and could even stop by next summer if current trends
persist. Indeed, there are early signs that industrial output growth may be
leveling off. And while the oil and gas boom has been a fiscal and balance
The assistance of the staff of the World Bank's Moseow Office, especially Christof Riihe,
lead economist, in drafting this speech is gratefully acknowledged.
35
Transition Years
of payments blessing, it is inevitably putting upward pressure on the real
exchange rate, which has played such a crucial role in the postcrisis indus
trial rebound. What will make GDP and industrial output growth sustain
able? And what is the best response to the oil and gas boom? Should, for
example, a higher windfall tax be levied, with the proceeds used to prepay
foreign debt or help cushion the considerable social costs of transition?
The last question points to an overarching challenge for Russia: how can
the level of poverty be reduced? For us at the World Bank, it is a grave
concern that so many Russians today face serious economic difficulties
in their everyday lives. While statistical problems and a large shadow
economy make precise measurement difficult, poverty is a problem, espe
cially among single elderly pensioners, children in one-parent homes,
and the chronically unemployed.
According to official data, the number of people living below the subsis
tence minimum decreased from 41 percent in the first quarter of this
year to 35 percent in the second quarter. The unemployment rate (based
on the International Labour Organization definition) fell from 12.1 per
cent to 11.4 percent during the first six months of this year. Real wages
at the end of April 2000 were 17 percent above the levels at the end of
1998 but still more than 20 percent below precrisis levels. Despite these
encouraging trends, 35 percent of Russians stillHve below subsistence
levels. Sustained, rapid economic growth will be needed to reduce
poverty significantly, but it will not be enough. Steps are also needed to
directly address Russia's poverty and social problems.
These questions can be looked at in the context of four immediate chal
lenges that the Russian government faces:
• ensuring that public finances and public debt are placed on a stable
long-run path so that genuine, long-lasting stabilization can be achieved
• completing the implementation of difficult structural reforms to
ensure that the postcrisis output rebound is translated into a long-run
trend based on new investment and a more competitive and efficient
enterprise sector
• providing social protection and reforming the labor market to ensure
that the truly needy are efficiently served while workers have the
necessary information and mobility to get suitable jobs
• improving public sector management
36
New Leadership, New Opportunities in the Russian Federation
These challenges form the focal points of our ongoing policy dialogue
with the government in the context of proposed new adjustment lend
ing. To be sure, there are other critical issues, such as the financial
sector, human resource development issues pertaining to education and
health, and management of the environment and natural resources.
However, we believe that these four challenges constitute the immediate
priorities and that once addressed they will create a springboard for
addressing the longer-term strategic issues.
But the fundamental question of implementation remains. We have
learned that no matter how cogent the conditionality or frequent the
monitoring by international financial institutions, it is Russian owner
ship that will ultimately drive successful implementation. It is therefore
extremely heartening to note that in June 2001, the team headed by
Mr. German Gref submitted to the government its long-term draft eco
nomic strategy, based on an in-depth analysis of economic problems and
objectives. In July the government approved both the long-term pro
gram and a blueprint of priority measures for the next 18 months. The
thrust of the new strategy is acceleration of market-oriented reform,
including reduction of government intervention in the economy;
increased efficiency in managing public funds; and radical tax and social
policy reforms, establishing a level playing field for all companies. Much
of this has formed part of past programs supported by the Bank and the
International Monetary Fund. But the government's program is home
grown and rooted in the lessons of the transition through the 1990s,
including the lessons from the 1998 crisis.
The comprehensive nature of the program will require strong and
coordinated efforts on the part of the government and strong political
will to pursue measures that may conflict with vested interests. There is
no reason to doubt the ability of the new team to deliver. But we must
recognize that the sheer scope of reform envisaged increases the risk of
slowdowns and partial implementation. The program of priority actions
alone, with its 18-month horizon, includes more than 130 measures,
about 100 of which will require that the Duma amend federal
legislation.
In this respect, it is heartening to note that the political situation is
solidifying, with the erstwhile confrontational stance between the Duma
and the president abating after the parliamentary elections late last year.
A more cooperative relationship has been developing since Mr. Put in
was sworn in in May. In this connection, Russia's long-awaited tax
overhaul got under way with Duma passage this August of the first four
37
Transition Years
chapters of Part 2 of the Tax Code, relating to personal income tax,
social fund contributions, value-added tax, and excises.
Given all this, we can say that the Russian Federation is indeed experi
encing a period of new leadership and new opportunities rooted in the
lessons of the past decade. Major challenges remain, however.
First Challenge: Improve Macroeconomic Management
While there has been a concerted attempt to tum the fiscal situation
around and address the precrisis inconsistency between fiscal and
exchange rate policy, the Russian Federation remains very vulnerable to
economic shocks, especially to reversals in oil and gas prices, and a slow
down in growth. This is a good time to review the macroeconomic les
sons of the past:
Lesson 1: Good macroeconomic management is necessary for sus
tained economic growth, as postcrisis events have shown.
Lesson 2: The combination of tight monetary policy, loose fiscal pol
icy, a fixed exchange rate, and excessive public borrowing inevitably
leads to macroeconomic crisis, as was the case in 1998.
Lesson 3: Russia's public finance institutions, including its tax admin
istration, the federal treasury, the budgeting system, and the public
debt management system, urgently need to be strengthened.
Level 4: Macroeconomic stabilization is not sustainable without deep
structural, social, and institutional change.
Second Challenge: Implement Structural Transformation
for Competition and Productivity Growth
The size and persistence of the output rebound we are now witnessing
were severely underestimated. Nevertheless, concerns about long-run
growth remain. While statistical problems make interpreting the data
tricky, there is a strong suspicion that net investment levels were probably
negative or close to zero throughout much of the 19908. This is consistent
with uncertain property rights, high marginal tax rates, a tendency
toward asset stripping, and exceptionally high real interest rates combined
with an appreciating real exchange rate between 1995 and mid-1998.
38
New Lew1ership, New Opportunities in the Russian Federation
At the same time, the Russian enterprise sector has been marked by per
vasive soft budget constraints in the form of hidden subsidies for tax and
energy payments channeled through the nonpayment system. A recent
Bank study estimated the size of these implicit subsidies at 7-10 percent
of GDP a year during the precrisis period, with annual subsidies from
energy alone on the order of 4 percent of GDP.
Subsidies through the tax system abated after the crisis, because the
government stopped borrowing and therefore had to tighten tax
enforcement. But the energy subsidy has grown with the rise in inter
national prices and the sluggish adjustment of energy prices to domes
tic inflation. Indeed, if price distortions are taken into account, the
energy subsidy from gas and electricity would in all likelihood be
considerably higher than the 4 percent of GDP estimated from
nonpayments alone.
At the same time, problems with the investment climate have kept new
investment levels, including foreign direct investment (FDI), low. Capital
flight has remained high, at US$1-US$2 billion a month, even in the
postcrisis period.
This configuration suggests that a cautious interpretation of the current
output rebound would characterize it largely as an increase in capacity
utilization from very low levels stimulated by the expenditure switch
toward domestic goods as a result of the devaluation. The pickup in
investment is probably a retooling of capacity that has lain unutilized
and dormant for several years.
To be sure, there is much to be happy about. The rebound has shown
that Russian managers, like their counterparts elsewhere, respond to
incentives and have chosen to increase output, profits, liquidity, and
real wages (which are now on the rebound as well) instead of accelerat
ing asset stripping. But the sustainability of growth will be ensured only
when enterprise budgets have been hardened and the investment cli
mate improves sufficiently to attract FDI in volumes consistent with
the size of Russia's economy and eliminate the incentives for capital
flight.
Many, if not all, of these ideas are recognized in the Russian govern
ment's own long-term strategic document. But difficult hurdles must be
overcome. Efficient enterprise restructuring requires hard budgets-the
foundation for a sustainable resumption of growth, as the European
Bank for Reconstruction and Development's latest Transition Report
39
Transition Years
notes. For the Russian Federation, this means that local governments
have to reduce the red tape for establishing small and medium-size
enterprises, which can benefit from the downsizing and unbundling of
unviable, large enterprises. The success of these enterprises has proved
decisive for growth in the Central European transition economies.
The Russian government must also increase transparency in privatiza
tion auctions and in the awarding of telecommunications licenses, and
it must be more aggressive in dealing with monopolies, including infra
structure monopolies and monopolies created by poorly regulated acqui
sitions and mergers. It must foster competition. It must be seen as fair,
transparent, and consistent in uniformly applying a clear set of rules to
all investors, domestic and foreign. Banks and enterprises must adopt
international accounting standards, and the foundation must quickly
be laid for a solid financial sector, the lack of which will constrain the
mobilization and efficient allocation of resources over the medium
term.
The list is daunting. Based on experience, we believe that the immedi
ate priority is a hardening of budgets constraints based on fully eliminat
ing nonpayments for energy and taxes and eventually on rational pricing
for energy based on long-run marginal costs. A natural concern on the
part of regional governors is how to deal with the possible social fall-out.
This is an area of great concern to the World Bank, and it brings us to
the next challenge.
Third Challenge: Craft Social Protection Policies
and Create Needed Institutions
A social protection system based on preventing enterprise exit through
explicit and implicit subsidies is costly and eventually unsustainable. It
is costly because it is a disincentive to enterprise restructuring, which in
turn impedes new job creation and growth. It is unsustainable because
implicit subsidies based on arbitrary, partial payment of tax and energy
bills ultimately lead to a debt crisis (as they did in 1998) or to the decap
italization of companies such as Gazprom and RAO UES. Moreover, the
untargeted, implicit nature of the subsidies is a recipe for corruption and
asset stripping.
Policymakers face a choice. On the one hand, they can preserve a sys
tem based on implicit subsidies that temporarily, but very inefficiently,
minimizes the social costs of transition but does not offer any long-run
40
New Leadership, New Oppartunities in the Russian Federation
upside. On the other, they can harden budget constraints to restructure
enterprises and lower entry barriers for small and medium-size enter
prises and other new investment. Such a policy could temporarily
increase the social costs already being incurred, but it could create better
jobs and long-run growth. The second option is clearly better when
viewed in a strategic, long-run context, but it calls for a more effective,
better-targeted social safety net that will help the truly needy during and
after the transition. Hard budgets and competition must thus be comple
mented by policies and institutions for social protection that support
structural change in enterprises and labor markets; address poverty,
especially deep poverty, head on; apply the resources currently used in
social protection much more efficiently; and build social protection
institutions (pension system, unemployment insurance, and basic
welfare support) that are sustainable in the long term.
The current social protection system in the Russian Federation does not
meet these criteria. Several corrective actions could be taken to address
the problem:
• Protect the poor through a simple, targeted, proxy means-tested
poverty benefit scheme, while eliminating many of the current social
protection programs.
• Exercise financial discipline and realign coverage and benefits in the
pension fund. employment fund, and social insurance fund for better
targeting and greater efficiency. A first step toward doing so has already
been taken with the consolidation of the social funds tax into one tax
to be centrally collected by the Ministry of Taxes and Fees (although at
up to 35 percent of the payroll. this tax continues to be high).
• Flatten the benefit structure in the pension system while raising min
imum pension levels. Monetize current in-kind benefits, especially
housing subsidies. This is a major issue, as it will give ordinary
Russians choice in their housing expenditures, improve management
of the existing housing stock, and encourage construction.
• Support (sub)sectoral downsizing and restructuring of declining
industrial sectors and regions (similar to the coal sector program)
with comprehensive subsectoral restructuring packages, including
liquidation and privatization; changes in ministerial responsibilities
that focus on regulation in support of competition (not protection or
promotion); and social support measures for affected employees and
communities.
41
Transition Years
Fourth Challenge: Improve Public Sector Management
Lasting progress in macroeconomic, structural, and social transformation
is possible only if supported by an effective, efficient, transparent public
sector that increases people's confidence in the state and sharply reduces
the scope for corruption. Four key tasks deserve early attention:
• Realign a complex and duplicative government structure, by simplify
ing the current structure, eliminating remaining commercial and
service obligations of ministries that are best left to the private sector
while strengthening their regulatory functions.
• Strengthen the civil service, by improving the uncompetitive pay
structure, reducing the excessive number of civil servants in some
areas, and upgrading the skills base through training and renewal of
the civil service.
• Strengthen the judiciary, by increasing-and paying-their low and
often unpaid salaries, improving inadequate facilities, and providing
technology and logistical support.
• Rationalize the complex and unclear intergovernmental relations
between federal and subnational authorities, by clarifying the revenue
and expenditure authority of different levels of government, strength
ening the effective control of federal tax authorities over federal tax
collection in the regions, providing incentives to subnational author
ities to introduce efficient administration and a competitive environ
ment for investment and productivity growth, and eliminating the
reliance on ad hoc negotiated deals between the federal and oblast
governments.
Conclusion
Everyone has been talking about the window of opportunity---okno
vozmozhnostei-in the Russian Federation. This window means different
things to different people. To short-term portfolio investors, it may rep
resent an opportunity to speculate on the exchange rate. To long-term
investors, domestic and foreign, it represents an anxious time of waiting
to see whether resolute steps will be taken to improve the investment
climate. To older Russians, it represents the hope of better prospects for
their children, even if they have had to make sacrifices. To the govern
ment, it represents a unique opportunity to accelerate reform based on
42
New Leadership, New Opportunities in the Russian Federation
the lessons of the 1990s, organized around the four challenges identified
above. To the international financial institutions, it represents a chance
to continue a policy dialogue, based on a clearer understanding of how
the Russian economy works, and a better reading of priorities.
But there is also a downside scenario: If oil and gas prices fall signifi
cantly, if macroeconomic and structural reforms are not accelerated
while the window remains open, if public borrowing resumes, then the
Russian Federation could once again face a serious downturn, with a set
back to the manufacturing sector. To be sure, there are many "ifs" in this
statement, but one should guard against history repeating itself.
The way to do so is for the Russian Federation to build on recent favor
able economic developments to create the sustained growth that is the
essential ingredient in ensuring greater prosperity for ordinary Russians.
The Bank is working closely with the government to meet the chal
lenges that undoubtedly lie ahead. It has made clear its willingness to
continue to provide strong support to Russia's economic reform efforts.
It looks forward to a continued fruitful partnership.
43
CHAPTER 4
Central Asia: Ten Years of Transition
From a speech given at the Central Asia Donors' Consultation
Meeting, Berlin, March 1, 2002
T he timing for this meeting is good, as the dust has settled a bit on
the events in and around Afghanistan and heightened attention is
focused on Central Asia. We at the World Bank welcome this increased
attention, since we have long felt that the international community had
not focused enough on the low-income countries of the Commonwealth
of Independent States (CIS), especially in Central Asia.
Overview of the Transition
The Central Asian republics were among the poorest and least devel
oped in the Soviet Union and among the least well known in the West
before the breakup of the Soviet Union. The new countries of Central
Asia were hit by a triple transition: adjustment to the economic shock of
the breakup of the Soviet Union, the transition from state planning to
market-driven economies, and an ongoing political transition.
