Creating Market Economy in Eastern Europe

Annual Paper

of “World Economies”

“Creating Market Economy in Eastern Europe”

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The Summary

Introduction

1. Meaning of market Economy and Tasks of the Transitions.

2. The Emergence of Market Economy in European countries.

2.1         . The Transition to a Market Economy.

2.2.  Poland and Hungary as the best example of transition in the East Europe.

 

3.   Moldova’s way to an open economy.

Conclusion.

Introduction

This paper is oriented toward the problems of transition and creating in countries of Eastern Europe, namely Poland, Hungary, all of which are attempting to make the transition under a democratic, parliamentary form of government.

The last new years have witnessed truly extraordinary events in the formally communist societies. Under newly established conditions of free speech and freedom of organization, communist principles of political and economic control have been widely repudiated, and communist governments have been swept aside, replaced by governments committed to democratic principles and a market economy. While in some countries and parts of countries former communist have not been decisively dislodged, in almost all cases communism has lost whatever remaining legitimacy it possessed, and it most of these societies the crucial economic issue has suddenly changed from reforming the socialist planning system by the introduction of market-like elements to moving to a market-economy with private ownership of most of society's assets.

There are several reasons why the task of designing this transition is fascinating, especially to economists.

First, the problem in new: no country prior to 1989 had ever abandoned the communist political and economic system.

Second, the experience to date indicates that countries attempting transition face a number of common problems and difficulties. While there are important differences in the inherited situations and the choices made by governments of these countries, the similarities in the problems they face and the difficulties they are encountering suggest that there is logic to the transition process.

Third, the absence of any close historical parallels and the limited experience economics in transition offer an opportunity and a challenge for development of normative transition scenarios. This turn out, however to be extraordinarily difficult to construct.

Finally, the problems are not waiting for annalists' solutions; decisions currently being made may lead to an evolution with irreversible consequences.

1. Meaning of Market Economy and the Tasks of the Transitions.

That economic system which brings together natural resources, labour supply and technology and which is principally privately owned and were government has to some extent always been involved in regulating and guiding the economy, has been referred to as "Market Economy". Yet, despite this history of government intervention, individuals in that country have always been able to choose for whom they will work and what they will buy.

Now 3 groups make decisions and it is their dynamic interaction that makes the economy operate. Consumers, producers and government make economic decisions on a daily basis, the primary force being between producers and consumers; hence, the market economy designation.

 Consumers look for the best values for what they spend while producers seek the best price and profit from what they have to sell.

Government, at state and local levels, seeks to promote the public safety, provides social safety-net, ensures fair competition and also provides a range of services believed to be better performed by public rather include education, health service, the postal service road and railway system, social statistical reporting and, of course, national defense.

In this market economy system, economic forces are unfettered, supply and demands build up the price of goods and services. Entrepreneurs are free to develop their business unless they can provide goods or services of a quality and price to complete with others; they are driven from the market.

By and large, there are three kinds of business:

1)          those started and managed personally by single entrepreneurs;

2)          the partnership where two or more people share the risks and rewards of a business;

3)          the corporation, there stock holders as owners can by or sell their shares at any time on the open market; this latter structure permits the amassing of large sums of money by combining investment, making possible large-scale enterprise.

Innovations in economic theory in the last two decades undoubtedly affect the way economists look at the transition problem and have probably made them more pessimistic about the ease with which it can be accomplished. Developments in transaction cost economics, the economics of information, the new institutional economics, and evolutionary approaches to economics have sensitized economists to the vital role that institutions play in economic process. One way of thinking about a successful market economy is that it is a set of convergent expectations in the population about how other people will behave; these expectations support an extremely elaborate division of labour or a high degree of specialization among individuals, organizations, and geographic areas.

In recent decades many economists have returned to the Schumpeterian view that the advantage of the market economy (relative to its alternatives) lies more in its facilitation of innovative activity than in its allocative efficiency.

The system of central planning is surely deficient in both respects but it is shortcomings seem to be much greater in the area of innovation than in allocative efficiency.

Another development in economics that has reduced the affractiveness of the large conception of market socialism is the increased attention paid to the motivation of government officials, both legislators and bureaucrats.

In the 1950's and 1960's, much of economic analysis was focused on market failures and government action to remedy these failures, under the implicit assumption that government officials would follow the rules laid down by the authorities. The analysis of the logic of collective action and the formation of interest groups the theory of rent-seeking behavior, and the study of the evolution of cooperation and norms have emphasized that government failure as well as market failure must be taken into consideration in designing institutions.

