The speed and comprehensiveness of reforms in Eastern and Central Europe over the course of the next year and one-half will determine whether the countries in the region attain the rapid economic growth of Southeast Asia or wallow in debt, stagnation, and hyperinflation like South America. So far, there is reason for both pessimism and optimism. Most of the East European governments recognize the importance of strict monetary discipline and the need to resist pressures for excessive wage increases in the public sector. However, the window of opportunity - when the public will accept the temporary hardships that come with a dismantling of the old system - is beginning to close in some of the countries, such as Poland. Populist pressures for easing monetary policy and removing wage ceilings on public sector employees are becoming stronger. Such pressures, if not resisted, could send East European countries down the road of spiraling wage price inflation which has wreaked havoc on South American economies.

On the whole, East European countries have moved rapidly on instituting the macroeconomic measures needed to stabilize the economies. Such measures include freeing prices on most tradeable goods, balancing the budget, reigning in inflation, adopting positive real interest rates, and moving toward currency convertibility. Reforms have come more slowly, however, on the structural reforms needed for a free market economy to rapidly develop. Regulations on private businesses are still burdensome, business licenses difficult to obtain, taxes are prohibitively high, and privatization of large industries is occurring at a painfully slow pace.

Poland

Poland is the former East Bloc country that has moved the quickest and furthest in economic reform since the iron curtain came tumbling down. Poland's plunge into a market economy began in January 1990 when the Balcerowicz economic reform program, as it is called after Poland's determined Finance Minister, brought a series of reform measures including sweeping price and trade liberalization and monetary stabilization. Balcerowicz rejected the idea that full employment was achievable, or desirable. The zloty was drastically devalued - from 700 zlotys to the dollar to 9500 to the dollar. Subsidies were eliminated and a program of privatization, financial restructuring, and tax reform was outlined.

There are many successes to report from Poland's march to a market economy. A $4.5 billion trade surplus was registered with Western Europe in 1990. Inflation was brought under control, the currency was made convertible, the budget was slashed, and the growth of the private sector has been remarkable.

Despite these and other successes, horror stories abound in the media about Poland. Living standards have dropped 30 percent, the gross national product has declined 16 percent, production is down 30 percent, and there is massive unemployment. Such statistics are misleading. Measuring communist economies and emerging market economies is like comparing apples with oranges. Take the reported drop in living standards. Communist systems - which ignore long food lines, poor-quality products and empty shelves - paint a rosier picture of life than reality merits.

Foods and goods of a diverse variety, once nearly impossible to find, are overflowing inside the shops and along the streets of Poland. Purchasing power, in terms of dollars, also is up. In 1989, the average monthly wage of Poles was $40 at the black market rate. It is now over $150.

Now consider the 30 percent decline in Poland's industrial production. Again, in communist economies, production is often highly exaggerated by factory managers trying to fill production quotas. Output is measured in quantity, not quality. The truth is that Polish factories are reacting to consumer demand - by producing, for example, fewer shoddy radios that no one wants to buy.

The drop in industrial production also does not account for the tremendous increase in private sector activity in 1990 and 1991. Most of this goes unreported because the government does not have the administrative capability to measure the private sector activity. Further, many businesses remain unregistered in order to avoid heavy taxes. According to Charles Wolf, dean of the RAND Graduate School, "The real economic value of Poland's current GNP probably exceeds that of the prior, non-market, command system." Private business emerged on a mass scale in 1990 and 1991. While in such a dynamic, changing economic environment as Poland, the accuracy of any statistics are suspect, there has been some preliminary measurements of Poland's emerging private sector. Over 515,000 new private businesses were registered in 1990 and small businesses - those employing five or less workers - accounted for 60 percent of small private sector production in 1990.' Excluding agriculture, the total added value of the private sector was 26 percent higher in 1990 than 1989.2

Poland's trade reforms made it one of the most open economies in the world in 1990 to imports. All Polish import quotas were eliminated - most duties are now zero or five percent; and no tariffs whatsoever are levied on 58 percent of goods entering the country. Poland's trade liberalization increased competition in the state monopoly-dominated Polish economy and brought prices down for Polish consumers and exporters. Partly as a result of the lower trade barriers, which enabled Polish companies to buy cheap imported components and thus reduce costs, Polish businesses increased exports by 50 percent in 1990.

