Colloquium 1995 Panel IV : External Economic Relations and Integration into the World Economy

Participation of International Institutions in the Reforming Process of Economies in Transition Katarzyna Zukrowska Economic reform of a post-communist economy is not a question of shock therapy, but of direct foreign investement. To create a favourable climate for investors, the groundwork must be laid at the political level, says Katarzyna °Zukrowska. Then it is up to the economy to do its work. Professor Zukrowska is working at the Institute of Development and Strategic Studies, Warsaw (1)

Introduction There are three options for a transitional strategy: the autonomous and nationalistic approach, involvement of another state (mainly regional power or a superpower), and support from international institutions. Most of the post-communist states have relied on international institutions in their transition strategy. This approach seemed to be not only the most effective choice but also a solution that is politically neutral. Effectiveness of the support towards systemic transformation which was supplied by international institutions derives from its: experience in macro-stabilisation policy; coordination of the steps taken by different institutions; conditionality; and finally knowledge of mutual relations between political and economic forces of each country. Neutrality of the aid is closely linked with the contemporary stage of development of international relations, enough to mention such features as end of the Cold War; victory of democracy and market over the communist experiment; globalization of technology, production and product; liberalization in international trade of goods and services; capital transfers; and finally, the universality of international institutions. This paper indicates why the role of international institutions is so important in the systemic transformation and how it changes with the advancement of the reforms. It also shows why other strategies for change are ineffective. Poland is used as a best example, indicating how the whole mechanism has been working, when put into motion. The Scale and Scope of Transformation Changes Transformation changes embraced parallel changes in both economic and political systems. In a comparatively short time these systems in the post-communist countries had evolved considerably, bringing them closer to the proven mechanisms of well-established Western democracies. Of course there are numerous things that still require mastering or even creation but today's system in the economies in transition is not only comparable but also compatible with the West. As Dahrendorf states: a political system can be changed overnight, economy requires years to change, while an open society can be created by an exchange of at least a generation. In the case of Poland, systemic changes were achieved by a shock therapy in the economic field and gradual change in the political sphere. Although in the political sphere the impression was that political power was transmitted totally to the opposition as Solidarity won the first free elections, nevertheless, the political division between the old and new elites was made clear: First, by the division of power between the President (W. Jaruzelski) and the government (T. Mazowiecki, heading a government consiting of Democratic and Peasants Parties and Solidarity). Second, by gradual changes in the central and local administration. Third, by the division of power in the Parliament, where the Senate (upper chamber) was overwhelmingly dominated by Solidarity, while the lower chamber represented more diversified political forces. Trying to complete the political issue in a short and comprehensive manner, it should be said that, within the advancement of the reforms the political power was changing both in the Parliament (Sejm) as well as in the government and at the presidential level. Poland has experienced a rapid progression, through six governments, with at least two failures in creating a government. The parliamentary elections have changed the representation in the Polish Sejm, which generally can be characterized as evolution from a dispersed representation to a more consolidated one. At the same time this consolidation became univocal with 30 percent of the voters - mainly the right wing orientation - not represented in the Sejm. This situation forces further integration of small and medium-sized parties, despite ambitions of their leaders. (2) The effectiveness of such pressure will be seen by the end of the year in presidential elections. Generally speaking, changes on the Polish political stage cannot be evaluated explicitly. On the one hand a post-communist President (animator of changes) has been replaced by a Solidarity leader and it is difficult to define this shift in terms of political orientation. It is not as simple as change from the Left to the Right or Center. On the other hand, parties represented in the Sejm have changed as well. Changes have occured not only within the parties but also in the framework of relations among them. Colours of the parties were most of all fading away, even some of the MPs were changing their orientation, moving from one parliamentary club to another.

