Achievements and Prospects after Ten Years of Transition--Remarks by Michel Camdessus

December 10, 1999

Remarks by Michel Camdessus
Managing Director of the International Monetary Fund
at The Warsaw School of Economics
Warsaw, Poland, December 10, 1999

I am delighted to have this opportunity to visit Poland at the end of a year in which the world has been reflecting on the first decade of one of the most momentous changes of this century in the history of Poland and, of course, in the history of the world. It is a unique period, in which a major component of the global economy is transforming itself from one system of economic organization to another system, which, for all its weaknesses, seems to be the equivalent in the economic domain of what Churchill had in mind in the political realm in describing democracy as the worst form of government, apart from all the rest! Reflection on your experience with the new system could provide a few pointers to changes that we should try to promote worldwide, since, as I believe to be true, one of the positive features of the regime you have admirably fought for is its capacity continuously to change and reform itself.

I have been privileged to visit Poland on three occasions during my time with the IMF. These visits have occurred at almost precisely five-year intervals, sufficiently far apart to discern the changes that have taken place in this country. In 1989, the country was deep in economic and political crisis, evident in the near-hyperinflation, falling output, shortages, high external debt, and profound sense of uncertainty about the future. By December 1994, after five years of courageous economic policy decisions and difficult economic conditions, it was clear that the turning point had been reached. But times were still hard, and I can recall observing that the changes which had already taken place were perhaps more clearly discernible to your friends from abroad than to the average family, valiantly striving to improve its standard of living.

Now the changes are palpable: there is a general atmosphere of vitality and greater confidence about the future. The improved economic situation is reflected in the fact that the average Polish citizen is better off by about one-fourth than before the transition began. In fact, welfare may have risen even more than this suggests, since a far smaller proportion of GDP is being devoted to inefficient or unproductive investment, allowing a higher rate of consumption than in the past. Inflation has fallen into the single digit range. The strong macroeconomic framework established early in the transition and the effective reforms in the enterprise and banking sectors, enabled Poland to withstand the global economic turbulence of the past two and half years. The rapid liberalization of many aspects of the economy, and building the institutions essential for a market economy have created the foundation for a vibrant private sector that already accounts for two-thirds of activity. This three-pronged approach to transition—liberalization, institution-building, and macro-economic management—has been accompanied by a determination to achieve more equity through social policies. And, not surprisingly, improving economic conditions have made room for increased intensity in political debate, a clear indication of the liveliness of your Churchillian democracy.

Your achievements to date point to a remarkable dedication to the task of transforming the country, to make up for lost time and the lost opportunities of the past. Your vision was motivated by the knowledge of Poland's great potential. Change was inevitable and you seized the opportunity to press ahead immediately and rapidly with the reform that was necessary. The task of the IMF was to assist you with the economic side of this transformation. An important aspect of it of course, but not the only one by far: because our work with you and the other countries in transition has given the world a thought-provoking illustration of the importance of the macroeconomic aspects of the transformation and of the essential synergy of social and economic factors to underpin lasting success.

* * * * *

Looking beyond Poland's borders, we see that a number of countries—notably the Baltics, Hungary, the Czech Republic, the Slovak Republic, and Slovenia—have been moving ahead with the transition, and a number of others are in a steady effort to catch up. Although there can be no doubt that the very worst period of transition is now behind us in virtually all the economies in transition, the picture that emerges is far from uniform. Progress has clearly been made in many respects. The basis for a market economy has been established, prices have been extensively liberalized, and inflation has been tamed. Growth has resumed, and people's living conditions are improving, albeit with considerable variation across the region and at a pace that is still far too slow. These accomplishments have reinforced—and have been reinforced by—the spread of democratic institutions in many transition countries.

