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Paper prepared for the CEPR Conference on “The Economic Consequences of the East”, held at the Deutsche Bundesbank in Frankfurt/Main, March 20-21, 1992. The views expressed are strictly those of the author. They should not be interpreted as official Fund views. Comments received on an earlier draft from Adrienne Cheasty, Carlo Cottarelli, Manuel Guitian, Richard Hemming, Henri Lorie, Erik Offerdal, Jim Prust, and V. Sundararajan are much appreciated. Tomas Balino was very helpful in directing me to essential material.
Some aspects of this issue have been discussed by the sequencing literature. See, for example, McKinnon (1991).
This discussion does not wish to imply that the market achieves this objective smoothly and optimally. It would be easy to think of exceptions (cobweb situations, monopolies, etc.). It also does not imply that all institutions are created by the spontaneous action of the market. Clearly the government needs to play a significant role in several areas.
This, of course, is one of the reasons for their low productivity.
In Czechoslovakia (1986), the German Democratic Republic (1982), and the USSR (1985), the output of state enterprises was about 97 percent of total output. See Thumm (1991), p. 49.
Some of this non-cash compensation is provided by the government, some by the state enterprises.
Thus the consumption function of individuals would have to include, as independent variables, time as well as income. For a theory that emphasizes the importance of time in consumption, see Tanzi and zee (forthcoming)
For example, enterprises have either not been allowed to keep depreciation funds on their capital assets or the depreciation allowed has been too low. The reason was that investment decisions even for replacement should be made centrally.
For a discussion of the misallocation of savings and resources in Eastern Europe see Easterly (1991), Thumm (1991), and Tanzi (1991a). Over the past decade the incremental capital output ratios for these countries became extremely large. See Thumm (1991), p. 48.
There were hundreds or even thousands of these implicit tax rates. These rates were not legislated and could be changed at the discretion of the planners.
Each enterprise was constrained to have an account in only one branch and to make all payments, except wages which were paid in cash, by checks drawn on that branch.
All wages were paid in cash.
Oral communication to the author.
The fact that the state enterprises were very large and relatively few in number facilitated the task of tax collection.
Since tax evasion did not exist, or was not supposed to exist, in centrally planned economies, there were no laws against tax evasion.
The fall in the tax level in China, Hungary, and Poland in recent years gives empirical support to the statement. It should be added that reducing the level of government revenues and expenditures has also been an important structural goal for the governments in the region in order to reduce the influence of the state in resource allocation.
Given the extremely high investment ratios in these countries, one could argue that they were successful in mobilizing total savings, although “mobilizing” may be the wrong word for the process that took place.
As indicated by the very low growth rates that accompanied the high investment rates.
Actually, if at the same time that individuals have greater access to financial instruments to place their savings they also have greater access to credit to finance their current spending, the net result may not be an increase in the rate of saving. It must be understood that eventually saving by household and private enterprises will need to replace saving by the state.
This does not imply that the government will not play any role in resource allocation. However, that role must be limited to the existence of public goods, externalities, and other conditions that justify government intervention in market economies.
Information on distribution of earnings in Eastern European countries Is provided in Atkinson and Micklewright (1991).
In some of these countries consideration is being given to the distribution to the population of vouchers which would allow them to purchase houses and shares in enterprises. There is still no experience of how well such schemes work.
One strong indication is the payment of reserve requirements with government paper.
For this reason bankruptcy laws are essential.
Thus to some extent state enterprises continue to face soft budget constraints.
This explains how, at times, the fiscal accounts of some countries have been in surplus while they were experiencing high rates of inflation. This has been Yugoslavia’s experience and, to a more limited extent, Poland’s. For a discussion of the experience of Yugoslavia, see Liviatan (1992).
Like large public debts, these contingent liabilities may require higher tax payments in the future.
This also raises questions about the effects of credit restrictions on the economy. To the extent that these restrictions crowd out private sector borrowers before they crowd out state enterprises, they may slow down the process of restructuring and reduce the efficiency of the economy.
In Poland, Hungary, and Russia, new banks have been licensed. While Poland and Russia have pursued liberal licensing policies leading to the creation of many small banks, Hungary has pursued a more cautions licensing policy.
