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Emerging Markets and Their Current Problems: The Czech Perspective

English Pages, 11. 3. 1999

We are quickly approaching the end of one of the most promising decades of the twentieth century. The decade started with many hopes, which were connected with the collapse of communism, with softening, if not eliminating of the East-West polarity and tensions, and with apparent Rostowian take-off of some developing countries which succeeded in breaking the vicious circle of poverty and underdevelopment.

I do not know whether the same feeling was dominant here, in India, as well, but in my country, in the Czech Republic, we were at that time convinced of the coming of a new world. Everyone foresaw the era of freedom, of democracy, of openness, the era of true independence, the era of the possibility to fulfil all personal dreams, desires and goals, which were blocked in the communist regime. Coming from Central (or perhaps Eastern) Europe, I can assure you that the same atmosphere prevailed in the whole, suddenly liberated part of Europe. My trips to South-East Asia and Latin America convinced me that the same atmosphere existed in those regions as well.

The feelings at the end of the 1990´s are definitely different and not so optimistic in spite of the fact that the countries in question underwent a rapid transition. They liberalized, deregulated and privatized their economies and societies (and my country was very radical in this respect) and - as a result of it - central planning and bureaucratic administration of the economies ceased to exist. Markets emerged but I do not dare to argue that deep, strong and really efficient markets have been created in less than a decade. Liberalization and deregulation is a necessary precondition but not a sufficient one for that. The markets have to evolve. They cannot be created by decree, by law, by regulation. We have to admit that the existing markets are still shallow, weak and, therefore, not fully efficient and that they are vulnerable to the whole variety of external or internal shocks. This is more true, the more the countries liberalized, deregulated and opened their markets to the rest of the world.

The liberal, market-oriented reforms created enormous expectations. The complexities and difficulties of the transition were – at least rhetorically – recognized, but almost everyone assumed that the elimination of the past irrational system would bring about tangible results in a relatively short period of time. (This feeling was, probably, stronger in the Czech Republic than elsewhere in the region, because 60 years ago, before the communist takeover, the country belonged among the most industrialized countries of the world. I know something about the attempts of India to industrialize its economy in the fifties and sixties and about Prof. Mahalanobis´ planning ambitions but we were in a much different position. We industrialized the already industrialized country which was a very unique – and, of course, unsuccessful – experiment. It led to a drastic deindustrialization after the collapse of communism and of its sheltered markets and to the quick return to a more or less normal, harmonic economic structure but at the costs of large-scale dislocations and disruptions.)

Most of us understood that the time scale, required for the rebirth of a full-fledged market economy together with the establishment of all corresponding institutions of market infrastructure, is much longer than was originally assumed and especially much longer than people wanted to wait. Because of that, the e – r gap (as I used to call the expectations – reality gap, see my 1997 Annual Hayek Memorial Lecture „The Transformation of the Czech Society: Retrospect and Prospect“, IEA, London, 17 June 1997) is getting bigger, not smaller.

I am sure you went through a very similar experience. It does not mean (or imply), however, that the market-oriented reforms should be interrupted or reversed. On the contrary, I am deeply convinced that they have no alternative and – even with the benefit of hindsight – I believe in my “Ten Commandments of Systemic Reform”, which I put together in 1993 (see my The Rebirth of Liberty in the Heart of Europe, CATO Institute, Washington, D.C., 1997) and which influenced on the one hand and reflected on the other the Czech economic transformation.

As I said, the end of 1990´s brought about the undeniable loss of a more or less general (or at least overwhelming) consensus both about the structure of the transformation strategy and the interpretation of transformation achievements. We should not panic, we should not accept cheap and oversimplified headlines in the media, we should pay more attention to the empirical data than to the political slogans used in the election campaigns and especially we should not become victims of vested interests of a very skilfully organized group of international advisers, investment bankers, powerful auditors and bureaucrats of international financial organizations. They established a very successful rent-seeking and pressure group.

To my great regret, the Czech economy is currently undergoing a severe depression which was initiated by a policy mistake in the middle of 1996. The rapid economic growth between 1993 and 1996 (in 1995 reached 6,4%) was accompanied by a typical external imbalance (growing imports led to the current account deficit of about 7% of GDP) and it provoked the Central Bank to dramatically slow down the money supply growth and to introduce other restrictive measures. The standard sequencing of events evolved together with avalanche of deteriorating confidence and we are currently in a deep credit crunch which is very difficult to overcome.

I am convinced that our case does not represent an accidental or isolated event. It is part of a more general framework which I want to shortly discuss now.

