High-Level Expert Group Meeting
6-7 April 1991
London, United Kingdom
Chaired by Mr. Pierre Elliott Trudeau
I. INTRODUCTION
1. On 6 and 7 April 1991, the InterAction Council convened
in London a High-level Expert Group on "Economies in
Transformation: Limitations and Potential of the
Transition Process", chaired by Mr. Pierre Elliott
Trudeau. The meeting was attended by five other members of
the InterAction Council -- Maria de Lourdes Pintasilgo,
Lord Callaghan of Cardiff, Miguel de la Madrid Hurtado,
Jenoe Fock and Mitja Ribicic -- and 19 experts. The list
of participants is annexed to this report as are the terms
of reference.
2. The 1990s might be characterized as the period where,
immediately following the end of the Cold War, "one world"
bearing the features of a market economy was being formed.
One way or another, all economies are always in transition
aimed at achieving the most flexible and efficient system.
However, the challenge posed by the economies of Central
and Eastern Europe is unprecedented: the transformation of
one system, predominantly based on central planning and
state ownership, into another, predominantly based on
market principles, private ownership and encouragement of
initiative and enterprise. In previous history, radical
transformations of this type took decades, if not
centuries, such as Europe during the 1930s and 1940s and
the Meji restoration in Japan. Today, the transformation
must be accomplished more rapidly. Economic change of such
a gravity demands above all also a tremendous cultural
transformation, which must take place in the minds of
people. To overcome psychological barriers, mentalities
and values will have to be adjusted. This will take time,
most probably a generation, before the changeover will be
consolidated.
3. While concentrating on Central and Eastern Europe, the
group drew also on the Latin American, Asian and Southern
European experiences. The countries in Central and Eastern
Europe -- while not being a homogenous group -- must not
only cope with changes in the economic, but also in the
political system. While a market economy is a condition,
although not a sufficient one, for democracy, democracy in
general is not a condition for a market economy. However,
in present circumstances democratization is vital for any
transformation to succeed. As Eastern European countries
should be closely associated with the European Community,
this will not be possible unless they are democracies. In
order to gain acceptance of the new values and to create
the civil society inherent in a democratic system, a
series of political as well as economic reforms will
eventually have to be put in place, safeguarding
individual freedom and human rights, ensuring free
elections and a parliamentary system based on political
pluralism, popular participation and political
accountability. The political and economic disintegration
accompanying the current reform processes in Eastern
Europe weakens these countries and their economies and
places extraordinary demands on the skills and vision of
the political leadership and the understanding,
cooperation and tolerance of the population.
4. With the acceptance of the market mechanisms, "one
world" is emerging where all countries may benefit from
the division of labour and economies of scale through
competition, freer trade and payments. During the
transition process towards a market economy, three key
tasks must be accomplished, which will be discussed later
in more detail:
- The adoption and implementation of appropriate macroeconomic stabilisation policies aimed at removing disequilibria with a view to facilitating economic growth (see paragraphs 19-20 below);
- The introduction and guarantee of property rights and the initiation of structural reforms, namely price and trade liberalization (see paragraphs 21 and 22 below);
- A phased process of privatization and commercialization of industry and services, in order to replace the hitherto political management of the enterprises by bureaucracies (see paragraphs 23-29 below).
II. GENERAL OBSERVATIONS
5. Neither the capitalist market system nor the socialist
command economy have proved to be perfect in satisfying
individual or collective needs or bringing about a fair
income distribution. The failure of the socialist model
should not be taken as a pretext to advance a
"theological" solution of pure capitalism as the only
possible alternative. Even among countries with successful
market economies, an amazing diversity prevails. The
experience of Western countries and Japan shows that
planning - though not centrally planned and authoritarian
- is not stultifying per se. In these countries,
Governments influenced the economy in the form of
indicative planning by means of incentives and other forms
of encouragement, forecasts and consultation. Regulation
of markets proved desirable to guarantee product quality,
consumer safety, institutional stability, market access
and competitiveness.
