Market reforms in the socialist countries of Central and Eastern Europe

by Ziad Ghanem

Following the Gorbachev era, it has become common to blame the failures of the socialist economies on the rigidities of the central planning system. Thus, it is often claimed that due to the absence of the disciplinary role of market relations, these economies lacked the incentives to integrate technological innovations at the enterprise level and therefore failed to effect a transition from extensive to intensive economic development¹. This view, however, conveniently ignores the negative economic consequences of the introduction of market mechanisms in Central and Eastern European Countries² (CEECs), which resulted from very early political challenges to central planning.

Unfortunately, Marxists have focused very little attention on the fact that as far back as the 1950s, in the midst of spectacular economic growth, arguments over a planned economic system versus market–based relationships had circulated among economists and policy makers in most CEECs, clearly indicating an underlying social contradiction. For example, in 1956, less than six years after a planned economy had been introduced in Poland, the official Economic Council argued in favour of a “decentralized model”³. Similarly, in Hungary, during the 1950s, the Economic Commission’s recommendations for market reforms were simply rejected by the Central Committee of the Communist Party as contrary to the basic principles of socialism⁴.

In fact, throughout the 1960s and 1970s, most CEECs experimented with reforms in the economic sphere that decentralized many decision-making powers to the level of the enterprise. These were mainly based on replacing directive “physical” commands with financial instruments and on introducing limited market mechanisms. The stated objective was to increase the efficiency and technological innovation of state-owned enterprises (SOEs) and to make them responsive to prices, costs, and consumer demand.

The most consistent application of these reforms was the Hungarian “New Economic Mechanism”. Introduced in 1968, it represented the most significant break from the classical planning system by replacing the system of compulsory plans with indirect controls over SOEs based on financial indicators and incentives. By the early 1980s, despite persistent economic difficulties and perceptible declines in efficiency levels, the Hungarians (unlike the Czechoslovaks and East Germans, who had recoiled from similar experiments) persisted in the implementation of enterprise self-management in most medium and large SOEs⁵, in effect, handing power over key economic decisions to enterprise managers⁶.

In general, the role of markets was the most extensive in Hungary and Poland, and the lowest in Czechoslovakia (after 1969) and Romania. However, the reforms, wherever and whenever they were implemented, only attempted to introduce a socialist market system, and despite allowing a larger role for the private sector, they stopped short of replacing state ownership of the main means of production with private property-based relations.

The Hungarian example demonstrated that the immediate impact of the introduction of market relations among enterprises and its concomitant strengthening of the position of SOE managers relative to the higher levels of state administration is a decline in economic efficiency. However, the effects of the economic deterioration proved to be almost negligible compared to the long term (social, political, and economic) consequences of unshackling enterprise managers from the constraint of complying with parameters administratively set by the plan. Increasing the freedom of economic activity of managers meant, in fact, increasing their ability to redirect enterprise activities toward furthering their personal interests. In search of possibilities of improving their economic and social status, enterprise managers were inevitably drawn toward the world market which offered them the possibility of storing wealth in hard currencies, access to a wide variety of consumer and luxury goods, and travel to the West.

Thus, economic decentralization has led trade with the West, since the 1960s, to grow at a faster rate than intra-CMEA trade. This provided the economic basis for the political decision in the 1970s by the countries of the region to reject the conception of two world markets and to opt for integrating into the international division of labour.

The new policies adopted were based on an attempt to integrate into the world economy via retooling local industries to the demands of the Western markets, financed through heavy borrowing from the main imperialist countries. Western licenses were purchased, and Western machinery and equipment were imported. As could be expected, Hungary and Poland were the most significant importers of capital-embodied Western technology.

A prominent example of this policy was Poland’s “New Development Strategy”; introduced in 1971, it relied on extensive foreign borrowing and the importation of Western technology. The rate of growth of fixed capital investment skyrocketed to an average of 21.3 percent per year during 1972-75 as compared to an average annual rate of about 7.6 percent during the preceding 15 years⁷. The share of imports of machinery and equipment from non-socialist countries in total machinery and equipment imports rose from an average of 21.2 percent during 1961-71 to an average of 43.3 percent during 1972-76, reaching a peak of 52 percent in 1975⁸.

To finance these imports, Poland received from Western banks $38.6 billion in long and medium–term credit during the 1971-80 period⁹. However, the transfer of Western technology during the 1970s failed to achieve the intended goals of increasing industrial exports to the West¹⁰. As a result, the debt servicing burden became so severe that the strategy was abandoned by 1976 – it was replaced by the “New Economic Manoeuvre”. The new policy imposed drastic reductions in the rate of investment and in the growth of hard currency imports. The rate of growth in investment in 1976-78 plummeted to 2 percent¹¹. Despite these draconian cuts, however, it was not until 1980 that the trade deficit with non-socialist countries was reduced substantially, from $3.0 billion in 1975 to $70 million in 1989¹². By 1980, Poland’s external debt had skyrocketed to $24 billion, and some 96% of the country’s total export earnings were being used for debt servicing¹³.

