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THE ROLE OF EDUCATION IN ECONOMIC TRANSITION AND POLITICAL TRANSFORMATION IN POST-COMMUNIST COUNTRIES BY DJAVID NOVROUZOV Dipl., Tashkent State University, 1985 M.S., University of Ill

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THE ROLE OF EDUCATION IN ECONOMIC TRANSITION AND POLITICAL

TRANSFORMATION IN POST-COMMUNIST COUNTRIES

BY DJAVID NOVROUZOV

Dipl., Tashkent State University, 1985

M.S., University of Illinois at Urbana-Champaign, 1995

THESIS

Submitted in partial fulfillment of the requirements

for the degree of Doctor of Philosophy in Education

in the Graduate College of the

University of Illinois at Urbana-Champaign, 2001

Urbana, Illinois

UMI Number: 3017173

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© Copyright by Djavid Novrouzov, 2001

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TRANSFORMATION IN POST-COMMUNIST COUNTRIES

BE ACCEPTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR

ABSTRACT

This study analyzes the role of investment in education in the political

transformation and economic transition in the 22 post-communist countries of the former Soviet Union and East-Central Europe In the first section an empirical analysis of the

determinant of economic growth and investment in physical capital is performed This analysis detects positive impact of investment in secondary education on economic

growth after applying appropriate lags to the variables and controlling for ihe initial level

of per capita income Foreign direct investment is also found to be one of the

determinants of economic recovery in the post-communist countries The analysis of

determinants of investment in physical capital and foreign direct investment reveals that political stability measured by the Freedom House index for democratization and

investment in education positively impact foreign direct investment In the second section the analysis of the determinants of democratization, human rights and political stability in

these countries is conducted This analysis finds strong direct impact of the level of

income and hence economic growth, and indirect impact of investment in education through economic growth on democratization, human rights and political stability The

third section focuses on the relations between education and poverty It finds that

investment in education has also direct and positive effect on poverty reduction In

particular, this study finds that secondary education has a positive impact on poverty reduction There is also indirect effect of investment in education which stems from its impact on economic growth and economic growth on poverty alleviation In addition the strong impact of economic growth and democratization on poverty reduction is also

detected Thus, the author concludes that despite high rates of investment in education in

ill

these countries in the past and its positive effects on recent economic recovery and

political liberalization, these countries need to maintain the high rates of this investment, and to upgrade and reform their educational system in order to successfully complete

transition to a market economy and to democracy while striving to eliminate poverty

iv

ACKNOWLEDGEMENTS

I wish to acknowledge the individual contributions from my committee members:

professor Alexander Ardishvili, professor James Ward and especially that of my advisor

professor Mobin Shorish and professor Walter McMahon I would also like to express

many thanks to Fanny and William Bryan, Jim Heins, William Frenkel, Rodrigo Velarde, John Owen, Dmitry Listengarten, my wife, Nazanine Agassi, and my parents for their continuing support, valuable suggestions and patience

TABLE OF CONTENTS CHAPTER

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Endogenous Growth 'T h€OrFY - - 2n TY HH re 12

Economic Growth in Post-Communist Counfries -<-s<<sc5 15 Determinants of Economic Growth: Supply Side Production Function .25

Investment: Demand Side and Feedback Effects - - - - -sc<seeesseex 36

Democracy: PrerequIsites and [Deterrn1narIfS - - - << «xxx sec 48

Democratization: Empirical AnalysS€S -c~SSS<sserexerre 54

Costs of Transition from Communism .cccececcsescessssceneeeeceesenaeeseeeees 72

Poverty: Definitions, Literature Review and Profiles ccsseeeeeceeeeee 78

Education and Absolute Poverty: Empirical Model - . -<+-s++ 89

CHAPTER 1 INTRODUCTION

At the beginning of the 1980s many people hoped for, but only a few could foresee the end of the Soviet empire This empire, which had its origins in the Russian revolution of 1917, appeared mighty and invincible It covered extensive geographic

areas that included the republics of the Soviet Union and East and Central Europe with

Poland, German Democratic Republic, Czechoslovakia, Hungary, Bulgaria, Romania,

Yugoslavia, and Albania, occupying 17 percent of the world area and accounting for 9 percent of the world’s population

This brand of Marxist ideology was exported to other continents and in some countries the Marxist regimes usurped power In Asia Marxist governments monopolized

power in China, Cambodia, Laos, Mongolia, North Korea, and Vietnam In North

America, Cuba is still ruled by a communist regime Lastly, in Africa some governments, such as those in Ethiopia and Angola experimented with Marxism

The communist world was not a homogenous and united entity The relations among some countries with communist regimes were far from cordial due to various interpretations of the Marxist-Leninist ideology and its application For example, there was strong and open hostility between the Soviet Union and its allies on one side, and China whose regime followed the Maoist type of communism, on the other In 1979, a military conflict broke out between the two communist countries — Maoist China and the pro-Soviet Vietnam Some communist countries such as Romania and Yugoslavia

proclaimed themselves as non-aligned to reduce the interference of the Soviet Union in their domestic and international affairs Finally, there were the dogmatic communist

regime of Albania which existed in almost complete autarky, and the inhumane regime of Cambodia, which was responsible for committing horrendous genocide against its own

people

The Soviet Union and its European satellites constituted a powerful empire in this

diverse communist world During the last years before its disintegration, this empire was

exploring space, conducting military aggression in Afghanistan, competing with its

adversaries in the west, generously supporting various leftist movements in the world,

building nuclear and conventional weapons in huge quantities, and sending local

opponents of the regime to jails and psychiatric wards The ideological allegiances

among the allies were zealously monitored and any deviation or open discontent with communism was harshly suppressed, such as the uprising in Hungary (1956) and in

