Colloquium 1996

Summary of Discussions Prepared by Ulrich Geza during his temporary services with the NATO Economics Directorate

Panel I: Balance Sheet of Economic Performance and Reforms in Cooperation Partner Countries The debate concentrated in greater detail on the topics presented by the panelists and clarified specific points raised. Due to the vastness and complexity of the Panel subject many questions had to remain unanswered and were reconsidered during the later debate. The following summary will show that the debate represented, in many aspects, the particularity of the experts' papers in the sense that specific problems of the reform process were singled out, rather than just giving a general overview of progress. Path Dependence and Soviet Legacy Several participants stressed that the degree of 'path dependance' varies from country to country and has a great impact on the success of reforms. It also determines, to a large extent, the radicality of the transition policies employed and the stage of reform a transition country has reached. Some countries might thus have already succeeded in overcoming much of the communist and planned economy legacy. It was, nevertheless, mentioned that others still experience considerable difficulties, in some extreme cases even reestablishing old ties which were thought to belong to the past (the example of CIS reintegration was given). Some participants, though, refused to generally condemn this type of return to previous relationships and recommended that transition countries in Central and Eastern Europe (CEE) should also reconsider their relationship with Russia. Others mentioned that geographic remoteness from Russia would make it easier for certain states to diversify their commercial relations. Concerning behaviour patterns and general attitudes, one of the panelists underlined his previously made statement that one cannot expect a greater change in such a short period of time. Transition from planned to market economies means a fundamental transformation of the overall economic system, which is not simple, especially as no historic examples can provide any guidelines. The first and most obvious consequences are a steep decline in production and GDP resulting in a drastic deterioration of living standards and social security. This feeling of insecurity, reinforced by the lack of law and order, would then reactivate the communist legacy and incite the population to vote for parties which promise to return to the old system. Not only old habits but also institutions dating from the communist era have managed to survive. This, said one of the participants, was one of the major reasons why decision-making processes are still slow. The phenomena of 'privatisation of the nomenklatura' was also mentioned in this context. On the one hand criticism was expressed as management structures remain unchanged; on the other hand, participants were asked to bear in mind that members of the old 'nomenclature' were the only ones with experience in industrial and business management. Market Forces and the Role of the State Much of the discussion turned around the crucial question of the role of the state in the transition process; whether it should have a strong influence or whether market forces should be left free to decide on adequate strategies. Not much of a consensus could be reached on this point, as participants from several transition countries experienced different results with diverse strategies. In this context an attempt was made to determine some of the major market forces and the persons, interests groups or institutions which really dispose of the economic power in transition countries. Obviously, that was a rather impossible task, but emphasis was put on the often neglected role of regional authorities and institutions which, particularly in Russia, have a major influence on economic, social and political developments. The discussion on the role of the state versus market forces very quickly brought up the conflict of objectives of the transition process: increase in competitiveness while maintaining reasonable social protection. One participant drew attention to the fact that CEE markets are already rather open and liberal, freely competing with western markets, implying that market forces have gained much influence over state intervention. The survival of many CEE privatised or recently created enterprises also suggests that competitiveness has improved greatly since the collapse of the bipolar system. Strong efforts and sound diversification strategies are, nevertheless, still needed in order to achieve a comparable level of productivity. In Russia, one of the panelists added, the economy has not yet reached that point. Although it would proceed on its way to the market economy, the state should therefore maintain a strong position because the consequences of the tough rule of free market forces could otherwise result in a social explosion. Statistics As in previous NATO Colloquia, precise statements and sound analysis were rendered very difficult as statistics in transition countries still do not seem to match international standards and quite often simply do not make any sense. A striking example was given by one of the experts, when he compared GNP and wages to saving and consumption rates. Whereas the first have experienced a dramatic decline over the past few years, the latter have risen in 1995, a contradiction that cannot be explained. Still, it was generally agreed that statistical methods have improved considerably, not least with the help of the European Union (EU) and other international organisations. Hidden economy Judgements on the overall situation in the CEE and CIS is further complicated by the large but unmeasurable share of the hidden economy in total production. Estimates, as several experts pointed out, are sometimes exaggerated but the great importance of non-accounted economic activities was widely recognised. Participants were nevertheless reminded that this sort of production reflects the old structures of 'nomenclature', which still seem to be in place with all its consequences on corruption, organised crime, etc. Participants also discussed the most appropriate approach to measuring the size of the hidden economy. No consensus was reached on that point either, as some favoured the monetary approach which consists of comparing capital flows, whereas others criticised this method, intimating that the wrong conclusions could be drawn. Central Asia Special emphasis was put on the discussion of the state of reform in Central Asia. One participant pointed out that due to their extreme isolation, politically and geographically, the newly independent republics in this area still lag behind in their approach towards the market economy and democracy. As for the Chinese penetration in these markets, a point that was raised in sequence, it was noted that not only China but also other East and South East Asian states try to increase their influence through investment and even migration. Though relations are not always very easy, these countries, through their early access, might take up large parts of the market, thus making it more difficult for Western countries to move in later. Because of the tremendous proven and potential oil and gas reserves in this region such a deficit might prove rather short sighted.

