Курсовая: Creating Market Economy in Eastern Europe
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“Creating Market Economy in Eastern Europe”
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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 of transition in the East Europe.
3. Moldova’s way to an open economy.
This paper is oriented toward the problems of transition and creating in
countries of Eastern Europe, namely Poland, Hungary, all of which are
attempting to make the transition under a democratic, parliamentary form of
The last new years have witnessed truly extraordinary events in the formally
communist societies. Under newly established conditions of free speech and
freedom of organization, communist principles of political and economic
control have been widely repudiated, and communist governments have been
swept aside, replaced by governments committed to democratic principles and a
market economy. While in some countries and parts of countries former
communist have not been decisively dislodged, in almost all cases communism
has lost whatever remaining legitimacy it possessed, and it most of these
societies the crucial economic issue has suddenly changed from reforming the
socialist planning system by the introduction of market-like elements to
moving to a market-economy with private ownership of most of society's
There are several reasons why the task of designing this transition is
fascinating, especially to economists.
First, the problem in new: no country prior to 1989 had ever abandoned the
communist political and economic system.
Second, the experience to date indicates that countries attempting transition
face a number of common problems and difficulties. While there are important
differences in the inherited situations and the choices made by governments
of these countries, the similarities in the problems they face and the
difficulties they are encountering suggest that there is logic to the
Third, the absence of any close historical parallels and the limited
experience economics in transition offer an opportunity and a challenge for
development of normative transition scenarios. This turn out, however to be
extraordinarily 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 Tasks of the Transitions.
That economic system which brings together natural resources, labour supply
and technology and which is principally privately owned and were government
has to some extent always been involved in regulating and guiding the
economy, has been referred to as "Market Economy". Yet, despite this history
of government intervention, individuals in that country have always 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 that makes
the economy operate. Consumers, producers and government make economic
decisions on a daily basis, the primary force being between producers and
consumers; hence, the market economy designation.
Consumers look for the best values for what they spend while producers seek
the best price and profit from what they have to sell.
Government, at state and local levels, seeks to promote the public safety,
provides social safety-net, ensures fair competition and also provides a
range of services believed to be better performed by public rather include
education, health service, the postal service road and railway system, social
statistical reporting and, of course, national defense.
In this market economy system, economic forces are unfettered, supply and
demands build up the price of goods and services. Entrepreneurs are free to
develop their business unless they can provide goods or services of a quality
and price to complete with others; they are driven from the market.
By and large, there are three kinds of business:
1) those started and managed personally by single
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 undoubtedly affect the
way economists look at the transition problem and have probably made them
more pessimistic about the ease with which it can be accomplished.
Developments in transaction cost economics, the economics of information, the
new institutional economics, and evolutionary approaches to economics have
sensitized economists to the vital role that institutions play in economic
process. One way of thinking about a successful market economy is that it is
a set of convergent expectations in the population about how other people
will behave; these expectations support an extremely elaborate division of
labour or a high degree of specialization among individuals, organizations,
and geographic areas.
In recent decades many economists have returned to the Schumpeterian view
that the advantage of the market economy (relative to its alternatives) lies
more in its facilitation of innovative activity than in its allocative
The system of central planning is surely deficient in both respects but it is
shortcomings seem to be much greater in the area of innovation than in
Another development in economics that has reduced the affractiveness of the
large conception of market socialism is the increased attention paid to the
motivation of government officials, both legislators and bureaucrats.
In the 1950's and 1960's, much of economic analysis was focused on market
failures and government action to remedy these failures, under the implicit
assumption that government officials would follow the rules laid down by the
authorities. The analysis of the logic of collective action and the formation
of interest groups the theory of rent-seeking behavior, and the study of the
evolution of cooperation and norms have emphasized that government failure as
well as market failure must be taken into consideration in designing
A vivid analogy stated by Vladimir Benachek of Charles University is that the
socialist economics are at the top of a small hill (the planned economy), and
they want to get to the top of a larger hill (the market economy). But in
between the two hills is a valley, which may be both wide and deep. The
analogy illustrates the point 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 hill was being eroded by the strengthening of special
interest groups and was perhaps, settling due to the seismic rumblings that
shattered the communist authority. The band of travelers must settle their
differences, agree on a route, and avoid the pitfalls and chasms along the
Perhaps economic analysis can facilitate the journey by designing a bridge
between the two hills. Given the absence of close historical parallels and
the severe limitations of economic models of society it is clearly beyond the
capacity of social engineers to draw up very precise plans for the bridge.
The Tasks of the Transitions
The list of activities which governments which governments must undertake in
countries attempting the transition to a market economy is truly staggering.
The list given here is designed to convey something of the enormity and
complexity of the job. First, there is a group of activities 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, environmental and
health regulations; rules regarding foreign partnerships and wholly foreign-
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 an Internal
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 and
investors; 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 affecting
landlord tenant relations; resolving the vexatious issue of restitution of
property 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-
Next there are some tasks related to managing the:
6. Reforming prices:
Enterprises that have been privatized will presumably be largely free to set
their own prices, but early on in the process, the demands of the government
budget will require raising prices on many consumer goods that have been
provided at prices for below cost.
7. Creating a safety net:
Setting up an emergency unemployment compensation scheme; targeting aid in
kind or in cash to those threatened with severe hard ship by the reforms.
8. Stabilizing the macroeconomic:
Managing the government budget to avoid an excessive fiscal deficit and
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 for economic activities;
establishing the private right to purchase services from railroads, ports,
and other enterprises which may remain in the public sector.
