Fiscal Policy: Issues During the Transition in Russia (Occasional Paper)

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Unfortunately this is what has occurred and the highly export-dependent economies of central and eastern Europe are being subject to a severe external demand shock. The slowdown in economic growth in occurred in virtually all the east European and Baltic economies and, generally, was more severe than was expected earlier in the year. Hungary is the principal exception, so far, to the general recessionary trend. Instead of improving on the relatively weak performance in , GDP in eastern Europe rose on average by just 2 per cent, less than half the rate implied by the official forecasts and nearly a percentage point lower than in The Baltic economies did rather better for the year as a whole just over 4 per cent but the deceleration from the rate was considerable.

For the leading reform economies and the Baltic states the relatively strong growth of the last few years was broken in mid, largely by the deterioration in external conditions; but weak domestic factors also played a role, especially in south eastern Europe. Some slowdown had been expected in some of the faster growing countries because of measures taken to check a too rapid growth of consumer spending and rising current account deficits, but the deceleration was much more than anticipated. The full extent of the slowdown is still not fully reflected in the statistics, partly because many of the data are not yet available and partly because of lags, for example, between the inflow of export orders and actual deliveries.

But the industrial production figures point to a rapid deceleration through the year, from a year-on-year average growth in eastern Europe of just over 6 per cent in the first quarter to 1. These aggregate figures conceal a wide variation in national economic performance but, broadly speaking, in most of the faster-reforming and faster-growing economies of central Europe and the Baltic states the growth rates of industrial production have fallen considerably, while in south eastern Europe the recession in industry worsened in the second half of the year. The deterioration in economic performance is also reflected in the labour markets where the modest improvements in the levels of employment slowed down or were reversed in most of the transition economies during and unemployment rates rose sharply from mid-year.

In December the unemployment rate averaged Unemployment has also continued to rise sharply in January and February , although this partly reflects the seasonal effects of a hard winter. In the CIS, the picture is also one of sharply deteriorating economic performance. Particularly hard-hit by both the Asian and Russian crises, output has fallen or at best growth has been severely weakened and the slender gains of more than offset.

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One of the crucial elements in the situation now facing the transition economies is the deterioration in their current accounts, all of which are in deficit. These deficits averaged about 4. The majority of these deficits were deteriorating throughout the year and towards the end of most of them were much larger than even the more pessimistic forecasts made at the start of the year.

For most of the east European and Baltic economies imports were still rising faster than exports last year and given the deterioration in their export prospects, the question arises as to how long the present deficits can be sustained. The more rapidly growing economies of the last few years — Croatia, Hungary, Poland and Slovakia, for example — have all had large increases in their current account deficits, underlining the dependence of the transformation process on imports and foreign borrowing.

But this import-dependent growth could be increasingly constrained in by at least three factors: the risk of a tightening of policy in some of the transition economies, shortfalls in capital inflows and the increased cost of foreign borrowing, and the slowdown in west European growth. The official forecasts for the transition economies table 3. But these are now looking very optimistic and it is increasingly likely that the actual outcomes will be much lower.

Given the sharp slowdown that now appears to be underway, this is not the moment to tighten fiscal policy in the transition economies, although the discussions in some of them suggest that this may be the intention. Such action, combined with an external demand shock, would intensify the downturn and ultimately be self-defeating by creating larger rather than smaller budget deficits.

If anything, there is room for a loosening of monetary policy, as in a number of countries real interest rates rose sharply last year and were one of the domestic factors that contributed to the slowdown. A faster rate of growth and of import demand in western Europe is highly desirable as the best way of supporting growth in the transition economies and also heading off the increasing pressures for protection from eastern imports, pressures which have already led to anti-dumping actions being started for a number of products. Western Europe is not only running a large current account surplus with the world but also with the transition economies.

If a faster growth rate in the EU cannot be achieved, ways should be found of recycling part of the EU current account surplus to the transition economies, especially to those which face increasing difficulties in raising funds on the international capital markets. This could involve official transfers or loans, but however it is implemented, the key point is to recognize that the west European current account surplus is having a deflationary impact on the countries of eastern Europe and the Baltic states.

