Beware the macroeconomic iceberg hiding in unchartered political waters
This blog has been co-authored by Caroline Freund and Melise Jaud.
As Arab countries mark the two-year anniversaries of their revolutions, economic challenges remain sharp, and the current political and policy uncertainty make it difficult to forecast how growth will evolve over the longer run. One way to reduce some of the guesswork is to look at what has typically happened in other transitions. In a recent paper, we identified and examined 90 attempts at transition from autocracy to democracy that took place over the last half century.
Our results offer a cautiously optimistic outcome for the Arab countries: most transitions are successful politically and/or economically. In particular, we find that 45 percent of transitions were rapid and complete, 40 percent were rapid but incomplete, and 15 percent achieved democracy gradually. Rapid is when the political change is completed within 3 years, complete is when a high level of democracy is achieved and maintained; incomplete is when the political change is rapid but democracy is achieved temporarily or only at very low levels.
One important message from these diverse experiences is that transition presents economic challenges, but recovery comes relatively rapidly in both complete and incomplete transitions, when resolution is rapid. As illustrated in Figure 1, for both rapid complete and incomplete transitions, growth typically dips for one or two years before it returns to or exceeds previous levels. Average income growth from three years before the decline to the point of lowest growth declines by around 11 percentage points (pp) for complete and rapid transitions and 7 pp for incomplete transitions (Figure 1 panel b). When the transition is gradual, economies tend to be both hit harder and longer. Growth declines on average by 21 pp during transition and remains negative for at least five years following the initiation of the transition.
But it is the effect of the type of transition on long-term growth that is most distinct. Countries that transit swiftly experience a significant long-run growth acceleration of 0.9 to 1.4 percentage points, comparing post-transition average growth to pre-transition average growth. In contrast, gradual transition is typically associated with a sharper downturn and a longer period of weakness.
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Why does the speed of transition matter more for economic prospects than the outcome of transition? The answer is that most gradual transitions are gradual by default not by design, with political transition happening in fits and starts, resulting in elevated political and policy uncertainty for many years. This gives investors, employers, and consumers the incentive to wait and see what will happen before risking capital.
A typical example is Romania, one of only two Eastern European countries that transitioned gradually. At issue was the 1990 election of the National Salvation Front, comprised of high-ranking officials from the ousted communist party. Numerous protests followed, some of which turned violent. The resulting uncertainty about Romania’s direction as well ongoing social unrest coincided with extremely poor economic performance. From 1991-1999, Romania’s GDP shrank nearly 2 percent on average each year, as compared with near zero growth for Hungary and almost 4 percent growth for Poland, two former communist countries with rapid and complete democratic transitions.
Importantly, there are some exceptions to this rule. Of fourteen gradual transitions, one was accompanied by strong economic performance, Ghana. In Ghana, a predictable but slow political transition coincided with ongoing economic reform. Political freedoms were granted little by little, beginning with free press, allowing human rights organizations, and elections in 1992. Then the elected President stepped down after serving two terms in 2000 as the constitution mandated, and the opposition party won elections. Importantly, during this period, President Rawlings continued with the economic reform that had brought Ghana the highest growth in West Africa in the late 1980s, and growth remained over 5 percent throughout the transition period. Ghana, gradual by design and not default, is the exception that proves the rule.
There may be a lesson here for the post-revolution countries in the MENA region. Open and unchartered political waters are enticing, but they may obscure the macroeconomic iceberg lurking beneath. A reasonable level of predictability is a prerequisite to growth. This means carefully plotting the direction of the transition, including all key stakeholders, announcing the route in advance, and sticking close to it.