Panel II: Living Standards, Social Welfare and Labour Market This panel addressed in greater detail some aspects of the social and human impact of economic reforms. The discussion clearly reached consensus on the fact that the transition period has caused some economic hardship for large parts of the population, especially those which are too old or physically unable to adapt to the radical changes. Transition from planned to market economies has resulted in a dramatic decline in industrial output and drastic cuts in the social welfare system. It was generally agreed that the main task of the current decision-making authorities must be to continue with the reform process while easing social pressure. In more specific terms the participants discussed the impact of reform policies on employment, poverty and wage differentials. Regional and sectoral particularities, as well as the role of labour unions were also referred to. Finally, special emphasis was put on the role of the European Union in the transition process, with particular regard to the education of the youth. Employment Participants widely agreed that the formerly unknown rise of unemployment in transition countries is directly related to the fall of output of the economy. In countries where output has already reached former (before transition started) levels, continuously rising unemployment might be a sign of increasing productivity of former state enterprises. Nevertheless, many tasks of an effective employment policy were not met and governments have not fully succeeded with their job creation schemes. One successful example was given where, in the Czech Republic, founders of newly created enterprises receive unemployment allowances for up to one year. Providing the fresh entrepreneurs with minimum security, this measure succeeded in generating some 100,000 jobs. This example was also presented as one way to keep people within the legal system. Though it was very hard to prove, one expert insisted that employment structures were distorted from the beginning as a result of inefficient labour markets during the Soviet era. Unfortunately, unreliable data on the existence of second jobs as well as the black labour markets make any analytic comparison impossible. Furthermore, second jobs are believed to make up about 17-20% in Russia, mainly in the private sector, thus representing a large part of the total employment. This also reaffirms the inadequacy of such comparisons. Poverty and Wages Increasing poverty and a sharp decline in real wages were generally thought to have placed great pressures upon the majority of the population. The growing importance of the black and hidden economy was also believed to have prevented effective social policies from being implemented due to a lack of financial means (diminishing tax base). Concern was expressed about the methods of measuring this pressure and especially about the way figures are compared in different countries. One speaker asked the participants to bear in mind that living conditions vary considerably in different transition countries, and argued that the number of people below the poverty line is dependent upon where the line is drawn, a rather deliberate decision which does not take into account each country-specific situation. If one established a country specific poverty line for each country, the result would be an inevitable loss in comparability. Therefore, the choice was either a deficient but comparable poverty line based on general economic figures, or no comparison at all. In terms of wages, one participant also warned against referring exclusively to average figures which, he believed, were more confusing than enlightening. Several studies confirm that wages have indeed become dynamic and show great disparities. This evolution would enable transition countries to create an effective, success-orientated and mobile labour market, indispensable for a well-functioning market economy. Labour Unions One of the panelists emphasized the crucial role of labour unions in the transition process. Whereas considerable progress has been made in other areas, labour unions still have not defined their new role in a transformed economic and political system. Labour unions on the one hand suffer from their organisational deficits - in private business unions have hardly any significance - and on the other hand from the lack of reform in the public sector - the necessity of a 'Perestroika' in the labour unions was mentioned. Still, participants favoured the establishment of cooperative tripartite structures which were thought to be extremely valuable to the success of reforms. Regional and Sectoral Differences The debate also focused on regional and sectoral differences which participants believed to have a great impact on social cohesion. Changing and declining sectors