Economic Reform and Structural Adjustment in East European Industry

WP/94/80-EA
Economic Reform and Structural Adjustment in East European Industry
by Eduardo Borensztein and Jonathan D. Ostry

A popular criticism of the reform process in a number of Eastern
European countries is that the decision to implement reforms relatively
quickly was responsible for a larger-than-necessary initial decline in
output. This view is based on the assumption that the massive relative
price shock associated with price and trade liberalization set in train
a process of resource reallocation which, in the short run, caused output
to decline. According to this view, therefore, a slower pace of price and
trade liberalization would have reduced the short-run output costs of the
reforms by mitigating the transitional output losses associated with
reallocating resources across sectors.

This paper examines whether it is reasonable to conclude that a
significant fraction of the initial declines in output in four Eastern
European countries (the former East Germany, the former Czechoslovakia,
Hungary and Poland) is attributable to structural change. A methodology
is presented which decomposes the total decline in output in the first two
years following the implementation of reforms into a portion associated
with resource reallocation across different industrial sectors (structural
change), and a portion due to macroeconomic forces (factors common to all
sectors within a country). The paper's finding is that most of the initial
decline in output in the region reflects macroeconomic rather than
structural factors.

Notwithstanding a number of caveats discussed in the paper, our
results suggest that proposals to slow down the pace of reform in other
economies in transition on the grounds that going slower would reduce
short-run output costs lack empirical support. In fact, since all the
economies in the region will ultimately have to undergo the structural
adjustment associated with their decision to become market economies, it
is not difficult to make the case that moving more quickly to implement
reforms (particularly as regards corporate governance and the imposition
of harder budget constraints) would have resulted in a faster resumption
of growth than occurred under alternative, more gradualist, strategies.
To the extent that political support for the reform process depends on a
timely resumption of growth in these countries, the results presented in
this paper suggest that a rapid implementation of structural and
stabilization measures is less likely to jeopardize the transition to a
market economy than more gradualist alternatives.