III. Main Features of the Economic Reform
In the traditional Soviet-type command economy prices play only a secondary role. They neither equilibrate supply and demand nor serve as parameters for optimal allocation of scarce resources. This was true about the Czechoslovak price system in the 1950s and the first half of the 1960s. Almost all prices were centrally fixed and kept constant for long periods. The necessary price changes were implemented simultaneously in the whole economy at discrete time intervals. The adjustments of some retail prices and some agricultural procurement prices were usually made every year, but wholesale prices were changed only once in, five years by a very extensive and laborious general revision of wholesale prices. The central authorities had - for ideological as well as political reasons - a very strong aversion to the upward movement of prices, so that only downward adjustments were usually allowed.
Two other features, namely uniformity and separation of prices, were also characteristic of the Czechoslovak price system. Uniformity meant that each particular commodity had only one centrally determined price which was valid in the entire country. The separation of prices meant that different prices were set independently of each other and that a change in one price had no influence on other prices. The typical example is the separation of retail and wholesale prices by the cushion of a highly differentiated turnover tax. As a result of these methods and principles of price-setting, the Czechoslovak price system became very distorted. Most prices were very far from the point at which supply equals demand, and although it is difficult to prove empirically, prices very likely deviated substantially from opportunity-costs. Consequently, serious tensions appeared in the Czechoslovak economy, resources were misallocated, structural disequilibria, characterized by excess supply of some goods and excess demand for others, became chronic, and administratively suppressed inflationary pressure began to mount.
The economic reform of 1958 left the price system untouched. Later, in the early 1960s, the growing general and structural disequilibria forced the government to at least partially abandon the rigid price policy. Prices still remained centrally fixed, but from 1963 on they were adjusted more frequently and in both directions. The explicit goal of this flexible price policy was to restore equilibrium between supply and demand, at least for some commodities.
The concept of market socialism required much more radical changes than merely a flexible price policy. It was clearly shown in theoretical discussions that the market mechanism cannot operate if most prices are centrally fixed, and free market pricing for the majority of products was postulated as an absolute necessity. Nevertheless, reformers did not want to leave prices totally uncontrolled, and they began to look for more subtle methods which would permit the government to keep the movement of prices under control without impairing the function of the market mechanism itself. It was agreed that administrative fixing of prices or price ceilings should be maintained only in special cases as a selective instrument, but not as a general principle.
The transition to free market pricing turned to be one of the most difficult aspects of reform. At first glance the solution might appear quite simple: merely let enterprises set their own prices. Such a solution, however, would have involved a risk of steep inflation, for the following reasons: (i) general disequilibrium, excess demand and sellers' market were inherited from the command economy; (ii) newly attained freedom could have been misused by enterprises for the rapid increase of wages and investment spending; (iii) the introduction of a capital charge and uniform taxation demanded a sudden increase of the level of wholesale prices as the profit margin built into old prices was not sufficient- and (iv) the relative prices were distorted by the long existent arbitrary price policy and therefore were very far from equilibrium prices.
Under such conditions the sudden abolition of central control over prices would very likely have caused rapid fluctuation of prices resulting in large shifts in demand. Most wholesale prices would have immediately jumped upwards to allow for newly introduced levies. Once prices began to rise, expectation of continued increases would lead workers to demand higher wages, and enterprises would in turn react to keep pace with rising costs.
There was a general consensus that the risk of inflation might be minimized by dividing the process into two stages. In the first stage the wholesale prices were adjusted, leaving retail price unchanged in order to prevent immediate shifts in consumer demand and requests for wage increases. It was not expected that the prices resulting from this stage of the process would be equilibrium or optimal prices. Rather, they were intended to be an initial rough approximation of equilibrium prices. The second stage involved the gradual transformation of centrally fixed prices into free market prices. Market forces would adjust prices to equilibrium, but it was hoped that these adjustments would not continue to entail very large price movements. As a preliminary step, the division of all prices into three categories was introduced, starting in January 1966. The three categories were: (i) centrally fixed prices which covered only about 15 per cent of the sales of producer goods but more than three-quarters of the sales of consumer goods; (ii) completely free prices which covered about 5 per cent of producer goods and more than 20 per cent of consumer goods; and (iii) limited prices which covered 80 per cent of producer goods but none of the consumer goods. This was not a great achievement, because due to the prevailing excess demand for producer goods virtually all prices in the category of limited prices remained stuck at their upper limits. The limited prices were therefore practically indistinguishable from centrally fixed prices.
