Whither Comecon? Centrally Planned Economies Slowly Tackle Reform of Their Mutual Trade and Payments Arrangements Martin Schrenk

Whither Comecon? Centrally planned economies slowly tackle reform of their mutual trade and payments arrangements Martin Schrenk

ims; ithe Union of Soviet Socialist Republics members and with the rest of the world, and and Eastern Europe struggle with market- even from one year to the next. Nonetheless, oriented reform of their economies, one of the numbers suggest orders of magnitude the major unresolved issues is the shape—and that underscore the need for reformers in indeed, future—of Comecon, formally known Eastern European nations to still look East, as the Council for Mutual Economic Assis- despite temptations to increasingly look tance (CMEA). This institution has governed West. their regional trade and payments arrange- • In the mid-1980s, for example, CMEA's ments for the past 40 years. Founded in 1949, share of total world exports was only in the it now includes Bulgaria, Cuba, Czechoslova- order of 8 percent (throughout this article, kia, the German Democratic Republic, Hun- CMEA refers to the Soviet Union and the gary, Mongolia, Poland, Romania1, the Soviet Six). However, the concentration on intra- Union, and Vietnam. Yugoslavia is an associ- CMEA trade ranged from something less ate member, while a number of other than one half for Hungary and Poland to nearly countries maintain a looser "observer status." three quarters for Bulgaria and Czechoslova- The urgency of the matter should not be kia (see table), with the Soviet Union ranking underestimated. Mutual trade looms so large as the principal trade partner for every in the total trade of all members that ignoring member of the Six. the need for redesigning the institution would • Raw materials and fuels dominate the pose a serious threat to the success of deliveries of the Soviet Union to the Six, economic reforms. In addition, the central- whereas manufactures (particularly machin- ized nature of the existing framework runs ery and consumer goods) dominate the counter to the very thrust of the recent may well lead to a radical reform of the deliveries of the Six to the Soviet Union. moves for systemic reforms. Not surpris- CMEA, if not its demise. The present state ingly, therefore, reformers in Eastern Europe of indeterminancy thus offers unique opportu- How CMEA operates and the Soviet Union recently rejected the nities for crafting a new framework. But it Trade among the various CMEA mem- traditional CMEA-regime. In January 1990, also raises considerable risks unless the costs bers has traditionally been governed by a at a meeting of the CMEA Council in Bulgaria, and benefits of the options are carefully complex set of rules that have evolved since they took the first steps toward reforming the weighed. the late 1940s. They are unlike those of any institution, setting in motion a process that of the familiar concepts of regional economic Importance of trade patterns integration, such as customs unions, free Trying to get a clear picture of the trade trade areas, or common markets. flows between the Soviet Union and the Bilateral clearing. In essence, the This article is based on "The CMEA System of Trade and Payments: Today and Tomorrow," by the Eastern European CMEA members (known CMEA is a common set of rules for planning author, SPR Discussion Paper No. 5 (January as the Six) is a frustrating exercise, due to and implementing bilateral trade agreements, 1990). Copies are available from the Bank's Country divergent, and in part, diffuse statistical as well as settling bilateral transaction ac- Economics Department, Socialist Economies Re- conventions of coverage, pricing, and cur- counts. Bilateral trade is further broken down form Unit, 1818 H Street NW, Washington, DC rency conversion. Strict comparability of data into a number of sub-balances that must be 20433 USA. is impeded, both for trade between CMEA cleared independently of one another, in