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 with nationally
representative interest groups. The tasks are organized into two categories:
they will determine the general institutional structure of society and set
guidelines that will be used in phase 2 to assign each enterprise to one of
many alternative "transition regimes".
Phase 2: The assigned phase
In this phase state-owned enterprises are matched with transition regimes.
One can assume that each state-owned enterprise is completely described by
some vector of attributes. These attributes specify such diverse 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
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
Phase 3: The enterprise-level negotiation phase
In this phase participants at the participants at the level of each
enterprise play an MB game (multilateral bargaining). For each enterprise the
structural parameters of the game are included in the characterization of 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 must consider the
need for such a transition. Today the need is clear: socialist and communist
systems have failed to deliver (in a liberal sense) anything like the
standard of material advance so often promised.
But more recent rasy assessments of central planning abound. Even as late 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 to 1975 the
Romanian economy had grown faster than any other country in the world (9,8
percent per annum). The Bank attributed this startling performance to the
fact that government, through its system of central planning, had control of
all resources. The Bank forecast a rasy future for Romania – growing at 8,7
percent per capita to 1990. Nor was Romania an aberration. The Bank published
in that same year of 1979 a most rasy history of, and prognostication for
Yugoslavia. Studies up to 1984 continued to show that central planning,
albeit somewhat modified in places, delivered the goods.
This review is not intended to score paints, but simply to remind us of the
long addiction of economists to planning and regulation.
The transition to a market economy always and at all times involves a
familiar list of policies.
First is financial stabilization reducing the budget deficit and the monetary
emissions of the central bank. This stabilization may involve many complex
policies – almost certainly a fax reform and expenditure controls,
particularly in the reduction of subsidies. There is no consensus on pegged
versus free exchange rates.
Second is deregulation, elimination a myriad of government controls and
establishing the framework for free contractual relationships. This priority
involves the recognition of property rights and the development of a legal
system suitable for a market economy. It also implies a diminished role for
the central planners as more room is provided for private initiative and
enterprise. But oddly enough it is widely recognized that there is a need for
more restraint on industry, particularly the heavy state owned firms, to
reduce pollution. Other areas of deregulation include trade reform and
Third is the reform and privatization of state- owned concerns to this list
should be added the 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 system and the development of commercial rather than planning
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 economy to a
market economy focusing on privatization is a novel orientation for this
chapter. In much of the literature on privatization in central and Eastern
Europe, either a case is argued for a particular transition proposal or
specific aspects of the privatization problem are isolated and considered in
The model focuses on the way in which government policies and enterprise-
level decisions are made and relatively less on the specific content of these
policies and decisions.
The conceptual model has been designed with five basic premises in mind:
multilateral bargaining, political economy, heterogeneity, decentralization,
4) Multilateral bargaining
In a world in which economic rights are ill designed, a bargaining problem
naturally arises. Throughout Central and Eastern Europe, this problem can be
conceptualized as a multifaceted conflict between multiple interests
representing workers, management, claimants to property rights based prior
ownership, foreign investors, representatives of different group in the
distribution chain, etc.
It is useful to distinguish two different kinds of bargaining problems. There
are issues that must be negotiated at the level of central government: for
example, what will be the nature the regulatory and legal infrastructure
within which these privatized enterprises will operate? Other issues concern
the disposition of individual state-owned enterprises and must be negotiated
on a case-by-case basis. In particular what will be the precise nature of
each corporate entity that is being packaged for sale to private buyers? Who
will control it? How will it be structured? What kind of compensation schemes
will be in place for management and workers?
What special provisions will be in place that affect the relationship between
the privatized entity and other firms, including established and new
competitors, firms that are up and down stream in the distribution chain,
etc.? In the discussion that follows, the focus will be on bargaining
problems of the latter kind. One presumes that, because of the complexity and
diversity of the issues during the transition, the state is not in a position
to resolve them by fiat rather, over the transition, the state 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 by the state
to facilitate an orderly negotiation of the issues. This institution would
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 guidelines whatever
as to how the issues should be resolved in this procedural vacuum, the
economic rights in question may simply be expropriated by whichever party -
typically the current management - is strategically located to do so.
Relative to the general trend that appears to be emerging in Central and
Eastern Europe, there should be made opportunities for decentralized
Our process-oriented perspective does suggest an indirect, "hand off" way to
exercise some control over this phase of the process, the government can
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 for privatization - the first
two parties have every incentive to design privatization plans that inhibit
competitive pressures, while the third will inevitably be more concerned this
effecting a successful sale of the enterprise than with issues such as the
competitiveness of the resulting market structure. From the standpoint of the
public interest then the outcome of multilateral bargaining is bound to be
sub-optimal, provided that participation in the process is restricted to the
three primary parties. Moreover, the directions in which these outcomes will
deviate from the optimal are more or less predictable.
The Multilateral Bargaining model provides a useful analytical tool for
investigating the effectiveness of this approach to policy making.
In other contexts, the multilateral Bargaining model has been used
descriptively to explain how during the process of multilateral negotiation,
coalitions are formed, deals are struck, and compromises are reached.
5) Political economy.
