A)PS I'Ve(, 
POLICY RESEARCH WORKING PAPER    18 66
Circumstance and Choice                                               Initial conditions and
economic policyjointly
determine the farge
The  Role  of Initial Conditions                                       differences in economic
and Policies in Transition Economies                                   performance among
transition econornies in Asia,
Martha de Melo                                                         Central and Eastern Europe,
and the former Soviet Union.
Cevdet Denizer
Initial contions dominate in
Alan Gelb
explaining inflation, but
Stoyan Tenev
economic liber-alization is tre
most importan it factor
deterrnning differences in
growth. But reformrt policy
choices are not exogenous.
Liberalization depends, in
turn, on both initia!
conditions and poiit;cal
reform
The World Bank
Development Research Group
December 1997



POLICY RESEARCH WORKING PAPER 1866
Summary findings
The experience of countries in transition from a planned      They find that intial conditions and economic policy
to a market-oriented economy has varied greatly. The       jointly determine the large differences in economic
clearest differences are between the East Asian countries,    performance among the 28 transition economies in the
China and Vietnam, and the countries of Central and         sample. Initiate conditions dominate in explaining
Eastern Europe (CEE) and the former Soviet Union            inflation, but economic liberalization is the most
(FSU). China and Vietnam have contained inflation and      important factor determining differences in growth. But
benefited from continued high growth in GDP since the       reform policy choices are not exogenous. They depend,
beginning of their reforms, while all CEE and FSU           in turn, on both initial conditions and political reform,
countries have experienced large declines in output, and    with political reform the most important determinant of
most have experienced hyperinflation.                       the speed and comprehensiveness of economic
But even in CEE and the FSU, differences are marked.     liberalization.
Some countries have lost over half of their GDP, and          Other findings provide additional insight into these
growth performance in a number of countries is still       relationships. Results show that iiberalization has a
poor, while others are growing strongly. Some are still     negative contemporaneous impact, but a stronger
suffering from high inflation while others have             positive effect on performance over time. The results also
successfully reduced annual inflation.                      show that macroeconomic and structural distortions are
What determines this divergence of outcomes across       negatively related to both policy and performance.
transition countries? No study so far has analyzed the      Regarding the former, unfavorable initial conditions
interaction of all factors, including initial conditions,   discourage policy reforms but do not diminish their
political change, and reforms, in a unified framework       effectiveness once they are implemented. The authors
including CEE, the FSU, China, and Vietnam. De Melo,        find some evidence that the influence of initial
Denizer, Gelb, and Tenev examine these broader              conditions diminishes over time. This is in part because
interactions, but focus first on the role of initial        many of the initial conditions are themselves modified in
conditions, such as initial macroeconomic distortions and    the course of transition. Monetary overhangs are
differences in economic structure and institutions, which   dissipated through inflation, industrial overhang is
have been emphasized less in the literature.                eroded as plants shut down, and market memory returns
through experience.
This paper - a product of the Development Research Group - is part of a larger effort in the group to provide a
comparative overview of the experience with the transition from central planning to a market economy. Copies of the paper
are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Cynthia Bernardo,
room MC2-501, telephone 202-473-1148, fax 202-522-1154, Internet address cbernardo@aworldbank.org. December
1997. (54 pages)
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about
development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The
papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the
countries they represent.
Produced by the Policy Research Dissemination Center



CIRCUMSTANCE AND CHOICE: THE ROLE OF INITIAL CONDITIONS AND
POLICIES IN TRANSITION ECONOMIES+
Martha de Melo, Cevdet Denizer, Alan Gelb, and Stoyan Tenev*
The World Bank
International Finance Corporation*
'Data used but not included here can be obtained from Stoyan Tenev. We are grateful to Craig
Bumside for valuable comments and suggestions. We also extend our thanks to William Easterly, Bert
Hofman, Aart Kraay, Norman Loayza, Peter Murrell, Randi Ryterman, Jakob Svensson, Gunter Taube,
Tevfik Yaprak, and other participants of the Macroeconomics and Growth seminar participants at the
World Bank, and to seminar participants in the Transition Economies section of the European
Economic Association meetings in Toulouse, September 1997, for their comments and suggestions.






L INTRODUCTION
The experience of countries in transition from a planned to a market oriented economy has
varied greatly. The clearest differences are between the East Asian countries, China and Vietnam, and the
countries of the Central and Eastern Europe (CEE) and the former Soviet Union (FSU). China and
Vietnam have contained inflation and benefited from continued high growth in GDP since the beginning
oftheir reforms, while all CEE and FSU countries have experienced large output declines, and most have
experienced hyperinflation. But even in CEE and FSU, differences are marked. Some countries have
lost over half of their GDP and growth performance in a number of countries is still poor, while others
are growing strongly. Some are still suffering from high inflation while others have successfully reduced
annual inflation to 50 percent or less. What are the main determinants of this divergence of outcomes
across transition economies?
The literature on transition emphasizes the importance of different factors in different country
groups. Many observers have, for example, noted that the inherited economic conditions, natural
resources, histories, and institutions of transition countries were very different between CEE and FSU.'
Drawing attention to these differences, they point out that the transition path of a given country will
depend both on its initial conditions and on the economic policies it chooses to implement. The empirical
analysis, however, has largely focused on the effects of policies2. Several recent studies have
1See for example Fisher and Gelb (1991), Bruno (I992, 1993)
2 A number of papers, Balcerowicz and Gelb (1996), de Melo, Denizer and Gelb (1996a), and Fischer, Sahay
and Vegh (I 996a,b) and Denizer (1997) do include one or two initial conditions in their analysis. However, these
studies ignore other initial conditions and therefore may have failed to capture some important dimensions of the
transition process.
2



emphasized the variability in policies and performance and have shown that government policies were
key determinants of cross-country variation in growth and inflation3. The analysis show that economies
in CEE and FSU contracted strongly as major reforms were initiated but mostly resumed growth about
two years later, after achieving price stability. The analysis also shows that delaying reforms does not
prevent output declines, and success in controlling inflation has been positively related to reforms. These
results suggest that the issue is not so much big-bang versus gradualism but one of achieving
macroeconomic stability and quickly shifting factors of production to the most efficient use.
These findings have in turn focused attention on the determinants of policy choices in CEE and
FSU countries. The emphasis has largely been on political transition, with little attention being given to
the role of initial conditions as a key factor shaping the reform process and hence economic outcomes'.
In particular, it is noted that there have been close links between political transition and intensity of
reforms (Balcerowicz and Gelb 1995, Aslund 1995, De Melo, Denizer, and Gelb 1996, and Aslund,
Boone, and Johnson 1996). Economic reforrn has been easier in countries where rapid and fundamental
political change has taken place. In these countries, an initial period of"extraordinary politics" provided
a window of opportunity for policy makers to push through decisive reforms. More recently, Shleifer
(1997), comparing the performance of Russia and Poland, has pointed out the importance of political
transition in determining the success of economic reforms.
3 See Aslund, Boone and Johnson (1996), de Melo, Denizer and Gelb (1 996a and b), de Melo and Gelb
(1996), Fisher, Sahay and Vegh (1996a,b), Sachs (1996a), Selowski and Martin (1996), and Hremandez-Cata (1997).
See Blanchard (1997), and Brixiova and Kiyotaki (1997) for theoretical aspects of transition.
4Ickes (1996) discusses some of the consequences of not including initial conditions in the analysis of reforms
and performance in the context of transition. In his review of the transition process, Murrell(1 996) points out that the
degree of political change and liberalization seems to be related to initial conditions and war.
3



It has been difficult, however, to accommodate the experience of China and Vietnam within the
above framework. The gradual reforms in these two countries compared to Eastern Europe were
broadly consistent with the limited extent of political change5. Their economic performance, however,
followed a pattern very different from the one observed in CEE and the FSU. While there are various
interpretations of the Asian experience with transition, a prominent feature of these interpretations has
been the attention paid to the role of initial conditions6. Initial conditions, and in particular structural
characteristics such as surplus agricultural labor, have been often referred to as the primary causes of
growth in socialist Asia7. Several studies have also recognized the role of initial conditions in shaping
Asia's reform strategy. Thomas and Wang (1997), for example, argue that "countries with relatively
stable political and macroeconomic conditions usually feel no particular urgency to reform, so they can
afford to conduct reforms in an evolutionary fashion, rather than risk political and economic chaos" and
"China and most East Asian countries belong to this group".
But none of these studies has taken an integrated approach to explaining the transition
experience. In particular, no systematic attempt has been made so far to look at the interaction of all
factors, including initial conditions, political change and reforms, in a unified framework comprising CEE
and FSU as well as China and Vietnam. This paper attempts to look at these broader interactions, but
initially focuses on the role of initial conditions, which has been less emphasized in the literature.
5 Vietnam went through a phase of rapid reform in 1989 in response to high inflation. In this regard, its
experience is different from that of China.
6 See for example the discussion in Sachs and Woo (1997) on the experimentalist and the convergence schools
of thought in interpreting the Chinese Experience.
' See Parker, S., Gavin Tritt and Wing Thye Woo. (1997) Some Lessons Learned from Comparison of
Transitions in Asia and Eastern Europe, in Woo W., Stephen Parker and Jeffrey Sachs (1997).
4



