Dividing history into discrete eras always carries the risk of overlooking disruptions within these periods. The road of reforms in Eastern Europe was not straight and smooth, but curvy and bumpy, especially in the mid-nineties. Rather than arising from the revolutionary changes, these bumps and interruptions were the unintended results of neoliberal policies. Poland, which had been one of the first countries to end state socialism, led the way again. High unemployment, widespread poverty, and frustration at the outcome of reforms convinced the majority of Polish voters to support the postcommunists (Sojusz Lewicy Demokratycznej, or Democratic Left Alliance) at the parliamentary elections in 1993.4 The SLD formed the government, together with the Peasant Party (Polskie Stronnictwo Ludowe, or PSL), which had already existed prior to 1989 as a “bloc party.” Hence the former comrades returned to power—in the heartland of anticommunist resistance, of all places. The Western media and governments were surprised and shocked about this caesura; our family friends in Kraków and Gdańsk were aghast. What had happened?
One reason for the reformers’ defeat lay precisely in the neoliberal buzzword “shock therapy.” Leszek Balcerowicz had avoided this term when propagating his plan to reform the Polish economy in 1989. But Western media promoted it as a neat formula to sum up the radical reform policies.5The Balcerowicz plan was basically to cause a big bang: If the pointless subsidies for foodstuffs, coal, rents, and many utility items were scrapped, the prices for all products decontrolled, the unprofitable large-scale enterprises privatized, and the borders opened to foreign businesses, after a short, painful period of adjustment, the Polish economy would reach an “equilibrium” and start to grow again. The equilibrium theory—the assumption that the markets will autonomously create a balance between supply and demand without state intervention—is one of the basic tenets of neoclassical economic theory. The Chicago School also relied on the rationality of market players. The concept of the “hidden hand” (which stemmed from Scottish Enlightenment thinker Adam Smith, one of the founders of modern liberalism) added a metaphysical dimension; the market was regarded as a last judgment over all goods that can be exchanged.
Unfortunately, the architects of the reforms misjudged the extent of the economic downturn when applying the recipes of the Washington Consensus.6 In Poland, the first country to introduce shock therapy, Finance Minister Leszek Balcerowicz expected the economy to shrink by around 5 percent and unemployment to rise moderately. In fact, the gross national product fell by 18 percent in the years 1990 and 1991, and industrial production dropped by almost a third. Inflation was not as easy to control as had been hoped, and capped wages (also intended to fight inflation) additionally dampened demand. Moreover, legions became unemployed: in 1992, 2.3 million Poles, or 13.5 percent of the adult working population, were without a job.7
Map 2. Central and Eastern Europe
Strangely, these disastrous figures did not move the new political elites to seriously doubt the recipes for reform. The entire former leadership of the Solidarność movement, including the former left-wing dissident Jacek Kuroń, the more liberal Adam Michnik, and the right-wing Gdańsk liberals, right up to Józef Tischner (a prominent priest and philosopher influenced by Catholic social teaching), continued to support Balcerowicz’s ten-point plan. The reason is probably to be found in human psychology. The reforms were like a pool of cold water that everybody jumped into without knowing how to swim. Because gradualism had failed with perestroika, the “Third Way” had been discredited by Yugoslavia’s disintegration, and the Western European welfare model was too expensive, the only life buoy floating in the pool was neoliberalism. The reformers saw no other choice than to cling to it.
Perhaps another reason why former Eastern Bloc countries embraced the reforms was that, in some respects, they echoed the communist rhetoric of the postwar period. In the early nineties, as previously under state socialism, people were told that sacrifices now would make way for a better future. The faith in progress and the effectiveness of the reforms from above were reminiscent of the communist era. Karol Modzelewski, one of the few intellectual Solidarność leaders to speak out against the radical reforms, remarked with some irony that the only thing that had changed in 1989 was the slogan—from “building socialism” to “building capitalism.”8 Even the two doctrines’ position on the state is more similar than one might presume. Orthodox Marxists believed that during a transitional period to create a classless society the state was necessary but that it would become superfluous once communism was established. The neoliberals needed a strong central bank and other state institutions to implement reforms before the hidden hand of the market would start to regulate all aspects of the economy and society and the state could be reduced to a minimum.
