Reform Reversals in Former Transition Economies of the European Union: Areas, Circumstances and Motivations

Abstract

The rapid journey from central planning to EU (euro area) membership stress-tested the social learning processes of FTEs. The desire to be anchored to the West, and to enter the EU spurred major reform waves and led to the introduction of best practice institutions very rapidly. This process most likely accelerated social learning, but apparently in many FTEs this learning was not fast enough to keep pace with the rapid reforms, leaving best-practice institutions with social norms that were not sufficiently strong to maintain them. So not surprisingly, widespread reversals emerged in the region, especially when the crisis hit these countries. In other words, reversals seem an inherent characteristic of the FTEs' journey towards a modern social market economy. Reform reversals can be formal reversals, which change legislation (or formal rules), or behavioral reversals, which erode the quality of an institution by materially changing the way it works, or a combination of the two. Spillovers, from formal to behavioral reversals (and vice versa), from reversals in one area to another one, and from one institution to another can play an important role in reform reversals by strongly impacting their nature and dynamics. In many cases, it was this interaction of reversals in different sectors that created a full-blown reform reversal episode. The financial sector seems particularly prone to behavioral reversals, both in public and private institutions. The Washington institutions played a dominant role in shaping the transition process. Following the start of the EU accession process, however, the EU gradually took over as the dominant external anchor. The EU acted as a strong anchor that could prevent or reverse formal reform reversals in areas covered by EU law. The anchoring role of the EU was however much weaker in the case of behavioral reversals. Our analysis naturally leads to the conclusion that the ultimate solution to prevent reform reversals is to accelerate social learning processes, particularly among parallel communities. It is also important to focus on the quality and internal coherence of reforms and newly created institutions.

Keywords: reform reversals, social norms, institution building, European Union, transition economies

JEL Classification: E6, H5, G2, J48, O5, P2