Czech Approach to Transformation

1. Czech Approach to Transformation Gradualism x Shock Therapy Accepted Transformation Strategy ShockTherapy Voucher (Coupon) Privatization A Specifically Czechoslovak Approach Critical Remarks Theoretical Concepts Linked with Critical remarks

2. Gradualism x Shock Therapy Gradualism – restructuring first, thereafter gradual privatization by standard methods Shock Therapy – mass scale privatization before restructuring, un-standard privatization methods necessary because of the lack of financial capital

3. Accepted Transformation Strategy Shock Therapy Prepared by a team organized by Vaclav Klaus (current President) Backed by Washington Consensus (International Monetary Fund´s (IMF) medicine) Fiscal Austerity Privatization Market Liberalization

4. Accepted Transformation Strategy Transformation Rules: (Vaclav Klaus 1994) Transformation is neither modernization, nor restructuring, nor the financial stabilization of individual firms, because all these are post-transformation tasks

5. Accepted Transformation Strategy Systemic change is primarily and mainly about privatization. Systemic change has its macroeconomic, liberalization and deregulation dimensions Privatization during transformation is different from privatization in the West Mixture of standard and non-standard methods A different role of the price of privatized firms (and privatization revenues) and different ways of evaluating privatized firms

6. Accepted Transformation Strategy The key task is looking for an owner who will perform post-privatization restructuring, not for a state bureaucrat who will restructure the firm before privatization Minimizing the period of pre-privatization agony, because no method exists to rationalize behavior of firms waiting for privatization

7. Accepted Transformation Strategy Macroeconomic, liberalization and deregulation dimensions Basic macroeconomic stabilization has to be carried out before the liberalization of prices and foreign trade (liberalization of internal and external markets) Liberalization of prices and foreign trade must be carried out at the same time (otherwise the behavior of inherited monopolies and oligopolies can endanger the whole process)

8. Accepted Transformation Strategy Liberalization of foreign trade must come after a significant devaluation of the currency, and it must be accompanied by introduction of internal convertibility of the currency Liberalization and deregulation steps must be as extensive as possible, economic variables must be free to move, except of the exchange rate – it has to become the anchor to which all other economic variables are tied

9. Accepted Transformation Strategy The Hypothesis of Two Cushions (Klaus 1994) After price liberalization there will be a rapid decline in real wages – decrease of costs for firms. This is the first cushion for firms. Strong devaluation before foreign trade liberalization supports exporters. This is the second cushion for firms.

10. Voucher Privatization State-owned firms were transformed into joint-stock companies 1664 joint-stock companies and property worth (in accounting value) almost 350 bill. CZK were totally or partially privatized in two waves, from 1991 to 1995

11. Voucher Privatization Mechanism Everybody could buy a voucher (for about 1000 CZK), specialized money – investment points - just for buying the stocks of privatized companies (nothing else) Centre for Voucher Agency (CVP, a state agency) was the market maker 1st wave occurred in 5 rounds, the 2nd wave in 6 rounds

12. Voucher Privatization The CVP announced for each round the price of stocks in investment points for all stocks (of each privatized company) Where demand was lower than supply, stocks were sold Where demand was higher, nothing was sold and the CVP increased the price in investment points for the next round

13. Voucher Privatization The first wave passed at the federal (Czechoslovak) level In 1995, there were 6 million shareholders in the Czech Republic. Voucher privatization improved the knowledge of citizens about the property relations they were not familiar before.

14. Voucher Privatization It helped to establish a capital market. It enforced the booked (dematerialized) form of security and the establishment of the Securities Centre – a special organization that keeps records of the mentioned securities It assisted with the birth of more than four hundred investment funds and unit trusts which in a short time became an important factor in the capital market

15. Voucher Privatization It demonstrated that it was possible to prepare a demanding technical system with millions of clients during a few months and operate it successfully

16. Critical Remarks There is no official evidence about the wild forms of privatization: the stripping of state assets and the tunneling of state enterprises during the so-called pre-privatization agony From the official point of view, this activity represented nothing more then the devaluation of privatized assets and therefore it was the private problem of new owners Is the unsustainability of Czech public finances somehow connected?

17. Critical Remarks Week cooperation between laws and economics The privatization process is a major legal transformation with dramatic economic consequences, but lawyers do not understand economic processes and economists have little regard for the law (Tomas Jezek, 1997)

18. Critical Remarks Speedy privatization without firm rules is a threat for emerging order Erosion of informal institutions Trade-off between the speed of change and business ethics Conservation of the rent-seeking behavior

19. Critical Remarks What does it mean private? Official statement from 1997 (Tomas Jezek) About 60% of state-owned assets were distributed free of charge (about 40% through voucher privatization, about 20% through free transfers to municipalities, the rest through restitutions) 30% were sold (direct sales and public tenders) 10% yet to be sold

20. Critical Remarks Czech “Banking Socialism” Banks stayed in the hands of the state They owned investment funds that owned the privatized firms Quasi-private property and connected problems Problem of bad credits Enormous increase of business credits Banks were privatized around 2000, it solved this quasi-private property problem, with considerable costs.

21. Theoretical Concepts Linked with Critical Remarks Stiglitz (Nobel Price Winner in Economics) criticizes the International Monetary Fund (IMF) and the Washington Consensus from the point of view of New Institutional Economics Washington consensus neglects the role of transaction costs

22. Theoretical Concepts Linked with Critical Remarks Roman Property Rights “Usus” => responsibility “Usus fructus” => you may take resources for your living “Abusus” => you may sell your property Quickly gained property does not create the sense of responsibility Question of Social Justice

23. Theoretical Concepts Linked with Critical Remarks Use and abuse of the theorem of Ronald Coase “Theory of lights off” Insufficient solutions for the enormous asymmetry of information during transformation