Transitional Success: USSR to EU
The Czech Republic
USSR to EU
Public finance policy
issues during the political
economic transition from
centrally planned socialist
economics to free market
V550 Dr. Mikesell
November 20, 1996
Summary: Restructuring for Transition
III. Transition to
Market Economy: 1990 - 1991
IV. Problems of
Transitional Monetary Policy and the Financial Sector: An Overview
V. Macro Economic
Stability: 1993 - present
VIII. Budgetary Overview:
1993 - present
IX. Tax Reform
Political Economic Considerations: 1996
XI. The EU and NATO
In 1989, after nearly 40 years of Soviet
control, Czechoslovakia once again became an independent nation, the Czech and
Slovak Federalist Republic. This transition from Soviet socialism to democracy
culminated throughout Central and Eastern Europe with the literal collapse of
the Berlin Wall in East Germany, the heroic Gdansk Shipyard Strikes in Poland.
The student and worker protests in Prague and Budapest were no less important.
The Czechoslovakian revolution took place
peacefully and over a much longer period of time than events in other former
Soviet Union or Warsaw Pact nations. Hints of major reform in Czechoslovakia
began as early as 1968. Czechoslovakian officials, under Soviet power, moved
incrementally to begin the long road towards decentralization and independent
Czechoslovakian rule. Their increasingly effective efforts became known as the
Prague Spring, a time of growth, change and development.
Success was, of course, neither immediate nor
easy to achieve. The Cold War reached a pinnacle in the Eighties and the winds
of change began to blow in Central and Eastern Europe. The CEE nations endured
many hardships. Soviet oppression, though waning by this time, became largely
unbearable. Change in Czechoslovakia came from the ground up; dissidents
quietly began to return to popular power. The revolution gained momentum by
1989. ‘Revolutionists’ began to demand sweeping economic and political reform.
They were backed by well organized and very timely strikes and protests. After
a two hour general strike on November 27, 1989, proving the immediate and
widespread power and cohesion of the revolution, the Soviet controlled
authorities finally agreed to negotiate.
Through the negotiation process and threat of
further massive general strikes, former dissidents assumed officially
sanctioned ‘concessional’ positions. Within months, they gained near complete
(and very real) control of the Federal Assembly. On December 29, 1989, Mr.
Havel, a very famous and popular Czech dissident, became President of
Czechoslovakia (renamed the Czech and Slovak Federalist Republic).
This initial political victory represents only
half of the nation’s success. Within the first three years of self rule, harsh
economic (and subsequent political) realities forced the nation to divide once
again. The nation as a whole was unable to accommodate the vast discrepancies
between the western Czech and eastern Slovak regions. Massive economic reforms
brought this to the popular agenda as Slovakia suffered greatly while their
Czech counterparts seemed to benefit from reform.
The government in Prague wished to move swiftly
to further reform efforts. Slovakia hindered Czech success and in turn suffered
greatly by this Czech-led reform. Slovakia simply could not move as rapidly
toward a market economy due to the economic configuration left to them by years
of Soviet planned economics.
Overview: Restructuring for Transition
In 1992, Vladimir Meciar, a very strong
nationalist was elected prime minister of the Slovak Republic, while Vaclav
Klaus, a moderate federalist, was elected in the Czech Republic. Unfortunately,
these two leaders were unable to agree on common economic and political
strategies to govern the CSFR. Klaus’s reform plans, now legendary, were simply
inappropriate for the fledgling Slovak regions. Slovakians felt alienated from
the government reform in Prague. Within a short time it was very clear that the
Czech regions could not completely support their Slovak countrymen through the
transition. The two leaders agreed to divide the Czech and Slovak Federalist
Republic (CSFR) into the Czech and Slovak Republics on January 1, 1993.
Federal assets and liabilities were split
between the two nations in a two to one ratio. The Czech Republic received the
larger portions reflecting both size and population. Again, the split was
achieved peacefully, without massive debate. The two countries agreed to form a
customs union. They implemented identical foreign policies with respect to
third countries, and forbid tariffs or ‘bans’ between themselves. They also
formed a temporary monetary union, which collapsed within months as both
countries unexpectedly experienced a massive drain on foreign reserves during
this time. To more fully understand the current developments in the Czech
Republic, one must examine the historical economic decisions made before the
break-up in 1993 as outlined below.
to Market Economy Overview: 1990-1991
CSFR economic reformers went to work immediately
following the collapse of Soviet rule. The reform package included near
complete liberalization of prices, a complete reversal of former exchange and
trade systems and an impressive preparation for massive and rapid
privatization. These efforts were supported by financial policies including a
“pegged” exchange rate, currency devaluations, and restrictive fiscal, monetary
and wage policies.
