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.
Social Policy
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.
Problems
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).
What is perhaps most impressive are the
obstacles Czech officials overcame in developing an effective monetary policy.
First, the entire CMEA trading block was virtually dismantled. Reform and
transition would be difficult even with stable trading partners. In the CMEA,
all of the countries were experimenting with and adjusting prices, exchange
rates and policies. It was very difficult to set monetary conditions correctly,
in real or absolute terms.
Second, within just a few short years, the CSFR
itself broke apart for economic and political reasons. This was largely
unexpected and proved difficult in the policy making arena. As the break-up
drew near, officials had a difficult time determining which policies should be
enacted based upon which of many scenarios might occur in the CSFR.
Third, after finally establishing the terms of
the CSFR split and negotiating a seemingly effective customs and monetary union
between the two new countries, the monetary union failed miserably. Within a
few months, the union caused significant drains on much needed foreign reserves
in both countries and had to be abandoned.
Finally, the Czech tax system had to be
completely overhauled. Additionally, the banking system needed massive reform.
Large spreads in interest rates were common and overall the banks were simply
reluctant to lend on any long term basis, a major impediment to domestic
investment and growth.
All of these massive changes occurred within
just a few years. Throughout these developments, monetary policy remained
extremely tight. At the onset of the reform period, it was at its tightest,
with a minor break late in 1991, once the political economic dust had settled.
Otherwise, the next monetary reprieve didn’t occur until the second half of
1993. By 1994, broad money grew at 30 percent compared with growth of 15
percent a year earlier. More important than doubling growth figures is that the
economy was able to withstand this growth by 1994!
Interest rates were high throughout the period,
and continue to remain high by most western standards (over 9 percent).
Interest rates were not directly controlled but were subject to central bank
reserve requirements and discount rate announcements. Liquidity was further
controlled through regular auctions of treasury bills.
Bank reform focused primarily on establishing
the legal framework for transactions between the central bank and newly
established commercial banks. Weaknesses still remain in reporting and
accounting and the reluctancy for banks to lend. Several commercial banks have
had to come back under government control to prevent major economic problems.
Macro
Economic Stability 1992 - present
By 1992, the CSFR began to show significant
signs of success. Though they were in fact more disadvantaged than many other
countries in the CEE, they fared well. Their export market consisted almost
entirely of former members of the Council for Mutual Economic Assistance (CMEA)
who were in the same transitional position as the CSFR, impeding efficient
trade. Fortunately, inflation on the whole in the CSFR remained remarkably low
when compared to the rest of the CMEA, as did external debt. Inflation did jump
just before the CSFR breakup into the Czech and Slovak Republics. Experts
suggest this occurred in part due to the fear of instability during the breakup
and in part due to an anticipated VAT. As expected, in 1993 (in the Czech
Republic), inflation rose again after introduction of the VAT.
In 1993, free from its less advantaged Slovak
counterpart, the Czech Republic better targeted its economic recovery plan. The
plan encompassed three main elements:
1) A balanced state budget that encompassed
sweeping tax reform;
2) A tight monetary policy to reduce the
inflation caused by VAT and other lesser effects (which also
improved its external position for trade and investment); and
3) Moderate wage increases (adjusted to
inflation) and a stable exchange rate.
This reform policy was backed by an IMF “stand
by” arrangement as a precautionary measure. The IMF would assist if the Czech
Republic needed financial assistance. This happened once early in 1993 and
Czech officials repaid the loan before it came due (much to the delight of the
IMF).
Unemployment remained remarkably low in the
Czech Republic at 3 percent in 1993, while Poland’s figures (another major
success story in CEE) still remain in double digits. Low, virtually
non-existent unemployment certainly contributes to greater political and
popular acceptance of the above fiscal and monetary policies.
Many attribute a major setback in the Polish
“Shock Therapy” reform efforts to the political demands of the labor unions.
The Polish President, Lech Walesa, understood the need to keep wages low to
implement the reform. But he feared for his political power and caved in to
labor pressures by granting wage increases. By doing so he nearly destroyed the
entire economic reform process. He claimed that had he not, the entire
political reform process would have crumbled.
Czech officials didn’t face this obstacle as
unemployment throughout the transition remained low. The political reform
process was slightly segregated from the economic reform process. The small
Czech population (roughly 10 million) was easier to organize than Poland’s 40
million. Regional differences were less and political factions less pronounced.
Regardless, by 1993, the Czech Republic had a very cohesive popular political
support base which facilitated the economic reforms.
