INSTITUTION BUILDING IN THE CIS-7: ROLE OF THE INTERNATIONAL COMMUNITY

Paul Hare, Heriot-Watt University, UK

The paper was prepared for the Lucerne Conference of the CIS-7 Initiative, January 20-22, 2003

The usual institutional disclaimer applies

Ideas and views set out in this paper are wholly those of the author and in no sense represent the official position or policy of any of the IFIs taking part in the CIS-7 Initiative, nor of their member governments. Likewise, any errors or omissions are entirely the author’s responsibility. However, the author appreciates the helpful comments from IFI staff on an earlier draft of the paper; these have led to numerous corrections and improvements. Further comments may be forwarded to the author by e-mail at: [email protected]

TABLE OF CONTENTS Executive Summary .................................................................................................................5 Institution Building in the CIS-7: Role of the International Community ..........................8 1. Introduction......................................................................................................................8 2. The CIS-7: Recent Trends and Current Situation .......................................................9 3. State Formation and Institution Building ...................................................................10 State Building ..............................................................................................................10 Political Shocks............................................................................................................11 Economic Shocks.........................................................................................................11 4. The Contribution of the International Community....................................................17 4.1 Summary Data ...........................................................................................................17 4.2 Moldova .....................................................................................................................20 Aid for institution-building..........................................................................................20 How effective has it been?...........................................................................................20 What remains to be done?............................................................................................21 Next steps - new directions for aid to Moldova...........................................................22 4.3 Armenia .....................................................................................................................23 Aid for institution-building..........................................................................................23 How effective has it been?...........................................................................................23 What remains to be done?............................................................................................24 Next steps - new directions for aid to Armenia ...........................................................24 4.4 Azerbaijan..................................................................................................................25 Aid for institution-building..........................................................................................25 How effective has it been?...........................................................................................25 What remains to be done?............................................................................................25 Next steps - new directions for aid to Azerbaijan........................................................26 4.5 Georgia.......................................................................................................................26 Aid for institution-building..........................................................................................26 How effective has it been?...........................................................................................26 What remains to be done?............................................................................................27 Next steps - new directions for aid to Georgia ............................................................27 4.6 Kyrgyz Republic ........................................................................................................28 Aid for institution-building..........................................................................................28 How effective has it been?...........................................................................................28 What remains to be done?............................................................................................29 Next steps - new directions for aid to the Kyrgyz Republic ........................................29 4.7 Tajikistan ...................................................................................................................29 Aid for institution-building..........................................................................................30 How effective has it been?...........................................................................................30 What remains to be done?............................................................................................30 Next steps - new directions for aid to Tajikistan .........................................................30 4.8 Uzbekistan .................................................................................................................31 Aid for institution-building..........................................................................................31 How effective has it been?...........................................................................................31 What remains to be done?............................................................................................31 Next steps - new directions for aid to Uzbekistan .......................................................32 5. Common Features of, and Problems with, Aid to the CIS-7 .....................................32 3

6. Conclusions: Next Steps ................................................................................................34 Voluntary colonialism..................................................................................................36 Copying of institutions.................................................................................................37 Local and regional experiments...................................................................................37 Aid linked to performance ...........................................................................................38

EXECUTIVE SUMMARY 1. Recent economic trends and reform progress in the countries of the CIS-7 are summarised, showing that they have suffered especially severe declines in average income (as compared to other economies in transition), accompanied by massive increases in poverty as measured by various simple indicators. 2. While all seven countries have achieved significant progress in market-building economic reforms, notably in regard to small privatization, and trade and the foreign exchange system, other important areas such as large privatization and price liberalization are mostly lagging behind. Corporate governance, infrastructure reforms and legal reforms have also progressed quite slowly. 3. The key reform tasks of the countries in terms of state formation and constructing the new institutions needed to operate a market-type economy are outlined. Three major areas of difficulty for aid donors are highlighted: (a) the objectives of the recipient states might not accord with donor views on moving towards a market-type economy; (b) theories of institutional design are not well developed, limiting both our understanding of the institutions needed for a well functioning economy, and of the linkages between institutional change and subsequent economic performance; and (c) there are serious lacunae in our understanding of the political economy of aid itself. 4. Aid flows from the IFIs and other donors are summarised, notably for the years 1998, 1999 and 2000. Net aid flows to the CIS-7 in the year 2000 ranged from 1.4% of GDP in the case of Uzbekistan - reflecting the limited engagement of that country with either the IMF or the World Bank - to a high of 17.8% for the Kyrgyz Republic. Of the overall gross flows to each country, the bilateral share was just 27% of the total for Tajikistan, rising to 71% for Georgia and 72% for Uzbekistan in the same year. 5. Net private investment flows to the region are virtually zero for four of the countries: Armenia (though flows from the Armenian Diaspora have recently been substantial), Georgia, the Kyrgyz Republic and Tajikistan. For Moldova, private flows were very substantial in 2000 (nearly 40% of GDP); they were also moderate in Azerbaijan (about 8% of GDP). Uzbekistan has experienced very fluctuating private capital flows, less than 1% of (officially recorded) GDP in 2000. The countries have not thus far proved especially attractive to foreign investors. 6. On the other hand, their growth performance since the mid-1990s has in some instances been impressive - albeit from a low base. 7. For each of the seven countries, the paper reviews how much aid has been provided, assesses how effective it has been in promoting institutional development, proposes three or four major areas of reform requiring attention, and outlines initial steps that might be considered to take such reforms forward. In all cases, the proposals need to be examined in the light of the often very considerable positive progress already achieved, including subtantial much needed institutional change already supported by aid from the IFIs. 5

8. In the case of Moldova, the three major areas suggested were: trade policy and operational practice; SME support and the surrounding legal/regulatory framework; civil service laws - and perhaps wider legislation on the operation of the labour market. 9. Urgent reform measures for Armenia included improving the investment climate; encouraging further privatisation and industrial restructuring; improve the environment for SMEs, including improved access to financing. 10. In Azerbaijan, key areas needing urgent reform included: infrastructural development; reform of electricity pricing and collection arrangements; and reform of the social safety net to provide better targeting of benefits. 11. For Georgia, aside from continuing efforts to unify the country or accept the de facto autonomy of certain regions, together with measures to improve management of the budget and fiscal policy, particularly urgent steps are needed in the following areas: reduction of corruption at all levels, improvements in governance; improvements in the general business environment; improvements in business-related infrastructure. 12. With its apparently renewed commitment to reform, there is an opportunity for the Kyrgyz Republic to achieve more rapid progress now, despite a difficult trading environment resulting from restrictive policies followed by neighbouring countries. Important areas for reform include: reforms in the agriculture sector; improving and targeting the social safety net; improving the composition and targeting of social spending (e.g. by concentrating resources on basic health care, basic education). 13. The political environment in Tajikistan remains difficult but it is important to undertake reforms that will benefit the country and foster growth even under present conditions, such reforms ideally contributing to a gradual enhancement of the country’s political stability and cohesion. Suggested reforms included: improving public administration and reforms of the civil service; improving the general business environment; and gradual elimination of quasi-fiscal subsidies in the energy sector. 14. Uzbekistan has enjoyed greater political stability than the other CIS-7 countries, but has chosen to use that stability to limit reforms in most areas of economic policy. Hence much remains to be done. A few key areas highlighted in the paper are: trade and exchange rate policy (incl. the exchange rate regime); privatisation of SOEs, and associated restructuring; support for SMEs; and reform of the all important cotton sector. 15. Common areas of reform important for the whole region, and still needed sustained attention, included the reform and liberalisation of agriculture; and extensive reforms to improve the business environment. 16. Aid programmes often gave rise to difficulties requiring quite sensitive treatment in relation to their need for counterpart funding, i.e. funding by the recipient government to provide local staffing and other resources needed to enable an aid programme to be effective. At times the agreed counterpart provision had not been in place, and this could delay project implementation and/or reduce project benefits. In addition, aid programmes

commonly impact on local labour markets in two ways: (a) by attracting skilled personnel who may in any case be in very short supply in the country concerned; and (b) by occupying considerable time of senior ministry staff in the recipient departments. These effects need to be borne in mind in designing future aid programmes. As ever, the conditionality associated with most aid programmes proves controversial, but it is clearly important both in aligning donor and recipient goals and in providing incentives for compliance. 17. Regional issues were found to be important for most of the CIS-7, by which I mean issues that cannot be solved by an individual country acting alone. Such issues included the problems of energy and water management and trade for the Central Asian countries, and wider issues of trade policy where progress clearly depended on cooperation from neighbouring countries to overcome barriers and bottlenecks, both logistical and administrative. 18. While much valuable institutional change has already taken place across the CIS-7, including a great deal supported by the IFIs, this paper has identified numerous areas where further reform is needed. In order to build up political support for reforms, the paper proposed focusing attention on a limited number of major reform areas in each country where tangible successes could be achieved fairly rapidly; with opportunities for learning across the region, copying best practice, and so on. This is in contrast to the more familiar approach whereby many reforms are expected to proceed simultaneously across a broad front. In practice the two approaches may differ less than I have implied, since nothing in my suggestions prevents the governments of the CIS-7 from making progress in areas in addition to those around which aid programmes might be focused. 19. The analysis set out here is in terms of a series of linkages: aid programme - institutional reforms - improvements in economic performance (GDP growth, poverty reduction). However, it is important to stress that the last link - that from institutions to growth - is poorly understood, and only likely to occur over quite a long period of time. Hence while we believe that many institutions are important for a market economy to function well, there are many details where we cannot be at all prescriptive, and many linkages within a given economy that have to be functioning before reforms start to reveal their benefits in terms of aggregate performance. 20. The paper concludes by discussing briefly four interesting, albeit quite controversial, approaches towards the general issue of assisting the CIS-7 to achieve sustained improvements in their economic performance. These approaches are: (a) voluntary colonialism; (b) the copying of institutions; (c) local or regional experiments; and (d) linking aid to performance.

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INSTITUTION BUILDING IN THE CIS-7: ROLE OF THE INTERNATIONAL COMMUNITY 1. INTRODUCTION Across the CIS, living standards have fallen substantially since the break-up of the Soviet Union in 1991. Seven of the smaller CIS countries have suffered especially severe declines in average income, accompanied by massive increases in poverty as measured by various simple indicators. In order to address these challenges, the CIS-7 Initiative was launched in April 2002 as a joint project of the IMF, World Bank, Asian Development Bank, and the EBRD (see Press Release, IMF, 2002b). While emphasising that the CIS-7 countries themselves - namely Moldova, Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Tajikistan and Uzbekistan - bear primary responsibility for their respective destinies, the Initiative envisages that the international community would extend strong support to those CIS-7 countries implementing vigorous reforms. According to IMF (2002b), this assistance will include four elements: o

More concessional financial support, as well as debt restructuring or debt relief where needed, in conjunction with strong reform programs, so that resources are well used;

o

Increased access for CIS-7 countries to industrial countries’ markets and promotion of direct investment;

o

Improved coordination between development agencies, anchored in country-led poverty reduction programs; and

o

Added support from international and regional institutions through technical assistance, policy advice and concessional financial assistance (including grants) in support of the reform efforts of the CIS-7 countries.

The main focus of the present paper is on the last of these four elements, with a little attention on the third. In order to design new modalities of international support to the CIS-7, it is clearly important to review the assistance already provided since 1991, and to assess its effectiveness with a view to drawing out lessons for the future. Since this is already rather a broad topic, I focus more narrowly below, seeking specifically to assess the role of international support in promoting and assisting institutional development in the CIS-7. Accordingly, the paper proceeds as follows. The next section presents a brief overview of recent economic trends and reform progress in the seven countries. Section 3 defines the key reform tasks of the countries in terms of state formation and constructing the new institutions needed to operate a market-type economy. The contribution of the international community towards accomplishing these tasks is sketched in Section 4 (reviewing both the IFIs, and other multilateral and bilateral flows), followed by an overview of some common themes in Section 5. It is, of course, all too easy to criticise past aid efforts with the advantage of hindsight, and with the advantage of more developed theoretical conceptions of the transition process than were available in the early to mid-1990s. I shall therefore try to avoid these mistakes in this

paper. Section 6 concludes by offering some concrete proposals for improving the effectiveness of the international community in supporting institutional development in the CIS-7. Before elaborating the detailed argument of this paper, however, it is useful to pause to indicate the key linkages that need to be established. The underlying conception we need to keep in mind is that of a causal chain linking: q needs/objectives of the country concerned; q aid flows; q institutional change; q subsequent economic performance of the country in terms of (a) overall GDP growth; and (b) poverty reduction and progress in improving other social indicators. It will be apparent in what follows that aid to the CIS-7 has already given rise to a massive amount of important institutional change, though there is much more to be done. To this extent the international community, and especially the IFIs through which most aid resources have been channelled, has achieved considerable success in promoting institutional change. Far less clear cut - and less well understood - are the linkages from institutional change to improved economic performance. Such improvements, when they come through at all, are likely to occur over a longer time scale than the implementation of a typical aid project, and may well require patience and persistence. Success may well also require a degree of selectivity and sensitivity, since as noted below we do know a good deal about the conditions under which aid efforts are unlikely to bear fruit. 2. THE CIS-7: RECENT TRENDS AND CURRENT SITUATION Table 1 presents a few basic economic and social indicators for the CIS-7, confirming that these countries are poor, both in terms of GDP per capita and the standard poverty measure; that they have experienced huge falls in GDP during the 1990s (with the interesting exception of Uzbekistan, on which see Zettelmeyer, 1999); that they are heavily indebted; and that foreign direct investment inflows have achieved at best moderate levels in the past few years. Table 2 draws on EBRD Transition Reports to assess the position of these countries in terms of various dimensions of economic reform, as of late 2002. While all seven countries have achieved significant progress in market-building economic reforms, notably in regard to small privatization, and trade and the foreign exchange system (except for Uzbekistan in the latter case), other important areas such as large privatization and price liberalization are mostly lagging behind. Even more significant, all seven countries have so far made at best only limited progress in regard to strengthening corporate governance and undertaking enterprise restructuring. Likewise, an effective competition policy is not yet well established in any of the CIS-7, and the financial institutions and associated markets are seriously under-developed. In the infrastructure sectors, often considered crucial for the smooth running of a market economy, the picture is generally bad, with many sectors at best only in the most preliminary stages of institutional reform. Even telecoms, an early candidate for market-based reform in many transition economies, and often attractive to foreign investors, has recorded surprisingly 9

little reform in the CIS-7. Three countries have made progress in reforming their electric power sectors, but otherwise there is still much to be done. Last, with legal reforms the picture is more mixed, with Moldova surprisingly far forward in its reforms, Azerbaijan and Tajikistan only in the early stages. In general, however, this is an area that needs to be assessed with some caution. For as the EBRD itself emphasises, there can be, and often are big differences between legal provisions formally “on the books” and the effectiveness of their implementation. Moreover, courts in general and the judiciary in particular are often not as carefully separated from the executive as they need to be to work well, and poor salaries and training often leave legal officials highly vulnerable to corruption. These problems are certainly widespread across the CIS-7. The underlying issue is a lack of familiarity with, and understanding of, the concept of “the rule of law”. 3. STATE FORMATION AND INSTITUTION BUILDING It is fair to say that the international community underestimated the difficulties of transition in the smaller CIS countries, especially those poor in key natural resources. Yet the CIS-7 have had to face remarkably severe problems, despite which they made impressive progress with reforms during the 1990s. These problems included the following: State Building The task of constructing new states - out of what were formerly Republican Governments within the Soviet Union enjoying rather limited powers - entailed establishing constitutions, governments, parliaments, political parties; as well as new currencies, central banks, fiscal authorities, social safety nets, etc.; and establishing borders, border controls, customs controls (since most former trade transactions and movements of people were within the former Soviet Union) (see Hare et al., 1999). The new states could not simply stand back and allow the market economy to “emerge” or, indeed to flourish unaided; rather, they had to be active states, active in areas wholly new and unfamiliar to the former Soviet administrations. To be effective in this endeavour, the states needed to be strong in the relevant sense, namely capable of designing economic policies and institutions suitable for a market economy; capable of writing and passing suitable legislation; and most importantly, capable of implementing the resulting laws in a fair and equitable manner. On the whole, the states of the CIS-7 were not strong in this sense. In particular, what we might usefully term the “implementation mechanism” under the former socialist system was essentially the communist party, with its network of party committees at every workplace, and at all levels of regional and local government. When party cells were removed from workplaces in 1990 and 1991, only the top levels of these societies’ implementation mechanism remained in place, namely the publication of decrees approved by a minister or by the Council of Ministers (cabinet), and of laws passed by the relevant parliament. The corresponding lower level structures were missing, and to a significant extent in the CIS-7 remain to be reconstituted.

