Can Fast-Track Reforms Fix Broken Economies?

FROM MARX TO MARKETS

NOT long ago, Warsaw was a drab city, full of decaying concrete, peeling paint -- and empty stores.Today, the streets are lit up with signs and window displays. Well-dressed shoppers flock to elegant boutiques stocked with Christian Dior perfume and Valentino shoes. Glistening showrooms offer ruby-red Mercedes and ice-blue Porsches. Even simple grocery stores have installed fancy gourmet counters featuring French fromage. Far into the night, workers hang shelves and paint away the drabness of four long decades of communism. The change came suddenly. On Jan. 1, 1990, Poland's Solidarity government executed a monetary Big Bang. By freeing prices, putting strict limits on wage increases, and imposing strict monetary discipline, the worthless zloty was transformed into a hard currency, convertible into marks, pounds, or dollars. Trade barriers were lowered and the doors opened to foreign investors. And all this not even a year after the Communists legalized the Solidarity opposition. But today, the dramatic success is endangered. Inflation remains dangerously high, and unemployment is rising rapidly. A series of banking and corporate scandals have rocked the reform-minded Polish government. Parliamentary elections are scheduled for Oct. 27, and reformers worry that the vote will produce a coalition government that lacks the strength to cope with the upheaval of converting communism to capitalism. As the campaign got under way, a key adviser to Finance Minister Leszek Balcerowicz, the architect of the ambitious Big Bang program, commented: "We fear the campaign will be emotional and destructive. It will be framed, 'Are you for or against economic reform? The answer is crucial, not only for Eastern Europe, but for the giant Soviet Union as well. Poland and its two fellow reformers, Czechoslovakia and Hungary, are test cases of how to create a market economy. East Europe is showing that it is possible to fill empty stores with goods and inject new energy into obsolete state-run economies -- even without the huge levels of foreign aid that the Soviet Union is seeking. But Eastern Europe also shows just how daunting the task ahead is. Oversized state enterprises must stop churning out unwanted products. If viable, they must be privatized; otherwise they must be cut back or even closed. This giant structural change must be accomplished while absorbing huge external shocks. Trade within the old Soviet bloc has collapsed and pessimists worry that millions could lose their jobs and that overall industrial production could shrink by as much as a half from 1989 levels. In 1990, Poland's gross domestic product (GDP) -- the total output of goods and services -- fell by 12 percent from 1989, and its industrial output by 29 percent, according to figures from the Organization for Economic Coopera tion and Development. Hungary's GDP dropped by 3 percent, as did Czechoslovakia's, and the declines are expected to continue this year.

Private sector surges ahead Yet, as the booming Warsaw streets suggest, everything is not gloom and doom. Before their Big Bang, Poles spent hours in queues. Goods at subsidized prices actually were not available at any price. Life costs more today but the queues are gone -- a tremendous increase in the quality of life. Most important, the new rules liberated private enterprise. At the end of 1989, private owners produced an estimated 8 percent of Poland's GDP. A year later, the official tally was 13 percent. The real figure could be much higher, because many entrepreneurs are less than honest with the tax man. Some economists estimate that private business now accounts for as much as 35 percent of all production. The private-sector boom has cushioned the slowdown in production at state firms. Where private enterprise has taken root, it is becoming the unofficial safety net for thousands of workers. At least one-third of the 1.2 million Poles laid off last year were hired by private companies. "We're seeing a miracle of private initiative," says Janusz Lewandowski, Poland's privatization minister. "Because we first jumped into this water of free pricing, what happens here is important for all of Eastern Europe."

No more gradualism For years, reform-minded East Europeans aimed to create a "social market economy," introducing the prosperity and efficiency of capitalism while retaining the social benefits of communism. The switch to a market-oriented economy, it was theorized, could be made step-by-step, with minimal pain and dislocation. That gentle tack now has been rejected, blamed for leading to the type of chaos provoked in the Soviet Union by Mikhail Gorbachev's perestroika (restructuring). East Europe's reformers don't want to fix the creaky communist system; they want to sweep it away. Following the Polish lead, Hungary and Czechoslovakia have embarked on ambitious reform programs, and even the less developed Balkan states, Romania and Bulgaria, have introduced "baby bangs." "We've learned that there is no third way between capitalism and communism," explains Ivan Lipovecz, editor of the Hungarian economic weekly HVG. "There's only capitalism."

