*** RECONSTRUCTING YUGOSLAVIA: WHAT�S THE MODEL? *** By Richard F. Kaufman and Janine R. Wedel (Editor�s Note: Prime Minister Tony Blair said that the Serbian people are completing the democratic revolution that the Polish began in the 1980s. The United States and the EU have promised to end economic sanctions against Yugoslavia and begin economic aid once the Vojislav Kostunica government takes power. The popular rejection of Milosevic is certainly a victory for democratic forces, but amidst the celebration there should be questions about the economic conditions and policies that may be associated with aid and loans to the new government--not only from the EU and the United States, but also from the IMF and World Bank. Richard Kaufman and Janine Wedel offer timely background on the potentially destabilizing impacts of Western aid to Yugoslavia and other transitional states from FPIF�s new book, Global Focus: U.S. Foreign Policy at the Turn of the Millennium (St. Martin�s Press, 2000). An excerpt about Yugoslavia from this essay follows.) The democratic upheavals of 1989, the collapse of the Soviet Union, and the demise of the Warsaw Pact were widely interpreted as cold war victories for free market capitalism. Throughout the region there was a sense of liberation from politically repressive and economically restrictive systems and a widespread desire to �return to the West.� Washington viewed its task as assisting with reforms in order to rapidly establish democracy and capitalism in the former communist countries of Central and Eastern Europe. After the breakup of Yugoslavia, several of the newly independent countries of the former Yugoslav federation were assisted by the West as well. The conventional view among Washington policymakers is that their reforms have mostly succeeded. As a March 1999 State Department report put it, �A region that was once the tinderbox of European conflict has become an area of increasing stability, security, and prosperity.� This unfortunately timed statement was contained in a document issued just days before NATO began bombing Yugoslavia. In reality, the record of the transitions to democracy and capitalism in Central and Eastern Europe is mixed: there have been successes, and there have also been failures and lost opportunities. Beginning in the early 1990s, there were voices who cautioned that there could be social and political backlashes if swift transitions to market economies caused severe economic disruptions, high unemployment, and increased poverty. Today, those who believe that the reforms worked argue that those fears were exaggerated. On the political side, conditions in the region are vastly improved over the communist period. One-party rule is over. Nearly all the countries have held free, multiparty elections, and civil liberties have been largely restored. On the economic side, however, sweeping claims of victory are premature and obscure the mistakes committed, the continuing turmoil, the regional disparities, and the serious problems that remain. With regard to security, the 1999 war in Yugoslavia demonstrates the persistence of internal instabilities and regional tensions. Yugoslavia was among the first countries in Eastern and Central Europe where economic reforms were attempted following the 1989 revolutions. In late 1989, Prime Minister Ante Markovic announced a program aimed at stabilizing the economy through rapid convertibility of the local currency (the dinar), cuts in government expenditures, and continuation of a privatization program enacted by the federal parliament a few months earlier. These �shock therapy� measures aimed at radical transformation of the economy were foisted upon the government by the IMF and the World Bank, and were promoted by Harvard economist Jeffrey Sachs. Almost simultaneously, the Polish government adopted a similar reform package, also recommended by the multilateral banks and promoted by Sachs. In 1990, the Czech Republic announced its own shock therapy reforms after the World Bank and the IMF conditioned loans to adoption of these reforms. More than anywhere else in this region, Yugoslavia defies facile assertions that Central and Eastern Europe have made smooth transitions to Western-style democracy and capitalism, or that fears of a backlash to �reforms� were exaggerated. In Yugoslavia, the inappropriately harsh reforms prescribed by the international financial institutions and foreign advisers were among many factors that contributed to the disintegration of political and civil order and the collapse of the state into nationalist regimes. As mentioned earlier, Yugoslavia, in an effort to cope with its foreign debt, was among the first to try the kind of economic �shock therapy� medicine later prescribed for the other former communist countries. As Susan Woodward (who served as a UN special representative in the former Yugoslavia in 1994) wrote in her history, Balkan Tragedy, the post-cold war period was a time �when the economic austerity and reforms required by a foreign debt crisis triggered a slide toward political disintegration.