Creating Market Economy in Eastern Europe

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Although it has some rolling hills and low mountains, Hungary is basically a flat country with good agricultural land and a favorable climate. As in other East European countries, the period since World War II has seen the population flow from rural to urban areas and a changing balance of industrial and agricultural activity. Today, approximately half the population lives in urban areas.

Hungary is not particularly prosperous. Most estimates of its gross national product or per capita gross national product place Hungary in the middle of the East European countries. It is generally wealthier than
Bulgaria and Yugoslavia and certainly wealthier than Albania; it ranks behind East Germany and Czechoslovakia. Hungary's per capita income appears to be close to that of Greece. In this sense, economic development remains a key issue in Hungary. By the standards of Western Europe, Hungary remains relatively poor; by the standards of the Third World, Hungary ranks among the more affluent countries.

2) The Hungarian Economy: Prereform

The postwar reconstruction of the Hungarian economy began quite modestly in 1945. Before the implementation of a three-year plan in 1947
(1947-1949), the main policies included stabilization of the currency, changes in the nature of rural landholdings, and the beginnings of nationalization. The first three-year plan was designed primarily to bring the economy up to prewar levels of economic activity.

During this time, a planning mechanism was created and the share of national income going to investment increased sharply. The changes were not radical, however, and balanced development was envisioned.

The era of balanced development came to an end with the introduction of a five-year plan in 1950. The share of national income devoted to investment was increased substantially, and the bulk of new investment was directed toward heavy industry. This policy was partially reversed toward the end of the plan period, but it was reaffirmed in 1955-1956.

A number of economic trouble spots cried out for attention. There was an observed need to improve industrial labor productivity, especially through the development of a better incentive system to offset the declining supply of labor from rural areas. Supply-demand imbalances were growing increasingly severe. Waste and imbalance in the material-technical supply system created the need for a substantially modified coordinating mechanism among enterprises.

In addition, excess demand for investment led to substantial amounts of unfinished new construction and to the neglect of old facilities. Some mechanisms for the more rational allocation of capital investment had to be found. The adoption and diffusion of technological advances were seen as inadequate. Technological improvement was considered crucial for continued development of the economy.

This background seems familiar: a small country, the Soviet
(Stalinist) model of industrialization, overcentralization, emphasis on extensive growth, rigidities of the plan mechanism, incentive problems, and the resulting difficulties. Against this background, the New Economic
Mechanism first promulgated in a party resolution in 1966 was put into, practice in 1968. Over twenty years later, it remains one of the most important reform programs of planned socialist systems.

3) Intent of the New Economic Mechanism

There is disagreement about the importance and effect of the Hungarian reform program. The New Economic Mechanism (NEM) has generally been interpreted as leaving the power to control the main lines of economic activity (volume and direction of investment, consumption shares) with the central authorities, while relying on the market to execute the routine activities of the system. The NEM called for substantial decentralization of decision-making authority and responsibility from upper-level administrative agencies to the enterprise level. In a general way, NEM bears a close resemblance to the Lange model. Let us consider the original blueprint of NEM.

The objective of NEM was to combine the central manipulation of key variables with local responsibility for the remaining decisions. The first change was a significant reduction in the number and complexity of the directives firms; for large state-owned firms, the traditional problems remain. Valuation is difficult, especially in loss-making enterprises.
Moreover, it is hard to find buyers for these types of enterprises, let alone to arbitrate the potential rights of past owners. And just as elsewhere, privatization in Hungary is likely to become slower and more difficult as the focus shifts to the less attractive, large enterprises.

In addition to privatization per se, Hungary has addressed the creation of infrastructure (for example, a stock market) and new rules designed to change the guidance of enterprises. Accounting procedures have been refined and bankruptcy laws strengthened so that state subsidies can be curtailed and hard budgets introduced into large state-owned enterprises.

Hungary has also pursued a variety of stabilization measures and has liberalized policies in the sphere of foreign trade, though to a lesser degree and certainly more gradually than Poland. Domestic price controls have been substantially removed, and enterprises are permitted to enter into and benefit from foreign trade transactions. Although there are limits on the holding of foreign exchange, the Hungarian forint is substantially convertible for business purposes. However, the Bank of Hungary has maintained controls such that it has access to foreign exchange earnings to serve as repayment of the Hungarian hard-currency debt. (Hungary has a per capita hard-currency debt roughly twice that of Poland). Hungary has followed a tight monetary policy designed to create a balanced budget and also to exert financial pressure on enterprises.

Hungary has very liberal laws regarding foreign investment, including the possibility of full foreign ownership with permission. Moreover, repatriation laws are liberal. Not surprisingly, Hungary has been considered a leader in the quest to attract foreign investment, though the magnitude of this investment and its overall impact on the Hungarian economy probably remain modest.

