A method for indicating economic transition with an application to Albania
Eastern Economic Journal, Fall 2002 by Hallwood, C Paul
This paper offers a method for assessing progress towards a market economy in transitional economies and applies that method to a largely overlooked economy, Albania, in the early stages of its economic reform following the fall of communism in 1992. The macroeconomic model outlined below allows for an increase in the role of relative prices, a major feature of transitional economic policies designed to promote efficient resource allocation. Specifically, we introduce relative prices in the form of the real exchange rate, which, apart from affecting a country's international competitiveness, measures the ratio of prices of nontraded goods to traded goods. As such, the real exchange rate affects very broad classes of goods, and is an important relative price in a transitional economy opening itself to the world economy.
A feature of our approach, which we exploit in our econometric modeling, is the interdependence of macroeconomic and relative price (or real exchange rate) equilibrium. Thus, the equilibrium real exchange rate is determined by the equilibrium relative prices of traded and nontraded goods in microeconomic equilibrium as well as by simultaneous internal and external balance in macroeconomic equilibrium. This is contrary to the strictly internal-external balance models of, for example, Allen and Stein [1995], Corden and Neary [1982], and Dornbusch [1973]. In fact, it is possible for an economy to be in macroeconomic equilibrium-operating at full employment with stable prices-while the level of the real exchange rate is more or less indeterminate. This would be the case in a centrally-planned economy, which was, in effect, ignoring relative price signals in resource allocation, or, in a transition economy where relative prices were yet to play a major role in resource allocation. However, as relative prices become incrementally more important in the allocation of resources, it becomes possible to talk about the "set of equilibrium relative prices"-which we proxy with the equilibrium real exchange rate.
What is important about this is that the equilibrium real exchange rate creates a "center of gravity" to which we expect the observed real exchange rate to gravitate. In a statistical sense, therefore, we expect that when relative prices have become important in a country's resource allocation, the real exchange rate will be mean-reverting.
But when relative prices are not yet much involved in resource allocation-as when reform policies have been inadequately applied-the real exchange rate need not be mean-reverting; indeed, it may follow a random walk. The assertion that relative prices, as measured by the real exchange rate, should be mean-reverting is nothing more than a statistical statement of a fundamental theorem in economics: if markets are "working" then prices will tend towards the equilibrium. An advantage of using Albania as a case study is that transitional economic policies were from the outset introduced unusually quickly [Clunies-Ross and Sudar, 1998], so that price signals were perhaps less confounded by vestiges of central planning than in some other transition economies.
Two problems could confound a statistical test of mean reversion of the real exchange rate. First, even when transition to a market economy has progressed quite far-that is, when relative prices are playing an increasingly important role in the transitional economy-the level of the equilibrium real exchange rate may itself be subjected to a series of shocks, so that mean reversion is not observed. However, neither shocks nor strongly statistically significant trends in the equilibrium real exchange rates of several Eastern European countries during the early stages of their transition were found by Begg, Halpern and Wyplosz [1999], Halpern and Wyplosz [1997], or Krajnyak and Zettelmayer [1998]. Secondly, macroeconomic stabilization policies may interfere with transition polices, temporarily preventing the observed real exchange rate from moving toward its equilibrium value. For example, inflationary monetary policy may so affect the nominal exchange rate that it is monetary policy, and not transitional structural policies, that drives the observed real exchange rate. For this reason we have estimated a monetary model of the lek's nominal exchange rate and find that monetary policy, more specifically the monetary-fiscal policy mix, in our data set was in fact well-behaved in Albania. This probably explains why in our data, according to the coefficient of determination, variation in the nominal exchange rate explains only about 37 percent of variation in the real exchange rate. Thus, the nominal exchange rate is by no means the only factor driving the real exchange rate, leaving for room for it to be also influenced as we hypothesize.
Our examination of Albania's real exchange rate, shown in Figure 1, continues as follows: we offer some stylized facts about the Albanian economy, followed by an outline of our macroeconomic relative-price model. We continue by discussing the determinants of the real exchange rate over successive stages of transition. We then discuss how we investigate the behavior of the lek's nominal exchange, and follow with a description of data sources. After a brief discussion of econometric methods we present tests for the stationarity of our real exchange rate time series followed by our results from estimating a monetary model of the nominal exchange rate.