� Yugoslavia was among the many countries whose economy was affected by the increase in energy prices in the early 1970s, followed by a recession in the West and the decline of world trade. At that time, international commercial banks were eager to recycle �petrodollars� by lending money to poorer countries at low interest rates, and Yugoslavia borrowed heavily in order to maintain the growth of its economy. But in the late 1970s another sharp rise in oil prices inflated bank interest rates--which were pegged to the U.S. dollar--to double-digit figures. Meanwhile, the commercial banks cut back on loans to Eastern Europe, including Yugoslavia. Belgrade sought to counter its debt crisis by adopting measures to restrict imports of consumer goods and encourage greater exports. These efforts to improve the trade balance failed; domestic production fell and imports continued to exceed exports. The results were aggravated balance of payments and foreign debt problems. In the 1980s, Yugoslavia borrowed even more from the International Monetary Fund, the OECD (Organization for Economic Cooperation and Development), other governments, and commercial banks in order to stabilize its foreign debt. Initially there was improvement in the external accounts, but the economy stagnated and debt payments had to be repeatedly rescheduled. Toward the end of the 1980s, only the IMF would provide additional loans. These loans always came with conditions attached, requiring more belt tightening measures from Belgrade. In 1987, the IMF�s conditions also included overtly political demands for increased federal authority over Slovenia, Croatia, and the other autonomous republics, in order to facilitate implementation of the austerity measures and economic reforms. In the republics, these recommendations were viewed with deep suspicion. By 1988, Yugoslavia�s economy had deteriorated badly, with inflation close to 200% and unemployment at 15%. The IMF advanced another loan with conditions that included limits on wages, government spending, and the money supply; the removal of price and import controls; and the beginning of a privatization program. The government�s efforts to enforce those conditions led to further difficulties, including food shortages and pay cuts. In reaction, there was a series of strikes and protests and a wider split between the federal government and the republics, where there was rising opposition to Belgrade�s efforts to broaden the powers of the federal government. Complicating the situation were the heightened tensions among the various ethnic groups. These included Serbs, Croats, Slovenes, Macedonians, and Montenegrins--who were each the majority within their respective republics but were minorities in one another�s republics--along with other minority groups such as Albanians and Muslims. Beginning in 1990, there were protests in Slovenia, where a Serbian domination plot was suspected. These were met by an explosion of Serbian nationalism led by then-communist party boss Slobodan Milosevic, a neo-Stalinist who supported moves for greater control by the federal government over the various regions. This included Kosovo, which had been granted status as an autonomous province rather than a republic. Milosevic manipulated public opposition to the economic austerity measures to gain support for his brand of Serbian nationalism. Those in Serbia who supported the economic reforms and the federal arrangement as it had existed became politically isolated. Slovenia and Croatia, both exhibiting broad support in principle for the liberal economic system that the reforms were attempting to achieve, became increasingly wary of Serbian nationalism and the threat to the republics. With the economy worse than ever, Prime Minister Branko Mikulic resigned at the end of 1988 and was replaced by Ante Markovic, who proceeded to implement the reforms set in motion by the IMF and the government�s Western advisors. But the economic decline persisted, and at the end of 1989, Markovic unveiled a �shock therapy� stabilization program requiring additional cuts in spending. In 1990, a new privatization scheme was announced in which shares in firms would be given to workers and managers. As late as 1990, Washington still believed things were going well in Yugoslavia. The Central Intelligence Agency reported that the economic stabilization program adopted the year before �makes bringing down inflation its first priority and has currency reform and a tight monetary policy as its centerpieces.