Czechoslovakia: Reluctant Reform

As one of Eastern Europe's staunchest free-market reformers, Vaclav Klaus, the Czechoslovak Finance Minister, battled throughout 1990 to put Czechoslovakia on a fast track to a market economy. It was a major coup when, at the end of the year, the 49-year-old economist won the reluctant backing of the government and parliament. Most Czech politicians harbor a lingering mistrust of capitalism and would have preferred a softer transition. "Klaus spent weeks running President Vaclav Havel through Economics 101," says a top aide in the Finance Ministry.

Now that his reform blueprint is law, the hard work begins. Unlike in Hungary and Poland, Czech Communists nationalized 100% of their economy, so rebuilding private markets will be a monster job. What's more, nationalist tensions in Slovakia now threaten to split the country of 16 million. The rebellious eastern republic is home to much of the country's ailing armaments industry, and, fearing massive unemployment, Slovaks want the transition to a market economy to slow down. Still, Klaus is determined to push even the most painful reforms with or without Slovakia. That will likely mean a showdown between the two republics this year. "We have no alternative," snaps Klaus. "Any deceleration of reform will hurt us more. We can't afford to lose this game."

Betting that the country is willing to suffer in the short term to join the European mainstream quickly, Klaus is forging ahead. Czechoslovakia had the most highly developed industry and work force in the East bloc, along with East Germany. Now, Klaus wants to salvage what he can. His No. 1 goal is to keep prices and wages under control.

FEW INVESTORS. At the same time he wants to speed privatization. Auctions for small shops and service companies began in January, and so far, 800 shops have been sold. Klaus wants to sell one-third of a total of 110,000 by yearend. Larger companies such as tractor makers and porcelain works will go on the block this summer. To light a fire under managers who are resisting privatization, Klaus is ordering them to come up with their own sell-off plansor risk being sacked. Their choices: auctions, a voucher scheme that would transfer ownership to individuals at a discount, or direct foreign investment.

Western investors in Prague are few so far. But with new laws designed to attract foreign capital that allow 100% repatriation of profits and two-year tax holidays, dealmaking may pick up. And although its technology is outdated, the nation's skilled workers and low labor costs are a big attraction. German companies are scouring Bohemia and Boravia for deals. The Czech industrial landscape and craftsmanship are similar to their own, and wages are only a fraction of those in eastern Germany.

Volkswagen Chief Executive Carl H. Hahn sees enough going on in the old Skoda works, the Czech auto maker, to justify putting in $6 billion over 10 years. The deal, cinched on Mar. 28, is worth nearly 10% of the entire Czech gross national product. The plan: to make Skoda one of VW's low-cost production centers for Europe. Says Brussels-based Daniel Arbess, of lawyers White & Case: "Completing the Skoda deal is really going to open the doors in Czechoslovakia." Meanwhile, Japanese-controlled Belgian company Glaverbel bought a 40% stake in glassmaker Sklo Union for $48 million, with an option to raise the stake to 67%. Other foreigners could follow suit.

A rush of Western investment is doubly important for Czechoslovakia, which is reeling from the collapse of trade with the Soviet Union. While Hungary and Pmland upped trade with the West sharply last year, the Czechs only managed a 4.5% boost. Still, Czech exports could benefit from a trade agreement with the Russian Republic signed in late March, the first such accord with an individual Soviet republic.

A SCAPEGOAT? For the moment, Klaus's popularity has surged along with support for rapid reforms. But as the real effects of his hard-nosed program begin to ripple through the economy, opinion could switch. Output could slide by as much as 10% this year, while inflation soars to 30%, and unemployment hits 7%. Finance Minister Klaus "will become a scapegoat," says Rudolf Baranek, president of the National Association of Entrepreneurs.

A weary but determined-looking Klaus refuses to consider a change of strategy. He may be right. Signs of change are seen everywhere in Prague. Near Charles University, the capital is lively with street vendors, strollers, and foreign visitors. Now Klaus has to persuade people who live under smokestacks in Slovakia that the market economy will benefit them, as well.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE