Stabilization, adjustment, and growth prospects in transition economies

Political change marked the difference between the approaches of the countries of Eastern Europe and the former Soviet Union (FSU). The Baltics and most Eastern European countries wanted to break away from communism and the FSU domination--so their transition was characterized first by political change. Communists were discredited and removed from power, creating a period of"extraordinary politics"and a window of opportunity for reform. The collapse of the FSU did not lead to political change in most FSU states. There were indications of discontent with the Union, but except for the Baltics these were not as strong as in the Eastern European countries and there were no explicit demands for independence. The former communists hoped that the Commonwealth of Independent States (CIS) set up after the collapse of the FSU would evolve into a loose federation maintaining old trade and financial links. Many FSU countries avoided policies different from Russia's. Most political leaders did not initially think that they would need structural reform policies which could diverge from Russian policies. The pace of reform quickened only after the collapse of the ruble zone in the FSU in 1993. Knowing where to go helped shape reform. The Eastern European and Baltic countries, wanting to join the European Union and encouraged to do so, first initiated political reform, which led to economic reform. Most FSU countries, not knowing with whom to align, initially saw no choice but the Russian Federation. Once reforms are launched, the outcomes are quite similar. Growth starts about two full years after stabilization, although it took about a year longer in the FSU. Initial conditions are important to the transition. Short to medium-term prospects seem most favorable to Eastern Europe and the Baltics, although they still have to catch up with the OECD countries. If admitted to the European Union, they may attain high growth rates even in the longer term. The FSU countries have even more catching up to do. In the short to medium-term, countries with slower population growth rates and strong reform efforts should enjoy rapid per capita growth. The Central Asian countries, with their high population growth rates, need economic growth rates faster than their population growth rates. This leaves little room for slowing reform. Given the benefits of integration, there is a strong case for Central Asian countries pushing for an economic union, which would also facilitate the restructuring of their economies.Public Health Promotion,Economic Theory&Research,Economic Conditions and Volatility,Environmental Economics&Policies,Banks&Banking Reform,Achieving Shared Growth,Governance Indicators,Economic Conditions and Volatility,Economic Theory&Research,Environmental Economics&Policies

Foreign entry in Turkey's banking sector, 1980-97

Despite high and volatile inflation, a record number of foreign and local banks entered Turkey's banking sector after the country relaxed rules about bank entry, and generally eliminated controls on interest rates, and financial intermediation in 1980. The country's financial integration with the rest of the world took a big step forward with the opening up of the capital account in 1989. Capital inflows rose significantly, and the financial system became increasingly linked with external markets. The author examines one dimension of liberalization: the impact of foreign banks entering the financial sector. Between 1980 and the end of 1997, 17 foreign banks, and a number of new local banks entered the sector. The author investigates how these banks'entry into the sector affected performance, based on three measures: net interest margin, overhead expenses, and return on assets (all expressed as a percentage of total assets). He finds that: 1) Foreign bank ownership is related to all three performance measures. 2) Foreign bank entry reduced the overhead expenses of domestic commercial banks, strengthening profits. 3) Despite their small scale operations, foreign banks entering the sector had a strong effect on competition. But the market could use more competition. 4) There are strong indications that foreign banks had a positive impact on financial, and operational planning, credit analysis and marketing, and human capital.Payment Systems&Infrastructure,Financial Intermediation,Financial Crisis Management&Restructuring,Banks&Banking Reform,Banking Law,Banks&Banking Reform,Financial Intermediation,Banking Law,Financial Crisis Management&Restructuring,Municipal Financial Management

Mongolia - Privatization and system transformation in an isolated economy

The authors examine the process of economic transformation in Mongolia, a huge, isolated, sparsely populated country. After identifying factors that led to formulation of a radical adjustment program in such an isolated country, they focus on Mongolia's innovative voucher privatization scheme, and the interplay between the speed of contraction in resource availability and that of the movement to a market economy. They show that the reform process was not smooth: that after the rapid formulation and implementation of major reforms, there was a marked slowdown, when reform timetables were revised and a more gradualist approach adopted. Later, reforms driven by the privatization program picked up momentum again. But one important lesson learned in Mongolia is that voters are likely to shy away from radical reformers when faced with growing shortages and a collapsing economy. In June 1922, the Mongolian People's Revolutionary Party (the former communist party) was returned to power in general elections, capturing 72 of 76 parliamentary seats. The authors identify factors related to speed versus caution: organization and institutional limitations; political considerations; whether a model of transformation exists; and a contracting resource envelope. Using a simple computable general equilibrium model, they analyze the impact of the cutoff of Soviet aid, which amounted to 30 percent of GDP, and of the disruption of trade. They conclude that preventing a decline in welfare of more than 20 percent - which is close to the decline in 1991 - would require aid flows of about 15 percent of GDP. Their model suggests that the rural sector is reasonably well insulated from external shocks, in sharp contrast with the urban sector. One response scenario explored by the model is that of massive reverse migration to rural areas. They point out that the more the resource envelope tightens and squeezes away the margin above subsistence, the harder it will be to sustain an orderly pattern of reform. In the extreme, this pattern may force the country to adopt a rationed wartime economy, despite intentions to shift to a market system.Economic Theory&Research,Banks&Banking Reform,Environmental Economics&Policies,Municipal Financial Management,Access to Markets

