A Report Card for Economies in Transition
John P. Hardt*
Dr. Hardt is Senior Specialist in Post-Soviet Economics of the Congressional Research Service of the Library of Congress, Washington, DC.
Toward a New Social Contract of Transition (1)All of the states of Central and Eastern Europe and the former Soviet Union are committed to transition. They are engaged in transformation from central-planning to market-based economies, and from single-party control to political pluralism. The governments have expressed these goals, but the pace of implementation of liberalising policies and laws varies widely, and the ultimate involvement of the newly defined states in the economy is yet to be determined.
No state has reached the point of self-sustaining reform from which the successful completion of the transition may be assured. Even the remarkably successful states in Central Europe and the Baltic states should be considered in mid-course of the transition. Although many new states do not appear to be well off the starting mark none should be written off at this time.
An assessment of where they started, an explicit vision and strategy of where they hope to end the transition and how they expect to get there is needed but lacking in most countries. A more articulated version of the "OECD model" that specifies objectives and success indicators relevant to key players seems appropriate. Likewise, clear identification of the players who judge and contribute to success is useful and necessary. These players are the electorate, the new entrepreneurial classes, the donors and the foreign investors.
In 1994 it was popular to declare some economies in transition successes and others failures. The London Economist had Poland "turning the corner" with an end of its post-revolution recession. Anders Aslund provided a very insightful and useful assessment of 27 countries in the region, finding eight successes and the rest failures. His focus was especially on inflation control with 50 percent per annum price inflation as the cut off and contested elections as a measure of democratic progress to facilitate economic reform. (2)
While achieving these measures of progress is necessary, they do not seem sufficient to make a judgement of success. A broader set of objectives and performance measures would appear to be necessary to obtain support and commitment from the key players to assure sustainable support based on a viable consensus for reform. The sustainability of the changes toward the central objectives of a democratic and market system under a rule of law should be seriously questioned.
Moreover, an assessment should be made not only on inflation control and elective politics but as to how much progress has been made toward higher living standards, employment opportunities and systemic changes generating confidence in the electorates and new entrepreneurial classes, satisfying conditionality of donors and attracting foreign investors. Both measures of efficiency and equity need to be served by transition, considerations especially critical to attaining support from the electorate.
For these countries to create a smoothly-functioning market economy, six critical success factors must be met:
"OECD MODEL" - Multiple Objectives and Performance MeasuresThe "OECD model" implies a number of criteria for judging the successful attainment of the strategic objectives of transition, with an emphasis on rising living standards, employment opportunities and financial stability as appropriate bases, as noted by the OECD Annual Report in 1992:
Today, the failure of the Soviet model strengthens a trend that in fact has been emerging in the world economy for some years. The concepts of pluralistic democracy and the market economy, the essential elements of the "OECD model," have exercised a strong attraction, not only in Central and Eastern Europe but also in certain countries of the rest of the world¬to achieve the highest sustainable economic growth and employment and a rising standard of living in Member countries, while maintaining financial stability, and thus to contribute to the development of the world economy. (3)
From the "OECD model", this author adduces six criteria for assessing progress toward the goal of democratic and market systems under a rule of law. (4)
The criteria merit more detailed discussion before suggesting a strategy and new social contract and proffering a report card on the economies in transition.
Financial StabilityThere is little question that macroeconomic stabilisation programmes need to liberalise prices, reduce trade and currency exchange barriers and adopt budgetary discipline that eliminates the practice of monetisation of deficits, and moves toward elimination of debt at international, national, and inter-enterprise levels. Monetary and financial stability would foster progress in other necessary reform measures, and also would benefit from progress in other reform measures. While reducing inflation below the 50 percent per annum level is important, support from key players is likely to be even more sensitive to other success indicators, especially rising living standards and attracting foreign investment.
