Academic journal article The Journal of Social, Political, and Economic Studies

The Czech Transition: Politics before Economics

Academic journal article The Journal of Social, Political, and Economic Studies

The Czech Transition: Politics before Economics

Article excerpt

Aviezer Tucker, Jana Balharova, Ivo Losman, Jan Nemec, Jan Nemecek, David Ondracka, Zdenek Pol1k, Roman Skyva, Martina-Vyrkova & Marketa Zidkova'

A group of Czech scholars examine the political and economic aspects of the post-Communist transition in the Czech Republic, and find that instead of adopting "shock therapy" to achieve a transition to a private enterprise economy, the Czech leadership concentrated on maintaining full employment in order to ensure the popular acceptability of privatization. However, they note the extent to which former members of the Communist hierarchy were able to benefit from the privatization of public enterprises.

Key Words: Czech Republic, Post-Communist Transition, Economic Privatization, Democratization

The general elections in the Czech Republic in June 1996 solidified a distinctively Western-European style of political culture in the Czech Republic. The ruling center-right three parties coalition composed of ODS The Civic Democratic Party, ODA The Civic Democratic Movement, and the Christian-Democrats received 99 of the 200 seats in the Czech parliament. The Social-Democrats received almost one third of the votes. The Communists received a little more than ten percent and the rightist Republican party a little less than ten percent. The ruling coalition's loss of absolute parliamentary majority should not obscure their winning a slightly increased share of the votes in relation to the 1992 elections; the loss of absolute majority is due to the complexities of distributing the votes of parties that did not pass the 5% threshold according to regional voting patterns in the Czech election law.

The establishment of a stable Western European political system in the Czech Republic is in sharp contrast to the return of former Communists to power in the second post-1989 elections in Lithuania, Poland and Hungary. We attempt to understand here the apparent smooth and successful Czech political transition. The most stark contrast is with Poland. Poland had a mass anti-Communist movement that was absent in the Czech Republic, where the dissident movement of Charter 77 numbered 2000 signatories. Yet, in 1993 Poland voted a reformed-Communist government that lost the 1997 elections. By contrast, the Czechs voted fairly consistently in the 1990, 1992, and 1996 elections.

There is a marked correspondence between the Czech public's evaluation of the economic transformation [see graph no.1] and the support for democratic parties. From the founding of the Czech Republic in 1993 until the onset of the economic crisis at the end of 1996, the percentage of respondents that evaluated the economic transformation as unsuccessful hovers below 20%, an identical 20% to the percentage the undemocratic Communist and Republican parties received together. Analysis of the regional voting patterns in the last Czech elections further supports the relation between economics and politics. The greatest support for the government coalition (58.84%) and the lowest support for the Communists and Republicans (11.17%) was in the most economically vibrant part of the country, the capital city of Prague. The lowest support for the coalition (35.7%) and the highest for the Communists and Republicans (24.12%) came from northern Bohemia, the most economically depressed part of the country.' Therefore, we try to understand the relations between Czech economic policies and their political effects.

An analysis of the Czech transition may form a basis for deciding if the Czech government has been smart or just plain lucky. Did Vaclav Klaus' government follow a better policy of transition than other East-Central European governments, or have the Czechs been lucky, having started their transition process with better initial conditions such as lower per-capita national debt, greater geographical proximity to the prosperous West, an unadaptable and an unreformed Communist party unlike as in Poland and Hungary, and an absence of the kind of clericalism that pushed Polish voters to support the reformed Communists. If the first possibility is true, understanding what actually has been happening in the Czech transition may suggest something like a recipe for a successful political transition.

The results of the Czech economic transition are mixed. Before the June 1996 elections, Czech Prime Minister Klaus described at home and abroad the economic transition as complete. He claimed that the "operation" is over and "the patient is in the recovery room," promising that there are no more painful measures in store for the Czechs; economic growth at 5% per year and low unemployment at 2.8% will be sustained.2 Yet, less than a year after the elections, the deficit in the balance of trade rose to over 10%, the pressure on the Czech currency, the Crown, grew and it had to be devalued by about 15% for the first time since 1992. The government had to introduce austerity measures that include reduction in real terms of salaries in the public sector, rise in interest rates, budget cuts in welfare and investment, state support in loans and guarantees to export, a rise in the excise and income tax, but also a four percent cut in corporate tax. Apart of the last one, these measures are likely to cut growth and lead to economic stagnation; unemployment has already risen to an unprecedented height of 5%3. Klaus' election promises did not prepare the Czech public for such measures. Consequently, the popularity of Klaus and his government fell to an all-time low. Since the middle of 1997 all polls showed the opposition Social Democrats with a lead of more than a 10% over Klaus' party. Since October 1996 the percentage of Czechs who regard the economic transformation as unsuccessful has been rising steadily after four years of stable 18 percent disapproval to a height of 44 percent in May of 1997 [see Graph No. 1]. To use Klaus' metaphor, the patient is outside the operation room, but it appears that he is waiting to enter the operation room, after being reassured by the doctor that the operation was over.

