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6. Transition Towards What?

6. Transition Towards What?

The pace of human development continues to accelerate. The world has changed more during the present century than in the previous nineteen centuries combined – economically, socially, politically, scientifically and technologically. In recent decades humankind has been buffeted by a bewildering array and intensity of transforming powers – democratization, decolonization, demilitarization, globalization, universal education, scientific advances, information, successive technological revolutions brought about by the automobile, telephone, radio, television, jet aircraft, computers, satellite communications and genetic engineering. Coping with such rapid change has not been easy. It has brought in its wake a broad array of problems – a widening gap between the most advanced and least developed sections both within and between nations, a disequilibrium between growth of population and economic growth, rising unemployment, alienated youth, increasing violence and crime, depletion of natural resources, degradation of the environment, overcrowded cities, mass migrations of talent from South to North, displacement of millions of political and economic refugees, the breakdown of the family and the erosion of traditional social institutions.

Although much has been learned about the various stages of social and economic development, much less is known about the actual process itself by which societies transit from one stage or level or form to another. As a result, our efforts to speed the transition are often haphazard, stumbling and fraught with difficulty. Today former colonial nations such as Vietnam and Zimbabwe strive to catch up with countries that have never been subject to foreign rule. The tribal nations of central Africa struggle at great cost to transform themselves into modern states. Even within the prosperous West, the speed and extent of progress is uneven, leading to the emergence of ‘developing countries’ within developed nations, of poverty-stricken families in inner cities with rates of chronic unemployment as high as 50 per cent or more.

Nothing is of greater value to humanity’s quest for progress than an understanding of the development process and the means for consciously directing it more effectively. The tremendous economic achievements of Japan during the post-war period, followed during the last two decades by other East Asian economic powers and most recently by China, suggest that the time required for transition can be substantially abridged and the fruits of development achieved much sooner than has been accomplished by nations in the past. The rising expectations of people around the globe and the potential risks of failing to heed their call have added a greater sense of urgency to the quest for this knowledge.

Eastern Europe

The challenges posed by extremely rapid transition are nowhere more graphically depicted than in the current transition of the countries of Eastern Europe after the collapse of the Berlin Wall, the end of the Cold War and the break-up of the USSR. Although this transition is often described in political and economic terms, it is far broader and deeper in its implications. These nations are in the midst of a simultaneous multi-dimensional transformation – politically, from authoritarian to democratic forms of government; economically, from a centrally planned command system to free market economies; industrially, from defence-oriented to consumer-oriented production; administratively, from highly centralized to decentralized systems; structurally, from state ownership of property to multiple forms of ownership in all spheres; socially, from closed and isolated to open and internationally integrated societies; culturally, from almost exclusive emphasis on values of equity and collective security to strong emphasis on the values of freedom and individual responsibility.

The transformation of Eastern Europe and the former USSR is of vital concern to all of us. Never before in human history has such massive change been carried out as an essentially peaceful revolution. The end of apartheid in South Africa and recent progress in the Middle East show that this process continues to have beneficial repercussions around the world. At the same time, this incredible advance has been accompanied by events that have destabilized the political and economic systems of the entire region, led to the break-up of the USSR, war in Bosnia, the collapse of the Warsaw Pact and the COMECON trade system, a massive brain drain and the threat of huge waves of economic refugees. These changes, too, have had implications for all nations within the region and beyond – severely affecting trade around the world, from the tea estates of Sri Lanka and India to the wheat fields of the United States, Australia and Argentina.

So, too, the further course of this transition will have a profound impact on all nations, both developed and developing. The future of world peace, the world political system and the world economy hang in the balance. A successful rapid transition will open up new markets to stimulate a new round of growth for the sluggish economies of the West, much as the Mar shall Plan stimulated American prosperity in the 1950s. It will equally present economic opportunities for developing countries unable as yet to meet the quality requirements of highly competitive Western markets. Failure of the transition holds the danger of economic collapse and political instability within Eastern Europe, which could even lead to renewed political tensions and an other economically devastating arms race. Already ongoing wars are being fought in the Balkans, the Caucasus and several other regions of the former Soviet Union. Crime is on the rise. Ominous signs have appeared that the authoritarian past is not yet fully buried and could once again arise, if the forward momentum of the transition process does not quickly improve the lives of people within the region. The whole world has an immense stake in the successful outcome of the transition in Eastern Europe.

Initial Results of Reform

The pre-existent conditions, the starting point of the transition, the timing, speed and extent of the reforms introduced during the past five years varied considerably among the 25 nations of Eastern Europe and Central Asia. But, with few exceptions, they were founded on the same general principles and on the policy recommendations of Western proponents of rapid transformation to total free-market liberal capitalism, based on a simultaneous shock strategy encompassing macro-economic stabilization, prices and property rights. Western governments and the international financial institutions, led by the IMF, strongly advocated this approach and linked financial assistance to its adoption. The strategy called for rapid deregulation of prices, privatization of farms and industry, introduction of a convertible currency, and balancing the budget to reduce the high fiscal deficits, primarily by reducing military expenditure and subsidies to producers and consumers. The assumption was that a programme with these elements would result in a significant increase in production, efficiency and the availability of consumer goods within a short time.

