the transformation of centrally planned economies

CHAPTER

16Plan or Price?

The Transformation of Centrally Planned

Economies

The challenge posed to the world economic order by the collapse of cen-trally planned economies can only be understood in the light of the longerhistorical development of the relations between these systems of economicmanagement and international financial institutions. Many commentatorshave asked whether any useful lessons could be learned in regard to the"transition" from the older history of socialist economic systems: was notthe new liberal market order completely different to central planning? Butin fact the past influenced crucial aspects of the transition. The difficulty ofthe transition may be explained not only in terms of expectations aboutsecurity inherited from the socialist system but also by the unique extent ofa collapse caused ultimately by profoundly misguided past policies.

There is also a concrete lesson to be derived from the two circumstancesthat in the Cold War era did most to poison the relations of the IMFand other international financial institutions with the socialist world: theintrusion of political considerations; and the willingness of the internationalinstitutions to tolerate the provision of inadequate economic information,with the result that programs and reform endeavors were devised in ignoranceof what was happening in the economy. If, as is suggested elsewhere in thisbook, the central feature of the modern economic system is a transition tomanagement on the basis of information, such deliberate ignorance cannotbe accepted as a foundation for policy support during the process of economicliberalization.

The Bretton Woods order and its institutions had been explicitly designedto encompass different political and also social and economic systems, and

547

"Obviously they want the same treatment as Brazil, Argentina, and Mexico"

16 Plan or Price? 549

to allow the greatest possible room within a global economic system for theprinciple of national sovereignty. In the course of the negotiations of 1944,the Articles of Agreement had been adjusted to allow the participation ofstates with monopoly trading systems. Eventually, however, the SovietUnion, for whose benefit these adjustments had principally been made, aftervigorous internal debate (see Chapter 3), never joined the IMF or the WorldBank.

For 45 years, the strained relations between the Bretton Woods institutionsand centrally planned economies were shaped by two sets of calculations—one political, the other economic—which reinforced each other. The firstwas quite at odds with the perhaps Utopian intentions of the founders, andtheir initial hopes for the postwar period. For the duration of the Cold War,the planned economies were subject to a political conditionality, in whicheconomies and reform programs were judged on the basis of assumptionsmade in the major Western countries about the character of their leadershipas much as about economic policy orientation or the feasibility of reformendeavors. The two most conspicuous examples are those centrally plannedeconomies, Yugoslavia and Romania, with the longest standing as membersof the IMF and the World Bank. As the two East European political systemsleast dependent on the U.S.S.R., they received much better treatment thanwould have been warranted by their economic performance.

The second consideration was much more in accordance with the liberaliz-ing vision of Bretton Woods. An economic logic drove the planned econo-mies to look for a greater opening to the international system, which couldmost simply be facilitated through closer relations with international financialinstitutions. Command economies at the outset, in the 1950s, proved quiteeffective instruments for promoting a basic industrialization concentratingon heavy industrial and military output (which had been the original goalof policymakers), or for managing the earlier stages of postwar reconstruction.At the start, this strategy produced very rapid growth. But in their originalform, the planned economies lacked a price mechanism that might haveprovided the signals required for the development of a more diversified andflexible economy. Rectifying this fundamental defect required a series ofincreasingly difficult and controversial choices between plan and market. Asplanners recognized the problems inherent to their system, they tried to takethe world market as an external yardstick that might provide them with anappropriate price structure. And as they applied international prices, theybegan to realize the desirability of obtaining particular goods—such as ma-chine tools—from industrially more advanced countries, and in general ofparticipating in the international division of labor. As they imported more,

550 INTERNATIONAL MONETARY COOPERATION

they needed to sell a greater quantity of exports, or to borrow more onWestern markets. The planned economies became drawn into monetarydiscussions as a consequence of external debt and exposure to internationalcapital markets. Liberalization of domestic prices in addition frequently pro-duced monetary disturbances.

In their classical form, as first designed in the late 1920s as a mechanismfor imposing high-speed industrialization, centrally planned economies didnot have or need a monetary policy properly speaking. They operated a dualor bifurcated system, in which a quite different monetary principle prevailedfor enterprises than for private households. Enterprises did not deal in orneed cash (except for the payment of their wages); their financial flows wereregulated not through a banking mechanism but by means of a credit planthat essentially simply replicated the fundamental production plan. Themonetary discipline for the enterprise sector stemmed exclusively from theplan. Individuals, on the other hand, dealt in cash and had no access tocredit. Although in the course of reform initiatives after the 1960s some ofthese distinctions were broken down, in practice households still receivedlittle credit from financial institutions. The major problem, especially in the1980s, came with the widespread realization that planning produced aninefficient allocation of resources. As the plan was weakened, the disciplineapplied to enterprises was relaxed, and policymakers found it difficult to usethe monetary management familiar in market economies. In the absence ofmonetary reform that would allow for control of the money supply throughthe techniques used in market economies, inflation resulted. Monetary claimshad built up (often termed "monetary overhang"), which had been controlledin the planned economy through price regulation, but which were assertedvery quickly as an inflationary force once prices were liberalized.

The rise of a new consensus about economics, with the realization thatthe rationality of economic choices depended on connections to a globaleconomy, also inevitably involved a potential exposure to external shockthat had been avoided in the closed and planned system. Some governmentsattempting to begin reform in the midst of a major global disturbance fearedthat globalization would mean importing the trauma. International contactsalways brought some danger of unanticipated disruption. The discussion ofreform in many planned economies began in the 1960s, but then the currencydisturbances and inflation and oil price shocks of the 1970s delayed theimplementation of economic change. At this time, some countries began toview reform primarily in terms of the benefits to be derived from foreignsources of capital. Then, in the 1980s, the international debt crisis affectedwould-be reformers severely, and in Yugoslavia contributed to the progressive


disintegration of the state. Chinese reforms, on the other hand, succeededrather better, in part because their introduction had been delayed, andChina had largely avoided the linkages established by most of the would-bereforming planned economies in the 1970s to international capital markets. Itsoon became clear, however, that dangers could not be avoided simply byperpetuating an autarkic stance. Too long a delay in implementing reformon the grounds that it held too many threats brought its own perils forthe governments involved. They faced increasing economic rigidities. Theyrejected competition and the restoration of private property, which wouldhave created incentives to break down those rigidities. The postponementof major aspects of reform contributed significantly to the discrediting ofSoviet and East European systems and laid the basis for the popular demo-cratic revolutions of 1989-91 (although the regimes were discredited formany other noneconomic, moral, and political reasons).

International financial institutions represented an increasing attraction,as an institutional embodiment of the market principle of prices, as upholdersand advisers on monetary discipline, and finally also as providers of resourcesthat might facilitate a solution to the initial balance of payments difficultiesinvolved in adjustment to the market. Adjustment, the traditional area ofconcern of the IMF, would be the key to a much wider range of macroeco-nomic changes. Multilateral institutions stood as door keepers to the interna-tional system. They held out both a philosophy of economic management,and the means, both monetary and technical, to implement that philosophy.In addition, Fund advice served in the same way as for other economies.Within the policymaking establishment, those who wanted reform and liber-alization hoped to use suggestions, memoranda, and guidelines produced fromthe outside, by well-respected international organizations and later also bysome prominent Western economists,1 as a way of influencing and shapingthe domestic debate. The international institutions gave advice that couldonly serve a purpose if it was used internally, usually by reform-minded civilservants.

The discussion of marketization, however attractive in economic terms,also frequently involved painful political choices. Accepting the marketmeant disappointing some firmly established expectations about future devel-opments, altering institutional structures, and attacking entrenched interestsbuilt around the process of central planning. Perhaps the process of changewould spin out of control or become unstoppable. One (sympathetic) Westernobserver, the socialist economist Paul Sweezy, concluded in the 1960s atthe end of a study of the Yugoslav experience: "Beware of the market; it iscapitalism's secret weapon!. . . Market relations must be strictly supervised


and controlled lest, like a metastasizing cancer, they get out of hand andfatally undermine the health of the socialist body politics."2 In addition,changes in the price structure that would eliminate or reduce subsidies tomany basic goods often appeared to be no more than a more modern variantof the old Stalinist exhortations to suffer present pain and sacrifice for thesake of future rewards. Since reforms brought such costly disruptions to theestablished ways of planned business, weak governments frequently found ithard to implement them. As more and more countries came to appreciatethe necessity of change, a number of paradoxes began to appear. Weaker stateshad perhaps the greatest economic incentives to change, but encountered themost difficult obstacles in the form of popular resistance to the impositionof sacrifice by an unpopular government. Political and economic changein consequence often stimulated each other reciprocally: only a politicaltransformation could make acceptable the social disturbances brought byeconomic change. This dynamic became ever more familiar as governmentsand oppositions looked at developments in other countries. In short, theexperience of reforms in other "socialist" countries served as models.

Commentators have often assumed, particularly since the dramatic trans-formations of 1989, that the process of change was a question of either-oralternatives, with a choice of plan or market. In fact, even the abrupttransitions were preceded by long periods of gradual adaptation, in which awhole series of very small issues each required resolution, and in which alarge number of steps to reform were taken. Individually, these were smallsteps, but when taken together, countries discovered, often to the surpriseof their leaders, that they had covered a large distance and had moved intoa new terrain where bolder and more radical action was required.

For much of the 1970s and 1980s, the difficulties of centrally plannedeconomies did not figure prominently as a particular "problem" in manydiscussions of the global economy. But there were lengthy analyses presentedby the IMF as part of the World Economic Outlook exercise, which includedsurveys of countries that were not at that time members of the Fund (includingthe U.S.S.R.).3 In addition, the existence of the IMF, and the principle ofexternal and unpolitical expert advice (inherently part of the overall concep-tion of surveillance), served as a powerful attraction for reforming groupswithin centrally planned economies. The fact that economic problems weretreated in a neutral and depoliticized way, and that centrally planned econo-mies were viewed and treated as nothing more than examples of specificproblems (such as the international debt crisis, or the distortions caused bysubsidies and controlled prices, or artificially set exchange rates) that occurredin other economies throughout the world and that might be dealt with


through specific solutions helped to make the discussion of reform easier.When all these issues became suddenly acute in 1989-90, and a systemictransformation started, the IMF was as a consequence able energetically toassert its position as an essential part and facilitator of the reform process.

