V Lessons Learned and the Task Ahead
- Bijan Aghevli, Eduardo Borensztein, and Tessa Van der Willigen
- Published Date:
- March 1992
The example of Czechoslovakia’s early stabilization success has shown that a previously centrally planned economy with limited macroeconomic imbalances can weather the cumulated effects of a large-scale liberalization and a severe terms of trade shock without letting either inflation or the external imbalance get out of hand. In Czechoslovakia’s case, the key to this success was a combination of restrictive fiscal, monetary, and incomes policies, as well as a realistic and stable exchange rate. Exchange rate policy had been the subject of particularly intense debate, but events seem to confirm that the exchange rate anchor provided a reference point around which newly freed prices arranged themselves quickly. Interestingly, and in contrast to some of its neighbors, Czechoslovakia allowed ex post real interest rates to be negative during the period of the price jump. This policy does not seem to have interfered with the stabilization effort at all, suggesting that, abstracting away from the initial price jump, inflationary expectations may have indeed been quite low.
At the same time, the decline in economic activity has been large. It is impossible to say quite how much of Czechoslovakia’s productive structure has become uneconomic, following the dismantling of the special trade arrangements of the former CMEA and the opening of the economy to the rest of the world. What is clear is that the new activities, which must eventually offset the termination of old ones, are emerging slowly. At the same time, however, it is possible that the decline in output has not been large enough. Many enterprises appear to be continuing to produce, for inventory or at a loss, while financing themselves by any means possible—notably by accumulating large debts to their suppliers. There are also other worrisome signs that enterprises may begin to clamor more loudly for the relief from government—in the form of subsidies, guarantees, and subsidized credits—that has hitherto been denied them. The Government will need to stand firm in resisting these demands and seek the rapid termination of loss-making production to avoid crowding out new initiatives and to avert the danger of a financial gridlock in the enterprise sector.
In large part, these developments may be a characteristic of the no-man’s-land in which central planning has already been abandoned, but a market system is still far from established. Ahead of both large-scale privatization and action to deal with enterprises’ inherited debt burden, plans to invest or to change the structure of production await decisions of new owners, and banks cannot properly evaluate projects. Although no Central or Eastern European country can yet offer any lessons on methods of privatization, the Czechoslovak example does demonstrate the perils of remaining in such a no-man’s-land and the need for the greatest possible speed in structural reform.
The success of Czechoslovakia’s initial stabilization effort thus marks only the first step in a long process of transformation. It is essential now that the hard-earned success of stabilization be safeguarded through the coming period, which is likely to become even more difficult on the fiscal front. But internal and external balances are only a necessary, and by no means sufficient, condition for growth, and the uncharted path of creating a dynamic market economy out of the remnants of the old system still lies ahead. As was the case with its introduction, the dismantling of central planning is happening for the first time in history. The ultimate objective of the transformation is clear, and a great deal is known about the framework, institutions, and policies that shape market economies. There is, however, no blueprint for getting from here to there.
Some crucial steps have already been taken in the process of structural reform. On January 1, 1991, those elements of reform that could be instituted at the stroke of a pen—devaluation and large-scale price and trade liberalization—were implemented, putting in place the main signals necessary for the workings of a market system. There now remains, however, the much more complex work of ensuring the effective transmission of these signals through the economy, and ensuring that appropriate incentives are in place to make economic agents react in an efficient manner. Four tasks stand out in this regard.
First, the Government will have to provide the entire framework of a market economy. A large part of the necessary legal system has already been put in place. However, the building of institutions to administer this system (such as antitrust and bank supervision offices) and to fulfill the other supportive functions of government (such as labor exchanges or trade and investment promotion activities) will inevitably take time, as will the provision of modern basic infrastructure.
Second, government interference with market signals should be minimized—the Government will need to refine the rather blunt instruments with which it has thus far conducted macroeconomic policy. To this end, a number of plans are under way, including a major tax reform in 1993, which should “level the playing field” and permit a more even spreading of the tax burden through a widening of the tax base; a replacement of the clearly distortionary direct credit ceilings on banks with instruments of reserve money management; and a phasing out of the excess wage tax.
Third, “noise” from the past should not be allowed to contaminate signals in the present. In this respect, it is particularly worrisome that the burden of bank debt inherited by enterprises from the old system obscures their current viability. Various solutions to this problem have been proposed, ranging from a complete write-off of debts as of some cut-off date to case-by-case debt workouts. A full solution is urgent; in October 1991, the Czechoslovak Government announced an important step in this direction in the form of a plan to write off a certain amount of enterprise debts ahead of privatization.
Finally, ensuring a “clean” transmission of signals through the system is not sufficient to ensure an efficient allocation of resources: economic agents need also to react to these signals in an efficient manner. Thus, more than all other structural measures, privatization is the key to the success of the reform effort. As outlined above, the absence of well-established markets implies that conventional methods would not achieve privatization on any major scale within the time frame desired. The Government’s chosen strategy is an eclectic mix of methods, which seeks a balance between the sometimes conflicting objectives of speed, of attracting appropriate expertise and capital, of raising public resources, and of political expediency. It cannot be overemphasized that little improvement in economic performance can be expected ahead of privatization, and hence that all efforts should be made to accelerate the process.
The structural measures required to lay the basis for a thriving market economy will take time. Moreover, there will be lags between implementation of these measures, decisions by economic agents to react to them, implementation of these decisions, and, finally, results. The nearly complete absence of an entrepreneurial tradition will lengthen this process significantly. It is impossible at this stage to predict just how long all these lags will delay an improvement in economic performance, particularly in the context of a highly uncertain, and perhaps worsening, regional economic climate. The challenge facing the Czechoslovak authorities now is to persevere with reform without losing the support of the public. This task will require political leadership capable of explaining the process and of containing the aspirations and impatience of the population. However, the maintenance of a relatively firm political and social consensus on reform through the turbulent early phase of reform has raised the odds in favor of success.