The Budget Reform in Czechoslovakia and the Czech Republic
4.7 Lessons and Conclusions
It is very likely that the Czechoslovakian budget experience, while slightly different than that of other East European countries (especially in quantitative terms such as the size of budget deficits), has numerous similar aspects. This permits lessons to be drawn and some general recommendations regarding economies in transition, particularly those still in earlier phases, to be made.
The first lesson relates to the stabilization phase of the reform. In very early stages, merciless liberalization as well as stabilization policies must be followed.
Experience shows (though not only from the former
CSFR),
that the budget situation tends to improve in this initial period; yet, the explanation can be only partially captured by explicit fiscal targets. The sources of this initial budget improvement were connected with the initial price escalation and the currency devaluation. The liberalization of prices (accompanied by restrictive stabilization policies) eliminated the formerly hidden monetary overhang linked to the decline of labor costs in the corporate sector (a consequence of the decline in real wages).The devaluation effected an increase of profits for exporters. Both factors led to a dramatic improvement of the financial position of enterprises with positive effects on budget revenue. This improvement, in fact, occurred at the moment of the output decline. The factors leading to this budget situation were clearly of a short- time nature. It is, therefore, extremely important to properly evaluate the size of this initial positive impulse and not to overestimate it since the latter may cause the fiscal policy reaction to be inappropriate (i.e., the output decline eliminates profitability, the gradual increase of real wages increases costs and reduces profits, etc.). The Czechoslovakian experience documented this risk in the form of a mid- course budget policy adjustment in 1991 that was probably an overcorrection and responsible for the deficit at the end of the year. In 1993, a similar mistake was already avoided.
The second lesson is that the initial restrictive orientation of fiscal policies does not necessarily extend beyond the short-term horizon and it may be even
Budget Reform in Czechoslovakia and Czech Republic 85 undesirable under certain circumstances. These include the need for the policy mix of fiscal and monetary policies to be coordinated, macroeconomic stabilization policy development hand in hand with a merciless institutional (systemic) reform, focusing the core of structural transformation on the microeconomic level, and so forth. If all of these conditions are in place, it is not necessary to maintain a restrictive pace of the fiscal policy for an undetermined period, but for the initial phase only. Otherwise, there would be a strong case to believe that developing such restrictive policies would have undesirable and counter-productive consequences on output.
This said, we are convinced that the budget is not an appropriate tool of supply-side management. Therefore, abandoning the restrictive character of fiscal policies in the transition time does not imply that we advocate the concept of expansionary fiscal policy (with fiscal deficits and so on). The experience of the Czech (and Czechoslovakian) fiscal authorities reveal that the most suitable concept is that of fiscal neutrality (neutrality in terms of demandlsupply management on aggregate levels, but not on the structural level). This target is not easily achieved given the fact that fundamental changes occur in the economic and fiscal framework over time (GDPItax base declines, tax reforms with changes in the structure of taxes and the tax rates, structural changes of the expenditure side of the budget, and others).
The third lesson is that the fiscal reform itself follows a certain scenario, which is largely predetermined by the transition framework. For instance, one of the first steps is a massive reduction of government subsidies to enterprises, connected on the one hand with price liberalization and, on the other, with the gradual lowering of corporate taxes. At the same time, new items in transfers to households appear as unemployment benefits, compensation benefits to the low- income categories of people, and so forth.
The tax reform is a crucial factor of fiscal strategy. At the earliest possible occasion, it is fundamental to create a neutral tax structure that can eliminate all the distortions of the old tax system and old tax policy (i.e., individual approach to taxpayers, avoidance of inappropriate social functions of taxes, and differentiated categories of taxpayers by source of income). These changes are unavoidable and should be made with as little hesitation as possible. The accompanying fundamental change in the structure of taxes (in light of harmonization with EC standards, especially with the introduction of the VAT) can occur later since it is not really a precondition for the development of a market environment.
