UNDP-WORLD BANK TRADE EXPANSZON PROGRAM COUNTRY REPOFRT 8 25403 December 1992 CZECHOSLOVAKIA Integrating into the Global Economy: A Transition Strategy This country report is a product of the joint UNDP/Would Bank Trade Expansion Program which provides technical and policy advice to countries intending to reform their trade regimes. The views contained herein are tose of the authors and do not necessariy reflect those of the United Nations Development Program or the World Bank. CZECHOSLOVAKIA Integrating into the global economy: a transition strategy Trade Policy Division Country Economics Department World Bank December 1992 Washington, D.C. This report was prepared under the Trade Expansion Program of the United Nations Development Program at the request of the Czechoslovak Ministry of Trade. The study team was led by Oleh Havrylyshyn, (Consultant) and included Andras Inotai and Branko Milanovic (World Bank); Blanka Kalinova (OECD); Vladimir Benacek and Michal Mejstrik (Center for Economic Research and Graduate Education, Prague); and Riccardo Faini, Carlos Rodriguez, Andrew Singer (Consultants). Jan Svejnar, (Consultant), acted as general advisor, Eva Skryjova provided research assistance and Leonila Castillo ensured all the necessary administrative support. The work is based on several missions to Czechoslovakia, by team members: October 18-21, 1990, February 1-14, February 26-March 2, and April 18-20, 1991. Table of Contents Page No. Executive Summary i Part I Liberalization xi Chapter 1. Trade Performance Before and After Reforms I Characteristics of Czechoslovakia's trade patterns 1 Concentration on CMEA trade 2 Concentration on heavy industry-energy-and resource-intensive exports 3 Loss of competitiveness and market shares 5 Response of trade patterns to reforms 6 The regional pattern of trade in 1991 7 Trade with individual countries 8 Impediments to geographic reorientation of trade 8 The commodity structure of trade 11 Preliminary analysis of the main trends for 1991 13 Chapter 2. Consolidating Trade Liberalization 17 Import regulations 17 Export regulations 21 Recommendations 26 Chapter 3. The Challenge Of New Global Relations 29 Reacting to the collapse of CMEA markets 29 Economic relations with the USSR 29 Trade relations with the European CMEA countries 34 Policy implications 36 West European markets: constraints and opportunities 37 Export barriers 37 Towards EC membership 38 Regional impacts of market reorientation 39 Strategic questions of trade policy 43 Part Two A Transition Strategy For Trade Policy 45 Chapter 4 Coordinating Trade Policy and Domestic Policies 47 Overview 47 Trade policies and macroeconomic stabilization 48 Chapter 5 Support Services for Exports: Contribution of Private and Government Sectors 53 Why support services matter 53 The provision of credit for export expansion 54 Recommendations for the short term 56 Recommendations for the longer term 57 Recommendations on the institutional delivery of services 47 Insurance of payment risks 57 Recommendations for encouraging insurance provision 58 Recommendations on institutional delivery of services 59 Technical support services in marketing, production, and other fields 60 Recommendations on technical support services 62 Recommendations on institutional delivery of services 63 Role of government institutions in promoting exports 64 Infrastructure development 64 Customs procedure 64 Basic information services 65 Export-marketing services 65 Financial services and export financing 66 Appendix 1. The Stabilization Program and Trade Performance 69 Appendix 2. Key Adjustment Mechanism: Privatization, Price Reform and Social Safety Net 85 Appendix Tables List of Tables Table 1.1 Direction of Czechoslovakian trade, selected years (percent shares, 1980-90) 3 Table 1.2 Product structure of Czechoslovakia's foreign trade, by SITC classification, selected years, 1980-90 4 Table 1.3 Market shares in total OECD imports: East European countries, selected years, 1975-89 5 Table 1.4 Czechoslovak exports, January-June 1990 14 Table 1.5 Czechoslovak imports, January June 1990/1991 15 Table 1.6 Czechoslovak structure of trade, January-June 1991 16 Table 2.1 The structure of Czechoslovak custom duties, with and without surcharge 18 Table 2.2 Quota growth and changes in the utilization rates for Czechoslovak exports under the Multifiber Agreement 25 Table 2.3 Dispersion of quota utilization rates and export concentration in EC markets for main Multifiber Agreement categories 26 Table 3.1 Projected liberalization of imports through EC agreement 39 Table 3.2 Trade orientation of the Czech and Slovak regions in 1990 (billions of Koruna) 42 List of Appendix Tables Table Al. 1 Interest rate structure as of February 1991 71 Table A1.2 Fiscal budgets, 1989-91 (billions of current koruna) 72 Table A1.3 Basic monetary statistics, 1970-91 76 Table A1.4 Monetary policy, 1989-91 78 Table A1.5 Koruna-dollar exchange rates, 1970-91 79 Table A2.1 Unemployment compensation schemes in Poland, Czechoslovakia and Hungary 92 Table A3.1 Geographic distribution of Czechoslovakia's foreign trade, 1989-1990 (millions of koruna) 97 Table A3.2 Product structure of Czechoslovakia's trade, by partner, 1990 (millions of koruna) 98 Table A3.3 Czechoslovakia's share in CMEA exports to the OECD, 1975 and 1987 (CMEA exports of each commodity group = 100) 99 Table A3.4 Indicators of Czechoslovakia's international competitiveness in the OECD market 100 Table A3.5 Unit prices of West German imports from Czechoslovakia, Hungary, and Poland, 1988 (deutschmarks per kilogram) 101 Table A3.6 Nominal protection in Czechoslovakia 102 Table A3.7 List of goods with regulated prices January 1, 1991 103 Table A3.8 List of goods (with tariff codes) under license regulation in 1991 104 References 107 Executive Summary More than most of the economies of Eastern Europe that made up the Council for Mutual Economic Assistance (CMEA), the Czechoslovak economy had depended on the USSR' for low-cost raw materials imports and assured export markets. This strong trade and technological dependence slowed technological development in Czechoslovakia and created a distorted industrial structure. While Czechoslovakia had avoided excessive indebtedness and maintained stable trade and fiscal balances, the shock in its terms of trade after termination of the CMEA exposed underlying imbalances that the artificial prices of the CMEA had obscured. The Economic Reform Program of the new Czechoslovak government has addressed these distortions and imbalances in a series of courageous and comprehensive policy measures. A solid stabilization program was undertaken to reduce government expenditures (especially subsidies) and maintain a tight monetary policy to stem any inflationary effects after the price adjustments of June 1990 and January 1991. Trade was substantially liberalized, and virtual current account convertibility was achieved for the koruna. Even with the strong trade liberalization measures, however, a number of problem areas and risks remain: * The very low level of tariff protection might create pressures to reimpose more harmful nontariff restrictions. * The inevitable westward reorientation of economic relations puts great pressure on negotiations to reach quick agreement with the European Community (EC), at the risk of obtaining limited concessions. * The collapse of the Soviet export market puts some strain on the adjustment and stabilization programs. * Restitution issues in the privatization program may affect early foreign investment inflows, putting greater pressure on exchange rate and trade instruments to achieve current account equilibrium. * The lack of experience in trading outside the CMEA means that various market mechanisms to support trading activities need to be developed quickly. I .This report, which covers a period of transition for the socialist countries in Eastern Europe and the former USSR, uses 'USSR' and 'Soviet Union' to refer to what are now-and were for some of the period covered here-the countries and republics that constituted the Soviet Union before its breakup. Thus the terms refer to the USSR both before and after its dissolution. Consolidating trade liberalization and promoting integration In the year before the recent reforms, four characteristics distinguished Czechoslovakia's trade performance: a high concentration of trade within the CMEA, especially with the USSR; a high concentration of exports on capital equipment and energy-or other resource-intensive goods; a small surplus in the trade balance which shifted sharply into a deficit as the transition began in 1990; and a modest growth in export volume, resulting in continued decline in global market shares. The Czechoslovak economy had been heavily centralized during the last decades, with over 97 percent of net material product originating in the socialist sector. Its private sector remained far smaller than that of Poland and Hungary. The consequences were a lack of competitive commodity specialization, of higher-quality production, and of marketing and management knowledge, and the development of strong socio-psychological barriers to private entrepreneurship and flexible business behavior. In addition, the rigid institutional pattern of highly centralized foreign trade organizations limited the emergence of meaningful export supply responses. The Czechoslovak economy, while open as measured by the ratio of trade to GDP, is less integrated into global trading networks and more strongly oriented to the USSR and other CMEA markets than the other major East European economies-Yugoslavia, Poland and Hungary. The others began to reorient away from dependence on the CMEA much earlier, and while much of their debt- financed investment was inefficient, they did begin to develop technical and institutional connections that can now be quickly expanded. Czechoslovakia, by avoiding such a debt burden, now lags behind in forging links to the global economy. The challenge, therefore, is to open the economy rapidly to. develop these links without swamping the existing structure of technologically backward production. Czechoslovakia today has one of the most liberal trade regimes in the world. Custom tariffs are low at about 5.3 percent and most tariff lines are bound under the GATT, adding to their credibility. More important, there are almost no nontariff barriers to imports. A few quantitative export barriers remain, but some of them will soon be dismantled. The main objective in trade policy should now be to consolidate the liberalization through the following measures: * Dropping the import surcharge on consumer goods and foodstuff as planned, to strengthen confidence in the new trade policy. * Introducing refunds or exemptions for custom duties on imported inputs used in export production. * Establishing an independent committee responsible for trade policy, to provide transparent mechanisms for fending off requests for quantitative import protection, based on the following principles: consumer and user interests must be represented in evaluating requests for temporary protection, any decision for temporary protection should rely on the least distortionary tools, anti dumping actions should be avoided in favor of safeguard measures, and tariffs should be the preferred tool for granting temporary protection. * Eliminating the few remaining requirements for export licensing with the exception of goods with restricted access in foreign markets (steel, textiles). For other commodities, the phasing out of export licensing should be coordinated with domestic price liberalization, which should proceed at the planned pace. * Reforming the system for allocating the remaining export licenses. Most licenses are allocated to established producers. Where domestic markets are not strongly monopolistic, an auction for licenses should be introduced and firms should be allowed to sell their licenses. For noncompetitive markets, a two-tier system could be introduced, with a basic quota for existing producers and an open quota auctioned off to new producers only. Strategies for diversifying exports The collapse of exports to the USSR created both a terms of trade shock and an unexpected demand shock, a macroeconomic problem that should be dealt with through macroeconomic policies. Microeconomic policies providing direct export support (subsidies, firm-specific export credits) must be avoided. Some combination of three policies needs to be applied: safety net measures to help the unemployed adjust to the new structures of production, some increase in generalized export credit allocated by banks on the basis of risk assessment, and continued negotiation of export agreements by government authorities. Strong pressures are likely to develop for government actions to help support industries or individual firms. In general, the authorities should rely on macroeconomic tools and avoid any return to selective government intervention. Any micro-level support should be the exception not the rule and should occur only under the following conditions: for products formerly exported in large volume to the USSR, that they will bounce back to higher levels in the future; that serious efforts are simultaneously being made by recipient firms to diversify exports to other markets; that there is clear evidence that the cost of closing down or cutting back exceeds the cost of government support. As long as prospects for economic recovery in the Soviet republics remain dim, resources to support industry restructuring should be applied to promote exports to new markets rather than to support exports with such an uncertain prospect of repayment. The argument based on the large size - 111 - of these markets is relevant only for the long run, by which time firms will find it easy to switch back to this technologically less demanding market. In exceptional cases, support may be considered for specialized investments for exports to the USSR that have a reasonable expectation of an early return and for which the costs of maintaining production are less than the costs of converting to other exports. Streetcars may be an example, but analysis is needed to confirm this or other cases. But even then, the cost of supporting exports must be less than the cost of unemployment compensation. Considering the energy intensity of much industrial activity, it would not be surprising to find that closing a factory saves more on energy, raw materials, and export-credit subsidies than it costs in terms of labor compensation for the unemployed. There are certain risks in relying on macroeconomic policies to address the Soviet export market. Anything but a modest effort to provide generalized export credits will undermine the stabilization programs. The other side of the coin is a risk that pressures to avoid employment cutbacks will find response in microeconomic-support measures (such as subsidies) or growing interenterprise credit. Association treaty with the European Community The Association Treaty with the European Community (EC), implemented January 1, 1992, will play an important role in anchoring trade liberalization. The treaty calls for complete liberalization of most trade-perhaps over 80 percent-within five years. While formal integration is unquestionably an objective, some tactical issues need consideration. Czechoslovakia's very low, bound tariffs leave little room for reduction in the second phase of negotiation. The Czechoslovak authorities should explore the EC's willingness to agree to some tariff restructuring, including a modest increase of the average up to EC levels (about 5.8 percent). Done properly by raising low tariffs and lowering high ones, this restructuring will lower effective protection and result in a more uniform tariff schedule whose slightly higher average should reduce pressures for increased protection. The key issue in the EC negotiations is the commitment to membership in the future. The gains from associate status may be limited since Czechoslovakia's average tariff is already low, especially if EC negotiations do not provide substantial early reductions of barriers to key exports. The gains may be further undermined by pressures to copy the agricultural support policies of the EC in attempts to harmonize trade policies. The biggest gain would be a commitment to full membership, but this may require activity at the political level, with individual EC governments. - iv - Domestic reform measures affecting trade Liberalizing trade and developing new trading relations are not,sufficient to advance the economy toward the market. If the necessary reallocation of resources is to occur, four key domestic adjustment mechanisms must be put in place: privatization, to provide for the profit-seeking motivations and incentives of producers to act freely on the market; price liberalization, to permit markets to signal producers, via free prices, about the most efficient direction of economic activity; financial system development, to provide effective mechanisms for allocating export credit on market terms; and a social safety net, to assist those dislocated by the shifts in resources to reestablish themselves in the new economic environment. The general strategy of reforms clearly recognizes this interplay of policy changes. What is needed now is close monitoring of the details of implementation. Privatization procedures, including a restitution law, have been put in place, but the process is expected to take a long time, especially for large enterprises. That may mean that restitution claims will need to be made clear first, before potential investors, particularly foreign investors, are likely to express any substantial interest in purchasing state property. The more rapidly privatization can be achieved, the more quickly industry will be able to respond to the new incentives for trade opportunities. Given the difficulties of privatization, one can expect a slow response of foreign trade. Uncertainty about restitution may delay foreign investment and many projects involving exports. The energies of management will be devoted first to privatization, delaying new investment and the reorientation of production. Consequently, the export supply response may be limited for the first year, as will be the ability of domestic producers to compete with attractive newly liberalized imports from the West. This is not to say that trade account movements will not occur. As in Poland in 1990, any substantial export expansion before privatization may depend more on devaluation and a sharp decline in domestic consumption than on substantial adjustment within industry. Freeing prices has been far easier than privatizing, both administratively and politically. Key consumer subsidies were reduced for public transport and gasoline in the third quarter of 1990, a partial but politically important liberalization. Wide-sweeping liberalization occurred in January 1991, leaving only about 20 percent of prices regulated. Further liberalization in mid-1991 and again at the end of 1991 has left a very small part of output subject to price controls-largely services, coal, medical products, and some sugar products. The most important immediate effect of price policy on trade responsiveness concerns export restrictions on. goods with regulated prices. Where ceiling prices are set to keep the price of key goods low (consumer goods and industrial inputs), the effect is continuing shortages and export restrictions to maintain domestic supply. Indeed, the lists of products subject to price ceilings and those subject to export licensing are almost identical. Thus export restrictions can be removed only after liberalization occurs. A less immediate and less evident effect of price liberalization may be the ability of monopolistic enterprises to increase prices. While import liberalization ought to provide a competitive stimulus, the combined effect of a 15 percent import surcharge and tariffs averaging 5.3 percent (and reaching 40 percent in several cases) provides a considerable margin for monopolistic behavior. The solution is not to reregulate prices, but rather to move quickly on privatizing and removing the surcharge to stimulate import competition. Another critical area of reform that will provide a boost to trade is in the financial sector. Improvements in financial intermediation and capital markets are needed if resources are to be reallocated to more productive opportunities. Especially important is the provision of new trade- related financial instruments-bank export credit assessment capacity, market-based export insurance facilities, and the like. Transition to a market economy is likely to be accompanied by increased unemployment, which government authorities estimate will reach about 5.2 percent of the labor force. These projections may be too optimistic, however, since the collapse of exports to the USSR may alone result in a loss of employment of nearly 5 percent of the labor force. Other estimates put unemployment at more than 10 percent. The social safety net now in place appears to be adequate. An official social minimum income level has been used for three decades in policy formulations and as the basis for direct cash assistance since 1988. On January 1, 1991 a relatively generous system of unemployment compensation was introduced-1,365 Korunas ($52) a month, equivalent to 47 percent of the average net state sector wage. The minimum benefit, applying to first-time job entrants, was 1,200 Korunas ($48) a month, set at the level of the social minimum (per capita in a four-member household). Role of government institutions in promoting exports Any government program that promotes exports should rest on the premise that the best policy for success is one of open trade and investment that encourages both imports and exports. Producing for - vi - export should be as profitable as producing for domestic consumption, which is best achieved not by special subsidies or other export incentives but by a liberal import regime that also boosts the efficiency of domestic firms. A stable macroeconomic environment is, of course, a basic requirement for successful trade liberalization and integration into the global economy. The government has other important roles to play as well. The focus here is on actions most closely related to international trade and finance: infrastructure development, simplification of customs procedures, improved information on foreign trade, expanded export-marketing services, and improved financial services in foreign trade, including facilities for export credit and export risk insurance. - vii - Chapter 1. Trade Performance Before and After Reforms This chapter sets the stage for those that follow by describing first the general characteristics of Czechoslovakia's trade pattern and performance before the recent trade reforms and then the initial response to the reforms. The first section begins with a general discussion of Czechoslovakia's trade structure, stressing its dependence upon CMEA and Soviet trade and explaining the ramifications of a decline in the support offered by these trade partners. Within the trade structure, the section examines specific industries held to be of crucial importance: machinery, manufactures, fuels and crude minerals, and more generally, resource-intensive goods. The discussion stresses Czechoslovakia's trade balance, decline in market shares, and the complications of readjusting a heavily centralized economy handicapped by one-sided infrastructural development that has failed to forge links with world markets. The chapter's second section focuses on specific European trade partners, including Germany, Austria, Hungary, Poland, and as a bloc, the EC, since these are the countries likely to be Czechoslovakia's major trading partners in the future as a result of the trade reforms and break-up of the CMEA. Thus, it progresses from an exploration of the weaknesses implemented by the socialist regime to a description of present-day attempts at international trade. Characteristics of Czechoslovakia's trade patterns Foreign trade is especially important to Czechoslovakia, with its small domestic market, as a mechanism for linking the economy into global financial relationships and technological advances. By most standards, Czechoslovakia is a fairly open economy. The ratio of trade flows (the sum of exports and imports) to GDP, a basic indicator of openness, has climbed steadily upward from 57.9 percent in 1980 to 69.8 percent in 1985 and 70 percent in 1989. Other Eastern European countries have not exhibited a similar trend (Collins and Rodrik 1991). Several characteristics distinguish Czechoslovakia's trade performance over the 1980s: a high concentration of trade with members of the Council for Mutual Economic Assistance (CMEA) and other socialist countries, especially the USSR; a high concentration of exports on capital equipment and energy- or resource-intensive goods; a small surplus in the trade balance, which shifted sharply into a deficit as the transition began in 1990; continued decline in global market shares with a loss of competitiveness, resulting in a positive but modest growth of export volume. Concentration on CMEA trade The Czechoslovak economy has been more dependent than many other Eastern European countries on the collapsing socialist markets, especially the USSR. For a number of export goods, the fading CMEA is still the exclusive market (street cars, river boats and ships, furniture, special machinery). For other goods, the export share to CMEA countries has been almost as large: more than 90 percent for office machinery and transport and telecommunication equipment and 70 to 90 percent for pharmaceutical products, industrial machinery, electrical machinery, passenger cars, and footwear. The problem is aggravated by the high share of military equipment in production and exports. The CMEA's share in Czechoslovakia's exports increased from 55A4 percent in 1980 to 58.6 percent in 1985 and reached a high of 63.4 percent in 1987 (table 1.1). Czechoslovakia's CMEA imports also rose from 56.4 percent in 1980 to 64.2 percent in 1988. Even as late as 1989, the CMEA share was still 54.9 percent in exports and 56.1 percent in imports, and about 30 percent of trade was with the USSR. Trade with OECD countries fell from about 30 percent in 1980 to less than a quarter of total trade in 1985 before starting to rise again after 1985-87 and reaching levels comparable to those for the CMEA area. Developing countries absorbed a declining share of total exports (11 percent in the early 1980s and 8 percent in 1989) and maintained their modest 6 percent share in total imports. In other Central and East European countries, the decline of CMEA and USSR trade relations began in the mid- to late 1980s and proceeded more gradually than in Czechoslovakia, where it shrank sharply in a single year-1990 (see Schrenk 1990 and Tarr 1991 for comparisons and appendix table 1 for details). Exports fell to 43.4 percent and imports to 44.4 percent of total trade, a loss of more than 10 percentage points in one year. The OECD's share increased to more than 42 percent, almost reaching the CMEA trade level. The EC overtook the Soviet Union as Czechoslovakia's leading trade partner. The drop in trade with the USSR (18 percent drop in exports, 19 percent in imports) accounted for much of the drop in CMEA trade. Changes in trade flows with other CMEA countries which were affected by a host of factors, did not exhibit a common pattern. The deep recession that hit the former East Germany and Poland took a toll on Czechoslovakia's exports to those areas, which declined by 36 percent and 27 percent, respectively. Meanwhile, thanks to the relative stability of Czechoslovakia's macroeconomic situation until 1991, import flows showed a steady increase from all socialist countries, except the USSR and Hungary. Czechoslovakia recorded a sizable deficit with socialist countries, accounting for more than 70 percent of its aggregate trade deficit. -2 - Table 1.1 Direction of Czechoslovakian trade, selected years (percent share), 1980-90 1980 1985 1989 1990J Ero CMEA 55.4 58.6. 54.9 43.4 USSR -30.8 35.5 -30.5 25.2 Other socialist 6.9 7.5 5.9 5.6 OECD countries 26.9 23.1 31.2 42.4 Developing countries 10.8 10.6 8.0 8.6 Total 100.0 100.0 100.0 100.0 Inports CMEA 56.4 64.2 56.1 44.4 (USSR) -31.2 -29.7 -21.6 Other socialist 6.3 6.4 6.2 6.8 OECD countries 27.0 23.2 31.1 42.6 Developing countries 6.8 5.9 . 6.6 6.2 Total 100.0 100.0 100.0 100.0 Source: Mission estimates Unfortunately, this seemingly dramatic rearrangement of trade was not the result of a successful reorientation from traditional to new markets. Rather, the fundamental causes were substantial changes in the exchange rate (several devaluations against convertible currencies and changes in the cross- exchange rate between the U.S. dollar and the transferable ruble) and the dramatic decline of trade relations with the CMEA. But while reliance on trade with the CMEA lessened somewhat, Czechoslovakia, along with Bulgaria, maintained the highest degree of reliance on the former CMEA of all its members (see Inotai 1990 and Tarr 1991). Concentration on heavy industry-energy-and resource-intensive exports During the 1980s, exports were dominated by machinery, which reached half of total exports in 1986 and 1987 (table 1.2). Manufactured goods represented more than 80 percent of total trade during the decade. However, between 1987 and 1990 machinery exports fell from 50.6 percent to 39.2 percent of exports, while the share of material- and energy-intensive products increased from 25.9 percent to 34.6 percent. In the commodity pattern of imports, decreasing energy import shares were replaced by higher shares of machinery and consumer goods. - 3 - Table 1.2 Product structure ot Czechoslovakia's foreign trade, by SITC classification, selected years, 1980-90 (percent shares) Caregory and SITC No. 1980 1985 1989 1990 E xports Food and livestock 1.1 1.03 4.63 5.46 Beverages and tobacco (1) 0.7 0.63 0.35 0.41 Crude materials (2) 3.4 2.57 3.68 3.74 Minerals, fuels (3) 3.6 2.52 5.19 4.36 Animals and vegetable oils (4) 0.0 0.02 0.13 0.34 Chemicals (5) 5.3 5.00 7.55 9.03 Mfd. goods classified by material (6) 15.4 14.8 22.44 25.63 Machinery and transport equipment(7) 59.5 60.3 44.39 39.16 Miscellaneous manufactures.(S) 10.82 11.2 9.67 10.40 Other transaction and goods 0.6 1.8 1.96 1.46 Total 100.0 100.0 100.0 ImDorts Food and livestock (0) 18.7 13.4 6.94 5.63 Beverages and tobacco (1) 1.1 0.8 0.71 0.80 Crude materiala(2) 16.9 16.4 8.76 8.32 Minerals, fuels (3) 2.2 2.82 17.31 14.32 Animal fats and vegetable oils (4) 0.4 1.1 0.36 0.56 Chemicals (5) 16.3 16.7 9.34 10.19 Manufactured goods classified by material (6) 11.8 12.3 10.42 10.65 Machinery and transport (7) 26.0 28.7 36.95 37.29 Miscellaneousmranufacturma(8) 4.6 6.6 6.15 9.11 Other transaction and goods 1.9 0.9 3.05 3.13 Total 100.0 100.0 100.0 100.0 Source: Mission estimates As in other CMEA countries, export and import patterns reveal substantial differences in trade with socialist and nonsocialist areas (shown in detail in appendix tables A3. 