Abstract: Nowadays Bulgaria is known as a former communist country that went through a transition period to a free-market economy. On November 10, 1989, a day after the fall of the Berlin Wall, the Central Committee of the Bulgarian Communist Party made the decision to strip Todor Zhivkov of his power. Bulgaria and the German Democratic Republic were not the only then communist countries whose governments collapsed in November 1989. Other Eastern Bloc countries went through the same in that month and the months after. What is the transition period? Does it vary on a case-by-case basis? If yes, which kind of transition is the best, if any? How are transition countries compared? What happened in Bulgaria during its transition period from a socialist economy to a free-market economy? How did the Bulgarian economy transition compared to some of the other transition economies?
This paper aims at answering these and similar questions. Part one explains the two different approaches on transition – shock therapy and gradualism – including how successful they were in several countries – Russia, China and Poland, picked on a random basis as positive or negative examples of one of the two approaches. Part two discusses the case of Bulgaria compared to other transition economies. Part three draws a conclusion on the case of Bulgaria from the conducted research.
Shock therapy or gradualism
When we talk about transition periods in the world of politics, we may refer to it as cultural, economic, political or social transition. In this paper, the transition period is referred to as the economic transition from a socialist centrally planned economy to a free-market economy in former communist countries including Bulgaria.
Two approaches are most commonly known about the transition period – shock therapy and gradualism – with the former referring to a fast transition period including sudden price liberalization and privatization of state-owned enterprises (SOEs) and property, and the latter referring to a slow transition period. (Aziz 2006) Shock therapy, whose architect is former Minister of Economy and Finance of the Russian Federation Yegor Gaidar, and was strongly approved of by the International Monetary Fund (IMF), also has another goal – to make the transition to a free-market economy irreversible. For that purpose, the shock therapy approach stood on four pillars – liberalization of prices, privatization of state property, elimination of state monopoly on domestic and foreign trade, and macroeconomic stabilization, each of which has to be implemented simultaneously. (Gidadhubli, Mohanty 2002; Marangos 2003) Macroeconomic stabilization is referred to as the stabilization of the value of the currency attained by cutting government spending. (Aziz 2006)
Transition from a centrally planned economy to a free-market economy includes privatization of state-owned assets. The term privatization is generally referred to as the transfer of state-owned assets into private hands, leading to the growth of the private sector at the expense of the public sector to the extent that the private sector becomes the dominant one in an economy, and its further growth is also encouraged by business-friendly policies and safe political, social and economic environment for investments. In cases of forcefully taken private property, privatization is referred to as the return of state-owned assets to its previous owners. (Bitzenis 2003; Aziz 2006)
Together with privatization comes restructuring in the transition process or the reform in the public and the private sectors of the economy. In the public, or government, sector restructuring during a transition period is referred to as adopting laws, regulations and policies that would encourage a more business-friendly environment and would improve efficiency in the government, whereas in the private sector restructuring during that period is referred to as businesses’ adopting policies and strategies that would improve efficiency in their day-to-day operations. (Bitzenis 2003) In other words, both sectors would conduct reforms within themselves in order to adapt to the new economic conditions, and therefore become sustainable or they would risk collapsing quickly, as the case of Bulgaria will show later in this paper.
Restructuring may be observed before, during or after privatization. With the case of state-owned enterprises (SOE), it matters whether their restructuring comes before or after privatization. If restructuring happens before privatization, a characteristic of the gradualist approach, the government will spend more on an SOE in order to maintain the latter’s position in the market and also in order for the government to maximize revenues. (Bitzenis 2003)
Common sense tends to indicate that the shock therapy approach is better than the gradualist approach. The dominant private sector creates jobs keeping the unemployment rate down while also bringing more revenue to the government due to the government’s implementation of a more business-friendly environment. That business-friendly environment includes low taxes, less but fair regulations, low crime rate and efficient government. Moreover, the government will not be spending on unprofitable SOEs which will be either private or shut down due to bankruptcy or unprofitability to the owners.
