Ideology and the cold war.

Shock or Crawl

The collapse of communism in the formal Union of Soviet Socialist Republics (USSR) is a defining moment in the world's history. Newly independent states had to transition from a planned economy to a free market economy. In the context of post communist transitions, one question that should be answered is which approach to market reforms should states utilize, shock therapy or gradualism? This essay will explore outcomes of reforms in post communist Poland and Hungary, and illustrate that because of different internal dynamics including history, infrastructure, and politics, a one size fits all approach to market transition will not work in all post communist transitions.

Before the watershed event of the Soviet Union collapses in the late twentieth century, there was another momentous event; America and its allies put aside their philosophical differences and joined with the Soviet Union to defeat Hitler's repugnant ideology. After World War II, the West began to see how diametrically opposed to the Soviet government and economy they truly were; this lead to the Cold War. The Cold War is the long, none direct confrontational, war between the former Union of Soviet and the United States of America. According to Mark Kramer, "The fierce ideological divide, pitting liberal democratic capitalism against Marxism-Leninism, provided a crucial backdrop for the Cold War."[1] The Cold war lasted for several decades and eventually the Soviet Union and its economic system collapsed. The end of the former Soviet Union, and the newly independent states transition toward a free market economy, established that capitalism and its market principles is the best way to organize an economy.

Although markets have many positives, markets also have several failures. Some major types of market-failures are natural monopoly, externalities, the unequal destitution of public goods, and asymmetric information. Kenneth Bickers writes, "A normative theory of market-failure predicts that regulation will be instituted to improve economic efficiency and protect social values by correcting market imperfections."[2] Therefore policy measures taken by these governments in post communist states had to not only reform to a market economy, they had to simultaneously guard against market failures that could cause social discontent. In any transitions to a market economy, authorities must skillfully use institutions to guard against all these types of failure, and the readiness of these institutions should dictate which approach to market reforms a government should employ.

There are a couple of reasons why crafting the right approach for transition for post communist states is imperative. First, prior to the collapse to the communist political and economic system, this type of transition has never been attempted. Second, countries attempting transition were completely changing the fabric of their nation. As stated in the International Business Research, "A country that wished to change to a market base economy needed to restructure many things such as market liberalization, privatization, institutional development, structural adjustment, economic policy program of stabilization, deregulation and integration with the global economy."[3] There was a broad agreement on what these new states needed to accomplish. There only area of discussion was how they should go about implementing these market reforms. The Washington consensus of radical rapid change initiative to adopt a market economy, called "shocked therapy," was conducive to Poland's transition.

The history of Poland and the state of her economy in the early 1990s made Poland a prime candidate for shock therapy. But like many post communist states, the economy and industrial base inherited by the new government was full of inefficiencies at every level. Luckily for Poland, its economy was less planned then many post communist states were in the early 1990s. According to Jeffery Sachs, a decade earlier, Poland had practically crippled the party state on which the functioning of the economic system depended.[4] Also, Poland had a history of practicing capitalism even during its communist era. According to Katchanovski, private farming remained dominant in the agricultural sector during Poland's communist era.[5] Therefore when Poland applied the rapid change of "shock therapy" to place its economy on a fast track to complete economic transformation, it had some practice and institutions in place to manage this swift transformation.

Poland was the pioneer for formal communist states. Poland had a freely elected parliament, with a large noncommunist majority, and approved the so-called Balcerowicz program, shock therapy, in December 1989.[6] The program consisted of a whole host of coordinated liberalization measures ultimately aimed at implementing full scale capitalism quickly. This would prevent reminisce of communist party from reverting back to the old system, if they were ever to return to power. The Polish transition was watched very closely by its neighbors. It was obvious that many of the policies and systemic changes introduced in Poland were necessary to reform to market economy, but the speed of implementation in Poland was extremely unique.

Although many did not believe Poland's approach would work, Poland's political leaders insisted on this path. First, Poland's transition went through a few faces. From, 1989-1993, the first stage of Poland's shock therapy was implemented. According to Michael Keane, this initial approach disregarded market-economy institution building, and moved too fast towards trade liberalization.[7] Regardless of Poland's conduciveness to shock therapy reforms, its transition was difficult. According to Grzegorz Kolodko, Poland started losing its GDP at the beginning of its reform process.[8] Nevertheless, Poland stuck with their recovery strategy. From 1994-1997, the "strategy for Poland" was implement, and the economy entered a fast growth. According to research, GDP per capita grew at an average annual rate of 6.4%, achieving a cumulative increase of 28%.[9] From 1998-2001, this period the economy cooled down and grew at a lower rate. Then from 2002-2004, the economy returned to the path of rapid development, with a reorganization in the area of public finance and the accession to the EU.[10]

While Poland's transition was not without bumps in the road, the transition to market economy worked using the "shock therapy" approach. They made the transition from a planned economy to a market economy and acceptance into the European Union. According to Alan Smith, "By the middle of I990 the neo-liberal viewpoint, or 'Washington consensus', had become the dominant paradigm for analyzing the transition to a market economy in Central Eastern Europe and was becoming a blueprint for other economies in transition."[11] The reforms in Poland produced many positives. The International Monetary Fund (IMF) stressed that inequality was worldwide in post communist transitional economies, with Poland being the exception. The new leaders in Poland understood that the collapse of communism was not complete across the USSR and, they wanted to move as close to the West in terms on policies as soon as possible; the results were apparent. The IMF then concludes that Poland is also the only transition economy that experienced substantial growth, and real GDP was 28 percent higher in 1999 than in 1989.[12] In contrast, only a few other countries like Albania, the Czech Republic, and Hungary managed to keep GDP to within a few percent above or below their previous communist levels. It is clear that economic reform measures taken in Poland was radical, swift, and the results were unmistakable. Shock therapy seems to have succeeded quite well in Poland.

