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Economics: Czech Republic Case Study: Transition


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About this Lesson

  • Type: Video Tutorial
  • Length: 7:13
  • Media: Video/mp4
  • Use: Watch Online & Download
  • Access Period: Unrestricted
  • Download: MP4 (iPod compatible)
  • Size: 77 MB
  • Posted: 03/29/2010

This lesson is part of the following series:

Economics: Full Course (269 lessons, $198.00)
Economics: International Focus (25 lessons, $43.56)
Economics: Transition Economies (4 lessons, $7.92)

Many countries that transition from communism to capitalism are thrown into turmoil. In 1989, Czechoslovakia had a revolution that took them through this transition. This video lesson looks at this experience in the context of an economic case study. Taught by Professor Tomlinson, this video lesson was selected from a broader, comprehensive course, Economics. This course and others are available from Thinkwell, Inc. The full course can be found at The full course covers economic thinking, markets, consumer choice, household behavior, production, costs, perfect competition, market models, resource markets, market failures, market outcomes, macroeconomics, macroeconomic measurements, economic fluctuations, unemployment, inflation, the aggregate expenditures model, banking, spending, saving, investing, aggregate demand and aggregate supply model, monetary policy, fiscal policy, productivity and growth, and international examples.

Steven Tomlinson teaches economics at the Acton School of Business in Austin, Texas. He graduated with highest honors from the University of Oklahoma and earned a Ph.D. in economics at Stanford University. Prof. Tomlinson's academic awards include the prestigious Texas Excellence Teaching Award given by the University of Texas Alumni Association and being named "Outstanding Core Faculty in the MBA Program" several times. He has developed several instructional guides and computerized educational programs for economics.

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Many countries that make the transition from communism to capitalism are thrown into turmoil. But, occasionally a country does it so smoothly and successfully that it's worth notice. Consider the case of the Czech Republic. In 1989 Czechoslovakia had a quiet revolution from communism to a free market. And today the statistics are impressive. The gross domestic product in the Czech Republic grew by 4.5 percent in 1995 and is currently growing at 6.0 percent a year. Industrial production has been rising at a rate of more than 9.0 percent for two years in a row. Per capita income is already equal to that of Portugal, a member of the European community. And, inflation is occurring at a rate of less than 10.0 percent a year. Unemployment is the lowest of all European countries at 3.5 percent. And, the government is currently running a budget surplus and foreign capital is flowing into the country. How did this happen? What made Czechoslovakia's transition smoother than that of other countries?
Let's consider the things that economists would say that the Czech Republic has done correctly. The first thing was maintaining tight control of the money supply during a period where inflation was a huge risk. After Czechoslovakia underwent its quiet revolution, one of the first steps in the transition to a free market was the deregulation of prices. Prices which had been controlled by the government where customers had to go to state run retail stores and wait in long lines to buy low quality goods at fixed prices. That system was dismantled and prices were set by the interaction of supply and demand. Typically, when prices are deregulated in a former communist country there is a period of rapid inflation as built up inflation works its way through the system and prices increase rapidly. But, because Czechoslovakia maintained tight control of its money supply what happened was that there was a period of inflation at a rate of about 47.0 percent in the first six months of 1991. But, then by 1992 the inflation rate was down to 11.0 percent. And, today it is under 10 percent. So, tight control of the money supply helped avoid what is frequently a problem for countries in transition and that is, inflation.
Now, how was the government able to resist printing a lot of money? Well, the second key to success factor was control of the government budget deficit. Rather than continuing to subsidize the formerly state owned enterprises, Czechoslovakia, and then after 1993 the Czech Republic, sought subsidizing, cutoff government funds to these enterprises and therefore was no longer responsible for government revenue to what became the private sector. So, the government was able to reduce its expenses and therefore didn't need to run a deficit. And, because it wasn't running a deficit it didn't need to print money and therefore, inflation was averted.
Well, then what did these enterprises do for capital if the government wasn't funding them? The third factor was the transition to private ownership. The Czech Republic used a voucher system. It gave every household vouchers, which they could then use to bid for shares in enterprises that ere being sold from the government to the private sector. And, this is exactly what happened, people in Czechoslovakia and in the Czech Republic got ownership of formerly state run businesses. About 1,500 formerly state owned businesses were privatized and now owned by the shareholders who are citizens of the Czech Republic. Also, in addition to this, new enterprises were started. By 1993, there were one million unregistered private businesses. Many of these businesses were retail operations selling goods and services that were previously available only in government run stores. So, the privatization of capital proceeded smoothly. The government gave the vouchers, allowed the bidding, and created a system whereby the private citizens owned shares in the businesses.
Now, of course, they had incentives to regulate the businesses themselves, the shareholders to exert pressure on managers to make the businesses profitable. Now, it took time for this transition. And, certainly, unscrupulous managers in the meantime were able to take advantage of their position and take assets out of the business or use them for their own advantage before shareholders really learned how to exert their power. But, this is a matter of education. People in Czechoslovakia for a while had not been used to exerting shareholder power to make businesses run well. And, therefore, they had to learn how to do this.
Well, this brings us to the fourth key to success factor and that is trade liberalization. That is, competition was allowed both within the economy and tariffs and quotas were lowered so the foreign competition put extra stress on domestically owned businesses to increase their performance. Trade liberalization created the market as a coordinator and motivator for people to succeed rather then government coercion. So, those are the key success factors for the Czech Republic's transition from communism to capitalism.
Why was it that Czechoslovakia was able to follow these steps so smoothly, whereas other countries stumbled along the way? Well, consider that underneath the economy there were things going on in that country among those people and with those resources that were unique. First of all, Czechoslovakia had been a capitalist country before its communist takeover after World War II. Therefore, the institutions were in place. People had a history of capitalism in that country. They understood the institutions of democratic capitalism. Even though it had been communist for a generation, it was very quick to learn how to use capitalist institutions and methods again, so, a history of capitalism. Also, it was thoroughly industrialized before the communist revolution. There were factories, there was industrial production, and they already had an industrial revolution.
Whereas, in Russia the Industrial Revolution had not occurred in 1917, when they became a communist country. So, the idea that industrialization could occur without central planning was already well taking root in Czechoslovakia. And, therefore, whenever they liberalized in the 1990s they could go back to their industrial base and their habits of industrial production. They also were heavily influenced by Western Europe because of their proximity to Western European countries, Austria, Germany, they were well-integrated into European economy all ready. And, they have since officially become a member of the European Union. So, their links to Western Europe were already established historically and culturally and now they have been cemented by a legal pact.
So, Czechoslovakia was different from other communist countries. Because of its integration with Europe, because of its history of democratic capitalism, because of its preexisting industrial base its movement to a capitalist free market economy was smoother. But, still, those four factors are going to be necessary for any country that wants to make the transition. Tight money in order to prevent inflation, government budget maintains balance, the liberalization of trade and the privatization of formerly state run enterprises. When a country can pull those off successfully, and it helps if you have had some experience with capitalism, then the transition from communism to the free market can run more smoothly.
International Focus
Transition Economies
Case Study: Successful Transition in the Czech Republic Page [2 of 2]

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