Along with a large number of other traditionally socialist nations in Central Europe, the Czech Republic, over the past three decades, has exerted a great deal of effort to make the transition from a socialist economic system to a market-based economic system. The Czechoslovak Republic had a reputation for being among the most communist countries in the world before the Velvet Revolution in 1989[1]. On January 1, 1993, Czechoslovakia was officially divided into two republics, Slovakia and the Czech Republic.[2]. Since then, the Czech Republic has made significant strides toward a more stable democracy, and as a result, it has reaped the benefits of democratic elections in recent decades. Despite a transition recession, rising inflation, and widening income gaps in the early 1990s, when the Czech Republic first began its economic transition, this paper concludes that the country’s subsequent wave of policy changes was critical to the current economy’s successful transition.
The circumstances associated with the change in the economic system and the division of Czechoslovakia certainly had to be acknowledged during the initial period of the economy’s transition. Czech, one of the countries that had been a part of the European communist bloc before its fall in November 1989, started the process of economic transitioning after the fall of the Berlin Wall.[3]. Because of this, the countries possessed cultural values and features and a sociocultural and economic foundation, which had been molded by around four decades of communism.[4]. The Czech Republic had a significant benefit over other communist bloc nations in Europe because it had only been subject to socialism for over 40 years as opposed to their roughly seven decades of experience, which came to a close Soviet Union’s collapse. This gave the Czech Republic a distinct competitive advantage. The shorter period had the effect of reducing the substantial obstacles that would arise during the process of developing an economy based on market principles.
When Czechoslovak was split into two republics in 1993, Czech had more solid economic roots than Slovakia did at that time. The Czech Republic, particularly its capital city of Prague, had a thriving tourism economy, which contributed to the relatively low unemployment rate in that country.[5]. The Czech Republic has inherited several businesses that are generally medium-sized, in addition to having a substantial tourism economy[6]. These sectors were quite successful in their commercial dealings with the EU’s surrounding markets[7]. For the Czech Republic to successfully implement its trade liberalization program and fully recover from the economic downturn it experienced in the early 1990s, it was vital for the country to have a healthy tourism industry as well as a medium-sized economy. The Czech Republic’s GDP per capita in 1990 was $3,594.71, while inflation averaged roughly 7% annually.[8] The real GDP growth rate in the country dropped from 4.5% to around -11.60% in 1991, which indicated a more moderately severe recession in 1991 than in 1989. In 1989, the real GDP growth rate in the country was approximately 4.5%. In 1993, the country’s unemployment rate was 3.8%, which was a relatively low percentage.[9].
The economic transition process in the Czech Republic was focused on establishing new economic reforms after the fall of communism in 1989. At the start of 1990, the process of economic transition was initialized by formulating policies for economic reforms. These economic reform policies include Microeconomic stabilization, privatization, trade and price liberalization, budget constraints on enterprises and banks, the tax system and reforms on public sector institutions, and the country’s legal system.
Privatization, which happened right after Czech started its economic transition, is the change of ownership of institutions and enterprises previously owned by the government to be owned by private individuals and the public. Privatization in the Czech Republic commenced immediately after the end of communism and the start of the economic transition in the year 1990. Privatization was done in steps that were initiated by mass privatization. After the formation of Slovakia and the Czech Republic, both countries inherited voucher privatization schemes of firms owned by the state initially located in Czechoslovakia. The Czech Republic employed a voucher privatization scheme during the transition process. The voucher privatization scheme enabled the massive transfer of state-owned properties into private ownership. However, this approach was counter-productive to the economy’s growth since most new owners and shareholders were economically small and lacked the capital to upgrade the technology. Because of this, these companies were sold to major investment firms, which ultimately wound up controlling more than 70 per cent of the vouchers after the sale.[10]. State-owned banks controlled many of these investment funds with poor management skills.
Privatization in the Czech Republic was one of the strategies of the transition process. At the start of 1990, state-owned enterprises and institutions made up 2% of the country’s GDP. However, privatization was attributed to 70% of GDP in 1995 and 80% at the end of 1990[11]. This resulted from extensive and massive privatization due to implementation privatization policies in the transition process. However, privatization was ineffective in introducing important changes to the business sector. The changes that privatization aimed to facilitate were corporate governance and management behaviours of large and significant business sectors. Weakness in corporate governance resulted in an increase in wages above productivity levels, thus leading to an increase in production costs.[12]. In addition to flaws in corporate governance, a greater portion of the privatization process was carried out through leverage, which led to the establishment of businesses that lacked capital but carried enormous debt loads. Changing the business sector to be dominated by private owners required the imposition of budget constraints which would have ensured the capital sustainability of the firms. However, this was not the case since most of the funding banks were owned by the state and thus failed to impose budget constraints due to their ineffective operations and poor corporate governance and management behaviours.
Along with privatization, Czech took over the communist Czechoslovakia’s overall macroeconomic stability, which helped the country make a smooth transition. Formulation and execution of reform measures are required to achieve monetary and fiscal policy stability during the transition process. These measures are then reviewed to establish whether or not macroeconomic stability has been achieved. The cautious fiscal and monetary policies of former communist Czechoslovakia were passed down to this nation, contributing to its current macroeconomic stability.[13]. These restrictive fiscal and monetary policies contributed to microeconomic stability until the start of 1990. The success of these fiscal and monetary policies was evidenced by the introduction of price liberalization, which resulted in a rapid fall in inflation from the rate it was after the increase as a result of price liberalization.
