Eastern Europe
Guidelines for reform

There have been various criticisms of the view that there is an `ideal' sequence of actions that the transforming economies of Eastern Europe should take. Some emphasize the differences in their initial conditions and preferred destinations, while others argue that all actions must be taken at once and that their actual sequencing merely reflects the differing speeds at which different parts of the programme proceed; yet others maintain that these programmes are largely beyond policy-makers' control and have a momentum of their own.
In Discussion Paper No. 575, Research Fellow David Newbery sets out the guiding principles whereby policy-makers may best make the choices that become available during transformation process. First, they should keep open desirable and foreclose undesirable options. For example, breaking up privatized monopolies is difficult, but splitting them up before privatization keeps open the possibility of subsequent mergers in cases of genuine synergies. Second, governments' precommitment to future supportive actions is required to rule out the possibility that current choices will be nullified in the near future. This is necessary to assure decentralized agents taking costly current choices that they will receive an adequate fraction of the associated future benefits. Democratic governments may avoid precommitment problems by creating decentralized, autonomous institutions with well-defined mandates for action.
Newbery argues that most of the sequencing issues resolve into three key concerns: ensuring macroeconomic stability; not ruling out options for subsequent reforms, specifically those that promote competition; and maintaining political support for the completion of the reform process. The inefficiencies and stagnation of the Soviet-type economies were intimately linked to their monopolized production structures: enterprises' bargaining power implied that very low-powered regulatory incentive schemes could ensure macroeconomic stability. Systemic reform should aim to improve enterprises' incentives for efficiency, innovation and growth through demonopolization. Small firms would then be disciplined by the credible threat of bankruptcy and compelled to hold down wages and choose investment prudently. Large state enterprises can be broken up while maintaining macroeconomic stability and the necessary social infrastructure by retaining low-powered regulatory schemes for enterprises remaining in the state sector. Newbery warns in conclusion that rapid privatization of existing monopolies may lead to the worst of all possible outcomes: stagnation associated with inequality and social tension.

Sequencing the Transition
David M Newbery

Discussion Paper No. 575, August 1991 (AM)