But what happened in the Czech Republic was very different. Price liberalization and economic deregulation were quickly followed by a large restitution program and privatization of small enterprises: Twenty thousand restaurants, printing shops, gas stations, and other "mom and pop" businesses were auctioned off under the authority of local governments in 1990-91. Then the Czechs proceeded rapidly--some said recklessly--with privatization of large businesses.
This is the heavy lifting in post-communist reform, because separating the assets and liabilities of major state enterprises is extraordinarily complex. In a world where no operations went bankrupt because they were all state-owned, firms lent each other money willy-nilly. Good loans? Bad loans? Hey--we're all one big happy mega-state. Who's responsible for environmental liabilities? Pensions owed? Accounts payable? Not even your Excel-crunching CPA wants a piece of this action.
The Czechs cut this Marxist knot by sponsoring two ingeniously crafted competitions for the two "waves" of large-scale privatization in 1992 and 1994. The Ministry of Privatization required each of the 4,000 or so major state enterprises to file a privatization proposal describing the firm's asset base, its business plan, and the optimal means of privatization. (The proposals included various means of assigning equity, but shares in a newly private company were often set aside for "voucher privatization," wherein stock shares were distributed to the three-quarters of Czech adults who bought coupon booklets for the nominal sum of $35.) Then, with very short deadlines to limit mischief or delay, competing proposals were entertained by the ministry. The 20,000 proposals it received composed a database that allowed it to go where no government had gone before: turning most of a country from state socialism to private capitalism in under four years.
What happened next involved sins of omission and commission. What Klaus's government missed, at least in part, was the importance of property rules that went beyond the initial distribution of equity shares to private owners. Klaus had assumed that rules would develop spontaneously to create a vibrant capital market, and he was not far off--not nearly so far off as BusinessWeek was in its December 15, 1997, issue when it dismissed the Czech financial markets as "another place where free-market rhetoric went haywire."
But Klaus did not recognize that the new economy needed a new legal structure to spark spontaneous order. Unconventional approaches such as "one man, one share" successfully moved huge state-owned enterprises into private hands. But this could be accomplished only through rules that explicitly did not respect property rights: Government bureaucrats were called on to create ownership, cancel old assets and liabilities, and then distribute the new shares like the Tooth Fairy. Once those private rights were out in the marketplace, however, a new system was required to define what private ownership really meant.
In your standard-issue capitalist economy, shareholders have strong assurances that managers, or those who own more shares than they do, won't steal them blind through the sort of insider schemes for which socialist enterprises have become notorious. This is because firms, to attract equity investors to begin with, have to convince people that they will utilize funds for the good of all stockholders. Through a combination of private law (corporate charters), capital markets, and public rules (including courts to adjudicate fraud and embezzlement), corporate agents have incentives to treat your invested capital like it's yours and not theirs.
But while the demand for transparency and integrity operates powerfully on firms that must attract investors, the newly minted Czech firms were created out of thin air (or, rather, a dense communist fog). No corporation had to attract fresh capital to get going. Hence, a different set of incentives were in place. Many firms, focusing on growth, behaved pretty much like firms in developed economies, taking pains to protect the interests of their shareholders in the hope of attracting more investors. In some situations, however, managers or a majority of shareholders found that, without much trouble from the legal system, they could transfer company assets to other corporations which they alone controlled. This effectively cashed out the minority shareholders.
Under such circumstances, the Prague stock exchange has not done well in recent years: The PX50 index, set at 1,000 when trading began in 1993, hovers at about 500 today, the main problem being investor uncertainty about protection of minority shareholders. As Tomas Jezek, chairman of the Prague stock exchange, notes, "There have been too many cases of disappearing value because assets were stolen. The success of fast privatization risks being lost if the government is unprepared to protect private property."
The failure to establish a new legal framework for ownership is particularly glaring in the case of bankruptcy laws, which were suspended altogether for two years during mass privatization. This was, perhaps, a logical thing to do in order to prevent reform from drowning in a sea of litigation. But no comprehensive bankruptcy law has yet been crafted, and the current procedures lead to very confused and lengthy litigation. The incentives created by the delays and confusion are clear: "Clients know how to shift assets to create new companies," asserts one Czech economist.
A related failure involves the simple establishment of the rule of law--well, simple to you and me, safely tucked into a cozy Western bed every night. In a country without an independent judiciary--indeed, where the judicial system is widely feared and distrusted (and widely disobeyed, a holdover from the hostility courts engendered during the days of communist rule)--enforcing the law isn't so simple.
Consider a civil lawsuit in the courts right now. The case springs from an instance in which an investment fund was robbed of $870,000 in assets when the securities registration agency wrongly issued fund shares to some guy who showed up with a fake passport and a forged letter demanding them. The embezzler was never captured, but he did manage to sell the shares to new "investors." So the fund is suing the Finance Ministry, which supervises the official registry system. As cut and dried as the state's liability may appear, the case is being widely followed because it is unclear if the government will make good on its mistake. While the stock registry now uses smartcards and other devices to reduce fraud, uncertainty about investor rights plainly discourages capital formation.
While Klaus's initial reform program failed to adequately ensure property rights, his government seriously exacerbated the problem by putting the brakes on the privatization of key "strategic" sectors: the railways, telecommunications, airlines, petroleum refining, gas and electricity, and, perhaps most important of all, banks. Some Czech firms were exempted from privatization altogether, remaining in the hands of government ministries. Others, while turned into joint stock companies, continued to be closely tied to government by virtue of huge equity stakes deposited in the National Property Fund, a state agency managing the government's portfolio of privatization shares. (During the privatization of large enterprises, the Ministry of Privatization approved many plans that deposited substantial ownership shares in the NPF.) While state assets with a book value of some CZK341 billion (about $10 billion) were dispersed to citizens through voucher privatization, some CZK209 billion (about $6 billion) in assets remain in state hands. According to the NPF vice chairman, Petr Cermak, the state retains significant holdings in numerous industries (see table).
But it is the banks that are crucial to the overall health of the system. They dole out capital to the various sectors of the economy, largely determining which industries will grow and which will wither, which new technologies will be adopted and which will be rejected. The government owns 49 percent of the largest Czech bank, Komercni, and between 20 percent and 50 percent of the other major ones. Jezek, the stock exchange chairman, was minister of privatization in the first elected post-communist government, from 1990 to 1992. He says the status of bank privatization is just where it was "when I left the Privatization Ministry in June 1992. Klaus made no change--nothing."
Leaving the banks in state hands undermines efficiency throughout the economy, as money is invested not just in firms which promise to show the greatest productivity gains but in failing firms for political reasons. Letting the railways remain 100 percent state-owned, for example, allows an enormous amount of featherbedding. That deprives expanding economic sectors of affordably priced labor and limits international competitiveness (particularly problematic in the currency crisis spurred by a burgeoning trade deficit). Overall, restructuring--which, even more than in the West, is a euphemism for laying off unproductive workers--is slowed because no governing party likes unemployment. With unemployment only now rising to 5 percent, the government has been persistently criticized by The Economist for having too few people out of work. The alleged culprit: state-owned banks propping up economically shaky firms.
The effect of central banking is similarly problematic. The Czech government, like all others, protects liquidity in the banking system socially.Hence, the economic irrationalities of socialism, in which firms are bailed out of the consequences of bad decisions with subsidized credit, reappear. When banks are tied to the state via social ownership, their political clout lessens the independence of the central bank, distorting credit allocation. If a bad loan made by or to a politically important customer is guaranteed by the state, there is a clear moral hazard. Lots of inefficient (or corrupt) enterprises get the money; taxpayers (and efficient firms denied credit) get the boot.
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