WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

As part of a wiiw series of events, essays and analyses commemorating the 30^th anniversary of the fall of the Berlin Wall, we interviewed our Senior Research Associate and former Deputy Director Peter Havlik. We asked him what the fall of the Berlin Wall meant for Czechoslovakia, and to share his views on the current prospects of its two successor states. wiiw’s special report on 30 years of transition and convergence was published recently and is available here.

How would you describe the situation in Czechoslovakia back in 1989? Were there also signs of a system change like in Poland and Hungary?

One has to remember that the year 1989 was almost the last year of  ‘perestroika’ (transformation) and ’glasnost’ (openness) that started in the Soviet Union in mid-1985, after Mikhail Gorbachev became chairman of the Soviet Communist Party. There was also the Solidarność (Solidarity) movement in Poland and round table discussions with opposition forces in Hungary. The period of late 1980s was really fascinating.

In Czechoslovakia, there was literally nothing comparable at that time. Resignation and apathy was the dominant mood in the society. After the Warsaw Pact Invasion in August 1968, and after the so-called normalisation period that followed during 1970s, the Czechoslovak leadership was one of the most rigid and conservative within the former Eastern Bloc - including the Soviet Union itself. There was a small and isolated dissident movement, the Charta 77 in late 1970s. Charta 77 was also not very well known - due to persecutions by the state authorities, censorship and also due to the widespread feelings of resignation, apathy and fear. At its highest point, by the end of the 1980s, there were slightly more than 1000 signatories of a Charta 77 human rights petition (out of the population of more than 15 million, including more than 1.5 million members of the Communist Party).  

wiiw’s official name at that time was ‘The Vienna Institute for Comparative Economic Studies’, as we were mainly engaged in comparing the system of capitalist market economy in the West with those of the socialist planned economies in the East. In October 1989, for example, we organized a lecture by a certain Václav Klaus who later on became one of the leading Czechoslovak and Czech reformers. In his lecture at wiiw, he talked about economic reforms in Czechoslovakia, about how successfully socialist enterprises had already transformed, and how well they now reacted to market signals and so on. He painted a rather favourable picture of the Czechoslovak economy. After his presentation, I asked him: “Mr. Klaus, do you think that Czechoslovak enterprises should also be privatised?” His answer was: “No, there is no need for privatisation. Our enterprises have already been transformed and react to the market signals”. This was one month before the Velvet Revolution on 17^th November in Prague!

Which transition strategy was actually by Czechoslovakia - was it shock therapy or a more gradual model? 

In the early 1990s, the majority of people - including leading Czechoslovak economists, the President Václav Havel and other members of the new government - still talked about reforming the socialist system, not about introducing a liberal market economy. The term ‘capitalism’ was largely avoided. Only later, in 1991 and 1992, discussions centred on the shock therapy versus a gradual introduction of the market economy. There were basically two prominent economists who argued for these different options. Both came from the Institute of Forecasting at the Czechoslovak Academy of Sciences in Prague. One was the above mentioned Václav Klaus, who was a proponent of the shock therapy, and the other was Valtr Komárek, the director of this institute and a proponent of gradual transition. Mr Komárek was an older economist with extensive experience in consulting abroad. He, for example, spent a couple of years as an advisor of Che Guevara in Cuba in the 1960s. And he pointed out the dangers of a shock therapy, including its adverse social and political consequences.

In the end, Václav Klaus prevailed. His ideas of a rapid liberalisation of prices, foreign trade and the exchange rate, were implemented. Foreign advisors played almost no role in Czechoslovakia. Mr Klaus was not only an economist, but also a very clever and skilful politician and very soon he understood that in order to implement his ideas, he needed a political party. And so he established the liberal-conservative ODS (Civic Democratic Party) in April 1991, of which he became a head. The ODS served as an instrument for gaining political support to implement his favoured liberal reform strategy.

How was the privatisation of state property actually managed, and did any of the privatisation proceeds actually find their way into the state budget?

Privatisation was a very complicated endeavour everywhere and there were different ideas how to do it. In Czechoslovakia, the small and medium-sized businesses were either returned to their former owners in the framework of the so-called restitution or auctioned. This was basically done within 2 or 3 years, including the housing stock, small agricultural plots, retail shops, small factories, etc.