Social consensus needed Whenever the old communists tried to raise prices - the essential ingredient of economic reform - they were rocked by labor unrest. Lack of popular support and fear of a social explosion explain much of the failure of President Gorbachev's economic reforms. In contrast, most East Europeans so far have put up with the higher prices, factory closures, and social strains. Why? One reason is that until now their democratic governments have enjoyed an unusual legitimacy. The communists were imposed from outside, sustained in power by the Kremlin. Today, East Europeans hold their future in their own hands. If there is hope for the Soviet Union, it is that its revolution will produce the same social cohesion as that in Eastern Europe, perhaps under an energetic le ader such as Boris Yeltsin. "From the beginning it was obvious that the transformation will have social costs - the bankruptcy of big factories and little nonprofitable farms," explains Adam Michnik, editor in chief of the Polish daily Gazeta Wyborcza. He says the plan's success depends on "a big social consensus." The danger is that the powerful social cohesion that launched the reforms could collapse. Post-revolution blues, some observers fear, could unleash destructive ethnic nationalism, as has occurred in Yugoslavia. Recently, riots in Romania by miners angry over price increases forced Prime Minister Petre Roman to resign. Surprisingly, reformers argue that the answer to this anger and impatience is faster, not slower, transition to a market-based economy. To succeed, change will have to be fast enough to create a constituency in favor of the new system. That's why officials throughout Eastern Europe are scrambling to speed privatization and create financial institutions. Until recently, the sell-off of state companies was stalled, as officials agonized over accurate pricing. Now, Hungary, Czechoslovakia, and Poland have decided to pursue simpler methods to sell thousands of state enterprises by year-end. "We have to go very, very fast, because we are creating the market itself," explains Tomas Jezek, Czech privatization minister. "The British privatized in the ocean of market and ocean of private property already existing. We don't have that luxury."

Trade barriers pose threat Signs are appearing that the supposedly fragile East European economies are able to fend for themselves in world markets. In 1990, Polish exports to the West jumped by an amazing 45 percent, creating a $4.7 billion trade surplus. Hungary's exports soared 35 percent for a $950 million surplus. As they break into Western markets, however, the East Europeans are colliding with high tariffs and import restrictions designed to shield industries from foreign competition. Quotas prevent Hungary from selling much of its bountiful harvest to Western Europe, Czechoslovakia from exporting its cheap steel, and Poland from unloading its inexpensive textiles. "I see tens and tens of foreign visitors and they always ask, what can the West do?," asks Ivan Svitek of Czechoslovakia's Finance Ministry. "I always say, 'What about trade?' The reaction is always 'No.' Right now there are quotas on trade, textiles, agricultural products in the EC and in the United States."

Pressure on EC The failed Soviet coup could lead to unexpected help. In order to stabilize the fragile new democracies, the European Community (EC) has pledged to move faster toward granting former Soviet allies some kind of associate membership - including free trade. "We can no longer make nice declarations about freedom in the East on Sunday and not come up with the necessary commercial concessions on Thursday," says Jacques Delors, president of the EC Commission. The dangers are clear. If Eastern Europe's economies are not given breathing room, the pain of reform will become unbearable. Already Hungarians smirk, "We pay Swedish taxes and receive Albanian wages."

'More and more difficult' "It's getting more and more difficult, so I have to come here every day and look around and find the cheapest things," complains Lajosne Buki, a shopper in an open-air market in Budapest. "I can only survive if I buy the cheapest." Workers at the former Lenin Shipyard in Gdansk, site of the Solidarity trade union's strike against Poland's communist regime three years ago, are just as angry. While private entrepreneurs have benefited from reforms, they have not. "I am frightened; I am dissatisfied. All the older workers are," says 46-year-old welder Jan Kozlowski. "We hoped it would be better, that things would change. But for us, so far it hasn't." While fear for the future is widespread, few look back nostalgically to the old communist days. Most East Europeans realize that this is a historic opportunity. For decades, their small nations were squeezed by their neighbors, first by Nazi Germany, and then by Soviet communism. Now the last Soviet troops are leaving, and Germany is a prosperous democratic partner. The Eastern nations' models are clear: their prosperous capitalist neighbors. Eastern Europe has the ultimate goal of joining the great West European Common Market. "Eastern Europe isn't going to collapse," predicts a confident Jiri Dienstbier, Czech foreign minister. "We are at the center of Europe - and we are determined to succeed."