EAST BLOC ECONOMIC REFORM: LESSONS FOR SOUTH AFRICA

I have always puzzled as to why some formerly communist countries came out of the bloc so much more quickly (pun intended) and effectively than others.

Estonia –the flavour of the month amongst commentators – is a wonderful prototype of successful reform. No one knows exactly how much the per capita income of Estonia was before the introduction of market-based reforms in the early nineties. But anecdotal accounts suggest that it, and life quality in general, was poor. But we do have decent statistics from 1995 onwards.

What we also know, is that the country’s economic system changed from a communist/socialist one in the years up to 1989, to a free-market system. Today its economy is the tenth freest in the world.

Here is a table setting out the change of Estonia to a free-market system, according to the Freedom of the World Index, together with its per capita GDP over the period (The freedom rating components of 1990 are sparse, and the average does not contain all the elements available):

1990 1995 2000 2005 2010 2014 2015 2016
Economic freedom 4.49 7.60 7.96 7.82 7.80 7.95
GDP per capita (Constant 2010 $) 7313 10108 14681 14282 17453 17733 18094
Unemployment 1.5 10 15 9 16 9 7 5

 

What we note is that:

  • Economic freedom gradually increased;
  • The country’s real per capita GDP grew by 150% between1995 and 2016;
  • After volatility in the years of the transition and the financial crisis, unemployment has declined steadily.

A point that should not be left unmade, is about basic education.  In 2015, Estonia was ranked in the top ten nations in both math and reading in the PISA international educational rankings, and in science it was ranked third in the world behind Singapore and Japan.

Estonia has one of the most decentralised education systems in the world. This extends not only to school management, but also to teachers. Promotion and appointment of teachers, curriculum, time allocation and testing procedures are mostly decied at school level.

Moreover, Estonia has school choice. In addition to a guaranteed place in a local public school, a learner may also apply to any private or selective school, each of which receives a state subsidy, but may charge extra. That has the benefit of introducing competition into the education arena, resulting in incentives for both private and public schools to improve.

The combination of a free market and good education has predictably unleashed the growth potential of the Estonian economy.

A comparison of Estonia with its peers – ie former Soviet satelite states that emerged from the former East Bloc – shows how important a free market is. The graph below compares average annual real per capita GDP in dollar terms. That way of measurement is more useful than percentage growth, because to a large degree it eliminates the phenomenon of convergence – namely that poorer countries, all things being equal, grow percentage-wise faster that wealthy ones.

Country Average economic freedom rank (90-15) (EFW) $ per capita GDP growth 1995-2016
Estonia 13.8 1207
Georgia 18.75 591
Lithuania 29.2 1503
Ave 1st quartile 20.58 1100
Latvia 30.4 1306
Slovak Rep 40.8 1116
Romania 51.5 502
Ave 2nd quartile 40.9 974
Czech Rep 51.6 652
Hungary 54.33 481
Poland 67 934
Ave 3rd quartile 57.64 689
Bulgaria 68.33 419
Slovenia 73.22 726
Croatia 79.4 484
Ave 4th quartile 73.65 543

 

There is no question: Those countries that maintained a high level of economic freedom in the post-communist era, and did so over a number of years consistently, on the whole reaped the benefits.

Having said that, Georgia is an outlier. Despite its considerable economic freedom, its performance (as measured here) was average at best. That is largely the result of the fact that it started off a lower base than any of the other countries. If measured in percentage terms, its per capita GDP grew at a phenomenal 12 percent per annum, higher than any country on the list. That is despite the fact that it has relatively poor education, as the next graph shows (It is ranked 105 out of 139 in the Global Competitiveness report). By contrast, Poland (with 4th best education among the countries shown) does quite well despite a lack of economic freedom:

Country Education rank $ growth
Estonia 5 1207
Slovenia 52 726
Czech Rep 59 652
Poland 72 934
Lithuania 73 1503
Bulgaria 87 419
Latvia 88 1306
Georgia 105 591
Hungary 111 481
Croatia 112 484
Romania 115 502
Slovak Rep 118 1116

 

None of this should come as a surprise. In South Africa we also, like these former East Bloc countries, emerge from an era of economic mismanagement. We too need to reform our economy in order to create jobs for all. As the above evidence shows, that will only produce optimal dividends if we – besides drastically improving education – reform all aspects of the economy, including taxes and high state spending, inflation (especially of asset prices), international trade and business regulation including labour, and the rule of law – an essential part of market freedom. Needless to say, the right to protection of private property is a cornerstone of the rule of law, and its threatened abolishment will destroy any ambitions of productive reform.

By way of comparison, this is where South Africa stands:

Average free-market rank 1990-2015: 75.33

Education rank: 114

Average annual per capita growth in dollars 1995-2016: $98.

In other words: Our average free-market rank would place us second last on the list, if we were to be compared to the former communist countries.

Our education ranking is just about doubly as bad as any on the list.

And our annual per capita growth in dollars is less than 10% of the freest countries, and less than 20% of the least free group. Even percentage-wise, our per capita GDP is worse than any country on the list.

Click on this link for a graph showing just how badly we compare:

https://data.worldbank.org/indicator/NY.GDP.PCAP.KD?end=2016&locations=GE-EE-LT-LV-CZ-MU-PL-RO-ZA&start=1995

It is fair to say our reform project is in trouble, and a drastic U-turn is called for.

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