Annual Paper
of “WorldEconomies”
“Creating MarketEconomy in Eastern Europe”
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The Summary
Introduction
1. Meaning of market Economy and Tasks of the Transitions.
2. The Emergence of Market Economy in European countries.
2.1 . The Transition to a Market Economy.
2.2. Poland and Hungary as the best example oftransition in the East Europe.
3. Moldova’s way to an open economy.
Conclusion.
Introduction
Thispaper is oriented toward the problems of transition and creating in countriesof Eastern Europe, namely Poland, Hungary, all of which are attempting to makethe transition under a democratic, parliamentary form of government.
The last new years have witnessed truly extraordinaryevents in the formally communist societies. Under newly established conditionsof free speech and freedom of organization, communist principles of politicaland economic 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 of countriesformer communist have not been decisively dislodged, in almost all casescommunism has lost whatever remaining legitimacy it possessed, and it most ofthese societies the crucial economic issue has suddenly changed from reformingthe socialist planning system by the introduction of market-like elements tomoving to a market-economy with private ownership of 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 there areimportant differences in the inherited situations and the choices made bygovernments of these countries, the similarities in the problems they face andthe difficulties they are encountering suggest that there is logic to thetransition 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 irreversible consequences.
1. Meaning of Market Economy and the Tasksof the Transitions.
Thateconomic system which brings together natural resources, labour supply andtechnology and which is principally privately owned and were government has tosome extent always been involved in regulating and guiding the economy, hasbeen referred to as «Market Economy». Yet, despite this history ofgovernment intervention, individuals in that country have always been able tochoose for whom they will work and what they will buy.
Now 3groups make decisions and it is their dynamic interaction that makes theeconomy operate. Consumers, producers and government make economic decisions ona daily basis, the primary force being between producers and consumers; hence,the market economy designation.
Consumerslook for the best values for what they spend while producers seek the bestprice and profit from what they have to sell.
Government,at state and local levels, seeks to promote the public safety, provides socialsafety-net, ensures fair competition and also provides a range of servicesbelieved to be better performed by public rather include education, healthservice, the postal service road and railway system, social statisticalreporting and, of course, national defense.
In thismarket economy system, economic forces are unfettered, supply and demands buildup the price of goods and services. Entrepreneurs are free to develop theirbusiness unless they can provide goods or services of a quality and price tocomplete with others; they are driven from the market.
By andlarge, there are three kinds of business:
1) those started and managed personally by singleentrepreneurs;
2) the partnership where two or more people sharethe risks and rewards of a business;
3) the corporation, there stock holders as ownerscan by or sell their shares at any time on the open market; this latterstructure permits the amassing of large sums of money by combining investment,making possible large-scale enterprise.
Innovationsin economic theory in the last two decades undoubtedly affect the wayeconomists look at the transition problem and have probably made them morepessimistic about the ease with which it can be accomplished. Developments intransaction cost economics, the economics of information, the new institutionaleconomics, and evolutionary approaches to economics have sensitized economiststo the vital role that institutions play in economic process. One way ofthinking about a successful market economy is that it is a set of convergentexpectations in the population about how other people will behave; theseexpectations support an extremely elaborate division of labour or a high degreeof specialization among individuals, organizations, and geographic areas.
In recent decades many economists have returned to theSchumpeterian view that the advantage of the market economy (relative to itsalternatives) lies more in its facilitation of innovative activity than in itsallocative efficiency.
The system of central planning is surely deficient inboth respects but it is shortcomings seem to be much greater in the area ofinnovation than in allocative efficiency.
Anotherdevelopment in economics that has reduced the affractiveness of the largeconception of market socialism is the increased attention paid to themotivation of government officials, both legislators and bureaucrats.
In the1950's and 1960's, much of economic analysis was focused on market failures andgovernment action to remedy these failures, under the implicit assumption thatgovernment officials would follow the rules laid down by the authorities. Theanalysis of the logic of collective action and the formation of interest groupsthe theory of rent-seeking behavior, and the study of the evolution ofcooperation and norms have emphasized that government failure as well as marketfailure must be taken into consideration in designing institutions.
