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Johns Hopkins University Speech: Europe, the Systemic Consequences of the Recent Crisis and the Need to Re-Formulate the Case for Capitalism

English Pages, 23. 9. 2010

I would like, first of all, to express my thanks for giving me the opportunity to be here. In spite of having visited tens of American universities in the past two decades that followed after the fall of communism when we became a part of the free world again, I have never been to Johns Hopkins, one of the most famous American universities, well-known for its high quality and its emphasis on research. Thank you for the invitation.

In my early academic years in the 1960s, when I was research fellow at the Institute of Economics of the Czechoslovak Academy of Sciences in Prague, I came across the name of your university in connection with articles and books written by the world-renowned economist of Hungarian, which means Central European, origin, Béla Balassa. His name is most often mentioned in economic textbooks in connection with the so called Balassa-Samuelson effect, which tries to explain the relationship between purchasing power parity and cross-country productivity differences. But Professor Balassa also wrote one of the first theoretical books on the most important post-second world war development in Europe: “The Theory of Economic Integration” (1961).[1] Because the European integration is absolutely crucial for us now, I will start by addressing this issue first.

Based on my many visits in this country, I have the feeling that Americans do not have a proper understanding of the European integration. Partly because they don’t care, partly because they a priori see it as a positive development bringing a chance of having a less complicated and more coherently behaving partner on the other side of the Atlantic, and partly because they do not have patience with small countries, often changing names and size of their territory. The famous remark by Henry Kissinger about Europe’s telephone number is still relevant.

Americans usually underestimate what happened in Europe in the last 50 years. In the 1950s, the leading idea behind the European integration was to liberalize, to open-up, to remove barriers at the borders of individual countries, to enable free movement of not only goods and services but of people and ideas around the European continent. It was a positive concept. It should continue and be promoted by all those who have a liberal (in European terminology), which means not statist or nationalistic, world-view or Weltanschaung.

It changed during the 1980s and the decisive breakthrough came with the Maastricht Treaty in December 1991. Political interests to unify Europe and to create a new superpower started to dominate. Integration had turned into unification, liberalization into centralization of decision making, into harmonization of rules and legislation, into the strengthening of European institutions at the expense of institutions in member states, into the enormous growth of democratic deficit, into post-democracy.

The recent dispute over the Lisbon Treaty, which ended when I signed it as the last one in Europe, was about whether to go ahead with this – freedom and prosperity endangering – process or whether to interrupt it. Some of us are not happy to be brought back to the centrally organized and controlled world that we got rid of more than 20 years ago.

Mentioning the past, we can say with confidence that as regards our country, the transition from communism to a free society is over, which is by no means a small achievement. We have become a normal – whatever it means – European country and as a consequence of this, we have to solve already standard “European” problems, not the specific problems of a country in transition. This seems to be, however, in many respects a mixed blessing.

In the process of the gradual adjustment of our political, social and economic system to the rules and institutions of the European Union, we imported both its positive as well as its less positive attributes and features. Even though our post-communist era is being characterized by a complete disbelief in the ability of the government to intervene in the economy and by a belief in radical deregulation, liberalization, privatization and desubsidization of the economy, we – with some resistance and reluctance – came to accept the very rigid and demotivating European economic and social system and are – nowadays – confronted with its problems.

We became EU-members in May 2004 because we wanted to participate in the European integration process. We did not want to stay aside, as we were forced to throughout the communist era. However, for many of us in Europe, and especially for those who spent most of their lives in a very authoritative, oppressive and non-functioning communist regime, the undergoing weakening of democracy and free markets on the European continent is an undesirable development.

We witness a gradual shift from liberalizing and removing all kinds of barriers towards a massive introduction of regulation and harmonization from above, towards the ever-expanding, overgenerous welfare system, towards the new and more sophisticated forms of protectionism, towards the continuously growing legal and regulatory burdens on business, towards the markets undermining quasicompetition policies, etc. All of that weakens and restrains freedom, democracy and democratic accountability, not to speak about economic efficiency, entrepreneurship and competitiveness.

It brings me to the recent, only very slowly abating financial and economic crisis. It came as a surprise for most of the economists, for all the politicians, as well as for the public. Almost nobody expected it. The people shared the belief in the omnipotence of central banks and governments to control the macroeconomy and in the feasibility, rationality and productiveness of microeconomic regulation, especially in the financial and banking sectors.

This belief proved to be wrong. The economists have slowly begun to understand the causes of the crisis and finally came to the conclusion that it was a consequence of a combination of failures. Searching for one simple reason was a mistaken strategy. On the macroeconomic side, it becomes more and more accepted that the origin of the crisis was connected with the unprecedented build-up of imbalances in the world economy, with the unusually long period of low real interest rates and of excessive money supply and with political playing with the mortgages. Especially in the United States of America. On the microeconomic side, it became clear that the existing partial and very imperfect regulation did not help. On the contrary, it distorted the rational behavior of banks and other financial institutions and motivated them to look for ways to escape it by means of various “financial innovations”.