The actual results were quite contrary to the expectations of these countries’ Western economic advisers, as well as to the governments and people of the region. The initial phase of reforms had a disastrous impact on the economies, on the people and in some countries on peace and political stability. From 1990 to 1993 production in all 25 nations declined drastically, from a minimum of 10 per cent in Poland, 20 percent in Hungary and 22 per cent in the Czech Republic to a maximum of 45 per cent in Russia, 57 per cent in Latvia and 75 per cent in Armenia. Investment fell by an average rate of 13 –14 per cent per year from 1990 to 1992, and by a three-year total of more than 50 per cent in Russia. The fall in real incomes followed that of output, and the impact was made even more severe, especially for pensioners, by the simultaneous dismantling of the vast social support system and dramatic increase in the cost of essential consumer goods. The drastic decline in living standards for the vast majority has been accompanied by the emergence of a new class of instantaneous millionaires, some on the basis of their ability in combining factors of production in new circumstances and others due to hoarding of goods under inflation, loopholes in newly enacted legislation on privatization, and personal influence with those in power.

Inflation in most of these countries gained tremendous momentum as the reforms proceeded. In 1993 alone, consumer prices rose by more than 100 per cent in 15 countries, out of which 11 former republics of the USSR reported increases of more than 300 per cent. This was accompanied by a sharp rise in unemployment from extremely low historical levels prior to 1989 up to an average of 17 per cent in 1994.

The tremendous physical and psychological stress experienced by people in the region as a result of the economic collapse is reflected in the sharp fall in birth rates and the steep rise in death rates. Since 1989, the birth rate has fallen by more than 20 per cent in Poland, 25 per cent in Bulgaria, 30 per cent in Estonia and Romania, 35 per cent in Russia and more than 60 per cent in Eastern Germany. Such abrupt changes have been observed previously in industrial societies only during times of war. Infant mortality is rising in many of the countries. Not surprisingly, there have been increasing indications of public discontent and voter dissatisfaction with the course of the reforms in the vast majority of countries.

Simultaneous Shocks

The collapse of the East European and Central Asian economies from 1990 to 1994 resulted from their exposure to a series of simultaneous shocks.

  1. Stabilization and adjustments: The majority of countries, having suffered from inflation and balance of payments problems in the 1980s, applied sharp stabilization and adjustment programmes in the early 1990s to stop inflation, balance budgets, and close balance of payments gaps, while at the same time liberalizing prices in order to correct major price distortions. These deflationary policies led, in most cases, to sharp declines in output.

  2. Resource allocation: Sudden dismantling of the central planning machinery responsible for the allocation of materials for current production and allocation of funds and materials for investment in these countries was another shock. It proved impossible in the majority of countries to create and organize, overnight, commodity and financial markets of sufficient depth and flexibility to substitute effectively for the planning machinery.

  3. Import liberalization: Drastic import liberalization led to the inflow of better-quality, lower-priced foreign goods that depressed demand for domestically produced goods. The shock impact of imports was aggravated by the fact that farmers in the region were forced to compete in some cases with subsidized agricultural products from the West.

  4. Privatization: Although the actual progress of privatization has been relatively slow in most instances, the uncertainty regarding the future status and ownership of enterprises and property has inhibited investment, slowed up current production, and led to widespread plunder of state property.

  5. Trade: As the socialist structure of these countries began to change and the political influence of the Soviet Union diminished, there was a huge drop in the trade between countries of the region, and, following the break-up of the USSR, between the republics of the Soviet Union as well.

Not all countries in the region experienced all five shocks. Those that were spared proved better able to sustain output and real incomes. Czechoslovakia had not suffered from inflation and was largely free of external debt. Hungary, which had decentralized its economy and had introduced significant elements of the market in production and investment before 1989, was not subject to the sudden shocks due to import liberalization and termination of planning.

Lessons from the Reform

The failure of the transition strategy to produce the anticipated results has given rise to extreme hardship, growing anxiety, frustration and anger within these countries. Internationally, it has generated intense debate about the reasons for the failure, the efficacy of ‘shock therapy’, and the appropriateness and adequacy of Western assistance. These questions reflect an inadequate under standing, both within and outside the region, of the stages and process and essential conditions for an effective transition under the circumstances prevalent in Eastern Europe at the time. Understanding of this failure holds the key not only to the rapid revitalization of the former Soviet and other Eastern European republics, but also to meeting the challenges of present and future transitions in Africa, Asia and the West. This understanding can be summarized in the form of several lessons that can be derived from the general experience of countries in the region.

  1. Multi-dimensional transitions cannot be brought about by uni-dimensional strategies: The economic dimension of transition cannot be viewed and acted upon in isolation from its political and social dimensions. The reform programme was developed and guided by domestic and foreign economists who viewed the transition much like a change of clothing – the casting off of one set of economic principles and the adoption of another – ignoring the critical importance of social and political factors. This view could be summed up in the often expressed attitude, ‘Good economics makes good politics!’

    Transition is the process by which society moves from one form or level of activities to another. While social scientists conveniently divide social activity into several categories – political, economic, social, educational, religious, cultural – in practice these distinctions are at best only partially true. Economic activities in any society take place on the foundation of the political system, social values and customs, and the psychological aspirations and attitudes of the people. During normal periods of slow and gradual change, the impact or role of other dimensions operates below the surface and appears minimal. Economists studying the results of economic variables tend to overlook the influence of factors from other fields on the assumption that non-economic factors are constant. Under relatively stable and static conditions, these economics principles can be employed to predict changes in economic variables to a considerable extent. But under circumstances in which underlying economic, social and political conditions are undergoing radical change, the relevance and predictive capacity of purely economic concepts is quite limited. This was the situation confronting the states of the region at the beginning of the transition period, and the reason why the actual results of the reform differed so drastically from what had been anticipated.

    The situation in Eastern and Central Europe was further complicated by the disproportionately large size and importance of the defence sector in the economy. This necessitates, not only a change from one economic system to another, but also a restructuring of the entire economy from a defence orientation to a consumer orientation. This change in structure could not be brought about by reliance on macro-economic policy.

