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Ten Years After: First Lessons Drawn

English Pages, 18. 11. 1999

With the benefit of hindsight, with the advantage of 10 years' experience, with all the victories and losses, pluses and minuses, successes and disappointments, we can dare to make first generalizations – both as regards political and economic aspects of transition from communism to free society and market economy. Let me use this opportunity for expressing several remarks to this topic.

A. Political Side

1) We can make a strong point that open, pluralistic and democratic society has been created.

1a) All transformation measures have been done by democratically formed political structures, at least in the Central and East European region, where political pluralism, parliamentary democracy, competition of political parties, unconstrained freedom of the media, etc. fully dominate (it was probably not the case when we move more to the East or South);

1b) It suggests that transition was not masterminded from above, that it was not dictated by one autocratic politician or another, that it was the product of a very specific and complicated mixture of intentions and spontaneity, of design and of action, of planned and unplanned events;

1c) It is easy to criticize the outcome of such an evolutionary and uncontrolled process from outside (as uninvolved observers), from abstract theoretical or vested interests positions, from absolutistic ideological principles, but the transition was not an excercise in applied economics it was “real life” with all its contradictions and ambivalences.

The task of politicians was to get support for transition; some of us succeeded, some of us not; our success or failure, however, dramatically influenced the level of transformation costs (this is how we call the costs of undergoing transition);

What the politicians had to do?

2a) The politicians had to defend or rehabilitate the role of political parties (the word “party” was totally discredited in the communist era) and to block accepting the third way thinking based on loose, fuzzy organisations like civic movements, national fronts for or against something or somebody;

My experience tells me that there is a strong correlation between the presence of a standard political structure (with well-defined political parties) and the success of transition (and I believe the history will prove that I was right);

2b) The politicians had to fight the romantic or pseudoromantic point of view based on two dangerous ideas:

- it is possible (when changing society) to look for new, unknown, untried solutions, to use the collapse of communism for creating another utopia;

- it is possible to get something for nothing, there is such thing as a free reform, there are no transformation costs;

I believe that the last ten years demonstrated that both ideas were and are wrong, but we have to admit that it has not been fully accepted either in the postcommunist world or in the rest of the world. Because of that the expectations–reality gap (E-R gap) has been steadily growing, not narrowing. There is no doubt that much has been accomplished in this past decade. We have witnessed an enormous change in the basic substance of life in most of the transition countries, but the expectations have been growing even faster. The road from communism to free society and market economy is rocky, nevertheless some people do not want to take into consideration that there is no magic carpet which could avoid the necessity of our travelling it. To my great regret such a fairy tale is still here. I have to say that this fairy tale is supported by activities of international consultants and advisors, of investment bankers, of bureaucrats of international organizations who pretend that the only missing factor is listening to their advice. They represent, however, a very well functioning rent-seeking group. Additional problems come from inside. For some people feeling bad feels so good that they invest a lot in criticism, scepticism and the creation of bad mood. To fight such attitudes represents a challenge which the politicians very often do not win. At least in my country.

3) Serious discussion of the political aspects of transition would require to deal with several other important, non-trivial issues. I will just name some of them:

transition is a sequence of policy decisions, not a once-for-all policy change (wrong debate about gradualism or schock-therapy);

transition is based on human choices (influenced by ideas, prejudices, dreams and interests), not on scientific knowledge (Hayekian point about human action or human design);

transition brings democracy, but more democracy typically enhances the power of interest groups in general, and blocks further reforms in particular;

during transition from communism the first problem was to concentrate on solving the dichotomy “oppression vs. freedom” whereas the not less important dichotomy “anarchy vs. order” was - especially in the first period - usually neglected or at least underestimated;

the critical factor affecting transformation costs is the interaction of formal vs. informal rules on the one hand and the gap between rules and their implementation.