of the economy, such as agriculture, light industry and defence (see also Panel III) are especially relevant. Participants more or less agreed that major difficulties did not result from a lack in demand but from a deficit in sales and marketing capabilities. Under the old system, production rather than selling was the main concern. An open attitude and sufficient flexibility were thought to be the key to success. Retraining programmes should focus on the commercial side of business rather than on the technical side. One participant was rather surprised to see a boom in public sector employment, which he thought was an administrative growth with the aim of easing unemployment pressures. As the other booming sector of private services has only generated very little growth in employment, further analysis was thought to be necessary in order to make any affirmative statement. Taking Albania as an example, regional differences were highlighted during the debate. These differences are, to a large extent, due to the afore-mentioned sectoral difficulties, as some of the declining sectors were concentrated in certain areas. Greater conflict potential exists where regional differences are created along ethnic lines. Participants expressed their concern about these ethnic divisions and warned that they might result in similar disastrous conflicts as has been experienced in the former Yugoslavia. Education and the role of the EU The prospect of future integration of CEE countries into the EU and the EU's role in assisting the transition economies in their search for efficient market economies was discussed in detail. Participants also took into account the effects of further integration on the EU labour market, agreeing that a coordinated strategy was necessary in order to implement successful policies. The importance of flexibility and creativity in developing an appropriate model for CEE social systems was emphasized because the social systems in CEE countries will remain less developed than those of EU states for quite some time. The CEE populations will therefore need to understand that they must maintain their competitive advantage of low labour costs in order to promote economic growth and, eventually, adopt their social security to EU standards. Education was thought to be of paramount importance to the future development and economic growth of transition partner countries. Participants put special emphasis on two main areas of education: the transfer of commercial and marketing skills and training in democracy. Participants agreed that young people especially have to learn how to become mobile, flexible and market orientated. Difficulties were seen in finding the appropriate institutions which could effectively implement training programmes as previous attempts have had very mixed results.

Additional Presentation to Panel II: Migration Tendencies In the brief discussion following the presentation on migration problems two main points were addressed. The first one dealt with risks that result from migration tendencies, not only for the West but also for the East, whereas the second part more specifically examined the interrelationship between economic development and migration pressures. Risks resulting from migration Due to tightened immigration policies in most Western countries, major risks, participants pointed out, come from illegal migration. The reasons for this are mainly of an economic nature, as illegal immigrants usually do not benefit from social security but work on the black market. Destination countries not only miss out on non-declared tax revenues, but illegal work also takes away jobs. With unemployment being a major problem in most destination countries, all participants agreed that illegal immigration is of great concern to everyone. Other risks result from so-called internal migration, which still makes up the bigger part of total migration. Internal flows can be interregional (mainly for ethnic reasons) and rural-urban (mainly for economic reasons). Overpopulation, rapid urbanisation and slum creation can be among the consequences of such movements, directly threatening the social and political stability. Interrelationship between economic development and migration pressures Several speakers stressed the importance of sound economic growth if migration pressures are to be kept in check. Although there was some disagreement as to whether most refugees and asylum seekers flee for economic reasons or because of war and ethnic tensions, there was general consensus that further economic decline and social pressure could easily result in a migration explosion from Eastern Europe, especially from Russia and the Newly Independent States. Economic difficulties could also cause Western countries to take a tougher stand on migration policies than they already do.