  2. Political and social consensus is essential for rapid social change: In a democratic society, the market cannot be instituted by decrees or authoritarian methods which belong to the old sys tem. In the new political climate, reforms will be successful only in the measure that they are understood and accepted by the population. The vitality of the market depends on releasing the initiative of people to act in their own perceived best interests by producing and distributing goods and services for consumption by others. This initiative cannot be ordered, it can only be encouraged. Economic policy recommendations failed adequately to anticipate either the impact of the programme on the people or their reaction to it. In the early stages of reform, the public exhibited an incredible degree of patience, tolerance and endurance under conditions of growing hardship. Gradually public resentment and personal suffering (especially for the aged, children and new entrants to the work force) became so severe in some countries that no government could have sustained the programme without facing political upheaval or violent revolution.

    There is some truth in the argument that ‘shock therapy’ did not fail in Russia and other countries, because it was never actually implemented. At each crucial juncture either the central bank or the government pulled back from enforcing the necessary fiscal discipline. But it is equally true that ‘shock therapy’ never could have been implemented by a democratic government, when it imposed such enormous hardship on the people and generated a polarization and fragmentation of political forces within the country. Where similar strategies have succeeded in other parts of the world, it has usually been under authoritarian governments, such as in Chile.

    Where force is not possible, the only viable alternative is to build social consensus in support of the reform strategy. Ultimately, the success of the reform measures will be determined by one factor – the extent to which the people understand, accept and are motivated to act under the new system. Before introducing any new measure, maximum effort should be made to communicate its purpose and nature to the people and win their understanding and approval. Public education is the most powerful policy instrument. With public opinion widely divided over the best course of action, it is necessary to win back the understanding, support and endorsement of the population for an alternative programme which the major parties and social groups can back. This requires educating the public to understand both the costs and benefits involved in any reform strategy, the trade-offs between immediate advantages and immediate sacrifices required to establish a new and stable equilibrium.

  3. Economic strategy must be balanced: A market economy can be introduced gradually or step-wise, but it cannot be introduced in a fragmentary or piecemeal manner. Deregulation of prices was the most prominent feature of the strategy in most countries, because it was the easiest to implement. But under conditions of shortages in economies dominated by huge monopolistic enterprises, price deregulation led to skyrocketing prices and spiralling inflation. A market flourishes only when several essential conditions are met – freedom of pricing, freedom of entry and exit from industry, free flow of information, unrestricted movement of goods and services, competition between enterprises, control of monopolies, and private ownership of property. The entire package of free market practices must be implemented hand in hand, otherwise it does not work. Freeing pricing without first regulating or dismantling monopolies, promoting privatization of land and enterprises, ensuring free flow of goods, and establishing wholesale markets and multiple distribution out lets lead to speculation, soaring prices, hoarding and falling production. Historically, the free market evolved over centuries in conditions of surplus production and stable currency, neither of which exist in Eastern Europe to day. Efforts to accelerate the development of the market will have first of all to meet the political, legal, social and economic conditions historically required for its creation. And these conditions must be met simultaneously.

  4. Macro-economic stability is a precondition for increasing production: It is extremely difficult to increase production in a context of general macro-economic instability and hyperinflation. The rapidly falling value of local currencies minimized their utility as a medium of exchange. Agricultural as well as industrial enterprises seeking a stable medium in which to hold their wealth increasingly resorted to hoarding marketable, non-perishable commodities such as food grains or converting local currency into foreign money wherever possible. This was particularly devastating for agriculture, where higher production was desperately needed to meet consumer demand and reduce dependence on food imports. The breakdown of the local currency as an effective medium of exchange was accompanied by an unfavourable shift in the terms of trade between agriculture and industry, resulting from the near-monopolistic position both of the suppliers of farm inputs, especially fertilizers and farm machinery, and the processing units that purchased farm produce, such as dairies and meat processing plants. Together, these factors precipitated a rapid fall in farm production and food availability. There can be no solution to the food problem without first establishing a stable medium of exchange.

  5. Macro-level policy must be complemented by micro-level change: Putting in place the right macro-level policies may be necessary, but it is far from sufficient to create a functioning market. The governments of the region have been so preoccupied with ‘re-engineering’ their economic and political systems and with meeting the conditions to attract foreign aid and investment that they have tended to over look the many essential and practical steps needed to implement the reforms on the ground. Even if governments had been able to get all the laws and economic policies ‘right’ the first time, there is no assurance that the actual impact on the people would have been less harsh than it has been.

    The so-called ‘shock therapy’ strategy pursued by these countries has been widely criticized for its severity and seeming indifference to social costs. But debates regarding the appropriate speed and social cost of reforms divert attention from a more fundamental problem with this approach. The essence of shock therapy is a reliance on macro-economic factors to bring about a radical restructuring of the economy and a radical change in the behaviour of individuals and enterprises. While monetary policy may prove useful for dealing with short-term adjustment problems within a relatively stable environment, there is no evidence to support its use as the principle instrument for social transition. Monetary variables are indicators of the functioning of an economy, but the essential factors which determine the strength and health of an economy are the productivity of its enterprises and its workforce and the material resources of the country. Tight monetary policy can generate intense short-term pressure for change in behaviour, but this pressure is applied indiscriminately and often with unexpected and unanticipated results. The primary result of premature liberalization of prices was to encourage trade and speculation while discouraging production and investment. It distracted attention from fundamental changes in institutions and social attitudes needed for the transition to be successful.

    Macro-level policy measures have to be complemented and supported by parallel micro-level efforts to educate the population about the new economic system, to generate a free flow of information – not just freedom, but the actual exchange of information, which is still severely limited in these countries – to develop new distribution systems, to impart appropriate business and managerial skills, to provide access to credit, to build up new social institutions and to en courage and promote new enterprises. In most cities of the former Soviet Union, for instance, there is not a single whole sale market for food. There are no systems for consumer credit, no agencies in charge of promoting small business development. In the absence of these and other essential micro-level conditions, even the right macro-level strategy will not evoke the anticipated response.

