VOL. 2, NO. 2FEBRUARY 2007 EconomicLetter

After the Fall: Globalizing the Remnants of the Communist Blocby Julia K. Carter

Insights from theF E D E R A L R E S E R V E B A N K O F D A L L A S

The pace of globalization has quickened in the past two decades,

driven by technology that makes it cheaper and easier to share information

across borders. Faster economic integration has coincided with an ideolog-

ical shift pushing countries to shed layers of government intrusion and pro-

mote economic freedom.1

In this cauldron of economic change, China and India have taken

center stage with their rapid growth and booming exports. Meanwhile, with

less fanfare, the 27 nations once under Soviet hegemony have also been try-

ing to redefine themselves. They form a vast region—stretching from the

Baltic Sea to the Mediterranean, from Germany to central Asia—that broke

free from decades of communist rule more than 15 years ago.

Faster economic

integration has

coincided with an

ideological shift pushing

countries to shed

layers of government

intrusion and

promote economic

freedom.

2EconomicLetter FEDERAL RESERVE BANK OF DALLAS

Former Communist Bloc Countries

RUSSIA

FINLAND

AUSTRIA

ITALY

SPAIN

SWEDEN

NORWAY

GERMANY

FRANCE

AL

HUNGARY ROMANIA

BULGARIATURKEY

DENMARK

POLAND

BELARUS

UKRAINECZECH

SLOVAKIA

GREECE

CYPRUSNORTH CYPRUS

ANDORRA

NETH.

BELGIUM

IRELAND

SERBIA

ALBANIA

MOLDOVA

LITHUANIA

LATVIA

ESTONIA

LUX.

BOSNIAand

HERZ.

CROATIA

SLOVENIA

SWITZERLAND

MACEDONIA

GREENLAND

ICELAND

ETHIOPIA

ERITREA

SUDAN

EGYPT

NIGER

MALI

NIGERIA

SOMALIA

LIBYA

CHAD

ALGERIA

TUNISIA

ROCCO

TOG

O

BENIN

GHANA

E

BURKINA FASO

DJIBOUTI

JORDAN

ISRAEL

LEBANON

ARMENIAAZERBAIJAN

GEORGIA

KYRGYZSTAN

TAJIKISTAN

KUWAIT

QATARU. A. E.

OMAN

YEMEN

SYRIA

IRAQ

IRAN

OMAN

SAUDI ARABIA

AFGHANISTAN

PAKISTAN

INDIA

C H I N AKAZAKHSTAN

TURKMENISTAN

UZBEKISTAN

MYANMAR

NEPAL

BHUTAN

SRI LANKA

BANGLADESH

MONGOLIA

U. K.

3

A half century or more of statecontrol had left the former Soviet bloceconomies backward and isolated—inneed of major transformations. Freedfrom communism, nearly all thesecountries sought a path to prosperitythat lay in emulating the West’s open,free market economic model.

They didn’t march in lockstep.Estonia, the Czech Republic and othercentral European countries have madesignificant progress in becoming glob-al players. Russia and most of the for-mer Soviet republics continue to strug-gle with the vestiges of their commu-nist pasts. The Asian giants’ greatstrides have led to questions about thepace and depth of the former Sovietbloc’s capitalist transformation. Beforedismissing its transition as a failedexperiment, it is important to weighthe progress made and obstacles stillfaced on the road to capitalism.

Toward a New Era The Soviet Union’s demise sent

shock waves across a significant eco-nomic space.2 Today, the regionincludes 169 million workers and 403million consumers, with per capitapurchasing power of $7,100 a year,just below the world average of$8,200.3 All told, the region produces$2.9 trillion a year—about 5.4 percentof the global economy.

By contrast, the U.S. employs 138million workers to meet the needs of297 million consumers. WesternEurope has 160 million workers and393 million consumers.4 While roughlyequivalent to the former communistcountries in labor force and popula-tion, both the U.S. and WesternEurope are far more prosperous, witheconomies at least four times larger.The glaring differences in living stan-dards between the West and theSoviet bloc were a key factor in dis-crediting communism.

