Plan&Market  Eastern Europe in Transition


Views and Facts


Let us now look more closely at the individual hypotheses.

The first hypothesis A1 corresponds to the old views of von Mises and Hayek. It had little support after World War II but became quite popular again after 1989.

It is probably true, although I am not sure whether it can ever be proved independently of hypothesis A2. 

Maybe the centrally planned command economy could actually work if completely isolated from capitalism on some remote planet preferably outside the Solar system.It seems clear, however, that it has not been able to keep up in competition with the vigorous dynamics of capitalist economies as postulated by hypothesis A2. Of course, this is my personal view which is perhaps shared by some of my colleagues but other people may have different belief about the validity of these hypotheses.


For example Michael Ellman clearly rejected A1 when he wrote:



'it seems to me wrong to place the blame for the collapse on the system exclusively. In an earlier period, the system was quite compatible with rapid economic progress. I see the collapse of the Soviet economic system at the end of the 1980s as a contingent  phenomenon, resulting from the interaction of the system, the economic policies pursued, and the domestic and international environment in which it found itself'
(Ellman, 1993, p. 2). 

He then vehemently supports hypothesis A2: 'The former Soviet system collapsed, in my opinion, because of its inability to compete successfully with the OECD countries and because of the response of its leadership to this failure. The crucial spheres of this competition concerned personal consumption and technical progress' (Ellman, 1993, p. 3).



Grzegorz Kolodko also rejected A1: 'one should not oversimplify the conclusion drawn from the historical experience of the CPEs. It is not true, as recently and quite often suggested, that under a centrally planned economy allocation of resources was always inefficient and investment was largely wasted . . . One cannot negate the fact, that in several cases . . . the CPEs exercised firm economic growth' (Kolodko, 1993, pp. 44-5). He then seems to suggest that what appeared to be the economic collapse of communism, may have been - at least partly - explainable by cyclical fluctuations in rates of economic growth and by external shocks: 'During 40 years of their history there were some sort of growth cycles . . . For a more recent period, however, . . . the picture is less bright.

The condition has clearly deteriorated in almost all CPEs . . . due mainly to the CPEs' lack of proper adjustment to the supply shocks of the 1970s' (Kolodko, 1993, p. 45). If I read it correctly Kolodko implies that the system might have not collapsed if it could only have been isolated from external shocks.


The relative inefficiency of the Soviet-type system has been documented many times. One of the striking pieces of evidence - quoted in Niels Mygind's chapter - is the finding (Dellebrant, 1992) that Estonia and Finland were at about the same level in 1940 and that in 1990 Estonia had only around 40 per cent of Finland's GDP.

The question about the causes of the collapse of communism is closely related to another question, namely why the capitalist market economy proved to be more efficient and dynamic than the centrally planned command economy. There are several and again not necessarily mutually exclusive answers.

1) Traditionally the most common answer has been that the neoclassical view of allocative efficiency and the Pareto optimality of the market economy has been superior to the distortions and misallocations of the command economy.

2) A second explanation is based on the informational efficiency of decentralized markets and the costs of overcentralization in a command economy.

3) Third, the better incentives in privately owned firms lead to more rational management decisions, more intensive innovations and more rapid technical change.

4) In several recent papers, Pavel Pelikan has promoted an innovative view of the importance of private ownership for the efficient allocation of 'economic competence' .

5) Finally, one can see also a substantial difference in the way the two systems change their organizational structure. The centralized reorganizations in a command economy are acts of social engineering which can have disastrous effects because they have not been subjected to the 'survival' tests before being implemented. On the other hand the market economy is a self­organizing system in which spontaneously appearing mutations survive only if they prove to be viable. Its evolution resembles Darwinian natural selection. The crucial difference is in the opportunity to try diverse structures. Private ownership of capital guarantees that a multitude of new ideas is tried, even if some of them may appear absurd on the first glance. In a command economy with public ownership only what seems to be most rational to the members of the 'committee' will be tried.


