TRANSITION TO MARKET ECONOMY

BALCEROWICZ

 

Report on paper 'Common Fallacies
 in the Debate on the Economic
Transition in Central and Eastern Europe'
by Leszek Balcerowicz

 Regina Jain


 

As the nations of central and eastern Europe are undergoing a transition from centrally planned to free-market economies, political debate in these countries necessarily focuses on economic policy of the region. In his paper, 'Common fallacies in the debate on the economic transition in central and eastern Europe,' Leszek Balcerowicz, former Polish finance minister and architect of Poland's 'shock therapy' economic plan, presents some of the fallacies often found in these debates and attempts to clarify some of the issues involved.

One fallacy pointed out by Balcerowicz is the mistaken cause and effects involved in judging the outcome of a particular policy. Often times, an economic policy is evaluated by selecting a particular economic phenomena that occurred during the period the policy was implemented and comparing it with the situation that preceded the policy. The crucial mistake here is that economic phenomena always have more causes than a particular policy; there are too many factors in the global economy for this approach to have any value. Balcerowicz suggests that a policy would more meaningfully be analyzed by comparing the phenomena in the time period of implementation of that policy to the phenomena that would have occurred under similar circumstances with an alternative policy. This type of fallacy can be likened to 'rejecting some medical treatment just because it is accompanied by certain unpleasant sensations.'

 

As the nations of central and eastern Europe have experienced a transition in their political structures as well, Balcerowicz points out the role of 'visibility effects' in countries that have recently obtained a great deal of political freedom. He contrasts the 'positive bias' of a dictatorship, i.e. propaganda, with the 'negative bias' of mass media of a free society; negative events always make better news stories in a free press. Issues that were never discussed in the press under Communism, such as crime, poverty, and inequality, are now commonly covered, thus creating the impression that all of these phenomena have increased dramatically. The result can be a significant distortion of public perception in the economic condition of the nation which may in turn create a further negative impact on the nation's economy. Thus, Balcerowicz cautions negative events must be viewed in proper perspective.

Balcerowicz then continues on to introduce the concept of a 'maximum speed' for economic and institutional change; although difficult to quantify, he believes all structures have a maximum speed of transformation, and disregard for the issue of maximum speed leads many to make incorrect judgments about certain aspects of transition. Anyone criticizing the speed of transition must first state what 'maximum speed' they are using as their yardstick for judgment.

 

What determines, for any particular outcome, the maximum speed of a process of institutional or economic change? Balcerowicz points out that there are inherent human limitations of information processing and learning, and he refers to what he calls a 'reform possibilities frontier' (analogous to the production possibilities frontier). He discusses the fact that this frontier may be dramatically different for different countries. He cites the banking and financial sectors, extremely knowledge-intensive industries, as having a relatively slower 'maximum speed' than many other industries. Additionally, he divides the transition into three broad categories - macroeconomic stabilization, microeconomic liberalization, and institutional restructuring - and acknowledges that the first two categories have a much faster maximum speed than the third category. Essentially, Balcerowicz believes that the concept of 'maximum speed' should be used to classify the various alternative strategies, by comparing the speeds of the strategies with the maximum possible ones.

Balcerowicz then goes on to discuss fallacies in the debate of privatization. He first states that a radical liberalization-stabilization plan is an important factor in the privatization of a post-Socialist economy; it forces state enterprises to get rid of excess assets more readily than under a lax macroeconomic policy and limited liberalizations. He then broaches the issue that has surfaced in relation to a study of Polish state enterprises, which shows many have readjusted quite well to the changes in the transition. Balcerowicz expounds on what he terms an 'additive relationship' of an enterprise's environment and its internal structures: liberalizing a firm's environment will of course improve its performance, even if its internal structure remains intact. But once this structure is rid of internal inefficiencies, there is potential for much more improvement.

 

Additionally, Balcerowicz discusses the fact that in issues of privatization, often the private-nonprivate differential is discussed in broad and generic terms. But he argues that not only the size of the private versus nonprivate sectors is important, but their distribution across the economy. Certain sectors of the economy are more crucially privatized early in the transition to facilitate further growth and privatization.

Balcerowicz then comes back to the issue of visibility effects in the discussion of privatization and unemployment. Many analysts argue that faster privatization leads to more open unemployment than does slower privatization. But slower privatization comes along with the prolonging of state enterprises which accumulate mass amounts of hidden unemployment. Private firms, although initially creating unemployment by eliminating inefficient uses of labor, generate more profits and are therefore capable of making more investment to maintain and enlarge to labor force. They are thus accommodating more labor permanently and productively in the labor force, rather than simply masking hidden unemployment.

 

In addition to issues of privatization, another commonly debated question is what role the state should take during the transition and in the emerging state structures. The concept of the 'modern mass democracy' calls for the demand for public intervention in problems of market failure or urgent social problems. In the special case of the current economic transition in central and eastern Europe, however, one must keep in mind that the state is a limited resource (so it is in western developed economies, but the situation is more drastic here) and Balcerowicz urges that due to its many constraints, all proposed state interventions should be analyzed in terms of opportunity costs. A particularly compelling factor in the argument for a limited role of the state in transition is the factor of the 'rules of the game' in the political aspects of transition. In transition, the political system is more apt to select people with other qualities than are needed for rational economic decisions. Also, politicians wishing to obtain a stable base of support may be faced with incentives to ignore factors beneficial to long-term economic development in exchange for short-term goals (again, this is relevant in industrialized developed nations as well, but transition makes this factor much more acute).

These are just some of the factors and issues that must be considered when analyzing any debate over postcommunist transition. Undoubtedly, as the transition process progresses, we will have to once again reexamine these issues, as well as tackle entire new ones.

 

Sources

Balcerowicz, Leszek, Common fallacies in the debate on the economic transition in central and eastern Europe, European Bank for Reconstruction and Development working paper no. 11, London: EBRD, October 1993.

 

 

 

 

 

 

 


 

 

 

 

 

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