Comparative Economic Studies in Europe: A Thirty Year Review [1st ed.] 9783030482947, 9783030482954

Table of contents :
Front Matter ....Pages i-xxvii
Introduction (Wladimir Andreff)....Pages 1-10
Front Matter ....Pages 11-11
The Political Economy of Socialism Revisited (Hans-Jürgen Wagener)....Pages 13-33
The Development of Thinking on the Czechoslovak Economic Transformation (Martin Myant)....Pages 35-56
The Hard Budget Constraint as the Pillar of the Economy (Michael Keren)....Pages 57-72
Illiberal and “Inward-Looking” Drives: What Fuels Them? (Daniel Daianu)....Pages 73-96
The Political Economy of Sovereign Wealth Funds (Jürgen Jerger)....Pages 97-107
Front Matter ....Pages 109-109
European Higher Education: Challenges and Achievement (Bruno Dallago)....Pages 111-147
Eurozone: Crisis, Policies and Reforms (Enrico Marelli, Marcello Signorelli)....Pages 149-170
Brexit: The Lure of the Neoliberal Thought Collective (Jens Hölscher, Peter Howard-Jones)....Pages 171-189
The Limits of Europe: Lessons from Post-Communist Experience for the Post-Brexit Union (László Csaba)....Pages 191-210
Eurozone Membership and Foreign Direct Investment (Randolph Luca Bruno, Saul Estrin)....Pages 211-226
Multinationals from Post-socialist Countries: How Large Their Foreign Investments Can Be? (Magdolna Sass)....Pages 227-248
Non-Observed Economy vs. Shadow Economy and Informal Employment in Poland: A Range of Mismatching Estimates (Philippe Adair)....Pages 249-278
The Yugoslav Successor States: From Self-Management Socialism to Political Capitalism (Will Bartlett)....Pages 279-296
Is (Post-Communist) China Becoming a Dominant Economic Power in South East Asia? (Desmond Okwor, Johannes Stephan)....Pages 297-319
The Power of Technology in the US and China: A Comparison (Vittorio Valli)....Pages 321-354
Front Matter ....Pages 355-355
Electronic Commerce—Markets, Competition, and Social Welfare: A Clash with History of Economic Thought (David M. Kemme)....Pages 357-376
The Economic Determinants of the Olympic Performance in Communist and Post-Communist Countries (Wladimir Andreff)....Pages 377-412
Introducing Hard Budget Constraints Without Restricting Entrepreneurs: The Role of Voluntary Agreements in UEFA’s Club Licensing and Financial Fair Play Regulations (Egon Franck)....Pages 413-437
Back Matter ....Pages 439-455

Citation preview

STUDIES IN ECONOMIC TRANSITION

COMPARATIVE ECONOMIC STUDIES IN EUROPE A Thirty Year Review

Edited by Wladimir Andreff

Studies in Economic Transition

Series Editors Jens Hölscher The Business School Bournemouth University Bournemouth, Dorset, UK Horst Tomann Department of Economic Policy and Economic History Freie Universitaet (FU) Berlin Berlin, Germany

This series brings together theoretical and empirical studies on the transformation of economic systems and their economic development. The transition from planned to market economies is one of the main areas of applied theory because in this field the most dramatic examples of change and economic dynamics can be found. It is aimed to contribute to the understanding of specific major economic changes as well as to advance the theory of economic development. The implications of economic policy will be a major point of focus.

More information about this series at http://www.palgrave.com/gp/series/14147

Wladimir Andreff Editor

Comparative Economic Studies in Europe A Thirty Year Review

Editor Wladimir Andreff Pantheon-Sorbonne University Paris, France

ISSN 2662-6675 ISSN 2662-6683 (electronic) Studies in Economic Transition ISBN 978-3-030-48294-7 ISBN 978-3-030-48295-4 (eBook) https://doi.org/10.1007/978-3-030-48295-4 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2021 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

In Honour of Horst Brezinski

Contents

Introduction Wladimir Andreff

1

Political Economy in Comparative Studies The Political Economy of Socialism Revisited Hans-Jürgen Wagener The Development of Thinking on the Czechoslovak Economic Transformation Martin Myant

13

35

The Hard Budget Constraint as the Pillar of the Economy Michael Keren

57

Illiberal and “Inward-Looking” Drives: What Fuels Them? Daniel Daianu

73

The Political Economy of Sovereign Wealth Funds Jürgen Jerger

97

vii

viii

CONTENTS

Comparative Economics Still on the Tracks European Higher Education: Challenges and Achievement Bruno Dallago

111

Eurozone: Crisis, Policies and Reforms Enrico Marelli and Marcello Signorelli

149

Brexit: The Lure of the Neoliberal Thought Collective Jens Hölscher and Peter Howard-Jones

171

The Limits of Europe: Lessons from Post-Communist Experience for the Post-Brexit Union László Csaba Eurozone Membership and Foreign Direct Investment Randolph Luca Bruno and Saul Estrin Multinationals from Post-socialist Countries: How Large Their Foreign Investments Can Be? Magdolna Sass Non-Observed Economy vs. Shadow Economy and Informal Employment in Poland: A Range of Mismatching Estimates Philippe Adair

191

211

227

249

The Yugoslav Successor States: From Self-Management Socialism to Political Capitalism Will Bartlett

279

Is (Post-Communist) China Becoming a Dominant Economic Power in South East Asia? Desmond Okwor and Johannes Stephan

297

CONTENTS

The Power of Technology in the US and China: A Comparison Vittorio Valli

ix

321

New Extensions of Comparative Economic Studies Electronic Commerce—Markets, Competition, and Social Welfare: A Clash with History of Economic Thought David M. Kemme

357

The Economic Determinants of the Olympic Performance in Communist and Post-Communist Countries Wladimir Andreff

377

Introducing Hard Budget Constraints Without Restricting Entrepreneurs: The Role of Voluntary Agreements in UEFA’s Club Licensing and Financial Fair Play Regulations Egon Franck Index

413

439

Notes on Contributors

Philippe Adair, Ph.D. in Economics and Ph.D. in Sociology, is the former Dean of the Faculty of Economics and Management, University Paris-Est Créteil. He is a member of the ERUDITE research team and has supervised thirteen PhDs. He taught in Algeria, Djibouti, Morocco, Poland, Tunisia, Ukraine and Vietnam. He specialises in labour economics and financial analysis. His two main research topics are the informal economy and small businesses funding including microfinance in developing/transition and developed countries. His areas of expertise are the EU and North Africa. He records over 100 publications, including chapters in ten books and twenty-five articles in ranked journals. References: Philippe Adair at IDEAS ideas.repec.org/e/pad118.html, Philippe Adair at ResearchGate www.researchgate.net/. Wladimir Andreff Emeritus Professor at the University Paris 1 Panthéon-Sorbonne; President of the Scientific Council at the Observatory of the sports economy, French Ministry of Sports; EACES Honorary Member and former President (1996–1998); 2019 Chellarurai Award of the European Association of Sport Management; Honorary President of the International Association of Sports Economists and of the European Sports Economics Association; former President of the French Economics Association (2007–2008). He has taught in 15 universities abroad (Algiers, Rio de Janeiro, Quebec, Beijing, Moscow, Istanbul, San Marino, Novosibirsk, Tashkent, Prague, Santo Domingo, Ekaterinburg, Sochi, Sao Paulo). He serves as a member of nine editorial boards xi

xii

NOTES ON CONTRIBUTORS

and peer reviews with 25 economic journals. He authored 16 books and 471 articles/book chapters, in 18 languages, and edited 17 books in three research areas: international economics, comparative systems and transition economics, sports economics. Last published book: An Economic Roadmap to the Dark Side of Sport, Palgrave Macmillan 2019; last edited book: Disequilibrium Sports Economics: Competitive Imbalance and Budget Constraints, Edward Elgar 2015. Will Bartlett is Visiting Senior Fellow in the Political Economy of South East Europe at the LSEE Research Unit of the European Institute at the LSE. He is Coordinator of the LSEE Research Network on Social Cohesion in South East Europe. Since December 2018 he is Editor-in-Chief of the peer-reviewed journal Economic Annals, published by the Faculty of Economics at the University of Belgrade. His research has focused on the socio-economic development of the successor states of former Yugoslavia through the perspective of political economy. He is the author of Europe’s Troubled Region: Economic Development, Institutional Reform and Social Welfare in the Western Balkans, Routledge, 2008. He has acted as a consultant for the European Commission, European Training Foundation, the Regional Cooperation Council, UNDP, UNICEF and various bilateral donor organisations. Randolph Luca Bruno is Associate Professor in Economics at University College London, School of Slavonic and East European Studies. His research output has been published into journals such as the Review of Economics and Statistics, Economic Letters, Journal of Common Market Studies, Economic Systems, and he has risen funding from the Department for International Development and Horizon 2020 bodies. He also works as consultant for the World Bank, the European Commission and the UK Government. His research revolves around topics such as the labour market dynamics in Europe, the entry process of new firms (e.g. domestic vs. foreign via FDI) in institutionally weak environments as well as the understanding of the root causes of long-run economic development and innovation technology upgrading trajectories. He has been secretary of the EACES (2014–2016) and he holds visiting positions at the London School of Economics and Political Sciences, at the Università della Svizzera Italiana and at the University of Bari.

NOTES ON CONTRIBUTORS

xiii

László Csaba A distinguished professor of international political economy at Central European University and Corvinus University of Budapest, honorary professor of economics at Szent István University/Gödöll˝ o, Member of the Hungarian Academy of Sciences, between 2012 and 2015 also of the social science section of Science Europe/Brussels, and since 2013, of Academia Europea/London. Author of 13 books and 389 articles and chapters in books published in 22 countries, editor of 6 volumes. In 1998–2000 President of the European Association for Comparative Economic Studies. On the editorial board of 10 international and 7 Hungarian academic journals. His academic work invited 153 reviews and over 1890 independent citations internationally. His recent output includes the book: Válság, gazdaság, világ/Crisis, Economy, Globalization/.Budapest: Éghajlat Kiadó, 2018, and chapters: ‘Liberalization: Waves and Counter-waves in Postcommunist Change’ in: Kollmorgen, J. et al. eds./2019/: Handbook of Political, Social and Economic Transformation, Oxford University Press; and ‘Banking and Fiscal Union in the EU: A Solution or a Trap?’ in: Atkonson, T., et al. eds.: Nationalstaat und Europaeische Union: eine Bestandaufnahme, BadenBaden: Nomos Verlag, 2016, pp. 109–126 and ‘Economic Policy: Path Dependence and Path Creation’ in: Morys, M. ed.: Economic History of Central, Eastern and Southeast Europe from 1800 to the Present London: Routledge, 2020/in print/. For more info cf his personal web: www.csa bal.com. Daniel Daianu Professor of economics at The National School of Political and Administrative Studies in Bucharest; Member of the Romanian Academy, President of the Romanian Fiscal Council, Member of the Board of the National Bank of Romania (2009–2014); Member of the European Parliament (2007–2009); Chairman of the Supervisory Board of Banca Comerciala Romana (2005–2007); Finance Minister of Romania (1997–1998); President of EACES (2002–2004), Member of the Board of Trustees of Friends of Europe; Fellow of CASE (Warsaw); visiting professorships at Berkeley, UCLA, Bologna University. Author of Emerging Europe and the Great Recession, Cambridge Scholars Publishing, 2018; Which Way Goes Capitalism?, CEU Press, 2009; Transformation as A Real Process, Ashgate, 1998; Economic Vitality and Viability. A Dual Challenge for European Security, Peter Lang, 1996; co-editor of The Crisis of the Eurozone and the Future of Europe, Palgrave Macmillan, 2014; with

xiv

NOTES ON CONTRIBUTORS

Radu Vranceanu (ed.), Ethical Boundaries of Capitalism, Ashgate, 2005; with Thanos Veremis (ed.), Balkan Reconstruction, Frank Cass, 2001. Bruno Dallago, Ph.D. is Professor of Economics at the Department of Economics and Management, University of Trento, Italy. He was visiting professor at various universities, including the University of California at Berkeley, USA, the University of North Carolina at Chapel Hill, Hitotsubashi University, Zhejian University, Kyoto University, the University of Pécs, Tshwane University of Technology, Corvinus University of Budapest, Zhejiang University. He was the president of the EACES (1994–1996), and its secretary (1990–1992) and is a member of the International Advisory Board of the Institute of Economics of the Hungarian Academy of Sciences. His research interests include the European Union, comparative economics, the transforming economies of Central and East Europe, SMEs and entrepreneurship, local development. He is the author and editor of several scholarly books and journal articles, including One Currency, Two Europe, World Scientific, 2016, Transformation and Crisis in Central and Eastern Europe: Challenges and Prospects (with Steven Rosefielde), Routledge, 2016, and Entrepreneurship and Local Economic Development: A Comparative Perspective on Entrepreneurs, Universities, and Governments, (edited with E. Tortia), Routledge, 2018. Saul Estrin is a Professor of Management and was the founding Head of the Department of Management at LSE. He was formerly a Professor of Economics, and Faculty Dean, at London Business School (LBS). He also held the Adecco Professorship of Business and Society at LBS and was the Research Director of its Centre for New and Emerging Markets. His research covers a variety of fields in comparative economic systems including the economics of transition, privatisation, foreign direct investment and entrepreneurship. He has published around 150 books and scholarly papers in these areas, in journals such as Quarterly Journal of Economics, Strategic Management Journal, Journal of Economic Literature and Review of Economics and Statistics. In recent years, his research has concentrated on the way that national economic institutions influence the character and extent of entrepreneurship in that country, with papers on the impact of bankruptcy laws, innovation policies, property right and government policies on entrepreneurship, especially high employment growth entrepreneurship. He was from 2014 to 2016 the President of the EACES.

NOTES ON CONTRIBUTORS

xv

Egon Franck is a Professor of Strategic Management and Business Policy at the University of Zurich, Switzerland. He served in different positions inside and outside academia, as a vice president of the University of Zurich (2008–2012), as a member of the UEFA Club Financial Control Panel (2009–2012), as a member of the UEFA Club Financial Control Body (from 2012 onwards) and as the president of the Academic Sports Association Zurich (from 2008 onwards). His current research interests focus on the strategies and governance structures of sports organisations. Jens Hölscher Professor of Economics at Bournemouth University. Before he taught at the Universities of Berlin, Swansea, Birmingham, Chemnitz and Brighton. He held Visiting Professorships at the Universities of Halle (Institute of Economic Research IWH), Perugia, East Europe Institute Regensburg, Danube University, Bonn (ZEI), Bolzano-Bozen, Frankfurt (Viadrina), New Brunswick in Cairo, Almaty (KIMEP and KBTU) and the Centre of Economic Research at the Deutsche Bundesbank. In Bournemouth he acted as Head of Department for over six years and Trustee of the Board of Governors for two years. He is the coeditor of Palgrave’s (Macmillan’s Global Publishing) book series Studies in Economic Transitio”. He was President of the EACES in 2008–2010. Peter Howard-Jones is a post-doctoral visiting fellow at Bournemouth University, having gained a Ph.D. in August 2019 with a thesis entitled ‘The Influence of the Washington Consensus Programme on the Transitional Economies of Eastern Europe—A Firm Level Micro Economic Analysis’. Teaching experience across a range of subjects with positive student feedback referencing an ability to provide a personal historical perspective to theory and contemporary events. A Retired multinational Chairman, CEO and management consultant, skilled in Negotiation, Business Strategy and Planning, Business transformation, Management and Mergers & Acquisitions (M&A). Extensive international experience, particularly in Europe and South East Asia, in the profitable development of both food and non-food multinational fast-moving consumer goods and OEM engineering companies. Jürgen Jerger is Full Professor (Chair for International and Monetary Economics) at the Department of Economics, University of Regensburg since 2002. Previously he held positions at the universities of Freiburg (Germany), Giessen, Erlangen-Nuremberg and Duisburg. As a visiting professor he taught in St Petersburg (Russian Federation) as well as in

xvi

NOTES ON CONTRIBUTORS

Astana and Karaganda (Kazakhstan). He served as the Director of the Institute for East and South European Studies Regensburg—OsteuropaInstitut (2007–2011). Other functions include the position of a Vice President for International Affairs of his university (2012–2013) and Dean of his faculty (2017–2019). His professional tasks and services include the membership on the editorial boards of Economic Systems, Südosteuropa and International Economics and International Economic Policy and— since 2012, on the executive board of EACES. He was the EACES Vice President (2016–2018) and now is its incumbent President (2018–2020). David M. Kemme is Professor and Morris Chair in the Department of Economics at the University of Memphis. https://www.memphis.edu/ economics/faculty/dmkemme.php He received his B.A. in mathematics from Miami University and Ph.D. in economics from The Ohio State University, was a Fulbright Scholar in Poland and has received numerous grants, from IREX, Pew Charitable Trusts, USIA and the US Department of State, inter alia, for research on economies of Eastern Europe and the CIS. His research interests are in international, emerging and transition economics, developmental finance and financial crises, financial economics, macroeconometric modelling and forecasting in transition economies. Recent publications may be found in the Journal of Comparative Economics, Economic Systems, Soviet Studies, Review of Development Economics, International Review of Economics and Finance, Review of International Economics, Journal of International Finance and Money, European Financial Management, and Journal of World Business, inter alia. He is an active member of the European Association of Comparative Economics, other associations and editorial boards, and serves on the Executive Committee of EACES. Michael Keren was born in Germany, since 1933 in Israel. B.A. in Economics and Political Institutions (Keele University, UK); M.A. in Development Economics (Williams College, MA, USA); Ph.D. in Economics (Yale University). Since 1966 at Department of Economics, Hebrew University, Jerusalem. Research interests: Economics of bureaucracy: incentives, structure and efficacy. Comparative economic systems and planning theory. Transition to the market in Eastern Europe. Enrico Marelli is Full Professor of Economic Policy at the University of Brescia (Italy). He studied, taught and carried out research at Bocconi University (Milan, Italy), London School of Economics (U.K.),

NOTES ON CONTRIBUTORS

xvii

University of Pennsylvania (USA). Previously Full Professor of Economic Policy at the Universities of Trieste and Cagliari (Italy). Visiting periods at the University of Strathclyde (Glasgow), Hitotsubashi University (Tokyo), Universitatea de Vest din Timisoara (Romania), Higher School of Economics (Moscow). Executive committee member of EACES in 2010–2012. Key research interests: comparative economics, European economic integration and policies, economic policy, labour economics, regional economics. Among the recent publications: Europe and the Euro. Integration, Crisis and Policies, co-authored with M. Signorelli, Palgrave, 2017. Martin Myant is Professor Emeritus at the University of the West of Scotland, UK, and Associate Researcher at the European Trade Union Institute in Brussels where he was formerly head of the research unit on European Economic, Employment and Social Policy. He was a member of the EACES Executive Board (2008–2020). He has been researching the economic and political development and recent history of east-central Europe for many years with a primary focus on the Czech Republic. His publications include Transition Economies: Political Economy in Russia, Eastern Europe, and Central Asia (with Jan Drahokoupil), Wiley-Blackwell, 2011. Desmond Okwor studied International Business in Developing and Emerging Markets at TU Bergakademie Freiberg and International Project Management at University Paris-Est Créteil. He secured his doctorate in the field of Development Economics in 2019 from the TU Bergakademie Freiberg on micro-insurance in Sub-Saharan Africa with a particular focus on the conditions for such an institution in his home country Nigeria. Even before he completed his doctorate, he was appointed senior project manager with the Graduate and Research Academy of the Freiberg University, where his tasks include setting up a structural doctoral programme and the mentoring of doctoral students in terms of methodology. He has continuously been teaching in the fields of International Business, Economic Development and Applied Econometrics. Magdolna Sass is senior research fellow at Centre for Economic and Regional Studies, Institute of Economics, Budapest, since 1996. Her areas of expertise are foreign direct investment and internationalisation of firms. She has been involved in several research projects on European,

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national and regional levels. She has published more than 180 papers, including in Eastern European Economics, Post-Communist Economies, Europe-Asia Studies, European Planning Studies, European Urban and Regional Studies, Review of Managerial Science and Acta Oeconomica. She is member of the editorial board of Post-Communist Economies and Croatian Economic Survey. She was president of EACES (2016–2018). Marcello Signorelli is Full Professor of Economic Policy and President of the Teaching Council at the Department of Economics of the University of Perugia (Italy), and member of the Presidency Council of the Italian Economic Association. He was EACES President in 2010–2012 (and, before, Vice President and Secretary). He organised the first world congress of comparative economics in Rome 2015. At the University of Siena he graduated in Economics, obtained a two-year specialisation Diploma in Banking Disciplines and a Ph.D. in Economics and Agricultural Policy; while at the University of Warwick and University of Florence he obtained a European Master in Labour Sciences. He spent short or longer periods for research and/or teaching activities in several Universities like Columbia University, University of Warwick, University of Sassari, University College of London, Hitotsubashi University of Tokyo, NRUHSE of Moscow and St. Petersburg. He published numerous articles in international journals and some books of which Europe and the Euro. Integration, Crisis and Policies co-authored with E. Marelli, Palgrave, 2017. Johannes Stephan Professor at the TU Bergakademie Freiberg since 2013. His main fields of research evolve around the central theme of conditions of economic development, with particular foci on systemic transformation, on monetary policies and exchange rate arrangements, on the role of foreign direct investment for technology transfer and spillovers, and on the role of natural resources for economic development. He studied at the FU Berlin between 1988 and 1994, was awarded his Ph.D. from the University of Birmingham in 1997, and habilitated in Freiberg in the year of 2012. He started his career at the Halle Institute of Economic Research, where he left in 2009 as head of department for industrial organisation and regulation. He has secured funding for several research projects, among which three international research projects are in the EU’s framework programmes.

NOTES ON CONTRIBUTORS

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Vittorio Valli is Professor emeritus of Economic Policy at the University of Turin. He taught at the University Bocconi in Milan, at the Universities of Padua and Turin and was visiting professor at the Institute of Economic Research at Kyoto University, Nice University and Seoul National University. He was visiting scholar at Brown University and at the University of California (Berkeley). He was the first president of the Italian Association for the Study of Comparative Economic Systems (AISSEC) and of the European Association of Comparative Economic Studies—EACES (1990–1992). He is the vice president of the ‘Osservatorio sulle economie emergenti’ of Turin (OOET). His latest books are: The Economic Rise of China and India (2015), Accademia University Press; The Economic Rise of Asia: Japan, Indonesia and South Korea (2017), Accademia University Press (2017); The American Economy from Roosevelt to Trump (2018), Palgrave Macmillan. His personal site is https://www.vittoriovalli.eu. Hans-Jürgen Wagener is Emeritus Professor of economics at Europa Universität Viadrina Frankfurt (Oder). Born in 1941 he graduated from Munich University. After a spell as researcher at Osteuropa-Institut Munich and the Vienna Institute for International Economic Comparisons he became Professor of economics at Rijksuniversiteit Groningen, The Netherlands, in 1975. In 1993 he moved to Europa Universität Viadrina where he founded the Frankfurt Institute for Transformation Studies. He was President of EACES in 1992–1994. Main fields of research are comparative economic systems, transformation studies, European integration and history of economic thought.

List of Figures

The Hard Budget Constraint as the Pillar of the Economy Fig. 1

Transition countries, GDP per capita, 1989–2004 (Source IMF, World Economic Outlook, September 2006. Missing data for 1989–1992 or 1993 are supplemented from UN sources)

67

Illiberal and “Inward-Looking” Drives: What Fuels Them? Fig. 1

The relation between protection and economic openness

93

The Political Economy of Sovereign Wealth Funds Fig. 1

Conditions for revolution under different institutional arrangements

105

European Higher Education: Challenges and Achievement Fig. 1

Tertiary educational attainment, by country, 2000 and 2018 (% of the population aged 25–34, 25–64 and 55–64) (Source Elaboration on Eurostat database [https://ec.europa.eu/ eurostat/tgm/table.do?tab=table&init=1&language=en& pcode=sdg_04_20&plugin=1])

135

xxi

xxii Fig. 2

Fig. 3

Fig. 4

Fig. 5

LIST OF FIGURES

Annual expenditure on public educational institutions per student at tertiary level of education (ISCED 2011), 2016 (Notes *2014, **2015, ***Private government dependant institutions. Source Eurostat database) Gross domestic expenditure on R&D, by sectors of performance, by country, 2018 (% of GDP) (Note Public sector includes Government sector, Higher education sector, and Private non-profit sector. Source Eurostat database [retrieved 24 March 2020]) Researchers (right axis) and scientific output related to R&D personnel (left axis), 2016 (Source Elaborations on data from World Development Indicators, World Bank) H index score and rank, 2019 (Source Elaborations on data from https://knoema.com)

136

138

139 139

Eurozone: Crisis, Policies and Reforms Fig. 1

Official interest rate: ECB vs. FED (January 1999–December 2019) (Source ECB and FED)

158

Brexit: The Lure of the Neoliberal Thought Collective Fig. 1 Fig. 2 Fig. 3 Fig. 4 Fig. 5

UK exports and MNE’s sales in EU (Source Authors from Theurer et al. 2018) UK imports from the EU and affiliate sales in the UK (Source Authors from Theurer et al. 2018) Share of EU inputs into UK and UK inputs into EU (Source Authors from Theurer et al. 2018) Product regulations (Source OECD) Labour regulations (Source OECD)

176 177 177 178 180

Multinationals from Post-socialist Countries: How Large Their Foreign Investments Can Be? Fig. 1

FDI stock as a % of GDP (2017) (Source OECD [https:// data.oecd.org/fdi/fdi-stocks.htm])

234

LIST OF FIGURES

Fig. 2

Fig. 3

Sums of outward FDI stock to the selected countries and sums of mirror statistics on inward FDI of selected countries, coming from the analysed country (million USD), 2017 (Note Selected countries: Austria, Czech Republic, Estonia, Finland, France, Germany, Hungary, Iceland, Italy, Poland, Slovenia, Turkey, USA [those, which publish BMD4 FDI data according to the nationality of the ultimate controlling owners], without round tripping. Source Own calculations based on OECD BMD4 data) Comparison of “own” and “mirror” statistics on outward FDI from the analysed countries, million USD, 2017 (Source Own calculations based on OECD BMD4 data)

xxiii

238

241

Non-Observed Economy vs. Shadow Economy and Informal Employment in Poland: A Range of Mismatching Estimates Fig. 1

NOE categories and types (Source UNECE [2003], Eurostat [2014])

252

Is (Post-Communist) China Becoming a Dominant Economic Power in South East Asia? Fig. 1 Fig. 2 Fig. 3

Examples of actual trade with China falling short of predicted values (in natural logs of trade data at current prices) Examples of actual trade with China exceeding predicted values (in natural logs of trade data at current prices) Vietnam: actual trade with China catching up to predicted values (in natural logs of trade data at current prices)

312 313 314

Introducing Hard Budget Constraints Without Restricting Entrepreneurs: The Role of Voluntary Agreements in UEFA’s Club Licensing and Financial Fair Play Regulations Fig. 1 Fig. 2 Fig. 3

Aggregate European top-division operating profits (Source UEFA [2019, p. 93]) Aggregate European top-division net results (Source UEFA [2019, p. 94]) Evolution in European top-division club net equity (assets less liabilities) (Source UEFA [2019, p. 116])

417 417 418

List of Tables

The Hard Budget Constraint as the Pillar of the Economy Table 1 Table 2

Governance indices in selected countries Corruption perceptions, selected counries, 2012–2018

65 66

The Political Economy of Sovereign Wealth Funds Table 1

Top 10 Sovereign Wealth Funds (by total assets)

98

European Higher Education: Challenges and Achievement Table 1 Table 2 Table 3 Table 4

Shares (%) of revenues for a sample of European universities, 2006 Public funding allocation mechanisms in European countries Overview of indicators used in funding formulae Public funding to universities and GDP growth

125 126 127 130

Eurozone: Crisis, Policies and Reforms Table 1 Table 2 Table 3 Table 4 Table 5

GDP growth rate (2007–2019) in selected countries Current account balance to GDP (2000–2019) in selected countries Unemployment rate (2007–2019) in selected countries Public deficit to GDP (2007–2019) in selected countries Public debt to GDP (2007–2019) in selected countries

152 154 156 161 162

xxv

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LIST OF TABLES

Table 6 Table 7

Public investment to GDP in per cent (2007–2019) in selected countries National (or “regional”) GDP to world GDP (in PPP)

162 168

Eurozone Membership and Foreign Direct Investment Table 1

Estimation of the gravity equation

220

Multinationals from Post-socialist Countries: How Large Their Foreign Investments Can Be? Table 1 Table 2

Table 3

Table 4

Outward FDI from the analysed countries (million EUR and EUR), 2017 Top 10 host countries of Visegrad outward OFDI from the Visegrad countries and their shares in total outward OFDI in %, 2017 Top 10 host countries of outward OFDI from the Baltic countries and Slovenia and their shares in total outward OFDI in %, 2017 Correlations between “own” and “mirror” FDI statistics, 2017

235

235

236 243

Non-Observed Economy vs. Shadow Economy and Informal Employment in Poland: A Range of Mismatching Estimates Table 1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7 Table 8

Undeclared work and the shadow economy in Poland: a range of mismatching estimates Expenditure on non-declared goods and services and undeclared work in Poland (2007 and 2013) Self-employment as percentage of non-agricultural employment Various estimates of the percentage of informal wage employment in Poland Share (%) of NOE/SE in GDP: Poland Tax gaps in the EU transition countries (% of GDP) Trends in the size of the shadow economy (% of GDP): Poland Benchmarking macro-estimates and coverage of NOE/SE in Poland (2013)

255 256 257 259 261 263 269 271

LIST OF TABLES

xxvii

Is (Post-Communist) China Becoming a Dominant Economic Power in South East Asia? Table 1

Gravity models of bilateral trade in South East Asia

308

The Power of Technology in the US and China: A Comparison Table 1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7 Table 8 Table 9 Table 10

US and China: selected economic indicators OECD-PISA test values and rankings (a) Selected employment, research, and technology indicators in the US and China Sectoral percentages of employment in the US and China (2000–2018) Employment and GDP by main sectors of activities in China (1978–2018) Production of passenger cars and commercial vehicles in the US and China (million) Selected growth indicators in the US and China. 1978–2018 annual average % growth rates Physical output in selected industrial and services sectors in China Indicators on China’s international trade and FDI stocks: 1982–2018 (current billion US$, or % of GDP) Selected energy indicators in the US and China in 2018

322 325 328 333 334 335 340 342 344 350

The Economic Determinants of the Olympic Performance in Communist and Post-Communist Countries Table 1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7

Communist (post-communist) countries: Medal totals at Summer Olympics Communist and post-communist countries: Medal totals at the Winter Olympics Distribution of Olympic medal totals and economic development Tobit estimation of medal wins at the Olympics Tobit estimations of medals won at Winter Olympics Disqualifications of Summer Olympics medallists per nation, 1992–2016 Medal win distribution at the 2014 Sochi Winter Games

381 383 385 399 402 406 407

Introduction Wladimir Andreff

Since 1990, EACES has organised 15 biannual conferences, the last one held in Warsaw, 6–8 September, 2018. The 16th biannual conference will be held in Naples, in September 2021 on “Thirty Years after the Fall of the Iron Curtain: Transition and Convergence”. EACES has also organised many workshops, and a biannual rotation, through elections, of its President and Executive Committee members. However, one member has stayed in the Managing Board (being re-elected nine times in a row) for 18 years, from 1992 to 2010: he was the EACES Treasurer, Professor Horst Brezinski. His name is definitely and tightly associated with the EACES history and development and all members are grateful to his efficiency and good-heartedness over all his long service time. Horst Brezinski was a student at the Universities of Kiel and Göttingen, then he passed his PhD dissertation at the University of Paderborn in 1978, and his Habilitation in the same university in 1992. As a consequence, he was appointed as a full professor at the “TU Bergakademie Freiberg” University where he served as the Dean of

W. Andreff (B) Pantheon-Sorbonne University, Paris, France e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_1

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the Economics Faculty, 1994–1996, and a Vice-rector of the University, 1997–2006. In 2013, Horst Brezinski has moved to the Poznan University of Sciences wherefrom he retires this year. The present volume is an opportunity to celebrate by the same token Horst Brezinski’s prestigious academic carrier, his retirement, his service with the EACES, and his scientific achievements. His publications were first focused on the former Soviet-type economies, then on their transformation into market economies (privatisation, new international integration, the microeconomics of transition) and, more recently, on the provision of international public goods and international climate protection. In 1990, EACES was founded with the general scientific purpose to initiate and co-ordinate international collaboration designed to assist the advancement of theoretical and applied knowledge in the field of comparative economic studies in Europe and elsewhere. Practically, at that time a major research focus of many members-researchers was, though not exclusively, on the collapse of the former Soviet economic system and the first steps of its post-communist transformation; this was partly due to the fact that about 40% of its members were from Eastern Europe and the Soviet Union. As it can be checked in reading the 90 EACES Newsletters published so far, so-called transition economies remained the core research topic for two decades or so. However, during the past decade, EACES members’ researches increasingly diversified towards new topics and different geo-political and economic areas, a new trend which came alongside a deeper cooperation with other international (non-European) associations for comparative economic studies. The present volume in a sense is exemplary of the aforementioned evolution with more papers on economic issues regarding EU countries than transition economies properly speaking, more interest for China and South East Asia than Russia, and some brand new topics in comparative studies such as the digital economy and sports economics. The sample of chapters gathered here is rather representative since most are authored by former or incumbent EACES Presidents and Executive Committee members, the rest by Horst Brezinski’s former collaborators or close colleagues. The volume reads as follows. Since comparative economic studies were always fuelled through some channels by political economy and nonmainstream economics, a Part I (Chapters 2 to 6) is devoted to what remains of such political economy approach thirty years after. Part II

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(Chapters 7 to 16) exemplifies that, though more diversified across countries and economic issues, the typical comparative economics analysis is still alive and in a good shape. Part III (Chapters 17 to 19) provides three examples of how comparative economic studies can be extended to actually new topics and areas. Hans-Jürgen Wagener (Chapter 2) revisits the political economy of socialism, its evolution and contradictions. First, its former research programme is confronted to the one of (mathematical) economics. As a historical science, it has little to say about how to run this system. This doctrinal body of the Stalinist economic system emerged in the early 1950s though its roots can be traced back to the 1930s in the Soviet Union under Stalin’s supervision, including the discussion about the status of economic laws (welfare maximisation, the balanced proportionate development of the economy, the law of value) in a socialist system. Commodities and the law of value haunted socialist political economy and opposed tovarniki and ne-tovarniki in the Soviet Union advocating two different models of a socialist economy with regards to the consequences of the law of value in terms of allocation and distribution—directive central planning with mathematical optimisation versus decentralisation, self-managed firms and parametric forms of central planning. Martin Myant (Chapter 3) shows how much past economic thinking and debates, as they developed since the 1960s’ reforms, have influenced the Czechoslovak path of economic transformation. The post1968 normalisation created dividing lines across Czechoslovak pro-reform economists as well as between an old generation and a younger middle generation around Vaclav Klaus. Economic thinking in Czechoslovakia right before the collapse of the Soviet system was also impacted by Gorbachev’s measures in the Soviet Union and resulting new mood. Comparisons with Hungary and Poland show similar attractions for the ideas of Mises and Hayek, but also a developing recognition in those countries that their critique of socialism was not enough for a reform strategy, and help understand why the three paths of economic transformation eventually have been different. The slower pace of pre1989 economic change and political liberalisation in Czechoslovakia and restricted scope for debate and discussion helped those economists who believed that the fastest possible privatisation would be possible to triumph politically.

