The Communist government of Czechoslovakia was ousted in the socalled

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1 Journal of Economic Perspectives Volume 5, Number 4 Fall 1991 Pages The Economic Transition of Czechoslovakia from Plan to Market Josef C. Brada The Communist government of Czechoslovakia was ousted in the socalled Velvet Revolution of November 1989, and the new regime adopted as its goal the transformation of the economy to one based on markets and private property, and also one more dynamic and productive than its predecessor. This unprecedented transformation poses a variety of intellectual, political and economic questions. At the same time that the economic system is being transformed, the government must also ensure that the hybrid economy that exists during the transition functions sufficiently well to maintain adequate living standards and to sustain political support for the reform process. In this paper I examine the economic and intellectual legacies that have shaped the transition process in Czechoslovakia, describe the system changes implemented or contemplated for the near future and briefly comment on macroeconomic performance. Legacies of the Past Czechoslovakia was created out of parts of the Austro-Hungarian Empire after World War I. The western parts of the country, Bohemia and Moravia, inherited a large share of the Empire's modern industry (Spulber, 1966, pp ) while Slovakia was largely agrarian. As a result of this high level of Josef C. Brada is Professor of Economics, Arizona State University, Tempe, Arizona and Visiting Professor, Leuven Institute for Central and Eastern European Studies, Catholic University of Leuven, Leuven, Belgium.

2 172 Journal of Economic Perspectives industrialization, Czechoslovakia's interwar per capita income was comparable to that of Austria and Belgium, although it is now admitted in Czechoslovakia that, after 40 years of Communism, per capita income is no more than half of that of its capitalist neighbors, but still higher than that of its socialist neighbors. One intellectual legacy that has influenced the debate regarding the transformation is a strong liberal concern for economic equity to be achieved largely through state intervention. 1 In the post-world War II period, it was the pre-communist bourgeois government that nationalized large firms, carried through an extensive land reform and introduced an elaborate scheme for planning (Pryor, 1973), in the name of social justice that was thought impossible to achieve in an unregulated capitalist economy. This liberal tendency was also evident in reform proposals introduced by the Dubček regime in These reforms, popularly associated with the economist Ota Šik (1967, 1972), called for "socialism with a human face," a mixture of market-based efficiency and socialist-based equality and economic security. A second intellectual tradition is that of fiscal conservatism. The government had followed restrictive macroeconomic policies during the Great Depression, in a determined effort to maintain domestic price stability and the international value of the koruna. This conservatism carried over to the Communist regime, and thus the government that entered office in 1989 was faced with a gross hard currency debt of only $7.9 billion and little of the money overhang that has fueled inflation and hampered the development of markets in Poland and the USSR (Dlouhý, 1989). However, this fiscal conservatism has forced the new government to follow a very restrictive monetary and fiscal policy and to show great concern for inflation. The Communist regime also left behind less helpful legacies. On the intellectual side was the stagnation in economics after the Soviet invasion in Many capable economists were driven from their profession, contacts with the west were sharply curtailed, and no serious writing about economic reform was permitted. As a result, the November revolution found the country's economists unprepared and ill-equipped to develop a comprehensive reform package. Another Communist legacy was an industry that was antiquated by world standards and heavily dependent on the Soviet Union for markets and for inputs of raw materials and energy, which it squanders prodigiously. The growth of net material product in the 1980s had declined to 2 percent and the efficiency of resource utilization was declining (Dyba and Svejnar, 1991; Brada, 1989). 1 I use the terms liberal and conservative to characterize economic policies according to usage common in the United States. In Eastern Europe and in much of the specialist literature the terms are used in exactly the opposite ways; conservatives are those reluctant to make sweeping changes in the system while liberals advocate the rapid introduction of markets, private property and generally conservative monetary and fiscal policies.

