The dissolution of Czechoslovakia and the creation of the Czech Republic and Slovakia as independent nation states and economies caused limited disruption. This experience offers insights for Scotland as it considers independence from the rest of the UK.
In the early 1990s, a number of multinational unions disintegrated in Europe. First the Soviet Union collapsed in 1991, then Yugoslavia gradually broke apart during 1991-92 and finally Czechoslovakia split up at the end of 1992.
The last case was unique as the successor countries managed to steer clear of open nationalist conflicts and avoided major economic disruptions after the break-up. Instead, the dissolution of Czechoslovakia unfolded in an orderly and negotiated fashion – subsequently termed the Velvet Divorce (after the country’s Velvet Revolution of 1989, which ended communist rule).
In comparison with the bouts of hyperinflation and bloody conflicts in the aftermaths of the Soviet and Yugoslav disintegrations, the Czechoslovak case stood out for being largely uneventful.
What were the economic effects of the break-up of Czechoslovakia?
Czechoslovakia’s dissolution was also unique in that the two successor states – the Czech Republic and Slovakia – put considerable effort into maintaining solid economic and political ties with each other after separation. A customs union and free labour mobility continued until both countries joined the European Union (EU) in May 2004, when their bilateral agreement was superseded by the EU’s single market.
The two countries also intended to continue using the koruna (crown), their common currency. But in contrast to the customs union and common labour market, the currency union proved short-lived, collapsing after only six weeks. The Czech Republic continues to use its own koruna, which it introduced in 1993. Slovakia, on the other hand, decided to give up its newly acquired monetary autonomy in favour of joining the euro area in January 2009 as the second country in Eastern Europe (after Slovenia in 2007).
Despite different starting conditions and diverging policies, economic developments in the two countries have followed surprisingly similar trajectories. Unemployment in Slovakia rose sharply immediately after independence, but it declined as the country benefited from significant inflows of foreign direct investment after joining the EU (see Figure 1).
The difference in unemployment between the two countries fell from 10 percentage points at the beginning of the 2000s to only two percentage points in 2008. It increased slightly after the global financial crisis of 2007-09, but the evolution of unemployment has remained remarkably similar in both countries. This reflects not only that the two labour markets have remained largely integrated despite the break-up, but also that they have followed similar industrial developments, especially a focus on the automotive industry. This creates important spillovers between the two countries and regions within them.
Figure 1: Unemployment rates in the Czech Republic and Slovakia
Figure 2: Inflation rates in the Czech Republic and Slovakia
Figure 3: GDP per capita in the Czech Republic and Slovakia
Sources: Eurostat, Oesterreichische Nationalbank, European Commission
Note: EU15 – 15 member states (as before 2004), EU27 – not including the UK
Despite their different monetary policies, the similarity of inflation developments in the two countries is also stark (see Figure 2). The initial devaluation of the Slovak currency – together with politically motivated and excessive public spending – fuelled an acceleration of inflation in Slovakia during the 1990s and at the beginning of the 2000s.
Nevertheless, the objective of becoming a member of the euro area motivated the authorities to bring inflation down to 2% a year by the end of that decade. Despite having an independent currency, Czech monetary policy and its outcomes have closely followed developments in the euro area.
What can we learn from the experiences of the Czech Republic and Slovakia?
Given the orderly nature of the establishment of the Czech Republic and Slovakia – and the continuation of close economic ties afterwards – the dissolution of Czechoslovakia could offer important lessons for other countries hoping to follow a similarly amicable path as they part ways. Although the starting conditions are largely different, there may still be valuable lessons for Scotland and the rest of the UK to consider if Scotland were to become independent.
First, the cost of betting on currency separation can be very low while the potential profits are large. In the Czechoslovak case, it was widely expected that any new Slovak currency would depreciate against the Czech currency once both were introduced. In anticipation of this, Slovakia experienced capital flight in late 1992 and early 1993 (even though official policy was to retain the koruna): Slovak households and firms sought to hedge against the possibility of the introduction, and devaluation, of Slovak currency by converting funds into hard currency or transferring them to Czech banks.
