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07. The World Economy at the Beginning of the Twenty-First Century

The year 2001 marked not only the beginning of the twenty-first century but also
the end of the first decade of experience with a truly global economy. Since the definitive
collapse of the Soviet Union in 1991, nearly every nation in the world has accepted the
need to adjust its own economic policy and structure to the demands of the emerging
global marketplace. When President Boris Yeltsin of Russia pronounced the Soviet
Union dead and dissolved at the end of the failed coup against Mikhail Gorbachev in
August 1991, he also proclaimed the definitive failure of the Communist experiment with
centrally planned, essentially self-sufficient economies. From that time one, policymakers
in each country, regardless of their political ideology, have had to come to terms with
market forces that have swept around the earth.
The new winds of change carry the consequences of startling advances in
information and communications technology, informing millions of people everywhere of
new possibilities for employment and consumption and thousands of firms of new
opportunities for investment and growth. Small wonder that capital, labor, and product
markets respond with volatile prices and disconcerting quantity movements. Already,
political forces in some countries are reacting to insulate their constituencies from of the
consequences of globalization. Malaysia maintains the capital controls it imposed in
1998, pointing to the apparent success of mainland China in sustaining rapid growth with
strict capital controls. The European Union countries tighten their acceptance of refugees
while the United States increases its Border Patrol on the Mexican border. Non-tariff
barriers arise everywhere in the industrialized countries on new pretexts of environmental
and human rights safeguards. No one can predict how the various countries and regions
of the world will adapt to this new historic epoch of rapid technological change combined
with the opening of new markets. The current global marketplace is not immune to major
disasters and setbacks.
How did this new global economy emerge in the first place? It seems clear that
the economic success of western Europe in recovering so quickly and definitively from
the devastation of World War II was instrumental by setting an example. Gradually,
individual countries in other regions of the world found their own methods to imitate the

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European success. The first, and most noteworthy, follower in Europes footsteps was
Japan; indeed, the Japanese boom was both longer and stronger than Europes long
postwar boom. From the late 1940s to the early 1970s, the growth rate of Japanese GDP
was in excess of 10 percent annually, unique in the history of economic growth. By 1966,
Japan had become the second largest economy in the world, which it remains to this day.
In the relatively depressed 1970s and 1980s its growth slowed somewhat but was still
higher than that of most other areas of the world economy. Not until the 1990s did it
suffer a prolonged slowdown and an increasing crisis of confidence in its economic
institutions.
Although frequently referred to as a miracle, there were, as in Europe, solid
reasons for this performance. First was the phenomenon of technological catch-up. From
the late 1930s to the late 1940s, the Japanese economy had been isolated from the rest of
the world, and Japan could borrow many technological innovations at minimal cost. That
is scarcely a sufficient reason for Japans high growth rate, however; if it were, many
other countries would have done likewise. More important was Japans high level of
human capital, which enabled Japan to take advantage of superior technology. Moreover,
after Japan made up for its technological lag it became a leader in introducing new
technology, especially in such areas as electronics and robotics. For this it could draw on
not only its stock of human capital but also the high levels of saving and investment of
the Japanese people, as well as the sophistication of Japanese management, which
realized the high payoffs of industrial research and development. All this was combined
under the direction of a stable government that was committed to realizing and
maintaining export-led growth, even more so than its European exemplars.
Japan consistently ran the largest export surpluses in the industrialized world.
Finally [but not exhaustively], and more speculatively, one might cite the spirit or
mentality of the Japanese people more collectivist [in a general sense], more
cooperative, more given to team play. This is manifest in both the attitudes of employers
toward their employees, with lifetime employment the rule in most firms until the malaise
of the 1990s forced unemployment rates even higher, and in government policy, with
provoked the epithet Japan, Inc., as applied by some critical western observers.

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Other Asian countries, led first by South Korea and Taiwan, also had extremely
high growth rates for both total output and foreign commerce; by 1990, they were joined
by Thailand, Malaysia, and even Indonesia as it reoriented its economic strategy away
from dependence on oil exports. Several of the reasons for Japanese economic success
could also apply to them high savings rates, a well-educated population, and stable
governments that supported export-led growth. They had the further advantage of an
elastic supply of labor as their baby booms of the 1960s came of age and migrated from
the countryside into the major cities and the state-of-the-art factories built by Japanese or
American multinational firms. Urbanization and factory work also had the effect of
reducing fertility rates remarkable quickly, so that the proportion of the population in the
prime working age groups rose sharply.
Singapore and Hong Kong occupied very special positions in the international
economy, although the provision of the 1964 treaty between the United Kingdom and the
Peoples Republic of China, according to which Hong Kong reverted to Chinese
sovereignty in July 1997, caused much anxiety among that territorys Westernized
population. Overall, the Pacific Basin area, including Australia and New Zealand, which
had been a marginal participant in the world economy before the mid-twentieth century,
became a major actor in the last quarter of that century.
Such was not the case for Latin America, whose countries found it difficult to
shift course from import substitution industrialization to export-led industrialization. The
oil shocks of the 1970s led to increasingly unfavorable trade balances, especially those of
Argentina, Brazil, and Mexico. To finance the deficits, Latin American governments
found easy credit from international banks awash with deposits of oil revenues from the
OPEC cartel members. The alarmingly high levels of international indebtedness in the
1980s threatened the entire system of international payments when the dollar
strengthened sharply in the early 1980s.
In the 1990s, however, some progress began to be made as Mexico tried to follow
the example of Chile in encouraging foreign investment and expanding exports,
especially into the North American Free Trade Area. Despite the setback of the Mexican
peso crisis in 1995, other Latin American countries continued to switch toward
apertura policies, gradually opening up their economies and financial systems to the

