We here in the United States, and People in the West generally, are exhilarated by developments in Eastern Europe. The “evil empire” of the Soviets seems to be in dissolution, as East Germans vote with their feet, and as Poland, Hungary, and now also Czechoslovakia replace years of Communist rule with new democratic institutions and move toward replacing central direction of the economy with market mechanisms. Even the Soviet Union itself seems to many observers to be headed down the path of political and economic reform in the direction of democracy and capitalism.

Unfortunately, formulating a Western economic policy in response to these developments is no easy chore, not the least of the reasons being a wide divergence of interests among the Western allies. West Germany, for example, has a clear stake in raising the living standards of ethnic Germans now resident in Poland, Hungary, and Czechoslovakia. Otherwise, they might take the Federal Republic up on its open-ended and until now virtually meaningless offer to welcome them as immigrants. Several hundred thousand highly trained, German-speaking, and easily assimilable young East Germans are one thing; hordes of Poles, Hungarians, and Czechs quite another.

Because of these (and other) differences among the Western allies, a fully coordinated economic response to the unfolding events in the East is unlikely. Nor is it necessary. This is one area in which America can quite sensibly go it alone.

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I

The currency is worthless. Foreign indebtedness is high. The infrastructure is run down. Democracy is attempting to take root in the rocky soil of authoritarianism.

The USSR, 1990? Yes. But also Germany, after World War I. Then, America and the European democracies poured hundreds of millions of dollars of loans into the coffers of their past (and future) adversary, restoring real wages and output and creating the world’s most modern road and marine transport systems.

That good deed did not go unpunished. Nor may the similar one we are being urged to perform for the Soviet Union by a mixture of humanitarians, academic economists with longstanding Greenback-party inclinations (wipe out debt), believers in the end-trend (the end of Communism, the end of history), and a broad spectrum of people who, commendably, think that we have an obligation to help the masses suffering under Communism establish more vibrant economies.

But before plunging in with assistance, or even ordinary venture capital, we should consider several facts, not the least of which is whether trying to aid the Soviet economy, after only the limited changes proposed by General Secretary Mikhail Gorbachev, is at all feasible.

There is no longer any question that the Soviet economy is a mess. As two Soviet experts (Nikolai Shmelev and Vladimir Popov) have put it, “There is not enough of anything, anywhere, at any time.” The government concedes that 1,000 of 1,200 everyday consumer goods are now in short supply. Only the supplies of useless rubles and unspendable savings have gone up.

Such facts are no longer state secrets. On the contrary, it seems to suit Gorbachev’s purpose to trumpet them far and wide: he tells us that the Soviet Union is suffering from “economic deadlock and stagnation,” from “slowing economic growth,” and from “a shortage of goods.” One of his chief economic advisers, Abel Aganbegyan, provides gory details about “the deep-seated deformations in the development of the Soviet economy,” among which are “wage-leveling and neglected material incentives.”

This litany of woes can be taken as making a good case for aid of various sorts, which is what Gorbachev intends. But a mere recitation of need is not enough to demonstrate that aid—credits, subsidized loans, investment guarantees, preferential access to markets—would be used to improve the efficiency of the Soviet economy. The continued Soviet refusal to move to a market economy, and the parallel unwillingness to address the nation’s budget deficit, moot the question of whether we should help. We simply cannot, even if we choose to. For any assistance would disappear down what Shmelev and Popov call the Soviet “black holes’ that swallow resources.”

That Gorbachev and his followers have no taste for what they see as the evils of a market system is demonstrated not only by their repeated statements to that effect but even more convincingly by their actions. Recent experience with the cooperative movement is a vivid case in point.

“Cooperatives”—really small, private businesses were legalized in a move that Deputy Prime Minister Leonid Abalkin called “the first step toward the formation of a socialist market.” The result was a burgeoning of mostly small businesses: restaurants, cafés, food shops, printers. Prices were high—perhaps three to eight times the level in state shops—but the goods were available.

