Teleki László Foundation Institute for Central European Studies

Budapest 1996

In association with

International Centre for Ethnic Studies, Kandy, Sri Lanka

The PEW Charitable Trust, Philadelphia, PA, USA

Tulane Institute for International Development, Arlington, VA, USA

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This paper aims at providing a review of economic transformation taken place in Eastern Europe after the collapse of the Soviet-type state-socialist political and economic system. This troubled transformation process constitutes the economic background of sharpening ethnic conflicts in the region.

The analysis covers Hungary, the Czech Republic, Slovakia, Bulgaria, Rumania and three of the successor states of former Yugoslavia, namely Slovenia, Croatia and Macedonia.

The study is organized as follows. The first chapter describes the sympthoms of economic crisis, analyses the reasons for disappointing macroeconomic performance. The second chapter deals with the key problems of economic transformation with special regard the problems of privatization and the fiscal consequences of the economic transition. The third chapter deals with the prospects of regional cooperation. The fourth chapter analyses the question of foreign assistance. It has predominant importance in the transition since countries of the region struggle with increasing disequilibrium problems both in external and internal terms and it has become more and more obvious that they can not be stabilized by themselves. The fifth chapter analyses the ethnic dimension of economic transition. The sixth deals with the question how independence has affected macroeconomic situation in the successor states of former federal states Czechoslovakia and Yugoslavia. Finally, the last chapter summarizes the main findings of the paper and draws certain conclusions.

The reform of public statistics in the transforming East European countries is a problem for two reasons. On the one hand there has to be a complete change from the old system of material balances (MPS-system) to the gross national product (GNP) system that is used in market economies. On the other hand, profound structural changes are currently taking place, and these are producing new social, economic, and in the final analysis statistical arrangements. Hungary, Poland, former Czechoslovakia published fairly reliable statistics even in the socialist era. Contrary to them at the end of the 1980s Rumania published only two pages on foreign trade in its statistical yearbook! At the beginning of the 1990s considerable efforts have been made for upgrading statistical system in all transforming countries, however, statistical sources have been in transition as well. Thus statistical data from transforming states in Eastern Europe must be treated carefully, must be regarded with certain reservations.

In the economy from 1989 the macroeconomic indicators of the region have shown for more than a decade the strengthening of depression. East European economies were struggling with serious difficulties already in the 1980s, already at that time there was a drastic switch in the rate of economic growth.

By the second half of the eighties (to different extent in different countries) a certain duality appeared: on the one hand the official economy dominated by huge firms of the socialist sector and the cooperatives, on the other hand there was the second (and third) economy in opposition with the first, characterised largely by market relations and which spread – unlike the official economy – with spectacular speed. This strongly restricted, only partially registered, pursued as a secondary activity (beyond work in the government sector), dynamically developing, intricate economy and the considerable surplus income gained from it evaded the government control.

In the 1980s first of all Poland and Hungary were burdened by large debt servicing obligations what resulted in considerable loss of income and net outflow of capital. The answer of the economic policy of the time was a drastic change in the breakdown of national income into accumulation and consumption. In Poland and Hungary accumulation went back abruptly (in Czechoslovakia more mildly) since 1978 and after that it stagnated at a low level. Consumption however mildly grew in all the three countries over the whole period. Economic policy shifted from the burden of decreasing domestic use of national income as much as possible to accumulation. In Rumania and Bulgaria the situation was much worse.

After this difficult decade the foreign markets of East European countries have been shaken. Their main partner the Soviet Union was no more able to pay either in cash or in goods. To make matters worse, in June of 1990 the GDR ceased to exist what disrupted from one day to the other the previous economic cooperation between Eastern Central European countries and the Eastern provinces of the new unified Germany. Consequently, it is not surprising at all that macroeconomic and macropolitical environment just in the period of their systemic change were largely similar to those of the Great Crisis of 1929–1933.

It was clear from the outset that the transformation into a market economy of what for decades had been a centrally administered economic system would be linked to considerable setbacks in overall economic performance. Since 1989 all the transforming countries underwent a deep recession. GDP decreased since 1989 by 20–30% and the decline in industrial output was even more, approximately 30–40%. The drop of agricultural output was far less 5–15%, despite the fact that agriculture was undoubtedly the area in the transforming economies in which there have been the greatest number of changes. (A positive phenomenon that as a result of restitution private farming became once again possible on land that has been returned to its rightful owners. However, the concomitant practice of dissolving cooperative and state-owned farms happened too fast and led to considerable falls in production, so that balance of trade in the foodstuffs sector significantly deteriorated.)

In consequence of the sharp decline in production the rate of unemployment grew rapidly and with the exception of the Czech Republic it exceeded sizeably the 10%. In the 1990–92 period the decline of economic performance and especially that of industrial output well surpassed decrease in the number of persons employed, so productivity, however low in international comparison, diminished even further. But from 1993 industrial productivity -especially in Hungary – substantially improved. (As regards the situation in the Czech Republic it is worth mentioning that industrial activity compared to its 1989 level decreased by more than 35% but the official rate of unemployment is well below 5%. This clearly shows that so far there has not been systemic change in the microsphere and this fact is a clear sign of the deteriorating efficiency of the Czech economy.)

Macroeconomic data showed a certain weakening of the recession for 1993. All countries of the region witnessed a decrease in the negative GDP and industrial growth rates, and since than the economy has bottomed out or is on the moderate upturn. In 1994 Poland was in the middle of increased economic growth for the second year running, whereas the Czech and Slovak Republic, Hungary for the first time achieved a slight increase in the gross domestic product. In the case of Rumania whose reformist policy was for a long time vacillating and undecided positive growth is predicted for 1995 at the earliest. After the courageous start in 1991, political instability in Bulgaria led to stagnating reforms in the following years and to a severe economic recession that had not come to an end in 1994. In 1995 all the transorming countries achieved economic growth, however, it would be premature to speak about general prosperity in the region, since all countries’ economic performance lag behind the 1989 level and the basis for economic growth is still rather unstable.

The reasons for the above presented macroeconomic situation need special explication. The question what caused the forceful and longer-than-expected decline in economic activity can be answered in the following way: One reason for the deep recession is the collapse of CMEA and Soviet markets. The export and import of these countries in CMEA relation taken separately was 10–25% of GDP in the middle of the eighties. As part of CMEA planned and organised activity in all countries capacities were created whose products cannot be sold on other markets or can be sold with huge losses. Radial CMEA trade structure even reinforced the role of the Soviet Union in export-import relations. The collapse of CMEA markets occurred when in 1990–1991 the Soviet Union could no more pay in hard currency but requested hard currency payment against his own shipments. Therefore all the transforming countries were compelled to hold back drastically their export to the Soviet Union. The result was that utilization of non-convertible capacities went drastically back. Such loss of output has naturally multiplicator effect, resulting in even more loss of capacity utilization and spreading unemployment.