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global markets. Argentina stopped dead its bouts of inflation by establishing a currency
board that made the peso fully convertible with the U.S. dollar. If that experiment with
dollarization proves successful, one may expect other Latin American countries to
follow, as did Ecuador at the end of 1999. As both trade and output rose to record levels
for the world as a whole at the close of the twentieth century, Africa remained a dark
cloud on the horizon.
The new nations that emerged with the end of European colonialism lacked the
necessary resources, both natural and especially human, to cope with the complexities of
a modern economy. Political circumstances likewise hindered efforts of economic
development. Ethnic enmities engendered frequent civil wars and coups detat. Most
nations fell under the sway of one-party governments with varying degrees of dictatorial
control.
In the Republic of South Africa, long dominated by its white minority of British
and [mainly] Boer descent, the black majority finally obtained something approaching
political equality in the early 1990s. But ethnic rivalries and resorts to violence among
factions of the majority threatened to vitiate any economic advantages that might have
resulted. The extreme ethnic and language diversity of the African continent appears to
have stymied efforts to build the institutions of property rights and contract enforcement
necessary to obtain the benefits of market-based capitalism. The poorest, and slowest
growing, countries in the world continue to be in Africa, the continent most plagued by
disease, civil war, genocide, and unstable governments.
Another region of the world that has acquired greatly increased economic
significance in the latter part of the twentieth century is southwest Asia, or the Middle
East. The reason for its increased economic importance can be succinctly summarized in
a single word: oil. Oil was discovered in Iran [then called Persia] in the first decade of the
twentieth century, and subsequently in several Arab states bordering the Persian Gulf
Iraq, Saudi Arabia, Kuwait, and the smaller emirates but as late as 1950 the region
accounted for little more than 15 percent of total world production. The United States at
that time was still far and away the largest producer, with more than 50 percent of the
total.

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In 1960 those countries, along with Libya and Venezuela, formed the
Organization of Petroleum Exporting Countries, OPEC, which several other countries
later joined. By 1970 OPEC nations accounted for more than one-third of total world
energy production. In 1973, in the wake of the fourth Arab-Israeli war, they acted in
cartel fashion to increase sharply the price of crude petroleum, an action they repeated
later in the decade, with the result that the world price rose from $3 per barrel in 1973 to
$30 in 1980, a ten-fold increase. Given the world economys high degree of dependence
on petroleum by that time, the effect on the economies of both highly industrialized and
developing nations was devastating.
The developing nations suddenly faced much larger deficits in their balance of
payments, forcing them more deeply into debt, whereas the industrial nations
encountered stagflation stagnation of output and employment combined with
inflationary price rises. The situation persisted until 1985, when the U.S. dollar was
reduced in value on the foreign exchange markets by concerted action among the central
banks of the industrialized economies. By 1986, the price of oil dropped dramatically, the
dollar was weaker, and inflation had been brought under control throughout the
industrialized world. Unemployment, nevertheless, remained high, although growth rates
began to pick up again. Despite the reduction in the price of oil, demand for it did not
grow as rapidly as total output, a marked change from the conditions of the 1950s and
1960s.
Even the short-lived invasion of Kuwait by Iraqs dictator Saddam Hussein, in
1990, caused only a small and brief rise in the price of oil. It fell again as soon as Iraqs
forces were ejected even though it took several years for Kuwaits oil production to come
back to earlier levels. Thanks to the increased efficiency with which energy was used in
the industrialized world and the increased availability of alternative sources of energy,
when the price of oil suddenly tripled again in 2000, the effects were not nearly as
dramatic as in the 1970s.

