Transition Economies and Foreign Trade (Routledge Studies of Societies in Transition, 17)

Transition Economies and Foreign Trade

Most books on transition economies concentrate on their internal fortunes. Few have analyzed the effect that the change in system has had on foreign trade and export performance – this new book from Jan Winiecki redresses that balance. Winiecki looks at transition economies from a macro level, in the performance of East–Central Europe, as well as from the micro level, in the performance of enterprises on international markets. The book’s intriguing analyses include: • • • •

the legacy of the communist past upon foreign trade transition; the reorientation of exports from the East to the West; trade and exchange rate regimes and their impact upon foreign trade performance; and post-transition problems associated with potential membership of the European Union.

Transition Economies and Foreign Trade makes the bold claim to have solved puzzles that have hindered the subject for years. By taking the distortions of the communist era into consideration, Winiecki has explained the phenomenon of the decline in output and trade, as well as the disappearance of dual commodity structure of exports in the early transition phase. This topical and timely book should become essential reading for students and academics with an interest in international economics as well as being of great use to business analysts and policy makers. Jan Winiecki is Chair of International Trade and Finance at the European University-Viadrina in Frankfurt (Oder).

Routledge Studies of Societies in Transition 1 The Economics of Soviet Break-up Bert van Selm 2 Institutional Barriers to Economic Development Poland’s Incomplete Transition Edited by Jan Winiecki 3 The Polish Solidarity Movement Revolution, Democracy and Natural Rights Arista Maria Cirtautas 4 Surviving Post-Socialism Local Strategies and Regional Response in Eastern Europe and the Former Soviet Union Edited by Sue Bridger and Frances Pine 5 Land Reform in the Former Soviet Union and Eastern Europe Edited by Stephen Wegren 6 Financial Reforms in Eastern Europe A Policy Model for Poland Kanhaya L. Gupta and Robert Lensink 7 The Political Economy of Transition Opportunities and Limits of Transformation Jozef van Brabant 8 Privatizing the Land Rural Political Economy in PostCommunist Socialist Societies Edited by Ivan Szelenyi 9 Ukraine State and Nation Building Taras Kuzio 10 Green Post-Communism? Environmental Aid, Innovation and Evolutionary Political Economics Mikael Sandberg

11 Organisational Change in PostCommunist Europe Management and Transformation in the Czech Republic Ed Clark and Anna Soulsby 12 Politics and Society in Poland Frances Millard 13 Experimenting with Democracy Regime Change in the Balkans Geoffrey Pridham and Tom Gallagher 14 Poverty in Transition Economies Edited by Sandra Hutton and Gerry Redmond 15 Work, Employment and Transition Edited by Adrian Smith, Al Rainnie and Adam Swain 16 Environmental Problems of East Central Europe (2nd Edition) Edited by F W Carter and David Turnock 17 Transition Economies and Foreign Trade Jan Winiecki 18 Identity and Freedom Mapping Nationalism and Social Criticism in Twentieth Century Lithuania Leonidas Donskis 19 Eastern Europe at the Turn of the Twenty-First Century A Guide to the Economies in Transition Ian Jeffries

Transition Economies and Foreign Trade Jan Winiecki

London and New York

First published 2002 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an imprint of the Taylor & Francis Group This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 2002 Jan Winiecki All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Winiecki, Jan. Transition economies and foreign trade / Jan Winiecki. (Routledge studies of societies in transition ; 17) Includes bibliographical references and index. 1. Europe, Eastern–Commerce. 2. Europe, Central–Commerce. 3. Exports–Europe, Eastern. 4. Exports–Europe, Central. 5. International trade. 6. Europe, Central, Economic conditions–20th century. I. Title. II. Series. HF3500.7.Z5 W56 2002 382~.0947—dc21

2002048568

ISBN 0-203-16459-8 Master e-book ISBN

ISBN 0-203-25877-0 (Adobe eReader Format) ISBN 0–415–25334–9 (Print edition)

Contents

List of illustrations Acknowledgements Introduction 1 The legacy of the communist past and its impact on foreign trade in transition

vii ix 1

6

2 Foreign trade adjustment in early transition

39

3 Successes of trade reorientation and trade expansion: an enterprise-level approach

61

4 Institutions and foreign trade reorientation: how much impact upon performance?

94

5 Post-transition foreign trade problems and prospects: the economics and political economy of accession References Index

118 137 144

Illustrations

Figures 1.1 1.2 3.1

Patterns of changes in the share of industry in GDP and employment with GNP per capita Changes in the share of industry in GDP and employment with GNP per capita Changes in the share of engineering goods in Hungarian exports

11 15 70

Tables 1.1 1.2 1.3 1.4 1.5 1.6 1.7 2.1 2.2 2.3 2.4 2.5 3.1

High resource intensity of communist economies in comparison with Western economies Shares of engineering industries in manufacturing output in selected economies Commodity composition of exports from communist economies Extractive industries’ shares in aggregate employment Relative prices of engineering goods exported from communist countries Relative prices of manufactures exported from communist countries Changing export structures of middle-developed economies Share of industry in GDP Ratio of inventories to GDP Ratios of gross fixed capital investment to GDP Imports according to uses Dynamics and geographic composition of exports Exports to the world market

8 12 20 24 26 27 35 42 45 46 49 57 62

viii Illustrations 3.2 3.3 3.4 3.5 3.6 5.1 5.2 5.3

Outputs and exports in selected Czech and Hungarian industries Heavy industry exports for selected product groups Relative prices of manufactures exported from East–Central Europe Polish–Italian intra-firm trade in cars Polish foreign trade of foreign firms Changes in the developmental distance Shares in exports to the EU FDIs in East–Central and Eastern Europe

69 72 74 83 87 119 120 125

Acknowledgements

The author and publishers would like to thank the following for granting permission to reproduce material in this work: Witold M. Orłowski for the use of part of Table 3.2 from his book Droga do Europy. Makroekonomia wstepowania do Unii Europejskiej, GUS (Central Statistical Office), 1996. The Centre for Research into Post-Communist Economies for the use of Tables 1.2, 1.5, 1.6 from The Stuctural Legacy of the Soviet-Type Economy, CRCE, 1992 Vladimir Benacek for the use of data and a quotation from his research report The Competitiveness and Trade of Industries in Transition. CERGE, Charles University, Prague, Discussion Paper No. 7, 1997, pp. 1–19 Chapter 2 was first published as 'Solving Foreign Trade Puzzles' in Post Communist Economies 12:3, 2000, Taylor and Francis Ltd. [http://www.tandf.co.uk/journals]. Chapter 3 was first published as 'Successes of Trade Reorientation and Expansion in Post-Communist Transition' in Banca Nazionale del Lavoro Quarterly Review, June 2000, No. 213. Every effort has been made to contact copyright holders for their permission to reprint material in this book. The publishers would be grateful to hear from any copyright holder who is not here acknowledged and will undertake to rectify any errors or omissions in future editions of this book.

Introduction

Although the number of monographs and collections of conference papers on post-communist transition can now be counted in their hundreds, surprisingly few have been devoted to surveying the foreign trade issues emerging during the transition process. And in any case the latter are usually collections of papers dealing with specific foreign trade issues (e.g. foreign direct investment) or foreign trade of particular transition countries. What the present writer finds missing are books generalizing the experience of all, or a specific subset of, transition countries. This book intends to offer such a wide-ranging overview. Generalizing on the experience of East–Central European countries in transition, it looks at trade determinants, evaluates their export performance during the process at the country and enterprise levels, and assesses the impact of policies upon performance. The layout of the book is as follows. In Chapter 1 the legacy of the past is examined. It has been one of the central themes of this author’s transition writings that the communist economic system, with its structure of incentives and resultant severe distortions, heavily influenced the transition process. An overwhelmingly large part of transition surprises and unresolved theoretical disputes stems from the underappreciation or outright neglect of the impact of the communist past (see e.g. Winiecki 1990, 1991a, 1993, 1995, 1997a, 2000b). Accordingly, Chapter 1 looks at the inherited patterns of output and foreign trade in the transition countries of East–Central Europe and stresses the communist system-specific excess demand for inputs (both of domestic and of foreign origin), demand pressures for imports from the West, strong disincentives to export, and other developments that affected external performance under the communist regime and, at the same time, influenced the transition to a market economy. The last section takes into account the industry-wise differentiation of the impact of

2

Introduction

the communist legacy. The closer the industries were to the real comparative advantages of these middle-developed countries, the weaker that impact has been and the better the prospects for survival in transition. Chapters 2 and 3 deal with foreign trade during the transition process. The former tries to address foreign trade developments that most surprised the pundits. Thus, it looks first at the most characteristic transition features: the steep fall of aggregate output and foreign trade, the near disappearance of trade among the former members of the communist quasi-integrative grouping of COMECON, the rapid increase of trade with the West (especially Western Europe), the substantial changes in the commodity structure of these countries’ exports, and so on. As stressed above, behind most deviations from the expectations of observers of the transition process (expectations based largely on the experience of liberalizing developing countries) was the impact of the communist past. From the one-off correction of excess demand for producer goods (including imports from other COMECON countries) to the alleged declining sophistication of transition countries’ exports, the past has been at the root of most of the explanations. For although the aims of liberalization in developing countries (LDCs) and those in the post-communist countries have been the same – the establishment of an open capitalist market economy – the paths and particular outcomes have been different. The elimination of distortions in the existing markets in LDCs is not the same as the establishment of nonexistent markets in post-communist economies. Chapter 3 concentrates on enterprise-level determinants of the surprisingly good export performance of East–Central European countries to the European Union. It is stressed that high export growth rates – substantially above the growth rates of world exports – have been accomplished by enterprises pursuing a wide range of strategies. Some strategies could only be pursued in the short term, such as the ‘distressed sales’ strategy. Other strategies lasted longer. They also entailed some cases of refusal to adjust as some firms in heavy industries ran down their equipment, while using the depreciation allowances to cover wages and other variable costs. Although, paradoxically, they attained some temporary comparative advantages in the process, they in fact doomed themselves to wither away in the long run. More optimistically, it is underlined in this chapter that many more already-privatized ex-SOEs (state-owned enterprises), as well as still unprivatized SOEs, in the industrial sector made strong efforts to

Introduction 3 adjust, successfully finding niches in both domestic and world markets. Liberalization in less- and middle-developed market economies assumed a shift of resources from the protected (non-tradable) to the competitive (tradable) sector. This takes time. As the post-communist industrial (tradable) sector was – by contrast – too large, the resources were already employed (however inefficiently) in the tradable sector; both the speed of reorientation and the number of trials were larger than in LDCs. It is also underlined that, over time, new players appeared in the foreign trade area. Foreign direct investment (FDI) by multinational firms and smaller companies began increasingly – in some countries, even overwhelmingly – to contribute to both exports and imports. For obvious reasons due to the weaker pull of the domestic markets, the smaller the host country the more pronounced the export orientation has been. These new players were also ‘generic’ middle-sized and small domestic private firms. It is noted that different export strategies have had differing impacts upon export performance in different periods of the transition process. For example, foreign affiliates and domestic ‘generic’ private firms need more time to become established and/or turn outward for expansion. Accordingly they are much more important now than they were in early transition. As they are the most promising export-oriented economic agents, the surprisingly good export performance may be said to have rather solid foundations. Chapter 4 is different in its concentration on institutions and policies rather than economic agents. It evaluates the impact of trade regimes and policies pursued upon trade, in particular export performance. Interestingly it transpires from the analysis that what matters most for successful performance is the fundamental concordance with the basic stabilizing and liberalizing thrust of the transition program. Fluctuations in the degree of protection of the domestic market during the transition, as long as they stay within certain limits, have been less harmful than might have been expected. This is not particularly surprising. After all, external economic openness is influencing foreign trade not only directly, but also indirectly. The pressure of foreign competition on the domestic markets also contributes importantly to performance. An even more interesting conclusion concerns exchange rate regimes, given the lively debates in early transition about the superiority of some regimes over others. But the fact is that the pegged regime, the floating regime, or the fully fixed (currency board) regime may successfully contribute to performance if the overall thrust of

4

Introduction

transition moves the economy in the desired direction of an open market economy. This has been the experience of Poland, Slovenia, and Estonia, each originally choosing a different regime. Again, as in trade policy, moderation of exchange rate policy within a given regime matters more than the regime itself. The fifth, and last, chapter deals with post-transition issues as a number of East–Central European countries find themselves at the pre-accession stage, with the prospect of joining the European Union in the not too distant future. Thus, this chapter looks at foreign trade and, more widely, the prospects for foreign economic relations from the perspective of future membership. The chapter consists of two distinct parts. In the earlier one an economic perspective is considered, looking at the performance of other middle-developed countries that joined the EU earlier to see how much they benefited in terms of trade, investment, and, importantly, reduction of the developmental distance to the mature EU economies. The prospects for post-communist high performers from the region are encouraging. If they do not botch the job (as Greece did), then their performance is going to improve and the distance reduced. In the second part a political economy perspective is applied. Some trade benefits of being inside rather than outside the EU are considered, with respect to so-called ‘sensitive’ products. Even more importantly, the effects of the interaction between membership of the strategic/military alliance of NATO and that of the economic one, the EU, are looked at and found to be complementary. Just as NATO membership for some countries of the region reduces the risk of trading with and investing in these countries, thus contributing to economic performance, so EU membership reinforces both strategic interests and economic interests, contributing accordingly to the resolve of NATO members to intervene in case of need. Having presented the layout, some definitional issues are briefly considered at this point. Thus, transition, transformation, and systemic change are the terms used interchangeably to describe the institutional change from a communist political and economic system to a democracy and market capitalism. The time-spans considered are between 1989 and 1990, the period when transition began, and 1997 and 1998, the period for which the latest trade and related statistics are available. East–Central Europe is a term that may generate some confusion as it has been defined differently at different times and in different contexts. Here, it applies to those countries stretching from Estonia in the north-east to Slovenia in the south-west. In most comparisons,

Introduction 5 however, it is limited to post-communist members of COMECON, excluding post-Soviet states and the now defunct German Democratic Republic. A question may be raised as to why not all the post-communist countries of Europe are taken into consideration. The answer is rather simple. What the present writer considers in this book is foreign trade issues emerging in transition from one economic system to another. Including the post-Soviet and post-Yugoslav states would complicate the analysis by adding the effects of territorial (and economic) disintegration. The author gratefully acknowledges permission from the editors and publisher of Post-Communist Economies to adapt the article published in the No. 3, 2000, issue as Chapter 2, and that from the editors and publisher of Banca Nazionale del Lavoro Quarterly Review to adapt the article published in the June 2000 issue as Chapter 3. He would also like to thank the International Center for Economic Research, and its Director, Professor Enrico Colombatto, for the opportunity to spend some months working on the book in the Center’s facilities in Turin in 1998–99 (where Chapters 1–3 took their early shape).

1

The legacy of the communist past and its impact on foreign trade in transition

Introduction In order to evaluate better the foreign trade potential of postcommunist economies in transition it is very important to understand the past, first of all the impact of the structure of incentives upon the performance of enterprises in the centrally planned and administered communist economy. For it is the legacy of that past in terms of dynamics, structure, and quality of output, as well as institutional characteristics of the tradable sector, that strongly influenced the performance of transition economies in their trade reorientation. This influence had been particularly strong in the early transition period, say 1990–94.

Inherited pattern of output Distorted output growth The starting point, as stressed by many analysts, is the perennial excess demand and shortage that appeared almost from the start and had become a permanent feature ever since. Analysts point to the de facto distorted structure of incentives to execute and exceed plan targets that were positively correlated with volume or value of output but not negatively correlated with production costs. This created a system of financial irresponsibility, called by Kornai (1979, 1980) ‘soft’ budget constraint, that – in spite of numerous ‘reforms’ – was not eradicated from the system until its very end. As every enterprise demanded more and more labour, capital, and inputs to make plan fulfillment easier, shortages emerged and persisted, engendering an overall climate of shortage, with adverse consequences for cost and quality. Persistent shortages, and concomitant pressure for more output, imbued managers and workers with a

The legacy of the communist past 7 careless attitude toward everything but quantity. In addition, cost and quality suffered from the time profile of the incentives for enterprises. The perennial chase after monthly, quarterly, and annual bonuses under the conditions of supply uncertainty resulted in intermittent periods of forced idleness (due to the lack of supplies) and rush to fulfill or exceed plan targets, regardless of cost and quality of output. Shortages, and accompanying – adverse – output characteristics, tended to change their intensity over time but never disappeared from the system. The dynamics of changes in the level (and structure) of shortages was associated with the so-called investment cycles (see e.g. Bauer 1978, Winiecki 1982). Excess demand created the constant pressure to expand capacity and, in this way, output. Investments, however, had to be included in the medium-term (usually five-year) investment plans. Enterprise managers were usually able to outwit central planners and obtain higher levels of supplies (production factors, inputs) for investment projects relative to the levels of output that these projects actually were able to deliver. Under the reigning informational asymmetry this discrepancy gradually became more obvious to the planners over the period of the first two–three years of the medium-term plan, generating extra tensions between the (by now revealed) much greater demand for supplies needed to complete investment projects and actual capability of these economies to deliver. Shortages of intermediate and capital goods multiplied. That, in turn, necessitated cuts in the number of investment projects (usually the least important politically, not the least efficient!) and in the second part of the medium-term plan shortages subsided somewhat. It is quite obvious that both the statics and dynamics of economic growth under the communists entailed an inordinate amount of waste. The waste was clearly system specific. One of its manifestations was the much higher use of inputs per unit of output. Table 1.1 presents in comparative perspective the use of energy and steel per $1000 of GDP that was uniformly 2–2.5 times higher in communist than in market economies. It should be noted, however, that higher costs and lower quality were only some of the side effects of the workings of the system. Output structure suffered, too. Let us keep in mind that under the general conditions of uncertainty enterprises tried to obtain more and more inputs to ensure easy fulfillment of plan targets. Grossly excessive inventories became the norm. The same applied to investments. In consequence, the shares of intermediate and capital goods industries increased much beyond those in market economies at similar development levels,

8

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measured roughly by GNP per capita. And all this without commensurate effects on the output side; the share of ‘throughput’ (intermediate consumption) in gross output was distinctly higher in communist economies than in market economies to the detriment of the share of newly added value (roughly GDP). Underspecialization and output structure Not only system-specific institutional characteristics, such as the structure of incentives and informational asymmetries within the multi-level planning hierarchy, but also policy-specific characteristics affected output structure (as well as quality and cost) in communist economies. Distortionary effects were, firstly, the result of the importsubstitution-oriented strategy. Except for the former Soviet Union, all other European communist

The legacy of the communist past 9 economies belonged to the small-country category, that is those that are expected to derive largest benefits from participation in the international division of labor. A forced imposition of the inward-oriented import substitution strategy caused them to forgo most of the advantages of international specialization based on comparative costs. Semi-autarkic inward orientation is less costly in large countries that are to a smaller extent dependent on foreign trade. Elsewhere, as noted long ago in Little et al. (1970) and Balassa et al. (1971) with respect to LDCs, it generates an overgrown industrial sector and intra-industry structural distortions. An extreme version of import substitution pursued by communist economies inevitably generated even greater distortions than those in LDCs. Not unexpectedly, the share of industry expanded far beyond what was typical for countries at their range of GNP per capita, and more interestingly this tendency continued throughout the whole period of their existence. At the intra-industry level the result was the overexpansion of intermediate-input-producing industries: iron and steel, cement, basic chemicals, etc. The communist economies also pursued the strategy of early production of capital goods, in fact too early for their level of economic development (a characteristic to be discussed later, in the next section). This generated additional distortions. For not only did small communist economies produce too large an assortment of goods in too small quantities per production run, using too many intermediate inputs and production factors in the process, but also the more sophisticated the product (and capital goods are usually the most sophisticated), the more adverse was the impact on cost and quality. The import-substitution-oriented strategy was not the only source of underspecialization in communist economies. Another was the tendency of each enterprise to turn out as many inputs as possible inhouse. In the overall climate of shortage, low reliability of outside supplies, and permeating uncertainty, enterprises tended to produce internally as large a share of intermediate inputs, and even parts and components for productive equipment, within a given enterprise. We may reinterpret the foregoing as another ‘import substitution’ strategy. That is, enterprises pursued their own ‘import substitution’, trying to ‘import’ as little as possible from other socialist enterprises (whether from domestic suppliers or from other COMECON countries, that is European communist countries subordinated to the Soviet Union). The resultant structural distortions were no less grave than those resulting from import substitution at the national economy level

10

The legacy of the communist past

that lowered the optimum production scale across the industrial structure. In fact, as we shall see, they were even graver. The distortionary effects of ‘import substitution’ at the enterprise level, called by the present writer a ‘do-it-yourself bias’ (Winiecki 1984a, 1988), were the outcome of the following processes. The small scale, often one-of-a-kind production of intermediate inputs, instruments, parts, and components for equipment, etc., used up much more material, labor, and capital than in the case of specialized subcontractors, instrument suppliers, and servicing by equipment producers. As a consequence, the often already suboptimum production scale (due to extreme import substitution) became even lower, as an important part of the resources of enterprises were tied up in these unspecialized activities. The size of enterprises in the centrally planned and administered economy was therefore much larger for a given level of output than in comparable enterprises in a market economy at similar development levels. Large shares of employment and equipment were used in the production of goods and services made without much learning by doing, due to the (often drastically) insufficient production scale. The more sophisticated the product, the more parts and components were necessary, the more ‘maintenance intensive’ the equipment, and – consequently – the larger was the size discrepancy in question. For these very reasons those most affected were the engineering (machinery and equipment) industries. It was estimated that even in such a large country as the former Soviet Union, 70 percent of engineering industry plants produced at below optimum production (see the literature quoted in Winiecki 1988). Here we come to the conclusion already intimated above that the do-it-yourself bias had even stronger distortionary impact than the import substitution strategy at the national economy level, because the former Soviet Union displayed very similar structural characteristics to the much smaller COMECON economies, not only with respect to the distorted size of enterprises but also to the distorted intra-industry output structure and excessive share of industry in GDP. Thus, the share of industry in GDP and employment tended to increase without limit, while in market economies it stabilized at a certain development level and then at maturity began to decline. The only limit for communist economies was the inability at some point to reallocate resources any further toward the industrial sector. The foregoing resulted in stabilizing these shares at much too high levels compared to reference market economies (see Figure 1.1). Also with respect to intra-industry structure, the distortions were

The legacy of the communist past 11

Figure 1.1

Differing patterns of changes in the share of industry in GDP and employment in accordance with GNP per capita: changes in market economies and communist economies. M1 and C1: shares of industry in GDP; M2 and C2: shares of industry in employment

Source: Winiecki (1988).

largely the same in all communist economies. Too large a share of the extractive industries, called upon to alleviate shortages created by distorted incentives, and, within manufacturing, the oversized heavy industries, especially engineering, at the expense of light, consumergoods-producing industries were characteristic of all communist economies, both large (the former Soviet Union) and small (the remaining COMECON countries) alike. It is clear from Table 1.2 that the shares of engineering industries in Czechoslovakia, Hungary, and Poland, that is countries for which comparable data were available at the time, made these countries similar, not to market economies at roughly similar development levels, but to those at much higher development levels: namely, Austria, Sweden, and Germany. This created the impression that communist economies had caught up the mature market economies in terms of ‘modern’, ‘progressive’, etc., output structure – an impression cultivated by communist propaganda.

12

The legacy of the communist past

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The impression was, however, highly superficial because the impressive shares of engineering and other ‘modern’ industries were not reflected in the quality of goods produced by these allegedly ‘modern’ industries. For system-specific reasons communist economies were unable to produce goods of comparable quality (including technological sophistication). Not only the distorted incentives leading to distorted output growth and structure but also more general systemic characteristics made the accomplishment of comparable quality levels a goal beyond reach. Without scarcity prices that would have, inter alia, differentiated between products of different quality, without the ‘hard’ budget constraint that would have forced enterprises to cease producing low-quality goods for which there was no demand (other than forced demand), and without domestic and foreign competition that would have put pressure on enterprises to raise product quality, nothing would change the situation for the better. But the term ‘quality’ has so far been considered in the narrower sense of quality of materials and quality of labor inputs (craftwork and diligence). But the term ‘quality’ in the broader sense comprises also technological sophistication of products and processes. It follows that one should explain here the impact of distorted incen-

The legacy of the communist past 13 tives to innovate to round off the legacy of the communist past for the pattern of output. Sources of technological obsolescence The structure of incentives in the centrally planned and administered economies strongly discouraged technological change. This author stressed long ago (Winiecki 1982) the risk aversion of enterprise managers as the prime reason for their extreme reluctance to innovate. He stressed that managers in question were taking into account the time profile of incentives and tried to reduce the risk of non-fulfillment of output targets and resultant loss of (monthly, quarterly, annual) bonuses. They avoided innovation as much as possible if new technology, and associated organizational rearrangements, affected the existing productive capacities. Under such circumstances they preferred investment in new capacities, using the same (often already obsolete!) technology, to technological modernization. The rationale was simple: even if innovation were to result in an increase in output at some point in the future, any delay in the completion of the modernization project would affect their current bonuses (and such delays were the norm rather than an exception). Therefore, the construction of another plant, or another production line within the existing plant, reduced such risk to zero because it did not affect the existing production line(s). The latter would continue producing the targeted output (affected only by systemic, output-related uncertainty but without additional, also systemic, and technological modernization-related uncertainty). Thus, innovation, instead of being ‘sucked’ by enterprises, had to be ‘pressed’ upon them from higher levels of the planning–administrative hierarchy. Another reason for the technological obsolescence, so characteristic of a large part of industry in communist economies, is the impact of the inward-oriented industrialization strategy that results in too large a number of products being manufactured in too small quantities. Given the propensity to produce too large a range of final products, and moreover as much of intermediate inputs as possible within the national economy, centrally planned and administered economies faced the impossible task of ensuring an up-to-date technology for too many products (intermediate and final). In consequence, since there were simply not enough resources to spread new technologies over such a large number of products, extreme import substitution forced a large proportion of enterprises to produce with outdated technologies (regardless of disincentives to upgrade technology).

14

The legacy of the communist past

Interestingly, as proven by Winiecki (1988), disincentives to innovate existed both with respect to innovation proper (new products and processes) and imitation (licensed products and processes). Since imported technology interferes as much as a domestically generated one with the production process from the existing capacities and, moreover, sets higher demands with respect to construction quality, input quality, etc., it was resisted as resolutely as the domestically generated one. Thus, bad innovators turned out to be bad imitators as well. There was yet another important and, again, system-specific source of obsolescence resulting in lagging productivity, higher costs, and lower quality than in the case of comparable production in market economies. The term ‘technological modernization (upgrading)’ is used here for reasons of convenience only. The literature on technological change has stressed for years the impact of accompanying organizational change, pointing out that technological change brings about the largest improvements in productivity if it is integrated with more efficient use of all resources: labour, fixed capital, raw materials, and intermediate inputs. In short, it is the continuous rearrangement of all activities that ensures year-on-year improvements in performance (Eliasson 1976). New technologies alone contribute from 20–30 percent to 60–70 percent of the aggregate productivity increase; for manufacturing as a whole that contribution does not exceed half of the total (see e.g. Carlsson 1981, with respect to Swedish industry). Since meddling in the existing productive capacities was anathema for managers of enterprises in communist economies, this important and lasting source of productivity increases was beyond reach in such economies. Furthermore, not only organizational rearrangements but even technological upgrading were not welcome – for the same reasons. To sum up, the imperative to continuously restructure enterprises technologically and organizationally stems, first of all, from the constant preoccupation with profitability, attainable by reducing inputs per unit of output. This is stimulated by the need to survive in a highly competitive environment and changes in tastes of consumers. Such a market system-specific environment was completely foreign to communist economies.

Level of economic development: interaction with output and trade patterns Before turning to issues associated with foreign trade under central planning and administration and its effects on transition, I wish to introduce at this point an issue rarely considered in the context of

The legacy of the communist past 15 comparative economics, namely the multiple interactions between the level of economic development (roughly measured by country GNP per capita) and both output and foreign trade patterns. What follows should help us to explain both the past patterns of trade under the communist economic system and the expected patterns in postcommunist transition and beyond. Economic development entails structural change, at earlier stages associated most strongly with industrialization and the resultant increase in the share of industry in GDP. Figure 1.2 presents the stylized pattern of change in the share of industry. It does so separately for large and small market economies as the former tend to increase the share of industry faster, at earlier stages of economic development. The reason for the divergence is simple. It is profitable to establish industries characterized by scale economy at a lower level of GNP per capita because the demand in the former is sufficiently large in absolute volume terms for the establishment of scale-economy-dependent factories. At higher levels of development that difference disappears as small market economies increase the share of industry, with the increase based on greater specialization than in large countries.

Figure 1.2

Changes in the share of industry in GDP and employment in accordance with GNP per capita changes: the cases of large (L) and small (S) market economies

Source: Chenery and Syrquin (1975).

16

The legacy of the communist past

Apart from the earlier establishment of scale economy industries in large countries, the stylized sequence of emerging industries in the industrialization process is roughly similar. At the low level of economic development dominant in terms of share in value added are those industries primarily processing agricultural, forest, and mineral commodities. This means food products, leather and leather products, textiles, and also simple wood and non-metallic mineral products. Unsophisticated technology required for their manufacturing, low skills, and production independent of scale economy would all combine to add relatively little value to that of processed commodities. At the middle level of economic development, clothing, footwear, pulp and paper, simpler petroleum and coal products, rubber and metal products all become more important than at the lower level. Steel and, depending on natural resources, non-ferrous metals come later, at an upper middle level. Heavy manufacturing industries usually follow the light ones. At the same time early industries expand both horizontally, increasing the range of manufactured products, and vertically, adding more value (wood products to furniture, non-metallic mineral products to pottery and chinaware, and later to cement and glass products). At the higher levels of economic development, while the market economies approach industrial maturity, chemical and engineering industries expand the fastest. Within the latter, production of consumer durables precedes in market economies that of machinery and transport equipment. In terms of shares in industry value added, engineering industries take the lead at this stage, surpassing food industries. Further changes take place usually at those stages when the share of industry in GDP and employment not only stabilize but begin to decline. These changes in the structure of industry and in industry’s share of aggregate output and employment, associated with the changes in the GNP per capita, have been well described in the economic development literature (see e.g. the literature quoted in Winiecki 1988). Much more rare were the attempts to link the developments on the output side to those on the input side. Let us, then, fill in the gap in the foreign trade context considered here. At each level of economic development – from an underdeveloped, predominantly agrarian economy to a mature industrial economy – changes in output structure strongly interact with a variety of changes affecting inputs. Thus, the availability of production factors changes at each development level. There is a continuous shift in the balance between unskilled labor and capital, because more capital becomes

The legacy of the communist past 17 available as economic development progresses. The same happens later between these two factors and skilled labor, as the economy absorbs more and more graduates of the evolving educational system. In fact, without such changes new and expanding industries that require different factor input ratios could not operate efficiently. But it is not only the production factors that change, but also the physical and social infrastructure. The physical infrastructure (roads, harbors, transportation, electricity, steam, water supply, telecommunications, etc.) becomes increasingly available, supporting the development of new industries. But even that is not enough (if it were, communist economies would not have generated such distorted output structures!). The social infrastructure affects the supply side very strongly. The property rights establishing the structure of incentives conducive for economic development, a well functioning judiciary, and private arbitration smoothly solving cases of non-compliance with business contracts, the so-called ‘soft infrastructure of the market’ (see Niskanen 1991) – such as trust extended beyond the closest relatives and collaborators, professional standards of performance, business ethics – all matter increasingly as the national economy gets more and more complex. Moreover, as a part of the social infrastructure, the economy develops new supply-side characteristics. The financial system evolves, becoming not only larger but also more varied. At higher levels of development a larger range of financial institutions offer an increased variety of lending instruments, as well as issuing securities. An increasing range of ever more sophisticated business services, other than financial ones, emerge and expand. In an economy where the composition of factors differs from that demanded to produce a given range of goods in particular industries, where the physical infrastructure is inadequate, and – even more importantly – where the social infrastructure does not facilitate the establishment, operation, and expansion of ever more sophisticated industries, the probability of failure increases almost exponentially at any level of economic development. This is what in fact had taken place under the communist economic system. These economies had chosen the so-called ‘steep ascent’ approach to industrialization, establishing not only scale economy industries but also engineering industries, and those producing capital goods in the first place, at the early stages of their economic development. The outcome was not difficult to predict. Forced to operate with the wrong factor mix (too little capital and skilled labor at the early stages), with technologies that they were hardly able to master (let

18

The legacy of the communist past

alone upgrade), and marred by a structure of incentives that discouraged both innovation and even plain good work, as well as by the rigid planning system (while flexibility was what mattered), communist economies became producers of shoddy goods, even if the industries turning out those goods happened to be classified as ‘modern’. They became a class apart, that is a class of backward machinery producers. At the same time an apparently strange thing happened to their export pattern from the vantage point of international trade theory. Heckscher–Ohlin theory posits that as the share of capital-intensive goods in industrial production increases, their share in a country’s exports should also increase, with a lag. The country changes from being an exporter of predominantly (unskilled) labor-intensive goods to being an exporter of predominantly capital-intensive goods. The phenomenon is known as the theory of factor reversal. Empirical studies confirming its existence started with the classical one concerning Japan (Heller 1976). However, communist economies distinguished themselves by being unable to complete the structural change process in the area of foreign trade. They indeed shifted output and employment structures in the more capital-intensive direction, displaying structural similarity with the highly developed mature industrial economies of the West (while producing largely low-quality, technologically obsolete machinery and equipment and other substandard goods), but their export structures remained stuck at the level of an (at best) middle-developed market economy. In fact, in the later years they even registered a change in the pattern toward a larger share of less sophisticated, less value-adding manufactures (as well as greater shares of commodities). All this prompted the present writer to call them at one point ‘permanently developing countries (PDCs)’, that is economies that never really matured (Winiecki 1989b). The foregoing considerations are of more than just historical interest. While evaluating the foreign trade prospects of post-communist economies in transition, what this author found missing was precisely the understanding of the linkages between their future patterns of comparative advantages and their real level of economic development. The latter has been roughly within the range of what the World Bank classification calls lower and upper middle-income countries, with, for example, Bulgaria or Romania located at the lower end of the range, and Czechoslovakia (and later the Czech Republic and Slovakia) located at the upper end. Another implication of such an approach is that, given their middle-developed economy status, considerations of comparative advantages should also take into account export patterns of other

The legacy of the communist past 19 middle-developed (or middle-income) economies, applying a comparative perspective.

