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IN
1989, MOST economists thought the problem of transition
was one of allowing prices to float to market clearing levels.
After all one of the most observable problems throughout
the former socialist economies was the existence of pervasive
shortages. Indeed prices did need to be freed up. But we
learned in the process that free pricing required a network
of institutional reforms to define and enforce private property
rights and secure the freedom of contract. By the mid-1990s
economic attention had moved away from the macroeconomic
stabilization, privatization and price liberalization agenda
to a broader notion of institutional reform. Since that
time, political economists have also
learned that discussion of institutional reform is incomplete
unless we can talk meaningfully
about cultural attitudes and beliefs. There is no doubt
that perhaps the most
important advice an economist (of any stripe) can provide
to a reforming government
is to stress how much incentives matter. But we do not adequately
understand
incentive mechanisms unless we also understand how individuals
within a
specific context attribute social meaning to the incentives
they face. Thus, we economists
are faced with a dilemma at the beginning of the 21st century
that was widely recognized
in the 19th century to do good economics one must study
the interaction of
the economy, polity, and society and that nothing is as
dangerous as an economists who
attempts to pro-offer advice based on a study of the economy
isolated from all other factors.
In
this talk I want to stress three simple points about the
transition from the former socialist system to a market
economy:
- Transition
problems are not economic problems, but political
and legal problems;
-
Change requires an accurate defining of the “here” from
which reforms start and a good
idea of the “there” to which change is to
accomplish;
-
Effective change of the political and legal institutions
requires government to establish
a binding and credible commitment
to reform.
The
sad reality is that throughout Eastand Central Europe and
the former Soviet Union
there has been a general failure to take
the necessary political and legal reforms.
Moreover, the analysis of the transition
problem has been stymied over the
past decade by a general failure to recognize
the de facto organizing principles that
governed the former socialist economy and
thus analysts have failed to deal adequately
with the socialist legacy in designing
reforms. Especially foreign advisors
have been content to proceed as if
the de jure economic relationships in the
former
system defined economic life. But such
intellectual laziness means that one can
never develop a good political economy model
of the transition because you have failed
to accurately describe the “here” from which
you hope to transition to a “there”. 1
Of
course, the problem is compounded by the
fact that no consensus has emerged on the
“there” that policy reforms are to be directed
at achieving.2
Before
going further let me state the basic economic principles
underlying my analysis, and the policies I would advocate.
They are as follows:
- The
economics of the transition is really pretty simple economics
- get out of the way of individual attempts to realize
the mutual benefits of exchange.
- Economics
is fundamentally about exchange and the institutions within
which those exchanges take place.
- Secure
property rights, freedom of pricing, sound monetary policy,
fiscal responsibility and open international trade.
I simply
do not see an alternative. Joseph Stiglitz might not agree
with me, but the evidence simply does not support his claims
that capital controls, infant industry protections, and
Keynesian macroeconomic policies are keys to successful
development. Economic development results from encouraging
individuals to be willing to “bet on their ideas” and to
find the financing to bring those “bets” to life. In short,
economic development emerges in a social ecology that promotes
freedom of action and internalizes the responsibility for
those actions.
Ironically,
one of the surefire ways to determine whether a country
has adopted successful economic reforms would be seeing
the number of individual bankruptcies increase. The recent
financial scandals in the US are not “collective” tragedies.
The “collective” tragedy would be to not let Enron go bust,
or Arthur Anderson to lose its reputation because of the
political clout of its officers. A vibrant market economy
is a profit and loss system. If firms who do not
satisfy the demands of consumers are protected from going
out of business, then resource allocations will not result
in a manner that tends toward efficiency. Waste of resources
will result and the economic system will not generate generalized
prosperity. It is precisely because entrepreneurs reap profits
for satisfying the demands of their fellow men, and suffer
losses for the failure to do so in a cost effective way
that the market system is a reliable mechanism for resource
allocation.
The
scourge of successful reform efforts is the desire to protect
people from the rigors of market discipline. This is as
true for the labor force as it is for the entrepreneurial
class. Persistence of inefficient organizations and patterns
of resource (both capital and labor) use simply ensure that
short-term pain is sacrificed for long-term misery and economic
deprivation. The pattern must be broken and the creative
destruction of economic change must be allowed to run its
never-ending course.
So
when in a reforming economy you see zero to few bankruptcies
(of either old or new firms), employment concentrated in
the former state-owned enterprises, and the persistence
of the underground economy you can confidently conclude
that reforms have not been effectively implemented.
