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By how much did socialist economies underperform? A crosscountry investigation By TAMÁS VONYÓ* This paper applies panel econometrics with country-fixed effects for 16 West and 9 East European countries to isolate the differential in growth rates of per capita GDP between socialist and nonsocialist economies from supply-side determinants of relative growth performance in the post-war period. Vonyó (2008) developed a model that explains economic growth in the OECD between 1950 and 1990 by convergence, labour-force growth, and the temporary output gap reflecting wartime destruction and post-war dislocation. All three factors were significant drivers of growth, with the effect of the post-war output gap gradually weakening over time. I apply this framework with some modification. Controlling for catch-up potential, labour-supply flexibility and the postwar output gap with a linearly declining time-trend, being a command economy still had a large significant negative effect on annual growth rates: almost three percentage points between the 1950s and the 1970s, and approximately 4.5 percentage points in the 1980s. Why are some countries rich while others are poor? Diverging development in the global economy has long been a prime interest of economists and historians alike, and both attribute an instrumental role to political and economic institutions. Perhaps nowhere has this consensus been demonstrated more convincingly than in post-1945 Europe, where two fundamentally different growth strategies had developed, one of which has since clearly failed. The falling behind of Eastern Europe in income per head and productivity during the period of state socialism has been subject to a myriad of studies. Most blamed it on the intrinsic inefficiencies of central command and the shortage economy.1 Particular emphasis was laid on the growing technological lag vis-à-vis advanced western nations and on the lack of technological adaptability. Planned economies achieved ‘a satisfactory productivity performance in the era of mass production, but could not adapt to the requirements of flexible production technology during the 1980s’.2 The rate of economic growth in Eastern Europe was indeed falling sharply after the early 1970s and its relative underperformance compared to the western half of the continent became increasingly more difficult to refute.3 Figure 1 about here As shown in Figure 1, growth rates in real GDP per capita were particularly modest in contrast with the record achieved by countries in Southern Europe that were at a similar level of development after World War II. In this comparison, command economies seem to have started to perform poorly already during the 1960s, and the gap in annual growth rates between the two peripheral regions of Europe remained close to two percentage points until the collapse of the communist bloc. However, it has not been shown how large the relative underperformance of socialist economies actually was. * Author affiliation: Tamás Vonyó, London School of Economics. 1 See Eichengreen, The European Economy, chapter 5, Kornai, The socialist system, and Kalecki, Socialism, among others. 2 Broadberry and Klein, ‘When and why’, p. 37. 3 Berend, Central and Eastern Europe 1 A simple eyeballing of comparative national-income estimates for different parts of Europe, or of growth rates derived from them, is insufficient because it ignores the substantial variation in initial conditions and system-independent supply side determinants of growth. Similarly, the handful of growth-accounting exercises comparing Eastern and Western European economies at similar levels of development only differentiate between the contributions from proximate sources of growth across space and over time.4 To mount an adequate answer to the question by how much socialist economies underperformed we need a quantitative model that captures the gap between the exogenously determined growth potential of a country and its actual growth record. This paper applies panel econometrics with country-fixed effects to isolate the differential in growth rates of per capita GDP between socialist and non-socialist economies from supply side factors that influenced relative growth performance during the post-war period on both sides of the Iron Curtain. Controlling for convergence, labour-supply flexibility, and the gradually diminishing role of post-war reconstruction, I demonstrate that being a command economy still had a large significant negative effect on annual growth rates, which increased substantially only between the 1970s and the 1980s. Although the primary aim of the paper is to measure, not to explain, the underperformance of Eastern Europe, the econometric findings also suggest that the region could not exploit its potential for reconstruction growth in the early post-war decades. This outcome, at least in part, resulted from labour-supply constraints due to large population losses during the 1940s. The paper is structured as follows. Section I reviews the existing literature on the determinants of post-war growth in Europe and develops the analytical model. In Section II, I discuss the sources of data and explain the necessary revisions. Section III presents the econometric results and makes a preliminary attempt at locating the potential causes behind the size and evolution of the gap between socialist and non-socialist economies in their pace of development. Section IV discusses further implications and avenues of research to explore. Section V concludes. I. Modelling post-war growth There is a vast literature on the economic development of post-war Europe. To explain the rapid growth of continental economies in the 1950s and 1960s and their sudden slowdown thereafter has long been a primary concern for economists and economic historians alike. It is a widely shared notion that pent-up demand for consumer products in domestic markets and booming exports following the liberalisation of international trade gave a strong boost to investment and through that productivity growth. In the unique context of the post-war