Inherited pattern of trade Aggregate trade characteristics Toward the end of the 1980s, as communist history drew to a close, centrally planned and administered economies still traded largely among themselves. For the members of the Soviet-dominated COMECON this ranged from 40–50 percent to as much as 75 percent (with erratic Romania under Ceausescu being a striking outlier). This pattern of trade, which was even more distinctive in the 1950s and 1960s, had been shaped by the two intertwined forces. On the one hand, the Soviets pressed very strongly for inward trade orientation, that is toward other ‘fraternal’ countries. Although these pressures subsided over time, they were always present and certain imports from the world market (meaning the West) were basically ‘off limits’ until the very end (e.g. civilian aircraft). On the other hand, the systemspecific structure of incentives prodded enterprises to supply other COMECON countries rather than the more demanding world market. Thus, the geographic pattern of trade had been distorted in favor of countries under Soviet domination, displaying systemic similarity that facilitated exports. The use of the so-called gravity models of international trade repeatedly pointed to the unusual nature of the pattern in which trade with what at best might be called middle-developed economies prevailed over trade with other, also geographically close, economies, but with much higher levels of income. Modeling postWorld War II trade confirmed what economic history had shown long ago with respect to pre-World War II trade, namely that the share of East–Central and East European countries in their aggregate trade was in the range of 15–25 percent (except for the large country, that is the former Soviet Union, where that share had been shown to be even smaller). The geographic pattern had been interrelated with the commodity pattern of trade. The commodity pattern of aggregate trade, on both the export and import side, has been dominated by engineering products (both final and intermediate). Thus, to the uninitiated, the trade – especially export – pattern confirmed what the industrial structure pattern suggested. Namely that communist economies were mature industrialized economies with heavy, especially engineering, industries dominating in both output and exports. And it was only the ‘small

20

The legacy of the communist past

print’ in the statistics of international trade, hardly noticed by many, that suggested something was amiss. This missing factor was, as noted earlier in a different context, the quality of traded goods. The combination of materials quality, work quality, and technological sophistication – all dependent on a system-specific structure of incentives – exercised a continuous, and adverse, pressure on output quality. However, low quality – and, in relative terms, increasingly low quality – did not affect all the foreign trade of communist economies to the same extent. In fact it did not affect the intra-COMECON trade at all. Unsurprisingly, with persistent excess demand present all the time, even if to a different degree (see above), SOEs and consumers (starved even more than the SOEs of good-quality products) gobbled up whatever was available, both low-quality domestic goods and low-quality goods from other COMECON countries. The story was markedly different with respect to trade with the West. The foregoing differentiation suggests the existence of a dualistic trade pattern among communist economies. Dualistic trade pattern of communist economies A look at the commodity structure of the exports of communist economies supports the suggestion. Table 1.3 brings into focus the respective shares of exports of engineering goods of COMECON member countries in their trade with the West and in their mutual trade. The difference could not be more striking, with the shares of 7DEOH (DVW±&HQWUDO(XURSHDQFRPPXQLVWHFRQRPLHVFRPPRGLW\ FRPSRVLWLRQRIH[SRUWVLQLQVKDUHV

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The legacy of the communist past 21 engineering exports to other East European communist economies being two to four times higher than those to the West. Quite obviously, although communist economies were accepted by each other as mature industrial economies exporting a lot of machinery and equipment, they were not accepted as such by Western mature, industrial economies (a point stressed in the preceding subsection). If their engineering goods were accepted in COMECON markets but not elsewhere, then the former markets must have differed from the rest of the world. And they did. The most important reasons for the difference in question were presented in the previous section. Both the structure of incentives, a system-specific variable, and the pursued strategy, a policy-specific variable, created distorted economies generating persistent excess demand under the circumstances of a ‘soft’ budget constraint that, inter alia, discouraged good work at the individual worker’s level and discouraged innovation at the enterprise level. Quality in both narrower and wider terms suffered as a result. The inward-oriented industrialization strategy superimposed on the distortionary development produced its own distortions, resulting from the production of too large a range of too sophisticated goods for the level of economic development. As resources were not available for continuous technological upgrading of too large a range of manufactured products, technological obsolescence of a large part of production was assured, quite apart from the resistance to innovation at the enterprise level. It is worth noting that Table 1.3 presents only calculations concerning exports of some more and less sophisticated manufactures. Yet another characteristic feature of communist countries’ exports had been a relatively very high share of commodities (raw materials, fuels, agricultural products) in their exports. Market economies at similar development levels registered larger shares of manufactures, as well as trading more (on exports per capita basis). The foregoing explanations in terms of the theory of comparative economic systems should be combined with the explanations in terms of international trade theory. And a theory that best explains the persistent underperformance of communist economies in manufactured exports is, as stressed long ago by Winiecki (1983, 1984b), Burenstam-Linder’s (1961) ‘preference for similarity’ theory of trade in final manufactured products. Burenstam-Linder stressed that each industrialized market economy has a certain range of exportables determined, first of all, by its domestic demand, a demand strong enough to create competitive production and marketing base. Comparative advantages of a

22

The legacy of the communist past

country’s firms are based upon skills gained from designing, producing, marketing, and servicing those goods. Thus, the ability to satisfy domestic demand creates foundations for export expansion, first to countries with similar demand structures (and income levels) and later to the rest of the world. Similarities with the domestic demand structure – and therefore lower marketing costs – determine the sequence: domestic market–similar markets–dissimilar markets. This theory reveals important differences between the behavior of exporters in the market and centrally planned and administered economies. First of all, export-allocated products passed no domestic market test. Under the conditions of persistent excess demand, producers could safely disregard any information flowing back from the market. Although the quality of goods allocated for the world market was sometime improved by extra care (e.g. during the assembly stage), such measures could at best improve the quality of work (at a high cost!) but not quality stemming from innovation in input characteristics, superior technological processes, better product design, etc. Furthermore, exports from these economies did not pass the similar markets’ test either. The most similar market conditions existed in other COMECON countries that also suffered from similar distortions. In the climate of persistent excess demand, very much like at home, anything could be sold – and it generally was. Thus, exported products did not pass any real test on the similar markets. The test took place with (successful or unsuccessful) attempts to export to the dissimilar markets, that is to the world market, and only there. It is no surprise, then, that manufactures produced under the undemanding conditions typical of a centrally planned and administered economy and untested by any competition worth its name rarely gained acceptance on the world market. And if they did it was very often at a hefty discount. On a more general plane communist economies conducted trade without regard for, or in reality without even knowing, their comparative advantages. Without scarcity prices and with a highly complicated set of subsidies, surtaxes, underpriced producer goods (capital goods and intermediate inputs), too low asset valuations, depreciation rates, etc., knowledge of comparative advantages was next to impossible. The question of whether a product, or a product group, or even products of an entire branch of industry, should be imported or exported, was largely left unanswered. Therefore, any gains from trade were often accidental and if they were achieved they might even have passed unrecognized. In the trade among COMECON countries, and later

The legacy of the communist past 23 also in arbitrary quasi-specialization, planners and state trading companies knew neither their relative costs at world market prices of inputs nor the world market prices of their outputs as accounts were settled in non-convertible fictitious currency, transferable roubles. In their trade with the world market they at least knew the prices, even if their own costs continued to remain a mystery. Under such circumstances, where nothing could be established with certainty, economics took a back seat and political factories proliferated. They reflected more the political clout of some communist party bosses or planning bureaucrats than economic competence resulting from the achieved level of development. This added an extra burden to the one stemming from the inward-oriented industrialization strategy that pushed central planners and their political bosses to establish industries which their economies were not yet able to master. In the trade with other COMECON countries cost/price mysteries could be disregarded at the time – and they were – because trade was largely mandated from above by supply agreements between the respective planning and foreign trade institutions. But, given the dualistic trade patterns, the story could not be treated with such equanimity in the case of trade with the West. There, the possibility of dumping what in planners’ jargon was called ‘soft goods’ (meaning substandard goods, including machinery and equipment) was close to zero without substantial discounts (or even zero, with or without discounts). As manufactures were sold with great difficulties, and at reduced prices at that, planned exports, required to pay for what planners regarded as necessary imports, were complemented by commodities such as raw materials, fuels, and agricultural products. Yet another characteristic of communist economies was that they registered not only oversized industries in the aggregate but also relatively oversized extractive industries (see Table 1.4). The general climate of shortage, coupled with the inward-oriented industrialization strategy, induced central planners to solve the shortage of raw materials and fuels first of all via investments in domestic production. However, except for the former Soviet Union, the communist economies of East–Central and Eastern Europe were not particularly mineral resource rich. Therefore, a large share of these extractive activities were unprofitable at world market resource costs. Exports of these commodities (and often agricultural commodities as well) to the West might have brought about losses rather than gains from trade. To sum up, dualistic trade patterns resulted in strikingly different trade structures. COMECON-bound exports were overwhelmingly

24

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manufactures, with engineering goods the largest share, while in Westbound exports commodities were very prominent, and among manufactures it was the less sophisticated standardized intermediate inputs and light industry consumer goods that dominated, with engineering goods registering much lower shares. However, there was a common suspicion that trade often brought about losses rather than gains in the absence of proper domestic relative prices and realistic exchange rates. Export dynamics under systemic and policy disadvantages: higher costs, lower earnings, and falling market shares The foregoing considerations present a static picture of weak external performance of COMECON economies that does not take into account changing patterns of interaction between the largely unchanged system-specific structure of incentives in communist

The legacy of the communist past 25 economies and the changing requirements of the inward-oriented industrialization strategy at different economic development levels. The effect of that interaction had been continuous weakening of export performance and rising costs of exports. The premature establishment of engineering and other heavy industries, producing too sophisticated goods for the development level of the communist economies, imposed heavy costs upon these economies (as stressed already earlier in the chapter). But this was not a one-off operation. As these industries expanded and extended their range of products, the inefficiencies associated with such an industrial structure increased as well. The more products, especially final products, were manufactured, the larger was the demand for small quantities of various intermediate inputs, the lower the production runs of the latter, and consequently the higher the costs. Furthermore, as industrial structure had shifted partly to more sophisticated products, the demands resulting from manufacturing complexity increased the burden imposed upon the performance of these economies. This was because the more sophisticated the product, the more parts and components were needed for its production, the higher were the quality requirements with respect to inputs and manufacturing processes, and the greater was the cost disadvantage. Higher requirements also affected quality in both narrower and wider terms as communist economies, using – for system-specific reasons – obsolete technologies, produced sophisticated manufactures at low-quality levels. Again, the more sophisticated the products, the greater was the quality distance. This distance increased over time as the centrally planned and administered economies turned out to be decreasingly able to adjust to the ever higher economic competence required for modern manufacturing. Nowhere else were these weaknesses so dramatically apparent than in the case of engineering products. Table 1.5 presents relative unit (kilogram) prices of engineering exports to European Economic Community markets over the period of 20 years, 1965–85. What is of particular interest is not the rather expected fact that communist economies obtained lower prices than other foreign competitors but the continuing decline of relative prices vis-à-vis other exporters. The average kilogram price obtained by COMECON countries in the aggregate in 1965 was equal to half the price obtained by Western exporters, but 20 years later it was equal only to 28 percent of that price; that is, the relative price declined by almost a half to about a quarter of the price obtained by others. Moreover, all seven COMECON countries registered the decline.

26

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Some would note that kilogram prices at such an aggregation level (the whole engineering industry) are a rather crude measure that may mean two things: it may explain differences in quality and sophistication of the same exported product and it may explain the different product structure of exports at the same level of sophistication and quality. However, one way or another, unit (kilogram) prices show the differences in value added due to the quality and structural characteristics of exports, and even without giving weights to each characteristic convey a lot of useful information. As shown in Table 1.5 some countries registered small temporary increases in relative export prices in the 1970s before these prices declined again. This was due to a high increase in imported intermediate products from the West that were used as inputs in Westbound exports. Such practices raised costs considerably and had to be abandoned in the face of rapidly deteriorating trade balances (see Winiecki 1988). Interestingly, Czechoslovakia and the former German Democratic Republic, areas that were industrialized long before the communist takeover, underwent characteristic ‘reprimitivization’ of their export structure vis-à-vis the West. The Czechs, whose kilogram prices of engineering exports were on a par with German ones immediately after World War II, obtained barely half of Western prices 20 years later, in 1965, and exactly one-fourth in 1985, on a par with Bulgaria, Poland, or the former Soviet Union. The above assessment that the more sophisticated the product group or industry, the greater the problems with maintaining the

The legacy of the communist past 27 required standards of quality and technological sophistication, is supported by Table 1.6, where the same aggregate relative prices are shown for a number of large product groups over the 1965–80 period. The more sophisticated the products of a given product group, the lower the relative prices obtained by communist exporters. Even leaving aside the engineering products, the rest of Table 1.6 largely supports the assessment. At the same time, however, as more sophisticated industries were continuously losing ground in terms of export prices obtained, some less sophisticated light industry product groups in fact gained in relative terms. Although, given the systemic distortions, we cannot say anything about the profitability of these exports, the very fact that the price distance was shortened (based on quality and sophistication and/or intra-industry product structure) was encouraging, for it revealed where these economies possessed comparative advantages. Unfortunately, they were often in industries that had been competitive before communist rule (a point to which we shall return later in this chapter). Altogether, over time, relative prices obtained for manufactured exports to the world market declined on the average. This meant that these countries had to sell more to pay for the same volume of imports from the world market (as import prices from the latter did not decline in relative terms). With the rather weak non-price comparative advantages of communist economies this became more and more difficult. Moreover, export-allocated manufactured goods required extra expenditure (more labour, higher quality inputs, etc.) that made these exports often unprofitable. Worse still, in their trade with the West the communist economies not only paid more for inputs and obtained less 7DEOH 5HODWLYHXQLWNLORJUDP SULFHVRIPDQXIDFWXUHVH[SRUWHGIURP FRPPXQLVWFRXQWULHVREWDLQHGLQ((&PDUNHWVLQVHOHFWHG SURGXFWJURXSVLQ±SULFHVREWDLQHGE\DOOH[SRUWHUVRQ WKH((&PDUNHWV  ,QGXVWU\RUSURGXFWJURXS





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28

The legacy of the communist past

for exported outputs, but also were losing their market shares, while their competitors on the Western markets, namely middle-developed West European countries and newly industrialized developing countries, were, by contrast, gaining them. These problems apparently did not affect intra-COMECON trade, which was unrelated to any comparative cost/quality/price/market share considerations. However, structural change under the communist economic system, with its distorted incentives and distorted prices, imparted a capital-intensive bias upon the production pattern, quite apart from political preferences and industrialization strategy. A dominant part of price distortions displayed the same bias in the sense that they made capital less costly than had actually been the case. Preferences cum distorted prices combined to generate a specialization pattern of centrally planned and administered economies in capitalintensive goods. However, these economies, in spite of high rates of gross fixed capital formation, were not sufficiently capital abundant to have such a large part of their exports composed of capital-intensive goods. They were also less capital abundant, in Heckscher–Ohlin theory terms, compared to the mature, industrial economies of the West. And yet a share of capital-intensive intermediate manufactures had been the only markedly growing part of their Westbound manufactured exports. Both domestic production and export expansion were, then, suspected to be loss makers (see the literature surveyed in Winiecki 1988). Moreover, both capital-intensive production and exports were associated with high resource intensity. But except for the former Soviet Union no other COMECON country was particularly resource rich. Therefore, the high real cost of natural resources combined with the high real cost of capital to make a substantial, albeit unknown, share of aggregate output and exports unprofitable. As the shift of resources toward heavy industry continued till the collapse of communism, this share tended to increase.

Legacy of the past and trade prospects Summary of system- and strategy-specific distortions The overview of the communist economy, put within the framework of that economy’s external economic relations, revealed certain features that must have affected these economies, and especially their SOEs, once they faced the challenge of transition to a different economic system, a market economy. These features were primarily the following:

The legacy of the communist past 29 1

2

3

4

5

6

Too large a range of products were produced by manufacturing industry (both final and intermediate) than in market economies at an approximately similar GNP level per capita. In a basically autarkic economy this must have translated into too high costs due to too short production runs (and obsolete technology due to limited resources that had to be spread over a large number of products). Too large a range of goods were produced in too many enterprises. Given the do-it-yourself bias of SOEs that tried to produce as many inputs as possible in-house, intermediate products were manufactured not only in specialized supplier enterprises but also very often in user enterprises, in still smaller quantities, further reducing the benefits of learning by doing (and drastically rising costs). Products manufactured were of markedly lower quality than comparable goods in market economies. In fact all goods produced (not only manufactures but manufactures first of all, given their complexity) were of substandard quality. This was lower quality in the narrow sense of careless, sloppy work that was the hallmark of all output, except the most strongly controlled one (and at a high cost at that). Of the too many goods produced in communist economies a major part was additionally produced with largely obsolete technology. This obsolescence was not only the result of resources being spread over too many manufactured products (see 1 above), but also due to the extreme anti-innovation bias of the communist economy that slowed down the adoption of technology even when the resources were available. The dualistic trade patterns that resulted from different requirements of the COMECON market and the world market created special incentives to produce rather sophisticated goods, especially engineering products, for the former market but at very lowquality levels, both in the narrow and in the larger sense (i.e. including up-to-date technology). Thus, communist economies became – uniquely in economic history – backward producers of machinery and equipment. These characteristics exerted ever stronger adverse pressures on the performance of these economies that increasingly lagged behind that of market economies, even more so as the latter combined this with the structural shift in the world economy toward industries based on entrepreneurship, innovation, customization, and generally decentralized initiatives – all antithetical to

30

The legacy of the communist past the centrally planned and administered economy (see e.g. Winiecki 1984a).

Not all characteristics listed above augured equally badly for SOEs challenged by the systemic change, called ‘transition’ or ‘transformation’ in the literature of the 1990s. One could easily imagine that with the change in the structure of incentives and increased economic openness the impact of certain characteristics would disappear rather quickly. Thus, the trauma of transition in these respects would be a relatively short-run phenomenon. However, other characteristics would exert an impact for much longer and might even endanger the very survival of transforming SOEs. Besides, one might expect that the same characteristic would sometimes affect different industries differently, depending primarily on whether the level of sophistication of a given industry or product group was at or above the level of economic competence of a given economy. Impact on survival prospects Let us begin with the simplest possible case, that of the low quality resulting from negligent work, which might be expected to disappear relatively rapidly after the change in the structure of incentives. The preconditions for their disappearance, as in all other cases, would be: •

•

the market system whose institutional rudiments could be – and in fact often were – introduced very quickly, right at the start of transition; and the dominance of private ownership, emerging over a more or less extended period, but necessary for better (because incentivecompatible) control over performance.

Once both are in place, bad working habits acquired under communism would be expected to disappear relatively quickly, even if the debate continues as to how quickly the new formal rules of the game (incentives) would erode the resistance to decent performance resulting from the impact of informal rules (e.g. work attitudes evolved under communism). Furthermore, and more importantly from the vantage point of this inquiry, one should expect that greater difficulty in adjustment would be faced by those former SOEs that sold mostly or exclusively in the domestic and COMECON markets, that is markets where consequences of bad habits were not moder-

The legacy of the communist past 31 ated to some extent by the higher standards required from those exporting to the world markets. To this one should probably add the differentiated impact on improvements in quality exerted by product characteristics that allow for different degrees of quality supervision. Here, the quality of manufactured products would improve faster than that of construction ‘products’, as on-the-spot supervision over work quality is much less effective in the latter than in manufacturing, where both operations and products are much more standardized. Also, the quality level of the latter is revealed only step by step, often long after the production process has ended. Production of exportables would, then, be expected to register quality improvements shortly after the start of transition. Note that in all the cases considered in this section a fair degree of competition is assumed, either from foreign firms (in the case of larger domestic firms) or from domestic private firms that have already started as private ones (in the case of smaller privatized enterprises). Wherever such competitive conditions did not prevail, it would take more time to eradicate the bad habits acquired under communism as less pressure would be exerted on managers and workers of privatized firms. In the not yet privatized SOEs, where incentives compatibility would not exist to the same degree as in private firms, quality improvements would be even slower due to weaker corporate governance and/or the frequent presence of political economy considerations (‘too big to fail’ factor). Moreover, such attitudes would be expected to take place even in the face of a fair degree of competition. However, the story is not so simple in the case of some other characteristics. For example, too large a range of manufactured products turned out by communist and later post-communist industries should not be regarded per se as an irremediable disadvantage. If the ex-SOEs possessed some competitive advantages, then insufficient benefits from learning by doing due to limited volume of output could, in principle, be remedied by increased volume resulting from gaining a larger share of the domestic market and, possibly, the world market. But, let us add, this is a big ‘if’ indeed. In order to achieve this, privatized firms would have to fulfill a number of requirements: •

Firstly, the possession of competitive advantages already assumed a certain degree of specialization. Thus, a given producer of a product, or product range, would normally be expected to have specialized in this product or these products. This is not a tautology because that requirement would more often than not exclude firms producing intermediate inputs for final output that

32

•

The legacy of the communist past were hived off from ex-SOEs in the privatization process (former in-house suppliers of inputs). For they usually produced these inputs at a drastically low volume and correspondingly high cost. Secondly, the re-emergence of incentives to innovate in a market economy with private firms would mean that any economically efficient process or product innovation would be of interest for privatized ex-SOEs. But, in order to be able to benefit from innovation, the technological distance between the processes used and products manufactured in these firms should not differ too much from the best practice in a given industry or product group in order to be absorbed by these firms.

It is here that the large product range characteristic and the technological obsolescence characteristic created a highly destructive mix, affecting a number of SOEs or ex-SOEs in a range of industries. For it often happened that central planners not only decided to start manufacturing certain products which remained beyond the level of economic competence of a given economy, but also decided on the specific technology that might have been obsolescent from the start. If a manufactured product was beyond the level of economic competence of a given communist economy, while the equipment that was used could not be upgraded (but only scrapped), the very viability of such a firm under normal market economy conditions would be under threat. For obsolescent physical capital also limited the acquisition of industry-specific human capital, already adversely affected by insufficient learning by doing due to limited output volume. Firms possessing neither physical-capital- nor humancapital-related advantages would be prime candidates for exit. Unfortunately for the transition prospects, ‘political factories’ created by central planners’ fiat without regard to any economic rationale were not an exception. As well as those factories that were unviable from the start one should also include firms that either existed in pre-communist times or were established under communism but could, in principle, become competitive under normal conditions but were made unviable over time. Incorrect product range decisions, distorted investment patterns resulting in the use of hopelessly obsolescent technology, as well as other errors made repeatedly over a number of decades, might have actually reduced these firms’ existing physical and human capital below survival level. The number of such firms in both categories was very significant at the end of the communist system, although their share of the total differed from industry to industry (and, let us add,

The legacy of the communist past 33 from one post-communist country, or group of countries, to another; this issue is discussed elsewhere). The last comment allows us to return to the requirements that had to be fulfilled for previously ‘underspecialized’ privatized firms to succeed under the competitive conditions of the market. Apart from the already achieved degree of specialization stressed earlier and relatively shorter technological distance from foreign competitors, one should add two more requirements. Thus: •

•

Thirdly, the higher technological/organizational/qualificational demands, associated with the level of development demands, that were needed in a given industry (or product group), the stronger would be the threat to survival for both already privatized and SOEs. One might expect, for example, a severe threat to survival for firms in, say, the electronic components industry, an archetypal industry with which communist economies were unable to cope successfully. For this is an industry based on a high rate of innovation, requiring rapid equipment replacement, and demanding strong entrepreneurial spirit – all characteristics antithetical to the actual performance of the centrally planned and administered economy. The share of non-viable firms would be expected to be particularly high in this and other industries displaying similar characteristics. Fourthly, for the firm less exposed to normal (i.e. world market) requirements, the more domestic or COMECON-market oriented it was, the greater would be the behavioral distance between actual behavior and that desired to succeed in achieving a satisfactory competitive position (quite apart from other differences in terms of product range, quality, technological sophistication, etc.). This affected most strongly enterprises from heavy industries, primarily engineering, as COMECON countries traded heavily in machinery and equipment among themselves. Textiles and clothing industries in smaller countries would also be adversely affected as these industries exported large shares of output to the undemanding market of the Soviet Union.

Survival prospects and trade performance: real-life approximations The differentiated evaluation of survival prospects above is simultaneously an evaluation of trade reorientation prospects. It is, however, conducted at a rather high level of generalization. Therefore, in this

34

The legacy of the communist past

last subsection some evaluations are formulated in terms of actual industries in the post-communist world whose survival cum trade prospects might be expected to be relatively greater. Besides, some other features significant for survival and foreign trade prospects, associated with the performance of the political economic system of communism, are brought into the picture. As already stressed earlier, a good starting point would be to look at the export patterns of these middle-developed market economies in Europe and beyond that did not undergo such dramatic systemic shifts. And since we are dealing here with European post-communist countries, the best choice for comparison would be European middledeveloped market economies. A general characteristic of the range of exportables of the latter has been the prevalence of light industry products in their early export patterns. This is confirmed in Table 1.7. What has been changing over time, or was different across middledeveloped economies at markedly different GNP levels per capita (compare Spain and Portugal in Table 1.7), was the greater role of industries characterized by higher degrees of processing. Also, the role of industries producing intermediate inputs for further processing, often for heavy industries, has increased over time (and the rise in GNP per capita). Only at the fairly high levels of GNP per capita does the share of engineering exports begin to resemble that of mature, industrialized market economies. This is what happened in Spain and Ireland at the beginning of the 1990s, but still has a long way to go in much less developed Portugal. The pattern in question has been strikingly similar – and may be even more pronounced – among the so-called ‘Asian Tigers’. The foregoing pattern of exports from middle-developed economies had been confirmed empirically in detailed studies of structural change in a large number of less- and middle-developed economies by Hollis Chenery and associates (see in particular Chenery and Syrquin 1975). It reflected changing comparative advantages of middledeveloped economies. Therefore, as a first approximation, one should expect less adjustment problems and greater export orientation in post-communist economies of the region primarily in textiles, leather products, wood products, and non-metallic mineral products at such economies’ relatively lower (‘lower middle-income’) development levels and to expect the same primarily in clothing, footwear, furniture, pulp and paper, paper products, steel, and metal products for those at somewhat higher (‘higher middle-income’) development levels. The second approximation should take into account historical

 



 



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36

The legacy of the communist past

patterns of output and trade of the countries under consideration, that is their export specialization in pre-communist times. Thus, as noted some time ago: new competitiveness is most probably going to mean first of all old competitiveness [i.e. comparative advantages] these economies possessed in the past … And, because adjustment under competitive conditions is the easier, the less sophisticated the product [one should expect] … traditional exports of light industry manufactures to expand first. Thus, textile and clothing from Hungary and Poland, shoes from Czechoslovakia, glassware from Czechoslovakia, pottery from Poland, etc. are likely to increase their shares in both these countries’ exports and European Community imports. (Winiecki and Winiecki 1992: 126) The third approximation should take into consideration the nature of structural distortions under the communist system and the prospective export impact of the existence of a large, oversized, heavy industry subsector. It is only to be expected to find within such a large and varied subsector a certain number of firms (a minority, nonetheless!) that would be able – after a serious effort – to survive and, then, to compete successfully on the world market on the basis of discovered comparative advantages. One might include an addendum to the last approximation, concerning those countries that achieved industrialization long before the advance of communism and underwent a peculiar ‘reprimitivization’ of their output and export structure. This applies to Czechoslovakia (later the Czech Republic) and the German Democratic Republic, that is the present eastern Laender of the Federal Republic of Germany. Czech lands at the turn of the previous century were already among the largest and most efficient centers of heavy industry in the world, especially engineering, and one might have hoped that some of these capabilities would have survived the reprimitivization process. Similar islands of capability could have survived in the eastern Laender. This suggests that in the Czech Republic, as well as in the post-communist part of Germany, the share of potentially successful enterprises in heavy industries would be, ceteris paribus, greater than elsewhere. Having outlined a tentative and broad survival map of privatized and, as yet, not privatized state enterprises in terms of industries, we turn next to some other characteristic features that would be helpful in

The legacy of the communist past 37 the analysis at the level of enterprises, rather than that of industries. Two such features are worth mentioning at this stage of analysis. Firstly, it should be kept in mind that the dispersion of efficiency levels across firms within any industry under the communist economic system has been very much greater than under normal market conditions. This applied to every industry, no matter how high or low the mean efficiency of that industry in comparative terms. The reasons for such a high tolerance of often extremely inefficient SOEs (even in terms of the already low efficiency levels in communist economies) were largely twofold. Planning bureaucrats usually presented the results of supervised enterprises to their superiors in the hierarchy in terms of averages (e.g. a number of supervised SOEs that fulfilled a given plan target or an aggregate plan fulfillment of a given target for all supervised SOEs). Therefore, to keep averages satisfactory, they tended to reallocate resources from better to worse SOEs. Thus, the actual level of efficiency of enterprises was often unknown to the higher level planning bureaucracy. Also, the aeconomic nature of the system excluded the normal selection process that forces exit on the most inefficient firms. Even those firms generally known to have been inefficient survived for decades and, at worst, were merged with better ones – another way of reallocating resources from better to worse firms. The consequences, in turn, were that in all industries one would find a large collection of inefficient and very inefficient firms whose prospects of survival ranged from poor to non-existent. This would apply to both industries in which post-communist economies in transition would have comparative advantages and those in which they would not (although for obvious reasons one would expect a larger share of such firms in the latter). Another helpful feature is associated with an extremely interesting analysis made in the 1980s by the Czech economist Kolanda (1984). Kolanda analyzed the export efficiency of Czech SOEs and discovered that the most efficient exporters were usually: (a) not very large; and (b) not located in large industrial centers. The sources of that empirical observation are not difficult to find for a seasoned Sovietologist. The largest enterprises were shown many times to be monuments of terrible waste, even by the standards of the generally wasteful communist economies. As the showcases of ‘socialist construction’ they were showered with privileges in terms of access to scarce resources, capital investment, labor, foreign exchange, etc., while at the same time the planning bureaucrats and their political masters showed unusual leniency to precisely the same SOEs – and for the same reasons. The

38

The legacy of the communist past

outcome was less output from more input and higher wages and perks for lower plan fulfillment, bringing in their wake greater demoralization than elsewhere. To the best of my knowledge no similar study has ever been conducted in other communist countries. Its implications, however, are important for the analysis of export prospects at the enterprise level. The political economy of communism suggests, then, that aboveaverage export performers in transition should be looked for first of all among those firms that were not very large and, therefore, not showered with distortionary and demoralizing privileges. An additional indicator would be location away from the major centers of political power, with their tendency to protect their own ‘priority’ SOEs, usually again the largest ones. Both features allow us to look at the potential survival map, as well as export performance, in a more realistic manner. The analysis of country-level comparative advantages, associated with the level of economic development (and associated economic competence), is reinforced here by the analysis of enterprise-level competitive advantages. How actual developments in transition conformed to the expected pattern outlined here is another matter (and the subject of future research).

