The Economics of Convalescence

Leszek Balcerowicz: Socialism, Capitalism, Transformation. Central European University Press, Budapest - London - New York, 1995, 377 pp.

Much has been written on the economic reforms under way in East and Central Europe, some of it from the standpoint of international politics, some from the ivory tower of pure economics, and quite a proportion from within the safety of the walls of Western European or US universities. Little is known, however, about the actual views of those who themselves shaped the transformation processes as politicans, and who, as economists, were deeply aware of the real stakes, driving forces and implications of changes. One such "split" personality is the former Polish Deputy Prime Minister, Leszek Balcerowicz, regarded by many as the father of the Polish economic shock therapy. His book therefore deserves attention as the work of both an insider and of a professional economist involved in what he is writing about.

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Transformation and stabilization

Balcerowicz contributes three precisely formulated conclusions for the understanding of the social and economic transition processes in post-communist Central and Eastern Europe. All three merit a somewhat longer discussion.

1) "An extreme case of inherited macroeconomic instability calls for the rapid implementation of a tough stabilization programme." The "textbook" types of transition imply movement between stable states. Where, however, the initial state is unstable, transition cannot be a simple process since, in changing the institutions, the rules of the game and property relations, care must be taken that destabilization does not get out of control or become irreversible. Thus the task in hand is huge, and in Poland, as a minister, Balcerowicz himself took part in accomplishing it. Success there, measured by the macroeconomic figures, cannot be doubted, but with hindsight it is also easy to see that the polarization of society was a considerable risk factor.

In general, there is not much profit in meditating over how a process, the outcome of which is already known, would have turned out, had the initial state been different. Thus it is quite superfluous to ask what the transition in Central Europe would have been like under stable economic conditions, especially as we now know that transition itself has a destabilizing effect as it destroys several old structures at one and the same time. Nevertheless, it is worthwhile pointing out that in Hungary, the work carried out between 1987 and 1989 by various government-sponsored and academic institutes and teams, aiming formally at laying the foundations for the stabilization policies of the time, had a major role in preparing the ground for economic transformation. Several reform moves were recommended as tools for stabilization only to be implemented later as part of the transition. These moves included, for example, the liberalization of imports, the further relaxation of measures regarding the influx of foreign direct investment along with privatization itself.

2) "There are important interlinkages and synergies within the package of market-oriented reforms." The author's examples concern mainly the stabilization-supporting effects of liberalization; they also emphasize that there are powerful synergic relations between profound institutional change and an improvement in economic indicators.

That approach, however, may be extended to several other areas as well, and frequently harmful synergies may be observed. Finance offers many examples of such negative synergy. Devaluation of the national currency, for instance, boosts exports and reduces imports but state revenues from imports fall much more slowly since imports are increasingly expensive. Favourable effects make themselves manifest rapidly, whereas negative effects only reveal themselves later. Every devaluation has an inflationary effect, and even without further borrowing, devaluation increases the foreign debt when expressed in terms of the national currency.

In running the transforming economies, governments, since they are reducing the state-owned sector and in consequence of liberalization, have to rely increasingly on monetary policy. Balcerowicz indicates the considerable synergic effects, including some that do not become manifest immediately. The governments of the countries in transition must learn the intricacies of how to prepare the ground for measures involving complex effects. That is an objective pointing beyond transition in a strict sense, something that not only pioneers of economic transformation like Balcerowicz, but others, too, must be ready for.

3) "Different processes of economic reform have different maximum possible speeds." This crucial observation concerns reform processes within a particular country. The danger of "voluntarism," so frequently referred to - usually with regard to the past - in connection with the old socialist economic policies, is very much present also in steering the course of economic transition. Short-term stabilization may be successful within a couple of months, and the liberalization of imports or prices does not require new structures. On the other hand, the legal and institutional system of a well-functioning market economy cannot be established overnight.

Trying to speed up this construction process artificially is extremely risky, but makers of economic policy must also be warned not to believe in the "artificial development of an equilibrium". If certain structures or regions of the economy have already reached European standards of development, while others are in an even worse state than previously, then the government cannot afford not to intervene to a certain extent on the pretext that the power of the state is receding. Nor can the institutional structures of the state be expected within a few years to adopt of themselves the same requirements and pace which have become general in the private sector by the rapid transformation. The reform of the government sector is an integral part of the transformation even if the reform measures involved must often be implemented by civil servants against their own interests.

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