Prof. Leszek Balcerowicz: For the reforms in Ukraine to succeed politics should be separated from business

Second, because of a total monopolization; there was no market competition under socialism. And third, given this total concentration of political power, when this power landed in the hands of crazy or incompetent individuals, disasters produced by policies had followed. Examples include economic and human catastrophes produced by Stalin in the Soviet Union, Mao in China, Khmere Rouges in Cambodia. These were genocides. There were many less drastic but economically disastrous policies under socialism, like these which had led to the foreign debt crisis in such countries like Poland, Bulgaria, Hungary, Romania.

So, the lessons from history, not only from socialism, is that the worst policies have been pursued not under democracies but under non-democracies. And there have been very few good dictatorships, they are very rare. Most dictatorships are awful, because they violate human rights, and they are usually very bad, as I said for the economy, for economic growth. The second lesson would be that the worst catastrophes which produce deep breakdowns in the economy are not due to free markets (contrary to what many Western economists think) but by excessively concentrated political power. So limiting political power by introducing or maintaining checks and balances is like an insurance against the worse catastrophes. And this is not only theoretical in this country, I think.

Against this bad experience of socialism, the collapse of this regime was a very good and positive news all over the former soviet bloc. However, what has happened after this collapse has differed in the longer run both in the economic and non-economic dimensions.

What do we know? We know that the growth of the economy in the former socialist countries has sharply diverged in the longer run. Poland, my native country, has managed almost to double the GDP during last 20 years, while some other economies including Ukraine are still barely at the level of GDP which existed during the last year of socialism. Generally speaking, countries of Central and Eastern Europe have performed better economically than countries of the former Soviet Union (except for the Baltics). And what is less known is that countries which have achieved faster economic growth, also achieved better results on life expectancy and in mortality rate among children under 5 year old. So when you look at the data for life expectancy you’ll see, for example, that in Czech Republic (the same goes for Slovenia) the expected life expectance at birth in years has moved from 71 in 1990 to 77 in 2007 similarly for other Central European countries like Poland. But in Ukraine it has declined from 70 to 68. The same goes for Russia. And the mortality rate of children under 5 years old has sharply declined in all Central European countries between 1990 and 2007 but it barely moved in Ukraine (from 25 to 24 per 10,000 live births), while in Poland it has declined from 17 to 7. Therefore, there’s a strong link between economic improvement and non-economic improvement.

What explains the differences in economic growth? There is a massive research, so we don’t need to speculate. We are on the solid empirical grounds. Based on this research I would single out two main factors. First – the sharp differences in the economic growth are largely explained by a different extent of market reforms and rule of law. It’s not enough to have more markets, you need rule of law, so that you have equal protection of property rights and do not need to be afraid of your own state. Countries which moved more in the direction of honest markets, rule of law, equal protection of property rights, have achieved better results than those who moved less. The second important factor is the extent to which economies have suffered booms and bust. Booms are of two kinds, fiscal (if Government spends too much) and private credit booms. Most booms are produced by bad policies, bad monetary and fiscal policies. This was true for Spain, for Ireland, for Unites States, for Britain, but also for Bulgaria, the Baltics and for Ukraine. There was a huge boom in Ukraine between 2004-2007 and there was a collapse of almost 15% GDP in 2009. This was produced by policies; this was not a natural disaster.

Longer term growth is like driving a car in long-term race. You need a good car (with Trabant you cannot beat Mercedes), but you need a prudent driver, too. So prudent macroeconomic policies are the second factor.

The fact that Poland has achieved the largest increase in GDP between 1990 and 2011 is due to these two factors. First we introduced many reforms (but the Baltics introduced even more reforms). But there was a second factor: we have avoided extreme booms and as a result we have avoided the deep recessions – so far. Poland has been growing during last four years, while some countries’ GDP has been declining.