2

Foreign trade adjustment in early transition

Introduction This chapter is about certain surprising foreign trade patterns of postcommunist economies in transition. The patterns of trade, as they evolved in early years of the transition to the market, surprised the cognoscenti. They thought they knew most of the answers concerning the questions of simultaneous stabilization and liberalization, largely on the basis of what they thought to be very similar developments in developing countries. However, the steep fall in aggregate foreign trade at the start of transition (accompanying the steeper still fall in aggregate output), the near disappearance of trade among members of COMECON, the very rapid increase of exports to the West, and the halving of the share of engineering goods in aggregate exports from post-communist economies, altogether with some other developments, surprised many observers and prompted the reassessment of earlier expectations. But the reassessment often went in the wrong direction. The reason was, as has often been the case in post-communist transition (see Winiecki 1993, 1995), neglect of the past distortions generated by the workings of the communist economic system. Most of the surprising behavior is explainable by the interaction of the past distortions, inherited from the communist economy, and the workings of the emerging market system in the open economy setting.

Steep fall of output in early transition: where did it come from? Disappointed expectations and search for culprits I begin with the steep fall in output in early transition because it is, in my opinion, impossible to dissociate the fall in exports to

40

Foreign trade in early transition

ex-COMECON members from the general fall in demand experienced at that time. According to the protagonists of the so-called ‘heterodox’ stabilization programs, changes in the level of output (output loss) as a result of stabilization programs were expected to be small. Their experience with stabilization programs applied in some LDCs, where the nominal anchors helped to reduce the costs of restoring stability to the highly inflationary economy, suggested as much. Theoretical underpinnings of ‘heterodox’ programs were more dubious but they pointed in the same direction. Interestingly, some protagonists of ‘heterodoxy’ went even further and stressed that, in fact, output might even increase slightly. These rather surprising expectations were based on certain credibility considerations that brought Kiguel and Liviatan (1992) to believe that low credibility of stabilization programs would accelerate certain purchases, thus boosting demand. This, in turn, was expected to more than compensate reductions in demand resulting from the longer-term effects of a program. However, greater knowledge of the type of economies to which the ‘heterodox’ stabilization program was to be applied suggested otherwise. Not only should one not expect an increase in output, but even a small fall in output was beyond reach. Post-communist economies undergoing not only stabilization, but also unprecedented transition from one system to another at the same time, faced unavoidably large output losses. It is undoubtedly true that ‘heterodox’ stabilization programs were associated with the simultaneous liberalization-oriented reforms, but there is a great deal of difference between distorted markets in LDCs and non-existent markets in communist countries on this point (see e.g. Balcerowicz 1993). An explanation of the communist systemspecific distortions-based expectations will be given later in this section. For the moment it is sufficient to remind the reader that output indeed fell steeply in early transition. Since early, pre-transition expectations of the ‘heterodox’ program’s outcomes did not materialize, a debate ensued, still ongoing to this day, that searched for the determinants of the so radically different outcome from the one expected by its protagonists. The range of views expressed was truly staggering and no consensus has ever been achieved. However, the debate pointed more often than not at two ‘culprits’. One was the excessive macroeconomic restraint, while the other pointed to the collapse of the communist system-specific co-ordination mechanism (and, simultaneously, to the slow emergence of the market-

Foreign trade in early transition

41

specific one). I am not particularly convinced about the importance of either. Each one could serve as the preliminary hypothesis as to the cause of the fall in output in the early transition period. But neither can survive scrutiny of the statistical evidence accumulated in the 1990s, to say nothing about theoretical scrutiny based on our knowledge of the communist economic system and its impact on the shift away from that system. Here, I am going to deal with the relevance of these two ‘culprits’. The main criticism of the most often quoted determinants of the unexpectedly large fall in output is that those pointing to either macroeconomic restraint or weak co-ordination seem to make an unstated assumption. They assume that, with the change in underlying economic conditions (less restrictive macroeconomic policy or strengthening of the market co-ordination mechanism), the old level of output will be restored. If macroeconomic policy is the real ‘culprit’, then the easing of that policy is expected to bring about the opposite effect to the one registered in transition under macroeconomic restraint, that is an increase in output. But for macroeconomic expansion to be successful, we have to assume that the structure of demand will not change. Otherwise simple addition to the level of demand via expansionary macroeconomic policy will not be effective, since the change in the structure of demand would also necessitate a change in the structure of supply. And the latter is not attainable as a consequence of expansion, pure and simple. Adjustment of the supply structure is necessary in the first place. Expansionary macroeconomic policy is effective only if there has been no structural change. That is, if more money means more demand from the existing supply structure. We cannot assume, however, that an economy undergoing fundamental transition from one economic system to another will maintain the (very peculiar) structure of demand from the communist past. Major demand shifts should be expected to take place and supply shifts would be expected to follow. Additionally, demand and supply shifts would affect different economic sectors differently. Now, from my considerations of the distorted patterns of economic growth under the communist system (see especially Winiecki 1988), I draw the conclusion that the highly distorted, oversized, industrial sector is going to be under greater pressure than other sectors. Thus, transition must necessarily affect industry more severely, correcting graver distortions there than elsewhere. And if theoretical arguments based on knowledge of the centrally

42

Foreign trade in early transition

planned and administered communist economy are not enough, the decade of the 1990s offers plenty of empirical evidence. Thus, a fall in the share of the most distorted, and therefore most affected, industrial sector should be expected – and this is what has happened across countries pursuing post-communist transition. A change in the industry’s share of some East–Central European economies in transition is shown in Table 2.1. Another popular argument, that is disruptions in the co-ordinating mechanism of central planning, is even less convincing in its role as the main ‘culprit’ of steep output decline. Under the co-ordinating mechanism of central planning inputs were allocated in accordance with the priorities of planners who preferred a particular structure of output. Therefore, structural stability of output is an even more important assumption for this particular explanation. However, internal economic liberalization, the opening up of the economy vis-àvis the world market, as well as the rapid emergence of the competitive private sector, all affect the structure of output of an economy in transition. A large – and rapidly increasing – part of domestic demand is satisfied without recourse to the old patterns of co-ordination of state enterprises carried over from the communist economy. On the average, output fell not because there was nobody ready to co-ordinate the flow of inputs but because a sufficiently broad range of products faced a systemic-change-determined fall in demand, with the steepness of the fall being differentiated by industry and product group. The inputs were available, even from the old players, SOEs, and privatized ex-SOEs; it is outputs that were not needed under the particular economic circumstances of a historical 7DEOH (DVW±&HQWUDO(XURSHDQHFRQRPLHVVKDUHRILQGXVWU\LQ*'3 ± &RXQWU\







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Foreign trade in early transition

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systemic change. Therefore, inputs were not produced or, if they were (in line with the old ‘shortage-economy’-based behavior), they remained unsold and swelled inventories. This happened regardless of the type of co-ordination mechanism. Communist system-specific explanations Of steep aggregate output fall The whole debate on the sources of steep output fall, pursued often more at the emotional level (the oft-repeated charge of ‘unbearable cost of transition’) than at the analytical level, has been misguided from the start. This was largely due to the fact that it did not explain well the effects of past, system-specific distortions on the level and structure of output in transition to the market. True, the protagonists of the collapse of the co-ordinating mechanism of central planning as the main source of the drastic fall of output did look to the past, but theirs was a perverse interpretation of the impact of the communist economic system on transition. For it assumed (contrary to the long-existing evidence) that the co-ordinating mechanism had worked well and it was only its disappearance that caused trouble! Of all the transition puzzles the last one seems the most puzzling. This is so because of the very great ease with which not only comparative systems’ analysts (Sovietologists) but almost everybody else – academics, business people, politicians, and tourists who had visited the communist world for more than a day or two – could see at least some potential sources of output fall if, some day, the transition to a more efficient economic system took place. Glaring discrepancies between what was officially stated about the communist economies and what was there for all to see – enormous (and highly visible!) waste, excessive use of raw materials, overinvestment – suggested answers as to why output would have to fall in transition. But somehow many critics of the communist economies forgot their earlier fulminations against the waste, or ‘production for production’s sake’, benefiting nobody except those producing goods that were not needed under a less wasteful economic system. A typical communist economy had, for example, a higher intermediate consumption than GDP, regardless of its size and level of specialization! With the start of transition and drastic fall in output, many of them suddenly began to value the ‘lost’ output much more than in the past. Nonetheless a systemic shift from plan to market strongly suggested

44

Foreign trade in early transition

that a fall in output would occur and that it would unavoidably be very large. Its sources would be manifold but all associated with the systemspecific distortions generated by the centrally planned and administered communist economy. Below I list four major sources of output fall: 1

2

At the most elementary level, we should expect a fall in output that in fact did not exist but was nonetheless registered by official statistics. In an economy with extremely high agency costs (see, in particular, Jensen and Meckling 1976), where the measurement takes place without markets (see Winiecki 1991a), there is enormous room for the undetected doctoring of performance reports, also with respect to output. One should single out two types of doctored reporting, both very successful under the communist economic system (see e.g. Winiecki 1988). The first and simplest were write-ins (the Russian term is pripiski). There was a long tradition of brazenly reporting higher output than the one actually produced. The second type of doctored reporting were hidden manipulations of output structure registered as output growth but actually were only increasing prices. There is an extensive literature on the subject pursuing analysis at the micro level. Also, at the aggregate level, various empirical studies recalculated, depending on the economy in question and the period in its history, realistic growth rates for a given communist economy. These rates amounted to between 20 percent and 90 percent of the officially registered rates! One should expect these ways of doctoring reports on output to disappear with the shift from an economic system where firms are paid by what they tell, to the one where they are paid by what they sell. The major part of output that disappeared, particularly at the beginning of the transition period, was, however, output that did physically exist, but would not have existed in a much less distorted capitalist market economy. I would associate this type of disappeared output first of all with the grossly oversized input inventories. Various calculations showed inventories in communist economies to be 2–2.5 times higher than in mature Western market economies. According to Shmelev and Popov (1989), the inventories:GDP ratio in the Soviet Union in 1995 was equal to 0.79, while in the USA in the 1980s it was some 0.30–0.35. Table 2.2 shows adjusted estimates for selected communist economies.

Foreign trade in early transition

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Now, with the advent of transition, with price liberalization, and the hardening of budget constraint, it became unprofitable to carry such huge stocks of inputs. SOEs needed them under the conditions of system-specific extreme unreliability of supply. Therefore, with the systemic change and the disappearance of such conditions, enterprises had strong incentives to sharply reduce orders for new inputs in order to limit the level of inventories to the one needed under the market system. At the same time they had extra incentives to use up inputs from the existing oversized inventories, whenever they could, because apart from reducing the financial burden of carrying too large inventories, they could count on windfall profits from using inputs bought at low, controlled prices and selling outputs at high, liberalized prices. Even if we assume, conservatively, that only half of these excessive inventories were due to system-specific inefficiency and the other half reflected a lower level of economic development (and associated lower aggregate efficiency) this source alone makes room for the fall of output to the tune of 10–15 percent or even 20 percent of GDP! It should also be noted that most of the fall in inventories would be concentrated in the grossly oversized industry. Besides, it should be stressed that it was not just the enterprise sector that displayed the characteristic feature of excessive inventories. Under the communist system households also carried larger inventories for the same reasons (unreliable supply). In adjusting to shortages, they made larger food purchases than required, given their current needs, because they were uncertain as to when they would be able to make the next purchase. Much of that excessive

46

3

Foreign trade in early transition low-quality food was subsequently spoiled (on these points see Winiecki and Winiecki 1990). With the disappearance of shortages, emergence of competition, and resultant rapid improvements in quality, precautionary purchases of non-durable consumer goods would be expected to disappear as well. This would translate into lower purchases and, in turn, lower orders from retailers, contributing to a fall in industrial output. (It also explained why a fall in output, even if differentiated by size, affected both producer and consumer goods’ industries.) Excessive investments were another well-recognized characteristic of the communist economy. On the average, throughout their existence, to achieve 1 percent growth of GDP communist economies needed about 2 percent growth in gross fixed capital investments, a ratio unprecedented in economic history. For a selected comparison with capitalist market economies, see Table 2.3. A substantial part of these excessive investments stemmed from the same high degree of uncertainty and absent risk of financial failure, which caused SOEs to persistently run excessive inventories. Thus, they often established various technologically unrelated units such as construction, machinery maintenance, instrument manufacturing, transport, etc., because it was safer – even if much costlier – to ensure that various activities unrelated to a given SOE’s production profile were implemented in-house. Consequently, state enterprises became highly underspecialized conglomerates of a sort (see Winiecki 1984a, 1988). Again, as in the case of lower levels of inventories, one should expect that increasing reliability of supplies and services after the beginning of transition, imposed by market discipline, would 7DEOH 6HOHFWHGFRPPXQLVWDQGPDUNHWHFRQRPLHVJURVVIL[HGFDSLWDO LQYHVWPHQWWR*'3UDWLRRIJURZWKUDWHV± &RPPXQLVWHFRQRPLHV

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result in a decline in demand for non-core investment goods. This would apply to demand for metal-working machinery in user enterprises, to construction equipment used in non-construction firms, to trucks, vans, and pick-ups for all producers that used to collect undelivered inputs from unreliable suppliers, or for buses bringing employees from distant towns and villages. Furthermore, in contrast with the one-off downward adjustment of input inventories, a fall in demand for that type of investment good, resulting from an increase in the level of specialization in enterprises in transition, is of a permanent nature. Of course, the transition to a market economy would be expected to generate increased demand for investment goods in core activities (and it duly did!). The proportions between various categories of investments would be expected to change (more machinery and equipment, less construction; more specialized machinery, a less unspecialized one), but for a given output level and structure, inherited from the communist economic system, the level of demand for investments would decline permanently. Finally, the political shift from a communist to a democratic regime suggested a change of military doctrine and a reduction in the level of military expenditure. Since a substantial part of aggregate expenditures were those on military hardware, these cuts meant, again, a permanent reduction in demand for engineering and other industrial products.

Except for non-existent output, whose disappearance was noted by more knowledgeable Sovietologists, the foregoing sources of a steep fall in output were hardly noticed by members of the economics profession writing on post-communist transition. A notable exception is that most astute observer of the communist and post-communist economies, Janos Kornai. But even he mentions input inventories’ adjustment as one among many determinants of a fall in output (see Kornai 1994). Interestingly, the statistics he uses in the same article reveal (without in fact being referred to) that in 1989–92 in Hungary gross fixed capital investment fell to 76.9 percent of the 1989 level but gross investment, including inventories, fell to 58.5 percent (both figures in constant prices). The same data for Poland, drawn from national statistics, reveal the same pattern. Gross fixed capital investment in 1989–92 declined to 87.8 percent of the 1989 level but gross investment declined again much more, to 62.9 percent (both figures also in constant prices). Changes in stock data are less reliable than those of

48

Foreign trade in early transition

flow data (given the valuation problems under high and variable inflation). Nonetheless the Czech aggregate inventories:GDP ratio decreased steeply from 0.94 in 1989 to 0.59 in 1992 (V. Nachtigal, private communication). Flow data confirm the trend although not the size of the inventories’ reduction. Thus, scattered data confirm expectations concerning a very large impact of the decreasing output on the level of inventories. And since the brunt of adjustment was felt by industry, its output fell much more heavily than GDP. Data for investments and military hardware expenditure complete the picture of a very large fall in output, especially industrial output.

Contribution of foreign demand to the aggregate demand fall: the myth of ‘lost’ Eastern markets So far we have treated the fall in aggregate demand in precisely the way indicated, that is the aggregated manner. But the decomposition of the fall in aggregate demand must reveal what is of primary importance here: that is, the contribution of foreign trade to the fall in output. Generally speaking, increased exports reduce the extent of the fall in output, while increased imports, substituting for domestic production, aggravate the fall. Fortunately, in the case of East–Central European economies in transition, exports to the world market became a strong prop for the otherwise falling production. But imports – surprisingly for many – declined at the same time as exports increased, sweeping away earlier concerns among experts and policy makers about balance of payment being a severe constraint on transition to the market. Just like elsewhere, and also with respect to foreign trade, the impact of the past has been a significant (but not an exclusive) determinant of trade patterns in transition. Expectations, as with the aggregate output path, were different from what actually happened. Almost everybody feared an import surge since it was widely expected that producers and, especially, consumers would quickly take advantage of trade liberalization (on this point see Gacs 1994). What the observers did not take into account was the system-specific structure of communist economies’ imports. Better knowledge of communist economics would suggest that whatever import increase took place after the opening up, it would be largely compensated by a substantial drop in traditional (i.e. system-specific) imports. The input–output data for those communist countries that published their figures (Czechoslovakia, Hungary, Poland) revealed an increasing import intensity from the 1960s to the 1980s. Engineering

Foreign trade in early transition

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The systemic change forced SOE managers to reassess the rationale for both extremely high-input inventories, as well as their preference for imported inputs over domestically produced ones (the reasons for that preference with respect to inputs from the West were obvious: higher quality and timely delivery). A reassessment should produce a sharp initial fall in imports because an economically efficient choice for SOE managers would, again, be to draw on the existing inventories of imported inputs rather than to keep them at the extremely high levels of the past. A decline in imports resulting from the drop in the level of orders intended to reduce inventories of imported inputs to manageable (read: ‘financially sound’) levels was reinforced by other import changes, also determined by past trade patterns, that reduced the level of aggregate imports even further. Firstly, the disappearance of excess demand for investment and reduced level of expenditures for military hardware (see the previous section) reduced the level of imports indirectly, as a lower level of output for these goods translated into a lower demand for imported inputs to these outputs (it was known that the engineering subsector had been a heavy importer of Western inputs; see e.g. the data and literature quoted in Winiecki 1988). Secondly, the establishment of a realistic exchange rate also revealed a range of unprofitable exports, sometimes requiring for their manufacture large amounts of costly Western inputs (in fashionable language, they were

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Foreign trade in early transition

often value subtracting rather than value adding). The demand for these imports dried up after the start of transition. Overall, the fall in system-specific imports in the first year or two of the transition process compensated well for the surge in consumer goods’ imports experienced by East–Central European countries. Indeed, the share of imported consumer goods in the total imports from EU countries doubled in Czechoslovakia, Hungary, and Poland between 1988 and 1992 (correspondingly from 5.4 percent to 11.4 percent, from 8.8 percent to 16.4 percent, and from 7.8 percent to 15.3 percent). But at the same time the share of imported inputs markedly decreased (with corresponding decreases of 6 percent, 10.3 percent, and 7.9 percent), making room for a surge in consumer goods imports. However, more important for the analysis pursued here are two issues that have been hotly debated in early transition and – in the opinion of the present writer – have not found well-substantiated explanations until now. Everybody was impressed by the rapid reorientation of East–Central European trade toward the West, but these impressions apart, a convincing explanatory framework has not yet been formulated, let alone gained consensus. The issue will be taken up briefly in the next section. The crucial issue to be considered in this section, however, and the one creating much intellectual confusion, is the role of the dissolution of COMECON in the fall of aggregate output in early transition. The rapid decline of a very large part of trade between ex-members of COMECON strongly reinforced the fall of output. From the statement formulated in the preceding manner there is only one step to the conclusion that the dissolution of COMECON, decided in 1990, was the source of the drastic decline in foreign trade between transition countries. This, rather unfortunate, step had often been made by those writing on post-communist transition, although there is no theoretical rationale to deduce the latter from the former. Nor, in fact, is there any logic that would support the linkage. The fact of the collapse of trade among former COMECON members has duly been noted. Given the size of the fall, it could hardly have been otherwise! However, most of the interpretations of that fact have been grossly erroneous, showing a deep misunderstanding of what had actually happened, apart from the easily calculable trade figures. The end of the COMECON arrangement has been regarded by not a few analysts as the major source of trade decline among its exmembers. Some simply – but as we shall see erroneously – ascribed

Foreign trade in early transition

51

trade and, consequently, output losses to the dissolution of COMECON (e.g. Fischer and Gelb 1991). Others went even further, blaming post-communist countries in transition for their unwillingness to band together to ‘soften the blow’, whatever that might mean. In the latter’s opinion the deliberate decision of East–Central European policy makers to end the ‘COMECON story’ entailed a considerable cost to their societies (a dramatic fall in intra-regional trade). Their initiative to dissolve COMECON was even compared to wounding themselves. No questions were asked about or analyses made of the patterns of intra-COMECON trade in the communist period and their possible impact on transition. Nor was the possibility of continuation of those patterns within the framework of transition to the market seriously considered. Rare were assessments such as those by Kornai (1994) or Aslund (1994) who stressed rightly that COMECON trade patterns were dependent on the fundamental features of the communist economic system and, with the disappearance of that system, trade links would be strongly affected as well. Since changes in the structure of production were unavoidable in transition, as suggested earlier, changes in foreign trade were inextricably linked to output changes. To begin with, the sources of the steep decline in trade among former members of COMECON are generally the same as the general sources of decline in output in early transition. Apart from the trade in raw materials that largely survived the collapse of communism because it was (largely) based on near world market prices for corresponding quality, most of the trade consisted of intermediate inputs and investment goods. They were usually of substandard quality and saleable only on the COMECON markets due to the generalized excess demand (and ‘soft’ budget constraint). The trade in question also consisted of, no less substandard, consumer goods (saleable for the same reasons). Once countries had embarked on the path of transition, demand for an overwhelming part of these imports disappeared. With hardening budget constraints, SOEs reduced input orders and eliminated unnecessary investments. Furthermore, the remaining orders were placed where they were more profitable and not where SOEs were earlier administratively ordered to place them. Consequently, a substantial part of the remaining orders was placed on the world market further reducing the trade level among countries in transition. One extra determinant of the rapid fall in demand for imports from ex-COMECON members should also be brought into the picture. It is the near simultaneity of transition, at least of the East–Central

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European countries. Poland, Hungary, the former Czechoslovakia, and, more haphazardly, Bulgaria and Romania all started stabilization cum liberalization transition programs within one year. In each post-communist economy in transition SOEs and privatized ex-SOEs tried to adjust to the new market discipline, cut down on new input orders, postpone or scrap investment plans, and in the respective cases also faced lower orders for military hardware. Goods not needed under normal market circumstances (or not needed in such quantities or of such quality) were weeded out of the economy. A steep decline in output, especially industrial output, followed. But the behavior of, say, Polish firms affected not only domestic production but also production in other ex-COMECON countries as orders for the now unneeded inputs or investment goods imported from, say, Hungary or Czechoslovakia were cut severely or cancelled altogether. And since just about every country in the region, except for the former Soviet Union, started at about the same time, producers felt simultaneously the impact of sharply reduced system-specific demand both from home customers and from those in other transition countries. Since a very large part of intra-COMECON trade was of the sort described here, the trade with other countries of the region plummeted at the start of transition. To sum up, there was no wilful abandonment of the trade with other post-communist economies. Simply, with the launching of a decentralized market system, the microeconomic decisions of privatized ex-SOEs and much more numerous SOEs corrected the distortions inherited from the communist economic system and eliminated the demand for goods not needed under normal economic circumstances in which prices, quality, and financial discipline matter. These corrections entailed a reduction of orders for goods not only produced domestically but also imported from other countries with similarly distorted output patterns. The simultaneity of microeconomic corrections aggravated the macroeconomic decline in the level of output. The ‘lost’ Eastern markets that could, allegedly, soften the aggregate output fall were a myth. The shallowness of the ‘cost of COMECON’s dissolution’ argument can be exposed by the following thought experiment. Assume for a moment that all seven original members of COMECON set themselves simultaneously on a course of transition to a capitalist market economy but for some reason (presumably known to those who stressed COMECON’s importance) decided to ‘band together’, that is to maintain the institutional structure of COMECON. Would the trade among these countries survive intact?

Foreign trade in early transition

53

The answer is an emphatic ‘NO’. Microeconomic adjustment at enterprises and the availability of world market alternatives would reduce the trade strongly to new, substantially lower levels. Also, the structure of trade would change, reflecting to a greater extent the comparative advantages of each country, rather than supply decisions taken by central planners. The existence or non-existence of the COMECON institutional framework would be irrelevant for intraregional trade once ex-members set themselves on a course of transition to the market. COMECON institutions on top of marketdetermined trade relations would play purely an ornamental role. Of course, one could imagine the existence of COMECON institutions with the authority to direct trade, but then there would be no transition. Tertium non datur. Now, as a second part of this thought experiment, let us assume that COMECON’s dissolution has taken place, but one exCOMECON country has decided to retain the communist economic system, while the others set themselves on a transition course. Would the trade with the remaining communist economy survive? The answer is, with respect to its imports, a no less emphatic ‘YES’. With the communist economic regime in place, the systemic distortions would remain in place as well. The level and structure of demand would not change and, therefore, excess demand for imports would continue. Therefore, the imports of such an economy would suck in whatever was available in other ex-COMECON countries, because SOEs in the non-reforming communist economy would display the same characteristics, demanding more inputs, more investment goods, more everything, in order to reduce system-specific supply uncertainties. Exports would be different, though. Firms in countries undergoing transition would import only those goods whose price, quality, and other characteristics (delivery schedule, after-sales servicing) reflected their new needs, while at the same time taking into account new opportunities to import goods from elsewhere that resulted from opening up their economies. Therefore, they would buy from their unreformed neighbor much less than in the communist past. Interestingly, the second part of this thought experiment found its real-life counterpart in early transition. In 1990 Poland had already set itself on a course of transition, whereas the former Soviet Union was still a centrally planned and administered communist economy. The outcome was inevitable: Polish firms rapidly increased exports to the Soviet Union whose SOEs behaved in a manner typical of a communist ‘shortage economy’. At the same time, Polish firms drastically

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reduced their demand for both Soviet intermediate inputs and investment goods. In consequence, Poland achieved a very large trade surplus with its then unreformed neighbor (an equivalent of $7 billion).

Returning to normality: changing trade composition The transition augured a return not only to a market-driven domestic demand, freed from the distortions of the communist economic system, but also to comparative/competitive advantage-driven foreign demand. As post-communist economies liberalized, not only internally but also externally, and non-market economies dwindled to an exotic margin (Cuba, North Korea) the foreign demand of East–Central European economies in transition became again, as half a century earlier, the world market demand, with foreign trade losing its nonconvertible/convertible trade dualism and becoming limited, for all practical purposes, to convertible currency trade only. With Soviet political pressure for the maintenance of a closed nonmarket bloc gone and with the distorted incentives structured to sell on the undemanding COMECON markets gone as well, the stage was set for the emergence of new trade patterns. These must have entailed the shift to where the markets are, that is the shift toward the highincome Western economies, and, given the geography of ex-COMECON economies (except post-Soviet states), particularly toward Western Europe. The other side of the coin must have been the shift away from trade among East–Central and Eastern Europe. Post-communist economies from East–Central Europe should expect an increased market for their goods in the high-income Western countries on the grounds of both classical, Heckscher–Ohlin, theory and later trade theories concentrating on the trade in manufactured products. To begin with the classical-theory-based grounds for increased exports, the East–Central European economies have been, vis-à-vis the West, labor- rather than capital-abundant economies. Therefore, one should expect, on the basis of Heckscher–Ohlin factor proportions’ theory, increased exports of traditional labor-intensive manufactured goods (although exports of capital-intensive goods increased as well; this phenomenon requires a separate inquiry, pursued in Chapter 3). At the same time, the preference-for-similarity theory of Burenstam-Linder (1961) and later theories stressing quality differences within the framework of intra-industry trade suggested that significant intra-industry trade could emerge between post-communist

Foreign trade in early transition

55

economies and Western economies. Within the framework of trade in products differentiated by quality (and, correspondingly, by price) lower-income post-communist economies in transition would export less sophisticated versions of a given product and import more sophisticated ones. (More often than not the intra-industry trade along these lines would conform also to Heckscher–Ohlin theory, as less sophisticated versions would be manufactured with greater labor inputs than more sophisticated ones.) Trade in intermediate products, inputs for further processing or assembly, is less well underpinned theoretically, but an oversized industrial sector in post-communist economies opened up possibilities for better performing firms (privatized ex-SOEs and SOEs alike) to search for prospective buyers in the world market. Inputs whose production requires relatively skilled (but simultaneously low-paid) labor in conjunction with relatively large amounts of (less sophisticated) capital equipment would, on the average, stand a greater chance of succeeding in the world market. Locational advantages, that is closeness to some large production centers in Western Europe, would also give an advantage to producers of some bulky inputs in post-communist economies, adjacent to these centers. It is worthwhile remembering that, for example, some 40 percent of Austrian exports travel no farther than 250 km from Austria’s borders. Location as a source of comparative advantage matters – all the more so as some other factors tend to get more uniform (e.g. tariffs). As these considerations attest, there has been an array of reasons explaining why a spurt of exports from the East to the West might occur. And it did occur, but with the correction that its dynamics much exceeded expectations. Table 2.5(a) shows the change in both aggregate exports of ex-COMECON countries of East–Central Europe (except the former Soviet Union and its successor states) and for Westbound exports. For all countries, except Romania, the data show that exports to the West increased very rapidly between 1988 and 1994 and that the trend of rapid export growth also continued beyond that date. It should be noted, however, that the aggregate export data are distorted by the overvaluation of intra-COMECON trade in international statistics until the collapse of communism and disappearance of intra-COMECON trade. Since data for 1988 were distorted upwards, aggregate exports in Table 2.5(a) tend to show smaller increases than actually was the case. The twin developments of the extremely rapid expansion of Westbound exports (and, with a lag, imports as well) and the disappearance

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Foreign trade in early transition

of system-specific distorted intra-COMECON trade in heavy manufacturing (especially engineering) products also resulted in the geographic reorientation of trade. In all East–Central European countries under consideration the share of trade with the West increased very rapidly, while that of the East (ex-COMECON) declined dramatically. The data are shown in Table 2.5(b). Here, in turn, the scale of geographic reorientation is somewhat exaggerated. The share of intra-COMECON trade is overstated because data based on COMECON prices overstate the share of intraCOMECON trade in aggregate trade. More realistic data based on domestic costs of exports would reveal that even under communism the costs of Westbound exports had been higher than the price data would show. But by 1988 only Hungary and Poland had adjusted their statistics sufficiently to correct, largely, for these distortions. Therefore, the shares of intra-COMECON trade for 1988 are more overstated in the remaining three countries: Bulgaria, Czechoslovakia, and Romania. It is worth stressing the fact, clearly visible from Table 2.5(b), that the emerging new trade patterns largely meant the return to the old pre-communist trade patterns. The comparison of the respective shares of Westbound and Eastbound exports in 1928 and 1994 and 1996 is conclusive in this respect. This, again, should not be regarded as a surprising development. What has been termed here ‘the return to normality’ in foreign trade, that is to world-market-driven demand, restored the importance of normal determinants of foreign trade. Thus, income-level differences (and their concomitants: different factor supplies), locational advantages (geographic or, more precisely, economic distance, taking into account transport costs), differential supplies of natural resources, etc., all began to matter. Since the trade patterns of East–Central Europe in the interwar period reflected these differences, the renewed importance of these factors meant a shift toward the geographic composition existing before the imposition of the communist economic system. It is within the framework of this return to the trade based on determinants, well researched by international trade theories, that we should look at the disappearance of the dominant part of intraCOMECON trade. Pre-World War II trade among East–Central European countries that later became members of the communist quasi-integrative grouping absorbed a relatively small part of their aggregate trade, as shown by the 1928 data on Eastbound trade in Table 2.5(b). In the light of the foregoing considerations, the claims that intra-East trade has been (recklessly? wilfully?) neglected by

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East–Central European countries in their headlong rush toward the West are not supported by either international trade theory or economic history. The elimination of communist system-specific intra-COMECON trade in the first few years of transition to the capitalist market economy resulted in the change of yet another trade pattern, namely in the commodity composition of East–Central European exports. The workings of communist economics produced a particular dual export structure. Exports to the West reflected the low level of competitiveness of the communist economies and, therefore, consisted of commodities and less sophisticated manufactures. On the other hand, intra-COMECON exports, that is exports to undemanding markets, suffering from persistent excess demand, were overwhelmingly manufactured exports, and, within manufactures, primarily concentrated on heavy industry’s investment goods and intermediate inputs. As shown earlier in Table 1.3, the share of engineering goods’ exports by East–Central European economies to each other in 1989 amounted to almost half of their exports (49.5 percent) and the share of the same exports to the Soviet Union were even higher (53.7 percent). However, due to the often low quality and technological obsolescence of these goods, they were hardly saleable on the world markets. Therefore, by contrast, their Westbound exports of engineering goods amounted only to 15.8 percent. Given the distorted nature of the dual export structure, it should be expected that the duality in question would disappear rather soon, precisely with the disappearance of the distorted, excessive demand for domestic and imported capital goods and intermediate inputs for further processing in heavy industries. A concomitant expectation would be that the new export structure would become uniform, regardless of the direction of trade (as has been the case all over the world), with the share of engineering goods in exports equal roughly to that of the Westbound exports in the communist period. For it is only shares of exports to the world market that reflected the actual capacity of post-communist economies in transition to competitively produce the most sophisticated manufactures in the early transition period. And this is what actually happened within the two- to three-year time-span. The disappearance of the dual export structure and the resultant reduction in the share of sophisticated manufactures in the aggregate exports have been criticized as a backward step, a regression toward the lower development levels. Again, the criticism is completely unjustified and simply neglects the distortive nature of communist economics. For it is communist system-specific distortions that

Foreign trade in early transition

59

produced the pseudo-modern, ‘progressive’, commodity structure of COMECON countries’ exports, whose aggregate share of engineering goods was reminiscent of that of mature market economies such as Germany, Sweden, the UK, or Switzerland. However, as communist economies were at a much lower development level, a systemic shift to a market economy revealed their true development level – and reduced the share of engineering goods accordingly.