Political Shocks With the exception of Uzbekistan, all the other countries of the CIS-7 have experienced civil or international conflict during the 1990s, with the unsurprising consequence that the momentum of and commitment to economic reforms has fluctuated considerably. Several of the conflicts remain unresolved, though active hostilities have mostly ceased. Many of the countries have experienced extreme instability in their governments, e.g. Moldova with 10 governments in 12 years. Moreover, the persistence of conflict and the inability of governments to establish secure conditions across the whole country has resulted in considerable out-migration from some of the CIS-7 (e.g. Moldova, Armenia, Georgia, Tajikistan). The same instability has also restricted, in some countries (e.g. Moldova, Tajikistan), the areas in which the International Financial Institutions (IFIs) and other aid donors could safely operate. Economic Shocks The countries experienced drastic adverse shifts in their terms of trade, especially due to the rise in energy prices towards world market levels. This was accompanied by the loss of major export markets in the rest of the former Soviet Union. Taken together with the countries’ poor access to and little knowledge of other potential markets, and the loss of the subsidies and transfers that formerly occurred as part of the Soviet budgetary system, the balance of payments of the CIS-7 countries came under considerable strain. Further, the above three problems contributed greatly to the accumulation of external debt by the CIS-7, notably to Turkmenistan and Russia to cover energy supplies. More recently, the region has been adversely affected by further shocks due to the Russian financial crisis (1998), and the follow up to the events of September 11th 2001. _______________ These complex circumstances - albeit not understood or properly anticipated in the early 1990s - have combined to make the design of institutional reforms to support a market-type economy in the countries of the CIS-7 unusually difficult. Several other factors have complicated the transition process for the CIS-7. These concern: (a) the objectives of these new states; (b) the poor state of theories of institutional design for a market economy; and (c) our limited understanding of the political economy of aid processes. I remark briefly on each of these points. (a) Objectives of new states In much of the literature on transition it is taken for granted that the states concerned wish to build market-type economies along western lines, and a great deal of the advice, support and aid they have received has been provided on that assumption. However for some states, including some of the CIS-7, this has clearly not been their immediate goal. Rather, their focus has been on political survival and on gradually establishing the conditions for political stability, with economic reforms sometimes coming a poor second to such core concerns. In other words, establishing the state in the first place has had to take precedence over the preparation and implementation of complex economic reforms. Moreover, even when a reasonably stable state is in place, such as in Uzbekistan, it cannot be taken for granted that rapid steps towards constructing a market economy would necessarily be acceptable to the government. 11

Hence in thinking about the role of IFIs, and the possible contributions of other aid donors, it is important always to have in mind the nature of the state in question, and to be aware of the type of economic system it seeks to construct. Needless to say, this would never preclude offering advice to the effect that some or other proposed institutional arrangement was likely to be ineffective or inefficient - not only with reference to how we think of a well functioning market economy, but with reference to the stated objectives of the state concerned. (b) Theories of institutional design How do we build a market economy, or more exactly, how do we advise and assist the countries of the CIS-7 to do so - in terms of the three principal types of aid, namely policy advice, technical assistance, and funding for projects? Several approaches can be envisaged: Respond to requests from the recipient government This takes the view that governments know what they want or need. Aid provided on this basis will at least in principle meet the recipient’s objectives, but it might not do much to meet such typical aid agency objectives as fostering sustained economic growth, reducing poverty, and the like. This highlights the point that aid agency objectives and the aims of recipient governments may well not coincide, though one hopes that there would be sufficient areas of overlap to permit constructive dialogue, constructive engagement. Respond to specific crisis situations Most emergency relief falls under this heading, but aside from that one can imagine numerous situations where, say, a balance of payments crisis prompts technical assistance to improve the recording and monitoring of international transactions, advice on export promotion and financing, and balance of payments support from the IMF. Likewise, a credit/banking crisis might stimulate assistance to reform the banking system, a budgetary crisis might give rise to assistance with tax reform, budget planning and prioritisation, and so on. In such cases, the recipient government is likely to be quite receptive to the support offered, whereas in more normal times it might not perceive these areas as requiring reform or significant policy intervention at all. A crisis often mobilises political support for reform in a particular area, at least in part by contributing to the (painful) learning process of political leaders and their advisers. On the other hand, crisis condition do not always offer the best setting in which to implement reforms. Prescriptive approach, based on standard views of what a market economy “needs” It is easy to write lists of the institutions needed by a well functioning market economy. The EBRD has implicitly done so in developing its so called transition indicators to measure progress towards a market economy, and I did so myself in Hare (2001). The fact remains that we do not know what is really required, at least not with great precision. The diversity of institutional structures around the world make clear that there are many ways of “solving” particular institutional problems, such as getting capital into new businesses, protecting property rights, financing government, and managing competition (to list just a few examples). It is not easy to say that one or other is the right way. More often, however, it is possible to highlight deficiencies in existing economic

arrangements and structures. For instance, it is usually safe to argue that state or private monopolies are undesirable, and that the entry of new firms should be encouraged in most sectors; equally, a tax system where what is paid by a firm depends on how well it can manipulate the accounting system or how effectively it can negotiate with the relevant ministry is pretty evidently undesirable. Nevertheless, while constructing a list of institutions and then proceeding to offer aid to do everything at once sounds like a good idea, it is probably not. Even the accession countries of Central and Eastern Europe, currently in the process of incorporating most of the EU’s acquis communautaire into their respective domestic legislation, are finding the process difficult, time consuming and immensely costly. For the CIS-7, remote from developed country markets, with no prospect of EU accession or anything like it (the proposed CIS Customs Union scarcely stands comparison), and with at best fragile states in place, attempting to do too much too quickly can only result in very poor outcomes. In this regard, the more cautious, nuanced approach of World Bank (2002a), has much to be said for it, focusing as it does on four main themes: complement what is already there; innovate by encouraging reform experiments (sectoral or regional, as appropriate); connect market players through information flows and open trade; and promote competition among jurisdictions, firms and individuals. Evidence-based approach This can be considered from either a microeconomic or a macroeconomic perspective. In terms of the former, it would be necessary to compare the economy being studied with suitable comparators (e.g. other low-income economies) judged to be functioning better, developing more successfully according to various criteria. Then one might look at such indicators as: q q q q q

number of new firms and rate of new business formation; job creation and job losses by sector; entry, exit and concentration in various markets; extent and form of privatization by sector; sources of investment funding for new firms, established firms, etc.;

Taking the first indicator as an example, most countries, including those of the CIS-7, claim to have suitable policies in place to encourage new firm formation. Outcomes, however, are extremely diverse, and one could well find suitable comparisons that would indicate that actual rates of new business formation in a given country are far below what they ought to be. This is turn provides a starting point for devising and introducing more effective policies, and taking steps to improve the business environment. Moreover, thinking along these lines reminds us of one of the early transition mistakes, namely to over-emphasise the role of privatisation in creating a new private sector, as against the role of new business formation, the role of entrepreneurs. The key importance of the latter is the theme of McMillan and Woodruff (2002), drawing on the experience of China, Vietnam, and some of the CIS countries (notably Russia, Ukraine), among others. At the macro-level, one would be seeking evidence about the statistical correlations between 13

measures of liberalisation and market-type reform and the subsequent growth performance. Many studies on this have been carried out by now, some of which are reported in Hare (2001). They generally find that price and trade liberalisation are important for growth, as is the legal environment for conducting business (property rights, contracts, and the like), but the impact of financial sector reforms, detailed aspects of privatisation programmes, and so on are much harder to pick up. Hence while of great interest in themselves, such studies do not appear to provide the sorts of concrete guidance that either aid donors or recipient governments are likely to require. Moreover, the more careful study of Falcetti et al. (2002) found that the positive effect of reforms on growth found by most studies is sensitive to simultaneity bias, and when this is allowed for in a fuller model of reforms and growth the impact of reforms is less clear cut. Instead, the impact of initial conditions turned out to predominate. However, one should not read to much into this particular finding, since a dozen years after the start of transition it is hard to believe that initial conditions - however they may be defined - can continue to exert much influence on economic performance. If there is a general lesson to be drawn out here, it is surely that our understanding of institutional design and of the linkages between institutional change and subsequent economic performance are still quite limited. (c) Political economy of aid The international community provides support to transition economies, including the CIS-7, through many channels, the most important of which are as follows: Multilateral aid •

IMF, World Bank, EBRD, Asian Development Bank - mostly loans (on favourable terms, reflecting the high rating of the IFIs in the world financial markets) for balance of payments support (IMF) or for specific projects (the development banks); some grants and loans to support technical assistance and policy advice in a diverse range of fields.

•

European Union - the TACIS programme - grants for technical assistance and policy advice, limited amounts of investment.

•

Other multilateral assistance (e.g. UNDP, other UN agencies, etc.) - mostly grants for programmes and specific projects. Bilateral aid

•

Individual governments provide aid to a variety of countries, in the form of technical assistance and policy advice, as well as funding for specific projects. Project funding can take the form of outright grants, or loans on favourable terms.

•

Various private foundations, not-for-profit organisations and NGOs provide aid, mostly in the form of donations to support specific projects, activities (e.g. Oxfam, based in the UK; Médicin sans Frontières, based in France).

Especially for smaller recipients, the resulting plethora of donors can be immensely confusing

and the various projects and aid activities can be difficult to coordinate and manage effectively. Inexperienced ministries of finance or economic ministries can find that many of their top staff are almost wholly occupied trying to oversee their diverse aid projects. Even worse, efforts to secure even more aid can sometimes prove to be an unhelpful diversion from the real business of running the country, and establishing the appropriate institutional procedures and structures to do so effectively. This raises a very real question concerning the absorptive capacity of a country, in other words, how much aid (say, as a percentage of GDP) could a given country fruitfully make use of? In terms of hard numbers, this question is not well understood, though a few poorly substantiated numbers can be found in the relevant literature. For instance, within Europe the European Commission has suggested that the transition economies on track for early EU entry would not be able to use productively any support they receive in excess of around 4% of their respective GDPs - accordingly, in the enlargement negotiations this has provisionally been set as the upper limit on EU support. To my knowledge, however, there is no real basis for this number except in the EU’s determination not to spend too much on the enlargement process. Aid donors themselves frequently fail to coordinate, despite often having the best of intentions, and since they operate with different budget cycles, project scales and durations, different administrative procedures, and have diverse reporting and monitoring requirements, it is not surprising that a substantial fraction of aid achieves disappointing outcomes. One must also add to this picture the disparate and often inconsistent objectives of aid agencies, their lack of “fit” with the objectives of recipient governments, and in many instances the latters’ corruption or limited political/managerial capacity to manage certain types of project (see Martens et al., 2002). Moreover, while some aid is clearly designed to be capacity-building, and hence is naturally time-limited (to the extent that efforts are successful), a great deal is project-based in which the donor community funds the initial investment costs while the recipient is expected to finance running costs and service the resulting loan obligations. For commercial projects, provided that they are well selected, this approach frequently works well, since there is an identifiable revenue stream from selling the project output that ought to be sufficient to meet these costs. For public sector infrastructure projects the situation is often rather different, since the government has to find a revenue stream both to operate the project and to service its initial costs. Ideally, of course, if the project is occurring against the background of an economy that is already growing, and where revenue collection is improving, additional tax revenues should be available to cover these project costs. Countries receiving a lot of aid in relation to GDP, and much of that in the form of (soft) loans rather than outright grants, can rapidly run into payment difficulties if these conditions do not hold. Some of the CIS-7 countries may well find themselves facing this sort of problem. Several studies have investigated the effectiveness of aid in terms of its impact on economic growth, and to a lesser extent upon poverty reduction in the recipient countries. Burnside and Dollar (1997) used a World Bank database on foreign aid to investigate the links among aid, economic policies and growth of per capita GDP. They found that aid had a positive impact on growth in countries with sound policies (notably, good fiscal and monetary policies, open foreign trade policy), while in countries with poor policies aid had no positive impact. Further, aid appeared to exert no systematic effect on a recipient’s policies, and the overall 15

allocation of aid appeared not to reward good policies - the authors found that the strategic interests of donors resulted in much aid going to countries which proved unable to benefit noticeably from it. Indeed, Alesina and Weder (2002) carried out an extensive empirical study of aid flows to many countries, focusing on determinants of the average constant dollar flow to each country over 1975-1995, and found “no evidence that less corrupt governments receive less foreign aid” (p1136). Here I am taking the view that corruption is likely to be negatively correlated with the overall quality of economic policy. In their second paper, Burnside and Dollar (1998) focused on the impact of aid on poverty reduction, taking changes in infant mortality rates as an indicator of this1. While not as strong and clear cut as their growth results, they found that in good policy environments aid does contribute to reducing infant mortality, while in poor environments it does not. Extending this analysis of the impact of aid on poverty reduction, Collier and Dollar (2002), developed a simple aid allocation model through which they demonstrated that a reallocation of existing aid flows to countries capable of using it more effectively could roughly double the annual number of people lifted out of extreme poverty. In a somewhat different direction, Collier and Dehn (2001) argue that the above analysis should be extended to allow for the impact of economic shocks. They use the example of negative shocks affecting a country’s export prices and find that the adverse effect of such shocks on growth can be greatly lessened by an increase in aid. Hence aside from targeting aid towards countries with good policies, they therefore suggest targeting it towards those experiencing adverse shocks, while noting that donors have not tended to target aid flows in these ways. Arguing against this approach, Hansen and Tarp (2000) confirm that aid affects growth, but their finding was not conditional on good polices. Instead, they found that in a model that controls for investment and human capital, aid had no significant (direct) effect on growth, suggesting that its impact is indirect, via its effects on investment, and possibly on human capital formation. Summing up this debate about aid effectiveness, Benyon (2001) draws out five reasonably robust conclusions that are worth noting briefly here. They are: q Aid allocation procedures need reform to take more account of needs and effectiveness. q The focus on poverty reduction in international aid efforts implies that it would be desirable to reallocate considerable aid from middle-income countries to low-income countries. q Some focus on countries pursuing “good” policies is justified, but rather as a second order criterion for aid allocation. q Aid allocations should become more performance related, and programme managers should not merely seek to spend up to their budgets. Evidence that aid has good effects provides a case for increasing aid, not merely q improving the allocation of existing budgets. 1

This is not necessarily a good measure of poverty reduction in all countries; and if applied to the CIS countries it would encounter the additional difficulty that mortality rates are still often measured using an inappropriate methodology dating from the Soviet Union.

These are important points, but even so, our understanding of the political economy of development assistance still appears to be quite poor. It is to be hoped, therefore, that in the course of pursuing the work of the CIS-7 Initiative a better grasp of these issues will emerge to the benefit of the Initiative itself as well as more widely. This will entail, as Martens et al. (2002) rightly stress, a more systematic study of donor objectives and incentives, the incentives and constraints faced by recipient organisations, and the proper measurement and monitoring of aid project outcomes. It will also require a better understanding of the circumstances in which aid is likely to be associated with improved growth performance, and real improvements in the economic position of the very poor (poverty reduction). Some learning from past mistakes and misunderstandings, and a greater awareness of the incentives of all those involved in the aid process would also be helpful, as argued through numerous examples and illustrations by Easterly (2002). 4. THE CONTRIBUTION OF THE INTERNATIONAL COMMUNITY Since each country has its own special features, it is most useful in this section to summarise the position country-by-country using a common framework, after first presenting some summary data. This approach will facilitate the subsequent review of some common themes in Section 5. The emphasis in this section and the next will be on the contribution of aid to the process of developing the institutional framework needed to operate a well functioning market-type economy in the countries of the CIS-7. 4.1 Summary Data Basic data on development assistance are regularly assembled by the Development Assistance Committee (DAC) of the OECD. Summary data for the countries of the CIS-7 for the years 1998, 1999 and 2000 are provided in Table 3. Evidently, net aid flows to the CIS-7 are rather diverse, ranging in the year 2000 from 1.4% of GDP in the case of Uzbekistan - reflecting the limited engagement of that country with either the IMF or the World Bank - to a high of 17.8% for the Kyrgyz Republic. Of the overall gross flows to each country, the bilateral share was just 27% of the total for Tajikistan, rising to 71% for Georgia and 72% for Uzbekistan in the same year. Net private flows to the region are virtually zero for four of the countries: Armenia2, Georgia, the Kyrgyz Republic and Tajikistan. For Moldova the private flows were very substantial in 2000 (nearly 40% of GDP), presumably due to the privatisation of wineries, parts of the electricity sector, parts of telecoms, etc., though these flows have not yet resulted in significant new investment in most sectors. In contrast, the inflows into Azerbaijan (about 8% of GDP) are presumably largely accounted for by oil and gas development in the Caspian Sea, and hence should mostly correspond to new investment. Uzbekistan, the remaining country, has experienced very fluctuating private capital flows, only amounting to less than 1% of GDP in 2000. Leaving aside special factors (Moldova’s privatisation, Azerbaijan’s oil and gas), these 2

But to a far greater extent than the other countries, Armenia has benefited from transfers from the Armenian Diaspora in recent years, much of which is channeled through the US-based Lincy Foundation.

