Hatton W. sumners Distinguished Lecture Series - Klaus

April 16, 1999

by Václav Klaus

It is a great honor for me to be asked to speak in the NCPA Hatton W. Sumners Distinguished Lecture Series. I have been following the NCPA activities and publications for some time and I am glad to say here that I learned a lot by reading them. The more difficult it is for me now to find something innovative, important and relevant to discuss here.

We are -- very rapidly -- approaching the end of the century and the beginning of a new one. I do not like strong and easy but deceptive words and concepts but they are sometimes appropriate. We can say -- at least looking at the world from Central Europe -- that the twentieth century brought us two wars, two occupations of our territories and two dangerous ideologies -- fascism and communism. We were three times liberated -- from the Austro-Hungarian monarchy, from German occupation and from communism. Only three decades -- the twenties, the thirties, and the nineties -- were the episodes of freedom and liberty which is approximately one third of the whole century. Knowing the circumstances, it is very difficult to say whether it is a good result or a bad one. And especially as compared to whom or to what other era of our history?

I agree with Isaiah Berlin who said that "horrors in the 20th century were not caused by the ordinary negative human sentiments, they have been caused by ideas." This is a very important point. I am really more afraid of some ideas than of nasty people, of wicked or evil persons, or villains. And even if communism is over, I am not alone who sees, hears and feels ideas I consider dangerous. We should not interpret the end of communism as a final and comfortable victory. We should be, therefore, "on guard."

Contrary to the "end of history" or "end of ideology" schools, the end of communism does not mean end of the great ideological debate which dominated the 20th century. It began one. Or it should have. The debate should have taken place much earlier in this century, but communism distracted us from it. Looking around -- in America, in Europe, in my own country -- I do not have the feeling that someone like me (or the readers of NCPA newsletters) is on the winning side. I agree with one of the few of French liberals (in the European sense) Pascal Salin that "we are not the winners of the present time. So far the victory is that of social democracy." He sees Mr. Clinton, Mr. Blair, Mr. Jospin, Mr. Schroeder, Mr. Prodi (the new Mr. Europe) and I see Mr. Zeeman and Mr. Havel in my country.

The "Third Way" ideas are here again and I have to repeat my well-known phrase which was made in January 1990: "The third way is the fastest way to the third world." We should not fall into such trap as in the past. I would like to discuss some issues I consider relevant in this respect. I will start with complications of transition economies and emerging markets, the will continue with the contemporary European challenge where the idea of unification replaced the idea of liberal economic order, and finally I will say a few words about more general issues which are conquering (or trying to conquer) America and are exported to the rest of the world with almost the same success as Hollywood movies.

1. The Problems of Transition

The decade of the nineties started with many hopes connected with the fact that communism, collapsed. I always add that it was not defeated, it -- sort of -- melted down. The long-time awaited event created enormous expectations and as a result of it, the e-r gap, the expectation-reality gap (see my 1997 Annual Hayek Memorial Lecture, IEA, London, 17 June 1997) in spite of many undeniable achievements in most of transition countries during the decade -- has been growing which led to a serious loss of confidence both of transformation strategies. Dramatic controversy about it continues and will be with us for some time to come.

I am sorry to say that western intellectual contribution to this debate has not been very helpful. There has been almost no serious academic research concerning transition from communism to free society, and the quality of available texts is not above the former sovietologist literature which we -- living in communism -- did not find very helpful either. We learned a lot from ideas and concepts belonging to mainstream economics but were not enriched by a more or less descriptive sovietologist literature which was usually less sophisticated than our own (which was done in a much more complicated environment). It seems to me now that everyone almost forgot the evils and irrationalities of communism and is surprised that its dismantling is not fast enough and that it takes non-zero time to replace it with a full-fledged market economy.

The academic analysis is made up for by a non-academic one. The debate about transition economies (and emerging markets) is dominated by a very powerful rent-seeking group of advisors consultants, of investment bankers, of powerful auditors and especially of bureaucrats of international financial organizations who have a vested interest to prolong transition as much as possible, and not to let transition countries to do it domestically (which means without them). My refusal to unconditionally surrender to their views and my statement "I am not ready to pay hard money for soft advice" (which Milton Friedman dubbed "Klaus's law") made me many enemies in this privileged group.

