Absorptive Capacity, Trade and
Transition in Relation to
‘High-tech’ Export:
Evidence from the Czech Republic,
Hungary and Slovakia
Master Thesis International Economics and Business By Marie Pijper
Studentnumber: 1238078 Rijksuniversiteit Groningen March 2007
Acknowledgements
First, I would like to thank my tutors Mr Van Leeuwen and Mr Los for their help, advice and patience. I would also like to thank Olaf de Groot for clarifying the statistics relating to the empirical research.
Table of Content
Introduction p. 5
Chapter 1: Theoretical Background
1.1 Introduction to AC p. 9
1.2 Technological Progress p. 9
1.3 Determinants of AC p. 11
1.4 Carriers of Knowledge p. 13
1.5 Trade and Trade Policies p. 15
Chapter 2: (Limitations of the) Socialist System and Transition Process
2.1 Purpose of the Chapter p. 18
2.2 Economies prior to 1945 p. 18
2.3 The economies during 1945 – 1989 p. 20
2.4 The Beginning of Transition: 1989 - 1993 p. 27
2.5 Elements of Transition p. 32
Chapter 3: Empirical Research
3.1 Variable Construction p. 42
3.2 Descriptive Analysis p. 45
3.3 Regression Analysis p. 53
Conclusions and Suggestions for Further Research p. 64
Appendices p. 67
List of Abbreviations
AC - Absorptive capacity
CEE - Central and Eastern Europe
CEEs - Central and Eastern European countries; Poland, the Czech Republic, Slovakia, Hungary, Bulgaria and Romania.
CEEs’ - Central and Eastern European country’s CEFTA- Central European Free Trade Area CMEA - Council for Mutual Economic Assistance DCs - Developed countries
EBRD - European Bank for Recovery and Development EU - European Union
FDI - Foreign direct investment GDP - Gross domestic product
ICT - Information and communication technology IMF - International Monetary Fund
LDCs - Less developed countries MNE - Multi-national enterprise MNC - Multi-national company
NATO - North Atlantic Treaty Organization NEM - New Economic Mechanism
OECD - Organization for Economic Cooperation and Development R&D - Research and development
SMEs - Small and medium sized firms SOE - State-owned enterprise
VAT - Value added tax
Introduction
After the fall of the communist system, the Central and Eastern European countries (CEEs)1 have gone through dramatic changes. Transition for CEEs means moving from a socialist to a capitalist market system. Since the initial output and GDP collapse, and inflation in CEEs after 1990 (Blanchard, 2003), the countries have developed at a different pace. Some CEEs have been more successful in terms of economic performance and institutional change than others (EBRD Transition Report 2000). In this paper, the developments in export performance of CEEs will be examined. The definition of export performance used in this paper will be the share of export from high-tech industries to total export. Or in other words, the larger the share of high-tech industries in total exports, the better the export performance. In wake of liberalization and structural reforms, exports have come to be regarded as an engine of economic growth.
Figure A.1
Export Performance (share of high-tech export to total export)
0 0,05 0,1 0,15 0,2 0,25 1993 1994 1995 1996 1997 1998 1999 2000 2001 year E X P -h t/ to t. E X P Eger,t Enet,t Ecz,t Ehun,t Esvk,t
All data used for constructing the graph are in constant US dollars. Eger,t = export performance of Germany at time t
Enet,t = export performance of the Netherlands at time t Ecz,t = export performance of the Czech Republic at time t Ehun,t = export performance of Hungary at time t
Esvk,t = export performance of Slovakia at time t
Further information and explanation is to be found chapter 3.
As one can observe in figure A.1, the export performance of CEEs varies considerably. In comparison to the two Western countries, some CEEs (the Czech Republic and Slovakia) have a poor performance while others (especially Hungary) reach high-tech industry shares of nearly 25 percent. Considering the well developed human capital of CEEs (Djarova, 1999; Barrel and Pain (eds), 1999; Lankhuizen, 1999; and Van Bergen, 2002), one may wonder why not all CEEs have developed into knowledge-based economies. An extension of the factor proportions theory of trade flows splits labor into high-skilled and low-skilled labor. The theory predicts that if a country has a high skilled labor force, it will tend to export goods
1 The Central and Eastern European countries are Poland, the Czech Republic, Slovakia, Hungary, Bulgaria and
produced with high-skilled labor (Martin, 1994). With borders opening up, one might have expected knowledge to spill over from industrialized countries to CEEs through trade. This would have given CEEs the chance to improve their technology level and increase their export share of high-tech industries. But in reality, on average, the share of high-tech industries in the total economy remains rather small (compared to Western European countries) and CEE engineers are forced to look for jobs abroad. This latter process is better known as ‘brain drain’ (Husted and Melvin, 2001, p. 295).
After reading the research done by Maureen Lankhuizen (1999) on the potential for the Baltic States to increase their level of technology, this paper will argue that CEEs can increase their share of trade from high-tech industries in total trade through increasing their absorptive capacity (AC). The paper will also attempt to explain current export levels from high-tech industries according to CEEs’ AC so far. AC is the less-developed country’s (LDCs) ability to effectively absorb knowledge spillovers from developed countries (DCs) made available to them through bilateral trade linkages. Another vehicle for knowledge transfer may be investment. Effectively absorbing spillovers means detecting, assimilating and using that knowledge to one’s own benefit in production. With sufficient AC, CEEs would be able to use the knowledge generated in other industrialized European countries to increase their own level of technology in production. A higher level of technology would, ceteris paribus, increase their competitiveness compared to other LDCs. This would then in turn, ceteris paribus, increase their share of high-tech export and foster economic growth.
The theory of AC, however, does not account for changes in institutions (the transition process) and the organization of the innovative systems. Although some CEEs might now have economies that look like a capitalist system, the transition process has not been completed yet and has taken longer than expected. The development of AC has therefore to be placed parallel to the transition process. Furthermore, CEEs have gone through different transition processes. The processes can be split into two main categories: a radical or a gradual approach. Elements of the transition process include privatization, liberalization, stabilization and institutional reform. It is assumed that differences in the transition process yield different outcomes in the levels of ‘high-tech’ export. The research question is defined as: How can the export levels of high-tech industries reached so far be explained according to CEEs innovative systems (AC) within the limitations of its transition processes?
This paper will focus on the three CEEs depicted in figure A.1. Namely, the Czech Republic, Hungary and Slovakia (also named the Slovak Republic). This selection is based on two main assumptions: the countries have to be rather similar to some other industrialized European countries, and the differences between the countries should also be minimized, or else they are incomparable. The latter is important for the empirical research. Too many differences would make the interpretation of the results quite difficult and elaborate.
around the nations’ capitals (Prague and Budapest) and other big cities, while the countryside remained rural.