In spring 1990, the Interim Committee agreed "that the Fund, in thecontext of a broad international cooperative effort, must continue to provideassistance as these countries steer their economies toward a market systemand integrate them into the world economy." The East European countriesdeserved assistance, though not, the Committee noted, "at the expense ofthe developing countries."4 In the Annual Report of 1990, a broad-basedstrategy was recommended by the IMF, involving the replacement of centralplanning with macroeconomic management, the reform or end of pricecontrol, the development of a working tax structure, the reduction of sizeof the public sector (privatization), the implementation of legal changes toallow greater scope for the private sector, a move to currency convertibility,and the elimination of the state monopoly over foreign trade.5 The systemicadvice was also backed by a substantial commitment of resources, whichplayed an important part in the early stages of the reform process: SDR 3.6billion ($5.0 billion) in 1990/91, and a further 0.4 billion ($0.56 billion)in 1991/92. It was a critical measure of outside confidence and supportat the moment when reform moved from incremental change to systemictransformation.

Reform and Political Stability

China in the early 1980s provides the most striking example of reformphased so as to avoid disruptions brought from the world's credit markets,and based primarily on step-by-step domestic changes. The foundation forrestructuring lay in an increase in agricultural output following the introduc-tion of market mechanisms in the countryside. The reform of the externalsector alone and in isolation was recognized as an insufficient basis for theraising of productivity and the maintenance of social stability.

In December 1979, the Central Committee of the Chinese CommunistParty resolved that in the past too much emphasis had been laid on steeland heavy industry and that lighter industry and agriculture had been ne-glected. Some of the highly capital intensive old prestige projects, includingthose that had involved foreign investment, such as the Baoshan steel plant


financed by Japan, were scaled back. The State Planning Commission formu-lated a new policy of "readjustment, transformation, consolidation and im-provement."6 In practice, agricultural reform meant acceptance of the familyrather than the commune as the basic unit of rural economic activity, whichwould market products grown on plots of land privatized as a result of localinitiatives. Planning would be supplemented through the adoption of adecentralized and market-oriented approach. As a contemporary Chineseanalysis put it: "It is inconceivable that an immense economy like ours couldbe managed by administrative orders issued from above by an organizationof supreme authority. . . . Reality shows that such a system can only resultin technical stagnation, chaos in production, severe bureaucratism, and lackof efficiency."7 Already by the mid-1980s, the state-owned sector contributeda far lower share of output than in other socialist countries; and this processof informal privatization laid a basis for new dynamism through the creationof private property, and investment sustained through self-finance.8

Part of the new course involved an approach to multilateral financialinstitutions, which involved intrinsically political as well as economic debate.After the Chinese Revolution, Western governments had recognized theKuomintang government in Taiwan Province of China ("Republic of China")as the only legitimate Chinese authority. In August 1950 the revolutionaryPrime Minister, Zhou Enlai, wrote to the IMF's Managing Director that thePeople's Republic of China constituted the only legal government, and atthe IMF Annual Meeting in 1950, Czechoslovakia, Yugoslavia, and Indiaunsuccessfully put forward a resolution requiring the exclusion of the repre-sentatives of the Republic of China. The diplomatic isolation of the People'sRepublic of China by the West ended in 1971, and was followed by a rapidincrease in trade contacts. In 1973, the President of the World Bank, RobertMcNamara, invited the People's Republic of China to apply for membership,but received no immediate reply.9 No decision in practice could be takenabout the issue of membership in international financial institutions duringthe life of Mao Zedong.

Almost immediately after the reform initiatives of December 1978, adiscussion began of membership of the IMF and the World Bank. In part,perhaps the attraction was negative: a Chinese membership would involveforcing out Taiwan Province of China. The Vice-Chairman of the ChineseCommunist Party and the driving force behind the economic reforms, DengXiaoping, stated that "there would be no hitch on China's part in joining theIMF if the Taiwan issue is settled."10 But the positive appeal of membership ininternational institutions was far stronger. It would bring increased flows ofinformation, and international openness, and above all it would lock in the


reforms. The World Bank might make available resources for developmentprojects. As McNamara pointed out to a Chinese delegation visiting theWorld Bank, membership of the Bank entailed first joining the IMF.11 TheFund's Executive Board agreed that, with effect from April 17, 1980, the"Government of the People's Republic of China represents China in theFund," and then raised the Chinese quota substantially. It had been unalteredsince the first determination of quotas at Bretton Woods, at SDR 550 million;it was now raised to SDR 1,200 million ($1,560 million) and then quickly,as a consequence of the Seventh General Review of Fund quotas, to SDR1,800 million ($2,340 million).12

Initially in late 1980 and 1981, the Chinese government hesitated in usingthe resources of international institutions, as it believed that the Chineseeconomy was showing serious signs of overheating. After that, however, Chinabecame a major user of program loans, and the World Bank became (afterJapan) the second most important source of external finance. By 1987, Chinaaccounted for 6.1 percent of World Bank lending and 16.0 percent of Interna-tional Development Association (IDA) credits.13 In the initial phases, IMFcredit also provided an essential source of balance of payments assistance. Innegotiating the stand-by arrangement concluded in 1981 (which, togetherwith a loan from the Trust Fund, amounted to SDR 759 million or $905million), the IMF took the position that the government's assessment of itsbalance of payments position for 1981 was too pessimistic. It argued that theconstraints on reform, supply bottlenecks (particularly in energy), and theemergence of inflationary pressures required an import of capital goods. Overthe period of the Seventh Five-Year Plan, the IMF encouraged China to runa substantial current account deficit in order to modernize the economy anddevelop China's export potential.14 In 1986, the Fund concluded anotherstand-by arrangement for balance of payments assistance. In the second halfof the 1980s, an outward-oriented strategy involved the abandonment ofimport substitution. Special Enterprise Zones (SEZ) and "open cities" with aspecial legal, tax, and tariff status developed with a speed equivalent to thatof the other rapidly growing East Asian economies. Between 1986 and 1991exports grew tenfold. Some observers began to call China the newest andcertainly the largest Asian "tiger."

Apart from an appropriate sequencing of reform measures, first agriculturalliberalization, and then an encouragement of more general private sectordevelopment in commerce, manufacturing, and finance, China had the ad-vantage of not having incurred a large debt to private sector creditors. Incontrast with attempts at reform in the Soviet Union and in communistEastern Europe during the 1980s, the Chinese reformers looked much more


to international institutions and much less to commercial creditors.15 Theystarted to call the representatives of those institutions "foreign monks" (re-calling the technically educated and very supportive Jesuit missionaries ofthe seventeenth century) rather than "foreign devils."16

Rapid growth often involves, at least for a time, large current accountdeficits. They may be viewed as a concomitant of the growth process. If theyreflect inflows of capital invested productively, they should not be a sourceof concern. Ensuring that the flows are really used productively, however,requires the generation of market signals in the domestic economy. Interna-tional financial institutions played a valuable role in reassuring authoritiesabout the possibility and desirability of growth. Such reassurance was mucheasier in the case of countries that had not experienced, in the shape of theinternational debt crisis of the 1980s, shocks stemming from the consequencesof bank-financed balance of payments deficits.

Yugoslavia stands at the opposite end of the reform spectrum to China.China began with domestic reforms, and appeared slow in freeing the econ-omy to international markets. In Yugoslavia, a far-ranging internationalliberalization was accompanied by a severe debt crisis as well as by inadequatedomestic reforms and the almost total absence of any domestic politicaland social consensus. Indeed, the government often secured internationalapproval by the appearance rather than the reality of domestic change.

Of all planned economies, Yugoslavia for a long time was the most exposedto international forces and seemed to many influential figures in the Westthe most promising candidate for a reform and an adoption of market mecha-nisms. In 1961 and 1965, the government had introduced partial liberaliza-tions of the trading system, in association with the introduction of a unifiedexchange rate (in 1961) and devaluations of the dinar. But import restrictionsbegan to appear again, and new reform programs were needed but not imple-mented. At the end of the 1970s, Yugoslavia financed its increased currentaccount deficits through international borrowing. In the course of 1980alone, the Yugoslav external debt in convertible currencies rose by a third,to $17.6 billion.17 The Five-Year Plan developed for 1981-85 was to besupported by a lengthy Fund arrangement (a three-year stand-by ofSDR 1,662 million, or $1,960 million), with the aim of strengthening thebalance of payments, maintaining an exchange rate that would keep theeconomy competitive, and scaling back the rates of growth from the highlevels of the late 1970s (the projected growth would begin at 3 percent andrise to 5 percent by the end of the Five-Year Plan).

The outbreak of the international debt crisis forced a change of course inYugoslavia, despite an impressive balance of payments improvement in 1981.


At first Yugoslavia tried to obtain a three- to four-year loan from the Bankfor International Settlements (BIS), which could clearly not be regarded assimply a bridging loan, and was thus refused.18 The package eventuallynegotiated19 included the elements familiar from other debt agreements: $600million new medium-term bank money; a rollover of short-term credit; a$500 million BIS credit; a $275 million World Bank structural adjustmentloan; an intergovernmental support package of $1,300 million; as well asthe already agreed $1,960 million IMF stand-by arrangement. After the debtcrisis, Yugoslavia's economic development took place nominally under Fund"supervision": first through the device of the stand-by arrangement; from1986 to 1988 through the enhanced surveillance mechanism; and in 1988through a new stand-by arrangement in conjunction with a rescue packagecoordinated with commercial banks and bilateral official creditors. It re-mained a largely nominal external control, however, since Fund missionswere not informed of crucial policy decisions (for instance, they knew nothingin advance about the 1988 debt default) and since the statistics supplied bythe Yugoslav authorities on critical components of the reform efforts, notablyon fiscal and monetary performance, were illusory. The figures were perhapsnot deliberately deceptive in the sense that the authorities did not possessanywhere a true second set of accounts; but they were manufactured by aweak, divided, and incompetent bureaucracy that had almost no access toany measure of how the economy actually functioned. Yugoslav statisticsremained in consequence fundamentally meaningless. The experience consti-tutes one of the most striking examples of how international institutionswere subject to a political pressure, exercised in the belief that Yugoslaviaconstituted a positive and non-Soviet economic as well as political experi-ment within the socialist bloc.