All these countries had in the eighties efficiency problems, performance lagging behind aspirations. This contradiction had to be surmounted in Hungary and Poland by increased indebtedness, in Czechoslovakia, Rumania and Bulgaria by a strict application of the planned economy. But the social crisis was rekindled by the sharpening of these conflicts. After the systemic change the antagonisms and problems delayed or denied for a while broke open together with the problem of debt servicing. The abrupt surfacing of these delayed problems resulted naturally in recession.

During the forty years long period the economic structure of these economies and human motivations and reactions within economic relationships were adjusted to the requirements of planned economy . Transition to market economy makes obsolete a large part of what existed and functioned in the old system. Therefore in the first phase of transition economic recession cannot be avoided.

In all East European countries the heavy industry – military industry complex concentrates of productive forces pursue mass production with obsolete tools of production. This over-dimensioned part of the economy cannot be utilized profitably under conditions of open market economies. Reorganization and adaptation of their viable parts and bankruptcy of the rest is inevitable. In Czechoslovakia, Rumania and Bulgaria but also in Hungary and Poland characteristic units of the industrial organizations were big enterprises with several establishments and thousands of employees. State farms and cooperatives were organized with the size of 5–10.000 hectare land in each East European agriculture. (With the exception of Poland.) Under such conditions efficient agricultural production was impossible. (As an exception in Hungary a dual agricultural system evolved thus a more or less rational symbiosis of large farms and secondary activity small-scale production came about.) The so-called “reverse pyramid” of the enterprise structure of the economy (few small and medium sized units, many large ones) was rapidly disintegrating in all the transformating countries and in the process of transition small and medium sized enterprises/establishments did arise from the viable elements of previous large enterprises. In this respect the most important development is that relying on possibilities of free market entry which existed since 1990 in all the transforming countries small and medium sized private (often joint) ventures multiplied in all East European countries. However this budding sector cannot of course replace in volume of production, number of jobs etc. what has been lost at large units.

The majority of experts are convinced that it contributes to the deepening of recession that legislation and government measures do not help enough, in fact in several aspects hinder the enfolding of transformation. Of course the inevitable difficulties, the lack of any historical or foreign experience with the management of such kind of transformation all have a role in it. But not only this.It is obvious that transformation attacks strong class and group interests. The other serious question lurking behind the surface of transformation is which strata – and first of all which elite strata – will be the losers and which the winners of transformation. Consequently political forces approach only marginal questions from the consideration of economic rationality. The whole management of transformation turns around questions like “who will come to power?”, “who will be proprietor?” and in these skirmishes macroeconomic rationality has been pushed into the background.

Main problems of transformation can be singled out from several points of view. Within the framework of this study it is impossible to go into all of these questions in detail. Thus this paper concentrates on two basic questions of transformation. One is problem of denationalization and privatization, the other is the fiscal consequences of economic transition with special regard to the adjustment of the large budgetary redistributive systems to the requirements of market economy.

In all the transforming East European countries a basic, and in the long run decisive factor of not only economic but also social transformation is giving the dominating state property assets into private property. Irrespective of party affiliation it is a general opinion among the political elites and economists that only private property, the personal interest of the proprietor in accumulating capital and personal material risk can overcome the wasteful use of resources, improve competitiveness, instigate rational changes in the economic structure. In order that private property become predominant a large part of state assets must be privatized. Moreover it is stressed in all transforming East European countries that privatization builds up a proprietor class without which social and political democracy cannot be viable.

The most important sign of the spread of the private sector is the growth of the number of private ventures which in last years was spectacular. Part of private ventures is very successful, they increase the number of their employees, their capital accumulates rapidly. Nevertheless the spread of private ventures in Eastern Europe is still modest and this not for political but for economic reasons. The explanation is the scarcity of domestic capital, the general uncertainty in the business environment, the underdevelopment of the credit market, strong inflationary tendencies, the severe credit conditions, the insufficient market experience, the low purchasing power. It is still a common phenomenon that family members pursue private activities as a secondary job retaining – if possible – their materially and socially more secure main job.

The difficulties with dismantling state property are particularly great under present East European circumstances. In Eastern Europe not a small part of the economy should be privatized as in some market economies (such as Great Britain) but the dominant sector of the economy should change owners. So the strategy “first scale it up then sell” can be applied only to a limited extent; the economies of the region are burdened by deep and durable recession; and this is not favourable for capital acquisition. Beyond this domestic capital seeking investment possibility is also scarce in these countries. The above mentioned adverse economic and political circumstances explain why governments accessed to power since 1990 developed and operate the most diverse schemes of privatization.

In each country the authorities differentiate between so called small and large privatization. Small privatization means privatization in retail trade, catering, tourism, construction and personal-industrial services. Small privatization concentrates on giving into private property (or leasing out) the autonomous units. Large privatization means the transformation of large and extra-large monopoly position enterprises, the breaking of their monopoly position and giving them into domestic, foreign mixed property.

Despite the fact that there is a national consensus in all transforming East European countries in favour of privatization the process and its results are still lagging behind originally optimistic expectations. It is unquestionable fact that small-scale privatization can be regarded as an essentially finished process in all East European countries, but large-scale privatization is far from being finished. With the exception of Hungary assets privatized up to now amount to merely 10–30% of total assets to be privatized. In case of large enterprises, to make matters worse with the profitable units sold, the remaining ones might be unsaleable. Privatization encounters inexperience, insufficient expertise, underestimation of asset value, lack of true accountability. Negotiations on privatization deals are frequently prolonged to such an extent, that in the end many of potential investors choose to abandon the whole thing because of these delays and indecision.

Consequently large-scale privatization will inevitably require a considerably longer period than originally planned and it will take at least a decade or even more. There is a strong probability that the part of national economy remaining in state property will be larger than it is in Western Europe. This raise the following fundamental question: what will be done with state property large enterprises until they find a buyer? How could it operate in a market conform way remaining for years in state property? Unfortunately politicians and economists so far have paid very limited attention to this fundamental problem.

Among the crucial long-term macroeconomic problems of the economic transition in the East European economies is the rise in the fiscal deficit and public debt. This occurs in all the economies, irrespective of the speed of economic transition they choose or the progress they make with institutional and structural reforms. The deterioration of the fiscal balances can be ascribed not only the impact of the stabilization programs and the political and economic constraints on deficit reduction, but to the major structural, institutional and ownership changes associated with the transition. The first macroeconomic factor to be mentioned is the fiscal impact of the partly inevitable drop in output and the associated fall in employment, which cause an abrupt decline in revenues (because the fall in production and demand reduces taxable incomes) and a steady increase in expenditure.