Privatization of state enterprises has not moved nearly as quickly as the Polish authorities initially envisioned. However, municipal privatization of shops, stores, and restaurants has been carried out at a brisk pace. Around 60,000 of these formerly municipally-owned entities have already been privatized. The government hopes the remaining 40,000 will be sold off in the next year or two.

Over 190 state enterprises, of sizes ranging from 100-800 employees and assets up to 40 billion zlotys, have been turned over to the private sector in the last year. The Ministry of Ownership Changes is employing a number of different methods for privatizing enterprises including direct asset sale, management/employee buyout, public offering, trade sale, and the recently announced mass privatization program.

Poland will privatize 400 enterprises - comprising one-fourth of Polish production - through a complex privatization scheme that would make 27 million Poles immediate shareholders. Controlling interests, in the form of shares, are to be transferred to between 5 and 20 privatization funds that would resemble U.S. mutual funds. Each Pole born before 1974 would then be given a share in each mutual fund. The mutual funds - managed by Western investment firms - would then set about the task of restructuring and liquidating enterprises. After one year shares in the mutual funds would be freely tradeable. The Polish plan is one of the most ambitious, comprehensive, and risky proposals for privatization to be found in Eastern Europe.

Poland is on the road to economic prosperity. To be sure, it still has a long way to go. Taxes are too high, unemployment will increase substantially when decrepit state-owned factories go bankrupt, and small businesses still face numerous bureaucratic and economic obstacles - such as high interest rates. However, the biggest current danger is that the government will give in to populist pressures to reinflate the currency; this will kill the anti-inflation program and could jeopardize the entire reform program.

Bulgaria

Bulgaria is usually lumped in with Romania as being the most economically backward and slowest to reform of the East European countries. This was appropriate in 1990 when the political stalemate between the ruling socialist party and the opposition Union of Democratic Forces (UDF) delayed real economic reform. However, since December 1990 when a coalition government was formed and the UDF was given responsibility for economic policy, the Bulgarian government has moved rapidly on radical economic reforms. The economic situation inherited by the UDF was bleak. Non-agricultural output fell 20% in 1990 and the collapse of the Soviet market and the dismantling of the intra-CMEA trading block hit Bulgaria especially hard due to its very high reliance on CMEA trade. Another powerful shock to the Bulgarian economy was the Gulf Crisis, which led to severe energy cuts and, in some places, 24-hour lines for fuel. Because of the worldwide sanctions against Iraq, for whom Bulgaria is a creditor, Bulgaria was unable to recover its hard-currency loans to Iraq and faces a shortfall that could well eliminate all of the nation's hard-currency reserves.

Against this backdrop the government implemented a Polish-style shock therapy reform program. Prices were freed on almost all goods but energy. Prices soon rose to market levels causing a temporary price adjustment of 350 percent in February. Inflation fell to 45 percent in March and to only 3.5 percent in April. Shops are now filled with goods. Farmers now able to sell their produce at market prices have increased production so fast that prices are currently declining for some foodstuffs. Bulgaria also significantly liberalized trade barriers resulting in great increases in imports which, in turn, helped lower inflation.

Since January, the government has adopted a strict monetary policy. Interest rates were raised from 4.5 percent to 45 percent and then up to 52 percent in June and the lev is being maintained within a band of 15-18 lev to the dollar. Also this year, a tripartite commission concluded an agreement on wage policy that would impose strict financial discipline on state-enterprises, and impose wage ceilings.

The government is committed to cutting the budget deficit by 10 percent of GNP.3 One way Bulgaria plans to cut expenditures as well as to combat the country's oil shortages is by eliminating subsidies for oil and gas. This would result in a 50-70 percent increase in energy prices. Another important reform is that the private sector will be allowed to enter the gas and oil market.

