Source: Development Outreach

A great transformation of the former Soviet bloc has occurred in the last decade. In a few regards, the transformation has brought about similar results. The notorious shortages have by and large disappeared. The high inflation of the early transition has abated all over. The production of unsaleable goods has stopped, and the previous over-industrialization has given way to a large service sector. Foreign trade has been re-directed from the communist world towards the West.

More striking, however, is how great the differences have become among the post-communist states. In terms of economic system and growth, they can be roughly divided into three groups. About half of the countries seem to have become reasonable market economies and they have accomplished growth of at least 4-5 percent in some recent years. These winners are Central Europe, the Baltics, Slovenia, Croatia and Albania, but also Armenia, Georgia and Kyrgyzstan.

The second group consists of countries that have undertaken substantial market economic reforms but have failed to achieve significant growth or have faced serious growth reversals because of financial crises. They are Bulgaria, Romania, Macedonia, Russia, Ukraine, Moldova and Kazakhstan. Arguably, these are the most interesting countries today, because their fate does not seem determined as yet, and they are important countries.

Finally, a third group of countries has opted out of market economic reform. The worst examples are Yugoslavia, Belarus, Turkmenistan and Uzbekistan, but so far Azerbaijan and Tajikistan also pertain to this group. At least in the first four, transition is over in the sense that it is not going further. Nor is it likely to do so until their current rulers have been ousted.

At first sight, the geographical pattern seems strong, but Central Asia and former Yugoslavia are spread over the three groups. Countries with good preconditions perform better, but they do so to a large extent because of better policies.

The most illustrative contrast is perhaps between the two neighbors Poland and Ukraine. In terms of growth, their differences are enormous. Poland has grown economically by 30 percent since 1989, while Ukraine has not recorded one single year of growth and its GDP is officially down by 60 percent. Culturally, they are close. Their languages are confusingly similar, and Western Ukraine was part of Poland until 1939, and it never belonged to the Russian Empire. Their industrial structures are also quite similar. The difference is that Poland pursued radical economic reform from the outset, while Ukraine opted for slow reform. Today, we see the difference.

Many such comparisons can be made. Today, successes and failures are often taken for granted, but neither was inevitable. All countries that opted for radical reform have accomplished something, while those that did not have largely failed. The initial reform strategy has been of fundamental and lasting importance. Countries have ended up either in a virtuous circle or in a vicious circle.

An important observation is that democracy and market reform have gone hand in hand. All the successful countries are reasonably democratic, the intermediary group is partially free by the Freedom House standard, while all the countries that have not really reformed are outright dictatorships. Dictatorship means no market reform, and poor democracy means poor reform.

The virtuous circle means that democracy has won. A market economy caters best to the interest of all, generating economic growth that is more or less equally distributed. The successful reformers have much more equal income distribution than the partial reformers. Political stability and peace have been no benefit. The most unstable governments have been in Poland, the three Baltic states - all successful reformers - and in the less successful Bulgaria. Nor has social peace been an advantage. Apart from the Russian reformers, no reformer faced such public acrimony as Leszek Balcerowicz did in Poland. Arguably, two successful reform countries, Poland and Hungary have the best and most contentious media, together with Russia. Successful reform is no cakewalk. It is not based on a social consensus among the elites but on democracy. The main enemies of successful market economic reform have naturally been those who had the most to lose from a free market. Contrary to what socialists want to think, they were not the ordinary people, but the privileged economic elite - state enterprise managers and various officials. They have persistently warned that the workers may rise against racial market reforms, but the workers have stayed quiet.

The real struggle of the transition has been between reformers and this rent-seeking elite. Where ordinary people have understood this and been free, reform has won. Where dictatorship has prevailed, the rent-seeking elite has been victorious. The main threat to the transition was that the state would be usurped by a corrupt rent-seeking elite, as happened most conspicuously in Yugoslavia, Belarus, Turkmenistan and Uzbekistan.

Today, many blame privatization for the failures of transition, but it has not been the decisive factor. The successful reformers have largely privatized more than the unsuccessful, and there privatization has definitely contributed to growth. Since the beneficiaries of little reform were already in positions of economic power, they did not need privatization. The public property was in effect theirs. Any privatization to anybody else has diluted their ownership. Their big money was made on government subsidies, subsidized credits and privileged access to arbitrage between state-controlled prices and free prices, which they extracted through management theft.

In the coming decade, the successful reformers are likely to forge ahead, particularly the candidate members to the European Union, though a couple of weak states might face setbacks. Among the hard anti-reform dictatorships, we may forget about market reform until these dictators are ousted. The big question is what will happen to the partially-reformed countries, notably Russia and Ukraine.

Contrary to the dominant current Western mood, there is hope. After all, both countries are democracies, though not very liberal ones, and democracy is the key to solution. Moreover, Communist Parties have failed to win elections in either countries, and their tide has evidently passed. Basic market economies are in place. The key problem is how to defeat or discipline the dominant "oligarchs," who have enriched themselves through extraordinary rent seeking. This situation is reminiscent of the end of feudalism or mercantilism. The answer then was to drive monopoly rents down through increased competition and undermine the political power of the aristocrats by mobilizing the rising middle class and civil society. A difference is that the current threat comes from the state, which was much smaller at the end of feudalism. These reflections indicate what the outside world should encourage in the former Soviet Union.

The end of feudalism was brought about by free foreign trade. Similarly, the openness to foreign trade has been one of the best indicators of successful structural reform. Unfortunately, none of the big former Soviet states is a member of the WTO, nor likely to join before 2004. Because of the passivity of the WTO, the World Bank needs to play a more active role in trade liberalization.

As the state is part of the problem it must be reformed. One part of the solution should be to reduce state revenues in states such as Russia, Ukraine and Moldova, which still collect one third of GDP. The IMF should fight not for higher taxes and revenues but for the balancing of the budget at a lower level, which Ukraine's new Prime Minister Viktor Yushchenko has suddenly accomplished.

A problem that unfortunately must be solved with administrative means is the re-organization of the state. Most post-Soviet states have a hybrid constitutions, combining a presidential system with a parliamentary system, which mess up their governments. They should choose, and as the prime issue is to get sound checks and balances a parliamentary system seems preferable.

Old Soviet bodies, such as branch ministries, must at long last be abolished. In particular at local levels, officials still interfere in enterprise management as in the old Soviet days, although enterprises may be formally private. Inspections have become a post-Soviet scourge. The slogan must be: Get the state and its servants out of enterprises. Small enterprises can and should especially be favored through small lump sum taxes without book keeping and simplified registration.

The decisive struggle will be the regulation of the natural monopolies and energy companies - oil, natural gas, coal and pipelines, which are the natural habitat of oligarchs. When they have been sorted out, the transition battle has been won.

Democracy is not only a public good or an ideal, but an effective lever for the success of market economic reform. Similarly, free and pluralist media are essential for the success to reform. If everything fails, the last way out is external default. The outside world should not balk at applying it. It as worked wonders in Poland and Bulgaria, and it may already have done so in Russia. As there is no fruitful alternative to market reform, I would expect one country after the other to ascend to the right track, but it can take long time as evidenced by persistently poor economic policies in many African countries and the slow deregulation in India and Pakistan. Post-communist transition has entered known ground - the battle against monopoly rents.