settlement, it combined with wage moderation to facilitate full employment and sustained growth.5 Demand-side theories, however, failed to explain the marked differences in average rates of economic growth amongst industrialised nations. In the mainstream literature, post-war growth has been explained primarily by supply-side factors. Convergence is the most commonly stressed of them all. The presence of a large transatlantic productivity gap at the end of World War II together with trade liberalisation, fixed exchange rates and domestic market reforms allowed European economies to achieve rapid growth by adopting American technology.6 Dennison pointed out that fast growth in productivity was also supported by an extensive scope for structural change driven by the reallocation 4 Balassa and Bertrand, ‘Growth performance’; Van Ark, ‘Convergence’; Sleifer, Planning ahead Lámfalussy, The United Kingdom and the Six; Eichengreen, ‘Institutions’ 6 Baumol, ‘Productivity’; Abramovitz, ‘Catching-up’; Nelson and Wright, ‘Rise and fall’; Crafts, ‘The golden age’ 5 2 of low-productivity labour from agriculture to manufacturing and services.7 Kaldor specifically argued that the growth of national income was led by industrial expansion which, in turn, relied on increasing industrial employment. Industrial investment enjoyed increasing returns to scale, and thus labour expansion lead to faster growth in productivity and output.8 Kindleberger developed a similar hypothesis, in which labour-supply flexibility stemming from underemployment in agriculture, increased labour participation, or immigration, limited the growth of real wages, making investment more profitable. Investment in new technology, in turn, acted to enhance labour productivity, which further increased the profitability of investment.9 Structural modernisation and conditional convergence are both relevant to the history of command economies as well. The Solow model or extensions thereof suggest that, conditional upon the rate of investment and population growth, countries with initially lower capital-labour ratios can achieve relatively faster growth in labour productivity due to high marginal returns to capital.10 Under the rule of diminishing returns, socialist industrialisation was also expected to face an eventual slowdown in economic growth.11 The ability to rely on idle labour reserves in agriculture in the process of industrialisation was also critical for underdeveloped countries.12 Allen demonstrated that the forced reallocation of labour and resources from agriculture to heavy industry made a very substantial contribution to high income growth in the USSR both prior to and after World War II. Investment-led growth could be sustained as long as the rural labour surplus was not absorbed.13 The role of labour-supply flexibility secured by other factors such as increased participation or population growth is less prominent in the existing literature on socialist economies. Although the rising rate of female employment received strong emphasis, it has been mentioned more in the context of social policy and rarely recognised as a response to labour-supply constraints. The notion that postwar growth was largely a reflection of a reconstruction effect that propelled war-shattered economies back to their long-run productive potential has been similarly neglected.14 Although Jánossy himself witnessed and studied post-war economic development from the eastern side of the Iron Curtain, his theory was applied predominantly in the western literature, particularly in the context of the West German growth miracle after 1948.15 By contrast, his views, radically at odds with the prevailing Marxist orthodoxy, were swiftly rejected by leading economists in his native Hungary, and were only recently acknowledged as relevant in a socialist context.16 Beginning with the seminal article of Dumke, cliometric investigations tested the relative explanatory power of these alternative supply-side theories in the context of post-war growth in Western Europe.17 Both Dumke and Temin employed simple cross-country models regressing the average annual growth rate of real GDP per capita on initial income levels to account for convergence, 7 Denison, Why growth rates differ Kaldor, Causes 9 Kindleberger, Europe’s postwar growth 10 See Mankiw et al, ‘A conntribution’, among others. 11 Horvat, Towards a theory 12 Nurkse, Problems of capital formation; Lewis, ‘Development’ 13 Allen, ‘Capital accumulation’, Idem, Farm to Factory 14 Jánossy, The end of the economic miracle 15 Manz, Stagnation und Aufschwung; Abelshauser, Wirtschaft in Westdeutschland; Idem, Wirtschaftsgeschichte; Borchardt, Perspectives; Eichengreen and Ritschl, ‘Understanding’ 16 See Vonyó, Socialist industrialisation. The Hungarian Economic Review (Közgazdasági Szemle) published three influential articles by Tibor Erdős, Zoltán Román, and Ferenc Molnár in its 1967 volume that all laid a barrage of criticism on the Jánossy thesis. 17 Dumke, ‘Reasessing the Wirtschaftswunder’; Wolf, ‘Post-war Germany’; Temin, ‘The golden age’ 8 3 the share of agriculture in the labour force to measure lags in structural development, and the difference between real GDP per capita in 1938 and 1948 to reflect wartime dislocation. Vonyó developed a more sophisticated framework with panel regressions estimating country-fixed effects.18 He also showed that a conditional convergence model becomes over-specified with the inclusion of variables accounting for structural development that strongly correlate with differences in income levels. Instead, his model includes labour-force growth to account for labour-supply flexibility. The effect of the post-war output gap is estimated at two stages. The first stage separates the time-constant component from an interaction term that includes a linear time trend. In the second stage, the countryfixed effects are regressed on the values of the output gap measured in 1948. This paper applies a revised version of this model with four decadal intervals between 1950 and 1990 for an extended sample that includes 16 Western and 9 Eastern European countries (see notes