1 and A3.2). Machinery accounted for nearly 60 percent of exports to the CMEA in 1990, and raw materials and agricultural goods for less than 7 percent. For nonsocialist countries, machinery accounted for only 20 percent of exports-dropping from 30 percent in 1986-and primary goods for 22 percent. The changes in the commodity structure of Czechoslovakia's trade, while not as dramatic as the changes in geographic composition, reflected the reorientation of trade toward industrial countries. The share of products that are exported primarily to industrial countries, such as food and textiles, showed a marked increase, while the share of commodities that had formed the bulk of exports to socialist countries, such as machinery and transport equipment, declined. Imports showed the same pattern, albeit somewhat less pronounced. Mineral and fuels showed the greatest drop, mostly reflecting the fall in trade with the USSR, while the share of most manufactured imports increased. - 4 - Loss of competitiveness and market share Czechoslovakia's positive trade balance and low level of foreign debt during the 1980s, while suggesting good external performance, masked an underlying erosion of market share and competitiveness. In fact, Czechoslovakia had awa had a trade imbalance, but it was implicitly covered by the politically-based favorable terms of trade with the USSR. Imports of Soviet raw materials were underpriced relative to Czechoslovakia's heavy-industry exports. A comparison of shares in OECD import markets of four East European countries shows that Yugoslavia was the only one that increased its market share after 1975 (table 1.3). Czechoslovakia performed as poorly as Poland and even more poorly than Hungary, two countries that experienced open external deficit problems in this period, and whose loss of competitiveness was well-recognized. Yet Czechoslovakia was frequently considered the country with the best prospects because of its low external debt and balanced budget. Table 1.3 Market shares in total OECD imports: East European countries, selected years, 1975-89 Czechoslovakia Hungary Poland Yugoslavia Total imports 1975 0.28 0.21 0.54 0.31 1980 0.23 0.20 0.40 0.30 1985 0.19 0.19 0.28 0.36 1989 0.18 0; 19 0.29 0.42 Machinery impons 1975 0.21 0.09 0.27 0.21 1980 0.14 0.12 0.25 0.25 1985 0.08 0.07 0.09 0.20 1987 0.07 0.07 0.09 0.26 Source: OECD trade by commodities, imports, various issues. At a more detailed level of commodities, Czechoslovakia's declining competitiveness vis-a-vis other CMEA countries is even more evident (appendix table A3.3). Czechoslovakia improved its competitive position in the raw materials and energy markets, in which it certainly has little future comparative advantage, but lost shares in most manufactured product markets, mainly machinery (from 0.21 to 0.07 percent). Based on the thirty-three product groups (at the two-digit level) that represent its main exports, Czechoslovakia improved its market position in only six items (meat, crude rubber, pulp and paper, crude fertilizer, plastic materials, and cork and wood manufactures), while losing ground in all the remaining product groups, including all machinery and industrial - 5- consumer goods. Even when compared with largely unsuccessful CMEA competitors in the OECD market (appendix table A3.4), Czechoslovakia lost shares in most machinery, chemical, and industrial consumer goods markets, and gained shares in food, beverages, and raw materials. The drop in its share in total CMEA machinery exports to the OECD from 19.0 percent in 1975 to 14.8 percent in 1987 indicates that it may have lost its frequently cited comparative advantage as the region's leading industrial economy during that time. In a broader international comparison, its loss of competitiveness appears even starker. In 1975, Czechoslovakia's income from machinery exports to the OECD equaled that of Yugoslavia, Malaysia, or Brazil. By 1987, that income had dropped to 29 percent of Yugoslavia's, 16 percent of Malaysia's, and 14 percent of Brazil's. Malaysia, Thailand, Mexico, China, Hungary, and Poland increasingly gained market shares at Czechoslovakia's expense, as had Austria, Spain, Taiwan, Korea, Singapore, Brazil, and Yugoslavia. Response of trade patterns to reforms This analysis of recent developments in Czechoslovak foreign trade compares the first half of 1991 with the first half of 1990. It finds the following pattern in trade for the first half of 1991: * Strong decline in both exports and imports, but no pressure on foreign reserves. * Dramatic decline in exports to the Soviet Union and, to a lesser extent, to the CMEA. * German and Austrian dominance of new trade flows. * Some strong export surges (Bohemian machinery exports to Germany), but very fragmentary. Czechoslovakia's exports to the CMEA counties fell 34 percent between the first half of 1990 and the first half of 1991 (table 1.4), much more severely than the 17 percent drop between 1989 and 1990. Exports to OECD countries remained nearly constant in dollar value (they fell 0.6 percent) during 1990 but dropped 9.6 percent in the first half of 1991. Exports to developing countries also declined-by 22 percent between 1989 and 1990 and by 14 percent the next year. Final consumption contracted as a result of a negative shift in Czechoslovakia's terms of trade-oil and energy imports accounted for 34 percent of import costs, up from 17 percent in 1989, when the volume was also 25 percent higher. Sujan (1991) estimated that these external shocks caused a decline in net material product of 400 billion korunas (Kcs)-from 180 billion Kcs to 584 billion Kcs. The Institute of Economics estimates the GDP decline at 15 percent for the first quarter of 1991. Excluding the rapid fall in private domestic investment, this breaks down into a 15.5 percent drop in private consumption, - 6 - a 7.4 percent drop in exports, and a 4.2 percent rise in imports. While this estimate reduces the direct role of exports, it still shows that trade plays a key role in the short-run contractionary effects. The regional pattern of trade in 1991 The basic trends up to 1990 were not reversed in the first half of 1991. Exports continued to fall more rapidly in real terms (koruna values adjusted for exchange rate changes) than imports (-19 percent and -16 percent) because of the collapse of exports to the USSR (by 45 percent) and of imports from former socialist countries (by 53 percent). Cuts of such an intensity were not expected. Even more surprising was the fall in trade with industrial market economies: real exports fell by 10 percent. The slight increase in exports to the EC (6 percent) was more than counterbalanced by declining exports to other industrial economies. Czechoslovakia was unable to compensate for the loss in its Eastern European trade with gains in exports to the West. And neither the discriminatory quotas of the EC nor the recession in the West could be blamed for the trade blows. The core problem is the difficulty of adjusting rapidly and the uncertainties in state enterprises. One small positive sign was a slight upturn in export earnings in the second quarter of 1991-up to $900 million a month after a sluggish first quarter when they averaged only $570 million a month. On the import side, there was change as well. Once most oil imports from the Soviet Union began to be valued at world market prices and trade accounts were settled in dollars, the value of imports from the Soviet Union increased by 21 percent, although this trade contracted in volume. Thus imports from other countries shrank, with those from the remaining CMEA countries contracting by 53 percent (Poland, Hungary, and Bulgaria were the worst hit). The impact of devaluation became apparent: as imports from Eastern Europe had to be paid for in convertible currencies (only 10 percent of total imports were realized through clearing arrangements such as the CMEA) they became more expensive, and the shortfall in supplies from these countries was not compensated for by increased imports from the West. Real imports fell by 42 percent from EFTA and by 17 percent from the EC. Because of devaluations, there was only a mild balance of trade deficit in 1990 of $335 million, much of it due to the $840 million deficit in trade with the USSR. Surpluses were accumulated mainly with Germany ($243 million), Yugoslavia ($192 million), Hungary, Poland, and EFTA. It is interesting to note that these structural trends look a lot like the trade structure of 1928 before the distortions introduced by central planning and CMEA mechanisms, as shown in table 1.4. The biggest share of Czechoslovakia's trade is with Western Europe, a result consistent with recent -7 - econometric simulations of natural trade patterns for Central Europe (Havrylyshyn and Pritchett 1991). However, this return to a more natural pattern of trade merely reflects a sharp decline in the volume of trade with the USSR and CMEA, rather than a structural transformation directed toward Western European markets. Trade with individual countnes Czechoslovakia's trade-both exports and imports-was expanding in the first half of 1991 with only two of its major trading partners, Italy and the Netherlands (tables 1.4 and 1.5). Germany, Belgium, Poland, and Yugoslavia (a traditionally strong trade partner) were absorbing expanding volumes of Czechoslovak exports, while their own exports to Czechoslovakia were declining, roughly keeping pace with the decline in total trade. Imports from France, Japan, and the United States were expanding while exports were declining. Both exports and imports were dropping slightly with trade partners Austria, Canada, Denmark, Egypt and the newly industrialized countries. Finland, Switzerland, and the United Kingdom showed larger declines in trade with Czechoslovakia, although the pattern fluctuated. The most dramatic declines were in trade with Bulgaria, China, India, Romania, and, excluding oil imports, the USSR. Thus Czechoslovakia's trade seems to be reverting to its traditional pattern, with Austria, Germany, Italy, and Yugoslavia its main trade partners. The nature of trade relations with Hungary, Poland, and the republics of the Soviet Union will depend on the outcome of structural adjustment in those economies. The earlier devaluations had still not had any visible effect on exports by mid-1991, except in a few cases. While this does not necessarily imply an unfavorable assessment-not enough time has passed for firm judgments-the results do indicate that Czechoslovakia needs to be prepared for a difficult period of adjustment to new price incentives. The following section discusses the reasons why this adjustment will not be easy. Impediments to geographic reorientation of trade As a result of both the relatively low level of foreign debt and the balanced budgets, prospects for the Czechoslovak economy were often assessed more positively than those for other CMEA countries. While both factors offer additional resources and maneuvering room in the painful process of restructuring and geographic reorientation of external economic relations, the need for significant restructuring of production remains. -8 - Over the last forty years, the country's economic strategy has been based on regional autarky and self-sufficiency within the CMEA. Plans for long-term structural transformation were first implemented in the 1970s, but global economic and technological requirements and conditions were not well-incorporated in the development of petrochemical, nuclear equipment, transport equipment, or textile machinery sectors. Barriers to the free flow of information, technological innovation, and people (tourism) held back development of not only the economy but also social values and business attitudes. Technological development and quality standards were shaped by Soviet requirements, which usually fell short of international standards and differed from them in other important ways (electrical, railway, pollution, safety specification). Therefore, reorientation of current production requires much more than a "simple" technological upgrading. In some cases, even qualitatively and technologically competitive goods formerly delivered to the USSR and other CMEA countries are hard to shift to other markets because production capacities were based on huge Soviet demand (a new factory producing 4,000 electric street cars , yearly production of 90,000 motorcycles) of which industrial market demand may be only a small fraction. To meet industrial market demand, these capacities would be underutilized, gains from economies of scale would disappear, and unit costs would increase to a level at which these products would become uncompetitive. Furthermore, one-sided infrastructure development-oil and gas pipelines, electricity grid, special railway connection between Eastern Slovakia's steel mill and Soviet iron ore location-makes the Czechoslovakian economy extremely vulnerable and constitutes a major barrier to trade expansion with other partners. Regional autarky had created a closed 'reproduction cycle' in Czechoslovakia. Frequently, low- quality Soviet raw materials and semi-manufactured goods were processed by equally uncompetitive Soviet and CMEA-made installations. Partial substitution of Western inputs for traditional imports would have, in most cases, increased unit costs, whether because the Western equipment was inappropriate for processing Soviet materials or because processing Western basic materials created huge losses for Soviet-made installations. The opening up of an economy to foreign trade is usually accompanied by a rise in imports, which, after a lag, is followed by a rise in exports. This process had already begun in the late 1970s in Hungary and, to some extent, in Poland. In Czechoslovakia, an apparently healthy trade balance was the result of depressed modernization, and substantial trade deficits are expected to accompany import liberalization and to shape the financial environment of restructuring and reorientation. -9- Czechoslovakia's export pattern is strongly dualistic. Most goods are exported either to the CMEA or to the convertible currency area. Eighty-four percent of food products (83 percent for meat and 93 percent for fruits and vegetables), 70 percent of mineral raw materials (100 percent of crude rubber, pulp, and paper), 98 percent of wood manufactures, and 91 percent of glassware are sold in non- CMEA markets. Thus, market shifts are likely to meet serious barriers in the commodity pattern of exports, and most machinery can be marketed only within the CMEA and, increasingly, only in the Soviet Union. This duality is less accentuated in Poland's exports and virtually unknown in Hungary's. At almost double the OECD average, Czechoslovakia has one of the most energy- and material- intensive economies, a fact that is also reflected in export unit prices far below world prices. Thus in 1987, the price of Czechoslovak exports to the European Community reached 8.1 percent of the EC's average import prices for telecommunication equipment, 24.5 percent for paints and coatings, 25.4 percent for engineering products, and 60-64 percent for textiles, chemicals, ferrous metal products, and paper. Unit prices for Czechoslovak exports to the Federal Republic of Germany (FRG) fell considerably in the 1980s compared to those for Poland and Hungary (appendix table A3.5). Of Czechoslovakia's seventy-five major exports to the FRG, export prices were higher than Hungary's prices in only eighteen cases and below Hungary's prices in fifty-six cases; they were higher than Poland's export prices in thirty-six cases, lower in thirty-one cases, and the same in five. These data hardly support the widespread view that Czechoslovakia is more developed than the other reforming economies of Eastern Europe. Czechoslovakia's economy was also much more heavily centralized during the last decades than that of Poland or Hungary. More than 97 percent of net material product originated in the socialist sector. The consequences were not only the lack of a competitive commodity pattern and higher- quality production but also the creation of strong psychological barriers to private entrepreneurship, flexible business behavior, and marketing and management experience. And, until very recently, the rigid pattern of highly centralized foreign trade organizations seriously limited the emergence of a meaningful export supply response. In sum, while the Czechoslovak economy was very open as measured by the ratio of trade to GDP, it was less integrated into global trading networks than Yugoslavia, Poland, and Hungary, the other major Central and East European economies. Those countries reduced their dependence on CMEA trade much earlier, and although their use of borrowed funds was inefficient over the past fifteen years, they did begin to develop technical and institutional connections that can now be quickly - 10 - expanded. Their experience with Western firms, technologies, and communications puts them ahead of Czechoslovak enterprises and institutions in this respect. Czechoslovakia avoided a debt burden at the cost of foregone opportunities to forge such links. As a result, Czechoslovakia now faces the challenge of opening the economy to promote these links without overwhelming its existing structure of technologically backward production. The commodity structure of trade Two groups of products determine the specialization pattern of the Czechoslovak economy: fuels and crude minerals (SITC codes 2 and 3) and manufactures (SITC codes 6 and 8). Both groups increased their trade balances remarkably in the last eighteen months, with fuels and minerals moving into net imports and manufactures into net exports. For fuels and crude minerals, the increase was due to a dramatic change in oil prices, while for manufactures the change was due simply to maintaining the previous level of exports. Clearly, neither of these changes indicates a decisive mobilization of the economy for expansion. For another important trade group, machinery and equipment (SITC 7), both exports and imports fell, although machinery remains a net export. The evolution of trade in these commodity groups with market economies (including developing countries) clearly shows stagnation in the share of manufactures in exports (appendix table A3.9). Falling exports of food and fuels were compensated for by increases in exports of chemicals and machinery. The most dramatic changes occurred in trade with the USSR (appendix table A3. 10). Recently, raw materials have constituted over 88 percent of Czechoslovakia's imports from the USSR, almost exclusively at the expense of machinery imports. Machinery exports to the USSR also dropped significantly. This shortfall was seemingly compensated for by exports of manufactured and chemical products. But considering that exports to the USSR collapsed in 1991 (they declined by 45 percent), it seems likely that exports of manufactures and chemicals have simply declined less rapidly. The commodity structure of Czechoslovakia's trade with the other CMEA members shows a severe 53 percent drop in imports from these countries in the first half of 1991 but only a 9 percent drop in exports, resulting in a trade surplus of nearly $200 million (appendix table A3. 11.). Particularly noteworthy was the rise in Czechoslovakia's exports of manufactured goods and imports of fuels (both in absolute terms). The slowdown in exports and imports of machinery is not surprising. Developing countries became an emergency substitute for plummeting oil imports from the USSR (appendix table A3. 12). These oil imports came at the expense of contracted imports of food, crude - 11 - minerals, and manufactures. Exports of machinery and other manufactured products to developing countries remained relatively strong, although decreasing in absolute terms. The EC holds a dominant position among Czechoslovakia's industrial country trade partners. The pattern of imports from the EC has remained virtually unchanged (appendix table A3. 13). Machinery kept its traditionally high share, and manufactured goods, their low share. There was some increase in machinery exports, at the expense of manufactured products. Czechoslovakia's trade with the EC is clearly dominated by the exchange of manufactured goods for machinery, which implies a generally labor-intensive specialization (less skilled labor exchanged for more skilled labor) and a stress on intraindustry trade. A closer look at the country composition of this trade shows that this pattern of specialization is dominated by trade with Germany (appendix table A3. 14). The rise of exports to Germany (especially machinery exports) is remarkable and seems to have had a significant role in maintaining the Bohemian economy. Forty-six percent of Czechoslovakia's exports to Germany went to Bavaria (while only 19 percent of Czechoslovakia's imports came from Bavaria, which is exactly Bavaria's share in Germany's GDP). This pattern may help explain the low unemployment rates in Bohemian districts along the Bavarian border. Czechoslovakia's trade with Austria bears many similarities with its trade with Germany, especially on the import side (appendix table A3.15). On the export side, Austria's share of crude materials and fuels is higher than Germany's, mainly because of proximity-most crude materials come from former CMEA countries and much of Czechoslovakia's processing is concentrated in the eastern part of the country Czechoslovakia's trade with Hungary deserves special attention (see Benacek 1988), as does its trade with Poland and the former German Democratic Republic. Despite planning barriers to efficiency (similarly distorted prices, trade subsidies and taxes, explicit quota system), the intensity of trade with Hungary was relatively high in the past, oriented to exploit Czechoslovakia's comparative advantage in natural resource-based goods and Hungary's advantage in labor. Their mutual trade relied on intraindustry specialization in manufactures, and traces of this pattern can still be seen in recent data (appendix table A3. 16). Czechoslovakia has increased its net exports of raw materials, and both chemicals and manufactured goods increased their shares in mutual exchanges. Trade with Poland has exhibited a similar development, except in natural resource goods, where Czechoslovakia is traditionally a net importer (appendix table A3.17). While Czechoslovakia, Hungary, and Poland - 12 - are all undergoing drastic restructuring of their economies, there has been some continuity in their trade, at least from the perspective of Czechoslovakia's exports. Overall, exports of several natural resource-based products (wood, coal) showed a dramatic increase. Some machinery products did very well (buses, cars, drilling machines, tractors), while others did poorly (locomotives, lathes). Although the sample of high- and low-growth goods compiled by Czechoslovakia's Statistical Office (appendix table A3.18) is too small and unrepresentative for even an intuitive assessment of comparative advantage, it appears that unskilled labor-intensive exports have performed better than human or physical capital-intensive exports. Imports of natural resource-intensive goods generally declined, except for iron ore and black coal (appendix table A3. 19). This trend may have been influenced more by contracting domestic demand than by the development of domestic import competing commodities. Preliminary analysis of the main trends ror 1991 Preliminary data for all of 1991 show a surge in exports in the second half of the year, especially to market economies, a reversal of the pattern in the first half of the year. Exports to former CMEA countries also grew in the second half of the year, reducing the overall decline for 1991 compared to the picture in June 1991. Imports declined substantially (21.9 percent), but exports fell by only 6.1 percent. If these data hold, the results will confirm the government's expectations. An import decline was expected-although perhaps not such a severe one-given the sharp contraction in economic activity as hard budgets were put in place and the currency was devalued. The 20 percent decline in exports to the USSR is smaller than might be expected, considering the confusion in markets there. Finally, the growth in exports to the West reflects the benefits of reform. - 13 - Table 1.4 Czechoslovak exports, January-June 1990 Millions of Kcs (f o. b. J Percenraee share 1990 1991 91/90 1985 1990 1991 1928 Total exports 170,640 137,629 0.81 100.0 100.0 100.0 100.0 Convertible currency countries 83,542 123,191 1.47 n .a. 49.0 89.5 n.a. Non-convertible currency countries 87.098 14.438 0.17 n. a. 51.0 10.5 n.a. USSR 47,976 26,585 0.55 33.2 28.1 19.3 2 Other CMEA 19,669 17,880 0.91 22.1 11.5 13.0 21 Other planned' 11,023 10,656 0.97 6.9 6.5 7.7 6 European Community 51,993 225 1.06 14.9 30.5 40.1 43 EFTA 16,726 11,774 0.70 8.7 _ 9.8 8.6 17 Other OECD countries 8,786: 3.050 0 35 2.5 5.1 2.2 7 Developing countries 14,467 12,412 0.86 11.9 8.5 9.0 4 Austria 9.678 7305 0.75 . 4.1 5.7 5.3 15 Beltium 1.609 2,231 1.39 0.6 0.9 1.6 Bulgaria 3,034 793 0.26 2.7 1.8 0.6 Canada 784 498 0.64 0.4 0.5 0.4 China (PRC) 3.727 720 0.19 2.8 2.2 0.5 Denmark I,108 961 0.87 0.4 0.6 0.7 Egypt 1.190 941 0.79 0.6 0.7 0.7 Finland 1.610 1.023 0.64 0.7 0.9 0.7 France 3.845 3.410 0 89 1.5 2.3 2.5 2 Germany (united) 29,069 33,802 1.16 14.4 17.0 24.6 28 India 1,442 711 0.49 0.7 0.8 0.5 Italy 5,023 6001 1.19 I1.7 2.9 4.4 4 Japan 1,447 1.031 0.71 0.6 0.8 0.7 Hungary 6,418 5 794 0.90 4.1 3.8 4.2 7 Netherlands 3,676 3,929 1.07 1.3 2.2 2.9 2 Newly industrialized countries 831 635 0.76 0.1 0.5 0.5 Poland 7,515 9.536 .27 7.9 4.4 6.9 4 Romania 2,373 0.58 1.5 1.4 1.0 4 Soviet Union 47,976 26,585 0.55 32.9 28.1 19.3 2 I Switzerland 3.229 1,577 0.49 1.5 1.9 I I United Kingdom 4597 2,764 0.60 2.0 2.7 2.0 7 United States 1,433 1,032 0.72 0.6 0.8 0.7 6 Yugoslavia 5,369 9,218 1.72 3.1 3.1 6.7 5 Note: Data for 1990 are in current prices but recalculated on the exchange rate of 1991 a. The 'other planned' countries are Yugoslavia, North Korea, China, Vietnam, Laos, Cuba. b. The newly industrialized countries are Hong Kong, Singapore, Taiwan, South Korea, Greece, Spain, Mexico, Brazil, Argentina. Source: Federal Statistics Ofrice, 1991. - 14 - Table 1.5 Czechoslovak imports, January-June 1990/1991 Millions of Kcs o., I b PrnwaRe share __W 91/90 1985 r~~199 1991 1928 Total imaorts 176,438 147.599 0.84 100.0 100.0 100.0 100.0 Convertible curwtncy countries 81,786 138,401 1.69 n.a. 46.4 93.8 n.a. Non-cnvertiblecurrency 94,652 9,198 0.10 n.a. 53.6 6.2 n.a. countries USSR 42,573 51,528 1.21 36.2 24.1 34.9 2 Other CMEA 25,720 12,033 0.47 23.7 14.6 8.2 21 Other planned 12,018 5,766 0.48 7.3 6.8 3.9 6 European Community 52,102 43.032 0.83 14.6 29.5 29.2 45 EFTA 25.676 14,975 0.58 8.7 14.6 10.1 15 Other OECD 4,837 5,746 1.19 2.8 2.7 3.9 7 DevelopinR countries 13,512 14.460 1.07 6.8 7.7 9.8 4 Austria 14,511 9,510 0.66 5.2 8.2 6.4 7 Belgium 1 37 1,291 0.94 0.8 0.8 0.9 Bulearia 2,714 773 0.28 2.4 1.5 0.5 Canada 281 209 0.74 0.2 0.2 0.1 China (PRC) 5,772 2,007 0.35 2.5 3.3 1.4 Denmark 923 813 0.88 0.5 0.5 0.6 Egypt 1,461 498 0.34 0.4 0.8 0.3 Finland 1,159 449 0.39 0.5 0.7 0.3 France 2,793 2,854 1.02 1.6 1.6 1.9 2 Germany (United) 34,290 26,493 0.77 17.2 19.4 17.9 38 India 2,252 471 0.21 0.8 1.3 0.3 Italy 3,643 4,664 1.28 1.8 2.1 3.2 4 Japan 891 1,773 I .99- 0.6 0.5 1.2 Hun2ary 5,455 3 106 0.57 4.3 3.1 2.1 7 Netherlands 2 240 2,583 1.15 1.2 1.3 1.8 3 Newly industrialized countries I 180 1,020 0.86 0.1 0.7 0.7 Poland 15,650 7,586 0.48 8.1 8.9 5.1 4 Romania 1.540 521 0.34 1.8 0.9 0.4 3 Soviet Union 42,573 51.528 1.21 30.5 24.1 34.9 2 Switzerland 7,426 3,489 0.47 3.4 4.2 2.4 United Kingdom 4.984 2.410 0.48 2.1 2.8 1.6 5 U.S.A. 939 2,746 2.92 0.4 0.5 1.9 5 Yugoslavia 4,667 3,430 0.73 3.3 2.6 2.3 ____ 3 _ Note: Data for 1990 are in current prices but recalculated on the exchange ratc of 1991 a The 'other planned' countries are Yugoslavia, North Korea, China, Vietnam, Laos, Cuba. b. The newly industrialized countries are Hong Kong, Singapore, Taiwan, South Korea, Greece, Spain, Mexico, Brazil, Argentina. Source: Federal Statistics Office, 1991 - 15 - Table 1.6 Czecboslovak structure of trade, January-June 1991 Millions o Kcs fo. b. Percenta c share ExipoirTs Iports Exports mnus EX 1991 EX 1989 IM 1989 IM 1991 inmports Total 137629 147 599 -9,970 100.0 100.0 100.0 100.0 Food 9,980 6,748 3.232 7.3 4.6 4.6 6.9 Beverages, tobacco 1,143 906 237 0.8 0.4 0.6 0.8 Crude minerals 6,821 15,065 -8,244 5.0 3.7 10.2 8.8 Fuels, lubricants 5,394 50,420 -45.026 3.9 5.2 34.2 17.3 Animal fats & oils 208 484 -276 0.2 0.1 0.3 0.4 Chemicals 16,483 14,408 2,075 12.0 7.6 9.8 9.3 Manufactured 38,722 14,156 24,566 28.1 22.4 9.6 10.4 Machinery, equipment 42.308 36,581 5,727 30.7 44.4 24.8 36.9 Manufactured articles 16,565 8,658 7,907 12.0 9.7 5.9 6.2 Miscelilaneous 5 173 -168 0.0 2.0 0.1 3.1 - 16- Chapter 2. Consolidating Trade Liberalization The shift to a-liberal trade regime, with trade flows that are no longer centrally controlled but allowed to respond freely to income and price incentives, represents a major break with the past. The transition has been made more difficult by the breakdown of the old system of centralized international trade, the collapse of trade with the USSR, and the severe recession in many Eastern European countries. For the transition to be successful, market forces must be allowed to operate to bring about a radical change in the sectoral and the geographical composition of Czechoslovakia's trade, in the context of a well defined and transparent set of institutional rules for international trade. Trade reform will play a pivotal role in transforming Czechoslovakia's economy from a centrally planned to a market system. In particular, trade liberalization will be instrumental in providing economic agents with undistorted price signals for tradable commodities and in limiting monopolistic practices. A liberal orientation of the trade regime will also be a decisive factor in achieving Czechoslovakia's full integration into the world economy. This chapter reviews Czechoslovakia's trade regulations and considers what policies might best serve the process of transition. It evaluates the current import regime, and the reforms already undertaken by the authorities, and assesses the system of export regulations. Recommendations are presented for consolidating the liberalization of trade achieved so far. ImpoFt regulations Before the most recent reforms, neither the exchange rate nor tariffs had any substantial role in determining foreign trade flows. Both imports and exports were centrally determined. Differences between domestic and international prices were offset by a complex system of taxes and subsidies (FENZO). Foreign exchange controls and direct import licensing were other problems. A major step in the transition toward a market-based system of trade was a radical reform of the foreign exchange allocation system. Since 1988, enterprises have been allowed to engage directly in foreign trade, rather than only through official trade organizations. In January 1989, a foreign exchange retention scheme was introduced, and in January 1990, the commercial and the noncommercial exchange rates were unified. Finally, in January 1991, full current account convertibility of the koruna was established through a decree of the Ministry of Foreign Trade. The decree anticipated many of the provisions of the new draft Foreign Trade Law (which was awaiting parliamentary approval at the time this report was written). The decree provides for - 17 - unrestricted access for businesses