After half-hearted economic reforms in the early 1980s, the rise of
Solidarity (which had been outlawed in 1982) proved that major systemic and structural reform was necessary. Even so, and despite the fact that Polish economic performance was deteriorating badly, serious economic reform did not begin until the late 1980s.

3) The Polish Transition: The "Big Bang" in Practice

The Polish transition from plan to market has been watched closely by a variety of interested observers. Although many of the policy and systemic changes introduced in Poland are familiar hallmarks of the general reform scene, the speed of implementation in the Polish case is unique.

There had been attempts to decentralize decision making in large state- owned Polish enterprises in the 1980s, but these reforms failed to change outcomes (a possible exception is their contribution to the wage explosion that took place toward the end of the decade). Moreover, on the eve of reform in Poland (the reform program began officially on January 1, 1990), macroeco-nomic conditions there were in a state of severe disequilibrium.
Although the exact nature of monetary overhang in Poland (as elsewhere) has been the subject of debate, there was a significant budget deficit, wage increases were out of control, and hyperinflation had resulted. Poland's hard-currency debt position was better than that of Hungary, but the debt that had been accumulated did little to stimulate the Polish economy, the zioty was overvalued, and no debt relief from external sources was in sight.

In the fall of 1989, most price controls were lifted (on both producer and consumer goods), public spending was reduced, and the zioty was devalued. In the second stage of major reform, begun in 1990, the budget deficit was sharply cut, largely through a reduction of subsidies to state enterprises. A positive real rate of interest was to be implemented, and the market was to be used to signal changes in the value of the zloty. The latter was a critical measure, because foreign trade and the impact of this trade on the Polish industrial structure was to be a key component of the overall reform strategy. In January of 1990, the government set the exchange rate of the zloty at 9500 to the dollar (this represented a devaluation from 1989), a rate roughly approximating its value on the black market, and it established convertibility of the zloty for international trade. Many trade restrictions were eliminated, and internal exchanges were set up to handle the buying and selling of hard currencies. Although these changes resulted in domestic inflation, the initial increases proved to be short-term and the exchange rate of the zloty has proved to be realistic.

Finally, wage increases were to be controlled partly through wage indexation and partly through a new tax on wage increases that exceeded established guidelines.

Privatization is a major element of the Polish strategy of transition.
In 1990 the Polish government passed a law creating a Ministry of Ownership
Change, a mechanism to supervise the process of privatization.
Privatization has proceeded rapidly, though it has been achieved mainly for small enterprises in the trade and service sectors. Industrial output in the private sector grew by 8.5 percent in 1990 and is reported to represent roughly 17 percent of total Polish industrial output
Though privatization has been very successful for small-scale enterprises, the picture for large state enterprises is quite different. For reasons we noted earlier, privatization of these enterprises has proceeded very slowly. In addition, the economic position of these enterprises worsened as the state took decisive measures to introduce a hard-budget constraint. In addition to price changes and wage limitations, subsidies have been ended and protection from foreign competition has been sharply reduced. This new setting has encouraged enterprise managers to reduce costs by restricting unnecessary output and reducing the labor force. However, the strong commitment to rapid privatization was reinforced in June of 1991, when it was announced that a major portion of state industry would be privatized through creation of stock funds, with the population receiving vouchers.

Beyond these changes in the state sector, new guidelines have been introduced to monitor enterprise performance. Furthermore, a new Industrial
Restructuring Agency will consider how remaining state enterprises should be handled, to what extent privatization is possible, and what restructuring should take place for those enterprises that are not viable in the new setting. These new arrangements are designed to ensure a rapid transformation of the Polish industrial structure, to make it similar to and competitive with market economic systems, and to achieve this result quickly and as openly as possible.

Note that these comprehensive reforms in Poland cover all the critical areas discussed in Chapter 4 and earlier in this chapter. Moreover, beginning from very precarious economic circumstance in 1989, these changes were introduced simultaneously and rapidly. We will now do our best to assess the early results.

