Marching Backwards: Slovakia's Counterrevolution

"Why can’t they," wailed Professor Henry Higgins about women in G.B.Shaw’s Pygmalion, "be more like us?" With more tact but equal impatience, businessmen in Slovakia tend to reel back, asking: "Why can’t the Slovaks be more like the Czechs?"

Slovaks authorities disdain that comparison. "At the time of the divorce," says Pavel Ochotnicky, chief economist at state-owned savings bank Slovenska Sporitelna, "Czechs had all the essentials of a state — army, police, the very idea of ruling a country. In 1991 we began from scratch."

Under communism, indeed, Bratislava’s ministers were little more than marionettes manipulated by party leaders in Prague. (Sometimes these bosses were Slovaks, such as Alexander Dubcek and Gustav Husak, but Slovak powerlessness persisted.) After three years of independence, central government remains small. But key offices of state are now established and preside over a stabilization program bringing low inflation (under 10% annually) and, at 5.8%, the second fastest GDP growth in the ex-socialist world. In 1994 - 1995 hard currency reserves doubled and the trade deficit was halved, with exports to OECD countries in 1994 skyrocketing almost 50%, to $2.6 billion.

Yet businessmen were anxious last August in Bratislava, sweating as much from psychological stress as from summer heat. Why didn’t the government stick to a privatization scheme that worked? Why are bureaucrats at every level so infernally aggressive? Is Slovakia a reformer’s nightmare, a place where East Europeans are frittering away their initial success?

Meciar’s Counterrevolution

The main reason for this bleak assessment is the third government of Vladimir Meciar, formed in November 1994. Two things characterize the new Meciar politics. On one level, his government signifies the return of a clique descending from the old communist nomenklatura, and this brings with it many discredited communist habits. ”People are starting to govern as in the old days,” says Brigita Schmognerova, an opposition deputy and former minister. ”The first rule is to escape responsibility for any decision. The second is that every decision must benefit the rulers.”

Patronage, indeed, lubricates Meciar’s political machine. Purges removed over 4,000 business, government, and media leaders in favor of Meciar cronies. State jobs – as teacher, postman, industrial manager or TV director – come only with a recommendation by the cadre of Meciar’s Movement for a Democratic Slovakia (HZDS) and its coalition partners – the Slovak National Party (SNS) and the Workers Party (ZRS). The antimonopoly office is no longer headed by young technocrats who jibbed previous governments into dismantling state monopolies. Now it is bossed by an ex-carpenter commonly referred to as ”woodenhead” who does not dare to question the wisdom of the powers that be.

More ominously, in a bid for total control, Meciar tried last May – falling 20 votes short of the necessary two-thirds majority – to impeach his nemesis, President Michal Kovac. (The silver lining in this is that Meciar could not even deliver all of his coalition’s votes, a sign that his rule is not the irresistible steamroller he claims it to be.) In a cloak-and-dagger fashion, Kovac’s son was also kidnapped near Bratislava and later discovered half-conscious, in an abandoned car outside Vienna. It is believed that Meciar’s police wanted to facilitate in this way his extradition to Germany, where he is wanted on tax fraud charges. (Unlike Austria, Slovakia lacks an extradition treaty with Germany.)

On another level, Meciar’s regime harks back to an even older tradition of Mitteleuropean politics: that virulent strain of corporatist authoritarianism of the 1930s and 1940s. Divisions within a democratic government incite calls for strong medicine – on the one hand to stop seeming political rot and, on the other, to invest the state with not only material power but also the imponderable force of majesty. Throughout the region that terrible majesty assumed the form of race-based, demagogic states such as rump Slovak Republic ruled, under Hitler’s tutelage, by Monsignor Tiso.

Given Meciar’s deeds and that precedent, few can blame Slovaks for experiencing deja vu. Example: Meciar himself proclaimed his government’s intent to restrict births among Slovakia’s gypsies. ( Luckily, the assault has been merely verbal, with no legislative follow-up – so far.) More covertly, state industries – following the classic corporatist design – are hived off in secret deals to Meciar’s cronies. From Slovnaft, the monopoly state oil company, to the armaments firms being collected into a holding company controlled by Julius Toth (a former HZDS finance minister), Meciar is bludgeoning Slovak industry into a political money and patronage machine.