The major weakness undermining the effectiveness of Yugoslav reformsin the first half of the 1980s was the acceleration of inflation. There hadbeen a slight fall in the rate of price increases in 1982, but from then oninflation levels rose. Without a notion of property and ownership, such ashad been created for instance in the Chinese countryside after the reformsof the late 1970s, there were few limits on the growth of credit. Enterprisesthat were not controlled or "owned" felt no hesitation in supplying or takinggoods to or from other enterprises on credit, without much concern abouthow the supplies would be repaid. Eventually, they believed, rightly, thesedebts would be monetized by the central bank. One of the dilemmas ofreform appeared to be that a price liberalization, such as that implementedby Yugoslavia in 1983, invariably led to price increases. Monetary authoritiesaccommodated these increases; and at the same time, states in an incom-


pletely controlled federal system used the monetary system to finance theirfiscal deficits.20 The monetary expansion provided the fundamental dynamicof the Yugoslav inflation, which became ever more apparent in price behavioras price controls were reduced or eliminated, and the monetary overhangcould be fully expressed on the market. The consumer and enterprise sectorscould no longer be treated as separate. In these circumstances, the externalexchange rate came to play a major role as the only reliable guide as to whatstability might mean. The behavior of this rate, however, was affected bythe developing inflation. As they detected signs of price increases, Yugoslavsworking abroad reduced the scale of their remittances, and corporationstried to avoid repatriating their export earnings. There was in consequencecontinual pressure on the exchange rate, and a massive depletion of reserves.

A further liberalization of prices and import regulations in May 1988provoked an even more dramatic rise in consumer prices. The Yugoslavauthorities argued constantly, and utterly erroneously, that the fact that thereal (that is, price-deflated) money supply was falling indicated that theywere in reality pursuing a contractionary monetary policy. (In fact, real moneysupply always falls in an accelerating inflation, as the velocity of circulationincreases.) Prices, which had increased by 120 percent in the course of 1987,rose by 195 percent in 1988, and by a hyperinflationary 1,240 percent in1989. Hyperinflation in turn strained beyond endurance the federal system,already weakened by nationality conflicts, and in this way precipitated thebreakup of the Yugoslav state from 1991. An attempt at "shock therapy" atthe end of 1989, involving the lifting of price and trade controls and theintroduction of a convertible currency pegged to the deutsche mark, achievedonly a brief success. By now, another problem had emerged: the fiscal policyof the federal states was no longer set at the center. In the course of 1990increased fiscal deficits accumulated as a result of uncontrolled spending bystates. Individuals took advantage of convertibility to escape from the dinar,with the consequence of a rapid loss of reserves. A shock in short could onlybe sustained by a well-functioning and consensual political system, whichclearly did not exist in Yugoslavia in 1990 or 1991—but had not existed atan earlier stage either.

The Long Path to Reform in Central Europe

Central European political and economic reform did not start with thedramatic political events of 1989, but had much deeper roots. The same


hope that internationalism would sustain the process of domestic economicadaptation that motivated the Chinese discussion of the late 1970s inspiredEast and Central European reformers; but, because of the geopolitical situa-tion, the implementation of reform took much longer. The structural distor-tions caused by the emphasis on heavy industrial output in the Soviet model,and the politically powerful interest groups clustered around heavy industrialmanagement, made reform additionally harder. A discussion of a greater rolefor prices in making economic decisions had occurred already in the 1960s,with simultaneous debates in the U.S.S.R. (where the principal advocatewas Yevsai Libermann), Poland, and Czechoslovakia. Reformers tried toapproach international institutions for support. In December 1966, for in-stance, Janos Fekete, then a relatively junior official at the National Bankof Hungary, visited the IMF to explain details of the reform measures thatwould be launched in January 1968, and which were, he said, "based on anapproach broadly that of the Fund."21 In 1967, as a result, extensive discus-sions began with Hungary, and a general movement of centrally plannedeconomies into the Bretton Woods framework appeared likely: the firstcandidates would be Hungary, Czechoslovakia, and Poland, while Romaniawas expected to follow later. Poland indeed had already begun to discuss arenewed IMF membership after de-Stalinization and the other politicalchanges of 1956.22

As these discussions proceeded, however, the political element in eco-nomic reform became more obvious and more disturbing. In the course of1968, some of the Fund's informal contacts in the planned economies beganto present arguments that indicated that no clear boundary existed betweeneconomic reform proposals and ideas critical of the whole political orientationof the U.S.S.R.'s European empire. A Polish representative to the GeneralAgreement on Tariffs and Trade (which Poland had joined in 1967) forinstance explained to an official of the IMF that "there were some in authorityin Poland who were aware that they were paying a high price in continuingto trade with Soviet Russia. However, it was difficult to convey to certainofficials in charge of enterprises that it did not make economic sense to sellat high cost to Russia and to import at a high cost in exchange for the goodsexported.... He thought that the Fund would do a good service if it produceda kind of critique of the economic policies of the socialist countries. Suchan appraisal would be seriously studied and would serve to point out to thosein power that their policies were out of date and not in the long-term interestof their countries." The Fund official replied that "it would be undiplomaticfor the Fund to issue a critique of socialist economic policies, especially ata time when some efforts were being made to review and change these


policies."23 The pace of reform appeared to be increasing. In May 1968, asthe political reform movement in Czechoslovakia blossomed, the liberaleconomist and Deputy Prime Minister Ota Sik announced that Czechoslova-kia would wish to join the IMF.24

After a Soviet military invasion in August 1968 ended the "Prague Spring,"the U.S.S.R. vetoed the membership of Warsaw Pact countries in interna-tional financial institutions. Romania alone, as the state least dependent onthe Soviet Union, continued to press for an association, and joined the IMFin December 1972. It was a step that had not, however, been taken completelyindependently. In 1973 the Romanian government discussed this experience,and the Fund's practices and policies, with other members of the Councilfor Mutual Economic Assistance (CMEA), including the U.S.S.R..25 In 1971and again in 1975 and 1976, Hungarian negotiators claimed that there was"a body of opinion in Moscow interested in and even inclined to such amove"; and that the Soviet position had become "softer."26 Even the U.S.S.R.occasionally gave reminders that the decision of 1945 had been to postpone,and not to refuse, membership of the Fund and the Bank. In 1973, forinstance, Deputy Trade Minister Vladimir S. Alkhimov told an Americannews magazine that the decision on joining the IMF was "up to our Treasury.I know that they don't like some of the IMF's procedures, such as its systemof voting. . . . But I wouldn't rule it [membership] out forever."27 In the 1970sPolish officials and ministers wanted to join the Fund, but found the Sovietsinflexible on this issue. The Polish government was in consequence onlyprepared to apply for membership after Hungary had shown the way.

In the mid-1970s, a wider rapprochement between Central Europe andthe international financial system was held up, not so much by Sovietpressure, but rather by the consequences of the first oil price crisis for thenon-oil producers. A major goal of the domestic reform exercise in CentralEurope lay in bringing domestic and international prices together, but theincrease in Western prices made such a move practically impossible forHungary and Poland, which were unwilling to face the domestic unpopularitythat would follow from sharp price increases. For some time, moreover, theSoviet Union used the new disorder as a way of binding the members of theCMEA more closely by supplying them with oil at prices below the newworld market levels. It is not surprising that it was precisely the reformersin Poland and Hungary who were most articulate in calling for a stabilizationof the world economic and monetary system in the middle of the turbulencesof the early 1970s. Some even called for the restoration of gold as a "disciplin-ary gimmick" that would ensure world price stability.28 Inflation and rapidchanges in parities defeated their objective of moving their economies closer


to a single world market and increased the artificiality of the price structurein most Central European countries. The oil crisis forced a retreat into theerroneous and harmful belief that "there were two world markets and negativeevents on the capitalist market did not affect our economic relations withour socialist partners."29

Romania, despite its advantages in the 1970s as a major energy producer,did not seem an altogether alluring model for the integration of a socialisteconomy into the world order. Along with a very dynamic economy, andvery high growth rates in the 1970s (there was general agreement that theprojected 10-11 percent growth of the plan period 1971-75 had actuallybeen realized), there were major problems. Romanians were reluctant tosupply economic information, with the result that until 1980, the Fund couldnot compile a country page for its International Financial Statistics publication.External advice that did not amount to praise for the Ceau§escu regime wasunwelcome. In a system that did not permit public discussions of ideas orpolicy, government officials found criticism unfamiliar, and feared it.

As a consequence, Romanian programs were rather smaller than the gov-ernment had initially hoped. The IMF agreed a first credit tranche drawingin November 1973, but in the absence of more detailed information refusedhigher tranche drawings. There were new stand-by arrangements after Roma-nia was hit by natural catastrophes—floods in July 1975 and an earthquakein March 1977—but they were accompanied by a continuing suspicion thatincorrect data had been supplied. Once the Fund program ended in September1978, the agreed performance criteria were immediately broken. By the endof the 1970s, a more skeptical attitude toward the Romanian experimenthad developed in the Fund; although the World Bank continued to supplyrather upbeat verdicts on Romanian performance.30

A reward of membership in international institutions appeared to be aready access to international capital markets. A growing Romanian deficiton the current account (which rose from 1.5 percent of GNP in 1978 to 4percent of GNP in 1980) was financed quite smoothly at first, throughinternational borrowing.31 By 1981, however, conditions on the market hadbecome more difficult, and Romania wanted to use a Fund arrangement asa way of reassuring its foreign lenders. Romania pressed for a longer (three-year) commitment under the extended Fund facility, on the basis of aprecedent in the case of Yugoslavia, but never obtained it. As part of theconditionality of a SDR 1,102.5 million ($1,300 million) three-year stand-by arrangement, Romania in 1981 agreed to reduce the current accountdeficit to 2 percent of GNP in the next financial year and to prepare aschedule for the elimination of the majority of consumer price subsidies.