4) The Polish Economy in the 1990s

It is clear that economic reform in Poland has been radical and has moved sharply and swiftly away from the plan toward the market. In addition to the expanded influence of market mechanisms, decision making has been decentralized, private property introduced, and incentive arrangements changed. By most standards, the initial results have been encouraging.

First, stabilization measures cut the rate of inflation sharply from a reported 40-50 percent per month at the end of 1989 to roughly 4-5 percent per month in 1990. At the same time output fell, though supplies of consumer goods in stores increased. Employment in industry declined by 20 percent during 1989 and 1990, although it is reported that only a relatively small portion of this reduction in the labor force was caused by forced layoffs. The unemployment rate was reported to be 6.5 percent at the end of 1990.

Another major positive facet of the Polish reform experience has been the foreign trade sector. There has been a significant expansion of exports, especially to hard-currency markets. This expansion resulted in part from the devaluation of the zloty to market-clearing levels and in part from the reorientation of trade away from the Soviet Union and other
East European trading partners. At the same time, as a result of restrictive policy measures and the higher domestic cost of these imports, import demand declined.

A third qualified success has been privatization. Although the initial pace of privatization was rapid, this early privatization was largely that of small-scale enterprises in the area of trade and services. Although
Polish reformers take seriously the need to pursue privatization of major state enterprises, bringing this about will remain a critical task for the next several years.

Can these achievements be sustained in the coming years? We discuss this issue more generally in the next section, but the Polish case deserves specific comment. Quite clearly, the continued success of the Polish transition will depend on the continuing implementation of appropriate stabilization measures. Although this may seem relatively straightforward, it requires cohesion and commitment among policy makers and willingness among the populace to pay the costs of the transition. Pressures for wage increases must be resisted, and the process of privatization must proceed.
To the extent that the latter can be achieved, the contours of new market arrangements can be defined. Finally, although uncertainty in foreign markets remains, relief of hard-currency debt will unquestionably add a measure of flexibility.

Another issue is the extent to which the Polish "success" (if we can call it that) was promoted by Western assistance. In light of the Polish leadership's commitment to rapid transition, the West has provided considerable assistance in the form of exchange-rate stabilization funds, debt restructuring, and government guarantees.

HUNGARY: THE NEW ECONOMIC MECHANISM AND PRIVATIZATION

Early works in comparative economic systems devoted little attention to the Hungarian economy. Over the last twenty years, however. Western economists have begun to pay more attention to Hungary.

As one prominent observer of Hungary and other East European systems has noted, "The Hungarian reform experience says as much about central planning as it does about Hungary, and therefore an understanding of that experience is important for those interested in the prospects for reform in all of Eastern Europe, and indeed, in the Soviet Union. In other words,
Hungary is a prototype of economic reform for the former planned socialist economic systems of Eastern Europe, and presumably elsewhere. These thoughts, expressed some ten years ago, remain relevant in the 1990s as
Hungary, like other socialist systems, pursues a transition to the market.
However, the background of reform in Hungary is important to a proper analysis of contemporary problems and prospects.

Prior to 1968, Hungary applied the Soviet model of centrally planned socialism in a typical fashion. But then, in 1968, Hungary began to introduce by far the most radical economic reform attempted in Eastern
Europe (with the exception of Yugoslavia). In the words of one early observer of this reform, it clearly represents the most radical postwar change, in the economic system of any Comecon country, which has been maintained over a period of years and gives promise of continuity.

Although the reform program in Hungary met with only partial success, the problems that have arisen (conflicts of objectives, for example, and difficulty in persuading participants to change their ways) are fundamental to the reform experience of planned socialist systems.

Hungary shares many features with other Eastern and Southeastern
European countries, such as Yugoslavia. It provides a refreshing contrast to the Soviet Union, which in some important respects is atypical. Hungary is a small country heavily dependent on foreign trade. The Hungarian experience with reforming foreign trade, and in particular its efforts to become integrated into the world economy both East and West, is prototypical. The difficulties of reforming the foreign trade mechanism arc crucial to the Hungarian economy as well as to the economies of many other systems of Eastern Europe.

