Transitional Success: USSR to EU (184137)

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The Czech Republic

Transitional Success:


Public finance policy issues during the political

economic transition from centrally planned socialist

economics to free market democratic capitalism.

V550 Dr. Mikesell

November 20, 1996

Rick Ferguson

Eric Martin

Dmitri Maslitchenko

Table of Contents

I. Introduction

II. Political Summary: Restructuring for Transition

III. Transition to Market Economy: 1990 - 1991

IV. Problems of Transitional Monetary Policy and the Financial Sector: An Overview

V. Macro Economic Stability: 1993 - present

VI. Monetary Policy: 1993

VII. Intergovernmental Financial Relations

VIII. Budgetary Overview: 1993 - present

IX. Tax Reform

X. Current Political Economic Considerations: 1996

XI. The EU and NATO

XII. Conclusions

XIII. References


In 1989, after nearly 40 years of Soviet control, Czechoslovakia once again became an independent nation, the Czech and Slovak Federalist Republic. This transition from Soviet socialism to democracy culminated throughout Central and Eastern Europe with the literal collapse of the Berlin Wall in East Germany, the heroic Gdansk Shipyard Strikes in Poland. The student and worker protests in Prague and Budapest were no less important.

The Czechoslovakian revolution took place peacefully and over a much longer period of time than events in other former Soviet Union or Warsaw Pact nations. Hints of major reform in Czechoslovakia began as early as 1968. Czechoslovakian officials, under Soviet power, moved incrementally to begin the long road towards decentralization and independent Czechoslovakian rule. Their increasingly effective efforts became known as the Prague Spring, a time of growth, change and development.

Success was, of course, neither immediate nor easy to achieve. The Cold War reached a pinnacle in the Eighties and the winds of change began to blow in Central and Eastern Europe. The CEE nations endured many hardships. Soviet oppression, though waning by this time, became largely unbearable. Change in Czechoslovakia came from the ground up; dissidents quietly began to return to popular power. The revolution gained momentum by 1989. ‘Revolutionists’ began to demand sweeping economic and political reform. They were backed by well organized and very timely strikes and protests. After a two hour general strike on November 27, 1989, proving the immediate and widespread power and cohesion of the revolution, the Soviet controlled authorities finally agreed to negotiate.

Through the negotiation process and threat of further massive general strikes, former dissidents assumed officially sanctioned ‘concessional’ positions. Within months, they gained near complete (and very real) control of the Federal Assembly. On December 29, 1989, Mr. Havel, a very famous and popular Czech dissident, became President of Czechoslovakia (renamed the Czech and Slovak Federalist Republic).

This initial political victory represents only half of the nation’s success. Within the first three years of self rule, harsh economic (and subsequent political) realities forced the nation to divide once again. The nation as a whole was unable to accommodate the vast discrepancies between the western Czech and eastern Slovak regions. Massive economic reforms brought this to the popular agenda as Slovakia suffered greatly while their Czech counterparts seemed to benefit from reform.

The government in Prague wished to move swiftly to further reform efforts. Slovakia hindered Czech success and in turn suffered greatly by this Czech-led reform. Slovakia simply could not move as rapidly toward a market economy due to the economic configuration left to them by years of Soviet planned economics.

Political Overview: Restructuring for Transition

In 1992, Vladimir Meciar, a very strong nationalist was elected prime minister of the Slovak Republic, while Vaclav Klaus, a moderate federalist, was elected in the Czech Republic. Unfortunately, these two leaders were unable to agree on common economic and political strategies to govern the CSFR. Klaus’s reform plans, now legendary, were simply inappropriate for the fledgling Slovak regions. Slovakians felt alienated from the government reform in Prague. Within a short time it was very clear that the Czech regions could not completely support their Slovak countrymen through the transition. The two leaders agreed to divide the Czech and Slovak Federalist Republic (CSFR) into the Czech and Slovak Republics on January 1, 1993.

Federal assets and liabilities were split between the two nations in a two to one ratio. The Czech Republic received the larger portions reflecting both size and population. Again, the split was achieved peacefully, without massive debate. The two countries agreed to form a customs union. They implemented identical foreign policies with respect to third countries, and forbid tariffs or ‘bans’ between themselves. They also formed a temporary monetary union, which collapsed within months as both countries unexpectedly experienced a massive drain on foreign reserves during this time. To more fully understand the current developments in the Czech Republic, one must examine the historical economic decisions made before the break-up in 1993 as outlined below.

Transition to Market Economy Overview: 1990-1991

CSFR economic reformers went to work immediately following the collapse of Soviet rule. The reform package included near complete liberalization of prices, a complete reversal of former exchange and trade systems and an impressive preparation for massive and rapid privatization. These efforts were supported by financial policies including a “pegged” exchange rate, currency devaluations, and restrictive fiscal, monetary and wage policies.

Monetary Policy

Although monetary policy is discussed in a separate section, it needs to be briefly addressed here to understand the conditions in which the transition occurred. Monetary policy in the initial stages of transition ensured that inflation remained in control throughout currency devaluations and price liberalizations. The CSFR devalued its currency by 20 percent in 1991 after several smaller devaluations before hand. Taken as a whole, these devaluations reduced the value of the currency by half within six months. Generally, monetary policy remained tight throughout the entire period.

Fiscal Policy

Undoubtably, the goals of the CSFR economic reformers were to drastically reduce government spending. The former centrally-planned, output-driven economic policies were no longer effective for the new capitalist democracy. Restructuring government expenditures was a key component of reform. The main changes, aside from massive privatization discussed below, forced reduced subsidies wherever possible. Every sector of society, with the exception of health, welfare and education, saw an abrupt end to government subsidies. In 1991 alone, for example, officials reduced government spending by 12 percent to reach 47 percent of GDP. This trend continued throughout the transition. Massive government spending, a hallmark of socialism, ended virtually overnight.

Areas where government spending remained high would remain so throughout the reform process. Health and welfare for poor, elderly, unemployed and children is a very difficult situation in any government, especially one in transition. Reformers focused primarily on industry and energy in the initial stages, leaving the areas of greater uncertainty to be dealt with in a more stable political environment.

Price Liberalization

As an almost immediate measure, subsidies to foodstuffs and energy were reduced by nearly 50 percent. Retail prices for most household items increased by nearly 25 percent literally overnight. By the end of 1991, the Czech government controlled only 6 percent of prices in the country as compared with 85 percent in early 1990. Only basic necessities, oil, and agricultural products remained under state control. To offset some of these shocks, wages increased, though only slightly and not nearly enough to meet the increased cost of living. Politically powerful trade unions prevented the passage of even more drastic reform measures. Plans in 1991 to increase the price of electricity, heating oil and coal by nearly 400 percent and rent by 300 percent were delayed until 1992 and 1993.

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.

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