The Political Economy of Transformation

The last years economics has been confronted with a new puzzle: the transformation of an economic system. The profession has enthousiastically adopted the challenge and produced a flood of publications. The question of objectives, of the final state to be reached has been treated extensively. The system elements or institutions which are required to support a fairly efficient market process are rather well known. There is much less unanimity in the profession about the process of transformation, the sequencing of steps, the pace, the appropriate procedures to liberalize, to monetize and to privatize. Of course, economic theory has been preoccupied with comparative statics rather than with dynamics. But dynamics in itself is less accessible for general theory in that the process, other than its objectives, is highly dependent upon the historical initial conditions which differ from country to country.

Convergence theories of the sixties and seventies predicted that the two rival political economic systems would more or less rapidly assimilate each other and inevitably move toward each other. The East was to be enriched with market elements, while the “mixed” economic order of western capitalism had already adopted elements of state intervention into production and distribution processes. The problem with this theory, as is now becoming apparent, was that only the West was capable of “mixing”, whereas the socialist societies were constantly on the verge of “capsizing” through concessions made to political liberalization (party competition, freedom of opinion), national independence, decentralized forms of ownership, and competitive price formation, to say nothing about “economic democracy”. Western admixtures were regularly taken back. Everywhere the self-transformation of socialist societies foundered on the political elites’ justified fear of downward paths. The “oil-spill thesis”, which predicts that the entire system will be spoiled when just a single “alien” element or move is introduced, turned out precisely not to apply to those systems for which it was meant to hold true in the twenties by von Mises, i.e., western capitalist democracies. All the more clearly, however, was it corroborated for the state socialist regimes. As is shown by the results of the debates of the sixties and seventies over economic reform in the eastern block, these regimes did not manage to incorporate their opposite principle in both sufficient and harmless dosage.

Imagine a market economy operating like a network of micro-computers and a socialist economy being represented as a system which basically consists of one single mainframe with a hierarchical and centrally administered structure determining what users are allowed to produce and to exchange with each other. The transformation of a socialist to a market economy is like changing simultaneously the operational system and most of the software running with it, especially those for administrative governance. Considering the hardware and its operational software as the constitution of the computer, the transformation has to deal with two problems: First, it is fairly unclear how to split up the mainframe and how to reconstruct the resulting subunits into smaller independent workstations. But decentralization and reregulation involves envisaging the network configuration of the new system. Second, the reforms must be implemented while the old system is continuously active, which means that its routines cannot be simply deleted or easily downloaded. The system imposes severe restrictions on software manipulation and is fairly resistent against interrupts that allow for specific interventions. Furthermore, there is no way to turn the system temporarily off.¹ Only parts of the programs and of the equipment can be removed or replaced, of course, with a risk of triggering chaotic behavior or losing control because of partial system breakdowns.

According to the historian Perry Anderson (1962: 161), convergence is a striking feature of modernity:“the enormous reduction in the number of discrete forms of society under the impact of modern capitalism: above all, from the extraordinary variegation of primitive cultures, to the lesser number of religious civilizations, down to the global uniformities of industrial living today; but also from the formidable diversity of pre-capitalist relationships of production and power, to the relatively stark simplicity of the institutional map of the contemporary world” . This essay is concerned with one aspect of convergence at the level of countries, namely, the growing similarity (if any) of formal rules with respect to the economic process in capitalism (cf. North 1990: 4, 36, 47).

The transformation of socio—economic systems is the outcome of complex changes in institutions and economic and non—economic variables. Transformation can take place in different ways (cf. Wagener 1993), provided that changes in various areas are mutually compatible, that other elements of the socioeconomic system adapt, and that barriers to change are overcome.

In 1989 economic theory found itself confronted with an explicitly formulated demand: new East European governments started to look for its help in designing a virtuous sequence of transformation measures.

The transition from a communist economic system to a market economy raises numerous issues. One of the trickiest problems is the rearrangement of the public finance system. The traditional base, the publicly owned enterprises, is crumbling, and revenue sources have to be sought elsewhere.

The main target of fiscal adjustment in a distorted market economy is associated with the elimination of inflationary pressure stemming from persistent fiscal deficits. Owing to unsustainable public debt, sooner or later such a deficit cannot be financed in a non inflationary way. The monetization of deficit and imposition of inflationary tax leads to the acceleration of inflation and further deterioration of the fiscal stance (Calvo 1988). Such developments turn against the allocative efficiency and ultimately against growth. In the case of transition economies the situation is quite similar, although there are some specific features, which have to be taken into account (Kopits 1991). The structure of revenue and expenditure in the centrally planned economy (CPE) had significantly contrasted with that of market economies (Chand and Lorie 1992). The main source for the budgetary revenue had been the state firms with only a minor position of direct taxes from the private sector and the households. The bulk of expenditure was linked to the heavy subsidies supporting real income of the population and to the subsidies provided to inefficient state enterprises, although the real burden of the latter is often overestimated.

Poland was the first of the former socialist countries to launch a radical programme to transform its economy. The shock therapy, implemented on the 1st January 1990, was intended simultaneously to achieve macro-economic stabilisation and to facilitate the structural adjustment of industry. An ambitious programme of privatisation was intended to accompany this transformation process, redistributing property rights and reducing the importance of Stateowned enterprises. A second aspect was to be the emergence of a new private sector. This would contribute to increases in supply and employment of the redundant work force and speed the transformation of the industrial structure by enhancing the development of new sectors.

Since the Chinese economy achieved exceptionally high growth rates in the somewhat sluggish world economy, many observers now regard China as the new economic miracle of the 90’s (The Economist, 1992). This should be a disturbing observation for the mainstream theory of transformation since the Chinese government neither underwent a democratic revolution nor pursued any systematic policy directed at the transition to the market. Although the 14th party congress in 1992 followed the Dengist line that the market economy is not “capitalist” by necessity, the centaur of the so-called “socialist market economy” is not only the ideological umbrella for a market economy under the tight grip of communist one-party rule, but also designates an economic system with a large share of public ownership. No wonder that the Chinese success is praised by the protagonists of a gradualist approach to transformation for instance in Russia, who try to protect the state industry from larger privatization attacks by radical reformers (Herrmann-Pillath 1993b).