The widespread optimism that emerged in 1989 as Europe's former centrally planned economies embarked on their transformation to market economies has given way to deep concern. Barring blatant policy mistakes, many expected that rapid growth would enable these countries to catch up with Western Europe within twenty years. Measured output has fallen dramatically, unemployment is fast rising above West European levels, initially explosive inflation remains out of control, budget deficits are deepening, and there is now widespread concern that the economic downturn may prove permanent.

In Discussion Paper No. 734, Research Fellow Charles Wyplosz notes that this rapid deterioration of economic conditions has coincided with the end of the political consensus that seemed to characterize the post-1989 `honeymoon' period. Even as political pressures to slow reform are mounting, however, elections and opinion polls continue to show majorities in favour of continued reform. What initially appeared to be a technical challenge for economists how to reform a former centrally planned economy has now become a challenge for politicians. Even the best- designed policy packages may receive fatal blows from combinations of political forces.

Wyplosz assesses the political acceptability of a `big-bang' reform that is clearly welfare-improving in economic terms since it raises per capita income. He finds that this may be rejected ex ante, however, and even if accepted ex ante, it may meet stiff political resistance ex post. A possible solution would be to adopt a more egalitarian approach, in order to guarantee that `losers' will fare almost as well as `winners', although this runs against well-known disincentive risks. Wyplosz also shows that improved access to cheap foreign loans can enhance a reform programme's political acceptability, although an enhanced role for domestic credit markets may stiffen political opposition by exacerbating ex post inequality.

After the Honeymoon: On the Economics and the Politics of Economic Transformation
Charles Wyplosz

Discussion Paper No. 734, November 1992 (IM)