The new EU member states of Central and Eastern Europe (CEE) have been massive beneficiaries of financial arrangements since their accession to the European Union (EU). Net official inflows amount up to two or three per cent of their Gross Domestic Product (GDP) – comparable in relative size to those under the Marshall Aid for Europe after the Second World War. Comparisons can be deceptive however, since the Marshall Aid – the European Recovery Program to give it its official name – which came into effect in 1948, consisted predominantly of concessional loans to buy mostly American goods, while EU monies are non-refundable transfers to less well-off member states.
Every beneficiary in CEE regards the receipt of EU funds as natural – as they are entitled to according to the logic of the Union – given that income levels of the recipient countries are below EU average. The CEE countries both receive a disproportionately high share of European structural funds, and contribute less than their populations’ share to the common budget. Funding from structural funds and matching secondary domestic monies are behind every second public sector investment in the Czech Republic and Poland. In Hungary meanwhile over 90 per cent of public sector projects are fully or partly financed by EU funds.
The general public and political classes of the countries concerned however seem to take the EU’s generosity so much for granted that the authorities who redistribute the funds do not feel any need to express gratitude. In fact, public opinion, to varying degrees across the beneficiary nations, has been growing ever more critical, even hostile towards the European Union and things European. There are surely interesting social psychology reasons for such a curious rapport between beneficiaries and contributors, but that goes beyond the scope of this article. What intrigues me here is why we did not receive sizeable transfers earlier. Why not right at the outset of the regime change when the need was the greatest?
In 1990 the CEE nations were not offered any recovery programme comparable to the Marshall Plan. That programme helped Western European nations back on their feet after the cataclysm of the War by playing a large part in West Germany’s Wirtschaftswunder and the similarly impressive French and Italian growth miracles. History did not repeat itself in CEE. Still, at the time we expected and indeed called for support of the former planned economies, a repetition – mutatis mutandis – of the Marshall Plan. But reconstruction of the CEE region in the 1990s was to follow a different path. Given that the EU has been recently heavily subsidising the new member states, it seems logical to revisit the motives why such a programme was not offered twenty-five years ago.
Few people bother now to dwell on that conundrum. Better late than never, they might say. What is arguably more topical is the curious fact that the generous EU funding levels of recent years do not seem to have fed through to impressive results in CEE. Take but one indicator: real convergence. In spite of the sizeable inflows, few CEE countries have managed to converge to their eternal benchmark, that is, to Western European levels.
It may be a closed chapter in history books, but it is still instructive to recall that marvellous short period after the change of political regime. Governments of advanced countries did actually initiate certain financial support schemes and technical assistance for CEE, administered mainly through multilateral financial institutions such as the International Monetary Fund and the World Bank, and through multinational accords (for example by the G24, a group of donor countries). It is sadly also true however that the size and composition of those support programmes failed to match the needs of the CEE region which soon slipped into a deep and protracted transformational crisis.
My particular reason for revisiting the issue of Western support (or lack of) at the start of our regime change is admittedly personal, and it has been triggered by an anniversary: ten years since the set-up of a scholarship fund and preceding investment fund that I was involved in.
The investment fund, the Hungarian–American Enterprise Scholarship Fund (HAESF), was set up in 2004, endowed from monies from the Hungarian–American Enterprise Fund. The fund has so far supported four hundred researchers, practitioners, students and academics to study or get experience in top American institutions. The financial contribution of the Fund amounted to 11 million USD, not including local expenditures borne by host institutions. This scholarship initiative, I am convinced, deserves attention as it can help us better understand the theme of this essay.
The US Congress passed its Support of East European Democracies Act (SEED) in 1989. The acronym “seed” was deliberately chosen for its marketing aspect: lawmakers intended the funds to act as seed money. It was the time of the presidency of George H. W. Bush, right after the US–Soviet agreement on the peaceful transformation of the region. One of the first measures of the Act was the foundation of the Hungarian–American Enterprise Fund (HAEF) for which USAID, the federal agency for administering civilian foreign aid, allocated 72 million USD. Ten similar funds for CEE countries were established later.