Breakup of the Soviet Union
The breakup of the Soviet Union hit the Central Asian republics espe
cially hard, a fact that has long been underestimated. First, trade and
transit were interrupted, with new borders created; transportation costs
increased, including those associated with illegal check points (a truck
traveling from the Kyrgyz Republic to the Russian Federation is esti
mated to have to pay up to US$1 ,000 in bribes along the way); and
traditional markets collapsed, especially in the Russian Federation.
These changes reduced industrial and agricultural production in Central
Asia, where they disrupted access to inputs and markets. Second, the
Central Asian republics lost subsidies for budgets, enterprises, and
households-direcdy and indirectly, through transfers for pensions and
other social payments as well as through below-market prices on
45
Transition Years
transport and energy. Third, the republics lost access to secure water and
energy resources within the region, access that is key for agriculture,
industry, and households. Fourth, they lost administrative strucrures and
skilled labor, as many Russians left. Fifth, they were left with large envi
ronmental burdens, including the Aral Sea ecological disaster and indus
trial, nuclear, and biological waste. Finally, some countries (Tajikistan)
experienced civil war. As a result of these disruptions, the Central Asian
republics sustained huge economic losses, resulting in economic declines
of 20-60 percent of GDP between 1990 and 1995/96, losses that far
exceeded those experienced in the United States during the Great
Depression of the 1930s.
Market Reform and Institution Building
Replacing state management with market-driven economic systems
was-and still is-a major challenge for the new republics, which, in
contrast to Central European countries, had no recent market experi
ence. Like other former Soviet republics, the Central Asian countries
initially faced major macroeconomic instability, but they were able to
bring high inflation under control relatively quickly. Market-oriented
policy reforms showed mixed progress, advancing most in Kazakhstan
and the Kyrgyz Republic and least in Turkmenistan and Uzbekistan.
Market institution and capacity building advanced slowly in all Central
Asian republics. Some progress was made in setting up central banks
and payments systems, basic national administrative structures, and
legal systems. But fundamental weaknesses remain in the civil service,
budget management, regulatory and judicial systems, and control of
corruption.
Political Reform
Progress in creating democratic institutions, civil society, and social
capital has been slow, and in some countries there have arguably been
reversals. Regional political cooperation has been minimal, despite some
regional cooperative declarations and institutions. Significant economic,
political, and personal rivalries have grown among the five countries
and their leadership. Meanwhile, Central Asian countries are said to be
vulnerable to extremist influences and movements. But civil society,
including a vibrant NGO sector, has become stronger in some countries,
especially the Kyrgyz Republic.
46
Central Asia: Ten Years of Transition
Current Economic and Social Situation
Some economic recovery began in 1995/96, but it was dramatically
interrupted by the Russian crisis of 1998. Since 2000 there has been rea
sonably good growth-propelled in part by Russia's recovery--giving
some hope that the worst is over. Some countries, however, especially
the Kyrgyz Republic and Tajikistan, are still suffering from the lasting
impact of the earlier economic shock, with high debt burdens and low
per capita incomes that place them among the poorest of the world's
developing countries. All countries suffer from increased inequaliry and
serious poverty (most severe in Tajikistan, where 70-80 percent of the
population lives in poverty).
Social sector indicators remain relatively strong, according to official
data. But some indications suggest that these data substantially underes
timate the decline in some key social conditions. Social spending by
governments is very low by international standards and in comparison
with countries in Central Europe and even Russia. Tajikistan is a dra
matic outlier even by Central Asian standards.
The disintegration of "economic space" in the region as a result of the
lack of cooperation is dramatic. Maintenance of dams and irrigation sys
tems is very poor, with enormous waste of scarce water resources and
risks of catastrophic failures. Lack of cooperation and political tensions
exist over intraregional water allocations. And countries are planning
large, wasteful investments in water storage and transmission, based on
suboptimal design at the country, rather than the regional, leveL The
results are man-made droughts and major economic, social, and environ
mental problems. Trade and transit of goods and people are growing
problems in the region. Uzbekistan's currency and trade policies, for
example, require tariff and quantitative controls that disrupt trade and
transit for the entire region. (The government plans to reform these
policies.) HIV/AIDS and tuberculosis and drug trade and use have also
become regional issues. The poorest subregions within countries (the
Ferghana Valley and the Aral Sea region) are hardest hit, with the poor
est segments of the population bearing the greatest brunt of regional
disintegration.
Challenges for the Future
The countries of Central Asia face a common set of challenges, but the
intensity and impact of these challenges differ significantly from country
47
Transition Years
to country. Some challenges require country-level solutions. These
include reforming markets, building institutions, improving the invest
ment climate, meeting social service needs, and reducing high levels
of external debt. Other challenges require regional solutions. These
include trade and transit, regional water and energy issues, oil and gas
pipeline access, communicable diseases and drugs, and environmental
issues. In addition, some countries face special needs for concessional
finance and all require further political reforms.
Looking at the key challenges country by country, we can paint the
following broad-brushstroke picture:
• Kazakhstan is probably in the best shape and currently has the
brightest economic future among the Central Asian countries,
comparable to that of the Russian Federation and Ukraine. The
major risk for the longer term may lie in the inappropriate use of its
energy resources, which has plagued many other resource-rich devel
oping countries.
• Uzbekistan faces serious challenges in most dimensions. Because it is
a key player in the region, progress in economic reforms, improve
ment in its economic performance, and increased readiness to deal
with regional issues in a cooperative manner would have major bene
fits for the region as a whole. Should the country stagnate--or worse,
go into an economic and political tailspin-the implications for its
neighbors, especially the poorest, the Kyrgyz Republic and Tajikistan,
could be disastrous.
• The Kyrgyz Republic has made progress in reforming its economy and
building a vibrant civil society. But lack of market access, severe
institutional weaknesses, pervasive poverty, and an unsustainable
level of debt provide tremendous challenges and risks.
• Tajikistan is similar to the Kyrgyz Republic in the nature of the chal
lenges it faces, but the challenges are more pronounced, particularly
those relating to institutional weaknesses and the risks of internal
conflict.
• Turkmenistan is an outlier even within the region in its near total
isolation and lack of reforms. There is no indication that its position
will change in the foreseeable future. It represents a significant obsta
cle to any effort to increase regional cooperation in key areas, espe
cially water.
48
Central Asia: Ten Years of Transition
Key Opportunities and Constraints
Several opportunities and constraints confront the international com
munity as it considers increasing its support for reform and development
in Central Asia. Opportunities include the recent economic recovery,
the region's natural resources, the countries' strong human capital base,
the possibly increased willingness of national leaders to push forward
with reforms and regional cooperation, and the new international atten
tion being given to Central Asia. Constraints includes weak democratic
institutions and social capital; weak institutional capacity and invest
ment climate; lack of market access; limited commitment to reform,
capacity building, and regional cooperation; lack of resources for public
investment and social spending (in some countries); and debt overhang
(in some countries).
What Can the International Community Do?
Given these opportunities and constraints, what can the international
community do? Based on its experience, the World Bank has identified a
few key priorities for the international community as it reinforces its
commitment to support economic recovery, poverty reduction, and
regional cooperation in Central Asia. The priorities can be divided into
country-specific and regional dimensions.
Country-Specific Priorities
The countries of Central Asia face important country-specific policy
challenges.
Democracy building and political reforms. Bilateral donors, some multilat
eral institutions (such as the Organization for Security and Co-operation
in Europe [OSCE] and the United Nations [UN]), and international
NGOs should take the lead in this area, but all donors can support the
development of participatory approaches and stronger civil society in
their specific spheres of involvement.
Capacity building. Technical assistance, training, and programs and proj
ects that help reform the public administration, judiciary, and market
institutions and develop civil society can be supported by a broad range
of external supporters. Capacity building is an area in which the World
Bank is especially active.
49
Transition Years
Improving the investment climate. Technical assistance, training, and pro
grams and projects for improving the regulatory framework, registration,
inspection and licensing, property and bankruptcy legislation, and other
areas that improve the investment climate are essential to support pri
vate investment, especially by small and medium-size firms. The inter
national financial institutions have a special role to play here.
Investment in physical and social infrastructure. Direct financing and
budget support for programs and projects in these areas are essential, but
they need to be combined with sectoral reforms and institution building,
for sustainability and effective targeting. Many donors can contribute in
this area, but they need to cooperate to ensure appropriate sectoral
approaches.
Concessional finance and debt relief. International financial institutions have
so far been the principal source of international financial support; increased
support from this source is likely to be llmited. For the poorest countries
(the Kyrgyz Republic and Tajikistan) increased bilateral concessional
finance (linked to good performance) will be essential. Debt relief for these
countries should be promoted using the appropriate instruments (Paris
Club, enhanced Heavily Indebted Poor Countries [HIPC] initiative).
The Poverty Reduction Strategy Papers process. The Poverty Reduction
Strategy Papers (PRSP) process for the poorest countries (borrowers
from the International Development Association [IDA]) is the appropri
ate framework within which the countries and the international com
munity can cooperate to formulate appropriate country-specific strate
gies and external support. The World Bank will continue to support the
PRSP process in partnership with others. It will strengthen its own
capacity in the region by placing its country director and senior tech
nical personnel permanently in Central Asia (in Almaty, Kazakhstan).
Regional Priorities
Several important regional priorities must be addressed. For these issues,
important cross-border effects mean that only regional cooperation can
achieve satisfactory solutions.
Water Management
The Aral Sea Basin Program, while not without its difficulties, prOVides
an important analytical base, institutional lessons, and programmatic
50
Central Asia: Ten Years of Transition
foundation for further initiatives by the international community in
helping develop regional approaches to water policy and management.
All donors should use opportunities for high-level dialogue to press the
leadership of the five Central Asian countries to work closely together
in this essential area, even if in the immediate future much of the sup
port will likely have to focus on bilateral and trilateral cooperation
among selected Central Asian countries and on country-specific reform
and investments for improved water management and use. Attention
will need to be paid to the role of Afghanistan as a potentially signifi
cant player in the regional water situation.
Energy
Donors can advise on energy, transit, and trade options and finance
high-priority investments, preferably with private sector participation.
Energy sector reforms, including improved payment discipline, will have
to be a key aspect of such support. Attention needs to be paid to the
potential for Central Asia to provide Afghanistan with electricity and
the potential of routing international oil and gas pipelines through
Afghanistan once the country returns to normal.
Trade and Transit
Donors can help by supporting Uzbekistan's incipient currency and trade
policy reforms, which could help eliminate one of the major constraints
to regional trade and transit. Support for investment and institution
building to facilitate and provide the infrastructure for trade are also high
priorities. The Asian Development Bank and the European Commission
have been lead instirutions in this area. Others, including the Bank,
could add their support based on relevant experience elsewhere.
Communicable Diseases
Donors such as the World Health Organization, UN agencies, and the
World Bank should press countries to recognize and combat the dual
threats ofHIV/AIDS and tuberculosis.
Drugs
Relevant UN and bilateral agencies should promote the fight against the
spread of drug transit and use in Central Asia.
51
Transition Years
Implications for New Regional Donor Initiatives for Central Asia
The World Bank Group stands ready to support the countries of Central
Asia and the international community in their joint efforts to improve
the prospects of the 55 million inhabitants of the region and in ensuring
better integration of the countries of the region with each other and
with their neighbors, including Afghanistan.
The four principles on which donors and countries agreed during the
recent London conference on the seven low-income CIS countries
(Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan,
and Uzbekistan) are relevant for any regional initiative in support of
Central Asia. These principles state the following:
• The CIS-7 are to reinforce their own policy reform and capacity
building efforts.
• The CIS-7 are to cooperate with each other in their respective subre
gions (especially Central Asia and the South Caucasus).
• The international community will provide enhanced support in
response to strong country performance, through enhanced trade
access, concessional finance, and debt relief.
• International financial institutions will continue to provide strong
and more closely harmonized support to the countries and the inter
national community.
Several other considerations should be borne in mind as the interna
tional community considers options for developing new initiatives of
support for Central Asia:
• Remain realistic and plan for the long haul. The constraints are seri
ous, especially in the absence of a strong political umbrella for
regional cooperation, such as that provided by the Stability Pact for
South East Europe, which in turn is anchored in hopes for eventual
EU accession of countries in that region.
• Build on country demand in developing pragmatic solutions, but
stress performance and keep pushing at the highest level for
fundamental change. The desire for strong reforms and regional
cooperation is currently at best mixed; in some countries it is totally
absent. "Opportunistic" responses {including confidence-building
52
Central Asia: Ten Years of Transition
steps, bilateral and trilateral initiatives, and other responses) are
therefore needed, most likely leading to incremental change for now.
Financial support should be linked to performance-to steps that rep
resent real change and lasting improvements in economic and social
conditions, especially of the poor. Opportunities for more fundamen
tal changes and solutions should continuously be explored, especially
in dialogue at the highest political levels.
• Work in partnership and do not duplicate efforts. The PRSP process
provides the best available instrument for donor cooperation and
coordination in the IDA countries of Central Asia ( the Kyrgyz
Republic, Tajikistan, and Uzbekistan). The principles of the Compre
hensive Development Framework also apply elsewhere, but they need
to be developed on more of an ad hoc basis.
• Address the external constraints affecting the prospects of the poorest
countries--their need for more concessional (grant) finance and debt
relief. The appropriate forums for doing so are the consultative group
meetings of donors for individual countries and the Paris Club meetings.
CHAPTERS
Economic and Social Dimensions of
Enlargement of the European Union
From a speech given at a conference sponsored by the European
Union Presidency and the European Network of Economic Policy
Research Institutes (ENEPRI), Brussels, November 15, 2000
M y friend Stanley Fischer at the International Monetary Fund likes
to remark that from all the research he and his research depart
ment have conducted to explain the growth performance of transition
economies, the one explanatory factor that stands out most clearly is the
country's distance from the heart of Western Europe. This is consistent
with my own observation from years of extensive travel throughout
Central and Eastern Europe that the idea that most vividly captures peo
ple's imagination is not anything lor the World Bank might say or do
but the idea of reducing that very distance-by joining the European
Union (EU).
The potential social impact of EU enlargement is giving pause, not only
in candidate countries, which may be concerned about withstanding
heightened competitive pressures, but also in member countries, where
fears of large-scale labor migration have been blown out of proportion. I
hope that this conference will help deflate these fears. Indeed, I would
like to point out how much, in my view, the interests of member and
candidate countries converge in this area. Their common interests are to
create jobs at home and to struggle against social exclusion.
This convergence of interest should come as no surprise, if you consider
how much both sides have already gained from integrating with each
other. Comparing GNP levels across Central and Eastern Europe and
Central Asia in 1991 and 1999 reveals a telling story. Central Europe
and the Balties saw a contraction in GNP in 1991/92 but then
The assistance of Michelle Riboud, former Senior Economist in the Europe and Central
Asia Region and current World Bank Sector Director for Human Development in the
South Asia Region, in drafting this speech is much appreciated.
