The Czech Miracle

Why Privatization went right in the Czech Republic.

Thomas W. Hazlett from the April 1995 issue

(Page 2 of 4)

The Czech market reformers' list is just as comprehensive but prioritized differently. They have always seen the central reform, on which all other success hinges, as getting the vast bulk of capital out of the state's hands. The other reforms are merely a prelude to the central symphony of capitalism: private ownership of the means of production. Klaus considered a halfway market-socialist economy merely a higher circle of hell. His strategy rejected gradualism at two fundamental levels. Economically, only privatization of the great majority of productive assets could lead to the ultimate payoff--massive industrial restructuring. And politically, only the presentation of an aggressive, radical plan--a plan with a capitalist vision--could defeat the overwhelming reactionary forces of stasis and ugliness.

The Czech reformers believed that the approach preferred by Havel and most of the post-communist regimes in Eastern Europe was wrong in its economics--it eschewed radicalism in favor of perestroika--and in its politics--it offered paeans to democratic process but denounced strong political parties or platforms. This soft-pedaling of reform coupled with the romantic belief that democracy would, by itself, solve the problems of post-communist society, was absurd to the strident market liberals led by Klaus. They became democratic Bolsheviks, committed to creating a strong platform and a clear vision of bold, decisive public action. They saw the power vacuum created by the collapse of communism and argued that if a dynamic liberal agenda did not quickly fill it, reactionary sloganeering soon would.

The radical capitalist reforms in the Czech Republic reflect the belief that the key to success is a shift in the property-rights structure of society. As Klaus noted in a November 1993 speech at the Czech Economy Society in Prague: "The key task is looking for an owner who will perform post-privatization restructuring, not for a state bureaucrat who will restructure the firm before privatization."

The Czechs augured that without a radical shift to private property, reforms would be fruitless. How could one "reform" a vast auto plant if it were still owned by the state? Or bring balance to government expenditures if subsidies to bankrupt government companies continued? Or end subsidies if state ownership continued? Or restrain wages if the government employed most of the work force--a work force that now voted in non-rigged elections? Klaus saw quick privatization of state assets not as a luxury, but as the essence of reform. It would, he said, "minimize the period of pre-privatization agony, because no method exists to rationalise the behavior of firms waiting for privatization (without reintroducing central planning)." The parenthetical is hardly a throw away: It is the approach, to one degree or another, of rising political parties in every other country of the Eastern bloc.

Not only did reform without private property, and lots of it, make little economic sense, the Czech liberals believed that the only way to keep the reform flame on high was to overwhelm the public with so much opportunity that Czechs would not have time to quarrel over details. Dumping massive amounts of state property into private hands would not only achieve efficiency--production goes up as socialism goes down--but create a feeding frenzy on the corpse of the socialist state. This frantic cleansing process channeled society's political energy in a most productive way. Instead of decades-long maneuvers to position this or that interest group for the next well-considered round of privatization, the most calculating men and women snatched their opportunities to become vested in the property now (briefly) available. The social dynamic was goosed by a rush not to chaos and disorder--as in the first Bolshevik uprising--but by the self-
affirming excitement of a race to stake their claims. The gold rush was on, and Czechoslovakians were given one brief shining moment to either become capitalists or to sit on the sidelines of history. Entrepreneurs overwhelmed the political fixers, and the Czech Miracle was born.

Structurally, there are two key elements to the Czech economic reforms. The first is the logic of the "mass privatization." This was an idea hatched by Dusan Tríska, who had seen the plan suggested in a Polish policy paper in 1989 and knew about a giveaway of the government's power company to citizens in British Columbia in the 1970s. Adult citizens would bid for companies with voucher coupons, with each entitled to buy one booklet of 1,000 "points" for a nominal sum. The idea was appealing because simply transferring assets to private citizens is equitable and democratic. It also had a very practical aspect to recommend it: Assets could be privatized with minimal payment. That's a fairly important feature when you are dealing with 15 million near-penniless survivors of communism. So on philosophical grounds--"you deserve a break today"--as well as pragmatic ones--"no cash? no problem!"--turning over state enterprises to the citizens, one man, one share, seemed the right thing to do.

