Stuck in Transition: a Mea Culpa and an important step forward

No, it is not the author of this posting who professes guilt, but, much more astonishingly, the European Bank for Reconstruction and Development (EBRD). And it does it in its latest flagship publication, the recently published Transition Report which goes by the flashy title “Stuck in Transition”. The report argues that since the mid-2000s, exacerbated by the present crisis, EBRD’s client countries in Central and Eastern Europe, in the Caucasus and Central Asia, plus Russia have stalled in their efforts to push market-friendly reforms. And this inactivity will, different from country to country, slow their catching-up to “Western” countries. This will keep these countries far away from the (virtual) “transition frontier”.

The report establishes a close connection between dmeocratisation and economic development – the twin mandates of EBRD. The argument is that development promotes democracy; large natural resources impede democratization, because economic liberalization reduces the power of strong vested interests – which again profit less from more openness than other parts of the population.

What is radically new (at least for EBRD) in this report is the importance it ascribes to functioning institutions for general economic success and specifically the transition process. The report’s authors in this follow D. Acemoglu and J. Robinson’s influential 2012 book “Why Nations Fail: the origins of power, prosperity and poverty”, New York 2012, which was already positively reviewed in this blog: “It’s the politics, stupid!”, 9/4/2012. These authors argue with painstaking research and vehemence the importance of social institutions, i.e. the organization of society and economy for successful economic development. They describe e.g. the beneficial pre-conditions which made the industrial revolution successful in England, they describe the deleterious influence of slavery on slaveholder societies around the world, arguing that slaves have no incentive to work hard or design productivity-enhancing mechanisms, because their lot does not improve, but all the potential spoils go to the slaveholder, etc., etc.

The Transition Report in this sense argues for a much wider institutional agenda than the usual mainstream trinity of “liberalisation, stabilization and privatization” and includes appropriate regulation, effective governance, strict rule of law with an independent judiciary, low corruption and a generally positive business climate as essential for further success with transition – all things more or less missing in many of EBRD’s client countries. EBRD also accepts that factors outside the competence of national governments play a role, such as history, geography, climate, as well as economic integration, education levels and know-how of the populations, plus the structure of democratic institutions, especially the acceptance, even promotion of civil society institutions. EBRD also enters virgin territory by stressing the importance of economic appropriation mechanisms, unhindered by discrimination based on gender, race, social background. In short, “inclusion” (whose integration into the evaluation of EBRD projects was especially close to this author’s heart when working at EBRD) has a long way to go in many of the countries analyzed, especially with regard to access to jobs, working conditions and access to education.

What I find remarkable in this is that by analyzing the deficiencies in all these (and other) areas, EBRD implicitly conducts self-criticism of its own 20-year old business model which measured transition impact by project volume and direct market-structure indicators. EBRD thus becomes the first International Financial Institution that re-invents and enlarges its business model – which, given the persistent transition gaps, obviously has been flawed. Of course, even while giving a lot of attention to these new institutional dimensions of transition in the future, EBRD will still stick to its core business, i.e. project finance.

Frequently elections, crises or other large disruptive events are seen as those moments when radical reforms can be pushed through, because such events may shatter established elites’ power and vested interests. However, as is the case here, the recent crisis has led to more retrenchment, to more stalling of market-friendly reforms, to a consolidation of the ubiquitous oligarchs’ power. Also, populations have become reform-fatigues, no wonder if one considers that within 20 years this is the second very deep crisis. Let us remember that after 1990, many of the EBRD’s client countries lost up to 50% of their GDP, which a number of them still have not recovered.

In the face of this, EBRD delineates a positive way forward: if at national level reforms stall, anti-corruption measures etc. can be promoted at regional or local level; if more openness for foreign direct investment can be generated, this can set a dynamic towards more openness in other areas in motion; if local institutions are strengthened, this can spill over into the national level; if national elites block reforms, civil society organisations could step in and monitor government functions, also with the help of social media.

This Transition Report is very realistic (after more than 20 years of sobering experience!) of what IFI can achieve. But it is also pragmatic and ambitious by seeing that the economic leverage generated via project finance can be used effectively to create more equitable and productive conditions, if larger parts of the populations can be made beneficiaries of the fruits of effective private projects.

In 2001, then World Bank President James Wolfensohn raised hell by branding corruption as the major impediment towards economic and social development and integrating anti-corruption measures into the World Bank’s country strategies and projects. Today, EBRD goes an important extra step by identifying the wider institutional environment as  t h e  factor enabling transition towards a functioning market economy and expanding its business model to incorporate advice and measures to improve institutions. This is an important step, although it is sobering to read EBRD’s assessments of the gaps in these institutions in its client countries. To fill these gaps much resistance will have to be overcome! EBRD’s owners will have to provide strong political support for this agenda for EBRD’s contribution to be successful.

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Filed under Crisis Response, Fiscal Policy, Global Governance, Socio-Economic Development

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