Despite the stand-by arrangement, difficulties in paying debt service mounted,and by September 1981 there were delays in payments. Although the condi-tions of the stand-by arrangement were violated, the Romanian authoritiesattempted to "insist" on the release of the drawing due on November 15and refused to request a formal rescheduling of bank debts. They preferredinstead to let smaller banks quietly withdraw credits and to negotiate on abilateral basis with the larger creditor banks.32 The result of this unwillingnessopenly to acknowledge the payments problems was a sharp deflationary crisisas Romania repaid almost all its foreign currency debt. It might be viewed,at least from the standpoint of the creditor banks, as a heroic performanceby a government with sufficient authority to force its population to pay thehigher cost of quick adjustment. It was thus fundamentally the gesture of adictatorship. The result was a dramatic fall in imports from market economiesand a shift to greater dependence on CMEA trade.33 The repayment wasalso necessitated by the Romanian obsession with not disclosing economicdata.

As a consequence of the Romanian decision to repay external debt at anyand all domestic costs, a general Central European debt crisis did not breakout until six months later, and involved Poland and Hungary, and notRomania. It has been described, briefly, above. Hungary had attempted tolink domestic reform with institutional internationalization from 1979, whenthe more liberal "New Economic Mechanism" had been reintroduced. Atthe beginning of 1982, new regulations allowed greater scope for privateenterprise, particularly in services. But the deflationary early 1980s were atleast as unpropitious as the highly inflationary mid-1970s for exposure to aninternational economic and financial order. Hungary actually joined the IMFand the World Bank on May 6, 1982, in the midst of its debt crisis.

The liberalization carried out in 1982-83 went at a faster pace than hadbeen spelled out in the letter of intent prepared for the first Hungarian IMFprogram. Gasoline prices were increased and the forint devalued farther thanhad originally been suggested. But the risk of a major foreign currency crisisremained. The withdrawal of foreign bank deposits constituted a monthlydrain of at least $30 million in the first half of 1983, and the governmentexpected the gross capital outflow for the year to amount to $1.75 billion.Hungary negotiated with the major creditor banks. At the same time, theBIS committed additional funds in support.34 Hungary also—without tellingWestern creditors or the IMF—tried to replace the lost credits with increasedinter-CMEA credits from the U.S.S.R., a strategy that lasted until theU.S.S.R. insisted on a reduction of credit lines in 1984.35 (In 1989, it emergedthat there had been a consistent misreporting of Hungary's external andinternal debts over the course of the 1980s.)


In 1983, Hungary prepared a much more extensive economic reformprogram. A paper prepared by Vice-Prime Minister J. Marjai envisaged thereduction of most consumer subsidies in stages beginning in 1984- Thereduction in subsidies would be compensated through wage increases; inorder not to penalize enterprises, the existing very high profit taxes shouldbe cut as wages rose. A general freeing of wage setting would facilitate themovement of labor out of low-efficiency and loss-making enterprises. Thecombination of a mildly inflationary impetus, with the imposition of enter-prise budget restraints, could accelerate a transition to market economics.Credit offered through the State Development Bank would be limited.36 Thisreform would be accompanied by a long-term IMF package. Throughout thenegotiations, the Hungarian negotiators insisted that the length of the pro-gram was more important than the quantity of funding. It was essential tosecure an external support for a sustained process of adjustment.37 In January1984, a new stand-by arrangement was approved to accompany the Hungarianstabilization plan.

During the 1980s, Hungary implemented a gradual incremental liberaliza-tion, accompanied by external support. In 1986, commercial banking wasseparated from the activities of the Bank of Hungary, and the new bankingsystem was allowed flexibility in setting interest rates for enterprises. In May1988, Hungary negotiated an SDR 265.35 million ($357 million) stand-byarrangement. In 1989, banks were permitted to take deposits from and lendto the household sector. In order to strengthen and consolidate the reformimpetus, a new stand-by arrangement was agreed on March 14, 1990, tendays before Hungary's first free elections since the 1940s. In February 1991,the process of structural adaptation was supported through a three-yearextended Fund facility.

The end result of increased liberalization in gradual doses in the 1980sdid not look encouraging. As in other planned economies, growth rates hadfallen sharply in the course of the decade. The average annual growth rateof real GNP for the first half of the decade had been 1.4 percent; it fell to0.5 percent in the second half.38 The crisis of the end of the 1980s provedto be not just a crisis of the planned economy, but also a demonstration ofthe inadequacy of Hungarian-style gradualism.

A Model Reformer

Economic reform initiatives in Poland often appeared to follow a similarcourse to the Hungarian experience, but the dynamic instability of Poland's


political evolution generated a very different outcome. In the 1970s underFirst Secretary Edward Gierek, the Communist Party attempted to promotemodernization. As in Hungary, the oil shocks in the Western economiesconstituted a caesura. Growth rates fell off after the mid-1970s. Social resist-ance to the reduction of consumption levels constrained the Polish regimeeven more than in Hungary. Government attempts to raise (or "liberalize")prices not only formed a leitmotif running through Poland's economic andsocial experience between 1970 and 1990, but also a fundamental cause ofpolitical change.

The government had been shaken by working class protest in 1970, whenGierek's predecessor Wladyslaw Gomulka had been forced to resign. Whilein the first half of the 1970s, the average annual rate of real consumptionincrease was 9 percent, in the second half of the decade it fell to 4 percent.The regime knew its weakness, and saw its unpopularity as limiting thepossibility for effective action. In 1976, confronted with popular demonstra-tions, it backed down on an attempt to increase prices. Instead it encourageda buildup of Western debt, a substantial proportion of which was used tofinance increased consumption. From 1977 to 1980, a third of credits areestimated to have been used in this way, the largest part of them to pay forpurchases of agricultural goods.39 Poland became the world's third largestwheat importer. Some Poles suspected that after 1978 an increasingly politicalmotive underlay the enthusiasm of Western governments for loans. TheGerman Chancellor, Helmut Schmidt, who publicly urged German banksto extend credits to Central Europe, hoped that credit would contribute topolitical stabilization and the implementation of gradual reform. Westernengagement also had a purely commercial motive. A combination of promptservice payments, skillful debt management by a limited number of state-owned banks, and the widespread assumption by creditors that there existeda Soviet "guarantee" or "umbrella," made Poland appear as a model debtor.Gierek's attempt to buy popularity with foreign money succeeded only inraising consumption levels. It brought none of the hoped-for macroeconomicgains, and almost no increases in productivity levels. Prices remained dis-torted, and an attempt to correct them provided the trigger to the crisis oflegitimacy of the Polish regime that developed in the course of 1979 and1980.

Poland became one of the first states shaken by the international debtcrisis. As in other debtor countries, maturities shortened in the early 1980s,and the surge of interest rates increased the cost of service.40 In order to dealwith the unanticipated decline in foreign lending, the Prime Minister, EdwardBabiuch, attempted a drastic Romanian-style adjustment program aimed ateliminating the Polish trade deficit in the course of a year, and repaying


foreign debt. In 1980, the government repaid about a fifth of its long- andmedium-term debts (about $5.2 billion), in addition to paying $2 billion ininterest. France agreed to a rescheduling of official credits. The domesticside of adjustment was to be accomplished through price increases, whichthe government hoped to camouflage through undertaking quality reductionsfor goods that would stay at the same price, and by introducing the "reforms"at the start of the summer holiday season.41 This attempt to raise prices onthe sly failed miserably. Initial strikes against the price hike were successfulin obtaining wage increases, and these victories of the workers' oppositiongroups helped to create a national movement (Solidarity), which demandedthe creation of free trade unions, the right to strike, and freedom of speechand publication.42

For some time in 1981, it appeared that it might be possible, given skillfulnegotiating by both the government and the opposition, to produce a consen-sus around economic reform, coupled with some measure of political opening.Both sides agreed on the desirability of some measure of liberalization. Butthe opposition found it hard to accept the responsibility for a harsh stabiliza-tion that the government was attempting to impose on it, while the regimewas stalling on demands for further political liberalization. Solidarity leadersinsisted, rightly, on some measure of power: they did not simply want totake the hard task of selling an initially unpleasant liberalization packageand thus making the government's part easier. They worked out their ownplans. There was even a detailed blueprint prepared by Professor LeszekBalcerowicz of the Warsaw School of Planning and Statistics, drawn up onthe basis of discussions that had been taking place since 1978. Its mainsuggestion was an operation of independent firms, run on a self-managedbasis, within a market and cut off from central planning. This plan had beendrawn up in the knowledge that it represented a second-best solution to afull transition to the market—but the basic premise of the would-be reformerswas that they needed to stay within the boundaries of "our understandingof political realism." At this time this included both remaining within theCMEA, and not introducing private property.43

Some elements of economic reform were realized in Poland between Sep-tember 1981 and February 1982. Large economic supra-enterprise organiza-tions and the so-called branch ministries were abolished, and responsibilitydecentralized to the enterprise level. Firms were given greater autonomy insetting wages. A unified external exchange rate was introduced. But in itsessentials, the program brought by the government to the Polish parliamenton December 1, 1981 (termed the "provizorium") ignored Solidarity's sugges-tions. To emphasize the fact that the decrees were not the result of negotiationwith the domestic opposition, the government announced them during a


meeting of Warsaw Pact defense ministers in Moscow. In fact, it was theworld political scene that shaped the outcome of the upheavals of 1980-81.A different international context might have made possible an agreementon a more far-ranging reform, including both political and economic ele-ments. Some Solidarity activists, as well as sympathizers outside Poland,advocated a Marshall Plan style aid package that would make bearable thecosts of reform. The government too hoped for a broad-based internationalsupport. On August 14, 1981, the first secretary of the Polish CommunistParty, Stanistaw Kania, and the Prime Minister, Wojciech Jaruzelski, traveledto a meeting with the Soviet leader Leonid Brezhnev in the Crimea, andinquired whether Poland might join the IMF. The Soviet Foreign MinisterAndrei Gromyko firmly opposed the suggestion, as did a Soviet delegationunder the head of Gosplan which was sent to Poland to investigate Polishconditions. In the meantime, the Polish government had made other sound-ings (the Foreign Minister asked the Pope about IMF membership); andin November 1981, despite continued Soviet hostility, Poland applied forreadmission to the IMF.44

In fact, however, the political part of the reform endeavor came to anabrupt halt on December 13, 1981, with the imposition of martial law andthe banning of Solidarity. This visibly and brutally destroyed both the domes-tic and the international basis for consensus over reform. The United Statesimposed economic sanctions, including a veto of Polish membership of theIMF. Martial law also threatened the process of debt negotiation.

