HANDOUT 4
The Economic Dimension of Transition
Part I: The Shock Therapy Model
Jeffrey Sachs - model of “shock therapy”: an economic theory of transition
Based on a globalised, unified capitalist world: this would be brought about by formulating
a policy of transformation in Central and Eastern Europe.
He created a model of behaviour of the revelant actors and of the ways in which they would
interact in certain circumstances faced with their particular constraints and incentives.
Various names for this model:
Shock Therapy/Treatment
Radical Economic Reform Plan
the Economic Big Bang
Initially supported by US and British policy-makers andmost East European economists advocating reform.
The Shock Therapy Model Involved:
(Macro-Policies for Restructuring)
1) Breaking-up up of COMECON region, especially breaking-up the C/E Euro countries from the USSR.
2) Making a “root and branch” switch to a particular form of capitalist institutional structure in each state a precondition for normalising relations with that state.
3) Imposing, therefore, a “hub and spoke” structure on the relationship between the West and C/e Euro with each target state in the region relating to the others principally vai its relationship with the Western hub. (American policy between 1990-92 continued to favour the maintenance of a Moscow-centred economic sphere in the Soviet region, except for the Baltic Republics.)
4) Starting the process of regional transformation in the states with the most politically sympathetic governments and then using both negative and positive incentives to extend the required mix of domestic policies across the region as a whole.
5) Western states to provide, in the main through their multilateral organisation, the necessary positive incentives for co-operative governments and constraints for unco-operative governments.
6) The revivial of economic activity in co-operative target states woulf take the form of trade-led growth directed towards Western Europe compensating for COMECON’s collapse.
7) Co-operative states would gain full access to the market of the EC (partly through radically changing some of its key institutional pillars, such as its trade regime and CAP), very substantial economic assistance and eventual membership of an enlarged EU.
This approach:
a) urged the break-up and in effect the start of a competitive race by E Euro states to prepare themselves for direct entry into the W Euro market;
b) rejected mixed or hybrid forms of socio-economic system on the grounds that market socialism had already proved unworkable;
HOWEVER, this necessitated radical reform of the EC to accommodate an ‘export surge’ from C/E Euro states and called for an unprecedented degree of funding from co-operative states in the West.
By 1990, this overall model was pushed forward as a comprehensive economic strategy for the
region as a whole.
This was especially favoured because the model was already being used in Yugoslavia and
Poland:
“Poland will bring in the first comprehensive market-oriented reforms in Eastern Europe.”
“The Yugoslav outcome would differ from Poland’s for Yugoslavia would maintain, in
large measure, its self-management approach to corporate governance.”
(Sachs, 1990)
By 1990 this approach was adopted by the G7 states.
[Fr-Ger proposals to keep the USSR and C/E Euro linked via a free-trade regime were rejected; Fr proposals for a strategy which would engage in large public infr-structure projects covering the former USSR and C/E Euro were cut-short; a further Fr idea for a pan-European Confederation embracing both the EC and the whole of the East were repudiated. Poland and Yugoslavia were used as examples for a successful way forward.]
The path forward, seen by most C/E European supporters of ST lay through the gradual adsorption of the states in the region into the Western economy institutionalised in the various multilateral organisation, especially the EU. Because of this the desired out come was identified as:
- a unification of Europe in a single market;
- the regional development of prosperous capitalist democracies.
- the official projected outcome of ST was to be “democratically-based increased living
standards and freedom.”
At the base of this transformation was the idea that the post-communist world would have the potential to grow more rapidly than the developed world and thereby narrow the gap in living standards, if the states concerned “harmonised” their economic institutions and joined their economies to the global economic system.
The Strategy of ST had:
1) A very paticular institutional “matrix” which included: open trade; currency convertibility; and the private sector as the “engine of growth”.
2) Core reforms that needed to be achieved for the model as a whole to be viable:
a) open international trade
b) currency convertibility
c) private ownership as the main force for economic growth
d) corporate ownership as the dominant organisational form for large enterprises
e) opneness to foreign investment
f) membership of key international economic institutions, including the IMF, World Bank and
GATT
[Reforms a/b/e/f - were about changing a state’s external politico-economic relations; reform d - was about a particular form of ownership; and reform c - was about what is generally seen as capitalism.]
It was argued by the advocates of this strategy that:
by joining the rest of the global economy the states of C/E Euro would be able to import some of the prosperity from the rest of the world, usually through the importation of new technologies, organisational patterns, managerial methods and financial capital. Only these could overcome the economic legacy of the previous 40 years.
Another core requirement for the success of economic transition was foreign direct investment. In order to get this the strategy called for the creation of a free trade regime and the right institutional and economic conditions in C/E Euro.
