prague social science studies pražské sociálně vědní studie

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Public policy and forward studies series - March 2007
PRAGUE SOCIAL SCIENCE STUDIES
PRAŽSKÉ SOCIÁLNĚ VĚDNÍ STUDIE
ON THE ORIGINS OF ENTREPRENEURSHIP IN TRANSTION COUNTRIES:
THE CASE OF CZECH ENTREPRENEURIAL ELITE
2007
Vladimír Benáček
Public policy and forward studies
Preliminary version,
forthcoming in March, 2007
Faculty of Social Sciences, Charles University / Fakulta sociálních věd UK
Faculty of Arts, Charles University / Filozofická fakulta UK
Origins of Entrepreneurship
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Vladimír Benáček
This text has passed reviewers’ comments.
This study was commissioned as part of Research Objective MSM0021620841
Development of Czech Society within the EU: Challenges and Risks.
Copyright  Vladimír Benáček
ISSN 1801-5999
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Vladimír Benáček
On the Origins of Entrepreneurship in Transition
Countries: The Case of Czech Entrepreneurial Elite
VLADIMÍR BENÁČEK, FACULTY OF SOCIAL SCIENCES, CHARLES
UNIVERSITY
Abstract
Based on the Czech experiences from the post-communist reforms, the aim of the
paper is to shed light on why the early stages of transition in all post-communist societies
offered so many opportunities to the nomenklatura and why the access to capital
ownership could not avoid frauds or even capital-destructive transactions. A special
attention is given to corrective processes of economic re-adjustments when the social
order converges gradually to more standard capitalist organisation. The main
characteristics of these evolutionary processes were: parallel restructuring at economic,
political, social a legal levels; high speed and intensiveness of changes that were full of
bends and blind alleys; peacefulness in their external environment; and non-violence in
domestic negotiations. The changes were particularly intensive in the eight EU accession
countries. The European Union played a very important disciplining role in that respect.
As a policy recommendation, the domestic policy-making should refrain from the
direct confrontation of adversaries. Instead of a subjecting them to centralised command,
the conflicts among post-communist winners and losers should be re-directed to
negotiable adjustments at micro-social levels. The unique combination of gradualism in
changes and the rapidly progressing stages of transition, heading towards the creation of
new entrepreneurial elites, led societies towards a new equilibrium accompanied by
accelerating growth and stabilising social order. The lessons from the peaceful, fast and
effective transitions in the countries of Central and Baltic Europe enriched the history of
capitalist development despite their peregrinations and trials and errors in human
confrontations. As such, they can be used to contemplate similar transitions in other
societies.
Keywords: Entrepreneurs; economic transition; social adjustment; economic elites;
adverse selection.
AUTHOR’S ACKNOWLEDGEMENS AND CREDITS
Contact address for comments and correspondence: [email protected]
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On the Origins of Entrepreneurship in Transition
Countries: The Case of Czech Entrepreneurial Elite
1. ENTREPRENEURSHIP UNDER COMMUNISM
The failures of the communist economic management throughout Central and
Eastern Europe resulted in a domino of political upheavals unparalleled in human history.
The resultant coups, achieved so easily, were named “velvet revolutions”. Some political
speculators therefore question whether the dismantling of communism was a genuine
demise or rather an attempt at retrenchment by the communist elite. A massive
apparatchik involvement in the privatisation in practically all transition countries and the
sophisticated techniques used for the acquisition of property suggest that more scrutiny of
the processes of new entrepreneurship in these countries deserves attention. Where could
entrepreneurship in transition countries come from? Did it depend preponderantly on
imports from the advanced capitalist countries? Or was there a sort of a conjunction of
entrepreneurial "animal spirits"?
We will concentrate in this paper on the primary drivers of transition viewed via
the prism of entrepreneurship1, considered as the salient feature of emerging new
capitalism and indispensably connected with the evolution of its new social structures. The
class of great entrepreneurs, i.e. those who own a vast stock of capital and hire labour, is
of a particular importance among them. Concerning the method, the theories of transition
will be confronted with empirical evidence taken from the Czech experience.
Before going into more detail let us start with an old joke as an outline.
1/ All are employed – but no one works.
2/ No one works – but the output target is always fulfilled.
1
In this paper we treat entrepreneurship in the wider sense: as economic, social and political
decision-making, organisation and leadership concerning not only enterprises, but also institutions
of public administration, political parties and formal and informal civil organisations. The control
over ownership in societies, where property rights oveer the "means of production" were
previously guaranteed for the government only, became the crucial issue to be solved before an
authentic entrepreneurship could scale the heights.
Entrepreneurship therefore cannot do without private property, individualism, free competition and
incentives for innovations open to all. These are the constitutional institutions of capitalism. To the
contrary, societies ruled by hierarchies and commands must deny or suppress them.
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3/ Output target is always fulfilled – but there is nothing in the shops.
4/ There is nothing in the shops – but the people have everything.
5/ People have everything – but they all swear at the regime.
6/ All swear at the regime – but in elections they all vote for the communists.
There may be a lot of exaggeration in this joke but its anecdotal wisdom also
reveals that practicing the communism required a great deal of entrepreneurship for each
“miracle”. But what kind of entrepreneurship could it be? Baumol, 1990, provides the clue
when he stressed that human entrepreneurial activities were omnipresent and could never
be destroyed. The problem is in which alternative economic fields – productive,
redistributive or destructive – and under what conditions the entrepreneurship is allocated in
the given period. Baumol’s classification also allows distinguishing between the
Marshallian-Schumpeterian productive entrepreneurship and its other orientations. The
crucial role is then played by economic incentives and market institutions, which should
be fine-tuned in order to enhance productive entrepreneurship and to divert it from
redistributive, predatory or destructive ventures.
Therefore, however bizarre the organisation of communist economies, some
entrepreneurship found always its way there. Practicing the communism thus required a
great deal of entrepreneurial skills because its management for a survival had to overcome
the chaotic information about cost efficiency and also the structure of gluttonous final
demand had to be ranked by some priorities, which were all in conflict. Its managers
therefore had to make up for a lot of market deficiencies and behave "entrepreneurially".
According to Leibenstein, 1995, entrepreneurship is based on devising schemes that would
substitute for the missing or failing markets.
Missing and failing markets were actually the defining characteristics of
communist economies. Hypothetically speaking, entrepreneurship in communism had a
large space for its command, provided it would not be prosecuted as illegal. However,
quite often it was. That was a natural reaction, though a similar one to the suicidal reaction
of a body rejecting a transplant that could save it. Entrepreneurship is an act of individual
supremacy and it leads to enrichment. But communism is hostile to individualism (except
to its Great Commander) and enrichment so achieved cannot be tolerated. Thus
communism has a built-in mechanism for its own destruction. Communist systems could
not but abandon the capitalist principles of three freedoms (i.e. economic, social
/democratic/ and personal freedom) and resign from the notions of individual choice that
were manifested, for example, in consumer sovereignty or political suffrage. If
communism is brought to fight for its survival, it naturally sticks back to denying all
previous attempts at introducing some rudimentary market or democratic principles. This
is best explained by looking at Cuba (Benacek, 2006b).
Indeed, all communist systems in Europe, Asia or America were violent
experiments of social engineering based on the military deterrent and aiming at returning
the society to systems akin to feudal organisation. Kornai, 2005, considered communism a
detour. Indeed, it was a reaction against the flow of history that was discarding the
autocratic social organisation and the belief in its supernatural origin guaranteed, for
example, by the God (Hegel) or by the universal laws of Nature (Marx). Thus capitalism
was a gradual evolution, progressing since the times of Renaissance, that was pushing
Western civilisations ever closer to the organisation based on individual initiatives and
private property. It accelerated the social development dramatically since the 19th century.
The trend was confirmed in already advanced capitalist countries during 1950s, after a
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short wavering caused by the Big Crash (1929-33) and the War (1939-45). After the
worldwide fall of Communism in 1990s it even further accelerated, as the average growth
in GDP of the world increased to over 4% and in many transition countries it reached rates
over 6% in the long run.
The failures of the communist economic management throughout Central and
Eastern Europe and China were very serious. In no single case communism could provide
sufficient consumer choice, as it was standard in developed market economies.
Nevertheless, its system of Party command could achieve political integrity, the supply of
basic investment goods and satisfy the consumer subsistence. The enormous GDP capture,
where 70-80% of the GDP were redistributed by the state budget, sufficed for building a
credible deterrent of both military and police to secure the communist rule its succession,
if that would be a unanimous priority of the elite of nomenklatura 2.
