I Introduction

Bijan Aghevli, Eduardo Borensztein, and Tessa Van der Willigen
Published Date:
March 1992
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On December 10, 1989, it had been over forty years since the Communist party assumed control of the Czechoslovak Government, and over twenty years since the reforms of the “Prague Spring” failed. This was the legacy inherited by the new “Government of National Understanding,” formed on that day, and by its successor, the democratically elected Government that took office in June 1990, which was virtually identical in composition to the interim Government it replaced. The economic legacy was shaped both by the distant past—Czechoslovakia’s prewar history as a major industrial power—and by the recent past—slow economic decline under the Communist regime.

Before even its foundation as an independent state in 1918, and up to German occupation in 1938, Czechoslovakia had enjoyed a well-developed market system. By contrast, under the Communist regime, state control over the economy was more pervasive than elsewhere in Central and Eastern Europe. Almost all the means of production, including agriculture and small businesses, were in the hands of the state. The only significant physical asset in private hands was about half of the housing stock. Decisions relating to production, investment, and foreign trade were made by the state. Prices were centrally set, and wages tightly controlled. Efforts in the mid-1960s to reform this system, particularly by delegating decision making to enterprise management, were entirely reversed after 1968. Thus, although the market system survived as a dim memory, most skills associated with that system had faded by the 1980s.

Industry enjoyed a privileged position during the Communist era, and was relatively advanced by the 1980s, although plagued by inefficiency and outdated technology. Industrialization since 1948 had been guided both by the planners’ preference for heavy industry and by the international division of labor within the Council for Mutual Economic Assistance (CMEA), which was only loosely related to Czechoslovakia’s comparative advantage in a worldwide setting. Consequently, the economy had become extremely vulnerable to the terms of trade shock attendant on the collapse of the CMEA in January 1991.

The integration of Czechoslovakia into the world economy and the accommodation of the (long stifled) expression of its citizens’ preferences call for a drastic change in production patterns. The country’s industrial legacy affects this change in several ways. On the one hand, Czechoslovakia is endowed with a well-educated and skilled work force; it has also been left with a sizable stock of capital, at least some of which is usable in the new environment. These factors augur well for the success of reform in the longer term. On the other hand, Czechoslovakia’s highly processed products are geared to specific needs and markets, and their redesign will require expertise, investment, and time. Thus, in the short run, Czechoslovakia’s relatively advanced industrial structure can only complicate and slow the reorientation of production.

Finally, both in pre-Communist and Communist days, Czechoslovakia consistently implemented cautious macroeconomic management. Unlike other Central European countries, it did not experience runaway inflation in the 1920s.1 During the Communist era, fiscal and credit policies were consistently conservative, and budgetary subsidies to enterprises were relatively small. Foreign debt was kept low, particularly compared to other centrally planned economies (Chart 1), and domestic imbalances were clearly smaller than in most centrally planned economies in the region. Recorded inflation was low, at an average of about 1½ percent a year over the 1980s, and hidden inflation is thought to have amounted to no more than 3 percent a year. Moreover, both anecdotal evidence (the absence of pervasive shortages) and trends in the income velocity of money (which had declined only slightly during the 1980s) suggested that excess demand had not built up in the form of a large monetary overhang.

Chart 1Comparative Foreign Debt Levels, 1989

Sources: Country authorities; and IMF staff estimates.

From a macroeconomic point of view, therefore, Czechoslovakia enjoyed perhaps the best starting conditions for reform in Central and Eastern Europe—although the nearly complete domination of production by the state and virtual absence of any market mechanisms called for perhaps even more extensive structural reform than in the other planned economies. The Communist regime had initiated only a few cautious steps toward reform in late 1987. These included a small liberalization of the exchange and trade system aimed at encouraging exports in convertible currencies, a slight move toward greater enterprise autonomy, and a rationalization of wholesale prices, which continued to be administratively determined.

A more complete historical background is provided by Prust and IMF Staff Team (1990) and Solimano (1991). For experiences with hyperinflation in the 1920s, see Dornbusch and Wolf (1990).

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