The effects of financial liberalization and new bank entry on market structure and competition in Turkey

Until 1980 Turkey's financial system was shaped to support state-oriented development. After the 1960s the financial system, dominated by commercial banks, became an instrument of planned industrialization. Turkey had an uncompetitive financial market and an inefficient banking system. Controlled interest rates, directed credit, high reserve requirements and other restrictions on financial intermediation, and restricted entry of new banks -plus the exit of many banks between 1960 and 1980- created a concentrated market dominated by banks owned by industrial groups with oversized branch networks and high overhead costs. Turkey since 1980 has seena trend toward liberalization of its financial market. Reforms eliminated interest rate controls, eased the entry of new financial institutions, and allowed new types of instruments. Regulatory barriers were relaxed, attracting many banks (both Turkish and foreign) into the system, and Turkey's banking system became integrated with world markets. The author examines how reform has changed the system, focusing on Turkey's commercial retail banking market. He finds that: (1) Although reform reduced concentration in the industry, leading banks are still able to coordinate their pricing decisions overtly. High profitability appears to have resulted from the banks uncompetitive pricing rather their efficiency. Deregulation and liberalization should be continued and strengthened. (2) The entry of small-scale firms alone is not enough to increase competition, so new banks should probably not be expected to alter the market structure. (3) To promote competition will require addressing barriers to both entry and mobility. The main barrier to mobility seems to be the size of the large banks, which exerts a significant negative effect on competition. (4) Interbank rivalry among the leading banks cannot be facilitated without creating new banks of a certain size with a reasonable number of branches. Breaking up public banks (which hold 30 percent of sectional assets, excluding the Agricultural Bank and three development banks) could help create 15 to 20 new banks with 40 to 50 branches. This would reduce concentration and improve mobility in retail banking. (5) Breaking up public banks before privatization would probably also improve their governance structures and efficiency. (6) Promoting the entry of nonbanks and local banks would also increase the number of institutions competing for deposits. Turkey lacks a healthy variety of credit institutions and should consider developing a mortgage market and creating institutions for housing finance.Payment Systems&Infrastructure,Financial Intermediation,Economic Theory&Research,Banks&Banking Reform,Markets and Market Access,Banks&Banking Reform,Financial Intermediation,Economic Theory&Research,Markets and Market Access,Access to Markets

The savings collapse during the transition in Eastern Europe

The authors assess the presence and extent of involuntary savings by comparing the predicted savings rates of market economies with those of the pre-transition economies. On balance, predicted savings rates fell short of actual savings rates, especially for the former Soviet Union and the Baltics -- providing some support for the notion of excessive pre-transition savings. Comparing the savings behavior of market economies and transition economies, they found substantial similarities, except for a negative link between savings and GDP growth. As the fastest-growing transition economies are at the bottom of the adjustment J-curve, the finding is consistent with consumption smoothing. Finally, they explored whether differences in the extent of economic liberalization affected savings rates in the cross-section of transition economies. They found that liberalization is associated with lower savings, with a one-year lag. To the extent that liberalization is perceived as an indicator of likely future growth, this behavior is consistent with smoothing in the face of a J-curve change in output.Insurance Law,Banks&Banking Reform,Economic Theory&Research,Environmental Economics&Policies,Insurance&Risk Mitigation,Environmental Economics&Policies,Banks&Banking Reform,Economic Theory&Research,Insurance&Risk Mitigation,Rural Poverty Reduction

Monetary policy during transition : an overview

In this paper, the authors examine monetary policy in 26 transition economies in Central and Eastern Europe (CEE) and the Former Soviet Union (FSU) between 1989-1994. They provide a schema for classifying the use of 6 important monetary policy instruments, both direct and indirect, and suggest criteria for defining market-oriented use of these instruments. They assess the extent of market-oriented instruments use during the period under review and around stabilization. The impact of instrument use on inflation and financial depth, which declined dramatically during the transition's early years, is also explored. The authors indicate several clear patterns. Among them, by the end of 1994, slightly less than half the countries were relying primarily on market-oriented forms of monetary instruments and had moderate or low reliance on such instruments. Countries quickly formulating a monetary policy response were more likely to switch to market-oriented instruments. Second, CEE countries moved more rapidly than FSU countries towards these forms, even when stage of stabilization is controlled for. Third, using credit ceilings appeared helpful in the year of stabilization, especially in CEE countries; the elimination of these controls was associated with effective stabilization. The authors conclude that monetary stability goes hand in hand with adjustment in the real sectors. Generally, the relatively weak link between market orientation of instruments and indicat effective suggests thst inflation control and financial depth are more directly related to policy stance, which is in turn related to broader structural reforms.Payment Systems&Infrastructure,Economic Theory&Research,Fiscal&Monetary Policy,Environmental Economics&Policies,Banks&Banking Reform,Macroeconomic Management,Environmental Economics&Policies,Banks&Banking Reform,Economic Stabilization,Economic Theory&Research

