The Presentation Today

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• Definitions
• Traditional literature on the transition
  characterises policy quality from the speed and
  degree of implementation of the main
  prescriptions of the Washington Consensus
• - macroeconomic stabilisation
• - price and foreign trade liberalisation,
• - privatisation (the good policies,
  Balcerowicz, 2003)
• OR from the EBRD indices of Transition Progress
  private sector share of GDP, small and large
  scale privatisation, governance and enterprise
  restructuring price liberalisation, trade and
  exchange rate system, competition policy banking
  reform and interest rate liberalisation,
  securities markets and non-bank financial
  institutions infrastructure

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• OR the cumulative summation of these indices over
  time, e.g. the Cumulative Liberalisation Index
  (CLI) used by Fischer and Sahay (2000).
• Critics, in turn, simply tend to juxtapose
  gradualism to shock therapy within the same basic
  approach.
• We, instead, call for a greater consideration of
  policy quality, judged from
• the consistency or targets,
• the choice and intensity of qualitative and
  quantitative policy instruments and packages,
• their sequencing and speed,
• the coordination of policies delegated to
  different agencies.

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A choice between shock therapy or gradualism
exists only in a handful of areas (1) trade
liberalisation, (2) the elimination of subsidies,
(3) privatisation, (4) capital account
convertibility and, especially, (5)
dis-inflation. Here relative merits of speed
and delay depend on the actual trade-offs between
targets at a particular time and place, and on
government preferences. Gradualism may have net
advantages. There were benefits from Polish slow
disinflation, its late mass privatisation, its
delay in capital account convertibility or from
Czechoslovak maintenance of price and wage
subsidies. Conversely, Polish and Czechoslovak
rush to liberalisation, soon reversed, only gave
two unnecessary jolts to their economies.
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2. Overshooting stabilisation programmes  In
1990-91 undoubtedly the Polish stabilisation plan
overshot, and so did many of the plans that took
it as a blueprint. On 1-1-1990 the exchange rate
was set at the rate prevailing in the free
segment of a dual market, obviously higher than
the equilibrium rate in a unified market. This
was inflationary. Nominal monetary targets, based
on an under-estimated prospective inflation, led
to an unintended credit crunch. Real wages,
indexed with very low elasticity with respect to
prices, took the brunt of adjustment they
collapsed and so depressed consumption demand.
Investment was out of the question.
Inflationary paper profits boosted tax
revenues, generating an unintended budget
surplus. An unintended current account surplus
was generated by recession and excessive
devaluation, building up foreign reserves that
had to be expensively sterilised. Disorganisation
was rampant, and recession set in.
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The initial tasks confronting the Polish
government were daunting they were navigating in
uncharted waters. But without hindsight it was
clear that their programme would have
overshot. Imagine an alternative scenario
prices are freed to market-clearing level, but
wages are also freed, or a lower and affordable
real wage is indexed at 100 instead of the
entire current level being indexed at only 10 of
inflation. Money targets are kept constant in
real terms the zloty floated and thus
initially devalued much less than it was money
interest rates are adjusted more frequently,
rising and falling with inflation but more
slowly, without targeting intermittently a
positive real rate. Under this set of policies
overshooting, if any, would have been less
severe. Frequently over-shooting takes the form
of excessively high interest rates.
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3. Real interest rates   Targeting positive real
interest rates is not supported by any known
economic theory. They are supposed to encourage
savings but outside the hyper-inflationary zone
savings may or may not be promoted by high real
rates. An ageing population, for instance, like
any target-saver might save more at lower
rates. In any case real interest rates in the
transition have been highly variable and
occasionally exceedingly high. In the next figure
they go off the scale, being taken to extremes in
Russia in 1994. In Poland in 2000-2003 real
interest rates were maintained above 6 for
inflation rates below target and below Eurozone
inflation. Note that the rates in the figure
are calculated deflating money rates at current
inflation, and therefore are under-estimated at
times of de-celerating inflation as in most of
the period considered.
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High interest rates are recessionary through
their impact on both investment and international
competitiveness (through stronger exchange
rates). In Russia they encouraged the
de-monetisation of the economy (through barter,
payment arrears, money substitutes).
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4. Other examples of poor policies
Non-sustainable combinations of high interest
rates, overvalued exchange rates and low targets
for government deficits these are the
ingredients of the Russian financial crisis of
August 1998, and other instances such as the
Czech koruna crisis of 1997. Exchange rates
boosted by high interest rate policies undermine
their own credibility by adverse impact on the
trade balance and the cost of servicing
government debt. Setting limits to the
government deficit calculated on a cash basis
instead of accruals gives an incentive to the
government to postpone expenditure rather than
restrain it together with high interest rates it
was a major factor in the de-monetisation of the
Russian economy, through arrears in the payment
of wages and salaries, pensions and government
