Out of the Red: Building Capitalism and Democracy in Postcommunist Europe

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After the fall of the Berlin Wall, the countries of East-Central Europe embarked on a journey to transform themselves into democratic capitalist societies. Their governments searched for strategies that would allow them to pursue radical market reforms within the context of nascent democratic politics. Poland adopted a neoliberal strategy that attempted to push through as much reform as possible before an antireform backlash could occur. In the Czech Republic, a social liberal strategy for transformation attempted to combine neoliberal macro-economic policies with social democratic measures designed to avert such a backlash.

A detailed analysis of Poland and the Czech Republic suggests that alternation between strategies has been the secret to the success of East-Central European countries.

This comparative case analysis identifies the significance of reform mistakes during transition and the corrective benefits of policy alternation, its claims illustrated with an in-depth study of privatization policy in the two countries.

Mitchell A. Orenstein delves into the historic struggle to build capitalism and democracy during a decade of post- communist transition in East-Central Europe and develops a model that explains why democratic policy alternation may accelerate policy learning under conditions of uncertainty and constraint.

Out of the Red is accessible to a general audience and as such is suitable for both graduate and undergraduate courses on political economy. It will be of particular interest to economists, political scientists, sociologists, students of postcommunism, and anyone interested in the relations between capitalism and democracy in the contemporary world.

Mitchell A. Orenstein is Assistant Professor of Political Science, Syracuse University.

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Out of the Red: Building Capitalism and Democracy in Postcommunist Europe

By Mitchell A. Orenstein

University of Michigan Press

Copyright © 2001 Mitchell A. Orenstein
All right reserved.

ISBN: 047206746X

Strategies for Transformation

The danger does not lie with the masses, as is believed by people who stare as if hypnotised down into the depths of society. The deepest core of the socio-political problem is not the question of the economic situation of the ruled but of the political qualifications of the ruling and rising classes. The aim of our socio-political activity is not to make everybody happy but the social unification of the nation, which has been split apart by modern economic development, and to prepare it for the strenuous struggles of the future.

--Max Weber 1994, 26
Poland's goal is to be like the states of the European Community. Although there are many submodels within Western Europe, with distinct versions of the modern welfare state, the Western European economies share a common core of capitalist institutions. It is that common core that should be the aim of the Eastern European reforms. The finer points of choosing between different submodels--the Scandinavian social welfare state, Thatcherism, the German social market--can be put off until later, once the core institutions are firmly in place.

--Jeffrey Sachs 1993, 5
Governments that came to power in 1989 in East Central Europe had to develop "strategies for transformation" that addressed the central problem they faced of building capitalism under conditions of political democracy. Throughout the postcommunist countries, the most influential strategy, in both its economic and political dimensions, was the "neoliberal" strategy, often called "shock therapy." Neoliberal strategy for transformation emphasized the importance of establishing basic economic reforms to promote growth and market rationality in the face of democratic interest group opposition. It proposed to create free markets, free trade, and a stable monetary environment quickly before such political opposition could emerge. The neoliberal strategy for transformation was widely debated in postcommunist Europe and criticized in some circles for posing a threat to democracy. These critics generally argued that shock therapy's single-minded pursuit of economic reform endangered support for and development of democratic institutions. They recommended that governments should instead pursue more cohesion-oriented strategies that would compensate reform losers and tie the interests of a broader cross-section of the population into the reform effort. This chapter explores both theoretical positions and the conflict between them that unfolded over the period 1989-99. This provides an important background to the study of actual governmental strategies for transformation in Poland and the Czech Republic since 1989, because these theories often deeply influenced practitioners of reform.

Neoliberal Economic Blueprint

In both Poland and the Czech Republic, neoliberal economic blueprints were deeply influential for the project of building capitalism. Neoliberal economic programs proposed for postcommunist Europe drew heavily on previous applications of the so-called Washington consensus on economic policy in countries around the world (Williamson 1990, 1997; Naim 2000). Despite some obvious peculiarities of the postcommunist countries, leading neoliberal economists quickly came around to the view that postsocialist economies would respond favorably to the same basic package of stabilization and liberalization measures normally applied elsewhere in the developing world (Blanchard et al. 1991, 1). According to a short book coauthored by Olivier Blanchard, Rudiger Dornbusch, Paul Krugman, Richard Layard, and Lawrence Summers in 1991 that I take to represent a consensus statement of "the mainstream of modern Western economics" (as claimed on the back jacket), two features distinguished the postcommunist countries from others. First, the distorted price structure of socialism was expected to result in "larger changes in relative prices, income distribution, and firms' financial positions than is typically the case during stabilization" (Blanchard et al. 1991, 2). Second, the different institutional and ownership structure of the former socialist firms was expected to cause them to adjust differently than in traditional market economies. Under socialism, most enterprises were state owned and responded more to administrative decisions of the responsible "line" ministries than to price signals or market demand. For this reason, rapid privatization became a major priority of neoliberal reform, along with macroeconomic stabilization and price and trade liberalization.

