The Output Decline in the Aftermath of Reform: The Cases of Bulgaria, Czechoslovakia, and Romania


WP/92/59-EA

The Output Decline in the Aftermath of Reform: The Cases
of Bulgaria, Czechoslovakia, and Romania
by E.R. Borensztein, D.G. Demekas, and J.D. Ostry

This paper analyzes a number of issues surrounding the declines in
economic activity experienced by three Eastern European countries--Bulgaria,
the Czech and Slovak Federal Republic, and Romania--in the period since
market-oriented reforms were initiated in these countries. As the review
of developments in these three countries indicates, price and trade
liberalization--including the dismantling of CMEA trade practices--should
set in motion a series of changes that, over time, would be responsible
for a radical transformation of their productive structures. This process
of resource reallocation could easily generate a decline in aggregate output
initially, especially if an expansion of activities that were profitable
under the new relative price structure was delayed by significant adjustment
costs and uncertainty.

Apart from these long-term, structural factors, output in the three
countries under review has also been affected by more conventional macro-
economic forces. The combination of large increases in domestic energy
prices (as subsidies for energy use were reduced) and policies necessary
to contain inflation in response to price liberalization created a contrac-
tionary situation for output owing to both supply-side and demand-side
factors. This raises two empirical questions that may help to explain the
declines in output in these three countries. First, to what extent did the
fall in output for each country reflect structural change (a reallocation of
resources across sectors) rather than a conventional recession? Second, to
what extent have demand-side versus supply-side forces been dominant in
generating the output decline? The paper uses simple econometric techniques
to investigate these two questions. Regarding the first, the empirical
findings are remarkably strong in pointing toward conventional macroeconomic
factors as the main explanation for the output declines. Regarding the
second, the findings are more mixed.