The Czech Miracle

Why Privatization went right in the Czech Republic.

There are, at bottom, just two ways to bring economic rationality to a state which has seen none of it. One is to carefully analyze the situation, to call high-level conferences and consult with international experts, to measure each tentative step, to be cautious of doing the wrong thing--of going too far, of giving away too much. The other path is to decide that speed is the very essence of reform and that the great catastrophe lies not in doing the wrong thing but in doing nothing.

Most of Eastern Europe has chosen the cautious route. Alone among the former satellites of the Soviet Union, the Czech Republic has elected to go fast. Now as Hungary, Poland, and Russia struggle to emerge from the abyss of the planned economy, as Romania and Bulgaria and Ukraine bobble in a post-socialist/pre-capitalist never-never land, a thriving marketplace is flashing its sparkle in the Czech Republic, a modern experiment in radical capitalist transformation.

The Czech model was not how the Western experts had charted the East European reform era. Some did support macroeconomic "shock therapy," which has had notable successes in freeing prices and privatizing small enterprises, but the idea of turning state socialism into private enterprise in an instant--that they considered impossible. If the United Kingdom, with its commercial law, its investment bankers, its management consultants, its brokerage houses, and its stock exchanges took all of the 1980s to privatize 50 or 60 state-owned firms during the regime of the Iron Lady, then surely the task of privatizing the Czech Republic's 2,700 state-owned firms could not be done overnight.

In 1990, Czechoslovakia was the most socialized of any economy in the Warsaw Pact: 97 percent of productive assets were owned by the government. Hungary and Poland, at about 80 percent state owned, were teeming meccas of laissez faire by comparison. By March 1995, however, the assets of the Czech Republic, the two-thirds of Czechoslovakia which split from the Slovak Republic on January 1, 1993, were 80 percent owned by private persons or corporations--easily the highest ratio of any ex-communist European country. Poland, the test ground for early reforms including "shock therapy," is still unhappily stuck at 55 percent private, the same level as Hungary, a country with a 25-year head start on reform.

And the Czechs are not just privatizing like mad, they are "growing the economy." Czech living standards are increasing rapidly. Inflation--which had its pop when pent-up Crowns were unleashed in the early 1990s--is now under 8 percent a year; indeed, the currency has held its ground against the U.S. dollar since 1991. Exports are booming and the federal budget is in surplus. Unemployment is at 3.5 percent, a remarkable feat considering that layoffs from newly privatized firms are virtually ubiquitous. The expanding service sector is swallowing up thousands of "workers" from the "industrial" sector (such employees did not in fact engage in much productive work, nor did their factories demonstrate more than a semantic allegiance to industry). As Prime Minister Václav Klaus announced last summer, "We are the first Eastern bloc nation to emerge from major surgery and make it into the post-op recovery room."

Most phenomenal, however, is the electoral payoff of what the government still resists calling the "Czech Miracle." While reformers all across the formerly communist nation-states are in hurried retreat, as former apparatchiks turned populists steam back into power, the classical-liberal government headed by Prime Minister Klaus enjoys no serious political challenge from left or right. Prague is in full bloom and the Czechs are far too busy tending garden to launch the dirigiste backlash which swirls violently just beyond.

The Czech reforms were uniquely radical in transferring property from state ownership to private hands, and the society has responded with a flowering of initiative and entrepreneurship. And something more: civility. Politicians in the Czech Republic do not triumph by denouncing foreigners and Jews; the disagreements and arguments of this democratic land have not produced gridlock; frustration and hate do not cloud the cobbled byways of beautiful and historic Prague. And 56 percent (to 12 percent pessimists) of Czech citizens feel "generally optimistic" about their future.

Soon after the communist government in Prague collapsed in the "Velvet Revolution" of November 1989, a government was formed by the new prime minister, Václav Havel. One of the greatest of the dissident writers in Czechoslovakia, Havel earned his anti-communist stripes by doing hard time in a socialist reformatory. He commanded a powerful moral authority. Havel's economic ideas were, however, somewhat poetic; his principled opposition to the hardness of communism had made him squeamish vis à vis the harsh realities of a market economy.