The initial results of the transition process in Hungary have generally been positive when judged against the sorts of expectations that we discussed earlier. At the same time, it is proving difficult to sustain popular support as the inevitable costs of the transition process take their toll.

4) The Hungarian Economy in the 1990s

In spite of a tendency to compare the processes of economic reform in
Poland and Hungary, there are important differences between the two systems, and especially in the degree to which prior reform had taken place. Although some would argue that the New Economic Mechanism was quite limited compared to contemporary reforms, nevertheless the reform process has a significant history in Hungary. The differences between the Hungarian and Polish cases are important.
Inflation has been much less serious in Hungary than in Poland. The annual rate of inflation for 1989 has been estimated at roughly 17 percent.
Although the inflation rate increased to about 29 percent in 1990, this performance has been viewed as positive. In addition, wage increases have generally been controlled. Largely because of a shift away from trade with former CMEA trading partners, the volume of Hungarian trade has declined.
At the same time, the Hungarians have experienced growth in exports to
Western markets and a generally weak domestic demand for imports — both important developments for the overall trade balance. The good news on the exports side, however, tends to be sector-specific. Hard-currency debt remains a serious problem, and the movement toward a convertible currency has been much slower than in the Polish case. Finally, the Hungarian budget deficit has increased.

The Hungarian economy was projected to shrink by approximately 3 percent in 1991, and associated declines in consumption and investment were anticipated. The state property agency is moving ahead with privatization.
The overall relatively slow pace of reform in Hungary may well dictate less sharp downturns and less severe fluctuations during the periods of downturn but, at the same time, rather slower recoveries and a longer time in which to achieve normalization. As with Poland, the effectiveness of the macroeconomic policies being implemented, world market conditions (such as the price of oil), and domestic structural change through privatization will all affect both short-term and longer-term outcomes.

EASTERN EUROPE: THE REFORM SCENE

The transition from plan to market in Eastern Europe is important, not only for those who live with and implement the transition, but also for those interested in the subject of comparative economic systems. For a variety of reasons, if the transition cannot succeed in countries such as
Poland and Hungary, it is unlikely to succeed elsewhere.

Obviously, it is too early to render any definitive judgment on these cases, let alone on the more general issues of transition. Indeed, it is difficult to chart even basic day-to-day changes in these countries. That having been said, let us try to assess the outcomes that have occurred so far.

Judged in terms of our earlier discussion of economic reform and projected outcomes in the early stages of transition from plan to market, there is room for guarded optimism as we examine the early results in
Hungary and Poland. At the same time, there remain a number of basic forces that will heavily influence future economic trends.

First, although initial political transformations are substantially complete in Eastern Europe (with important exceptions such as Yugoslavia), there are cases (such as Romania) where political instability and a lack of cohesion (derived in part from the political legacy of the communist era) make agreement on reform very difficult. Clearly, in these cases, the path of reform will be slower and much more difficult than in the leading cases that we have examined.

Table 2. Political and Economic Developments in Eastern Europe: A
Summary

Second, the initial results of the transition have been generally as expected. In Table2 I summarize a number of useful indicators. As anticipated, in all cases there has been a downturn in output — occasionally a downturn of significant magnitude. Inflation has been very uneven and in some cases (such as Yugoslavia and pre-reform Poland) very rapid. However, post-reform inflation rates generally leave some room for optimism, especially in those cases where stabilization policies have been developed and applied.

Third, we have noted that initial privatization usually proceeded rather quickly but that, after the privatization of small firms (especially in the service sphere), the pace of change decreased significantly. This latter development reflects the onset of major difficulties: the private sector must now absorb large, state-owned, loss-making, and often technologically backward enterprises. The privatization of these firms presents serious problems, as does a setting where valuation is fraught with difficulties, buyers are hard to find, claims from the past must be handled, and contemporary management skills are wanting.

Fourth, although inflation and unemployment have necessitated a growing concern for safety-net measures of various types, there is also a sense that the availability of consumer goods and services has improved.

All of these considerations seem to support a measure of optimism about the eventual outcome of the transition process. At the same time, there are important dimensions where change must be sustained if the transition is to be successful. Stabilization policies must be maintained — a tall order in those cases where consumer patience is lacking.
Privatization must proceed, and it must increasingly reflect the contours of new market arrangements, including the infrastructure required for markets to function effectively. These changes must be sustained even in the face of political dissension, consumer dissatisfaction and an uncertain international economic environment. These restraining forces will in large part dictate the pace and ultimate success or failure of the transition process.

3. Moldova’s way to an open economy.

Moldova has faced significant and escalating economic difficulties since its acquisition of independence in 1991. This situation is reflected in the main macroeconomic indicator for the republic - Gross Domestic
Product (GDP) -, which has dropped by nearly 60%.