Yet we can see a widening gap among the transition economies: one of performance, and increasingly also one of structure and institutions, so pronounced that we must begin to wonder whether it is still useful to analyze the transition economies as a homogeneous group. Why is it that Poland and several other economies have experienced a more rapid economic renaissance than other transition economies? And more importantly, based on the experience of the past decade, what challenges lie ahead, not only for Poland, but also for other countries in transition. It is only natural that such questions receive close attention one decade into the transition.1

The case of Russia, difficult as it may be, deserves special mention as a country with admirable human and economic resources, but also one that suffers from the worst of the legacy of more than seventy years of central planning. In that perspective, it is little wonder that the country's seven-year struggle to transform itself into a modern market economy has produced such stresses in the economy. It would indeed be irresponsible—to the people of Russia, and to our entire membership—if the IMF were not prepared to assist Russia through this difficult transition. Equally it would irresponsible for the IMF to extend financial support unconditionally; that is not and never has been our way of doing business in any country. That is why, although Russia's recent macroeconomic performance has exceeded our expectations, the decision on whether to proceed with further financial assistance hinges on reaching satisfactory assurances that new flows will be put to good use in a program that stresses structural reform and good governance with the full support and firm commitment of the Russian authorities.

* * * * * *

It is now time to touch on a few aspects of the transition experience: the initial conditions, the broad strategy and intensity of the reform effort; and the content of the reform programs that have been implemented, before turning to some principles that should guide our thinking about the future direction of policy. And I shall conclude of course by coming back—giving honor where honor is due—to the current prospects of Poland.

The initial conditions faced by countries have been extensively analyzed and clearly varied widely. Countries' natural resource endowment, the initial level of per capita income, the proximity to potential or existing trading partners, the degree of industrialization and extent of state ownership, the dependence on COMECON trade, are all factors that varied widely among the countries in transition. But these factors do not constitute a full explanation of cross-country differences of progress along the transition path. We are now ten years into the transition: experience and academic research show increasingly clearly that it is today's policies, rather than yesterday's obstacles, that determine whether countries succeed. Difficult conditions do not render reforms impossible or ineffective: instead they make them more necessary, and certainly more challenging.

We have seen wide variation in the broad strategy and the intensity of the effort which countries have brought to reform. There is another, less tangible, set of factors that has come into play. Each country faced difficult political and social conditions at the start of the transition, but countries' differing capacity and willingness to react has been a major factor in determining the outcome of the reform experience to date. Three broad factors explain this variation.

  • One, in many countries, especially in the former Soviet Union, the basic institutions of government had to be built from the ground up. As the Soviet Union crumbled, where there had been one country, suddenly there were fifteen, each with the need to establish the machinery of government and to define economic policy priorities. Elsewhere, notably in Central Europe, basic institutions were already in place, although of course they had to be restructured or reoriented.

  • Two, the institutions of civil society are just as crucial to successful reform effort. Poland, for instance, has benefited enormously from having preserved or created the key institutions of the family, the unions, the church, and the press. And to promote markets and entrepreneurship, there is an even less tangible factor: a culture that fosters the rule of law and the acceptance of codes of conduct that are honored by market participants on the basis of enlightened self-interest. Efficient, transparent markets, a critical goal of the reform effort, require a clearly defined and well-enforced legal framework. That much is well known, and indeed much necessary legislative work is underway. But those countries where the transition is advancing most smoothly—where markets are best developed—are those where respect for the law, for private property, and for voluntary market-based codes of conduct are most firmly entrenched.

  • Three, countries have varied considerably in the coherence and strength of their response to the intense demands of building new economies. Here I am reminded of Lescek Balcerowicz's notion of a period of "exceptional politics"2, the finite window of opportunity created by a populace that was longing for economic change in the aftermath of social and political upheaval. Those countries that tapped this non-renewable national resource, by combining strong stabilization measures—the indispensable ingredient—with vigorous structural reform, are generally those where the recovery is the strongest. Most important was a clear, coherent vision of what needed to be done. Unfortunately, some countries did not avoid the temptation of seeking an elusive "third way," frequently by creating new versions of old models. Valuable time was lost, and their recovery has been delayed.

From this we see national "ownership" of policies as a key precondition for successful reform. Determined implementation, by a government firmly committed to a coherent, nationally defined strategy, that enjoys broad-based support, is all-important. It almost certainly outweighs the sometimes rather technical considerations involved in determining whether the sequence of reforms is precisely correct. It is all the more important given the disappointingly limited amount of official international financial support that was available in the early years of the transition, and the correspondingly greater significance of the relatively limited level of foreign private investment. Countries that were seen to be acting resolutely to stabilize and reform their economies not only attracted the largest flows of direct investment from abroad but had the earliest harvest of the positive fruits of transformation.