6. No pure capitalist nor socialist system exists in the
world. Most capitalist economies especially in Western
Europe and Japan, are characterised by a mixed system,
with a vigorous private sector and a strong and large
public sector (averaging 40 per cent of GNP). Determining
the nature of the most efficient mix is the key challenge
for each economy. A bipolar economy also exists in China
where the importance and efficiency of private initiative,
production and enterprise as well as the market system are
recognized, although state entrepreneurship and
collectivisation are upheld as the basic condition. One
irritant in previously centrally planned economies is that
the process of planning remains in the hands of former
Communist Party functionaries who do not believe in
markets and have a lot at stake in preventing the success
of the transformation. Although the distinction between
both systems is blurred, the European Bank for
Reconstruction and Development (EBRD) has set as prime
conditions for assistance a strong embrace of the free
market, privatization and strict adherence to market
forces, as well as the adoption of some form of a
parliamentary system. While it is the intention of EBRD to
have these conditions fulfilled, it is clear that this
cannot be an immediate process and will take time. Several
years ago, even some OECD countries would have had
difficulties meeting present EBRD conditionality.
7. The role of Government in fostering economic
development is essential, even in a capitalist system. Its
function is to ensure an allocation of resources
compatible with certain goals and values of society, to
achieve a fair distribution of income (through taxation
and a social security system), to provide infrastructure
and to keep the economy stable by avoiding excessive
fluctuations (inflation or deflation) -- while observing
the principle of subsidiarity, namely that decisions
should be taken at the lowest possible level at which they
can be effective. However, if the role of Government in an
economy increases excessively, that economy will tend to
become less efficient, as is being experienced by many
developing countries.
8. The goals and processes of development must be
redefined beyond the simple indicators of GNP-measured
economic growth and welfare. New sets of indicators should
be introduced which are capable of reflecting diverse and
normative cultural goals, along the lines of the Human
Development Index (HDI) developed by the United Nations
Development Programme (UNDP) or the Index of Sustainable
Economic Welfare (ISEW) developed by the World Bank and
others.
9. Time-sequencing is critical for the success of any
economic and social transformation and for avoiding too
high a cost of social dislocation. As every transformation
is multi-dimensional and long-term in character, it must
be addressed in multi-disciplinary ways and involve
methodologies and policy tools drawn from economics,
political science, ecology, sociology and decision and
information theory. Above all, it must make haste
slowly.
10. In a transformation, market discipline must be
introduced at the enterprise level through import
competition, insulation of management from political
pressures, and controls over credit and subsidies. The
goal is that all enterprises be managed in the same way as
private enterprises in a competitive market economy.
11. Privatization entails a process of identifying those
areas where economic activities should be organized and
owned or controlled by the private sector in order to
raise efficiency and productivity. Incidentally, this
process can take place without necessarily involving the
change-over of a system.
12. When the previous social order is being destroyed,
standards of living are likely to decrease. Thus, this
process must be smoothened by sufficient economic
assurance and income security measures for the population,
in order to maintain social stability of a country. To
that end, essential social services should be preserved
and social compensatory policies adopted.
13. The transfer of technology and capital from the West
will be indispensable to facilitate the transformation and
the related modernization process. The private sector, in
particular multinational corporations, will have an
important role to play in that respect.
14. All political forces of a country must display a clear
and strong commitment towards the reform goals. The
Government economic policy team must avoid sending
different signals. The actual time-frame of the transition
will be affected by political pressures and struggles and
by the people's perception of the political legitimacy of
new leaders and institutions which replace the old system.
As transformations entail a high economic and political
cost, societies must be fully informed of the programmes
and their likely implications. The conclusion of social
pacts with unions and entrepreneurs may bolster the
tolerance and establish a consensus. Without strong
political leadership, popular participation and pluralism,
economic transformation is bound to produce undesirable
results.
