The Road to a Free Economy Once upon a time in 1989. And the journey is on going
Note from the Editor. János Kornai needs no introduction to our readers. He is an intellectual force to be reckoned with in the service of liberty. The following pages are an extract from his memoirs specifically selected from a time of great change in Hungary, to which he, working as a non-political man of science, brought a significant contribution. To his credit, he does not shy away from discussing his failures or from admitting the uncertainties regarding his true impact on historical proceedings. This thoughtfulness is found throughout the entire book.
The passages extracted herein deal with his awareness of the intractable contradictions of the previous political and economic system, as well as uncertainties regarding how much longer it could go on like this. The fall of Communism in Eastern Europe opened up new vistas for development and an acute competition took place between different visions. He is forceful in rejecting so-called “third way” approaches which preserve some of the worst incentives and mechanisms of the prior mode of organization, marrying them to the new in a manner which he thought would produce significant imbalances down the line. This does not mean that he was a dogmatic liberalizer, preferring the gradualist view that was vindicated in the end, as rapid privatization schemes for state property enriched oligarch or created entrenched corruption around managers of state-owned firms with diffuse population ownership through voucher programs.
As a careful chronicler of that period, he defaults to referencing his writings and those of others at the time, in particular to establish to what extent he, after explicitly rejecting a political career, could have influenced the debate in Hungary regarding the new economic system.
In these fascinating details, we find also a mirror for what went on in Romania, Poland, Russia and elsewhere, with victories, defeats, and drawn out reforms that delayed true development. We urge readers to read carefully and think, in these momentous times of the pandemic, about Lenin’s injunction that “there are decades when nothing happens, and weeks when decades happen”.
(Excerpt from János Kornai’s By Force of Thought. Irregular Memoirs of an Intellectual Journey [Chapter 19], Cambridge, Massachusetts & London, England: The MIT Press, 2006.)
Had I forecast the collapse of the regime? Yes and no. Yes: several hundred pages in The Socialist System support the hypothesis that internal reforms cannot save the system. Instead, they undermine its foundations. The more the oppression is lifted and the more bureaucratic discipline loosens, the less possible it becomes to maintain the old power relations. No: Neither my book nor any other scientific analysis of the socialist system stated (or could have stated) exactly when the end was nigh. Laws governing the paths of heavenly bodies are far simpler than those of societies consisting of millions of people. It would show unwonted intellectual arrogance for a social scientist to claim prescience based on scientific theory about when and where a revolution or war would erupt. Yes: Those with inside knowledge of the socialist system sensed increasing signs of disintegration in 1986 and 1987. The imminence of the crisis was apparent less in its economic woes (the Soviet economy had been worse off before—for instance, when Hitler’s forces occupied the western parts of the country) than in mounting disenchantment among the political, economic, and military elite. As we drew near to the great event of the fall of the Berlin Wall, which in retrospect is generally agreed to mark the first day of a new historical era, processes signaling the end of the old regime were already at work: talks between the authorities and the opposition on Polish parliamentary elections, and Hungarian roundtable negotiations. In any case, from the point of view of the great collapse the most important factor was not what happened in Hungary or Poland, although that certainly contributed to the erosion. The decisive events occurred in the Soviet Union. Although the reforms introduced in the second half of the 1980s did not achieve what Mikhail Gorbachev, their initiator and leader, had hoped—they did not lead to a renewal of socialism or strengthening of the Soviet Union—their effect proved to be of great significance in world history. The atmosphere became freer, the system “softened”, and, with this, a basic change occurred in Soviet foreign policy and military doctrine. Earlier, Soviet tanks had been dispatched to Hungary, Czechoslovakia, and even Afghanistan. It seemed, a few years before the collapse of the empire, that the Soviet Union would not be capable of such an intervention again, inside or outside its borders. Some recalled words of Lenin: “For a revolution to take place it is not enough for the exploited and oppressed masses to realise the impossibility of living in the old way, and demand changes; for a revolution to take place it is essential that the exploiters should not be able to live and rule in the old way” (1964 , p. 97).