A vividanalogy stated by Vladimir Benachek of Charles University is that the socialisteconomics are at the top of a small hill (the planned economy), and they wantto get to the top of a larger hill (the market economy). But in between the twohills is a valley, which may be both wide and deep. The analogy illustrates thepoint that the centrally planned economics did have a coherent economic system(i.e. they were at the top of their hill). One might add that the smaller hillwas being eroded by the strengthening of special interest groups and wasperhaps, settling due to the seismic rumblings that shattered the communistauthority. The band of travelers must settle their differences, agree on aroute, and avoid the pitfalls and chasms along the way.
Perhaps economic analysis can facilitate the journeyby designing a bridge between the two hills. Given the absence of closehistorical parallels and the severe limitations of economic models of societyit is clearly beyond the capacity of social engineers to draw up very preciseplans for the bridge.
The Tasks of the TransitionsThe list of activities which governments which governmentsmust undertake in countries attempting the transition to a market economy istruly staggering. The list given here is designed to convey something of theenormity and complexity of the job. First, there is a group of activitiesrelated to creating a new set of rules:
1. Setting upthe legal infrastructure for the private sector:
Commercial andcontract low, antitrust and labour low, environmental and health regulations;rules regarding foreign partnerships and wholly foreign-owned companies; courtsto settle disputes and enforce the laws.
2. Devising asystem of taxation of the new private sector:
Defining accounting rules for taxationpurposes, organizing an Internal Revenue Service to collect taxes from theprivate sector.
3. Devisingthe rules for the new financial sector:
Defining accounting rules for reportingbusiness results to banks and investors; setting up a system of bankregulation.
4. Determiningownership rights to existing real property:
Devising laws relating to the transfer ofproperty, and laws affecting landlord tenant relations; resolving the vexatiousissue of restitution of property confiscated by communist governments.
5. Foreignexchange:
a) setting therules under which private firms and individuals may esquire and sell foreignexchange and foreign goods;
b) setting therules in the same area for the not-yet-privatized enterprises.
Next there are some tasks related tomanaging the:
6. Reformingprices:
Enterprises that have been privatized willpresumably be largely free to set their own prices, but early on in theprocess, the demands of the government budget will require raising prices onmany consumer goods that have been provided at prices for below cost.
7. Creating a safetynet:
Setting up an emergency unemploymentcompensation scheme; targeting aid in kind or in cash to those threatened withsevere hard ship by the reforms.
8. Stabilizingthe macroeconomic:
Managing the government budget to avoid anexcessive fiscal deficit and managing the total credit provided by the bankingsystem.
Finally there are tasks related toprivatization:
9. Small-scaleprivatization:
Releasing to the private sector trucks andbuses, retail shops, restaurants, repair shops, warehouses, and other buildingspace for economic activities; establishing the private right to purchaseservices from railroads, ports, and other enterprises which may remain in thepublic sector.
10. Large-scaleprivatization:
Transferring medium and large-scaleenterprises to the private sector; managing the enterprises that have not yetbeen privatized.
An abstractModel of the Transition consist of three main phases:
Phase 1: The cabinet-level negative phase
In this phase members of the centralgovernment interact with nationally representative interest groups. The tasks areorganized into two categories: they will determine the general institutionalstructure of society and set guidelines that will be used in phase 2 to assigneach enterprise to one of many alternative «transition regimes».
Phase 2: The assigned phase
In this phase state-owned enterprises arematched with transition regimes. One can assume that each state-ownedenterprise is completely described by some vector of attributes. Theseattributes specify such diverse aspects of the enterprise as:
a) the nature ofthe products produced by the enterprise, a description of its plant andequipment, and technology it utilized;
b) adescription of its financial states;
c) the placeof the enterprise within its industry, including its market share and thenature of its competition;
d) someindication of the risk profile of the firm;
e) thedistribution of information within the enterprise;
f) the natureof «measurement errors» in monitoring the performance of theenterprise;
g) therelationship between the enterprise and the state bureaucracy;
h) the«distance» between the enterprise and founding ministry;
i) anypotential synergies between the enterprise and some prospective foreigninvestor. Phase 3: The enterprise-levelnegotiation phase
In this phaseparticipants at the participants at the level of each enterprise play an MBgame (multilateral bargaining). For each enterprise the structural parametersof the game are included in the characterization of the transition regime towhich 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.