15. The experience with industrial and structural policies
in industrialized countries -- and the role played by the
state in a mixed economy as is the case in virtually all
OECD countries -- may hold lessons for the development of
comparable policies by economies in transformation. One of
the essential features of Western industrial policies was
that governments rarely engaged in creating industries,
but nudged or strengthened industries of strategic
importance in indirect ways by creating the necessary
framework and conditions for the functioning of markets:
- as purveyor of public goods, Governments provided infrastructure, educational (re)training facilities and related employment schemes;
- Governments sought to encourage entrepreneurship, private initiative and innovation by a variety of indirect means, such as facilitating the emergence of strong and stable financial institutions and intermediaries and the adoption of a conducive legal framework and fiscal, tax and currency policies.
16. Industrial policies were tailored in accordance with
the cultural peculiarities and the specific circumstances
of each country. The formulation of all-encompassing
blueprints or recipes would have served little practical
purpose. Instead, countries in transformation have the
opportunity to set their own priorities and establish
guidelines from inside.
17. This experience underlines that capitalism does not
necessarily entail the absence of planning. But it does
not involve central planning of a whole economy.
III. GUIDING PRINCIPLES
18. Any transformation must take into account the
political context of a country, the degree of education of
its people, the specific circumstances and actual state of
its economy, the size of its population and the existing
infrastructure of institutions, especially in the
financial field. Thus, there cannot be a universally
applicable blueprint. Yet, a number of pragmatic elements
or guiding principles emerged from the discussion which
policy-makers should be aware of and take into account
when charting the transformation of their economy.
Eventually, a set of indicators should also be introduced
capable of measuring the pace and magnitude of change to
the new economic system.
Macroeconomic stabilization
19. The adoption of proper macroeconomic policies aimed at
stabilization and at stimulating economic growth is of
paramount importance, both for developing countries and
Central and Eastern European countries. In the short run
(nine to twelve months), a series of measures must be
taken, if possible quickly and consistently, but not
necessarily as "shock therapy" to enable the market to
function: a move towards price liberalization to reflect
the true value of goods and services; the introduction of
an exchange rate policy to reflect its true value on the
basis of purchasing power assessments (implying a movement
towards some form of convertibility of currency -- e.g. in
CSFR on current accounts only); and the adoption of
restrictive fiscal and monetary policies (aimed at fiscal
balance and the control of money supply). The main
objective of such macroeconomic stabilization is to
restore money to its normal role as a vehicle by which an
economy can work in an optimal way. Ultimately,
stabilization must be linked to the development of
appropriate strategies for sustainable economic growth.
20. The period of implementation for such a programme --
normally agreed with the IMF -- is set, in the medium
term, at three years. Stabilization has to imply a cut in
real wages if consumption is excessive. But if the
standard of living is to be protected and social hardship
minimized, production and employment should not be allowed
to collapse. Consequently, a number of regulations will
need to remain in force, such as ceilings on prices and a
prudent wage policy (e.g. indexing of minimal wage). The
immediate key problem will be how to protect basic
standards of living.
21. Price liberalization is aimed at eliminating a variety
of price distortions and administrative impediments
inherent in centrally-planned command economies: first,
relative price distortions where prices and wages have
been artificially kept low, e.g. in agriculture and
certain sectors of industry; second, policy-based price
distortions which served social objectives by heavily
subsidizing e.g. housing, food, health care, education and
public transportation.
22. Sustainable economic development and growth must be
induced as quickly as possible through a set of
consistent, interrelated policies: the development of a
government industrial policy ("strategic view of future"
drawing on the experience of Japan, the newly
industrialized countries of South East Asia and Europe),
the building of a reformed public sector (infrastructure),
privatization, support to small- and medium-scale
businesses and export promotion, especially to OECD
countries.
Privatization and commercialization
23. Privatization cannot be seen as a goal in itself and
in isolation from the overall transformation process. A
privatization strategy, as one element of achieving a
market economy, can be carried out with various
instruments: the sell-off of companies and their assets;
encouraging the creation of new private enterprises; the
provision of the necessary underlying structure for the
private sector, including the financial sector and
internal capital markets to allocate capital, a labor
market with functioning workers organizations, the legal
framework (adjudication of claims, anti-monopoly law,
consumer and environmental protection laws) and tax
legislation, including enforcement. Care must be taken
that previous public monopolies are not turned into
private ones. Only privatization will guarantee a process
of educating and settings, up a new managerial class. In
practice, the biggest obstacles to privatization are the
lack of an effective savings-mobilizing mechanism and of
financial intermediaries, the absence of property rights
and the need to settle problems of ownership, involving
either restitution or compensation.
