Velvet Devolution

Is the "Czech Miracle" over? Or still to come? A report from Prague.

Thomas W. Hazlett from the March 1998 issue

(Page 3 of 3)

As Alena Buchtikova, an economist at the Czech National Bank, explains: "The old big state banks were privatized only partially, and the state guarantees in these banks enabled the persistence of some of the old rigidities and inefficiencies." Banks faced new clients with no economic track records and felt political pressure from above; the result was "rather uncritical lending." The problem of bad debt began a spiral, with banks preferring "to extend credit to ailing firms, rather than enforce the credit contracts, in order to hide the real extent of the nonperforming loans in the banks' balances." By June 1996, an astounding 39 percent of bank loan portfolios were "classified," meaning that "there exists uncertainty about their repayment."

Klaus's famous liberalism finally collapsed under the temptations of office. By the time he was forced to resign, he was barking at foreign investors and imposing government sanctions to keep wages in the private sector down. Even the opposition Social Democrats were complaining that 45 very large "strategic" firms held by the Klaus government should have been privatized long before. As economist Jiri Schwarz, president of the free market Liberal Institute, put it: "We are very happy with the progress we have made since 1989. But we are not at all happy with the progress we have made since 1994."

"We simply stopped," declares Jezek. He says Klaus "was interested in the transformation effect of privatization, and once that had been done, he declared it finished. It was only halfway accomplished." Jezek believes bureaucratic inertia--precisely the factor that Klaus described in 1990 as the "reform trap"--has overtaken the zeal to privatize remaining "strategic" industries. "Many people in control of the National Property Fund are simply not interested in finishing the job," he says. "They are on boards of directors and do not desire change. Government has not the dynamism and force to finish its task."

With serious problems still to be tackled, Klaus delivered no program. He barely survived a June 1996 election, having to form a coalition government with two other parties. Blaming his coalition partners, Klaus all but shelved further efforts at economic liberalization and declared the transformation complete.

Did Klaus, the radical capitalist, turn soft on socialist control? I spent an hour with him a few weeks before he finally resigned. It was a notably contentious interview, in which he began by vehemently denying that he had ever declared any "Czech Miracle" to begin with (while pointedly invoking the term only moments later in the conversation) and then zealously defended state ownership of at least 25 percent of the economy. The question I was most anxious to ask him concerned the pace of privatization. Here's how that exchange went:

Me: "The question that a lot of people are asking now, and not just critics but people who are quite sympathetic, is, What is the current status of the privatization program? The concern is that great progress was made up through 1993 and 1994, but it seems that no progress has been made since."

Klaus: "That's really not true. [It] is a very simplified evaluation of events in this country. It is definitely much easier to start with the small privatization, to privatize small-scale businesses. It is simple, and it can be done in a very short period of time. The privatization of standard firms is more or less over....we are now privatizing with a much slower pace firms which are in [a] typical European country somewhere between the private and public sector. So, to privatize telecom, to privatize railways, to privatize nuclear power stations, to privatize some network industries in the distribution of, let's say, gas or electricity--is a
...different story. [There's] just no connection whatsoever with the transition from communism to capitalism. Most of the Western European telecoms are in...public hands, most of European railways are in...public hands. And so on and so forth."

After this curious mixture of denial and confirmation concerning the slackening pace of privatization, Klaus went on to compare the policy situation in the Czech Republic to that of France's state-owned telecommunications sector. While a country ruled for most of the past two decades by socialists, boasting a top-heavy bureaucracy, high taxes, and heavily regulated labor markets, struck me as an odd model for what Klaus had once called "capitalism without adjectives," his example was even more provocative because it was out of date: France has privatized its telecommunications monopoly and begun to open its market--as have all the other major countries of Europe.

Bravely defending perhaps the last state-owned telecommunications monopoly in the Organization of Economic Cooperation and Development is in striking contrast to Klaus's emphatic rejection of the social-democratic "third way," and to the pledge he made in a 1990 interview with REASON ("No Third Way Out," June 1990) to attack the "giant, powerful state monopolies" with a "philosophy [that] can be summed up as demonopolization" (his emphasis). Perhaps, as the press has widely alleged, Klaus became fearful of the destabilizing political effects that widespread layoffs in the new firms would have, or perhaps he was seduced by the realpolitik advantages of go-slow privatization on a case-by-case basis, presided over by the governing party. Whatever Klaus's motivation in pulling back, the current situation ironically confirms his own early warnings about the disastrous consequences of slow privatization.