How have the former communistnations done in forging open, marketeconomies capable of prospering in aglobalizing era? A.T. Kearney Inc. andForeign Policy magazine calculate an

FEDERAL RESERVE BANK OF DALLAS EconomicLetter

annual globalization ranking to meas-ure the degree to which 62 countriesare enmeshed with the rest of theworld.5 It consists of four parts: eco-nomic integration through trade andinvestments; technological connectivitythrough the Internet; personal contactsthrough phone calls, tourism andremittances; and political engagementthrough treaties and internationalorganizations.

The Czech Republic and Sloveniaranked above Germany in 2006, large-ly because of higher trade-to-GDPratios and more international tourism(Table 1). Hungary rounded out thetop 20 most globalized countries, andCroatia came in ahead of France,Portugal and Spain. Slovakia,Romania, Poland and Ukraine did bet-ter than such countries as Mexico andArgentina, but Russia ranked wellbelow them.

By opening once-closedeconomies, China and India havebecome powerful symbols of global-ization. However, both ranked belowthe ex-Soviet bloc countries. AlthoughChina came close on foreign directinvestment and United Nations peace-keeping missions, it was lower oninternational tourism and politicaltreaties. India trailed on many meas-ures, but trade and tourism represent-ed the widest gaps. The Kearney/ForeignPolicy ranking doesn’t cover the restof the former communist countries,although reports suggest Estonia andperhaps others have achieved a highdegree of globalization.

The globalization measure sug-gests the former communist countriesstill have far to go. No country is closeto Singapore, Switzerland, the U.S. orIreland at the top of the rankings.Only Slovenia has made a significantmove up the globalization ladder sincethe first index in 1998. The rest of thecountries are about where they werein the pecking order, although somemight have made absolute progressbecause overall globalization has beenrising.

The Index of Economic Freedom,

Rank Country(out of 62)

16 Czech Republic17 Slovenia18 Germany20 Hungary22 Croatia23 France24 Portugal25 Spain26 Slovakia30 Romania33 Poland39 Ukraine42 Mexico43 Argentina47 Russia51 China61 India

NOTE: Former Soviet bloc countries are in bold.

SOURCE: A.T. Kearney and Foreign Policy.

Table 12006 Globalization Rank, Selected Countries

calculated by the Heritage Foundationand The Wall Street Journal, gaugesthe extent to which nations allow mar-kets to operate.6 Its componentsinclude freedom to trade, openness toforeign investment, burdens of gov-ernment regulations and taxes, soundmonetary policy and enforcement ofproperty rights.

No ex-Soviet bloc economieswere among the seven nations classi-fied as “free” in 2007. Only Estoniaand Lithuania did well enough to rankas “mostly free”—the index’s secondbest category. They’re joined by Japanand most of Europe outside theUnited Kingdom and Ireland. The twoBaltic republics had historic ties toWestern Europe, and their communistrule began during World War II, ageneration behind Russia and otherparts of the former Soviet Union.

A dozen former communist coun-tries have achieved “moderately free”

status, including the Czech Republic,Georgia, Hungary, Slovenia andBulgaria. They share the category withthe likes of France, Mexico and Brazil.The 10 countries that haven’treformed as much are classified as“unfree,” including Poland, Ukraineand Russia. Belarus and Turkmenistanrank toward the Heritage/WSJ index’sbottom as “repressed” economies.Their ways of doing business haven’tchanged much since Soviet times—government interference and owner-ship are widely practiced. TheHeritage/WSJ index doesn’t trackSerbia and Montenegro.

Like the Kearney/Foreign Policyranking, the economic freedom meas-ure finds few global stars among theremnants of the Soviet empire. Amongthe 19 countries Heritage/WSJ hastracked for at least a decade, Armeniaand Georgia improved the most, risingfrom repressed to the cusp of mostlyfree. Poland and the Czech Republichaven’t risen in the rankings, despitetheir favored position abuttingWestern Europe.

