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February 23, 1990
"Even in a Very Optimistic Scenario, It would take 30 Years for Per Capita GNP in those Countries to Catch Up to a U.S. Economy Growing at 2.5 Percent Per Year - Eastern Europe's Paper Economies"
San Jose Mercury News
By Timothy Taylor
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AFTER decades of centrally planned mismanagement, the governments of eastern Europe and the Soviet Union have destroyed the basis for knowing anything about their own economies, even something as basic as the size of their economies.

The Mercury News provided a unwitting but glaring example of this problem in the series "Undoing communism," which ran from Sunday through Wednesday in the Business section. The first article of the series offered statistics for some East European nations. For example, the GNP of East Germany was given as $207 billion and the population as 16.6 million. Those numbers together imply that per capita GNP in East Germany is $12,470.

If that estimate is correct, then per capita GNP in East Germany is higher than Great Britain ($12,340), only 3 percent behind France ($12,803), and just 6 percent behind West Germany ($13,323). But everyone agrees that the East German economy is inefficient to the point of collapse, not even in the same ZIP code as the economies of Western Europe.

In fact, overestimating the size of communist economies is a venerable tradition. The standard source for these statistics is an annual report of the U.S. Arms Control and Disarmament Agency. This official U.S. government document claims that East Germany is slightly richer on a per capita basis than West Germany and only 5 percent behind Japan! To pile absurdity on absurdity, the report also estimates that per capita GNP in Czechoslovakia is higher than in Britain. And that per capita GNP in the Soviet Union and Bulgaria and Hungary is higher than in Italy or Spain.

How can it be that all the anecdotal evidence says that the communist economies are in a shambles, but the standard U.S. government estimates, cited by papers from the Mercury News to the New York Times, claim they are nearly on a par with developed market economies?

Apparently, the estimates of the size of the communist economies have relied on the arbitrary prices set by communist governments. The moribund East German is only on a par with the West German economy if one accepts the official exchange rate: one ostmark equals 50 cents. But on the black market, an East German ostmark is worth about a nickel. At that value, East Germany's per capita GNP is close to that of Brazil or Mexico.

The problem of calculating gross national product reveals the central difficulty that communist economies face: They can't make economic decisions because they don't know what anything is worth. In an economy where prices have no touchstone in reality, who can say whether a business is an inefficient money-loser that should be closed, or an efficient operation that is foreordained to lose money by an irrational price system?

Market prices should not viewed as sacrosanct, whether in the communist nations or in the United States. Markets need to be prodded by government to address social needs like pollution, poverty, education and scientific research. But markets do need to be free enough to provide some honest feedback and incentives.

Once communist governments allow prices and profits to start talking, their workers and managers need to start reacting. Western investors and governments can be of only limited help in their attempt at economic transformation.

For example, the communist economies need hundreds of billions of dollars worth of investment capital, far more than Europe or Japan or the United States can provide. But if the communist economies can manage to save 16 percent of GNP, a rate achieved by a number of countries around the world, they could save a year's worth of GNP every six years. In addition, such a commitment to rebuilding their own economies would draw private foreign investment like a magnet.

Rather than providing capital, I suspect that the greatest service the West can provide to the communist economies is to help the workers and managers react appropriately to a market.

Almost none of the adults in the communist economies have ever worked or managed in a market-oriented system. Even with more informative prices and more available capital, it's not clear that they will know what to do. By openness and interpersonal contacts, by teaching and example, Western businesses, government and educators can help that learning process.

It will take decades to undo the economic damage of communist mismanagement. As a rough illustration, make the (generous) assumption that per capita GNP in the Soviet Union and Eastern Europe is now about half that of the United States, and that an economic miracle transforms those economies so that they start growing at 5 percent per year.

Even in this exceedingly optimistic scenario, it would still take 30 years for per capita GNP in those countries to catch up to a U.S. economy growing at its historical average of 2.5 percent per year. A more realistic and dismal forecast is that today's communist economies will take at least two generations to approach the standard of living in the United States and other market economies.

Cold realism about the economic prospects of the communist countries, no matter how disheartening, is a moral obligation. Otherwise, unrealistic economic expectations in the communist countries will threaten the political miracle that seems to be taking root in eastern Europe and casting seeds into the Soviet Union.

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