3 Josef C. Brada 173 Managing the Transition to Capitalism The November revolution replaced the Communist regime with a transition government that, in turn, was succeeded by the Parliament and executive elected in June 8 9, Civic Forum and its Slovak counterpart, Public Against Violence, emerged as the major Parliamentary force. Unfortunately, Civic Forum encompassed so broad a political spectrum that it split apart in February 1991, due to internal conflicts over the pace and nature of the economic transition. On one side was Václav Klaus, the Minister of Finance and self-proclaimed disciple of Milton Friedman; on the other President Havel, Foreign Minister Jiří Dienstbier and others who argue for a slower, more moderate reform that would bring about "capitalism with a human face," and who have left the Forum to form a new political organization. Mr. Klaus has retained the leadership of Civic Forum, and his policies are reflected in the economic manifesto Civic Forum issued in January 1991 calling for as extensive and rapid a development of markets as possible. Perhaps most telling is its response to liberal calls for greater concern for social equity in the implementation of the reform: "Our approach to the establishment of social justice stems from the belief that equity and justice mean equal opportunities, not equal outcomes." 2 However, it has proven difficult to move this reform agenda through Parliament. Key issues in the transformation are creating markets, privatization, and the opening of the economy to world trade. The price system inherited from the Communist regime contained significant distortions. Most distorted were the retail prices of food and energy prices, both of which were kept artificially low. The debate on price liberalization centered on two issues: the impact of food price increases on the distribution of income and the fear that rapid price increases would set off an inflationary spiral. Many subsidies were eliminated in mid-1990, although retail prices of manufactured goods remained fixed. Households were compensated for foodprice increases through increased incomes and pensions. On January 1, 1991, there was a broader freeing of prices, resulting, by the third week of the month, in a 31.8 percent increase in food prices over those in December. Nevertheless, much production continues to be subsidized, and prices of energy, rents, and many goods have been kept low to placate consumers. Industrial wages on a job-by-job basis are determined by a nationwide schedule that can be supplemented, within specified limits, by plant-level collective agreements. The government and the trade unions have agreed on minimum and maximum wage changes for 1991, with a guarantee that real wages will not decline by more than 12 percent in the first quarter of 1991 and by no more than 10 percent in any subsequent quarter. Also part of the 2 Hospodařské Noviny, January 18, 1991.

4 174 Journal of Economic Perspectives agreement was unemployment compensation of 65 percent of wages for the first 6 months of unemployment and 60 percent for the second, as well as the establishment of a retraining program for laid-off workers. Whether this Austrian-style nationwide wage settlement can become a useful tool of macroeconomic policy without hampering labor mobility and wage flexibility remains to be seen. The easiest part of creating markets freeing wages and prices has been partly achieved. The more difficult steps of creating markets that allocate goods and factors in an orderly and efficient manner remains to be accomplished. A financial crisis has been brewing in the enterprise sector. In the centrally planned economy, enterprises operated without working capital, paying each other on the basis of permanent credits issued by the state bank. The reform of the banking system left the state bank with the traditional functions of a central bank while enterprise finance devolved to western-style commercial banks, who inherited the old debts of the enterprises. With the central bank running a very restrictive monetary policy, many firms are effectively without working capital, and thus are delaying, or simply failing to make, payments to suppliers. This liquidity crisis has disrupted supply, with some firms refusing to make deliveries to customers who are not current in their payments. Given the lack of information on the financial status of individual firms, such decisions appear arbitrary (Hospodařské Noviny, January 16, 1991). Faced with massive withdrawals by the population, largely in anticipation of price increases, the commercial banks raised interest paid on deposits to percent and then, to maintain their own profitability, unilaterally raised the rates firms pay on debts from around 6 percent to 20 percent. This step exacerbated both the growth of inter-enterprise debt and bottlenecks in interenterprise deliveries. With profits and liquidity of the enterprise sector under pressure, the Czechoslovak financial press and President Havel have both characterized the situation as one of crisis. Czechoslovak policy-makers fear that easing credit to provide liquidity for profitable enterprises and to validate outstanding inter-enterprise debt would enable unprofitable firms to cover their losses by issuing more debt, leading to inflationary pressures. The failure to create an effective bankruptcy law that would drive unprofitable firms out of existence is thus a major shortcoming of the reform process in Czechoslovakia, as in other East European countries. Czechoslovakia is pursuing a two-track policy of "little privatization" and "big privatization." Small businesses and shops not returned to their former owners under the Restitution Law are being auctioned off to the public. The first auction, of 16 stores in Prague, was held on January 26, garnering 22 million koruny ($786,000). Private entrepreneurs are also encouraged to start businesses, and by March 1991, 736,000 had registered, although many now complain of bureaucratic obstacles to private business. Since most large businesses were nationalized by the pre-communist regime, few large industrial