Beforeconsidering the transition to a market economy, we must consider the need forsuch a transition. Today the need is clear: socialist and communist systemshave failed to deliver (in a liberal sense) anything like the standard ofmaterial advance so often promised.
But morerecent rasy assessments of central planning abound. Even as late as 1979 theWorld Bank published a long and detailed study of Romania – the most Stalinistof the eastern block. The Bank found that from 1950 to 1975 the Romanianeconomy had grown faster than any other country in the world (9,8 percent perannum). The Bank attributed this startling performance to the fact thatgovernment, through its system of central planning, had control of allresources. The Bank forecast a rasy future for Romania – growing at 8,7 percentper capita to 1990. Nor was Romania an aberration. The Bank published in thatsame year of 1979 a most rasy history of, and prognostication for Yugoslavia.Studies up to 1984 continued to show that central planning, albeit somewhatmodified in places, delivered the goods.
This reviewis not intended to score paints, but simply to remind us of the long addictionof economists to planning and regulation.
2) Transitions
Thetransition to a market economy always and at all times involves a familiar listof policies.
First isfinancial stabilization reducing the budget deficit and the monetary emissionsof the central bank. This stabilization may involve many complex policies –almost certainly a fax reform and expenditure controls, particularly in thereduction of subsidies. There is no consensus on pegged versus free exchangerates.
Second isderegulation, elimination a myriad of government controls and establishing theframework for free contractual relationships. This priority involves therecognition of property rights and the development of a legal system suitablefor a market economy. It also implies a diminished role for the centralplanners as more room is provided for private initiative and enterprise. Butoddly enough it is widely recognized that there is a need for more restraint onindustry, particularly the heavy state owned firms, to reduce pollution. Otherareas of deregulation include trade reform and currency convertibility.
Third is thereform and privatization of state- owned concerns to this list should be addedthe reduction in monopoly power not only of industry but also of trade unions,and in particular the reform of labour laws. The reform of the banking systemand the development of commercial rather than planning criteria in banking italso of the utmost important.
3) ThePolitical Economy of Transition in Eastern Europe:
PackingEnterprises for Privatization.
An abstractmodel of the transition from a centralized command economy to a market economyfocusing on privatization is a novel orientation for this chapter. In much ofthe literature on privatization in central and Eastern Europe, either a case isargued for a particular transition proposal or specific aspects of theprivatization problem are isolated and considered in detail.
The modelfocuses on the way in which government policies and enterprise-level decisionsare made and relatively less on the specific content of these policies anddecisions.
Theconceptual model has been designed with five basic premises in mind:multilateral bargaining, political economy, heterogeneity, decentralization,and pluralism.
4) Multilateral bargaining
In a world inwhich economic rights are ill designed, a bargaining problem naturally arises.Throughout Central and Eastern Europe, this problem can be conceptualized as amultifaceted conflict between multiple interests representing workers,management, claimants to property rights based prior ownership, foreigninvestors, representatives of different group in the distribution chain, etc.
It is usefulto distinguish two different kinds of bargaining problems. There are issuesthat must be negotiated at the level of central government: for example, whatwill be the nature the regulatory and legal infrastructure within which theseprivatized enterprises will operate? Other issues concern the disposition ofindividual state-owned enterprises and must be negotiated on a case-by-casebasis. In particular what will be the precise nature of each corporate entitythat is being packaged for sale to private buyers? Who will control it? Howwill it be structured? What kind of compensation schemes will be in place formanagement and workers?
What specialprovisions will be in place that affect the relationship between the privatizedentity and other firms, including established and new competitors, firms thatare up and down stream in the distribution chain, etc.? In the discussion thatfollows, the focus will be on bargaining problems of the latter kind. Onepresumes that, because of the complexity and diversity of the issues during thetransition, the state is not in a position to resolve them by fiat rather, overthe transition, the state is presumed to be one negotiator among many.