Surprisingly, that was suddenly not their volition in 33 countries of the world 3. It
was an unexpected discontinuity. The bottom-line for its explanation is that we cannot
resolve the massive abandonment of communist economic system by a mere offensive
from the trenches of their external and internal opponents. There must have been a coacting from their own lines. Thus the communist societies were not void of entrepreneurial
spirit, even though, from the very systemic arrangement, it could not have been properly
allocated. For example, communism lacked correct incentives (such as the rewards by
performance), necessary instruments (such as the market competition, auctioning and free
pricing) and institutional backup (such as the private property). We can distinguish two
roots, which moulded the massive rise of the Czech (and Slovak) private economic activities
after 1989: the legacy of preceding capitalism and the legacy of totalitarian socialism.
The Central European and the Baltic countries, but to a lesser extent the other
countries of the Soviet Empire, could still rely on the cultural principles that characterised
their societies two or three generations ago. Actually the legacy of Czech capitalist
consciousness during the communist days could be traced to the traditions of F. Palacký
(1798-1876), K. Havlíček (1821-1856) or T. Baťa (1876-1932), who were liberals of
cosmopolitan background, stressing the build-up of Czech bourgeois vitality in contrast to
the local religious, nationalistic or agricultural sentiments, as it was common among
conservatives at that time. In 1913 the Czech Lands were the most industrially developed
part of the Hapsburg Empire, competing technologically and commercially with the most
advanced countries in Europe. The brand names of Škoda, Křižík, Kolben, Bata, Avia, Jawa,
Tatra or Živnobanka were the entrepreneurial flagships of international competitiveness.
This trend continued during the period of Czechoslovak independence in 1918-1938. In
1948 the Czech Lands had the most competitive economy of Central/Eastern Europe, with a
2
In this study the meaning of "nomenklatura" is assuming that the communist system had its own
non-dissident political, economic and cultural elite. We will concentrate predominantly on the
economic elite, in contrast to apparatchik elite of communist party secretariats. The former will be
characterised by its engagement in "reformed economy", alignment with technocracy and
acceptance of human capital, even though its real power stemmed from various forms of social
capital (e.g. political capital, network capital and informal relational capital).
3
There were two exceptions only. In contrast to others, the ancien régime in North Korea and
Cuba stack to its old priorities, what could hardly happen, would their charismatic leaders Kim Ilsung and Fidel Castro not be in command. Notwithstanding their exceptionally weak economies
and a myriad of powerful external and internal pressures, these most inflexible and isolated
communist regimes survived (Benacek, 2006b).
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long tradition of openness to the world (Benacek, 2003). The following principles
characterized the Czech society and formed the economic development before 1939 (see de
Ménil, Maurel, 1993):
• Reliance on democracy;
• A combination of market competition with foreign trade controls, cartels and
bureaucratic interventions;
• Restrictive monetary policy and convertibility;
• Enforcement of private property rights;
• Liberal attitude towards religion and other nationalities;
• Competition between Czechs and the local German and Jewish minorities;
• Intensive free trading, mainly with its Western and Southern neighbouring countries;
• Division of labour and specialization in labour and human capital-intensive industries.
It is interesting to notice how in mere 3 years of 1990-92 the Czech society returned
to these principles, which the external political forces had been trying to suppress
systematically for 50 years. The recovery went sometimes to shocking details, like
increasing the share of exports to Germany from 8.3% in 1989 to 33.3% in 1992 and
bringing the territorial structure of trade to a close similarity with that of 1928. The legacy
of capitalism and the memory of self-reliance were most useful in situations when the
workers had to forage moonlight and barter things for livelihood. The reason was not only
the shortage of products under central planning, but that the employment in the hierarchies
of nomenklatura was not opened to competition among talents. Also the incentives for an
engagement of human capital in enterprises were distorted.
Therefore the national stock of productive human (entrepreneurial) capital could not
have been used fully in the official economy. The business skills remained to a large extent
outside of nomenklatura, where they were used either in retail trafficking (e.g. working as
taxi drivers, tradesmen or shop assistants) or in do-it-yourself household and fraternity tieups – such as housing upkeep, car repairs, sports, arts, holidays, underground political
dissent, etc. Entrepreneurial skills of the shadow private sector were to a large extent
frittered away by high transaction costs on the exchange side and by a poor access to
technology. Nevertheless, it was a valuable entrepreneurial training that could be most
useful whenever small businesses would be liberalised. Due to internal barriers that varied
among sectors and regions and the use of different ingenious techniques for overcoming the
shortages 4, the legacy of capitalist entrepreneurship in communist countries was spread
asymmetrically throughout the society.
The legacy of totalitarian socialist entrepreneurship was of different stock. It
concerned the party bureaucrats who had to invent the most bizarre tricks in order to push
through the unviable system of blind central command to achieve at least some sort of
performance. If it were not for the common good, the nomenklatura would do it at least
for their own “residual claimancy” to be satisfied, which actually raised their activity to a
status of entrepreneurship. The Brezhnev style of corporate management introduced in
early 1970s could not avoid innovation or flexibility, whatever absurd were both in their
processes and outcomes. As an option, the management of enterprises could either take an
4
Remember that much of the mentioned "shadow" entrepreneurial activities in communist
countries were illegal, while at the same time the parallel official positions were often given to
people without entrepreneurial talent and where the collective rules were undermining strategic
initiative and risk-taking, without which entrepreneurship cannot exist.
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inward orientation towards innovation and efficiency or an outward orientation towards
negotiations with the vertically superior bureaucracies.
Given the known lack of microeconomic fundamentals, as it came clear from the
Hayek versus Lange-Lerner controversy, the socialist management of efficiency could rely
on rudimentary principles only, such as the minimisation of queues, inputs of material and
energy or imitation of products and processes used in market economies (Kornai, 1980). It
was also combined with a redistributional "innovation" – with bargaining for a softer output
plan or for a higher quota on inputs. A success in any of these was a sophisticated
entrepreneurial treat where the gains were personal and they could be used for the build-up
of powerful private social/relational capital (see Bezemer, Dulleck, Frijters, 2003).
The reforms in communist countries since early 1970s offered nomenklatura more
initiative. If an apparatchik fulfilled the plan target and showed sufficient loyalty to the
superiors, he/she received a free hand to exercise power over resources, staff policy and
bonus remuneration in the economic unit belonging to his/her respective rank in the
hierarchy. On the equal horizontal level of bureaucratic subordination the manager had
powers to collude with other "partners" in order to form cartels, information asymmetries
and political coalitions, which liquidated potential interference in the production,
distribution or planning processes. In their relation to various superiors (on the level of
state planning, district council supervision or party subordination) bureaucrats had a wide
range of alternatives for negotiations and vertical collusions in order to strengthen their
strategic standing.
With the widening possibilities for the official (and unofficial) accumulation of
wealth, the socialist millionaires cropped up everywhere since the late 1970s. The situation
in communist countries has taken another dimension when in 1983 Andropov's doctrine
(Zeihan, 2006) switched the communist strategic orientation from external imperial
expansion to concentration on domestic reforms, enterprises, technological innovations and
more flexible management. Such changes, however, were not possible without relinquishing
the extent of the Soviet world control. All that offered national entrepreneurship a new spur
for an even greater autonomy.
The resulting socio-political antagonism caused by the different relationship to
entrepreneurship before the fall of communism can be identified with three social groups.
We will call them "marketeers", "nomenklatura" and “outsiders”. The following
approximate list of activities can be made in order to distinguish between them:
(i) Marketeers: private farmers, repair workers, artisans, tradesmen; catering and
hotel staff, cab drivers, foreign exchange touts, greengrocers, used car dealers; shop
managers, shop assistants, stock keepers; popular entertainers, artists, top sportsmen;
administrators of queues, bureaucrats issuing licences, certificates and permits; ringleaders
of organized crime.
(ii) Nomenklatura: directors of companies, their deputies, heads of divisions or
financially independent units; paid party apparatchiks, high-ranking bureaucrats at
ministries, district and municipal councils; high-ranking officers in army and police.
(iii) Outsiders: people with low degree of revealed entrepreneurial aspirations.
These again could be divided into two groups: those with human and entrepreneurial
capital practicing mainly in the do-it-yourself activities (latent outsiders) and those lacking
such skills (passive outsiders). Among the former there was a large subgroup of middle class
who were people with high productive potential underpinned by education and morals
calling for democracy: doctors, engineers, teachers, computer operators or scientists, whose
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potential of entrepreneurial skills could not be used under the communist system. Their
expectations for a change were very high.