A second basic premise is that any policy recommendations must be both
economically and politically consistent. This consistency requires a
specification of the relationship between short-term economic developments
and longer-term political ramifications. Obviously, economic policy
objectives cannot be pursued in isolation, since the prevailing political
configuration will constrain the set of options available to planners of the
transition process. On the other hand, economic post-privatization economy
develops, new interests will acquire economic power and new institutions will
emerge to strengthen the power of groups that wish to defend these
institutions. The dynamic interaction between these economic and political
facets of massive privatization programs must be taken into account. Indeed,
one can expect that models, which ignore political economic feedback effects,
will have a natural tendency to overestimate the prospects for a successful
The following example illustrates the kind of political-economic interaction
that could adversely affect the reform process. Policy makers in Central and
Eastern Europe appear to be overly complacent in their reliance of foreign
competition as the main disciplinary device that will force monopolists to
operate efficiently. Indeed, Polish officials cite their country’s liberal
tradition in the area of trade policy when questioned about the viability of
this approach to antimonopoly policy. Our dynamic political-economic
perspective leads to skepticism about this heavy dependence on competition
If a seems very likely, the post-privatization industrial structure turns out
to be highly over-concentrated and inefficient, then the main effect of
threatening foreign competition will be to unleash a powerful confluence of
political forces in favor of protectionism. Owners of the domestic
enterprises will lobby to defend their rents, managers will lobby to defend
privileges, and workers will lobby to defend their jobs. Because the problem
of unemployment never really arose under communism, the potent tension
between introducing free trade and maintaining employment levels never became
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 that in the
Soviet Union, even though, as I have emphasized, the setting is rather
different. The brief political thaw following the death of Stalin in the
early 1950s did permit a freer discussion of ideas, which, along with growing
problems of economic performance, led to limited attempts to develop and
implement economic reform. Initially, these changes were modest in scope, and
they typically followed the Soviet reform pattern: Try to improve decision
making while preserving socialist objectives and the essence of the planning
system. This was the focus of the New Economic System in the GDR and of the
New Economic Mechanism introduced in Hungary in 1968. The potential for
genuine economic reform was certainly limited by Soviet 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 sustained on a limited basis, to become the
background for more serious reform in the present era. There were, then,
numerous attempts at reform 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 secular decline. The magnitude of
this decline (see Table 1) has varied from case to case, but overall it has
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 it
was most serious in Poland and Yugoslavia. Repressed inflation, though
difficult to measure, grew in importance in the 1980s.
Second, East European countries relied heavily on foreign trade as a means of
stimulating economic growth in the 1970s. Their strategy was to promote
exports in Western markets so that the imports required both to stimulate
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 a significant
slackening of Western markets at the very time when East European nations
were becoming more aggressive in these markets. East European imports were
sustained, but largely by means of building a substantial hard-currency debt.
The magnitude of debt repayment subsequently led to considerable internal
belt-tightening for these countries in the 1980s — precisely the opposite of
what had been intended.
Third, one could argue that in Eastern Europe, the possibilities for
economic growth through extensive means had initially been less promising
than in the Soviet case and had been exhausted more quickly. In light of the
level of economic development in Eastern Europe compared to that in the
Soviet Union, it is not surprising that the imperative for reform was strong
and that developments of the Gorbachev era quickly spilled over into Eastern
Europe. In the absence of Soviet backing, interest in the administrative
command model faded fast.
Table 1. Economic Growth and Performance in Eastern Europe:
The Background to Reform
East European Reform Programs: Similarities and Differences
In this chapter we pay special attention to Poland and Hungary. We do so
because these countries are both examples of aggressive reform but have
employed different strategies. However, before we consider these cases in
greater detail, it is useful to summarize the East European reform
experience, noting important similarities and differences among the various
cases. 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 these
countries seek to replace the planned economy with a market economy rather
than attempting merely to modify the former.
Second, transition programs have varied in speed and intensity. Some
countries have pursued reform on a "gradual" basis, whereas others, like
Poland, have pursued what is often termed a "big bang," or rapid, approach to
reform. However, we must remember that even in those countries not pursuing a
"big bang" or "shock therapy" approach, the process of transition in Eastern
Europe has been relatively rapid, especially when compared to reforms of the
past - and notably so when compared to the recent Soviet record. It is
important, therefore, to be aware of the basic issues associated with
transition and of the extent to which the attempted speed of transition
alters the overall reform experience.
Third, although it is possible to examine and understand the basic elements
of economic reform and even of transition from one system to another, we
really do not have a general theory of change in economic systems. In some
cases — for example, during such a period of rapid change as the 1990s — it
is difficult even to develop a way to classify the issues involved in
Fourth, important differences exist from one country to another. Our view of
the socialist transition process is heavily influenced by our image of the
best-known and most advanced reforms, such as those of Poland, Hungary, and
Czechoslovakia. We know much less about, and tend to pay less attention to
developments where reforms are proceeding at a slower pace, as in Romania and
Bulgaria. Figure 1 offers a simple, stylized view of contemporary political
and economic reform (transition) in Eastern Europe.
Figure 1. Reform in Eastern Europe
POLAND: FROM PLAN TO MARKET VIA SHOCK THERAPY
Until Solidarity won the parliamentary elections in Poland in the summer of
1989, the Polish economy had been, since the end of World War II, a rather
typical planned socialist economic system. State ownership predominated, and
though economic reform was attempted in varying degrees at different times,
little real systemic change had taken place. Moreover, as Table 1 shows, the
rate of economic growth continued to decline, and the period saw recurring
shortages, increasing inflation, and an understandably declining 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 differed
significantly from the gradualist approach being discussed in other
socialist systems. In addition to treeing prices, Poland implemented monetary
controls, the zloty was made convertible into hard currencies, and steps were
taken to control wage increases.
As we shall see, the "shock therapy" approach has not been without critics.