55
Transition Years
experienced a sustained economic recovery, driven primarily by exports
to the EU. In contrast, the countries in the Commonwealth of Inde
pendent States (CIS) saw a continuous economic decline between
1991 and 1998. The result in terms of relative economic strength is
striking:
• In 1991 the GNP of Central Europe and the Baltics was one-third
that of the CIS. In 1999 it was one-third larger.
• In 1991 Russia's GNP was seven times that of Poland. In 1999 it was
barely larger.
• In 1991 Poland's GNP was roughly the same as Ukraine's. In 1999
it was five times larger. In 1999 more than two-thirds of Poland's
exports but less than 20 percent of Ukraine's went to the EO.
Of course, no one claims that EU integration on its own accounts for
such different trajectories. Stabilization and structural reforms were key.
But no one would deny that integration with the EU provided the
framework and the impetus for countries to forge ahead.
On the EU side, the countries of Central and Eastern Europe have become
the EO's second-largest export market (after the United States}-and one
in which the EU enjoys a sizable trade surplus.
This is not to say that the integration process has been or will be pain
less. To the contrary, countries are facing critical social challenges: deal
ing with the ensuing economic restructuring, providing social protection
without blunting incentives or compromising fiscal sustainability, invig
orating labor markets, enhancing human capital, and combating social
exclusion.
Economic Restructuring
At the heart of the matter is the fact that the ongoing recovery in Cen
tral and Eastern Europe has created very few net jobs. To be sure, there
has been a massive amount of "labor churning," as jobs shifted from
dying industries to new, often smaller-scale greenfield operations, first in
services and more recently also in industry. Reflecting on the parallel
experience in the former German Democratic Republic, officials in
Saxony estimate that three-quarters of the population now have differ
ent jobs than they did 10 years ago.
56
Economic and Social Dimensions of Enlargement of the European Union
But even in a well-performing country like Hungary, the level of
employment remains more than 20 percent below the 1990 level. In
Poland it remained almost unchanged in the face of a 45 percent GDP
expansion (cumulative) between 1993 and 1999, and unemployment
remains high, at 13 percent of the labor force.
As a result, the incidence of poverty in Poland was higher in 1998 than
in 1991. Indeed, across the countries of Central and Eastern Europe,
unemployment and underemployment, particularly in rural areas, have
been leading causes of the increase in absolute poverty. In most of the
region, 15-20 percent of the population is poor, and the figure is as high
as 40 percent in Romania. Only the most affluent countries in the
region, the Czech Republic and Slovenia, have been spared.
The pressure to restructure is unlikely to let up. Across the board, con
tinued trade liberalization will likely heighten competitive pressures,
particularly as it extends to the often overmanned agricultural sector.
Implementation ofEU policies (on state aid and internal markets, for
example) will also speed the restructuring of declining industries (such
as steel and coal) and force other large employers in sectors such as ser
vices (banking, transport) and utilities (railways, telecom, power) to
shape up. More jobs will be lost in the process.
Labor Market Policies
To facilitate a shift in jobs from declining to growing activities, candi
date countries may need to maintain a greater degree of labor market
flexibility than is commonly the case among current EU members. The
25 percent ratio between minimum and average wages observed in the
Czech Republic is likely, for instance, to do more to create jobs than the
France-like 50 percent ratio observed in Poland.
Of course, reducing unemployment will require measures that go beyond
labor market policies. More active housing markets, for instance, would
also help prevent workers from being trapped in "rust belts" after their
jobs have moved elsewhere.
Social Protection
Appropriate social safety nets are also needed. Accession countries are
already spending heavily on social security: as a percentage of GDp, they
57
Transition Years
spend as much as member countries. Per capita income is 33-66 percent
lower than in the EU, however.
To finance social safety net systems, labor is sometimes heavily taxed:
labor tax wedges in several accession countries exceed those observed in
recent EU member countries (more than 50 percent in Czech Republic,
for example, and about 35 percent in Ireland).
Without action, social protection could weaken even further. In
Romania, for instance, the rate of contribution to the public pension
scheme-which rose from 14 percent of wages in 1990 to 37.5 percent
today-would need to rise to 62 percent over the next 50 years to keep
the current system afloat. The alternative of subsiding social security
systems out of general taxes is not fiscally sustainable.
Not surprisingly, a growing number of candidate countries (including
Bulgaria, Hungary, and Poland) are looking for innovative ways to
ensure social protection while invigorating labor markets. An example is
the movement toward multi pillar pension systems or the focus on target
ing of cash benefits.
Human Capital Development
Whether or not good jobs become available over the medium term will
depend fundamentally on the extent to which countries succeed in redi
recting their human capital and the social programs that help build it
toward the needs of a globally integrated market economy. Several can
didate countries have made good strides toward reforming human capital
sectors. Latvia, for example, has strengthened education, and the Czech
Republic has strengthened the health sectors. Sustained efforts will be
needed for these efforts to bear fruit and benefit all members of society.
Social Inclusion
In the meantime, one needs to recognize that economic restructuring of
the magnitude experienced can strain the social fabric and raise the spec
trum of social exclusion, in member and candidate countries alike. Within
candidate countries, two groups are particularly vulnerable: children, who
represent 18-59 percent of the poor in the region, and ethnic minorities
(85 percent of the Roma in Bulgaria live in poverty). The Bank was glad
to see the EU take up their causes in the context of accession.
58
Economic and Social Dimensions of Enlargement of the European Union
Table 5~1. Selected World Bank Interventions in Central
and Eastern Europe
Area Sector or project
Enterprise restructuring Coal mining in Poland; railways in Poland and
Romania; rural sector in Poland
Social protection Social protection reform in Bulgaria
Labor markets Employment services in Poland
Human capital development Education reforms in Bulgaria, Hungary, and
Latvia; health sector reforms in Latvia
Social inclusion Community services reforms in Lithuania;
child welfare reform in Romania
The candidate countries are confronted with unprecedented social chal
lenges. It is heartening to see the innovative spirit with which they are
dealing with them.
Benefiting from and Supporting Innovative Policies
Dealing with these challenges remains very much a national responsibil
ity. But as the acquis (the body of common rights and obligations that
bind all member states within the EU) develops in social areas, it will
benefit from the lessons learned from innovations by candidate coun
tries. The impact of these innovations will reverberate beyond the can
didate countries themselves, helping Europe move forward. Indeed, they
will form part of the new members' dowry to the enlarged union. The
World Bank is helping these innovations flourish and spread with inter
ventions in key areas (table 5-1).
59
CHAPTER 6
Staying the Course in the Balkans
Op-ed article published in the International Herald Tribune, by
Johannes Linn and Christiaan Poortman. then World Bank
Country Director for South East Europe, August 3,2002
I n July, we set out for a 10-day trip through the Balkans by car along
highways, byways, and rutted tracks, with the aim of getting a better
sense of what has been achieved in the region and the challenges ahead.
Our trip took us from Zagreb in Croatia through Bosnia-Herzegovina,
Montenegro, Kosovo, and into Albania. We had previously visited Ser
bia. Along the way we met hundreds of people, from senior government
officials and parliamentarians to poor mountain farmers and community
activists. All of them spoke of the difficulties they face, the frustrations
of chaotic political systems, the lack of government capacity and infra
structure, the burdens of corruption and government interference, and
the ineffectiveness of legal systems.
And yet everyone insisted that things are getting better, and most are
optimistic about the future. In Kosovo, a chief editor, Veton Surroi, told
us, "At last, we can laugh about things-the worst is behind us."
Despite questions about the effectiveness of donor efforts in the region,
and the sustainability of reform and the prospects for peace and EU inte
gration, we saw firsthand that the financial and political support for the
West Balkans has produced some impressive results since the early 19905.
The current danger is that the international community may lose interest
as crises in other parts of the world claim attention. This would leave the
job in the Balkans half done and risk reversing hard-won gains.
The international community has invested billions of dollars in the
Balkans over the last 10 years, starting with Albania in the early
1990s, followed by Bosnia-Herzegovina since 1996, Kosovo, and now
Macedonia and the Federal Republic of Yugoslavia.
Reprinted with permission. Christiaan Poortman is currently vice president, Middle East
and North Africa Region, World Bank.
61
Transition Years
During our trip, we saw many examples of progress on the ground. In
Mostar the gulf between the Bosniak and Bosnian Croat communities is
being bridged, quite literally, by the reconstruction of the Stari Most, a
symbol of Bosnia's historic tolerance for diversity among its people. In
the Albanian capital of Tirana, the mayor is making heroic efforts to
clean up illegal commercial development and to provide a safer environ
ment for the citizens. And all across the region, governments are work
ing on strategies to reduce poverty and unemployment which define a
long-term vision and realistic programs for economic recovery and social
inclusion.
Statistics confirm the picture of progress and stability that we saw in
the Balkans. An the economies of the region have experienced rapid
economic growth in the last few years, especially Albania, which has
quadrupled its per capita income since 1992. Bosnia-Herzegovina
and Kosovo have also grown rapidly since the fighting stopped, and
Yugoslavia has started its recovery since the departure of Slobodan
Milosevic and the start of serious economic reform.
A building boom is under way as individuals pour their savings and
remittances from family members abroad into houses, shops, and other
small businesses. Crime and violence are down, and refugees are return
ing to their homes in unexpected numbers.
The international community has provided basic security through its
military presence. It has also helped to rebuild public buildings, schools
and roads, power and water supply systems. It has worked to privatize
public enterprises and banks. It has assisted in building government
institutions where none or only weak ones existed before. And by sup
porting democratic and participatory processes, it has given civil society
the chance to engage and grow.
The Stability Pact for South East Europe and the Stabilization and
Association Process of the EU, combined with the political changes in
Yugoslavia and Croatia, provide the framework for cooperation and
regional integration. This offers a political anchor for economic and
social reforms and provides a sense of political and economic stability for
the first time in years.
So far so good. But the job is only half done, and there is a risk that
expectations may outrun progress. Weak institutions and corrupt politi
cians may slow or reverse the process. Large pockets of poverty and
social exclusion could become endemic. Meanwhile, mountains of
62
Staying the Course in the Balkans
garbage and plastic debris spoil the splendid countryside, rivers, and
beaches, and untreated sewage pollutes the aquifers and coastlines,
causing sickness and discouraging tourists. Too often, the countries' edu
cation, pension, and health systems fail the young, the old, and the sick.
While the challenges remain daunting, donor support is slated to drop in
Albania, Bosnia-Herzegovina, and especially Kosovo, while Serbia is only
at the start of its reconstruction program. Private foreign investment
remains low, as foreign investors have not yet recognized the progress
made on the ground or are turned off by the remaining difficulties.
The long time horizon of EU integration and the high hurdles of the
industrial countries' visa regimes give a sense-particularly to the
young-that they remain second-class citizens, isolated from Europe and
the rest of the world.
What can be done? All parrners must stay the course. Governments and
politicians need to improve their policies and performance. They must
take on corruption and crime and deal openly with their electorates and
civil societies. And they have to manage the rapidly growing expecta
tions of their people.
The international community must continue to support governments
which move forward with reforms. This means sustained efforts to open
up Western markets, as well as financial support for investments in safe
roads, clean water, and reliable power. It also requires help to develop
sound institutions and assistance for education, health, and a clean
environment.
Much has been achieved in the last few years by the countries of the
Western Balkans and by the international community. Now we must
consolidate the gains through continued engagement, effective coordi
nation, and financial support, not at postcont1ict levels but high enough
to make sure that progress continues.
63
CHAPTER 7
Structural Reforms for Sustainable
Growth in Turkey
From a speech given at the conference "Structural Reforms for
Sustainable Growth," Istanbul, November 29,2000
T urkey enters the twenty-first century with enormous opportuni
ties. Its young population, dynamic private sector, and pivotal
geographic location give it the ability to move to the forefront of
emerging markets. Turkey's potential to become a member of the
European Union (EU), a regional leader, and a major world economy
was recognized at the Helsinki EU Summit and by its inclusion in the
020. Its success will be a boon for its people, an example and engine
of growth and source of stability for the region, and a boost to the
global economy.
To release Turkey's full potential, the government has launched a major
economic reform program. This program responds to three core eco
nomic challenges:
• taming chronic inflation and breaking the grip of high real interest
rates through permanent fiscal adjustment designed to put public
finances on a sustainable path
• raising productivity and stimulating growth through second
generation structural and institutional reforms aimed at creating
a world-class environment for private investment
• empowering all of Turkey's citizens and addressing disparities in eco
nomic opportunities through public investment in health, education,
and social protection
The assistance of Ajay Chhibber, Country Director for Turkey, and the staff of the Turkey
Country Office in drafting this speech is gratefully acknowledged.
65
Transition Years
The Context of Reform
Twenty years ago Turkey embarked on a journey to integrate into the
global economy and modernize its economic institutions. Turkey's econ
omy, like that of many developing countries, was inward-looking and
closed, relying on import substitution to spur development. In the early
1980s, Turkey carried out sweeping reforms designed to shift to an out
ward orientation, opening the economy to external competition and lib
eralizing the financial sector. These first-generation policy reforms met
with much success. Trade accelerated, competitive private industry and
finance emerged, and Turkish entrepreneurship thrived in this more lib
eral environment.
Today Turkey is engaged in the second stage of its journey, tackling vital
structural and institutional reforms. These second-generation measures
aim to ensure that private entrepreneurship moves toward productive
activities and away from rent-seeking. Critical to success are efforts to
strengthen public management and accountability and establish trans
parent regulation in line with international standards in banking,
telecommunications, and energy. Strong and credible public institutions
will support private sector development and help attract the foreign
direct investment that Turkey needs to sustain high growth, technologi
cal innovation, and external competitiveness.
The government has recently taken important steps to modernize
Turkey's public institutions. It established the Banking Regulation and
Supervisory Agency and an independent telecommunications regulator.
It has also taken action to tackle corruption. The government's recent
request for Bank support for its anticorruption efforts is an important sig
nal of its resolve in this area.
Second-generation reforms are as difficult as they are essentiaL The road
ahead will be long, and potential pitfalls are many. But Turkey can draw
encouragement from the tremendous achievements of the past 20 years
and from the progress with reforms over the past 18 months under the
current government.
Priorities of Reform
The World Bank's recent Economic Report demonstrates that credible fis
cal adjustment is central to addressing inflation and a prerequisite for
sustainable growth. In the past, unsustainable fiscal policy put repeated
66
Structural Reforms for Sustainable Growth in Turkey
pressure on the lira and contributed directly to chronically high infla
tion. It left the country vulnerable to crises; when crises hit, as in 1998,
fiscal policy options were limited to contractionary measures to ensure
financial stability, exacerbating in a procyclical fashion the impact of
internal and external shocks. The report also suggests that economic
growth has remained below potential due to macroeconomic instability,
low productivity growth, and insufficient investment in human
capital-all related directly or indirectly to weak fiscal policy.