17

countries have not thus far proved especially attractive to foreign investors. On the other hand, their growth performance since the mid-1990s has in some instances been quite impressive - albeit from a low base in all countries except Uzbekistan - as Table 4 shows. Thus four of the countries - Armenia, Azerbaijan, the Kyrgyz Republic and Tajikistan - have been growing at respectable, indeed quite rapid, rates since the mid-1990s, while two of them - Georgia and Uzbekistan have been growing but at slower rates. Moldova’s experience is much more erratic, with the 1998 Russian crisis resulting in a marked downturn in that year and 1999, and growth since then accelerating somewhat but not yet clearly sustainable. In all of the countries in the CIS-7 group there must be aspects of their national accounts statistics that are questionable, to put it mildly. Numerous Fund reports on the countries allude to such problems, which appear to be especially severe for Uzbekistan. In other words, while from one point of view Uzbekistan is a puzzling country as a CIS state reporting higher GDP now that at the start of transition, it might be a good deal less puzzling if some of the deficiencies in its national accounts statistics were resolved to reveal a more valid picture of the country’s economy. Its performance might then not look so favourable3. That said, in the medium and longer term the sustainability of growth in all of the countries will depend on achieving adequate rates of savings and productive investment, since much of the growth to date was almost certainly accomplished on the basis of fuller utilisation of existing productive capacity rather than through the creation of significant new capacity4 in either existing or new activities. Since all the CIS-7 countries are small, highly open economies, a major influence on their growth prospects will be their respective trade policies, both intra-regionally and in relation to the wider world. In that connection, studies to establish which activities or sectors are potentially competitive in these countries could be very valuable, as would a systematic investigation of the trade barriers the countries still face in key markets. The continuation of economic growth, and ensuring that such growth is accompanied by significant poverty reduction, will also entail further institutional reforms, including in the machinery of policy-making and implementation. Some of the needed measures will serve to remove some of the defects of the existing economic environment, others will build the new institutions needed for successful development. All, as indicated in the previous section, need to pay attention to the prevailing political conditions, and to provide well directed incentives for implementation and compliance. We now discuss the role of aid in creating these conditions, country-by-country. In doing so, 3

Concerning measures of GDP and other macroeconomic statistics, it is useful to distinguish between technical problems, which probably affect such measures in all the CIS-7 countries; and problems of a more political nature, resulting in the numbers being deliberately mis-reported. Uzbek growth series are unreliable because of inappropriate GDP revision procedures. 4

In making these points about growth I need to avoid the fallacy of assuming that there is a 1-1 correspondence between investment and growth. While not many countries have sustained rapid growth without high investment, many have had high investment and failed to grow. So at best investment is necessary for growth, certainly not sufficient. And measures to foster growth should be making investment in many areas more profitable (i.e. demand side effects) rather than simply allocating public funds to investment (supply side approach). The latter is likely to prove ineffective.

we start the commentary on each country by presenting a table of aid recently received by or committed to that country. The information presented is not quite complete, but it is sufficient for our purposes, at least in identifying the principal official funding flows. Though individual IFIs and other aid agencies do operate internal procedures to evaluate the effectiveness of their own operations, including the effectiveness of specific aid-financed projects, the publicly available information includes little that could be regarded as an “output” of aid operations. Most published information essentially reports “inputs” into the aid process. This reflects the fact that most aid agencies work in terms of budgets and financial allocations, and so this is the aspect of their operations that is easiest to report. It is also, often, the aspect that provides the basis for staff incentives within aid agencies, as Martens et al. (2002) emphasised. Our task, nevertheless, is to bring out as far as possible the contribution of official aid flows to institution-building across the CIS-7. To evaluate this, I first try to indicate which parts of the aid flows might have contributed to the formation of market economy institutions. Second, I use recent reports by the IFIs to illustrate where there remain severe or significant institutional failures. Then finally, combining these two aspects, I attempt to indicate where existing aid efforts have so far failed, and why; and where additional aid would be valuable, making clear how I think it could work. To structure this discussion, and to enable me to keep it within manageable limits, I make use of the template shown in Table 5. Although necessarily quite sketchy, the template does help to indicate just how far some of these countries have already advanced, given their respective starting points at the beginning of the 1990s. For none of the CIS-7 countries is still close to the structure inherited from the central planning era, shown in column 2 of the template. However, none of them is yet close to column 4, the market economy “ideal”. Table 13, later, shows where I judge each country in the CIS-7 should be located in relation to columns 2 and 4 of table 5. In constructing that table I have followed EBRD conventions in treating a score of 1 as indicating little or no change in a given area, a score of 4 as indicating virtually full compliance with normal, market-economy practices. An alternative approach to that suggested here would have been to assess institutional changes sector-by-sector across the CIS-7 region. Then one might find, for instance, that financial sector aid projects were relatively successful while those in the power sector, or some other infrastructural sector, might prove less successful. However, neither the detailed sectoral data, nor the necessary resources and time, were available to enable this alternative to be pursued systematically. In each of the country subsections that follow, there is a table summarising the aid received by the country or committed to it by multilateral agencies and various bilateral donors. That part of the aid contributing to institution building, the core theme of the present paper, is not easy to separate out. However, we can make some initial judgements in order to advance the analysis a little. First, aid described as “technical assistance” can be regarded as contributing to institutionbuilding, certainly in its intent. Second, although little or none of the reported aid to the various CIS-7 countries was explicitly categorised as “policy advice”, discussions associated with the PRGF from the Fund and the various stages of SAC funding from the Bank clearly 19

belong in that category. Much of the TACIS aid from the EU falls into one of other of these first two categories, and hence contributes to institution-building. Third, many individual investment projects funded by the IFIs are only approved following discussions with the recipient government and its agencies on a diverse range of often very micro-level institutional reforms needed to ensure the viability and success of the projects concerned. Hence the very approval of these projects implies that an attempt has been made to foster institutional change and reform, the desired changes often being written into the formal documentation associated with project approval. Also, the funding of particular investment projects is often accompanied by parallel loans or grants providing related technical assistance on such topics as project preparation, project management and implementation, and advice on policy and regulatory issues for the sector concerned. Last, once a project has been implemented, the IFIs in particular (and to some extent, other donors) increasingly carry out reviews of their performance and effectiveness. They do so according to a variety of criteria, including of course the basic requirement to earn the returns needed to service and repay the associated loan. Given the emphasis on poverty reduction nowadays in the IFIs’ approach to aid, one would expect to see the impact of projects on poverty reduction highlighted in such reviews. However, my concern here is solely with their possible impact upon institutional development. In this respect, the post-implementation reviews performed by EBRD are most informative, since they explicitly seek to assess the transition impact of their individual projects, meaning by this the impact of projects on various dimensions of the institutional infrastructure of a market-type economy. The dimensions they examine mostly have to do with: (a) demonstration effects; (b) linkages (both upstream and downstream); (c) other improvements in the competitive environment; and (d) other learning effects. For each of the countries of the CIS-7, therefore, we need to assess, as far as possible, how much of the aid received could be regarded as directed towards institution-building; to evaluate how effective this aid has been; to identify what remains to be done; and hence to propose the most appropriate next steps in terms of aid from the international community. Some of the general points made about Moldova apply more or less without change to the other countries; however, the points are not unnecessarily repeated in each sub-section. 4.2 Moldova Table 6 summarises the principal aid contributions received by Moldova in recent years, indicating some of the main areas towards which it has been directed. Aid for institution-building Of the aid for Moldova, I judge that from one-quarter to one-third can be regarded as contributing directly or indirectly towards institutional development. This means that in the year 2000, for instance, when total net aid flows amounted to USD 123 million (9% of GDP), around USD 40 million of that (about 3% of GDP) should be treated as contributing to institution-building. How effective has it been? There has been real progress in many areas of Moldovan economic practice but the combination of autonomous efforts by the country, and a wide range of aid-supported activities, leaves some important deficiencies in the institutional structure.

Aid focusing on relatively technical areas, such as presenting national accounts, establishing procedures to enable the national bank to function properly, designing a new tax system for the country, etc., has been effective in the sense of imparting and disseminating the relevant knowledge and understanding, though less so in terms of fostering effective implementation. Aid directed at areas that are either inherently contentious, or which turned out to be politically “delicate”, has proved far less productive. In Moldova’s case, such issues are quite numerous as a result of: q pervasive corruption, bureaucracy and weak administration; q strong tendency for jobs to be allocated on the basis of “favours” and connections rather than on the basis of ability and competence; q low level of respect for the law and poor understanding of the concept of “rule of law”; q the continuing political divisions of the country, with Transnistria only acknowledging the Chisinau government’s authority in very limited areas. The consequence is a poor investment climate, unattractive to foreign investors. Moreover, despite its recent accession to WTO, Moldova’s economic difficulties are still exacerbated by problems in its trading environment, some of which are a domestic responsibility - such as corrupt customs officials, inefficient and slow border crossing procedures, etc. Some trading problems, however, are not of Moldova’s making. For instance the EU has not made it easy for Moldova to export wine and other food sector products into EU markets, with the result that a good deal of recent investment in these sectors has not turned out to be very productive for the country. In addition, border controls and transport costs determined by Ukraine and Russia in particular have seriously constrained Moldovan exports to markets that were very important in the past. The Moldovan column in Table 13 sums up my assessment of how far Moldova has progressed in the direction of forming a market-type economy. What remains to be done? If aid donors sought to be prescriptive, they might proceed by comparing columns 3 and 10 of Table 13, hence identifying the key institutional “gaps” in relation to Moldova’s progress towards a market economy. Then new aid could be directed towards filling the identified gaps. But our earlier discussion suggests that this might not prove very productive since it might not fit with the objectives of the country itself; it might cut across local and regional conflicts; it might pressure a not very secure government to do too much too rapidly; and hence it might foster a cycle of repeated failure that can only weaken subsequent reform attempts. An alternative, and I suggest more promising approach, would be along the following lines. Identify two or three priority areas where early action has a good chance of proving successful, and where it could have a significant - tangible - impact on the economy’s performance, and focus aid on these areas. This does not mean, of course, that other areas are suddenly to be regarded as unimportant, since it would always be open to the Government of Moldova itself to introduce reforms in such areas, regardless of aid flows. 21

In the case of Moldova, I would highlight just three fields5: q q q

trade policy and operational practice; SME support and the surrounding legal/regulatory framework; civil service laws - and perhaps wider legislation on the operation of the labour market.

Next steps - new directions for aid to Moldova My concern in this paper is solely with the institution-building component of aid, so I make no particular comment about the diversity of project-based aid going to Moldova, some of which, as noted above, is certainly accompanied by useful technical assistance that will strengthen the capacity of the country in such matters as project design and implementation, sector regulatory issues, etc. Concerning the three fields of institutional and policy reform highlighted above, the international community could usefully negotiate with the Government of Moldova as well as lower levels of government, NGOs, private companies, and the like, in order to devise appropriate measures that could then be supported by aid. There is no space here to discuss all three areas, so let me focus briefly on just one, trade policy. As a small, trade dependent economy, Moldova’s future growth is bound to be closely linked to successful export performance. This entails creating favourable conditions for private sector developments in areas where Moldova is, or has the potential to be competitive notably agricultural produce, food processing, parts of light industry. Both domestic and foreign investment will be needed to take advantage of these possibilities, so the creation of a strongly supportive investment climate is critical. In the case of foreign investment, of course, this is important both for the financial resources per se, but also for the management expertise, new technology and market knowledge that often accompanies it. In some markets, as noted above, Moldova faces restrictions on its exports from trade partners such as the EU. Where such restrictions exist, it is clear that quite aside from any financial aid, an enormous contribution to Moldova’s future development can be made simply by lifting, or at least easing, these constraints. Likewise, partner countries also need to implement some of the measures listed below, as improvements only on the Moldovan side of transactions will not suffice. Measures by trade partners cannot of course be included among the conditions associated with aid packages from the IFIs to Moldova, but they could be sought through some of the wider, multilateral discussions contributing to the work of the CIS-7 Initiative, as is clearly envisaged in the second recommendation of IMF (2002b) (see the opening page of the present paper). Last, resolution of Moldova’s internal political divisions would contribute greatly towards an improved trading environment. Aside from these basic points, success in expanding exports is likely to need significant improvements in the following related areas (details could quickly be developed by tracking a few export and import consignments, following them through the various procedures as they

5

Others could easily come up with a different list. The point is to set a limited agenda of reforms, work to it with enough effort to make it succeed, then move on to other areas.

currently function - I suspect the result would be both revealing and shocking): q q q q q q q

tariff structure - some simplification to reduce differentiation between trading partners; taxation of business - should be far less discretion and less opportunity for negotiation, lower basic tax rates, uniformly and rigorously applied; administration of border controls affecting both imports and exports - need simpler procedures, more standardised, less corruption, fewer delays; export credit guarantees, export insurance, and related financial services to support trade; limited physical infrastructure improvements, e.g. to road and rail links, border crossings, and the like; some allocation of public resources to active export promotion (using resources released by reducing or eliminating subsidies to existing loss-making firms); and measures to encourage new entry, encourage exit of poorly performing firms - in other words, improve the domestic business and competitive environment.