As an illustration of the size of such groups, we can use the data from the Czech
survey of Vítečková, 1992. The pre-transition society in Czechoslovakia could be
intuitively structured as 10-15% belonging to group (i), 4-8% to group (ii) and 77-86%
remaining in the group (iii), of who a quarter could be classified as "latent" entrepreneurs.
This had an impact on how the economy was split informally into the State, the officialprivate and the shadow-private sectors. Their sizes differed by countries. According to
Janacek, 2000, the share of official-private sector on GDP in 1989 was 1.5% in
Czechoslovakia, 8.5% in Eastern Germany, 14% in Hungary and 26% in Poland.
However, what mattered for the potential of entrepreneurship were the extents of the
shadow economy and autonomous managerial activities of nomenklatura. Although their
fuzzy watersheds can be hardly quantified, their presence and the crucial importance for
the communist economies are undeniable. When the window-dressing of central planning
and hierarchical subordination finally lost the institutional support in 1990, the enterprises
and the economy hardly recognised any change at the beginning: the long-established
"shadow management systems" were already in control of the economy and ready for
transition (Benacek, 1995). However, the transition was tougher and different in its
contents than anyone could have presumed.
2. ENTREPRENEURSHIP IN THE EARLY STAGES OF TRANSITION
It follows that it was the nomenklatura of state enterprises and not the central
planners who were in control of the official parts of the economy and who could gained
even more when Andropov and Gorbachev doctrines undermined the instruments of
totalitarian collectivism. Such national systems were ready for a breakthrough, once a
strong external shock cracked the institutional braces in merely one country. There was a
risk and uncertainty in individual cases but under the premise of a “velvet revolution” the
nomenklatura could not expect to lose much as a group. A similar situation rested with the
marketeers and "latent" outsiders: they expected a better deal once their activities were
liberalised. Although the group of passive outsiders could gain the least in entrepreneurial
advantages, they were also inclined for a change – their gains were associated with higher
consumer choice and the introduction of democracy. Thus the surprising discontinuity in
the collapse of communism was not so sudden – it was backed by long-evolving new
expectations along all structures of the society.
As the 17 years of transition later revealed, the small-scale entrepreneurial gains
were favourable for the latent outsiders. In the long run they used their human capital,
organisational skills and endurance for the majority of gains in the small businesses and
self-employment. For example, in the Czech case 21% of all employees were registered as
self-employed businesses by 1994. In 2003 that number increased to 33% 5. These figures
show a very high degree of entrepreneurial organisation in an international comparison.
Also in other Central European and Baltic countries the rise of self-employed among the
former outsiders was very high (Selowsky and Mitra et al., 2002) and comparable with the
5
According to the Czech Statistical Office, Annual Yearbook, 1996 and 2004.
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situation in advanced market societies.
The transition hit harshly the private sector that was already established under
socialism – i.e. the marketeers. As pointed out by Winiecki, 2000, and Winiecki et al.,
2004, the emergence of new business opportunities after 1989 caused bankruptcies not
only among the state firms but also among the old private businesses. The reliance on the
shortage economy, the lack of discipline and entrepreneurial vision, and the failures in
restructuring caused shrinkage of the old private sector by 40-75%, while at the same time
the new the start-ups coming from the group of latent outsiders contested the markets. We
can therefore come with a general hypothesis that the group of socialist “marketeers” did
not prove to have sufficient skills for an easy transition to the ranks of new entrepreneurs.
The reason was a dramatic change in incentives and in the environment of businesses after
the fall of the iron curtain. The incentives under communism induced the marketeers to
profit from the excess demand, black market prices and corrupt state bureaucracy;
altogether, not a useful experience for acting under functioning markets. Therefore we
should not expect a significant shift of this group to positions of grand entrepreneurs.
The transition process after the fall of communism could be split into several
domains:
a/ Transition of management from collectivist centralised bureaucracy (often confused
with central planning) to autonomous competing bidders for new managerial positions.
b/ Transition of the fiscal system, which included the transition from high taxes and price
controls to low taxes and liberalised pricing.
c/ Transition of openness from international trade functionally separated from the internal
economy to mutually interlinked external and internal economies.
d/ Transition of ownership from state monopolies to private enterprises that concerned
industrial enterprises, collective ownership of land, commercial banking, etc.
Taking all four domains into unity could be described as the transition of
entrepreneurship. It concerned the behavioural quintessence of capitalism – the role of
individuals in taking decisions, contracts, risks and property claims associated with
profits. The free space opened for the development of entrepreneurship can be thus
considered the decisive driving force towards capitalism. Its transition was moving it
from dysfunctional and illicit institutional schemes towards efficient organisation and
decision-making based on democracy and economic freedom. There is no democracy
without capitalism and its entrepreneurship.
In the next analysis we will concentrate on the evolution of grand (i.e. the largescale) entrepreneurship in Czechia. As leading social agents of capitalism, this economic
elite is called "the top hundred thousand" in the popular parlance. Their characteristics are
that they act as legal entities of enterprises and not as physical persons, such as selfemployed tradesmen. The legal form of grand entrepreneurship is best represented by the
ownership of joint stock or limited liability companies. Their necessary characteristics are
that they hire labour and that the ownership concerns such a volume of capital that could not
be financed directly from wages. We will assess the transition of four groups of economic
agents into the position of grand capitalist entrepreneurs.
Our further estimates will be based on the survey of Vítečková, 1993. It deals with
the structure of Czech private entrepreneurs in December 1992, classified by their origin
into four groups of professional ranks in communist management (i.e. that one before 1990):
top, middle, low and none. But what is the relationship between four Vítečková's
professional ranks and our previous classification into three groups? The first two groups of
(i.e. those of high and middle ranks, in contrast to low ranks) can be taken for proxies
closely correlated with our group of "nomenklatura". The "latent" subgroup of outsiders and
the group of marketeers can be both traced mainly in the low rank and only partially in the
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"no position" rank of the communist management. The data reveal that the access to new
riches was subject to high asymmetries in the potential for ownership gains.
The quantitative characteristics in Vítečková's survey were drawn from a sample of
1000 businessmen, each of who had registered as a firm with the status of a legal entity
("legal person") that hired a staff of employees during the first three years of transition. It is
important to mention that it excluded persons licensed to self-employed proprietorship.
While the latter numbered over 1 million licensees in 1992 (out of the full-time Czech
employment of 5 million), the number of private business companies registered as legal
entities was 83,695. We could therefore presume that this number of enterprises might
generate approximately 160 thousand positions of new high-ranking private entrepreneurs –
the new entrepreneurial upper class (riches nouveaux) of the early Czech post-communist
elite.
We will test the hypothesis that Czech "grand entrepreneurs" with capitalistic
businesses of hired labour were to be recruited from the set of nomenklatura, i.e. from the
existing top and middle bureaucrats of the communist ancien régime. We estimated their
number at 262 thousand, out of the population of 10.5 million. They were supposed to
compete for 160 thousand positions as owners of new private firms with the status of legal
entities. The stylised facts characterising the origin and mobility of the Czech entrepreneurs
are summed up in Table 1. Our task is to estimate the approximate probabilities of becoming
a high-ranking new entrepreneur. The results based on the method of simulation are in the
column E.
Table 1: Structure of Czech Private Entrepreneurs in 1989 and 1992
(stylized facts)
Old positions of
"new"entrepreneurs
of 1992 prior to
1990
(C)
Shares
on total
in %
(D)
Probability of
transition from A
to C in %
(E = C / A)
Rank in the
communist
management
prior to 1990
Estimated
no. of
workers in
1989 (A)
Shares
on total
in %
(B)
Top
Middle
Low
None (both latent and passive)
38 000
224 000
885 000
0,7 %
4,2 %
16,5 %
17 600
25 600
70 400
11 %
16 %
44 %
46,3 %
11,4 %
8,0 %
4 227 000
78,7 %
46 400
29 %
1,1 %
5 374 000
100 %
160 000
100 %
3,0 %
TOTAL
Source: Own estimates by using the data for column D from Vítečková, 1993.
Columns A and B show the estimated breakdown of the total Czech employment in
1989 by four managerial categories /ranks/ based on own estimates. The structure of
professional transition to a group of 160 thousand new large private entrepreneurs at the end
of 1993 according to the characteristics collected by Vítečková, 1993, is indicated in column
D. This is used in column C for estimating the number of those who established large
businesses in 1990-92. Their structure is classified and ranked according to their highest
working assignments achieved anytime during their careers before 1990.