The previous findings on policies and politics raise several important issues related to the role of
initial conditions in transition economies. The first issue is: How important are initial conditions in the
determination of policy choices? Related questions are: Is the large variation in policies mainly due to
different rates of political change, as argued by many, and does this mean policy makers do not take into
account initial conditions of their countries in formulating reform policies? Are there relevant economic,
social, and institutional circumstances that act as constraints or catalysts to reforms? For example,
WDR 1996, notes that "countries' characteristics--their unique advantages and disadvantages--
influence what policies can be chosen and what leaders can accomplish".
A second, related issue is: Through what channels might initial conditions affect policies? Do
they directly influence their effectiveness and hence the policies being chosen? Murrell (1996), for
instance, has observed that policies may have "become increasingly homogeneous overtime but
outcomes have become more varied, suggesting that initial conditions greatly determine the effectiveness
of policies". If so, can slow reforms be viewed as a rational response to lower effectiveness of policies
under unfavorable initial conditions?
A third, issue relates to the impact of initial conditions on performance. Assuming there is an
indirect effect on performance through policy choices, do we observe in addition a strong direct effect of
initial conditions on growth and inflation? If initial conditions have an independent effect on
performance, how does this effect evolve over time and what is in general the time profile of the impact
of initial conditions on the policies-performance relationship? Do we observe a diminution of the effect of
initial conditions on policies and performance or is this effect magnified over time?
Given these questions, we analyze here the role of initial conditions and their interaction with
5



policy choice and economic performance dufing the transition period in 28 countries. The nature of the
problems addressed in this paper requires a sample which is consistent with respect to the beginning of
transition for different countries. China's shift to more market-oriented economic policy started in
1978; Vietnam's reform program (doi moi) was launched in 1986; in Eastem Europe and Mongolia, and
in the FSU, the major events that marked the revolutionary change in political and economic systems
occurred in 1989-90 and 1991 respectively. The duration of transition in the FSU and our preference to
work with a balanced sample constrain the length of the time series for these sub-groups of countries to
five years. Our main sample therefore includes observations for the periods 1979-83 for China, 1987-91
for Vietnam, 1990-94 for Eastern Europe and Mongolia, and 1992-96 for the FSU.
In the next section, we discuss a range of initial conditions as well as some special factors that are
thought to affect the transition experience. A total of 11 country-specific factors are considered as
potentially important. Utilizing principal components analysis we derive and interpret main clusters of
the full range of initial conditions. Two such clusters are used in subsequent multiple regression analysis.
In section III, the focus is on whether these initial conditions, together with a political change variable,
explain the choice of reform policy. We test for the impact of initial conditions on policy and
performance over time. We then use the results from the regression equations to come up with estimates
of the relative importance of initial conditions and policies in determining performance, as measured by
growth and inflation. In this section we also study the time profile of output and inflation in transition
economies taking initial conditions and policies into account. Section IV summarizes the main findings
of the paper.
6



Standard caveats on data problems, which are especially severe in transition economnies, apply to
conclusions drawn here. These problems include difficulties in estimating deflators; difficulties in deriving
consistent measures of trade and balance of payments over time; over-reporting of output at the
beginning of transition and under-reporting of output as transition and private sector development
proceed'. With this in mind, conclusions are drawn with modesty.
II. INITIAL CONDMONS, CLUSTERS AND OTHER FACTORS AFFECTING
TRANSITION
11.1 Transition and Initial Conditions
Despite a common legacy of planning, the transition economies started out under different
circumstances. There were substantial differences in terms of the initial level of development,
macroeconomic distortions, integration into the trading system of the socialist countries, extent of prior
reforms etc. In Eastem Europe, the beginning of the transition process was marked by a wave of largely
peaceful political revolutions in 1989, accompanied by an economic shock from the breakdown of the
CMEA trading arrangements. For the FSU republics, the collapse of the Soviet Union in 1991 was the
defining political and economic event, as a result of which these countries gained their independence and
began their transition to market economies. Reforms in China and Vietnam started earlier, but without a
radical polMical change. Drawving on the literature and our own earlier work on transition, we identify 11
variables, sunaxized in Tables 1 and 2, to characterize the initial conditions of transition economies just
8 Kaufmnan and Kaliberda (1996) and Johnson, Kaufman, and Shleifer (1997) provide an interesting analysis of
the size of unofficial economy in transition economies.
7



prior to their shift towards market-oriented development-1978 for China, 1986 for Vietnam, 1989 for
Eastern Europe, and 1989-91 for FSU and Mongolia. In Table 1, we group indicators for initial levels of
development, resources and growth. Table 2 presents variables reflecting initial macroeconomic
distortions and institutional characteristics of the transition economies.9
As shown in Table 1, transition countries span a considerable range of development. Income
levels (INC), measured in 1989 US$ but reflecting purchasing power parity incomes in the base year,
ranged from $800 in China to over $ 9000 in Slovenia. Per capita income for China is widely debated
but at the start of its transition was perhaps half that of Albania. Social indicators roughly followed
income levels; life expectancy ranged between 61 and 75 years and infant mortality rates, from 8 to 66.
Urbanization (URBAN) is another proxy for level of development. Its cross-country
distribution closely mirrors that of income levels, with lower income countries being on average more
rural.
Industrialization is another indicator of development, but overindustrialization--or industrial
distortion (INDIST)--was common in socialist countries. It is defined here as the difference between
the actual share of industry in GDP and the share predicted by the regression analysis in Chenery and
Syrquin (1989).'1  Industrial shares were often high because trade, financial services, and business and
consumer servicesweretypically repressed in socialist countries.1' In 1989, only Hungary, Slovenia and
90ther historical and cultural factors can be expected to affect a society's success in managing transition, but
no attempt is made here to capture these.
'0The high share of industry in China (in contrast to its low level of urbanization) is partly due to extremely low
prices in africulture relative to industry.
Services were suppressed in communist countries partly for ideological reasons that held non-material output
to be "unproductive." See Easterly, de Melo, and Ofer 1994 for econometric estimates of the gap in actual and expected
levels of services in Russia and other former Soviet states.
8



Croatia had service shares of 50 percent of GDP, a typical level for upper middle-income countries.
Bulgaria, Romania, Czechoslovakia (especially Slovakia), Armenia and Poland had industrial shares of
over 50 percent of GDP; Russia, and countries in the north-eastem part of the FSU were close to this
level. In Vietnam in nid-80s, agriculture accounted for a larger, and industry for a smaller, GDP share.
Three indicators of resources and growth are considered. The richness of natural resources
(RICH) differs significantly among transition countries, as indicated by the rough characterization in
Table 1. At first sight, resources make the transition easier but this may not be so"2. The resource rich
countries of Central Asia, for example, have to surmount enormous production and logistical problems
(pipeline transit rights) before realizing their oil and gas potential. In some cases, the availability of
potentially exportable energy resources may permit governments to delay reform (Azerbaijan, and
Turkmenistan). On the other hand, for energy importers, the break up of the CMEA and the USSR has
entailed a large terms of trade shock, leading to growing external indebtedness.
Location (LOCAT), defined as geographical proximity to thriving market economies, may be
especially important during transition because it facilitates the import of market institutions and the
adjustment of trade patterns. Moreno and Trehan (1997), for example, show that even in the case of
market economies, location is an important determiinant of growth and that this correlation reflects more
than common shocks. Countries from Central Europe and the Baltics may have benefited from better
access to Western markets as well as stronger incentives to adopt the institutional framework of the
European Union because of prospective membership. China and Vietnam are close to some of the most
rapidly growing market economies in the world. At the other end of the spectrum are the remote
12 See Sachs and Warner (1996) for a recent discussion of the effects of natural resources on growth.
9



landlocked countries from Central Asia and the Transcaucasus, with essential connections routed
through Russia. We use a dummy variable to indicate that a particular country has a thriving market
economy as a neighbor.
Reported prior economic growth rates (PRGR) in CEE and FSU during the second half of the
1980s were mostly positive, with mildly negative rates found in Romania and Slovenia. Growth tended
to be higher in the poorer countries (Mongolia, Moldova, Kyrgyzstan, and Turkmenistan, plus Vietnam
and China).  This is included as an initial condition because it has been observed that growth in the
earlier stages of socialist accumulation is higher and that countries found themselves at different stages of
this process at the beginning of transition. The more mature countries were experiencing stagnation, if
not declining growth, whereas poorer countries were still benefiting from higher growth.
Variables reflecting initial economic distortions and institutional characteristics are shown in
Table 2. Open inflation was chronic only in Poland and the Yugoslav Republics in 1989, but repressed
inflation (REPR), in the form of a monetary overhang, was high in most of CEE and the FSU. The
indicator of repressed inflation used in Table 2 is the increase in deflated wages less the change in real
GDP from 1987 through 1990; this suggests that the strongest inflationary pressures in CEE were in
Bulgaria, Romania, and Poland and the weakest were in Czechoslovakia and Hungary"3. Repressed
inflation was highest, however, in the FSU, where upward pressures on prices mounted after 1987,
propelled by glasnost and diminishing Union control over the Republics. Macroeconomic imbalances
were quite severe in Vietnam in the mid 80s, but China began its reforms at the end of the 70s without a
13Direct estimates of money overhang are difficult to obtain because of difficulty of estimating the underlying
voluntary money demand functions.
10