Regarding the first factor – the extent of reforms – it is about what system has emerged after the collapse of socialism. Depending on the nature and the extent of reforms different institutional systems have prevailed in the former socialist countries.

As I said that there is no one good example of good socialism. If you have a monopoly of state ownership you can’t have democracy, you have a total politicization of economic life and you can’t grow in the longer run. That’s a very bad system.

So it is only capitalism which is capable of producing better economic (and non-economic) performance, but there are different kinds of capitalism. The former socialist economies have been moving to different kinds of capitalism. And this largely explains the different results in the economic and non-economic sphere.

There are many ways in which you can block the development potential of capitalism by distorting it. If you have a distorted capitalism, you can’t be very successful compared to more free market and rule-based capitalism. What are the main distortions which block the development potential of capitalism? First, as I mentioned, a very uneven protection of private property rights, which is usually called crony-capitalism. This means that there is a minority of politically connected businessmen and the discriminated majority. Such a system is not only unjust, it is also inefficient. The unequal protection of property rights creates uncertainty and under such regimes it happens that state apparatus is used in competition – which is destructive competition – raiding, for example. And you can’t be successful under such a system in the long run. Individual businessmen can, but the economy can’t.

Second distortion – the lack of competition is to some extent related to the first factor (unequal protection of private property rights), but it may also be brought about by formal or informal trade barriers. Without competition capitalism cannot work well. It will work, only a little better than socialism. So you have to look at the barriers to competition. For example in Greece, there is probably little competition, because the export to GDP ratio in Greece, a small country, it’s only 20%. And in small country the competition mostly comes from outside, so something has been wrong with competition in Greece.

The third distortion is a predatory and unpredictable regulation which produces a bad environment for ordinary businesspeople. Still, another barrier is a heavy taxation. Taxes consist of two parts – official taxes and corruption payments, so you have to sum up these two. It may turn out that most businesses, except for the privileged ones, are hit by a very heavy taxation – and under very heavy taxation you can’t grow. Official taxes are high when spending is high. And when spending is high, it is usually social spending and it is usually high when it is badly targeted, which means that only small percentage of poor people really gains social benefits and most of the benefits will go to richer people. And I think this is the case of Ukraine.

So as you can see, it’s not enough to abolish socialism. The real challenge is to build free market, rule-based capitalism and if you don’t you can’t be very successful even after the collapse of socialism. The differences I can see between Central-Eastern Europe economies and most countries of the former Soviet Union is that there is a lot more of competition, more separation of politics from business and more rule of law in Central Europe than in other countries. So they have to catch up in those respects.

What is also worth stressing, and I’m doing this on purpose being here, is that if you look at the experience of former Soviet bloc, you’ll see that those countries which have been leaders in the economic reforms are also the most democratic. Central-Eastern Europe have the same level of democracy as the West, according to the existing rankings. This shows that, at the minimum, there is no inherent conflict between democracy, market reforms and economic growth. Of course, democracy also requires rule of law (not only the elections) and the rule of law means you limit the power of the state. This is the essence of the rule of law. Nobody’s above the law.

Central Europe has combine market reforms, democracy and rule of law and achieved the best economic results while the worst economic outcomes are found in countries which have diverged from democracy in our region. I don’t think Belarus is a success story. It’s a clear violation of human rights as recently witnessed. And without huge Russian subsidies there would be an economic disaster in Belarus. Belarus is certainly not a good model for any reasonable person.

