After socialism and dirigisme : which way?

The author identifies fundamental economic changes in the last 20 years that have influenced the emergence of a new paradigm on economic reform. The new orthodoxy on economic reform emphasizes smaller government, trade liberalization, business deregulation and privatization, macroeconomic austerity, and the role of free markets for resource allocation and growth. After describing diverse country experiences in economic reform, the author summarizes his findings on key aspects of the design of economic reform programs. Shock treatment (as opposed to the gradual approach) requires a strong government with broad social support, as the costs of the policies are paid upfront and the benefits may take time to accrue. If the program involves protracted social hardship, political support will begin to evaporate and pressure will build for a reversal of reform. Important choices must be made about the sequence of macroeconomic adjustment and consolidation and structural reform. Implementing tax reform and converting quotas to tariffs improve the fiscal budget, so they contribute to macroeconomic stabilization. But premature financial liberalization, before the budget is balanced and real interest rates are at a reasonable level, may lead to financial crisis, as happened in Chile in 1982-83. Massive privatization of large-scale firms can have both stabilizing and destabilizing macroeconomic effects, for example. If it means getting rid of loss-making public enterprises, it could save scarce government resources. But if the resulting output and unemployment costs are socially unsustainable, pressure may mount for the government to come to the enterprises'rescue. The shift from an economy with controlled prices to one in which most prices are market-determined generally involves a big hike in price levels. Chile and Mexico illustrate the stubbornness of the inflation that may follow. China, Korea, and Chile represent countries that carried out economic reform under authoritarian governments that postponed political reform to gain political legitimacy from the fruits of consolidated economic reform. In countries where economic and political reform are pursued simultaneously (as in Eastern Europe and Russia), fragile democracies with a fragmented party system and weak social institutions and governments do not provide the most favorable political environment for implementing and consolidating complex and painful economic reforms. Under these conditions, governments are bound to face the dilemma of either postponing economic reform to avert a political crisis or to backslide in democratization to apply painful economic policies - both unsavory choices.