and enterprises to foreign exchange for current account transactions. Each Czechoslovak resident is entitled to an annual allowance of Kcs5,000 for travel abroad. Capital account transactions are still restricted. The present govermnent inherited a tariff schedule with low rates-not surprising considering the very limited role of tariffs in a centrally planned economy.2 The average tariff is at most 5.3 percent (table 2.1)-the average depends on the weighting procedure applied. Nearly all custom duties (4922 tariff lines out of 5,090, or 96.7 percent) are bound under GATT regulations and so cannot be increased without consulting trade partners. Sixty-eight unbound custom duties were unilaterally reduced in 1989 (and later revised on February 1, 1991), leading to a reduction of both the average tariff and tariff dispersion. Table 2.1. The structure of Czechoslovak custom duties, with and without surcharge (percentage) Sector Minimwn duty Marimum duN Mean Standard devation Wthout V,1h Wthout Wth Without Wth WVthout Wish Agriculture 0 0 10 28.5 2.0 8.5 2.4 10.4 Mining 0 0 5 5 .1 .1 .7 .7 Manufacturing 0 0 70 70 5.6 12.5 4.2 11.2 Consumer goods 0 0 70 70 6.9 22.6 5.4 10.4 Intermediate goods 0 0 25 40 4.9 6.1 3.2 5.6 Capital goods 0 0 27 34 5.0 8.0 2.7 7.8 Whole economy 0 0 70 70 5.3 12.1 4.2 11.2 Source: Mission calculations based on data provided by the Czechoslovak Customs office, with the 20 percent surcharge in effect until June 1990. On December 28, 1990, a 20 percent temporary import surcharge, covering mostly foodstuff and consumer goods, was introduced for balance of payments purposes, as allowed under Article XII of the GATT. The surcharge has significantly modified both the level and the structure of nominal protection. The average (unweighted) rate of nominal protection rose from 5.3 percent to 12.1 percent (table 2.1), while the dispersion (standard deviation) increased from 4.2 to 11.2. Goods subject to surcharges face an average tariff of 26.7 percent, those with no surcharge, a rate of 4.6 (Messerlin 1991). Indeed, the most crucial feature of the temporary surcharge is its discriminatory nature. The average rate of nominal protection remained unchanged for the mining sector and increased by only 3 2. The preliminary proposal put forward by the previous Czechoslovak government in the initial round of the Uruguay negotiations was to reduce custom rates by 30 percent. Ihe new government envisages proposing a more modest reduction of 13 percent. - 18 - percent for capital goods and 1.2 percent for intermediate goods. The main beneficiaries of the surcharge are agriculture, whose average custom duty rose 6.5 percent, and, most of all, consumer goods, whose duty rose 15.7 percent. The increase in the average rate of protection was accompanied by a substantial rise in the standard deviation. The frequency distribution of custom duties changed with the surcharge as well (appendix table A3.6). Before the introduction of the import surcharge, 97.95 percent of custom duties were concentrated in the 0-15 percent range; since the surcharge, only 65.63 percent are in this range. It might have been preferable had the authorities applied the surcharge a few months earlier, when they announced the devaluation of the koruna, thus preventing a speculative surge in imports. As it is, the distortionary effects of the import surcharge are unquestionable, even if its discriminatory character can be justified as a means of avoiding the higher production costs for domestic firms that an across-the-board tariff increase wo'uld have entailed. It is therefore essential that the temporary nature of the measure be stressed. Even abolition of the import surcharge will leave intermediate imports subject to a positive, albeit low, tariff, thereby penalizing exports. The authorities ought to consider introducing a mechanism for refunding these duties to exporters, or for exempting them. The abolition of all quantitative controls on imports was the most dramatic break with the past trade regime. A system of import licenses remains in effect for only a few items such as drugs, weapons, and ammunitions, whose trade most countries monitor carefully. However, the draft foreign trade law (article 1 of part V) leaves the Ministry of Foreign Trade with discretionary power to impose quantitative restrictions, thereby exposing the ministry to pressure from interest groups seeking such protection. The geography and the commodity reorientation of Czechoslovakia's trade will require a shift of productive resources among sectors and firms that will generate transitional costs, leaving some sectors and firms as winners and some as losers. As experience shows, the losers will exert considerable pressure for protection from competition. Because tariffs are bound under the GATr, pressures for protection are likely to take the form of demands for nontariff restrictions. To avoid this, it is essential that Czechoslovakia have in place a set of well-defined, transparent rules governing requests for temporary protection. GATT safeguards and other procedures, such as antidumping measures, while being a credible and effective tool against undesired increases in tariff protection, are biased in favor of those seeking protection; they give little or no weight to the costs that even temporary protection imposes on the economy as a whole. Indeed, in most countries, the'injured firm has the initiative of asking for safeguard measures, and regulatory bodies are required only to assess - 19 - whether injury to the firm or industry has occurred. The fact that protection of one sector constitutes a tax on other sectors and penalizes users of the good, whether consumers or firms, is not weighed in the balance. As a result, even procedures that are in accordance with the GATT are biased toward the granting of protection-antidumping procedures even more than safeguards.3 In the spirit of the GATT "wise men's report' (the Leutwiler report), it is recommended that Czechoslovakia set up an independent commission to evaluate requests for temporary protection. The commission should be obligated to take into account both the costs and the benefits to the economy of such measures. To be effective, the commission will need a clear mandate, and its independence should be unquestioned. Users of the commodity for which protection is sought should receive adequate representation in hearings. Finally, for deserving requests, the commission should rely on the least costly measures needed to achieve the desired level of protection-very short-term temporary tariffs. The commission should refrain from granting quantitative protection to domestic producers. There has been considerable discussion over the past year about raising the level of protection somewhat to compensate for the sharp reduction in protection caused by the elimination of all licensing procedures. There are several considerations on both sides of the argument. Binding tariff lines requires long and difficult negotiations with the GATT contracting parties. There are indications, however, that the EC might agree to an increase in Czechoslovakia's average tariff up to the EC's level as part of the association process. (Czechoslovakia's average is 5.3 percent compared to the EC's 5.8 percent.) Czechoslovakia could also appeal to the principle of credit for unilateral liberalization or, in the spirit of the Uruguay Round's inclusion of nontariff barriers, to the application of a "protection balance sheet' which would clearly show Czechoslovakia's overall liberalization even if the average tariff rate is increased a few points. Another argument in favor of tariffication is the political-economy advantage of responding to demands for protection without resorting to less transparent licensing mechanisms. Finally, tariffication provides an opportunity for moving to a uniform or nearly uniform tariff schedule, thereby reducing dispersion and, probably, high effective protection of some sectors such as processed food and consumer goods. Against tariffication is one very strong practical argument: it may simply be impossible to achieve the agreement of all contracting parties. In addition, seeking to replace reduced quantitative 3. See Hindley (1991) for a succinct review of the protectionist bias of antidumping articles in the GATT. - 20 - restrictions with compensatory tariffs, whatever the economic merits, may erode the goodwill Czechoslovakia enjoys internationally. And finally, the sharp devaluation has already provided domestic firms with a substantial improvement in their competitive position, a World Bank study finds. On balance, the purely economic rationale for substituting higher tariffs for reduced nontariff protection may be overwhelmed by two counterpoint arguments. First, the political infeasibility of getting agreement internationally may make the point moot. Second, tariffication makes sense economically only if dispersion is also reduced (ideally by a move towards uniformity) and if there is a commitment to future reductions of the tariff levels, whether unilaterally or in connection with EC or Uruguay Round commitments. Export regulations Czechoslovak authorities have taken several steps to deregulate export flows. There is no longer a general requirement for trade licensing for exports, and enterprises can freely engage in export activities. General or sectoral schemes aimed at affecting exports through price incentives are virtually nonexistent: Czechoslovakia's trade policy does not rely on either export taxes or subsidies. Some export restrictions remain, however, covering some 20 percent of merchandise exports, according to the Ministry of Trade. The export earnings retention scheme, which had been in effect since January 1, 1989, was dropped after the introduction of internal convertibility. For imports, the trade regime affects trade flows mainly through price instruments (tariffs) rather than through quantitative regulations; for exports, licenses are still required for three categories of goods: * Sensitive goods, such as arms, weapons, and explosives. * Selected 'essential" inputs for domestic producers. * Commodities subject to quantitative restrictions imposed by foreign partners (mainly "voluntary" export restrictions). There is of course no question about the need to carefully monitor arms trade, and export licensing is a common practice among countries. Export restrictions on "essential' inputs are much harder to justify. Restricting exports to ensure a steady flow of basic inputs for domestic production and to limit monopolistic price increases only makes sense if imports are not available as an alternative source of - 21 - supply. But if domestic users can meet their requirements through imports at given (tariff-inclusive) prices and unhindered by quantitative restrictions, they will be protected against unjustified price increases and disruption of supply due to shortages. Thus, this objective is already-and more effectively-achieved by Czechoslovakia's liberal import regime. Export restrictions do not perform a useful function in this respect znd should be eliminated as planned. Where there are price regulations, however, temporary system of export restrictions may be needed if the administratively set price is lower than the international price. Several commodities subject to export restrictions as essential goods are also subject to price control-cereals, coal, electricity, flour, sugar, pork, poultry, milk, metallurgical products, pharmaceuticals, and leather, to name some. For such commodities, liberalization of domestic prices needs to accompany the phasing out of the export licensing. The last category of licensed exports-those with restricted access to foreign markets, like textiles and steel-cover various types of arrangements (chapter 5 discusses the topic in detail). The European Community imposes restrictions on textile products, metallurgical products, and mutton. The United States, Canada, and Norway limit exports of textile goods, generally in the context of the Multifiber Agreement (MFA). The European Community also has initiated several antidumping cases against Czechoslovakia's exports of petrochemicals. But most export barriers take the form of voluntary export restrictions (VER). While the authorities may need to regulate exports through a licensing system to ensure compliance with export restraint agreements, care is required to avoid bias in the allocation of licenses. According to the Ministry of Foreign Trade, existing exporters receive most (close to 90 percent) of the export licenses, with new exporters competing for the remaining open quota. This system is likely to generate several inefficiencies, however, to the extent that the distribution of licenses does not reflect their value to different exporters. The existing system also acts as an impediment to industrial restructuring and provides little incentive for exporters to fill their quota allotments or upgrade the quality of their production. The inefficiencies associated with suboptimal distribution of quota allotments can add considerably to the losses from restraining exports (see Anderson 1985). The optimal allocation of export licenses under a quota would produce uniform quota rents for each exported commodity. (A quota rent is the difference between the price under the export restraint and the price that would have prevailed in its - 22 - absence; for instance, under competitive conditions, the level of marginal cost.) Simple criteria such as base-year quantity result in inefficient distribution of licenses because exporters' valuations of licenses do not affect their allocation. Furthermore, if quota licenses are simply allocated to (specialized) producers on the basis of their past export performance, the composition of exports will not change and no quality upgrading effect will occur. Under fairly general conditions, export restrictions expressed in physical units will prompt exporters to upgrade the quality of their production (see Bark and de Melo 1987). This would represent a welcome effect for Czechoslovak products, which still face a quality problem. South Korea and Malaysia, for example, allocate licenses on the basis of the previous year's unit export price, so firms that upgrade their products and increase their export price receive a larger allocation. Finally, if export licenses are renewed automatically, there is little incentive for exporters to strive to fill their export allotment. To avoid this undesired effect, South Korea takes into account a firm's previous year's export performance in both restricted and unrestricted markets in allocating export rights for textiles.4 A competitive rather than administrative-based system would achieve a more efficient distribution of export licenses. Even if the government wishes to allocate licenses to exporting firms based on some administrative criteria, it should allow license-holding firms to trade their licenses on a secondary market. If the government decided instead to auction export licenses directly, the quota rents would go to the government instead of the firms. In both cases, however, the distribution of export licenses will reflect their value to holders. Furthermore, export licenses will be shifted to products with higher per unit quota rents, which under plausible conditions, will be the higher-quality products. Finally, the existence of a positive price for licenses will provide a further incentive to use their full quota allotment. An auction system for quota licenses may not be effective if domestic exporters do not behave in a competitive fashion. For instance, an astute monopolist would always raise the export price in 4. By promoting exports to nonrestricted markets, the government may be trying to encourage export diversification and gain a favorable position in the event export restrictions spread to these markets as well. There may be undesired effects, however. Firms may be induced to export to unrestricted markets at below marginal costs, which may provoke the importing country to impose restrictions (or to initiate an antidumping case), thereby frustrating the objective of export diversification. See Bark and de Melo (1988). - 23 - response to a voluntary export restraint so that the price of a license becomes zero.5 Similarly, oligopolistic producers could collude to achieve the same outcome. Under such circumstances, the government might wish to use a different scheme. One possibility is to use a two-tier system in which the basic quota is allocated to current producers (based on export performance, including quota filling and unit export prices) and the remaining quota is sold in an auction open only to new producers. To minimize the favoring of incumbents, the price for the allocated quota would be determined by the previous auction value. To prevent incumbent firms from crowding out new firms, incumbents could apply for the open quota if it was not fully sold during auction. In all cases, firms would be allowed to trade their export licenses. This system would achieve more efficient distribution of the export quota among incumbent exporters, while also encouraging new entrants into the market, thereby promoting industrial mobility and restructuring. Reforming export license allocation may be particularly important for Czechoslovakia. Quotas for textile and clothing exports have become increasingly underutilized in recent years (table 2.2). Quota levels have increased only modestly (an average of 6 percent a year) since 1985 so that is unlikely to explain declining utilization. (Indeed, simple statistical analysis shows that changes in the quota utilization rate are positively, albeit not significantly, correlated to the growth rate in the quota level.6) Analysis of the quota utilization rate among different national markets within the European Community under the Multifiber Agreement shows that only large quotas in a few EC markets (mostly Germany) are being filled while quotas on smaller markets are systematically underfilled (table 2.3). This pattern seems to reflect a less than successful effort by Czechoslovak firms to diversify their exports toward alternative markets. A more competitive system of export license allocation might overcome this shortcoming. 5. Even if markets are not segmented and arbitrage possibilities limit monopolistic pricing behavior in the restricted market, the price of licenses may not be significantly different from zero. See K. Krishna, 'The case of the vanishing revenues: auction quotas with monopoly,' American Economic Review, 80, 4, 828-836, 1990. 6. The correlation coefficient is .317, with a t-value of 1.25. - 24 - Table 2.2 Quota growth and changes in the utilization rates for Czechoslovak exports under the Multiriber Agreement 1985-89 Category Average Average quota change in growti utlizaton 1 0.02142 -5.823 110 0.07044 -18.380 117 0.0535S -5.545 12 0.03272 -13.668 13 0.20282 5.743 16 0.00264 -11.238 17 0.04166 8.878 18 0.15612 -0.939 19 0.04343 -0.491 2 0.00548 -3.974 20 0.04666 -7.405 21 0.03979 -0.255 24 0.09559 -0.807 26 -0.01778 -10.651 3 0.03545 -5.666 31 0.04993 -8.978 32 0.06556 0.862 36 0.09731 -10.717 37 0.04151 -8.767 39 0.05066 -4.976 4 0.10927 -9.430 5 0.07788 -6.425 6 0.07461 6.016 61 0.08447 0.887 66 0.04940 -8.365 67 0.06551 -1.361 69 0.16168 -2.449 7 0.05235 8.246 73 0.05021 -10.203 76 0.07596 -13.797 8 0.02389 -0.839 9 0.03290 -1.089 90 0.04502 -17.771 91 0.07683 -13.130 Aggregate average 0.06080 -5.074 Note: Regression X = 317 (254) = 1.28 Source: Authors' calculation based on World Bank data. - 25 - Table 2.3 Dispersion of quota utilization rates and export concentration in EC markets for main Multifiber Agreement categories Calegory Concentration Coefficient of VaHriadon 1985 1989 1985 1989 117 .18 .14 .41 .34 16 .35 .24 .64 .78 17 .40 .39 1.76 1.76 2 .25 .26 .17 .26 24 .62 .55 . .33 .46 3 .38 .40 .82 .34 6 .80 .61 .62 .56 76 .79 .77 .61 .88 Note: The concentration ratio is measured by the Herfindahl index with respect to Czechoslovak export shipmenu to EC markets. The coefficient of variation is measured as the ratio of the standard deviation to the mean of the quotas' utilization rates. Source: Author's calculation based on World Bank data. Recommendations The following measures could strengthen and consolidate Czechoslovakia's new trade regime and help the government resist requests for nontransparent forms of protection. They would also enhance the efficiency of resource allocation and contribute to Czechoslovakia's integration into the international economy. * Dropping the temporary import surcharge on consumer goods and foodstuff to avoid distorting the price signals for domestic producers and inducing an undesired shift in resources at the expense of export production. * Proceeding with restructuring of the tariff schedule by reducing high tariffs and raising low ones to reduce the dispersion and move more quickly toward a uniform rate for all goods. * Establishing a refund or exemption scheme for exporters, for customs duties on imported inputs. Indirect exporters (i.e., local suppliers of inputs to exporters) should be included. * Establishing an independent commission to review requests for temporary protection, with transparent procedures that discourage requests for quantitative protection. The commission should give full weight to the costs of protective measures to the economy as a whole by considering the effects on users of the commodity (consumers and other industries). Protection, if granted, should be through tariffs-and for a maximum period of one year. - 26 - * Eliminating the few remaining export licensing requirements, except for goods with restricted access to foreign markets. For others, the phasing out of the export licensing system must be closely coordinated with liberalization of domestic prices. * Reforming the system of allocating export licenses so that established producers do not automatically get the lion's share. Where domestic markets are sufficiently competitive, auctioning licenses or allowing license-holding firms to trade their licenses is an efficient approach. Noncompetitive markets may require a two-tier system that allocates a basic quota to existing producers (based on past export performance) and auctions off an open quota to new producers only. - 27 - Chapter 3. The Challenge of New Global Relations Trading arrangements and external conditions are another important element of effective trade policy. Czechoslovakia is now dealing with three very important issues of this type: adjusting to post- CMEA trade mechanisms, reacting to the dramatic collapse of CMEA exports, and negotiating some form of institutional integration into the EC. Replacing the barter-like procedures of CMEA trade with market-based trading at world prices is a medium-term microeconomic issue best dealt with by the introduction of adjustment mechanisms-privatization, price liberalization, safety nets, and trade liberalization (see chapter 2). The collapse of the Soviet export market is a short-term macroeconomic problem best regarded as a terms of trade or demand shock (see chapter 2). This chapter examines the microeconomic details of these issues, considers relations with Western markets (in particular the EC), and then synthesizes the three problems into a common framework. Reacting to the collapse of CMEA markets The anticipated reorientation of the trade of East European economies from the CMEA to Western economies-some analysts predict a reversal of shares to one-third CMEA, two-thirds West (Havrylyshyn and Pritchett 1991)-has been occurring far faster than expected. The Soviet market, in particular, has collapsed to less than half of its 1989 value. World market prices and convertible currency payments were introduced into CMEA trade in January 1991, and the enormous size and rapidity of the transition impose a heavy economic burden on all small Eastern European countries that export manufactured products and import mainly raw materials and energy. For Czechoslovakia, terms-of-trade losses are calculated at $1.8 billion (World Bank staff estimates) to $2 billion (Mejstrik 1990). Economic relations with the USSR In current local currency prices, trade with the USSR started to decline after 1987, but the situation did not become critical until 1990, when export and import volumes dropped substantially. Between 1987 and 1990 exports fell nearly 30 percent (18.5 percent between 1989 and 1990) and imports 33 percent. Despite these changes, Czechoslovakia maintained its share in total Soviet imports, and continued as the main Soviet supplier in several categories of products and even adding some between 1983 and 1989. In 1989, 60 percent of the USSR's truck imports, more than one-third of its textile - 29 - machinery and railway equipment purchases, and a quarter of its, furniture, energy machinery, and leather shoe imports came from Czechoslovakia. By January 1991, it became clear to Czechoslovak economic policymakers that prospects were bleak for increasing exports and imports to the USSR above the level established in the previously signed contracts. Current export contracts (including the not very reliable indicative list) amount to $1,770 million and imports to $2,190 million, or less than 50 percent of exports and 70 percent of imports in 1990. Consequently, $4 billion in products regularly exported to the USSR must find new markets or additional financing (either inventory financing or export credits, or both), or production must fall. Czechoslovakia has signed two government-level trade agreements for 1991. One promised delivery of 2 million tons of oil to Czechoslovakia in exchange for 1,400 Tatra trucks (the previous annual level was 4,000), pipelines, oil drilling machine, and foodstuffs. Based on the world market price of oil at the time of signature ($22 a barrel), usual deliveries worth $320 million were expected. If oil prices fall, the agreement is valid for the 2 million tons of oil only, with no increase in oil imports or in exportable goods allowed within the framework of the agreement. Since manufacture of the Czechoslovak export items need substantial imports from the West, the general impact on the trade balance is likely to be negative. The second agreement covers the indicative list of $1.45 billion in Czechoslovak exports and $1.87 billion in Soviet imports. Soviet deliveries to Czechoslovakia consist mainly of raw materials, such as iron ore, cast iron, ferrous metals, natural gas, and nuclear fuel. No oil or machinery is included in Soviet deliveries; seventy percent of Czechoslovak exports are machinery, with industrial consumer goods (toys, textiles, shoes, sporting goods) and foodstuffs (meat, butter) filling out the list. Czechoslovakia proposed additional products (furniture, machinery) to balance the value of mutual deliveries, but the Soviet Union was unwilling to accept further items. While the indicative list may be better than no agreement at all, it is far from satisfactory. For one thing, the indicative list does not guarantee delivery of the listed exports and imports; all deliveries are subject to company-level contracts. Second, vital Czechoslovak export goods are either excluded from the agreement, or they are included in drastically reduced quantities. Among those not included are electric street cars (produced in a new factory built exclusively to produce for the Soviet market), textile and metalworking machinery, automobile lights, and motorcycles. Third, the Soviet concern that most of the Czechoslovak machinery exports be delivered to it on favorable credit terms implies both an inevitable choice between additional financing and lower exports, and an increase in its - 30 - current $400 million deficit in the indicative list. And last, although the supply of some strategic basic materials seems to be guaranteed, there are uncertainties about the quantity of paper, cotton, and non- ferrous metals to be delivered. Of crucial concern is the supply of raw materials and energy on which the Czechoslovak economy depends and which has previously been met, for the most part, by the USSR. Oil, natural gas, and other raw materials are the most critical. Even with the decline in economic activities in 1991, Czechoslovakia still needs 13 million tons of crude oil (imports peaked at 16.6 million tons in the mid-1980's). The USSR promised 7.5 million tons, 2 million tons to be delivered in exchange for goods and 5.5 million tons for cash. To make up the additional 5.5 million ton shortfall, Czechoslovakia has been negotiating on the republic level (Russia, Ukraine) and with the Tjumen region, but to no avail so far. The Adria pipeline, with a rated annual capacity of 5 million tons, could almost fill the gap, but for technological reasons its actual capacity is only about 3.5 million tons. Three agreements cover natural gas deliveries. Part of the gas is included in the indicative list, another part is in payment for earlier Czechoslovak investment in the Soviet gas extraction industry, and the third is in return for the transit charge owed by the USSR for its gas exports to Germany via Czechoslovakia ($400 to $450 million annually). Prospects for the supply of various raw materials from the USSR are mixed. Some items are part of the indicative list, while others are expected to be acquired from the republics. Imports from non- CMEA sources such as China could also be considered. Along with the sharply falling trade volumes comes a growing deficit in Czechoslovakia's trade with the USSR. Even if all products on the indicative list are delivered and the USSR delivers the full 5.5 million tons of oil for cash at the price of $20 a barrel, Czechoslovakia would have a $1.2 billion deficit in its trade with the USSR (every one dollar change in the price of oil would have a $40 million impact on the trade balance). Czechoslovakia and the USSR signed four financial agreements in December 1990 and January 1991: * A $150 million line of credit has been opened to finance bilateral trade imbalances. This is likely to be used by Czechoslovakia in 1991 to cover a portion of its emerging trade deficit with the USSR. * The USSR agreed to repay $125 billion in Czechoslovak investments in the USSR, over a period of four years in quarter-year installments ($312.5 million yearly). - 31 - * The USSR agreed that its accumulated deficit (to the end of 1989) in bilateral trade with Czechoslovakia could be used by Czechoslovakia to finance its deficit with the USSR. A sum of about 1.2 billion in transferable rubles, which the USSR was to have repaid after 1995 can be used by Czechoslovakia if its trade deficit in 1991 surpasses $462.5 million ($150 million+$312 million). * To cover its Kcs 2.75 billion trade deficit with Czechoslovakia for 1990, the USSR was allowed to deliver requested goods (mainly raw materials, except for oil) to Czechoslovakia before the end of March 1991. Any remaining deficit would have to be paid in convertible currency and would be added to the trade financing facilities mentioned above. While agreements do not mention interest and conversion rates, it is expected that ruble-denominated debts can be converted to US dollars at a rate of I to 1. Enterprises are able to retain only a modest part of their convertible currency earnings: 40 percent goes to the Presidential Fund for debt financing, and varying proportions of the remaining 