Secondly, according to the EBRD transition indicators in 2003, the three countries have currently a well functioning market economy. Their privatization is close to standards and performance of advanced industrialized countries, most tariff barriers have been removed, prices have been liberalized, banking reform and interest rate liberalization are significant, and in mid-2002 all three countries had a private sector share of 80% of GDP. But, it must be said that on average Hungary has received the most successful indicator figures and Slovakia least successful ones, of the three countries selected. Finally, the Czech Republic, Hungary and Slovakia are all WTO and OECD members.
The final argument is based on a more social perspective. The three countries, together with Slovenia and Poland, have on average the highest life expectancy compared to other transition economies in CEE. By 2003 the Czech Republic, Hungary and Slovakia had established private pension funds and engaged in further reform of health care and pension systems (EBRD Transition Report 2003). Furthermore, all three countries have re-established their level of real GDP after the initial output collapse in 1989. By 2002, the estimated level of real GDP was above the level of 1989, indicating recovery (EBRD Transition Report 2003). This information indicates that the three countries provide better prospects for their population compared to other transition economies.
The results of the selected CEEs will be compared to the Netherlands (in chapter 3) in order to be able to judge the performance of the three CEEs. Germany will be used as a benchmark, as it indicates a more ‘average’ export performance (see figure A.1). Without comparison to Western industrialized countries, one cannot draw any conclusions from past performance of the countries selected. One may expect CEEs to have a better export performance the more similar their results are to those of the Netherlands. Results underperforming those of Germany will be seen as an indication of a poor export performance.
The Netherlands is relatively similar in size with a government strongly emphasizing its knowledge-based economy as the Dutch main competitive advantage. This strong political emphasis on innovation grew during 1996/1997 under the presidency of Prime Minister Kok. He stressed that developing a knowledge-based economy was important for sustaining the economic growth (Tissen, den Haan & Jongedijk, 1998). Then again, the presence of a large ICT and electronics multi-national like Philips can easily leave its mark on the observed patterns within a small country like the Netherlands. However, the performance of the Netherlands will be most interesting for judging the performance of the Czech Republic, Hungary and Slovakia. Germany being one of the ‘super-powers’ within the EU, relatively close to the three CEEs in question (compared to France and Great Britain for example), belongs to the top of knowledge-based economies world-wide according to Tissen, de Haan & Jongedijk (1998). Actually, science-based industry (characterized by innovative activities linked to high R&D expenditures and academic research) is said to be a German creation (Fagerberg, Guerrieri & Verspagen (eds.), 1999). Although Germany is not as specialized in the export of high-tech products according to figure A.1 (like the Netherlands), its R&D expenditure is comparable to that of countries like the USA, Japan and Sweden. Namely, between 2.5 and 3% of GDP (Tissen, den Haan & Jongedijk, 1998).
Chapter 1: Theoretical Background 1.1 Introduction to AC
CEEs offer well-qualified and experienced workers and Western-like engineering employees (Barrel and Pain (eds), 1999 and Van Bergen, 2002). Another characteristic is the European-like education and culture (Djarova, 1999). One would expect that with a relatively high quality of the human capital stock, CEEs would have caught up with the level of technology in Western Europe. This, however, is not always the case – as one can see in figure A.1. Lankhuizen (1999) argues that countries are not able to assimilate knowledge spill-overs if they do not have sufficient absorptive capacity (AC), even if their stock of human capital is well developed. The definition of AC2, as stated in the introduction, is the less-developed country’s ability to effectively absorb knowledge spill-overs from developed countries made available to them through international trade and investment. If one imagines a country’s AC to be like a sponge and a bucket of water represents a product, or an investment, with an amount of knowledge in it, then one can use the following metaphor: The bigger and better the sponge, the more water one can absorb from an other nation’s bucket. This is turn implies that more (foreign) water can be emptied in one’s own bucket. Crucial is that a well developed AC will let LDCs benefit from knowledge spill-overs from DCs in order to improve their own level of technology and hence their export performance.
The term AC in this paper should not be confused with the concept capital absorptive capacity, which according to Stevens (1971, p. 19) “refers to the amount of foreign capital or foreign aid (…) that a country can use productively during a given time span”. However, if one would replace capital and aid by the word knowledge in the previous reference, it would come very close to the definition of AC used here. In addition, Das & Powell (2000) describe AC as part of a capture-parameter, which together with the trade volume determines the spill-over coefficient between a source and its destination. Much like Lankhuizen, they describe AC as “the recipient’s capability to identify, procure and utilize the diffused technology” (2000, p. 3).
For most CEEs, the output and GDP collapse during the 1990s resulted to a large extent from the decline of ‘protection’ by the Stalinist economy3 which manifested itself in a lack of competitiveness and a growing technology gap in comparison to developed countries during the Communist era (Fagerberg e.a., 1994 and 1999; Aldcroft & Morewood, 1995). Hence, catching-up with (Western) developed countries was crucial for CEEs in order to be able to compete on the international market and to‘re-enter’ Europe after the Soviet era. During this process of catching-up, a well developed AC can play a key role at a time where countries wish to achieve technological growth in order to enhance economic growth.
1.2 Technological progress
Tissen, den Haan & Jongedijk (1998) observe that like one century ago, the Western world is in a transitional phase (without perhaps being aware of it) lead by technological developments. A century ago our agricultural society moved towards an industrial society. Today we are in a transitional phase towards a knowledge-based economy, whereby technology plays a key role in the development and spread of knowledge. Furthermore, with consumers being more and more interested in technologically advanced products with better features, the key for producers is to improve the quality of their goods and services in order to
2 This definition has been derived from the paper by Lankhuizen (1999). 3
gain and retain customer loyalty. Hence, within the new “The click here economy”4, technological progress is crucial.
Fagerberg, Guerrieri and Verspagen (eds.) (1999) share the same idea on the importance of technological development on long-term economic development: “For a long time, economists used to focus on differences in the supply of capital and ‘land’ (…) to explain differences in growth performance. However, it is now commonly accepted that the ultimate source of economic growth is to be found in ideas, (…), including the ability to apply new ideas to practical uses in an efficient manner.” (1999, p. 1) Relating the debate to trade, the authors more specifically state that trade performance is closely related to technological catch-up. “In fact, one of the most striking findings from studies of successful catch-up is that it is associated with both a general improvement in trade performance and a radical change in the composition of trade. For instance, the catch-up of Western Europe (…) from the 1950s onwards was associated with rapidly increasing export market shares for products embodying these technologies.” The authors suggest that the same idea of the 1950s in Western Europe would apply to CEEs currently (1999, ch. 1).
