--.l..l.l.-“.-- “--- . . .-~---_--_-- l1 tiittvl St,aks Wnt~ra.1 Accounting Office GAO Report t,o the Chairmen, Committee on Foreign Relations, U.S. Senate, and Comtiittee on Foreign Affairs, House of Representatives EASTERN EUROPE Donor Assistance and Reform Efforts 142738 --- 8 National Security and International Affairs Division B-240544 November 30,lQQO The Honorable Claiborne Pell Chairman, Committee on Foreign Relations United States Senate The Honorable Dante B. Fascell Chairman, Committee on Foreign Affairs House of Representatives As East European countries move toward democratically elected governments and market economies, U.S. decisionmakers are faced with determining appropriate U.S. assistance for the region. This report provides information on international economic assistance to five East European countries. Western and Asian democracies, and the European Community, World Bank, and International Monetary Fund, have made commitments of $8.5 billion to Poland and Hungary and are planning assistance to other East European countries. Although conditions in the region vary by country, economic growth in each is highly dependent upon private sector investment. We are sending a copy of this report to the Secretary of State and other interested parties. Copies will also be made available to others on request. This report was prepared under the direction of Allan I. Mendelowitz, Director, International Trade, Energy, and Finance Issues, who may be reached on (202) 275-4812, and Harold J. Johnson, Director, Foreign Economic Assistance Issues, who may be reached on (202) 275- 5790. Other major contributors to this report are listed in appendix I. Frank C. Conahan Assistant Comptroller General , Executive Summ~ The extraordinary and rapid developments in Eastern Europe represent Purpose a major turning point in Europe’s postwar history. As East European countries now move from centrally planned economies to decentralized market-based economies, the United States and other countries are pro- viding assistance. To help decisionmakers in determining appropriate US. assistance for the region, GAO is providing information on interna- tional economic assistance to five East European countries-Poland, Hungary, Czechoslovakia, Bulgaria, and Romania. Specifically, GAO'S objectives were to determine (1) which countries and multilateral donors are providing economic assistance, (2) what assistance is being pro- vided, and (3) what the socioeconomic problems and opportunities are in these five countries. Because communist countries have never before made the transition Background from a planned economy with a one-party political system to a market economy with a democratically elected government, there is no model for doing so. However, East European countries are beginning to take such steps as establishing market-based prices, reviving the private sector, and restructuring the public sector. The United States and other countries are providing assistance to facilitate economic and political change and help maintain peace and stability in the region. Both the public and private sectors in donor countries are providing assistance through bilateral and multilateral arrangements. The United States, Germany, Japan, Italy, France, and the United Results in Brief Kingdom are providing about three-fourths of the $8.5 billion in aid committed to Poland and Hungary as of May 1990. Aid commitments are in the form of grants, loans, credits, advice, and in-kind benefits. This assistance covers a wide range of activities in such fields as economics, finance, education, agriculture, and the environment. In addition, aid is needed to encourage political reform. Donor countries have moved quickly to provide assistance to Poland and Hungary and to make plans for other East European countries. In addi- tion, multilateral organizations, such as the World Bank, the Interna- tional Monetary Fund, and the Organization for Economic Cooperation and Development, have begun to provide aid. Some of the major economic problems facing East European countries are declining gross national products, large foreign debts, antiquated industrial bases, and over-reliance on the Soviet Union, Conditions vary Page 2 GAO/NSIAD-91-21 Eastern Europe Executive Summary by country, but all have economic growth potential. Growth, however, is highly dependent upon substantial foreign investment. The region has a large and relatively highly educated, low-paid work force and is highly industrialized. Principal Findings Bilateral and Multilateral Over 30 U.S. government agencies are providing almost $700 million in Donors Provide Many assistance to Poland and Hungary in areas such as economic stabiliza- tion and structural adjustment; private sector development: trade and Types of Aid investment; and educational, cultural, environmental, and democratiza- tion efforts. The European Community and other donor countries are assisting Eastern Europe in the areas of agricultural and environmental develop- ment, training, and investment. Multilateral assistance includes estab- lishment of (1) the $1 billion Polish Stabilization Fund to support Poland’s currency as the government undertakes economic reforms and (2) the European Bank for Reconstruction and Development, which will provide loans for private sector projects, infrastructure development, and environmental efforts. Poland and Hungary both have economic stabilization arrangements with the International Monetary Fund. The arrangement with Poland was completed in February 1990 and authorizes purchases up to $723 million to support the government’s economic program aimed at decreasing the rate of inflation and promoting a market economy. The arrangement for Hungary, approved in March 1990, authorizes purchases up to $206 million to support the government’s efforts to reduce domestic and external economic imbalances during the process of restructuring the economy. The World Bank has provided $781 million in project loans to Poland, primarily for environmental, energy, and transportation activities and to support private sector export promotion and agroprocessing indus- tries. The Bank has provided Hungary with three project loans, amounting to $366 million, to support Hungary’s structural adjustment program and to modernize and expand agricultural enterprises and the banking system. Page 3 GAO/NSIAD-91-21 Eastmn Europe ExecutiveSummary Economic Problems and Enterprises in the East European centrally planned economies were Opportunities organized as large, state-owned monopolies. In the traditional centrally planned economy, virtually all the means of production are turned over to state ownership. The state’s central authorities plan for the inputs and outputs of state-owned enterprises, with inputs generally being cen- trally allocated. Virtually all prices are fixed by the central planners, and foreign trade is controlled by state-owned organizations. These industries suffer from outdated technology, lack of competitive incen- tives, and shortages of production materials, resulting in low produc- tivity rates. The East European countries have had little experience with commercial banking and securities markets, and their currencies have been nonconvertible, thus limiting trade and investment. Reforms are underway, but the process of developing the financial sys- tems that can aid domestic economic growth will be slow. Most of the countries in Eastern Europe-particularly Poland and Hungary-have large foreign currency debt levels which severely limit their ability to resolve domestic economic problems. The countries also face massive infrastructure needs. Roads, telecommu- nications, railways, and port facilities are inadequate for expanded international trade. Years of depending on heavy industry for develop- ment, relying on environmentally damaging high-sulphur coal for power, and refusing to control or treat hazardous wastes have extensively dam- aged vegetation and water resources and have begun to affect health. Pollution-related cancers and infant mortality are increasing, as are the number of people dying from environmentally induced diseases. Health standards in general are considerably lower throughout the region than in Western Europe. Per capita gross national product of the East European countries remains considerably below that of the United States, and standards of living are far below those of most West European countries. Key indica- tors of availability of common consumer goods show that East European standards parallel those of Greece and are a bit ahead of some Latin American countries. Although conditions vary by country, the combination of comparatively low pay and high skill levels in a large labor pool of relatively highly educated workers offers opportunities to attract development capital. Despite the immediate socioeconomic costs in undertaking economic structural reform, the East European countries must undertake certain Page 4 GAO/NSIAl%Bl-21 Eastern Europe Executive Summary fundamental measures if they are to succeed in establishing and sup- porting a market economy. The success or failure of donor assistance to these countries depends at least as much on the host governments’ implementing economic reform measures as on ensuring the effective- ness of the assistance strategies. The countries must place greater reli- ance on market-based prices, revive their private sectors, establish financial markets, and improve their infrastructures. Over time, the suc- cess of these efforts will undoubtedly vary among the countries, sug- gesting