An investment fund, even if financed from the public purse, is a business-like venture, rather than a vehicle of straightforward aid. But aspects of support were present from the outset of the Seed Act. Such a fund acquires equity participation or raises capital in domestic firms (be they Hungarian, Polish, Albanian or Russian etc.) that show growth potential. By doing so, the fund can help the recipient country in two ways. One is by alleviating the inherited shortage of capital at a time when private funds, geared to make a quick return on their investment, are reluctant to enter a location still perceived as too risky. Secondly, such a fund can improve corporate governance: representatives, in this case of the American investment fund, that are elected to sit on local corporate boards can inject their international business standards and expertise into domestic practice, and inject professionalism into management structures.
Hungary in transformation was (and still is) clearly in need of external help on both accounts: capital and professional standards. The entrepreneurial skills and management knowledge acquired under the socialist planned economy regime were hopelessly insufficient for survival in the capitalist landscape. Deep-rooted routines of doing business under Communism were a liability not an asset in a market-based system. The stock of physical capital meanwhile was not as scarce as widely perceived. Many large public sector enterprises kept considerable although under-utilised capital stock on their books. But what could be done with stock that was technically obsolete machinery, good for making low-end products specially designed for the Russian buyer? The obvious answer, with the benefit of hindsight, was “not much”. But at that time the meagre reality of the low technological and competitiveness levels of the planned economies of Eastern Europe was not that obvious, either in business circles or in the intelligence community. When the reality emerged it turned out to be much darker than official statistics had indicated. It was not obvious either that the Soviet Union, a superpower and major market (well, a “market” of sorts), would disintegrate with the speed it did, and, consequently, a vast amount of productive industrial and commercial assets owned by Hungarian and other CEE firms would become “sunk capital” overnight. Capital shortage was a curious thing: a typical state-owned firm in Hungary owned a number of under- utilised real estate assets, from corporate hotels at Lake Balaton to kindergartens and non-core service facilities, to warehouses in distant strange locations. Once a zoo turned up on the books of a publicly owned company when it came up for privatisation. As you can imagine, professional investors considering options during the privatisation process regarded such items not as assets but liabilities.
The actual competitiveness of planned economies hence was poor, as the shock-like transformation of post-unification Eastern Germany revealed “uebernacht”. Former flagship companies were suddenly rendered unviable when half their potential output evaporated in tandem with the disintegration of the Comecon (the barter- like product exchange regime of planned economies). Few firms can survive the collapse of half of their market, and bureaucratic state entities, reformed or otherwise, were particularly ill-equipped to cope with the changes. Consequently, most large-scale state-owned enterprises were doomed to bankruptcy even if a level of domestic demand remained for some of their products.
The bottom line is that output collapsed in all the transition countries after 1990 and that the depth of the contraction exceeded anybody’s wildest guess. What happened was not foreseen before the magic year, a fact which is a point of departure for figuring out the motives behind the Western behaviour of the day.
The speed of events taking place in CEE around 1990 caught the world and its decision-makers unprepared. Seen from the West, German unification was concluded in a surprisingly quick and peaceful manner, and at marginal external cost. Similarly, the regime changes in Poland, Hungary and Czechoslovakia, as well as the transformation in the Baltic States, were all completed faster than analysts had generally foreseen, and arguably faster than most Western governments would have liked.
What most analysts – on both sides of the former “Iron Curtain” – misread was the true level of productivity, efficiency and competitiveness of the planned economies. Textbooks at the University of Economics in Budapest referred to East Germany (GDR) as one of the ten most powerful industrial nations of the world, on a par with South Korea. Western analysts generally concurred. The Soviet Union was considered, right up to its disintegration, as a highly industrialised country; although whether it was termed an advanced nation is another matter. Again, with hindsight, we know how much has remained of East German industry after the shock of unification, or how deep the crisis was that engulfed Russia, Ukraine and the other former Soviet republics. Yet, in 1989, positions of relative power or strength were not so clear. Soviet official statistics could not be taken seriously, nor could data from other countries under non-democratic and non-market conditions, a point to note when considering China.
