1 The Journey
The symbolic representation of the fall of the Berlin Wall on November 9, 1989, began a steady and dramatic process of political and dynamic change that totally transformed Europe and in the process created a framework of a âbrave new worldâ, which few would have thought possible in the aftermath of the Second World War. The emerging economies of Central and Eastern Europe wanted to improve efficiency and productivity through creating new market structures but also to integrate with the global economy via trade and foreign investment which would catalyze their moribund economies. By 1990, the process had become irreversible, particularly with German reunification and the removal of the ancien regime in most countries. The dissolution of the economic and trade framework of the Council for Mutual Economic Assistance1 (CMEA often called the Comecon) was the final blow to the trading arrangements of these countries that had bound them together in the post-war period under the political and economic hegemony of the USSR. Effectively, export and import trade, technology transfers as well as foreign investment with the European Union (or the European Economic Community, EEC, as it was then called) took over the external economic framework of the former communist economies.
This book is a detailed analysis of structural change in the face of high trade growth by the Central and Eastern European Countries (hereafter called the CEECs). We are interested in the trading relationships, but go far beyond trade. Later, we describe the structure of this book. How do we define our country set? There are different definitions for the region. The World Bank defines Central Europe as: Bulgaria, Croatia, Czech Republic, Hungary, Poland, Romania, Slovak Republic and Slovenia. The International Monetary Fund (IMF) classification of Central Europe (CE5) is the following: Czech Republic, Hungary, Poland, Slovak Republic and Slovenia. In addition, the IMF has defined separately Southeast Europe EU members (SEE EU) as Bulgaria, Croatia and Romania.
Our CEECs are Bulgaria, Czech Republic, Hungary, Poland, Romania and the Slovak Republic. Central Europe is unambiguous. Bulgaria and Romania have complex individual and developmental issues compared to the rest of the designated countries and can usefully be termed as Eastern Europe. Further, historically in the 1990s, these six countries were at the forefront of political and economic reforms and were the earlier countries to request educational and cultural support for their newly formed societies. We have left out Slovenia and Croatia since they were members of the former Republic of Yugoslavia and therefore have some unique historical inheritance that does not necessarily fit in with the other countries. Hence, our group consists of the CEECs in most of the book. Much of our applied analysis can be utilized broadly for other countries such as the Commonwealth of Independent States (CIS), but the details apply to our six specific cadet countries.
The political costs were not negligible with the dissolution and civil war in the former republics of Yugoslavia, and the âvelvet divorceâ of the Czech and Slovak republics (from the erstwhile state of Czechoslovakia). The economic costs at the initial stages of the creation of the new economy were also substantial with years of recession, unemployment, open inflation and social crises. These were mostly in the nature of sunk costs, which independent of success or failure of the economy-building process would be lost forever and could not be recouped. Some of these costs were in the nature of fixed costs, including the rise of inequality and social disruption, which would continue for a long time. Whatever the âmodelâ used for the creation of new markets and structures, often called a choice between âshock therapyâ and âgradualismâ, the socio-economic costs would have been substantialâthere seemed to be little developmental light at the end of the economic tunnel. However, these countries persevered and by the turn of the decade of the 1990s, most of the economies that we analyze here had emerged from the tunnel into a new socio-economic dawn, and produced more prosperous and stable societies. The first period, that of âtransitionâ, was effectively completed by the end of the decade.