The shock therapy approach also had its success stories. In fact, it was first applied in Poland as part of the country’s stabilization and liberalization program which was initiated on January 1, 1990 by then Finance Minister of Poland Leszek Balcerowicz. (Marangos 2003) With inflation rate at 244 percent in 1989 and 640 percent in 1990, low wages and overall economic decline, the country had its first parliamentary elections after peaceful talks between the Polish Communist Party and the democratic opposition. (Jeffries 1993) The Communist Party largely lost the election.
The transition program in Poland was named after Leszek Balcerowicz – the Balcerowicz Plan. It comprised of ten bills in an effort to attain a free-market economy as soon as possible in Poland. The ten bills established procedures for bankruptcy by unprofitable enterprises, prohibited printing of money by the Polish Central Bank in order to finance budget deficits and for other purposes, tied interest rates to inflation rates, abolished preferential lending terms for state-owned companies, curbed pay raises in the public sector above the price growth, implemented uniform tax rules, required companies to sell all foreign currencies to the state, established uniform customs rate on imports, determined the employment agencies’ responsibilities, and guaranteed temporary unemployment benefits. (Warsaw Voice) The transition period in Poland started with increased unemployment rate and recession but the country soon witnessed economic growth, all of that, as it may be speculated, was thanks to the combination between a shock therapy approach and the Balcerowicz Plan.
However, the cases of Russia and China indicate the exact opposite. Russia went through a shock therapy, while China went through a gradualist approach, and most economists expected that Russia will have a way more successful transition period than China. (Aziz 2006) Russia had a more urban and educated population, and more natural resources than China, yet for the course of eight years after 1989 the two countries’ real gross domestic products (GDP), measured in 1987 dollars, were nearly mirrored – from about $700 billion in Russia and $300 billion in China in 1989 to $700 billion in China and $400 billion in Russia in 1997. (Aziz 2006)
At the end of the 1980s Russia was the largest producer of oil, gas, coal, wheat and other goods. (Aziz 2006) Meanwhile, only 2 percent of its population lived in poverty. (Stiglitz 2003)
However, by 1997-1998 poverty level in Russia increased twenty-fold to the shocking 40 percent. (Stiglitz 2003) Meanwhile, prices rose by a lot more than what Yegor Gaidar and Russian President Boris Yeltsin publicly predicted or tried to reassure the public with. According to Mr. Gaidar, prices would rise to only 200 percent, while just two months after the price liberalization on January 1, 1992 the average rise of prices in consumer goods was between 400 and 500 percent, compared to merely a 300 percent average growth in working people’s income thus forcing millions of Russians to take from their savings to make ends meet. (Gidadhubli, Mohanty 2002) In theory, the shock therapy approach includes rise in unemployment and reduced living standards but as long as microeconomic and macroeconomic reforms are implemented simultaneously. (Marangos 2003)
The price hikes led to hyperinflation and devaluation of the ruble, the Russian currency, a contrary scenario to the shock therapy approach’s fourth pillar – macroeconomic stabilization. For the first four years only – between 1992 and 1995 included – annual inflation rates in Russia were 2,509 percent, 840 percent, 215 percent, and 131 percent respectively. (Gidadhubli, Mohanty 2002) In fact, the ruble collapsed in August 1998. (Robinson 1999)
It is important to note that the privatization process in Russia included flaws that led to few benefiting from the transition period at the expense of the many who were left worse off than before the beginning of the transition period. Those few would later be referred to as oligarchs. (Gidadhubli, Mohanty 2002; Odling-Smee 2006; Aziz 2006, Robinson 1999) Privatization of SOEs and property in Russia was initiated by a decree signed by President Boris Yeltsin that entitled every citizen to a 10,000 ruble voucher with which they could buy shares in SOEs as part of the privatization program. The vouchers, which essentially had the function of bank checks that would have to be honored by the relevant institutions, were not personalized. Moreover, the 10,000 ruble value of the voucher was nominal, and there was no clarity on its real value besides the assurance by President Yeltsin and the privatization coordinator of his cabinet, Anatoly Chubais that it was worth two Volga cars, thus possibly encouraging Russians to participate in the mass privatization of SOEs. The final result of the mass privatization was the state-owned enterprises and property having ended up in the hands of very few individuals, the oligarchs. These oligarchs also took advantage of the outdated accounting system in the country and government connections to take the ownership of SOEs for very low prices. (Robinson 1999; Gidadhubli, Mohanty 2002)
It could be concluded that the shock therapy in Russia was conducted with lack of or delayed legislative reforms concerning privatization as well as lack of transparency in the privatization process, namely the value of the state property undergoing privatization and the real value of the 10,000 ruble vouchers available to every citizen in the country.