If the estimated structures in columns B and D, and the sum of column C are closely
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related to their real distribution 6, then the following implications can be drawn:
a) There is a very high probability (46.3%) between the incidence of having been a
communist bureaucrat in a top or middle managerial position and the membership in an
emerging class of new capitalist entrepreneurs. The difference between the transition
probability in this group compared with the groups of communist management in middle
and lower ranks is striking and robust to the error terms. If we keep in mind that in 1992
approximately 75 % of the output was still produced in the non-private sector 7, then
practically all the departures of former top nomenklatura (forced or voluntary) until 1992
must have been directed to establishing private businesses that would be prepared to absorb
the wave of privatisation and loans awaited after the end of large-scale privatisations in
1993-95. This would be a good managerial foresight, confirming the optimistic expectations
from 1989.
b) Since 95% of the top and middle ranking managers prior to 1990 were members
of the Communist Party (CP), and a high proportion of the low ranking managers also had
to be party members, then approximately 37-42% of the Czech emerging high capitalist
class in 1992 were people associated with the CP. Such estimate can be drawn from results
in column C 8. However, if we presumed that the CP membership was most often just a sign
of mere opportunism greedy for power, the real qualities of new Czech entrepreneurs were
much more subject to flaws in character and ethical integrity than to being stalwarts of
Marxian doctrines.
c) Our estimates point at the error of many observers of transition who assumed that
the Eastern totalitarian societies were void of any efficient entrepreneurship and economic
rationality. Thus these qualities would have to be imported nearly exclusively from abroad,
e.g. by inviting emigrants or foreign investors 9. On the contrary, we presume that a fast and
peaceful transition to new capitalist entrepreneurship cannot be dissociated from former
domestic management, domestic traditions and domestic resources in all stages of transition.
6
Naturally, we cannot take the simulated stylised facts in Table 1 strictly at face value of their point
estimation. The error term in estimates in column E can be relatively large. Its value depends mainly
on the robustness of estimates in column B, provided we could assume that the error terms of data
given in column D were low with a mean of zero. We estimated that the error term in data of column
B could range from 10% through 20%. As can be easily simulated, such variations do not cause a
significant qualitative bias in column E that could reverse the tenor of our conclusions. The other
instability can be generated by the total number of positions in new large businesses (summed in
column C), which potentially could vary from 145 to 180 thousand positions. Their influence would
be most sensitive in the group of former top nomenklatura. Then its probability of transition would
be subject to a variation by plus/minus 6 percentage points. That is again an acceptable error term.
7
It should be said that even though the number of big private enterprises was already large, the
majority of output rested still in the State or in the partially de-etatised enterprises. Only in the
next 5-8 years their employment and ownership moved to the hands of pre-activated private
entrepreneurs, as the scope of privatisation widened and deepened, and as the companies under
incomplete ownership went bust or unbundled under the pressure of competition.
8
This estimate is consistent with the conclusions of Matějů, 1997, and Machonin et al., 2006, pp.
45 and 79, where the latter estimate the share of former nomenklatura of 36.8% for 1994, without
distinguishing between the high, middle or low ranks.
9
The strategy of massive imports of entrepreneurs from abroad was applied first in Hungary. In
other countries it was much later (e.g. in Czechia and Slovakia in late 90s). It was not a losing
strategy because indigenous entrepreneurs had a longer period for proving their capacities (or
incapacities) of leadership, what caused less political discontent when the flood of foreign
competitors finally arrived.
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Vladimír Benáček
Indeed, our data are not in conflict with the assumption that entrepreneurial drive was
present in all societies and the selection of post-communist economic elite, if left without
external discrimination, could not avoid former elite. For example, it targeted 27% of all
new entrepreneurs among nomenklatura in the Czech case.
d) At the same time it is clear that it was the selection of communist elites that was
subject to political bias, discriminating against entrepreneurial skills: only approximately
15% of former nomenklatura succeeded in re-gaining their position among grand
entrepreneurs in the first three years of transition. Of course, the later stages also offered
them a chance for re-switching, even though more advanced capitalism offered an even
higher risk of exit of nomenklatura from the previously gained position among elite. We can
see that having a peaceful transition was an objective that could be shared among both
nomenklatura and outsiders.
e) Even though the tributes paid to the Czech nomenklatura for their peaceful
surrender could seem to have been undeserved (at least morally), that still would not deny
the fact that local nomenklatura had some objective economic reasons for being a leading
group in becoming entrepreneurs. Discriminating the nomenklatura in their access to
property was not practiced legally in post-communist countries. Indeed, we lack evidence
that an introduction of such legal barriers might have speeded up the processes of social
adjustment and the selection of optimal structure of entrepreneurs significantly. The only
evidence of institutional barriers placed on nomenklatura, that one practiced in the
privatisation in Eastern Germany, would point to an opposite: the preference given to
imported entrepreneurs (e.g. from Western Germany) did not improve the competitiveness
of local enterprises and led to other tributes (such as high wage and social compensations
to local workers) that undermined the pace of East German transition and led to the worst
results from all transition countries in Central Europe.
f) A final judgment about an easy penetration of communist elites into the ranks of
large entrepreneurs cannot be drawn during the early stages of transition. For example, the
assessment how successful was the old-new economic elite in competing with remaining
60% of newcomers and with international businesses could be conclusive only twelve years
later. We will discuss it in the last chapter.
g) If the nomenklatura were subject to a certain degree of efficiency, competition
and meritocracy, then they could have had motives to take part in the dismantling of the
inefficient system of planning, public property, bureaucracy and political paternalism, which
limited their motives for more wealth and power. That implies that nomenklatura should not
mind velvet type of revolutions so much. More surprisingly, this statement can also work
vice versa. Thus even the new political elite, recruited from the ranks of former dissidents,
may have reasons for accepting their former oppressors as competent business allies.
h) The rate of transition of former low-ranking state managers and supervisors into
new grand entrepreneurs is very high, forming 44% of their total number, although a
probability of succeeding in such a move would be around 8% only. However, not a large
part of them can be expected to come from among the group of marketeers, as we already
discussed. Thus many of the latter either remained in small businesses or became a hired
labour in businesses of their more successful competitors.
i) Only a small fraction of people (1.1%), who were neither engaged in the
communist nomenklatura networks, nor in any formal managerial position, have after 3
years succeeded in becoming grand entrepreneurs. Unfortunately, the data from Vítečková,
1993, do not allow us to separate from the statistical sample of the "no managerial rank"
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Vladimír Benáček
those belonging to marketeers or to "latent" and "passive" outsiders, respectively. If we
would assume that 30% of this heterogeneous group were people with organisational or
technical skills and that they formed 75% of new entrepreneurs coming from this group,
then the probability of transiting from among the group of passive outsiders would be mere
0.4%. That would be one out of 250 only.
j) Even if we admitted that the managerially less motivated workers represented the
majority of skilled (latent) outsiders, we still cannot exclude the existence of high barriers to
outward mobility from this numerous subgroup of former non-CP wage earners. According
to the previous assumptions, their chances for becoming large entrepreneurs would be 2.8%
only. That is still below the national average of 3% – implying the continuation of past
selection bias discriminating the human capital and the existence of other barriers precluding
the skilled outsiders from entrepreneurial entry after 1989 10: lack of wealth, lack of pull
from the network of cronies and the pressure of adverse selection acting against people with
high moral principles.
k) In this paper we concentrated on the emergence of new grand capitalists.
However, the group of outsiders and low-ranking communist managers were not cut off
their chances completely. There was still opened an access to small-scale capitalism, for
example, to self-employed businesses. The pressures of hard budget constraint were often
harsher there than in large (privatised) businesses, where the transition was cushioned by
special government policies [Winiecki et al. 2004]. Nevertheless, as in the Czech case, the
progress in scope and in efficiency of self-employed or family-type of businesses
throughout 1990s was significant, becoming the springboard for future expansion into
becoming larger firms.