Moreover, although the Polish case quickly attracted the interest of those
who study the problems of socialist transition, it was viewed as unique. Thus
it was argued that. for a variety of reasons that were discussed earlier,
reform was much more likely to succeed in Poland than in a case like the
Soviet Union. But before we examine the Polish reform experience in greater
detail, we must review what brought the Polish economy to the reform phase
and how, at that point, it might be different from other socialist countries.
I begin our discussion of Poland with a brief examination of the setting.
Then I discuss the Polish command system, considering the extent to which
this system led to distortions in the Polish economic structure. Finally, I
turn to the issue of transition and examine the mechanisms utilized and the
results achieved thus far.
1) Poland: The Setting
By European standards, Poland is a relatively large country. With a land area
of just over 300,000 square kilometers, it is just over half the size of
France. Moreover, with a population that approached 38 million in 1990,
Poland is some 68 percent of the size of France in terms of population.
Poland is frequently viewed as having a homogeneous society, a factor that
facilitates economic reform. Although social homogeneity is difficult to
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 of religion, 95
percent of the Polish population is Roman Catholic. From a stannic
standpoint, 98.7 percent of the population is Polish, and only a few minority
Urbanization and industrialization have changed the nature of Polish life and
customs, but the church, family, and folk ties that have sustained Poland for
a long time remain strong. Thus, although Poland must deal with problems of
modernization, it also has valued traditions and a clear identity. These
qualities make implementing change more manageable here than in many other
In terms of natural resources, Poland is a country of considerable regional
diversity, though major portions of the land area are not especially fertile.
Poland's main energy resource is coal; basic minerals and some deposits of
oil and natural gas also exist. Both basic data and methods of computing
economic aggregates of socialist systems are currently under scrutiny. New
evidence that will make it possible to do different kinds of computations may
well lead to important adjustments. With these reservations in mind, however,
we note that Poland was reported to have a per capita gross national product
of approximately $4500 measured in 1989 U.S. dollars. This figure places it
between the high-income countries of the region (Hungary and Czechoslovakia)
and the low-income countries (Bulgaria, Romania, Yugoslavia) and at one-
quarter that of the United States. Prior to the onset of major economic
reform, the bulk of Polish industry was state-owned and planned. Agriculture
(representing roughly one-fifth of total Polish output) was a mixed system
wherein the private sector produced about three-quarters of the total
agricultural product. Foreign trade turnover — that is, exports plus imports
— represents roughly one-third of Polish product, again using U.S. dollar
2) Poland: The Command Economy
The organizational arrangements of the Polish command economy were
established immediately after World War II and closely resembled those
prevailing in the Soviet Union. There was widespread nationalization of
property, central planning mechanisms were established, and agriculture was
socialized. In addition to organizational arrangements, Polish economic
policies of the era, such as those on investment, sectoral development, and
the like, closely mirrored the Soviet model.
Although Poland attempted modification of the command system as early as 1956
when collectivization was abandoned, little actually changed. Over time,
private agriculture was neglected by the state, and continuing political
protests, especially in the early 1970s, signaled both political and economic
The 1970s was a difficult decade for many countries, especially those that
rely on imported oil. The Polish strategy in the 1970s and later was to
stimulate the domestic economy through the importation of foreign technology.
This was not an unreasonable strategy in theory, but Western economies were
themselves in the midst of the energy crisis and the recession it caused.
Poland's effort to expand exports failed, hard-currency debt accumulated, and
the projected impact of Western technology on the Polish economy was minimal.
As the 1970s came to an end, it was evident that domestic retrenchment would
be essential — a difficult path in light of the continuing unrest among
Polish workers. The 1980s began with roughly three years of martial law and
an attempt to achieve economic stabilization.
After half-hearted economic reforms in the early 1980s, the rise of
Solidarity (which had been outlawed in 1982) proved that major systemic and
structural reform was necessary. Even so, and despite the fact that Polish
economic performance was deteriorating badly, serious economic reform did not
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 by a
variety of interested observers. Although many of the policy and systemic
changes introduced in Poland are familiar hallmarks of the general reform
scene, 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 change outcomes
(a possible exception is their contribution to the wage explosion that took
place toward the end of the decade). Moreover, on the eve of reform 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) has been the subject of
debate, there was a significant budget deficit, wage increases were out of
control, and hyperinflation had resulted. Poland's hard-currency debt
position was better than that of Hungary, but the debt that had been
accumulated did little to stimulate the Polish economy, the zioty was
overvalued, and no debt relief from external sources was in sight.
In the fall of 1989, most price controls were lifted (on both producer and
consumer goods), public spending was reduced, and the zioty was devalued. In
the second stage of major reform, begun in 1990, the budget deficit was
sharply cut, largely through a reduction of subsidies to state enterprises. A
positive real rate of interest was to be implemented, and the market was to
be used to signal changes in the value of the zloty. The latter was a
critical measure, because foreign trade and the impact of this trade on the
Polish industrial structure was to be a key component of the overall reform
strategy. In January of 1990, the government set the exchange rate of the
zloty at 9500 to the dollar (this represented a devaluation from 1989), a
rate roughly approximating its value on the black market, and it established
convertibility of the zloty for international trade. Many trade restrictions
were eliminated, and internal exchanges were set up to handle the buying and
selling of hard currencies. Although these changes resulted in domestic
inflation, the initial increases proved to be short-term and the exchange
rate of the zloty has proved to be realistic.
