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Janos Kornai The collapse of the socialist system in eastern Europe and the Soviet Union is one of the major events of this century, perhaps the most important of all. The transformation now taking place is without any precedent in history. The original development of capitalism was a process that lasted for centuries. The almost total liquidation of capitalism in the countries ruled by communist parties took place-in historical terms-in a very short period of time, but it was carried out by force and repressive methods. The transformation which has now begun is diverting these countries back onto the path of capitalist development and the hope is that the process will take place much faster than the original emergence of capitalism. And another hope can be expressed: that the governments of these countries will not resort during the process to the arsenal of political violence and repression in order to speed it up. Although the post -socialist transformation is a historically unique phenomenon, some components and features of it show a similarity with other processes or events that took place under other circumstances. Other empires before the Soviet empire collapsed. The political structures of other countries took the path from dictatorship to democracy. Under other conditions, state assets have been privatized, inflation has been curbed, foreign capital has flowed in, new oligopolies have formed, and so on. The uniqueness lies in the new, specific configuration of these component processes and may other phenomena.



The Political Economy of Transformation

1. The Economics of Disintegration in the Former Soviet Union

The wave of political revolutions sweeping eastern Europe in 1989 wreaked havoc on the established economic arrangements for production and trade. Central planning, price controls and managed trade collapsed. Contrary to initial expectations, private initiative was often slow to fill the vacuum. The shift towards markets, in consequence, proved far more costly than initially expected: industrial production in the transition economies has fallen by 30%–40%. While a considerable fraction of the decline reflects the discontinued production of unwanted shoddy products, the shift to markets has undoubtedly lowered the living standards of sizeable social groups, in particular recipients of fixed incomes with limited outside employment opportunities.1
Holger C. Wolf

2. The Transition to a Market Economy: Are there Useful Lessons from History?

The mostly peaceful revolutions in central and eastern Europe at the end of the 1980s marked the ultimate breakdown of the traditional socialist systems in the region. Following many years of half-hearted and inconsistent reforms and growing popular pressure for more political freedom, the transformation of the entire social system came to be seen as the only way of overcoming the prevailing political and economic problems. The former European members of the Council for Mutual Economic Assistance (CMEA)1 decided to transform both their centrally-planned economies and their socialist political systems. The transition towards a democratic constitutional state, a market-type economy and social pluralism reflects the growing desire for a liberal way of life in eastern Europe.
Joachim Ahrens

Price Liberalization

3. A Model of Price Liberalization in Russia

While the world focused on the hasty disassembly of the Soviet Union, the people of the Russian Republic focused on the next revolutionary transformation: the radical reform of their economic system. On 2 January 1992 the government eliminated most price subsidies, allowing prices to be determined by market forces. As a result, most prices paid by consumers rose dramatically. While the price increases were politically unpopular, elimination of subsidies was necessary to avoid the collapse of the food sector.1 While such a collapse was averted, the liberalization still ignited impassioned debates in the Kremlin and in households and firms throughout the republic. The debates have had special charge since, in the short run, many have faced hardships as a result of the liberalization, while, over the longer run, the ability to sustain better living conditions hinges on the establishment of a price structure which rapidly conveys accurate information about the changing economy.
Jonathan J. Morduch, Alan M. Taylor

4. The Initial Welfare Consequences of Price Liberalization and Stabilization in Poland

Polish consumer welfare apparently decreased dramatically after a major stabilization and reform program was initiated in January 1990. The statisticallymeasured real wage fell by almost 20% in 1990. Estimates of the drop in real private consumption change range from 5% to 16%. Recent stabilization and reform initiatives in Russia have also resulted in a sharp fall in real income and consumption.
Bryan W. Roberts