� The CIA stated in a report submitted to the Joint Economic Committee that the initial results were favorable but that tougher measures needed to be implemented. However, U.S. policy toward Yugoslavia was shifting. Once communism collapsed in Central and Eastern Europe, the special relationship Washington had maintained with Yugoslavia seemed less important than it had been during the cold war. In the early 1980s, the State Department had helped organize a consortium of banks, called �The Friends of Yugoslavia� to assist that country with its foreign debt problem. However, later in the decade, the Bush administration rejected a request by Markovic�s government for economic assistance with the reform process. Fighting broke out in 1991 in Slovenia and Croatia, which had been the first republics to gain their independence. Eventually an extremely bloody civil war and an �ethnic cleansing� campaign were waged in Bosnia-Herzegovina. By 1994, an estimated 200,000 people had been killed, and 3.4 million more were made refugees or displaced persons before that republic achieved independence. In 1999, a decade of violence was capped with a new war in Kosovo, when the NATO alliance attacked Serbia in response to the intensified persecution of Kosovar Albanians. It will never be known whether the train of political and military events that began in 1989 could have been prevented or ameliorated. Although there was a multitude of factors involved, a better outcome may have resulted if the West had adopted a more flexible approach to Yugoslavia�s financial and economic needs before the state broke apart. The U.S. and the West lost whatever chances there were to deal with Yugoslavia�s economic problems before they grew to crisis proportions, helping to ignite extreme ethnonationalism. Recommendations U.S. and Western economic policies toward the countries of Central and Eastern Europe following the collapse of communism were a patchwork of grants, loans, and technical assistance. The policies were generally not well-conceived, adequately coordinated, or wisely implemented. No one should be surprised that such a mixed bag has netted mixed results. It was most unfortunate that a critical (if not the leading) role was given to the international financial institutions and especially the IMF. Their ideas for transforming the economies of the region were poorly designed and contributed to the deep and prolonged economic downturns and disruptions that spread throughout the region. The repercussions of the unemployment, poverty, corruption, and other social ills and injustices that ensued are still being felt, and large segments of the population are still suffering. A successful assistance program must include the following reforms. 1. There is a need to change the approach to assisting countries in transition. �Shock therapy� and other rapid or radical changes should not be employed unless accompanied by countercyclical programs to prevent or soften the effects of economic downturns. Such ameliorating measures must protect children, the elderly, and other vulnerable parts of the population. 2. In assessing the results of assistance, there should be less reliance on traditional macroeconomic indicators--such as gross domestic product, inflation rates, foreign direct investment, and budget and trade deficits--and greater emphasis: (1) on the presence of an institutional framework, such as a legal and regulatory infrastructure for a market economy; (2) on democratic governance; and (3) on social indicators such as education, health, poverty, and the environment. Often policies that respect local opinion and democratic practices will help produce sustainable change. 3. Programs--such as the privatization of state-owned enterprises and the removal of trade barriers and price controls--should not be undertaken as ends in themselves but should be matched by actions that assure greater accountability, competition, legal justice, and fairness. 4. Substantial amounts of targeted grant assistance--not just technical advice--should be extended to countries in transition in order to improve social and environmental conditions. Preservation and improvement of the social safety net should be considered as important as any other part of a reform proposal. (Richard F. Kaufman <[EMAIL PROTECTED]> is director of the Bethesda Research Institute and an associate of Economists Allied for Armed Reduction. He specializes in international economics and national security. Janine R. Wedel <[EMAIL PROTECTED]> is an associate professor at the Graduate School of Public and International Affairs at the University of Pittsburgh. She has studied East Europe�s evolving economic and social order for 20 years, conducted 8 years of fieldwork in the region, and published 3 books.) --------------------------------- The Progressive Response 6 October 2000 Vol. 4, No. 38 Editor: Tom Barry ---------------------------------------------------------------------- --- The Progressive Response (PR) is a weekly service of Foreign Policy in Focus (FPIF)--a "Think Tank Without Walls." A joint project of the Interhemispheric Resource Center and the Institute for Policy Studies, FPIF is an international network of analysts and activists dedicated to �making the U.S. a more responsible global leader and partner.� We encourage responses to the opinions expressed in PR and may print them in the "Letters and Comments" section. 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