 than they were in the s and the s, but real long-term interest rates, which were very high for a long time, have fallen only slightly below those in the United States which is at a very different stage in the cycle and need to fall further if investment is to rise and capacities to expand sufficiently to absorb the unemployed.
In sum, a significant cut in unemployment in the EMU area requires a period of above-average rates of investment and of output growth. The confidence with which the prescription is administered does not yet correspond to a convincing mass of evidence". The reduction and control of inflation occupies a prominent position in the "Washington Consensus" and has clearly been given high priority in western Europe and in the transition economies.
This was a reaction to a general acceleration of wage pressures in Europe in the late s and the cost-push effects of the two major oil shocks of the s. The key argument for focusing on inflation as a principal objective of macroeconomic policy is that it distorts the information content of the price mechanism and by disrupting the basic coordination system of the market economy reduces the propensity to invest and hence economic growth.
Also high rates of inflation are often accompanied by high rates in its variability and this also has a negative effect on expectations. The justification for continuing to give priority to inflation control, even when it has virtually disappeared in western Europe, is that without an attentive monetary policy it can quickly accelerate and veer out of control again. But both the costs of inflation and the dangers of acceleration once any slippage is allowed may be exaggerated. The evidence suggests that inflation is costly in terms of lost output only when annual rates exceed 40 per cent — then there is a danger that high inflation will lead to low growth rates.
In most of the transition economies annual inflation rates are now below 20 per cent, with many in single digits, but, paradoxically, there appears to be a positive relationship between output growth and the average inflation rate between and In contrast, the excessive emphasis on rapid price stabilization in Russia, for example, involving increasingly tight monetary policy, has had highly negative effects on the real economy and has contributed to the growth of payments arrears and other perverse outcomes.
It would not be sensible to react to such price increases with tighter monetary policy. Nor is it necessarily desirable to accelerate the process of freeing controlled prices. It is well known and accepted that public and semi-public housing rents are heavily subsidized in the transition economies and that a move to more economic levels is necessary for an improvement in the housing stock. In western Europe inflation rates are practically zero at the present time yet policy is still deeply concerned that small monthly increases could set off another inflationary surge.
But the evidence suggests this concern is misplaced: there appears to be no grounds for believing that inflation is related to previous rates of increase 14 and therefore little risk of an acceleration getting out of control. Moreover, this pre-emptive stance of monetary policy, at insignificant rates of inflation, appears to make no acknowledgement of the fact that inflationary expectations have changed significantly since the s and s, and that the structural and technical changes that have occurred in the developed economies since then have reduced the likelihood of present wage and price setting behaviour being quickly reversed.
However, the belief that monetary policy will be tightened in response to minor upward deviations from set targets has a depressing effect on expectations of output growth and the propensity to invest. The view that close to zero inflation is a necessary, and even a sufficient, condition for strong, sustained growth and falling unemployment is not based on historical evidence.
But continuing to focus on such an objective is likely to have deleterious effects on the prospects for reducing the currently high rates of unemployment in western Europe. The weak links between strong policy recommendations and the supporting empirical analysis are not confined to the labour market and domestic prices. The transition economies were advised in that price and trade liberalization could not be introduced gradually despite the experience of western Europe which phased out its wartime price controls in line with supply-side improvements to avoid boosting inflation and which, together with North America, started to liberalize its foreign trade gradually over a long period starting in the s and which is still not complete.
Some economists 17 find a close and positive relationship, emphasizing the benefits of removing the static and dynamic costs of import substitution; others 18 contend that the presumed relationship depends on the validity of specific microeconomic assumptions which rarely appear in reality and that once increasing returns to scale and productivity-boosting investment are brought into the picture the standard case for liberalizing trade to boost growth breaks down and a plausible case for interventionist policies can be made.
Again, a careful review of the empirical evidence underlines its inconclusiveness — it is possible that trade liberalization may in fact favour output growth but not in a straightforward manner and that in the short run the adjustment costs may predominate over the benefits. However, there are two points to emphasize here.