that a long-term perspective will be needed to assess the success or failure of donor assistance. In this report GAO provides information on bilateral and multilateral Recommendations assistance to five East European countries. GAO is making no recommendations. GAO did not obtain written agency comments on a draft of this report. Agency Comments However, during the course of the work GAO discussed its findings with officials of the Department of State who have been charged with coordi- nating all U.S. government assistance to East European nations. GAO has incorporated their comments in this report where appropriate. Page 6 GAO/NSL4B91%1EastemEurope Contents Executive Summary 2 Chapter 1 8 Introduction Objectives, Scope, and Methodology 10 Chapter 2 12 Donor Assistance and U.S. Bilateral Programs and Efforts European Community Assistance 14 .20 Investment Other Multilateral Programs and Efforts 22 Chapter 3 27 Socioeconomic Economic Overview Economic Potential 27 36 Conditions and Future Steps Necessary 36 Reform Efforts in East European Countries Appendix Appendix I: Major Contributors to This Report 40 Tables Table 2.1: Donor Aid Commitments to Poland and 13 Hungary Table 2.2: Type of Donor Aid Commitments to Poland and 13 Hungary Table 2.3: SEED Fiscal Year Appropriations and 15 Authorizations Table 2.4: Western Joint Ventures in Eastern Europe 20 Table 3.1: Annual Growth in Real Output 30 Table 3.2: Hard Currency Debt of Five East European 33 Countries Table 3.3: Availability of Consumer Goods 34 Table 3.4: Estimates of 1989 Per Capita Gross National 34 Product Table 3.5: Measures of National Health 35 Figures Figure 1.1: Five East European Countries 9 Figure 3.1: Gross Domestic Product Growth in Five East 28 European Countries Figure 3.2: Labor Productivity in Five East European 29 Countries Page 6 GAO/NSIADBl-21 Eastern Europe Contents Abbreviations AID Agency for International Development CMEA Council for Mutual Economic Assistance EBRD European Bank for Reconstruction and Development EC European Community ECU European Currency Unit GAO General Accounting Office GDP gross’ domestic product GNP gross national product IMF International Monetary Fund OFKD Organization for Economic Cooperation and Development OPIC Overseas Private Investment Corporation SEED Support for East European Democracy U,N, United Nations Page 7 GAO/NSIAD-91.21 Eastern Europe Chapter 1 , Introduction The long-term goal of U.S. policy in Eastern Europe is to encourage the region’s economic and political integration into the democratic world and thus end the division of Europe that followed World War II. The policy is being pursued by providing assistance to East European gov- ernments on an individual basis. The extraordinary and rapid developments in Eastern Europe (see fig. 1.1) in 1989-90 constitute a major turning point in Europe’s postwar his- tory. Most of the peoples of Eastern Europe have made it clear that they wanted a radical and decisive change in the way their political and eco- nomic affairs were conducted. As a result, the ruling Communist parties were compelled to share or to relinquish power in Poland, Hungary, Czechoslovakia, Bulgaria, Romania, and East Germany, which are now moving, at varying rates of progress, towards pluralistic forms of gov- ernment and decentralized, market-based economies. At the beginning of 1989, only the governments of Poland and Hungary were committed in principle to far-reaching changes, and even they were hesitant to implement significant aspects of the reforms they had prom- ised. Governments in the other countries either had promised reforms that were only being implemented on a piecemeal basis or had denied the need for reform whatsoever. By the end of 1989, the drive for reforms had accelerated rapidly in Poland and Hungary, and most of the other countries were committed to some transformation of their eco- nomic and political structures, Economic and political changes in Eastern Europe occurred for many reasons, including declining stan- dards of living and disappointment in the progress of economic reform; a desire for democratic, pluralistic governments; and the withdrawal of Soviet political and military support for the indigenous Communist governments. Page 8 GAO/NSIAD-91-21 Eastern Europe Chapter 1 Introduction Figure 1.1: Five East European Countries i Sea Note: The US government has not recognized the incorporation of Estonia, Latvia, and Lithuania into the Soviet Union. Other boundary representation is not necessarily authoritative. Throughout 1990, the East European countries faced a formidable array of problems, including the need to restore political and social stability while implementing economic stabilization and structural adjustment programs. While the political changes were dramatic and rapid, the pace of economic change is inherently slower. Because of variances in their Page 9 GAO/NSIAD-91-21 Eastern Europe Chapter 1 Introduction economic and political situations, each government undertook a some- what different approach in implementing necessary economic reforms. The reforms generally included a number of measures to convert from a planned to a market economy, such as establishing market-based prices, reviving the domestic private sector while encouraging foreign investment, restructuring the public sector, establishing financial markets and improving financial systems, and integrating their economies with international markets. At the same time, these governments are also faced with the needs of wide-ranging infrastructure restoration, which includes rebuilding tele- communications and transportation systems and undertaking costly environmental cleanup measures. Our objectives were to determine (1) which countries and multilateral Objectives, Scope,and organizations are providing economic assistance to five East European Methodology countries, (2) what assistance is being provided, and (3) what socioeco- nomic problems and opportunities exist in Poland, Hungary, Czechoslo- vakia, Romania, and Bulgaria. The availability of information concerning donor assistance and socioeconomic conditions varies for each country. Statistics are often unreliable and/or unavailable and are gathered and reported differently than in the United States and other industrialized countries. East European data have often been modified for political considerations. However, we believe that the data can indi- cate general trends and thus are of some use. We did not include East Germany in our review since German reunifica- tion makes its economic and political situation unique. Also, we have retained the term “Eastern Europe” rather than the frequently used “Central and Eastern Europe” because Germany is part of Central Europe and would be an exception to virtually every generalization about the economic condition of the region. In undertaking our assessment, we reviewed documents and interviewed officials of the Departments of Commerce, State, and the Treasury and the Agency for International Development (AID) concerning their involvement in setting policy and planning and coordinating assistance for Eastern Europe. We also interviewed officials of the Federal Reserve Bank of New York to determine their assessment of western financial Page 10 GAO/NSIAD-91-21 Eastern Europe Chapter 1 Introduction institutions’ investment in the region. We obtained information from U.S. embassy officials in Bonn, Warsaw, Budapest, and Prague. In Buda- pest, we interviewed Hungarian officials to obtain their opinions on their reform efforts and assistance needs. We interviewed officials of the European Community (EC) in Brussels, the Organization for Economic Cooperation and Development (OECD)in Paris, and the International Monetary Fund (IMF) and International Bank for Reconstruction and Development (World Bank) in Washington, DC., to determine what assistance is needed by European nations and what role and aid their respective organizations are providing. We also spoke with officials from the U.S. missions to the EC and the OECDto obtain their assessment of the economic and political changes occurring in Eastern Europe and to get information on U.S. efforts to coordinate donor assistance to the region. Representatives of U.S. and West German institutions and foundations provided us with their opinions on U.S. and West European geopolitical and economic goals in Eastern Europe and shared the results of their research on the economies and reform efforts of the region. Similarly, representatives of U.S. commercial and investment banks provided their views on the outlook for lending and investment activities in Eastern Europe. We analyzed documents, studies, books, and reports on the East European economies and reform efforts. We did not obtain written agency comments on a draft of this report. However, during the course of the work we discussed our findings with officials of the Department of State, which has been charged with coor- dinating all U.S. government assistance to East European nations, and incorporated their comments where appropriate. Our audit work was conducted from November 1989 through July 1990 in accordance with generally accepted government auditing standards. Page11 Chapter 2 I Donor Assistance and Investment Eastern Europe is receiving many types of assistance from public and private sectors in the United States and other countries through bilat- eral and multilateral arrangements. The aid takes the form of grants, loans, credits, advice, and in-kind benefits and covers a wide range of activities in