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Europe 2000: A View From Prague

English Pages, 12. 12. 2000

1. Traditional thanks for the invitation, not many opportunities to be in Sweden and to speak in Sweden. Your country has for us two specific features:

 - new EU member country;

 - country with a very specific welfare state characteristics.

2. The title of my speech is too promising. On the other hand, I know that it is very difficult or literally impossible to say anything new, productive, provocative, surprising, and I cannot promise any "breakthrough".

My perspective has two dimensions which may be different from yours:

 - we are, in the Czech Republic, "only" ten years after;

 - we are the candidate country for EU membership.

3. A few words about The Problems of a Newly Born Democracy and Market Economy Ten Years After the Collapse of Communism:

I hope we can all agree that open, pluralistic and democratic society has been firmly established.

I would dare to say more than that. Not only the current stage, but the entire process of the transition was democratic. All the difficult, untried, unknown and politically costly transformation measures have been done by democratically formed political structures, at least in the Czech republic and in most of Central Europe, where political pluralism, parliamentary democracy, fierce competition and rivalry of political parties, unconstrained and therefore absolute freedom of the media fully dominate (this was probably not the case when we move more to the East or South of Europe).

This, more than anything else, is important for the understanding of the course of the transition and of its results. It implies that the transition was not masterminded from above, that it was not dictated by one politician or another, that it was - on the contrary - the “joint” product of a very complicated mixture of intentions and  spontaneity, of design and action, of planned and unplanned events. There have been all the time two main groups of players: the “reformers” operating in the political sphere and the general public (with all its heterogeneity and diversity). It has been a standard mistake both at home and abroad to assume that the course and the results of such a multidimensional process have been fully in the hands of the first group. 

It is easy to criticize such an evolutionary and, therefore, uncontrolled process from outside (as uninvolved observers), from abstract theoretical positions, from absolutistic ideological principles, but it is not fair. We should accept that the transition is not an excercise in applied economics, that it is “real life” with all it takes.

I do not suggest that the politicians do not bear a very specific responsibility. Their task was to formulate a clear and strong vision of where to go, to suggest a viable transformation strategy, to be able to administer the everyday mechanics of the transition and to get (and maintain) sufficient political support for doing it. Some of us succeeded in it, some of us not. Our success or failure, however, dramatically influenced the level of transformation costs and – consequently – the fates and living conditions of millions of people. Some of us have been aware of it.

Starting with the political side of the transition, one of the numerous early tasks the politicians had to go through was to defend and rehabilitate the role of political parties. As you know, the word “party” was totally discredited in the communist era and it was, therefore, crucial not to base political life on the loose, fuzzy organisations such as civic movements and national fronts (for or against something or somebody), which have a different role and function in society.

My personal experience suggests that there is a strong correlation between the presence or absence of a standard political structure (with well-defined political parties) and the success of transition (and I believe the history will prove validity of this “theorem”). This is, however, something not generally accepted.

Another important – if not the most important – task for politicians was to fight the romantic or pseudo-romantic dreams based on two, always available and always fashionable, ideas:

1. the ambition – when changing the society – to look for new, unknown, untried solutions, to use the collapse of communism for creating another utopia;

2. the desire to get something for nothing, the hope that there is such thing as a free reform, a free fundamental restructuring of society and that the heavy transformation costs can be avoided.

I believe that the past ten years proved that both ideas have been wrong, but they are still with us. Based on such or similar illusions, the expectations-reality gap (E‑R gap) has been in the Czech Republic steadily growing, not narrowing. There is no doubt that a lot has been accomplished in this past decade (and many statistical indicators demonstrate it quite clearly). We have witnessed an enormous change in the basic substance of life; the expectations have, however, been growing even faster.

The road from communism to a free society and market economy is not straightforward. Nevertheless, some people do not want to take into consideration that there is no magic carpet which could takes us there without the necessity of our own building and travelling the road. To my great regret, such a fairy tale is still there.

There have been many competing visions of where to go which is natural and, in addition to it, for some people – especially for typical Central European intellectuals – feeling bad feels so good that such people invest a lot in criticism and scepticism and in creation of “a bad mood”. To contest such attitudes is a challenge that politicians do not win very often. At least not in the Czech Republic.

