Economic Research Forum (ERF)

How to reform: lessons for MENA from post-communist transition

What can reformers in the MENA region learn from the transition experiences of the formerly communist countries of Central and Eastern Europe and the former Soviet Union? This column outlines several insights – first and foremost, that economic reforms do not succeed without political reforms.

In a nutshell

To achieve sustainable growth, reforms should be designed and sequenced in such a way that their benefits are broadly shared and the public has equal access to emerging economic opportunities.

Reforms cannot be delayed indefinitely, as they were in the Soviet Union, where governments refused to undertake decisive reforms of inefficient economic structures.

The complexity of designing sustainable and inclusive market reforms should not be used as an excuse for non-reform.

The Arab Spring has shown that the old model of economies in Middle East and North Africa (MENA) is no longer sustainable. While the post-Arab Spring experience has been very heterogeneous, it is clear now for every country in the region that reforms are needed. Their societies should become more open and inclusive, their political institutions more transparent and accountable, and their economies more internationally integrated and less reliant on state ownership.

The European Bank for Reconstruction and Development (EBRD) is now operating in a growing number of Arab countries and territories. What lessons for MENA can be taken from the post-communist countries that have been our traditional focus of operations?

Despite many differences between Central and Eastern Europe and the former Soviet Union, on the one hand, and MENA, on the other, one obvious similarity is the objective of the reforms: the citizens of these countries would benefit from transition to a market-based economy developing (or preserving) democratic political institutions.

While nowadays we have a much more nuanced view of the balance between state and market than in the early 1990s, there is still no sustainable alternative to democracy, a market economy and international integration. Neither state capitalism nor crony capitalism can deliver peace, prosperity and social cohesion.

Critics of this view often refer to China – but China itself is also moving in the direction of private ownership and international integration. Moreover, China’s spectacular growth has mainly been driven by private or privatised firms, while imbalances and risks have arisen due to inefficiencies and incentive problems in the state sector.

On the other hand, even though there is a general consensus on the destination point, it is much harder to figure out how to get there. And this is where the experience of post-communist transition offers several important insights.

First and foremost, we know that economic reforms do not succeed without political reforms. The 2013 Transition Report (EBRD, 2013) showed that in the post-communist region, there is a strong positive correlation between the quality of democratic institutions and pro-market economic reforms. There are countries that have become democracies – and these are precisely the countries that have built sustainable market economies that are well integrated into the global economy.

At the other end of the spectrum, there are countries that have reversed democratic reforms and built crony capitalism – naturally failing to complete market reforms. There are no countries that managed to combine a centralised political system and a competitive, transparent, non-corrupt economy. In other words, in the post-communist transition, democratic and economic reforms have gone hand in hand.

In last year’s Transition Report (EBRD, 2016), we argue that this experience can be explained by the fact that the success of reforms depends on their political legitimacy. In this report, we rely on disaggregated data on the evolution of the income distribution – thus looking beyond growth in GDP or average income.

We also use data from the ‘Life in Transition Survey’ undertaken jointly by EBRD and the World Bank (Aksoy et al, 2017). We show that in many transition countries, reforms have resulted in impressive GDP growth but they have not delivered prosperity for the majority of their citizens. Not surprisingly, in such countries, reforms have been rejected.

Moreover, in many of these countries, dissatisfaction with reforms has resulted in the rise of populist politicians who then centralised political power, removed checks and balances and built crony capitalism. On the other hand, countries that built up inclusive political institutions of democracy managed to share the benefits of reforms more broadly – thus preventing a reversal of reforms.

Given that post-communist countries started transition with virtually complete equality in nominal incomes, all of them have experienced an increase in measured income inequality. But not all increases in inequality have resulted in reduced support for reforms.

In line with recent evidence from psychological research (Starmans et al, 2017), we show (Guriev, 2017) that residents of post-communist countries actually prefer fair inequality to unfair inequality. But they do not accept unfair inequality – which we define and measure as inequality of opportunity. Inequality of opportunity is the part of inequality that is explained by factors beyond an individual’s control – such as parental background, place of birth, gender, ethnicity and race.

We show that it is this kind of inequality that results in lower support for reforms. In contrast, the residual inequality – driven by effort and luck – does not give rise to rejection of reforms. It is not surprising as the differences that emerge due to effort – rather than driven by circumstances of birth – are perceived as fair inequality and are socially acceptable.

This analysis has clear implications for MENA reformers. Replacing inefficient economic institutions does bring economic growth. But to make reforms and growth sustainable, the reforms should be designed and sequenced in such a way that the benefits of the reforms are broadly shared and that the public has equal access to economic opportunities emerging due to the reforms.

This is of course easier to do in more open and inclusive political systems. The argument that it takes an autocratic regime to force through unpopular reforms may backfire: if the interests of too many are neglected, the reforms will eventually be reversed.

But the other important lesson from command economies is that reforms cannot be delayed indefinitely. The Soviet Union was a global superpower. As described in Alexei Yurchak’s insightful account of the beliefs of the last Soviet generation (Yurchak, 2005), it was supposed to last forever. One after another, Soviet governments refused to undertake decisive reforms of inefficient economic structures.

The Soviet Union ran out of resources and was no more – thus providing the ultimate proof of Herbert Stein’s famous law: if something cannot go on forever, it will stop. The complexity of designing sustainable and inclusive market reforms should not be used as an excuse for non-reform.

Further reading

Aksoy, Cevat Giray, Francesca Dalla Pozza and Ralph De Haas (2017). ‘The LiTS Survey: A Decade of Measuring Transition’, VoxEU.org, 17 August.

EBRD (2013) Stuck in Transition? Transition Report 2013, European Bank for Reconstruction and Development.

EBRD (2016) Transition for All: Equal Opportunities in an Unequal World – Transition Report 2016-17, European Bank for Reconstruction and Development.

Guriev, Sergei (2017) ‘Impact of Cycle on Growth: Human Capital, Political Economy, and Non-performing Loans’, in Investment and Growth in Advanced Economies, European Central Bank, Frankfurt am Main.

Starmans, Christina, Mark Sheskin and Paul Bloom (2017) ‘Why People Prefer Unequal Societies’, Nature Human Behaviour 1: 0082.

Yurchak, Alexei (2005) Everything Was Forever, Until It Was No More: The Last Soviet Generation, Princeton University Press.

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