We are now in the climatic stage of the revolution. In some ways it resembles the climax in Eastern Europe in 1989. But there is one major difference: in the case of Eastern Europe the climax marked the beginning of a new era. When the communist system was swept away, the foundations of an alternative system were already present. There were nations with long histories; there was a more or less well-organized opposition and a general desire to become part of the modern world.

Not so in the Soviet Union. The foundations for an alternative system of organization are missing. We are at a loss even to describe the territory we are talking about. It will take a long time and a great deal of effort to transform the republics into independent states with well-functioning administrations. The same applies to the state-owned enterprises that make up the bulk of the economy. In these circumstances, the collapse of the Soviet system is unlikely to give birth to a new system. It is more likely that one revolutionary climax will be followed by another until the very foundations of civilization will be destroyed. How far the process of destruction can go is anybody’s guess. But the Russian Revolution of 1917 provides some indication: industrial production in 1917 had already fallen to 25 percent of its level in 1913, and by 1921 it had fallen to 16 percent.

What can the international community do in the face of this seemingly inexorable descent into chaos? The key is to help bring a functioning monetary system into existence. There can be no market economy without money; money is primarily a question of credibility, and in today’s conditions it is impossible to establish a monetary system that would enjoy the confidence of the people without Western involvement. In the midst of decay and disintegration, there are some forces at work on integration. They need to be reinforced. I realize that the private sector cannot do much about monetary reform, but the government can.

Registration in Czechoslovakia for its voucher-based large-scale privatization scheme was due to close on January 31, but officials have extended the deadline. For the past two months, citizens have been buying voucher booklets at 35 crowns each, paying a registration fee of 1,000 crowns ($35), a little more than the weekly average wage. Later the coupons can be exchanged for shares in state companies, representing about 40 percent of the economy.

So far 271 investment funds have been registered. These funds will be able to bid for firms where direct voucher bids amount to less than the book value. The funds may also solicit vouchers from citizens and invest them on citizens’ behalf. Several funds are aggressively advertising to attract investors. For example, the Harvard Capital and Consulting Fund is running advertisements guaranteeing investors a tenfold return on their 1,000 crown voucher.

The present situation in the former Soviet Union is marked by chaos and extreme fragility—in the words of George Soros, the situation is "not just grim but potentially cataclysmic." On the economic front, output is falling rapidly across the region, with no immediate end in sight. Interrepublican trade is threatened with collapse, with potentially catastrophic effects on the economy of the region. On the political front, a variety of personalities—the former Communist Party, the military, national minority groups—are emerging in Russia to challenge President Boris Yeltsin.

Few would have predicted a decade ago that a peaceful dissolution of the Soviet empire was possible. This is the third great transformation of the 20th century. The first two (the two world wars) resulted in 60 million deaths, but the CIS is now providing an institutional framework for a peaceful third transformation—a critical role even if the CIS eventually becomes "little more than a footnote in history," in Strobe Talbott’s words. (Cheryl Gray)

Make no mistake, this is one of the greatest economic challenges in history. However, it’s different from most economic reform challenges. The Soviet Union, a staggering economic underachiever, is not lacking in resources. That region is the number one owner of natural resources. Petroleum reserves rival those in the Persian Gulf. It has terrific technological resources; it is third in the world’s stock of scientists and engineering. The USSR has devoted as many resources to research and development as the United States or Japan. What ultimately led to the current collapse—the fall of output to the present level—was that incentives were spectacularly misaligned for such a long time.

We can expect poverty to increase in countries in transition and to become quite pervasive in the Balkan countries and the former Soviet Union. Limited administrative capacity could prove to be the most serious bottleneck, as meritocratic bureaucracy has little recent tradition in these countries. Furthermore, the task of income redistribution is particularly difficult, because a great percentage of the poor live in rural areas that are hard to reach. This argues for retaining simple and reasonably efficient support schemes that are already in place (such as family allowances). Targeting should be done by identifying the needy by certain easily verifiable characteristics (for example, unwed mothers, children under a certain age, the aged); complicated means-testing programs should be avoided. (Branko Milanovic)

The presence of a large number of firms that are nonviable under competitive conditions, considerably complicates the reform strategy, as full implementation of liberalization and stabilization could generate a level of enterprise bankruptcy and unemployment that no government could survive. The depressed level of demand could undermine even the healthier enterprises and cut into fiscal revenues. A vicious cycle of recession and inflation could be the result. In addition, private investors, whether domestic or foreign, will be less interested in assuming ownership of existing firms that are insolvent or require costly restructuring and will opt instead to start new ventures, free of the legacies of the past, including liability for environmental damage.

