|Creating Market Economy in Eastern Europe |
Annual Paper of “World Economies” “Creating Market Economy in Eastern Europe” ПРИМЕЧАНИЕ: Раздел 3 данной курсовой работы и имеет отношение только к нашей республике, просьба обратить на это внимание и для каждого конкретного случая его необходимо переделывать под свой регион. Carried out By nd year student The Summary Introduction 1. Meaning of market Economy and Tasks of the Transitions. 2. The Emergence of Market Economy in European countries. 1. . The Transition to a Market Economy. 2. Poland and Hungary as the best example of transition in the East Europe.2. Moldova’s way to an open economy. Conclusion. Introduction This paper is oriented toward the problems of transition and creatingin countries of Eastern Europe, namely Poland, Hungary, all of which areattempting to make the transition under a democratic, parliamentary form ofgovernment. The last new years have witnessed truly extraordinary events in theformally communist societies. Under newly established conditions of freespeech and freedom of organization, communist principles of political andeconomic control have been widely repudiated, and communist governmentshave been swept aside, replaced by governments committed to democraticprinciples and a market economy. While in some countries and parts ofcountries former communist have not been decisively dislodged, in almostall cases communism has lost whatever remaining legitimacy it possessed,and it most of these societies the crucial economic issue has suddenlychanged from reforming the socialist planning system by the introduction ofmarket-like elements to moving to a market-economy with private ownershipof most of society's assets. There are several reasons why the task of designing this transition isfascinating, especially to economists. First, the problem in new: no country prior to 1989 had ever abandonedthe communist political and economic system. Second, the experience to date indicates that countries attemptingtransition face a number of common problems and difficulties. While thereare important differences in the inherited situations and the choices madeby governments of these countries, the similarities in the problems theyface and the difficulties they are encountering suggest that there is logicto the transition process. Third, the absence of any close historical parallels and the limitedexperience economics in transition offer an opportunity and a challenge fordevelopment of normative transition scenarios. This turn out, however to beextraordinarily difficult to construct. Finally, the problems are not waiting for annalists' solutions;decisions currently being made may lead to an evolution with irreversibleconsequences. 1. Meaning of Market Economy and the Tasks of the Transitions. That economic system which brings together natural resources, laboursupply and technology and which is principally privately owned and weregovernment has to some extent always been involved in regulating andguiding the economy, has been referred to as "Market Economy". Yet, despitethis history of government intervention, individuals in that country havealways been able to choose for whom they will work and what they will buy. Now 3 groups make decisions and it is their dynamic interaction thatmakes the economy operate. Consumers, producers and government makeeconomic decisions on a daily basis, the primary force being betweenproducers and consumers; hence, the market economy designation. Consumers look for the best values for what they spend whileproducers seek the best price and profit from what they have to sell. Government, at state and local levels, seeks to promote the publicsafety, provides social safety-net, ensures fair competition and alsoprovides a range of services believed to be better performed by publicrather include education, health service, the postal service road andrailway system, social statistical reporting and, of course, nationaldefense. In this market economy system, economic forces are unfettered, supplyand demands build up the price of goods and services. Entrepreneurs arefree to develop their business unless they can provide goods or services ofa quality and price to complete with others; they are driven from themarket. By and large, there are three kinds of business: 1) those started and managed personally by single entrepreneurs; 2) the partnership where two or more people share the risks and rewards of a business; 3) the corporation, there stock holders as owners can by or sell their shares at any time on the open market; this latter structure permits the amassing of large sums of money by combining investment, making possible large-scale enterprise. Innovations in economic theory in the last two decades undoubtedlyaffect the way economists look at the transition problem and have probablymade them more pessimistic about the ease with which it can beaccomplished. Developments in transaction cost economics, the economics ofinformation, the new institutional economics, and evolutionary approachesto economics have sensitized economists to the vital role that institutionsplay in economic process. One way of thinking about a successful marketeconomy is that it is a set of convergent expectations in the populationabout how other people will behave; these expectations support an extremelyelaborate division of labour or a high degree of specialization amongindividuals, organizations, and geographic areas. In recent decades many economists have returned to the Schumpeterianview that the advantage of the market economy (relative to itsalternatives) lies more in its facilitation of innovative activity than inits allocative efficiency. The system of central planning is surely deficient in both respectsbut it is shortcomings seem to be much greater in the area of innovationthan in allocative efficiency. Another development in economics that has reduced the affractivenessof the large conception of market socialism is the increased attention paidto the motivation of government officials, both legislators andbureaucrats. In the 1950's and 1960's, much of economic analysis was focused onmarket failures and government action to remedy these failures, under theimplicit assumption that government officials would follow the rules laiddown by the authorities. The analysis of the logic of collective action andthe formation of interest groups the theory of rent-seeking behavior, andthe study of the evolution of cooperation and norms have emphasized thatgovernment failure as well as market failure must be taken intoconsideration in designing institutions. аvivid analogy stated by Vladimir Benachek of Charles University isthat the socialist economics are at the top of a small hill (the plannedeconomy), and they want to get to the top of a larger hill (the marketeconomy). But in between the two hills is a valley, which may be both wideand deep. The analogy illustrates the point that the centrally plannedeconomics did have a coherent economic system (i.e. they were at the top oftheir hill). One might add that the smaller hill was being eroded by thestrengthening of special interest groups and was perhaps, settling due tothe seismic rumblings that shattered the communist authority. The band oftravelers must settle their differences, agree on a route, and avoid thepitfalls and chasms along the way. Perhaps economic analysis can facilitate the journey by designing abridge between the two hills. Given the absence of close historicalparallels and the severe limitations of economic models of society it isclearly beyond the