Retrouvez l’enregistrement et le texte de la conférence de Sergeï Guriev intitulée « Political economy of reforms and implications for ethics of liberalism »
The great experiment of post-communist transformation in the last 25 years has produced many important lessons on the drivers of economic and political change and on essential components of functioning liberal democracies. When the Berlin Wall fell and when two years later Soviet Union disintegrated it was clear that the old system was bankrupt, both economically and socially. It seemed that transition to market economy and democratic politics was the only way forward. Some countries have indeed completed this transformation relatively quickly. Others have been progressing at a much slower rate. It was most worrisome, however, that certain countries went in circles and have experienced not only reforms but also reversals of the reforms.
Why were the reforms reversed? The explanation is the political economy of the large-scale institutional change. Even if reforms produce growth, the public will only support them if the benefits of the reforms are shared broadly. What is less obvious is how to achieve this in practice in every specific case. This is especially difficult if the interest groups who stand to lose from the reforms are deeply entrenched. In a country with mature political institutions, the reformers can commit to compensate the losers from the reforms. However, if the modern political system is only being created, there are no commitment mechanisms: the winner takes it all. Therefore those in power understand that once the reforms take power away from them, they will have no guarantees to assure their share in the benefits of the reforms.
What are the political institutions that allow for commitment to broad distribution of economic gains? The major lesson from transition is very simple: these are democratic institutions that make sure that the government is elected by the people and is transparent and accountable to the people. These institutions include political checks and balances, functioning courts, political parties, active civil society, competitive and uncensored media. This sounds like an idealistic view from an undergraduate textbook but the transition experience shows that economic reforms did work better in the countries that managed to develop such political institutions than in non-democracies. In the post-communist region, there is a strong correlation between the degree of democratic development and the social and economic outcomes. The countries that have managed to build a functioning democracy are the ones that have also demonstrated strong economic performance. On the contrary, the countries where autocrats managed to consolidate their regimes have seen the reversals of economic reforms and stagnation.
Twenty five years ago this outcome did not seem pre-determined. At that point, many economists thought that the inevitable pain of economic reforms implied a need for strong leaders who would force the reforms through against the will of majority. Some such leaders emerged. But wherever the reformers did not benefit the majority, these reforms were eventually reversed. And the main lesson was that the mechanism for assuring the “inclusion”, i.e. for sharing the benefits of the reform was the democratic political system. The countries that have built such political systems may have had a slower pace of the reforms but these reforms were widely accepted and therefore irreversible. And vice versa, the countries without inclusive democratic institutions still lag behind in economic terms as well.
There is certainly a very important exception to this rule: China has been able to build checks and balances within the communist party, regular rotation and meritocratic selection without introducing formal democratic institutions. This created the pro-growth incentives at all levels of the bureaucratic hierarchy. There remains a puzzle why these informal institutions have been sustained over almost forty year – and for how much longer the political elites will respect these rules of the game.
The political economy of reforms has major implications for our understanding of liberalism, in particular, that the two definitions of liberalism – the social liberalism and the classical (or economic) liberalism – are much more closely related than we could have thought otherwise. Usually, the classical liberalism emphasizes the importance of freedom. Its economic facet focuses on the benefits of market economy – and this is how liberalism is understood in Europe where liberals belong to the “right” side of the political spectrum. In the US, “liberals” are understood as social liberals who emphasize the value of equality – and therefore belong to the “left”. The twenty five years of post-communist transition have shown that the arguments of European “right” are not at odds with those of the American “left”. Moreover, if economic liberals want to prevent reversing their reforms, they have to take into account the arguments of the social liberals – simply as the market reforms that are not perceived as fair cannot be sustainable.
Definition of fairness is highly culture-specific. Different societies understand fairness in very different ways. Probably, the lower common denominator for fairness is equality of opportunity – the concept that individuals have the same set of opportunities irrespective of circumstances of birth, such as parental background, gender, race, place of birth etc.
No country assures perfect equality of opportunity. Even in North European countries – which are assumed to be successful in combining market economy with social cohesion – family background is an important determinant of opportunity. Moreover, it is not clear that equality of opportunity is even theoretically achievable. Indeed, once we accept that children’s success is an important part of any parent’s utility function, this immediately implies that equalizing children’s opportunities becomes problematic. First, it undermines the parent’s opportunity. Second, equalizing children’s opportunities requires ruling out transmission of wealth and human capital from parents to kids – which is against family values in most modern societies.
Whether equality of opportunity is achievable in practice or in theory, it remains a conventional benchmark for most if not for all countries. Usually, economic liberals support equality of opportunity for two reasons. First, it is very hard to argue against equality of opportunity on ethical grounds. Second, inequality of opportunity is economically inefficient: if certain categories of individuals are denied opportunity because of circumstances of birth, the economic welfare is in general lower than in case each can choose a career that is best for him or her. But political economy of reforms points to a third important reason for economic liberals to support equality of opportunity. The economic reforms that reduce equality of opportunity are eventually politically unsustainable.
