25 Years of Transition: Post-Communist Europe and the IMF

Abstract

The past 25 years have seen a dramatic transformation in Europe’s former communist countries, resulting in their reintegration into the global economy, and, in most cases, major improvements in living standards. But the task of building full market economies has been difficult and protracted. Liberalization of trade and prices came quickly, but institutional reforms—in areas such as governance, competition policy, labor markets, privatization and enterprise restructuring—often faced opposition from vested interests.
The results of the first years of transition were uneven. All countries suffered high inflation and major recessions as prices were freed and old economic linkages broke down. But the scale of output losses and the time taken for growth to return and inflation to be brought under control varied widely. Initial conditions and external factors played a role, but policies were critical too. Countries that undertook more front-loaded and bold reforms were rewarded with faster recovery and income convergence. Others were more vulnerable to the crises that swept the region in the wake of the 1997 Asia crisis.
In contrast to the turbulence of the first decade of transition, the early and mid-2000s saw uniformly strong growth. With macroeconomic stability established and key market-based frameworks largely in place, the region experienced large capital inflows, supported by a benign global environment and increasing confidence in rapid convergence with Western Europe—especially for those countries that joined the EU during this period. Widespread foreign bank ownership brought much-needed credibility and technical know-how, and facilitated the provision of financing to the region—indeed to excess, causing growth to become increasingly imbalanced. The resulting vulnerabilities were exposed when the global and euro zone crises struck at the end of the decade, hitting the region harder than any other.
In the wake of these crises, countries embarked on significant consolidation, although some continue to struggle to restore competitiveness and fiscal sustainability against the backdrop of slow growth and lingering structural weaknesses. New analysis shows the effect of widening disparities within the region: the more advanced countries now have more in common with Western European economies than they do with some other former communist countries. But even in the better-performing economies, the pace of convergence has slowed substantially. And reform momentum has generally slowed over the years, with a risk of reversals emerging in a few countries.
To revitalize the convergence process—and, for some countries, to reduce the risk of falling back into crisis—stronger commitment to market-based policies is needed. Two broad priorities stand out. First, a renewed focus on macroeconomic and financial stability in some countries, to rein in persistent deficits and increasing debt, and to address rising levels of bad loans in banks. Second, to raise the pace and depth of structural reforms in areas such as the business and investment climate, access to credit, public expenditure prioritization and tax administration, and labor markets.
The influx of new member countries at the start of transition was a huge challenge to the IMF both operationally and intellectually. The IMF has been closely involved with the region ever since, providing a mix of policy advice, program lending and specialized training and technical support as country needs have evolved.