capacity of social engineers to draw up very preciseplans for the bridge. The Tasks of the Transitions The list of activities which governments which governments mustundertake in countries attempting the transition to a market economy istruly staggering. The list given here is designed to convey something ofthe enormity and complexity of the job. First, there is a group ofactivities related to creating a new set of rules:1. Setting up the legal infrastructure for the private sector: Commercial and contract low, antitrust and labour low, environmentaland health regulations; rules regarding foreign partnerships and whollyforeign-owned companies; courts to settle disputes and enforce the laws.2. Devising a system of taxation of the new private sector: Defining accounting rules for taxation purposes, organizing anInternal Revenue Service to collect taxes from the private sector.3. Devising the rules for the new financial sector: Defining accounting rules for reporting business results to banks andinvestors; setting up a system of bank regulation.4. Determining ownership rights to existing real property: Devising laws relating to the transfer of property, and laws affectinglandlord tenant relations; resolving the vexatious issue of restitution ofproperty confiscated by communist governments.5. Foreign exchange:a) setting the rules under which private firms and individuals may esquire and sell foreign exchange and foreign goods;b) setting the rules in the same area for the not-yet-privatized enterprises. Next there are some tasks related to managing the:6. Reforming prices: Enterprises that have been privatized will presumably be largely freeto set their own prices, but early on in the process, the demands of thegovernment budget will require raising prices on many consumer goods thathave been provided at prices for below cost. 7. Creating a safety net: Setting up an emergency unemployment compensation scheme; targetingaid in kind or in cash to those threatened with severe hard ship by thereforms.8. Stabilizing the macroeconomic: Managing the government budget to avoid an excessive fiscal deficitand managing the total credit provided by the banking system. Finally there are tasks related to privatization:9. Small-scale privatization: Releasing to the private sector trucks and buses, retail shops,restaurants, repair shops, warehouses, and other building space foreconomic activities; establishing the private right to purchase servicesfrom railroads, ports, and other enterprises which may remain in the publicsector.10. Large-scale privatization: Transferring medium and large-scale enterprises to the private sector;managing the enterprises that have not yet been privatized. An abstract Model of the Transition consist of three main phases: Phase 1: The cabinet-level negative phase In this phase members of the central government interact withnationally representative interest groups. The tasks are organized into twocategories: they will determine the general institutional structure ofsociety and set guidelines that will be used in phase 2 to assign eachenterprise to one of many alternative "transition regimes". Phase 2: The assigned phase In this phase state-owned enterprises are matched with transitionregimes. One can assume that each state-owned enterprise is completelydescribed by some vector of attributes. These attributes specify suchdiverse aspects of the enterprise as: a) the nature of the products produced by the enterprise, a description of its plant and equipment, and technology it utilized; b) a description of its financial states; c) the place of the enterprise within its industry, including its market share and the nature of its competition; d) some indication of the risk profile of the firm; e) the distribution of information within the enterprise; f) the nature of "measurement errors" in monitoring the performance of the enterprise; g) the relationship between the enterprise and the state bureaucracy; h) the "distance" between the enterprise and founding ministry; i) any potential synergies between the enterprise and some prospective foreign investor. Phase 3: The enterprise-level negotiation phase In this phase participants at the participants at the level of eachenterprise play an MB game (multilateral bargaining). For each enterprisethe structural parameters of the game are included in the characterizationof the transition regime to which the enterprise is assigned. 2. The Emergence of Market Economy in European Countries. 2.1. The Transition to a Market Economy 1) The Successes and Failures of Central Planning. Before considering the transition to a market economy, we mustconsider the need for such a transition. Today the need is clear: socialistand communist systems have failed to deliver (in a liberal sense) anythinglike the standard of material advance so often promised. But more recent rasy assessments of central planning abound. Even aslate as 1979 the World Bank published a long and detailed study of Romania– the most Stalinist of the eastern block. The Bank found that from 1950 to1975 the Romanian economy had grown faster than any other country in theworld (9,8 percent per annum). The Bank attributed this startlingperformance to the fact that government, through its system of centralplanning, had control of all resources. The Bank forecast a rasy future forRomania – growing at 8,7 percent per capita to 1990. Nor was Romania anaberration. The Bank published in that same year of 1979 a most rasyhistory of, and prognostication for Yugoslavia. Studies up to 1984continued to show that central planning, albeit somewhat modified inplaces, delivered the goods. This review is not intended to score paints, but simply to remind usof the long addiction of economists to planning and regulation. 2) Transitions The transition to a market economy always and at all times involves afamiliar list of policies. First is financial stabilization reducing the budget deficit and themonetary emissions of the central bank. This stabilization may involve manycomplex policies – almost certainly a fax reform and expenditure controls,particularly in the reduction of subsidies. There is no consensus on peggedversus free exchange rates. Second is deregulation, elimination a myriad of government controlsand establishing the framework for free contractual relationships. Thispriority involves the recognition of property rights and the development ofa legal system suitable for a market economy. It also implies a diminishedrole for the central planners as more room is provided for privateinitiative and enterprise. But oddly enough it is widely recognized thatthere is a need for more restraint on industry, particularly the heavystate owned firms, to reduce pollution. Other areas of deregulation includetrade reform and currency convertibility. Third is the reform and privatization of state- owned concerns to thislist should be added the reduction in monopoly power not only of industrybut also of trade unions, and in particular the reform of labour laws. Thereform of the banking system and the development of commercial rather thanplanning criteria in banking it also of the utmost important. 3) The Political Economy of Transition in Eastern Europe: Packing Enterprises for Privatization. An abstract model of the transition from a centralized command economyto a market economy focusing on privatization is a novel orientation forthis chapter. In much of the literature on privatization in central andEastern Europe, either a case is argued for a particular transitionproposal or specific aspects of the privatization problem are isolated andconsidered in detail. The model focuses on the way in which government policies andenterprise-level decisions are made and relatively less on the specificcontent of these policies and decisions. The conceptual model has been designed with five basic premises inmind: multilateral bargaining, political economy, heterogeneity,decentralization, and pluralism. 