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In Chapter 4, Michael Keren contends that the state, as the agent that defines and protects property and contract, has a key role in the economy and must not be left out of the analysis. An important lesson of transition is the major effect of the hardness of the budget constraint on the process, the resulting economy, and the state. Without a state strong enough the firms’ and other organisations’ budget constraint—a concept due to Janos Kornaï–cannot be hardened as it is required in a well-functioning market economy. To be hard, the budget constraint needs protection and here the state’s vital role manifests in extreme differences in the success of transition in countries of very similar socialist economic structure, though with different historical past: contrasting Eastern Europe versus the former Soviet Union. Daniel Daianu (Chapter 5) points at the evidence of mounting illiberal inclinations in the industrialised world and democratic societies with an “inward-looking” syndrome of rising nationalism taking place as well. Contending that democracy has a liberal core but can also be driven by illiberal components, he suggests an interpretation in terms of new threats, disruptions, and failed public policies. The latter is applied to the relationships between markets and liberalism, to new trends (insecurity, new technologies, social fragmentation, intolerance, immigration) which fuel illiberal propensities nowadays, the weakening legitimacy and democratic accountability of the European Union, the former Single Market rationale, unethical behaviours of the business elites and immigration in Europe. The chapter ends up with policy recommendations to keep citizens and elites in line with not losing trust in democratic values. Chapter 6 by Jürgen Jerger exemplifies the new modelling approach to political economy with the case of Sovereign Wealth Funds (SWF). It is observed that the use of SWF is much more common in countries with autocratic political regimes. The theoretical (mathematical) model shows that a SWF is a means to stabilise autocratic regimes. Ruling elite might have an incentive to put part of their income into such an investment vehicle because a SWF gives it credibility with respect to their future decision on redistribution to the poor. Such credibility is crucial since it helps to prevent the poor from staging a revolution. With Chapter 7 starts up a series of chapters regarding the European Union (EU), including the last member countries which joined it. Bruno Dallago presents universities as a support to EU integration, with particular concern for a unified labour market, in a context of greater international competition among economies and fiscal crises in many

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European states. European higher education institutions strengthen the value of their education and knowledge output while reinforcing their economic basis in line with European Commission and national governments strategies implementing the necessary reforms. The fundamental component of this approach is the so-called Bologna Process which aims at ensuring comparability in the standards and quality of higher education qualifications among European countries. The outcome of these processes has been important, but much remains to be done. The chapter critically analyses the evolution of the European higher education and research system within this frame with a view to the goals pursued, the results achieved and the challenges ahead. Enrico Marelli and Marcello Signorelli (Chapter 8) review the recent economic situation, trends and perspectives of the Eurozone, and tackle the issues resulting for the Eurozone from the financial crisis and Great Recession followed with a so-called Eurozone sovereign debt crisis, even worsened by wrong or delayed economic policies, i.e. the monetary policy by the European Central Bank, progressively more accommodative over time and austerity fiscal policies. Such policies improved the financial situation though without alleviating either economic disparities across Eurozone countries or social and political problems. The chapter discusses those policies adopted in the Eurozone, and emphasises their limits, as well as key reforms required for guaranteeing euro survival in the long run. In particular, the authors contend that previous austerity policies should be replaced with supporting aggregate demand through public investments, namely a European investment plan, to make more robust the economic recovery and improve the social condition, severely deteriorated because of the long crisis. The subsequent improvement of the economic and social situation will also make more feasible the adoption of institutional reforms, necessary to guarantee the continued existence of the euro in the long run. In Chapter 9, Jens Hölscher and Peter Howard-Jones attempt a preliminary economic assessment of Brexit based on contrasting the agenda of the neoliberal wing of the Conservative party with a competing left wing ideology. The former agenda relies on continuation of laissez faire, migration control, increasing inequality, a low tax low wage economy, stagnating income and deteriorating public services while the latter ideology supports the nationalisation of the utilities and the railway system, the regulation of capital, necessitating some element of control

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to prevent flight, the deregulation of labour, increased taxation, particularly on corporations to repair the damage to infrastructure and public services and provisions enacted to improve wealth distribution. Between these two standpoints, the authors consider the economic effects of Brexit on the UK’s foreign trade, foreign direct investment, prices and pound exchange rate, migration and employment, fiscal pressure and debt and UK financial services. They conclude that the economic case for leaving the EU has not been made yet. Laslo Csaba (Chapter 10) assesses how much accession to the EU provided a safe haven to post-communist transformation. From a quantitative standpoint, a considerable degree of convergence is witnessed, especially in Central European countries. Despite improved performance, in Hungary Euro-scepticism has been elevated to the level of governmental policies for a decade by now. It is contended that Hungarian and European interests tend to overlap. Common rules and procedures yielded more transparent, more efficient arrangements than the purely local ones, from monetary policy to environmental protection. The new leadership since 2010 raised an antagonistic line against the EU burdened by crisis management, later by adjusting Fiscal and Banking Union with the European Central Bank providing unlimited amounts of liquidity. Hungarian leadership has used this window of opportunity to construct something brand new in terms of a political regime. Though Brexit is a single event so far, what is observed in Hungary is likely to be a case to be generalised: more rather than less Euro-scepticism. In Chapter 11, Randolph Bruno and Saul Estrin estimate the effects of European Monetary Union (EMU) membership on foreign direct investment (FDI), going beyond previous literature on the cross-border impact of a common currency that has concentrated on international trade effects. The gravity model is used for explaining bilateral cross-border FDI flows of 34 OECD countries between 1985 and 2013. A variety of econometric techniques ensures the robustness of the results found for both FDI flows and stocks. The estimated impact of EMU membership on FDI is estimated to be significant and positive, at around 130% which underlines the role of FDI as a channel for benefits from deep economic integration between countries. Magdolna Sass (Chapter 12) first stresses that we do not have a clear picture about the real extent and size of outward FDI realised by indigenous firms from post-socialist countries. This is due to balance of payments data that aggregate outward FDI realised by resident firms,

INTRODUCTION

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mixing up transactions by locally owned or controlled firms and foreignowned or controlled firms, subsidiaries of foreign multinational companies, which operate in a given country. A new methodology is adopted, based on mirror data of major partner countries hosting outward FDI, which helps tracing the ultimate controlling owner of the investment and thus the real origin of FDI. A clearer picture of outward FDI is provided for eight post-socialist countries. Outward FDI stock controlled by Czech and Slovak firms ultimately is larger than what is presented as outward FDI data from the Czech Republic and Slovakia, and to a lesser extent Latvia and Lithuania. Estonia, Hungary, Poland and Slovenia act as intermediary countries for FDI: local subsidiaries of foreign multinationals represent a substantial share of total outward FDI and indigenous multinationals hold a smaller share of total outward FDI. Chapter 13 by Philippe Adair is about the different metrics that can be used to estimate the non-observed economy (NOE) as against the shadow economy (SE) which exhibits large discrepancies throughout the EU transition countries, and then each methodology is implemented in the case of Poland. Direct measurement from tax audits, household informal expenditure, labour force surveys and Eurobarometers provide piecemeal estimates. Indirect measurement from cross-section analyses is drawn from discrepancies on the market for goods and services, the money market and the labour market. Other macro measurements provide time-series estimates based on electricity consumption and structural modelling of multiple indicators—multiple causes (MIMIC). Finally, the chapter addresses the gap in NOE/SE estimates from national accounts adjustments vs. MIMIC. Will Bartlett (Chapter 14) argues that in some of the successor states of former Yugoslavia an economic system of political capitalism has replaced the former economic system of socialist self-management. The case study approach emphasises the importance of interlinkages between the political and economic aspects of transition where political capitalism is identified as a distinct economic system which embodies strong mutual inter-connections between political and managerial elites fitting well the legacy of self-managed socialism. In Croatia, the commanding heights of the economy were captured during the wars of the 1990s by new elites of returning emigres and managers without strong connections to the former communist party. In Serbia, the old elites were reproduced under the period of sanctions, sanctions-busting and the development of organised crime networks. In both variants the ruling political elite

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dominate the economy, extracting quasi-rents and undermining productivity and economic growth. In contrast, Slovenia which became an EU member state in 2004 developed a form of coordinated market economy emerging from the old self-management system. These examples suggest that political capitalism is not a natural consequence of the transition from self-management, but rather a consequence mediated by the effect of war, conflict, and sanctions. In Chapter 15, Desmond Okwor and Johannes Stephan pick-up the question of whether the old communist idea embedded in China’s regime will evolve to dominate the capitalist system in the long run. Though China is successfully catching up and has gained considerable economic weight globally, it is also an emerging power in its own region of South East Asia. To check whether China is going to dominate its regional neighbouring economies, the authors use a gravity model applied on bilateral trade between China and its South East Asian partners. The assumed future role of China in its own backyard region is not yet identifiable through analysis of trade data. Vittorio Valli (Chapter 16) compares the US and China’s economies assuming that technology is a key factor for economic development and economic power. He assesses the sources and impact of technological power and its changes in both countries from 2000 to 2018. Empirical analysis screens data as regards capital accumulation, education, R&D activities, learning by doing processes, industrialisation and deindustrialisation, structural change and the different stages of the Fordist model of development as well as resulting international trade, the relationships between military and civilian production, environment and the emergence of the “green economy”. All factors both explain why at present the United States is the top world technological power and why China has been rapidly catching up. Though in some niches or sub-sectors China has already exceeded, or will soon exceed, the United States, given the larger demographic and industrial size and a still higher economic momentum. David Kemme (Chapter 17) provides a first example of new areas that could benefit from comparative economic studies in the future with the analysis of electronic commerce in the double perspective of comparing it with terrestrial commerce and with theoretical economic expectations. First is raised the issue of endogenous preferences and the role of (terrestrial) markets as an institution influencing culture, tastes preferences, values and interpersonal relationships in new and sometimes unpredictable

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ways. Further digital markets provide massive amounts of information for consumers and producers, but that information may be asymmetric and create market power on either side of the transaction. Then electronic commerce opens questions about the evolving market structure, market power, market efficiency and the distribution of the gains of trade. In the past, central planning was thought to be an alternative to markets in determining production and consumption opportunities, but as a practical matter failed due to the information requirements. The socialist theoretical controversy about centrally planned socialism is revisited in a way that questions whether or not modern information systems would have made a difference in the functioning of the planning system in the former Soviet Union, or in a resurrected planned economy, or planned society. Today information is available and may be utilised by private entities, government entities, or even machines to influence or control the production and allocation of labour, goods and services, and thereby social norms as well. Whether the Internet will be enslaving, or liberating remains an open question. Chapter 18 by Wladimir Andreff extends the area of comparative studies to sports economics. The author reminds us the statist model of sport in communist countries and its overshooting Olympic performance. Reforms and the Soviet system’s final collapse eventually left room for a market compatible sport system during the post-communist economic transformation. All these changes affected Olympic performance downwards. Econometric modelling explains all nations’ medal totals at Summer Olympics and the outlier (over-performing) situation of sampled communist then post-communist nations. A similar model adapted to Winter Games again provides a statistically significant explanation of how medal totals have evolved in the same set of communist and post-communist countries. Used for forecasting, these models enable checking the impact of doping on Olympic performance. In this respect, the 2014 Sochi Winter Olympics provide a natural experiment of doping when comparing, for the Russian winter Olympic team, medals forecast with medals total actually won at the Games before and after Russian athletes’ disqualification. Egon Franck (Chapter 19) starts from Kornaï’s soft budget constraint phenomenon to analyse European professional club football to which UEFA responded with introducing a Club Licensing and Financial Fair Play Regulations. A Break-Even Requirement and a Fair Market Value Principle were the main elements of these regulations. In 2015 a new

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concept of Voluntary Agreements was added. The author contends that the latter makes the Financial Fair Play less vulnerable to the criticism that it discriminates against true entrepreneurs wishing to develop mismanaged football clubs into sustainable businesses. Voluntary Agreements give such entrepreneurs more flexibility to invest, which would be of particular importance in environments where quality is only slowly remunerated by the football markets. The fact that not a single Voluntary Agreement has been signed until January 2020 is hard to reconcile with the allegation of discrimination. In addition, in different chapters of this book the reader will find some avenues for further research. Hope this will make the EACES still alive over the next thirty years and, no doubt, comparative economic studies for ever.

Political Economy in Comparative Studies

The Political Economy of Socialism Revisited Hans-Jürgen Wagener

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Introduction

Marxist–Leninist political economy was a master science under communism. Its contents were unquestionable truths. Its study was obligatory at school and university. Hundreds of able scholars were busy in the field. The print run of textbooks was counted in hundreds of thousands. Yet when the political regime of communism collapsed in the Soviet Union and Eastern Europe, the industry of Marxist–Leninist political economy collapsed as well and the subject fell into total oblivion. Nevertheless, the history of the socialist economic system cannot be fully understood without the history of its political economy. Marxist–Leninist political economy deals with three historical modes of production, the pre-capitalist, the capitalist, and the socialist. The first two have been treated in depth by Marx and Engels and then by Lenin. The political economy of capitalism can only be an elaboration of their infallible insights. On the other side, Marx and Engels had been rather reticent about the political economy of socialism and also Lenin was not very outspoken. It was even disputed whether such thing did exist at all. Stalin

H.-J. Wagener (B) European University Viadrina, Frankfurt (Oder), Germany e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_2

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ordered in 1937 an authoritative textbook on political economy that only after long discussions among the authors and with him personally came off the press in 1954, a year after his death. Political economy, as it was taught in post-war Eastern Europe, was a Soviet undertaking. It complemented the Soviet-type economy that was imposed throughout the region by the Soviet hegemon. Only when attempts at system reform were ventured in Eastern Europe in the late 1950s and the 1960s did economic thinking enter new paths and some new national textbooks got published (for instance Lange [1959]1963 in Poland and Politische Ökonomie 1969 in East Germany). After a while political economy of socialism dissolved into the economic analysis of the planned economy in Poland and Hungary, East Germany returned to Soviet textbook orthodoxy. So did Czechoslovakia after the choking of the Prague Spring in 1968 (see Wagener 1998; Chavance 2000). In contrast to mathematical economics, political economy has attracted little attention in the West. Only French scholars have done some serious work on it (for instance Chavance 1980; Lavigne 1985). In the following section we will address Marxist–Leninist political economy and (mathematical) economics as two different research programs. Section 3 deals with the hesitant emergence of the political economy of socialism. Section 4 asks the question “power or economic law?” Section 5 will explain what is meant by economic laws of socialism. The most disputed issue was Marx’s law of value: is it valid under socialism or not? Section 6 deals with this question. Section 7 presents a brief conclusion.

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Political Economy and Economics

The term “political economy,” originating from the early seventeenth century, has covered different subject matters changing with the problems and topics that were analyzed under this heading. When Karl Marx ([1859]1999) wrote his Critique of Political Economy, he started from production, distribution, exchange, and consumption, but made quite clear that he meant to put them in their social-historical context. In particular, they had to be put into the context of “civil society”’ the intermediary social stratum introduced by Hegel ([1821]1999; §§ 182– 256) between the family (household) and the state (oikos and polis ). Thus political economy is not an amalgam of politeia and oikonomia, but the analysis of the relations which have developed in-between, namely of civil

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society. In his review of Marx’s book Engels ([1859]1999) wrote: “Political economy is the theoretical analysis of modern bourgeois society and therefore presupposes developed bourgeois conditions”. From here start the Marxist–Leninist understanding of political economy and also the disputes about its proper meaning. While political economy with Marx and Engels has two objectives, the analysis of production, distribution, exchange, and consumption and the analysis of their socio-historic conditions and implications, Lenin ([1899]1964) confined the definition to the sociological approach: “It is not with ‘production’ that political economy deals, but with the social relations of men in production, with the social system of production.” This definition is quoted approvingly in the 3rd edition of the authoritative Soviet textbook Political Economy (Akademie [1958]1959, p. 13).1 The textbook is quite explicit about the social-historical approach: “Political economy studies the production relations, the basis of society in its interaction with the superstructure, the ideology, political views and institutions. Political economy is a historical science” (p. 14). One could be of opinion that modern micro-economics is utterly relevant for socialist economic planning, but it has not been approached by Marxist–Leninist political economy. There is a simple reason that reveals itself when we ask two questions: who are the actors, individuals or collectives, and which are the guiding puzzles? Individuals, no doubt, are influenced by social relations (Coleman 1990), but it is their private decisions and actions that are central to “Western” social and economic theory: methodological individualism. In Marxist–Leninist political economy individuals do not show up, only collectives or classes: capital and labor, the masses, the proletariat, the bourgeoisie, the party etc. According to the 1954 textbook (Akademie [1954]1955, p. 14), at the center of interest are “questions that affect the vital interests of people, of society, of classes. Are the downfall of capitalism and the victory of the socialist economic system inevitable? Do the interests of capitalism contradict the interests of society and the progressive development of mankind? Is the workers’ class the gravedigger of capitalism?” No doubt, positive answers to these questions will reinforce self-confidence of socialist citizens: political economy has also a propagandistic function.

1 The third edition has an own chapter on the subject of political economy which was covered in the first edition (Akademie [1954]1955) only in the introduction.

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In the classical Ricardo–Marx tradition the classes of capitalists, workers, and landowners are analyzed with their specific income categories profit, wages, and rent. The main puzzles are exploitation, distribution, and accumulation. In the neoclassical tradition profit, wage, and rent are remunerations of productive factors capital, labor, and land. The guiding puzzles are allocation and growth. Classes vanish.2 In 1935, Oskar Lange ([1935]1968) published his essay “Marxian Economics and Modern Economic Theory” stressing the claim that Marxian economics is superior to general equilibrium theory when it comes to grasping the fundamental tendencies of the evolution of the capitalist system. However, “irony of Fate” (p. 71), it has little to say about the problem of optimal distribution of productive resources in a socialist economy. By the end of the 1950s, a new effort started in Soviet economics using mathematical methods (Belykh 2007). This had two advantages: first, the party watchdogs were unable to follow the argument, and secondly, the problems treated were properly economic, that is equilibrium and efficiency. This approach quickly developed its own habitat, new institutes (the Central Economic-Mathematical Institute in Moscow, the Institute of Economics and Organization of the Siberian branch of the Academy of Sciences) and a new journal (Ekonomika i matematicheskie metody). Mathematical economics developed in deliberate opposition to political economy and was perceived as such in these circles (Sutela 1984). This does not imply that political economists did not recognize the utility of the new approach and, conversely, that the mathematical economists did not subscribe any more to Marxism. Newer textbooks stressed the importance of mathematical approaches sometimes referring to a remark of Marx that the use of mathematics is the hallmark of true science ((Politische Ökonomie 1969, p. 349, the remark is reported by Lafargue [1890]1982, pp. 293–294). But they made no attempt at dealing with economic theory within the confines of political economy. In line with his earlier statement, Lange in the first volume of his Political Economy (Lange [1959]1963)3 claimed that the principles of rational 2 Marxists therefore denounce neoclassical economics as apologetic: it sanitizes economics of class relations. 3 Lange saw only the first of the planned three volumes to press. A second, fragmentary volume has been edited from his estate. It is worth noting that the East German translation (Lange [1959]1969) appeared only in 1969 when the East German reform era had come to an end. The editors were impelled to criticize in the introduction Lange’s

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economic behavior are a universal praxiological postulate, but not necessarily a description of actual behavior. Economic theory based on these principles, which is worked out, for instance, in marginal calculus, optimal planning, linear programming etc., “is a science auxiliary to political economy” (Lange [1959]1963, p. 200) and, hence, should be included in textbooks. Such an integration of the social theory of the economy, i.e. political economy, and the theory of optimal economic behavior, i.e. economics, did not prevail in the academic tradition of the socialist countries. Thus both are to be treated as distinct research programs. Lange’s even-handed, but not uncritical reception of Marxist and “Western” theory is reflected in the chapter on economics which he, together with Włodzmierz Brus, Tadeusz Kowalik, and Ignaty Sachs, contributed to the UNESCO survey of the sciences of man (Lange et al. 1970).4 Apart from giving an overview over the Marxist and “Western” approaches, they probe into the possibilities of a (re-)integration of economic science. For Marxist political economy it would imply getting rid of the “excess of historicism” (p. 287) and developing further the principles of rational economic behavior. For “Western” theory it would be necessary to leave the ivory tower of pure theory. This reflects the convergence hypothesis propounded by Tinbergen in the 1960s. The 1960s saw a stormy development of mathematical economics in the Soviet Union. At the same time, Samuelson’s Economics had been translated into Russian in 1964 even if in a purged form (Gerschenkron 1978).5 On the other side, Marxian economics experienced a remarkable revival in the West. But “it still seems we must wait several decades for that “generalized political economy” postulated by Merleau-Ponty … and formal analysis of rationality which created “the impression of social indifference” (5) and his “de-apologization and de-ideologization of present day bourgeois economics” (18). It becomes rather bizarre when the co-founder of modern welfare theory is accused of “criticizing topics like welfare theory in the main immanently and insufficiently in their apologetic function” (19). 4 Oskar Lange died rather early in 1965. As it seems, the impartiality of his collaborators led them too far: some “unhappy circumstances” hindered them from completing the chapter themselves, as the (West-)German book edition of the chapter remarks (Lange et al. 1972, p. 121). It is not too far-fetched to suspect after the events of 1968 the party censorship behind these unhappy circumstances. 5 This was by no means the only translation. Already in 1961 Luce and Raiffa’s Games and Decisions of 1957 had been translated, In 1964 Allen’s Mathematical economics of 1956, in 1965 Baumol’s Economic theory and operations analysis of 1961, just to name a few. A translation of Keynes’ General Theory had already appeared in 1948

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Perroux, and of which capitalism and socialism were to be but two special aspects” (Lange et al. 1970, p. 298).

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The End of Political Economy?

Marxist–Leninist political economy was one of the three pillars of communist social science. Following the division of Engels’s Anti-Dühring it consisted of philosophy, political economy, and scientific communism.6 Marxist–Leninist political economy was first and foremost the political economy of capitalism with Marx’s Capital as foundational scripture. This provided a large body of uncontroversial textbook material and took up a large part of the curriculum. It was updated by Lenin’s theory of state-monopoly capitalism and imperialism, but further developments of the capitalist system and its theory found only scant reflections in the textbooks. The fate of capitalism was a historical law. The political economy of socialism did not take center stage right from the beginning of the communist period. This was due to the fact that it was disputed whether such thing did exist at all. Already Mikhail TuganBaranovsky had expressed the view that the demise of capitalism also will bring political economy as theoretical science to an end. Evidently, the classless society will dispense with class relations as central problem of political economy. The proletarian revolution and the overcoming of capitalist commodity production will leave nothing to be studied by political economy was the opinion of Rosa Luxemburg, too, and Nikolaj Bukharin considered political economy the science of capitalism which will be substituted by a theory of economic policy (Lange 1970; Trifonow and Schirokorad [1972]1973, p. 14). Lapidus and Ostrovityanov7 wrote still in 1930: “Since … the rural natural economy and the communist economy are organized and directed by the conscious human will, there is no material that could be studied by political economy” (quoted ibid., p. 106; see also Davies 1989, pp. 155–162). This follows logically from the absence of civil society between the rural household and the state under socialism. (Katsenelinboigen 1980, p. 24). For many East German economists these Russian translations were the only access to Western economic thinking, since GDR publication and import policy was much more restrictive than the Soviet. 6 In Engels ([1878]1947) the third section was headed simply “socialism”. 7 The latter became one the chief editors of the 1954 textbook on political economy.

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In the early years it was disputed whether the socialist mode of production is governed by any economic laws. From Marx is derived the basic law of capitalism: the maximization of profits and accumulation. It is an “objective” social law operating behind the back of the economic actors. No such basic law imposes itself upon the socialist mode of production. There is no unconscious “objective” force compelling the planner to fulfill consumer demand or to be efficient what, of course, is his immediate target (as Stalin later formulated). In the pre-war period, the basic law of socialism is the plan or the dictatorship of the proletariat. Objective economic laws do not play a role regulating the transition economy (Trifonow and Schirokorad [1972]1973, p. 50). Critics of this view spoke of subjectivist voluntarism which, if unchecked, will impede socialist development. The economists of the pre-war period committed the methodological error of confounding the objective in socialism with the spontaneous in capitalism (ibid., p. 112). The first twenty years of Soviet rule did not see any systematic efforts to establish a political economy of socialism. Only in 1937, when the new Soviet constitution was passed, the CPSU Central Committee demanded a curriculum of political economy and a corresponding textbook. The following years saw the drafting of several model texts and lively disputes among the economists and with the political leadership (Sutela 1991; Singh 1998; Pollock 2006). Stalin himself intervened establishing the basic tenets. In January 1941, shortly before the German assault on the Soviet Union, Stalin, Prime Minister Molotov, and the head of state planning Voznesensky discussed drafts of the textbook with the team of economists. The decisive signal was given by Stalin in this discussion when he criticizes the proposition that the law of value has been overcome by socialism (Singh 1998, p. 11). This revision was made public for the first time by an anonymous editorial, published in the Party’s theoretical journal Pod znamenem marksizma (Under the Banner of Marxism), which in 1943 criticized voluntarist economic theorizing suggesting a role for the law of value in socialist planning (Anonymous [1943]1944).8 8 At the time, the American comrades in arms were fascinated by the surprising turn in Soviet economic thinking. Abbreviated translations appeared immediately in the Marxist journal Science and Society and in The New York Times. An unabridged version and two comments were published in The American Economic Review (Anonymous 1943/1944, Raya Dunayevskaya 1944). The first comment by Carl Landauer (1944, p. 340) states that the article has been written by leading Soviet economists headed by Lev A. Leontiev. This is highly probable, since Leontiev was not only co-editor of the Party journal and

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After the war, the project gained new momentum. In 1950 three high level discussion rounds took place and another one in 1952 which was preceded by Stalin’s written Remarks on Economic Questions (see the minutes of all five rounds of discussion in Singh 1998). From November 10 till December 17, 1951, some 250 economists gathered in the Kremlin to discuss the draft. Chair was secretary of the Central Committee Malenkov, his deputy was Suslov head of the Agitprop department of the Central Committee (see Pollock 2006, pp. 184–200, for a detailed summary). Finally, Stalin (1952) published his remarks in his last book Economic Problems of Socialism in the USSR which served as definite guideline for the new textbook to be published after his death in 1954 (Akademie [1954]1955). In a similar way, an East German textbook was called for by the Party in the late 1960s. The chief authors in the large collective team were eminent economists who had propagated the economic reforms initiated in 1963 and the book was meant to represent the reform thinking. The team was headed by Politbureau member Günter Mittag. The draft had been discussed with the First Secretary of the Party Walter Ulbricht, who contributed an extended preface, and with several of his Politbureau colleagues (Politische Ökonomie 1969, p. 20). What could be more authoritative? The print run is said to have been almost 1 million (Nick 2011, p. 26)—for a population of only some 17 million. All the more strange is the fate of the book. When the textbook finally appeared in 1969, the reform was practically dead and Ulbricht’s era almost at an end. With him the book disappeared only two years after publication from the shelves: “It also was forbidden to quote the book; it simply did not exist” (Krömke in Pirker 1995, p. 42). In fact, team leader Mittag had anticipated the political switch to the decidedly antireform Honecker and intervened in the final editing in favor of centralism and traditional planning (Wolf 1991, p. 12). However, it can only be suspected that it was less the text, but Ulbricht’s preface and the extensive references to his writings that became unacceptable after his demise. As textbook it was substituted by a recent Soviet publication (Tsagolov [1970]1972). Editor and head of the team of authors was Nikolaj A. Tsagolov chair of political economy at Moscow State University and undisputed leader of the Moscow school for almost 30 years. As such he secretary of the party’s social science academy, but as one of the chief editors of the textbook project had discussed the matter with Stalin in 1941.

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was a prominent representative of the ne-tovarniki, i.e., economists who claimed that socialist production was basically not commodity production emphasizing central planning and giving as little room as possible to commodity-money relations and the law of value (Blagikh and Dubyanskij 2014, pp. 503–506).

4

Power or Economic Law

The question of economic laws is intricate (Zamagni 1987). Scientific laws reflect necessities, logical, psychological, natural-technological, and— according to Marxism—historical-teleological. Stalin (1952) answered Böhm-Bawerk’s famous question “power or economic law?” decidedly by “power and economic law.” In the classical natural law tradition he discerned historical laws of the development of modes of production, i.e., historical materialism, and technical-natural constraints. Both are objective: they cannot be changed by human will, but by understanding them the progressive class and the socialist planner can utilize them consciously. The change of mode of production is a question of power, the fact that it happens is a historical law. It is the task of the socialist state to apply the objective economic laws to planning and managing the national economy. Stalin’s approach became authoritative for most textbooks on political economy of socialism even if his name is not always mentioned (cf. Lallement 2014). Behavioral regularities derived from rationality and utility maximization that are responsible for most theorems in modern economics are not elaborated in orthodox socialist political economy and its textbooks. Individual behavior and preferences are not determining socialist economic activity. For Oskar Lange ([1959]1963, p. 82), by contrast, the central tenet of socialist political economy holds that the “technical and balance laws of production, the laws of human behavior, and the laws of interplay of human actions continue to operate objectively, independently of human will and consciousness”. However, they do not operate spontaneously in an uncontrolled way or, as Engels ([1878]1947) had put it: “Man’s own social organization, hitherto confronting him as a necessity imposed by nature and history, now becomes the result of his own free action. The extraneous objective forces that have hitherto governed history pass under the control of man himself.” The market alienates man, the plan restores his sovereignty, and this is the message.

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Although Marx and Engels continuously stress the chaos of the market, they concede at the same time that it spontaneously produces order, the division of labor and the price system, and that competition is responsible for the dynamics of the capitalist system. There is, however, an antagonistic contradiction between the planned organization of the enterprise and the costly anarchy at the level of total society. Socialist political economy holds that productive socialization and planning on the firm level has to be complemented by economy-wide socialization and central planning (Tsagolov [1970]1972, pp. 120–124). If planned cooperation within the firm is more productive than simple commodity production, planned cooperation above the firm level will be superior to capitalist competition. This hypothesis, hitherto not borne out by practical experience, is sold as objective historical truth lacking, however, any theoretical foundation.9

5

Economic Laws of Socialism

Which are now the economic laws of socialism? Marx ([1857]1993, p. 173) has formulated the often quoted first economic law: “Economy of time, to this all economy ultimately reduces itself. …Thus economy of time, along with the planned distribution of labor time among the various branches of production, remains the first economic law on the basis of communal production.” In Capital Vol. 3 he specifies: “It is only where production is under the actual, predetermining control of society that the latter establishes a relation between the volume of social labortime applied in producing definite articles, and the volume of the social want to be satisfied by these articles” (Marx [1894]1959, p. 138). Neoclassical microeconomics has specified allocation rules that correspond to this general view. This line of reasoning was, however, not followed by the political economy of socialism. Stalin (1952, pp. 45– 46) formulated the basic economic law of socialism and he confirmed the law of the balanced, proportionate development of the national economy. The first postulates “the securing of the maximum satisfaction of the constantly rising material and cultural requirements of the whole of society through the continuous expansion and perfection of socialist production on the basis of higher techniques.” The second is postulating 9 Transaction cost economics and a theory of the firm à la Coase remained alien to socialist political economists.

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the efficient use of resources by conscious planning. Both may be subject to historical laws or natural-technical constraints. But by themselves they are normative propositions which should guide the socialist planner very much like neoclassical rules of optimal allocation. The latter, however, are specific in defining praxiological optimality conditions while the former remain rather general. Optimality and efficiency as economic “laws” of socialism stood quite naturally central for the mathematical school of economics. The basic economic law defines the objective function of planning, planned proportional development the efficiency of economic activity. The law of value as third complement is the basis for material stimulation of production (Dadajan [1970]1973). So, what is the difference with the political economy of socialism? Political economists content themselves with stating welfare maximization as objective of socialist planning and cost minimizing proportions of inputs as necessary condition for the achievement of this objective. Stating sensible norms, however, is not sufficient. What is needed is elaborating the implications of these norms or sound economic analysis as is provided by the optimal planners, but also by neoclassical theory as Oskar Lange (1935/1968, p. 72) has remarked: “But in providing a scientific basis for the current administration of the capitalist economy ‘bourgeois’ economics has developed a theory of equilibrium which can also serve as a basis for the current administration of a socialist economy. It is obvious that Marshallian economics offers more for the current administration of the economic system of Soviet Russia than Marxian economics does.” Mathematical economists have no antipathy to the tools which “bourgeois” economists are also using: “Only people who have the most primitive notions at their disposal will hold the view that the mathematical theories of our forefathers and differential quotients are incompatible with the Marxist-Leninist world view” (Dadajan [1970]1973, p. 258, quoting Nemchinov). A political economy of socialism would need both, mathematicalstatistical tools of optimal planning (efficiency), and behavioral patterns of human action (operational feasibility). In fact, it failed with both respects. While the mathematical school of optimal planning provided the tools, it was repudiated by the political economists despite some lip-service as to the usefulness of mathematical methods. The study of individual action and social relations, i.e., sociology, was considered for a long time a bourgeois science and, hence, not practiced. Textbooks claimed an ex ante

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unity of individual and social interests under socialism and, at the same time, stressed the priority of the social above the personal interests, i.e., the party and the state above the individual (see, for instance, Politische Ökonomie 1969, pp. 194–201; and Tsagolov [1970]1972, p. 138).

6

Commodities and the Law of Value Under Socialism

A major point of controversy among political economists, and then with Stalin, were questions about the existence of commodities and the role of the law of value under socialism. Marx and Engels were adamant about commodities arising only under private property market capitalism. Marx’s definition of the law of value, on the other hand, is straightforward describing the average rule of commodity exchange: “The value of one commodity is to the value of any other, as the labor-time necessary for the production of the one is to that necessary for the production of the other” (Marx [1867]1909, p. 46). This law is valid also under socialism although neither commodities nor values as an indirect social relation exist: “The producers do not exchange their products; just as little does the labor employed on the products appear here as the value of these products, as a material quality possessed by them, since now, in contrast to capitalist society, individual labor no longer exists in an indirect fashion but directly as a component part of total labor.” Nevertheless, labor time regulates the distribution of consumer goods: “But as far as the distribution of the latter among the individual producers is concerned, the same principle prevails as in the exchange of commodity equivalents: a given amount of labor in one form is exchanged for an equal amount of labor in another form” (Marx [1875]1970). The mystery of “value” can be deciphered by reading carefully chapter 1 of Capital I. Socially necessary labor determines the quantity of value of commodities. At the same time, value is the expression of a cryptic social relation: “It is value, rather, that converts every product into a social hieroglyphic” (Marx [1867]1909, p. 84). In the bourgeois market context, the allocation of total available labor time as socially necessary labor is ascertained only ex post after the working of the market. Value appears as material property of products thus obscuring the social relations for the producers. Socialist society consciously allocates its total labor directly, as Robinson did individually, according to the time necessary for the production of goods and to need. Speaking of “value”

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under socialism therefore disregards the social content of the concept. Value represents only the quantity of socially necessary labor time, the property as social hieroglyphic has vanished. Engels in his Anti-Dühring ([1878]1947) is even more explicit as to allocation under socialism: “It is true that even then it will still be necessary for society to know how much labor each article of consumption requires for its production. It will have to arrange its plan of production in accordance with its means of production, which include, in particular, its labor-powers. The useful effects of the various articles of consumption, compared with one another and with the quantities of labor required for their production, will in the end determine the plan. People will be able to manage everything very simply, without the intervention of much-vaunted ‘value’.” With the qualification “very simple” he obviously has fallen prey to theoretical over-optimism. Comparing the useful effects of products with one another requires measuring the use value of products not in incommensurable physical units, but in comparable utilities. The quantities of labor required for their production represent their value. What is not needed is commodity production and, hence, value as social hieroglyphic. Here Engels comes very close to the second law of Gossens. A modern solution of the puzzle was presented by Polish economists who, obviously under the influence of Oskar Lange, disentangled the theoretical problem of optimal allocation from the institutional problem of commodity production and stated: “Generally speaking, the operation of the law of value leads to a division of social labor between its various applications, in which the relation of its effects to (socially indispensable) outlays of labor, is the same for all of these applications” (Brus and Łaski 1964, p. 47). The puzzle of the law of value haunted socialist political economy and economic policy for years. The starting signal was given by Stalin in his 1941 discussion with the textbook team when he criticized the proposition that the law of value has been overcome in socialism (Singh 1998, p. 11). We need not trace the steps in the following discourse (see Trifonow and Schirokorad [1972]1973; Pollock 2006; Kaser 2008). It centered a long time around the question of commodity production under socialism, since it was assumed that commodity production implies

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the law of value. This is true, but the reverse, the law of value implying commodity production, is not.10 For Stalin (1952) commodities materialize when products change ownership in exchange. This is the case in the relations between the state and the cooperative sector and between both of them and the consumer sphere, but not within the state sector. The third edition of the textbook (Akademie [1958]1959, pp. 581–590) enlarged this domain to all products, consumer goods as well as producer goods. For also within the state sector, where goods do not move from one owner to another, goods are commodities, since they are bought and sold for money. A more elegant explanation is the distinction between legal and economic property rights introduced by P. Zaostrovtsev who remarked that relevant for commodity exchange between state firms is not the transfer by a single owner, the state, but the exchange between economic units authorized to dispose of products (see Behrens 1961, pp. 37–40). This view hardly fits Engels’ ([1878]1947) description of the socialist economy as producing directly use values according to a central plan. All labor will be immediately socially necessary and no commodities show up. The full organizational integration of the socialist economy within a huge single cooperative was then put forward by Kautsky (1892) in his comments to the Erfurt program. It finally got canonized by Lenin’s (1918) vision of a socialist economic system: “The whole of society will have become a single office and a single factory, with equality of labor and pay.”11 The contradiction between these two views forms the basis of the conflict between tovarniki and ne-tovarniki or two models of a socialist economy. On the one hand, there is Lenin’s hierarchically structured uniform system that is centrally planned top down using, of course, bottom up information. No commodity exchange is taking place, but only addressed supplies between the units of this system as is the case in a large enterprise. On the other hand, there is a two (or multi) level 10 It should be remembered that prices have two functions: rate of exchange between commodities and opportunity cost in the choice of alternative production lines and consumption decisions. Such choices have to be made, as Marx and Engels have stressed, also in a socialist non-market regime. 11 This vision was reiterated by Bucharin and Preobrazhensky (1920, pp. 55, 58): “if all factories, firms, the whole of agriculture form a huge cooperative”, a general production plan will be needed. This plan, however, will not be produced by the state which has withered away under communism, but by various statistical and calculating bodies.