Beyond this focus on fiscal policy, the Economic Report underscores the
fundamental need for structural reform to achieve sustainable fiscal
adjustment and promote economic growth. Improvements in public
expenditure management will help ensure the quality of fiscal adjust
ment and protect vital public spending for health and education. Social
security reform is addressing financial imbalances in the public pension
system and opening the door to private sector participation through
voluntary supplemental pension schemes. Reforms in telecommunica
tions and energy are paving the way for much greater private participa
tion and steadily increased competition in line with World Trade
Organization and EU standards. Energy reform will also address the
threat to fiscal stability posed by the growing stock of government
guarantees. Agriculture reform targets a reversal of the decline in agri
cultural productivity, which is undermining rural living standards. The
shift to direct income support for farmers will replace costly indirect
subsidies; accompanying measures to privatize state-owned agricultural
enterprises will promote private participation in processing and market
ing activities. Reforms in the financial sector are raising productivity by
increasing the efficiency of financial intermediation. By strengthening
enforcement of prudential standards in line with international norms,
financial sector reform will also reduce the risk of costly bank bailouts in
the future. Within this context of deep structural reform, privatization
will playa pivotal role in redefining the role of the state, generating
productivity gains, attracting foreign investment, and helping reduce
the burden of public debt.
World Bank Support
The Bank is strongly supporting the Turkish government's reform pro
gram, as it supported the first-generation reforms launched two decades
ago. During the 2000 fiscal year (July 1999-June 2000), the World Bank
Group provided about US$2 billion in new loans and investments to
Turkey in support of economic reforms, social development, earthquake
67
Transition Years
emergency recovery, and reconstruction assistance. The Country
Assistance Strategy for the next three years foresees US$5 billion in
new Bank lending under a scenario of sustained reform. Bank support
will also encompass economic analytical and advisory work-building
on the results of the Economic Report and the earlier Living Starulards
Study-including a Public Expenditure and Institutional Review, which
is under preparation.
68
PART 3
Key Thematic Perspectives
T he third group of chapters presents five speeches dealing with cross
cutting thematic issues of special relevance for the transition
economies in the region. Chapter 8 deals with good governance,
chapter 9 with legal reform. The issues raised in these speeches, which
were given in 200 1, are as relevant today as they were then. They are
also among the more difficult and long-term reform challenges facing
the transition economies. All stakeholders, including the World Bank,
still have much to learn about how best to craft the institutions and the
political will needed to ensure lasting improvements in governance,
in the battle against corruption, in legal and judicial reform, and in
capacity building.
Chapters 10, 11, and 12 deal with key sectoral policy and reform chal
lenges in the energy sector, in the social area, and in environmental pro
tection. These are core areas of continuing concern in all countries in
the region, even as the specifics of reform needs vary across countries
and subregions. Long-term sustainable growth in the region will clearly
depend on how effectively the challenges in these three areas are
addressed.
69
Transition Years
A new body of research confirms these interrelationships, although the
direction of causality is not always clear. Evidence suggests that a state
with transparent and effective institutions is associated with higher
income growth, national wealth, and social achievements; institutional
ized democratic competition and meritocratic government; policies and
a legal framework that are not "captured" by vested interests; and a civil
society and free media whose independent voice enhances the accounta
bility of the government.
There is also clear evidence of the severely negative impact of ethnic
fragmentation and ethnic tensions on economic development. Ethnically
fragmented countries (and regions within countries) tend to provide
fewer and lower-quality public goods, such as education. Institutions that
guarantee minority rights and that provide opportunities to resolve con
flicts have been shown to offset the side effects of polarized societies.
So what is new in the recent focus on good governance is a much deeper
appreciation of the complementarities of reforms across different
realms-economic, political, social, and regional. Although the Bank
has been in the business of good governance since its very inception,
this recognition has had a profound influence both on what we do and
how we do it. Let me briefly summarize what this new understanding has
meant in practice.
Changes in What We Do
We are placing much greater emphasis on public sector management
reforms. Two innovative adjustment loans, to Albania and Latvia, have
been designed as multiyear programs of support to strengthen gover
nance. They address the roles and responsibilities of government min
istries and agencies, develop conflict of interest legislation and asset dis
closure rules, and enhance the judicial system.
We have made fiscal transparency a key goal of adjustment operations.
In the Russian Federation, for example, we are focusing on developing
a treasury system that provides the basis for timely audits of fiscal
accounts. Similar programs have been developed in Hungary and
Kazakhstan and are under discussion in other countries in the region.
In Albania we have supported a more open process of budget formula
tion through a Medium-Term Expenditure Framework. This framework
makes government policies and their link to proposed budget outlays
clearer and available to the public.
72
Good Governance and Transparency in the Transition Economies
We are dealing head on with the scourge of corruption, which often
allows nontransparent institutions and inefficient policies to survive
despite their damaging social consequences. Six countries in the
region-Bosnia and Herzegovina, Kazakhstan, the Kyrgyz Republic,
Poland, Romania, and the Slovak Republic-received assistance this
year for diagnosing problems of corruption and developing strategies
for reform. The Bank conducted governance and anticorruption work
shops in several countries, including Bosnia and Herzegovina, Poland,
Romania, and Turkey.
We are giving greater attention to local-level capacity building and
community-driven development. The Local Initiatives Project in Bosnia .
and Herzegovina is a good example of local-level institution building.
The project gives low-income microentrepreneurs access to credit
through NGOs that serve as microfinance institutions. Half of the loans
went to women and one-fifth to returning refugees or displaced persons.
We are also introducing better monitoring and evaluation procedures of
our own operations, both ro encourage greater accountability among
counterparts and to enhance safeguards in our lending activities. In our
operations aimed at reducing red tape, bribes, and other extra costs of
doing business, for example, we are starting to monitor impact by
directly surveying local firms (an example is the fourth Structural
Adjustment Credit for Armenia).
We are taking our research agenda to new frontiers, exploring such
issues as the impact of civil wars, state capture, and even the structure of
political institutions on the quality of governance, economic growth,
and poverty alleviation. A major new report, Transition after a Decade,
highlights the critical role of new businesses as the engine of growth in
transition economies. Another report, Anticorruption in Transition, for
the first time, investigates the patterns, levels, and causes of corruption
and provides ideas and recommendations for designing and implement
ing effective anticorruption strategies.
Changes in How We Do It
In developing our Country Assistance Strategies, we are engaging in
extensive consultations not only with national governments but also
with civil society groups, the private sector, and local governments
and national legislatures. During the recent consultations on the new
Country Assistance Strategy for Armenia, for example, we talked with
73
Transition Years
particular, the tasks of enhancing regional security, fostering conflict
resolution, and promoting democracy continue to be essential precondi
tions for improving governance in the economic realm, especially in
transition economies.
The success of the World Bank's work in the region is highly dependent
on the success of the OSCE-and other agencies and donors-in achiev
ing their political mission. In Bosnia and Herzegovina, and now in
Yugoslavia, the Bank's work began only once the efforts to resolve con
flict and promote a stable political framework had achieved success. In
Kosovo and Macedonia, our operations are highly dependent on the
capacity to resolve ethnic tensions. Our work in the Caucasus requires
the continued efforts of the OSCE and others to resolve regional security
issues. In Belarus and many Central Asian countries, we hope that efforts
to promote democracy and participation will create new opportunities
for kick-starting the reform agenda.
Democratization, enhanced regional security, and free markets can be
achieved and consolidated with external support, giving scope for organ
izations such as the OSCE, the World Bank, and its many parrners. Our
complementary actions and the potential synergies arising from our close
cooperation can and should enhance stability and prosperity.
76
CHAPTER 9
Legal and Judicial Reform in the Transition
Economies of Europe and Central Asia
From a speech given at the conference "Empowerment, Security,
and Opportunity through Law and Justice," St. Petersburg,
July 11 , 200 1
The Importance of Legal and Judicial Reform in the
Europe and Central Asia Region
Why is a separate session being devoted to Europe and Central Asia
when just this morning we completed a global conference on legal and
judicial reform? The reason is that the Europe and Central Asia region
faces particularly difficult challenges in the area of legal and judicial
reform.
December 2001 will mark the 10th anniversary of the end of the Soviet
Union. For a decade now, the countries of this region have struggled to
emerge from centralized economies and nondemocratic regimes to
become democracies with free market economies.
One of the biggest shifts in our understanding of transition over the
course of this decade has been on the role of legal and judicial institu
tions. At the start of the transition, legal and judicial reform were not at
the top of the agenda. Part of the reason was that the transition
economies faced several critical tasks-fighting runaway inflation, haIt
ing the initial decline in growth, establishing some order in the fiscal
system-that required immediate and urgent policy reforms. But it is
also true that at the start of transition, there was a belief that the rapid
development of private property ownership and the entry of new busi
nesses and entrepreneurs would create the demand for the development
and enforcement of a legal framework to protect property and contract
rights. It was recognized early on that legal and judicial reform could not
The assistance of Friedrich Peloschek, Lead Counsel in the World Bank's Legal
Department, in drafting this speech is gratefully acknowledged.
77
Transition Years
Other countries have also taken key steps forward. The process of
appointing judges in Georgia through judicial qualification examina
tions set the standard for appointing judges throughout the region.
Several countries, including Latvia, Moldova, and Romania, have estab
lished judicial training centers. Poland leads in introducing practice
based teaching methodologies at its law faculties to ensure that future
lawyers are equipped to handle real-life challenges.
Contributions of the Donor Community
Systemic legal and judicial reform requires fundamental reforms of key
institutions-a process that takes time and requires considerable com
mitment from the countries themselves. Where there is commitment,
donors can help.
Donors have played a role in the judicial reform process. In Armenia
and Georgia donors are assisting local counterparts in a comprehensive
judicial reform process that includes establishing a new court adminis
tration system and modem case management procedures, strengthening
the enforcement function, upgrading the institutes responsible for judi
cial training, and carrying out a professional public information cam
paign to communicate the new roles and responsibility in the justice sys
tems. In Albania and Georgia assistance was provided for the difficult
process of recertification of judges. The World Bank is involved in assist
ing new judiciaries in Bulgaria, Croatia, and Kazakhstan, and it may
soon start activities in other countries.
Donors have also contributed to education and outreach efforts. The
European Union, Germany's GTZ, USAID, Canada's CIDA, Britain's
DFlD, and the Soros Foundation have provided crucial support in
establishing judicial training centers around the region and in support
ing associations of judges that are advocating for change. The Central
and Eastern European Law Initiative (CEELl) and the Soros Foundation
have also led the way in creating legal clinics that give law students an
opportunity to obtain practical experience while providing needed ser
vices to their communities on issues ranging from small business devel
opment to obtaining unpaid salaries and other benefits for laid-off
workers.
In the Russian Federation, the Russian Foundation for Legal Reform
funded through a World Bank loan-has been instrumental in developing
80
Legal and Judicial Reform in the Transition Economies of Europe and Central Asia
textbooks and educating the public about the rule of law. The founda
tion has also helped make the law more accessible, through its support of
public interest law centers around the country.
Donors, then, clearly can playa useful role in supporting legal and judi
cial reform. But it is important that we carefully coordinate our assis
tance, pursue an appropriate division of labor, and remain modest in our
expectations about how much can be achieved how quickly by outside
advice and finance.
Future Challenges
The most important reason for our gathering today is to identify and pri
oritize the challenges ahead. I have already touched on what I believe to
be the basic challenge: converting the law from words on a page into a
reality for the citizens of the region. Four sets of actions are needed to
make this happen.
First, we need to establish an independent, efficient, and accountable
judiciary. Doing so requires a well-trained, well-funded cadre of judges
who decide cases not based on connections or pressures or payments but
according to the law and the facts before them. Such a judiciary must
also be empowered to review the acts of the executive branch, through a
process of administrative review.
Justice must be administered efficiently. In too many countries in this
region, the adjudication of a simple civil matter can take several years.
Court administration processes need to be modernized and clerks and
other support staff better trained so that judiciaries can dispense
decisions more quickly.
The judiciary must be accountable--easy to say and difficult to achieve.
Transparency, publicized opinions, clear standards and procedures, peer
review, and a vibrant free press and civil society are likely to be the key
ingredients of judicial accountability.
Second, we need to make sure that the judicial system is accessible: a
well-trained, independent judiciary is of little value if it is not accessible
to all elements of society. We must work together to ensure that we do
not create a system that serves elites only. Increasing access to justice
and educating the public about their rights are also key concerns.
81
Transition Years
About three years ago, in our work with the Russian Federation, we con
cluded that one of the most significant areas requiring reform is the level
of explicit and implicit subsidies provided by the energy sector to the
economy as a whole. This is, in effect, a simple measure of the financial
viability of the sector. It also broadly measures whether the sector will be
able to sustain and expand its services over time, whether it allocates
scare energy resources efficiently, and whether it relies on quasi-fiscal
flows that could endanger the macroeconomic stability of the country.
While some assumptions have to be made concerning the true economic
value of the energy being supplied, it is possible to calculate these subsi
dies on a sufficiently consistent basis to chart progress in a specific coun
try and to compare progress across countries.
At the beginning of the transition, energy supplies throughout the
region, particularly in the CIS, were heavily subsidized. The three com
ponents that make up the subsidies--nonpayments for energy con
sumed, tariff structures that do not recover the full cost of the energy
supplied, and excessive losses that reflect both operating inefficiencies
and theft-reflect the legacy of widespread expectations that energy
should be provided at little or no cost. Let's take a brief look at each of
these components.
Strengthening payment discipline is a critical first step in reducing
implicit energy sector subsidies. Doing so requires both securing a high
level of payment compliance and replacing barter transactions with cash
transactions. It involves an extensive effort aimed at all categories of
customers. Measures to address nonpayments among industrial, commer
cial, and residential customers have to be coupled with the introduction
of hard budget constraints, since in several countries state-owned and
budget-funded enterprises represent the largest part of the nonpayment
problem. Without putting in place effective measures to deal with non
payments, efforts to increase tariffs to full cost recovery levels can be
seriously undermined.
In order for a country's energy sector to be efficient and remain finan
cially viable, tariff levels need to be high enough to recover costs. In the
short run this means that tariffs have to cover input, operating, and
maintenance costs. Over the longer term, tariffs also have to contribute
the funds required for the capital investment needed to sustain the sec
tor. Depending on the circumstances in a particular country, this means
setting tariffs equal to either long-run average cost or long-run marginal
cost (taking into account the discount factors applicable to future
investment requirements).
84
Transition in Central and South East Europe and the CIS: The Energy Dimension
Increasing tariffs to full cost recovery levels has consequences. Tariff
increases can be difficult politically, and timing may become critical in
determining a government's willingness to take necessary action. In an
ideal world, an independent regulator should be able to act on tariffs with
out being influenced by political considerations. But in this region, we are
some way away from achieving that level of regulatory independence.