Two years after adopting the Balcerowicz Plan, Poland’s economy actually did begin to show signs of recovery. But the upswing came too late to convince the voters. A growing number among Polish society did not want any more shocks or therapy. Many supporters of Solidarność stayed at home during the parliamentary elections of 1993. The postcommunists, who could rely on old party structures and supporters, emerged as the victors. Following this bombshell in Poland, there were parliamentary elections in Hungary. Here the socialists gained an outright majority of parliamentary mandates in 1994. In East Germany the PDS (Partei des demokratischen Sozialismus, Party of Democratic Socialism), the successor party to the SED, gained four Berlin constituencies at the parliamentary elections and became established as a regional East German party. In 1995 the former communist youth functionary Aleksander Kwaśniewski consolidated the SLD’s lead in Poland, defeating the former labor leader Lech Wałęsa at the presidential elections.
This postcommunist turnaround, which the term far more aptly describes than the upheavals of 1989, coincided with a shift in the constellation of international actors. While the IMF and the World Bank had initially been the predominant agents of reforms (the Balcerowicz Plan hinged on the approval of the former), the influence of the European Union now grew. This was due not least to the 1991 treaty of association binding the Visegrad group, and subsequently all Eastern European countries, to Brussels. The European Union focused on the “third dimension” of transformation—rebuilding state structures and strengthening the judiciary—as well as consolidating constitutional democracy and maintaining at least minimal social benefits. With the postcommunists in power, the welfare state was no longer considered obsolete, and the impoverishment of large sections of the population was more critically observed. The new Polish and Hungarian governments slowed down the privatization of major industrial combines and made job preservation a top priority.
Despite this attenuation of the neoliberal hegemony in Eastern Europe in the mid-nineties, the postcommunists did not attempt to turn the clock back. They held on to the principle of reforms and persisted with their political practice. There were internal and external issues behind this continuity. For one, the postcommunist governments could not afford to radically change course. Debt-ridden Hungary and Poland, especially, were dependent on the goodwill of Western financial institutions and investors. Second, the Polish and Hungarian postcommunists were left-wing in the same vein as New Labour in the United Kingdom. They knew how often state intervention had failed before 1989 and therefore tended to act with “the market” in mind. The party leaders in each country—veteran reform communists such as Gyula Horn and the former youth affairs functionary Kwaśniewski—had experienced the demise of state socialism and the dysfunctional nature of planned economies firsthand. They hoped for a return to power and full coffers for themselves, but without a reversion to the situation before 1989.
The postcommunists were also aware that they faced mistrust at home and abroad. To compensate, they tended to overconform to contemporary neoliberalism. Beards and turtleneck sweaters—the trademarks of opposition members who came to power in 1989—were banished to history. With his permanent solarium tan and gleaming white smile, Aleksander Kwaśniewski embodied Eastern European aspirations to westernize on a visual as well as a political level. Thus the Polish and Hungarian postcommunists contented themselves with moderating the force of neoliberalism and changing only the sequence of reforms, stabilizing state institutions and state industry before embarking on privatization.9 The electorates’ rejection of neoliberal reforms in most East Central European countries (with the temporary exception of the Czech Republic, where Václav Klaus remained in office until 1998, when he stepped down in the wake of the bank crisis) reveals much about the relationship between democracy and market economy, which was regarded as symbiotic in the West. It was only possible to introduce such radical reforms because these countries’ democratic structures were still inchoate. The postcommunist societies were too busy mastering the everyday challenges of transformation to put up much resistance to radical reforms. In Poland, moreover, some leading advocates of the government’s polices openly stated that democratic resistance could and should be disregarded. Adam Michnik put it bluntly in several editorials for the daily Gazeta Wyborza (the most successful quality newspaper of all postcommunist countries, which he had founded) when he wrote that the broad masses had little understanding of economic policy and that rapid and irreversible reforms were therefore the best recipe.10 Many intellectuals from Solidarność circles shared Michnik’s opinion. The tragedy of the trade union movement was that its brightest minds entered into government, where they cooperated on a program that could hardly be reconciled with the interests of their own clientele.11
In Russia in 1993, the Congress of People’s Deputies refused to back the reforms, prompting President Boris Yeltsin to resort to alternative methods. He dissolved parliament and, when his opponents refused to yield, had armed forces open fire on the building. The outcome was 187 fatalities and permanent damage to Russia’s fledgling democracy. In broad terms, then, the neoliberal reforms in Eastern Europe were pushed through on the basis of deficient democracy—a scenario that in some respects was repeated in technocrat-ruled Greece and Italy during the initial phase of the euro crisis. The governments under Loukas Papadimos and Mario Monti were not elected but appointed in the wake of the crisis. These two former bankers tried to implement austerity measures and reforms without a democratic mandate. But they were both defeated by internal resistance—and Monti, finally, at the next parliamentary elections.
