Colloquium 1996 Summing Up

Economic Developments and Reforms in Cooperation Partner Countries: The Social and Human Dimension John E. Tedstrom Senior Economist, RAND Santa Monica, California

In his opening statement to this conference, Ambassador von Moltke reminded us that as early as 1991 NATO adopted a new Strategic Concept. At its heart, this new Strategic Concept recognizes that security in Europe, as everywhere, depends on more than just military power. Indeed, security must be underpinned by stable societies. This critical element--stability--is dependent on, and is best achieved by, efficient, competitive economies that reliably provide for the well-being of their citizens. This is especially true for today's Europe; for after the fall of the iron curtain and the collapse of the Cold War, the greatest threat to the security of all Europeans--from the East and West alike--comes not from some outside aggressor but from economic decline and social instability at home. By addressing the socio-economic aspects of security in Europe, NATO has taken a vital step toward ensuring the long-term well-being of all Europeans. Let me state at the outset that my comments today on the socio-economic dimensions of security are based on a very specific vision for Europe in the 21st Century. My vision is of a Europe that is united and strong, peaceful and stable at home, and an active, successful participant in the global economic and political arenas. This vision of Europe, importantly, includes Russia, for I am convinced that for historical, cultural, and geographic reasons this is the only logical formula and the only one that promises long-term growth, stability, and security on the continent. How to get from where we are now to this new Europe has been the intellectual and policy challenge facing us all since the beginning of the decade. In order to understand better the dynamic process--how to move to the new Europe--we must begin by examining where we are now. In his key-note address to this conference, Dr. Hethy presented a useful framework for thinking about this dynamic when he eloquently explained the distinction between economic transition and transformation. His approach is disarmingly simple, and like many simple ideas, his is powerful in its ability to explain a complicated problem. Economies in transition have an end point in mind--there is a broad social and political consensus on the ends if not the means of reform. In other words, these economies are moving from system A to system B, and system B is clearly defined, even if the path from A to B is not. A transformation economy, in contrast, realizes that it must shift away from its socialist system toward something new, but there is no consensus on what that new system is. Transformation countries in Europe have generally succeeded in destroying much of the infrastructure of their old system but have not been able to develop a new, robust institutional framework to replace it. This distinction is important and explains a great deal why some countries--the transition countries--succeed, and others--the transformation countries--do not. If we examine the leading economies of the region, Poland, Hungary, the Czech Republic, Estonia, and Slovenia, they all have had a clear vision of their end goals. This allowed them, each from its own initial conditions, and each in its own way, to pursue a consistent set of policies over the long run. It is this consistency and single-mindedness of purpose, not some silver bullet or magic wand that has allowed these countries to begin to achieve economic recovery. This is not to say that Poland, Hungary, and the others all shared the same vision or pursued identical reforms in some perfect sequence. In fact there are many acceptable end points and just as many transition paths. The US, Japanese, and German economies are all unique and all have their own natural strengths and weaknesses. All of these economies, however, even though they are unique, all respond in the same qualitative way to economic stimuli. If their central banks increase the money supply to cover government spending, inflationary pressures are bound to increase. The lag time between printing the new money and accelerating inflation will be different--in Ukraine it is about 8-12 weeks, in Russia as much as 6 months--but the qualitative response is the same and is predictable, and this is what policymakers must keep foremost in their minds. And the rule applies for microeconomic change as well. Privately run firms in market economies and in planned economies alike tend to perform better than state-owned firms. Recently, for example, France had to bail out its state-owned railroad to the tune of $150 million, spreading that cost over millions of taxpayers who never used these services and running the risk of increased taxes, higher interest rates, higher inflation or some combination of these problems for the entire country. If there is still any doubt about the fact that these economies respond in similar ways, go further back in history. Although all the partner countries enjoyed strong economic growth from 1950 through the mid-1970s, is it any coincidence that by the end of the 1980s, they had all run out of steam? I don't think so. Likewise, since the beginning of transition and transformation, all of the countries have struggled with the same types of socio-economic decline: increased unemployment, a decline in real incomes, a growing tax burden, and a decline in social services. In most countries, income and wealth gaps have grown and there is some question about the role of the "new rich." In most cases, significant second economies, some dominated by organized crime, have emerged. And it's also no coincidence that the transformation countries have had a tougher time with organized crime than have the transition countries. The impact of restructuring varies strongly with the concentration of defense industry. Not only do we see this at a national level--Russia suffers more than the Czech Republic--but also regionally within countries. In regions with high concentrations of defense industry the socio-economic impact of reform has been painful and the results of conversion have been slow in coming. Indeed, as a further point in favor of my argument that economies respond alike, even though they have significant differences, one of our presenters here recounted the story of a British defense contractor that took 50 years to convert to civilian employment as it transversed England's own transition from a more or less planned economy since the end of World War II. Because the issue of military integration is central to NATO's agenda, the problems of defense industry and conversion received