Czechoslovakia in 1968

The citizens of the Soviet Union and Eastern Europe had certain rights that were a

source of pride of the communist state For, example, employment was guaranteed by the constitution and unemployment rates were almost negligible Free public health care and

education were considered the major achievement of the regime In addition, housing,

utilities and basic necessities were relatively accessible and were often subsidized by the state Nominally, the society was promoted as egalitarian, where ethnic minorities and

women enjoyed the same rights as the rest of the population In fact, the distribution of

income was also relatively better compared to some developed economies of welfare

socialism According to Milanovic (1998) “Overall income distribution was more

egalitarian than in most market economies even after allowing for (a) fringe benefits and various forms of implicit income received by the nomenklatura and (b) direct

subsidies.”(p.15) Similarly Vecernik (1998) argues that “[t]he communist society

appeared extremely equalized in terms of wages, income and the consumer market

Furthermore, people were drilled and indoctrinated in the ideology of equality such that higher incomes and wealth were always considered to be unfairly acquired In line with its ideological and pragmatic functions, the communist state protected people in their jobs

and provided them with a minimum security in exchange for loyalty and formal support.” ( p.247)

The ultimate goal of the communist regime was to build a classless society with

an efficient economy in which all the needs and desires of the population were fulfilled

People in this ideal society were imagined as omnicompetent, humanitarian,

internationalist and devoted to communist ideology In order to fulfill these goals, the communist leadership early on recognized the important role of education in the process

of indoctrination and in the formation of these new communist people (Shorish, 1994,

industries and defense (claimed to be 25 percent of the GDP), at the expense of other sectors of economy, especially those which were related to the production of consumer goods and services (Malia, 1994, p.372) As a result of this overemphasis, quota driven production, price control and the overall inflexibility of the system to technological change, the available goods and services were often short in supply or of poor quality The product rationing and long lines in stores were typical of everyday life in many

socialist countries, and in essence, were a fair illustration of the clumsiness of the

centrally planned economies Finally, despite some progress in equalization efforts, communist societies remained unequal with the upper class — the communist

nomenklatura having full control of political and economic power and privileges that the rest of the population did not enjoy In connection with this, Vecernik asserts that

“{tjotalitarian control of the populace is a more important explanatory key to the social policy under the communist system than the universality of social generosity Work was not only a right, but primarily a duty and, consequently, administration of employment served as a tool of domination over the citizenry Of course citizenry resisted by shirking, depleting working ethics e.t.c.“ (p.192)

However, in the 1980’s, after almost three decades of rapid economic growth,

communist countries of the Soviet Union and East and Central Europe began to stagnate

By this time a general apathy of the population about the goals of communism and the legitimacy of the leaders’ power plagued this society In Poland, for example, the

growing irritation with communist rule and poor economic performance led to overt

demands for political changes Ironically, it was the workers organized in the Solidarity movement who revolted against the rule of the party, which was supposed to represent

their interests Although it was a first serious blow to the communist rule, one might argue that a threat to the regime could not be considered as credible since the military power of the Soviet Union still could effectively suppress any attempts to diverge from communist rule

Nevertheless, by this time the Soviet Union was exhausted by the arms race with

the West, the war in Afghanistan and continuing economic decline The new communist

elite that came to power in the USSR, realizing the need for changes, attempted to

revitalize and energize the crumbling economy through the implementation of more

liberal economic policies Thus, the Soviet leadership introduced reforms that were aimed

to earn credibility among the population and were outlined in the policies of Perestroyka and Glasnost’ Perestroyka aimed to introduce some elements of market economics into the ailing Soviet economy The second, Glasnost’ sought political liberalization of the society by allowing plurality of opinions, while still maintaining a one-party monopoly Finally, the re-approachment with the West was pursued in order to end the many

decades of confrontation This new approach of the Soviet leadership eventually

unleashed so many forces that they, first, eliminated the Kremlin’s grip over its European

satellites, who rushed to dismantle the system that was imposed on them after the Second

World War Furthermore, these reforms ignited the centrifugal forces within the USSR

Nationalist, pro-independence and anti-Soviet movements began to mushroom in the

republics of the Soviet Union The failed coup of August, 1991 in the USSR, whose

organizers hoped to retain communism and the idea of the Soviet Union, led to the final

demolition of this country

Newly independent countries of the USSR and communist-free European states

acquired the opportunity to proceed with economic transition - to abandon central

planning and to build market institutions - and with political transformation - to dissolve the communist party monopoly on power and to establish a multiparty democratic

society This process, which began in the late 1980’s, is still on going

In retrospect it seems these communist countries occupied a special niche

separate from that of developed and developing countries By and large, the overall

standards of living there were lower than in the West, and in terms of the GDP per capita the communist countries mostly fell in the middle income category - one of the

characteristics of the developing countries At the same time communist countries had

certain features that distinguished them from developing countries and made them

comparable to developed countries This was not just the scale and size of

industrialization, the extraction of oil and gas or the consumption of electricity These features also included some of the indicators related to the quality of human life, such as child morbidity, mortality rates, literacy, education, consumption of printed material, and some others

