Introduction

After the breakup of the Soviet Union, the CIS-7 faced exceptional challenges in building new states, democratic institutions, and market economies. All of the CIS-7 started from a situation of complex dependency on the Soviet Union, including massive transfers and subsidies and the trade arrangements of the Council for Mutual Economic Assistance (CMEA). The shocks associated with the breakup—notably the disruption of economic relations with established regional partners, termination of large fiscal transfers, and severe energy price adjustments—compounded the problems of severe structural rigidities and weak institutions.

Creating new states and achieving macroeconomic stabilization have been major successes of the reforms in the CIS-7, while building democratic societies, achieving fiscal and external adjustments, and implementing structural changes have proved to be more challenging. The international community provided substantial assistance to the CIS-7 during the 1990s—assistance that helped keep living standards from falling catastrophically. However, the debt-servicing capacity of many of the CIS-7 did not improve to the extent envisioned. Many of the countries have encountered serious debt problems.

This chapter presents a synthesis of the papers, presentations, and discussions at Lucerne and is organized around two key objectives of the conference. The first is to help bring about a common understanding among CIS-7 governments, civil society, and external partners about the transition experience of the 1990s and the key features of the CIS-7 that conditioned the transition process and could influence future progress. Also important to the understanding of the recent past is the role of the international community, especially as it relates to the buildup of external debt in these countries. The second objective is to clarify common aspects of the agendas for growth and poverty reduction in the CIS-7, and areas in which the countries and their external partners can work together to achieve faster progress.

Past Developments and Remaining Challenges

Initial Conditions

The move from plan to market in the CIS-7 has proved slower and more difficult than initially anticipated. Progress in the CIS-7 has also been slower than in other countries of the former Soviet Union (FSU). This discrepancy can be at least partly explained by the especially unfavorable initial conditions the CIS-7 faced.¹ Apart from Uzbekistan, all had relatively small populations, ranging from four to eight million. Conditions varied from country to country, but the overall pattern was one of consistently poor economic indicators. For example, compared with other former Soviet republics at the beginning of the transition period, the CIS-7 had:

• Lower industrial output, labor productivity, and average monthly wages and higher unit labor costs.
  
  
• Slower per capita growth, lower per capita income, less developed infrastructure, fewer fixed assets per capita, and fewer employees per 10,000 with higher education.
  
  
• Fewer exports to destinations outside the FSU (although comparable exports to other former Soviet republics) and larger external current account deficits.

The CIS-7 also were more rural and farther from economic centers than the other former Soviet republics. Except for Georgia's access to the Black Sea, all are landlocked. In 1989, all of them had higher proportions of their populations with monthly household per capita incomes below 75 rubles than the FSU average—in some cases, substantially higher, such as in the three Central Asian republics of the Kyrgyz Republic, Tajikistan, and Uzbekistan. Most of them experienced armed conflict or serious civil unrest during the initial decade of their independence.

Growth and Poverty in the 1990s

Most of the CIS-7 experienced economic decline in the early to mid-1990s, consistent with the transition predictions for a sharp recession followed by a period of surging growth fueled by productivity gains. Between 1990 and 1995, real gross domestic product (GDP) in the CIS-7 countries fell by an average of 53 percent. The duration and depth of the recession exceeded expectations, and the subsequent economic recovery suffered a serious setback in the aftermath of the regional financial crisis of 1998. Macroeconomic stability also proved a serious challenge for most countries.

The initial growth recovery in the CIS-7 was driven by consumption, both private and public, which had been suppressed during the first years of adjustment. The contribution of investment was marginal and that of net exports mostly negative. Growth tended to be concentrated in a few sectors (raw materials, agriculture, and services) and proved to be uneven and volatile—depending on weather conditions and a few commodity prices (oil, gold, aluminum, and cotton).

In agriculture, land reform allowing private land ownership laid a good foundation for initial productivity gains. Growth in the services sector (mainly trade, catering, and transportation) reflected small-scale privatization and private ownership. Industrial growth has been heavily biased toward natural resource-based, non-labor­intensive sectors. The manufacturing sector experienced the deepest and longest decline and has not yet shown tangible signs of recovery. This decline partly mirrors the disruptions in input supplies caused by the change in trade patterns and terms-of-trade shocks.