  6. Government regulation is essential for a free market: A free market does not mean an unregulated one. Quite understandably, decades of totalitarian government had generated such powerful resentment against strong government that by way of re action the society sought for solutions which did not require government to take a highly visible, leading role. The reform programme was based on the implicit assumption that the market is a self-regulating mechanism which can substitute for regulation by government. This notion is contradicted by the experience and practice of every major market economy in the world. Government plays a critically important role in defining and protecting property rights, ensuring competitive conditions, controlling monopolies, regulating foreign trade, establishing and enforcing quality standards, safeguarding the rights of investors and consumers, preserving the environment from over-exploitation and pollution, encouraging investment, and upholding the rights of employees to minimum wages, safe working conditions and social security in the case of lay-offs. The policies that have made possible the most successful recent development initiatives of nations around the world, especially in Japan and the newly industrialized nations of the Pacific Rim, do not support the argument for unregulated free market forces. These countries combined freedom for entrepreneurial initiative, private property and market prices with care fully crafted industrial policies and tightly controlled foreign trade and investment practices to nurture and protect nascent industries and restrict foreign investment. At the same time, they organized the importation of foreign technology on a massive scale. They utilized import tariffs, export incentives, tax relief and other mechanisms to guide development of their domestic economies.

    The reform programme involved the dismantling of most of the administrative mechanisms by which an economy can be monitored and controlled by government. In place of free market conditions, organized crime and corruption became rampant. In seeking to reject thoroughly the authoritarian form of government that suppressed the rights of the people, many of these countries allowed the power and authority of their central governments to de cline to the point where they could no longer enforce conditions needed for operation of either a command economy or a free market system. The power of government in the West may be veiled by the fact that its laws are usually obeyed without the need for exercise of force, but the threat of enforcement is as real for tax evaders in North America as it was for free marketers under the communist regime in USSR. Regardless of the system, strong government is a prerequisite for a strong economy.

    The experience of the past few years has clearly demonstrated that the state must play a very active role in order to bring about a smooth and rapid transition and this role cannot be limited purely to regulation of the market. Intervention will also be necessary in the form of central planning and industrial policy, at least during the transition period. The radical restructuring of entire industries – defence, agriculture, aluminium, steel – is too complex and massive an undertaking to be made the responsibility of market forces and individual firms.

  7. Agriculture has to be given a special status: For reasons discussed in the previous chapter, the state has an especially important role in the regulation of agriculture. After the collapse of communism in Eastern Europe, the rise of free market and free trade polemics generated considerable confusion regarding the necessity and legitimacy of state regulation and intervention in protecting and preserving agriculture, which is the beneficiary of innumerable subsidies and supports in virtually every industrialized nation. It is ironic that advice coming from overseas almost invariably recommended eliminating sup ports to this critical sector of the economy. In the midst of radical economic revolution, the economy, especially the agricultural economy, is in no position to adapt simultaneously to the dual stresses of internal reorganization and external competition.

  8. New institutions and systems are needed to create a market economy: The establishment of a free market system is retarded by the absence of many basic commercial institutions and systems. The market economy has given birth to a vast array of institutions by which, and through which, it operates – stock and commodity exchanges, systems for mass production, just-in-time inventory management, commercial insurance, franchises, mail order catalogues, courier services, feeder airlines, producers’ and consumers’ cooperatives, marketing boards, export pro motion agencies, leasing, venture capital and mutual funds, credit and collection agencies, commodity brokers, real estate agents, trade unions, industrial associations, industrial estates, exclusive export processing zones and countless others. Our knowledge of transitions will be complete and our capacity to abridge the time and costs of change will be full only when we have come to understand the role of these institutions and have found ways to develop them rapidly.

    The need for new institutions in Eastern Europe is apparent in all fields of commercial activity. It is particularly acute in agriculture. Hoarding, speculation by traders, regional shortages and price variations have been aggravated by the absence of alternative systems of distribution to replace the old centralized food procurement system. Privately operated commodity exchanges have sprung up to handle wholesale transactions. But unfamiliarity with such institutions, and the lack of a firm legal basis for enforcement of contracts and a system of grading and inspection to guarantee the quality of produce traded, have kept most buyers and sellers away. A mechanism is needed to insure distribution of food to deficit areas, to guarantee farmers an indexed floor price for foodgrains under conditions of unstable, soaring prices, and to establish and maintain a national buffer stock against emergency. The Indian Food Corporation and Indian National Dairy Development Board, the autonomous marketing boards in the UK, and the US Commodity Credit Corporation are model institutions from which the Eastern Europeans need to borrow, adapt and innovate to suit the conditions of vast food-deficit nations.

    Simple commercial systems need to be created to support commerce and industry as well – even such basic systems as telephone listings of sources of products and services that are found in every telephone directory in the West. If trade is to develop between private enter prises, credit checking agencies and collection agencies need to be established. For enterprises which do not qualify or cannot compete for limited bank resources, financial institutions offering hire purchase or leasing of industrial and consumer goods are necessary. The market reforms were expected to lead to a rapid proliferation of new small enterprises, but most of those created so far are engaged only in trading and retail sales. Small business development centres, business incubators, industrial estates, and venture capital funds are needed to encourage entrepreneur ship. Some large industrial enterprises have begun leasing portions of their space and equipment to groups of employees who form small businesses for production of equipment and components. This practice should be encouraged and popularized as a natural step towards privatization.