In this respect the widespread expansion of education and impressive

achievements in terms of educational indicators is a main feature distinguishing

communist societies from Third World countries Needless to say, education was an important political device to socialize and indoctrinate masses and at the same time make citizens functional in the centrally planned economy Starting with the Narkompros (Narodny Komissariat Prosvesheniya - The Ministry of Education in post-revolutionary Russia) in the early 1920’s, Russian education was envisioned by the adherents of the Marxist authority as an important vehicle of mass mobilization and socialization, a device

that would serve the political agenda of the communist rulers

All socialist countries of East Central Europe and the USSR had a relatively well-

developed educational system [Illiteracy rates were almost negligible, basic education was compulsory with rates of enrollment averaging 95-100 percent, and the rates of participation in secondary education were also high The number of people with higher education was constantly growing and was comparable to developed countries The overall expenditure on education took about 7 percent of GDP across the countries

In the USSR, according to official Soviet sources almost 3/4 of the population of

the Russian Empire in 1896 of age 9-49 was illiterate Soon after the communist

revolution, the new government successfully implemented the decree on the elimination

of illiteracy of the population of Russia adopted in 1919 Thus according to the data for

1926 more than half of the population of the USSR became literate (71.5 male and 42.7 female) By 1979 USSR had 0.2 percent illiteracy rate ( Naselenie SSSR, 1983, pp.102- 123) However, the high level of literacy in the communist countries does not accurately represent so-called functional literacy According to Micklewright (1999) “‘The general opinion of school system under socialism is that children accumulated a lot of

knowledge, but were relatively weak (in comparison with children in Western countries)

in applying this knowledge in new situations - a disadvantage in the now emerging

market economies that probably require greater adaptability from the individual (in one sense) than under the planned system.” (p.3 56)

With the collapse of communism, the transition to market and political

transformation, education might be viewed as an important asset Previous heavy

investment in human resources is hoped to facilitate the process of transforming the

communist societies into the prosperous countries with efficient market systems and

democratic forms of government

The main purpose of this study is to analyze the effects of investment in education

on short-medium term outcomes of economic transition and political transformation in 22

post communist countries since the early 1990’s This study covers Bulgaria, Hungary,

Poland, Romania, Czech and Slovak Republics, Slovenia, and the countries of the former Soviet Union including Armenia, Azerbaijan, Georgia, Estonia, Belarus, Moldova,

Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, Russia, Latvia, Lithuania, Uzbekistan and Ukraine

This study is based on empirical analyses and is structured as three closely

interlinked essays, the main theme of which is the direct and indirect monetary and non-

monetary returns to investment in education in these post-communist countries The first chapter analyzes the determinants of economic growth in these countries and focuses on

the role of investment in education in the recent economic recovery This chapter also tackles the issue of sustainability of future economic growth The second chapter

analyzes the political transformation of the communist societies It considers the direct and indirect impact of education on democratization, human rights and political stability The third chapter is devoted to the analysis of the quality of life during economic

transition and political transformation However, its focus is limited to the problem of poverty in these countries In particular this chapter analyzes the determinants and

correlates of poverty At the end, in the conclusion the findings will be summarized and

the current trends of educational development and its problems will be discussed The study hopes to contribute to a better understanding of the problems of economic

development in transitional post-communist countries This investigation into the patterns

of development in the post communist countries and the focus on the role of the

investment in human capital might clarify some questions whether the current processes

in post-communist countries fit the worldwide trends of development Thus, this study

might be of interest not only to students of economic development and transition, but also

to policy makers concerned with economic, social and educational reforms

CHAPTER 2 EDUCATION AND ECONOMIC RECOVERY IN POST-COMMUNIST COUNTRIES

Economic growth reflects a positive change in the total output produced by a country’s economy The total output is usually measured by Gross National or Gross Domestic Product — the value of all final goods and services produced in country’s

economy within a certain period of time However, often the value of output per capita is used as an indicator of the welfare of the population and its success in economic

development Therefore, sustained economic growth that in general directly leads to an

increase of per-capita income of the population is considered to bring positive effects to the population’s standards of living on average Yet, this indicator is unlikely a perfect

measure of the quality of human life (Sen, 1999; Easterly, 1999)

In addition, sometimes there are negative effects that are associated with

economic growth First, there might be negative externalities that are related to the

environment such as air and water pollution, and deforestation Second, economic growth

in the command economies of socialist countries often resulted in the production of

goods and services that were of inferior quality and faced meager demand Third,

currently there is a concern that economic growth in wealthier countries stimulated by increased globalization of the world trade lead to the environmental degradation and the standardization of tastes and values that are propagated by multinational corporations Hence some cultures consider globalization a form of imperialism, where rich nations try

to dictate their norms, values and tastes to the rest of the world (Shorish, 1998)

Nevertheless, the presence of economic growth per capita is one of necessary but

not sufficient condition for economic development Thus, its presence or absence is still