Panel III: Armed Forces and Defence Industry in Transition Economies: The Human Dimension Whereas the previous panels mainly dealt with the economies of transition countries as a whole, the third panel concentrated on the specific problems related to the military and defence industry. As the discussion reaffirmed, this sector is probably the hardest hit by transition policies. Participants emphasized that this has particularly tough social and human consequences for the workforce, as the personnel employed in the Military Industrial Complex (MIC) were not only extremely well qualified but also enjoyed most of the privileges during the communist era. Speakers fully agreed upon the fact that the only solution to further decline is an effective and rapid conversion of industrial production and scientific research capacity. Definition problems Panelists slightly disagreed on the definition of 'conversion' and 'defence industry'. In general terms there was consensus that conversion means the reallocation of military assets to the civilian sector. As many military goods can be employed in the civilian sector (so-called dual-use products), some participants argued that real defence conversion must include research and production capacities. One could therefore speak about conversion in a narrow as well as in a wider sense. The latter would then embrace investment in new production technologies and scientific (civilian) research. Production and Employment Although the shares of defence industry and military production were not in all countries as high as in the former Soviet Union, they still constitute a considerable share of economic output in all transition countries. Participants pointed out that, because the Warsaw Pact has ceased to exist, military production in all transition countries has collapsed, resulting in widespread overemployment and, where excess workers were fired, in unemployment. Contradictory figures about the outcome of this development still continue to confuse analysts. As one speaker mentioned, many people from production and research facilities in the MIC were reemployed in other sectors if they were mobile and flexible enough. Their excellent technical skills, he continued, would make it relatively easy for them to find new jobs. Civilian Production One speaker drew attention to the fact that even before the changes took place, parts of the military industrial complex produced civilian goods, like televisions or other electrical equipment. Therefore, he felt very surprised by the simultaneous decline in civilian production, as one would have thought that the civilian sector could have offered a good opportunity to reemploy free production capacities. Other participants explained this seeming paradox by the lack of marketing capabilities and commercial orientation of the former state enterprises. Privatisation and change in ownership structures In the specific case of Russia, only 10% of the enterprises in the MIC were excluded from privatisation, one of the speakers said. Despite this extensive privatisation scheme, some deficits seem to prevail in the real ownership structures. A recent survey confirmed that many employees believe that their privatised company is still controlled by the state. This might reflect the fact that the management in control has not changed much, even if official ownership structures have altered. It also shows that many former directors might have succeeded in acquiring considerable status in the firm during the privatisation process. On the other hand, another participant argued that the former communist managers were the only ones with some management experience. It would thus be necessary, at least in the short and medium term, to make best use of them until new managers arrive. The Chinese example Several speakers pointed to the Chinese military conversion programme as an example to learn from for transition countries. One participant mentioned the 50% success rate of Chinese military conversion projects. Others argued, though, that the Chinese example has only very little validity, because most of the projects receive considerable subsidies, a fact which makes a straight forward comparison rather difficult. They also stressed that one cannot really talk about conversion in the Chinese case, as many soldiers and facilities are just brought into the production process as 'free assets', meaning that the state continues to pay them as regular military. It is obvious that this results in a complete distortion of production costs. Research and Marketing When asked about possible keys to success in military conversion, most speakers acknowledged the paramount importance of investment in research facilities and in efforts to transform former state enterprises into commercial, market orientated and competitive companies. One speaker especially stressed the importance of seeing conversion in a broader sense, meaning that one should not just take production lines and gear them to civilian production. Heavy investment in diversification strategies is needed in order to meet the requirements of the market economy. Image and organisational behaviour In this context, speakers thought it was crucial to improve the general public image of Russian goods, especially those coming from the MIC. Even if Russian products were competitive in terms of quality and costs, Russian consumers would still tend to buy foreign products just because of their image. In-depth marketing research, which might be able to detect reasons for this attitude, is still not done because of old and rusty organisational behaviour patterns. This, a participant argued, was mainly due to the planned production and fixed order administration during the former Soviet Union. Military orders would arrive according to plan and no commercial skills were needed in order to sell the products. Many responsible managers therefore still believe that success had to do with product technology and not with marketing. US-Russian joint ventures in the military and the dual-use sector would thus offer great complementary advantages, with Russian engineers supplying technological knowledge and US employees offering an insight into marketing and distribution techniques. Restructuring, downsizing and rightsizing As former communist countries integrate into the Western economy and eventually into Western institutional structures, many opportunities for economic growth and industrial diversification exist. Participants stressed that government authorities and responsible managers should not confuse the terms restructuring, downsizing and rightsizing when talking about conversion. Whereas fundamental restructuring of the former state enterprises, no matter which sector, is an indispensable condition to promote future economic growth, downsizing might have very destructive effects on the industrial potential, especially of the MIC. Rightsizing, though, one speaker insisted, might be necessary as military production capacities are still too important in most transition countries and not everything can be converted to civilian production. It is important, he continued, that the people in charge of conversion understand the different meanings of these terms so that they can adopt their own appropriate strategy.