Although monetary policy is discussed in a
separate section, it needs to be briefly addressed here to understand the
conditions in which the transition occurred. Monetary policy in the initial
stages of transition ensured that inflation remained in control throughout
currency devaluations and price liberalizations. The CSFR devalued its currency
by 20 percent in 1991 after several smaller devaluations before hand. Taken as
a whole, these devaluations reduced the value of the currency by half within
six months. Generally, monetary policy remained tight throughout the entire
Undoubtably, the goals of the CSFR economic
reformers were to drastically reduce government spending. The former
centrally-planned, output-driven economic policies were no longer effective for
the new capitalist democracy. Restructuring government expenditures was a key
component of reform. The main changes, aside from massive privatization
discussed below, forced reduced subsidies wherever possible. Every sector of
society, with the exception of health, welfare and education, saw an abrupt end
to government subsidies. In 1991 alone, for example, officials reduced
government spending by 12 percent to reach 47 percent of GDP. This trend
continued throughout the transition. Massive government spending, a hallmark of
socialism, ended virtually overnight.
Areas where government spending remained high
would remain so throughout the reform process. Health and welfare for poor,
elderly, unemployed and children is a very difficult situation in any
government, especially one in transition. Reformers focused primarily on
industry and energy in the initial stages, leaving the areas of greater
uncertainty to be dealt with in a more stable political environment.
As an almost immediate measure, subsidies to
foodstuffs and energy were reduced by nearly 50 percent. Retail prices for most
household items increased by nearly 25 percent literally overnight. By the end
of 1991, the Czech government controlled only 6 percent of prices in the
country as compared with 85 percent in early 1990. Only basic necessities, oil,
and agricultural products remained under state control. To offset some of these
shocks, wages increased, though only slightly and not nearly enough to meet the
increased cost of living. Politically powerful trade unions prevented the
passage of even more drastic reform measures. Plans in 1991 to increase the
price of electricity, heating oil and coal by nearly 400 percent and rent by 300
percent were delayed until 1992 and 1993.
Foreign Trade and Investment
After an initial currency devaluation of nearly
50 percent, the government adopted an adjusted exchange rate connected to a
“basket” of convertible hard currencies. Internal convertibility of hard
currencies was established in 1991. These two measures combined to foster trade
and investment. Initially, the CSFR set a 20 percent surcharge on imports
coupled with a 5 percent tariff. These obstacles soon ended as major provisions
were passed to more actively encourage trade and investment. Initial steps
toward private property rights and the dissemination of publicly owned lands
further enhanced the investment environment.
Privatization is by far the most critical and
complicated development the CSFR had to address. Speed was critical. The
‘default mechanism’ ensured that current managers and persons of powers would
assume control and create their own joint venture agreements with foreign
State firms that were nearly completely
vertically integrated needed to be desegregated by form and function. And the
process had to be done well, for flailing industries would simply increase
state expenditures. Failures did not decrease expenditures in compliance with the
transitional reform strategy. The CSFR privatization plan was threefold.
Small-scale privatization was the easiest. Retail stores, restaurants and small
service or industrial workshops were sold to the highest bidders in weekly
public auctions. Where no CSFR buyers were found, a second round of auctions
allowed foreigners to bid.
Property restitution was more difficult. The
government needed to equitably redistribute land that had been taken nearly 40
years earlier. This is a difficult and involved issue. CSFR citizens are
allowed to claim land taken from them, though the burden of proof is on them.
Where no proof exists, special arrangements can be made for state assistance.
In areas of conflict, the issue will be brought to the courts. A large part of
the country was not in private hands before Soviet rule. Some of this land can
be used as an offering to parties where disputes over ownership exist. Also,
lands that have been improved (shops, developments, houses, etc.) are sold at
specially determined rates to the former property owners. Prices and possible
alternative compensation for those owners who do not wish to purchase these
‘improvements’ are again settled by a special court arrangement.
Large-scale privatization progressed swiftly.
Some state-owned firms were sold outright to private interests while others
remained under indirect state control until buyers were found, legal or
economic concerns settled, or parliamentary debate resolved.
The strong tradition of labor unions and their
political strength proved crucial to social security reforms throughout CEE.
The CSFR was no exception. Labor unions were instrumental in keeping CSFR
unemployment at very low levels and social safety net benefits quite high.
Essentially the state guaranteed incomes at a minimal level to meet the ‘cost
of living’ for the unemployed or the under-employed. Pensioners and parents of
children received benefits adequately covering bare essentials. Further
benefits for health care were distributed at the local level as the health
system still remained under state control.
of Transitional Monetary Policy and the Financial Sector
Since the introduction of reforms, monetary
policy played a key role in the economic stability of the Czech Republic throughout
the transition. Inflation remained surprisingly low (though relatively high in
1989 and 1990), exchange rates were relatively stable (after initial
fluctuations), and external reserves stayed strong throughout the period
(spurred by unusual and unexpected outside interest in the Czech Republic as
the first reformer to prove its success).
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