Moves to Free Market Challenge Eastern Bloc : Flexibility Needed to Turn Around Disastrous Economies of Poland, Soviet Union, Analysts Say

When Harvard University economist Jeffrey Sachs visited Poland recently, he found an economy straight out of “Alice in Wonderland.”

Because air travel is heavily subsidized by the government, a 180-mile plane ride from Warsaw to Gdansk cost the equivalent of $2.90. A fading post card cost a quarter of a cent because the state stationery store had not thought to keep prices current.

As an adviser to the new Solidarity-run government, which is trying to move Poland back through the Communist looking glass and toward a free-market economy, Sachs hardly knows where to begin.

He and most other outsiders prescribe nothing less than the kind of off-with-their-heads solution that the Queen of Hearts would have ordered--dismantling Poland’s economy and building a new one from scratch.

Must Recraft Industry

The pricing system must be reformed, most economists believe, so that prices reflect supply and demand. The agricultural sector must be uprooted so that the country can feed itself. Industry must be recrafted without the heavy subsidies that have kept inefficient factories alive. The Poles must begin to build such basic economic fixtures as a stock market, banks and other credit facilities.

Poland’s new government on Friday announced just such a program, designed to quickly begin conversion to a market economy by Dec. 31. Warsaw said it hopes to win approval of its plan by late November by the 152-country International Monetary Fund, in time for Western nations to begin new loans and debt-relief programs in early December.

“What we must do is a quick transformation of the present economic system into a market system,” Finance Minister Leszek Balcerowicz told a news conference in Warsaw. “We have a great and unrepeatable chance” to adopt “a system whose effectiveness is proven all over the world. But we have to do it in a very difficult economic situation.”

During the transition, economists acknowledge, Poland will have to endure extraordinary trauma--hyperinflation, deep recession, conspicuous shortages and a serious erosion of living standards--as it moves in fits and starts toward a new economic order. The political pressure will be enormous.

“People are going to have to suffer, and they have to have faith that short-term decreases in living standards will bring longer-term gains,” said Charles Movit, an economist at PlanEcon, a consulting firm that specializes in Eastern Europe. “The question in Poland is, are people going to accept Solidarity’s word for it?”

Poland is not alone at the brink of the free-market abyss. Other Eastern Bloc countries--including the Soviet Union--have either started down a similar path or at least considered it.

The Soviet economy, the oldest and most rigid among the Communist states, is in many ways the worst off, with extreme inflation in a few already private sectors and severe shortages of food and other goods. In the face of strikes and ethnic rivalries, President Mikhail S. Gorbachev has postponed liberalization of prices indefinitely.

Czechoslovakia is not far behind but the system there has been made more workable by an easing earlier of some restraints. Hungary, which began its shift years ago, is far ahead of other Eastern Bloc states. East Germany has yet to begin.

‘No Blueprint’

“There really is no blueprint,” Movit said. “No one has ever done what they are trying to do.”

Poland has settled one issue by forgoing gradualism in favor of what is known as the Big Bang approach--an all-at-once conversion to a free-market economy.

“If you decontrol only some prices, you sometimes make the situation worse, not better,” explained Brookings Institution economist Robert Z. Lawrence.

Lawrence cites the example of China, which removed controls on agriculture but neglected to decontrol consumer goods as well. As a result, when farmers came to the cities to buy goods, they cleaned out the stores and drove urban prices up.

But a sudden transformation will also would pose difficulties. of its own. For one thing, the kinds of steps Poland plans--must take to make the switch--such as devaluing its currency and cutting back its government subsidies--are almost certain to intensify inflation and worsen the current economic slump.

“Our biggest problem is how to adjust so that at the same time our domestic situation doesn’t deteriorate,” Balcerowicz said during the recent International Monetary Fund meeting in Washington.

Many economists also fear that giving private interests control of industries and holding wages down may not be possible for a socialist government.

Shift May Be Impossible

University of Maryland Prof. Bartlomiej Kaminski, writing in the Financial Times, said that he fears that industry has become so concentrated that it may be impossible to shift to the kind of competition traditionally expected from a “private sector.”

As an interim step, Kaminski said, he favors “autonomization”-- breaking up Poland’s huge, state-run sectors into smaller units that can be forced to compete with each other. Only then, he argued, can the government successfully remove price and currency controls.

For the longer term, Western economists are looking to help Poland and other willing Eastern European nations do nothing less than replace government-controlled economies with free markets.

Under communism, the government distributes goods from place to place largely by rationing--much like a supply chit in the military. Money is irrelevant.

Free markets, by contrast, allocate goods through prices and wages that are based primarily on the available supply and demand for each product or service.

It is a long way from one system to the other. For starters, Western economists, concentrating for now on Poland, prescribe these steps:

* First, authorities must establish a system of wages and prices that actually reflects reality and is not influenced by subsidies and other government actions.

That means unifying Poland’s current multi-tiered exchange rate--the Polish zloty trades officially at several different values, depending on what it is being used for--and stabilizing it at a realistic level against the dollar.

* Next comes the Polish agricultural system. Although Poland already allows its farmers to own land, the rest of the farm sector--tractors, seed, fertilizer and technology--are rationed by the state and need to be made more widely available for crop yields to increase.

Also important is to begin a massive agricultural extension program to teach Polish farmers how to farm. Under Poland’s state planning, most farmers have learned to raise only a single crop and lack the knowledge needed to modernize and diversify.

* The Poles then must put as much of their industry as they can into private hands--that is, sell it to private citizens or investors. What cannot be sold off must be made to operate at a profit. Currently, money-losing factories are financed by the government, bloating the budget deficit.