B. Economic Side

The challenge for any transition economy in the economic field at the very beginning was manyfold:

- to minimize the inevitable economic decline which followed the fundamental change of economic conditions or parameters (they were partly the result of the transformation strategy itself, partly the unintended consequence of the altered international environment);

- to eliminate the inherited excess demand (or forced savings) at the moment of price liberalization without initiating galloping inflation or even hyperinflation;

- to liberalize prices and foreign trade without creating difficult social conditions and economic imbalances;

- to deregulate markets even if there remains to be a very imperfect market structure;

- to privatize state ownership rapidly, efficiently, with domestic participation and in a socially tolerable way;

- to change institutions, rules and legislation as fast as possible but in a democratic (and constitutional) way.

1. Managing the first stage of transition when the costs greatly exceeded the benefits (at least in economic sense)

Transition economies succeeded in the above-mentioned tasks with mixed results. I have no ambition analyzing other countries as such analyses are usually very superficial and will instead concentrate on the Czech economy only.

The Czech Republic´s transformation shake-off led to a visible output loss: it amounted to 1/3 of industrial output, 1/4 of agricultural output and 1/5 of GDP. The figures are relatively high but they are lower than in most of the transition countries and, what is even more important, there was no way to avoid it.

Due to a lesser inflationary imbalance we “enjoyed” during the communist era and due to very cautious and restrictive macroeconomic policy after its end but prior to the price liberalization, the highest rate of inflation was “only” 57% (in the year of price liberalization) and it rapidly declined to a 10% annual rate in the following years.

As a result of restrictive monetary and fiscal policy and of sharp devaluation of the crown before the foreign trade liberalization, the dangerous trade imbalance did not take place and thus it was not necessary to stop its development by introducing administrative measures.

It is difficult to say only a few words about privatization without caricaturing it. It needs a special lecture which I am not able to make now. I would like to differentiate at least transformation privatization and classical privatization and to mention a very specific Czech voucher privatization.

To summarize the above as regarding the first stage of transition, we can say that we succeeded in minimizing the gap between costs and benefits, in avoiding price-wage-price or price-exchange rate-price spirals with fatal consequences which we had been afraid of so much, in dismantling old institutions, in minimizing difficulties in the social field with a relative success.

2. Managing the second stage when the benefits started to exceed costs

The main feature of the second stage was the resumption of economic growth. In the Czech Republic

- it led to a real wage increase of one third;

- it led to a rapid growth of the tertiary sector, to a visible improvement in environment and infrastructure;

- it was characterized by an extremely high investment ratio, by investments-saving imbalance, by growing trade deficit, by massive inflow of foreign capital and, gradually, by deteriorating balance of payments position.

Relatively rapid growth, balanced budget, low inflation, uninterrupted inflow of foreign capital, made us relatively comfortable and we did not see the first “warning” signals of the growing imbalance, which – in a small, open economy – leads not to domestic inflation but to balance of payments (current account) difficulties.

3. Managing the growing imbalance: hard landing because of insensitive macroeconomic policies

The task of the government, and especially of monetary authorities, was to slow down the growth of domestic aggregate demand and to ensure “a soft landing”. We did not succeed in it. The central bank made a fundamental mistake and its “overkill” destabilized the economy.

Standard anatomy of a currency crisis developed:

- first collapses within the banking sector;

- growing uncertainty among foreign investors (and especially speculators);

- economic growth started declining (with a standard lag after the change of monetary policy);

- budget revenues began to fall, the government attempted to balance the budget by cutting expenditures (which contributed to the decline of demand);

- the attack on the crown followed (with the absence of pre-attack abandonement of fixed-exchange rate);

- 10% devaluation and the huge loss of currency reserves;

- political instability;

- extreme vulnerability of the banking and financial sector led to many bank failures;

- continuation (and even reinforcement) of the monetary restriction in the form of high real interest rates and of stricter reserve requirements (and other similar regulatory measures);

- credit crunch.

4. Another Upturn?

We are hopefully approaching the turning point based upon the growth of consumption and exports whereas the resumption of investments has not yet arrived. It depends on the change of climate in the banking sector. The change itself depends on accepting on the side of the central bank, foreign investors and international financial institutions that our banking problems reflect current macrosituation rather than the systemic issues. We are, however, far from reaching such consensus.

Conclusion

Transition is not an easy task. It is a unique historic event, in many respect unparalled in recent history. We should not pretend now that it would have been possible to make it differently.

Václav Klaus, Notes for Prague Conference, November 18, 1999.