The Economic Transformation of Eastern Europe: The Case of Poland - Comment

By Zajicek, Edward K.; Heisler, James B. | American Economist, Spring 1995 | Go to article overview

The Economic Transformation of Eastern Europe: The Case of Poland - Comment


Zajicek, Edward K., Heisler, James B., American Economist


In a recent article for The American Economist, Jeffrey Sachs (1992) provides a review of Poland's economic reform and prospects for the future. In this article, Sachs argues that despite some shortcomings, the comprehensive economic reform package introduced in 1990 ". . . has had a profound beneficial effect on the Policy economy." Both economic theory and empirical evidence, however, suggest that this conclusion is too optimistic. This paper analyzes Sachs' statement in the light of Poland's economic performance during the first three years of transition to capitalism. It focuses on the real economic impact of privatization, free trade policy, and macroeconomic stabilization measures.

In the beginning of January, 1990, the Solidarity-controlled government introduced bold measures to reform the economy. Rather than introduce reforms gradually, the Polish government decided to opt for shock therapy and a rapid pace of market reforms. This program called for a free price system, drastic cuts in subsidies, a free trade policy, convertibility of currency based on a fixed rate of exchange, wage controls, a balanced budget, and elimination of "easy" credit to state enterprises.

Following the Polish example, similar measures have been adopted in many countries of Central and Eastern Europe. The governments of these countries and their economic advisors (both foreign and domestic) share the belief that market forces are powerful enough to do most of the necessary economic restructuring. It is also believed that private property is essential to the process of market development. Convertibility of currency and a free trade policy would allow these economies to replace the artificial price system, based on arbitrary decisions of the central planner, with world prices. This, according to Sachs and Lipton (1990), ". . .would immediately create domestic competition as well as a realistic structure of prices that would mimic that of Western Europe." Privatization, on the other hand, is necessary for the development of "a real competitive market." In short, if prices are freed, the economy privatized, free trade allowed, and subsidies to state enterprises eliminated, the price mechanism and real competition will automatically develop. This will cause the supply effect to emerge and an increase in production (from the same amount of economic resources) will take place. In addition, the price mechanism will generate a competitive environment in which efficient firms will prosper but unprofitable companies will have to cease their operations. The market, guided by an "invisible hand," will do much of the economic restructuring.

In his article, Sachs writes that "Poland has made it more than half-way through the reform process needed to transform itself into a market economy. The price system now works according to supply and demand; international trade is free, and as hoped, both exports and imports are rising, new private firms are forming and growing at a rapid rate." This all has happened indeed, but the cost has been incredibly high, perhaps too high to justify the "shock" approach advocated by Sachs. The first two years of economic reforms in Poland were characterized by a very deep recession.(1) As compared to 1989, GDP fell by almost 20 percent, industrial production by 35 percent, real wages by almost 25 percent, and the official unemployment rate increased from 0 to over 11 percent of the labor force.(2) Investment expenditure, which started to decline in 1989, fell by 10 percent in 1990 and by an additional 4 percent in 1991. The rate of inflation (CPI), which during the period of 1985-1988 was running at an average rate of 28.4 percent a year, reached hyperinflationary levels by the end of 1989; in 1990 the rate of inflation was 586 percent. In 1991, despite harsh anti-inflationary measures administered by the stabilization program, inflation was running at about 70 percent, which was two and a half times the average rate experienced in 1985-88. …

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