Consumption continues to be the main driving force of growth in Moldova and possibly Uzbekistan and Tajikistan. In the rest of the CIS-7, growth in 1998­2001 appears to have been driven by export expansion and investment in export-oriented sectors. Exports, however, are concentrated mostly in resource-intensive sectors, with little spillover to the rest of the economy and limited potential for job creation. Investment has proved to be volatile, focused in selected sectors, and has not been sufficient to compensate for the erosion of the capital stock, thereby undermining further increases in factor productivity. Overall, by 2001, none of the seven countries had been able to restore real GDP to its 1989 level, and the median GDP was only 62 percent of that in 1989.² By the same year, the other countries of the FSU had reached 80 percent of their 1989 median GDP, and the European Union accession countries had reached 98 percent.

The record on poverty is linked to macroeconomic stability and GDP growth. At independence, average income per capita within the CIS-7 was considerably lower than in the other countries of the FSU, but high social expenditure guaranteed some minimum income and services to the vast majority of population. Income inequality was also generally low, with only Azerbaijan, Tajikistan, Turkmenistan, and Uzbekistan experiencing Gini coefficients of over 0.3. Independence has been marked by falling real wages and substantial long-term unemployment, while the stressed social protection system failed to mitigate the impact of economic collapse on the poor. For countries for which time series data are available, the proportion of the population living in poverty appears to have peaked in 1999, following the aftershock of the Russian financial crisis.

Surveys undertaken in 1999 for six of the CIS-7 indicate rates of poverty (using a poverty line of $2.15 per capita a day at purchasing power parity) ranging from a low of 19 percent in Georgia to a high of 68 percent in Tajikistan.³ As estimated by Falkingham (Chapter 6), this finding implies that more than 15 million people out of a total population of about 57 million live in poverty. Moreover, the decline in measured output was accompanied by an increase in measured inequality across the region. Rural poverty is a major problem in the CIS-7, exceeding urban poverty in four out of the seven countries (the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan). A high poverty rate in rural areas is partly a historical phenomenon but also reflects the immense dislocation from the shrinking industrial sector to agriculture immediately following the breakup of the FSU.

Growth in the agricultural sector appears to have an important impact on rural poverty. In particular, agricultural growth was more associated with rural poverty reduction than growth led by nonagricultural sectors. The benefits of agricultural growth were transmitted to the rural poor via the increase in labor, livestock, and land assets as well as beneficial returns to market participation. At the same time, as highlighted by Cord, Lopez, Huppi, and Melo (Chapter 7), land has been found only weakly correlated with household welfare. Hence, in addition to land reform, complementary public goods (development of markets for land rental, agriculture products and inputs) have been identified as necessary to ensure that privately held land assets achieve higher productivity.

Less progress has been achieved in nonincome dimensions of poverty—notably access to key social and physical services. The social systems and infrastructure inherited by the CIS-7 went well beyond the levels that the economies themselves could support, and they have deteriorated significantly. There is evidence to suggest that social sector policies and expenditures have benefited the affluent more than low-income households.

The Policy Record

To a large extent, the mediocre growth performance of the 1990s reflects the mixed track record in the implementation of reforms. The CIS-7 adopted measures for structural reform in the 1990s, especially in the latter years of the decade. Lane (Chapter 3) and Pomfret (Chapter 4) provide assessments of key achievements and remaining challenges at the end of 2001.⁴ None of the CIS-7 has progressed very far, however. Below are some snapshots:

• All seven countries applied for membership in the World Trade Organization, and Georgia, the Kyrgyz Republic, and Moldova had already joined by 2001. Regional cooperation efforts have been limited to establishing mostly politically motivated preferential trade agreements with marginal impact on trade performance. In addition, the proliferation of nontariff barriers in the form of informal controls, licenses, and other approvals is an important constraint to export development. Customs services suffer from lack of expertise, weak staff capacity, corruption, and obsolete physical infrastructure.
  
