standards of living there fell far short of those in the vibrant West. The
irony was that East Germany's GDP estimates did not seem out of line. The
narrow spread between West and East German standards of living appeared
the result of West Germany's understating its progress. Each country, for
example, counted the number of cars it produced. But West German statistics
did not fully capture the quality difference between a 1950 Mercedes,
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say, and one assembled in 1988. Meanwhile, the design of the Trabant, the
boxy, pollution-belching East German sedan, hadn't changed in thirty years.
So the quality-adjusted production gap between the two economies was
almost certainly greater than generally thought.
The fall of the wall exposed a degree of economic decay so devastating
that it astonished even the skeptics. The East German workforce, it turned
out, had little more than one-third the productivity of its western counterpart,
nothing like 75 percent to 85 percent. The same applied to the population's
standard of living. East German factories produced such shoddy
goods, and East German services were so carelessly managed, that modernizing
was going to cost hundreds of billions of dollars. At least 40 percent
of East German businesses were judged so hopelessly obsolete that they
would have to close; most of the rest would need years of propping up to
be able to compete. Millions of people were losing their jobs. Those people
would need retraining and new work, or else they were likely to join the
throngs migrating west. The extent of the devastation behind the iron curtain
had been a very well kept secret, but now the secret was out.
At least East Germans could look to the West Germans for help. The
other nations of the Soviet bloc all were suffering the same blight or worse,
yet they had to fend for themselves. Poland's great reformer, Leszek Balcerowicz,
was taking a page from the book of another great economic reformer,
Ludwig Erhard. The economics director of West Germany under
the Allied occupation in 1948, Erhard sparked the revival of the devastated
economy by abruptly declaring the end of price and production controls.
Erhard arguably overstepped his authority doing this, but he made the announcement
on a weekend, and prices had completely changed by the time
the occupation administration could react. The gambit worked. To the
amazement of critics, West Germany's stores, which had been gripped by
chronic shortages of food and merchandise, quickly flooded with goods,
and its notorious black markets dried up. At first prices were exorbitant,
but they declined as additional supply overwhelmed demand.
A Western-educated economics professor from central Poland, Balcerowicz
followed Erhard's example to propose what he called a market revolution.
Everybody else called it shock therapy. When Solidarity won the
Polish election in August 1989, the economy was on the verge of collapse.
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There were food shortages in the stores, hyperinflation was destroying the
value of people's money, and the government was bankrupt and couldn't
pay its debts. At Balcerowicz's urging, the new government designated January
1; 1990; as the day of the "big bang/' when virtually all price controls
would cease. I met him for the first time at an international banking meeting
in Basel, Switzerland, a few weeks before the event, and he astonished
me by saying he did not know whether the strategy would work. But, he
said, "you cannot reform by small steps." He was convinced that in a society
where the government had dictated every aspect of buying and selling for
four decades, there was no such thing as a smooth transition from central
planning to competitive markets. Drastic action was required to spur people
to start making their own decisions and, as he put it, to be convinced
that change was inevitable.
His big bang, predictably, brought tremendous upheaval. Just as had
happened in Erhard's Germany, prices initially leaped up—the zloty lost
almost half its purchasing power in the first two weeks. But more goods
appeared in the stores, and gradually prices evened out. Balcerowicz had
people constantly checking the shops, and as he later recalled, "It was a very
important day when they said, 'The price of eggs is falling.' There was no
more eloquent sign that the shift to a free market had begun to work.
Poland's success encouraged Czechoslovakia to try an even bolder reform.
Vaclav Klaus, the economics minister, wanted to turn state-owned
enterprises over to the private sector. Instead of trying to auction them off
to investor groups—no one in Czechoslovakia had much ready cash—he
proposed to distribute ownership to the entire population in the form of
vouchers. Each citizen would receive an equal allotment of vouchers, which
could be traded or sold or exchanged for stock in a state-owned enterprise.
In this way, Klaus wanted not only to bring about "the radical transformation
of property rights" but also to lay the groundwork for a stock market.
Klaus talked about this and many other ambitious plans in a lunchtime
presentation at a Fed conference at Jackson Hole, Wyoming, in August
1990. A square-built man with a brushy mustache, he was fierce about the
urgency of reform. "Losing time means losing everything," he told us. "We
have to act rapidly because gradual reform provides a convenient excuse to
the vested interests, to monopolists of all kinds, to all beneficiaries of pater
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nalistic socialism, to change nothing at all." This sounded so fiery and uncompromising
that when we opened the floor for questions, I brought up
the impact of the reforms on people's jobs. "Are you contemplating providing
some kind of social safety net for the unemployed?" I asked. Klaus cut
me short. "In your country you can afford such luxuries/' he said. "To succeed
we need a clean break with the past. The competitive market is the
way to produce wealth, and that's where we're going to focus." He and I
became good friends, but this was the first time in my life that I had ever
been rebuked for not sufficiently appreciating the power of free markets. It
was a singular experience for an admirer of Ayn Rand.
A
A
s the Eastern European countries raced ahead with reform, the instability
in Moscow only seemed to worsen. It was hard from the West
even to determine what was going on. Just a week after being elected president
of the Russian Republic in June 1991, Boris Yeltsin visited New York
and spoke at the New York Fed. Yeltsin had gotten his start as a construction
industry boss and had been Moscow's mayor in the 1980s; then he'd
quit the Communist Party to take up the cause of radical reform. His election
with a nationwide majority of 60 percent was a crushing defeat for Communism.
