Sample Paper on Reforms in Transition Countries of Central and Eastern Europe

The Institutional Reforms in Transition Countries of Central and Eastern Europe and Their Effects on the Economy

Introduction

As explained by Zecchini (2013), countries that are changing from using centrally planned economies to adopting market economies are collectively known as transitional countries or economies. Such countries undergo different kinds of structural transformations all intended to establish and develop market-based institutions as a way of liberalizing the economy. Transitional economies in Central and Eastern Europe include Romania, Russia, Ukraine, Armenia, Bulgaria, Georgia, Hungary, Latvia, Croatia, Czech Republic, and Poland among others. From the early 1980s, several transitional countries in Central and Eastern Europe started introducing a number of institutional reforms in their economies with an aim or spearheading rapid economic growth and development. Over the past 25 years, these transitional countries have established dramatic transformation leading to major improvements in living standards and their integration into the global economy. The established institutional reforms include liberalization of prices, liberalization of trade, liberalization of foreign exchange, restructuring, privatization, macroeconomic stabilization, as well as reforms in the energy sector among others. This paper discusses only three institutional reforms namely (1) liberalization of prices, trade, and forex, (2) restructuring and privatization, and lastly (3) reforms in the energy sector. These three institutional reforms are discussed together with their effects on the economy.

(a) Liberalization of Prices, Trade, and Forex

The liberalization of prices, trade, and forex exchange happened alongside each as they were implemented nearly at the same time. Over the past 25 years, transitional economies in Central and Eastern Europe worked harder to liberalize the prices of goods and trade in order to create an open market system. Initially the governments in these country controlled prices of goods, trade and foreign currency exchange; the government control prevented establishment of free market and trade thus leading to inefficiency and monopolization.

The purpose of this institutional reform was not to prevent the central government from determining the prices of goods and services but rather to allow market forces to determine prices thereby enabling the countries to become part of the global economy. Initially, the central governments were responsible for planning all aspects of the economy including setting prices of goods and services as well as trade. In addition, the was a need to allow market forces to determine the forex rates to allow their local currencies become part of the global forex market.

The initial steps made by each country were to lower the trade barriers especially between countries across the region. They started with their neighbouring countries before extending to the global presence. The centrally planned system had created so many trade barriers in these countries leading to a shut off economic contact and trade as well as the world’s price structure with other countries across Europe and abroad. Countries started by lessening government regulations and restriction on trade as well as control of market prices.

Liberalization of foreign currency exchange took place faster across all transitional countries in the region. Majority of the countries liberalized forex by removing regulatory and legal charges that affected forex market. I addition, they removed the central bank’s singled handed determination of currency exchange rates as well as allowing free participation of local currencies in the global market.

Effects on the Economy

The liberalization of prices and trade created so many beneficial effects on the economy in this region. First, it removed government control thus allowing prices of goods and services to be determined by market forces resulting in fair trade and commerce. This eventually led to high trade volume across Central and Eastern Europe due to the conducive market environments thus their integration into the global economy.

The liberalization of trade as well as goods’ prices allowed greater participation by private entities in the economy. Initiation, before these reforms, there was limited participation by private entities as the government alone centrally planned the market (Sykora &Bouzarovski 2012, p 44). This resulted in speedy wealth creation in the region accompanied by development of private sector economies. Most countries undertook bold liberalization of trade alongside prices thus leading to faster convergence of income and recovery or prices.

Liberalization of trade, prices, and forex created conducive business and investment environment leading to high inflow of foreign direct investment (FDI) into the country. Most economies benefited from high FDI inflows leading to speedy economic growth and development. Local businesses also started booming as they benefited from the inflow of foreign investments and capital expenditure. Foreign direct investment inflow was heavily invested in the manufacturing sector leading to raid industrialization. In essence, liberation of trade, prices, and forex made the region more attractive to foreign investors. It also led to high trade balances for goods and services as well as improving income and transfer balances in these countries. Lastly, the liberalization of foreign exchange led to increased foreign exchange reserves by most countries in the region.

However, on the negative side, liberation of trade and prices led to high inflation and major recessions in some countries (Bjornskov & Potrafke 2011, p 88). This occurred because the freeing up the price controls broke the linkage with other economies thus such countries have to establish new economic partners in free market. Fortunately, the inflation was controlled as the market stabilizes.