In some instances, to be sure, this was because state officials diverted goods to cooperatives in return for bribes or a piece of the action. But mainly these small-scale operations thrived on the ingenuity of their owners, producing some 25-30 billion rubles’ worth of goods and services in 1989—goods of tolerable quality, available without queuing, and at market-clearing prices. The cooperative movement, Abalkin told his fellow deputies in the Supreme Soviet, had brought many “businesslike, enterprising people, able organizers, well versed in marketing and capable of identifying production reserves and making the economy flexible and dynamic.” Just the medicine, one might have thought, for the ossified Soviet economy.

But his fellow deputies disagreed, with Gorbachev leading the charge. How was it possible, Gorbachev asked, for soap, otherwise virtually unobtainable, to be available at a cooperative for 40 kopecks—eight times the state price? Obviously the cooperative must have stolen from state supplies. “Economic salvation cannot come out of the pockets of the working class,” added Venyamin Yarin, a deputy from Siberia, to what one correspondent reported as “a murmur of agreement.”

“You have to take public opinion into account,” Gorbachev also warned. And public opinion was best expressed by the burning down of a cooperative pig farm that had provided a northern region with its first fresh meat in twenty years. The farmers were “making too much money,” Soviet television reported. “Now the district has no meat,” was the wry comment of the (London) Independent’s Moscow correspondent. Meanwhile, cooperatives were being subjected to progressively more stringent regulation: outright prohibition from some activities, controls on the prices they might charge, punitive taxes.

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As this experience reminds us, Gorbachev believes that the creative forces which must be liberated if the Soviet economy is to thrive can (in the words of Marshall Goldman) “be mobilized within a system that continues to be centrally supervised by the state.” Judy Shelton, author of the masterful The Coming Soviet Crash,¹ puts the same point more pithily when she says that Gorbachev’s view is “that the system has gotten off track, not that the tracks were laid out wrong.”

Hence, rather than adopt market-based incentives, Gorbachev has relied increasingly on command-and-control techniques to improve the functioning of his economy. The agricultural sector is now under the control of one of the most vocal opponents of economic reform. The problem of shoddy goods has been addressed not by unleashing market forces but by hiring an army of “quality inspectors.” And the problem of shortages is being met by reimposing what Abalkin admits are “rigid state orders” and export controls—both emergency measures, he says. In short, centralized control is increasing, not decreasing.

Nor is there much hope that Gorbachev and his colleagues will reverse course, and suddenly realize the virtue of relying on market forces to allocate resources in their massive economy. Even the reformer Abalkin favors a comprehensive price and-income policy (read: price and wage controls). The very best that can be expected, barring the always possible sudden change in policy, is that Abalkin’s latest proposal will be adopted. He wants to begin creating a limited market in 1991-92 by allowing some auctions and trade fairs, and permitting firms to sell goods produced in excess of state orders (which planners can always increase) at free-market prices.

To offer aid to an unregenerate planned economy is to ignore our experience in lending to centrally directed Latin American countries and to Poland during the last thaw, when it all went down the drain. It is also to ignore the fact that the USSR’s budgetary situation is one which would cause a zipping of the wallets of the International Monetary Fund and the World Bank. Or, we think it would. For the fact is that we know very little about the true size of the Soviet budget deficit.

The Soviets now put it at 12 percent of GNP, about four times the U.S. level. And they swear that this time they are telling the truth. Yet not many months ago these same budget-makers issued a prospectus in connection with some international borrowings: it quite remarkably showed the Soviet budget to be in surplus.

But assume that the Soviets are now giving us accurate figures. Might it not make sense to lend to them anyway? After all, the American budget is hardly a model of fiscal probity, and foreigners lend our government billions quite regularly.

The answer is that there are budget deficits and there are budget deficits. Ours is distinguished from the USSR’s, first, by its small size relative to the size of our economy: about 3 percent for us compared with at least 12 percent and perhaps twice that for them. Second, our deficit is declining, while the USSR’s appears to be rising. More important, our deficit is grafted onto a market economy, theirs onto a centrally planned economy. As Judy Shelton points out, a budget deficit in any country is inflationary. In America, that means higher prices. In the Soviet Union, where prices are not free to rise in response to the increased money supply resulting from the deficit, it means greater strain on the central-planning system: shortages; queues; reallocations of resources in a doomed effort to meet first this shortage, then that one; and a piling up of useless rubles in savings accounts.