Finally, wage increases were to be controlled partly through wage indexation
and partly through a new tax on wage increases that exceeded established
Privatization is a major element of the Polish strategy of transition. In
1990 the Polish government passed a law creating a Ministry of Ownership
Change, a mechanism to supervise the process of privatization. Privatization
has proceeded rapidly, though it has been achieved mainly for small
enterprises in the trade and service sectors. Industrial output in the
private sector grew by 8.5 percent in 1990 and is reported to represent
roughly 17 percent of total Polish industrial output
Though privatization has been very successful for small-scale enterprises,
the picture for large state enterprises is quite different. For reasons we
noted earlier, privatization of these enterprises has proceeded very slowly.
In addition, the economic position of these enterprises worsened as the state
took decisive measures to introduce a hard-budget constraint. In addition to
price changes and wage limitations, subsidies have been ended and protection
from foreign competition has been sharply reduced. This new setting has
encouraged enterprise managers to reduce costs by restricting unnecessary
output and reducing the labor force. However, the strong commitment to rapid
privatization was reinforced in June of 1991, when it was announced that a
major portion of state industry would be privatized through creation of stock
funds, with the population receiving vouchers.
Beyond these changes in the state sector, new guidelines have been
introduced to monitor enterprise performance. Furthermore, a new Industrial
Restructuring Agency will consider how remaining state enterprises should be
handled, to what extent privatization is possible, and what restructuring
should take place for those enterprises that are not viable in the new
setting. These new arrangements are designed to ensure a rapid transformation
of the Polish industrial structure, to make it similar to and competitive
with market economic systems, and to achieve this result quickly and as
openly as possible.
Note that these comprehensive reforms in Poland cover all the critical areas
discussed in Chapter 4 and earlier in this chapter. Moreover, beginning from
very precarious economic circumstance in 1989, these changes were introduced
simultaneously and rapidly. We will now do our best to assess the early
4) The Polish Economy in the 1990s
It is clear that economic reform in Poland has been radical and has moved
sharply and swiftly away from the plan toward the market. In addition to the
expanded influence of market mechanisms, decision making has been
decentralized, private property introduced, and incentive arrangements
changed. By most standards, the initial results have been encouraging.
First, stabilization measures cut the rate of inflation sharply from a
reported 40-50 percent per month at the end of 1989 to roughly 4-5 percent
per month in 1990. At the same time output fell, though supplies of consumer
goods in stores increased. Employment in industry declined by 20 percent
during 1989 and 1990, although it is reported that only a relatively small
portion of this reduction in the labor force was caused by forced layoffs.
The unemployment rate was reported to be 6.5 percent at the end of 1990.
Another major positive facet of the Polish reform experience has been the
foreign trade sector. There has been a significant expansion of exports,
especially to hard-currency markets. This expansion resulted in part from
the devaluation of the zloty to market-clearing levels and in part from the
reorientation of trade away from the Soviet Union and other East European
trading partners. At the same time, as a result of restrictive policy
measures and the higher domestic cost of these imports, import demand
A third qualified success has been privatization. Although the initial pace
of privatization was rapid, this early privatization was largely that of
small-scale enterprises in the area of trade and services. Although Polish
reformers take seriously the need to pursue privatization of major state
enterprises, bringing this about will remain a critical task for the next
Can these achievements be sustained in the coming years? We discuss this
issue more generally in the next section, but the Polish case deserves
specific comment. Quite clearly, the continued success of the Polish
transition will depend on the continuing implementation of appropriate
stabilization measures. Although this may seem relatively straightforward,
it requires cohesion and commitment among policy makers and willingness among
the populace to pay the costs of the transition. Pressures for wage increases
must be resisted, and the process of privatization must proceed. To the
extent that the latter can be achieved, the contours of new market
arrangements can be defined. Finally, although uncertainty in foreign markets
remains, relief of hard-currency debt will unquestionably add a measure of
Another issue is the extent to which the Polish "success" (if we can call it
that) was promoted by Western assistance. In light of the Polish leadership's
commitment to rapid transition, the West has provided considerable assistance
in the form of exchange-rate stabilization funds, debt restructuring, and
HUNGARY: THE NEW ECONOMIC MECHANISM AND PRIVATIZATION
Early works in comparative economic systems devoted little attention to the
Hungarian economy. Over the last twenty years, however. Western economists
have begun to pay more attention to Hungary.
As one prominent observer of Hungary and other East European systems has
noted, "The Hungarian reform experience says as much about central planning
as it does about Hungary, and therefore an understanding of that experience
is important for those interested in the prospects for reform in all of
Eastern Europe, and indeed, in the Soviet Union. In other words, Hungary is a
prototype of economic reform for the former planned socialist economic
systems of Eastern Europe, and presumably elsewhere. These thoughts,
expressed some ten years ago, remain relevant in the 1990s as Hungary, like
other socialist systems, pursues a transition to the market. However, the
background of reform in Hungary is important to a proper analysis of
contemporary problems and prospects.
Prior to 1968, Hungary applied the Soviet model of centrally planned
socialism in a typical fashion. But then, in 1968, Hungary began to
introduce by far the most radical economic reform attempted in Eastern Europe
(with the exception of Yugoslavia). In the words of one early observer of
this reform, it clearly represents the most radical postwar change, in the
economic system of any Comecon country, which has been maintained 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, and
difficulty in persuading participants to change their ways) are fundamental
to the reform experience of planned socialist systems.