Debt had played a crucial part in the shifting balance between Eastern andWestern orientation in Polish politics. Until April 1981, Poland was regularlyservicing its debt, despite the disruptions to output caused by the politicalturmoil. For some time, the U.S.S.R. tried to prevent a loosening of Polishpolitical control by the provision of financial assistance. Since the U.S.S.R.reduced its deposits in Western banks between December 1980 and March1981 by $3.1 billion, it was assumed by Poland's creditors that their loanswere being repaid with Soviet help. In fact, the U.S.S.R. indeed advisedagainst some Polish suggestions that they should declare a unilateral default,and provided the means to continue payments.45 On August 31, 1981, Poland'smedium- and long-term foreign liabilities had stood at $23.4 billion. Theyincluded $8.5 billion nonguaranteed debt to private creditors (501 banks),with the largest claims being held by German banks (around $2 billion).The German banks had adequate reserves against potential losses in CentralEurope, and the exposure of bankers in other countries was insufficient tocreate a systemic threat of the kind posed one year later by Mexican develop-ments (the largest exposure of a U.S. bank in Poland amounted to 8 percent


of its capital).46 In the Paris Club rescheduling of debt in April 1981, in theface of the political uncertainty surrounding the rise of Solidarity, a clausehad been added (Article IV, Paragraph 3) providing for the suspension of theagreement without notice in the case of "exceptional circumstances." Thesewere understood to include both "the entry of foreign troops into Poland,whether they were invited by the Polish government or not"; and "the emer-gence of violence among Poles." Most creditors believed that GeneralWojciech Jaruzelski's imposition of martial law unambiguously constitutedthe latter. After December 1981, the imposition of Western economic sanc-tions by the major creditor countries meant that new foreign funds wereunavailable (apart from some officially guaranteed credits from Austria).

Jaruzelski's government tried to muddle through. After 1982, economicgrowth resumed, at an annual rate of some 4 percent, but output neverreached the peak levels of the late 1970s. Military expenditure increased.The regime both recognized that reform was needed, and at the same timeit knew that it was too weak to make the necessary moves on its own. Couldinternational support, this time from the West rather than the U.S.S.R.,help? The price for international assistance, however, was a domestic politicalas well as economic liberalization. The U.S. attitude involved a leveragingof economic change into political adaptation. In 1986, the U.S. governmentlifted its veto on Polish membership of the IMF; and, as a result of one ofthe conditions imposed by the United States for IMF membership, the Polishgovernment freed all of its 225 political prisoners and declared a generalamnesty. The movement of Poland toward the international economy contin-ued to be carefully analyzed by the underground Solidarity organization. InSeptember 1985 the Solidarity office in Brussels sent a message to the IMF'sManaging Director stating that the movement welcomed Polish membership,and urging that "the IMF should familiarize itself with the numerous reformprojects worked out in 1981" (such as the Balcerowicz plan). It also addedthat "only extensive, all-embracing economic reforms can achieve positiveresults and that partial modifications, on the other hand, can only achieveresults opposite to the expected."47

The results of partial reform became apparent in 1988-89. Throughout1987, the government puzzled over the problem of how to make economicreform acceptable. One of the more innovative solutions involved a rangeof opinion surveys, intended to impress on the public the inevitability ofsome kind of price rise ("Do you prefer a 50 percent rise in the price ofbread and 100 percent for gasoline, or 60 percent for gasoline and 100percent for bread?"). There was also a referendum on economic reform. Inlate 1987, after a substantial delay, the second stage of the economic reform


process envisaged in 1981-82 began to take effect. At the end of 1988,the government of Mieczyslaw Rakowski lifted restrictions on the establish-ment of private firms- Two obstacles stood in the way of further reformsat this stage: one international, the other domestic. The debt mountainhad been increasing, as official debt piled up due to the suspension of thedebt service in 1982-84 and subsequent restrictions on debt service. Theunpaid interest was capitalized into the sum of the outstanding debt, withthe result that it rose from $25,950 million at the end of 1981 to $39,170million by 1988.48 But there could be no further credit inflows without anIMF program, and the IMF would not support an unsustainable program.Rakowski's realization that the government would be unable to meet itsforeign debt obligations drove him to a consideration of more extensivedomestic economic reform and liberalization. As elsewhere, the debt crisisproved to be a catalyst for a profound reorientation of economic policy aswell as of political structures.

The second problem was domestic. The most contentious aspect of thereform was the "adjustment" (or elimination) of subsidies. The rate of pricerises increased (the average of consumer prices rose by 25 percent in 1987and 60 percent in 1988), and sparked two waves of renewed labor unrest.Faced with these conditions, the government admitted Solidarity representa-tives to a Round Table to discuss the political future of Poland, then legalizedthe movement (April 1989), and allowed its candidates to contest a restrictednumber of seats in parliamentary elections (all of which the government lost).The General Secretary of the Soviet Communist Party, Mikhail Gorbachev,telephoned the Polish Prime Minister to urge him to abide by the electionresults. After a series of unsuccessful experiments in forming a communist-led government, a Solidarity-led government with Tadeusz Mazowiecki asPrime Minister was installed in September 1989. The effects of partial eco-nomic reform had in the event augmented the political crisis, and led to acomplete collapse of the old order.

In its first months in power, the Mazowiecki government launched itsown very radical version of a reform program. At the outset, Mazowieckihad remarked that "I am looking for my Ludwig Erhard!"49 The man appointedas Finance Minister, Leszek Balcerowicz, had been the author of the influen-tial 1981 program; and since 1987 had been involved in intensive privatediscussions of economic reform involving privatization, currency convertibil-ity, the liberalization of international trade, and the abandonment of notionsof import substitution.50 After the revolution, in the words of one observer,"economics revealed itself with a vengeance to be the key determinant of


the political realm. . . . What is the essential point of reference, the short-hand designation, the symbol associated today with the Polish revolution?...it is . . . the Balcerowicz Plan."51

The fundamental threat to the plan was monetary. A partial financialreform at the beginning of 1989 had created a two-tier Western-style bankingsystem, with a central bank and also a network of (fundamentally regional)commercial banks. The new banks were, however, in most areas in a practi-cally monopolistic position, and they continued, without much central con-trol, to give credit to enterprises. Once price controls were lifted, the conse-quence of an uncontrolled explosion of enterprise credit would be inflation.In consequence, in late 1989, as a result of the combination of price liberaliza-tion with the fiscal aftermath of the previous regime's last-minute attemptto buy for itself political stability, Poland was threatened by hyperinflation.Between December 1988 and September 1989, open inflation rose to 230percent. In October, it seemed that hyperinflation had arrived. Consumerprices increased 54 percent in a single month.52 Tackling this became themost urgent economic issue, as well as an opportunity for a much morebroadly based reform. Pegging the zloty to an external standard could be theonly guarantee of monetary control. Only ten days after the formation ofthe government, Balcerowicz traveled to Washington to lay out the detailsof the government's very radical reform and stabilization program in hisspeech at the IMF Annual Meeting.

Already in September budget spending was reduced by cutting the coalsubsidy. Credit to the nongovernment sector was cut. The gap between theofficial exchange rate and the market rate was reduced. Wages would beheld in check by a tax of 100 to 200 percent on wage increases in excessof a sum set at 80 percent of the cost of living increase. The two principlesunderlying the reform package were that stabilization should be accomplished"quickly and decisively" and that there should be a move to market mecha-nisms. In a memorandum for the IMF, the Polish government stated that:"We believe that speed is of the essence, so that the transitional stage—sohard on society—will be as short as possible. Radical change is also dictatedby the bad experience with piecemeal reforms in the 1980s."53

The most radical phase of the reform, the Balcerowicz plan implementedin January 1990, was explicitly designed as a "shock treatment" and con-structed in a deliberately tight time frame. Balcerowicz believed that thegovernment should use the political capital generated by the honeymoonperiod of transition to democracy in order to introduce reforms that wouldbe beneficial in the long term but inevitably carry short-term costs. The

5 70 INTERNATIONAL MONETARY COOPERATION

outcome of a liberalization, he thought, could not be predicted. No onecould forecast how output, prices, and external trade would behave in acompletely transformed situation. But the level of certainty about the out-come would not be increased if the reforms were to be applied more slowly.As a result, a rapid passage through government committees and throughparliament with an imposed deadline of January 1 offered an alternative farsuperior to unending negotiations about individual details of the plan.

In addition, as a result of the democratic revolutions Poland stood at thefocus of world attention, but it could not expect to occupy that place for long.The country should use its "five minutes of history," Balcerowicz thought, inorder to introduce a program so ambitious that it would encourage creditorsto accept a generous solution of the international debt issue. It was consciouslydevised as a program that would appear to the rest of the world as a modelof the application of economic liberalism, a new version of Ludwig Erhard'sachievement.

It included the achievement of fiscal balance in 1990, a sharp restrictionof monetary growth, the continuation of a tax-based wage indexation policy,a lifting of price controls (with especially dramatic effects in energy: therewas to be a fourfold increase of the coal price for industrial consumers, andsixfold for retail customers; and a 300 percent rise in electricity prices). Theforeign exchange market was to be unified, in order to create greater incen-tives to export. Credit policy would be tightened (with the result that "someenterprises are likely to become bankrupt and close"). But the policy wouldalso be supported by a Labor Fund, financed from a 2 percent levy on thepayroll of enterprises, to create a "protective shield" for those workers maderedundant in the course of the transition, and to pay for retraining andvocational training programs. Pensions benefits and family allowances wouldbe reviewed on a quarterly basis. IMF drawings would be used primarily tobuild up Poland's foreign currency reserves. This was in essence a programlargely produced in Poland—and not either an "IMF program" or one laiddown by any one of the numerous foreign advisers who now descended onWarsaw.