3. THE MEANING OF TRANSITION
The recent post-communist "transition" is often interpreted as economic, political
and social transformation of institutions required for the passage from centrally planned to
market economy. It is an insufficient and rather delusive interpretation. Transition should
be studied on real systems, as they were, and not on abstract systems, saying as the reality
ought to be.
a/ A transition so defined would have fuzzy time constraints, if taken literally. The
passage from non-market to market institutions has been a tendency characterising the
social development in the last 300 years, at least. The post-communist transitions would
10
This is a rather disturbing finding because the group of skilled outsiders is quite numerous (24%
of labour force) and it forms the social group of middle class. According to many authors, it is the
middle class that acts as the social force upholding democracy and capitalist pro-market
institutions. Offering low incentives for the prosperity of middle class thus threatens the political
and economic stability of the whole society. It is a common observation of politics in transition
countries of Central Europe that dissatisfied members of middle class were prone to collude
politically with the lower classes. The latter, once they lose the trust in having a chance for
becoming members of the middle class, tend to support redistributional policies that undermine the
otherwise high growth of the transition economy. Thus we could observe high political instability
in transition countries: there were governments, notwithstanding their political orientation, that
having failed in satisfying the expectations of its middle class electorate were superseded soon by
another government, which was stricken by a similar fate.
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Vladimír Benáček
be just mere series of casual "great transformations" in human history (according to
Kornai, 2005, by referring to Polányi, 1962).
b/ Real transitions were neither a departure from economic systems of central planning,
nor they aimed at the attainment of perfect market economies because both could hardly
exist in a pure real form. It would be more realistic to think about a replacement of rigid
(hierarchical) social governance by a more flexible mechanism opened to (market)
competition, which became the target of government policies. Institutions of advanced
capitalist countries served as examples to be replicated; however, their concrete
implementation was a creative process that offered many local aberrations. However, in
contrast to governments, neither that was the primary objective of the entrepreneurs-to-be,
i.e. the dominant inherent agents of changes.
c/ Thus the primary objective of transition was a shift to new riches, even though not
necessarily by means of Pareto-improvements on the production side. Institutional
revamping was considered as their primary means only, subject to a bias when
redistributional aspects started to dominate over the productive aspects. Obsession with
privatisation, asset stripping and escape from the rule of law were as much a part of
transition as were the property rights, democratic polls and individual freedom.
d/ The real achievement of transition was a shift to another imperfect market economy
subject to domestic folklore and international pressures exercised under highly unstable
leadership and weak feedback about what had been already accomplished.
The communist social system was full of long-suppressed and accumulated
conflicts, which had to be addressed to find a new social equilibrium. An immediate
explosion of these conflicts and an attempt to eliminate the past elite would have
unleashed chaos in society for a long time to come. A peaceful transition had to be
gradual, and that made co-acting with the outgoing power essential. The whole process of
the subsequent social, economic and political transformation cannot be achieved by means
of revolutionary commands but through step-by-step negotiations at the micro-level. This
can be likened to a process of market ‘tâtonnement’, i.e. a global social auction first
described by Walras (see Jaffé, 1983) and to the processes of bargaining for the optimal
redistribution of property rights, as explained by Coase, 1960. The optimal redistribution
of property cannot be a one-off game. It is the quest for reciprocal re-adjustments among
millions of domestic agents looking to reallocate their diverse interests and capacities. It
would therefore be a mistake if some domestic central authority or intervening external
force were to mastermind and dictate the course of these complicated processes.11
Settling local inter-human relationships that had been fettered for decades had to
be left to local negotiations in an environment of centrally secured non-violence.
Surprisingly, these originally highly improbable gradual readjustments occurred
independently in all post-communist countries. They happened despite the myriad of local
trials and errors, missed chances and moral compromises that affected nearly everyone
and disappointed the expectations of an instant ‘justice’. It was clearly a strategy of second
best that was easily criticised for its seeming blindness. Nevertheless, the amazing
processes of social tâtonnement, a social parallel to market clearing, in which the
resolution of human conflicts could be fine-tuned gradually and in peace, became, in the
end, a strategy more efficient than any exogenous social engineering. As Kornai, 2005,
11
Such failing examples can be found in the US interventions by power in Iraq and Afghanistan or
in the external imposition of reforms during the German unification. A more acceptable example
can be found in China, as well as in Central and Baltic Europe.
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Vladimír Benáček
pointed out, such transitions were, after all, still extremely fast and unprecedented in
human history.
The gradual contest for capitalism was the most characteristic feature of the
evolution of entrepreneurship, especially in the crucial field of capital redistribution and
ownership, where human conflicts were for centuries most violent. Thus the peaceful
evolution of entrepreneurship, intertwined with the necessary gradual ownership changes,
can be regarded the cornerstone of post-communist transition (see also Popov, 2000).
The bottomline of post-communist transitions is that they were not a centrally
operated plan of social engineering, though there were many camp followers who claimed
such a calling. It was a natural process of exceptionally rapid social evolution, triggered
by lifting the threat of (Soviet) military intervention that was later complemented by
lifting the threat of local police intervention. From the very start it was open-ended and
driven by a myriad of autonomous bargaining and adjustments at social, economic and
political micro-levels when the constraints of communist institutions were gradually
abandoned. After the new ownership structures were stabilised (what took some 5-10
years), the issue of property rights was again relevant and the demand for other regulatory
institutions was increasing. Thus the speed of transition reforms gradually decelerated,
becoming restrained by rising regulatory institutions. Since the autonomous
transformation of ownership proceeded faster than many other parallel changes (e.g. in the
public administration or in democratic social culture), for many years it was ahead the
languid legal framework. Then, as the legislation was catching-up gradually with the real
changes, many processes of restructuring got suddenly stuck in a semi-finished stage and
thus remained incomplete and suboptimal.
As is shown in Figure 1, transition was characterised by an institutional
liberalisation, accompanied by a frenzied autonomous economic activity in reallocations,
innovations and re-adjustments. In the Czech case it was the period 1990-1997. The
sudden jump-start of entrepreneurship in post-communist countries would not be possible
without such a prior liberalisation and legal short-cuts, even up to a point of informal
institutional vacuum, which slashed down the transaction costs of establishing and running
businesses. All that was reversed in the later stages of transition.
Degree of
intensity
Institutional constraints
Flow of real economic adjustments
1982
1989
1997
2000
2007
Figure 1: The interplay between institutional (regulatory) constraints in transition
and the reallocative economic adjustments
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Vladimír Benáček
The data of Bažantová, Kolář and Barbořík, 2006, illustrate such an inversed
institutional evolution. For example, meanwhile it required to issue 194 new laws and 417
by-laws each year in average in order to turn the communist legal system into the
capitalist one during 1990-92 12, and 65 laws plus 262 by-laws annually in average during
the period of stabilisation 1993-98, the expansion of legal regulation accelerated in later
years (1999-2006) by issuing 119 and 400 new laws and by-laws each year in average,
respectively. The number of proposals of new laws increased even six-fold during 19992006 if compared with 1992-98. Even though the burden of institutional regulation was to
a large extent imported from the framework of acquis communautaire, approximately
55% of regulatory norms in Czechia have still of national origin. The transaction costs of
entrepreneurial activities, such as the establishment of an enterprise or hiring labour, also
copied the U-shaped schedule of institutional changes in Figure 1.
The transition countries thus acquired new economic leaders (entrepreneurs) within
approximately 3-8 years, instead of a couple of generations, as it used to be in the
traditional capitalism. However, the gains in speed were in conflict with the quality of
selection. The quick outcome was economically suboptimal due to the bias caused by
adverse selection. Akerlof, 1970, was the pioneer in describing how uncertainties,
asymmetric information, incomplete markets and imperfect institutions (e.g. in contract or
liability enforcements) led to a dominance of goods of low quality ("lemons") over the
goods of high quality ("cherries"). Unfortunately, such a bias does not influence the
selection among non-homogenous products or parties interested in insurance only – the
cases used for illustration by Akerlof. It concerns also the selection of agents on labour or
capital markets, when their backing institutions are obscure and the information is flawed.
In such opaque situations the selection of new owners cannot but become dominated by
the networks of relational (social) capital. Resultant outcomes then can differ widely from
the selection based on other criteria, such as the endowments with human capital, financial
capital or entrepreneurial skills, because in the early stages of transition the endowments
of social and other types of capital are not highly positively correlated.