Though he was subordinate to Gorbachev, his popularity coupled
with his impetuousness made him a magnet for attention—like Khrushchev
in an earlier era, he seemed to personify his country's unnerving contradictions.
His first trip to the United States in 1989 had been a disaster—people
remembered mostly the news reports of his behaving erratically and getting
drunk on Jack Daniel's.
Gerald Corrigan, the president of the New York Fed, had taken the
lead in encouraging Wall Street to connect with the Soviet reformers, something
the Bush administration wanted to see happen. So when Yeltsin came
to town, the New York Fed invited him to speak at a dinner of some fifty
bankers, financiers, and corporate chiefs. Yeltsin arrived with a large entourage,
and Corrigan and I talked with him briefly before he was introduced to
the assembled dinner guests. The Yeltsin we met that night was no drunken
buffoon; he seemed smart and determined. At the podium, he spoke co
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gently on reform for twenty minutes without notes and then answered detailed,
specific questions from the audience without calling on his advisers
for help.
It was increasingly unclear whether Gorbachev, or anyone, could end
the Communist regime without causing a complete collapse into violence.
After Gorbachev dissolved the Warsaw Pact in June and launched his plan
to reconstitute the USSR as a voluntary confederation of democratic states,
the resistance facing him became brutally apparent. In August a coup attempt
by Stalinist hard-liners almost brought him down—to many it was
only the inspired theatrics of Yeltsin, who climbed on a tank outside the
Soviet parliament, that enabled Gorbachev to survive.
The West started looking for ways to help. That was the reason Treasury
Secretary Nick Brady and I led a team to Moscow in September to
meet with Gorbachev and confer with his economic advisers. Our ostensible
mission was to assess what reforms were needed for the Soviet Union
to join the International Monetary Fund, but mainly we wanted to see for
ourselves what was going on.
From the perspective of the Fed and the Western world, in purely economic
terms the Soviet Union was not much of a concern. Its economy
wasn't that large; of course there were no reliable statistics, but experts estimated
its GDP to be about the same size as the United Kingdom's, or
about one-sixth the size of all Europe's. The iron curtain had kept it so isolated
that its share of world trade was small. So was the amount of debt it
owed Western nations, which might be subject to default if the government
collapsed. But none of this took into account nuclear warheads. We were all
acutely aware of the danger a Soviet collapse could pose to the world's stability
and safety.
For that reason alone, we were horrified by the picture that emerged
during our stay.
It was clear that the government was falling apart. The institutions of
central planning were all beginning to fail, and the well-being of the population
was threatened. Eduard Shevardnadze, who was then foreign minister,
told us of unrest in the Soviet republics along Russia's border—he said the
lives of the twenty-five million ethnic Russians living in those regions could
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be in jeopardy. Worse, he said, was the risk that Russia and Ukraine, which
both held weapons from the Soviet nuclear arsenal, might end up at odds.
The economic data, which were fragmentary at best, were equally
alarming. Inflation was out of control, with prices going up by anywhere
from 3 percent to 7 percent a week. This was because all of the central
mechanisms of production and distribution were breaking down, and more
and more money was chasing fewer and fewer goods. In an effort to keep
things moving at all, the government was flooding the economy with cash.
A Gorbachev aide told me, "The printing presses can't keep up. We are
printing rubles twenty-four hours a day."
Over all this hung the shadow of not being able to put food on the
shelves. There had been times in the past when the output of Ukraine had
made it famous as the breadbasket of the world. But while harvests were
still relatively bountiful, some of the crops had rotted in the fields because
there was no way to collect and distribute the produce and grain. Soviet
grain purchases from abroad were up to forty million tons a year. Bread
shortages were a sore point in the national memory—it was the Bread Riots
of 1917, when the old women of St. Petersburg rose up in rebellion, that
helped bring about the fall of the czar.
A separate conversation gave me a glimpse of how brittle this economy
was and how difficult it would be to change. Boris Nemtsov, a reformist
economist, confided, "Let me tell you about military cities," and rattled off
names I'd never heard of. Across the nation, Nemtsov explained, were at
least twenty cities, each of two million people or more, that had been built
around military plants. They were isolated and specialized and had no reason
to exist other than to serve the Soviet military. His point was clear:
ending the cold war, and shifting to a market economy, would leave entire
cities and millions of workers with little to do and no ready way to adapt.
The rigidity built into the Soviet economic system was far more extreme
than any we'd ever encountered in the West. Among the many worries was
that, in order to survive, these military workers, who included world-class
scientists and engineers and technicians, would eventually have to sell their
skills to rogue states.
There were more briefings, but the message was the same. When we
met with President Gorbachev, and he repeated his goal of making the
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nation "a major trading force in the world/' I admired his courage. But in
the margin of my notepad I jotted down, "USSR is a Greek tragedy waiting
to happen."
G
G
rigory Yavlinsky chief economist for Gorbachev's Council of Minis
ters, led a delegation in October 1991 to Thailand, where the World
Bank and International Monetary Fund were holding their annual meeting.
This was a truly historic moment: the first time Soviet officials had ever sat
down with the key economic policymakers of the capitalist world.
The Soviet Union had already been granted provisional status—formally
giving it access to IMF and World Bank advice, but not to loans. Yavlinsky
and his team came to argue that the confederation of remaining Soviet re
publics ought to be accorded full membership. The question of massive
Western loans was not immediately on the table—the Soviets insisted they
could manage the transition to a market economy themselves, and none of
the G7 nations was offering.
The discussions lasted two full days, and if I had to pick a word to describe
