The Collapse of the Command Economy
According to the Hungarian economist, Janos Kornai, economic systems may generally be divided into those limited by demand (market economies) and by supply (command economies).(2) The author of the Polish economic transformation program, Leszek Balcerowicz, distinguished the following basic features of a command economy: 1 - overwhelming nationalisation, 2 - hierarchical managment of the state-owned economy by means of centrally fixed parameters, 3 - unlimited access of enterprises to central funds ("soft budget constraint") and 4 - foreign trade monopoly isolating the economy from abroad.(3)
Symptoms of a systemic crisis of the Soviet-type command economy had been accumulating since the mid-1970s. The following are among the most frequently analysed reasons for this crisis: an excessive military burden, exhaustion of cheap resources, frustration of the planning system and labour morale, a chronically low level of innovation and a growing technological gap, as well as an overwhelming wastefulness resulting from the imbalance of supply and demand ("economics of shortage").(4)
The said symptoms included rapidly worsening efficiency indicators, a growning foreign debt of all the Comecon member-countries. In Poland these symptoms were also expressed by an absolute decrease of the national income since 1979. In the mid-1980s the crisis symptoms were exacerbated, while even martial law proved unable to re-animate the Polish economy. Reforms of the planning and management systems failed as they could not break the vicious circle of the ideological dogmas of "real socialism". Half-measures offered by economic policy-makers in the shape of self-government enterprises, joint ventures or leases, seemed more easy to reconcile with the system but were not enough to animate economic growth. In the late 1980s all the Soviet-type economies of East Central Europe began to decline, which resulted in the collapse of their political systems and the decomposition of the Soviet empire.
Systemic Transformation
Generally speaking, the following stages of post-communist economic transformation can be distinguished: 1 - incomplete reform of the command economic system; 2 - its failure; 3 - breakthrough reforms; 4 - economic decline connected with the systemic transformation; 5 - stabilisation; 6 - return to sustained growth based on the driving forces of the market economy.
Of course, the timing, depth and consequences of the undertaken steps differed from country to country. Step three was first taken in Poland in 1989 and was the most radical "shock therapy". Elsewhere the breakthrough reform started a little later and was less radical. As a result, some countries, such as Hungary or Czechoslovakia (the Czech Republic and Slovakia from 1993) managed to follow Poland or even to catch up with its economic recovery (Poland in 1992, Hungary, the Czech Republic and Slovakia in 1993), while others, such as Bulgaria and Romania, were too slow and too cautious, and thus too little was changed for them to recover. Ultimately, in 1996 and 1997 they had to start the second attempt at a breakthrough reform.
According to Leszek Balcerowicz, the economic transformation includes three basic elements: 1 - macroeconomic stabilisation, 2 - microeconomic liberalisation and 3 - radical institutional reconstruction.(5) The turning point of the economic transformation is reached at the moment when demand becomes the barrier of economic growth instead of the former supply limitations. Poland, Czechoslovakia and Hungary reached this point in 1990 or 1991, Slovenia in 1992, the Baltic states in 1993, while Bulgaria, Romania as well as Belarus, Ukraine and other post-Soviet republics have not yet reached this point.
During the transformation, East Central European economies had to solve numerous problems. Firstly, the macroeconomic stabilisation had to deal with inflation, budget deficit and trade deficit. This stage was most costly in Poland, where the Balcerowicz "shock therapy" revealed the scale of economic irrationality, including hidden unemployment and over-use of other resources. The social costs of economic transformation in Poland were huge and quickly eroded the political influence of the post-"Solidarity" reformers.
Secondly, the old system of artificial economic parameters, such as prices, wages, rates of exchange, and so forth had to be replaced by a system of market-regulated parameters.
Thirdly, the progress of privatisation was essential for the restructuring and intensification of the East Central European economies and became an important indicator for foreign investors.
Fourthly, modernisation of the fiscal system allowed for rationalisation of the links between enterprises and the budget. The "soft budget constraint", typical for command economies, was to be eliminated. The first country to introduce a uniform personal income tax was Hungary. The fiscal reform was soon supplemented by the introduction of the value added tax. Central banks adopted roles typical for such institutions in market economies.
Fifthly, reconstruction of stock exchanges solidified grounds of market economies. The first three stock exchanges in Warsaw, Prague and Budapest were even rated among the most courageous "experiments in contemporary economics".