In contrast to Russia, China went through a more gradualist approach. (Hitt et al. 2004) The Chinese economic transition included a relative preservation of the authoritarian political system unlike in Russia whose planning mechanism, the Gosplan, was eliminated thus leaving the role of the state in the economic reforms almost entirely fictive (Gidadhubli, Mohanty 2002). The central government’s decision making role on economic matters weakened but a more indirect involvement was preserved and local governments were given more power. (Hitt et al. 2004; Aziz 2006) Also, it is important to note that unlike the Russian government, which was rather weak and relatively passive in its role in the transition period, the Chinese government provided preferential treatment to local firms that have business agreements with foreign firms. (Hitt et al. 2004; Yang 2005) Since 1978, when the economic reforms started in China, the Chinese government has given a preferential treatment toward foreign investors, namely the firms that open offices in China and partner with local firms. After the death of Mao Zedong in 1976 and the ascendance in power of Deng Xiaoping in 1977 the country started to open up for foreign investments implementing incentives for this purpose. (Wong 1987) Starting from the year 1980 up to the mid-1990s such firms were taxed on their income at a 33 percent rate, compared to domestic firms, taxed at 37 percent, that were not doing business with foreign firms before the taxation reform in 1994 that instituted a unified taxation. (Yang 2005; Aziz 2006)
Four so called Special Economic Zones (SEZs) – Shantou, Shenzhen, Xiamen and Zhuhai – were established in 1980 by the Chinese government. In these SEZs diverse economic activities between foreign and domestic business entities started to develop. These economic activities ranged from exports to imports, technical exchange, economic cooperation and others. (Wong 1987)
Besides the SEZs, the Chinese government under the rule of Deng Xiaoping gave price and ownership incentives to farmers, a policy that would give farmers the right to sell a portion of their crops on the free markets. This policy increased the portion of crops sold on the free markets from merely 8 percent in 1978 to about 80 percent in 1990 – a 10-times higher share in a little more than ten years. (Aziz 2006)
While the Polish transition serves as an example of a successful transition to capitalism by using the shock therapy approach, the Chinese transition to capitalism serves as an example of how a gradualist approach could be an option for a successful transition as well. Meanwhile, the Russian transition to capitalism serves as an invaluable example of how the shock therapy approach may eventually fail. By not establishing the regulations needed to promote competition and thus not attain a more genuine form of capitalism, the shock therapy approach may appear to be a failed transition policy. In a Russian style shock therapy approach, a different form of capitalism – controlled by the oligarchy – takes roots, together with the middle class and some businesses’ uncertainty about the long-term future of the business environment.
The case of Bulgaria
It is difficult to define whether the Bulgarian transition period followed the gradualist or the shock therapy approach. On the one hand, there was an instant price liberalization of more than 70 percent of commodities in 1989, a characteristic of the shock therapy approach. As a result of the price liberalization, prices increased by more than four times leading to an inflation rate of 330 percent in 1991. (Bitzenis 2003; Borensztein, Demekas, Ostry 1993)
However, the Bulgarian government conducted restructuring before privatization leading to increased spending on unprofitable SOEs, a characteristic of the gradualist approach. Spending on these SOEs led to an increase in debt and the creation of so called “bad loans” problems because of lack of revenues to cover budget deficits. (Bartlett, Rangelova 1997; Bitzenis 2003) This scenario, as mentioned earlier in this paper, is contrary to the shock therapy approach.
This kind of spending would lead the country to an economic, financial and banking crisis – a triple crisis – by 1996-1997, combined with a catastrophic inflation rate – hyperinflation – before a currency board was established that would stabilize the economy.