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system with a planning center using economic levers and more or less autonomous firms. This does not presuppose market coordination, but tovarniki speak of commodity production and commodity-money relations if calculation in pure use values is substituted by calculation in exchange values (khozraschet ). The exchange value need not be a market price, but can be some form of planned or contracted price or even a shadow price derived from optimal planning.12 The Soviet mathematical economist Viktor Nowoshilow ([1967]1970, p. 271) made clear that optimal planning—implying also planned proportional development as one of the economic laws of socialist political economy—neither contradicts nor restricts the operation of the law of value, as many political economists assumed. The full application of the law of value, i.e. equilibrium prices, and an optimal plan can only be realized simultaneously, since optimal prices are the other side of the optimal plan. Ne-tovarniki like Tsagolov ([1970]1972, pp. 252–268) have great pains to solve the contradiction of production for society as a whole, and not for distinct “others,” and the obvious existence of commodity-money relations under socialism. They stress the difference between spontaneous capitalistic and planned socialist commodity production and the transitory character of the latter. In particular, Tsagolov ([1970]1972, pp. 283–284) disliked restricting the discretion of the planner, i.e., the party: “The law of value is a specific law of commodity production.” After the victory of socialism, the process of production and reproduction “is regulated by other laws, among which the basic law of economics.” “Value is an objectively existent category. Price, however, as a specific exchange relation need not only be the result of objective factors, but can be the result of conscious influence.” This, of course, is true, but, as Nowoshilow ([1967]1970, p. 269) has remarked, it always comes at a price, namely a suboptimal allocation of resources, thus thwarting welfare maximization or the basic law of economics.

12 The most efficient example of commodity-money relations in combination with planned proportional development of production is relational exchange as it is practiced by large capitalist companies like Volkswagen. Intermediate product deliveries are fixed in long-term bilateral contracts specifying all conditions including price. This system is functioning on the basis of firm autonomy, hard budget constraints and the rule of law. By the way, Volkswagen was in state ownership and still is partly owned by the state. Socialist reformers never have taken this option seriously into account.

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Both views lead to different visions of economic reform. Optimal planners mostly think in terms of the hierarchical system and directive central planning and suggest forms of optimization for the economy as a whole or for individual parts of it. Tovarniki tend to advocate decentralization, self-management of firms, and parametric forms of central planning. From the 1960s on, economic science and economic policy started to take its own way in the different countries of Eastern Europe trying to depart from the Soviet model of development and Soviet-type political economy of socialism (Chavance 2000). The short-lived GDR textbook Politische Ökonomie (1969) was an attempt into this direction. But even this textbook distrusted economic levers: “The economic system of socialism is never and never can be an ‘economic mechanism’ where correct human behavior is elicited quasi automatically by a system of economic levers” (212). This was targeted at the Hungarian reform system of 1968 called “New Economic Mechanism’.” Economic reforms met with strong political resistance inside the GDR and from the Soviet hegemon. Compared with this, economic science showed a remarkable autonomy in Poland, Czechoslovakia (at least till 1968), and Hungary.

7

Conclusion

The socialist system is meant to do away with capitalist capital–labor relations thus abolishing exploitation. The economic law of motion of (capitalist) society fades away under socialism: capitalist growth and innovation result from competitive rivalry. Concentration in monopolistic multinationals and progressive state interference reduce the dynamic, so it is said, and intensify the socialization of production preparing the economic structure for a socialist takeover. Clearly, after the revolution Marxist political economy seems to have lost its object. This prompts the question whether there is a political economy of socialism and, in particular, an economic law of motion of socialist society. As a matter of fact, there is none: the law of motion is political—the conscious planning and management of the economic system. At the center of this process stands the Party, and Party resolutions are the only references in addition to the works of Marx, Engels, and Lenin in “official” textbooks. It was out of question for orthodox political economists, however, to take the behavior of the Party and state bureaucracy as objects of research and investigate the implications for economic decision making. It was János Kornai (1980) who first attempted to fill the lacuna stressing

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that the set of institutional phenomena, above all state paternalism, determined typical behavioral rules generating economic phenomena like chronic shortage. If we regard the evolution of the economic system, its institutional structure, vested interests and the behavior of the economic agents as genuine fields of research of political economy, there still remains the problem of resource allocation. It can hardly be separated from the social conditions within which it is treated despite its praxiological character. Quite contrary to the assessment of modern economic theory as apologetics by Marxist–Leninist political economists, Oskar Lange ([1959]1963, ch. 5) has stressed the relevance of neoclassical microeconomics and elaborated the general character of the principle of economic rationality and its crucial role for the political economy of socialism. As a science analyzing the historical development of modes of production and of class relations within them, political economy has a legitimate place in the history of economics. The political economy of socialism focusses upon the socialist mode of production. However, it remained descriptive defining concepts, interpreting the actual operation, emphasizing its harmonious (non-antagonistic) properties and the historical superiority of the socialist system, stressing the guiding role of the Party. By positing “objective” economic laws, it attempted to analyze the working of the system. But it neither succeeded in elaborating the economics implied by these laws, nor did it approach the socio-political behavior of the actors of the system. So, it never could gain the status of a critical science as did the political economy of capitalism. Under really existing socialism it was a closed doctrine. However, the defects can be remedied. The multidisciplinary approach of political economy, bringing together history, economics, sociology, and political science, is by no means limited to one particular slice of economic history. As political economy of socialism its object, really existing socialism, has vanished for the time being. In general, political economy ought to be an open science analyzing the economic behavior and organization of economic actors and their social and political relations.

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Marx, Karl. ([1859]1999). A Contribution to the Critique of Political Economy. Transl. S. W. Ryazanskaya. Moscow: Progress. www.marxists.org/archive/ marx/works/download/Marx_Contribution_to_the_Critique_of_Political_ Economy.pdf. Accessed 09-25-2018. Marx, Karl. ([1867]1909). Capital. A Critique of Political Economy. Vol I. The Process of Capitalist Production. Chicago: Charles H. Kerr. oll.libertyfund.org/titles/marx-capital-a-critique-of-political-economyvolume-i-the-process-of-capitalist-production. Accessed 05-11-2018. Marx, Karl. ([1875]1970). Critique of the Gotha Program. In Marx/Engels Selected Works (Vol. 3, pp. 13–30). Moscow: Progress Publishers. www.mar xists.org/archive/marx/works/1875/gotha. Accessed 05-11-2018. Marx, Karl. ([1894]1959). Capital. A Critique of Political Economy. Vol. III. The Process of Capitalist Production as a Whole. Moscow: Progress Publishers. www.marxists.org/archive/marx/works/download/pdf/CapitalVolume-III.pdf. Accessed 09-10-2019. Nick, Harry. (2011). Ökonomendebatten in der DDR. Schkeuditz: GNN Verlag. Nowoshilow, Viktor V. ([1967]1970). Die Messung von Aufwand und Ergebnis. Probleme der Messung von Aufwand und Ergebnis in der optimalen Planung. Transl. from the Russian. Berlin: Die Wirtschaft. Pirker, Theo et al. (1995). Der Plan als Befehl und Fiktion. Wirtschaftsführung in der DDR. Opladen: Westdeutscher Verlag. Politische Ökonomie des Sozialismus und ihre Anwendung in der DDR. (1969). Berlin: Dietz. Pollock, Ethan. (2006). Stalin and the Soviet Science Wars. Princeton: Princeton University Press. Singh, Vijay. (1998). Stalin and the Making of the Political Economy of Socialism. Revolutionary Democracy, IV (2), 1–34. www.revolutionarydemoc racy.org/rdv4n2/polecon.htm. Accessed 10-12-2018. Stalin, Joseph W. (1952). Economic Problems of Socialism in the U.S.S.R. Moscow: Foreign Languages Publishing House. Sutela, P. (1984). Socialism, Planning and Optimality: A Study in Soviet Economic Thought. Helsinki: Societas Scientiarum Fennica. Sutela, P. (1991). Economic Thought and Economic Reform in the Soviet Union. Cambridge: Cambridge University Press. Trifonow, D. K., & Schirokorad L. D. (Eds.). ([1972]1973). Geschichte der politischen Ökonomie des Sozialismus. Grundrisse. Transl. from the Russian. Berlin: Die Wirtschaft. Tsagolov, Nikolaj A. (Ed.). ([1970]1972). Lehrbuch Politische Ökonomie. Sozialismus. Transl. from the Russian. Berlin: Die Wirtschaft. Wagener, Hans-Jürgen (Ed.). (1998). Economic Thought in Communist and PostCommunist Europe. London: Routledge. Wolf, Herbert. (1991). Hatte die DDR je eine Chance? Hamburg: VSA Verlag.

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Zamagni, Stefano. (1987). Economic Laws. In Steven N. Durlauf & Lawrence E. Blume (Eds.), The New Palgrave Dictionary of Economics. 2nd ed. (Vol. 2, pp. 697–700). Basingstoke: MacMillan. Zweynert, Joachim. (2014). ‘Developed Socialism’ and Soviet Economic Thought in the 1970s and Early ’80s. Russian History, 41, 354–372.

The Development of Thinking on the Czechoslovak Economic Transformation Martin Myant

1

Introduction

This chapter addresses the question of how the state and level of economic thinking in the 1970s and 1980s in Czechoslovakia influenced economic strategies in the years after 1989. The differences between the countries of east-central Europe in post-1989 economic strategies are relatively well known. The development and importance of economic thinking before 1989 is less well covered, especially for Czechoslovakia. Comparisons with Hungary and Poland confirm the importance of intellectual development in the pre-1989 period for explaining the different economic strategies pursued in the following years.

The author would like to acknowledge the helpful advice and comments from Beáta Farkas, Tomasz Mickiewicz, and Hans-Jürgen Wagener. M. Myant (B) European Trade Union Institute, Brussels, Belgium e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_3

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2

Economic Thinking Before 1970

Czechoslovak economic thinking in the early state socialist period lost contact with the country’s pre-war traditions. Marxist political economy was completely dominant. The architects of reforms in the late 1960s developed a critique of central planning based on empirical observation without reference to non-Marxist economic theory. They took ideas from other socialist countries, notably the Soviet Union and the more theoretical works of Brus (1972) in Poland on market relations in a socialist economy, available in Czech translation in 1964. From these starting points they developed a first reform programme. A very similar process was under way in Hungary, leading there to the so-called New Economic Mechanism, introduced in 1968. In terms of what was accomplished, Czechoslovakia’s reforms were not particularly radical, quickly encountering a perennial problem of market reforms. Whenever a significant imbalance appeared, the centre felt obliged to use its administrative power to put the problem right, contradicting the aim of enterprise independence. That early experience led to a radicalisation of thinking, including advocacy of financial and managerial independence of enterprises, supported by a degree of employee involvement, free prices, currency convertibility and a capital market enabling successful enterprises to acquire more finance for investment (Klacek and Kupka 2018, Myant 1989a). Theoretical depth was added by a recognition of the merits of the critique of central planning by Mises and Hayek which was known from its discussion by Brus (1972) and then after the translation of one of Mises’s works in 1968. Karel Kouba (1970, p. 75), one of leading figures in reform attempts, implicitly accepted the critique, seeing the ‘main deficiency of the central plan’ being the absence of ‘an objective price structure’. However, apart from a short piece by Václav Klaus in 1968, nobody publicly doubted that the benefits of a market system would still be attainable under socialism (Klacek and Kupka 2018, p. 122).

3

The Effects of Normalisation

In Czechoslovakia the Soviet military invasion of 1968 led to the intellectually bleak period of ‘normalisation’. However, isolation was never as absolute as in the 1950s. A community of educated economists had had varying degrees of involvement in the thinking of the 1960s

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and had been introduced to economic thinking from outside, including Samuelson’s basic textbook, although not yet in a Czech translation. However, normalisation meant that the economic reforms of the 1960s were mentioned in the public sphere only to dismiss them. This period saw a division in the life-paths of economists that led to differences in thinking so profound as to be reflected in sharp disagreements over economic strategy after 1989. A number of prominent Czechoslovak economists emigrated, including Ota Šik, the Director of the Economics Institute of the Academy of Sciences and the leading figure in the reform attempts of the 1960s. He did not regain influence after 1989. Others who had been active in preparing and supporting the reform agenda of the 1960s were expelled from the party and prevented from practicing as economists, although many were still able to function in other professional jobs. Very few had to resort to less-skilled manual work. These fates largely delineated a distinct older generation. A lesser penalty was to be suspended from party membership, which was still compatible with working in the Economics Institute. This was the typical fate of a younger generation who could survive being purged by pointing to their minor, or non-existent, involvement in political activities. Only one individual who had been expelled from the party continued working in the Economics Institute, becoming the librarian and thereby able to supply information and publications to those who had been expelled. Klaus and his allies later condemned the older generation for allegedly aiming to repeat the reforms of the 1960s, meaning that they would lead the country back to what was by then widely seen as the dead end of reform communism. Petr Pithart, Czech prime minister from 1990-1992, became more critical of the middle generation over the years. In 2004 he thought that ‘in terms of theory they were prepared… but as for the actual situation, how our economy functions and what kind of sociological links it has, on that they had simply no idea’ (quoted in Šulc 2011, p. 234), adding that this is one of the explanations for ‘why Klaus’s Czech road ended in such a loss of face’. He was probably too generous in terms of their theoretical level. A textbook for university students was probably closer to the truth when arguing that ‘the best economists from the men ˇ of 1968—Karel Kouba, Cestmír Kožušník and Otakar Turek … rid themselves during their years of forced silence of nostalgia for market socialism and were better prepared for the complications of the transition … than were the right-wing radicals. However, their circumspection did not find a strong political expression’ (Vencovský, Pulpán ˚ et al. 2005, p. 341).

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4

The Old Generation

Those excluded from public involvement did not all accept enforced silence. Several were keen to discuss, in small informal groups, samizdat publications, typically limited by the technology of the time to nine copies, and sometimes émigré journals. Much of their writing concerned assessment of the current economic situation and StB (Státní bezpeˇcnost , state security police) files show the authorities’ concern to prevent publication abroad and to obstruct contacts with foreign nationals and with the most prominent dissidents whose phones were generally tapped. However, the StB was constrained by the regime’s commitment to a form of ‘socialist legality’ (Kopeˇcek 2019), meaning that they had to operate within a legal framework. Much of their effort was restricted to accumulating information and periodic searches of flats and offices—as far as possible without the targeted individuals knowing anything about it—enabling them to copy intended publications. The written output of opposition economists included some quite ˇ substantial pieces of discussion. Cestmír Kožušník, a prominent figure in 1968, was assumed to be the author of a 12,000-word reflective review of Kornai’s Economics of Shortage. This book was published in English (Kornai 1980) and Hungarian in 1980 and translated into Czech by the Economics Institute in 1982 but considered appropriate only for circulation in very small numbers without a formal public discussion. The author of the review linked Kornai to reform ideas from the 1960s which he judged by the time to be inadequate, leading to the conclusion that ‘leading organs’ should initiate a discussion on the reasons for economic weaknesses and on the means to put them right (ABS KR 653908 MV, p. 370). Otakar Turek, another prominent figure from the 1960s, was under surveillance with mountains of information passed to the security police by his office companion. The StB was convinced that he was seeking to harm Czechoslovakia, possibly through espionage and probably by accumulating information on the state of the economy to be published abroad. A search of his flat—he was unaware at the time of this and of almost all the rest of the surveillance—revealed a 3000-word document on the country’s economic problems, dated June 1980. It embodied an excellent summary of the problems and inconsistencies of central planning, providing contemporary empirical evidence and arguing that the visible inefficiencies had systemic roots. Any solution he judged to be

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even harder than in the 1960s because of a whole number of changes in the outside world, including greater interdependence of economies and increasing environmental problems. Solutions would have to ‘emerge as the result of a collective intellect’ (ABS KR 706019 MV, p. 1016). The purpose of the document remained unclear, but the StB concluded that it was intended as part of an approach to the leadership rather than as an attempt to harm the country’s interests by publication abroad. They then finally interviewed Turek, warning him against contacts with opposition activists, something he allegedly indicated he would ‘bear in mind’, but he continued writing on the failings of the existing system. More enthusiasm for imported economic theory was shown by Lubomír Mlˇcoch, as expressed in a series of lectures at the Economics Institute in early 1970 on the theory of the firm (Mlˇcoch 1970), shortly before he was excluded from teaching and publishing. He covered neo-classical, behavioural, linear programming and other theories also attempting an application of marginalist theory to the enterprise under central planning. Searching for an objective for the state-owned enterprise was a theoretical novelty, but seeking a single objective function and applying marginalist methods was ultimately unconvincing. The key to understanding enterprise behaviour is the nature of bargaining between the central authorities and enterprises such that the latter pursues different objectives during plan formulation and when trying to reach set targets. Mlˇcoch was subsequently obliged to work in an enterprise and produced a major work of empirical theory—not using tools of other economic schools—on the behaviour of the enterprise under central planning, documenting the diverse ways in which managements can bargain and soften their plan targets with clearly damaging effects in terms of economic efficiency. This was published only later (Mlˇcoch 1990), but a typescript, completed in 1983, was widely circulated and respected among professional economists in the late 1980s. It matched with Kornai’s analysis of enterprise behaviour, available shortly beforehand. However, Mlˇcoch’s contribution had no direct policy implications, beyond showing up the failings of central planning. He remained primarily a theoretician, isolated from the first changes after 1989 when he put an absolute priority on returning property to former owners. An exceptional figure in a different way was Zdislav Šulc, as shown in his memoirs (Šulc 2011) and other writings. He was an economic journalist in the 1950s and until 1969, seeing and reporting the workings of

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the economic system, before finding a temporary place in the Economics Institute, writing a thesis on economics and democracy. He was expelled from the party in 1971 and could then find only manual work. He was an early signatory of Charter 77, the opposition manifesto produced in 1977, and contributed to a samizdat publication produced by his wife (Šulc 2000). She suffered occasional StB harassment and their flat was among the few systematically bugged. His magnum opus (Šulc 2004) was a 350-page book completed in 1985 entitled The State and the Economy of which nine samizdat copies were produced. It was formally published only many years later. It built from a substantial knowledge of different schools of economic thought and contained a critique of central planning, covering enterprise behaviour, - based partly on observation from his various workplaces in a way that he felt added to Kornai’s contribution. Above all, he was proud of linking analysis to a programme for economic reform. The proposals were very precise, including a state property fund as formal owner of enterprises which were then to be compelled to pursue commercial objectives within an environment of free prices. He explicitly rejected the alternative of full self-management. He had been arguing in similar terms in 1969, but he added to his thinking from that time with a willingness to take lessons from the German ordo-liberal school and from West German experience after World War II. Remarkably, nobody else in Czechoslovakia before him seems to have followed this, although its relevance to a transformation strategy should be obvious to anyone looking for historical precedents. A key figure for him was Walter Eucken and his analysis of the working of the German wartime ‘centrally administered’ economy (Eucken and Hutchison 1948a, b). Eucken argued from systematic empirical observation that this was a fundamentally different system from a market economy with the key difference being the necessary absence of a functioning price mechanism. Šulc noted the similarities to observed behaviour and failings of the Czechoslovak centrally-planned economy and concluded, as had Eucken, that only the freeing of all prices could create the preconditions for rational economic decisions. This he therefore placed as the first step in a reform agenda (Šulc 1990b). He had no objection to the existence of small private enterprises, but kept himself to analysing a ‘non-capitalist’ system. He took Eucken’s argument that the combination of market relations with private ownership is ‘not necessary’ (Eucken and Hutchison 1948a, p. 80), because a

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centrally administered economy visibly coexisted with private ownership. Šulc accepted that the converse need not apply—market relations could still be incompatible with state ownership—but he believed his means for ensuring enterprise independence from the central administration would prove sufficient. Thus, he did not favour privatisation, but it was not to prove difficult later to add a strategy of gradual sale or transfer of state-owned assets.

5

The Middle Generation

A younger generation, with less active involvement in 1968, was to become a middle generation that played a substantial role in economic policies in the 1990s, including several of those who worked at some point in the Economics Institute. However, this was no longer a centre for thinking on economic reform or on the nature and problems of different economic systems. Economic reform was not a subject for open discussion: even the word had become a taboo. There was no explicit criticism of Marxism, but nor was Marx the starting point. This generation had learned about a range of alternative theoretical approaches and had access to publications from abroad, as is reflected in some of their work, albeit most successfully in the application of particular techniques or concepts that could be used to measure economic performance. This included production functions, growth accounting and macroeconomic imbalances, all now analyzed with the help of statistical and econometric methods, helping to show the growing problems in socialist economies and declining efficiency by the 1980s. Researchers had little to say in public about possible solutions. Those that did followed the official line that the existing system could still be improved through careful choice of success indicators and better planning techniques. A key figure in encouraging slightly wider thinking in the 1980s was Václav Klaus who was to prove himself as an organiser of discussions. He worked in the Economics Institute from 1964 and established a club of young economists, studying and discussing Samuelson’s textbook. He was never a party member and was therefore never expelled, but he was moved out to the State Bank in 1971 where he was still treated with some suspicion, notably with restrictions on foreign travel. He was able to visit Hungary in 1984 and it annoyed the security police when an article he wrote was published there in English. He annoyed them again when he visited Poland and gave an interview to a local newspaper contrasting the

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more liberal atmosphere there to conditions in Czechoslovakia (ABS, KR 797608 MV). He started organising a series of seminars in 1980 in the State Bank— through an organisation formally tasked with a scientific-educational role—with selected discussion contributions published in a twice-yearly periodical with print runs of 100–200. Originally billed as focusing on economic modelling, discussions moved on to include more general issues of economic policy, including once the daring topic of reform attempts in Hungary, a theme that found no place in official public discourse. At some point in mid-1984 the StB were alerted to these seminars and detailed reports from at least one informer operating close to Klaus provide more information. Attendance reportedly grew from 50 to 120, of whom the informer recognised two Charter 77 signatories and two economists previously expelled from the party, Kouba and Mlˇcoch. The informer did not add that there were also government employees, including František Vencovský, then deputy minister of state planning. Three age groups were identified, covering the older generation, the middle generation, including faces from the Economics Institute, and younger economists at the start of their careers. These reportedly enthusiastically absorbed the relatively open style of debating but would go home ‘in a deep depression at the economic situation and convinced of the need for a radical solution’ (ABS KR 797608 MV, p. 261). Tomáš Ježek, an active participant who became Minister for Privatisation in the Czech government from 1990 to 1992, was later interviewed by the StB and confirmed the informer’s observation that Klaus was the ‘spiritual father’, the driving force and organiser who chaired all sessions (ABS KR 797608 MV, p. 373), although he was formally working with a committee of six. Klaus reportedly actively led the discussions, encouraging speakers towards critical and unorthodox positions. His conception, set out at the fiftieth meeting in March 1985, was reported to be providing an opportunity for those excluded from working in economic theory, such as Mlˇcoch, and as a means to bring together people who could support each other and spread ideas to create a ‘new philosophy of thinking which does not correspond with official science’ (ABS KR 797608 MV, p. 285). At the same time, he wanted broad participation and included debates on quite detailed issues of contemporary policy that involved speakers fully acceptable to the regime. He did not favour outright opposition and the published collections were, in his view, carefully enough written to keep within the limits of the possible. In fact,

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Kouba reportedly annoyed him by arguing for a more open opposition to the official positions, risking, in Klaus’s reported view, narrowing the seminars’ appeal (ABS, KR 797608 MV, pp. 127–129). Clearly, this was not an attempt to formulate an alternative policy agenda, but it was arguably a first step towards the dialogue craved, as indicated above, by Turek, Kožušník and others. They, however, were not present and nor was Šulc. The security police decided that these seminars should be stopped after they had discovered that another series was being run, also under the title of the same scientific-educational organisation, by Miloš Zeman. He had been expelled from the party in 1970 and then found a home, alongside some other intellectuals under political suspicion, in Sportpropag, an organisation running sporting facilities which contained a unit tasked with forecasting the future needs of sport and physical education. Zeman and others found the means to interpret this rather broadly. He had been responsible for publishing a collection of contributions in 1983 which was judged by the party hierarchy to be ‘non-Marxist’, incidentally also containing chapters by Kouba and Klaus, the latter expressing his view that accepted economic theory was inadequate. Zeman had then been forced to find an alternative employment, from which, to the horror of the StB, he was again organising seminars, and again inviting Klaus as a speaker (Zeman 2005, pp. 59–63, Sommer et al. 2019, p. 80). The StB interviewed the organisers of both of the seminar series, in the hope of frightening them and then, without openly intervening, ensured that the relevant top managements closed the seminars down before Klaus’s 57th event, scheduled for January 1986. Zeman continued with sporadic seminars, sometimes allowed and sometimes forbidden. In August 1989 an article in his name was finally published (Zeman 1989), leading to a television debate and a substantial sensation (Zeman 2005, pp. 60–69). The theme was forecasting, his professional activity. In the witty and incisive style that was to become well known to the public in later years, he likened established thinking to that of a marathon runner who had lost sight of the other competitors over the horizon and therefore assumed himself to be in the lead. The fault lay in the lack of a feedback mechanism to exercise control over those in power. This established Zeman as a leading critic of the old, if not a visionary for the future. Although Klaus’s seminars did not fulfil his ambition of creating a ‘new philosophy of thinking’, they did establish him with a substantial community of economists as the leading figure in such an attempt.

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In his own economic thinking, Klaus’s defining characteristic, as outlined by Geršl (2006), was faith in what he saw as ‘standard’ economic theory, which meant the orthodoxy of the time in western economic thinking. In contrast to individuals mentioned above, he did not seek the most appropriate theoretical approach for solving problems. Instead, he seemed to be seeking out problems that could be understood in terms of ‘standard’ economic theory. A continual concern, from the 1960s onwards, was inflation, which he understood as a state of macroeconomic imbalance that might or might not be reflected in open price increases. From an early Keynesian interpretation, when that was standard in the UK and US, he moved increasingly to neo-classical economics and to Milton Friedman’s views on the centrality of controlling the money supply. He linked this change in his thinking to 1970 when he was absorbing works of Mises and Hayek (Hájek and Klaus 2001, pp. 343–345). His defence of ‘standard’ economic theory led him to maintain its universal applicability to all economic systems. This contrasts with the approaches of Mlˇcoch, Šulc and others who sought alternative tools for analysing a socialist economy. In fact, Klaus wrote little about economic systems and what he did write led to the conclusion that Czechoslovakia was largely already a market economy, albeit of a distorted kind (Klaus and Tˇríska 1988). His focus was on macroeconomics and imbalances at the macro level. He used econometric methods in a search for inflationary pressures and evidence of forced saving and panic buying in the face of shortage. Despite imaginative efforts, neither he nor other researchers could show macroeconomic disequilibrium as a major problem for the Czechoslovak economy (Myant 1989a, pp. 213–219), in obvious contrast to Poland. He found himself arguing that ‘macroeconomic instruments’ could bring equilibrium on all important markets, largely solving the system’s problems (Klaus and Tˇríska 1988, p. 825). He later admitted that he did not know ‘precisely where we are, where we want to go and, especially, how to get there’ (Klaus 1989, p. 31). On whether policy changes could be made without systemic changes he was ‘not sure about it’ (Klaus 1989, p. 11), but he defended very modest changes being undertaken by the government in late 1989 when on a trip to Chicago in August 1989, claiming that ‘we are already in a transitional process concerning the economy’ (Betz-Eck 1989). His first published contribution after 1989, albeit written in 1988 (Klaus 1990), advocated a process of gradual change

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rather than a single act and warned against excessively restrictive policies that would slow economic growth. It could be read as a cautious and equivocating version of Šulc’s proposals.

6

The Gorbachev Factor

From 1987 the atmosphere in Czechoslovak economic debate began to change. The stimulus, as in other intellectual fields, was the change initiated in the Soviet Union under Mikhail Gorbachev (Pullmann 2011; Kopeˇcek 2019). A very direct consequence of Soviet changes was a desperate bid by the Czechoslovak party leadership to keep pace with the introduction of a law in the USSR defining independence for stateowned enterprises. Rather than being shown up by waiting to be told, they set about developing a Czechoslovak version. The task was taken on by Vratislav Šlajer, working in a training unit attached to the government, who had had the good fortune to have seen one of the samizdat copies of Šulc’s book. He approached the author for help and Šulc obliged with a modified version of a draft law on the same topic prepared in 1969. Despite Šlajer’s attempts to reuse this, the published version was substantially amended to avoid any references to market relations (Šulc 2011, pp. 191–194). Other figures from 1968 found their way back towards acceptability, partly thanks to the Institute of Forecasting, a multi-disciplinary body established in 1987 with the formal task of working on a long-term forecast for the economy and society. The head was Valtr Komárek, an economist who consistently favoured a change in sectoral structure away from traditional heavy industries but who had little to say on systemic reform. He recruited economists and social scientists with diverse views, including eight later to become government ministers, among them Klaus, Ježek and Zeman. He also involved Turek and others from the older generation. The Institute of Forecasting was the nearest to a possible centre for preparing a strategy of economic transformation. Its internal discussions led to a synthesis, complete in early 1989, that contained many worthy ambitions for improving economic performance, but was vague or evasive on crucial issues and internally inconsistent as a result of the conflicting views of the multiple authors. On the price system it advocated gradual

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freeing, tied to steps to reduce the power of potential monopolies. On enterprise independence, it set out various alternatives without a clear proposal. On property forms it favoured ‘a plurality’ which did include ‘private enterprises without limitations to their size’ (Komárek et al 1990, p. 228). There was no discussion on how to reach this plurality of ownership forms. At least discussion had started, bringing together the generations. Some critical contributions could be published and the older generation had little reason to exercise internal censorship, having no careers to defend. Turek (1989) and Šulc (1990a) offered the most coherent and detailed programmatic proposals, albeit without any references to privatisation. A new, younger generation was appearing, with more explicit commitment to neo-liberal thinking. Among the ‘middle’ generation Ježek was unusual in identifying with this trend before 1989, translating and circulating Hayek’s Road to Serfdom and confident that he was excellently prepared for preparing the transformation that was to come. However, Hayek and Mises were useful primarily for their critique of central planning. This gave them an obvious appeal across east-central Europe where economists could quickly relate to their arguments and become admirers, although their ideas were little use for describing the complex nature of a real market economy or for giving guidance on how it could be achieved. This became clearer in Hungary and Poland before it was clear in Czechoslovakia.

7

Parallels with Hungary

Hungarian economic thinking developed within a less repressive environment and there was no analogy to the separation into two generations of economists. The reform of 1968 was partially reversed in the 1970s as the centre retook control, but the thinking behind it was revived in the face of economic difficulties after 1979 and intensified at the end of the 1980s. The learning process among economists was therefore more continuous and collective, building notably from a famous contribution by Marton Tardos in 1972 for achieving an institutional system to guarantee enterprise independence through competing state-owned holding companies. Debate reopened in 1982 in the mainstream media, building from Tardos’s earlier proposals to consider workers’ self-management at enterprise level, a state-property agency supervising enterprises only for long-term profitability, self-managed holding companies or control

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through share holdings by pension funds (Swain 1992, p. 135, Berend 1990, pp. 247–249). One economist who went further was Tibor Liska with his conception of ‘entrepreneurial socialism’. He was prevented from publishing freely, such that the book he completed in 1964 was not officially published in Hungarian until 1988, although his main ideas had been summarised by others (Bársony 1982) and were debated in a series of weekly seminars that he organised in 1982. His model was for a market system with free prices in which everybody would be allowed to bid for the right to exercise ownership rights over individual items of state property. This was tried out in an experiment in a cooperative farm where activities were put out to tender (Berend 1990, p. 252). The important point for the development of economic thinking is that Liska’s ideas were discussed, criticised and generally dismissed as unworkable for large-scale enterprises, especially by Berend and Kornai. Although Liska’s conception differed substantially from later ideas for rapid, mass privatisation in Poland and Czechoslovakia, this debate has been quoted as enabling Hungarian economists to conclude that dispersed private ownership was unworkable so that ‘the flaws of the voucher proposal were already known’ (Mihályi 2000, pp. 141–142). In April 1987, facing a worsening economic situation, the ruling party initiated a debate involving a large number of professional economists and accepted much of what was proposed by the strongest advocates of a more rapid pace of transformation. One key issue was caution over the ‘strict limitation of demand’ applied through the 1980s which, in the critics’ view, should not be taken too far as it was causing such major financial difficulties in many enterprises that they would face bankruptcy if not helped by the centre, thereby preventing the development of a market system (Antal et al 1987, pp. 193–194). This could be a warning against the kind of shock therapy later introduced in Poland. The second issue was enterprise transformation on which previous ideas had been developed and supplemented with thoughts on privatisation, albeit with the acceptance that ‘genuine privatization is a very slow procedure in a country where private wealth is negligible’ (Tardos 1992, p. 293). Kornai (1990), intervening for the first time in a current policy debate, was even more forceful, suggesting that state ownership would dominate for another 20 years. This was not well received among advocates of radical reform and Tardos (1989) found an apparently ambitious way forward, including a capital market with citizens able to buy

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shares, while most of the shares in bigger enterprises would be owned by other enterprises through forms of mutual ownership. Tardos mentioned vouchers only as a possible extension of his holding-company model such that state-controlled insurance companies, pension funds and municipalities could acquire shares in state-owned enterprises (Greenhouse 1989, p. 4). Caution was stimulated by two further factors. The first was the experience of privatisation at the end of the 1980s (Stark and Bruszt 1998, pp. 58–64). Thanks to a number of changes in enterprise laws to allow for more forms of ownership, it became possible for enterprise directors to set up a new company and transfer to it assets of a state-owned company. This so-called spontaneous, or nomenklatura, privatisation, allowing rapid individual enrichment of powerful individuals, won widespread criticism and the government in March 1990 responded by creating the State Property Agency as the ultimate owner with aims that included strengthening the state so as to protect its property. The second feature was that political changes led to contested elections in April 1990 and thence to a government which left the most radical economists linked to the political opposition. Change was therefore slow, albeit with pressure for faster privatisation of large enterprises which the government gradually accepted, especially by more sales to foreign companies. Hungary’s experience, when set against that of Czechoslovakia, shows past history influencing the transformation strategy. It was often suggested that past economic reforms meant that things would be easier because of greater experience of market relations. It seems at least as important that experience of reform and the ability to discuss and debate policies helped economists to formulate thinking and to avoid advocating some of the policies pursued in Poland and Czechoslovakia. That does not mean that governments did not make other mistakes or that prospects were particularly good in view of the low level of economic competitiveness and a level of per capita external debt that was higher even than that of Poland.