Economic transformation in East Central Europe has faced numerous obstacles and barriers. Economic restructuring proved to produce huge social costs. It was increasingly difficult to convince the employees of "socialist" value-deducting enterprises to accept local shock therapies, which included reduction of employment, the linking of wages with efficiency, the elimination of various social privileges and even, in the worst cases, the closure of factories. Shortage of funds for investments made the creation of new jobs very difficult. On the other hand, without economic rationalisation, "socialist" enterprises would hopelessly continue to consume huge budget subsidies feeding inflation and wastefulness. Other obstacles included foreign indebtedness (especially high in the cases of Poland and Hungary), dependence on the Soviet economic area (particularly grave in the case of the Baltic states, Belarus and Ukraine), environmental pollution, vague legislation leaving gaps filled by ever-growing economic crime, inefficiency and corruption of the bureaucracy and underdevelopment of the social, communication and transportation infrastructure.
Some Individual Cases
Before any generalisation is made, some of the most important cases of East Central European transforming economies should be briefly examined.
The first country to institute a "shock therapy" was Poland, in 1989. Under the pressure of a clear economic disaster, its initial objective was basically to overcome hyperinflation and then to eliminate the "soft budget constraint" and to introduce market parameters. Initial hyperinflation made the social costs of the Polish breakthrough reform very high. Nevertheless, the economic decline was reversed in 1992. By that time almost all prices had been freed, the Polish zloty made an internally convertible currency and the seller's market had been replaced by a buyer's market. High unemployment and pauperisation of individual farmers (which had been an exception in the region) created widespread discontent. The social costs of transformation resulted in the defeat of the post-"Solidarity" reformers in the parliamentary election of September 1993. The post-communist opposition created a new cabinet which generally continued earlier policies but slowed down privatisation and strengthened the roots of "political capitalism" founded by the former communist nomenklatura. Nevertheless, the overall growth rate of the Polish economy remains one of the highest in Europe.
In Czechoslovakia the economic transformation was started in early 1991 when most prices were freed, internal convertibility of the crown was introduced and tariffs were lowered, retail trade was privatised and a property restitution law was passed. In 1992 mass-scale coupon privatisation was started. The social costs of these reforms have also proved higher than expected which, along with the awakening of nationalist feelings, led to the split of the country into the Czech Republic and Slovakia in January 1993. For some time it seemed the Czech economic transformation would be a success but, despite the recovery which started in 1993, structural changes proved to be too superficial. For instance, the mass privatisation failed to rationalise the former "socialist" industry as most of the coupons were bought out by unrestructured state banks. As a result, in early 1997 the Czech economy faced a declining growth rate and accumulating problems. In Slovakia the value-deducting socialist industry has been an even heavier burden, so an apparently better economic performance may not last.
Hungary went through a serious economic breakdown in 1991 and 1992 but consistent reforms created market parameters and stimulated efficiency. As a result, Hungary became the largest capital importer in the region. Despite problems with the restructuring of collectivised agriculture, recovery started in 1993. Nevertheless, the high social costs of economic restructuring led to the defeat of the ruling right-of-centre coalition in mid-1994. A new government was formed by post-communists and liberals who generally continued earlier policies but could not avoid a slight slow-down of economic growth in 1995 and 1996.
Bulgarian transformation began in 1991 under conditions of market disequilibrium and high inflation. The first non-communist government was too late and too moderate at the initial stage of reform. Some prices were liberated and small trade firms were privatised but large value-deducting enterprises remained untouched. In spite of this, post-communists returned to power in October 1992 and won a landslide victory in the 1994 election. The post-communist government has frozen structural reforms, leading to a repeated wave of high inflation, market shortages and popular discontent. As a result of another economic decline, the April 1997 election brought a liberal-national coalition back to power with a strong determination to radically restructure the Bulgarian economy.
In Romania the post-communist elite continued to rule after the bloody coup of December 1989 which brought the Ceausescu regime down. The government's devotion to radical change was low for fear of social discontent. In 1991 most prices were freed and small trade firms were privatised, while the former nomenklatura appropriated larger firms. Collective farming was almost untouched. As a result, after a temporary recovery in 1994 and 1995, structural problems re-emerged as a serious obstacle to growth and the economic situation deteriorated in 1996. All this ended with the defeat of post-communist candidates in the presidential and parliamentary elections of late 1996. The new Christian-Democratic and liberal coalition launched the second stage of transformation.