Hence market pundits, the military intelligence community and industrial strategy experts in the West all overestimated the economic capabilities of planned economies in the 1980s. Let us not forget either though that the Western defence establishment had a vested interest in overestimating the economic and military might of adversaries in Eastern Europe and hence maintaining their own defence and security budgets. But business analysts, less influenced by institutional interests and budgetary considerations, also failed to realise the seriousness of the problems in the Socialist commonwealth that had gradually accumulated in material structures as well as in human relations, skills and values. We who lived here through these decades were only slightly better in forecasting; few of us reckoned that so many economic players, relieved from the administrative burdens and restrictions of the previous regime, would fare so badly when faced with market competition in the 1990s. Let us also admit though that a quarter of century has not been long enough to agree on a convincing and clear explanation for the unexpected depth of the transition crisis that hit the CEE region.
The case of mainland China, the growth champion, only adds to the puzzle. The West considers China’s transformation from a planned economy as a huge success, indeed a discomforting success. China’s perception however has gradually improved over time, but some interesting similarities exist between China’s position, performance and growth prospects in the early 2000s and those of the CEE region in the late 1980s. Recall the year of 1989. While Western politicians and personalities spoke haughtily of the merits of democracy and market economy, western trade unions were at the same time worried about well-trained, fast-learning, low wage workers (Poles, Hungarians, Romanians) quickly pulling industry and jobs eastwards. It is difficult today however to imagine any Westerner considering sending development aid to communist China. Isn’t it more than enough to allow the transfer of technology (legal and otherwise), flows of direct investments and market access for Chinese products? Similarly, some stakeholders and opinion shapers believed in 1989 that Central and Eastern Europe was on the verge of a great boom. What could possibly stop suddenly democratic and market-oriented Czechoslovakia, Poland and Hungary prospering once they left behind their obsolete social order? At a stretch, the same prognosis even applied to post-communist Russia and other legacy nations of the Soviet Union with their history of massive industrialisation since the 1930s.
Today, we know any parallel between present-day China and Eastern Europe at that time is flawed. China’s policy of cautious gradualism provided a particular frame for economic transformation, a very different scenario from the instant marketisation that happened in CEE. Look at the dynamics of the processes, for instance the speed of privatisation. The change of property patterns in key sectors in CEE took as little as four years or, under the more cautious governments, over a decade, but even that was still shockingly fast and incurred unavoidably high failure rates. In contrast, changes in property titles have been evolving now for half a century in China, while it still remains hard to apply Western concepts of private property for nominally private firms.
Differences between China and CEE are also as wide in terms of social aspirations and patterns. In Hungary, capitalism evolved mostly within the framework of the Austro-Hungarian Monarchy. Consequently, consumer aspirations were traditionally linked to the patterns and levels of their German–Austrian equivalents. However, at the historic moment of regime change in 1990, productivity and labour income, household savings and wealth, and other key indicators of advanced capitalism were a small fraction of the traditional Austrian and German benchmarks. With such a high but unrealistic aspiration level, many people were guaranteed to feel deep disenchantment with the change of the political system. Chinese societal aspirations on the other hand have been formed differently in recent decades, with consequences for politics and economics.
China’s and CEE’s respective geopolitical room for manoeuvre has also been different. When the East European regimes changed, free market concepts were in their heyday the world over. Market optimism imbued the West as well as the East. Advocates of market fundamentalism branded as retrograde any attempts by CEE governments to protect their markets or to apply measures to shape market processes. Representatives of the neo-liberal mainstream repeated the mantra that “you can’t cross a chasm in two small jumps”. That is, it is time-wasting and futile to try gradualist policies. On the contrary, if a chasm happens to be wide and deep, one can indeed try to find ways to cross it other than jumping, such as descending carefully and climbing cautiously uphill, or simply looking for a more appropriate crossing location. The Chinese political class had by that time more than enough of “big jumps forward” – and they negotiated their historic roads in a more careful fashion.
In short, Eastern Europe in 1989 was unlike China then or later. Our region was, of course, also different from the southern periphery of Europe when authoritarian regimes collapsed in that part of the world. So it could be said that the transition (or rather transformation) process of CEE was (and still is) unique. The ex ante views in the international community about the regime changes ranged from the exuberant to the cautiously optimistic. No pressing need to offer massive financial support was voiced. The West, unlike in 1947, sensed no emergency. In 1989, CEE was not a target of geopolitical competition. In 1989 no alternative social vision was questioning Western values, a very different scenario than after the Second World War in Europe when the further enlargement of the Soviet sphere of influence was a prospect to be taken very seriously indeed. Communism still had Western believers and supporters in the 1950s; by the end of the 1980s however, liberal market concepts stood more or less alone and uncontested. The rapid disintegration of the Soviet Union in the early 1990s then seemed to dash any reason to “woo” CEE through generous financial aid.