The problem was what to do with the big state-owned enterprises. These could not be easily returned to their former owners. Some of them were established only during the socialist period, others were expropriated from their former German or Jewish owners after the war. The Benes Decrees played a key role here. Czechoslovakia finally opted for the voucher privatisation of big enterprises, an idea had already been privately developed in the 1970s by Dušan Tříska, whom I also knew personally from those times. Dušan was a mathematician and a very clever guy, and as a Deputy Finance Minister during early 1990s he advised Václav Klaus on voucher privatisation.

Another reason for the voucher option was that Václav Klaus didn’t want to sell Czechoslovak enterprises (the ‘family silver’) to foreigners. He was completely against foreign participation in the privatisation process. Given that there was not sufficient domestic capital, Mr Klaus argued that voucher distribution would be the most ‘social’ (and politically instrumental) way to distribute state property among Czechoslovak citizens. And his idea gained quite some popularity, especially at the beginning. The absence of any capital market regulations was disregarded and the speed of privatisation gained priority over quality and legality. Another, less mentioned factor, was that Czechoslovakia - due to its negligible foreign debt – actually did not need foreign capital like, for example, Hungary did (the need for foreign technology and management know-how was another story).

Actually, many large voucher-privatised enterprises soon went bankrupt, either because they were ‘tunnelled’ by a widespread practice in which the new owners (often just the old managers) extracted the valuable assets and sold them, or because they lacked the necessary capital for modernisation. As a consequence, the state had to replenish the capital of many privatized enterprises, and especially to take over non-performing and frequently fraudulent credits provided by several ‘para-state’ big banks, in order to prevent them from bankruptcy and to avoid adverse social consequences. Finally, by the mid-1990s, it was recognised that it is very difficult to get these enterprises to stand on their own feet without outside help, and the country had to reluctantly open to foreign investors. Many big enterprises and banks then were first refinanced from the state budget and then sold to foreign investors. This was the case for example with Skoda Pilsen (Siemens) or Skoda Mladá Boleslav (Volkswagen), as well as with a number of domestic banks. Ceská Sporitelna or IPB were sold to Erste Bank, Bank Austria, KBC or Raiffeisen at enormous costs for the Czech state.

In 1993, Czechoslovakia was dissolved into two states – the Czech Republic and the Slovak Republic. This dissolution went down in history as the most peaceful separation of two states, but how and why did it actually happen?

In my view, perhaps it’s the naïve view of an economist, a fundamental disagreement on the speed and the mode of transition, together with diverse economic fundamentals, were the main causes for the dissolution of Czechoslovakia.

One part of the early Czechoslovak economic reforms was to stop armaments production – at that time the country was one of the leading weapons producers in the Eastern bloc. Already during the so-called First Republic (1918 - 1938) and as a German Protectorate (1939-1945), the Czech Republic produced advanced heavy guns, planes, tanks, small arms and so on. After the war, in the course of a ‘socialist industrialisation’ and for Cold War strategic considerations, parts of this heavy weapons production was located in Slovakia. When the federal government in Prague, of whom President Havel and Prime Minister Klaus were major proponents, decided to scale-down the weapons production, many Slovak enterprises were disproportionally affected.

The concepts of transformation differed substantially among the Czechs and the Slovaks. This conflict escalated in 1992, when the prime ministers Vladimír Mečiar and Václav Klaus finally proclaimed the dissolution of the country and the founding of the two separate states as of January 1993.

Another factor was nationalism, especially the Slovak one (as well as a more disguised Czech one). Slovaks demanded more independence, but I think this would have been granted to them, and different concepts of economic reforms played a crucial role in the Czech-Slovak split. In this sense, the common Czech-Slovak state became a victim of diverse transition concepts.

It seems that by mid-1990s both countries were in the middle of a transition shock. How did it affect ordinary people’s lives?  

Between 1991 and 1993, unemployment became a serious issue. This was a completely unknown phenomenon in Czechoslovakia before. In the Slovak Republic, the unemployment rate (more than 13%) was three times as high as in the Czech Republic, partly due to the above-mention structural effects.

