The Demonetization of the East
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The Demonetization of the East
Overview
In December 2002, Poland made a landmark decision to buy 48 F-16 Falcons from Lockheed Martin, a major American defense company. Valued at $3.5 billion, this deal is the largest defense order ever made by any country in Eastern or Central Europe. The financial package includes soft loans and a major offset program, which involves purchasing from Polish manufacturers to balance the costs in foreign exchange.
Offset Agreements
Offset deals, such as co-production, licensing, and joint ventures, are common in the defense sector. They're offered even to wealthier nations like Israel, but in Central and Eastern Europe, these arrangements are more widespread than many realize. Studies show that barter-like deals, often called "compensation," make up 20 to 40 percent of transactions in former Soviet economies. Corporate debts, payments for goods, and taxes frequently involve non-cash components, highlighting a demonetized economic landscape.
The Economic Impact of Communism's Fall
The collapse of communism resulted in a shrinking manufacturing base and the decline of the agricultural and mining sectors in transitioning countries. Export revenues in hard currency dwindled while unemployment soared?"impacting one-fifth of Poland's population, a third in Macedonia, and three-fifths in Kosovo.
Rather than regenerating these cash-strapped economies, the IMF imposed strict austerity measures, further reducing disposable incomes and regional trade. This environment made countertrade and non-cash dealings, such as barter and offset, thrive.
Historical Context and Current Practices
COMECON, the former eastern trade bloc, relied on a barter system using a fictitious "wooden" ruble. Communist countries were often obliged to accept unfair trade terms, usually benefiting the Soviet Union. Rising debts ultimately led to the system's collapse, with Russia paying off debts through aircraft and weapons to Eastern European countries instead of cash.
Russia still uses this method, compensating Kazakhstan with goods for leasing the Baikonur Cosmodrome. Until 2000, wage arrears and taxes in Russia were often settled in kind. Nations like Ukraine, Armenia, and Belarus trade food and commodities with Russia in exchange for gas debts and disposal of nuclear waste. Complaints about quality and delivery issues abound, but options are limited.
Barter isn't a relic of the past. Payments-in-kind to Gazprom have surged, reflecting rising tariffs. The use of "veksels" (corporate promissory notes) increased by 60 percent. This trend highlights the emergent demand for barter experts, such as Igor Makarov, who managed Gazprom's gas sales in the Commonwealth of Independent States.
As state subsidies diminish and consumer power wanes, countertrade transactions increase. Transitioning economies face massive inter-corporate debt, often resolved through barter. In Macedonia, this debt neared $600 million in 2001, almost one-fifth of its GDP.
Pros and Cons of Barter Trade
Supporters of barter trade, including consultancies and trading firms, argue that it provides a way to trade with countries lacking convertible currency, thus preserving foreign reserves by eliminating the need for hard currency.
However, the US Embassy in Moscow highlights barter's negative impact on Russia: it reduces tax receipts, distorts prices, oversupplies products, undermines monetary policy, and complicates economic measurements, leading to poor policy decisions. Barter persists due to short-term management views, its role as a social safety valve, and weak bankruptcy laws.
Consequences and Transition
Barter not only demonetizes and distorts economies but also tends to militarize the region. While everyday goods are unwanted, military equipment like MiG jets and patrol boats are in high demand. Turkmenistan's coast guard on the Caspian Sea, built through a gas-for-goods deal with Ukraine, exemplifies this.
Non-cash transactions represent a third of the region's GDP, eluding taxation and inviting capital flight. Barter acts as a non-tariff barrier by binding specific buyers and sellers. The recent Russia-China agreement to ban non-cash transactions in border areas underscores this issue.
Complex countertrade deals often invite corruption. In 2002, Radio Free Europe/Radio Liberty reported the conviction of a former Russian Defense Ministry official for embezzling $450 million in a multistage barter agreement.
The Future of Barter
In the long run, barter is expected to fade. As former Soviet satellites focus trade towards, or join, the EU, countertrade will remain confined to financially struggling former Soviet Bloc economies. Eventually, market realities will usher in the use of cash for optimal resource allocation.
Consumers in barter-reliant countries will tire of poor-quality, delayed goods. Cash-driven imports and exports will increase, "ghost" factories will close, and governments will improve tax collection. A foreign-owned banking system will more effectively match savings to investments. Ultimately, barter will become a marginal, last-resort activity.
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