What became known as the "Washington Consensus" was a set of policies that were developed in response to the inflation crises in the developed market economies in the s and s and to the Latin American debt crisis in the s. The "consensus" comprised two major elements, one concentrating on macroeconomic stability and the other on so-called supply-side reforms which would underpin both macro-stability and create the basis for spontaneous and sustained economic growth. Macroeconomic stability, reflecting the experience noted above, focused essentially on lowering inflation and then pre-empting any further outbreak with strict and attentive monetary policies.

At the same time not only were general government budget deficits to be lowered in order to support the objectives of monetary policy but the level of government spending was also to be reduced as much as possible, the assumption being that the smaller the role of the state, whether in the actual production of goods and services or in its attempts to intervene in the workings of the economy, the better would be the economic performance of the private sector and of the economy as a whole. The programme of supply-side policies followed from the latter point: product and factor markets should be deregulated as far as possible, state owned assets and supply of services should be privatized, and international trade and capital markets liberalized.

This "mainstream" policy framework was firmly in place when the communist regimes of eastern Europe and the Soviet Union collapsed between and Confronted with economies dominated by state owned enterprises and widespread government intervention and characterized by high levels of economic inefficiency and extensive restrictions on private initiative, the advice from most western governments and the international financial institutions was derived directly from the Washington Consensus: the transition to a market economy could best be made by liberalizing and privatizing the economy as quickly as possible while macroeconomic policy should establish and maintain low rates of inflation and balance in the general government and current accounts.

Previous issues of this Survey 3 judged that this approach greatly underestimated the task of creating a market economy: it focused on too narrow a set of exclusively economic variables and ignored the risk that liberalization without the appropriate institutional infrastructure was unlikely to establish a functioning and "efficient" market economy.

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Macroeconomic stabilization was unlikely to lead to sustainable development unless accompanied by a carefully sequenced programme of structural reforms. Moreover, in many transition economies, and Russia was a prominent but not unique example, it was difficult to see how the standard macroeconomic policy package could easily be applied when the banking and financial sector was so underdeveloped that the links between the real and financial sectors of the economy were too weak to support the use of traditional monetary instruments or when governments were unable to control their expenditure and revenue because there was no functioning fiscal system.

In several respects many of the policies recommended by the "mainstream" consensus have come dangerously close to being dogmas based on oversimplified models and incomplete evidence. The certainty with which they are proposed and pursued is not reflected in the available empirical evidence. This tendency to simplification is not confined to the policy recommendations for transition and developing economies.

Unemployment in the European Union is by all accounts its major political and social problem and its major economic failure. However, comparisons with the United States, the usual exemplar in matters of labour market flexibility and lowering unemployment, do not suggest an unequivocal difference between Europe and America.

Real wages in Europe appear to have been flexible in the s and do not appear to have been more rigid than in the United States; 4 and, more recently, one leading labour economist has concluded that the assertion that "European unemployment is high because European labour markets are "rigid" is too vague and probably misleading. Many labour market institutions that conventionally come under the heading of rigidities have no observable impact on employment". Virtually every fall in unemployment in western Europe in the last two decades or so has been accompanied by an easing of macroeconomic policy either fiscal expansion, or lower interest rates, or devaluation, etc.

Thus without demand, increased flexibility can have no effect. Restrictive macroeconomic policies over a long period, 6 linked more recently to the objectives of the Maastricht Treaty, have kept growth well below the 3 per cent annual average forecast when the Single Market was completed and, in turn, have led to an adjustment in productive capacities consistent with a lower expected rate of growth and an unemployment rate of around 10 per cent. Profit shares are now higher than they were in the s and the s, but real long-term interest rates, which were very high for a long time, have fallen only slightly below those in the United States which is at a very different stage in the cycle and need to fall further if investment is to rise and capacities to expand sufficiently to absorb the unemployed.