economic, financial, educational, training, food, medical, agricultural, and environmental areas. While most of the aid is currently being provided to Poland and Hungary, other East European countries are expected to be eventual recipients as well. In addition to the United States, many major industrial nations have given aid to Eastern Europe; multinational organizations and institu- tions such as the Organization for Economic Cooperation and Develop- ment and the European Community have been instrumental in developing and coordinating assistance programs. As of May 2 1, 1990, the donor countries had committed $8.51 billion in assistance to Poland and Hungary, and the EChad committed $1.02 billion (see table 2.1). In addition, of the approximately $8.51 billion committed, $3.94 billion, or 46 percent, is in the form of export credits and project financing (see table 2.2). Although overall U.S. assistance is less than that being pro- vided by Germany and Japan, State Department officials noted that other bilateral donors are providing most of their assistance in the form of loans or tied aid and that the United States is the largest donor of grant assistance. A high-level U.S. official said that the United States is attempting to convince other bilateral donors to provide more grant assistance. Page 12 GAO/NSIADBldl Eastern Europe Chapter 2 Donor Assistance and Investment Table 2.1: Donor Aid Commitments to Poland and Hungary (as of May 1990) Dollars in millionsa Commitments Commitment8 Commitments for Poland Donor nations for Poland for Hungary and Hungaryb Total Germany $1,729 $1,134 $22 $2,005 Jacan 742 643 18 1.403 United States 261 37 377 675 Italy 484 146 28 657 France -_--- -..- 581 0 0 581 United Kinadom 161 28 0 190 Othersc 621 310 170 1,100 European Community 236 761 26 1,023 Total $4.815 $3.059 $641 $8.514 aThe aid commitments represent amounts reported to the European Community. bThis category consists of commitments made jointly to both Poland and Hungary and is separate from commitments made solely to Poland or Hungary. CThe 18 other countries contributing aid to Poland and Hungary are Australia, Austria, Belgium, Canada, Denmark, Finland, Greece, Iceland, Ireland, Luxembourg, the Netherlands, New Zealand, Norway, Por- tugal, Spain, Sweden, Switzerland, and Turkey. Source: European Community Commission Directorate General for External Relations, May 21, 1990. Table 2.2: Type of Donor Aid Commhments to Poland and Hungary Dollars ._ .- in mrllronsB . .~ ~~~-..-.-_ - ..-. Grants and Percent of Export credit/ Percent of Other Percent of Donor nation5 loans total aid project finance total aid aidb total aid Total Germany $1,528 53 $1,331 46 $25 1 $2,885 Japan 144 10 1,258 90 0 0 1,402 United States 371 55 143 21 161 24 675 ita& 260 40- 290 44 107 16 657 France 83 14 383 66 115 20 581 United Krngdcm-. 157 83 17 9 16 9 190 bthersC 264 24 514 47 322 29 1,100 European Community .--- 733 77 0 0 230 23 1,023 Total $3,601 42 $3.936 46 $977 lid $8,514 aThe figures below represent aid commitment amounts reported to the European Community. bThis category represents foreign assistance not specified in the form of grants or loans, such as some forms of environmental assistance and technical training. CThe 18 other countries contributing aid to Poland and Hungary are Australia, Austria, Belgium, Canada, Denmark, Finland, Greece, Iceland, Ireland, Luxembourg, the Netherlands, New Zealand, Norway, Por- tugal, Spain, Sweden, Switzerland, and Turkey. dPercentages may not total 100 due to rounding. Source: European Community Commission Directorate General for External Relations, May 21, 1990. Page 13 GAO/NSIAD91-21 Eastern Europe Chapter 2 Donor Aeeistance and Investment The*Support for East European Democracy (SEED)Act of 1989,author US. Bilateral ized funding for U.S. aid to Poland and Hungary. With the Department Programs and Efforts of State coordinating efforts, a council of more than 30 agencies is focusing on aid to Eastern Europe. Some U.S. government agencies are also reassigning staff to activities related to East European needs. Given the scale of these needs, it is generally believed that private sector investment will be a necessary complement to official assistance. The U.S. government has instituted some programs to provide funds and information to the private sector to facilitate investment. SEED Act of 1989 The SEEDAct was enacted “to promote political democracy and economic pluralism in Poland and Hungary by assisting those nations during a critical period of transition and abetting the development in those nations of private business sectors, labor market reforms, and demo- cratic institutions; to establish, through these steps, the framework for a composite program of support for East European Democracy.” The SEED Act authorized over $900 million in funding for fiscal years 1990-1992. Congress appropriated up to $418 million and provided $240 million in guarantees for 1990, as shown in table 2.3. Page 14 GAO/NSIALHJl-21EastemEurope Chapter 2 Donor Assistance and Investment Table 2.3: SEED Fiscal Year Appropriation8 and Authorizations Dollars in millions 1990 1990-92 Program Appropriation Authorization Polish Stabilization Fund -- 200.0 __-~ __- 200.0~ Polish ~--_. Enterprise Fund 45.0b 240.0 Hungarian -______~~_____Enterprise Fund .-.--____-.--- 5.0 - 60.0 Private --_------ farmer aid to Poland ~-__ 10.0 0 Farmer-to-farmer --- program for Poland .--____ 1 .o 0 Educational and cultural programs _---- 3.0 12.0 Student --.---~~ exchanges -__~ 2.0 ___.---________ 10.0 Labor support --__________ ____- 1.5 5.0 Technical training ~- --____-~-~ 2.0 0.5 Democratic institutions 4.0 ---~ 12.0 _--._----_ lO.Ob --___ 0 Medical supplies for Poland 2.0 4.0 Environmental programs --~.-~- -~-. --- 3.3 10.0 Energy programs ___--- - 10.0 30.0 Food aid for Poland -__ -- 125.0 1250a Peace --. Corps _____.-~- --~ 2.0 6.0 Trade - _~.-. Development and -- .__- Program 2.0 6.0 Total ti7.ac 72O.!V aFiscal year 1990. bThe Urgent Assistance for Democracy in Panama Act of 1990 (P.L. 101-243)authorized $10 million for democratization efforts in Eastern Europe. These funds were reprogrammed from the $45 million appro- priation for the Polish-American Enterprise Fund. cDoes not include (1) $40 million in guarantees for an Overseas Private Investment Corporation program for Poland; (2) $200 million in guarantees under the Trade Credit Insurance Program; and (3) December 1989 emergency aid to Romania in the form of $500,000 through the International Red Cross and $250,000 for medical supplies. The SEED Act focuses on five elements of assistance: (1) economic stabili- zation’ and structural adjustment2 programs to assist implementation of economic refbrms; (2) private sector development through loans, grants, guarantees, equity investments, technical assistance, and training; (3) trade and investment programs to encourage U.S. private sector investment; (4) educational, cultural, and scientific activities, which ‘Policies that are designed to lead to short-term internal (employment and inflation targets) and external (equilibrium in international payments) balance, such as the adjustment of the exchange rate. ‘Policies that lead to long-term internal and external balance, such as divestiture of unprofitable public sector enterprises. Page 16 GAO/NSIAD-91-21 Eastern Europe Chapter 2 Donor Aesbtnnce and Investment include publicly and privately funded scholarships; and (6) other pro- grams, to include environmental, health, food aid, and development of democratic institutions. The administration has proposed a new policy standard that would tailor U.S. assistance to the specific needs of each East European country as it shows progress toward political pluralism and economic reform, enhanced respect for internationally recognized human rights, and a willingness to build a friendly relationship with the United States. To achieve these objectives and to concentrate U.S. efforts on areas where the United States can have maximum impact, the administration sees the need for assistance in four general areas: l Democratic initiatives. This effort would support institution building, including parliamentary structures, political systems, and free media coverage. . Technical training and assistance. This effort would include support for market-based financial and economic institutions. l Environment. This category would provide assistance in cleaning up the environment and establishing model projects. . Transitional economic support. This category would include stabilization and structural adjustments as well as support for privatization through public sector-sponsored funding mechanisms as a means of aiding investment in the private sector. In some cases, U.S. assistance has been part of multilateral assistance programs. For example, the SEEDAct authorized $200 million, which was appropriated, to support Poland’s Stabilization Fund,3 seeking to lessen the variability of the Polish currency after a sharp devaluation and to encourage its convertibility into western currencies. The IMF endorsed the creation of this fund, and other industrial countries joined the United States in contributing to it. Domestic changes in Eastern Europe have prompted a reevaluation of U.S. export control policy. Before the dramatic changes in these coun- tries, the United States, in cooperation with allied countries, severely limited the export of a variety of equipment and technology that could be of military or economic benefit to communist countries or other “unfriendly” nations. These restrictions have been