4.3 Armenia Table 7 summarises the main aid flows to Armenia in recent years, both by donor and to some extent by type of activity supported. Aid for institution-building The identifiable technical assistance and policy advice components of aid to Armenia are relatively small for most of the major donors except USAID and EU-TACIS; and much of the other aid provided to the country has been disbursed on a few large projects. While beneficial in themselves, such aid only contributes modestly to institutional development through such ancillary activities as training programmes and the like. Overall, my preliminary judgement about the share of aid to Armenia that can be regarded as contributing towards institutional development is around 25%. Thus in the year 2000, when net aid flows amounted to USD 216 million (11.2% of GDP), I would regard about USD 55 million of this (say just under 3% of GDP) as supporting much needed institutional change. How effective has it been? While significant progress has been achieved in many fields of economic reform, a serious impediment to Armenia’s economic recovery and sustained growth is the continued stalemate over the disputed Nagorno-Karabakh region. While the armed conflict ceased some time ago, the failure to settle the problem at the political level has resulted in the partial isolation of Armenia, seriously limiting its trading opportunities. Moreover, security within Armenia is poor in some areas, and this too both limits domestic economic activity and creates difficult conditions for the international agencies and NGOs seeking to operate aid projects. More concretely, while privatisation overall continues slowly, the banking system is finally in private hands, and efforts to privatise parts of the power sector are finally making some notable progress, with the recent sale of the electricity distribution company and one of the largest power plants. Efforts to support SMEs and to restructure and sometimes close lossmaking state owned firms, on the other hand, have not yet proved very successful. Hence substantial resources continue to be mis-directed towards failing firms, and the poor investment climate, extensive corruption and the complex administrative procedures needed to 23

carry on any legitimate business have deterred much activity and potential new development. To this extent, institution-building aid to Armenia has not proved a great success story so far. The Armenian column in Table 13 sums up my assessment of how far Armenia has progressed in the direction of forming a market-type economy. What remains to be done? As with Moldova, improvements in trade policy and the institutional environment for trade are vital, though not likely to prove wholly successful without a resolution of the key political issue referred to above. How helpful the international community can be in promoting such a resolution is not clear to me, though continued mediation through OSCE auspices or the Council of Europe might well help. That aside, and following the focused approach suggested above for Moldova, I would propose for Armenia a concentration of aid efforts for institutional development related to the following areas: ∃ ∃ ∃

improving the investment climate; encouraging further privatisation and industrial restructuring; improve the environment for SMEs, including improved access to financing;

Next steps - new directions for aid to Armenia Constructing a suitable institutional setting to further the above goals is not easy at the best of times, partly because the exact requirements/desiderata are still rather poorly understood, partly because the implementation of relevant measures in Armenia encounters political difficulties, regional loyalties, corruption and the like. Breaking into the resulting vicious and self-defeating circles, and hence starting a process of sustained economic improvement and confidence building in relation to the subsequent stages of reform, is the challenge facing both Armenia itself and the international community in providing assistance. The three areas proposed above are closely inter-related, but let me focus here, for brevity, on the investment climate. Fundamentally, what motivates people to undertake investment in the private sector is the prospect of profit, so if we seek to improve the investment climate, this entails: (a) creating the conditions under which many economic activities - both new and old appear to potential investors to be profitable; and (b) ensuring that those who invest are then able to hold on to most of the profits their activities generate, so that they can both become richer, employ more people, and grow their businesses. The conditions for profitability are partly macroeconomic - in terms of low and stable inflation, sound trade policies, stable fiscal and monetary policies - and partly more microeconomic in the sense of requiring protected property rights, free entry into various markets (no artificial protection for established firms, for instance), easy and quick administrative procedures to secure necessary licences and permits, and the absence of official corruption and private protection rackets from all these arrangements. In Armenia, ensuring the last of these requires political will of a high order, which was not forthcoming during the 1990s. Enabling investors to keep most of their profits requires low and stable taxation, with no

discretion for tax officials, no bargaining over effective tax rates. And again it requires corruption and mafia-like activities to be severely curtailed. 4.4 Azerbaijan Table 8 presents the major aid flows to Azerbaijan in recent years, distinguishing between multilateral and bilateral flows, and identifying some of the key sectors or activities that have received external funding. Aid for institution-building Much of the aid to Azerbaijan has gone to a few large projects in the energy sector, hydropower, and so on. Taking identified and costed TA activities together with a fraction of project funding for related technical and policy advice, I judge that about 20-25% of the aid to Azerbaijan can be regarded as institution-building. Hence of the 2000 aid flow of USD 139 million, up to USD 33 million counts as institutional in the sense of this paper; this amounts to just under 0.75% of GDP. How effective has it been? As for Armenia, the fact that the Nagorno-Karabakh conflict remains unsettled is a strongly negative factor across the region. Nevertheless, despite this, the neighbouring conflict in Chechnya and other shocks, Azerbaijan’s macroeconomic stance has been remarkably successful - low inflation, strong balance of payments, solid growth. However, growth mostly derives from the oil and gas sector, while other sectors show little sign of growth; however, the past two years have witnessed growth in other sectors, including in agriculture. The economy needs to diversify, and needs to do much more to lift the mass of the population out of poverty - in part by ensuring that incomes derived from the energy sector find their way into the rest of the economy. As regards institutions, there are some positive achievements to note, linked to the Fund’s PRGF Program. The Program has started the process of strengthening the banking sector, largely by assisting in the closure of Agroprombank and clearing up its debt stock. It has also aided the development of institutions to manage the country’s growing oil wealth, notably by developing asset management and expenditure regulations to improve the functioning of the Oil Fund. Despite these significant gains, in many respects the business environment remains hostile and difficult, the legal and regulatory environment is in poor shape, the tax system functions badly and financial markets/banks still provide inadequate services to both new and existing businesses. Reform efforts in all these critical areas have only borne limited fruit. The Azerbaijani column in Table 13 sums up my assessment of how far Azerbaijan has progressed in the direction of forming a market-type economy. What remains to be done? In many sectors of the economy the infrastructure is in very poor condition. This includes agriculture, where irrigation systems have been neglected for some years, large parts of the road network, as well as distribution networks for the public utilities - water supply, sanitation, electricity distribution, and so on. In addition, the domestic distribution of energy resources, especially electricity, is characterised by a range of quasi-fiscal subsidies resulting in low tariffs, well below cost as well as below world market prices. This situation is accompanied by considerable non-payment by final users, with several groups of the 25

population actual exempted from payment obligations. There is also considerable theft of electricity. To improve policy in this sector would impose significant costs on many poor people, a circumstance that explains part of the political opposition to real change in this area. To make progress, therefore, it is likely that significant reform will only be accepted when the social safety net is also reformed, with better targeting of household support to protect the most poor and vulnerable. Hence three key areas on which the next round of institutional reforms in Azerbaijan could be focussed are: ∃ ∃ ∃

infrastructural development reform of electricity pricing and collection arrangements; reform of the social safety net to provide better targeting of benefits.

Next steps - new directions for aid to Azerbaijan I focus here on electricity pricing, not least because it is a rather widespread problem across the CIS, and because the economic impact of seriously wrong prices can, over time, prove very damaging in two respects: (a) unduly low prices ensure that domestic companies will not wish to invest to improve domestic supplies, or to take on additional customers - hence the domestic quality of supply is likely to deteriorate over time; and (b) investors in other sectors can be misled by the low prices into believing that certain activities are profitable when they are not, so the wrong kinds of investment can be stimulated, and desirable investment - such as in energy-saving projects - can be discouraged. What aid can do in this area is to assist Azerbaijan to re-design its energy tariff, and to introduce the systems and procedures that ensure better collection, including the removal of all rights to free electricity. In many countries it has been found that the privatisation of energy distribution companies can be a significant step in the right direction, especially if foreign owners take a large share in the newly privatised utilities. For new owners will be able to bring to bear their experience of collecting revenues in other markets, they will have strong commercially-oriented incentives, and will wish to have in place suitable rules of the game to give them the powers to enforce revenue collection and cut off non-payers. This approach may well do the trick in Azerbaijan, provided that prices at which electricity is supplied to the distribution companies are themselves set on a full cost recovery basis. 4.5 Georgia The major aid flows to Georgia in recent years are summarised in Table 9 Aid for institution-building Much of the USAID contribution to Georgia counts as institution-building, as do the TA and policy advice components of other subventions. Altogether, I would judge that of the year 2000 aid flow of roughly USD 170 million (5.3% of GDP), about 20-25% of the total can be considered as support for reforms and institutional development; thus about USD 40 million or so (1.3% of GDP). How effective has it been? Serious constraints on development in Georgia result from the failure to settle the conflicts in Abkhazia and South Ossetia; many policies simply cannot, under present conditions, be

enforced across the whole country. Hence there is an urgent need for country either to reestablish control over all its territory, or to accept the de facto autonomy of several key areas. The latter would, of course, entail reaching agreement with the leaders of these areas on taxsharing and on utility charging (regions such as Abkhazia and South Ossetia do not currently pay for the electricity they consume). At the macroeconomic level, while progress has occurred, there were problems over a failure to achieve fiscal policy targets in 2001 which resulted in a temporary suspension of Fund and World Bank activities in the country. By end-2001, funding was back on course. Nevertheless, major reform of the fiscal system is needed, including the adoption of a new budget systems law, establishment of a single treasury account, various measures of tax administration. As regards trade, although Georgia lies on potentially important trade routes (including routes of pipelines), the country’s political environment seriously limits much international trade. Aside from such macro issues, the microeconomic conditions for growth and development are still very poor, with extensive corruption at all levels of government, a discouraging business environment, seriously neglected business infrastructure. The last of these is an issue both in agriculture, where irrigation systems have not been maintained, and in urban areas where basic supplies of water and electricity are erratic to say the least. With power supplies, one problem is Georgia’s indebtedness to Turkmenistan, occasional failures to pay on time, and the resulting interruptions of energy supplies. This is quite apart from the plethora of rules and regulations - and associated bribe-taking - that strangle new business before it can even start. It is no surprise, therefore, that Georgia has a large second economy, and proposals to discourage it under existing conditions are surely the height of folly, since some business and income generation, including for the poor - has to be regarded as better than none. The Georgian column in Table 13 sums up my assessment of how far Georgia has progressed in the direction of forming a market-type economy. What remains to be done? From the above discussion, three key areas of reform in Georgia are thus: ∃ ∃ ∃

reduction of corruption at all levels, improvements in governance; improvements in the general business environment; improvements in business-related infrastructure.

Next steps - new directions for aid to Georgia Let me focus here on the tricky issue of business-related infrastructure, which in Georgia’s case refers to a number of different issues, as summarised below (with no pretence at presenting a full list): Agriculture - maintenance and development of irrigation systems Towns and villages - ensuring reliable supplies of electricity and water Trade - adequate roads, border facilities and the like. First, an important aspect of all these problems is basic maintenance. There is little point in funding new capital projects to develop infrastructure improvements if the systems are not in 27

place to ensure that existing infrastructure is maintained adequately. To a significant extent this is a matter of public spending priorities, as well improving revenue collection from existing and new taxes. Second, in the case of roads within Georgia an important issue is the large number of road blocks and checkpoints - even within the capital, Tbilisi - that impede internal trade and raise costs for everyone by levying unofficial “fees”. Again there is no benefit to additional or improved roads if these merely provide opportunities for additional theft and bribery. The same is true at border crossings, which are too often lucrative sources of bribes rather than institutions that help Georgia to boost export revenues - to put it perhaps too delicately, the objectives of customs officials and border guards on the one hand, and the government on the other, are not exactly well aligned. Aid to bring about improvements in these areas needs to be designed quite carefully in order to motivate compliance with improved standards of economic behaviour. For instance, if the government is really unable to exert control over its own road system, it might do better to tolerate a form of informal privatisation by, in effect, renting out stretches of road to various individuals (who might formerly have been regarded as bandits), giving them a mixture of rights and responsibilities: (a) the right to prevent anyone else from drawing income from the same stretch of road; (b) the responsibility to use part of the revenue they collect to maintain the road. The government might be able to set a maximum price, and also have the power to withdraw contracts that were not satisfactorily fulfilled. No one could pretend that this is a very desirable solution to a real economic problem, but given prevailing political constraints there might be nothing better6. 4.6 Kyrgyz Republic Table 10 presents the main flows of aid to the Kyrgyz Republic, broken down by major donor and to some extent by type of activity/sector supported. Aid for institution-building In the year 2000 Kyrgyzstan received USD 215 million (17.8% of GDP) in aid, within which I judge the institution-building component to be about 15-20%, so about USD 40 million (or 3.5% of GDP). How effective has it been? As a small, trade dependent but landlocked country, the Kyrgyz Republic needs good relations with its neighbours in order to prosper. Unfortunately, there have been trade disputes with Uzbekistan as well as with Kazakhstan which have made the trading conditions quite difficult. The recent renewal of growth in Russia and Kazakhstan, two of the major markets for the Kyrgyz Republic, are likely to improve matters if the growth is sustained, and if diverse trade barriers currently in place are relaxed or lifted. Effective trade liberalisation across the whole region would be enormously beneficial for the country. In regard to energy and water trade, the transactions that occur are largely barter-driven and not based on economic pricing. Not only does the Kyrgyz Republic have a difficult business environment, but public spending 6

This is evidently not an approach that could be supported by the IFIs. It can be argued that the proposed policy would impede trade, but I would argue the opposite, since one partially regulated road charge is likely to be less distorting than the ten unofficial ones that might be in place now.

has not been well targeted on priority areas. Such careful targeting is especially vital in view of the constraints on aggregate public spending that result from the country’s mounting debt problems, limiting the country’s capacity to borrow. While initially a relatively rapid reformer amongst the CIS countries, reforms stalled in the second half of the 1990s. More recently, with improving macroeconomic stability in 2001-2002, there have been encouraging signs of a renewed commitment to further reforms. Recent aid to foster institutional reforms has been quite effective in terms of delivering improved institutions, but less so in terms of delivering improved performance, though the reasons are not wholly due to problems within the country itself. The Kyrgyz column in Table 13 sums up my assessment of how far the Kyrgyz Republic has progressed in the direction of forming a market-type economy. What remains to be done? Concerning market-oriented institutional reforms in the Kyrgyz Republic, there is considerable unfinished business despite the country’s good start. Due to financing constraints, low savings rates and lack of financial intermediation there is a very low level of investment in the country, and some of the other problems facing the country are not greatly different from those of its neighbours, namely energy policy and the removal of subsidies; further privatisation and restructuring of major SOEs; creating a more favourable business environment; and so on. However, to focus on three specific areas, bearing in mind the aid agencies’ objectives of poverty reduction, I would suggest the following: ∃ ∃ ∃

reforms in the agriculture sector; improving and targeting the social safety net; improving the composition and targeting of social spending (e.g. by concentrating resources on basic health care, basic education).

Next steps - new directions for aid to the Kyrgyz Republic The agriculture sector, for much of the rural population, scarcely enables people to do much better than achieve a very basic level of subsistence. At the same time it is beset by extensive governmental rules and regulations limiting the availability and allocation of key inputs. Product markets are poorly developed except at the very local level, and much infrastructure in agriculture has experienced years of neglect. Hence to improve the situation within a reasonable period calls for a multi-dimensional approach including the following elements: (a) a substantial withdrawal of government controls; (b) investment in infrastructure where returns are likely to come through quickly; (c) renewal and repairs to old infrastructure, again starting with areas where returns can be rapid; (d) revival of regional markets and the export trade; (e) improvements in agricultural advice/extension services. 4.7 Tajikistan Aid to Tajikistan is presented in Table 11, which gives a breakdown by the major multilateral and bilateral donors, indicating also some of the main programmes and projects supported in recent years.

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Aid for institution-building The aid flow to Tajikistan, the poorest of the CIS countries, in the year 2000 amounted to about USD 142 millions (15.3% of GDP). Of this, about a fifth can be regarded as contributing to institution-building, roughly USD 30 millions (about 3% of GDP). How effective has it been? The civil war that ended with a peace agreement in 1997 seriously disrupted economic reforms and market development, and even now the security situation in parts of the country is not good. The recent intervention in Afghanistan has raised political tensions throughout Central Asia, and for Tajikistan it will be especially crucial both to preserve the current peace agreement, and to improve macroeconomic stability. With recent progress on small privatisation, land reform, and aspects of trade and exchange rate policy, as well as a renewed effort to privatise some of the larger firms, Tajikistan is nevertheless moving in the right direction. At the same time, there are severe problems in the business environment, not helped by the limited administrative capacity of the government, poor infrastructure and a poorly functioning financial sector. The result has been to limit FDI inflows, as well as to discourage domestic investment, including the formation and development of new SMEs. Yet under present conditions the government has limited options, in part because it raises rather little tax revenue (far less as a proportion of GDP than other countries of the region), in part because it is already highly indebted and this limits its borrowing capacity. In addition, large quasifiscal deficits are tolerated, notably in the energy sector (gas and electricity). Trade has also proved a difficult area, not because of the country’s own policies but due to disputes with neighbours, frequent closures of borders and other disruption. Hence better economic coordination across the Central Asian region would be very beneficial for Tajikistan. The Tajik column in Table 13 sums up my assessment of how far Tajikistan has progressed in the direction of forming a market-type economy. What remains to be done? The requirements in Tajikistan clearly overlap heavily with those for some of the other countries under discussion here. They can be summed up quite simply and briefly in the following selection of key areas: ∃ ∃ ∃

improving public administration/civil service reforms; improving the general business environment; and gradual elimination of quasi-fiscal subsidies in the energy sector.