Hungary shares many features with other Eastern and Southeastern European
countries, such as Yugoslavia. It provides a refreshing contrast to the
Soviet Union, which in some important respects is atypical. Hungary is a
small country heavily dependent on foreign trade. The Hungarian experience
with reforming foreign trade, and in particular its efforts to become
integrated into the world economy both East and West, is prototypical. The
difficulties of reforming the foreign trade mechanism arc crucial to the
Hungarian economy as well as to the economies of many other systems of
1) Hungary: The Setting
Hungary is located in central Europe. Its land area of approximately 36,000
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 population of
Illinois. Although Hungary is not self-sufficient in energy, it docs have
supplies of coat, oil, and a number of minerals, including important bauxite
Although it has some rolling hills and low mountains, Hungary is basically a
flat country with good agricultural land and a favorable climate. As in other
East European countries, the period since World War II has seen the
population flow from rural to urban areas and a changing balance of
industrial and agricultural activity. Today, approximately half the
population lives in urban areas.
Hungary is not particularly prosperous. Most estimates of its gross national
product or per capita gross national product place Hungary in the middle of
the East European countries. It is generally wealthier than Bulgaria and
Yugoslavia and certainly wealthier than Albania; it ranks behind East Germany
and Czechoslovakia. Hungary's per capita income appears to be close to that
of Greece. In this sense, economic development remains a key issue in
Hungary. By the standards of Western Europe, Hungary remains relatively
poor; by the standards of the Third World, Hungary ranks among the more
2) The Hungarian Economy: Prereform
The postwar reconstruction of the Hungarian economy began quite modestly 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 of nationalization. The first
three-year plan was designed primarily to bring the economy up to prewar
levels of economic activity. During
this time, a planning mechanism was created and the share of national income
going to investment increased sharply. The changes were not radical, however,
and balanced development was envisioned.
The era of balanced development came to an end with the introduction of a
five-year plan in 1950. The share of national income devoted to investment
was increased substantially, and the bulk of new investment was directed
toward heavy industry. This policy was partially reversed toward the end of
the plan period, but it was reaffirmed in 1955-1956.
A number of economic trouble spots cried out for attention. There was an
observed need to improve industrial labor productivity, especially through
the development of a better incentive system to offset the declining supply
of labor from rural areas. Supply-demand imbalances were growing increasingly
severe. Waste and imbalance in the material-technical supply system created
the need for a substantially modified coordinating mechanism among
In addition, excess demand for investment led to substantial amounts of
unfinished new construction and to the neglect of old facilities. Some
mechanisms for the more rational allocation of capital investment had to be
found. The adoption and diffusion of technological advances were seen as
inadequate. Technological improvement was considered crucial for continued
development of the economy.
This background seems familiar: a small country, the Soviet (Stalinist) model
of industrialization, overcentralization, emphasis on extensive growth,
rigidities of the plan mechanism, incentive problems, and the resulting
difficulties. Against this background, the New Economic Mechanism first
promulgated in a party resolution in 1966 was put into, practice in 1968.
Over twenty years later, it remains one of the most important reform programs
of planned socialist systems.
3) Intent of the New Economic Mechanism
There is disagreement about the importance and effect of the Hungarian reform
program. The New Economic Mechanism (NEM) has generally been interpreted as
leaving the power to control the main lines of economic activity (volume and
direction of investment, consumption shares) with the central authorities,
while relying on the market to execute the routine activities of the system.
The NEM called for substantial decentralization of decision-making authority
and responsibility from upper-level administrative agencies to the enterprise
level. In a general way, NEM bears a close resemblance to the Lange model.
Let us consider the original blueprint of NEM.
The objective of NEM was to combine the central manipulation of key variables
with local responsibility for the remaining decisions. The first change was a
significant reduction in the number and complexity of the directives firms;
for large state-owned firms, the traditional problems remain. Valuation is
difficult, especially in loss-making enterprises. Moreover, it is hard to
find buyers for these types of enterprises, let alone to arbitrate the
potential rights of past owners. And just as elsewhere, privatization in
Hungary is likely to become slower and more difficult as the focus shifts to
the less attractive, large enterprises.
In addition to privatization per se, Hungary has addressed the creation of
infrastructure (for example, a stock market) and new rules designed to change
the guidance of enterprises. Accounting procedures have been refined and
bankruptcy laws strengthened so that state subsidies can be curtailed and
hard budgets introduced into large state-owned enterprises.
Hungary has also pursued a variety of stabilization measures and has
liberalized policies in the sphere of foreign trade, though to a lesser
degree and certainly more gradually than Poland. Domestic price controls have
been substantially removed, and enterprises are permitted to enter into and
benefit from foreign trade transactions. Although there are limits on the
holding of foreign exchange, the Hungarian forint is substantially
convertible for business purposes. However, the Bank of Hungary has
maintained controls such that it has access to foreign exchange earnings to
serve as repayment of the Hungarian hard-currency debt. (Hungary has a per
capita hard-currency debt roughly twice that of Poland). Hungary has followed
a tight monetary policy designed to create a balanced budget and also to
exert financial pressure on enterprises.
Hungary has very liberal laws regarding foreign investment, including the
possibility of full foreign ownership with permission. Moreover, repatriation
laws are liberal. Not surprisingly, Hungary has been considered a leader in
the quest to attract foreign investment, though the magnitude of this
investment and its overall impact on the Hungarian economy probably remain
The initial results of the transition process in Hungary have generally been
positive when judged against the sorts of expectations that we discussed
earlier. At the same time, it is proving difficult to sustain popular support
as the inevitable costs of the transition process take their toll.