All the leaders of Central European post-Communist countries faced at the dawn of 1990 three simultaneous tasks: Democratizing society and the political system, restructuring markets and firms, and stabilizing the economy. Governments that attempted to achieve all three goals together had to face high unemployment in countries where the population is perhaps not used to hard work, yet is unaccustomed to being unemployed or occupationally mobile. The Czech case is particularly interesting in this context. Instead of trying to achieve all three goals, the Czech government attempted only democratization and stabilization. We try to prove that the successful political transformation was achieved at the price of delaying some of the necessary painful restructuring. This delay had some severe economic bad effects that surfaced toward the end of 1996 and led to an economic crisis. Still, the delay in restructuring may have enabled the entrenchment of Democracy.

There are two common obstacles to understanding the Czech transition. First, Klaus' "Thatcherite" and libertarian rhetoric hides more than it reveals the policies of his government. Since Klaus' rhetoric was far better publicized and known than his policies, political scientists are not always aware of the gap between them.4 The second methodological mistake is to look only at the economic level rather than at its interactions with politics. Economists who study the Czech economy know quite well that Klaus' policies were not free-market-oriented. However, they limit their analysis to describing and criticizing the Czech policy deviations from the abstract free-market model, ignoring the political effects of the economic policies that in turn affect the economic level. As much as political scientists are mistaken to examine only Klaus' rhetoric, economists are shortsighted in examining only his immediate economic policies. Our analysis must be at once political and economic.

We attempt to demonstrate that the initial purpose of Klaus' economic policies has been political, to create and maintain a sentiment of security in Czech society, assuming correctly that as long as people feel confident in their prospects for employment and in having a safe place to live in they do not turn to the political extremes. When gradual restructuring turned into stagnation, it led to the economic problems that surfaced at the end of 1996.

Czech Policies of Transition

Labor Policies

The starkest contrast between the Czech Republic and East European countries like Poland that went through economic "shock therapy" followed by the return of the Communists to power is the "miraculously" low rate of Czech unemployment. Unemployment peaked at 4.4% in early 1992. By late 92 it fell to 2.5% where it remained until the end of 1996, the lowest unemployment rate in Europe. Since many unemployed are Romanies (Gypsies) among whom nearly half are unemployed,5 even the tiny Czech unemployment had cultural/ethnic rather than economic reasons for unemployment. Patently, Klaus' "Thatcherism" was not very Thatcherite. Czech labor conditions even turned the country into an immigration destination.6 The other side of the low unemployment is low productivity, when compared to Poland or Hungary. Considering inflation, from 1990 to 1995 Czech salaries grew 6% above the increase in productivity.7 Low productivity led eventually to accelerating trade deficit that demolished the fixed exchange rate policy. In comparison, Polish unemployment was in 1993 over 15%. Polish productivity rose, but the reformed Communists regained power.8

In Cook's opinion, the 3% jobless rate reflected lack of restructuring and bloated payrolls. Shortage of labor hurt the economy because it forces employers to hire less than qualified labor. Full employment causes lack of discipline, and rise in salaries without rise in productivity.9

The architect of Poland's short-lived shock therapy, Leszek Balcerowicz, explained the low Czech unemployment in relation to the Polish one by citing various "tricks" of the Czech government. In 1990 the Czechoslovak government stopped paying pensions to those who continue to work after retirement. Consequently, pensioners numbering 4% of the work-force retired. In Poland, no such measures were taken. Czech unemployment criteria are stricter than Polish, and it is paid for six months while in Poland it is paid for one year. The statistical rules are different in the Czech Republic, so citizens that are considered employed in the Czech Republic are registered as unemployed in Poland, eg people who go through retraining.10 Direct measures taken by the Czech government to prevent unemployment include doubling the income tax after retirement age, thus vacating in Rutland's assessment 300,000 jobs, and extending maternity leave from half a year in 1989 to four years today.11

While all these factors are real, we will try to demonstrate that the most effective macro-economic pro-employment policies of the Czech government that delayed restructuring since 1990 were: Actual subsidies, exchange rate controls, and most importantly"privatization" Czech-style.


Direct subsidies to producers and consumers ended at the beginning of the transition program, leading to a jump in prices in 1991. Subsidies were maintained for farms and railways but eliminated for manufacturing. The government paid for bad loans of enterprises through the creation of a consolidation bank, to allow privatization without debts.12 But since 1993 "bad debts" of banks and "bad receivables" of enterprises have been fulfilling identical function to subsidies while management continues as before, with soft budget constraints, monopolistic behavior, and until the summer of 1997, no bankruptcies.13 The absence of bankruptcies is possible through a government policy to bail out failing state and private enterprises and banks, thus preventing redundancies.