Living StandardsThroughout the region the transition started with a recession or deep depression as state support for traditional priority sectors such as defence and heavy industry collapsed and bottlenecks from the breakdown in regional trading systems depressed output. As a result effective employment and real income fell below pre-revolution levels of 1989. With the resurgence of output in services and privatised sectors, income stabilised and started up in some countries. The availability of food and consumer durables revived, but with unequal distribution. The continued fall in the quality of life accentuated by sharply lowered living standards is indicated by each of the following "externality" measures which have been in deepening crisis.
The quality of life measures added to the perceived fall of real income accentuated by income inequality may explain why many polls indicate citizens feel they are worse off than under the old regime and also that the new legal and regulatory systems are against them and favour a new elite.
The central indicators of success in earlier Western industrial economic development were the economic miracles that could be measured in real terms, e.g. the several decades of OECD countries' growth from 1950-1973 found the average real income more than doubled without extreme inequality. (6) Perhaps as persuasive as rising real income and improved living standards in Japan, were general access to consumer goods such as the four Cs: personal cars, computers, air conditioners and colour television sets.
Likewise, the shifts from bicycles, radios, and watches to availability in the market and peasant access to motorcycles, television sets, and refrigerators in China were a recognition that rural modernisation was beneficial and a meaningful stimulus to the participants in rural modernisation. The availability of a variety of consumer goods in East-Central Europe and parts of the former Soviet Union has increased substantially, although income distribution does not make the new consumer goods accessible to all.
While the quality of life receded under the old regime standards, paradoxically the burden of social expenditures burgeoned to one quarter of the gross domestic product in the period of 1985-90 for social welfare, education and health. Particularly burdensome has been the cost of maintaining pensions. Ironically, the rise in these social welfare costs were concommitment with liberalisation in reform-oriented countries during the communist period. (7) Now these expensive "entitlements" claim a disproportionate share of tax revenues without an improvement of the quality of life commensurate to the cost.
Employment OpportunitiesStatistics on employment are especially unreliable. The reasons illustrate some changes in the economies: many new jobs have developed in the privatised sectors, especially in services and small scale enterprises which tend to understate employment; many state enterprises report employment that includes workers who generate little output, i.e. "concealed" unemployment.
Those countries that find ways to support labour-intensive improvements in their infrastructure and their quality of life (environmental quality, health, education, and housing) will generate productive employment. Foreign direct investment attracted by skilled labour and low real wage costs can generate substantial new employment in large scale enterprises.
According to Machowski and Schrettl:
At present exchange rates, wage costs in the CEE region average only one-tenth or less of western German levels. Even on very optimistic assumptions about growth of labour productivity in the CEE region, a huge wage differential is bound to persist for the foreseeable future. (8)
While employment opportunities may increase, the discrimination developing in employment practices in many countries is leading to a new underclass especially populated by unemployed women and many minority groups. (9) The U.S. Secretary of Labour Robert Reich in the interest of combating discrimination and ensuring equity in the United States called for "a new social contract between business, government and citizens to help millions of Americans in the anxious class survive in today's economic order of down-sizing, reengineering and global competition." (10)
This call may resonate in Eastern Europe today. A former chairman of the U.S. Council of Economic Advisors called attention to the trade-off between efficiency and equity that may also seem relevant today in Eastern Europe, "The rights and powers that money should not buy must be protected with detailed regulations and sanctions, and with countervailing aids to those with low incomes. Once those rights are protected and economic deprivation is ended, I believe that our society would be more willing to let the competitive market have its place". (11)
Market-Facilitating InstitutionsThe destruction of the old, Communist, command economic institutions left a void and the development of the necessary and progressive role of the market friendly state has been delayed in many states, actively opposed in others. Without a legal and regulatory framework both efficiency and equity are adversely affected; crime and corruption are encouraged. Under these circumstances citizens feel the new system is not on their side, entrepreneurial groups - private owners, managers and workers - are not protected from the powerful old party holdovers and new criminal organisations, foreign investors and donors do not have the sufficient degree of economic, commercial and political stability that would attract investment or assistance.
