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

Transition Economies and Foreign Trade

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

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

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

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

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

Transition Economies and Foreign Trade Jan Winiecki

London and New York

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

2002048568

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

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

Contents

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

vii ix 1

6

2 Foreign trade adjustment in early transition

39

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

61

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

94

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

118 137 144

Illustrations

Figures 1.1 1.2 3.1

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

11 15 70

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

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

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

viii Illustrations 3.2 3.3 3.4 3.5 3.6 5.1 5.2 5.3

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

69 72 74 83 87 119 120 125

Acknowledgements

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

Introduction

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

2

Introduction

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

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

4

Introduction

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

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

1

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

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

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

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

8

The legacy of the communist past 7DEOH +LJKUHVRXUFHLQWHQVLW\RIFRPPXQLVWHFRQRPLHVLQFRPSDULVRQ ZLWK:HVWHUQHFRQRPLHVWKHFDVHVRIHQHUJ\DQGVWHHO &RXQWULHV

(QHUJ\LQWHQVLW\LQNJ RIFRDOHTXLYDOHQWSHU 86

6WHHOLQWHQVLW\LQNJRI VWHHOFRQVXPSWLRQSHU 86

&RPPXQLVWHFRQRPLHV %XOJDULD &]HFKRVORYDNLD *'5 +XQJDU\ 3RODQG 8665

     

     

:HVWHUQHFRQRPLHV  $XVWULD %HOJLXP 'HQPDUN )LQODQG )UDQFH *HUPDQ\ ,WDO\ 1RUZD\ 6ZHGHQ 6ZLW]HUODQG 8.

          

          

1RWH,Q86GROODUVGDWDIRURU 6RXUFH:LQLHFNL 

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

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

10

The legacy of the communist past

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

The legacy of the communist past 11

Figure 1.1

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

Source: Winiecki (1988).

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

12

The legacy of the communist past

7DEOH 6KDUHVRIHQJLQHHULQJLQGXVWULHVLQPDQXIDFWXULQJRXWSXWLQ VHOHFWHGFRPPXQLVWPLGGOHGHYHORSHGDQGPDWXUH:HVWHUQ HFRQRPLHVLQDQGLQ

&RXQWU\

(QJLQHHULQJLQGXVWULHV 



  

  

0LGGOHGHYHORSHG:HVWHUQHFRQRPLHV ,UHODQG  6SDLQ  *UHHFH 

  

0DWXUH:HVWHUQHFRQRPLHV  $XVWULD 6ZHGHQ 1HWKHUODQGV *HUPDQ\

   

&RPPXQLVWHFRQRPLHV  &]HFKRVORYDNLD +XQJDU\ 3RODQG

  

6RXUFH:LQLHFNLDQG:LQLHFNL 

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

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

14

The legacy of the communist past

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

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

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

Figure 1.2

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

Source: Chenery and Syrquin (1975).

16

The legacy of the communist past

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

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

18

The legacy of the communist past

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

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

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

20

The legacy of the communist past

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

)RRG 5DZPDWHULDOV H[FOIXHOV )XHOV &KHPLFDOV (QJLQHHULQJ JRRGV 2WKHU PDQXIDFWXUHV D

(DVWERXQGD

$JJUHJDWH

:HVWERXQG

'HYHORSLQJ

 

 

 

  

 

  

  

  

   

  











([FOXGLQJWKH8665EXWLQFOXGLQJWKHIRUPHU*'5

6RXUFHV 9DULRXVLQWHUQDWLRQDOVWDWLVWLFV

8665

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

22

The legacy of the communist past

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

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

24

The legacy of the communist past 7DEOH ([WUDFWLYHLQGXVWULHV¶VKDUHVLQDJJUHJDWHLQGXVWULDOVHFWRU¶V HPSOR\PHQWLQVRPHFRPPXQLVWDQG:HVWHUQPDUNHWHFRQRPLHV DQGLQ &RXQWULHV





&RPPXQLVWHFRQRPLHV %XOJDULD &]HFKRVORYDNLD +XQJDU\ 3RODQG 8665

    

    

   

   

 

        