After its departure from the former Yugoslavia in 1991, Slovenia embarked upon systemic transformation, creating the foundations of a national economy and overcoming the economic decline inherited from the communist past. By 1994 the Slovenian econony had entered a recovery within a market economy system.
The three Baltic states -- Estonia, Latvia and Lithuania -- started systemic transformation in 1992, soon after they regained independence after the collapse of the Soviet Union in 1991. Their situation was more complicated than elsewhere in East Central Europe because of their economic dependence on Russia and other former Soviet republics, as well as by political problems caused by their Russian minorities. As a result of the detachment from the Soviet economic area, in the years 1991-1993 Latvia and Lithuania lost about half of their GNP, while Estonia lost about 35 percent of its GNP. By 1995 all three had begun to recover, having created foundations of their national economies including central banks, internally convertible currencies and tariff frontiers. They were already well-advanced in the economic transformation, curbing inflation, privatising industry, agriculture and trade and restructuring the geographic composition of foreign trade. In Estonia and Latvia the economic recovery was slightly faster than in Lithuania. It was also only in Lithuania that former communists returned to power in 1993 and were voted out of power in 1996. In Estonia and Latvia the post-communists remained a marginal phenomenon.
General Remarks
It is extremely difficult to generalise regarding the achievements of economic transformation in countries whose points of departure and main problems have differed greatly. Synthetically, these achievements are expressed in the overall attractiveness for foreign investors, being a function of the country's purchasing power, costs of production, labour productivity, rate of growth and economic risk. The most attractive investment markets of East Central Europe include the Czech Republic, Hungary and Poland (the latter recently catching up with the leaders), followed by Slovakia, Slovenia and the Baltic states. The lowest investment risk ranking followed a similar pattern.
Regional success stories are numerous, but it remains an open question whether they outweigh the regional failures. The success stories include the Polish business-like spirit, Czech and Hungarian economic stability, the Baltic states' emancipation from the Soviet economic grip, and also perhaps the recent display of Bulgarian and Romanian common sense in voting the post-communists out of power. Another promising phenomenon is the creation of the Central European Free Trade Area (CEFTA) in 1991. Its founding member were Poland, Czecho-Slovakia (both countries remained members) and Hungary. In 1995 Slovenia joined and in 1997 Romania is likely to join the CEFTA.
During the economic transformation in East Central Europe two main trends may have been recorded. One could be called the reformist or modernising trend. It included attempts to curb budget deficits, internal debt and inflation, and to promoting privatisation and market institutions (free pricing, personal income tax, VAT, convertible currencies, stock exchanges etc.) The other trend was a conservative tendency on the part of some of the beneficiaries of the old system (the state bureaucracy, workers of value-deducting enterprises, etc.) to yield to the pressure. The latter tendency was not an openly expressed desire to return to the past and was usually concealed by slogans of a "third path" between socialism and capitalism. The East Asiatic New Industrial Countries were often quoted as patterns for East Central Europe, with little reflection on the cultural differences between the two regions.
Generally speaking, the economic transformation in East Central Europe has proved a much longer and more painful process than initially expected. Nevertheless, it is the author's belief that, perhaps with the sad exception of Belarus, all the countries in question will soon become viable market economies and democracies.
Wojciech Roszkowski
Director, Institute of Political Studies
Polish Academy of Sciences
e-mail: POLITIC@ISSPAN.WAW.PL
Endnotes:
1. This article is an abridged version of a presentation given to the Department of Political Science at the University of Melbourne on 12 March 1997 and is based on a more general text co-authored with Professor Jan Kofman in Polish for the Studia Polityczne in Warsaw.
2. Janos Kornai, Neidobor v gospodarce [Shortage in the Economy], (Warsaw:PWE, 1985), p. 58 ff.
3. Leszek Balcerowicz, Systemy gospodarcze [Economic Systems], (Warsaw: SGPIS, 1988), pp. 148-192.
4. cf. eg. Jan Drewnowski (ed.), Crisis in the East European Economy, (London: Croom Helm, 1982).
5. Leszek Balcerowicz, 'Fundamenty szybkiego rozwoju' [Foundations of Rapid Development], Zycie Gospodarcze, No. 24, 1994.
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