This ruble “overhang” creates a dilemma for Gorbachev. If he keeps the lid on prices, the distortions in his economy become exacerbated, production remains stagnant, and the overhang grows. If he takes the lid off prices, they will soar, until purchasing power and the supply of goods achieve some balance. This latter course he has specifically rejected, on the ground that “after two weeks of such a ‘market,’ all the people will be on the streets. And it will smash any government, even one which declares its devotion to the people.”

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Gorbachev could, of course, reduce the strains on his country’s resources by further cuts in his military budget. The Soviets, in what is probably an understatement, claim to be spending about 12 percent of their national income on defense, roughly twice what we spend. But the International Institute of Strategic Studies in London notes that the Soviet figure may well exclude military space and nuclear programs, and “existing military-assistance programs” (to Afghanistan, Cuba, and Nicaragua, among others).

Instead of reducing his military power in relation to our own, however, Gorbachev would much prefer to have the West provide the goods and cash he needs to soothe his angry consumers. And so he has proposed a latter-day version of his beloved Lenin’s New Economic Policy (NEP), a program inaugurated in 1921 in response to widespread unrest among the starving peasants. The essence of NEP, as the historian Theodore Draper characterized it, “was to use capitalists . . . against capitalism, to use capitalism against itself. This was the rationale for inviting foreign capitalism into the Soviet Union in the form of mixed enterprises and economic concessions.” But the improvements NEP brought in economic performance were soon swamped by Stalinism and World War II. Four subsequent efforts at reform—by Khrushchev (1957), Kosygin (1965), and Brezhnev (1973 and 1979)—also proved disappointing. Now there is Gorbachev’s perestroika.

Gorbachev has never asked for direct government-to-government aid. Like Lenin before him, he wants bank loans and capital investments by private parties. And Western bankers seem eager to lend, although a bit less so recently, since the pace of change in Eastern Europe has made the future more difficult to predict. In January 1988 the Soviets made their first trip to Western bond markets; they sold an issue totaling some $78 million with ease. In all, the Soviets have increased their debt to the West from $13 billion in 1983 to more than three times that level now, and could, over the next few years, borrow some $30 billion more to finance perestroika.

Yet bank loans today are no longer private capital, in the strict sense of the term. Like most Western governments, ours would be subsidizing most of the loans to the Soviet Union, either directly, by providing investment and deposit insurance, or indirectly, by serving as payers of last resort. Should Moscow prove unable to repay its mounting debts, the West’s bankers are certain to ask for government bailouts, as they have already done in the case of Latin American loans that have gone sour. The least our government can do now, then, is inform the bankers that there will be no such bailout if these Soviet loans are not repaid.

That leaves the question of equity capital to be invested by private companies in the hope of making customers of the Soviet Union’s 286 million consumers, or of developing Soviet products for export. American companies seem eager to give investment in the USSR a try. Although they have concluded only some 80 joint ventures (the total for all foreign companies is around 1,100) since the beginning of 1987, more are in the works, more than 300 if the Soviets are to be believed.

These ventures are not to be mistaken for examples of the free flow of investment capital. Rather, they represent the flow of American capital directed to uses that suit the Soviet state. The investment will have to be in the form of joint ventures with the Soviet state (only one of the ways in which perestroika borrows from NEP) or with cooperatives, and on stiff terms. The share of foreign capital initially was limited to 49 percent; that limitation has now been removed, de jure, but may well remain in force, de facto: only 4-5 percent of joint ventures entered into so far have majority foreign ownership, according to Business International, a firm that keeps close tabs on these deals. “Fundamental decisions” relating to the joint venture’s activities must be made with the unanimous consent of the board, which board must include some Soviet citizens. Profits will be taxed at a rate of 30 percent, with an additional 20 percent taken if they are transferred abroad. But these taxes may be waived if the joint venture invests in products deemed of national importance by the Ministry of Foreign Economic Relations. So—and contrary to the impression created by press reports about the opening of mobile pizza parlors and McDonald’s—the Soviets are not confronting foreign investors with a neutral, free-market set of incentives. The areas in which foreigners will be encouraged to invest are those chosen by the Soviet government for their strategic importance to its economy and security. Capitalists are welcome; those willing to serve the interests of the Soviet state are more welcome than others.