In case of communist nomenklatura, expecting such a correlation between various
forms of capital would be naive, since the endowments of relational capital were often in
conflict with the endowments of human capital, especially among apparatchiks. In case of
technocrats, a positive correlation was a part of their carrier building, even though the
quality of their human capital did not have to be high. Firstly, it was not very useful vis-àvis the usefulness of the relational capital that was dominating. Academic titles in
communism were mere signalling tools – a sort of an additional bonus for a cherry on a
cake, which could be received for the provision of services of the relational capital. In
addition, the quality of the human capital in communism was generally overestimated. As
Beirne and Campos, 2006, have tested recently, the official evaluation of the stocks of
human capital in transition countries was incorrectly measured and should be downgraded,
if its seemingly high volume is weighed by performance. The estimates by means of
educational production function led to lower levels of endowments relative to capitalist
countries than was originally thought. That would also explain why the human capital in
12
It should be added that the new laws of 1990-92 were targeted at liberalisation and abolition of
the former communist constraints to all three freedoms, meanwhile the new legislation in the
second half of transition was to a large extent regulatory and raising the transaction costs of the
economy.
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Vladimír Benáček
transition countries could not become the driving force of transition.
The importance of signalling in the period of transition, which would constrain the
extent of adverse selection of new entrepreneurs in an opaque environment, could have
been of paramount importance. Unfortunately, the general uncertainties made signalling
either ineffective or counter-productive. The trust in the past communist management was
from obvious reasons very low at the very start. Also the initial trust in moral authorities
(e.g. in political dissidents) was fading away, as their ethical constraints limited the power
of their strategies useful for the main objective of transition (i.e. the property acquisition).
Thus what remained was the signalling about some recent entrepreneurial success. But
could such a claim be credible once it was achieved within an extremely short business
history in an environment where decisions were not subject to repetition? They were just
one-off shots that had to be taken immediately as the occasion appeared. The success was
to a large extent a random process where the network of cronies could significantly
manipulate (down or up) the transaction costs of such random games. The abuse of ethics,
bluffing, moral hazard and frauds became decisive moments of such games. The natural
high demand for signalling became the driver of its massive abuse and the rise of adverse
selection – selection of the bad ones 13.
4. THE BIAS IN THE POLICIES OF PRIVATISATION
As we have explained it above, transition means a dramatic breakthrough in
changing those parts of social order that are subject to man-made decisions. These are
political, economic and social institutions, with the property rights in the forefront. They
determine the quality of the core agents of capitalism, and through these agents they also
influence the quality of transition. Let us therefore look more closely at the structure and
the role of institutions in general. The notion of “order” is a pivotal concept in explaining
the social development and organisation. According to Hayek, 1973, it was in the tradition
of German philosophy to distinguish between the natural fundamentals, i.e. the
spontaneously evolving real base of human existence that he called “Cosmos” on one
hand, and the man-contrived infrastructure of that spontaneous order called “Taxis”, on
the other hand. Taxis reflects the aims (i.e. the interests and policies) of specific social
groups. Hayek claims that it is impossible to introduce a new viable order by force – by
simply manipulating Taxis, irrespective of the state of Cosmos. In another words, Taxis
ought to be re-adjusted in parallel with the natural evolution in Cosmos. While the latter is
objectively determined, the former depends on human perception and the willingness to a
change. Thus Cosmos and Taxis are often in conflict.
We can use Hayek’s reasoning and argue that the collapse of communism was a
natural process of correction at the levels of both Cosmos and Taxis because the
communist institutional setup was an attempt at social engineering aiming to stop the
13
For example, one of the most controversial defaults in property rights was masterminded by
Viktor Kožený who controlled over the portfolio of Czechoslovak enterprises worth billions of
dollars by advertising his business skills of a Harvard Business School graduate and who
nicknamed his asset-stripping Harvard Capital Investment Funds to "Harvard". Another
controversial case of asset disappearance of an even larger magnitude concerned Nomura
investment bank – a symbol of Japanese growth, diligence and restructuring skills.
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Vladimír Benáček
evolution of capitalism by bringing the society back to pre-capitalist organisation. That
brought the command-economies to a universal retardation. The call for institutional
adjustments was immanent among all those agents who could foresee their own real
improvement once an institutional change could be introduced. The crucial moment came
when even the nomenklatura recognized a case for general Pareto-improvement. The
central part of changes hinged on an introduction of economic liberties, including the
enforcement of property rights (as legal norms) and an opening-up of speedy privatisation
(as an open auction), that both belonged to Taxis.
However, in the reality of transition the body of Taxis, as the pivotal instrument of
the communist social organisation, could not be changed as quickly as the speed of
privatisation would require. Thus privatisation could not avoid being caught in the vicious
circle of the impossible: introducing new Taxis before having new Cosmos and
developing new Cosmos before having new Taxis. Based on Hayek's typology, the clashes
between these two intertwined conditions for a balanced development, as seen at various
angles of observation, are indicated in Table 1.
The right-hand side of the table is the man-contrived contribution to otherwise
spontaneous social order. Taxis is a result of social negotiations and administrative
enforcement by orders of agents with a power in the hierarchies of governance. According
to Hayek, development is an evolutionary process, which stems out from interactions at
the micro-level of its agents, i.e. at the socio-economic grass roots of Cosmos. Thus it is
the left column of Table 1, which should determine the induced adjustments in the right
column. Communism was an abuse of Taxis in an attempt to reverse the order of causal
relationships. The main objective of such social engineering was to redistribute the wealth
and the endowments of factors.
Table 1: The typology of various aspects of „social order“ and their potentially
contradicting duality
TAXIS:
Social order endogenously given as
man-contrived
Regulation of social and economic
activities
Politics
Organisation of enterprises
Ownership and redistribution
of wealth
Hierarchies of governance
Institutions of power and bureaucracy over
the reallocations of factors
Formal rules, formal networks, laws and
judiciary, political parties, enforced
conventions.
COSMOS:
Social order exogenously given as
spontaneous
Personal liberty and entrepreneurial
capacities
Economy
Technological progress
Wealth and property rights
Free markets and competition
Endowments of production factors and their
market allocation
Informal rules, ethics, behavioural patterns,
social interaction in personal networks.
Since the power of incumbent hierarchies is underpinned by formal institutions and
laws, adjustments of both hierarchies and Taxis to the developments in Cosmos are
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Vladimír Benáček
subject to inertia. Some observers speak in this context about path-dependency,
embeddedness or hysteresis. We cannot say after 17 years of transition, even in the most
successful transition countries of Central Europe, that all man-contrived features of the
command economy have been eliminated. Their institutions have been only gradually
catching up with the calls for changes. The political bargaining process was often very
slow – i.e. the deficits in efficiency of political "markets" for institutional changes were
evidently lagging behind the breakthroughs in economic market clearing and industrial
structures. In the early stages of transition, let us say in the first five years, the taxis could
not but move within the communist legislation, judiciary and formal networks.
Privatisation had to be carried out in that opaque period and actually ignore the law.
Such a situation offered an environment that facilitated the past elite transiting to
new entrenchments of economic power. Privatisation became the main channel for a tradeoff between the old political and the new economic powers. In order to find workable
analytical concepts, we will use two typologies of the evolution of the private sector:
“privatisation from above” and “privatisation from below” 14. The former is based on
turning existing state-owned enterprises into private hands, which crucially depends on the
activity of the government and its subordinated institutions. The alternative ("from
below") approach to the rise of the private sector leads to the establishment of authentic
private sector by the creation of “de novo” private firms. In the strategy “from below” the
activism comes from the grass roots of the economy, i.e. at the autonomous level of firms.
There it is the entrepreneurial productive activity of their owners what matters. The
difference between the two concepts rests in the difference between the de iure and the de
facto meaning of “privatisation”. While the latter stresses the creation of new property, the
latter is oriented to changes of existing assets. Their opposing relationships to the
Hayekian notions of Cosmos and Taxis are crucial for their alternative functioning.
In contrast to the development of private ownership by evolution in the traditional
market economies, private ownership in the initial transition period could be easily
established by a “privatisation shock” – i.e. by the privatisation from above. There, the
initial selection of both the owners and the property privatised was subject to an
“acquisition bias” that depended on how the selection techniques departed from the
criteria of perfect market bidding that included free competition and access to information.
For example, the administrative methods of privatization had the following structure in the
case of Czechia (computed from the value of all productive assets held by the State in
1989) 15:
a/ retail auctions (0.7%), public tenders (1.3%), voucher privatisation by individuals
(12%), restitution (11%), transfers to cooperatives (8%);
b/ voucher privatisation by investment funds (27%), transfer to municipalities (18%),
direct sales to pre-determined buyers (4%), liquidation (2%), retained state
ownership (16%).
