Neoliberalism’s Inherent Problems

Why was the path to market economy—to use a buzzword of the nineties—so rough? Most transitology attributes the crises of the 1990s to insufficient, abortive, or half-hearted attempts at reforms—in a sense, then, to a lack of neoliberalism.31 It is true that the drawn-out reforms in Romania, Bulgaria, and Ukraine had worse results than the shock therapy in the GDR and Poland, or its milder variants in the Czech Republic, Slovakia, and Hungary. But the other extreme—weakening and self-disempowering the state, as occurred in Russia under Boris Yeltsin—was equally fatal.

Even if privatization, the key element of reforms, had worked as the experts had intended, one inherent, systemic problem would have remained: an excess of state companies for sale. Even if there had been more Western investors, the oversupply was bound to cause a sudden drop in prices (here, one might even justifiably say “there was no alternative”), and the closure of tens of thousands of companies. Because there was a glut of state enterprises on offer, many were sold at dumping prices or with massive subsidies from the state. Western investors were able to cherry-pick state socialist assets. The mass-scale, rapid privatization of half a continent’s state industries depressed “the market.” It was no auspicious start for the fledgling market economies.

The excess of companies earmarked for privatization had a second, unintended result, which can be illustrated by the example of the automotive industry. Western groups such as Volkswagen and Renault took the opportunity to acquire companies like Škoda in the Czech Republic or Dacia in Romania. But one such takeover was enough to break into the postcommunist automobile market and export to Western Europe. With so many state companies on offer, a number of them, including FSO in Poland (where the Polonez was produced), ARO in Romania (an off-road vehicle manufacturer), and VAZ in Russia (Lada), failed to sell. These enterprises or parts of them were eventually privatized with great difficulty, but many other companies and works remained unsold. This could be regarded as a form of market adjustment, which the architects of privatization had taken into account and even welcomed. A less welcome side effect was that the millions of newly unemployed consumed far less. The impoverishment of large sections of society caused a downward spiral that also hampered many of the new businesses founded in the early nineties. A third problem of privatization was that Western investors were also concerned with eliminating potential rivals in order to dominate the market. For this reason, some of the companies which did not find international partners fared better than those which were sold right away, disproving all the prognoses of the early nineties. One example is the Polish shipbuilding industry in Gdynia, which experienced a positive boom in the late nineties and even expanded into the old EU countries. It was hit by bankruptcy in 2007, however, when the competition from China and South Korea grew too strong and the European Union refused the Polish government any further assistance.

China and Vietnam proceeded differently with their state industries. Both these countries kept existing combines under state control but left new industries to the private sector. Only an in-depth comparison of countries, branches, and companies could show which approach to transformation was more successful in the long term. The Polish shipyards were driven out of the market partly because the Chinese currency (yuan, officially renminbi) remained undervalued while the fully convertible Polish złoty appreciated against the dollar. Moreover, Polish workers demanded higher wages than their counterparts in China. Hence, other factors than gradualism versus shock therapy need to be taken into account. Nevertheless the early and radical liberalization in Poland had severe side effects and triggered a process of deindustrialization, which the West had been going through since the 1970s.

The historical comparison of different paths of transformation points to another factor: timing. This was a variable that was given little consideration in the Washington Consensus or by the individual national reform strategies. Whether Western investors could be found for postcommunist companies depended to a large degree on when reforms and privatization were concluded.

The countries of East Central Europe, where regime changes first took place, had a head start of two years on the former Soviet Union and its successor states. Southeastern Europe, where the postcommunists remained in power after the first free elections, also experienced economic reforms later. These countries were, moreover, disadvantaged by their fewer contacts with the West prior to 1989. Consequently, Western corporations which had already invested in Hungary, the Czech Republic, or Poland—geographic proximity to the European Union was another significant factor—had fewer incentives to take over or found additional factories in the Baltic states, Southeastern Europe, or the former Soviet Union. In general terms, this shows that neoliberal reforms could never be the ideal way for every postcommunist country, even if stringently implemented. Contingencies, which have been shown to affect every historical process, played an important part.

Paradoxically, timing disadvantages, and the emulation of the “reform pioneers,” triggered a new dynamic toward a neoliberal order in the late nineties. The governments of the Baltic states, Slovakia, Romania, and other countries were sorely aware that the first window for entering the global markets had closed. These latecomers became all the more determined to jump on the neoliberal bandwagon, in order to claim their share of international investments. They attracted Western companies with even more radical reforms, and lower social security contributions and tax rates. The result was a second wave of neoliberalism. In turn, this competition (Mitchell Orenstein describes it as “competitive signaling”)32 put additional pressure on the pioneers and ultimately on the entire European Union. Some countries reacted by partially turning away from the neoliberal model, albeit on more political grounds. Examples are the special case of Belarus and in some respects the Russian Federation since President Vladimir Putin’s second term in office.

