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Back | Programme Area: Special Events (2000 - 2009)

Lessons from Transition Economies: Strong Institutions are More Important than the Speed of Reforms (Draft)

Ten years ago, on the eve of transition, economic discussion in the profession was dominated by the debate between shock therapists, who advocated radical reforms and rapid transformation, and gradualists, justifying a more cautious and piecemeal approach to reforms. Shock therapists pointed out to the example of East European countries and Baltic states – fast liberalizers and successful stabilizers, that experienced a recovery after 2 to 3 years fall in output, while their CIS counterparts were doing much worse. Gradualists cited the example of China, arguing that the lack of recession and high growth rates is the direct result of the step by step approach to economic transformation. Shock therapists were arguing that “one cannot cross the abyss in two jumps”, that rapid liberalization allows to avoid painful and costly period, when the old centrally planned economy (CPE) is not working already, while the new market one is not working yet.

As time passed, there appeared statistics that allowed to test the predictions of theories. Quite a number of studies were undertaken with the intention to prove that fast liberalization and macro-stabilization pays off and finally leads to better performance (Sachs, 1996; De Melo, Denizer, and Gelb, 1996; Fisher, Sahay, Vegh, 1996; Aslund, Boone, Johnson, 1996; Breton, Gros, and Vandille, 1997; Fisher, Sahay, 2000). To prove the point, the authors tried to regress output changes during transition on liberalization indices developed by De Melo et al. (1996) and by EBRD (published in its Transition Reports), on inflation and different measures of initial conditions.
The conventional wisdom was probably summarized in the 1996 World Development Report From Plan to Market, which basically stated that differences in economic performance were associated mostly with "good and bad" policies, in particular with the progress in liberalization and macroeconomic stabilization: countries that are more successful than others in introducing market reforms and bringing down inflation were believed to have better chances to limit the reduction of output and to quickly recover from the transformational recession. “Consistent policies, combining liberalization of markets, trade, and new business entry with reasonable price stability, can achieve a great deal even in countries lacking clear property rights and strong market institutions” – was one of the major conclusions of the WDR 1996 (p. 142). The conclusion did not withstand the test of time, since by now most economists would probably agree that because liberalization was carried out without strong market institutions it led to the extraordinary output collapse in CIS states. Liberalization may be important, but the devil is in details, which often do not fit into the generalizations and make straightforward explanations look trivial.

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