Introduction
Transition, a process that has been followed for almost 20 years now by the former socialist economies of Central and Eastern Europe, entails a shift from an economic system characterized by public ownership and (usually) central planning to one in which economic coordination is provided to privately owned firms via markets. The socialist systems delivered slow growth, macroeconomic imbalances and political repression; transition promised high growth, mass consumption, integration with the developed economies of the West and political freedom. Most of these promises have been brought into question by the credit crunch of 2008 and the subsequent economic crisis, which seems likely to have even more savage corollaries in 2009 and beyond in many transition economies.

This article considers the ways in which the principal drivers of transition–for example, EU and global trade integration, or foreign direct investment–are likely to be affected by the recession. Transition can be viewed as one element in the broader process of globalization, so our analysis also ponders whether this will be temporarily or even permanently halted by the economic downturn. It also considers in more detail some of the likely implications of the recession for the transition economies, noting that the impact is likely to be more serious in some countries (i.e., Estonia, Hungary, or Bulgaria) than others (i.e., Poland, Czech Republic, and Russia). This is a consequence of the particular transition path that they chose, for example with respect to the speed of privatization, openness to foreign direct investment, and degree of integration with the EU, as well as being significantly affected by initial conditions, notably market-related reforms pre-transition and natural resource endowments. It concludes that the convergence between developed and transition economies will probably resume, although performance may become more heterogeneous, for example between EU and non-EU members, and within the CIS between resource-rich and resource-poor economies.

Transition, globalization and the credit crunch
Transition is usually conceived in an evolutional and uni-dimensional way, with a clear view of the starting and finishing points as well as the path. Thus, transition programmes tended to represent the rapid application of Washington consensus programmes to economies that were not always less developed, but which had some of the characteristics of underdevelopment: weak market supporting institutions, high levels of state intervention and price regulation, and very limited integration into global product, service, or capital markets. But radical formal changes in, for example, ownership arrangements or property rights laws did not necessarily imply immediate substantial changes in practice. In particular, the changing and creation of institutions and the promotion of efficient privately owned enterprises and of independent financial institutions proved difficult, with achievements measured in decades rather than years, and a variety of political and economic approaches emerged as a result. As the EBRD Transition indicators show, success in building a market economy, and in national economic performance, even during the years of boom, was heterogeneous, being influenced by integration into the world trading system (notably EU accession); ownership of significant natural resources; or highly favourable preconditions (e.g., some liberalization pre-transition and a broad political consensus in favour of the reform process).

Some of the drivers of globalization and success in transition are rather similar. Because of differences in factor costs, notably labour, profitability can be increased by the transfer of production from developed to developing countries, provided costs in terms of management and control, transport, trade barriers etc., are not too high. In fact, these costs have been falling for a number of reasons. Developments in information and communication technologies have reduced the costs of transacting abroad; while some developing economies have begun to address those weaknesses in their institutional, legal and policy environment which affect the costs of doing business in their countries. The global policy environment has been benign, promoting an enormous expansion in world trade, foreign direct investment and outsourcing.

These drivers are also associated with the transition process. Many transition economies were not exactly developing countries (though GDP per capita was well below Western levels) but had similarly high barriers to trade and capital flows, though often with greater levels of human capital. Moreover, if ‘distance’ represents a way to describe barriers to trade and foreign direct investment, raising both transport costs and the costs of doing business in unfamiliar surroundings, then abolishing communism reduced ‘distance’ for many transition economies, especially those bordering the EU. Finally, the liberal policy environment was valuable to many transition economies in allowing them to reorient their trade patterns back to market-based pre-communist norms.

The first two drivers seem unlikely to alter. Technological changes are irreversible and likely to continue despite the credit crunch; and while performance has been heterogeneous, the general direction in at least the most advanced transition economies has been for entrenchment of institutional reform. While it is early to evaluate the impact of the credit crunch on the policy environment, the tone of the international debate suggests that the lessons of the 1930s have been learned. In any case, for the transition countries which have acceded to the EU, Brussels is the pivot of the policy environment.

