[3] In essence, one transition mode is the functional restructuring of state institutions from being a provider of growth to an enabler, with the private sector its engine.
Rationing of essential consumer goods, trade quotas and tariffs and an active monetary policy to ensure that there was sufficient liquidity to maintain commerce might be needed.
The strategy was strongly influenced by IMF and World Bank analyses of successful and unsuccessful stabilization programmes which had been adopted in Latin America in the 1980s.
The strategy incorporated a number of interdependent measures including macro-economic stabilization; the liberalization of wholesale and retail prices; the removal of constraints to the development of private enterprises and the privatization of state-owned enterprises; the elimination of subsidies and the imposition of hard budget constraints; and the creation of an export-oriented economy that was open to foreign trade and investment.
Stabilization was deemed a necessity in Hungary and Poland where state budget deficits had grown and foreign debts had become larger than the country's capacity to service.
Western advisers and domestic experts working with the national governments and the IMF introduced stabilization programmes aiming to achieve external and internal balance, which became known as shock therapy.
They tended to support privatization without prior industrial restructuring; an exception was to be found in Eastern Germany where the Treuhand (Trust Agency) prepared state-owned enterprises for the market at considerable cost to the government.
It had been expected that the introduction of current account convertibility and foreign trade liberalization would force a currency devaluation that would support export-led growth.
As imports grew and exporters failed to respond to opportunities in world markets due to the poor quality of their products and lack of resources for investment, the trade deficit expanded, putting downward pressure on the exchange rate.
The central banks in several countries raised interest rates and tightened credit conditions, depriving state agencies and enterprises of working capital.
The Central and Eastern European economies began growing again around 1993, with Poland, which had begun its transition programme earliest emerging from recession in 1992.
[17] High interest rates induced a "credit crunch" and fuelled inter-enterprise indebtedness and hampered the expansion of small and medium-sized enterprises, which often lacked the connections to obtain finance legitimately.
Although the foundations had been laid for a functioning market economy through sustained liberalization, comprehensive privatization, openness to international trade and investment, and the establishment of democratic political systems there remained institutional challenges.
[20] Ten years on, in the Transition Report for 2010, the EBRD was still finding that the quality of market-enabling institutions continued to fall short of what was necessary for well-functioning market economies.
The EBRD expressed concerns about regulatory independence and enforcement, price setting, and the market power of incumbent infrastructure operators.
The slowdown hit government revenues and widened fiscal deficits but almost all transition economies had experienced a partial recovery and had maintained low and stable inflation since 2012.
Some nations have been experimenting with market reform for several decades, while others are relatively recent adopters (e.g., North Macedonia, Serbia, Montenegro), and Albania.
In some cases reforms have been accompanied with political upheaval, such as the overthrow of a dictator (Romania), the collapse of a government (the Soviet Union), a declaration of independence (Croatia), or integration with another country (East Germany).
Mr Tanzi stated that these spending programs must be financed from public revenues generated—through taxation—without imposing excessive burdens on the private sector.
[29] According to the EBRD a well-functioning market economy should enjoy a diverse range of economic activities, equality of opportunity and convergence of incomes.
However economic reform had slowed in areas such governance, enterprise restructuring and competition policy, which remained substantially below the standard of other developed market economies.
[33] Over the decade 1994 to 2004, the transition economies had closed some of the gap in income per person with the average for the European Union in purchasing power parity terms.
However the rapid growth rates of that period of catch-up had stalled since the late 2000s and the prospects for income convergence have receded according to the EBRD's prognosis, unless there are additional productivity-enhancing structural reforms.
[34] The recent history of transition suggested that weak political institutions and entrenched interest groups had hindered economic reform.
The report acknowledged that the academic literature was divided on whether economic development fostered democracy but argued that there was nonetheless strong empirical support for the hypothesis.
Countries with a strong institutional environment – that is, effective rule of law, secure property rights and uncorrupted public administration and corporate governance – were better placed to attract investment and undertake restructuring and regulatory change.
In a wider sense, the definition of transition economy refers to all countries which attempt to change their basic constitutional elements towards market-style fundamentals.
Their origin could be also in a post-colonial situation, in a heavily regulated Asian-style economy, in a Latin American post-dictatorship, or even in a somehow economically underdeveloped country in Africa.
In addition, in 2002, the World Bank defined Bosnia and Herzegovina, and the Federal Republic of Yugoslavia (later Serbia and Montenegro) as transition economies.
The five states deemed to have made the most progress (Poland, Hungary, the Czech Republic, Slovenia and Estonia) - constituting the Luxembourg Group - were invited in July 1997 to begin accession negotiations (these began in March 1998).