60 percent go to the Union-Republic Fund and to municipality funds (in a 9 to 1 proportion). Raw material-and energy-exporting companies are allowed to retain the lowest share of total earnings-estimates range from 6 to 14 percent. Manufacturing companies seem to do better. Since Czechoslovakia imports its raw materials and energy needs almost exclusively from the Soviet Union, the fact that Soviet enterprises, with their paltry retention allowances have relatively less money for imports than do other types of enterprises, is a serious concern. The low retention allowances, also discourage exports and lead to underinvoicing. Furthermore Soviet companies with hard currency are increasingly looking for Western goods, which are expected to bring them a higher return in national currency, or depositing part of their export earning in foreign banks. Together, these factors explain why Czechoslovakia was unable to negotiate any new oil deals with enterprises. Prospects for fulfilling other trade agreements with individual republics, regions, or enterprises valued at $260 million-S 100 million to Ukraine, $80 million to Uzbekistan, $50 million to Belorussia, and $30 million with the Lada company in Gorki-seem increasingly gloomy. Attempts to sell furniture, shoes, and wood products to the Russian Republic in exchange for oil have been abandoned. The prohibition against barter further narrows the possibilities for maintaining previous trade relations or expanding trade into new areas. Export possibilities to the USSR are further constrained by financial and trade policy measures taken (or not taken) in the Soviet Union. Authorities are reluctant to open letters of credit, yet without them, licenses are not granted for exports to the USSR because of fear of nonpayment. In addition, discriminatory Soviet import duties of up to 1,300 percent (!) and export levies have severely hindered trade. - 32 - Compared with these problems, agreement on world market prices seems relatively easy-particularly if no trade takes place. The largest Eastern European foreign trade organization, exporting mainly transport vehicles, reached a favorable price agreement with its Soviet counterpart based on convincingly documented prices of small volumes of exports to the West and the prices of the main international competitors; additionally, Czechoslovakia's 30-year presence in the Soviet market, its established service network, and reliable spare part deliveries narrowed the initial price difference and helped increase the price level. Another foreign trade organization exporting mainly machinery found it much harder to reach an agreement. Its exclusive Soviet partner negotiated separately with potential production companies and made up a price list based on quality and performance differences between Western and Soviet products. Competing Czechoslovak products were put on the Soviet price level, emphasizing their technological backwardness compared to Western substitutes and ignoring their relatively advanced technological level compared to Soviet goods. Czechoslovak enterprises produce goods appropriate for Soviet markets, but they are not allowed to export until satisfactory price agreements have been reached. Relations between central trade organs and enterprises have been disrupted as a consequence of economic decentralization and political turmoil. Enterprise-to-enterprise trade relations cannot be established since no one knows whether a Soviet enterprise will have the right to export or the money to import. The indicative lists deliberately left out most consumer goods and some of the machinery, since these were considered appropriate products to be dealt with on the enterprise level. This system has not worked out, however, and Czechoslovak exporters may be forced to begin credit-financed exports. In addition, despite the collapse of traditional institutional linkages, it is still very difficult to reach the end use of Czechoslovak products in the USSR. Negotiations are still carried out with foreign trade companies, often in the presence of Gosplan and ministerial officials. Institutional barriers exist on the Czechoslovak side as well. Traditional foreign trade organizations cannot contact Soviet enterprises, while Czechoslovak enterprises complain that they are prevented from entering into direct deals with Soviet and other partners by foreign trade organizations still trying to monopolize the market. The dramatically worsening financial situation in the former Soviet Union is disturbing for both the short and the longer run. With rapidly growing indebtedness and a skyrocketing debt payment obligation, the Soviet Union is primarily interested in obtaining as much convertible currency from its Central and Eastern European partners as possible. The situation may be further aggravated if oil prices fall or remain low. At $20 a barrel, total Soviet income from energy exports in 1991 may - 33 - reach $17.3 billion; every dollar change in price has an $830 million impact on export income. Thus export and import interests are moving increasingly apart. No import commitments accompany recent export deals. Even in the $320 million barter agreement, the USSR has repeatedly tried-unsuccessfully so far-to separate its oil deliveries from Czechoslovakia's exports to get cash for the oil exports before any of the Czechoslovak exports are marketed in the USSR. Some Czechoslovak enterprises complain that even the scarce convertible currency is spent on alternative Western goods that crowd out traditional exports-even when the imports are costly and inefficient for the USSR7. Reversing the process will take time, time that most Czechoslovak firms do not have. Trade relations with the European CMEA countries Trade with the small European CMEA countries did not fall as sharply as that with the USSR in 1990. Trade expanded by 2 percent with Hungary, remained at its 1989 level with Poland (but exports fell sharply while imports rose), and declined by 20 percent with Bulgaria and by 26 percent with Romania. Total turnover with the four countries reached almost 7 billion transferable rubles, more than 50 percent of it with Poland and nearly 20 percent.with Hungary. As a result of massive imports from the GDR and Poland, total imports from the small CMEA countries outpaced imports from the USSR for the first time in more than a decade. In 1990, two major shocks in the small CMEA market hit the Czechoslovak economy: the dissolution of the German Democratic Republic and its subsequent monetary union with West Germany, and the production and trade impacts of Poland's economic shock therapy. East Germany was Czechoslovakia's second largest CMEA partner and the country with which the intraindustrial division of labor had reached its highest level under the umbrella of regional autarky. Specialized items produced in accordance with CMEA specialization and cooperation schemes accounted for 43 percent of bilateral trade. Sixty percent of exports and imports consisted of machinery products. More than a quarter of Czechoslovakia's exports of electrical machinery and about one-fifth of its exports of agricultural machinery, office equipment, and measuring instruments were marketed in the GDR. In turn, the GDR supplied almost half of Czechoslovakia's imports of agricultural machinery, two-fifths of its imports of optical goods and car components, and more than a quarter of its imports of measuring instruments, fertilizers, and telecommunication equipment. With 7. Recent imports of subway trains from France are an example. The trains were not equipped for Russian climate and maintenance norns, and broke down within a year. Similar Czechoslovak products could be used for twenty-five years. - 34 - the dissolution of the GDR in 1991, Czechoslovak exports to the area fell by 30 percent, and signed export orders totaling 300 million transferable rubles-primarily for machinery, but also some raw materials-were erased overnight. In turn, collapsing GDR firms attempted to export everything they had available as West German competition rendered them highly uncompetitive on Western and domestic markets. As a result, imports from the GDR increased by 3 percent in 1991. Adverse impacts accumulated in two areas: production and trade financing. Only one of the 92 firm- and government-level production and specialization agreements survived the shock (not surprisingly, it was the USSR-Czechoslovakia-GDR agreement on natural gas delivery). The other contracts, some of them based on decades-long cooperation in agricultural machinery, truck construction, and production of car assembly parts, were canceled. Particularly hard hit was production of specialized, custom-made models for the GDR market (for example, spare parts for IFA trucks of agricultural machinery). At the same time, it is becoming increasingly difficult to service GDR-made machinery, either because production has ceased, or because parts are available only for convertible currency and at extremely high West German prices (machinery and Traban-Wartburg car parts were immediately priced as if they were West German products). A substantial part of the passenger car industry and most of the agricultural machinery industry may soon be out of business. Increasing imports and rapidly falling exports opened up a substantial merchandise trade deficit (480 million transferable rubles and another 200 million transferable rubles in services, mostly due to the collapse of GDR tourism). With monetary reunification, deficits will gave to be settled in deutschemarks (DM). The exchange rate for converting the transferable Ruble is expected to be somewhere between the artificial rate established for GDR exports to the USSR (1 ruble = 2.34 deutschemarks) and the financial market rate (0.20 rubles to 0.30 deutschemark). As a result, the deficit would be between DM 140 - 200 million and DM 1.6 billion, probably in the lower half of this wide range. According to some proposals, this sum will be credited to Czechoslovakia, to be settled by commodity exports within five years. Other proposals urge the German government to cancel the 1990 trade deficit with GDR completely. Czechoslovakia would argue that the GDR broke several of its contracts, as well as the CMEA requirement that spare parts continue to be supplied for at least ten years, and that the costs of the resultant economic damage ought to be deducted from the trade deficit. Czechoslovakia also began to move into deficit in its trade with Poland, after years of surplus. With the gradual opening of the Polish economy in the second half of the 1980s, Czechoslovakia began to - 35 - be outcompeted in a number of Polish markets in which it previously held a leading position. The large decline in demand in Poland in 1990 curbed Czechoslovak exports by 27 percent, while Polish exports to Czechoslovakia increased by 10 percent, leading to a deficit of Kcs 7 billion Czechoslovakia's trade deficit with its CMEA partners (Kcs 12 billion) comes exclusively from its trade with the GDR and Poland. While its trade surplus with the USSR expanded, its accumulated deficit with the GDR and Poland reached Kcs 17 billion. As of the mission's visit, under the new CMEA trade principles, surpluses and deficits in bilateral trade were to be settled in goods until March 31, 1991 and in convertible currency thereafter, with the exception of Czechoslovakia-Hungary trade, for which national currencies remain a reciprocally accepted means of payment. Goods included in the 1990 trade'protocol can be. delivered at the old transferable ruble prices, but the importer is not obliged to accept the goods if an enterprise-level contract is not concluded. preliminary data provided by the CMEA bank in Moscow show that Czechoslovakia has a trade surplus of 178 million transferable rubles with Bulgaria and 172 million transferable rubles with Romania and a deficit of 134 million transferable rubles with Poland and with Hungary. Czechoslovakia has submitted a purchase list to Bulgaria and Romania, containing mainly products that had been part of traditional protocols (machinery, some food, almost no industrial consumer goods). Although the rules for the game seem to be clear, no one seems to know what will happen if a country is unable to deliver the requested goods or if the country with the surplus thinks that cash payment in convertible currency should be given priority over non-vital commodity imports. New trade and payments agreements in convertible currency have been signed with Bulgaria, Hungary, and Poland. They contain no agreement on volume and pattern of trade, and no indicative lists. Czechoslovak Trade Ministry officials estimate that trade turnover with Bulgaria ($100 million) and Romania ($60 million) will decline to 20 percent of 1990 levels, while trade with Hungary ($600 million) and Poland ($1000 million) might even be halved. Exports and imports are expected to be in balance, except with Hungary, where a Czechoslovak deficit of $80 million is expected. Most trade is expected to be on a barter basis between enterprises, particularly if prices rise rapidly. Policy implications The picture painted above, while something of a worst-case scenario, is nonetheless a realistic one. It is serious enough to warrant both macroeconomic policy reactions to offset the decline and microeconomic policy reactions to reconcile the short-run adjustment needs. - 36 - Two strategic issues emerge with particular urgency: What should be the government's position concerning trade with the CMEA, especially the Soviet Union, and how fast and with what commodity and geographical priorities can trade reorientation be achieved? Strategic decisions about the Soviet market depend on what scenario seems most likely for the future of the Soviet economy. If Soviet economic problems are considered temporary, and an early revitalization is expected, Czechoslovakia should maintain some market presence and use various economic instruments (financing exports and inventories, establishing direct contacts with companies, improving service and marketing activities, opening new trade offices in most major Soviet cities) to ease temporary difficulties. But if the analysis convincingly suggests no hope for a meaningful Soviet recovery in the near future, this traditional market needs to be abandoned as soon as possible so that scarce resources can be concentrated on a massive reorientation and the financing of unavoidable temporary losses (unemployment, restructuring, technological upgrading, retraining). West European markets: constraints and opportunities Since 1989, Czechoslovakia has been very active in its economic diplomacy. It signed a new trade agreement with the United States in April 1990 based on the most favored nation principle, followed in May 1990 by a trade and economic cooperation agreement with the European Community. That agreement grants Czechoslovakia higher steel and textile quotas, stipulates the progressive dismantlement of quantitative restrictions, and promises more liberal treatment of products often submitted to antidumping action. Since January 1991, the EC has granted Czechoslovakia special treatment under the generalized system of preferences (GSP), except for exports of sensitive products. Export barriers Despite these agreements, Czechoslovakia faces significant barriers to its export in three areas: textile quotas under the Multifiber Agreement (MFA), prices and quota restrictions in steel, and antidumping actions in chemicals. The antidumping barriers are particularly strong-Czechoslovakia faced thirty-four antidumping cases in the 1980s, a disproportionately higher share than its import share, with a tariff-equivalent effect in chemicals, for example, of 16 percent. Another indication of the bias against Czechoslovak and other East European exporters is the applied tariff on steel of about 5 percent, compared to 1.5 percent for world exports (Messerlin 1991b). In general, the restrictions are much less severe in U.S. markets, which is hardly surprising or significant, considering Czechoslovakia's small trade volume and market shares in the United States - 37 - (Czechoslovakia's steel exports constituted 0.39 percent of U.S. imports compared with 7.02 percent of EC imports in 1986). Considering the much greater distances involved, exports to the United States are not likely to grow as fast as exports to the EC8. Czechoslovakia therefore needs to focus more attention on reducing the barriers in the EC through negotiation of associate (or affiliate) status. Towards EC membership Membership in the EC is a high priority for Czechoslovakia for both historical-political reasons-as a clear sign of a "return" to Europe-and economic reasons-as a means of guiding reorientation requirements toward the emerging European center of gravity. Negotiations on the association treaty with Brussels were the focal point of economic diplomacy during 1991. The treaty is viewed as a vehicle for eliminating all quantitative restrictions and establishing a schedule for tariff reductions on a nonreciprocal basis ("positive asymmetry"). The agreement recognizes that Czechoslovakia will establish various mechanisms for special cases according to GATT articles on safeguards, balance of payments measures, anti-dumping, and other exceptional measures in certain cases for five years only under standstill arrangements or article XXVIII. There are some cautionary notes to be made about the association agreement, however. In the sensitive agriculture, steel, and textile sectors, liberalization will occur over five years and will free about 60-65 percent of trade with the EC, compared with 80 percent for other goods. And the process of liberalization for these products is complex. Textiles tariffs are to be cut in stages, and non-MFA quotas are to be cut to half the Uruguay Round levels. Reductions of quotas and tariffs for steel are conditioned on declines in Czechoslovak production. In agriculture, reductions will occur on the basis of reciprocity for individual products. Table 3.1 summarizes the picture on the import side. 8. Gravity model predictions of East European trade patten shifts show the U.S. share of export markets changing very little from its present 2-3 percent and that of Europe increasing sharply from about 30 percent to 60-80 percent. See Havrylyshyn and Pritchett (1991). - 38 - Table 3.1. Projected liberalization of imports through EC association agreement Category Perrentage of imports Tariffs of 0 .1% to 4 % 20-25 Fully free in five years 55 Sensitive products, liberalized in nine years 10 Automobile 05 - used cars (same as sensitive products) - new cars tariffs = 80 % of basis by March 1, 1992, then cut by one fourth every two years Agricultural duty free 10 Source: Mission estimanes. Czechoslovakia's economic interests lie with the rapid dismantling of barriers to the sensitive goods already mentioned. Yet Czechoslovak experts express some concerns about the future of economic relations with the EC for several reasons. First, the country's low average tariff level of 5.3 percent narrows the potential benefits that may come from the asymmetrical treatment of traded goods. Moreover, since Czechoslovakia grants GSP treatment to all developing countries, including the newly industrialized countries, the EC may become a major beneficiary of this system. Second, it is not clear whether the national restrictions to be eliminated will be maintained as Community-level restrictions after the creation of the single European market. Third, the growing fears voiced by some EC members about the improving competitiveness of East-Central European economies may bring about a slowdown in the EC's opening toward this region. Fourth associate status does not automatically lead to full membership, although it can ease the way. Regional impacts of market reorientation A major trade reorientation frequently occasions debate about the differential impact of such changes among regions of a country-for example, northern and southern Italy and industrial and agricultural areas of Spain in the case of EC membership, or the industrial provinces of Ontario and Quebec and the agricultural western provinces on the question of the U.S.-Canada Free Trade Agreement. In Czechoslovakia, the issue is whether Slovakia will be hurt more by the shift from CMEA markets while the Czech lands will benefit more from integration into the EC. If this is a false concern, that needs to be demonstrated. If it is not, then policies need to be formulated to offset such - 39 - differential effects, otherwise political consensus may be lost. While the issue is too complex for quantitative analysis in this report, several observations can be made. There is a widespread conviction that the Czech republic can be transformed into a competitive, world-market-oriented economy faster and with less pain than can Slovakia, based on the evidence of Bohemia's greater degree of economic development, "better" production structure, lesser dependence on the CMEA, and more favorable geographic location. A regional analysis of exports paints a rather more differentiated picture, however. Up to 1948, while Bohemia and Moravia developed several highly competitive industrial activities, Slovakia remained engaged primarily in agriculture. However, the vast industrialization process that began after 1948 and that has intensified in the last two decades brought industrialization to Slovakia as well. Indeed, by mid-year, its engineering output per capita was higher than that of Bohemia. In addition, Slovakia's capital, stock is considerably newer than that of the Czech region, although not necessarily more technologically advanced. Slovakia's industry is dominated by large raw material- and energy-intensive sectors producing semimanufactured products (steel, petrochemicals) for export and for Czech industry. The share of military production is much higher in Slovakia (60 percent) than in the Czech region, employing about 100,000 people (8 to 10 percent of industrial jobs). About half of Slovakia's exports to the USSR consisted of military equipment until 1990, when Soviet military purchases dropped substantially; other Warsaw Pact members had also relied heavily on Slovak deliveries before dissolution of the pact. In 1990, Czechoslovak federal authorities decided to halt all arms exports. To a certain extent, Slovakia's industrial structure is the result of geographical factors and of the CMEA-type international division of labor. Slovakia obtained Soviet raw materials and established strong bilateral contacts with the USSR (oil pipeline to Slovnaft, Bratislava, or the steel mill in Kosice), and with Poland and Hungary. The Czech republic, relying on indirect Soviet inputs channeled through Slovakia, supplied Slovakia with higher value-added machinery and industrial consumer goods. Its foreign exports focused on the GDR, Poland, and the USSR as its major markets for machinery and equipment. As Czechoslovakia's export pattern changed, with machinery and final goods increasingly being replaced by less technology-intensive products and semimanufactured items, Slovakia's export orientation shifted slightly away from the CMEA market. In 1990, the Czech republic accounted for 75.9 percent of Czechoslovakia's total exports and imports (table 3.2). Considering that Slovakia accounts for about one-third of the country's industrial production, the region's foreign trade seems to - 40 - be-contrary to perceptions-somewhat less oriented toward the CMEA and more toward the OECD, especially the EC, than does that of the Czech region. The CMEA region accounted for 43.2 percent of Slovakia's exports compared with 43.9 percent for the Czech Republic and 39.1 percent of imports compared with 45.8 percent. The EC accounted for 29.1 percent of Slovak exports compared with 25.5 percent of Czech exports and 25.4 percent of imports compared with 22.9 percent. While these statistics suggest that a shift has occurred in Slovakia toward OECD exports, the situation is likely to change with further economic reorientation. The competitiveness of Slovak exports outside CMEA markets is derived largely from its use of underpriced raw materials and energy (with the underpricing equal to the difference between CMEA and world market prices). As this difference disappears and Soviet deliveries become smaller and more uncertain, Slovakia's export capacity is likely to be hit significantly. Thus, while this analysis of Slovakia's relative shares in CMEA and OECD exports does not necessarily undermine the argument that Slovakia is more vulnerable to the decline in CMEA and Soviet trade, it does change the nature of the argument. Slovakia's exports may be more affected than the Czech region's not only by the loss of Soviet markets, but by the greater dependence of its non-USSR exports on previously underpriced raw materials imported from the USSR. It must also be recognized, however, that many Czech firms rely on intermediate inputs from Slovakia, and these firms could also be affected after a lag. Determining how these impacts might differ requires a fuller interindustry analysis, which is beyond the scope of this report. Differences in how Czech and Slovak economic policymakers evaluate the possibilities and risks that shape their economic strategy are certainly affected by economic realities. Slovakia, with a more sanguine assessment of the future of the Soviet Union, prefers a more cautious reform policy, emphasizing the social component of restructuring as well as the efficiency element, and a more selective process of privatization. Slovak policymakers also seem to be more sensitive to the entry of foreign capital and try to limit its influence or link it to national economic priorities (employment, technology input, high share of domestic input). Preliminary analysis shows that the Czech republic is clearly winning out over Slovakia in attracting foreign direct investment, probably as much because of the Slovak government's efforts to impose such conditions as for reasons of development, infrastructure, or geography. - 41 - Table 3.2 Trade orientation of the Czech and Slovak regions in 1990 (bilL;oos of Koruna) Czech rerion Slovak Region Total Amouns Share (%) Amourn Share % Exports 216.5 164.4 52.1 75.9 24.1 To socialist countries 106.7 80.6 26.1 75.5 24.5 CMEA 94.7 72.2 22.5 76.2 23.8 other socialist countries 12.0 8.4 3.6 70.0 30.0 to non-socialist countries 109.8 83.8 26.0 76.3 23.7 OECD countries 91.3 69.1 22.2 75.7 24.3 EC countries 57.1 42.0 15.1 73.6 26.4 other OECD countries 34.2 27.1 7.1 79.2 20.8 Developing countries 18.5 14.7 3.8 79.8 20.2- Imports 246.3 185.0 61.3 75.1 24.9 From Socialist countries 125.7 96.7 29.0 77.0 23.0 CMEA 108.8 84.8 24.0 78.0 22.0 other socialist countries 16.9 11.9 5.0 70.3 29.7 from nonsocialist countries 120.6 88.3 32.3 73.2 26.8 OECD countries 103.7 74.8 28.9 72.2 27.8 EC 58.0 42.4 15.6 73.2 26.8 other OECD countries 45.7 32.4 13.3 80.9 29.1 Developing countries 16.9 13.5 3.4 79.6 20.4 Source: Mission estimates. Recently, these differences have manifested themselves in two ways. Slovak authorities-motivated by growing production and employment problems-unilaterally announced in January 1991 that Slovakia would resume military production despite the federal ban on military production and exports since late 1990. The decision creates a constitutional problem since production is directed by economic ministries at the republic level, while foreign trade is under federal control. So while Slovakia may resume military production, it is forbidden to export any of it. The outcome could be higher resources expended on growing inventories or an independent external economic policy that would seriously threaten the political stability of the country. The second manifestation of growing differences is in the competition for foreign direct investment, a rivalry that could come to undermine Czechoslovakia's economic policy priorities. This tendency may be strengthened by the devolution of authority over foreign investments (joint ventures) and incentives to the republic level in 1991. Still, one should not read too much into such regional rivalry; similar competition for investment is common among the provinces of Canada and the states of the - 42 - United States-in fact, wherever federal divisions of power exist. But experience in these places also suggests that foreign investors, not the competitors, are the primary beneficiaries of this rivalry. Bohemia, Moravia, and Slovakia are highly integrated economically. Economic and political decisions that ignore this fact would only increase the problems emerging from the transition to a market economy. Nonetheless, federal politics cannot completely avoid some differences, and attempts to force complete commonality of approach may only exacerbate the desire for differentiation. Strategic questions of trade policy Proponents of supporting a market presence in the USSR through export-credit financing or other extraordinary means argue on the grounds of the large size of this market, the capability of Czechoslovakia's firms to channel Western inventory to the USSR, the high costs of recapturing the market after the economy recovers, and the need to secure the supply of raw materials. The force of these arguments lessens, however, as the period of economic crisis in the USSR lengthens. Recent developments in the USSR, confirmed by an increasing number of surveys and reports, tend to support the view that there will be no rapid economic recovery and that the crisis is likely to deepen. Debt servicing and import financing are becoming critical, institutional disorder is spreading, and serious political conflicts are still a risk. Soviet raw material and energy deliveries are expected to fall considerably short-promises, export financing, and signed contracts notwithstanding. Countries previously heavily dependent on the Soviet economy, such as Finland, Poland, and. Hungary, are accelerating their economic reorientation and developing damage-limitation policies. For Czechoslovakia as well, rapid reorientation to other markets is required not only by the emerging market mechanisms but also by the need for an emergency strategy of damage limitation. Until mid-1991, efforts to reorient the Czechoslovak economy had not produced spectacular results. Distorted prices prevented rational investment and resource allocation decisions. Formidable barriers remained in the form of heavy centralization of production and foreign trade activities; the absence of flexible small and medium-size firms, of any substantial private business activity, and of foreign direct investment; and the continued loss of the economic, technological, social, and other benefits of complete integration in world markets. The first positive results, though modest, appeared in 1990. Imports from the OECD area rose rapidly, filling large shortages in consumer goods and machinery purchases; machinery imports from the OECD area rose by 65 percent, compared with a 52 percent increase in total imports from the - 43 - area. Export reorientation remained limited to neighboring Germany. Some companies tried to shift part of their collapsing exports from the GDR to West Germany or worked to maintain their East German market through their West German business and service network (8,000 Skoda cars were exported in this way in 1990 and 15,000 