The most important achievement of 1966 was probably what was to have been the 'last general revision of wholesale prices'. The price revision consisted of two parts. In the first part price indices for 25,144 groups of products were computed by electronic computer 35 and applied to existing prices. In the second part the individual prices 'm each group were adjusted according to actual costs, taking into account supply and demand.
Newly computed prices were applied in January 1967. In spite o the utilization of very modem techniques, the results were not as good as expected. 36 The central organs wanted the average enterprises to be without any net profit, so the applied formula for prices was: price equals average costs plus tax deductions. The outcome of the price revision did not fulfill this expectation. In fact, the new prices redistributed several billions of crowns into the net profits of enterprises. It has never been fully explained how such a gross discrepancy could appear. The most probable reasons were incorrect estimates of costs, wrong reevaluation of prices of imported goods, and falsification of input data by enterprises. This situation once more revived the fear of steep inflation, and so the second stage - the freeing of prices - was postponed. During the second half of 1967 a partial adjustment of prices was prepared using the same computerized method, and taxes and subsidies were also adjusted. This corrected most of the irregularities in the distribution of profits, so that the category of free prices could be moderately enlarged in the following year.
Even more important changes transpired in the character of 'limited prices'. Starting in 1968, the central authorities began to outline limits for the aggregate price indices rather than for prices of individual commodities. The bargaining between the Central Price Office and enterprise was initiated with the aim of arriving at written agreements in which the enterprises would commit themselves to keep the average level of their prices within given limits. When such an agreement was signed, the enterprise became free to change prices of individual products according to the market situation. A complex system of accounting allowing for the control of the level of prices in each enterprise was enforced.
The shares of price categories were expected to be changed in 1969 as follows: for producer goods the share of completely free prices was to reach 45 per cent of sales, proportionally reducing the share of limited prices while keeping fixed prices unchanged. For consumer goods, free prices were expected to cover 39 per cent of sales, limited prices 16 per cent, and fixed prices 45 per cent.
In the middle of 1969 the process was also reversed in the field of price policy. Prices were frozen and they have remained frozen from that time. This is not surprising, since political uncertainty and economic instability following the Soviet invasion disturbed the market equilibrium and caused inflation. The demand for consumer goods expanded rapidly because people lost their confidence in the stability of the currency and preferred to invest their savings in more reliable forms of durable consumer goods, such as textiles.
It is not clear how many prices were already free before they were frozen on 2 July 1969. According to some reports it was about 30 per cent of the sales of consumer goods. The freeze was also not total; 5-10 per cent still remained in the category of free prices and approximately 50 per cent of the prices were said to be in the category of limited prices. For all practical purposes the limited prices were no very different from fixed prices, because "prices of all products in the category of limited prices were set as maximum prices at the level of prices existing on 1 January 1970." 37
Although the general prohibition against raising prices was extended through the years 1970 and 1971, it was apparently still expected that the price freeze would eventually be replaced by at least a partly decentralized and more flexible price system. The Central Committee, however, demanded development of very strong instruments of central price control which would effectively guarantee the long-term stability or even the decline of the price level. The following quotation from the article of two workers of the Federal Price Committee is very typical of the situation in 1971:
"The abolition of the prohibition against price raises must not provide room for price increases. This is required so that a rational system o central price control may be established, which would be based on central approval of changes of price levels, by the centrally established rules for calculation of prices, and on decisions about competence in price administration." 38
Almost all the uncertainties and ambiguities were removed in 1972. The role of prices was finally downgraded to be a supplementary instrument of plan implementation. A system of annual and five yea plans of price changes was developed, which was made obligatory for central organs as well as for enterprises so as to eliminate spontaneous price movements. The annual plans contain only a minimal amount of necessary price changes, because "the purpose is to guarantee that price adjustments are not repeated at short intervals of time, and that the level of prices is maintained for certain periods ... More important price adjustments will be concentrated at the end of the fifth or at the beginning of the sixth Five-Year Plan.."39