  9. Information is a stimulant and fuel for transition: The shortage of reliable in formation and of institutions to disseminate it are major constraints on the development of the market. In a command economy, a few people at the top receive most of the information and take most of the decisions, while the rest of the population carries them out. In contrast, the market is based on millions of decisions taken every day by millions of individuals in fields, factories and retail stores around the country. All these decision makers require timely access to re liable sources of information. Information is needed to make sound business decisions, such as the production of or demand for different commodities or variations in price by region or over time. Easy access, maximum dissemination, full disclosure, precise accuracy and credibility are imperative. Creating these conditions will require the establishment of new institutions and substantial investment in infra structure. In many of these countries, the press has freed itself from being solely an instrument of government, but television is still largely under state control. In the entire former USSR today there is no adequate agricultural extension service to transmit research findings from the laboratory to the field, especially to small private farmers. Poor communications systems are incapable of handling the large volume of telephone, fax, telex and computerized messages needed for commercial linkages with other countries.

  10. Catalytic initiatives can release social dynamism: Social change is facilitated and accelerated by initiatives to introduce or demonstrate new patterns of activity and behaviour appropriate to the goals of the transition. One of the most successful initiatives of the Russian government in recent years has been the distribution of millions of small private agricultural plots to urban and rural households. Since a food shortage in the urban areas was the most pressing problem and greatest source of anxiety for the population, the government took steps to distribute more than 16 million small private plots to urban and rural families, so that highly vulnerable households could produce at least a portion of their own food requirements. These plots now account for more than 50 per cent of vegetable production and 80 per cent of potato and fruit production in Russia. Transitions require changes in behaviour and the private plots became an activity in which millions of people could participate in order to augment their own living standards and alleviate national food shortages. Similar catalytic efforts are needed in other fields to engage the population actively in new and improved activities.

  11. Reduce reliance on foreign aid: The prospect or lure of foreign aid has itself become an impediment to successful transition. In order to qualify for foreign assistance, these countries have overlooked the vast under-utilized resources available domestically, rejected the knowledge and advice of their own most experienced people in favour of foreign advice, sacrificed their most cherished social values, discarded even successful institutions and systems, and taken steps which, it was painfully obvious to many within these countries, could not possibly lead to the intended results under the prevalent conditions. In the 1950s, the Soviet Union man aged to recover from the horrendous destruction it suffered during the Second World War and to embark on a period of rapid industrial growth without any external assistance. But today, without having passed through the ravages of war, the republics desperately seek foreign support and feel helpless without it. It is right that the world community should generously support the successful completion of the reform process in this region that is so vital for world peace. But it is also right that these countries should recognize the enormous untapped potentials which they possess – human, natural and productive – rather than be distracted by the prospect of a large in flux of foreign capital.


The extreme damage wrought by the economic reform programme in these countries over the past half decade necessitates an urgent search for more viable alternatives, a search that has been retarded until now by the widely held view that none exists. Very recent events in Yugoslavia suggest that even in the limited area of economic stabilization and adjustment, an alternative strategy can be more successful. Although the long-term impact of the Yugoslav experiment is an yet unknown, its remarkably positive initial results merit serious consideration.

The economic disorder that accompanied recent political developments in Yugoslavia resulted in an explosive increase in prices of more than 100 per cent per month in 1992. Despite efforts to control monetary expansion, hyperinflation exceeded three million per cent in 1993 - far higher than the inflation rate reached in Germany following the First World War and, quite probably, the highest rate in recorded history. The price spiral was accompanied by a steep fall in real purchasing power by as much as 75 per cent. The budget deficit increased rapidly as the value of government tax revenues fell further and further behind the rising cost in current terms of its expenditures, due to the time lag between tax declaration, collection and expenditure in a period of very rapid price increases.

In January 1994, the government embarked on a comprehensive monetary reconstruction programme to achieve price and exchange rate stability; to remove administrative controls over production, investment, prices, salaries, and interest rates; to re-establish the role of the central bank in monetary stability; to reorganize public finances through an efficient tax system, including more efficient tax collection and better coverage of the lage `grey' economy; to reduce government administrative and defence expenditure to the maximum possible extent; to maintain price supports for important agricultural commodities as an incentive for production; to stimulate economic activities of private, cooperative and public sector enterprises through equal access to credit and government facilities; and to encourage the takeover of sick firms by stronger, more efficient companies. At the same time, the programme was intended to mitigate the harsher effects of shock therapy programme was intended to mitigate the harsher effects of shock therapy programmes on the working class and fixed-income pensioners by providing free scope for collective bargaining, enforcement of a minimum wage policy and a social safety net for the unemployed.

It was recognized from the outset that stability of the currency was an absolute precondition for the success of the reform programme, which depended in turn on the firmness and consistency with which it was implemented. The central element of the programme was the introduction of a new currency, the `superdinar', in parallel to the existing currency, but without demonetizing or confiscating it. Inspired by an experiment in the Soviet Union during the 1920s, the value of the new currency was tied to that of the Deutsche Mark and made fully convertible without restriction. Based on the country's very limited foreign currency reserves, new issues of the currency were to be utilized primarily to inject real purchasing power into the economy, revive demand and stimulate production, while covering the government's budget deficit during an initial six-month period needed for sufficient recovery. In this way the foreign currency and gold reserves were used as a buffer to moderate contraction of the money supply and avoid the shock usually accompanying such efforts. Issuing of the old dinar was stopped, but it remained in circulation as legal tender. An interest rate of six per cent was established for the superdinar - the first real, positive interest rate in years - to make holding the new currency an attractive alternative to hoarding goods or foreign exchange. It had been widely anticipated by foreign experts that this strategy would result in an immediate run on the country's foreign reserves and thereby a collapse of the new currency's foundation.