I must say the acceleration of events exceeded my wildest dreams. I tried to prepare intellectually for imminent radical changes. I looked at books about Latin American military dictatorships and the initial experiences of democracies that replaced them. I returned to my macroeconomic textbooks to refresh my knowledge. I spoke to historians and quizzed them about how the crumbling and then collapse of great empires took place. I had several discussions at Harvard with my fellow professor Jeffrey Sachs about the prospects for radical change. Sachs had gained a great name for himself when his advice provided the basis for curbing hyperinflation in Bolivia. That had probably swayed Lech Wałesa and his economist advisers when they approached him to be economic adviser to Solidarnosc, before the collapse of communism. Sachs began to be strongly interested in Eastern Europe at that time, as I did in macroeconomic stabilization.
One essential change was required of me as the one-party system gave way to free elections and a multiparty system. I needed to be available with suggestions for helping my country back on its economic feet and for accomplishing the transition to a market economy. I had been focusing on positive scientific work. From then on, I had to give adequate emphasis to a normative approach and consider economic policy, too.
In 1992, the American Economic Association did me the great honor of inviting me to deliver the Ely Lecture at its annual congress. There I spoke on the role of the state in the post-socialist period.5 The lecture included a sentence for which I have been much criticized since, although I still stand by it: the socialist system gave rise to a “premature welfare state”. I also delivered in 1992 the Myrdal Lecture in Stockholm, in honor of the great Swedish economist Gunnar Myrdal. I spoke of tightening up financial discipline and hardening the budget constraint. The Road to a Free Economy sharply criticized the inconsistent ideas for changing ownership relations in the final stage of reform socialism. There was to be a capital market without real private capital, cross-ownership of stakes in state-owned enterprises, “holding companies” managed by state bureaucrats behaving like owners, enterprise self-management like Yugoslavia’s, and so on. I wrote that I was fed up with this practice of simulation. We have already tried our hand at simulating quite a number of things. The state-owned firm simulates the behavior of the profit-maximizing firm. Bureaucratic industrial policy, regulating the expansion or contraction of various branches of production, simulates the role of competition. The Price Control Office simulates the market in price determination. The most recent additions to this list are the simulated joint stock companies, the simulated capital market, and the simulated stock exchange. Together, these developments all add up to Hungary’s Wall Street—all made of plastic! These same banks, joint stock companies, and stock exchange are but fakes. What is going on here is a kind of peculiar “Monopoly” game, in which the gamblers are not kids but adult officials, who do not play with paper money but risk real state funds. The most important point in the book, if its messages had to be ranked in that way, would certainly be that, in my opinion: The patching and darning of socialism had to end. There was no third road. The subject seemed to have been dropped from the agenda for a while, but the vision of a third road (or third way, as many authors call it) is imperishable and is just beginning to revive. Capitalism is inevitably replete with injustices and infringements of human dignity. People are all the angrier with the prevailing conditions when economic troubles appear. Few people have any desire to see the old regime back, but many people turn a sympathetic ear to calls for rejecting the new regime. The flood of ideas includes the “third road” versions of the old: romantic, “people’s” anti-capitalism; Nazi-style hatred of bankers; campaigning against plutocracy and robber capitalism; and New Left demonization of multinational corporations and globalization. Many of these standpoints should be criticized not so much for their economic content but rather for their hazy analysis and conceptual confusion.
Economists at that time recommended one of two courses of action. One strategy that was first recommended by The Road to a Free Economy supported the organic development of the private sector. The prime tasks were to dismantle the great barriers to private enterprise and liberalize entry into production. Startups of new private firms had to be allowed and even encouraged. The property rights of the state-owned enterprises should not be squandered but should be sold at fair prices. Free distribution of state property should be avoided. If a state-owned enterprise was not viable it had to be liquidated. All these developments had to be accompanied by a hardening of the budget constraint. Such a change in ownership relations could be accomplished only gradually, not at a gallop, and it has therefore been known in Western debates as the gradualist strategy. The rival proposal focused on disposing of state property as quickly as possible. This was the strategy of accelerated privatization. Proponents argued that as the old state-owned enterprises could not be sold overnight, the state should not wait for a proper buyer but should distribute to every citizen vouchers representing state assets. Each citizen has a right to his or her share of the state property; and by lodging the voucher with an investment fund, every individual would gain a stake in the enterprises formerly owned by the state. Those who recommended this approach were not against new private firms being started, but they wished to focus the attention of politicians, economists, and the state administration on voucher privatization instead. The Road to a Free Economy argued strongly that plans for free distribution were misguided: “It leaves me with the impression that Daddy state has unexpectedly passed away and left us, his orphaned children, to distribute the patrimony equitably… The point now is not to hand out the property, but rather to place it into the hands of a really better owner.”