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one of the important indicators for analyzing the gap and the potential for convergence

among poor and rich countries Moreover, education has critical importance for economic growth, and as the World Bank asserts: “Economic growth is explained only in part by

stocks of labor and physical capital The largest component of growth that these do not explain is due to improvements in quality of the labor force, including increased

education and better health, together with technological progress and economies of

scale.’ (The World Bank, 1995, p.3)

This chapter attempts to analyze the factors that stand behind the economic

recovery and sustainability of economic growth in the countries of the former Soviet Union and the ex-socialist countries of East and Central Europe The primary focus is on the role of education for economic growth

This chapter is structured as follows First, it discusses endogenous growth theory and augmented Solow models and the core role of human resource development A

review of relevant empirical studies will be also provided Second, it will provide a brief overview of some recent outcomes and patterns in the economic performance of the post-

communist countries in transition from central planning to market economies Third, the specification of the empirical model will be laid out and some of the data reliability and

biasedness issues will be discussed The results of statistical analyses and discussion will conclude the chapter This analysis covers fifteen former Soviet republics plus Bulgaria, the Czech Republic, Hungary, Poland, Romania, Slovakia and Slovenia Although the present analysis involves shorter term development in the post-communist countries, namely the period of 1994-1999, the author is trying to explore the forces which will influence the long-run outcomes More specifically, the author attempts to investigate

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whether there is any impact of the past investment in education on the current pattern of economic performance in these countries

Endogenous Growth Theory

The impact of investment in education on economic growth is very well

documented The majority of studies on the relationship between education and economic

growth confirm the substantial positive effects of education on economic growth Most of

the literature shows that returns to education are similar if not larger than those to

investment in physical capital (Schultz, 1962; Blaug, 1976; Easterlin, 1981;

Psacharopolous, 1994; World Bank, 1995) Thus, education is often crucial for economic

development to occur For example, The World Bank states that: “Education contributes

to economic growth, but education alone will not generate growth That requires not only investment in human capital through education, health and nutrition, but also in physical capital.” (World Bank, 1995, p.3) At the same time investment in physical capital is not

a sufficient condition for economic growth Schultz (1962) and Adelman (1984)

demonstrate the danger of underdeveloped countries pursuing heavy investment in

physical capital at the expense of human capital accumulation

Clearly, education contributes to economic growth through the increased productivity of the labor force enhanced by the investment in human resources However, the existing formal theoretical framework for the analysis of economic growth could not fully capture these effects of education

For example, the Harrod-Domar model of economic growth explains growth solely

by the rate of domestic savings, leaving out the impact of investment and borrowing from

abroad On the other hand, the improvement of the Harrod-Domar model with Solow’s

exogenous growth theory (Solow, 1956) left most of the growth unexplained and hence

attributed a significant part of it to exogenously determined technical change and population

growth rates

Moder endogenous growth theories and empirical work, pioneered by Romer (1986) who argued that technical change has been endogenously determined, and Lucas (1988), and subsequently developed by Barro (1991, 1995, 1997,1999), Romer (1990), and McMahon (1998, 1999) highlight a central role of investment in education in explaining economic growth This theory not only considers investment in human capital as one of the

leading direct forces behind modern economic growth, but also accounts for externalities produced by investment in education, knowledge, and technology These external effects

offset the diminishing return from the investment in physical capital Educated labor forces increase productivity but also create knowledge within the firms, which spills over into the whole economy

Lucas (1988), for example, observes that the divergence in growth rates among the poor, middle, and high-income countries is strongly related to the level of educational

development The author builds a framework, which explicitly adds human capital in the aggregate production function of the economy This human capital, endogenously

determined and created by the investment in education is employed within the firms It also represents externality — public good In Lucas’s formulation, it is the average level of skills

or human capital in economy which is an external effect This knowledge created by

education is not culturally or ethnically specific, “but just human” (p.15)

The empirical studies of last decade utilize the framework outlined by the

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endogenous growth theory Temple (1999) provides a detailed review of recent works on economic growth, and endogenous growth in particular Among many empirical works

on new growth theories, it is worth mentioning the empirical studies by Barro (1991,

1995, 1997,1999, 2000), Mankiw, Romer and Weil (1992), McMahon (1994, 1998b,

1999), Lau, Jamison, Liu, and Rivkin (1993), Shaunglin (1998), Lau (1990), Kim and Lau (1996) These studies have employed country and cross-country data, and have found strong impacts of investment in human resource development on sustained economic growth Moreover, the empirical studies of developing economies show that, as with the case with investment in physical capital, the simple borrowing of Western technologies will not bring economic growth about, and furthermore, investment in education is the key for development (Sorensen, 1999) Some scholars provide analyses of the feedback effects from economic growth on investment in physical and human capital For example, McMahon (1998b, 1999) analyzing determinants of economic growth in fast growing

countries of East Asia, finds powerful feedback effects from economic growth and

investment in education on the investment in physical capital

Thus, the theoretical framework suggested by the logic of endogenous growth theory, generated an abundance of empirical studies on the role of education in

explaining economic growth However, the impact of education on the development of transitional economies of the former socialist countries of East and Central Europe and

the former Soviet Union has not been fully investigated Although a certain degree of

excellence in the human resource development during communism and references to its obsolescence, is widely acknowledged in the analyses of post-communist economies (The World Bank, 1996) However, the economic literature on transition focuses mainly

