The collapse of output in Eastern Europe after the implementation of the recent economic transformation programs has greatly exceeded expectations. The basic view presented in this paper is that a large proportion of the fall in output can be explained by “trade implosion”: a situation in which trade is destroyed for lack of market institutions not simply as a consequence of textbook changes in relative prices or movements “along transformation frontiers.” The trade implosion view is relevant for explaining the collapse of both domestic and international trade (particularly trade among countries that belonged to the Council for Mutual Economic Assistance, or CMEA) and ultimately some part of the collapse in output.
We single out the credit market as one of the key underdeveloped institutions in Eastern European economies. We advance the hypothesis that the fall in output associated with monetary contraction may be significant when credit markets are underdeveloped. The conjecture that credit contraction may partly explain the output decline is examined for the cases of Bulgaria, Czechoslovakia, Hungary, Poland, and Romania, with special reference to Poland. Although results are highly tentative, we show that the credit hypothesis cannot be dismissed out of hand. On the contrary, statistical analysis for the case of Poland suggests that at least 20 percent of the output decline, during the first quarter of the stabilization program, can be attributed to the initial credit contraction.
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)| false “Output Decline in Hungary and Poland in 1990/91: Structural Change and Aggregate Shocks,” Commander, Simon, and Fabrizio Coricelli, paper presented at the conference on Macroeconomic Situation in Eastern Europe, held jointly by the International Monetary Fund and World Bank in Washington, June 4– 5, 1992.
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It should be noted, however, that incomes policies have also been tried in RCPEs, so they cannot be listed as a major innovation of PCPEs.
It should be noted that in CPEs interenterprise credit was forbidden by law.
This is a very partial account of the inflationary mechanism in RCPEs. As pointed out by Blejer and Szapari (1989) and Kopits (1991), for example, RCPEs tend to develop higher fiscal deficits under reform policies than under strict central planning because of the greater difficulty of collecting taxes in a more decentralized environment. This point has been further developed by McKinnon (1991).
Under the present assumptions, the real interest rate would also be zero.
Notice that in Table 1 we deflate credit by the producer price index, which likely underestimates the increase in input prices (the relevant prices for estimating B/Pt).
Furthermore, Table 2 assumes that previous liquidity-sales ratios, or output ratios, reflect normal liquidity needs and thus apply to the period after the transformation programs were implemented.
It should be noted that this fall in inventories in Czechoslovakia is an estimate by the authors. It was calculated by assuming that the revaluation of the stock of inventories on January 1, 1991, does not include January inflation.
In Czechoslovakia, firms were taxed on capital gains independent of whether inventories were actually spent on production. It is estimated that revenue from this tax amounted to about 3 percent of GDP in Czechoslovakia and to more than 10 percent of GDP in Poland. See Barbone (1992).
It is an open question whether the after-reform positive association between bank and interenterprise credit persisted after the first quarter of 1990.
It is worth noting that—in contrast with the sharp declines in the other four countries—real wages in Hungary increased by about 2 percent during 1990.
For Bulgaria, Czechoslovakia, Poland, and Romania, wage behavior partly explains the high profitability of enterprises given large increases in nonlabor input prices. However, the share of wages in total costs is relatively low in these countries, which are characterized by high energy and material intensity of production processes. Consequently, the liquidity that can be generated by borrowing from the workers is limited.
Credit dependence is measured by the ratio of bank credit for working capital to total costs.
Regressing proportional wage changes against the proportional credit increase for 85 branches of industry in Poland (as described in the following section), we obtain a credit coefficient equal to 0.33, with a t-statistic equal to 1.9.
This would be the proper deflator if input prices were highly correlated with output prices.
The equations were estimated using a two-stage least squares method and 85 observations. The instruments used were the constant and the ratio of bank credit to sales in 1989:4. A linear version of this equation is reported in Berg and Blanchard (1992). Using the same sample, they show that point estimates predict a negligible (although statistically significant) effect of credit on output. However, the linear restriction is not warranted by the underlying model that is being tested (see Calvo and Coricelli (1992a, 1992b)).
This would be the proper procedure if input prices across sectors rose at about the same rate.
The collapse of the CMEA could also be seen as partly reflecting the absence of credit markets across Eastern Europe and the former Soviet republics. Thus, one possible way to help CMEA trade recover (but not necessarily domestic trade) would be to expand international credit—an outcome that requires the cooperation of all countries concerned.
For the sake of brevity, the following discussion stays away from structural issues like privatization and the cancellation and socialization of enterprise debt, which are discussed in Calvo and Coricelli (1992b) and Calvo and Frenkel (1991a, 1991b).
See Calvo and Coricelli (1992b) for an application of this argument to Poland in the second half of 1990.
In the case of imported inputs, the increase in the domestic price can be contained by limiting the size of the initial depreciation of the exchange rate. This is relevant for countries like Czechoslovakia and Poland, which have adopted exchange-rate-based stabilization programs. The case for a smaller initial price shock, including initial depreciation, is argued by Bruno (1992).
That such anachronistic pricing rules were in force in the early stages of programs is argued by Lane (1991), Blanchard and Layard (1991) for the case of Poland, and Lipton and Sachs (1992) for the case of Russia.
Argentina in the early 1980s is a case in point. In 1976, Argentina’s authorities announced a gradual phasing out of import subsidies. The program was discontinued in 1981, and tariffs remained high until recently.