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Reawakening: A Market Economy Takes Root In Eastern Europe

Special Report


Andrzej Kita used to fear success as much as failure. As the owner of one of Poland's few private companies under the Communists, he lived in the shadows, trying to conceal his company's growth and bribing authorities to let him stay open. Although the regime tolerated some private enterprise, the secret police hounded owners, hauling them off to jail for months. "They would burst in and scream 'nobody move,' " says Kita. "They would have destroyed me."

But last year, as Poles lunged toward a market economy, Kita jumped out of the shadows. His Akita Electronics, a printed-circuit-board maker with $1 million in sales, is now one of Poland's hottest new-era companies. Despite the country's economic nosedive, Kita is planning to plow $400,000 into a new factory to double his work force and output. Today, on the front of a white stucco building in Cracow, the name Akita Electronics leaps out in two-foot letters, just above the boss's ice-blue Porsche. "Everything will sell here," says Kita. "Everything is in demand."

A corps of energetic entrepreneurs is working feverishly to rebuild amid the ruins of the former East bloc's command economies. Thousands of new shopfronts and plants dot the landscape. While news reports focused on obsolete industries and filthy air, Hungarians, Czechs, and Poles were already barging ahead. In the first 15 months since the Communists lost power, Eastern Europe has seen the rise of 1 million new owners. Astonishingly, private-sector activity accounts for as much as 35% of gross national product in Hungary and Poland (charts).

While the former East bloc is percolating at the grass roots, the region's fragile new governments face staggering challenges. Unwinding the command economies without heaping too much pain on the populace is a Herculean job. Privatizing industrial dinosaurs, snuffing out inflation, coping with massive layoffs, all these tasks lay ahead (page 54). The biggest economies--Czechoslovakia, Hungary, and Poland--are making the most progress. Yugoslavia, wracked by ethnic conflict, is on the brink of breakup, while less developed Romania and Bulgaria are barely out from under their former rulers.

Where the private sector has taken root, it is becoming an unofficial safety net for thousands of workers fleeing bankrupt state companies. Industrial production is collapsing, and trade with the once-all-important Soviet market has plummeted. Fully one-third of the 1.2 million Poles laid off last year were hired by private companies. "It explains why people haven't rioted in the streets," says German economist Horst Brezinski. Despite the gloom, East Europeans can today buy everything from mangoes to Apple computers, albeit at Western prices. Restaurants and copy shops along Erzsabet Korut Street in Budapest bustle with activity late into the evening, while across town, dispirited managers at the state phone company punch out at 3 p.m.

RECURRING NIGHTMARE. Budapest, Prague, and Warsaw were hubs of European culture and business for much longer than they were outposts of communism. Now, they have reactivated their strong ties to the West, pushing the idea of a Central European renaissance and rebuilding bridges to West European intellectual, scientific, and cultural life. They are also urgently knocking on NATO's door and pressing for membership in the European Community by the end of the decade.

Almost overnight, the "three hopefuls" have turned their backs on Moscow. The implosion of the Soviet market and the end of cheap Soviet oil and gas imports have made all Eastern Europeans wary of their neighbor. Some fear the turmoil in the Soviet Union could careen their way. The nightmare is thousands of refugees pouring across the borders if the Soviets pass a liberal emigration law anytime soon. "East Europe is the first line," says George Schopflin, an expert on the East at the London School of Economics.

Life would be a lot simpler if someone had charted the course from communism to capitalism. Instead, resurgent entrepreneurs from Gdansk to Szeged are mapping the critical first steps on the road back to a market economy. At the most primitive level, former black-market traders, ambitious teenagers, and laid-off factory workers are amassing huge cash hoards by dodging customs duties and selling coveted import goods on open markets. These traders are poised to become hubs for distribution as flows of imports and exports grow.

At another level, university professors, engineers, and former party officials are raking together cash for startups, filling niches with Western-style service and manufacturing operations. Services of all stripes, from restaurants to software houses to picture framers, are popping up. And now, satellite dishes, auto parts, and construction machinery are made in garages and makeshift factories across the region. "They will be the engine," says Holger Schmieding, an East Europe expert at the Kiel Institute for World Economics. Mostly, the ventures are financed by small caches of capital from family and friends.

The newly minted governments of Eastern Europe are crucial partners of the entrepreneurs. The drama of democracy unfolds day by day in the three capitals. Earnest officials are piecing capitalist institutions back together. By the end of 1991, many of the hundreds of laws necessary for market economies will be in place.

Privatization of the state's gasping giants will be key. The immediate task is to bust up the East's command structure in which sprawling factories vertically produced all they needed: Czech engineering company Skoda, for example, made its own steel, machine tools, and nuclear reactor cores. Now, the new technocrats want to break off bits and pieces of industry into hundreds of small, efficient companies that will either attract entrepreneurs and Western joint-venture partners or, they vow, get shut down.