For their world development assessment the World Bank "calls for a stronger orientation toward the market and a more focused and efficient public sector role. History suggests that this is the surest path to faster growth in productivity, rising incomes, and sustained economic development."
From this "rethinking the role of the state" in the transition to market economics, one may conclude that the minimum new institutional developments required for market-friendly institutions, early in the transition, are the following. (12)
Openness to World Market EconomiesMembership in international economic institutions and commitment to assistance programmes fosters the development of open economies with convertible currencies, reduction of trade barriers, and acceptance of rules of the game in the international market place. Membership and programmes with the International Monetary Fund, World Bank and its affiliates, EBRD, and OECD condition assistance on reform progress and adherence to the principles of openness.
Moreover, membership and adherence to the World Trade Organization will also require evidence of commitments to open market reform. Although sceptics might say that the countries in transition seek membership solely to obtain loans and access to Western markets, not because of a commitment to reform and open economies; nevertheless, the "dues" for membership are implementation of reforms.
Steps in accession to the European Union or other regional trade and investment agreements suggest not only openness but also development of better statistical systems, harmonisation of laws with those of market economies and acceptance of criteria of free flow of investment, people, technology and credit in both directions. (13) Still, accepting the full body of EU laws in the acquis communautaire is not enough, the legislation must have oversight and enforcement.
Bilateral agreements with major trading countries such as Germany and the United States also suggest adherence to principles of international and regional associations, e.g. acceptance of principles of national treatment, protection of intellectual property, protection from expropriations. Access to markets, investment, and technology tend to reinforce the transition to an open economy. East European economies currently with low real wages may find the gap in real income will rapidly close with Western Europe once the transition is completed. (14)
Political and Security StabilityMany in Central and Eastern Europe look to membership in NATO as important for political and security stability, just as membership in the European Union might be for fostering economic stability and growth. Many states of the former Soviet Union encouraged membership and integration into the Commonwealth of Independent States as a measure toward economic integration and political and security stability. Others have sought bilateral agreements with the United States along with NATO membership (or pre-NATO Partnerships for Peace).
Most of the Western industrial economies and economies in transition were signatories or successor states to the Helsinki Final Act and seek a more active Organization for Security and Cooperation in Europe (OSCE). Finally the United Nations as a global organisation may provide some economic, political and security stability. The use of peacekeeping forces represents to some a means for maintaining stability.
The CIS, OSCE, and UN have been criticised for their inability to stop the fighting in ex-Yugoslavia and Chechnya. Nevertheless, these groups may together represent an influence on stability that is greater than the separate impact of any one such group. Indeed, together they may develop the balance between centrifugal and centripetal forces in the region as states strive to retain their sovereignty and separate identity while benefiting from the collective integrating forces that promote economic growth, political stability and security. (15)
Moreover, if weapons production and inventories are down-scaled during restructuring with special attention to weapons of mass destruction, the destabilising threat of a substantial stocks of weapons will be reduced. The break-up of countries in the former Soviet Union and Central Europe may have some salutary political and economic effects. Ivo Bicanic argues that in the transition as unitary states - from the old communist to the new market- system the regional impacts may be "destabilising, inequality-generating and asymmetric".
Such developments provide strong incentives to break from the "convoy effect" of preserving the union and favour the "go-it-alone" or trends toward developing political independence in smaller states. If these divorced or independent states follow more avidly domestic reform and openness as smaller more homogenous sovereign states they may develop a more stable and secure environment than if they had stayed in the larger, diverse union. (16)
This development suggests the advantages of the commonwealth over the confederative approach, e.g. the Tatarstan agreement with the Russian Federation fits more into the British Commonwealth tradition than a more unitary federative approach such as in the United States of America. Likewise, settling disputes within the former Soviet Union in the various independent states could draw on the negotiation formula of the Russian Federation for settlement of the federative issues with Tatarstan, Bashkortostan, and Sakha. The destructive example of Chechnya may be of value. (17)
Vision, Strategy, and the Social Contract (18)Each of the critical interest groups would be more supportive if the leaders of the economies in transition had a clear articulated vision of where they were going and had a strategy for getting there. Historical experience and current assessments support the importance of a vision and strategy as supportive of relevant success criteria and for general consensus-building among major interest groups. East Europe may reasonably expect a substantial improvement in living standards after the transition, an economic miracle; an economic miracle (Chudo) may also be envisioned in Russia. (19) Objective requirements of the OECD model we defined are met, a substantial improvement in the benefits to major players in absolute and relative terms may be expected.