The former East Germany did not go through a political transformation crisis as did Poland, Hungary, and, somewhat later, the Czech Republic and Slovakia. Despite the election victories of the PDS, the West German elites and Chancellor Helmut Kohl had a firm grip on power. But the economic transformation crisis in the region was all the more dramatic on account of the measures introduced in 1990. Without any major declarations or ideological justifications—neither Kohl nor his finance minister Theo Waigel were Thatcherites or advocates of the Chicago School—the economy of the GDR was exposed to the most radical shock therapy in postcommunist Europe.12
The first shock was the “economic union” of July 1990. Its extent can be better gauged by looking a little further back in economic history. In the 1980s, the GDR was only able to export at drastically reduced prices. The (strictly confidential) rate of exchange for one West German mark used for internal clearing by the Bank for Foreign Trade deteriorated from 2.50 East German marks in 1980 to 4.40 in 1988.13 The black market rate was even worse, having leveled off at around 7:1 after the fall of the Iron Curtain but occasionally dipping considerably lower (see fig. 4.1).
Fig. 4.1. A currency exchange office at Berlin’s Zoo station on November 10, 1989. Photo: ullstein bild / Ritter.
Other East Central European currencies depreciated as well. The Czechoslovak crown fell below its previous black market price of fifteen koruny to one German mark. Whereas Václav Klaus let the currency float, Helmut Kohl decided on a political exchange rate. In spite of warnings by the West German Central Bank, which argued for an exchange rate of two East German marks to one West German mark, the currency union was enacted in summer 1990 at an exchange rate of 1:1 (the only exceptions being large savings deposits and company debts, where a rate of 1:2 or 1:3 applied). The upward revaluation meant that all wages, salaries, rents, and other cost factors were converted evenly.14 Thus products from the GDR became four times more expensive than they had been in 1988.
The imbalance is even more staggering in relation to Czechoslovakia, which was about as wealthy and developed as the GDR. As mentioned above, the Czechoslovak crown was devalued to around one-third of the previous official exchange rate. Against the depreciated Czechoslovak currency, East German currency appreciation made goods from the former GDR around twelve times more expensive. It is no wonder that this imbalance caused huge economic problems for East German industry. In the rush to accomplish German unification, nobody looked beyond the borders of Germany; the currency union was administered and communicated like an internal affair.15
Why did Helmut Kohl opt for a currency union and reform under these conditions? Besides the pressure from East Germany, he was probably concerned about his success in the first nationwide elections in the fall of 1990. He also seems to have believed optimistically that East Germany could be westernized quickly. In his election campaign, Kohl promised a flourishing future of green pastures (“blühender Landschaften”) which soon became a laughingstock. In the spring and summer of 1990, a third argument gained urgency: if incomes in the former GDR remained too low, ever more East Germans would leave for the West. Indeed, a saying went: “if the deutschmark comes, we’ll stay; if it doesn’t, we’ll go away” (“kommt die DM bleiben wir, kommt sie nicht, geh’n wir zu ihr!”16). East Germans soon found that the mark came, but the jobs were gone.
The second shock for the GDR economy was German unification in October 1990, by which it also entered the European Community. The economy of the former GDR had no customs, tariffs, or other defenses against competition from the West. Unification brought it the most radical liberalization in the former Eastern Bloc. In spite of all the neoliberal rhetoric, neighboring Czechoslovakia proceeded with greater caution. Finance minister Václav Klaus took a gradual approach to decontrolling the prices for consumer goods, and liberalized foreign trade in several stages. This gave Czech companies the opportunity to adjust to European and global competition. Klaus also took care to accommodate the public. The property market remained strongly regulated, with capped rents and protection against eviction for long-term tenants. As rents remained relatively low, individuals could more easily weather a job loss or change of workplace or other negative outcome of the reforms.