Conclusions In the preceding three sections, I dealt with various communist economic system-specific influences upon foreign trade in the transition of East–Central European countries. I explained, firstly, where the dramatic fall of output in early transition came from, pointing to the inevitability of such a fall and its origin in the distorted nature of communist economics. I also stressed that it was the communistsystem-generated distorted demand whose disappearance affected both domestic producers and producers from other ex-COMECON countries, once transition started. The foreign trade consequences of this claim were then considered. Transition meant the disappearance of distorted excessive demand in a country undergoing such change and all East–Central European countries began transition within the short time-span of about one year. Therefore, the domestic demand of each country of the region suffered simultaneously from reduced orders made by domestic firms vis-à-vis other domestic firms and by similar cuts made by firms in other countries in transition that were also undergoing the process of getting rid of system-specific demand distortions. I strongly argued that both sources of demand fall, domestic and foreign, worked in the same direction, that is reinforcing the fall in output, and – given their nature – were inevitable. Therefore, the criticism that these countries neglected Eastern markets was unjustified. An additional proof of the foregoing can be found in the preceding section, where it was shown that present shares of Eastbound trade are roughly at the level of those in the interwar period. And in this interwar period the trade of these countries had also been affected by the traditional determinants of international trade (as formulated in a range of trade theories). In that last substantive section I also pointed to further important changes in the geographic composition of East–Central European countries’ trade that in the 1990s, unsurprisingly, roughly returned to that already registered in pre-communist times. Finally I dealt with the

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dual commodity structure of exports reflecting differing demand conditions in the COMECON and world markets. This duality, I stressed, should be expected to disappear with the disappearance of the system-specific distortions – and it duly did. As a general conclusion it may be stressed that the neglect of the communist system-specific legacy on foreign trade behavior in transition is a serious error. It leads, in consequence, to incorrect conclusions concerning trade dynamics and structure, as well as leaving various aspects of changing trade patterns unexplained.

3

Successes of trade reorientation and trade expansion An enterprise-level approach

Introduction The geographic structure of trade of East–Central European postcommunist economies underwent radical change in early transition. After just a few years (from 1989, the last full year of communism, to 1992, or 1994 at the latest) the dominant part of their trade, both exports and imports, shifted from the East (i.e. intra-COMECON) to the West, that is to trade with the mature market economies. The general thrust of the reorientation from the macro-level vantage point has been dealt with in Chapter 2. Particularly striking was not only the speed of the Westward reorientation but also its other features. Thus, the trade of the East–Central European transition countries, especially of those regarded as ‘success stories’, has been growing at a distinctly higher rate than world trade in general. Such dynamics has been in stark contrast with the foreign trade performance of communist economies in the preceding decades, where they lagged increasingly behind other country groups. To give a better idea of the dynamics of the Westward reorientation, Table 3.1 presents the 1989–96 data on exports to the West (i.e. OECD countries) both in absolute terms and relative to the dynamics of world exports. It emerges quite clearly from the table that successful transition countries increased their exports at almost twice the rate of world trade in the period under consideration (and Czechoslovakia, and later the Czech Republic, increased its exports at about three times the rate registered by world exports!). Thus, the trade not only was reoriented Westward, but also grew at rates much higher than elsewhere. An important consequence of the rapid growth in exports has also been the reversal of another longterm trend. While communist countries had been losing their world market shares (excluding the distorted trade among themselves) for decades, post-communist countries of the region had been increasing

62

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their shares significantly in the 1990s. Calculating the shares for exports yields the following increases: from 0.2 percent to 0.4 percent for the Czech Republic, from 0.2 percent to 0.3 percent for Hungary, and from 0.3 percent to 0.5 percent for Poland. The Czech data do not present the full story as they compare the 1989 share for Czechoslovakia with the 1996 share for the Czech Republic alone (adding data for Slovakia would improve the record further). Bulgaria also doubled its share, but from a very low base (from 0.04 percent to 0.09 percent); the only distinct laggard has been Romania whose share declined. These countries were especially successful in the demanding markets of Western Europe, increasing their exports much faster than the growth of aggregated imports of EU countries. To give but one example, Polish manufactured exports to the EU only in 1992–95 increased by 67 percent in the face of aggregate growth of manufactured EU imports by 7 percent! All in all, the foreign trade performance has been very impressive and surprised nearly everyone, especially as the communist record in this respect had been so uniformly bad – and increasingly bad at that (see Chapter 1 and, in more detail, Winiecki 1988). Such dramatic improvements required explanations and the literature on transition, and more specifically on foreign trade in transition, offers some answers.

Trade reorientation and expansion 63 At the most general level it has been stressed, rightly, that there is a strong correlation between the success in transition from plan to market (and parallel to, or in fact preceding, transition from totalitarianism to democracy) and the foreign trade performance on the world market. The best study in that genre is the one by Kaminski et al. (1996). Their findings are, however, too general for our purpose. It is undoubtedly true that without the internal and external liberalization, without sound macroeconomic policy, and without the build-up of market institutions (and, let us add, without privatization) performance in foreign trade, just as economic performance in other areas of economic activity, would have been much weaker. The differences between the ‘success stories’ and the stories of Bulgaria and, even more so, Romania (to say nothing about countries further East) are a good example of the basic soundness of transition-based generalizations. However, the general thesis is unable to explain the particular dynamics of trade reorientation, nor its other characteristic features. After all, the Westward trade reorientation could have taken place at any speed, higher than, equal to, or lower than the growth of world trade. Moreover, the general thesis cannot explain particular aspects. It cannot explain the commodity composition, or structure, of trade in transition. Nor it is able to explain the changes in that structure over time. In fact, both geographic and commodity structures need a combination of historical (communist system-specific) and tradetheoretic explanations to show the contribution of both local and worldwide determinants of exports. The general thesis is, of necessity, silent on enterprises and their behavior in transition, on their adjustment, non-adjustment, or quasiadjustment strategies. It cannot tell us, either, about the relative importance of certain types of strategies, pursued by enterprises, or industries, over time, that is at different phases of the transition process. And it is the foregoing broad range of issues that this author addresses below. The need for such a broad approach is reinforced by an assessment of the more detailed trade-in-transition literature. If the trade-successfollows-transition-success approach is too general for the purpose at hand, the detailed studies of foreign trade or, more often, exports are usually too specific. They tend to concentrate on a single issue, such as the ‘distressed sales’ of traditionally Eastbound goods on the Western markets, the role of FDI in generating foreign trade, the issues affecting commodity composition (e.g. the role of intra-industry

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trade), or certain institutional arrangements (outward processing trade). Rarely do they try to look at a combination of factors that determine the successful world market performance of enterprises from the countries under study. And no foreign trade study to date has looked at the changing importance of various strategies pursued by these enterprises (state-owned, privatized, foreign, or de novo private firms) in the transition process.

Communist history and trade theory: do expectations match? Although the emphasis here is on micro-level performance, it is impossible – as stressed already – to abstract from history and theory. Therefore, I begin with a brief comparative inquiry into the rationale of trade performance expected on the basis of Soviet system-generated output cum trade distortions and on the basis of the dominant trade theories, both classical (Heckscher–Ohlin) and alternative ones, explaining primarily trade in manufactures. To begin with, I posited earlier that since post-communist economies in the region displayed many characteristics of middledeveloped (even if distorted) economies, the search for expected trade patterns in transition should begin with a look at the trade patterns of middle-developed countries in non-communist Western Europe that belong – in terms of development level measured in GNP per capita – to the same intermediate group of countries. The difference between them and post-communist countries of East–Central Europe, a very significant one, is that the former did not undergo any traumatic systemic changes, and therefore their development patterns – including trade patterns – may be regarded as more or less typical. I noted, for example, that the output and trade patterns of such middle-developed countries as Spain, Ireland, and Portugal registered much larger shares of light industries’ products in their exports, in comparison with communist countries’ exports. Therefore, one should expect a shift in the commodity export structure in transition that would result from faster increases in exports of light industries’ products, also those characterized by higher degrees of processing: clothing, furniture, pottery and china, glass and glass products, etc. These expectations, based on historical/empirical observations of the stages of the economic development process, accord perfectly with trade theory-based expectations. The comparative advantages of middle-developed economies are expected to lie largely in products

Trade reorientation and expansion 65 requiring large quantities of semi-skilled labor (often products that are at the same time also natural resource intensive). Most of the industries listed above belong to that category. In fact, it would be difficult to expect otherwise as different development levels are strongly associated with different factor abundance patterns. Another relevant, expectations-related, comment is that new patterns of comparative advantages may also mean old patterns of comparative advantages that (hopefully) survived communist economic-system-generated distortions. Pre-war Czechoslovakia and Hungary, and to a somewhat lesser extent Poland, Romania, and Bulgaria, could even then be roughly classified as middle-developed economies. Consequently, once communist system-specific barriers to normal developmental patterns have been removed, their exports should increasingly reflect the interrupted pattern of development of the pre-communist past, that is the respective comparative advantages of middle-developed economies at a somewhat earlier development stage. Their exports would, then, contain larger shares of early industrialization-related products such as textiles, leather, wood products, etc. The exception should be Czechoslovakia (now the Czech Republic rather than Slovakia), because the Czech lands of the Habsburg Empire had already been a century earlier a large center of heavy industries, especially engineering. Under communism they underwent the peculiar process of economic ‘reprimitivization’ (see Chapter 1). Therefore, under new circumstances, the Czechs should return more easily to their old patterns of exports, consisting of a larger share of heavy manufactures than those in the other post-communist countries under consideration. Other expectations are centered on industry branch characteristics that might have affected export prospects in transition. Thus, one should expect, for instance, that within an oversized – and severely distorted – heavy industry a minority of good performers, or at least firms with the capability to adjust, would emerge. They would then, with an often major effort, find profitable niches on the world market. The foregoing squared reasonably well with trade-theoretic rationale offered earlier that post-communist economies would probably do reasonably well in exporting some intermediate inputs for further processing, especially in capital-intensive industries, including engineering, where a favorable mix of relatively skilled (but low-paid) labor combines with large amounts of capital (but capital usually of a not very sophisticated variety). This type of comparative advantage squares well with the theoretical strand of thinking that differentiates

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between horizontal and vertical intra-industry trade and links the latter with differences in the level of economic development and associated different factor proportions (see, in particular, Falvey 1981). Within the framework of vertical intra-industry trade, middledeveloped post-communist countries would export less sophisticated value-adding parts, components, and final products within the SITC product groups and import more sophisticated value-adding ones. Within the considered framework of vertical intra-industry trade one can also fit the trade based on the expanding possibility of fragmentation of production processes. Over time, especially since the 1970s, manufacturing activities began to be increasingly broken down according to the labor intensity and capital intensity of the various stages of processing. In order to improve competitiveness through the reduction of labor (more precisely, unskilled and semi-skilled labor) costs, Western firms, multinationals and others, moved labor-intensive and increasingly also simple capital-intensive phases of manufacturing outside the high-income, and therefore high-wage, areas. Thus, differences in factor endowments led to the emergence of yet another form of intra-industry trade that differed from the traditional definitions of that trade, based on product differentiation or differences in product quality. This type of trade should also expand in transition – and beyond – as it is based on the same differences in factor endowments between post-communist East–Central Europe and the Western world (Western Europe in the first place, given its geographic proximity). Now, since the initiative to de-localize phases of production comes usually from firms in mature market economies, the increase in the role of that type of trade has been related to the appearance of multinational enterprises (MNEs) in countries in transition. However, even without the MNEs’ presence through direct foreign investment, this type of trade began making its mark in the trade relations between Western and Eastern Europe in the last decade before communism’s demise. I have in mind what is known in West European terminology as outward processing trade (OTP), and in US terminology as maquiladora, that is the processing of or assembling inputs exported from a more developed country to a less developed country and then shipped back to the more developed country. The two-way movement has usually been facilitated by some quota or tariff advantages. These types of exports, mostly in light, labor-intensive industries, have been on the increase since the 1980s and their importance accelerated in the 1990s under the conditions of systemic change (see e.g. Lemoine 1994, Synowiec 1995). This expansion has often taken place through arm’s-

Trade reorientation and expansion 67 length trade (often even at the initiative of major retailers, rather than manufacturing firms), without the MNEs’ presence there. All together it may be said that there is a reasonably good concordance between considerations based on the level of development (even taking into account communist mal-development) and those based on comparative and other advantages stressed by respective trade theories. This should not be regarded as surprising. After all, each development level is associated with a given mix of production factors, classical and non-classical, that in turn are suggestive of comparative advantages of a country under study. Of course, given communist system-specific distortions, some expectations would not fit any trade theory. For example, no locationbased trade theorizing would be specific enough to take into account the peculiar distortions from which the Czech author Kolanda (1984) drew the conclusion that the least demoralized enterprises, and therefore the best performing in Westbound trade, would be those that were not too big and were usually located far away from the communist centers of power (of course, given communist censorship, he did not say that in so many words). In Kolanda’s assessment, the relative lack of attention resulted in a smaller share of investment blunders, or in less pampering of management and workers with privileged access to scarce resources, and associated high wages. His analysis of early foreign trade performance in transition by Czechoslovakia (Kolanda 1993) seems to have confirmed the pattern under different systemic conditions. Finally, one important communist system-specific characteristic seems to be worth signaling at this point, given its potential for affecting the export performance in transition. Thus, I stressed long ago (Winiecki 1990) that the external liberalizations of the (then) communist economies and those of LDCs must differ in one important respect (holding everything else constant). In the latter countries liberalization traditionally aimed at the change in the relative size of the tradable and non-tradable sectors in favor of the former via the resource allocation mechanism. In the former ones, the tradable sector (roughly agriculture plus industry) has already been too large and, therefore, the increase in the supply of exportables must mean something other than the shift of resources from the non-tradable to the tradable sector. And it did mean something else. For communist economies the main problem throughout their existence had been to find goods of sufficiently good quality within the tradable sector that would be saleable on the world market. In other words, the task was to find ‘saleables’ within the much larger category of tradables!

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Now, in post-communist economies that task has become much easier, because, with internal and external liberalizations, many disincentives to turning out higher-quality goods disappeared, while the range of produced goods has been so large that a self-selection for success within that range became possible. The foregoing may be, by the way, one of the major explanatory variables of the extraordinarily rapid Westward export surge of the countries under consideration. This linkage is one of the topics that I am going to consider at some length later.

Westbound export surge The early ‘distressed sales’ argument The trade reorientation was not only rapid but also broad based. Data on exports from East–Central European economies in transition, classified in accordance with SITC product groups, suggest export increases over a very broad product range. An even more interesting picture emerges, as shown recently by Benacek (1997), when one calculates not only export dynamics, but also the relationship of exports to outputs. Benacek calculated that these ratios increased in early transition (1989–94), often substantially, across the board for both light and heavy industries. His calculations for selected industries in both broad groups of manufacturing products for the Czech Republic are shown in Table 3.2(a). My own calculations for Hungary for the same early transition period (1990–94) in Table 3.2(b) confirm the pattern of increasing export:output ratios for both light and heavy industries (although in contrast with the Czechs, the Hungarians increased the ratios more in light than in heavy industries). A predictable ‘outlier’ in the pattern was – in both countries – engineering industries. The reasons for the decline of the ratio in question are obvious. With the disappearance of the communist economic system the markets for obsolete machinery and equipment disappeared as well, both domestically and in other ex-COMECON countries. Accordingly, the exports of engineering goods registered a drastic fall. The extent of that fall is shown in Figure 3.1, where exports of engineering (SITC 7) goods from Hungary are shown to have declined from very high levels (45–60 percent of total exports to communist countries) to something like 15 percent. Thus, by 1992, Hungarian exports of engineering goods to both East and West registered roughly similar shares in total exports. Such an outcome should have been

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Figure 3.1

Changes in the share of engineering goods in Hungarian exports: from communist economy to early transition

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expected as the earlier 3:1 ratio was a system-specific aberration, resulting from the existence under communism of dual foreign markets: the undemanding COMECON market and the demanding world market (on this point see Chapters 1 and 2). The general pattern of increases in export:output ratios in both light and heavy industries was, however, in conflict with the earlier outlined expectations of stronger comparative advantages of most East–Central European countries in transition in the unskilled/semiskilled labor-intensive industries, roughly associated with light industries (exceptions might be Czechoslovakia, later especially the Czech Republic, and to some extent Hungary). This discrepancy between expectation and reality, coupled with rapidly increasing exports of heavy manufactures from the countries in question, gave rise to the inquiry as to the causes of the phenomenon. The ‘culprit’, most often pointed at, has been the so-called distressed sales strategy of SOEs in these countries. In accordance with the thesis, in order to survive the simultaneous fall of domestic and exCOMECON demand, state enterprises simply redirected Westwards

Trade reorientation and expansion 71 products exported to the East in communist times. The alreadymentioned exception was, presumably, engineering goods, given the limited market for technologically obsolete and low-quality machinery and equipment outside the (by now disappeared) communist world. As a preliminary hypothesis of the easily observable phenomenon, the distressed sales argument did well, but questions arose rather quickly, as empirical studies gave the above thesis somewhat limited support. For example, Hoekman and Djankov (1996) do not regard distressed sales as an important factor in the dynamic growth of Westbound exports, estimating them to be limited to something in between 12 and 20 percent of the aggregate exports in that direction. Kaminski et al. (1996) stress that for the Visegrad countries (former Czechoslovakia, Hungary, and Poland) at least some of the large increases in manufactured exports were the outcome of redirection of these goods from the ex-COMECON markets (as well as the replacement of some East German exports to the EU). They add (but without much reference to empirical material) that with respect to Hungary and Poland redirection appears to have played an important role. Their assessments would square rather well with suggestions that a major decline in Hungarian Westbound exports in 1993 and a slowdown in Polish exports that year were the consequence of the disappearance of loss-making exports. Enterprises suffering losses for some time were no longer able to continue such exports (for Hungary, see comments by Kornai 1993). Brenton and Gros (1997), by contrast, treat the issue as little more than marginal. They report to have detected major shifts in the product structure of Westbound trade of analyzed transition countries, in comparison with the traditional exports of these countries. Given the changes in the commodity composition of exports they do not regard the redirection issue as a major contributor to the major expansion of trade with the West. Given these, and other, differences of opinion, common sense suggests starting with the economic logic of the argument and, then, turning to the basic statistics for a preliminary confirmation or refutation, as the case may be. Thus, certain manufactured products, heavily traded among COMECON countries, could have been redirected to Western, especially geographically proximate West European, markets. Knowledge of the communist economic system suggests that the ease of redirection would be negatively correlated with the degree of sophistication of the products. Basic inputs, or some less sophisticated manufactured products, would stand better chances of being exported than machinery and equipment.

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And this is roughly what happened. Table 3.3 shows the dynamics of exports for two periods 1988–92 and 1992–95 for some heavy manufactures. Exports of bulk chemicals, rubber products, paper products, and iron and steel products increased in the earlier period, that is the one associated with the simple redirection of traditional COMECON exports. This increase has been registered for five countries (Bulgaria, Czechoslovakia, Hungary, Poland, and Romania) in 16 cases out of 25 and, if Romania (a definite ‘outlier’ in the earlier period) is excluded, in 16 cases out of 20. Thus there is some support for stressing the importance of simple redirection of traditional communist exports to the West. But the support only goes that far. For if one looks at the later, 1992–95, period one finds that the export dynamics has been sustained or has accelerated in the following years. The growth of exports of the products in question occurred, in comparison with the 1992 level, in 24 out of 25 cases (with Romania joining all the other countries in this export growth). 7DEOH '\QDPLFVRIKHDY\LQGXVWU\H[SRUWVIRUVHOHFWHGSURGXFWJURXSV LQWKHWZRSHULRGV±DQG±VWDUWLQJ\HDURIHDFK SHULRG  %XON FKHP LQRUJ 6,7&

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Trade reorientation and expansion 73 However, in order to prove the existence of distressed sales it is not enough to show that exports increased as such. Distressed sales are just what the term means, that is sales at any price (even at a loss). We do not have the cost data for East–Central European enterprises for these years (and even if we had, it would not help us much given the then different accounting standards). But economic logic suggests that no firm can continue selling at below production cost in the long, or even in the medium, run. Therefore, although one could accept the redirection of trade thesis as a reflection of common strategy, chosen by SOEs in heavy industries (in order to maintain certain volumes of output rather than close production lines) in the short run (say till 1992), the thesis would be much less acceptable in the medium run. For SOEs could not afford to accumulate losses all the time till 1994 or later. For this very reason the data in Table 3.3, registering the continuous – and often even accelerated – growth of exports in the later period, cast doubt on the simple relocation thesis. If East–Central European exporters maintained their market shares, or even increased them in the longer run, then they might have simply been efficient exporters rather than distressed producers exporting at any price. Given the foregoing, should we reject the thesis on distressed sales and substitute an alternative one of an efficient search for new markets in early transition? The answer is that we cannot do that – and for a number of reasons. The first reason is that we have not yet looked at the producers’ costs and prices that East–Central European exporters obtained on the Western markets. Costs, as already mentioned, are not obtainable, but the unit prices on the EU market are – and that should tell us something, but not everything, since unit prices (on a per kilogram or per ton basis) are indicative of two things together: higher (or lower) unit prices for a given product, or a shift to higher (or lower) value products within a given product group (for more detailed analyses of the methodological issues involved, see Ohlsson 1980). Thus, changes in the unit cost indicator may mean either of the two outcomes. In the case we are interested in, lower unit prices in 1990–94 than in earlier periods may suggest distressed sales, but not necessarily so. For lower unit prices may alternatively mean a shift within a given product group toward simpler, lower value-added products. Francoise Lemoine (1994), who looked at the unit prices of East–Central European exports to Western Europe, did not find the decrease in unit prices in the 1988–93 period to be a common phenomenon. The only major product group she analyzed, and where the results were ambiguous,

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was iron and steel (SITC 67). But then she registered declining unit values for simpler, less value-adding products, and rising unit values for more value-adding ones. From the relative size of both types of exports within that product group in the period under consideration she concluded that exporters restructured their product range toward the upper end of the product change. The unit price data in Table 3.4 for other heavy industry product groups (engineering goods, chemicals, tires) seem to confirm Lemoine’s findings that no general decrease in unit prices took place in the early transition period in comparison with the earlier communist period. And in light industry product groups there have been significant increases in unit prices relative to both the communist past and present competitors on Western markets. Incidentally, what might have misled not a few analysts in the field 7DEOH 5HODWLYHXQLWNLORJUDP SULFHVRIPDQXIDFWXUHVH[SRUWHGIURP (DVW±&HQWUDO(XURSHDQFRXQWULHVREWDLQHGRQWKH((&(8 PDUNHWLQ±SULFHVREWDLQHGE\DOOH[SRUWHUVRQWKH ((&(8PDUNHW  (QJ 6,7& %XOJDULD        &]HFK5HSXEOLFE       +XQJDU\       3RODQG       5RPDQLD        D

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Trade reorientation and expansion 75 of transition economics were very low absolute unit prices obtained by post-communist economies (relative to those of their competitors in the West European markets). It was only a single step from discovering low unit prices obtained in the early 1990s to the conclusion that these low unit prices were a characteristic feature of transition strategy. As such they were arguments in favor of the distressed sales thesis. However, as shown in Chapter 1, communist economies had registered low relative unit prices of their exports for decades. In fact they had registered not only low, but also decreasingly low unit prices. Thus, low unit prices in the early 1990s were a stage in a long-term trend that at that time had not been reversed by the transition process. This is, by the way, quite typical of a certain type of approach to the transition process that looks at the starting point of transition as a kind of t0 period in a model, where nothing of importance comes from the past. But in the case of post-communist economies the communist past casts a long shadow. Another example of such an approach is the ‘discovery’ of declining male life expectancy during the transition process that was also accepted on the basis of a model-without-memory and interpreted as an outcome (a part of an ‘unbearable cost’) of transition. However, again, the decline in male life expectancy was not a new, dramatic, transition-related phenomenon, but a continuation of a well-recognized long-term trend that started in the former Soviet Union in the late 1950s, in former Czechoslovakia, Hungary, and Poland in the late 1960s, and in Bulgaria and the former GDR in the early 1970s (no data for Romania were ever made available). Thus falling male life expectancy in early transition has, again, been a stage in a long-term trend not yet reversed by the transition to normality. It should be noted, however, that in successful transition countries the trend was reversed. Returning to the main theme of this chapter, some distressed sales might have taken place in early transition – and they certainly did – but they should not be regarded as the main engine of the successful export reorientation and expansion. The data on both export volumes and unit prices are not suggestive of sales at any cost (unsustainable in the longer run and otherwise easy to notice via downward unit price changes). But before we decide that the opposite view is closer to the truth, that it was largely the successful strategies of SOEs and privatized firms that explain successful reorientation and expansion, the issue should be scrutinized a bit further. Again, in terms of economic logic, there are no prima-facie arguments in favor of Polish, Hungarian, etc.,

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comparative advantages in, say, steel making. Thus, if these countries have continued to export iron and steel, as well as iron and steel products, and in fact significantly increased these exports in the 1990s, there should be some rationale explaining the phenomenon. In economic terms the advantage could come from lower costs of primary inputs, but all COMECON countries, except the Soviet Union, imported iron ore and all but Poland imported coking coal. And all of them, again except the Soviet Union (and until the late 1970s also Poland), were net importers of energy inputs. Thus, their comparative advantages could not come from lower costs of material inputs (at comparable prices). Alternatively, the advantages could come from more advanced technology, or better organization of the production flow, but studies conducted long ago (see e.g. Szpilewicz 1979) showed Poland and Hungary, for which comparable data then existed, to be far behind Western countries in technological/organizational issues. Thus, the answers must lie outside standard economic logic. And it is on this issue that I concentrate in the the following subsection. ‘Distressed non-replacement of capital’ strategy: a complement to the ‘distressed sales’ argument Given that distressed sales cannot be seen as the main driving force behind the reorientation and continuing dynamic expansion of Westbound exports, we should look for other, less explored determinants. One very interesting interpretation of the behavior of enterprises in transition comes from Benacek (1997). Using the Czech data from Table 3.2(a) as a starting point, he suggests the following. The general expansion of exports, either in those industries that have been credited with relatively strong comparative advantages, or in those that were expected to shrink (if not actually fold up), is in many cases the outcome of peculiar adjustments taking place at the enterprise level under the circumstances of excess labor and capital inherited by enterprises from the past. These conditions, combined with certain privatization strategies, offered firms the opportunity to adjust to new circumstances in highly unusual ways. Generalizing on Benacek (1997)’s considerations that were formulated with respect to Czech industry, but have a region-wide application, the following characteristics of production cum export environment for enterprises may be indicated: •

New owners were different from the central planners and their political masters who decided on investment allocation in the past.

Trade reorientation and expansion 77

•

•

•

•

Even if enterprises have not yet been privatized, the managers and workers (wherever the latter have a strong voice, as in Poland) are to an important extent de facto owners, with claims to a substantial part of any surplus of receipts over expenditures. New owners, in cases other than the direct sale to strategic investors (often foreign ones), acquired the property at ‘bargain basement’ prices. In the cases of citizens’ privatization (like Czech coupon privatization) that price was approximately zero. The situation was not much different in the cases of insiders’, managers and employees, privatizations. And in SOEs yet to be privatized the appropriation of surplus on the basis of de facto ownership has been pursued at zero cost. Given the foregoing, Benacek is right to stress that in many cases the acquisition of property rights may be treated as a nearly free gift. An important consequence is that new owners’ or de facto owners’ expectations of the return on capital differ strongly in the downward direction from typical owners of a capitalist firm. Expectations of the return on capital are strongly reinforced by the situation pertaining in the market for used (second-hand) physical capital. Firstly, a substantial and, in heavy industry, dominant part of capital is industry or even firm specific and cannot be sold. Besides, even if general purpose machinery and equipment can be sold, the obtainable price for these capital goods is very low because of similar supplies from other SOEs and exSOEs that are trying to get rid of excess physical capital. New owners, given the signaled characteristics of property rights, have more limited access to the financial markets than owners of well-performing larger private firms, especially those under strategic ownership by foreign MNCs. The latter allow banks to be more confident about the sense of their restructuring strategies. Therefore, the former firms’ capability to restructure by scrapping large chunks of the old and installing new machinery and equipment is relatively low.