Decomposing the overall eco-nomic freedom rankings shows thatthe former communist countries aredoing well on avoiding oneroustaxes—even a bit better, in fact, thanthe seven free countries (Chart 1).They’ve nearly brought themselves upto the world standard in monetary dis-cipline, openness to trade and limitedrole of government in the economy.The mostly or moderately free beginto diverge from the unfree andrepressed in other aspects of econom-ic freedom—reducing red tape forbusiness, deregulating the financialsector, increasing flexibility of labormarkets, welcoming foreign invest-ment, protecting property rights andfighting corruption. At the same time,both groups’ scores decline, fallingwell below the standards of the freenations. The property rights and cor-ruption readings for the unfree andrepressed countries are particularlydisappointing, compared with boththe region and the free nations.

4EconomicLetter FEDERAL RESERVE BANK OF DALLAS

0

10

20

30

40

50

60

70

80

90

100

Moderately/mostly free Unfree/repressed

Fiscal Monetary Trade Government Regulation Financial Labor Investment Propertyrights

Corruption

Free countries

Chart 1What’s Holding the Bloc Back?(Heritage/WSJ Index of Economic Freedom)

Index, 100 = best

SOURCE: The Heritage Foundation/Wall Street Journal 2007 Index of Economic Freedom.

Fiscal freedom is a measure of the burden of government from the revenue side. It

includes both the tax burden in terms of the top tax rate on income (individual and

corporate separately) and the overall amount of tax revenue as a portion of GDP.

Monetary freedom combines a measure of price stability with an assessment of

price controls. Both inflation and price controls distort market activity. Price stability

without microeconomic intervention is the ideal state for the free market.

Trade freedom is a composite measure of the absence of tariff and nontariff barriers

that affect imports and exports of goods and services.

Freedom from government is a measure of the extent of government expenditures

and prevalence of state-owned enterprises. Ideally, the state will provide only true

public goods, with an absolute minimum of expenditure.

Freedom from business regulation is the ability to create, operate and close an

enterprise quickly and easily. Burdensome, redundant regulatory rules are the

most harmful barriers to business freedom.

Financial freedom is a measure of banking security as well as independence from

government control. State ownership of banks and other financial institutions

such as insurer and capital markets is an inefficient burden.

Labor freedom is a composite measure of the ability of workers and businesses to

interact without restriction by the state.

Investment freedom is an assessment of the free flow of capital, especially foreign

capital.

Property rights is an assessment of the ability of individuals to accumulate private

property, secured by clear laws that are fully enforced by the state.

Freedom from corruption is based on quantitative data that assess the perception of

corruption in the business environment, including levels of governmental legal,

judicial and administrative corruption.

erately or mostly free former commu-nist bloc countries was $11,373 in2005, one and a half times the $7,992in the 12 countries ranked as eitherunfree or repressed (Table 2). Thefreer countries do better at preservingtheir currencies’ value. Mostly andmoderately free countries average rel-atively low inflation of 4.6 percent,compared with 10.2 percent for theunfree and repressed countries. Thefive nations with the lowestKearney/WSJ scores suffer double-digit inflation, topped by Uzbekistan’s21 percent. Keeping central banksindependent from government influ-ence fosters the monetary restraintnecessary for price stability. EU man-dates for low inflation provide addi-tional discipline for the 10 nations thathave joined the economic bloc.

Despite a spotty record on eco-nomic reform, the ex-Soviet blocnations have made some strides inglobalizing. From 1997 to 2004,exports and imports as a share ofGDP rose in all but four of the 27countries. A dozen of them posted

5FEDERAL RESERVE BANK OF DALLAS EconomicLetter

gains of 20 percent or more, led bySerbia and Montenegro at 69 percent,Georgia at 67 percent and Poland at52 percent. Trade, moreover, hasdiversified, particularly for the centralEuropean nations. They’re now tiedmore closely with Western Europethan with the former Soviet bloc coun-tries.

A few countries are doing well inthe highly diversified services trade.As a share of GDP, it’s 40 percent inEstonia, 38 percent in Croatia and 30percent in Bulgaria. Internationaltourism receipts are 47 percent ofAlbania’s exports and 41 percent ofCroatia’s. In some countries, however,increased trade reflects economiesdominated by natural resources. Oiland natural gas as a share of exportswas 82 percent for Azerbaijan, 50 per-cent for Russia and 26 percent forBelarus—all unfree.