In the short-term this is an inescapable side effect of the stabilization programs because of the associated contraction of demand, the increasing openness of the economies and the cessation of negative value added production. This decline is strengthened by inherited structural distortions and the slow and weak supply response of the economies due to rigidities in factor markets, though this depends on the level of progress in economic reform and the level of development of the market mechanism.

The consequences of this loss in output and hence employment for fiscal revenues are very serious. Fiscal expenditures are increased as unemployment and social security expenditures rise. Furthermore, the decline of output is sometimes so strong that it necessitates the replacement of the abolished subsidies by direct or indirect forms of enterprise protection, to mitigate the negative impact of economic decline on the economy. Also unfavourable to the fiscal balance is the increasing openness of the economy: there are substantial losses from the decline in tax and customs revenues due to import liberalization and from the currency devaluations that accompany the process of opening up the economy.

Developments associated with import liberalization have an adverse effect on revenues. While additional revenues emerge from the tradables sector as imports and incomes increase, foreign competition reduces the income of enterprises in the import-competing sectors of the economy, and so lowers budget revenues. Import liberalization is generally accompanied by institutional liberalization which leads to an increasing number of market participants and to a growth in the share of the tradable sector in private hands. This increases the proportion of illegal imports upon which tariff and tax payments are not made, since the liberalizations are generally not accompanied by improved tax and tariff supervision. Therefore in some countries (notably Hungary and Poland), the increase in imports was not accompanied by increasing revenues for the budget from the tradable sector.

One of the most important macroeconomic factors associated with the transition is steady inflation. The level of this depends on the degree of inherited financial instability, the significance of the monetary overhang, and the state of the real and financial markets in the economy. Inflation influences both public expenditures and revenues, and the financing of the public deficit. It reduces the level of real incomes, domestic demand, and consumption thus leading to smaller consumption tax revenues (expect for products with low demand elasticity). Inflation has an even stronger short-term impact on expenditure than on revenue. It increases the operating costs of the public sector and the nominal value of subsidies and transfers paid by the Treasury, if their real value is to be preserved. Furthermore, if the deficit is bond-financed then it increases the debt-service and interest expenditures.

Turning to the institutional changes, the privatization of state-owned firms has a negative fiscal impact, even though it increases the current revenues and reduces some fiscal expenditure, because the potentially collectable amount of tax and the receipts from certain taxes (mainly income and turnover taxes) are cut by the tax concessions given to privatized firms, the growth in tax evasion and the black economy, and the fall in the state’s income from dividends. Meanwhile spending is increased by the employment consequences of privatization, which are financed by the budget and the state’s assumption of some of the debts of formerly state-owned firms during preprivatization reorganizations. Another important institutional factor is the reform of the banking system and the improvement of the banks’ liquidity position. It partly devolves on the budget to support the recapitalization of the banking system, solve the problems of poor debt portfolios and a growing stock of non-performing loans, and establish funds to mitigate the risks of lending and so the risk aversion in the banking sector. Meanwhile the fiscal position is affected by microeconomic reforms such as the new bankruptcy legislation. Such laws are required to increase the financial discipline on firms and promote a reduction of inter-firm lending, but their short-term impact on the fiscal balance is highly negative, as they cause a fall in production, a rise in unemployment and a decline in privatization revenues. So in summing up it is obvious that East European countries have to face with intensifying disequilibrium problems and these increasing problems inevitably lead to serious social consequences.

The previous socialist regime defined as state activity to secure the conditions of reproducing labour force and its costs were to a large extent borne by state and society. It was in accordance with socialistic ideas and the eminently social goals of the system that education and health services be free or payment for them be nominal, that the state stand for pensions and sick pay and a large part of the costs of child rearing. There was an effort to give new families subsidized flats etc. A large part of the costs of reproduction of labour force did not figure in wages. They were financed by the state budget under the system of redistribution. Although in the agony of the system, since the eighties part of these costs were shifted on to citizen, essentially the redistributive character of the system did not change.

In consequence of this practice in all East European countries welfare expenditures of the state budget remained high in international comparison. Welfare expenditures of the state budget were much higher in these countries than in market economies at a similar level of economic development what resulted in itself in a high share of budgetary redistribution.

Welfare commitment of the state and the operation of the respective institutional system becomes problematic precisely when GDP produced decreases, since in this case provision on constant level requires a higher share from GDP, i.e. redistribution, rechannelling of resources. On top of that systemic change in itself results in tensions, since market economy on the given level of development involves a considerably lower level of social services, whereas the rapid spread of unemployment after the change of the system creates new and justified demand towards social services. Besides that under government financing social service institutions necessarily are wasteful and negligent and this in itself justifies their “marketization”.

Tensions arising from the drop of GDP and systemic change may result in particularly high taxation of citizens and ventures which hinders transformation and also in a high deficit of the state budget which is dangerous due to its inflationary effects. The easing of these tensions is painful however since it comes about through strong reduction of the level of social services and the erosion of the purchasing power of pensions.

Under the new circumstances, the march towards market economy, when the performance of the economy is much worse than was in the past the former high burden on the state budget cannot be maintained. But the reduction of social allowances would further worsen the situation of the poor and increase – as an effect of systemic change – the differentiation of income and wealth. Can the government under such circumstances initiate a reduction of the large redistributive systems and thereby further deteriorate the living standard of low income strata, increase income and wealth differentiation and risk political stability? Or: can they assume the risk of a total collapse of the state budget? One thing is certain: the delaying of the reform of the state budget due to political considerations is a burden on the whole society, but there are not painless alternatives.

The forms of regional economic and political cooperation in the Eastern/Central European region are manifold. At least four different “organizations” can be enumerated in this respect: the Central European Initiative, the Carpats Euroregion, the Visegrad Cooperation and the Central European Free Trade Association. The latter is of utmost importance from an economic point of view, while the other three can not influence regional trade significantly, firstly, because of political orientation, and the lack of financing and of agreement on the abolishment of trade barriers between the member countries.

CEFTA came into operation, when Poland, Czecho-Slovakia and Hungary concluded a free trade agreement, which took effect in March 1993. The contracting parties decided to establish a free trade area gradually, covering all industrial and agricultural products by gradually eliminating tariffs and non-tariffs barriers to trade, commencing on March 1, 1993 and ending January 1, 2001.

The cooperation of the Visegrad 3/4 was trying to establish political and economic cooperation on the basis of their common cultural, historical and geographical past and present. The countries involved have the same interests; in economic terms, the producers and traders of the region have a deep understanding of each other, and in this respect their cooperation can promote the modernization of their economies and societies.