Ironically, Václav Klaus, an economist who had not participated in the dissident movement, was inherited by Havel as finance minister, having been appointed by a gasping "reformist" communist government in 1989. By June 1990, Klaus had split from the Civic Forum, Havel's party, to form his own Civic Democratic Party, a party preaching a faster, more radical transition to capitalism. After the election of June 1992, Klaus replaced Havel, who was moved to the largely ceremonial position of president. Consistently, Czechs say that Havel, while a national hero, is simply "too soft" to make the hard decisions. Klaus is not.

Klaus's tough love won the policy debates early on, a fact Klaus credits to the one favor which Soviet domination had granted. When Russian tanks rolled through Wencelas Square, crushing the Prague Spring of 1968, they discredited the notion of "reform socialism" forever. When someone suggested a "third way"--neither capitalist nor communist--Klaus says the answer was smart and final: We tried that. When economic policies end up flattened with tank-track marks on their topside, you tend to remember the botch.

So the path was clear for quick action. Even before he became prime minister, Klaus and reform-minded liberals had enacted a commercial code (partly borrowed from Germany but tailored to domestic institutions), a restitution process, and a privatization law. The code set up a legal system so that contracts and property rights, the necessary legal pre-conditions of a market economy, could flourish. While establishing the most far-reaching restitution program in the Eastern bloc, the law set lightning- fast deadlines--those who wanted to file claims to "reprivatize" property expropriated by the communists after 1948 had less than a year, until September 30, 1991. The government did not want properties in limbo for years of wrangling over historic ownership rights. The initial privatization policy was intended for small-scale enterprises--restaurants, retail stores, printing shops, gas stations--to be sold by local governments. Since they were small potatoes, the move was relatively easy and uncontroversial: New owners would run things more efficiently, and it was not complicated to figure out who owned what when just a dab of physical assets were involved.

Restitution claims were opened up in November 1990 and moved about $4 billion in assets immediately into private hands. In all, some 100,000 physical properties, including farms, houses, and small businesses, were quickly restituted. Small-scale privatization auctions began January 26, 1991, and were essentially completed by the end of that year, when over 20,000 properties had been sold (25,584 by the end of 1993). The results were encouraging: Workers or others knowledgeable about a business were typically high bidders, and entrepreneurial talents were immediately unleashed. Managers who had adroitly pilfered state assets were turned into profit-minded capitalists in the stroke of a winning bid. Resources became efficiently utilized, and consumers gained a new importance.

The change was visible to the naked eye. As a visitor to Prague in July 1990, I was pained over the gaping hole in the consumer-service infrastructure. Restaurants were rarely open to tourists, even when personnel were on duty and tables empty, and shopping opportunities for convenience items were absolutely nil. The food was abominable; each meal seemed a weird experiment in nutritional efficiency (don't even ask about the communist-bloc yogurt). Just over a year later, in September 1991, I returned to a city bursting with bars and restaurants which catered to the tourist. The food was good--and cheap. By September 1992--the food increasingly delicious--I was complaining about rising prices and the annoying influx of Western fun seekers. Today the secret is out, and the streets of Prague are clogged with consumer demand.

Small-scale privatization was, however, only the beginning. The core of the Czech reform program, and what has driven its successes full throttle, is the tactical genius demonstrated by a Bolshevik troika of free-market economists in Prague. First there is Klaus, a relatively anonymous number cruncher who worked in the banking sector under the communists. And then there are two former professors at the Prague School of Economics who fell under the sway of the late Nobel-prize winning economist F.A. Hayek: Tomás Jezek, Hayek's Czech translator and the first minister of privatization (now a member of the Czech parliament), and Dusan Tríska, a flamboyant intellectual-turned-entrepreneur, who currently runs an electronic stock exchange more computerized than NASDAQ. From Hayek's work, they learned subtle lessons about information, property rights, and institutional transformation no other former communist country has taken to heart.

Reform elsewhere has had a hierarchy: 1) establish macroeconomic stability (bring inflation under control and stabilize the exchange rate); 2) create, or patch up, commercial law; 3) deregulate prices; 4) liberalize markets by allowing new entry including imports; 5) privatize small-scale enterprises; 6) privatize large-scale enterprises. Country after country has worked from the same list; time after time they have stalled out before getting to step 6.

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