monetary overhang.
Reflecting the desire of authorities to create a regionally interdependent communist economy,
trade shares in GDP (TDEP) were high for most CEE and FSU countries and trade flows were
concentrated within the CMEA area. Compared to the counterfactuals generated by gravity models
(Winters and Wang 1994), trade flows within the area were especially large for the smaller republics of
the USSR, while trade outside the area was very small. The breakdown of the CMEA and the collapse
of the USSR therefore caused tremendous disruption in the international trade and payments of these
countries. CEE countries were less dependent on CMEA trade than FSU countries, and hence suffered
somewhat less from disruption. The effects of disruption also depended partly on location; some
countries could benefit from cross-border trade with rich neighbors, while others were not so fortunate.
China had long left the Soviet orbit, but Vietnam was still part of the CMEA and felt the effect of its
collapse.
A final measure of economic distortion is the black market exchange rate premium (BLMKT).
A high black market exchange rate premium is an indicator of expectations of depreciation and/or
foreign exchange rationing. A high differential between the official and the free exchange rate can also be
interpreted as a distortionary tax on exports and subsidy on imports (Easterly, 1994). It stimulates the
diversion of resources from the official to the informal sector, a process which is often associated with
consumption of real resources in directly unproductive activities. Black market premia were especially
high in FSU, Mongolia, Bulgaria, Romania, and Vietnam. They were relatively modest in countries that
had some previous experience with reforms like Hungary and the former Yugoslav republics of Croatia,
Macedonia, and Slovenia. The black market premium in Czech and Slovak republics was high according
11



to intemational standards, but low compared to the average for transition countries. China also began
reforms with a relatively low level of distortions in its foreign exchange market.
Table 2 also includes two variables reflecting initial institutional characteristics of the transition
economies. (STATE) is a categorical variable differentiating among countries that were independent
states prior to 1989 (value of 2); members of decentralized states like the former Yugoslav republics or
core countries of centralized federal states like the USSR (value of 1); and new nation states (value of
0). These last needed to build national institutions --including systems of democratic representation,
justice, and security as well as economic institutions such as a central bank and customs bureau - while
confronting economic changes."4 The non-Baltic FSU, in particular, lacked national institutions; until
recently, these former Soviet republics were territories in a highly centralized political union,
characterized also by a brain drain from the periphery to the center. New nation states arising from the
former Yugoslavia and former Czechoslovakia were not faced with such serious problems, as the federal
systems in these countries gave substantial powers and responsibilities to the constituent republics.
Furthermore, the historical ties and the political affiliation of CEE countries with Western Europe have
given them a clear sense of direction lacked by the new nation states of the FSU.
Another institutional variable, "market memory" (MARMEM), captures the lack of familiarity
of the non-Baltic FSU with market institutions. While this is related to the STATE variable discussed
above, it is likely that MARMEM has a separate influence on the reform process, particularly on the
14Recent cross-country growth studies emphasized the importance of institutional/political variables. See
Alesina (1997), and Knack and Keefer (1995) for examples.
12



ability of societies to deal with the disequilibria of the transition." Not having a single generation in the
society with prior experience of the workings of market economy could provide a basis for adopting a
wait and see approach to reforms or for reverting repeatedly to old ways of doing things. In fact, both
types of reform outcomes have been observed in certain FSU countries, and policies that could be
regarded as "a clean break with the past" have been more difficult to adopt and the unwillingness of
some non-Baltic FSU countries to leave the ruble zone until Russia forced them to do so, versus the
Baltic countries' decision, to leave the ruble zone quickly could partly reflect the importance of prior
experience with a market based system. If transition is viewed as a process of large scale institutional
change, then this variable could be very important (Dewatripont and Roland 1997).16 We use the
number of years under central planning as proxy for this variable.
11.2 Initial Conditions Clusters
Initial condition variables (ICVs) can be used individually in regression equations, but
interpretation of any individual coefficient is only meaningful when everything else is held constant.
Moreover, ICVs are often related and they exert their effect jointly, so that the individual approach
suffers from the omitted variables problem and results estimated coefficients that are biased. An
alternative approach is to include all ICVs in the same equation, but the fact that there are II of these
variables, some possibly correlated with each other, makes this less useful. In order to reduce the
dimensionality of the ICVs and to deal with multicollinearity, we rely on the method of principal
"While Schultz (1975) uses the concept of the ability to deal with disequilibria in a market economy context,
it is also highly relevant in the transition context. The ability of transition economies to reallocate resources toward their
best use and to establish institutions to that end has been a major determinant of transition pattems. On this see WDR
(1996).
The experience of market-based law, for example, was never lost in CEE:WDR 1996.
13



components."
For the initial conditions identified earlier, the first two principal components account for most of
the variation. While it is always difficult to interpret principal components, in this case they seem to have
consistent interpretations that are robust to a sensitivity analysis whereby principal components have been
derived for modified sets of initial conditions. In all cases, the first two components explain between 64
percent and 75 percent of the variability of the initial conditions. Hence, in the subsequent analysis we
will use only the first two principal components. They are presented in Table 3 and interpreted as
follows:
PRINM: The most important cluster has high positive correlations, or loadings, for economic
distortions (IDEP, REPR, BLMKT) as well as for MARMEM. The weights for these variables given in
the eigenvector suggest that PRINI might largely be interpreted as an index of the degree of
macroeconomic distortions at the beginning of transition and a measure of unfamiliarity with market
processes. With liberalization these distortions would translate into shocks to the economy and can
therefore be viewed as a measure of the intensity of transitory shocks when controlling for the level of
liberalization. Loadings are somewhat lower, for the negatively signed STATE and LOCAT variables
although the corresponding weights in the eigenvector are still sizeable. Countries with higher scores on
trade dependence, black market exchange premium, repressed inflation and market memory and with
lower values for STATE, and LOCAT will tend to have higher values for PRINI.
PRIN2: The second most important cluster has high positive loadings for per capita income
7For a thorough description of this technique see Dunteman (1989).
14



(INC), urbanization (URBAN), and over-industrialization (INDIST) and might therefore be interpreted
as an index of the overall level of development, incorporating the so-called "socialist development
overhang'. For brevity, we will call this component "overindustrialization". Poor but resource-rich
countries tended to grow faster prior to transition, so PRIN2 has also high negative loadings for
resources and prior growth (RICH, PRGR). PRIN2 might therefore be interpreted as reflecting a cluster
of higher income, resource poor countries that reached diminishing returns to investment and ran out of
steam before reforrns began because of structural distortions reflected in overindustrialization. It is, in
fact, the case that growth slowed noticeably in the richer countries of CEE and the FSU during the 60s
and 70s. Labor force participation rates had stabilized at high levels, and rapid capital accumulation was
offset by declining capital productivity.8 To the extent that structural distortions are reflected in PRIN2,
we can also view this second component as a measure of what the supply shocks would be when prices
are liberalized and free entry allowed. Changes in the parameters of the initial conditions dominating
PRIN2 can only occur relatively slowly so that we can interpret this component as reflecting persistent
conditions. To sum up, countries with higher initial per capita income, higher urbanization, over-
industrialization, poor natural resources and low growth rates prior to 1989 will tend to have higher
values for PRIN 2.
Given the nature of the principal components procedure, an important implication of these
results is that macroeconomic distortions together with historical recollection of a market economy
tended to be relatively uncorrelated in the pre-transition period with level of development and industrial
overhang. Using the first two principal components as indices, we can group the transition economies
lsSee Ofer 1987 and Easterly and Fischer 1994 for a discussion of factors leading to the Soviet economic
decline.
15



along the two dimensions of macroeconomic distortions and over-industrialization. It can be seen in
Figure 1 that the FSU states are uniformly high on the first dimension, but differ a great deal on the
second. The Central Asian states were far less developed than the Slavic one, and the Central and
Eastern European countries tend to cluster in the first quadrant. The Czech and Slovak Republics, for
example, have a very high level of structural imbalance, but low macroeconomic distortions.
Interestingly, countries like Hungary, Croatia, and Poland--that had a relatively long history of prior
reforms and more liberal economic systems--have moderately low values for both macroeconomic and
structural distortions. Finally, the East Asian economies and Albania form a separate group,
characterized by a relatively low level of development, and also by lesser structural and
macroeconomic distortions.
11.3 Economic Policies, Political Change and Other Factors
An integrated view of transition requires us to consider initial conditions along with other factors,
especially economic policies, political reforms, and regional tensions. Economic policies are proxied by
economic liberalization indices originally developed in de Melo, Denizer, and Gelb (1996a). We use the
annual liberalization index (LIE) which represents the level of liberalization achieved in each year. Of
course, some countries initiated partial liberalization within the socialist context prior to transition. In
Poland and Hungary, reforms were undertaken in 1968 and 1981 respectively, while Yugoslavia
abandoned formal planning in the 1950s. But prior to 1990, other countries in Eastern Europe
(Bulgaria, Romania, former Czechoslovakia) had departed little from the Soviet model of central
planning and, notwithstanding the limited initiatives under perestroika in 1987, there were no major
16



reforms in the USSR prior to 1991. China's transition started in 1978 from no prior reforms, though in
a mainly rural setting. In South Vietnam, a small private sector and some market practices were
preserved after the unification in 1974. The liberalization index incorporates the extent of prior reforms in
each country in its initial value.
As mentioned earlier, the links between politics and reform are also important. The transition
countries now display significant variation in the degree of political freedom and civil liberties achieved
(see Table 5). Many have made a rapid transition to democracy, but in a few countries political freedom
has eroded after some progress early in the beginning of transition. This erosion of political freedom has
sometimes been related to ethnic, religious or cultural tensions deeply rooted in history. We use the
index of political freedom (FREEDOM) by Freedom House to represent political change.
Finally, six of the 28 countries covered here have experienced serious regional tensions: wars,
internal strife, or prolonged war-related blockades. We use a dummy variable RT(regional tensions) to
capture the disruptive effects of these events.
mL. INITIAL CONDITIONS, ECONOMIC LIBERALIZATION AND PERFORMANCE
ILi Explaining the Relationships
We now focus on the links between initial conditions, policy reform choices given by the
liberalization indices, and performance outcomes measured in terms of growth and inflation. We posit
the following system of equations; where "i" represents country and "t" represents year:
17