This capital flight was the main reason why the two successor states decided to abandon the common currency after only six weeks. The Slovaks who transferred their funds to Czech or foreign banks were then rewarded with a handsome profit of around 20%. Discussions of Scotland’s currency options are undertaken elsewhere in this series .
One clear lesson is that if two currencies are expected to diverge in the future, the anticipation of this change can create an immediate incentive to transfer funds to whichever country is expected to end up with the stronger currency. The cost of such speculation is essentially zero: it is as easy as transferring one’s account balance. As long as the common currency survives, the holder of funds deposited in either country can continue to use them in either country. But once the separation happens, the profit (or loss) will be equal to the rate of devaluation (or appreciation).
Promises and reality
Second, the case of Czechoslovakia demonstrates that there is often a disconnect between politicians’ public pronouncements before an important decision (such as independence) and the subsequent reality. The voters, especially those in Slovakia, were promised that independence would bring instant benefits. Instead, as Figure 1 shows, independence was followed by a discrete increase in unemployment.
Similarly, voters may not, in reality, keep the politicians accountable for their pre-independence promises. As a result, political developments may gain their own dynamics as the disintegration of the union unfolds, which could be difficult to foresee in advance.
Third, while bilateral trade is bound to fall after disintegration, some of this is likely to be due to trade diversion, not trade destruction. In the case of the Czech Republic and Slovakia, goods and services that used to be traded within Czechoslovakia found new buyers elsewhere, primarily in the EU.
If Scotland were to become independent, it would likely seek access to new markets. Given Scotland’s location, obtaining some kind of preferential trade arrangement with the EU would seem the obvious choice.
In that way, some of the expected loss of trade with the rest of the UK could be compensated by a growth of trade with the EU (as has been the case in Ireland over many decades). Of course, this will not be instantaneous. Nevertheless, the Czechoslovak experience shows that it is possible for a small country to build new partnerships with larger trading blocs like the EU relatively quickly.
Despite the short-term costs and disruptions, the Czech Republic and Slovakia have prospered since gaining independence. Both joined the EU in 2004 and are also members of the OECD. In terms of GDP per capita, both countries are making progress at closing the gap with the EU average (see Figure 3). They have gone from approximately half (Czech Republic) and one-third (Slovakia) of the EU level to 66% and 58%, respectively, during the last two decades.
One could even argue that the separation in 1993 has brought some favourable outcomes: for example, the two successor countries have become less politically unstable. The two countries (and their citizens) maintain close ties: they are both part of the Visegrád Group (along with Hungary and Poland); and Czechs and Slovaks frequently cross the border, as tourists and migrants alike.
Similarly, Scotland and the rest of the UK could prosper and maintain vibrant economic ties with each other.
Where can I find out more?
- Monetary and fiscal policy in a newly independent Scotland: Lessons from the dissolution of Czechoslovakia?: Frantisek Brocek derives early lessons from Czechoslovakia for Scotland.
- The stability of monetary unions: Lessons from the breakup of Czechoslovakia: Jan Fidrmuc, Julius Horvath and Jarko Fidrmuc present analysis of the break-up of Czechoslovakia in the Journal of Comparative Economics in 1999.
- Did austerity cause Brexit? Thiemo Fetzer discusses the economics of Brexit.
- Can money buy EU love?: Jan Fidrmuc, Martin Hulényi and Cigdem Borke Tunal? analyse the Brexit referendum results from an economic perspective.
Who are experts on this question?
- Julius Horvath, CEU Budapest, Hungary
- Jirí Vecerník, Institute of Sociology, Czech Academy of Sciences, Prague, Czech Republic
- Oldrich Dedek, Czech National Bank
- Martin Guzi, Masaryk University Brno, Czech Republic
- Marin Kahanec, CEU Vienna, Austria, and Central European Labour Studies Institute (CELSI) in Bratislava, Slovakia