Foreign Trade and Investment
After an initial currency devaluation of nearly 50 percent, the government adopted an adjusted exchange rate connected to a “basket” of convertible hard currencies. Internal convertibility of hard currencies was established in 1991. These two measures combined to foster trade and investment. Initially, the CSFR set a 20 percent surcharge on imports coupled with a 5 percent tariff. These obstacles soon ended as major provisions were passed to more actively encourage trade and investment. Initial steps toward private property rights and the dissemination of publicly owned lands further enhanced the investment environment.
Privatization is by far the most critical and complicated development the CSFR had to address. Speed was critical. The default mechanism ensured that current managers and persons of powers would assume control and create their own joint venture agreements with foreign entities.
State firms that were nearly completely vertically integrated needed to be desegregated by form and function. And the process had to be done well, for flailing industries would simply increase state expenditures. Failures did not decrease expenditures in compliance with the transitional reform strategy. The CSFR privatization plan was threefold. Small-scale privatization was the easiest. Retail stores, restaurants and small service or industrial workshops were sold to the highest bidders in weekly public auctions. Where no CSFR buyers were found, a second round of auctions allowed foreigners to bid.
Property restitution was more difficult. The government needed to equitably redistribute land that had been taken nearly 40 years earlier. This is a difficult and involved issue. CSFR citizens are allowed to claim land taken from them, though the burden of proof is on them. Where no proof exists, special arrangements can be made for state assistance. In areas of conflict, the issue will be brought to the courts. A large part of the country was not in private hands before Soviet rule. Some of this land can be used as an offering to parties where disputes over ownership exist. Also, lands that have been improved (shops, developments, houses, etc.) are sold at specially determined rates to the former property owners. Prices and possible alternative compensation for those owners who do not wish to purchase these improvements are again settled by a special court arrangement.
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.
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 didnt 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 Polands 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 didnt face this obstacle as unemployment throughout the transition remained low. The political reform process was slight