Chapter 15. Trade and economic reform in transition economies^[272]

15.1 Introduction

In this chapter, some of the key reforms in trade and related economic policies undertaken during the process of transition from a centrally planned, to a market driven economy are identified and their effects on agricultural production, trade levels and food security explained. The reforms included not only changes in trade policies but also a package of significant changes in property rights, price regimes, and in the institutions coordinating economic exchanges. The review, whilst focusing on the formerly centrally planned economies of Central and Eastern Europe and the former USSR, contrasts trends in these countries with reforms that have been undertaken in a more gradual and controlled fashion in China. Comparisons across the range of transition economies allow a number of key determinants of the impact of reform on agricultural production, trade levels and food security to be identified.

The most striking observation when looking at these countries is how diverse their experience has been so far. In China, the reforms began in agriculture. Agricultural production, productivity, and rural incomes soared immediately after the reforms and the growth of the sector contributed importantly to poverty reduction and improved food security. Unlike China, agricultural output in the Russian Federation and Eastern Europe collapsed in the immediate wake of the reforms, increasing the numbers in poverty and reducing levels of food security. However, after a few years, growth resumed in Central and Eastern European countries (CEECs), and both incomes and food security improved. In contrast, agricultural production continued to decline in Russia and many other countries of the former USSR for almost a decade, with negative effects on food security, especially for low-income groups. These widely different experiences were the result of a complex set of factors and their interactions. Only some of the major factors and developments are identified in this section^[273].

15.2 Causes of growth and decline during transition

One can distinguish several patterns in agricultural transition, summarized in Figures 15.1 to 15.3. The first pattern, referred to as the Chinese pattern, is characterized by a strong increase in output and productivity from the start of transition. During the first decade of transition, output increased on average by more than 50 percent in China, while labour productivity and yields increased by 40 percent. Growth continued during the years afterwards. A similar, though more muted pattern was observed in Albania, after a sharp reduction in the indicators in the first two years of transition.

Figure 15.1 Changes in gross agricultural output (GAO), in transition economies, first decade of transition (index)

The second pattern is that of Central Europe, where a decline in output coincided with a strong increase in labour productivity because of a heavy outflow of labour from agriculture. This is the pattern followed by, for example, the Czech Republic, Slovakia and Hungary. Output declined by around 30 percent during the first years of transition, but stabilized after 4 years. At the same time, agricultural labour productivity increased rapidly: on average around 10 percent annually during the first transition decade. After three years, yields also started to increase, by 3 percent annually on average.

A third pattern is that of the Russian Federation, Ukraine and Belarus and several other Newly Independent States (NIS^[274]). Here both output and productivity declined throughout the first transition decade and only started recovering after 1999. On average output fell by almost 50 percent in these countries and both yields and labour productivity by around 30 percent.

Figure 15.2 Changes in agricultural labour productivity (ALP), transition economies, first decade of transition (index)

Figure 15.3 Changes in yields, transition economies, first decade of transition (index)

Initial conditions, illustrated in Table 15.1, affected the way in which trade and other economic reforms influenced agricultural performance, as well as poverty and food security. Nevertheless, reform policies did have a significant effect as well, and the relative impact of the initial conditions decreased as transition progressed.^[275]

First, price and trade policies diverged among the formerly centrally planned economies. In China, as in many developing countries, agriculture was taxed through price and trade regulations. In contrast, in most of the CEECs and the former USSR, agricultural producers and food consumers were supported with heavy subsidies. Under the central planning system, planned inter-country trading regime among the centrally planned economies dominated their trade patterns countries. China, on the other hand, traded mainly with non-CMEA countries.

As a result, price and trade liberalization had vastly different impacts. In China, the administered prices that farmers received for their output were increased. The rise in prices in the late 1970s and early 1980s partly explains the increase in farm profits during this period. In most other countries liberalization implied price and subsidy cuts, because of the heavy consumer and producer subsidization. In many countries the combination of the fall in the real price of output and the rise in the real price of inputs led to a crisis in the agricultural sector.

Table 15.1 Pre-reform indicators, transition economies, 1978, 1989 and 1990

Note: Pre-reform indicators are from the following years: 1978 for China, 1989 for the CEECs and 1990 for the Former USSR

Source: World Bank, ADB; de Melo et al.; FAO; OECD and European Commission

The negative impact was reinforced by the collapse of the CMEA trading system, which led to trade disruptions in countries where CMEA trade integration was strong, and by the shift to hard currency payments for imports. The impact on consumers was mixed: real food prices increased significantly, but with trade liberalization consumers had access to higher quality imported food products, and indirectly pushed domestic food companies to improve their standards.