4. The Problems of the Deepening of the European Integration Process:

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 European unification and the other is the widening, the expansion of European Union to the East. I deliberately said “nominally” because, as I understand it, both processes do not represent true interests, dreams and ambitions of the European citizens. They are – both of them – advocated by several specific groups of European society only and are in the interest of one very influential rent-seeking group, the group of European bureaucrats, who are and will be visible net benefactors of both processes. There is no other “concentrated” group in Europe which could play the role of a countervailing power. With uninvolved and indifferent majority of Europeans, who live in a nirvana of unconsciousness of what is going on and who maximize all pleasures coming from a relatively easy life of mature, rich and in many dimensions “unconstrained” society which is unaware of its limits (and of its strong rivals and competitors), a small minority can have a decisive power.

I would like to say a few words about the European Monetary Union, but I have to admit that I am a very special person to talk about monetary unions, because I am well-known for dismantling monetary union called Czechoslovakia. It gives me, however, a very special perspective and a special sensitivity to this topic.

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, and that there is no lack of knowledge. The problem is whether we use the existing knowledge or not. 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. 

Well-known economists continue 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 has been repeatedly emphasised as well that the benefits of free-trade are connected with a free-trade area and a customs union, and not with a monetary union. It has been argued that the appeal of getting something for nothing is wrong, that it is not possible to convert a variable into a constant without paying an inevitable price, without provoking movements of some other variable or variables.

I could go on with similar arguments, but it seems to me that it does not help because it became normal to talk about the benefits of a monetary union and not about its costs.

There will be costs and not just benefits. I will discuss here one issue only. 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 support these assumptions. In such a situation, something else must become flexible. We call this variable fiscal transfers but their potential size and frequency have not been seriously discussed. (All of us know that the size of fiscal transfers in a recently created monetary union called Germany was and still 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 fiscal transfers from one part of the union to another and I know that it was impossible to continue.)

When introducing EURO, it was - 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, however, that this can be a viable institutional arrangement. I am convinced of the inevitability of the following path: monetary union à fiscal union à political union. One of the consequences of EMU, and I include it on the side of costs, will be therefore the emergence of a fiscal and political union. And the justified question is: Do we really want a political union? I would strongly argue that we shouldn´t feel being guilty of a deadful sin when we raise such a question or even give a qualified answer to it.

The existence of a monetary union without political union means that countries delegate monetary policy to a supranational agency. It can be neutral only on condition that there is a unified economic interest. It is, however, a very problematic assumption 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.

5. The Problems of the Widening of the European Integration Process:

My starting proposition is that the candidate countries – among them the Czech Republic – have a clear and straightforward interest: to participate in the European integration process, not to be left aside or behind, not to stay in a sort of vacuum. They have no real alternative to the entry into the EU.

It should not be forgotten that to enter EU will be costly for them (as it has been costly even before entering). Their citizens are not sufficiently aware of it and they implicitly – and perhaps correctly – assume that it would be more costly not to enter. (To compare both types of costs together with their time structure is, nevertheless, difficult if not impossible.)

There are benefits connected with EU membership as well but they come with a delay and are less tangible than the costs. Nevertheless, this is what the citizens of these countries do not know.

My conclusion is that the candidate countries assume that the benefits are bigger than the costs.

Talking about interests, we should define who is on the other side. There is nothing like an EU interest. EU does not behave – in this respect – as an entity. Only individual member countries have an interest (or interests). There is probably one exception. The bigger the EU, the bigger the political role and prestige of EU bureaucracy. As a result of it Brussels is more in favour of enlargement than individual member countries.

The individual countries of the EU have a much less clear interest than the candidate countries:

 - they know that they do not have the right to close the doors of their own distinguished club and to block other Europeans from entering it (it has, however, no relation to their genuine, down-to-earth interests);

 - their interests are very heterogeneous (big vs. small countries, northern vs. southern countries, geographically more distant countries vs. countries close to new members, more agricultural vs. less agricultural countries, rich vs. less rich countries, etc.);

 - the signing of association agreements between EU and its future members together with their radical liberalization and widespread opening after the end of communism have led to a situation in which the existing EU members will not gain much from enlargement as compared to what they get now. (The "benefit" curves of members and candidates have different shapes);

 - EU members are rationally or irrationally afraid of the costs of enlargement (because of inevitable fiscal transfers from various structural funds, because of the unpleasant problem of sharing farm subsidies, because of potential domestic employment problems caused by labour flows from new member countries, etc.).