Those of us who lived here at that time and were somewhat knowledgeable about the genuine state and sinister legacies of the obsolete state socialist system, as well as the precarious starting position of the “new democracies”, found the West’s parsimonious attitude, for all our empathy to the West, a strategic mistake. The horrible cost of German unification signalled that transformation would be longer and harder than generally thought. The size of the support funds set up by the Western community (G7, G24) did not even come near to the bill paid to modernise East Germany, and signalled that they were mere gestures only.
Let us take the Hungarian case. External aid and transfers to Hungary amounted to some dozens of millions of dollar say ear – while the interest payments on the inherited government debt that the Hungarian National Bank had to fork out was as high as one and a half billion (that is one thousand five hundred million) USD annually. Hungary, being by far the most indebted of all the CEE countries,was an outlier among the former planned economies. The numbers are shocking though, and seemed even more so at that time. The transfers did not include concessional trade loans, and with good reason. Most of them were tied loans, designed to finance the import of goods from the donor economy; the lower interest in such cases representing a sort of subsidy for the firms of the advanced exporting country. IMF and World Bank loans are also not included, being interest bearing and tied to tough policy conditions.
But this is not to reopen old wounds; there has been enough self-pity around nowadays. Still, what a cursory look at the facts reveals is that the transformation processes in CEE coincided with a peak era for globalisation, that the free world promised too much to these societies, and asked too much of them. People were not adequately prepared for the shocks in terms of their material conditions, knowledge base or social psychology conditions. The penetration of foreign capital turned out to be faster than society could either accept or absorb. The entry of foreign assets coincided with a meltdown of domestic wealth. The final balance probably remains just about positive in all the recipient countries, but the bottom lines are less impressive than they could have been had more organic processes taken place. Our current pressing task is to find out what factors can help progress in the eastern semi-periphery of Europe – now.
This is the context in which the Seed Act and its country funds are relevant. They may not have involved many billions of dollars, but even so not all the monies available were drawn upon and properly spent, in some cases, like Hungary and its HAEF. At the close of this fund the exit value surpassed the initial investment as the investment portfolio yielded enough to cover all operational costs as well as expenditures on technical assistance. The fact that the seed money was not used up even during the volatile and difficult early years of transition, and that there were sums to return, seems to have taken the donor by surprise. A dilemma thus arose upon the closure of successful country funds: should the proceeds return to the US Treasury, or should at least part of the cash remain in a country where the fund functioned prudently and responsibly? The solution in Hungary’s case, copied later with the Baltic fund, was to leave behind half of the sum, for funding education scholarships in the US. Several similar projects are now available for Hungarian students. Recent research data shows the usefulness of HAEFS in its first decade. As a bilateral fund, in addition to its professional impact, it also helps to improve the image of both countries, a much needed exercise.
In an ideal world, many more young professionals would have been given the chance to attend top academic institutions and learn US business practices from the inside and return home with invaluable knowledge to help the modernisation process. Well, history took another turn, modernisation, as so often, ended up a half-success only. Reintegration and convergence have been slower than hoped for. Convergence toward the European average has been stalled for a decade now. If “creative destruction”, to use Schumpeter’s term, had been less extreme, with the destruction part restricted to an unavoidable minimum, and if the impressive convergence of the first decade of our transition had been followed by a similar second decade – Hungary would not be so dependent on EU funds as a net beneficiary as it is now.
But this is again counterfactual history. Realities dictate that young Hungarians take part in international knowledge transfers. We all hope that they, upon return, will put to use what they have learned in foreign centres of excellence. There is no royal way to catch-up. What happened twenty-five years ago teaches us that it is essential to face reality, and acknowledge the true state of one’s society and economy. External financial support will not solve most underlying problems, even if it is forthcoming. There are no short-cuts to progress. Examples of excellence, however, can be internalised. A better trained and motivated younger generation could become a real asset for the much dreamed-of and longed-for catch-up.