By 1994, foreign trade increased substantially,
with much of the growth occurring between EU member nations. Tourism in Prague,
now a “must see” on any European vacation, contributed to increased trade to
maintain a strong balance of payments and a surplus in the current account.
Though FDI by 1994 had decreased (after very high initial investments in 1992
and 1993), the
capital account maintained high inputs due to
the rise in borrowing of Czech firms (which proved even better for Czech long
term economic success).
GDP began to rise slightly after a period of
decline from 1991-1993 of nearly 20 percent. Privatization entered its second
round in 1994 for enterprises being privatized through voucher programs. The
first wave of privatization is considered a remarkable success (a model to be
used farther east). As this first wave ended in 1993, the Prague stock exchange
began trading and the banking system went though increased and improved
reforms. The Czech Republic was a leader in the CEE in trade and investment.
Economic reform efforts, coupled with the above mentioned political support,
put the Czechs at the forefront of CEE success.
Industry
Industrial output by 1993 declined by nearly 21
percent compared with 1991 figures. This can partially be explained by
increases in the service sector, as investment soared in service sectors and
dropped dramatically in the industrial sector. Also, the industrial sector was
the most inefficient sector in the former centrally planned economy and much of
those inefficiencies were corrected with the introduction of market reform.
Most industries produced less as consumption dropped. And they did so more
efficiently as output based economic plans were no longer used.
It is significant to note that the Czech Republic
does not have an industrial policy. They feel the state does not have enough
information or resources and thus it is most efficient to allow the private
sector complete control. Government could assist with exemptions and
subventions, but the market should determine winners and losers.
However, the Czech government continued, through
1994, to bail out state-owned enterprises, mostly due to their economic
(employment) and political leverage. In essence, this hurts struggling smaller,
private, firms that are unable to compete with giants, let alone subsidized
giants. These large industrial subsidies are all but gone in most industries
today, however they still exist for politically sensitive or economically vital
industries. In some cases the government reluctantly returned to subsidies as
not all of the initial privatization efforts proved successful. Some large
enterprises were not effectively dismantled and the resulting giant enterprises
were simply too large and inefficient for the new market economy. It took
several years, in some cases, to learn this lesson.
Prices
Consumer price inflation by 1993, after the
initial shocks of the VAT, stabilized at 18 percent. Experts estimate the VAT
added 7 percent to inflation during 1993 and an additional 2 percent can be
attributed to government administered price regulations. Price regulations
remained mostly in the utilities sector. Adjustments from 1994-1995 increased
prices in several key areas including gas, oil, transportation, medicine and
telecommunication tariffs.
Wages
Wage restraints through a “tax based income
policy” was an important feature of the CSFR. Wage restraints ended in 1993,
but had to be brought back by the end of the year by the Czech government. The
rational behind bringing the restraints back was that market forces were not
yet adequate to control wage increases. Wage increases had to remain close to
increases in consumer prices to avoid inflationary difficulties. Therefore, as
late as 1995, up to 100 percent tax rates were applied to wage increases over
allowable limits, effectively keeping wages at desired rates.
Monetary Policy: 1993
By 1993, Czech monetary policy began to
stabilize in conjunction with political and economic indications of success.
The basic aims of monetary policy at this point were simply to maintain
internal and external currency stability. Officials kept the Czech crown pegged
to stable European currencies and prevented inflation from rising above 10
percent. In a somewhat disguised blessing, foreign capital flowed into the
Czech Republic at high rates in 1994 causing officials to raise reserve
requirements from 9 to 12 percent to insure inflationary stability. The banking
system, though still flawed, was able to withstand the pressures. The economy
certainly welcomed the increased capital.
By 1993 and even more so by 1994, monetary
policy was less of a political tool in the reform process. Stability in many
respects had been achieved. The nature of further reform and continued
stability relied almost entirely upon fiscal decision-making. To fully
understand and appreciate the political economics of reform from 1993 onward,
both fiscal and monetary, an examination of the Czech budget is helpful.
Defining the role of the state in the new market oriented economy is critical.
Two main issues must be examined, the resources and informational capabilities
of the state. Both are limited and both are not independently effective. The
budget and the political issues surrounding its passage are important in
understanding the Czech approach to stability now that much of the transition
has been rather successfully completed.
Intergovernmental Financial Relations
Before the budget analysis, a brief overview of
intergovernmental financial relations may be helpful. The Department of
Finance makes budgetary estimates for the Ministry of Economy. They regulate
spending and essentially decide which organizations and institutions receive
the much sought after government subsidies. They are also responsible for
government accounting, financial management and regulation of wages. The
Department of Finance is classified under the Ministry’s “Administration and
Finance” section.
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