International report: Reality Czech

After a shaky start, free enterprise takes root.

“They finally nabbed him,” mumbles Robert, a 25-year-old driver with Vega Tour in Prague, as I climb onto the curb from his minivan. Then he throws his newspaper down in disgust.

“Who?” I ask.

“Viktor Kozeny,” replies Robert, who bears a passing resemblance to hockey star Jaromir Jagr. He points to the story in Prague's tabloid Blesk.

Kozeny, a notorious 42-year-old fraudster, has come to symbolize the darker side of the Czech Republic's rebirth as a free-enterprise state in the early 1990s. The plan looked great on paper: after more than four decades of communism, everyone was supposed to be given an equal chance to join in the new capitalist order by taking a direct stake in the economy. In a privatization scheme to transfer state-owned assets into the hands of ordinary Czechs, the government of then- prime minister Václav Klaus took the unprecedented move of selling inexpensive booklets of vouchers that could be converted into shares of companies on the brand new Prague Stock Exchange. Virtually all the country's blue chips, including banks, telecoms and breweries, were sold for a small fraction of their true value. It would have been a windfall opportunity for ordinary investors, but for one small problem: few people knew anything about investing.

There were others, however–mostly Czech entrepreneurs familiar with western-style money management–who closed in for the kill. They created investment funds that offered to convert vouchers into shares of professionally managed stock portfolios. All were not crooked, but many were. The biggest of these Gatsby-style operators was Kozeny, a Harvard-educated man who had worked as an investment banker in London. With the assistance of a slick TV campaign, Kozeny–today known as the Pirate of Prague–promised the new generation of shareholders a tenfold return if they invested in his Harvard funds. Two years later, he quietly fled the Czech Republic on an Irish passport. Today, some 240,000 former investors in Harvard funds are owed US$403 million. Those former investors include members of Robert's family.

Kozeny is also wanted in the United States, for allegedly defrauding investors of US$182 million in an oil scam in Azerbaijan. Late last year, as Robert's paper reported, the FBI caught up with the Pirate of Prague in Lyford Cay, a Bahamian haven for the super rich. Extradition to the U.S., where Kozeny could face up to 25 years in prison, is now underway.

In the Czech Republic, Kozeny's arrest was a reminder of the country's shaky initial experience of capitalism. But it belies the fact that the country's economy has undergone a major transformation since then. In the past 10 years, it has thrown off the shackles of Soviet-era central planning to become a magnet for multinationals–including Canada's Magna International Inc., Celestica Inc. and Bombardier Inc.–looking to exploit cost advantages in the former East Bloc. “We're always looking for a highly skilled and motivated labour force,” says Daniel Witzani, director of corporate communications at Magna International's European headquarters in Oberwaltersdorf, Austria.

Indeed, the country has emerged as the shining economic light of the Visegrád Group, an informal economic alliance formed in 1991 by the Czech Republic, Slovakia, Poland and Hungary. The so-called V4 became European Union members in May 2004, and each is experiencing healthy real GDP growth, ranging from 3% to 5% for 2005, compared with an anemic 0.8% and 1.4% for Germany and France, respectively. The Czech Republic has probably been the biggest V4 recipient of foreign direct investment since the Iron Curtain came down in 1989-1990.

Foreign direct investment to the republic (population 10.3 million) was US$10.9 billion in 2005, helped in large part by such incentives as a 10-year tax holiday on investments of US$4.8 million or more, and a US$10,000 one-time subsidy for each new job created. “Most companies that open one plant, open a second,” says Bob Frelich, the director in the Chicago office of CzechInvest, a business development agency of the Czech government. Frelich's territory includes Ontario and Quebec, where he is currently negotiating with a number of companies–mostly in automotive, IT and precision engineering–about expansion in the Czech Republic.