The region has become an attrac-tive destination for foreign capital, byand large eclipsing China and India.The ex-Soviet bloc nations received$72 billion in direct investments in

Eight former communist countriesjoined the European Union in 2004:the Czech Republic, Estonia, Hungary,Latvia, Lithuania, Poland, Slovakia andSlovenia. In January, Bulgaria andRomania became the EU’s 26th and27th members. The countries benefitfrom unrestricted trade, investmentand tourism within the EU, and mem-bership should encourage furtherglobalization and reform. Perhapsmore important, strong ties to WesternEurope create a bulwark against thebacksliding that plagues Russia andseveral other former Soviet states.

The Kearney/Foreign Policy glob-alization rankings cover too few coun-tries for analysis, but the Heritage/WSJdata provide a reasonably good basisfor examining the former communistcountries’ divide. Globalization andeconomic freedom are closelylinked—simply put, market-orientedcountries tend to be more open—sothe freedom measure should captureat least some of the region’s integra-tion into the world economy.

Leaders and Laggards Initial conditions after the Soviet

Union’s demise varied. Some countriescould reconnect historic ties toWestern Europe. Others depended onRussia’s economy and aligned them-selves with the Kremlin. Nations haddifferent labor forces and industrialmixes. However, all had a chance tochoose between swift reforms andslow adjustments. As countries re-gained sovereignty, they diverged notonly on the pace of reform but alsoon economic performance.

By several broad measures, thefreer economies are doing better.From 1993 to 2005, seven mostly ormoderately free nations were amongthe region’s 10 fastest growing interms of real per capita income. Moretelling, perhaps, Ukraine, Tajikistanand Moldova, all unfree, actually sawtheir economies contract over this peri-od. Overall, growth is highly correlatedto economic freedom (Chart 2).

Per capita income in the 14 mod-

–2

0

2

4

6

8

10

40 45 50 55 60 65 70 75 80

Heritage Index of Economic FreedomUnfree/repressed Moderately/mostly free

Moldova

TajikistanUkraine

Uzbekistan

Russia

Belarus

Azerbaijan

Croatia

PolandKazakhstan

Albania

Armenia

EstoniaLatvia

Georgia

Lithuania

Czech Republic

SlovakiaHungary

Slovenia

Bulgaria

Romania

KyrgyzstanMacedonia

Chart 2Freer Economies Grow Faster(12-year annual growth in inflation-adjusted per capita income)

Percent

NOTE: Data for Bosnia and Herzegovina, Serbia and Montenegro, and Turkmenistan were not available.

SOURCES: The Heritage Foundation/Wall Street Journal 2007 Index of Economic Freedom; World Bank, WorldDevelopment Indicators database, per capita income, 1993–2005.

billion over the past five years, out-pacing China’s $9.2 billion and India’s$7.2 billion.

Business integration has grownrapidly in the former Soviet bloc.Mergers and acquisitions increasedfrom 13 deals valued at $34 million in1989 to 367 deals valued at $15.2 bil-lion in 2004. Such multinationals asGeneral Electric, Vodafone and Ford,along with thousands of other compa-nies, have put down roots in Romania,the Czech Republic, Hungary, Polandand other countries.

National financial industries haveemerged as well. As a share of GDP,the former communist countries’ pri-vate-sector lending grew from an aver-age of 20.6 percent in 1998 to 29.3percent in 2005. Russia had $4.9 bil-lion in initial public offerings in2005—2.9 percent of the world totaland more than Germany’s $4.7 billion.Poland wasn’t far behind with $1.5 bil-lion in IPOs. Stock markets are thriv-ing. The capitalization of the region’s6,000 public companies has climbedto nearly $1 trillion.

Technology advances globalizationby facilitating cross-border communica-tions. Mostly or moderately free nationsmake up eight of the 10 former com-munist countries with the most secureInternet servers per 1 million peopleand telephone subscribers per 1,000people (Table 3). The most technologi-cally connected countries includeEstonia, Slovenia and the CzechRepublic, and they’ve become keyplayers in outsourced business services.