A fourth problem inherent in the neoliberal order was the liberalization of foreign trade. Milton Friedman and a number of Eastern European experts argued that the domestic and foreign competition would drive state enterprise to modernize. But the formerly state-run industries were simply not able to compete, especially in consumer goods manufacturing, where there was much pent-up demand in the nineties and thus great potential for growth. When the import market was opened, the citizens of the former Eastern Bloc were keen to buy Western products. They had had enough of scratchy toilet paper, dreary suits, and unreliable washing machines and cars. Domestic industries would probably have been able to manufacture the desired products themselves in a few years, but the colorful consumer world of the West was initially far more attractive. In the former GDR, a pioneer of liberalization, this problem was especially pronounced. Eastern products were hard to sell in the early nineties. They did not gain greater consumer appeal until “ostalgie” (nostalgia for East Germany) evolved, endowing them with symbolic value. Again, Russia was an extreme case. Liberalization and the complete neglect of domestic agriculture and food manufacturing had absurd results. In the mid-nineties, the supermarkets of St. Petersburg and Moscow stocked almost exclusively imported foodstuffs. This placed a strain on the trade balance and further hampered the domestic consumer goods industry and agriculture.

A fifth problem was the routine approach to economic recipes. When introducing reforms, policymakers paid too little regard to the fact that each postcommunist country presented a different set of economic, social, and cultural circumstances (which are analyzed in greater depth in the section on human capital). However, in the course of the transformation crises, neoliberalism proved adaptable. Even convinced neoliberals such as Leszek Balcerowicz and Václav Klaus ultimately acted with pragmatism.

This raises the question of whether neoliberalism is a consistent ideology at all.33 As discussed above, the neoliberal practice of the 1990s entailed a number of deviations and compromises, but the core remained the same throughout: privatization (especially, but not only, in the economic sphere) and faith in the efficiency and rationality of the market. Flexibility is one of the major strengths of the neoliberal order. Despite the transformation crises, market economies developed in all postcommunist countries—even in Belarus to a degree.

Contrary to the neoliberal condemnation of big government, the success of new market economies depended primarily on the conditions provided by the state and administrative reforms. Liberalization and deregulation, on the other hand, proved counterproductive time after time. This is illustrated by a historical comparison with the postwar era in Western Europe (or the Western-oriented countries of the Far East, such as Japan, South Korea, and Taiwan). The socioeconomic context in the Federal Republic of Germany and other Western European countries was more conducive to developing new industries and export markets. In relation to the countries’ purchasing power, the deutschmark, French franc, Italian lira, and other currencies remained undervalued for many years; foreign trade was liberalized in stages. Thus market players could concentrate on the domestic market before starting to export.

Moreover, the currencies’ exchange rates were fixed by the Bretton Woods system, and flows of international capital remained regulated. A flight of capital as occurred from post-Soviet Russia could not happen under these conditions. Had they prevailed in Russia, they would have forced the oligarchs to reinvest more of their profits at home.

But the postwar Western economic system had ceased to exist in 1973 (when the oil crisis broke out, by which time the Bretton Woods system had already collapsed). Two decades later, it could have provided retrospective inspiration at best. Since the failure of gradual reforms to socialism prior to 1989, there was no approved or even broadly debated countermodel on a global level. True, the reforms in Eastern Europe were moderated in the mid-nineties in response to the acute crises and problems. But the postcommunists and the Left in the West lacked the power and intellectual resources to develop a convincing alternative to the Washington Consensus.

China, where the economy remained much more tightly regulated, might have provided a countermodel. Here, market-based reforms were tried out on certain economic sectors or special zones (such as Shenzhen) before being applied to the entire country. In the nineties, however, the viability of the Chinese economic model was yet to be proven. Furthermore, China’s gradual reform program was devised on the premise that the communists maintained their power monopoly. That would have been unacceptable in Europe, though Putin’s advisors began to contemplate the Chinese model toward the end of his first term. They suggested that the Chinese combination of capitalism with an authoritarian regime might be better suited to Russia than attempting to apply neoliberal reforms.34

Although some policymakers in the nineties had fundamental misgivings about the neoliberal order, they rarely expressed them. Openly denouncing market failures or criticizing capitalism would have seemed iconoclastic then. On the contrary, key players such as Leszek Balcerowicz vigorously defended the shock therapy, albeit for surprisingly disparate reasons. While in 1989–90 Balcerowicz pleaded mainly economic reasons (that there had been no alternative), in his 1995 review of transformation he cited mainly political arguments. Above all, he argued that it was necessary to present the reform-averse populace with a fait accompli in order to implement the reforms.35 In addition, shock therapy served to remove the “red barons” and weaken postcommunist networks. Perhaps Balcerowicz’s inconsistencies were overlooked because the reforms were starting to take effect. Poland took the lead again, achieving economic growth in 1992, and slowly raising wages and salaries in the following years. Hungary and the Czech Republic also experienced recoveries, and the Baltic states began to prosper. (See fig. 4.2. For the sake of visual clarity, this shows a selection of, rather than all, postcommunist countries.)

Fig. 4.2.  Transformation crises and economic growth, 1992–2000. Source: WIIW Report 2012 (Table I/15).

Inviting prospects were painted, then, on a global level (by the IMF, the World Bank, the OECD, and other international organizations) and within the former Eastern Bloc. This dynamic explains the fact that all postcommunist countries in Europe applied similar economic recipes over the course of the 1990s, regardless of the sometimes-devastating transformation crises that arose. While variations were possible, from voucher privatization to manager buyouts and bidding processes, each had the same goal of privatization. Some countries hesitated initially to open their markets to Western imports, but eventually foreign trade was liberalized in all of them. Deregulation followed either from above, by reform legislation, or as the indirect consequence of weakened government.

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