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Mitchell A. Orenstein is Assistant Professor of Political Science, Syracuse University.

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Out of the Red

Building Capitalism and Democracy in Postcommunist EuropeBy Mitchell A. Orenstein

University of Michigan Press

Copyright © 2001 Mitchell A. Orenstein
All right reserved.
ISBN: 9780472097463
Strategies for Transformation

The danger does not lie with the masses, as is believed by people who stare as if hypnotised down into the depths of society. The deepest core of the socio-political problem is not the question of the economic situation of the ruled but of the political qualifications of the ruling and rising classes. The aim of our socio-political activity is not to make everybody happy but the social unification of the nation, which has been split apart by modern economic development, and to prepare it for the strenuous struggles of the future.

?Max Weber 1994, 26

Poland?s goal is to be like the states of the European Community. Although there are many submodels within Western Europe, with distinct versions of the modern welfare state, the Western European economies share a common core of capitalist institutions. It is that common core that should be the aim of the Eastern European reforms. The finer points of choosing between different submodels?the Scandinavian social welfare state, Thatcherism, the German social market?can be put off until later, once the core institutions are firmly in place.

?Jeffrey Sachs 1993, 5

Governments that came to power in 1989 in East Central Europe had to develop ?strategies for transformation? that addressed the central problem they faced of building capitalism under conditions of political democracy. Throughout the postcommunist countries, the most influential strategy, in both its economic and political dimensions, was the ?neoliberal? strategy, often called ?shock therapy.? Neoliberal strategy for transformation emphasized the importance of establishing basic economic reforms to promote growth and market rationality in the face of democratic interest group opposition. It proposed to create free markets, free trade, and a stable monetary environment quickly before such political opposition could emerge. The neoliberal strategy for transformation was widely debated in postcommunist Europe and criticized in some circles for posing a threat to democracy. These critics generally argued that shock therapy?s single-minded pursuit of economic reform endangered support for and development of democratic institutions. They recommended that governments should instead pursue more cohesion-oriented strategies that would compensate reform losers and tie the interests of a broader cross-section of the population into the reform effort. This chapter explores both theoretical positions and the conflict between them that unfolded over the period 1989?99. This provides an important background to the study of actual governmental strategies for transformation in Poland and the Czech Republic since 1989, because these theories often deeply influenced practitioners of reform.

Neoliberal Economic Blueprint

In both Poland and the Czech Republic, neoliberal economic blueprints were deeply influential for the project of building capitalism. Neoliberal economic programs proposed for postcommunist Europe drew heavily on previous applications of the so-called Washington consensus on economic policy in countries around the world (Williamson 1990, 1997; Namm 2000). Despite some obvious peculiarities of the postcommunist countries, leading neoliberal economists quickly came around to the view that postsocialist economies would respond favorably to the same basic package of stabilization and liberalization measures normally applied elsewhere in the developing world (Blanchard et al. 1991, 1). According to a short book coauthored by Olivier Blanchard, Rudiger Dornbusch, Paul Krugman, Richard Layard, and Lawrence Summers in 1991 that I take to represent a consensus statement of ?the mainstream of modern Western economics? (as claimed on the back jacket), two features distinguished the postcommunist countries from others. First, the distorted price structure of socialism was expected to result in ?larger changes in relative prices, income distribution, and firms? financial positions than is typically the case during stabilization? (Blanchard et al. 1991, 2). Second, the different institutional and ownership structure of the former socialist firms was expected to cause them to adjust differently than in traditional market economies. Under socialism, most enterprises were state owned and responded more to administrative decisions of the responsible ?line? ministries than to price signals or market demand. For this reason, rapid privatization became a major priority of neoliberal reform, along with macroeconomic stabilization and price and trade liberalization.

Neoliberal economic reform programs consisted of three basic elements: stabilization, liberalization, and privatization. The logic of stabilization and liberalization derives from the equilibrium theory that lies at the heart of neoliberal economics, combined with the monetary theory of inflation. Since inflation is caused mainly by monetary expansion, neoliberals prescribed a stabilization package that would cut fiscal deficits, stem monetary growth, and eliminate price-distorting subsidies to public enterprises (Blanchard et al. 1991, 5). Simultaneous price and trade liberalization would cause prices to quickly adjust to equilibrium levels, under a sustainable macroeconomic regime. Accurate price signals, once attained, would cause economic actors to adjust their behavior spontaneously to market rationality (Johnson and Loveman 1995).

However, recognizing that stabilization and liberalization would at first cause an initial bout of inflation, neoliberal economists counseled reliance on stiff tax-based wage controls, to prevent incomes from catching up with prices (Blanchard et al. 1991, 7). In employing wage controls, neoliberals departed from the free market prescriptions of their orthodox liberal forebears. Their reliance on these so-called heterodox techniques, including state intervention to control the price of labor, is part of what marks them as ?neoliberals.?

Neoliberal economists expected their reform program to be particularly painful in the postcommunist context, but they felt that there was ?no way to avoid this outcome? (Blanchard et al. 1991, xiii). Stabilization and liberalization would sharply reduce average real wages in the economy over the medium term. Unemployment rates would rise as enterprises shed labor in an effort to enhance productivity. But these social costs of adjustment had to be paid, and the quicker the better. The process of transition from communism to capitalism was envisioned as a process of creative destruction, like all innovation (Schumpeter 1942; Havrylyshyn and McGettigan 1999b).

Since they expected state-owned enterprises to adjust less quickly than private firms might to market signals, neoliberal economists strongly recommended rapid privatization (Blanchard et al. 1991, xiv). Neoliberal economists also recognized other institutional changes would have to be made, summed up in the rubric of ?restructuring.? Within restructuring, Blanchard et al. included transforming the banking and financial system; creating conditions for foreign investment; reforming the legal system, particularly commercial law; creating a market in housing to insure labor mobility; and promoting training in core capitalist professions, such as law, accounting, and finance (Blanchard et al....