Despite this fading of colours, we could see that parties started to differ in their programmes, not only in their rhetoric. The main indicators concerned some domestic issues as well as foreign policy. In the first case the main problem concerned gradual or "shock" changes in the economy, in other words the issue of the engagement of the government and the reform of the administration. In foreign policy the main question dealt with the integration within EU and NATO membership, in other words the sovereignty issue was raised. Political evolution in Poland, with its accelerated fermentation, has quickly caught up with the stage that is characteristic of contemporary political development in the West. This can be seen by the fact that the division between the political Left and Right has been replaced by division of those who opt for a more liberal approach to the world's economy and further integration leading towards global managerial solutions, and those who opt for more nationalism and sovereignty in their policy. This evolution and changing strength of political power, as well as political egoism of different parties, can be considered as a set of main arguments that support the idea of participation of international institutions in the reform process. Other arguments can be found in the economic field. Political scientists, who try to present this problem, usually refer to the main question: from were does the first push come: from the political or the economic field? In the Polish case it is clear that the first push towards systemic changes was defined by political decisions. Although, the economy has played a crucial role in this process. With a better economic performance the pressure to change the system would be weaker. Economic transformation in Poland has been discussed widely not only in the literature but also here, at the NATO Economics Colloquium in 1993, by the author of Polish economic reform, Leszek Balcerowicz. I will briefly repeat that Polish achievements in the reform process can be ascribed to a very simple mechanism: the market. (3) The whole idea of economic changes consisted of combination of a external and domestic, which have formulated the framework for: Macro-stabilisation policy. Liberalisation of prices. Liberalisation of foreign trade. The aquired strategy had three anchors, being a traditionally heterodox approach: Control over the money supply. Exchange rate of the Polish zloty. Control of the rise of incomes. The third anchor is considered to be the main difference between an orthodox and heterodox approach. It gives additional guarantees that pressure from employment does not break the tight corset of money supply, bringing a strong impulse in inflationary pressure. As forces of the Polish market were too weak and warped they have been additionally reinforced by signals coming from the world market, namely from the European Union, EFTA and CEFTA. After a short period, when prices reached their equilibrium on a rather high level, prices have stabilized and the inflation rate fell, although it is still higher than planned. This therapy has enabled a quick departure from the transformation crisis and a return to growth. The Polish economy started to grow in May 1992, that is two and a quarter years after Balcerowicz launched his plan. Now Poland is considered to be one of the leaders in the process of transformation, along with Hungary, the Czech and Slovak Republics.

In summary: the first stage of reform can be labeled as political. There are several reasons behind this: (1) reform was pushed by political decisions; (2) systemic changes required establishment of political and market institutions, as well as the introduction of legal regulations which were in the hands of politicans; (3) the state sector dominated the economy, which has given stagnating impulses towards the strategy to change, as a normal reaction to preserve the old structures; (4) some of the economic decisions were delegated to international institutions, which has eased their fulfillment. Within advancement of the reform the decisions gradually became dominated by economic reasoning and their political background lost power. The private sector started to dominate the economy; all the economic subjects have adjusted to the tough requirements of the market; and common interests have been articulated - which helped to form pressure groups, or lobbies, which were increasingly oriented towards the future, not towards protecting former privileges. The Question of a Reforming Programme All countries in the region have reservations concerning the strategy for change. The first set of questions concerns the touchy problem of sovereignty. (4) It is understandable that each country tries to protect its sovereignty, especially when it has been recently acquired. Countries must calculate what they win and what they can lose in this process. Is the result of such a calculation positive or negative? The Polish experience indicates that it was a calculation with a net gain. It is clear that in an interdependent world, countries are less sovereign than when the world consisted of more independent states. Such a development explains that all countries lose their sovereignty on a similar scale. Explaining this fact, one has to stress that the reduction of the state's sovereignity is affected by: Developments in international institutions and relations among them. Developments in the international economy, by globalisation of the product, production and technology caused by internationalisation of the economy, and accelerated by intensifying