considerable attention at this conference. Although we did not reach agreement on some important issues, I'd like to offer two observations one of which may be controversial. The first ingredient for successful conversion is capital. Lots of capital. Without adequate capital, either from domestic or foreign sources, the firm is not likely to survive the conversion attempt. The second successful ingredient is the market. There are two dimensions to the role of the market. First, as always, the market sends the necessary signals to producers concerning demand, price points, quality requirements, and the like. Second, successful conversion firms must learn to successfully market their products--that is, to use the information generated by the market effectively. This was first driven home to me in a study we did at RAND in which we interviewed a large number of Russian defense firms. The firms that were most successful in their attempts at conversion were the ones that had established marketing offices, though of course this wasn't the only thing they were doing right. Another important focus of this conference was education and its role in the socio-economic development of the partner countries. There was a considerable divergence of views on the quality of Russian education and science, in particular. This debate won't be resolved here. I would only offer the observation that the economics and business professionals whom I know, both theoreticians, executives, and policymakers, have adapted very quickly to the new demands of the post-Soviet era. Whatever the current status of the education system, we must focus on the pace and direction of change, and I find that the most important point to me is the adaptability of talent and the ability of people in many disciplines to respond to changing realities. In conclusion, I would offer four broad observations and three challenges: Observation number 1: Transitions and Transformations are processes, not events. Even in the leading countries, there remains much to be done and even the most lagging economies have made important progress in some areas. Pronouncements on the success or failure of any particular reforming country are premature, even though it is appropriate and important to subject these economies to rigorous and unforgiving analysis constantly--identifying strengths and weaknesses, obstacles and opportunities. Observation number 2: All these reforming economies, unique though they are, do respond similarly and predictably to economic stimuli. I find it terribly frustrating when Russians say "we can't reform because we're too big," or when Ukrainians say "we can't reform because of our energy problems," and when Belarussians complain "we can't reform because...we speak Belarussian." These are excuses and carry no water, and they do reflect, in large part, a lack of will on the part of the political elite and a lack of understanding and consensus at the grass roots. Moreover, to say that these societies can't achieve the same recovery and growth in economic well-being that others in the region have achieved is in the end demeaning to their citizens who ultimately deserve a better future. Observation number 3: Openness helps a lot. The countries that have been most successful moved decisively to open their economies to both trade and investment. They took scary steps to allow foreigners to buy equity stakes in their prized firms. They created an investment climate that not only built confidence among domestic investors, but that made their countries more competitive in the world of foreign investment. Economic openness has been a driving force and a key facilitator in the recovery of these economies and lagging economies should take a lesson from this experience. Observation number 4: Stability at home is important for economic renewal. Let's all admit that there is no perfect path to a modern market economy and acknowledge that any plan is bound to cause its own internal inconsistencies and problems. Once we come to terms with that, it's clear to me that a stable, though imperfect plan is much preferable to a plan that is constantly being second guessed. Of course transitions are dynamic processes and require constant attention. But reforms need to be consistent in purpose and direction, and not reveal a lack of commitment. Otherwise, no one, either domestic business people or potential investors from abroad, will have the necessary confidence in the basic economic and commercial framework and will not be active supporters of the reforms. Now for the challenges. Challenge number 1: To NATO. Build on your new Strategic Concept. Consider growing your Economics Directorate and giving it a higher profile. Three specific initiatives come to mind that would capitalize on NATO's new vision and the economics expertise it has developed over the years: 1) Continue with your excellent analyses of the partner economies, especially their defense industries so that integration can be as smooth and efficient as possible. This should include studies of defense budgets, conversion, and military R&D issues. 2) Expand your involvement in bilateral assistance to the partner countries on these important issues. And 3) Pursue deeper involvement in the multilateral assistance efforts of the World Bank the European Union, the OECD, and others. Challenge number 2: To the countries in transformation. Move to a transition strategy. Focus now not on fine tuning your current reform agenda but on building a broad and strong social and political consensus on where you're headed. Then, in partnership with key Western institutions like NATO, move forward through the difficult changes that are both necessary and inevitable. There is no alternative to moving from transformation to transition. Challenge number 3: To the leading transition countries. As you look West, don't forget your brethren in the East. Your interest in the lagging countries is at least as great as is the Alliance's. Moreover, now that you are on the road to recovery and to integration into the European economic, political and security system, you have a responsibility to assist those countries who have been slower to meet the challenges of reform as fully as you have. Not to single any country out, it is worth noting that Poland has already shown signs of its willingness to play this role, especially with regard to Ukraine. I know that your resources are strained and you are limited in what you can do. Setting a good example and sharing your know-how is a good start. But have no doubt: by stepping up to this critical challenge you will immeasurably strengthen your place and role in the Greater European Community and help secure a brighter future for everyone.