Neoliberal economic reform programs consisted of three basic elements: stabilization, liberalization, and privatization. The logic of stabilization and liberalization derives from the equilibrium theory that lies at the heart of neoliberal economics, combined with the monetary theory of inflation. Since inflation is caused mainly by monetary expansion, neoliberals prescribed a stabilization package that would cut fiscal deficits, stem monetary growth, and eliminate price-distorting subsidies to public enterprises (Blanchard et al. 1991, 5). Simultaneous price and trade liberalization would cause prices to quickly adjust to equilibrium levels, under a sustainable macroeconomic regime. Accurate price signals, once attained, would cause economic actors to adjust their behavior spontaneously to market rationality (Johnson and Loveman 1995).

However, recognizing that stabilization and liberalization would at first cause an initial bout of inflation, neoliberal economists counseled reliance on stiff tax-based wage controls, to prevent incomes from catching up with prices (Blanchard et al. 1991, 7). In employing wage controls, neoliberals departed from the free market prescriptions of their orthodox liberal forebears. Their reliance on these so-called heterodox techniques, including state intervention to control the price of labor, is part of what marks them as "neoliberals."

Neoliberal economists expected their reform program to be particularly painful in the postcommunist context, but they felt that there was "no way to avoid this outcome" (Blanchard et al. 1991, xiii). Stabilization and liberalization would sharply reduce average real wages in the economy over the medium term. Unemployment rates would rise as enterprises shed labor in an effort to enhance productivity. But these social costs of adjustment had to be paid, and the quicker the better. The process of transition from communism to capitalism was envisioned as a process of creative destruction, like all innovation (Schumpeter 1942; Havrylyshyn and McGettigan 1999b).

Since they expected state-owned enterprises to adjust less quickly than private firms might to market signals, neoliberal economists strongly recommended rapid privatization (Blanchard et al. 1991, xiv). Neoliberal economists also recognized other institutional changes would have to be made, summed up in the rubric of "restructuring." Within restructuring, Blanchard et al. included transforming the banking and financial system; creating conditions for foreign investment; reforming the legal system, particularly commercial law; creating a market in housing to insure labor mobility; and promoting training in core capitalist professions, such as law, accounting, and finance (Blanchard et al. 1991, xvi-xviii). However, neoliberals tended to underestimate the difficulty of such reforms (Johnson and Loveman 1995, 38) and regarded institutional reforms as distinctly secondary, to be left, perhaps, for a second stage of transition. Some important items were left off the list almost entirely, particularly reform of the social sector, such as health, education, and welfare. Only unemployment insurance was a priority area (cf. Sachs 1993, 46). Furthermore, neoliberals offered few substantive ideas or theories for how to restructure supporting institutions of the capitalist economy, such as banks, courts, and universities. Neoliberal blueprints emphasized spontaneous adjustment to market signals and offered little guidance on restructuring institutions, short of destroying them altogether or "privatizing" them.

Neoliberal Political Strategy

Neoliberal economic blueprints were certainly radical, entailing a wholesale transformation of postcommunist economies and societies. How did neoliberals plan to implement painful, long-term programs of stabilization, liberalization, and privatization under conditions of political democracy?

Neoliberal economists generally took an ambiguous stand on democracy, praising it in principle, but decrying many of its effects. While neoliberal economists appreciated the democratic idealism of East Central Europe, they viewed real democratic politics as a potential obstacle to sustainability of radical reform blueprints. Jeffrey Sachs (1993), a Harvard economist who advised the government of Poland on its radical "shock therapy" program of reform, expressed concern that new democratic institutions could undermine reform as a result of (1) organized opposition from interest groups associated with the old regime; (2) disorganized opposition from new populists hoping to capitalize on economic disappointment; and (3) popular uncertainty about the benefits of reform. Sachs notes that reform winners often take years to feel sure about their economic success, while losers feel the costs immediately (see also Dahrendorf 1990). Given this problem of timing and coordination, "the great political task is to follow the path of reform in the face of inevitable anxieties, vested interests fighting for the status quo, and demagogues ready to seek political power by playing on the public's fears" (Sachs 1993, 3). Providing stable political backing for the reform effort was key. Neoliberals therefore generally viewed the problem of simultaneous transition as one of insuring continuity in the face of democratic political risk. This risk was judged to be higher in new democracies than in consolidated ones, because of weak party systems and inexperience in dealing with democratic institutions (Balcerowicz 1995, 151-52).