4) Multilateral bargaining In a world in which economic rights are ill designed, a bargainingproblem naturally arises. Throughout Central and Eastern Europe, thisproblem can be conceptualized as a multifaceted conflict between multipleinterests representing workers, management, claimants to property rightsbased prior ownership, foreign investors, representatives of differentgroup in the distribution chain, etc. It is useful to distinguish two different kinds of bargainingproblems. There are issues that must be negotiated at the level of centralgovernment: for example, what will be the nature the regulatory and legalinfrastructure within which these privatized enterprises will operate?Other issues concern the disposition of individual state-owned enterprisesand must be negotiated on a case-by-case basis. In particular what will bethe precise nature of each corporate entity that is being packaged for saleto private buyers? Who will control it? How will it be structured? Whatkind of compensation schemes will be in place for management and workers? What special provisions will be in place that affect the relationshipbetween the privatized entity and other firms, including established andnew competitors, firms that are up and down stream in the distributionchain, etc.? In the discussion that follows, the focus will be onbargaining problems of the latter kind. One presumes that, because of thecomplexity and diversity of the issues during the transition, the state isnot in a position to resolve them by fiat rather, over the transition, thestate is presumed to be one negotiator among many. Bargaining problems of this kind can be resolved in a variety of ways.At one extreme, an explicit institutional structure may be established bythe state to facilitate an orderly negotiation of the issues. Thisinstitution would specify: a) the interests that should be represented in the bargaining process; b) the space of issues over which these interests can negotiate; c) what degree of consensus is sufficient to conclude negotiations; d) who will represent "the state" the founding ministry are some agency established specially to deal with privatization; e) what will happen if negotiations break down? At the other extreme the state may provide no procedural guidelineswhatever as to how the issues should be resolved in this procedural vacuum,the economic rights in question may simply be expropriated by whicheverparty - typically the current management - is strategically located to doso. Relative to the general trend that appears to be emerging in Centraland Eastern Europe, there should be made opportunities for decentralizednegotiation. Our process-oriented perspective does suggest an indirect, "hand off"way to exercise some control over this phase of the process, the governmentcan introduce some checks and balances into the negotiations. For example,of the three "primary" parties at the bargaining table-management,employees of the enterprise, and the state agency responsible forprivatization - the first two parties have every incentive to designprivatization plans that inhibit competitive pressures, while the thirdwill inevitably be more concerned this effecting a successful sale of theenterprise than with issues such as the competitiveness of the resultingmarket structure. From the standpoint of the public interest then theoutcome of multilateral bargaining is bound to be sub-optimal, providedthat participation in the process is restricted to the three primaryparties. Moreover, the directions in which these outcomes will deviate fromthe optimal are more or less predictable. The Multilateral Bargaining model provides a useful analytical toolfor investigating the effectiveness of this approach to policy making. In other contexts, the multilateral Bargaining model has been useddescriptively to explain how during the process of multilateralnegotiation, coalitions are formed, deals are struck, and compromises arereached. 5) Political economy. аsecond basic premise is that any policy recommendations must beboth economically and politically consistent. This consistency requires aspecification of the relationship between short-term economic developmentsand longer-term political ramifications. Obviously, economic policyobjectives cannot be pursued in isolation, since the prevailing politicalconfiguration will constrain the set of options available to planners ofthe transition process. On the other hand, economic post-privatizationeconomy develops, new interests will acquire economic power and newinstitutions will emerge to strengthen the power of groups that wish todefend these institutions. The dynamic interaction between these economicand political facets of massive privatization programs must be taken intoaccount. Indeed, one can expect that models, which ignore politicaleconomic feedback effects, will have a natural tendency to overestimate theprospects for a successful transition. The following example illustrates the kind of political-economicinteraction that could adversely affect the reform process. Policy makersin Central and Eastern Europe appear to be overly complacent in theirreliance of foreign competition as the main disciplinary device that willforce monopolists to operate efficiently. Indeed, Polish officials citetheir country’s liberal tradition in the area of trade policy whenquestioned about the viability of this approach to antimonopoly policy. Ourdynamic political-economic perspective leads to skepticism about this heavydependence on competition from abroad. If a seems very likely, the post-privatization industrial structureturns out to be highly over-concentrated and inefficient, then the maineffect of threatening foreign competition will be to unleash a powerfulconfluence of political forces in favor of protectionism. Owners of thedomestic enterprises will lobby to defend their rents, managers will lobbyto defend privileges, and workers will lobby to defend their jobs. Becausethe problem of unemployment never really arose under communism, the potenttension between introducing free trade and maintaining employment levelsnever became apparent. 