In macroeconomic literature, technological progress is thé factor that determines the persistent rise in living standards in industrialized countries in the end. Solow developed a model where in the long-run steady state of that model, total output growth is determined by technological progress and population growth, and growth in the output per worker is solely determined by the rate of technological progress. This form of technological progress is called labor-augmenting because it causes the efficiency of labor to rise at some constant rate. The Solow model takes the level of technological progress as exogenous (Mankiw, 2000, ch. 4 & 5). Providing that all countries benefit equally from this exogenous technological growth, Solow states that countries converge to the same level of productivity (Fagerberg, Verspagen and Von Tunzelmann, 1994).
However, research that followed up on Solow showed that this perception of technological progress (as exogenous) proved to be a problem. According to other authors5 technological progress can not be examined separately from capital accumulation and investment in human capital (Fagerberg, Verspagen and Von Tunzelmann, 1994). Secondly, technology is not a truly public good. Its usage can be bound by legislation and other means, and it is mostly embedded in organizations. Hence, it is unlikely that countries converge to the same level of productivity as mentioned before. As an alternative, Kaldor developed a model were technological progress was seen as endogenous. According to Kaldor, investment and learning were interrelated, which lead to a model were technological progress could be explained by a function of capital accumulation per worker. Hence, the rate of technological progress is not given but dependent on the prospects within a given sector.
Other models6, that perceive technology as an endogenous factor, are “based on the Schumpeterian idea that innovation by private firms drives the growth process” (Fagerberg, Verspagen and von Tunzelmann, 1994, p. 9). According to this perspective, the firms’ incentive to innovate (and hence to invest in technology development) lies in the exclusive monopoly they receive for using the innovations. In other words, investing in human capital and R&D will pay off. Furthermore, the benefits of these innovations are likely to spill over
4 Tissen, den Haan & Jongedijk (1998), derived from Business Week, 22 June 1998.
5 Abramovitz and David (1973), Nelson (1973) in Fagerberg, Verspagen and von Tunzelmann (1994). 6 Romer (1990), Grossman and Helpman (1991) and Aghion and Howitt (1992) derived from Fagerberg,
within, and across industries. Meaning, the national economy would benefit as a whole from firm-based technological development (Fagerberg, Guerrieri and Verspagen (eds.), 1999). And indeed, research by Jansen and Landesmann (in Fagerberg, Guerrieri and Verspagen (eds.), 1999) concludes that more advanced economies also produce more technologically advanced products and have more advanced production processes. This in turn is said to be determined by skill and R&D variables. The more resources are available for human capital and R&D, the better the prospects will be for economic growth (ceteris paribus).
1.3 Determinants of AC
This paper attempts to explain differences in export performance by differences in absorptive capacity (AC). According to the literature mentioned above, one expects LDCs with a better developed AC to be more able to implement and use foreign (DCs) technology in their own production. These new (foreign) technologies will enhance the competitiveness of a LDC and stimulate trade (since the products made in the LDC become qualitatively better). Export improvement will be expressed as the change in the share of export from high-technology industries within total export. So, potentially, the better developed the AC is, the larger the share of export from high-tech industries. The determinants of AC according to Lankhuizen (1999) are the number of research performed within the country itself integrated with the production of goods and services, and a country’s communication channels.
Domestic R&D
By engaging in R&D a LDC will develop the ability to detect, absorb and use foreign knowledge spill-overs made available to them through trade and foreign investment. In the same way it will be easier for a chef rather than an average person, to distinguish all the different flavors in a dish, select the corresponding ingredients and create the recipe for personal use. The more people engaged in R&D, the better the AC. Hence, the more a country is engaged in R&D within high-tech industries, the better the AC, and the larger the share of high-tech export in total export.
More important for a country’s AC is the degree to which R&D is integrated with production (Lankhuizen, 1999). The more scientists and researchers engaged in integrated R&D7, the “easier” it will be for a LDC to identify, assimilate and exploit knowledge spillovers from DCs. One of the problems in former socialist CEEs was the lack of integration between R&D and business. R&D was conducted separately and innovations were imposed upon firms by the socialist governments. Innovations lacked creative competition. Clearly, R&D was not very responsive to consumer demand (Lankhuizen, 1999).
The management and organization of R&D is another important issue next to integration with business. However, this paper will not go into the organization of R&D. The widespread view in Barrell and Pain (1999) is that R&D generates spillovers of importance for other firms. This may encourage other, R&D-intensive, firms to locate in the same region. This potential increase of production would clearly benefit economic growth in the region. Beije (1993, p. 20) also mentions that “firms (...) quite often discover unexpected things. Hence, social benefits exceed private ones”. Knowledge can be seen as an undiscovered pool in this case, open to all firms within the country. But one has to bare in mind that R&D is conducted by single firms, and not the country as a collective. Whether a company will engage in R&D depends on the time-cost trade-off function, market uncertainty, competition in R&D and horizontal cooperation within a country (Beije, 1993). Most firms tend to spend their R&D
7 Integrated R&D is R&D directed towards the innovation and improvement of (new) products and/or production
budget on applied research which is dedicated to the completion of a new production process and/or product. A company will want the benefits of the innovation to exceed the costs of R&D.
The authors Cohen and Levinthal (1989) assume that firms not only invest in R&D to generate innovations, but also invest in R&D to learn from their competitors and extra-industry knowledge sources (e.g., university and government labs). The authors have claimed that R&D has two ‘faces’, of which the latter is in accordance with my reasoning above. In addition to R&D enhancing technology transfer by improving the ability of firms to learn (‘absorptive capacity’), R&D has the more conventional role of stimulating innovation. R&D then directly influences the level of technology without improving the AC.
To improve the share of high-technology export, more research will need to be conducted in this area. This will be tested in chapter 3. In the research, an export improvement is therefore associated with an increase in the share of R&D expenditure in high-technology industries compared to total R&D expenditure.
Infrastructure (telecommunication)
Communication channels are the key for knowledge to be exchanged. According to Lankhuizen (1999), LDCs need to install channels for communication “in order to coordinate and integrate knowledge throughout the research sector” (p. 26). Telecommunication is becoming a much more crucial area within an economy, influencing the communication system (Müller, 1988). Better and more telecommunication facilities, like the Internet and mobile phones, improve the communication and co-operation between firms, and between firms and its customers. Furthermore, network services may help in spreading existing services from within organizations, and lead to the further integration of office functions. Linked to the demand for telecommunication networks is the size of the telecommunications equipment. During the 1980s the European Community already recognized the importance of eliminating all barriers to trade in telecommunications by 1992, when the internal market had to be completed. Mainly technical obstacles caused for the delay in achieving an effective internal market (Müller, 1988). Hence, not only telecommunication networks, but also the telecommunications equipment plays a crucial role in the act of communicating. Equipment will, however, not be the focus of this paper.