enforced through the 3An internationally supported fund to support the Polish currency. Page 16 GAO/NSIAD91-21 Eastern Europe Chapter 2 Donor AssMance and Inveetment Coordinating Committee on Multilateral Export Controls.4 Committee members have agreed to significantly relax licensing requirements for machine tools, telecommunications, and computers. Most commonly available personal computers and some mainframes are now decon- trolled. In addition to aiding the nations in Eastern Europe, relaxing export controls will also benefit U.S. companies that manufacture these items by providing a new market for their products. Coordination of U.S. The Department of State is the lead agency for coordinating U.S. assis- Assistance tance to Eastern Europe. The Deputy Secretary of State is the coordi- nator for the U.S. program and chairs the coordinating council of the over 20 government agencies providing assistance to Eastern Europe. The U.S. effort focuses on technical training and assistance, environ- mental assistance, democratization efforts, and support for private sector development. Every 2 weeks, the State Department publishes a periodic update of US. assistance efforts to Eastern Europe, called Focus on Eastern Europe. U.S. Agency Funding and Most of the funds under the 1989 SEEDAct were allocated to specific Staffing programs and, within particular programs, to particular projects. As a result, some agencies that either did not receive SEEDact funding or received funding only for specific purposes are using funds from their own program budgets for projects they view as important but that were not identified in the SEEDact. Some agencies, such as the Departments of State, Commerce, the Treasury, and Agriculture, are also reassigning staff to handle East European assistance needs. For example, the State Department reported that it has reassigned over 100 staff to Eastern Europe from other posts. The Department of Commerce is sending For- eign Commercial Service officers to Eastern Europe and has reassigned Washington, D.C., staff from other areas to East European initiatives. The U.S. Information Agency is using some of its own funds to promote democratization efforts, and the Departments of Commerce and Labor are using their own funds to encourage private sector investment and to provide training programs for Eastern Europe. The Enterprise Funds To promote the development of the private sector in Poland and Hun- gary, the United States has established the Polish-American Enterprise 4Cnmmittee member countries include Japan, Australia, and North Atlantic Treaty Organization countries except Iceland. Page 17 GAO/NSIAD-91-21 Eastern Europe chapter 2 Donor Amistanee and Investment Fund and the Hungarian-American Enterprise Fund. These funds are intended to provide assistance through grants and loans, equity invest- ments, support for feasibility studies, training, and technical assistance. In general, the funds will act as development banks and will engage in various activities, such as making direct loans to private entrepreneurs, lending to venture capital funds, taking an equity position in private companies, issuing bonds, buying stocks and bonds, and working with retail banks. The 1989 SEEDAct authorized $240 million dollars for the Polish-Amer- ican Enterprise Fund and $60 million for the Hungarian-American Enterprise Fund over a 3-year period. The fiscal year 1990 appropria- tion was $46 million for Poland6 and $6 million for Hungary. Polish- or Hungarian-owned firms or proposed joint ventures with U.S. firms may apply for funding, and the funds will support establishing new firms as well as privatizing existing firms. The funds will operate under the overall supervision of a binational board of directors, while day-to-day activities will be handled by professional management teams, hired by and responsible to the respective boards. The Overseas Private The Overseas Private Investment Corporation’s (OPIC) purpose is to pro- Investment Corporation mote economic growth in developing countries by encouraging private investment. The agency assists U.S. investors by (1) insuring investment projects against a broad range of political risks and (2) financing invest- ment projects through direct loans and/or loan guarantees. The agency also sponsors investment missions that are designed to introduce senior US. business executives to key business leaders, potential joint venture partners, and high-ranking government officials in the host country. In October 1989, OPICsigned bilateral agreements with Poland and Hun- gary and has since sent several investment missions to those countries. In January 1990, OPIC issued political risk insurance covering General Electric’s joint venture with a Hungarian lighting company and is con- sidering other investor-proposed projects. The agency has developed several new initiatives to better serve the needs of Eastern Europe, including (1) the East European Growth Fund, which has a target funding level of $200 million and is designed to raise private capital to fund new enterprises and make equity investments; (2) the Small Busi- ness Loan Guaranty Program, which will provide loans up to $500,000 %lO million was reprogrammed under public Law 101-243 for supportof democratic institutions in Eastern Europe. Page 18 GAO/NSlAD91-21 Eastern Jhrope cnyptcr2 Donor Asebtanee end Investment to small business investors; and (3) the Environmental Investment Fund, which has a target funding level of $100 million and which is directed toward investments in environmentally sound, natural resource enterprises. The Eastern Europe In an effort to provide interested investors with data on Eastern Europe, Business Information the Commerce Department established an information center in January 1990. The Eastern Europe Business Information Center serves as a cen- Center tral clearinghouse for information on business opportunities in Eastern Europe and on U.S. government programs supporting expanded private enterprise, trade, and investment. The Center has received thousands of inquiries from potential U.S. investors and receives, on average, about 200 calls per day. Most of the information the Center provides consists of economic reports, some market research, and lists of contacts within the various countries. The majority of the information provided is on Poland and Hungary, although information on other East European countries is available. The Center is preparing a bulletin with lists of contacts at OPIC, AID, and other relevant agencies, along with reference information on investing in the region. The Center also provides information on joint ventures between U.S. and Central or East European firms or enterprises. According to Commerce officials, the majority of investments in Eastern Europe will be joint ventures. Most countries in the region have laws that stipulate that com- panies must invest in, or with, East European fu-ms. As an indication of the importance of foreign investment in joint ven- tures, table 2.3 shows the numbers and types of joint ventures, as of May 1,1990, in Eastern Europe, as well as the legal conditions governing them. Currently, Hungary has the most liberal investment laws in the region in the areas of currency, exports, taxation, and repatriation of profits laws. While Poland has the most joint ventures with western partners, Hungary has the most joint ventures with U.S. partners. Page 19 GAO/TVSIAIb91-21 Eastern Europe chaptm 2 Donor Aatd&ance and Investment Table 2.4: Western Joint Ventures in Eastern Europe Total JVs* ~t$.$ with western Country partners pat&s Major sectors Legal conditions Poland 666 60 Food processing and construction 100 percent repatriation of export earnings. materials 100 percent foreign ownership allowed Access to foreign exchange. Himgary 600-700 140 Consumer goods, services. Light 100 percent foreign ownership allowed. manufactunng Easy licensing procedures. 100 percent repatriation of domestic and foreign profits. Czechoslovakia- 32 1 Manufacturing, tourism Repatriation of profits for hard currency - exports only. Allows for majority ownership. JVs have lower tax rate. Bulgaria 60 IO Food processing, footwear, Repatriation not guaranteed, must be chemicals, electronics through export earnings. 