The government has been regulating the cost of rents and utilities in municipal houses.14 Though some state housing were privatized or restored to their pre-1948 owners, rents in magistrate (state) housing continue to be heavily subsidized by the state. The tenants of restored properties enjoy state rentcontrols that create a great gap between the protected rent and what would have been the market rent. In central Prague, tenants pay as little as 5% of the market rent. These measures prevent homelessness and ensure Czechs that they will not be "thrown to the street," give them a sense of confidence about having a place to live, but prevents the new owners of restored real estate to develop it and create a real estate market. 80% of Czechs expressed in 1995 satisfaction from their housing situation.15

Yet, the regulation of rents prevents incentives for increasing the supply of housing and creates a problem in housing for younger families. The housing market has not been restructured. In 1995 the government began to slightly liberalize rent regulations by allowing municipalities to moderately raise rents according to inflation, the quality of apartments, and their location. Apartments that have been built since June 1993 are excluded from state regulation.16 Further rise in rents took place in July of 1997 by as much as 100%, partially as a result of the recent economic crisis that forced the government to decrease public demand and increase its revenues. There is a consensus that the question of rents is basically political.17 Czech governments cannot deregulate the housing market and demolish housing security that exists today in the basic Citizens' Code legislation, without serious adverse political reaction.

Exchange Rate Controls

At the beginning of the transformation process, the crown was deliberately devalued at K28 = $1 to increase exports, dissuade imports (both create employment), and make the country attractive to investors. The central bank had intervened to maintain the undervaluing of the Crown. Relatively low inflation [see graph No. 2], high interest rates and stable exchange attracted foreign capital. From 1991 to May of 1997 the Crown has been gradually revalued because exchange rates remained fixed for six years while inflation ran at about ten percent per-year.18 This revaluation could have been maintained, after the initial boost for the economy through undervalued currency for the first years of transition, had there been corresponding rise in productivity and GNP, but the stagnant productivity forced the recent devaluation to about K33 to the dollar. After the speculative rush, the Central Bank continues to control exchange rates.

Privatization, Czech Style

In evaluating Czech privatization, we should remind ourselves why do economists and others recommend privatization: It founds democracy and personal freedom on a society of owners that balances the power of the state; it raises the efficiency of management through market discipline and competition and by eliminating government interference; creates responsibility of management to owners; raises revenues and ends losses for government budget; allows firms to raise capital, thus helping to develop capital markets and savings; and assists in the social anti-communist revolution by devolving power from nomenclature Communist party management. There are four possible types of privatization: 1. Spontaneous, i.e. the Communist management starts behaving as owners. 2. Giving away gratis the properties. 3. Contracting out the properties to the highest bidder. 4. Selling the properties to local or foreign investors. In choosing a type of privatization, the following considerations are paramount: 1. Speed: Slow restructuring results in short term decisions of management and labor and acceleration in Communist management practices, i.e. theft and embezzlement increase before the new owners arrive. 2. Which typos of firms should be privatized. 3. The extent of state restructuring prior to privatization. 4. And the role of banks and financial companies in the process.19

Today, 15% of Czech properties remain state-owned, 15% (mostly in agriculture) were given to cooperatives, 10% were restored to pre-1948 owners, and the rest was "privatized." Czech "privatization" can be divided into privatization of small businesses and pseudo-privatization of large state conglomerates. Small businesses such as shops, hotels, restaurants & etc. were restored to pre-Communist owners or bought by new owners. There, privatization achieved most of what economists expect, despite cases when new owners bought underpriced businesses and sold stocks and equipment and then returned the businesses to the state after making a profit.

The restructuring of the small business sector created jobs that allowed one quarter of the work force to change jobs since the 1989 revolution. Labor mobility has been from agriculture and industry to the services sector. The industrial sector declined from 46.5% of the labor force in 1991 to 41.6% in 1995, while the services sector grew from 46.6% in 1992 to 51% in 1995.20 It is reasonable to assume that the workers who lost their jobs in industry and agriculture during this period were absorbed by the growing privatized services sector.

The Czech privatization scheme for large state businesses consisted of distributing vouchers to every citizen who registered for them, more than three quarters of the population. The vouchers could be used to bid for privatized companies or could be sold. The voucher system was launched before the 1992 elections, thus building an electorate with a vested interest in the success of privatization.

Czechs sold or invested most of the vouchers (72%) in Privatization Investment Funds (PIFs). These PIFs had to be approved by the National Property Fund (NPF) following a submission of an offer that specified what they intended do with the properties. Each PIF can own at most 20% of each firm. A typical firm is owned by a group of PIFs and the NPF has a minority share. A few of the bigger PIFs are controlled by known or unknown foreign capital. All other PIFs are controlled by the four biggest Czech banks: Ceska sporitelna, Komercni banka, Ceskoslovenska obchodni banka, Investicni a postovni banka, and by the biggest Czech insurance company (former state monopoly) Ceska pojistovna.