24. In several countries, such as CSFR and Germany,
re-privatization of previously confiscated land and assets
to their erstwhile owners or, as in Hungary, their
compensation must be distinguished from the genuine
privatization process. In Poland, restitution claims
amounted to some 13,000 trillion Zlotys or 1/3 of the
total budget revenues. In Germany, the slow pace of
clarifying restitution claims has become a central issue
delaying the badly needed flow of new investment.
25. The process of privatization involving the sale of
companies should initially begin with small-scale shops
and businesses and the service sector. In this case, the
auction system may serve as an effective mechanism. It
will be equally important to identify enterprises suitable
for privatisation which have the capacity and potential to
become operators in the international economy as quickly
as possible. In the agricultural sector, land can be
privatized or leased (while maintaining collective
ownership, as in China) and has proved to raise
productivity.
26. Most heavy industry and large-scale state enterprises
will for some time remain protected given the lack of
finance, apprehension about foreign control of key sectors
and the inefficiency of production (high wages, high
indebtedness). They will need to undergo first a process
of restructuring, including de-monopolization, and of
commercialization of their activities as a necessary
precedent for effective privatization later, if that
should be desired as these societies become more
self-confident and democratically choose their future
paths for development. Thus, a government-owned sector may
exist for many years to come. The real issue will be how
to manage it without political interference and pressures
of agents of the state in accordance with market
principles and requirements. Joint stock holding
companies, owned 100 per cent by Government, may be a
suitable solution as they can function like a company in a
private market. As the commercialization process is also
bound to cause bankruptcies and unemployment, such
consequences should be taken into account when deciding
whether inefficient industries should be (temporarily)
preserved or closed.
27. A privatization of select large-scale businesses could
be accomplished through a voucher system (which poses
enormous logistical problems) or the sale to the public
(which poses pricing difficulties and may suffer from lack
of cash and savings). In terms of strategy, care should be
taken that not only the most profitable enterprises or
enterprises from a few sectors only (leaving other sectors
entirely public) are sold off -- often at relatively low
prices --, but also that a Government is not left with the
least viable, least effective and technologically outdated
enterprises which might represent a considerable fiscal
drag on the budget. Such conversion will be difficult.
28. An overall review and reorientation of safely nets
should accompany the privatization and commercialization
processes with a view to reforming and adapting them in
line with the requirements of the new situation and not
necessarily emulating Western models which by themselves
are now affected by changes. Safety nets may be achieved
through income security measures (e.g. by assuring social
security or unemployment benefits), albeit at lower
levels, the launching of labor-intensive infrastructure
projects and the introduction of a creative labor market
policy, including retraining and skill enhancement schemes
aimed at bridging the qualification gap and generating
sufficient employment opportunities.
29. New small business development should be encouraged,
especially in the relatively over-industrialized countries
of Eastern Europe, which lack trade and services. Such
enterprises require little capitalization, absorb labor
and meet real existing consumer demand ("cafe
society").
Internal and external levels of financing
30. The destruction of the old and the management of the
economic system requires a massive transfer of capital,
technology and resources. There is a simultaneous need to
produce sufficient levels of internal savings in order to
support privatization and new investment. In the past,
planned economies held debt accumulation, both public and
private, to petty levels compared to the West. As many
capital assets (land, housing, factories) did not trade in
any markets, there was no corresponding debt reflecting
financing or refinancing. Instead, investment was financed
from current budgets.
31. Internally, the mobilization of capital and savings
for productive investment and capital formation through
savings institutions becomes a critical element. A system
of institutional investors must be built up to provide for
a regular savings effort. Moreover, stock exchanges should
be established. This will require time and patience. Given
the relative lack of professional skills in this area,
outside expertise and assistance will need to be
enlisted.