In sum, a significant cut in unemployment in the EMU area requires a period of above-average rates of investment and of output growth. The confidence with which the prescription is administered does not yet correspond to a convincing mass of evidence". The reduction and control of inflation occupies a prominent position in the "Washington Consensus" and has clearly been given high priority in western Europe and in the transition economies.

This was a reaction to a general acceleration of wage pressures in Europe in the late s and the cost-push effects of the two major oil shocks of the s. The key argument for focusing on inflation as a principal objective of macroeconomic policy is that it distorts the information content of the price mechanism and by disrupting the basic coordination system of the market economy reduces the propensity to invest and hence economic growth.

Also high rates of inflation are often accompanied by high rates in its variability and this also has a negative effect on expectations. The justification for continuing to give priority to inflation control, even when it has virtually disappeared in western Europe, is that without an attentive monetary policy it can quickly accelerate and veer out of control again. But both the costs of inflation and the dangers of acceleration once any slippage is allowed may be exaggerated. The evidence suggests that inflation is costly in terms of lost output only when annual rates exceed 40 per cent — then there is a danger that high inflation will lead to low growth rates.

In most of the transition economies annual inflation rates are now below 20 per cent, with many in single digits, but, paradoxically, there appears to be a positive relationship between output growth and the average inflation rate between and In contrast, the excessive emphasis on rapid price stabilization in Russia, for example, involving increasingly tight monetary policy, has had highly negative effects on the real economy and has contributed to the growth of payments arrears and other perverse outcomes.

It would not be sensible to react to such price increases with tighter monetary policy. Nor is it necessarily desirable to accelerate the process of freeing controlled prices. It is well known and accepted that public and semi-public housing rents are heavily subsidized in the transition economies and that a move to more economic levels is necessary for an improvement in the housing stock. In western Europe inflation rates are practically zero at the present time yet policy is still deeply concerned that small monthly increases could set off another inflationary surge.

But the evidence suggests this concern is misplaced: there appears to be no grounds for believing that inflation is related to previous rates of increase 14 and therefore little risk of an acceleration getting out of control. Moreover, this pre-emptive stance of monetary policy, at insignificant rates of inflation, appears to make no acknowledgement of the fact that inflationary expectations have changed significantly since the s and s, and that the structural and technical changes that have occurred in the developed economies since then have reduced the likelihood of present wage and price setting behaviour being quickly reversed.

However, the belief that monetary policy will be tightened in response to minor upward deviations from set targets has a depressing effect on expectations of output growth and the propensity to invest. The view that close to zero inflation is a necessary, and even a sufficient, condition for strong, sustained growth and falling unemployment is not based on historical evidence.

But continuing to focus on such an objective is likely to have deleterious effects on the prospects for reducing the currently high rates of unemployment in western Europe. The weak links between strong policy recommendations and the supporting empirical analysis are not confined to the labour market and domestic prices. The transition economies were advised in that price and trade liberalization could not be introduced gradually despite the experience of western Europe which phased out its wartime price controls in line with supply-side improvements to avoid boosting inflation and which, together with North America, started to liberalize its foreign trade gradually over a long period starting in the s and which is still not complete.

Some economists 17 find a close and positive relationship, emphasizing the benefits of removing the static and dynamic costs of import substitution; others 18 contend that the presumed relationship depends on the validity of specific microeconomic assumptions which rarely appear in reality and that once increasing returns to scale and productivity-boosting investment are brought into the picture the standard case for liberalizing trade to boost growth breaks down and a plausible case for interventionist policies can be made.

Again, a careful review of the empirical evidence underlines its inconclusiveness — it is possible that trade liberalization may in fact favour output growth but not in a straightforward manner and that in the short run the adjustment costs may predominate over the benefits. However, there are two points to emphasize here.

First, the scale of the adjustment shock of liberalizing trade will depend on how far the domestic output, employment and relative price structures have to change in response to the new competitive pressures. For many transition economies the scale of restructuring required by the shift from central planning to competitive markets is so large that the domestic economic, political and social institutions, which are also in a state of transition, are unable to cope with the adjustment costs, which in turn may generate large-scale resistance to reform.