flows of capital; Relations among countries and of countries with international institutions. Making the decision about a transformation strategy, each country must take into account the fact that: International institutions are changing their character and are shifting from closed clubs into universal ones. This motion can be ascribed to depolitisation of the international economy, mainly achieved by the end of the Cold War. Some of the institutions, which were considered to be most effective tools of the Cold War were closed down or replaced by new ones of a more general character. Transforming countries are not able to change on their own and there are several reasons behind that: their capital accumulation abilities are limited; their knowledge of how to change is limited; and the burdens of change are rather high and they are totally imposed on the population which in a short term reduces support for the reforms. A second set of questions tackles the issue of the width of the opening of the economy. Experience in this field shows that the opening should be rather wide. Protection prolongs only the transition period, not necessarily reducing the burdens. Usually, gradualism is accompanied by the same costs as shock, although the results are limited and the time of transformation prolonged. Opening of markets plays a specific role, as was mentioned above, enforcing the signals of the market. Government is not able to point out which branches of production should be developed in the future, and which should be considered as declining. Moreover, such decisions are politically dangerous as they undermine the support of the electorate. Decisions in this field can be made with the support of intensified competition. It has helped to count the costs, and finally it is one of the measures showing that ECE countries compete with traditional factors: exchange rate, labour costs, raw material costs, but their competitiveness is very limited as far as modern factors are concerned. Development apart from the mainstream economy will widen the gap which exists in this specific field. Moreover, competition is one of the most effective tools which decides the competitiveness of the country, branch, or product. (5) It dictates the elasticity of the economy to change, adapting to the new requirements of the world market. Saying this we have to remember that the economy is a process and does not like stagnation. Stagnation for the economy is equivalent to losing the ground in competition and competitiveness. (6) This finding is fully supported by evidence coming from the contemporary economy. Enough said of the development of former CMEA countries apart from the mainstream economy. This is not the only example supporting this finding in contemporary economic relations.

Poland was one of the countries which despite relatively decentralized external relations was rather self-sufficient economically which in consequence resulted in rather limited openness of her economy. The big distance in this specific sphere had to be overcome in a short period after 1989. Economies in transition are opening gradually but they have to accept the fact that with time passing and the advancement of reforms, the opening will be wider. It will embrace not only the liberalisation of goods but also liberalisation of capital flows, liberalisation in services transfers and finally liberalisation of the movement of labour. Regulations in those four spheres are mainly reached on a regional level in the institutionalisation of integration processes in Europe. Specifically, this is defined by the EU Europe Agreement and follows summits of the Union, adjusting the association agreements to changing conditions and fulfilling the existing gaps according to the demands of economies in transformation. Regional solutions are not the only unique arrangements in this field. Establishment of the WTO - as an effect of the Uruguay Round - also brings some predictability in regulations concerning international trade. This concerns general rules liberalising world trade i.e. reductions of custom duties and non-tariff barriers. But it also formulates new rules of the game in case of so called "sensitive goods" such as agricultural products, textiles, steel, etc. For the first time in world trade history we are facing regulations concerning capital flows and trade of services, as well as intellectual property. (7) This fact shows that the process of desindustrialization of national economies is also reflected at the level of international relations. It can be expected that the GATT/WTO can play a special role in international trade, being a safeguard which determines if relations among certain economic blocks of regional integration - namely the multiplying FTAs (free trade areas) - are not turning into blocks of aggressive protection or expansion, creating thus obstacles towards further liberalisation of international relations. GATT/WTO can be considered as a tool in international relations which has a double-fold role to play: (1) it leads towards development of globalism and not regionalism; (2) it can be considered as an institution with a crucial role in the future international relations which can create mechanisms for global management. In sum: trade - traditionally - is considered to be the best instrument in creating wealth. In such conditions, opening of the economy not only helps to adjust to new market requirements, helps to restructure the economy, but it also acts as a multiplier, giving employment to the domestic labour force and thus increasing the wealth of the country.