The importance of external ties is emphasized in the network perspective. A network consists of suppliers, government agencies, clients, non-governmental organizations and other stakeholders. A more developed network helps the entrepreneur to discover opportunities, secure resources and gain legitimacy (Elfring and Hulsink, 2001). Although Elfring and Hulsink come to the previous conclusion after studying start-up firms, one may assume the importance of networks apply to entrepreneurs in general. Namely, in order to innovate, any company will need to discover new opportunities and access to other resources. Infrastructure is therefore not only important for ties between entities, but for access to information in general. Access to news bulletins, reports, working papers, databases, manuals and other sources in writing or digital, all need a well functioning infrastructure. A better infrastructure will facilitate investment and the import and export of goods, as well as knowledge.
factors8 that determine a country’s innovation potential (which strongly resembles the idea of AC, according to my interpretation). The communication infrastructure enables a country to gain the technology and transfer it between participants of the research sector. Tissen, den Haan and Jongedijk (1998, ch. 1) even conclude that without an excellent physical infrastructure, economic growth through innovation and development would prove to be unsuccessful. According to the authors, economic success lies in the combination of infrastructure and knowledge flows.
As a determinant of AC, the amount of mobile subscriptions will be used in this paper. Telephone networks link various parties electronically with each other, so that interactive exchange of information becomes possible. Hence, the communication through voice, message and image is very direct. The amount of subscriptions is expected to increase as the economy grows. Over time the provision of telecommunication services has improved significantly in terms of efficiency, because of economies of scale and better use of inputs. Important technical developments in transmission techniques and reductions in the cost of services provision, further added to the growth in telecommunications output. This in combination with increasing economic wealth will imply that the amount of communication lines will grow and the population becomes more ‘mobile’.
1.4 Carriers of Knowledge
In the previous section it has been explained that a country can improve its export performance (increasing the share of high-tech export in total export), by stimulating its AC. However, without access to knowledge spill-overs, the AC will be of little use. Clearly, in order to stimulate the export of high-tech industries there has to be knowledge from abroad that can be effectively absorbed and implemented in the production of those high-tech products. As mentioned at the beginning of this chapter, knowledge spill-overs from abroad are made available to LDCs through international trade and investment. This section will evaluate two important modes for gaining access to foreign knowledge-spillovers: the import from foreign high-tech industries and the inflow of foreign direct investment (FDI). The two carriers of knowledge will function as control variables in the empirical research to follow.
Technology import
The assumption behind this control variable stems from the Embodied Spillover Hypothesis. This hypothesis states that technical knowledge flows through traded goods. State-of-the-art innovations created by R&D in DCs are embodied in commodities produced. Through trade, innovations will therefore spill over to LDCs. The implications of R&D spillovers on economic growth, total factor productivity, future profits and investment have been shown by Bayoumi et al. (1996), Coe et al. (1995), and Coe & Helpman (1993). The papers all provide an explanation of a positive relationship between the increase of DCs’ R&D stock and the economic prosperity of LDCs. In trade, geographical proximity plays an important role in the flow of knowledge. Empirical research has shown that most knowledge spillovers originate from close trading partners.
Another view on technology import is that an importer will gain information through its direct contact with foreign suppliers. In this case knowledge is transmitted through the act of trading, rather than being embodied in the products traded. As mentioned in the previous determinant, a good infrastructure as a base for communication is essential in this case. But also the entrepreneurs’ ability to communicate clearly is important. Furthermore, governments
8
can also take an active part in the transmission of knowledge through trade. The ministry of foreign affairs in the Netherlands, for example, established a centre to improve import from developing countries (Centrum tot Bevordering van de Import uit ontwikkelingslanden) in 1971. They have set up seminars and workshops (IOB-Evaluaties N°281, 1999) that have proved to be efficient in improving the organization skills of the participating entrepreneurs (from LDCs). This in turn benefited the export of developing countries.
For a country to absorb knowledge in order to improve their export, it is assumed that more products from foreign high-technology industries that contain relevant information will need to be imported. This will be tested in the empirical research. A larger share of high-technology import in total import will be expected to improve a country’s export performance.
Foreign Direct Investment
Investment inflows are determined by market size, the cost and quality of labour, proximity, access to raw materials, taxes and regulations, and entry modes. Theory suggests that capital will move from capital rich to capital poor countries. But this does not mean that capital moves into only one direction. Investments that will only acquire a small share of a foreign business (less than 10% of the shares) are called Foreign Portfolio Investment (FPI). Foreign Direct Investment (FDI) are investments with which one gains control over a business, or a large part of the shares. Most FDI is conducted by multi-national enterprises (MNEs). Interestingly for this paper, FDI plays a key role in technological progress. Namely, diffusion of technology can go through FDI as FDI includes extensive negotiations, briefing, monitoring and evaluations. FDI can take various forms. Investors can purchase existing assets in a foreign country; make new investment in property, plant and equipment abroad; or participate in a joint venture with a local partner.
A framework for analyzing the decision to engage in FDI, based on three advantages that FDI may provide in comparison to exports, is the OLI paradigm (Pedersen, 2002). OLI is an abbreviation of: Ownership, Location, and Internalization. For FDI to be undertaken, according to the OLI-paradigm, three conditions must be satisfied: First, the MNE (or other type of firm) must have an Ownership advantage relatively to local firms. Secondly, the host country must have a Location advantage. Without locating abroad, one is ‘just’ an exporter. And finally, full control remains with the investing company because of the Internalization advantage (Pedersen, 2003). This final advantage is a reason for keeping the company’s knowledge to itself to avoid the risk of imitation. The knowledge-capital model by Markussen is based on the OLI-paradigm and argues that MNEs ownership advantage lies in knowledge-based assets rather than physical assets (Markussen, 2000). Because knowledge has the characteristic of a public good, it may be used in various countries. Hence, receiving investment by Western multinationals will give the firms and entrepreneurs in LDCs access to technologies and processes that may otherwise have been inaccessible trough regular trade. This notion is further strengthened by Harrison, Dalkiran & Elsey (2000) and Barrell & Pain (1999). They suggest that FDI will contribute to technology transfer because FDI not only involves the transfer of capital from one country to the other, but the investments will go hand in hand with extensive negotiations, briefing, monitoring and evaluations. FDI may be even necessary to carry information abroad since tacit knowledge and ideas are difficult to license or to copy according to the authors.
flow of capital, knowledge would still be very likely to be transmitted through the mobility of labour (Barrell and Pain, 1999). Employers that resign or get fired will take their (tacit) knowledge elsewhere. According to Moosa (2002), “FDI by MNE is considered to be a major channel for the access to advanced technologies by developing countries. (…) Knowledge transferring from the MNE (…) may leak out to the host country, giving rise to an externality known as the spill-over effect from FDI.” (p. 87-88). Let us view this capital as an asset, or even a good. Referring back to the Embodied Spill-over Hypothesis, the spill-over effect of FDI would suggest that a country will increase access to foreign knowledge spill-overs through this form of import. However, Leahy & Neary (1999) warn that FDI benefits the host country only if the degree of the technological spillover is high enough. But the latter should be achieved in high-technology industries which are characterized by intensive R&D.