It was claimed that failure to implement this style of economic strategy (aimed at making a connection with the world economy) would lead to problems such as: an unconvertible currency. an unreformed industrial structure; and a hostile investment climate.
[Generally this approach and vision of joining the global economy was a powerful motive for C/E Euro reformers - here again we can look at the examples of Poland and Yugoslavia; also the adapted version used in Hungary and the Czech Republic, and in the early 1990s (1992-93) in Russia through Gaidar’s reforms.]
It was explained that such an opening-up of the C/E Euro economies to global capital was the necessary first step for government policy. This kind of policy justified sudden switches to free trade; it justified early convertibility as a means to anchor world prices in the domestic context - thus promoting economic revival through trade; it justified foreign direct investment as indispensible for privatisation and structuring.
SHOCK THERAPY
It is usually referred to as the 3 “izations”:
1) Liberalization
2) Stabilization
3) Privatization
Recently a 4th has been added - Institutionalization
As it has turned out in practice - these “izations” progress in a very partcular pattern, covering the interaction of actors with each other and with their environment:
1) the liberalizing/stabilizing shock
2) the international shock
3) privatization and foreign direct investment
4) trade-led growth
5) political/institutional consolidation and growth
Shock Therapy, Democracy and ‘Civil Society’
Cardinal goals of ST have been the achievement of democracy and freedom. Although the building of a civil society has not been emphasized, this has been a constant theme of ST supporters. Yet these goals have been treated as ends and not means. As ends, they have been discursively very important because they have been used as core justifications of the means of ST. However, the liberal principle that ends should govern means has been operationally rejected within ST in favour of a more “dialectical” approach: the existing social, legal and political institutions are likely to be resistant to ST, but ST is the only, or best, path to truly democratic, legal and civil institutions, so the existing institutions must be negated from above and outside in order to realise true democracy and civil society.
Between 1990-1995
Most governments in post-communist C?E Euro have to some degree tried to lock themselves into the strategy envisaged by ST (especially in terms of the relationships with the global economy) and have tried to combine the demands of the international financial institutional and the EC/EU with often comflicting domestic pressures.
Some governments have drifted, without any coherent policy, and only a few, such as Romania, have consciously sought a different road to another form of capitalism.
By the mid-1990s
The path of progress for ST has proved unstable and many analysts are now criticising this model of economic transition. Although by the beginning of 1996 many analysts do begin to identify an up-turn in the economic climate within the region (things are beginning to stabilise - but is it already too late, politically.
So far, 5 major charges are levelled against ST and what it has created in C/E Euro:
Ithat its macro instruments of regional fragmentation and domestic shock change have been
immensly costly in the short and medium terms;
IIthat ST free trade-led policy for economic revival was largely misconceived;
IIIST’s macro policies for sustained economic revival have tended to weaken rather than strengthen
long-term revival;
IVthe practice of ST on the part of Western actors has sharply diverged from the theory in ways
that have damaged C/E Eruo states;
Vin terms of its own criteria, ST has been a failure.
The implementation of ST has brought about a “double-depressive-shock” in the region:
- part of this has been the result of the ST model’s insistance on the break-up of the COMECON
area, rather than maintaining regional trade and production linkages through a customs union
and new payment arrangement . . .
- part of the shock has come from the implementation of the ST domestic policy cycle . . .
All commentators on the region now know about these effects:
1) increased unemployment
2) reduction in real incomes
3) reduction in levels of production
IMPORTANTLY, an OECD study entitled “Integrating Emerging Market Economies into the International Trading System” (1994-96) - analysed the state of economic transition in the region, specifically the depression being experienced by the mid-1990s. It pin-points the major causal factors (all deriving from the short-term consequences of ST):
IIt states that the “stabilisation” aspect, especially the credit squeeze via credit ceilings, was “indentified as the emportant element contributing to the recession, especially at the beginning of the reform process”.
IIThe fragmentation of COMECON-regime trade had a disastrous impact on industrial outpu: “according to some calculation, this volume effect alone can explain most of the fall in output in Hungary and the CSFR and about one third of the decline in Poland”.
IIIKey institutional vacuums, as pointed out by the critics of ST, such as the absence of a financial system, meant that “all countries suffered from an inadequate supply-side response”, in other words a downward spiral into protracted depression.
This study, along with others, concluded by the mid-1990s that, dispite a host of arguments presented by ST supporters, the then contemporary situation, the simple undeniable fact, was that the entire ST programme held the depression as its core feature.