LIBI-t= a + bLIB it-, + b,, PR NI1 + b2 PRJN2i + b3FREEDOMt + b4RI,± T (I+l)
PERFORMANCE,t = z + yOPRINli + yMPRJN2i + Y2 LIBI +yLIB i, + y4RT i + e (IIL.2)
While we expect economic performance during transition to depend on initial conditions,
reforms and special factors such as war and regional tensions, previous studies for CEE and the FSU
(De Melo, Denizer, and Gelb 1996, Selowsky and Martin, 1997) have found strong evidence that the
effect of liberalization is non-linear over time. In particular, empirical results suggest that good
performance (high growth, low inflation) depends negatively on the size of the contemporaneous
liberalization step but positively on the "accumulated stock" of reforms. We, therefore, expect y2<0
and y3>0. Also, in order to have an overall positive effect of liberalization on perfornance in the
steady state where LIB(t-1) = LIB (t), we would expect jy3j>y2j. With respect to macroeconornic
distortions as reflected in PRINI, we expect their effect on performance to be negative. PRIN2
captures structural distortions which were higher in more developed socialist countries. We therefore
expect yl<O.
What are the implications of these relationships for the expected signs of the coefficients in the
liberalization equation? In the performance equations, both contemporaneous liberalization and
unfavorable initial conditions are expected to have a negative impact on growth and inflation. A
negative relationship between unfavorable initial conditions and degree of liberalization would
therefore be consistent with behavior which attempts to smooth output during transition. In these
18



countries slower reforms would have a smaller negative effect on performance in the short run and in
this way might be favored to try to compensate for the negative impact of more unfavorable initial
conditions. This logic would suggest a negative association between LIB and PRIN1, or bl< 0. Initial
conditions could also have a direct effect on liberalization outcomes, due for instance to lower
effectiveness of reforms under more unfavorable initial conditions.
It is more difficult to form expectations about the sign of b2. To the extent that PRIN2 reflects
structural distortions and has a negative impact on growth, we would expect the above reasoning to
apply to PRIN2 as well. However, PRIN2 is dominated by indicators of level of development, and it is
not a priori clear how this affects policy choices. Level of development, for example, tends to be
positively correlated with political freedom, and as such is likely to be positively associated with
liberalization. A higher level of development may be also associated with a lower marginal utility of
income and therefore with a greater capacity to absorb negative shocks; this could imply a positive
relationship between reforms and PRIN2. And finally, if administrative capacity to implement reforms
is positively correlated with level of development, and if this capacity constraint is binding during
transition, then we would also expect to observe a positive relationship between PRIN2 and LIB. All
these hypotheses therefore suggest a positive association between PRIN2 and our liberalization index.
The hypothesis, based on empirical results from previous studies by Selowsky and Martin
(1997), and de Melo, Denizer and Gelb (1996) that performance depends negatively on the level of
contemporaneous liberalization but positively on the accumulated stock of reforms, also has
implications for the effect of past liberalization on current policy choices, in the context of output
smoothing behavior. Given this trade-off a higher level of achieved liberalization allows a larger
19



contemporaneous liberalization step for a targeted GDP growth rate. We therefore would expect
contemporaneous liberalization to depend positively on the extent of past reforms.
As previously discussed, the "window of opportunity" argument suggests that radical political
change may be associated with greater tolerance on the part of the populace to economic hardships in
the short run. Political change can therefore support more forward-looking behavior which places
greater value on future benefits making it easier to bear any immediate cost of liberalization in
expectation of its future benefits. We therefore, expect b3>0.
The above equations can be thought of as forming a recursive system in which policy does
not depend directly on current performance. The exclusion of the performance variable from the
liberalization equation is consistent with a view of policy formation as a forward looking process in
which policy makers assess the likely impact of initial conditions and policy on performance over time
and decide on an optimal reform path within the political envelope in a given country. However,
simultaneity between performance and reforms can still be an issue if the error terms of the two
equations are contemporaneously correlated.(Kennedy, 1994). To check this we estimated the system
using 3 SLS and SUR methods. The results indicate that our system does not suffer from simultaneity.
We therefore proceed under the assumption that the disturbance terms of the two equations are
uncorrelated and use OLS estimation procedure in the analysis.
The assumption that disturbance terrns are uncorrelated implies that performance surprises do
not lead to revision of reform plans. This would be realistic if such surprises could be attributed to
transitory shocks or if revision costs are high due for example to complexity, interdependence of
20



different policy measures or credibility effects of policy reversals. One could also question the very
assumption of rationality, which is implicit in the above formulation, in the case of unprecedented
systemic changes of this nature. It can be argued, however, that even large mistakes in estimating the
effects of liberalization and initial conditions on perfonnance may not lead to major reassessment of
reform programs especially in the direction of slowing the process. To use an analogy between reforms
and investment decision, any losses associated with over-optimism or over-pessimism will be to some
extent of the nature of sunk costs. For example, an underestimation of the negative short-term impact
of liberalization may cause a larger than anticipated decline in output but it also brings the economy
closer to the point where, because of large accumulated stock of refonns, the total impact of
liberalization on performance would be positive. It is therefore conceivable that mistakes of this nature
may even lead to acceleration of reforms.
111 2 Empirical Analysis: Cross Section Equations and Relative Reform Effort
We begin the empirical analysis of the relationships between initial conditions, reforms, and
performance by looking first at cross-country variation using the average values for the respective
variables over the five-year period. The results are presented in Table 4. In the liberalization equations
(AVLIB in equations 4.3 and 4.4), we observe a negative and statistically significant association
between liberalization and our index for initial macroeconomic distortions (PRIN1). This result seems
to indicate that severe macroeconomic distortions tend to be associated with slower reforms. The
coefficient for PRIN2 has a positive sign suggesting that, on average, more developed countries tend to
liberalize more. However, PRIN2 is statistically significant only in Eq 4.4, in which political freedom is
excluded. In Eq 4.4, PRIN2 probably captures some of the effect of democratization on reforms due to
21



the positive association between level of development and political change in our sample. The level of
political freedom (AVFREE) has a strong and positive association with the degree of liberalization as
demonstrated by the results for Eq. 4.3. This seems to corroborate previous findings that rapid and
fundamental political change makes reform easier.
Political change and initial conditions do not exhaust the list of factors that may determine the
policy choices of transition economies. Individuals, historical and cultural factors, external aid and
demographic structure may also play an important role. As the WDR (1996) on transition points out,
"most decisive reforms have reflected the vision of one leader or a small and committed group"
(WDR, 1996, p. 11). One way to assess the importance of such factors for individual countries is to
look at the residuals from equations 4.3 and 4.4. These capture the deviations of actual liberalization
from what could be viewed as a "normal" level of liberalization for a given set of initial conditions and
political freedoms.'9 In Table 5 we compare rankings of the transition economies under AVLIB and
under the residuals. Countries such as the Kyrgyz Republic, Estonia, Lithuania, and Moldova have
liberalized substantially more than expected given their initial conditions. On the other hand, countries
such as the Czech and the Slovak Republics, which started with very good initial conditions, show
negative values of the residuals despite a high degree of liberalization achieved. Ukraine, Romania,
Belarus and Turkmenistan are among the countries that have liberalized substantially less than expected
for their set of initial conditions. Countries that have liberalized under relatively lower levels of political
freedom improve further their position in the ranking by the residuals from Eq 5.3. Examples include
19 It is tempting to call the residuals indices for the relative reform effort in the spirit of the tax literature, which uses
smimlar approach to derive measures for tax effort. See for example Lotz and Morss (1969).
22



Vietnam, Uzbekistan, and Tajikistan.
The results from the performance equations (4.1 and 4.2) suggest a negative association
between PRINM and PRIN2 and economic performance. The effects of PRIN1 on inflation and growth
are larger and have statistical significance. The coefficient for PRIN2 is not statistically significant in
either performance equations. Regional tensions are statistically significant and important in both the
growth and inflation equations; countries that have suffered from wars and other disruptions have
experienced a substantially lower growth rate (5.6 percent less per annum) and higher inflation than
other countries, controlling for initial conditions and liberalization. The coefficients for AVLJIB are
negative and statistically insignificant. However, we know from previous studies that the relationship
between reforms and performance is highly non-linear over time, a feature that cannot be captured by
this simple functional form and by cross-country regression only.
ILL 3 Panel Estimates: Main Results
As described earlier, the panel data set includes observations from five years for each of the 28
countries, with different periods for different subgroups. We allow a wider set of functional forms to
exploit the time dimension of the data set and to capture potential non-linearities. As discussed earlier,
previous studies have found strong empirical evidence for a non-linear relationship between reforms
and performance. DLTALIB, the first derivative of the liberalization index with respect to time
captures the extent of any "liberalization shock." To test whether the effectiveness of policies depends
on initial conditions we construct four new variables, PRiLIB, PR2LIB and DLTPR1 DLTPR2. These
are interaction terms between LIB and DLTALIB, on the one hand, and PRINI and PRIN2 on the
other. Fmally, to look at how the impact of PRINI and PRIN2 on LIB and performance varies over
23