were expected to be sold in 1991). A leading foreign trade organization substantially increased exports of some traditional machinery (grinders, milling machines, presses). The first foreign direct investment activities were reported. On the negative side, Czechoslovakia did not expand its sales of technologically leading goods, and large-scale advertising campaigns in West Germany, following German monetary union, remained largely unsuccessful. With the absolute value of exports to the USSR continuing to fall since 1989, the share of CMEA trade in total trade is likely to fall from 50 percent (in 1989) to less than 30 percent, and the Soviet share from 30 percent to 15-20 percent. However, true trade reorientation, based on rapidly increasing trade with all partners, will take much longer. Policy responses to declining CMEA trade must be consistent with the expanding opportunities of Westward-oriented trade. As long as exports to the USSR continue to fall and the prospects for Soviet economic recovery remain dim, the sensible course of action will generally be to direct resources to support restructuring for production for new export markets rather than to maintain exports to the USSR through credit financing. There may be some exceptions. A few firms with very specialized investments oriented to Soviet standards (say, streetcars, although expert engineering and cost analyses would be needed to decide the issue) may find that if early returns of orders can be expected, the costs may be lower to maintain production for USSR exports than to convert to other exports. But even in such cases, the cost of supporting exports would have to be lower than the cost of unemployment compensation to make continued production for Soviet markets worthwhile. Considering the energy intensity of much industrial activity, it seems likely that the savings in energy, raw materials, and export-credit subsidies from closing a factory more than outweigh the costs of unemployment compensation. In the long run, of course, the size of the Soviet market is an important consideration, but it should be easier to switch back to these technologically less demanding markets in the Soviet Union at some time in the future than to switch from low quality to higher quality exports now. - 44 - PART TVO A TRANSITION STRATEGY FOR TRADE POLICY Chapter 4. Coordinating Trade Policy and Domestic Policies Overview The Czechoslovak authorities are as firmly committed to a program of substantial and rapid trade liberalization as they are to overall reform of the economy to speed its transition from socialism to market-based mechanisms. But the task is not easy. Despite early impressions that Czechoslovakia was in better economic shape than other Central European countries, it is now clear that it too faces several macroeconomic disequilibria that must be addressed. It is useful to think of the reform program as comprising five main elements: * Macroeconomic stabilization * Price liberalization * Privatization * Creation of a social safety net * Liberalization of foreign trade In addition to the usual relationships between macroeconomfic and foreign trade policies, Czechoslovakia faces a particularly sharp and unique trade-off: the need to incorporate some measures into its stabilization program to buffer the unemployment shocks caused by the collapse of exports to the U.S.S.R. This is explored further in Section B. Trade policies and domestic policies on price liberalization, privatization, and the social safety net constitute the microeconomic elements of the transition program. Of the various links between trade and the three domestic policies, two stand out. First, early and effective privatization is a prerequisite for the structural adjustments that trade liberalization is meant to stimulate. Second, an open and liberal import regime is essential to offset the monopoly power effects created by the small size of the economy and the high degree of concentration inherited from the past. With respect to trade policy (see chapter 2), two key concerns stand out. One is the very low level of tariffprotection, which is appropriate to the needs of a competitive opening up of the economy but tends to increase lobbying pressures for non-tariff import restrictions. The other is the inevitable reorientation of economic relations toward Western countries, especially Europe, which puts great pressure on Czechoslovak authorities to negotiate for the most favorable form of association with the EC. - 47 - The five key issues emphasized above-the stabilization implications of the collapse of exports to the USSR, the.need for rapid privatization to allow trade policies to have the desired effect, the need for liberal imports as an antimonopoly tool, the risk of low tariffs creating pressures for nontariff protection, and the pressure to negotiate a favorable EC association agreement-are linked together by a common underlying root cause. That root cause is the technologically backward and distorted industrial structure created by Czechoslovakia 's comfortable dependence on the USSR for low-cost raw material imports and assured export markets (see Chapter 3). Czechoslovakia's apparently stable trade balance was a mirage. In fact, trade was balanced only in financial terms because the artificial prices of CMEA trade favored Czechoslovakia. At world prices, there had always been a trade deficit, but the implicit economic "debt" accumulated in trade with the USSR was not being debited and has in effect been "forgiven." But this gift had a heavy price. Czechoslovakia's dependence on the USSR and other CMEA partners was greater than that of Poland and Hungary and resulted in an economy that was more autarkic than theirs. With its technological developments focused strongly on the Soviet relationship, Czechoslovakia was falling farther and farther behind global standards. The problem now is to overcome the double short-term shock of facing real world prices for raw material imports and a declining volume of exports to the USSR while-also beginning to integrate Czechoslovakia's distorted and technologically lagging economy into the global economy. Trade policies and macroeconomic stabilization Although Czechoslovakia has no foreign debt problem, a number of macroeconomic disequilibria have revealed themselves in the 1990's. One is the inflationary pressures created as price liberalization has released the excess supply of money (monetary overhang). Another is the large debt burden carried by state enterprises to state banks. These debts, including the nonperforming perpetual accounts, are financially destabilizing both for the enterprises that are unable to service them and for the banks that hold the assets and are unable to exercise their new freedoms as credit-issuing intermediaries. A third macroeconomic imbalance is created by the sharp decline in production and employment that occurred in 1991. In response, the authorities have implemented a restrictive macroeconomic stabilization program: a fiscal surplus of nearly 1 percent of GDP; monetary expansion of 5.9 percent a year in the face of expected inflation of 30 percent or more to achieve the anti-inflationary effect of restrictive fiscal policy; and a sharp devaluation of more than 80 percent over one year, combined with a shift to - 48 - internal convertibility. The course followed is a sensible one, but the external shock of collapsing Soviet trade, plus the inevitable delay in privatization, puts considerable pressure on the program. Collapsing exports to the USSR came at the worst possible time, adding to the recessionary forces accompanying adjustment. A 50 percent drop in Soviet exports by itself may generate as much as a 5 percent fall in GDP. Reduced imports of Soviet raw materials may cause further production cutbacks because of supply bottlenecks, while sharp cuts in subsidies bring state enterprises up against hard budget constraints, also forcing back production. This decline in GDP may be greater than the 10 percent expected. Inflation looked likely to exceed its 30 percent target, with the consumer price index registering a 35 percent rise in the first two months of 1991. The picture looks better for devaluation and internal convertibility goals. They are likely to remain on target if changes in the black market premium are any indication: it fell substantially, from 150 percent in January 1990 to, 15 percent in January 1991. But developments in the current account are not yet clear enough for assessing the convertibility program. In the near term, the appropriateness and sustainability of an exchange rate of 28 Kcs to the dollar may be less important than the sustainability of the tight monetary policy. For now, the prudent course is to continue a restrictive policy. If the recession is worse than expected and the unemployment effects of the collapse of USSR trade exceed 10 percent, pressures for monetary easing will arise. Autonomous expansion of interenterprise credit must be stemmed before any monetary easing is considered, however. There may come a time when a trade-off is inevitable between using macroeconomic policy to deal with the extra unemployment (some additional monetary expansion and allowances for limited export-credit financing) or risking -a buildup of political pressures that eventually force the use of less efficient microeconomic tools, such as direct subsidies to production and unsalable inventories. Trade and domestic reform measures Three key domestic adjustment mechanisms must be put in place to allow for the necessary reallocation of resources to occur. Privatization is required to give scope to the profit-seeking motivations and incentives of producers to act freely on the market. Price liberalization must take place to permit markets to signal to producers, via free prices, the most efficient path for economic activity to follow. And a social safety net needs to be in place to ensure that those dislocated by the shifts in resources are not abandoned but are assisted in reestablishing themselves in a new economic environment. - 49 - The general strategy of reform in Czechoslovakia has taken this interplay of policy changes well into account. The details of tactical implementation need careful attention. Privatization procedures, including a restitution law, are in place, but the process will take a long time. Restitution claims will have to be clear before any serious interest in purchasing state property is likely to be expressed, especially by foreign investors, despite very liberal regulations on foreign investment. The process of drafting privatization proposals, valuing assets, receiving Ministry of Finance approval, and offering shares for sale will also take time. Finally, the uncertainty of how individuals will use their vouchers to buy shares when no mechanism exists for this purpose further complicates the process. The slow pace of privatization will have repercussions on foreign trade. Uncertainty about restitution will discourage major foreign investment and delay many projects involving exports. Management old and new will devote its energies to the privatization problem first, also delaying substantial new reinvestment and reorientation of production. Consequently, the supply response of exports may be limited for the first few years, as will be the ability of domestic producers to compete with attractive, newly liberalized imports from the West. Thus substantial current account pressures may exist for some time. This is not to say trade account movements will not occur, but as in Poland in 1990, any substantial export expansion before privatization may depend more on the lagged devaluation effects and the sharp decline in domestic consumption, and less on substantial adjustment within industry. The sooner privatization can proceed, the greater the response to foreign trade opportunities and competition. The freeing of prices has been far easier to implement both administratively and politically than privatization. A wide-sweeping liberalization of prices occurred in January 1991 that left only about 20 percent of prices regulated. The most important immediate relation of price policy to trade policy concerns the need for export restrictions on goods with regulated prices. Such restrictions can be removed only after price liberalization occurs. A less immediate and less evident effect of price liberalization may be the ability of monopolistic enterprises to raise prices without increasing supply. While import liberalization ought to provide a competitive stimulus, the combined effect of an average 15 percent import surcharge and tariffs averaging 4-5 percent, but reaching as high as 70 percent, provides a considerable margin for monopolistic behavior. The solution is not to re-regulate prices, but to move quickly on privatization and removal of the 15 percent surcharge to stimulate import competition. In countries undergoing restructuring and privatization, unemployment is generated through both the shedding of redundant labor in grossly overstaffed state enterprises and the closing down or - 50 - scaling down of numerous enterprises or whole branches of production. Czechoslovak authorities project that unemployment will reach 5.2 percent of the labor force. The collapse of exports to the USSR may alone disemploy up to 5 percent of the labor force-some estimates even put this as high as 10 percent. Czechoslovakia has a long tradition of unemployment insurance and social assistance. On January 1, 1991, the government introduced a relatively generous system of unemployment compensations with benefits averaging 47 percent of the average net state sector wage. No special fund for unemployment benefits was set up, and the benefits will be paid out of regular government revenues. Since these payments are likely to be quite large-and larger than expected-the govermnent may want to consider special taxes to provide at least partial coverage, as is common in most industrial countries. Since the slow process of privatization will also delay the inflow of foreign investments, the effects on the economy are not likely to be felt for some 3 to 5 years. That means that Czechoslovakia will have to face relatively high levels of unemployment, resulting from systematic and structural causes (overstaffing and inappropriate structure of production) and from the collapse of CMEA trade. From the Czechoslovak perspective, that collapse is an exogenous shock that is unlikely to be reversed in the immediate future and so must be absorbed by existing mechanisms. Czechoslovakia's pre-existing social safety net and its recently introduced unemployment compensation are just the mechanism needed to ease the adjustment to trade shocks or opportunities. - 51 - Chapter 5. Support Services For Exports: Contribution of Private and Government Sectors In countries embarking on trade policy reform, the need to supplement policy incentives like devaluation and trade liberalization with various kinds of institutional assistance to exporters is commonly argued. In transitior. economies such as Czechoslovakia's, producers have almost no experience with markets or international trade and finance procedures, because the country has engaged in very little market-based trading and because official foreign trade organizations have monopolized trade. Three types of support service are particularly relevant for Czechoslovakia: • Provision of export credit. * Insurance or guarantee of payment for exports. * Provision of technical support services needed for export expansion, covering production methods, marketing, and information. Why support services matter In the past, export flows were centrally determined according to such objectives as the distribution of monopoly production units among CMEA members, the need to serve Soviet policy through highly subsidized arms sales to client states, and the need for each industrial ministry to earn enough foreign exchange to pay for its own imports. The new government intends a radical change in approach to foreign trade, with export flows determined primarily by market forces reflecting Czechoslovakia's areas of international comparative advantage. In the inevitable and substantial adjustment process for industry that follows, there will by losers as well as winners. The faster the government is able to demonstrate clear and substantial economic gains from the process, the greater the chance of retaining political support for the reforms despite the pain involved. Thus, the faster exports expand, the more likely it is that the adjustment process will be sustained. And this is where support services can have an important impact. All three types of services described here support export expansion in firms able and willing to exploit their competitive advantage in response to the new incentives created by the policy reforms. But without access to additional credit and to insurance to reduce the risks of nonpayment in distant and unfamiliar markets, export expansion will be slowed. And finally, the changeover from the old incentives for exports (government purchase orders, subsidies) to the new ones (profits) implies major changes in methods - 53 - of production, attitudes toward quality, and worker motivation, as well as learning about marketing almost from scratch. Czechoslovakia has substantial potential for fast export expansion, but achieving it will require a radically changed production base. Two examples illustrate the potential and the need for support services. In less than two years, a shirt factory transformed its production from long runs of standard business shirts for the domestic market and CMEA to short runs of high-fashion, medium-quality shirts for the German market. Wages are perhaps one-fifteenth those in Germany-equivalent to those in North Africa. Yet the factory is just a short, easy drive from German customers. In the early days, the price advantage was so great the German buyers were willing to provide free in-factory technical assistance. Marketing assistance was not really needed, since buyers drove over to the factories once they heard what was available. To fully exploit this area of very clear comparative advantage, however, beyond the expansion of an occasional factory, will require much more technical and marketing support. In the traditional glassware area of Novy Bor in northern Bohemia, some of the damage done to the industry over the past forty years by the nationalization of the small village workshops into a monopoly combine is beginning to be undone. Glass decoratQrs are leaving that organization to again set up independent workshops in their villages. With the right help in methods and marketing, diversity will return to this industry. While a future in exports looks very bright for these light and flexible industries near the German border, things look much less promising for the many heavy engineering plants spread throughout the country. Many of these enterprises were established to serve the requirements of the CMEA. Transforming them into internationally competitive units is likely to require fundamental and painful changes, far beyond the provisions of export support services. The provision of credit for export expansion Under the old regime, all exports were sold through the fifty or so foreign trade organizations, each with a monopoly in its particular product range. Since the trade organizations had monopolies in both exports and imports, they were able to finance their own activities to a large part by obtaining extended credit from foreign suppliers. Local manufacturers, exporting through the trade organizations, were usually paid on shipment, thus virtually eliminating their need to seek specific export credit from the market. - 54 - Since all longer-term investments were decided centrally by the Planning Commission and then automatically financed, there was also no need for an active market in longer-term project finance to serve exporters wishing to expand. Nor was there much need for banks to be experts in foreign operations. Today, the demand for short-term credit has exploded. The old rules governing payments in the domestic market have gone, leaving suppliers to collect on their own but without the skills or leverage needed to do so. That means that domestic commerce is absorbing much more bank credit than before. Devaluation has also increased the demand for credit to finance imports. And the steady rise in the number of firms directly engaged in importing or exporting following the foreign trade organizations' loss of monopoly control has further increased the demand for bank credit. Development of an effective credit market lags far behind this exploding demand. Banks need to transform themselves from,specialized monopolies into universal commercial banks, but progress so far seems limited. The problem is daunting. Under the old regime, for example, only one bank handled foreign currency operations. Now, all commercial banks will need to develop these skills. Clearing a cheque from Germany normally takes two months. Obtaining a simple bank guarantee still requires ministry approval. Progress is further constrained by a cap on lending rates (currently 24 percent) and limits on lending volumes for individual banks. Such tight regulation of the credit market combined with the caution of banks in the face of major change seriously limits the supply of new credit for financing export expansion. The problem is compounded by the fact that much of the existing supply of credit has been locked up in underperforming assets, another legacy of the old regime. Before the bank consolidation action (see chapter 1), at least 30 percent of borrowers were said to be in severe financial difficulties, and it is unclear how much this situation has improved since then. One reason was the huge levels of stocks tolerated by the old system-wholesale trade, for instance, still operates with a stock turnover time averaging 92 days. One large engineering enterprise admitted to holding stocks valued at kcs 5 billion. A recent government action was intended to transfer between 50 percent and 80 percent of the stock level as of November 30, 1990 from general overdrafts, averaging 22 percent, into eight-year term loans of 11 to 15 percent (typically 12 percent), to be paid off on a straight-line basis. But unless there is an economic upturn soon, this measure may merely prolong the problem. Seriously underperforming stocks need to be revalued realistically through liquidations or distress sales and - 55 - perhaps as part of privatization. New deposits could then be channelled into new, more productive assets instead of being absorbed into continually growing underperforming loans. Market-determined interest rates would help to speed this process; heavy interest rate subsidies are likely to slow it down. But even if this new scheme does free up some of the resources tied up in dead stocks, bankers indicate that these resources would not be available to banks as additions to new lending, since existing volume limits would remain unaffected. Thus the tightness in the emerging credit market continues. Recommendations for the short term As inflationary fears subside, authorities should eliminate both interest rate caps and volume limits on bank lending, and exporters should compete with other users in an unimpeded credit market. This may not be possible in the short term, however, pending broader financial sector reform. A second-best solution would be to accept the reality of continuing credit allocation but to allocate credit specifically for export purposes to stimulate entry into global markets. Interest rate subsidies to support exports should be avoided, however. They are of uncertain value as an instrument for extending exports, and there are better ways of supporting export expansion (Fitzgerald and Manson 1988). But a different policy should apply to export credits for the Soviet Union. Once firm orders come in again from that region, at whatever level, Czechoslovak exporters should start quickly to compete without subsidies or they should use export credit or other assistance to redirect their productive resources to other activities. If the Soviets continue to press for very long supplier credits, (five years for factory machinery, for example), exporters should follow Hungary's example: accept orders only if backed by bank guarantees and use the guarantees to raise financing, wherever they can, on an unsubsidized commercial basis. Export credit for consumer goods under Berne Union rules is likely to be used by Soviet negotiators and in general practice does not exceed six months, while credit beyond three years is found only for very large orders of capital goods. In the short term, authorities should encourage and perhaps even subsidize training of bank staff in export financing and related international operations. Much if not all of this training can be done through private sector efforts, with the government acting as an information intermediary, arranging foreign aid financing for copayments through the State Bank. - 56 - Recommendations for the longer term In the longer tern, what matters is to have effective and active credit markets that provide exporters with both short-term working capital and longer-term project finance. A fully developed market for financial services for exporters would provide the following specific services through specialized intermediaries or service suppliers: * Short- and medium-term finance for preshipment working capital and postshipment credit extended to buyers. * Risk insurance, both commercial and political. * Insurance or hedging the risks of future currency movements. * Longer-term project finance, to support the expansion or adaptation of productive assets for exports. Because of the specialized nature of these services, their development could be strengthened and expedited through the injection of foreign financial services. Joint ventures are the currently popular way of achieving this transfer of know-how, but it can be purchased as well, should an institutipn prefer to retain local ownership and control. It is essential as a first step to proceed with financial sector reform as quickly as possible; and secondly, that, in support of that reform process, the CSFR government should utilize Technical Assistance liberally, so as to inject quickly the know-how needed to develop all these vital export support services. Recommendations on the institutional delivery of services These services can be delivered by the newly emerging universal commercial banks, by other specialized institutions, such as invoice factoring houses, export bill discounters, credit insurers (see next section), and longer-term industrial finance providers. If special export lines are to be rediscounted by a wholesale tier in the banking system, this could be done by the central bank. There is little need for a specialized export-import bank. The only real contender for this role, Obchodny Bank, has wisely decided that its future is as a universal commercial bank, not an export-import bank. Insurance of payment risks The population of Czechoslovakia was much more insurance-minded than that of most other Soviet bloc countries, a legacy of its pre-World War II economic strength. Under the old regime, 99 percent of personally owned housing was insured, as was the contents of 75 percent of homes. - 57 - Insurance coverage for business enterprises was, however, more affected by Communism. For a time, insurance of enterprise assets was actually forbidden. Even in later years, there was little incentive for an enterprise to insure its assets since the government, not the enterprise, made all reinvestment decisions. Under the old regime, there were only two insurance companies, one in each of the two republics. They offered very limited export credit insurance coverage. The state never encouraged such coverage with any enthusiasm, nor did it provide any subsidies to cover export payment risks in developing countries. The government apparently took the view that these exports, which were dominated by arms sales, were political gifts, for which there would be little or no pressure for eventual payment. The only risks covered by the state insurers were the formal bankruptcy of the buyer and losses resulting from contested credit documents. No information on coverage of exports could be obtained, but indipations are that even the foreign trade organizations-to whom the service was directed-gave the scheme little credence. There have been few real changes in this situation under the new government. The insurance companies do not seem to have actively marketed their services to emerging exporters, and real change will have to await fundamental reform of the insurance market, which is now beginning. The law demonopolizing the insurance industry in the Slovak Republic went into effect only in February 1991. It allows for up to 25 percent foreign participation in insurance companies and for a transition toward a more fully open market. The law for the Czech Republic is still being formulated. That law is expected to be more open to foreign participation, allowing up to 45 percent participation and only a one-year transition period. As a result, the Czech state insurance company is already seeking a joint-venture partner, despite its commanding monopoly position. The company has for some time expressed a willingness to extend its export credit coverage to political risks, as long as the state gives support. The discussion on support has centered on a straight annual subsidy, but the Minister of Finance made it clear that no funds would be available from the 1991 state budget for the subsidy. Recommendations for encouraging insurance provision Export insurance services should be encouraged in three phases, as follows: * The government should give particular attention to such services as an element of a broader effort to create a competitive market in insurance services. Only services that are viable on a fully commercial basis should be considered in this initial phase. As in the case of credit services, bringing - 58 - in foreign know-how, either through joint ventures or consulting services purchased by local institutions, will be critical. * At a later stage, following the practice in most OECD countries, the government may wish to offer political risk guarantees covering transactions in developing countries and perhaps in ex-CMEA markets. If so, it should direct the guarantees through the newly created commercial market in export credit risk insurance. Commercial insurers could thus extend the coverage offered, backed by the state guarantees. Experience in OECD countries, where the practice is common, suggests that it should be possible to operate such a system at no cost to the state budget in most years. * If despite the arguments against export subsidies-which are the same for subsidies to export credit risk coverage as for direct subsidies for export credits-the government eventually decides to introduce this form of tied development aid, the subsidy amount should be determined in advance. Practice should follow recent OECD guidelines on limiting subsidies to a predetermined fixed annual sum, rather than agreeing to open-ended subsidies. This fixed fund could then be allocated to specific contracts according to national aid priorities, the value of the contract