Slovak reform is quickly becoming a part of this spoils systems. ”Abusing the privatization program is not merely politics,” says Gabriela Kaliska, a former opposition member of parliament. ”It is the main part of a counterrevolution.” What Meciar’s rule is attempting to undo is Slovakia’s bid for a free market and a democratic society.

The Early Success

Central Europe has nearly six years of experience with what works in privatization and what does not. Three fundamental questions face any would-be privatizer: Should property be given away or should it be sold? Should preferences be given to insiders (i.e., the old managers and workers ) or should restructuring be entrusted to new outside owners? What institutions should replace the state in monitoring and supervising the managers of privatized enterprises?

A giveaway to the general population was the privatization strategy followed by the then Czechoslovakia and continued in Slovakia during its first year of independence. Every adult citizen was entitled to buy for a nominal sum the same number of privatization vouchers, which could be invested – either directly at auction or through investment funds – in a long list of firms being privatized. No privileges were given to insiders, and enterprises were compelled to privatize, though they were given some latitude in how to go about it. Few restrictions hindered new investment funds which offered their shares in exchange for vouchers held by the population. The funds then invested their new ”voucher capital” to acquire large blocks of shares in privatized enterprises.

The result was quite impressive. Some 503 big Slovak companies were privatized in the first round of the vouchers privatization scheme agreed to by the old Czechoslovak federation. Combined with the 10.000 small businesses sold during the small privatization program, these firms produce nearly 60% of Slovak GDP. Employment in this new private sector is growing on average 2% per year, whereas employment in the state sector continues to fall. Ownership was dispersed, kick starting the development of capital markets. At the same time, a number of large funds held significant enough stakes to exert pressure on the management of privatized enterprises. The hold of the old nomenklatura was being broken, fueling an economic and political renewal.

What the architects of this ”mass privatization” understood (even if it went against the advice of most Western experts) was that sales under East European conditions would both be excruciatingly slow and bring little or no revenues for the state. Few foreigners were willing to buy (and if done on a sufficiently large scale, such foreign acquisitions would be nothing short of political dynamite). And prospective domestic buyers lacked the capital necessary to purchase large industrial enterprises. Except in the case of a few good firms, sales at realistic prices thus lead to little or no privatization. Countries like Poland and Hungary expected big windfalls from direct sales, but were disappointed and most big enterprises remain in state hands.

To make sales brisk, assets must be sold far below their value. And this is what makes them so attractive to people like Meciar. For such sales are also, in truth, giveaways. But unlike the open and equitable distributions through a voucher scheme á la Czech Republic and Slovakia in the early days of independence, Meciar’s direct sales are selective giveaways in which those who control the government and their friends reap rich rewards.

Steals and Deals

Instead of building on Slovakia’s early track record, Meciar tried to derail it during each of his three ministries. Each time Meciar railed against voucher privatization, ultimately canceling its second wave after 3.5 million people had already bought their vouchers. Direct sales, he said, inject funds into the treasury as they build up a class of native owners. Because these sales are conducted in secret and their terms are unknown, it is impossible to verify whether or not they are contributing much – if anything – to the government’s purse. However, the fact than 39% of Slovnaft shares (more later) were sold directly to a Meciar supporter for less than half of their quoted price on the Bratislava stock exchange indicates that maximizing revenues is far from a government priority.

Since returning to power, Meciar’s government has held a fire sale of state firms. In six months property valued at SK20 billion has been sold, with the National Property Fund (NPF) getting back barely SK3 billion. Compare this with the SK 35 billion the NPF obtained through direct sales between 1991 and 1994 (about one third of which was conducted by Meciar’s previous governments.)

By converting his nomenklatura cronies into outright owners of Slovakia’s enterprises, Meciar inhibits a prime goal of privatization: depoliticization of the economy. The political vetting of sales Meciar’s regime undertakes and the inevitable quid pro quo that such deals entail mean that powerful new link are forged between those who control industry and those who rule over the political machine. The new business class can insist on subsides, tariff protection, monopoly power, tax concessions, and friendly regulation. And the new political class can insist that the spoils of crony businesses enrich the coffers of political parties and the pockets of politicians.