Fourth, for all this discussion of institutional context, clearly the substance and content of policies has had an important bearing on the relative progress with rebuilding economies. What has been achieved? And, by implication, as I shall discuss shortly, what remains to be done?

Most countries have come a long way in stabilizing their economies. The defeat of inflation by most countries is the most striking achievement of the first decade of transition. Those countries where it has recurred know from experience that it is a threat that can—and must—be contained. How easily this region could have taken the Latin American path of earlier decades, and succumbed to the temptation of indexation to compensate for the initial price shock—and would have paid the price of chronic inflation. But you heeded their more recent experience, responding to inflation by a single-minded focus on macroeconomic policy. I need hardly dwell on these virtues. After the initial—and probably inevitable—deterioration in the fiscal situation, major efforts were made to strengthen fiscal positions. Monetary and credit policies have, on the whole, been designed with the overriding objective of countering inflation to lay the basis for growth.

Technically more complex was the choice and operation of exchange rate regimes, one that continues to attract much attention. Pegged regimes were adopted formally by only a relatively few countries, but de facto pegs have been a feature in most countries at some stage or another of the transition. As confidence was restored, some countries have felt able to "exit" from pegs to more flexible regimes; Poland has demonstrated well how this can be done. In the years ahead, the transition economies will face the same dilemmas in choosing regimes that confront all policymakers around the world. An active debate is in progress at present, but increasingly we hear a preference being expressed for regimes at one end or the other of the spectrum: firm peg or free float. This debate also delivers a very clear message: it is the strength of domestic economic policies that is key to stability and growth.

The first rounds of external sector and domestic economic reforms have now been pushed through by most countries. Substantial progress has been made with price liberalization, and external trade reform. In short, markets have been established. But too many imperfections remain, offering an open invitation to corruption. In several countries the institutional framework remains incomplete: laws are not yet in place and more important the rule of law needs to be strengthened further. And although fiscal consolidation has served to bring deficits down to more manageable levels, major distortions remain in tax systems and in the structure of expenditure that may impede future growth and the efficient, equitable use of resources.

The financial sector is crucial. All the experience of transition economies and of the international crises of the past decade point to the central importance of a strong financial system. Introducing sound regulation and supervision, accompanied by bank privatization, were obvious first steps in financial sector reform. Certainly countries seeking access to international capital markets, should have had a strong incentive to strengthen their domestic financial systems. Unfortunately the record is very mixed. Poland and Hungary are among the countries that demonstrated the importance of strong domestic financial systems to underpin the credibility of monetary policy during periods of turbulence in international markets. And yet, other countries have lagged seriously, and remain vulnerable to both domestic and external shocks.

The approach to privatization has been one of the more contentious issues, receiving much attention from day one. Most early strategies for reform envisaged ambitious programs of privatization that would have been the spearhead of reform. In practice, in most countries, the privatization of existing large-scale state enterprises still has far to go. In retrospect, in this first decade of reform, the key to economic recovery has been found, not so much in the speed of privatization per se, but in the degree to which market discipline has been introduced. And that discipline was available from two sources: first, from hard budget constraints imposed on enterprises; and second, from the growth of new, competitive private enterprises—often small-scale—but increasingly important in aggregate. However, as Yegor Gaidar has reminded us,3 where other—financial, legal and administrative—reforms are incomplete, even privatized enterprises may face an ineffective budget constraint.

Perhaps then, at this stage of the transition, we should think in terms of the privatization of the economy—that is creating the conditions that promote the entry of new private enterprises and that also encourage all enterprises to be competitive—rather than the privatization of enterprises. But as China and Vietnam have discovered after long periods of formidable economic performance without privatization, eventually the burden of inefficiency of a hard core of state enterprises can no longer be ignored and painful reform becomes inevitable sooner or later. An important avenue is foreign investment: both through direct new capital flows and privatization by sale to foreign investors provide essential impetus to development through new capital, technology, and improved governance.