The lack of proper supervision of these new private banks has led to questionable practices on the part of some of them. Unfortunately, the skills needed for proper supervision are still in very scarce supply.
The informal market that I have in mind is similar to the “curb market” that was so important in Korea. The kind of informal market for credit that has been established among state enterprises in the economies in transition (which have been lending to each other) is contributing to distortions and is reducing the effectiveness of credit policy. It is also allowing some of these enterprises to remain in existence.
See Corbett and Mayer for a discussion of this point. However, the question of whether they would have the competence to perform this important function remains.
Because of the interest that it had to pay on the bonds, the Central Bank ran large quasi-fiscal deficits. A very conservative fiscal policy by the government was required to compensate for this fiscal deterioration.
A convinced Ricardian might argue that the increase in public sector debt would be accompanied by an increase in private saving with no effect on the economy. However, given the institutional set up of these countries, even convinced Ricardians might have doubts on the realism of that outcome.
In Czechoslovakia, there is a plan to use the proceeds from privatization to buy out some of the bad debts on the books of the banks.
This is not going to be an easy task since there are great differences between, say, the American view and the European continental view. The economies in transition must at some point choose between these two views of the role of the state.
Of course, some subsidies may be explicit but given outside the budget. Most economists would be against extrabudgetary activities.
For example, it is generally better to give cash to families rather than subsidies through what they buy. But cash transfers may require higher tax revenue and institutions that may not be available in the short run. Implicit transfers can be achieved simply but less efficiently through, say, the overvaluation of the exchange rate or the subsidization of the price of energy.
All the Eastern European countries have plans to introduce value-added taxes by 1993 at the latest. Hungary was the first to do so after a long preparation. Russia and most of the other countries of the CIS have just introduced one, on January 1, 1992, with very little preparation, Bulgaria, Czechoslovakia, and Romania are planning the introduce a value-added tax on January 1, 1993. For a full treatment of value-added taxes in these countries, see Tait’s chapter in Tanzi (1992), pp. 188-208.
For example, nobody knows the impact on various income groups that would result from the bringing of the energy price in Russia to the world level. In fact, in the absence of an equilibrium rate of exchange, it is even difficult to determine what the world price would be in rubles.
For a full treatment of Issues of tax administration, see Casanegra, Silvani, and Vehorn’s chapter in Tanzi (1992), pp. 120-41.
In Hungary, the setting up of a modern tax administration is well advanced since that country started earlier. In other countries only limited progress has been made so far.
The demographic situation in some Eastern European countries is an important continuing factor to the unsustainability of the current social security scheme.
For the connection between high social security taxes and the underground economy, see the chapters by Del Boca and Forte and by Contini in Tanzi (1982).
Whether health expenditure will remain a responsibility of the public sector or is shifted to the private sector is one of the many important decisions to be made regarding the role of the state.
Whether monetary policy should also be used for stabilization remains a controversial issue. The recent recession in industrial countries seems to have promoted once again such a role for monetary policy.
In general, these two policies are less clearly separated in developing countries than in industrial countries. For example, in Latin America, the Central Banks have, in several cases, financed activities that have caused them to experience large quasi-fiscal deficits. The reason is the one mentioned earlier--the less developed are the institutions, the more difficult is the separation of policies.
When fiscal objectives are being pursued through monetary instruments, the fiscal deficit as commonly measured is not as significant a variable as often assumed. In this case, balancing the budget may not necessarily be a worthwhile policy goal.
When the measured fiscal deficit is given great prominence in the negotiation of adjustment programs, there is the danger that countries may be induced to keep the deficit low by perpetuating the recourse to policies that artificially keep the deficit down.
Some observers are urging the government of these countries to assume the debts of the enterprises before privatizing them.
Given the weakness of current fiscal institutions, this may not be the right time to inject this capital in the commercial banks. But waiting will only increase the size of these liabilities. The Chilean solution, which required the Central Bank to assume debt equivalent to about 25 percent of GDP, was introduced when the government was making great and successful efforts to improve the public finances. There must be a firm cut-off date when a Chilean-type solution is contemplated. All debt and financial problems prior to the cut-off date may be alleviated, as long as it is understood that, after the cut-off date, banks face hard budget constrains, and are on their own.
However, by facilitating the financing of the deficit, it might also delay the required adjustment, as it has happened in Italy.