A vivid analogy stated by Vladimir Benachek of Charles University is that the socialist economics are at the top of a small hill (the planned economy), and they want to get to the top of a larger hill (the market economy). But in between the two hills is a valley, which may be both wide and deep. The analogy illustrates the point that the centrally planned economics did have a coherent economic system (i.e. they were at the top of their hill). One might add that the smaller hill was being eroded by the strengthening of special interest groups and was perhaps, settling due to the seismic rumblings that shattered the communist authority. The band of travelers must settle their differences, agree on a route, and avoid the pitfalls and chasms along the way.

Perhaps economic analysis can facilitate the journey by designing a bridge between the two hills. Given the absence of close historical parallels and the severe limitations of economic models of society it is clearly beyond the capacity of social engineers to draw up very precise plans for the bridge.

 

The Tasks of the Transitions

The list of activities which governments which governments must undertake in countries attempting the transition to a market economy is truly staggering. The list given here is designed to convey something of the enormity and complexity of the job. First, there is a group of activities related to creating a new set of rules:

1.         Setting up the legal infrastructure for the private sector:

Commercial and contract low, antitrust and labour low, environmental and health regulations; rules regarding foreign partnerships and wholly foreign-owned companies; courts to settle disputes and enforce the laws.

2.         Devising a system of taxation of the new private sector:

Defining accounting rules for taxation purposes, organizing an Internal Revenue Service to collect taxes from the private sector.

3.         Devising the rules for the new financial sector:

Defining accounting rules for reporting business results to banks and investors; setting up a system of bank regulation.

4.         Determining ownership rights to existing real property:

Devising laws relating to the transfer of property, and laws affecting landlord tenant relations; resolving the vexatious issue of restitution of property confiscated by communist governments.

5.         Foreign exchange:

a)         setting the rules under which private firms and individuals may esquire and sell foreign exchange and foreign goods;

b)         setting the rules in the same area for the not-yet-privatized enterprises.

Next there are some tasks related to managing the:

6.         Reforming prices:

Enterprises that have been privatized will presumably be largely free to set their own prices, but early on in the process, the demands of the government budget will require raising prices on many consumer goods that have been provided at prices for below cost.

7. Creating a safety net:

Setting up an emergency unemployment compensation scheme; targeting aid in kind or in cash to those threatened with severe hard ship by the reforms.

8.         Stabilizing the macroeconomic:

Managing the government budget to avoid an excessive fiscal deficit and managing the total credit provided by the banking system.

Finally there are tasks related to privatization:

9.         Small-scale privatization:

Releasing to the private sector trucks and buses, retail shops, restaurants, repair shops, warehouses, and other building space for economic activities; establishing the private right to purchase services from railroads, ports, and other enterprises which may remain in the public sector.

10.        Large-scale privatization:

Transferring medium and large-scale enterprises to the private sector; managing the enterprises that have not yet been privatized.

An abstract Model of the Transition consist of three main phases:

Phase 1: The cabinet-level negative phase

In this phase members of the central government interact with nationally representative interest groups. The tasks are organized into two categories: they will determine the general institutional structure of society and set guidelines that will be used in phase 2 to assign each enterprise to one of many alternative "transition regimes".

Phase 2: The assigned phase

In this phase state-owned enterprises are matched with transition regimes. One can assume that each state-owned enterprise is completely described by some vector of attributes. These attributes specify such diverse aspects of the enterprise as:

a)   the nature of the products produced by the enterprise, a description of its plant and equipment, and technology it utilized;

b)   a description of its financial states;

c)   the place of the enterprise within its industry, including its market share and the nature of its competition;

d)   some indication of the risk profile of the firm;

e)   the distribution of information within the enterprise;

f)    the nature of "measurement errors" in monitoring the performance of the enterprise;

g)   the relationship between the enterprise and the state bureaucracy;

h)   the "distance" between the enterprise and founding ministry;

i)    any potential synergies between the enterprise and some prospective foreign investor.

 Phase 3: The enterprise-level negotiation phase

In this phase participants at the participants at the level of each enterprise play an MB game (multilateral bargaining). For each enterprise the structural parameters of the game are included in the characterization of the transition regime to which the enterprise is assigned.