Moosa (2002) also warns that “(…) the corresponding benefits of foreign technology accruing to the host country (…) may turn out to be negligible or even negative. This may be caused partly by the inability of the host country to absorb the foreign technology properly.” (p. 88). All the knowledge embodied in the investments would remain within the subsidiary and not spill-over into the host country because of its inability to grasp this knowledge and make use it. One may interpret the following by saying that without sufficient AC a country would not be able to improve its export performance through attracting FDI. In this negative case, FDI would most likely be determined by the (low) cost of labor rather than the quality of labor in LDCs. Whether FDI is associated with technological growth or low costs of labour will be determined in chapter 3.
1.5 Trade and Trade Policies
The significance of import from Western high-tech industries and FDI, in addition to a well developed communication network and the conduct of integrated R&D, on the export performance of CEEs as explained in the preceding paragraphs, puts a large emphasis on the trade patterns and trade policies of the CEEs involved. Hence, the desired export performance has to be accompanied by the appropriate trade strategy.
In general, factors with an impact on growth are the accumulation of physical capital, skills and knowledge; openness in trade, investment and ideas; and institutions. International trade is crucial for smaller countries, like most European countries, because these countries are not self-sufficient the way large countries may be (Jepma, Jager and Kamphuis, 1996). There are several gains from trade (Hansen and Nielsen, 1992). Namely, both trading partners can exploit scale economies, overall market size effects, and their comparative advantage through specialization and efficiency gains. The latter two are a direct outcome of the fact that through trade more product variants become available. Trade also benefits consumers. These welfare gains come from an erosion of the market power of producers. Prices will tend to decrease as a result of trade because of the increased competition among producers. Also, if there are no barriers to trade, the flow of goods and services are no longer restricted, thereby producing a larger number of product variants to consumers.
opportunity to expand markets as well as to earn foreign currency. Hence, increasing export shares will increase a country’s income and lead to an increase in economic growth, ceteris paribus (Lankhuizen, 1999).
A country’s export performance depends on its competitiveness. This, in turn, is determined by productivity, wages and technology. Both an increase in productivity and technology has a positive effect on export (Lankhuizen, 1999). An increase in productivity will make goods and services relatively cheaper, and an increase in technology improves the quality of goods and services, making them more appealing for other countries to purchase. Also, technological progress can improve production mechanisms, and thus improve productivity and efficiency that will in turn increase the export share. An increase in the wages, on the contrary, decreases export. Higher wages drive up costs, which in turn drive up prices, making goods and services relatively more expensive.
In case of CEEs, technical standards at the beginning of transition were not up to the level of industrialized countries in Europe. It had become difficult for products from CEEs to meet the multiplicity of requirements and standards of Western European countries, with their relatively lower quality. Therefore, improving the level of technology, and thereby the quality of products, became a crucial issue for CEEs in order to close the gap in competitiveness. Åslund and Warner (2003) have shown that the quality of exports is a significant factor in explaining the amount of CEE and CIS export to Europe. Increasing the export share therefore implies increasing the quality of products.
Now that the relationship between trade and economic growth has been established, let us briefly look at the three main trade strategies a (developing) country might decide on according to Husted and Melvin (2001). In case of a primary-export-led strategy, a country would exploit its natural comparative advantage by focusing on exporting its natural resource based goods. For the Czech Republic this would be for example coal, kaolin, clay, graphite, timber; for Hungary bauxite, coal, natural gas; and for Slovakia brown coal, lignite, iron ore, copper and manganese ore (www.infoplease.com). But, markets for primary products do not tend to grow fast enough to match development. According to Davis and Tilton (2002), empirical studies have identified some explanations for this phenomenon. The first is that the prices of primary goods have fallen relative to the prices of manufactured goods. Secondly, the market for primary products is rather volatile and makes the planning of development programs difficult. Also, in the case of mining, rents may be misused and wasted.
The import-substitution strategy seeks to encourage local production by setting up barriers to foreign goods. “Tariff differentiation between members and non-members [of a trade union] is expected to favor imports from member countries at the expense of non-members. However, such arrangements do not simply divert trade; they may also create trade if they help accelerate growth” (www.unctad.org).9 However, based on the paragraphs above, trade restrictions worsen consumers’ and producers’ position by mainly driving up prices and restricting the variety of goods available. Furthermore, this strategy would tend to limit the development of other industries which are not protected.
Finally, a country could also decide for an outward-looking strategy. This strategy would seem most desirable, and in line with the reasoning of this paper. According to this strategy, sectors in which a country has a potential comparative advantage will be stimulated, hopefully
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to increase exports of these products. In case of a well skilled labour force, one would stimulate the manufacturing of products in high-technology industries where skilled labour is used intensively. Furthermore, this strategy includes keeping open markets (no trade barriers like in the previous strategy), maintaining competitive export prices and minimizing governmental interference on factor markets.
Chapter 2: (Limitations of the) Socialist System and Transition Process 2.1 Purpose of the Chapter
In order to explain the development of a country’s AC, one has to take into account the organization and institutions surrounding the process of innovation and change. As mentioned previously, the transition process has accounted for significant changes in the economies and institutions of the countries involved. The development of AC has to be placed within the context of the economic process of transition within the selected countries that was initiated in 1989. This chapter will aim to evaluate the different economies, their receptiveness to AC and their institutional change over time. Or in other words, what have the implications been of the changing economic systems on technological development and trade over time?
First, an overview of the economies prior to 1989 will be given. By examining the economic past, one may expect to have some aid for explaining transitional developments later on. After the brief overviews of the economies prior to WW II, the emphasis will be on the Soviet-type economy that determined the landscape within CEE for forty years. Because the Soviet-type economy “became the blueprint for every other centrally planned economy in the twentieth century” (Pomfret 2002, p. 11), the model had a major influence on the Czech Republic, Hungary and Slovakia for forty years. Providing a historical overview is important because it sheds light on the legacy of the three CEEs.
Secondly, the turbulent period between 1989 and 1993 will be examined. Here the general characteristics of transition and relevant country specific events that took place during the initial years of transition will be explained. Finally, the main elements of transition will be discussed: privatization, price liberalization, macroeconomic policy and institutional reform. The aim is to determine whether and to which extent these elements have influenced, or still influence, the development of AC and/or trade.