  
• The record of privatization has been uneven. Privatization of small companies was completed in the 1990s, but with mixed results across countries. Divestiture of large enterprises proceeded much more slowly and remains incomplete. In general, privatization in the CIS-7 did not lead to the desired restructuring, as incumbent managers retained control and competition policies were ineffective. Furthermore, corruption is widespread and property rights insecure. These factors help explain the apparent paradox of low economic dynamism despite substantial private sector ownership.
  
  
• The privatization of land has been limited, partly because governments have been reluctant to grant full property rights. The best performers have been Armenia and Georgia, where independent private farms now dominate the use of arable land. But redistribution has led to fragmentation of land holdings and greater consumption of own production, and thus lower marketed output.
  
  
• The major achievement in the financial sector was the establishment of two-tier banking systems and a large number of new private banks. However, no country has yet created an efficient financial sector—intermediation is weak, investment financing limited, and lending expensive.
  
  
• Legal and judicial reform enabling the state to play the key role of providing law and order has been incomplete, not so much in terms of legislation as in terms of implementation and enforcement. Commercial courts function particularly poorly in Azerbaijan, Moldova, and the Kyrgyz Republic, challenging the enforcement of contracts and protection of property rights. The introduction of judicial qualification exams and higher salaries for judges had a positive effect on the independence and effectiveness of the judiciary in Georgia. However, corruption is widespread in all the CIS-7, to varying degrees discouraging economic agents from productive activities.
  
  
• All the CIS-7 countries have undertaken ambitious tax policy and administration reforms over the past decade. Inadequate enforcement—sometimes owing to a lack of political will to implement needed policy and administrative reforms—and weak staff capacity are the remaining important challenges.
  
  
• Public expenditure has undergone considerable adjustment, and core public expenditure management institutions and systems (treasury, budget, and local governments systems) have been developed. However, unclear definition of the role of the state, institutional weaknesses, and lack of strategic medium-term planning hamper the ability of the CIS-7 to provide core functions, address market failures, and serve the priorities of poverty reduction.
  
  
• Infrastructure is generally unsatisfactory. Telecom systems were weak at the beginning of the transition and did not keep pace with developments in global standards. Transport facilities have deteriorated because of inadequate investment or maintenance. Both power and water suffer from underpricing and wastage of resources. Reform of public utilities is an urgent priority for most of the CIS-7.

The main challenges for policy and institutional reform are as follows:

• Improve the investment climate, notably through good governance, rule of law, and effective institutions.
  
  
• Strengthen domestic resource mobilization and public expenditure management, especially for human development and poverty alleviation.
  
  
• Enhance global integration and regional cooperation among countries that share common borders, especially as regards trade, transit, and natural resources.

The Role of the International Community and Debt Problems in the CIS-7

The international community has been assisting the CIS-7 since independence, providing policy advice, technical assistance, and financial aid. It is difficult to evaluate the quality and impact of policy advice, but in general the record of the CIS-7 suggests that the major problem so far has been weak implementation rather than wrong advice from the international community.⁵ With hindsight, however, it appears the donors may have underestimated the scale of initial dislocation in the CIS-7 following independence, the degree of the countries' previous dependence on the Soviet Union, and the associated obstacles to rapid reform, as concluded by Helbling, Mody, and Sahay (Chapter 2). Technical assistance, in the form of training or secondment of experts, has been wide-ranging. As discussed by Lane (Chapter 3), this assistance has been most successful in professional and technocratic areas such as establishing functioning central banks, treasuries, and tax and customs departments. There has been significantly less progress in areas such as enforcing the rule of law, combating corruption, and generally creating an investment-friendly business environment.

Aid flows have ranged from an annual 1 percent of GDP in Uzbekistan to 4 to 5 percent in Moldova and Azerbaijan and 7 to 9 percent in Georgia, Tajikistan, and Armenia. The largest assistance, nearly 17 percent of annual GDP, was provided to the Kyrgyz Republic.⁶ Multilateral lending appears to be positively correlated with bilateral assistance, which to some extent may reflect cofinancing or, more generally, the signaling effect of multilateral lending.