Here too, as with loans, there is no justification whatever for the U.S. government to provide subsidies, either through insurance or through credits below market rates. If that is what Bush promised Gorbachev at Malta, Congress should say no.

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II

The case of Poland is a more difficult one, both because the facts are more ambiguous and because large domestic ethnic and trade-union constituencies create enormous pressures for action—any action, no matter the likelihood of success. Unlike the Soviet Union, Poland has begun the difficult tasks of bringing its budget under control and making its currency convertible. And unlike the Soviet Union, Poland seems willing to move from a centrally directed socialist system to a market-oriented economy.

Indeed, on August 1, 1989, most government controls on retail prices were removed, as a consequence of which food prices rose sixfold in state stores, and by perhaps twice that much in private outlets. But since the price increases were offset by wage indexation, and since the higher prices did not find their way fully into farmers’ incomes (the state-owned distribution system having absorbed most of the extra payments), shortages persisted.

Little wonder, then, that Poland’s economy remains in a shambles, a testimonial to the horrors of centralized planning. The head of the Finance Ministry, Leszek Balcerowicz (an economist, trained at New York’s St. John’s University, and until recently on the staff of the Central School of Planning and Statistics), has inherited an inflation which experts estimate at 30-40 percent per month. To bring it under control, Balcerowicz will have to do some combination of three things: cut Poland’s arms budget; reduce subsidies that have kept the prices of consumer goods low and queues long; and/or cut interest payments on Poland’s $39-billion foreign debt.

The Solidarity government is privately passing the word that it is making every reasonable effort to cut its military expenditures. Thus, unnamed “American officials” have reportedly been informed that the new Polish government has refused to contribute to a Warsaw Pact fund being established by the Soviets to modernize the Pact’s armed forces after current arms negotiations are completed. Against that must be set the fact that Moscow acquiesced in the formation of the government only after Solidarity agreed to leave control of the army and the police force in the hands of the Communists, unlikely advocates of cutbacks in military expenditures. How this tension—some Poles’ desire to reduce defense costs, the Communists’ desire to maintain or increase them—will be resolved, we cannot know.

The elimination of subsidies is equally difficult. Going “cold turkey” would exacerbate the round of price increases, and produce what economists call “corrective inflation.” By that is meant increases high enough to discourage demand and, simultaneously, to encourage the production and sale of various commodities—to the point where demand and supply balance. As noted above, the Poles appear to have begun just such a process, by allowing some food prices to rise, and by reducing some subsidies to farmers. But we do not know just how much short-run pain Poland’s consumers and farmers are willing to bear in order to obtain the long-run benefits of market prices. What we do know is that Farmers’ Solidarity and the United Peasants’ party, the latter a member of the coalition government are already calling for the reinstitution of subsidies.

Furthermore, the established unions already have warned that they will adopt a militant stance on behalf of their six million members. If the unions succeed in wringing wage increases from the new government, or in postponing the slimming-down of the bloated public sector, the deficit will soar, reigniting the inflation that the subsidy cuts are intended to dampen. And if union demands are denied, the result, warns Harvard’s Jeffrey Sachs, an economic adviser to Solidarity, could be “a wave of strikes, civil unrest, and violence.”

Given these constraints, Solidarity’s least painful course is to turn to the West for help. Sachs has summarized Poland’s minimum needs, as he sees them: $1 billion immediately from “the central banks of the industrial countries”; $700 million from the International Monetary Fund; $500 million from the World Bank, to be followed by “a sharp cut in the $39-billion foreign debt that hangs heavily over its [Poland’s] future”; further “U.S. financial support” to the total tune of about $3 billion; perhaps three times that from “America’s allies”; and “further lending” by the IMF and the World Bank. That largesse, plus “economic reforms,” would, Sachs feels, do the trick.