With direct sales, windfalls abound. Take the case of the energy company Slovnaft. First the government fused it with Benzinoil, giving Slovnaft up to 90% of oil and gas distribution in Slovakia, sway it is extending into next door Moravia. In August it sold a 39% stake in Slovnaft (reportedly for half the price Slovnaft shares were fetching on the open market, and for now down payment) to Slovintegra a.s., a private company controlled by Slovnaft’s general director, Slavomir Hatina. Although some outside shareholders (the EBRD is one) exist, Hatina gained near majority control of the company through this sale and the SK1.2 billion worth of Slovnaft equity he secured in earlier direct sales. A supporter of HZDS since its founding four years ago and, it is said, a key financial backer of the party through his control of Slovnaft’s purse, Hatina sits atop the most valuable property in Slovakia.

Or consider the case of Julius Toth, the finance minister in Meciar’s previous government. From his Kosice redoubt, Toth controls the country’s sole private bank and the VSZ steelworks, and has been put in charge of the holding company that will receive a majority of Slovakia’s armaments manufacturers. VSZ alone is responsible for 16% of industrial production and 26% of exports. Together with Slovnaft, with its 7% share of industrial production, the two companies had revenues equal to 8% of Slovakia’s GDP in 1993. So, these deals are not peanuts.

Two factors matter in direct sales: political links, and division of the spoils among the coalition partners. ZOS Vrutky, a profitable monopoly rail construction firm, was to be acquired by the wife of SNP deputy Vitazoslav Moric. When reports of the proposed sale caused a scandal, ZOS Vrutky was sold to a legal entity, the bearer owner of which is reported to be no other than Mrs. Moric. Tire-maker Matador Puchov was turned into a joint-stock company in which workers got 20% of the shares, and managers, led by Stefan Rosina, a close associate of finance minister Jan Ducky, received 80%. But when outsiders are trying to acquire some assets, even when they are likely to pay a more realistic price, they are shown the door. A lawyer for an Austriancompany shut us out in its bid for a piece of Slovnaft, says: ”It isn’t because we are foreign that they don’t want us to invest. They don’t want to sell shares in the company because they want to keep all the profits for themselves.”

Mimicking their bosses in Bratislava, local politicians create their own spoils system. In Zilina, the town council empowered the mayor to sell directly – and without review – any property with a value of SK800,000 or less. Soon after, the mayor sold to an HZDS supporter for SK125,000 a villa valued at SK5 million, which rented annually for SK750,000. Later he sold a SK10 million villa to the chairman of Matica Slovenska (a supposedly nonprofit pro-Meciar group devoted to nationalist causes ) for SK1.00. ”I am resolved to promote and assist Matica for as long as I live,” says Mayor Slota. And he does. Matica also received, for a similar SK1.00 the profitable printing presses of the state firm Neografia Martin.

Vague and/or malleable laws invite lawlessness. Although only two new privatization acts have passed since 1992, amendments have occurred, on average, every 51 days. Even when Slovakia’s high court speaks, the government feels no compulsion to act. One noisy affair is that of Novaky Chemical a.s. On November 3 last year, the NPF agreed to sell 51% of Novaky to the Czech firm Inekon, which deposited $2.5 million as a down payment. That day, Meciar’s third ministry took office and immediately nullified the deal. Six months later, the Constitutional Court declared the act that enforced this, as well as many other nullifications, unconstitutional. But Inekon still does not possess its shares, despite quiet intervention by Czech diplomats and a contract provision that imposes a SK50,000 fine each day of further delay.

Laws also provide camouflage. Take the 1994 change to the statutes of the NPF. Before 1994, privatizations were vetted by the cabinet and officials of the Ministry of Privatization, a process that subjected sales to some public and parliamentary scrutiny. Saying -- wait for it – that he wanted to depoliticize sales, Meciar shifted all oversight the NPF’s presidium, equally packed with the men of his coalition. But now decisions can be made much more swiftly and without disclosure or scrutiny by the opposition.