Bulgaria was comparatively slow on its privatization efforts, especially until 1997 before the establishment of the currency board which fixed the old Bulgarian lev to the German mark. The Bulgarian government enacted a law in 1992 on privatization that divided SOEs into three categories depending on their value: one category worth under 10 million old leva (BGL, the currency board would fix 1,000 BGL to the value of one German mark, and three two years after the establishment of the currency board the BGL will be redenominated whereby 1,000 BGL will be equal to 1 new Bulgarian lev, BGN (Bitzenis 2003)), another category worth between 10 million and 200 million BGL and a third category worth over 200 million BGL. A government agency, the Privatization Agency (PA), was in charge of the privatization of the second and third categories with the latter requiring the endorsement by the Council of Ministers, while the first category of SOEs, according to the law, was responsibility to be privatized by one of the five branch ministries. (Bitzenis 2003) As the official graph above shows, the PA had a better privatization record in 1998 and 1999 preceded by very weak privatization performance – less than half or a little more than half of that in 1998 – on the second and third categories for five years. In fact, 1999 was the only year when the PA attained its privatization forecast. (Bitzenis 2003)
Just like in Russia and the Czech Republic, mass privatization occurred in Bulgaria too, a characteristic of the shock therapy approach. However, the mass privatization program first started on December 19, 1995 after a three-year debate on its process. This date was comparatively late for a transition economy and therefore inconsistent with the shock therapy approach. The voucher privatization, also known as mass privatization, in the Russian Federation started in 1992, only one year after the beginning of the country’s transition period, while it started four years after the beginning of Bulgaria’s transition period. (Democracy 1997)
Data from the PA on the first wave of mass privatization indicates that 18 percent of the state property went into private hands after the first wave of mass privatization. That first wave lasted one year. The results brought mixed interpretations. On the one hand, this success rate might be perceived as positive considering the harsh and unstable economic and political conditions in Bulgaria, including the overall impression that the government was relatively unwilling to sell its property, but on the other hand it was less than what was anticipated from a mass privatization program. (Democracy 1997)
Privatization didn’t have much progress later either. By 1997, only 20 percent of the state property was privatized while the SOEs had largely been unprofitable. Apparently the Bulgarian government’s spending money on the SOEs didn’t bring much utility to Bulgaria if any, besides keeping unemployment rate down in the short run without worrying much about the long run. (Barlemann, Nenovsky 2003)
Instead, the socialist government led by Zhan Videnov from 1995 until 1997 granted its, otherwise formally autonomous, commercial banks – former branches of the Bulgarian National Bank (BNB), Bulgaria’s central bank – unrealistically high credit lines. These banks would later be bailed out by BNB by its purchase of government securities thus increasing the Bulgarian government’s internal debt and complicating its fiscal house. BNB would also use another monetary tool in order to keep SOEs afloat – giving credits (loans) to SOEs or the Ministry of Finance. (Barlemann, Nenovsky 2003)
Before the financial crisis started, the beginning of Bulgaria’s transition from a socialist economy to a free-market economy was accompanied by numerous hardships. The country had witnessed economic recessions until 1994 – the first year when its GDP increased. However, that increase was minuscule – only 1.8 percent, according to the National Statistical Institute (Dobrinsky 2001) – compared to the gigantic recession for the period between 1989 and 1993 of a decrease of 27.7 percent. The only somewhat good news about the data is that it does not take into account the private sector which was starting to establish itself in the country. One of the reasons for the economic decline at the beginning of Bulgaria’s transition was the U.N. embargo on Yugoslavia and the Iraq-Kuwait war. (Minassian 1998; Bartlett, Rangelova 1997) Yugoslavia and Iraq were then Bulgaria’s main trading partners.
