Economic Reform in Eastern Europe and the U.S.S.R

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Economic Reform in Eastern Europe and the U.S.S.R.

Stanley Fischer

The NBER's research on economic reform in Eastern Europe and the U.S.S.R. is part of its overall project on "The Economics of National Security." Research Associate Olivier J. Blanchard of MIT directs the work on the macroeconomics of stabilization, while Research Associates Kenneth A. Froot of MIT and Jeffrey D. Sachs of Harvard oversee the research on the structural elements of economic reform.

There are no historical examples of economic reform as broad and rapid as what is now envisaged in Eastern Europe. In analyzing the reform processes there and in the Soviet Union, we have had to draw on both theory and the partial reform experiences of other economies. The extent to which simple theory - for example, supply and demand analysis, and intermediate macroeconomics - can illuminate the experiences of the formerly socialist East European economies is impressive. The precedents come from reform attempts in the developing countries, from the reform programs in China, Hungary, and Yugoslavia, and from the industrialized economies, including Britain with its privatization program. However, there is always the question of whether different methods are needed for systemwide reform - such as the privatization of all industry - than for more modest reforms that have been attempted within a market economy.

Now, roughly two years after serious systemwide reforms became a realistic prospect, the early and tentative lessons are beginning to come in.

The Problem

The problem in all the reforming countries is how to transform into a modern western market economy an economy with massive, and sometimes near total, state ownership, which relies to a considerable extent on central planning and pursues international trade on a quasi-barter basis at prices that differ grossly from those in the rest of the world. The social cost must be as low as possible. While there has been much discussion of which is the best western model, the formerly socialist economies have a way to go before having to choose the West German, or the U.S., or some other model.

The reforming economies started from different points. Some, such as Hungary and Yugoslavia, were significantly decentralized; the extent of public ownership differed; and some, such as Poland and the Soviet Union, had developed massive macroeconomic imbalances, visible in large budget deficits and inflation. These differences affect their reform strategies.

The Challenge

Two years ago, the reform process posed several key policy and intellectual challenges: 1) How to shift from a severely distorted price system to a reasonably rational one. 2) How to create functioning markets to replace the planning system. 3) How to privatize. 4) Would it be possible to use the usual macroeconomic methods to stabilize socialist economies? 5) Does reform have to await the creation of a viable banking system? 6) How rapidly can reforms take place?

Tentative Answers

Price Reform

The rational price system for a country that wants to integrate into the world economy is world (relative) prices. World prices can be imported through a convertible currency, with low and uniform tariffs. With current account convertibility, imports are available at world prices, and exporters can earn world prices for their products. Then, given the exchange rate, international competition forces domestic producers to sell at world prices and, by allowing domestic producers to sell abroad, ensures that goods will not be sold in the domestic market below world prices.

Thus, price reform does not require an elaborate process of decontrol in which economic policymakers try to guide prices to the proper levels - the process can be left to the international markets. The early evidence also suggests that price reform can take place rapidly. Convertibility can be put in place at the start of the reform process, as it was in Poland, at an exchange rate that is consistent with balance-of-payments equilibrium. …