2.2. Poland and Hungary as the best example of transition in the East Europe Economic Reform in Eastern Europe: The Background The background of economic reform in Eastern Europe is not unlike thatin the Soviet Union, even though, as I have emphasized, the setting israther different. The brief political thaw following the death of Stalin inthe early 1950s did permit a freer discussion of ideas, which, along withgrowing problems of economic performance, led to limited attempts todevelop and implement economic reform. Initially, these changes were modestin scope, and they typically followed the Soviet reform pattern: Try toimprove decision making while preserving socialist objectives and theessence of the planning system. This was the focus of the New EconomicSystem in the GDR and of the New Economic Mechanism introduced in Hungaryin 1968. The potential for genuine economic reform was certainly limited bySoviet influence. Indeed in some cases (such as Czechoslovakia in 1968),reform was abruptly forestalled by Soviet intervention. In other cases,such as Hungary, reform attempts dating from the late 1960s were sustainedon a limited basis, to become the background for more serious reform in thepresent era. There were, then, numerous attempts at reform in EasternEurope. What were the major forces promoting these efforts? First, as was the case in the Soviet Union, rates of economic growthin Eastern Europe have undergone a long-term secular decline. The magnitudeof this decline (see Table 1) has varied from case to case, but overall ithas been pervasive. Moreover, these countries had taken pride in being high-growth economies, even if the costs, such as little growth of consumer well-being, were also high. At the same time, growth in productivity slackened,especially in the late 1970s and 1980s. And inflation quickened, though itwas most serious in Poland and Yugoslavia. Repressed inflation, thoughdifficult to measure, grew in importance in the 1980s. Second, East European countries relied heavily on foreign trade as ameans of stimulating economic growth in the 1970s. Their strategy was topromote exports in Western markets so that the imports required both tostimulate technological change in industry and to enhance consumer well-being could be obtained without the growth of hard-currency debt.Unfortunately, this strategy was not successful. The energy crisis led to asignificant slackening of Western markets at the very time when EastEuropean nations were becoming more aggressive in these markets. EastEuropean imports were sustained, but largely by means of building asubstantial hard-currency debt. The magnitude of debt repaymentsubsequently led to considerable internal belt-tightening for thesecountries in the 1980s — precisely the opposite of what had been intended. Third, one could argue that in Eastern Europe, the possibilities foreconomic growth through extensive means had initially been less promisingthan in the Soviet case and had been exhausted more quickly. In light ofthe level of economic development in Eastern Europe compared to that in theSoviet Union, it is not surprising that the imperative for reform wasstrong and that developments of the Gorbachev era quickly spilled over intoEastern Europe. In the absence of Soviet backing, interest in theadministrative command model faded fast. Table 1. Economic Growth and Performance in Eastern Europe: The Background to Reform| |1961-70 |1971-80 |1981-85 |1985 |1986 ||Eastern |3.4 |2.4 |1.0 |.2 |2.2 ||Europe | | | | | ||Bulgaria|5.0 |2.3 |.1 |-3.2 |4.7 ||Czechosl|2.4 |2.3 |1.0 |.4 |1.9 ||ovakia | | | | | ||East |3.2 |3.5 |1.7 |3.3 |1.6 ||Germany | | | | | ||Hungary |3.1 |2.5 |.6 |-2.3 |2.4 ||Poland |3.3 |3.0 |1.0 |.2 |2.1 ||Romania |4.2 |3.5 |-.6 |-1.4 |3.1 | East European Reform Programs: Similarities and Differences In this chapter we pay special attention to Poland and Hungary. We doso because these countries are both examples of aggressive reform but haveemployed different strategies. However, before we consider these cases ingreater detail, it is useful to summarize the East European reformexperience, noting important similarities and differences among the variouscases. To do so will entail some repetition of basic themes. First, economic reform in Eastern Europe (at least in Poland, Hungary,and Czechoslovakia) is generally described as a transition in that thesecountries seek to replace the planned economy with a market economy ratherthan attempting merely to modify the former. Second, transition programs have varied in speed and intensity. Somecountries have pursued reform on a "gradual" basis, whereas others, likePoland, have pursued what is often termed a "big bang," or rapid, approachto reform. However, we must remember that even in those countries notpursuing a "big bang" or "shock therapy" approach, the process oftransition in Eastern Europe has been relatively rapid, especially whencompared to reforms of the past - and notably so when compared to therecent Soviet record. It is important, therefore, to be aware of the basicissues associated with transition and of the extent to which the attemptedspeed of transition alters the overall reform experience. Third, although it is possible to examine and understand the basicelements of economic reform and even of transition from one system toanother, we really do not have a general theory of change in economicsystems. In some cases — for example, during such a period of rapid changeas the 1990s — it is difficult even to develop a way to classify the issuesinvolved in transition. Fourth, important differences exist from one country to another. Ourview of the socialist transition process is heavily influenced by our imageof the best-known and most advanced reforms, such as those of Poland,Hungary, and Czechoslovakia. We know much less about, and tend to pay lessattention to developments where reforms are proceeding at a slower pace, asin Romania and Bulgaria. Figure 1 offers a simple, stylized view ofcontemporary political and economic reform (transition) in Eastern Europe. Figure 1. Reform in Eastern Europe POLAND: FROM PLAN TO MARKET VIаSHOCK THERAPY Until Solidarity won the parliamentary elections in Poland in thesummer of 1989, the Polish economy had been, since the end of World War II,a rather typical planned socialist economic system. State ownershippredominated, and though economic reform was attempted in varying degreesat different times, little real systemic change had taken place. Moreover,as Table 1 shows, the rate of economic growth continued to decline, and theperiod saw recurring shortages, increasing inflation, and an understandablydeclining work ethic. Beginning in 1990, Poland took decisive steps toward a market economy.This "shock therapy" approach was to be sudden, and in this it differedsignificantly from the gradualist approach being discussed in othersocialist systems. In addition to treeing prices, Poland implementedmonetary controls, the zloty was made convertible into hard currencies, andsteps were taken to control wage increases. As we shall see, the "shock therapy" approach has not been withoutcritics. Moreover, although the Polish case quickly attracted the interestof those who study the problems of socialist transition, it was viewed asunique. Thus it was argued that. for a variety of reasons that werediscussed earlier, reform was much more likely to succeed in Poland than ina case like the Soviet Union. But before we examine the Polish reformexperience in greater detail, we must review what brought the Polisheconomy to the reform phase and how, at that point, it might be differentfrom other socialist countries. I begin our discussion of Poland with a brief examination of thesetting. Then I discuss the Polish command system, considering the extentto which this system led to distortions in the Polish economic structure.Finally, I turn to the issue of transition and examine the mechanismsutilized and the results achieved thus far. 1) Poland: The Setting By European standards, Poland is a relatively large country. With aland area of just over 300,000 square kilometers, it is just over half thesize of France. Moreover, with a population that approached 38 million in1990, Poland is some 68 percent of the size of France in terms ofpopulation. Poland is frequently viewed as having a homogeneous society, a factorthat facilitates economic reform. Although social homogeneity is difficultto measure and may well be overstated in the Polish case and in other cases(for example, there are regional differentials, urban-rural differentials,and the like), the basic statistical evidence