The four biggest banks were created by functionally splitting the former state monopoly, Stitni banka Ceskoslovenska, which controlled 80% of the market. The state still controls the banks through the National Property Fund. Thus, the ownership structure of Komercni Banka, the biggest bank, is 48,73% NPF, 28,27% Czech firms, 7,47% Czech individuals, and the rest by foreign investors. The main savings bank, Ceska Sporitelna is owned by: 45% NPF, 32% Investicni a postovni banka (IPB), 14% the Prague municipality, 4.7% Czech individual share-holders and 3% by pension funds. The government maintains control of all the four banks and the insurance virtual monopoly.21

... the Czechs have now... a "national financial capitalism"... resembling that of Germany, but with a central role of the national government as a "core investor indirectly controlling (via NPF and through the network of its capital shares) more of less the whole economy.... if we want to know what controls a typical Czech privatized enterprise, we mostly find a complicated chain of capital shares in the end thereof being NPF.22

"...the pattern of ownership in the Czech Republic will probably be a variety of state capitalism similar to Germany or Japan. Power will rest with industrial managers, government ministries and banks, all closely interrelated."23

The banks are both owners and creditors.

The ownership control of enterprises was believed to be a key prerequisite of their efficient economic performance. The voucher privatization... seems to lead to results very distant from this officially declared neo-liberal target. The new owners are mostly institutional owners (PIFs) without appropriate managing, controlling and supervising powers. They hold large property in several tens of even hundreds of businesses but only limited qualified professional skills and capacity. And, like in the model of the central planning, they have a lack of information - the information monopoly is on the side of enterprises' managements.24

Reed reached similar conclusions:

Leading Czech banks hold shares in many of the investment funds.... The funds, in turn, hold shares in many of the companies to which the banks lend. Skeptics of "the Czech miracle" warn that banks may hold off on foreclosing bad loans to concerns in which they hold interests.25

King jr. thinks correctly that when there are too many shareowners there are no owners. Company directors do not follow instructions. There is predominant boardroom sloth on the part of directors and non-active share owners; the system does not reward achievement.

Most big Czech companies are ruled by investment funds, themselves often owned by Czech banks. Far from prodding managers to perform - or sacking them - the funds have grown plump on behind-the-scenes trading and their 2% yearly management fees. In turn, few managers own company shares, giving them little reason to make good.26

Klaus' original policy may well have been to postpone the restructuring of some economic sectors until other parts of the economy developed sufficiently to absorb the workers who would lose their jobs. The main goal of the particularly Czech model of privatization is the preservation of full-employment as a politically more significant goal than restructuring or productivity. Society sensed tangible benefits from privatization. Even those Czechs who sold their vouchers received cash from PIFs equivalent to an average monthly salary, while no unemployment ensued.

Nevertheless, the achievement of low unemployment was bought at the cost of delaying restructuring, thereby allowing a good deal of corruption and embezzlement on the part of the managerial nomenclature, something that is in colloquial Czech "tunnelling" - the managerial misappropriation of company funds. Banks have been managing firms not just in accord with the political interests of the government but also according to their own interests: Forcing firms to undertake unprofitable transactions that benefit the controlling bank, forbidding deals with other banks, forcing firms to take over-expensive loans from the controlling banks, and forbidding the firms to issue stocks or accept foreign partners: all of which is against the basic purpose of privatization.27

Politically, Czech "privatization" pacified the Communist managerial nomenclature. In all post-communist countries the communists elites attempted to preserve their status and privileges. In the former Yugoslavia they adopted nationalism, in Hungary and Poland the Communists adapted themselves to changing socio-economic circumstances to become a viable political force on the left. The Czech model of privatization allowed the nomenclature to maintain its economic, as distinct of political, hegemony. Without control, the management has been tunnelling the properties they manage. Further, the profitability of PIFs investments in privatized companies depended greatly on obtaining inside information on assets, liabilities, and profitability. Such information is not publicly available. But the old networks of the Communist party nomenclature and their inner core, the former networks of the secret police, the StB, can connect investment funds with management information. Frequently, scandals involving Viktor Kozeny, privatization and inside trading with some former-secret-police background are divulged in the Czech media. For example, Viktor Kozeny the owner of the largest private investment fund, Harvard Investment & Capital (named after the university that bestowed on Kozeny an MBA before the 1989 revolution) that dispersed itself in the summer of 1997 fled the Czech Republic and lives in the Bahamas, risking arrest for inside trading if he returned.

