10 YEARS OF CHANGE IN EUROPE

10 YEARS OF CHANGE IN EUROPE

It was just over 10 years ago that Central and Eastern Europe embarked on the unprecedented transformation from communism to capitalism. The process began with elections in Poland in June 1989. It then spread to other countries, led to the fall of the Berlin Wall and the unification of Germany, culminating in the collapse of the Soviet Union two years later, which effectively ended the Cold War.

The subsequent experience of these countries has been mixed and uneven. They can be placed in three groups based on economic performance: the achievers, the strugglers, and the basket cases.The achievers include Poland and Hungary, as well as the Baltic republics and Slovenia. These countries promptly adopted radical reforms (so-called shock therapy). They have shown strong growth, declining inflation, largely stable currencies and diminishing fiscal deficits. They are well advanced in the privatization process. And they have drastically changed the geographical structure of their foreign trade - away from the former Soviet bloc and toward Western markets.

The second group - the strugglers - includes Romania and Bulgaria, as well as the Czech Republic and Slovakia. The first two of these countries embarked on the transformation process much later, while economic reforms were less cohesive than those among the achievers. More recently, they were hurt by the Kosovo war.

The Czech Republic was initially among the best performing countries. It adopted gradualism in its economic reforms (the so-called velvet revolution), which was politically beneficial. However, economically the velvet revolution turned out to be a failure. In particular, the widely publicized total privatization was a fiction, which was compounded by rising trade deficits and a run on the currency, and a subsequent recession.

The third group - the basket cases - includes Russia, as well as Belarus and Ukraine. Russia started the transformation process by adopting the shock-therapy model, but it abandoned it after a few years as the free-market reformers were removed from power, influence of the former communists increased and corruption spread. Privatization turned out to be a sham, with the old communist managerial class calling the shots. This culminated in the financial crisis of August 1998, a massive debt default and political chaos. Only the rise in oil and natural gas prices - Russia's main export items - prevented the country from a total collapse.

The most important obstacles that all countries - including the achievers - encountered over the past 10 years have been political and social tensions, and lack of capital.

Political and social tensions were a logical consequence of the transformation process. Economic reforms were associated with price liberalization, market deregulation, and ending of state subsidies. The result was steep inflation usually followed by recession, cuts in real wages, and rising unemployment.

The immediate effect of the economic reforms was that broad segments of the population were thrown into poverty, while the rapidly growing entrepreneurial class was getting richer. The rising disparities in income and wealth led to envy, resentment and a general stratification of societies. During the 45 years of communist regimes, people lived in egalitarian societies characterized by equality of scarcity. The shops were empty, but they were empty for everybody. Now the shops are full but some people have the money to buy and some don't, and some have more than the others.

The second major problem on the road from planned to market economies is a chronic lack of capital. These are all capitalist countries without capital. It is easy to understand this phenomenon when looking at their history. This is an area that over centuries had been ravaged by wars, revolutions, occupations, expropriations, currency devaluations and other upheavals - events not conducive to accumulation and preservation of private savings.

The shortage of homegrown capital makes these countries dependent on an inflow of foreign capital. Consequently, one of the most important policy priorities should have been creating conditions for attracting foreign capital and building confidence of foreign investors. Countries that understood this truth have thrived.