At the same time, for all four countries, becoming full EC-members is a top priority. This aim seems to be well founded, if we take into account the universal practice of small countries, outside the main trading blocks of world economy, to join one of the three major dynamic blocks in order to become integrated into the world economy. The establishment of a new regional trading block is not a viable option for the East European countries. First, due to their limited economic potential and the failure of previous attempts for similar cooperation; and secondly, close regional cooperation – according to the experiences of developing countries – does not advance ‘handicapped’ countries in their pursuit to catch up with the developed world. This type of regional integration is characterized by a relatively small and underdeveloped regional market and by the low level and proportion of intraregional trade, along with financial problems – due to the lack of convertible currency –, similar structures of exports and imports, and the lack of regional trade infrastructure etc. Because of the above-mentioned problems the participating developing countries have been experiencing a significant fall in their share in world trade. The main reasons for the fall are the trade-diverting effects of regional integration, which is deeper than the degree of integration into the developed world. (The question whether the European Union is capable and willing to play the role of a dynamic medium for the Visegrad countries automatically arises, but this topic is too exhaustive and should be addressed in another study.)

Another argument is that the potential for intense intra-industrial trade between the countries of the Visegrad region is quite low. It is true, that these countries inherited large industrial capacities in order to supply each other, but the majority of these capacities represent an obsolete technological level. Moreover, parallel capacities were built up in the analyzed countries and, according to their production factor endowments, these countries are rather competitors than cooperators in foreign trade. Thus, the mere realization of regional integration offers small advantages to these countries, whereas, integration into a bigger and more advanced economic unit would induce more profitable intra-industrial trade within the enhancement of regional trade.

The Visegrad countries, with a relatively low percentage of intraregarding foreign trade turnover, never represented an organic economic unity. These countries, for decades in their modern economic history have had much closer and tighter links with bigger economic units, e.g. the Austrian Empire, Germany or the Soviet Union; with the larger economic body “organizing” the economic and political relations between the countries of the region.

Foreign trade turnover between Visegrad 3/4 began to diminish in the 80’s and suffered a great decline in 1990. This is discouraging even in spite of the fact, that in the 90’s the turnover has decreased by the smallest degree among the former CMEA countries. In 1985, the share of Poland and Czecho-Slovakia in Hungary’s turnover, was close to 10 per cent, but after the conclusion of the CEFTA agreement, it decreased to about 4 per cent in 1992. The data for Czecho-Slovakia are 13 and 7 per cent and for Poland 9 and 5 per cent respectively. Recognizing the fact that the share of intra-CMEA trade was artificially large in comparison with that of other regions and taking into account the comparative advantages, the production factor endowments or the level of traditional economic and trade links before World War II, tendencies to reestablish the former level of intraregional trade should be rejected. However, according to estimates and the results of widely used economic models, the present level of intraregional trade is artificially low. In this respect, not only the recession and the collapse of the regional trade organization – CMEA – has to be mentioned as a cause, but the trade-diverting effects of the improved market accessibility to the EC (and EFTA) as well. (However, it should be emphasized, that while “trade-diplomacy” is affecting regional turnover to a great extent, the main determinants of the foreign trade performances of the Visegrad countries lie in their domestic economic policies and situation.)

With the considerable decrease in the significance of regional trade in the region (taking into account either volume or commodity structure), and the polarization of regional trade, no significant effect can be expected from an agreement, which covers less than 10 per cent (less than 4 per cent in Hungary) of foreign trade turnover in each country. The extent of covering is even smaller, if we take into account, that in the first phase the abolishment of tariffs effect less than 50 per cent of Hungarian exports to the Czech Republic and Slovakia. Moreover, agricultural and food products, which are important for almost all the analyzed countries, are predominantly excluded from the agreements.

In principle, the conclusion of the CEFTA agreement set similar conditions on the trade of the Visegrad countries with the European Community, with EFTA and with each other – which can prevent further discrimination of mutual trade, and thus, can stop the trend of contracting mutual trade. However, some considerable trade-diverting and trade-creating effects have survived in regional trade, and in the total trade turnover of the Visegrad countries. This is partly due to the difference between the timetables and commodity structures of the CEFTA-agreement, the Association Agreements and pacts concluded with the EFTA and partly to the similar commodity structures of foreign trade of the Visegrad countries. For example, the Eastern and the former Soviet exporters of raw materials can be crowded out by the exporters of the Visegrad 3/4. That way, to a limited extent, partial trade development can allow the growth or survival of uncompetitive sectors and companies in the long run and thus, hamper the restructuring of the industry. On the other hand, this phenomenon can help, in the short term, by reducing the social costs of privatization or transition.

Because of the parallel industrial structures and similar production capacities, the further use of non tariff barriers will firstly hit exporters of the Visegrad region. The use of non-tariff barriers was legitimised by the CEFTA agreement and is fortified by the recession on the main markets and the domestic recession.

Because of the ambiguous approach of the countries involved, the chances of establishing a properly functioning free trade area prior to 2001 are rather slim. Negotiations e.g. between Poland and Hungary have clearly demonstrated it. Even the disenchanting 1993 performance of the Visegrad countries on the EC markets did not motivate the countries to shift from passive to active partnership.

As it was mentioned earlier East European countries have to face with intensifying disequilibrium problems both in external and internal terms. There are two basic reasons for this phenomenon. On the one hand during the transformation period the need for capital has considerably increased in the region. On the other hand, in consequence of deep recession internal financial resources have been dramatically shrinking. Consequently, the dependence on external financial resources have considerably increased in case of all East European countries, because they can not be stabilized by themselves.

However, opportunities for raising funds to ease the symptoms of crisis and to facilitate economic modernization are rather limited. There have been disappointing experiences with western aid. Borrowing has played much bigger role in financing transformation, however, it has proved rather expensive form of raising funds since international bankers have had reservations about the stability of transforming East European countries thus these countries have been forced to borrow at a higher rate of interest which has made external borrowing less favourable. So compared with expensive external borrowing foreign direct investments have been promised to be considerably cheaper form of financing.

Transforming economies of Eastern Europe suffer from serious deficiencies that must be overcome if catching-up with advanced western countries and with the region’s own historical potential is to be achieved. These deficiencies are as follows: 1. The capital stock gap, which is due to a chronic shortage of capital and to capital obsolescence in the course of transformation. 2. The technology gap, which is closely linked to the lack of innovative firms and competition on the one hand and on the other hand, to the lack of intracompany technology flows and cross-licensing that dominate international technology trade. 3. A lack of entrepreneurship, which is a consequence of the totalitarian socialist period.

Foreign direct investments are of predominant importance in the transition period since the massive inflow of foreign direct investments can play decisive role in filling the capital and technology gap and in creating a market-conform business environment. Foreign investors transfer not only capital and technology, but also knowledge of modern business behaviour and techniques. Furthermore, foreign direct investments can contribute to economic growth via the increasing capital and technology spillovers. Economic growth is vitally important for sustaining transformation because privatization and modernization are inevitably accompanied with mass unemployment and unprecedented social tensions. These undesired phenomena must be alleviated, otherwise social disturbances could derail transformation.