The report card for economies in transition chooses this version of the OECD model as it reflects the perceived views of groups that make a difference by their support as to whether the transition will be sustainable and successful. The electorate of the countries in transition must support a set of core principles, should share a vision and understand a strategy for reaching the overall objective of prosperity and peace. The new left has organisational advocates and traditional appeals drawing it toward status quo ante but cannot resist the demonstration effect of performance as a stimulus to supporting reform.
The new entrepreneurial groups or classes in the states in transition replace the rent seeking groups that require deficit financing to retain the status quo ante by populist measures. The tipping of the balance between new reform "winners" and entrenched "losers" is accelerated by privatisation, restructuring and corporatisation. The new entrepreneurial private groups suffer during the transition from a problem common to many revolutionary changes.
Machiavelli warned The Prince: "There is nothing more perilous to conduct, nor more uncertain in its success, than to take the lead in the introduction of a new order of things. For the innovator has for enemies all those who have done well under the old conditions, and lukewarm defenders in those who may do well under the new." (20) Especially with privatisation, corporatisation and success the balance shifts. Corporatisation is essential as it requires good corporate management. (21) The new entrepreneurial groups also include workers in privatised enterprises. (22)
Foreign investors and donors may both favour the same criteria with the former replacing the latter in weight and influence as the transition progresses. A vision and strategy for the transition is not yet clearly or credibly articulated by the reforming governments of states in transition to the important actors. A current comprehensive assessment as to where the transition countries have come from, and where they are now, is useful for all participants. Where they expect to end up is a particularly missing piece.
Knowing better where they have to go to complete the course would be a stimulus for effective time phasing and coordination and provide a proactive basis for building a consensus wide enough to encourage all groups to stay the course. The historical processes in Post-World War II development of the Western industrialised economies all benefited by a credible vision of where they were to end up in the transition. The rapid economic growth of the OECD countries from the 1950s to the 1970s in which real income more than doubled was important evidence of a credible economic miracle. Expanding benefits of increased trade and investment within the market economies accentuated the collective benefits.
These developments in a stable political and security environment made the promise of prosperity and peace a realistic vision. This vision would likely be persuasive to the electorate, the new entrepreneurial classes, the donors and investors if credible. An explicit strategy and clear success indicators would contribute to more coordination of collective effort and consensus building. The support of the electorates, entrepreneurial groups and donors have been and are important but foreign investors play a uniquely important role.
The crucial importance of investment for countries in transition has been widely accepted based on historical experience and is the crux of Western assistance policy. While official assistance is initially necessary to fill the financial gap, private capital flows should be relied upon as soon as feasible to supply the funds necessary to maintain monetary stability and restructure the economy.
Foreign direct investment will be the major engine of growth coupled with initially modest but expanding domestic investment. Not only would foreign investment provide new technology, but with it would come modern management and marketing techniques to improve the competitiveness of the economy. Foreign investment provides current account finance without debt, and, as several large investments in Central Europe have shown, indicates broad confidence in the reform process.