Good countries or good projects ? macro and micro correlates of World Bank project performance

The authors use data from more than 6,000 World Bank projects evaluated between 1983 and 2009 to investigate macro and micro correlates of project outcomes. They find that country-level"macro"measures of the quality of policies and institutions are very strongly correlated with project outcomes, confirming the importance of country-level performance for the effective use of aid resources. However, a striking feature of the data is that the success of individual development projects varies much more within countries than it does between countries. The authors assemble a large set of project-level"micro"correlates of project outcomes in an effort to explain some of this within-country variation. They find that measures of project size, the extent of project supervision, and evaluation lags are all significantly correlated with project outcomes, as are early-warning indicators that flag problematic projects during the implementation stage. They also find that measures of World Bank project task manager quality matter significantly for the ultimate outcome of projects. They discuss the implications of these findings for donor policies aimed at aid effectiveness.Housing&Human Habitats,Poverty Monitoring&Analysis,Banks&Banking Reform,Economic Theory&Research,Country Strategy&Performance

Capital flows, macroeconomic management, and the financial system - Turkey, 1989-97

Recent developments in a number of emerging economies have heightened interest in the relationship between macroeconomic management and financial regulation, in an environment of open capital accounts and large-scale movements of private capital. The authors analyze the Turkish experience with capital flows in a macro-economy characterized by chronically high inflation and fiscal deficits. They study the relationship between capital flows, macroeconomic management, and vulnerability in the financial system. Their analysis highlights the importance of fiscal policy in an era of large capital flows. Fiscal imbalances contributed both to real exchange rate appreciation and high real interest rates in Turkey. The high interest rates the government must pay on domestic debt have become one of the key issues of Turkey's macroeconomic management. Only by reducing its interest expenses can fiscal deficits be reduced and greater stability be achieved. The Turkishbanking system, in becoming increasingly integrated with international financial markets, has become vulnerable to shifts in market confidence. Banks borrowed abroad in response to macroeconomic imbalances to benefit from high interest rates on domestic loans and government paper. In the process, the banks have exposed themselves to interest rate risk, to foreign-exchange risk, and to large credit risks. To reduce the Turkish economy's vulnerability to external shocks, financial regulation must be strengthened simultaneously with the achievement of macroeconomic stability.Capital Markets and Capital Flows,Fiscal&Monetary Policy,International Terrorism&Counterterrorism,Economic Theory&Research,Banks&Banking Reform,Macroeconomic Management,Economic Theory&Research,Banks&Banking Reform,Financial Economics,Settlement of Investment Disputes

Development Economics and the International Development Association

Prevailing economic ideas -- and fashions -- about development have influenced the International Development Association (IDA) since its creation in 1960. The creation of the organization itself is the result of two contemporaneous facts: an urgent need to channel development finance to least-developed countries and an increasing pressure on World Bank management to directly address the issue of poverty in developing countries. Changing views, over time, have been a rationale -- and, at times, a justification -- for emphasizing poverty and social sectors; for providing grants to particular groups of countries; and for strategic choices and sectoral priorities. IDA has been influential in development debates and been an advocate for specific views about development policy. This paper gives an overview of these views and documents how they have shaped the activities of the organization since its creation. After a brief review of development thinking and of the organization of research at the World Bank, the paper documents the shifts that have taken place in country allocations and in sector emphasis in IDA over the past 50 years and highlights the strategic themes that have guided its development agenda: toward increasing country selectivity; from projects to programs; from conditionality to country ownership of reforms; and from input-based to results-based performance.Economic Theory&Research,Environmental Economics&Policies,Banks&Banking Reform,Achieving Shared Growth,Debt Markets

Household savings in transition economies

During the transition from central planning to market economies now under way in Eastern Europe, output levels first collapsed by 40 to 50 percent in most countries, then staged a modest recovery in the last two years. Longer-term revival of growth requires a resumption of investment and thus, realistically, of domestic savings. To explore the determinants of household savings rates in transition economies, the authors studies matching household surveys for three Central European economies: Bulgaria, Hungary, and Poland. They find that savings rates strongly increase with relative income, suggesting that increasing income inequality may play a role in determining savings rates. Savings rates are significantly higher for households that do not own their homes or that own few of the standard consumer durables-possibly because, with no retail credit or mortgage markets, households must save to purchase houses and durables. The influence of demographic factors broadly matches earlier findings for developing countries. Perhaps surprisingly, variables associated with the household's position in the transition process-including either sector of employment (public or private) or form of employment-do not play a significant role in determining savings rates.Environmental Economics&Policies,Services&Transfers to Poor,Economic Theory&Research,Banks&Banking Reform,Payment Systems&Infrastructure,Safety Nets and Transfers,Rural Poverty Reduction,Environmental Economics&Policies,Banks&Banking Reform,Economic Theory&Research