That means ending state monopolies and eliminating the massive government subsidies that help keep prices artificially low and enable Polish companies to continue operating at a loss and making products that prove uncompetitive in international markets.

* Poland must also deregulate the economy and eliminate rules, such as prohibitions against business deals and advertising, that impede business operations.

Only then, say U.S. economists, will Poland be able to attract the substantial foreign investment that it will need to build its economy. “You have to know that if you go into business you won’t be at risk,” said Harald B. Malmgren, a Washington-based trade and economic consultant.

Poland must develop a comprehensive social security and unemployment benefits system that can provide a safety net for individuals who are displaced in the conversion to a market economy. Otherwise, said Eugenio Lari, the World Bank’s top Poland expert, the Polish people will lack the needed confidence to gamble on new jobs and businesses.

“Right now,” he said, “they are afraid that if they are thrown in the street, they won’t survive.”

Any new economic plan must involve tight money and credit policies, sharp cuts in spending and a hold-down on wage increases, all to help temper the inevitable burst of inflation that will result when prices are freed up in the face of soaring demand and increasing shortages. PlanEcon’s Movit estimates that Poland’s inflation rate has recently soared to about 50% a month.

Glut of Unusable Money

In the Soviet Union, where authorities have postponed reforming the pricing system, the results have been serious shortages of goods and a glut of unusable money. If the Soviet government does not sop up the excess money--say, by allowing people to buy their own houses or selling special new treasury bonds--before allowing market forces to set price levels, most Western economists believe that inflation will explode as too much money chases too few goods.

The Soviets also will have to clamp down on wage increases, according to Western economists, until purchasing power is in line with the Soviets’ ability to produce.

To many economists, however, the problems posed by the transition are more political than economic. Breaking up the traditional central control of the economy means stripping the entrenched bureaucracy of its longstanding stranglehold over economic decision-making.

And the inevitable bouts of hyperinflation and then unemployment--combined with a sharp reduction in living standards--portend political turmoil that would be difficult under any economic system.

Brookings’ Lawrence, who took a firsthand look last year at the Soviet economy, is not confident about the future. “I came away totally pessimistic,” he said. “I guess you’re not going to do it without tremendous political cost.”

Poland bit the bullet last week. Early in the week it devalued the zloty by 20%, the first of many such devaluations expected. Market forces should ultimately drive the zloty’s value far lower than the state-controlled rate and that, in turn, should make Polish products cheaper and, therefore, more competitive on world markets.

Then on Friday, the government outlined a sweeping two-phase program that will provide for rapid conversion to a free-market economy.

Phase 1, to be instituted by Dec. 31, will involve loosening state ownership of property, breaking up government-owned monopolies, reforming the state budget, revamping the banking system, creating new unemployment benefits and streamlining state-owned enterprises.

Shift to Private Enterprise

In Phase 2, to begin early next year, Poland will launch a major new effort to curb inflation by revamping the budget and tax system and ending credit and subsidies to government-owned corporations. It also plans to convert many state-owned enterprises to private ownership and to create a bond and stock market.

Most important and perhaps most risky, Poland will try to hold wage increases down--even in the face of soaring prices--by limiting previously automatic pay boosts tied to the inflation rate.

“We must introduce a wage-and-price policy that will stop the inflationary process,” Balcerowicz said. “Without approval of this point, I can see no chance for leading Poland out of its crisis.”

The new turn toward capitalism has caught Western nations, particularly the United States, divided over whether and how far to help the Eastern Bloc states modernize.

Wary of the mistakes of the 1970s, when the West “threw money” at Poland’s fledgling reform efforts, White House officials and many U.S. allies have urged caution. They argue that all aid should be held up until Poland actually begins to make specific reforms.

Evidence Is Needed

“We are expecting not to do very much of anything until the basic steps have occurred--until there is evidence of economic restructuring,” said Barber B. Conable Jr., president of the World Bank, which is considering a $300-million loan to Poland.

But congressional Democrats, anxious to outdo President Bush, are pressing for a far more ambitious program that ultimately could top $1 billion. As a result, the Administration and Congress have launched into a virtual bidding war, with the White House announcing last week another $200 million in aid to Poland, in part to head off the congressional push.

The money will supplement about $119 million in new U.S. aid that the President announced during his visit to Poland in July and another $108 million approved after Solidarity took power.

Washington also will help Poland hammer out accords with the International Monetary Fund and World Bank that could lead to about $800 million in new loans from those institutions. European countries and Japan are launching similar moves.

In addition, the United States is providing a spate of technical assistance, not only to Poland but to other East Bloc states. Federal Reserve Board Chairman Alan Greenspan is traveling to Moscow this weekend to advise the Soviets on how to reform their economy.

Plan to Mobilize Support

Commerce Secretary Robert A. Mosbacher recently returned from Poland with a plan for mobilizing support from U.S. business. And Washington plans to send Agriculture Secretary Clayton K. Yeutter to Warsaw to discuss ways to free up Poland’s farm sector.

Private experts, too, are heading for the East in droves. Lawrence noted that almost a dozen economists from the Brookings Institution here were out of town last week on advisory missions to East Bloc countries. The IMF and World Bank also are sending teams of advisers.

The United States has also offered $250 million in food aid.

Balcerowicz says that Poland hopes to use the first $500 million of the new aid to help unify and stabilize its exchange rate. The rest will go to help enable Poland to keep buying needed imported goods during the transition.

Even before the latest round of economic changes, PlanEcon’s Movit saw reason for hope. “If you begin with clear timetables, there can be clear progress as well,” Movit asserted. “In six months, the entire Polish economy should be redone. I have confidence that it won’t be rolled back.”