In 1996 and 1997, as mentioned earlier, both a banking and a currency crisis occurred in Bulgaria after a continuation of the bad fiscal and monetary policy by the Bulgarian government and the Bulgarian banks respectively of keeping unprofitable SOEs afloat thus increasing the country’s internal debt. (Barlemann, Nenovsky 2003; Filipov 1998) BNB and the commercial banks, especially BNB as a central bank, were used as lenders of first resort instead of lenders of last resort as central banks tend to be used in the western capitalist world including the United States. Losses by SOEs were covered by the central bank and the commercial banks. Thus, regardless of whether or not BNB and the commercial banks’ behavior was intentional to create an economic crisis, they nationalized the SOEs’ losses. The nationalization of losses, turning losses into a concern of the entire country thus forcing everyone to pay for these losses, is typical of transition economies – where a frequently encountered business behavior was the expectation that losses would be covered by the government or the central banks. Such a belief of entitlement to bailouts, borne by the utopia derived from the communist ideology, is a recipe for disaster in a capitalist economy or an economy transitioning to capitalism where less government and more individuality by businesses is, and should be, observed and maintained.
Unfortunately, such a business behavior was not the only cause of a slow, at best, economic transition in Bulgaria. The banking sector in Bulgaria was also relatively incompetent and weak during the transition period. There were numerous weak, and sometimes dubious, bank loan decisions resulting in a lot of bad credits and bank runs, devaluation of the currency and therefore hyperinflation, as the data indicate: a doubling of the consumer price inflation for 1996 only followed by a nine-fold increase in 1997, reaching to one of the most severe consumer price inflation rates in the transition economies.
Among the reasons for the occurrence of these bad credits were poor communication bankers due to relatively unfriendly relationships between state and private banks, inadequate data, asymmetrical information between the lender and the borrower, insider lending and other lapses in the banking system. Asymmetrical information put the borrower in a better position. Banks in Bulgaria lacked the reporting sources on a borrower’s credit history which made it difficult for a lender to determine whether a particular borrower would be a good payer of their loans. (Barleman, Nenovsky 2003; Koford, Tschoegl 1997)
One case in point for the occurrence of bad credits was the appearance of the so called credit millionaires in Bulgaria in the 1990s, a unique trait of the transition economies. (Koford, Tschoegl 1997) Credit millionaires were people who applied for multimillion bank loans for projects for profit but would later not repay these loans at all or merely repay a very small portion of it at the end of the day.
There were several ways to obtain loans in Bulgaria in the 1990s. One way was to establish non-existent firms, or enterprises that exist in the writing, set up papers, but don’t exist in reality. The sole purpose of the scam was to capture the loans demanded by the potential borrower. That borrower would later disappear, phantomi, or ignore demands for repayment while living well. Bank lenders failed in distinguishing good borrowers from bad borrowers. Bank lenders instead oftentimes relied on the borrowers’ reputation because of lack of credit reports and history of the potential borrowers (Koford, Tschoegl 1997)
Another way to become a credit millionaire was to establish a bank. In the 1990s the deregulation of the Bulgarian banking system led to the establishment of a lot of banks many of which would later fail. (Kalcheva 2003; Koford, Tschoegl 1997) Such was the case of Agrobusinessbank in the city of Plovdiv, the second largest city in Bulgaria. The bank was established by Hristo Aleksandrov, a former waiter, and was co-owned by Hristo Danov, a former barman. In Bulgaria, people like Mr. Aleksandrov and Mr. Danov from the city of Plovdiv were then referred to as Plovdiv brokers. Agrobusinessbank went bankrupt in 1991 mainly due to bad insider lending, lending to their own “enterprises” worth 54,617,000 BGN for media projects, agricultural projects and the support of Botev Plovdiv, a soccer club. Agrobusinessbank was later bought by BNB for the symbolic price of 1 BGN. (Filipov 1998) This may sound as unbelievable as buying Sovereign Bank for 1 U.S. dollar, yet it was not an uncommon practice in Bulgaria regarding business purchases mainly in the 1990s. On June 14, 1999, the Council of Ministers sold 71 percent of the stakes of Kremikovtzi. Ltd., the country’s largest steelmaker, for 1 dollar to Daru Metals, Ltd. which would later change its name to Finmetals Holding, Ltd. Kremikovtzi then had 645 million BGN in debt and 250 million BGN in hidden debt. (Television 1999) The debts that these entities had incurred was the most consistent reason why they were sold for such ridiculously low prices.