time, we interact the two principal components with time dummies using PRINI and PRIN2 in year 1
as a control group. We first estimate our basic equations H1. 1 and 11.2 and obtain the following
results (t ratios are presented in parenthesis below the coefficients):
(A) LIB= 0.182 + 0.641LIB(-1) - 0.022PRIN1 + 0.021PRIN2 + 0.015 FREEDOM - 0.026RT
(8.69)  (16.93)     (-2.64)       (2.02)       (4.33)            (-1.15)
R2Adj=0.86, N obs=140
(B) LOGINF= 4.80 + 2.5LIB-3.4LIB(-1) + 0.97PRIN1 + 0.17PRIN2 + 1.69RT
(11.31) (1.86) (3.05)    (6.89)      (1.08)      (4.56)
R2Adj=0.39, Nobs=140
(C) GROWTH=-10.41 - 17.54LIB + 32.6 LIB(-1) -2.95PRIN1 - 3.37PRIN2 - 11.16RT
(-4.37) (-2.31)    (5.19)     (-3.71)         (-3.73)     (-5.34)
R2Adj:=0.43, N obs=140..
In (A), PRINM has a negative and statistically significant effect on LIB. The impact of PRIN2
is positive and also significant at the conventional.5% level. These results are in line with our previous
findings that macroeconomic distortions tend to have a negative, and development a positive although
less significant, impact on liberalization. FREEDOM is again positively associated with liberalization
and is highly significant.
The results for the growth and inflation equations are also in conformity with the expected
relationships. Current liberalization has a negative impact on growth and is statistically highly
significant. LIB is also positively associated with current inflation although the coefficient is
24



marginally insignificant. As expected, LIB(-I) has a strong positive impact on performance and the
results are highly significant. These results therefore seem to indicate that performance depends
positively on the "accumulated stock" of reforms even if negatively affected by the size of the
contemporaneous liberalization step. The coefficients for LIB and LIB(-1) imply that a liberalization
step that more than doubles the previous period's level of liberalization is required for the overall
effect on growth to be negative. This is most likely in the early stage of reforms. Countries that
started with some history of reforms may have had more incentives to liberalize rapidly because the
total effect on performance is more likely to be positive.
As before, initial conditions have a significant impact on performance. PRINI has a negative
and statistically significant effect on growth and inflation. PRIN2 also preserves its sign from the cross-
sectional regressions, but is now also statistically significant in the growth equation. RT has a stronger
effect on growth and inflation than before since it now is a year dummy as opposed to a country
dummy in the cross-sectional regressions.
To illustrate graphically the implications of these results for the effects of initial conditions on
growth we use the partial derivatives for GROWTH with respect to PRIN1 and PRIN2 in (C) to
construct "isogrowth" lines for different sets of initial conditions and superimpose the "isogrowth"
lines on Fig. 1 to obtain Fig.2. The picture helps with the visualization of the effect of initial conditions
on growth. It also clarifies the importance of initial conditions in explaining the different growth
performance of China and Vietnam, and to some extent Albania, compared to other transition
economies. China and Vietnam, for example, lie on an isogrowth line which is about 14 % higher than
25



the isogrowth line for most of the FSU republics.20
Similar equations have also been estimated excluding China and Vietnam. They produce
similarly-sloped growth lines and an "out of sample" growth bonus for China and Vietnam about 7
percent higher than for the FSU. This bonus is especially interesting in highlighting the strength of
observed structural and institutional features of China and Vietnam,even when set in a CEE/FSU
context. The difference of 7 percent between the two estimates is also instructive as it may highlight
the importance of other factors that are specific to East Asian economies.
Table 6 shows the impact of initial conditions on policy effectiveness and the time profile of the
effect of initial conditions on liberalization and performance taking the interaction terms into account.
Equations 6.2 and 6.4 include interaction terms between the policy and the initial conditions variables in
order to test for the effect of initial conditions on the effectiveness of policies. Interestingly, we find
that PRILIB and PR2LIB are positively associated with performance. Only the coefficient of PR2LIB
in the growth equation is statistically insignificant. The results for PRiLIB suggests that the higher the
degree of initial macroeconomic distortions the higher the effectiveness of reforms in respect to both
growth and inflation. The coefficient for PR2LIB in the inflation equation can be interpreted as partial
evidence that the effectiveness of reforms in curtailing inflation is higher at higher levels of development
which is associated with higher levels of distortions. With respect to DLTPR1 and DLTPR2, which
capture the effect of initial conditions on the size of the liberalization shock, we expect to observe
20We also estimated a reduced-form equation by regressing growth on initial conditions political freedom and
regional tensions to capture the total, direct and indirect (through liberalization), effects of initial conditions on growth.
The results were similar.
26



negative signs in the Growth equation and positive signs in the Inflation equation. The results in
equations 6.2 and 6.4 do not support this, however. The coefficients for DLTPR1 and DLTPR2 in
both performance equations are statistically insignificant and only the coefficient for DLTPR1 in the
growth equation has the "expected" sign. We test for robustness of the results in equations 6.2 and 6.3
by excluding China and Vietnam from the sample. The results continue to hold for inflation and,
although somewhat less strongly, for growth as well. Interestingly, with this restricted sample, the
coefficient for PR2LIB in the growth equation is highly insignificant and now has a positive sign.
The results, therefore, do not support the hypothesis that the effectiveness of reforms is
necessarily lower under unfavorable initial conditions as reflected in PRIN1 and PRIN2. On the
contrary, we find some evidence that the effectiveness of liberalization is higher at higher levels of
macroeconomic and structural distortions. Going back to our previous findings about the negative
association between macroeconomic and structural distortions and reforms, this suggests that the
negative association can not be explained by the lower potency of reforms under unfavorable initial
conditions. Unfavorable initial conditions discourage reforms but effectiveness of reforms is not
reduced once they are implemented. This however, does not imply that steady-state growth rate of
countries with good and bad initial conditions will be similar with similar sets of policies. Country
specific factors, such as location can still be expected to play a role. For example, as shown by Radelet,
Sachs, and Lee (1996) and Sachs and Warner (1996b,c) countries that are landlocked are likely to have
smaller long- run growth rates than countries with easy market access.
LI14 The Relative Importance of Policies and Initial Conditions
The performance equations also provide a rough indication of the relative importance of initial
27



conditions versus policies. By construction, PRINM and PRIN2 have ranges and standard deviations
that are three to four times larger than the range for LIB. With respect to the variance of growth, the
regression results suggest that PRINM and PRIN2 separately exert a smaller effect on growth variance
than reforms, but that their combined effect is comparable in size to the effects of reforms.2' In the
inflation equation, the effect of PRINI is particularly strong and even dominates the effects of
liberalization policies.
To derive more accurate estimates of the explanatory power of initial conditions relative to
policies, special factors and interaction terms, we follow a methodology developed by Schmalansee
(1985) which uses the adjusted R2 to set plausible bounds for the variance explained by different
groups of coefficients. To calculate these bounds, we estimate three models. The first is the full
model, which includes as regressors contemporaneous and lagged liberalization, interactive terms,
initial conditions, and regional tensions. The adjusted R2 shows the percent of total variance in
performance explained by our full set of regressors. Next, we estimate the model, restricting the
coefficients to zero for a set of factors. By subtracting the adjusted P3 from this regression from the
adjusted P3 from the first regression, we compute a rough measure of the total variation explained by
these factors. Finally, we estimate the model, restricting to zero the coefficients not in the given set.
Its adjusted P3 provides a second crude measure of the amount of total variation explained by the
included set of factors.
The results of this procedure are presented in Table 7. We find that policies have the highest
21 This is based on the properties of variances assuming the regressors are independent random variables.
28



explanatory power among all sets of factors in the growth equations, accounting for 35 to 40 percent
of the variation in growth that is explained by the model. Initial conditions are also important
contributing 19 to 30 percent of the explained variance and PRINI has a higher explanatory power
than PRIN2. Interaction terms play a relatively less important role. In the inflation equation, initial
conditions dominate with PRINI being especially important. Interaction terms come second with 22 to
25 percent of the explained variance in inflation.
We do the same exercise for policy as a dependent variable and find that political change has
the highest explanatory power accounting for 38 to 90 percent of the explained variance. PRIN2 may
also be important; however the range of the estimate for its explanatory power is wide.
ms5 The Influence of Initial Conditions over Time
We next explore the time profile of the relationships between initial conditions, reforms and
performance. As described above, we interact the two principal components with the year dummies
using the principal components in year 1 as control group. Results are presented as equations 6.6, 6.7
and 6.8. With respect to liberalization (Eq. 6.8), the signs and the magnitudes of the coefficients
suggest convergence over time; less developed transition economies and those with more severe
macroeconomic distortions start slowly but gradually catch up. The evidence for convergence with
respect to performance is less conclusive. PRINI continues to have a negative impact on growth
throughout the period, but this impact is diminishing over time as the coefficients exhibit an increasing
trend and tend towards zero. Only the coefficient for the interaction term in year 3 (PR1Y3) is not
statistically significant. The signs of the coefficients for PRIN2 are also negative throughout the period
but their magnitudes do not exhibit any particular trend. Also, none of the coefficients is statistically
29