The bias to non-competitive transfers or to methods where insider position was
strong, such as to privatization techniques concentrated in the group b/, was evident in
other countries too, not only in Czechia (Benacek, 2001). Privatisation from above,
14
This typology was first applied by Gruszecki and Winiecki, 1991, and later used by Benacek,
2001 and Winiecki et al., 2004.
15
According to the data of the Czech Statistical Office, 1998, and the Czech National Property
Fund, 1997.
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Vladimír Benáček
compatible with non-competitive transfers, is a one shot game subject to information
asymmetry and no one could expect that its outcome would result in a sharp improvement
of efficiency. For example, the objective of many new owners could be acquiring debts
and practising asset stripping for mere private consumption.
In consequence, intransparent methods of bureaucratic privatisation "from above"
strengthened the pre-conditions for the rise of adverse selection among entrepreneurs,
socio-economic institutions and policies. The economy of Czechia, similarly as in other
transition countries, was split into two diverging parts: on one hand there were firms with
unambiguous ownership structure and with owners acting as principals subject to hard
budget constraint and clear accountability, which exited from transition as internationally
competitive entities. On the other hand, there were firms with opaque ownership where
agents could dominate the principals and shift entrepreneurial liabilities upon the society –
on shareholders stripped of rights, employees, suppliers, banks, municipalities or state
budgets. As argued by Pejovich, 1994, or Loužek, 2005, the main objective of
privatisation should be seen in creating free markets for institutions, incentives supporting
property rights and the selection of the most efficient agents. Unfortunately, the
privatisation in Central and Eastern Europe often failed in succeeding even in that goal
because the new entrepreneurial elite found itself in a situation where it was more
advantageous to postpone enforcement of property rights and to continue with rentseeking strategies.
As a result, the problems with governance and management in the state sector
contaminated also the privatised enterprises. The governments, instead of standing by the
policies defending market discipline (e.g. the hard budget constraint and debt
reimbursement) and market sustainability (e.g. pro-investment climate, transparency of
information and competition), over-protected old enterprises transferred high taxes on
successful firms, arranged for investment barriers and engaged in anti-competitive
practices. We can therefore show in Table 2 how the contradictions inherited from the
communist order, as described in Table 1, transformed into a bias in policy-making in the
early stages of transition.
Table 2: The bias in policy-making when politics dominate over economics in the
privatization stage of transition
ECONOMICS
Independent firms
Private property
Incentives /”carrots”/
Wealth creation
Capital accumulation
Market competition
Profits and asset returns
Free trade
Hard budget
Creditor-dominance
Low transaction costs
POLITICS
State authority
(Semi-)Public property
Fiats /“sticks”/
Wealth redistribution
Capital consumption
Market regulation and bureaucracy
High taxation and subsidies
Restrained trade
Soft budget
Debtor-dominance
High transaction costs
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As administration-driven privatisation “from above” could not succeed in creating
effective final owners, a new round (or even several additional rounds) of re-privatisations
had to follow. The structure of new “capitalists”, many of who came from former
nomenklatura, was bound to be only transitory. There were too many agents who lacked
incentives or capacities to help their principals in the accumulation of wealth. There were
some principals who also lacked both and failed, but there were many others with good
entrepreneurial potential who were not backed by institutions for the defence of their
property rights. Granted the conditions that caused adverse selection of the new elite and
the external shocks to their stability, the vested interests forced the new capitalist elite to
collude with the state bureaucracy in order to retain their position and defend their
objectives. Free markets and competition became the most effective (and therefore most
feared) instruments for revealing the non-tenability of their status. Thus the policies as a
spin-off of privatisation “from above” and its non-authentic entrepreneurs acquired a
strong bias towards regulation, restrained trade and soft budget legislation.
Once the early stages of transition were associated with the state-administered
privatisation, bureaucratic policy-making, information asymmetry, adverse selection,
moral hazard and institutions in conflict with free markets, the most important capital for
becoming an entrepreneur was the social (network, relational) capital (Sik, 1993, Mateju,
1993). As further analysed by Bezemer, Dulleck, Frijters, 2003, the economic behaviour
of entrepreneurs in transition cannot be explained without recourse to the concept of social
capital. Thus we should distinguish between the human capital, as the capacity directly
associated with market-related efficiency in decision-making, organisation and innovation,
and the social capital, as the capacity associated with redistributional coalitions,
bureaucracy and state capture that are negatively associated with the efficient functioning
of markets.
The social capital in the time of the fall of communism was highly concentrated in
the communist nomenklatura network because hierarchies formed the core of both formal
and informal channels of communist governance. The politicians of velvet revolutions,
who relied on the invisible hands of free markets to administer the post-communist
“governance clearing”, have not succeeded in dismantling the old social capital of
communist insiders and in replacing it by a new network of outsiders. Therefore, it was
obvious that nomenklatura could retain or even strengthen their initial advantage and use it
in their favour in the first round of privatisation. As a paradox, it was most probably the
most natural and rational approach to transition. Definitely it was not an ideal solution
because it was rife with many blind alleys. Nevertheless, it was the least risky pragmatic
approach, provided the mechanisms of spontaneous socio-economic ‘tâtonnement’ of reallocations were not institutionally blocked, thus leading to the fastest ways out of the
myriad of micro-conflicts that would not have been otherwise solved.
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5. ENTREPRENEURSHIP IN THE LATER STAGES OF TRANSITION
We have mentioned in the previous chapters that the transition from communist
socialism to capitalism was impeded by the inability to dismantle the previous institutional
order in a sufficient speed 16, so that the spontaneous changes in the economy could not be
supported by an equally progressing institutional setup. The clash of spontaneous
development from “below” with its lagging institutional barriers was imminent. It took
several years to undermine gradually the ensuing deadlock. Such situation strengthened
the comparative advantages of nomenklatura for getting an easier access to the assets
privatized by insider bureaucratic methods that deviated from the standards of competitive
bidding under perfect information. As argued by Loužek, 2005, installing an ideal
environment for transition was practically unachievable and both the governments and the
economic agents must have accepted the solution of the second best. There were hardly
any tractable institutional alternatives that would guarantee a Pareto-optimal
improvement, as there were no alternatives without social clashes. The trade-offs between
social peace and legal institutions supporting transparent and fairer access to property
were evident.
Practically in all transition countries the resolution of this crucial choice was
straightforward 17: the preference was given to social peace and to an uncertain
roundabout way of getting out of the emerging institutional tangle. It can be resembled to
the "turnpike theorem" of the growth theory: instead of travelling between two points by
the shortest (but dangerous and slow) road, a detour is made to a more distant trunk road
where the interferences (like social conflicts) are less burdensome for the transition.
The distribution of new ownership after the first wave of mass privatisation failed
in satisfying the condition of finding the final and the most efficient owners. The
obsession with privatisation resulting from the illusion of “windfall gains” led to a social
myopia, which overlooked more productive alternatives of de novo enterprises, often
representing a more creative entrepreneurial achievement. The crucial question of
transition then remains: how the society is capable of launching processes after the initial
“privatization shock” and resulting detours, which would bring gradually a convergence to
16
One of the reasons impeding the attainment of a speedy institutional transition concerned the
limited capacities of the experienced lawmakers. The imposition of democracy was generally a
process with a higher priority than the introduction of property rights and their enforcement. The
argument was that it was simply politically unacceptable to postpone the buildup of democracy
and throw the limited resources into the revamping of economic institutions. The prevalent cryptolibertarian approach to economic institutions even affirmed that liberalised markets were selfsustaining and self-enforcing, thus the economic freedom was guaranteed even without extensive
legal framework. The idea that emerging rickety markets could fail and lead to adverse selection
and suboptimal allocation of resources was taken for just a short-run transitory problem. True, in
the long-run many of these issues were effectively eliminated because of the competition from
abroad. However, approximately a half of the GDP is produced in internationally non-tradable
sectors where domestic competition is often weak. There the hysteresis of previous institutional
vacuum left its traces that for long will make transition countries different from advanced capitalist
countries without that historical taint.
17
The only country where they a different strategy was Eastern Germany. The take-over of West
German institutions, including their human capital, was a highly enticing idea. Unfortunatly, an
important part of indigenous social interaction was thus skipped, which paradoxically slowed
down the speed of transition.
24
Vladimír Benáček
an optimal equilibrium in the ownership structure (Pejovich, 2004).
It should be stressed that, once detours began to dominate the strategy of transition
and the delays in installing institutions supporting entrepreneurship and wealth creation
became socially accepted, their postponed instalment cannot be left to anarchy. Otherwise
the institutions are privatised and installed by the dominant agents – oligarchic or mafian
networks. The initial crony capitalism could easily turn into the capitalism of gangsters.