The total effect of the program was estimated to involve in the immediateaftermath of the "shock" a drop on real wages of between 30 and 40 percent.But it appeared to be strikingly popular. In an opinion poll held on Janu-ary 4, 1990, over half of those surveyed claimed to be in favor of the "shockcure." The new government's approval ratings stood at 90 percent.54 Whenthe IMF's Managing Director traveled to Poland in December 1989, he wassurprised by the broad range of support for the program from Solidarity,church leaders, parliamentarians, but also from the leaders of the former


official (that is, communist) unions and from the President, GeneralJaruzelski.55

The IMF program (an SDR 545 million ($740 million) stand-by arrange-ment) approved in February 199056 was designed as a demonstration ofexternal support and as a reassurance and a catalyst for foreign investorsinitially hesitant about Poland's prospects for stability. The Fund's prepara-tions, and the discussion on the Executive Board, also emphasized that itwas essential to protect the neediest groups in the population and to providefunds for retraining and unemployment benefits to cushion the process oftransition to the market economy.57 Some of the Polish advocates of thereform plan even felt that the IMF should have taken a tougher stance onfiscal issues, and especially about the question of pensions, which later provedto be one of the most intractable difficulties facing the reform government.Within Poland, the idea of conditionality was not used by the governmentto justify its program, which it explained as being necessary for "our internalconsiderations," but rather in terms of making the program internationallycredible and achieving a debt reduction. Balcerowicz later argued that "thiswas not only truthful but also probably politically more effective than tryingto push through tough measures on the pretext that the IMF had imposedthem."58

At the beginning, no one knew quite how the key economic indicatorswould develop over the course of the transition. Most, including the majorforeign economic adviser of the Solidarity government, assumed that thegreatest problems would be in the first months rather than years of therestricting program.59 In the first half of 1990, fiscal policies turned out tobe even tighter than had been anticipated, because the initial estimates ofrevenue had been rather low and failed to take account of the effects ofinflation. At the same time, the output collapse appeared greater than antici-pated, although much of the fall proved to be partly an optical illusionbrought about as a consequence of the exaggeration of production figuresfor 1989, and partly because statistical collection involved primarily the largestate-owned factories most hit by the collapse of production. Thus the earliestofficial Polish figures gave the decline of GDP in 1990 as 18-20 percent,but more recent calculations place it more modestly at between 5 and 10percent.60 The result of a strong fiscal performance combined with an appar-ently dramatic output decline played into the hands of officials from the oldplanning authorities, who now began to argue that a demand-oriented policyon allegedly "Keynesian" lines should be applied in order to promote recovery.They said that they did not want to modify the basic impetus toward liberaliza-tion and structural change of the reform; but at the same time, they claimed


that the shock had been "overcooked." As a result in the third quarter of1990, fiscal policy was relaxed, wages began to increase at a faster ratethan had been targeted, and the basis of the IMF program was endangered.Negotiating a new program in 1991 became much harder, although eventuallyan extended facility of SDR 1,224 million was approved by the Fund inApril 1991. The central bank's response to enterprises paying higher wagesand to the new fiscal policy was monetary expansion.

In addition, social pressures mounted. During the summer of 1991, in therun-up to elections, the Ministry of Social Affairs received desperate phonemessages every morning from all over Poland requesting emergency resourcesfor the support of the unemployed, funds that the government provided.The consequences of adding new social expenditure to existing and ratherinefficient social transfer mechanisms inherited from the socialist past pro-duced a growing fiscal problem; and at the same time, because of the inaccu-rate targeting of the older transfers, many of the problems of the new povertywere left unaddressed.

At this time, the prospects for Poland looked bleak: the budget deficitwas out of control, and the IMF support was suspended in September 1991,with the result that the initial drawing on the extended Fund facility was notfollowed by subsequent installments.61 But at the same time, the privatizationprogram of share-offerings for large enterprises continued, and some 70 per-cent of retail stores were transferred to private management. Very quicklya vigorous private sector developed. The increase in the number of smallbusinesses alone generated employment equivalent to 7 percent of the workforce.62 The ending of the old "official rate" and the adoption of a realistic,perhaps even slightly undervalued, exchange rate in addition set off an exportboom. Export earnings increased faster than had been anticipated, and thefirst estimates showed that in 1990 Poland had run a surplus on currentaccount in convertible currencies of $700 million.63

The April 1991 Fund facility paved a way for a negotiated solution to theinternational debt problem. At a meeting of the Paris Club on April 19-21, 1991, the official creditors agreed to an extraordinary debt reduction onthe $33 billion outstanding debt that was equivalent to 50 percent of thenet present value. The relief was to come in two stages, the second of which(in 1994) depended on continued compliance with Poland's commitmentsto the IMF. The debt plan thus secured a longer-term framework for thecontinued application of successful policies. The Paris Club agreement alsoin turn facilitated a solution to the problem of the (smaller) volume ofoutstanding bank debt, some $12 billion in capital and capitalized interestarrears.64 The negotiation of a solution to the long-standing debt problem,


as in other severely indebted countries, could only be accomplished ade-quately in the more general context of a reorientation and adjustment ofthe entire approach to economic management. A major Polish mistake,which for a long time acted as an irritant and a deterrent to new foreigninvestment, was the failure to reach agreement on the bank-held (LondonClub) foreign debt (there was eventually an agreement, but only in 1994).Despite the delay in negotiating, the early adoption of liberalization was astep toward a satisfactory debt accord. The "big bang" approach had createda Polish model of how to carry out an economic transformation.

Renewed growth in Poland was delayed by the drastic fall in exports tothe East as a result of the collapse of the Soviet Union (1990-91); but realGDP had already begun to grow again in 1992 (1.0 percent) and rose at amuch faster rate in 1993.65 In 1992, the government of Hanna Suchockabegan to pay greater attention to issues of micro-adjustment (such as reformof the financial sector and improvement of credit allocation) that had beenrelatively neglected in the rush to conclude the original stabilization plan.This development reflected a more general experience of the economictransition. The IMF came to the overall conclusion that by 1992, "the focusof discussions on eastern Europe is increasingly shifting to the microeconomicaspects of reforms. These are proving more difficult to formulate and imple-ment than expected initially."66 But the Polish case also demonstrated howthe first true experimenter in Central Europe was also the first country toshow sustained recovery and growth. The uncertainties in Poland's post-communist era development, and the challenges to the IMF programs in1990 and again in 1991, underlined the degree of difficulty in the economictransformation. The experience suggests a lesson, that is similar to thatderived from other cases (for instance, Turkey at the end of the 1970s): notevery reforming country whose IMF program runs into unexpected problems(not necessarily from a commodity shock) is inevitably doomed to see theexperiment fail. Given sufficient commitment to reform, the setbacks canbe overcome; and the existence of the program may work as a helpfuldisciplining instrument (even, in some cases, without the disbursement ofresources).

Why Hesitate?

Czechoslovakia too had been concerned with the possibility of economicreform even before the political upheaval of 1989. In May 1989, the Federal


Finance Minister and the President of the Czechoslovak State Bank hadvisited the IMF to discuss the possibility of membership. They announcedthat they were preparing the political gamble of a two-year economic reformprogram to be launched in 1990. But unlike in Poland, the old regime nevereven had the chance to alienate the population by imposing price rises. Thecommunist government was quite unpopular enough on its own account, andthe example of effective Polish and east German anti-communist revolutionproved inspirational. It was the new democratic Czechoslovak governmentthat applied for membership of the Fund on January 22, 1990. A few weekslater, Bulgaria, also shaken by the political turmoil, pledged free electionsand proposed to join the international financial system. By 1990, the priceof a failure to undertake economic reform had become as clear as the priceof undertaking it with the insufficient support and legitimacy of old-styleEast European regimes.

The most successful efforts at reform involved, as already in the Polishcase, a quick and far-reaching implementation. The Czechoslovak federalgovernment in May 1990 accepted a "Strategy of Radical Economic Reform"and implemented it at the end of the year. As in Poland, it involved priceliberalization, privatization, the liberalization of the external trade regime,and the introduction of currency convertibility (on January 1, 1991, sup-ported by an IMF program). Monetary stabilization was easier, because therehad been a much less pronounced development of a monetary overhang inthe immediate pre-reform period. The mass privatization program, involvingvouchers generally distributed to the population, was implemented morequickly than in Poland (where privatization had been delayed by the adoptioninitially of a mechanism rather more suited to the privatization of a few publicsector enterprises in advanced industrial countries). The major architect ofthe reforms, Vaclav Klaus, the Finance Minister of the Czech and SlovakFederal Republic (and later the Prime Minister of the Czech Republic), likeBalcerowicz in Poland concluded that the hotly debated issue of sequencingwas essentially a diversion from the real problem. "I am deeply convincedthat the idea of sequencing is just a technocratic or rationalistic notion basedon unrealistic beliefs in social engineering, in scientific control of the reformprocess, and in the fine tuning of reforms. . . . The only prescription that mustbe followed for successful institutional and systemic change is macroeconomicstabilization based on prudent macroeconomic policies."67

Partial reform, gradualism, or even carefully sequenced reform producedfew useful or attractive results in Central Europe. In Poland, gradual attemptsat economic reform during the 1980s had failed, and the failure precipitated ageneral crisis of the system and the implementation of a far-ranging economicreform that was only acceptable because it was accompanied by democratiza-


tion and the creation of a legitimate political system. In Hungary, despitea great deal of discussion, the economy remained fundamentally a nonmarketsystem until the end of the 1980s. Some elements of gradualism remainedin the Hungarian approach to reform after 1989: for instance, a reluctanceto use a commitment to a fixed exchange rate as an anti-inflationary instru-ment; and a willingness to tolerate inflation and fiscal deficits. The resultsof this reform program surprised many commentators, who on the basis ofa relatively strong performance in the 1980s believed that Hungary wouldbe the first Central European economy to show a recovery in output; in fact,in this regard, the turnaround followed rather than preceded the reappearanceof economic growth in Poland. In other countries, debates began as towhether output falls could be avoided. In Romania, the contraction of creditwas more than compensated by a sharp growth of interenterprise credit; butthis attempt to soften the impact of reform only made the microeconomicaspects of the transition much harder.