significant. The results for the inflation equation are similar. Countries with more severe initial
macroeconomic distortions continue to suffer from higher inflation rates throughout the period,
although the negative impact of PRIN1 is diminishing over time. The time profile of the coefficients for
PRIN2 is less clear and none of the coefficients is statistically significant.
As implied by our model, initial conditions have a direct effect on performance as well as an
indirect one through their impact on policy choices. It is instructive to compare the two effects and
derive their evolution over time. The total effects are calculated by adding the direct effect of initial
conditions on performance from equations 6.6 and 6.7 and the indirect contemporaneous and lagged
effects of initial conditions on performance through their effect on liberalization, obtained by
multiplying the coefficients for PRINI and PRIN2 from equation 6.8 with the LIB and DLTALIB
coefficients from Eq.6.6 and 6.7. The results are shown in Table 8 for Growth and Table 9 for
Inflation. As the results indicate, adverse initial conditions continue to have a negative, although
diminishing, impact on performance throughout the period. Second, the direct effects are stronger in
magnitude than the indirect effects operating through the liberalization channel for both PRINI and
PRIN2. A third observation is that the effects ofPRIN1 on performance exhibit a more pronounced
trend than the effects of PRIN2.
The results shown in Table 6 can also be used to decompose the performance (growth and
inflation) and reform paths22 of transition economies into components reflecting the influence of
22The decompositions of the reform path is based on the following equation: Lib=0.072+0.62Lib(-l)
- O.O9Prinl+0.06Prin2+0.02PR1 Y2+ 0.03PRI Y3+0.05PR1 Y4+ 0.1 OPRlY5-0.02PR2Y2-0.03PR2Y3-
0.07PR2Y4-0.08PR2Y5+0.05 Freedom.
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liberalization and initial conditions over time. We present results only for growth in Fig.3 using the
average values for the FSU countries as illustration. The picture clearly shows the positive and
growing impact of liberalization and the diminishing negative impact of DLTALIB on growth.
Convergence with respect to PRINI is illustrated by the decreasing distance between the PRIN1 line
and the horizontal axis. It can also be seen that the positive effect of liberalization overtakes the
negative impact of DLTALIB in year 2.
The decomposition of the reform path of transition economies, again using average values for
FSU, is presented in Fig. 4. At early stages of transition, a lower level of past liberalization and higher
initial macroeconomic distortions limit the extent of liberalization. Political change, however, at this
stage is more dramatic and largely drives the policy choices. Over time, the effect of the accumulated
stock of reforms, as measured by the lagged liberalization index, grows in importance simultaneously
with a decreasing negative influence of initial macroeconomic distortions. The dirminishing effects of
initial conditions over time is shown by the convergence of PRINI and PRIN2 to the zero line.
Finally, an interesting question is whether these results continue to hold if using the
contemporaneous sample 1989-96 for all transition economies. In essence, this sample is unbalanced
with respect to the length of the pre- and post-reform periods for different sub-groups of countries.
We find that our main results are supported by this dataset.
I V. CONCLUSIONS
Casual observation suggests that transition countries fall into three broad groups: the sharply-
recovering countries of CEE; the slower-adjusting FSU countries; and the East Asian countries which
31



responded to reforms with accelerated growth rather than initial contraction. In this paper we depart
from previous research that focussed on the relationship between policy and performance to analyze
the sources of cross-country variation in both reform policy choices and economic performance. A
special focus is given to the role of initial conditions, as well as to the role of political developments.
We also include a variable to represent regional tensions -- noneconomic events such as wars and
blockades that can have a major economic impact.
Countries may differ in many dimensions, but we find that most of the variation across 11
initial conditions can be summed up in their first two principal components. The first can be
interpreted as measuring macroeconomic imbalance and unfamiliarity with market processes (market
distortions); the second represents the level of socialist development and its associated structural
distortions (overindustrialization). Countries cluster into four broad groups. Those in the FSU all
started from deep market distortions, but the Slavic countries were far more developed than those in
Central Asia, and had more serious structural distortions. Countries in CEE had lesser market
distortions but, being relatively more developed, had severe structural distortions. China and Vietnam,
and to a lesser extent Albania, formed the final group of countries with lower structural and market
distortions.
Linkage between initial conditions, policies and performance is then specified as an equation
system and tested to ensure recursivity. Policy reform, which is represented by econornic
liberalization, depends on initial conditions, political change and regional tensions. Economic
performance, measured in terms of growth and inflation, depends on initial conditions, economic
policies and regional tensions. Cross-section equations suggest that initial conditions are indeed
32



important, both for performance and the speed of economic liberalization; also that political reform, in
particular, affects the speed of economic liberalization. Belarus and Uzbekistan offer examples of
countries where political change and economic liberalization proceeded relatively slowly.
Comparing actual and predicted econornic liberalization provides a new ranking of countries.
Mongolia and the Kyrgyz Republic, for example, reformed more rapidly than would have been
expected given their initial conditions; Bulgaria and Romania reformed more slowly. The Czech
Republic, which is normally thought of as a very rapid reformer, is only average once its unusually
favorable initial conditions are taken into account.
Moving to estimates using panel data, regressions confirm that adverse initial conditions are
associated with slower economic liberalization. This may be because governments are reluctant to
accept upfront costs of sharp reforms on top of the losses they are experiencing from the dissolution of
the old system. Indeed, very sharp economic liberalization is associated with an output contraction, but
this is a temporary phenomenon, as the effect is speedily offset by the positive cumulative effect of past
liberalization efforts. As in other studies, the relationship between economic liberalization and
performance is highly non-linear over time.
The explanation that difficult conditions are associated with slow reforms because they
diminish the effectiveness of reforms is not supported by the regressions. Unfavorable initial conditions
discourage reforms but effectiveness of reforms is not reduced once they are implemented. Moreover,
countries cannot avoid the costs of non-reform, especially if deeply embedded in a disintegrating
economic and political system. Those fortunate enough to have exports that can be redirected to
market econornies -- such as Uzbekistan with its gold and wool -- can of course cushion a more
33



gradual reform process more easily than the others. Having potential exports on the other hand, such
as natural gas which cannot be exported due to problems of accessing pipelines, may delay essential
reforms and deteriorate perfornance; Turkmenistan offers an example.
Regressions confirm the adverse effect of macroeconomic and structural distortions on
performance. A typical country in CEE benefits over the first five years by some 5 percent per year
relative to the Slavic states of the FSU; China and Vietnam benefit by some 14 percent per year from
their more favorable initial conditions. A possible objection to this large estimate is that it includes a
range of factors not captured in the initial conditions but nevertheless important in differentiating East
Asian from European experience. An out-of-sample estimate of the growth bonus for China and
Vietnam, estimated using the sample of CEE and FSU countries only, still suggests a growth bonus of
7% per year. East Asian structural characteristics have been important, no matter how you look at
them.
Nevertheless, applying the procedure due to Schmalensee (1985) shows that policy is still the
most important factor determining growth differences between the 28 countries in the sample. Initial
conditions dominate in the inflation equation. And political reform emerges as the most important
single determinant of the speed and comprehensiveness of economnic liberalization.
The final question addressed in the paper is whether the influence of the initial conditions on
performance grows or diminishes in the course of transition. Results suggest that their influence
diminishes, a conclusion that might be surprising in the light of cross-country growth regressions that
show a persistent impact of variables such as location that are included in the initial conditions. Many
of the conditions woven into the principal components are, however, themselves modified in the
34



course of transition. Monetary overhangs are dissipated through inflation; the industrial overhang is
eroded as plants shut down, and market memory returns through experience.
35



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40



Appendix
Definition of variables used in the analysis
AVGR - average growth.
LOGAVIN- log of average inflation.
AVFREE- time average of the index of political freedom from Freedom House.
LIB- index of liberalization developed in DDG (1996).
DLTALIB- the first derivative of LIB with respect to time.
AVLIB- time average of the liberalization index.
INC- GDP at PPP per capita.
BLCMKT- black market exchange rate premium.
INDIST- the difference between actual and predicted share of industry in GDP.
LOCAT- a dummy variable with I if a country has a thriving market economy as a neighbor.
MARMEM- the number of years a transition country has been under central planning.
PRGR- average GDP growth 1985-1989.
"REPR- a measure of repressed inflation, calculated as the difference between growth of real wages" and real GDP growth over
1987-90.
RICH- a dummy variable that assumes a value of I if a country has economically important endowments of energy resources.
STATE- a categorical variable with 2 if a country was an independent state at the beginning of reform, I if a country was a member
of a decentralized federal state (Yugoslav republics) or was the core state of a centralized federal state (Russia, Czech republic), 0 if
none of the above.
TDEP- a measure of trade dependence, calculated as the ratio between the average of exports and imports and GDP.
URBAN- share of urban population in total population.
PRIN I- the first principal component, which reflects the degree of macroeconomic distortions.
PRIN2- the second principal component, which reflects the degree off structural distortions.
PR LIB- interactive termn between PRIN I and LIB.
PR2LIB- interactive termn between PRIN2 and LIB.
PRiYj- interactive term between the principal components and year dummies, where i= 1,2 and j=1-5.
FREEDOM- index for political freedom. Source: Freedom House.
RT- regional tensions, a dummy variable assuming value of I if a country has experienced war or blockade in a particular year.



