From Plan to Market, From Regime Change to Sustained Growth in Central and Eastern Europe By



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From Plan to Market, From Regime Change to Sustained Growth

in Central and Eastern Europe

By


Ivan T. Berend

As a critique of the laissez-faire concept in interpreting Central and Eastern European transformation, I would suggest that the process does not end with systemic change. Laissez-faire interpretations maintain that economic growth, prosperity, and catching up are automatic outcomes of marketization. The reality is different. Systemic change, in the sense of economic transformation, would be senseless without creating the potential to respond to the challenge of the technological-structural revolution of the age. Successful restructuring cannot be the mere result of marketization and privatization. It cannot happen without the massive participation of transnational companies. Their investments, however, is not guaranteed and might be a mixed blessing. Appropriate international and national environments are required to generate a spin-off effect and avoid the rise of a dual economy with advanced foreign enclaves in an environment of continued peripheral backwardness. The first decade of transformation clearly reflects two, rather different possible outcomes of transformation and different responses to technological-structural challenges in the diverse areas of Central and Eastern Europe.
State socialism collapsed in Central and Eastern Europe a decade ago. In most cases the change of the regime was quite peaceful since the Soviet Union gave up control of the area, and the communist elite lost its self-confidence and hope to be able to solve the towering economic problems. In the decisive Polish and Hungarian cases significant opposition emerged from without and/or within the ruling party to either attack the regime or to reform it radically. A stormy and spectacular transformation began and characterized the entire period of the 1990s.
From the very beginning, a vast literature of “transformatology” came into sight. Advisers of newly appointed governments, scholars, and experts of various international institutions worked out hundreds and thousands of studies, recommendations and critical analyses alike. A broadly accepted set of criteria for a reform program, the so-called Washington consensus of 1989, originally applied to less developed, crisis-ridden Latin American countries, was offered as a blueprint for the process of Central and East European economic transformation.1 This prescription was offered for former state socialist countries by the international financial institutions: the International Monetary Fund, World Bank, and the American administration. Its central elements were macro-economic stabilization those countries with significant inflation and indebtedness; the building of new institutions, and legislation necessary for a market economy; price and trade liberalization, and radical privatization of the previously nearly complete state-owned and operated economy.
Most of the “transformatology” literature, covering these above-mentioned topics, is based on the explicit or implicit assumption that the elimination of deformed non-market economies, a restoration of market, and private ownership, paired with a laissez-faire free market system would automatically solve all of the major economic and even social problems of the transforming countries. The transition from plan to market is, thus, the key to the door of prosperity, and catching up with the West. “The economic reforms,” stated Jeffrey Sachs in 1991, “will set in motion a sustained process of economic restructuring…Once market forces are unleashed, there should be a strong pull of resources into the previously neglected [service] sectors…Agriculture is another area where we should expect major restructuring…The third major trend that we should expect is a complete restructuring within the industrial sector, from energy-intensive heavy industry to more labor-intensive and skill-intensive industries that can compete on the world market…Western firms…are likely to set up operations…for the sake of export production, in the same way as European firms are investing in Spain…”2