4) The Hungarian Economy in the 1990s
In spite of a tendency to compare the processes of economic reform in Poland
and Hungary, there are important differences between the two systems, and
especially in the degree to which prior reform had taken place. Although some
would argue that the New Economic Mechanism was quite limited compared to
contemporary reforms, nevertheless the reform process has a significant
history in Hungary. The differences between the Hungarian and Polish cases
Inflation has been much less serious in Hungary than in Poland. The annual
rate of inflation for 1989 has been estimated at roughly 17 percent. Although
the inflation rate increased to about 29 percent in 1990, this performance
has been viewed as positive. In addition, wage increases have generally been
controlled. Largely because of a shift away from trade with former CMEA
trading partners, the volume of Hungarian trade has declined. At the same
time, the Hungarians have experienced growth in exports to Western markets
and a generally weak domestic demand for imports — both important
developments for the overall trade balance. The good news on the exports
side, however, tends to be sector-specific. Hard-currency debt remains a
serious problem, and the movement toward a convertible currency has been much
slower than in the Polish case. Finally, the Hungarian budget deficit has
The Hungarian economy was projected to shrink by approximately 3 percent in
1991, and associated declines in consumption and investment were
anticipated. The state property agency is moving ahead with privatization.
The overall relatively slow pace of reform in Hungary may well dictate less
sharp downturns and less severe fluctuations during the periods of downturn
but, at the same time, rather slower recoveries and a longer time in which to
achieve normalization. As with Poland, the effectiveness of the macroeconomic
policies being implemented, world market conditions (such as the price of
oil), and domestic structural change through privatization will 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, not only
for those who live with and implement the transition, but also for those
interested in the subject of comparative economic systems. For a variety of
reasons, if the transition cannot succeed in countries such as Poland and
Hungary, it is unlikely to succeed elsewhere.
Obviously, it is too early to render any definitive judgment on these cases,
let alone on the more general issues of transition. Indeed, it is difficult
to chart even basic day-to-day changes in these countries. That having been
said, let us try to assess the outcomes that have occurred so far.
Judged in terms of our earlier discussion of economic reform and projected
outcomes in the early stages of transition from plan to market, there is room
for guarded optimism as we examine the early results in Hungary and Poland.
At the same time, there remain a number of basic forces that will heavily
influence future economic trends.
First, although initial political transformations are substantially complete
in Eastern Europe (with important exceptions such as Yugoslavia), there are
cases (such as Romania) where political instability and a lack of cohesion
(derived in part from the political legacy of the communist era) make
agreement on reform very difficult. Clearly, in these cases, the path of
reform will be slower and much more difficult than in the leading cases that
we have examined.
Table 2. Political and Economic Developments in Eastern Europe: A Summary
Second, the initial results of the transition have been generally as
expected. In Table2 I summarize a number of useful indicators. As
anticipated, in all cases there has been a downturn in output — occasionally
a downturn of significant magnitude. Inflation has been very uneven and in
some cases (such as Yugoslavia and pre-reform Poland) very rapid. However,
post-reform inflation rates generally leave some room for optimism,
especially in those cases where stabilization policies have been developed
Third, we have noted that initial privatization usually proceeded rather
quickly but that, after the privatization of small firms (especially in the
service sphere), the pace of change decreased significantly. This latter
development reflects the onset of major difficulties: the private sector must
now absorb large, state-owned, loss-making, and often technologically
backward enterprises. The privatization of these firms presents serious
problems, as does a setting where valuation is fraught with difficulties,
buyers are hard to find, claims from the past must be handled, and
contemporary management skills are wanting.
Fourth, although inflation and unemployment have necessitated a growing
concern for safety-net measures of various types, there is also a sense that
the availability of consumer goods and services has improved.
All of these considerations seem to support a measure of optimism about the
eventual outcome of the transition process. At the same time, there are
important dimensions where change must be sustained if the transition 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 contours of new market arrangements,
including the infrastructure required for markets to function effectively.
These changes must be sustained even in the face of political dissension,
consumer dissatisfaction and an uncertain international economic
environment. These restraining forces will in large part dictate the pace and
ultimate success or failure of the transition process.
3. Moldova’s way to an open economy.
Moldova has faced significant and escalating economic difficulties since its
acquisition of independence in 1991. This situation is reflected in the main
macroeconomic indicator for the republic - Gross Domestic Product (GDP) -,
which has dropped by nearly 60%.
The agricultural sector has been strongly impacted by the nation’s economic
difficulties, as well as by adverse environmental conditions. In 1993
Moldova’s agricultural harvest was adequate, a considerable portion remained
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 were damaged beyond use.
In the summer of 1994, a simmilar stream of natural disasters, including a
drought, followed by a hurricane, followed by a flood, 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 activities include: refrigerator,
television furniture, clothing, and agricultural machinery production. The
Republic’s threatens the productivity of this sector. Of the republic’s 262
production enterprises, 60% experienced production declines. Over all in
1993, many industrial enterprises operated at levels 50% lower than their
The decline in production has negatively influenced the budgetary capacity of
the Moldovan Government to address social and other issues. In November 1994,
for example, budget areas reached a level of US$ 70 million. As a result
sizable delays exist in payments of mages, pensions, stipends and other
allocations. Natural resources within the country are few. The situation in
Moldova’s energy sector is strained, therefore, more so as nation’s capacity
to import energy continues to deteriorate. All types of fuel, including coal,
oil and natural gas, delivered from the Russian Federation, equaled US$ 250
million as of late 1994.
