East Europe after 1989

Financial Express, 7 November 2009

When the Soviet empire collapsed, the countries of Eastern Europe began on the project of economic development that is akin to what we in India have been engaged in. There were a few important differences when compared with what we have done.

The first was the attitude towards capitalism and freedom. Eastern Europe had chafed in misery for decades under a totalitarian regime, based on central planning and a welfare state. They knew how bad that was, and were single mindedly focused on the task of achieving freedom and capitalism. As an example, in Warsaw, the posh building that housed the communist party was given over to the new stock exchange. In India, we have never had this level of clarity on the goal.

The second big difference was the tangible dimensions of this goal. Capitalism and freedom are big words - how are they to be achieved at an operational level? In Eastern Europe, two tangible goals dominated: to join the European Union, and to join NATO. All economic policy decisions were viewed from the perspective of getting into the EU, and all international relations questions were viewed from the perspective of getting into NATO.

This matters a lot. In India, it is not hard for an expert to look at the international experience, identify best practices, and offer blueprints for how the country should work. E.g. nothing prevents India for learning how the VAT works in the EU, and rapidly implementing the GST. But political support for change is generally hard to find. In Eastern Europe, specific questions about law, regulation and the role and function of government agencies were and are answered through reference to the EU.

The project of achieving freedom and capitalism on the Western model saved a lot of time in domestic debates. As an example, in Eastern Europe, there is no policy discussion about capital account convertibility. All the countries adopted capital account convertibility because this was a basic element of the package deal of being European.

Similarly, all countries in Eastern Europe wisely understood that setting up a banking system is hard, so the market share of foreign banks ranges from 40% to 100%. This has worked pretty well, including in the crisis of 2008/9. Having such a big role for foreign banks, with full convertibility, has led to problems. But there are few alternatives for a developing country, given the difficulties of setting up a strong banking system from scratch. As an example, India is a failure story where foreign banks were shunned, and the resulting banking system has largely avoided getting involved with the project of India's economic growth. The East Europeans picked a better path when compared with us: they have a genuine banking system while we do not.

In looking back over the last 20 years, two statements are simultaneously true. First, a lot of progress was made, and the lives of people in Eastern Europe are undoubtedly better when compared with 1988. Second, setting up the institutions that make possible the synchronised dance of capitalism and freedom has proved to be much harder than expected, even given the existence of the EU as a clear recipe to emulate.

On the positive side, the change is hard to exaggerate. A visitor to Warsaw or Prague today sees a modern and sophisticated country. Of the countries of Eastern Europe, 10 have joined the European Union and 12 have joined NATO. These are massive changes.

But there are many problems, and while Eastern Europe has had good growth and will continue to have good growth, rising up to Western European levels is hard and will take a while. By and large, the politics has proved to be more difficult than expected. In many countries, multi-party democracy with freedom of speech and fair elections has not yet fallen into place. The lack of these checks and balances has hindered the emergence of a competitive market economy: too often, powerful politicians have hijacked parts of the economy for private benefit.

One dimension of this problem is just the generational change which is inevitably hard. For people who grew up with communism, it is inherently hard to cope with political and economic freedom. Angela Merkel was 35 when the Berlin Wall came down, and she has clearly reinvented herself in the following period. But she is a Ph.D. in physics, and is the exception that proves the rule. Most people found it very hard to shift their ways of thinking even though they were keen to reinvent themselves.

The children born free in 1989 are now 20 years old. The coming 25 years will see this generation dominate society, and this will be a much better period for East Europe. A similar demographic transition will take place in India in the coming 20 years also, when the generation that rises to prominence will be free of the blinkers of autarky and socialism.

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