If governments can keep their reforms on track, a new type of player, the conglomerateur, could emerge to power the economy into the next phase. A handful of nimble entrepreneurs have made enough money to build up small empires, in some cases from scratch. Gabor Renyi, head of Hungary's Novotrade, for example, is a former Party member who has parlayed cash from his $61 million computer trading company into 68 startups, from fast food to film production. Pioneers like Renyi are well-connected to the West and could be important links for foreign investment.

Last year, the much-hoped-for infusion of capital from the West turnedout to be a trickle instead of a flood.The initial enthusiasm of Western executives turned to dismay when they saw the crumbling infrastructure and met disheartened former communist managers who hadn't a clue about Western markets. But investors with iron stomachs and long horizons are beginning to move in. Several $100 million-plus deals were signed in the past three months as Western corporations took a second look (page 51). Just as important, a steady stream of small sums is flowing into Eastern Europe. Successful emigrants, investment funds, and government-sponsored projects are all pumping in money for startups, modest loans, and small state buyouts. Hungarian emigre Peter Rona heads an $80 million fund that's launching a Budapest record company, among other ventures. Poles in Chicago have sent millions to relatives and ship entire container-loads of PCs and copiers to startups.

BOHEMIAN BANKER. The entrepreneurial rush started in Poland and Hungary, where limited private ownership was tolerated under Communist regimes. But Czechoslovakia, once one of the most insulated of East bloc countries, is also awakening from a deep sleep. Private owners already number 300,000, from zero a year ago. Emigrant Jiri V. Kotas, returning home from Canada, launched the country's first private bank. Bank of Bohemia opened on Apr. 1 with 10 branches aimed at financing small service and retail businesses. "Small business is the backbone of all Western economies," says Kotas, a 38-year-old historian who did a three-year stint at the free-market Heritage Foundation in Washington. Kotas is starting out with $10 million he obtained from Czech trade unions and other sources. The plan is to start lending small sums for everything from shoe-repair shops to toilet-and-sink manufacturers. Credit decisions will be a group endeavor to teach banking skills to the staff of 35, many of whom are graduates of the Prague School of Economics. Even before the doors opened, the bank had commitments for $71 million in deposits.

So far, however, demand for capital far outstrips supply. Most entrepreneurs finance startups with cash hidden under mattresses, some $25 billion or so accumulated over decades of communist rule. Budapest entrepreneur Andrea Gallai poured $80,000 of private savings into her first venture, a picture-framing business. "Everyone has stashed away some wealth," says Gallai. Tapping a new government fund for entrepreneurs, Gallai, 34, now plans to open 19 franchises of her RakpArt Gallery by yearend.

Once their businesses are launched, the East's new entrepreneurs must cope with uncertain supplies, staggering interest rates, and high taxes. But the trenches are filled with individualists, once outcasts in the communist system, and emigrants who have returned to rebuild their homelands--and get rich, too.

Hard-driving Hungarians Zoltan Palmai Jr. and Sr. are all of the above. After the state forced the sale of large hotels in 1985, Palmai Sr. left to build and renovate hotels for Holiday Inns Inc. in the U. S., while Palmai Jr. learned hotel management in Budapest and Miami. Now, they are back in business with a vengeance. Last year, they reopened their Victoria Hotel, Hungary's first private four-star hotel since the 1940s. In a city desperately short of Western-style hotels, the Victoria's 32 rooms, complete with direct-dial phones and satellite TV, have drawn occupancy rates of 70% even in off-season. At $80 to $120 a night, they cost half that of rivals. The new owners expect their $1.7 million investment to turn a profit within three years.

A handful of entrepreneurs with major resources are already beginning to slug it out in international markets. Poland's Witold Zaraska is racing to build a 14-story international business center in Kielce, 110 miles south of Warsaw. Last fall, Zaraska bought a major stake in Exbud, a profitable construction and trading company he used to manage for the state. Exbud employs 11,000 people, 80% of whom are working on construction projects abroad.

Sitting in his plush penthouse office suite, Zaraska surveys a 430,000-square-foot complex that will include conference halls, leisure and sport centers, hotels, and housing units--all with state-of-the-art satellite, digital, and cellular telecommunications. Boasts the 5-ft.-2-in. Zaraska: "In five years, we'll be one of the largest construction firms in the world." Motivating Poles is no problem, says Zaraska, if you pay them in hard currency. He now plans to capitalize on his low labor costs by making bargain-basement bids on construction projects in costly eastern Germany.