This assumption was in the air of the age. The competition of advisers and new governments in radicalism and the attempt to make a tabula rasa, to unleash almighty market automatism was partly a consequence of lack of experience in an unbeaten road, but most of all, of the Zeitgeist of the 1980s and 1990s, dominated by a Chicago school version of laissez-faire ideology, or, as George Soros named it, market fundamentalism, which “disregard social values” and “seeks…to impose the supremacy of market values...”.3 “Reaganomics” was presented as an overall, quick solution to economic ills. Thatcherism successfully undermined the concept of Sozialpartnerschaft. These ideals, advocated by the great powers, the international financial institutions, and hundreds of experts, and advisers, penetrated Central and Eastern Europe and the entire world. No doubt, if accepted, they served propaganda and public relation goals well, received headlines and tremendous applause in the West. Provided that this program represented the only successful road towards an automatic economic restructuring and prosperity generated by the introduction of market economy, it was logical to urge fast and radical strokes of market reforms. The speed is important if you have to go through the “valley of tears” (Dahrendorf). The faster one concludes transformation, maintained the advocates of this concept, the better it is, because the pain of transformation will disappear and one can reach the other end of the valley of tears earlier. As Michael Mandelbaum of Council on Foreign Relations most characteristically phrased it, “If the people…can endure the hardship that the policies of stabilization, liberalization, and institution building inflict, they will emerge at the other end of the valley of tears, into the sunlight of Western freedom and prosperity”.4
Thinking in the framework of the laissez-faire paradigm, the dramatic decline in output and GDP during the early 1990s was not as bad as the people of the region thought, because, things first had to be worst to get better later. The dramatic economic crisis is nothing else, as János Kornai interpreted, than a “painful side effect of the healthy process of changing the system”. A “transformational recession,” caused by a transitory “shift from the sellers’ to a buyers’ market; contraction of investment; a shift in the composition of foreign trade; disruption of coordination, enforcement of financial discipline”. The appropriate cure of the malaise is to “accomplish the task [of market reforms] faster”.5 Jeffrey Sachs similarly warned in 1991: “The time in the valley [of tears] depends on the consistency and boldness of the reforms. If there is wavering or inconsistency in economic measures, it is easy to get lost in the valley. Argentina has been lost for forty-five years”.6 He, as well as many others, advocated “comprehensiveness and speed in introducing the reforms” which “can and should be introduced quickly, in three to five years”.7 He also maintained that “macroeconomic stabilization can also be achieved relatively quickly”. However, he added, restructuring that follows reform will take “presumably a decade or more”.8
In sum, if you marketize and privatize fast, not only will systemic change and marketization be concluded in a decade or so, but also the restructuring that automatically follows and generates prosperity. This concept implicitly suggests that Eastern European backwardness is a mere consequence of the planned economy and state socialism. If this was the case, indeed, it would be enough “to return to normalcy” by introducing Western type of market economy by bold and radical reforms.
In reality, the backwardness of the area and the failed attempt to catch up with the West has a long history. During the second half of the 19th century most of the area adopted the Zeitgeist of laissez-faire, free trade and export-led industrialization, and joined the international European economy. That attempt, however, failed, or, at least met with only limited success: Central and Eastern Europe remained agricultural, rural, and traditional, compared to the industrialized and urbanized West. 9 After World War I, in a radical departure from the past, the countries of the region turned to economic nationalism, introduced high protective tariffs, strong state interventionism, some kind of planning, and replaced export-led policy with import-substitution. The result, nevertheless, was the same semi-failure and continued backwardness.10 The planned economy of state socialism was only a new, bitter, and extremist version of economic nationalism. State interventionism and autarchy served to avoid hopeless competition, and reach the Western level. The effort, again, failed. In other words, Central and Eastern Europe, consequently, is not in a position to simply reject the unpleasant and unsuccessful intermezzo of the last half a century and “return to normalcy”. Rebuilding a private-market economy with all of its institutions and legal prerequisites, i.e. systemic change itself, cannot simply produce a mechanism of successful sustained growth, leading to catching up. This mechanism has never worked in this area. A brief comparison can illuminate the longue durée of economic trends in the region: 11
Central and Eastern Europe’s per capita GDP as percentage of the West