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on the problems of economic liberalization, macroeconomic stability, structural

adjustment, foreign trade and other issues Thus, the influence of the past investment in

education in these countries on the current performance requires more attention

Therefore, it is crucial to explore whether some present outcomes of economic

transformation in the post-communist countries are determined by the investment in

education in these countries

Economic Growth in Post-Communist Countries There is a consensus in the literature on transition that economic growth requires certain prerequisites (Gillis, Perkins, Roemer, & Snodgrass Gillis, 1992; the World Bank

1996; De Melo, Denizer, Gelb, & Tenev, 1997) It requires the absence of wars, a stable

political situation, the rule of law and the elimination of wide-spread corruption

However, there are other equally important elements that should be taken into consideration The list of these elements could be extensive, yet such conditions as a country’s geography, colonial past, ethnic and religious composition, traditions of self- government, distribution of wealth among the classes, and scale and scope of

development of human resources are crucial Given these preconditions, the successful

implementation of market-oriented policies and the creation of institutions that support

these policies are required Yet the speed and design of reforms will be subject to the constraints of pre-existing factors

The former socialist countries are admittedly not a homogenous group in terms of their historical background and the level of economic development prior to the collapse

of the communist regimes Hence these prerequisites for reforms differ widely during the

15

early stage of transition However, the subsequent development demonstrates that the roles of initial conditions are being diminished in the course of transition (De Melo, Denizer, Gelb, & Tenev, 1997)

Yet, at the early stage, at the beginning of the 90’s, the transition from command and centrally planned economy did not appear to be as a painless process across the post- communist world All countries experienced shocks of various degrees, accompanied with a dramatic fall of their output (see Table A1) Living standards of the majority of the

population fell dramatically, while high rates of inflation eroded the savings of the

population This process jeopardized the safety net of the population, and rising

unemployment poverty and increased income inequality became a stark reality in the

supposedly egalitarian socialist societies Political instability plagued some countries In others territorial conflicts dimmed the prospects for rapid development

On the other hand a dramatic fall in GDP was not viewed as a completely bad

event since useless and obsolete goods could not be produced any longer Subsequently, this decline in industrial production brought the level of environmental pollution down (The World Bank 1996, p 33) Another striking feature of the transition was that the fall

in the official GDP coincided with the rise of an informal economy If the latter were

included into the accounting of GDP that would make the fall of GDP less dramatic but

still substantial

Clearly, East and Central European countries seemed to have some advantages in

preconditions in launching economic and political reforms as compared to the republics

of the former Soviet Union First, most of them, with the exception of Slovenia and

Slovakia, had traditions and experience of independent governance Second, Hungary,

16

Poland, and Slovenia already had some experience with some forms of market

institutions These countries avoided the bloodshed of interethnic wars Even Slovenia’s movement for succession from Yugoslavia was relatively bloodless and the conflict was resolved in 10 days (The EIU Country Profile Slovenia, 1998-1999) However, the

Slovenian economy was hit as the result of this succession (Cvikl, Kraft and Vodopivec,

1993)

Still, these countries had limited knowledge about the transformation of their

economies These economies were dominated by industries and agriculture with

outmoded technologies and poor managerial techniques In addition to this, their

economies, with exception of Slovenia were integrated with each other through the

mechanism of the COMECON The COMECON - the Council for Mutual Economic Assistance comprised of the USSR, Poland, Hungary, Czechoslovakia, Bulgaria,

Romania, East Germany, Vietnam, Cuba, Mongolia and for a brief period Albania The goal of this organization was to integrate the command economies into a trade block and thus to keep these countries away from market-determined world trade The system relied

on central planning, where government sets the production quotas and prices With the

collapse of the communist regime COMECON was abolished However, the dependence

on the inter-trade for some countries within the COMECON was enormous

On the other hand the shock of transition for the post-Soviet countries had a

greater magnitude The economic disintegration coincided with the collapse of the USSR

For most republics of the Soviet Union their independence “dropped from the sky”

Despite a lack of experience in governance during first years of independence, these countries, with exception of Russia, faced seemingly insurmountable challenges of

17

curbing political and economic chaos This chaos resulted from the disruption of the

economic mechanisms of the integrated system of the command Soviet economy In this hierarchically structured system each unit was positioned upstream or downstream, with

Gosdarstvennyi planovyi komitet - GOSPLAN (The State Planning Committee) on the top

of the pyramid deciding production quotas, distribution of inputs and outputs and

monitoring of the production quotas fulfillment (www fas.org/nuke guide/russia/agency/ gosplan.htm)

The command dictates of the centralized economy were shaken with the slow

emergence of some forms of market in the later years of the USSR However, with the

collapse of the Soviet Union the old institutions were removed (overnight in some

countries), but the new institutions which support a market system did not emerge as

rapidly In addition to this, unlike Central and East European states, some of the

countries of the former Soviet Union introduced their own currency as a measure to

further their independence from Moscow’s monetary policy This action, during the

already existing severe macro-economic conditions, initially caused high disruption of

inter-republic trade and inflation skyrocketed Needless to say, the countries of the former

