Promises and challenges. Internationalisation of the transition economies

Economic openness, overwhelmingly to the West, has been translated into an economic success by those countries which were able to internationalise their economic and political institutions and integrate with institutions of the West. Such openness has in turn influenced politics and societies as to make any economic reversal very costly. There is still a long path of development ahead, however, which may be undermined by the greater difficulty in establishing competitive political systems across the entire region.

Dimensions of transformation

Some 30 years ago the former centrally-planned economies of the Soviet bloc embarked on a road to openness, often from a very high degree of political and economic autarky. Economic internationalisation was an essential component of the post-communist transition and was seen as such from the very beginning, even if countries varied somewhat in the speed with which they progressed. The transition badly needed access to foreign technology and know-how as technological backwardness was widely recognised as one of the weakest points of the old system. They also desperately needed access to capital. In most countries, the domestic market size was relatively small. Without international trade they could not benefit from the gains that narrower specialisation and larger-scale production could generate. Moreover, while pre-transition trade was limited, the breakdown of the old system in many places served to disrupt important production chains that had to be reconnected or replaced. This was particularly true in the former Soviet Union and ex-Yugoslavia, where a great deal of domestic trade became foreign trade almost overnight.

International integration reinforced other reforms – or at least raised the political costs of backsliding on them. Foreign direct investment, for example, created new constituencies concerned with clear, secure property rights and efficient institutions, while foreign trade quickly created new production links and flows that would be costly to disrupt. Entry into international institutions, like the World Trade Organisation and the European Union, likewise served to entrench various strands of domestic institutional and policy reforms. However, such openness came at a price, as many of the new market economies experienced balance-of-payments crises, persistent challenges with respect to questions like exchange-rate policy and exposure to western financial volatility. Progress differed across countries and this has necessarily led to disparate outcomes in terms of depth of integration, economic openness and political institution building. Often the facets of internationalisation had identifiable institutional and political preconditions, thus how fast and how far any of the countries transitioned was not a result of a simple choice by their policymakers.

In most Eastern European states, the liberalisation of trade in goods and some (non-financial) services tended to proceed fastest, often with radical distributional – and, in some cases, political economy – consequences. The initial phase of often a partial opening (subject to a number of exceptions, such as export quotas, restrictions, and taxes) often helped insiders to amass fortunes and capture political and economic space, however in the longer term the countries that were more successful in adopting export-driven growth models achieved better GDP growth. The economies of Central Europe, particularly the Czech Republic, Slovakia and Poland, benefitted enormously from becoming part of western (chiefly German) supply chains. The export performance of the countries of the Commonwealth of Independent States (CIS), which succeeded the Soviet Union, on the other hand, was driven more by energy and primary commodities exports as well as trade between themselves rather than a genuine integration into the supply chains of the developed western economies.

Success and failure

Despite the difficulties of macroeconomic stabilisation in the 1990s and the economic specifics of the liberalisation process, the transition countries of Central and Eastern Europe never really considered slowing down or reversing the process of financial integration with the West. Together with trade integration, it has been one of the great successes of the post-communist period. It happened, hand-in-hand, with institutional integration as investors gained confidence in the credibility of newly established financial markets. In the post-2008 crisis era, with more volatile capital flows and more pervasive bank regulation, countries that lack such an institutional “seal of approval” (e.g. non-EU countries) may find it harder to attract foreign investment.

The large-scale post-1989 movement of people, while controversial politically in the West and contributing to the poor demographic trends of the East, has been central to the economic modernisation of post-communist societies through flows of remittances, knowledge and experience gained and transmitted by migrant workers, and the networks created. To further this process, accession to international economic institutions like the IMF, World Bank, WTO and the OECD – and especially an economic and political union like the EU – was often a period of intense growth-inducing policy reform. Even membership to NATO, a political and military-security organisation, played a role in the transition, insofar as the requirements for new members included the settlement of territorial disputes with neighbours, stable democratic institutions and democratic control over its armed forces. Institutional integration with the West, comprehensive in its directionality has been a true success of the post-1989 transition.

While the direction has overwhelmingly been towards open market economies, the integration paths have varied. The commodity-rich countries of the former Soviet Union had perhaps the least difficulty in identifying their immediate export opportunities – the USSR had already been well established as an exporter of hydrocarbons, in particular, but also metals. Even as oil and metals production in these countries fell sharply for a time in the early 1990s, exports held up relatively well since domestic consumption fell even faster. Broadly speaking, exports of primary products were critical for Russia (hydrocarbons and metals), Kazakhstan, Azerbaijan and Turkmenistan (hydrocarbons), Ukraine (metals) and Belarus (petroleum products refined from Russian crude). This development path has generated substantial wealth for some groups within these societies but has not allowed for the creation of complex and redistributive domestic economies.  