to Figure 1). The only additional explanatory variable is a dummy for socialist economies. Since this distinction yields time-constant values, its effect is modelled in essentially the same way as that of the post-war output gap. Growthit = α + β1 Incomeit + β 2 Labgrowthit + δ1GAP* Time − δ 2 Socialist* 60s − δ 3 Socialist* 70s − δ 4 Socialist* 80s + ui + xt + ε it u = a − β 3 GAP − β 4 Socialist + e [1] [2] The only difference is that the variable is interacted with period-fixed effects, instead of a time trend. Unlike in the case of the output gap, we cannot a priory assume a gradual increase or decline of the effect of institutional divergence over time. Period-fixed effects are estimated separately, in order to isolate period-specific unobserved characteristics from the trajectory of socialist underperformance. The dependent variable is the average annual logarithmic growth rate of GDP per capita measured at constant prices. Income denotes the log ratio between the USA and country i in per capita GDP at the start of each decade. This modified specification turns the coefficient on convergence positive and gives a direct interpretation to the period-fixed effects as measures of relative growth performance.19 To account for the post-war output gap I take the average annual logarithmic growth rate of GDP per capita between 1938 and 1950 (between 1934 and 1950 for Portugal and Spain to reflect the impact of the Spanish Civil War).20 Hence the negative sign before the coefficient ß3. The positive sign before the δ coefficient indicates that the negative effect of wartime growth is assumed to gradually diminish over time. To estimate the impact of the output gap on post-war growth, we need to add δ1 to ß3 once for the 1950s, twice for the 1960s, three times for the 1970s and four times for the 1980s. The δ coefficients for the interactions of the socialist dummy with period-fixed effects measure if and to what extent the relative underperformance of command economies worsened compared to the 1950s. Labour-force growth is measured as the average annual logarithmic rate of increase in the size of the total economically active population as defined by the ILO: the number of those aged 15 and 18 Vonyó, ‘Post-war reconstruction’ 19 The typical specification of using initial income levels instead of distance to the frontier yields very large negative coefficients for convergence and large positive coefficients on dummies for subsequent periods since income levels increase over time across the whole sample. It also yields very large values for the intercept. 20 The more sophisticated specification used by Vonyó (2008) that tries to account for lost growth during the war years cannot be applied to this extended sample because GDP data for Eastern European countries in the interwar period is scarce and often of very poor quality. For the same reason, the gap cannot be measured before 1950. 4 above who supply their labour at a given point in time. This definition assures that the variable is not endogenous to economic growth. It does not automatically increase with employment because it includes the unemployed, too. It depends strongly on factors such as enrolment in higher education, or the retirement age. However, in the post-war period cross-country differences in labour-force expansion reflected above all differential rates of population growth that, in turn, can be explained mostly by international migration patterns. The size and direction of immigrant flows are determined primarily by international differences in income levels, not growth rates.21 In the post-war era, the western offshoots had the largest number of immigrants and also the smallest growth rates of GDP per capita among advanced nations. Furthermore, as the cases of colonial repatriates in France, the UK or the Netherlands and East German refugees in West Germany demonstrate clearly, immigration into European countries after 1950 was often driven by non-economic factors. II. Data Levels of both GDP per capita and population are derived from the most recent versions of the Maddison series. The contributors of the Maddison Project, a collaborative international initiative to update and extend comparative historical national accounts, provide estimates for most countries represented in my dataset.22 Data for East and West Germany separately, consistent with the Maddison series, are reported in the Total Economy Database of the Conference Board.23 Labour-force statistics, both for the total economically active population and its occupational structure, are drawn from the online database of the ILO for 1980-90, and from an ILO compendium for 1950-70.24 Any study of socialist economic development needs to treat data on national income with more than a modicum of suspicion. Official statistics were distorted to a large but non-quantifiable extent through several factors. Whereas physical output series are considered comparatively trustworthy, aggregates expressed in value terms reflect unrealistic producer prices, incorrect weighting inasmuch as industry was always attributed a higher than actual share in net material product, and inappropriate methods employed in the computation of index numbers.25 Estimates for the 1950s were particularly inflated as political leaders frequently required an upward correction of figures to support official propaganda. Thankfully, independent western research on East European economies established alternative national income series of superior quality. They relied on physical output indicators published in official sources, but computed index numbers by extrapolation from independently constructed benchmarks, and applied western national accounting standards. The most substantial work was carried out by the CIA and the U.S. Congress Joint Economic Committee for the U.S.S.R. and by the Research Project on National Income in East Central Europe (Research Project) under the leadership of Thad P Alton at Columbia University and the Riverside Research Institute in New York. In a long series of publications, the latter reported GNP estimates for Poland, Czechoslovakia, Hungary, Bulgaria, Romania, and Yugoslavia, which constitute the foundation of the Maddison data, besides the earlier work published in the pioneering Income and 21 Borjas, Economic research Bolt and Van Zanden, ‘Maddison Project’, data available online at: http://www.ggdc.net/maddison/maddisonproject/home.htm 23 Available online at: http://www.conference-board.org/data/economydatabase/ 24 LABORSTA Internet: http://www.laborsta.ilo.org; ILO, Labour-force estimates 25 Net Material Product was the national accounting concept used by CMEA countries. It is conceptually similar to GDP, but excludes services deemed unproductive, especially housing and the government. 