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The Collapse of the Soviet Bloc

In the latter half of 1989 a series of events unfolded in eastern Europe that was as
momentous as it was unexpected: the [mostly peaceful] overthrow of Communist regimes
in one country after another. Poland and Hungary led the way, but few outside observers
expected the other nations to follow suit. Amazingly, they did so: Czechoslovakia, East
Germany, Bulgaria, finally Romania, and, belatedly, Albania.
A mixture of political and economic motives underlay the revolt of the masses, in
the once Communist-dominated lands. The regimes in those countries had been imposed
by the Soviet Union without the consent indeed, against the will of the people. Had
those regimes been able to deliver on their promises of improved material conditions and
a higher standard of living for the people, the latter probably would accepted their
deprivation of liberty; but the regimes did not. On the contrary, the material
circumstances, including living and working conditions, of the masses steadily
deteriorated, in contrast to the ease and abundance that they could observe on television
in their Western neighbors, and to the lavish lifestyle of the new ruling class, the upper
echelons of the Communist parties, word of which gradually filtered out.
The masses had shown their displeasure on several occasions in the past: East
Germany in 1953, Hungary in 1956, Czechoslovakia in 1968, and Poland more than
once. On those occasions the Soviet Union had used armed forces to quell the rebellions
[or, in the case of Poland, that regimes own armed forces]. Why it did not do so in 1989
is an interesting question that will be explored shortly; but it did not. The roots of popular
discontent were thus deep, and although the sudden success of the revolts took the world
the Communist leaders as well as Western observers by surprise, some harbingers
could be observed.
In 1980 Polish workers led by Lech Walesa, an electrician in the shipyards of
Gdansk, formed a labor federation, Solidarity, independent of the state and of the
Communist Party. The regime tolerated it for a time, but in December 1981 the
government proclaimed martial law ostensibly to prevent Soviet intervention and
imprisoned Solidaritys leaders. Unrest continued; in April 1989, in an effort to defuse
the unrest, the government again legalized Solidarity, and arranged for partially free

7
elections in June [partially free, because a majority of the seats in the Sejm, or
parliament, were reserved for government candidates]. When Solidarity won all but one
of the seats that it was allowed to contest, one of its leaders became prime minister under
a Communist president in September 1989.
This opened the possibility for economic reform to make the transition from a
centrally planned to a capitalist market economy. The strategy employed by the finance
minister, Lescek Balcerowitz, was dubbed shock therapy. This began in January 1990
with deflationary measures combined with liberalizing prices and remove trade barriers.
Unfortunately, his reduction of government expenditures undermined his political
support. Only proceeds from rapid privatization could keep the government budget in
balance. But several factors discouraged foreign investors from buying into the large state
enterprises, after small and medium-sized state enterprises producing for local market had
been privatized. The lack of proper cost accounting records combined with the
uncertainty of future markets for the output of coal mines, steel mills, and shipyards made
any investment risky. In addition, Poland was reluctant to cede managerial control to
foreign companies, who would have no political constraint against laying off most of the
labor force. Finally, Poland had accumulated a large stock of existing foreign debt owed
to Western governments and financial institutions, which it could no longer repay.
For all these problems, after ten years of rapid changes of government and rebuffs
by the European Union and foreign investors, Poland had become the first transition
economy to recover its pre-1990 level of output and moreover achieve sustained
economic growth. In retrospect, it appears that the political confusion created by making
so many changes at once allowed Polands economic reformers to stay on track toward
creating a functioning market economy. It helped that Western governments and
international agencies arranged to defer repayment of Polish debts until 2001, which
allowed private banks also to reschedule debt payments in 1994. Whether Polands
economic success made other so-called transition economies willing to endure the pain
of Polands shock therapy, however, was another matter.
After the failure of the 1956 rebellion in Hungary the new government installed
by the Soviet Union cravenly followed the Soviet line in foreign policy for example, it
provided some token forces in the 1968 invasion of Czechoslovakia but it return was