The Central European economies, benefiting from proximity to Germany and Austria, moved quickly to reorient their economies towards Western Europe, attracting considerable foreign direct investment and gradually integrating into larger value chains as suppliers of relatively complex goods. This was especially the case for the Czech Republic, Slovakia, Hungary and Poland. Physical proximity to the heart of the European Union’s single market brought other benefits, as it ensured that these countries were a relatively high priority for western governments seeking to support the transition. These have become the key economic success stories of transition.

Choices

In other countries within easy reach of Western Europe, trade focused initially on less complex products. The Balkan countries started in a less promising position than the Central Europeans or even the Baltic states in terms of economic and political conditions, as well as location. The series of wars that followed the breakup of Yugoslavia, as well as political instability in Albania, Bulgaria and Romania, impeded both domestic reforms and internationalisation throughout the 1990s. As a result, exports from this group of countries were dominated by less sophisticated goods and some primary commodities. In many cases, exports were insufficient to cover the cost of imports and they depended heavily on remittances and access to foreign (often debt) financing. Eventually, a reform push towards integration with the EU led to the creation of buddingmodern knowledge and information technology industries, exceptionally successful in the Baltic countries.

A large number of economies, particularly in the former Soviet states, were heavily reliant on remittances, exporting labour rather than raw commodities or processed goods. In the case of labour-exporters in the Caucasus and Central Asia, this implied a high degree of sensitivity to the performance of the receiving economies, particularly Russia and Kazakhstan. This was true, albeit to a lesser degree, of Central European countries sending workers to Western Europe.

Yet even within these groupings, and sometimes at the margin between them, the choices and trajectories of different countries have varied, reflecting in particular the different incentives and constraints that sometimes uncertain elites faced at the outset. Much also depended on progress (or the lack thereof) made with respect to other reforms, such as financial-sector development or privatisation. For example, oil producers in the former Soviet Union chose very different strategies for realising that potential. While Russia consistently emphasised domestic control over sensitive sectors like oil and gas and carefully limited foreign participation, Azerbaijan and Kazakhstan badly needed both foreign capital and foreign expertise in their oil and gas sectors. For both political and commercial reasons, they were initially inclined to prefer western partners to Russian ones, and they consequently became extremely eager to attract large inflows of investment. Turkmenistan followed a third path, emphasising both state ownership and limited foreign involvement.

Challenges ahead

Internationalisation since 1989 has profoundly influenced the former communist countries primarily economically but also politically. The unfinished transition process has put into perspective the vast differences between the countries that emerged from the deep shadow of the Soviet Union and the enormous difficulties they had in constructing functioning political and economic structures. Three decades on, the future of the entire region is inexorably linked to the West and the ideas of open markets and (some form of) political democracy have taken roots across (almost) the entire post-Soviet space. These roots are, of course, deeper in some countries than in others. 

Integration into western markets and institutions has resulted in the spread of market mechanisms, knowledge and technology acquisition, albeit to varying degrees across countries. For the majority, this road has led to integration into new regional production networks and West European value chains. The transition countries that achieved deeper international integration, despite some pitfalls, also achieved greater domestic welfare gains. The transition economies of Central Europe, the Baltics and, to a lesser extent, Southeast Europe can look towards deeper integration and an economic future associated with that of developed Western Europe, whether or not they join the EU.

While “re-joining Europe” has clearly been of great benefit over the last quarter-century, these countries are now increasingly affected by the challenges facing “Old Europe”, and their future prospects will depend on how well the continent does in reviving growth and tackling the rise in social and economic inequality that has been observed in recent years. Furthermore, the perceived slowdown – and in some cases partial reversal – of domestic institutional reforms in some of the new member states is creating tensions within the EU. This may mean that integration between the new members and the old European core slows down or even stalls for a period.

For countries less advanced in their integration, this path carries a similar promise and challenge. They face uncertain economic futures as they will have to adopt potentially painful and politically difficult packages of reforms that include simultaneously completing the opening of the current and capital accounts, together with pro-competition policies to boost the competitiveness of domestic tradeable sectors and structural reforms aimed at flexible labour markets. As the political capital of early transition has been spent, citizens of former communist states may exhibit reform fatigue. At the same time, geopolitical tensions to the East and South, as well as a backlash against globalisation in many countries of the West create a much more difficult environment for further integration. This means that the transition economies in the Western Balkans and CIS may experience a longer and more gradual integration in an environment in which the economic benefits of internationalisation do not appear as immediate or appealing as they did in the 1990s and early 2000s. 

This essay draws heavily from a chapter co-authored together with William Tompson in the forthcoming edited volume titled Economic History of Central, East and South-East Europe, published by Routledge.

Kiril Kossev works at the directorate for financial and enterprise affairs at the Organisation for Economic Co-operation and Development (OECD). The views expressed are the author’s own and do not necessarily reflect the position of the OECD or its member states.

Central Europe, economics, Post-communist transition