There is also an issue of affordability and social impact, which makes it
important that governments develop and implement social safety net
measures to accompany any significant increase in tariff levels. A variety
of social safety measures have worked with varying degrees of effective
ness in different transition economies.
The so-called "lifeline" block tariff approach involves providing a low
cost, low-volume block of energy (for example, 50 kilowatt hours per
month of electricity) to all consumers. Provision of this energy may be
cross-subsidized from a second or third block of energy consumption (for
example, from consumption in excess of 300 kilowatt hours per month)
from (presumably wealthier) consumers. This system worked well in
Hungary and some other countries in Central and South East Europe. In
other countries, however, it has acted as an incentive for meter tamper
ing and other forms of theft.
Vouchers targeted to the neediest families provide a specific subsidy to
pay for energy consumption. A third option, the so-called "notional bur
den approach." is designed to deliver social protection in the form of
housing allowances. Financial support is provided to pay the cost of util
ity services that exceed a certain percentage of a family's income
(thresholds of about 20 percent of a family's income are typical).
Payments can also be channeled through family allowance programs,
where they exist.
These approaches depend on effective measures to identify the needy.
But properly designed for a specific country's circumstances, a targeted
approach is clearly more efficient and more affordable than the un tar
geted approach that results from across the board energy subsidies.
Of course, one way to avoid having to raise tariffs is to lower costs. Cost
control, therefore, is another important avenue for lowering the need for
energy subsidies. An important source of costs is excessive losses. One of
the most common sources of these losses is the use of consumption
"norms" for consumers who are not metered. Poor network maintenance
can also cause excessive operating losses. In some countries, energy
85
Transition Years
theft-in the form of meter tampering, bypassing meters, and colluding
with energy utility employees {such as meter readers)-is a major prob
lem. Georgia and the Kyrgyz Republic, for example, have experienced
theft levels of more than 20 percent of generated electricity. Dealing
with excessive losses requires a clear commitment on the part of energy
companies and governments to introduce metering, properly maintain
networks, and enforce laws addressing theft.
What are the consequences of these subsidies in the energy sector? Let
me return to the example of the Russian Federation. Implicit subsidies in
the Russian energy sector in the past generated unsustainable economic
trends that were partly responsible for the 1998 financial crisis. These
subsidies undermine the investment climate in several ways. First, the
low effective prices for energy delayed much needed restructuring of the
old enterprises by effectively subsidizing them, encouraging inefficient
energy consumption by both firms and households and making the Russ
ian Federation 15-20 times more energy intensive (in terms of energy
use as a share of GDP) than advanced energy-efficient economies such
as Germany and Japan. Second, smaller financial surpluses in the energy
sector have led to underinvestment in the long-term productive and
generative capacity of the sector.
The effective energy subsidy in the Russian Federation (defined as the
shortfall in actual payments relative to long-run marginal cost) remains
high. The 1998 ruble devaluation pushed these subsidies to their 1999
peaks. Since then the subsidy has gradually declined. At the beginning
of 2002, the effective subsidy for electricity was 50 percent, down from
95 percent in 1998; the effective subsidy for gas was 58 percent, down
from 92 percent in 1999. The reduction in these subsidies reflects an
active program by the government and service providers that includes
the tightening of financial discipline to strengthen cash collections,
phased increases in real tariffs, and the establishment of mechanisms for
better budgeting for energy use by budget entities. The past practice in
which oblast governors and large incumbent enterprises devised schemes
of mutual noncash offsets in which the enterprises were forgiven a part
of their tax debt in return for political complacency and social protec
tion is now widely discredited. Cash collections are now at about 100
percent for both electricity and gas. Consequently, the main subsidy is
the difference between the current prices for electricity and gas in the
Russian Federation and the true economic cost of service provision.
According to our estimates, the total size of subsidies in the Russian gas
and power sectors is now on the order of US$20 billion a year. Both
86
Transition in Central and South East Europe and the CIS: The Energy Dimension
Gazprom and RAO UES have identified the domestic tariff levels they
believe are necessary to provide full financial viability in the energy sec
tor and are pressing for tariff increases to these levels. Of course, it will
be essential to ensure appropriate governance of these two energy giants
so that the financial resources mobilized by higher tariffs are actually
channeled into better and more efficient services for consumers.
Across the region, progress in achieving financial viability within the
energy sector has varied significantly. In Central and South East Europe,
the EU accession countries are all well on the way to achieving sustain
able financial viability in the energy sector; only some of the non-EU
accession countries still have to address this challenge effectively. In
contrast, almost all of the CIS countries still maintain significant energy
sector subsidies.
The countries of Central and South East Europe generally charge higher
tariffs, at levels that, according to broad industry experience, can be
expected to cover costs. The CIS countries still tend to charge much
lower tariffs, which clearly do not cover costs. As a percentage of GDP,
current subsidy levels remain high in several transition economies,
especially in the CIS and the Balkans. Fortunately, many CIS countries
are now focusing on subsidies in the energy sector. Ukraine, whose cash
collections in the electricity sector were less than 20 percent as late as
1997, is now collecting almost 90 percent of its current receivables for
both electricity and gas. Azerbaijan is implementing a program to
improve cash collections in the electricity and gas sectors from less than
50 percent to 100 percent over a five-year period. To do so, it has initi
ated a program to attract private sector involvement in the domestic gas
and domestic power sectors. Moldova is clearly showing the benefits of
private sector involvement in its electricity distribution business. And
Armenia has privatized its power distribution business and is supporting
the efforts of the new owners to improve collections.
Looking ahead, how can the countries that lag behind best address the
issue of financial viability? The first step is to acknowledge the problem.
This may seem an obvious suggestion, but several CIS countries do not
yet appear to have recognized energy sector reform as a pressing concern.
The second step is to develop a work-out plan with appropriate sequenc
ing. Our experience has suggested that attention initially needs to be
directed at the point at which energy is transferred to the end consumer.
This means dealing with payment issues. It also means that the distribu
tion end of the business needs to be made financially viable if the rest of
87
Transition Years
the sector is to become so. As part of the work-out plan, careful consid
eration needs to be given to developing and introducing a social safety
net to mitigate the consequences for the poor of a transition to full cost
recovery tariff levels.
During the implementation phase, governments would benefit from pri
vate sector involvement. Unfortunately, the interest of strategic
investors in purchasing and investing in privatized energy utility compa
nies, particularly in the poorer countries of the CIS, has diminished sub
stantially in recent years. There remain, however, opportunities for
private sector participation through concessions and management con
tracts. In addition, there is the possibility of public-private partnership
arrangements. The Pamir power plant project in Tajikistan, which is
supported by the Aga Khan Foundation and is receiving financial assis
tance from the World Bank and the International Finance Corporation,
is an excellent example of how a public-private partnership arrangement
can generate financing for an energy sector project in a very poor
country with a difficult investment climate.
In conclusion, the benefits associated with energy sector reform---espe
cially addressing the financial viability of the energy sector in a coun
try-are substantial and can extend well beyond the sector itself. The
energy sector plays a significant role in the overall economy of the tran
sition economies; without energy sector reform and viability, the transi
tion process is much more difficult and delayed. This is not to suggest
that achieving energy sector viability will, in and of itself, enable a
country to successfully complete the transition process. But it does sug
gest that without addressing this component of the overall reform
agenda, a country will have difficulty completing its economic transi
tion. We at the World Bank Group are fully committed to working with
the countries and partners in the region to complete the reform agenda
in the energy sector.
88
CHAPTER 11
Transition in Central and South East Europe
and the CIS: The Social Dimension
From a speech given at the conference "Modernization of the Russian
Economy: The Social Context," Moscow, April 2-4, 2003
T ransition in the region has not been easy. For six years, beginning
in 1990, output declined dramatically, with measured GOP falling
by a third. The region then stagnated for another three years. Fortu
nately, in 1999 a vigorous economic recovery began for the region as a
whole.
There were, however, significant differences between Central and South
East Europe and the former Soviet Union. In Central and South East
Europe, the transition recession was short and relatively shallow, lasting
only two to three years, with a loss of 10-20 percent of GOP. The
recession was followed by a steady recovery, which raised GOP to about
20 percent above GOP in 1990. In contrast, in the former Soviet Union
the initial decline lasted much longer (seven years) and caused GOP to
fall by as much as 50 percent (more in some countries, such as Georgia,
where GOP declined by two-thirds). Since 1999 the recovery has been
rapid and sustained, with growth rates of 4-5 percent-above those of
Central and South East Europe. However, GOP in 2002 remains about
30 percent below its 1990 level.
These economic developments resulted in dramatic social impacts, espe
cially in the former Soviet Union:
• Inequality increased, with Gini-coefficients rising substantially. In
some countries, such as Armenia, income inequality is among the
highest in the world.
The assistance ofPrddeep Mitra, Chief Economist for the Europe and Central Asia
Region, and the staff of the Chief Economist's Office in drafting this speech is gratefully
acknowledged.
89
Transition Years
• The incidence of poverty increased significantly, to more than
30 percent in the Russian Federation immediately after the 1998
crisis and to more than 70 percent in Tajikistan, the poorest former
Soviet republic.
• Living standards dropped in most countries: in the Russian Federation,
male life expectancy fell to 57 years, five years below that of India.
• Spending on and the quality of social services and safety nets dropped
dramatically, especially in the former Soviet Union. In 1999 mea
sured annual per capita spending on health and education in most
of the poor former Soviet Union countries did not exceed US$20.
The Russian Federation spent less than US$100-much less than
the $350 the EU accession countries spent and far below levels in
Western Europe.
In sum, at the outset, the social impact of the transition recession was
dramatic, especially in the Commonwealth of Independent States (CIS)
(the non-Baltic former Soviet Union republics). Inequality and poverty
increased, living standards fell, and the quality of social services and
safety nets declined. Indeed, we might want to add a fourth transition
dimension-the social transition-to the triple transition (political,
institutional, and economic) these countries had to weather.
In the initial years of the transition, scant attention was paid to the
social implications and costs of the transition process, presumably
because it was assumed that the traditionally low levels of inequality
and poverty and the high levels of social services and safety nets of the
socialist era would readily carryover into the postsocialist period. The
depth of the transition recession in most CIS countries, combined with
the dramatic and generally highly unequal reallocation of assets from
the public to private owners, made this tum out to have been a false
assumption.
The better performance of countries of Central and South East Europe
in terms of social conditions is attributable partly to the less severe and
shorter transition recession. But it was also the case that these coun
tries paid greater attention to their social services and social safety nets
and were generally more successful in redistributing state assets in a
more transparent and egalitarian manner. In contrast, the CIS coun
tries tended to neglect the social aspects of transition in the early
years. In the Russian Federation, for example, only during the second
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Transition in Central and South East Europe and the CIS: The Social Dimension
half of the 1990s was the World Bank able to get a serious dialogue
going with government counterparts on matters of social policy; in
Ukraine such dialogue started only in 1999. Often the change in
policy focus came with a change in political fortune of the govern
ments in power, as the negative social impact translated into protest
votes in national elections.
But it is also fair to ask whether the economics profession more generally
paid enough attention to the social aspects and costs of the transition
process since 1990. Most reviews of the transition experience that I am
aware of focused on the economic and institutional dimensions of the
transition process until, in 2000, the World Bank put the spotlight on
poverty and inequality in the region in a major publication. Even this,
one might argue, came somewhat late, although the analysis in this
report was based on country-specific investigations that had started in
many cases years earlier.
Fortunately, times have changed: there is now a near universal recog
nition in the region of the importance of the social dimension of the
transition process and the need to deal with many of the pressing
social challenges. This follows not only from the recognition that bet
ter social policies are needed for better social outcomes but also
because it is now increasingly recognized that better social conditions
have a direct feedback to better economic performance and greater
political stability.
What are the most important social policies? The standard trio is of
course education, health, and social protection. But I believe we also
need to add two other aspects of social policy: the need for growth-ori
ented poliCies and the need to empower citizens to manage their own
community affairs and express their demand for better governance.
Education
Education is a key element of social policy. For the individual, educa
tional achievement is a key determinant of employment and income
earning opportunities and of whether or not an individual ends up poor
or well-off. For a country, educational achievement and support for life
long learning are essential underpinnings of long-term productivity
growth and of the ability to compete in the modem world of knowledge
economies.
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Transition Years
Key objectives of an appropriate educational policy framework are
improvements in accessibility, quality, and efficiency. Key elements of
such a policy include the following:
• a rationalized school network that reflects changing demographics
• higher teacher salaries and improved training
• modem curricula and teaching methods, which rely less on rote
learning and more on stimulating students' curiosity and developing
their problem-solving capacities
• use of modern information technology and distance learning
• a focus on adult learning as part of a life-long learning framework
something that is especially important given the relatively old popu
lations in the transition economies
• improved administration and financing of education at all levels of
government
Health
Good health is important for the welfare of individuals; sickness and
disability are major causes of poverty. Health is also a key ingredient in eco
nomic performance. Recent estimates for the Russian Federation, for exam
ple, have shown that if the current trends in the HIV/AIDS epidemic go
unchecked, Russia's economic growth potential will decline significantly.
Key elements of an appropriate health policy include the following:
• a sharper focus on prevention rather than merely on curative medi
cine, including promotion of better lifestyles regarding alcohol,
tobacco, and drug use as well as sexual practices
• adoption of modem treatment practices and efficient management of
health facilities
• higher salaries and improved working conditions for public health
workers
• introduction of sustainable health insurance systems
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Transition in Central and South East Europe and the CIS: The Social Dimension
• a policy framework for developing a competitive pharmaceuticals
industry
• improved administration and financing of health at all levels of gov
ernment
Social Protection
As poverty increased, employment in traditional sectors declined; tradi
tional pension systems became financially unsustainable in many transi
tion economies in the wake of the transition recession. With a rapidly
aging population, reform of social safery nets, unemployment insurance,
and pension systems took on a high priority.
Central European governments managed to maintain social protection
systems and were able to begin to reform them gradually, albeit imper
fectly to date. They still face high unemployment, due in part to inflexi
ble labor markets, poor work incentives, and high labor taxes. And
while much progress has been made in some of the Central European
countries with pension reform-indeed some of the most advanced
pension reform initiatives are to be found in Hungary and Poland
much remains to be done to put these systems on a sustainable footing.
Some former Soviet republics, including the Russian Federation and
Kazakhstan, have also come some way in reforming their social protec
tion system. In the Russian Federation, social safety net and pension
reform were initiated as part of a program of structural reforms supported
by World Bank adjustment loans.
Big challenges remain, however, in completing the reforms, that is, in
ensuring financial sustainability, low marginal labor taxes, efficient tar
geting of benefits to the most needed, strong administrative capacities,
and, for the multipillar pension systems, in developing well-functioning
domestic financial markets in which to invest private pension funds.