Regions

1870

1913

1938

1973

1989

Western Europe

44

44

44

45

40

Overseas West

32

30

35

38

32

The aggregate, comparative index of economic development levels, GDP per capita, clearly shows that during the three-quarters of a century, between 1870 and 1983, market and private economy could not generate automatic prosperity and the catching up process. Central and Eastern Europe’s relative position vis-à-vis Western Europe and the overseas West remained unchanged. Ironically, state socialism with its planned economy generated a slight transitory catching up between 1950 and 1973, followed by an even steeper decline. Ultimately, the region landed on a lower peripheral level than ever before, or, using Jeffrey Sachs’ metaphor, “was lost in the valley of tears” for all of the modern era.
The transitory strength, and, in some places, popularity of state socialism emerged from its promise to cope with historical backwardness, reach prosperity and high living standards. The regime, in the last analysis, collapsed because it could not fulfill its program and did not lead to the Promised Land. The regimes’ legitimacy was undermined; a deep disappointment penetrated the masses and even the elite.12 The peoples of the area longed for a change, and, as the leading slogan of 1989 clearly reflected, wanted to “join Europe”. As the demonstrators, welcoming Secretary of State, James Baker, in Tirana airport, expressed on their posters: “Albania wants to be like America!”
The change of the regime, however, is far from equivalent to an automatic beginning of sustained growth and catching up. As an economic historian of the region, I strongly argue against the implicit assumption of a great deal of transformatology literature suggesting that sustained economic growth and catching up with the West is an automatism which starts to work when a country adopts the Western market model.
At this point, I must return to the often-analyzed question of economic decline, or “transformational recession” in the early 1990s. Was it, indeed, a merely unavoidable consequence of changes from the plan to the market, as, among many others, János Kornai interpreted?13 In my view, the “transformational recession,” as Kornai named it, was only one element of a long, deep, and complex economic crisis in the area. One should not forget that the crisis had begun much earlier, basically from the mid-late 1970s, when the steam had already run out of the economic drive of forced industrialization in Central and Eastern Europe. Growth slowed significantly – from an annual 3.1 per cent and 3.5 per cent between 1950 and 1973 to 1.3 per cent and 1.2 per cent between 1973 and 1989 in Czechoslovakia and Hungary respectively.14 Between 1978 and 1983, Polish GDP declined by more than 10 per cent. During the second half of the 1980s, Romania experienced 0.7 per cent, Yugoslavia 0.5 per cent, and Poland 0.2 per cent annual growth, compared to the 3.6 per cent growth rate of the OECD countries. Aside from this, the terms of trade for the state socialist countries began to deteriorate: during the first decade after the first 1973 oil shock, they suffered a 20 per cent decline, and for some countries even a 26-32 per cent decline of terms of trade. Foreign trade deficits dramatically increased, and almost all of the region’s countries dropped into an indebtedness trap. At the time of the collapse of the regime, Poland accumulated nearly $42 billion, Hungary more than $20 billion, Bulgaria nearly $10 billion, the state socialist countries altogether $110 billion in debts. Debt service consumed a substantial portion – 40 per cent to 75 per cent – of the countries’ hard currency income.15 Quite a few countries started to lose control over inflation. That was an overall economic crisis characterizing the last one and half decades of state socialism. Transformation, however, except in Hungary and Poland, was not on the agenda yet. This crisis, needless to say, did not end with the collapse of the regime, but continued; moreover, it became even more serious.
We have witnessed a long economic crisis in Central and Eastern Europe from the mid-1970s on up to now. A quarter-century long crisis is not unknown in economic history. This is a kind of Great Depression, Europe experienced during the last third of the 19th century, then in the interwar decades, then again, during the last third of the 20th century. The phenomenon is well explained by economic cycle theories. I prefer, as the most convincing and proven, Joseph Schumpeter’s theory on structural crisis. Caused by a major “set of technological changes”, the replacement of the old technological regime by a new one, leads to the decline of the old leading sectors and export branches based on old technology. This generates a wide-ranging slowing down and decline, and causes an economic crisis even in rich, advanced countries. It happened at the end of the 1970s and early 1980s, when, even in the West, double digit inflation and unemployment, and a significant decline in output exhibited the destruction of the structural crisis. However, rising new technology, “the technical advances in microelectronics”, as Everett Rogers stated, “that occurred in the 1970s and 1980s have spurred the Communication Revolution…[connected with the emergence of new] high-technology industry…one in which the basic technology underlying the industry changes very rapidly”.16 A new infrastructure emerged, as Daniel Bell called it, a “post-industrial society”, with an increasing number and share of white-collar employment in the ever-growing service sector. The adjustment to the new technology led to the emergence of new industries, new leading export sectors. The structural crisis, as Schumpeter explains, led to a “creative destruction”, paving the way for new technology and prosperity. This adjustment created, indeed, solid ground for an impressive new boom in the United States and some other advanced countries.
The structural crisis in the backward areas, however, has a somewhat different outcome. It is definitely destructive, but lacks the creative impact. The peripheral countries of the world economy suffer more because of the severe decline of their terms of trade. Prices and markets for their export items, less processed and much less sophisticated than those of the core countries, drastically decline. They do not have sufficient sources for research and development, know-how and financial sources to follow closely the new technological-industrial revolution, build up new leading export sectors. In other words, they suffer all the negative consequences of the structural crisis but are unable to catch the stormy wind of technological changes in their sails. The “peripheral structural crisis”, as I call this phenomenon, is destruction without creation. Central and Eastern Europe experienced this situation three times from the 1870s to the 1970s-1990s and had only a “backward” exit. The countries of the region preserved their obsolete economic branches and export sectors, and sold the otherwise unsaleable old products in a safe and highly protected regional market. That was guaranteed before World War I in the framework of a multi-national empire, (Habsburg or Russian). In the 20th century, in an alliance system led by a nearby great power (Hitler’s Germany, then Stalin’s Soviet Union).