The view of the “accelerators” gained the upper hand in the debates among Western economists in Washington’s international financial institutions, politicians, and academic economists at leading universities. A few thought as I did and favored gradualism, but ours was a minority view in the West. Most of the Western advisers who influenced the governments undergoing post-socialist transition favored the strategy of accelerated privatization. The course of events differed from country to country. In some, high proportions of state assets were handed out free; in others, small proportions or hardly any. Russia was the prime case of forced-pace privatization, which there contributed greatly to encouraging an almost irreversible, unfortunate process of world-historical weight as it produced an extreme concentration of assets in the hands of a few “oligarchs”. Hungary also had loud and influential advocates of a handout scheme and a bill to that effect was introduced in Parliament. But ultimately, the strategy of accelerated privatization was rejected in favor of the kind of sequence of events recommended in The Road to a Free Economy. Most experts, ten to fifteen years later, agree, in hindsight, that the gradualists were right.
If the private sector is to increase gradually, not in leaps and bounds, then the state owned sector cannot disappear suddenly. State property and private property will continue to exist side by side for a considerable time. The Road to a Free Economy expressed my distrust of state ownership. I objected to the head of a state-owned enterprise being viewed as an entrepreneur and receiving the independence and commercial freedom allowed a manager responsible to real owners for a company’s performance. Those doing business with state money are not entrepreneurs. I was especially afraid of schemes that sought to hand companies over to their employees but actually allowed them to fall into the hands of the managers. You have to beware of the claws of the executives of state-owned enterprises, I urged, and experience would prove me right. The operation and privatization of the state-owned enterprises, less dominant but still numerous, came to be surrounded by abuses and corruption. The administrative and political controls were insufficient, the privatization procedures lacked transparency, and the press and the public lost track of what was happening.
The Road to a Free Economy caused a stir by calling for rapid macro stabilization and related price liberalization, as opposed to a gradual alteration in ownership relations. I prescribed surgery for the sick Hungarian economy. The phrase “shock therapy” became widespread in international debates at the time, but I avoided it as far as I could, for two reasons. Those advocating shock therapy were pressing for very rapid action on both privatization and restoration of the macro equilibrium, whereas I was a gradualist on ownership relations while advocating swift and radical action in macro stabilization. So I was concerned to have the word “stabilization” in my formula. In stabilizing the economy, the “shock” is probably not an instrument of treatment. It can rather be viewed as a side effect, perhaps worth tolerating for the sake of favorable results expected in the end. To return to the debates of 1989–1990, I became isolated in Hungary with my proposal for stabilization surgery, which was not accepted by other economists or any influential political forces. This rapid, radical solution was put into effect in some other countries, notably Poland, the Czech Republic, and Russia. In the first two, it was remarkably successful. In the case of Russia, experts at home and abroad still debate whether the stabilization carried out with dramatic speed and many victims was necessary or should have been avoided, and whether it was ultimately beneficial or instead detrimental to the country’s future development
The book was not in the shops before Paul Reti, an editor of the business weekly HVG, interviewed me. One of his questions was, “Do you not think your program would gain acceptance more easily if it were some party’s, not ‘above party’?” I wrote and published the book before the country’s first free general elections. I addressed it primarily to the future Parliament and government that would form out of the democratic process, at a time when I still could not know their political makeup. This was my answer to the journalist: “I do not imagine we should put our trust in some advisory body above parties that would listen to my proposals and then implement them. That can only be done if some party or parties with the support of a majority in Parliament adopts them and there is no opposition force. To use a term popular with Hungarian political analysts and journalists in 2004, it thematized the economic debate. The expression “thematization” is among the most fashionable at the moment. Fashions like this fade as quickly as they come. It may easily happen that later readers of this book no longer understand the expression”. Then the interviewer asked me a follow-up: “Would you be prepared to be an adviser in the future, or even take a political role?” I replied, “I would like to remain fundamentally a man of science; I do not want to be a minister, a member of Parliament, or an appointed adviser.”