First, the scale of the adjustment shock of liberalizing trade will depend on how far the domestic output, employment and relative price structures have to change in response to the new competitive pressures. For many transition economies the scale of restructuring required by the shift from central planning to competitive markets is so large that the domestic economic, political and social institutions, which are also in a state of transition, are unable to cope with the adjustment costs, which in turn may generate large-scale resistance to reform.
The study of Romania in this Survey provides a telling example of this. Secondly, economic growth and development is a highly complex process, the causes of which are still poorly understood; but economic historians, and economists outside the neo-classical persuasion, have always emphasized the crucial role of institutions in stimulating and facilitating the process of change and of mobilizing and expanding the resources available for development. In the presence of a heavily distorted output structure, weak corporate governance and the absence of appropriate institutions — the situation in many transition economies — rapid trade liberalization may be more likely to lead to unemployment and stagnation rather than economic growth and positive structural adjustment.
But generalizations are difficult. Poland, Hungary and, to a lesser extent, the Czech Republic appear to have gained from opening their economies to international trade, but there is little sign of similar responses in Romania or Russia or many of the other countries that are lagging behind in the process of reform. It is sometimes argued that the transition economies where GDP growth has been most rapid are those where liberalized trade and current accounts emerged quickly, where structural reform was rapid, and where inflation was falling.
An alternative view is that the most successful reformers appear to be those where the initial conditions — in terms of both the required scale of restructuring and the institutional capacity to handle it — were more favourable to a faster rate of transition. In other words, governments were able to implement — and their electorates were willing to tolerate — a faster rate of change than in other transition economies.
But this means that the pace of reform is largely determined by the historical legacy and not only by the choice, or the "political will", of governments. To a considerable extent, the predominant concerns are the same in most countries, and the. These pressures are likely to push countries in similar directions.
However, policy issues alone do not determine the course of reform. Another consideration is the political framework—what ideas are predominant, or what schools of thought compete on the policy-making stage, and what ideas and interests the politicians represent. Finally, the purpose of this chapter is to assess how these considerations affect the kinds of states the former communist countries are becoming and what future developments appear likely.
Thus, the last section suggests four plausible future models, commenting on the probability of each and what factors may influence them positively or negatively. The aim of post-communist economic transition can be described broadly as to build capitalism—to depoliticize the economy, to activate markets, and to institute private ownership of the means of production Kornai, An underlying belief supported by the new institutional economic history is that the economic institutions of capitalism can generate economic growth North, A number of recent econometric studies covering a large number of countries support this view Sachs and Warner, ; Gwartney et al.
A number of the 22 countries of interest here appear already to have entered a period of sustained economic growth under a new economic system. Yet only Poland, having recorded several years of considerable growth, appears to have entered a stage of sustained growth. However, in most cases it takes a long time before substantial growth can be expected. What other criteria can be used to measure the attainment of capitalism? We have settled for a qualitative target—capitalism—and its attainment should be measured by qualities. Three obvious criteria are financial stabilization, liberalization, and private-sector development: financial stabilization means that money is stable enough to function as a reliable means of exchange, liberalization is necessary so that market allocation can substitute for vertical state commands, and a dominant private sector is required to render ownership apolitical and pluralist.
Each of these three criteria can be quantified, and the question is at what point we can say that a market economy has been reached.
In practice, the most obvious success indicator has been low inflation. The control of inflation and the return of economic growth are closely related. No post-communist country has restored growth without limiting inflation to 40 percent per annum or less, while all the countries that have contained. There is also a strong correlation between inflation and decline in output.
In, nearly all the countries got inflation down to below 40 percent per annum. In Belarus, on the other hand, inflation may explode again. There have been several such cases in which inflation has fallen temporarily to a low level and then increased. Examples are Russia and Ukraine in the summer of In those two cases, the temporary stabilization was based entirely on monetary policy and not on a sufficient reduction of the budget deficit. Sustained monetary stabilization needs to be based on fiscal adjustment as well. Only when the budget deficit has been limited so that what remains can be