Mertik thinks that Czech managers predicted that voucher privatized companies would be controlled by the managers rather than by the owners, and maintained their power by initiating leveraged buy-outs when they could raise the funds, and voucher privatization when they could not, maintaining their power either way. The management class of the late eighties survived the fall of communism.28

Kapoor elaborates further on the negative economic effects of Czech privatization; it insulated owners and therefore managers from the market. "Privatized" Czech industry has not gone through restructuring. Until the summer of 1997 when several travel agencies went bankrupt, there had been no bankruptcies in comparison with an annual rate of 30,000 in Hungary. As a result Czechs do not show great rise in productivity, in contrast with Poland and Hungary.29

The government currently has a 25 % stake in the banking sector, largely through its holding in the top four banks which together control more than 70% of deposits and loans. This state of affairs has long fed suspicions that the state has used its influence in order to block bankruptcies and lay-offs that would occur if the banks

began foreclosing on overdue loans.30

Czech banks act for political rather than economic reasons. They bail out smaller banks that get into trouble, e.g. Ekoagrobanka. The National Property Fund retains control over some "privatized" businesses, e.g. OKD mines in Ostrava, where it controls the board of directors and management. Consequently, for political reasons, it supports gradual restructuring, not to upset social conditions in Ostrava. Private investors cannot control OKD.31

Despite the negative economic effects of the Czech voucher privatization, the net political effect is that there is much less unemployment than there would have been otherwise, and greater feeling of security for employees and managers. In Rutland's opinion, Klaus is more of a pragmatist than a neo-liberal. He prefers social harmony to monetarist considerations.32

The "privatization" of the health service followed a similar path. Before 1989 there were two levels of health care, one for the Communist functionaries and another universal one for ordinary people. The level of treatment for ordinary people was partially dependent on a mixture of bribery and "connection-protection." Klaus' government broke the monopoly of the state and allowed private health care providers to operate in the market to offer higher levels of health care. Still, it maintains at the same time a national health service (under a different name) subsidized in part by taxes levied on private health providers. When private health providers get into trouble, the government moves to protect the insured.


In 1991 Czechoslovakia hourly wages were 50% of those in Poland, though productivity was higher. The low salaries were not challenged by a trade union movement. The Czecho-Moravian Chamber of Unions (CMKOS), that replaced the Czech and Slovak Confederation of Unions (CSKOS), that had replaced the Communist era Revolutionary Union Movement (ROH), regards itself as a leftover from Communist times, disputes managing properties and giving benefits for their members. Apart from a partially successful strike of railway workers and a failed strike of teachers there have been no strikes or labor disputes.33 A tripartite council of government, employers, and trade unions was developed to negotiate salaries. Organized labor has no political representation in parliament. Following their Communist traditions, the unions regard themselves as semi-official and the workers distrust them. Rutland suggests that in the Czech Republic there is nascent corporatism; trade unions acquiesce in government policies in return for allowing them to keep their properties and operate. "This is very different from the original Thatcherism, which shunned corporatist intermediation and relied on high unemployment to bring labor into line and limit wage inflation."34 This corporatism is in Rutland's opinion part of the anti-confrontational tradition of Czech political culture. Currently, the Social-Democrats attempt to connect with regional trade unions but this effort is at its infancy and it is far from clear whether it will be successful.35

The onset of economic crisis in late 1996 led to the beginning of labor unrest. The government is aware that raises in public sector salaries would ruin the stabilization policies; therefore, it attempts to return to its earlier successful corporatist policies in a council of unions, government, and employers.36

Unfinished Transition

The absence of restructuring is even more evident in the state civil service, the security services, the judiciary and the education system. All these bureaucracies have not changed considerably since 1989. The voting pattern in the military and the police is completely different than that of the general population; in the 1996 elections 38% voted for the Social-Democrats, 18% for the Communist Party, 14% for Klaus' Civic Democratic Party, 14% for the Republican party, and 9% for the junior members of Klaus' coalition. Bearing in mind that there is a one-year conscription for males, one notes that nearly half of the Czech defense services support extremist undemocratic parties.37

The rule of law demands an effective, competent, impartial and independent judiciary. This does not quite exist yet because the personnel of the communist judiciary system that had no concept of independence or role of law has not been replaced and is engaged today in extensive corruption. Foreign investment that confronts opaque and murky capital markets where the government, the banks, the PIFs and firm managers seem to collaborate in illegally sharing profits has nowhere to turn to because the police and courts will not challenge established power. The courts are so overworked that a firm that needs to have its case heard in this century must resort to bribes. Investment has an increasing incentive to go to other emerging markets.38

Authoritarian education by incompetent teachers is still prevalent within state schools despite the emergence of some independent schools with higher quality of instruction. The 1990 higher education reform law decentralized universities before they were reformed.39 Power in the universities lies with a democratically elected senate that elects deans who control budgets and have the authority to hire new people or fire old employees. When the universities were democratized they were full of lecturers appointed according to loyalty rather than competence. University personnel have been electing deans who protect their positions, promote them, and prevent competent teachers from replacing them.

When school teachers demanded higher wages, the government considered the public resentment of teachers associated with the previous regime, and simply ignored them. The strike collapsed soon after it had started. Pilip, the minister of education was rewarded by being appointed the economics minister with a similar task of resisting pay-raise demands from the public sector.40

What Will the Government Have to Do?

The present crisis may now force the Czech government to implement the restructuring policies it has avoided for a long time: First and foremost the privatization of the biggest banks and insurance companies. This should have a ripple effect on restructuring the market. It appears as though this privatization will be both gradual and partial - smaller banks first with the government will still keep some control over the privatized banks, e.g. by controlling the largest bank that can in turn control the smaller ones.