It is necessary to warn against the attempts to once again blame problems in the market as problems of the market. The current crisis was not the result of a market failure or of any inherent deficiency of capitalism. It was a government failure, resulting from the immodest ambitions to insensitively intervene in such a complex system as society and economy. Government actions and interventions caused, prolonged, and dramatically worsened the crisis.

The crisis will sooner or later be over. The long term damage, however, will stay. The adversaries of the market have managed to create a far-reaching mistrust in the system, but this time not only in the free market capitalism, in the laissez-faire system, in the capitalism of Adam Smith, Friedrich von Hayek and Milton Friedman, as it was the case 70-80 years ago, but in the highly regulated capitalism of the current era. And this is disturbing.

As a small and highly open economy the Czech Republic could not isolate itself from the visible slowdown of the world economy and particularly from the recession in the countries of our main business partners. Our GDP fell by some 4% in the year 2009.

We were lucky that our banking and financial system had not been overexposed to bad loans before the crisis, which helped and helps. We also have a big advantage in our own currency. The exchange rate of the Czech crown fluctuates; it is not a constant fixed for ever. The small open economies which accepted euro as their currency, or are firmly attached to euro through various rigid monetary arrangements, have been more affected by the current world-wide crisis.

People like me understood very early that the idea of European single currency is a dangerous project which will either bring big economic problems or will lead to undemocratic centralization of Europe. Everyone sees now that the eurozone project has not succeeded in delivering the positive effects that had been rightly or wrongly expected from it. It was mistakenly and irresponsibly presented as an undisputable economic benefit to all the countries willing to give up their own “long treasured” currencies. Extensive studies that were published prior to the launch of the European single currency promised that the euro would help to accelerate economic growth and reduce inflation and stressed, in particular, that the member states of the eurozone would be protected against all kinds of external economic disruptions (the so-called exogenous shocks).

It is quite evident that this has not happened. After the establishment of the eurozone, the economic growth of its member states had even slowed down compared to the previous decades, thus increasing the gap between the rate of growth in the eurozone countries and that in other major economies – such as the United States and China, smaller economies in Southeast Asia and other parts of the developing world, as well as Central and Eastern European countries that are not members of the eurozone.

During its first 10 years, the eurozone has not led to any measurable homogenization of its member states’ economies. The eurozone, which comprises 16 European countries, is not an “optimum currency area” as defined by the economic theory. In such a situation, it is inevitable that the costs of establishing and maintaining it exceed its benefits.

My choice of the words “establishing” and “maintaining” is not accidental. Most economic commentators were satisfied by the ease and apparent inexpensiveness of the first step (the establishment of the common monetary area). This helped to form the impression that everything was fine with this project.

However, over the last decade, the economic performance of the eurozone countries diverged and the negative effects of the “straight-jacket” of a single currency have become more and more visible. When “good weather” (in the economic sense of the word) prevailed, no visible problems arose. Once the crisis (or “bad weather”) arrived, the lack of homogeneity manifested itself very clearly. In that sense, I dare say that – as a project that promised to be of considerable economic benefit to its members – the eurozone failed.

Another issue is the possible collapse of the eurozone as an institution, the demise of the euro. To that question, my answer is no, it will not collapse. So much political capital had been invested in its existence and in its role as a “cement” that binds the EU on its way to supranationality that in the foreseeable future the euro will surely not be abandoned. It will continue to exist, but at a very high price – the low economic growth.

I agree with Yuval Levin[2] who recently stated that we have to reformulate the case for capitalism. He sees that the system is under serious assault by two ruinous trends:

– “by a growing collusion between government and large corporations” and
– “by a welfare state expanding its reach well beyond the needy.”

I agree with him that “the growing collusion of big business and government and the growing middle-class welfare state are expressions of a longstanding distaste for the market economy.” We, in the Czech Republic, based our transition from communism to a free society, to parliamentary democracy and market economy on radical liberalization, deregulation, privatization and desubsidization, on stressing that we are “pro-market” and not “pro-business” and I’m sorry to see that this fight is not yet over. It must be fought again and again. In America, in Europe, in the Czech Republic.

Václav Klaus, The Transatlantic Leaders Forum, Johns Hopkins University, Washington D.C., USA, September 22, 2010

[1] R. D. Irwin, Homewood, Il, 1961. The book was translated into Czech very soon and published under the title “Teorie ekonomické integrace”, Svoboda, Praha, 1966.

[2] Y. Levin, “Recovering the Case for Capitalism”, National Affairs, No. 3, Spring 2010; www.nationalaffairs.com/publications/detail/recovering-the-case-for-capitalism


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