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Economic Transformation of the Czech Republic: The Challenges that Remain

English Pages, 29. 9. 1996

In the last couple of years I made several attempts to discuss - in a more theoretical way - the transformation of a former communist country into a free society and a market economy. My texts were widely published and discussed, both at home and abroad. Moreover, I was lucky to have an opportunity to convert some of the ideas of liberal (I use the term in its original European meaning) economists and other thinkers in social sciences into practice.

We have (in our country) - after almost seven years of radical restructuring of the whole political, social and economic system - completed one difficult stage of the transformation process. The relevant questions are: How to continue? Is the transformation over? Is there - in our situation - a special role for the government as compared to its role in standard countries of the West? What are the new challenges? What remains to be done?

There is no doubt that our society - in all its dimensions - is very different as compared to what it used to be in the communist era. Some changes are visible at first sight, some not. There have been probably more changes in the „software“ than in the „hardware“ of the whole socio-economic system which may confuse some observers, but I am sure that the overall political, economic and social restructuring went better than had been expected (and I do not talk about the Czech Republic only).

In 1993 (and with some modifications in 1995 again), I formulated my ten commandments of a systemic reform and I am quite happy that it is not necessary to rewrite them yet. They included the following postulates:

- the fundamental transformation of the whole society in a historically short period is a feasible task (which is a non-trivial conclusion because 6 - 7 years ago when we started, many doubted such a possibility);

- there is no way to master-mind the whole transformation process and to accomplish optimal sequencing of individual transformation measures;

- there is - in reality - no choice between the so-called shock therapy and gradualism. Both terms are very simplified concepts suitable for a journalists’ discussion, they should not be used in a serious argumentation;

- the crowding-out of non-viable economic activities (and the consequent economic decline) represents an inevitable part of the transformation process;

- an important role is played by the very early price liberalization which must be straight-forward and wide-ranging. The same is true of foreign trade liberalization;

- there is no economic law saying that the faster the economic restructuring (and privatization), the higher the rate of unemployment (just the opposite is true);

- two economic variables - wages and the exchange rate - are of crucial importance. At the very beginning of the transformation process these must be pushed down by restrictive macroeconomic policies to create the so-called „transformation cushions“;

- the post-transformation recovery and long-awaited catching-up process cannot be artifically accelerated or shifted in time;

- the rapid transformation privatization, which is something conceptually different from classical privatization, must be done at a very early stage of the whole process;

- the radical transformation (in a unique and non-repeatable political atmosphere) should be used not only for dismantling old institutions of a command economy but for non-establishing the institutions of a paternalistic, overregulated welfare state as well.

This is - in a very condensed form - both a normative blueprint and a positive description of the transformation process in the Czech Republic. We are now in a situation which can be described in the following way:

- the economy has been mostly privatized; the share of state ownership is relatively small and declining; the mass privatization is over; we have entered the era of serious ownership restructuring, which will lead to a gradual improvement of corporate governance and of company’s efficiency;

- the government is trying to avoid being involved in any form of microintervention, but the pressures of partial interests, of lobbying of all kinds, of corporativism and syndicalism, of patterns of paternalism imported from abroad are getting stronger because - after their initial weakness - these pressure groups have become consolidated and their strength has grown;

- the economy started to grow, all macroeconomic figures (expressed in rates of growth) have positive signs and the economic growth around 5% per annum seems to be a feasible middle-term prospect;

- the main bottleneck on the supply side is represented by the low unemployment rate (around 3%) and the resulting shortage of labor and a net inflow of foreign workers which restrains the rate of economic growth in the short-run;

- relatively strong growth, low unemployment, rapid growth of wages, residual deregulation of prices, rapid adjustments of domestic prices to world prices, frequent changes in the structure of the economy with corresponding movements of relative prices, etc. bring about continuation of inflation around 8 - 10% per annum and the further disinflation process becomes very difficult;