Now let me move briefly to the prospects of Europe. The year 2012 will be a difficult year as the average growth in European Union is expected to be zero. Of course, there are some exceptions - Poland, Lithuania, Estonia are expected to grow about 2%, while Greece and Portugal would be on the decline. This does not mean that such a situation has to prevail in the longer run. European Union is a hugely important economic bloc, especially for countries which are close to it geographically. Let me stress that the main solutions to the problems in countries which have problems like Greece, Spain, Portugal, Italy, are to be found in the reforms in these countries. There is no European solution for Italian problems. But there are the Italian solutions both for the problems of Italy and of Europe. What do I mean by that? I mean that if a country, especially a large country, develops problems because of previous errors, it is up to this country to correct these problems, because there is no funds which would be sufficient for Italy, as it has the third largest public debt in the world. I’ve just returned from Italy, from the conference with PM Monti and I think there is a good chance for Italy to overcome problems via reforms. You overcome your problems with corrective policies, not with bailouts, meaning official credits. Official credit can help you only if it leads or supports good programs. But if official loans do not support a good program they are only compensating factor as for this more demanding external environment are better policies. And in every country there is a scope for better policies, technically speaking. The country I know the best is Poland. I’m not going to be very detailed about it, but let me say from a distance and time perspective what, in my mind, were the most important reasons for success so far in Poland. We have our problems too, for example our courts are too slow (but they are independent and not corrupted). Our taxes are too high, because our public spending is too high. But what have been the reasons for success for Poland so far? First, I think we have avoided extreme booms which are always fuelled by excessive credit. Why was it so? We have had a rather disciplined monetary policy which was focused on lowering inflation. When we started in 1990 the inflation was 30%-40% a month, like in Ukraine. But finally we brought it to 2%-3% in 2004 and we switched 10-12 years ago to inflation targeting. We have avoided the peg to a dollar or to euro. By the way, if you want to maintain a peg, you have to have a very disciplined public finance. If your public finance is fragile the peg will be under attack and there is uncertainty and foreign direct investment is discouraged. Because people are afraid that there may be drastic devaluation. So monetary policy regime is important for growth and there are demanding requirements for hard pegs. Coming back to Poland, why we have avoided extreme fiscal booms? Our fiscal policy was far from perfect, but was not catastrophic. In 1997 in our constitution we have introduced a special article which says that pubic debt to GDP cannot exceed 60% of GDP and the ordinary legislation introduced two thresholds 50% & 55% of GDP after which corrective actions are mandatory. However, it is worth introducing something in the constitution if the constitution is respected. If constitution remains on paper it doesn’t matter very much what does it contain. Here again we came back to the rule of law.

There were other two ingredients for Polish success. First, from the very beginning there was a clear separation between politics and business, there were politically privileged businessmen - no businessmen who obtained their wealth because of political connections. So there was no crony-capitalism in Poland. Uniform rules, reasonable equal protection for everybody, for every private business person. Second, from the very beginning, we introduced massive competition. We dismantled monopolies, we opened the economy to extend our world and there were no  informal barriers to competition because there were no informally privileged businessmen. So we have massive competition and reasonably equal treatment of private ownerships, plus, of course, privatization. I think these were the most important reasons for Poland’s success during the 20 years.

I’m not going to say directly what should be done in Ukraine, coming from outside Ukraine. But I think everybody can see what would be some lessons for Ukraine. Certainly the general lesson would be that if there have been many distortions in the economy it has been bad for the past, because with very distorted system, a country was not able to grow fast in the past. But with many distortions you have ample room for improvement so you can do many reforms which would strengthen your country. And there are many reforms one can see even from the distance which could improve Ukrainian economy to start with huge inefficiency in energy sector, which makes Ukraine first fiscally fragile, because of huge subsidies to energy, and second – creates a dependency on Russia. Some other reforms include a clean separation between politics and business that would require the political change from the very top, because there is a political reason for such a system. And it always requires energetic civil society.

And to finish let me say there is one special chance for the Ukraine – its connection with the European Union, the possibility of signing the deep trade treaty which is on the table. There is a readiness on the EU side to sign it but would never come into being with the present policies in Ukraine regarding the selective justice or rather injustice. Even if there were readiness on the side of the officials in the European Commission it requires the signing the treaty by the respective Governments. And it would not happen without a change of the policies I’ve mentioned. And the signing the deep integration treaty of Ukraine and EU could be of great economic importance to Ukraine.