2.2 Economies prior to 1945
The Czech lands and Slovakia and Hungary up to WW I
The Czech Republic consists of the two ancient lands Bohemia and Moravia, of which Bohemia has been the most important. During the 19th century the Czech lands emerged as the most important industrial part of the Habsburg Empire. The lands became large producers (Bohemia especially) of iron and steel, agricultural machinery, railway rolling stock, chemicals, glass, porcelain and fire arms (Hyde-Price, 1996, ch. 2). When the Austro-Hungarian Empire was created in 1867, the Czech lands were the industrial heart of the Empire. They were at the forefront of technological development and international trade within Europe. During the First World War the Czech lands actually benefited from the war through orders from the Empire for military supplies. Problems presented themselves ‘only’ at the end of WW I, as shortages of fuel and raw materials arose (Aldcroft and Morewood, 1995).
Hungary was split into three parts under Turkish rule until the Austrians defeated the Turks and Hungary was given to the Habsburgs in 1699. Eventually, the Habsburgs agreed to create a Dual Monarchy and the Hungarians regained rule over their territory. By the end of WW I, Hungary ended on the losing side and saw its territory being split up into new (reborn) states. Hungary lost, in comparison to the pre-WW I situation, 68 percent of its territory and 59 per cent of its population (Aldcroft and Morewood, 1995, p. 7). Another main problem was the loss of raw material sources. Due to this lack of resources, Hungary had great difficulty servicing its developing industry. Also, the country lost half of its industrial enterprises. The concentration of manufacturing in Budapest lead to disproportionate shares of industrial activity and restricted the industrialization of the more backward areas in Hungary. Industrialization of the total country was further restricted by the destruction of the integrated transport system that had existed until WW I. The destruction also closed Hungary’s roads to Prague, Bucharest and Belgrade, hindering international trade (Aldcroft and Morewood, 1995, ch. 1). Overall, technological growth deteriorated.
The Interwar period (and WWII)
Before discussing the economic developments in CEE, the creation of Czechoslovakia by the end of WW I (1918) deserves some attention. The new Czechoslovakia inherited only 25% of the population and 20% of the territory of the late Austro-Hungarian Empire, but it possessed 67% of its industrial capacity (Hyde-Price, 1996, ch. 1). Furthermore, Czechoslovakia was considered the only (Western-like) democracy in CEE during the inter-war period (Aldcroft and Morewood, 1995, ch. 1). However, this does not imply that Czechoslovakia did not face great challenges. On the contrary, the main task was to integrate the less developed Slovak regions with the Czech lands. Also, in practice the Slovaks were looked down upon by the Czech and all key administrative positions were taken by Czechs. By the end of the 1930s, Czechoslovakia was the only CEE country that matched the Western industry’s share of national income of more than 50 per cent (Aldcroft and Morewood, 1995, ch. 2 and 3).10 Let us now examine the economic developments, and their implications on technological development and trade, within CEE during this period. The first economic change was land reform. Large estates were broken up into smaller estates to secure the economic independence of peasants. The main objective of the land reforms was to empower the population in terms of economic independence. The results were, however, questionable. Many of the newly established smaller estates proved to be inefficient as the owners lacked equipment, resources and knowledge. Improving efficiency would not simply solve the problems, since the country-side suffered from underemployment (Aldcroft & Morewood, 1995, ch. 3).
Secondly, in order to foster industrial growth during the 1920s, the countries used trade regulation, not only to protect the domestic production, but also for revenue purposes. Important in this perspective were the new imposed tariffs. Once completed in 1926, the new tariff structure in Czechoslovakia “represented 36.4 per cent of the total value of imports” (Aldcroft & Morewood 1995, p. 30). The Hungarian tariff of 1924-25 “introduced stiff protection for industrial goods covering over 2000 items (…)” (Aldcroft & Morewood 1995, p. 30). However, this new structure was devastating for small private owners that bore the burden of higher prices and tax. Furthermore, based on section 1.5, trade restrictions may worsen consumers’ and producers’ position by driving up prices and restricting the variety of goods available.
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During this period state intervention grew. Next to the imposed trade barriers, governments nationalized foreign capital. “Industry was (…) favored with (…) exemption from taxes, cheap factory sites, subsidized railway rates, maximum fuel prices, exemption from customs duties (…), and specific subsidies to encourage the development of certain sectors (…)” (Aldcroft and Morewood 1995, p.31). As a result, the level of output matched or exceeded prewar levels. This does not imply that innovation and development benefited as well. As will become more evident later, state intervention can hamper competition. As a result producers have less incentive to innovate and change in order to attract customers.
Finally, during the 1920s, CEE suffered from inflation. Hungary11 even experienced the case of hyperinflation, leading to the complete collapse of the currency. The reasons behind the hyperinflation and collapse were the excess demand as a result of large budgetary deficits and growth in money supply. Issuing money was considered easier than imposing new taxation systems. As a result, “the state’s ability to generate real revenue diminished sharply as the costs of collection rose and the value of money became almost worthless” (Aldcroft and Morewood 1995, p. 33). In order to stabilize the (new) currency, Hungary’s government formulated a tripartite reconstruction package consisting of: balancing the budget, the flotation of a foreign loan and reorganizing the central banking system (Aldcroft and Morewood, 1995, ch. 2). By 1924 the new currency was stabilized. Czechoslovakia, on the contrary, was the only CEE state to partially avoid and overcome the devastations of severe inflation. First, a new currency was introduced in 1919 – the Czech crown – which replaced the previous currency from the old Empire. Secondly, there was a set ceiling on the printing of money and current circulation was reduced by 20 percent (to prevent so-called supply-side inflation). And thirdly, state finances were secured and the budget was balanced by 1921. In 1923, stabilization was finally completed and the Czech crown appreciated (Aldcroft and Morewood, 1995, ch. 2).
As a result of the different inflation ‘experiences’ one may expect there to be differences in the trade conducted. The more stable a currency is, the less the perceived risk due to better trading conditions; the more international trade will be conducted (ceteris paribus). Due to the international trade, companies will be more inclined to innovate in order to match foreign competition. As a result, more R&D will be conducted and the AC of a country improves. Furthermore, trade will give access to foreign knowledge spill-over (Embodied Spill-over Hypothesis) which can be used to improve national production. And indeed, unlike Hungary, Czechoslovakia was affected by “Western developments in business organization, rationalization, new methods of production and factory layout, mechanization and mass production, and the use of new forms of energy (…)” (Aldcroft & Morewood 1995, p. 45) as a result of international trade. More importantly, in terms of innovation, Czechoslovakia was the only state that kept pace with the technological and production changes in Western Europe during the 1920s.
