The development of services in transition economies

Table of Contents

1 Introduction

2 Background
2.1 Services - A definition of the tertiary sector in developed market economies
2.2 Economic features of planned economies and the relevance of services

3 The development of services in the domestic and international trade of transition economies
3.1 The growth of the service sector since 1990
3.2 Trade in Services

4 Contribution to Development Sustainability

5 Resume and Future Outlook

Bibliography

Appendix

1 Introduction

It is by now more than a decade ago that the formally centrally planned economies in Central and Eastern Europe have started to transform into market economies when the collapse of the Soviet system was confirmed in 1989. In fact, they constitute a unique historical example with a large set of economies undergoing this extremely drastic systemic change within a very short period of time. The adoption of a new model based on free market economy supports the rebuilding of one Europe which will benefit from high economic and social growth potential as well as political stability and security.

One essential characteristic of a free market economy is, as will be outlined in the paper, a high proportion of services. Realizing this quality in the transition economies signifies a great challenge as their service sector was extremely underdeveloped in the planned economies. One reason was this deficiency was the excessive supply control of the government which failed to respond to growing demand for services and entirely neglected sectors such as financial, business, and real estate services.

The rapid development of the service sector as a feature of the world’s economic development over the last thirty years suggests the question whether the post-communist economies today have followed this trend or whether they are still characterized by a higher share of the industrial sector and less services due to the preference of central planners for (heavy) industry and the distinct negligence of services which has weighed heavily on the costs of transition.

In fact, aggregated country data reveals that the service sector in transition economies has turned to be a major platform for enterprise start-ups which seek to deliver market-driven products to the consumers. Furthermore, services are expected to play a vital role in coping with unemployment in relation to industrial restructuring.

In this paper, the question mentioned above will be addressed by depicting the development of the service sector in the transition economies of Central and Eastern Europe on the background of the economic characteristics of their socialist past. In this portrayal, both domestic growth and international trade of services will be accounted for. Finally, it will be discussed in which way the service sector represents a strong impetus in the fight against unemployment and hence contributes to a sustainable development in the future.

2 Background

2.1 Services - A definition of the tertiary sector in developed market economies

Services are broadly defined as consisting of all economic activities other than agriculture, mining, manufacturing, construction and electricity, gas and water (utilities) whereas service providers are the enterprises whose main purpose is the rendering of services (United Nations 2001, p. 6).

The service sector – often dubbed tertiary sector besides the agriculture (primary) and industry sector (secondary) - comprises intangible goods, on the one hand such well-known as the government, education and health, on the other hand such new as modern communications, information, and business and financial services. Characteristically, producing services involves the provision of human capital in the form of labor, knowledge and skills while it is likely to require less natural capital and more human capital than producing agricultural or industrial goods. Services can be either based on high technology and advanced service or on large quantities of low-skilled labor.

In comparison to goods, services have the following four characteristic features (Fidrmuc 1997, p. 8) :

1. Services are non-storable and thus have to be produced and consumed simultaneously at the same time and at the same location.
2. Many services are non-tradable.
3. The quality of services can only be assessed after the consumption because of their intangibility which leads to problems of asymmetric information; the sale of services strongly depends on the experience and credence of the buyer which enhances the role of the reputation of the provider of services.
4. Due to the existence of market failures associated with e.g. imperfect information and competition, services are regulated in most countries.

The costs of (knowledge-based) services are, contrarily to those of manufacturing, mostly composed of high inputs of qualified labor whereas production costs are negligible.

In the modern economy the appearance and growth of services seem to be the result of the total reorganization of the economy. There is a symbiotic relationship between goods and services as many manufactured goods include a substantial service component, for example software. Simultaneously, services stimulate growth outside the service sector and productivity increases due to these linkages among services and other activities.

Like that, an efficient service sector is often viewed as a prerequisite for economic growth. Especially knowledge-based services, named strategic business services, are a powerful drive to upgrading the educational level and skills of employees (see 4).

