Communism was an awful system for people trapped behind the Iron Curtain. The political cost was enormous. Personal rights and individual liberties were sacrificed to protect the power of the state. Human rights were abused, dissidents were imprisoned, and some killed. Communism also imposed huge economic costs. Collectivised agriculture, central planning, price controls, and government-run industries were among the policies that resulted in a debilitating misallocation of resources. And because labour and capital were poorly utilised, living standards lagged far behind Western nations.
The eventual collapse of the Soviet Empire freed hundreds of millions of people from political tyranny. And most nations that emerged have done a decent job of establishing democracy. Establishing genuine capitalism, though, has been a bigger challenge. Part of the problem is policy. And to be more specific, data from the Fraser’s Institute’s Economic Freedom of the World shows that the major difference today between Western Europe and Eastern Europe (nations that were part of the Soviet Bloc) is that the former get much better scores for “Legal System and Property Rights.” Indeed, the average ranking of Western European nations is 20.6 (with 1 being the best) while the average ranking of Eastern European countries is 67.1 (Economic Freedom of the World ranks 159 jurisdictions).
Most nations that emerged have done a decent job of establishing democracy. Establishing genuine capitalism, though, has been a bigger challenge.
Why does this matter? The Fraser Institute argues that a bad score for this variable makes widespread prosperity much harder to achieve:
“The key ingredients of a legal system consistent with economic freedom are rule of law, security of property rights, an independent and unbiased judiciary, and impartial and effective enforcement of the law… Security of property rights, protected by the rule of law, provides the foundation for both economic freedom and the efficient operation of markets… Perhaps more than any other area, this area is essential for the efficient allocation of resources. Countries with major deficiencies in this area are unlikely to prosper regardless of their policies in the other four areas.”
To be sure, looking at averages for entire regions buries some important details. Estonia, which is part of Eastern Europe, ranks 23rd in this key category. Italy, meanwhile, is ranked only at number 70, notwithstanding the fact that it is part of Western Europe. And Poland ranks 45th, much better than Greece, which ranks 62nd.
But this actually reinforces the argument. Estonia and Poland are two of the more successful nations to emerge from the wreckage of Communism. Italy and Greece, by contrast, are plagued by moribund and anaemic economies. These nations confirm that the rule of law (which is basically what is captured by “Legal System and Property Rights”) is critically important for a prosperous market economy.
Culture also matters. People behind the Iron Curtain were subjected to decades of propaganda about the supposed inequity and iniquity of the capitalist system. And even if they intellectually understand that they are better off today because the Soviet Union disintegrated, there’s still some vestigial suspicion of markets.
People behind the Iron Curtain were subjected to decades of propaganda about the supposed inequity and iniquity of the capitalist system.
To make matters worse, the transition away from Communism often exacerbated that scepticism. In some cases, the process of privatisation created windfall gains for those with special connections to government. And in cases when privatisation didn’t occur, that meant governments providing subsidies to state-owned enterprises. Yet those subsidies generally get targeted to insiders. To the degree that these examples of cronyism are perceived as being part of the capitalist system, it’s understandable that ordinary people are less than enthused about the market economy.
How pervasive is the problem? Once again, the database from Economic Freedom of the World is very instructive. If you examine the overall ratings for “size of government”, Eastern European nations are actually ranked significantly better, with an average ranking of 89.2 compared with 129.2 for Western European countries. This is because tax rates tend to be lower (many former Soviet Bloc nations have flat tax regimes, for instance) and welfare states aren’t as burdensome.
But if you dig into the details and examine the various components that determine size of government, there’s one area where Eastern Europe lags behind. The numbers for “Government Enterprises and Investment” are better in Western Europe. This variable is important, according to Economic Freedom or the World, because it:
“…measures the extent to which countries use private investment and enterprises rather than government investment and firms to direct resources. Governments and state-owned enterprises play by rules that are different from those to which private enterprises are subject. They are not dependent on consumers for their revenue or on investors for capital. They often operate in protected markets. Thus, economic freedom is reduced as government enterprises produce a larger share of total output.”
Politicians play too large a role in the allocation of capital in former Communist nations.
In other words, politicians play too large a role in the allocation of capital in former Communist nations. And when you combine low scores for rule of law with poor scores for government control of investment and allocation of capital, this underscores the need for further reforms in Eastern Europe. However, such changes are difficult in nations where people incorrectly think that cronyism is part of capitalism. Particularly when politicians don’t have much incentive to reform policies, since genuine capitalism means they have less ability to hand out favours in exchange for power and money.
However, there is no alternative to reform in a competitive global economy. Nations that maintain statist policies will lose jobs, investment, and entrepreneurs to countries where there is better protection of the rule of law and less economic intervention. For Eastern European nations, which already face severe demographic challenges because of ageing populations and falling birthrates, the loss of productive resources – especially the emigration of young people – is a crippling blow.
The bottom line is that post-Communist nations need to choose genuine capitalism if they want a brighter future for their citizens.
Nations that maintain statist policies will lose jobs, investment, and entrepreneurs to countries where there is better protection of the rule of law and less economic intervention.