is strong. In terms ofreligion, 95 percent of the Polish population is Roman Catholic. From astannic standpoint, 98.7 percent of the population is Polish, and only afew minority groups occur.Urbanization and industrialization have changed the nature of Polish lifeand customs, but the church, family, and folk ties that have sustainedPoland for a long time remain strong. Thus, although Poland must deal withproblems of modernization, it also has valued traditions and a clearidentity. These qualities make implementing change more manageable herethan in many other countries.In terms of natural resources, Poland is a country of considerable regionaldiversity, though major portions of the land area are not especiallyfertile.Poland's main energy resource is coal; basic minerals and some deposits ofoil and natural gas also exist. Both basic data and methods of computingeconomic aggregates of socialist systems are currently under scrutiny. Newevidence that will make it possible to do different kinds of computationsmay well lead to important adjustments. With these reservations in mind,however, we note that Poland was reported to have a per capita grossnational product of approximately $4500 measured in 1989 U.S. dollars. Thisfigure places it between the high-income countries of the region (Hungaryand Czechoslovakia) and the low-income countries (Bulgaria, Romania,Yugoslavia) and at one-quarter that of the United States. Prior to theonset of major economic reform, the bulk of Polish industry was state-ownedand planned. Agriculture (representing roughly one-fifth of total Polishoutput) was a mixed system wherein the private sector produced about three-quarters of the total agricultural product. Foreign trade turnover — thatis, exports plus imports — represents roughly one-third of Polish product,again using U.S. dollar measures. 2) Poland: The Command Economy The organizational arrangements of the Polish command economy wereestablished immediately after World War II and closely resembled thoseprevailing in the Soviet Union. There was widespread nationalization ofproperty, central planning mechanisms were established, and agriculture wassocialized. In addition to organizational arrangements, Polish economicpolicies of the era, such as those on investment, sectoral development, andthe like, closely mirrored the Soviet model. Although Poland attempted modification of the command system as earlyas 1956 when collectivization was abandoned, little actually changed. Overtime, private agriculture was neglected by the state, and continuingpolitical protests, especially in the early 1970s, signaled both politicaland economic difficulties. The 1970s was a difficult decade for many countries, especially thosethat rely on imported oil. The Polish strategy in the 1970s and later wasto stimulate the domestic economy through the importation of foreigntechnology. This was not an unreasonable strategy in theory, but Westerneconomies were themselves in the midst of the energy crisis and therecession it caused. Poland's effort to expand exports failed, hard-currency debt accumulated, and the projected impact of Western technologyon the Polish economy was minimal. As the 1970s came to an end, it wasevident that domestic retrenchment would be essential — a difficult path inlight of the continuing unrest among Polish workers. The 1980s began withroughly three years of martial law and an attempt to achieve economicstabilization. After half-hearted economic reforms in the early 1980s, the rise ofSolidarity (which had been outlawed in 1982) proved that major systemic andstructural reform was necessary. Even so, and despite the fact that Polisheconomic performance was deteriorating badly, serious economic reform didnot begin until the late 1980s. 3) The Polish Transition: The "Big Bang" in Practice The Polish transition from plan to market has been watched closely bya variety of interested observers. Although many of the policy and systemicchanges introduced in Poland are familiar hallmarks of the general reformscene, the speed of implementation in the Polish case is unique. There had been attempts to decentralize decision making in large state-owned Polish enterprises in the 1980s, but these reforms failed to changeoutcomes (a possible exception is their contribution to the wage explosionthat took place toward the end of the decade). Moreover, on the eve ofreform in Poland (the reform program began officially on January 1, 1990),macroeco-nomic conditions there were in a state of severe disequilibrium.Although the exact nature of monetary overhang in Poland (as elsewhere) hasbeen the subject of debate, there was a significant budget deficit, wageincreases were out of control, and hyperinflation had resulted. Poland'shard-currency debt position was better than that of Hungary, but the debtthat had been accumulated did little to stimulate the Polish economy, thezioty was overvalued, and no debt relief from external sources was insight. In the fall of 1989, most price controls were lifted (on both producerand consumer goods), public spending was reduced, and the zioty wasdevalued. In the second stage of major reform, begun in 1990, the budgetdeficit was sharply cut, largely through a reduction of subsidies to stateenterprises. аpositive real rate of interest was to be implemented, andthe market was to be used to signal changes in the value of the zloty. Thelatter was a critical measure, because foreign trade and the impact of thistrade on the Polish industrial structure was to be a key component of theoverall reform strategy. In January of 1990, the government set theexchange rate of the zloty at 9500 to the dollar (this represented adevaluation from 1989), a rate roughly approximating its value on the blackmarket, and it established convertibility of the zloty for internationaltrade. Many trade restrictions were eliminated, and internal exchanges wereset up to handle the buying and selling of hard currencies. Although thesechanges resulted in domestic inflation, the initial increases proved to beshort-term and the exchange rate of the zloty has proved to be realistic. Finally, wage increases were to be controlled partly through wageindexation and partly through a new tax on wage increases that exceededestablished guidelines. Privatization is a major element of the Polish strategy of transition.In 1990 the Polish government passed a law creating a Ministry of OwnershipChange, a mechanism to supervise the process of privatization.Privatization has proceeded rapidly, though it has been achieved mainly forsmall enterprises in the trade and service sectors. Industrial output inthe private sector grew by 8.5 percent in 1990 and is reported to representroughly 17 percent of total Polish industrial outputThough privatization has been very successful for small-scale enterprises,the picture for large state enterprises is quite different. For reasons wenoted earlier, privatization of these enterprises has proceeded veryslowly. In addition, the economic position of these enterprises worsened asthe state took decisive measures to introduce a hard-budget constraint. Inaddition to price changes and wage limitations, subsidies have been endedand protection from foreign competition has been sharply reduced. This newsetting has encouraged enterprise managers to reduce costs by restrictingunnecessary output and reducing the labor force. However, the strongcommitment to rapid privatization was reinforced in June of 1991, when itwas announced that a major portion of state industry would be privatizedthrough creation of stock funds, with the population receiving vouchers. Beyond these changes in the state sector, new guidelines have beenintroduced to monitor enterprise performance. Furthermore, a new IndustrialRestructuring Agency will consider how remaining state enterprises shouldbe handled, to what extent privatization is possible, and whatrestructuring should take place for those enterprises that are not viablein the new setting. These new arrangements are designed to ensure a rapidtransformation of the Polish industrial structure, to make it similar toand competitive with market economic systems, and to achieve this resultquickly and as openly as possible. Note that these comprehensive reforms in Poland cover all the criticalareas discussed in Chapter 4 and earlier in this chapter. Moreover,beginning from very precarious economic circumstance in 1989, these changeswere introduced simultaneously and rapidly. We will now do our best toassess the early results. 