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given some limited freedom in domestic affairs. In 1968 it instituted a New Economic
Mechanism that was a compromise between strict central planning and a free market
system. It also developed closer relations, political and economic, with western Europe. It
allowed the formation of opposition political parties which, in 1989, negotiated with the
government for a peaceful transition. In a free election in May 1990 a coalition of three
former opposition parties won a clear majority in the new National Assembly.
Hungarys initial economic reforms were more rapid than Polands, based on a
longer period of introducing price liberalization under the Communist regime and
promoting exports to the West. This experience also allowed Hungary to encourage rapid
privatization of its state enterprises, principally by offering excellent terms to foreign
investors. As a result Hungary quickly garnered more foreign investment than any other
transition economy. Unfortunately, for its further progress, many of the state enterprises
were simply handed over to the politically savvy apparatchiks who managed them; this
entrenched their political influence in the government. Exercising political influence
proved to be their comparative advantage compared with modernizing their plants and
marketing their products. Off to a promising start, Hungarys growth by the end of the
1990s turned out to be disappointingly low. The explanation lies partly in the relatively
poor performance of exports, but mainly in the failure of the privatized state enterprises
to modernize. With the example of the relatively peaceful transitions in Poland and
Hungary before them, students and workers in Czechoslovakia stepped up their protests
and mass demonstrations. At first the government responded with violent repression, in
which hundreds were killed and injured; but eventually it agreed to negotiations.
In December 1989 Alexander Dubcek, the leader of the Prague spring of 1968,
was elected chairman of the new parliament and Vaclav Havel, a writer who had been
imprisoned for his human rights activism, became president. In July 1992 the Slovak
National Council [regional parliament] passed a sovereignty declaration. Shortly
thereafter the Czech Republic agreed to a separation, which became effective January 1,
1993. The peaceful dissolution of Czechoslovakia stood in marked contrast to
contemporary events in Yugoslavia. Czechoslovakias initial political stability made it
appear to be the country most likely to carry out the wrenching transition from plan to
market. It had no foreign debt, unlike Poland, and it had begun limited liberalization of

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prices and encouragement of private plots following the Hungarian example. Moreover, it
had a skilled labor force and a reputation for high quality manufactures. But then it
delayed privatization because of conflict between the Czechs and the Slovaks. When the
two regions separated in 1993, the creation of separate currencies and border controls for
trade set back reform further. Then, the marketing scheme devised in the Czech Republic
for privatization via vouchers distributed to everyone, which could be used to buy shares
in investment funds focusing on different industries, proved to be vulnerable to
manipulation and fraud by opportunistic insiders. This experience discouraged foreign
and domestic investors alike, especially after the Russian default in 1998.
The German Democratic Republic [East Germany] celebrated its fortieth
anniversary in October 1989, an event attended by Soviet President Mikhail Gorbachev.
Shortly thereafter, however, the Central Committee of the East German Socialist Unity
(Communist) Party deposed its veteran leader, Erich Honecker, who was subsequently
charged with various crimes, including misappropriation of government funds.
Meanwhile thousands of East Germans, unable to migrate directly to the West, had begun
to flee through Czechoslovakia to Hungary, hoping thereby to reach Austria and the
West. The new Hungarian government obliged them by opening the border to Austria.
One of the most dramatic and symbolic events of 1989 was the destruction of the
Berlin wall. The wall had been erected around West Berlin by the East German
government in 1961 to prevent the escape of its subjects to the West. For almost three
decades it stood as a symbol of Communist tyranny and repression. Spontaneously, on
the night of November 9-10, without hindrance from the East German authorities,
demonstrators from both East and West Berlin began destruction of the wall, and
thousands of East Berliners streamed out into the West. Events moved rapidly thereafter;
the West German authorities, caught by surprise no less than those of the East, made
emergency arrangements to care for the refugees, but also sought to persuade the East
Germans to stay where they were.
In July 1990 they created and economic and monetary union with the German
Democratic Republic, which ceased to exist as a separate state on October 3, when it was
incorporated with the German Federal Republic. The political urgency to complete
reunification as quickly as possible before Russias leadership changed its mind led to an

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expensive economic gesture converting the East German currency [ostmark] into the
West German currency [deutschemark] at a rate of 1 to 1. The market rate was at least 6
to 1 and possibly as high as 12 to 1, so that while East German workers [who voted
overwhelmingly in favor of reunification on West Germanys terms in April 1990] were
made six to twelve times better off than before, unfortunately, this meant that their
employers, which became mostly West German firms after privatization of the former
state enterprises, could no longer afford to employ them. Consequently, unemployment
soared so that continued unemployment benefits to East German workers were added to
the expense of rebuilding the decayed and obsolete infrastructure of East Germany. The
increased tax rates on West Germany firms and workers required to finance the
reunification with East Germany, in turn, raised unemployment rates in West Germany.
The continued economic burden of reunification for Germany, stemming from the
original political decision to make monetary union as favorable as possible for East
Germans, slowed down Germanys economic growth in the 1990s, with spillover effects
on the rest of Europe.
As the remaining central and east European countries threw off their shackles with
the Soviet Union, the same set of problems that bedeviled the first four transition
economies occurred with different variations and complications. So, while all of them
had remarkably similar economic structures at the outset, thanks to Soviet policy in
dispersing heavy industry and collectivizing agriculture, and all of them sought to
achieve the economic structures of western Europe as quickly as possible, the paths taken
for the transition process varied considerably. Each country dealt with its particular set of
political and cultural constraints in its own way.
Bulgaria, for example, obtained a new reform regime with elections in the spring
of 1990s, but found its agricultural output devastated because the peasants who had only
recently been collectivized sought to reestablish their previous property rights. After
experiencing corrupt governments and widespread financial scandals, Bulgaria finally
adopted a currency board in 1999 to end inflation and financial uncertainties. Thanks to
the previous travails, reform may now find continued political support, much as in the
earlier Polish experience.