Soviet Union shared a similar inheritance with the East and Central European countries, that of industries with outmoded technologies and poor managerial techniques and

extremely inefficient agriculture based on collective and state farming

However, the signs of economic recovery became visible earlier in Eastern

Europe in 1993-1995 (Figures B1-3) Later some of the CIS countries joined the recovery process The UN Report (1996) on transitional economies asserts: “Just as the magnitude and depth of the transitional depression had in general been foreseen at the start of the

18

transition process, so the speed and strength of recovery was also unexpected.” (p 67)

Evidently, the variety of preconditions for recovery for individual countries played some role However, with time it became more evident that the relative

heterogeneity among the countries was not the only explanation of their experience in

transition A study, using 28 countries of Eastern Europe, CIS and Asia by De Melo

(1997) finds that “ the initial condition dominates in explaining inflation, but economic

liberalization is the most important factor determining differences in growth Thus, the

influence of initial condition diminishes in the course of transition.” ( p.33)

The approach to the reforms differs significantly across the countries Hence, the

outcomes were affected It seemed that price and trade liberalization, fiscal and monetary

stabilization and privatization were essential policies for the stimulation of economic recovery The difference in approaches to reforms permits identifying general trends among the transitional countries (Figures B1-7)

The non-CIS countries of East and Central Europe and Baltic States, the most successful group of countries, have pursued liberalization (price and foreign trade) along

with fiscal and monetary stabilization (Figures B1-2) This group advanced structural

adjustment processes through privatization Policies such as the shock therapy approach and other neo-liberal policies proved to be difficult for the population, and became

subject to harsh critique For example, Przeworski (1995) argues that the role of the state should not have been reduced as a result of transformation, to protect the most vulnerable groups of the population The bold pro-market reforms put these countries on the course

of successful recovery and perhaps helped further accelerate economic growth Export re-orientation and growth in investment in fixed assets are often cited as the major

19

sources of recovery in this group, which includes the Czech Republic, Estonia, Hungary, Poland and Slovenia (The EIU Country Profiles 1998-1999)

They were followed by Latvia, Lithuania and Slovak Republic in economic transformation Here, as in the first group, implementation of reforms has produced

positive effects on economic growth On the other hand, Romania and Bulgaria represent

the last of the non-CIS countries where success of transition is yet to come These two countries demonstrated more cautious approaches to reforms, combined with the populist policies conducted by their governments As a result, in the 1990’s the economic

performance there was cyclical, and the signs of sustained recovery are barely visible (Figure B3)

There is some evidence that these countries’ growth will be sustained as it has been in the second half of the 90’s So far the only exception in the first group was the Czech Republic whose economy entered a recession at the end of the 90’s However,

according to Pehe (1998) the Czech republic’s economic recession was caused by poorly resolved issues of governance and control over the newly privatized enterprises, the lack

of reforms of the banking sector and domestic political problems resulting in

governmental crisis Economic expansion also could be foreseen in the second group The last group is still in the process of reforms and might be susceptible to drawbacks

In the countries of the Commonwealth of Independent States several patterns of

transition are notable The first is probably represented by the small economies

“experiencing regional tensions such as interethnic conflicts, civil wars and low political

stability As a result, their economies hit rock bottom, so that their governments faced the

necessity of increasing liberalization and macro-economic stabilization This group of

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countries includes Armenia, Azerbaijan, Georgia, Kyrgyzstan, Moldova and Tajikistan

High-speed recovery started in the Transcaucasian states of Georgia, Azerbaijan, and Armenia in the second half of the 90’s (Figure B4) For example, Armenia has been showing positive rates of growth 5 percent on average since 1995 and many drastic reforms such privatization of land introduced with vigor, brought positive impact on subsequent development Georgia who probably suffered the most among the CIS

countries from the interethnic conflicts and civil war in the beginning of the 1990s, still implemented vigorous pro-market reforms Although starting from a very low base, high rates of economic growth persisted there during the rest of the nineties, with the highest

in the CIS rates of 6-7 percent Finally, relatively gradualist reforms along with massive

inflow of foreign capital into the oil sector fueled the resumption of economic growth in Azerbaijan Azerbaijan price liberalization combined with fiscal and financial discipline

produced excellent results allowing the country to enjoy zero inflation at the end of the nineties (The EIU Country Profile, Azerbaijan 1998-1999) Nominally a friendly regime for foreign investment attracted the highest Foreign Direct Investment in the oil sector, but high corruption and autocratic rule makes prospect for development relatively dim (Aliogly, 2000, p.10)

The economic growth has been sustained in the leader of bold pro-market

reforms, Kyrgyzstan (Abazov,1999) Kyrgyzstan has been praised as a leader of radical and rapid pro-market reforms, which made this country a regional leader in Central Asia (Figure B6)

On the other hand Tajikistan appeared to be the least successful because of a less

favorable environment for economic take-off (Figure B7) Inability of the autocratic rule

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to compromise with the opposition prolonged the civil war Gradually the government started price liberalization and financial stabilization, and desperately attempted to invite

foreign investors Thus, although growth resumed during the last few years, current conditions in the country instill a certain degree of pessimism for the outlook on the development in this poorest country in the CIS Finally, reforms have not yet produced

sensible results in Moldova in terms of the resumption of economic growth despite

relatively successful policies of economic liberalization, stabilization and on-going

privatization (Figure B5)