5. The Sale of Shares to Foreign Companies

Eastern Europe is now experiencing a very difficult transformation which involves all institutional levels. The creation of a viable private sector seems to be the most important and most complex aspect of such transformation. The debate over the obstacles and problems created by such a task has focused on many aspects, such as the creation of a credit market and of a stock market, the managerial structure and the effects of concentration. The essence of the problem remains, however, how to privatize existing firms. For larger industrial firms the answer is even more difficult, since there is a large number of potential buyers of their shares: current workers in the firms, mutual funds, holding companies, banks, pension funds, citizens, government or foreigners. Foreign companies are very appealing potential buyers, since through ownership they could have an incentive to transfer much needed technological and managerial skills.
Francesca Cornelli

6. Foreign Direct Investment and Privatization

After decades of socialism, in which huge state-owned firms produced in accordance with central planning, the countries of central and eastern Europe aim to reestablish a market economy. Systemic transition creates a host of supply-side problems since a long history of central planning and near-autarchy within the Council for Mutual Economic Assistance (CMEA) have to be overcome. The countries of the ex-CMEA area have to open up towards the world economy (which renders a considerable part of the capital stock obsolete), microeconomic adjustments at the level of individual firms have to be achieved, whole industries have to be restructured and the long-neglected service sector has to be expanded.
Paul J. J. Welfens

7. The Political Economy of Privatization

Until recently, research on privatization has focused almost exclusively on whether, and under what circumstances, a change in ownership leads to gains in efficiency and increases in social welfare. One of the fundamental questions has been whether ownership or competition is the key variable. With an emphasis on allocative efficiency, the focus has been on how to increase competition, especially in industries having the characteristics of natural monopolies, externalities and public goods. In these cases measures of regulation and deregulation seem to be more crucial than ownership.1
Alfred Schipke

Trade and Financial Markets

8. European Integration: Lessons from the South and Prospects for the East

Montesquieu, an influential French philosopher of the eighteenth century, inspired by his experience in Britain, thought that trade between two nations was always mutually beneficial and naturally created peace:
Peace is the natural effect of trade. Two nations who traffic with each other become reciprocally dependent; for if one has an interest in buying, the other one has an interest in selling; and thus their union is founded on their mutual necessities, (de Montesquieu 1748)
Hirschman, a respected economist of the twentieth century, called this component the supply effect of foreign trade. But he also recognized another component, which leads to dependence and influence between trading nations, and he called it the influence effect:
Among the economic determinants of power, foreign trade plays an important part…. Commerce, considered as a means of obtaining a share in the wealth of another country, can supersede war…. The internationalization of power over external economic relations would go far toward the goal of a peaceful world. (Hirschman 1945)
When a large state directs its trade away from large and toward small trading states, it gains more influence because of its power to interrupt the commerce with the dependent small states. One example was the German-Bulgarian trade in 1938, where Germany deliberately built up a position to control more than half of Bulgaria’s exports and imports. More recently, the Soviet Union built a position of substantial power within the trading bloc of members of the Council for Mutual Economic Assistance (CMEA). Small countries such as the central European states, want to enjoy the supply effect and minimize their dependency on foreign trade. This was one consideration which led to the demise of the CMEA system and to the reorientation of trade with neighboring, friendly countries such as members of the European Community (EC), allowing substantial benefits from the supply effects of trade. Forty-five years earlier, the Marshall Plan had a similar objective: to create a system of mutual dependencies, where western European countries would integrate as a region, reduce the risk of potential hostilities, and enjoy the benefits from free trade. The eastern European transition led to the demise of the CMEA system, which was characterized by large one-sided dependencies and only limited economic effects of foreign trade. The integration of eastern European countries into a larger European Community is expected to further increase mutually beneficial economic effects and to reduce remaining political effects of foreign trade.
Oliver Fratzscher