22 5 Wealth series edited by Simon Kuznets.26 Although these alternative estimates have not been accepted without controversy, they remain widely acknowledged as the best available. The most heated debate surrounded the national accounts of the U.S.S.R. for the 1970s and 1980s. After the seminal paper of Khanin and Seliunin, several scholars claimed that even CIA figures overstated Soviet growth.27 However, serious doubts have been raised about the reliability of these radical re-estimates. There remains a lack of clarity concerning some of the sources and methods Khanin and Seliunin had used, which made some of their results non-replicable. Furthermore, they seem to have neglected serious index-number problems when estimating hidden inflation that formed a core foundation of their arguments.28 Therefore, most western academics have continued to adhere to the CIA figures, which have been repeatedly refined over the 1980s and early 1990s.29 The country with the weakest GDP data in East Europe is undoubtedly Albania. National accounts were poorly constructed, especially for the 1950s, and there is hardly any statistical evidence on output for the interwar years. Gaps were filled by Maddison with crude estimates constructed by averaging the growth rates of neighbouring countries. One way of controlling for the weakness of the Albanian data is to exclude them from the analysis. Another is to include a dummy variable, additional to the one accounting for the difference between socialist and non-socialist countries in the size of the country-fixed effects. The coefficients we thus obtain can be interpreted in two ways: (i) that we provide a purified measure for the underperformance of command economies that does not depend on inaccurate estimates, and (ii) that Albania had a unique growth experience even in comparison with other command economies. It remained effectively the only developing country in Europe, reflected both in low income levels and remarkably high rates of population growth by western standards. Albania was also governed throughout the post-war era by an autarchic Stalinist regime that showed more resemblance with North Korea than with other East European communist states. One additional country for which the Maddison data are highly questionable is East Germany. Levels reported in the Total Economy Database are derived from the work of Sleifer. The Federal Statistical Office constructed a benchmark for East and West German national income after reunification, which put the former GDR at 31 percent of the West German level in both GDP per capita and labour productivity in 1991. Sleifer computed an index of East German GDP for 1950-90, building on sectoral data reported by both the Research Project and the German Institute of Economic Research (DIW), and also by other West German publications.30 The time series can be considered reliable for the period after 1960, for which they correspond well, at least in terms of growth rates, with the more conservative estimates of Merkel and Wahl.31 However, between 1950 and 1960, the index numbers of Sleifer suggest much higher growth rates than what we can derive from the GDP levels computed by Ritschl and Spoerer based on the work of Merkel and Wahl.32 Furthermore, both series yield levels of GDP per capita for 1950 that are far too low to be acceptable, if one trusts the comparative literature on East and West German growth across World War II and the immediate postwar years. Grünig estimated East German GDP per capita in 1936 at 103 percent of West Germany.33 We can confirm this figure precisely with regional income levels published by the governing body of 26 For details see Maddison, World Economy, pp. 469-471. Åslund, ‘How small’; Ericson, ‘Soviet statistical debate’ 28 Harrison, ‘Soviet growth’, p. 159. 29 See Ellman and Kontorovich, Disintegration. 30 For details see Sleifer, Falling behind, p. 17 and pp. 176-178. 31 Merkel and Wahl, Das geplünderte Deutschland 32 Sleifer, Falling behind, p. 176; Ritschl and Spoerer, p. 26. 33 Grünig, ‘Volkswirtschaftliche Bilanzen’ 27 6 the U.S. occupation zone.34 However, if we extrapolate from the official 1991 benchmark both the Maddison data for West Germany and the index numbers of Sleifer for East Germany, then GDP per capita in the GDR in 1950 comes out to only 52 percent of the corresponding western level. This benchmark would suggest a much larger decline in East German national income between 1936 and 1950 than the most widely accepted estimate of Barthel.35 Instead of using weak output data from the early 1950s, I compute an East-West benchmark for GDP per capita in 1950 by accepting both the 1936 benchmark of Grünig and the estimated growth rate in net national income for 1936-50 by Barthel. This approach puts East German GDP per capita at 65 percent of the West German level in 1950 and yields more reasonable growth rates for the 1950s.36 For the period 1936-39, the growth rate of GDP per capita for the later GDR and Germany as a whole are assumed to be identical. Levels between 1960 and 1990 are determined by backward projection from the 1991 benchmark, using the GDP series of Sleifer and official population statistics.37 III. Empirical results The main regression results are summarised in Table 1. As shown in columns I and II, convergence as a principal driver of post-war growth is equally prominent regardless whether we estimate the model on the full sample, or only on Western Europe. The main quantitative