The second group consisting of the larger economies of the CIS such as Russia, Ukraine and Kazakhstan has been comparatively less successful in creating conditions for

recovery and economic expansion (Figures B5-6) Though many pro-market reforms

were introduced in Russia, and later in Kazakhstan, they have been erratic and often

implemented with difficulties due to unstable political conditions Some reforms, as was

the case of Russian privatization, produced controversial results due to widespread

corruption and criminalization of the economy Kazakhstan on the other hand was a late

starter Cautious gradualist approaches to the reforms have not produced significantly positive results (Esentugelov 1996, pp 211-212) At the same time, Kazakhstan was successful in bringing foreign direct investment in its abundant oil sector Nonetheless,

starting in 1999, there appeared to be some evidence of the resumption of economic

growth in Russia and Kazakhstan, that is becoming robust presently

In contrast Ukraine’s performance during the 90’s was a failure Ukraine having been one of the developed and industrialized countries in the USSR adopted very slow

and less consistent policies of reformation This reasonably rich country lagged behind of

the rest the CIS considerably The economic growth rates have been negative for all the

‘nineties and only now the Ukrainian economy is starting to grow at a very modest rate of

0.5 percent (RFL/RL Newsline, 2000, February 2)

The final group includes the least market sympathetic countries with authoritarian regimes These countries are Belarus, Uzbekistan, and Turkmenistan (Figures B5,7) Here the course of reforms wholly depends on the will of their respective presidents The

economies of these states are virtually controlled by their authoritarian rulers who decide

most of the policy making Gradualism and statism as a form market socialism has indeed translated into lesser degree initial shocks in Belarus and Uzbekistan The Uzbek official

statistical data have shown moderate rates of growth since the second half of the nineties However, given very high population growth in the country, and its heavy dependence on

exports of the devastating for ecology cotton-monoculture and gold, raises suspicion of

the success of the regime’s economic policies

In Belarus, the performance has been highly cyclical and uneven Price

liberalization and privatization has been gradually introduced However, the government has poured in plenty of funds in support of state owned enterprises in industry and

agriculture Small private businesses are subjected to the constant harassment from the

pro-Communist government Heavy subsidies of the parastatals pushed the Belarus

economy only temporarily, before it plunged again during the end of the 1990’s (The EIU

Country Profile, Belarus, 1998-1999; Szyszlo, 2000)

Finally, the case of Turkmenistan illustrates how development could be arrested

even under conditions of relative political stability and abundance of oil and gas reserves

The minimalist approach to reforms was advocated believing that the country’s riches

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will come from the exports of natural gas and oil The head of the people of

Turkmenistan -Turkmenbashi- president Saparmurad Niyazov promised 10 years of

prosperity, but the country started with a 25 percent contraction of GDP Arbitrary

intervention in the economy, totalitarian control, import substitution policies, along with

populist policies of free stuff depleted the resources of this most underdeveloped country

in the USSR Even the media, which is controlled by the regime, could not completely

conceal the failure of the official policy (Neytral’ny Turkmenistan, N 168, 1997, p.1)

One might agree that the lessons of economic recovery during transition are still

too early to generalize Thus, according to the UN commission: “the question of

economic growth has been central to economic analysis ., however, the process of transition from plan to market offers a number of challenges both to theorists and to practitioners and, as is usual in unprecedented events, there are probably more questions

than answers and the answers do not always point in the same direction It is fair to say

that the understanding of the underlying processes which are shaping the macroeconomic dynamics in the transition economies is still very limited The scarcity of statistical

information, its often low level of reliability, (further undermined by frequent revisions),

the lack of consistency in the data, and the often long publication lags, all reinforce the

difficulties of interpreting the process of economic transformation.’ (UN Economic

Survey of Europe, 1996, p.67)

Yet the review of initial stages of transition indicates that price and trade

liberalization, fiscal and monetary discipline (which brings recovery of investment and

expectations), policies which lead to the emergence of efficient markets for funds,

structural adjustment such as privatization and enforcement of bankruptcy laws (which

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are directed to eliminate subsidies of inefficient enterprises and enforce the competition),

export orientation and the encouragement of foreign investment (especially that brings new skills, effective technologies and managerial techniques) are among the most

essential factors in stimulating economic growth It seems that those who pursue these

reforms, subject to policy constraints, gain more than slow starters and gradualist

reformers However, besides the approach to reforms one might expect that human

capital would play one of the crucial roles in the determination of success or failure of any economic policy

Determinants of Economic Growth: Supply Side Production Function

In order to test the implicit impact of investment in education on economic growth in

the post-communist countries, one can use the Cobb-Douglas production function

augmented with human capital in the form suggested by McMahon (1998b) The aggregate production function for the whole economy in the reduced form is written as

growth rate (dN/dt 1/N) will result in workable empirical model (McMahon, 1998b)

In this model the real growth rate per capita is determined by the marginal products

of the inputs (2rguments of the function) multiplied by the corresponding investments to

these inputs as a proportion of the output The overall empirical model takes the following form:

(2) y-n =alt+agh/Y¥ + az I/Y + azlsec/¥+ agli/Y + asY/Nioa) + a¿n + e

where

y-n = per capita growth rate, y = growth of real GDP, and n = growth rate of population