Next steps - new directions for aid to Tajikistan Tajikistan, like most other countries of the CIS-7, needs to improve its business environment, mostly by intervening and regulating far less than it currently does, and by having far fewer licensing/registration requirements, all of which provide opportunities for delays, higher business costs, and the forms of bribery and corruption that drive many businesses into the informal sector. Naturally, businesses need to register for tax purposes and to comply with health/public safety regulations, but there should not be much more to it than this, and perhaps the key step would be for policy to be built around the simple idea that “business is desirable”

- it is to be welcomed and encouraged, not regulated and stifled. This basic change in attitude might be fostered through a number of well designed demonstration projects to promote SMEs - for instance, a designated area of the country could be promoted as a “regulation-free zone”. 4.8 Uzbekistan Aid provided to Uzbekistan in recent years is summarised in Table 12. Aid for institution-building The lack of institutional reforms has resulted in limited involvement in the country by the international community, with the World Bank and IMF in constant dialogue but not currently implementing programmes. Nearly three-quarters of the aid to Uzbekistan is bilateral, with the largest single donor being Japan. Relatively small amounts of the aid flow in 2000, which amounted to USD 186 millions (1.4% of GDP), can be regarded as institutional development, probably not much more than 10-15% of the total, or USD 20-25 millions (no more than 0.2% of GDP). How effective has it been? Since Uzbekistan has hitherto taken the official view that it does not wish to undertake substantial institutional change with a view to building a market economy, it is not easy to discuss the question of effectiveness. A good deal of the machinery of central planning remains in place, including state orders, multiple exchange rates, extensive controls over foreign trade, and so on. Privatisation, industrial restructuring and banking sector reforms have all progressed slowly, and the investment climate is poor, with little FDI currently flowing into the country. All in all, institution-building in Uzbekistan, even at the very basic level of key macroeconomic policy developments, has not advanced very far. The Uzbek column in Table 13 sums up my assessment of how far Uzbekistan has progressed in the direction of forming a market-type economy. What remains to be done? The short answer here is almost everything, since few areas of policy, institutions, legal framework, etc., can yet be regarded as satisfactory from the standpoint of operating a markettype economy. The question, though, is whether the government can easily be convinced of the need for change, especially as - at least according to official statistics - the country has performed better than anywhere else in the CIS since 1991 (though I earlier noted some reservations about this official position). It is evident that a great deal of external financing for Uzbekistan could be unlocked if the country could agree to a broad swathe of measures to improve the investment climate, both for domestic investors and for foreign investors too. Such measures would need to address at least the following interconnected areas: ∃ ∃ ∃

trade and exchange rate policy (in particular, the exchange rate regime urgently needs comprehensive reform, to move the country away from the present highly regulated, multiple-exchange rate system); privatisation of SOEs, and associated restructuring; support for SMEs. 31

In addition, given its importance for the agricultural sector and in exports, reform of the cotton sector is critical for Uzbekistan. Next steps - new directions for aid to Uzbekistan While stressing the interconnectedness of these areas, I shall focus on privatisation and restructuring. One can debate at length on the mechanics and modalities of privatisation, but this is not the place to do so. Rather, my preference is to leave that aside while dwelling on the institutional conditions, about which we already know a good deal. Looking around the transition economies, we can find bad institutional structures as regards privatisation - such as the Romanian model; and much better approaches such as that adopted in Hungary. We don’t have to copy the exact arrangements, of course, but there is sufficient knowledge about the alternatives within the international community to enable us to propose to Uzbekistan some privatisation options or models that have a high chance of working, and that deal more or less well with the well known issues of: methods and techniques of privatisation; asset valuation; post-privatisation ownership structures; the treatment of social assets; employment and investment conditions; and so on. Likewise with industrial restructuring, it is highly inefficient to continue to subsidise hopeless firms inherited from the country’s socialist past, and while one might not find the political support to shut them all down “tomorrow”, some way must be found to organise an orderly programme of closures and/or restructuring. Failure to do so is not only wasteful in itself, but it can inhibit new entry, since the survival of these old firms is frequently accompanied by a variety of market restrictions to protect what markets they still have. This is part of the institutional structure that makes the whole business environment so bad. 5. COMMON FEATURES OF, AND PROBLEMS WITH, AID TO THE CIS-7 In designing and implementing aid projects across the CIS-7, a number of common problems can usefully be highlighted. In the above discussion, certain sectors or issues cropped up repeatedly. Two of the most important of these, critical for the economic performance of the whole region and also potentially contributing importantly to poverty reduction, are the reform of agriculture, and the need for substantial efforts to improve the general business environment. The EBRD’s Transition Report for 2002 pays particular attention to these dimensions of the overall reform process, but we lack the space to elaborate in depth in the present paper.. Many aid projects/activities involve counterpart funding, usually taking the form of locally provided staff, use of government buildings, and the like. Several donors to CIS-7 countries, notably the World Bank, report that such funding had often proved inadequate - less than originally agreed - thereby delaying the implementation of projects or reducing their expected benefits. This issue is often important with infrastructure projects. For instance, the benefit of investment in a new road is greatly reduced if there are not established systems in place to ensure regular maintenance to an adequate standard - yet in parts of the CIS-7 it is reported that roads are deteriorating faster than they are being built; similarly with parts of the rail network. Likewise, education projects that focus on school building are unproductive unless there is an adequate supply of teachers and support staff, as well as supplies of teaching

materials in the relevant language(s). frequently overlooked “on the ground”.

These are obvious points, but are surprisingly

An issue in regard to project staffing concerns the impact on the local labour market. Especially in small countries receiving aid from diverse sources, and hence operating many projects at any given time, there is a significant likelihood that the local staff required to operate the projects might be drawn from ministries or the private sector, and might be attracted by the wages offered by aid agencies, which are often higher than the usual local wage rates. Aid agencies usually try to staff their projects on the basis of merit, in other words they will do their best to ensure that project staff are suitably qualified and experienced, and have the ability and motivation to do a good job. In many countries, including across the CIS-7, such people are relatively scarce or hard to identify. This is particularly the case in environments where family or clan loyalties, or particular regional affiliations, have traditionally been more important in getting jobs than real ability. In addition, major aid agreements commonly require government approval and/or ratification by the parliament before they can come into effect, and this part of the aid process has often been slower than expected. Likewise, procurement arrangements and tendering procedures have often proved slow and cumbersome (and sometimes open to accusations of corruption), creating yet another source of delayed project implementation. The conditionality of aid programmes is an interesting aspect of the aid delivery process. Most individual projects funded by EBRD, ADB, the World Bank, and so on, have conditions attached to the various stages of disbursement, mostly relating to needed reforms in the particular market or sector, management and ownership structures of the firms concerned7. Sometimes projects are delayed when one or more conditions is not met, sometimes lenders tolerate a breach of conditions rather than face implementation delays. This is also the case in regard to Fund programmes such as the support offered to the CIS-7 under the PRGF. Detailed conditions are set in the initial agreements - covering core IMF concerns, various shared areas, and non-core issues8 - including a schedule of reviews linked to successive stages of funding disbursement. Many of these reviews, however, including several relating to countries of the CIS-7, request waivers of performance criteria, in other words they seek continued funding in situations where the agreed conditionality is not being satisfied. This always presents the Fund with a dilemma, which appears at times to be resolved by recommending continued funding subject to some new, deferred or reinforced performance conditions. The incentive effects of this procedure are not particularly desirable. Further, while many observers of the practices of aid agencies have tended to criticise the extensiveness of conditionality in the allocation of aid resources, Easterly (2002) is unusual in suggesting that aid could be far more effective if conditionality were both stronger, and 7

The type of conditionality associated with funding from different donors varies considerably. In part this reflects the diverse types of funding - with EBRD projects mostly in the private sector using largely nonconcessional funding streams, Bank and Fund activities mostly built around programmes of lending to the governments concerned and often involving highly concessional lending. 8

For instance, privatisation conditions would now only be included among the conditions in a PRGF loan if, for the country concerned, privatisation was considered important for the macroeconomic situation in the country. For a recent review of experience with the PRGF, see IMF (2002c)

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designed in ways that accorded more with the compliance incentives of the recipient country (see also the review of Easterly in Wacziarg, 2002). We return to this point in the conclusions. For the countries of the CIS-7, regional issues and approaches to economic policy and reforms also need to be highlighted. For Central Asia they arise because some countries have plentiful water supplies, others have energy supplies, and much trade involves these commodities, but often exchanged at prices determined through bargaining between governments rather than through any form of market process. Issues of water and energy are largely beyond the scope of the present paper, though it is clearly important to draw attention to their significance for the region. For Moldova and the Caucasus Area, regional issues concern more general trading arrangements with neighbouring countries, including, however, the transit of oil and gas. Here there is scope for massive improvements in the institutional arrangements, the difficulty being that success requires agreement with countries other than the CIS-7 themselves, and this might not be easy to achieve. 6. CONCLUSIONS: NEXT STEPS In this review of aid to the CIS-7 we have seen that aid flows have been large as a proportion of recipient country GDP (except for Uzbekistan), and that within the total flows, aid that can be interpreted as supporting the reforms and institutional change associated with building market economies has amounted to anything up to 4% of GDP in the last couple of years or so. This is a lot of aid, but despite it we have noted that the route to a market economy has proved tortuous and difficult, and that much of the institution-building aid has been less effective than one might have hoped. Many gaps and serious imperfections remain in the institutional structures of the CIS-7 when looked at from the standpoint of what we think is needed to construct a well functioning market economy. As noted above, Table 13 provides a cryptic summary of my assessment of the current situation in each country, using a range of simple indicators. That said, it is only fair to emphasise that a great deal of very positive and worthwhile progress has nevertheless been achieved in institution building, notably through the aid programmes of the IFIs supported by the larger bilateral donors to the CIS-7. But as noted above, the international community lacks knowledge of the precise links that eventually translate institutional changes into sustainable economic growth (ideally, accompanied by significant poverty reduction), and in any case we expect such links to operate slowly, gradually functioning better as more and more elements of the market system are slotted into place. Given this mixed, but in many respects still unsatisfactory situation, how ought the international community to proceed, what should be its next steps, for instance towards designing the next generation of aid programmes for the region? One way forward is via the specific suggestions for each country sketched in the country subsections of Section 4, above. In each subsection I took the view that focussing the aid effort was likely to prove more productive than what might otherwise be termed more of a “scattergun” approach, and suggested two or three key areas crying out for urgent attention in terms of institution-building. Quite probably all of the areas identified are problematic for all

of the countries, but I argued that a focused effort could help to build momentum and commitment for further reforms by generating some early successes9. Hence even if we think we can identify 25 major problems in a given country, I strongly believe that focusing initially on as few as two or three offers potentially large payoffs for aid agencies - as well as for the recipient countries, of course. Suggesting different problem areas for the different countries in part reflects their individual circumstances, and in part provides a valuable opportunity for experimentation and learning across the CIS-7, since the different countries would have the chance to see other institutional issues being addressed elsewhere and might choose to learn from the successes and failures of these diverse initiatives. The particular areas highlighted for early attention in Section 4 are summarised in Table 14, for reference. At this stage in the argument, it is useful to stress once more that we are really interested in fostering institutional change because we think it will help the countries of the CIS-7 to achieve sustained economic growth, and also to reduce the shares of their respective populations below the poverty line referred to in Table 1. This unavoidably raises the issue of how well we understand growth processes in general in the economies in transition, how far such growth depends on the extent and type of institutional change, various measures of the initial conditions in each country, and a variety of other indicators. The recent study of Campos and Coricelli (2002) explores these important questions, finding that transition economies have reasonable growth prospects and potential, and that their growth has indeed been held back by institutional failures. However, when it comes to the details, our knowledge is pretty weak. Thus we really need to know a great deal more about the linkages between institutions and economic growth, about the dynamics of institutional change (including its political economy), and the connections between reform strategies and transition paths. We know too little about all these matters - so on the one hand there is a need for more micro-level research, and on the other, we should beware of being overly prescriptive in designing aid programmes to foster institutional change. What really matters, surely, is achieving good outcomes for the CIS-7, not whether or not particular institutions conform to familiar western models. Finally, in the light of the preceding discussion, let us conclude by considering a number of alternative mechanisms through which aid might be delivered to the CIS-7, bearing in mind the need to provide stronger incentives for compliance on the part of the recipient countries. Some of what follows might seem a little bizarre, but I would argue: (a) it is sometimes very useful to examine apparently “off the wall” ideas in the process of designing something new, because even when not acceptable in themselves, they might suggest ways of modifying existing practices to achieve some of their benefits; (b) as an outsider in relation to the international institutions, I can float ideas that might be too controversial politically if raised internally.

9

In adopting this approach, I am therefore paying attention to the political economy of reforms. I am aware that a more “technical” approach to reforms could easily argue for diverse reform measures across the whole field of needed institutional reforms, as a pre-condition for achieving rapid progress in terms of economic performance. However, that is only true if diverse measures could be absorbed into the local “culture” and if they could be implemented effectively more or less simultaneously. I seriously doubt this possibility in many of the countries of the CIS-7.

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Accordingly, I outline here four ideas, none especially new, but none yet tried in the countries of the CIS-7. These ideas are: (a) voluntary colonialism; (b) direct copying of institutions from another country or region; (c) local and regional experiments; (d) linking aid delivery to performance not promises. Let us consider each in turn. Voluntary colonialism10 Sometimes this is not so voluntary, as with the occupation of Germany and Japan after the Second World War; sometimes it really is voluntary, as when new states have acceded to the United States, or when Germany was reunified in 1990. In all such cases, the institutional arrangements of the dominant power are quickly transplanted to the other country or region. These institutions may or may not take root quickly, may or may not be well adapted to local cultural specificities, but they do provide a consistent, functioning model of how an economy may be run - including everything from property rights through to corporate law, tax rules and the regulation of financial markets. Hence when it works, this approach can prove spectacularly successful. For countries of the CIS-7 this approach does not appear so attractive, as for most of the seven there are no obvious role models who are likely to be invited in to run one or other country. None of the neighbouring countries in the region is yet economically very successful, so there are no natural candidates for a potential country “manager”. The one exception, of course, is Moldova. This country used to be a province of Romania in the distant past, and in the early 1990s political leaders did toy with the notion of a reunification of the country. However, internal political divisions within Moldova, together with the unappealing incompetence and mis-management of the early Romanian post-communist governments, effectively killed the idea. More recently, though, Romanian governments have been getting to grips with reforms and their negotiations for EU entry have progressed to the point where Commission papers published this Autumn indicate that Romania is on track for EU accession by 2007 (along with Bulgaria). Consequently, Moldova’s best hope for a successful economic future might well lie in the direction of a merger with Romania - the economics of such a move are increasingly compelling, in my view. Naturally, this is hardly a suggestion that could be put forward by the IFIs associated with the CIS-7 Initiative, and the politics of any possible moves in the direction of a merger would be difficult at best. Given that, one might think that a form of half-way house, whereby the European Economic Area (EEA) takes in Moldova and offers, in that context, substantial trade concessions to assist Moldovan exports, might prove an attractive alternative. Indeed it might, though it does need to be borne in mind that the currently planned next stage of EU Enlargement will already create some strains for EU agricultural policy - falling well beyond the limited scope of this paper - and in my view the EEA is unlikely in the near future to embody extensive trade concessions in agriculture and the food sector. Unfortunately, these are just the sectors where concessions would be most beneficial to Moldova.

10

While I have encountered this idea before, I was reminded of its possible relevance to the present paper by my colleague, Dr Geoff Wyatt, who raised it during my presentation of an earlier version of this paper at a departmental seminar at Heriot-Watt University.