8

Parallels with Poland

Polish experience differed from that in Czechoslovakia in several respects. There was generally a freer atmosphere, allowing for more pluralism of opinions, but there was no equivalent to the reform attempt of the 1960s. The first such serious attempt came in the early 1980s, linked to the

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rise of Solidarity. That ensured a strong bias towards self-management, a proclaimed objective of the new union although more as a political project than as part of a mechanism for economic management. This timing also coincided with a prevailing sense of crisis both economic, with high external debt and pervading shortages, and political, with the collapsing authority of the ruling party and government. Crisis meant pressure for rapid and dramatic change rather than for a slower evolution that seemed more acceptable in Hungary. The crisis and rise of Solidarity in 1980 put issues of political change and economic policy above those of changes to the economic system. Economic advisers divided into ‘optimists’, represented by Stefan Kurowski who believed a new policy orientation could bring economic recovery and ‘pessimists’, represented by Ryszard Bugaj, who saw no alternative to accepting reduced real wages, but wanted political change in return (Myant 1982, pp. 207–208). Both of these advisers to Solidarity suffered internment under martial law in 1981-1982, but were later able to express their views more freely than those silenced in Czechoslovakia. However, close links to the Solidarity union generally led to an emphasis on the need for political change while avoiding prior support for government-decided price rises aimed at restoring market equilibrium. Such was the essence of Bugaj’s contributions in 1986 which were still subjected to substantial pre-publication censorship (Myant 1989b, pp. 18–19). Kurowski could teach again at the Catholic University in Lublin where he worked with others on questions of economic reform. However, a substantial book on economic policy written in 1987 and 1988 had very little new to propose in this area, emphasising instead a political critique of the existing system as a totalitarian regime that set such inappropriate priorities such as military production (Kurowski 1990, p. 340). As he had argued in 1981, the need was for a structural change ‘from tanks to washing machines’ (Myant 1982, p. 208). He can be found accepting the need for increases in the prices of basic foods, but the mainstream Solidarity position, including in Round Table discussions of February to April 1989, still showed opposition to accepting a fall in nominal living standards. New thinking on the economic system therefore developed at a distance from the Solidarity union. The regime, verbally committed to market-oriented reform, could not solve the problem of global macroeconomic equilibrium as it could not hold back wage demands in face of price rises that it tried to institute. Reform was to be pursued with renewed vigour in a so-called second stage

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in 1987, only to be met with a rising strike wave in opposition to large price rises. Changes in enterprise law also allowed spontaneous privatisation to powerful managers, as in Hungary, and that spawned considerable and lasting distaste (cf Balcerowicz 1995, p. 355). This may therefore have dampened enthusiasm for rapid and uncontrolled privatisation in later years. An important line of thinking for an alternative was developed by Janusz Lewandowski and Jan Szomburg. They started with an interest in self-management as advocated by Solidarity and therefore not primarily as a means of enterprise management (Lewandowski and Szomburg 1985). However, studying Mises’s arguments in the socialist calculation debate, they accepted the need for a genuine capital market and private ownership if any market was to function rationally. Presenting their views at a conference in 1987, they saw no useful way forward apart from ‘an act of euthanasia’, dividing up state property. In view of the inadequate level of domestic savings, shares would be distributed in part in exchange for free vouchers given to every citizen and in part on favourable terms to enterprise employees (Lewandowski and Szomburg 1989). Lewandowski later became Minister for Privatisation, but they were already amending their views as he took office, criticising the free distribution of shares on many grounds, including that the resulting dispersed ownership would contribute nothing to solving concrete problems of enterprise transformation. They looked favourably on a road of commercialisation of enterprises, rewarding incumbent management with shares such that they would gradually become joint owners (Lewandowski and Szomburg 1990, pp. 12–14). The voucher method was later adapted and applied more gradually and in modified form to a minority of existing enterprises. Thus, these two authors had followed a familiar intellectual trajectory of enthusiasm for Mises’s views, tempered when they saw the difficulties in translating them into credible policies. Another group developed around Leszek Balcerowicz, producing a reform model in 1980 based on self-management. Apart from Mises and Hayek, he later learned more about capitalist economies through studying the experiences of South Korea and, as one of the few to follow Šulc’s example although the two presumably had no knowledge of each other, the post-war German experience. However, he, and his colleague Marek D˛abrowski (1990), took a different route from Lewandowski and Szomburg. Criticising what he understood to be Kornai’s view, D˛abrowski concluded that shortage in Poland was not caused by the economic

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system but by excess demand and that that needed to be solved before a reform could be effective. He added, and Balcerowicz (1995, p. 347) was to give some acceptance to the same view, that conditions of market equilibrium could lead to changed behaviour from enterprises while still under state ownership. There was therefore hope before privatisation which, they had concluded, would be a relatively slow process. The free transfer of shares was rejected as it would not lead to active owners and, it was argued, would contribute to inflation by increasing personal wealth and hence spending power. Instead, the programme favoured by Balcerowicz put the primacy on ending wage indexation so as to stop inflation. The main alternative for radical reform at the time, one which he rejected (pp. 343–344), put all the emphasis on privatisation without attempting to control wage increases by administrative means. The story of Balcerowicz’s rise to become Minister of Finance and how he won approval for his programme is retold elsewhere (Balcerowicz 1995, Kowalik 2011). He was not the first choice of Tadeusz Mazowiecki, Poland’s post-communist prime minster taking office in September 1989, but he could fit the bill as potentially ‘Poland’s Erhard’. His radical stabilisation programme did not build from detailed experience of past economic reform attempts which were anyway less revealing in Poland than in Hungary or Czechoslovakia. It was largely based on precedents from IMF stabilisation packages for countries facing severe internal and external disequilibrium. It had great attractions from the political point of view. It was presented as a radical and decisive step at a time of economic and also political crisis as the new Solidarity government lacked a plausible economic strategy. The details were worked out rapidly, without much open discussion, and approved by parliament with minimal debate or opposition. The essence of the Balcerowicz programme was price and currency liberalisation, including a sharp devaluation raising import prices, alongside very strict wage control, such that price increases led to a fall in the real level of demand and a resulting decline in output. Controlling inflation was not a new priority and greater urgency seemed to be added after the last communist-led government liberalised food prices, leading to a new wage-price spiral. However, there were immediate criticisms that the programme had ‘over-shot’ and that a milder shock would have been sufficient. Balcerowicz did not deny that he had not made precise predictions of the effects of what he described as his ‘jump into the hole, without checking either the state of the water or the depth

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of the drop’ (Myant 1993, p. 84). The important point may be that the exact consequences were not a major concern because, unlike their colleagues in Hungary, these Polish economists did not see the danger of anti-inflationary measures blocking systemic transformation. That had not been part of Poland’s limited past experience of economic reforms. They were soon to be faced with the need for improvisation to deal with consequences of enterprise debt and impending bankruptcies.

9

Czechoslovakia’s Transformation

The Czechoslovak transformation followed changes in Hungary and Poland, but no systematic lessons were taken from those two countries. Economists in all cases seemed to work only from their own country’s experiences. Political changes led to the rise of Klaus to the position of federal minister of finance. However, the new deputy prime minister in the Czech government was František Vlasák, a former minister in 1968 who was supported and trusted by Václav Havel for his role in November and December 1989. He immediately set about creating a commission to work on systemic change, bringing in Šulc, Turek, Kouba and others. They produced an excessively detailed programme, ready in May 1990, which included Šulc’s idea of a National Property Fund that would oversee state-owned enterprises and that would be able to sell them into private ownership. As new private enterprises were by then welcomed and rapidly appearing, this would have put Czechoslovakia in a fairly similar position to Hungary at the same time. Klaus, in the meantime, brought in Ježek and Dušan Tˇríska—a close colleague later revealed to have been an StB informer—as advisers. According to Ježek, it was while walking in a garden in the middle of a large meeting in February 1990 that he and Tˇríska came up with the idea of voucher privatisation (Husák 1994, pp. 102–103). Klaus was reportedly angry, having previously avoided mentioning privatisation, but quickly adopted the idea as his own. There were suggestions that exaggerated pride in the originality of the idea were leading to delusions of a possible Nobel Prize (cf Pithart 2015, p. 121). The trio had missed the benefits of reflection and discussion that had tempered enthusiasm for rapid, mass privatisation in neighbouring countries and seemed unaware that their idea was not new. Apart from Polish and other precedents Jan

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Švejnar, returning from emigration in the US, was proposing a transformation strategy including free distribution of shares and was even present at precisely the same meeting. His ideas were ignored. The subsequent development of the Czechoslovak transformation strategy is covered elsewhere (Myant 1993). It included an attempt at rapid, mass privatisation accompanied by vitriolic condemnation of Šulc’s conception as no more than an attempt to repeat reform communism. For Ježek (2007, p. 19), the only barrier to his ‘clear’ concept was the ideas from 1968 and he was totally opposed to a National Property Fund that he saw as just another State Planning Commission: nothing should be allowed to happen before enterprise privatisation. This was to prove more complicated in practice. There was an analogy to Poland’s shock, but with less dramatic effects. Again, there were alternatives, based on speedy price liberalisation but a slower opening of the economy such that a degree of continued protection would obviate the need for too large a devaluation, thereby holding price increases in check. Needless to say, Šulc pointed out that this would have been in line with previous West German experience. Irrespective of the economic merits of the argument, Klaus was driven by a political imperative to appear confident and decisive and to win accolades abroad for path-breaking measures. Opinion polls, and also contributions in parliamentary debates, confirm that he had successfully created the impression of being an expert in ‘standard’ economic theory, giving him the right to be trusted on economic policy issues that few claimed to understand. The days when he would encourage wide-ranging debate, even if also nudging it in a particular direction, or seek to cooperate with those who did not accept his views, passed when he became an ambitious politician. Opponents, who never achieved the same political profile, were successfully denigrated as relics of the past. Pithart, who should have been much better informed than most of the public, later recognised that ‘in 1990 the transformation scenario was implemented which should not have won’ (Pithart 2015, p. 243) and regretted that he had allowed himself to be convinced by Ježek’s insistence on the need for the fastest possible privatisation. Assessing how far a different strategy could have led to a substantially different outcome is beyond the scope of this chapter.

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References ABS (Archiv bezpeˇcnostních složek, Security Services Archives). https://ebadat elna.cz. Antal, L., Bokros, L., Csillag, I., Lengyel, L., & Matolcsy, G. (1987). Change and Reform. Acta Oeconomica, 38(3–4), 187–213. Balcerowicz, L. (1995). Socialism, Capitalism, Transformation. Budapest: Central European University Press. Bársony, J. (1982). Tibor Liska’s Concept of Socialist Entrepreneurship. Acta Oeconomica, 18(3–4), 422–455. Berend, I. (1990). The Hungarian Economic Reforms 1953–1988. Cambridge: Cambridge University Press. Betz-Eck, S. (1989, August 20). Economist Lifts Curtain on Czech System. Chicago Tribune. Brus, W. (1972). The Market in a Socialist Economy. London: Routledge & Kegan Paul. D˛abrowski, M. (1990). Reforma, rynek, samorzad. ˛ Warsaw: Panstwowe ´ Wydawnictwo Ekonomiczne. Eucken, W., & Hutchison, T. (1948a). On the Theory of the Centrally Administered Economy: An Analysis of the Germane Experiment: Part I. Economica, 15(58), 79–100. Eucken, W., & Hutchison, T. (1948b). On the Theory of the Centrally Administered Economy: An Analysis of the German Experiment: Part II. Economica, 15(59), 173–193. Geršl, A. (2006). Ekonomické myšlení Václava Klause do roku 1990. Prague: Nakladatelství Karolinum. Greenhouse, S. (1989, December 17). Eastern Europe Awaits the Storm. New York Times. Hájek, P., & Klaus, V. (2001). Václav Klaus narovinu. Prague: Rabbit & Rabbit. ˇ Husák, P. (1994). Budování kapitalismu v Cechách Rozhovory s Tomášem Ježkem. Prague: Mladá fronta. Ježek, T. (2007). Zrození ze zkumavky: Svˇedectví o cˇeské privatizaci 1990–1997 . Prague: Prostor. Klacek, J., & Kupka, V. (2018). Renesance cˇ eské ekonomie Pražské jaro 1968 a ˇ Ekonomický ústav CSAV. Soudobé Dˇejiny, 25(1–2), 109–146. Klaus, V. (1989). Socialist Economies, Economic Reforms and Economists. Prague: ˇ Prognostický ústav CSAV. Klaus, V. (1990). K obsahu i strategii pˇrestavby hospodáˇrského mechanismu. Hospodáˇrské noviny, No.2, supplement, pp. 3–5. Klaus, V., & Tˇríska, D. (1988). Ekonomické centrum, pˇrestavba a rovnováha. Politická Ekonomie, 36, 817–829.

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Komárek, V., et al. (1990). Prognóza a program. Prague: Academia. ˇ Kopeˇcek, M. (2019). Vládnout právem Ceská právní vˇeda od “represivní legality” k právnímu státu, 1969–1994. In M. Kopeˇcek (Ed.), Architekti dlouhé zmˇeny ˇ Expertní koˇreny postsocialismu v Ceskoslovensku. Prague: Argo, Filozofická ˇ fakulta Univerzity Karlovy, Ústav pro soudobé dˇejiny AV CR. Kornai, J. (1980). The Economics of Shortage. Amsterdam: North Holland. Kornai, J. (1990). The Road to a Free Economy. New York, NY: W. W. Norton. Kouba, K. (1970). Comment on Academician Khachaturov’s Paper. Planning and Market Relations (pp. 73–8). Prague: Economic Institute of the Czechoslovak Academy of Sciences. Kowalik, T. (2011). From Solidarity to Sellout: The Restoration of Capitalism in Poland. New York, NY: Monthly Review Press. Kurowski, S. (1990). Polityka gospodarcze PRL. Warsaw: Editions Spotkanie. Lewandowski, J., & Szomburg, J. (1985). Samorzad ˛ w dobie, Solidarno´sci”. London: Odnowa. Lewandowski, J., & Szomburg, J. (1989). Własno´sc´ jako próg reformy gospodarczej. Przeglad ˛ Polityczny, 12, 20–28. Lewandowski, J., & Szomburg, J. (1990, November 9). Dekalog prywatyzacji. Tygodnik Solidarno´sc´ , 45 (112). Mihalyi, P. (2000). Corporate Governance Before and After Privatization: The Lessons from Hungary. In E. Rosenbaum, F. Bönker, & H-J. Wagener, (Eds.), Privatization, Corporate Governance and the Emergence of Markets (pp. 139– 154). Basingstoke: Macmillan. ˇ Mlˇcoch, L. (1970). Teorie firmy. Prague: Ekonomický ústav CSAV. Mlˇcoch, L. (1990). Chování cˇeskoslovenské podnikové sféry. Prague: Ekonomický ˇ ústav CSAV. Myant, M. (1982). Poland: A Crisis for Socialism. London: Lawrence and Wishart. Myant, M. (1989a). The Czechoslovak Economy 1948–1988: The Battle for Economic Reform. Cambridge: Cambridge University Press. Myant, M. (1989b). Poland—the Permanent Crisis? In R. Clarke (Ed.), Poland: The Economy in the 1980s (pp. 1–28). Harlow: Longman. Myant, M. (1993). Transforming Socialist Economies: The Case of Poland and Czechoslovakia. Aldershot: Edward Elgar. Pithart, P. (2015). Po devˇetaosmdesátém Rozpomínání a pˇremítání. Prague: Academia. Pullmann, M. (2011). Konec experimentu: Pˇrestavba a pád komunismu ˇ v Ceskoslovensku. Prague: Scriptorium. ˇ Sommer, V., Spurný, M., & Mrnˇ ka, J. (2019). Rídit socialismus jako firmu. Techˇ nokratické vládnutí v Ceskoslovensku 1956–1989. Prague: Ústav pro soudobé ˇ dˇejiny AV CR.

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Stark, D., & Bruszt, L. (1998). Postsocialist Pathways: Transforming Politics and Property in East Central Europe. Cambridge: Cambridge University Press. Šulc, Z. (1990a). Cílové rˇešení a problémy pˇrechodu v ekonomické reformˇe. Hospodáˇrské noviny (No.ˇe, supplement), pp. 6–11. Šulc, Z. (1990b). Jak se zrodil západonˇemecký “hospodáˇrský zázrak”. Prague: Práce. Šulc, Z. (2000). Psáno incognito Doba v zrcadle samizdatu 1968–1989. Prague: ˇ Ústav pro soudobé dˇejiny AV CR. Šulc, Z. (2004). Stát a ekonomika. Prague: Nakladelství Karolinum. Šulc, Z. (2011). Z jevištˇe i zákulisí cˇeské politiky a ekonomiky Vzpomínky novináˇre a ekonoma 1945–1995. Brno: Doplnˇek. Swain, N. (1992). The Rise and Fall of Feasible Socialism. London: Verso. Tardos, M. (1989). Economic Organization and Ownership. Acta Oeconomica, 40(1–2), 17–37. Tardos, M. (1992). The Property Rights in Hungary. In J. Kovács & M. Tardos (Eds.), Reform and Transformation in Eastern Europe: Soviet-Type Economies on the Threshold of Change (pp. 283–295). London: Routledge. Turek, O. (1989). Podklad pro „ˇríjnový“ materiál PgÚ—úsek rozvíjení reformy, typescript. Vencovský, F., Pulpán, ˚ K., et al. (2005). Dˇejiny mˇenových teorií na cˇeském území. Prague: VŠE. Zeman, M. (2005). Jak jsem se mýlil v politice. Prague: Ottovo nakladatelství. Zeman, M. (1989, August). Prognostika a pˇrestavba. Technický magazín, pp. 6–9.

The Hard Budget Constraint as the Pillar of the Economy Michael Keren

1

Introduction

The transition from bureaucratic socialism to the market is a matter of the past, yet the past has left its marks on the economies that made this transition. An important lesson of this transition is the major effect of the hardness of the budget constraint (BC) on the process, on the resulting economy, and even the state as a whole. The hard budget constraint (HBC) may seem too technical a concept to attract much attention, but closer examination reveals its central importance to the economy in particular and to the state in general. Neither should one overlook its ethical import: an HBC means that you receive the fruits of your own labor, that you earn what you have contributed, and that your punishment fits your crime. To be constrained by your budget means that you are protected from the fangs of predators and that others need not fear that you may deprive them of what is theirs. To be hard,

I am grateful to Naftali Greenwood who has rendered this paper legible. M. Keren (B) The Hebrew University of Jerusalem, Jerusalem, Israel e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_4

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however, your BC needs protection, and to grant this protection is the task of the state. The vital role of the state can be seen in the extreme differences in the success of transition in countries that had very similar economic structures under socialism. The countries of Eastern Europe that joined the European Union in 2004 were much more successful in transforming their economies from the centralized socialist mode to the market paradigm than were the successor states of the former Soviet Union (fSU), headed by the Russian Federation. Even the EU joiners, however, are a disparate group in their religion, history, and success in creating a well-functioning economy. Thus Bulgaria is by far the least successful of the EU joiners in subduing corruption (see Sect. 5 below). The fSU countries, however, are in a different league altogether: they plunged into a morass of corrupt kleptocracy, from which they have not yet managed to extricate themselves.1 The different paths of these two groups of countries may be blamed on extreme differences in the kind of state that emerged from the collapse of the communist regimes. The explanation lies in the success that governments had in instituting an environment that supports capitalist entrepreneurship, i.e., one that eradicates the obstacles that socialism places on the path to private entrepreneurship. Socialism, as the term is used in this paper, is a system that prohibits private ownership of means of production, or of productive organizations, i.e., totally forbids the founding, nay, the very existence of non-state firms and allows private enterprise to play no role. The end of socialism therefore meant that private entrepreneurship was henceforth permitted. The success of private entrepreneurship, however, requires the protection of property and contract, i.e., the safe ownership and transfer of assets by non-state legal persons. The extent to which this radical change occurred took on very different guises in the countries discussed: In some of the East European countries, the old communist regime was swept out of power and its apparatchiks were replaced by new elites that aimed at radical market reforms. This group of countries intended to join the EU and the latter’s accession requirements accelerated the change in their polity. These were the first states to emerge from the transformational recession, as the post-communist decline in output was called by Kornai (1993, 1994) and their income slump was the gentlest 1 Hopefully Ukraine under Zelensky may be on its way to a cure, despite the best efforts to Trump it.

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(see Sect. 5). Yet even here there were laggards, vis. Bulgaria, where corruption was too deep to even try to suppress. Bulgaria was slower than the others to defeat this scourge and is still hampered in its often half-hearted fight against it. Some countries that were initially successful, e.g., Poland and Hungary, are backsliding. Here history is to blame (Economist 2019b). When the Soviet Union collapsed, weak new states had to sink roots in its ruins. The major successor countries, Russia and Ukraine, were slow to rebound to their pre-transition income levels. Where growth has taken root in fSU countries, usually it has been thanks to commodity exports, mainly oil. The only exceptions are the three Baltic states, which joined the EU. As a point of reference, it may be instructive to bring two countries in eastern Asia, China and Vietnam, into the picture. Although the Communist Party remains in power in both, socialism in the sense defined above was given up by Deng some four decades ago and somewhat later in Vietnam, and private entrepreneurship was allowed to enter and flourish. Many state-owned enterprises (SOEs) were sold to private interests and the symbiosis of private firms and SOEs that now exists has achieved remarkable growth. These East Asian tigers highlight the opportunity that Eastern Europe squandered. To sum up, one can find many differences among these four groupings of formerly socialist economies. Some trace to history and others to religion, and each of these features has its influences. The most important characteristic, however, is the nature of government that arose in each country—which, of course, was affected by some of the historical factors. An efficient private market requires hard budget constraints, freedom of entry, and, obviously, some degree of assurance of ownership. Accession to the EU, even its very promise, was highly effective in advancing real reforms (Pinto et al. 1993). Most countries that did not join the EU and had no prospect of joining have not yet managed to achieve the assurance of property and competition. The affaire Yukos is a case in point; it shows that under Putin there can be no rule of law; instead it is replaced by the law of the ruler and his whims. It is the relations that exist among the state, private ownership, and entrepreneurship (with special emphasis on incentives for entrepreneurs) that explain why weak states, or arbitrary states, find it hard to transition to efficiently-run capitalist economies. Section 2 examines the incentives of bureaucrats and Sect. 3 probes the motivation of the socialist manager.

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The following Sect. 4, argues why the state cannot be constrained by a hard BC. Section 5 compares the different growth experiences of the countries of Eastern Europe as against those of the fSU. The final section, “The lessons of the transition,” concludes.

2

Bureaucratic Incentives

To appreciate why a real change in the bureaucratic state’s behavior could be initiated only upon the transition, we must first understand the roots of bureaucratic behavior. The first point to stress is that momentary income is not at the top of bureaucrats’ priorities. Bureaucrats are concerned with their lifetime careers and select their strategies in reference to this long-term goal. Those who determine their progress are their superiors. Therefore, managers have to remain in the good graces of their bosses, who shape their career and reputation. In a market economy, outsiders who may offer them alternative employment would also base their bids on a reputation determined by superiors. They would usually be concerned with profits or, to be more precise, with their firms’ success in the market. This is what counts: falling behind competitors may sound an alarm ahead of a possible takeover or even bankruptcy, endangering the actors’ incumbency. Therefore, a capitalist manager always has to take profitability and market position very seriously. Comparisons with Hungary and Poland show similar attractions for the ideas of Mises (1920, 1970) and Hayek (1945, 1978), but also a developing recognition in those countries that their critique of socialism was not enough for a reform strategy. In socialism, no alternative employers exist. Superiors in the industrial ministry and the Party are the sole arbiters of careers and it is to their interests that the manager must cater. To the socialist superior, today’s profits are of secondary importance at best and have scanty influence on a manager’s lifelong career; they count for little in his incentives. What counts for the socialist manager is adherence to the (ever changing) plan and its spirit (Sect. 3). One of Kornai’s greatest insights is his recognition of the close relation between socialism and the soft budget constraint (SBC). In fact, the SBC is the obverse of the inability to close down loss-making firms and the need to supply them with liquidity to enable them to stay alive. The reason for this is that decisions to found or wind down firms in a socialist economy are political in nature, taken by political authorities for whom, again, profitability plays a very minor role. Given the arbitrary

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price system, this is perhaps sensible. The SBC allows enterprises to disregard the market and keep risky innovation at arm’s length. Hence the first task in transitioning to the market is to harden the budget constraint.

3

Socialist Managers

Socialist managers, as we have seen above, aim at pleasing their superiors and, as a corollary, refraining from annoying them. How do they accomplish the latter and what, in turn, is their derived maximand? It is often taken for granted with regard to any manager of any productive or even administrative unit that profits are their concern. This, however, does not hold for many classes of firms, even in market economies. Consider government-owned firms, SOEs, in market economies: managers of public firms are often judged by criteria that have little to do with profits. They sometimes have to supply, say, electricity, without even being sure that the consumers will pay for its use, as the Indian example shows (BBC 2006; Economist 2005). At other times, their political bosses are interested in maximizing employment and abhor any dismissals that profit-seeking would require. For others, what counts is “jobs for the boys.” In all these cases, profitability has very low priority. Public utilities, even when private, are assured of their basic profits and often strive for an easy life that will not endanger their continued incumbency as sole suppliers. The same applies to monopolists, who are sure of their protection against competition.2 For managers in socialist Soviet-type economies (STEs), in contrast, profit-seeking is not a priority goal and profits themselves are of low priority, as noted. Whatever their true incentives may have been, it is arguable that the primary task in the transition was to change these socialist incentives into profit-seeking ones. First, however, we have to understand what really drove these socialist SOE managers. To do this, we first have to identify the environment in

2 A personal anecdote regarding AT&T in the 1960s may be in place here. I had an appointment in western Massachusetts with a friend who lived in its far east when my grandmother died in New York and I had to stay for her funeral. I knew only my friend’s first name, the initial of his surname, and the name of his (big) university, but not his college. With this meager information, I called AT&T and asked for assistance. It took over two hours to locate our friend, and the friendly operator helped me patiently. I doubt that this would have occurred in the competitive environment of today’s phone industry.

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which they functioned. The core of a socialist economy is public ownership of all means of production, i.e., firms. Such was the case in most East European economies or in most sectors of all of them.3,4 In a socialist economy, there can be no entry or exit of enterprises unless it is initiated by the state. There is no trade in the ownership of firms, and, thus, no capital market. As a result, a competitive socialist market cannot function effectively and cannot support a scarcity-based price system (Keren 1993). To sum up: In an STE, all enterprises are bureaucratically run as parts of one huge monofirm, as Western researchers call it. Enterprise managers and higher-ups operate in one huge bureaucracy drawn from the Partyapproved Nomenklatura and are responsible for resource allocation, each in his or her allotted purview. What should a bureaucrat avoid so as not to displease her superiors? Consider the following examples: missed deliveries that disrupt supplies to consumers’ markets and lead to demonstrations and strikes; production stoppages triggered by missing inputs that the enterprise should have delivered. Such events, which can be blamed on the enterprise, have to be avoided. Hence the manager has to endeavor to fulfill plans of the sort that may change with changing circumstances. Profits are of interest, if at all, to the ministry of finance, which has little influence on the careers of enterprise managers.

4

The State and the Hard Budget Constraint

How can a hard budget constraint be imposed on economic agents in a socialist state apparatus that is transitioning to a market economy, i.e., undergoing quite a revolutionary change (Ivlevs et al. 2019)? Socialist bureaucrats need much discretion to be able to soften the budget constraint; thus the bureaucracy is easily corruptible. Managers of weak firms can and do make use of bribery to ensure their enterprise’s continued existence and their own incumbency (Berliner 1959). Depriving the bureaucrats of this discretion would reduce their ability to trade favors. The importance of privatization lies in its being a step that helps impose an HBC. It is clearly neither a necessary nor a sufficient step.

3 The GDR had a significant private industrial sector for most of its existence and Poland allowed private retail trade in agriculture. 4 This has not been the case in China since Deng allowed non-state firms to enter.

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That it is not necessary we learn from the evidence of Pinto et al. for Poland, where the very threat of an HBC prompted managers to behave entrepreneurially (Pinto et al. 1993). We also have examples from Russia, where private bodies continued to receive cash infusions from the Central Bank almost until 1998. The reason privatization conduces to the imposition of HBCs is only indirectly linked to the change in ownership. To force an SOE to go out of business, an explicit decision is needed; with a private firm, it is the infusion of funds that requires such a decision. To impose controls over the central bank, the state-owned banks, the taxman, and local authorities—all of which served during the transition as conduits of liquidity to loss-making firms, both private and public—a strong state is needed. Another priority in the transition is war on corruption. Corruption, as said above, is endemic in communist societies because of the bureaucrats’ extensive discretion and the blanket prohibition of private activities. These provide both demand for and supply of protection, krysha (“roof”) in Soviet parlance (Economist 2004). The Czech tunneling misadventures, in which managers found ways of gutting a firm of all valuable assets, leaving behind a debt-laden empty shell (Friedman et al. 2003; Atanasov et al. 2006; Coffee 1999; Johnson et al. 1990; Svitek 2002; Mertlik 1997; Kotrba 1994) demonstrate how corruption can soften the BC. Another example is the way oligarchs take control over public assets; yet another is the way losing enterprises manage to survive by tax arrears and questionable barter operations (Ivanova and Wyplosz 1999; Brana and Maurel 1999; Guriev et al. 2002; Guriev and Ickes 2000; Keren 2000b; Marin and Schnitzer 2002). Thus it takes a strong state to control corruption, carry out a “clean” privatization process, and stanch unauthorized leaks of liquidity. A strong state, while clearly necessary, is not a sufficient condition. But what is meant by a strong state? It is a state whose governing organs are capable of imposing their policy on the state bureaucracy. In particular, its government should be able to defang the bureaucracy and render it unable to dispense favors and exercise arbitrary powers. This is not a costless strategy because it may mean that powers that Western market economies consider necessary for the protection of the public, such as sanitation and firefighting regulations, may have to be given up or weakened because burdensome inspections by the controlling organs are often used to impose “protection” rackets on resisting firms. The temporary

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removal of such powers, until the relevant departments are cleaned up, may be unavoidable. The next section, using governance indices and the growth record of various transition countries, illustrates what has come to be called the Great Divide between successful and unsuccessful transitions and advances various factors that trace these different paths to differences in efficacy among the post-communist states.

5

The Great Divide

Table 1 below shows remarkable consistency among countries—Belarus is the sole outlier—in rankings by diverse indicators supplied by different institutions and based on diverse criteria. The former STEs may be divided into three groups. Estonia, representing the Baltic states, may be considered part of Western Europe. All East European countries, from Poland to Bulgaria, comprise the second group, and the fSU countries—the third grouping—rank far below the others by all indicators. The first two groups benefited from the institutional requirements of EU accession. The need to legislate and enforce the acquis communautaire forced these countries to endeavor to adopt the institutions of the established capitalist market states. In this effort, they received technical aid from the veteran EU member states. The change over time is displayed in Table 2, which shows the development of the CPI, Transparency International’s widely used corruption index. Two countries, Belarus and the Czech Republic, show remarkable improvement over time. The latter took the path of privatizing by Investment Privatization Funds that were poorly supervised and enabled tunneling, i.e., “[the] undesirable transfer of assets and profits out of enterprises for the benefit of controlling shareholders” (Svitek 2002, p. 88) and the low corruption score of 49 in 2002—rising to a more respectable 59 by 2018—may have been earned by that episode (Table 2). The present events in Belarus may prove that the fairly consistent improvement in its CPI may have been a sham. Several countries, Romania and Bulgaria among them, show hardly any change in their corruption scores. Poland opens with a slow advance until 2015, followed by a retreat. Hungary is fairly stable and high until 2014 but then starts a fairly steep decline. (Is this a product of its incumbent “illiberal democracy?”) Ukraine, the lowest ranked in 2012, starts climbing after the recent elections.

65 45 37 53 37 41 33

47 46 44 42 39 32 28

Governance Indices, Selected Countries Source WDIEXCEL.xlsx, 2018–2019.

77 65 65

73 60 59

Estonia Poland Czech Rep. Romania Hungary Belarus Bulgaria China Ukraine Russia 37 55 55 37 37 20 20

72 55 55

CPI Bertelsmann Economist Score Foundation Intelligence 2018 Transformation Unit Index Country Ratings

Country

36 24

59 47 33 53

77 62 62

Freedom House Nations in Transit Ratings

Governance indices in selected countries

Table 1

47 59 47 35 47 35 22

71 59 71

Global Insight Country Risk Ratings

33 49 29 34

31 38

65 60 53

IMD World Competitiveness Yearbook

41 50 32 50 32 32 24

67 59 50

34 42

37

48 35

71 53 47

PRS World International Economic Country Forum Risk Guide EOS

51 39 57 36 39 36 33

73 63 61

39 54 50 43 35 22 21

75 69 60

World Varieties of Justice Democracy Project Project Rule of Law Index

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Table 2

Corruption perceptions, selected counries, 2012–2018

Country

Estonia Poland Czech Rep. Romania Hungary Belarus Bulgaria China Ukraine Russia

Corruption perceptions score 2018

2017

2016

2015

2014

2013

2012

73 60 59 47 46 44 42 39 32 28

71 60 57 48 45 44 43 41 30 29

70 62 55 48 48 40 41 40 29 29

70 63 56 46 51 32 41 37 27 29

69 61 51 43 54 31 43 36 26 27

68 60 48 43 54 29 41 40 25 28

64 58 49 44 55 31 41 39 26 28

Source WDIEXCEL.xlsx, 2018–19.

Figure 1 provides empirical data that test the thesis. We can see three groupings of countries in the figure: China, marked by spectacular growth; several East European countries that enjoyed intermediate growth; and then Russia and Ukraine, which have not yet rebounded to their 1990 output levels. Of the latter two, Ukraine is the weaker because it has not had full control of its territory—thanks to Russia—and only recently elected a president who seems to be fighting in earnest the kleptocratic oligarchy that has run the country to date. Russia, still ruled by Putin and the old KGB-FSB siloviki, has not yet established a reliable rule of law.5 Both countries have been growing since 1998, but Russia has pulled ahead on account of the sharp rise (until the arrival of the corona virus) of energy prices. Clearly, there are many alternative ways of explaining the different experiences of these three groups of countries. The need for a strong state, I believe, is the most convincing: it is a necessary (but, as said above, not sufficient) condition for an effective transition. Yet all the alternative explanations are grounded in history, from the distant past to recent and very recent times: 5 The recent arrest of an Israeli who was allegedly caught with a small amount of marijuana, and at this writing is being held as a hostage to keep a Russian hacker from being handed over to the United States, is a recent case in point.