Other entrepreneurs are simply taking advantage of Eastern Europe's hunger for basic consumer goods. A few get rich so quickly that they snap up any kind of business they want. Warsaw residents Halina and Bogustaw Tyzus, once blue-collar workers, made their first million on a simple scheme to print and sell glossy horse posters and calendars. The posters were an overnight success after decades of government-issue calendars. Today, the Tyzuses run a small empire, including a graphics shop, a riding-equipment shop, an art gallery, a gourmet grocery store, and 247 acres outside Warsaw where stables for a future horseback-riding resort are under construction. No doubt many startups are benefiting from a kind of Wild West climate in which old laws go unenforced and new ones have yet to be written. In Poland and Hungary, officials openly tolerate thousands of unregistered vendors who have set up burgeoning markets yet pay no taxes. Says Hungarian Industry Minister Peter Bod: "We have no money and no energy to go after them. We're just happy they exist."

PRINCE OF SHADES. As a result, there's a new class of suitcase importers. They arrive on returning flights from Seoul, Taiwan, and Hong Kong with trunks full of everything from Spandex tights to VCRs, all for sale in the big-city open markets. Aeroflot's return flights from South Korea's Kimpo Airport carry Poles who exceed baggage limits by up to 400%. East Europe's new traders can be seen throughout Asia--in Hong Kong they're called dao ye, a derogatory term meaning "barter man." There, they snap up silk ties, toys, cosmetics, and electronic goods by the thousands, bringing home bulging bags of stock.

One shadow marketeer in Warsaw, who says he routinely bribes his way past customs officials, made a quick $1,400 last summer--half a year's income--by selling 200 pairs of Taiwan-made flip-up sunglasses to fashionable boutiques. The shop owners made out well, too. They bought dozens but filled out receipts for only three pairs each, keeping down their tax bill.

In Czechoslovakia, construction tycoon Miroslav Svarc escapes a huge tax bite for wages and benefits working through a convenient loophole: His 500 workers declare themselves self-employed. As a result of this scheme, he can pay them double or triple the average wage. "Before, they would do nothing all day," declares Svarc. "Now, they really work during working hours."A former carpenter who once toiled 12 hours a day to earn $416 a month, Svarc, 42, now runs more than a dozen businesses with sales of $9 million. He is eager to bid on a state-owned department store in downtown Prague. Svarc recently opened the country's first 24-hour food market. Already grossing nearly $ 1 million, it could be the first in a chain he hopes to launch.

In a jammed barracks located in a grim, working-class district of Budapest, Laszlo Kovacs struggles 14 hours a day to keep his new telecom company afloat. "You just can't make enough profit to cover a 30% interest rate," grumbles Kovacs, a gruff chain-smoker, one of six owners who bought the electronics-components and satellite-dish business from their former employer, an agricultural cooperative. Dunamenti Hiradastechnika (that is, Along-the-Danube Telecommunications) also has been slammed by the mounting lineup of companies unable to pay their bills as key customers go belly-up. Taxes take a 40% chunk out of earnings, and Kovacs must fork over 43% of his payroll to a social security fund, roughly five times the amount paid by state-owned enterprises.

Yet because of new--if still-tenuous--ties with the West, Kovacs expects a modest profit for 1991. His company earns 25% of its revenues from a contract to supply components to Hungary's famed lightbulb maker Tungsram, now owned by General Electric Co. And he's putting the company on steadier ground through a joint venture giving German electronics concern Electroreith a 47% stake. The Germans will lower their costs by farming out production of components to Hungary. In return, Dunamenti gets Electroreith's technical expertise and help training his workers.

OVER THE HUMP. That's the kind of knowhow East Europe desperately needs. "The question is how to get them over the management-expertise hump," says Jacek Rostowski, a British economist advising Warsaw. A few lucky entrepreneurs have snared Western partners and receive daily management tutorials. But most startups are forced to patch together bits and pieces of capitalist skills as best they can. Poland's Finance Ministry is borrowing the idea of a "business incubator" in Gdansk, modeled on technology parks in the West. And now, there's a U. S. business school in Prague that imports experts from the University of Chicago, Carnegie Mellon, and elsewhere in the U. S. By the end of the year, 70 MBAs are expected to graduate.

Who would have thought there was any promise in the polluted lands of Eastern Europe? And who would have believed that Czechoslovakia, Hungary, and Poland could look better than East Germany, once the jewel of the Soviet empire? Eastern Germany has lost its glitter. The grand scheme for currency union threw one-third of the work force onto the street, and discontent is rising. Then, in early April, the head of Germany's privatization agency was assassinated. Suddenly, Eastern Europe, where costs are lower, is looking better and better.

For Czechs, Hungarians, and Poles, being the poor cousins of Europe for a decade or more will be hard to swallow. But a political and economic standoff like the one unfolding in the Soviet Union, is unthinkable. Besides, East Europe's masters of improvisation are already sending a jolt of energy through exhausted economies. Says Malgorzata Zuch, a Polish entrepreneur who has a small business importing foreign newspapers: "I have courage. Every day is exciting." With that kind of spirit, East Europe may just beat all the odds.Gail E. Schares in Prague, with Ken Olsen in Budapest, Lynne Reaves in Warsaw, and Elizabeth Weiner in New York

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