The Role of International Institutions The role of international institutions in transformation of post-communist countries is rather multidimensional in its character. Some of the aspects of this support were discussed earlier in my paper. Now I would like to make some generalisations. International institutions engaged in transformation of post-communist countries can be divided into several categories, which derive from the role they have played and the purpose for which they were established: (1) financial; (2) integrational; (3) coordinating; (4) guaranteeing security; (5) advisory; (6) defining policy. Their geographical range permits division into: (1) regional; (2) global or universal. Most of the studies present principles of one organization, rarely do they analyse a group as is done in the study, quoted above, called Assistance to Transition. The list of international institutions engaged in transformation is long as it covers such organisations as: International Monetary Fund (IMF), World Bank, EBRD, European Union, EFTA, CEFTA, PHARE Fund, London Club, Paris Club, International Finance Corporation, OECD, NATO, OSCE, GATT/WTO, G-7, G-24, etc... The sequencing of aid provided by international organisations forms an extended web in which support from one of the organizations is conditioned by acceptance of the transformation programme by another. Not speaking groundlessly, it should be said that the crucial role in the setting of international organisations is played by the IMF. This organisation, or rather a stabilisation programme accepted by this organisation, opens the door to other international institutions, such as the World Bank or leads to reductions of foreign debt. Moreover, most of the programmes presented within the framework of EU association agreements, where foreign credits were at stake, also required an opinion of the IMF. Despite the fact that international institutions have played a multifunctional role in the process of systemic transformation in the post-communist region, the depth of their engagement varied from country to country. Moreover, the financial support of those institutions, despite the role they played in the region, is limited and does not exceed 30 US$ per capita on the average. (8) Information concerning this issue are diversified; according to other sources per capita rate of annual support did not surpass US$49. (9) Generally, over the period 1990-93, some $ 22 bn, i.e. just over one quarter of total receipts of external resources was in the form of official aid on concessional terms. Poland with Estonia and Albania are in the group of recipients of relatively big support in comparison with the rest of the transforming countries. Table I Western Assistance to Transition in billion US$ Aid and its destination 1992 1993 Total Net Receipts of which 28,6 23,3 CEECs 10,6 8,4 NIS 18,0 14,9 of which Russia 7,9 11,5 Concessional Aid of which 6,8 6,1 CEECs 3,4 2,6 NIS 3,4 3,5 of which Russia 1,9 2,1 Source: OECD. Aid and other resource loans to the Central and Eastern Countries and the New Independent States of the former Soviet Union in 1992 and 1993, Paris 1995. Quoted after Dispatch from Berlin, June 1995, p. 7.

Poland can be considered as the best illustration of the transition strategy that was applied with the active support of international institutions. This strategy is fully adjusted to specific conditions of all post-communist countries which make an attempt to build capitalism without the capital. In such conditions, when home resources of capital are limited, countries have to take into account all possibilities of attracting foreign capital of different forms. This explains why the following comments are derived from the experience gained in this country. The first phase of the transition was made possible by international institutions as they have supported the economies in transition with: Expertise, know-how and experts. Financial aid. Reduction of the external debt burden. Help in restructuring the economy. External disciplining role in case of stabilisation policy (as far as the scale of the budget deficit was concerned or the inflation control). Reference to other institutions. Conditionality. Support for the gradual introduction of currency convertability. Adjustement of their aid closer to the requirements of the transforming economies. Action as an external leverage helping to keep the changes on course. It would be difficult to present Polish contacts with all the international institutions, therefore I will concentrate on the main international pillars in the transformation strategy: the IMF and the EU. Both those organizations can easily serve as illustrations supporting the above-mentioned functions of international institutions in the transformation strategy. In the Polish strategy of establishing international institutional contacts, IMF was the first step. The Fund played the role of a specific safeguard for the other Polish partners, as it led towards: (10) Creating conditions for the introduction of reforms (establishment of the stabilising fund for currency convertability initially limited to the internal market). Improvement of Poland's situation in the eyes of foreign governments, investors and bankers. Creating a precondition for loans from the World Bank. Creating a precondition for talks with other international organisations. In return the Polish government had to accept certain