9. Reforming the Financial System

Reform of the financial system is at the heart of the transformation of formerly centrally-planned economies into market economies. In a market economy the financial system plays a coordinating role that is a necessary complement to the decentralization of economic decisions. In centrally-planned economies resources are allocated through a combination of fiat and bargaining, and enterprises’ access to resources does not depend on their solvency. State enterprises face “soft budget constraints” and can continue to operate regardless of continuing losses, as their operations continue to be financed through easy credit and subsidies (Kornai 1980). If the centralized allocation of resources is eliminated, but enterprises’ solvency constraints are not enforced, the result is a “no-man’s land” in which firms’ demand for credit is unlimited at any interest rate—because they never anticipate having to service their debts—and only quantitative credit controls can restrain their borrowing (Beksiak 1989; Dooley and Isard 1991). Unless these credit controls are so detailed as to be tantamount to central planning, they will result in an arbitrary allocation of resources across different activities which is antithetical to a transformation to a market economy. The transition to a market economy thus depends on establishing financial discipline by building a sound financial system.1
Timothy D. Lane

Social Implications of Transformation

10. Human Development and Women’s Lives in a Restructured Eastern Bloc: Lessons from the Developing World

Most of the economic literature on restructuring eastern Europe and the former Soviet Union has centered on macroeconomic adjustments, privatization and price liberalization (for example, Kornai 1992a; Sachs 1992; Fisher and Frenkel 1992). The importance of those policy discussions is obvious enough. What appears at times to be lost in these discussions, however, is that the ultimate goal of economic transformation is improving the quality of life for the people of the former Soviet bloc and not merely the introduction of a functioning market economy.
Stephan Klasen

Industry Studies

11. Foreign Direct Investment in Eastern Europe: The Case of Telecommunication

Joseph Stalin once vetoed a plan to extend Russia’s telephone network, saying he could “think of no better instrument of counter-revolution” (Economist, 8 February 1992). In centrally-organized economies like those of eastern Europe communication between private people was not encouraged. Telephones were considered a luxury and modern telecommunication techniques were unknown.1 The only communication links that were promoted were those in offices and factories between superiors and subordinates.2 Superiors gave orders to their immediate subordinates, who performed their tasks as they were told and reported back only to their superiors. Although such vertical links were important, no further horizontal communication was encouraged. On the contrary, information was often kept a secret within each office and the secrecy was mostly welcome as a means to avoid criticism. Naturally, in such a communication structure few phones were needed.
Sophia Eltrop

12. The Breakdown of the Soviet Oil Empire and its International Ramifications

By the time of the failed August 1991 coup in Moscow, the ailing national oil industry had just passed the peak of its inter-republican integrity: at the threshold of the 1990s the fifteen republics of the fabulous “unbreakable union” achieved the highest degree of their oil interdependence with an obvious reliance upon Russia’s oil supplies. In 1990, in particular, the Russian Federation accounted for 90 percent of Soviet production of crude oil and gas condensate, 65 percent of the country’s refined products output, and 95 percent of its foreign trade in liquid fuels. Furthermore, Russia occupied a unique position in that it was the only Soviet republic with a surplus of both crude and products, supplying excess oil to all the Soviet “have nots” (Figure 12.1). The second largest oil producer, Kazakhstan, responsible for a much smaller share of national oil production (4 percent), had to import Siberian crudes to feed two of its three refineries and could not fully satisfy its own products needs. Meanwhile, the other four oil-processing republics (Belarus, Azerbaijan, Lithuania, and Turkmenia), which hosted about 16 percent of the country’s refinery runs and enjoyed product surpluses, had to rely on Russian feedstock supplies. At the same time, other Soviet republics, including the traditional oil-producing and refining states of Ukraine, Uzbekistan and Georgia, were heavily (if not exclusively) dependent on deliveries of both crude and product surpluses from Russia. As for 1991, disaggregated data on crude oil balances of the republics in the former Soviet Union (FSU) show a substantial divergence in the degree of self-sufficiency in crude, which ranged from around 150 percent for Russia and Kazakhstan to some 70 percent for Azerbaijan and Turkmenistan, to less than 33 percent for Uzbekistan, to between 5 and 10 percent for Belarus, Ukraine, and Georgia, and to zero in case of Lithuania and those ex-Soviet republics which have no refinery capacity (Table 12.1).
Eugene M. Khartukov, Dmitry A. Surovtsev
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