As a result, new owners or de facto owners may choose an atypical strategy of running down existing equipment and, at best, replacing only the worn-out parts in obsolete equipment as long as the value added generated in that manner exceeds the variable costs (wages). This possibility was noted also by Jackson and Repkin (1997). Benacek (1997) emphasizes that the strategy of the sunk cost situation in which capital need not be replaced in full, or in some cases need not be replaced at all, is to run it down to zero post-depreciation value,

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to establish a new, albeit temporary, competitive advantage. Artificially created low-to-zero capital costs of production have the same international trade effect as competitive advantages created by the firm via its technological and organizational or other cost-reducing superiority. It is understandable – according to Benacek – that many of the firms following such a capital non-replacement strategy will simply wither away, even without the officially declared bankruptcies. Thus, it may be said that the foregoing strategy is a medium- to long-term equivalent of the short-term ‘distressed sales’ strategy, a distressed nonreplacement of capital strategy, that largely precludes long-term survival. In the meantime, however, by pursuing one or another variant of such a strategy, SOEs or ex-SOEs may survive and even give the appearance of profitability on their domestic and export sales. The situation outlined above is not typical of just the Czech Republic. The Polish iron and steel industry may be another example. At the time of writing Poland is in its 11th year of transition and more than 20 steel mills, large and small, have survived, often pursuing only a partial equipment replacement strategy (and cutting employment along the way), producing less than before 1989 and the collapse of communism, but in all cases exporting a significant part of their output. The logic of the ‘distressed non-replacement of capital’ strategy implies to the present writer that the argument of distressed sales gets a new lease of life. Under the described circumstances temporary profitability, maintained until the complete run-down of equipment, allows otherwise inefficient producers to continue manufacturing and exporting for much longer than originally thought possible under the distressed sales argument. In industries such as steel making, where the average lifetime of the equipment is long, this strategy could continue for even a decade or more (as the Polish case may suggest). Consequently, when we add the share of distressed sales (estimated differently by different analysts) to the share of sales associated with the ‘distressed non-replacement of capital strategy’ (that could only be guesswork), we may arrive at a somewhat more significant share of the total than earlier quoted estimates for distressed sales alone. The feeling of this author is, however, that even in the early period, say until 1992–93, the foregoing aggregate would not be the dominant contributor to the very rapid growth of Westbound exports. Other determinants would contribute much more than both the distressed sales and ‘distressed non-replacement of capital’ survival strategies. It is to these determinants that we are going to turn in the following sections of the chapter.

Trade reorientation and expansion 79

Another past history-based determinant: transforming oversized industry from burden to opportunity The first of the three determinants, and also in a chronological sequence in which they exerted their maximum influence on export expansion, is the oversized tradable sector in the post-communist economies under consideration (in fact in all post-communist economies). As stressed in Chapter 1, the distorted, oversized industrial sector in the communist past had been the main source of turbulence in all the centrally planned and administered economies. However, one may assume – as we already did – that in the postcommunist period, with most disincentives to decent work removed by the transition to the market, opportunities for better performance improved considerably. A large number of enterprises across the whole manufacturing spectrum gained the opportunity to survive and prosper, even if they were all burdened to varying extents by excess (and often obsolete) capital and huge overstaffing. What mattered most was the willingness to try. The necessary conditions might have been – and usually were – very stringent. But a spate of enterprise-level studies suggests that whenever the initial conditions were not that bad and managers were ready to take the lead, trade unions ready to compromise, and workers ready to adjust to new, more demanding working patterns, the probability of success (in the short to medium run at least) increased significantly. Of course, quite a few enterprises chose the strategies outlined in the preceding section. The strategy of running down the physical capital more often than not excluded the probability to survive in the long run. But even the short-term distressed sales strategy, if renounced relatively quickly and followed by serious adjustment effort, offered a glimmer of hope. What was also needed in nearly all cases was a judicious injection of at least some new capital, technology, and marketing skills. The level of development-related reasons determined that enterprises in labor-intensive and labor- cum resource-intensive industries were better positioned to take advantage of new opportunities. In fact, in a substantial number of cases new opportunities were the rediscovery of old opportunities. Enterprises established before communist rule that cultivated pre-communist traditions of decent performance even under the adverse conditions of disincentives to good work had definitely better chances to succeed in transition. All in all, many enterprises in industries closer to pre-communist economies’ comparative advantages have succeeded in surviving and prospering, or at the

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very least in getting a ‘breather’ that – well used – promised better survival prospects in the future. The export statistics of the countries under consideration, concerning the performance of light industries, prove the point. As the calculations of export shares of these industries made by Lemoine (1994) reveal, in 1988–93 Bulgaria, Czechoslovakia, Hungary, Poland, and Romania increased their shares in aggregate exports to EU countries: • • •

in leather products from 3.6 percent to 4.6 percent; in clothing from 12.1 percent to 17.0 percent; in furniture, footwear, and other manufactures not elsewhere classified from 8.4 percent to 9.6 percent.

Interestingly, in the same period when exporters of some light industries’ products increased their shares in total exports, so did those of some heavy industries’ products. Among these heavy industries were engineering goods (non-electrical and electrical machinery and transport equipment), whose combined share increased from 14.3 percent for the group of countries in question to 21.8 percent. The increase was not of the same size across ex-COMECON countries. Most impressive gains have been registered – not unsurprisingly – by the most developed countries in East–Central Europe: Czechoslovakia (from 16.2 percent in 1988 to 25.6 percent for the Czech Republic and Slovakia taken together in 1993) and Hungary (from 13.5 percent to 25.5 percent). However, engineering industries registered gains in all countries, except Romania, in the period analyzed in the study above. Thus, for some countries at least, the engineering industries performed better than aggregate predictions for the countries as a group would suggest. This seems to indicate that, given the very large number of enterprises in all industries, either those where post-communist East– Central Europe possessed comparative advantages, or those where it did not, it was always possible to find winners who displayed their competitive advantages at the level of the firm, in spite of missing comparative advantages at the level of the country. This is not an unknown phenomenon. In all countries there are good performers that survive and prosper, competing against firms from other countries where the comparative advantages of those countries correlate positively with the competitive advantages of firms. The success stories are firms at both ends of the possible spectrum: firms in industries in which their countries lost their comparative advantages

Trade reorientation and expansion 81 long ago but where some firms continue to thrive in spite of adverse country-level conditions; and firms in more sophisticated industries in which countries do not yet possess comparative advantages, but selected firms have already succeeded in getting ahead of the rest. What differentiates post-communist countries in transition is the sheer number of firms in the oversized industrial sector from which winners could possibly emerge. The emergence of ‘success stories’ might have been supported by another feature typical of the communist economic system, namely the extremely wide range of enterprise performance within each industrial branch or even product group under central planning and administration of the economy. However, what had been acceptable in the no-exit economy ceased to be so in transition to the market. Thus, the worst performers were often (albeit not always!) liquidated by withering away or bankruptcy, but the best prospered in the new, more demanding environment. Summing up these considerations, it may be argued that in the postcommunist environment the inherited oversized industrial sector, with its excessively large range of the then unsaleable tradables, turned from the long-term burden to short- to medium-term opportunity. Stabilization cum liberalization programs in developing countries, if successful, tended to reallocate production factors from the nontradable sector to the tradable one. By contrast, in post-communist countries the production factors were already there, however distorted, excessive, and, in the case of the labor force, often demoralized. So, wherever distortions were not overwhelming, and willingness to try was strong enough, competitive exporters emerged faster than they would have emerged in liberalizing LDCs, where only resource reallocation could expand the range of exportables. Everything, of course, has a price, and in this case the price was a high casualty rate in terms of number of enterprises that had (or still have) to exit, a rate certainly much higher than in the case of new firms in liberalizing LDCs. But this should be seen as one more unfortunate legacy of the communist past.

Impact of newcomers The arrival of MNEs We should note that the determinants of trade expansion are not clearcut, easily compartmentalized categories. In fact, there has usually been some overlap between most of them. Thus, one can easily understand

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why the management and workers of some firms that pursued ‘distressed sales’ strategies in the early years of transition did not have enough stamina to enter the demanding period of adjustment and decided to muddle on through the ‘distressed non-replacement of capital’ strategy, thus switching from one strategy to another. Next, SOEs and ex-SOEs pursuing one or another strategy (or each of them in turn, as the previous paragraph suggests) would all come from the excessively large pool of firms in the oversized post-communist industrial sector. But this is not the end of the overlap. The topic of this subsection, that is the impact of FDI by MNEs, gives rise to yet another overlap. FDIs in East–Central and Eastern Europe have registered a significantly greater share of ‘greenfield’ investment projects than those in other regions of the world. Nonetheless, the share of acquisitions of (overwhelmingly) state-owned firms – especially in the case of largerscale FDIs – created an overlap between the large pool of firms in the oversized post-communist industry and MNEs’ activities affecting the trade performance of the countries in question. There is, however, one qualitative difference between the former overlap and the latter. One may assume – with a high degree of probability – that it was the poorer SOEs that slipped from one non-adjustment strategy to another, while the better SOEs attracted the attention of foreign MNEs and were privatized through acquisition by the latter. In the foreign trade context, which is of primary importance here, the contribution of MNEs from a host country perspective is seen not only in terms of the traditional benefits of capital and technology transfer, the transfer of management skills, and fostering a marketbased business culture, but more specifically in terms of opening up new marketing and sales channels abroad. New exports are expected to be accomplished through sales to other subsidiaries or, also within the MNE framework, through marketing goods abroad to the MNEs’ customers. Theoretical and empirical studies of foreign trade and investment offer certain suggestions as to the type of exports that would result from the presence of multinational manufacturing firms. One type of trade flow would be the exchange of inputs sent from the MNE’s headquarter to a subsidiary and the reverse flow of finished products sent from a subsidiary to the headquarter. Balcet and Enrietti (1998) present a typical case of this type of exchange between Fiat (Italy) and Fiat (Poland) reproduced here as Table 3.5. Statistics refer to Italy and Poland, but give or take a few Lancias and Alfa-Romeos, Polish– Italian automotive trade is an intra-firm, that is intra-Fiat, trade.

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It is worth keeping in mind, however, that in more horizontally integrated MNEs the flows would be multidirectional, rather than bidirectional, with inputs flowing to a new subsidiary from the headquarters and other subsidiaries, and the new subsidiary would not only be assembling the finished products and producing some inputs for use in those products, but also specializing in some inputs and selling these inputs to other subsidiaries within a given MNE system. Thus, for example, the pattern of trade flows to and from the newly built General Motors plant in Gliwice (Poland) may look different in the next decade from the Fiat pattern in the 1990s. Another point to make is that the statistics in Table 3.5 hide in the SITC 781 (passenger cars) trade balance yet another kind of trade flow of a more traditional type. In a pioneering work BurenstamLinder (1961) pointed out that countries exchange similar manufactured goods, but of different quality (and associated different price). In the literature on intra-industry trade, this type of trade flow later gained the name of vertical intra-industry trade. Falvey (1981) pursued the approach further, linking it to the classical Heckscher–Ohlin model. The exchange of finished products between Fiat/Italy and Fiat/Poland follows the pattern described above. Fiat/Poland has been producing in Poland and exporting to Italy lower quality/less expensive models (Fiat 126, Cinquecento), while first importing and later also assembling higher quality/more expensive brands such as the Punto, Bravo/Brava, and other brands, as well as those of other Italian manufacturers: Lancia and Alfa-Romeo. The German car manufacturer Volkswagen follows a somewhat similar trade pattern vis-à-vis its Czech subsidiary (Skoda). Higher priced Volkswagen brands are marketed in the Czech Republic via Volkswagen’s subsidiary’s sales force there, while modernized Skodas are exported, not only to Germany, but also to third countries, especially to those where Skoda’s brand recognition was already relatively high in the past. This strategy has been pushed one step further in

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Poland, where Volkswagen converted its local acquisition (in Posnan) into an assembly plant. Finally, while talking about MNEs’ impact upon trade flows we should also mention the ‘classical’, or horizontal intra-industry, trade. This is primarily the ‘trade among equals’, that is among countries with similar factor endowments. The basis of trade here is the ‘love of variety’ or a search for the ‘ideal variant’ of a product and differentiated products from abroad either increase the range of choice or bring some domestic customers closer to their ideal variants. Within the framework considered here, that is mostly the trade between middle-developed, post-communist East–Central Europe and the mature, developed economies of the West, the expectations are that the earlier forms of intra-industry trade – parts and components for finished products and lower-quality finished products for higherquality finished products – would dominate the trade patterns. Turning from theory to empirical studies in search of confirmation of our expectations, it should be stressed at the outset that empirical exercises so far have drawn on the extremely limited statistical base. Even the latest, and most exhaustive, study by Aturupane et al. (1999) relies on data for the 1990–95 period. The problem is, however, that the period may have been sufficient to study foreign trade patterns in the early transition, but is rather insufficient for the study of FDIgenerated trade flows. This is so because in early transition Hungary nearly monopolized all FDI flowing into the region. In 1994 FDI in Hungary amounted to half of all foreign investments in East–Central and Eastern Europe. The Czech Republic started its FDI some two to three years after Hungary, with Poland surging forward to the first place it occupies now only in the second half of the 1990s. Thus, whatever generalizations are formulated on the basis of studies like the one mentioned above, they should be interpreted with caution. For the FDI patterns in the other countries studied might have been less well established, given the very limited presence of FDI there at the time, when FDI studies turned to the available statistics. After all, FDIs in East–Central and Eastern Europe amounted in 1995 to only 3.8 percent of the world total, and that share inched upward only slightly in the following year or two (4.6 percent in 1997, including the postcommunist countries of the former Soviet Union, but excluding those of former Yugoslavia). With this caveat in mind, we now turn to the findings of Hoekman and Djankov (1996) and Aturupane et al. (1999) that are roughly in line with what has been expected on the basis of trade theory. Vertical intra-industry trade dominates the trade of East–Central and Eastern

Trade reorientation and expansion 85 Europe in general, and trade with the EU countries in particular. In the case of the latter some 80–90 percent of all intra-industry trade is vertical (similar goods differentiated by quality and price). A very high level of disaggregation in the studies referred to here, however, does not allow us to establish the existence of the parts and components or finished products patterns that were strongly present in the intra-firm trade, especially with regard to trade between the subsidiaries in LDCs and the headquarters (and subsidiaries) in mature developed economies. Both studies showed that the vertical intra-industry trade is positively and significantly correlated with FDI, which confirms expectations in this respect. However, the earlier study (Hoekman and Djankov 1996) noted that if some ‘outliers’ (FDI in the automotive industries of the Czech Republic, Hungary, and Poland) and electrical machinery and equipment (FDI in Hungary) are excluded, then the relationship becomes less robust. This prompted these authors to hypothesize that ‘exports are mostly “home grown” and intra-industry trade is substantially arm’s-length in nature’ (p. 7). Regardless of whether this is really the case, it is doubtful whether their findings indeed support the foregoing interpretation. Firstly, one should look to the motives of FDIs, especially in lower- and middleincome countries, where horizontal intra-industry trade plays a limited role. A plethora of earlier studies concerning manufacturing FDIs in LDCs suggest that MNEs come to these countries motivated by either of two aims: to capture the local markets or to use them as a sourcing base for their foreign sales, or for intra-firm sales to their other subsidiaries. The first type of investment project, that is the search for markets, generally dominated and, as shown in the survey by Lankes and Venables (1996), it may have dominated FDIs in the postcommunist countries of the region as well. This type of trade would be expected to generate an unbalanced trade: mostly imports of parts and components to post-communist economies; that is, one-way rather than two-way vertical intra-industry trade. The foregoing does not reduce the importance of FDI in generating trade flows: the implication is that the impact of such host-market-oriented FDIs is largely related to host countries’ imports. On the other hand, in typical sourcing-oriented FDIs their impact would be largely related to exports. Such export-oriented FDIs tend to exploit locational advantages and those in the countries in question would lie – to a substantial extent – in labor-intensive production (Hoekman and Djankov (1996) and Aturupane et al. (1999) report positive and significant correlations with labor intensity of traded

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products). Given that the trade would again be unbalanced, but in the opposite direction, it is exports from such subsidiaries that would dominate the trade flows. Again, the importance of FDI would not be questioned here, only its ability to generate balanced vertical intraindustry trade. The available data on trade flows generated by firms under (whole or partial) foreign ownership in Poland confirm the foregoing patterns. Out of 16 product groups in industries with the largest FDI in 1997, one registered 9 product groups with a significant excess of imports over exports and 6 product groups with the reverse pattern. There was only one ‘outlier’ (rubber and rubber products), where intra-firm trade was balanced (assumed here as a deviation not exceeding 15 percent). The details are given in Table 3.6. Also, as expected, FDI-generated exports exceeded imports in industries characterized by high labor and natural resources intensity. Thus, it may be said that at least in the case of Poland MNEs conformed largely in their foreign production and export patterns to the comparative advantages. Thus, exports may be seen as ‘home grown’ (see Hoekman and Djankov 1996) only in the sense that specialization patterns are based on the home-grown, that is countryspecific, comparative advantages, regardless of whether these exports are arm’s-length exports or intra-firm exports of MNEs. However, even such a circumscribed interpretation of the above assessment should be qualified further. The fact that exports exceeded imports generated by FDIs in Poland in capital- and technologyintensive industries does not mean that an export base is not established there. On the contrary, in road vehicles Polish exports by MNEs in 1997 reached over $1.7 billion. This was a typical vertical intraindustry trade in the sense described above: exchange of lower-quality cars for higher-quality cars (plus imports and exports of car parts, with more sophisticated, and costly, parts imported and less sophisticated ones exported from Poland). Since Polish exports of passenger cars and car parts have been growing rapidly, we may soon see the emergence of a new export specialization. This is very much in line with what has already happened, for example, in Spain and Ireland in Western Europe and in South Korea in East Asia. And what was said about Poland applies equally to other middle-developed successful transition countries. Besides, one should keep in mind that the large inflow of machinery and transport equipment by MNEs today suggests that future output of foreign-owned firms will expand substantially. Judging by the past patterns of the increased share of exports being generated by foreign-

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owned firms (this has been the experience of Hungary and Poland so far) an increasing part of the future output would be exported. And changing comparative advantages of middle-developed economies suggest that an increasing part of the exportables would be more sophisticated physical capital- and human-capital-intensive goods. Be that as it may, FDIs have played an important role in the Westward trade reorientation of post-communist economies’ trade, but much greater in later expansion than in the initial shift from Eastbound to Westbound trade. Thus, to use Poland’s example again, firms with foreign capital participation accounted for 38 percent of Polish exports in 1996, but much less in the early phase of transition (10 percent in 1992). The increasing role was registered even earlier in Hungary where by 1992 the share of firms with foreign participation was 30 percent, compared to 11 percent in 1990 (Hamar 1993). But Hungary is an exception, as that country was the early leader in inward FDI. Exports of de novo private-sector firms Last but not least, we shift our attention to yet another category of newcomers, that is to the generic private sector: domestic firms that have been established as private ones from scratch. These firms were overwhelmingly established, and outside Hungary and Poland exclusively, after the communist collapse. They will be playing an increasingly important role in the future export performance of these economies. The above hypothesis is based on the comparative experience of other middle- and highly developed economies, where small and medium-sized enterprises (SMEs) play an important role in export performance, and de novo firms in post-communist countries are mostly, if not almost exclusively, SMEs. Even leaving aside the wellknown position of Germany’s Mittelstand firms, other countries register the shares in aggregate exports of SMEs in the range from 15–20 percent (e.g. Singapore, Australia) to more than 50 percent (Italy, Taiwan), with countries such as Japan, South Korea, Denmark, the Netherlands, Sweden, and Switzerland finding themselves in the middle range of 30–40 percent. Communist economies have been, as is well known, economies of oversized firms. Therefore, the starting point of transition was not one of significant exports generated by SMEs. However, as the sector expanded, its export activities began to grow as well. Neither industrial, nor foreign trade statistics reveal the export shares of firms of differing size in terms of output or employment. We have no regular,

Trade reorientation and expansion 89 comparable data on export shares of SMEs and their changes over time. However, even if we cannot draw conclusions concerning the export dynamics of SMEs in the countries under consideration and the resultant growing shares in aggregate exports, we can at least expect – on the basis of other countries’ experience – that these shares will grow. Some patterns in post-communist countries in transition are nonetheless discernible. Thus, de novo firms had become an important intermediary in imports and exports in early transition, as they more easily found markets for products of the then largely state-owned firms, since both manufacturing SOEs and state trading organizations were not as flexible and efficient in spotting opportunities offered by the world market. Somewhat later, however, they were followed by generic private firms that found markets abroad for their own production. A survey by Szymanderski (1996) of a sample of Polish private entrepreneurs exporting their own products to the West revealed how important for all of them was their earlier experience in the West. A large share of them worked (legally or illegally) there for periods ranging from a few months to a number of years, or at a minimum visited the West frequently enough on business (often working for state trading organizations). All this gave them both knowledge of the markets and business contacts to rely upon. One may surmise that what worked so well for private producers should have worked even better for private traders. No surprise, then, that by mid-1995 private firms had a 55.4 percent share in Polish exports and 69.7 percent in Polish imports (Zarzycki 1995). The overwhelming share in the above was held by generic private firms, the exception being a few large privatized foreign trade organizations. This pattern may have been repeated in those East–Central European economies that had more intensive interaction with the West in the communist past. Apart from Poland, that would include Hungary, the Czech Republic, to a smaller extent Slovakia, and – from outside the range of interest here – also Slovenia. There are no data on exports by SMEs, only on exports by foreign trade firms in Poland in the study by Zarzycki (1995). Nonetheless, they are indicative of export patterns as well. Firstly, many generic private firms do not use foreign trade intermediaries and export goods themselves. Secondly, if they use intermediaries, then they more often than not use other SMEs, because for large trading firms the size of their export offer would not be particularly attractive. Thus, exports from small and medium-sized exporting firms are largely intermediated by trading SMEs. With these qualifications in mind, the Polish data show that the

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generic private sector concentrated, not unexpectedly, on exporting labor- or natural-resource- cum labor-intensive products. Already in 1994 SMEs had shipped abroad 79.9 percent of aggregate exports of textile and clothing, 75.9 percent of agricultural produce and food products, 63.9 percent of furniture, and about half (50.2 percent) of engineering products. Most of their exports went to EU countries: their share of total exports in 1994 was 73.9 percent. There are three reasons for such production and trade patterns in the generic private sector: 1

2

3

These firms are overwhelmingly new firms. They are relatively or even absolutely small and, therefore, did not accumulate enough capital. A natural choice for a small firm is labor-intensive rather than capital-intensive production because the latter usually requires a certain minimum efficient size even in the start-up period. Besides, in the post-communist economies with their underdeveloped financial markets biased against small private firms, these firms’ ability to raise sufficient capital to start capitalintensive production is much lower than in the West. Not only does the naturally small size of start-up firms suggest low capital intensity but so does the comparative advantage of these economies that lies to a substantial extent in labor-intensive products. These products, often combined with local naturalresource-intensive products, have been an increasing part of exports since 1989. The concentration of the generic private sector on geographic areas closest to the manufacturing base (in Poland, 80.7 percent of exports to the countries of the former Soviet Union and 73.9 percent of EU-bound exports) is also explainable in terms of the size of these firms. As transportation, insurance, marketing, and other costs rise with distance, it is largely the bigger firms that can afford to search for distant markets.

In theory, with the structure of incentives set right in transition, generic private firms could also thrive in human-capital-intensive (high skill- or research-intensive) production, but at the same time not in capital-intensive production. The level of education and the extent of R&D activities in the past are suggestive of such production. There are, however, surprisingly few studies that concentrate on the generic private firms in post-communist transition. Privatized and not-yetprivatized firms absorb an overwhelming share of research. But the circumstantial evidence from press reports on ‘high-

Trade reorientation and expansion 91 technology’ firms invariably reveals the dynamic expansion of small firms in the generic private sector that produce and export highly sophisticated goods. Often they are already firms that have crossed the threshold of SME size (in Poland, up to 250 persons), such as Atlas, producer of glues used in the construction industry, which already exports a substantial share of its products. A study by Kaminski (1998) shows the increase in the share of technology-intensive products in Westbound exports from 8.8 percent in 1984–89 to 14.8 percent in 1990–95 and of human-capital-intensive products from 12 percent to 16.7 percent respectively. These aggregate figures may contain a substantial share from the generic private sector. In all countries with a similar extent of knowledge of the West (see above) and with similar progress in transition to a capitalist market economy one should expect similar results. The tradition of the Czechs in mechanical engineering may suggest that quite a few privatized SOEs are returning to their former competitiveness, while the relatively high share of FDI in Hungarian engineering presages a rather rapid turnaround of the old SOEs now turned MNE subsidiaries. The latter, in fact, began back in 1996. All this refers to larger firms, but Czech, Hungarian, and other SMEs in human-capital-intensive industries or product groups should also expand rather quickly – for the same reasons that obtained in the Polish case. It is at this point that the existence of yet another overlap between the categories of exporters should be pointed out. Quite a few of the exporting private SMEs may be enterprises already accounted for in the earlier subsection, namely small and medium-sized firms under full or partial foreign ownership. In fact, the latter may have shown a higher propensity to export, and for two reasons. Firstly, these ‘minimultinationals’ have a natural advantage in being able to find export markets, which may be intra-firm markets in the first place. And, secondly, although those domestic SMEs exporting to the West are usually run by individuals who have reasonably good knowledge of market conditions in the West, as shown in the survey by Szymanderski (1996), the ability to obtain a variety of exportsupporting services in the export markets may be superior in ‘mini-multinationals’ to that in domestic firms (given the longer track record, the location of headquarters in the export market, etc.).

Conclusions These considerations led the present writer to emphasize a surprisingly large number of contributing microeconomic factors to the

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unexpectedly strong Westbound export surge by post-communist economies in transition. It is, most probably, the combined effect of the influence of these factors that made aggregate performance so outstanding. The usual approach has been to positively evaluate institutional progress in the transition process or register significant restructuring and deduce from them the improved trade performance. The surprise often expressed by analysts at the strong export drive of these economies might have had its roots in the underrated range of contributing factors, as various authors stressed a more limited number of microeconomic export determinants. I looked at the most often stressed microeconomic explanation, that is distressed sales, and found it logically convincing, with some empirical and historical evidence supporting the logic of trade diversion. But the same logic forced me to accept a time limitation on distressed sales, because no firm can sustain sales at a loss for a long time. Next, following Benacek (1997), I extended the argument to the medium and long run by describing what I call a distressed non-replacement of capital strategy. It has been noted that the strategy of running down obsolete equipment as long as the value added is sufficient to cover variable costs and generate enough profit to continue operating is pursued at the cost of long-term survival. But in the meantime it allows the firm to be internationally competitive. An important consequence of the run-down strategy is an extension of the distressed sales concept to the medium or even the long run, as shown by the account of the Polish steel industry. The most novel – and possibly also explaining most of the Westward export shift – is the difference between the typical postcommunist country and typical LDC in terms of the source of expansion of the tradable sector. Here, the old weakness of oversized but badly performing industry was turned in transition into a potential strength. The firms need not reallocate their resources to the tradable sector or be established there from scratch – they were already there. There is no free lunch, though, as stressed by Milton Friedman. The price is a high exit rate by those already there but handicapped from the start by the follies of central planners or so distorted over the decades of disincentives to perform decently that they had little chance to survive. The next source, that is FDI, is largely a derivative of the preceding one. Most FDI, especially large FDI, took the form of buying some assets of or the whole of privatized SOEs rather than making greenfield investments. Takeovers by foreign firms strongly reinforced the survival probabilities of firms in the tradable sector in

Trade reorientation and expansion 93 most cases. Their export performance in Hungary and elsewhere proves the point. Finally, it is worth stressing the role of the generic domestic private sector. Given the nature of its origin and expansion in the postcommunist transition, it should be stressed that new private firms would be expected to expand first in the industries that require relatively little capital and a great deal of labor, namely unskilled, semi-skilled, and to some extent also skilled labor (human-capitalintensive industries). Firstly, these countries’ comparative advantages lie in labor-intensive production. Secondly, an accumulation of capital requires either time or well-functioning financial markets able to support high-risk projects of new entrepreneurs. Polish exports from SMEs reflected such expectations well. As a final comment, I would like to stress the changing weights of the microeconomic determinants of export expansion in the long run. Obviously, even the ‘distressed non-replacement of capital’ strategy cannot last for ever. Those firms with capital run down close to zero wither away. So do handicapped firms within the oversized tradable sector. But the remaining factors increase in importance over time. It is the dynamics of the domestic generic private sector and that of firms with foreign capital participation that will decide the sustainability of East–Central European economies’ export performance and increasing competitiveness in the years to come.

4

Institutions and foreign trade reorientation How much impact upon performance?

Introduction In the two preceding chapters I analyzed the adjustment of foreign trade to systemic change, that is to both internal liberalization (the establishment of market economies) and external liberalization (the opening up of these economies to the external world). I focused in Chapter 2 on the adjustment at the aggregate, national economy level, and in Chapter 3 on the performance at the enterprise level. In the latter I looked at the external economic activities of domestic firms (stateowned, privatized, and de novo private firms) and foreign-owned firms. However, a full-fledged story of the reorientation of foreign trade, especially exports toward the world market, and particularly West European markets, requires something more than that. It also requires – for completeness – an analysis of a larger institutional framework, within which economic agents operate on an international plane. In such an analysis we should, for a start, note a fundamentally different role of foreign trade in a market economy (compared to that in a planned economy) and indicate an extended range of transition tasks to be accomplished through the opening up. Next, moving from more general to more specific issues, the analysis should look at the particular institutional choices in foreign economic relations (trade regime, exchange rate regime, FDI regime), as well as at the specific policies pursued within those regimes. Choices should, then, be linked to outcomes in terms of trade patterns, dynamics, and structure. It is precisely these issues that I will concentrate upon in this chapter.