Bargainingproblems of this kind can be resolved in a variety of ways. At one extreme, anexplicit institutional structure may be established by the state to facilitatean orderly negotiation of the issues. This institution would specify:
a) the interests that should be represented in thebargaining process;
b) the space of issues over which these interests can negotiate;
c) what degree of consensus is sufficient toconclude negotiations;
d) who will represent «the state» the founding ministry aresome agency established specially to deal with privatization;
e) what will happen if negotiations break down?
At the otherextreme the state may provide no procedural guidelines whatever as to how theissues should be resolved in this procedural vacuum, the economic rights inquestion may simply be expropriated by whichever party — typically the currentmanagement — is strategically located to do so.
Relative tothe general trend that appears to be emerging in Central and Eastern Europe,there should be made opportunities for decentralized negotiation.
Ourprocess-oriented perspective does suggest an indirect, «hand off» wayto exercise some control over this phase of the process, the government canintroduce some checks and balances into the negotiations. For example, of thethree «primary» parties at the bargaining table-management, employeesof the enterprise, and the state agency responsible for privatization — thefirst two parties have every incentive to design privatization plans thatinhibit competitive pressures, while the third will inevitably be moreconcerned this effecting a successful sale of the enterprise than with issuessuch as the competitiveness of the resulting market structure. From thestandpoint of the public interest then the outcome of multilateral bargainingis bound to be sub-optimal, provided that participation in the process isrestricted to the three primary parties. Moreover, the directions in whichthese outcomes will deviate from the optimal are more or less predictable.
TheMultilateral Bargaining model provides a useful analytical tool forinvestigating the effectiveness of this approach to policy making.
In othercontexts, the multilateral Bargaining model has been used descriptively toexplain how during the process of multilateral negotiation, coalitions areformed, deals are struck, and compromises are reached.
5) Politicaleconomy.
A second basic premise isthat any policy recommendations must be both economically and politicallyconsistent. This consistency requires a specification of the relationshipbetween short-term economic developments and longer-term politicalramifications. Obviously, economic policy objectives cannot be pursued inisolation, since the prevailing political configuration will constrain the setof options available to planners of the transition process. On the other hand,economic post-privatization economy develops, new interests will acquireeconomic power and new institutions will emerge to strengthen the power ofgroups that wish to defend these institutions. The dynamic interaction betweenthese economic and political facets of massive privatization programs must betaken into account. Indeed, one can expect that models, which ignore politicaleconomic feedback effects, will have a natural tendency to overestimate theprospects for a successful transition.
Thefollowing example illustrates the kind of political-economic interaction thatcould adversely affect the reformprocess. Policy makers in Central and Eastern Europe appear to be overlycomplacent in their reliance of foreign competition as the main disciplinarydevice that will force monopolists to operate efficiently. Indeed, Polishofficials cite their country’s liberal tradition in the area of tradepolicy when questioned about the viability of this approach to antimonopolypolicy. Our dynamic political-economic perspective leads to skepticism aboutthis heavy dependence on competition from abroad.
If a seems very likely, the post-privatizationindustrial structure turns out to be highly over-concentrated and inefficient,then the main effect of threatening foreign competition will be to unleash apowerful confluence of political forces in favor of protectionism. Owners ofthe domestic enterprises will lobby to defend their rents, managers will lobbyto defend privileges, and workers will lobby to defend their jobs. Because theproblem of unemployment never really arose under communism, the potent tensionbetween introducing free trade and maintaining employment levels never becameapparent.