4) The Polish Economy in the 1990s It is clear that economic reform in Poland has been radical and hasmoved sharply and swiftly away from the plan toward the market. In additionto the expanded influence of market mechanisms, decision making has beendecentralized, private property introduced, and incentive arrangementschanged. By most standards, the initial results have been encouraging. First, stabilization measures cut the rate of inflation sharply from areported 40-50 percent per month at the end of 1989 to roughly 4-5 percentper month in 1990. At the same time output fell, though supplies ofconsumer goods in stores increased. Employment in industry declined by 20percent during 1989 and 1990, although it is reported that only arelatively small portion of this reduction in the labor force was caused byforced layoffs. The unemployment rate was reported to be 6.5 percent at theend of 1990. Another major positive facet of the Polish reform experience has beenthe foreign trade sector. There has been a significant expansion ofexports, especially to hard-currency markets. This expansion resulted inpart from the devaluation of the zloty to market-clearing levels and inpart from the reorientation of trade away from the Soviet Union and otherEast European trading partners. At the same time, as a result ofrestrictive policy measures and the higher domestic cost of these imports,import demand declined. аthird qualified success has been privatization. Although the initialpace of privatization was rapid, this early privatization was largely thatof small-scale enterprises in the area of trade and services. AlthoughPolish reformers take seriously the need to pursue privatization of majorstate enterprises, bringing this about will remain a critical task for thenext several years. Can these achievements be sustained in the coming years? We discussthis issue more generally in the next section, but the Polish case deservesspecific comment. Quite clearly, the continued success of the Polishtransition will depend on the continuing implementation of appropriatestabilization measures. Although this may seem relatively straightforward,it requires cohesion and commitment among policy makers and willingnessamong the populace to pay the costs of the transition. Pressures for wageincreases must be resisted, and the process of privatization must proceed.To the extent that the latter can be achieved, the contours of new marketarrangements can be defined. Finally, although uncertainty in foreignmarkets remains, relief of hard-currency debt will unquestionably add ameasure of flexibility. Another issue is the extent to which the Polish "success" (if we cancall it that) was promoted by Western assistance. In light of the Polishleadership's commitment to rapid transition, the West has providedconsiderable assistance in the form of exchange-rate stabilization funds,debt restructuring, and government guarantees. HUNGARY: THE NEW ECONOMIC MECHANISM AND PRIVATIZATION Early works in comparative economic systems devoted little attentionto the Hungarian economy. Over the last twenty years, however. Westerneconomists have begun to pay more attention to Hungary. As one prominent observer of Hungary and other East European systemshas noted, "The Hungarian reform experience says as much about centralplanning as it does about Hungary, and therefore an understanding of thatexperience is important for those interested in the prospects for reform inall of Eastern Europe, and indeed, in the Soviet Union. In other words,Hungary is a prototype of economic reform for the former planned socialisteconomic systems of Eastern Europe, and presumably elsewhere. Thesethoughts, expressed some ten years ago, remain relevant in the 1990s asHungary, like other socialist systems, pursues a transition to the market.However, the background of reform in Hungary is important to a properanalysis of contemporary problems and prospects. Prior to 1968, Hungary applied the Soviet model of centrally plannedsocialism in a typical fashion. But then, in 1968, Hungary began tointroduce by far the most radical economic reform attempted in EasternEurope (with the exception of Yugoslavia). In the words of one earlyobserver of this reform, it clearly represents the most radical postwarchange, in the economic system of any Comecon country, which has beenmaintained over a period of years and gives promise of continuity. Although the reform program in Hungary met with only partial success,the problems that have arisen (conflicts of objectives, for example, anddifficulty in persuading participants to change their ways) are fundamentalto the reform experience of planned socialist systems. Hungary shares many features with other Eastern and SoutheasternEuropean countries, such as Yugoslavia. It provides a refreshing contrastto the Soviet Union, which in some important respects is atypical. Hungaryis a small country heavily dependent on foreign trade. The Hungarianexperience with reforming foreign trade, and in particular its efforts tobecome integrated into the world economy both East and West, isprototypical. The difficulties of reforming the foreign trade mechanism arccrucial to the Hungarian economy as well as to the economies of many othersystems of Eastern Europe. 1) Hungary: The Setting Hungary is located in central Europe. Its land area of approximately36,000 square miles makes it roughly the same size as the state of Indiana.Its population of about 11 million is comparable to that of the populationof Illinois. Although Hungary is not self-sufficient in energy, it docshave supplies of coat, oil, and a number of minerals, including importantbauxite deposits. Although it has some rolling hills and low mountains, Hungary isbasically a flat country with good agricultural land and a favorableclimate. As in other East European countries, the period since World War IIhas seen the population flow from rural to urban areas and a changingbalance of industrial and agricultural activity. Today, approximately halfthe population lives in urban areas. Hungary is not particularly prosperous. Most estimates of its grossnational product or per capita gross national product place Hungary in themiddle of the East European countries. It is generally wealthier thanBulgaria and Yugoslavia and certainly wealthier than Albania; it ranksbehind East Germany and Czechoslovakia. Hungary's per capita income appearsto be close to that of Greece. In this sense, economic development remainsa key issue in Hungary. By the standards of Western Europe, Hungary remainsrelatively poor; by the standards of the Third World, Hungary ranks amongthe more affluent countries. 