Copying of institutions The best example of institutional copying can be found in the efforts of would-be EU entrants to adopt the complex rules, procedures and institutional structures of the EU’s acquis communautaire. 10 countries of central and eastern Europe are now deemed to be ready for EU accession around 2004, following years of negotiation with the European Commission and immense volumes of legislation to put the acquis into their respective domestic legal domains. The costs of this transplantation of institutional practices have been large, but the countries concerned see their futures as part of western Europe, and are also well aware of the benefits of EU membership in terms of attracting foreign investment, modernising their economies, and the like. This is why they have been willing to bear the costs. None of the CIS-7 is in a similar situation (other than Moldova, referred to above). Moreover, without the attraction and benefits of EU membership or something roughly equivalent to that, one could not seriously advise the countries of the CIS-7 to adapt the acquis, since many of its provisions are better adapted to more prosperous countries that can more easily afford its more expensive features. Is there any other suitable institutional model that could be copied? To find a model, one has to look for countries that are enjoying economic success, preferably countries with which one or other CIS-7 state already enjoys good relations, and with which it shares a degree of cultural affinity. Examples do not readily come to mind. However, thinking along these lines does suggest the possibility of links between Uzbekistan and (western) China. For as noted above, Uzbekistan is the least reformed of our seven countries, still operating significant aspects of old-style central planning in the form of state orders and other centralised structures. True, China has immense problems in its banking and financial sectors, and has not yet got a grip on the problem of reforming inefficient, loss-making state enterprises, so one could hardly advise Uzbekistan to copy China’s practices in these fields. On the other hand, through its township and village enterprises (TVEs), China has found a novel way of fostering quasi-private sector activity, essentially growing thousands of new businesses from virtually nothing, in what appears to outside observers to be an extremely unpromising legal and institutional environment. So instead of copying western models which are not yet working in the conditions of the CIS-7, Uzbekistan could well learn from China - not everything, but at least how to go about fostering new business activity on a massive scale11. One can also think of WTO membership as a means of imposing some institutional rules on a country, principally in the trade area but also in fields of policy that impact on trade, such as domestic competition policy, pricing of public utilities, etc. Of the CIS-7, Moldova, Georgia and the Kyrgyz Republic are already members of the WTO, Armenia’s accession is imminent, and the other countries are at various stages of discussion/negotiation over eventual accession. This process might slowly contribute towards institutional modernisation in the trade and related areas, though one should not expect this to be a very rapid process. Local and regional experiments Because we lack knowledge of how best to deliver aid to support particular activities or types

11

It is worth remarking here that even the Chinese themselves were hugely surprised at the success of their TVEs. But having observed the success, they have proved pragmatic enough to let the experiment run its course.

37

of institutional reform, it can be helpful to deliver it through a mixture of competition and experimentation. For instance, if we wish to support SME development in a given country, it might make sense to set up, say, five agencies in different regions, give them funding for an initial two-year period to foster new business formation - but make subsequent tranches of support dependent on their success in delivering new business starts (taking care not to be fooled by registrations of businesses that existed in name only, of course). An agency that failed to foster enough new businesses would simply be closed, while those doing better would see their funding expand. In pursuing this approach I would also not be prescriptive in telling each agency how it should go about its task, partly because we don’t know the best way of encouraging new businesses to form, partly because I would wish to trust local people to know best how to steer their way through the local cultural/political environment. However, one would naturally wish to demand proper accountability of all funds released to such projects. Aid linked to performance The question of aid conditionality was already referred to in the previous section. What I wish to propose here is along the lines of Easterly (2002), in that it seems to me useful to find a way of delivering aid without being drawn into endless debates about whether this or that condition has or has not been fulfilled, or whether some previously set condition might even be waived for a time. Instead why not simply make aid, or significant chunks of it, depend on performance already achieved. One example should be sufficient to make the point. Thus take the example of trade policy. Instead of offering aid to foster export development before a country has done anything to improve its export regulations, its customs procedures and the like, one might offer aid to support further improvements in trade performance conditional on past export growth. This means that a country making no effort to improve its trade will get no aid, while a country already making serious efforts will be aided. This is surely correct in terms of the underlying incentives for the governments concerned. Even more concretely, aid to improve infrastructure around a border crossing could be made conditional on improving the flow of goods across the border, reducing delays and transit costs, before any new development is approved. It can be argued that this approach is quite problematic in two respects: (a) some new spending might be needed even to take the first steps in improving performance; and (b) there could be some new forms of monitoring difficulty to do with the mis-reporting of performance. I am unconvinced by either of these arguments. For one thing, in virtually all organisations some savings can be achieved and procedures changed without additional spending, merely through a modest reallocation of an existing budget. There can be few situations where it is truly impossible to take some steps to demonstrate a commitment to reform. Further, all conditionality requires various indicators to be measured and performance to be reported to the donor organisation, but it is not clear why the situation I have outlined would give rise to more than the usual level of difficulty. Naturally there will be some distortions, as always. Moreover, it is already an established part of IMF practice to require prior action by the government concerned with a given programme before any disbursement of funds takes place. When programmes are determined to be “off-track” disbursements are suspended; and for countries with low credibility, seeking to establish a track record in policy implementation, it

is quite usual for a Staff Monitored Program (without any disbursements) to be in place for a time. Far from being unduly harsh, therefore, this approach of basing much aid on prior performance is potentially very effective in aligning country incentives with the country’s own stated objectives and with aid agency objectives. Moreover it is totally in line with very standard procedures that form part of western countries’ normal commercial approach to enterprise restructuring. Typically, when a western firm is in difficulties and seeks additional help from banks and other creditors, it will be told to go away and do what it can itself before seeking additional external funds. In other words, firms in difficulties are expected to get restructuring well under way before anyone is likely to advance new funding. This seems exactly the right approach, and in my view it should apply to the allocation of aid just as much as it already does to the allocation of commercial funding to firms in distress. Applying a combination of the above approaches to aid allocation, I am confident that the international community can deliver aid to support institutional change across the CIS-7 more effectively than was done in the previous decade. As is nicely pointed out in IMF (2002d), changing institutions is difficult for three reasons: lack of relevant knowledge; the entrenched positions in society of diverse interest groups; and straightforward inertia. External aid can help a good deal with the first of these and can sometimes find ways of mobilising or circumventing the second. As regards the third, inertia, there is not much to be done directly, though one has to hope that examples of success elsewhere, including local successes within a country, will sooner or later unlock the barriers to change and allow the gradual formation of new institutional structures.

39

References ADB (2001a), Country Strategy and Program Update (2001-2004): Azerbaijan, July, Asian Development Bank ADB (2001b), Country Strategy and Program Update (2002-2004): Tajikistan, July, Asian Development Bank ADB (2000a), Country Assistance Plan (2001-2003): Uzbekistan, December, Asian Development Bank ADB (2000b), Country Assistance Plan (2001-2003): Kyrgyz Republic, December, Asian Development Bank Alesina, Alberto and Weder, Beatrice (2002), “Do Corrupt Governments Receive Less Foreign Aid”, American Economic Review, vol.92(4), pp.1126-1137 Åslund, Anders, Boone, Peter and Johnson, Simon (2001), “Escaping the Under Reform Trap”, IMF Staff Papers, vol.48, Special Issue, pp88-108 Benyon, Jonathan (2001), “Policy Implications for Aid Allocations of Recent Research on Aid Effectiveness and Selectivity: A Summary”, paper presented at OECD seminar on Aid, January 2001, Paris Buiter, Willem and Fries, Steven (2002), “What Should the Multilateral Development Banks Do?”, Working Paper No.74, London: EBRD Burnside, Craig and Dollar, David (1998), “Aid, the Incentive Regime, and Poverty Reduction”, World Bank Working Paper No.1937, June, Washington, DC: The World Bank Burnside, Craig and Dollar, David (1997), “Aid, Policies and Growth”, World Bank Working Paper No.1777, June, Washington, DC: The World Bank Campos, Nauro F. and Coricelli, Fabrizio (2002), “Growth in Transition: What we Know, What we Don’t and What we Should”, Journal of Economic Literature, vol.XL(3), pp.793-836 Collier, Paul and Dehn, Jan (2001), “Aid, Shocks and Growth”, World Bank Working Paper No. 2688, October, Washington, DC: The World Bank Collier, Paul and Dollar, David (2002), “Aid Allocation and Poverty Reduction”, European Economic Review, vol.46(8), pp.1475-1500 DAC (2002), Statistics on Development Assistance and Debt, Development Assistance Committee of the OECD, Paris: OECD (OECD website)

DFID (2000a), “Moldova: Country Strategy Paper”, London: Department for International Development DFID (2000b), “Central Asia and the South Caucasus: Strategy Paper”, London: Department for International Development Easterly, William (2002), The Elusive Quest for Growth, Cambridge, Mass.: The MIT Press EBRD (various years), Transition Report and Transition Report Update, London: EBRD EBRD (2002a), Strategy for Georgia, March 26th, London: EBRD EBRD (2002b), EBRD Investments 1991-2001, London: EBRD EBRD (2001a), Strategy for Moldova, November 20th, London: EBRD EBRD (2001b), Strategy for Armenia, December 11th, London: EBRD EBRD (2001c), Strategy for Uzbekistan, London: EBRD EBRD (2001d), Strategy for Tajikistan, London: EBRD EBRD (2001e), Strategy for Kyrgyzstan, London: EBRD EBRD (2001f), Strategy for Azerbaijan, London: EBRD Falcetti, Elisabetta, Raiser, Martin and Sanfey, Peter (2002), “Defying the Odds: Initial Conditions, Reforms, and Growth in the First Decade of Transition”, Journal of Comparative Economics, vol.30(2), pp229-250 Hansen, Henrik and Tarp, Finn (2000), “Aid and Growth Regressions”, DERG, University of Copenhagen, mimeo Hare, Paul G. (2001), “Institutional Change and Economic Performance in the Transition Economies”, ch.3 (pp77-99, incl. discussion), Economic Survey of Europe 2001, No.2, Geneva: UNECE Hare, Paul, Batt, Judy and Estrin, Saul (eds) (1999), Reconstituting the Market: The Political Economy of Microeconomic Transformation, Amsterdam: Harwood Academic Publishers IMF (2002a), Poverty Reduction, Growth and Debt Sustainability in Low-Income CIS Countries (incl. Country Note Annexes, and Appendix Figures and Tables), prepared jointly by World Bank, IMF, ADB and EBRD for London Conference on CIS-7, February 2002; Washington, DC: IMF IMF (2002b), “Ministers Endorse International Initiative for Seven Poor Countries of the 41

Commonwealth of Independent States”, Press Release No.02/23, Joint Press Release of the World Bank, ADB, EBRD and IMF; Washington, DC: IMF IMF (2002c), Is the PRGF Living up to Expectations? An Assessment of Program Design, Occasional Paper 216, Washington, DC: IMF IMF (2002d), Promoting Better Institutions: The Role of the IMF, Panel Discussion at IMF’s Third Annual Research Conference, Transcript, November 8th 2002, Washington, DC: IMF IMF-A (2001a), Republic of Armenia - Recent Economic Developments and Selected Issues, SM/01/136, Washington, DC: IMF IMF-A (2001b), Republic of Armenia - Staff Report for the 2001 Article IV Consultation and Request for Three-Year Arrangement under the PRGF, EBS/01/61, Washington, DC: IMF IMF-AZ (2002a), Azerbaijan Republic - Staff Report for the 2001 Article IV Consultation, First Review under the PRGF, and Request for Waiver of Performance Criteria, EBS/02/21, Washington, DC: IMF IMF-AZ (2002b), Azerbaijan Republic - Selected Issues and Statistical Appendix, SM/02/35, Washington, DC: IMF IMF-AZ (2001), Azerbaijan Republic - Request for a Three-Year Arrangement under the PRGF, EBS/01/91, Washington, DC: IMF IMF-G (2002), Georgia - Second Review under the Three-Year Arrangement under the PRGF, Request for Waiver of Performance Criteria, and Request for Rephasing of Disbursements, EBS/02/117, Washington, DC: IMF IMF-G (2001a), Georgia - Recent Economic Developments and Selected Issues, SM/01/310, Washington, DC: IMF IMF-G (2001b), Georgia - Staff Report for the 2001 Article IV Consultation, First Review under the Three-Year Arrangement under the PRGF, and Request for Waiver of Performance Criteria, EBS/01/173, Washington, DC: IMF IMF-K (2002), Kyrgyz Republic - First Review under the Three-Tear Arrangement under the PRGF, EBS/02/106, Washington, DC: IMF IMF-K (2001a), Kyrgyz Republic - Staff Report for the 2001 Article IV Consultation and Request for Three-Year Arrangement under the PRGF, EBS/01/187, Washington, DC: IMF IMF-K (2001b), Kyrgyz Republic - Statistical Appendix, SM/01/349, Washington, DC: IMF

IMF-K (2000), Kyrgyz Republic - Selected Issues and Statistical Appendix, SM/00/197, Washington, DC: IMF) IMF-M (2000), Republic of Moldova - Recent Economic Developments, SM/00/271, Washington, DC: IMF IMF-T (2001a), Republic of Tajikistan - Staff Report for the 2001 Article IV Consultation, First Review under the Third Annual Arrangement under the PRGF, and Request for Waiver and Modification of Performance Criteria, EBS/01/46, Washington, DC: IMF IMF-T (2001b), Republic of Tajikistan - Statistical Appendix, SM/01/97, Washington, DC: IMF IMF-T (2001c), Republic of Tajikistan - Second Review under the Third Annual Arrangement under the PRGF and Request for Waiver of Performance Criterion, EBS/01/98, Washington, DC: IMF IMF-U (2002a), Republic of Uzbekistan - Staff Report for the 2001 Article IV Consultation, SM/02/66, Washington, DC: IMF IMF-U (2002b), Republic of Uzbekistan - Statistical Appendix, SM/02/68, Washington, DC: IMF IMF-U (2001), Republic of Uzbekistan - Recent Economic Developments, SM/01/19, Washington, DC: IMF McMillan, John and Woodruff, Christopher (2002), “The Central Role of Entrepreneurs in Transition Economies”, Journal of Economic Perspectives, vol.16(3), pp.153-170 Martens, Bertin, Mummert, Uwe, Murrell, Peter and Seabright, Paul (2002), The Institutional Economics of Foreign Aid, Cambridge: Cambridge University Press Mercer-Blackman, Valerie and Unigovskaya, Anna (2002), “Compliance with IMF Program Indicators and Growth in Transition Economies”, IMF Working Paper WP/00/47, Washington, DC: IMF Musso, Alberto and Phillips, Steven (2002), “Comparing Projections and Outcomes of IMFSupported Programs”, IMF Staff Papers, vol.49(1), pp22-48. Pomfret, Richard (2002), Constructing a Market Economy: Diverse Paths from Central Planning in Asia and Europe, Cheltenham, UK: Edward Elgar UNECE (2002), Economic Survey of Europe, 2002 No.1, Geneva and New York: UN Economic Commission for Europe Wacziarg, Romain (2002), “Review of Easterly’s The Elusive Quest for Growth”, Journal of Economic Literature, vol.XL(3), pp.907-918 43

World Bank (2001a), “Country Assistance Strategy of the World Bank for the Republic of Armenia”, Report No.22111-AM, April 25th, Washington, DC: The World Bank World Bank (2001b), “Country Assistance Strategy: Progress Report of the World Bank Group for the Kyrgyz Republic”, Report No.23185-KG, November 9th, Washington, DC: The World Bank World Bank (2002a), Building Institutions for Markets, World Development Report 2002, Washington, DC: The World Bank Zettelmeyer, Jeromin (1999), “The Uzbek Growth Puzzle”, IMF Staff Papers, vol.46(3), pp274-292 Zinnes, Clifford, Eilat, Yair and Sachs, Jeffrey (2001), “The Gains from Privatization in Transition Economies: Is ‘Change of Ownership’ Enough?”, IMF Staff Papers, vol.48, Special Issue, pp146-170

Tables Table 1. Basic Statistics Indicator Country

Population 2001, mn

Real GDP, 2001 as % of 1989

Per capita GDP,2001 USD

Poverty, $2.15 per person per day 1999, %

External debt/GDP 2001, %

External debt/exports 2001, %

FDI (net) / GDP 1995 2000, %

Moldova

4.3

35

374

55

98.7

217.2

3.9

Armenia

3.0

69

702

44

43.4

267.7

5.2

Azerbaijan

8.1

57

696

24

24.9

61.0

Georgia

5.4

36

581

19

56.5

275.1

3.8

Kyrgyz Republic

4.8

69

308

49

114.4

287.9

4.4

Tajikistan

6.5

52

161

68

95.9

139.3

1.8

Uzbekistan

25.4

103

237

22

72.8

159.4

Totals (where applicable)

57.5

Sources: IMF, EBRD

45

Table 2. Dimensions of Economic Reform, 2002 Country Reform Indicator

Moldova

Armenia

Azerbaijan

Georgia

Kyrgyz Republic

Tajikistan

Uzbekistan

Private sector share of GDP, % *

50

70

60

65

60

50

45

Small privatization

3+

4-

4-

4

4

4-

3

Large privatization

3

3+

2

3+

3

2+

3-

Governance and restructuring

2

2+

2

2

2

2-

2-

Price liberalization

3+

3

3

3+

3

3

2

Trade and foreign exchange system

4+

4

4-

4+

4

3+

2-

Competition policy

2

2

2

2

2

2-

2

Banking reform and interest rates

2+

2+

2+

2+

2+

2-

2-

Securities markets and non-bank financial institutions

2

2

2-

2-

2

1

2

Telecoms

2+

2+

1

2+

2+

2+

2

Electric power

3+

3+

2+

3+

2+

1

2

Railways

2

2

2+

3

1

1

3

Roads

2

2+

2+

2

1

1

1

Water and waste water

2

2

2

2

1

1

1

Commercial law

4-

3+

2

3-

3+

1+

3-

Financial regulation

3

3-

1

2+

2-

3

2-

Enterprises

Markets and trade

Financial institutions

Infrastructure

Legal reforms

Source: EBRD Transition Report, 2002 Note: Numbers are ratings given by the EBRD using a scale running from 1 (little or no reform) to 4+ (complete reforms, conditions as in a well functioning market economy). * mid-2001.