Role of external liberalization in transition There is an enormous difference between the role of foreign trade under a communist centrally planned and a capitalist market economy. At the aggregate, country level, instead of earning ‘precious foreign

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exchange’ – as the communist propaganda language had it – to pay for necessary (or deemed to be necessary) imports, trade in the latter economy increases specialization possibilities through participation in the international division of labor. At the disaggregate, enterprise level it means allowing firms to buy inputs and everything else wherever they are least expensive at a given quality level and to sell their products wherever they can realize the largest profits. Clearly, the value added increases as a result. This crucial difference continued till the very end of the communist regimes in East–Central Europe. The so-called ‘reform regimes’ did not differ very much from the more orthodox communist regimes in this respect. For reasons explained in Chapter 1, even Hungary, the most persistent tinkerer with communist economic institutions, was still ‘fairly separated from the impact of world market even in late 1980s’ (Gacs 1994: 3). However, in post-communist transition there are also two other immensely important goals to be accomplished through external liberalization. Firstly, the free trade regime was expected to ‘import’ the proper, that is world market, price structure to the heavily distorted economies beginning their shift to another economic system. The prices of both exportables and importables in post-communist economies were (rightly) expected to adjust quickly to world market prices for products and services of a given quality. The non-tradable sectors of the economy were expected to follow suit, once the true costs of factors and inputs had been revealed. These confrontations would jump-start the process of revealing the comparative advantages of countries and firms in post-communist transition. Apart from ‘importing’ proper prices, a free trade regime was also to ‘import’ competition. Communist economies were known to be highly concentrated. Apart from being conglomerates of related and unrelated economic activities (see, among others, Winiecki 1988), particular products were often manufactured by very few firms, sometimes just one or two. Internal liberalization entailed, of course, the liberal right of establishment. Therefore, it was assumed that de novo private firms would soon compete successfully with the state enterprises (and later with privatized ex-SOEs), but it was deemed probable primarily in laborintensive manufacturing (and service) activities. Wherever the capital threshold was rather high, in the short to medium run the competition in capital-intensive activities could realistically come only from abroad. Although these two demands on external liberalization – preferably attaining a regime as close to the free market as possible – were of

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overwhelming importance, they were not the only benefits of opening up, alongside the traditional, so to say, ‘textbook’ benefits of free trade. However, other expected benefits were derivatives of the foregoing, overwhelmingly important ones, as well as those of the overall transition measures. Take, for instance, the FDI regime, crucial from the longer-term perspective of post-communist economies and their place in the international division of labor. The ability to set up a regime conducive to the inflow of FDI would basically depend on the progress of transition in general, not external liberalization alone. There has been something akin to general agreement among those who were not openly hostile to the market on the above three reasons for opening up post-communist economies. However, the issues concerning the extent and speed of opening up, to say nothing about the sequence and, at times, even the choice of liberalizing measures, were hotly debated among both mainstream economists and those belonging to other theoretical strands. In order to meaningfully present the debate and its impact upon transition it seems necessary to remind readers about the noticeable evolution in mainstream economic thinking in the post-war period with respect to economic openness, which was viewed over the years in the following manner: •

•

•

At first it was seen as dangerous for economic development. Therefore, external economic relations (currency, trade in goods and services, and capital flows) were tightly controlled by the state, in accordance with the tenets of the then prevailing thinking of ‘development economics’. Later, in the 1980s, there was a noticeable change in the thinking about economic development strategies pursued since the 1950s in most LDCs. The change was one of the results of clearly visible economic failures registered by those pursuing activist, or dirigiste, development policies. Consequently, economic openness was ‘rediscovered’, so to say, to be of crucial importance for economic development. However, on the basis of experience of LDCs, it was seen as a goal to be achieved in a long process spread over a number of years. Even after the turn in favor of external liberalization, full-fledged liberalization has been regarded as a luxury of sort by most mainstream economists. The luxury of convertibility on both the current and capital account was deemed to be affordable only at the highest levels of economic development (the one achieved by rich Western economies).

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Such evolution has also been characteristic of the two most important international financial institutions, the Washington-based International Monetary Fund and the World Bank, whose voices (and various forms of financial support) were to be very important for policy makers in post-communist countries. Termed ‘the Washington consensus’, the views dominating in these institutions on the issue of economic openness were at the time of the communist collapse – at the turn of the 1990s – much more pro-market and pro-openness than they were before. They were roughly in line with the general evolution of mainstream views on these subjects or maybe even slightly ahead of them. However, as briefly noted above, external liberalization, encompassing trade liberalization, the establishment of a market-based exchange rate regime, and its corollary, that is currency convertibility, has been regarded as a ‘drawn-out process’ (Thomas and Nash 1991: 32), measured in terms of years and in some respects (full convertibility) even decades. To give but one example at the turn of the 1990s, the consensus view on the later phase of trade liberalization, entailing the establishment of a relatively uniform, low tariff at about 10 percent ad valorem, was expected to be completed within a time-span of 3–10 years. Full convertibility was not even considered as part of a standard liberalization package.

Intellectual debates on external liberalization part of overall transition package The debates, hectic as they were, given the urgent need to make decisions as rapidly as possible, were strongly influenced by Western advice, particularly that from the IMF and World Bank. They were also influenced – although often too little (see Winiecki 1993, 1995) – by the need to acknowledge the legacies of the communist economic system. These, in turn, required measures not envisaged by those who modeled their packages on the basis of the experience of liberalizing LDCs. Certain measures concerning the removal of the legacy of the communist past seemed self-evident for those intent on breaking with the past. Thus, there was little debate in Poland, Hungary, and Czechoslovakia – in that chronological order – on the need to eliminate so-called compensatory accounts, that is the system of export and import subsidies and taxes that de facto severed the link between the domestic and international economy. The experience has been such that communist reformers, to say nothing about more market-oriented

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analysts, were conscious of the disadvantage of being separated from the stimuli generated by the world market. Overall, in the early debates on external liberalization, gradualism was the order of the day, supported by international financial institutions. However, the argument was – quite unexpectedly – won by radical rather than gradual proposals. One should stress in this respect the irreplaceable contribution of Jeffrey Sachs, a Harvard professor with practical experience in advising governments on how to cope with the simultaneous problems of stabilization and liberalization. His proposal of a ‘big bang’, that is a combination of radical internal and external liberalization (combined with stabilization measures), went far beyond the standards of the then ‘Washington consensus’. Instead of trade and foreign exchange liberalization based on a timetable measured in years, he proposed to the Polish government a simultaneous liberalization of the domestic economy and foreign trade regime, combined with a high degree of current account convertibility. How revolutionary Sachs’s proposal seemed at the time may be measured by the fact that the farthest reaching proposal on the table was the one suggested by the present writer in his article in the Financial Times, before the fall of communism (Winiecki 1989a). It assumed an interval of 12–18 months between radical internal and external liberalization along roughly similar lines. Sachs, about half a year later, argued in favor of the simultaneity of liberalization and against spreading the shock to domestic economic agents over a year or two, to say nothing about the 3–10 years envisaged by the ‘Washington consensus’. His eloquence (fortunately!) won the day and the Polish transition program started on January 1, 1990, with both very far-reaching internal and external liberalization. Czechoslovakia accepted the argument during 1990 and started its transition program a year later with a similarly radical two-pronged liberalization. Although the Hungarian elite never acknowledged the strength of the foregoing argument, governmental policies by and large followed the same pattern. In the apt words of Csaba (1994) gradualism was preached, while radicalism practiced. Bulgaria and Slovenia differed in the choice of regime, but not in the general thrust of their external liberalization. In East–Central Europe only skillfully regrouped Romanian communists were much less radical in both internal and external liberalization. They did not stabilize much, either. Although the general thrust of the external liberalization component of the transition package has largely won acceptance within the

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elites in East–Central Europe (with some exceptions), there has been much less agreement on specific measures. With respect to trade policies, the following measures have been generally accepted: • •

• •

the already-mentioned elimination of export and import subsidies and taxes; the removal of other quantitative restrictions on imports (although here there were differences, e.g. between the more radical stance of the Czechs and the more cautious one of the Hungarians); tariff simplification (the reduction of the variation in tariff rates across product groups); and the decrease in the absolute tariff levels.

At the same time, however, the debates expressed many fears as to the possible balance-of-payments effects of radical import liberalization. Given the decades of persistent shortages, it was feared that ‘hungry’ post-communist consumers would reveal import demand beyond the capacity of exports to ensure trade and balance-of-payments equilibrium. This gave rise to a variety of proposals aimed at the reduction of expected dramatic increases in the imports of consumer goods. On the one hand, some trade policy measures, such as tariff surcharges or payment deposits, were proposed with respect to these imports. On the other, many suggested an initial buffer, protecting domestic producers against inexpensive imports, in the form of a sharp devaluation of domestic currency at the start of the transition program. Policy makers – to be on the safe side – on the whole chose both (with Hungary being a partial exception). In the event, as shown in Chapter 2, these fears were grossly exaggerated. Transition, which is a systemic change, was bound to affect not only the import demand of households (starved for so long of decent consumer goods), but also the demand for imports in general (as well as the supply of exports). Consequently, the decline in imports of intermediate inputs, not needed under the hardening budget constraints of SOEs in the emerging market economies, more than compensated for the expected rise in the imports of consumer goods. The fears of the initial consumer goods surge shift our attention to another arm of foreign economic policy, that is to the exchange rate regime and policies pursued within the selected regime. The choices here were more contentious, with the differences of opinions stemming from both theoretical differences and practical considerations of what is feasible under given circumstances.

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Take the basic choice between a fixed and flexible (floating) exchange rate regime, or any intermediate regime between the two ‘pure’ models. With relatively low inflation in communist Czechoslovakia, the post-communist reformers could envisage the introduction of a truly fixed, rather than pegged, exchange rate regime. What was needed – they might have assumed – was a devaluation at the start sharp enough to absorb the effect of price liberalization and the (presumably short) period of return to low or no inflation. Such a choice, however, was beyond the bounds of what was feasible at the time in Poland or the former Yugoslavia, that is countries on the verge of hyperinflation. The debate centered around the choice of the initial exchange rate regime. In Poland analysts preparing what was later known as the ‘Beksiak Report’ for the parliamentary ‘Solidarity’ faction (for the English edition, see Beksiak et al. 1990) were in favor of a floating exchange rate regime. They argued about the need for internal consistency among liberalization measures; the price of foreign exchange and that of other production factors and inputs should be equally market determined. Such a choice was consistent with the so-called orthodox stabilization/liberalization approach. Experts from international financial institutions and many others, including the path-breaking Jeffrey Sachs, were recommending a pegged exchange rate. Their arguments were twofold. On the one hand, they pointed to lower costs of what has been known as the ‘heterodox’ stabilization cum liberalization program (in comparison with the ‘orthodox’ one). Anchors such as pegged exchange rate, wage controls, etc., were supposed to reinforce the orthodox macroeconomic policy measures in orientating the economy toward lower inflationary expectations. On the other hand, they argued that in the situation of near hyperinflation and the weak faith in the domestic currency (the ‘dollarization’ problem) a pegged exchange rate provided an unambiguous reference for domestic nominal prices, and therefore encouraged economic agents to use domestic currency in their transactions. That, in turn, made the movements of domestic monetary indicators more predictable, improving both the quality of monetary policy and business decisions. Most experts regarded the pegged exchange rate as a temporary device. In discussions in the fall of 1989 in Poland, Sachs regarded it as necessary for the first three months. Afterwards the country should switch to a more flexible, intermediate regime (see e.g. Sachs 1996). This is what Poland did, moving to a pre-announced crawling peg. However, it did so after 17 rather than 3 months, and at a double cost

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of contributing to an unnecessarily large import surge from summer 1990 till spring 1991 and a less easily measurable slowdown in the shift of resources toward the manufacturing of exportables (or, to be more precise in the inherited environment, toward the manufacture of saleable exportables). To play an active stabilizing and liberalizing role, trade and exchange rate policies should be correlated with the relatively farreaching extent of convertibility. It is in this respect that the divergence of opinions was the greatest. Clearly, Westerners drew on their own early post-World War II experience and on subsequent LDCs’ experience, while formulating their views on the subject. In Western Europe, Hochreiter (1996: 9) noted that, after World War II, ‘convertibility was not seen as an instrument of economic policy, but rather crowning result of a long development process’. In the case of some West European countries the process lasted until the late 1980s and early 1990s. Also, some academics of a more interventionist persuasion even regarded full current account convertibility as a luxury. In their view the right of households to purchase foreign exchange at the legal rate, to hold foreign exchange bank accounts, and to use their foreign exchange for tourism and purchases abroad, was a luxury transition countries could not afford (e.g. Williamson 1991). What they regarded as suitable for transition economies was something akin to a free trade regime in inputs and capital goods for everybody or only for exporters. That was what helped East Asian countries that switched to export orientation in the early 1960s and consequently improved their export performance dramatically. However, some experience had been gained, after all, in the meantime. What had then been seen as brave swimming against the misguided dirigiste tide (Lal 1984, 1994, Prowse 1993) would not do much good at the time of the liberalization wave sweeping the world. It would look like unimaginative timidity at the threshold of the 1990s. This latter view prevailed in the debates and – more importantly – among policy makers in East–Central Europe.

Trade policies: radical liberalization, ‘Westernized’ protection, and integration As stressed already, all East–Central European reformers, except Romania, accepted the idea of the paramount contribution of free trade to transition and tailored their trade regimes accordingly at the start of the process. Therefore, they liberalized foreign trade at an unprecedented speed (Gacs 1994) if compared with the experience of

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Western Europe after World War II and that of liberalizing developing economies from the 1960s to 1980s. Up to 90 percent of imports and exports were liberalized in the first year or so. Import tariffs were established at levels envisaged by the ‘Washington consensus’ (around 10 percent). As noted earlier, the fear of the rising tide of consumer imports and resultant balance-of-payments imbalances prompted reformers nonetheless to take some precautionary measures at the outset. Apart from a large initial devaluation (Poland, Czechoslovakia), they included, inter alia, a temporary import tariff surcharge, especially on consumer goods’ imports (Czechoslovakia), import deposits, compulsory credits or a similar constraint on the financial resources of importers (Czechoslovakia, Hungary), and a certain, usually small, number of quotas. With respect to the last category of protectionist measures the aggregate consumer import quota in Hungary was the most visible remnant of thinking in terms of communist ‘shortage economy’. Quite probably, in the thinking of Hungarian policy makers at the start of transition the aggregate limit on the import of consumer goods was seen as equivalent to an initial large devaluation that Hungary, the only pegged exchange rate regime in East–Central Europe, did not do at the start. In fact, the rapid liberalization in all countries under consideration still hid certain differences in terms of the aggregate level of tariff protection. The average nominal tariff level ranged initially from about 18 percent in Hungary to less than 6 percent in Czechoslovakia, with Poland located somewhere in between. What also mattered was the low coverage and (even lower) frequency of non-tariff barriers at the start of transition. Trade liberalization proceeded even further from mid1990 to mid-1991 in the case of the three early transition countries. In Poland, in the summer of 1990, the policy makers decided to suspend or cut almost 60 percent of all tariffs, thus reducing the average nominal tariff to about the Czech level. This movement toward the near free trade regime did not last long, though. The liberal honeymoon began to fray at the edges in late 1991. After September 1991 Poland discontinued the suspension of tariffs. In the next year or so product- or product-group-specific tariffs were imposed throughout East–Central Europe. New non-tariff measures of protection were reintroduced, or introduced for the first time. The transition economies in question began to ‘Westernize’ rapidly in this respect. That is, they began to look – in terms of trade protection armory – much like modern Western economies, although the extent of non-tariff protection was nonetheless lower in East–Central Europe

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than in Western Europe. New states, namely the Czech Republic and Slovakia, and also Slovenia, followed suit. Only Estonia, after achieving independence, dismantled in mid-1992 almost all communiststyle export controls, reduced its tariff rates to zero, and did not follow the urge to introduce quantitative barriers. Before following certain common twists and turns of trade policies characterizing most of the post-communist economies in transition in East–Central Europe, it is imperative, however, to consider both the causes of the very rapid liberalization and those of some early departures from the first and best, that is free trade, regime. Rapid liberalization, contrary to some opinions bemoaning the competition to make an even bigger ‘bang’ than earlier starting transition economies (see e.g. Williamson 1991), was, firstly, the logical consequence of the acceptance of the above argument of combining at the start of transition both internal and external liberalization. Secondly, the speed and extent of external liberalization were based on the strength of the argument of the triple impact of an open regime upon the post-communist economy, that is upon specialization patterns, ‘import’ of world relative prices, and that of competition. The more open the regime, the stronger the desirable impact upon the emerging market economies in all three areas. The lack of serious resistance to the far-reaching external liberalization had other determinants. An intellectual determinant was the high tide of liberal economic thinking. Apart from its well-grounded theoretical rationale, it was simply extremely popular at the time. A political determinant might have been particularly important. The late Mancur Olson was insistent in his second major book, The Rise and Decline of Nations (1980), that a major overhaul of the economic system in the liberal – free market cum free trade – direction had the greatest probability of success after a major institutional discontinuity. A lost war, a revolution, etc., eliminates or at least sharply reduces the influence of various redistributive pressure groups that are then not able to resist successfully the introduced liberalizing measures. From this, he maintained, stemmed, inter alia, the success of the socalled ‘German miracle’ of 1948. In fact, it was no miracle at all, but a cautiously designed liberalization, flowing in the face of the dirigiste prescriptions of the day (its cautiousness stemming precisely from the completely different intellectual and political climate of the late 1940s!). The collapse of communism was a discontinuity of even bigger historical proportions. Unsurprisingly, such a discontinuity all but eliminated the former power structure (disappearance of the totalitarian

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monopoly of the Communist Party) and rendered impotent or weakened informal pressure groups existing under communism, such as, for example, a heavy industry lobby. Now, with the old pressure groups disappearing, or in disarray, and new ones only beginning to establish themselves, policy makers had almost a free hand in crafting the program of systemic change, including external liberalization, as close to their economic ideas as possible. And since these ideas were close to the free market and free trade ideas, the outcome was a very rapid – and little opposed – liberalization, including external liberalization. On top of the above, there exist what Balcerowicz (1993) calls the period of ‘extraordinary politics’. The collapse of an intensely disliked regime generates a lot of popular enthusiasm and willingness to accept sacrifices on the path to a different future. But this window of opportunity does not last for very long. As the costs of the chosen strategy inevitably rise, ‘reform fatigue’ (see Bruno 1992) sets in and resistance to change begins to increase. Mounting costs of economic openness – output fall, unemployment, more rarely bankruptcies – ended the liberal honeymoon in 1990–91 and policy makers, feeling the weakening resolve of the population, began to yield to the reborn and regrouped protectionist pressure groups. Just as Poland was in the forefront of liberalization, so from mid1991 it led in the opposite direction. A series of tariff and non-tariff barriers to protect agricultural producers were introduced in May 1991. New tariff structure in August of that year raised the overall level of nominal protection. In the following January, the subsequent government sharply raised tariffs both to protect domestic producers of what was then perceived to be high-tech products (cars, TV sets, audio equipment, personal computers, etc.) and to raise revenue in the face of a rapidly widening budget deficit. In Czechoslovakia, some agricultural protection via quotas started in September 1991, only nine months after the start of the transition program. In January 1992 coal, textiles, and clothing were affected by additional protection. In Hungary, already protected by the aggregate consumer import quota, the general quota had been supported by additional quotas, protecting to some extent Hungarian coal mining, as well as textile and clothing industry products. Not much later substantial increases in tariff rates on some consumer durables, among others – as in Poland – on cars and TV sets, were introduced. This was to be only the first stage. After Czechoslovakia split, the competitively weaker part, Slovakia, decided to introduce temporary import surcharges. The same was done by the Polish government of

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the moment in 1992. Among the Baltic countries Lithuania was most active in erecting tariff barriers. An emerging balance-of-payments crisis in Hungary resulted in an 8 percent temporary surcharge on imports (except those of machinery and energy sources) introduced in early 1995. The trend of increasing piecemeal protection continued until the mid-1990s. Other measures began to be tested in those years as well. Interestingly, the testing ground often became other post-communist countries that did not pursue transition as thoroughly and allowed their heavy, energy-intensive industries to compete on the basis of strongly underpriced inputs. Hungary, for example, introduced quotas on a number of steel products vis-à-vis the successor states of the former Soviet Union (as well as the Czech Republic and Slovakia!). Poland enacted anti-dumping regulation, started first inquiries, and issued first verdicts, also against some of the Soviet Union’s successor states. Reborn and regrouped protectionist pressures indeed made themselves felt. They were old trade unions, or, as in Poland and Bulgaria, new non-communist trade unions as well. They were also old heavy industry lobbies that found new allies in the government and political parties, both collectivistically and nationalistically oriented. Whether for reasons of maintaining the illusion of industrial might, or for the greater glory of the nation, or simply for reasons of political expediency, protectionism was found to be the most easily mounted political workhorse. Additionally, policy makers of all political persuasions found tariffs to be a tempting vehicle to raise additional revenue in the face of mounting budget deficits everywhere, excluding Czechoslovakia and later the Czech Republic. Popular consumer durables especially became the target in this respect. Finally, certain protectionist measures were introduced under pressure from some important foreign direct investors. The 10-year protection period for small cars produced by Fiat was the price paid by Polish consumers for the singularly inept deal struck by the Polish communist authorities back in 1987 that made subsequent sales of the small-car factory possible only at the high cost of protectionist concessions. In some other cases temporary protection has simply been the price paid for foreign investment to be made at all in what was then perceived to be a high-risk environment. Two comments seem necessary in analyzing trade policy developments in post-communist East–Central Europe. The first concerns the normative assessment of the early departure from the near-free trade

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policy stance by early transition countries of the region. Although in Poland, Hungary, Slovakia, and the Czech Republic we have noted a protectionist tide, beginning in the second half of 1991, the assessment of the development in question need not be unequivocally negative. As stressed by Kaminski et al. (1996), paradoxically, an increase in tariffs may in fact indicate a success in moving toward a market-based, open economy regime. The abolition of non-market-type barriers that shielded producers in communist times and the establishment of a close to free trade regime constituted dramatic changes in the competitive conditions in these economies. Once the protective effects of the initial large devaluation were eroded, enterprises found themselves under severe competitive pressure for the first time. Unsurprisingly, they clamored for protection. Therefore, Kaminski et al. point out, not without reason, that ‘the pressures for protection … indicate that these countries are well advanced towards being market economies as domestic producers have felt the chill winds of competition and have become sensitive to developments in international markets’ (1996: 428). In this sense we may talk about the Westernization of trade policies. The second comment concerns the assessment of the extent and depth of the departure from the near-free trade position taken by these countries in their trade policies in the early period of transition. For even if the pressures for protection are a good sign (see the preceding paragraph), giving in to these pressures is not. The question is, then, to what extent did East–Central European countries depart from the early near-free trade stance in, roughly, the 1991–95 period? The answer may be given indirectly, by comparison with the West. The fall in the level of tariff protection resulting from successive tariffcutting GATT ‘rounds’ resulted – after the first oil crisis in the early 1970s, and even earlier – in the construction of elaborate systems of non-tariff barriers. Barriers ranged from the multilateral agreement on textiles and clothing (the so-called multifibre agreement) to various national non-tariff barriers. They included such obstacles as the famous, or infamous, French invention of the early 1980s, when imported video cassette recorders were administratively processed at the customs in one place only in the whole of France, and the place far removed from any maritime access (Poitiers). Since most products were coming from Japan, it was a barely disguised way of slowing down the stream of imports (to give the only local producer time to catch up). Compared to the foregoing variety of quantitative barriers, technical standards, and subsidies affecting the contestability of markets in

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mature Western economies, measures applied by East–Central European countries, except free-trading Estonia, were closer to unorganized ‘ad hocery’, or reactions to localized pressures for protection. The situation did not change much in the second half of the 1990s, although the external framework changed substantially, if not dramatically. The European Agreements (EAs) provided that tariffs on industrial goods imported from the EU member countries would be reduced to zero in five 20 percent installments. Thus, in the period of 1991–95 the imposition of non-tariff barriers (NTBs) was often accompanied by increases in tariff protection, although often only temporary (see the quoted tariff surcharges). By contrast, from the mid-1990s onward, the introduced protection rules and actual applications of NTBs were accompanied by the prescribed rapid reduction of tariffs vis-à-vis those countries with which East–Central Europe conducted more than twothirds of their aggregate trade. To this one should also add the liberalization of the substantial part of trade within the CEFTA (Central European Free Trade Agreement) area. Interestingly, as evidenced in a series of World Bank papers (Kaminski 1999a, 1999b, 1999c), there has been no ‘clear-cut relationship between falling tariffs and increasing NTBs’. After looking mainly at the Hungarian and Polish cases, the author in question concluded the following. Given the experience of the West in the 1970s and 1980s, the decline in tariff protection should have triggered a strong wave of NTB-based protective measures. Registering cases of what was called ‘piecemeal protectionism’, described earlier in this section, some observers of trade developments in the post-communist transition predicted just that. But no systematic pattern of increased non-tariff protection in response to falling tariffs had been observed in the pre-accession period. Kaminski (1999c) looked at both the frequency of NTBs and their coverage, the latter being a more realistic measure reflecting the percentage of the aggregate value of imports affected by such barriers. His calculations show that in Hungary in 1997 the frequency was substantially lower than in mature Western market economies, but coverage was higher (22 percent of imports covered vs. 6 percent in Canada, 8 percent in the USA, and 11 percent in the EU). The full implementation of the EA-prescribed tariff reductions was expected to reduce the coverage to a level below that of the EU (8.2 percent), although still above those of Canada and the USA. According to Kaminski’s analysis, among the East–Central European countries in the front line for EU membership Hungary

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displays relatively the strongest tendency to use non-tariff protection measures. Poland is next in line, with Estonia being the paragon of free trade at the other end of the spectrum. However, even if some countries have pursued more active (meaning protectionist) trade policies than others, the foregoing cannot be unequivocally evaluated as an example of the protectionist trend in post-communist transition, at least among the successful countries. On the contrary, while the majority of East–Central European countries introduced, for example, ‘modern’, Western regulations concerning anti-dumping and countervailing duties, their active use has been an exception rather than the rule. Thus, Kaminski (1999c) stresses that even the measures maintained or introduced in the relatively protectionist countries under consideration may be seen more as irritants than formidable barriers to trade with these countries. Overall, then, his assessment is that ‘despite some occasional slippage, the CE-5 [Central European countries first in line for EU membership] countries have stayed the liberal course’ (1999c: 24). The linkage between staying the liberal course in foreign trade and the overall transition process that exactly stayed the liberal course suggests itself very strongly.

Exchange rate regimes and policies The 1989–91 debates did not create any consensus with respect to the choice of exchange rate regimes by the transition economies of the region. The three countries soon to be regarded as ‘success stories’, that is (chronologically) Poland, Hungary, and Czechoslovakia (later the Czech Republic), opted indeed in favor of the pegged exchange rate regime, strongly preferred by both international financial institutions and most analysts. However, some other countries chose differently. Thus, Bulgaria, and somewhat later – after the break-up of former Yugoslavia – Slovenia, opted in favor of the managed float. The choice of the latter two countries might have been explained in terms of necessity rather than preference, as the choice of the fixed, or pegged, regime presupposes the availability of reasonably sizeable foreign exchange reserves, which these two countries clearly did not have. However, as time progressed, other countries of the region, again, chose differently. Estonia, for example, chose a fully fixed exchange rate regime of currency board. With these varied exchange rate regimes East–Central European countries in transition tried to achieve basically the same range of traditional policy aims:

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ensuring internal macroeconomic stability by influencing price level; ensuring external macroeconomic stability by influencing the balance of payments; and ensuring microeconomic competitiveness vis-à-vis the external world by the stable real exchange rate.

Since there are clear incompatibilities between the various aims assigned to the exchange rate policy, the chosen regimes and subsequent policies had to give priority to some aims rather than to others. Moreover, these priorities have been changing over time as economic conditions gave rise to other, more urgent concerns. In fact, not only priorities, but regimes themselves have been changing as well (see e.g. Koch 1997). To begin with policy, rather than regime, changes among the three countries of the region that chose the pegged regime policy, the differences have been substantial and they, in fact, increased in the first few years of transition. The chronologically first pegged regime, in Poland, started in a near-hyperinflationary situation. The peg – as stressed already – was supposed to be maintained only for a few months to stabilize the domestic currency and start the de-dollarization process, necessary for macroeconomic stability, including the resumption of saving in domestic currency. Clearly, internal macroeconomic stability was the primary aim at the start. But other aims, associated with export competitiveness and the balance on the current account, were not left unattended. A sharp devaluation at the start of the transition program was to improve, albeit temporarily, the position of domestic producers who, as a result, gained a breathing space before the chill winds of competition began to blow for the first time in half a century. For reasons explained in Chapter 2, the expectations of a rapidly growing import/export gap due to the consumer import boom never materialized and Poland achieved a sizeable surplus on its current account in the first year of transition. It would have been even greater, but the still very rapid, although falling, inflation largely eroded the undervaluation of the Polish currency and resulted in increasing imports in the last months of 1990 and early 1991. The shift from a large surplus to a small deficit in 1991 was due to the prolonged period in which the Polish currency was pegged at the same ($ = 10,000 zlotys) level. However, in those 17 months from January 1990 till May 1991 CPI-measured inflation exceeded 300 percent. Clearly, whatever undervaluation existed earlier, it had been eroded during the latter part of the period in question. These large swings in

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the real exchange rate did not help Polish firms in their efforts to shift resources from non-tradables to tradables. With the profitability of exports on the decline, the resource shift slowed down as well, a point made by this author at the time (Winiecki 1991b). Later attempts at using the exchange rate as a competitiveness-oriented instrument were spasmodic as a result. Devaluations had to be large and, moreover, even the change of the exchange rate regime from adjustable peg to crawling peg did not end discretionary devaluations that during the 1991–93 period occasionally accompanied the pre-announced devaluations, made within the framework of a crawling peg regime. The Hungarian adjustable peg differed from the Polish one. Firstly, it had been discretionary through and through, until the change in the exchange rate regime in 1995. Secondly, given less disequilibrated macroeconomic conditions, it aimed at maintaining the stability of the real exchange rate through ex post discrete devaluations. Compensating for inflation on an ex post basis only was to play additionally an anti-inflationary role. Thirdly, Hungarian exchange rate policy was pursued without the initial large devaluation. Therefore, the competitiveness aim of exchange rate policy depended only on discrete devaluations during the transition process. The shift of policy priorities was also observed in the case of Hungary. With the rapidly growing current account deficit in 1993–94, the anti-inflationary aim had to be sacrificed and the frequency and size of devaluations increased (7 percent in July 1993, 4.5 percent in September 1993, 8 percent in August 1994, with smaller devaluations interspersed in between). Just before the introduction of the stabilization package, including the change in the exchange rate regime in March 1995, another large devaluation (9 percent) again took place. Czechoslovakia, and later the Czech Republic, decided to establish a pegged exchange rate regime but took the long-term stability of the peg very seriously. Historically, like the Germans, the Czechs displayed a strong anti-inflationary bias. Therefore, they hoped to extinguish corrective inflation through a restrictive macroeconomic policy in the early transition period and convert a pegged exchange rate regime into a fully fixed one. Inflation increased sharply, as expected, at the start, in 1991, to 57 percent. Nonetheless, given the shift to an expansionary monetary policy, it got stuck later at the level of 10 percent per annum until 1998 (except for the year after the ‘velvet divorce’ from Slovakia, that is 1993). Under such circumstances, the probability of maintaining the peg decreased with each passing year. Some intermediate attempts at shoring up the pegged rate by introducing the exchange rate band in

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February 1996 failed to impress the financial markets that looked at the unchanged fundamentals and expected the koruna to be devalued sooner or later. Indeed, in May 1997 the currency crisis forced the Czech National Bank to go off the peg and float the currency. After separation, Slovakia pursued the pegged exchange rate regime but with less stress put on fixity of the rate. Subsequent infrequent devaluations reflected the variety of concerns of Slovak policy makers. Interestingly, Slovakia – in contrast with Poland, Hungary, or the Czech Republic – stayed with the pegged exchange rate regime throughout the period under consideration. What is worth stressing with respect to the three countries that did change the regime is the difference in timing of the change. In the case of Poland a shift from the adjustable to the crawling peg took place in late 1991, after strong erosion of the initial undervaluation of Polish currency. The 17 percent devaluation in May 1991 was followed a few months’ later by a shift to the pre-announced crawling peg with a monthly devaluation rate set initially at 1.8 percent. The rate of crawl was later repeatedly reduced as inflation declined (however slowly) over time. In Hungary in 1995 and in the Czech Republic in 1997 the change in regime has been associated with the balance-of-payments crises. Large increases in current account deficits, coupled with portfolio capital outflows, exerted pressures on the domestic currency that had to adjust downward – devalue or depreciate – under the circumstances. The scale of the adjustment has been, however, remarkably low, around 10–15 percent, when compared to the experience of Mexico or some South-East and East Asian countries. Since both Hungary and the Czech Republic have been regarded as rapidly opening emerging markets, confidence in their economies has been high. Persistent current account deficits have been seen by international financial markets as normal in the case of radically liberalizing economies undergoing rapid modernization and taking advantage of direct foreign investment and other capital inflows. It is usually an excess of current account deficit over what is regarded by these markets as a reasonably ‘safe’ level that becomes a cause of concern and may generate a currency crisis. Determinants of ‘excess deficit’ may be varied: a premature consumption boom (before productivity and other effects of modernization take hold) or some institutional, supply-side problems (see Winiecki 2000a). Once the macroeconomic restraint is applied in the short run and supply-side measures are introduced to make the economy more flexible in the medium run, the deficit usually falls. But it might continue at fairly

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high levels rather than disappear, without unduly worrying the financial markets. And this is, in fact, what happened in the foregoing countries. Poland started, more recently, on the same path as Hungary and the Czech Republic. The current account deficit began to grow rapidly from 1997, reaching in 1999 the level that the financial markets regard as excessive, even for a successful, fast-modernizing economy. Thus, since 1999 Poland has been living in the shadow of the currency crisis but little has been done, in terms of macroeconomic restraint, to prevent its occurrence. However, due to the propitious external conditions and some positive autonomous internal developments, further growth of the deficit has been prevented and the confidence of markets is still fairly high. This is evidenced, for example, by the FDIs that have been flowing in at the significant rate of $6–8 billion annually in recent years. The jury is still out for the verdict on the threatening currency crisis. But even if it occurs, it is expected to be rather mild, along the lines of the Hungarian and Czech crises. Each of the three countries considered above underwent at least one change in the exchange rate regime during the transition process. In fact, Poland went from the adjustable peg to the pre-announced crawling peg and later to a floating rate with a crawling band, and toward the end of the decade to a (nearly) free float. Hungary, as noted already, shifted in 1995 from the (highly discretionary) adjustable peg to the crawling peg, with a declining monthly devaluation rate of the crawl. The Czech Republic has been forced off the peg but policy makers chose a managed float as the preferred alternative in the period of adjustment. An interesting case is that of Slovenia. It used to be the most developed and economically Westward-oriented part of the former communist Yugoslavia. Therefore, reorientation of trade in that direction has been much easier there than in the ex-member states of the COMECON. The Slovenes, after gaining their independence, established a new currency without many foreign exchange reserves and chose, suitably, the floating exchange rate (managed float) for their tolar. The exchange rate policy has primarily aimed throughout the whole period at maintaining a relatively stable real exchange rate. In that they have been helped by the relative internal and external stability of the Slovene economy. Another ‘success story’ is that of Estonia, which chose a free trade regime, while at the same time its exchange rate regime (currency board) excluded any possibility of exchange rate policy. Thus, the

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export performance of Estonia’s enterprises has been due to their discoveries of world market niches. These were found, maintained, and expanded in the institutional environment of a free trade regime. The high predictability of doing business abroad under such a regime has more than matched any benefits that enterprises could draw from an exchange rate policy trying to maintain a real exchange rate at roughly the same level. However, macroeconomic stability considerations are only of indirect interest for this chapter. What matters most is the influence of exchange rate regimes and policies upon the foreign trade reorientation of the post-communist economies of the region and their export performance in particular. It is from the above point of view that both trade and exchange rate regimes and policies should be considered here.