to local industry, and evidence of subsidies to competitors. As for the export credit guarantees themselves-which are employed in some countries to encourage banks to lend to exporters-the trend in OECD countries is for governments to stay out of the business of guaranteeing the repayment performance of exports. There are other, more effective ways that governments can help to improve the workings of the credit market for exporters. Broadly, modernization of the banking and insurance sector will provide better credit for exporters. Since what really matters is the ability of banks to appraise the risks of lending to exporters, support for training and technical assistance in appraisal skills within banks would be a far more cost-effective instrument than subsidizing export credit guarantees. Indeed, subsidies and guarantees reduce the impetus of banks to develop much-needed appraisal skills. Recommendations on institutional delivery of services At a time when OECD governments and the more successful developing country exporters are turning away from state involvement in the delivery of export credit risk services (see Keesing and Singer 1990 b), the Czechoslovak government should proceed cautiously in setting up new agencies to deliver such services. It should actively support the development of a competitive market in the types of export credit risk coverage that represent viable commercial profit opportunities for private 59 - insurers. Later, the government can decide whether to add state guarantees or subsidies to this active market. Technical support services in marketing, production, and other fields Since the free trade organizations had monopolies in exporting, marketing was their concern. But because of the way CMEA worked, there was little of the active involvement with the marketing effort that is typical in market economies. On the production side, the lack of market pressures meant that there was less incentive to keep up with improvements in product design, quality assurance, worker attitudes, and production methods. The Czechoslovak Chamber of Commerce and Industry, funded by the Ministry of Foreign Trade, operated as the closest equivalent to an official trade promotion organization. From offices in Prague and Bratislava, it administered government support for participation in trade fairs, published magazines and guides for exporters and foreign buyers, and gave advice on international trade law. But its trade information services were rudimentary, since its foreign trade organization members built up their own specialized resources and contacts. These organizations viewed the chamber primarily as a conduit for high-level government-to-government contacts, particularly with other state-trading countries. Research on international trade and the collection analysis, and publication of trade statistics were hoarded by the Research Institute for Foreign Economic Relations, in Prague, which was also funded by the Ministry of Foreign Trade. The Institute provided no firm-level services in direct support of exports. The Trade Ministry itself operated a network of eighty-seven trade missions, run through the country's embassies abroad. These missions were strongest and largest in the state trading countries, where they appear to have operated virtually as unofficial agents for the foreign trade organizations. The trade missions seem to have been less effective in the market economies, where the foreign trade organizations operated through their own large networks of export agencies. Today, all these institutions are fighting hard for their survival. Without their monopolies, foreign trade organizations have been losing business badly. They are heavily criticized by manufacturers, who view them as ineffective price negotiators and poorly informed on technical sales functions. Their penchant for agreeing to package deals that combine some goods in high demand with less attractive goods is also criticized. Foreign trade organizations are unlikely to survive in their established form. One of Czechoslovakia's first bankruptcies, which occurred in 1991, was a foreign - 60 - trade organization; one can expect this to be the first of several. Some trade organizations are talking of transforming themselves into Japanese-style trading houses, serving small and medium-size manufacturers. But Czechoslovakia's central location in Europe means that many such manufacturers will probably be able to quickly develop the skills to export independently, so only a handful of trade organizations are likely to survive with such a strategy. The Research Institute is already raising an increasing share of its revenue from sale of its publications, to make up for big cutbacks in state funding. But it does not yet seem to have expanded actively into firm-level support services or to have acquired the staff it needs to offer such services. The Chamber of Commerce and Industry is fighting hardest for its survival. It has made some improvements to its services linking buyers directly with Czechoslovak suppliers, though this has been constrained by its computer hardware resources. It has started preparations for a world trade center in Czechoslovakia, affiliated With the international network of world trade centers. It hopes to host the European Community's information center in Prague. Most important, the chamber is lobbying hard for the establishment of a system of compulsory regional chambers, such those found in much of Western Europe. This lobbying has not been well received by politicians, however, who are averse to any form of state compulsion. Without the assured funding that compulsory membership would bring, the future existence of the chamber would be uncertain, and at the least, its operations much smaller. Similar efforts to define an institutional role are occurring within the Ministry of Foreign Trade. Confusion is evident within trade missions, which do not seem to know where to send buyer enquiries, now that the old monopolies are gone, and seem to be making no effort to extend their services to new exporters. The Ministry plans to establish a trade information system to inform trade missions abroad about exporter supply capabilities within the country and to inform exporters about export opportunities abroad. The Ministry has discussed an aid project with the International Trade Center in Geneva to provide a large-capacity personal computer, plus some training. This effort is certainly to be encouraged, as long as private information networks are also free to develop. It is clear from fieldwork that few Czechoslovak manufacturers have any experience in export marketing. None of the enterprises visited by the mission had conducted any formal export market research. Some local service providers have set up shop in the private sector. Most appear to be one- person operations, typically run by former executives of foreign trade organizations offering overseas contacts rather than strategic marketing support. On the production side, an interesting development is the establishment of a small operation in Prague by one of the regional German technical supervision associations (Techischer Ueberwachungsvereine, or RWTUV), which have the exclusive right in - 61 - Germany to approve a wide range of products and production processes. RWTUV is one of the few service suppliers in Czechoslovakia actively supporting exporters, many of which are eager to learn about meeting German approval obligations, in order to export there. In addition, manufacturers exporting to Germany and other EC markets will soon need to meet quality systems approval at the plant level, under the EC standard EN 29000 (equivalent to ISO 9000). RWTUV is training Czechoslovak specialists to provide support services to help plants develop systems that meet EN 29000 requirements-a more cost-effective approach than using its own German specialists for this preparation work. Once this work is complete, however, the actual approval process will be carried out through RWTUV. Recommendations on technical support services Experience in other countries suggests that government financial support in the form of cost- sharing grants to exporters for the purchase of technical support services will pay handsome returns in the form of increased export earnings (Keesing 1989). In Czechoslovakia, too, this approach is likely to be the most cost-effective and influential means of promoting export expansion. The task is enormous, and the sooner enterprises bring in outside expertise in marketing and production, the sooner will exports expand. In marketing, the country is starting almost from scratch. Limited observations within factories suggest not only that equipment is outdated, but also that work methods, quality assurance, and worker motivation have dropped badly below the levels required to maintain international competitiveness. Outside know-how must be injected as quickly as possible. In nearly all areas that matter, foreign know-how can be bought from independent service suppliers, without the need to sell off equity, as is frequently assumed. Indeed, in many product areas, this approach is likely to appeal more to foreign buyers than is equity participation. A recent study of direct foreign investment out of the United Kingdom found most of it to be motivated primarily by a desire to obtain access to protected or otherwise difficult-to-supply foreign markets or to expand market share by buying up competitors (Singer 1990). Firms that in years past might have set up captive production units in low labor countries to supply OECD markets now find it more advantageous to buy at arm's length from independent suppliers. There will be only a handful of "gems' among Czechoslovak enterprises that, like Skoda cars, will be enthusiastically bought up by foreign firms wanting to extend their market share. But for most enterprises, an alternative method of injecting foreign know-how will be needed. Promoting the use of firm-level technical support service thus deserves the highest priority. - 62 - Recommendations on institutional delivery of services One of the important attributes of a cost-sharing grant system is that it supports access to a plurality of specialist service suppliers, both local and foreign, freely selected by exporters to meet their individual needs. In the early days, service suppliers will be in high demand, but later, local suppliers will emerge to take up market opportunities in service supply. The government should actively encourage pluralistic supply, accepting an initial emphasis on foreign supply and resisting efforts to establish a central state-run trade promotion organization. Contrary to popular perception, such organizations have been found to be of limited usefulness, even in the best of cases (see Keesing 1989 and World Bank/UNDP 1990). A decision on where to place the trade information system, which is being planned as a central service linked to the network of trade missions, should be based on plans for the future of the trade missions themselves. If the government decides on a compulsory system of chambers of commerce, then there is likely to be pressure to follow the Austrian model, in which the national chamber operates as a central supplier of marketing services and also operates a network of trade missions. The system is funded by a levy on trading activities that is authorized by the government. Such an arrangement is not recommended for Czechoslovakia. Czechoslovakia ought first to encourage exporters to seek help from local commercial marketing specialists based in each market and to co-fund a commercially operated "matching service' in Prague, to help foreign buyers locate the most suitable suppliers. Any decision about whether the chambers should be compulsory needs to be considered separately from the issue of institutional delivery of services since effective services are better provided by a plurality of specialists. The relevant concern behind a compulsory system of Chambers of Commerce is how best to create effective representation for industry and commerce in their dealings with goverrunent. The pressure to fund free centralized services will be greatest in the area of market information. Against the contention that this information is a public good, the strongest argument is that where information truly has value, exporters will be willing to pay for it. Increasingly in other countries, such as France, Germany, the Netherlands, the United Kingdom, and the United States, information services are being provided by the markets rather than as a free public good. A clear early decision by the government to opt for a market approach will encourage commercial suppliers into this market, an approach that will serve the needs of exporters much more effectively than any free public service could ever do. - 63 - Role of government institutions in promoting exports The best policy for promoting exports is an open trade and investment policy that encourages both imports and exports. Producing for export should be as profitable as producing for domestic consumption. This objective is best achieved not through special subsidies or other export incentives, but through a liberal import regime, which promotes exports, while also stimulating more efficient production by domestic firms. Above all else, successful integration into the global economy requires *a stable macroeconomic environment. Beyond establishing a favorable macroeconomic and microeconomic policy environment, governments have an important role to play in developing infrastructure, simplifying customs procedures, improving information on foreign trade, expanding export-marketing services, improving financial services in foreign trade, and ensuring development of facilities for export credit and export risk insurance. Infrastructure development There is a critical need to begin the modernization of telecommunications and transport networks. Some small but immediately helpful actions can also be taken. The authorities should ensure that imports of telecommunications equipment (telex and facsimile machines, multiple-line telephone units, computers) are not encumbered by high tariffs (currently from 14.0 to 18.6 percent plus the surcharge) and that customs clearance is quick and straightforward. Helpful actions in the transport sector would include rapid and early privatization of truck transport units, auctioning of individual pieces of equipment to speed establishment of new private sector transport firms, and regulatory review to ensure a favorable environment for new private sector transport services. Czechoslovakia's central location in Europe means that much of its trade is likely to be transported by road. Facilitating and encouraging small and medium-size transport firms should thus be a key early policy measure to promote trade. Customs procedures Simplifying the legal and physical aspects of customs clearance is both an important signal of a new emphasis on liberal trade and a direct cost-reducing incentive for imports and exports. The main steps-some of which are being taken under the technical assistance project with the EC-are simplifying customs forms and harmonizing them with international standards, computerizing customs administration, increasing entry and exit points, easing rules of inspection and verification, and -64 - switching from comprehensive to random inspection. Investment in computer hardware and software to improve data collection at customs points will also be a low-cost high-yield action. Basic information services The authorities should improve the availability of information needed for trading activities, such as basic statistics on import and export flows, lists of businesses involved in various lines of production and services both domestically and in other countries, and descriptions of trade regulations. Authorities responsible for trade-related policies (Ministries of Foreign Trade, Industry, Finance and the Central Bank) should begin by improving their own gathering and analysis of statistical data. Technical assistance projects, such as the ongoing projects with the EC to improve customs data and with ITC/UNCTAD to improve Ministry of Foreign Trade data systems, are a good way to begin. This information also needs to be made easily available. Laws and regulations should facilitate the development of private sector firms offering such services. Regulations must not impede private sector involvement, and public sector information on trade (statistical compendia, data banks, customized processing of data) should be provided to those seeking it on a fee-for-service basis. When the government does not charge a fee for the information it provides, private organizations seeking to provide the same services are at a severe disadvantage, and the government receives no feedback on the usefulness of the information it collects. Export-marketing serices Government authorities should avoid establishing public agencies to provide export credit, export credit insurance, or export promotion and marketing services. Rather, the focus ought to be on facilitating private sector development of export-support and marketing services that were unavailable in the past. While it is true that governments around the world have such official trade promotion organizations, objective assessments have almost always concluded that they serve, at best, a marginal role at high cost, while impeding the development of efficient private sector providers of such services. At the very least, public-funded agencies should not have a monopoly on such an activity, and they should operate on a fee-for-service basis. In all the areas of export support services, the need for outside technical .assistance is great. While this assistance is channeled through the government, its emphasis should be on facilitating private sector market-based provision of services in export marketing analysis, management, and production. The government needs to ensure open access to foreign firms providing such services. Many foreign firms will find it advantageous to establish - 65 - branches in the country, thereby providing rapid access to this kind of know-how. Government resources spent on export-marketing services ought to go toward channeling donor funding of technical assistance or business development loans to the private sector rather than to public entities. FYnancial services and export financing Extensive training is needed in the financial sector on the technicalities of international commercial operations: letters of credit, foreign currency transactions, and the like. International donor funds are widely available for such activities, but they cannot go directly to private entities. Government units, therefore, need to act as intermediaries. Most countries have established some form of support for export financing-subsidized credit, foreign-exchange risk coverage, and export risk insurance. Objective assessments have generally found these activities to be inefficient or marginally effective at best. But governments do have a role to play in establishing networks of financial services for international trade operations, export credit, and insurance. The problem has been too much involvement and involvement of the wrong kind. In the early phases of the transition, when market-based institutions are not yet in place, it is certainly appropriate for government authorities to encourage their rapid development. Most immediate and most important, regulations should be reviewed to ensure that there are no impediments to private sector provision of such services, whether by domestic or foreign firms. Government agencies that provide such services should be subject to competition. Monetary authorities have an important role to play in providing rediscounting facilities for export credits. Authorities can help with export-risk insurance by channeling technical assistance and other resources for training activities to develop the skills needed by banks and insurance companies doing their own assessment of risks. The government can also facilitate insurance-pooling arrangements among private sector domestic institutions, avoiding potential collusion effects by ensuring that foreign financial firms are free to offer their services as well. -66 - APPENDIXES Appendix 1. The Stabilization Program and Trade Performance Czechoslovakia has undertaken a courageous program of comprehensive reform intended to transform the economy from a centrally planned to a market-based system. While trade policy reforms and liberalization are the focus of this report, any consideration of the strategy for integrating Czechoslovakia into the global economy must also consider the other elements of the transition program: macroeconomic stabilization, price liberalization, privatization, and social progress to ease adjustment. The macroeconomic stabilization measures provide the secure environment needed for market-based responses to trade liberalization measures. Price liberalization, privatization, and safety net mechanisms also critically contribute to the responsiveness of the economy to trade promotion incentives and influence the short-run prospects of trade performance and foreign investment. Overview of macroeconomic situation The stabilization program has three elements: * Substantial cuts in government spending, especially subsidies to state enterprises, resulting in a planned surplus of nearly 1 percent of GDP. * Restriction of money supply growth to 5.9 percent, aimed at keeping inflation to 30 percent after the effects of widespread price liberalization. * Devaluation of the koruna to 28 to the U.S. dollar and establishment of internal or current account convertibility. There is no question that this is the correct course to follow. From the viewpoint of trade performance, this program provides exactly the stable economic environment needed to promote appropriate new trade and foreign investment responses. It does so in several ways. The strong fiscal and monetary discipline of the stabilization package gives the signal of sound economic management that most analysts agree is the first prerequisite of a successful outward-oriented trade promotion strategy (see, for example, Sachs 1989, Edwards 1990, Havrylyshyn and Thalwitz 1991). The hard- budget constraint on state enterprises pushes them to seek more efficient production opportunities, including exports or competitive import-substitutes, even before privatization. Perhaps most directly beneficial to trade promotion is the unification of the exchange rate and its devaluation, which together with trade and price liberalization make exports more competitive and domestic production - 69 - more efficient. These stabilization measures are expected to result in a 10 percent drop in GDP in 1991 and a 5.2 percent increase in unemployment and 30 percent inflation. The structure of the financial system Until 1989 the structure of the financial system was quite simple. The Savings Bank received nearly all koruna deposits from individuals, leading a small fraction directly to enterprises and depositing the rest at the State Bank. The State Bank played the role of central bank and major lender to enterprises, a system that was equivalent to 100 percent reserve requirements with direct credit rationing through Central Bank rediscounts. In 1990, the State Bank was divided into the Central Bank and the Commerce Bank, which handles credit transactions. There are two other state-owned banks with relatively modest market participation. The system remains under the control of the state- owned institutions, although private banks, whether foreign or domestic, are permitted under the reform. In January 1990, interest rate controls were lifted and all banks were allowed to compete for all types of deposits. From June 1990 to November 1990, the Savings Bank lost Kcs 16.2 billion in withdrawals from individual accounts, while the other banks in the system registered increases of Kcs 5.4 billion. The net loss in deposits of Kcs 10.8 billion reflects reduced demand for Koruna assets because of expectations of inflation and devaluation. Before 1990, borrowing rates were set at around 2 percent for demand deposits and 4 percent for time and savings deposits, while lending rates to enterprises stayed around 5.5 percent. Since liberalization, interest rates have risen significantly. By February 1991, lending rates (which rose as high as 24 percent; see table A1.1) were slightly below the inflation rate target for 1991 (30 percent), but most of the 1991 inflation probably took place in January and February, when the overall price index rose by 25.8 percent and 8.8 percent, respectively. Authorities expected inflation to proceed at the rate of about 1 percent a month for the rest of 1991. Even if this rate were exceeded somewhat as a result of the mid-1991 round of price liberalization, lending interest rates might remain high in real terms when measured against expected inflation. This may contribute to an already complicated situation in the real economy, but can be justified as an attempt to avoid a speculative inflationary outburst. - 70 - Table Al.l Interest rate structure as of February 1991 Inerces rates Transferable deposits I month 5.5 3 months 9.0 6 months 10.7 9 months 11.5 Long-term bond 5 years 23.0 Savings accounts 9 months to I year 14-15 1-2 years 15.5-16.5 24 years 17.5-18.5 Loans Onc year 16.5-24 1-5 years 18-24 5 years+ 21-24 Ovcrdraft 30-38 Source: Commerce Bank. In the mid-1960s the government expropriated the operating balances of state enterprises deposited in the financial system in order to cover its own financing needs. In return, enterprises received a special line of credit for working capital. This line of credit came to be called the "perpetual credit line" because it had an undefined maturity, and because, in practice, all nominal interest accrued was automatically rolled over. When people started to withdraw their funds from the banks after financial liberalization began in mid-1990 banks tried to collect the loans made to state enterprises, which had received the bulk of banking system resources. Since these enterprises had no funds with which to repay their debts, the basic insolvency of the financial system became evident and interest rates rose substantially. The financial position of the Commerce Bank deteriorated rapidly since a large fraction of its accounts were invested in the nonperforming perpetual portfolio. In March 1991, to alleviate the liquidity situation, two-thirds (Kcs 120 billion) of the perpetual account debt was absorbed into a new Consolidation Bank or Fund. Enterprises are to repay this amount over eight years at 13 percent interest. While this cleans up the balance sheets of both the Commercial Bank and debtor firms, the problem remains large. Kcs 60 billion in debt remains to be paid (or rolled over) at 24 percent, and another Kcs 350 billion or so of "performing" debts at lower rates is also owed-debt that could be considered "performing" only while state firms were heavily - 71 - subsidized and the economy was not facing a 10 percent decline in GDP. Any extension of debt absorption beyond the perpetual accounts would merely substitute an easy debt policy for the previous subsidy policies. What is important to note here is that the liquidity problem of the financial system, while considerably ameliorated, still bears some risks. Recent fiscal developments In 1990 the Treasury managed to generate a Kcs 1 billion surplus, less than the budgeted surplus of Kcs 5.4 billion. For 1991, budget projections called for a surplus of Kcs 8 billion, close to 0.8 percent of GDP (table A1.2). The most significant changes in the projected budgets between 1990 (before the reform) and 1991 (after the reform) are the Kcs 64 billion reduction in subsidies to enterprises (down from an initial planned level of Kcs 114 billion in 1990) and a Kcs 59 billion increase in social security outlays (up from a programmed level of Kcs 101 billion in 1990). The main reasons for the increase in social security outlays are, on the one side, the adjustment in payments due to past inflation and, most significantly, was the rise in unemployment compensation benefits as GDP fell 10 percent below the expected level. Table A1.2 Fiscal budgets, 1989-91 (billions of current koruna) Actual Projected 1989 1990 1991 Revenue 463.7 466.0 464.5 Income & profits taxes 168.6 159.3 158.2 Payroll taxes 112.3 109.3 119.3 Taxes on trade 8.0 11.8 8.0 Fenzo n.a 8.1 0.0 Custom duties n.a. 3.7 8.0 Indirect taxes doc. 132.0 142.9 154.3 Other revenue 43.0 42.7 24.7 Expenses 473.3 465.0 456.5 Goods and services n.a. 180.1 191.2 Social security 96.2 114.7 160.1 Transfer to enterprise 102.2 101.2 49.5 Capital expenses 47.3 50.8 45.2 Other expenses n.a. 18.2 10 Surplus/deficit (9.6) 1.0 8.0 Source: Ministry of Finance. The most significant change in the tax system in 1991 was the elimination of the tax/subsidy compensation scheme for foreign trade operations (FENZO) that completely severed domestic prices - 72 - from foreign prices even for goods that were traded internationally. While the FENZO scheme had little net fiscal: impact (subsidies to exports were almost balanced by collections from imports), its elimination restores market arbitrage for the prices of internationally traded goods. With implementation of internal convertibility of the koruna and elimination of the FENZO scheme, the domestic and international prices of traded goods are once again linked. The transmission of prices across that link will, however, be fully restored only after trade flows reach normal levels of operation, a goal that could take several months for imports and perhaps years for exports. The temporary surcharge of 20 percent on imports of consumer goods was expected to double custom duties revenue in 1991 (to Kcs 8 billion), but early 1991 data show collections lagging far behind this level, suggesting that import projections were too high or that exemptions were greater than projected. Since there is already some discussion about how long the surcharge will be maintained, its contribution to the budget may change later in the year, affecting the estimate of an overall surplus of Kcs 8 billion for the year. Monetary policy The elimination of most subsidies and the liberalization of prices that began in 1990 also brought with it a significant increase in inflation, a phenomenon more appropriately considered as a once-and- for-all adjustment of prices toward their equilibrium level, following decades of controlled prices in a centrally planned economy. Like other socialist economies, Czechoslovakia had a significant degree of monetary overhang as a consequence of price controls, money creation, rationed supplies, and a lack of attractive alternatives for the use of the monetary balances. Unable to shift their holding of domestic currency into goods, many chose to purchase foreign exchange in the black market. The black market premium thus became an indicator of currency overhang. During the 1980s, the premium ranged from 80 percent to 180 percent (table A1.5). Following the liberalization measures of mid-1990, the premium fell to the 15-20 percent range and should continue falling as internal convertibility takes hold (foreign exchange licenses are just starting to be granted). The index of the real value of the broad money aggregate (M2) increased