Neoliberals' strategic response to the dilemma of democratic instability and risk was twofold: to call for the political insulation of reformers from "normal" democratic politics, and to push reform as quickly as possible through a window of opportunity they saw opening after the political revolution of 1989.

In calling for the political insulation of reformers from normal democratic politics, the neoliberal perspective was deeply technocratic. Neoliberals believed that only a politically insulated team of trained economists could devise and implement a radically efficient set of reforms, while withstanding pressures from well-organized interest groups and guarding the stability of reform. They argued that the strongest opposition to reform would come from interest groups attached to the old regime that would take advantage of weak democratic institutions to serve their own particular interests, at the expense of the public good. This discourse of opposition to "special interests" was evident in Western neoliberalism as well under Thatcher and Reagan. Neoliberals, pointing to "public anxieties" about the transformation in the East, also did not believe that individual postcommunist voters would necessarily understand or act in their best interests in the confusing context of transition. Most former communist citizens would not be able to judge what economic policies were advantageous to them and which were not. Therefore, neoliberals argued for placing extraordinary authority in an apolitical "reform team" to enact changes to serve the public interest, properly understood. Neoliberal economists had unbounded confidence in the ability of the Ministry of Finance to isolate itself from politics and make unerring judgments about optimal economic policies. Furthermore, policy mistakes were never a real concern. Like all modern revolutionaries, neoliberal economists believed that they had discovered the right way forward by scientific means. The political problem of transition was envisioned as one of ensuring that the people followed along.

As part of their technocratic political approach, Sachs and others argued for an increase in executive power to facilitate the transition (Sachs 1993, 113). Sachs advocated a strong presidential system similar to that of France, where the president has wide authority to rule by decree. This would enable the president to enact decisions of the neoliberal reform team by decree. Such a strategy corresponded with neoliberal political tactics in countries around the world, which often relied on a "concentration of decision-making power in coherent reform teams that are insulated from the influence of other bureaucratic groups and from business associations, labor unions, various civil society organizations, and political parties" (Greskovits 1998, 35-36). Neoliberals were skeptical of parliamentary democracy, which they believed could easily be manipulated by special interests, and pinned their hopes instead on strong, insulated executive powers. However, despite calling for limits on parliamentary democracy, neoliberals implicitly argued that their strategy would produce more substantively democratic results. Neoliberals were sincere democrats insofar as they believed that remaining true to a technocratic program of economic change would bring widespread public benefit in the future. Public welfare was their chief concern, and this altruism is what they believed set them apart from the "normal" democratic politics of self-interest (Balcerowicz 1995).

The second element of the neoliberal political strategy was speed. Neoliberal economists argued for the necessity of pushing reform through in a brief window of opportunity and getting as much done as possible before a democratic reaction occurred--to ensure against democratic policy instability. Poland's neoliberal finance minister, Leszek Balcerowicz, provided the most sophisticated theoretical presentation of this view in his article "Understanding Postcommunist Transitions." He wrote, "The key to understanding the interaction between the political and economic dimensions of post-communist transitions is to realize that any great political breakthrough in a country's history is followed by a period of 'extraordinary politics' that soon gives way to 'normal politics' " (1995, 160-61). In other words, a political breakthrough like the one that occurred in 1989 was expected to produce a "special state of mass psychology" in which individuals were more willing to act and think in terms of the common good, eschewing the narrow interest-based perspective of "normal politics." Extraordinary politics, according to Balcerowicz, translates into an exceptionally high readiness to sacrifice for the common good; and therefore to accept neoliberal economic reform. "The brevity of the exceptional period means that a radical economic programme, launched as quickly as possible after the breakthrough, has a much greater chance of being accepted than either a delayed radical programme or a non-radical alternative" (1995, 162). Reformers should therefore seize the window of opportunity provided by extraordinary politics to achieve as much of their reform agenda as possible, before the normal politics of self-interest returns.