effect of extending the analysis to command economies is that the coefficient on the post-war output gap becomes insignificant. We only obtain a statistically significant result, if the Socialist dummy is included in the model. Column III suggests that over the period, on average, Eastern European countries grew three percentage points slower annually than they should have based on the predictions of the supply-side model. However, this relative underperformance was not time constant. Once we include the interaction terms with period fixed effects, it becomes clear that the relative growth perfomrance of command economies worsened substantially and significantly only after the 1970s. We do not see the gradual deterioration stressed by previous scholarship or suggested by a simple glance at the regional growth differentials presented in Figure 1. If anything, the Eastern European growth record improved in the 1960s, following the experience of western economies. The 1980s represent a clear climacteric. Table 1 about here If we account for this factor, the combined effect of convergence and labour-supply flexibility appears even stronger than what we estimate for the group of western countries only. As shown in Figure 2, the structural dynamic of catch-up growth was also remarkably similar in Eastern and Western Europe. At the start of the post-war era, European economies present an almost perfect correlation between the share of agriculture in the labour force and their distance to the world productivity frontier. Furthermore, the correlation coefficient remains practically the same (r = 0.902), if calculated for a pooled sample over the entire period 1950-90. However, the potential for reconstruction growth becomes significantly smaller. A one percent annual decline in GDP per capita during the 1940s raised the growth rate in the following decade by 0.22 percentage points in Western 34 Länderrat des Amerikanischen Besatzungsgebiets, Statistisches Handbuch, pp. 600-601. I divided Berlin between the eastern and western sectors using the population shares according to the 1939 census. 35 Barthel, Ausgangsbedingungen, Table 61. 36 This benchmark is also very close to the estimates of Stolper and of Ritschl and Vonyó for comparative industrial labour productivity. For details, see Ritschl and Vonyó, ’The roots of economic failure’, Appendix: Table A3. 37 Statistisches Bundesamt, Bevölkerungsstatistische Übersichten, p. 24. 7 Europe but only by 0.18 percentage points in Europe as a whole, even after we control for socialism. This result accords with the earlier finding of Vonyó that the reconstruction dynamic was stronger for core western industrialised nations than for semi-peripheral countries.38 Figure 2 about here The results also show that the distinction between socialist and non-socialist economies makes an important contribution to our understanding of the European growth trajectory between 1950 and 1990. Whereas improved performance in the 1960s was a continent-wide phenomenon, driven by increased economic openness, domestic reforms and political rapprochement between the rival ideological blocs, the substantial underperformance during the 1980s is predominantly an Eastern European story. The growth deceleration in the West can almost entirely be explained by the fact that the core countries exploited their catch-up potential and that the growth-enhancing effect of the postwar output gap had long vanished. The relative underperformance of socialist economies remained uniform between the 1950s and late 1970s and only worsened significantly after 1980. Finally, column VI confirms that under the Stalinist dictatorship of Enver Hoxha, Albania had a dismal growth record even in comparison with other command economies in Eastern Europe. The inclusion of the dummy variable for Albania in the regression explaining the country-fixed effects does not alter the coefficient on the post-war output gap. Also, the trajectory of growth rates in Albania looked very similar to other members of the Soviet bloc, with a slowdown in the 1970s and virtual stagnation after 1980. The relative underperformance of other socialist countries in GDP per capita growth averaged 2.9 percent between 1950 and 1980 and 4.4 percent in the 1980s. This substantial gap comes across vividly on the scatter diagram in Figure 3. Eastern Europe was a world apart from the convergence club that emerged in the West between 1950 and 1990. The growth record of Albania was the most disappointing, but Poland and Romania also grew much slower than what would have been predicted by their initial conditions. Figure 3 about here What the diagram doesn’t show is an even more crucial fact behind the astonishingly large negative coefficient for the Albanian dummy: modest growth in GDP per capita despite exceptional labour-supply flexibility. Albania was not only economically, but also socially underdeveloped in a European context. This was reflected in the remarkably high rate of population growth that averaged 2.5 percent annually over the whole period, and which almost tripled the labour force. The post-war experience of Albania exemplified that of a Lewis-type developing country with unlimited supply of labour, where the vast reserves of underemployed workers in the primary sector alone would have sufficed to facilitate industrialisation. Any further expansion in the labour force acted to enhance the denominator in GDP per capita, and thereby slowed down economic growth. As in other developing nations, excessive population growth only conserved the dominance of agriculture in the economy, which still harboured 54 percent of all job seekers in the country in 1990. Table 2 about here 38 See Vonyó, ‘Post-war reconstruction’, pp. 231-233. Econometrically, the impact of the post-war output gap is reduced by the period-fixed effects, as the latter reflect the extent to which Europe as a whole rebounded from weak growth in the 1940s. Without the period dummies, the growth-enhancing effect of the output gap in the 1950s comes out to 0.34 percent p.a. for Western Europe and 0.28 percent for the full sample. 