32. There is an absolute necessity to reduce Government
balance of payments debt in order to mobilize and dynamize
private and institutional savings for the purpose of
ensuring higher production. To this end, public revenues
and taxes must be increased, while public expenditures
must be cut. Governments that are bankrupt are unlikely to
attract foreign investment. The awesome magnitude of this
task can be illustrated by the fact that during the first
three months of 1991, the budget deficit of the USSR is
already bigger than that planned for the entire year. This
type of policy is bound to cause hyperinflation.
33. One way of generating a stream of income for the
public budget may be the monetization of the vast
Government-owned housing stock that has no market value,
after problems of ownership have been settled. This might
eventually lead to the emergence of a home equity loan
market which could form a new source of capital formation
for investment.
34. External finance from public sources, including
international agencies, and the Western private banking
sector will be required for long-term private and public
investment in order to let the countries and their markets
(with a population of 400 million in Eastern Europe)
emerge as viable economic players and partners. However,
there is doubt whether sufficient excess capital exists in
the West to support such transformations. The fact that
the real rate of interest is higher than ever, suggests
that there is currently no surplus of savings that can be
redirected. Germany and Saudi Arabia no longer provide
savings to the world economy. The requisite level of
resources required worldwide (for developing countries,
debt-reduction policies, demands by Eastern European
countries and the Soviet Union and the requirements of the
United States) could thus only be secured through fiscal
policies by Western countries. This will only be feasible
and acceptable if the entire range of problems and their
full implications are openly discussed and understood by
the public. An extraordinary situation has already arisen
where private Western creditors are no longer prepared to
extend credits without full guarantees by their respective
governments.
35. The catastrophic and rapid increase in external debt
of the countries in transformation must also urgently be
solved through effective debt reduction and relief
packages. Recent debt rescheduling agreements with Poland
and Egypt will undoubtedly hasten the process of debt
reduction along. The way how the debt of countries in
transformation is managed will determine whether they will
be able to access markets for new financing.
36. The end of the cold war has made reductions in
military expenditures by all countries possible, which
should provide another source for long-term domestic and
external finance. Further, as military expenditures
continue to decline in relative terms in the United States
and USSR, more attention is needed to accomplishing
conversion of military production facilities. This would
help meeting vast civilian needs for infrastructure and
innovations, such as more energy-efficient
technologies.
International trade
37. The trade picture for the Central European countries
in transformation is rather bleak caused by two major
shocks. The first was the complete collapse of the Soviet
system which is speeding up the need for transformation by
the former member countries of the Council for Mutual
Economic Assistance (CMEA) in order to compensate for the
loss of trade with the USSR. The switch to the convertible
ruble in the CMEA trading system as of 1 January 1991
constitutes another burdensome change. The second main
shock was the disappearance of the German Democratic
Republic, which was the second most important trading
partner for CMEA countries. The immediate task is to
re-establish trade among the former CMEA countries, where
market connections and technological fits already exist.
Western assistance for long-term intra-regional trade
financing will be crucial.
38. The liberalization of foreign trade cannot be
unilateral. Free access to markets cannot be imposed on
countries without reciprocity by OECD countries. If there
is no adequate reciprocity, the solution will be
inefficient and will lead to the demise of GATT into
regional trading blocs. The openness of Western markets to
exports from the countries in transformation will be
critically important for the success of the transformation
process. For Eastern Europe, existing quotas for steel,
textiles and other products could be reduced and a
different type of trading arrangements may have to be
devised in order to avoid the erection of a "new iron
curtain in reverse". Adequate provisions must also be made
to enable the acquisition of new technologies and goods.
Better market access for agricultural goods from Eastern
European countries will boost the transformation process.
To that end, the European Community's Common Agricultural
Policy, in particular, requires urgent review and
adjustment.
IV. ACTION IN SUPPORT OF ONGOING TRANSFORMATION
PROCESSES
39. The InterAction Council could call for a series of
concrete action and measures which could contribute to the
processes of transformation currently under way.