But as we all know, by far the most painful phenomenon of the past decade has been the social deprivation that has appeared: unemployment, the effects of inflation on saving and pensions, the general degradation of public services, especially public health and education, and the emergence in many countries of widespread poverty. True, some of these problems have been mitigated by declining inflation, and the revival of growth. Some countries were able to construct social safety nets, often by restructuring them so that protection no longer depended on enterprises. But the reform of social safety nets has too often been limited not only by budget constraints and slow recovery, but also by insufficient national mobilization and inadequate international support for this purpose. I still believe that the international community should have done more and better in this domain.

If nothing else spurs us to action then it should be the desire to help those "silent martyrs" of the transition by pursuing policies that aim to ameliorate poverty, to improve social conditions, to reduce unemployment, and to raise living standards equitably across the whole spectrum of society. That, ultimately, must be the goal of economic policy—in transition economies, and everywhere else. And without progress on this front, then the support for sustained reform could become even more precarious. What then, can be done to consolidate and to accelerate the transition process?

* * * * *

Of the many lessons that emerge from the experience to date, let me highlight two. The first arises from the tremendous achievement that has been made of stabilizing economies that could easily have descended into hyperinflation. This is a legacy that must be preserved and strengthened to offer a firm foundation for future growth. I do not intend to belabor the point for I believe that this lesson is one that is well known and is being practiced. I would merely say to you: "stay the course."

The other lesson of experience calls for a shift in emphasis in formulating reforms, bringing greater attention to bear on the social, and political institutions underpinning all other aspects of reform. I use the word "institution" here in its widest possible sense, to cover the constraints or frameworks within which markets operate, be they formal—constitutions, laws, or regulations—or informal, such as norms of behavior, conventions, and codes of conduct. This idea, for which I do not claim any originality, leads us down two closely related avenues: the balance between the public and private sectors—in other words, what is the appropriate role of the State—and the opportunity now to focus on a second generation reforms.

This suggests for the transition countries a few more specific principles to keep in mind for the next few years. They are principles that can act as lodestars for all countries at all stages of the transition. Let me identify four.

First to promote actively the highest standards of governance by building a framework with which government, enterprises, financial institutions, and individuals should be able to deal with each other at arm's length, and in a transparent manner. This implies a greater emphasis on the rule of law and respect for property, not only through legislation but by the development of an independent judiciary and court system that can enforce contracts and property rights. It means that enterprises should be held to high standards of corporate governance and accountability. It entails comprehensive fiscal and administrative reform to improve the efficiency of government and to bolster a sense of citizens' responsibility toward the State. All of this will be most effective in an environment in which broad policy is established in a participatory manner, with good communication among enterprises, labor unions, civil society, and the government. If major progress could be made on all these fronts, then we would begin to see an end to the most common and most serious complaint that we hear in country after country through the region: corruption and distrust of government. This is a challenge, I am certain, you in Poland are addressing in your own way, taking the bull by the horns.

Second, it is vital to press ahead with the development of the economic institutions to support a sound, stable, competitive, well-managed macroeconomy. Here the key ingredients are: a simple, equitable, efficient tax system; expenditure policies that minimize unproductive spending; a soundly regulated and supervised financial system that is open to competition, including from abroad; the conduct of monetary policy that increasingly relies on modern, market-based instruments. And all this should be based on transparency in policy formulation and implementation, drawing to the fullest extent on internationally recognized standards and codes of practices. In these areas the international community can continue to help, and the IMF in particular is ready to support these changes through our continued policy advice and technical cooperation.

Third, long-term prosperity obviously rests on the promotion of a vibrant, competitive private sector. An essential element is to release the latent potential of today's state enterprises through an effective program of modernization and privatization that builds upon the legal, financial and other reforms that are underway. Whether or not full-scale privatization proceeds rapidly, a priority should be to ensure that these enterprises face market discipline especially through hard budget constraints. The momentum for private activity will also come from two other sources: one is the energy of the small-scale privately owned businesses that, in several countries, already account for a major share of national output, and the other is the dynamism, technology and finance of foreign capital, especially through direct investment. Ultimately, the development of all components of the private sector rests heavily on progress in creating favorable conditions for investment: in other words progress on the broad reform agenda and a stable macroeconomic environment.