The study of Romania in this Survey provides a telling example of this. Secondly, economic growth and development is a highly complex process, the causes of which are still poorly understood; but economic historians, and economists outside the neo-classical persuasion, have always emphasized the crucial role of institutions in stimulating and facilitating the process of change and of mobilizing and expanding the resources available for development. In the presence of a heavily distorted output structure, weak corporate governance and the absence of appropriate institutions — the situation in many transition economies — rapid trade liberalization may be more likely to lead to unemployment and stagnation rather than economic growth and positive structural adjustment.

But generalizations are difficult. Poland, Hungary and, to a lesser extent, the Czech Republic appear to have gained from opening their economies to international trade, but there is little sign of similar responses in Romania or Russia or many of the other countries that are lagging behind in the process of reform. It is sometimes argued that the transition economies where GDP growth has been most rapid are those where liberalized trade and current accounts emerged quickly, where structural reform was rapid, and where inflation was falling.

An alternative view is that the most successful reformers appear to be those where the initial conditions — in terms of both the required scale of restructuring and the institutional capacity to handle it — were more favourable to a faster rate of transition. In other words, governments were able to implement — and their electorates were willing to tolerate — a faster rate of change than in other transition economies.

But this means that the pace of reform is largely determined by the historical legacy and not only by the choice, or the "political will", of governments. To a considerable extent, the predominant concerns are the same in most countries, and the. These pressures are likely to push countries in similar directions.

However, policy issues alone do not determine the course of reform. Another consideration is the political framework—what ideas are predominant, or what schools of thought compete on the policy-making stage, and what ideas and interests the politicians represent. Finally, the purpose of this chapter is to assess how these considerations affect the kinds of states the former communist countries are becoming and what future developments appear likely.

Thus, the last section suggests four plausible future models, commenting on the probability of each and what factors may influence them positively or negatively. The aim of post-communist economic transition can be described broadly as to build capitalism—to depoliticize the economy, to activate markets, and to institute private ownership of the means of production Kornai, An underlying belief supported by the new institutional economic history is that the economic institutions of capitalism can generate economic growth North, A number of recent econometric studies covering a large number of countries support this view Sachs and Warner, ; Gwartney et al.

A number of the 22 countries of interest here appear already to have entered a period of sustained economic growth under a new economic system. Yet only Poland, having recorded several years of considerable growth, appears to have entered a stage of sustained growth. However, in most cases it takes a long time before substantial growth can be expected. What other criteria can be used to measure the attainment of capitalism? We have settled for a qualitative target—capitalism—and its attainment should be measured by qualities. Three obvious criteria are financial stabilization, liberalization, and private-sector development: financial stabilization means that money is stable enough to function as a reliable means of exchange, liberalization is necessary so that market allocation can substitute for vertical state commands, and a dominant private sector is required to render ownership apolitical and pluralist.

Each of these three criteria can be quantified, and the question is at what point we can say that a market economy has been reached.

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In practice, the most obvious success indicator has been low inflation. The control of inflation and the return of economic growth are closely related. No post-communist country has restored growth without limiting inflation to 40 percent per annum or less, while all the countries that have contained. There is also a strong correlation between inflation and decline in output.

In , nearly all the countries got inflation down to below 40 percent per annum. In Belarus, on the other hand, inflation may explode again. There have been several such cases in which inflation has fallen temporarily to a low level and then increased. Examples are Russia and Ukraine in the summer of In those two cases, the temporary stabilization was based entirely on monetary policy and not on a sufficient reduction of the budget deficit. Sustained monetary stabilization needs to be based on fiscal adjustment as well. Only when the budget deficit has been limited so that what remains can be financed by noninflationary means has inflation been brought under permanent control Fischer et al.

The frightening case is Bulgaria. In , its inflation had decreased to 64 percent, but it doubled the next year—to percent. Inflation was again reduced to 33 percent in , but as the budget deficit stayed at almost 7 percent of gross domestic product GDP , the exchange rate collapsed in As a consequence, inflation surged again to percent a year Stockholm Institute of East European Economies, , and the associated social cost is likely to be very high.