The problem is not whether the government has declared new capitalist institutions, but
whether the State is able their enforcement. The State must remain strong, what does not
mean that it must rely exclusively on its central punitive authority. Microeconomic agents
must be constantly disciplined by keeping them under competition and a threat of
countervailing coalitions among them. I.e. the bulk of disciplining must be shifted on
them, instead on relying on dysfunctional institutions. What kind of conditions and
processes were available that would bring about the task of convergence to a viable
alternative? There are five such self-disciplining factors:
• Building competition by liberalising the markets internally and externally;
• Opening the market contestability to an easy start-up of the de-novo sector;
• Lowering the transaction costs of running businesses by having a very simply tax,
wage and social security schemes;
• Rising hard budget constraints by minimising the government expenditures to
enterprises;
• Privatising the banking sector to renowned international owners for who the
defaulting and corruption are viable ways of enrichment.
This is the reduced institutional regime that is depicted in Figure 1 for the period of
1990-97. However, from the very start of transition the preparation for a pending
institutional storm must be in progress. The process of legislative changes was found to be
the slowest and the most resistant to progress among all reform agenda practically in all
transition countries. In this respect the EU accession process played a highly positive role
because it forced the accession countries to introduce some of the highly liberal parts of
acquis communautaire, for example the competition, contestability and free trade policies
and the Copenhagen criteria of competitiveness. The judiciary and the law enforcement
were the critical bottlenecks, even though the demand for them was sharply increasing in
the later stages of transition. After 16 years of transition there is still much to be improved,
especially if the whips and carrots of the European Commission faded away after the EU
accession.
The rise of the de novo sector had two main channels: foreign and domestic. The
penetration of foreign direct investors was not uniform in all countries. However, as the
countries lagging behind recognised the advantages of FDI, their willingness to adjust
laws and institutions to become more market-compatible was increasing. The development
of indigenous entrepreneurship, concentrated mainly in the small and medium-sized
enterprises, was as important as the foreign one (Benacek, 2001). In many transition
countries the efficiency of this sector was even higher than the efficiency of the former
large state-owned enterprises privatised by vouchers or employee or managerial buy-outs.
Small and medium-sized enterprises and the FDI firms were also the creators of new jobs,
which raised their moral standing in the society.
The opening to spontaneous competition countervailed effectively the holes in
legislation in the tradable sectors. On the other hand, the lack of competition in the nontradable sectors (e.g. in state monopolies such as energy, transport, public utilities,
25
Vladimír Benáček
healthcare, education, police and defence) caused that failing entrepreneurs reallocated
their activities there. There they could use again their fading social capital and form
redistributive coalitions with the profit sector. They became pseudo-entrepreneurs who
instead of using their own financial capital could run a business of their own based on
public assets. The tendency to combine highly efficient forms entrepreneurship with
parasitic state capture is a risk that is immanent in many transition countries.
At the end, the roundabout anarchic transitions turned nearly everywhere to a
surprising (though still only partial) success. The resolution of conflicts by the socioeconomic ‘tâtonnement’ and Coasian re-negotiations was successful but only there where
their transaction costs were low or offered a terminal algorithm. The institutional build-up
in later stages of transition could be highly instrumental in that. The lowering of risks,
uncertainties and the higher transparency of accounting, loans and debt disbursement
allowed an easier cost-benefit analysis, which speeded up the transfer of property to more
efficient owners. The wave of bankruptcies and the diminishing availability of assets for
predatory stripping diminished the strength of vested interests lobbying previously for
incentives and institutions that were not market-compatible. Time was gradually moving
the pendulum towards reforms favouring the economics column of Table 2.
Given the development of the environment that followed the market requirements,
the Central European and the Baltic countries have turned gradually from laggards in
growth into Europe’s most dynamic economies. Their catching-up with the level of less
wealthy countries of the EU-15 is undisputable. Countries like Estonia or Slovakia became
leaders in reforms between the EU-27 and the liberalisation of their economies brought
spillovers of reforms in other countries in Europe. Even though there have remained in
transition countries still too many impediments to free markets in order to call them
"functioning market economies", the indices of economic freedom have been improving
recently and the entrepreneurship based on extra-market transactions and information
asymmetry was sharply reduced.
The role of the nomenklatura among entrepreneurs has been steadily declining
since the end of the first wave of privatisation in transition countries. The subsequent
waves of secondary re-privatisations and bankruptcies favoured the young elite without
any links to former communist networks (Machonin et al., 2006). The importance of
indigenous social (relational) capital in entrepreneurship engaged in competitive and
contestable sectors has been losing ground by being crowded out by the human capital and
the networks of international capital (Tuček, 2006). The downfall of important part of the
economic old-new elite was again an evolutionary and not a violent process forced from
above.
The analyses of Laki and Szalai, 2006, reached a similar conclusion, noting that the
stabilisation of indigenous grand entrepreneurs in Hungary in the late 1990s was reason to
set aside initially high concerns that the transition in post-communist countries may have
undermined national integrity by depriving them of the national elite and the ability to
compete internationally. The majority of indigenous grand entrepreneurs of 2005 typically
started out as small businesses and a record of productive capital build-up.
Inefficiency measured by loss making dropped substantially from the privatised
enterprise sector. At present the main burden of dead-weight losses in GDP is
concentrated in the expenditure side of the state budgets, which still amount around 45%
of the GDP. Their inefficient allocation to insufficiently restructured public services
(defence, police, education, health care and public administration), whose functioning is in
26
Vladimír Benáček
conflict with the market competition, is a burden that constrains directly the growth in
approximately a quarter of the economy 18. It is on the expenditure side of state finance
where introducing entrepreneurial techniques of management could bring most radical
gains in its efficiency. The spinoffs of such an entrepreneurial revolution could be even
more important by curbing the negative externalities of bureaucracy, corruption and
excessive taxation on the private sector. Inefficient the public administration, as the legacy
of the communist past, is a problem that impedes the spontaneous entrepreneurship in all
transition countries. Over-regulation by acquis communautaire combined with the local
folklore of State bureaucracy, its corruption, rent-seeking and politics responding to
demands for State populism and redistributional policies present the most serious
impediment to the rising entrepreneurship in transition countries.
We can conclude by pointing to the recent empirical evidence about growth.
According to growth statistics, the advances in the healthy market-based sectors of the
post-transition economies more than compensated for the under-performing sectors, the
majority of which are under the protection of insufficiently restructured public finance.
What matters is the trend in reforms supporting entrepreneurship. As discussed above, the
speed of such reforms has been converging to the low levels of the EU-15. Also many new
reforms are building barriers to entrepreneurship. Instead of speaking about the merits of
recent high growth in post-transition countries, we should rather raise a question: why is
their average growth rate mere 5% and why is it not higher? The burden of responsibility
rests in the hands of the politicians, perhaps even more now than anytime before during
transition. But is it the fat carps themselves who will be willing to drain their muddy
pond?
18
There should be considered an even more sophisticated explanation of the inefficiency in the
public sector: as the accounting for the value of government expenditure is based on the artificial
cost mark-up given to the quantity of „services“ rendered, the official contribution of this sector to
growth can be quite high. The problem is in the dissociation of costs from their utility. While the
government can allocate a rising amount of funds to the public sector in a profligate Keynesian
way (e.g. due to rising budget indebtedness or proceeds from privatization), there is no safeguard
that also the utility to consumers will rise accordingly. High level of corruption in the government
sector in the transition countries and populist expenditures aimed at bribing the voters backfire and
undermine the competitiveness in the private sector. It can go up to the point when rising public
expenditure leads to a decrease in total social utility. Unfortunately the GDP accounting statistics
is not immune to confusions between growth and inflation when estimating the adverse spillovers
of the public finance.
27
Vladimír Benáček
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PRAGUE SOCIAL SCIENCE STUDIES / PRAŽSKÉ SOCIÁLNĚ VĚDNÍ STUDIE
Public policy and forward studies 2003 – 2005 (CESES)
ON THE ORIGINS OF ENTREPRENEURSHIP IN TRANSTION COUNTRIES:
THE CASE OF CZECH ENTREPRENEURIAL ELITE
Vladimír Benáček
PSSS Edition, Public policy and forward studies series, March 2007
Published by:
Faculty of Social Sciences, Charles University, Smetanovo nábřeží 6, Prague 1
Contact address: [email protected]

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