Table 3. Aid Data, 1998-2000 (USD millions) Country\Year

1998

1999

2000

Net ODA

40

107

123

Bilateral share (gross ODA)

55%

48%

50%

Net ODA/GNI

2.3%

8.9%

9.1%

Net private flows

14

150

482

Net ODA

143

209

216

Bilateral share (gross ODA)

47%

36%

65%

Net ODA/GNI

7.5%

11.3%

11.2%

Net private flows

0

32

-21

Net ODA

100

189

139

Bilateral share (gross ODA)

35%

31%

51%

Net ODA/GNI

2.4%

3.8%

2.9%

Net private flows

232

339

476

Net ODA

171

245

170

Bilateral share (gross ODA)

46%

32%

71%

Net ODA/GNI

4.7%

8.6%

5.3%

Net private flows

48

33

24

Net ODA

225

283

215

Bilateral share (gross ODA)

35%

41%

42%

Net ODA/GNI

14.4%

24.1%

17.8%

Net private flows

21

29

5

106

123

142

Moldova

Armenia

Azerbaijan

Georgia

Kyrgyz Republic

Tajikistan Net ODA

47

Country\Year

1998

1999

2000

Bilateral share (gross ODA)

38%

29%

27%

Net ODA/GNI

8.6%

11.9%

15.3%

Net private flows

6

6

-8

Net ODA

158

155

186

Bilateral share

78%

73%

72%

Net ODA/GNI

1.1%

0.9%

1.4%

Net private flows

549

-132

124

Uzbekistan

Source: DAC (2002)

Table 4. Growth Rates of Real GDP in the CIS-7, 1995-2001 (in percent per annum) 1995

1996

1997

1998

1999

2000

2001

Moldova

-1.4

-5.9

1.6

-6.5

-3.4

2.1

6.1

Armenia

6.9

5.9

3.3

7.3

3.3

6.0

9.6

Azerbaijan

-11.8

1.3

5.8

10.0

7.4

11.1

9.9

Georgia

2.4

10.5

10.8

2.9

3.0

2.0

4.5

Kyrgyz Republic

-5.4

7.1

9.9

2.1

3.7

5.1

5.3

Tajikistan

-12.5

-4.4

1.7

5.3

3.7

8.3

10.3

Uzbekistan

-0.9

1.6

2.5

4.4

4.1

4.0

4.5

Year Country

Source: Transition Report in 2002, London: EBRD

49

Table 5. Institutional Reforms - Template Initial Position

Current position (2000 or 2001)

Market Economy Ideal

Macroeconomic Reforms Central Bank

Branch of Gosbank

Independent Central Bank with an inflation target

Currency

Rouble

Currency under the control of the Central Bank

Exchange rate policy

None - controlled from Moscow

No single rule, but for traders and investors a degree of exchange rate stability or predictability is valuable.

Fiscal policy taxes

Mostly based on turnover tax + tax on above-plan profits

PIT, VAT and profits tax. Low and fairly uniform tariffs, few excises.

Fiscal policy spending

Priorities and spending total set in Moscow

Priorities set by the government in the light of expected tax revenues

Local government

Little local taxation, lowerlevel budgets set by Moscow

Local taxation + government grants to meet local spending needs

Delivery of public services

Many delivered through SOEs, little through local government

Mostly should be delivered through local government

Social safety net

Not needed for those of working age as officially there was no unemployment. Pensions based on work record. Many benefits paid through SOEs.

Provision by a poor country cannot be exten-sive. Need basic protection for sick, disabled, children, unemployed and pensioners. Incentives for selfprotection (insurance) plus modest public benefits. Provision should be through public agencies.

Budget balance

Set in Moscow, incl. transfers needed to achieve balance

Aim for budget balance that the country can manage, given available resources and commitments.

Public expenditure man’t

Based on annual planning cycle. Many targets and quantitative controls, poor financial control.

Need effective PEM system, but in a poor country need something that is easy to operate, cheap to administer and consistent with good incentives for honesty.

Initial Position

Current position (2000 or 2001)

Market Economy Ideal

Microeconomic Reforms Pricing - general

Mostly fixed for long periods, except for markets for private food production and black markets

Mostly flexible, set in the market; need adequate competition

Pricing - utilities

Fixed for long periods, at prices well below world market prices

Need for regulation of private monopolies, unbundling of competititive activities

Wages

Fixed by the state, higher wages in priority sectors or unpleasant locations. Poor incentives in relation to educational levels.

Fixed in the market, incl. by negotiation between employers and workers or their trade unions. May need minimum wage

Trade policy

Set in Moscow. Extensive quantitative controls and complex tariff structures. Much trade a residual element in the planning process.

Conform to WTO trading principles, incl. implications for domestic policies.

Markets - goods

Business sector transactions through the plan plus informal trading by enterprise managers. Personal consumption through the retail network, but shortages and rationing common, limited choice, limited competition.

Free markets, with appropriate market infrastructure in place

Markets - land

Illegal to trade in land - no market, so no market institutions like a proper cadastre.

Free market, with market institutions like a cadastre to register titles.

Markets - assets

Almost none, unless an asset transfer was approved in the plan.

Generally free market for assets, whether new or used.

Markets - nonfinancial services

Limited private activity in personal services. Virtually no markets for business services.

Generally free markets, incl. a major development of business services and supporting institutions

51

Initial Position

Current position (2000 or 2001)

Market Economy Ideal

Markets financial services

Virtually non existent. No real banks, no markets for financial assets.

Commercial banks to provide normal competitive banking services to households and firms. Insurance companies, pension funds well developed. Wide range of financial assets to be traded - government and private.

Labour market

Some assignment of people to jobs, no unemployment, poor work discipline

Competitive assignment of people to jobs, rewards for good work performance

Ownership of firms

State or collective owned little formal difference. Most private business illegal until mid-1980s, then limited forms allowed.

Mostly private; owners can be shareholders, managers, workers; foreign entities can hold ownership stakes, etc.

Ownership of land

All state owned except for small private plots in agriculture.

Mostly private

Physical infrastructure

Based on central plans, integrated into all-Union system

Based on national needs, integrated with neighbours to ensure efficient resource use (energy and water) and low transactions costs (trade)

Legal aspects

Weak legal protection, contracts often over-ridden by administrative fiat, depending on needs of the plan.

Contract and property rights fully protected in law.

Table 6. Aid to Moldova Multilateral (situation to May/June 2002) IMF (Moldova joined the Fund in August 1992)

Extended arrangements: SDR 76.69 mn Systemic Transformation: SDR 13.13 mn PRGF, approved 21/12/00, running until 20/12/03 Committed: SDR 110.88 mn; Disbursed: SDR 18.48 mn Technical assistance: 17 missions between January 1997 and May 2002 to advise NBM, MoF, MoE on diverse aspects of policy, public administration and reforms.

World Bank 1996, investment loans (IBRD): (Joined 1992, PSD I, $35 mn, credit line for restructuring IDA eligible in First agriculture project, $10 mn 1997, IDA only Energy project, $10 mn since May IFC investment of $10 mn in INCON, a major agro-processor 2000) Since 1997, more projects followed: General education project (IDA $5 mn, IBRD $16.8 mn) PSD II to train business managers, $9mn (IDA) Cadastre project, IDA $15.9mn Social Investment Fund project, IDA $15 mn Social Protection Management Project, IDA $11.1 mn Health Investment Fund project, IDA $10mn, Dutch gov’t $10 mn Structural adjustment operations 1994 First Structural Adjustment Loan, $60 mn (IBRD) 1997 Second Structural Adjustment Loan and Credit ($100 mn, of which IDA - $45 mn) 1999 SAC, $40mn, replacing the final $30mn tranche of the above; the second tranche of this SAC II supplemented by $10mn from Dutch gov’t June 2002, proposed SAC III, $30mn Additional projects in the pipeline/in preparation Technical assistance projects - not separately identified. EBRD

Total value of projects in Moldova with EBRD participation amounts to Euros 318mn. 25 projects have been signed, committing Euros 190.6mn of EBRD resources, of which Euros 154.4mn have been disbursed. New projects valued at around Euros 13mn are in preparation. 74 Technical Cooperation projects have been completed or approved, valued at about Euros 10mn

ADB

None. Moldova is not a member.

UNDP

[no information]

EU

PCA in place Assistance under the TACIS programme, funds committed about Euros 67 mn (grants) since 1991, focusing on agriculture, private sector development and human resources development. About 30 projects operating. 53

Other

[no information]

Bilateral US - USAID

About £30mn per year (grants), total technical assistance so far of over $226mn.

Germany

Recent agreement under which Germany provides DM20mn of aid, allocated to rural restructuring, micro-lending, and wine industry restructuring.

Sweden - SIDA From 1996, total aid has been about $12mn. In 2001, it amounted to $3mn. In addition $4mn per year is provided to support the payments balance, subject to continued IMF financing. Dutch gov’t

Cofinancing of World Bank projects (noted above), $20mn

UK - DFID

£3.7mn committed since 1991, mostly responding to specific requests from Moldovan or UK parties. Focus on agriculture and the financial sector. From 2002, expect flow of aid of about £2-2.5mn per year.

France

2001, credits of about FF3mn, grant for technical assistance on private sector issues of about FF3.5mn.

Summary Top 10 donors of gross ODA (1999-2000, average), USD millions

United States IDA Netherlands EU IMF Japan Germany Switzerland UK

Sources: IMF-M (2002a), EBRD (2001a), DAC (2002)

37 35 8 7 6 3 2 2 1

Table 7. Armenia Multilateral IMF (Joined the Fund in May 1992)

Stand-by credit, SDR 43.88 million; amount drawn SDR 13.50 million Systemic Transformation, SDR 25.31 million ESAF (1996-99), committed and disbursed: SDR 109.35 million PRGF, 2001 onwards - committed SDR 69 million (3 year programme). Some technical assistance missions, advice from the Resident Mission (16 missions in the period 1998-2000).

World Bank (Joined the Bank in Sept. 1992)

IBRD loan, 1993, USD 12 million for institution building. IDA investment credits during 1990s - 22 in total, diverse sectors (15 still being implemented, 8 are closed). Commitments USD340.9 million, disbursements USD 169.2 million by end-2000. Adjustment lending totalled USD 245 million Technical assistance financing (credits) USD 20.8 million (incl. the institution building loan). Bank grants for various technical studies, training activities

EBRD

At end-2001, EBRD had six signed projects, committing Euros 133.3 million, of which Euros 100.6 million was disbursed (4 loans, 2 equity investments). Sectors: thermal power plant (to enable a nuclear plant to be closed); air cargo terminal; banking sector; electricity distribution another project, supporting a wholesale food market, was cancelled. EBRD support for electricity privatization, and funding for technical assistance.

ADB

None. Armenia is not a member

UNDP

About USD 3 million per year, focused on good governance and poverty reduction.

EU

About Euros 290 million in aid during the 1990s, about a quarter through TACIS, most of the rest on food aid, food security and humanitarian assistance. Small sum for nuclear safety. EU Country Strategy Paper (2002-2006) focusing on institutional reform and social impact of transition, spending about Euros 10 million per annum.

Other

Implementation of CAS programme involves many partners working with the World Bank: the multilateral ones include: UNDP, EU-TACIS, UNICEF, OSCE

Bilateral Linked to World Bank

Implementation of CAS programme involves several bilateral donors incl.: US TDA, USAID, DFID, German TA, Dutch Government, SIDA, KfW, etc.

55

USAID

Spending USD 50-70 per annum, mostly on infrastructural and institutional issues.

Germany

Focus on support for SMEs. E.g. in 1999-2000, KfW provided over 1000 small loans to SMEs, amounting to Euros 5.5 million.

UK

Focus on poverty reduction, public sector reform (e.g. customs administration), social and economic development, regional admin. Spending ? 2-3 millions per annum.

France

Support for energy sector, telecoms, plus technical assistance in accounting standards, customs regulation. Spending Euros 2-3 million per annum.

Netherlands

Focus on agriculture, also moving on to industry and IT. Spending Euros 3-4 million per annum.

Summary Top 10 donors of gross ODA (1999-2000, average), USD millions

United States IDA EU IMF Germany Japan IFAD Netherlands Greece France

76 60 17 14 8 6 6 5 3 2

Sources: IMF-A (2001a), IMF-A (2001b), World Bank (2001a), EBRD (2001b), DAC (2002)

Table 8. Azerbaijan Multilateral IMF (Joined the Fund in Sept. 1992)

ESAF/PRGF, SDR 93.60 million committed, SDR 81.90 drawn EFF, SDR 58.50 million committed, SDR 53.24 drawn PRGF (approved June 2001), SDR 80.45 committed, SDR 8.05 million drawn. Over 50 technical assistance visits since 1995 on a wide range of monetary policy, tax policy government spending-related issues.

World Bank Joined Bank in Sept. 1992, and IDA in March 1995)

Four key areas: institutional reforms to support private sector development; enhance competitiveness, notably in agriculture; poverty alleviation; resettlement of IDPs. At end-2001, USD 461.6 millions committed to 16 operations, USD 256.1 disbursed. These included institution building TA I (USD 18 million), and SAC I (USD 77 million, in two stages). Institution building TA II, USD 16.8 million - due for approval late 2002 SAC II, USD 60 million - due for approval late 2002 In addition, the Bank has undertaken several studies that contributed to policy advice.

EBRD

At end 2000, 17 signed projects committing Euros 392 million, of which 51% disbursed. Sectors - oil and gas, water, power, transport. 33 TA projects involving funding of Euros 10.5 million, mostly focused on project preparation and implementation, some general advice.

ADB (New member of the Bank, joined late 2000)

Classified as B1 country, hence eligible for Asian Development Fund (ADF) financing, but revenue earning projects can also be funded from the Bank’s Ordinary Capital Resources (OCR). 2002-2004, 7 public sector loans planned, totalling USD 168 million. 5 loans classified as “poverty” oriented. Programme focuses on rural development, water supply and sanitation, and roads. 18 TA projects in the pipeline, amounting to USD 10 million, plus reports on key issues to contribute to policy advice.

EU-TACIS

Over 1998-2000, Euros 12.7 million in grants to support transition in financial sector, legal reforms, SMEs, etc.

Other

Islamic Development Bank - about USD 73 million in loans, mostly for infrastructure rehabilitation projects.

57

Bilateral

Germany

About DEM 94 million in loans for investment projects through KfW plus DEM 10 million for TA grants to support these projects. Projects mostly in infrastructure and SME support. 2000-2001, further commitments of DEM 40 million.

Japan

2 major loans of USD 100 million for polyethylene plant, USD 340 million for hydro power project. Also, USD 2.2 million in grants to support equipment procurement.

Turkey

USD 250 million loan, partly used to finance Turkish exports. Discussions to reschedule repayments have taken place.

Summary Top 10 donors of gross ODA (1999-2000, average), USD millions

IDA Japan EU United States Germany IMF WFP UNDP UNHCR Norway

44 24 21 16 14 8 3 2 2 2

Sources: ADB (2001a), IMF-AZ (2001), IMF-AZ (2002a), IMF-AZ (2002b), DAC (2002), EBRD (2001f)

Table 9. Georgia Multilateral IMF (Joined the Fund in May 1992)

Stand-by, SDR 72.15 million committed, SDR 22.2 million drawn ESAF, SDR 172.05 million committed, all drawn PRGF (2001-2004), SDR 108 million committed, SDR 27.00 million drawn 10 Technical Assistance missions in past two years - mostly on PEM, tax code, national accounts statistics, banking system. IMF funding suspended for part of 2001

World Bank (Joined Bank in August 1992, IDA in August 1993, IFC in 1995)

IDA funding - 24 investment and TA credits and 5 adjustment operations to March 2002, committing USD 649.8 million. Funding included structural adjustment credits (most recently SAC III), and institution building projects, e.g. in energy transit. IFC funding - 8 projects to date, committing USD 81.6 million. Various technical assistance missions/projects, policy advice - e.g. in privatisation of electricity distribution and generation. Bank funding suspended for part of 2001.