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Romanias violent deposition of its idiosyncratic dictator, Nicolae Ceausescu, by
executing him on Christmas Day in 1989, was followed by the same Communist party
officials continuing to rule a demoralized population. The slow pace of reforms and lack
of economic results for the first decade have kept the Romanians demoralized. Albanias
peculiar version of Stalinism came to an end in 1991, but initial economic reforms
consisted of a series of Ponzi schemes that defrauded most Albanians of whatever
savings they had.
Migration to Europe seemed the best economic strategy for them, or failing that,
running the western blockade of the former Yugoslavia. Yugoslavia itself, although not a
Soviet satellite, likewise endured several years of turmoil associated with attempts at
political and economic reform. As a federation of distinct ethnic groups, its situation was
complicated by separatist movements as well as movements for economic reform. In
1991 the constituent republics of Slovenia and Croatia declared their independence from
Yugoslavia, and the republics of Macedonia and Bosnia-Herzegovina moved in the same
direction. The republic of Serbia, the largest and strongest of the federation members,
attempted to prevent their secession by armed force, leading to all-out civil war. The
situation was further complicated by the fact that many ethnic Serbs lived in the other
republics, and formed paramilitary forces to cooperate with Serbia. In the ensuing melee
thousands of innocent civilians on both sides were slaughtered in the name of ethnic
cleansing. The outbreak of horrors only too reminiscent of the worst genocidal atrocities
during World War II, in a region that caused the outbreak of World War I at the
beginning of the twentieth century, finally led to NATO intervention at the end of 1995.
While this stabilized the situation in Bosnia-Herzegovina, it did nothing to resolve the
underlying tensions among Serbs, Croats, and Muslims. Serbs continued to be whipped
into a nationalistic frenzy for achieving a Greater Serbia by their former Communist
leader Slobodan Milosevic. Croats consolidated their territorial gains under the leadership
of their President Franjo Tudjman, who had allied them with Nazi Germany during
World War II. Muslims found it possible to import freedom fighters from sympathetic
Muslim nations with the tacit agreement of Western powers.
Milosevics last gasp as a warlord led him into ethnic cleansing of Kosovos
Muslims, which finally provoked NATO into an air war against him in 1999. Finally, by

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winter 2000, Serbs had elected a replacement as president, causing the Western powers to
move quickly to begin the transition process, now complicated by the effects of a decadelong blockade of what remained of Yugoslavia combined with the effects of the more
recent strategic bombing of Serbia. Transition wont be made easier by the ongoing
repatriation of refugees from their European hosts to Croatia, Bosnia, Kosovo, and now
Serbia.
The desire for liberty wafted itself across the breadth of Asia. The government of
the Peoples Republic of China had allowed a limited introduction of free markets and
free enterprise in the 1980s. This policy had been notably successful in the rural sector,
and agricultural output increased substantially along with the incomes of farmers and
farm workers. The policy also generated demands for greater political freedom and
democracy: for seven weeks in April and May 1989, students and others staged daily
demonstrations in historic Tiananmen Square in the heart of Beijing. For a time it
appeared that China, like Eastern Europe, might undergo a peaceful transition toward
more democratic forms, but in the end the hard-liners won the upper hand, and on June 4
armored columns gunned down the demonstrators by the hundreds or thousands, and
smashed their symbol, a plastic replica of the Statue of Liberty. Nevertheless, the
entrenched Communist leadership continued their policy of economic reforms, taking
advantage of their access to the trading facilities of Hong Kong, which finally returned
under Chinese sovereignty in July 1997. Its status as Special Economic Region was
intended to maintain the economic advantages of Hong Kong for the Chinese mainland
and serve as an example for the eventual reunification with Taiwan.
Despite Western concerns about human rights in China and its continued exercise
of capital controls that should have limited foreign investment, China continued to
progress toward a market economy by expanding its exports to the West and taking
advantage of capital infusions from Honk Kong and Taiwan. After years of negotiating
with the United States and the European Union, China gained accession to the World
Trade Organization in 2000, which assured it if a permanent place in the global
marketplace regardless of its authoritarian regime. Meanwhile, its economy continued to
grow at spectacular rates similar to those achieved by Japan earlier, albeit from a much
lower base of per capita income.