100 percent foreign ownership allowed. - Romania 5 1 Data processing, chemicals Romanian partner must have majority ownershib. aJV denotes joint venture. Source: Eastern Europe Business Information Center, Department of Commerce, May 1, 1990. The European CommunityG Commission, the executive arm of the EC, is European Community leading efforts to coordinate international assistance to Eastern Europe. Assistance To do so, the ECCommission has begun hosting a series of meetings with donor countries and organizations such as the IMF, the World Bank, and the OECD. The State Department is the primary U.S. representative at these meetings, although representatives of other agencies also attend as appropriate. In July 1989, the donor countries signed an agreement to provide assis- tance to Eastern Europe and at the same time gave the EC Commission the role of acting as a clearinghouse for this international assistance. According to one U.S. official, the EC is well suited for this role because, as an institution, it has (1) authority and prestige, (2) funds and resources, (3) skillful administrators, and (4) a nonmilitary orientation. The EC Commission has two roles with regard to aid to Eastern Europe: (1) to direct and oversee specific EC assistance to Eastern Europe and (2) to act as a clearinghouse for bilateral assistance to the region. As a result, the Commission has direct authority over EC assistance but relies on voluntary cooperation in coordinating bilateral aid. “The EC consists of 12 member states: Belgium, Denmark, France, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, the United Kingdom, and Germany. Page 20 GAO/NSIAD91-21 Eastern Europe - chapter 2 Donor Ae&tance and Investment As donor countries move from providing emergency aid to longer-term, more complex technical assistance, the EC clearinghouse approach is proving less effective, according to EC and U.S. officials. EC officials stated that a natural tension exists when a multilateral organization attempts to coordinate bilateral assistance efforts. For example, some countries do not report all their assistance projects to the EC working groups. EC Working Groups The EC Commission has established working groups on agriculture, training, environment, and investment to (1) develop priorities for assis- tance, principally to Poland and Hungary, (2) act as a clearinghouse for bilateral assistance from the donor countries, and (3) develop and imple- ment ECassistance programs. The ECCommission provides aid to Eastern Europe using criteria that require recipient countries to have pluralistic political systems with no institutionally favored party, to make movement toward free market economies, to have free labor unions, and to demonstrate respect for human rights. In late 1989 and early 1990, the working groups sent fact-finding mis- sions to Poland and Hungary to assess the two nations’ needs. Based on the missions’ assessments and other information, each working group began planning assistance efforts for the two countries. Working Group on The agriculture working group, established in August 1989, has prima- Agriculture rily focused on Poland but has provided some aid to Hungary and some emergency food assistance to Romania. Agricultural assistance to Poland consists of immediate food aid and longer-term agricultural help. The working group has coordinated donor assistance by matching bilat- eral aid to Polish requests. Donated food provided to Poland is sold through state stores at market prices. Revenues from these sales are given to the Polish government to help fund technical agricultural projects that will improve and expand Poland’s agricultural sector. Hungary has a surplus of agricultural products, so food aid has not been needed. Instead, Hungary has requested technical assistance to update and improve its agricultural sector. Hungary is particularly interested in sending students to the West to study advanced agricultural methods and practices. Page 21 GAO/NSJ.AD-91-21 Eastern Europe Chapter 2 Donor Assistance and Investment Working Group on The training working group was established in September 1989 because Training of Polish and Hungarian requests for training in a wide range of areas- banking, agriculture, language, civil service, environment, and voca- tional training. The EChas proposed the creation of a European Founda- tion for Vocational Training in West Berlin and a university exchange program for teachers and students. The university exchange program will target teachers and students in key fields, such as management and business administration, applied economics, applied technologies, lan- guages, agriculture, and environmental protection. Working Group on the The environmental working group began meeting in September 1989. It Environment serves primarily as a clearinghouse and coordinating mechanism for assistance provided by donor countries through bilateral agreements to Poland and Hungary. These two countries have requested help with air pollution reduction, hazardous waste removal, waste management, and water treatment. Potential projects include developing a hazardous waste incineration plant, a water desalinization plant, and an energy conservation plan for the Polish food processing industry. Working Group on The investment working group was convened in November 1989 in Investment response to Polish and Hungarian requests for assistance. The group has two major objectives: (1) to act as a clearinghouse on foreign private investment activity in the two countries and (2) to develop a data base that will include information on tax and investment treaties, national commercial laws, and issues, concerns, and successes of foreign corpora- tions doing business in the region. This information will be made avail- able to private investors interested in the investment climate in Eastern Europe. Donor countries have used other multilateral organizations and institu- Other Multilateral tions, in addition to the IX and the ECCommission, to provide assistance Programs and Efforts to Eastern Europe. This multilateral assistance takes the form of sup- porting economic stabilization and structural adjustment programs, pro- viding vocational and management training, assessing environmental concerns, and promoting foreign investment. Two primary examples of multilateral aid are the Polish Stabilization Fund and the European Bank for Reconstruction and Development (EBRD).While Poland and Hungary have received the bulk of donor aid, the European Community, the OJXD,the IMF, and the World Bank are also providing assistance to other East European countries. Page 22 GAO/NSIAD-91-21 Eastern Europe chapter 2 Donor Assistance and Investment The Polish Stabilization Under the 1989 SEEDAct, Congress authorized a $200 million contribu- tion to the Polish Stabilization Fund. The Fund was endorsed by the IMF Fund and supported by other donor countries. The US. Treasury took the lead in conducting negotiations with Poland on how the Fund would work and on establishing rules concerning its use, repayment schedules, and initial contributions. The $1 billion fund was established to accomplish two reforms: (1) to support a relatively fixed exchange rate for the zloty (the Polish cur- rency) after sharp devaluation and (2) to help ensure that the zloty is convertible for current account transactions, i.e., to allow residents to freely purchase currency through authorized foreign exchange banks. These reforms officially went into effect January 1, 1990. When the Stabilization Fund was set up, there was neither a foreign exchange market nor any way to transfer funds from one bank to another, unless the currency was physically transported from one bank to another. Therefore, in order to implement the Stabilization Fund, Poland must thoroughly restructure its banking system. International donors have provided various types of contributions to the fund. For example, the United States and the United Kingdom have pro- vided grants; Germany and France have provided lines of credit; Japan has provided a loan with a below-market interest rate; and Canada has provided a “no interest, reimbursable grant.” Before the monies could be deposited in an account (held by the New York Federal Reserve Bank), Treasury negotiated specific agreements with the donor nations to account for their laws and the fluctuations in the various exchange rates. The European Bank for In 1990, the French proposed creating a multilateral development bank, the European Bank for Reconstruction and Development. The purpose Reconstruction and was to demonstrate the commitment of the donor countries to East Development European countries committed to making political and economic reforms. The Articles of Agreement establishing the bank were signed on May 30, 1990. With up to 42 members, the bank is headquartered in London, its president is a former adviser to the French President, and it is scheduled to be operational in 1991. The United States will be the largest indi- vidual shareholder, with a 10 percent share. The ECcountries individu- ally, the European Community as an organization, and the European Page 23 GAO/NSL4D-91-21 Eastern Europe chapter 2 Donor AssLetance and Investment Investment Bank will together control 51 percent of the shares; other European countries, 12 percent; the Soviet Union, 6 percent; the East European countries, 7 percent; and other nonregional countries, 14 per- cent. The capital base will be 10 billion in European Currency Units (ECU)~($11.7 billion in U.S. dollars), with 30 percent in paid capital and 70 percent on call.8 For the first 5 years, at least 60 percent of the bank’s lending (in aggre- gate and by country) will be devoted to projects in the private sector. The balance will be available for infrastructure or environmental loans that support the development of the private sector or for public enter- prises that operate in a competitive fashion. It is intended that the bank coordinate its efforts with the IMF and the World Bank. The International The International Monetary Fund is a multinational organization with Monetary Fund 151 member countries. If a member country is having balance of pay- ment problems, it can request a standby arrangement with the Fund, which typically lasts 12-15 months. Under the standby arrangement, the IMF provides to a country a line of credit in return for the country’s agreement to undertake economic reform. The IMF emphasizes policies that reduce demand, focus on increasing exports and hard currency bal- ances, and promote currency stabilization. The IMF sets quarterly goals and criteria in order to monitor a country’s performance and timely compliance with the program. Poland and Hungary both have standby arrangements with the IMF. The arrangement with Poland was signed in February 1990 and authorizes purchases up to $723 million over 13 months to support the govern- ment’s economic stabilization program. This program aims at decreasing the rate of inflation and promoting a market economy. Hungary has had four arrangements since May 1988. The arrangement approved in March 1990 authorizes purchases up to $206 million over a 12-month period. This arrangement supports the government’s economic and financial program, which hopes to reduce domestic and external economic imbal- ances during the process of restructuring, reforming, and liberalizing the economy. 