I have expressed my views about transition (and described my experience with it) in many speeches and articles and it is probably too early to add anything to my original "Ten Commandments of Transition" (luncheon address delivered to the plenary meeting of the Group of Thirty, Vienna, April 1993; also published in Renaissance: The Rebirth of Liberty in the Heart of Europe, CATO Institute, 1997). I will, therefore, make only several short remarks:

To paraphrase the well-known saying (ascribed to Milton Friedman) I can say that "there is no such thing as a free reform." The change of the whole system is very costly. The transformation costs consist of the loss of output (and income), of the fundamental redistribution of gains and losses in society, of the increase of inequality in income and wealth, etc. The costs have to be paid by citizens of the transforming countries themselves and the contribution of the rest of the world is marginal (if any and if not a negative one);

The reforms usually started with emphasis on liberalization, deregulation and privatization. The implementation of such reform measures created weak and shallow markets and imperfect market infrastructure. The inefficient (or not fully efficient) markets and surrounding institutions increased transformation costs and unpleasant feelings of less successful participants of the transition process. We are heavily criticized for weak markets and imperfect institutions, but there was no other way how to proceed. In addition to it, our distrust of the state and its potential positive, constructive contribution was much stronger in our part of the world than in yours. In the past we suffered more from "government failure" than you and we believed in the idea that market failure is much smaller and less dangerous than the failure of government. Karl Brunner once said that the state should be "an umpire of a positive sum game and not an operator of anegative sum game" and we accepted this approach as a guideline;

We understood very soon that the fallacy of the artificially introduced dilemma called "shock therapy vs. gradualism" which used to be so popular in the literature. We can confirm that the systemic change is a sequence of many distinct choices over time on separate components of anoverall reform plan and not a single decision. It takes a whole historic period. It is not an exercise in applied economics. It is not done in a laboratory or in a vacuum, it is done inside a very complicated political process in an open, democratic and pluralistic society (there is no masterminding of it);

Many reforms failed or had very high costs because of their partiality and because of the time inconsistency problem connected with the fact that individual reform measures have different time dimensions. This is an unavoidable fact of life which should not be so superficially criticized as it is usually done with the high-brow approach of those who either do not care or have their own interests.
What are the main future dangers?

The country in the moment of transition does not make marginal changes (as a non-transition country). It makes substantial changes. There has not been a long, gradual, spontaneous evolution of institutions, rules or networks of relations based on the enormous variety of human interests, hopes, dreams and ambitions as in your country. Because of that, we still live in a "preemptive" system which does not have the friendly, softening mechanisms of intermediation between invisible hands of the market and visible hands of the government. Such an intermediate structure cannot be imposed upon society from above, it has to evolve. In our society, the strong and noisy pressure groups often succeed in using legislation for gaining powers and privileges at the expense of both individual citizens and the state and for shifting society from traditional liberal democracy to neocorporativeism. It has an important connection to the currently fashionable idea of communitarianism (which I will discuss later). Communitarianism is less dangerous in a mature, sufficiently diversified society but it may very easily refeudalize society in a immature (and in this respect shallow) society (see my speech at the Alpbach Forum 1998 Seminar devoted to "Society and the Crisis of Liberalism", 22 August 1998; published in Policy, No. 4, Vol. 14, 1998, Sydney).

Second problem is connected with the existing fragility and vulnerability of transition economies and with the growing requirements of a globalized environment. The transition countries have particular propensities, especially to higher inflation and to current account deficits (see my speech "Emerging markets and Their Current Problems: The Czech Perspective" delivered at the Delhi School of Economics, New Delhi, 11 March 1999) which are not compatible with fixed (and stable) exchange rates. Transition economies have, at the same time, investment-savings imbalances and they need foreign capital to ensure some sort of equilibrium. Foreign capital wants, however, fixed exchange rates and easy outflow's possibilities. All of that does not simultaneously exist and will probably never exist.

The reconciliation of all those variables cannot be easily masterminded ex-ante. It must be enforced upon the economy ex-post, as a result of economic, financial and currency instability (or crisis). It creates, however, a politically and socially very complicated situation and, as a result of it, the political support for the continuation of transformation is underminded. This is what we have seen in recent years, and paradoxically especially in more successful transition economies.

2. European challenge

Europe is currently -- at least nominally -- preoccupied with two parallel processes: one of them is the deepening of the European integration process, the movement towards unification and the other is the widening, the expansion of EU to the East. I deliberately said "nominally" because both processes do not represent true interests, dreams and ambitions of the European citizens. They are -- both of them -- more or less in the interests of only one rent-seeking group, the group of European bureaucrats who are and will be the only net benefactors of both processes. There is -- at the same time -- no concentrated group which could play the role of a counterveiling power. With uninvolved and indifferent majority of Europeans, who live in a nirvana of unconsciousness of what is going on and who maximize the pleasures coming from a relatively easy live of mature, rich and in may dimensions "unconstrained" society which is unaware of its limits (and of its strong rivals and competitors), a small minoritycan have a decisive power.