The Bulgarian experience illustrates the danger of trying to do only what is absolutely necessary, effectively walking a tightrope on the verge of an abyss. The countries most successful in controlling inflation have not calculated how large a deficit they can finance. Instead, they have aimed at a balanced budget or a small budget surplus. Croatia had a budget surplus of 0. Presumably, some of these countries harbor hidden semifiscal budget deficits, but that is an additional argument for eliminating the official budget deficit. With the exception of Croatia, not a single post-communist country has managed to achieve what would be considered low inflation in the West.

This illustrates both how difficult and how important it is to combat inflation. One reason for the lingering high inflation is the existence of hidden deficits, often bad debts taken over by the government. Another reason is that these countries started with extremely devalued currencies, and real revaluation often. Substantial relative price adjustments are a third reason. In hindsight, common complaints that too much attention was being devoted to combatting inflation appear particularly misplaced Nuti, ; Nuti and Portes, ; Portes, There is no room for fine-tuning in post-communist stabilization.

Another important criterion for successful transition is deregulation. In theory, stabilization can take place without liberalization, but in the reality it has proved impossible in the post-communist countries because price regulation is usually connected with substantial subsidies that must be reduced if financial stabilization is to succeed. These indices try to compound various indicators of liberalization, such as foreign trade obstacles, price regulation, tax levels, freedom of enterprise, and quality of financial markets.

The World Bank liberalization index shows a clear correlation between liberalization and financial stabilization de Melo et al. In an international context, most of the post-communist countries do not rank very high on the rather varied liberalization indices. The Heritage index, which endeavors to reflect , includes countries. It puts the Czech Republic as no. The Fraser Institute ranks countries for Its earlier point of measurement puts the transition countries at a disadvantage, and the highest-ranking transition country is the Czech Republic at no.

We can somewhat arbitrarily choose one of the liberalization indices and define a market economy as a country that surpasses a certain level on that index. Examining how far different countries have advanced toward a market economy at various times, it appears reasonable to put the threshold at 0. Thus, we say that any country that surpasses this level is sufficiently liberalized to qualify as a market economy. Almost all the post-communist countries had passed this test by We could also use the qualification of an open economy according to the criteria defined by Sachs and Warner , which they identify as the threshold to economic growth.

Today those criteria would result in approximately the same four countries being excluded. Moreover, there is only one example of an outright backlash after significant liberalization, namely Ukraine in , which at the time had not been highly liberal-. With the exception of the four outliers, then, we might dare to suggest that sufficient liberalization to form a market economy has been undertaken, although this is only a tentative empirical conclusion.

Yet even if much remains to be deregulated, the paradigm has changed to that of a market economy. We might also note that with regard to liberalization, the danger of going too far seems remote, while the risk of not going far enough is very high. The third criterion for the transition to capitalism is expansion of the private sector, whether through privatization or the opening of new private enterprises. These two approaches are often presented as alternatives, but in reality tend to be complementary. To develop the private sector takes longer than to undertake financial stabilization or liberalization.

Unfortunately, statistics on ownership are of particularly poor quality. EBRD offers the most complete picture, but provides only estimates, which tend to be very conservative. No Western country has more than about 35 percent public employment or public share of GDP produced. Thus, the threshold for capitalism might be set at 65 percent. By , all of the Central European countries, apart from Bulgaria and Romania, appear to have approached that level, and only the three Baltic states, Russia, and Kazakstan in the New Independent States. There is a remarkable correlation among the above three criteria for capitalism.

Two countries—Tajikistan and Turkmenistan—have not met any of the criteria. Bulgaria and Belarus have met only the liberalization criterion, and Azerbaijan has achieved only financial stabilization. However, reforms have progressed in all 7 countries, with the possible exception of Uzbekistan, and several of them may have passed the threshold for privatization in Therefore, of the 22 countries, 5—Azerbaijan, Belarus, Bulgaria, Tajikistan, and Turkmenistan—are failures to date, and 17 countries seem to be achieving capitalism. Is it sufficient to examine only these three key criteria?