However, aid has come at a price. The combination of extremely difficult initial conditions, lagging reform, slow growth, and exogenous shocks—ranging from conflict to the consequences of the Russian crisis of 1998—means that debt and debt service have become a problem not fully foreseen in the early years of transition, especially in Georgia, the Kyrgyz Republic, Moldova, and Tajikistan. Servicing the debt consumes resources that might otherwise support poverty reduction and long-term growth. This situation raises the question of whether the international community practiced "overlending" on insufficiently concessional terms in the 1990s. This question cannot be answered unambiguously, given the critical role of external support in preventing even worse declines in living standards. In recent years, however, the pace of reform and growth has picked up, while donor financing has become more concessional.

The Way Ahead

Achieving broad-based growth of employment and income opportunities in the CIS-7 requires resolute efforts to strengthen the stabilization gains and address a variety of second-generation structural reforms. Timely progress on the remaining agenda will require urgent action to address the capacity weaknesses of the CIS-7. The effective combination of domestic effort and international assistance is also critical for moving forward. The priorities are as follows:

• Strengthen ownership of reform programs and their implementation and improve governance.
  
  
• Enhance donor assistance for countries that follow appropriate policies.
  
  
• Build domestic capacity to enable the design and implementation of necessary reforms.
  
  
• Increase regional cooperation and trade to overcome both the damaging effects of conflict and the handicaps of small size or remote location.

Reform Ownership, Governance, and Institutions

The CIS-7 have made real progress in the transition from plan to market, but deepening and intensifying reforms will depend on genuine, broad-based ownership of the process by governments and the public. It will also depend on formulating homegrown programs, as discussed by Luong (Chapter 8). Securing genuine ownership depends critically on ensuring participation of the political and official establishment, civil society, and citizens themselves in the design, implementation, and evaluation of development strategies, targets, and outcomes. The poverty reduction strategy paper (PRSP) approach, which stresses "putting the country in the driver's seat" and the key role of participatory processes in poverty reduction strategy formulation, execution, and follow-up, is an important model in this respect. Building on initial experience and lessons from the PRSP process is helping create broad-based support for essential reforms.

For the PRSP processes or other country-owned development strategies to work, they need to be based on effective priority setting. Early worldwide experience with PRSPs suggests that this is one of the most difficult tasks countries face in strategy development. Nevertheless, addressing it is critical for the CIS-7, which are faced with a combination of limited domestic and external resources and across-the-board demands for spending, especially on infrastructure, health, education, and social safety nets. An important related task is reaching a consensus on the optimal size and appropriate role of the public sector.

Special attention needs to be paid to maintaining human capital in the CIS-7. Public action is also needed to protect and build capabilities so that the population is able to take advantage of new income-generating opportunities. Comprehensive reforms to unlock efficiencies and ensure provision of appropriate service levels remain a priority, notwithstanding the urgent need for investment in schools and primary health care facilities. Unless governance and structural issues are tackled, however, higher spending in the social sectors may do little to enhance human capital.⁷

Measures are needed to enhance domestic resource mobilization, including measures that improve the investment climate to expand the revenue base. As discussed by Vandycke (Chapter 9), much of the private sector in the CIS-7 is concentrated in exploiting arbitrage opportunities that result from weaknesses in public sector governance, including predatory tax enforcement, ad hoc incentives, and frequent and piecemeal changes in laws and regulations. Particular attention should be paid to reforms that provide stronger incentives for businesses to operate in the formal economy.⁸

Effective action on the above agenda implies significant governance reforms. Stronger and more accountable institutions are needed to promote dynamic private sector development and to deliver on key public services. While recent evidence suggests that corruption may be moderating in the CIS-7, it remains a severe problem and needs to be faced squarely.⁹ Thus, a key step is countering the influence of vested interests such as the central, regional, and local elites inherited from the Soviet era, as highlighted by Luong (Chapter 8).¹⁰

The foregoing agenda requires governance reforms and institution building to be undertaken by the CIS-7 themselves. However, donors can provide support in the following areas:

• Encourage the development of transparent and accountable governmental and other institutions.
  
  
• Develop independent and impartial judiciaries.
  
  
• Strengthen decentralization once the necessary capacity and administrative and governance infrastructure are in place.
  