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3 China 2.5

Estonia China

2

Russia Ukraine Slovenia

1.5

Hungary

Czech 1

Poland Russia

Poland 0.5

Czech Republic Estonia

Slovak Republic Slovenia Ukraine

0

Fig. 1 Transition countries, GDP per capita, 1989–2004 (Source IMF, World Economic Outlook, September 2006. Missing data for 1989–1992 or 1993 are supplemented from UN sources)

• Religious differences have been advanced as an explanation: the successful European transition countries are mainly Catholic and the failures are either Eastern Orthodox or Moslem. One should remember, however, that in the past it was thought that Protestantism or Jewishness were necessary conditions for capitalist development. • Many East European countries were once ruled by the AustroHungarian Empire, whereas the former Soviet Union’s roots are in Russian Tsardom. Concepts such as the rule of law were quite foreign to the latter but not to the former (Figes 1996). • Soviet Russia had been under socialist rule since 1917 and Eastern Europe had been so only since 1945 (and the Baltic states since 1940). While a few East Europeans remain who lived as adults before the advent of communism, nobody in Russia who experienced life under the Tsars survives.

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• The transition process in Eastern Europe was greeted by many as liberation from foreign domination (Economist 2019b) though there are those who hanker after the good old safe days of the socialist past (Economist 2019a), whereas in Russia many saw it as the end of the empire and the diminution of the stature of one of the two Great Powers—relegation to a lower league on the international stage. These historical accounts doubtless have weighty explanatory power. But the conduit, the medium through which they acted, is the differing efficacies of government in the fSU and the East European countries. This is certainly true with respect to both the behavior of the bureaucracy and the concept of the state held by the citizenry and the very different ideas about the division of powers and limits on the state’s authority in the Habsburg and the Romanov empires. Yet the third factor, the events surrounding the transition and the manner in which the transition was ushered in, are the most telling. The Soviet Union collapsed in the midst of a power struggle between Mikhail Gorbachev and Boris Yeltsin. The strong centralized Soviet state disappeared and on its ruins appeared new states that had not been independent states before, if ever. Even the Russian Federation was previously a mere province of the central state and had a very subsidiary role as a governing entity. Although it did inherit many of the Soviet ministries upon the disintegration of the USSR, it was essentially a new weak state. Corruption was rife, with the police often in its snare. Law and order was privatized to the mafia and property, private and public, was prey to the oligarchs. None of the needed institutional reforms could be introduced under Yeltsin; they had to await Putin’s rise to power (Mohácsi Nagy 1997; Keren 2000a). The situation of the other members of the Commonwealth of Independent States (CIS) was no better. Only the Baltic states, whose history strongly resembles that of the East European countries, fared better, for reasons mentioned in the previous paragraph. Have things changed since Putin took over? In many respects they have. Lawlessness has declined and the enforcement of the central government’s fiat has improved. In particular, the haphazard operations of the tax authorities and inter-enterprise arrears and barter have been eliminated, and enterprise budget constraints have been hardened. The Yukos affair, however, shows that the separation of powers that is so important

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for the protection of property did not exist and that the judiciary remains weak, unprofessional, and under the ruler’s thumb.6

6

The Lessons of Transition

The simplest standard model of an economy has two sets of actors: firms and households. Government is omitted; the economy reaches its efficient equilibrium without it. The reason is simple: ownership and contract are assumed to be secure. Property, it is presumed, cannot be alienated without the owner’s consent and needs no institutions and organizations for its protection. The transition has shown that these matters cannot be taken for granted and that the main distinction between countries that transitioned more successfully and those that have not managed to restart their growth lies in the efficacy of the state and its policies. The breakdown of rule of law in Russia and the “spontaneous privatization” period were the first indications that the state, as the agent that defines and protects property and contract, has a key role in the economy and must not be left out of the analysis. They inspired a flood of theoretical studies on corruption that use the insights gained through the development of the new institutional economics and advances in game theory. They also yielded descriptive data. Transparency International, the creators of the Corruption Perception Index; Daniel Kaufmann and his associates at the World Bank, who developed governance indexes; Friedrich Schneider and associates, who measured the shadow economy; and the Institute for Management Development and their World Competitiveness Yearbooks all made their first appearance in the 1990s. The measures of the shadow or underground economy have deeper roots, going back to research by Gregory Grossman and Vlad Treml in the 1970s. In these respects too, however, global statistics were introduced after the start of the transition (e.g., Schneider 2006; Medina and Schneider 2018). These developments and others like them make it possible to do quantitative research that embodies institutional variables, as could not have been done before transition. Much of this research was inspired by the events of transition, especially in Russia, which took researchers of the field by surprise. I doubt whether these areas of study and the databases related to them would exist in the 6 Source: IMF, World Economic Outlook, September 2006. Missing data for 1989– 1992 or 1993 are supplemented from UN sources.

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absence of the collapse of the “planned economies.” They are lessons of the transition.

References Atanasov, V., Black, B., Ciccotello, C., & Gyoshev, S. (2006). The Anatomy of Financial Tunneling in an Emerging Market. www.eu-financial-system.org/ Berlin2006_Papers/Atanasov.pdf. BBC. BBC News. (2006). India Struggles with Power Theft. http://news.bbc. co.uk/go/pr/fr/-/2/hi/business/4802248.stm. Berliner, J. S. (1959). Managerial Incentives and Decision Making: A Comparison of the United States and the Soviet Union. In Comparisons of the United States and Soviet Economies: A Compendium of Papers Submitted to the Joint Economic Committee of the Congress of the United States, 349–376. Brana, S., & Maurel, M. (1999). Barter in Russia: Liquidity Shortage Versus Lack of Restructuring. http://www.wdi.umich.edu/files/Publications/WorkingPa pers/wp271.pdf. Coffee, J. C. (1999). Privatization and Corporate Governance: The Lessons from Securities Market Failure. Journal of Corporation Law, 25, 1–39. Economist. (2004). The Economist, Jan. 22, 2004. Meet the Oleagarchs. Russia’s Power-Brokers Must Now Fawn at the Feet of Capricious Officialdom. Economist. (2005). The Economist, Sept. 22, 2005. India’s Electricity Reforms. Economist. (2019a). The Economist, Oct. 31, 2019. Thirty Years After the Berlin Wall Fell Germans Still Don’t Agree on What Reunification Meant. Economist. (2019b). The Economist, Oct. 31, 2019. Freedom, Warts and All: Central and Eastern Europeans are Mostly Happy with Progress Since 1989. Figes, O. (1996). A People’s Tragedy: The Russian Revolution: 1891–1924, 923. London: Jonathan Cape. Friedman, E., Johnson, S., & Mitton, T. (2003). Propping and Tunneling. Journal of Comparative Economics, 31, 732–750. Guriev, S., & Ickes, B. (2000). Barter in Russian Firms. In P. Seabright (Ed.), The Vanishing Ruble: Barter and Currency Substitution in Postcommunist Economies. Cambridge: Cambridge University Press. Guriev, S., Makarov, I., & Maurel, M. (2002). Debt Overhang and Barter in Russia. Journal of Comparative Economics, 30(4), 635–656. Hayek, Friedrich von. (1945, September). The Use of Knowledge in Society. American Economic Review, 35(4), 519–530. Hayek, Friedrich A. (1978). Competition as a Discovery Procedure. In New Studies in Philosophy, politics, Economics and the History of Ideas. Chicago: The University of Chicago Press.

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IMF. (2006, September). World Economic Outlook Database. http://www.imf. org/external/pubs/ft/weo/2006/02/data/WEOSep2006all.xls. Ivanova, N., & Wyplosz, C. (1999, March). Arrears: The Tide That Is Drowning Russia. Russian Economic Trends, 8(1), 24–35. Ivlevs, A., Nikolova, M., & Popova, O. (2019, November). Former Communist Party Membership and Present-Day Entrepreneurship in Central and Eastern Europe. IZA DP No. 12761. Johnson, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1990). Tunneling. American Economic Review, 90(2), 22–27. Keren, M. (1993). On the (Im)possibility of Market Socialism. Eastern Economic Journal, 19(3 Summer), 333–344. Keren, M. (2000a). An Essay on the Political Economy of Transition: How the Collapse of the Russian State Led to Russian Non-Transition. The Soviet and Post-Soviet Review, 27 (1), 7–16. Keren, M. (2000b). Barter and Arrears, Soft Budget Constraints and Transformation in Russia, Unpublished ms. Kornai, J. (1993). Transformational Recession: A General Phenomenon Examined Through the Example of Hungary. Économie Appliqé, 46(2), 181–227. Kornai, J. (1994). Transformational Recession: The Main Causes. Journal of Comparative Economics, 19(1), 39–63. Kotrba, J. (1994). Czech Privatization: Players and Winners. CERGE-EI and University of Pittsburgh, April. Marin, D., & Schnitzer, M. (2002). The Economic Institution of International Barter. The Economic Journal, 112, 293–316. Medina, L., & Schneider, F. (2018, January). Shadow Economies Around the World: What Did We Learn Over the Last 20 years? IMF WP/18/17. Mertlik, P. (1997, March–April). Czech Privatization: From Public Ownership to Public Ownership in Five Years? Eastern European Economics, 35(2), 64–83. Mohácsi Nagy, P. (1997, April). The Meltdown of the Russian State. Paper presented at the Bar-Ilan Conference, The Changing Role of Government in an Integrated World, 13–14. Pinto, B., Belka, M., & Krajewski, S. (1993). Transforming State Enterprises in Poland: Evidence on Adjustment by Manufacturing Firms. Brookings Papers on Economic Activity, 1, 213–270. Schneider, F. (2006). Shadow Economies and Corruption All Over the World: What Do We Really Know? http://ssrn.com/abstract=936127. Svitek, L. (2002, June). Privatization in the Czech Republic During the Transition Years: Success or Failure? Master of Science thesis in International Resource Planning and Management, Naval Postgraduate School, US Navy. von Mises, L. (1936). Economic Calculation in the Socialist Commonwealth. American Economic Review (1936 Supplement). Reprinted in von Mises, L. (1975/1920). Economic Calculation in the Socialist Commonwealth. In S.

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Adler (Trans.), F. A. Hayek (Ed.), Collectivist Economic Planning (pp. 87– 130). Clifton, NJ: Augustus M. Kelley. von Mises, L. (1990). Economic Calculation in the Socialist Commonwealth. Ludwig von Mises Institute. Kindle.

Illiberal and “Inward-Looking” Drives: What Fuels Them? Daniel Daianu

1

Introduction

The distinction made between “liberal” and “illiberal” democracy is both conceptually and operationally meaningful, but can still sow seeds of confusion. This is because democracy has liberalism in its genes; liberalism in a deep sense embodies spiritual and civic commitment to a host of de facto and de jure values. These values and the related political regime mean, basically, power in the hands of citizens (the people) and decision-making made via institutionalized checks and balances— what John Kenneth Galbraith and others referred to as countervailing power, which prevents absolute power from being ceaselessly accumulated. Democracy implies an effective separation of powers; it also implies respect toward fellow citizens, tolerance, and ethical conduct in social and political life. Within this interpretation of democracy, liberalism is a fundamental, organic foundation of democratic parties’ Weltanschauung; this foundation is present from the right to the left of the democratic spectrum, in the philosophy and conduct of political parties. In democratic

D. Daianu (B) The National School of Political and Administrative Studies in Bucharest, Bucharest, Romania e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_5

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Europe, for instance, Christian democracy and social democracy belong to an enlarged political “family” that relies on deep liberalism at its core. Liberalism in a deep sense is also mindful of the social embeddedness of markets; society is seen not as an agglomeration of individuals who are devoid of joint goals and social purposes. The extent to which liberalism in Europe overlaps with what one meets in the US, is subject to debate. For there are significant differences in terms of the relationship between the public and the private spheres, the size and content of state intervention in the economy, regulatory systems, etc. Admittedly, conservative political philosophy contains a liberal component when it assimilates the rules of political competition and a democratic political regime. But there is evidence of mounting illiberal temptations in the industrialized world, in democratic societies; an inward-looking syndrome (rising nationalism) is also taking place. Are these temptations linked with temporary phenomena, in the “extraordinary times” we are living through, or do they have deeper roots? An answer to this question begs an examination of trends in society and economy, of the emergence of new (unconventional) threats, of disruptions and, not least, of failed public policies. The argument that “liberal democracy” is on the wane is misleading to the extent that policies can be corrected, that citizens and elites alike do not lose trust in democratic values. It may also be true that, although democracy has a “liberal core,” it can also be driven by “illiberal” components, and that the magnitude of the latter can vary. But for democracy to survive, its liberal core must be preserved.

2

Democracy and Economy

Liberalism and democracy have an economic foundation. Freedom cannot exist in the absence of a free economy, without people (as economic actors) having the freedom to make choices about consumption and production, and, ultimately, to make political choices. A system of property rights lies behind decisions which mirror individual and organizational preferences (at enterprise level) in the allocation of resources, in production. Clearly defined property rights, transparency and the institutional/legal capacity for enforcing them are called for in free economies. But decent capitalism demands a public sector and policies for the provision of public goods that enable people to live as dignified citizens.

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Totalitarian “experiences” teach us about the relationship between society and property rights. The command (communist) system excludes economic freedom in resource allocation and production; this system operates according to the logic of a single enterprise, as a fully centralized, command system.1 National-socialism/fascism demonstrates that private property can underlie a totalitarian regime when property rights do not “work” for the separation of powers or discourage/prevent an abusive concentration of power, but are instead subservient to abusive and evil power. Adolf Hitler’s seizure of power was backed by business circles eyeing expansion at home and abroad. Those business circles presumably feared the growing power of the socialist movement in Germany, not least because of the Great Depression. Modern capitalism implies cohabitation between public sector and private sector, ideological/political choices, and management of what economists refer to as “externalities” and market myopia2 ; these mould the proportion between the two spheres. The public sector, via its own policies and productive and financial assets, is asked to provide public goods that are essential for society; and it is asked to implement policies that enhance the very functioning of the private sector, to preserve the “social cement” in society, and to mitigate economic disparities (inequalities among people). Income distribution plays a paramount part in the metabolism of capitalism and requires an effective answer as far as public policies are concerned—in the sense that markets should not be left to decide everything, whatever the consequences may be. As libertarians, who oppose any interference with markets, would say. There is in capitalism an almost inherent dynamic of asset concentration, which can negatively affect its homeostasis and, ultimately, the democratic nature of a regime. Middle-class erosion is to be viewed in this context. Thomas Piketty’s, Emmanuel Saez’s and Gabriel Zucman’s works are to be interpreted from this perspective. The impact of new technologies and automation (not least in creating the possibility for massive structural unemployment) should be considered in formulating public policies.

1 As can be read in the Communist Manifesto (Karl Marx, Friedrich Engels, 1848), The State and Revolution (V. I. Lenin, 1917). 2 For instance, internalising the effects of climate change, it manages the relationship between the present and the future generations (which is a weakness of the general equilibrium models).

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Democracy relies on a “culture of freedom,” which, as history shows, cannot take root within a short time span, nor “imported”, or imitated, as one chooses; roots are important. The United Kingdom is the most relevant example of the limits put on absolute power, a process that started more than eight hundred years ago3 and which evolved over centuries toward an advanced democracy. After gaining independence, the United States set off with a constitution that mirrors the way in which the Founding Fathers understood the importance of the separation of powers,4 even though equal civil rights for women and African-Americans were only granted much later. These examples are not meant to suggest that people living elsewhere should take a similarly lengthy approach in obtaining democracy. Yet, it is a fact that time cannot be compressed at will in terms of institution-building; the “Arab Spring” is a telling case in this respect. Democracy advanced at different speeds on the old continent, with institutional frailty being visible especially in central and eastern European countries. Illiberal propensities in the countries that shrugged off communism after 1989 can be associated with their pre-communist and communist track record in terms of economic development and political regimes. But other causes, which are to be found in western European countries as well, are also at work. For how else can one explain the radicalization of politics in western countries?

3 Markets, Liberalism, and Democracy---Where Limits Show Up Economic freedom5 is the driving force behind entrepreneurship and a vibrant economy. The thinking of Adam Smith, John Stuart Mill and, later, the “Austrian School” is quite relevant in this regard. Development is inextricably linked with markets and entrepreneurship, and the progress of less advanced economies provides many lessons in this respect. The collapse of communism was brought about, primarily, by innate flaws in the command system, as Ludwig von Mises and Friedrich von Hayek had, among others, anticipated. Their dispute with Enrico Barone,

3 See Magna Carta Libertatum (1215), which sought to confine the monarch’s power. 4 Bearing in mind, of course, the absolute power of royal/princely regimes in Europe. 5 Markets exist even in command (communist) systems, yet they operate underground in the main. Ironically, they help the system work by ‘greasing the wheels’ of the machinery.

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Oskar Lange, Abba Lerner, Fred. M. Taylor and others on The Economic Calculation is famous. It is noteworthy that Joseph Schumpeter proved ambivalent in judging the systems’ dynamics in “Capitalism, Socialism and Democracy” (1942). This work introduces the term “creative destruction.” But Schumpeter’s death in 1950 prevented him from getting more knowledge on the Stalinist command systems at work, and he did not witness the decay and collapse of communism. Over the past few decades, China’s economic miracle has been probably the most convincing proof of the extraordinary energy that economic freedom provides in unleashing entrepreneurship, in pushing an economy ahead with the government (state) still the key player in steering the economy and allocating resources, and in building competitive advantages (via industrial policies).6 The “return to Europe” of former communist countries in central and Eastern Europe involved radical institutional transformation and entailed economic progress—some less spectacular aspects of the transition notwithstanding. That there is a resurrection of national economic interests in this region of the European Union is an evolution that deserves an analysis on its own; part of it is linked to fear of the “middle income trap” and asymmetries in the functioning of the Single Market. But markets do not bring optimal results automatically. Market failures require government intervention. This has brought about, over time, the development of public sectors, the setting up of public and private institutions that insure against risks (pension systems, health-care systems, etc.), and mechanisms for the regulation and supervision of financial markets, including antitrust law (against collusion/oligopolistic agreements, rent-seeking). Bismarck’s Prussia saw the first ever social insurance arrangement within a capitalist system. The very functioning of the democratic state has required public policies meant to ensure basic public goods, among which defence and security, education and health (areas that should not be left in the care of the private sector alone), a judicial system based on the rule of law (“no one is above the law”), etc. History shows that where social cohesion is badly damaged, negative consequences arise and “social capital” and “social cement” get diluted, whereby cracks emerge in the democratic process that may give rise to social and political conflict. 6 For an illuminating analytical explanation of China’s economic rise see Justin Yifu Lin’s (2012).

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Whenever inequality crosses the frontier of what people/citizens perceive as tolerable, when the sense of “social justice” and fairness is blatantly disregarded, it is democracy that bears the brunt. The remedy can be found in the formulation and implementation of corrective public policies; failing to do so makes matters worse. Social fragmentation and growing perceptions of individual and collective insecurity can augment political demands for protection via government intervention. The backlash against globalization (de-globalization), a spreading propensity to turn inwards and the rise of protectionism,7 are associated with the fallout from a simplistic (neoliberal) vision of globalization, one which disregards (and underestimates) market failures and the number of losers from global competition. The higher the number of losers (whose ranks have been growing in advanced economies over the last couple of decades), the more vigorous is the political demand for protection, and the stronger is populism in terms of rhetoric and political action. In other words, globalization, as an embodiment of liberalization/economic openness, unless it is wisely and pragmatically managed, leads to fierce counter-reactions. It is often said that people do not grasp the benefits of globalization. The problem with this assertion is that while benefits may prevail over costs at the aggregate level, at local/community level costs may be massive and social dislocations hard to bear.8 And where communities are rife with losers, their interests can easily be articulated in a quest for protection. Brexit and the 2016 presidential election in the US (the impact of fake news and media manipulation notwithstanding), epitomize an undeniable reality, one which can be seen in other, older EU member states as well. It is no wonder that international institutions, like the World Bank, the International Monetary Fund, the OECD, the EBRD, etc., pay increasing attention to negative effects of globalization, and to a thinning of the social fabric and social fragmentation that can end in full-blown political disarray; there is even talk of the need to redesign the social contract in view of increasing distributional tensions and a spreading sentiment of unfairness in society.9 Major central banks (the Federal Reserve, the Bank

7 Daniel D˘aianu (2017) (see the Appendix). 8 David Autor (2016, 2019). 9 Maurizio Bussolo et al. (2018).

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of England, the ECB, etc.) devote increasing attention to income distribution, a research topic one could hardly have imagined them focusing on not so long ago. Things get more complicated in countries where political leaders justify public policies that entail high social costs by repeating constantly that “there is no other way,” or “that this is what international markets demand.” This type of argument is likely, in the end, to damage the institutional and political legitimacy of policymakers; and it can fuel social and economic pressure (on the part of local business groups) in favor of protectionism. A reinterpretation of globalization, of global markets is, therefore, needed; one that takes into account the wide diversity of citizens’ social and economic circumstances. In other words, a narrowly understood economic liberalism, i.e., market fundamentalism, can pave the way for the erosion of the social foundation of democracy, i.e., the erosion of the middle class. Under such conditions, political extremism and exacerbated populism emerge. Market fundamentalism works against liberalism, against democracy, in its deep meaning.10 Just as one can talk about “illiberal democracy,” one can identify “undemocratic liberalism” (Yascha Mounk).11 This happens when people feel that they no longer have a grip on their lives, when they lose trust in their leaders, and when they ascribe decisions to the power of money (i.e., government capture by interest groups which are seen as illegitimate). Elites and governments need to overhaul national and international policies so that they be able to “manage capitalism”12 for the benefit of society at large. Jack Snyder observes that over the past 30 years liberalism has become “disembedded”; that “elites in the US and Europe have steadily dismantled political controls that once allowed national governments to manage capitalism. They have constrained democratic politics to fit the logic of international markets and shifted policy-making to unaccountable bureaucracies (2019).

10 See also Daniel Daianu (2011, 2018). 11 Yascha Mounk (2018). See also Dani Rodrik (2018). 12 Jack Snyder (2019, p. 54).

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4 More on What Fuels Illiberal Propensities Nowadays Economic insecurity and its “illiberal” fallouts can be related to a dramatic shift in the balance of power in the global economy, especially toward new economic powerhouses (China in particular, but also India, etc.). Robert Kaplan alludes to this with a metaphor: “The Return of the Marco Polo World.”13 Trade disputes can mushroom in such an environment, not least due to geopolitical and security reasons (just think about the implications of artificial intelligence, or the use of G5 technology). Social fragmentation and anxiety, which mirror economic insecurity, can be fostered by new technologies (e.g., “big data,” the power of some companies—the Facebook scandal is a harbinger in this regard) and strengthen the case for government intervention, not only via regulatory steps. New technologies can even enhance the resort to illiberal methods in societal management. Fear of the unknown (of all sorts), of insecurity in general, has to be factored in. People need to feel comfortable in a habitat where they have lived for a long time, and this sentiment cannot be divorced from habits and customs, from a sense of belonging to communities that share identities. But things can turn highly complex (even ugly) when identity, ethnic, religious aspects fuel illiberal impulses and hate. Here, the democratic process may easily go astray. Social media, can fuel radicalization, anger, hate, intolerance. Radical groups, “supremacists” of all sorts can use new technologies to spread their thinking; this poses a dilemma to public authorities: how to discourage, even prohibit such manifestations while observing the rules of free speech, of democracy. But when radical groups clash with the values that underpin democracy, when their actions do a lot of harm, they need to be forestalled, punished. An increasingly controversial policy issue is immigration. The fact is that however much one is attentive to humanitarian concerns, massive flows of people can tense social and political relations in local communities, in recipient countries. A free flow of labor internationally is much more complicated and politically sensitive than the flow of capital or of goods. Capital comes in and goes out; people do not operate following the same logic. This is why, properly calibrated immigration policies 13 Robert Kaplan (2018). See also Kishore Mahbubani (2018).

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are needed together with development policies in poor countries, or in countries ravaged by military conflicts. There is also a disconnect between economic developments and social and political dynamics, which are defined by fury at, and protests against the elites, especially the political establishment.14 The role of fake news, disputing the “truth” (scientific and of any other sort) need to be mentioned in this context. Likewise, the rejection of “experts,” who are blamed for failed public policies (e.g., the light-touch regulation paradigm when it comes to financial markets) should not be overlooked. When people are looking for responses to overall insecurity, a sort of demonstration effect in both economic and politic regimes can be at work. There are world political/institutional structures which feature a single ruling party. These are not by definition closed systems. China has opened up its economy for almost four decades by introducing market-based reforms; these reforms have proved remarkably successful in modernizing the country, even though the political system has remained that of a single party. Some go so far to argue that there must be something quite singular about the Chinese model—what former Polish finance minister Grzegorz Kolodko calls “Chinism”,15 which seems quite odd as a view. There is also a sort of a fascination with the “economic model” of Singapore, although this is a very small (city) state. And hands-on economic policies practised in not a few emerging Asian economies have explanatory power too, for it is hard to refute them analytically in view of their achievements. In addition, in times of economic and security strain, of major disruptions, or when facing major ecological challenges, the appeal of less deliberative decision-making setups may be quite luring. But it is one thing to use authoritarian, less deliberative processes within a democratic (liberal) framework, and another to alter the democratic nature of a system (society), to give up its liberal core; there is a red line which should not be crossed, albeit one could argue about its outline and fine print. Even in China, inroads of political pluralism should not be ruled out over the longer run, although authoritarian characteristics will probably remain there for a long time in view of the complexity of its

14 Ruchir Sharma (2018). 15 Grzegorz Kolodko (2018).

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society; pluralism will be more likely once citizens vie and get more voice (to use Alfred Hirschman’s concept16 ) in the running of their country. To be fair with the latter remark, “voice” and legitimacy/accountability are getting at the forefront of public debates in western (advanced) societies as well. Why is it so? For many people feel that they have no longer a say in the running of their societies, or that they have been forgotten, that “elites” do not pay attention to their interests. In this regard, the rejection of mainstream parties can be interpreted through several lenses: the impact of the Great Recession and myopic public policies that have deepened social cleavages; a kind of institutional sclerosis (in the spirit of Douglas North and Mancur Olson Jr.’s writings17 ), which can occur in advanced capitalism as well18 ; a new industrial revolution, aging, and a shift of power toward Asia—all of which seem to confound elites and governments in western societies alike.

5 The European Union and the Question of Legitimacy and Democratic Accountability The European project aimed to reconstruct economies after World War II and put aside the great rivalries between European powers—principally Germany, on the one hand, and France and the UK, on the other. It was a success story, despite the bumpy road toward building a new Europe— from six founding states in 1957 to 28 member states by 2013 (but before Brexit). But the EU is a vast, very intricate institutional construction. The union’s economic gains hid for quite a while the incompleteness of its design (to take just one example, the lack of a significant budget, as stipulated by the 1977 MacDougall Report, of 2–2.5% of GDP at the beginning and 5–7% of GDP upon the establishment of monetary union). The financial crisis that broke out in 2008 underscored the shortcomings of its decision-making procedures and a stark fact: European institutions suffer from a “democratic deficit,” as many pundits and officials have put it. Financial assistance programs for beleaguered eurozonecountries (grappling with liquidity and solvency crises) have been implemented via 16 Alfred Hirschman (1972). 17 Douglas North (1981) and Mancur Olson Jr. (1982). 18 See for instance Steven Levitsky and Daniel Ziblatt (2018).

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sui generis methods and mechanisms. The latter, albeit largely understandable due to the enormous pressure of events and the need to manage acute crises, have fuelled popular discontent and increased the amount of distrust in the functioning of national and European institutions. The then EU commissioner for economic affairs, Pierre Moscovici, and other high-ranking European officials (including Germany’s former finance minister Wolfgang Schäuble) were quite candid in noting that the decision-making framework in the euro area needs to be reformed as part of the push to streamline public institutions and policies, in order to give them more legitimacy. In light of the need to reform eurozone institutions and policies a key question arises: can financial integration overcome economic fragmentation without fiscal arrangements, i.e., risk-sharing schemes? Fiscal integration implies more than institutional cooperation; it requires institutional integration and a eurozone budget, which leads implacably to the fundamental political question of the eurozone—integration. But political integration in the euro area is a fantasy under the present circumstances. Besides, there is a fundamental contradiction in European integration, which is epitomized by Dani Rodrik’s trilemma: integration (globalization via the “single market”) can hardly cohabit with autonomous economic policy and with democratic accountability19 at the national level20 ; something must give in in this triumvirate. This trilemma may simplify reality, and trade-offs and compromises may be worked out. However, it poses a formidable challenge to the eurozone unless integration is backed by policies and mechanisms that can iron out excessive heterogeneity and competitiveness gaps between member states—policies and tools which would prevent growing tensions that erode the social fabric and give rise to extremist reactions, populism, Euroscepticism, etc. Again, the incompleteness of the eurozone is to be singled out, for this is not a genuine monetary union, as it lacks proper fiscal arrangements (as one finds in the US, in Germany as a federal state, etc.). Why is the fiscal challenge critical to the eurozone? Deeper integration (including a sizeable single budget, among others) would bring, as mentioned above, the political issue to the fore. Wealthier/creditor 19 The status of being accountable to the voters who gave a mandate to top public servants. 20 Dani Rodrik, ‘The Inescapable trilemma of the global economy’, 27 June 2007 (personal blog). See also his essay ‘The Double Threat to Liberal Democracy’ (2018).

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countries fear a “transfer union” (fiscal transfers), however much sense the latter makes in a monetary union that would not be merely a single currency area. Yet, beyond narrowly defined economic interests,21 there are constitutional impediments posed by arrangements that involve fiscal transfers. Here lies the greatest difficulty in reforming the eurozone. To believe that the Banking Union (when it is completed with the setting up of a single deposit insurance scheme and a more solid common resolution fund) can make up for fiscal arrangements is, arguably, an unrealistic approach. For the eurozone to be viable, both public and private risk-sharing schemes are needed.

6

Reconsidering the Single Market Logic

The Single Market (which sees the EU as a whole) would better rely on a revamped conceptual framework—some of it suggested in the Monti Report of 2010 and, earlier, in the Sapir Report of 2003. However much we praise and value competition as a driver of entrepreneurship and economic dynamism, there are market failures and power asymmetries in the EU which need to be seriously addressed. The financial crisis has indicated the flaws of a paradigm that takes for granted that markets always know better, that systemic risks are non-significant, that “light touch regulation” is fine, that business unethical conduct is quite rare. The Single Market policies should heed the lessons of recent decades, which teach that increasing income inequality, “winners take all” competition, harm economic growth over the longer term. The reform of finance has to go on and adequate regulation and supervision of financial markets (including shadow banking) should be implemented; this should rely on stronger capital and liquidity requirements, the taming of casino-type activities, and the functioning of a sort of Glass-Steagall legislation—as several reports commissioned by the European Commission have alluded to, although not clearly enough. Arguments that such measures would dent European banks’ ability to compete with American and Asian competitors are questionable.

21 The euro functioned as an undervalued Deutschmark and guilder, fuelling exports; the euro operated also as an overvalued lira, escudo and peseta. This fostered the emergence of large imbalances between north and south in the eurozone.

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If we accept, as a working assumption, that deeper integration is the way forward for the EU in order to cope with current and future challenges, a more balanced policy paradigm is badly needed. To the extent member states are asked to relinquish more of their sovereign prerogatives, what would be lacking in the policy mix at the national level has to be replaced by an enlarged and more diversified tool and policy box at the supranational level; in the eurozone this would take the form, for example, of a “collective unemployment insurance scheme.” This logic could be seen as a “subsidiarity principle in reverse,” and would fit a motion to a more integrated EU. The EU budget reform must not lose sight of the need to reduce economic discrepancies in the Union, the need to foster cohesion. A topic that seems to be underplayed by EU institutions is the massive labor migration from central and eastern European New Member States (NMSs); in some countries (the Baltic in particular), up to 15, 20%, even 25% of their active labor force moved westwards in the last couple of decades. One could argue that this is an inevitable outcome of the functioning of the Single Market against the backdrop of large income differentials, that these flows may have peaked in recent years and even reverse movements may take place due to economic catching up. But such a line of reasoning can be seen as self-serving once the overall reality, and not the ideology of the functioning of the Single Market is taken into account. There are pieces of analysis that seem to be out of touch with the reality of the Region. Gaetano Basso, Francesco d’Amuri and Giovani Peri, notice that “the average elasticity of population size to employment shocks is much lower in the euroarea than in the US, with point estimates of 0.2 and 0.8, respectively” (Labor mobility and adjustment to shocks in the euroarea: the role of immigrants,” VoxEu, 13 February 2019). Factually it can be correct when it comes to most of the euroarea. But their analysis is glaringly myopic in view of the enormous outflow of labor from Baltic economies following the Great Recession and austerity policies. In contrast, IMF experts are quite thorough in this regard (Ruben Atoyan et al., “Emigration and Its Economic Imapct on Eastern Europe,” Staff Discussion Notes, Washington, DC, July 2016).Remittances to the tune of billions of euros cannot offset a massive depletion of human capital, both volume- and quality wise. Shortage of human capital is increasingly widespread in NMSs, and this shortage would cripple their ability to deal with the middle income trap in the future. There are also major social and

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political implications of this phenomenon. This is why EU public policies and the EU budget need to consider it attentively. Unless changes in EU policies are made, fragmentation and “renationalizing” tendencies will continue to gather force, and the Union will be constantly battered by internal shocks and conflicts among member states; muddling through will be the hopeful scenario, and fading away/demise would be the bad outcome. It is hardly realistic to think that European economies could achieve, on average, the growth rates of previous decades—for the foreseeable future at least. Demographic change, an overwhelming debt overhang (on average, about 250% of GDP, both private and public, in eurozone), the poor functioning of the eurozone, and too little investment handicap, inter alia, Europe. However, there are ways to make economies more robust There is need to invest more, to improve the quality of public goods (education), to pay more attention to R&D and make the Union more attuned to a digital world which is increasingly dominated by the US and China, and to alter the current deflationary bias of the eurozone by changing its policy matrix.

7

Business and Ethics

Big Business has to show convincingly its social responsibility mission, if it actually operates. There has been a rising number of scandals in finance, in other industries, which foment hostility toward business companies and their perceived reckless profit-maximization behavior (short-termism at the expense of society’s stakeholders’ interests). Christine Lagarde, the former IMF chief, pointedly asked the financial industry to “broaden its sense of purpose” because it has strayed from its original purpose; that it has to reshape itself and be aligned with societal values.22 She and heads of major central banks, such as Mario Draghi from the ECB and Mike Carney from the Bank of England, have referred to a “culture of finance” that has gone astray. Tax evasion and tax avoidance have turned into a big policy issue in the EU and blame has to be assigned to the connivance of not a few member states in this regard. Big business has to change its conduct, be more ethical. Unless this happens, even more radical ideas will encroach on

22 Christine Lagarde (2019).

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peoples’ minds, which may be inimical, in the end, to checks and balances, to democracy. The latter relies on a strong middle class, on an equitable income distribution and on a sense of trust and fairness among social and political actors. When mistrust and animosities abound, the social fabric is torn apart and democratic politics are impaired. More authoritarianism in public and political life would be on the rise. And radical ideas, on the left and the right sides of the political spectrum will continue their rise. Paul Collier insightfully notes that capitalism needs reinvention via ethical behavior and more attention to community values.23 Raghuram Rajan, a former IMF chief economist and former governor of the Bank of India, also thinks that community should play a larger role in how market-based economic systems do function.24 Their line of reasoning hooks up with the Zeitgeist in the western world after the eruption of the Great Recession (the global financial crisis). They both argue that there is need for pragmatic and enlightened policy-making. The fact that they reject extreme individualism and short-termism, and that they focus on “community,” reminds the train of thought of the well-known sociologist Amitai Etzioni.