Institutional development has sometimes been contrasted with them. The relationship is difficult to measure, but the attempts that have been made show a strong positive correlation between these three key criteria for the transition to capitalism and institutional development de Melo et al. There has been widespread concern that the transition from communism to capitalism has been marked by considerable social hardships see the chapters in Section IV of this volume. Initially, anticipated high social costs in the form of a sharp decline in output, leading to a drastically falling standard of.

A common argument was that a swift transition would lead to greater adjustment costs than would a more gradual transition, and would therefore lead to social or political upheaval that could derail the whole transition process see also Nelson, in this volume. Many believed that the population would accept only a certain level of social costs and that this absolute limit must not be reached.

A wide range of possible disasters was invoked, including starvation; social unrest because of excessive poverty, price increases, and income differentials; and labor unrest because of low wages and mass unemployment.

Fiscal Policy Issues During the Transition in Russia : Augusto Lopez-Claros :

Today we have the record, and it is very clear. In general, there is a distinct positive correlation: the more radical the reform—in terms of deregulation, stabilization, and privatization—the smaller the total decline in output. The differences in the decline in output are stunning. Official statistics generally overstate the decline in output, but the real decline has been reassessed at 7 percent in Poland and about 50 percent in Georgia, which is still a stark contrast.

Statistics for income differentiation exist for only a few countries, but there appears to be a sharp divide between Central Europe, with more radical reforms, and the New Independent States, with slower reforms. In Central Europe, the least radical reformer, Bulgaria, displays the greatest income differentiation in the region World Bank, Previously, the Soviet Union had greater income differentials than Central Europe, but the differences were of much smaller magnitude.

Unemployment is perplexing because there is no correlation between it and decline in output or the nature of reform. Although social suffering has been great, it is remarkable that these widely expected problems did not result in social upheaval although ethnic strife has erupted in several countries. Today few remember that the EU sent food aid to Poland in the winter of because of fears of starvation. The same fear was stronger in Russia in the winter of , but starvation did not occur. Communist governments had long argued that they could not raise consumer prices because of the danger of social unrest.

When the Soviet government raised meat prices in , it faced substantial riots, notably in Novorossiisk. The Polish government fell because of workers' unrest when it tried to raise food prices in December , and it suffered serious unrest again in for the same reason. Yet none of the post-communist governments has experienced any serious popular unrest because of price liberaliza-.

One explanation is that price increases for a few staple goods, such as meat and bread, are easily perceived as directed against the working man to the benefit of the elite, and can thus give rise to strikes and riots. Wider price deregulation, however, is clearly a change of paradigm and a transition to another economic system, not just an act of redistribution.

Moreover, the very drastic price deregulations underlined how serious the crisis was, and there was no obvious alternative. In most countries, the previous level of price subsidies was untenable, and the preceding shortages were truly unbearable. Labor unrest was another concern before the reforms. Many of the new post-communist governments were very worried about strikes over wages. Yet the region has in fact been characterized by a very low level of labor unrest, and wage pressure has been remarkably limited.

A similar worry was that unemployment would skyrocket; there were forecasts that it would rise to half the labor force in a year or two. The rate of unemployment has risen, but on the whole has been lower in Eastern and Central Europe than in Western Europe, where it lingers at around 11 percent of the work force.

In hindsight, it is obvious that the organization of labor remains very weak, and that the very limited degree of collective action would render significant strikes implausible, particularly in the short term. As workers have accepted massive reductions in real wages, employers have had little reason to lay them off, which is a major reason why unemployment has increased far less than output has decreased. However we look upon the transition process, the empirical result is that it is better to undertake all the main transformations in concert and as rapidly as possible.

There are no economic or social arguments for proceeding slowly. This was indeed the argument of a broad economic prescription literature from the beginning Kornai, ; Lipton and Sachs, ; Blanchard et al. How can the above empirical results be explained logically? Why have the costs of slow reform been so high? How do inflation, regulations, and state ownership cause economic decline? Much of the discussion about post-communist transition has concerned structural adjustment costs and how they can be minimized.