Nevertheless, despite the above mentioned difficulties, economic reform -
including privatization and the transition to a market economy - is being
actively pursued in Moldova current economic crisis and into a more healthy
Building of the state and its sovereignty has allowed Moldova to accomplish
some important achievements in economic reform, i.e., financial stabilization
on a macroeconomic level and a lessening of the economic crisis and its
The success of macroeconomic stabilization has also helped to increase the
level of confidence and trust in Moldova amongst the international community.
The reforms are being supported by foreign creditors and by technical
assistance from donors, including the United Nations, the European Union,
USA, Germany and Netherlands.
In order to further development the private sector, it is necessary to
continue reforms and to improve mechanism supports and stimulating them.
Further-more, macroeconomic stabilization will not last unless the reforms
reach all parts of the national economy.
Although the hand code contains some contradictions, new important measures
on agriculture have been taken, such as the liberalization of economic
activity and privatization of the industrial sector of the agroindustrial
complex, contributing to a relative stabilization of the market for food
products and to an increase in imports.
Success in promoting economic reforms in Moldova - privatization of the state
property, liberalization of prices in the real estate market liberalization of
intern, trade, establishment and development of the banking system and of the
financial market - allowed Moldova to be placed in the 11th position
amongst the 25 countries of Central and Eastern Europe, the Baltic states and
the Commonwealth of Independent States (CIS) in a classification made by the
European Bank for Reconstruction and Development.
We can, therefor, conclude that 1995 was the first year of transition,
following the first destructive stage of the reforms, to a better stage.
However, although macroeconomic stabilization is encouraging the continuous
evolution towards a market economy, it does not guarantee an increase in the
national economy. These problems will require a longer period to solve than
that required for achieving macroeconomic stabilization.
Economic Performance in Moldova 1989-1995:
|Poland||Hungary||Czech and Slovak Federal Republic||Bulgaria||Romania||Albania||Yugoslavia|
|Limited efforts in the 1980s||Important: New Economic Mechanism since 1968||Limited: ended by Soviet inter vention 1968||Limited||None||None||Important Worker: management and market socialism|
Per Capita GNP - 1989,
in U.S. S
|Percent Change in GNP: 1989-90||-8.9||-3.6||-3.2||-3.6||-11.3||n.a.||-6.9|
|Official Consumer Price Index in 1989, 1980 = 100||3387||276||120||363||186||n.a.||761175|
Real per Capita Disposable Income in 1989,
1980 = 100
|Current Economic Reform||Aggressive pursuit of transition, privatization continues||Ambitious transition plan in progress: stabilization, privatization, and attention to trade||Transition pursued with caution; initial results not as good as in Poland but positive||Reform began in 1991; price flexibility, privatization, and trade reform||Modest reforms from 1991; price adjustment, some privatization, and foreign investment||1990-91: Limited first steps; decentralization, some privatization, and restructuring||Political turmoil and an economy largely without guidance|
In conclusion to all said I want to present a brief survey of the present
stage reached in the transformation process in the various countries of
Eastern Europe. As an initial, superficial impression, it can be said that
the farther west the countries a located, the more advanced the process now
- The transformation process is at its most advanced in Poland,
Czechoslovakia and Hungary. All three countries now have stable parliamentary
democracies in which non-communist parties hold the majority. Although the
initial situations in the three countries were very different, they have also
all set about establishing a market economy system with considerable energy.
Since it is thus in these three countries that the most experience has now
been gathered, I have considerate my remarks on them (later on).
- In the political sense the situation in the three Baltic countries
is similar to that of Poland, Czechoslovakia and Hungary. They too have
completed the change to parliamentary democracy. However, economic
transformation is especially impeded by the fact that owing to their
histories as Soviet republics their economics are particularly closely
interwoven with thus of to rest of the former Soviet Union.
- Romania, Bulgaria and Albania have so far made less progress than
their counterparts to the north and west both in the political and the
economic transformation process. Here too, though, freely elected parliaments
have now undertaken the first legislative steps towards crating a market
economic order. However, it is still early as yet to assess the political
stability of these countries or the success of the economic reform they have
so far embarked upon.
- What path will be taken in future by the successor states to the
former soviet Union and those of former Yugoslavia is, in my opinion, still a
totally open question. Neither the geographical borders of these countries
nor their political or economic systems can be foretold with any degree of
- Finally, the former East Germany occupies a special place, amongst
the transforming countries. On the one hand, reunification with former West
Germany has ensured that the conditions for political and economic
transformation are now absolutely secure. On the other hand, the fact that
income levels for those in employment have been rapidly catching up with
those in the west has also crated considerable growth and employment
problems. In the real world, the transformation process has proceeded very
differently in the three furthest advanced countries of Poland, Hungary and
Czechoslovakia. In Poland and Hungary, the planned economy system had
gradually been shot through with various holes during the past ten years, in
stark contrast to Czechoslovakia and East Germany.
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2. Blanchard O., Layard R. : Economic Change in Poland, 1990
3. Kornai I. : The Road to a free Economy
4. Rausser G.C. : A Noncooperative Model of Multilateral Bargaining
5. Schumpeter I.A. : The Theory of Economic Development
6. World Bank : World Development Report, 1990
7. Giersch H. : Tawards a Market Economy in Central and Eastern Europe,
8. Kahtzenbach Erhard : Problems of Reconstructuring in Eastern Europe
9. Gregory P.R., Streart R.C. : Comparative Economic Systems
10. Hartmats R: Making markets: Economic transformation in Eastern Europe
and the Post Soviet States.
|Annual Output Growth||8,8||-1,5||-18,0||-29,1||-1,2||-31,2||-3,1|