Are the pro-market reforms compatible with equality of opportunity? The answer is a qualified yes. In some cases, equality of opportunity even requires markets. For example, if we want to provide similar opportunities to entrepreneurs with and without inherited wealth, the most efficient way to do it is through developed financial markets. Financial markets also provide individuals – irrespective of their initial wealth – from risks (that disproportionally hurt the poor). Access to financial services also makes workers more mobile – and thus protects them from local economic shocks and monopsonistic exploitation.
However, the markets do not always deliver equality of opportunity. There are a number of conditions that the state can fullfil. First, the state has to support basic economic institutions: rule of law, property rights and competition. Second, the state should assure equal access to public goods such as education, healthcare and infrastructure.
Third, the state should provide social safety nets for those whose human capital is hit by market reforms. The issue of social safety nets has become especially important in recent years when the pace of the economic change has become qualitatively different. Previously the change in relative returns to occupations would take decades. Therefore individuals could count on one occupation during their lifetimes – and then possibly encourage their children to choose another, more relevant occupation. Nowadays, we see that economic change has accelerated so that human capital depreciates within one generation’s lifetime. The situations where individuals have to retrain within their lifetimes (or reduce working hours or retire early) have become very common.
These three factors explain why in many cases the liberal pro-market reforms may require more government rather than less government. On the other hand, with all the importance of government intervention to support the market, we still should not forget that government failures are very common. For example, when we advocate the government to address the failure of asymmetric information (e.g. in the financial markets) we should remember that government itself suffer from inherent informational and incentive problems. The view of omnipotent, omniscient and benevolent government is not realistic. Also, government has to be funded, and taxes are distortive. Therefore we should limit government intervention to situations where market failure is clear and where the government can correct the inequality of opportunity. For example, students from poor families should get scholarships and/or subsidized student loans but there is nothing wrong with charging high tuition for those who can afford it.
The solutions are not always obvious. The perception of high risk of reform reversal may prevent the creation of the very institutions that reduce this risk – and therefore create a vicious circle. A typical example is the illegitimate privatization which has taken place in some transition countries. Privatization often creates losers. Most often, before privatization, state owned firms are inefficient and in particular employ excess labor. The privatization therefore raises the efficiency of privatized firm, but the released workers have to be supported by the state (hopefully through the proceeds from privatization sales). If privatization is perceived to be legitimate, the new owners do not fear expropriation and are prepared to pay high price for the privatized assets. Thus the government’s revenues from privatization are high and there are enough funds to compensate those losing from the privatization. If state assets are privatized in a non-transparent way, then the public deems privatization unfair, there is a political support for renationalization. This risk is priced in at the privatization stage hence privatization revenues are low – which adds to the perception that the privatization is unfair.
Another lesson from the reversals of economic and political reforms in transition economies is the importance of media. Reforms are sustainable when they are perceived to be fair. But perceptions may be manipulated. If media are free and competitive, the public is eventually informed about the costs and benefits of the reforms. And this is why various anti-market interest groups are interested in capturing or censoring the media to bias the public’s perceptions. In recent decades we have witnessed the emergence of new business model of media-industry conglomerate: interest groups use media to misinform the public; the misinformation allows them introduce or keep in place policies that generate rents; they use rents to fund media. This model is very stable for two reasons. First, the public may not be even aware of the fact that media are captured. Second, the entry of new, independent media is difficult as the whole media industry is distorted by cross-subsidization by rent-seeking business groups. This model is especially dangerous as it may prevent or reverse reforms that promote both growth and equality of opportunity but run against the vested interests.
Media freedom per se is also not a guarantee against reversals. Even if media are free and competitive, there are still costs for the public to process the information. In many cases, citizens have access to objective information but rationally choose to remain uninformed simply because tracking and digesting all the relevant information is too costly. This implies that populists may have a change even when media are free and democratic institutions are in place. The experience of the transition economies suggests however that the populists dislike checks and balances and media freedom most. Once they get to power, they start with introducing overt or covert censorship and with removing checks and balances.
The saying goes that it is hard not to throw away the baby with dirty bathwater Designing and implementing inclusive liberal reforms that promote markets growth while preserving equality of opportunity is difficult. However, there is no attractive alternative. There are many countries that have no equality and no growth – essentially they manage to throw away the baby without spilling a drop of the dirty water. These are the countries with corrupt and unaccountable governments where investors are scared of expropriation – hence there is no growth, and where success is linked to political connections – hence no equality of opportunity. Finally, there is a communist alternative which is often considered as a model of equality at the cost of low growth. However, communist society also features high inequality it is just it is not the monetary income that matters but the access to ability to spend it on cheap and high quality products. In North Korea, even access to education is officially regulated based on family background. This makes it different from continental Europe where strong democratic institutions assure true equality but slow growth.
Given all the challenges faced by economic liberals, one should not underestimate the successes achieved by pro-market reforms. Despite the reversals and crises in the last few decades, the world economy has been growing at an unprecedented rate allowed hundreds of millions of people to exit poverty. And most of this growth has occurred in countries committed to capitalism. Even in China where state owned enterprises still dominate the economy, the growth came from private and privatized firms.
It may well be the case that global economy will no longer grow at 4-5% per year. However, even if the global growth rate slows down to 3 percent per year, average living standards will double by 2040 with striking implications for eradicating poverty. This should and will be achieved through inclusive market reforms.
fondation Éthique et Économie 