The auto industry has become particularly important for Czechs, in part because they have long had a strong engineering and machining tradition. Today, the sector accounts for 20% of manufacturing output and 130,000 jobs. On the strength of its automotive industry, the Czech Republic and neighbouring Slovakia have earned the nickname Detroit East. Between them, the two countries have five auto plants, including two operated by TPCA (Toyota Peugeot Citroën Automobile), a joint venture that produces cars for all three automakers. (At US$1.65 billion, Czechs have billed their TPCA plant, which began production last year, as the biggest private-sector investment in central and eastern Europe since the fall of communism.) Meanwhile, Hyundai of Korea is negotiating a US$1.2-billion deal to open a plant near the eastern Czech town of Ostrava.

That kind of critical mass explains why Magna International, based in Aurora, Ont., operates four automotive plants in the republic. “We follow our customers wherever they go,” says Witzani, noting his company supplies, among others, Volkswagen-Skoda, DaimlerChrysler AG and BMW from the Czech Republic. But supply-chain integration is not the only reason Magna and other automotive companies–including Delphi, Tyco, Ingersoll Rand and Johnson Controls–have set up shop here. Labour costs in the country's automotive sector are between US$3 to US$6 per hour, compared with an average wage of US$29 an hour in western Europe.

What's true for the auto sector is true for other manufacturers. Last year the annual Brno Trade Fair–located in the country's No. 2 city–attracted 2,250 engineering, machining and transport companies from 33 countries looking to tap into opportunities on the ground. “The Czech Republic has many business advantages, including easy access to most European countries,” says Michael Lichter, general manager of a passenger train plant owned by Bombardier Transportation in the northern Czech town of Ceská Lípa.

Lichter admits that multinationals are pushing salaries up, but he does not expect the cost advantage to disappear anytime soon in the Czech Republic or other V4 countries. (Bombardier Transport also operates plants in Poland and Hungary.) “The difference is so huge that it will take five to 10 years before hourly rates begin to approach parity,” says Lichter. He adds that Bombardier Transport is now looking beyond the labour market for cost savings. “In December 2005, we opened a procurement office in Prague to source less expensive suppliers,” says Lichter.

The story is much the same at Toronto's Celestica, which makes computer networking and IT-related assemblies at two plants. “The Czech Republic has a well-managed economy, availability of skilled labour and a healthy infrastructure,” says spokesperson Pam White from Celestica's Toronto office. “It's proven to be a good investment.”

While manufacturing is key to the republic's economy, in the past couple of years multinationals have started opening call and outsourced-services centres in Prague. Perhaps the best example of this emerging trend is the global consulting firm Accenture, which is providing outsourced HR and IT services from the Czech capital to a global base of clients. “Prague is cheaper than Frankfurt or London,” says Frelich, “but at the same time it offers multinationals a large pool of university students, and an eye-catching location that can attract an expat community.”

Czechs have worked hard to erase the bitter memory of their first brush with capitalism. But the ghosts of Kozeny and other pirates of Prague linger to this day–at least at the Prague Stock Exchange. Only one company has come forward with an IPO since the exchange opened for business in 1993. On top of that, of the nearly 2,000 companies that listed during the heyday of privatization, more than 1,500 have since been delisted. The reason? Lack of liquidity. The situation seems unlikely to change anytime soon–in part because Czech companies tend to get bought out by multinationals as soon as they begin to show signs of promise.

But Peter Formánek, president and CEO of the Canadian Chamber of Commerce in the Czech Republic, says this should not worry Canadian companies sitting on the investment sidelines. “Investment risk is very low, banks are solid, and there are many cost and tax advantages,” says Formánek. There is also the larger issue of establishing a foothold in a new and reinvigorated central Europe–at least before adoption of the euro, probably by 2010, makes everything more expensive.

At a cocktail party at the Canadian ambassador's residence in Prague, Eva Anderová, general manager of The Prague Post–the city's English-language weekly–leans into a conversation to share an anecdote. According to a recent government census, Anderová says, the number of atheists in the Czech Republic has risen to 60% from 40% since the fall of communism. So has capitalism disillusioned the Czechs? “No,” says Anderová, a lanky woman, six feet tall with closely cropped blond hair. “We're just more realistic.”