7The E%lJ serves as a common basis for determining exchange rate parities and as a means of settle- ment for the 12 member nations of the EC. ‘With a 10 percent share of the EBRD, the United States will have a funding commitment fixed in dollars of $360 million for paid-in capital and $817 million available on call. This sum translates into an annual commitment of $70 million of budget authority for paid-in capital and $163.4 million of program limitations for subscriptions to callable capital. Page 24 GAO/NSIAD-91-21 Eastern Europe chapter 2 DonorAh&ance andInvertment The IMF also provides economic assistance through an extended fund facility, which is designed to be of a longer duration (3-4 years) than standby arrangements. It is expected that the current standby arrange- ment with Poland will evolve into an extended fund facility, due to the ambitious nature of the economic changes that Poland is making. The World Bank During fiscal year 1990, the World Bank extended five project loans totaling $781 million to Poland. The projects focus on (1) providing tech- nical assistance for dealing with environmental problems; (2) restruc- turing the transportation sector; (3) improving energy conservation, pricing, and environmental impact; (4) supporting private sector export promotion; and (5) modernizing and expanding agroprocessing industries. The Bank has provided Hungary with three project loans amounting to $366 million to (1) support Hungary’s structural adjustment program, (2) modernize and expand the export capabilities of agricultural enter- prises, and (3) modernize and expand the banking system. During fiscal year 1990, no project loans were extended to the other East European countries. However, Czechoslovakia has applied for membership in the Bank, Bulgaria has expressed interest in joining, and Romania has been a member since 1983. Organization for Economic The Organization for Economic Cooperation and Development is an Cooperation and international group of 19 European countries? the United States, Canada, Japan, Australia, and New Zealand. Its mission is to achieve Development high economic growth and development, and financial stability among member nations and, thus, to contribute to the development of the world economy. All East European countries except Albania have requested OECD assis- tance in one form or another. For example, the government of Poland has asked that the OECD undertake a detailed review of its economy, including identifying what measures are needed for reform. As a result of these requests, the Secretary General of the OECD organized a special task force to address issues related to increased involvement with ‘European membership consists of Austria, Belgium, Denmark, France, Finland, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, and the United Kingdom. Page 26 GAO/NSIAD91-21 Eastern Europe Chapter2 Donor A.m&tance and Investment Eastern Europe and, in September 1989, issued a series of options on how the organization could respond to requests for technical assistance. The OECDis also developing the Center for Cooperation with European Economies in Transition. The Center will be the focal point for all OECD contacts with East European countries, will respond to requests for information and documentation from these countries, and will initiate and coordinate OEXDanalyses and activities related to Eastern Europe. In addition, the Center will organize visits from, and OECDexpert mis- sions to, Eastern Europe; will organize or help arrange seminars, work- shops, and conferences on issues related to social and economic reform; and will coordinate the OECD'Sefforts with those of other international bodies, such as the EC,IMF, and World Bank. Page 26 GAO/NSIAD-91-21 Eastern Europe &&economic Conditions ad Refom Efforts in East European Countries The East European countries have been undergoing severe economic dif- ficulties since the early 1970s and are now in a state of economic decline. Poor growth in gross national product (GNP); economic isolation from the international economy; an antiquated industrial base and infra- structure, and environmental problems; and large foreign debts are some of the major problems confronting the region. Standards of living remain far below those of most Western European countries. The East European countries vary in their natural, capital, and human resource bases but all have growth potential if the requisite economic structural adjustments are undertaken. There appears to be general agreement that the primary catalyst for growth in the region must be through domestic private sector initiatives, supplemented by private sector investment from industrialized countries and by economic assis- tance from the United States, Western Europe, Japan, and international financial institutions. Enterprises in the East European centrally planned’ economies were Economic Overview organized as large, state-owned monopolies. These industries suffer from outdated technology, lack of competitive incentives, and shortages of production materials, resulting in low productivity rates. In most of these countries, central planners controlling the state firms failed to properly coordinate supplies of labor, material, and productive capacity. Long production lead times meant that equipment was outdated by the time it was actually installed and operating. For the most part, economic expansion in state-owned industries was brought about by massive increases in material and labor inputs and not by improvement in productivity. These production inefficiencies were hidden by massive government subsidies and by arbitrarily set prices that masked true costs. The subsidies created a large “hidden inflation” that strained national budget and banking resources when central gov- ernments had to increase subsidies to cover rising real costs. In addition, the central planners, lacking profit incentives, imposed no hard financial discipline on the state-owned operations, and unprofitable firms were not allowed to go bankrupt. (Fig. 3.1 shows the average gross domestic product (GDP) growth for the periods 1961-73,1974-82, and 1983-88, and the annual average for 1989 in the five countries we reviewed.) ‘In the traditional centrally planned economy, virtually all the means of production are turned over to state ownership. The state’s central authorities plan for the inputs and outputs of state-owned enterprises, with inputs generally being centrally allocated. Virtually all prides are fixed by the cen- tral planners, and foreign trade is controlled by state-owned organizations. Page 27 GAO/NSIAD-91-21 Eastern Europe Chapter 3 Socioeconomic Conditions and Reform Efforts in East European Countriee Figure 3.1: Qroso Domestic Product Growth in Five East European Countries 7 (Numbers In parcent) r---l 1951-73 Source: International Monetary Fund. 1989 figures are from Central Intelligence Agency estimates of gross national product. Lacking a pricing mechanism that properly related supply to demand, producers could not make rational decisions about what to produce. Instead, the central bureaucracies made decisions based on their prefer- ences for producing specific goods and services and used prices as a method for redistributing income. This system led to inefficient pricing decisions and a sometimes seemingly irrational waste of resources. For example, it has been reported that some East European farmers ended up selling grain to the state, then buying subsidized bread to feed live- stock because bread was cheaper to use than the unsubsidized grain from which the bread was made. While it is difficult to measure economic output in these economies, there is general agreement that absolute productivity was lower than Page 29 GAO/NSIAD-91-21 Eastern Europe chapter 3 Soctoeconomic Conditions and Reform Efforts in East European Countries reported and that the labor productivity trend, as defined as percentage of change in output per worker, had been declining throughout the region, (See fig. 3.2.) For example, a steel plant in Poland employed 30,000 workers to manufacture the same amount of steel as a U.S. plant employing 7,000 workers. Figure 3.2: Labor Productivity in Five East European Countries 10 (Percentage chrngr In output par rmployu) Source: Institute of international Finance As table 3.1 demonstrates, the annual growth rates for the economies of East European countries have varied greatly during the mid- to late 1980s. Estimates of their growth in 1989 indicate that many of these countries actually suffered declines or minimal growth in real output. Page 29 GAO/NSIAD-91-21 Eastern Europe. Chapter3 Socioeconomic Conditions and Reform Efforta in EastEuropean Countrles Table 3.1: Annual Growth in Real Output (Percent Change) Country 1985 1988 1987 1988 198ga Polandb 3.6 4.2 2.0 4.1 -3.0 Hungaryb -0.2 1.5 4.1 0.4 0.6 Czechoslovakiab 3.0 2.6 2.2 2.5 2.0 Bulgariaa 1.8 5.3 5.1 2.4 -0.4 - Romaniab 5.5 6.1 4.6 3.3 1.7 United Stat& 3.6 3.0 3.5 4.4 2.8d FranceC 1.7 2.1 2.3 3.4 3.5d ltalyC 2.9 2.9 3.1 3.9 3.ld -- West