At a joint discussion meeting with the Commission of the European Communities, held in London on 4 May to mark the publication of Economic Transformation in Central Europe: A Progress Report the following day,* Richard Portes and Joan Pearce reviewed the Central European countries' economic transformation since 1989 and discussed policy proposals for their continued integration into the world economy. Portes is Director of CEPR, Professor of Economics at Birkbeck College, London, and editor of the volume. Pearce is Head of Unit for Eastern Europe in the Directorate for International Economic and Financial Affairs, Commission of the European Communities. The views expressed were their own, however, not those of the Commission of the European Communities nor of CEPR, which takes no institutional policy positions.

Portes noted that macroeconomic stabilization, price liberalization and the development of new private enterprise have proved relatively successful, and exports to the West have grown rapidly, but the development of market economy financial and legal institutions and the restructuring of state industries have been slow. The Visegrad three (now four) have witnessed major declines in GDP and industrial output, and the incipient recovery of late 1992 will require substantial investment if it is to be sustained. This output collapse resulted not from a Schumpeterian process of `creative destruction', but rather from errors in macroeconomic stabilization policy and the relative neglect of structural reforms at the microeconomic level.

Portes then reviewed the key problems now facing the Central and East European Countries (CEECs), in particular the former CSFR, Hungary and Poland. There is a fiscal crisis, since taxes on enterprise profits which previously contributed significantly to state revenues fell sharply with output and profitability, although there has been some progress in controlling public expenditure. And there are deep-seated problems in credit markets. The mere enactment of bankruptcy laws will not enable severely undercapitalized banks to withstand political pressures to finance struggling state firms that are `too big to fail'. Recapitalization of banks is therefore required if they are to reduce `creditor passivity', enforce bankruptcy, and encourage enterprises to secure their own cash flows.

`State desertion' has also left many enterprises adrift, as privatization has moved too slowly to establish new structures of corporate control. New firm growth cannot substitute for restructuring in the short term, so conscious industrial policies are required to deal with the remaining state sector and promote privatization. Incomes policies are needed to legitimize the austerity policies needed to restrict wage growth; otherwise, allowing massive unemployment to become the only means of controlling wages risks a major political backlash. The CEECs must also undertake substantial institution-building if their currently underdeveloped domestic financial markets are to channel their savings which are quite high by international standards into effective investment. The collapse of trade with former Soviet Union and the rest of Eastern Europe has also featured prominently in accounts of the CEECs' output collapse, but their reorientation of trade to the West especially to the European Community has also proceeded much faster than expected. This clearly demonstrates that these economies are capable of adjustment, but their opening to Western imports proceeded too abruptly, and they might do well to consider more protection in the short run.

Joan Pearce welcomed the publication of the book, which was particularly timely because the Commission was in the process of reviewing its programme of assistance to Central and Eastern Europe (PHARE). For several reasons this programme had proceeded more slowly than had been hoped: these economies' transformation was both unexpected and unprecedented, so many policy responses had to be derived from scratch; within the Central and East European countries there were inevitably serious administrative and political obstacles; the Commission services had to cope with a growing number of recipient countries (now 11), whose circumstances differed significantly; and some aspects of technical assistance took time to show results. Furthermore, the programme was required to fulfil three objectives: to be demand-driven, cost-effective and fast-disbursing. But these represented an `inconsistent triangle', since any two could be met but not all three together.

The speed of events in Central and Eastern Europe had imposed an ad hoc response, but assistance would be more effective if it was designed within an overall strategy. For this reason, PHARE was now shifting towards multi-annual programming with medium-term policy objectives. This would enable priorities to be addressed in a more coherent and sustained way.

Pearce described how the `Europe Agreements' concluded with six CEECs would provide a political, legal and economic framework for Community assistance programmes. An important provision of these agreements was the approximation of laws. Bringing the legal and regulatory systems of the CEECs into line with those of the Community would play a key role in encouraging market-oriented behaviour by state enterprises and attracting foreign direct investment. Measures to accelerate market access would be announced at the Copenhagen Council, though recession in EC member states was making it difficult for them to move as fast as was economically desirable. The Copenhagen Council would also follow up the undertaking made at Edinburgh to decide on how the Associate countries of Central and Eastern Europe could prepare for accession to the European Union. The opening up of a clear prospect of future participation in the Union should help to compensate for the limited progress in improving market access.

* Economic Transformation in Central Europe: A Progress Report, edited by Richard Portes
Available for £23.50/$40.00 from CEPR, 90-98 Goswell Road, London EC1V 7RR
(ISBN 1-898128-00-6)
or for ECU 29.50 from the Office for Official Publications of the European Communities, L-2985 Luxembourg (ISBN 92-826-5680-2, Catalogue number CM-78-93-289-EN-C).