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©International Monetary Fund. Not for Redistribution order to integrate trade into production One of the main problems with this trading losses. The prevailing view is that over the planning and reflect the varying degree of system is that domestic relative prices in one last two decades the terms of trade have on competitiveness of the traded goods in country—determined largely by distributional balance been highly unfavorable for the Soviet Western markets. A surplus in one sub- or political considerations rather than market Union—an outcome that is often interpreted balance cannot be used to settle a deficit in forces—interact with very different sets of as a "hidden subsidy." This has resulted in another. Similarly, surpluses with one coun- relative prices in other CMEA countries, as part from the commodity pattern of trade, try cannot be used to settle deficits with well as the competitive world market. The which shows the Soviet Union selling mostly others. As a result, the CMEA's common potential for large profits and losses resulting "hard" (easily exportable to the rest of the accounting currency—the "transferable ru- from noneconomic differences between rela- world) raw materials, including hydrocar- ble"—lacks both currency convertibility and tive price systems are neutralized through a bons, in exchange for mostly "soft" (essen- "commodity convertibility," along with other "price equalization" mechanism, which may tially uncompetitive by international stan- functions normally associated with money. deploy a variety of means (such as taxes and dards) manufactures. In addition, raw materi- This rigid framework means that govern- subsidies, differential exchange rates, etc.). als have tended to be "underpriced," while ments must plan the size and composition of In effect, this diverts all differences between manufactures have tended to be "over- mutual trade in great detail, closely monitor- domestic and converted border prices into the priced." ing actual activity to minimize the accumula- budget. These short-term gains for the Six, how- tion of unplanned imbalances. Actual transac- Macro-balances and exchange rates. ever, have exacerbated distortions of the tions are recorded and cleared through Under traditional central planning, from which price structures, fostering delusions of cost clearing accounts held with the International the CMEA regime has been derived, the competitiveness. Indeed, this has been a Bank for Economic Cooperation (IBEC) in external balance is maintained by govern- major force behind the growing structural Moscow, a subsidiary organ of the CMEA. ments controlling all transactions at the micro problems in a dynamic perspective. Bilateral As with any clearing system, currency level. Concern for ex post balances is treaties implemented under tight government reserves are not required. reinforced by the fact that unplanned sur- control have created supply monopo- Prices. Agreement on prices is explicitly pluses are highly undesirable for the creditor lies—especially if specialization agreements or implicitly included in the bilateral treaties. country, because the lack of currency or assign production to one of the countries—and The "Bucharest formula"—a 5-year moving commodity convertibility turns them into product development has been discouraged average of world market prices, converted involuntary trade credits. The main instru- when new and superior products disturbed through the official CMEA exchange rate into ments of control, therefore, are export and the agreed balances. In the end, the export transferable rubles—serves as the basis for import quotas and licenses, often down to the industries have been locked into an une- determining transfer prices. This formula, level of the firm. In this framework, the conomic output structure, and outmoded however, generates unambiguous reference exchange rate does not—and is not supposed product and process technologies, which have prices only for publicly quoted basic commodi- to—provide a market signal. increasingly made them uncompetitive by ties. For manufactures, however, product world market standards. As a result, the Six specifications rarely match, and, more often Impact of CMEA rules now face severe supply constraints when it than not, "external" price information is One of the most serious short-term comes to exporting to the world market, and, either arbitrary, of poor quality, or outdated. problems with the existing CMEA regime has making matters worse, there is a lack of The pricing rule thus operates essentially as been the impossibility of assessing gains from export marketing know-how and infrastruc- a starting position for bilateral haggling, with trade. Indeed, a long-running controversy ture. agreed transfer prices often differing substan- among Western analysts, as well as among Together, these physical, technological, tially both from the reference basis and trade negotiators of the CMEA countries, and institutional constraints have created a between pairs of countries. concerns the estimation of net gains and high degree of "structural dependency" of

1*ade flows for the CMEA {1988} (percent of total exports and imports

Exports Imports Developed Developed market market Six' USSR economies LDCs Rest? Six USSR economies LDCs Rest

Bulgaria 18.1 62.8 6.4 9.1 3.6 20.1 53.7 15.5 7.8 2.9 Czechoslovakia 29.9 43.1 16.3 4.7 6.0 32.3 40.3 18.6 3.5 5.3 German Dem. Rep. 26.1 34.8 29.9 3.6 5.6 25.3 36.8 31.8 2.7 3.4 Hungary 17.0 27.6 39.5 9.9 6.0 18.7 25.0 43.3 7.7 5.3 Poland 16.2 24.5 43.3 10.2 5.8 17.2 23.4 45.7 7.1 6.6 Romania 16.8 24.0 33.7 19.0 6.5 24.6 24.0 13.5 18.8 19.1 USSR 48.9 21.9 14.2 15.0 54.1 25.1 8.2 12.6

Sources: Based on official statistical yearbooks of the reporting countries and UN estimates. 1Six: Bulgaria, Czechoslovakia, Geman Democratic Republic, Hungary, Poland, and Romania. 2Rest: Rest of the world (predominantly Yugoslavia and China).

