In the midst of a severe crisis provoked by separatist regions and Russian aggression, the president of Ukraine found time in 2015 to declare his allegiance to pro-market reforms, invoking the tenets of Thatcher and Reagan. In 2009, Georgia’s president exalted the ideas of Hayek, Friedman, and Rothbard while presenting his Act of Economic Freedom to parliament. After 50 years under socialism, leaders and ruling parties in Eastern Europe not only advocated for neoliberal policies but also acted on them. And many governments seem to have gone much farther than necessary, enacting extravagantly neoliberal policies that are rarely encountered even among Western members of the European Union. Why?
In their fine new book, Hilary Appel and Mitchell A. Orenstein highlight a central puzzle. Economic policy reforms are meant to be bitter pills—good for a country in the long term, but tough for voters in the short term. Given that reforms exact pain on voting publics, most governments do their best to avoid them. So why did all the postcommunist countries spend the better part of two decades rushing to adopt pro-market policies, going to occasionally exorbitant lengths to do so? Furthermore, governments are typically understood to have a short window of opportunity to enact open-market reforms, and yet Eastern European governments on both the left and the right spent the better part of 20 years in pursuit of economic liberalization. Now that we know that those countries have ended up in very different places on the political and economic spectrum, this question becomes even more puzzling.
Appel and Orenstein argue that investor perception helped drive those countries’ long stints with pro-market reforms. The fall of communism opened up what looked like vast possibilities for Western countries with capital surpluses to take advantage of the relatively cheap, high-skilled workforces in Eastern Europe. To that end, the authors say, postcommunist governments hastened to enact the gamut of market-friendly policies—at times even showy and untested ones, such as flat taxes, levels of central bank independence well above the norm, and exotic privatization schemes—in hopes of standing out.
These two authors are excellent stewards through this retrospective of the postcommunist transition process and the relevant literature, guiding us through the policy laboratories of Eastern European countries since the fall of the Berlin Wall. They bring decades of insightful scholarship into this tour through 25 years of policy making. The section discussing privatization illustrates their point nicely: unleashing the rights for state-owned enterprises was, perhaps more than any other reform, mandatory for nearly all of the postcommunist countries. Appel and Orenstein describe how governments of all stripes faced issues both of marketing and of substance. In the Czech Republic, for example, authorities rejected a proposed plan for employee buyouts because employee shared-ownership programs “sounded too communist” (p. 56).
We know from the recent financial crisis that even sophisticated investment firms rely on imperfect cues. But the authors’ theory of reform as competitive signaling to attract investment raises another puzzle. To use the language of the original economic models of signaling, it seems as though postcommunist countries hoped to end up in a separating equilibrium; that is, they hoped these reforms would set them apart from the crowd. But if all 28 countries ended up enacting very similar policy measures, the equilibrium should have been a pooling one, in which the supposed signals lose their meaning once too many countries send them. It could be the case that, even for countries hoping to attract investment, the cost of not undertaking the reforms was higher than that of undertaking them. If every country had jumped on the bandwagon of liberal policies, to avoid doing so would set a country apart in exactly the wrong way: it would look like a laggard compared with its market-friendly counterparts. This implies a different kind of race: one of keeping up rather than of pulling ahead. And it requires a closer examination of the pain that voters were willing to bear in exchange for promises of jobs and technology, which, in many cases, did not bear fruit.
It is also puzzling that greenfield investors were responsive to the reform hijinks that the authors describe. Chapter 4 details what the authors call “avant garde reforms,” in which the postcommunist countries served as a laboratory for many exotic reforms that had heretofore only been a twinkle in economists’ eyes. Why would outward direct investors be duped by these theatrics? Portfolio investors, who have incentives to follow the herd, have been shown to be responsive to heuristics and gimmickry (Julia Gray, “International Organization as a Seal of Approval: European Union Accession and Investor Risk,” American Journal of Political Science, 53 (4), 2009, and The Company States Keep: International Economic Organizations and Investor Perceptions; Sarah M. Brooks et al., “Categories, Creditworthiness, and Contagion: How Investors’ Shortcuts Affect Sovereign Debt Markets,” International Studies Quarterly, 59 (3), 2015). But investors who are looking to build an automotive plant cannot pull out their investment capital and relocate, as stock market investors can.
Integration with international organizations (IOs) also played an important role that merits further exploration. Membership in the EU and NATO held out the prospect not only of wealth but also a means of affirming a Western identity, which many countries viewed as being rightfully theirs (Frank Schimmelfennig, “The Community Trap: Liberal Norms, Rhetorical Action, and the Eastern Enlargement of the European Union,” International Organization, 55 (1), 2001; Milada Vachudova, Europe Undivided: Democracy, Leverage, and Integration after Communism, 2005). And in the 1990s, it seemed possible that even the Central Asian countries could one day claim a European birthright.
The authors note that IOs cannot tell the whole story. But because foreign investors and IOs wanted similar things, it is difficult to discern whom these policies were meant to please. Appel and Ornstein point out that the literature on international influence usually focuses on a single institution, and they are correct that international influences of all varieties— IO forces as well as bilateral ones, public along with private—should be taken into account in assessing the motivations of postcommunist governments.
This book takes a first step toward unraveling myriad simultaneous processes. In the 1990s, economic and political reform seemed inextricable. Because the single-party, closed-economy model had fallen, all the inverse components—democratic political institutions along with open economies—seemed part of the same basket. But as the authors discuss in their conclusion, we now know that democracy is optional. Investment continues to flow into “illiberal democracies” such as Hungary and Poland, even as their governments roll back political reforms and civil liberties.
With the murder of journalists in Bulgaria and Slovakia, the crackdowns on courts and civil liberties in Hungary and Poland, and rampant corruption in Romania, the news coming out of Eastern Europe is rarely heartening. And those are just the EU members. Farther east, Ukraine has somehow managed to tremble on the brink of collapse for nearly a decade; Russia has reinvigorated its campaign to undermine Western political structures. In this context, it seems quaint to remember the heady days of the 1990s and early 2000s, when Bulgaria and Slovakia enacted picture-perfect economic policies to enter the queue for EU enlargement; when many touted Hungary and Poland as model reformers for others to emulate; when Ukraine’s “Orange Revolution” triumphed over corrupt one-party rule; and when Medvedev’s Russia seemed set to embrace Western institutions. In the face of the changes since then, it is time to examine a new set of questions about the relationships among capital flows, economic policies, and political institutions. It will be the work of the next decade—requiring tools of analysis from comparative and international political economy, as well as from transition studies—to assess what went wrong and why.