conditions, mainly a strict policy on stabilisation. Each piece of the instalment was paid against realization of the consecutive stages of the agreed programme, according to the time-schedule. Any deviation from the rules could cause an adjournment of payments, which has happened twice in the case of Poland. This required further negotiations with the IMF and led towards a new agreement, adjusting the terms of the contract to the new conditions. Hungary, Russia and other East Central European countries experienced similar disciplinary measures, which at the same time indicated the flexibility of approach towards any economic or political constraints. The agreement with the IMF was a precondition for reducing the debt with foreign creditors grouped in the London and Paris Clubs. Arrangements in both cases were reached on similar conditions, leading towards 50 percent reductions of foreign indebtedness. The first agreement was reached with the Paris Club which groups creditors with state guarantees. The road to an agreement with the London Club was longer and finally ended in 1994. The agreement perceives the ways that the remaining debts are to be repaid, which is conditioned by the economic situation of the market and takes into account the problem of accumulation of repayments. In 1994 the share of scheduled repayments of the Polish debt did not exceed 2,7 per cent of the state budget. (11) As time passed, when international institutions became convinced that Polish reforms had passed the "point of no return", the conditions were becoming less and less arduous, although they were still imposing some limits on the government. The main principles behind those limits, concerned two aspects: Continuation of the reform, according to the formerly worked out and presented agenda. Imposing certain limits in "spoiling money" as we have to remember that inflation can be used in a state's policy to reduce the nominal expenditures of the government. The European Agreement that was signed on 19 December 1991 in Brussels has formulated conditions on which Poland became an associate member of the Community. The document came into force after the full procedure of ratification on 1 February 1994. Until that date the co-signatories of the agreement were bound by the conditions of the Interim Agreement.

Under the conditions of the European Agreement - Poland has started to create a FTA with the Community. The opening of the markets was asymmetric on both sides as it was an agreement between markets representing different levels of industrial development. Conditions of the agreement, generally, are divided into three groups, which concern: (1) raw materials and low processed products; (2) highly-processed products; (3) goods for which liberalisation of turnover is postponed (agricultural products, textiles, coal and steel, etc.). The European Agreement provided conditions to protect some of the branches of industry that are considered important to the economy and too weak to be exposed to the pressure of direct competition. It also imposed some quotas on imports from Poland - mainly for goods considered to be areas of particular specialisation. The 1993 Copenhagen EU summit has changed the agenda of abolition of those quotas and increased them in many cases. Despite all the criticism addressed to the limitations of Polish exports to the EU market, until now Poland has not taken full advantage of all the existing opportunities. This is supported by the evidence that in some cases of quotas imposed on agricultural products only 20 percent was utilised in 1992-1993. The argument for increasing the quotas and reducing the time in which they become mandatory was very simple: The share of ECE exports covered by the quotas was very small in the EEC turnover, but it was rather high for the ECE countries. The share of those goods was meaningful for the ECE countries. Industries protected by the quotas imposed by EU were in decline since the 1960s and ECE exports were not the reason for their problems. Changes in this field are advantageous for both partners and in both cases they lead towards an increase of wealth. Opening the market with the European Union has played a crucial role in the process of marketisation of Poland's economy. Generally it has fulfilled four functions: It has increased the competition on the market, forcing the enterprises to catch up with Western suppliers, with better quality goods and with a wider range of choice. It has helped to balance the gap between demand and supply on the market. It was one of the market tools which has actively worked in fixing the equilibrium prices, putting a ceiling on their hikes. Finally, the consumers have learned to demand better quality, better choice and better service. In sum: the role of international institutions was crucial in the first stages of the reforming process. Now, with the advancement of the reforms it will presumably be addressed towards more concrete activities not being limited to macro-stabilization policy. Not always, at the starting point, was the offered aid adequate to the needs of a country, but this was adjusted according to the demands. The possibilities of using the financial aid were limited by the structure of the aid which was very often in disparity with the needs. Some guilt, in low capital acquisition, can be ascribed to the transforming countries, as they did not develop a proper network of information.