Strategic business services (SBS) is a sub-sector of the service sector including computer software and information processing services, R&D and technical services, marketing services, business organization and human resource services. These services determine the competitiveness of an industry and represent a decisive source of growth and dynamism of companies. Developed countries benefit from the expansion of SBS in terms of efficiency and employment while SBS impact both services and manufacturing sectors (OECD 1999).

The type of strategic service industry which is central to economic development and facilitates the production and distribution system, especially financial, retail, transportation and communication, is often referred to as organizational service. In providing network-style connections, these services generate externalities in their use, which are strongly positive in the early stages of development but diminish and may even turn negative as the network matures. This phenomenon can be observed in the telecommunications industry where the externalities, created by scale economies in the provision of services, are largely positive until the economy becomes “saturated” (Rask 1994, p. 469).

The process of economic growth and the increase of efficiency of the economy is related to the relative growth of importance of the service sector, although there is no linear interdependence. However, there is no developed market economy in which the service sector has not grown in the last two decades and does not constitute a significant part of the national economy.

2.2 Economic features of planned economies and the relevance of services

Marxist roots evolved first in the Soviet Union and later in the other European countries that constituted the “social camp”: Albania, Bulgaria, Czechoslovakia, the German Democratic Republic (GDR), Hungary, Poland, Romania, the Soviet Union and Yugoslavia. As widely perceived, neither the doctrine of communism nor its way of implementation was home-grown in most of these countries but has been imposed from the outside, namely by the Soviet Union as a consequence of World War II. Communism aspirations in Russia and the Soviet Union were the result of a long historical struggle to overcome their backwardness in terms of the level of economic development and wealth-generating capacity from manufacturing activities. Especially Russia only had a limited capacity for catching up with countries which had successfully gone through an industrial revolution, and thus approached their goal of reaching par with the stronger states of western Europe.

After World War II, there were three economic classifications to be distinguished by communist doctrine: agrarian (Albania, Bulgaria, Rumania), industrial-agrarian (Hungary, Poland, Soviet Union) and industrial (Czech Republic, GDR).

In general, economic growth and development consists greatly of a progressive division of labor throughout the production and distribution systems which splits a cohesive whole into various separate operations. However, according to the heritage of socialist countries these essential service functions were supplanted with a command structure in which development of independent service industries lags behind that of manufacturing and agriculture (Rask 1994, p. 467). Thus, the broken connections resulting from labor division were replaced by commands from the centre, rather than by efficient organisational services which did not arise as a result of a profit-making opportunity but as part of an overall plan for the economy. It was ignored that efficiency in the manufacturing and agriculture sectors as well as in the market system itself requires an efficient service industry.

Hence, all the socialist economies were strongly controlled by the government who initially refused to respond to a growing demand for services. Modern services such as financial or business services were unnecessary under socialism and there was no need for the legal and institutional framework which underpins a market economy.

Without services such as transport, banking, computer software, financial services which are at the core of an efficiently operating market system, a reasonably modern industry in a market environment cannot survive. In contrast, paradoxically, striving to create a private market structure, services tended to be the least developed, least appreciated, and most unbalanced sector of countries in early transition. The services inherited from state socialism were rudimentary and were not suited to assist the emerging private sector under market conditions in any way. Like that, distribution and insurance were just two examples of services which were undercapitalized, understaffed und thus only poorly developed. Other basic sectors like accounting, legal and travel agencies were even less established or non-existent. Public transportation and telecommunication services (e.g. telephone, fax) were decisively unreliable whereas the latter was often only available for a minority of the population. Private transportation, too, was rudimentary and incapable of handling its role in the economy. The entire retail, hotel, café and restaurant infrastructure was scarce and of poor quality and thus had to be developed from infancy.

In other areas, such as basic education, a strong and broad base already existed which facilitated the rapid assimilation of strategic services such as information-based industries.

At the start of the transition the service sector in the CEEC accounted for only 30-40% of the GDP produced in these countries which is about half of the rate in the industrialized countries. As a consequence this relative underdevelopment of services, the economy as a whole was characterized by low efficiency and low growth of productivity.

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