8

Liberalism and Immigration in Europe

With the benefit of hindsight one can argue that the migrants crisis in Europe has been in the pipeline for quite a while. The lack of a common immigration policy, botched interventions abroad that have misfired, the human disaster in Syria, permeable EU frontiers, and the diminishing cohesion and trust among EU members states have all, inter alia, brought about this crisis—quite likely, more threatening than the eurozone crisis. It is true that aging in Europe is a formidable challenge and that immigration can help improve demographic trends at home over the longer run. There are also humanitarian concerns and the very values of democratic Europe which commend certain actions and support a vision. But to hail a massive flow of migrants/refugees as the solution to demographic strain at home, in Europe in general, is to underestimate the policy conundrum many governments are facing, which is, not least, related to security

23 Paul Collier (2018). In a sharp critique of “neo-liberalism” Paul Mason talks about a post-capitalist future (2015). 24 Raghuram Rajan (2019).

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and social stability concerns. One should not mix up a possible opportunity over the longer term with existing policy trade-offs and enormous security concerns. Europe cannot harbor whoever flees areas of much distress around the world. A wise balance has to be found in this respect between solidarity, humanitarian concerns, and pragmatism, common sense in public/economic policies. Otherwise we will see failing EU policies repeatedly. Having said, one has to be resolute in combating racism, xenophobia, and hate overall and in identity politics in particular. The EU needs to have a more clairvoyant international aid and development policy. The EU needs to cooperate more closely with neighboring countries, to help countries where refugees are hosted.

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Conclusion

Liberalism at its core identifies itself with democracy, the rule of law, fairness, and respect for fundamental human rights. Yet, when globalism, as a vision, leads to unrestrained liberalization by disregarding market failures and losing sight of those who lose in economic competition, and when the disruptive impact of new technologies is underestimated, democracy is jeopardized and “radicalism”25 of all sorts gains ground. This happens because the social fabric is worn thin, the middle class (its social basis) withers, confidence in the ruling elites fades away, and, ultimately, a crisis of democratic governance is brought about. Simultaneously, authoritarian propensities and endeavours crop up.26 Markets have to be judged, therefore, in their social and cultural context, while society is to be understood as more than a competition among individuals and company level profit-maximizers. Highlighting the social responsibility that many companies talk about is not sufficient in this regard. Rediscovering Karl Polany’s outlook on the “markets know best paradigm”27 and Max Weber’ emphasis on ethical conduct (which can be linked with

25 Wolfgang Munchau, too, roots the rise of radical ideas in the failure of neo-liberalism, of unmanaged globalization (2019). 26 See also Yascha Mounk and Roberto Stefan Foa (2018). This issue of Foreign Affairs contains a set of texts listed under the generics ‘Is Democracy Dying?’. 27 Karl Polanyi highlights the need for society to protect itself against unrestrained markets (New York, Farrar and Reinhart‚ 1944).

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Adam Smith’ Theory of Moral Sentiments ) makes sense in trying to figure out a way out of a seemingly historical conundrum. Neither do markets care about ecological threats. Nicholas Stern, years ago and, at the time, being the chief economist of the World Bank, pointed out that the inability of our models and policies to pay due regard to climate change and ecological menaces is, quite likely, the greatest market failure in human history28 ; this, simply put, is a strong criticism of practiced public policies and of underlying cognitive approaches. In the European Union (and the eurozone) reforms are needed to increase the legitimacy of—i.e., the democratic nature of—its institutions; markets need to be viewed in their social embeddedness. In order to avoid worst-case scenarios, pragmatic public policies need to reconcile the requirements of a free economy with what political and social inclusion mean in a democracy. Working on a “new social contract” is a must for making our societies more inclusive, for averting their further radicalization. A new social contract would have to redefine the boundaries of the welfare state, restore the principle of “equal opportunities” at the center of social policies, find ways to foster social inclusion (minimum wage is an idea to be considered), adapt education to what new technologies entail in their cultural and social impact, combat economic (power) concentration that is inimical to sound competition and that leads to market abuse, reduce (if not eliminate) the range of “winners take all” competition, rein in finance, punish tax evasion and tax avoidance resolutely, make the corporate world behave more responsibly socially, etc. It may be that we are going through the downward phase of a very long-term economic cycle (Kondratiev, Schumpeter29 ). Such a phase can explain the “inward looking syndrome” (a resurrected nationalism) one sees in industrialized societies; the Great Recession (the global financial crisis) belongs, admittedly, to the downward phase of a secular cycle. The new industrial technological revolution and the emergence of new global

28 Nicholas Stern quoted by The Guardian, 29 November 2007. 29 Nikolai Kondratiev, a famous Russian statistician who passed away in a Soviet gulag.

He identified successive secular (very long-term) cycles (40–60 years) driven primarily by technological developments; these cycles would mirror social tensions and culminate in major conflicts. Joseph Schumpeter also thought in terms of long-term cycles in his ‘Theory of Economic Development’ (1911), where he emphasises ‘revolutionary’ technology clusters that change society’s technological foundation.

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economic powerhouses play an important part in such dynamics, which are increasingly non-linear and disruptive. What Gideon Rachman calls the “rise of the civilisation state”30 compounds the geopolitical and a related political and economic regime completion/confrontation. The strain in society which is caused by economic conditions can be compounded by inter-ethnic and religious conflicts. “The clash of civilizations” that Samuel Huntington forebode a couple of decades ago seems to find concrete forms in various parts of the world. Wars and geopolitical tensions do exacerbate “civilizational” misunderstandings. For world peace it is vital to prevent major conflicts, trade wars, and the destruction of the multilateral system that was created in the aftermath of World War II (starting with the Bretton Woods system). This does not mean that major stakeholders in a global order cannot proceed to reform the multilateral order and inter-country relationships. One can imagine the emergence of a several bloc based international economic system, which should prevent the complete dismantling of an orderly, rules-based global system. The liberal order of the world, as established after the victory over Nazi Germany and its allies, is being severely tested.31 But the liberal idea still has much support in the industrialized world. However, if its power to shape people’s minds and conduct is to continue, an enlightened version of liberalism (“embedded liberalism”32 ) needs to operate and political elites need to show more respect for their fellow citizens. “Winners take all games” and extreme income inequality have to be fought against if democracy is to survive. Elyseum, the movie with Matt Damon as its main character and which portrays a dystopian world in which a superrich minority lives on a giant spaceship while the rest of people lives on a decrepit earth, is a very powerful metaphor about what can go terribly wrong in the decades to come. The resilience of nation states needs to be considered in regional and international arrangements. This must be taken as a key datum in dealing

30 Gideon Rachman (2019). 31 Richard Haass (2018) examines the Trump administration’s attitude towards the

order established after World War II, and its global impact. 32 As put by John Ruggie, who is quoted by Jack Snyder (Op. cit, p. 54).

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with the tense relationship between nation states and global markets33 . The demise of nation states, as it was postulated by some pundits a couple of decades ago,34 has proved to be a false dawn.35 This reality poses major challenges in the European Union, for avoiding its further fragmentation against the backdrop of a seriously strained transatlantic relationship, trade conflicts, and a shifting balance of economic power toward Asia. Nota bene: a report of the authoritative EEAG group on the European economy talks about “A fragmenting Europe in A Changing World”.36 By the way, those who advocate a “European sovereignty” in order to deal with future challenges imply, one way or another, a form of European nationalism. However, the latter rests on reconciling national with EU level interests. To the dismay of many, a fragility of democracy (i.e., of liberal values) is now all too apparent. This is all the more reason to learn the lessons of ancient and recent history, to be candid and honest about mistaken policies, and to be bold in trying to amend them. Democracy, with its liberal genes, is the best political regime mankind has come up with, at least in the West. Remembering Winston Churchill’s words is as timely as ever.

Appendix: The “Inward Looking Syndrome”---Simple Analytics of a Trade-Off Dilemmas an open society has when facing threats and trade-offs may be captured by economic analysis. More specifically, one can relate protection/security to openness (economic freedom) as public goods. This may be illustrated as a social utility function which includes protection/security (S) and economic freedom (O) as an expression of economic openness, as public goods. A function F = F (S, O) would 33 For Yael Tamir, the problems are rooted in the growing clash between nationalism and neoliberal globalism (2019, pp. 48–53). This issue of Foreign Affairs has on its front cover and as its leading topic “The New Nationalism”. 34 Kenichi Ohmae (1995). 35 William Pfaff seems to have had a much more acute sense of history in this respect

(1993). See also my “Economic Vitality and Viability. A Dual Challenge for European Security” (1995, Chapter 3 in particular). 36 EEAG (European Economic Advisory Group), Quite tellingly, the last chapter is called “Looking outward: Western disarray, China rising”.

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indicate levels of citizens’ comfort in terms of these public goods; it could look like F = ((1 − a) xS + a xO), where (a) would be a variable in consonance with people’s attitude toward the two public goods; this variable could not be higher than 1 and not lower than 0. The substitution between protection/security measures and economic openness (economic freedom) has limits because these two public goods (as a state of the social and economic system) are not completely independent of each other; from a certain level, protection measures, or restrictions may distort open society (democracy) exceedingly. Likewise, a total openness of the economy/society, with no rules and protection measures, may cause enormous costs, social anomia. The graph below illustrates citizens’ growing need for protection in times of hardships, when threats abound. Various combinations of (S) and (O) may be imagined so as to ensure a degree of citizens “acceptance that would minimize discontent/discomfort in given conditions.” An optimal combination is where the price line (S, O) is tangent to the preference (social choice) curve (I). The (a) point refers to an initial level of economic freedom—as flows of capital, workforce, investment, and the range and scope of regulations. At point (a) things are relatively good, calm, and this is revealed by the price line between (S) and (O); a steeper slope, Pa, shows that (S) is regarded as being sufficient (people feel safe) and economic openness as a public good is in high demand. When times worsen a more inward-looking society emerges; such a turnaround is revealed by the change in preferences in favor of (S). When the need for protection measures grows, the change is reflected by a less steep slope of the relative price (Pb), between (S) and economic openness (O); this may involve protectionism and other restrictive measures and their combination is indicated by point (b) on the indifference (utility) curve. The graph below simplifies reality not least because it refers to people in general, but, nonetheless, is not irrelevant. Who decides and how decisions are made regarding the two public goods brings politics into the limelight, as citizens may have different options, may share different political views or values; a community may be made up of different ethnical groups and religions, a large part of the population could be made up of immigrants, etc. In a democracy, one is tempted to say that the social collective option (social) is given by the majority vote. But things are much more complicated if society is profoundly divided and various values are guiding people’ choices (The Nobel Prize winner John Kenneth

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Arrow explained the difficulties of building social utility functions in his “Social Choice and Individual Values, Wiley”, 1951). Moreover, economic interdependencies between states may be very strong (Fig. 1). It is also a fact that the way people value protection vs. openness may vary over time. What is abnormal, unpalatable today, may be termed differently at another moment in time; it may be that people adjust to different circumstances, their habit change. Protection measures can trigger similar responses from partners—and trade wars will likely lead to damages for all parties involved. Therefore, any measures at a national level should be pondered given potential answers from partners. Widespread protectionism comes along with significant dangers; beggar your neighbor policies can easily backfire. It is worth recalling that the globalism of the XIX century Victorian Era was followed by commercial and “hot” conflicts. The analysis should be adapted for the case of economic and military alliances. For example, within the EU there is a pressing need for common efforts in the area of intelligence, border protection, military defense—as all these are European public goods. The context outlined above might explain why some developed states seem to be seeking to regain a former power status via a journey back in time. There are additional aspects that can help to see through future trends: Graph: The relaon between protecon (S) and economic openness (O) S

a I b Pa

Pb

F(S,O)

Fig. 1

The relation between protection and economic openness

O

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• The global economy gets multipolar. • The EU is fragmented by centrifugal forces and weakened by Brexit. • The post WWII institutional economic arrangements (“Bretton Woods’ arrangements”) are under siege due to alternative accords and institutions promoted mainly by China. • Unrestrained globalization has brought benefits, but it has also damaged social cohesion by neglecting distributional effects. • “Realpolitik”, as a way to articulate foreign policies, goes up at the expense of placing moral values and the interests of what is called the international community at center stage. Can an open international system, which is based on multilateral accords, be saved under such circumstances? Such a question begs others: • Are there international arrangements that can address and redress flaws of unrestrained globalization? • Is it possible to reinvent the EU, to make it fit the new conditions in the global economy? • Can the Eurozone be turned into a genuine monetary union, with proper fiscal arrangements? For this to happen the German-France nexus is vital. • Can the EU get safer security arrangements? This involves its relations with the US and NATO, with Russia, the US-Russia relations. • How should military conflicts, in different areas of the globe, be tackled? • How would the new big rivals in the world (the US and China) cooperate on issues of interest for the whole world, in a systematic way? PS. This text is a revised and expanded version of the piece that was published (in Romanian) by Contributors, 5 May 2018. Eurozine published it as “Is Democracy threatened to lose its liberal core?,” August 3, 2018; it was also published by Western Commerce Review in August 2018 and RJEA, June 2019.

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References Autor, D. (2016). Trade and Labor Markets: Lessons from China’s Rise (MIT, February). See also his Work of the Past, Work of the Future”, VoxEu, 19 March, 2019. Bussolo, M., Davalos, M., Peregine, V., & Sundaram, R. (2018). Toward A New Social Contract. Washington, DC: The World Bank Group. Collier, P. (2018). The Future of Capitalism. Allan Lane: Facing the New Anxieties. Daianu, D. (1995). Economic Vitality and Viability: A Dual Challenge for European Security. Frankfurt am Main: Peter Lang (Chapter 3 in particular). D˘aianu, D. (2011, July 21). Markets and Society: When High Finance Corrodes Economy and Undermines Democracy. Eurozine. https://www.eurozine. com/markets-and-society/. D˘aianu, D. (2017). The New Protectionism. World Commerce Review, Spring. D˘aianu, D. (2018). Emerging Europe and the Great Recession. Cambridge: Cambridge Scholars Publishing. EEAG (European Economic Advisory Group). (2019). A fragmenting Europe in a changing world. Munchen: CESIFO. Haass, R. (2018, March 21). Liberal World Order, R.I.P., Project Syndicate. Hirschman, A. (1972). Exit, Voice and Loyalty. Cambridge, MA: Harvard University Press. Kaplan, R. (2018). The Return of the Marco Polo World. New York: Random House. Kolodko, G. (2018, January 18). Capitalism, Socialism or Chinism? EconoMonitor. Lagarde, C. (2019, February 28). The Financial Sector: Redefining a Broader Sense of Purspose. 32nd World Traders Tacitus Lecture, London. Levitsky, S., & Ziblatt, D. (2018). How Democracies Die. New York: Viking. Lin, J. Y. (2012). The Quest for Economic Prosperity. Princeton: Princeton University Press. Mahbubani, K. (2018). Has the West Lost It? London: Allen Lane. Mason, P. (2015). Post-Capitalism: A Guide to Our Future. Penguin Books: London. Mounk, Y. (2018). The People vs. Democracy. Cambridge, MA: Harvard University Press. Mounk, Y., & R. S. Foa. (2018, May–June). The End of the Democratic Century by Foreign Affairs. Munchau, W. (2019, February 25). The Future Belongs to the Left, Not the Right. Financial Times. North, D. (1981). Structure and Change in Economic History. New York: Norton.

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Ohmae, K. (1995). The End of the Nation State. The Rise of Regional Economies: New York, Free Press. Olson, M., Jr. (1982). The Rise and Decline of Nations: Economic Growth, Stagflation and Social Rigidities. New Haven: Yale University Press. Pfaff, W. (1993). The Wrath of Nations. New York: Simon & Schuster. Piketty, T. (2014). Capital in the 21st Century. Cambridge: Harvard University Press. Piketty, T., and E. Saez. (2013). Top Incomes and the Great Recession. IMF Economic Review 61(3), 456–478. Polanyi, K. (1944). The Great Transformation. New York: Farrar & Reinhart. Rachman, G. (2019, March 7). China, India and the Rise of the “Civilization State”. Financial Times. Rajan, R. (2019). The Third Pillar: How Markets and the State Leave Community Behind. London: Penguin Press. Rodrik, D. (2007, June 27). The Inescapable Trilemma of the Global Economy (personal blog). Rodrik, D. (2018, February). The Double Threat to Liberal Democracy. Project Syndicate. Sharma, R. (2018, April 27). Prosperity Is No Lock on Popularity. New York Times. Schumpeter, J. (1942). Capitalism, Socialism and Democracy. New York: Harper and Row. Snyder, J. (2019, March–April). The Broken Bargain: How Nationalism Came Back. Foreign Affairs, p. 54. Stern, N. (2007, November 29). Quoted by The Guardian. Tamir, Y. (2019, March–April). Building a Better Nationalism. Foreign Affairs, pp. 48–53. Zucman, G. (2015). The Hidden Wealth of Nations: The Scourge of Tax Havens. Chicago: Chicago University Press.

The Political Economy of Sovereign Wealth Funds Jürgen Jerger

1

Introduction

Sovereign Wealth Funds (SWF) play a significant role in many countries. Table 1 lists the 10 largest SWF by total assets. Since the countries differ very much in size, the two last columns also report the population size of the respective countries and the TA/pop ratio. China alone manages four out of the 10 largest SWF. It gets immediately clear, however, that even the combined value of these funds is quite low in per capita terms when compared to other countries. With the very notable exception of Norway—where the total SWF assets are now above the one trillion US-$ mark—the political systems of all countries in the table are characterised by some deviations from the ideal of a perfect democratic system, albeit to quite different degrees. Indeed, apart from Norway, SWF are quite uncommon in stable democracies—and rather small if they exist at all. If the list in Table 1 were extended, the Korean Investment Corporation of South Korea with 131.6

J. Jerger (B) Department of Economics, University of Regensburg, Regensburg, Germany e-mail: [email protected] Leibniz Institute for East and Southeast European Studies Regensburg, Regensburg, Germany © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_6

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Table 1

Top 10 Sovereign Wealth Funds (by total assets)

Fund Norway Government Pension Fund Global China Investment Corporation Abu Dhabi Investment Authority Kuwait Investment Authority Hong Kong Monetary Authority Investment Portfolio GIC Private Limited SAFE Investment Company Temasek Holdings Qatar Investment Authority National Council for Social Security Fund

TA (bn. US-$)

Country

1098.200

Norway

Pop. (mn.)

TA/Pop

5.4

203.4

940.604 696.660 592.000 509.353

China Abu Dhabi Kuwait China

1433.8 1.5 4.2 1433.8

0.7 464.4 141.0 0.4

440.000 417.845 375.383 328.000 324.966

Singapore China Singapore Qatar China

5.8 1433.8 5.8 2.8 1433.8

75.9 0.3 64.7 117.1 0.2

Sources https://www.swfinstitute.org, http://worldpopulationreview.com, own calculations The TA/Pop ratio is stated in 1000 US-$ per capita. All data refer to 2019

bn. US-$ under management (which is about 2600 US-$ per capita) would be the next SWF (at rank 14) in a democratic country. The largest SWF in a European Union member country—the Nuclear Waste Disposal Fund in Germany with around 27 bn. US-$ under management—was founded only in 2017 and has a very specialised agenda as its name suggests. From these observations—and bearing in mind that there are exceptions—it seems fair to state that SWF are more popular in less democratic political systems. This paper provides a political economy rationale for this feature. More precisely, it will make the case that a SWF may serve as a means to stabilise an autocratic regime. The causal link emphasised in the model is that a SWF gives credibility to an autocratic elite to provide a sufficiently high degree of redistribution to the poor in the future. This credibility prevents the poor from staging a revolution that would bring the autocratic regime to an end. An important feature of a SWF in this respect is that it usually invests money internationally and therefore will not be (partially) destroyed during a potentially violent revolution. Whereas this paper provides a formal model of the interplay between income from the extraction of natural resources and the political system, the idea is far from being new. E.g. Eifert et al. (2003, p. 1) note that “[j]ust as political traditions shape the use of oil income, the income

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itself has shaped the political economy of petroleum exporting countries.” Dunning (2008) also argues along these lines. SWF are not exclusively, but mainly filled with money from the export of natural resources such as fossil fuels. In this sense, the stabilising role of SWF for autocracies can be viewed as another channel through which the well-known resource curse may be effective; see e.g. Corden and Neary (1982), Corden (1984) and Neary (1984). The paper is an extension of the literature on SWF that so far mainly focused on aspects below the level of the political system such as their management and transparency, the differential treatment of public and private funds, and the potential market power of SWF, to mention just a few; see e.g. Truman (2010), Kemme (2012) and Bernstein et al. (2013). The rest of the paper is organised as follows: The basic set-up of the model is presented in Sect. 2. Section 3 then looks at the properties of the model equilibria when SWF do not exist. In Sect. 4, SWF are introduced and shown to have a stabilising role for autocratic regimes. Short concluding remarks are offered in Sect. 5.

2 2.1

The Model

Inequality, Taxation, and Revolution

The following model is based on the political-economy model set out in Acemoglu and Robinson (2001) and Acemoglu and Robinson (2006, Chapter 16). They elaborated the basic framework with the crucial distinction between an elite (however defined) that has the de jure power in a political system and the poor that have no possibility to directly influence the political decisions by the elite. Still, the poor may wield some de facto power which comes from the possibility to stage a revolution that—if successful—would drive the elite out of its privileged position. Acemoglu and Robinson also introduced the basic idea that the elite may use redistribution in order to pacify the poor to such an extent that they (rationally) abstain from staging a revolution. Clearly, this is also in the interest of the elite. The extension (apart from a helpful simplification to a 2-period framework) in this paper is the introduction of a SWF that may reinforce the credibility of redistributional policies in a dynamic context. In doing so, I draw on previous joint work with Dimitri Migrow, see Jerger and Migrow (2010).

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Consider a society with a population of mass 1, a fraction δ < 1/2 of which belongs to the elite, whereas the remaining (1 − δ) is the mass of the poor. Aggregate income y is exogenous. Without any redistribution, the distribution between the elite and the poor is characterised by the share θ (1 − θ ) of y that goes to the elite (poor). Therefore, primary incomes per capita for both groups are given by θ·y δ

(1)

(1 − θ ) · y , (1 − δ)

(2)

yE = yP =

where a superscript E (P ) signifies the elite (poor). There may be some distribution which is modelled such that there is a tax rate τ that applies to incomes of the elite as well as the poor but that is redistributed to the poor only. However, the amount that is available for redistribution falls short of the tax revenue τ · y by some share C(τ ) that may be thought of as depicting the usual efficiency cost of taxation and redistribution. The cost share function C(τ ) has the following properties: C  (τ ) > 0, C  (τ ) > 0, C(0) = 0 and C  (1) ≥ 1. These assumptions ensure that there will never be a complete expropriation of the elite by the poor via redistribution.amount that is available for redistribution falls With these specifications and assumptions, the group specific incomes per capita after redistribution (secondary incomes), denoted by y i , i ∈ {E, P} are given by 

y E = (1 − τ ) · y E =

(1 − τ ) · θ · y δ

y P = (1 − τ ) · y P +

(τ − C(τ )) · y 1−δ





=

[(1 − θ ) · (1 − τ ) + (τ − C(τ ))] · y . 1−δ

(3)

(4)

Since taxation/redistribution benefits the poor at the expense of the elite, the elite will prefer a tax rate of τ = 0 as long as they can be sure of their social status as elite. Due to the properties of the cost function C(τ ), the poor wouldn’t vote for an arbitrarily high tax rate. It is helpful to compute the tax rate τ P that the poor would prefer by maximising their

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secondary income (4). This immediately yields the first-order condition   (5) θ = C τ P . Unsurprisingly, this implies a preferred tax rate τ P that is increasing in the degree of inequality θ . A tax rate τ > 0 will only be in the interest of the elite if they can’t be sure of their position. Following Acemoglu and Robinson (2001), this may be the case due to the de facto power of the poor who might drive the elite out of their position. More precisely, let’s assume that a revolution gives all resources permanently to the poor—so this would be a complete expropriation in the Marxian sense. Whereas revolutions in our model are assumed to be successful in this sense, they come at a cost for the poor. This cost is specified as a share 0 ≤ μ ≤ 1 of income y that simply disappears due to the revolution. Therefore, μ might be thought of as capturing the productivity of the elite—or as an inverse measure of the de facto power of the poor. Note that after a revolution the poor will only get (1 − μ) · y even if the elite is completely expropriated. Looking at the revolution as a choice variable of the poor, for μ = 0, a revolution is inevitable, whereas for μ = 1, a revolution doesn’t make any sense. This setup also implies, however, that the elite will be expropriated in a revolution and therefore has any incentive to pacify the poor with a redistributional scheme that makes them less likely to stage a revolution in the first place. In order to pin things further down, we assume a distribution of μ according to  H μ with probability q , (6) μ= 1 with probability 1 − q where μ H is assumed to follow a uniform distribution on the (0, 1)— interval and denotes the degree of destruction that occurs with probability q if a revolution is staged. 2.2

Timing and Intertemporal Utility

There are only two periods t ∈ {1, 2} which suffice to illustrate the most important points—and which is a significant simplification of the Acemoglu and Robinson framework. Initially, the elite is assumed to wield

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de jure power and is therefore able to decide on whether or not to offer redistribution by implementing τ P as defined by Eq. (5). At the start of any period, the value of μ is revealed and correctly observed by the elite and the poor. With this knowledge, the elite decides on whether to implement τ = 0 or τ = τ P . Next, the poor decide whether or not to stage a revolution. Clearly, the elite takes into account the impact of its decision on this decision of the poor. Intertemporal utility for both groups is simply given by the discounted sum of the expected group specific income Ui =

2 

β t−1 yˆti ,

(7)

t=1

where i ∈ {E, P}. The discount factor 0 < β < 1 is t assumed to be identical for both groups.

3

Equilibria Without SWF

Now we look at equilibria of this structure with no SWF in place. In order to proceed step by step we start out without any redistribution and then consider the decision of the elite on redistribution. 3.1

No Redistribution

If there is no redistribution, the poor know that a revolution staged in  t = 1 gives them an income of 1 − μ H · y in both periods. Without a revolution their income is simply given as y P = y P according to Eq. (2). Therefore, Eq. (7) implies the following revolution condition   (1 + β) · 1 − μ H · y (1 + β) · (1 − θ ) · y ≥ , 1 − δ 1  −δ

 

income of the poor with revolution

income of the poor without revolution

which is equivalent to μ H ≤ θ.

(8)

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If (8) does not hold, the elite is safely in place, even if there is no redistribution. In this case, they will therefore use their de jure power in order to set τ = 0. The de facto power of the poor implied by (8) does not suffice to change this outcome. 3.2

Including Redistribution

If (8) holds, the elite can still try to prevent a revolution by introducing redistribution. It can credibly commit to τ = τ P only for t = 1, however. If the no-revolution condition holds in t = 2, the elite has an incentive— and the power—to reset distribution to τ = 0, whereas it will stick to offering τ = τ P if μ < θ in t = 2. The calculation of the expected twoperiod income of the poor thus has to take into account the probability of redistribution in period 2. Due to the assumption of μ H following a uniform distribution, this probability is given by Pr(μ < θ ) = q · θ . Therefore, redistribution stops in t = 2 with probability (1 − q · θ ). Taking this into consideration, the expected income stream (7) of the poor, conditional on redistribution in t = 1 is given by    P     τ −C τP · y P P P = 1−τ ·y + E U 1−δ    P   τ −C τP · y ·β ·q ·θ P P . + 1−τ ·q ·θ ·β · y + 1−δ Hence, the revolution condition in this case can be written as   (1 + β) · 1 − μ H · y

≥ 1−δ 

     y · (1 − θ) · 1 + β − τ P · (1 + β · q · θ ) + τ P − C τ P · (1 + β · q · θ) , 1−δ

(9)

Clearly, the expected income if a revolution is staged in t = 1 is the same as before, since it does not depend on redistribution. Equation (9) can be simplified to   1+q ·β ·θ θ · τ P − C τ P < θ, (10) μH ≤ θ − 1+β   where the second inequality follows from θ · τ P > C τ P . Comparing (10) and (8), it is immediately clear that the possibility to redistribute reduces the range of values for μ H that will lead to a

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revolution. The threat of the de facto power of the poor hence leads to concessions that are in the interest of the elite.

4

The Role of a SWF

Even when there is redistribution, the threat of a revolution does not completely disappear for sufficiently small realisations of μ H , as made clear by (10). The straightforward idea of increasing τ beyond τ P can be ruled out because of the efficiency cost C(τ ). The inability of the elite to ensure a non-revolution decision by the poor is partly driven by its inability to commit in t = 1 to redistribute also in t = 2 as explained in the last section. This clearly increases the willingness to stage a revolution in t = 1 by the poor. What can the elite do about this? They  can set aside a fraction α of  their period 1 secondary income 1 − τ P · θ · y and invest in a SWF. This   fund S = α · 1 − τ P · θ · y remains in the hands of the elite if there is no revolution in t = 1 and in t = 2. If there is a revolution in t = 2, the poor also take over S. Since SWF are usually invested abroad, it is assumed that S is not subject to the partial destruction by the factor μ in case of a revolution. Any S > 0 increases the potential gain of the poor from a revolution in t = 2; more on that below. But this also increases the willingness of the elite to offer redistribution in t = 2—and credibly so from the perspective of t = 1. Hence, a SWF may serve as a remedy to the credibility problem of the elite. Essentially, the SWF increases the de facto power of the poor in t = 2, thus potentially preventing them from staging a revolution. In order to treat this analytically, the size of the SWF has to be determined. In order to do so, we start with the observation that without a revolution and without redistribution, the poor can secure a total income of y P · (1 − δ) = (1 − θ ) · y in t = 2. If their de facto power in t = 2 should go up unconditionally, the poor must be better off even in the worst case, which is given by μ = 1. Hence, only a SWF of the size S ≥ (1 − θ ) · y

(11)

is able to increase the de facto power of the poor in t = 2. It was noted above that S also increases the potential gains from a revolution by the poor in t = 2. Hence, from the point of view of the elite, there is also an upper limit of S above which a revolution might be prevented in t = 1

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but get more likely in t = 2. Specifically, this is the case when S exceeds secondary income of the poor under no revolution. This requires    (12) S < (1 − θ ) · y + τ P − C τ P · y. In what follows, I assume a size of S such that (11) holds with equality. This immediately yields the following value for the share α the elite has to put into S: 1−θ  . α= 1−τP ·θ

(13)

From this, we can directly re-compute the condition for a revolution under the assumption that a SWF is introduced by the elite as follows         (1 + β) · 1 − μ H · y (1 + β) · y · (1 − θ) · 1 − τ P + τ P − C τ P ≥ , 1  −δ 1  −δ income of the poor with revolution

income of the poor without revolution

(14) which boils down to

   μH ≤ θ − θ · τ P − C τ P

(15)

Looking at (15) and (10) makes clear that the elite is now able to prevent a revolution for a larger range of values of μ H . Formally, this requires 1+β·q·θ 1+β < 1 which is obviously the case since q · θ < 1. Figure 1 summarises the three revolution conditions in (8), (9) and (10), respectively. If there is no redistributional system in place, all values μ H ∈ [0, θ ] lead to a revolution. If the elite (rationally) introduces redistribution via a tax system, this range shrinks. And adding a SWF further reduces the range of μ H that would drive the elite out of their privileged position.

τP, S 0 Fig. 1

τP

τ =0 1 θ

μH

Conditions for revolution under different institutional arrangements

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5

Conclusions

In this paper, I looked at the potential of SWF to stabilise autocratic regimes. It was shown that this property can indeed be identified in a relatively simple dynamic model. More precisely, a ruling elite might have an incentive to put part of their income into such an investment vehicle. The reason emphasised here is that a SWF gives credibility to the elite with respect to their future decision on redistribution to the poor. This credibility is crucial for the elite since this helps to prevent the poor from staging a revolution. Within the logic of the model presented here, the elite is not able to rule out revolutions entirely. But the higher initial inequality, the higher is the incentive for the elite to run a SWF. It is very clear that the model of this paper highlights a very specific property of SWF. This is not meant to deny other roles—such as extending the time frame over which the proceeds from the extraction of finite natural resources are used. It does, however, fit quite well the observation that the use of SWF is much more common in countries with autocratic political regimes rather than in more democratic countries.

References Acemoglu, D., & Robinson, J. A. (2001). A Theory of Political Transitions. American Economic Review, 91, 938–963. Acemoglu, D., & Robinson, J. A. (2006). Economic Origins of Dictatorship and Democracy. Cambridge: Cambridge University Press. Bernstein, S., Lerner, J., & Schoar, A. (2013). The Investment Strategies of Sovereign Wealth Funds. Journal of Economic Perspectives, 27 (2), 219–238. Corden, W. Max. (1984). Boom Sector and Dutch Disease Economics: Survey and Consolidation. Oxford Economic Papers, 36, 359–380. Corden, W. Max, & Neary, J. P. (1982). Booming Sector and De-industrialisation in a Small Open Economy. The Economic Journal, 92, 825–848. Dunning, T. (2008). Crude democracy. Natural resource wealth and political regimes. Cambridge: Cambridge University Press. Eifert, B., Gelb, A., & Tallroth, N. B. (2003). Managing oil wealth. Finance and Development, 40(1), 40–45. Jerger, J., & Migrow, D. (2010). Stabilisierungsfonds und makroökonomische Governance. In R. Ohr (Hrsg.), Governance in der Wirtschaftspolitik, Schriften des Vereins für Socialpolitik, Band 326, S. 97–117.

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Kemme, D. M. (2012). Sovereign Wealth Fund Issues and The National Fund(s) of Kazakhstan. SSRN Electronic Journal (1036). Neary, J. P. (1984). Deindustrialisation and the Dutch Disease, CEPR Bulletin. Truman, E. M. (2010). Sovereign Wealth Funds: Threat or Salvation? Peterson Institute for International Economics.