Conclusions: The Future Role of International Institutions International institutions are taking over part of the duties that traditionally belonged to the governments. This is due to the fact that it is very often impossible for the government to implement a decision which is unpopular and which can bring short term disturbances on the market, but which in the long run will accumulate wealth. Such decisions also concern withdrawal of some privileges which were introduced in different political and economic circumstances, while in contemporary conditions they can be considered as factors which simply: (1) undermine the integration process (widening and deepening); (2) act against the Maastricht criteria of convergence; (3) limit the increase in competitiveness. In such conditions we can face, on the one hand, a development which will lead towards a further limitation of national governments' control over the market and devaluation of the political options of different programmes. On the other hand, we will face the widely discussed problem of global governance, with such questions as: which institutions or countries can play this role? How and under what conditions? Who supports such an idea and who is against it? What are the arguments in favour of such a solution and what can be considered as an obstacle to putting it into practice? Is it necessary to give supranational powers to international institutions in order to achieve global governance? How will this influence the sovereignty of different countries? What are the fields in which sovereignty must be limited? The main arguments supporting the idea of global governance embrace the following set: growing interdependence of the world; security and stabilising factors; long perspective goals of limiting the development gap between the North and the South; interdependence between new development patterns, based on liberalisation of trade of goods and services, capital flows and intellectual property, and accelerated de-industrialisation of national economies and international relations. Footnotes Katarzyna Zukrowska is a professor affiliated with the Institute of Development and Strategic Studies, Plac Trzech Krzyzy 5, 00-507 Warsaw. Poland. Tel no.: + (48 2) 693 55 36; fax no.: + (48 2) 625 06 76. P.G. Lewis, Political Institutionalisation and Party Development in Post-communist Poland; V. Zubek, The Reassertion of the Left in Post-communist Poland in: Europe-Asia Studies, formerly Soviet Studies, Volume 46, No.: 5/1994; M. Dehnel-Szyc, J. Stachura, Gry polityczne - orientacje na dzis, Warszawa 1991. L. Balcerowicz, Lessons from Economic Transition in Central and Eastern Europe, in: Poland. International Economic Report 1993/1994, ed. J. Bossak, Warsaw School of Economics, 1994. K. Zukrowska, Szerolie otwarcie. Polska gospodarka w aktywnym otoczeniu miedzynarodowym. Volumen 1994. The Single European Market and Beyond. A Study of the Wider Implications of the Single European Act, ed. D. Swann, London, New York 1992; European Competitiveness, K.S. Hughes, Cambridge University Press, 1993. Growth, Competitiveness, Employment. The Challenges and Ways Forward into the 21st Century. White Paper, 1994, Brussels. P. Bozyk, An Evolutionary Mode of Transformation of External Relations, WERI, Centre for International Comparative Studies, Working Paper 114, Warsaw 1994. Od Gatt do WTO. Skutki Rundy Urugwajskiej dla Polski, ed. J. Kaczurba, E. Kawecka-Wyrzykowska, Warsaw 1995. The World Competitiveness Report 1994, World Economic Forum, Lausanne 1994, p. 10. Poland. OECD. Economic Surveys. 1994. Assistance to the transition. Survey. 1995, Institute for East West Security Studies. PECAT, Warsaw 1995. Bibliography Consequences of the Uruguay Round for the Polish Economy, in: Transforming Polish Economy 1994, IRiSS, pp. 233-244, 1995. Participation of the International Institutions in the Transformation of East Central European Countries, World Economy Research Institute. Centre for International Comparative Studies, Warsaw School of Economics, Working Paper No. 123, 1995. Internationalization and Competitiveness, IRiSS, p. 22, 1995. Book: Wide Opening. Polish Economy in an Active International Environment. Warsaw, 1994. Foreign Direct Investment, in: Transforming Polish Economy 1993. IRiSS, pp. 196-206, 1994. Poland in International Economy, in: Social and Political Dimensions of Polish Policy in the 1990s. IRiSS, pp. 115-124, 1994. Ownership Changes in the Polish Arms Industry: Security Issues, co-author L. Turczynski, in: Privatization in NACC Countries, NATO Economics Colloquium 1994, pp. 183-194. Institutionalization of Polish Foreign Economic Relations. IRiSS, p. 42, 1994.