The Problems of a Newly Born Democracy and Market Economy
(Ten Years after the Collapse of Communism)

Václav Klaus

With the benefit of hindsight, with the advantage of already more than ten years´ experience, with all the victories and losses, successes and disappointments, we can make first generalizations about the collapse of communism and the birth of a democratic and free society in the Czech Republic. Let me use this opportunity to say a few words about it.

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.

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.

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