Contrary to expectations, the initial months of the programme have yielded spectacular results. Inflation fell to zero per cent in the first week after the issue of the new currency and remained below one per cent during the first five months. Instead of a massive outflow of foreign currency through conversion of superdinars, people have rushed to cash in their foreign currency, resulting in a 60 per cent increase in the nation's reserves during the first three months. One of the most significant features of the programme has been its fair distribution of benefits and low social cost to the population. In contrast with the widespread outrage felt by Russian citizens over repeated episodes of demonetization and confiscation of household savings, the Yugoslav people have enthusiastically accepted the new currency as representative of a new deal for the poor and the working class. In addition, instead of the severe contraction of output experienced elsewhere, production rose by more than 100 per cent during the first five months, stimulating an increase in employment and demand for new investment. Real tax revenues have increased significantly.

The astonishing initial success of the programme can be attributed to its balance and comprehensiveness, and to the following specific features: the government's recognition that stabilization was absolutely essential to economic recovery; the widespread public support for the programme, which was in large part due to the efforts to protect weaker sections from its harshest effects; the simultaneous relaxation of controls on industry; support for a natural rather than a forced process of privatization, based on the specific circumstances of each firm rather than on ideology; continued price supports for agriculture and a minimum wage for labour, which are crucial for maintaining food supplies and social stability; and rejection of import liberalization in order to protect domestic manufacturing against a major shock during the initial period of recovery. Possibly the greatest strength of the Yugoslav programme is that it was of necessity conceived by people within the country rather than by foreign experts, and depended entirely on domestic resources and capabilities for its accomplishment, rather than on pleas for foreign assistance. Self-reliance released the creativity, generated the determination and mobilized all available resources to make the transition successful.

It is too early to predict the eventual outcome in Yugoslavia, subject as it is to extraordinary external constraints on public policy. However, the initial evidence is sufficient to demonstrate that alternative approaches can and must be fashioned which are more comprehensive in scope, more balanced in implementation, more pragmatic in conception and less influenced by extreme ideological viewpoints. It is likely that further study of the Yugoslav model will reveal important applications not only for countries suffering from hyperinflation or the effects of radical transition, but for those carrying out more modest programmes fo economic reform.

Recommendations for Accelerating Transition in the East

Conditions within the 25 nations of Eastern Europe and Central Asia vary significantly enough to limit the scope for broad generalizations on strategy beyond the statement of principles presented in this chapter. However, there are a number of specific recommendations applicable to all or most of these countries that can be applied to accelerate the pace and ease the pain of transition.


Generate consensus for the transition programme: The transition should be an expression of the will of the society for change and it should help generate greater unity and harmony within the society. Further attempts to put through any macro-economic reform package will meet with strong political and social resistance unless a national consensus on the strategy is arrived at beforehand. Any programme involves a set of choices regarding which are the most accept able costs and important benefits. Before launching new initiatives, governments should conduct public inquiries and debate alternative packages of policies and practices. The inquiry should realistically access the expected costs and benefits of each package. After educating the public about the need for choice and the necessary costs involved, the final selection of the most accept able package should be made by the people themselves through a national referendum.


Establish macro-economic stability: The errors in earlier efforts at adjustment and stabilization have led some to argue for a series of compromise programmes that do not seriously ad dress the imminent dangers of hyperinflation and economic collapse. No transition strategy can be successful without first creating stable conditions for economic growth. No effort to improve agricultural production or the availability of food will be successful so long as the currency is not accepted as a stable means of exchange. This is the ultimate justification for the insistence of the international lending community on harsh measures to stabilize the economy. If the previous stabilization programmes have not proved politically viable, socially acceptable or economically effective, alternative programmes similar to the Yugoslav strategy must be attempted without further delay, backed by the full commitment of government. In some cases, it may be necessary to temporarily reintroduce controls on wages and prices as an interim measure to stop the free fall of the currency. But whatever the method, it is essential that this effort be combined with simultaneous implementation of other essential policies.


Eliminate crop losses: In Russia and the other republics of the former USSR, highest priority in agriculture must be given to efforts that will increase the availability of food and reduce the huge crop losses and massive food imports. These losses vary by crop and region but average between 25 and 50 per cent of total field production for major crops. A reduction in crop losses could completely eliminate millions of tons of grain imports. The reasons for such enormous losses include poor quality of seeds and planting material, the lack of sufficient local storage capacity, in efficient and inappropriate equipment for planting, harvesting, storage and processing, poorly motivated farm workers and short age of labour at harvest time. Demonstration projects have proved that potato losses can be reduced from 35 per cent to under 5 per cent in one year. A viable solution requires concerted and coordinated activity by government, industry and agriculture at a time when each is operating in isolation from the others.

The main elements of a viable plan to reduce losses for foodgrains, vegetables and potatoes have been proposed by a Dutch cooperative agri-business firm. The aim of the plan is to reduce food imports to zero and eliminate food shortages within three to five years. The plan requires acquisition of foreign production and storage technology, but depends only marginally on import of equipment, most of which can be manufactured in domes tic defence facilities. The hard currency requirement is minimal. But the plan does re quire a leading role by government and financial assistance to farms. In order to be effective, it needs to be supported by a massive public education campaign on use of new technology to eradicate crop losses combined with demonstration plots on both large-scale and small private farms throughout the country. The Commission recommends immediate implementation of the plan with the objective of improving the agricultural economy, increasing the food supply and completely eliminating dependence on food imports.


