International Economic Research

Asano "Twilight in the Village Nara"

International Economic Research

Applying Complex Systems Research to International Development: The Role of Institutions in Central and Eastern Europe

Roxana Wright
Assistant Professor of Management
Keene State College
Keene, New Hampshire

Philip Vos Fellman
Professor of International Business Strategy
Southern New Hampshire University
Manchester, New Hampshire

1.0 Introduction

In this paper we investigate the various roles that a number of local and national institutions have played in the comparative development of the countries of Central and Eastern Europe. Our analytical framework is built around a transformational view of the transition from planned to market economies. However, we believe that our framework offers a unique comparative treatment of the respective roles of legal, informal and international institutions. Our qualitative evaluation indicates that the evolution of these countries according to their progress towards a market economy is heterogeneous in nature, and is not monotonically dependent upon time. We have found that for slow reformers the dominant institutions reflect the state's reluctance to relinquish control over resources and state unwillingness to integrate regionally. Countries which demonstrate intermediate levels of development typically have a rather strong "pull" towards regional integration. Consequently, their governments have significantly adjusted and amended the historical role of the state in order to allow for the development of private sector commercial and market interests. In those countries which exhibit the most advanced levels of economic and political development we find that they have not only developed and refined the foundations of market exchange, but have also developed effective institutional environments based on rules of transparency and self-reinforcing governance.
The study of policy variation and of the sources of variation in economic development has profound implications for decision makers at all levels. The present paper evaluates the largely gradual and substantially diverse evolutionary processes that have shaped and continue to reshape the economies of Central and Eastern Europe. The progression from hierarchical, centrally planned economies to decentralized market systems is not always smooth or unidirectional. Empirical data shows that political and economic regression is always a possibility and that the introduction of retrogressive processes is a constant danger to economic prosperity. The old, idealized model of continual progress towards a perfectly functional market-based system with progressive adaptation of companies, consumers and institutions is a profound over-simplification. In the real-world context, actors in any evolving economy are perhaps best understood as adaptive agents within interpretative systems (Aoki, 1998). These systems accumulate and incorporate knowledge, repair inefficiencies and embed themselves into the environment. The approach taken in the present study reflects a analysis approach, which we believe is consistent with the "transformation" view of the transition process. This framework brings interpretations stemming from evolutionary and institutional economics (Nelson and Winter, 2002, 2006), network analysis (Carley and Svoboda, 1996) and economic embededness, as well as Marxist political economy and regulation theory (Pavlinek, 2002).
The transition process can be generally characterized in terms of the revolutions and political changes that have resulted from the end of the centrally-planned party-state system, economic reform, and the impact of reform. Reform in the Central and Eastern European countries has been a process of marketization, including the liberalization of prices, the opening of markets, industry and enterprise privatization and structural reform, as well as national processes of globalization led by the liberalization of foreign trade and new accession to international markets, institutions, and financial structures. Countries in the CEE have experienced transformations that are not simply the result of a single imposed design. There have been numerous approaches to reform, differing shifts in political power, and a substantial variety of situations involving inherited political and social institutions influencing the course of reform.
In the present paper, we argue that the emergence of new political and economic systems can only take place through the gradual evolution of markets and institutions through what is essentially an organic process of growth. Our framework draws on the evolutionary and transformational view of transition, however we offer several significant differences in our treatment of the role of institutions in economic development. While the transformation framework stresses the similarities between developments in CEE countries after 1989-1990 and takes a rather monolithic view of the previous state socialist system, we approach the entire situation more along the lines of a dynamic fitness landscape map (Kauffman, 1993, Fellman, Post, Wright and Dasari, 2004) with differing initial states and sensitive dependence on initial conditions (Bonabeau, 2002). This evolutionary framework (or "complexity science" framework) allows both for a multitude of outcomes, in what Stark (1992) describes as a "plurality of transitions" as well as for the discussion and analysis of emergent behavior in the path to market economics.

