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stood at 72 percent of their 1995 value, Romania stood at 107 percent and Hungary’s exports skyrocketed to 236 percent of their 1995 level.

Although in 2000-03 the time profile of developments in exports of these countries has become roughly similar, with Bulgaria’s growth on par with that of Hungary and below that of Romania, the losses incurred in 1992-96 turned out to be very difficult to recover. Romania’s export growth during the 1999-2003 was much stronger than that of Bulgaria. The gap between these two countries has been increasing in favor of Romania every year since 1995. During Romania’s recent expansionary period over 1999-2003, Romanian exports recorded the third fastest growth among European transition economies.<sup>8</sup> The differences between three countries stem from differences in economic policies. Hungary, which consistently stayed the reform course, outperformed both Bulgaria and Romania. While there were not significant differences in approach taken initially to economic reforms, Bulgaria had a clear disadvantage, i.e., huge sovereign debt incurred before the collapse of central planning. In addition, it had looser macroeconomic policies and state owned enterprises had easier access to bank credits.

The seeds of subsequent economic collapse of Bulgaria in 1996, planted several years earlier, were apparent in three important features in Bulgaria’s export performance prior to the crisis that set it apart from Central European radical reformers. First, exports to the EU contributed much less to overall export recovery than in CEEC-3 economies (see Section 2.C below). Second, different products in terms of factor intensities drove the overall export recovery. Last but not least, Bulgaria’s export performance turned out to be non-sustainable over a longer period of time, as exports collapsed in 1996 setting Bulgaria apart not only from CEEC-3 countries, but also Romania.

The reasons for the collapse were rooted in aborted first-generation reform measures and the absence of structural, second-generation reforms. More specifically, the failure to introduce hard-budget constraint on SOEs combined with various schemes of privatizing stream of benefits from state-owned assets has led to the meltdown of the banking sector and the collapse of the economy. Consider first that the Bulgarian ‘melt-down’ in 1996-97 cannot be explained by historically high dependence on ‘socialist trade.’ For instance, Baltic States were more dependent on this trade than Bulgaria and experienced higher decline in output (Table 2). But none of them experienced the second transformational recession, as all the contraction occurred during the period following immediately the demise of central planning.

Although there appears to be a strong positive correlation between the size of contraction in output and the share of CMEA exports before the demise of the CMEA, the “pre-transition” level of dependence on socialist markets fails to explain considerable variation in output decline among CEEC-10. This seems to suggest that policies did play an important role. Consider the following. Despite its low level of trade with CMEA countries in 1989, the contraction in Romania’s output was higher than that of several other CEECs (e.g., Hungary and Poland) with much higher exposure to CMEA markets. Bulgaria registered similar contraction in output as Estonia, albeit the latter was much more heavily depended on socialist trade. Hence, reforms and good policies appear to have weakened the negative impact of initial conditions.

Yet, their absence raised the cost of adjustment. Consider first that higher level of dependence on trade with CMEA suggest that a much larger share of industrial output would face more challenging conditions of switching sales to ‘real’ fully contestable world markets. Second, the absence of shift to hard budget constraint was bound to create not only rapidly expanding 8 For an extensive discussion of Romania’s trade performance and its drivers, see World Bank (2004) and Kaminski and Ng (2004).