The world economic crisis of the late 1970s and early 1980s drastically aggravated the position of the CEECs as principal and interest payments on debt became a major drain on export earnings. Manipulation of the international financial markets by the G-7 countries, particularly through large increases in interest rates and restrictions on the availability of funds, further aggravated their situation.

As the failure of the development strategy based on Western credits became apparent, the regimes followed two divergent paths of development. The two most centralized economies were successful in reducing their international debt burden: Czechoslovakia and Romania followed a policy of slow growth and repaying international debts for the 1980s; GDP growth rates averaged 2.7 percent and 4 percent respectively for the 1977-86 period¹⁴. Both entered the period of transition to capitalism with very little foreign debt.

In the remaining countries, where market reforms were most advanced, international debt kept accumulating out of control. For example, Poland, in the late 1980s, suffered from huge inflation, widespread shortages, and a very large and unserviceable external debt. During the 1977 to 1986 period, Poland managed to achieve a 1.4 percent average GDP growth rate, the lowest level among all CEECs¹⁵.

In Hungary, the accumulation of foreign debt had led to negotiations with the International Monetary Fund (IMF) and the implementation of a stabilization program in 1982-83¹⁶. Implementation of the program, however, further aggravated the debt burden, which again increased at the beginning of 1985¹⁷. Hungary managed to surpass Poland and to achieve the second lowest average GDP growth rate – 2.5 percent – of all CEECs between 1977-86¹⁸, however, with the added proviso that this was achieved at the cost of attaining the highest level of debt in per capita terms of all CEECs¹⁹.

In short, the experience of the CEECs has demonstrated the existence of a contradiction within the socialist mode of production between the scientifically and democratically elaborated economic interests of society, as expressed through the planning of the publicly-owned economy, and the inherent striving of the managerial strata to increase its control over the assets which the state has entrusted to it.

But for this managerial stratum, the accumulation of wealth (in a form of “primitive accumulation of capital”) depended not only on their private control over the means of production (as a step toward full property rights) but also on the availability of conditions of commodity production and exchange. This being the fundamental reason underlying the constant striving by enterprise managers to gain the freedom to trade in the world and domestic markets.

Notes:

1. Aganbeguian, A. G. (1987), Perestroïka: le double défi soviétique, Economica, Paris.

2. My references to Central and Eastern Europe will primarily encompass, Czechoslovakia, Hungary, Poland, and Romania. Despite limiting the scope of the analysis, it is my opinion that these countries provide enough varied historical experiences to justify some basic generalizations.

3. Kaminski, B. (1995), “The legacy of communism”, in Hardt, J. P. and Kaufman, R. F. (eds.) East-Central European Economies in Transition, Joint Economic Committee, Congress of the United States, M. E. Sharpe, Armonk, New York, pp. 9-24.

4. Csaba, L. (1995), ‘Hungary and the IMF: The experience of a Cordial Discord”, Journal of Comparative Economics, vol. 20, pp. 211-234.

5. Lee, B. and Nellis, J. (1990), Enterprise Reform and Privatization in Socialist Economies, World Bank Discussion Papers, The World Bank, Washington, D. C., p. 10.

6. Voszka, E. (1993), “Spontaneous privatization in Hungary”, in Earle, J. S., Frydman, R. and Rapaczynski, A. (eds.) Privatization in the Transition to a Market Economy: Studies of Preconditions and Policies in Eastern Europe, St. Martin’s Press, New York.

7. Fallenbuchl, Z. M. (1983), East-West Technology Transfer: Study of Poland 1971-1980, OECD, Paris, p.105.

8. Ibid.

9. Terrell, K. (1992), “International Technology Transfer and Efficiency in Socialist Enterprises: The Polish Failure of the 1970s”, in Hillman, A. And Milanovic, B. (eds.) The Transition from Socialism in Eastern Europe: Domestic restructuring and Foreign Trade, Regional and Sectoral Studies, World Bank, Washington, D. C, p. 265.

10. Ibid., p. 266.

11. Ibid., p. 265.

12. Fallenbuchl, Z. M., op cit., p. 104.

13. 13. Bjork, J. (1995), “The uses of conditionality: Poland and the IMF”, East European Quarterly, vol. 29, no. 1, p. 91.

14. International Monetary Fund (1995), World Economic Outlook, May, Washington, D. C., p. 131.

15. Ibid.

16. The stabilization program aimed at ensuring debt repayment through surpluses in the current account. Thus, investment and capital goods imports were cut and successive devaluations of the forint were coupled with export promotion policies.

17. Lavigne, M. (1993), A comparative view on economic reform in Poland, Hungary, and Czechoslovakia, Economic Commission for Europe, Discussion Papers, vol. 3, no. 2, New York, p. 4.

18. IMF, op cit.

19. Lavigne, M., op cit.

Spark! #8 – p.24-27