Sachs’s plan for a dash to market freedom—“just say no” to controls and subsidies—has great merit and considerable appeal to many Polish officials, presumably including Finance Minister Balcerowicz, who is saying all the right things: Poland must impose budget austerity and privatize loss-making public enterprises. But Balcerowicz has also expressed doubts about the efficacy of cuts in defense expenditures, says he is “uncertain how they [Poles] will react” to an austerity program, and talks about the need for “social safeguards,” i.e., more welfare payments, to ease the pain of austerity. Hardly the gritty determination of a dedicated budget cutter.

Tadeusz Syryczyk, the new Industry Minister, although reported to be a committed privatizer, also faces a bleak situation. Some 70 percent of the economy is in state hands, and the nomenklatura—defined by the Economist as “the mafia of political appointees who run the Polish economy as well as most other things”—will not easily give up control of those enterprises. Indeed, these bureaucrats have already begun to interpret “reform” as meaning that they should siphon funds from the state-owned firms they manage into enterprises they are now permitted to own personally—a kind of “privatization-by-theft” that may produce an unpleasant backlash.

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None of this means that American economic policy toward Poland should remain frozen in a time-warp of the cold-war era. But anything beyond the assistance we have already decided upon should be based on a realistic analysis of what can actually work rather than a fear that Poles might again riot against Poles, Polish workers might again refuse to work in Polish factories, Polish farmers might continue refusing to feed Polish consumers, or Polish voters might reinstate a Communist government. Our aim should be to help Poland help itself.

Technical assistance—including large-scale educational and training programs in the technologies and ways of the free market—plus a reduction of any barriers to Polish imports, would constitute help of precisely that nature. This might be supplemented by in-kind contributions of seed, tools, farm equipment, and fertilizer, made by private American citizens and corporations to the 2.7 million private Polish farms that account for almost 80 percent of their country’s farmland and produce three-quarters of its eggs, milk, grain, and beef, and 90 percent of its fruit and vegetables. By allowing such contributions to be deducted from income tax, our government would bear some of the costs of this in-kind aid.

But what about the knotty question of Poland’s hard-currency foreign indebtedness? Of the $39 billion, $26 billion is owed to creditor governments (the so-called “Paris Club”), $9 billion to the commercial banks, and the rest to others, including some Eastern-bloc governments. To service all of these debts, Poland would have to use 90 percent of its export earnings, leaving precious little to pay for imported machinery and other items it must have if it is to build up its export potential.

What happens to the $9 billion owed to the banks can be of little concern to the U.S. government. The exposure of American banks represents a very small part of the total Polish debt, and of the banks’ capital. The amount owed to the U.S. government is also minor, perhaps 10 percent of the $26 billion owed to all governments. Consequently, we can do little, on our own, to relieve Poland’s debt burden.

This leaves open three possibilities. The first is a debt-forgiveness program, agreed to by all members of the Paris Club. But collectively to forgive Polish debt on such a scale would be to trigger a wave of requests for similar treatment from other non-poor countries. (After all, a recent memorandum by the U.S. Department of Agriculture concludes, “the Polish people are not starving.” Per-capita meat consumption is “on a par with much of Western Europe. . . .”)

The second possibility is to lend Poland more money, to be used in part to repay past loans. But such piling-on of debt has in the past only exacerbated the debtors’ plight, both because it enables them to postpone reforms and the domestic austerity programs essential to eventual repayment, and because it adds to the debt burden that must eventually be repaid.

Finally, the creditors could reschedule Poland’s debt payments, say by allowing interest due to remain unpaid, and to accrue as additional debt. This would mean that Poland’s debt would increase annually by the amount of the unpaid interest. If Poland’s exports do not grow by something more than that accumulation—i.e., do not increase by more than the interest rate—its debt burden will steadily mount.

None of these alternatives is painless. But the situation may not be as demanding of American intervention as it at first appears. Unlike us, the Germans, Poland’s largest creditor, have a historic obligation and real incentives to be lenient. For one thing, the cost of a bit of debt forgiveness may be far less than the cost of assimilating a wav of non-German-speaking immigrants. For another, Poland represents a sound long-term investment for German industry. It is good business, therefore, for the German government to provide Poland with assistance, if only to help it create the stable economic environment which German industrialists need.

