In the eighth John Bonython Lecture, Václav Klaus, Finance Minister of Czechoslovakia, gives an account of his government’s attempts to move away from a socialist system towards a free-enterprise system. Originally an advocate of a ‘market economy without adjectives’, he now calls for ‘an unconstrained, unrestricted, full-fledged, unspoiled market economy’. Progress towards this is slowed by opposition from old-style socialists, encouraged by the advice of Western Keynesians and interventionists. ‘But we will not given up, we will not let them win, we have to demonstrate that socialism can be dismantled’.
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Dismantling What?
The title of my lecture is somewhat misleading, because we have to distinguish between explicit and implicit socialism, between Soviet-type and welfare-state-type socialism; we have to fully grasp the meaning of last year’s Bonython Lecture by James Buchanan, ‘Socialism Is Dead But Leviathan Lives On’. It is relatively easy to dismantle a one-party system, to formally liquidate institutions of central planning, to disgrace communist ideologies and irrational and dysfunctional economic policies, and to provide legal guarantees for free speech. It is much more difficult, however, to construct from scratch a stable political system based on several well-defined and transparent political parties, to create efficient markets in a highly-monopolised and semi-closed economy, to uproot leftist ideologies and distortions in behaviour and the expectations associated with them, to stop deep-rooted government interference in the economy, to block popular redistributional practices, to dissolve dangerous lobbying, rent-seeking, protectionist organisations and pressure groups, and so on.
Creating a new political, social and economic system is a formidable task. It is even more difficult (in my country of Czechoslovakia) after 40 years of ideological brainwashing, with serious ideological and social prejudices, with lost memories, with unprepared teachers, journalists and ‘scribes’ of all kinds, and with various wrong signals coming from Western countries. The ideological or psychological side is very important, but the practical, ‘material’ side is no less demanding. We are confronted with an unavoidable J-curve2 concerning living standards, industrial and agricultural output, and GDP. Any movement forward requires the elimination of old, inefficient, unsustainable, artificially-promoted economic activities, and the replacement of disguised, hidden, unreported and non-measurable economic and social negative phenomena with visible, measurable and, therefore, reported evils: open unemployment rather than hidden un- employment in the form of labour hoarding, open inflation instead of repressed and hidden inflation, output losses instead of output gains dissipated in unsaleable inventories at home or in frozen assets in various developing countries.
It is common knowledge, embodied in the classical Mises-Hayek arguments, that irrational success indicators used in the planning process, along with distortions in prices, create a wasteful economic system which penalises ‘positive’ activities and promotes economically, socially and environmentally damaging activities. The latter must (and will) be halted. But the opposition to doing that is enormous and survives the dismantling of the formal institutions of explicit socialism. Most of the countries of Central and Eastern Europe have succeeded in dismantling explicit socialism. But replacing it with a functioning free market system will be our task for the whole decade of the 1990s.
Two Serious Western Misunderstandings
The implicit assumptions that the East Europeans will lose nothing when the socialist redistributive process is stopped, and that the systemic change is an easily manageable technical task, constitute two serious misunderstandings in the West.
Traditional comparisons of spiritual and material life in Eastern (or rather Eastern European) and Western countries in recent decades give us a somewhat simplified, black-and-white picture, which reinforces an a priori belief that citizens of ex-socialist countries have absolutely nothing to lose and are therefore eager to jump on the ‘road to freedom’ despite all the suddenly-emerging uncertainties of the transitional period, despite all the potentially unfavourable combinations of success and failure, despite emerging inequalities of income and wealth (and the accompanying envy), and despite the loss of a relatively easily self. arranged leisure, of a strange kind of comfort and of undemanding individual irresponsibility. Susan Marie Szasz put it clearly in the Winter 1991 issue of Policy: ‘Are they [the people of Eastern Europe and the Soviet Union], in return for true freedom, prepared to give up bread lines for unemployment lines?’ (Not that we had bread-lines in Czechoslovakia, though there were queues for many other products.) The answer is far from a simple ‘yes’. I have to argue that the ‘West’ seriously underestimates the relative material ‘lightness of being’ in countries like Czechoslovakia in the past decades even if it might be — to use the title of the famous novel by Milan Kundera — for many other reasons ‘The Unbearable Lightness of Being’.
At the same time, the ‘West’, basically because of the lack of understanding of the enormous fragility of its own political, social and economic system (as Thomas Sowell reminds us), underestimates the relative difficulties of the transitional period. I am again and again shocked when the same people theoretically harshly criticise the scope of human oppression in communist countries but do not believe that I, like millions of other Czechs and Slovaks, was not allowed to travel abroad between the end of the Prague Spring and the beginning of our Velvet Revolution, which means almost 20 years. I am again and again surprised that distinguished Western Sovietologists, after years of accurately describing the wasteful economic activities of a command economy in their sophisticated, now partly obsolete, textbooks, criticise us for our inability (and, of course, unwillingness) to orchestrate Keynesian, expansionary macroeconomic policies and/or interventionist industrial and sector policies. I have to add that such notions are frenetically applauded by our old central administrators as well as by their intellectual supporters in the academy.
