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Michael Bruno is Professor of Economics at Hebrew University, a Research Associate at the National Bureau of Economic Research, and a former Governor of the Bank of Israel. He holds degrees from Cambridge University and Stanford University. This paper was written while the author was a Visiting Professor at the Massachusetts Institute of Technology and a Visiting Scholar in the IMF’s Research Department. He wishes to thank Massimo Russo and Michael Deppler for initiating this study, and many members of both the European I and Research Departments for helpful discussions and comments on earlier drafts. He is likewise grateful to Olivier Blanchard, Mario Blejer, Kemal Dervis, David Lipton, Stanley Fischer, and Hans Schmitt.
Hungary started its reform process at an earlier stage, and some of the lessons from this experience are of considerable importance. However, the scope of the reform in the other four countries and the speed with which it was initiated have no precedent in a command economy.
It is important to point out that unlike many past cases, IMF programs in Eastern European economies thus far have typically been self-imposed, drastic adjustment programs, to which the IMF has given its blessing rather than having been the primary initiator. (See Table 2 for comparative details of IMF programs in Eastern Europe.)
A more detailed discussion of developments in each country can be found in individual country surveys published by the Organization for Economic Cooperation and Development (OECD) and the IMF (Demekas and Khan (1991) and Aghevli, Borensztein, and van der Willigen (1992)), Recent papers on Hungary (Dervis and Condon (1992)), Poland (Berg and Blanchard (1992)), and Czechoslovakia (Dyba and Svejnar (1992)) were presented at a February 1992 National Bureau of Economic Research (NBER) conference on transition in Eastern Europe.
By 1982 over 50 percent of consumer goods were free of control, the percentage gradually increasing to 80 percent by 1990 and to over 90 percent in 1991. Trade liberalization proceeded more slowly. On the Hungarian economic reform process since 1968, see Boote and Somogyi (1991). For a good account of the more recent economic developments, see the OECD Survey on Hungary (OECD (1992b)).
Also, in Poland the weakening of state control had already started in 1981, with two solidarity-induced laws that gave a measure of autonomy to firms and induced the beginning of a private sector outside agriculture. Poland’s other institutional reforms, however, lagged behind Hungary’s. See Lipton and Sachs (1991).
In an interesting recounting of economic developments in these countries in the precommunist era (Solimano (1991)), Czechoslovakia stands out as having had a prudent macroeconomic tradition. It also had the most developed industrial structure by the time communism took over. Major subsequent development took place in Slovakia, which has undoubtedly had repercussions on Czechoslovakia’s present structural reform process and interrepublican political and social problems.
The average tariff dropped from 18 percent in 1985 to 16 percent during 1986–89 and to 13 percent in 1991. The share of imports liberalized rose from zero to 16 percent in 1989 and 37 percent in 1990, to reach 72 percent in 1991; see Dervis and Condon (1992).
Chile’s 1970 stabilization is the only successful example of the gradualist approach (the trade liberalization, interestingly enough, was done relatively quickly). The social cost, however, was extremely high, and the strategy would probably not be feasible in an open democracy. For a comparative analysis of the stabilization and reform experience in Latin America and Israel, see Bruno (forthcoming, 1993). Fischer and Gelb (1990) were among the first to discuss the phases of reform for Eastern Europe.
Hungary could afford gradualism, because, as noted earlier, its opening up and structural reform process had been going on for much longer—in a sense, since 1968.
This is a convenient reference point because it corresponds to recent inflation rates in the successful stabilizers of high inflation—Bolivia, Chile, Israel, and Mexico. See Bruno (forthcoming, 1993).
An interesting question is whether different initial conditions in the various countries might have led to different relative biases in these price shock estimates.
In Israel this is called the “dentist effect” (because dentists raise their fees by the same rate at which the price of their material inputs rises, even though these inputs comprise only a small portion of the cost of treatment).
In the Polish case, in the initial absence of alternative inflation-immune financial assets, the free market exchange rate reflected a stock demand and far exceeded the relevant purchasing power parity exchange rate. This was the reason the authorities chose a smaller devaluation than initially planned. Ex post it may still have been too high—note that it took a year and a half of substantial inflation until the real appreciation of the exchange rate began to “bite” from a competitive point of view.
There is some doubt about the relevance of the -5 percent projected output drop. According to participants in the planning stage, this estimate had been arbitrary and was not based directly on any of the plan parameters.
This information comes from an unpublished World Bank report based on interviews in 75 state-owned enterprises in September 1991.
A recent estimate by Rodrik (1992) of the ex-U.S.S.R. trade shock, which includes the effect on the terms of trade for Hungary, Poland, and Czechoslovakia, is remarkably close to the numbers appearing in the brackets in Table 3, so they may include terms of trade effects after all. In any case, neither the IMF’s nor Rodrik’s estimates include Keynesian multiplier effects or the effect of aggregate supply curve shifts under wage rigidity (see Bruno and Sachs (1985)).
This is a clear case in which the short-run marginal product of additional infusion of foreign capital inflow is very high. Given excess capacity in complementary factors of production, the marginal GDP product of foreign exchange equals the reciprocal of the ratio of raw materials to GDP.
In the case of the Common Market, it has taken quite a few years to phase out declining industries—for example, coal and steel.
The deficit includes arrears to the nonbank public and unpaid obligations of the government to the domestic banking system. The cash deficit for 1991 is estimated at 5.7 percent.
In theory, once there is positive real growth of GDP, the money supply could be increased, assuming stable velocity, at the rate of real growth. However, this decision had best be left to the discretion of monetary policy and an independent central bank and should not be built in as a potential source of deficit financing. Otherwise, political pressures on the central bank to accommodate a deficit may become ruinous. Recent developments in several of the countries in question bear out the importance of this caveat.
This procedure was followed in Israel in recent major debt-rescheduling schemes for the Histadrut-owned (trade union federation) industrial conglomerate (Koor) and in the settlements belonging to the Kibbutz movement. Both groups were in severe financial straits in the aftermath of the 1985 stabilization programs. The Kibbutz movement’s cumulative debt had reached some 15 percent of total GDP before the financial restructuring plan was implemented. In another group, the Moshav (cooperative) movement, an earlier scheme had to be shelved because of noncompliance and political pressure, and a new one has yet to be instituted.