A: At the end of 1993, Poland was starting to grow. Russia was only making the first steps. The Soviet Union broke up in January 1992, and then, in the summer of 1993, the attempted coup collapsed under Yeltsin’s leadership. So you could sense that in 1993 Russia was still trying to define its existence. The reform program was really only beginning. Institutions of the command economy fell apart, the fledgling structures of the market economy were only beginning to emerge. There was tremendous pressure on the reformers to move quickly because of all the uncertainty. They really didn’t know what the future would bring.

Reformers hoped that by moving quickly they could make the democratization irreversible. The resulting privatization was very unsatisfactory. Reformers gave away ownership and control to existing oligarchs—nomenklatura managers who dominated those firms—and cooperated with the new oligarchs. The new oligarchs enriched themselves during the final period of the old regime or in the early inflationary years of the new regime and used their money to snatch the most lucrative areas of the Russian economy. The reformers leaned on them for support, and through the seriously compromised "loans for shares" scheme, transferred additional assets to these magnates.

A: The reformers also had an ideological urge to move quickly. They felt that creating the private sector would generate demand for positive institutional reforms. But in this they were wrong. In a distorted socio-economic system, in order to survive, the private sector will adapt to its environment and not necessarily have an incentive to establish good corporate governance or engage in competition.

A: In contrast to the remorse one could sense in Russia over the collapse of the empire and the loss of superpower status, the atmosphere in Central and Eastern Europe was very different. Their economies were more open. It was much easier for them to turn westward, both to increase their trade and politically, as they felt part of Europe in a very natural way. There was a feeling of liberation, a wish to make a new start. With this atmosphere their previous experience of market economies, it was much easier to build institutions.

A: That was a mistake. But Prime Minister Vaclav Klaus and his advisors genuinely believed that effective markets would emerge quickly once vouchers were auctioned off. Because voucher owners didn’t know what they were buying, in other words, the performance of enterprises that issued the vouchers was unknown, those markets didn’t work well. This is a clear example of the lack of institutional underpinnings—in terms of corporate governance, proper control, disclosure regulations, and so on. Real markets thus could not develop, and you ended up with a rather paradoxical situation in which the vouchers were eventually bought up by banks that were still under state control. These banks became the owners of the companies. The lender-borrower relationship with firms became quite complicated. This contributed to the weakness of the Czech banking system.

A: Hungary opened the gates to foreign banks and succeeded in creating a modern competitive financial service sector by the mid-1990s. Poland, having successfully implemented a rapid stabilization and liberalization, became more cautious when it came to privatization, including foreign involvement in the banking sector.

A: Especially in Russia, but also in other countries of the former Soviet Union, hyperinflation, together with the collapse of the real economy, caused deep impoverishment, revealed not simply by the growing number of poor but also by the deteriorating mortality statistics. In Russia, for example, life expectancy for men has declined precipitously.

A: This period has been extremely hard on many people. The frustration and disappointment have been exacerbated by the naive belief that political liberation and economic freedom somehow bring about Western living standards very quickly. Of course, it couldn’t happen overnight. In most transition economies, a complete readjustment was necessary. Millions of citizens in the former Soviet Union and other transition countries face hardships and discontent.

A: Not in countries that underwent dramatic political changes. Besides, the contrasting production structures at the outset of reforms really made a difference. In the Soviet Union, but also to some extent in Central Europe, there was a peculiar system of gigantic single production units, dominating huge areas and using inputs from other gigantic single production units. Whole cities were built around these colossal plants, which were supplied from other factory towns thousands of kilometers away. So an extraordinary artificial interdependency among different areas emerged that made the production structure very rigid and fragile. With the collapse of the Soviet-dominated trade organization Comecon, as different opportunities in trade opened up, industrial structures across the region, from the Elbe to Kamchatka, became obsolete. The collapse of this rigid structure was especially severe in the former Soviet Union.

The story in China has been different. China did not go through a drastic change in its political system. Of course, China endured a series of political upheavals, including the Cultural Revolution, prior to the reforms. But then in 1979 Deng Xiaoping restored order, stabilized the country, and launched economic reform. In addition, the Chinese economy consisted of self-sufficient regions, which—once the reform took hold—developed natural trade linkages with one another. With the advent of China’s opening to the outside world, a competitive manufacturing industry was gradually built with huge export capabilities.

A: Indeed, we now realize that initial conditions were very different in the individual transition economies—something I don’t think we attached enough significance to initially. As I mentioned, the rigid production structure affected the countries of the former Soviet Union much more than the countries of Central and Eastern Europe. No doubt geography, cultural background, and historical familiarity with the market economy helped Central Europe quickly restore its traditional ties to Western Europe.

A: Supporting Russia presents a great challenge to the Bank. Russia now has a chance for a new start: it faces favorable macroeconomic conditions almost for the first time, partly as a result of rising oil prices. It also has a government that is interested in reform and, with better relations with the Duma, is strong enough to implement its program. In areas of tax reform, relations between the center and the regions, financial sector reform, and corporate governance, the Bank can make a strong contribution with analytical and sector work. It may also be able to provide loans. So over the next few years, the Bank’s role in Russia could be important. It is crucial that in this period Russia undertake the structural reforms that are fundamental in establishing a healthy market economy.

A: We face similar challenges there. The challenges in Ukraine are perhaps even more difficult than in Russia. Ukraine has not had the opportunity to make a new political start, and the strong anti-reform forces there make decisionmaking very difficult. Corruption is a very serious and tough issue. In Central Asia, Kazakhstan has oil and Turkmenistan is starting to export its gas again, but it is important that those countries make an effort to build up small and medium-size enterprises. The World Bank Group can support these efforts. In Europe, as the 10 accession countries move closer to joining the European Union, they will have alternative sources of funds. Nevertheless, over the next few years the Bank will have a role to play in helping finance the necessary pre-accession changes.

A: I believe the Bank will move toward simplified conditionality and support of countries with strong track records. This change in direction is based in part on our research on aid effectiveness. It is consistent with the notion that borrower countries should participate more actively in World Bank projects. And it is consistent with President Wolfensohn’s thinking about the Comprehensive Development Framework, expressed clearly in the recent poverty reduction strategy. These ideas will be increasingly operational and will have a strong effect on what the Bank does. The Bank could, for example, shift its activity in the direction of programs instead of projects.