Lessons from transition economies: strong institutions are more important than the speed of reform

After the Soviet Union collapsed in December 1991 and market reforms were initiated, the economic performance of the successor states was disappointing. The reduction of output that occurred in the former Soviet Union during the 1990s should be considered as an exceptional case in world economic history since no extraordinary circumstances, such as wars, epidemics, natural disasters have occurred.

The paper attempts to identify the underlying reasons for the dramatic decline in output, living standards and life expectancy in the former Soviet Union (FSU). The paper addresses three key questions:

• why has the reduction of output and incomes in FSU been so deep and so long?
• to what extent was this collapse caused by the initial conditions and circumstances, i.e. predetermined and hardly avoidable?
• to what extent was it “man made”, i.e. the result of poor economic policy choices?

The paper’s explanation for the collapse of output in the FSU is that the speed of reform per se (shock versus gradual transition) did not matter a great deal. The unique magnitude of the recession was caused primarily by the following factors:

• greater distortions in industrial structure and external trade patterns on the eve of the transition
• the collapse of state and non-state institutions, which occurred in the late 1980s - early 1990s and which resulted in chaotic transformation through crisis management instead of organized and manageable transition.
• poor economic policies, which basically consisted of macroeconomic instability and import substitution, whether the pursued reforms were gradual or radical
• weak institutional capacity of the state and the lack of enforcement of rules and regulations

The author concludes that differing performance during transition depends mostly on the strength of institutions and not so much on the progress in liberalization per se. The author attributes the dramatic decline in output and living standards in the former Soviet Union to the absence of strong institutions and the ability to enforce law and order. The author recommends that a combination of the rule of law and democracy is required in the FSU in order to deliver efficient institutions and economic recovery.