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©International Monetary Fund. Not for Redistribution large segments of industry, the main export the short run. The alternative—increased given the vastly diverse economic weight of sector for the Six. In the view of most borrowing in convertible currency to finance the members. The fact that a radically observers, this dependency is so severe that the import of current inputs from other reformed CMEA would necessitate all coun- it could not possibly be rectified overnight, sources—would also not be possible, given tries moving "in step" on unfamiliar, complex constraining their reform options for years the amounts involved, existing debt burdens, issues, such as a measure of coordination of to come. borrowing requirements for modernization, macroeconomic management and develop- and time necessary for effective restructur- Options for the future ment of a common external trade policy, ing. Free trade thus can at best serve as the makes a sufficient rate of progress exceed- At this stage, a comprehensive blueprint goal at the end of a long-term process of ingly implausible. for the future shape of the CMEA has yet to systemic and structural change. Reformed bilateralism. This seems to emerge. However, a number of changes are Furthermore, even if an immediate transi- narrow the range of options to some form of being discussed, all of which could become tion to free trade—associated with a radical reformed bilateralism, which would amount elements of a revised CMEA framework, contraction of CMEA transactions—were to a refined bilateral framework for trade and including complete autonomy of producing economically feasible, it might not be desir- payments between pairs of countries, cover- and receiving firms to conclude commercial able. There are presumably plenty of in- ing rules and procedures on which the two contracts on volumes and prices; the intro- stances in which long established exports to could agree. It would also capture the duction and gradual extension of limited the Soviet Union are in line with comparative growing practice of denominating some bilat- convertibility; an increased use of convertible advantage; the problem is rather that under eral transactions in convertible currency but currency as a unit of account and for settling the present CMEA rules and practices they short of settlement of claims through unre- aggregate (inter-country) balances; and the remain concealed. More important, by effec- stricted currency transfer. In principle, it creation of a limited equilibrium exchange rate tively terminating most exports of manufac- would be a transitional framework that would through the auctioning of foreign exchange tures from the Six to the Soviet Union, the aim at a gradual movement toward a free earned by exporting firms. But actual and existing trading links would be severed. This trade regime. The pace of transition and the proposed changes are frequently difficult to amputation could cripple the economies of the share of trade covered under each agreement distinguish, dates of introduction of an- Six. If and when they have to start competing could be determined by the parties involved. nounced changes are often unclear, and some with newcomers in the market of the Soviet Similarly, the relative size of trade covered proposals are evidently "trial balloons" or Union, their established trading links may be by each agreement could be changed over negotiating devices. Nonetheless, it is possi- their most precious competitive edge. time by mutual agreement—perhaps gradu- ble to identify a number of conceivable Radically reformed CMEA. The crea- ally scaling down from 100 percent to zero. configurations and evaluate their likelihood. tion of a radically altered multilateral CMEA, Ultimately the rationale for—and the ultimate Unchanged CMEA. The continued op- along the lines suggested by some reform- scope of—mutual relations would shift from eration of an unchanged CMEA, with each ers—essentially economic integration into a structural dependency to evident mutual gain, member maintaining its current level of "common market" comparable to what is and if such a regime ever did fully take hold, intra-CMEA trade, is receding quickly as a expected for the post-1992 European Com- it would constitute a de facto demise of the plausible outcome. The status quo has been munity—is unlikely to be politically feasible. CMEA as we now know it. rejected by all reforming countries, including The long history of acrimonious conflicts "Small CMEA." Recently, the creation the Soviet Union, because of efficiency within the CMEA, and its record of inability of a new regional trade and payments considerations and the realization that the to arrive at a consensus on common programs framework has been suggested for those traditional CMEA regime is not only alien to of actions, do not support the assumption countries among the Six that are opting for a a reformed economic system but could that political management of the CMEA would similar trajectory of system reform. The threaten the progress of system reform. be any easier in the future. It is difficult to institutional framework would be equivalent Virtually the only set of circumstances under imagine how an effective integration program to an extension of the concept of reformed which this possibility could emerge would be can be agreed upon and carried out on the bilateralism to more than two countries. a collapse of reform efforts in most CMEA basis of a unanimous decision of all members, Advocates point to the analogy of the gradual countries, accompanied by a reversal of the as required by the CMEA statutes. And it is opening of the post-war trade and payments opening of these economies to the world equally difficult to imagine a transition to a system of Western Europe within the frame- market. universally acceptable majority voting rule, work of the European Payments Union. The "Free trade" regime. Prompt and com- members of the EPU entered the transition plete integration into a multilateral trading process in 1950 virtually without currency system with full currency convertibility would reserves and with national regimes of narrow bring the embedded distortions and structural bilateralism lacking convertibility. But by dependencies immediately to the surface. Martin Schrenk 1958, when the EPU ceased to operate, they The immediate effect would be to reduce German, is a Bank consult- emerged with a multilateral regime with full CMEA trade to the small fraction that is ant on questions of eco- convertibility and sufficient currency re- currently traded in freely convertible cur- nomic system reforms in serves. The two cases are indeed similar in rency. The resulting trade contraction would Eastern Europe. From many important respects. However, they make it an unrealistic option for all of the Six, 1967 to 1987 he was a differ in one critical area—the institutional as they would need to quickly find a way to Senior Economist working conditions that govern the behavior of for the Bank on Yugoslavia, replace the CMEA sources of imports with Romania, Afghanistan, firms—making the outcome less than clear. alternative ones in the convertible currency China, Poland, and Hun- Political context area. Their structural supply constraints gary. make a diversion of exports to competitive An analysis of the economic gains and convertible currency markets impossible in costs associated with each of the options is