Macroeconomic policy must take account of the potential conflict between the speed of reforms and the rapidity with which it is possible to liquidate nonviable firms. These considerations suggest the need for more careful coordination between the implementation of reforms at the macro level and that at the enterprise level. Given the relative difficulty of the latter, a pace of reform that is restrained only by implementation capacity will not necessarily be an optimal or very sustainable approach to the transition. (Sanjay Dhar)

It is in the United States’ self-interest to have a strong and vibrant commercial presence in the former Soviet republics. Steps taken now to establish and ensure growing economies in the former Soviet republics will create new buyers for U.S. agricultural products, manufactured goods, and services.… However, the United States is currently playing a very small role in aiding and assisting the former Soviet republics. Only about 6 percent of the aid and assistance to the former Soviet republics, or under $5 billion, is currently coming from the United States. The United States is providing less aid and assistance than Italy, which has an economy approximately one 10th the size of that of the United States. It is useful to remember some of the features and lessons of the original Marshall Plan. George C. Marshall presented the general outline of what became known as the Marshall Plan on June 5, 1947. The independent Economic Cooperation Administration was established to administer the program, which provided $13.3 billion in assistance to Europe from 1948 to 1952. In 1992 dollars this is equal to approximately $100 billion. (National Planning Association)

It is widely believed that the collapse of Council for Mutual Economic Assistance (CMEA) trade in 1990 and a further decline of intraregional trade in 1991 (when it dropped by 15–40 percent in real terms) led to sharply reduced economic activity in Central and Eastern Europe and the former USSR. According to this belief, a decline in exports led to unused capacity in export industries while raw material and energy shortages in Central and Eastern Europe and the unavailability of manufactured inputs in the USSR produced supply bottlenecks that reduced aggregate output. Many observers conclude that a revival of intraregional trade, through a mechanism that could substitute for the defunct CMEA, is needed to stimulate economic recovery in the region. But if intraregional trade was, in the past, uneconomically high, then efforts to prevent its decline may be either futile or counterproductive.

The deeper integration of Poland, Hungary, and Czechoslovakia into the European Community poses a number of problems despite their association agreements. Will the European Community be willing to admit more member countries with relatively low incomes, thus creating greater budgetary strains on the Community? What about economies with large but relatively inefficient agrarian sectors and with a large proportion of their industry in such sectors as steel—sectors in which current EC members face painful restructuring problems of their own?

Although the temptation to engineer general solutions to the region’s problems is great, it is unlikely that such broadly based proposals can be implemented in the near term. The most important advice that may be given is that, as prices are rationalized, protectionist policies should be eschewed as much as possible. (Josef C. Brada)

A. Without doubt the World Bank is a venerable institution that has gained massive experience in the past decades; we are still in the process of building up our operations. But this should not lead to rivalry. On the contrary, it makes a lot of sense to make the most of resources through coordination of our efforts, especially when it comes to cofinancing opportunities in public sectors of the member states, developing infrastructure, and, particularly, participating in energy, transport, telephone, and environmental projects of the postcommunist economies. We should not be seen as competitors in the market; that is certainly not very constructive. A coordinated approach would benefit us and recipient countries as well. Providing conflicting technical assistance, for example, could lead to disastrous consequences.

What can the World Bank do? The first actions of the Bank will be geared toward alleviating import constraints in areas where we can get the quickest and largest payoff. We hope that during the next 12 months we will be able to commit something like $2.5 billion, about half of which could go to Russia, in line with the relative size of that country. There will be a general import rehabilitation operation for Russia; when the other republics are ready, we’re prepared to implement similar programs. At this stage, negotiations about import alleviation loans are most advanced with the Baltic countries, Kyrgyzstan, and Kazakhstan, and preparation has started in Ukraine and Armenia. For fiscal year 1995, which begins in July 1994, we hope to be able to commit about $4.5–$5 billion to the successor states of the Soviet Union. The first slew of operations is a general import rehabilitation program. We would like then to quickly move to a second generation of operations whose structural and policy elements are still to be agreed on. I refer in particular to oil and agriculture.