GermarV 2.0 2.3 1.9 3.4 4.9* aEstimates. bGross national product ‘Gross domestic product. *Figures for second quarter 1989, year-to-year change. Source: Figures for East European countries from the Institute of International Finance. Figures for other countries are from the UN. Economic Commission for Europe. Economic Isolation The East European countries largely isolated themselves from the inter- national marketplace by trading primarily among themselves for the past 40 years. Much of their trade occurred within a single trading bloc, the Council for Mutual Economic Assistance (CMEA), also known as Comecon. As a result, their economies lacked the dynamic impetus of competition provided by the world economy. Trade within the CMEA relied upon barter-style arrangements to balance trade among its members. When forced to obtain goods outside their trading bloc, most East European countries developed unfavorable trade balances, exacerbated by their nonconvertible currencies2 One result for some of these countries was a serious external debt problem that per- sists today. Another result of the relative isolation from the international trading community was the insulation of East European industries from foreign competition. This insulation reduced the availability of consumer goods and lessened the incentive for improving product quality. This insularity also reduced opportunities for obtaining economies of scale available to higher exporting countries, as well as the general benefits of interna- tional trade, such as access to greater quantities of goods and services or the opportunity to benefit fully from specialized production. Moreover, 2A nonconvertible currency cannot be freely exchanged against another currency. Page30 GAO/NSJAD-91-21 Eastern Europe Chapter 3 Lbchecanondc Conditiona and Reform Efforts ln East European Countries diminished contact with the international trade and finance centers lim- ited East European countries’ access to foreign sources of capital. Another problem resulting from past reliance on trade within the CMEA is that moving away from the former trade patterns will be costly for the East European countries. Initially, the CMEAtrade system was advantageous to the Soviet Union, since it was able to receive goods from other CMEAcountries at prices that were lower than prices pre- vailing outside the trading bloc. Following the increases in oil and energy prices in the 197Os, however, the advantage shifted, and East European countries were able to buy Soviet oil and natural gas below world prices. Recently, however, the Soviet Union has proposed that CMEAcountries pay world prices for oil, using hard currencies. It will be difficult for the East European countries to raise hard currencies, however, since many of their potential exports are not competitive. In addition, East European countries have had little current experience with commercial banking or with securities markets. Until recently, for instance, private ownership of the means of production generally was not allowed, so the need for stock markets did not exist. Banking was conducted by state institutions. In addition, the currencies of these nations were nonconvertible, thus limiting trade. Reforms are underway, but the process of developing the financial sys- tems that can aid domestic economic growth will be slow. Poland, for instance, has introduced a banking system that includes privately owned banks under central bank regulation. The absence of an efficient mechanism to clear checks or transfer money between banks, short of physically withdrawing money from one bank and redepositing it in a second, however, will limit the development of financial markets. Hun- gary has introduced a stock exchange, but few trades occur. nadequateInfrastructure Roads, telecommunications, railways, and port facilities in Eastern Europe are not adequate to aid greater levels of trade with Western Europe. Transportation systems, for instance, are oriented to trade within the CMEAbloc, principally the Soviet Union. Also, telecommunica- tions systems generally cannot easily be adapted to more modern Y Western technologies. Page 31 GAO/NSIAD-91-21 Eastern Europe Chapter 3 Socioeconomic Conditions and Reform Efforts ln East European Countries Environmental Situation Eastern Europe has severe environmental problems. Years of depending on heavy industry for development, relying on environmentally dam- aging high-sulphur coal for power, and refusing to control or treat wastes have extensively damaged vegetation and water resources and have begun to affect health. Throughout the region, forests and croplands have been heavily contaminated. For example, it is reported that one-third of Bulgaria’s forests have pollution-related damage, one- half of Czechoslovakia’s forests are damaged or dying, and much of Poland’s farmlands have been hurt by high acid levels and metals. Eastern Europe’s air and water resources have been similarly devas- tated. Much of Hungary’s population breathes air with pollution levels higher than its own national maximum safe-level limits, and drinking water in the southern part of the country is reportedly seriously con- taminated with arsenic. Poland produces a reported 6 times more air pollution per unit of output than does Western Europe, and 95 percent of its rivers are severely polluted. Seventy percent of Czechoslovakia’s rivers are polluted. The health of East Europeans has also suffered from ecological misman- agement. It is reported that pollution-related cancers and infant mor- tality are increasing in Czechoslovakia, a growing number of Hungarians die from environmentally induced diseases, and pollution-related heart disease and infant mortality are at high levels in Romania. The World Bank estimates that 10 percent of Poland’s gross national product is lost through employee illness and industrial problems related to contaminated water. Officials in Hungary calculate that illnesses caused by pollution take up over 13 percent of that nation’s health budget. The West German Institute for Economic Research has projected that $200 billion would be needed over the next 20 years to clean up industrial pollution in Eastern Europe. External Debt Most of the countries in Eastern Europe-particularly Poland and Hun- gary-have large hard currency debt levels, as shown in table 3.2. These debts severely hinder their abilities to resolve their domestic eco- nomic problems. Page 32 GAO/NSIAD-91-21 Eastern Europe . - I Chapter 3 Socioeconomic Conditions and Reform Efforts in East European Countries Table 3.2: Hard Currency Debt of Five East European Countries Dollars in billions U.S. -. Country 1980 1981 -___. 1982 1983 1984 1985 1988 1987 1988’ -- 1989’ Poland ..- .-. 25.0 25.5 24.7 --__-- 26.4 26.8 29.3 33.5 39.2 38.5 39.5 Hungary 9.1-__----------_ 8.7 7.6 8.2 8.9 11.8 15.1 17.8 18.0 20.7 Czcchoslovakla 5.0 4.6 3.9 4.0 3.6 3.8-- 4.5 5.8 6.1 7.8 Bulgana 3.5 3.1 2.8 2.4 .-__ 2.3 3.7 4.9 6.2 7.5 ______--__ 10.0 Romania 9.4 10.1 9.7 8.7 7.1 6.6 6.4 5.1 2.2 0.4 aEstimate. Source: U.S. Central Intelligence Agency During the 1970s the East European countries borrowed heavily on the international financial markets to finance industrial investment. How- ever, poor investment decisions, economic inefficiencies, mediocre export competitiveness with resulting low foreign exchange earnings, and high interest rates on their external debt created severe economic and financial difficulties. Problems were compounded after 1985 when East European countries tried to shift domestic polices toward economic growth and investment that relied heavily on imports from nonsocialist countries. Their current account balances3 worsened, and external debts rose. Standards of Living Standards of living throughout Eastern Europe remain far below those of most West European countries. Key indicators of availability of common consumer goods show that East European standards parallel those of Greece and are a bit ahead of some Latin American countries. (See table 3.3.) 3The difference between exports and imports of goods and services, minus net transfer payments made to foreigners. Page 33 GAO/N!XAD-91-21 Eastern Europe Chapter3 Socioeconomic Conditiona andReform Efforta in EastEuropeanCountries Table 3.3: Availability of Consumer Qoodr Number per 1,000 persons Country ---- Automobiles Telephones Television se6 Poland ------.--___-. 105 118 85 Hungary 145 134 275 Czechoslovakia ----- 173 226 122 Bulgaria - 120 200 96 ------ Romania ---.___-.-_---..