Growth~Oriented Policies
Much of the increase in poverry created by the transition recession can
be--and has begun to be--reversed with economic recovery and sustained
growth, which increases incomes and employment and creates the fiscal
resources needed to resuscitate social services and safety nets. Hence
93
Transition Years
there is a need to create a favorable investment climate, which is a key
ingredient for growth, and social policy. There is a need to avoid policies
that reduce economic growth-subsidies for unprofitable enterprises,
subsidies for energy and communal services, unsustainable fiscal policies
that engender inflation and indebtedness-which often are introduced
in the name of social justice. In fact, these policies not only endanger
growth, they also undermine precisely the social goals they are intended
to support.
Empowering Citizens
A final key element of social policy is empowering people to participate
in their communities' affairs and to be informed about and provide feed
back on the quality of government policies and programs. This can take
various forms: consultation and participation of NGOs and other civil
society organizations in policy formulation and program design, as well
as in implementation; the direct involvement of communities in proj
ects affecting them; and the use of surveys and explicit feedback mecha
nisms to allow people and enterprises to express their views about the
quality of public services, regulations, and other public sector activities
that affect them. We have found in our project work that when we
involve local people in local decisionmaking, projects show better and
more sustainable economic and social results.
We have learned a lot since the transition started. We now better under
stand the disruptive impact of the political, institutional, and economic
disintegration of the centrally planned economies in Central and South
ern Europe and the CIS during the early years of the transition. We
understand that market-oriented reforms are essential for long-term
recovery but also that they take time and are hard to design and imple
ment, not least because of the tough political choices they impose on
the champions of reform. Finally, we have learned that appropriate
social policies-in the broadest sense of the term-are an essential
ingredient of a successful transition process. Building up the institutions
that effectively respond to the social needs of a country takes time and
may involve difficult tradeoffs in the financial, economic, and political
spheres. In the end, managing the transition-like managing any
process of deep social change-is as difficult as it is essentiaL This is a
lesson that is being learned the hard way today in industrial countries,
especially in Japan and Germany.
94
CHAPTER 12
Progress and Challenges in Meeting
Environmental Goals in Europe and
Central Asia
From a speech given at the Fifth Ministerial Pan-European
Environmemfor Europe Conference, Kyiv, May 21,2003
The World Bank is pleased to be involved in the Environment for
Europe process and to see our collective efforts since the first conference
in 1991 come to fruition. Clearly, much remains to be done on the
regional environmental agenda. But the Bank has also witnessed signifi
cant improvements in environmental quality over the past decade. I will
begin by highlighting a few of the achievements that lay a strong foun
dation for future progress. I will then layout the case for action on
Millennium Development Goal seven, which aims primarily at ensuring
environmental sustainability, including access to safe drinking water and
sanitation, carbon emissions, forests and protected areas, and improving
the situation of slum dwellers.
Celebrating Progress to Date
One of the most important regional accomplishments of the past decade
has been in the area of energy efficiency. For Europe and Central Asia as
a whole, carbon emissions have declined 28 percent and energy effi
ciency has increased 21 percent since 1992. Almost all countries are
showing some improvement in this area. Much of this reduction has
come about simply because of the economic collapse in the region, but
many countries have implemented structural changes and restored GOP
growth without a return to old levels of pollution and contamination. In
fact, incentives have been adopted almost everywhere to improve effi
ciency and reduce emissions of greenhouse gases per unit of GOP. The
reduction in implicit and explicit energy subsidies has been especially
The assistance of Jane Holt, Sector Manager for the Environment in the Europe and
Central Asia Region, in drafting this section is gratefully acknowledged.
95
Transition Years
important, since such subsidies promote excessive use of energy. In
Ukraine, for example, authorities collected only about 20 percent of
receivables for electricity as recently as 1997. Today collection rates are
almost 90 percent for both electricity and gas. Over that same period,
Ukraine experienced a more than 24 percent increase in energy
efficiency.
We have already seen some major improvements in the provision of
clean water for human use and irrigation-high priorities throughout
the region. In Kazakhstan, for example, rehabilitation of the water sup
ply in several small cities and rural settlements has already improved the
health and sanitation of nearly 1.6 million people, or 10 percent of the
country's population. In Uzbekistan additional trunk mains and house
hold connections have been provided to some 2 million rural people
who did not have access to safe and reliable water.
Institutional reforms and more economic pricing have led to more effi
cient use and provision of water, thus reducing associated pollution. In
the Baltic region such reforms, together with the installation of meters
to measure consumption, cut daily per capita water use by more than
100 percent, reducing the amount of water needing treatment and
enabling utilities to meet European Union (EU) hygiene requirements.
The utilities have used the improved cash flows to improve services,
reduce leaks (in some cases cutting losses by half), and install more
energy-efficient pumps.
The Bank has also seen important successes in efforts to tackle trans
boundary water problems, particularly around the regional seas. Overuse
of fertilizers combined with municipal and industrial wastewaters from
17 countries have seriously degraded the Danube River and the Black
Sea ecosystems, disrupted fisheries, reduced biodiversity, posed health
threats to humans, and resulted in billions of dollars of losses to the
economies of six countries. Since 1992 there has been a concerted effort
to identify the major sources of point and nonpoint pollution and to
begin addressing them. This is being done by restoring wetlands to trap
nutrients along the Danube River, reducing nutrient runoff from agri
cultural practices, and improving or introducing municipal wastewater
and sewerage treatment before discharge into the sea. In the broader
context of the Danube Black Sea Program, the Bank welcomes the
opportunity to support development of cooperative water programs for
South East Europe and the Mediterranean that were endorsed at the
Athens conference on sustainable development for a lasting peace held
earlier this month.
96
Progress and Challenges in Meeting Environmental Goals in Europe and Central Asia
A similar multicountry, integrated approach is under way to tackle the
main point and nonpoint sources of pollution threatening the Baltic
Sea. The estimated total nutrient load per year is about 750,000 tons of
nitrogen and 37,000 tons of phosphorus a year, most of it from agricul
ture. Early results from demonstration projects to support better agricul
tural practices promise runoff reductions of about 28 kilograms of nutri
ents per hectare, and efforts are under way to replicate these new
practices on a large scale.
The Balkan countries have joined longstanding programs to clean and
safeguard the Meditetranean, following strict provisions of the "blue
flag" program to certify beaches and coastlines for swimming and tourist
use. In the Caspian Sea, the five littoral states are beginning joint efforts
to tackle potential oil spills, prevent the introduction of invasive
species, and protect sturgeon populations. And recent improvements to
irrigation and drainage systems in Central Asia go some way toward sav
ing at least part of the Aral Sea.
Major efforts are under way to make more sustainable use of the region's
forests. Certification is being promoted as an incentive to apply sounder
managerial methods, and countries in the region are increasingly adopt
ing fees for the felling of trees. From Bosnia and Herzegovina to Bulgaria
to the Russian Federation, efforts are under way to ensure that forests are
better safeguarded from fires and pests, as well as from illegal logging and
unsustainable practices. Where areas are already under commercial use,
regulations are being put in place to require sufficient replanting to
ensure sustainable growth.
The amount of forest area under national protection has also increased
Significantly since 1999. with the latest data showing that 7 percent of
land is in protected areas. Since the early 1990s about 500,000 hectares
have been brought under improved management, and efforts under way
will include an additional 800,000 hectares of forest ecosystems in these
protected areas.
Emissions trading in carbon rights is also beginning to take off. The
countries of Europe and Central Asia have enormous potential to
benefit from participating in this market. Countries in the region can
implement carbon reduction programs at a relatively low cost and sell
carbon rights to other countries that find it less expensive to buy
rights abroad than to undertake carbon-reducing measures at home.
The World Bank has supported these efforts, first with a Prototype
Carbon Fund and more recently with a Community Development
97
Transition Years
Fund. These facilities provide financing for projects that reduce car
bon emissions through carbon sequestration. By reforesting 6,000
hectares of degraded agricultural land, for example, Romania will
sequester almost a million tons of carbon dioxide equivalent over
15 years. In compensation, the government will receive payments
from the Prototype Carbon Fund.
Another area of major accomplishment has been the phasing out of
ozone-depleting substances, primarily in the Russian Federation but
also in Belarus, Ukraine, and several Eastern European countries.
Funds from the Global Environment Facility, the World Bank, and
other donors compensate enterprises in these countries that phase out
the production of chlorofluorocarbons and halons, the most potent
ozone-depleting substance. Seven Russian enterprises have partici
pated in this program.
Last, but certainly not least, has been the adoption of EU environmental
directives by the accession candidate countries, together with a plan for
implementing them. These new entrants should be congratulated for
their political leadership and commitment to the environment. Of
course, the costs of meeting the environmental component of the EU
acquis are high-about US$100 billion over a 20-year period for
Bulgaria, Romania, and the Eastern European candidate countries-but
these countries are committed to this process.
All this progress shows that there is heightened recognition that envi
ronmental considerations are critical to the health and prosperity of
people and a key factor in ensuring sustainable growth and poverty
reduction. In turn, the importance of the environmental agenda has
brought an increasing awareness of the vital role of ministries of envi
ronment in the region and the role they will need to playas the transi
tion proceeds. This is especially important since the vigorous economic
recovery that began for the region as a whole in 1999 is set to continue
in 2003 and beyond, making the region one of the most economically
dynamic in the world. We want to be sure that this recovery does not
lead to a revival of the old environmental threats.
Much of the improved understanding of environmental issues can be
traced back to the Environment for Europe Process and its continued
focus on moving the environmental agenda forward. Notwithstanding
the progress and good news that I have highlighted, I hope this confer
ence will spotlight the most important of the outstanding environmen
tal problems and renew our commitment to help tackle this unfinished
98
Progress and Challenges in Meeting Environmental Goals in Europe and Central Asia
agenda, especially in the countries of South East, Central, and Eastern
Europe and Central Asia.
Meeting the Challenge of the Environmental Millennium
Development Goal
The Millennium Development Goals (MDGs) were developed by the
United Nations and endorsed by the heads of state of virtually all coun
tries. They offer a Widely accepted approach for moving forward on the
unfinished development and transition agenda in a way that integrates
environmental issues into a comprehensive development framework and
focuses on real monitorable outcomes. I am delighted that the govern
ment of Ukraine is using the MDG framework to shape its economic
development plan more broadly.
The MDGs consist of eight goals with the overarching objective of halv
ing the share of people living in poverty by 2015. They were adopted at
the Special UN Millennium Summit of the UN General Assembly in
2000 and reiterated at the Johannesburg Summit in 2002. MDG Seven
requires governments to commit to meet target indicators concerning
levels of safe drinking water and sanitation, carbon emissions, forests
and protected areas, and conditions of slum dwellers.
What do these goals mean for the countries of Europe and Central Asia?
I would like to share with you our preliminary assessment and to draw
attention to subregions and sectors in which we will need to increase our
collective efforts over the medium term if these targets are to be met.
The Bank has also statted to assess the potential costs of the required
effort, to help set priorities and determine financing gaps as we move
forward on this agenda.
The greatest challenge to meeting the environmental targets seems to be
in water supply and sanitation. Although official data show that 91 per
cent of the population have access to improved water supplies, poor
water quality constitutes a major health threat. Among the countries in
the Eastern Europe, Caucasus, and Central Asia region, the Central
Asian countries will need to mount the biggest effort in this area.
Within Central and Southern Europe, the biggest gaps are in Albania
and Romania. The Bank has serious concerns about the sustainability of
many urban water companies, especially in secondary towns, but most
effort needs to be made in rural areas, where access to safe drinking
water and sanitation is significantly lower than elsewhere. Roughly
99
Transition Years
30 percent of rural households in the region do not have access to piped
water, and much of the piped water is of poor quality. In rural Moldova
60 percent of water sampled from water supply systems did not meet
water quality standards. Even in Ukraine 25 percent of nonpiped water
does not meet bacteriological and chemical standards. We therefore
have to be sure to measure the right dimension of water access, that is,
access to safe water.
For basic sanitation, the current level of access is 93 percent and the tar
get value is 95 percent, a relatively small increase. The main problem in
this sector is that sewage systems are in a serious state of disrepair and
need immediate attention if the situation is not to worsen in the coming
years. The situation is most serious in Albania, Romania and the coun
tries of Eastern Europe, the Caucasus, and Central Asia.
Let me tum to the challenge of forests. With 40 percent of its land sur
face covered by forests, Europe and Central Asia has a higher than
average share offorest cover (the world average is 30 percent), and its
forest areas are increasing, according to official statistics. Albania is
the only country in the region with declining forest cover. However,
the quality of these forests, as measured by canopy and old growth
forests, continues to deteriorate. And illegal logging is a problem in
some countries.
In the energy sector, energy efficiency has improved, but the Europe
and Central Asia Region still remains the least energy-efficient
region in the world in terms of GDP per unit of energy use. An
increase in efficiency of 58 percent is needed if the region is to
reach the same energy efficiency level as other countries at similar
levels of development. The removal of subsidies, which remain high,
would help a great deal in this regard, especially in the non-Baltic
former Soviet republics and the Balkans. If the Russian Federation
were to remove energy subsidies, its energy efficiency would increase
significantly and carbon dioxide emissions would fall 17 percent.
Throughout the region, carbon emissions need to be cut in half to
reach the same per capita level as other countries at similar levels of
development.
In addition to these sectoral challenges, meeting the MOOs will require
a sharper focus on implementation and monitoring of results at the
country leveL This, in tum, will require increased joint work to establish
credible data, differentiated by rural and urban areas, to identify gaps
and prioritize actions for meeting the targets.
100
Progress and Challenges in Meeting Environmental Goals in Europe and Central Asia
The mandate to meet goal seven greatly increases the responsibility
of ministries of the environment, whose task it will be to drive and
monitor the agenda in this area. In many cases, doing so will require
strengthening the capacity of ministries and developing horizontal
links with other ministries responsible for water, sanitation, energy,
forestry, and biodiversity. Of course, many of the investments most
directly affecting the environment will be made by line ministries or
municipalities. This means that ministries of the environment need
to forge partnerships with these other entities. In this regard, I am
delighted to announce that the Bank and its capacity building arm, the
World Bank Institute, have teamed up to mobilize US$1 million for
capacity building of environment ministries in the Russian Federation,
Ukraine, and the five countries of Central Asia over the next three
years for this purpose.
We all need to work together to continue the important efforts that
have already begun in these areas, to identify those interventions that
have worked well, and to make a special effort to scale up or replicate
those that have achieved significant progress. Meeting the challenges I
have mapped out requires a substantially increased effort by the interna
tional community and by the countries themselves.
The World Bank's Europe and Central Asia Region has projects under
implementation totaling US$1.9 billion and projects under preparation
totaling US$1.5 billion (including funding from the Global Environ
ment Facility [GEF]) dedicated to improving the environment. We will
also continue our many efforts of analysis and technical assistance
designed to help improve our knowledge and understanding of the envi
ronmental problems and solutions in the region and to build improved
national capacities to deal with them, in close cooperation with our
partners. On behalf of the World Bank, I want to pledge our continued
support for the Environment for Europe process and our strong wish to
work with you in the years to come.