The same decisive minority has no interest in the only European project which is worth of being done -- in redefining Europe along classical liberal ideas, in dismantling "soziale Marktwirtschaft" (social market economy), in breaking down paternalism and corporativism flourishing these days in Western Europe more than in any other part of the world.

The recent most important European "deepening" project is the EMU. Some of us know the microeconomic assumptions which are necessary for the existence of an optimum currency area. Empirical data do not confirm the hypothesis that Europe is a optimum currency area which implies that the EMU is a political project to create an optimum currency area by means of introducing single currency before the necessary preconditions are met and without estimating (and explaining to the users of single currency) the costs of such an arrangement.

In addition to it, monetary union was created in Europe without the existence of a political and fiscal one. I do not believe it can bring a stable solution -- it will either collapse (which I do not expect) or will require transforming EU into a political and fiscal union.

Some European citizens want it, some do not which is legitimate but the European political union should not be sold with a different price tag. It should not be pretended that Europeans get a life without exchange rate for nothing. There will be non-zero price for it. Euroland is not a nation, it has no President, no Congress, no Treasury Department, it has only FED which is not enough. I am afraid that the Maastrict "Eintopf" (not perfectly translated as hodgepodge) is not the American melting pot (which, in the meantime, ceased to exist) and that it can bring about a new wave of instability. I take it very seriously.

3. More General Issues

In the developed world, and especially in America, I see three basic problems. The first is the new round of attacks on the liberal and neo-liberal model, the second is environmentalism, and the third is communitarianism.

The first problem is connected with the new arguments for regulation of industry, commerce, business, financial sector, banking, simply of everything. Regulation is for today's socialists what public ownership of the means of production and central planning were for their fathers and grandfathers half a century ago. Regulation is continuing to dangerously grow. Regulation is now defended by sophisticated economists who study market failure (without comparing it with government failure) and who advocate -- almost innocently -- many forms of debilitating pieces of regulation. Joseph Stiglitz (with his influential world Bank position) praises China for deferring privatization and argues that "liberalization can proceed safely only with strong regulatory institutions" whereas I have the feeling that it needs sufficiently cautious macroeconomic policy "only". Most of us have the feeling now that there is far too much policy and regulation around already but the public-choice school arguments have become almost "old-fashioned" and forgotten and the advocates of regulation are on the move.

Environmentalism with its "Earth First!" arguments represents these days "Leviathan Two" (as someone called it recently) menace which may be more dangerous than old socialism. the environmentalist's goals are easy to raise and defend (and they are shared by many of us) but their advocates do not accept the main economic concepts which include the idea of opportunity costs, the idea of Pareto optimality, and the idea of trade-offs. Environmentalism is above all an ideology that sees the world as infinitely complex and interdependent. Their supporters are victims of an old doctrine which is based on the idea that the more complex the world is, the more government intervention, regulation and control it requires. It was rejected by Hayek who argued exactly in an opposite way (see his Use of Knowledge in Society, the American Economic Review, 1945). the more complex the society is, the more it needs the market. Environmentalists suppose that because of an overwhelming interdependency we live in a world of pervasive externalities which means that private contracts are not sufficient and that the government has to step int. we know, on the contrary, that we have to enforce property rights and introduce price signals as the only way out. (Ecological disaster in countries without private property and prices is well-known and I can talk about it from my own experience for a long time).

I see a dangerous virus of demagogy and romanticism in the visions of communitarianism (or a civic society as it is called in some countries). Communitarianism -- as I see it -- represents a new version of an old anti-liberal approach to society, a shift from traditional liberal democracy to new forms of collectivism, a romantic dream and "a constructivistic attempt of improving the moral systems of the face-to-face group on the large, anonymous society" (G. Radnitzki, The Inconsistency of Liberal Compromises, Journal des Economistes et des Etudes Humaines, 1996, No. 4, Vol.7). Communitarianism wants to change human beings and this is very dangerous. Its advocates have the feeling that they have been chosen to advise, to moralize, to know better than the "normal" people what is right or wrong, what the people should do, what will be good for them. They want us not only to be free, but to be good, just, and moral as well. Of course, in their definition of what is good, just and moral.

Communitarianism wants to socialize us by forcing us into artificial, not genuine, not spontaneously formed groups or groupings. In this respect, it is another version of corporativism and syndicalism.

All of that can transform free world into something else, into a "brave new world" some of us know from our own experience. I know that many things I mentioned are "obvious" but I agree with Peter Bauer that "the most important duty of a academic is to keep on insisting on the obvious". I tried to do.