- .._._ -- 11 130 ixa United States 572 650 621 Japan 235 535 250 Germany 446 641 377 Argentina 127 100 213 Brazil -_-___-__-------- 76 90 184 Mexico 65 90 108 Greece 127 373 158 ‘NA denotes not available. Source: Building Free Market Economies in Eastern Europe, Institute of International Finance. Per capita GNP of the East European countries remains considerably below that of the United States. Table 3.4 shows that only Czechoslo- vakia has achieved as much as one-third the estimated 1989 U.S. per capita GNP of $21,036. Table 3.4: Estimates of 1989 Per Capita Gross National Product U.S. dollars ----____ ._ Percent of U.S. per Per capita gross capita gross national Country national product product Poland $4,565- 22 Hungary 6,108 29 Czechoslovakia 7,878 37 Bulgaria 5,710 2? Romania 3.445 16 Source: U.S. Central Intelligence Agency. Health standards are considerably lower throughout Eastern Europe than in the more industrialized nations. The relatively high mortality rates, which recently have increased for the first time since World War II, are a manifestation of the generally low quality of health care. How- ever, East European statistics do compare favorably with those of Latin America. (See table 3.5.) Page 34 GAO/NSUD-91-21 EasternEurope Chapter 3 Socioeconomic Conditions and Ref’orm Efforts in East European CWntrie~ Table 3.5: Measures of National Health Persons er Annual mortality per Infant mortality per Country physic k n 1,000 population 1,000 population Poland 490 IO 18 Hungary - 310 14 17 Czechoslovakia 280 12 13 Bulaaria 280 NAa 15 Romania 570 11 25 United States 470 9 10 Japan 660 5 6 Germany 380 7 8 Argentina 370 9 32 Brazil 1,080 8 63 Mexico 1.240 6 47 Greece 350 10 13 BNA denotes not available. Source: World Health Organization, 1989 World Health Statistics: World Bank, World Development Report 1989; and International Institute of I-lnance. While the East European countries confront an array of economic Economic Potential problems, they all have economic growth potential. This growth, how- ever, is highly dependent upon substantial foreign investment. Although conditions vary by country, the region generally offers a large labor pool of relatively highly educated but low paid workers. The region is highly industrialized, but these industries need considerable modernization. For the present, the combinations of comparatively low pay and high skill levels of East European workers offer opportunities to attract development capital. A leading economic forecasting group reports that the average hourly manufacturing wage in Hungary, Poland, and Yugo- slavia in 1988 was between $1.36 and $1.71, including fringe benefits and pension costs; in Czechoslovakia, it was between $2.05 and $3.08. The group also reports that the percent of the labor forces in Hungary, Poland, and Czechoslovakia with secondary/high school educations or industrial equivalents was 23.9, 21.9, and 21.9 percent, respectively. In addition, between 7.0 and 9.9 percent of these countries’ workers had a college or university education, and highly skilled personnel, such as scientists and engineers, are available at relatively low costs. Page 36 GAO/NSJAD91-21 Eastern Europe Chapter 3 Socioeconomic conditione and Reform Efyorta In East European Countries The East European countries need to take numerous measures to trans- Future Steps form their centrally planned economies to functioning market econo- Necessary mies. Economic experts generally agree on the steps needed for reform, but there is no consensus on how to approach implementation. Some countries in the region have started to establish the foundations for market-based economies, but they differ in regard to their commitment to reforming their economies, the type of reform measures needed, and the status of these reform efforts. Assistance from donor countries, including the United States, will prob- ably be an essential element in the success or failure of these reform efforts. Investments in Eastern Europe by domestic and foreign private investors will also be essential, according to most experts. In providing assistance and making investment decisions, however, it is important that the donor countries and investors understand the nature and mag- nitude of the changes that the East European countries must undertake. Economic reform in the region is not new. For much of the 40-plus years in which centrally planned economies dominated the region, govern- ments experimented with different approaches for reforming central planning mechanisms and introducing some elements of free markets and private ownership. There was a general realization that the tradi- tional model of the centrally planned economy had been unsuccessful. The changes made to economies during these previous attempts at reform have modified most East European systems so that they no longer have planned economies as classically defined. The economic reform movement currently under way in Eastern Europe is a complex process. The OECDreported, for example, that the reforms combine previous efforts at modifying centrally planned economies with a new principle of liberalizing the economy while concurrently democra- tizing the government. While retaining certain elements of previous attempts at reform, the new process is more radical in that its objective is the complete transformation of the system’s economic and political structures, At the same time, these reform efforts impose costs on the East European countries. Phasing out administrative allocation of resources, closing inefficient operations, and removing guarantees of employment are difficult steps. Experts agree, however, that the countries of Eastern Europe must undertake certain fundamental measures if they are to succeed in estab- lishing and supporting a market economy. While there is no agreement on the ideal way to undertake the reform efforts or the order in which Page 36 GAO/NSLAD-91-21 Eastern Europe Chapter 3 Socioeconomic Conditions and Reform Efforta in East European Countries they should be implemented, the success or failure of donor assistance to these countries depends at least as much on implementing these mea- sures as on ensuring the effectiveness of the assistance strategies. Nec- essary steps that the OECDand others have identified are 9 Greater reliance on market-based prices: Under central planning, prices are not based on true costs or scarcity of goods. Frequently, prices of key goods, such as food or housing, reflect the subsidies provided by the state rather than the ability of companies or nations to produce goods efficiently. As subsidies and price controls are removed, increased prices for many goods and services are inevitable. In the view of most experts, essential components of these reforms will be breaking up inefficient state-owned monopolies, eliminating subsidies, and removing or sub- stantially reducing the power of the central planners, thereby transfer- ring the ability to make decisions to the individual firm or enterprise. Furthermore, as prices become efficient market signals, it will be impor- tant that economic policies avoid inflation that would distort these signals. . Revival of the private sector: While there remains considerable debate over the future role of governments in the economies of Eastern Euro- pean countries, most experts believe that it will be necessary to turn a large share of production over to a revived private sector. The govern- ments of these countries will have to take a number of steps to do this, including establishing the legal basis for private ownership, encouraging private investment, and altering their tax systems to reflect these changes, Most experts also believe that restrictions on foreign invest- ment will have to be relaxed or removed. Foreign investment will bring needed capital as well as access to western technology and innovations in management and worker training. . Improvements in infrastructure: Eastern Europe now lacks the infra- structure needed to transform its economies. Current telecommunica- tions systems, for instance, must be upgraded to support advances in financial services. Transportation and goods-handling systems, such as roads and port facilities, must also be improved. . Establishment of financial markets: In economies with a greater reliance on markets to set prices, financial markets and systems will be more important. Investment and business decisions depend largely on access to capital and on the ability to receive timely payment for the goods and services that are produced. These decisions also depend on knowledge that the institutions that provide capital and a payments mechanism are safe and sound. Finally, financial markets are essential to development of market-based interest rates, the mechanism by which capital can be Page 37 GAO/NSIADQl-21 Eastern Europe chapter3 E3odoeconomic ConditionsandReform Efforta in EastEuropeanCountries allocated most efficiently, replacing current reliance on central planners to allocate investment funds. The outcome of these reform efforts will likely be uncertain for several years to come. Changing political leadership and differing economic con- cerns and reform goals will influence the ultimate results. Over time, the success of these efforts will undoubtedly vary among the countries, sug- gesting that a long-term perspective will be needed to assess the success or failure of donor assistance. Page38 GAO/NSIADI)l-21EasternEurope 1 / ,, ..:, I: Page39 GAO/NSIADol%lEasternEurope i Major Contributors to This Report James M. McDermott, Assistant Director National Security and Debra M Crowe Adviser International Affairs ’ Forg;, Adviser John D. De Division, Washington, Jean-Paul Reveyoso, Evaluator Rona H. Mendelsohn, Editor DC. John R. Schultz, Assistant Manager for Planning European Office and Reporting Kurt W. Kershow, Evaluator-in-Charge Mary A. Needham, Evaluator (486018) Page40 GAO/NSIAD-91-21 EasternEurope i -_.- -I--- -----~-- --- I. 1 - i ; Ordtving Informatiou ‘I‘htb first five copies of each GAO report are free. Addit,ioual copit~s are $2 each. Orders should be sent to the followiug address, accom- panied by a check or money order made out. to the Superintendent of Documents, when necessary. Orders for 100 or more copies to be mailed to a siugle address are discounted 25 percent.. 1J.S. Gtvleral Accounting Office PA). 130x 60 16 Gai thersburg, MD 20877 Orders may also be placed by calling (202) 2756241.
Eastern Europe: Donor Assistance and Reform Efforts
Published by the Government Accountability Office on 1990-11-30.
Below is a raw (and likely hideous) rendition of the original report. (PDF)