During the last couple of years the amount of invested foreign capital has been substantionally increased, mainly in the countries of the Visegrad group. (Among Visegrad countries Hungary and the Czech Republic have achieved the most remarkable results in attracting foreign direct investment.) Thus the importance of foreign direct investment has been appreciated for the host East Central European economies mainly in terms of investment and technological upgrading. Foreign direct investment achieved a sizeable share in foreign trade, investment and to a lesser but not negligible extent in total production and employment. Nevertheless, it must be emphasized that foreign direct investment in many cases have produced mixed results. There are numbers of convincing evidences that the activity of foreign firms is responsible for shrinking domestic production and decreasing employment. In all countries concerned the regional distribution of foreign companies can be characterized by serious disparities. Foreign investors’ decisions concerning investment locations were strongly influenced by transport and communication related considerations. The reason for this was the regrettable fact that the physical infrastructure in all East European countries have been in undeniably poor shape. In consequence of poor physical infrastructure foreign investors have given priority to those parts of East European countries that were closer to their homeland, to the heart of Europe. The traditionally more developed western parts of “Visegrad” countries have proved much more successful in attracting foreign companies. An other major characteristic of regional distribution has been marked concentration of foreign companies in he capitals of CEE countries. Thus foreign direct investments have markedly contributed to the increasing regional disparity in all transforming East European countries.

For example, in Hungary at the end of 1991 almost two-thirds of foreign companies, both in terms of numbers and capitalization were located in Budapest or in the neighbourhood of Budapest. By the end of 1993 the share of Budapest and its region has dwindled to a certain extent, but at that time still it has had the biggest share in FDI by locating approximately the half of foreign capital invested in Hungary. Furthermore, in general it can be stated that in the western part of the country much more foreign company can be found than in the less developed eastern and southern part. (As a matter of fact up to 1991 southern Hungary was pretty successful in attracting foreign investors but the escalation of the civil war in Yugoslavia disastrously hit that part of Hungary – not only in this aspect.) The unambiguous regional disparity of FDI can be seen in comparing related data from different counties of Hungary. At the end of 1993 in terms of FDI per capita figures of Gyôr-Sopron-Moson, Vas and Zala counties were 9–10 times higher than figures of Szabolcs-Szatmár and Békés counties.

However, the most serious disparity in the regional distribution of foreign direct investments can be found in the new Slovak Republic. In mid-1993 as a clear sign of the most pronounced concentration in terms of capitalization Pozsony and its region accounted for more than 70% of foreign investments. Pozsony’s share in FDI was alone 56%. Besides Pozsony and its region sizeable amount of foreign capital have been invested in Poprád, Nyitra and Rozsnyó. The cumulative share of the above-mentioned territories in FDI reached 85%.

So the picture is rather complex and shadowy. This means that it would be premature to state that foreign direct investment plays decisive and absolutely positive role in the modernization process of East European countries.

The countries of Eastern Europe were situated in the whole of their history in the buffer zone of larger political and military powers. Their whole past is characterized by discontinuities and instabilities. Only in the XX. century countries of this region were forced to change four times their political and economic orientation, system, their model of growth and development. The position of each individual nation changed dramatically during the last century, ancient countries were dismembered or partitioned, new states were created inhabited by several nations, ethnic groups are currently being oppressed were in dominating position in the past.

After the First World War countries of Eastern Europe were created in the name of self-determination and in the name of ethnic principle. Unfortunately these principles were implemented in rather voluntarist way. The right for self-determination and the ethnic principle in many cases were ignored thus newly created states were inhabited by several nations and – to make matters worse – were full of animosity.

The defective peace settlement (with the exception of Poland) was reinforced after the Second World War and the Soviet hegemony oppressed ethnic tensions in the region. However, these ethnic tensions, came to the fore again when the power of the Soviet Union began to erode and after the collapse of the Soviet-type state-socialist political and economic system it became one of the most serious problems in Eastern Europe.

Relationship between ethnic groups is burdened with a very sad inheritance from the Soviet period as during the last 40 years national minorities had to suffer from intensifying feelings of relative deprivation. Nationalist-communist leaderships implemented preferential policies intended to benefit their own majority people at the expense of national minorities. They initiated and carried out uneven development across sectors and regions. Regions populated by majority people were favorized while territories populated by minority ethnic groups were frequently neglected. Within the framework of the so-called socialist industrialization nationalist-communist authorities made strenuous efforts to change the ethnic make-up of minority populated areas. At first they deprived these territories of all kinds of development thus forced out the massive emigration or relocation of minority people and after a decade they carried out huge investments some minority areas combined with the large-scale settlement of majority people.

The drastic and artifical change of ethnic make-up can be very clearly seen in Transylvania where the former capital of the province Kolozsvár (r. Cluj-Napoca) had absolute Hungarian majority (about two-thirds of population) in 1956 and at that time such important centres of Hungarian culture and history as Nagyvárad (r. Oradea and Szatmárnémeti (r. Satu Mare) had absolute Hungarian majority too. All towns in the land of the Sekels were populated almost exclusively by Hungarians. However, in consequence of the large-scale Rumanian settlement (mainly from Oltenia) by 1990 only one fourth of Kolozsvár’s population remained Hungarian. (It is worth mentioning that only in 1989 ten thousand Rumanians were settled down in the city.)

By the 1980s Nagyvárad and Szatmárnémeti have also lost their Hungarian majority but the percentage of Hungarians has remained higher than in Kolozsvár. Towns in the land of the Sekels were flooded by Rumanians too. In the eighties the Rumanian authorities settled down more than 20 thousand Rumanians in Marosvásárhely (r. Tirgu Mures) and about 8 thousand Moldavians in Csíkszereda (r. Miercurea Ciuc). Nevertheless, thanks to their stronger ethnic background towns of the land of the Sekels so far have succeeded in preserving their convincing (65–75%) Hungarian majority with the exception of Marosvásárhely where the Hungarian majority is significantly less.

There have been the same developments in Slovakia since the Slovak authorities made and make every effort to eliminate the clear absolute Hungarian majority along the existing Hungarian–Slovak frontier. (More than one fifth of Slovakias territory approximately 11 500 km2 is populated by Hungarians who compose absolute (in many cases more than 80%) majority in 432 settlement.) For example, one of the most important Hungarian centres in Slovakia, Komárom (slov. Komarno) was inhabitad by more than 90% with Hungarians after 1945 but according to the 1991 population census the share of the Slovaks increased above one-third.

Building a new nuclear power station in Mohi (slov. Mohovce) the about 8–10 kilometres to south by evacuating Mohi’s and three neighbouring villages’ population from the territory.

By the collapse of the Soviet-type state-socialist political and economic system the resources of this policy were exhausted but the situation of national minorities did not improved considerably because of worsening economic conditions. Under worsening economic circumstances political leaders are increasingly tempted to engage in nationalist appeals and to seek scapegoats for policy failures and unfulfilled promises. The more limited the leadership’s ability to solve complex social and economic problems, the greater the temptation to resort to nationalist appeals. There are convincing evidences that if ethnic majority support is needed to remain in power, contending political leaders stake out more and more extreme positions on ethnic issues as a way of proving their bona fides.