The problem with much of the theoretical literature on how to minimize adjustment costs is that it assumes a good government, working in the interest of the people. In practice, however, structural adjustment costs appear to be a secondary concern.

Economic Crises in Post‐Communist Russia

Instead, the most serious social costs result from rent seeking by an elite that is exploiting the state for its own enrichment. In a way, the state was privatized because so much of society was nationalized. To understand this drama, we need to identify the main means of rent seeking. The fundamental method of rent seeking was arbitrage: to buy something cheaply at fixed state prices and sell it at a high free market price at home or abroad. The great bonanza of arbitrage was in and , when raw materials, notably oil, gas, and metals, sometimes cost as little as 1 percent of the world market price.

The trick was to have access to these commodities in Russia and to be able to sell them abroad at the world market price. Considering the domestic and world market prices and the volume of exports of these commodities, it is easy to conclude that total rents arising from the export of oil, gas, and metals amounted to about 30 percent of Russia's GDP in A second, similar source of rents was import subsidies. Multiple exchange rates allowed this kind of arbitrage.


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In , an importer of essential foods paid only 1 percent of the official exchange rate, and no less than 15 percent of Russian GDP went to import subsidies that year International Monetary Fund, , Import subsidies did not show up in the Russian budget, as they were financed with Western commodity credits off the budget.

Yet the Russian state is responsible for servicing and paying back these debts. The import subsidies went to a small group of commodity traders in Moscow.

Fiscal Policy Issues During the Transition in Russia

A third form of rents was huge subsidized credits. When prices were liberalized in January , money became scarce as the money supply did not rise as rapidly as prices. State enterprises urged the government and the Central Bank to replenish their working capital. Unfortunately, the government and the Central Bank accommodated them. As a result, from June to September , the money supply increased by almost 30 percent a month. The two latter types of reform would reduce the abuse of market power and improve effective corporate control exercised through domestic financial institutions and markets, thereby supporting market-driven restructuring.

Shortly after independence in August , the Ukrainian Government liberalized most prices and created a legal framework for privatization, but widespread resistance to reform within the government and the legislature hindered reform efforts and led to some backtracking. Sharply declining output, lack of access to financial markets, and massive monetary expansion to finance government spending resulted in hyperinflation.

Thus, in the Ukrainian central bank replaced the old currency, the karbovanets, with the hryvnia and attempted to keep it stable in relation to the dollar. The currency continued to be unstable through the late s. This made the Ukrainian economy vulnerable to external shocks. The IMF encouraged Ukraine to quicken the pace and scope of reforms to promote economic growth. After the global crisis, and as the euro crisis intensified, Ukraine suffered from a drought in capital flows which put strong downward pressure on the hryvnia.

Then, the central bank admitted defeat and let the currency float. Currency depreciation was an economic headache for Ukraine in the short term. The IMF ended up freezing the deal in after Kiev failed to touch the costly subsidies. Corruption, poor governance, interstate conflict, and political situation are other major problems. Businesses operating underground tend not to pay taxes, further depriving the government of funds.

However, the level of reforms in Ukraine with respect to privatization, banking reforms, and infrastructure have been half-hearted. In the course of , the outbreak of a severe banking, currency and sovereign debt crisis could not be prevented. This led to a significant decrease in the value of the ruble, eventually forcing the Russian government to devalue the ruble in Russia did not perform much better in the foreign sector and FDI flows were not significant given the size and needs of the Russian economy.

During the period, the Russian government had large budget deficits that reached as high as 9. The crisis led to the demise of many Russian banks which had held government debt. The crisis caused: Russian interest rates soared aimed inconsistent macroeconomic policy which triggered the crises. Hence, prices on the Russian stock market plummeted; and the value of the Russian ruble sank. In addition, foreign reserves decreased substantially during that time. Russian economy was vulnerable because of more fundamental problems related to the economic policy and economic structure.

These included the failure to institute tax reform, property rights, and bankruptcy laws and procedures. Later on, Russia made some attempts to perform economic reform during this period by moving from the centrally planned economic system and introducing market prices for most goods and services.