Fourth, far from being seen as the cherry on the pudding, key social goals, especially poverty reduction, must be brought to the center of each country's policy agenda. As a minimum policies should embrace cost-effective expenditure programs aimed at human development and reducing poverty; a well targeted social safety net; a tax system that ensures a fair distribution of the tax burden without distorting incentives to work; and labor market policies aimed at ensuring high levels of productive employment. Many countries also face the pressing need to undertake pension reforms to reconcile two basic goals: decent standards of living for the elderly and the long-term viability of the public finances. And there is a social dimension to policies that aim at reducing regional disparities, for instance by promoting labor mobility through retraining, improved housing or infrastructural investment in the most remote regions. All this is a clear illustration of what I see as the circular linkages among strong macroeconomic management, high-quality growth, and poverty reduction. Without the first two, there is little chance of reducing poverty. Without the latter, then the broad-based support for policy implementation will be absent.

* * * * *

Before concluding, permit me to turn back to Poland, and to mention briefly some of the specific challenges that seem to lie in store.

Poland's progress, viewed in a ten-year perspective, has been remarkable, and the courage that the government, institutions and people of the country have shown in achieving these results inspires confidence that you can and will rise to whatever challenges lie ahead. In the past two years, Polish economic performance has cooled off a little from the high rates that had occurred for a number of years, but this slowdown has been notably smaller than that experienced by other emerging market economies in this and other regions. Poland's established policy record leaves little doubt that that the right blend of policies can be found to foster high investor confidence and provide a new impetus to economic activity and employment. And here let me renew my challenge of five years ago, on which you have already made so much progress, of bringing your inflation rate down to the low single digit range within the next two to three years.

Looking to the longer term, the major part of what we have come to regard as the "transition agenda" is already complete, and in one of the key remaining areas, ambitious targets for privatization have now been established. But I know that you will not see this as a time or reason to rest on laurels. For Poland has long harbored the ambition of catching up with other industrial countries with all this implies for integrating even more fully with the global economy. As in the past, a sound fiscal policy will remain the fulcrum of successful adjustment in Poland. And, without question, there are major challenges still to be faced: the costs of remaining restructuring in the real economy; the need to provide for improved infrastructure; to tackle issues such as the environment; and, of course, the importance of working for a reduction in the tax burden over the medium term.

Poland, together with other Central European countries, will continue to face new issues and tough challenges. For during these exciting ten years of transition, the world at large has also changed enormously. Within the region, the European Union has expanded and the euro has been created, establishing powerful new momentum toward further integration. Poland has made accession to the EU a priority, a path that will entail significant challenges over the next years as you develop a coherent strategy for accession and integration.

* * * * *

Mr. Chairman, at the end of this decade of transition, coincidentally on the eve of the millennium, it is natural to look ahead, and I am happy to observe that the prospects for the medium to long-term are getting distinctly brighter. The transition economies as a group have witnessed traumatic change, but their responses, although varied, mean that they are now poised for further progress and growth. We have seen that they all face complex challenges whether they are still in the earlier stages of transition, or, like Poland, well established on a path of convergence with other industrial countries. If the past decade has been one of stabilization and consolidation, let us work together to make the next decade one of integration, growth and social progress. All Europe, and not only Poland has everything to gain from it. And speaking from the global vantage point of the IMF let me add, in concluding, that this will be a precious contribution of yours to the stability of the world.

1Early in this tenth anniversary year of the transition, a conference was held at the IMF in Washington in February 1999. Its proceedings are summarized in Saleh Nsouli "A Decade of Transition: Achievements and Challenges," Finance and Development, June 1999; and also in IMF Survey, February 22, 1999, Vol. 28, No. 4 (p. 49). Among more recent papers is one by the IMF's first Deputy Managing Director Stanley Fischer and Ratna Sahay "The Transition Economies After Ten Years" (unpublished manuscript) presented at the conference "Ten Years After: Transition and Growth in Post-Communist Countries," organized by the Center for Social and Economic Research Foundation and held in Warsaw, Poland, October 15-16, 1999.
2Balcerowicz, Leszek, "Fallacies and other Lessons," Economic Policy, (December 1994), pp. 17-50
3Remarks made during the IMF conference "A Decade of Transition: Achievements and Challenges" (ibid, unpublished).


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