Should far-reaching marketization of all aspects of economic life be the policy goal in Central and Eastern Europe? Surely one goal of marketization has been to modernize production processes and improve international competitiveness in these damaged economies. Yet recent currents of thinking contend that in certain sectors of the modern capitalist economy the most competitive forms of coordination are neither market nor statist but new forms that we are only beginning to understand (networks, alliances, interfirm agreements, and the like.) A policy of all-encompassing marketization across all sectors would therefore pose a new obstacle to international competitiveness. Markets are but one of many coexisting coordinating mechanism in modern capitalism. (David Stark)

The gap between men’s and women’s wages in Central and Eastern Europe is not so very different from Western wage differentials, despite the socialist ideology of gender equality. The average compensation of women is 67 percent that of men in Czechoslovakia, 73 percent in Hungary, and 77 percent in Poland. On the other hand, extensive maternity and childcare leaves, rights to return to employment after leave, and enterprises’ provision of crèches and kindergartens have facilitated the employment of women with small children in most Eastern European countries. According to an estimate for Hungary, mothers of small children work on average 50 percent of the standard working hours because of legal entitlements and leave taken for children’s illnesses.

As unemployment hits Central and Eastern Europe, women may be given lower priority than men both because employers tend to view women as less productive workers and because their first responsibility is perceived to be in the home. Younger women are also likely to be affected by a decline in childcare services. (Monica Fong and Gillian Paul)

More than two years have gone by since the series of political changes in Central and Eastern Europe, and hopes for a rapid transition to prosperous market economies have all but faded. Startling changes were observed in most of these countries. But the initial euphoria has been replaced by a more sober assessment of the magnitude of and complications entailed in the task ahead—which in turn is dwarfed by the challenge facing the ex-Soviet states.

Four major causes of the declines in output:

A. The monetary and fiscal measures we are talking about are to ensure the macroeconomic stabilization of Russia, which is a key to further progress in the economy. Only if enterprises feel the heat from being overmanned or in a redundant line of business will they be willing to make adjustments. We at the Fund think that the government should not excessively subsidize enterprises or provide them with cheap or easy credit. Unemployment must come at some stage; it will be the result of the need to close or scale back the old plants before new employment opportunities have had a chance to develop. The most important thing is to ensure that the government has an adequate social safety net in place. I do not think, however, that there is a magic solution to avoiding the pain of transition. Of course, the costs of adjustment should be minimized as much as possible. A key way to minimize them is to move quickly in reforming enterprises and enforcing the hard budget constraint.

A. Yes, because we didn’t have any better alternatives at that time. But I would be careful about using the term "shock therapy" and would distinguish between different phases of the transition process. Each phase encompasses different policy instruments.

Macroeconomic stabilization could be accomplished fast. Shock treatment—in other words, fundamental shifts in macroeconomic policy using such instruments as the exchange rate, interests rate, and budgetary measures—could bring quick results. Liberalization is not a technically complicated process and could also be accomplished rapidly. I never suggested shock therapy in dealing with basic institutional reforms (particularly privatization), which requires overhauling the legal and organizational frameworks, retraining former administrators, and recruiting new staff. These measures take a long time and cause lots of uncertainty.

In spring 1991 the Slovenian government designed an economic program to achieve economic sovereignty. The main objectives of the program were to avoid the resurgence of hyperinflation that plagued the rest of the former Yugoslavia. On October 7, 1991, the parliament declared the tolar the sole legal tender in Slovenia. During the subsequent monetary conversion the commercial banks were closed for three days. Borders were closed to prevent illegal inflows of Yugoslav dinars. The conversion of dinar into tolar banknotes was largely accomplished in the first 36 hours. All contracts and bank accounts were converted to the tolar on a one-to-one basis. Dinar cash notes were converted to tolar notes, with a limit of $500 per person.

The Slovenian experience shows that:

Estonia adopted a specific monetary mechanism—a currency board—designed to make the kroon a stable and convertible currency from the start. The IMF tried at first to delay introduction of Estonia’s currency, arguing that the country was not yet ready and that the currency should be introduced late in 1992 or in 1993. As it turned out, Estonian authorities decided to proceed on their own, in view of the urgency of the situation and with confidence that the monetary reform could be carried out quickly and successfully. On the eve of the monetary conversion, the IMF provided some last-minute technical support and followed up with negotiations for a stand-by loan after the monetary reform had taken place.