Table 1: Initial Level of Development, Resources and Growth
Per cap   Urbanization             Distribution of GDP              Predicted    Average Natural Location
GROUP   COUNTRY   NP at PP (% of population)                1990 cur prices                 Share of   % growth resources
US$ 1989     1990         Industry      Agriculture     Services      Industry    1985-89
Central    Albania     1400         37           0.37           0.26          0.37           0.34        3.6    poor       I
and       Bulgaria     5000        68            0.59           0.11          0.30           0.36        2.7     poor     0
Eastern    Croatia     6171        62            0.35           0.10          0.55           0.34        0.2     poor     I
Europe  Czech Republic  8600       65             0.58          0.07           0.35          0.37        1.6    poor      1
Hungary     6810        62            0.36           0.14          0.50           0.37        1.6    poor      I
FYR Macedonia  3394         59           0.43           0.12          0.45           0.34        0.2    poor      0
Poland     5150         62            0.52          0.13           0.35           0.39       2.8   moderate    I
Romania    3470          53           0.59           0.14          0.27           0.37       -0.8   moderate   0
Slovak Republic  7600       57            0.59          0.07           0.35          0.36        1.60    poor      I
Slovenia    9200         62           0.44           0.05          0.51           0.39       -0.4    poor       I
Yugoslavia    NA                       0.45           0.10          0.45                       0.2     poor
Czechoslovakia   NA                      0.59          0.07           0.34                       1.6    poor
FSU        Armenia    5530          68           0.55           0.11          0.34           0.35        2.7    poor      0
and       Azerbaijan    4620        54           0.44           0.22          0.34           0.36        0.8    rich      0
Mongolia   Belarus     7010         66           0.49           0.22          0.29           0.37        5.2    poor      0
Estonia    8900         72            0.44          0.20           0.36          0.34        2.7    poor       I
Georgia     5590        56            0.43          0.22           0.35           0.35        2.4   moderate   0
Kazakhstan    5130        57           0.34           0.29          0.37           0.38        4.3    rich      0
Kyrgyzstan    3180        38           0.40           0.33          0.27           0.34        5.2    poor      0
Latvia     8590         71           0.45           0.19          0.36           0.35        3.5    poor      I
Lithuania    6430        68            0.45          0.27           0.28          0.35        2.9    poor       I
Moldova     4670         47           0.37           0.32          0.31           0.35        5.7    poor      0
Russia     7720         74           0.48           0.15          0.37           0.41        3.2    rich       I
Tajikistan    3010       32            0.34          0.27           0.39          0.34         1.9    poor      0
Turkmenistan   4230       45            0.34           0.29          0.37           0.35        5.0    rich      0
Ukraine     5680        67            0.44          0.21           0.35           0.40        2.4   moderate   0
Uzbekistan    2740       41            0.33           0.31          0.36           0.37        3.9   moderate   0
USSR        NA                       0.44           0.18          0.38                       3.8    rich
Mongolia    2100         60            0.41          0.20           0.39          0.40        5.4   moderate   0
East       China*       800         18           0.49           0.24          0.27           0.46        9.0   moderate   I
Asia      Vietnam*      1100        19           0.23           0.41          0.36           0.30        5.0   moderate    I
Notes:  * Statistics for 1978
** Statistics for 1986
Predicted share of industry is derived using the regression results in Syrquin and H. Chenery (1986)
Source: The World Bank:History of Planned Economies,
World Development Report (various issues), staff estimates



Table 2:Initial Economic Distortions and Institutional Characteristics
Repressed Black market   Trade    Years under    State
GROUP   COUNTRY   Inflation   premium    dependence    central
1987-90   1990 (°/O)   1990 (% )   planning
Central    Albania       4.3       434          6.6         47           2
and        Bulgaria      18        921          16.1        43           2
Eastern    Croatia       12         27          6.0         46           1
Europe  Czech Republi  -7.1         185         6.0         42           1
Hungary      -7.7       46.7        13.7         42          2
FYR Macedono    12          27          6.0         47           1
Poland      13.6       277          8.4         41           2
Romania      16.8       728          3.7         42          2
Slovak Republi  -7.1       185          6.0        42           0
Slovenia      12         27          4.0         46           1
Yugoslavia     12         27          6.0
Czechoslovakia  -7.1       185          6.0
FSU        Armenia      25.7       1828        25.6         71           0
and       Azerbaijan    25.7       1828        29.8         70           0
Mongoli    Belarus      25.7       1828         41.0        72           0
Estonia     25.7       1828         30.2        51           0
Georgia     25.7       1828         24.8        70           0
Kazakhstan    25.7       1828        20.8         71           0
Kyrgyzstan    25.7       1828        27.7         71          0
Latvia      25.7       1828        36.7         51          0
Lithuania    25.7       1828        40.9         51           0
Moldova      25.7       1828        28.9         51          0
Russia      25.7       1828         11.1        74           1
Tajikistan   25.7       1828         31.0        71           0
Turkmenistan   25.7       1828        33.0         71          0
Ukraine     25.7       1828         23.8        74           0
Uzbekistan    25.7       1828        25.5         71          0
USSR        25.7       1828
Mongolia      7.6       1400         31.0        70           2
East        China*       2.3       208          1.0         46           2
Asia      VietNam*       15        464          7.2        21**          2
Notes: Repressed inflation is calculated as percent change in real wage less the percent change
in real GDP over 1987-90.
* The numbers for China and Viet Nam are for the period before 1978 and 1986
respectively.
** Average for North and South Vietnam
Trade dependence is defined as the ratio between the average of exports and imports
and GDP.
Source: The World Bank, Syrquin and Chenery (1989), Tarr ( 1993).



Table 3: Results from the Principal Component Analysis
Variation                         Eigenvectors                      Correlations*
Component  Proportion Cumulative      Variable   PRIN I   PRIN2       Variable      PRIN I        PRIN2
PRINI          0.39       0.39        INC         -0.03     0.50      INC         -0.06 (0.78)   0.86 (0.00)
PRIN2          0.28       0.67        STATE       -0.36     -0.21     STATE       -0.75 (0.00)   -0.37 (0.06)
PRIN3         0.09        0.76        PRGR        0.16  j  -0.35      PRGR        0.33 (0.09)   -0.61 (0.00)
PRIN4          0.07       0.83        RICH         0.12  j  -.        RICH        0.24 (0.21)   -0.62 (0.00)
PRINS          0.06       0.89        TDEP         0.40     0.14      TDEP        0.84 (0.00)    0.24 (0.21)
PRIN6         0.03        0.92        BLCMKT   0.46         0.06      BLCMKT   0.96 (0.00)    0.10 (0.61)
PRIN7          0.04       0.96        INDIST      -0.12     0.39      INDIST    -0.26 (0.18)    0.68 (0.00)
PRIN8         0.02        0.98        URBAN        0.00     0.52      URBAN       0.001 (0.99)   0.90 (0.00)
PRIN9          0.01       0.99        LOCAT       -0.32     0.05      LOCAT    -0.66 (0.00)    0.08 (0.68)
PRINI 0        0.01       1.00        MARME    -0.42        0.01      MARMEM   0.87 (0.00)   -0.01(0.94)
PRIN I 1       0.00       1.00        REPR         0.41     0.03      REPR        0.86 (0.00)    0.05 (0.80)
Note: * P-values in parenthesis



Table 4: Partial Associations Between Performance,
Liberalization and Initial Conditions
(Based on Cross-country Regressions)
Dependent Variable
LOGAVIN       AVGR         AVLIB        AVLIB
Eq 4.1       Eq 4.2       Eq 4.3       Eq 4.4
INT         4.64        -4.43         0.29         0.54
PRINI       1.18        -4.03        -0.05        -0.07
464          -2.54
PRIN2       0.04        -1.25         0.03         0.13
AVLIB       1.23        -3.44
AVFREE                                0.04
RT          1.42        -5.66
a18         -306
Adj R2     0.644        0.602        0.7003        0.55
N obs        28          28            28           28
Note: t-ratios below coefficients



Table 5: Ranking of Transition Economies by AVLIB and Residuals from Eq 5.3 and 5.4
Country       AVLIB  AVFREE  PRINI  PRIN2   Residuals   Residuals  Rank by  Rank by Resid Rank by Resid
from Eq 4.3 from Eq 4.4  AVLIB   from Eq 4.4   from Eq 4.3
Albania        0.46      4.4      -1.12   -1.15   -0.050     -0.019      17          16            18
Armenia        0.50      6.8       0.79    0.94   -0.082     -0.096      15          22            23
Azerbaijan     0.38      3.2       1.00   -0.03   -0.006     -0.083      22          19            15
Belarus        0.37      5.8       1.19    0.73   -0.139     -0.168      23          26            26
Bulgaria       0.55      7        -0.55    0.56   -0.098     -0.099      14          23            25
China          0.12      0        -1.00   -2.62   -0.147     -0.166      28          25            27
Croatia        0.71      4.8      -1.07    0.32   0.127       0.047       8          12            4
Czech Republic  0.72     8.6      -1.43    1.20   -0.065     -0.077       6          17            21
Estonia        0.84      8.2       0.33    1.24   0.159       0.170       1           3             1
Georgia        0.44      4.6       0.84    0.41   -0.028     -0.088      20          20            16
Hungary        0.75      9.6      -1.47    0.08   -0.056      0.088       4           8            19
Kazakstan      0.48      4.4       1.07   -0.62   0.066       0.100       16          7            8
Kyrgyz Republi  0.67     6.8       1.03   -0.53   0.140       0.270       11          1            2
Latvia         0.72       8        0.46    1.15   0.058       0.073       7          11            11
Lithuania      0.79      9.6       0.52    0.91   0.062       0.171       2           2            10
FYR Macedonia  0.70      5.6      -0.80    0.09   0.102       0.084       9           9            6
Moldova        0.56      5.2       0.80   -0.32   0.091       0.125       13          5            7
Mongolia       0.45      6.6       0.29   -0.68   -0.095      0.022       19         14            24
Poland         0.78      9.4      -1.18    0.15   -0.004      0.129       3          4             14
Romania        0.46      3.8      -0.94    0.29   -0.059     -0.188      18          27            20
Russia         0.63      6.8       0.34    0.28   0.038       0.077       12         10            12
Slovak Repuibli  0.69    7.8      -1.25    1.12   -0.043     -0.080      10          18            17
Slovenia       0.75      5.4      -1.24    0.83   0.111       0.006       5          15            5
Tajikistan     0.31      1.8       1.01   -0.49   0.005      -0.090      26          21            13
Turkmenistan    0.20     1.4       1.27   -0.87   -0.067     -0.138      27          24            22
Ukraine        0.34      6.8       0.91    0.53   -0.226     -0.197      24          28            28
Uzbekistan     0.41      1.6       1.15   -1.15   0.140       0.102      21           6            3
Vietnam        0.34       0       -0.92   -2.38   0.063       0.024      25          13            9
Source: Freedom House (various issues) autbors estimates.