Among the nations once part ofthe Soviet empire, faster growth andprice stability go along with greatereconomic freedom—a result consistentwith other parts of the world. Risingtrade, investment and connectivity sug-gest movement toward integrating intothe world economy, another worldwidetrend. The region, however, remainspoorer and less globalized than manyearly 1990s optimists had hoped.

Obstacles to Overcome Why hasn’t the former Soviet bloc

6EconomicLetter FEDERAL RESERVE BANK OF DALLAS

ConsumerEconomic Annual pricefreedom per capita inflation

index income (annual(100 = best) (dollars) percent)

Moderately/mostly free 11,373 4.6Estonia 78.1 12,986 4.1Lithuania 72.0 10,924 2.7Czech Republic 69.7 16,658 1.8Armenia 69.4 3,319 .6Georgia 68.7 2,303 8.3Slovakia 68.4 12,537 2.7Latvia 68.2 10,244 6.8Hungary 66.2 14,453 3.6Slovenia 63.6 19,661 2.5Bulgaria 62.2 6,118 5.0Albania 61.4 3,998 2.4Romania 61.3 6,882 9.0Macedonia 60.8 4,990 .5Kazakhstan 60.4 6,109 7.6

Unfree/repressed 7,992 10.2Kyrgyzstan 59.9 1,204 4.3Moldova 59.5 1,300 11.9Poland 58.8 10,909 2.1Tajikistan 56.9 834 7.1Azerbaijan 55.4 3,552 9.7Croatia 55.3 10,793 3.3Bosnia & Herzegovina 54.7 5,014 1.9Russia 54.0 8,116 12.6Ukraine 53.3 4,269 13.5Uzbekistan 52.6 1,270 21.0Belarus 47.4 5,454 10.3Turkmenistan 42.5 4,750 10.7

Serbia & Montenegro Not ranked 4,330 17.3

NOTE: GDP-weighted averages.

SOURCES: The Heritage Foundation/Wall Street Journal 2007 Index of Economic Freedom;World Bank, World Development Indicators database; International Monetary Fund, WorldEconomic Outlook 2006.

Table 2Freedom and Prosperity

2005, or 7.9 percent of the world total.Inflows were about the same asChina’s and far more than India’s $7billion. Portfolio investments in debtand equity securities averaged $15.8

Table 3Now Connecting…

Secure Internet Fixed-line and mobileservers phone subscribers

(per million people) (per 1,000 people)

Moderately/mostly free 24.8 981Estonia 101.9 1,260Slovenia 79.1 1,278Czech Republic 41.7 1,392Latvia 37.8 937Hungary 30.0 1,217Lithuania 21.7 1,235Slovakia 18.4 1,027Bulgaria 8.7 966Romania 5.4 673Georgia 4.5 337Armenia 1.3 260Kazakhstan .9 350Macedonia .5 642Albania .3 154

Unfree/repressed 7.1 566Croatia 39.6 1,065Poland 22.0 777Moldova 3.6 391Bosnia & Herzegovina 3.3 507Russia 2.4 508Ukraine 1.3 545Kyrgyzstan .6 106Belarus .5 578Azerbaijan .5 333Uzbekistan 0 79Turkmenistan NA 82Tajikistan NA 46

Serbia & Montenegro 2.3 910

NOTE: Population-weighted averages.

SOURCE: World Bank, World Development Indicators database.

made more progress toward globaliza-tion and economic freedom? Justabout all nations accept these con-cepts in principle, but the path fromclosed, protected markets runs overrough terrain, with political as well aseconomic hazards.

Countries are more likely toembrace globalization and economicfreedom if they expect to benefit withjobs, growth and higher living stan-dards. History shows global capitalismdelivers—but not always in the shortrun. Communism left a legacy ofshoddy production techniques, under-employment and high costs, so theex-Soviet bloc nations faced hurdlesin a global marketplace.