Comparative Economics Still on the Tracks

European Higher Education: Challenges and Achievement Bruno Dallago

1

Introduction: The Evolution of Universities

Universities are among the oldest institutions in the world and they are also among the most open to society and internationally. They went through deep changes in their organization and roles through centuries, yet the modern university evolved in Europe in the Middle Ages. The medieval Latin term universitas denoted a community or corporation devoted to learning and education; its corporate existence had been

A previous version of this chapter was presented at the 4th Canadian International Conference on Advances in Education, Teaching and Technology 2019, University of Toronto, 27–28 July 2019. Unless otherwise specified, the information sources are the documents and websites of the EU. B. Dallago (B) Department of Economics and Management, University of Trento, Trento, Italy e-mail: [email protected]

© The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_7

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recognized and sanctioned by civil or ecclesiastical authority or by both.1 The documented topic moment was the acceptance by the University of Bologna in 1158 (or 1155) of the Constitutio Habita, which guaranteed that a traveling scholar had the right to unrestricted passage for the purpose of education. This moment is considered to be the origin of the fundamental principle of academic life: academic freedom (Moutsios 2012). Initially, universities cultivated culture and educated the children of the ruling classes in both civilian and ecclesiastical subjects. With the establishment of capitalism, universities became institutions of higher education of a non-vocational type, endowed with the right to confer degrees whose codified value was generally recognized in the labor market. Following their involvement also in research, universities played a fundamental role in innovation and economic development, gained prominent economic and social role, and became soon concern for policies and public funding. As their role evolved, the universities’ traditional aspiration to academic freedom and governance autonomy conflicted with the authorities’ will to control or govern universities. The dispute came essentially from two sources: the social and economic role of universities as providers of recognized degrees and the universities’ increasing need for financial resources. The financial crisis of many states and the stagnation of real incomes dramatically exacerbated public and private difficulties in financing growing education and research costs. The successful experience of a limited number of world-level universities, particularly in the United States, to attract significant amounts of external resources, particularly from private industry and public agencies, fostered the evolution of the entrepreneurial university as part of the relation among government, universities, and business. In this model, the university pursues the economic value of its education and research missions (Dallago 2014). Yet this regards only a limited number of world-class universities, particularly in Anglo-Saxon countries. While in the Middle Ages the European university was typically international and used Latin as the international language of the educated and leading community, the advent of the nation state after the Westfalia peace in 1648 changed the landscape. Universities became increasingly national: they became often part of the state apparatus and submitted 1 See sities.

https://en.wikisource.org/wiki/1911_Encyclop%C3%A6dia_Britannica/Univer

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to a national (or state or regional, in federal countries) minister, were financed in large part from the state budget, used the national language and paid attention to national issues and goals in their education and research policy primarily. Awarded degrees were recognized only within the national borders. The process of European integration brought a new goal for universities to the forefront. In the institutional architecture that evolved, national governments have predominant competences in education and, less so, research, while EU only has complementary competences. The national nature of universities is thus at odds with the essence of European integration and the aim of developing a European labor market and education and research space. The chapter uses an economic perspective to analyze higher education in the perspective of European integration. It looks also at the consequences for the labor market (EC 2005a). The next section considers the needs and limits of the European integration process and looks at the consequences of European institutions and their relations with national institutions, with particular concern for higher education. As explained in Sect. 3, there are strong and resilient national traditions and cultures within the EU, while the EU has only partial and soft competences in the field of higher education. A fundamental issue is how these diversities could and should be managed in order to support European integration, with particular concern for the economy. Section 4 looks at the achievements that the drive to integration of European universities has actually achieved and concludes that, along with important outcomes, many problems are still open. Section 5 concentrates on some important features of the context, which became prominent following the international crisis. These have to do primarily with the growing fault between the countries of Northern Europe and those of Southern and Eastern Europe, with important consequences for universities. Section 6 concludes.

2

European Integration and Higher Education

The distribution of competences in higher education between national or local governments and the EU is defined in the 2007 Treaty of Lisbon and based on the EU fundamental principles. According to the principle of subsidiarity, defined in Article 5 of the 1992 Maastricht Treaty, decisions are taken as closely as possible to the citizens and the EU has competence only where its action is more effective than action taken at other levels.

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Moreover, according to the principle of conferral (Article 5 of the Maastricht Treaty), the Union acts only within the limits of the competences conferred upon it by the member states in specified areas. In the field of education, the EU has competences supporting member countries and in that of research it has competences parallel to those of member countries. Particularly in the former case, the role of the EU is indirect and has to relay on the willingness of national governments to develop and be part of a European educational system. Conversely, the EU role is more direct and effective in the case of research (Dakowska et al. 2018). Such a distribution of competences is a problem for European integration. The soft EU approach is at odds with the fundamental role of states and the differences among national systems of education based particularly on the varieties of the relationship between universal values and the search for a national identity (Hörner et al. 2015). Moreover, the success of integration requires that educational systems are at least mutually compatible, for cultural, social, and economic reasons. In spite of its limited competences, the EU has devolved a great deal of attention, effort and resources to the field of education, with fair success. However, if member countries do not converge in the economy (Dallago 2016) and education systems converge, new problems may appear in the form of brain and skill drain to the disadvantage of more vulnerable member countries. There are two main reasons behind the EU drive to education integration: first, create a homogeneous European cultural space fostering and supporting the cooperation and integration of European societies. Education belongs in the founding and fundamental values of the European Union and is essential for promoting cultural, social and political integration (EC 2018a; Rome Declaration 2017). Second is the importance of education for economic and social reasons. The role of higher education is fundamental for supporting EU integration. Yet the EU is an incomplete and asymmetric integration of different countries (Dallago 2016). Incompleteness means that the Union lacks fundamental institutional features and components, such as political union. Asymmetry means that the Union has diverse kinds of competences in different fields, such as in the monetary and fiscal domains. The split of competences between the Union and national governments is not problematic when policies are not necessary, i.e., when markets can autonomously fix unbalances or can provide the resources necessary to do so. The theory of Optimum Currency Areas (OCA) defines the necessary

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conditions, such as labor mobility, that make the use of one common currency as advantageous compared to having more currencies (Dallago 2016; Baldwin and Wyplosz 2012). Various authors have long highlighted (Eichengreen 1991; Eichengreen et al. 1990; Feldstein 1991; Friedman 1997; Obstfeld and Taylor 1997; Sala-i-Martin and Sachs 1991) that the Eurozone is not an OCA. It is thus important to see which can be the contribution of European higher education policies in filling this gap. Labor market (im)mobility is the essential, yet most problematic OCA criterion (Zimmermann 2009). Various studies, referring to different periods of time, have found that labor market shocks led to weaker internal and external migration in Europe than in the United States (Bonin et al. 2008; Decressin and Fatás 1995; Bentivogli and Pagano 1999; Gáková and Dijkstra 2010), although the situation improved slightly following the crisis (Dao et al. 2014; Jauer et al. 2014). The role of labor mobility in reducing the differences in economic development between the states is important in the United States. In the EU, this effect is much lower and labor mobility is not important in reducing disparities among EU member countries. Free circulation of people within the EU for labor reasons is one of the fundamental principles of the EU, with modest effects. Rules in the labor market remain mostly national, due to political and cultural factors, different languages, social interests, institutional and real constraints, such as the different recognition of degrees and the rigidity of the housing market in many countries. The EU also tried to foster integration by supporting the circulation of migrants, with doubtful outcomes and national opposition. Among the most important labor market differences are entry and exit flexibility, usually greater in the United Kingdom and Ireland, seniority relations and firm specific investment, which are more important in continental Europe. Due to these features, financial shocks have faster and greater consequences in the former countries than in continental Europe. While faster reaction fosters adaptation, it also increases contagion in the real economy. In countries like Germany, alternative instruments of flexibility exist, such as reduced working hours. Where neither mechanism works well, as in countries of Southern Europe, labor reallocation is slow and youth and long-term structural unemployment are high. In the resilient countries of Northern Europe, employee–employer relations are more cooperative, pay is better related to workers’ productivity, hiring

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and dismissing workers is more flexible, and labor participation activity rate is also higher. Institutional variety of labor markets across countries and different legal systems leads to different behavior of economic actors, different types and features of contracts among parties, as well as different ways and intensity of the transmission of shocks (La Porta et al. 2008; Ménard and Marais 2006). Welfare systems are typically important in Europe, but they have different features and organizations, different dimension and costs, different incentive effects, and different consequences for economic activity, in spite of some convergence (Bouget 2003; Sapir 2006). Downward wage rigidities in the EU were particularly pronounced before the crisis in many countries, depending on the features of trade unions and the degree of centralization of wage bargaining (Crouch 2012; Freeman 2008). Downward nominal wage rigidity is stronger when unemployment is low, union density is high and strict employment protection legislation is in place (Holden and Wulfsberg 2008). Downward nominal wage rigidity is stronger in Southern European countries (Italy, Greece, Portugal and Spain) and in Northern European countries (Denmark, Finland, and Sweden). In continental countries (Austria, Belgium, France, Germany, Luxembourg, and the Netherlands) and Anglo-Saxon countries (Ireland and the United Kingdom), downward nominal wage rigidity is weaker. However, rigidity decreased somewhat with the crisis, particularly in vulnerable countries, through labor market reforms (OECD 2014). Low labor mobility and weak contribution of immigration have two distinct effects. First, adjustment processes must go through more problematic channels to regain competitiveness, such as through internal devaluation. Second, the low mobility of labor opens the possibility for policies to take an antilabor stance, e.g., in the form of bad quality labor contracts. The intent is to increase competitiveness through cheaper labor and not through investment, with negative consequences for the size of the domestic market and international specialization. Differences in labor market efficiency are large within the EU and the Eurozone (Eurostat 2018; WEF 2018) and the bulk of labor mobility is within regions of the same country (Gáková and Dijkstra 2010). Under these conditions, common policies become more difficult and less effective. Increasing labor mobility is fundamental in order to weaken the probability and effect of asymmetric consequences from shocks and upgrade the effect of common policies. The EU action in higher education finds a strong motivation in these issues.

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3 Higher Education and the EU Strategy and Goals European Higher Education Institutions (HEIs) are subject to a double set of pressures: those typical of any developed area and those deriving from the European integration (EC 2017). As to the former, universities in the European Union are called to pursue economic value to support innovation (Forge et al. 2013). This is evidenced in both European and national strategies and is more stringent in countries fighting with budget and financial problems (particularly in Southern Europe) and those characterized by neoliberal political views (such as Great Britain). A fault line is evident between Northern European countries—where higher education is generally free of charge and much of research is government-sponsored—and Southern European and AngloSaxon countries, where economic value is fundamental in both education and research.2 This distinction makes difficult setting up joint education and research programs among HEIs belonging in different groups of countries. Since most of the competences—and all primary competences in the field of higher education—belong in national countries (central governments in most countries, regional governments in others, such as Germany), countries follow idiosyncratic paths and the EU does not have any compulsory role. Pressures coming from European integration include ideals and aims and economic and organizational needs of integration. These pressures led the EU to take the lead in setting up a European system of higher education, including the development of European universities, and moving toward a European Education Area (see below). Although these moves have HEIs as their primary target and are based on ideal and scientific motivations, their final goals have social and economic nature (EC 2017). The EU goal in the economic and social fields is to coordinate countries in moving toward mutually compatible and effective higher education systems without jeopardizing intercountry cultural differences. The European system of higher education is relatively simple: a continuously

2 See EC (2018g) and Tuition Fees at Universities in Europe in 2019—Overview and Comparison, 9 Aug 2018, https://www.mastersportal.com/articles/405/tuition-fees-atuniversities-in-europe-in-2019-overview-and-comparison.html.

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moving undertaking, with important achievements duly accomplished with some faults and failures and with ambitious goals ahead. Erasmus (EuRopean Community Action Scheme for the Mobility of University Students) is the forerunner of European programs in education, an EU student and teacher exchange program established in 1987 after the 1981–1986 period of pilot student exchanges. Later accomplishments include different versions of the Erasmus program and the Bologna Process (see below). Additional programs involve cooperation with universities of particular countries, such as former countries in transformation (Phare, Tempus). The number of students who took part in the Erasmus program in 2006 was over 150,000, almost 1% of the European student population. The share among university teachers was still higher: 1.9% of the European teacher population, or 20,877 people. In 2013–2014 academic year, the number of recipient students was 272,497, which increased the total number of Erasmus students to 3.3 million since the beginning (EC 2015c). In 2017 the number of students increased to 797,000, that of organizations to 84,700 and the budget reached e2.6 billion (EC 2018e, f). The Erasmus program had parallel programs, in particular the Erasmus Mundus (EM) program aimed at converting European higher education into a world standard and attracting third-country students with ad hoc teaching courses and scholarships. The Lifelong Learning Programme (LLP) originated by incorporating the Erasmus program and a number of independent programs, such as Leonardo da Vinci, into Socrates program. The latter was established by the European Commission in 1994 and was transformed into Socrates II in 2000. LLP replaced Socrates during the 2007–2013 budget as an umbrella program. During these years, LLP was the single financial instrument of the European Commission for managing education and training policies. The program, with a total budget of e7 billion over seven years (2007–2013), was managed and funded through a network of national agencies. More ambitious and far-reaching projects, such as Erasmus Mundus, were managed and financed either directly by the European Commission or through its Education, Audiovisual and Culture Executive Agency (EACEA). LLP continued the main actions launched under previous action programs and included six specialized subprograms.3 LLP supports 3 These programs were: (1) Comenius, sustaining actions for pre-university schools; (2) Erasmus, supporting exchanges of higher education students and cooperation between

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the development of lifelong learning in member countries’ education and training systems. The program supports exchanges and connections between people, institutions, and countries within the European Union and the European Economic Area. Analyses and opinions on the effect of EU programs vary. Although some doubts exist on the effect of selection and self-selection mechanisms among students, it is undoubted that programs gave a boost to the interaction and cooperation of European HEI and students of different countries, with potential positive outcomes for the integration of Europe. Erasmus+, or Erasmus Plus, replaced LLP in the following 2014– 2020 budget period, with an overall budget of e14.7 billion. Erasmus+ combines all the EU’s current schemes for education, training, youth, and sport.4 The program provides, through home institutions, grants for study, work placement, training, and cooperation actions for students, teachers, and administrators in another country. A decision to extend the program over the next budget cycle 2021–2027 was taken, with a doubled budget of e30 billion. The achieved organizational stability of Erasmus+ also needs that the home university fully recognizes the period and related activities that students spend at another university in another country, in spite of the significant differences among national systems of higher education. To do so, European universities adopted a set of mutually compatible organizational and academic principles through the so-called Bologna Process (EC 2018c). The Bologna Process is a voluntary intergovernmental cooperation of 48 European countries, including non-EU countries, and the European Commission.5 Its aim is improving the compatibility between national

universities and colleges; (3) Leonardo da Vinci, for actions in vocational education and training; (4) Grundtvig, pursuing adult education; (5) Transversal, covering activities across all sectors of education and training; (6) Jean Monnet, supporting institutions and actions in favor of European integration. 4 These include the Lifelong Learning Programme, Youth in Action and five international cooperation programs (Erasmus Mundus, Tempus, Alfa, Edulink, and the program for cooperation with industrialized countries). 5 Members include the 28 EU member countries (including Great Britain, plus Albania, Andorra, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Georgia, Iceland, Kazakhstan, Liechtenstein, Macedonia, Moldova, Montenegro, Norway, Russia, Serbia, Switzerland, Turkey, Ukraine, Vatican). Most countries adhered since the beginning in 1999.

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features and internationalization of higher education, also to make European universities more competitive and attractive. The Process guides and coordinates the activity of institutions and persons directly involved in higher education (universities, teachers, and students), national authorities, stakeholders (associations, employers, quality assurance agencies, international organizations), and the European Commission.6 Along with increasing intercountry compatibility, the Bologna Process supports the modernization of education and training systems to make sure these meet the needs of a changing labor market. Key focus areas include lifelong learning, employability, funding, degree structures, international openness, data collection, quality assurance, and learning outcomes, i.e., the definition of what students should know and can do on completing their degrees. Implementing these goals fosters mobility, supports qualifications and skills, and improves the effectiveness and efficiency of the labor market. Placed under the Lisbon Recognition Convention, the Process created the European Higher Education Area (EHEA) in 2010,7 introduced the three-cycle system (bachelor/master/doctorate), and strengthened quality assurance. It also introduced a common system of ECTS credit points (European Credit Transfer and Accumulation System) and the diploma supplement to ease the recognition of qualifications and periods of study abroad.8 According to the system, one year of full-time academic study corresponds to 60 ECTS points, split down in lectures and homework of 1500–1800 hours

6 The European Qualifications Framework (EQF) was adopted in April 2008 and the European Register of Quality Assurance Agencies (EQAR) was established in June 2008. 7 EHEA member countries adhere to the European Cultural Convention and to the objectives of the Bologna Process in their own systems of higher education. The process, started with the Sorbonne Declaration signed in 1998 by the ministers of France, Germany, Italy, and the UK, pursues two aims: harmonizing the architecture of the European higher education system in order to promote mobility of students, graduates and teaching staff, and ensuring the recognition of qualifications in the job market (http://www.ehea.info/media.ehea.info/file/1998_Sorbonne/61/2/1998_S orbonne_Declaration_English_552612.pdf). 8 The Diploma Supplement (DS) is a document accompanying a higher education diploma, providing a standardized description of the nature, level, context, content, and status of the studies completed by its holder. It is produced by the higher education institutions according to standards agreed by the European Commission, the Council of Europe, and UNESCO.

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per year. However, differences exist among countries in the level of implementation and the exact definition of what one credit means (Faber and Westerheijden 2011). The EU activity in making higher education “more European,” i.e., make national systems better compatible and integrated, includes the Paris Communiqué of May 2018 (EHEA 2018) by the 48 Education Ministers on the priorities for the coming years. These include an inclusive and innovative approach to learning and teaching, with particular concern for the access of underrepresented and vulnerable groups and environmental sensitivity. The 2017 Gothenburg Social Summit represents a fundamental event in the definition of the European Commission vision for 2025 of a European Education Area. The Area foresees the free movement of learners in a continent “…where spending time in another Member State – to study, to learn or to work – has become the standard and where, in addition to one’s mother tongue, speaking two other languages has become the norm” (EC 2018b). This means creating the conditions for increasing labor mobility, particularly of highly educated and skilled people, thus contributing to improve labor mobility and labor market efficiency. The Commission identified three key priorities to pursue the goal: a network of European universities, the automatic mutual recognition of diplomas to remove barriers to student mobility, a European student card to facilitate the secure exchange of student information and reduce administrative burden for higher education institutions. The European Commission launched a call in October 2018 to test the European Universities model. “European Universities are transnational alliances of higher education institutions from across the EU that share a longterm strategy and promote European values and identity. The initiative is designed to significantly strengthen mobility of students and staff, and foster the quality, inclusiveness and competitiveness of European higher education” (EC 2019a). Equally important is that “…European Universities will also contribute to the sustainable economic development of the regions where they are located, as their students will work closely with companies, municipal authorities, academics and researchers to find solutions to the challenges their regions are facing”9 (EC 2018b). 9 As a result of the call, announced in June 2019, 17 European Universities involving 114 HEI from 24 countries were selected. Each European University receives up to e5 million in the coming three years out of an overall budget of up to e85 million available.

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The three priorities pursue three distinct goals through various: (a) improve the interconnection among European HEIs and students’ mobility; (b) create a set of supranational agreements for the mutual recognition and acceptance of diplomas based on the comparability of standards and quality of higher-education qualifications covering bachelor, master, and, since 2003, also doctoral levels (“Bologna Process”); and (c) increase the level and the quality of higher education (Europe 2020 strategy).10 All these actions are based on the free will of member countries to participate and coordinate their policies with other countries, also supported by other organizations, such as the European University Association. National idiosyncrasies remain, but are placed in a common framework. Fundamental competences continue to belong in member countries; the EU provides a coordinating frame and a set of common goals and adds further resources to the primary resources that continue to come from member countries. The end outcome is a more standardized and perhaps better quality system of higher education, more and better opportunities for students, teachers, and universities, and better integration of labor markets.

4

Outcomes and Achievements

Achievements have been remarkable, particularly so if one thinks at the complexity of the issue and the resilience of national systems. The European landscape of higher education has changed significantly, with particular reference to openness, quality, and integration. It became truly European in many senses, including teaching approaches, hosting foreign students, availability of international mobility programs, trans-European cooperation for teachers, financial sources for studying/teaching and researching.

For the next long-term EU budget (2021–2027), the Commission proposed to fully roll out European Universities under Erasmus+, with a significantly increased budget (EC 2019a, b, c). 10 The Europe 2020 strategy has set as a target that 40% among the 30–34 year olds

have a higher education qualification by 2020. Presently (in 2016) the rate was 39% on average in the EU-28 and in 18 countries the rate reached or surpassed this threshold. The highest rates are generally in northern European countries (Lithuania 59%, Ireland 53%, and Sweden 51%), while the lowest rates are in Italy and Romania (26%) (EU 2018c; Fournier et al. 2019).

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However, the European higher education system is not really integrated: national idiosyncrasies remain and barriers that students have to afford for having their international experiences fully recognized at home continue to be significant. Transaction costs for academic teachers and the system complexity increased significantly, particularly for evaluation and assessment procedures. One should neither overlook the potentially negative consequences of stronger standardization on innovation and quality and variety of teaching and research. Analyses and assessments of outcomes and effects of reforms concentrate on higher education, but hints also exist on more general economic and social effects, with particular concern for the labor market. Enders, de Boer, and Westerheijden (2011) present one of the first comprehensive analyses putting the evolution of the European higher education system into a dynamic perspective: “While signatory countries have to some extent interpreted the [Bologna] Declaration in their own ways, the process rapidly achieved a wide acceptance. Focusing at first on reforming study programmes into the two-cycle ‘bachelor-master’ structure, concerns about comparability soon pushed quality assurance and accreditation and degree recognition firmly into the mix” (Enders, de Boer, File, et al. 2011, p. 2). This recognition led to include Ph.D. courses as the third cycle and to link the European Higher Education Area with the European Research Area, a decision taken in Berlin in 2003 (Kottmann 2011). The relation between common aims and achievements and national idiosyncrasies and goals was and is the most intractable issue of the Bologna process. The process was initiated to streamline national higher education systems to a common “European” system, but also to provide support for initiating or strengthening the reform of national systems, in spite of the nonbinding nature of the Bologna process. This created a unitary European frame based on national diversities (Faber and Westerheijden 2011). Pursuing economic value is a common thread at both Union and national level. Universities need to attract an increasing amount of external resources and to rely progressively on market-type governance solutions, replacing bureaucratic governance (Jongbloed 2010). Also important is the political call to universities to play a useful role in the country’s competitiveness, in both education and research. Universities should consequently increase their willingness and capacity and that of their teachers and researchers to produce economically and socially useful

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knowledge and restructure teaching programs and methods so as to increase the employability of their students (Dill and van Vught 2010).11 The traditional governance structure in European universities, particularly in continental countries where most universities are state-owned, was centered on the state. However, since the 1990s, there was a growing involvement of more actors and a move toward more autonomy and indirect governance. While previously the government was the fundamental player in one-level governance, stakeholders obtained an active role in a multilevel multi-actor governance system with important consequences for the working of universities (Van Kersbergen and Van Waarden 2001). Governance became more complex and required stronger internal coordination, but also became more open to the external world and required also more external coordination (de Boer and File 2011). Economic value received prominence, together with the central role of evaluation and accountability (de Weert 2011). The reform of governance has, among others, the aim of attracting external resources from the private sector and through the participation of national and international competitive calls for education programs and research funding. Achievements are mixed: while universities rely more on external resources that until the 1990s, the private sector contribution increased only marginally. More important are international resources, in particular from the European Union. However, national public expenditure and investment continue to be fundamental. According to a study by Aghion et al. (2008), government appropriations are the dominant although decreasing source, exceeding two-thirds of the total revenue, in all EU countries except the United Kingdom and Ireland. Tuition fees are an important source only in Italy, Spain, and the United Kingdom. In most countries the aggregate share of grants and contracts ranges between 10 and 20% and is increasing (Table 1). Although government funding continues to dominate, its allocation has progressively lost the nature of grants and is increasingly allocated on preestablished performance formulas and competitive mechanisms (Tables 2 and 3).

11 In some European countries Universities of Applied Science, particularly in Germany and other central European countries, contribute to the existence of a dual university system. These universities are devoted to practice-led research distinct from university research (de Weert 2011).

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Table 1

Shares (%) of revenues for a sample of European universities, 200612

Belgium Denmark Germany Ireland Italy Netherlands Spain Sweden UK Total

Budget per student (e 000s)*

% budget from public core funding

% budget from tuition fees

% budget from competitive research grants

% of budget from other sources

11.3 11.4 9.6 12.7 10.1 20.5 7.0 16.2 24.5 16.1

65 70 73 38 63 68 62 60 35 58

5 0 1 32 12 7 16 0 23 11

21 19 22 18 12 15 10 34 21 19

9 2 4 12 9 10 13 6 20 11

* PPP adjusted Source Aghion et al. (2008 p. 31)

Overall and compared to the United States and Japan, universities in many EU countries continue to be underfunded (Bennetot Pruvot et al. 2019). However, more prominent is the divergent evolution of long-term public funding trends in different countries (Table 4). Over the period 2008–2017, Austria, Germany, and Sweden had both significant and comparatively sustained funding growth. In France and the Netherlands, investment was more limited, although on a relatively stable trajectory. In Luxembourg and Turkey, public funding nearly doubled in the period. In various countries higher education budgets were the target of repeated cuts. Particularly large were cuts in Greece, while Italy stabilized at low funding level after significant cuts until 2013. Only in the Czech Republic and Spain there was a modest recovery in 2017. Other countries with negative patterns are Estonia, Lithuania, Great Britain, and Serbia. A third group of countries show a recovery pattern after years of severe cuts (Hungary, Latvia, Ireland, Island) or less severe cuts (Slovakia, Croatia) or mild cuts followed by significant recovery (Poland, Portugal). In most cases, improvements took place after 2013. The situation is varied also looking at the enrollment of students and its relation to public funding (Bennetot Pruvot et al. 2019). In the 16 countries where public funding was higher in 2017 than in 2008, comparing funding to student population trends provides contrasted situations: in 6 countries (Luxemburg, Switzerland, Norway, Sweden, Poland, Portugal)

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Table 2

Public funding allocation mechanisms in European countries Funding formula Primarily input-oriented

Primary Brandenburg mechanism (Germany), Catalonia (Spain), Czech Republic, Frenchspeaking Community of Belgium, Hesse (Germany), Hungary, Irelanda , Iceland, Latvia, Netherlands, Polanda , Portugal, Romaniaa , Swedena Secondary mechanism

Primarily output-oriented

Performance contracts (with impact on university funding)

Negotiated or historically determined block grant

Denmarka , Austria England (UK), Finland, Flanders (Belgium), Irelandb , Polandb

Denmarkb , Estonia, France, Italy, North Rhine-Westphalia, Norway, Switzerland

Estonia, France, Italy, North Rhine-Westphalia (Germany), Norway, Swedenb

Austria, Catalonia, Czech Republic, Hesse (Germany), Hungary, Poland, Sweden

Brandenburg (Germany), England (UK), France, Hesse (Germany), Ireland, Latvia, Netherlands, Portugal

a Teaching funding only b Research funding only

Source Curaj et al. (2015, p. 161)

public funding growth is superior to student enrollment growth, while in another 9 countries (Turkey, Germany, Austria, Denmark, Belgium, Netherlands, Island, France, Croatia) the reverse situation holds. In 17 countries, cuts in public funding were serious, yet the effect depended on the growth of students’ enrollment. Particularly strained was the situation in 3 countries (Ireland, Greece, and Great Britain) in which fund cuts proceeded with enrollment increase. In 10 other countries (Slovakia, Finland, Slovenia, Hungary, Italy, the Czech Republic, Spain, Baltic

x

x

x

x

x

x

x

x

x

x

x

x x x

x

x

x

x

x

x

x

x

x

DK ES-CA

x

x

x

x

DE

x

x

CZ

x

BE

x

x

x

x

x

x

FI

x

x

x

x

x

x

x

x

x

x

x

x

FR HU

Overview of indicators used in funding formulae

No. of BA/MA students No. of doctoral students/ candidates No. of staff Floor surface ECTS attained/exams passed/year completed BA/MA degrees obtained Doctoral degrees obtained/theses completed Research evaluation mechanisms Patent applications Successful patent applications External funding obtained EU/international funding obtained Scientific activities

Table 3

x

x

x

x

x

IE

x

x

x

x

x

x

x

x

x

IT

x x

x

LT

x

x

LV

x

x

x

NL

x

x

x

x

x

x

x

x

x

PL

x

x

x

x

x

x

x

x

x

x

PT

x

x

x

x x

x

x

x

x x x

x

x

RO

x

x

x

x

x

SE

x

x

UKEN

(continued)

x

x

x

x

x

x

x

SK

EUROPEAN HIGHER EDUCATION …

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(continued)

BE

Research contract obtained International ranking outcomes National ranking outcomes Graduate employment rate International students International staff Diversity-related indicators Community outreach Review of strategic plans of universities Publications/citations x Student/staff ratio Income from science and technology transfer Degree completion in standard time of studies Students who took exams Staff structure/quality “Added value” of a diploma

Table 3

x

x

x x

x

x

x

x

x

x

x

x

x

FI

x x

x

DK ES-CA

x x x x

DE

x

x

CZ

x

x

x

x

x

x

x

x

x

x

x

x

FR HU x

IE

x

x

x

IT

LT

LV

x

NL

x

x x

x x

x

PL

x x x

x

x

PT

x

x x

x

x

x

x

RO

x

SE

x

x

SK

UKEN

128 B. DALLAGO

CZ

DE

DK ES-CA

FI x

FR HU

IE

IT

LT

LV

NL x

PL

PT

RO

SE

SK

UKEN

Notes The table gives only an approximate idea of the differences and similarities among countries, since each entry may have diverse definitions in different countries. Moreover, in Belgium, Germany, Spain, and the United Kingdom there are important differences among regions, not distinguished in the table. Abbreviations refer to: AT: Austria, BE: Belgium, CZ: Czech Republic, DK: Denmark, DE: Germany, EE: Estonia, ES-CA: Catalonia in Spain, FI: Finland, FR: France, HU: Hungary, IE: Ireland, IT: Italy, LV: Latvia, LT: Lithuania, NL: Netherlands, PL: Poland, PT: Portugal, RO: Romania, SK: Slovakia, SE: Sweden, UK-EN: England in the United Kingdom Source Simplification of Table 3 of Claeys-Kulik and Easterman (2015, p. 28)

No. of publishing researchers

BE

EUROPEAN HIGHER EDUCATION …

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Table 4

Public funding to universities and GDP growth

Category

Description

Systems

Funding ↑ > GDP ↑

Investment above economic growth Investment below economic growth Investment despite economic decline Disinvestment despite economic growth Disinvestment greater than economic decline

AT, DE, DK, LU*, NL, NO, SE, TR, CH* FR, HU, IS, PL

Funding ↑ < GDP ↑ Funding ↑ - GDP ↓ Funding ↓ - GDP ↑ Funding ↓ > GDP ↓

HR, PT CZ, EE*, ES, FI*, IE, LT, LV*, RS, SK GRa , IT, SI*

Notes Public funding to universities and GDP growth Systems not included: BE-fr, BE-fl, UK (all 4 systems) * Shorter time frames: CH (2008-09/2014-15); EE, GR, LV, SI (2008-09/2015-16); FI (201011/2015-16); LU (2009-10/2016-17) Source Bennetot Pruvot et al. (2019)

Countries) both funding and enrollment decreased, suggesting declining higher education systems. One important cause of the scattered picture of European countries is different national growth rates during the post-crisis years. National (dis)preferences also played an important role. In some countries, higher education institutions were called to pay a disproportionate price for the crisis. This is the case of Greece, Italy, and Slovenia, in which funding decreased more than the fall of GDP. Equally negative was the case of countries (Czech Republic, Estonia, Spain, Finland, Ireland, Lithuania, Latvia, Serbia, and Slovakia) in which economic growth coincided with disinvestment. The most virtuous case is that of Croatia and Portugal, in which increasing investment in higher education took place despite economic decline and that of countries (Austria, Germany, Denmark, Luxemburg, Netherlands, Norway, Sweden, Turkey, and Switzerland) in which investment was above economic growth. Finally, in France, Hungary, Iceland, and Poland, investment was below economic growth. Although the role of teachers and researchers is central in both the restructuring and internationalization of education and research, not all teachers and researchers participate in the new drive (Leisyte and Enders 2011). Moreover, the new system and its governance indirectly contributed to growing differentiation among and within universities.

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The need to rely increasingly on external resources allocated in a competitive way gave an advantage to universities which could set up the necessary structures and competences. These are mostly large universities from more developed and better organized countries. Within universities, the differentiation between individuals and research groups was equally noteworthy. Although many took a passive attitude, others became proactive, took initiative, and competed successfully. The distinction was in part based on reputation and positive outcomes of research and education assessment. However, in many cases, the strength of the home university and the ability to be part of strong networks also played important roles. In a survey undertaken in 2017 with responses from 303 institutions from 43 higher education systems, the European University Association (EUA)13 found that “National strategies, where existent, seem to give impetus and serve as a driver for institutions, although they do not stand out as the first source of inspiration for institutional learning and teaching strategies. Overall, institutions that have a learning and teaching strategy seem more influenced by university alliances at the national, regional, or international level” (Gaebel and Zhang 2018, p. 7). National strategies exist in 78% of responding institutions, while external quality assurance and funding and financial incentives to foster compliance exist in more than half of respondents, supported by European instruments, such as the Standards and Guidelines for Quality Assurance in the European Higher Education Area and the European Qualifications Frameworks. Although all these measures are generally considered to be useful for the quality of higher education, there is concern for the growth of bureaucracy, the restriction of autonomy and academic freedom, and the risk of decreasing traditional institutional funding. Overall, “…governments remain the primary funding source for higher education institutions. The figures and trends show that European investment in education and R&D, especially from private sources, is not pushing Europe towards parity with its global competitors….” (Enders, de Boer, File, et al. 2011, p. 9). Moreover, European countries are different, with the countries of Southern Europe and even more so of Eastern Europe in disadvantaged situations. “Any effort at integrating 13 EUA is the largest and most comprehensive organization representing more than 800 universities and national rectors’ conferences in 48 European countries. EUA plays a crucial role in the Bologna Process and in influencing EU policies on higher education, research and innovation (https://eua.eu/).

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higher education into a European Higher Education Area will invariably need to accommodate an increasingly rich variety of systems with regard to cultural norms, economic policies, organizational structures and GDP levels” (Enders, de Boer, File, et al. 2011, p. 9). The added value of the Bologna process in this perspective is that of mutual adjustment: “…a process in which national governments continue to adapt their policies nationally, but in response to, or in anticipation of, the policy choices of other governments” (Faber and Westerheijden 2011, p. 15). Thanks to voluntary coordination, the international mobility of students and teachers increased dramatically and the development of transnational research groups was also an undeniable European success. Moreover, the reform of degrees has open the way to setting common European standards for quality assurance and learning outcomes. Again, these are commonly set goals that national governments have to implement through a system of self-certification by national authorities against a common checklist (http://www.ehea.info/page-qualificationframeworks). Due to the sensitivity of the issue, the coordination work continues also through the work of the Bologna Follow-up Group (BFUG) (http://ehea.info/page-the-bologna-follow-up-group). There are still problems in the implementation of the commonly agreed standards and structures, with countries often going their own way in both the degree of implementation and the particular features of the implemented standards (EC 2018d). Idiosyncrasies concern both EHEA foundations (three-cycle degree structure including ECTS and Diploma Supplement, recognition of qualifications and quality assurance) and priorities added subsequently (learning and teaching, social inclusion, and employability). Most EHEA countries have implemented the three-cycle degree system in line with Bologna guidelines, although some countries still need to implement further reforms. Significant differences persist in degree structures, in particular in labor market recognition of first-cycle qualifications. In half of the countries, the majority of first-cycle graduates continue to study in a second-cycle program. Conversely, in a quarter of countries, less than 25% move directly into the second cycle. Moreover, different countries offer different, usually shorter higher education programs, usually vocational in character or outside the three-cycle-degree structure. In some cases, these programs are not recognized within the national higher education systems. ECTS has been adopted in most countries for credit accumulation and transfers, with learning outcomes and student workload

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increasingly used as the basis for credit allocation, although European rules are not yet the common basis for the correct implementation of the system (EC 2015b). The Diploma Supplement is implemented in most countries according to commonly agreed principles, except the third cycle. Also the implementation of national qualifications frameworks (NQFs) is in line with the Framework for Qualifications of the European Higher Education Area (QF-EHEA) in most countries. Correspondence is self-certified and the national qualifications framework is used by national authorities in public policy and for coordinating qualifications across sectors and levels of education. With this progress, the content of national legislation and regulation is generally coherent with the international legal framework. Formal compliance with most aspects of the Lisbon Recognition Convention (LRC) of 1997 at national level is well established across EHEA (https://www.coe.int/t/dg4/highereducation/recognition/lrc_ EN.asp?). There are still important recognition problems, though, while automatic recognition still requires considerable effort. Considerable quality assurance achievements concern primarily internal practices. External quality assurance is usually undertaken by independent agencies working in line with the Standards and Guidelines for European Quality Assurance (ESG) (https://enqa.eu/wp-con tent/uploads/2015/11/ESG_2015.pdf). Unfortunately, national legislations restrict the fulfillment of external quality assurance to the use of national quality assurance agencies and prevent the implementation of the European Approach to the Quality Assurance of Joint Programmes (https://www.eqar.eu/assets/uploads/2018/04/02_ European_Approach_QA_of_Joint_Programmes_v1_0.pdf). Among subsequently added priorities, employability is particularly important for the labor market, yet problems are still significant and differences among countries important. Systematic efforts are needed to improve the relationship and match between higher education and the labor market. The problem is particularly significant in some countries, where graduate unemployment remains a significant problem.

