How to Privatize Successfully - Part I

Changing the economic system is not an easy task. And, of course, it is more complex when carried out half-heartedly. As privatisation is only a part of this process, it may not succeed if done in an isolated manner. It needs certain other changes and a competitive environment to bear fruit.

A case in point is Czechoslovakia. It provides us with a very good learning experience to see how after the fall of a collectivist state the gigantic task of changing the economic system was handled.

Presently, Dr Vaclav Klaus is President of the Czech Republic. He was Prime Minister from 1992 to 1997. Dr Klaus was one of the key members of a movement, Velvet Revolution, which overthrew communism in Czechoslovakia and one of the founders of the Czechoslovak Civic Forum Movement, the leading political organisation following the Velvet Revolution in 1989.

He was the first non-Communist Finance Minister of Czechoslovakia. He is a highly awarded economist and politician, with many publications and awards, including the Schumpeter Prize for Economy. He is of the opinion that it is much more difficult to change the economic system. The starting point of this change in Czechoslovakia was liberalisation and de-regulation of markets.

This move consisted of three main liberalisation's:

i) price liberalisation, ii) trade liberalisation, and iii) business liberalisation. As to the price liberalisation, he says for others it is difficult to imagine but for 40 years people in Czechoslovakia had totally frozen and administered prices. So liberalising prices was a dramatic shock.

Making a comparison, he says Australians spent years or decades discussing liberalising the price of milk in Australia! But in Czechoslovakia they didn't have just one case of milk! They had hundreds, thousands of prices with possibly the same impact upon individuals in different groups of society.

The second move, trade liberalisation, was also a dramatic one. It meant opening the country after 40 years of semi-autocratic and protected economy. And, the third one was liberalisation of entry into the market for all types of enterprises, both private and foreign.

He says these three liberalisation's represented the first stage of transition, and not only changed the whole society but enormously increased the supply of goods and services also. It effected an equilibrium in the market overnight. It interrupted some of the old, deeply built-in behaviour of citizens; it attacked and endangered various old habits they inherited from the communist past.

He readily admits that realising such changes was socially difficult, politically relatively brave but technically easy because most of the measures required just had to be announced. Again citing the case of milk price, he says that to deregulate or liberalise the price of milk Australians, or for that matter anyone, don't need sophisticated theories.

Don't need the involvement of university professors or experts on micro- or macro- economics. It is sufficient to meet at eight o'clock in the evening and to announce on TV that tomorrow morning at 8am the price of milk is free to move. That is what they did in Czechoslovakia.

However, he says, the second stage of transition was not an easy one. It required more positive and constructive activity from the government. Because, it was necessary not only to introduce such passive transformation measures, but also to implement some active measures. It was necessary to build, establish new, and/or transform old institutions and organisations.

And, of course, he rightly admits, the crucial point in this respect was privatisation. But, it was really impossible to wait for the slow emergence of hundreds and thousands of private enterprises - built starting from nothing - and for the slow disappearance of state-owned enterprises which eleven years ago in former Czechoslovakia represented almost 100% of the whole economy. He emphatically says: So we had to privatise. It's an accepted exercise.

Here it is quite relevant to repeat a story that he tells: in one of the conferences of Mont Pelerin Society, he met one Polish guy who was the second member of the Society following him from the post-communist world.

He wrote a very interesting study suggesting that privatisation was a mistake. He is unique, he is alone in this. But do you know why? His disbelief in the capabilities of the government is so absolute that he even wouldn't let the government privatise - that's really rather revolutionary. But he is alone in this respect.

Dr Klaus's narrative of their privatisation is but immeasurably instructive. He says: We had to privatise, we decided, and it was necessary to privatise the state-owned firms on a massive scale, on a wholesale basis, not just individual firms.

This is something I always have to repeat and to stress because everyone compares privatisation in post-communist countries with privatisation in France, Sweden, the Netherlands. I am not an expert on it, but I always say that the brave Margaret Thatcher privatised three or four firms a year, whereas we had to privatise three or four firms per hour! Because otherwise it would have taken a century to do that job. For that reason, we had to use some non-standard methods of privatisation; we had to do experiments and different exercises.

So privatisation in Czechoslovakia was extremely difficult both politically and technically. Rather he says: I'm sure that in any country as well, whatever the government does, the politicians are accused either of favouritism - of selecting inappropriate owners - or of not getting the best or highest possible price.

In any individual case, in any Western country, this is the case. When I look in Europe at privatising Air France or privatising one firm in Belgium or one in Sweden or the Netherlands, or elsewhere, it is the same story.

So we [the government] were definitely the perfect option for such criticism because in thousands of cases, some were successful and some were not successful. Some of the future owners succeeded fully, some did not. Some immediately tried to get rid of the assets in a rather cheap way and so on.

But, if privatisation needs to be done, it has to be done because it is the decisive step in transforming the economic system. So, in Czechoslovakia too, Dr Klaus says, privatisation was done and it was the decisive step. It was like crossing the Rubicon. The political costs were unavoidable but it had to be done and to be done as quickly as possible.

Relating other aspects of privatisation, he says: The problem is that the people in my country and elsewhere probably assumed, that because of the undisputed efficiency of the private market economy as compared to the command economy or centrally planned economy, that every firm and economic activity had to succeed.

You know very well that it's not true even in a major, stable, developed economy. And of course it is much less true in an economy in transition with a dramatically changing economic environment, in competition with much stronger partners from the rest of the world, and without sufficient experience.

As is said, "There are no free lunches," Dr Vaclav Klaus reminds that there are no 'free' economic transitions. The 'economic transition' is a very costly process. It's an investment and usually, just like any investment has costs and benefits and the business people know that usually when you make an investment, you pay the costs first and you may get the benefits with a considerable delay. The transition from communism to a free society was an investment in some respects, and the costs were really enormous.

Also, he makes a mention of the size of the costs his country had to go through. And, according to his estimates, in his country they were lower than in other countries. In the first three years of transition they lost one third of their industrial output - one third.

As he says if we take all of the business people, two would succeed and one would collapse. They lost one quarter of their agriculture output - one quarter - and they lost one fifth of their GDP -and it was lower than in most of the countries in transition.

So in Czechoslovakia too, transition and privatisation were connected with many business failures and the one who was blamed was the government, of course, not the individuals owning and managing those firms. He tells that it became fashionable to argue that the failures were caused by unsuccessful privatisation and an insufficient legislative and institutional framework.

And, he admits, there is no doubt that both privatisation and the formation of new legislation of market accompanying institutions was as imperfect as any human activity. But the main problem, in his opinion, was that the citizens were not prepared to accept or to live with the phenomenon of a business failure, both at micro and macro level.

As to foreign help in the process of transition, he tells that sometime back he was asked to give a speech together with German economists to compare the transition and transformation of Germany in the 1950s and the Czech Republic in the 1990s.

He says it was a very interesting exercise; one of the differences was really the fact that there was huge foreign help to Germany. We didn't get it, we have really got nothing in the last ten years, and we didn't ask for it. The role of the rest of the world in this respect was really zero.

Note: This article was completed in July 2007.