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By how much did socialist economies underperform? A cross-country 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 non-

socialist 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 post-

war 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

2

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 5 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’

3

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 post-

war 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 8 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’

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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 country-

fixed 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.

itti

ititit

xusSocialistsSocialist

sSocialistTimeGAPLabgrowthIncomeGrowth

εδδδδββα

+++−−−+++=

80*70*

60**

43

2121 [1]

eSocialistGAPau +−−= 43 ββ [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.

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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 22 Bolt and Van Zanden, ‘Maddison Project’, data available online at: http://www.ggdc.net/maddison/maddison-project/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.

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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 post-

war 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. 27 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’

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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.

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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 post-

war 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.

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In order to trace the very substantial relative underperformance of Eastern Europe further, I re-

estimate 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’

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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

11

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

12

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.

Although the primary aim of the paper was to measure, not to explain, the underperformance of

Eastern Europe, the econometric findings suggest that several countries in the region could not exploit

their potential for reconstruction growth in the early post-war decades. This, at least partly, resulted

from labour-supply constraints stemming from large population losses suffered during the 1940s. By

contrast, the lack of economic openness does not appear to have been a strong limiting factor in

socialist growth, but further research is needed, if we wish to provide a comprehensive explanation of

the growth trajectory that Eastern European economies established in the era of state socialism.

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15

Table 1 Regressions explaining economic growth in 25 European countries

I II III IV V VI

Initial income 3.2639*** 3.3983*** 3.3983*** 3.7686*** 4.1206*** 4.1569*** (3.86) (4.75) (4.75) (5.77) (9.74) (9.83)

Labour-force growth 0.3120* 0.5078*** 0.5078*** 0.2850* 0.2870** 0.2869**

(1.84) (3.38) (3.38) (1.96) (2.14) (2.14)

Output gap * Time 0.1332** 0.1294*** 0.1294*** 0.0888** 0.0852** 0.0852**

(2.01) (2.95) (2.95) (2.19) (2.28) (2.28)

1960s 0.9952*** 0.7474*** 0.7474*** 1.1407*** 1.1618*** 1.0254***

(3.17) (2.82) (2.82) (4.13) (5.80) (6.34)

1970s -0.3009 -0.5232 -0.5232 -0.0265

(-0.66) (-1.50) (-1.50) (-0.07)

1980s -0.7816 -1.3683*** -1.3683*** -0.4474 -0.3475 -0.3850*

(1.52) (-3.64) (-3.64) (-1.12) (-1.51) (-1.69)

Socialist * 60s -0.6680* -0.3832

(-1.73) (-1.15)

Socialist * 70s -0.5253

(-1.32)

Socialist * 80s -1.8415*** -1.5879*** -1.4614***

(-4.37) (-4.57) (-4.42)

(constant) 0.9085 -0.0916 -0.0916 -0.3494 -0.7701* -0.8027* (1.38) (-0.12) (-0.12) (-0.50) (-1.79) (-1.86)

N 64 100 100 100 100 100

F 22.50 43.34 43.34 38.65 48.96 56.64

R2 0.76 0.79 0.79 0.84 0.83 0.83

Regressions explaining country-fixed effects

Output gap -0.3526** -0.1861 -0.4103** -0.2780* -0.2598 -0.2652**

(-2.54) (-0.74) (-2.65) (-1.72) (-1.48) (-2.12)

Socialist -3.2342*** -2.7274*** -3.2643*** -2.9144***

(-6.49) (-5.27) (-5.77) (-6.66)

Albania -4.5877***

(-4.38)

(constant) 0.3111 0.1669 1.4208*** 1.1556*** 1.3376*** 1.3985*** (1.45) (0.46) (4.41) (3.45) (3.66) (5.13)

N 16 25 25 25 25 25

F 6.48 0.54 21.84 14.03 16.69 28.31

R2 0.32 0.02 0.67 0.56 0.60 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.

16

Table 2 Regressions explaining economic growth in 9 East European countries

I II III IV V

Initial income 6.6435*** 4.5555*** 5.0055*** 6.1959*** 4.8435*** (5.82) (3.98) (7.27) (5.72) (6.63)

Labour-force growth 1.0293** 0.1170 0.0829 1.4226*** 0.2071

(2.34) (0.41) (0.31) (3.22) (0.59)

Output gap * Time 0.0783 0.0523 0.0476 0.1057 0.0550

(0.81) (0.99) (0.93) (1.18) (1.01)

1960s 0.6861* 0.8447*** 0.8057***

(1.67) (3.30) (2.89)

1970s -0.2437

(-0.50)

19 80s -2.0518*** -1.8518*** -1.8358***

(-3.90) (-5.56) (-4.30)

(constant) -6.9866*** -3.0585* -3.7807*** -5.7933*** -3.1523*** (-4.62) (-1.70) (-3.64) (-4.42) (-2.97)

Albania included YES YES YES NO NO

N 36 36 36 32 32

F 15.35 37.23 46.21 19.04 40.33

R2 0.66 0.91 0.91 0.73 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.

17

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)

0

1

2

3

4

5

6

1950s 1960s 1970s 1980s

Av

era

ge

an

nu

al

gro

wth

ra

te i

n G

DP

p.c

. (%

)

West

South

East

18

Figure 2 Structural underdevelopment in Europe in 1950

ALB

BUL

CZ

GDRHUN

YUG

POL

ROM

USSR

AUT

BEL

DK

FIN

FRA

GER

ITA

NL

NOR

SWE

CH

UK

IRL

ESPPOR

GRE

0.5

11.

52

2.5

Inco

me

gap

rela

tive

to th

e U

SA

(ln

rat

io)

0 20 40 60 80

Share of agriculture in the labour force (%)

r = 0.925

19

* The regression line is fitted to the actual values of 16 West European countries

Figure 3 Economic growth and convergence in Europe 1950-1990

ALB

BUL

CZ

GDR

HUN

YUG

POL

ROM

USSR

AUT

BEL

DK

FIN

FRA

FRG

ITA

NL

NOR

SWE

CHUK

IRL

ESPPORGRE

1.5

22.

53

3.5

4

Ann

ual g

row

th r

ate

in G

DP

p.c

. 195

0-90

(lo

g%)

0 2000 4000 6000 8000 10000

GDP per capita in 1950 in 1990 GK dollars

Actual values Fitted values*

20

Figure 4 Socialist economic growth and labour-force expansion in the 1950s

ALB

BUL

CZ

GDR

HUN

YUG

POL

ROM

USSR

33.

54

4.5

55.

5

Ann

aul r

ate

of g

row

th in

GD

P p

er c

apita

(lo

g%)

-.5 0 .5 1 1.5

Annual rate of labour-force growth (log%)

21

Figure 5 Demographic constraints and socialist economic growth in the 1950s

ALB

BUL

CZ

GDR

HUN

YUG

POL

ROM

USSR

33.

54

4.5

55.

5

Ann

ual g

row

th r

ate

in G

DP

p.c

. 195

0-60

(lo

g%)

-2 -1 0 1 2

Annual rate of population growth 1939-50 (log%)

22

Country-fixed effects derived from column III in Table 2.

Figure 6 The impact of size on relative growth performance 1950-90

ALB

BUL

CZ

GDR

HUN

YUG

POL

ROM

22.

53

3.5

4

Ann

ual g

row

th r

ate

of G

DP

p.c

(lo

g%)

0 10 20 30

ALB

BUL

CZ

GDR

HUN

YUG

POL

ROM

-4-2

02

Ann

ual g

row

th rat

e co

untry

FE

(lo

g%)

0 10 20 30

Average population size 1950-90 (million)