After the collapse of state socialism, this type of “backward” exit from the structural crisis was blocked. Without technological adjustment, the only shield against competition on the world market, although counterproductive in the long run, was Comecon isolation and regional self-sufficiency. After 1989, however, the countries of the region lost the protective shield of the safe and undemanding Comecon market, were forced to enter the world market and compete with the advanced countries, which have already adjusted to the new technological age. Moreover, they had to compete not only on the world market, but also on their own, opened domestic market. As a consequence, the peripheral structural crisis, prolonged since 1973, not only continued but also became much deeper during the 1990s.
Serious policy mistakes also contributed to the economic drama of the early 1990s. Richard Portes noted “serious macro-economic policy errors…[such as] initial excessive devaluation of the currency”. Instead, he recommended, “do not devaluate excessively; peg initially: then go to a crawling peg”. Another major policy mistake was that “the opening to trade with the West – with convertibility, low tariffs, and few quantitative restrictions – was too abrupt…”.17 Domenico Nuti rejected the interpretation of economic decline as a “necessary concomitant of transition”. In his view, it was an “unnecessary consequence of policy failure”. Most of all “the failure in government management of the state sector”.18
Although the march towards Europe and the reform from plan to market, in the long run, are very positive changes in the region, and this is the only promising road after the failure of state socialism. The economic policy during the first part of the transition period was, however, in many respects, mistaken. The difficult transformation process required a pragmatic and ideologically non-biased approach to reality. The countries of transformation should not have had to attempt to jump directly from a centrally planned to a laissez-faire economy, from an entirely state-owned to a one hundred percent privatized economy. State regulations and government policy were needed in the difficult transformation process when self-regulating mechanisms were not yet developed and market imperfections and non-market friendly behavior among the players was the rule. A regulated market, instead of a self-regulating market, a mixed economy with a restructured and efficient state-owned sector for at least a period of time, and a “fine mixture between market and state”19 would have been a more natural transition from plan to market. This approach, however, was immediately rejected and most of the transforming countries rushed to join the Reaganites and blame “big government”, and state intervention. It caused unnecessary pains, led to the collapse of a great many old companies, which lost the bulk of their value and had to be sold for a fraction of their previous value. All these contributed to mass unemployment, a sharp decline in living standards, especially for certain rather vulnerable layers of the society. People in poverty, those with incomes less than 35 per cent to 45 per cent of the average wage, increased from 14 per cent to 54 per cent in Bulgaria, from 4 per cent to 25 per cent in the Czech Republic, from 25 per cent to 44 per cent in Poland and from 34 per cent to 52 per cent in Romania during the early 1990s.20 “Living standards of 57 per cent of the population of Russia”, reported the journal of the World Bank in October 1999, “are below the minimum subsistence level…the average life expectancy does not exceed 61.7 years”.21 Social polarization, an emerging mortality and health crisis, sharply declining life expectancy sharply declined – all of them phenomena typical for 19th century “wild capitalism,” or, very late 20th century “bandit capitalism”, as two leading economists, N.Stern and J.Stiglitz named it.22
Can all these be considered unavoidable negative side effects of a positive transformation, or, the economic and social decline became much steeper and deeper because the “transformational recession” was deepened by severe policy mistakes? Peter Murell’s theoretical explanation hit the head of the nail: “Economic and political decisions”, he maintains, “are circumscribed by limits in social knowledge…inherited from the past…If one attempts to eradicate all…characteristics [of existing organizations] immediately, then one invites economic collapse…Large changes in the legal and policy framework produce highly dysfunctional outcomes…”.23 Not only speed and scope, but the inappropriate adoption of the laissez-faire market model also caused “highly dysfunctional outcomes”. Grzegorz Kolodko, arguing against laissez-faire policy,24 quotes three genuine authorities, George Soros, the World Bank, and IMF’s Stanley Fisher: “The untrammeled intensification of laissez-faire capitalism and the spread of market values into all areas of life”, warns Soros, “can cause intolerable inequities and instability”.25 “Establishing a social consensus will be crucial for the long-term success of transition”, argues the World Bank in its report on “From Plan to Market”, since “societies that are very unequal in terms of income, or assets tend to be politically and socially less stable and to have lower rates of investment and growth”.26 Stanley Fisher argues in the same way: “adjustment programs that are equitable and growth that is equitable are more likely to be sustainable”.27
Regulation, state intervention, and a mixed economy are among the requirements for Central and Eastern European transformation. After a decade, it is clear that all of the transformational economies are mixed economies, and this fact, provided that they adopted good policy, did not block the road for successful transformation at all. In Hungary, one of the success stories of transformation, “under the privatization law, 92 firms will remain in permanent state ownership”.28 In one of the most successfully transforming countries, Slovenia, “the state still owns more than 50 per cent of total assets in the economy”.29 The state needed and still needs to guide the extremely complex process of transformation. In 1997, the World Bank called the attention to the important role of governments in various fields where market automatism will not work.30 Governments have a role in macroeconomic policy, investment in basic social services, education, training, and infrastructure, creating and keeping a strong social safety net in order to prevent disastrous social side effects for the most vulnerable parts of the society.
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