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The Political Economy of Introducing Free Markets: Notes for IIASA Conference

English Pages, 14. 1. 2012

Thank you for giving me the opportunity to be at this very unique gathering with all of you. It is nice to meet so many old friends. It is rather curious that I have not yet participated in any conference organized by the well-known International Institute for Applied Systems Analysis. There is a reason for it, however. As an economist who strongly believes in the standard economic paradigm and who has been opposing the attack on economics coming from the approach of the so called systems theory for decades, I used to have aprioristic reservations because of the name of the institute. The distinguished group of economists who gathered here in the last two days suggests that I should have paid more attention in the past.

When I originally received your invitation, I asked myself why you suggested me to speak about the “Non-Economic Factors of Economic Reforms”. Was it because for years I had been accused by my political opponents of reducing the complex task of transition to its economic dimension? Hopefully not, because they were, of course, not fair. A fundamental systemic change, in the 1990s called transition, is a multidimensional process and people like me always knew it. Nevertheless, we wanted “only” to change the political, social and economic systems, we didn’t want to change mankind – this is something we left to other people to attempt at.

The politicians like me, who were actively involved in the transition at that time, understood quickly that the sophisticated theories of the optimal sequencing of reform measures prepared in the communist era both in our countries and in the West were practically of no use. It was evident that a complex systemic change couldn’t be organized or masterminded by a philosopher–king (nor by a group of academic economists). This change was – as I used to describe it – a mixture of spontaneity and constructivism where political leaders (and their academic advisors) were just one side of the whole process. The millions of finally free people, fascinated by the arrival of freedom, wanted to live without being planned and controlled by anyone and there was no way stopping them doing so. Individual citizens, voters, civic organizations, political parties, businesses, NGOs and all other economic agents had, of course, different short-term and long-term interests and motivations than the architects of the reforms. We knew it but foreign advisors and commentators usually neither saw, nor respected this elementary fact.

We also experienced that it was relatively very easy to build a negative consensus, that is, to agree upon what we didn’t want, such as continue living under communism, but it was much more difficult to find a positive consensus, a positive vision firstly where to go, and secondly how to get there. The genuine conflict of visions, a healthy process in a democracy, happened to be – in any case – another complication. It sometimes led to inconsistent, controversial and contradictory steps and measures which was, however, inevitable. The overall systemic change is not an exercise in applied economics.

It shouldn’t be forgotten that the changes started whether we wanted them or not, whether we had the feeling that all relevant, highly needed preconditions had been met or not. As I said, it was not possible to stop the spontaneous behavior of millions of people, even if we wanted it, which certainly was not the case. In addition to it, we knew that it was necessary to fill in the vacuum created by the collapse of institutions of the old regime as soon as possible.

This simple truth had provoked many both friendly and unfriendly discussions and criticisms which had their rational basis, while other attacks had mostly political rather than substantial motives. In this connection, I want to touch at least two very controversial issues concerning the sequencing of the transformation:

- the macroeconomic dilemma: the liberalization of prices and foreign trade vs. the creation of a stable macroeconomic framework in advance;
- the institutional dilemma: the liberalization, deregulation, privatization prior or after having a solidly built institutional framework?

For the majority of economists, the first issue was conceptually relatively simple. They knew that liberalizing prices and foreign trade without having a certain degree of macroeconomic equilibrium would bring about galloping inflation or hyperinflation together with huge balance of payments problems. Some of us knew it sufficiently well, some of us even succeeded to avoid doing it in a wrong sequence. My country experienced the lowest inflation because of the lower level of macro-disequilibrium we inherited from the past and because of the very cautious monetary and fiscal policy we implemented immediately after the fall of communism. Our first post-communist state budget – for the year 1990 – was a surplus budget and I put a lot of my political capital into pushing it through.

The second issue was and still is more contested. Our various, sometimes very loud critics – the academic, ivory tower economists, especially the adherents of the institutional school, the political opponents of all colors and prejudices of the radical transition and of the fundamental systemic change, the believers in all kinds of third ways and in the possibility of efficient and productive masterminding of a complex human society – assumed for very contradictory reasons that it was possible to postpone the quickly evolving spontaneous processes until the government delivers “efficient” institutional framework – including the rule of law with all the necessary legislation and law enforcement and institutions and only after that to let the market economy go ahead. This was, of course, a total nonsense, and it should be stressed very loudly, at least now and here.