In short, the more things supposedly change, the more they
in reality have stayed the same. There is no reason whatsoever
for the persistence of an underground economy in a liberalized
environment except for the fact that the costs of doing
business have remained too high - including taxes, regulations,
and other fees.3
What
is the persistence of an underground economy telling us?
- The
political and legal environment makes it impossible for
people to bet on their ideas and realize the mutual benefits
from exchange in an above-ground and transparent manner.
- People
will find creative ways to realize the
benefits from exchange, but lack of transparency
does present a serious limit to
the expansion of this creative energy.
Once
we recognize that the spirit of enterprise
is not something that we have to create,
but instead cultivate, then our policy advice
moves from concerns with efficiency to
questions of how do we get institutions that
cultivate economic life. How do we get the
correct institutions?
The
institutions operating in a society can
be defined, following Douglass North, as
the formal and informal rules that govern social
intercourse. It is important to understand
that formal rules are only rules if
they find legitimacy in the informal rules that
individuals within that context respect. On
a superficial level speed of reform is judged
by changes in the formal rules, but this
misses out on the constraint that the informal
rules place on the acceptability of the
formal rules. Whenever I discuss this I am
reminded of the Woody Allen movie Bananas
from the 1970s - after the revolution
succeeds he announces that from now
on everyone will wear their underwear on
the outside of their clothes. The revolutionaries
look at one another in bewilderment.
The formal pronouncement has
no resonance within the population. The
same problem confronts the postcommunist revolutionaries
when they make the
less bizarre pronouncements - such as, from
now on everyone can buy and sell whatever
they desire and pursue their fortune
as they see fit provided they are responsible
for costs they incur, or from now on
everyone will respect private property and
the freedom of contract. The problem isn’t
that the words spoken are incoherent, but rather that the
words don’t have social meaning to the audience who hears
them, if they hear them.
The
most important issue the formal institutions must deal with
is that of the threat of predation - from private and more
importantly public actors. The social context of the socialist
system was one of public predation, and the threat of private
predation in the underground activities. The threat of private
predation was real, but as evidenced through the choice
by many to continue to engage in underground activity this
threat was less onerous than the predation individuals were
subjected to above ground by public officials. The persistence
of underground markets in the post-communist period suggests
that the situation has not changed as much as one might
have hoped.4
Guarding
against predation is a function of political and legal changes
that establish a regime of private property rights and a
rule of law. By this I don’t mean the law of rules -
transition economies don’t need more rules and statutes.
What is required, however, is the firm commitment to a regime
of private property and freedom of contract. The functional
significance of the rule of law lay in (a) the generality
of the law, and (b) the predictability of the law. By generality,
I refer to the fact that the law is equally applicable to
all citizens, including those entrusted to enforce the law.
The arbitrary whim of those in positions of power is minimized,
and rulers are held accountable for their actions along
with everyone else in society. By predictability, I refer
to the property of the rule of law that these rules are
known in advance and thus actors can incorporate these laws
and their enforcement into their commercial calculation
when making decisions. Economic actors must be able to assess
the risk associated with business ventures. To engage in
this sort of risk-assessment, along with prospective entrepreneurial
appraisement, the economic decision must be made within
a fairly stable environment. Just as unpredictable bouts
of inflation can distort economic decision-making so can
unpredictable bouts of predation from either private or
public actors.
The
simple making of a public announcement by the government
that from now on contracts will be enforced and public predation
will be kept to a minimum are not enough to change the expectations
of the entrepreneur or the private investor in a potential
business venture. Talk is cheap, as they say, and individuals
in transition economies do not trust their government. Mechanisms
of tying the rulers’ hands must be introduced. A credible
and binding commitment to limit government predation has
to be established and must be signaled effectively to the
population. If no credible commitment is established and
signaled then reform measures will not be trusted and business
ventures will be channeled to underground activity, or to
non-productive activities intended to curry favor with government
officials.
I have
argued in my writings that this concern with signaling provides
a new argument for “shock therapy” than the more traditional
emphasis on simultaneity. But I have also emphasized in
my work that “shock therapy” - as a literal reading of
the analogy would suggest - is not a cure, it is a treatment
that enables the patient to get on the path to recovery.
In addition, I think there are certain policy steps that
rulers’ could take which would be more effective than others.
First, we need to make sure that fiscal incentives are aligned
to promote economic development. This is best accomplished
through fiscal federalism - decentralize the taxing authority
to the local level. Same thing with economic regulation.