Bulgarian agriculture was particularly affected by the years of socialism. As the most regulated sector of the Bulgarian economy, agriculture, once a net exporter of goods, is now a net importer. Bulgaria has taken steps to allow reprivatization of land at a rate of .7 hectare for every 1 hectare taken. The Bulgarians will be able to dispose of the land as they see fit, a process which has already filled shops and begun to bring prices down.

Privatization has only recently gotten under way in June with auctions for shops and restaurants. State enterprises are soon to be converted to joint-stock companies and contracts to manage various state enterprises will be signed with private firms in order to relieve the middle layer, communist nomenklatura resistance to privatization. Interestingly, the government plans on making gas stations a prime early target for privatization because state inefficiency in this sector is highly pronounced.

In summary, although unbeknownst to most in the West, Bulgaria has taken dramatic steps to liberalize its economy. Though it is not likely to grow as quickly as the wealthier countries of Central Europe such as Hungary, and Czechoslovakia, and Poland, if it continues to pursue resolutely market liberalization, Bulgaria should begin to experience steady growth beginning in a few years.

Czechoslovakia

It took over a year after the so-called "velvet revolution" of November 1989 for Czechoslovakia to launch an ambitious economic reform program. There were a number of reasons for Czechoslovakia's slow start. Having the highest living standards among former East Bloc countries and very low rates of inflation, there was less incentive to move quickly than in Poland. Further, the government was split about the pace and extent of the transition to a market economy. The social democratic wing of the ruling Civic Forum government was still talking about a "third way," while Finance Minister Vaclav Klaus and his supporters argued for capitalism with no adjectives - rejecting any compromise between capitalism and socialism.

Klaus and his supporters won the initial battle and Czechoslovakia introduced its economic reform package in January 1991. Prices were liberalized, most non-tariff barriers such as quotas and licensing restrictions were eliminated (although a protectionist 20 percent surcharge was imposed on imports), internal currency convertibility established, and small-scale privatization launched.

Prices on 85 percent of goods were freed January 1 - prices will be liberalized on another 5 percent of goods this Fall. Unlike in Poland, there was not a noticeable change in the supply of goods in stores. Reason: Czechoslovakia did not previously experience the severe shortages present in other East European countries and further, the import surcharge prevented Western consumer goods from entering the market.

After prices were initially pushed up 35 percent in January to market-clearing levels, a tight monetary policy has kept inflation under control. Interest rates are restrictive and high, at 22%, though this represents a softening from last year's 24% rate.

Declining Soviet trade, price liberalization, the necessity of using hard currency instead of barter with the Soviet Union, and the Gulf Crisis, caused the government to devalue the krona three times in 1990- in January (18.6%), in October (55%), and in December (16%). To stabilize the exchange rate, the krona is now pegged to a basket of western currencies. The current rate is 28 krona to the dollar. Czechoslovakia has also brought its balance of payments into equilibrium.

In the economy at large, state production fell by 3 percent in 1990, while the government expects production to fall another 12 percent in 1991. Rapid growth of the private sector is essential so jobs are available for displaced workers from the state factories which will need to lay off excess labor. Currently 200,000 people are unemployed in Czechoslovakia, representing 2.8 percent of the workforce.

Fundamental tax reform has yet to be implemented. Taxes on private business are so high that companies risk going out of business unless they find ways to avoid taxes. As in the other East European countries, business taxes need to be cut drastically to give new entrepreneurs a chance to flourish. .In the winter of 1991, however, modest rate reductions in the turnover taxes did occur. Turnover taxes were consolidated into four different rates - 0, 12, 22, and 32 percent - and then the rate was chopped 2 percent in the top three brackets to stimulate growth and consumer demand.

Privatization of the economy has barely begun. A little over 3500 shops and restaurants were auctioned off in the first six months of 1991. On average, 80 percent of entities up for sale have been sold in each auction and they are fetching two times the asking price. Small-scale privatization will be carried out by auction, some with and some without foreign investment. All proceeds from the auctions will be frozen for 2 years as an anti-inflationary measure. There are no special privileges for employees of these auctioned companies. Large-scale privatization is to begin in Czechoslovakia in January 1992. The privatization process has been decentralized. Each firm has been charged with drafting their own proposals for privatization and submitting these to the Czech and Slovak privatization ministries by December 1991.4 Czechoslovakia plans on privatizing up to 1,000 state firms through a voucher scheme. Vouchers, sold to citizens at very low prices, would allow Czechs and Slovaks to purchase shares in state enterprises directly or to purchase shares in mutual funds (who would then use the coupons to buy shares in state firms). The latest plan is for the voucher privatization to take place in three rounds of auctions; the first of which is to take place in January.