ALBANIA'S EARLY ECONOMIC TRANSITION-SOME BACKGROUND
Politically, the rise to power of the non-communist Democratic Party of Albania during the general election of March 1992 was a watershed event in Albania. At this time, economic policy veered from acute central planning towards important marketoriented reforms.' Following severe declines in GDP from 1990 to 1992, high inflation in 1991 and 1992, and enormous fiscal and balance-of-payments deficits beginning in 1990 [IMF, May 1994], comprehensive price and trade-system reforms were quickly introduced. Also, new fiscal and monetary measures were aimed at stabilizing the macroeconomic economy. A "central role was assigned from the outset to price, exchange and trade liberalization" [IMF, May 1994, 158]. Structural reforms were to be phased in over several years covering, privatization of farmland and most public enterprises, as well as financial sector reform. Very quickly the small retail and service sectors were almost completely privatized; the construction sector was extensively privatized. Large industrial units remained publicly owned, but became subject to a harder budget constraint than formerly.
In October 1994 the IMF commented that "Albania had been successfully implementing a comprehensive economic adjustment effort since mid-1992" and "program policies have been implemented broadly as intended" [October 1994, 329]. That is, privatization objectives had been largely achieved, "sweeping price liberalization measures" had been implemented and foreign trade and foreign currency systems had been liberalized. Furthermore, under the terms of the IMF's second Enhanced Structural Adjustment Facility loan of September 1994, Albania was expected to proceed with further structural reform of the large public enterprises and the banking system, as well as to create a legal framework for a private enterprise economy.
According to the European Bank for Reconstruction and Development (EBRD) [Aoki and Kim, 1995], by 1994 Albania had moved 50 percent of its GDP production onto a private-sector basis-more than Bulgaria, Moldova or Romania, and only slightly less than the acknowledged reform-minded Hungary. Also according to the EBRD, Albania had achieved "market economy" status in trade and foreign exchange reform, and these reforms had progressed more than in any other sectors.
Typical of other eastern and central European transition economies, reform of Albania's nontraded goods sector (for example, public utilities) lagged its traded goods sector. There were various reasons for this: everything could not be done at once, IMF conditionality favored reform of other sectors first, and retention of the public utilities in public ownership could be used to cushion the harshness of market reforms which were expected to increase sharply the rate of unemployment.
Yet even with economic reform underway, market-failures abounded. For example, restructuring of companies to give efficient corporate governance had hardly progressed. Similarly, little progress had been made in shaping banks into efficient financial intermediaries. From 1993 Albanian companies increasingly used pyramid borrowing schemes to raise funds. In essence, companies attracted funds by paying very high rates of interest-10 percent per month and more, and were able to do so only by attracting ever more depositors. Even if the fraudulent element of pyramid borrowing is overlooked (that is, depositors' savings were simply stolen) its existence is a symptom of severe problems with the system of financial intermediation in Albania. Banks are supposed to be the specialist financial intermediaries that reduce adverse selection and moral hazard risks. Absent an efficient banking system and other means of reducing adverse selection and moral hazard, such as disclosure laws, financial intermediation is almost bound to be inefficient. Thus, the widespread use of pyramid schemes in Albania reflected a structural weakness. This was a weakness that had bitter political implications. The breakdown of the pyramid schemes led to rioting and the severe disruption of legal order in 1997. Exactly which date marks the end of Albania's early transition is difficult to determine. It was certainly possible to say that progress had halted sometime in 1997. But we have chosen an earlier date, summer 1996, when milder signs of social breakdown under the strains of transition were already becoming apparent.
MACROECONOMIC BALANCE
HASH(0x1022eedd0)
CONCLUSIONS
We have argued that in a transitional economy the real exchange rate, determined by the relative abundance of traded and nontraded goods, is a key relative price in both microeconomic and macroeconomic equilibrium. Furthermore, we have argued that both the equilibrium real exchange rate and the volatility of the nominal exchange rate are likely to be impacted by the introduction of economic liberalization policies.
In our country application, we have found strong evidence of mean reversion for the real value of the Albanian lek exchange rate for the transitional period from 1992 to 1996. In terms of the theoretical analysis presented in this paper, and given the relatively low correlation between the lek's nominal and real exchange rate, this result suggests that the reform process had been effective for Albania until the beginning of civil unrest from mid-1996. That is, the real exchange rate has provided a "center of gravity" or an attractor for relative prices. Furthermore, our estimate of a monetary model of the nominal lek exchange rate found undershooting, which also supports the view that economic reform was progressing well.
http://www.findarticles.com/p/articl..._n9137220/pg_2
Pėrgjigju Duke Cituar
Krijoni Kontakt