8 In order to trace the very substantial relative underperformance of Eastern Europe further, I reestimate the main regressions for a limited sample that includes only the 9 socialist economies. The results are reported in Table 2. Column I confirms that convergence was also a dominant aspect of post-war growth under central planning, as argued in Section I; if anything, even more important than in western countries. Although the limited sample does not allow us to use regression analysis to explain the country-fixed effects, it becomes clear from the results that reconstruction growth did not play a prominent role on the eastern side of the Iron Curtain. If the growth potential derived from the post-war output gap did not significantly decline over time, then this potential could not have been significant in the first place. The period-fixed effects further reduce the coefficient on the interaction term. They also turn the seemingly substantial impact of labour-force growth negligible and statistically insignificant. The decadal dummies make it clear that the growth record of socialist economies improved significantly between the 1950s and the 1960s, and deteriorated sharply in the 1980s. The 1970s only saw the reversal of the improvements of the previous decade. This result stands regardless whether the sample includes Albania or not. The most successful period for Eastern Europe in terms of economic growth was between 1960 and early 1970s. Socialist economic development was relatively most disappointing during the first and last decades of the period under investigation. For the latter, the explanation is well established and hard to refute. Analogous to the experience of developing regions, the 1980s were a period of deep structural crisis in most command economies. The oil shocks and the emergence of flexible production technology rendered their industries uncompetitive and generated large balance-of-trade deficits. Rising interest rates introduced to combat inflation in creditor nations meant that the cost of debt servicing after the substantial loans opened during the 1970s became much more expensive. With falling export revenue, the only way to avert a crushing balance-of-payments crisis was to limit imports and avoid additional borrowing, which lead to austerity and through that a contraction in aggregate demand. The three countries with reasonable growth rates after 1980 represented exceptions from this pattern. The USSR was one of the world’s main exporters of hydrocarbons, and thus enjoyed growth in export revenue. Czechoslovakia did not borrow extensively in the 1970s and thus did not need to tighten the belts. Hungary would have had to, but it joined the IMF in 1982, which secured its position as a debtor. Why the growth performance of the region during the 1950s was also much weaker than what would have been warranted by supply-side conditions is harder to explain. Both Marxian orthodoxy and neoclassical growth theory predict investment-led growth to be most successful at the early stages of planned industrialisation characterised by the lowest levels of capital intensity. Furthermore, the massive scale of wartime destruction and post-war dislocation attributed an enormous growth potential to Eastern European economies during the reconstruction period. However, the regression results indicate that the reconstruction dynamic was weak in socialist economies. As argued by Jánossy and confirmed econometrically by Vonyó, reconstruction growth was conditional upon adequate labour supply, upon which the long-run productive potential of the economy depended.39 This is the key concept to solving the puzzle. Whereas in Western Europe, World War II was mostly a war of destruction and dislocation, along the Eastern front, it was above all a war of extermination. This resulted in comparatively much larger population losses during the 1940s: thanks to colossal wartime casualties, both military and civilian; the Holocaust that affected most severely the 39 Jánossy, The end of the economic miracle; Vonyó, ‘Post-war reconstruction’ 9 countries where the European Jewry had been concentrated; and lastly the expulsion of minority Germans from East and Central European states and the former eastern provinces of Germany that were ceded to Poland and the USSR, in accordance with the Potsdam Agreement, after 1945. While the latter featured prominently in the literature of the West German economy, it has been largely overlooked in the economic history of Eastern Europe.40 As a means of collective punishment for the crimes of Nazi Germany, sixteen million Germans were uprooted between 1945 and 1951: two million deported to remote regions of the USSR, twelve million forcefully re-settled to Germany and Austria, with around two million fallen during the process or gone missing. The largest German minorities lived in post-war Poland and Czechoslovakia, which, as a result, also hit hard by the Holocaust, recorded the highest rates of decline in their resident population between 1939 and 1950. By contrast, the population of East Germany increased by ten percent over the same period, precisely due to the influx of German expellees.41 Figure 4 about here Due to the large variation across countries in population growth during the 1940s, labour-force expansion in the subsequent decade was not the determining factor of labour-supply flexibility. Hence the insignificant coefficients obtained on labour-force growth after controlling for period-fixed effects reported in Table 2. As shown in Figure 4, there was, if anything, a negative correlation between labour-force growth and the growth of GDP per capita during the 1950s. Theoretically, this could be explained with the possibility of labour reallocated from agriculture fuelling industrialisation in the early post-war period. However, since collectivisation was a long drawn-out process in several countries (Hungary, GDR), or did not take place at all (Poland, Yugoslavia), the farming sector had a limited capacity to release labour during the 1950s. Figure 5 about here The truth was that countries which recorded strong labour-force growth