All Commentary
Tuesday, May 1, 1990

Eastern Europe: The Economic Stakes Are High

Mr. Small is a computer engineer in Manchester, New Hampshire.

History is being made with astounding speed in Eastern Europe, as one Communist regime after another seems to be capitulating to the will of the people. After 45 years of cold war, and with the apparent blessings of the Kremlin, several major Eastern European countries appear to be racing each other to embrace the benefits of democracy and capitalism.

If Eastern Europe’s march toward capitalism continues at anything near its current pace, the world’s economy could undergo major, even drastic, changes.

The first effects of the events within the Warsaw Pact already are being felt. Since the end of World War II, the economies of the United States and its NATO allies have been on a partial war footing, building armaments to protect Western Europe against a possible Soviet invasion. This sector of the U.S. economy is sure to contract in the wake of a more peaceful Europe. News stories already have appeared about Pentagon plans to cut back major programs, mothball naval vessels, and demobilize some military units.

We can expect to see layoffs in the defense industry as well as bankruptcies among companies that depend upon defense contracts. Given the speed of current events, defense contractors are going to have little time to diversify into other areas, making the impact of expected budget cuts even greater.

Beyond the relatively obvious effect on the defense industry, we must analyze the possible impact of a capitalist Eastern Europe on the economies of the free world. If present trends continue, several powerful economies may suddenly be added to the world scene. Depending upon the results of the democratic movements in these countries, the impact on the world economy could range from trivial to dramatic.

If the movement toward capitalism succeeds, the countries of Eastern Europe could be the economic miracles of the next several decades, becoming the new Japan, Korea, and Taiwan of the early 21st century. In fact, they could build up their economies even faster. They have no devastating war to recover from, and an educated and skilled labor force is already in place. The motivation to work for profit and a better life certainly seems to be present. The current standard of living is low by Western standards, with frequent shortages of even the most basic products. Given these conditions, we can expect that, at least for a while, a 1ow-c st pool of skilled labor will be available to fuel new economic development. Unshackled from socialism, Eastern Europe could become a major consumer and producer of manufactured goods on the world market.

As conditions now stand, however, it is unlikely that Eastern Europe will become a major consumer market, although many a Western European manufacturer already is looking east with a gleam in his eye. The economies of Eastern Europe are a mess, undoubtedly a major contributing factor to the current political upheaval. While we may see a short buying spree,particularly of personal consumer items, the supply of hard currency in these countries won’t support a long-term flow of goods across the border. Many of these countries already are heavily indebted to Western banks, and the relative trickle of goods across the new open border between East and West Germany already is having a detrimental effect on the value of the East German mark on the black market.

Although they may soon run out of money, the people of Eastern Europe do have a healthy appetite for Western goods. Their economies are a shambles, but a trained, low-cost work force with a desire to improve its standard of living is an excellent starting point for a massive economic expansion. Without a true capitalist society, however, very little can be accomplished.

Affirming Private Property

The advancement of capitalism in Eastern Europe depends upon the recognition of private property rights and contractual law by those in power. Investors must be allowed to own property, be able to have faith in the legal system, and be permitted to take profits out of the country. Opening up Eastern Europe to free enterprise will bring in much-needed capital from foreign investors, provide lessons in business and technology to the local work force, and create opportunities for local start-up companies that will be needed to support the factories built by foreign investors.

Foreign involvement is needed for several reasons. First, foreign investors have the capitalist know-how to set up productive businesses. They have access to, and detailed knowledge of, Western markets. And perhaps most important, they have access to the hard currency and financial resources of the West. Restricting investment to residents would result in a much slower and less efficient buildup of the economy, with far more failures due to the trial and error nature of such a buildup.

Once production and exports are increased, Eastern European economies will start to earn hard currency that can be reinvested in local businesses so as to bolster the country’s ability to produce for its own needs; or the money can be used to buy consumer goods, raw materials, and capital goods from abroad.

Western Europe, because of it cultural ties and geographic proximity, will feel the major effects of any economic expansion in the East. If, for example, substantial new loans are made to Eastern Europe, it is likely that a large flow of goods will begin to move from West to East, and profits of Western manufacturers will climb. In order to pay off the loans, however, productive enterprises will have to be developed quickly in the East. This period of development will provide another opportunity for Western companies in the form of low- cost production facilities close to major Western European markets. This, in turn, could lower the price of European products and make them more competitive with Asian products, in both European and American markets.

The down-side of this would be some loss of manufacturing jobs in Western Europe. In addition, Eastern Europe might become more attractive for investment than Latin America or Africa. This could result in a decline in new investment in those areas. In the longer term, however, Eastern Europe is likely to become integrated into the existing European economic system. When the standard of living and labor costs in Eastern Europe reach a par with the rest of Europe, the tide of investment will turn outward again. A larger pool of European industrial and business concerns will once again be looking at Third World countries for new investment opportunities.

On the opposite end of this spectrum of possibilities is the vision of an Eastern Europe reduced to a charity case and dependent upon handouts from the industrialized nations, much like many Third World nations that overdosed on socialist policies. The people of Eastern Europe have lived under a Big Brother socialist system for a long time, and may not be willing to give up the security blanket of a welfare state for a competitive system in which they sink or swim on their own merits. The laziness that is bred and nourished by government guarantees of job security, minimum wages, subsidized housing, and other such “benefits” is a powerful counter to the sow-what-you-reap philosophy of capitalism.

The costs of socialism are often hidden from the man on the street, who doesn’t see the lost opportunities, the lost discoveries, and the lost standard of living that might have been achieved under a capitalist system. Socialism provides an illusion of something for nothing while the economic system feeds on itself. Without the growth stimulated by some degree of capitalism, socialism eventually collapses, as it is now collapsing in Eastern Europe.

The scenario of a democratic, but socialist and impoverished Eastern Europe also could have a major economic impact on the industrialized West. In this case, we might see massive mounts of foreign aid poured into Eastern Europe. In this scenario, it wouldn’t be Western companies investing in new production facilities, but rather Western governments pouting in tax money to prop up the new Eastern European governments. This would add enormous amounts of debt to the world’s balance sheets. This money, like the loans to many other governments, would likely never be recovered. The resulting defaults and write-offs, combined with existing bad loans, could contribute to an economic calamity of global proportion.

The most likely scenario for Eastern Europe is a mixed economy, retaining socialist qualities while adopting some capitalist attributes. The government control inherent in the socialist philosophy is something that appeals to politicians and bureaucrats of every persuasion. If, however, capitalism is adopted with the fervor of a religious conversion, the industrialized world and newly developed nations could see both profits and com petition from Eastern Europe in the not-so-distant future. Capitalism adopted as a reluctant admission of the failure of Communism, however, will result in a relatively stagnant Eastern Europe, with the same problems that plague many other nations with controlled economies.