The third peculiarity of East German transformation was its unusually fast and radical process of privatization. First, all large companies were transferred to the Treuhand (literally, trust fund) privatization agency. This colossus held over thirteen thousand companies, where more than four million people were employed.17 The second step was the sale of these companies to domestic or foreign investors. But the oversupply of companies thus created was bound to cause a drastic drop in prices. When Treuhand proudly announced in 1994 that it had completed its task, it had incurred a loss of more than 250 billion marks rather than making the expected six hundred billion profits on privatization.18 Neighboring Poland and Czechoslovakia again proceeded more carefully and kept some companies under state or mixed ownership and management for many years.
The threefold shock therapy in the former GDR caused industrial production to drop within a few years to a mere 27 percent of the rate in 1988.19 No other country in Europe, aside from war-torn Bosnia and Herzegovina, experienced such a dramatic decline. Amid this historically unprecedented depression, newly founded businesses had difficulty getting off the ground, too. Unemployment rose in some regions to over 30 percent. Such disastrous economic conditions would have provoked mass protests and revolts in any other postcommunist country. But the GDR had ceased to exist, and within the enlarged Federal Republic, political stability was ensured. Moreover, the German government compensated the losers of transformation with early pension schemes and generous unemployment benefits. These payments have often blurred the fact that the transformation was originally designed along neoliberal lines. The economist Hans-Werner Sinn criticized the government’s economic policy in the former GDR as tantamount to “insolvency with special social benefits” (“Konkursverwaltung mit Sozialplan”).20
The East Germans responded once again by voting with their feet. In the first four years after unification alone, some 1.4 million East Germans migrated to the former West Germany. After this initial exodus, labor migration abated, only to increase again in the late nineties, reaching a new climax in 2001 when 230,000 East Germans migrated west.21 The statistics on company formations, which are considered in greater depth below in the comparative chapter on Central and Eastern European cities, give an indication of how badly these people were missed. The number of migrants from East to West Germany between 1989 and 1993 roughly corresponded with the number of new enterprises founded in Czechoslovakia in the same period. Germany’s economic policy after 1990 has often been justified with the claim that it was the only way to stop further migration from the GDR.22 But this goal was evidently not achieved. The former GDR was drained.
For several years, the German government pursued policies that effected comprehensive changes in the East while causing minimal disruption in the former West Germany. Nevertheless, transfer payments to the former GDR (including pension, health, and unemployment benefits) knocked the national budget and social security system off-balance. The result was tax increases and a nationwide economic crisis. Complaints about the “reform gridlock” (Reformstau) under the last Kohl government (1994–98) signaled the arrival of semantic ripples from the postcommunist economic reforms in western Germany. The term was coined to criticize the fact that more and more reforms were becoming necessary, even in the former West Germany. After some initial hesitation, Kohl’s successor, Gerhard Schröder (the self-proclaimed “reform chancellor”), took advantage of this drive for change to carry out some drastic social and labor market reforms between 2001 and 2005 (see chapter 9 on cotransformation).
Despite the neoliberal hegemony, the political practice of reform in Eastern Europe always diverged from the pure theory. This was due in part to the compromises that the reform politicians were forced to make. In Poland, no government could afford to ignore the concerns of trade union workers in the industrial region of Upper Silesia or the shipyard workers along the Baltic coast. The Polish government’s policy on the national shipbuilding industry is a good example of pragmatism in practice. When it became clear in 1992 that the large shipyards along the Baltic coast could not survive independently, the state helped out by deferring social security contributions, cancelling tax debts, and arranging bank loans. In this way it hoped to make businesses fit for privatization rather than immediate sale or closing. The German Trust Fund privatization agency proceeded in a similar way in the former GDR. Such measures actually conflicted with the Balcerowicz Plan of 1989 but proved in retrospect to be useful and stabilizing. In view of this, in 1991 political scientist Adam Przeworski proposed that an optimal economic policy is, by necessity, inconsistent.23
The Polish postcommunists won the election of 1993 not least because they promised to take a careful approach to privatizing major businesses. By this time, the process of “small privatization” in craft and trade, the catering sector, and other consumer services had been largely accomplished in all countries of the Visegrad group (though it had proved more difficult in the former GDR in the face of West German competition). Where large businesses were concerned, the government assumed safeguards for investors and in many cases engineered privatization by giving banks company shares in place of loan repayments.24 In this way, the state increasingly resumed an employer function. Privatization was not cancelled, just postponed to a time when a better price could be obtained.