from 100 in 1970 to a high of 337 in 1989, a threefold rise during a period when net material product just doubled (table A1.3). While some of this growth may be explained by a high income elasticity of demand for money (a value of 1.5), at least part of the growth in real money was probably due to an increase in the degree of monetary overhang given the lack of spending alternatives. - 73 - The availability of foreign exchange for imports, the elimination of subsidies, and the restoration of price flexibility have all contributed to the restoration of equilibrium in the money market, as evidenced by the fall in the black market premium for foreign exchange. Henceforth, the rate of inflation is likely to be much more closely related to expansion in monetary aggregates than it has been in the past. The change in the monetization trend was abrupt after the first liberalization measures of 1990. The index of real M2 fell from a record high of 337 to 284 in 1990 (a 16 percent fall) and was expected to drop to 236 by 1991, an additional 17 percent fall. The monetary program for 1991 calls for a 5.9 percent growth of nominal broad money, with domestic credit expected to increase by 16.3 percent (the difference in growth rates of the two aggregates is due to a planned fall in international reserve assets). While the rates are high by historical standards, they appear to be highly restrictive in the current situation. The CPI inflation rates of 25 percent for January 1991 and 8.8 percent for February have already pushed the rate for the year to more than 35 percent, and mid- year price liberalizations are expected to boost prices again. Considering this inflationary trend, the programmed rates of monetary and credit expansion will be highly restrictive, particularly with the economy already facing the prospects of a deep contraction because of the sharp decline in exports to the USSR. While a decline in real money was required to eliminate the monetary overhang inherited from previous years of price controls and shortages and was appropriate during liberalization of the foreign exchange market, more flexibility may be needed now. If the contraction in economic activity turns out to be much more severe than anticipated, the 5.9 percent target may need to be revised as long as the premium on foreign exchange remains within tolerable levels. However, the prudent path of monetary expansion should not be abandoned. In addition to the economic stabilization argument for flexible revision of the money growth target, there are two other reasons for recommending a somewhat higher-and perhaps more realistic-growth rate. First, with the apparent overshooting of the expected inflation target of 30 percent, the program targets may be inconsistent, making the 5.9 percent rate impossible to achieve without a GDP decline larger than 10 percent. Insisting on unachievable targets could undermine the credibility of the government's otherwise sensible policies. Second, the combined effect of the demand shock from the collapse of exports to the USSR and the reductions in production attributable to the transition program (hard-budgets, in particular) may push the GDP decline beyond 10 percent, leading to a rise in social and political pressures for undesirable measures, such as meeting the demands for export credits for the Soviet market. If the possibility of such outcomes is not incorporated into macroeconomic projections in advance, ad hoc solutions may be applied at the local - 74 - level that are likely to be more distortionary than would be a slight easing of macroeconomic policy. The balance is a delicate and difficult one, but (unlike the case of Poland) tight money policies are being aimed at inflation rates in the double, not the triple digits. Macroeconomic effects of the collapse in trade with the USSR One complication that may seriously affect the macroeconomic outcome for 1991 is the collapse of exports to the USSR. The direct effects of a 50 percent decline in USSR exports include unemployment as high as 200,000 to 250,000 people and a drop in tax revenues of as much as Kcs 22 billion. Pressures have built to provide supplier credits far in excess of the 1991 budget provision of Kcs 500 million for export promotion. Estimates of financing needed to sustain exports to the USSR range as high as Kcs 80 billion. State Bank allowances in the 1991 program have included up to Kcs 10 billion credit line creation by banks, but pressures will continue either for more credits or-more dangerously-for other forms of indirect support for affected enterprises. The government is, of course, in no position to finance such an expansion in export credits under its budget and monetary program for 1991. Any additional export financing granted would directly affect the budgetary and monetary projections at a time when. the macroeconomic equilibrium is already precarious. The financing of exports to the USSR is the most crucial macroeconomic problem currently being faced. If only a fraction of the expected $4.5 billion in projected exports to the USSR can be exported because of the lack of financing, the effects on the real sector could be even more substantial than the expected fall of 10 percent in GDP for 1991. But to provide all the needed financing through domestic credit expansion would imply a rate of monetary expansion totally inconsistent with inflation projections and seriously risk the danger of a run against the currency. The problem of exports to the USSR needs to be considered from several perspectives. Incentives are needed to encourage domestic firms to diversify their exports away from the USSR. Some credits could be offered through competitive commercial channels, but only on the condition that firms explore diversification alternatives, including the option of selling their accumulated stocks in other markets at significantly lower prices. Some decline in output needs to be accepted, and appropriate actions taken to buffer the effects. - 75 - Table A1.3 Basic monetary statistics, 1970-91 M2h/lH M2/GDP M2/CPI Deposis Currency CPI 1970 35.3 n.a. 100.0 116.1 17.8 89.4 1975 48.5 n.a. 175.7 197.7 27.7 90.1 1980 54.6 53.2 217.8 270.4 41.6 100.0 1981 56.3 58.0 228.4 292.2 43.3 100.8 1982 58.0 60.4 233.7 317.3 46.1 105.9 1983 60.4 62.9 248.5 337.4 49.3 106.9 1984 62.8 63.2 262.4 360.2 52.0 107.9 1985 64.4 63.7 271.6 377.3 53.9 110.4 1986 66.7 64.3 288.6 390.5 56.2 111.0 1987 68.9 66.6 307.8 415.0 58.6 111.1 1988 69.8 71.2 325.1 464.5 62.5 111.2 1989 71.1 71.6 337.3 475.6 68.0 112.8 1990 67.1 65.4 283.9 474.4 72.5 128.6 1991b n.a. 56.8 235.8 506.5 83.6 167.1' n.a.: not available M2h/lH: Household holdings of currency plus demand and time deposits divided by household income. M2/GDP: Total M2 divided by GDP. M2/CPI: Index of the real value of M2 in terms of the CPI (1970 =100). Deposits: Total sum of Demand and Time deposits by households and enterprises in Billions of K. Currency: Currency outside banks, in Billion K. a. Estimated CPI inflation rates of 14 percent in 1990 and 30 percent in 1991. b. Data estimated from the monetary program for 1991. Declining exports to the USSR are equivalent to a deterioration in the terms of trade: if the problem were expected to be temporary, credit financing might be justified. But a substantial decline is expected in the Soviet share in Czechoslovakia's trade, and a return to previous levels of exports is unlikely for at least another two or three years. Thus, there is little justification for giving any but very limited amounts of direct credits. The economic effects of this demand shock are unquestioned, but they must be dealt with largely with macroeconomic tools. If export credits are expected to be very tight, pressure will shift from the monetary and finance authorities to the domestic exporters and the USSR importers, which is where it belongs. Exporters will be pressured to restructure more quickly and Soviet importers to seek internal financing. Any residual amount that is still problematic will certainly be much less than the Kcs 80 billion estimate. - 76 - Macroeconomic developments and the foreign exchange market Until January 1991, Czechoslovakia had a system of foreign exchange controls for both commercial and capital account transactions. On January 1,1991 the government introduced significant price liberalization and full convertibility of the koruna for current account transactions ("internal convertibility") with convertible currencies. Anticipating the implementation of internal convertibility, the Czechoslovak authorities undertook a substantial real devaluation of the koruna during 1990. Three nominal devaluations-18 percent on January 8, 55 percent on October 15 and 16 percent on December 28-brought the exchange rate for the koruna for commercial transactions down to Kcs 28 to the U.S. dollar by January 1, 1991. Prior to those devaluations, the koruna was substantially overvalued at an official rate that was sustained only by a rigid system of controls-as evidenced by a black market premium exceeding 100 percent (see table A1.5). The exchange rate is now set by the State Bank in terms of a currency basket, presently including the deutschemark, the U.S. dollar, the Austrian schilling, the Swiss franc, and the French franc. Since January 1991, the State Bank has been committed to keeping the koruna fixed in terms of the basket. Any modification in absolute value larger than 10 percent must be approved in advance by higher authorities. The devaluations, together with the introduction of internal convertibility, resulted in a dramatic narrowing of the gap between official and black market rates to a level (15 percent in January 1991) not experienced for 15 years. An extremely tight monetary policy also helped (broad money increased only 1.7 percent during 1990). The economic reform program introduced in January 1991 was widely anticipated and discussed during 1990 resulting in some disturbances in the financial and foreign exchange markets. With everyone anticipating that the program would require significant devaluations and that an initial acceleration in inflation would follow price liberalization, individuals and businesses shifted from koruna assets into goods and foreign exchange and enterprises increased their imports. - 77 - Table A1.4 Monetary pol;cy, 1989-91 Billions of Percentage koruna change 1989 1990 1991 1990 1991 Net int. reserves 16.4 -5.5 -52.0 -133 -845 Net domestic credit 578.9 635.8 739.3 9.8 16 State firms & govt. 532.0 585.9 683.9 10.1 16 Households 46.9 49.9 80.4 6.4 61 Privatization funds -- -- -25.00 -- - Broad money 547.8 557.3 590.1 1.7 5 Money 311.1 276.1 322.6 -11.3 16 Quasi-money 236.7 281.2 267.5 18.8 -4% Source: State Bank of Czechoslovakia. Since 1989, enterprises had been allowed to retain part of their hard currency export earnings in special foreign exchange accounts, to be used as needed for imports related to their production activities. Anticipating some reduction in the liquidity of these deposits, enterprises used up a significant amount of these earnings during 1990. And, in fact, the government introduced new rules requiring firms to use up the deposits in their foreign exchange accounts by December 1991. The rise in imports during the second half of 1990 seems to have stopped once the reform package was announced in January 1991, and imports have since stabilized at previous levels and may even have fallen. There has been no boom in imports of consumer goods despite the lifting of all foreign exchange controls for such purposes (except the license requirement). This is attributable to three factors: the sharp devaluation, the decline in economic activity expected to take place during 1991, and the introduction of a 20 percent surcharge on all imports of consumer goods. The surcharge is expected to be temporary and therefore works as a clear inducement to postpone purchases. Anyone may obtain foreign exchange for imports of goods, although they must first obtain a foreign exchange license. Registration for obtaining a foreign exchange license is handled at the Ministry of Foreign Trade. The license is granted automatically for the purpose of obtaining foreign exchange and is not associated with the specific products to be imported. In fact, there is no import licensing under the - 78 - new system except for a few products (mainly drugs and firearms). Unless granted a specific authorization r;elated to their business needs, enterprises are not allowed to hold foreign exchange. For households, the restrictions on holding foreign exchange are less stringent. Individuals must either exchange for koruna any holdings of foreign exchange valued at more than Kcs 5,000 (about $200) or deposit the foreign exchange in a foreign exchange account in a domestic bank. They are not required to explain the origin of the funds and may withdraw them freely for imports or travel abroad. The authorities have expressed their intention to proceed to total external convertibility of the koruna as soon as conditions allow. The premium on the black market has been reduced to a level that can be explained by the mere existence of restrictions to convertibility. This suggests that full convertibility might be introduced without the need for further devaluation. There is the possibility, however, that individuals and enterprises would decide to shift their existing koruna deposits and currency into foreign liquid assets, particularly if further significant increases in prices are anticipated. Table AlS Koruna-dollar exchange rates, 1970-91 Commercial Paralel Premum rate market (%) 1970 27.0 40.9 51.4 1975 20.9 23.5 12.4 1980 14.2 26.2 84.5 1985 17.2 34.7 101.7 1986 15.0 29.7 90.8 1987 13.7 27.8 102.9 1988 14.3 33.4 133.5 1989 15.05 42.39 181.2 1990 (Ian/April) 16.57 41.14 148.3 1991 (January) 28.00 32.20 15.0 Source: Stae Banik of Czechoslovakia. Significant new inflation seems unlikely, however, considering the tight monetary policy of the State Bank, which calls for only a 5.9 percent expansion in the broad money supply aggregate for all of 1991. Only considerable relaxation of the target is likely to result in a sharp increase of inflation. - 79 - Nevertheless, further uneasy in the financial markets is to be expected in reaction to the uncertain effects of privatization and restitution. In liberalizing the foreign exchange market, Czechoslovak authorities have chosen a sequential strategy of first gradually opening the trade account and only then opening the capital account. Sequencing strategy has been widely discussed in light of the experience of several Latin American countries that opened their economies beginning in the late 1970s. Most of these countries chose to grant full convertibility on the capital account before they had eliminated a wide variety of restrictions-both tariffs and quantitative restrictions-that were preventing integration of the goods markets. The capital inflows that went to those countries in response to the high interest rates could not be channeled to imports because the economies remained relatively closed. In consequence, the currencies experienced significant real appreciation. With expectations of continuing real appreciation, the economies became even more profitable for incoming short-term capital, which generated a vicious circle of capital inflows and real appreciation. The result was foreign exchange runs and several hyperinflation episodes fostered by the devaluations and the inherited external debt. Considering this experience, the path followed in Czechoslovakia seems the more prudent one, since immediate integration of the domestic goods market with the external markets is not possible. The country faces the challenge of having to diversify its trade pattern toward convertible currency countries, a task expected to take a considerable amount of time and effort, particularly when undertaken concurrently with privatization. A relatively high and stable real exchange rate for the koruna is essential for foreign trade diversification. The transformation of the Czechoslovak economy into a market economy will require substantial foreign investment. This investment will best be assimilated by means of a competitive and well-integrated capital market, with no restrictions on foreign exchange transactions. Therefore it is important that the remaining restrictions on foreign exchange transactions be gradually lifted as soon as the fears of uncontrolled inflation are gone. If short-run capital flows become a problem for the conduct of monetary policy, they could be controlled either by minimum maturities for inflows or by limits on the maximum amount of sales of foreign exchange for outflows. There is already some flexibility in the instruments available for dealing in foreign exchange. Firms engaging in international trade (holding a foreign exchange license) with an annual turnover of over $50 million are entitled to apply for a foreign exchange account to keep balances denominated in terms of foreign exchange. For all other enterprises engaged in foreign trade the official position is - 80 - that they do not need to keep balances in foreign exchange since they can meet all their foreign exchange needs by paying with koruna at the current exchange rate. Financial institutions that hold a foreign exchange license are entitled to keep foreign exchange balances. Most foreign exchange deposits of households are held by Obchodni Bank and Commerce Bank, whose holdings are estimated at $253 million as of January 1991 (an additional $118 million was held in enterprise foreign exchange accounts). The Commerce Bank alone has 110,000 individual accounts. Banks are free to dispose of foreign exchange deposits as they wish, provided they keep a coverage ranging from 90 percent to 105 percent. Most of these funds are apparently reinvested overseas rather than at the Central Bank. Trade policy implications of the macroeconomic situation The process of deep structural adjustment in Czechoslovakia is certainly going to affect the structure of foreign trade. Under the old economic system, tariffs and exchange rates had no effect on resource allocation since internal prices were totally independent of foreign prices because of the automatic compensation mechanism of the FENZO system. Probably because of their irrelevance, tariffs were quite low and had no manifest protectionist intent. Conventional quantity restrictions were insignificant on the import side, but there were significant restrictions on exports of inputs for the domestic industry. All these restrictions, together with central planning directives and the trade monopolies of the foreign trade organizations have essentially been abolished. To buffer the impact of the sudden opening to external competition, the authorities imposed a temporary import surcharge of 20 percent on consumer goods. There are clear indications of pressures on the Ministry of Trade to increase protection levels. Because the majority of tariffs are bound under the GAIT, there is a risk of resort to nontariff barriers on an ad hoc basis. Unless the additional protection is used as a bargaining tool to gain access to the restricted European markets, it is bound to induce the wrong production incentives at a crucial time for investment decisions. The significant real devaluation since mid-1990 and the import surcharge on consumer goods appear to have checked the import boom experienced in late 1990. The low level of economic activity is also restraining imports. The problem now is not the high level of imports but the low level of exports as a result of the collapse of the USSR market. The main calls for intervention come in the form of demands for subsidies for the affected export industries, but as the economy recovers, protectionist pressures are sure to develop from the import competing sector as well. - 81 - Given the important structural changes that are taking place, close attention must be paid to the level of the exchange rate, especially as the final resolution of the problem of exports to the USSR unfolds and imports settle to a new level after the trade policy effects are fully established. Capital inflows still remain an uncertain variable and will probably remain so until the issues of privatization and restitution are finally settled. In conclusion, the exchange rate seems appropriate for 1991, given the still relatively closed economic structure and the contribution of IMF stand-by funds. Current account prospects, however, remain quite uncertain. Flexibility is called for in this most important area of macro policy affecting trade performance. - 82 - Appendix 2. Key Adjustment Mechanisms: Privatization, Price Reform, and Social Safety Net Trade liberalization has become.widely recognized as an important element in the transition from centrally planned socialism to a market economy (Havrylyshyn and Tarr 1991). Its main role is to provide a set of world price signals for the domestic market and to impart a competitive stimulus to the domestic economy. But trade liberalization and the development of new trading relations cannot by themselves advance the economy toward the market. Three key domestic adjustment mechanisms must be in place for the necessary reallocation of resources to occur. Privatization is required to create the profit-seeking motivations and incentives for producers to act freely on the market. Price liberalization must take place to permit the markets to signal producers, via free prices, about the most efficient direction for economic activity. And a social safety net needs to be in place to ensure that those dislocated by the inevitable shifts of resources are not unfairly left without means and are assisted in establishing themselves in a new economic environment. This interplay of policy changes is well-recognized in the general strategy of the Czechoslovak reforms (Scenario of Economic Reform, September 1990) and needs no further elaboration. At this stage of the reform process, it is important to keep a close watch on the details of implementation to ensure consistency among the various components. Privatization Until the November 1989 revolution, the Czechoslovak economy was one of the most centralized of East European economies, with a huge preponderance of state sector activities. In 1989, the state sector plus cooperatives accounted for 96 percent of net value added and 90 percent of employment. Although some decentralizing measures were undertaken after 1987 (including introduction of workers' councils in enterprises), the key features of the centralized command system were unchanged. Czechoslovakia thus embarked on economic transformation from a significantly different starting point than Hungary and Poland, which had been undergoing economic decentralization for 10 to 20 years before the political changes of 1989-90 and where the private sector played a greater role, especially in agriculture and services. Czechoslovakia's different starting point has both drawbacks and advantages for the privatization of the state sector. Among the drawbacks are the lack of a management culture and entrepreneurial - 83 skills, an industrial structure that is not based on comparative advantage, and slow technological progress. On the other hand, a relatively unambiguous definition of ownership-enterprises belong to the state and not to workers or management-represents an advantage. In April 1990, workers' councils were abolished and enterprises were "renationalized" and allowed to begin their transformation from state-ownership to corporations.9 It is easier for the government to proceed with privatization in Czechoslovakia than in countries where decentralization and labor-management have deeper roots and where employees came to view at least some management prerogatives as belonging to them. The goal of rapidly privatizing a significant proportion of state assets has been hampered, however, by the decision to proceed with full restitution of ownership of property that was nationalized during the period of Communist rule. The decision was motivated by the desire to establish a precedent of legal respect for private property and to assure potential foreign investors that they will not be left without legal protection of their property rights in the unlikely event of a future nationalization. The restitution bill slowed the process of privatization because, to decide what belongs to the state and can be privatized, one has first to sort out what belongs to previous owners. The residual, as it were, can then be privatized. In emphasizing restitution, Czechoslovakia follows the path taken by the former East Germany. In Hungary and Poland, by contrast, restitution is only symbolic and involves only small enterprises and retail and service sectors. This difference reflects historical differences in these countries at the time of nationalization. Czechoslovakia has had an egalitarian distribution of income and wealth, with no large landowners, as in Poland and Hungary. The industrial sector had a more modern class structure, with a sizable urban middle class and relatively well-paid blue-collar workers. Thus, the nationalizations that occurred in Czechoslovakia in the 1940s were probably perceived as socially less acceptable than those in Poland and Hungary, which affected only a relatively narrow segment of the population. Restitution has to grapple with a number of difficult issues. First was the choice of cutoff date-whether the end of the war, May 1945 (Communist takeover), or February 1948. Nationalizations that took place between 1945 and 1948 were often of the punitive kind (reprisals for collaboration with the Nazis) or affected assets previously taken over by the Nazis from their legitimate owners. Even with general agreement that the cutoff date should be the Communist 9. At the same time, equality of treatment for all types of property becane constitutionally guaranteed. See Mejstrik (1990, p. 14). - 84 - takeover, there was further difficulty. What about the laws passed by the democratic parliament (in which the Communists were the largest party) prior to the Communist coup but that did not take effect until say, March 1, 1948 or later, after the demise of the democratic parliament? Second, what type of restitution should be made? Restitution in kind, even when possible, after more than 40 years is fraught with complexity-factories, buildings, and shops may have expanded, improved, or deteriorated. Cash restitution is expensive, and the government would not have the resources for large-scale cash restitution. One way to avoid this difficulty would be to distribute vouchers to former owners entitling them to purchase shares in privatized companies, an alternative favored by the Slovak government because it involved no financial cost. 7hird, would restitution also apply to Czechoslovak emigres? The Slovak government was further concerned that its enterprises be transferred largely to the current citizens of Slovakia. After a long process of legislative drafting, the restitution bill was passed in February 1991. The cutoff date was set at February 25, 1948. The restitution would be of the three types: in cash, in vouchers, and in kind. Press reports estimate that of roughly Kcs 300 billion ($11 billion) of property subject to restitution, most would be in kind. In cases where property is deemed to have deteriorated, former owners would be entitled to cash compensation not exceeding Kcs 30,000 (about $1,100) and compensation in securities (shares of privatized companies or vouchers).'0 Former Czechoslovak citizens would be eligible for restitution if they became permanent residents of Czechoslovakia for at least two years. A few days after the restitution bill was passed, the Federal Parliament passed the large-scale privatization bill (officially entitled 'Law on Transfer of State Property to Other Persons"). The privatization law ingeniously blends state decisions and independent decisions of enterprises to become privatized. Individual enterprises that wish to draft their own privatization proposals must include all relevant information about the enterprise: designation of the property to be privatized, valuation of the enterprise, proposal on the future corporate form (joint-stock, limited liability), time frame for privatization, and discussion of people or entities expressing an interest in buying the enterprise (or its part). The proposal is then submitted to the founding organ. After another iteration between the founder and the enterprise, the proposal is submitted for approval to the Federal Ministry of Finance 10. The estimates given in press reports are not substantiated. If even approximately correct, they suggest a sizable proportion of assets subject to substitution of nearly 10 percent (Kcs 300 billion of Kcs 2,700 billion in state assets according to Statistical Yearbook 1990, p. 191. - 85 - if the enterprise was founded by a federal body or to an "appropriate" republican body if the enterprise belongs to a republic. When a privatization project is accepted, the enterprise is officially transferred to the Fund of National Property (at the federal or republican level). The fund then proceeds with privatization of the enterprise. The law allows two types of privatization: by auction and by private agreement between the buyer on the one hand and enterprise and all the bodies of state administration on the other. No discounts are to be given. The proceeds of privatization are received by the fund and can be used only to take over debts of the privatized firms, to pay for the cash part of the restitution, and to cover the operating expenses of privatization. Another interesting feature of the Czechoslovak proposal is that the two phases of privatization- corporatization (creation of a joint-stock company) and then privatization-have been effectively merged into one phase whereas other east European countries have clearly separated the two phases. Under the Czechoslovak privatization law, both phases occur simultaneously as the enterprise works out its privatization proposal." Workers are not entitled to any special treatment, but in working out a privatization project, enterprises can propose a certain discount for its employees, or even a full employee-buy-out. The state administration, however, makes the final determination. Early proposals by some of Czechoslovakia's key economists and government officials had called for privatization through the distribution of (practically) free vouchers to all citizens, which could later be used to purchase shares in privatized companies. The rationale for the vouchers is that they solve the problem of enterprise valuation (the value of an enterprise would be established through a bidding process in which all citizens would have equal chance to participate), and they circumvent problems of shortages of funds or their concentration in the hands of foreigners or the former nomenklatura. The 1991 law, however, is much less explicit about the role of vouchers (called "investment coupons") than might have been expected. The law leaves open how many vouchers will be issued and what portion of state property they will cover. The vouchers will be nontransferable, and they will be distributed equally to all persons older than 18 years of age. They seem to have been relegated to a supporting role in the process (in the event auctions or private placements do not elicit 11. By the end of 1990, there were only about 50 corporatized state-owned enterprises. - 86 - sufficient interest of buyers).'2 This is not unlike the situation in Poland, where the role of vouchers has been left equally vague. Restitution has to take place before it becomes clear what part of the economy might be subject to privatization. It is estimated that about 30 percent of state-owned enterprises (public utilities, social services) will not be privatized at all. Of the remaining 70 percent, the best firms, accounting for perhaps 10 percent, should be privatized through the use of standard techniques (sales to private investors, joint ventures, employee share ownership plans). The worst enterprises, possibly another 10 percent, would be closed down; vouchers would be used primarily in the privatization of the "main body" of the state sector, the 50 percent of "average" enterprises. Small-scale privatization Due to its intrinsically easier nature, small-scale privatization has progressed further than the large- scale privatization of the state sector. According to the law of October 1990 on small-scale reprivatization, all private property nationalized by a series of acts in 1959 will be returned to its former owners. This includes some 70,000 workshops, restaurants, pubs, rental houses, and the like. 13 Small properties belonging to the state and that had not been nationalized would be sold to Czechoslovak citizens by auction. The first auctions of workshops, restaurants, and various service outlets took place in January 1991. All Czechoslovak citizens are allowed to participate in the auctions (foreigners are allowed to participate only if the property remains unsold). These auctions have been successful, with the sale price often exceeding the threshold price set by the government several times over-ten times over in the first auction in Prague. Small privatizations, with weekly auctions in numerous cities, continue apace. The government expected that about 100,000 small-scale units would be privatized during 1991. However, even small-scale privatization is not free of problems. Little of retail trade has been privatized because prospective buyers are deterred by high real interest rates (for financing inventories), obligations to continue providing some items (food) for at least two years after the 12. The open-ended role of vouchers can be also observed in the evolution of various draft of the privatization law. In the earlier drafts, details regarding vouchers figured more prominently (e.g., percentage of shares that can be acquired for vouchers, value of vouchers distributed to each citizen, citizens' payments for vouchers). In the final bill, none of these details is mentioned. This leaves the government a lot of flexibility when deciding on the use of the voucher scheme. 