  
• Encourage large-scale privatization—recognizing that the way it is undertaken is critical for success.

Successful liberalization will depend on a combination of central governments adopting and implementing the reforms and empowering potential winners from reform at the local and regional levels. Doing so will not be quick or easy. Potential winners from reform are often widely dispersed across economies and societies, while potential losers are often concentrated and powerful.

Donor Assistance

It probably would have been more helpful if donors had offered more grants in the early years of transition. World Bank and International Monetary Fund (IMF) lending to these countries is strictly on concessional terms. The World Bank, through the International Development Association (IDA), is moving to provide grant funding, although the global claims on its grant-making capacity are likely to greatly exceed the resources available. It is important that other donors, especially bilaterals, enhance their grant-based financial support to the CIS-7.

There has been recent progress on the debt front. Countries have engaged in more active debt management, as evidenced by the Paris Club rescheduling of the debt of Georgia and the Kyrgyz Republic. More concessional rescheduling could be available following continuing reform implementation. In this regard, donor willingness to pledge highly concessional assistance at the Kyrgyz Consultative Group meeting is encouraging. However, the debt implications of external financing will continue to be problematic for some time. In determining the extent of assistance, donors need to move with greater determination toward meeting the aid targets under the Millennium Development Goals, while ensuring that the terms of the aid are sufficiently concessional to avoid another debt run-up.

Several initiatives could improve the impact and effectiveness of such assistance. One priority is to allocate donor funds more effectively through better coordination of aid and the avoidance of wasteful duplication. Better donor coordination in technical assistance would also help, with each institution (including U.N. agencies and nongovernmental organizations) providing assistance in line with its comparative advantage. The PRSP process, which emphasizes partnerships among donors as well as between donors and PRSP countries, can be a powerful new tool for improved donor coordination. One possibility is pooling donor funds together with the development of public-private partnerships to avoid overlapping (or competing) donor programs. Well-designed public-private partnerships and greater private investment generally would expand the flow of resources beyond the limited funds available from the international financial institutions (IFIs). For private investment flows to become substantial, the CIS-7 will need to build investment climates conducive to private sector development, including small and medium-size enterprises.

The CIS-7 thus need to play their part. Donors are focusing on assisting countries that demonstrate a commitment to sound policies and substantial reforms. Highly concessional finance and debt relief will succeed only if linked to effective macroeconomic performance and continuing structural and social reform. There may be a case for not cutting off assistance to poor performers, on the grounds that disengagement could strengthen the hand of local groups opposed to reform. There may be strong external pressures to continue providing assistance to prevent recipients from becoming failed states. But a more effective external financing environment (including grant aid) should include the understanding that support may be withdrawn if recipients persistently fail to live up to reform commitments.

Securing greater resource flows on better terms to support countries' reform programs is only part of the picture. If reforms are to be effectively implemented and sustained, leading to faster growth and poverty reduction, the international community and the CIS-7 need to work together to accelerate capacity building.

Capacity Building

Substantial portions of donor assistance to the CIS-7 have directly supported institutional development—ranging from a high of one-quarter to one-third of the total in Moldova to a low of 10 to 15 percent in Uzbekistan, with most other countries averaging an institutional development component of 20 to 25 percent. The track record has been mixed, in part owing to the diffusion of efforts across a wide range of issues. Capacity building needs to focus on reform in three areas: improving public expenditure management, upgrading revenue administration, and enhancing capacity in data collection and monitoring. For these areas, donors can provide financial assistance, technical assistance, training, and targeted partnerships.

Current public expenditure management systems do not serve the priorities of poverty reduction strategies well. Too little attention goes to the relative effectiveness of different programs in terms of alleviating poverty, with insufficient priority for social protection expenditures that target the poor, or for health and education. To ensure that multiyear plans for poverty reduction and other priorities are appropriately financed, capacity is needed to better match medium-term budgetary resource allocation to projected expenditure needs. As discussed by Betley (Chapter 5), this requires moving away from short-term budgeting decision making toward medium-term budgetary frameworks. It is encouraging that Armenia, the Kyrgyz Republic, and Moldova are already adopting such frameworks, and that the other four CIS-7 countries are planning to do so as well.