While Balcerowicz acknowledges that "time-consuming institutional reforms" cannot be completed during the brief window of extraordinary politics, he does not offer any theory of reform under normal political behavior. Balcerowicz instead offers a theory of revolutionary moments, providing the theoretical justification for the political insulation of a reform team, free from "normal" democratic pressures, pursuing its work as quickly as possible, and implementing reforms, if necessary, by decree, before interest groups mobilize and the public sheds its willingness to sacrifice.

Neoliberal political-economic strategy for dealing with the problems of building capitalism under conditions of democracy therefore consisted of three elements:

1. an emphasis on "getting the prices right" quickly and creating a macroeconomic environment that encourages spontaneous adjustment to economically efficient behavior;

2. political insulation of reformers from interest group pressures; and

3. the use of a window of opportunity to push reform through.

Political Sociological Critiques of Neoliberalism

Neoliberal theory and strategy of reform was deeply influential in postcommunist Europe. However, it was far from uncontested. The most influential alternative to neoliberalism came from the standpoint of institutional political sociology or socioeconomics. This approach is based on the view that the economy is only one among several social subsystems (Offe 1984, 52; Etzioni 1988; Potucek 1999), and that for a society to modernize successfully, it must forge complex linkages between the increasingly diversified arenas of politics, society, and economics, effectively institutionalizing conflicts and organizing participation (cf. Huntington 1968, 8-9). This view has its roots in the political sociology of Max Weber and Emile Durkheim. Therefore, I call this the political-sociological or cohesion-oriented perspective (see quote from Max Weber at the start of this chapter), since it emphasizes the need for mechanisms of social cohesion to counteract the powerful and divisive forces of modern economic development.

Many previous authors have identified "gradualism" as the main alternative to "radical" neoliberal economic thought. However in my view, gradualism has always been somewhat of a straw man, constructed by radical neoliberal theorists to help justify their own approach (see also Kornai 2000 on this point). No one, to my knowledge, ever argued that postcommunist Europe should follow the same policies as the radicals advocated, but only more slowly. There have been institutional economic approaches to the problems of transition that suggested that the spontaneous adjustment expected by neoliberals was unlikely to occur because of institutional factors, and that institutional change would necessarily take a long time (Murrell 1992a, 1992b; Dewatripont and Roland 1996; see also Amsden, Kochanowicz, and Taylor 1994). However, it seems more accurate to label this an institutional critique of neoliberal market economics, rather than gradualism. In fact, most everyone now agrees that some reforms can be undertaken quickly, and some more slowly, so even if there once was a division between radicals and gradualists, it no longer exists. The division I point to between efficiency-oriented economic theories and cohesion-oriented political-sociological theories has been the relevant divide in debates on the political economy of simultaneous transition to capitalism and democracy. Still, many analysts have couched the debate in terms of radicalism versus gradualism, so it will sometimes be necessary to use these terms, though advisedly and with the above caveats.

The first political-sociological critique of neoliberal transformation strategy came from Adam Przeworski, a political scientist and social democratic theorist with long experience analyzing neoliberal reforms in Latin America. When the locus of neoliberal revolution shifted from Latin America to his native Poland, Przeworski in 1991 came out with a book, Democracy and the Market, that challenged some of the key propositions underlying the neoliberal strategy. Przeworski's critique centered on the "technocratic policy style" of neoliberalism, particularly the insulation of reformers from interest group pressures and the emphasis on speed. Przeworski argued that neoliberal reformers' insulation from the social costs of transition made them likely to implement reforms that were more costly than most people would prefer. This, combined with the inevitably high social costs of reform and uncertainty about its eventual benefits, would cause an antireform backlash to occur. Here Przeworski concurred with the neoliberals, who also expected a backlash. But he went further by hypothesizing that this antireform backlash would foster a start-stop-start cycle of radical and gradualist reforms (represented by lines R and G in figure 1) that would destabilize democratic politics and undermine the progress of market economic reform.


Excerpted from Out of the Red: Building Capitalism and Democracy in Postcommunist Europe by Mitchell A. Orenstein Copyright © 2001 by Mitchell A. Orenstein. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

List of Figures
List of Tables
Introduction 1
1 Strategies for Transformation 11
2 Poland's Shock Therapy and Beyond 25
3 Czech Social Liberalism and Beyond 61
4 Privatization 96
5 Democratic Policy Alternation 128
Notes 145
References 149
Index 161
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