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Western observers and no doubt many in the Soviet Union and Eastern Europe
as well wondered why the Soviet Union did not use armed forces to quell the rebellions
in the satellites, as it had done before and as the Chinese government did against its own
people in June 1989. A full explanation has not yet emerged, but when it does it will
probably feature the economic debility of the Soviet Union itself as well as
contemporaneous political developments. In 1964 conservatives in the Communist Party
hierarchy deposed the ebullient Khrushchev, putting in his place Leonid Brezhnev, who
ruled for almost two decades. Under Brezhnev the Soviet economy stagnated;
inefficiency and corruption flourished. A reform instituted in 1965 encountered the
opposition of the entrenched bureaucracy [which expanded by 60 percent between 1966
and 1977] and was quietly shelved a few years later. Both the economic growth rate and
productivity declined.
When Mikhail Gorbachev the first Soviet leader born after the October
Revolution came to power in 1985 the economy was in a state of crisis. Gorbachev
undoubtedly realized that the Soviet Union was no longer in a position to enforce its will
on its reluctant former satellites. Its greatest need was to reform itself, hence Gorbachevs
program of perestroika [restructuring] and glasnost [openness]. Although Gorbachev
placed greater emphasis on perestroika he even published a book with that title that was
translated into several languages it was glasnost that had the most immediate effect.
Glasnost in the Soviet context meant greater freedom of expression [for the press, in
particular], an ability to discuss and debate both official policies and their alternatives,
and even [to some extent] an ability to act independently of the party and the state in
political matters.
Partly as a consequence, the Baltic republics of Latvia, Lithuania, and Estonia
declared their independence, which was confirmed in 1991. Others moved in the same
direction, and even the huge Russian Republic under the popularly elected presidency of
Boris Yeltsin began to act independently of the Communist Party. One of the
justifications of glasnost was to enlist the initiative and enthusiasm of the population for
the tasks of perestroika, or economic restructuring. Nowhere, however, did Gorbachev
spell out precisely what he meant by restructuring, beyond some rather vague
generalizations about improved cost accounting, devolution of decision making to the

14
level of the enterprise [as against the planning authorities and ministries], the necessity of
enterprises to make profits [i.e., the abolition of subsidies], and similar matters. In his
book he referred to the importance of mass initiative, an apparent oxymoron, and
described perestroika as a combination of democratic centralism and self-management,
a flat contradiction in terms. Gorbachev apparently favored a return to something like
Lenins New Economic Policy, in which the state would retain control of the
commanding heights of the economy but allow limited private enterprise in the
remainder. He was caught in a bind, however, between the conservatives of the party
hierarchy, who favored maintenance of the status quo, and radical reformers who wanted
to abolish the system of central planning altogether and move to a pure market economy.
While the debate on the ultimate nature of the reform raged, a few limited reforms
were actually effected. For example, many economic activities that had formerly taken
place on black or grey markets private handicraft production, petty trading, the
production of various personal services were legitimated, provided that the producers
also held full-time jobs in state enterprises. Cooperatives could be formed to produce
consumer goods or services, subject to the same restrictions. Individuals or families could
lease and land for agricultural production, again subject to some restrictions. The Soviet
Union also allowed some foreign capital to enter into joint ventures with the state-owned
enterprises.
In August 1991, on the eve of a new treaty between the Soviet Union and some of
its constituent republics that would have given far more power to the latter, a small group
of hard-liners in the Communist Party attempted a coup detat. The coup leaders,
including Gorbachevs handpicked vice president, the head of the KGB, and the minister
of defense, placed Gorbachev, then vacationing in the Crimea, under house arrest,
suspended press freedom, and declared martial law. The Russian populace, however,
especially the inhabitants of Moscow and Leningrad, refused to be cowed. Under the
leadership of Boris Yeltsin, and with the support of some military units that came to his
defense, they openly defied the coup leaders, who quickly lost courage and fled, only to
be arrested. Even though the coup attempt failed, Gorbachevs vision of the future of the
Soviet Union was dashed by Yeltsin, now president of the Russian Republic.

15
Focusing his political talents on eliminating the power of the Communist Party,
Yeltsin experimented with an apparently endless variety of economic and political
reformers, always somehow maintaining himself in power while the economy suffered all
the woes of the transition economies. After narrowly winning reelection as president in
1992 and 1996, he appointed a rapid succession of prime ministers, all of whom failed to
establish any control over the central banks accommodative financing of Russias new
robber barons. This new elite took over the privatized state enterprises on terms most
favorable to themselves and their cronies and managed them to their personal benefit,
extracting as many resources as quickly as possible and investing the proceeds abroad.
With the Russian default in August 1998 on ruble bonds owed to its own citizens, it
became clear to all the world that Russias attempt to become a capitalist democracy had
merely ended in it becoming a Third World kleptocracy. Yeltsin responded by firing his
prime ministers even more rapidly, finally settling on a former KGB spy, Vladimir Putin,
who had spent much of his career in East Germany. In his final act of political derring-do,
Yeltsin resigned in favor of his latest protg as acting president.
Putin then managed to win election on his own, mainly by consolidating his
authority over the secret police and the military while directing a savage war against the
rebellious Muslim province of Chechnya. As the new century began, it appeared that
Putin was determined to backtrack on the dismal path followed by Russia since 1991 and
try to strike out on a new path similar to that taken the Chinese Communists, namely
maintaining political power by force while allowing market capitalism to develop in
special areas. The rise in oil prices in 2000 was making his task all the easier while
keeping Russia fully engaged in the global trading economy.