1) Hungary: The Setting

Hungary is located in central Europe. Its land area of approximately
36,000 square miles makes it roughly the same size as the state of Indiana.
Its population of about 11 million is comparable to that of the population of Illinois. Although Hungary is not self-sufficient in energy, it docs have supplies of coat, oil, and a number of minerals, including important bauxite deposits.

Although it has some rolling hills and low mountains, Hungary is basically a flat country with good agricultural land and a favorable climate. As in other East European countries, the period since World War II has seen the population flow from rural to urban areas and a changing balance of industrial and agricultural activity. Today, approximately half the population lives in urban areas.

Hungary is not particularly prosperous. Most estimates of its gross national product or per capita gross national product place Hungary in the middle of the East European countries. It is generally wealthier than
Bulgaria and Yugoslavia and certainly wealthier than Albania; it ranks behind East Germany and Czechoslovakia. Hungary's per capita income appears to be close to that of Greece. In this sense, economic development remains a key issue in Hungary. By the standards of Western Europe, Hungary remains relatively poor; by the standards of the Third World, Hungary ranks among the more affluent countries.

2) The Hungarian Economy: Prereform

The postwar reconstruction of the Hungarian economy began quite modestly in 1945. Before the implementation of a three-year plan in 1947
(1947-1949), the main policies included stabilization of the currency, changes in the nature of rural landholdings, and the beginnings of nationalization. The first three-year plan was designed primarily to bring the economy up to prewar levels of economic activity.

During this time, a planning mechanism was created and the share of national income going to investment increased sharply. The changes were not radical, however, and balanced development was envisioned.

The era of balanced development came to an end with the introduction of a five-year plan in 1950. The share of national income devoted to investment was increased substantially, and the bulk of new investment was directed toward heavy industry. This policy was partially reversed toward the end of the plan period, but it was reaffirmed in 1955-1956.

A number of economic trouble spots cried out for attention. There was an observed need to improve industrial labor productivity, especially through the development of a better incentive system to offset the declining supply of labor from rural areas. Supply-demand imbalances were growing increasingly severe. Waste and imbalance in the material-technical supply system created the need for a substantially modified coordinating mechanism among enterprises.

In addition, excess demand for investment led to substantial amounts of unfinished new construction and to the neglect of old facilities. Some mechanisms for the more rational allocation of capital investment had to be found. The adoption and diffusion of technological advances were seen as inadequate. Technological improvement was considered crucial for continued development of the economy.

This background seems familiar: a small country, the Soviet
(Stalinist) model of industrialization, overcentralization, emphasis on extensive growth, rigidities of the plan mechanism, incentive problems, and the resulting difficulties. Against this background, the New Economic
Mechanism first promulgated in a party resolution in 1966 was put into, practice in 1968. Over twenty years later, it remains one of the most important reform programs of planned socialist systems.

3) Intent of the New Economic Mechanism

There is disagreement about the importance and effect of the Hungarian reform program. The New Economic Mechanism (NEM) has generally been interpreted as leaving the power to control the main lines of economic activity (volume and direction of investment, consumption shares) with the central authorities, while relying on the market to execute the routine activities of the system. The NEM called for substantial decentralization of decision-making authority and responsibility from upper-level administrative agencies to the enterprise level. In a general way, NEM bears a close resemblance to the Lange model. Let us consider the original blueprint of NEM.

The objective of NEM was to combine the central manipulation of key variables with local responsibility for the remaining decisions. The first change was a significant reduction in the number and complexity of the directives firms; for large state-owned firms, the traditional problems remain. Valuation is difficult, especially in loss-making enterprises.
Moreover, it is hard to find buyers for these types of enterprises, let alone to arbitrate the potential rights of past owners. And just as elsewhere, privatization in Hungary is likely to become slower and more difficult as the focus shifts to the less attractive, large enterprises.

In addition to privatization per se, Hungary has addressed the creation of infrastructure (for example, a stock market) and new rules designed to change the guidance of enterprises. Accounting procedures have been refined and bankruptcy laws strengthened so that state subsidies can be curtailed and hard budgets introduced into large state-owned enterprises.

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