Study benefits of economic union: Of the estimated 50 per cent fall in GDP among the republics of the former Soviet Union, approximately half can be attributed to the break-up of the economic union. Restoration of a common economic space – which is being criticized internationally as a surrender of sovereignty to Russia at a time when both Western Europe and North America are striving for closer economic union – could immediately restore most of that lost output. The advantages of cooperation between republics needs to be care fully examined. A study should be conducted by a credible institution to estimate the economic losses incurred by the break-up of the common economic space between the former Soviet re publics and to assess the benefits of restoring an economic union in some form. It should estimate overall economic growth and living standards for each republic over the next five years operating within and outside the economic union. This study can serve as a powerful argument for closer cooperation among the republics. The study can be undertaken at very low cost by a consortium of researchers from different research institutes within the Commonwealth of Independent States.


Privatize and develop road transport: Transportation is a major bottleneck to development of a market economy in much of the region. Under the centrally planned system, most freight was hauled by trains over main routes to large cities for distribution in bulk by huge government procurement agencies. Under a market system, millions of small producers and consumers must be free to buy or sell wherever the price is most attractive. This requires a vast proliferation of small goods transporters in the private sector, which are rare in many countries today. The large freight transport monopolies have to be replaced by entrepreneurial companies with small fleets competing for freight business. Immediate steps are needed to expand capacity and introduce competition in this vital sector by promoting the development of private road transport companies at the national, regional and local level. Special loan and leasing programmes should be established to enable small firms and individuals to purchase vehicles and pay for them out of the revenues generated from use.


Regional models and pilot programmes: Pioneering initiatives need to be encouraged to act as demonstrations and catalysts for new types of activities in the country. In a region as vast and diverse as this and in countries such as Russia, which extends over eleven time zones, no single model or pattern will be widely applicable. Therefore, several areas in each country representing different economic and social conditions should be selected for establishment of model transition programmes. In each area, a study should be conducted of resources and economic potentials, existing institutions and infrastructure, current levels of skill and social attitudes regarding the market system. Detailed strategies should be devised to educate the public about untapped opportunities, strengthen the institutional infrastructure, impart needed skills, establish catalytic demonstrations and encourage multiplication of successful new activities. A plan should be adopted at the forthcoming UN Social Summit for establishing model district programmes in Eastern and Central European countries. Plans for transition should cover all of the factors listed above, providing trained personnel to assist in the establishment and initial operation of new institutions and systems.


Plan for institutional development: An assessment of the type and functioning of existing institutions and economic systems should be compiled to identify missing links that need to be provided to support the transition. Based on this study, a master plan should be drawn up for establishing the necessary institutions and systems in each country. In order to prepare a cadre of managers for private sector industry and institutions, specialized institutes of management should be set up in each country.


Launch a massive programme to impart new skills and attitudes to the population: In countries where private enterprise was extinguished for decades, entrepreneurial, financial and marketing skills can be extremely limited. An analysis should be undertaken of the types and levels of skills needed for transition to a market system, covering areas such as entrepreneurship, management, national and international marketing, strategic business planning, finance, quality control, product development, production technology, design, and human resource development. Experience in former colonial nations where entrepreneur ship was also stifled for a long period indicates that a profound change in attitude is necessary before people will risk leaving or forego seeking salaried and pensioned jobs in favour of self-employment, even when the salaried jobs are scarce or unavailable. Such a basic change of attitude, which normally requires a change of generation, can be accelerated by a massive programme of public information, education and demonstration spanning several years.


Study the benefits of economic recovery on world trade: Recessionary trends are affecting many parts of the world today. The prognosis in the West, especially in the European Union, is for slow growth during the 1990s. The progress of developing countries is impeded by slow growth in the industrialized nations and the collapse of Eastern Europe. What would be the impact on the world economy of a rapid recovery and economic expansion in the countries of the region? What would be the result elsewhere of further decline in Eastern Europe? These questions are of vital relevance to the entire world. A detailed study should be conducted under the auspices of the United Nations, OECD or the European Commission to quantify the potential gains or losses to the global economy of rapid or slow progress of the transition in Eastern Europe and Central Asia.


Scientific resources: Science has been one of the greatest casualties of the reform programme. Severe fiscal constraints have forced governments to reduce drastically budgetary allocations to research institutions, leaving most of these institutions with little or no source of revenues to support their activities. High priority must be given to developing a detailed plan for preservation of the scientific research infra structure during the difficult transition period and for restructuring it so that it can be integrated effectively into the emerging market system. The drain of talents must be stopped by a concerted national effort to exploit each country's competitive advantage in science by marketing these capabilities internationally, and particularly by linking up with other countries in the region and with developing countries that can most benefit from the region's scientific and technological capabilities.


Search for a New Model

Ironically, despite all the international debate about transition, thus far the actual goal of the transition process has never been clearly spelled out. It is widely presumed to be to some form of capitalist system, but which variety – the Swedish? The Japanese? The American? Although the ostensible goal of transition has been to economies based on private ownership, three years after the initiation of transition programmes, very little privatization has actually taken place in most countries of the region. It is widely believed that acceleration of this process will lead to rising unemployment and a widening gap between the rich and the poor, leading to the creation of a huge under class that had been virtually eradicated in previous decades. Is this result really the best these countries can hope for in the foreseeable future?

The events in Eastern Europe have been widely hailed as a victory for democratic capitalism over authoritarian communism. The obvious failure of the latter has been used to support the claim of the former to be the sole political and economic heir to the next millennium. This view has been applied to justify the imposition of radical shock therapy on the unsuspecting and unprepared populations of Eastern Europe and stringent structural adjustment programmes on many developing countries. But the claim itself is based on a limited and superficial interpretation of history.

