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Several Remarks on Transition Economies and the European Monetary Union

English Pages, 16. 6. 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.

Everyone in our part of the world foresaw the era of freedom, of democracy, of openness, the era of true independence, the era of the possibility to fulfill all personal dreams, desires and goals, which were blocked in the communist regime. Everyone expected the improvement of material well-being 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 ex-communist countries underwent a rapid transition. They liberalized, deregulated and privatized their economies and societies 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.

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. 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) is getting bigger, not smaller.

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 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 campaignings and especially we should not become victims of vested interests of a very skillfully 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 accompanyied 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 of environment 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.

The first task is to find out what happened and why it happened. We should be able at least to answer a simple question why it did not happen in all transition economies.

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. 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 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.

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. The IMF and its influence-respecting central banks in the affected countries did not succeed in distinguishing 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.

Now a few words about the EMU. I am a very special person to talk about Monetary Union, because I am well-known for dismantling one monetary union called Czechoslovakia.

As a politician and a former economist, I have a frustrating feeling that everything about EMU has already been said, that there is nothing to add, that there is definitely no lack of knowledge. Famous economists repeatedly tried to explain basic, more or less textbook arguments about both optimum currency areas and monetary unions, but I am afraid the architects of EMU didn´t listen carefully or sufficiently.

The economists continued to remind us that the conditions for a successful monetary union are microeconomic, which means that they have directly nothing to do with the macroeconomic conditions specified at Maastricht.

It was repeatedly emphasised that the benefits of free-trade are connected with the European Economic Community (which means with a free-trade area and a customs union), and that they are independent of a monetary union.

It was argued that the appeal of getting something for nothing is wrong. It was stressed that it is not possible to convert a variable into a constant without paying an inevitable price, without initiating or provoking movements of some other variable or variables.

We could go on with similar arguments, but it seems to me that it´s not sufficient because nobody wants to listen. They want instead to talk about the benefits of a Monetary Union and not about its costs. There will be costs and not just benefits. It seems to me that the architects of the euro must be - to use labels well-known in the economic profession –new classicals or at least elasticity optimists. They have to assume that prices and wages in Europe are so flexible that exchange rate adjustment is not, and will never be, needed. Additionally, they have to assume that labour mobility is very high. The empirical data do not, as I see them, support these assumptions. In such a situation, something else must become flexible and mobile. This variable, of course, exists and we call it fiscal transfers among individual member countries of the EMU. It is a mistake that their potential size and frequency have not been sufficiently or openly discussed. All of us know that the size of those fiscal transfers in a recently created Monetary Union called Germany was and is enormous. I am aware of the size and frequency of fiscal transfers in a Monetary Union which used to be called Czechoslovakia. I was its last Minister of Finance who was sending the fiscal transfers from one part of the Monetary Union to another and I know that it was impossible to continue.

The architects of EMU probably implicitly or subconsciously assumed that currency domain (monetary union) can be greater than fiscal domain (fiscal union). As far as I know, it has never been proved that this can lead to a viable institutional arrangement. I am convinced of the inevitability of the one-way street, of the inevitability of the path: monetary union – fiscal union – political union. Therefore, one of the consequences, and I include it on the side of costs, will be the emergence of a fiscal and political union. And the justified question is: Do the Europeans really want it? Do they really want a political union?
The existence of a monetary union without political union means that states delegate monetary policy to a supranational agency. It could eventually be neutral in my understanding only on condition that there is a unified economic interest. It is, however, a very problematic assumption to expect anything like that when we look at the current European heterogeneity. I´m afraid, therefore, that the costs and benefits of European monetary union will not be equally distributed among its members which will put the newly created European Central Bank under tremendous pressure.

Recently, I had the opportunity to discuss the Euro with an influential European parliamentarian. After a while, he couldn´t find enough arguments in favour of EMU and the debate forced him to reveal his deeper thoughts. I understood that he didn´t care about the lack of arguments for EMU because he had a strong argument against something else. He explicitly stated that EMU is against something or someone. I feel that the danger is in an undeniable undertone of anti-Americanism and anti-Asiatism in his arguments. He hopes to check the assumed global dominance of the US and the assumed economic strength of Japan and other South-East Asian countries through the vehicle of a united Europe. It seems to me that he did not know that competitiveness has no connection with size. He forgot that the economic power of Singapore or Hong Kong is not based on a common currency or a political union. We should not underestimate such way of thinking.

This brings me to my last point. The Euro, it seems to me, is the most important change in the international monetary architecture since Bretton Woods in 1944 and the biggest voluntary giving-up of national sovereignty in human history - as an alternative to something else. I am convinced that Europe doesn´t need unification but a liberal order. The relevant question is whether EMU brings us closer to such a goal or keeps us preoccupied with an alternative endeavour. In this respect I am not very optimistic.

Václav Klaus, The Dow Chemical´s Executive Exchange Forum, Le Plaza, Brussels, 16 June 1999.