This made the Russian ruble convertible for trade transactions, and the economy was opened to foreign trade and investment. Russia also lifted its restrictions on capital inflows. After , FDI inflows grew exponentially, due to investments in newly liberalized sectors. After reaching record heights in , the financial crisis led to a collapse in FDI, as the global economy entered into a recession. Foreign investors remain motivated by the continued strong growth of the consumer market and affordable labor costs, together with productivity gains.


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They also continue to be attracted by high returns in energy and other natural-resource related projects. The second largest investor was Germany, with 99 projects in different sectors. Since early s, the economic situation in Belarus was characterized by a dynamic economic growth. On the one hand, as a state-dominated economy, with only limited relationships with the world financial markets, has been less affected by the severe effects of the financial crisis.

On the other hand, a sharp decline in both Russian economic subsidies and foreign trade with Russia stemming from the global crisis has had a significant impact on the Belarusian economy, albeit with some lag. Consequently, in , GDP growth was marginal at 0. The gradual recovery following in resulted in a substantial increase of wages and the already high level of financing of government programs. As a result, the annual GDP grew by 7. This crisis stemmed from the fact that the authorities kept the de-facto fixed exchange rate regime for too long and the exchange rate remained too strong.

Significant control and influence of the state on the economy were the main prerequisites of the crisis. The authorities used growth-promoting policies, expansionary credit practices and broadly applied generous financing of various state programs. This was together with a significant boost of wages and an increase in demand for value-added, primarily imported goods.

Thus, the crisis emerged from devaluation expectations in as a result of diminishing foreign exchange reserves of the National Bank. The results of the crisis generated a significant effect on all sectors of the economy lacking funds in foreign currencies to pay for imported production inputs and goods. While the Government reported a growth of GDP by The contribution of added value of industry in GDP amounted to In addition, the country has a broad agricultural base and is fully self-sufficient in agricultural production and also provides export opportunities.

The Belarusian economy is dominated by state controlled sectors. FDI into the Belarusian economy was relatively moderate through — However, FDI in Belarus averaged Equity injections totally USD Capital mobility is important issue because, in a world with high capital mobility, national governments can follow expansionary fiscal policies without confronting large-scale crowding out implied by these policies. Furthermore, the existence of high capital mobility rules out the constraints imposed by domestic credit markets and money supplies. Thus, monetary policy is rendered much less effective under this condition.

The presence of internationally mobile capital also means that capital owners do not bear the full burden of corporate income tax. In a such environment, capital may freely move to a country where the return is higher, i. The saving-investment approach to capital mobility was first presented by Feldstein and Horioka It is based on the assumption that, in a world with perfect capital mobility, a country will indicate very little correlation between domestic saving and investment in the long run. Thus, by comparing the correlations between domestic saving and investment rates in various countries, one can determine the degree of capital mobility.

However, our study is based upon the same postulated relationships between domestic investment and saving rates; but it is not concerned with assessing the correlation between them. Rather, this study attempts to present further evidence on capital mobility by exploring the causal relationship between saving and investment rates in six eastern European countries. In a world with imperfect capital mobility, changes in saving must create changes in investment and vice versa. Thus, the presence of any form of causal relationship between these two series must be interpreted as an indication that national capital markets are not open; capital flows are hindered; hence there is no financial integration.

If, however, no causality is found, one can conclude that the economy is open and capital is mobile Leachman Given the data availability, the annual data — for the following economies are used: Estonia, Latvia, Lithuania, Ukraine, Belarus, and Russian Federation. The selection of time period is dictated by the availability of data. Figures 1 , 2 , 3 , 4 , 5 and 6 Appendix 1 illustrates the variables for each country and in Appendix 2 , data sources, definition of variables, study period are collected together.


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This approach has two important advantages. Two steps should be followed before applying the bootstrap panel Granger causality: testing the panel for cross-sectional dependence and testing for cross-country heterogeneity. The first issue implies the transmission of shocks from one variable to others. In other words, all countries in the sample are influenced by globalization and have common economic characteristics.

The second issue indicates that a significant economic connection in one country is not necessarily replicated by the others.


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