Depending on their perceptions of these causes, different people may regard different target systems and different transitional strategies as desirable. The important questions to decide are:

a) How essential is the rapid liberalization of internal and external markets?

b) How essential is the rebuilding of the institutions of the free market economy and especially how essential is rapid privatization?

c) What kind of role should government play in the target system and during the transition towards it?

Answers to these questions may be important for understanding the motives of post-communist politicians. Do they aim for the free capitalist market economy based on private property and minimal government intervention, or for some kind of third way 'social market economy' with government 'guiding' the market by enforcing strong social policies and possibly maintaining a large chunk of the economy in state ownership? The reluctance to liberalize markets rapidly and to privatize state owned firms may be an indication of the latter position.

Probably only a minority believes today in hypothesis A3. Hardly anybody would openly ask for the restoration of Soviet-type communism, but some may still believe that market socialism or some kind of the 'third way' rather than the return to capitalism should be the target.


Immediately after the 'Velvet Revolution' in 1989, Ota Sik, the father of the 'Third Way' concept, returned to Prague with the hope of implementing his ideas there.


 According to his own description (Sik, 1990), the target system was not to be much different from some versions of Western capitalism. Markets for goods, labor and capital were supposed to be almost completely free and government was supposed to avoid discretionary interventions as much as possible. 

The main role of the government was to set the institutional framework for the economy and to use the tools of economic policy for achieving social goals.

Sik did say, though, that he favored some forms of 'macroeconomic programming'. Some remnants of socialism would be encountered in combining various forms of property rights: private, cooperative, state and employee co-ownership in private firms. Employees would be able to participate in management and profits. Sik claimed that such a system - he was not sure whether to call it socialist or not - would guarantee full employment, economic efficiency and elimination of the conflicts between labor and capital. But even that was too much for the post­communist generation.


 They refused to listen to him and set the country on the path leading directly to a highly liberal form of capitalism.Their idea is succinctly summarized in the following recent statement of Vaclav Klaus:

The fashionable ideologies of the fifties and sixties suggesting the crucial role of governments, state ownership, planning, development agencies and development aid are over. The old utopian dreams of social engineering are forgotten and it has been more and more accepted that everything starts with an individual human being, with his or her behavior and activity, with free markets, private property, and private initiative. The collapse of communism gave a final blow to the previous etatist thinking (Klaus, 1995).


Mario Nuti believed that market socialism was feasible and would have been an improvement over the traditional Soviet-type system
He blamed communist politicians for their inability to implement the appropriate reforms: "speculation about a possible alternative model of "market socialism" - a "Third Way" - is a purely intellectual exercise . . . It cannot possibly involve claims to superiority over the capitalist system but it might well have been an improvement over the half measures taken in the name of reform. However, market socialism today cannot be regarded as a blueprint for action in Central Eastern Europe: obtuse procrastination on the part of past and present socialist leaders 
. . .  has made it impossible for anything but a version of capitalism to be the target model for Central Eastern European countries: when a boat is sinking, it is no time to experiment with the floating properties of alternative rafts" (Nuti, 1992, pp. 19-20).


Historical developments also forced John Roemer to revise considerably his idea of market socialism. It now differs from pure capitalism mostly by using 'coupons' to simulate popular ownership of capital. "My intent is to propose an economic mechanism that differs quite modestly from the successful capitalist market economies: a lesson of the Bolshevik experience is that one is ill-advised to redesign too many moving parts in a complex machine at the same time. . . . The market socialism that I have outlined is a pale shadow of what Marx thought possible, or of the Bolsheviks' utopian dream. It is a society in which many of the conflicts of capitalist society would remain." (Roemer, 1993, pp. 105-06).