Labor markets are telling. Theformer communist countries average9.9 years of schooling per person age25 and over, a big edge over China’s5.7 years and India’s 4.8 years.Although the region’s workers are bet-ter educated than their competitors inChina and India, they’re also morecostly—even taking into account theirhigher productivity. According to theConference Board, for every dollar aU.S. employee earns, a worker gets 73cents in Poland, 63 cents in the CzechRepublic and 58 cents in Hungary.7

China’s and India’s unit labor costs aremuch lower—at about 20 percent ofthe U.S. costs.

While the ex-Soviet bloc com-pares favorably with many low-wagenations in educational achievement, itdoesn’t match Western Europe or theU.S. in years of schooling or instruc-tional quality. The former communistnations occupy an awkward middle—not developed enough to competewith the U.S. and Western Europe, notcheap enough to vie with China andIndia.

Integrating into the world marketinvolves more than education. Nationsneed improved infrastructure, particu-larly for transportation and communi-cations. Foreign investors expecteffective financial institutions, efficientregulatory regimes and protection ofproperty rights. In themselves, new

7FEDERAL RESERVE BANK OF DALLAS EconomicLetter

laws may not be enough. Formercommunist countries must hone theirbusiness skills and rediscover suchcapitalist virtues as entrepreneurship.

Building the foundation of a mar-ket economy takes time—longer thanmany had anticipated in the euphoriaof communism’s collapse. For themost part, the ex-Soviet bloc countries

have delayed or slowed globalizationand economic reform while address-ing the backlog of developmentneeds. Other impediments have led tofoot-dragging on globalization andreform. In some countries, corruptionhas been thwarting reform, withentrenched interests protecting theirturf, even if it means opposing poli-

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EditorRichard Alm

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cies that might benefit economies as awhole. A few nations suffer from whateconomists call the resources curse:the neglect of broad developmentneeds as the state profits from oil orother natural wealth.

Undoing the corrosive legacy ofcommunism has proven a dauntingtask. A decade and a half after the fallof the Soviet Union, an economicdivide has formed along Russia’s fron-tier. In countries to the east, exceptthe Baltic republics, economieshaven’t broken free of governmentshackles. Countries to the west, fur-ther along toward globalization andeconomic freedom, have orientedthemselves toward Europe, with manyjoining the EU. The vast economicspace that was once the Soviet empireis likely to bear the marks of this splitfor decades to come.

Julia Carter is a senior economic analyst in theResearch Department of the Federal Reserve Bankof Dallas.

Notes1 See “Racing to the Top: How GlobalCompetition Disciplines Public Policy,” FederalReserve Bank of Dallas, 2005 Annual Report.2 Until 1991, eight countries composed what

used to be called the communist bloc: theU.S.S.R., Albania, Bulgaria, Czechoslovakia,Hungary, Poland, Romania and Yugoslavia. Notall of them had been communist since 1922.Several countries came under communist influ-ence during World War II. The U.S.S.R. splin-tered into Armenia, Azerbaijan, Belarus, Estonia,Georgia, Kazakhstan, Kyrgyzstan, Latvia,Lithuania, Moldova, Russia, Tajikistan,Turkmenistan, Ukraine and Uzbekistan.Czechoslovakia split into the Czech Republic andSlovakia. Yugoslavia disintegrated into Bosniaand Herzegovina, Croatia, Macedonia, Serbia andMontenegro, and Slovenia.3 All gross domestic product figures in thisreport were calculated as an average of the U.S.dollar measure and the purchasing power parityinternational dollar measure, which come fromthe World Bank’s World Development Indicatorsdatabase.4 Western Europe refers to Switzerland and the15 members of the European Union prior to the2004 and 2007 expansions.5 A.T. Kearney/Foreign Policy Globalization Index2006, available at www.atkearney.com andwww.ForeignPolicy.com.6 The Heritage Foundation/Wall Street Journal2007 Index of Economic Freedom, www.her-itage.org. The index does not cover Serbia andMontenegro. The Fraser Institute also producesan annual study of economic freedom around theworld, which generally agrees with the Heritage/WSJ index but covers only 18 of the 27 coun-tries studied.7 “Competitive Advantage of ‘Low-Wage’Countries Often Exaggerated,” The ConferenceBoard, Executive Action Series no. 212, October2006.