2.3 The economies during 1945 - 1989
The Communist era
During the period 1949 – 1953, Stalinism spread across Central and Eastern Europe12. The socialist economic system had three fundaments: a monoparty, state ownership and central planning. The Council for Mutual Economic Assistance (CMEA or Comecon), determined foreign trade behavior. The CMEA was established in 1949 and had a major impact on trade
11 The same holds for Poland.
12 Except for Yugoslavia, who broke up with the USSR in 1948, the Soviet political and economic influence
patterns in CEE by centralizing trade and isolating enterprises from world markets, and creating a duality in trade (Lankhuizen, 1999). Duality in trade implied that there were two separate international markets for trade: one for CMEA members and one for non-members. In Czechoslovakia and Hungary, the Communist regimes were firmly in place by 1949. Their international trade was oriented towards the USSR and their domestic economies pursued an extreme form of Stalinism. This included “state-owned industries, central planning and preparations for collectivization of agriculture” (Pomfret 2002, p. 15). The USSR viewed Czechoslovakia as very important. Next to its strategic position within the European continent, Czechoslovakia was economically significant (see the previous history). Hungary, on the other hand, was perceived important in terms of linking the economically significant Northern CEEs and the southern Eastern European countries. Hence, it was in the interest of Moscow to impose a firm grip on these nations.
Let us examine the implications of the Soviet-style economy (central planning (1), state-owned industries (2) and the collectivization of agriculture (3)) and the CMEA (4) on the economies of CEE. The aim is to demonstrate the weakness of the Soviet-style economy in terms of innovation and technological development. The focus will be on issues 1, 2 and 4, because products produced in the agricultural sector are mostly considered to be of lower technology whereas the paper focuses on high tech goods.
(1) Implications of the hierarchical structure of authority and the rigid planning of production and distribution on the level of innovation and technological development were dramatic. Producers were not responsive to consumer demands, because they had no incentives to do so. Supply was determined from above, eliminating any kind of consumer sovereignty. Also, emphasis was placed on military equipment and heavy industry instead of consumer goods and services. Central planners were good at meeting simple objectives and had no aim to satisfy consumer utility. The predominant role played by the quantity targets in the economic plans and the management objectives set to fulfill these plans, resulted in a disproportionate emphasis being placed on the quantity, instead of quality, of production (Wolf, 1988, ch. 2). Hence, central planners did not control the quality and variety of consumer goods and services (Pomfret, 2002, ch. 2).
Furthermore, managers were encouraged, by the central planners, to keep holding on to their equipment as long as possible to avoid stoppages associated with replacement of capital. Hence, instead of replacing the machinery and equipment before the end of its physical life by improved and more productive capital, managers held on to their outdated capital. When capital was finally replaced, central planners preferred the same machinery and equipment as before. They knew the characteristics and capabilities of the same equipment, and avoided the uncertainty associated with technologically advanced capital that had been developed by a separate R&D organization13 (Pomfret, 2002, ch. 2). Another factor that added to the lack of initiative to innovate and change were the collusive practices of managers. At times of plan failures or other misfortunes, managers saw themselves often inclined to lie to their superiors to hide the issue at hand, because managers were expected to keep the companies running at all times. As a result, collusion with colleagues in order to conceal or twist the truth became a habit. These practices lead to the lack of entrepreneurial and competitive managers (Estrin and Cave (eds.), 1993).
13 Managers were not to take an active part in the improvement of the production process. Hence, any changes
Another important manifestation of the hierarchical structure of authority and the rigid planning was the organization of research and development. According to the theory of AC, it is important for domestic R&D to be integrated with production. However, during the Communist regime, innovation and development were separated from production, because “R&D was considered to be of strategic importance for industrialization and technological progress” (Lankhuizen, 1999, p. 27). This ideology “was a result of Cold War and sustaining the military potential” (Gubriel, 2002, p. 12). The author concludes that the “concentration on military technologies without any transfer of these achievements into commercial implementations had a negative impact on the whole economy” (Gubriel, 2002, p. 12). During this era there was little money directed towards high-tech industries to engage in R&D. Instead money was put to outdated heavy industry (Saxonberg, 2003). In Czechoslovakia this implied a cut in investment from the Czech world-leading consumer products and light industry.
CEE research organizations were integrated into Soviet research organizations, or the organizations had to serve industrial ministries. Universities engaged in research only to a very limited extend. Professors were expected to spend most of their time teaching. Enterprises were simply to implement the innovations generated by the central R&D institutions. Separation of research organizations, production and universities resulted in a lack of sharing and coordination of the different types of knowledge within an economy (Lankhuizen, 1999).
(2) One of the main features of the communist system was an economy where property ownership was the responsibility of the state. For the central planning mechanism, wide-scale public ownership was considered necessary to allow for the imposition of state control over resource allocation and production. Hence, rather than providing competitive markets, socialist economies were developed to suit the preferences of the planners at the center. These planners “frequently reduced the number of firms through amalgamation in order to facilitate the planning process” (Estrin & Cave (eds.), 1993, p. 9). Communication between the central planners and the conglomerates was more efficient than between the central planners and many separate enterprises. Large firms would favor the conditions for economies of scale, which were considerable for heavy industry and the supply of intermediate goods (which were the focus of central planners). By 1989, for example, the average number of workers in a CEE firm was 3,000 against about 300 workers in the West (Estrin and Cave (eds.), 1993).
It is believed that the lack of (private) small and medium sized firms (SMEs) has a very negative effect on competition, and thus the technological and productivity growth (according to the assumptions made in chapter 1). In short, when there is no (or very little) competition on the market, an entrepreneur has less of an urge to improve his product or production process in order to improve efficiency and/or quality of his product in order to stand out on the market. Since there was virtually no consumer power, the state-owned producer could stick to producing the same product since it would sell anyway. Furthermore, in terms of production, the focus was on costs rather than quality as economic activities were amalgamated in order to achieve economies of scale. Clearly, state-owned property and central planning did not benefit the development of AC within a country.
surpluses would be exported in order to pay for the start-up of the industrial sector. The second objective was to gain control over the rural communities. Collectivization was said to improve total productivity and supply cheap food to the urban population. The latter would help to keep the wages at a low level (since the demand for wages would be lower due to the low costs of living) (Aldcroft and Morewood, 1995, ch 4 and 5).
However, the agricultural policy proved to have another outcome. Throughout the 1950s, the agricultural sector was a lower priority than the industrial sector within CEE. Because of the urge for industrialization, investment went to the industry. Table 2.1 demonstrates a clear shift in the distribution of national income. Furthermore, the policy of collectivization proved to be harmful to some farmers. High taxes were levied on non-collective farms in comparison to the significantly lower taxes on collective farms. Also, the supply and distribution of machinery, seeds and other inputs were controlled by the state. Where collective farms had access to a greater portion of what was available, individual peasants were completely denied access to the state supplies (Aldcroft and Morewood, 1995, ch. 6).