5 The Economic Transition of Czechoslovakia from Plan to Market 175 enterprises will be restored to their former owners. Instead, these will be privatized through the sale of shares to domestic and foreign buyers. A unique feature of the Czechoslovak privatization will be the distribution of vouchers to citizens, enabling them to bid for shares of firms being privatized. To utilize vouchers in this way, a registration fee of 2000 koruny ($70) must be paid by the bidder. Private ownership of agricultural land is also permitted, and cooperatives must now compensate owners of land for its use. Since the policy of Civic Forum is to do away with large agricultural collectives, further measures regarding the privatization of agriculture may be expected. In the area of foreign trade, the koruna was made convertible for residents on January 1, The exchange rate itself was the object of considerable controversy. Radical reformers sought to raise the rate from 15 Kcs/$ in 1989 to 36 Kcs/$ to stimulate exports, while their opponents sought a rate closer to the purchasing power parity rate of around 10 Kčs/$. The existing rate of 28 Kcs/$, reached after two devaluations and supplemented by a 20 percent surcharge on imports, is a compromise between these two positions. Hidden constraints still exist on trade. Only firms inscribed in the national register may engage in trade, and this excludes private firms. The currency regulation requires all exporters to sell their foreign exchange receipts to the commercial banks, and importing firms cannot import values in excess of their holdings of domestic currency. In view of the limited nature of the trade liberalization, the government should not have to use much of the standby resources provided by the IMF, the Group of 24 and the EC to defend the exchange rate. At the same time, the benefits of trade liberalization to the economy may be quite limited. The government does envision significant foreign ownership of capital, although this is controversial. In the first privatization auctions, Czechoslovak citizens were accused of fronting for foreign investors. However, foreign investment into state-owned enterprises is being actively encouraged, with Volkswagen's investment, which may eventually reach $6.4 billion, into the Škoda car factory the most notable result so far. Macroeconomic Performance The reform measures taken so far are not yet paying off. Gross national income and real wages both grew by 1 percent in Then national income fell by 2.8 percent and real wages by 4.8 percent in 1990, and Czechoslovak government sources expect the decline to proceed faster in In the first quarter of 1991, industrial output was only 88 percent of the first quarter of Meanwhile, unemployment climbed from zero in 1989 to 1.3 percent in 1990 and is headed for 5 percent or higher in A particular problem is that unemployment is about twice the national average in Slovakia, where firms oriented toward the Soviet market predominate. This regional disparity has led

6 176 Journal of Economic Perspectives to political and social conflicts between Czechs and Slovaks. Women and young workers also have suffered disproportionate joblessness. Inflation was running at 1.4 percent in 1989, reached 9.2 percent in 1990, and may exceed 20 percent in 1991 (Federal Statistical Office, 1990; Janček et al., 1990). To be sure, this poor performance is in part the result of exogenous factors. The collapse of trade with socialist countries, and particularly with the USSR, created input shortages and caused many Czechoslovak firms producing machinery, consumer manufactures and weapons to lose a major part of their sales. Exports to socialist countries fell by about 10 percent in 1989, and for the first three quarters of 1990 they were down by a further 20 percent. Imports from the USSR have also fallen, especially those of oil, which now has to be paid for in convertible currencies. Moreover, there was little success in redirecting exports from the Soviet market to the west in Despite a government budget surplus and virtually no growth in the money supply, inflation is potentially a serious problem. Some of the inflationary surge is due to the one-time elimination of subsidies on food and energy and to the effects of devaluation. However, the danger is that either an inflationary spiral will develop, fueled by the expansion and monetization of inter-enterprise debt and further dissaving by households, or that the government's fear of such a spiral will lead to a strengthening of price and wage controls, thus cutting short the process of developing markets. Government policy-makers have no idea of how the economy will respond to reform measures, but they do expect the situation to worsen, and public opinion polls suggest that the population shares this view. Most Czechoslovak economists believe that the bottom will not be reached before 1993 or 1994 for production and even later for employment. Conclusions Czechoslovakia has taken positive steps toward a market economy based on private ownership. Nevertheless, many of the old rules, regulations and restrictions continue to exist, as do old ways of interpreting economic outcomes and implementing economic policy. Unless progress continues to be made in liberalizing markets, freeing enterprises and individuals to pursue their own ends, and privatizing state-owned industry, pressures will build to create a corporatist society with extensive state ownership and attenuated markets. Macroeconomic policy must be used more effectively to manage aggregate demand so as to make up for lost export markets and declining consumer demand.

7 Josef C. Brada 177 References Brada, Josef, "Technological Progress and Factor Utilization in Eastern European Economic Growth." Economica, November 1989, 56, Dlouhý, Vladimir, "Disequilibrium Models of the Czechoslovak Economy." In Davis, Christopher, and Wojciech Charemza, eds., Models of Disequilibrium in Centrally Planned Economies. London: Chapman and Hall, 1989, Dyba, Karel, and Jan Svejnar, "Czechoslovakia: Recent Economic Developments and Prospects." American Economic Review, May 1991, 81, Federal Statistical Office, Czech and Slovak Federal Republic, Forecast of the Czechoslovak Economy, Prague: FSU, Janaček, Kamil et al., Social Feasibility of Czechoslovakia's Economic Reform. Prague: Ekonomicky Ustav CSAV, Pryor, Zora P., "Czechoslovak Economic Development in the Interwar Period." In Victor S. Mamatey and Radomir Luza, eds., A History of the Czechoslovak Republic Princeton: Princeton University Press, 1973, Šik, Ota, Plan and Market Under Socialism. White Plains: International Arts and Sciences Press, Šik, Ota, Czechoslovakia: The Bureaucratic Economy. White Plains: International Arts and Sciences Press, Spulber, Nicholas, The State and Economic Development in Eastern Europe. New York: Random House, 1966,

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