That said, clearly each country has primary responsibility for its own
development and for folding the MDG targets into national policies and
development strategies. I hope all countries in the Eastern Europe, Cau
casus, and Central Asia region will follow Ukraine's lead in using the
MDG framework as a means of setting specific targets for carrying out the
environmental strategy they have collectively brought to this conference.
I believe we owe a debt of gratitude to the United Nations Development
Programme for defining the MDG goals and targets and for its efforts to
101
Transition Years
assist in their monitoring. Environmental sustainability is closely linked
with all of the MDGs, particularly those aimed at reducing child mortal
ity and combating disease. Environmental action may be among the
most cost-effective ways of achieving many of these other goals and
protecting the richly diverse ecosystems of the region, from the taiga to
the Carpathians.
102
PART 4
Beyond Europe and Central Asia
T he fourth group of chapters includes two speeches that reflect a
broader context beyond the Europe and Central Asia region.
Chapter 13 summarizes the implications of the new global approach to
development agreed on at the Monterrey and Johannesburg Summits for
the small, poor countries of the Commonwealth of Independent States.
At these summits, developing and industrial countries agreed to a com
pact under which the developing countries committed to undertake the
necessary reforms needed to generate sustained development in their
countries while the industrial countries committed to make available
the incremental financial assistance needed to finance reforms, invest
ment, and debt relief in the developing world. Chapter 14 takes an even
broader perspective, by sketching a number of key ideas on how to
address the long-term sustainable development challenges the world
faces. This was a very brief speech I delivered at a workshop of German
development experts as a member of a panel of three, whose other mem
bers were billed, respectively, as the richest man in Germany and as an
aggressive spokeswoman of the antiglobalist coalition "Attac."
The volume closes with a postscript in chapter 15, based on a speech I
gave in late September 2003, shortly after my retirement from the World
Bank (the piece was updated in February 2004). As a summary of the
state of the region and its outlook for the future, this chapter rounds out
and brings up to date my thinking on how far this region has come and
what are the key risks, opportunities, and tasks for the future. With all
the risks and challenges that remain-and there are many, even and
perhaps especially for the newly minted EU member countries--l am
struck by how far the region has come in 15 years; how fundamental and
irreversible the changes have been; and how integrated, open, and
increasingly successful the newly unified Eurasia region has become,
having overcome 80 years of division into hostile and systemically
opposed camps, separated by seemingly insurmountable barriers both on
the ground and in peoples' minds. It is my fervent hope that future gen
erations in the region will be able to live peacefully and prosperously
together on their interlocking continents now that the walls and cur
tains and systemic divides have largely disappeared.
103
CHAPTER 13
A New Global Approach to Development
From a speech given at the Consultative Group Meeting on the
Kyrgyz Republic, Bishkek, Kyrgyz Republic, October 9,2002
T his meeting comes at a pivotal time. The international commu
nity, like the Kyrgyz Republic, has internalized the principles of
the Comprehensive Development Framework-country ownership,
inclusion, donor partnership, and a focus on results-and is looking
for ways to implement this new approach to development, as agreed at
the Monterrey and Johannesburg Summits. This meeting also comes
as we see the completion of the first round of Poverty Reduction
Strategy Papers in Central Asian countries and as we increasingly rec
ognize regional issues through forums such as the CIS-7 initiative. It
also comes at a time when the international community is giving
Central Asia increased attention, including in connection with the
forthcoming Global Mountain Summit. If we can use this opportunity
to weave all of these trends together, we will indeed have a very
successful meeting. Let me try to capture for you some of the key ideas
and initiatives that are emerging in the international development
dialogue.
The Monterrey and Johannesburg Summits
The Financing for Development Conference held in March 2002 in
Monterrey, Mexico, marked an important turning point in meeting our
aspirations on development, as embodied in the UN Millennium Devel
opment Goals. At Monterrey the international community reached con
sensus on an architecture of mutual responsibility for achieving the UN
Millennium Development Goals, based on two pillars:
The assistance of Lilia Burunciuc, Central Asia Country Program Coordinator for Europe
and Central Asia, in drafting this speech is gratefully acknowledged.
105
Transition Years
that will help track progress, assess the poverty reduction impact of poli
cies contained in PRSPs, and signal the need for corrective action. This
is a difficult area-an area in which the Kyrgyz National Strategy for
Poverty Reduction will need continued strengthening.
As the focus shifts from preparing PRSPs to implementing the strategies
they set out, a number of additional challenges are emerging. A key
challenge for countries like the Kyrgyz Republic is to continue to extend
the participatory process for the elaboration and monitoring of PRSPs.
For the longer term, the most important and most difficult challenge is
to implement and monitor the progress of pro-poor growth policies and
programs outlined in the PRSPs.
For the multilateral and bilateral development agencies, the challenge
lies in better prioritizing and coordinating programs in line with country
strategies while helping countries implement agreed upon country
strategies and over time helping further improve the strategies in a
process of continuous and joint learning.
The CIS-7 Initiative
Since the dissolution of the Soviet Union, the Bank has become increas
ingly aware of the very severe economic and social disruptions experi
enced--especially by the smaller and low-income republics, including the
Kyrgyz Republic-as a result of the disruption in trade, financial, water,
energy, and institutional links that had been so important in the Soviet
Union before 1992. As a result of these disruptions, but also because of a
history of conflict and uneven progress with policy reforms and institu
tion building, the low-income countries in the Commonwealth of Inde
pendent States (CIS) now face an urgent need to accelerate poverty
reduction and economic growth while ensuring fiscal and external debt
sustainability. They also face the challenge of regional cooperation and
reintegration in key areas such as trade, energy, water, and human devel
opment. The World Bank has partnered with the Asian Development
Bank, the European Bank for Reconstruction and Development, the
International Monetary Fund, bilateral donors, and the concerned gov
ernments to launch a collaborative international effort to enhance
poverry reduction in seven CIS countries: Armenia, Azerbaijan, Georgia,
the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan.
The CIS-7 initiative places strong emphasis on renewed reform and
regional cooperation efforts by countries. The Kyrgyz Republic has been
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A New Global Approach to Development
in the forefront of putting such efforts into action. It has made a tremen
dous effort to develop a full-fledged national strategy for poverty reduc
tion and has generally demonstrated a persistent commitment to reform
implementation. It has also consistently supported initiatives for
regional cooperation.
For the donor community, the CIS-7 initiative is also an avenue for
mobilizing support that rewards good performance. The Kyrgyz Republic
has already benefited from the Paris Club debt flow restructuring, which
gave the country some breathing space for the next three years. The
Paris Club have expressed a willingness to consider further debt relief
actions, including a possible debt stock reduction at that time. They will
revisit the issue in 2004.
This Consultative Group Meeting is a unique opportunity for the Kyrgyz
government and the donor community to jointly take hold of the coun
try's national strategy for poverty reduction agenda and to commit to
each other, in the spirit of the CIS-7 initiative, to move forward in fur
ther developing clear priorities, implementing the agreed upon agenda,
and mobilizing the much needed financial support for the Kyrgyz
Republic.
Today's Consultative Group Meeting is one of the concrete steps meant
to make the Monterrey and Johannesburg agreements and the CIS-7 ini
tiative a reality. It is an excellent opportunity for the government and
the donor community to commit to implementing the new global devel
opment agenda in the Kyrgyz Republic in key priority areas of its ambi
tious National Strategy for Poverty Reduction. I would like to appeal to
this distinguished group of donors to lend their hand of support as the
Kyrgyz Republic moves forward with implementing a difficult and coura
geous reform agenda for sustainable recovery and poverty reduction.
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Transition Years
invested nearly US$2 billion in global environmental protection
initiatives.
Since the end of the Cold War development assistance has declined, but
assistance is more effective today than it used to be, because it is less
often misused for political reasons.
Thesis No.3 (Fact): The next 50 years will be decisive for the
future of mankind and marked by great opportunities and great
risks
In the coming 50 years the course will be set for the long-term survival
of humanity. By the year 2050 the world's population will probably
increase by two to three billion before stabilizing. Given 3 percent
annual growth, global GNP will quadruple by 2050. The demand for
food will double unless consumers fundamentally change their consump
tion behavior in relation to GDP growth. Energy demand will increase
sharply. Some 150,000 new power plants worldwide will each generate
1,000 megawatts of power by 2050. Environmental pollution will worsen
dramatically, with carbon dioxide emissions rising from 6.8 gigatonnes to
25-26 gigatonnes. Migration pressures, the risks of war, and terrorist
actions will increase.
Against this backdrop, mankind has the opportunity to radically restruc
ture production, consumption, and income and property distribution,
setting in motion a development process that will lead to less poverty,
more stability, and preservation of the environment. If no such restruc
turing takes place, the risk that poverty will grow, political instability
increase, and environmental harm become irreversible will become
extraordinarily great.
On the basis of these three theses I would like to put forward seven
propositions for future discussion.
Thesis No.4 (Proposition): We must find and implement compre~
hensive, overlapping, and integrating approaches and solutions
The industrial countries must make it an urgent priority to speed the
pace of their structural reforms and develop better technologies, espe
cially in energy and transportation. In the developing countries we must
concentrate primarily on achieving the Millennium Development Goals
(MDGs) by the year 2015. We must accept the concept and the now
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Ensuring Peace, Alleviating Poverty, and Protecting the Environment
generally recognized practice of the Comprehensive Development
Framework (CDF) as a framework for better cooperation between host
and donor countries. In this connection, host countries' will to act and
the broad-based participation of the general public and civil society in
these countries are essential. Protection of the environment is also an
integral component of the CDR
Thesis No.5 (Proposition): Energy generation and use must become
more efficient and environmentally friendly
We need pragmatic and politically acceptable approaches to energy,
including investments in environmentally friendly generation and
transmission methods; more intensive research on new technologies in
energy generation and use; and elimination of energy subsidies-which
in the developing countries alone could result in savings ofUS$100
billion dollars-together with targeted financial assistance for the poorest
users. Similar policies are needed in water supply and agriculture.
Thesis No.6 (Proposition): We must involve the private sector by
emphasizing the "triple bottom line"
Private enterprises are increasingly realizing the enduring benefits of the
financial, social, and environmental aspects of their work. Greater trans
parency is also needed.
Thesis No.7 (Proposition): The participation of the population at
large, of civil society, and of communities in the decision processes
affecting them is decisive
When people feel they have a say in decisions affecting them they
assume more responsibility for the consequences of their actions.
Implementation and outcomes, especially in the environmental
sphere, improve.
Thesis No.8 (Proposition): We must pay more attention to the
role of women, not just in education and health policy but also in
legal and financial reforms, environmental and agricultural policy,
and other areas
We have been talking for years about the special role of women in
child-raising and health. Women also need legal safeguards and access
113
Transition Years
to financial resources, including microcredit. They must be more
specifically considered in the context of environmental and agricul
tural policy.
All of these propositions and their implementation form the basis for
the next thesis:
Thesis No.9 (Proposition): We must double development assis
tance, especially by funding debt relief for the poorest countries
and providing assistance for global protection of the environment
In practice, this means more money for bilateral government
programs, more support from public and private sources for NGOs and
other organizations of civil society, and building up of the multilateral
funds, including the International Development Association, the
GEF, Heavily Indebted Poor Countries initiative, the HIV/AIDS
Fund, and UN agencies.
Assistance should be increased in a way that reflects the new Monter
rey Consensus. In this connection, host countries have undertaken to
do more in the economic, social, and environmental policy spheres,
while donor countries intend to open their markets wider and provide
more development aid.
Thesis No. 10 (Proposition): We cannot overlook the dangers cur
rently threatening us-such as the conflicts in the Middle East and
Kashmir-and their possibly catastrophic outcomes for peace,
poverty, and the environment
Are we doing enough in the various high-level international bodies to
bring about peaceful solutions to these conflict situations?
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CHAPTER 15
Postscript: The Economic Outlook for Eurasia:
From Transition to Sustained Growth and
Integration?
Based on a speech given at the Second Annual Eurasia Summit on
Economic Development, Energy, and Regional Security, organized
by the Business Council for the United Nations, Eurasia Group
and the United Nations Development Progmmme, New York,
September 24,2003. Updated in]une, 2004.
F ifteen years have passed since the start of the transition from
Communism to democracy and market economics in the countries
of the former Soviet empire. Looking back, it seems like a short time
span that has brought many and major changes to the region. One pro
found change was that, as the Soviet Union and its political and
economic empire disintegrated, the divide that had stretched across
Europe and through Turkey into southwestern Asia also disappeared.
This permitted an old, long-forgotten geographic concept-Eurasia-to
gain new currency and meaning, with profound economic and political
significance. The peaceful and prosperous integration of the countries
and economies of Eurasia is now a real hope after many decades of
forced separation that had followed many centuries of uneven economic
and social development punctured by wars spilling across countries and
continents.
What is the economic outlook for Eurasia, particularly the fonner Soviet
Union, Turkey, and Central and South Eastern Europe? These countries
represent the part of Eurasia left behind in the spurt to prosperity and
democracy that benefited Western Europe, North America, and Japan
during much of the twentieth century. The isolation and misdirected
economic management under Communism-and in the case of Turkey the
legacy of the failed Ottoman Empire and the incomplete modernization
and transition of the country under Ataturk and his successors--caused
these countries to fall behind their Western neighbors. The question is
whether these countries have finnly embarked on a path toward sustained
economic growth after the painful transition following the collapse of the
Soviet Empire and the reintegration of economic space in Eurasia.
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Transition Years
The short answer is that after nearly a decade of economic collapse and
social stress, there are now good prospects for this region and its popula
tion of about 500 million people. Recently, it has been one of the most
dynamic regions in the world in terms of economic growth, with annual
per capita income growing at an average rate of about 4-5 percent over
the past four years, even as recession gripped much of the rest of the
world. Prospects for continued economic growth in the region also
remain strong. At the same time, with a few exceptions, there is now
peace in the region. And democracy, while still a work in progress in
many countries, may have a greater chance than ever before of succeed
ing in the long term. One of the main drivers of this positive develop
ment has been the great pull exerted by the European Union (EU), with
prospects of joining now much enhanced for those Eurasian countries
closest to it. And even for those that cannot or do not aspire to member
ship in the EU, the example ofEU institutional and political develop
ment and many of the European, transatlantic, and global institutions
(the Organization for Security and Co-operation in Europe, the Council
of Europe, NATO, the World Trade Organization [WTO], the Bretton
Woods institutions) exert a strong pull towards economic and institu
tional modernization, integration, and peaceful democratic development.
Of course, the countries in Eurasia face many challenges and risks in
bringing about a prosperous, peaceful future. Since the region is highly
heterogeneous~and opportunities and challenges hence vary signifi
cantly across countries-it is best to look briefly at individual countries
and subregions to get a better sense of the outlook piece by piece and
then assemble the pieces of the puzzle into one big picture.
