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Transition: Changes after Socialism
(25 Years Transition from Socialism to a Market Economy)
Summary of Conference of Professor Leszek Balcerowicz, Warsaw School of Economics
at the EIB Institute, 24 November 2014
Leszek Balcerowicz
The subject of this lecture is to take stock of the experience of Poland and other countries that have
moved from socialism to a free market economy. First, we must define socialism. I use the term as it
was used by Marx, who defined its characteristics, although it was also known as communism. The
main institutional characteristics of socialism are:
1) A monopoly of the public sector on all economic activity; there are no private firms.
2) Resource allocation takes place through a command and control system; there is no room
for the market.
As a result there can be no democracy, defined as a political system where competitive elections are
held regularly. Equally there is no freedom of expression. This makes necessary a set of repressive
institutional arrangements, symbolised better than anything else by the KGB (the Soviet security
agency).
Socialism had a dreadful impact on societies where it was adopted. As a socialist system provides
incentives for waste and inefficiency and lacks checks and balances it has led to catastrophic policies
which produced deep declines in income and at times sharp falls in population ( e.g. the famines
caused by Stalin’s and Mao’s policies).
Compare for example the performance of two countries with a free market economy, Spain and
Austria with two socialist countries, Poland and Hungary. Between 1950 and 1990 a very wide gap
developed in living standards. (See table below). A similar gap developed between East and West
Germany and many other cases. Most tragic is the case of the two Koreas. North Korea is a gulag,
while South Korea is a dynamic capitalist economy. In 1950 both countries had the same per capita
income, while in 2003 that of North Korea was only 7% of that of South Korea. When political power
is very concentrated it falls at time in hands of psychopaths whose policies are not only detrimental
to the economy, but can also lead to genocide (e.g. Mao, Stalin, the Khmer Rouge).
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• Countries under socialism lost a lot of distance to Western European
economies.
Per-capita GDP (in 1990 international dollars) in 1950 and 1990:
Poland vs. Spain
Hungary vs. Austria.
(239%)
14000
12210
(261%)
16881
18000
14000
10000
10000
(42%)
(102%)
2000
(38%)
5115
6000
(98%)
(149%)
(67%)
2447 2397
2000
1950
Poland
6471
6000
3706
2480
1950
1990
Spain
Hungary
1990
Austria
Source: Maddison Database.
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But, you may ask, what about the performance of China? There have been two phases in Chinese
development. Until the late 1970s the adoption of Maoist socialism caused growth to lag behind that
of developed economies. Thereafter the command economy was largely abandoned in favour of
market economy principles. China is still not a democracy, but the economy started growing fast.
Exports and foreign direct investment are now five times those of India’s, and several hundred
million people have been lifted out of poverty.
Against this background, the collapse of socialism and of Soviet bloc is the most positive event that
has occurred after the Second World War. Initially all countries of the former Soviet Bloc seemed to
be moving along the path leading to democracy – i.e. political competition and the rule of law- and
a capitalist market economy. But after two or three years, paths began to diverge.
Let us look first at democracy: the diagram below shows that according to an index of political
freedom, Centre and Eastern European countries have become fully institutionalised democracies.
Democracy means that accession to political power happens through elections and not through
other mechanisms like revolutions or coups d'état. Centre and Eastern European countries are
democratic in that sense, along with Mongolia, which may be of interest. Under Yeltsin, a great
reformer, Russia also began heading towards democracy. But then Yeltsin made a mistake and
appointed Putin as his successor, who engineered a reversal of all political and economic reforms.
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Political freedom 2012 (Polity IV)
10
5< fully institutionalized democracies
5
-5< mixed, or incoherent, authority regimes <5
0
-5< mixed, or incoherent, authority regimes <5
-5
-5> fully institutionalized autocracies
-10
Source: Polity IV Project
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Now look at the economic regime. As socialism meant the monopoly of state ownership, it would
seem logical to measure the transition to a market economy by looking at the share of the private
sector in GDP. Some former Soviet bloc countries like Belarus or Turkmenistan still have a
predominant public sector. But at first glance in most other countries private sector shares are
between 65% and 80%.
90
1994
Private sector share in GDP (%)
2010
80
70
60
50
40
30
20
10
0
Source: EBRD - Structural and institutional change indicators
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But this indicator can be misleading as nominal private ownership can hide very different political
and institutional set ups. In most Central and Eastern Europe private firms operate on a level playing
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field and there is no systematic patronage by politicians and bureaucrats. In some other countries,
however, you have what I would call temporary private ownership. This is particularly the case of
Russia under Mr Putin. Here the success of private enterprises, particularly large ones, depends very
much on political connections and connections with the KGB rather than on management skills and
innovation. If you have very good political connections you can destroy your competitors. If you do
not, you might be the one to be destroyed. And uncertainty on how long a firm can survive in such
an environment diverts the energy of entrepreneurs from managing their firms efficiently into
seeking political connections.