Hungary

After decades of cautious fits and starts with economic reform, in 1991, Hungary finally bit the bullet and launched an economic reform plan to rapidly move the country to a full-fledged market economy. However, as in the rest of Eastern Europe, the triple external shocks, consisting of the collapse of Soviet trade, the decline of CMEA trade, and the gulf oil crisis, severely jolted the economy.

Due to its robust trade with Western Europe, Hungary's economy was probably the best positioned in Eastern Europe to withstand the shock of the Gulf Crisis and the collapse of the barter market with the Soviet Union. Nevertheless, the Hungarian economy was hit hard by the external shocks. Economists estimate that the twin shocks will, in the end, wipe out 30 percent of Hungary's hard-currency reserves.5 The Hungarians predict that the Gulf Crisis cost them $700 million in higher energy bills.

The changeover to "hard ruble" and dollar exchange has driven up inflation in Hungary, with the rate running at 34 percent annually and still rising. By maintaining a very tight monetary policy, the government hopes to cut inflation to 20 percent in 1992; 14 percent in 1993; and 9 percent in 1994.

The government plans to eliminate the 4 percent budget deficit by 1994 through real budgetary reform; not just cutting expenditures one by one. Instead, the goal is to significantly curb the state's oppressive role in the economy. Currently, the 64 percent of Hungarian GDP goes through the state budget - Hungarians want to cut it to 57 percent by 1994.

With the collapse of the communist system, surplus employment is being cut back by newly competitive industry. Hungarian unemployment - 1.7 percent in 1990 - rose to 4 percent by this June and is expected to reach 9 percent next year. Increases in the cost of living have prompted calls for wage increases. Substantial wage increases, however, would drive unemployment even higher in the months ahead. Calls for a comprehensive. West European-style social "safety-net" have also become louder, also jeopardizing economic reform.

Hungary has moved aggressively in 1991 to liberalize prices and trade. Price controls have been eliminated on 90 percent of goods. The average tariff rate has been cut from 16 to 13 percent, 99 percent of applications for permission to import restricted western consumer goods were granted in the first half of 1991, and licenses are now required for only 10 percent of imports.

Full convertibility of the forint is expected by 1994; this will involve a substantial devaluation of the forint. The official exchange rate of 75 forint to the dollar will need to be brought more in line with the black-market rate of 85-90 forint to the dollar.

The government hopes to privatize 50 percent of state assets by 1995. Thus far, only 12-15 percent of state assets have been privatized. Obviously, privatization must be accelerated for the government's ambitious goal to be realized. Unlike Czechoslovakia and Poland, Hungary has no plans for giving away state assets through a mass share distribution scheme. Instead, the State Property Agency (SPA) relies on a variety of approaches to quicken privatization such as controlled spontaneous privatization, investor-led privatization, public stock offerings, direct trade sales, and Hungarian-style corporate takeovers.

Romania

The economic outlook for Romania is the bleakest in Eastern Europe. Ceausescu's policies of harsh austerity and forced industrialization left the country utterly impoverished; Romania's per capita income is the lowest in Eastern Europe. The country's political instability delayed the implementation of economic reform.

Since December 1990, the economy has rapidly deteriorated. Industrial output fell 20 percent, yet wages increased on average 100 percent. Economic decision making became fragmented and there was no significant increase in private sector activity. Food and heating were rationed.

The dire economic situation forced the government to introduce market-oriented reforms in 1991. Prices and wages have been partly liberalized. However, price controls remain on 30 percent of items in an average family budget. These controls are creating supply and demand imbalances.