The fourth lesson is drawn from the solution to the puzzle of the following issues: reduction of the size of the budget (the budget/GDP ratio), maintenance of a balanced budget, continuity of the social functions of the budget, and the strategy of shifting the decisive responsibility for social welfare from the budget to individuals. A successful achievement of these multiple objectives ban only be
achieved with a major reform of the social security, health and social insurance systems. This promises to be the most difficult task of fiscal authorities during the transition and is far from being successfully resolved. In an effort to increase the role of the individual decision on levels of benefits as well as decisive participation in financing the costs of those future benefits, the issue of reforming the social security, health and social insurance systems will not be successfully solved if not accompanied by efficient income policies vis-ri-vis households.
A further related set of problems is associated with improving the efficiency of government public expenditure and consumption. In the past, a significant feature of public expenditure was a tremendous extent of budget resources, which was the function of at least two factors. The first was the anonymous nature of government money and the second consisted of technical deficiencies in the control of allocation and efficiency of public spending. Incidentally, this part of fiscal strategy in the economies in transition resemble problems of fiscal authorities in most other countries, the developed market economies included. In finding schemes to increase the efficiency, we suggest the shift from the so-called 'demand principle' of spending to one by which ministries base financing on integral medium-term programs. These programs should reflect the society's preferences for a certain period as well as contribute to more effective resource allocation and a greater effectiveness of the public sector as a whole.
The fifth lesson relates to the issue of balancing the budget. It has been argued that a balanced budget is inappropriate as soon as the stabilization issue has been properly solved and the budget should then play a more active role via deficit financing. Universal agreement is still outstanding regarding this issue, and we are not convinced that state bureaucrats are able to make better strategic structural decisions than private investors. The main concern about the hypothetical fiscal deficit lies in the difficulties associated with financing such an increasing burden and the unavoidable crowding-out effect it produces (opinions that the budget deficit has no crowding-out effect, but rather a crowding-in effect are just speculation). Furthermore, the transition countries are still not fully opened vis-ri-vis the rest of the world, which gives them more autonomy in their decision-making (for instance, in the area of monetary policy), but also sets some limits on the use of various instruments of macroeconomic policy. This is of only minor concern as long as the country does not have to face the situation of a massive inflow of foreign capital. Fortunately, the Czech Republic is now in a situation in which such capital arrives, but at the cost of the central bank's efforts to combat the monetary risks of a suddenly increased money supply. In this context, even fiscal policy can not remain neutral since the development of the net credit to government has a tremendous effect on monetary aggregates.
The final lesson of this exposition once again encompasses a mixture of problems; including, the allocation of privatization receipts, the budget/GDP ratio,
Budget Reform in Czechoslovakia and Czech Republic
and the domestic debt. At the beginning of the reform, it has been argued correctly that the privatization revenue should remain outside the budget. The main reason was an apprehension about adding the privatization revenue to the current budget due to the potentially counter-productive effect on fiscal restriction and the aggregate demand management. Therefore, the money was frozen on separate accounts and its use was severely limited. These symptoms implied that the main argument was a macroeconomic one. Now that stabilization has been successfully achieved, the state budget appears to be in an increasingly explicit asymmetric position. On the one hand, the capital revenue of the state is not part of the state budget and, on the other, most of the capital expenditure items are carried outside the state budget; thus, the current budget revenue is being used not only to cover the current expenditure, but also the capital one. It is consequently completely appropriate to consolidate the balance of the state budget with that of the National Property Fund (which is managing the privatization program). In proceeding in this manner, it is essential to be aware of the specific character of the privatization receipts, which are a typical capital revenue, but only temporary. Decisions concerning the use of this revenue should be of paramount importance. As a result, it would be most suitable to utilize the money, for instance, to resolve some legacy inherited from the past (distortions in balances of financial institutions, ecological damages, domestic debt service, specific projects to improve the infrastructure, and the like). Such problems are related, in one way or another, to past decisions of the formerly centrally planned state and represent possibly the last obstacle to the successful establishment of a market economy in a country in transition.
Notes
[ I ] Already in 1990, the first private schools appeared. Despite a rapid development of these activities, they remain a minority. Private schools obtain 90% of the level of subsidies allocated to public schools.
[2] The data on budget results are given according to the former Czechoslovakian ( ~ s F R ) methodology which corresponds to the decision-making process. Thus, the results differ from the statistics of the International Monetary Fund.
References
Monetary survey, S B ~ S 1989-1992.
State budget of the
CR
1993.State final accounts of the ~ s F R 1989-1992.
State final accounts of the