TransitionRecession  

Causes of the Czech Republic's Decline in GDP since 1989: Two Opposing Views

by Colleen E. Feehan

During the first year after the collapse of Communism and the radical economic reform in Czechoslovakia (1991), the GDP and its major components declined considerably, while inflation and unemployment increased. There exist differing views on the causes of this decline. In contrasting the view of Ivan Sujan and Milota Sujanova to that of Milos Pick as presented at the Vienna Institute for Comparative economic studies (WIIW), an evaluation of these theories can be made.

After the collapse of the Soviet-type economic system, the Czechoslovak government implemented the following reform packet:

  • "(a) The liberalization of a wide range of domestic prices, including those of all tradable goods and non-tradable goods produced under reasonably competitive conditions;

  • (b) The introduction of the koruna's "internal" convertibility and the establishment of a unified exchange rate responsive to supply and demand;

  • (c) The installation of an adequately financed social safety net to meet the needs of persons becoming unemployed or suffering losses in income as a result of the adjustment process;

  • (d) The progressive restructuring and privatization of state-owned enterprises;

  • (e) The implementation of restrictive macroeconomic policy in order to achieve economic stabilization through fiscal and monetary restraints and appropriate exchange rate, price and wage policies (Sujan and Sujanova 41)."

Because the fiscal and monetary policies pursued during the first half of 1991 were overly-restrictive, changes in macroeconomic policy for the second half of 1991 were undertaken. Despite these changes, statistics show that the economy was relatively successful during the first phase of transition and would probably complete it. The changes in macroeconomic policy lowered inflationary pressures that resulted from the quick liberalization of 85% of prices on January 1, 1991. As a result, the private sector developed rapidly in response to removal of administrative restrictions, price liberalization and bank credit provisions. In turn, exports recovered after an initial period of major decline. However, the economy experienced a severe recession. In order to spare the population of such a painful transition, the government shifted the emphasis from restrictive monetary and fiscal policy (stabilization) to restructuring and growth in 1992 (Sujan and Sujanova 41-42).

Sujan and Sujanova mainly attribute the recession to "external shocks associated with the disintegration of the CMEA." External shocks were responsible for about 5.8 percentage points of the total 15.1% decline in real GDP from 1990-91. The impact of these external shocks (of which the collapse of the CMEA played a predominant role) was also reflected in the decline in consumption and investment and the increase in unemployment. They partially contributed to inflation and created strong pressure to a current account deficit by lowering export volumes and increasing import prices (Sujan and Sujanova 42-43).

The massive liberalization of prices was the main source of inflation in 1991. Other effects were reflected in reduced real demand for consumer goods and investments, which caused the GDP to contract by 5.1 points after having a corresponding effect on the rise of unemployment. Also, the massive devaluation of the CSK contributed to more than one quarter of total inflation (Sujan and Sujanova 43).

Sujan and Sujanova also attribute the recession to restrictive government policies. "One of the major problems was the fact that the state enterprises avoided the impact of restrictive policies by increasingly relying on the inter-enterprise debt (credit)" Despite the macroeconomic restriction, the debt rose fast accompanied by only a limited restructuring of enterprises. However, restrictive macroeconomic policy considerably reduced domestic demand (primarily for fixed investment). This resulted in an additional decline in GNP of 6.6 percentage points and had a corresponding effect on rising unemployment (Sujan and Sujanova 43).

In addition to the collapse of the CMEA, the break-up of the CSFR had grand effects on the GDP in the Czech Republic. "The recovery of economic growth which started during the second half of 1992 was interrupted by the split of the CSFR and postponed to 1994 (Sujan and Sujanova 47)" A decline in trade followed the break-up having a negative effect on the aggregate demand and the GDP. Since the Slovak GDP was smaller than that of the Czech Republic, the negative effect was greater in Slovakia. The GDP has declined annually by 2.2% in the first quarter and by 0.9% in the first three quarters of 1993. The split of the CSFR accounts for one of the greatest factors of the decline in GDP (Sujan and Sujanova 44-45).

In comparison, the Czech Republic had the best starting point at the beginning of the second stage of transition, with the highest level of per capita GDP and savings of the four countries with the best economic conditions in Eastern Europe.

Statistical data on GDP components reveal that the moderate decline in the first half of 1993 did not arise from a lack of demand. Aggregate demand increased by 4.6%. All components of domestic and foreign demand increased sans exports to Slovakia. The increase in aggregate demand was fully satisfied by increased imports leaving no room for GDP growth. The continuing world recession (lowering it by 2.1%) and a restrictive budget policy (creating an unnecessary surplus) were among the negative effects on GDP (Sujan and Sujanova 47).

Critics of Sujan and Sujanova's theory have claimed that such a massive devaluation and such restrictive macroeconomic policy at the beginning of reform were not necessary. It is evident however that the impact of external shocks coupled with the impact of the reform steps was virtually impossible to predict prior to implementation of policy (Sujan and Sujanova 43).

Pick claims that the GDP decline was mainly caused by "macroeconomic stabilization policy-- by a considerable restriction of aggregate demand (in 1991 mainly of domestic demand, and in 1993 mainly of demand for exports to the Slovak Republic) (Pick 34)." A global GDP decline, as well as a real increase in exports and imports, took place in the form of a structural shift to less qualified activities of production. "Within industry, the share of over-dimensioned heavy industry and raw materials production increased further at the expense of the more highly qualified manufacturing industry. The global and structural decline also led to a short-term decrease in productivity and utilization of production capacities." Another result was an increase in unit costs and lower profitability leading to constant pressure on the price level and the exchange rate (Pick 34).

The global and structural decline in GDP is "the price paid for the destructive adaptation to premature and overdosed (almost complete) foreign trade liberalization." This creates barriers to short-term growth and long-term development (as it postpones technological advancement).

The main cause for the destructive consequences of premature foreign trade liberalization and the following "market clearing" is the structural (qualitative) nature of the Czech economy's "technology gap" (Pick 35).

Pick's interpretation of the causes of decline in GDP are flawed. "Together with Komarek-- and some other Czech economists opposing the fast strategy of transition-- he put too much belief in Keynesian economics, basically claiming that insufficient aggregate demand was the main cause of GDP decline during transition. Instead of restrictive monetary and fiscal policy they proposed expansionary policy (Kyn)." The main cause of the decline in GDP was in fact the external shocks of the break-up of the CMEA. Secondary to this was the restrictive macroeconomic policy implemented in the first phase of transition, followed by the break-up of the CSFR. As Sujan and Sujanova claim, statistical data proves that aggregate demand increased, foreign and domestically.

BIBLIOGRAPHY

  • Kyn, Oldrich. Comments on HAS#3-Outline.

  • Pick, Milos. "Transition to growth and structural adaptation." Czech Economists on Transformation: May 1994.

  • Sujan, Ivan and Sujanova, Milota. "The macroeconomic situation in the Czech Republic." Czech Economists on Transformation: May 1994.

 

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