in the 1950s typically suffered the heaviest population losses during the 1940s. Thus their potential for reconstruction growth was constrained by severe labour scarcity at the onset of post-war recovery. The main exception was the GDR which could rebound strongly after 1950, despite a constant outflow of dissidents to West Germany, because the earlier influx of expellees had made its labour supply sufficiently flexible. Figure 5 correspondingly indicates a strong positive relationship between the growth of GDP per capita during the 1950s and population growth in the 1940s, with Albania once more the only outlier. IV. Further implications There are three main alternative explanations for the growth trajectory of the socialist economies in Eastern Europe that we can discuss briefly. The fact that this trajectory showed considerable improvement in the 1960s and early 1970s compared to the 1950s may be a reflection of: increased economic openness, increased political openness and with that a diminishing defense burden, and structural shifts in the composition of investment. 40 Ambrosius, ‘Der Beitrag der Vertriebenen’; Vonyó, ‘Bombing of Germany’; Braun and Mahmoud, ‘Employment effects’ 41 Reichling, Die deutschen Vertriebenen 10 Amidst rising Cold-War tensions and in response to the Marshal Plan, the members of the Soviet Bloc established the Council of Mutual Economic Assistance (or as it was known in the West the COMECON) in 1949. During the first ten year of its existence, it advocated a policy of national autarchy, which meant that there was very little trade even between member states. First the shift to ‘bloc autarchy’ in 1959 and later a gradual opening up to capitalist and developing markets increased both the export and import intensity of COMECON economies sharply until the early 1970s. Détente also brought with it opportunities for technological co-operation between eastern and western companies, that were particularly successful in car manufacturing. Increased openness might have led to a temporary improvement in the relative growth performance of command economies. However, this hypothesis is difficult to test in the present framework. The empirical literature has experimented with different measures of openness and several of them might have affected socialist development contemporaneously. Furthermore, the inclusion of any measure of openness in the present model would be problematic because, after controlling for size, most of the variation would be across the socialist-non socialist divide. Therefore, openness would strongly correlate with the Socialist dummy and thus the coefficients would reflect the effect of other unobserved factors. This is something we can exploit to test for the lack of openness as a significant limiting factor of post-war growth in Eastern Europe. As all socialist countries lagged behind other nations at a similar developmental stage in openness, theory would predict that this should have limited the growth potential of the smallest countries the most. Large, complex economies, such as the USSR, but even Poland or Yugoslavia, were able to exploit economies of scale and concentrate resources within national borders, and thus were less dependent on foreign trade. However, as shown in Figure 6, we can only observe weak and statistically insignificant correlations between population size and relative growth performance among socialist economies. Figure 6 about here The era of Détente that gave rise to the strategic concept of peaceful coexistence, codified in the Helsinki Accords of 1975, might have improved conditions for economic growth east of the Iron Curtain through another channel instead. When tensions between the nuclear superpowers were tense, Eastern European economies carried a comparatively large defense burden. As the latter diminished after the early 1960s, more resources could be allocated to productive use, like investment in new machinery and plant. During the 1980s, this process was reversed as the Cold War intensified once again. While this argument is very convincing, it requires further data to explore. Estimating the defense burden is a difficult and laborious task, which has only been carried out for the USSR and mainly for the 1970s and 1980s. As a first attempt, cross-country data could be collected to construct consistent estimates on the share of national income devoted to military spending. Finally, conditions for growth might have improved in the 1960s and worsened in the 1980s due to structural shifts in investment activity. At times of great structural transformation, when production moves from agriculture to industry or from the latter to services (as in the 1950s and 1980s in both Eastern and Western Europe), economies need to allocate substantial resources to build new infrastructure. Once, the new buildings stand, investment shifts from structures to equipment, as the latter are exposed to a much higher rate of depreciation. Equipment investment, in turn, is seen as a prime determinant of long-run growth in endogenous growth models and empirical research built on 11 them.42 The implication of this insight is that even at constant rates of investment, socialist economies might have spent a substantially higher proportion of national income on productive machinery during the 1960s and early 1970s than they did in the 1950s and 1980s. To test this hypothesis requires detailed statistics that allow us to construct reliable series of investment disaggregated into different types of capital, methodologically consistent both across countries and over time. For early years, this is only possible for a few Central European countries with sufficiently good data, and thus it cannot be incorporated into the cross-country analysis presented in this paper.43 V. Conclusions The falling behind of command economies in Eastern Europe during the post-war era has inspired economists and historians alike and featured prominently in the literature on comparative economic development. Much effort has been invested into defining the causes of this relative underperformance, but the question by how much socialist