Similar critiques have also focussed concern in the following areas:
1) the failure of the ST trade regime
2) the failure of the transition economies to gain full acess to the EU market
It has been concluded that the tragic result of these politico-economic interactions has been that the domestic depressive shocks, policed by the IMF and designed to lay the basis for an export-led revivial, have largely led these countries up a “blind alley”, prolonging the depression. The origins of the revival, in so far as it has come, has not been led by foreign trade but by domestic consumption. Yet the policies of the international financial institutions have been overwhelmingly directed at reducing domestic demand pressures, stamping out inflation, lowering wages and reducing government deficits through spending cuts.
CONSTITUTIONALITY VS SHOCK THERAPY IN RUSSIA
The most direct and brutal test of the relationship between liberal principle and ST ocurred in Russia in 1993. The Yeltsin government derived its authority from parliamentary elections held in 1990 during the Gorbachev period. The Russian parliament elected at that time had then elected Yeltsin as president and, in the autumn of 1991, voted hm emergency powers for a year to give him a free hand with econmic transformation. By the autumn of 1992, with real wages down to 40% of their levels at the start of the year, the majority in parliament began to swing against the Gaidar reforms. By the spring of 1993 Yeltsin was on a collision course with the deputies.
From the spring of 1993 Yeltsin embarked upon a drive to flout the constitution in order to crush erstwhile supporters within the Russian parliament. The parliament’s powers were not, in fact, very extensive. It could not vote on the government’s programme or pass a vote of no confidence in the PM. It could not approve individual ministers. But on the other hand, it could not be dissolved by the president and it has substantial power over budgetary matters.
Faced with parliamentary opposition to his economic programme, Yeltsin decided to announce the dissolution of parliament, an act expressly prohibited in the constitution. When the Mps sought to resist this act by occupying the parliament building, Yeltsin had them surrounded and cut-off, and this led to an ill-judged but constitutionally legitimate effort by the parliament to strip Yeltsin of power. Yeltsin responded to a march on a radio station with a military assault on parliament building. After the defeat of the opposition, Yeltsin also imposed censorship and closed-down hostile newspapers. Mps who had participated in the occupation of the Whitehouse were thrown out of their flats within 3 days of the victory.
Western governments ans ST supporters supported Yeltsin’s unconstitutional acts. The parliament leaders were branded as the “Old Guard”. “Yeltsin was faced with the alternative of surrendering to the Old Guard or breaching the constitution” he was reported in the West. This is propagandistic: the parliament had not been asking Yeltsin to surrender; they had been opposing his ST policy.
REACTIONS IN CENTRAL/EASTERN EUROPE
By the mid-1990s the populations of the region have not only suffered hardships but have elected governments on political platforms that have subsequently been blocked, in Hungary, Poland and Slovakia, by Western pressure. Attempts at ultr-nationalist backlash by the Christian Nationals in Poland, the Republicans in the Czech Republic, the Slovak Nationalist Party or the Csurka breakaway from the MDF in Hungary have all been repudiated by the electorates in the region. In general, the extreme right has been far weaker electorally in Eastern Europe during the 1990s.
Instead voters have turned back to the one political current in the region that has received no support whatsoever from the West: the ex-communist socialist parties. These have achieved victories in Poland, Hungary, Bulgaria, Lithuania, Estonia, Ukraine and have become important also in the former GDR.
ROMANIA: A DIFFERENT WAY FORWARD
A stark contrast in the policy field would be that between Hungary, Poland, the Czech Republic on the one side and Romania on the other. The Romanian case may be taken as a paradigm of an alternative, national, capitalist strategy of transformation counterposed to the ST cycle of “opening to globalism”. The Iliescu regime rejected a sweeping liberalisation of prices, avoided bankruptcies and large lay-offs of workers, sought to maintain the big industrial enterprises and directed its privatisation efforts towards management and worker buy-outs, largely excluding foreign capital. The government was also cautious about liberalising its trade regime. As a result of these policies it was largely rebuffed by the major international economic organisations.
Romania initially suffered from acute internal tensions as a result of the form of transition from the Ceaucescu regime. It also suffered from an acute hard-currency shortage. Nevertheless, like Poland, the Romanian economy returned to growth by the end of 1993 with a 1% rise in GDP, and grew by a further 1% the following year. By 1995 it was reported “Romania, little noticed by the West, delivered last year probably the most impressive performance in Eastern Europe”.
This does not mean that the Romanian experience should be erected as some sort of superior strategy to that of Poland, for example. Since 1989 the Romanian people have probably suffered more than the Poles. It does suggest 2 possible lines of investigations:
1) Romania had no significant foreign debt and this makes it similar to Poland with its debt reductions;
2) ST opening to global forces is at the very least no panacea if recent growth records are the standard of judgement: Romania has revived far more strongly than wide-open Hungary or the Czech Republic.