The Evolution of the European Union

In the last four decades the European Community itself was being transformed. In
the early 1970s the Belgian prime minister, Leo Tindemans, at the invitation of his fellow
heads of government, prepared a report that envisaged completion of the union by
1980. That proved much too ambitious a goal, given the fundamental differences between
the member states on the necessary reforms and the constitutional structure of the

16
eventual union not to mention the effects of the oil shocks of the 1970s. The report was
never implemented. After a few years in the doldrums the movement to relaunch
Europe gained new force in the 1980s.
Under the leadership of Jacques Delors, a former French government official and
a strong proponent of European unity, who became president of the EC Commission in
1985, the European Council [heads of state or government] decided in principle to
proceed to greater union, and in February 1986 signed the Single European Act (SEA).
Specifically, the SEA required that the Community adopt more than 30 measures to
remove physical, technical, and fiscal barriers in order to complete the internal market by
December 31, 1992. In fact, the deadline was not met, but soon afterward all the
necessary measures were in place, and the EC became a Community without frontiers.
The movement for unity got a boost from another direction in 1986 when the
governments of France and the United Kingdom agreed to allow a railway tunnel to be
built under the English Channel. Such a tunnel, sometimes called a chunnel, had been
proposed as early as 1870, and periodically thereafter, but had never been realized. A
remarkable feature of the proposal was that it was to be financed entirely by private
capital, without subsidies. The chunnel was completed in 1994, shortly after the entry
into force of the Single European Act.
The European Monetary System (EMS), with its associated Exchange Rate
Mechanism (ERM), had been established in 1979, but the coordination of monetary
policies not to mention the creation of a single monetary policy remained one of the
greatest hurdles in the way of complete economic unity. In 1991 the Community decided
to create its own central bank in 1994, to be followed by a single currency in 1999, but an
exchange rate crisis in September 1992 forced the United Kingdom and Italy out of the
ERM, and postponed other measures. Instead of a central bank, a possible forerunner, the
European Monetary Institute, was created in 1994 with headquarters in Frankfurt. It
became the European Central Bank in 1999.
In spite of these setbacks, the proponents of European Unity persevered; in
December 1991 the Council of Europe, meeting in Maastricht, the Netherlands, signed a
new treaty intending to create an ever closer union among the peoples of Europe. The
new treaty, which did not take effect until November 1, 1993, nearly two years after the

17
meeting in Maastricht, changed the name of the European Community to the European
Union. It also increased the power of the European Parliament, called for joint actions
in foreign and defense policy with the eventual goal of a Common Foreign and Security
Policy (CFSP), and introduced the principle of subsidiarity, under which policy-making
power would devolve to the lowest possible level of government. Another feature of
the treaty was explicit provision for an Inter-Governmental Conference in 1996 to review
progress under the treaty and to make any necessary adjustments.
Another favorable development in 1993 was the creation of a European Economic
Area (EEA) by a merger of the European Community with most members of the
European Free Trade Association (except Switzerland), which took effect January 1,
1994. Shortly afterward four members of EFTA Austria, Finland, Norway, and Sweden
applied for membership in the by then renamed European Union; they were accepted,
effective January 1, 1995. Each country, however, held a referendum on the terms that
had been agreed upon, which for most of them meant accepting a reduction in their level
of agricultural subsidies compared to the Common Agricultural Policy. The referendums
started with Finland, moved to Austria, then to Sweden, and finally to Norway, each
passed with smaller and smaller majorities until Norways electorate actually rejected
membership, just as it had a generation earlier in 1972.
By coincidence, another large free trade area also came into existence on January
1, 1994. This was the North American Free Trade Agreement (NAFTA), consisting of the
United States, Canada, and Mexico. The agreement providing for NAFTA allowed a
fifteen-year transition period, during which it was likely that other nations in the Western
Hemisphere would become members. NAFTA, with a total population of more than 360
million, had a combined gross domestic product of approximately $7 trillion. For
comparison, the EEA, which included Norway and Iceland as well as the 15-member
European Union, had a population of 372 million, and a combined gross domestic
product of approximately $7.5 trillion.

