Czech Reforms: Klaus May Keep Wearing The Velvet Gloves

On billboards plastering the Czech countryside in anticipation of parliamentary elections on May 31 and June 1, the stern image of Prime Minister Vaclav Klaus is nowhere to be seen. That's because his brusque style doesn't endear him to voters. Instead, his Civic Democratic Party trumpets his success in managing the economy. "The Czech krona--on the way to a world currency," says one of many such billboards, which seem somewhat bizarre.

Voters may not like Klaus, but they appreciate his policies and are poised to give him a second four-year term. Polls put Klaus's center-right ruling coalition well ahead of the weak opposition, headed by the Social Democrats. If Klaus prevails, the Czech Republic will have defied the trend in other Central European countries of ousting governments that did the heavy lifting in dismantling the old socialist systems. A backlash against the sacrifices of market economics has helped put former communists in power in both Poland and Hungary--and could do the same soon in Russia.

What is Klaus's secret? Despite his staunch free-market rhetoric, he both delivers the economic goods and cushions the blows. Growth is a strong 5% in the Czech Republic--much better than the norm in Western Europe--and roughly two-thirds of the economy has been privatized.

PRESERVING THE SAFETY NET. But Klaus's reforms haven't created the hardship seen in parts of Poland and Hungary. That's because Klaus, though he hates to admit it, has left key elements of the social safety net intact. Rent controls ensure affordable housing. Artificially low energy prices help keep inflation in check. Health-care reform has been delayed. And unemployment is barely 4%, partly because his vaunted scheme of privatizing via vouchers for citizens did not push companies hard to restructure. He also set up an excellent system for finding displaced employees new jobs. None of this involves out-of-control spending. Klaus's welfare state is trim enough to keep the budget deficit below 3% of economic output.

But there is a risk to the Prime Minister's strategy. Companies have yet to be forced to become competitive, because their shares are being managed by relatively passive investment funds, often owned by banks. These, in turn, are still state-owned--which means they haven't pushed their charges to shape up.

A NEW BREED OF INVESTOR. Klaus's plan is to complete the industrial remake during his second term. With the Prime Minister's blessing, a new breed of more dynamic investors is now coming to the Czech Republic. They see profit in applying finance and marketing skills to former state factories. The leader of this group is U.S. financier Mike Dingman, who rocked Prague when he revealed that he had gained control of several Czech companies last fall. Dingman is aggressively reshaping and modernizing his properties, and he is laying workers off. But the thinking is that the economy is much better prepared to absorb workers than it would have been three or four years ago.

It is hard to argue with Klaus's approach. The Czech Republic has one of Europe's soundest economies. If there is a worry, it is that Klaus's go-slow strategy may have cost the Czech Republic in terms of building management talent. Poland, which underwent shock therapy, now has a vibrant new class of entrepreneurs. But it also suffered high unemployment, and such aggressive reformers as former Finance Minister Leszek Balcerowicz were rewarded for their efforts by being thrown out of office. Klaus, by contrast, is on the verge of getting four more years to finish his work.

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