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 Plan&Market 

Eastern Europe in Transition

1

Many Western experts judge the success of East European transformation strategy quite differently from Michael Intriligator. This can be documented by the following excerpts from the recent article in The Economist:

The fastest-reforming economies, by the EBRD's and most other reckonings, are to be found in Central Europe. They include Poland, the Czech Republic, Slovakia, Hungary, Slovenia and the Baltic states of Estonia, Latvia and Lithuania. All have the foundations of a market economy securely in place. Poor as the post-communist countries may be, their economies compare promisingly with those of Western Europe. The Czechs, for example, fulfil the Maastricht-treaty criteria for sound public finances better than most present EU members. Despite the economic upheaval, unemployment rates are generally lower than, say, that of Spain . . . If the success of these efforts is far from assured, they do indicate that a watershed has been passed. Across the whole region, the possibility and desirability of creating capitalism has now been accepted, even by the laggards. . . . countries escaping from communism have shown that they can indeed change the economic structure of their societies in as little as three years. What is more, they have done so with little outside help. (The Economist, 3 December 1994)

This evaluation is well complemented by the following two tables: 1) EBRD ranking of the East European countries' progress on the way towards market economy and 2) the dynamics of real GDP in the transition period. The first six columns of Table 11.1 give scores - from 1 (little or no progress) to 4 (a lot of progress) - on essential aspects of the systemic change. The last column is my calculation of the unweighted average of these scores.

Table 11.1: Marking to market

L

S

R

P

F

B

A

Czech Rep.

4

4

3

3

4

3

3.5

Poland

3

4

3

3

4

3

3.33

Hungary

3

4

3

3

4

3

3.33

Slovakia

3

4

3

3

4

3

3.33

Estonia

3

4

3

3

4

3

3.33

Slovenia

2

4

3

3

4

3

3.16

Croatia

3

4

2

3

4

3

3.16

Lithuania

3

4

2

3

4

2

3.0

Latvia

2

3

2

3

4

3

2.83

Macedonia

2

4

2

3

4

2

2.83

Kirgizstan

3

4

2

3

3

2

2.83

Romania

2

3

2

3

4

2

2.83

Russia

3

3

2

3

3

2

2.66

Bulgaria

2

2

2

3

4

2

2.5

Albania 

1

3

2

3

4

2

2.5

   

The meaning of columns:

L =Large privatization, 
S = Small privatization, 
R = Restructuring of companies, 
P = Prices, competition,
F = Trade - foreign exchange, 
B = Banks, 
A = Average.

 

  Score: 
4 = market economy,
 1 = little progress
.

 

 

 

 

 

 

 

 

 

 

 


 

Remaining countries

Ranking of the by average score: 
2.16 Moldova,
2.00 Uzbekistan, 
1.83 Armenia, 
1.66 Belarus, Kazakhstan, and Tajikistan, 
1.33 Azerbaijan, Georgia, and Ukraine,
1.16 Turkmenistan.

 

Source: European Bank for Reconstruction and Development as published in The Economist,

2

 

Table 11.2: Index of real GDP 1988 = 100

  1989 19901991 19921993 19941995**
Czech Rep.* 101.40 100.99 86.65 80.50 80.50 82.92 87.06
Slovakia* 101.40 100.99 86.65 80.50 77.28 81.14 84.39
Poland 100.20 88.58 82.38 83.20 86.53 90.85 95.40
Hungary 99.80 95.81 84.31 80.43 78.82 80.40 82.81
Slovenia 98.20 93.58 84.88 79.36 80.16 84.17 89.22
Estonia 103.30 99.17 86.28 63.84 61.93 65.03 68.93
Latvia 106.80 109.90 100.78 56.43 49.66 51.15 52.69
Lithuania 101.50 96.43 83.79 54.47 45.75 46.67 48.53
Moldova 108.80 107.17 94.42 74.30 67.62 50.71 50.71
Romania 93.10 86.21 74.40 62.94 63.57 65.48 67.44
Bulgaria 98.10 89.17 78.74 72.68 63.96 49.89 46.39
Albania 109.80 98.82 69.27 63.87 70.90 75.86 79.65
Russia 101.90 98.23 87.43 69.94 61.55 52.32 48.65
Kirgizstan 103.80 107.12 101.77 76.32 64.11 57.70 58.86
Belarus 108.00 104.76 101.51 90.35 79.50 62.01 57.67
Ukraine 104.10 100.56 86.98 74.81 64.33 49.54 50.53
Kazakhstan 98.00 90.16 78.71 66.90 58.87 44.16 38.86
Tajikistan 93.50 92.94 84.85 58.55 42.16 31.62 n.a.
Turkmenistan 93.10 94.50 93.93 89.23 80.31 64.25 61.04
Uzbekistan 103.10 107.53 106.57 91.65 89.81 87.12 83.63
Armenia 114.20 104.49 92.16 87.55 74.42 74.42 74.42
Azerbaijan 99.40 87.97 86.30 60.41 52.56 40.99 36.89

Note: * Czechoslovakia before 1993. ** Forecast.
Sources
: EBRD and WIIW.

In his chapter, Niels Mygind produced an enormously rich base of empirical facts. They may be quite useful for getting an insight into both general and specific aspects of the transformation process in the Baltic countries. I would disagree with only a very few statements and conclusions of his chapter. However, this is partly because they mostly conform with conventional wisdom on the transition.

3

His initial attempt to construct a general model of interactions among various economic, social and political factors in the transformation process is somewhat disappointing. Although I do think that it is impossible to fully understand the complexities of the transformation process without having such an interaction in mind, I could not see from the brief presentation at this conference what kind of conclusions one could draw from it. A quick look into his book Societies in Transition (Mygind, 1994) revealed the problem. 

It appears that Mygind is aiming for some grand synthesis of at least five different paradigms: 1) Marxian 'historical materialism'; 2) the 'decision-information-motivation' (DIM) approach to the theory of comparative economic systems, (Neuberger, 1971); 3) neoclassical economics; 4) new institutionalist economics of Williamson, North and others; and finally 5) 'the cultural approach' of Gollestrup (Mygind, 1994, p. 13). This is not only a very difficult, but also a very dangerous path. I cannot keep myself from making a comparison with the past theories of 'optimal mix' of capitalism and socialism, or at least of some of their ingredients, plan and market, public and private ownership and so on. It seemed to some that if those systems had different drawbacks, some combination of them ought to be better than any of the pure types. But, as discussed above, if the distinct systems are based on incompatible 'rules of the game' or incompatible coordinative mechanisms, their mixing would worsen the performance, not improve it. Similarly historical materialism, neoclassical economics, the DIM approach or new institutional economics have their own drawbacks and limitations, but you do not necessarily get better theory by mixing them together. They are based on distinct paradigms, start from quite different assumptions and often use very different methodological tools.

Mygind's 'model' is flawed because 1) it is not clear what the underlying assumptions are; 2) the individual elements of his 'model' are defined only vaguely; 3) it is hard to see how some of these elements would respond to changing inputs from the rest of the system; 4) the overall interactive structure of the model is not very convincingly specified. Analysis of this kind of model can hardly lead to firm conclusions about the resulting processes. In some cases Mygind formulates 'results' that seem to be verified by what has been actually happening in many transitional economies. The problem is, however, that these 'results' do not clearly and necessarily follow from the behaviour and interactions of elements of the model as he has formulated it. Mygind's language with statements like 'this will result in . . . ' or 'it will have positive (or negative) effect on . . .' is misleading because it presents what has been observed to happen as if it followed necessarily from the assumptions of the model, but it does not.

4

Let us now inspect Mygind's chapter from the point of view of transition hypotheses. He attributes the major part of the economic setback to economic fragmentation (hypothesis B5) and to the decline of aggregate demand (hypothesis B6). Mygind acknowledges certain aspects of the cost of transition hypothesis B4, but does not seem to give it a prominent place in the explanation of transition difficulties.

Mygind points out that the disintegration of the USSR and COMECON between 1990 to 1992 led to a sharp fall in demand for Baltic products from Russia and the other republics of the former Soviet Union as well as from other countries in COMECON.

"The disintegration of the former Soviet Union, and the transition to world market prices have led to a disruption of former trade links and serious problems on the supply and the demand side for the industry. . . . Trade with the former Soviet Union fell by more than 50 per cent in 1991, and this trend continued in 1992. "

Furthermore,

"The general development in 1990-92 was a sharp fall in the demand from Russia and other republics in the Former Soviet Union and also from other countries in COMECON. Most of the trading partners, especially in the Former Soviet Union could simply not pay for the goods. This resulted in increasing interfirm arrears and a change to barter trade, but first of all it resulted in a sharp fall in trade. All three Baltic countries were seriously hit by this development. "

It started with the politically motivated economic blockade of Lithuania in the spring of 1990, spread to all three countries when the blockade began to disintegrate, continued when Baltic currencies were removed from the rouble zone, and reached a peak in 1992 after Russia liberalized its own prices and allowed the prices of exported raw materials to jump to world market levels. This was a severe shock for the Baltic economies which resulted in hyperinflation, and a sharp reduction in the supply of energy and other essential raw materials so that 'many firms had to stop or drastically cut production, and in most houses and official buildings the temperature was much lower than normal'. The desperate attempts to redirect trade away from the countries of the former Soviet bloc did not work sufficiently fast, because Finland the closest and most natural partner of Baltic countries was also affected by the Soviet disintegration. A peculiar brief interlude occurred in 1991 because the Baltic countries started price liberalization before Russia while still being in the rouble zone. Russians, who faced empty shops in their own country, generated an extra demand for Baltic products.