Wage ceilings should temporarily slow the exorbitant wage increases, however various proposals to index wages to inflation, if implemented, will set off an inflationary wage-price spiral. This would ruin any chance the economic reform program has to succeed and further deter foreign investment. Seeing the likely consequences of wage indexation. Finance Minister Eugen Dijmarescu spoke out against the idea.

The lei has been devalued three times in an attempt to move towards internal convertibility, but the official rate is still overvalued. It is likely that Romania will stay for the time being on a dual exchange-rate, with an official rate applying for certain goods and services, and a market rate for all other products. Prime Minister Petre Roman stated in late June that the lei would be fully convertible within three months. The exchange rate will be fixed between the official rate - 60 lei to the dollar - and the black market rate - 200 lei to the dollar.

Privatization has moved very slowly, however the government is committed to giving back to the people 30 percent of the total stock of state assets. Thus far, a comprehensive plan detailing how to distribute shares in state enterprises or mutual funds to the Romanian citizens has yet to be unveiled.

A new round of economic reforms was announced by the government in early July: taxes and customs duties will be cut, all price controls will be phased out by January 1992, inefficient, unprofitable state enterprises will be allowed to go bankrupt, and the lei will be made convertible by year's end.

Romania does not have a substantial foreign debt to worry about, but the legacy of Ceausescu starved the economy and left it fearfully weak. Vast amounts of restructuring are still to be done before Romania rejoins the rest of the economic world, however the government's newfound determination to push ahead radical economic reform is encouraging.

Yugoslavia

For years, Yugoslavia was considered the showpiece of East European socialism. It was relatively prosperous compared to the other East European countries, however the country's civil war and Serbia's refusal to abandon communism has wreaked havoc on the economy.

Prices and trade have been liberalized to a great degree and in the first phase of reform (early 1990) inflation was substantially reduced after reaching 2700 percent in 1989. However, inflation is once again out of control due to the government relaxing monetary policy. This led to the beginning of a wage-price inflationary spiral.

Industry remains in the hands of the central bureaucracies, and production, down 10 percent in 1990 and 25 percent so far this year, is expected to decline by a total of 30 percent by the year's end. Unemployment is difficult to precisely calculate, but estimates range from 5 percent to 18 percent and rising. The prospects for improvement of economic conditions are bleak as long as the civil strife continues and Serbia continues to bully the other republics.

Any economic reforms taking place in Yugoslavia before Slovenia and Croatia's declarations of independence came from the republic governments, not the Serbia-dominated central government.

Conclusion

All in all, most of Eastern Europe appears to be moving ahead fairly rapidly with various reform programs. Strict monetary policies need to be retained, however much greater emphasis must be given to structural and "micro" reforms.

The tax systems, which are some of the most burdensome in the world on private businesses need to be overhauled. The prohibitive tax burdens on businesses slow economic growth and development by discouraging hard work, savings, investment and the production of goods and services. Also hindering the rapid development of new businesses are government regulations, difficulties in obtaining business licenses and numerous other bureaucratic obstacles which should be eliminated.

Also obstructing the East Europeans on the march to the free market are communist apparatchiks who are still blocking reform at all levels of government. For instance, Poland's ambitious mass privatization plan was recently rejected by the communist majority in the parliament's lower house.

As structural and "micro" reforms are implemented and the private sectors rapidly grow - from the ground up - the economies should begin to grow. Economic growth, in turn, will allow the East European people to see the tangible benefits of free trade and free markets.

NOTES

1. World Economy Research Institute, Poland: International Economic Report t990ll991 (Warsaw: Warsaw School of Economics, 1991), p.64.

2. Most of the increase came in trade, not production. Production output of the private sector grew 8 percent in 1990.

3. John Williamson, The Economic Opening of Eastern Europe (Washington, D.C.: Institute for International Economic Affairs, 1991, p.74.

4. The privatization ministries are then charged with accepting the enterprise's plan for privatization or choosing an alternative approach.

5. This on lop of Hungary's debt payments, which, per capita, are the highest in Eastern Europe. Debt service is 10-11 percent of Hungarian GNP.

William D. Eggers is a policy analyst in East European and Soviet economic affairs with The Heritage Foundation in Washington, D.C. Research assistant Christopher Jones contributed to this article.