The Czech Republic continued with the fiscal and monetary policy of prudence during the transition process. This fiscal policy was tight and restrictive. As a consequence of this, the national budget was quite close to being balanced from the time the transitional era started until the year 1998. However, by the end of 1998, the budget deficit had reached more than 2% of the country’s GDP. The parliament approved a budget with a 2% fiscal deficit in 1999, which resulted in less restrictiveness of the fiscal policy of prudence. This means that the government incurred a deficit of 3, which was 2% of GDP. Like other countries during the transition process, the Czech Republic was impacted by a financial crisis, which affected the Asian region.[14]. Due to its resilience, it could withstand the storm of the financial crisis without causing any long-term damage to the financial markets.
On the other hand, as shown in figure 1, there were immediate repercussions, which led to an increase in inflation from 8% in 1997 to 11% in 1998. There was also a drop in GDP by 1% in 1997-1998. To battle the economic slump and rising inflation between 1997 and 1998, the government adopted a new monetary policy in 1998. The new monetary policy had a rise in the overall rate of inflation as its primary objective. The Consumer Price Index (CPI) increase that is not affected by indirect taxes or the consequences of regulated process changes is referred to as “net inflation.” In 1998, a range of 5.5–6.5 per cent was chosen as the goal range for the monetary policy regarding net inflation. However, this monetary policy’s effectiveness was hindered by a drop in demand and prices of commodities such as food and oil. For this reason, at the end of 1998, net inflation had dropped by 1.7%, below the set target. After 1998, the overall inflation dropped to 2.5% in 1999, as shown in figure 2.
This country was in the process of joining the European Union (EU) organization, and the requirement for membership of the EU is for a country not to have a fiscal deficit of more than 3% of GDP. For this reason, the Czech Republic tightened its monetary policy in early 2000 to reduce the fiscal deficit.[15]. In 2002, the country’s fiscal deficit dropped from 6% of GDP to 3%, which enabled the country to attain EU membership.
During the socialist era, the banking system comprised a moon banks system with one central bank and other specialized banks subordinated.[16]. At the start of the transition period, existing banks experienced challenges of bad debts and relationship constrain with institutions which had the financial crisis.[17]. During this time, the banking system was made up of state-owned banks. Policy reforms during the onset of the transition process resulted in the implementation of new banking legislation, which allowed the formation of privately owned banks and foreign banks.
Rapid formation of private and foreign-owned banks contributed to easy access to their prime access to funds which led to their expansions beyond the control of the government[18]. The central bank failed to impose restrictive capital requirements before forming a bank. It adopted a soft regulation which allowed for the formation of banks with a minimal capital requirement characterized by low to absent supervision. This contributed to various effects that impacted the banking system and the capital market. Firstly, there were massive bankruptcies associated with small banks due to failure to pay their loans. Lack of capital restrictions and government supervision resulted in forming small banks with low equity capital. As a result, small banks could not manage to finance their operations and thus leading to their bankruptcies.[19]. Secondly, since the small banks acquired their capital funds from state-owned and large banks, their failure to pay their loans resulted in high rates of bad debts in big banks and those owned by the state. In addition to these effects, the crisis in the banking system negatively impacted economic growth since public funds were used to intervene in the ongoing crisis.
The crisis depicted by the banking system during the transition process was attributed to the failure of the central bank in policy formation, implementation and banking regulation.[20]. Failure of the banking system had a negative influence on the success of the economic transition. This is due to large amounts of public funds used to intervene in the crisis. The consolidation programme enabled the large banks to get CZK 50 billion from privatization proceeds to cover their bad debts. Small banks were also funded through the second consolidation programme.[21]. This banking crisis is attributed to the ineffective use of funds by the bank’s ownership structure.
Following the transition from a communist economy, this country enacted a market economy, which has evolved into an export-focused and liberal market economy.[22]. Since it is a member of the European Union and participates in the European single market, the export-oriented social market economic system is created to include the European social model. This economic framework places a strong emphasis on innovation and manufacturing. The Czech Republic is now a member of several organizations, such as the World Trade Organization (WTO) as well as the Organization for Economic Co-operation and Development (OECD)[23]. Machines, pharmaceuticals, electronics, and medical equipment are among the nation’s exports. The Czech Republic also imports minerals, chemicals, fuels, and mechanical parts. The exports of the nation are worth $258.9 billion, while its imports are worth $326.3 billion[24].
To conclude, when the Czech Republic first started its economic transition in the early 1990s, the country went through a transition recession, which was characterized by growing inflation and widening income gaps, just like the majority of other countries in Central and Eastern Europe at the time of transition. The first wave of reforms that the Czech Republic implemented had several deficiencies; nevertheless, as a result of improvements made during the second wave of reforms, the nation experienced economic development that can still be felt today and has been happening for the past three decades. In spite of difficulties during the transition that occurred in the early 1990s, when the Czech Republic first started its economic transition, the succeeding wave of policy changes that the country implemented was essential to the successful transformation of the current economy. The economy of the country has matured into a market economy, and it is a member of multiple organizations, including the EU.
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[24] Czech Republic | Imports and Exports
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