Eastern Europe
Reform in Czechoslovakia

At a lunchtime meeting on 6 December, David Begg discussed the progress and prospects of economic reform in Czechoslovakia. Begg is Professor of Economics at Birkbeck College, London, and a Research Fellow in CEPR's International Macroeconomics programme. His remarks were based in part on his article, `Economic Reform in Czechoslovakia: Should We Believe in Santa Klaus?', in issue no. 13 of Economic Policy . The meeting formed part of the Centre's research programme on Economic Transformation in Eastern Europe, which is supported by the Commission of the European Communities under its SPES and ACE programmes and by the Ford Foundation. The views expressed by Professor Begg were his own, however, and not those of the above organizations nor of CEPR, which takes no institutional policy positions.
Begg first noted that, unlike most of Eastern Europe, Czechoslovakia was a prosperous and open market economy during the inter-war period. Richer and more skilled than many countries in Western Europe, it also established a tradition of cautious monetary and fiscal policy which survived even the next four decades of central planning. In seeking to regain its position, Czechoslovakia begins with four major disadvantages. First, the post-1948 Communist regime imposed the most extreme centralization in Eastern Europe: only a few years ago 97% of its output was in the state sector (compared with 82% for Poland and 62% for Hungary). Second, as a result of this centralization and its high skill levels, it was abnormally dependent on exports to the Soviet Union; it has therefore suffered more than its neighbours from the collapse of intra-CMEA trade. Third, continuing Slovak separatist aspirations at best draw out negotiations and protract the implementation of reform: as the inefficient large industrial enterprises built in Slovakia by the former regime are closed down, it will suffer greater unemployment than the Czech lands during the transition to a market economy. Fourth, the reform process had a late start, beginning in earnest on 1 January 1991, a full year after Poland and many years after more gradual reforms began in Hungary.
Despite these considerable drawbacks, Begg maintained that there are grounds to believe that Czechoslovakia's radical reforms spearheaded by Finance Minister Vaclav Klaus and Economy Minister Vladimir Dlouhy may prove more successful than those elsewhere in Eastern Europe. As a result of its history of macroeconomic prudence, there was relatively little excess demand to be released when prices were liberalized. By adhering to a tight monetary policy and achieving a budget surplus, the government has managed to hold the line: following an initial price increase of 26% in January 1991, month-by-month inflation fell steadily, and during August-October inflation was zero.
Begg stressed the importance of microeconomic measures to the success of the reform programme. There is inevitably a failure of corporate control when central planning has been abolished but private ownership remains to be established, since managers have little incentive to resist workers' wage demands and may even engage in `spontaneous privatization' or theft of their enterprises' more portable capital. Czechoslovakia has been alone in Eastern Europe (except of course for the former GDR) in appreciating the need for massive and rapid privatization. This will not cure everything overnight, but it is a key, decisive and massive step in the right direction. While Poland and Hungary fiddle, Czechoslovakia is about to implement a radical voucher scheme to transfer a huge number of enterprises into private hands. The government is virtually giving them away to move them fast aiming to auction off some 10,000 state enterprises in six rounds by June 1992.
Begg maintained that enough of the legacy of the inter-war economy's success and skill base probably remains to lay the foundations for renewed industrial prosperity. By far the largest Western investment in East European industry is Volkswagen's DM 9 billion stake in Skoda (a controlling interest). VW professes such satisfaction with Czechoslovak workers that it has already followed this up with the decision to assemble the Passat in Bratislava. Even more remarkably, it has allowed the Czechoslovak managers to remain in place, whereas it has sent its own trained managers to run otherwise similar acquisitions in Poland, the Soviet Union and the former GDR.
Begg also cited the results of a recent study by Hare and Hughes, which stripped out the distortions of central planning by revaluing all inputs and outputs at world prices. Their results indicated that Czechoslovakia is beginning its reform programme with fewer problems than Hungary or Poland. The economic disaster areas activities that use more inputs than they produce output and hence have negative value added account for 19% of manufacturing output in Czechoslovakia but for 24% in both Hungary and Poland. Moreover, some 22% of its manufacturing output is already competitively priced in world markets, in comparison with 7% and 11% in Hungary and Poland respectively.
Begg concluded that the Czechoslovak government still has much to do. Output will fall by at least 10% in 1991, but it should bottom out in 1992 and then start growing. Price stability and a clear determination by the government to allow the private sector to take off should then make investment look even more attractive to foreign capital. We may soon be asking not why so many Western companies have invested in Czechoslovakia, but rather why they were so slow to see the business opportunities there.