The Russian Federation
Russia's economic recovery since the financial crisis in 1998 has been
buoyed by persistently high oil prices, but also by the cumulative impact
of 15 years of economic reform and recent political stability. Since 1998
the Russian economy has grown by about 30 percent; in 2003 GDP grew
7.3 percent. High oil prices, the effects of a drastic devaluation in 1998,
and the ability to employ underutilized capacity explain much of this
dramatic recovery. But business surveys (such as the so-called BEEPS
surveys conducted by the European Bank for Reconstruction and
Development and the World Bank) also show a notable improvement in
the perception of the investment climate in Russia since 1999, which
helps explain the flow of capital and a recent revival of investment
(albeit still heavily concentrated in the natural resource industries).
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Postscript: The Economic Outlook for Eurasia
With personal income growth outstripping sustained high economic
growth, per capita consumption is now estimated to exceed its 1990
level by 20 percent, and a new middle class is rapidly emerging.
Continued economic and institutional reforms are needed if Russia is to
maintain its strong economic performance of recent years. Further
improvements in the business climate through civil service reform and
improved governance at the federal, provincial, and local levels are essen
tial, as are reform of the banking sector, rehabilitation of infrastructure
{including information technology infrastructure}, and modernization of
education and health services. Early accession to the WTO is another
important factor and with recently announced agreements between Russia
and the EU, the prospects for Russia's early WTO membership have much
improved. President Put in has made it clear that he aims to maintain
strong economic growth, and he is expected to revive economic reforms by
mid-2004, having successfully completed the parliamentary and presiden
tial election cycle. Perhaps the greatest challenge for Russia in the longer
term is establishment of firmly democratic institutions, of secure property
rights, of effective legal and judicial bodies, and of an efficient, honest, and
impartial civil service at the national and subnationallevels. Without such
changes, economic growth-while sustainable in the near term, especially
with continued high oil prices--willlikely falter in the longer term.
Given Russia's size and centrality, a buoyant, stable, and democratic
Russia will be essential for the economic and political integration of
Eurasia. Recent efforts to create a common economic area covering
Belarus, Kazakhstan, the Russian Federation, and Ukraine can be seen as
an initiative to promote regional cooperation and integration. Past
efforts of this kind (including the Commonwealth of Independent States
[CIS]) have not been successful in creating a common economic space.
Much will depend on whether Russia can convince its neighbors that its
intentions are non-hegemonic and that it is not aiming to set up a
regional trading block that will prevent its members from seeking closer
cooperation with the EU and integration with the world economy.
Ukraine
In many ways Ukraine's good economic performance over the past four
years has presented the greatest surprise to those following developments
in the region. Despite low ratings on most comparative indicators of
good governance and the lack of significant energy resources, Ukraine's
economy has enjoyed sustained economic growth of at least 5 percent a
117
Transition Years
year-a surprising turnaround. Among the reasons for this unexpectedly
good performance are strong economic growth in the Russian Federa
tion, the cumulative impact of domestic economic reforms, increasing
political stability and predictability in economic management (even as
the domestic political situation remains murky for the outsider), and
Ukraine's increasingly solid orientation toward the EU. One underap
preciated fact about Ukraine is that Kiev has become one of the most
attractive cities in Europe.
The economic prospects for Ukraine are good if continued reforms-
including WTO accession, improvements in governance, and continued
orientation toward the EU-are combined with political stability in the
run-up to and following the 2004 presidential elections. Like Russia,
however, Ukraine faces downside risks for the longer term. Continuing
internal divisions between the east and west of the country, tensions
between democratic and nondemocratic forces, and the pervasive cor
ruption that still hampers the business climate and life of the average
citizen are all factors that can derail Ukraine's progress with political and
economic reforms. The outcome of the next presidential election-and
the manner in which it will be conducted-will be the weather vane
that will tell whether democratic and economic progress will continue
or whether serious detours and setbacks must be considered likely.
Other CIS Countries
Many of the smaller CIS countries were especially hard hit by the disin
tegration of the Soviet Union and the collapse of the Russian economy
in the wake of the financial crisis of 1998. But most have also shared in
the economic recovery of the Eurasia region over the past four years,
partly because of Russia's revival, but also because of domestic economic
reforms and their gradual integration with the world economy. Future
prospects for these countries are mixed, however.
Among the positive surprises are Armenia, Azerbaijan, Kazakhstan, and
Tajikistan, where economic reforms and political stabiliry have com
bined with improved regional economic conditions to produce signifi
cant economic turnaround and reasonable prospects. Among the more
disappointing performers are Georgia, Moldova, Uzbekistan, and, of
course, the outliers and nonreformers, Belarus and Turkmenistan.
Several cross-cutting mctors will determine the medium-term outlook
for these countries:
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Postscript: The Economic Outlook far Eurasia
• Settlement of regional conflicts; Central Asia's prospects would be much
enhanced by peace in Afghanistan and Iraq, nonnalization of inter
national relations with Iran, and improved cooperation among the
Central Asian countries themselves. Settlement of the Armenia
Azerbaijan conflict over Ngorno-Karabakh and of the division of
Georgia with its breakaway region. Abkhazia. would help regional
development in the South Caucasus. Settlement of the Transdnistria
conflict would help Moldova's development and regional integration
with Ukraine. International political support for the settlement of
these conflicts will be essential.
• Economic and governance reforms; Continued improvements in eco
nomic management and especially improvements in governance
(including transparency in the management of natural resources) are
critical. The recent peaceful political change in Georgia holds out
some hope that the country's internal divisions and corrupt manage
ment can now be turned around, but the economic and political
challenges facing the new president and his government are severe.
The oil and gas wealth of Azerbaijan and Kazakhstan and the recent
introduction of oil funds in Azerbaijan and Kazakhstan bode well for
continued sound economic management and prospects in both coun
tries, but the long-term outlook for democracy and good governance
and hence for political and economic stability remain uncertain. For
Central Asia, economic reforms in Uzbekistan are essential, given the
country's size. its central location. and the fact that its current restric
tive economic policies severely inhibit regional trade and cooperation.
• Regional integration and access to world markets; Most of the smaller
CIS countries are still isolated from world markets by a combination
of landlocked and remote location. poor domestic policies. lack of
transport infrastructure and regional cooperation, and lack of access
to industrial country markets, especially the ED. EU trade policies,
especially policies regarding agricultural trade, remain unfavorable
toward these countries. The future of these small countries will to a
large extent depend on peaceful and effective integration of their
economies with each other and with the rest of the world.
Turkey
During the past 18 months Turkey has been able to overcome many of
the symptoms of the economic and financial crisis that have plagued the
country in recent years. Economic growth has revived, inflation and real
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Transition Years
interest rates have dramatically declined, improved relations with Syria,
and enhanced domestic political stability since the national elections in
late 2002 have improved the outlook for continued financial stabiliza
tion and economic growth. Turkey still faces major challenges, however,
that, if not addressed, could yet derail the recovery and improved
prospects.
• Iraq: As long as the security and economic situation in Iraq remains
unsettled, Turkey will not be able to normalize its trade with this
important neighbor. The perception and reality of regional security
risks will remain, as will risks of continued confrontations over the
issue of the Kurdish minority and of possible frictions with the
United States and the EU
• Economic and financial risks: Turkey has a long history of stop-and-go
reforms and of recurrent economic and financial crises. Only persis
tent fiscal, structural, social, and governance reforms will address the
underlying causes of instability. The program of the current govern
ment is generally pointing in the right direction, and with its clear
majority in parliament it has the political clout to implement reforms
quickly and effectively. But progress with key structural and social
reforms has been uneven, possibly because of diverging interests
within the governing party and because of the lack of strong cohesive
leadership in the economic sphere.
• EU accession: Turkey's prospects for eventual EU accession have been
greatly enhanced by the decisions made at the EU Summit in Copen
hagen in 2002 and by the government's fast pace of domestic political
reforms. However, the recent failure of the UN, EU, Turkey, and the
Cypriots to reach a settlement in Cyprus, an unfinished economic
and political reform agenda in Turkey, and continuing deep divisions
within the EU about Turkish accession all imply that prospects for a
positive decision about the start of membership negotiations in late
2004 remain uncertain for now.
• Foreign direct investment: Turkey has a surprisingly poor track record
in attracting foreign direct investment, considering its favorable
location relative to European markets and its well-developed private
sector. Failure to attract foreign investment has many causes, includ
ing investors' perceptions of regional security risks, of poor gover
nance and high corruption, and of an inhospitable local business
community. The current government has vowed to change the reality
underlying these perceptions and to open up the country to foreign
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Postscript: The Economic Outlook far Eurasia
investors. Progress in this area will be a major indicator of progress
toward economic reforms and EU integration.
The Balkans
Compared with 3-4 years ago-and particularly compared with 8-10
years ago-the political and economic outlook in the Balkans has
greatly improved. The political changes and ensuing economic reforms
in Croatia and Serbia in 2001 in particular have led to a quantum leap
in the prospects of the region, reinforced by the salutary effects of the
South East Europe Stability Pact. The EU's decision to offer the Balkan
countries the long-term prospect of EU membership provides an essen
tial umbrella of political stability and an incentive for economic and
governance reforms that will, as elsewhere in Central Europe in the past
decade, help propel governments in the right direction of regional coop
eration and improvement of the business climate.
There are, however, still substantial risks in the short to medium term.
The unsettled territorial and political status of Kosovo with continuing
serious internal divisions, the domestic political uncertainties in Serbia
(and the as yet uncertain prospects of the union of Serbia and Montene
gro), and the legacy of the Bosnia conflict and of the Dayton Agree
ment, which have burdened Bosnia and Herzegovina with a huge liabil
ity of untesolved governance problems, are key issues yet to be addressed
by each country and by the international community. Additional chal
lenges arise out of the unfinished economic and governance reform
agenda in the region and the continuing difficulties of the region to
access EU markets, especially for agricultural products. As long as these
risks and challenges hang over the region, regional economic prospects,
security, and integration with European markets will remain uncertain.
The sooner these issues are addressed, the better.
The EU Accession Countries of Central Europe
Although by now taken largely for granted, it is an extraordinary his
torical development that eight Central European countries, including
three former republics of the Soviet Union, joined the European
Union in May 2004. Bulgaria and Romania will probably join the EU
in 2007, and Croatia may be admitted that year as well-all this
within less than 20 years of the fall of the Iron Curtain. One can only
be amazed by the extraordinary progress and success of the transition
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Transition Years
from command to market economy and from dictatorship to democracy
in Central Europe.
Even before the EU enlargement, foreign investors grasped the opportu
nities that this transition offered them, with levels of foreign direct
investment in recent years in this region exceeding those in most other
emerging markets. Investors have taken advantage of the rapid improve
ments in these countries' business climates and financial institutions, of
their highly educated but still relatively cheap labor forces, and of the
ease of access to Western markets, with the prospects of early integration
into the unified EU markets.
Looking forward, however, Central European countries face great chal
lenges, each of which also represents an opportunity. If the Central
European countries, their governments, and their people can respond
effectively to these challenges and opportunities over the next 10 years
or so, they will be able to replicate the extraordinary successes of Finland
and Ireland -relatively recent EU members that were able to convert
their rather backward economies into highly dynamic and successful
modem knowledge economies. If they fail to respond, they will stagnate,
at least in relative terms, and fall behind, as Greece and Eastern Ger
many did in the recent past.
The challenges-and opportunities-include the following:
• EU constitutional reform: The new member countries have an oppor
tunity to influence the expected new constitution of the EU and to
ensure that the decision making processes and institutions of the
enlarged EU function effectively and credibly. The disappointing out
come of the Brussels Summit in December 2003 attests to the diffi
culties that the enlarged EU will face forging consensus and making
decisions.
• EU economic performance: The new member countries will be much
affected by the overall economic performance of the EU. To a sig
nificant extent this will be determined by the ability of the larger
members of the EU, especially Germany, to carry out much-needed
structural reforms and to maintain a prudent fiscal and monetary pol
icy mix that limits undue indebtedness and keeps interest rates low.
• Continued economic transformation in the new member countries: Many
of the new member countries, especially the larger ones, are burdened
by old industries and relatively large rural sectors, high unemployment
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Postscript: The Economic Outlook far Eurasia
and inflexible labor markets, high and rising social spending require
ments for an aging population, significant infrastructure investment
requirements, and large environmental liabilities. Making the struc
tural, social, and environmental reforms and investments while main
taining a prudent fiscal stance will be difficult and politically chal
lenging. The influx of large financial transfers from the rest of the EU
to the new and poorer members will help in financing the needed
investments, but the institutional capacity needed to absorb these
funds effectively will need to be created. Managing the fiscal stresses
that especially the larger accession countries (Hungary and Poland)
are under, with record budget deficits and rising debts, will be a major
challenge.
• EU external economic policies: The new member countries have an
important opportunity to influence the approach of the EU toward
"Wider Europe"-as the neighbors to the east and south of the
enlarged EU are now increasingly referred to--and toward important
global economic issues, such as WTO negotiations (and especially
the EO's agricultural policy), the international debate on the global
financial architecture, and international support for the economic
and social transformation of the developing world with a view to
reducing global poverty and disparities.
Concluding Observations
Looking back over the past 10-15 years of political, economic, and
social transformation in Eurasia, one can only marvel at the overall
progress and success that are now becoming apparent after the painful
and difficult political disintegration and transition recession that gripped
the entire region during the early years-and for some during much of
the 1990s. The countries themselves and the international community
can take pride in the achievements of the transition process in Eurasia.
The prospects for continued progress of peaceful integration and contin
ued economic growth are good for now, especially as the largest coun
tries of the region-the Russian Federation, Turkey, and Ukraine-are
set to continue their recent recoveries and as the Central Europeans are
set to join the EO.
Of course, progress and prospects are not uniform across the region. At a
time when the world focuses on Afghanistan, Iran, and Iraq, it is impor
tant to remember that the belt of countries from the Balkans through
the South Caucasus and Central Asia still represents major challenges,
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Transition Years
as a number of temporarily "frozen" regional conflicts and several weak
and troubled states could very quickly tum into major sources of
regional and global instability.
Many challenges remain for the countries of the region and for the
international community. Among these challenges three stand out:
• Each country needs to ensure the appropriate fundamentals of eco
nomic policy and democratic governance and to foster regional eco
nomic cooperation in order to create a favorable business environ
ment for foreign and domestic investors alike.
• The process of integration of the Eurasian economy needs to con
tinue. Doing so requires efforts on the part of the enlarged EU not to
let a new divide grow on its eastern border. It also requires coopera
tion among all countries with their neighbors. Above all it requires
the existence of a peaceful, prosperous, stable, and democratic Russia
that acts as a good neighbor across the two continents.
• The international community needs to provide continued support,
especially to the smaller and economically weaker countries; to help
ensure an early settlement of still potent regional conflicts; and to
support the economic and social recovery of these countries, many of
which-especially in the Balkans. the South Caucasus. and Central
Asia-are still among the poorest in the world.
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