What did and what did not matter for satisfactory foreign trade performance After a brief overview of foreign trade and exchange rate regimes and policies, the time has come to take stock. Thus, we should evaluate to what extent – and in what manner – they affected the Westward foreign trade reorientation and, more generally, the foreign trade performance of the post-communist economies. While doing so, we should not forget that these institutions and policies were not operating in a void, but had been embedded in a larger institutional framework of transition to the market. Therefore, any evaluation should consider the institutions and policies concerning external economic linkages not just in terms of their impact (or the lack of it) upon export performance. They should also be viewed in terms of their impact relative to that of general transition measures (stabilization, internal liberalization, administrative capacity to manage the emerging regulatory regime, etc.). In Kaminski et al. (1995, 1996) a very important conclusion was drawn on the basis of the study of all post-communist countries, not just those from East–Central Europe. These authors posited that what mattered for export performance (dynamics, Westward reorientation, increase in value added of exports, etc.) was primarily the progress of a given economy in transition to the market. Thus, progress in stabilization mattered a lot. A steady decline in the inflation rate, after the initial, corrective price jump at the start of transition, has been strongly correlated with improving foreign trade performance. Soft, accommodative macroeconomic policy was, on the

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other hand, inimical to it. If governments continued to operate under the ‘soft’ budget constraint, then such a policy stance undermined incentives to reallocate resources toward exports or import substitutes. A weak pressure to adjust, under conditions where it is not difficult to sell the products, without changing either the product or the marketing strategy, slows down the reallocation process. Moreover, as Kaminski et al. (1996) noted, continuing high inflationary expectations create incentives to hold foreign currencies (the ‘dollarization’ problem). Excess demand for foreign currencies generates the tendency for domestic currency to depreciate. In turn, a weak, heavily undervalued currency shields the domestic market from foreign competition, once again undermining incentives to reallocate resources and improve productivity, quality, and technological sophistication. Internal liberalization has also been crucial. All strong export performers – assessed by the above authors – extensively liberalized domestic prices in early transition (by 1993 at the latest). Those who did not had to use various export controls to prevent ‘leaching’ from the domestic market of underpriced goods (e.g. energy inputs, steel and non-ferrous metals, cement, etc.). More importantly, underpriced inputs gave (or, in fact, continue to give) wrong specialization signals for actual and would-be exporters, making export success in terms of profitability, not just volume, well nigh impossible. By contrast, foreign trade and exchange rate regimes and policies – the main area of analysis in this chapter – were important to the extent that they correlated positively with the foregoing general thrust of the transition. Thus, extensive liberalization of the foreign trade regime at the beginning of transition mattered. It was at the time an important component of the fundamental process of removing the fetters of the centrally planned and administered economy. Countries that followed the strategy of radical, very extensive – internal and external – liberalization accomplished an impressive Westward reorientation of their trade in a relatively short time-span of a few years (see Chapter 2), as well as high export growth and, with a lag, also a shift toward the more value-adding manufactures (see Chapter 3). Interestingly, the rising tide of protection, roughly from late 1991 to 1995–96, did not change the picture materially. The initial liberalization has been so radical that tariff and NTBs, inclusive of administrative/technical barriers to imports, did not do substantial damage to the fundamentals of the open economy regime that prevailed there throughout the whole period under consideration. Poland, Hungary, and Czechoslovakia (and its successor states),

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that is countries that chose the path of partial retreat from the nearfree trade regime established in 1990–91, may be contrasted with Slovenia and Estonia that followed different paths. Of the two, the former followed the pattern of a markedly slower reduction of trade barriers over the whole period of its independence, while the latter chose very early in its existence the full-fledged free trade regime and stayed with it afterwards. In each of these cases sticking to the fundamentals of economic openness, one way or another, was also of primary importance. However, neither the period of rising protectionism, nor a subsequent one of falling protectionism vis-à-vis the countries of the EU and CEFTA, change the overall assessment with respect to all countries registering significant progress in transition. The basic thrust of external liberalization mattered, while later twists and turns did not, of course, as long as they did not deviate too much from that thrust. This was actually the case with respect to the ‘success stories’ of East–Central European transition under consideration. Policy shifts which were adverse to economic openness, wherever undertaken, were irritants rather than fundamental distortions of the process of economic openness. The above assessment is even more to the point with respect to the liberalization of foreign exchange. The free market fundamental of the open economy, that is currency convertibility (albeit initially only on the current account), was of great importance. So was the initial sharp devaluation of the national currency. Clearly, the aim to offer domestic firms a degree of protection to give them some time to adjust gradually to competitive conditions – as inflation reduced that degree monthly or yearly – was undoubtedly helped by such a measure. Of course, in practice it was difficult to ensure the ‘right’ amount of devaluation. But it did not matter whether policy makers initially ‘overshot’ or ‘undershot’, as long as subsequent policy conduct made sense. Only when the policy makers erred after the initial devaluation were the consequences adverse. This was the case for Poland in late 1990 and early 1991 or for the Czech Republic, where the de facto fixed exchange rate was maintained much too long against the changed fundamentals (continuing domestic vs. foreign inflation differential). Interestingly, the choice of a foreign exchange regime did not matter. Neither peg nor float, nor some other intermediate regime, prevented countries progressing in all areas of transition from achieving success in export performance too. Apart from these most often chosen exchange rate regimes, the currency board was also found to be successful, but again more successful where all the other ingredients of

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transition success were also present. Significantly, the choice of regime did not help the transition laggards, where transition was not progressing, was zig-zagging, or was derailed. No less interestingly, not only the choice of exchange rate regime, but also the change of the regime mattered very little. Hungary and the Czech Republic shifted once, away from a less or more stable peg, although to different regimes (see above). Poland changed the exchange rate regime three times. And, again, what mattered in these cases of a change of regime in all three countries was how the policy was conducted under a given regime. Countries successful in their overall thrust of transition have had problems of their own in the analyzed area. One problem has been near-continuous exchange rate appreciation (except in those countries with a currency board, where the problem did not arise). But, wherever the appreciation rate was not too rapid, the problem turned out to be manageable. Competitiveness did not suffer much as rapid productivity increases compensated for much of the increase. As noted aptly by Hochreiter (1996) the rise in real wages, affecting the real exchange rate, need not be viewed with alarm in transition economies trying to catch up with the West. As long as they are progressing along the path to an open market economy, better incentives, management methods, utilization of modernized capital equipment, etc., should result in substantial productivity increases that, in turn, should enable firms to pay employees higher wages. Consequently, the exchange rate would be expected to appreciate over time. Therefore, the view of Hochreiter – accepted later by many others – has been that appreciation need not always be the result of bad policies, such as, for example, excessive reliance on the exchange rate as an anti-inflationary measure, expansionary macroeconomic policy in the face of a peg maintained for too long, or rapidly growing wages relative to productivity. On the contrary, appreciation may be the result of ‘good policies’ by which he obviously meant progress along the path to a full-fledged open market economy, where rising wages are a sign of reducing the developmental gap with the Western economies. Another, even more striking, example of the dominant impact of aggregate progress in becoming a normal, well-functioning, open market economy over the impact of specific institutions of external economic relations has been the inward FDI issue. What foreign investors are normally interested in is stability, predictability, and transparency of the rules of the game under the general conditions of economic openness. The required minimum is openness on the current

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account, including the right to repatriate after-tax profits, and a minimum degree of openness on the capital account allowing the inflow and outflow of FDI-related capital. Once such a conducive institutional environment is available, additional incentives for multinational firms play only a secondary role. Investment decisions are made on the basis of the attractiveness of a particular domestic market or of a given economy as a source of supply, or both. FDI-specific rules may decide on one or another location for the investment within the economy, but rarely – if ever – will they tilt the decision in favor of a less stable, predictable, and transparent regime, no matter how attractive the offered concessions may be. The distribution of FDI in post-communist countries is yet another piece of evidence in the general pattern referred to above. Three middle-sized countries perceived as the ‘success stories’ of transition – Poland, Hungary, and the Czech Republic – received about two-thirds of all FDI, and two small successful countries, Slovenia and Estonia, registered some of the highest FDI per capita. Summing up, in external economic policies the most important success indicator has been their concordance with other policies pursued within the general framework of successful transition. Once the trade regime and the exchange rate regime ensured such concordance, once a high degree of economic openness was accomplished in the early transition period, the most important task was to maintain and expand that openness in the longer run. If such policies were pursued, policy errors and zigzags notwithstanding, the outcome would be good in terms of decent and improving performance.

5

Post-transition foreign trade problems and prospects The economics and political economy of accession

Introduction This book has followed a clear sequence of deliberations. It started in Chapter 1 with pre-transition issues, that is output and foreign trade patterns under the communist system and their impact upon prospective transition. Then, in the next two chapters it dealt with the transition in the foreign trade area at the macro (i.e. country) level (Chapter 2) and micro (i.e. enterprise) level (Chapter 3). Next, it considered the impact of foreign economic policies – trade policy and exchange rate policy – upon the performance of foreign trade in transition (Chapter 4). This last chapter deals with post-transition issues and deliberates on the foreign trade problems of East–Central European countries within the framework of the ongoing process of accession of the successful transition countries to the EU. Foreign trade, together with foreign investment (primarily FDI), are seen as major determinants of the main economic goal expected to be achieved through the EU membership. This goal is a reduction in the developmental gap between East–Central European countries and their West European neighbors, members of the EU. The gap, as shown in Table 5.1, increased during communist rule. It was larger at the time of communist collapse (1989) than before the war (see 1936 data) or at the beginning of communist central planning (1950). Three subsequent sections of the chapter deal with three determinants of accelerated economic development. Apart from foreign trade and foreign investment, official financial transfers from EU funds are considered as well. After considering the foregoing contributing factors the discussion shifts attention to institutional ones, stressing in the fifth section the impact of the improved institutional framework upon economic performance. The adoption of the tried and tested rules of the economic game (even if not perfect from the free market vantage point) will be an improvement upon the effects of the trial-

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and-error process of ‘rebuilding the ship at sea’. Next, the interplay of economic and strategic/military issues are considered and the conclusion drawn that NATO membership reinforces economic opportunities, while EU membership will reinforce the military security of East–Central Europe. Finally, in the last section a question is posed about serious alternatives to EU membership and, unsurprisingly, there are none. Thus, accession to the EU will be the beacon for the countries under consideration in the years to come.

How to reduce or close the developmental gap: the role of foreign trade The large developmental gap, measured in terms of GNP per capita, is expected to be reduced – maybe even closed in the very long run – due to the membership of East–Central European economies in the EU. At issue here, then, is the evaluation to which extent, if any, their membership is a proper means to that end. Clearly there are multiple effects of membership. Most of them, in the opinion of the present writer, may contribute to the increase in the rate of economic growth that in the last analysis is the ultimate effect. Let us begin with what has been mostly considered in this book, that is foreign trade, leaving aside the old debate on whether trade is an engine, hand-maiden, or (only) a consequence of economic growth. The coincidence of rapid economic growth and even more rapid increase in exports has been very well documented. And we do not see any need to start yet another discussion on causality. It is assumed here that membership of a large integrative grouping, whose members are economies intensively participating in the international division of labor (as measured by the ratio of exports+imports

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to GDP), would generally benefit its new member countries, for it would open up to them the large internal market of the grouping. Some may question, however, the scale of benefits resulting from the further deepening of trade with the EU countries. For, roughly, after five to six years of transition (1991–96), the share of exports to the EU in total exports of East–Central European countries ranged between 69.7 percent for Hungary (with Slovenia and Poland closely following Hungary) and 41.3 percent for Slovakia (lagging far behind these other countries). Since then, these shares have increased further to some extent. The only evidence available, which we are going to rely upon heavily in this section, is indirect: that is, it concerns the trade benefits of other middle-developed countries which joined the EU at some earlier date. Thus, Greece, Portugal, and Spain, in spite of the already high shares of their total trade with the EU before joining the grouping, increased in these shares five years by 15.3, 8.2, and 16.8 percentage points respectively as shown in Table 5.2. 7DEOH *URZLQJVKDUHVLQH[SRUWVRIQHZPHPEHUFRXQWULHVWRWKH(8 (8 GXULQJWKHILUVWILYH\HDUVRIPHPEHUVKLS &RXQWU\

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Clearly, playing by the same rules facilitates trade substantially. Even if the post-communist countries achieved successful reorientation in their foreign trade toward the largest neighboring market, that is the EU market, as shown in Chapter 2, there seems to be room for a further deepening of trade relations. The experience of middle-developed countries is also a good reference point concerning not only the geographic structure but also the dynamics of East–Central European trade with and (in the future) also within the EU. In other words, a look at the trade performance of the former after obtaining full membership is a reasonably good indicator of at least the room for the prospective trade performance of the latter. Orłowski (1996) calculated the export performance of four middledeveloped countries since the beginning of their EU membership in relative terms, that is in relation to the aggregate export growth rate of

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the four large ‘core’ countries: France, Germany, Italy, and the United Kingdom. The idea behind such calculations was clear: to see whether new members have been able to register higher export growth than ‘old’ members. The positive answer would suggest at least the potential for catching up. The answer has, in principle, been positive. That is, Ireland in all three subperiods since joining the EU in 1973 (1973–80, 1980–86, and 1986–92), Greece in the first subperiod after joining in 1981, and Spain and Portugal in the only subperiod in which they could be taken into consideration (1986–1992) displayed export growth rates higher than the four large ‘core’ countries. Excluding Greece, their exports grew some 50–60 percent faster than exports of the four. Thus, optimistically, the potential is clearly there. The only deviation from the pattern was Greece in the 1986–92 period, when its export growth rate was 2.7 percent compared to the 3 percent aggregate rate of the big four countries. Worse still, its export growth rate has been falling from one period to the next ever since 1964. However, as shown for example by Orłowski (1996), Greece has been not so much a part of the catching-up pattern of middledeveloped countries but rather a warning of how not to conduct economic policy if a country wants to decrease the developmental gap (more about this later in the chapter). Thus, the remaining countries are more important as references, assuming that post-communist countries do not repeat Greece’s populist policy errors. The importance of being insiders, however, is not related only to the overall benefits of becoming part of a large, integrated market, with the same rules of the game. There are also some specific benefits of being inside rather than outside the grouping. The EU and its predecessors have erected over decades a variety of interventionist barriers vis-à-vis outside (non-EU) imports in those product groups where they were losing comparative advantage, while respective domestic industries have remained an important source of employment. These product groups belong – in accordance with the official terminology – to the so-called sensitive products, namely iron and steel, bulk chemicals, textiles, clothing and footwear, as well as agricultural and food products. Quantitative controls, anti-dumping procedures, and other measures are applied in numerous cases, whenever domestic industries are threatened with ‘too much’ competition (for restrictions vis-à-vis East– Central European countries on ‘sensitive’ products, see Fritz and Hoen 1999). At the same time, the export structures that post-communist economies inherited from their distorted past (see e.g. Winiecki and

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Winiecki 1992) have included very high shares of products in these product groups. In accordance with calculations by Drabek and Smith (1995), in 1993 the share of ‘sensitive’ products in EU-bound exports was 36.3 percent for the Czech Republic, 42.7 percent for Poland, 47.8 percent for Slovakia, and as much as 51 percent for Hungary. The commodity structure of exports of post-communist countries in transition was expected to change over time toward more sophisticated, value-adding products. And the process is, indeed, taking place (Hungary has been the most conspicuous example). However, the process is necessarily a slow one, as it is associated with changes in the level of development and concurrent changes in factor supplies. Therefore, in the next 10 to 15 years sensitive products will continue to play a large – even if declining – role in these countries’ exports. In realpolitik terms there are, then, obvious benefits of being inside rather than outside the grouping applying restrictive measures vis-à-vis outsiders against products that make up such a large part of aggregate exports. Wellisz (1997) noted other important consequences of opening EU markets to ‘sensitive’ East–Central European products after the accession. Joining the EU will reinforce those countries’ comparative advantage in manufacturing labor-intensive, standard technology products. Freed from the threat of anti-dumping procedures and other exclusionary tactics, enterprises in the respective industries will be able to pursue the pricing policies reflecting their true advantages, raising the profitability of firms manufacturing these ‘sensitive’ products. The particular advantages pertaining to Poland have already been stressed with respect to improved access after accession. The expansion of export-oriented industrial branches manufacturing ‘sensitive’ products will generate jobs for low-skilled labor. Poland, with its heavy underemployment in agriculture, has a large pool of potential lowskilled workers who could be drawn into the industrial sector. With foreign capital flowing in, there will be little pressure on labor costs. Thus – says Wellisz – ‘adhesion to the E.U. may foster a Lewis-type extensive industrialization resulting in rapid job formation, and the absorption of labor reserves’ (p. 15). To the extent that a Lewis-type industrialization pattern is at all possible in the longer run (see the critique of Lewis in Lal 1983), Poland may become a country with a dual export structure this time – in contrast with the communist past – vis-à-vis the same group of countries. On the one hand, together with the other successful transition countries first in line for accession, it would shift partially toward more value-adding products in its exports, although more slowly than

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in the case of the other countries under consideration. On the other hand, it would maintain and even expand its labor-intensive, standard technology exports. Its export structure would, then, be more diversified, registering a longer range of exportable manufactures.

How to reduce or close the developmental gap: the role of FDI The FDI of MNEs is – at a minimum – contributing to economic growth of the host countries by increasing the volume of capital over and above the level available for investment as a result of domestic savings. But this is only one of the contributions of FDI described in the literature. The theory stresses the ‘package’ (or ‘bundle’) characteristic of FDI that makes it the superior alternative to other forms of capital flow. The fact that capital flows in a bundle, that is together with other production factors such as technology, management, marketing skills, etc., makes it much easier for the locals to master the skills necessary to start manufacturing, or other production of goods or services, in a host country. By contrast, when capital flows alone, all complementary factors have to be brought together by local firms. The learning process may last longer, encounter more difficulties, and consequently raise the costs of starting new production. Other problems may emerge as well. But the literature on the impact of MNEs upon host countries stresses some other growth-enhancing effects. Thus, spillover effects are underlined as a new subsidiary or a branch of an MNE gradually increases its purchases of inputs, as well as other goods and services, domestically. New requirements concerning technical specifications, quality, packaging, delivery speed, etc., raise the standards of performance ever more widely, in line with the volume and variety of host country purchases. Spillover effects take place also through other channels such as the movement of employees from the MNEs’ subsidiaries to local firms or to firms they establish themselves. The speed and extent of spillover effects depend, of course, on the level of development of the host economies. The smaller the developmental distance the faster the local content usually increases in the final product manufactured by a subsidiary in a given country. In mature market economies the local input content has been very high. For example, in the case of subsidiaries of US multinationals in Western Europe the local content has been fluctuating in the 90–95 percent range, in the case of US subsidiaries in Japan in the 87–91

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percent range, and in the case of foreign MNEs’ subsidiaries in the USA in the range of 85–95 percent (see Lawrence and Rangan 1999). In the case of middle-developed economies, a category to which most post-communist economies and 11 East–Central European ones belong, these shares are initially much smaller, but usually have the tendency to increase over time. In this respect the ‘success stories’ of transition do not look bad. For example, in the case of the Japanese car manufacturer Suzuki, the factory established in Hungary started manufacturing in 1992 with 25 percent local content which, however, almost doubled in 1993 (48 percent) and then continued the upward trend, reaching 53 percent in 1997 (Havas 2000). From the data scattered across countries and industries in the region the foregoing seems to be the normal pattern. Post-communist economies, in contrast with less- and middle-developed market economies, have additionally been handicapped by the deformities that reached under communism levels unknown elsewhere. Thus, domestic enterprises after the start of transition and the appearance of foreign multinationals on their markets have been forced to raise their productivity, quality requirements, reliability of deliveries, etc., much more sharply than other middle-developed economies not afflicted by communist standards. If, in spite of all the inherited problems, they have been doing increasingly well as subcontractors and suppliers of MNEs, then this is proof of the success of systemic transformation and of the strong impact of market incentives. Most of the countries covered in this book are ‘success stories’ of transition and as such have been of particular interest to multinational firms. As proven in numerous empirical studies all over the world, FDIs are made primarily under conditions of political and economic stability, economic openness, transparent rules of the game, burgeoning markets, and available complementary resources. Where these are in place, special incentives may be taken into account in investment decisions. It is no surprise, then, that two-thirds of all the FDI in East–Central and Eastern Europe went to five countries that are first in line for accession to the EU. They occupy the top positions in the lists of aggregate FDI and/or FDI per capita in Table 5.3. It is worth keeping in mind that the data in Table 5.3 show the FDI inflow before accession of even the transition leaders to the EU. Everything we know about the strategies of MNEs suggests that the flow of their investments should substantially accelerate once East–Central European countries join the EU. The two most important motives for FDI, leaving aside the search for natural resources, are the search for markets and that for complementary immobile produc-

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tion factors. The motives with respect to post-communist Europe are not expected to differ from the general pattern (see e.g. Lankes and Venables 1996, Meyer 1998). For West European foreign investors membership of the countries under consideration in the EU will mean that they will be playing in these countries by the same rules they have been accustomed to playing at home. Therefore, without the different risk levels, the patterns of investments are going to increasingly reflect the treatment of East–Central European members as part of the single market. Investments searching for markets will increase in volume. But an even larger increase will concern those in search of complementary production factors. In the latter type of FDI – and not only those from other EU members – the additional determinant will then be the certainty of gaining a relatively low-cost manufacturing base within the largest integrative grouping in the world. With respect to investments that have been made so far, this has been only a probability, albeit an increasingly high one. The adoption of the acquis communautaire will undoubtedly increase the cost levels in East–Central European countries. After all, part of the rules (e.g. the so-called ‘Social Charter’) has been established precisely for the purpose of reducing the comparative advantages of less rich members of the grouping. To this one should add the trend of currency appreciation as an effect of large capital inflows (Orłowski 1996). Nonetheless, cost differences will remain, as well as differing levels of entrepreneurial vitality, social mobility, and other differing

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characteristics between the vibrant aspirants and the congealed, overwelfarized ‘core’ members of the EU. These differences, we believe, will allow new members to grow at a faster rate than the old ones. Again, there is no evidence concerning the future. The only evidence, as in the case of relative export performance, is indirect, concerning the performance of middle-developed countries that joined the grouping earlier (see Table 5.1). The data on the inflow of foreign direct and portfolio investments to the countries included in Table 5.2 show that, within the time-span of six to seven years after Spain and Portugal became EU members, foreign investment skyrocketed, increasing by three to five times. The dip in 1992 reflected the West European recession, the crisis of the European Monetary System, and the outflows of portfolio investments from what was then perceived by financial markets as weak currency countries. In the second half of the 1990s FDI resumed its growth in both reference countries. The same may be said about Ireland, which is not included in the table. Note that Greece again did not follow the pattern outlined above as the populist/socialist government of Prime Minister Papandreou was distinctly hostile to multinational firms and foreign investors were visibly reluctant to invest in Greece. Consequently Greece registered an inflow of $9.3 billion over the period of 1981–93, while Portugal, a country of similar size and development level, registered $9.9 billion in half the time (1986–93). FDI in Spain in the same 1986–93 period amounted to $48.9 billion. Altogether, then, the experience of middledeveloped members of the EU suggests that not only the export performance, but also the FDI performance of East–Central European countries should improve substantially after accession, contributing to accelerated economic growth.

How to reduce or close the developmental gap: the (dubious) role of official transfers Large numbers of policy makers in the East–Central European countries that are first in line for accession have been looking covetously at the EU system of official financial transfers within the framework of structural funds and Common Agricultural Policy (CAP). In their public pronouncements these financial transfers have been stressed as clearly visible benefits of membership. The present writer harbors grave doubts about their importance and even – under certain circumstances – about their desirability. The critical view of public transfers is formulated at three levels:

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economic, political economy, and neo-institutional level. The first level of criticism is by now the standard one in economics. Public investment exerts a much weaker influence on long-term economic growth than private investment (see e.g. Barro and Sala-i-Martin 1991) because of its lower efficiency. This applies to public transfers within the EU as well. An empirical inquiry in Orłowski (1996) reveals a positive and significant correlation of FDI and the excess of GDP growth rates of middle-developed members over the rate of the ‘core’ members, but a negative correlation between public transfers and the latter. Leaving aside CAP-related payments supplementing farmers’ incomes, structural funds – as rightly stressed by Orłowski (1996) – belong to the ‘soft financing’ category. They reduce the risk level for investors in particular projects and, as such, do not enforce efficiency standards that are as strict as those in the privately financed projects. They may be preferred by governments for the purpose of financing long-term infrastructural investments, characterized by long recoupment periods, but a fine balance should be drawn here. Too large a share of public investments in aggregate fixed capital formation reduces the aggregate efficiency of investment because decreasingly profitable projects are added to the pool. Therefore, an increase in the share of public investment in the aggregate fixed capital formation of the economies of new East–Central European member states will weaken the relationship between investment and growth At this point the second level of criticism should be leveled at EU public transfers, namely that they create an opportunity to use these transfers in order to temporarily increase consumption. In accordance with the EU rules they are subsidies co-financing public investments. However, since public investments are financed through government budgets, the availability of external, grant-type resources may allow populistically-minded governments to switch a substantial part of earlier planned funds from public investments to consumption. That the above-formulated opportunity is not a hypothetical one is best shown by the oft-quoted example of Greece. In 1981–93 Greece, for a variety of reasons not relevant here, obtained more EU financial transfers than Portugal and Spain taken together (a total of $25.8 billion). Consumption in Greece increased within a decade by more than 10 percentage points (to 91.3 percent of GDP in 1990). The share of the state budget in GDP increased in the period of 1980–90 from 33.1 percent to 53.3 percent (again, see Orłowski 1996). Since it has been established empirically (see Barro 1997) that public consumption exerts a negative effect on growth, the underperformance of Greece in spite of – or rather as a result of – large public transfers is understandable.

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The third level of criticism goes back to Lord Bauer’s (1984) critique of foreign aid. Bauer argued that the inflow of funds that are distributed by public authorities tilts the balance between the state and the emerging civic society in favor of the former. The state apparatus distributing the ‘goodies’ becomes relatively more important as a result and, with it, the political mechanism of resource allocation. All walks of life – not only the economy – become more politicized when a substantial part of GDP is distributed through political rather than market mechanisms of resource allocation. The struggle for shares in the state-distributed ‘goodies’ draws social energy away from other, infinitely more important pursuits, such as wealth creation, strengthening the local community, intellectual pursuits, etc. Moreover, tilting the balance in favor of the state implies a larger share of redistribution, which in turn brings us back to the already-stressed adverse impact of non-productive government spending on economic growth. To sum up, financial transfers from EU structural funds should be treated with great caution. This does not mean that – judiciously used – limited financial resources could not enhance prospects for economic growth. But, certainly, maximization of financial inflows should not be a negotiating aim of East–Central European governments. What has been written here applies even more to direct consumption support through CAP-related financing. The best one could aim for under the circumstances is the transformation of consumption subsidies into subsidies financing technical cum institutional infrastructure in rural areas. To what extent such conversion will be politically possible remains to be seen.