Obviously the course and outcome of the reforms in Poland were strongly influenced by local circumstances, and like almost every problem, reasonable people seem to disagree on the best possible solution. The initially harsh impact of shock therapy, in terms of declining living standards and increasing unemployment was too steep of a path for other post communist countries to pursue. Instead, some newly independent states decided to follow the less painful route of gradual transition. They were supported by economists who agreed that markets are the best ways to organize an economy, but disagreed with the notion that shock therapy is the best approach during market transition. Some argued that the degree of severity and speed with which economic transitions ought to be pursued should take into consideration the human costs that would result from this process in terms of the growth of unemployment, poverty, and the willingness and ability of the population to tolerate the shock. They also argued that the ability of domestic industry to withstand foreign competition should first be established before full market liberalization.[13] Finally, there is major disagreement about the ability of pure market forces alone to stimulate economic recovery during the transition and whether the policies pursued in the initial stages of the transition will help or hinder economic recovery in the long run; this is why some transitional countries chose the path of gradualism to market reform.

One of those formal communist countries that chose to reform gradually is Hungary. Fist, geographical Hungary was not in a location like Poland. Hungary is a flat country with reasonable agricultural land located in the center of Europe. Because of its location and the damage the communist system did to its economy, Hungary was not a very prosperous country. Therefore, the first change Hungary made was to induce business activities by significantly reducing the number and complexity of the directives for firms. Unlike Poland, Hungary's approach to privatization was slower and more difficult. In addition to privatization, Hungary had to address the creation of infrastructure. For example, it had to create a stock market and design new rules to guide these new enterprises.[14] Accounting procedures had to first be refined and bankruptcy laws strengthened in order for state subsidies to be curtailed. The state also had to introduce hard budget constraints into large state-owned enterprises, unlike the soft budget constraints they were accustomed to during the communist era. This slow step by step policy went against the Shock therapy approach to reform that the West wanted and Poland followed.

Furthermore, because of the terrible state of its economy, Hungary had to pursue a variety of stabilization measures more gradually than Poland. Early in the reform, although domestic price controls were removed in Hungary, and enterprises were permitted to enter into and benefit from foreign trade transactions, the state still placed tough limits on the holding of foreign exchange.[15] The Bank of Hungary maintained controls over access to foreign exchange earning to focus on stability before full liberalization of their economy. According to Paul Hare, Hungary followed a tight monetary policy designed to create a balanced budget and also to exert financial pressure on enterprises.[16] Hungary decided to lay down the ground work before it fully embracing the free market system. As a result, Inflation was less serious in Hungary than in Poland. The annual rate of inflation during the early 1990s was lower than its counterparts Hungary also had increases in wages, and Hungarians experienced growth in exports to Western markets.[17] The complete date shows that Hungary's market reforms measure worked. Like Poland, both sates accomplished the same goal, establish a stable free market.

Therefore, how does a country determines which approach to market reform they should follow? First, we must recognize the complexity of a systemic overhaul and internal dynamics of each country. This is not as simple as changing from one leader to another, or simple changing currency. There is no exact science to how fast reform efforts should be implemented. The speed that a country takes to overhauling an entire economic system must first be guided by its history.

If a newly independent state has had very little no experience with a free market system, using shock therapy might make the situation even worse. The strongest economic argument in support of shock therapy is that a rapid transition to a full scale market economy minimizes the period over which mutually incompatible economic systems are required to coexist. In Poland the goal was to remove once and for all the organizational and economic basis of the Communist Party state, and it already had a history of doing this. The reformers, who have already ended the communist party rule, wanted to create an irreversible situation. Therefore, the shock therapy approach suited them perfectly. This may be true, but what about other countries who do not have a history of some form of market economy? if someone who have never swim is all of the sudden force to swim, the consequences could be disastrous.

According to McIntyre, because of swift market reforms in country that have not engage in truly free enterprise until the fall of the USSR, corrupt large enterprise were able to pervert the privatization process, and this had entirely destructive economic effects on these transitioning economies.[18] The rapid privatization in countries with no history of these practices, created a destructive effect on their economies in the initial phase of reform. According to Dallago, countries faced many difficulties due to policy mistakes because they were proceeding to quickly, whereas Hungary policy stability approach provided sufficient cooperation with other firms and clear division of labor among governments at different levels.[19] Therefore, history should factor into which path a country takes to transition.