The most extreme example of an economy that shrank from reformingaction may have been educative. In the former German Democratic Republic(GDR, or east Germany), under the old political regime, the internationaleconomy and its institutions loomed as a specter foretelling the end of acertain kind of controlled society. Throughout the 1980s, economic growthslowed down. Even according to the overoptimistic official data, use of thenet material product (NMP) for either consumption or investment grew onlyat 2 percent a year in the 1980s.68 The state attempted to stabilize itselfthrough massive loans from west Germany, but by the end of the 1980s it facedan imminent debt crisis. A calculation presented to the Central Committee ofthe ruling SED (Socialist Unity Party) in late October 1989 detailed thegravity of the situation. Just maintaining debt service would require an almostimpossible twofold increase in exports to the hard currency area. But withoutsuch an economic transformation, the GDR would have no alternative butto declare a moratorium. "The consequences of the immediately imminentincapacity to pay would be a moratorium in which the International Mone-tary Fund would determine what would happen in the GDR. Such a processrequires examination by the IMF of the affected country on matters of costdevelopment, currency stability, etc. This examination is linked with thedemand that the state should not intervene in the economy, should reprivat-ize enterprise, limit subsidies with the goal of a complete elimination, andend import restrictions. It is necessary to do everything to avoid taking thiscourse."69

In the end the GDR of course did join the international system, throughthe monetary and economic union with west Germany (July 1990), andthen in October 1990 political integration. The reform led to a larger drop


in output than in other Central European states, less because of the intrinsiccharacter of a transformation process than because of the shock producedby the sudden creation of a fully integrated labor market and currency unionwith an economy in the west with far higher levels of productivity. Thepeculiar nature of the east German collapse was thus not typical of themovement from the plan to market.

The Technical Support of Reform

A market economy cannot simply be conjured up, either by wishing it ordecreeing it. Its development depends on the existence and interplay of anetwork of institutions and legal provisions. Implementing a privatizationplan, or re-equipping central banks to deal with emerging domestic financialmarkets, or designing tax systems and administrations, or instituting socialsecurity networks are all extremely complex procedures and cannot be realizedsimply through a working out of first principles. The IMF, with other interna-tional institutions, played a vital role in providing technical assistance onsuch issues to formerly centrally planned economies in transition, not onlyin Central and Eastern Europe, but also in Algeria, Angola, Benin, CapeVerde, the Lao People's Democratic Republic, Mongolia, Mozambique, andViet Nam. The IMF Institute expanded in order to provide courses for officialsconcerned with the transition to the market. The IMF's Monetary and Ex-change Affairs Department gave advice and assistance on banking supervi-sion, payments and settlements mechanisms, and economic and monetaryanalysis. (For instance, at a very early stage of the Polish reform process, inthe spring of 1989, a staff team from that department helped to design aprocedure for monetary control and banking supervision. When the so-calledshock program started on January 1990, an IMF team worked on the imple-mentation of monetary policy.)70 The Legal Department drafted and revieweddraft legislation; and the Fiscal Affairs Department provided advice on taxpolicy, tax and customs administration, treasury systems, budgetary account-ing, public expenditure management, and social security. The Statistics De-partment advised on guidelines for the calculation of information essential toeconomic policymaking: the national accounts and the balance of payments.

The Soviet Crisis

In the case of the U.S.S.R. in the late 1980s, the pace of political changefar exceeded an economic transformation. There had been experiments with


an introduction of effective prices in the Khrushchev era, but the mainreforming energies of Mikhail Gorbachev, who became General Secretaryof the Communist Party of the Soviet Union in March 1985, were directedinitially at political restructuring. There could, however, be no doubt aboutthe existence of an economic crisis, or of the need for a radical solutionrather than piecemeal tinkering. In 1987, in the Soviet politburo, Gorbachevasked rhetorically why the reforms of Nikita Khrushchev in 1965 had pro-duced no real growth, and then gave as a reply the advice of Count SergeiWitte, the reforming tsarist Finance Minister and Prime Minister: "if reformsare made, they need to be undertaken quickly and in depth."71

According to Soviet official statistics, the average annual growth of netmaterial product had been 7.8 percent in the second half of the 1960s, but4.3 percent in 1976-80, and 3.2 percent in 1981-85.72 This was not duesimply to a slowing of the labor supply; productivity growth had also fallen.Gorbachev tried to promote an acceleration (uskorenie) as part of the TwelfthFive-Year Plan (for 1986-90), which involved increased investment in re-tooling, greater quality control, and an alteration of the "human factor."The most spectacular part of the program, an anti-alcohol campaign, failedto halt drunkenness at the workplace, and instead quickly became the objectof ridicule. The investment plans ran into bottlenecks.

The Twenty-Seventh Party Congress in February 1986 approved a schemethat was described as "radical reform" and was intended to create a "marketsocialism." There was, as Gorbachev put it one year later, no price system,only an absurd pattern of random figures termed "prices" that had beencreated as the chance relic of decades of planning.73 As part of the reformprocess, enterprises were to be allowed to deal directly with suppliers andconsumers and to be run on the principle of "self-financing" (1987 Law onEnterprises). Also in 1987, cooperatives were re-established, as a trainingground for future entrepreneurial talent. By 1990, 215,000 such cooperativesexisted, employing 5.2 million workers (though for many, this was not thefull-time occupation).74 In 1988 new banking institutions were created toperform commercial banking operations. In June 1990, joint-stock companiescould be established.

Attempts at creating a market socialism in practice, however, failed totackle two fundamental issues: they did not provide for effective competition,and they did not secure the principle of private ownership. The processestablished a decentralization, but without the coordination that would havebeen the outcome of an efficiently operating market based on the incentivescreated by private ownership. Gorbachev's advisers prepared a large numberof more far-ranging plans for a more thorough and effective transition to


the market, and for an abandonment of hybrid attempts at "market socialism."Abel Aganbegyan, Leonid Abalkin, Nikolai Petrakov, Stanislav Shatalin,Grigory Yavlinsky all developed schemes for the marketization of the Sovieteconomy, and all were not taken seriously by the political leadership. Yavlin-sky later complained, after his advice had been refused, that "you cannotknow what Gorbachev is thinking."75

As it was, political reforms began to destroy the central planning apparatus,and authority shifted away from the center. Already by May 1987, Gorbachevwas speaking about the complete discrediting of the administrative system.76

Output stagnated, and then declined sharply at the end of the decade. In1990, real GDP fell by 2.4 percent, and in 1991 by 17.0 percent.77

The effect of the revolutions in Eastern and Central Europe also shookthe U.S.S.R. By 1990, the central authority of the state had become lessacceptable to the Soviet population. The political and economic stabilityof the U.S.S.R. emerged as a central issue on the international politicalagenda. It provided the major theme of the Houston G-7 summit of July1990, which commissioned a study of the Soviet economy, and of reformscenarios, to be undertaken by the World Bank, the newly created EuropeanBank for Reconstruction and Development, the Organization for EconomicCooperation and Development, and orchestrated by the IMF. These multilat-eral institutions produced a report and recommendations which were pub-lished in 1991.78

Was this exceptionally thorough and well-prepared but rather academicdocument, which read as a indictment of previous Soviet policy, too hesitantand bureaucratic a response to the current problems of the peoples of theU.S.S.R. in 1990-91? Before a reform process could begin, those who wouldimplement it needed to realize the extent of the problems they had inherited,and to appreciate that no quick or easy fix existed. The study provided aneloquent statement of the difficulties that would face the reformers. It alsodemonstrated the theoretical and practical superiority of far-reaching reformin the Witte style over small-scale palliatives of the Khrushchev type. Atthe same time, it said little about the likely costs of a more dramatic reform,or on the effect on output or employment levels. In this way the reportcontributed to a debate that had already begun within the Soviet leadership.The study also acted as a disincentive to any Western government thatmight feel tempted, whether for general political reasons or from personalsympathy with the brave reformer Gorbachev, to support financially anincomplete or partial reform. At the Houston summit, the West GermanChancellor and Foreign Minister had demanded very extensive assistancefor Moscow.79 Such assistance could only lead to a dissipation of resources


and would be incapable of tackling the fundamental problems of the Sovieteconomy. Gorbachev later acknowledged that no amount of G-7 money in1990 or 1991 would have made a difference to the development of Sovieteconomics, or politics.80

At first, membership of the IMF had been seen fundamentally by Gorba-chev in terms of the desirability of greater Soviet access to Western privatecredit markets. In 1986, the U.S.S.R. offered to honor in part the pre-Soviet(tsarist) debt of Russia, a move widely interpreted as a conciliatory gestureto the international financial world. During the long period of debate aboutthe possibility of economic reform but inaction about its implementation,the U.S.S.R. came to depend increasingly on credit given or guaranteed byWestern governments concerned with Soviet stability, or (in the Germancase) eager to ensure that there were no obstacles to the process of buildingGerman unity, and that there would be an orderly withdrawal of foreigntroops from Germany. The foreign debt of the U.S.S.R., which had risenfrom $30.7 billion in 1986 to $53.8 billion in 1989 as a consequence ofperestroika loans, increased yet further by 1991 to $67.2 billion. By October1991, it was estimated that Germany alone had provided $30 billion for theU.S.S.R.81 The consequence was that in Russia serious economic reformbegan with the impediment of a very large external debt burden on thestate, owed largely to commercial banks but with a very evident politicalcomponent.

The London G-7 summit in 1991 referred to an Association Agreementwith the IMF and the World Bank as the best channel for external assistance,but this pace seemed frustratingly slow to an increasingly desperate Sovietleadership. Gorbachev had already begun internal discussions about an appli-cation for membership of the IMF in 1988, in part as a response to theincreasingly serious external debt problem of the U.S.S.R.82 Within twoweeks of the London summit, the U.S.S.R. announced, unilaterally andunexpectedly, that associate membership would be "humiliating," and thatit intended to apply for full membership of the Bretton Woods organizations.The United States promptly described the application as "counterproduc-tive."83 The discussion of reform had set off a painful discussion about howeconomic restructuring could be combined with Soviet political standing inthe world.