18
Limits to Growth?

In 1972 a research team associated with the Massachusetts Institute of

Technology published a book, The Limits to Growth, in which they predicted that the
limits to growth on this planet will be reached sometime within the next one hundred
years. They invoked five major trends of global concern:

Accelerating industrialization;

Rapid population growth;

Widespread malnutrition;

Depletion of nonrenewable resources and a

Deteriorating environment.
The book received a great deal of publicity for a scholarly production, and was the

subject of much public discussion. Although many critics believed that the authors had
overdramatized their conclusions especially the one that predicted a rapid cessation of
growth almost all agreed that they had truly identified trends of global concern,
notably population growth and environmental degradation. Most critics also agreed that
the trends were interrelated: malnutrition, for example, is especially prevalent in those
Third World countries that are experiencing rapid population growth [but it is not
unknown even in affluent countries such as the United States]. An incidental aspect of the
overthrow of Communist regimes in Eastern Europe was the revelation of the extensive
environmental damage occasioned by their programs of headlong industrialization.
Environmental damage is not confined to soviet-style economies, as the controversy over
acid rain testifies. But in the more affluent industrial economies there is a greater
awareness of it, and greater pressure by both public opinion and government to force
polluters to cease or to pay the cost of environmental clean-up.
The problems are serious, but they are not unprecedented, as many otherwise
intelligent people ignorant of history tend to assume. Throughout human history the
pressure of population on resources condemned the great majority of people to live at a
bare subsistence level. Some 200 years ago, T.R. Malthus provided a theoretical
explanation of why that would always be the case. Ironically, at the very time that
Malthus was writing a process the process of rapid technological change was under

19
way that vitiated his assumption. As already indicated, the next 200 years witnessed a rise
in living standards in many parts of the world that Malthus and his contemporaries could
not have imagined. In terms of total numbers and the rate of growth over the last halfcentury, the population problem is without historical precedent but numbers and growth
rates are not the only relevant variables. Population must be viewed in relation to the
resources available to support it; the volume of resources animal, vegetable, and
mineral to support the worlds population is also at an all-time high.
During the last hundred years or so the affluent nations of the world have
experienced a demographic transition from a regime of high birth and death rates to one
much lower, with a consequent reduction in the rate of population growth.; the
expectation is that as other, poorer nations increase their level of material well-being
they, too, will reduce birth rates and thus rates of population growth. Some experts even
believe that the world as a whole reached an inflection point from a rising to a declining
rate of growth for total population in the 1970s.
Despite the fears of pessimists, who always get more attention at times of crisis
such as the oil shocks of the 1970s, per capita income grew everywhere from 1985 to
1998 and then grew even more rapidly as the effects of globalization kicked in [and the
world price of oil fell sharply]. The one exception among major countries was the sad
case of Russia where the transition from Communism to market capitalism lagged behind
that of most other transition economies. Despite the fears of neo-Malthusians, moreover,
the growth of population worldwide continued to slow down even as the rate of growth
per capita incomes picked up after 1985.
Over the period 1971 to 2000, the International Monetary Fund estimates that
world gross domestic product grew on an average over 3.6 percent annually, while world
trade grew on an average over 5.7 percent annually. The are truly exceptional rates
historically, even as the world population approached the figure of 6 billion, far above the
limits imagined in Malthus times. The race between population and resources leads to
two related problems:

the rate at which resources are being used [and used up] and

the inequality in the distribution of resources.

20
There is no doubt that the world especially the affluent part of the world is
utilizing resources at historically unprecedented rates. That itself is a measure of its
success in mastering the environment and solving the economic problem, but it has also
given rise to fears of a total exhaustion of resources. Such fears are not unreasonable, but
they are not well-grounded historically; after all, it was the shortage of timber for
charcoal that led to the use of coke for smelting iron ore. There are many other instances
where temporary or localized shortages of particular resources have given rise to
substitutes, which often turn out to be more efficient or economical. In the nineteenth
century coal replaced timber as a source of inanimate energy; in the twentieth century
petroleum has largely displaced coal. Electricity, generated by water power, coal,
petroleum, and eventually nuclear power, proved to be the most versatile and almost
ubiquitous form of energy. Pessimists point out that coal and petroleum exist in finite
amounts, and their supply may eventually be exhausted; water power is subject to
physical limits on its use; nuclear power poses serious environmental hazards. Yet
optimists claim that solar energy the original source of both coal and petroleum has
scarcely been tapped directly/
The technology does not yet exist to exploit solar energy directly in more than trivial
amounts. But as the conventional sources of power become scarcer that is, as their price
rise the inducement to engage in research directed to solar energy will increase. That is
the way the economic mechanism functions; the possibilities are limitless.
The inequality in the distribution of resources among individuals, social groups, and
nations is at the very heart of the problem of economic development. Its solution will
not be easy; it will require study, research, and widespread institutional change. That is
the challenge currently facing both developed and undeveloped nations.