Freeman

ARTICLE

Czecho-Slovakia Rejoins the West

JULY 01, 1992 by SEAN GABB

Mr. Gabb is a senior policy adviser to the Slovakian government.

I had dinner recently with a friend in Prague. Before 1989, he had been a dissident economist. His open contempt for socialism had denied him a university post and earned him continual police harassment. Today, he is a senior official in the Federal Ministry of Finance. People address him as “Pan Doktor” and listen to him with respect. Prosperity, though, has not altered his opinions. He remains as committed now to free markets as in 1977, when as a graduate student he first read F. A. Hayek and Milton Friedman. Asked about the pace of economic reform in his country, he replied, “Radical problems need radical solutions.” These words express a majority of public opinion and the policy of almost every governing body in the Czech and Slovak Federal Republic.

 

An Unhappy History

The history of Czecho-Slovakia between 1938 and 1989 was bitterly unhappy. Before then, it was the 11th richest country in the world. The Czech lands contained the greatest concentration of industrial plants on the whole Eurasian land mass east of the Ruhr Valley. Slovakia possessed a thriving peasant agriculture. The country was the only democracy in the region. It stood out sharply from all its neighbors by importing rather than exporting refugees. Its cities were exciting, polyglot communities of merchants and artists. Franz Kafka and Karel Capek were among its leading writers. Leos Janacek was its leading composer.

 

Czecho-Slovakia was firmly part of the West.

Then in March 1939, it ceased to exist. The Munich Conference of five months earlier had given a great slice of its western region to Germany. Now the Germans annexed what remained of the Czech lands, and for the next six years ruled them as conquered provinces. Slovakia retained a formal independence, but was in fact a German satellite. The social damage was incredible. First, hundreds of thousands of Jews, Gypsies, and others were deported to concentration camps and murdered. Then, following the Allied victory, millions of the indigenous German community were expelled, with heavy loss of life. When reconstituted in 1945, the country was scarred almost beyond recognition.

It had little time for recovery. In 1948, the Communists took power in a political coup. They turned the country into a grim, Stalinist tyranny. The media were put under a close censorship. All opposition, real or imagined, was liquidated. The whole economy was nationalized. The effects of all this hardly need telling: While the prisons filled and the toll of broken lives mounted, CzechoSlovakia’s place in the world economic order steadily fell until it was the poorest country in Central Europe.

 

The Restoration of Liberty

The long nightmare came to an end with the revolution of November 1989. The new federal and state authorities immediately set about restoring freedom under the rule of law. Political freedom was restored almost overnight. This was an achievement so great and sudden that the most sober local account might be disbelieved. Let me therefore quote from a U.S. State Department report:

Czechoslovakia made impressive progress in restoring human rights in 1990. . . . Legislation providing for the rights of free speech, assembly, association and press was adopted, and the citizenry embraced these rights to create an active, pluralistic political life. Political offenses were eliminated from the criminal code, and legal provisions strengthening the right of due process for criminal defendants were approved. A sweeping presidential amnesty freed over 20,000 persons, including all known political prisoners. Arbitrary arrests, searches, and interrogations, which had been commonplace during the Communist regime, were eliminated in practice, and safeguards were adopted to prevent arbitrary interference with privacy, home, family, and correspondence. (Country Reports on Human Rights Practices for 1990 [Washington: U.S. Government Printing Office, 1991], p. 1123)

Economic freedom, however, will and must take much longer to restore. The task is colossal. My own country, Great Britain, made heroic efforts in the 1980s to reverse a generation of economic decline. But these efforts were made in a country that was still mostly capitalist, with a functioning price system and developed capital markets. The Czech and Slovak Federal Republic began its own transformation with none of these advantages. Economic assets were owned by the state to an extent rare even in the former Soviet bloc, and there existed no meaningful structure of relative prices by which to chart any economic course or measure any economic performance.

“Radical problems need radical solutions.” These words are not just a catchy slogan. The federal and state authorities have begun the most ambitious scheme of market reform ever attempted. Its purpose is to convert the Czecho-Slovak economy within three years from one based on central planning to one based on an almost completely free play of market forces. I describe this scheme under the following headings: currency convertibility, trade liberalization, restitution, small privatization, and large privatization.

