Western Lessons for Eastern Europe

The philosophes of the Enlightenment postulated the existence of a “state of nature” from which human beings negotiated a social contract. In societies encrusted with tradition, this notion is merely a useful metaphor. But occasionally, some great historical spasm may lead to circumstances that actually approximate a state of nature and citizens suddenly discover that they have the opportunity to redesign their society virtually anew.

The East European countries find themselves in such circumstances. Indeed, negotiations over the terms of a new social contract have already begun.

How can these societies organize themselves in a manner conducive to prosperity, productivity and simple fairness? Neither unleashing unbridled market forces nor maintaining bureaucratic central planning is the answer. The failures of the latter course are patent--indeed, they are the primary impulse for revolutions throughout the Eastern bloc.

But additionally--as even Adam Smith, the father of capitalist theory, understood--market incentives do not adequately address important collective needs. In the short run, the self-interested pursuit of profits provides powerful incentives for individual effort and drives resources toward their highest-paying use. But a system based solely on private motives and private returns overlooks important collective goals essential to the long-run quality of life.

The free market frenzy in the United States during the past decade demonstrates some of the pitfalls of unregulated capitalism. Despite the longest sustained expansion of the postwar period, the United States faces unresolved and worsening crises in education and health care. The nation’s infrastructure is deteriorating at an alarming pace, while the environmental toll of private economic activities continues to mount. Lax regulation of businesses with significant spillover effects, such as the savings and loan industry, has allowed private actors to make fortunes at the taxpayers’ expense.

And the “supply-side” expectation that the greater enrichment of the wealthy would result in dramatic trickle-down benefits for the poor has given way to the reality of greater income inequality and a higher poverty rate, increasingly concentrated among the very young.

In designing their new social contracts, the East Europeans must struggle to find the right blend of institutions and policies to encourage private initiative without sacrificing collective needs. Some examples are obvious and are already common in many advanced capitalist economies.

As most of the West European nations have demonstrated, high levels of efficiency, productivity and innovation are consistent with--indeed are supported by--comprehensive social welfare programs that include health care, family support, care for the aged, unemployment compensation and worker retraining and relocation assistance. In Eastern Europe, where the termination of government support for unsuccessful state-owned firms threatens the livelihood of millions of workers, programs providing temporary support for dislocated workers and their families are especially important.

But safety-net measures are not enough. In their understandable rush to dismantle the bureaucratic apparatus that strangled private initiative for so long, the East Europeans must be mindful of other appropriate and beneficial roles that government can play in market economies. For example, public programs will be required to meet the vast infrastructural needs of the region, and to reverse the environmental ravages of the past 40 years. There is no historical evidence that such collective concerns will be served by private market incentives.

Nor are unregulated markets always likely to yield desirable economic outcomes. Because the East Europeans have inherited highly concentrated industrial structures in which very few large firms account for the bulk of production in most industries, antitrust and other regulatory codes specifying allowable business practices are essential.

Regulation is also of great importance in the development and operation of financial markets. Such markets have both private and collective functions in modern economies. As the savings and loan debacle in the United States demonstrates, a reduction in regulation is not always in the collective interest. And as the prosperity and stability of the Japanese financial markets demonstrate, a high degree of regulation and administrative guidance over the decisions of private financial institutions can be the handmaiden of their success. Even as the East Europeans gut many existing institutions of government, they must erect powerful, autonomous central banks to realize the financial and macroeconomic stability on which market capitalism depends.

Finally, the newly elected governments in Eastern Europe will have to confront the problem of income inequality endemic to capitalism. Given the long tradition of egalitarianism in these societies, the emergence of large income differences, especially if accompanied by a decline in incomes for the poorest groups, is likely to produce the kind of popular resistance that could throttle further reform.

Fortunately, the experience of the advanced capitalist economies indicates that progressive income taxation and social welfare programs to assuage distributional inequities need not impede prosperity. Contrary to what avid supply siders argue, there is no simple relationship between national economic performance and the pretax or post-tax distribution of income. Among the advanced industrial countries, the United States has one of the most uneven distributions of income, accompanied by one of the lowest productivity growth rates, whereas Sweden, Japan and West Germany, with far more even distributions, boast superior productivity records.

Although the East Europeans have much to learn from the experience of other capitalist nations, in one area they are traveling in largely uncharted waters: They must design mechanisms to transfer state-owned enterprises, which are the backbone of their industrial economies, to some form of private ownership. But when few of their own citizens can afford to purchase these enterprises, and those who can are likely to have profitted most, either legally or illegally, under the old rules, how can this transfer be achieved equitably? And how can it be achieved in ways that prevent an excessive concentration of the nation’s wealth, and in ways that give the workers, who are well-educated and skilled, a stake in the performance of their enterprises?

The answer to these questions seems to lie in programs allowing groups of workers to purchase state assets and in programs giving workers some participation in enterprise decision making and profits even when they are not among its owners. Collective ownership of firms by groups of workers--so-called joint-stock companies--may represent the best means for dispersing the ownership of state assets and placing them in the hands of those most knowledgeable about how to utilize them. Such an arrangement also provides the motivation for enthusiastic worker effort that was sorely lacking under central planning. Furthermore, it’s consistent with the goal of democracy underlying the recent revolutions.

But the East Europeans must not limit themselves to collective ownership arrangements alone. Private ownership is vital to the success of market capitalism. Yet, as growing evidence from the developed capitalist economies indicates, privately owned companies that provide meaningful participation and profit sharing for their employees are likely to be repaid by increased worker effort and productivity. For the nascent East European leaders, who have been given the task of designing systems of greater democracy and greater productivity, programs to encourage the adoption of participatory arrangements in private companies should be especially attractive.

The challenges confronting the East European nations are enormous. Inevitably, as they seek to meet them, they will look westward for models and for guidance. But if they succeed, we in the West may well be casting our eyes eastward for lessons in how to achieve capitalism with a human face in the 21st Century.