economies actually underperformed compared to other nations at a similar developmental stage and facing similar supply-side conditions has not been answered. In this paper, I applied a model with country-fixed effects to isolate the differential in growth rates of per capita GDP between socialist and non-socialist economies from supply-side factors that influenced relative growth performance during the post-war period. Controlling for convergence, labour-supply flexibility, and the gradually diminishing effect of the temporary output gap caused by wartime destruction and war-induced dislocation, being a command economy still reduced annual growth rates by a significant margin. Given their growth potential, and controlling for period-fixed effect, socialist countries lagged behind western growth rates by almost three percentage points annually between the 1950s and the 1970s. This already wide gap increased to 4.5 percentage points in the 1980s. Europe’s only developing country, Albania, which yoked under an autarchic Stalinist regime, compared very poorly even with other command economies. 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Eichengreen, ed., Europe’s post-war recovery (Cambridge, 1995). 14 Table 1 Regressions explaining economic growth in 25 European countries I II III IV V VI Initial income 3.2639*** (3.86) 3.3983*** (4.75) 3.3983*** (4.75) 3.7686*** (5.77) 4.1206*** (9.74) 4.1569*** (9.83) Labour-force growth 0.3120* (1.84) 0.5078*** (3.38) 0.5078*** (3.38) 0.2850* (1.96) 0.2870** (2.14) 0.2869** (2.14) Output gap * Time 0.1332** (2.01) 0.9952*** (3.17) -0.3009 (-0.66) -0.7816 (1.52) 0.1294*** (2.95) 0.7474*** (2.82) -0.5232 (-1.50) -1.3683*** (-3.64) 0.1294*** (2.95) 0.7474*** (2.82) -0.5232 (-1.50) -1.3683*** (-3.64) 0.0888** (2.19) 1.1407*** (4.13) -0.0265 (-0.07) -0.4474 (-1.12) 0.0852** (2.28) 1.1618*** (5.80) 0.0852** (2.28) 1.0254*** (6.34) -0.3475 (-1.51) Socialist * 60s -0.6680* (-1.73) -0.3832 (-1.15) Socialist * 70s -0.5253 (-1.32) Socialist * 80s -1.8415*** (-4.37) -1.5879*** (-4.57) -1.4614*** (-4.42) -0.3494 (-0.50) -0.7701* (-1.79) -0.8027* (-1.86) 100 48.96 0.83 100 56.64 0.83 1960s 1970s 1980s (constant) 0.9085 (1.38) N F R2 64 22.50 0.76 Output gap -0.0916 (-0.12) -0.0916 (-0.12) 100 100 100 43.34 43.34 38.65 0.79 0.79 0.84 Regressions explaining country-fixed effects -0.3526** (-2.54) -0.1861 (-0.74) Socialist -0.4103** (-2.65) -0.2780* (-1.72) -0.2598 (-1.48) -0.2652** (-2.12) -3.2342*** (-6.49) -2.7274*** (-5.27) -3.2643*** (-5.77) -2.9144*** (-6.66) Albania (constant) N F R2 -0.3850* (-1.69) -4.5877*** (-4.38) 0.3111 (1.45) 0.1669 (0.46) 16 6.48 0.32 25 0.54 0.02 1.4208*** (4.41) 25 21.84 0.67 1.1556*** (3.45) 25 14.03 0.56 1.3376*** (3.66) 25 16.69 0.60 1.3985*** (5.13) 25 28.31 0.80 Note: The dependent variable in the fixed-effects regressions is the logarithmic annual growth rate in GDP per capita averaged over a decade. The superscripts *, ** and *** indicate significance at the 10, 5 and 1 percent levels respectively. Model (I) is estimated for 16 non-socialist countries only. Models II and III only differ in the regression explaining the country-fixed effects. 15 Table 2 Regressions explaining economic growth in 9 East European countries I II III IV V Initial income 6.6435*** (5.82) 4.5555*** (3.98) 5.0055*** (7.27) 6.1959*** (5.72) 4.8435*** (6.63) Labour-force growth 1.0293** (2.34) 0.1170 (0.41) 0.0829 (0.31) 1.4226*** (3.22) 0.2071 (0.59) Output gap * Time 0.0783 (0.81) 0.0523 (0.99) 0.0476 (0.93) 0.1057 (1.18) 0.0550 (1.01) 1960s 1970s 19 80s (constant) Albania included N F R2 -6.9866*** (-4.62) YES 36 15.35 0.66 0.6861* (1.67) -0.2437 (-0.50) -2.0518*** (-3.90) -3.0585* (-1.70) YES 36 37.23 0.91 0.8447*** (3.30) 0.8057*** (2.89) -1.8518*** (-5.56) -3.7807*** (-3.64) -1.8358*** (-4.30) YES 36 46.21 0.91 -5.7933*** (-4.42) NO 32 19.04 0.73 -3.1523*** (-2.97) NO 32 40.33 0.91 Note: The dependent variable in the fixed-effects regressions is the logarithmic annual growth rate in GDP per capita averaged over a decade. The superscripts *, ** and *** indicate significance at the 10, 5 and 1 percent levels respectively. 16 Average annual growth rate in GDP p.c. (%) 6 West 5 South 4 East 3 2 1 0 1950s 1960s 1970s 1980s West: Austria, Belgium, Denmark, Finland, France, Germany (West), Ireland, the Netherlands, Norway, Sweden, Switzerland, and the United Kingdom. South: Greece, Italy, Portugal and Spain. East: Albania, Bulgaria, Czechoslovakia, Germany (East), Hungary, Poland, Romania, the USSR and Yugoslavia. Figure 1 Economic growth in Europe 1950-1990 Source: Total Economy Database (GDP measured in 1990 Garry Khamis dollars) 17 2.5 ROM 2 r = 0.925 YUG BUL 1.5 GRE POR ESP HUN POL 1 GDR GER NOR .5 BEL USSR AUT FIN CZ IRL ITA FRA NL SWE DK UK CH 0 Income gap relative to the USA (ln ratio) ALB 0 20 40 60 80 Share of agriculture in the labour force (%) Figure 2 Structural underdevelopment in Europe in 1950 18 4 ITA AUT FRG 3.5 YUG BUL FIN 3 ROM IRL GDR BEL HUN USSRCZ 2.5 FRA NOR NL DK SWE ALB UK CH 2 POL 1.5 Annual growth rate in GDP p.c. 1950-90 (log%) GRE ESP POR 0 2000 4000 6000 8000 10000 GDP per capita in 1950 in 1990 GK dollars Actual values Fitted values* * The regression line is fitted to the actual values of 16 West European countries Figure 3 Economic growth and convergence in Europe 1950-1990 19 5.5 5 GDR 4.5 YUG 4 ROM CZ HUN 3.5 USSR ALB 3 Annaul rate of growth in GDP per capita (log%) BUL POL -.5 0 .5 1 1.5 Annual rate of labour-force growth (log%) Figure 4 Socialist economic growth and labour-force expansion in the 1950s 20 5.5 5 GDR 4.5 YUG 4 ROM CZ HUN 3.5 USSR ALB 3 Annual growth rate in GDP p.c. 1950-60 (log%) BUL POL -2 -1 0 1 2 Annual rate of population growth 1939-50 (log%) Figure 5 Demographic constraints and socialist economic growth in the 1950s 21 4 3.5 3 BUL ROM GDR HUN 2.5 Annual growth rate of GDP p.c (log%) YUG CZ ALB 2 POL 0 10 20 30 CZ BUL HUN 0 YUG POL -2 ROM ALB -4 Annual growth rate country FE (log%) 2 GDR 0 10 20 30 Average population size 1950-90 (million) Country-fixed effects derived from column III in Table 2. Figure 6 The impact of size on relative growth performance 1950-90 22