Niels Mygind pointed to the importance of a 'value system'. He is certainly right about that, but he also seemed to imply that people of Eastern Europe with histories, cultures and value systems different from the West should aim for target systems that are more akin to them, that is for systems that presumably lie somewhere in between the decentralized individualist capitalism of the West and the former centralized collectivist system of the East.
I disagree. What is here perceived as the value system of East Europeans may have been just the value system of their rulers. In a totalitarian society it is impossible to determine what people really want, because their will cannot be manifested, and because they are subjected to intense ideological manipulation. But let us admit that people - whether this was their 'natural' preference or not - actually embraced the collectivist values imposed on them by past propaganda. Does it mean that some mix of market and planning will be better suited for them than the pure market economy? I do not think so. I doubt that any combination of (command) planning and market forces is appropriate. Certainly, market systems have had variations relating to diverse cultures and historical traditions; however, not all of these variants were equally efficient.
  Any large interventions by the government that severely restricted or deformed private property rights, free pricing and competition always resulted in reduced performance by the market system. It is a misconception to believe that owing to different cultures and historical traditions the optimal arrangements of, for example, Asian markets should be substantially different from the optimal arrangements of European or American markets. Similarly, it is bad advice to tell East Europeans that because of their values and traditions they should preserve a higher degree of planning and collectivism in their economic system.


The preference for a 'third way' solution is even more visible in the chapter by Hans Aage. He pleads for a partial retention of state ownership and claims that 'the requirements of restructuring are so overwhelming that they can hardly be fulfilled by the invisible hand of the market, unless it receives some badly needed assistance from a firm and visible government policy'. 

How does Aage support this position? First, he says that 'a well functioning market economy . . . is not an original, natural state of economic life' and that 'it requires a complex system of legal, political and social structures that took five centuries to establish in Western Europe, and a further 200 years to establish a civilized, socially acceptable system'. Second, he says that high taxation restricts private property rights anyway: 'a 50 per cent profits tax that has full loss offset corresponds to a 50 per cent state ownership concerning the right to income. A tax on capital gains is similarly the equivalent of state ownership of part of the right to the capital value.'  Third, he brings forward a frequently repeated example of some Asian growth economies (Japan, South Korea, China) that used 'comprehensive state intervention' to achieve fast growth.

Fourth, he mentions the case of some Polish state enterprises that were reported to improve their efficiency during transition. Finally, he suggests that 'there is growing skepticism, for both theoretical and empirical reasons, towards unregulated market forces and trade liberalization.'

I am not impressed. Should we believe with Aage that because the East European countries missed seven centuries of the development of market institutions they would be better off retaining some state ownership? This is ridiculous. Eastern Europe missed at most 50 years of those seven centuries (70 years in the case of the former Soviet Union), and the economic implications of the difference between private and state ownership goes far beyond the 'taxation equivalence'. The crucial thing is who makes decisions. It is true that 50 per cent taxation restricts private property rights somewhat, but the decisions are still made by owners and managers of private firms. If state ownership were to be retained, decisions would remain in the hands of state bureaucrats who would most likely continue to produce negative value added. It may be true that under the pressure of hard budget constraints some managers of state­owned enterprises began to behave in a more business-like manner, but there is also plenty of evidence to the contrary. In any case managers of state enterprises would probably need strong guarantees that their enterprise would not be privatized in the foreseeable future to prevent the 'pre-privatization malaise'. Pavel Pelikan showed in his chapter quite well why China may not be a good model for Eastern Europe. I want to add just one point here: political freedom and democracy were among the main goals of the recent revolutions of East European people. I do not think they would welcome our suggestion that in a Chinese manner they should postpone the achievement of these two goals until after the economic transition was accomplished in a well­organized way under the firm hand of the government.




Michael Intriligator came out with another version of 'historical tradition' and 'third way' solution. Not unlike Ellman or Kolodko, he believes that Soviet planning played a positive role at low levels of development and became a burden only in recent years. 'Thus, one must give at least some credit to central planning, which, despite its well-known deficiencies and excesses, "worked" in the Soviet context.'

He also makes a reference to the controversial view of Dyachenko that 'the need for central planning is inversely proportional to the level of development'. Intriligator believes that sudden liberalization and privatization is a bad policy. At least for the foreseeable future, the goal should have been not a laissez­faire system, but a mixed economy with strong activist government that would concentrate on institution building and reorganization of the economy. The inefficient state­owned gigantic firms should not have been privatized but rather either left to wither away or to be privatized at some future date, when their efficiency improved. The new efficient enterprises should be created by state, local administrations, investment banks, foreign firms and international organizations.




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