The fall of the Berlin Wall marks the end of a confrontation between two divergent systems that have been struggling toward reconciliation throughout the present century – one based on the human right to freedom and the determinism of the free market, the other based on the right to basic economic security and the determinism of the state. One has made people subservient to the needs of the state, the other has left them subject to the whims of the market. True communism has never existed. What lived and has finally died in Eastern Europe is not communism, but statism, the domination of the state and use of state authority to govern the life of the nation, in practice reducing people to forced labour. True capitalism, which regards people as a factor of production, passed away more than half a century ago, when the challenge of communism prompted Western societies to incorporate socialist principles and measures to mitigate the blind justice of the free market. There are no true capitalist societies in the world. There are no free markets. The free market system is highly regulated and controlled by the very state over which it claims victory. But although in reality both systems are dead, the ideology of the capitalist system lives on and casts an illusory impression of supremacy.

Rather than searching for a victor and vanquished, the urgent need is to find a successor that combines and synthesizes the enlightened values of both systems – freedom and equality, liberty and security. It has been amply proved that the authoritarian state is incapable of exerting a benevolent authority over the people without imposing severe restrictions on freedom, stifling human energy and creativity, leading sooner or later to rising discontent and a loss of social vitality. It is also abundantly clear that money as an institution operating through the free pricing mechanism of the market system – although it does succeed in generating high levels of energy, creativity and productivity – regards people as a purchasable commodity or a potential market, but is otherwise indifferent to human values and welfare. Neither the determinism of the state nor the determinism of the market can be adequate in themselves to achieve the goals of peace and prosperity that we strive after.

It has been generally assumed that the transition now taking place in Eastern Europe will sooner or later lead these countries to adopt forms of government and economy identical to those prevalent in the West. But for those raised in a society that offered a great measure of social security, the poverty and insecurity of the Western system are gross inadequacies. While it is clear that these new democracies have rejected the authoritarian statist system, it is not yet clear what finally they will accept, discover or invent as a more acceptable alternative. The creativity and inventiveness they have exhibited in seeking an alternative in the past may quite possibly lead them to discover that better social system which both East and West are in need of.

Viewed from an evolutionary perspective, we may surmise the general direction and likely destination of that quest. The requirements of the state and the market must eventually give way to the needs of people. The values of authority and money must be supplanted by acceptance of the fundamental value of the human being. Human welfare and well-being must become the central determinants of social policy, in place of the compulsions of the centrally controlled state bureaucracy and the decentralized market pricing mechanism. The first essential step in that direction is a commitment by market economies to guarantee the right of every citizen to employment. Neither the mechanism of state planning and control nor the mechanism of market prices can accomplish this on their own. A blending of their values and methods – freed from the blinkers of dogma and the determinism of limited imagination – can lead us to the answer.

Wider Perspective on Transitions

The outcome of all great social transformations – of which the present instance ranks in magnitude and importance with that of the French Revolution and the movement which freed India and so many other former colonies from imperialism, economic exploitation and cultural domination – depends on the degree to which individuals and institutions within the society have been prepared to understand, accept and respond to the new environment ushered in by the transition. Two hundred years ago the people of France were ready to overthrow the old order but ill-prepared to create anything new, with the result that the old soon re-established itself and lived on for another century. It took India’s leaders more than four decades to prepare their people for freedom and it has taken another four to overcome the vestiges of colonial rule that prevented the country from releasing its energies for prosperity. Long after the foreign conquerors had left, colonialism lived on in the institutions of government and in the attitudes of the population. Decades of freedom and education were needed for the country to outgrow a sense of inferiority, a seeking for security, a feeling of submissiveness and complacency, and to acquire a sense of pride, ambition, high aspirations and expectations, a seeking for achievement, and a spirit of adventure and enterprise – and still the task is not complete.

Development is like a chemical reaction that is determined by the variety and quantity of elements present and the conditions under which they are put together. If one essential element or condition is missing, a social transition like a chemical reaction may not take place at all. The absence of peace in war-torn Africa or democratic freedoms in former colonial nations, the absence of social stability or an entrepreneurial class, the absence of a functioning banking or educational system, the absence of the minimum necessary infrastructure for transportation and communication – any one of these may be enough to prevent transition until the deficit is made up. If even an inessential element or condition is missing, the process of transition may take much longer than would otherwise be necessary. Lack of information, lack of education, lack of necessary skills, lack of supportive laws or incentives or protection against losses – insufficiency in any of these areas may be enough to slow or delay the process of change by years or even decades.

The world needs a coherent intellectual framework for under standing and dealing with radical transitions. High priority should be given to developing a fresh conceptual approach that is not en cumbered by allegiance to existing theories and systems. Transitions should be regarded as social transformations which depend on and result in corresponding changes in the political, economic and other spheres. Efforts to guide a multi-dimensional social transition through uni-dimensional strategies, particularly those limited to manipulation of macro-economic policy, are unlikely to yield the anticipated results. Even those transitions which are apparently confined to economic activities within a stable political context necessarily depend on changes in social attitudes and in social institutions which can be dealt with most effectively by assuming a wider perspective of the process. Clear visualization of the before and after states of transition, the existing system, the goals to be sought after, and a detailed picture of the changes that need to occur in behaviour, attitudes and institutions are necessary for deriving the most effective transition strategies.

With the knowledge the world possesses today, with the example of many successful nations over the last four decades, and with its highly educated and motivated people, surely the nations of Eastern Europe and Central Asia can abridge the time required and the hardship of lessons learned by trial and error to a few years. But this cannot be accomplished by sweeping remedies or hastened by over-eagerness or impatience. It will require application of a profound understanding of the process of development and transition. We believe that a properly conceived effort to draw on the best available knowledge and experience of other countries can generate a transition strategy that avoids the dangers and pitfalls of the initial approach to reform and puts in place the essential foundations for the new system to function effectively and generate benefits for the people before the dawn of the new century.