In October 1991, a few weeks after an attempted coup against Gorbachev'sfading authority had been undertaken by communist hard-liners, the U.S.S.R.eventually concluded the association agreement with the IMF. By that time,however, the issue of economic reform had proved, appropriately enough,to be the final element that drove the old Soviet empire apart. The Baltic


republics—Estonia, Latvia, and Lithuania—had already declared their inde-pendence in the course of 1991. On December 24, 1991, the Russian leader-ship under President Boris Yeltsin stated that it would introduce price andother economic reforms on January 2, 1992. The next day, Gorbachevannounced his resignation and the Russian flag was raised over the Kremlin.On January 7, Russia applied for full membership of the International Mone-tary Fund; and by May 1992 membership for the 15 states that had formerlybeen Soviet republics was approved in principle. One effect—an importantone—was at last to turn the Bretton Woods system into the truly universalframework envisaged at the conference of 1944. Even before Russia formallybecame a member of the IMF, it launched a radical price liberalization(January 2, 1992, one day before the membership application was sent) inwhich the Finance Ministry began negotiations with the IMF "as if we weremembers." Membership in the international institutions was an essentialpart of the effort of reforming and restructuring the Russian economy.84 By1994, looking back on the experience of reform, one former Russian FinanceMinister commented, half jokingly, that "they are citing the IMF the waythey used to cite Karl Marx."85 Few would disagree that this represents animprovement.

In Russia, reform began with an abolition of central planning, and adecontrol of many but not all prices. This was followed by a privatizationboth more extensive and rapid than that carried out in Central Europe.

The reform program in the former Soviet republics was supported by alow conditionality systemic transformation facility (STF) created in April1993 that allowed members to draw up to 50 percent of their IMF quota.Financing from this facility would be available to member countries "experi-encing severe disruptions in their trade and payments arrangements due toa shift from significant reliance on trading at nonmarket prices to multilateral,market-based trade." The conditions affected only the external trade regime,and included no fiscal criteria. The countries would simply agree "not tointensify exchange or trade restrictions."86

The economics of the transformation were difficult enough, even withoutthe attendant political complications. It was hard to see a future for a vastheavy industrial sector. A peculiarity of the Soviet economy had been therelatively minor role played by consumer industries (in the mid-1980s, theestimated world share of consumption in GDP was 78 percent; in the U.S.S.R.it was believed to be 55 percent).87 In addition, it was acknowledged thatall industries used labor with extreme inefficiency. In 1990, overmanning inthe Soviet economy had been estimated at over 20 percent. The LaborMinistry, Goskomtrud, estimated that 3 million workers were employed in


loss-making enterprises, although in the absence of an effective price structurethere was inevitably an arbitrary quality to such estimates.88 Even the "conser-vative" plans of the late Gorbachev years for a gradualistic transition to amore market-oriented approach acknowledged that many millions of jobswould be lost in the state sector. But the cost of these job losses in termsof social stability looked very high for a weak government: too high to beacceptable either to Gorbachev or to his Russian successors. Toward the endof 1992, the Russian government changed the emphasis of its reform ap-proach, ignoring advice from the IMF, and began to support industry more,to move away from the principle of fiscal and monetary stabilization, andto see inflation less as an economic threat than as a way of assuaging amultitude of political demands.89 For the early years, the fate of the reforminitiatives seemed constantly precarious, as if perched on a knife's edge.

In addition, for the initial period, Russia (and the 14 other former Sovietrepublics) faced enormous constitutional uncertainty. As struggles betweenthe Russian President and the Congress of People's Deputies unfolded, itappeared uncertain whether anyone had the political authority to launch areform strategy, whose initial consequences were bound to be hard to bear.For much of the early period, the Central Bank seemed independent of thegovernment, and committed to a course that produced ever higher rates ofinflation. As elsewhere under central planning, monetary policy had beenpassive. Monetary growth was held in check by price controls, not monetarycontrol. Price deregulation produced big increases, and raised demands forinterenterprise credit, which functioned as an uncontrollable source of claimsand drove inflation higher. The Central Bank accommodated this expansion.A central bank that is not independent of the business world can be asdestructive to monetary stability as a central bank overdependent on thegovernment. In the course of 1991, in the last days of the U.S.S.R., forinstance, the Central Bank advanced credits of Rub 600 billion to Sovietbanks.90 At times, the Central Bank saw its responsibility as lying in increasingmoney supply as fast as possible, in order to finance the pace of social change.The head of the money supply department of Gosbank, Yuri Balagurov, wasquoted as having said that "the only limit to the money supply in the SovietUnion today is the capacity of the money presses."91 Such attitudes, inheritedfrom the conditions of the Soviet economy, often simply carried over intothe new state. At the beginning of their existence as new states, all theessential elements of economic reform still lay ahead for the former Sovietrepublics. No one could be completely confident of the success of reform: itrequired a reorientation on a scale far greater than that of Central Europe,where radical reform had been preceded by a long period of experimentation


and reflection. On the other hand, failure would bring a certain prospect offurther economic collapse, and widespread social and political destabilization.

The integration of the former U.S.S.R. into the world economy was a taskof such magnitude that the only historical parallels seemed to lie in thepostwar reconstruction of Western Europe. Then, as after 1991, some ques-tioned whether the institutional management of such a transformation wasbest left in the hands of an agency whose responsibilities were global.

The experience of the reform process in Central and Eastern Europe hadtaught a number of important lessons, regarding the timing and extent ofreforms, the external framework, and the likely behavior of output duringthe transition. First, small-scale or half-hearted attempts at reform could notsucceed. The great historical designers of reforms—Sergei Witte or LudwigErhard—as well as a more recent example—Leszek Balcerowicz—realizednot only that a wide range of liberalization measures had to be undertakenwithin a very short space of time but also that the process of liberalizationrequires a large number of steps and is best understood as a self-sustainingprocess rather than a single dramatic gesture. This is an experience that inthe meantime had become familiar in many developing countries. Macroeco-nomic adjustment could not work without previous or simultaneous structuralreform: the two processes are inseparably connected. In particular, monetarystabilization required more than simply appropriate monetary policy on thepart of central banks. It depended on individuals and corporations whosecredit would be self-controlled as a consequence of the establishment ofproperty rights. This, in turn, however, was unlikely to occur without a firmcontrol on the part of the monetary authorities.

In order to make such a traumatic transition, a secure external frameworkwas required. The outside world would offer support in the form of resourcesand advice, and would also serve as a disciplinary mechanism of the kindprovided by a borrowing program under the surveillance of internationalinstitutions. There is a fascinating difference in views when the inhabitantsof formerly centrally planned economies express their opinions on the contri-bution to reform made by international institutions. In the pre-reform era,when factional disputes occurred within the administration and the rulingparty about what type of reform could or should be undertaken, outsideagencies, and especially the IMF, played a crucial part as allies of reform-minded administrators, and even, in the later stages, of some political figures.


After the reforms were implemented, when there was a general and wide-spread agreement that little alternative existed to continuing with the reformcourse, this role clearly fell away. Most of the politicians engaged in sustainingthe structural transformation now prefer to minimize the role of externalagencies, and of the IMF. They are right to think that they themselves bearthe ultimate responsibility for making national policy, and that they deserveacclaim for its successes. Most figures in the business world, however, claimthat the existence of a support and control mechanism from the outsideincreases the extent of domestic confidence in the reforms, and thus makesthese more likely to succeed in what may well be very volatile politicalconditions. In this way it provides a critical element in determining thesuccess of the transition.

A further lesson lay in the observation that in halting an inflationaryprocess, and in introducing a price mechanism, some output decline wasunavoidable (see Figure 16-1 ).92 Yet quick adjusters typically faced a lessserious collapse than slow reformers. In addition, slow reforms were muchmore likely to be shaken off course by the political repercussions of theearliest and bleakest moments of the reform. Quick reforms worked best,when supported in the appropriate framework.

There was also another, quite crucial, element necessary in the implemen-tation of reforms, as the most successful reformers had known. Too fewRussians at the turn of the century had supported Witte for his policies tostand much chance of success. Reforms would only work where they weresupported by a broad popular consensus, as in the case of the Polish "shocktherapy" of 1990. When imposed by a government uncertain of its authority,they were bound to fail (as in Poland or the U.S.S.R. in the 1980s), or ifimplemented, to lead to inflation (as in Yugoslavia in the 1980s). But ifthey could not be instituted through government diktat, it was equally futileto think that they might be launched simply on the say-so of a multilateralinstitution. The Managing Director of the IMF, Michel Camdessus, insistedagain and again on this point. Confronted by a statement by President Yeltsinto the effect that Russia would not allow itself to be dictated to by the Fund,he replied that "this shows that Mr. Yeltsin has fully understood how theFund operates." He told an interviewer from Izvestia "We don't imposeconditions on governments. Russia is a great country, but if you were a smallcountry, my attitude would be the same. If a program were to be imposedfrom outside, its chances to be fulfilled, to be implemented, would be minimal.For a program to have its chances, it has to be seen as really the programof the country, elaborated by the country. But, it also has to be credible tothe international community."93


Figure 16-1. Stylized Representation of Crisis, Adjustment, and Reform

Growth

Source: Michael Bruno, "Inflation and Growth in Recent History and Policy:Applications of an Integrated Approach," in Understanding Interdependence: TheMacroeconomics of an Open Economy, ed. by Peter B. Kenen (Princeton, New Jersey:Princeton University Press, 1995).

This reflection provided an appropriate verdict not just on the Russianreform process, but on the whole experience of the aftermath of centrallyplanned economies, and the role of international institutions. To a muchgreater extent than most commentators realized, the pressures to adopt marketsystems, to look at prices as a source of guidance for economic decisions,and to reform the law of ownership, rested on an internal dynamic. It wasless a case of a "Western victory" in an economic war that accompanied theCold War of the strategic planners than of an evolution and adaptation bysocieties that became capable of expressing their own demands and realizingtheir own interests. In this process, however, a substantial amount of externalhelp was required: not only financial, but most importantly the provision ofa disciplinary framework and the supply of technical assistance. This requireda quid pro quo, and in this regard we may learn a lesson of history.


One of the most destructive mistakes of international institutions in deal-ing with many planned economies in the 1970s and 1980s was a reluctanceto appreciate that effective help necessarily depends on the extent of self-realization of the extent of a problem. Such self-analysis on the part of acountry contemplating reform was reflected in the availability (or nonavail-ability) of genuine rather than distorted economic data, to the outside worldbut also to internal decision makers. This issue remained central after thepolitical transformation. After 1989, the process of transition could be re-garded as a particular instance of the implementation of surveillance: movingthe world economy toward openness, currency convertibility, a loweringof protectionist barriers, and, in general, toward the adoption of marketmechanisms, as a result of advice backed by funds. Financing would be madeavailable in case of need, and in response to the soundness of a reformconcept, rather than simply to political desirability.

the transformation of centrally planned economies

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