Second, at the outset of transition, China, and to a lesser extent Central Asian countries, had a much lower level of development. Not only was the initial level of poverty much higher and food security much lower, but also the agricultural system was quite different. The importance of agriculture in employment was much higher in China (around 70 percent) than in the Russian Federation (less than 20 percent), or in Central Europe (13 percent). Moreover, China’s agriculture was much more labour intensive: the ratio of labour to agricultural land area was higher than one, compared to less than 0.15 in Central Europe and the Russian Federation. This had an important impact on the reforms.

Reforms in China started with re-allocating land rights from the communes, brigades and teams to rural households. With very labour-intensive production, this caused a break-up of collective farms into small-scale household farms. The resulting changes in incentives caused a dramatic increase in productivity and contributed to a strong growth of output. In contrast, large-scale capital-intensive farming dominated in the Russian Federation and CEECs, where large-scale farms still cultivate much land. The difference between the Russian Federation and CEECs is not so much in the scale of the farm operations, but rather in their management. In CEECs, effective restructuring and hard budget constraints induced sharp shifts in input use and effective management reforms, causing gains in productivity levels. In contrast, farm restructuring in the Russian Federation was more superficial, and local authorities continue to influence farm management through informal relationships.

Differences in restructuring are linked to land reform. In CEECs land was restituted to former owners or distributed to farm workers. Although these land reforms were complex, they ended up with relatively strong and well-defined property rights. The Russian and Central Asian land reforms distributed land as paper shares, leading to weak land rights. As a result, family farming is emerging only slowly: large farms have less incentive to restructure and productivity is lagging.

Third, in Central Europe and the Russian Federation, the reform strategy included rapid privatization and restructuring of up- and down-stream enterprises. However, the removal of the central planning and control system, in the absence of new institutions to enforce contracts, to distribute information, and to finance intermediation, caused serious disruptions throughout the agro-food chain. In this aspect, China’s reforms differ considerably. In the initial phase, she chose not to disrupt agriculture by reforming the up-and down-stream sectors. In essence, the procurement and input supply systems remained fully under the control of the state during the early reforms. Deregulation of the input and output marketing was only allowed to take place several years after the initial reforms. This gradual liberalization strategy allowed enterprises to reap the informational benefits from price liberalization while avoiding the disruption associated with the breakdown of the planning system.

The importance of creating new institutions to facilitate the exchange of inputs for outputs and the trade of commodities can also be seen from the recent performance of CEECs and the Russian Federation. While output in the latter continued to decline, growth in CEECs resumed and increased with the emergence of new institutions for information, product exchange and contract enforcement.

Foreign direct investment (FDI) has also played an important role in the emergence of new institutions of exchange. Beyond supply of capital, foreign firms have introduced a number of arrangements to encourage greater production and to overcome transition constraints. For example, food processors have negotiated contracts with banks and input suppliers to provide farms with inputs that enable them to deliver high quality products to their company.

15.3 Food security

The changes that were induced by the first reforms undoubtedly had consequences on food security. The level of food security and changes during transition have differed importantly between countries. Before transition, whereas the average Hungarian consumed 3 100 kcal/per capita/day, Russians had a daily energy intake of 2 500 kcal/per capita/day and in China per capita consumption was 2 100 kcal/day. In comparison with countries of similar income levels, CEEC and former USSR countries had high levels of food consumption, sustained by food subsidies which kept food prices low. Consequently, initial drops in food intake after transition were not solely a consequence of lack of food availability but rather caused by a sudden lack of access to food by the collapse of these subsidies. Income declines and disruptions of social support systems also contributed to the initial drop in food entitlement.

In Central European countries - characterized by higher income levels, better developed social welfare systems, smaller output falls, and quicker turnaround with more successful reform effects - declines in income had limited effects on food intake, at least in terms of energy adequacy for most of the population. Hungary and Slovakia, for example, experienced average drops in energy intake of less than 5 percent during the first years of transition.

In Southern European transition countries, such as Romania and Bulgaria - with lower income, less developed social welfare systems and more pronounced output falls- poverty increased more strongly, and food consumption declined on average with 15 percent and more severely for the lowest income groups in the first stages of transition. These developments (and the factors behind them) were more marked in the Russian Federation, Ukraine, and Central Asia with some of them showing energy intake drops of more than 20 percent.