2.0 The Evolution of Institutions in Central and Eastern Europe

Economic sociology and political economy have generally viewed markets and states as strongly related, emphasizing the role of states in structuring markets and creating capitalism. In international relations, this approach has largely come about through the search for grand theory (i.e.,Gilpin, 1981, Keohane, 1984, Wallerstein, 1999, etc.). Generally, it has only been more recent scholars, led by Paul Pierson Theda Skocpol (2002) and R. Ned Lebow (1984, 1995, 2006) within the IR and IPE disciplines, and Richard Nelson, Sidney Winter and their colleagues who have participated in the DRUID (Danish Research Unit on Industrial Dynamics) conferences who have taken a more diverse, historical, heterogenous and organic view of economic change. Approaching the problem from a legal and instutional perspective Masahiko Aoki (2001, 2000a, 2000b, 1999, 1998a, 1999b, 1997, 1995) and Oliver Williamson (1995) have similarly led the development of a new approach to the field.
The transformation in Central and Eastern Europe has required states to negotiate between the simultaneous processes of privatization, democratization, and globalization. These countries' transformation into new societies based on new models of development in turn based upon interconnected changes in (a) the regime of accumulation, (b) the mode of regulation, and (c) the labor process model (including labor pool mobility) from at least a previously nominally hegemonic bloc ends up demonstrating a widely diverse set of economic development trajectories. Institutional uncertainties, such as those regarding formalized regulations, as well as normative expectations about the behaviors of various actors in the macroeconomic environment provide additional heterogeneity to transition results. These institutional uncertainties often took a higher place on official transformation agendas during the early stages of transition to market (in most cases, roughly until 1995). Subsequently, the increased number of formal regulations began to raise questions regarding their applicability and the degree to which they could and would be enforced, creating a different, but equally important type of uncertainty.
Political uncertainty also characterized the transition transformations (radical changes in governments, alteration of government's view on foreign investment, etc). Often, market uncertainties (obtaining access to resources, ability to find customers) shaped the strategic responses of high level actors in these economies, but this kind of response was always contingent on the conditions prevalent in the particular geographic location under consideration.
An additional layer of complexity in the transition process comes from the fact that the goal of transition is not a static state, but rather, an open-ended adaptation to a world which is itself in the flux of transformation. The outcome of transformations in CEE has been expected for some time now to be a set of different forms of capitalisms interconnected into a Western European system (Deacon, 2000). The transition environment has been characterized by the international development literature as highly volatile due to frequent changes in institutions and industrial structures. Among the unique features of CEE markets is the fact that informal institutions differ greatly from those of Western market economies, such as wide-spread traditional value systems (including collectivist, particularist, family-oriented values, and religion). These informal institutions continue to remain as an important factor impacting the development of the countries in the region.
The Central and Eastern European economies' political, economic and social evolutions are also strongly affected by the growing integration of some of the countries in the region with the European Union. These institutions of regional integration include EU-conform regulations, the enforcement of property rights, the enforcement of the free flow of products and resources, specific anti-inflation measures, EU promotion of economic growth and local competition, and the monitoring and pressure for prudent fiscal policy. The level of institutional change that is required to fulfill the criteria for membership in the EU is an important element of transition. The CEE markets are in a number of different positions with respect to their ability to catch up to the economic environment of the European Union. However, even for those countries which aspire to complete integration, many remain burdened with unprofitable state-run enterprises, poor corporate governance and socialist era welfare programs. Several contributors to the literature on EU accession are less than optimistic about the entire process (Tupy, 2003). Researchers recognize that accession to the EU is neither a necessary nor a sufficient condition for economic growth, but rather the combined effects of market access and economic liberalization, not EU membership, optimize economic growth.This literature characterizes EU membership trade arrangements as a way of limiting the CEE countries' comparative advantages. Accession members may also be disadvantaged by future EU initiatives, such as harmonization of taxes, which could further reduce their competitiveness. The accession of the rest of the CEE countries into the EU also raises the issue of whether 'East' - 'West' industrial networks will be a factor that improves the growth prospects of an enlarged EU or whether they will deepen the differences in levels of development and undermine the prospects for cohesion in Europe (Radosevic and Rozeik, 2005; Radosevic, 2004, Radosevic, 2002).
As regards the relevant effects that CEE integration into the EU may have on the local business environment, some analysts (Dyker, 2001) suggest that the process of trade liberalization between the CEE countries and the EU started with the accession talks and will not change significantly in the year of accession to the Union. As regards scale and competition effects, the enlargement could have positive or negative effects. All the CEE economies are weighed down by problems of inflation and/or balance of payments deficits. Accession to the EU should offer an opportunity to resolve these problems. However, in the absence of well-defined national policies such effects may be severely limited.