The agricultural sector has been strongly impacted by the nation’s economic difficulties, as well as by adverse environmental conditions. In
1993 Moldova’s agricultural harvest was adequate, a considerable portion remained uncollected and unprocessed due to lack of fuel, transportation, and financial resources. In addition, due to early November frosts, hundreds of thousands of tons of fruit, vegetables, and tobacco were damaged beyond use. In the summer of 1994, a simmilar stream of natural disasters, including a drought, followed by a hurricane, followed by a flood, caused even greater losses than those experienced the previous year.
The devasting flooding in August 94 alone brought about losses totaling US$
= 220 million, which exceeded the amount of Moldova’s industrial activities include: refrigerator, television furniture, clothing, and agricultural machinery production. The Republic’s threatens the productivity of this sector. Of the republic’s 262 production enterprises, 60% experienced production declines. Over all in 1993, many industrial enterprises operated at levels 50% lower than their full potential.

The decline in production has negatively influenced the budgetary capacity of the Moldovan Government to address social and other issues. In
November 1994, for example, budget areas reached a level of US$ 70 million.
As a result sizable delays exist in payments of mages, pensions, stipends and other allocations. Natural resources within the country are few. The situation in Moldova’s energy sector is strained, therefore, more so as nation’s capacity to import energy continues to deteriorate. All types of fuel, including coal, oil and natural gas, delivered from the Russian
Federation, equaled US$ 250 million as of late 1994.

Nevertheless, despite the above mentioned difficulties, economic reform -including privatization and the transition to a market economy - is being actively pursued in Moldova current economic crisis and into a more healthy economic state.

Building of the state and its sovereignty has allowed Moldova to accomplish some important achievements in economic reform, i.e., financial stabilization on a macroeconomic level and a lessening of the economic crisis and its social impact.

The success of macroeconomic stabilization has also helped to increase the level of confidence and trust in Moldova amongst the international community. The reforms are being supported by foreign creditors and by technical assistance from donors, including the United Nations, the
European Union, USA, Germany and Netherlands.
In order to further development the private sector, it is necessary to continue reforms and to improve mechanism supports and stimulating them.
Further-more, macroeconomic stabilization will not last unless the reforms reach all parts of the national economy.

Although the hand code contains some contradictions, new important measures on agriculture have been taken, such as the liberalization of economic activity and privatization of the industrial sector of the agroindustrial complex, contributing to a relative stabilization of the market for food products and to an increase in imports.

Success in promoting economic reforms in Moldova - privatization of the state property, liberalization of prices in the real estate market liberalization of intern, trade, establishment and development of the banking system and of the financial market - allowed Moldova to be placed in the 11th position amongst the 25 countries of Central and Eastern
Europe, the Baltic states and the Commonwealth of Independent States (CIS) in a classification made by the European Bank for Reconstruction and
Development.

We can, therefor, conclude that 1995 was the first year of transition, following the first destructive stage of the reforms, to a better stage.

However, although macroeconomic stabilization is encouraging the continuous evolution towards a market economy, it does not guarantee an increase in the national economy. These problems will require a longer period to solve than that required for achieving macroeconomic stabilization.

Economic Performance in Moldova 1989-1995:
| |1989 |1990 |1991 |1992 |1993 |1994 |1995 |
|Annual Output |8,8 |-1,5 |-18,0 |-29,1 |-1,2 |-31,2 |-3,1 |
|Growth | | | | | | | |
|Annual |4,5 |110,0 |162,0 |1276,4|788,0 |329,4 |30,2 |
|Inflation | | | | | | | |

Conclusion

In conclusion to all said I want to present a brief survey of the present stage reached in the transformation process in the various countries of Eastern Europe. As an initial, superficial impression, it can be said that the farther west the countries a located, the more advanced the process now is.

- The transformation process is at its most advanced in Poland,

Czechoslovakia and Hungary. All three countries now have stable parliamentary democracies in which non-communist parties hold the majority. Although the initial situations in the three countries were very different, they have also all set about establishing a market economy system with considerable energy. Since it is thus in these three countries that the most experience has now been gathered, I have considerate my remarks on them (later on).

- In the political sense the situation in the three Baltic countries is similar to that of Poland, Czechoslovakia and Hungary. They too have completed the change to parliamentary democracy. However, economic transformation is especially impeded by the fact that owing to their histories as Soviet republics their economics are particularly closely interwoven with thus of to rest of the former

Soviet Union.

- Romania, Bulgaria and Albania have so far made less progress than their counterparts to the north and west both in the political and the economic transformation process. Here too, though, freely elected parliaments have now undertaken the first legislative steps towards crating a market economic order. However, it is still early as yet to assess the political stability of these countries or the success of the economic reform they have so far embarked upon.

- What path will be taken in future by the successor states to the former soviet Union and those of former Yugoslavia is, in my opinion, still a totally open question. Neither the geographical borders of these countries nor their political or economic systems can be foretold with any degree of certainty.

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