This would force localities to compete for their tax base.
A minimum basic fee could be provided to the central government-
what is called reverse revenue sharing, e.g., 10 per cent.
This would give local rulers an incentive to pursue growth
enhancing policies because the incentives would be such
that they could maximize their revenue by maximizing wealth
enhancement. Second, I have argued that governments raise
revenue in one of three ways- borrowing, taxation, inflation.
The ability to monetize debt unleashes the natural tendency
in democratic governments to finance their affairs through
debt. So I have argued for a denationalization of money
either through a currency board (a poor solution) or the
adoption of a free banking system.5 By eliminating the
government’s ability to pay off public debt through the
hidden tax of inflation, free banking is one component that
would align the incentives such that government officials
had to be prudent in their promises of government programs
and subsidies to special interests. Finally, I have argued
that another policy that would send a strong signal of a
commitment to liberalization would be the pursuit of complete
free trade in goods, services, and even ownership. Yes,
let the foreign owners in to buy up your factors- with this
would come new technologies and new management skills that
otherwise would take longer to seep into the economy. In
addition, trade liberalization brings with it foreign products
and a price structure unencumbered by government tampering.
In short, fiscal decentralization, monetary denationalization,
and trade liberalization credibly commit the government
to a policy of non-interference in economic life and signal
to private actors domestically and abroad that if you want
to invest in this economy you need not worry about the meddlesome
actions of government.
My
contention is that if real existing socialism was characterized
by the omnipresence of the state in all walks of life, then
the transition economies that are most successful will be
the ones who minimize that presence the most. And thus,
I often argue that the governing principle of a liberal
society should be that a free society works best when the
need for a policeman is least. Those societies that promote
freedom and prosperity most are those that come as close
as possible to invoking the principles of self-governance
rather than coercive governance to ensure peaceful social
cooperation.6
So
what have we learned since 1989? Before addressing that
it is important to stress that while many things have changed,
the most essential economic reforms have been blocked. Shock
therapy hasn’t failed; it hasn’t been tried if we actually
look at the substance of reform packages rather than the
name that politicians give to their reforms. That much said,
the difficulties of the past decade have taught us two striking
lessons, and they are:
- Reform
is not just a matter of getting the prices right, but one
of getting the institutions right so that the price system
can work effectively.
- Getting
the institutions right requires a broader change in belief
systems among the public without which the needed institutions
will only be words on paper and not guideposts for real-life.
The
key changes in beliefs that must be adopted for the institutions
of a free and responsible people are (a) a shift from notions
of collective responsibility to individual responsibility,
(b) a respect and toleration of dissent and the dissenter
in society, and (c) a general respect for science and in
particular the idea that all opinions and norms must be
submitted to critical scrutiny of argument and evidence.
In
conclusion let me reiterate a basic tale about economic
growth and development. An economic system operates on the
basis of people, resources and institutions. The geographic
location of a country and the amount of natural valuable
resources at its disposal are exogenous factors. The disposition
of a population in terms of beliefs and talents is also
exogenous in the short-run. But the institutions (the rules)
which govern the way people interact with one another and
nature are endogenous. The Czech communists were able to
destroy an economy by changing the institutions within which
people interacted. And the Czech liberals will develop an
economy to the extent they can change the institutions in
a more wealth inducing direction. We can recognize the difficulties
of institutional change, and they are severe, but we also
must not lose sight of the basic lesson that the failure
of socialism and the transition experience teaches us- namely,
that only a system of property, contract and consent can
form the basis of a free and prosperous society. And we
should recognize the wisdom that Adam Smith had when he
wrote in his notebooks in 1755 that:
Little
else is requisite to carry a state to the highest degree
of opulence from the lowest barbarism, but peace, easy taxes,
and a tolerable administration of justice; all the rest
being bought about by the natural course of things.
Hard
to beat Smith’s words. So establish private property, protect
the freedom of contract, reduce the tax and regulatory burden
to a minimum, pursue a policy of monetary freedom, and open
your borders to goods, services and investors, and you will
unleash the entrepreneurial creativity of your population
and neighboring countries. A century of political freedom
and economic development was lost due to the seduction of
the socialist promise that all you had to lose was your
chains, but a real future of peace and prosperity awaits
for those who finally throw off the shackles of the state
and socialism and embrace the free market and the entrepreneurial
ethos of creative destruction.
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