We can say that the member countries assume that the costs of EU enlargement will be higher than the benefits. 

The serious (and fair) question is the following one: will the interests of both groups of countries – in the situation of asymmetric motivations – coincide? I have to insist that to raise such a question is not an expression of defeatist Europessimism, that it is – on the contrary – an expression of responsible Eurorealism. The refusal to accept such a question is either Euronaivism or a sheer hypocracy. 

Serious preparations (or homeworks) are unavoidable on both sides:

 - future members must be able to fulfil the Maastricht macroeconomic criteria (with all accompanying consequences) and to strenghten the microstructure of their economies. They have to harmonise their legislation before entry;

 - EU has to make institutional changes, otherwise it would not be able to deal with more than 15 current members.

I do not want to speculate whose task is more difficult, but I dare to challenge the dominant view that the unfulfilled tasks of the candidate countries represent the only existing obstacle to enlargement.  

6. Unification of the Continent or Liberal System?

This brings me to my final point which is the issue of sustainability of current EU economic and social practices (and of the ideologies behind them). In my understanding the current system is, at least in the long run, untenable. The question is whether there is an easy way to change it – in an entity which has an undeniable democratic deficit as well as a non-negligible, geographically given, distance between individual citizens and politicians in Brussels.

We need marginal, incremental, evolutionary changes (and they will be – eventually – realized), but we need more radical or revolutionary changes as well. Europe (or the Euroland) has been in the past decades a victim of a creeping bureaucratization, of an increasing regulatory activism, of nonreceding protectionism and of soft and all-embracing paternalism on the one hand and of increasing "planetary" ambitions vis-à-vis "Le dèfi americain" or the Asian challenge on the other. Both processes are wrong.  

Appendix 1

A serious discussion of the transition would require to deal with many other important, and definitely non-trivial issues. I will mention only 5 of them because I am afraid they are not sufficiently understood:

1. Transition is a sequence of policy decisions, not a once-for-all policy change (therefore, the dispute about gradualism or shock-therapy, which dominated the debate at the beginning, was wrong). 

2. Transition is based on human choices (influenced by ideas, prejudices, dreams and interests), not on scientific knowledge.  

3. Transition brings democracy, but more democracy enhances the power of interest groups. Their vested interests block further reforms.

4. During the transition from communism to a free society the first task was to fully concentrate on solving the dichotomy “oppression vs. freedom”, while the no less important dichotomy “anarchy vs. order” was – especially in the first period – not seen as crucial. That is to say, freedom was preferred to order. As a consequence, the institution formation – certainly not neglected as it is popular to say now – was not pushed to the forefront. The inherited low level of trust in the state and its institutions played an important role in it. It has not disappeared and remains to be low even now. Saying that I do not subscribe the currently fashionable idea that the transition can be divided  into the so-called first and second generation reforms, where the first generation reforms consists of liberalization and deregulation together with restrictive measures to achieve the macroeconomic stability, while the second generation reforms are devoted to “transparency in government and financial activities, good governance, sound legal, regulatory and supervisory frameworks, and fiscal policy sensitive to the social and economic needs and situation of its citizens”. The transition is indivisible and as one who was co-responsible for such a historic change I have to argue that we have always been aware of both aspects of transition.

5. Transition is “a homework”. It must be done at home and everyone must be an active part of it. To guarantee the widespread domestic participation becomes crucial for its success. The blueprints of the reform cannot be imported, the local knowledge is of significant importance. 