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©International Monetary Fund. Not for Redistribution beyond the scope of this article, but one can were to its economic advantage as well. difficult to imagine more than three compat- point to some relevant political and economic Apart from these obvious drawbacks, a ible countries (ruling out any future role for constraints. While the thinking about viable move toward reformed bilateralism offers at the German Democratic Republic), as the options is still very much in flux, and while the same time economic opportunities for the volume of mutual trade between prospective information on the positions of governments Six. The challenge is to progressively throw members would not be enough to create a is extremely vague, it appears at this juncture out the elements of the current CMEA- "critical mass." Second, several countries are that some form of "reformed bilateralism" is regime that make it so inefficient and already opening up their trade and payments the most likely outcome—followed by the inflexible, transforming it into a more advan- system and may not see sufficient grounds "small CMEA"—without a sharp dividing line tageous one for all participants. This would to adopt restrictive rules for a section of their between the two. involve building on the existing know-how and trade. Third, as bilateral relations with the In the case of reformed bilateralism, the trade with the Soviet Union to ensure Soviet Union would still continue, this option Soviet Union—given current trade flows and continued market access for the industries in would amount to the introduction of a third structural dependencies—would be the most which they enjoy a comparative advantage in trade and payment regime, creating additional important partner for every member of the expertise, contacts, goodwill, and proximity. rigidities and inefficiencies. Fourth, advocates Six. But as the Soviet Union can more easily A major unknown at this juncture, however, see this serving as a "core" for subsequent divert the bulk of its exports to Western is the direction and speed of further reform inclusion of the Soviet Union, but such an markets than can the Six, and as it does not of the Soviet Union. extension could recreate the conditions for depend on supplies from any single country As for the economic and political viability the conflicts that have often paralyzed the among the Six, while each of the Six is highly of the "small CMEA" option, the restriction CMEA and mitigate the prospects for a dependent upon the Soviet Union, it seems in membership could avoid the curse of the "radically reformed CMEA." to be in an inherently stronger bargaining present CMEA mechanism—the impossibil- In sum, the Eastern European countries position. Furthermore, as political detente ity of reaching a multilateral consensus on not only face formidable political and analytical chips away at the geopolitical rationale for the important matters. But the economic benefits challenges but they also must contend with a Soviet Union to maintain relations with the of setting up a new institutional framework unique—and often overlooked—set of chal- CMEA countries, it would be unrealistic to and supranational organization for such a lenges arising from the complex relations they expect it to "pick up the bill" for resolving the limited arrangement are not immediately have built up with one another over the past structural problems of the Six—unless this obvious for several reasons. First, it is 40 years. •

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