2) The Hungarian Economy: Prereform The postwar reconstruction of the Hungarian economy began quitemodestly in 1945. Before the implementation of a three-year plan in 1947(1947-1949), the main policies included stabilization of the currency,changes in the nature of rural landholdings, and the beginnings ofnationalization. The first three-year plan was designed primarily to bringthe economy up to prewar levels of economic activity. During this time, a planning mechanism was created and theshare of national income going to investment increased sharply. The changeswere not radical, however, and balanced development was envisioned. The era of balanced development came to an end with the introductionof a five-year plan in 1950. The share of national income devoted toinvestment was increased substantially, and the bulk of new investment wasdirected toward heavy industry. This policy was partially reversed towardthe end of the plan period, but it was reaffirmed in 1955-1956. аnumber of economic trouble spots cried out for attention. There wasan observed need to improve industrial labor productivity, especiallythrough the development of a better incentive system to offset thedeclining supply of labor from rural areas. Supply-demand imbalances weregrowing increasingly severe. Waste and imbalance in the material-technicalsupply system created the need for a substantially modified coordinatingmechanism among enterprises. In addition, excess demand for investment led to substantial amountsof unfinished new construction and to the neglect of old facilities. Somemechanisms for the more rational allocation of capital investment had to befound. The adoption and diffusion of technological advances were seen asinadequate. Technological improvement was considered crucial for continueddevelopment of the economy. This background seems familiar: a small country, the Soviet(Stalinist) model of industrialization, overcentralization, emphasis onextensive growth, rigidities of the plan mechanism, incentive problems, andthe resulting difficulties. Against this background, the New EconomicMechanism first promulgated in a party resolution in 1966 was put into,practice in 1968. Over twenty years later, it remains one of the mostimportant reform programs of planned socialist systems. 3) Intent of the New Economic Mechanism There is disagreement about the importance and effect of the Hungarianreform program. The New Economic Mechanism (NEM) has generally beeninterpreted as leaving the power to control the main lines of economicactivity (volume and direction of investment, consumption shares) with thecentral authorities, while relying on the market to execute the routineactivities of the system. The NEM called for substantial decentralizationof decision-making authority and responsibility from upper-leveladministrative agencies to the enterprise level. In a general way, NEMbears a close resemblance to the Lange model. Let us consider the originalblueprint of NEM. The objective of NEM was to combine the central manipulation of keyvariables with local responsibility for the remaining decisions. The firstchange was a significant reduction in the number and complexity of thedirectives firms; for large state-owned firms, the traditional problemsremain. Valuation is difficult, especially in loss-making enterprises.Moreover, it is hard to find buyers for these types of enterprises, letalone to arbitrate the potential rights of past owners. And just aselsewhere, privatization in Hungary is likely to become slower and moredifficult as the focus shifts to the less attractive, large enterprises. In addition to privatization per se, Hungary has addressed thecreation of infrastructure (for example, a stock market) and new rulesdesigned to change the guidance of enterprises. Accounting procedures havebeen refined and bankruptcy laws strengthened so that state subsidies canbe curtailed and hard budgets introduced into large state-ownedenterprises. Hungary has also pursued a variety of stabilization measures and hasliberalized policies in the sphere of foreign trade, though to a lesserdegree and certainly more gradually than Poland. Domestic price controlshave been substantially removed, and enterprises are permitted to enterinto and benefit from foreign trade transactions. Although there are limitson the holding of foreign exchange, the Hungarian forint is substantiallyconvertible for business purposes. However, the Bank of Hungary hasmaintained controls such that it has access to foreign exchange earnings toserve as repayment of the Hungarian hard-currency debt. (Hungary has a percapita hard-currency debt roughly twice that of Poland). Hungary hasfollowed a tight monetary policy designed to create a balanced budget andalso to exert financial pressure on enterprises. Hungary has very liberal laws regarding foreign investment, includingthe possibility of full foreign ownership with permission. Moreover,repatriation laws are liberal. Not surprisingly, Hungary has beenconsidered a leader in the quest to attract foreign investment, though themagnitude of this investment and its overall impact on the Hungarianeconomy probably remain modest. The initial results of the transition process in Hungary havegenerally been positive when judged against the sorts of expectations thatwe discussed earlier. At the same time, it is proving difficult to sustainpopular support as the inevitable costs of the transition process taketheir toll. 4) The Hungarian Economy in the 1990s In spite of a tendency to compare the processes of economic reform inPoland and Hungary, there are important differences between the twosystems, and especially in the degree to which prior reform had takenplace. Although some would argue that the New Economic Mechanism was quitelimited compared to contemporary reforms, nevertheless the reform processhas a significant history in Hungary. The differences between the Hungarianand Polish cases are important.Inflation has been much less serious in Hungary than in Poland. The annualrate of inflation for 1989 has been estimated at roughly 17 percent.Although the inflation rate increased to about 29 percent in 1990, thisperformance has been viewed as positive. In addition, wage increases havegenerally been controlled. Largely because of a shift away from trade withformer CMEаtrading partners, the volume of Hungarian trade has declined.At the same time, the Hungarians have experienced growth in exports toWestern markets and a generally weak domestic demand for imports — bothimportant developments for the overall trade balance. The good news on theexports side, however, tends to be sector-specific. Hard-currency debtremains a serious problem, and the movement toward a convertible currencyhas been much slower than in the Polish case. Finally, the Hungarian budgetdeficit has increased. The Hungarian economy was projected to shrink by approximately 3percent in 1991, and associated declines in consumption and investment wereanticipated. The state property agency is moving ahead with privatization.The overall relatively slow pace of reform in Hungary may well dictate lesssharp downturns and less severe fluctuations during the periods of downturnbut, at the same time, rather slower recoveries and a longer time in whichto achieve normalization. As with Poland, the effectiveness of themacroeconomic policies being implemented, world market conditions (such asthe price of oil), and domestic structural change through privatizationwill all affect both short-term and longer-term outcomes. EASTERN