Our critics did not see that there were transformation measures with objectively different time requirements and that their introduction and implementation couldn’t coincide in time. The institutional framework and the rule of law have to evolve, they can’t be “introduced”. Completing them takes years or decades, not days or weeks. Patronizing us in this respect was a very insensitive and thoughtless behavior on the side of some of our Western colleagues and of some of our domestic ones who wanted to play the role of detached commentators or of uninvolved observers. That was a very easy and comfortable position.

The crucial factor in transition was time. This issue has been discussed – at least at the beginning – under the totally misleading heading: gradualism vs. shock therapy. It should be stressed that both concepts are wrong – neither one has any meaning and any relation to reality.

Something else was important. It was necessary to put forward at one moment a critical mass of reform measures in order to send a strong signal to the citizens of our countries that we were serious and fully determined to transform the country. After that, the rule was – whenever there was an opportunity – to implement any measure which was prepared.

I also want to stress the importance of the interplay of economics and politics, of the economic and political sides of transition.

We all know that in order to succeed, with the difficult, painful, past behavioral patterns substantially disturbing reform measures, they have to gain a political support. My experience is that such a support mostly did not come. The economic reformers had to organize the political support themselves. Very often, their presidents or prime ministers were their main opponents, which happened also in my case, then in the role of finance minister*).

Another issue worth discussing is the necessity – or eventually the non-necessity – of the coincidence of political and economic reforms. The non-economic – cultural and historical factors and traditions – play a crucial role in it. Today, we see that this issue is not as simple or as straightforward as we supposed. It is difficult to generalize in this respect.

In Central and Eastern Europe, and especially in my country, this specific sequencing has never become an issue. Political and economic changes were done simultaneously, their coincidence was mostly automatic and their interplay proved to be positive. The sometimes stated dilemma of whether political and economic changes can be done independently and eventually with long delays was an artificial one for us. In our setting, they went together. We succeeded very rapidly to establish a standard political structure. In today’s China, the sequencing of reforms is evidently different. It would have been unimaginable for us to follow such a pattern twenty years ago. Nevertheless, with all my belief in the necessity of a genuine parliamentary democracy, I don’t want to exclude the possibility that it can go differently in different parts of the world. The question is how big the gap between those two types of reforms can be.

Another highly controversial topic – today almost forgotten (and used for political accusations only) – is privatization. In my country, we took three main assumptions for granted:

- the privatization must start immediately, or at least as soon as possible;
- the privatization must be organized. The spontaneous privatization, which happened in some Central and Eastern European countries, was unacceptable for us because it would had put the whole economy – with a direct support of the government – into the hands of people who became prosperous and/or influential in the old regime;
- we were convinced that we had to guarantee that the whole country was not sold to foreigners (who were the only ones with capital required by the standard privatization procedures).

The conclusion was and still is: the transformation privatization must give a special role for non-standard methods which were – logically – opposed by foreign investors and their advisors.

Final remark:   At the 1993 meeting of the Group of Thirty here in Vienna, I presented my “Ten Commandments of Economic Transformation” that were translated into several foreign languages in the following years. When I look at them now, almost 20 years later, I have to say that we are not much more clever today than we were at that time. The overall loss of the reform enthusiasm and the current economic problems in Europe should not make our confidence shrink.

Nevertheless, economic transitions of the 1990’s vintage are neither repeatable, nor necessary now. At least I hope. There is, however, another inevitable transition on the horizon in Europe: the transition from die soziale Marktwirtschaft to free markets. To achieve it would require similarly deep and radical changes, similar courage and risk-taking. Perhaps, this should be the topic of our next conference. The current European, non-functioning, overregulated and paternalistic welfare system deserves similar critical “system analysis”.

Václav Klaus, Economies in Transition – 20 Years After, International Institute for Applied System Analysis, Vienna, 14 January, 2012