Strategic Retreats

What he cannot spin off to his cronies, Meciar wants, in the good old corporatist tradition, to keep under direct state control. Indeed, Meciar’s law on so-called ”strategic” industries was carefully designed to bolster the interests of the political classes by providing them with a long- term source of patronage, while at the same time holding potential competitors (especially foreigners) at bay. Certain companies -- in areas such as telecoms, posts, gas, oil, electricity, arms, civil engineering, pharmaceuticals, forestry, water, and even a stud farm -- were deemed too important to be left entirely to private owners and the market. Property worth SK150 billion (nearly 40% of the total valuation given to the entire list of Slovak state companies before privatization) was designated as strategic. One-third of these would, says Meciar, never be privatized in any way. Others would be privatized through direct sales but only after the NPF transferred to the relevant ministry the firm’s ”golden shares” that, though minority stakes, will command the power to shape business decisions. Here is a return to ministerial management on the sly. And Meciar’s track record does not auger well: managers at Slovak Telecom, Slovak Power, and Slovak Energy Factories were dismissed in the past year for ”political insufficiencies”.

Disentangling the act’s maze of government, NPF, and private shares is certain to deter foreign investors. For it is impossible to say which strategic firms are covered by what provisions of the act, or how the state will acquire its ”golden shares” in previously privatized firms. ”This is nationalization by default,” says Vladimir Miskovsky, a former privatization official. ”If it persists, this program will doom industries in desperate need of foreign investment, like telecoms, to continuing decay.” Economists at the Bank of Slovakia fear that up to a quarter of Slovakia’s total $552 million of foreign direct investment may be withdrawn.

Bouncing Bonds

Perhaps the most brazen attack on the previous Slovak reform efforts was the outright cancellation of a program well on the way to realization. Upon his return last November, Meciar suspended the second wave of voucher mass privatization. But even he could not ignore the fact that 3.5 million Slovaks had paid the equivalent of a week’s average wage to subscribe to the second wave of vouchers. Meciar also needed to placate the IMF, which insists that Slovakia systematically privatize if a standby loan agreement is to be maintained. (With the old Czechoslovak clearing system for international trade ending October 1, the government is keen to maintain this option.) After months of waffling, Meciar canceled the voucher system in July, and a new wrinkle -- bond privatization -- was announced. Because its real purpose is political, the new scheme (a veto of the bill by President Kovac will almost certainly be overridden when parliament reconvenes in September ) promises to be more mess than mass.

The scheme is transparently simple -- and simply transparent. Everyone with a voucher will receive instead a bond, guaranteed by the National Property Fund (NPF), worth SK 10,000 and carrying an annual 11% interest. There are two major ways in which bonds may be used: to help purchase a home or flat; or to pay off installment debts incurred in a direct purchase of a company from the NPF. But as distinct from the voucher system, what the bond scheme lacks is an automatic conversion of the bonds into shares of a large number of privatized enterprises through a system of auctions open to all on equal terms. Allowing bonds to be used to pay NPF debts exposes the scheme’s hidden intent. Only firms that the NPF chooses are sold. And insiders who buy their shares through direct sales from the NPF (putting down little of the usually low asking price) can then buy the bonds at a discount from ordinary Slovaks and use their face value to pare down even further their privatization debts. So the scheme mainly serves Meciar’s political purposes: insiders’ route to ownership is greased; outside control is effectively excluded.

Economists at Slovakia National Bank also fear that the bonds -- acting as direct injections into the money supply -- may incite inflation. They are guaranteed by the NPF, which is unlikely to secure enough reserves to pay them off when they come due in 2001 because direct sales of NPF’s assets -- at the usually low prices -- will probably not generate enough revenue.Thus, either a massive default or the government being forced to print money to pay them off willbe the likely consequence.

Outsiders Out

In line with its commitment to nomenklatura control, Meciar’s government aims its lowest blows at the investment funds created in the first wave of vouchers privatization. Despite their limitations, investment funds, representing millions of small shareholders, have been the main outside investors who could take on the often thankless task of challenging managers and pushing for enterprise restructuring. By gaining control of two-thirds of the vouchers, the funds acquired a strong voice in newly privatized businesses. But that is precisely what earned them Meciar’s hostility. For the coalition’s ex-communist and nationalist firebrands, the funds are wicked speculators who robbed Slovaks of their heritage and, in the words of Stefan Gavornik, head of the NPF’s presidium, must now be ”punished”. How far he will go? There is a hint. ”Law,” saysGavornik, ”is not an issue in privatization.”