EBRD

Aim to expand private sector operations - focus on improving investment climate; financial sector; SMEs - via lines of credit and infrastructure developments; infrastructure; regional projects. By end-2001, 18 signed projects in power, financial, transport, natural resource and agriculture sectors. Total commitment Euros 249.1 million, of which 61.9% disbursed. Over 56 technical cooperation projects, mostly involving other donors total cost about Euros 9.16 million.

ADB

None - Georgia is not a member

EU

Various programmes to do with Food security, Macroeconomic assistance (helping Georgia with Soviet-era debt), Post-conflict rehabilitation. Also, EU-TACIS. Support for institutional reforms, infrastructure and the private sector. For 2000-2003, Euros 8.55 million committed for main projects, and a further Euros 2.5 million for small projects.

Other

[no information]

59

Bilateral

USAID

For 2001, total budget for Georgia of USD 100 million. Priority areas: humanitarian assistance; rule of law, governance and NGO development; SME and other small scale activities.

Germany

Euros 91.4 million committed through KfW for investment projects (loans) plus about Euros 13.8 million in grants for TA and training associated with these investments. Recent focus on municipal infrastructure, renewable energy, health.

Japan

2000-2001, grants of ¥1 billion to support increased food production (2 grants); rehabilitate main roads (1 grant).

Summary Top 10 donors of gross ODA (1999-2000, average), USD millions

United States IDA IMF EU Germany Japan Netherlands Switzerland UNDP Norway

52 49 23 21 18 11 4 3 3 2

Sources: DAC (2002), EBRD (2002a), IMF-G (2001a), IMF-G (2001b), IMF-G (2002).

Table 10. Kyrgyz Republic Multilateral IMF

June 1998, 3 year PRGF approved, committing SDR 73.38 million, of which SDR 30.38 million disbursed. Current position (April-2002): Systemic Transformation, SDR 8.06 million ESAF/PRGF arrangements, SDR 129.31 million Numerous technical assistance missions over the period 1997-2002.

World Bank

5 projects completed, costing USD 255 million; 19 projects under implementation, costing a further USD 50 million. Other projects in the pipeline. By April 2002, 24 projects totalling USD 614 million, with USD 442.5 million disbursed. Focus on poverty reduction, social protection, agricultural productivity, private sector and financial sector development; and efficiency of energy sector and urban transport. IFC projects active or under development in institution building financial sector, mining, agriculture extension and agro-processing, infrastructure. Various TA activities, incl. in the leasing and insurance sectors.

EBRD

11 investment projects committing Euros 158.5 million, of which Euros 111 million disbursed. 4 public sector, 7 private sector projects. Transition impact - limited success in SME sector, some financing problems. 63 TA projects with various partners.

ADB (joined in 1994)

15 loans for 12 projects approved to March 2000, all from ADF. Total commitment, USD 386 million. By early 2002, 20 loans committing USD 527.2 million, of which USD 316 million disbursed. Also, over 35 TA grants totalling USD 28.2 million, focusing on institutional strengthening and capacity building.

EU

PCA signed Feb.1995, effective from mid-1999. TACIS aid will focus on institutional reforms, support to private sector. Food security - Euros 35.5 million committed, Euros 30 million disbursed.

UNDP

Various projects committing USD17 million.

61

Bilateral US

In 2000, aid of USD 43 million committed, mostly top support/promote economic reforms. USAID - extensive TA and training programmes

Canada

Diverse TA activities, committing about Can.$3 million

Germany

Committed DEM 216 million up to 2000, of which DEM 158 million through KfW. DEM 58 million through GTZ for various TA projects.

Japan

JBIC - six loans totalling ¥25.6 billion for balance of payments support, airport project, 2 road projects ¥5.7 billion in grants, plus ? 2.36 billion in TA project grants.

Netherlands

Aid programme of USD 17 million - focus on health, legislative reform, management development, agricultural privatisation.

Switzerland

CHF 75 million committed to various technical and financial assistance projects. Focus on promoting transition in various sectors.

Summary Top 10 donors of gross ODA (1999-2000, average), USD millions

Japan ADB IDA United States IMF EU Switzerland Germany UNDP Netherlands

55 51 37 27 23 15 7 6 2 2

Sources: DAC (2002), EBRD (2001e), IMF-K (2000), IMF-K (2001a), IMF-K (2001b), IMF-K (2002)

Table 11. Tajikistan Multilateral IMF (joined May 1992)

Since 1998, PRGF funding in place, USD 130 million disbursed by mid2001. Current position (mid-2001): ESAF/PRGF Arrangements, SDR 72.28 million drawn out of a commitment of SDR 100.30 million (1998-2001). Debt problem has result in strict ceilings on sovereign guarantees on loans. Numerous TA missions since 1992 - various macro-policy topics.

World Bank (joined IDA 1993, IFC 1994)

Policy advice, institutional capacity building, financing post-conflict needs, etc. USD 211 million committed by early 2001, 16 operations on IDA terms; about USD 150 million disbursed. May 2001 - commitments for 2001/2 for poverty reduction and public investment about USD 430 million - from various donors. IFC have supported a few projects in Tajikistan.

EBRD

ADB (joined Dec.1998)

Focus on private sector development, support for SMEs, together with financial sector development and critical investments in infrastructure to relieve bottlenecks. By 2001, 5 projects approved with total cost of Euros 30.9 million, EBRD commitment Euros 16.9 million (80% disbursed). Sectors industry, finance, infrastructure. Numerous TA projects with various partners.

1998 - post-conflict infrastructure loan, USD 20 million. Current efforts focus on agriculture. 1999 - Social Sector Rehab. Loan, USD 20 million to support reforms in transport and energy sectors. 2000 - Road Rehab. Loan (USD 20 million) and Power Rehab. Loan (USD 34 million) approved. Other loans to support reform agenda in preparation.

63

EU

Aga Khan Foundation

Humanitarian relief and food aid, Euros 73 million. Arrears between Tajikistan and EU settled; this led to further funding: Loan of Euros 60 million for macro-financial assistance, grant of Euros 7 million TCA and TACIS programme form framework for future EU aid.

USD 110 million since 1992, initially controlling drug production and distribution, now into social and agriculture sectors.

Bilateral Various

Mostly small, except for USAID; limited information

Summary Top 10 donors of gross ODA (1999-2000, average), USD millions

IDA IMF United States EU ADB WFP Switzerland Germany UNDP Arab Agencies

29 26 22 16 11 5 4 4 3 2

Sources: DAC (2002), EBRD (2001d), IMF-T (2001a), IMF-T (2001b), IMF-T (2001c)

Table 12. Uzbekistan Multilateral IMF

World Bank (joined 1992)

EBRD

ADB (joined 1996)

Difficult relationship, suspended mid-1990s, resumed links from 2000/1. Staff Monitored government programme in 2002, but no Fund financing in place. Government not interested in market-oriented reforms and also claims that such reforms would require massive up front financing. The Fund does not accept this. From 1993, USD 21 million for institution building and TA, USD 160 million loan to support macro and structural reforms; USD 66 million loan to support cotton production improvements. Since 1996, some funding suspended. But to date, 9 loans amounting to USD 458 million, of which 56% disbursed - mostly infrastructure and TA.

24 projects costing a total of Euros 1.152 billion, with EBRD contribution of Euros 473 million (net of cancellations and repayments). About 65% disbursed, rest awaits satisfaction of implementation conditions. Most financial sector, some activity in natural resources, industry, etc. Transition impact - improving credit evaluation capacity of banks, support for SMEs, improvements in natural resource and infrastructure sectors. Numerous TA contracts with various partners.

Focus on transport infrastructure, education, agriculture. Since 1998, two loans for railway track rehabilitation, USD 140 million. Loan for road rehabilitation signed in 1998, but little implementation since then due to lack of institutional reforms. Credit lines to support agriculture and agribusiness (USD 50 million, USD 50 million); education projects, USD 97 million. In total, by end-2000, USD 377 million was committed .

65

EU

PCA signed 1996, effective from 1999 TACIS - Euros 111 million to end 1999, further Euros 15 million committed for 2001-2003. Mostly TA, focusing on institutional reform, rural development, social consequences of transition

UNDP

Since 1999, total funding of about USD 26.6 million

Other UN Agencies

Total commitment of about USD 26.6 million

Bilateral USAID

Since 1992, about USD 276.78 million allocated to Uzbekistan. Aims to develop Uzbek leaders, improve governance, capacity building in NGOs, etc. Now more focus on supporting private enterprise development.

Germany

Euros 130 million in financial cooperation through KfW, mostly grants on IDA terms. Support for rail sector under consideration. Further Euros 30 million in TA, mostly through GTZ as grants.

Japan

JBIC - 12 loans amounting to ¥ 98.8 billion. 1999 saw approvals of ¥ 25.9 billion in loans for telecoms and airport expansion projects. Education project supported by JBIC - ¥ 6.3 billion. Grants: ¥6.9 billion to 1998, plus TA of ¥2.4 billion.

Turkey

USD 250 million committed, credit lines to support Turkish exports plus a few big projects.

Summary Top 10 donors of gross ODA (1999-2000, average), USD millions

Japan United States EU Germany France UNDP UNICEF UK Switzerland UNFPA

82 27 13 9 3 1 1 1 1 1

Sources: DAC (2002), EBRD (2001c), IMF-U (2001), IMF-U (2002a), IMF-U (2002b)

Table 13. Progress towards a Market Economy - The CIS-7

Initial Position

Current position (2000 or 2001)

Market Economy Ideal

M

A

Az

G

K

T

U

Macroeconomic Reforms Central Bank

Branch of Gosbank

3

3

3

3

3

3

2

Independent Central Bank with an inflation target

Currency

Rouble

4

4

4

4

4

3/4

3

Currency under the control of the Central Bank

Exchange rate policy

None - controlled from Moscow

3

3

3

3

3/4

3

2

No single rule, but for traders and investors a degree of exchange rate stability or predictability is valuable.

Fiscal policy - taxes

Mostly based on turnover tax + tax on above-plan profits

2

3

2

2/3

2/3

2/3

2

PIT, VAT and profits tax. Low and fairly uniform tariffs, few excises.

Fiscal policy spending

Priorities and spending total set in Moscow

3

3

3

2/3

2/3

2/3

2

Priorities set by the government in the light of expected tax revenues

Local government

Little local taxation, lower-level budgets set by Moscow

3

2

2

2/3

2/3

2/3

2

Local taxation + government grants to meet local spending needs

Delivery of public services

Many delivered through SOEs, little through local government

2

2

2/3

2

2

2/3

2

Mostly should be delivered through local government

Initial Position

Current position (2000 or 2001)

Market Economy Ideal

M

A

Az

G

K

T

U

Social safety net

Not needed for those of working age as officially there was no unemployment. Pensions based on work record. Many benefits paid through SOEs.

2

2

2

2

2

2

1/2

Provision by a poor country cannot be extensive. Need basic protection for sick, disabled, children, unemployed and pensioners. Incentives for selfprotection (insurance) plus modest public benefits. Provision should be through public agencies.

Budget balance

Set in Moscow, incl. transfers needed to achieve balance

4

3

4

3

2/3

2/3

2/3

Aim for budget balance that the country can manage, given available resources and commitments.

Public expenditure management

Based on annual planning cycle. Many targets and quantitative controls, poor financial control.

3

3

3/4

2/3

2/3

2/3

2

Need effective PEM system, but in a poor country need something that is easy to operate, cheap to administer and consistent with good incentives for honesty.

Pricing - general

Mostly fixed for long periods, except for markets for private food production and black markets

4

3

3/4

3

3/4

3/4

2/3

Mostly flexible, set in the market; need adequate competition

Pricing - utilities

Fixed for long periods, at prices well below world market prices

3

3

2

2/3

2

2

2

Need for regulation of private monopolies, unbundling of competititive activities

Wages

Fixed by the state, higher wages in priority sectors or unpleasant locations. Poor incentives in relation to educational levels.

3

3

3

3

3

2/3

2

Fixed in the market, incl. by negotiation between employers and workers or their trade unions. May need minimum wage

Microeconomic Reforms

Initial Position

Current position (2000 or 2001)

Market Economy Ideal

M

A

Az

G

K

T

U

Trade policy

Set in Moscow. Extensive quantitative controls and complex tariff structures. Much trade a residual element in the planning process.

2

2/3

2/3

2/3

2/3

3

1/2

Conform to WTO trading principles, incl. implications for domestic policies.

Markets - goods

Business sector transactions through the plan plus informal trading by enterprise managers. Personal consumption through the retail network, but shortages and rationing common, limited choice, limited competition.

3

3

3

2/3

3

3

1/2

Free markets, with appropriate market infrastructure in place

Markets - land

Illegal to trade in land - no market, so no market institutions like a proper cadastre.

3

3

2/3

2/3

2/3

2

1

Free market, with market institutions like a cadastre to register titles.

Markets - assets

Almost none, unless an asset transfer was approved in the plan.

2

3

2/3

2/3

2/3

2/3

2

Generally free market for assets, whether new or used.

Markets - nonfinancial services

Limited private activity in personal services. Virtually no markets for business services.

4

3

3

3

3

2/3

2/3

Generally free markets, incl. a major development of business services and supporting institutions

Markets - financial services

Virtually non existent. No real banks, no markets for financial assets.

3

3

2/3

2/3

2

2

2

Commercial banks to provide normal competitive banking services to households and firms. Insurance companies, pension funds well developed. Wide range of financial assets to be traded - government and private.

Initial Position

Current position (2000 or 2001)

Market Economy Ideal

M

A

Az

G

K

T

U

Labour market

Some assignment of people to jobs, no unemployment, poor work discipline

2/3

2/3

2/3

2/3

2/3

2/3

2

Competitive assignment of people to jobs, rewards for good work performance

Ownership of firms

State or collective owned - little formal difference. Most private business illegal until mid-1980s, then limited forms allowed.

3

3

3

3

2/3

2

1/2

Mostly private; owners can be shareholders, managers, workers; foreign entities can hold ownership stakes, etc.

Ownership of land

All state owned except for small private plots in agriculture.

3

3

3

3

2/3

2

1/2

Mostly private

Physical infrastructure

Based on central plans, integrated into all-Union system

2/3

2

2/3

2

2

2

2

Based on national needs, integrated with neighbours to ensure efficient resource use (energy and water) and low transactions costs (trade)

Legal aspects

Weak legal protection, contracts often over-ridden by administrative fiat, depending on needs of the plan.

2/3

2/3

2/3

2

2/3

2

1/2

Contract and property rights fully protected in law.

Source: Author’s judgement. Note: Central columns refer to the countries of the CIS-7.

Table 14. Summary of Main Proposed Reform Areas Across the CIS-7 Country

Reform Areas

Moldova

(1) trade policy and operational practice; (2) SME support and the surrounding legal/regulatory framework; (3) civil service laws - and perhaps wider legislation on the operation of the labour market.

Armenia

(1) improving the investment climate; (2) encouraging further privatisation and industrial restructuring; (3) improve the environment for SMEs, including improved access to financing;

Azerbaijan

(1) infrastructural development (2) reform of electricity pricing and collection arrangements; (3) reform of the social safety net to provide better targeting of benefits.

Georgia

(1) reduction of corruption at all levels, improvements in governance; (2) improvements in the general business environment; (3) improvements in business-related infrastructure.

Kyrgyz Republic

(1) reforms in the agriculture sector; (2) improving and targeting the social safety net; (3) improving the composition and targeting of social spending (e.g. by concentrating resources on basic health care, basic education).

Tajikistan

(1) improving public administration/civil service reforms; (2) improving the general business environment; and (3) gradual elimination of quasi-fiscal subsidies in the energy sector

Uzbekistan

(1) trade and exchange rate policy (incl. exchange rate regime); (2) privatisation of SOEs, and associated restructuring; (3) support for SMEs; (4) reform of the cotton sector.

Source: Author’s analysis