In a more or less standard way, Mygind also attributes the decline in aggregate demand in all three Baltic countries to the very strict stabilization policy. Not only did declining real incomes reduce household demand but also 'the credit squeeze made it difficult for the firms to cover their deficit by bank loans. They had to cut down production that could not be sold at prices covering costs'.

5

Niels Mygind's chapter also adduces some evidence that suggests that all three hypotheses, C1, C2 and C3 claim to explain the differential success of individual countries in transition may be true. This holds both for the group of all three Baltic countries in comparison with other East European countries and the rest of the former Soviet Union as well as for the differences within the Baltic group itself. The Baltic countries as a whole are clearly more successful than the rest of the former Soviet Union but not as successful as Visegrad countries (Poland, the Czech Republic, Slovakia and Hungary). Within the Baltic countries, Estonia seems to be ahead of the other two. The comparison of Latvia and Lithuania is much less clear.

This can be explained partly by geographic proximity (hypothesis C1). Baltic countries, and specifically Estonia, are very close to Finland and Sweden but not as close to the rest of Western Europe as Visegrad countries and Slovenia. Geographic proximity has made the reorientation of trade links from East to West much easier and with fewer transaction costs. As long as East European communication (telephone, fax, mail and so on) and banking services (slow transfer of funds) remain backward, the advantage of reaching the country in a few hours by car, train or boat unquestionably helps not only trade but direct foreign investment as well. Geographic proximity also allows much more frequent commuting by East Europeans for shopping or work to West European countries or at least to watch West European television and thus get better information about the workings of the Western free market democracies.

The geographic proximity is closely related to the 'historical and cultural traditions hypothesis' C3. In their histories, the neighbouring countries may have mutually exchanged portions of their populations and almost certainly have had a need for frequent communication. As a result, at least part of the population usually knows the language and idiosyncratic national characteristics of their neighbour. This certainly facilitates the transition both because Westerners can present their business proposals in a more understandable and acceptable form while Easterners may learn faster from the West about how to operate in the market economy.

6

The fact that Poles, Czechs, Slovaks, Hungarians and Slovenes have had for more than a thousand years permanent political, cultural and commercial interactions with German­speaking neighbours certainly made the resumption of commercial ties with Germany and Austria after 1989 much easier. For Baltic countries, however, it works in two ways. On the one hand they had strong historical links to Finns and Germans which greatly facilitates reorientation to the West. On the other hand, the traditional links to Russia and the significant presence of a Russian population somewhat complicated the transition process. The historical and language differences also contributed to the greater success of Estonia as compared to the other two Baltic countries.

The higher degree of market-orientated values in Estonia can also be connected to influences from the surrounding world. The close linguistic relationship with Finland made the Estonians able to follow Finnish television and radio. Many Estonians lived in exile in Sweden, Finland and North America. This was to a certain extent also the case for Latvians and Lithuanians, but the language barrier implied that the influence of the Western style of living was smaller in these countries. . . . Latvia did not have such close links to the West as the Estonians did in relation to Finland. (Mygind)

7

The level of development hypothesis C2 seems to have some explanatory power as well. The Visegrad countries, and especially the Czech part of the former Czechoslovakia, were traditionally the most industrially developed part of Eastern Europe. Baltic countries and specifically Estonia and Latvia were not very far behind.

Both Estonia and Latvia were industrialized before the Soviet occupation. Tallinn and especially Riga were already important trade centres at the beginning of the century. Lithuania on the contrary had a large population in agriculture after World War II. Therefore the industry here was mainly built up under Soviet rule (Mygind).

The last observation is particularly important. For the countries that achieved a significant level of industrial development before the communist takeover, the transition process may be easier because it means rebuilding something that had already been there. There are three areas in which the previously achieved level of development may by crucially important.

8

First, there is a good deal of evidence that the industrial structure can itself be adjusted with more ease in a country where communist industrialization was built upon an industrial base created under capitalism. In such situations at least some of the huge socialist 'dinosaur' enterprises were created as amalgamations of previously existing smaller capitalist firms, whose skeletons and 'DNA' may be at least partially recovered even after half a century. It is much more difficult to restructure 'dinosaurs' that have been entirely newly created by socialist industrialization.

Second, the country that was already industrialized before communism must have had a stock of managers, entrepreneurs and people with skills needed in the capitalist market economy. A lot of that must have been lost as I have already mentioned above. Nevertheless, the recreation of these skills and professions may be easier than creating them anew in a country which has had very little business tradition.

Third and probably most important is the 'institutional memory' of such a country. It is much easier to recover and modernize the old economic and legal institutions in a country that once had a well­developed system of property rights, commercial law and so on than in a country that has little or no tradition in that area.

9

 

 

 

 

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