The forthcoming entry of the Czech Republic to NATO will require a restructuring of the military. The current argument is whether to phase out conscription and have only a NATO-compatible professional army. Future policy makers will have to consider measures to ensure that the military will serve the elected Czech government and will be found trustworthy by its NATO allies. The replacemnt of personnel in the police, judiciary, and education systems is not even under discussion, but may well become necessary. The European Commission demands that the Czech Republic cut its bureaucracy in preparation for joining the European Union.41 Though Klaus had some time to do all this before the 2000 elections, the political stalemate between the ruling coalition and the Social Democrats would have made further reforms and changes in policy difficult because they would have had to be negotiated with the Social Democrats.

A Recipe for Transition?

From a political perspective the Czech model of transition has been more successful than others. The Czech Republic did not see the return of the former Communists to power and consequently it has been witnessing the unhampered gradual growth of civil society and democracy. In our opinion, this was the result of the distinctively interventionist policies of the Czech government, which acted to ensure the Czech people employment and housing, a fixed exchange rate and low inflation, thereby creating a prevailing sentiment of security and confidence in a better future until the end of 1996. Klaus had the foresight to realize that economic transformation must serve political purposes; otherwise, political forces would render further economic transformation and political democratization impossible. Had the Czech government opted for a more radical Polish-style "shock therapy" economic transition, it would have created high unemployment and a prevailing atmosphere of insecurity and political extremism. The economic operation would have been successful, though the democratic patient could have been dead. An obvious question then is whether the Czech model of transition can be (or could have been) emulated elsewhere.

Poland's "shock therapy" finance minister, Leszek Balcerowicz, blamed the return of the Communists to power in Poland on the worse external and initial conditions in Poland in comparison with the Czech Republic, rather than on his policies. In his opinion, the initial macroeconomic conditions were better in Czechoslovakia, where there was no need to stabilize and restructure simultaneously. But we have demonstrated that the Czechs did not stabilize and restructure simultaneously! They have not restructured major sectors of their economy. Instead, restructuring has been slow and gradual. As statistical evidence about flows in the labor force demonstrates, while jobs were created in banking and trade, other jobs were eliminated in agriculture, heavy industry and mining.42 In other words, the government did not allow for restructuring job loss until new sectors of the economy developed sufficiently to absorb the layoffs.

Balcerowicz continues, arguing that Czechoslovakia had low external debt and a balanced state budget. Indeed, since the Communists in Czechoslovakia did not open to the West, they did not accumulate debts ($500 per capita in 1989 compared with $1000 in Poland and $2000 in Hungary). In contrast to the Slovak economy, the Czech economy suffered less from adverse external conditions because a smaller section of the economy was COMECON related. One can add Czechoslovakia's greater attraction to tourists (as a result of not fighting against foreign occupiers as the Polish did) and preferred geographic position. Economic discontent depends in Balcerowicz's opinion more on initial and external conditions than on shock vs. gradual therapy. The Czechs were also lucky in his opinion because they have not had militant workers such as those of Solidarity.43

The nastiness of the Communist regime in Czechoslovakia, an unreformed puppet regime of an occupying foreign power, helped the government of Klaus to survive without serious communist challenge and with discredited unions. But we think that the Polish communists discredited themselves in 1981 just as the Czechoslovak communists discredited themselves during the "normalization" that followed 1968. The Polish unions have been more militant and active than the Czechs, but it is not clear whether there has been a genuine attempt at Czech-style corporatism in Poland. The Polish policy has been far more radical and shock-therapy style than the Czech very gradual restructuring and led to far greater unemployment and the resulting political extremism. It can be pointed that the recent return of the non-Communists to power in Poland and a similar development in Lithuania prove that the former Communists are incapable of offering better solutions and return instead to a pattern of corruption and patronage that leads in its turn to a vote against them. Still, the inability of the reformed Communists to offer better solutions and their management practices should have been no surprise to electorates who had a very long time indeed to become acquainted with their former rulers. The only plausible reason in our opinion for the voting pattern in the second post-communist elections in Poland, Hungary, and the Baltics is a sense of desperation over economic insecurity and high unemployment. The gradual Czech policies prevented such a development.

The doctrine of "shock therapy" underlies what can be called "the sleeping beauty theory of capitalism." Once the communist system disappears and stops sedating the economy, it will spring back to life immediately. Better create the necessary conditions for a free market immediately and shorten the birth pangs of capitalism. This doctrine overlooks the fact that what disappeared in 1989 was the Communist ideology, but not the communist class structure and mentality. The nomenclature never heard the bugle call of history. It has been doing what every elite has been trying to do since history began: preserve its privileges in the best way it knows. Accumulation of wealth under Communism was a matter of knowing how to appropriate (or rather misappropriate, the border was very unclear) state funds. Once the time comes for "privatization" they do officially what they have always done unofficially; they take the state properties for themselves, go on getting state subsidies for their businesses (and themselves), and use Western advisers as free market ideological fronts. The only difference is that under the old system everybody was stealing a little and some redistribution was going on along patronage lines. Under such conditions and after decades of cultures that rewarded sloth, laziness and uncreativity, it is not very likely that there would be enough enterprise in the short term to absorb all those who lose their jobs in the process of rationalizing production and increasing productivity. Without any livelihood or foreseeable prospects and in fear of losing their state-subsidized homes, Eastern Europeans voted for a system which they thought they had the experience to manipulate sufficiently to their advantage to feel secure. All this could have been predictable before the first shock-therapist landed in Eastern Europe.