The new bond privatization act damns the funds as superfluous. Their role is now to be taken over by the state, at least until Meciar’s cronies become outright owners. Thus, until the installment debt of a direct sale is paid off, an amendment to the NPF’s charter, passed in July, grants the NPF the oversight of business decisions, such as investment, management changes, layoffs, and company bylaws, in all companies on the way to privatization.

Meciar’s ire costs. The 160 new investment funds (set up for the second wave) have been offered a scant SK500,000 ( about $100 per fund ) by the government to be divvied up as compensation. A second line of attack against the investment funds is to restrict their holdings to no more than 10% of a company’s shares. Because the first wave allowed for bigger holdings, many funds took stakes of 20 and 25% in some companies. If Meciar has his way they will be forced to sell these ”excess” shares, which will almost certainly be lapped up (cheaply) by insiders.

Attacks on the funds come on many fronts. PSIP fund, Slovakia’s second largest, had its license revoked on technical grounds. Stewardship of PSIP, which collected 25% of second wave vouchers, was given to Harvard Capital & Consulting Slovakia, whose most powerful board member, Vladimir Lexa, happens to be the father of Ivan Lexa, Meciar’s secret police chief. Trading in shares of VUB Kupon Found were suspended by the Ministry of Finance after VUB sold a one-third stake in the fund to Nomura Securities. To get along, some funds now go along. For example, Cassoviainvest took a minority stake in Agrizempa a.s., which was sold through direct sale to Meciar supporters. Other fund managers dither nervously in the office of Rudolf Lachkovic, president of the Association of Investment Managers and Investment Funds, fearing fresh assaults even as they look to the Kosice-based Constitutional Court to restore their rights.

Meciar Bound?

Recreating a politically controlled economy will not be easy. The market genie may not be so easy to reimprison in its bottle. Moreover, if Meciar’s erstwhile cronies, like Slavomir Hatina, are to reap maximum profits from their new holdings, they will need the foreign shareholders and capital markets that his government suppresses. Will they remain Meciar loyalists in the future, or will self-interest shatter the corporatist connections he is seeking to forge?

Hints that Meciar’s political privatizations breed dodgy allies are visible. Mr. P. Maisky, once an HZDS industrial backer, is an opposition supporter now that he controls most of the companies he set out to acquire in 1991. Some also interpret Julius Toth’s absence from Meciar’s third government as a sign that the powerful former finance minister may be wavering. The big unknown is how long it will take men like Toth and others hand-picked insider owners to respond to real business incentives.

Equally important, Slovakia’s infant constitutional system influences the political struggle. Though lacking history’s sanction, powerful bodies are arrayed (but not yet allied) against Meciar. Despite being a former Meciar supporter, President Kovac repeatedly flexes his independence by vetoing key HZDS legislation and (as during a summer visit to Washington) convincing foreign leaders to rebuke Meciar’s authoritarian ways. The Slovak National Bank rebuffs efforts to trim its anti-inflation program. Slovakia’s Catholic bishops (backtracking from some grim early political gaffes, such as being present when a monument to Monsignor Tiso was unveiled) preach derisively of Meciar’s cloaking his regime in Catholic garb. The Constitutional Court, though packed with old-line communist prosecutors, gutted Meciar’s economic program by declaring key HZDS laws unconstitutional.

Today these institutions may have shallow roots. Yet their legitimacy is no less than Meciar’s own, and in preserving their powers against his encroachments they provide the sort of contestability in politics that privatization should provide in business. The odds that Slovakia’s independent institutions will grow not fade will be enhanced if international institutions, foreign governments, and outside public opinion actively support the trend. (Here the silence of Czech premier Vaclav Klaus is deafening.) But only a combination of political and economic forces is likely to curtail Meciar’s ambitions. That prospects is Slovakia’s hope, and its continuing crisis.

Roman Frydman, Kenneth Murphy, and Andrzej Rapaczynski are directors of the Privatization Project’s Project Syndicate. Frydman and Rapaczynski are authors of "Privatization in Eastern Europe: Is the State Withering Away?" and Murphy is the author of "Retreat from the Finland Station: Moral Odysseys in the Breakdown of Communism."

With reporting by Andrej Juris, Anton Novak, Eugen Jurzyca, Jozef Hajko, Gabriel Palacka, Pavol Kinees, Ivan Miklos