Another factor that must guide a country in choosing the right path to transition should be the state of its infrastructure. As stated previously, markets have failures. Therefore no reform can be efficient without strong institutions. In Poland there were some institutaions in place to withstand shock therapy; in Hungary there not.

There is no doubt that shock therapy is painful in the short run. The high, declining living standards, increasing unemployment was judged excessive. Instead, a purportedly less painful exit route for reform was gradualism. More gradual changes added up to creditable progress in Hungary. Which model was more successful? There is no clear answer. Each country has to evaluate their own economy situation and what area of their reform they are currently in, and for there, they can determine the best approach to their economy reform. Both, shock therapists and gradualists, have their positives and their drawbacks. Poland has shown more success with the shock therapy, but they were further along than Hungary after the USSR came down.

More gradual changes added up to creditable progress in Hungary

The history, political landscape, and the readiness of market institutions should dictate which approach to market reforms a government should employ.

The different conditions under which transition have taken place in both countries played one of the major roles in formation of the market economies in them. After the collapse of communism, both countries had mostly the same problems and tasks of transitional period, but the process which had taken place in each of them differed in many dimensions. Poland took as an example of transition more rapid, as well as more revolutionary, means if economic transformations as a result of that much losses in employment as well as in welfare of the population at all took place at the beginning of the process of transformation. But the terms of the achievement of the final goal decreased proportionally to the measures implemented.

Hungary instead of so called "shock therapy" chose softer way of achievement market economy, though both countries practiced the involvement of the government during the first steps of transformation, and both of them had the same problem of the unattractiveness of the large enterprises, the involvement of the authorities in regulation of currency exchange for example was more strict in Hungary than in Poland , i.e. currency exchange market served only the interest of the big business and not the other sub-structures of the economy.

So, the empirical research of these two different approaches toward the transformation of the planned economy to market one, shows that the range of the methods applied can, in practice, vary depending upon the inner as well as outside influence of the political, economic an social system at all, but the long term interest of the state, or the core idea should always remain the same, hence no matter how but if it works it should be applied further as well. Each of the methods, as soon as it gives positive results , should be taken into account as a possible example or a model for other countries which face the same stage of transition to market economy , with only one exception that all the models can serve only and only as a strategic example of development , more profound than inquisitive one. States must themselves model their transitional process as soon as the cultural diversities still play a great role in creating Max Weber's "spirit of capitalism".

  1. Kramer, Mark. "Ideology and the Cold War." Review of International Studies, Vol. 25, No. 4. (1999). P.573.
  2. Bickers, Kenneth N. ""Market failures." Public Policy analysis: A political economy approach. p. 119.
  3. Alam, Quamrul. "Shock Therapy versus Gradualism: The Central Eastern Europe (CEE) and East Asia Compared-A Review of Literature." International Business Research, Vol. 2, (April, 2009). P.4.
  4. Sachs, Jeffrey. "Shock Therapy in Poland: Perspectives of Five Years." Apr. 1994 P 3.
  5. Katchanovski, Ivan. "Divergence in Growth in Post-Communist Countries." Journal of Public Policy, Vol. 20, No.1. (Jan. - Apr., 2000). P.56.
  6. Katchanovski, Ivan. "Divergence in Growth in Post-Communist Countries." Journal of Public Policy, Vol. 20, No.1. (Jan. - Apr., 2000). P.56.
  7. Keane, Michael. "Poland: Inequality, Transfers, and Growth in Transition." Finance and Development. March 2001, Volume 38, Number 1.
  8. Kolodko, Grzegorz. "Transition to a market. Why Gradualism Works and Radicalism Fails?." Original scientific paper; Received: April 04, 2005. P.56.
  9. Keane, Michael. "Poland: Inequality, Transfers, and Growth in Transition." Finance and Development. March 2001, Volume 38, Number 2.
  10. Keane, Michael. "Poland: Inequality, Transfers, and Growth in Transition." Finance and Development. March 2001, Volume 38, Number 2.
  11. Smith, Alan. "Shock Therapy or Gradualism." The Slavonic and East European Review, Vol. 72, No. 4 (Oct., 1994). P.596.
  12. Keane, Michael. "Poland: Inequality, Transfers, and Growth in Transition." Finance and Development. March 2001, Volume 38, Number 1.
  13. Hare, Paul. "Hungary's Transition to the Market: The Case against a 'Big-Bang'." Economic Policy, Vol. 7, No. 14, (Apr., 1992). P.236.
  14. Hare, Paul. "Hungary's Transition to the Market: The Case against a 'Big-Bang'." Economic Policy, Vol. 7, No. 14, (Apr., 1992). P.238.
  15. Hare, Paul. "Hungary's Transition to the Market: The Case against a 'Big-Bang'." Economic Policy, Vol. 7, No. 14, (Apr., 1992). P.238.
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  17. McIntyre, R. The Role of Small and Medium Enterprises in Transition: Growth and Entrepreneurship, Research for Action 49, UNU world Institute for Development Economic Research. 2001.
  18. Dallago, B. 'Small and Medium Enterprises in Central and Eastern Europe', Centre for Economic Institutions, Institute for Economic Research, University of Trento and Hitotsubashi University. 2003

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