(FORTUNE Magazine) – Four years ago, the Hungarian economy was deep in crisis: Inflation was rampant, unemployment was rising, and trade and government deficits were mounting. Making things even worse was the fact that 100 miles to the north, Hungary's old rival the Czech Republic was being hailed as one of the great success stories of the former communist world. But now, like the grade-school story of the ant and the grasshopper, Hungary is thriving, and the Czech Republic is in disarray. The fastest-growing economy in Central Europe today, Hungary will be first to join the European Union, while the Czech Republic lags at least five years behind. It turns out that Hungary's economic turmoil of the mid-1990s may not have been a sign of weakness after all; it may have been the growing pains of a communist country maturing into a market economy.

Such a transformation inevitably requires one major step: the sale of government enterprises to the public. While the Czech Republic did so all at once, through a convoluted voucher scheme designed to make every citizen an owner, Hungary was more cautious. Opting for initial public offerings and direct sales to strategic foreign investors, it handed over control of its enterprises, one at a time, to a combination of domestic and foreign interests. At the time, this caused no end of trouble, but it may well have been the more sensible approach.

Not that it looked all that sensible back in 1995. The new owners of Hungarian business, mainly foreign investors, were restructuring, and that meant large-scale layoffs. The layoffs created higher unemployment, which required greater government spending, which strained a country that had already been pushed to the limit by restructuring its banking industry and health-care system. Until tax revenues could catch up with government spending, Hungary had to print money and borrow more from abroad, which meant a higher trade deficit and growing inflation. To regain control, the Hungarian government introduced an economic-reform package that slowed things down and reduced inflation and government spending.

Throughout the painful economic-reform period of the mid-1990s, the Hungarian government stuck to its privatization course; today, with only one bank and several utilities remaining for sale, it has nearly completed the process--and it is reaping the benefits. With access to cash for investment through strong equity and debt markets, Hungarian companies are well positioned to expand. In addition, management expertise from foreign owners has put them at the cutting edge. Ameritech, for instance, has partnered with Deutsche Telekom to put the once-moribund Hungarian telco Matav on par with its Western European counterparts; Electrolux, through its countless investments, has transformed the appliance industry. Cashed up and confident, Hungarians today lead the region in banking, telecom, pharmaceuticals, and chemicals.

By contrast, the Czech Republic has fallen into strife. Privatization there has turned out to be on paper only. Through a byzantine series of arrangements, the voucher approach has created a situation where funds owned by banks are now the main shareholders of Czech companies. Since the government still owns the banks, those companies have effectively remained in government hands. Without access to cash or management expertise, many Czech companies are facing bankruptcy.

For the remaining 350 million people of the former communist world, the message is clear: Privatize directly and systematically. The Czech Republic is following suit now, however slowly and laboriously, by selling off its banks to foreign investors and dismantling its shareholding system. Poland is finally moving, albeit slowly, toward selling its largest companies. But the rest of the region, from the Ukraine to Romania and beyond, is still probably 20 to 30 years behind Hungary, bogged down in corruption, politics, and a fear of foreigners. And until these countries follow Hungary's lead and accept free enterprise as the driving force for change, their progress toward a market economy will be slow.

--Anna Bernasek