Table 6: Estimates of the Performance and Liberalization Equations
Depedent Variable
Growth   Growth   Loginf   Loginf    Lib    Growth   Loginf    Lib
Eq6.1    Eq6.2   Eq6.3   Eq6.4   Eq6.5   Eq6.6   Eq6.7   Eq6.8
INT          -10.41   -11.02    4.80     5.05     0.30    -11.19    4.72     6.27
-437     455    11.31    12.98      9.19    -4.59     10.79     7.50
LIB          15.06    16.40    -0.90    -1.29              15.80    -0.81
3.96     4.35     -1.33    -2.12             4.13     -1.18
DLTALIB    -32.60   -35.79    3.40       3.52             -31.10    3.91
-5.19    -5.13    3.05     3.15              -4.70    3.28
PRINI        -2.95    -6.11     0.98     2.42    -0.05    -6.90     1.16    -0.10
-3.71    -2.90    6.89     7.14    -3.74    -4.11     3.84    -2.95
PRIN2        -3.37    -4.40     0.17     0.06     0.04    -5.10     0.39     0.06
-3.73    -2.59    1.08     245      1.96    -2.97      1.27     1.86
PRILIB                 8.15              -2.65
2.43              -4.92
PR2LIB                 3.06              -1.11
0.99             -2.23
DLTPRI                -9.30             -1.26
-1.27            -1.07
DLTPR2                 0.73              -1.71
0.10             -1.45
PR1Y2                                                      4.88     0.24     0.02
2.03     0.55     0.so
PR1Y3                                                      3.24     0.01     0.03
1.36     0.02     0.70
PR1Y4                                                      5.98     -0.57    0.06
2.51    -1.32     1.37
PR1Y5                                                      6.00     -0.58    0.11
2.52    -1.36     2.22
PR2Y2                                                      1.49    -0.41    -0.02
0.63    -0.98    -0.52
PR2Y3                                                      2.88     -0.21    -0.04
1.21    -0.49    -0.83
PR2Y4                                                      1.52    -0.17    -0.06
0.64    -0.40    -1.25
PR2Y5                                                      2.37     -0.41    -0.07
0.99    -0.95    -1.43
RT           -11.16    -9.41    1.69     1.14             -10.03    1.59
-5.34    -4.41    4.56     3.33              -4.74    4.18
FREEDOM                                           0.04                       0.05
&00                        8.25
Adj R2       0.429    0.452    0.393    0.522    0.551    0.439    0.429    0.552
Nobs          140      140      140      140      140       140      140      140
Note: T-ratios appear below the coefficients



Table 7: Estimates of the Explanatory Power of Policy, Initial Conditions and Political Frecdom
Measure of Explanatory Power         Policy      Interactions    Initial Conds    RT          Prinl         Prin2       All variables
for Sets of Independent Variables    max  min    max  min         max    min  max   min  max   min    max    min    max=min
Growth
Percent of total variance
explained by set                    18.1  15.8    8.9   2.3       13.6   8.7   12.2  7.8  11.6   3.1    2.4    1.9           45.2
Percent of explained variance
explained by set                    40.0  35.0    19.7  5.1      30.1   19.2  27.0  17.3  25.7   6.9    5.3    4.2          100.0
Inflation
Percent of total variance              6.3  4.5    12.9  11.7       27.4   26.8   9.8  3.9   27    18.2    1.7         0        52.2
explained by set
Percent of explained variance
explained by set                    12.1  8.6    24.7  22.4      52.5   51.3   18.8  7.5  51.7   34.9    3.3    0.0         100.0
Policy                                Pol Freedom   Initial Conds      Prinl        Prin2     Total
max  min    max  min         max   min   max  min
Percent of total variance
explained by set                    50.3  20.7    34.4  4.8       7.4    4.3   26.8   1   55.1
Percent of explained variance
explained by set                    91.3  37.6    62.4  8.7      13.4   7.8   48.6  1.8  100.0



Table 8: Summary of Estimated Direct and Indirect Effects
of Initial Conditions on Growth
Relevant                                          PRINM
Parameters
year                        Direct effect on   Through     Through      Total        Comment
Growth    Liberalization  Liberalization
lagged       contemp
I    a4+b2*a2                  -6.90         -2.95         1.45       -8.40
2    (a4+a6)+(b2+b4)*a2        -2.05         -2.24         1.10        -3.19   b4 not significant
3    (a4+a7)+(b2+b5)*a2        -3.69         -1.96         0.96        -4.69  a7, b5 not significant
4    (a4+a8)+(b2+b6)*a2        -0.95         -1.00         0.49        -1.46   b6 not significant
5    (a4+a9)+(b2+b7)*a2        -0.94         0.31         -0.15       -0.78
PRIN2
I    a5+b2*a2                  -5.10         1.83         -0.90       -4.16
2    (a5+alO)+(b3+b8)*a2       -3.61         1.09         -0.54        -3.06   alO, b8 not significant
3    (a5+al 1)+(b3+b9)*a2      -2.22         0.65         -0.32        -1.89   al 1, b9 not significant
4    (a5+al2)+(b3+blO)*a2      -3.58         0.06         -0.03        -3.55   a12, blO not significant
5    (a5+al3)+(b3+bll)*a2      -2.73         -0.19         0.09       -2.83   al3, blInot significant
Notes. The estimated a's are taken from regression 6.6
The estimated b's are taken from regression 6.8



Table 9: Summary of Estimated Direct and Indirect Effects
of Initial Conditions on Inflation
Relevant                            PRINM                          Comment
Parameters
-year   .                  Direct effect on   Through    Through     Total
Inflation    Liberalization Liberalization
lagged      contemp
I    a4+b2*a2                 1.160        0.371        -0.295     1.237  a2 not significant
2    (a4+a6)+(b2+b4)*a2       1.400         0.282       -0.223      1.458  a2,a6,b4 not significant
3    (a4+a7)+(b2+bS)*a2       1.170         0.246       -0.195      1.221  a2,a7,b5 not significant
4    (a4+a8)+(b2+b6)*a2       0.590         0.125       -0.099     0.616  a2,a8,b6 not significant
5    (a4+a9)+(b2+b7)*a2       0.580        -0.039        0.031     0.572  a2,a9 not significant
PRIN2
1    a5+b3*a2                 0.390        -0.231       -0.048     0.342  coefficients not significant
2    (a5+alO)+(b3+b8)*a2     -0.090        -0.137       -0.028     -0.118  coefficients not significant
3    (a5+al 1)+(b3+b9)*a2     0.180        -0.082       -0.017     0.163  coefficients not significant
4    (a5+al2)+(b3+blO)*a2     0.220        -0.008       -0.002     0.218  coefficients not significant
5    (a5+al3)+(b3+bl I)*a2   -0.020         0.023        0.005     -0.015  coefficients not significant
Notes. The estimated a's are taken from regression 6.8
The estimated b's are taken from regression 6.7



Figure 1. Ranking of Transition Economies by the First Two Principal Components
PRIN2
1.5-
Czech Rep                                                             Estonia
*         Slovak Rep                                                                Latvia
*  1-                                  Armenia
Slovenia                                  Bulgaria                        Lithuania                                Belarus
Romania C                              0.5                                        *Ukraine
Hungary       C                                                           Russia              Georgia
Poland                     FYR Macedonia
-0-                                                              i PRIN 1
-1.6                 -1.1                  -0.6                  -0. 1                 0.4                   0.9  Azerbaijan        1.4
Moldova                  Kyrgyz Rep
-0.5-                               Tajikistan   *P   Kazakhstan
Mongolia                         Turkmenistan
Albania                                  -1
i  +                                             |                                  Uzbekistan     *
-1.5
-2
Viet Nam
China      *
-2.5
-3
Note: PRIN I - macroeconomic distortions and unfamiliarity with market process;
PRIN2- level of development and overindustrialization.



Figure 2. Isogrowth Lines for Sets of Initial Conditions
PRIN2
1.5
s    ~~~~~~~~-s                   '- s ~~~~~~~~~~~~~~~~~~Estom'ia-h
Cicsto,ii-b~    -Latvia
*'Slovakc Rep                -I                            -'-                         Arei         Blau
Slovenia               R                         -huania   *                                                      Belarus
Croatia                      Bulgaria
~~-   Croatia   Romania  '-        0.5       RG                               *Ukraine
Hungary                     -. Poland  FYR Macedonia                  Ru      - ~3ergI                                         Y
-1.6  -1 ~~~~~~~~~~~~~~~1-                                                         '%~~~~~~~zerbaijan1.4
-1 .6                -Al l.               -0.6                 -0.1               -   0.4                  0                    1.4: 
^  --  ~ -0-5 -   ~   ~     -   Tajikistan     *-
-MongoI?                       -         tazakhstan       2
Turkzb enistan
Albania                                                                         zbekistan
-1.5
2
-2
Viet Nam                                                                                           -      4
China                                         t     -- ---
-3 



Fig. 3 :Decomposition of the Growth Path of FSU Economies
15
LIB
10                                                                    .   . .  . .   . . .  . . . .  .  .  ~~~~~~~. .  .
PRIN2
4PRIN I          .           ,,*-   
,-5              DLTALIB T
-10 
/                                             ~~~~~~~~~~~~INTERCEPT
-15
-20
1                        2                         3                         4                         5
TIME



Fig 4: Decomposition of the Reform Path of FSU Economies
0.8
0.7Liberalization Index
0.6
0.5-
00.4                                                          LB4
0.3
Freedom
0.2
Intercept
0.1
PRINI
1                     2                Time 34 






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