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Working Paper Summaries (WP/92/1 - WP/92/47)
Article

“Stabilization and Reform in Eastern Europe: A Preliminary Evaluation”

Author(s):
International Monetary Fund
Published Date:
August 1992
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The paper examines the lessons that can be learned from the stabilization and price reform programs adopted with IMF support in five Eastern European countries—Hungary, Poland, Czechoslovakia, Bulgaria, and Romania—during 1990 and 1991. While the paper addresses common issues, it also discusses variations in performance, particularly if these reflect disparities in initial conditions. Unlike Hungary, which had already made considerable strides in the reform and opening-up of its economy, Bulgaria, Czechoslovakia, and Romania followed the earlier “big bang” approach of the 1990 Polish program. That is, besides following the “heterodox” approach to stabilization (as Israel and Mexico had in earlier programs), their programs were also very far-reaching and ambitious in their attempts to move quickly from the initial production equilibrium of the old system to the desired market-based productive structure.

The initial stabilization results have been impressive, although the price shock has turned out to be larger than expected, occasionally leading to inflation persistence. Likewise, in some cases, the balance of payments improvements may be transitory rather than permanent. Moreover, a fiscal problem has emerged within a year of the start of all programs because of the erosion of the enterprise profit tax base and increasing social pressures on the expenditure side.

The main surprise to policymakers and to the initial IMF forecasts has been the sluggish response of the productive system to the new price and incentive signals. The collapse of the Council for Mutual Economic Assistance led to a massive decline in output in almost all countries, but the contraction of internal demand and supply also helped to depress economic activity. The response on the supply side may, in turn, be related to the slow speed of structural adjustment and to the sluggishness of the privatization effort—both crucial to the timing of the output and employment rebound.

In this connection, the analysis suggests that price and exchange rate levels can be stabilized relatively rapidly. The adjustment of the production structure and of investment and ownership patterns to sharp changes in relative prices is of necessity much slower. Moreover, market failure may persist for a while, raising the vexing problems of sequencing and the need for residual government involvement in the transitional stage. In this context, issues relating to the financial fragility of the enterprise and banking systems as well as to the appropriate production, trade, and financial regimes for state-owned enterprises during the transition are also discussed.

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