The Czech success secret is the maintenance of a sentiment of security at all costs. The security sentiment is sustained by four economic factors (in descending order of significance):

1. Full employment.

2. Secure housing.

3. Fixed exchange rate.

4. Low inflation.

Before the currency crisis of May 1997 Klaus had been successful in achieving all these policy goals through government intervention. The only exception is the more than 50% inflation in 1991 as a result of price liberalization. The following policies of Klaus achieved the four goals (in no particular order):

1. State housing subsidies and regulated rent controls.

2. State subsidies to failed businesses to prevent bankruptcies.

3. Low salaries relative to productivity negotiated in a corporatist fashion with the unions.

4. Stable and undervalued currency maintained by state bank intervention.

5. Continued, though indirect, state control of enterprises through ownership of banks that in turn own PIFs and are at once owners and creditors of privatized enterprises.

6. Wide distribution of privatization vouchers to all the citizens.

7. Assuring the economic nomenclature of their continued status and privileges.

8. (Corresponding with numbers 5 to 7): Delay restructuring in the interest of full-employment until economic growth in liberalized sections of the economy can absorb the laid-off.

9. Initiating direct government measures to limit unemployment such as long maternity leave and encouragement for retirement.

10. Free market rhetoric largely for foreign consumption to encourage investment and integration with the West.

It seems that the difficult element to emulate in other countries is No. 3, where the unions and other pressure groups may be stronger, and the politicians not skilled and strong enough to resist their pressures. This may lead to a rise in salaries, high unemployment and inflation. The other nine policies are threatened by pressures from politically insensitive economists who ignore the political dimension and push for an economic shock therapy.

Klaus made the error of going too slowly. After achieving the lowest unemployment in Europe, he could have continued to gradually restructure, phase out one inefficient state industry after another, without too adverse political effects. But around 1994 the restructuring screeched to a halt. Had he continued with the restructuring, there would have been higher productivity, greater exports, and the present crisis would have been averted. Klaus' second mistake was in making false promises before the last elections. He should not have so clearly promised that there would be no more austerity measures. Consequently he lost confidence, and the Czechs are not prepared to make economic sacrifices after receiving promises that the transition is over.

Yet, the present economic crisis should not be blown out of proportion. Despite the crisis, the share of votes for extremist parties is not higher. Whatever happens in the next elections, democracy will be just as entrenched. The restructuring reforms that are likely to come are still less severe than the shock therapy of the early nineties in Poland because some restructuring has already taken place over the years. In a sense, Klaus' policy was an argument in favor of transition, the idea that it .is impossible to move overnight from Communism to free-market democracy. A transition period is necessary.


1. The Czech election results appeared in Mada fronta anes, 3 June 1996.

2. Vaclav Klaus, "Czeching into Capitalism," CATO Policy Report, Vol. 18 No. 2 (1996), 6.

3. Francis Harris, "Emergency Market," Business Central Europe, May 1997, 19-20.

4. A typical statement by Klaus is:

We want a market economy without any adjectives. Any compromises with that will only fuzzy up the problems we have.... The market is indivisible; it cannot be an instrument in the hands of central planners....

I often use the line by F. A Hayek that the world is run by human action, not by human design. To talk about planning an economic system is to talk in old terms, and I find myself sometimes having to teach Westerners about what the market really means. They often don't realize that they often might need a little market revolution in their own countries.... What we want is to establish the rules of market economy - not to plan its outcome. Vaclav Klaus, [February 1990] "Creating a Capitalist Czechoslovakia: An Interview with Vaclav Klaus," in Tim D. Whipple ed.,After the Velvet Revolution:

Vaclav Havel and the Leaders of Czechoslovakia Speak Out, (New York, Freedom House (Focus on Issues No. 14, 1991), 149-150. 5. Alaina Lenon, "No Land, No Contracts for Romani Workers," Transition, vol. 2, no. 13 (1996), 28-31. Aviezer Tucker, "The new Jews," Telos, No. 98-99 (1994), 209-215.

6. Tom Warner, "Migration to the Middle Ground," Transition, Vol. 1 No. 12

(1995), 26-32.