purchases from enterprises also caught in the
chain and responding with their own arrears
including tax arrears.
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Paradoxically, excessive real interest rates,
non-sustainable packages of interest/fiscal and
exchange rate policies, and cash limits for
government deficits are all enshrined in IMF
and World Bank policies. Another form of poor
quality is that of policy reversals. Beside the
protectionist involution of many countries after
initial over-enthusiastic and unilateral trade
liberalisation already mentioned reversals
have occurred, for instance, in the macroeconomic
stance adopted in Russia in 1992 by the
government in January-April and undone by the
Central Bank in the second half of 1992 with the
restoration of enterprise liquidity through large
scale. In Poland in 1995 the exchange rate was
forced down along the ceiling of the band around
the crawling peg only to be pushed up
intermittently by the market.
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Under Balcerowicz Mk-I unemployment rose from a
negligible level to a peak of 16.9 in 1994 due
to the government policies of 1993. Under Kolodko
unemployment fell by a million to 9.8 and GDP
rose by 28 (corresponding to almost the entire
increase of 29 that occurred in 1989-2001). In
September 1997 during the electoral campaign
Balcerowicz produced a three-page document dubbed
by the press The Second Balcerowicz Plan. He
criticised the government for having a too low
growth rate and proposed to raise it so as to
double GDP in the following ten years. (The rate
was 7.5 in the second quarter of 1997, already
higher than the 7.2 necessary to double GDP in
10 years). Back in government, Balcerowicz Mk-II
adopted a policy of cooling (zachlodzenie),
indeed overcooling (przechlodzenie) the economy
down to 3 in the second quarter of 2000 when he
stepped down as Minister of Finance, though he
acquiesced to a budget deficit increase under
Solidarity pressures.
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Growth deceleration continued under the influence
of high interest rates and strong exchange rates
adopted by Balcerowicz Mk-III (as Governor of the
National Bank of Poland), over-fulfilling the
target of inflation reduction and raising
unemployment (from 9.8 under the previous
government back up to over 17. Income growth
acceleration resumed when Kolodko Mk-II took over
again as Finance Minister (2002-2003), with his
policies of financial restructuring and debt
reduction of enterprises institutional
developments more active public policy
especially in investment reform of public
finances. Unfortunately the latest fiscal
incontinence of the Polish government has gone
some way towards justifying ex-post the
deflationary stance of NBP. Identical relative
performance applies to investment and GDP growth.
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GDP dynamics and unemployment rate in Poland in
19902007( 2004-06 forecast from PNFR
Program of Public Finance Reform)
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6. Central Bank Independence in the
transition CBI is a fairly recent invention,
dating from the 1980s. It is the child of
rational expectations theory and the vertical
Phillips Curve, and concerns for the credibility
of monetary policy (see Kydland-Prescott 1977 on
time inconsistency of discretionary monetary
policies, Barro-Grossman 1983 on reputation
building, Rogoff 1985 on the conservative
independent central banker). Transition
economies have implemented also due to
international pressure the German model rather
than the milder British, Japanese or even US
model of CBI, and in an even stronger version
(Alex Cukierman et al., 2002). This model has not
always performed well in the transition
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- some central bank governors look independent
but are not (Belarus)      - other central
bank governors are truly independent from the
government but are not exactly politically
independent technicians   - some
independent central bankers have pursued policies
manifestly contrary to the pursuit of price
stability (Russia 1992)  - real interest
rates have been pushed to inordinately high
levels (Russia 1994, Poland, etc.), as we have
already seen, with respect to the requirements of
domestic and external balance
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- Inflation targets have been treated not as
something to hit but to overfulfil, as if they
were central planning targets, and without
adjusting accordingly nominal interest rates
(Poland 2002, unlike the Czech Central
Bank in identical conditions).  
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7. Fiscalmonetary policy co-ordination An
independent Central Bank is confronted by an
equally independent government this raises the
most important issue of fiscal-monetary
coordination. It is well known that failure to
coordinate leads to higher fiscal deficits,
higher interest rates and stronger exchange rates
than would prevail in case of co-ordination, thus
adversely affecting output, net exports and
therefore employment.   A particular issue of
such fiscal-monetary coordination in Poland in
2003 has been the possible mobilisation of 7bn
reserves (out of a total of about 32bn) or about
3.5 of GDP, representing profits (half actually
realised) from the purchase of foreign
currency at exchange rates stronger than the
current rate.
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CONCLUSION   There are many ways to skin a cat
and to run a transition economy. The adoption
of simplistic hyper-liberal prescriptions such as
shock therapy in all policy areas, privatise,
privatise, privatise!, central bank independence
etcetera, ignoring the wide and complex range of
policy alternatives and the possible and likely
ways in which things can go wrong, can be and has
been in the transition a costly undertaking.
Differential performance of transition
economies cannot be explained satisfactorily
without facing the direct and side-effects of
widespread poor policies.