Czech Prime Minister Václav Klaus also deviated from his neoliberal concepts, although he continued to defend them vigorously to the outside world. Czech national banks were required to shore up major industry so that unemployment remained low. However, many companies could not service the debts, and by 1996 several major Czech banks were on the verge of bankruptcy.25 Czech journalists coined the term tunelování (literally, “tunneling”) to describe the cause of their country’s bank crisis. It evoked comical images of the managers of loss-making combines digging tunnels to the bank vaults to help themselves to the loot. In fact, the crisis was caused mainly by bankers giving loans without sufficient security, or on the basis of old-boy networks, thereby undermining their own institutions.
Privatization went hand in hand with corruption. Bribes and deceptions were employed when it came to rating businesses and selling business shares, and in everyday management. The most highly publicized case was that of Viktor Kožený, who purchased over a million privatization vouchers through his company “Harvard Capital & Consulting Investment a.s.” (Its only tenuous link with Harvard was Kožený’s bachelor’s degree from the university.) Eventually, he absconded to the Bahamas with a fortune of some 200 million dollars. There he was safe from all the requests for extradition from the United States (due to further scandals involving privatization in Azerbaijan) and the Czech Republic. In a sense, Kožený is a postmodern equivalent of the famous English train robber Ronald Biggs. But his loot was worth several times more, and allowed him to indulge in a high-octane, luxury lifestyle.
The bank crisis in a country that was thought to be a paragon of market-based reforms highlights two endemic problems of transformation: protracted bankruptcies and corruption. To the bankers’ and industrial managers’ credit, the loans given to large-scale Czech industries secured tens of thousands of jobs that would have been lost if their audits had been more stringent. Thus the Czech Republic was spared the kind of mass unemployment that the former GDR and Poland suffered in the 1990s. However, as in the global crisis of 2008–9, the Czech banking and economic crisis of 1996 very soon turned into a national budget crisis, followed by a recession that affected the entire economy. Only a devaluation of the Czech crown and state guarantees for the banks eventually brought about a recovery. Foreign banks were the ones to benefit, as they acquired Czech banks at cut-rate prices.
In contrast to the Visegrad countries and the former GDR, Romania and Bulgaria hesitated to privatize major state enterprises. But they did not find a “third way” between capitalism and socialism, or any other coherent program. In both Romania and Bulgaria, the postcommunists won the first free elections in 1990. Unlike the SLD in Poland or the Hungarian socialists, then, they did not have any time in opposition to regenerate, develop new programs, or acquire expertise in the field of economic policy. Initially, the Bulgarian and Romanian postcommunists tried to keep domestic industries afloat with state subsidies. When the burden on the state budget became too great, they privatized the industries, mostly by means of so-called manager buyouts. This entailed farming out or auctioning off businesses to their own executives. The practice created warped incentives by making it worthwhile to intentionally mismanage or break up state enterprises in order to buy them cheaply. The bidding process, moreover, was frequently distorted by nepotism and bribery. In the end, the state attained much smaller revenues from privatization than projected, and industrial production dropped, causing tax revenues to fall again. Romania and Bulgaria responded by printing more money. By the late nineties, they were suffering another period of crippling inflation.
In Ukraine and Russia, too, transformation was attended by deep crises. At first the Russian government approached economic reform by a process of “voucher privatization”—that is, a broad dispersion of vouchers, or company shares, among the population (following the model developed by Václav Klaus). By neoliberal logic, this would create a society of shareholders and proprietors. But the postcommunist public viewed equity culture and stock exchange trading with skepticism. Indeed, many shares turned out to be worthless, and voucher privatization failed to catch on in Russia. So the government tried to sell large companies by auction but did so in the worst possible way: it handed the role of auctioneer to Russian banks. This privatization of the very process of privatization (officially via a program in which the state received loans for its company shares) marked a moment of glory for the oligarchs. In cooperation with the banks they owned, they intentionally depressed the prices of the companies earmarked for sale. Corruption was an essential prerequisite for participating in the privatization of major state enterprises in Russia.