- more than sixty months of a fixed nominal exchange rate from the end of 1990 to February 1996 together with a large inflow of foreign capital and a positive balance of payments constrained the monetary policy of the Central Bank and made it more or less passive (which may be a good method how to discipline ambitious monetary authorities). The introduction of a relatively wide margin for fluctuations of the exchange rate in the spring of 1996 changed the situation sharply. It led to a slow-down of money supply growth in the summer and autumn of 1996, which may be a positive contribution to the overall macroeconomic situation;

- strong demand for money, attempts to slow down the supply of money, fragility of the banking sector plus financial weakness of many new, privatized or still state-owned firms keep both real interest rates and margins between interest rates on credits and deposits relatively high which becomes another inflationary factor (of the cost push variety);

- fiscal policy is based on an undisputed goal of a balanced budget and plays in our context a highly stabilizing role; the share of the budget on GDP has been continuously going down;

- rapid economic growth, very liberal import procedures, comparative advantages of foreign firms in entering the Czech market (because of their economic strength they are able to offer better starting conditions), subsidized products from the EU (with the backing of various methods of export promotion) --- all of this pushes domestic demand for imports above the level of exports which has led to a significant deficit in the balance of trade (which is only partially offset by positive balance of services). Exports are, moreover, very vulnerable to the world (and mostly European) economic conditions and to the different kinds of import restrictions existing everywhere, and to the insufficient domestic export promotion. The trade deficit is, therefore, considered to be the most important single economic problem of the current period.

Until now I have been looking at the economy from the purely domestic economic side. I wish to say a few words about the non-economic issues and about the role of external side of all of that now.

Until very recently the relative speed and smoothness of the Czech transformation process (social and political stability, low inflation and unemployment, more or less balanced and „just“ sharing of the transformation costs in the whole society, the ingenious voucher privatization method, etc.) guaranteed basic support for the sometimes popular, sometimes painful transformation measures.

The Czech society accepted (and „survived“) the negative „collapse effect“ of the dismantling of old institutions and activities, absorbed - with satisfaction - the positive „liberalization effects“ connected with opening of domestic and foreign markets (not only in economic sense). The Czech society now sees growing disparities in income and property (not everyone is on the winning side) and waits for a massive „wealth-effect“ of a normally functioning capitalist society and economy. In addition to this, inflation is more stubborn than everyone expected, voucher privatization is over, and more and more groups in society succeed in avoiding to pay their share of transformation costs. Those who cannot escape paying the costs blame the government for not defending them sufficiently - regardless of the existence of an apparent overall income growth. As a result, the basic (more or less unstructured and unconditional) support has been partly vanishing which was reflected in the results of the recent Czech parliamentary elections. The space for brave government measures is, therefore, narrower than before.

Finally, a few words on the role of the rest of the world in this complicated process:

Basic political support, macroeconomic stand-by arrangements and direct help were extremely important, especially at the beginning. They are of secondary importance now. I do not deny the positive role of learning from abroad but I have to insist upon that learning by doing (which means direct involvement in business with foreigners) has been much more important than professional consulting and advisory activity, because the first is a two-way process, and the second a one-way, non-binding, non-focused, non-market one.

The non-negligible external obstacle to our development comes from various forms of protectionism we face in various markets, in markets of EU countries, of some of the CEFTA countries as well as of other developed or developing nations. With all the promising rhetoric, the results are not that good. The current fashionable idea of fair trade instead of free trade may become very dangerous.

It is our duty, the duty to all of us, to promote free trade as much as possible and I add on both sides of the foreign trade equation. Not only on the import side (which is a usual argument), but on the export side as well (all forms of state subsidies and export promotion).

Foreign investors are extremely important but they should not expect advantages vis-`a -vis domestic firms. To give these advantages is not the way to build a healthy economy.

We are willing to be a full member of the European Union (not an external observer). This is serious and, at home, undisputed. Our membership in the European Union remains, therefore, our most important external challenge.

Václav Klaus, Institute of International Finance, Washington, D.C., 29 September 1996