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Czechs and Balances

Should the Czechs have tried economic shock therapy after their velvet revolution?

July 7, 2000

Should the Czechs have tried economic shock therapy after their velvet revolution?

Back in 1991, a managing director at J.P.Morgan’s mergers and acquisitions division quit his job to run a private equity fund investing in the Czech Republic. The fund had everything going for it: some of the world’s wealthiest and best-known backers, top-notch managerial talent, plus connections in the Czech government.

But the scheme folded after just five years, having failed to buy a single company. Czech officials, local authorities and communist-era managers had refused to give up control of any company in exchange for foreign investment capital.

Those who worked for the fund have gone on to other jobs. The Czechs, however, are still footing the bill for their arrogance. The collapse in mid-June of the Investment and Postal Bank, the country’s third-largest bank, could cost taxpayers $2 billion. This comes on top of the money — equaling about 8% of GDP — the government pumped into the banking sector in 1995. There seems to be no end in sight.

Ironically, the roots of the current troubles lie in the Velvet Revolution eleven years ago, when Czechoslovakia threw off communist rule in a mostly non-violent, carnival-like uprising. The “Velvet Revolution” was followed by an equally painless “Velvet Divorce,” as the comparatively wealthy Czechs cast off their poor relations in Slovakia.

However, the experience of non-violent political change and a peaceful breakup (so different from Yugoslavia’s) gave rise to a dangerous misconception. This was the belief that the Czechs’ only problem had been that the country had been held back from achieving its full potential during the Soviet occupation.

Therefore, to join the western democratic system and build a market economy, all they had to do was throw out the occupying power — and the rest would take care of itself. Or so the Czechs seemed to believe.

As a result, Prague assumed a superior attitude toward its ex-communist neighbors, including Poland and Hungary. The Czechs refused to join a united front in accession talks with the EU, insisting instead on fast-track special treatment.

Even more dangerously, the Velvet Revolution led to kid-gloves economic reforms. While foreign investors were kept at bay, state-owned enterprises were privatized using a voucher system. Initially intended to give all Czech citizens a meaningful stake in the economy, the system led to abuses and fraud. Worse, it failed to empower strong owners who could rein in communist-era managers.

Controlling stakes in Czech companies mostly passed to voucher funds and state-owned banks, such as the doomed Investment and Postal Bank. As to factory managers, they turned out to be obtuse apparatchiks no different from their former Soviet counterparts.

In sharp contrast, when Czech enterprises actually were sold to foreign investors — such as the sale of automaker Skoda to Germany’s Volkswagen, or the divestment of several world-famous Czech breweries — privatization was a resounding success.

On a lesser scale, the Czechs made the same mistakes in the economic arena as the Austrians made in the political arena after World War II. But the Allies gave Austria an easy, face-saving way out by agreeing to treat it as Hitler’s first victim, rather than an enthusiastic participant in the Third Reich.

As a result, Austria was not forced to undergo the painful politics and social upheaval of de-Nazification. Since the Velvet Revolution, the Czechs have chosen to treat the Czechoslovak Socialist Republic as a 45-year non-event. This turning of a blind-eye to the past worked in the early 1990s, but since 1997 — when a financial crisis hit the Eastern European economies — the Czech economy has been stagnating.

Meanwhile, Hungary and Poland went through a painful adjustment process and are now catching up with Western Europe, posting annual economic growth rates of around 6%. Until similar reforms are undertaken in the Czech Republic, it will remain an economic sick man of Eastern Europe.

What a shame for such a glorious country.