Economic misery plays an important role in ethnic conflicts of Eastern Europe. Nevertheless it would be a grave mistake to say that ethnic turbulences in the region originate from the worsening economic situation. They go back to centuries and the defective peace settlements of the XX century did not help to moderate them. That is why it would be foolish to say that economic development, the improvement of economic situation would inevitably eliminate the potential for ethnic conflicts, but hopefully it may considerably reduce the danger of violent conflicts. The split of Czechoslovakia convincingly shows that economic rationale must not be absolutized.

As a matter of fact after 1948 Slovakia was undoubtedly the beneficiary of the cohabitation with the Czechs. The Slovak economy grew more rapidly than the Czech economy. Between 1948 and 1989 republic income in the Slovak republic increased more than 11 times whereas in the Czech republic the increase was only 6 times. Especially in industry the development was very dynamic. While in the Czech part industrial output increased 12 times, in Slovakia the figure was nearly 33 times. Agriculture grew more rapidly as well. As a result, the levels of economic development in Slovakia and the Czech lands gradually were equalised, and by the end of the 1980s the gap had nearly disappeared. For a number of indicators Slovakia matched the Czech lands, and in some cases it even surpassed the Czech levels. (For example, the average wage at the end of the 1980s was 99,1% of the level in the Czech Republic, and the number of university students per 1000 inhabitants 105,7%.)

The rapid development of the Slovak economy was based on a higher rate of investment in Slovakia than in the Czech part. During the whole post-war period the share of gross investment in republic income in Slovakia significantly exceeded the corresponding figure in the Czech Republic. Between 1948 and 1989 the volume of investment in Slovakia increased nearly 18 times, while in the Czech lands it rose only 15 times. As a result, the amount of fixed capital grew more rapidly in Slovakia, and this capital had a more favourable age structure. Several new industries were built in Slovakia, and these industries became important suppliers of many industrial products.

The difference in the rate of investment between the two republics was associated with a redistribution of income from the Czech lands to Slovakia. The transferred amount is estimated approximately 15% of Slovak republic income in the 1950s, and between 5% and 7% of that republic income in the 1980s. Thus one Slovak generation has seen Slovakia change from a less developed agrarian country to an industrial economy, a process which was accompanied by a spectacular growth in standard of living – and all this was not enough to maintain the cohabitatition with the Czech, all benefits were outweighed by the desire for independence.

However, the importance of economic factors should not be underestimated. It can be seen on the disappointing example of Subcarpathia’s Hungarian minority.

The Hungarian community in Subcarpathia was treated with extreme harshness by Soviet invaders, it suffered very much from the severe Soviet collective punishment. In post-war conditions it was practically impossible for Hungary to take any step to improve ethnic Hungarian’s situation in the Soviet Union. Only at the end of the 1980s, the Gorbachev-era made it possible to achieve substantial improvement in this field. (But even in the late 1980s, only 7% of party members and 3% of the staff of public administration were constituted by Hungarians, while their percentage in Subcarpathia’s population has constantly been about 14–15%.)

In the independent Ukraine the political and cultural situation of Subcarpathian Hungarians considerably improved. There were remarkable achievements in developing the Hungarian educational system. In addition, Hungarian history is once again being thought in all Hungarian schools, which is not the case in other countries bordering Hungary with Hungarian minorities. In Subcarpathia bilingual (Ukrainian and Hungarian) place and street names have been introduced, streets and squares have been renamed, and scores of monuments and plaques to famous Hungarians have been erected. The celebration of Hungarian national holidays has been authorized, as has the Hungarian flag and national anthem and the use of the name Subcarpathia.

Unfortunately, all these favourable developments are increasingly overshadowed by the desperate economic situation in Subcarpathia. Living conditions – compared with Hungary – are extremely poor. That is why there is a growing tendency among Subcarpathian Hungarians to emigrate from their homeland before the increasing poverty and uncertainty. The most regrettable phenomenon is the massive emigration of intellectuals, which in longer run can be disastrous for those who remain loyal their homeland.

After the First World War two ethnically rather heterogeneous states, Czechoslovakia and Yugoslavia were created in the region between Germany and the Soviet Union. In the second Great European crisis both of them fell into pieces, but they took the winner side thus after the Second World War they were recreated. Their viability, however, has not increased so the collapse of the Yalta System has put their break up again on the agenda. The split of Czechoslovakia was carried out in a peaceful way but the break-up of Yugoslavia led to carnage. This part of the study tries to summarise the situation in three ex-Yugoslav republics (Slovenia, Croatia, Macedonia) and in the successor states of the former Czechoslovakia.

The national question, seen most of all in disagreement about the competencies of the federation versus the republics, and compounded by the emergence of the aggressive Milosevic regime in Serbia, brought about the break-up of Yugoslavia. Resentments about the Federal Fund for Less Developed regions, disputes over stabilization policy, tariffs and wages brought out intensive rivalry among Yugoslav republics and their constituent nationalities. Yugoslavia’s macroeconomic instability and falling living standards in the eighties made it clear that the existing political arrangements were inadequate for the tasks of economic management.

At the end of the eighties the creditability of the Yugoslav Economic policy seriously eroded, the large budget deficit and the extensive price indexation of wages resulted in hyper-inflation. The shock therapy stabilization programme of late 1989, which was introduced by the former Yugoslav government with a fixed exchange rate, a tight monetary policy and wage controls having been the pillars. After the initial success, the programme failed completely. The main reasons for the failure were the initial overvaluation of the dinar, inconsistency going back to the fact that the programme was left without consistent built-in nominal anchors, the weakness of wage controls and monetary overhang. Policy-makers started to pump money into the system and to increase wage levels. Consequently, the severe monetary restrictions were not able to counterbalance the increase in private and public spending thus price stability became unsustainable. All these failures ended in a deep recession without deflation. The restrictive practice of the former Yugoslav monetary policy collapsed in 1990. The mistakes of the National Bank of Yugoslavia resulted in a high dinar liquidity in the former Yugoslav banks. It can be stated without exaggeration that the collapse of the economic reform was one of the main reasons for the break up of Yugoslavia.

In the former Yugoslavia redistribution of income was implemented directly through the preferential allocation of credit to key industries such as socialised agriculture, exported to the CMEA, and the Yugoslav National Army. These flows were substantial, helping enterprises with negative value-added before subsidies to continue to pay wages and compressing the overall distribution of income between enterprises. The flows were based toward the less developed regions, enterprises in these republics received far higher redistributive subsidies than enterprises in the more developed regions. Nevertheless, it must bae emphasised that the coalition for easy money was not formed only on regional lines. Within each region there were strong forces advocating easy money but they were much stronger in the less developed republics. Monetary policy was highly politicised in Yugoslavia. The National Bank of Yugoslavia had a governing board, a majority could usually be put together by the three less developed republics (Crena Goa, Macedonia, Bosnia-Hercegovina) with the support of Serbia. The two more developed republics, Slovenia and Croatia, either joined the easy-money majority or were outvoted.