EUROPE: THE REFORM SCENE The transition from plan to market in Eastern Europe is important, notonly for those who live with and implement the transition, but also forthose interested in the subject of comparative economic systems. For avariety of reasons, if the transition cannot succeed in countries such asPoland and Hungary, it is unlikely to succeed elsewhere. Obviously, it is too early to render any definitive judgment on thesecases, let alone on the more general issues of transition. Indeed, it isdifficult to chart even basic day-to-day changes in these countries. Thathaving been said, let us try to assess the outcomes that have occurred sofar. Judged in terms of our earlier discussion of economic reform andprojected outcomes in the early stages of transition from plan to market,there is room for guarded optimism as we examine the early results inHungary and Poland. At the same time, there remain a number of basic forcesthat will heavily influence future economic trends. First, although initial political transformations are substantiallycomplete in Eastern Europe (with important exceptions such as Yugoslavia),there are cases (such as Romania) where political instability and a lack ofcohesion (derived in part from the political legacy of the communist era)make agreement on reform very difficult. Clearly, in these cases, the pathof reform will be slower and much more difficult than in the leading casesthat we have examined. Table 2. Political and Economic Developments in Eastern Europe: ASummary|Status |Country ||of | || |Poland |Hungary |Czech |Bulgaria|Romania |Albania |Yugoslav|| | | |and | | | |ia || | | |Slovak | | | | || | | |Federal | | | | || | | |Republic| | | | ||Post |Limited |Important|Limited:|Limited |None |None |Importan||Economi|efforts |: New |ended by| | | |t ||c |in the |Economic |Soviet | | | |Worker: ||Reform |1980s |Mechanism|inter | | | |manageme|| | |since |vention | | | |nt and || | |1968 |1968 | | | |market || | | | | | | |socialis|| | | | | | | |m ||Per |4607 |6303 |7922 |3610 |3154 |n.a. |3409 ||Capita | | | | | | | ||GNP - | | | | | | | ||1989, | | | | | | | ||in U.S.| | | | | | | ||S | | | | | | | ||Percent|-8.9 |-3.6 |-3.2 |-3.6 |-11.3 |n.a. |-6.9 ||Change | | | | | | | ||in GNP:| | | | | | | ||1989-90| | | | | | | ||Officia|3387 |276 |120 |363 |186 |n.a. |761175 ||l | | | | | | | ||Consume| | | | | | | ||r Price| | | | | | | ||Index | | | | | | | ||in | | | | | | | ||1989, | | | | | | | ||1980 = | | | | | | | ||100 | | | | | | | ||Real |116 |115 |115 |126 |121 |n.a. |114 ||per | | | | | | | ||Capita | | | | | | | ||Disposa| | | | | | | ||ble | | | | | | | ||Income | | | | | | | ||in | | | | | | | ||1989, | | | | | | | ||1980 = | | | | | | | ||100 | | | | | | | ||Current|Aggressi|Ambitious|Transiti|Reform |Modest |1990-91:|Politica||Economi|ve |transitio|on |began in|reforms |Limited |l ||c |pursuit |n plan in|pursued |1991; |from |first |turmoil ||Reform |of |progress:|with |price |1991; |steps; |and an || |transiti|stabiliza|caution;|flexibil|price |decentra|economy || |on, |tion, |initial |ity, |adjustme|lization|largely || |privatiz|privatiza|results |privatiz|nt, some|, some |without || |ation |tion, and|not as |ation, |privatiz|privatiz|guidance|| |continue|attention|good as |and |ation, |ation, | || |s |to trade |in |trade |and |and | || | | |Poland |reform |foreign |restruct| || | | |but | |investme|uring | || | | |positive| |nt | | | Second, the initial results of the transition have been generally asexpected. In Table2 I summarize a number of useful indicators. Asanticipated, in all cases there has been a downturn in output —occasionally a downturn of significant magnitude. Inflation has been veryuneven and in some cases (such as Yugoslavia and pre-reform Poland) veryrapid. However, post-reform inflation rates generally leave some room foroptimism, especially in those cases where stabilization policies have beendeveloped and applied. Third, we have noted that initial privatization usually proceededrather quickly but that, after the privatization of small firms (especiallyin the service sphere), the pace of change decreased significantly. Thislatter development reflects the onset of major difficulties: the privatesector must now absorb large, state-owned, loss-making, and oftentechnologically backward enterprises. The privatization of these firmspresents serious problems, as does a setting where valuation is fraughtwith difficulties, buyers are hard to find, claims from the past must behandled, and contemporary management skills are wanting. Fourth, although inflation and unemployment have necessitated agrowing concern for safety-net measures of various types, there is also asense that the availability of consumer goods and services has improved. All of these considerations seem to support a measure of optimismabout the eventual outcome of the transition process. At the same time,there are important dimensions where change must be sustained if thetransition is to be successful. Stabilization policies must be maintained —a tall order in those cases where consumer patience is lacking.Privatization must proceed, and it must increasingly reflect the contoursof new market arrangements, including the infrastructure required formarkets to function effectively. These changes must be sustained even inthe face of political dissension, consumer dissatisfaction and an uncertaininternational economic environment. These restraining forces will in largepart dictate the pace and ultimate success or failure of the transitionprocess. 3. Moldova’s way to an open economy. Moldova has faced significant and escalating economic difficultiessince its acquisition of independence in 1991. This situation is reflectedin the main macroeconomic indicator for the republic - Gross DomesticProduct (GDP) -, which has dropped by nearly 60%. The agricultural sector has been strongly impacted by the nation’seconomic difficulties, as well as by adverse environmental conditions. In1993 Moldova’s agricultural harvest was adequate, a considerable portionremained uncollected and unprocessed due to lack of fuel, transportation,and financial resources. In addition, due to early November frosts,hundreds of thousands of tons of fruit, vegetables, and tobacco weredamaged beyond use. In the summer of 1994, a simmilar stream of naturaldisasters, including a drought, followed by a hurricane, followed by aflood, caused even greater losses than those experienced the previous year.The devasting flooding in August 94 alone brought about losses totaling US$= 220 million, which exceeded the amount of Moldova’s industrial activitiesinclude: refrigerator, television furniture, clothing, and agriculturalmachinery production. The Republic’s threatens the productivity of thissector. Of the republic’s 262 production enterprises, 60% experiencedproduction declines. Over all in 1993, many industrial enterprises operatedat levels 50% lower than their full potential. The decline in production has negatively influenced the budgetarycapacity of the Moldovan Government to address social and other issues. InNovember 1994, for example, budget areas reached a level of US$ 70 million.As a result sizable delays exist in payments of mages, pensions, stipendsand other allocations. Natural resources within the country are few. Thesituation in Moldova’s energy sector is strained, therefore, more so asnation’s capacity to import energy continues to deteriorate. All types offuel, including coal, oil and natural gas, delivered from the RussianFeder
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