7. Stanislav Husko, 'Jemne doladovani nestaci" Ekonom, No. 31 (1996), 19.

8. Lexikon zemi, (Prague: Fortuna Print, 1995), 339.

9. Joe Cook, Help Wanted Central European Economic Review, Vol. 4 No. 1 (1996), 14.

10. Leszek Balcerowicz, Wolnosz i rozwoj, (Krakow, 1995).

11. Peter Rutland, "Thatcherism, Czech-Style: Transition to Capitalism in the Czech Republic," Telos, No. 94 (1993), 103-129. 12. Ibid.

13. Pavel Mertlik, "Czech Privatization: From Public Ownership to Public Ownerehip in Five Years?" in Vincent Edwards ed., Proceedings of the Conference on Central and Eastern Europe: 5 Years On. (Chalfont St. Giles Bucks: Buckinghamshire College, 1995), 452.

14. The relevant laws are: 403/1990, 458/1990, 87/1991, 137/1991, 172/1991, 162/1992, 267/1992, 133/1993, 116/1994.

15. J. Beranek, "Jak a za kolik bydlime," Listy, vol 7 (1995), 19.

16. According to Laws 30/1995 & 274/1995.

17. See the discussions in Ekonom No. 12 (1997).

18. Between 1991 and 1994, the crown had devalued in real terms by 12%. Problamy otevirani ceske ekonomiky' (Prague: VIE, 1994), 1419.

19. Josef M. van Brabant, "The Hobbled Transition - Mined Privatization Paths in the East," in Akyuz et al. eds., Privatization in the Transition Process: Recent Experiences in Eastern Europe, (Geneva: United Nations Publications, 1994), 6182.

20. Statisticka rocena CSU, (Prague, 1996).

21. Jan Mach/icek, "Mocni Pristich dnu," Respect, No. 23 (3 June 1996), 9-12. Jan Machacek & Marek Louzek, "4 nevesty na prodej," ResPect, No. 47 (18 November 1996), 18-24.

22. Mertlik, On Cit, 450.

23. Rutland, Op Cit, 117.

24. Mertllk, Op Cit, 459.

25. John Reed, "The Great Growth Race," Central European Economic Review, Vol. 3 No. 10 (1995-1996), 9.

26. Neil King Jr., "Who's Steering," Central European Economic Review, Vol. 4 No. 2 (1996), 10.

27. J. Raska Nc T. Marek, "Banky jsou podnikum spize pritezi, " Mlada fronta anes, 9 April 1996, 1.

28. Mertlik, Loc Cit.

29. Michael Kapoor, "Hands off' Business Central Europe, Vol 4 No. 31 (1996), 11-13.

30. Dean Calbreath, "Czech bank privatization: Let them go," Business Central Europe, Vol. 5 No. 31 (1996), 56.

31. Dean Calbreath, "Czech Coal Mines: Black tragic," Business Central Europe,

Vol. 5 No. 29 (1996), 28-29. 32. Mertlik, Op Cit, 458; Rutland, On Cit.

33. There are some independent unions of particular professions, or those associated with the Communist and Republican parties, but these are of small size and significance. J. Jarkovsky Vznik CMKOS, jeji postaveni a vyznam, (Prague, 1996).

34. Rutland, Op Cit, 121.

35. The role of the trade unions in the determination of Czech policies is grossly exaggerated in: Mitchell Orenstein, "The Failures of Neo-Liberal Social Policy in Central Europe," Transition, vol 2 no. 13 (1996), 16-20. Orenstein is right in claiming that Czech-social policies have not been neo-liberal. Instead of ascribing these policies to the government that enacted and implemented them, he ascribes them to the pressure and activities of the insipid Czech trade unions, Social-Democratic politicians, and the largely representative president Havel (who appointed Klaus in the first place in 1989). Orenstein's description of Czech trade unions resembles more the British trade unions were in the 1970s.

36. Ross Larsen, "The Unions' Turn," The New Presence, June 1997, 8-9. On the railway strike see the special issue of Tyden, 10 February 1997.

37. According to survey conducted by INFAS Factum foundation, published in Mlada fronta anes on 3 June 1996.

38. On the experiences of one fund manager see: Howard Golden, "Economic Crime Can No Longer Be Tolerated," The Prague Post, June 25 1997, A9.

39. Law 172/1990 (o vysokych skolach).

40. P. Holub, "Pilip for premier," Respekt, no. 10 (1997).

41. Interview with Dr. Gregor, the legal adviser to the European Union representative in Prague.

42. Daniel Munich & Vit Sorm, "The Czech Republic as a Low Unemployment Oasis," Transition vol 2 no. 13 (1996), 21-25.

43. Leszek Balcerowicz, "Understanding Postcommunist Transition," Journal of Democracy, Vol. 5:No. 4 (1994), 75-89.

[Author Affiliation]

Palacky University, Czech Republic

[Author Affiliation]

1 Dept. of Politics, Palacky University, Olomouc 77180, Czech Rep. Contact . This paper presents the conclusions reached at a seminar on Czech Transition directed by Dr. Aviezer Tucker at the Department of Politics and European Studies of Palacky University in Olomouc at the academic year 1996/7.

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