 

Currency Convertibility and Trade Liberalization

On January 1, 1991, the Foreign Exchange Act established internal convertibility of the crown. This allows corporate and natural persons registered as economic entities to buy unlimited amounts of hard currency from the central bank. They can use this to pay for the import of goods and services, or to pay royalties, interest on foreign loans, and dividends.

Although these entities are required to offer all hard currency they earn to the central bank at the official exchange rate, this has not proved onerous. A strict control of the money supply unique among the former Soviet satellites has produced a very close convergence of the official and black market exchange rates. Quite often, foreign visitors to Czecho-Slovakia will find as good a rate of exchange in the banks as on the streets. Indeed, whatever it may be in theory, the crown is emerging as one of the hardest currencies in Europe: Since my arrival here from London in November 1991, it has appreciated against the pound. And, while the law restricts private individuals to changing no more than 3,000 crowns per year into hard currency, this rule is seldom enforced.

Until 1991, all foreign trade with CzechoSlovakia was the monopoly of a few state-owned companies. These cared nothing about profit. Contracts were made on the basis of personal corruption or the espionage requirements of a Warsaw Pact member state. All trade in motor cars went through Motokov, in textiles through Centrolex, in heavy machinery through Skodaex-port, in electronic equipment through Kovo, in arms through Omnipol, in chemical products through Chemapol and Petrimex.

These companies were not abolished, but their monopoly was lifted, and they must now compete with private trading companies. On the whole, this has been to their benefit. Kovo has taken especially well to the new commercial imperative, even expanding and diversifying its activities. The result has been to open the country to normal international trade, private company with private company.

This has not meant the establishment of free trade. Tariffs are as high as 70 percent. Also, for a small range of goods, a license is required before foreign trade can begin. But Czecho-Slovakia is actively seeking to join the European Community, either as a full or associate member, and its tariffs will sooner or later need to be lowered. As for the restricted goods, most of these have military applications, and the rules are no different in principle from those long applied in most Western countries.

 

Restitution

One of the main problems at the start of the reform process was the complete absence of private enterprise. Unlike in neighboring Poland and Hungary, everything had been owned by the state. A company law was passed to allow the setting up of private businesses, and a start was made on making the necessary accompanying changes to the civil law and the taxation system. But far better than waiting while the new companies founded in 1991 grew large was to transfer existing state ventures into private hands.

So far, the most successful of these transfers has been restitution. This allows the owners—or their legal assignees or heirs—of property stolen by the Communists since 1948 to seek its return. The last date for filing claims was October 31, 1991.

There were some problems with this form of transfer. First, proving ownership was often difficult after up to 40 years of interrupted possession. Second, where houses or very small businesses were concerned, there was the position of current possessors to take into account. Third, the restitution law excluded Germans who had been expropriated between 1945 and 1948. This led to problems between Prague and Bonn, and at a time when a new treaty of friendship was being prepared between the two countries.

Even so, restitution worked. Property worth about a billion dollars has been put into private hands. Those who at first doubted its wisdom, like Tomas Jezek, Minister of Privatization in the Czech Republic, have been converted. He comments, “I have changed my former attitude toward restitution.”

 

Privatization, Large and Small

Under the Small Privatization Act of 1990, provision was made for the sale and leasing of small businesses—such as shops, restaurants, hotels, workshops, and so forth—at public auction. By the end of 1991, more than 21,000 units in the Czech lands and more than 8,000 in Slovakia had been sold, at an estimated value of $350 million. There is still a long way to go before the state has divested itself of every small business.

Until November 1991, there was often ambiguity as to whether a business should be put to auction or withheld for restitution. There remains the problem of “old structure personnel”—middle and senior management under the old regime—who deliberately obstruct the auctions. But the process can only be delayed, not prevented.

Under the Large Privatization Act of 1991, the 3,000 or so largest companies in Czecho-Slovakia are to be privatized by a method of their own choosing. Some have chosen sale by auction. Others have chosen sale to a foreign investor. The most notable examples of this have been the sale of the Skoda auto company to Volkswagen, and the sale of the state airline to Air France. Most, however, have chosen “coupon privatization,” a method first used in British Columbia, and suggested to the federal government by Jan Svejnar of the University of Pittsburgh.

In principle, the method is quite simple. The participating companies are to transform themselves into joint-stock companies owned by the state. Shares are then to be distributed free to those citizens who have registered as interested and who have bought books of investment coupons. The estimated value of these companies is around $10 billion. There is a registration fee of about $35.