13. An amusing story, illustrating problems with restitution, is related by Mladek (1990, p. 13). Former owners requested restitution of some 170 villas in Prague that presently house foreign diplomats. Some foreign embassies protested, threatening to nationalize Czechoslovak embassies in their countries. The law was amended and diplomatic villas were excluded from the list of property that can be restituted in kind. - 87 - privatization, an absence of incentives for the workers to 'self-privatize," and similar obstacles. New private investments in retail outlets are also hampered by the absence of commercial space. For example, many newly built residential areas in Czechoslovakia often have only a single large supermarket. Because of their large size and price, such supermarkets cannot easily be transferred to private hands, yet space for small stores is scarce or even unavailable. Unsettled ownership of land also complicates privatization."4 The money from small-scale privatizations will go into the National Property Fund at the republican level. Privatization and foreign economic relations Foreign interest in Czechoslovak enterprises is relatively high, thanks in large measure to Czechoslovakia's strategic location in the center of Europe, its long-standing industrial tradition (the fourth largest industrial power in Europe before World War II), an egalitarian income and wealth distribution with few class distinctions (minimizing the likelihood of social conflicts), and the low cost of labor relative to education level. Another possible advantage-although this is a matter of some dispute-is the absence of a strong proprietary or management interest among workers. Several major privatizations have attracted international attention. The most important is the agreement between the car manufacturers Skoda and Volkswagen. Volkswagen will begin with 31 percent participation, which it expects to increase to 70 percent by 1993, in the new firm. Total Volkswagen investment over four years is expected to amount to some DM 1.4 billion (DM 1.2 billion as direct equity contribution and DM 0.2 billion as payment to the Czechoslovak government for part of its shares). Other large Czechoslovak enterprises that are negotiating with foreign partners include the locomotive maker CKD, Svit footwear (formerly Bata) and Pilsner brewery. Under 1990 legislation, joint ventures must be authorized by the Ministry of Finance, with those in some sectors such as banking also requiring approval by the State Bank. But on the whole, foreign investment regulations are quite liberal and nondiscriminatory by international standards. Profit taxation rules for joint ventures are more favorable (40 percent tax rate) than for the domestic state enterprises (50 percent rate). The privatization law does not explicitly address foreign ownership. The implication is that foreign entities will not be treated any differently than domestic ones, but the process is designed in such a way as to provide a possible check on the extent of foreign ownership. Since privatization proposals 14. In Czechoslovakia, land was never officially nationalized cven if de facto it was used as stat property. All ownership titles still exist. Yet the number of claimants (because to the branching of families) exceeds severalfold thc original number of plots. - 88 - have to be accepted by government bodies, the government can reject proposals it considers detrimental to national interest even if the enterprise insists on being sold to a foreign buyer. More important, so long as the issue of restitution for a given asset is outstanding, this will not only hamper domestic privatization but will also deter foreign interest. The difficulties of privatizing rapidly may be reflected in foreign trade developments in a number of ways. Uncertainty about restitution will discourage any major foreign investment until 1992, and many projects involving exports will be delayed. The energies of old and new management will be devoted first to the privatization problem, delaying substantial new reinvestment and restructuring of production. Consequently, the supply response of exports may be limited for the first few years, and domestic producers will find it more difficult to compete with "attractive," newly liberalized imports from the West. Any substantial export expansion before privatization may depend more on the competitive boost of devalvation and the sharp decline in domestic consumption, and less on substantial adjustment within industry. The sooner privatization can proceed, the greater the expected response to foreign trade opportunities and competition. Price liberalization Price liberalization has been far easier to implement both administratively and even politically than privatization. In the third quarter of 1990, key consumer subsidies were reduced for public transport and gasoline, a politically important liberalization. On January 1, 1991, a wide-sweeping liberalization occurred that left only about 20 percent of prices regulated. Most of these prices were to be liberalized by the middle of 1991, except for about 12 percent of them, mainly consumer goods and public services, which will remain regulated until 1993. Price regulation consists of three categories: administratively set maximum prices, monitored price regulation, and prior notification regulation (see table A3.7 in appendix 3). The most important immediate relation of price policy to trade policy concerns the potential need to impose export restrictions on goods with regulated prices. If maximum prices are set so as to keep down the prices of key goods (consumer goods and industrial inputs), the likely effect, as is well- known to socialist economies, is shortages. Thus, for social and political reasons the authorities are obligated to impose export restrictions to maintain domestic supply. Because most of the products subject to export licensing are also subject to administrative maximum prices, removal of export restrictions can occur only when price liberalization occurs. - 89 - A less evident effect of price liberalization may be the ability of enterprises that still have monopoly power to raise prices without increasing supply. While import liberalization ought to provide a competitive stimulus, the combined effect of an average 20 percent import surcharge and the 80 percent devaluation since June 1990 provides considerable margin for monopolistic behavior. The solution is not to re-regulate prices, but to move quickly on privatization and removal of the 20 percent surcharge to stimulate import competition. 15 Unemployment and social safety nets The experience of countries further ahead on the road to restructuring and privatization (Poland and Hungary) indicates that the transition to a market economy is likely to be accompanied by increased unemployment. One reason is systemic-the gross overstaffing in state enterprises and an often obsolete (or inefficient) structure of production. Unemployment is generated in the shedding of redundant labor and in the closing down or scaling down of numerous enterprises. Excess labor from such systemic causes is estimated at between 20 and 25 percent of total state sector employment in most Eastern European countries. 16 Another reason for increased unemployment in some countries in Eastern Europe-Poland and Yugoslavia but not Czechoslovakia-is the restrictive fiscal and monetary policies needed to deal with severe macroeconomic disequilibrium and hyperinflation. In Czechoslovakia, there is yet another reason for high unemployment and that is the country's heavy reliance on CMEA trade. In 1989, about 55 percent of Czechoslovakia's foreign trade was conducted with other CMEA partners-30 percent of it with the USSR alone. The collapse of the CMEA, the transition to a system of accounts settlement in foreign exchange, the union of East and West Germany, and the economic crisis in the Soviet Union have strongly affected that part of the Czechoslovak industry oriented toward the CMEA market. The foreign trade shock of these changes (including the terms of trade deterioration following the increase in prices of the Soviet energy) will lead, at least temporarily, to an upsurge in unemployment. 15. The macroeconomic effect of any monopolistic behavior of this sort is at least temporarily positive, as the increased profits of enterprises ease liquidity problems. But this is a poor guide to the true economic efriciency status of enterprises. 16. For Czechoslovakia, recent estimates are 18 percent, see Brada (1989); for Poland, see Rutkowski (1990) and Rutkowski and Gora, who estimate about 25 percent in the late 1980s; for Yugoslavia, sce Dyker (1990, p. 140) and Karakasevic (1991); for the Soviet Union, Porket (1984) 'guesstimates the surplus at 15 to 20 percent. - 90 - As of March 1991, when the transition to a market economy had barely begun, unemployment stood at 150,000 people, or 2 percent of the labor force."7 In January 1991 alone the number of unemployed increased by 50 percent. Regional differences have appeared in the unemployment picture, with the rate of unemployment twice as high in Slovakia (2.4 percent)-where much of the heavy industry oriented toward the CMEA market is located-as in the Czech lands (1.1 percent) in January. The federal government forecasts that unemployment will reach 300,000 to 400,000 by the end of 1991, representing between 4.5 percent and 5.2 percent of the labor force. More pessimistic forecasts put unemployment at nearly 1 million (13 percent of the labor force). The unemployment resulting from the decline in exports to the USSR could reach well over 200,000. This would be twice as high as the increase in Poland in 1990 during conditions of severe macroeconomic adjustment. Unlike other Eastern European countries, Czechoslovakia already had a system of social assistance in place. An official social minimum income level had been used over the last 30 years in policy formulations (notably for determining minimum wage and wage scales) and, since 1988, as the basis for direct cash payments of social assistance. No other socialist economy in the region has had such an extensive welfare net or such an explicit program of social assistance. Welfare policy in socialist economies was traditionally limited to in-kind help to the elderly, handicapped, or sick; the main locus of social assistance was the enterprise. Czechoslovakia's vast social welfare net explains how the percentage of the poor in the country remained so low-5.8 percent in 1988 according to calculations of the Czechoslovak Academy of Sciences (Janacek et al. 1990, pp 30-31), and increasing to 10 percent by 1990. By comparison, the poverty rate in Poland and Yugoslavia was estimated at about the same time at 25 percent, and in Hungary at 15 percent. Unemployment compensation did not exist during the period of central planning since unemployment was virtually unknown. On January 1, 1991 the government introduced a relatively generous system of unemployment compensations. Unemployment benefits as a percentage of previous wages are higher in Czechoslovakia than in Poland and Hungary (table A2. 1). The rates are also 5 percentage points higher than the federally stipulated minimum: federal law determines the minimum rates while republics can choose to set higher rates (as they indeed did). 17. The labor force is defined as state sector employees plus employees of cooperatives plus total unemployed. -91- Table A2.1 Unemployment compensation scbemes in Poland, Czechoslovakia and Hungary (perfentages) Poland CzechoslovaUa Hungary I Year I Year I Year Duration of benefius 1-3 months 70 70 1-5 months 65 3-6 months 50 70 6-12 months 40 60 60 12 month average 50 62 65 Minimum benefit as percentage of minimum wage 95 85 n.a. Average benefit as percentage of average wage 50 47 n.a. Requirement of previous - I year 1.5 years employment of last 3 of last 3 First time job entrants - Social minimum Number of unemployed (thousands) 1,100 150 57 In percentage of labor force 6.5 2.0 1.1 Average amount of bencfit (USS) 68 52 n.a. Recipients of benefit as percentage of total unemployed' 80 56 63 n.a. Not available. a. For Poland, data at the end of 1990; for Czechoslovakia, March 1991; for Hungary, September 1990. Having a well-developed social assistance system meant that by January 1991 coverage by unemployment benefits was already almost complete."8 The average unemployment benefit was Kcs 1,365 ($52) a month, or about 47 percent of the average net state sector wage.19 The minimum benefit, applying to first-time job entrants, was Kcs 1,200 ($48) a month, which was the social minimum income level (per capita in a four-member household). The government expected unemployment-related spending in 1991 (with about 300,000 to 400,000 unemployed at the year-end) to total 0.7 percent of GDP. This is similar to the level in Poland in 1990 (0.6 percent of GDP), which was triggered by a somewhat higher rate of unemployment (6.5 18. Table A2. I shows that 56 percent of the registered unemployed were receiving unemployment benefits; the difference is accounted for by the mandatory one-month waiting period between the date of lay-off and the start of benefits. 19. A uniform 20 percent wage tax is assessed on gross state sector wages. - 92 - percent compared to 5 percent in Czechoslovakia) but with lower wage replacement ratios.20 About 60 percent of total expenditures is expected to be incurred for unemployment compensation (income support) with the remainder going for job-creation subsidies to enterprises and retraining of the unemployed including training for small-scale entrepreneurs. Since no special fund has been created for unemployment benefits, they will be paid out of regular government revenues. Considering that these expected payments are already nearly the size of the projected surplus (0.6 percent of GDP, c/f 1.0 per cent) and that unemployment may be higher than these estimates, the government might want to consider covering at least some of these benefits through special taxes, as is common in most industrial countries. The fragility of the macroeconomic situation provides a strong argument for such a course. Rapid privatization and inflow of foreign investments would certainly help alleviate the problem of unemployment. However, their effects are likely to be felt only in the medium term (3 to 5 years). Until then, Czechoslovakia will probably have to face relatively high levels of unemployment. Since the collapse of CMEA trade is, from the Czechoslovak perspective, an exogenous event unlikely to be reversed in the immediate future, rapid privatization and encouragement of foreign capital inflows are the two key levers whereby Czechoslovak industry could be reoriented. 20. The share of expenditures on unemployment compensations in GDP can be written as: UE N (UE/W ) (N/P) GDP (GDP/P)(W) where UE-unemiployment allowance, N=number of the unemployed, W=average wage, Ptotal population of the country. Since Poland's and Czechoslovakia's per capita GDP (GDP/P) and state sector wages (W) are similar, the difference in the share in GDP is mostly a function of the replacement ratio (UEIW) and unemployment ratec (NIP). - 93 - APPENDIX TABLES Table A3.1 Geographic distribution of Czechoslovakia's foreign trade, 1989-1990 (millions of koruna) Value % share 1989 1990 % change 19891990 Exports Total 217,530 215,257 -2.04 100.00100.00 Socialist countries 132,289 105,517 -20.24 60.8149.02 CMEA: 119,451 93,463 -21.76 54.9143.42 USSR 66,439 54,159 -18.48 30.5425.16 Eastem Germany 14,257 9,172 -35.67 6.554.26 Poland 18,438 13,394 -27.36 8.486.22 Hungary 8,641 8,841 2.31 3.974.11 Other socialist countries 12,838 12,054 -6.11 5.905.60 Yugoslavia 7,095 6,718 7.37 3.263.54 China 5,546 3,990 -28.06 2.551.85 Developed countrics 67,793 91,272 34.63 31.1642.40 EC 39,607 57,112 44.20 18.2126.53 Westem Germany 17,964 27,639 53.86 8.2612.84 France 3,936 5,662 43.85 1.812.63 United Kingdom 4,396 5,521 25.59 2.022.56 United States 1,413 1,639 15.99 0.650.76 Japan 1,343 1,592 18.54 0.620.74 Developing countries 17,448 18,468 5.85 8.028.58 Imports Total 214,702 238,202 10.95 100.00100.00 Socialist countries 133,786 121,876 -8.90 62.3151.16 CMEA 120,467 105,760 -12.21 56.1144.40 USSR 63,792 51,410 -19.41 29.7121.58 Eastem Germnany 16,797 19,499 16.097 7.828.19 Poland 18,485 20,370 10.206 8.618.55 Hungary 10,294 8,147 -20.86 4.793.42 Other socialst countries 13,319 16,116 21.00 6.206.77 Yugoslavia 7,170 7,588 5.83 3.343.19 China 5,902 8,180 38.606 2.753.43 Developed countries 66,717 101,480 52.11 31.0742.60 EC 38,265 56,664 48.08 17.8223.79 Western Germany 19,931 31,734 59.22 9.2813.32 Frnce 3,350 4,203 25.46 1.561.76 United Kingdom 4,731 6,862 45.04 2.202.88 United States 813 1,368 68.27 0.380.57 Japan 1,113 1,144 2.79 0.520.48 Developing countries 14,199 14,846 4.56 6.616.23 Source: Czechoslovak authorities. - 97 - Table A3.2 Product structure of Czechoslovakia's trade, by partner, 1990 (millions of koruna) Exports Irports Socialist countries Nonsocialist countries Socialist countries Nonsocialist countries Amount % share Amounr % share Anount % share Anount % share SITC 0 1,900 1.80 9,855 8.98 3,952 3.24 9,465 8.14 SITC 1 453 0.43 440 0.40 899 0.74 1,004 0.86 SITC 2 2,402 2.28 5,641 5.14 7,527 6.18 12,280 10.56 SITC 3 2,339 2.22 7,042 6.42 31,016 25.45 3,089 2.66 SITC 4 8 0.01 734 0.67 64 0.05 1,263 1.09 SITC 5 6,021 5.71 13,410 12.22 7,050 5.78 17,226 14.81 SITC 6 16,334 15.48 38,834 35.39 11,990 9.848 13,382 11.50 SITC 7 62,023 58.78 22,280 20.30 41,510 34.06 47,327 40.68 SITC 8 12,508 11.85 9,887 9.01 12,202 10.01 9;504 8.17 SITC 9 1,529 1.45 1,616 1.47 5;666 4.65 1,786 1.54 Total 105,517 100.00 109,740 100.00 121,876 100.00 116,326 100.00 Source: Mission estimates. - 98 - Table A3.3 Czechoslovakia's share in CMEA exports to the OECD, 1975 and 1987 (CMEA exports of each commodity group = 100) Czechoslovakia Hun ary Poland Product 1975 1987 1975 1987 1975 1987 Food and live animals 8.1 9.2 23.8 28.5 33.5 35.7 Beverages and tobacco 5.2 8.5 14.7 14.2 14.9 6.6 Crude materials 6.2 10.8 4.0 7.5 10.4 11.6 Mineral fuels, lubricants 3.3 2.3 0.4 1.9 18.5 5.3 Animal and vegetable oils 1.4 8.0 6.1 51.6 3.3 20.5 Chemicals 10.6 11.9 9.8 14.1 13.0 10.8 Manufactured goods 18.9 15.0 9.1 10.8 16.5 13.2 Machinery and transportation equipment 19.0 14.8 7.7 13.0 24.5 18.4 Misc. manufactured goods 17.8 14.1 18.8 17.5 20.4 18.9 Meat and meat preparations 3.4 11.5 23.0 40.5 37.9 35.4 Vegetables and fruit 9.9 10.5 23.5 32.2 22.7 36.4 Crude rubber 7.0 20.8 2.3 5.0 26.4 24.5 Cork and wood 8.3 12.2 3.0 4.0 6.5 8.1 Pulp and waste paper 20.3 33.9 2.5 0.2 5.5 4.0 Crude fertilizcrs 5.7 16.7 0.7 3.2 22.1 44.7 Coal, coke and briquettes 7.8 9.9 0.0 0.2 61.5 48.6 Organic chemicals 16.4 17.9 14.3 21.7 15.5 na Medicinal products 23.7 11.9 25.8 46.4 20.9 8.2 Artificial resins, plastics 20.5 26.1 14.5 19.5 5.0 9.7 Rubber manufactures 37.7 24.2 7.5 21.8 15.5 11.0 Cork and wood manufactures 12.4 16.5 6.1 12.5 11.5 15.4 Paper and paper manufactures 27.0 19.2 1.9 6.0 11. na Textile yam, fabrics 32.0 32.6 13.6 17.2 19.3 13.3 Non-metallic mineral manufactures 25.8 15.8 7.2 5.7 11.5 9.0 Iron and steel 28.4 21.0 11.3 11.7 12.7 11.0 Manufactures of metal 13.3 12.8 14.4 21.4 37.3 29.4 Power-generating machinery 12.2 19.2 7.4 9.0 42.4 18.6 Specialized machinery 32.5 28.1 2.4 15.9 20.7 10.9 Metal working machinery 19.3 14.9 10.7 17.7 20.5 na Other industry machinery 19.3 14.9 10.7. 17.7 20.5 na Office machines and ADP equip. 10.6 6.4 21.5 12.0 11.8 na Telecommunications 6.4 6.3 15.0 11.0 26.5 na Electrical machinery 12.4 11.1 29.3 27.8 14.0 na Road vehicles 25.4 12.2 3.8 7.3 15.5 na Furniture 9.8 7.9 8.2 8.0 20.5 na Clothing articles 13.8 10.8 29.1 24.0 22.5 na Footwear 29.1 23.4 9.6 19.7 27.5 na Prof. and scientific instruments 14.9 13.5 4.5 17.5 22.5 na Total exports 9.3 8.6 7.1 9.1 18.0 12.0 Source: OECD, Trade by Commodities, Serie C (various issues). - 99 - Table A3.4 Indicators of Czechoslovakia's international competitiveness in the OECD market Value of As a share of Product Czechoslovak main compednor's exports (million) exports (%) 1975 1987 1975 conmernor 1987 competitor Total exports to OECD 1642 3503 26.4 Brazil 7.7 Taiwan Chemicals 98 356 39.7 Spain 18.6 Spain Manufactured goods 461 986 24.1 Austria 13.6 Austria Machinery, equipment 288 458 22.9 Austria 3.1 Taiwan Industrial consumer goods 240 510 8.1 Hong Kong 2.7 Taiwan Total manufactured goods 1087 2310 25.2 Austria 5.6 Taiwan Organic chemicals 48 162 62.3 Spain 29.5 Spain Pharmaceutical products 11 14 24.4 Austria 5.1 Austria Plastics, artificial resins 9 98 15.3 Austria 15.7 Austria Chemical manufactures Rubber manufactures 14 41 6.9 Spain 6.9 Spain Cork and wood manufactures 13 46 6.5 Korea 5.2 Taiwan Paper and paper manufactures 17 51 6.2 Austria 3.7 Austria Textile yarn and fabrics 110 262 28.2 Austria 10.7 China Non-metallic mineral manufactures 74 183 32.3 Austria 19.4 Taiwan Iron and steel 193 330 36.0 Austria 21.7 Korea Manufactures of metal 21 47 10.6 Austria 1.8 Taiwan Machinery Power generating machinery 22 52 18.3 Austria 3.3 Mexico Specialized machinery 89 105 48.9 Austria 9.9 Austria Metal-working machinery 55 61 83.3 Spain 18.0 Taiwan Other industrial machinery 28 51 12.2 Austria 4.9 Taiwan Office machines 3 3 3.1 Hong Kong 0.1 Taiwan Telecommunications apparatus 3 8 0.7 Taiwan 0.2 Korea Electrical machinery 19 60 7.1 Singapore 1.6 Taiwan Road vehicles 65 108 17.2 Spain 2.1 Spain Industrial Consumer Goods Furniture 22 69 29.7 Yugoslavia 3.7 Taiwan Articles of clothing 81 179 4.0 Hong Kong 2.1 Hong Kong Footwear 42 76 10.5 Spain 2.1 Taiwan Professional and acient. instruments 7 12 13.7 Austria 4.0 Austria Miscellaneous manufactures 62 124 9.9 Hong Kong 2.1 Taiwan Note: based on a comparison with 13 countries (Hungary, Poland, Yugoslavia, Austria, Spain, Brazil, Mexico, People's Republic of China, Hong Kong, Republic of Korea, Malaysia, Singapore, Taiwan). Source: OECD. Trade by Commodities, Serie C. (1975 and 1987) and author's calculations. - 100- Table A3.5 Unit prices of West German imports from Czechoslovakia, Hungary, and Poland, 1988 (deutschemarks per kilogram) Czechoslovakia Hunearv Poland SITC Product 1981 1988 1981 1988 1981 1988 011 Bovine meat n.a. 10.99 n.a. 11.53 n.a. 6.97 012 Other meat n.a. 5.32 n.a. 4.59 n.a. 5.87 054 Vegetables 1.87 1.26 0.69 0.55 2.68 0.77 112 Alcoholic beverages 0.61 0.74 1.25 1.15 4.02 4.22 232 Synthetic rubber 1.01 1.12 - 1.26 1.78 1.38 247 Wood rough, squared 0.22 0.12 - - 0.19 0.15 248 Wood, simply worked 0.37 0.32 0.57 0.67 0.49 0.36 251 Pulp and waste paper 0.54 1.06 - - - 0.85 278 Other crude minerals 0.15 0.16 0.13 0.20 0.12 0.25 282 Ferrous waste, scrap 0.20 0.84 0.56 0.97 0.19 0.16 288 Non-ferrous waste 1.07 0.88 1.60 1.82 0.83 1.78 322 Briquettes. lignite 0.06 0.04 - - 0.14 - 325 Coke 0.17 0.16 - 0.21 - 0.15 334 Petroleum products 0.53 0.20 0.64 0.24 0.62 0.20 335 Residual petroleum pr. 0.88 0.33 0.71 0.28 0.47 0.23 511 Hydrocarbons 1.16 0.93 1.04 0.49 1.09 0.75 512 Alcohol, phenol 1.15 1.85 7.56 1.39 0.41 1.54 541 Medicines 72.57 171.10 75.67 223.01 98.59 - 562 Feriizers 0.36 0.13 0.33 0.24 0.33 0.20 571 Polymers of ethylene n.a. 1.56 n.a. 1.47 n.a. 1.93 573 Vinylchloride n.a. 1.51 n.a. 1.55 n.a. 1.68. 575 Other plastic materials n.a. 0.43 n.a. 1.50 n.a. 0.40 582 Plastic plate, shect n.a. 2.92 n.a. 3.21 n.a. 2.06 598 Misc. chemical Products n.a. 1.87 n.a. 1.03 n.a. 0.58 634 Veeners, plywood 0.85 0.36 0.61 0.67 1.20 0.63 635 Wood manufactures 0.45 0.37 0.93 0.48 1.68 0.63 641 Paper, paperboard 0.70 0.81 - 0.80 0.64 0.83 651 Textile yarn 2.65 2.99 7.18 5.91 6.09 - 652 Cotton fabrics, woven 10.70 11.43 17.24 11.92 11.81 9.72 653 Fabrics, synthetic 9.93 15.05 10.74 5.93 7.67 9.39 654 Other textile fabrics 13.15 7.51 27.60 - 18.40 18.37 658 Textile articlcs 9.95 9." 10.65 10.34 9.16 10.03 661 Lime, cement 0.10 0.14 - 0.09 0.10 0.08 n.a. not available. Note: Products with exports valued at more than DM 10 million. - 101 - Table A3.6 Nominal protection in Czechoslovakia Frequencv Distmbution (%J Nominal protecton range With the inport surcharge Wishout the inport surcharge .0- 7.5 56.07 79.52 7.6-15.0 9.56 18.43 15.1-22.5 4.70 1.33 22.6-30.0 26.42 .26 30.1-37.5 1.95 .36 37.6-45.0 .72 .04 45.1-52.5 .14 .02 52.6-60.0 .38 .02 60.1-67.5 .02 .00 67.6-75.0 .04 .02 > > 75.0 .00 .00 - 102 - Table A3.7 List of goods witb regulated prices January 1, 1991 Administranvely set prices (maximnum prices) 1. Fodder grain (wheat, barley, corn; wholesale prices) 2. Potatoes (consumer prices) 3. Raw lumber (class III) 4. Water from surface sources (including drinking water and waste) S. Coal (black and brown) 6. Natural gas (wholesale and consumer prices) 7. Central heating (consumer prices) 8. Electricity (wholesale and consumer prices) 9. Iron for recycling 10. Flour (eight sorts; wholcsale and consumer prices) 11. Sugar (consumer prices) 12. Pork (consumer prices) 13. Poultry (consumer prices) 14. Eggs (grade A, consumer prices) 15. Milk (consumer prices) 16. Railroad tariffs (passenger and cargo) 17. Bus tariffs (state enterpriscs only) 18. Post (office tariffs 19. Rents in state-owned apartmcnts Monitored prices 1. Fuel and oil products 2. Central heating (wholesale prices) 3. Metallurgical products (cast iron, profiles, etc.) 4. Basic chemicals (for further processing) 5. Pharmaceuticals 6. Cut wood 7. Leather (for further processing) 8. Cotton wool, absorbent cotton, paper napkins 9. Edible oil 10. Milk and bread products (yoghurt, unprocessed cheesc, etc.) 11. Mineral waters 12. Public urban transports Sectors with time-related price regulation monopoly or dominant sellers report price increases 1. Chemicals 2. Agricultural machinery 3. China clays 4. Bricks and roof tiles 5. Cellulose and paper 6. Construction glass 7. Children's clothing 8. Foodstuffs - 103- Table A3.8 List of items of goods (with tariff codes) under license regulation in 1991 Exports Arms, weapons and explosives 9301, 9302 Military weapons and arms 9306 Explosives 8710 Tanks and armored vehicles Licensed items of importing countries (EC, USA, Canada, Norway) Agreements on Textiles Stecl products Live animals and meat products Sekcted basic inputsfor domestic industry and agriculture and similar Part A: hems which will be regulated during the whole year 1991 Number of customs tariff Live animals and meat products 0102903 Live bovinc animals 013918, 013926 Live swine 0201-0203, 1601 Meat and meat products 0207390 Poultry and poultry cuts 0402 Milk and cream, concentrated or in powder 0406902 Cheese 0504 Bovine guts 0510 Selected animal waste used in the production of pharmaceutical products Vegetabk products 1001-105, 1104 Cereals 1107 Malt 1205-1207 Oil seeds 1210 Hops Food products and drinks 1701 Sugar 2304-2306 Oil cake Mineral products 2207 Ethyl alcohol 2620111, 7902 Zinc waste 2620201, 7802 Load waste 2620308, 7404 Copper waste 2620405,7602 Aluminum waste -104- 2507 Kaolin 2505 Natural sands 2523299, 2523906 Cement (grey) 2517108 Pebbles, gravel, broken or crushed stone 2701 Coal 2702100 Lignite 2704005 Mining coke 2704005 Metallurgic coke 2716003 Electric energy Pharmaceutical products 30002101 Human blood Wood and articles of wood 4401212 Wood in chips 4403207 Wood roughly squared 4407105 Coniferous wood sliced or peeled 4407911, 4407920, 4407997 Oak, beech wood sliced or peeled Raw hides and kather 4101, 4102, 4103904 Raw hides and skins of bovine, shecp, lamb and swine 4104-4107 Leather for shoes Textiks and textik articks 5101 Wool Base metals 7201, 7206 Non-alloy pig iron and ingot 7204 Ferrous waste and scrap 7207-7209. 7210-7214, 7216, 7218-7221, 7223-7227, 7229 7301-02, 7215207, 7215304, 7215401, 7222203, 7228503 Flat-rooted, flat-roled products of iron or non-alloy steel, bars and rods, angles, shapes and section of iron non-alloy steel, stainless steel in ingots or other primary forms, flat-roUed products of stainless steel, flat-roUed 7217 Wire of non-alloy steel 7304-7306 Tubes, pipes of iron and steel Precious metals 7106 Silver 7108 Gold - 105 - Part B: Items which will not be regulated after May 1991 Number of customs tariff Pharmaceutical 2922-3004 cxcl. 3002101 Human blood Vitamins, antibiotics, and other drugs Medical and surgical instrunents and apparatus 9018310 Disposable syringes with needles 9021400 Hearing aids Pulp, paper, and articles thereof 4702000 Chemical wood pulp 4703, 4704 Pulp unblcached 4703219, 4703294, 4704215, 4704291 Pulp bleached 4707 Waste and scrap paper Vegetable products 1101, 1102, 1103 Flour - 106- References Anderson, James. 1985. 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