One infamous example of how the state was cheated was the sale of the Yukos oil and gas group to the oligarch Mikhail Khodorkovsky. Having accumulated seed capital in the late eighties by importing Western products, he was appointed deputy minister for fuel and energy under Yeltsin. In this position, he acquired insider knowledge. Unsurprisingly, Yukos was eventually sold by a bank that Khodorkovsky controlled. The price at auction in 1995 for the company and all its oil and gas fields was approximately 350 million dollars. Two years later, its stock market value had risen to nine billion dollars.26
If the oligarchs had reinvested these huge profits in Russia, the damage to the state, society, and the national economy could have been contained. But they transferred much of their profit abroad. They did so for the kind of rational reasons that neoclassical economists and especially the Chicago School would certainly endorse. The oligarchs tended to control a certain market sector (thus there were nickel oligarchs, copper oligarchs, and the like as well as oil and gas oligarchs). Consequently, it was not necessarily profitable for them to invest further in Russia. Their trust in the Russian economy was limited—after all, they knew best how it was manipulated. By transferring capital to the West, they dispersed their assets and their risks, as any economic adviser would recommend. The semilegal and illegal practices of the oligarchs cannot, then, be solely attributed to post-Soviet cultural peculiarities.
There were other reasons why reforms did not work as planned in postcommunist Russia and Ukraine.27 The oligarchs simply seized the opportunities that the economic reforms offered; they were pioneers of capitalism who successfully accumulated capital. These “new Russians” flaunted their recently acquired wealth at home and abroad, becoming conspicuous consumers of luxury goods in Paris, Vienna, Berlin, and London, and even buying prominent football clubs such as London’s Chelsea FC. Supervisory bodies in the host countries could have investigated the origins of the invested funds, but none did. After all, the free movement of capital is one of the basic principles of neoliberalism. London, especially, and to a lesser extent, Vienna, thereby became accomplices to the oligarchs.
The main victim of this “raider capitalism” (рейдерство or reiderstvo) was the Russian state, which received only a fraction of the privatized companies’ worth after their sale. As in southeastern Europe, the outcome was a drop in industrial production, gross domestic product (which was approximately 35 percent in Russia in the 1990s28), and tax revenues, forcing the state to increase its debt. Again, the banks “solved” this problem by throwing high-interest government bonds onto the market. The debt burden, growing budget deficit, and flight of capital eventually led to the ruble crisis of 1998. Russian and foreign investors unloaded their state bonds in a panic; the Russian Federation was pushed to the brink of economic collapse and national breakdown.
In comparison to Russia, Ukraine appeared relatively stable. As a former Central Committee member of the Ukrainian Communist Party and director of a mechanical engineering and missile factory, President Leonid Kuchma, elected in 1994, stood for continuity with the Soviet Union. But Ukraine was no better able to ensure basic provisions for the populace than was Russia. Many industrial enterprises went bankrupt; the subsequent shortfall in tax revenue rendered the state unable to pay regular salaries, wages, or pensions. People still went to work, though, because despite rationed gas and electricity, their offices and workplaces were at least heated. It was precisely during this depression period that I visited Ukraine for professional reasons. The place to see was the beautiful West Ukrainian town Ľviv, which used to look a little like the black-and-white images of Prague that lured thousands of Americans to the “Wild East” in the early and mid-nineties. But while Prague blossomed, Ľviv was forced to limit household electricity and running water to only a few hours in the morning and again in the evening. The decrepit waterworks system, which dated back to the Habsburg era but had been poorly maintained by the communists, could cope with no more.
Population statistics on Ľviv show the demographic consequences of Ukraine’s economic demise. The town’s population shrank from 786,900 in 1989 to 639,000 in 2001, a reduction of almost one-fifth.29 Some people returned to the villages they had come from in the postwar era. (The same trend has been observed in Greece over the last few years.) Since the late nineties, ever more Ukrainians have migrated to Italy, Spain, and Portugal, typically to try their luck in either the construction business or home health care, depending on their gender. Several million Ukrainians have sought work in Russia since the economy began to pick up there in 2000. But the trauma of the 1990s, a period of demise and adversity in Russia, is not forgotten. In 2002, Swedish economist Anders Åslund compared the Russian transformation crisis with the global economic crisis in the 1930s. He found that the drop in economic strength and standard of living was more drastic in Russia in the nineties than in the United States after 1929.30