There was a sharp surge in inflation due to the liberalisation of prices. At the same time, the government, with Václav Klaus as Finance Minister, decided on a wide-ranging liberalisation of trade, involving an opening to imports without any tariff protection. A market exchange rate was introduced, approximately at the black market level, which involved a huge devaluation. This somehow served as a protection from imports, because these became very expensive. The shock therapy resulted in a transformational recession, which not only led to high unemployment, high inflation and a sharp drop in GDP as consequences, but also to a strong increase in inequality, which we observe until today. All of this eventually resulted in wide-spread disappointment and the social and political situation we witness today in both the Czech and Slovak republics as well as in other former Eastern Bloc countries.

Did this disappointment already trigger the nationalistic, xenophobic emotions that we observe in the Czech Republic today?

I would say it went together with the rapid transition and disappointments that inevitably followed. Another point was that people had very unrealistic expectations after the regime change. The overwhelming majority was convinced that if a capitalist market economy was introduced, their income level would soon correspond to that of Austria - within 10 years at the latest, i.e. by the year 2000. That was a widely shared expectation, not only among the population, but also among experts and reform economists like Václav Klaus and others. Actually, nobody in the country believed that it could be different or was unrealistic. Even today, despite impressive catching-up during the past decades, the real per capita GDP in the Czech Republic amounts to just 72% of the Austrian level (in Slovakia: 61%).

Would you have thought that this convergence process would take such a long time? That it would not take 10, but perhaps rather 40 years or even more?

Yes, I never believed in a rapid convergence. In fact we dealt with economic catching-up intensively in our past wiiw studies. We wrote already by the end of 1980s that the transition and convergence processes would last for a very long time, that it would be uneven, that there would be crises, and that not every country would be successful. We published such analyses and assessments for example in ‘Economic Reforms in Eastern Europe and the Soviet Union’ (Hubert Gabrisch (ed.), Westview Press Inc, 1989 – reprinted by Routledge in 2018) or in ‘Dismantling the Command Economy in Eastern Europe’ (Peter Havlik (ed.), Westview Press Inc, 1991.

What did the EU accession negotiations and the eventual EU membership bring the country?

The Czech and Slovak Republics were keen to ‘return to Europe’ and to reorient their economies and trade from the East to the West, especially after markets in the East collapsed. However, the trade reorientation was possible only gradually, not least because their products were simply not competitive. The West was also very cautious and EU member states initially didn’t want any free trade with the former Eastern bloc countries, and still maintained various protectionist measures against these countries’ exports. While the Czech Republic, for example, opened its markets almost completely after 1990, trade openness was not at all reciprocal (this changed in the late 1990s).

There were also Western proposals for the former Eastern bloc countries to first establish an economic integration zone among themselves. The idea of CEFTA originated from that time, it was supposed to be a kind of ‘waiting room for EU-membership’ after the collapse of COMECON. Well, later on, in 1996, EU accession negotiations actually started and in 2004, 15 years after the Velvet Revolution, these countries were finally accepted to join the EU club.

The accession negotiations were also very important for the establishment of democratic institutions in the country because human rights, independence of courts, the rule of law, etc. were high on the reform agenda. All these issues we now witness in the association talks with Ukraine, Georgia, Moldova or the Western Balkan countries. It was a very important anchor for democratic and liberal reforms in all former Eastern Bloc countries and their societies.

What are today the biggest economic challenges facing the Czech and the Slovak Republics?

For both, I think the biggest challenge is a too strong dependence on the German economy, and a too strong dependence on the automotive industry. I personally do not see much perspective for the automotive industry in the medium and long run in Europe, not least because of different climate and societal changes. This implies that another restructuring of the Czech and Slovak industries will rather soon be necessary. The Czech Republic probably has better pre-conditions for this, because its economy is more diversified, more flexible and not so much dependent on the manufacturing sector only.

As far as the Czech Republic is concerned, I also think the widespread aversion to European integration represents a very serious challenge. The associated nationalism in the country is a very dangerous development that unfortunately does not exist only there. In purely economic terms, this involves the prospective introduction of the Euro which, I believe, would be beneficial for the country – provided the EU successfully reforms.