The kroon was to be introduced at a fixed exchange rate vis-à-vis the Deutsche mark and with full backing of gold and foreign exchange reserves. The monetary conversion was undertaken June 20–22, at a conversion rate of 10 rubles per kroon for bank balances, wages, prices, and other contracts. The postconversion monetary policy guarantees the convertibility of kroons into Deutsche marks at the fixed rate of 8:1 for all current account transactions. The Estonian monetary reform clearly points the way for the new states of the former Soviet Union. Most, or all, will have their own national currencies. (Ardo Hansson and Jeffrey Sachs)

I would like to comment on the references to the IMF in the article "Crowning the Estonian Kroon" by Messrs. Sachs and Hansson in your October 1992 issue. Specifically, I believe that this article seriously misrepresents the role played by the IMF in the run-up to the introduction of the kroon on June 20, 1992.

The facts are that Fund staff began serious discussions with the Bank of Estonia on currency reform in January 1992 and initiated negotiations on a stand-by arrangement in early April. The Bank was already keen in January on an early reform. IMF staff continued to work closely with the Bank of Estonia throughout the spring and summer, providing assistance both in the general policy area and, in particular, on all aspects of the currency reform right up to the date the kroon was introduced. (John Odling-Smee)

A. I’m convinced that in Russia more government regulations lead to more monopolization, more excessive profits, and more conspicuous consumption. The market is a far better equalizing force than any kind of regulation, given a very corrupt state administration in Russia. According to opinion polls, 1 percent of Russians are extremely rich, and I have no doubt that extreme income differences could be socially dangerous. But the way to mitigate social tension and prevent rent-seeking is to go ahead with liberalization and privatization and create a large middle class. My worry is that liberalization is not going far enough, while the policymaking apparatus is disintegrating. Therefore, I support the introduction of constitutional changes, the call for new parliamentary elections, and as a result, a gathering of a new democratic assembly. In the meantime, the government should tighten up the macroeconomic policy as far as possible.

A. There is a legitimate case for cutting taxes in Russia, where people complain about the excessive tax burden. Public expenditures amount to only one-third of GNP, which indicates the country has already moved far in the right direction.

A. What Volski really suggests is that we learn from the Japanese and the Chinese models. But this is unrealistic. Those countries pursued prudent monetary and fiscal policies. Most had far better civil services and state administration than Russia has today.

A. I try to keep up with major current policy issues and provide advice on a general level, while others give more technical advice on specific issues. I work with a team of 10 senior people, among them Jeffrey Sachs, Davis Lipton, and Andrei Schleifer. I’m funded primarily by the Ford Foundation and the Swedish government, and we have some other sources of funding. Basically, this is a form of technical assistance for the Russian government.

In transition economies managers of state enterprises are gradually liberated from central control. In these new conditions state managers are still not motivated to maximize profits. This situation will change only if managers are subjected to effective control by financial markets through the exercise of shareholders’ voting rights and the associated threat of hostile takeovers. Neither the dispersion of shares among a large number of uninformed private shareholders nor the concentration of shares in investment funds is likely to achieve such effective control; diffused share ownership will leave managers still quite comfortable to exercise their discretionary powers. (Domenico Mario Nuti)

Our visits suggest that reforms in Russia have left firms in an environment of enormous uncertainty and high perceived risks. Many firms are starting to adapt, in the face of sudden inflation and large relative price shocks. Price liberalization has had some salutary effects on behavior. At the same time, local monopolies, vertical integration, and problems in the payments system slow the growth of competition. Improving the payments system is a top priority, although regularizing the settlement process could cause a further real decline in money holdings.

There are strong forces urging integration of the enterprise and banking sectors—an understandable response in the short term but one that in the longer term could make the economy structurally vulnerable in a crisis. Ownership and control are evolving rapidly, and it looks as though "insiders" will dominate in the foreseeable future. (Alan Gelb and I. J. Singh)

Recently, Mr. George Soros, an émigré from Hungary who is a businessman and humanitarian, came up with an innovative idea for Western assistance to the former Soviet Union. Soros proposes a massive injection of hard currency—$10 billion a year—to be paid out directly to the needy in Russia and other successor states of the defunct Soviet Union. This externally financed social safety net could generate demand for domestic and foreign goods and services without causing a drain on foreign reserves. It could check runaway inflation and stabilize the ruble, thus enabling unimpeded domestic financing of investment from private sources through the 1,500 commercial banks already in operation and through other credit institutions.