The practice is more difficult. Coupon privatization is to happen in two stages, during which it will be possible to exchange investment coupons for shares in companies. The first began in March 1992. Each stage of privatization contains several rounds in which shares are offered. Each round contains four phases.

In the first, the companies announce the value—expressed in investment coupons—of the shares to be offered in the round. In the second, the holders of investment coupons order shares in the companies of their choice. In the third, these orders are processed. In the fourth, the results of the round are announced. There are three possible results.

First, there is no excess of demand or supply. All the shares offered will be bought at the stated price. That will be the end of the round. Second, there is a lack of demand. All those who have ordered shares will be satisfied, and the excess will be reserved for the next round, in which they will be offered at a lower price. Third, there is an excess of demand. No shares are sold. Instead, coupons are returned to their holders and the shares are offered in the next round at a higher price.

Coupon privatization is a kind of lottery, in which there will be winners and losers. Most obviously, it will be possible for more astute investors—or those with inside information—to guess that certain shares will be undersubscribed in a given round. They will then be able to wait until a later round and buy what they want at a lower price. This will certainly cause resentment among less sophisticated or lucky investors, and may lead to wrangles over corruption.

There are more practical objections, put forward by the advocates of wholesale privatization by auction. They claim that the coupon method will delay foreign investment, since books of coupons are available only to Czech and Slovak citizens, and it will do little to break up the monopolies and cartels that currently dominate the economy.

It must also be said that coupon privatization is being tried in a country with an obsolete telecommunications network and a complete lack of financial experience. A similar scheme would cause problems in any Western country; and the advocates of privatization by auction are rubbing their hands with glee, waiting for its failure and their own moment of triumph when their alternative scheme is extended from small privatization to large. Only time can tell how the scheme will work in practice.

Nevertheless, registration went very well, with more than half the adult population buying books of investment coupons; and the first stage is, as I write, proceeding without obvious mishap. It may be that, as in so much else of their economic reform program, the Czech and Slovak peoples are so determined to put Communism behind them that even a flawed plan will be made to work.

 

Problems of Economic Reform

Not everything, of course, has gone smoothly. All major economic changes involve losses for some person or group. In January 1991, most prices were decontrolled. During the next few months, there was an average increase of 50 percent, and some prices rose by more than 200 percent. This was a fundamental requirement of the reform program. Forty years of price distortion had to be undone. But its effects in a low-wage, low-productivity economy were very sharp. Consider: The average male worker in CzechoSlovakia earns 3,480 crowns per month (30 crowns equal approximately one dollar). After income tax and other deductions, he takes home 2,800 crowns. Let’s assume that his wife brings in another 1,500 crowns, and then deduct 400 for rent and other services. This leaves 3,900 crowns per month to feed and clothe a family of two adults and usually two children. This is 130 crowns per day.

Now, a pound of beef costs 40 crowns, coffee is 38 crowns per pound, and a large loaf of bread is 25 crowns. Soap, toothpaste, and other toiletries cost English prices, which are rather higher than American. A good pair of boots can cost 2,000 crowns. Things like refrigerators, washing machines, television sets, and other consumer durables can easily cost a year’s disposable income, and often more.

Then there is unemployment. This has so far remained low in the Czech lands. But toward the end of 1990, it stood around 5 percent in Slovakia. Fifteen months later, it was 12.3 percent and rising fast. This part of the country had been turned by Stalin into a vast armaments factory. With the collapse of the Soviet empire, its market vanished. It is impossible to say how much of the now redundant heavy industry is worth privatizing—how much of it can be convened to civilian production and made to earn a profit.

The uneven suffering of the Czech and Slovak republics has led to a constitutional wrangle that may grow large enough to threaten the continued existence of the federal state. It can only be hoped that prosperity will return before any serious political and economic damage can result.

And Czecho-Slovakia deserves to be prosperous. Without significant help from the West—especially without any lowering of trade barriers by the European Community—it is fast throwing off the disastrous legacy of the half century that preceded 1989. It transformed itself at once into a constitutional democracy. It is transforming its economy with wonderful rapidity from one dominated by central planning to one based on markets and individual initiative.

I came to Czecho-Slovakia worried about what I might find. Four months later, I feel honored to be living through one of the most inspiring rebirths of modern history.

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July 1992

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