The main impetus was trade and its re-orientation from a trading bloc mainly serving strategic and geo-political interests (the CMEA and the Warsaw Pact) towards a more open trading system based on revealed comparative advantage. There has always been some symbiotic relationship between political and military alliances, economic development and international trade. The formation of NATO, the impetus behind transatlantic trade, the interrelationships of the European economic union and the strategic interests of the major European power are evidence of this type of relationship. But the former Soviet-based economic system of the CMEA and the Warsaw Pact went much further in stifling innovation and productivity, and therefore tended to become increasingly inefficient. When it collapsed, mostly due to its internal structural weaknesses, the former members in Eastern and Central Europe had a ready-made alternative. The logic was simple: initiate trade with (Western) Europe, create markets that will allow the continuation of such trade, build institutions that will facilitate that type of open trade and by having access to the largest homogenous market in the world increase productivity and efficiency leading to higher growth. Adam Smith emphasized that productivity was based on division of labour and specialization; but division of labour was possible and enhanced by the size of the market. As Smith (1789) so succinctly explained:
âAs it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market.â (Smith, 1789). This was the essential logic that the CEECs followed, but without central planning or directives, through the global market mechanism.
Transition began first with macroeconomic stabilization with the control of recession and fiscal imbalances; next, the related issue of the control of inflation as price and wage liberalization unleashed a wave of (hyper)inflationary pressures after decades of artificially imposed repressed inflation. Once growth had returned to reasonable levels, structural reforms beginning with small-scale privatization moving on to large-scale privatization of major state-owned enterprises (which essentially meant the whole industrial and manufacturing sectors) had to be carried forward. This process of course did not end with the decadal period of transition (the 1990s) and is still continuing, as we shall see later. Other structural reforms in the form of competition policy, trade and capital flows opening up, as well as governance and enterprise restructuring, moved more slowly but steadfastly in a positive direction. IMF (2014) emphasizes the five major objectives of the policy programmes that underpinned transition in the 1990s. First was macroeconomic stabilization; second was price and wage liberalization as well as liberalizing the current account and allowing convertibility of the domestic and international currencies for trade; third was enterprise reform, which was initially essentially a matter of privatization; fourth was the strengthening of social safety nets, which were of paramount importance in the former socialist regimes but could get lost in the zeal for creating a market economy; and finally, there was the development of institutional and legal frameworks based on ensuring property rights. We add a sixth policy objective: the support for international trade and its expansion as the sine qua non of economic growth for the future. To sum up, the requirements were: Stabilization of the macroeconomy including the external sector; Liberalization of prices, wages and interest rates; Privatization of enterprise and business as well as deregulation; and the Creation of new and missing markets. Later in the book, we term them as SPLC.
The political change was so rapid, fundamental and earth shattering, that policy makers had to make quick decisions and the policy debate was remarkably compressed, much more so than in a previous period of decolonization in developing countries that had faced similar dilemmas in state-building and economy-building. Blanchard et al. (1994) describe how it was believed by the local elites that microeconomic transition (privatization of state-owned enterprises or breaking up state monopolies) would have to be done rapidly while macroeconomic transition (price liberalization, current account convertibility, fiscal balances) would be very gradual. In effect, the policy cycles were reversed. Growth stagnation and high inflation (after years of repressed inflation) meant that macroeconomic challenges were imminent and hard choices made, affecting the lives of millions, would have devastating effects. The consequences were high: structural unemployment, stagflation and hyperinflation, removal of social safety nets and concomitant social deprivation.
The process therefore was not smooth; there were many road bumps on the way. International factors, including the series of financial crises (from Mexico to East Asia to Russia) in the second half of the decade had indirect but negative impact on regional economies and some threat of contagion remained. The European economy was not doing so well in the first half of the 1990s with currency crises and the burden of German re-unification. Overall, however, by the end of the 1990s, and the start of the decade of the noughties (2000 onwards), transition had effectively been accomplished. The journey then moved on to transformation where growth rates accelerated, structural reforms moved to levels approaching that of Western Europe and international trade, buttressed with foreign direct investment, became a major catalyst for growth and development. The prospects for accession to the European Union, and the detailed and often painstaking negotiations associated with the EU acquis communautaire (shortened to EU acquis hereafter) and its thirty-one chapters, which the central and east European countries needed to incorporate into their legal, social, political and economic structures, accelerated both economic growth as well as institutional reforms. In a sense, growth and institutions became complementary facets of the transformation process. The transformative role of the European Union was the great motivating force behind these positive changes. The European Union became, ...