0LGGOHGHYHORSHG:HVWHUQHFRQRPLHV  *UHHFH ,UHODQG 3RUWXJDO 6SDLQ 0DWXUH:HVWHUQHFRQRPLHV  %HOJLXP )LQODQG )UDQFH *HUPDQ\ ,WDO\ 1RUZD\ 6ZHGHQ 8. 86$

     

6RXUFH:LQLHFNL 

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

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

26

The legacy of the communist past 7DEOH 5HODWLYHXQLWNLORJUDP SULFHVRIHQJLQHHULQJJRRGVH[SRUWHG IURPFRPPXQLVWFRXQWULHVREWDLQHGLQ((&PDUNHWVLQ± SULFHVREWDLQHGE\DOOH[SRUWHUVRQ((&PDUNHWV  &RXQWULHV











%XOJDULD &]HFKRVORYDNLD *'5 +XQJDU\ 3RODQG 5RPDQLD 8665 &RPPXQLVWHFRQRPLHV ZHLJKWHGDYHUDJH

      

      

      

      

      











1RWH*'5UDWLRVZLWKRXWLQWUD*HUPDQWUDGHWKDWZRXOGORZHUWKHUDWLRVVWLOOIXUWKHU 6RXUFH:LQLHFNLDQG:LQLHFNL 

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

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





(QJLQHHULQJ &KHPLFDOV 7LUHV 3XOSDQGSDSHU *ODVVDQGJODVVSURGXFWV )XUQLWXUH 7H[WLOHV &ORWKLQJ

       

       

6RXUFH:LQLHFNLDQG:LQLHFNL 

28

The legacy of the communist past

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

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

The legacy of the communist past 29 1

2

3

4

5

6

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

30

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

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

•

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

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

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

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

32

•

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

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

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

•

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

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

34

The legacy of the communist past

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

 



 



6SDLQ 

    

  



     

   



6RXUFHV/DHQGHUEHULFKWH6WDWLVWLVFKHV%XQGHVDPWYDULRXV\HDUV

6HOHFWHGKHDY\LQGXVWULHV 3DSHUDQGSURGXFWV ,URQDQGVWHHODQGSURGXFWV &KHPLFDOV 0DFKLQHU\DQGHTXLSPHQW 0RWRUYHKLFOHV 3UHFLVLRQLQVWUXPHQWV

6HOHFWHGOLJKWLQGXVWULHV 7H[WLOHV )RRWZHDU &ORWKLQJ  )XUQLWXUH

,QGXVWULHVFRXQWULHV

 







  

 





   











,UHODQG 











3RUWXJDO 

 







 

 







7DEOH &KDQJLQJH[SRUWVWUXFWXUHVRIPLGGOHGHYHORSHGHFRQRPLHVFDVHVRI6SDLQ,UHODQGDQG3RUWXJDOLQGLIIHUHQWSHULRGV DQG*13OHYHOVSHUFDSLWD VKDUHVLQRIWRWDOH[SRUWV

36

The legacy of the communist past

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

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

38

The legacy of the communist past

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

2

Foreign trade adjustment in early transition

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

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

40

Foreign trade in early transition

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

Foreign trade in early transition

41

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

42

Foreign trade in early transition

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







%XOJDULD &]HFK5HSXEOLF +XQJDU\ 3RODQG 5RPDQLD 6ORYDNLD

 ±D E E  ±DF

 D    ±F

     ±F

1RWHV,QFXUUHQWSULFHV D 'DWDFDOFXODWHGVHSDUDWHO\IRUWKH&]HFK5HSXEOLF¶VSDUWRI&]HFKRVORYDNLD E 'DWDIRU D 7KHGDWDLQWKHPDLQVRXUFHDSSHDUWRRXQUHOLDEOHWREHSUHVHQWHGLQWKHWDEOH 6RXUFH(%5'7UDQVLWLRQ5HSRUW

Foreign trade in early transition

43

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

44

Foreign trade in early transition

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

2

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

Foreign trade in early transition

45

7DEOH 6HOHFWHGFRPPXQLVWHFRQRPLHVUDWLRRILQYHQWRULHVWR*'3 &RPPXQLVWHFRQRP\