Macroeconomic stabilisation, privatisation, restructuring and corporatistion will attract investment, reinforcing further reforms and improving creditworthiness. Establishing a modern commercial code in law and market friendly institutions supports the stability necessary to reduce risk in foreign commitments. Together effective economic reform and establishment of a commercial rule of law tend to attract more investment and greatly improve the ability to obtain finance on international money markets, completing a synergistic virtuous circle. Investment is a positive sum process in which the citizens and enterprises of economies in transition and Western countries alike gain substantial benefits in real income, profits and employment, and is very important for integration into the global market economy.
Moreover, mutually beneficial investment is the linchpin of partnership between economies in transition and the Western countries. Foreign investment in many countries in the former Soviet Union and Eastern Europe, to date, has been low largely due to the lack of a stable currency, economic restructuring and an inadequate legal framework; substantial domestic capital has tended to migrate out of many of these countries. Progress has been frustrated by measures intended to redress recession and unemployment, but through deficit financing these measures have destroyed the prospects for monetary stability necessary for reform and attracting investment.
Mistrust in the legitimacy of new leadership and lack of confidence in beneficial outcomes of reform have had a negative effect on support of the new regimes and led to rejections at the polls due to the deepening economic crisis. Thus a vicious circle of economic decline, debt accumulation, inflation, uncertainty and inadequate investment has occurred. Temporising and gradualism has proven to be an illusion with either the downward or upward process - the vicious or virtuous cycle - being the operative policy choices, with investment levels as the key barometer of longer term success. (23)
The success indicators, if achieved, could produce a virtuous circle for attaining prosperity and stability. Without a clear and credible strategy a vicious circle of persistent claims of rent seekers, government subsidies and protection, and providing for costly but inefficient welfare systems could undermine reforms.
Mid-term Report Card for the RegionAs promising as the changes seen in leading reform countries are, they have not yet passed the threshold of successful and self-sustaining democratic and market change. Labelling any countries in the region as failures is premature, and could lead to unfortunate policy implications of hopelessness in the new states and in non-engagement by the West.
Footnotes:The authors' views are his own and should not be taken to represent those of the U.S. Congress, Congressional Research Service of the Library of Congress or the United States government.
Quality of life measures as vividly assessed by Murray Feshbach at the colloquium should be explicit success indicators. See: Toward a Western Ecological Agenda, Murray Feshbach, in Ecological Disaster, Cleaning up the Hidden Legacy of the Soviet Regime, New York Twentieth Century Funds Report 1995, pp. 79-104. C.f. R. Rybkina, Statistika; sotsiologia, Voprosi Statistiki No. 1. 1995, pp. 3-5 inclusive. [the new monthly journal of the Russian Statistical Agency.].
Sharon Wolchik, Gender Issues During Transition, in JEC, East Central Europe, pp. 147-170. Michael Paul Sacht, Ethnic and Gender Divisions in the Work Force of Russia. Post-Soviet Geography, Vol. xxxvi, No. 1. January 1995, pp. 1-12.
Arthur M. Okun, "Equity and Efficiency, The Big Tradeoff". Washington, D.C., Brookings Institution, 1975, p. 119. C.f. Ed Hewett, Reforming the Soviet Union: Equality versus Efficiency, Washington, D.C.: Brookings Institution, 1988.
Stanley R. Sloan and Steve Woehrel, NATO Enlargement and Russia: From Cold War to Cold Peace? CRS Report 95-594 S. May 15, 1995. 45 p. John Tedstrom, Economic Integration in Post-Soviet Space: Russia's Broad Agenda. Santa Monica, California: RAND Corporation, forthcoming 1995.
Leszek Balcerowicz, Transition to the Market Economy: Polond, 1989-93 in Comparative Perspective in Economic Policy, A European Forum, Lessons for Reform, Cambridge University Press. Paul Marer, Hungary During 1988-1994: An American View, published in French, Economica Press, June 1994, edited by Marie Lavigne, in a book entiteld Capitalismes a l'Est, un Accouchement Difficile.
Ron Amann, Director of the Center for Russian and East European Studies, Birmingham University first used this reference in the context of regional reform in a discussion of the Russian "identity" crisis.