Transforming an entire society from socialism to capitalism is complicated business. You can be right about almost everything and still foul up some very important stuff. The process is not quite an academic exercise; when you play with real money, hopes, and dreams, conflict and gamesmanship rear their heads. Political coalitions form, group dynamics kick in, a free press piles on--and egos blow up like mushroom clouds.

So here on planet Earth, we're forced to grade on a curve. And the thing that strikes one as most remarkable about the Czech Republic's situation, post-Klaus, is how favorably that country's transformation compares to that of virtually
any other nation in similar straits. In a September 1997 draft of a forthcoming book comparing East European post-communist reform experiences, economists Patricia Dillon and Frank Wykoff of the Claremont Colleges write that "today's Czech Republic is usually considered the most successful of all the transition economies." It is not difficult to see why.

Take a look at the numbers. Even with the current difficulties, the post-transition growth rate has been stable and positive: 0.6 percent in 1993, 2.7 percent in 1994, 5.9 percent in 1995, 4.1 percent in 1996, 1.8 percent in 1997, and 2.8 percent (predicted by the Czech Statistical Office) for 1998. Labor productivity has grown an impressive 10 percent in the past year, and real wages have been rising almost as fast (7.7 percent in 1995 and 8.5 percent in 1996). This has occurred in the context of moderate inflation, rising recently to 10 percent, and very low unemployment. Both are much below the levels found in Slovakia, Poland, Hungary, and Russia.

Moreover, the Czechs are clearly leading the liberalization race. The country ranks 12th in The Wall Street Journal's "economic freedom" index (compared to 21st for Germany, 64th for Hungary, and 85th for Poland), while the World Bank's "Liberalization Index" gives the Czech Republic a score of 0.93--tied with Hungary and Estonia for the freest economy in the developing world (compared to 0.89 for Poland and 0.69 for Russia).

Given the barrage of publicity about the failure of Czech privatization to reorient the bulky, overstaffed state industries, I was surprised to learn that total industrial employment declined by half a million workers from 1990 to 1996 (from 1.7 million to 1.2 million). The bloated agricultural sector also has been slashed without massive unemployment: In 1990 it accounted for 8 percent of GDP; by 1995 it was down to 5.2 percent. Capital and human resources are streaming into the booming high-tech sectors and the previously starved service industries (see table).

World Bank studies show that, for all their shortcomings, the emerging Czech capital markets have tended to monitor corporate managers relatively effectively. A May 1997 World Bank report finds that, from 1992 to 1995, "Czech firms had the highest growth rates in labor and total factor productivity" among Eastern Bloc countries. The analysis even found that the much-maligned investment funds, including those owned by the banks, had performed OK. "The Czech model," the World Bank concludes, "offers useful lessons for other transition economies: the speed of privatization matters, and both more concentrated ownership and indirect ownership by banks leads to faster restructuring." In other words, Czech capital markets, compared to the relevant alternatives, work pretty well.

So the sky, while a bit darker these days, seems not to have fallen on the Czech Republic. True, growth has slowed, and real problems must be solved. But the economy has been transformed through the most aggressive reform program in the entire Eastern Bloc (save, perhaps, Estonia's), and further progress will no doubt accompany continued liberalization. Elections are likely to be held in June or November, and it is quite possible that Klaus's party, which now trails the Social Democrats by six to 10 percentage points in the polls, will become the loyal opposition. Perhaps more important, the communists have no party and no chance--a situation nearly unique in the region--and no serious electoral entity will attack Klaus's transforming achievements.

Except, perhaps, Klaus. When the prime minister announced pro-regulation policies in April 1997, The Prague Post reported, "Ironically, the concept of greater controls was criticized by the prime minister's allies while being heartily supported by his opponents." Klaus was finally forced from office in November 1997 by members of his own liberal coalition. One of them, Civic Democratic Alliance leader Jiri Skalicky, complained that Klaus's movement had to be saved from its leader: "I am afraid that Klaus...is trying to ruin all the good things he's done for this country." Purged of their contentious and confused messiah, perhaps the forces of liberalism can regroup. There's more of the Czech Miracle yet to be performed.

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