2.2.Poland and Hungary as the best example of transition in the East Europe
EconomicReform in Eastern Europe: The Background
Thebackground of economic reform in Eastern Europe is not unlike that in theSoviet Union, even though, as I have emphasized, the setting is ratherdifferent. The brief political thaw following the death of Stalin in the early1950s did permit a freer discussion of ideas, which, along with growingproblems of economic performance, led to limited attempts to develop andimplement economic reform. Initially, these changes were modest in scope, andthey typically followed the Soviet reform pattern: Try to improve decisionmaking while preserving socialist objectives and the essence of the planningsystem. This was the focus of the New Economic System in the GDR and of the NewEconomic Mechanism introduced in Hungary in 1968. The potential for genuineeconomic reform was certainly limited by Soviet influence. Indeed in some cases(such as Czechoslovakia in 1968), reform was abruptly forestalled by Sovietintervention. In other cases, such as Hungary, reform attempts dating from thelate 1960s were sustained on a limited basis, to become the background for moreserious reform in the present era. There were, then, numerous attempts atreform in Eastern Europe. What were the major forces promoting these efforts?
First, as was the case in the Soviet Union,rates of economic growth in Eastern Europe have undergone a long-term seculardecline. The magnitude of this decline (see Table 1) has varied from case tocase, but overall it has been pervasive. Moreover, these countries had takenpride in being high-growth economies, even if the costs, such as little growthof consumer well-being, were also high. At the same time, growth inproductivity slackened, especially in the late 1970s and 1980s. And inflationquickened, though it was most serious in Poland and Yugoslavia. Repressedinflation, though difficult to measure, grew in importance in the 1980s.
Second, East European countries relied heavily onforeign trade as a means of stimulating economic growth in the 1970s. Theirstrategy was to promote exports in Western markets so that the imports requiredboth to stimulate technological change in industry and to enhance consumerwell-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 East Europeannations were becoming more aggressive in these markets. East European importswere sustained, but largely by means of building a substantial hard-currencydebt. The magnitude of debt repayment subsequently led to considerable internalbelt-tightening for these countries in the 1980s — precisely the opposite ofwhat had been intended.
Third, one could argue that in Eastern Europe, thepossibilities for economic growth through extensive means had initially beenless promising than in the Soviet case and had been exhausted more quickly. Inlight of the level of economic development in Eastern Europe compared to thatin the Soviet 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 Europe 3.4 2.4 1.0
.2 2.2 Bulgaria 5.0 2.3 .1 -3.2 4.7 Czechoslovakia 2.4 2.3 1.0 .4 1.9 East Germany 3.2 3.5 1.7 3.3 1.6 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
EastEuropean Reform Programs: Similarities and Differences
In this chapter we pay special attention to Poland andHungary. We do so because these countries are both examples of aggressivereform but have employed different strategies. However, before we considerthese cases in greater detail, it is useful to summarize the East Europeanreform experience, noting important similarities and differences among thevarious cases. To do so will entail some repetition of basic themes.
First, economic reform in Eastern Europe (at least inPoland, Hungary, and Czechoslovakia) is generally described as a transition inthat these countries seek to replace the planned economy with a market economyrather than attempting merely to modify the former.
Second, transition programs have varied in speed andintensity. Some countries have pursued reform on a «gradual» basis,whereas others, like Poland, have pursued what is often termed a «bigbang,» or rapid, approach to reform. However, we must remember that evenin those countries not pursuing a «big bang» or «shocktherapy» approach, the process of transition in Eastern Europe has beenrelatively rapid, especially when compared to reforms of the past — and notablyso when compared to the recent Soviet record. It is important, therefore, to beaware of the basic issues associated with transition and of the extent to whichthe attempted speed of transition alters the overall reform experience.
Third, although it is possible to examine andunderstand the basic elements of economic reform and even of transition fromone system to another, we really do not have a general theory of change ineconomic systems. In some cases — for example, during such a period of rapidchange as the 1990s — it is difficult even to develop a way to classify theissues involved in transition.
Fourth, important differences exist from one countryto another. Our view of the socialist transition process is heavily influencedby our image of the best-known and most advanced reforms, such as those ofPoland, Hungary, and Czechoslovakia. We know much less about, and tend to payless attention to developments where reforms are proceeding at a slower pace,as in Romania and Bulgaria. Figure 1 offers a simple, stylized view ofcontemporary political and economic reform (transition) in Eastern Europe.
Figure1. Reform in Eastern Europe
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