Membership, institutional benefits, and economic performance In my earlier publications, where I looked at the transition process from the neo-institutional vantage point (Winiecki 1992a, 1992b, 1996a, 1997b, Krasznai and Winiecki 1995), I stressed the tortuous road for post-communist countries in establishing a well-functioning set of market institutions. Old rules from pre-communist times have been adapted and restored, while new ones have continuously been added in an effort to complete the market ‘rules of the game’. Using the parable from Elster et al. (1998), transition countries have been trying to rebuild a ship at sea. The foregoing process must necessarily be a slow one, at least relative to the demands of the situation. No matter how strenuously those involved have been trying to fill the gap between the supply of and

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demand for institutions that would ensure a tolerably good performance of the emerging market economies, the gap could be sufficiently narrowed only with the passage of time. In the meantime many types of transactions have not been completed, and certain investment proposals have been postponed or even abandoned. Transaction costs in these economies would, then, be higher and performance, accordingly, lower than in economies where market order evolved without major discontinuities. But the build-up of a well-functioning institutional framework means much more than incomplete rules, preventing transactions from being consummated and lowering the level of performance. Familiarization with the new rules by everybody concerned – from business people and their lawyers to judges and administrators – is time consuming and, therefore, costly. Precedents have to be set, judicial decisions made more or less uniform in similar cases, reducing the uncertainty of the outcomes of legal proceedings, and administrative decisions also have to apply the rules uniformly and therefore predictably. These developments may take years if not actually decades. Thus, even with the critical mass of rules already in place, economic agents, facing heightened uncertainty and unpredictability, may continue to incur high costs or, alternatively, may become altogether discouraged from transacting. The inevitable long learning process once again reduces the level of performance. But the story does not end there. Every economy needs a guarantee that transactions freely entered into will be efficiently enforced if a breach by one of the parties takes place. The presence of a guarantee of enforcement is extremely important. Nobel laureate Douglass North (1991) even states that ‘how effectively agreements are enforced is the single most important determinant of economic performance’. The unpreparedness of the judiciary to deal with the economic issues, the unavoidably slow familiarization with the rules, the overloaded judicial system, and ever-present corruption, all weaken law enforcement in post-communist economies, even the most successful ones. The difference is one of degree and the speed of change. However, even the speediest change must, I repeat, be gradual. Now, all these considerations assume, optimistically, that the laws passed are ‘good’ laws. However, the laws passed in these countries are anything but good laws, by which (rather old-fashioned but apposite) term I understand laws that are consistent with other parts of the legal system, transparent, and ensuring legal stability, that is not requiring frequent modifications (Winiecki 1996b). However, the pressure of time, the scarce knowledge, the lack of legal tradition (that, for

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example, could not evolve under the communist regime), as well as corruption, all contribute to the more than usual imperfect nature of the laws. It is with respect to institution building in the post-communist countries of East–Central Europe that I see no less strong argument in favor of EU membership. A well-functioning economic framework is crucial for long-term economic growth. To realize the importance of adopting the tried and tested set of rules common to all member countries of the EU let me refer to an earlier article of mine (Winiecki 1999). There, considering, in comparative terms, the process of building the institutional infrastructure, I drew readers’ attention to usually underappreciated benefits of German-style unification that in my opinion may be even more important than the money flowing into the former GDR. I wrote that financial resource flows matter but what matters even more is the fact that Eastern Germany, instead of hectically building the rudiments of the market system from scratch and for some time without visible effects in terms of marked improvements in efficiency, got at the start all the institutions of a market economy in an already well-developed (because tried and tested) form. East–Central European countries can attain these much less often mentioned institutional benefits on their own only with great effort – and in the longer run at that. Now, the thrust of my argument is already clear. I am strongly of the opinion that by joining the EU East–Central European countries in transition can gain considerably in terms of speeding up the process of establishing the institutional framework of the capitalist market economy. In fact they will gain not only due to the greater probability of having ‘good laws’, and having them much faster, but also due to inheriting in most cases already well-established routines (i.e. repeated and converging judicial decisions and administrative interpretations of the rules). This thesis requires two clarifications. The first concerns the difference between ‘good laws’ and ‘free market-enhancing laws’. It is quite clear to the present writer that the EU is an overregulated and overwelfarized grouping. Nor is it likely that it is going to move in the free market direction at anything but a snail’s pace. However, even if the laws are intrusive, often unnecessary, and always costly in their impact on the performance of economic agents, they are nonetheless ‘good laws’ in terms of the definition offered earlier. They are relatively well written, that is they do not require excessive interpretation or frequent changes, and therefore they are much better than what has been

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evolving – slowly, painfully, and costly – in East–Central Europe (to say nothing about Eastern Europe or ‘Far Eastern Europe’, that is Central Asian countries). Also, recourse to the international judicial system within the EU enhances the rights of individuals, in all their roles, including the entrepreneurial one. At present nothing like this protects, for example, business people against ‘bad laws’, internally inconsistent laws, and outright corrupt laws, or interpretations of otherwise inconsistent laws. Another, closely related, clarification concerns what I call ‘an Anglo-Saxon bias’ in interpreting the developments outside the AngloSaxon world, including East–Central Europe. Given the admirable and enviable tradition of the protection of individual rights, including property rights, in the respective laws of the UK and the USA, they look at various institutional arrangements from their specific vantage point, that is applying the highest standards to proposed arrangements. The British may be (rightly!) suspicious of various EU arrangements, even regardless of their increasingly accentuated interventionist/ redistributionist/protectionist biases, because they have the tradition that others may not. Thus, the East–Central Europeans do not have the tradition of Magna Carta of 1215 in protecting personal freedom or, for example, that of De tallagio non concedendo of 1297, establishing the principle of consent of the ruled on taxation. Neither they have the long tradition of extensive legal protection brought about (or reaffirmed) by the Glorious Revolution of 1688. Therefore, for East–Central Europe access to the already-existing, even if admittedly cumbersome and sometimes market-constraining, EU rules and, moreover, to the much more efficient judicial machinery, will be a significant step forward in the process of institution building. Relatively more efficient – even if not exactly free-market-type – institutions will raise the level of performance, accelerating, in turn, the economic growth of new member countries (as they did in the case of earlier middle-developed countries that joined the EU).

Strategic–economic interaction and its impact on trade, investment, and growth The present writer holds a rather particular view of post-communist countries’ membership of the EU and NATO. Generally speaking, two approaches are registered most often. The first approach is that memberships of these Western organizations are substitutes; the second is that they are complements.

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For example, Kierzkowski (1996) seems to lean toward the first approach. He stresses that the preconditions required for membership overlap to a large extent. These countries should decide themselves which membership is more important for them. And he answers the question stressing the priority of strategic (military security) considerations and, therefore, NATO membership. Interestingly, Jeffrey Sachs seems to look at membership of the EU (not only of NATO) in strategic, rather than economic, terms. In an interview in February 1996 for the major Polish daily Rzeczpospolita, he linked the strategic and economic issues of EU membership by saying that the EU shields Poland (and presumably other East–Central European countries) from ‘political turbulence and instability in Russia’. Therefore, he suggested forgoing the benefits of financial transfers if such a move would speed up the accession process. I am closer to the latter view, but see the argument in terms of a two-way interaction. Thus, membership of NATO reinforces economic benefits, while membership of the EU reinforces strategic benefits. Let me explain. Successful transition countries that become NATO members and other successful countries of the region that are, undoubtedly, going to follow them will benefit economically from membership of NATO. Foreign investors will treat their membership in the Western defense organization as an extra guarantee against political/military turbulence emerging from further east. Thus, for Western firms planning to invest in post-communist NATO members, such membership is an insurance policy against political risk. But, as signaled above, the membership benefits are interrelated both ways. It is not only economic aims that benefit from NATO membership. Also, strategic aims benefit from membership of the EU. It is imaginable, given the realpolitik lesson of the late 1930s (with their experience of appeasement), that NATO membership may not be a sufficiently strong defense shield after all. A replay of the ‘we do not want to die for Danzig’ story of 1939 cannot be completely excluded. The unfolding of the story may differ, however, when East–Central Europe becomes a part of a highly integrated economic grouping. It was stressed earlier in the chapter that there is a strong presumption in favor of accelerated economic growth resulting from accession. The new members, consequently, become relatively important recipients of exports originating from other EU member countries and hosts of substantial FDI from the rest of the EU. Such developments will significantly strengthen the resolve of West European members of both institutions to resist any threats coming from outside (bluntly

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speaking, from Russia). Arguing, again, in realpolitik terms, the West would then protect to a substantial extent its own interests. It is, of course, imaginable that if these countries remained open, unassociated economies, trading with everyone on a free trade basis, they would achieve the highest possible economic growth rates. However, in light of the foregoing, I would paraphrase Adam Smith by saying that in the case of East–Central Europe, it is not so much that ‘security comes before opulence’ but that the benefits of opulence, spread across the parties involved, also increase security.

Are there serious alternatives to EU membership for East–Central Europe? The considerations so far have been based on the unstated assumption that there are no other alternatives to EU membership for the postcommunist countries of East–Central Europe. The only choice, formulated explicitly, has been that between membership of the EU versus the free trade alternative (or, at a minimum, playing by WTO rules). The present writer hopes that the preceding sections of this chapter have shown convincingly that – criticism of the EU notwithstanding – at the right time and in the right place membership is by far the better alternative. Are there other institutional arrangements that could offer substantially similar benefits, but would allow these countries to avoid the twin burdens of overregulation and overwelfarization? Or, perhaps, the post-communist countries of East–Central Europe had the opportunity to create such arrangements, but rejected it carelessly? Consequently, the moment has passed and the ‘golden opportunity’ was lost. This section tries to answer the foregoing issue. Some analysts toyed at the early stage of transition with the idea that CEFTA might be such an alternative. However, the fast reorientation of foreign trade in the countries under consideration (see Chapter 2) revealed the relative market attraction of CEFTA and the EU in terms of percentage shares of trade directed toward each grouping. Thus, on the grounds of foreign trade flows following income levels alone, the issue was settled, apart from political economy and strategic/military grounds favoring membership of the EU. CEFTA is – if anything – rather a complement than an alternative, and a temporary one at that (as all CEFTA members aspire to join the EU). Throughout the transition, but particularly insistently in its early stage, some Western economists were trying to convince East–Central European governments, intent on accomplishing systemic change, that

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they should preserve or restore, to some extent at least, trade within the ex-communist area. Tracing that line of reasoning, CEFTA alone might not have been large enough, but the trade within the territory of the former COMECON was – they stressed – worth the effort. These analysts and politicians suggested that the means to that end was to be one form or another of a payment union. No such temporary arrangement could be regarded as an alternative to the (then still distant) membership in the EU, but the oft-stated rationale of such a payment union was to preserve or restore what used to be intra-COMECON trade. Thus, implicitly, any payment union was expected to slow down the reorientation of East–Central European trade toward the West. This phenomenon was explained at length earlier (see Chapter 2). To expect that a payment union would ‘revive some of the traditional exports [meaning communist times’ exports], especially in the investment goods area’ (Bofinger and Gros 1992: 25), was to thoroughly misunderstand the structure of aggregate and import demand under the old system. As already explained, the collapse of ex-COMECON countries’ trade in manufactures was not due to the lack of foreign exchange, but due to the disappearance of system-specific demand as these countries moved away from the communist economic system. No payment union would be able to prevent the collapse of such trade by countries undergoing systemic transition. Just as erroneous as the short- to medium-run recommendations presented above were all those medium- to long-run expectations that Russia would become a centerpiece of some new, market-based integrative arrangement. There are two errors involved here. The first is the result of a rather simplistic attraction to the wrong type of numbers. Namely, some politicians and pundits cannot accept the rather obvious truth that a large market is where there is a lot of money, not a lot of people. They have been attracted by the large number of people first in the former Soviet Union and now in Russia. The kind of error made here is similar to that made about a hundred years ago by US business interests that supported the US ‘Open Door’ foreign policy concerning access to the Chinese market. The fundamentally wrong assessment of the size of the Chinese market was encapsulated in an oft-repeated phrase: ‘if only each Chinese buys just one shirt a year, there would be a market for 200 million shirts there’. However, the Chinese – much less numerous than today – were too poor to buy US (or other Western) clothing. The same applies to Russia today. A comparison between Russia and the Netherlands is instructive

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here. The Russian population is exactly 10 times bigger (10:1). If we take Russia’s GNP per capita statistics seriously (which is something I would advise against) its GDP would be at best 2.5 times bigger (2.5:1). However, if we compare imports, Dutch imports would be at least twice as large. And markets for foreigners are only as large as a given country’s imports and, possibly, foreign investments to be made there. But if we compare FDI, then the ratio would be the reverse to that of the population of both countries. Clearly, there is much more money in the Netherlands than in Russia – and it is money that attracts imports and foreign investments. Thus, in terms of the market size Russia today is a much smaller market than the Netherlands. And this is not going to change even in the medium to long run (i.e. the next 10 to 25 years). From the foregoing vantage point even the CEFTA grouping looks much more impressive in terms of market size. Polish imports alone are roughly the size of Russia’s imports (in the last two to three years they have been even larger), and Polish inward FDI is much larger. Adding the other two relatively larger-sized good performers, the Czech Republic and Hungary, would make the CEFTA market substantially larger than the Russian one. And yet, in spite of strong quantitative evidence to the contrary, there are still those – almost exclusively in the West or in Russia – who paint rosy pictures of some, more or less vaguely specified, ‘free trade COMECON’, again with Russia as its centerpiece. A good example here is a much quoted report published by the Adam Smith Institute (Bell 1996). For Russia as a centerpiece of some market-based arrangement is not a monopoly of some nostalgic, leftist reformers. Bell regards the Westward trade reorientation of East–Central European countries as something temporary and quotes examples of export specialization potential among the East–Central European and ex-Soviet Union countries that would, presumably, reorient it again toward themselves. However, both the intellectual underpinnings and assessments find little, if any, support in economic history and trade theory. Westward reorientation is there to stay. After all, as shown already (see Chapter 2), the post-communist foreign trade patterns of the 1990s were – by and large – a return to the pre-communist past. Thus, once systemic deformities were eliminated with the collapse of the system, natural, trade-theory-based patterns were restored. Moreover, the experience of trade in manufactures after World War II points to intra-industry trade as an engine of foreign trade growth primarily among the mature market economies, but also between these

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economies and middle-developed countries (to which East–Central European countries belong). The vertical intra-industry trade, with more value-adding goods moving from the mature EU countries to East–Central European countries and less value-adding goods moving the other way round, will be an ever-growing part of East–Central European trade. However, apart from the documented relative insignificance of Russia as a center of any free trade or other integrative arrangement, there are institutional features that reduce the probable emergence of such a grouping down to zero. Russia’s transition failure has deeper causes than just weaknesses of stabilization, liberalization, and privatization. The dismal record of Russia in terms of fundamental institutional underpinnings of the systemic change, that is political liberty, law and order, and trust (see Winiecki 2000b), makes it next to impossible to reduce the extremely high transaction costs of the emerging economic system. As the present writer stressed in the pages of Neue Zuercher Zeitung (Winiecki 1996b), the historically determined demoralization, much greater than elsewhere, mitigates against the prospect of Russia’s gradual but firm progress toward market capitalism. In the very long run (30, 50, 70 years or more) the desired change may finally arrive, but the process of rebuilding the social capital will be long, bumpy, and full of zigzags. Before that happens there will be no takers of any integrative proposals in which Russia would be a partner, let alone the centerpiece. In conclusion, no dynamic, ‘free market post-COMECON’ may emerge as a serious alternative to EU membership. The trade links, the foreign investment links, and other increasingly tight links will continue to be forged at the enterprise level primarily with Western Europe.

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Index

Note: Page numbers followed by ‘t’ indicate tables; those followed by ‘f’ indicate figures. agreements, enforcement 129 Asian Tigers 34 Aslund, A. 51 Atlas 91 Aturupane, Ch. 84, 85 Austria: engineering industries 12t; exports 55 balance of payments: crisis, Czech Republic 111; current account deficit, Hungary 110, 111; fear of surge in imports of consumer goods 48, 50, 99, 102 Balassa, B. 9 Balcerowicz, L. 40, 104 Balcet, G. 82 Barro, R. J. 127 Bauer, Lord P. 7, 128 Beksiak, J. 100 Belgium, extractive industries 24t Benacek, V. 68, 76–8, 92 big bang 98 Bofinger, P. 134 Brenton, P. 71 Bruno, M. 104 Bulgaria 18, 52, 56, 63; exchange rate regime 108; exports 26t, 57t, 62, 62t, 72t, 74t; extractive industries 24t; foreign direct investment 125t; investment, ratio to GDP 46t; liberalization of foreign trade 98; light industry 80; as middle-

developed economy 65; protectionist measures 105; share of industry in GDP 42t; tariffs 103 Burenstam-Linder, S. 21, 54, 83 Canada: investment, ratio to GDP 46t; non-tariff barriers 107 capital: capital-intensive industries, internal liberalization 95; COMECON, capital formation 28; distressed non-replacement of 76-8; see also foreign direct investment; investments capital goods, production of in Communist economies 9 Carlsson, B. 14 CEFTA (Central European Free Trade Association) 107, 133–4 central planners, relationship with enterprise managers 7 Chenery, Hollis B. 34 China 134 CMEA see COMECON co-ordination mechanism, explanations for fall in output 40–1, 42–3 COMECON (Council for Mutual Economic Assistance): distorted economies 10; exports of engineering products to EEC 25–6; fall in trade between former

Index 145 COMECON economies 50–4; intra-COMECON trade 55–6, 58, 61; membership during transition 134; trade patterns 19-28 commodity exports, shift to light industries 64 Common Agricultural Policy (CAP) 126, 127 Communist economies: exports of manufactures to EEC 27; features of 28–30; output, impact of pressure to increase 6–14; trade patterns 19–28; see also stateowned enterprises comparative advantage 65; trade between communist economies 22–3 compensatory accounts, elimination 97 consumption: consumer goods, fear of surge in imports 48, 50, 99, 102; EU financial transfers 127; households, oversized inventories 45–6 convertibility 101 Croatia, foreign direct investment 125t Csaba, L. 98 current account deficit, Hungary 110 Czech Republic: CEFTA 135; exchange rate regime 108, 110–11, 112, 116; exports 57t, 61, 62, 62t, 72t, 74t, 122; foreign direct investment 84, 117, 125t; mechanical engineering 91; output and exports 69t; protectionist measures 106; share of industry in GDP 42t; small and medium-sized enterprises 89; tariffs 103, 105 Czechoslovakia 18, 52, 56, 70; devaluation 102; engineering industries 12t; exchange rate regime 100, 108, 110; exports 26, 26t, 61, 62, 62t; extractive industries 24t; GNP per capita 119t; import tariffs 102, 105; imports 48, 49t; inventories, ratio to GDP 45t, 48; investment, ratio to GDP 46t; liberalization of foreign trade 98; as middle-

developed economy 65; performance of heavy industry 80; performance of light industry 80; performance of state-owned enterprises 37, 67; protectionist measures 104, 114–15; reprimitivization of exports 36; Volkswagen 83–4 demand, excessive demand in Communist economies 59 devaluation 102; Czech Republic 115; Poland 109, 110, 115 development see economic development dirigisme 96, 101, 103 distressed non-replacement of capital 76–8, 92 distressed sales 63, 70–6 Djankov, S. 71, 84, 85, 86 ‘do-it-yourself’ bias 10, 29 domestic market, and trade 21–2 Drabek, Z. 122 dualistic trade pattern: COMECON and market economies 20–4, 29; disappearance of 58-9 economic development: EU financial transfers 126–8; impact of accession to EU 119–23, 124–6; level of and trade 14–19, 64–8; role of foreign direct investment 123–6 efficiency, state-owned enterprises 37–8 Eliasson, G. 14 Elster, J. 128 energy, Communist economies 7, 8t engineering industry: Communist economies 11–12; decrease in trade with the West 68; exports 25–6, 26t; Hungary 70f, 91; imports 48–9; increasing inefficiencies in Communist economies 25; intra-COMECON trade 58; output in Communist economies 10; performance during transition 80; see also heavy industry Enrietti, A. 82

146

Index

enterprise managers, and central planners in Communist countries 7 Estonia: exchange rate regime 108, 112–13; foreign direct investment 117, 125t; non-tariff barriers 108; protectionist measures 115 European Agreements (EAs), reduction of tariff barriers 107 European Economic Community (EEC): engineering imports from COMECON countries 25–6; imports from Communist countries 27t European Union (EU): accession of transition economies 118, 119–23, 124–6, 130; financial transfers 126–8, 132; imports 62, 90, 120; judicial system 131; non-tariff barriers 107; possible alternatives to 133–6; strategic and economic implications of membership 131–3 exchange rate regimes 3–4, 49, 99–101, 108–13, 115–16 exports: commodity exports 64; and domestic demand 21–2; engineering products 26, 26t, 34, 70f; EU membership, impact 120; export strategies 3; foreign direct investment, impact 85–8; heavy industry 72t; Hungarian engineering goods 70f; light industries 64; manufactures 74t; ratio to output, Hungary and Czech Republic 68–70, 69t; small and medium-sized enterprises 88–91, 93; as value subtracting 50; world market 61–4; see also trade extractive industries 23, 24t factor reversal 18 Fiat 82–3, 105 financial institutions, and economic development 17 financial transfers, European Union 126–8, 132 Finland: extractive industries 24t; investment, ratio to GDP 46t Fischer, S. 51 foreign direct investment (FDI) 3, 92,

116–17, 125t; economic development, impact 123–6; internal and external liberalization 96; Poland 112; protectionist measures 105; role in development 123–6; trade, impact on 81–8; see also investments France: extractive industries 24t; video recorders, non-tariff barrier 106 Friedman, Milton 92 Fritz, H. 121 Gacs, J. 48, 95, 101 GDP (gross domestic product): Communist economies 7; growth in and investments 46; industry’s share of in Communist countries 10, 11f; industry’s share of in market economies 15; inventories, ratio to 44, 45t; investment, ratio to 46, 46t; share of industry in 42t Gelb, A. 51 General Motors 83 geographic reorientation, normalization of foreign trade 56 German Democratic Republic (GDR): exports to EEC of engineering products 26, 26t; investment, ratio to GDP 46t; reprimitivization of exports 36 Germany: engineering industries 12t; extractive industries 24t; unification 130 Germany (FRG), ratio of investment to GDP 46t GNP (gross national product): GNP per capita, European countries 119t; and industry in Communist economies 11; and industry in market economies 15 gravity models 19 Greece: engineering industries 12t; extractive industries 24t; GNP per capita 119t; impact of EU financial transfers to 127; impact of EU membership 120, 121, 126; investment, ratio to GDP 46t Gros, D. 71, 134 growth see economic development

Index 147 Hamar, J. 88 Havas, A. 124 heavy industries: exports 72t; performance during transition 80; see also engineering industries Heckscher-Ohlin theory 18, 54, 55, 64, 83 Heller, P. S. 18 heterodoxy, explanations for fall in output 40 Hochreiter, E. 101, 116 Hoekman, B. 71, 84, 85, 86 Hoen, H. W. 121 horizontal intra-industry trade 85 households: oversized inventories 45–6; see also consumption Hungary 52, 70, 124; CEFTA 135; engineering 12t, 26t, 91; exchange rate regime 108, 110, 111, 112, 116; exports 26t, 57t, 62, 62t, 68, 70f, 74t, 84, 88, 120, 122; extractive industries 24t; foreign direct investment 84, 88, 117, 125t; GNP per capita 119t; heavy industry exports 72t; import tariffs 102; imports 48, 49t; increased trade with the West 68; inventories, ratio to GDP 45t; investment, ratio to GDP 46t; investments, explanations for fall in output 46t, 47; liberalization of foreign trade 95, 98; as middledeveloped economy 65; non-tariff barriers 107–8; output and exports 69t; overvaluation of intra-COMECON trade 56; performance of heavy industry 80; performance of light industry 80; protectionist measures 104, 105, 106, 114–15; quotas on steel products 105; share of industry in GDP 42t; small and medium-sized enterprises 89 import substitution, and underspecialization in Communist economies 8–13 imports: barriers 102; as result of value subtracting exports 50; see also protectionist measures; tariffs

industry: extractive industries 24t; fall in output during transistion 41–2; heavy industry 72t, 80; industrialization, Communist economies 17; intra-industry trade 54–5, 66, 83, 84–5, 86; laborintensive 79, 90; light industry 64, 80; share of in GDP 10, 11f, 15, 42t; see also engineering industry inflation, Poland 109 informational asymmetry, Communist economies 7 innovation: SOEs, after privatization 32, 33; and technological obsolescence in Communist economies 13–14 intermediate products, trade in 55, 65 International Monetary Fund (IMF) 97 intra-industry trade 54–5, 66; horizontal intra-industry trade 85; vertical intra-industry trade 83, 84–5, 86 inventories: GDP, ratio to 45t; oversized, and explanations for fall in output 44–5, 48; reduction of causing fall in imports 49 investments: Communist economies 7–8; implications of NATO/EU membership 132–3; ratio to GDP 46t; reduction of excessive investments 46–7, 49; see also foreign direct investment Ireland: engineering exports 34; engineering industries 12t; export structure 35t; exports and foreign direct investment 86; extractive industries 24t; GNP per capita 119t; impact of EU membership 121, 126 Italy: extractive industries 24t; investment, ratio to GDP 46t Jackson, M. 77 Jensen, M. C. 44 judicial system, European Union 131 Kaminski, B. 63, 71, 91, 106, 107, 108, 113, 114 Kierzkowski, H. 132

148

Index

Kiguel, M. 40 Koch, E. B. 109 Kolanda, M. 37, 67 Kornai, Janos 6, 47, 51, 71 Krasznai, Z. 128 labor-intensive industries: small and medium-sized enterprises 90; survival during transition 79 Laender 36; see also German Democratic Republic Lal, D. 101, 122 Lankes, H. P. 85, 125 Latvia, foreign direct investment 125t Lawrence, R. Z. 124 learning by doing 10, 29, 31, 32 legislation 129–31 Lemoine, Francoise 66, 73–4, 80 less developed countries (LDCs): import substitution, impact 9; importance of economic openness 96; liberalization 2 Lewis, William A. 122 liberalization: communist economies and LDCs compared 2–3, 67–8, 81; foreign trade 94–101, 114 life expectancy 75 light industries 64; performance during transition 80 Lithuania: foreign direct investment 125t; tariff barriers 105 Little, I. D. 9 Liviatan, N. 40 macroeconomic restraint, explanations for fall in output 40–1 manufacturing: exports 74t; exports from Communist countries to EEC 27–8, 27t; share of engineering industries 11, 12t maquiladora 66 mechanical engineering, Czech Republic 91 Meckling, W. H. 44 military expenditure, and explanations for fall in output 47, 49 Mittelstand firms 88 multinational enterprises (MNEs)

81–8; outward processing trade 66–7; role of FDI in development 123–6 Nachtigal, V. 48 Nash, J. 97 NATO, implications of membership 131–3 Netherlands 135; engineering industries 12t; investment, ratio to GDP 46t Niskanen, W. A. 17 North, Douglass C. 129 Norway, extractive industries 24t Olson, Mancur 103 Orłowski, W. M. 120, 121, 125, 127 output: Communist economies, impact of pressure to increase 6–14; fall during transition 39–48, 59; and foreign trade 14–19, 48–54 outward processing trade, multinational enterprises 66–7 ownership, former state-owned enterprises 76–7 permanently developing countries (PDCs) 18 Poland 52, 77; CEFTA 135; devaluation 102; engineering industries 12t, 26t; exchange rate regime 100–1, 108, 109–10, 111, 112, 116; export of manufactured goods 74t; exports 26t, 57t, 62, 62t, 86, 87t, 88, 90, 120, 122–3; extractive industries 24t; Fiat 82–3; foreign direct investment 86, 87t, 88, 117, 125t; GNP per capita 119t; heavy industry exports 72t; import tariffs 102; imports 48, 49t, 76; inventories, ratio to GDP 45t; investment, ratio to GDP 46t; investments, explanations for fall in output 47; iron and steel industry 78; liberalization of foreign trade 98; as middledeveloped economy 65; non-tariff barriers 108; overvaluation of intra-COMECON trade 56; performance of light industry 80;

Index 149 protectionist measures 104, 105, 106, 114–15; share of industry in GDP 42t; small and medium-sized enterprises 89; trade with Soviet Union during early transition 53–4 politics, and trade in Communist economies 23 Popov, G. 44 Portugal: export structure 34, 35t; extractive industries 24t; GNP per capita 119t; impact of EU membership 120, 121, 126 prices, distressed sales 63, 70–6 primary inputs 76 pripiski 44 private sector firms: small and medium-sized enterprises (SMEs) 88–91; see also multinational enterprises privatization: state-owned enterprises 2–3, 30–3; see also liberalization protectionist measures 101–8, 114–15; import substitution, and underspecialization in Communist economies 8–13; see also imports; tariffs Prowse, M. 101 quality: Communist economies 7, 12, 20, 21, 26, 27, 29; and privatization of SOEs 30–1 quotas, Hungary 105 Rangan, S. 124 reform fatigue 104 Repkin, A. 77 reprimitivization of exports 36, 65 research and development (R&D) 90 Rise and Decline of Nations (Olson) 103 Romania 18, 19, 52, 56, 63; exports 26t, 57t, 62, 62t, 72t, 74t; foreign direct investment 125t; industry of in GDP 42t; investment, ratio to GDP 46t; liberalization 98; as middle-developed economy 65; performance of heavy industry 80; performance of light industry 80

Russia 135; foreign direct investment 125t; see also Soviet Union Sachs, Jeffrey 98, 100, 132 Sala-I-Martin, X. 127 scale economy, and economic development 15–16, 17 scarcity prices, absence in Communist economies 12 Shmelev, N. 44 shortages, Communist economies 7 similarity, preference for, theory of trade 21–2, 54 skilled labor 17 Skoda 83 Slovakia: exchange rate regime 110, 111; exports 62, 62t, 120, 122; foreign direct investment 125t; protectionist measures 104, 106, 115; share of industry in GDP 42t; small and medium-sized enterprises 89; tariffs 103 Slovenia: exchange rate regime 108, 112; exports to EU 120; foreign direct investment 117, 125t; liberalization of foreign trade 98; tariffs 103 small and medium-sized enterprises (SMEs), exports 88–91, 93 Smith, Adam 122, 133 soft budget constraint 6, 113–14 South Korea, exports and foreign direct investment 86 Soviet Union: distorted economy 10; energy inputs 76; exports to EEC of engineering products 26t; extractive industries 24t; imports from Poland 90; inventories, ratio to GDP 44, 45t; investment, ratio to GDP 46t; trade 19, 20t; trade with Poland during early transition 53–4 Spain: engineering industries 12t; EU membership, impact 120, 121, 126; export structure 35t; exports 34, 86; extractive industries 24t; GNP per capita 119t specialization: privatization of SOEs 31–2; prospects for privatized SOEs 33; underspecialization and

150

Index

import substitution in Communist economies 8–13 spillover effects, multinational enterprises 123–4 stabilization program 40 state-owned enterprises (SOEs): efficiency 37–8; fall in trade between former COMECON economies 51–2; features of 28–30; and multinational enterprises 82; privatization 2–3; prospects for transition 30–8; quality of products 20; see also Communist economies statistics, doctoring of and explanations for fall in output 44 steel, Communist economies 7, 8t steep ascent, industrialization 17 structural changes, and economic development 14–19 Suzuki, local content in Hungary 124 Sweden: engineering industries 12t; extractive industries 24t; investment, ratio to GDP 46t Synowiec, E. 66 Syrquin, M. 34 Szymanderski, J. 89, 91 tariffs: non-tariff protection 102–3, 106, 107; reduction of import tariffs 99, 102; see also imports; protectionist measures technology: obsolescence in Communist economies 13–14, 29, 32; technology transfer, multinational enterprises 82 Thomas, V. 97 trade: COMECON countries 19–28; commodity exports, shift to light industries 64; dualistic trade pattern 20–4; exports to world market 61–4; foreign trade and fall in output 48–54; foreign trade, increase of with the West 68–78;

foreign trade, liberalization 94–7; multinational enterprises 66, 81–8; and output 14–19; outward processing trade, multinational enterprises 66–7; preference for similarity 21–2; problem of quality 23; prospects for transition economies 28–38; reduction of trade between former COMECON economies 50–4; reorientation of foreign trade during transition 54–9; trade restrictions, removal of 99; see also exports; protectionism trade unions 105 UK, extractive industries 24t USA: extractive industries 24t; inventories, ratio to GDP 44; nontariff barriers 107; spillover effects of subsidiaries 123–4 USSR see Soviet Union Venables, A. J. 85, 125 vertical intra-industry trade 83, 84–5, 86 Visegrad countries 71 Volkswagen 83–4 Washington consensus 97, 98, 102 waste: Communist economies 7; explanations for fall in output 43 Wellisz, S. 122 Williamson, J. 101, 103 Winiecki, E. D. 36, 46, 121–2 Winiecki, Jan 1, 7, 10, 13, 14, 16, 18, 21, 26, 28, 30, 36, 39, 41, 44, 46, 49, 62, 67, 95, 97, 98, 110, 111, 121–2, 128, 129, 130, 136 working practices, Communist economies 30 World Bank 97 Zarzycki, M. 89