world war two
Members of the Polish military take part in a ceremony marking the 75th anniversary of Nazi Germany's invasion of Poland, at the World War Two Westerplatte Memorial in GdanskReuters

The International Monetary Fund has stated in transforming communist Europe to the current integrated stage what mattered the most were the reforms that addressed the key imperatives of liberalising prices, stabilizing finances, privatizing state assets and building governance frameworks.

The people who led the reforms, the gravitational pull from Western Europe and the support from friendly countries outside Europe were instrumental for the transition to a market economy 25 years ago, said David Lipton, the First Deputy Managing Director at IMF, in a speech delivered in Warsaw on Friday, (24 October).

"Walking around Warsaw in the summer of 1989 was surreal. Sitting with key parliamentarians from Solidarity, (the first non-Communist Party-controlled trade union) just days after the sweeping and historic election victory, we heard that their plan was to use the newly gained majority in the parliament to force the communist government to carry out reforms and bear responsibility for its legacy," Lipton said.

"At the time, one could understand that impulse. We saw people waiting in lines outside grocery stores that had but a pyramid of canned goods piled in the window," he said.

Lipton said what they later found that the unseen was even worse.

"The economy was weighed down by a huge monetary overhang, the result of a flood of money financed deficits for the budget and state owned enterprises, combined with price controls that prevented the money from being inflated away."

The deteriorating conjuncture was piled on top of a system of resource misallocation and massive waste based on state owned enterprises, with no meaningful budget constraints producing the wrong goods, incentivised by nearly free energy, an unsustainable exchange rate, and accounting for 80% of Poland's exports.

"In the fall of 1989, as controls broke down, and the monthly inflation rate edged up into double digits, money changers one block from the central bank offered more zlotys for our dollars with every new day," Lipton said.

Lack of Experts and Legal Framework

There were no experts available locally or from outside to support or help the transition and even if there were, the legal system was not equipped enough to steer various reform measures.

"Within Poland, as across the region, there were few economists or policymakers with a deep understanding of market economics; and even fewer prepared for the complex task of transformation from central planning to the market. In fact, this knowledge did not really exist in the West either – not in the IMF, not anywhere."

Lipton said the wholesale economic changes required in Poland went far beyond the IMF's traditional macroeconomic expertise, and experience was not readily available.

Experts came from the UK, explaining how "privatisation" had worked in Margaret Thatcher's reforms. But the UK experience - discrete sales of large state firms, within the world's most stable legal and governance framework and based on valuations of assets in a clear economic and financial framework - had very little in common with the challenge facing Central and Eastern Europe.

"Here, the vast majority of enterprises, of every type and condition, needed to be put in private hands in what was largely a legal vacuum, with non-existent capital markets, and often deep macroeconomic instability."

Strategy Debate

In late 1989, a fierce debate broke out over what came to be called gradualism versus shock therapy, Lipton said.

"Many gradualists here and abroad argued that the structural flaws of the economy would frustrate attempts at liberalisation, and therefore that reforms should be implemented in a gradual, sequenced way.

"But for others, understanding the nature of the problem meant the opposite: reform was a seamless web that could only succeed if all the changes happened together."

That said, the evidence from the past 25 years has vindicated the seamless web theory of transition, Lipton said.

"There is an enduring debate about whether living standards fell sharply, or whether official statistics over-counted the disappearance of worthless industries and over-counted the rise in prices of goods that had been unavailable.

"There is no doubt that some reforms took much longer than anticipated, including privatization, both of banks and companies. But it seems clear that the countries that made sweeping changes, and that kept at reform and stabilization have done well."

Lipton said that countries that followed a more gradual path suffered from the decline of the old industries, and did not get the boost from the growth of new firms. In some countries bouts of macroeconomic instability repeatedly undermined reforms and sapped political momentum, he added.

The Present Situation

Most central European countries including Poland have made big economic achievements but challenges remain, Lipton says.

"Several Central European countries, including Poland, have achieved per capita GDP levels—in purchasing power parity terms—that put them on the lower rungs of the income ladder of the Eurozone and climbing."

"But the picture is not all rosy. A number of countries, especially in the Balkans and the Commonwealth of Independent States (CIS), are still far from completing transition, and have gone through repeated cycles of hope followed by crisis."