Panel IV: Scenarios for Economic Development and Social Cohesion During this particularly interesting debate, participants tried to assess possible scenarios in transition partner countries. Referring to the outstanding presentations, most speakers concentrated on characteristic data and events which are likely to have a major impact on future developments. The main questions in this context were how a continuous decline in standards of living, social security and public health can influence public opinion, and up to which point the population in transition countries is ready to accept a further decline. Living standards, productivity and the hidden economy Living standards have, with a few exceptions, declined considerably during the transition process, in some cases even dramatically. Participants made clear, though, that this decline was in most circumstances necessary, as wages and attributed social services had to adapt to the low productivity standards. It was thus a precondition for economic stabilisation and an important step towards increasing the competitiveness of privatised companies. At the same time, the breakdown of the welfare system contains several potential threats to social cohesion and overall stability. Several speakers mentioned the comeback of neo-communist parties as a first sign of deep dissatisfaction in large parts of the population with their current situation. There was general agreement that the main task for politicians in the future will be to maintain social cohesion. Without this cohesion, politicians will experience great difficulties in continuing their path to a market economy. In this context, participants made very mixed assessments of the impact of the hidden economy both on the economic reform process and on the maintenance of social cohesion. Whereas the impact on the reform process was generally judged as detrimental, participants acknowledged its positive effects on social cohesion. But the most disadvantaged social groups would often not benefit from these additional sources of income. One should, therefore, seriously think about a reallocation of social funds in order to put more emphasis on those who really need help and cannot (for mainly physical reasons) benefit from the hidden economy. Public perceptions about democracy and the market economy Public perception of a specific situation often differs from the bare statistics. If the subjective public perception of well-being is negative, even positive economic data will not make any difference. One speaker explained that the astonishingly high dissatisfaction with democracy and the market economy was due to a fundamental misunderstanding: people in CEE countries were told that transition means democracy and the market economy, whereas they do not understand that the current systems are still far from that. Politicians bear responsibility for using false terminology and therefore creating high expectations which inevitably will not be fulfilled, at least in the short to medium term. Several speakers stressed the need to explain to the populations of transition countries that democracy and the market economy are the ultimate goals of transition which will require a long time to achieve. Corruption versus insufficient institutions Corruption was widely thought to be one of the major obstacles to transition. Not only does it diminish the often slim financial base for government policies, but it also negatively shapes the public image of the institutions currently in place. Participants acknowledged the success of macro-economic stabilisation in many transition countries, but they also warned that this would only be the first step. Building up efficient and appropriate institutions still remains to be done and will take a long time. Such institutions would allocate resources more efficiently, particularly bilateral and international aid. Education Once again education was considered essential to the outcome of reforms. As during previous discussions, particular emphasis was put on the need for 'market orientation' of scientific engineers, who are often remote from commercial necessities. One expert also mentioned the lack of problem-solving capacities and the striking inequality in the current education system, whereby a small part of society receives excellent schooling and training whereas the majority is deprived of higher education. Inequality versus social cohesion The increasing inequality in transition societies and its impact was discussed in detail. Despite severe shortages, communist systems managed to establish a certain equality in standards of living, apart from the small number of highly privileged members of the 'nomenklatura'. Although the introduction of the market economy has opened a wide range of opportunities, many people feel that they are worse off than before, a feeling that is mostly due to the widening gap between different social strata. Social cohesion is seriously threatened by these developments. Four main 'ingredients' were believed to be crucial to the maintenance of social cohesion: economic growth, with benefits more equally distributed; improvement of the equalitity of opportunity; explanation of important policies to the population; and better education, with special regard to the understanding of democracy and the market economy. Russian election outcomes Several speakers also reviewed the possible effects of the outcome of Russian elections on the reform process. In particular, experts were concerned about the latest move by President Yeltsin to appoint General Lebed to the Security Council. No consensus could be reached, though, on the direct impacts of this decision, mainly due to the lack of information on Lebed's concrete political views and attitudes. Negative and positive scenarios were drawn and speakers generally agreed that Lebed might become a decisive factor in Russian politics. The example of Japan Finally, one participant drew a comparison between the situation in Japan after the Second World War and the difficulties facing the transition countries in CEE. But despite some similarities concerning the vastness and complexity of the task, other speakers stressed that too many differences existed to make any comparison sensible. Firstly, Japan introduced the market economy under the auspices of the American military administration, which made it much easier to tackle problems such as corruption or organised crime. Secondly, most of the industrial capacities had been destroyed during the war, leaving practically no obsolete technology, a fact that helped to force innovative research to develop modern and highly competitive equipment. Finally, Japan did not introduce democracy at the same time as the market economy which helped avoid confusion of the two in public perception. Transition countries, on the contrary, chose the radical approach of introducing democracy and the market economy simultaneously. This strategy led to a fundamentally different situation making comparisons between Japan and the transition economies of Central and Eastern Europe less than helpful.