2095. Ten Years of Post-SocialistTransition Lessons for Policy Reform

Grzegorz W. Kolodko
(April 1999)

It is naive to assume that a market economy can be introduced by "shock therapy." A market economy requires adequate institutions and appropriate behavior, both of which can be introduced only gradually because they require new organizations, new laws, and changes in behavior of various economic entities.

It is naive to believe that a market economy can be introduced by "shock therapy," Kolodko argues. In the several cases when it has been attempted, it has brought problems. A market economy requires adequate institutions and appropriate behavior, both of which can be introduced only gradually because they require new organizations, new laws, and changes in behavior of various economic entities.

In 1989 influential financial organizations, political bodies, and professional economists seemed to agree—the so-called Washington consensus—on the main points of economic policy reform. Although the economic policies underlying that consensus were developed with no concern for post-socialist transformation, they have significantly influenced economic thought and action in Eastern Europe and the countries of the former Soviet Union.

And because those policies were not designed for the overhaul of post-socialist economies, they have failed, especially since they have not yet brought sustainable growth.

A new post-Washington consensus is developing, based on lessons from experience so far. Post-socialist occurrences are also contributing to development policy reorientation. Among realities policy-makers must recognize:

• Above all, appropriate institutional arrangements are needed for growth.
• Institution-building by its very nature must be gradual.
• The size of government is less important than the quality of government policy and how the government changes.
• If the formation of institutions is left to spontaneous forces unleashed by liberalized markets, the vacuum will be filled by informal institutions.
• The judiciary system must be transformed to serve the market economy.
• Deregulating the post-socialist economy requires shifting competence and power from central to local governments.
• The development of nongovernmental organizations must be accelerated.
• Government concern about equitable growth and income policy is important during the transition.
• With the support of international financial institutions, countries must monitor and control short-term capital liberalization.
• The Bretton Woods organizations should reconsider their policies toward transition economies - and should especially provide more support for institution-building and equitable growth.

This paper—a product of Macroeconomics and Growth, Development Research Group—is part of a larger effort in the group to study the policy reforms for sustainable development and the role of institutional arrangements in managing transition to a market economy. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Jennifer Prochnow-Walker, room MC3-378, telephone 202-473-7466, fax 202-522-1152, Internet address jprochnow@worldbank.org. The author may be contacted at gkolodko@imf.org. (29 pages)

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