40. By introducing market mechanisms, Eastern Europe is
joining not only Europe, but the Western industrialized
world as a whole. In this global process, which is much
more significant than the Marshall Plan aid after World
War II and will have far-reaching global effects, the
InterAction Council should call on the United States and
Japan to assume a larger financial share in assisting
Eastern Europe as do the other Western European countries
in the context of the US$ 22 billion programme of the
Group of 24, coordinated by the European Community. The
West should channel its assistance in relation to the
fundamental economic - not political - objective of using
resources efficiently in the interest of people. Current
G-24 assistance is aimed at providing balance of payments
loans and supporting the macroeconomic reform processes in
Eastern Europe. Mere policy agreements and compromises on
the contents of future assistance will not be enough.
41. The InterAction Council should urge OECD governments
to support and finance a massive programme of
infrastructure investment which is an effective conveyor
belt for employment and technological change, readies
economies for privatization and encourages service sector
growth. The European Bank for Reconstruction and
Development (EBRD) should, in its public sector finance,
concentrate on the outright transfer of infrastructure
(both traditional and information-related) on a massive
and large scale.
42. The market-oriented reform process in Eastern Europe
is not uniform. In Germany, the transformation took place
virtually overnight. This did not allow for a convergence
of the two Germanies over time, with all its consequences.
In Central and Eastern Europe, the process evolves under a
certain degree of protection and adjustment possibilities.
The Soviet Union is lagging behind as its old
administrative system is being destroyed without being
replaced by a new system. A very gradual approach has
begun towards marketization/commercialization rather than
privatization. The InterAction Council should urge the
sustained conduct of a real and continuous dialogue -- on
the proper way towards a market-based economy between all
countries undergoing transformation, including, the Soviet
Union, and the Western industrialized countries. Although
most Central and Eastern European countries have already
become members of the Council of Europe, they should, like
Yugoslavia earlier, therefore also be offered association
with OECD as an additional institutional link to promote
constructive dialogue. To underpin this dialogue, EBRD,
the International Bank for Reconstruction and Development
(IBRD - the World Bank), the International Monetary Fund
(IMF) and the European Investment Bank should establish
resident advisory offices in the capitals of the countries
concerned. Such arrangements will lead to the emergence of
a new network of cooperation which will help establish new
and stable foundations for future cooperation,
understanding and trust.
43. The InterAction Council should endorse the report on
"The Economy of the USSR" by the staffs of the IMF, World
Bank, OECD and EBRD. As no follow-up dialogue has yet been
initiated on this report, the Council should call for, or
even organize, a meeting (in Moscow on ways in which the
report and its recommendations could be realistically
implemented. The Soviet Union cannot escape the necessity
of an urgent, strong programme of economic stabilization
and reform. The question is not whether a shock approach
or a gradual programme should be adopted, but whether the
Soviet Government is ready to accept the need for a real
transformation of the economic system and a full programme
of implementing the reforms, which may extend over a
number of years. This should include an explicit
commitment to aim at the establishment of a market
economy, a commitment to invest in labor-intensive
infrastructure and services and to privatize. Some
problems can only be dealt with by shock (e.g.
hyperinflation), others must not be (esp. in terms of
social costs). The alternative to such a measured approach
will be chaos and political repercussions on a broad scale
which can be in the interest of no country.
44. The InterAction Council should also renew its earlier
suggestion that, after a special transitional status, the
USSR be admitted to full membership in the World Bank, IMF
and GATT.
45. Given the present serious economic situation in
Eastern Europe and the Soviet Union, it is not expected
that private business will direct substantial investment
in those countries. Thus, the Council should call for
public sector aid, including large-scale technical
assistance programmes, by OECD Governments and should
emphasize that such aid not be withheld pending the
introduction of adequate political reforms. In these
circumstances, it is critical that, without further delay,
both sides start the proposed dialogue on policies,
identify investments feasible without full reform (e.g. in
the energy sector) and consider liberalization of
(agricultural) imports.
46. The Council should urge Western countries,
international financial institutions and the private banks
to assist countries in transformation in the development
of a functioning system of savings and capital formation,
the establishment of a system of financial intermediaries
and in the gradual development and establishment of a
social security system. The Council should also call for a
substantial transfer of knowledge and skills from the
Western private sector to support the transformation
process in a variety of specific areas, e.g. banking,
capital markets.