Convergence or divergence?
An economy’s ability to weather the storm depends both on its condition when the turbulence began, policies adopted in response, and on how long the turbulence lasts. Communism collapsed in part because it could not deliver growth in living standards comparable to developed economies; and transition will largely be judged by whether it has managed to reverse that divergence in GDP per capita. We consider the record in Charts 1-4 which show the level of GDP per capita (in purchasing-power-parity terms) as a percentage of the EU-15 average in the relevant year. The data are derived from the IMF. The groups of countries are the 10 EU Accession transition economies (Chart 1), remaining non-EU Central European countries (Albania, Bosnia, Croatia, the Former Yugoslav Republic of Macedonia, and Serbia) in Chart 2, former Soviet Union economies including Russia but excluding the Baltics (Chart 3); and Russia (Chart 4). The bars in each chart are for the first year when data are available, 2001 and 2008 respectively.

Chart 1. 

Note: The vertical axis clenotes the level of GDP per capita (PPP) as a percentage of the EU-15 average.

Chart 2.

Chart 3.

Chart 4.

Note: In each graph the vertical axis denotes the level of GDP per capita (PPP) as a percentage of the EU-15 average.

The process of convergence began at very different levels and has been heterogeneous. For the new EU members, GDP per capita increased slowly but steadily from 1993 to 2008, reaching some 50 percent of the EU-15 average. The other Central European economies started from a lower base and have closed the gap more slowly. Russia suffered grievously in the 1990s with a deep recession, but has restored its position and is now around 40 percent of the EU average, largely because of favourable resource price trends. However, transition has been less successful in convergence terms in other CIS countries, where starting from a very low base the situation deteriorated between 1994 and 2001, though the gap has closed a little since then. This group’s GDP gap vis-á-vis the EU is the largest in the region.
In this context, the credit crunch is likely to impact differentially to exacerbate the pattern in the charts. Thus, for countries that are integrated into European production and trade systems, the recession in Western Europe is likely to be amplified in the short term because of their relatively greater role in supplying inputs for European exports, for example in the vehicles sector. This may be partially offset by the increased incentives to reduce cost by transferring production offshore. Foreign and public sector indebtedness is also important, as this will restrict policy responses to the crisis. For example, countries which ran large structural public sector deficits like Hungary will be constrained in their policy response; while countries heavily reliant on overstretched foreign banks, like Latvia, may suffer more sharply in the global credit crunch. Thus, the Czech Republic and Poland may fare better than Hungary or Estonia. Interestingly, these differences are not well correlated with transition preconditions or the varying speeds or types of reform, but rather with recent macro-economic policy stances. However, EU membership, international support, and significant institutional modernization suggest that convergence will resume, in some cases after an interval. Russian growth is closely correlated with resource prices, but the high level of reserves gives considerable degrees of policy freedom and, as in most EU transition countries, convergence is also unlikely to slow significantly for long. The greatest dangers are for the other European and CIS economies that displayed very slow convergence during the boom. Some of them have fragile economic and political environments.

Conclusions
For most transition economies, the process of transition, like that of globalization itself, is likely to resume once the current crisis in developed economies is past. However, in the interim, some of the transition economies are likely to suffer rather more than the developed economies, implying that for some years the convergence process may go into reverse. These countries are likely to be those in the Balkans and former Soviet Union, rather than the new EU member states or Russia. However, some EU members will suffer more than others depending on the state of their public finances and international indebtedness. Moreover, whether the threats to convergence are short term or long, they may present serious challenges for the already relatively fragile political and institutional structures in these countries.

Although it is too early to judge, the fundamental forces driving globalization are seen not to have been altered by recent events. Even so, as the discussions at the April G20 summit in London indicate, when growth resumes it seems likely to take a more regulated form. This suggests that the transition process will then become re-established, certainly in the more advanced and stable economies, although perhaps also with greater emphasis on state direction or regulation than hitherto.

Saul Estrin is Professor of Management and Head of the Department of Management at the London School of Economics. He would like to thank Angela Lei for research assistance and Mario Nuti, Milica Uvalic and the editors for helpful comments on an earlier draft.