We are witnessing a visible increase in instability (both economic and political) in transition countries of Asia, Latin America and Europe. We know as well that the costs of it are very high and that they are paid by the affected countries themselves, not by anyone else. They are, therefore, highly motivated to look for its explanation and solution, more than the international financial institutions.

The first task is to find out what happened and why it happened. We should be able to answer a simple question why it did not happen in all transition economies. There must be – eventually – some important characteristics existing in the affected countries and non-existing in non-affected countries.

I mentioned countries of three continents, and did not mention the fourth continent, Africa. This may be important. It seems to me that Africa was not affected because in recent years the continent did not experience huge capital inflows, which can - practically overnight - change sign and become capital outflows. Similar differences can be found among countries inside continents. The more the country was considered to be a success (realized or promised), the more open and more deregulated it was, the more vulnerable to crisis it was and the more often the crisis really happened. Saying that, I do not want to suggest that there is a direct casuality between capital inflows and financial crises. I prefer to consider huge capital inflows to be a fertile land for a future crisis. And I would like to stress that I do not use this argument as a basis for the now-fashionable idea that the flow of capital between countries should be limited or restricted.

Recently, new, powerful and politically interesting explanation came to the fore. The affected countries themselves have been blamed for their political and economic immaturity, for the imperfection of their financial and banking systems, for the lack of their capital market supervision, for their incompleteness of property rights reforms, etc. This explanation is in my opinion based on the misunderstanding of the transition process and its peculiarities, it is based more on anecdotical evidence than on hard data and it seems to me that the well-known imperfections cannot explain the degree of instability and the severity of the recession.

I cannot buy this interpretation easily for a very simple reason. The whole decade of the nineties was in all these countries devoted to the institutional (sometimes – in the IMF jargon – called structural) transformation, and even if the relative success of it was very uneven, there is no doubt that the degree of immaturity or imperfection of those economies is much lower in 1999 than it was in 1990. Therefore, something else had to happen and I am afraid did happen.

The countries (or perhaps individual economic agents in those countries) exporting capital misinterpreted the economic preparedness (and health) of countries eager to import capital and sent there more capital than was appropriate. In addition to it, they (together with the IMF and World Bank) convinced the importing countries that the outflows of capital must have the same easiness as the inflows. An atmosphere was created where anyone who dared to raise simple questions about the rationality of such arrangement was caricatured as an anti-liberal advocate of mercantilism or of inward-looking economic policies.

Such arrangement, where some were more equal than others (in a true Orwellian sense), which was supplemented by quasi-patronage of IMF and by moral hazard connected with it, put all good cards into the hands of capital-exporting countries and placed all the risks on capital importing countries. It was not accepted that investors seeking higher returns in emerging markets than in developed countries must accept higher risks as well. On the contrary, the lenders could rely on being rescued – at least since the Mexico crisis in 1980. It was because capital investment was hypocritically interpreted as a help, as foreign assistance. I remember how often I warned foreign investors who wanted to help us and asked them to make a good business, not charity. The problem was reinforced by IMF´s interventions based on a traditional bureaucratic incentive to be involved. The IMF simply could not or did not want to let countries reform on their own. It would undermine its significance.

The problem was aggravated by handling the emerging-markets crisis when it developed. I agree with Jeffrey Sachs, Rudiger Dornbusch, John Makin, Martin Feldstein and many others who speak about mishandling of the crisis. The IMF and its influence-respecting central banks in the affected countries did not distinguish the fatal difference between inflationary and deflationary world, did not shift their policies in due time from fighting inflation (and external imbalance) to averting recession, did not understand that the scarce commodity may be demand, not supply, and that the dogmatic denial of the credit problem and the prolonged continuation of restrictive policies may become an economic suicide.

The IMF wanted to keep capital in the affected country by all means, especially by extremely high interest rates. Waiting for the magic return of confidence with high interest rates and with no new credits to domestic firms, however, did not work. It caused severe recessions and a financial distress. As a result of it, even healthy banks and companies collapsed, even the best-managed firms were driven into bankruptcy, originally good loans were rapidly turned into bad ones. Nevertheless, the affected countries were constantly blamed for their weak banks, for their bad loans, for their lack of financial supervision, for their imperfect capital markets and it was forgotten that in a deflationary situation even the best economies have similar problems.

I started my speech with stressing the importance of the fall of communism. But this historic moment did not end the great debates of this century. It began a new one, or, perhaps, should have. The debate we need now is between individualism and statism, between responsibility and free-riding, between liberty and social consciousness. It should have taken place much earlier in this century, but – at least in my part of the world – communism distracted us. We have to use the chance we have now.

Václav Klaus, Notes for the lecture at the Delhi School of Economics, New Delhi, 11 March 1999.