To make matters worse fiscal consolidation was extremely difficult in the former Yugoslav system. Voting rules in the parliament required consensus among the delegations representing the republics, however, in distributional contests over fiscal restraint, consensus proved impossible. Officially, the federal government ran no budget deficit at all, but in reality there were massive para-fiscal deficits, such as the central bank’s assumption of banks’ foreign exchange rate losses and deficits in the supposedly non-governmental Communities of Interest for Health-Care and Education.

Beside the above-mentioned elements the most important institutional impediment to stabilization was the very regrettable fact that the Yugoslav system lacked effective mechanisms for restraining nominal wage increases. Both the system of self-management, which gave workers the right to vote on income distribution, and the evasive subsidisation of enterprises, undermined any possibility of wage restraint.

After the secession the newly independent Slovenia had to face with the shocks of triple transition-the transition to an independent state, the transition to a market economy and the reorientation from former Yugoslav to international markets. In the process of its transformation to market economy Slovenia had to suffered declining industrial production and a rise in unemployment, however, at the same time it achieved remarkable successes in stabilizing its economy.

Slovenia, introducing it own currency, has become an economically independent state from October 8, 1991. Although Slovenia has established limited sovereignty in its fiscal and foreign exchange system long before the formal proclamation of independence, the possibilities for keeping track of its monetary aggregates were limited. A separate monetary system was the final step towards its full economic independence.

The main elements of the Slovene stabilization were as follows: Firstly, the defeat of soft money forces, embodied in the passage of the Bank of Slovenia law granting the central bank independence. Secondly, the fiscal consolidation, facilitated by renouncing obligations to the Yugoslav federal budget (such contributions were 5,15% of GDP in 1990, only 0,71% in 1991, and zero in 1992 and later) and the greater ease of producing a decisive parliamentary majority compared with the former Yugoslav period. Thirdly, the success of stabilization has been attributed to a great degree of wage restraint, which has been the product of social consensus in the time of national emergency.

The Bank of Slovenia could claim a considerable success, not only in reducing inflation, but also in setting up a new relationship between the bank, government and important borrowers. With its new-founded independence the Bank of Slovenia was able to implement a tight monetary policy. The establishment of an independent central bank meant the complete defeat of easy-money forces of Slovenia. The deficit of easy-money forces went back to the following developments: First of all, the electoral victory of non-communist forces in 1990 brought to government a new group determined to transform the institutions of the old regime. The withdrawal of the Yugoslav National Army (YNA) from Slovene territory, and the loss of YNA as a market, left army-related industries without their main political protector. (The needs of the new Slovene Territorial Defence Forces were far too modest to support Slovenia’s military-industrial complex.) At the same time, opposition from large-scale, loss-making enterprises was neutralised by the decision to avoid bankruptcies and subsidise losses through the budget. (This decision was taken in 1991 in view of the war situation and potential social disruption caused by bankruptcies.) An other important fact was that socialised agriculture, which played powerful role in advocating soft money, had a relatively weak position in the industrialized Slovene economy. Finally, Slovene leaders realised that the country’s only economic hope lay in integration with Europe, which could only be achieved with a strong currency and low inflation.

Incomes policy also played a key role in the stabilization effort. The drastic decrease of net personal income choked off domestic demand and eased cost pressures dramatically. Real wages reached their minimum level in February 1992. By December 1993 real wages had risen 49,8% from their February 1992 low, but real wages remained some 35% below their previous peak in 1989. Nevertheless wage setting in Slovenia has been highly politicised which means that with the ease of emergency situation it would be rather difficult to establish an adequate employer-employee bargaining framework and a more effective labour-government relationship.

After the difficult 1990–92 period the growth performance of the Slovene economy considerably improved. Following a 5,4% decrease in 1992 Slovenia’s GDP increased,3% in 1993 and since then growth performance improved, the Slovene economy grew by 5,5% in 1994 and approximately 4% in 1995. Unemployment is still rather high (about 14%). The most outstanding result has been achieved in curbing inflation. (The rate of inflation was more that 200% in 1992, 32,2% in 1993, 19,8% in 1994 and 12,6% in 1995.)

The second most developed republic of the former Yugoslavia, Croatia has to struggle with extremely difficult economic situation, owing to the Wars of Yugoslav Secession and the refugee crisis. (Some 40% of Croatia’s pre-war territory was occupied till August 1995 and more than 600 thousand refugees streamed in. Consequently, estimates were that Croatia’s output was about half of its 1990 level in mid-1993.

Under such desperate circumstances the Croatian government adopted a comprehensive macroeconomic stabilization and reform programme. A new law on the Bank of Croatia was passed which greatly increased the independence of the bank. (The law limited loans to the government to bridging loans repayable within the fiscal year. Such loans could not account for more than 5% of the government budget.) Economic stabilisation has been continuing since then, throughout 1994 and 1995, in spite of the war intervening in August 1995. The Croatian stabilisation programme has actually exceeded expectations in the firs place in view of inflation. The rate of inflation was 1501% in 1993, it fell to 97,4% in 1994 and in the first ten months of 1995 it amounted to only a mere 3%. The curbing of inflation was accompanied with a substantial improvement in growth performance of the economy. GDP started to increase in 1994 and has continued in 1995. In fiscal policy a new tax system was put into place on 1 January 1994. The new system expanded the tax base, profit and turnover taxes were made uniform. Late 1994 was only O,3% of GDP, and is projected to stay at a low level for 1995. The October 1993 stabilization programme relied heavily on wage restraint. Payments and compensation were rather limited lagging well behind the inflation. In 1994 targets were even more restrictive which eased cost pressures dramatically. To accelerate the transformation to market economy the Croatian government payed special attention to setting up market institutions. In accordance with the aim to speed up privatization a ministry for privatization and state holding management has recently been formed. VAT is planned to be introduced at the beginning of 1997.

The independent Macedonia has been in very difficult conditions. Its economy had much closer links with Serbia that either Slovenia or Croatia had. The country’s situation is aggravated by the active hostility of the neighbouring Greece. On top of that, there has been a more or less intense but permanent tension between the majority Slav population and the numerous Albanian minority, which makes up at least one fourth of the population. In addition, Macedonia was a net recipient of subsidies in the ex-Yugoslavia, it had to face an enormous negative fiscal losses after the break-up of the Yugoslav Federation.