Whenever I am in Moscow I am struck by how much more expensive everything is than in Poland
while it should be cheaper. Why is that? It is because of the system of “private ownership” based on
patronage which makes everything more expensive. This increasingly politicised system leads to the
destruction of private sector companies like Yukos and support to those whose owners are close to
Mr Putin. It encourages capital flight rather than investment and hence foreign indebtedness as in
the case of Gazprom and contributes to making the financial sector fragile. Furthermore Russia’s
economy is fragile as it depends increasingly on oil and gas exports to Europe and cannot easily
switch exports to China.
From all this we can therefore conclude that:
-
Democracy was introduced and maintained in the countries of Central and Eastern Europe
which introduced capitalism
Non-democratic political systems co-exist with quasi-capitalist economies such as Russia and
China and quasi-socialist economies such as Belarus and countries in Central Asia.
Hence it is clear that you can have forms of capitalism without democracy, but you cannot have
socialism and democracy.
Let us now look at what happens after the transition from socialism. Here we have huge differences
in outcomes, most importantly for economic growth. By the way, it is fashionable nowadays to say
that economic growth is not important, but this is what rich people say, who can afford not to care
about economic growth. But for poor people economic growth means apartments, better clothing
and health care, etc. It is convenient to split the period after socialism in two: from 1989 up to the
financial crisis of 2008 and afterwards. The diagram below shows that between 1989 and 2008 there
was wide variation across former socialist countries in the growth of GDP per head. Poland was best
performer, while Georgia, Ukraine and Russia were the worst - Georgia mostly because of the civil
war in 1990.
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(GDP per capita growth in 2008
in relation to 1989 level)
Source: EBRD Transition Report 2008; WB WDI, IMF WEO
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My conclusion is that it pays to move fast with reforms. If you have hyperinflation, you don't wait;
you must cut the budget deficit. You must liberalise a centrally planned economy in a massive way,
as was the case for Poland, the Baltics and Hungary initially. You must dismantle state monopolies one of the most important features of Poland’s program in 1990. And you have to open up to world
trade.
Institutions need to change. Here I would draw a distinction between the enterprise sector and
other sectors. In the enterprise sector, the necessary changes are clear: you have to privatize and to
introduce competition. As a rule, all enterprises should be private. You may have exceptions from
this rule, but the burden of proof should fall on those who want to make an exception. Reforming
the public sector is much more complex. In Poland you have the challenge of making the justice
system work faster and fairer or making the health service more efficient and better suited to the
needs of patients. So the true challenge I think is in reforming the public sector, not only in Poland,
but also in other countries. The key is that reforms should be sustainable. For that to succeed you
will need a very active civil society that believes in limiting the role of the state.
During the second period – after the financial crisis of 2008 - Poland avoided a recession thanks
mainly to prudent macroeconomic policies that prevented a boom and bust cycle. We never
dreamed of emulating the policies of Mr Greenspan. More generally, countries that did not
experience a boom – Germany, Sweden and Switzerland – also avoided a bust. But even the Baltic
countries, who could not avoid a boom and bust cycle, recovered quickly because they took
appropriate action. They bit the bullet and did not delay painful fiscal adjustment mainly through
expenditure cuts and sound reforms. But other countries, like Italy, Spain, Portugal, Cyprus and
Greece have struggled to recover because they did not take appropriate action. Greece, in particular,
relied instead on tax increases rather than expenditure cuts and reforms where not followed
through. Greece has not suffered because of austerity, but because of the composition of the policy
programme.
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25%
20%
GDP per capita (constant US$) change
between 2007 and 2012 (in %)
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
Source: World Bank, World Development Indicators
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In any case, it is clear that fiscal stances are very important for longer term economic growth. If you
have a chronically ill public finance, with high spending, persistent deficits, cumulative public debt, it
is a drag on economic growth. And when I look at Hungary and compare it to Poland, I am comforted
in my opinion: Polish fiscal policies have been far from ideal, but perhaps not as bad as in Hungary.
Finally, let me elaborate on some issues concerning public sector spending, in particular welfare
expenditure. I am not saying that welfare spending is good or bad: that is an ideological issue.
Welfare spending should be guided by a few underlying principles. First, it should not undermine the
health of public finance. Second, it should not discourage people from working and third, it should
not discourage people from saving. So if your welfare state complies with these three conditions
that is fine. But in most countries it does not and welfare spending is excessive and badly structured.
This was clear even before the crisis and now public debt is much higher.
In this connection, the largest public expenditure item in Poland is pensions. If you do not have
funded pensions but a pay as you go system, the obvious measure is to increase the retirement age,
especially for women. Why is that? Because women, on average, have a longer life expectancy. I am
only half joking when I say that feminism would require women to retire later than men. If it is
equitable that we should all live approximatively the same amount of years on a pension, who
should retire later? I am very surprised that so far no feminist movement has set this as one of its
main goals.
Health is also a major expenditure item. And I think that one can combine the protection of poorer
people with more efficiency. This can and should be done by scrutinising hospitals that currently
absorb between 50 and 60% of health expenditure in Poland. So I think that these are the main
areas that require further reforms in Poland. And I think probably in some other countries too.
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