I, = investment in physical capital

Ip Isecs In = investments in primary, secondary and higher education

Y/N = GNP per capita (initial level)

n= _ population growth rates

Since the data on investment in education in post-communist countries are scarce

and could not be broken down by level (- i.e primary, secondary, higher-) one might use gross enrollment rates as a proxy So the model takes the following form:

(3) y-n =ata)L,/Y + a2 GER1 + a3GER2+ ayGER3 + asY/Nooa) + aon + e

where

GER; = gross enrollment rates in primary, secondary and higher education

Data, Definitions, Sources

Average Real Per Capita Growth of Gross Domestic Product, y-n (1994-99), is the dependent variable in this statistical analysis In analyzing economic performance, 2

base year (1994) was chosen where (Y/N)o4 represents an initial condition, and therefore acts as a control for this starting point Choosing the 1994-99 growth rates as a dependent

variable minimizes the initial effects of the transitional shocks, which came before that

The initial GDP per capita reduces the effects resulting from the heterogeneity of post-

communist countries (see Figures B2-6) Because of the large and different initial shocks, the 1989-93 time series was not included In addition, the quality of data for those years

is very low

Growth rates are taken from the TransMonee database, and are updated for later

years using the EIU Country Profile reports and the WEFA forecasts for post-communist

countries for 1999 The overall estimation of Gross Domestic Product is not without flaws for these countries The impact of private sectors, especially in service industries is often ignored This practice prevailed in the estimation of the Net Material Product used

by Soviet statisticians who were excluding such sectors as education, health, and

passenger transportation and residential construction from the estimation of Material Product (Trem! and Hardt, 1972)

The size of the shadow economies that have swollen during the 1990’s is not precisely known This makes underestimation of GDP even more acute However, it is assumed to comprise 20-40 percent of the economies of these countries (The EIU

Country Profile, 1998-1999) The size of these countries’ economies is all consistently underestimated due to the presence of shadow economies But since the shadow economy exists in all of the countries, the effects of this underestimation are negligible in cross- country analysis

In order to reduce the bias of the measurement it was decided to use average rates

of growth of GDP The geometric mean of the growth rates for the years 1994-99 was calculated The average population growth rates using the TransMonee database available

27

from the Centre for Europe’s Children at http://eurochild.gla.ac.uk have been calculated

for these countries for 1994-99, and thus the real per capita growth rates are obtained by

subtracting the population growth rates from real GDP growth rates

Independent variables are mostly those that are described in equation 2 Thus the

following set of independent variables is selected for this model:

Ik/Y = Average Gross Domestic Investment as a Percentage of GDP (or Gross Capital Investment in Fixed Assets as Percentage of GDP)

There are no consistent and accurately measured time-series on Gross Domestic Investment for all countries under review The reliability of the data is often questioned even for the countries where accounting is better established High probability of

measurement errors calls for the use of the average rate of investment in physical capital

Besides the possibility of measurement errors, there are other problems GDI includes gross investment in fixed assets plus the change in inventories Often, especially in

command economies, real investment is small, but inventory accumulation is large due to the fact that there is no market for the low quality goods produced by state-owned

enterprises In addition some countries such as Belarus, Turkmenistan, Ukraine,

Uzbekistan are subsidizing state owned enterprises by providing them with the huge credits at interest rates that far below the rates of inflation This overstates GDI

remarkably Yet the rate of return on such investment is usually low and its contribution

to economic growth is minimal (The World Bank, 1996) The use of “investment in fixed assets” (which is a part of GDI) as a separate variable would be an improvement in

accuracy Unfortunately, the data on investment in fixed assets is not reported for Central Asian countries such as Turkmenistan, Uzbekistan, and Tajikistan Finally, as with GDP

estimation, a lot of investment activity goes unrecorded, or in countries where the level of

28

corruption and embezzlement is rampant the high numbers of investment may exist only

on the paper For the purposes of this analysis the GDI data were calculated from the EIU

Country Profile tables on Gross domestic product by expenditure and some missing

values were taken from the World Bank database at

worldbank.org/data/countrydata/eca/eca.nsf

FDI = Foreign Direct Investment as a Percent of GDP

Given these anticipated errors in the measurement of investment variables,

another solution to this problem could be the use of foreign direct investment, FDI, as a percentage of GDP in addition to the use of GDI Though, data on foreign direct

investment suffer from inconsistencies among the sources, FDI is still more reliable, since it is compiled by the non-local sources such as the IMF and the EIU Cumulative FDI 93-97 as a percent of GDP of 1994 (CFDI) and FDI in 1998 as a percent of GDP of

1994 are in turn used in this statistical analysis This variable calculated using the data on

FDI from the TransMonee database for 1993-98 and the EIU Country Profile Reports for

1998

GER; = Gross Enrollment Rates in Education

Gross enrollment rate is used as a proxy for investment in education This variable

is defined as a ratio of total enrollment regardless of age to the population of the age group that officially corresponds to the level of education

GER1 (1980) = Gross enrollment rates in basic education (6, 7-14 years) Data

sources are the UNESCO database, and the World Bank These data were compared with

Soviet statistical information from Narodnoe Khozyaistvo SSSR (1980, pp 461, 466-

467), Naselenie SSSR (1988, pp 50-95 and 96-97), and Robertson (1997-1999)