Arguably the most powerful, and therefore most distinguished, credit millionaire was former wrestler Iliya Pavlov. He owned Multigroup, a group of enterprises including Evroenergy which owned Plama, an oil refinery in Pleven. Just like the Plovdiv brokers, Multigroup also supported a soccer club, CSKA Sofia, among other things, a striking similarity. Multigroup received a total of 91.185 billion BGN in credits outstandingly granted by Balkanbank, one of the many bankrupted banks during the transition period in Bulgaria. Meanwhile, Evroenergy owed its bank over 200 billion BGN. (Filipov 1998; Barnes 2007)
The transition period from a socialist economy to a free-market economy in Bulgaria appears to be consistent with a third, middle, ‘road’ to its final goal – partial-reform equilibrium. According to this theory, incomplete reforms, as the ones in Bulgaria, would end up benefiting bankers, corrupt officials and managers at that time, also referred to by the theory as ‘first-round winners.’ (Barnes 2007) It is especially supported by the occurrence of the credit millionaires who, as mentioned above, would take advantage of the incomplete reforms and lack of expertise on lending funds on the part of bank lenders, among other things.
The banking and currency crisis in Bulgaria ended almost immediately with the institution of the currency board on July 1, 1997 by the Bulgarian government led by Prime Minister Ivan Kostov and endorsed by the IMF, accelerated the privatization rate, and stabilized the value of the lev and thus the inflation rate in the country. (Bitzenis 2003) That made the economic environment in Bulgaria more business-friendly resulting in an increase in foreign direct investments (FDI) too.
As mentioned above, the currency board anchored the old Bulgarian lev to the German mark. One thousand BGL would be equal to 1 German mark regardless of the changes in the values of the other currencies. There were two reasons for the choice of the German mark – the leading role of Germany in the European Union and the credibility of its monetary policy. (Kalcheva 2003)
The currency board imposed restrictions on the central bank in Bulgaria. BNB was reorganized into three main departments: a banking department, a banking supervision department, and an issue department responsible for the maintenance of the currency board which put an end to open-market operations, and with that the wasteful spending on SOEs and the printing of money. (Kalcheva 2003; Dobrinsky 2009) Supply of money would be in a one-to-one proportion with the level of foreign reserves in BNB.
As a result of the institution of the currency board, 1998 looked like a turning point for Bulgaria and its economy. Real GDP grew by 3.5 percent regaining half of the 7 percent drop in 1997, private consumption increased by 7.6 percent. Meanwhile, consumer-price inflation dropped dramatically from 1,082.3 percent in 1997 to 22.3 percent in 1998. (Angelov 2004)
The currency board is still active in Bulgaria with 2 BGN equal to roughly 1 euro, and guarantees a fiscally and monetarily stable environment.
Unlike many cases such as Poland, the Czech Republic, Russia, and China, it is unclear whether the Bulgarian transition from a socialist economy to a free-market economy was through following either the shock therapy approach or the gradualist approach. On the one hand, there was rapid price liberalization but on the other hand privatization was extremely slow. The different governments throughout the transition period put themselves into the position of pouring money into unprofitable SOEs for various political reasons such as keeping unemployment artificially low while allegedly being aware that their fiscal. Meanwhile, the banks’ monetary, policies would eventually lead to the collapse of the currency and the economy. All that was the reality until the institution of the currency board by the government of Prime Minister Ivan Kostov which would stabilize the inflation rate and improve the business climate making it more favorable for foreign direct investments. The case of Bulgaria is an important example of how the middle road – the partial-reform equilibrium – is likely to lead to an even less successful transition than that of a country that took the gradualist approach (China) or a successful shock therapy approach – that of Poland. Meanwhile, it is apparently not likely to lead to a less successful transition than that of a country that unsuccessfully took a shock therapy approach, such as the case of Russia even though it is closer to the latter rather than the former. These estimations are based on the countries’ highest inflation rates (the higher it is the less successful the result) and highest drops of real GDP (the higher it is the less successful the result). The case of Bulgaria is also an important example explaining the scheme of the credit millionaires, which is not typical of the other transition economies.
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