The CIS-7 have made advances in improving revenue administration over the past decade, including laying the groundwork for increased taxpayer compliance. However, staff capacity remains limited in important areas such as management, international accounting, and functional skills. Strategic objectives need to be translated into realistic work programs, with improvements in taxpayer registration and self-assessment, the audit function, collection enforcement, and services to taxpayers.¹¹

Better data collection and monitoring are needed in the CIS-7 to guide policy and investment decisions and to improve targeting and efficiency in the social sectors. Appropriately disseminated, good data will strengthen governance through greater transparency, and will be crucial in assessing progress and determining needs for achieving the Millennium Development Goals.

Regional Cooperation

The recovery and future prosperity of the CIS-7 will depend on mutual cooperation among neighboring countries in areas ranging from trade and transportation to water and energy. It is also important that the interests of the CIS-7 be appropriately taken into account in the Doha round of trade negotiations, especially given the importance of agriculture in most CIS-7 economies. Many CIS-7 countries now have very liberal trade policy regimes. However, as discussed by Michalopoulos (Chapter 10), their exports have tended to be concentrated in capital-intensive extractive industries, which offer limited prospects for employment growth and poverty reduction.

There are significant trade links among the Central Asian countries, but much more limited ones among the Caucasus countries, and very limited ones between these two groups and Moldova. Impediments to trade cooperation take the form of nontariff barriers (informal controls, licenses, and other approvals), institutional and bureaucratic constraints, and problems with customs services. While all CIS-7 countries are signatories to regional cooperation agreements, implementation lags far behind formal commitments. More effective trade integration will depend on reducing current impediments and moving simultaneously toward greater cooperation among subregional groupings and greater integration with the outside world. External partners will also need to support the strengthening of customs and tax administration and broaden assistance for standards and other trade-related institutions.

Improving transportation requires dealing with corruption, including very substantial unofficial payments for semicompulsory guard services that greatly increase transit costs. It also requires taking advantage of currently unrealized scale economies in transportation and improving logistics services. The CIS-7 would benefit from adhering to the TIR Convention and harmonizing transit fees and border procedures. The donor community could help in these and other areas through technical assistance, grant financing, and other support.¹²

Finally, both national action and regional cooperation in the energy and water sectors would pay substantial dividends for the CIS-7. As highlighted by Kennedy, Fankhauser, and Raiser (Chapter 11), these countries' most important natural resources—energy and water—are unevenly distributed. Azerbaijan and Uzbekistan have substantial energy resources, while Armenia, Georgia, the Kyrgyz Republic, and Tajikistan have important water resources, offering good potential for intraregional trade.

Greater regional cooperation requires reforming domestic power and water tariffs, which do not currently reflect the cost of provision. The reforms will need to begin with domestic price adjustment, which will be politically difficult. But price reform, both domestic and intraregional for energy and water trade, is essential to avoid continued deterioration in infrastructure. Price reform in regional trade of these commodities is also essential if countries are to reap its benefits. Here again, donors can help with technical assistance, grant financing, and other support, provided the countries manifest the political will for deeper reforms.

Conclusion

The CIS-7 faced enormously difficult conditions at independence and took some time to develop appropriate policy responses. In hindsight, external financial support should have been provided on more concessional terms. Bilateral grants to the CIS-7 fell well short of levels provided to other low-income countries. In recent years, however, most of the seven have pressed forward with an important—but still incomplete—reform agenda. Multilateral and bilateral partners have broadened and softened the terms of their assistance.

For the future, it will be essential for both countries and donors to translate a better understanding of the development challenges facing the CIS-7 into more effective reform implementation and external assistance. The growing divergence in the performance of the CIS-7 indicates that at some point it will be useful to review the continued relevance of the CIS-7 Initiative as a development cooperation mechanism. The four IFIs that sponsored the Initiative will continue to focus on the broad and mutually reinforcing areas for action outlined here—ownership and governance, finance and debt relief, and capacity building and regional cooperation.

References

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Burnett, Nicholas, and Rodica Cnobloch, 2003, "Public Spending on Education in the CIS-7 Countries: The Hidden Crisis." Available at www.cis7.org.

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