Generally, food intake (kcal/capita) remained surprisingly stable over the whole transition period, compared with output falls and with income drops. This was partly due to successful coping strategies at household level referred to as: “muddling through transition with garden plots”. In the poorer countries, households turned quite drastically to household food production. In some countries the share of household production in total consumption doubled. Even amongst the urban population ‘kitchen gardens’ have become important. Especially in former USSR, this shift was combined with increasing informal social exchange helping networks and barter trade. Diet composition shifted towards cheaper, but inferior energy sources (e.g. replacing cereals by potatoes).

The story was entirely different in China, where food security was highly problematic and poverty very high before transition. Daily energy intake was about 2 100 kcal/per capita/day and levels of severe poverty in the 1980s reached 44.7 percent. Since the start of transition, the poverty and food security situation has improved, with daily intakes increasing to 3 044 kcal/per capita. In the late nineties severe poverty levels had dropped to 30.8 percent.

15.4 Conclusion

First, it is clear from the discussion above that trade was only one of several key reforms that affected agricultural performance and food security in transition countries. The initial situation and transition changes differ strongly among countries. China had a poor level of food security at the outset of transition, but incomes and food security have increased dramatically within the rural population, in contrast to the situation in Central Europe and former USSR. Before transition, these countries had lower poverty levels and better food security status than market economies of comparable level of incomes. Food security was never a serious issue in terms of energy intake, except for the most vulnerable groups, such as pensioners, and except for some poorer European countries such as Romania. Yet during the initial stages of transition, this situation worsened considerably in several former USSR countries, although in general the situation is still better than in many other countries of comparable per capita incomes. In the former USSR, the rural population of several countries is still dealing with deep income poverty and lack of formal support systems, resulting in relatively low levels of food security.

Second, trade reform in general has reinforced changes induced by other reforms. For example, the initial negative effects on farm profitability of cuts in subsidies and price supports in CEECs and the former USSR have been reinforced by trade liberalization, which has increased competition with foreign imports. Trade liberalization also reinforced the reallocation of production activities caused by the abolition of central planning. Planned allocations of resources to the production of certain commodities, often in inappropriate regions, were no longer economically sustainable when trade had to be financed by hard currencies and when inputs were accounted for at real costs. The result has been a major reorganization of production activities across the region. For example, trade between the CEECs and the former USSR fell initially, while trade between the CEECs and the EU has intensified very strongly over the past decade (agri-food exports from CEECs to EU doubled while imports from the EU increased ten-fold). Another development was the shift from centrally imposed extreme specialization (e.g. dairy production in the Baltic countries and cotton production in parts of Central Asia) to more diversified production systems, thereby increasing domestic production of staple foods in those countries.

Third, the impacts of trade liberalization should be considered in combination with other aspects of economic integration in the regional and global economy such as increased flows of capital and labour.

• Labour migration has contributed to grow, from several CEECs to the EU and from USSR to Central Europe. The most extreme example is probably Albania, where close to one-third of the male workforce emigrated to neighbouring European countries, contributing strongly to growth and food security in Albania - the poorest country in Europe - mostly through remittance payments.

• Capital inflows from the West, in combination with integration in WTO and regional trade agreements, such as the Association Agreements with the EU, have contributed to macro-economic stability and policy credibility in those countries where basic reforms had been implemented, such as Central Europe, the Baltic countries, and Bulgaria after 1998. These factors had an important and reinforcing positive impact on growth indirectly by stimulating impact on foreign direct investment. Obviously, liberalized capital flows and trade can also reinforce domestic instability when the fundamentals and policy credibility are not there. This is well illustrated by the 1998 Russian financial crises.

• Foreign direct investment has played a key role in creating strong and sustainable productivity growth in the CEEC agricultural economies since 1993. Large foreign investments in the food industry and input supply industries have created productivity gains and institutional innovations throughout the food chain, with important spill-over effects on domestic companies and on farms, and thereby rural households.

• Increased involvement with global markets has, in the second phase of transition, also strongly contributed to growth in China. The effect was indirect, by contributing to new jobs and growth in non-agricultural sectors, thereby allowing rural labour to move out of agriculture into higher earning activities, and reducing the pressure on agricultural incomes.

A variety of particular evolutions in agricultural production, poverty, social security and thus food security can be distinguished between the transition countries, mostly due to differences in initial conditions and in reform policies. Trade and economic integration have mainly re-enforced these effects in direct and indirect ways and at national, regional and household levels. General trends indicate that trade is associated positively with lower poverty and food insecurity in transition countries.