The challenge how to proceed in the economic field was enormous even when the battle about ideology was won, when the market economy (as opposed to various third ways) was accepted as the necessary outcome. The problem was:

 – to minimize the inevitable economic decline which was to follow the fundamentally changed economic environment (it was partly the consequence of the transformation strategy itself, partly the unintended result of the collapse of former division of labor in the communist “commonwealth” on the one hand and of the dramatically increased globalization and, therefore, competition on the world markets on the other);

 – to eliminate the inherited excess demand (or forced savings) at the moment of price liberalization without initiating rapid inflation or even hyperinflation;

 – to set the exchange rate at a level which would have made it possible to liberalize foreign trade without creating a dangerous external imbalance which could easily lead to instability and crisis;

 – to liberalize prices and foreign trade without creating unberable social conditions and without deep micro-economic disruptions;

 – to deregulate markets with a very imperfect market structure (which means without waiting for the evolution of perfect markets);

 – to privatize the state ownership rapidly, efficiently, with sufficient domestic participation and in a socially tolerable way;

 – to change institutions, rules and legislation as soon as possible but in a democratic way. 

The dominant task was to keep the transformation going and not to get stuck in the “underreform trap” of partial, disconnected measures, which aggravate the economic situation and discredit reforms and reform politicians.

There are two main aspects of the external dimension of the transition problem. On the one hand there is the problem of incompatibility (or difficult compatibility) between genuine vulnerability of transition economies, their high degree of openness (as a result of radical liberalization and deregulation), growing interdependence of the world economy and an enormous degree of capital mobility. On the other hand, post-communist countries in Central and Eastern Europe are facing another new phenomenon – a new stage of European integration or unification.

Both issues are relatively new. The processes of transition in the past – in Spain and Portugal in Europe or in Latin American countries – were always characterized by the compatibility problem of exchange rate regimes and domestic macrostabilization policies. Growing capital mobility and globalization created a more recent problem of “incompatible trinity” of mobile capital, fixed exchange rates, and domestic monetary policy. The post-communist world has added to it another dimension and we now have a tetragon instead of triangle. The earlier, well-known problems are to be solved in a country where – at the same time – markets are to be created.

The question is how to do it. I have always rejected the so called sequencing imperative in transition as an attempt to mastermind the transition in a constructivistic way – with one exception: macroeconomic control must be guaranteed prior to the price (and foreign trade) liberalization. There is a plenty of evidence in favor of it. Recent developments have confirmed another rule: sound banking and financial system is a precondition for liberalization of financial flows (capital account liberalization).

The new European context represents another problem. The rapid pace of unification increases the vulnerability of weaker partners and the advantages (or a much more self-assured feeling) for the stronger or bigger ones. The deepening of European integration would be appropriate on condition there is wage and price flexibility (in both directions) and labour mobility as in the United States. If such flexibility and mobility do not exist fiscal transfers must take place (as in any other currency area). The unwillingness of the EU to accept such a logical argumentation is another complication for transition countries of Central and Eastern Europe. These countries have opened themselves to the EU more than the EU to them. The EU politicians do not like to hear it and they always try to argue that they do not force us to join the EU. But that is not fair as everyone knows that in the current atmosphere and situation it is not possible not to participate in the European integration process. It creates, however, another part of the costs of transition we have to pay.

To conclude, the first decade of the transition was a fascinating period for all who were part of it and we can confidently say that the old system is a history which has no chance to come back.

Appendix 2: Two remarks

I am often asked about the connection between the EU and EMU membership. It is for us not the issue of the day now but I see as an interim solution the participation of new EU members in ERM II. Other experiments are not necessary, especially we should not accept either an early euroization (à la dollarization) of our currencies or the obligatory establishment of currency boards. It would considerably increase the costs of preaccession era.

Relatively new, suddenly fashionable idea is the concept of the so called flexibility of EU, or to put it differently, of a two-tier EU, based on hard-core members (inner-core) and other members (periphery). I consider it a very misleading proposition – especially for future members. It sounds positively because it indicates some sort of freedom of choice for individual countries but it is not true. On the contrary, it is the fastest way to promote political union and to give a special, dominant role to the hard-core countries. It was explicitly stated by the Commission that the idea of flexibility "was conceived for those who wanted to advance forward", not for those "who want to advance backwards and reduce integration or extract themselves from certain policies". This special "flexibility" is a method to force less enthusiastic countries into accepting EU unionistic policies. It has no connection with more diversity because it requires to accept the acqui communautaire in full. Candidate countries have to accept the entire acquis, not only part of them, before entering.

Václav Klaus, 13.9.2000