Table 2.1 Structure of production in CEE by sector, 1950 - 1990
(Distribution of net material product, in %) Czecho- Hungary Poland14 slovakia Industry 1950 71.2 55.4 45.0 1975 75.6 53.1 70.8 1989 70.3 57.8 59.9 Agriculture 1950 16.2 24.9 40.1 1975 8.7 21.2 14.8 1989 9.6 14.5 14.7 Transport, commerce 1950 10.6 17.1 not availab. 1975 11.9 24.8 12.3 1989 19.5 24.6 22.3 Other sectors 1950 2.0 0.6 not availab. 1975 1.0 0.9 2.1 1989 0.6 3.1 3.1 Source: Lavigne (1995), p. 53 Not availab. = not available
(4) The foreign trade behavior of the CEEs was another ‘victim’ of state monopoly and rigid bureaucracy. In general, foreign trade in CEE was carried out by a number of state-owned foreign trade organizations. These trade organizations were subordinate to the Ministry of Foreign Trade within a country. In turn, the Ministry of Foreign trade was subordinate to the Council of Ministers, who had to act according to the plans made and decisions taken by the CMEA (Wolf, 1988, ch. 2). The trade conducted by the foreign trade organizations was fixed in five-year plans by the central planners, which was the result of the calculated excess demand and foreign exchange needs. Foreign trade only took place if it was deemed necessary
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for overall plan fulfillment. In general, central planners aimed to protect the CEEs from the uncertainties of the world markets in order to eliminate the risk of not fulfilling the economic plans. This created a so-called “trade aversion” within centrally planned economies.
Foreign trade organizations had the following characteristics: Generally, the trade organizations only engaged in foreign trade and did not supply the domestic market with goods. The limited degree of autonomy that the trade organizations enjoyed and their isolation from domestic trade, together with the fixed domestic prices at different levels of the production chain, resulted in the creation of dual markets. Trade within the CMEA was set according to fixed prices that were to meet policy objectives of central planning. Trade outside the CMEA was conducted with so-called foreign exchange currency or valuta currency, which was indeed subject to fluctuation (Wolf, 1988, ch. 2). This separation of trade will have had a negative effect on the transfer of knowledge spillovers to CEE. Because the domestic market was separated from the foreign (Western) trade market, knowledge embodied in the goods traded would not spillover to the domestic producers. Furthermore, domestic producers did not engage in the act of trading meaning that they did not acquire foreign know-how through communication. This limited the access to better technologies. The second characteristic of foreign trade organizations was the fact that they were (generally) non-competing with one another. A trade organization usually had a trade monopoly for a particular good, or range of products. Hence, the trade organizations, together with the Ministry of Foreign Trade, made up the state monopoly of foreign trade. The lack of competitive managers implied that one had little incentive to compete for exchange with foreign trade partners. Thus, like the production, the organization of the trade organizations was neither subject to change. Wolf (1988) states that the lack of competitive forces led to difficulties in exporting CEE goods to market economies worldwide, because trade organization was not comparable with Western countries. Hence, not only the domestic producers suffered from isolation and a lack of competition, the trade organizations that actually had some contact with the world market were suffering from a lack of competition as well.
In conclusion, the lack of integrated R&D and communication channels clearly hampered the development of the CEEs’ AC. Producers within the Soviet-type economies were not receptive to innovation and technological development. Secondly, the redirection of trade to the USSR limited the access to Western knowledge spill-overs embedded in the products traded. The foreign trade policy limited both domestic producers as well as trade organizations. Thirdly, the overall attitude of managers and planners was not directed towards innovation and change. One was not challenged to take initiative. Managers and planners aimed to please their superiors and held on to outdated technologies. Finally, the organization of R&D was directed towards space travel, sports medicine and military equipment. Consumer products were neglected, resulting in a technological slowdown. Not only the determinants of AC (being communication channels and integrated R&D) were neglected during the Communist regime, but the access to knowledge spillovers through trade and investment was hampered as well.
Economic reforms during Socialism
potential because of the gigantic bureaucracy. Therefore, economic reforms, to improve economic performance, were introduced. However, it was not until the 1960s that these definite reform movements spread across CEE and became apparent. It was during this period that Moscow encouraged the more independent and innovative policies within CEE, as a result of its own inability to come up with solutions to combat the weaknesses of the Soviet-style economy (Aldcroft and Morewood, 1995, ch. 6).
The reforms in Czechoslovakia, attempted to move away from the traditional central planning mechanisms as a result of the growing dissatisfaction among the population. In order to satisfy the population, the newly elected president Dubček announced this plans for “Socialism with a human face” in March 1968. Dubček promised ‘the widest possible democratization’. His promise implied “granting federal status to Slovakia, the introduction of (…) private enterprise, freedom of speech and religion and the curbing of police activities” (Aldcroft & Morewood 1995, p. 147). Unfortunately the planned reforms were put to a dramatic end by the Soviet-led invasion of 1968. The Czechoslovakian reforms were a threat to the Soviet empire, unlike the Hungarian reforms (as will be mentioned below), because they also called for radical political changes (Harrison, e.a. 2000). Clearly, there was a limit to which the USSR would tolerate deviation from the Soviet model.
As a result of the invasion, Czechoslovakia remained highly centralized during the communist era. During this era, Czechoslovakia (like Hungary) experienced the Soviet-style economy as a cause of economic decline, see table 2.2. Czechs resented the latter fact whereas Slovaks, on the contrary, experienced heavy industrial investment, mainly in armaments, chemicals and metallurgy.
Table 2.2 Growth rates in CEE and USSR, 1956 – 1990:
(Annual change of net material product, in %) Czecho- Hungary Poland15 USSR slovakia 1956-1960 7.0 6.0 6.6 9.2 1966-1970 6.9 6.7 5.9 7.1 1976-1980 3.7 2.8 1.2 3.7 1986-1990 1.0 -0.5 -0.5 1.3 Source: Lavigne (1995), p. 58
The first substantial economic reforms in Hungary were introduced in the 1960s. An example was the New Economic Mechanism (NEM) in Hungary of 1968. “The NEM replaced rigid administrative controls over enterprises with indirect controls based on financial indicators and incentives” (Harrison e.a. 2000, p. 395). The aim of the reform was not to introduce a market-based mechanism, nor to change the existing property relationships. Instead, one aimed to make the enterprises more responsive to consumers by introducing a socialist market system where enterprises were given incentives, with the result to strengthen the position of managers relative to the position of their superiors.
Furthermore, the government made significant changes in Hungary’s foreign policy after the peaceful ‘revolution’ of the 1980s. Next to the support of the Magyar communities abroad and the establishment of good relations with its neighbors, Hungary pursued the objective to integrate into Europe. The relatively open and tolerant Hungarian communist system opted to
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