And indeed, the Germans have already begun to move in this direction. In an agreement reached in Warsaw this past November, West Germany promised to forgive $400 million in Polish loans from German banks and to convert another $254 million of that debt into investment capital. In addition, Bonn will provide loan guarantees and insurance amounting to $1.6 billion to finance industrial projects that are likely to earn foreign exchange.

Poland can also count on the private sector in other Western countries to provide capital where truly economic opportunities for the use of that capital exist. If it is really the case that food-price reforms and a stripping-away of centralized control of distribution will make Polish agriculture prosperous, there is no reason to believe that American, European, and Japanese venture capitalists will resist the temptation to make a dollar (not a zloty, however, until it becomes convertible). In fact, joint ventures are already taking shape. The Polish embassy says that its government already has approved 650 joint ventures with Western companies, and Hubert Janizsewski, vice president of the country’s foreign-investment agency, expects that number will soon rise to 800, valued at $1 billion. Certainly these ventures are more promising than the special-development bank proposed by Felix Rohatyn. Such a bank would be nothing more than still another attempt at central direction of investment, this time by bureaucrats based in Paris instead of in Warsaw. There is little reason to believe that such a bureaucracy can more effectively pick winners than can the private investors who will be risking their own money.

This private money is far more likely to end up in goods-producing investment than is government-to-government aid, or grants allocated by disinterested bureaucrats with nothing to lose. Indeed, it is difficult to imagine an alternative more in Poland’s long-term interest than one that combines the following ingredients: reforms that only the Polish government itself is in a position to adopt; German self-interested largesse; profit seeking Western capital; and humanitarian and technical assistance from America. Certainly, our experience in Latin America and Africa suggests that the alternative—government aid and openhanded lending—results eventually in a cycle of default and impoverishment.

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III

In sum, the arguments against any extraordinary aid to the Soviet Union seem overwhelming. Even if we accept Gorbachev as a true economic reformer—and his reliance on command-and-control rather than market incentives argues against that view—we cannot be certain he will survive. We are dealing with a system, not a man.

Furthermore, the Soviet Union’s continued refusal to move toward a market economy, and its unwillingness to reform its currency or reduce its enormous budget deficit, make it doubtful that any assistance can be productively employed. Even by Latin American standards, the Soviet Union is a bad credit risk. True, it has substantial oil, gold, and mineral assets. But these are unlikely to be made available to creditors in the event of a default.

The case of Poland is more complicated, but the answer close to the same. Reform is in the offing, and if it comes, further carefully targeted aid might be effective. But it is far from certain that a government dominated by and beholden to trade unions will adopt the austerity programs that are the prerequisite to effective aid. And we should be alert to the danger that food contributions on too massive a scale might well wreck the vigorous farm economy by forcing it to compete with “free” products donated by us.

But perhaps the best thing we can do for Poland (and other reforming East European countries like Hungary) is fight to keep the channels of world trade open to their goods. For as Prime Minister Margaret Thatcher never tires of crying out in her increasingly lonely voice, Europe post-1992 might well become a fortress, repelling the invasion of goods from non-members of the European Community. If Jacques Delors and his socialist allies have their way, European producers will be encumbered with financing a series of expensive welfare measures. European industrialists are prepared to bear this burden—if they are given protection from lower-cost foreign competition, which competition will almost certainly include goods from Eastern Europe. Add to this the protectionist proclivities of Europe’s farmers, who will very much want to keep cheap Polish (and Hungarian) agricultural products out of their markets, and coal-mining unions who see cheap energy from the USSR as a threat to their members’ jobs. Such protectionism could in the end do far more to stifle the growth of the East European economies than a Western failure to pump massive new loans into those economies. Together with the British, the U.S can fight to prevent it from taking hold.

These, then, as matters now stand, are the things the United States can do for the East European peoples. They do not add up to the new Marshall Plan that Lech Walesa has called for, but unlike some of the other proposals that have been made, they do represent a program that can realistically be expected to do more good than harm.

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¹ Free Press, 246 pp., $22.50.