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Notes for the Berlin IIF Speech

English Pages, 4. 6. 2003

It is a great pleasure and honour to be here today and to be allowed to say a few words. I am aware of the fact that this meeting takes place at the moment of the Twentieth Anniversary of the Institute of International Finance. It is still a young institution but it has already developed into one of the leading organizations in global finance and I am convinced it will continue to expand its presence and activities. I have had the pleasure of speaking at your membership meetings in the past, and I have always enjoyed the opportunity to exchange views with you on various economic and financial issues. I have always had the feeling that I am here among friends. I am glad to be here.

As I said, this is not my first address to this distinguished audience. This is, however, my first speech here in my new position as the President of the Czech Republic who is, because of his formal duties, probably supposed to make only polite, non-provoking, empty speeches. I don’t know what to do with it. 

This is also my first speech here in a new, as I see it, in many respects different era. When I say different era I am not thinking of the often discussed and already mythologized events of September 11 and their follow-up in the form of the Iraqi war, even though I do not underestimate their importance. I have in mind the following four processes or phenomena:

-          the fact that several former communist countries entered the post-transformation phase, which was formally recognized by their invitation into the EU and by their recent signing of the EU Accession Treaty;

-          the qualitative changes in the European integration process, changes which started in Maastricht, gained momentum in the 1990’s, and reached their culmination in the current Convention on the Future of the EU; 

-          the end of the dreams about the New or Information Economy; the end of the dreams which reminded me of the dogmas of the so called scientific and technological revolution in Leonid Brezhnev’s times; the end of dreams which were spreading the hope that it is possible to forget good old economic truths and laws due to the invention of a new technology;

-          the recent visible slowdown of the European economy associated with the expansion of the political control of the economy, with the visible increase of rent-seeking and with the introduction of the single currency. 

Our era could be, undoubtedly, described by many other characteristics - I would mention e.g. the growing irresponsibility and incoherence of postmodern thinking and the fact that all sorts of noisy groupings of activists have obtained significant power without responsibility - but I hope I mentioned the most relevant ones. I would like to add a few explanatory arguments to them.

1. Central European countries have reached a post-transformation stage. They have succeeded in liquidating the formal structures and mechanisms of the communist society and in establishing the basic phase of the European version of the system of parliamentary democracy and market economy. 

The past decade gave us many important insights into the formation of freedom and free markets. We have learned things which were not clear, evident, or generally accepted when we started dismantling communism.

The crucial steps were liberalization of prices (after 40 years of frozen and administered prices), of foreign trade (abolishing state monopoly of foreign trade and opening the semiautarchic, protected economies) and of entry into the market for all types of enterprises. These were the necessary preconditions for all subsequent steps. I disagree with those who – like Joseph Stiglitz – argue now, ex-post, that gradualism and slow evolution of institutions (and of legislation) before liberalization of markets were possible and preferable.

The transition was not easy. People naively supposed that the private market economy (as compared to central planning and state ownership) guarantees – almost automatically – a success. They were psychologically not prepared for business failures, both at micro- and macrolevels. They felt that the politicians who had sold them the idea of capitalism, free markets, liberalization, deregulation and privatization without sufficient warnings cheated on them or betrayed them. 

Such feelings were based on the lack of understanding of the transition process, of substantial economic linkages and interrelationships, of formation of legislation and its enforcement, of the relationship between formal legislation and informal rules, as well as - and perhaps predominantly – on the misunderstanding of the human nature itself. It was forgotten that:

-          the formation of legislation and of institutions is and must be slow;

-          it is the result of evolution, not of anyone’ s dictate;

-          it is not the outcome of abstract rationalism, but of a complicated political process and of vested interests, lobbying and rent-seeking.

The transition countries are still in a fragile and vulnerable state and face another challenge. When they started, the dominant slogan was: “deregulate, liberalize, privatize”. Now the slogans have changed to: “regulate, adjust to all kinds of standards of the most developed and richest countries (regardless of your stage of development), listen to the partial interests of the NGO’s and follow them, get rid of your sovereignty and put it into the hands of international institutions and organizations, etc.” It changes the environment in which they exist and operate. The IIF should help to change it again.

2. Central and East European countries, the new members in the EU, need economic convergence with the old EU members. How is this attainable? Will the real convergence be made easier by nominal convergence (by entering the EU and by complying with the EU rules and policies) or will the catching-up be blocked or slowed down because of it? For me this is not a trivial issue. It is not true that it is sufficient to rely on the long-term overall positive effects of the European integration process. The formal unifications both of Italy in 1860 and of Germany in 1990 do not suggest that the nominal convergence helps. It was proved that in such a situation the economic convergence was not possible without massive fiscal transfers unavailable in the current EU.

3. In addition to it, the EU is not a stationary institution. Every treaty and summit take Europe closer to a Single European State and due to it, it is fair to speak about the ratchet effect (known from other processes). We have to ask whether the accelerated unification of the EU, the shift from EC to EU, EMU, possibly EFU and EPU, will increase the welfare (however defined) of EU citizens, will promote the freedom and liberty in Europe, will improve the functioning of the European society and economy, and will enhance the position of Europe in the world. I am afraid it will not. Economists know from their textbooks the difference between total and marginal costs and benefits. We have to distinguish the total benefits of the  EU membership from marginal benefits of further degrees of integration (or unification). The law of diminishing marginal returns has a general validity.

4. We are again witnesses of the disbelief in economic incentives, in the quality of the economic coordinating mechanism, in the price system. We are witnesses of the belief in promising, fashionable or modern products, technologies, or industries, and that these can be masterminded by omniscient bureaucrats in government agencies. I am afraid that we face the same utopias as in the past, now in their computerized, digitalized versions. I am convinced that the counter-arguments are the same today as in the past. We, from the former communist countries, know what we are talking about.

5. We have to ask as well whether the European economy can survive the rigidities of the European labour market, the burdens of the European welfare state and of the enormous size and scope of redistributive state activities as well as the costs of bureaucratic regulation in all aspects of business. We have to ask whether the individual, very diverse European economies can benefit from the existence of a single currency, from the uniform monetary policy, and from the absence of exchange rates among themselves.

My answers to all these questions are well-known. I believe they are mutually consistent. The problems I see in contemporary Europe have common roots – the misunderstandings of the causes of the Wealth of Nations, the ideas and assumptions about the world that have come to prevail among large sections of politicians, social scientists, journalists and other opinion-makers in our current world. We have to start changing them.

Let me, at the end, return to the IIF and let me thank you for your invitation. I wish you many more anniversaries. I have every confidence that your organization will continue to be one of the leading institutions in the financial community in the whole world.

Václav Klaus, Spring Meeting of the Institute of International Finance, Berlin, June 4, 2003