To summarise: the task of transformation is undoubtedly very challenging. We need to obtain and maintain sufficient popular support and cooperation (which we still have in Czechoslovakia) and we have to avoid all the traps of the transitional period.
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Privatisation is the top priority of all truly reforming economies. An overwhelming shift of property rights from government to private hands is essential if these economies are to become market systems. Privatisation must be carried out rapidly; thousands of state enterprises must be denationalised in several months or years. In this respect all comparisons with Margaret Thatcher’s achievements, despite my admiration of her personal integrity and her economic policies and political stances, are inapt and misleading. We cannot afford to privatise only a dozen state enterprises in a dozen years. Western consultants (very often highly-paid experts from international institutions), together with domestic opponents, raise objections to rapid privatisation because they are convinced that there exists no suitable basis for evaluating the state enterprises to be privatised in Eastern Europe: that until market forces determine the prices of outputs and inputs, enterprise profitability cannot be correctly evaluated and privatisation should be therefore postponed. As Charles Wolf Jr. aptly argued recently (‘Sweepstakes Capitalism’, The Wall Street Journal, July 12, 1991), ‘this objection is spurious. It arises from a misconception about the meaning of privatisation. . . . What is essential is an effective means for shifting ownership from state to private hands’. And I would dare to add, ‘and not the maximisation of government revenues from privatisation’. Czechoslovakia did not choose the ‘privatisation by randomisation’ suggested by the same author (i.e. a sort of national lottery) but invented and tries to realise a non-standard ‘voucher privatisation method’ which overcomes the valuation problem with a ‘free to choose’ procedure. The Czechoslovak citizens will receive vouchers (for a nominal price) and will be free to exchange them for shares in denationalised enterprises. This procedure, now being carefully studied by other reforming countries, should help us to achieve our priority reform target swiftly and without unnecessary delays.
Price deregulation is correctly understood in reforming economies to be the necessary precondition for a normally-functioning market economy. The problem is to implement such a drastic measure after decades of frozen, administered and disequilibrium prices (or prices formed, in the tricky bargaining process of the planning game, according to the ‘planning power of participating economic agents: see my ‘Socialist Economies, Economic Reforms and Economists,’ Communist Economies, No. 1, 1990). Price deregulation must take the form of ‘shock therapy because gradualism creates more problems than it solves. Partial deregulation creates new distortions in the price structure that are as bad as the old ones. Price distortions require new subsidies; new subsidies mean renewed government interference in the economy; and back we are with the old game. Price deregulation must therefore be overwhelming, and residual regulatory methods must be rather soft: instructive guidelines for price formation, not direct controls or directives.
Price deregulation results in a dramatic change in relative prices and, somewhat unexpectedly, in large shifts in consumption patterns. The consumer is bewildered at first, but, as a well-behaved homo economicus starts to adjust his purchases very quickly. It leads to large shifts in demand for industrial and agricultural products, and because producers have only a limited capacity to adjust, excess supply appears in many fields. Prices, as always, react faster than quantities and the whole economy is switched, practically overnight, from an excess-demand regime into an excess-supply regime with over-production, excessive inventories, bankruptcies, unemployment, etc. It is easy to liberalise prices, but it is difficult to help firms in trouble because of rapid price deregulation. Basically, you do not want to interfere with market forces but you have to admit that the change came too abruptly and that in many firms and industrial sectors the supply response is necessarily delayed.
Foreign trade liberalisation and currency convertibility are the most effective instruments of competition policy. International competitive pressures form the only feasible demonopolisation procedure because demonopolisation by break-up is a delicate and lengthy task. It necessarily takes time and expertise and is in one specific sense premature: we want to leave all kinds of industrial restructuring to the new owners, which means leaving it until after privatisation. The new owners and managers would do it more efficiently than government bureaucrats. Trade liberalisation and currency convertibility (at least current account convertibility) are the only methods of ensuring that domestic prices reflect international scarcities and availabilities. They cannot be introduced, however, before a devaluation that brings official exchange rates close to market ones.
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On the macroeconomic side of the reform, we have to avoid a similar dangerous trap. The macroeconomic task is conceptually simple, but practically very intriguing. Macroeconomic restriction, based on a state budget surplus and on very prudent monetary targeting, is absolutely necessary, since without it a vicious circle of inflation and stagnation will evolve and direct controls will be reintroduced. A restrictive fiscal policy coincides with the declining role of the state and with the cutting of all kinds of subsidies, which makes it easier. But it coincides also with a decreasing overall tax burden, with generous tax holidays and many types of tax exemptions, with growing uncertainty, with increasing unemployment and unemployment benefits, with various forms of wage and income indexation, and so on. Price liberalisation abruptly brings to a n end the old macroeconomic and microeconomic relationships, and the budgetary process becomes technically and organisationally very difficult.
The reformers are under heavy pressure to relax their restrictive macropolicies. They are accused of deliberately keeping aggregate demand at an insufficient level, and the well-known arguments in favour of Keynesian expansionary policy are endlessly repeated. We know, however, that the slope and position of our aggregate supply curve do not promise any positive short-term supply response, so that any loosening of demand constraints would be counterproductive and inflationary. But to keep macropolicy on track in a rapidly changing environment is almost impossible. Our task is to minimise errors, not to emit false signals or to reflate the economy.