(c) Restructuring and privatization

During the past two decades, the central and eastern European economies established quite a number of restructuring and privatization of the public sector. The ownership of public sector businesses and government parastatals were subsequently transferred to the private sector for effective management and governance (Smallbone & Welter 2012, p 34). Several government-owned enterprises, businesses, public services, as well as agencies were transferred to private ownership through privatization initiatives. Most of them were transferred to well-established businesses that operated for profit or, in some cases, nonprofit organizations.

In addition, high level was also undertaken in some public sector services such as public works and employments. Majority of the governments in Central and Eastern Europe economies also started outsourcing key services and government functions that were not effective and economical to private firms. Majority of the services that were outsourced t private firms include law enforcement, revenue collection, as well as prison management among others. Most countries successfully privatized public enterprise and did not encounter major oppositions except in Belarus (Aidukaite 2011, p 45). Most countries completely large scale privatization during their first decade of the transition process.

Effects on the Economy

The restructuring of economic sector and privatization of most public institutions in Central and Eastern Europe economies created a viable financial sector in the region. For instance, the privatization made the enterprises in these countries more capable of producing goods sufficiently and effectively. As a result, the productivity as well as the profitability of the enterprises improved significantly in the countries that undertook bold institutional reforms. The benefit of privatization and restructuring was evidence in the building of sound business environment, which allowed firms to expand and invest where necessary to spearhead economic growth. The result of privation was increase in economic growth as experienced by most countries across the region (Nepal & Jamasb 2012, p 102).

(d) Reforms in the energy sector

Energy sector was a prime target of system institutional reforms because of its significant roles in the economic development of the country; in every country, energy sector plays significant roles in either slowing or accelerating the economic development and systemic changes. The technical structure of energy sector of most countries in this region has always tended towards the establishment of natural monopolistic systems (Rodríguez-Pose & Maslauskaite 2012, p 56). Before institutional reforms, energy sectors in Central and Eastern Europe economies was highly politicized due to its strategic aspect in supplying the country’s security. In essence, the energy sector was serving several different social, geopolitical, ideological, as well as other purposes in the region. Reforms in the energy sector started with structuring and privatization as well as outsourcing of key business areas.

Reforms in the energy sector were initiated to achieve speedy microeconomic growth by all countries in the region. This is because most economic sectors of the transitional economies highly depended on energy production. This was undertaken primarily to bring the economy under control as well as create conducive business and investment environments. This reform demanded liberalization of the energy sectors from government control and monopolization (Hamm, King & Stuckler 2012, p 98).

Effects on the Economy

Reforms in the energy sector led to a change in the management thus ‘freeing’ the industry from hierarchical organization that was dominated by communist ideologies. The economic criteria such as reserves, costs, as well as profits started becoming significant factors in the energy sector unlike before the institutional reforms when it was highly politicized, leading to increased energy production in the region (Prishchepov et al. 2012, p 58). The productivity cost also reduced while at the same time efficacy was enhanced. Reforms in the energy sectors subsequently led to reduced unemployment rates in most countries in the central and Eastern Europe economies.

Reforms in the energy sectors resulted in sustainable macroeconomic stabilization across the region. Most countries benefits from lean energy sector (Cook (2013, p 87). The politicisation of the energy production was also significantly reduced. The result of reforms in the energy sector was increased production, profitability, and rapid growth of other industries.

Conclusion

Starting from early 1980s, transitional economies in Central and Eastern Europe took a number of institutional reforms that had significant economic impacts. Such institutional reforms, as discussed above, opened up the economy but also created a number of negative effects such as high inflation, which was quickly controlled. Almost all countries in Central and Eastern Europe suffered high inflation following the institutional reforms. The institutional reforms targeted various areas of the economy such as governance, privatization, labour market, competition policy, as well as enterprise restructuring. However, even though beneficial, some institutional reforms faced major oppositions due to various vested interests coming from some quotas of the economy and politics. Countries that undertook bold institutional reforms quickly benefited from faster income convergence and economic recovery leading to high rate of development and investments (Bell & Mickiewicz 2013, p 90). The region benefited from high capital investments and large FDI inflows due to implementation of institutional reforms.

 

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