Transition economies and European integration: Role of the state and the banking sector

Transition economies in Central and Eastern Europe have already completed the initial stabilization reforms and initiated the process of accession to European political and economic structures. Nonetheless, consensus exists that transition reforms are not complete. The state continues to exhibit a substantial influence over production activities. The banking and enterprise sectors face significant adjustments, particularly in light of increased competition due to European integration. ^ These aspects of transition from plan to market have not been thoroughly investigated in economic literature. In particular, the impact of structural and institutional reforms on macroeconomic policies has not been addressed explicitly and was not placed in the context of European integration. In this dissertation, we attempt to analyze what impact the not fully developed banking sector or incomplete enterprise restructuring may have on achieving transition economies\u27 goal of economic integration. Since the experience of transition economies after several years of reforms is analyzed, a transition economy possesses basically the same structure as a small market economy with two exceptions: certain goods continue to be produced by state-owned enterprises and the government induces production in the state sector through various subsidies. ^ We find that these differences may have a significant impact on the process of economic integration in transition economies, as they likely lead to continued reallocation of resources towards less productive uses. This is due to distortions in the labor markets and the banking sector, which occur with the introduction of the subsidies. Economic agents may exploit these distortions after the integration takes place, as capital flows will have to be completely freed. However, eliminating these distortions is socially and politically costly; outside pressure (such as the EU or the EMU accession requirements) may be necessary to fully restructure enterprises and develop the banking sector.