Efficiency Cost of Fiscal Equalization: The Case of Belarus

Belarus is the last command economy left standing in Europe. Because it still has an option of a gradual transition ("Chinese style'"), the study of Belarus’ case can present insights on the counterfactual to the "shock therapy" approach undertaken by the rest of the Central and Eastern European countries. However, the viability of the existing system hinges on its ability to weather short-term external economic shocks and to adjust to a significant list of medium term structural challenges. Now that more than half of Belarus’ consolidated public expenditures, excluding social security, takes place at the subnational levels of government, its ability to adjust largely hinges on the incentives that the system of intergovernmental relations presents to subnational officials. Belarus' experience with the recent recurrent macro-economic turmoil suggests that the incentives embedded in the system of intergovernmental fiscal transfers might hinder its ability to undergo fiscal adjustment and consolidation. Thus, since 2008, Belarus underwent one of the largest contractions in the size of government in the region, with public expenditures contracting by 12.9 percentage points of GDP and finally dropping to 37 percent of GDP at the end of 2011 (Figure 1).