But a second structural aspect has been equally important. It is the creation of succeeding "waves" of large-scale privatization, a formalized sequencing of abrupt deadlines by which project proposals have to be submitted to the Privatization Ministry. This seemingly bureaucratic constraint--calling for private firms or individuals to create great mountains of paperwork for government to administer--was an economic brainstorm. What it did was motivate a massive unveiling of the information as to what, exactly, constituted the Czech capital base. Not only what land, equipment, inventories, and productive capacity already existed, but what could--if reasonably deployed--exist in the future.

The information that the Czechs needed to privatize 3,000 large state enterprises was vast. The central authorities had little actual knowledge of the stock of social capital; the communists may have laid claim to most everything, but they were terribly sloppy bookkeepers. Just finding out what state enterprises consisted of--their physical equipment and inventories, their land and bank accounts, their liabilities, their accounts receivable--was a mess. The national financials, in other words, made Bill Clinton's foreign policy look orderly.

Just one complicating factor, for instance, were loans from one firm to another. Since the state never let any company go bankrupt, managers had incentives to borrow to the max. Who would lend? Other firms, of course--who could register paper assets (interest-earning bonds) while going to still another firm for needed working capital. If push came to shove, the government would rush in and offer subsidies to mitigate financial losses. It was a financial shell game, and, because firms never suffered for defaulting or being defaulted upon, no one entity really knew which loans were operative at any one time.

Against this lack of information, the secret weapon in the Czech Republic's remarkable transformation is what Klaus adviser Tríska calls "the highly flexible concept of a privatization project." Instead of bureaucrats going over the books and deciding what state assets to unload and how, the process is bottom-up. The public petitions the government to privatize a particular property. In effect, private citizens compete to present the best "privatization project" to the state. The advantage is obvious, according to the deputy secretary of the Privatization Ministry, Roman Ceska, who told me in September 1993: "We suffered from the Hayekian information problem."

This is the classic situation in any modern economy. As brilliantly posited by the late Austrian cum English economist F.A. Hayek, the problem is that (even in the best of circumstances) the essential bits of data upon which economies actually run are dispersed throughout society. The pertinent facts concerning demand and supply are known only to individual people who will only reveal such information when it is in their interest to do so. This is not the sort of governmental problem that can be fixed by further research. The data are nowhere available. Information about how, exactly, to achieve efficiencies are hidden deep within the recesses of the human imagination, only to be unlocked by the magnetic force of self-interest.

The Czech reforms have been explicitly designed to tap into this informational gold mine. Rather than dictating the terms of large-scale privatization in a world of darkness, the government has accepted proposals from private persons (not restricted to citizens--everyone, even foreign corporations, could play). The rules of the game were established by the privatization authorities and the deadlines were brutally short. But the projects were all designed by the private sector.

An example is provided by the privatization of the Hotel Pariz. A beautiful old inn built in 1903-07 and standing less than one mile from Wencelas Square in Prague, the building spans six stories and features 100 rooms, one café, one restaurant, and two banquet rooms. It has a secretarial center and will soon house a health club.

Antonín Brandejs is the general manager (and part owner). A Czech in his early 50s, Brandejs left his country during the political turmoil of 1968, living as a global nomad in Germany, France, Canada, and the Middle East. With the collapse of communism, he returned and sought to reclaim the business his family had owned since his grandfather purchased the hotel in 1923. It had been expropriated by the communists in 1948.

The struggle for the Pariz began in January 1991 when, under the newly enacted restitution law, Brandejs's family began the process of making a claim. They were entitled to the physical property minus the value of any improvements. But how you measure the value of such improvements is just the pesky sort of complication that has hammered every restitution program in Eastern Europe. An enormous amount of money had been spent in recent years on renovating the hotel, but much of the money was either wasted (for instance, some rooms in the luxury hotel were left without bathrooms and had to be re-renovated) or pilfered (through insider dealing, with suppliers giving kickbacks to hotel management).