In this highly unfavourable situation Macedonia has achieved a remarkable degree of stabilization. The withdrawal of the Yugoslav National Army and the imperative need to gain the confidence of the international lending community ere the main motive forces in the establishment of an independent central bank in 1991. In April 1992 Macedonia introduced its new currency. The creation of the national currency, the denar gave the central bank to opportunity to implement tight monetary policy, which was crucial to the stabilization effort. Political leaders have been willing to cut public consumption. The first stabilization package aimed at reducing public consumption from 38% to 35% of GDP. This was achieved mainly by eliminating subsidies. (However, the fiscal shock of separation coupled with the de facto Greek embargo has remained enormous.) Within the framework of a heterodox approach to stabilization income policy had a very important role. The most significant step in income policy was the law, passed in December 1993. It limited benefits and payments in kind for social sector enterprises, keeping wage growth 1,5% below inflation up to the monthly target in the economic sector. So far this law has held up.

Consequently, Macedonia has proved successful in creating its own national identity and it has been able to maintain higher living standards than other ex-Yugoslav republics except Slovenia, and also neighbouring Albania. In addition, while Slaw -Albanian relations are difficult, the participation of Albanian ministers in the present Macedonian government and the decision to open an Albanian faculty at Skopje University are very important positive steps.

The example of the three Yugoslav successor states has convincingly shown that a more homogenous society and political identity can achieve more coherent policy outcomes and it can prove much more effective in tackling delicate political and economic issues than an artificially created federal state with greatly different endowments. This is the most evident in the Sloven case, but even Macedonia has also proved remarkably viable in spite of its very unfavourable conditions.

1. The Czech Republic

The split of Czechoslovakia was undoubtedly beneficial for the Czech Republic. The Czech got rid of subsidizing Slovakia which provides further additional sources for economic development amounting to at least 2–2,5% of GDP. From 1993 the real output has gradually been improving. After 1994’s 2,6% real growth, in 1995 it is expected to reach 4%. In terms of internal balance indicators the Czech Republic has unique position among all the transforming countries. The Czech government managed to keep the budget in surplus. The government expenditure as a percentage in GDP is slowly declining, it stood 49% in 1994 and from data available on 1995 it can be inferred that it has further declined. Unemployment is unprecedently low, the rate of unemployment was only 3% in 1995. (However, in view of changes in production this remarkably low unemployment rate hides increasing efficiency problems, worsening international competitiveness.) The growth rate of private consumption has regularly been above GDP growth rate, while the index of industrial production has remained under it too.

Both export and imports have been expanding very dynamically, though the expansion of exports has slowed down. The trade balance up to 1995 had been almost balanced, this year brought a substantial deterioration in foreign trade. Trade balance is expected to show an almost $ 3 bn deficit for 1995. The rapidly increasing trade deficit of 1995 was largely attributed to the real appreciation of the Czech currency and the weak international competitiveness in terms of productivity. Thanks to previously balanced foreign turnover and favourable records of the former communist period (at least in the respect) the foreign indebtedness of the Czech Republic was quite low. The international debt of the Czech Republic only in 1995 exceeded $ 10 bn, but at the same time foreign exchange reserves have broken the $ 10 bn level. Thus there is no need for worrying about foreign indebtedness – at least so far.

2. Slovakia

The newly independent Slovakia is much worse equipped for transition than the Czech Republic. Nevertheless, in a wider comparison of transition economies Slovakia’s position is not so weak or unfavourable for example, its very low rate of foreign indebtedness give it a head start over the other countries in East Central Europe. As a result of internal and external shocks Slovaka’s real GDP declined by 25,6% in the 1990–93 period, mainly in consequence of its heavily distorted economic structure dominated by huge heavy-industry complexes.

Since the beginning of 1993 the Slovak Republic on the whole has achieved good results. In 1994 growth performance significantly improved, following five years of continuous decline GDP increased by nearly 5%. According to economic forecasts the rate of growth may reach 6,6% in 1995. In spite of improving macroeconomic performance unemployment has still remained rather high (13–14%) with serious regional disparities. (Traditionally the lowest rate of unemployment can be found in the capital (4–5%), while in the district of Rimaszombat (slov. Rimavska Sobota) unemployment was 26,4% in 1994.) Beside unemployment there are also a number of drawbacks: The lack of experts accustomed to running a state administration has caused a number of false expectations and estimated, in particular concerning government revenues. The budget deficit is continuously 5–6% of GDP causing serious difficulties. (It is worth mentioning that the budget deficit is approximately similar in size to estimates of resource transfers from the Czech Republic to Slovakia and this fact considerably worsened the country’s position.) Capital flight is also a serious problem. Substantial savings that could be used for internal investments are flowing abroad aggravating further the chronic lack of capital.

Transforming countries of Eastern Europe are forced to face with extremely difficult situation. This part of Europe has never been homogenous but in consequence of the 40 years of Soviet rule nowadays East European countries – irrespective of differences in the preparedness for the change – struggle with basically with the same challenges. The collapse of the Soviet-type state-socialist economic and political model caused double destruction to them. On the one hand they have to implement the complete overhaul of their economic system. On the other hand at the same time they are forced to face with the almost total collapse of their traditional foreign economic relations. Not surprisingly this process is accompanied with intensifying disequilibrium problems both in external and internal terms. Thus not only their past but their present and foreseeable future are characterized by discontinuities and instabilities.

In the early 1990s, after the collapse of the state socialist system they returned to the market economy, burdened with a sad inheritance, looking for their role in Europe, amidst an instable world political situation, a recessionist or in the best care sluggish economic environment, under changing world economic power relations.

The transition from the state-socialist model to the market economy is inevitably a forceful creative destruction. But the major problem is that destruction is abrupt and forceful, whereas creation is tentative, slow and gradual. Thus people in the region suffer from dramatic worsening of their living condition. Under worsening economic circumstances political leaders are increasingly tempted to engage in nationalist appeals and to seek scapegoats for policy failures and unfulfilled promises. The more limited the leadership’s ability to solve complex social and economic problems, the greater the temptation to resort to nationalist appeals. There are convincing evidences that if ethnic majority support is needed to remain in power, contending political leaders stake out more and more extreme positions on ethnic issues as a way of proving their bona fides.

Economic misery plays an important role in ethnic conflicts of Eastern Europe. Nevertheless it would be a grave mistake to say that ethnic turbulences in the region originate from the worsening economic situation. They go back to centuries and the defective peace settlements of the XX century did not help to moderate them. That is why it would be foolish to say that economic development, the improvement of economic situation would inevitably eliminate the potential for ethnic conflicts, but hopefully it may considerably reduce the danger of violent conflicts.

It is still an open question how the individual countries will find the path leading out of their serious economic situation and whether they are able at all to solve the basic problems of transition within a democratic political framework, maintaining political stability. There is no government in the area with and idea about what kind of market economy will arise in its country.