5 Industrial Specialization, Financial Stability, and the Output of Universities Pursuing economic value and adapting to new situations and opportunities are two fundamental aspects of European universities. The former

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comes from world trends and growing financial difficulties for governments in financing universities. The latter reflects the EU’s will and the member countries’ determination to create a European frame for HEIs and harmonize national education systems to support the integration of labor markets. Much of the EU action is concentrated on moving governments and universities in this direction, by proposing strategies and goals and providing (part of) the necessary resource basis. National governments are called to implement the necessary reforms. European higher education and research institutions have to strengthen the value of their education and knowledge output, leading to greater competition among universities. Moreover, universities should strengthen their economic basis, particularly important goal following the international crisis and the fiscal crisis of many European states. As a consequence, a kind of inefficient dichotomy developed between humanities and social sciences on one side and natural sciences and technology on the other. In research, the latter became prominent and enjoys increasing investments both in absolute and in relative terms. At the same time and similarly to the United States, enrollment in social sciences slightly increased in recent years, while that in natural sciences and technologies institutions slightly diminished (Eurostat database).14 The trend was not identical in all EU member countries, though. Universities of different countries pursuing economic value play different roles and are in diverse situations. Particularly important is the ongoing process of differentiation of international specialization within the EU, with important consequences for the demand of competences and skills. This creates different conditions for and places diverse requirements on universities, and opens different opportunities for people holding degrees. The EU is losing in innovation strength and competitiveness (Sonderman 2012), particularly vis-à-vis Eastern Asia, and has scattered internal innovation pattern (EU 2018a). Most EU member countries— including all of Central and Eastern Europe, their regions (except Prague) and an important part of the regions in old member countries—are moderate and modest innovators (EU 2018b; Hollanders et al. 2009). Countries and regions of Northern Europe (Sweden, Germany, Denmark, and Finland) are innovation leaders. However, recently important signs of 14 https://www.aaas.org/programs/r-d-budget-and-policy/historical-trends-federal-rd and https://www.nsf.gov/statistics/2018/nsb20181/report/sections/academic-researchand-development/expenditures-and-funding-for-academic-r-d.

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EU industrial policy for technologically highly advanced productions are taking hold (Hall and Milne 2019). The EU behaves like a kind of two-faced Janus. Member countries are increasingly split in their economic strategies. Various cases around the world, including the United States, China, and Northern Europe, show that success depends on these countries’ ability to foster a systematic approach to innovation, within which higher education and research have a central role, together with governments and business. Unfortunately, this is not the general case for Southern and Eastern EU member countries. The lack of a systematic approach to innovation and competitiveness in an important part of the EU is a serious problem for the process of integration, a problem that the EU reaction to the international economic crisis exacerbated. As a consequence, universities play different roles and the achievements of higher education differ considerably within the EU, although in recent years there was a general improvement in all member countries, at least in quantitative terms (Fig. 1). Yet the ratio 2:1 between the best and the worst performers remained roughly unchanged 70 25-34 2000 60

25-34 2018

25-64 2000

25-64 2018

55-64 2000

55-64 2018

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Fig. 1 Tertiary educational attainment, by country, 2000 and 2018 (% of the population aged 25–34, 25–64 and 55–64) (Source Elaboration on Eurostat database [https://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1& language=en&pcode=sdg_04_20&plugin=1])

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and strong differences in the levels of expenditure per enrolled student continue to persist (Fig. 2). The strategy prevalent in Southern and Central-Eastern European countries is based on cost cutting, as envisaged in the European Competitiveness Pact of 2011. Stabilization policies in financially unbalanced countries, such as Greece, Spain, Portugal, and Italy until 2013, strengthened this approach. While technical innovation was pushed to the background, this strategy foresees that countries gain competitiveness by decreasing wages and weakening welfare through internal devaluation and austerity policies. Inevitably, these countries are pushed to specialize in productions where competitiveness through cost cutting may compensate for a lack of innovation and higher productivity. These are productions where the competition from emerging countries is strong and growing. Consequently, the role of universities as producers of knowledge and skills becomes weaker and universities may be seen as a cost and not a resource for the country. In these countries the allocation of public resources to universities decreased. Cheaper labor means less demand for highly educated people and lower return to human capital (Corak 2013). The case of Northern European countries is remarkably different. Their EU references are the Lisbon Strategy and Europe 2020. The 60,000 € PPS per full-time equivalent student 50,000

€ PPS per student € per full-time equivalent student € per student

40,000

30,000

20,000

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Fig. 2 Annual expenditure on public educational institutions per student at tertiary level of education (ISCED 2011), 2016 (Notes *2014, **2015, ***Private government dependant institutions. Source Eurostat database)

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key elements of these strategies are investments in innovation, knowledge infrastructure, and human resources, plus high-quality services to support investment and attract resources. The role of universities is central for both high-level education, the number of degrees, research, and their cooperation with enterprises (Nielsen 2018). This strategy appears economically stronger and socially stable. Moreover, it guarantees remunerations in line with the existing level of income and quality of life. Northern European countries thus outperform other member countries in innovation, level of education, resources devoted to education, standard of living, social stability, and international competitiveness. Financial stability is another factor that may have important consequences for universities. Following the international crisis, government expenditure on education as a ratio to GDP decreased by 0.5% in the EU over the 2003–2017 period: it was 5.1% of GDP in 2003 and decreased to 4.6% of GDP in 2017. As a share of government expenditure, and considering that overall government expenditure as a ratio to GDP decreased by 0.4% over the period, the share of expenditure on education in total expenditure decreased more, from 11.0% in 2003 to 10.2% in 2017 (Eurostat 2019). The implementation of austerity policies made the situation particularly difficult in countries of Southern Europe, where the financial situation of universities worsened dramatically for two reasons. First and foremost, governments decreased their financing. In distressed countries, governments gave priority to fund primary and secondary education. As a consequence, public funding for tertiary education decreased as a share of overall funding for education, while private funding increased only marginally. Second, austerity worsened the financial situation of families and persons, many of whom had difficulties in pursuing university studies. As a consequence, the number of enrolled students in distressed countries decreased (OECD 2018). Similar observations hold for research expenditures, both public and private (Fig. 3). The crisis led part of the EU into a weak position, one that is bound to have permanent negative consequences for the future and may jeopardize European integration. Although consequences were direct and negative for universities’ financial and human resources, negative effects did not necessarily translate directly and fully in the quality of their work. Universities in distressed countries relied on their traditions and implemented resilience strategies, sometimes successfully. Pastor and Serrano (2016) find that research output does not depend exclusively on the amount of available resources.

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1.2

DK D

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Public sector

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P GR LT L SP HR

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Fig. 3 Gross domestic expenditure on R&D, by sectors of performance, by country, 2018 (% of GDP) (Note Public sector includes Government sector, Higher education sector, and Private non-profit sector. Source Eurostat database [retrieved 24 March 2020])

The weight of some countries—Bulgaria, Romania, Croatia, Cyprus, Slovenia, Hungary, Greece, and Portugal—in terms of publications is more than twice their weights in terms of R&D expenditure. Conversely, the weight of some larger countries in terms of R&D expenditure— Germany and France, but not the United Kingdom, Spain, and Italy—is higher than in terms of publications. Similar conclusions hold in terms of scientific output per capita, where intercountry differences are even larger (Figs. 4 and 5). A more refined analysis needs a distinction among sciences in both inputs (human and financial resources) and output (such as number of students obtaining degrees and publications).

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0.90 0.80 0.70

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2016 Articles per researcher

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0.50

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0 Cyprus Romania Croatia Italy Czech Rep.c Slovenia Spain Latvia Slovakia Greece Poland Netherlands Ireland Estonia UK Malta Portugal Belgium Denmark Luxembourg USA Finland Sweden Austria Lithuania Germany China France (2015) Hungary Bulgaria Japan Russia

0.60

Fig. 4 Researchers (right axis) and scientific output related to R&D personnel (left axis), 2016 (Source Elaborations on data from World Development Indicators, World Bank) 100 90

Citable documents H index Score

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Citable documents H index Rank

70 60 50 40 30 20 10 UK USA Germany France Japan Italy Netherlands Sweden Spain China Belgium Denmark Austria Finland Russia Poland Ireland Greece Portugal Czech Rep.c Hungary Slovenia Slovakia Croatia Estonia Bulgaria Romania Lithuania Cyprus Luxembourg Latvia Malta

0

Fig. 5 H index score and rank, 2019 (Source Elaborations on data from https://knoema.com)

6

Conclusion

The chapter critically analyzes the evolution of European higher education and research systems within the frame of European integration,

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stresses achievements under the leadership of the European Commission, highlights problems, drawbacks, fault lines, and challenges ahead. Part of these problems comes from the external context, particularly unfavorable for universities following the international crisis and austerity policies. However, many difficulties come from the very nature of the EU: a club of countries with different national educational and research systems, with different specializations and strategies, separated national labor markets. Although countries keep sovereignty in education and in part also research, the EU successfully coordinates member countries in the far-reaching and ambitious process of transforming higher education institutions and pursuing increasing integration of research and the educational system. Unfortunately integration of labor markets did not match this effort and the consequences are particularly disadvantageous in the Eurozone and contributing to high levels of youth unemployment, including highly educated people in selected countries. In spite of problems and disparities, results are important and overall positive. Among the most important positive outcomes are growing numbers of students having the opportunity to spend significant periods of their academic life in another country, while continuing their career at the home university. It is expected that these persons, once active in the labor market, will effectively take European values ahead and actively support European integration, although so far evidence is not conclusive. On the minus side and in spite of EU efforts, universities are still be largely funded through national public resources, while fiscal rules hardly stimulate private donors. Administrative approaches still dominate national public financing, i.e., financing after the number of students enrolled, or the number of teachers, with a modest role given to outcomes. European responses to the international crisis magnified these features and led to severe cuts in financing universities in various countries. Even the recognition of degrees within the EU, a goal pursued with determination, is still partial and meets various obstacles. This hinders the integration of the European labor and skill markets. In most European countries enterprises, governments and universities have difficulties in cooperating and coordinating their visions and activities. Universities were not particularly successful in establishing stable intercountry and interregional knowledge and research networks, in spite of EU programs and support, although lately some interesting institutional progress is taking place. Finally, although the new system led to growing education and research level and quality, growing standardization, bureaucratization,

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transaction costs, and burdens on teachers and researchers had negative effects on academic life and the traditional critical role of universities. Universities combine three main missions: education, research, and the third mission. Traditionally, prominence of top universities is in research, which also brings advantages to the other two missions. However, not all universities are equal and play the same role and countries are different. In later years the accent of academic policies moved to the advantage of education. This move has been particularly relevant in the EU, for good political, social, and economic reasons. There is a need to support integration within the EU, particularly so in the labor market of the Eurozone. Although the public role of universities in research remains invaluable, the role of education is prominent also for the economy. Enterprises have a keen interest in hiring good quality graduates, perhaps the fundamental and most effective mover of innovation and competitiveness. From this descends the interest of enterprises in maintaining links with universities also in the field of education: “…far too much attention has been paid to the contribution universities make to economic development such as spin-offs, patents and licensing as means for technology transfer, and … insufficient attention has been paid both in Europe and in the US to the contribution of universities to local and regional labor markets, through graduated students …” (Lawton Smith 2006, p. 6). The nature of the European integration, particularly in the monetary union, dramatically needs a more integrated higher education system as a necessary precondition for an integrated labor market. Yet there is a deep contradiction in the European construction: the European strategy and policy in the field of higher education has a soft and dynamic nature, based on the voluntary participation of member countries, continuous interaction and adaptation, and mainly national financial resources. Conversely, the monetary union is eminently coercive and static in its nature. After having freely decided to adopt the common currency, a country has to comply with predefined rules of financial discipline and accept monetary decisions taken looking at the entire Eurozone needs. The advantages from the monetary union are also considered in a static perspective of lower transaction costs and risks. The Economic and Monetary Union misses the fundamental dynamic perspective of growth and development. Without this perspective it is illusory to expect that labor markets can really integrate and avoid one-way brain and skill drain within the EU, with problematic consequences for the European integration.

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tent/140e560e-0ba0-11ea-bb52-34c8d9dc6d84?desktop=true&segmentId= 7c8f09b9-9b61-4fbb-9430-9208a9e233c8#myf%E2%80%A6. Holden, S., & Wulfsberg, F. (2008). Downward Nominal Wage Rigidity in the OECD. The B.E. Journal of Macroeconomics, 8(1), Article 15, pp. 48. Hollanders, H., Tarantola, S., & Loschky, A. (2009). Regional Innovation Scoreboard 2009. Brussels: Pro Inno Europe—Inno Metrics. http://www.pro inno-europe.eu/sites/default/files/page/10/03/RIS_2009-Regional_Inn ovation_Scoreboard.pdf. Hörner, W., Döbert, H., Reuter, L. R., & von Kopp, B. (Eds.). (2015). The Education Systems of Europe. Cham: Springer. Jauer, J., Liebig, T., Martin, J. P., & Puhani, P. (2014, January). Migration as an Adjustment Mechanism in the Crisis? A Comparison of Europe and the United States (OECD Social, Employment and Migration Working Papers No. 155). Paris: OECD. Jongbloed, B. (2010). Funding Higher Education: A View Across Europe. Brussels: ESMU—Modern Project. Kottmann, A. (2011). Reform of Doctoral Training in Europe: A Silent Evolution? In Enders et al. (2011), pp. 29–43. La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2008). The Economic Consequences of Legal Origin. Journal of Economic Literature, 46(2), 285–332. Lawton Smith, H. (2006). Universities, Innovation, and the Economy. London and New York: Routledge. Leisyte, L., & Enders, J. (2011). The Strategic Responses of English and Dutch University Life Scientists to the Changes in Their Institutional Environments. In Enders et al. (2011), pp. 143–157. Ménard, C., & du Marais, B. (2006). Can We Rank Legal Systems According to Their Economic Efficiency? In P. Nobel (Ed.), New Frontiers of Law and Economics (pp. 7–28). Zürich: Schulthess Verlag. Moutsios, S. (2012). University: The European Particularity (Working Papers on University Reform No. 18). Department of Education, University of Aarhus. Nielsen, P. (2018). Innovation Modes and Knowledge Relations: The Learning Match Between University and Enterprises in a Regional Perspective. In B. Dallago & E. Tortia (Eds.), Entrepreneurship and Local Economic Development: A Comparative Perspective on Entrepreneurs, Universities and Governments (pp. 165–185). Abingdon: Routledge. Obstfeld, M., & Taylor, A. M. (1997, March). The Great Depression as a Watershed: International Capital Mobility Over the Long Run (NBER Working Paper No. 5960). OECD. (2014). OECD Employment Outlook 2014. OECD Publishing. http:// dx.doi.org/10.1787/empl_outlook-2014-en. OECD. (2018). Education at a Glance 2018: OECD Indicators. Paris: OECD Publishing. http://dx.doi.org/10.1787/eag-2018-en.

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Otero, M. S. (2008). The Socio-Economic Background of Erasmus Students: A Trend Towards Wider Inclusion? International Review of Education, 54(2), 135–154. https://doi.org/10.1007/s11159-007-9081-9. Pastor, J. M., & Serrano, L. (2016). The Research Output of Universities and Its Determinants: Quality, Intangible Investments, Specialisation and Inefficiencies (SPINTAN Project: Smart Public Intangibles, Working Paper Series No. 5). Valencia: Instituto Valenciano de Investigaciones Económicas, http://www. spintan.net/c/working-papers/. Porter, M. (1990). The Competitive Advantage of Nations. London: Macmillan. Porter, M. (1998). Clusters and the New Economics of Competitiveness. Harvard Business Review, 77, 1–10. Rome Declaration. (2017, March 25). The Rome Declaration. Declaration of the Leaders of 27 Member States and of the European Council, the European Parliament and the European Commission. Council of the EU, Statements and Remarks 149/17. https://www.consilium.europa.eu/en/press/press-rel eases/2017/03/25/rome-declaration/pdf. Sala-i-Martin, X., & Sachs, J. (1991). Fiscal Federalism and Optimum Currency Areas: Evidence for Europe from the United States (NBER Working Papers Series No. 3855, NBER). Sapir, A. (2006). Globalization and the Reform of European Social Models. Journal of Common Market Studies, 44(2), 369–390. Sonderman, D. (2012). Productivity in the Euro Area: Any Sign of Convergence. (European Central Bank, 1431). http://www.ecb.int/pub/pdf/scpwps. van Kersbergen, K., & van Waarden, F. (2001). Shifts in Governance: Problems of Legitimacy and Accountability. The Hague: Social Science Research Council. WEF. (2018). The Global Competitiveness Report 2018. In K. Schwab (Ed.), Geneva: World Economic Forum. http://reports.weforum.org/global-com petitiveness-report-2018/?doing_wp_cron=1557072509.348274946212768 5546875. Zimmermann, K. F. (2009, March). Labor Mobility and the Integration of European Labor Markets (Discussion Papers 862). Berlin: DIW.

Eurozone: Crisis, Policies and Reforms Enrico Marelli and Marcello Signorelli

1

Introduction

The European Economic and Monetary Union (EMU), realized more than twenty years ago, represented the most robust and significant step in the more than six decades’ long process of economic integration in the European continent, started with the Rome Treaty in 1957. In the first decade, the introduction of the euro allowed the participating countries to grasp many benefits, for example in terms of interest rate reductions. Unfortunately, the financial crisis erupted in the world economy in 2007– 2008 and the Great Recession (2008–2009) had its deepest and more persisting impact in the euro area, because it was followed by the so-called Eurozone “sovereign debt” crisis (2010–2013). The double recession and the following slow growth or stagnation in the Eurozone (EZ), especially in some peripheral countries, has also been caused by wrong or delayed policies. It is true that the unconventional measures undertaken

E. Marelli (B) University of Brescia, Brescia, Italy e-mail: [email protected] M. Signorelli University of Perugia, Perugia, Italy e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_8

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by the European central bank (ECB)—started with the Draghi Presidency (November 2011–October 2019)—redressed the financial situation, but there are still wide disparities across the EZ countries and the general economic situation is still distressing in some countries, causing also social and political problems. A possible solution is therefore the need to change the macroeconomic policies, in particular reverting the “austerity approach” followed—especially in the years 2010–2013—by the national fiscal policies, constrained by strict budgetary rules. In consideration of the collapse both public and private investments in the crisis period—investments that in most EZ countries are still below the pre-crisis level—a great “European investment plan” could stimulate economic growth both in the short and in the long run. It might even help in the restoration of a pro-European sentiment, which lately appeared to vanish because of the dreadful economic and social situation. The change in public opinions will also make more feasible the radical institutional reforms necessary to “complete” the current EMU. Some proposals have been made by the EU institutions themselves, but at present most of them are not politically feasible. Only when European people will believe in the European project, further significant steps in the integration process—also in order to make more viable the monetary union—will be realistic. The structure of this chapter is the following. In Sect. 2, we summarize the main features of the double crisis that hurts the Eurozone over the last decade, including the slow more recent recovery. In Sect. 3 we discuss the policies adopted in the Eurozone, also emphasizing their limits. Section 4 discusses the key reforms needed to guarantee the survival of the euro in the long-run as well as the advisable changes in current macroeconomic policies, including the need to sustain investment. Section 5 concludes with recalling the EU position in the world economy.

2

Double Crisis and Slow Recovery

In the first decade after the start of the EMU (1999), the new currency— the euro—was considered as a strong currency (reaching the peak in nominal terms versus the US dollar in 2008), progressively reaching the reserve status. ECB primary goal—price stability—was overall fulfilled. The reduction in interest rates benefitted in particular the peripheral countries, but the so-called “bonus” of the euro unfortunately was wasted in some countries. It is important to remark that the monetary union

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was considered as irreversible, not only by the policymakers but also by the markets. The disappearance of the devaluation risk together with the (perceived) low default risk warranted almost identical interest rates on the bonds issued by all Eurozone countries, including the peripheral and most indebted ones. Of course, there were many imbalances, the most evident one referring to the current accounts of the balance of payments, structurally negative in the EZ peripheral countries and largely positive in Germany and few other countries (see also Table 2).1 The indebtedness of the private sector in many countries was considered the fuse capable to turn on the fire (Beker and Moro 2016). Regrettably, the global financial crisis, which started in the United States (2007–2008) with the subsequent “Great Recession” (2008– 2009),2 had a long tail in Europe. While the world economy, starting from the United States, had an almost continuous recovery since 2010 (see Table 1),3 the gap in economic growth between the United States and Europe, already present in the previous decades, was amplified in the last decade following the crisis. Structural differences (including demographic, technological and even institutional factors) play a role, but also the different macroeconomic policies can explain a large part of these divergences. The world economic recovery was favoured by the expansionary monetary and fiscal policies undertaken by most developed countries.4 Monetary policy, thanks to the “zero-interest rate policy” and to the unconventional measures, such as the quantitative easing (QE), soon implemented in the US, Japan, the UK and more recently (since 2015) the EZ. In addition to the accommodative monetary policy and numerous bank bailouts, also fiscal policies were extremely expansionary in most countries of the world, by allowing the full operation of the automatic

1 By focusing not only on this variable, but also on other considerations, Brezinski

(2019) states that “macroeconomic calculations show that Germany seems to be the biggest winner of the introduction of the Euro” (p. 183). 2 A more complete account of the crisis can be found in Marelli and Signorelli (2017a). 3 The countries considered in the table are the three major Eurozone countries and

the economies hit by the sovereign debt crisis; in addition, the United Kingdom and the aggregates (Eurozone and EU-28) are reported; finally, the two largest non-European countries with a market economy (US and Japan) are also included. 4 Notice that China, India and other emerging economies had only a mild deceleration in the year of the Great Recession.

3.3 5.2 3.5 3.8 2.4 1.5 2.5 3.1 2.6 3.1 1.8 2.2

2007

1.1 −3.0 −0.4 1.1 0.2 −1.0 0.2 0.5 −0.3 0.5 −0.3 −1.0

2008

2010 4.1 −0.3 −5.4 0.0 2.0 1.7 1.9 2.0 1.9 2.1 2.5 4.7

2009 −5.6 −6.4 −4.4 −3.6 −2.9 −5.5 −3.0 −4.5 −4.3 −4.4 −2.8 −5.5 3.6 2.8 −8.9 −0.6 2.1 0.6 −1.8 1.6 1.6 1.7 1.6 −0.5

2011 0.4 −0.3 −6.6 −2.1 0.3 −2.3 −3.3 −0.7 0.7 −0.4 2.3 1.8

2012

GDP growth rate (2007–2019) in selected countries

Note *Forecasts Source European Commission (European Economic Forecast, Autumn 2019)

Germany Ireland Greece Spain France Italy Portugal Eurozone U.K. EU-28 US Japan

Table 1

0.1 0.2 −3.9 −1.2 0.3 −1.9 −1.4 −0.5 1.7 0.0 2.2 1.6

2013 2.2 8.8 0.7 1.4 1.0 0.1 0.9 1.4 2.9 1.8 2.5 0.4

2014 1.7 25.2 −0.4 3.8 1.1 0.8 1.8 2.1 2.4 2.3 2.9 1.2

2015 2.2 3.7 −0.2 3.0 1.1 1.3 2.0 1.9 1.9 2.0 1.6 0.6

2016

2.5 8.1 1.5 2.9 2.3 1.7 3.5 2.5 1.9 2.6 2.4 1.9

2017

1.5 8.2 1.9 2.4 1.7 0.8 2.4 1.9 1.4 2.0 2.9 0.8

2018

0.4 8.6 1.8 1.9 1.3 0.1 2.0 1.1 1.3 1.4 2.3 0.9

2019*

152 E. MARELLI AND M. SIGNORELLI

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stabilizers and the adoption of additional fiscal stimulus packages (for example that decided by President Obama in 2009). The problem for the Eurozone was that the economy was hurt by the second recession in 2012–2013, due to the so-called “sovereign debt crisis”. After the “Greece case” in 2009–2010 (originally caused by cheating on the figures of the public deficit) and the collapse of confidence in the financial markets, contagion propagated to the countries in the EZ periphery, whose bonds suffered because of increasing “spreads” with respect to the interest paid on the German “bunds”. Top values in the spreads were reached in the so-called “Piigs” (Portugal, Ireland, Italy, Greece, Spain). In fact, such peripheral countries of the euro area were most affected by the sovereign debt crisis. They exhibited, before the crisis, different macroeconomic and financial situations, for instance relative to the private and public debts, but they generally suffered because of gaps in competitiveness (relative to Germany) and deficits in the current accounts of the balance of payment. The spreads on their sovereign bonds were so high because of the perception of two types of risks: (i) the default risk, i.e. the presumed inability to repay the public debt on maturity, (ii) the “redenomination risk”, i.e. the risk connected to a change in the currency of repayment of the debt. For the first time since the introduction of the euro, the markets were beginning to question the irreversibility of the common currency, because of either the possibility of exit by individual countries or even the disintegration of the monetary union. The contagion in the EZ was caused by both the financial international integration (many private banks in France and Germany held sovereign bonds of the Piigs and they abruptly decided to dismiss them) and the interconnection between public and private debt: a great part of the sovereign bonds were in the hands of private banks, in several cases of the same country issuing the debt. The problem is that, when a crisis happens, such private banks should be bailed out by the States, further increasing the deficit and the sovereign debt: this is the so-called “doom loop”. The financial situation worsened also because of delayed, inadequate or wrong policy responses by the EU institutions (as we shall explain in Sect. 3); this insufficient reaction by policymakers contributed to the second recession and subsequent weak recovery (since 2013–2014) in the EZ. While the original financial imbalances were in the private sector of

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Table 2

Germany Ireland Greece Spain France Italy Portugal Eurozone U.K. EU-28 US Japan

Current account balance to GDP (2000–2019) in selected countries 2000–2004

2005–2009

2010–2014

2015

2016

2017

2018

2019*

1.2 0.3 −9.3 −4.4 1.4 −0.4 −8.9 0.4 −2.1 −0.1 −4.3 2.8

5.8 −5.3 −13.1 −7.7 −0.3 −1.7 −10.3 0.2 −3.1 −0.5 −4.7 3.6

6.7 −0.7 −6.0 −0.5 −1.1 −0.7 −3.3 1.9 −3.6 1.0 −2.5 1.2

8.6 4.4 −0.2 2.0 −0.5 1.4 0.0 3.4 −4.9 1.8 −2.2 3.1

8.6 −4.2 −1.1 3.2 −0.6 2.6 0.6 3.6 −5.2 2.0 −2.3 4.0

8.3 0.5 −1.0 2.7 −0.6 2.7 1.0 3.8 −3.5 2.5 −2.3 4.2

7.6 10.6 −1.1 1.9 −0.6 2.6 0.1 3.8 −4.3 2.2 −2.4 3.5

7.0 0.8 −0.8 2.4 −0.4 2.9 −0.4 3.3 −4.3 1.9 −2.5 3.6

Note *Forecasts Source European Commission (European Economic Forecast, Autumn 2019)

the economy5 and public accounts deteriorated because of the recession, the EU institutions considered the public deficits and debts as the key cause of the imbalances. Thus, they imposed an “austerity” approach, leading to a partial improvement in public accounts after 2012, but causing an aggravation of the recession or a weakening of the subsequent recovery, as shown in Table 1 (see also Blyth 2015; Holland 2016). The current account situation of many EZ peripheral economies improved in the recent period,6 despite persisting imbalances, especially caused by the huge German surplus (see Table 2). To lessen the consequences on EZ aggregate demand caused by the austerity approach, at least Germany should have played the role of “engine of Europe”.7 From this perspective, the crisis was aggravated by a lack of macroeconomic

5 In fact, the original financial imbalances were, similarly to the US case, in the private sector, with very high private debt over GDP ratios in many EZ and EU countries (the United Kingdom, Ireland, Spain, etc.); many private banks (in Germany, France, etc.) were exposed to the debts of peripheral countries. In this situation, during crisis periods, sudden capital outflows may occur, causing imbalances in the EZ’s payment system (Acocella 2016; Beker and Moro 2016). 6 Partly due to a lower level or dynamics in the imports. 7 Similarly to the United States, that has been the engine of the world for many years,

thereby accepting to experience large current account deficits.

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coordination: while tight austerity was imposed on debtor (Southern) countries, creditor (Northern) countries followed balanced-budget policies, with large trade surpluses in the case of Germany (see De Grauwe 2013). However, it is remarkable that in more recent years (after 2009) it was not external demand that contributed to low economic growth in peripheral countries. In fact, many countries adopted “internal devaluations”, by cutting wages (at least in the public sector) or halting wage increases, thus improving the international competitiveness,8 at the cost of deteriorating social conditions and further compressing consumption and aggregate demand. We know that it would be preferable to increase competitiveness by enhancing productivity growth, but this requires more investments, innovations, appropriate industrial policies, etc. (see again the discussion in Sect. 3). In any case, rather than exports, it was internal demand that was seized in the crisis period: public spending (following the austerity measures), consumption (because of reductions in employment and/or wages jointly with an increase in the propensity to save due to a higher uncertainty and a worsening in the expectations) and especially (private and public) investment. Total investment has dropped in almost all EZ countries, more deeply (by about one third) in the peripheral countries, and almost everywhere is still below the pre-crisis levels. Now, ten years after the Great Recession and six years after the economic recovery in the Eurozone, we must recognize that there are considerable cross-country differences regarding the long-run impact of the crisis. The most dramatic and enduring effects concern Greece and Italy, where the levels of production and income are still, in 2020, significantly below the pre-crisis levels (2007–2008). On the opposite side, Germany and some other leading countries, recovered quickly and fully after the 2009 recession. In the middle, Ireland, Spain and more recently Portugal—although seriously injured by the double recession—had good recoveries after 2014. Nonetheless, also in the latter countries, the recession could have been less profound and social pain less outrageous if fiscal policy was more accommodative. In fact, the social impact of the double crisis has been deep in many EZ countries. The unemployment rate is still higher compared to precrisis levels, especially in Greece, Spain and Italy (Table 3). The dramatic 8 From Table 2, we can see that even the “Pigs” now exhibit current account surpluses (only Greece still has a deficit, but decreasing over time).

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Table 3

Unemployment rate (2007–2019) in selected countries 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019*

Germany Ireland Greece Spain France Italy Portugal Eurozone U.K. EU-28 US Japan

8.5 8.5 7.8 7.1 4.7 6.4 12.0 13.9 8.4 7.8 9.6 12.7 8.2 11.3 17.9 19.9 8.0 7.4 9.1 9.3 6.1 6.7 7.8 8.4 8.9 8.5 10.6 12.0 7.5 7.5 9.6 10.2 5.3 5.6 7.6 7.8 7.2 7.0 8.9 9.6 4.6 5.8 9.3 9.6 3.9 4.0 5.1 5.1

5.8 14.7 17.9 21.4 9.2 8.4 12.9 10.1 8.0 9.6 8.9 4.6

5.4 14.7 24.5 24.8 9.8 10.7 15.8 11.3 7.9 10.4 8.1 4.3

5.2 13.1 27.5 26.1 10.3 12.2 16.4 12.0 7.6 10.8 7.4 4.0

5.0 11.9 26.5 24.5 10.3 12.7 14.1 11.6 6.1 10.2 6.2 3.6

4.6 10.0 24.9 22.1 10.4 11.9 12.6 10.9 5.3 9.4 5.3 3.4

4.1 3.8 3.4 8.4 6.7 5.8 23.6 21.5 19.3 19.6 17.2 15.3 10.1 9.4 9.1 11.7 11.2 10.6 11.2 9.0 7.0 10.0 9.1 8.2 4.8 4.3 4.0 8.6 7.6 6.8 4.9 4.4 3.9 3.1 2.8 2.4

3.2 5.2 17.3 13.9 8.5 10.0 6.3 7.6 3.8 6.2 3.7 2.3

Note *Forecasts Source European Commission (European Economic Forecast, Autumn 2019)

effects in the labour markets especially concerned young people: youth unemployment greatly increased and has been persistent, with only small reductions in the most recent period (Marelli and Signorelli 2017b). Poverty or the risk of social exclusion still concerns more than 110 million people in Europe (almost the same as in 2008): this is the greatest failure within the objectives of the “Europe 2020” plan. The rising inequalities, also driven by an unregulated globalization process on a world scale (Fadda and Tridico 2017), explain to a large extent the political success of populist and nationalist movements, that are opposing the European project (see Sect. 4).

3

Economic Policies

We anticipated in the previous section that the economic and social situation in the Eurozone was aggravated by wrong or delayed policy responses. Even at the onset of the crisis, the financial situation deteriorated because appropriate crisis-management tools were lacking in the EMU setting: the “save-State” funds9 were introduced in 2010–2011, 9 That is the temporary European Financial Stability Facility (EFSF) and the permanent European Stability Mechanism (ESM). Notice however that big countries like Italy or also Spain would be, in any case, both too big to bail out (because of the limited size of

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but they were limited in size. Furthermore, the situation also worsened because of the early decision about the “private sector involvement”, that excluded the complete bail out of sovereign bonds (i.e. the MerkelSarkozy’s declaration at Deauville, in Autumn 2010). The “save state funds” provided help to the countries with debt problems through the involvement of the so-called “troika” (European Commission, European Central Bank, International Monetary Fund), that required in the first place macroeconomic adjustment and fiscal consolidation of the assisted countries.10 The termination of the peak of the “spread crisis” was favoured not so much by the use of the mentioned “save state funds”; the key reason is, instead, provided by the new ECB’s strategy—consisting in both credible announcements and new monetary policies—that began with the presidency of Mario Draghi. In particular, after his announcement made in July 2012 “we shall save the euro, whatever it takes”, the Outright Monetary Transactions (OMT) plan11 was launched in September 2012, providing unlimited support to the most vulnerable countries. Although never implemented, it succeeded in reducing the spreads of peripheral countries. Thus, Draghi was able, despite the opposition of some representatives in the ECB board (from Germany and other countries), to partly overcome in an indirect way one of the institutional shortcomings of the ECB, i.e. not being a “lender of last resort” for the States (see De Grauwe 2013). Also the real economy’s recovery in the EZ has been favoured by the monetary policy adopted by the ECB under Draghi presidency. First of all, the ECB introduced the “zero interest rate” policy12 following the

the mentioned funds) and too big to default: their failure would almost certainly cause a systemic crisis and the likely collapse of the euro. 10 Financial help was given in 2010–2011 to Greece, Ireland, Portugal and the following year to Spain and Cyprus (see Marelli and Signorelli 2017a, Chapter 6). 11 The previous Securities Market Program (SMP), adopted in 2010–2011, was more limited in size, duration and it was targeted to specific countries. 12 The Main Refinancing Operation (MRO) rate reached exactly 0% in 2016; the rate on overnight deposits, negative since 2014, is now (from September 2019) equal to − 0.5%. Figure 1 shows that both in the first decade after euro’s introduction and in the subsequent crisis period (2008–2014) monetary policy was more active and expansionary in the United States than in the EZ; but interest rates began to rise in the United States in 2016 and, despite the recent reductions in 2019, are still higher than the zero-rate by the ECB.

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7 6 5

FED BCE

4 3 2 1 0

Fig. 1 Official interest rate: ECB vs. FED (January 1999–December 2019) (Source ECB and FED)

FED’s example (Fig. 1). Regarding the unconventional measures, after the mentioned OMT plan, a QE was activated in 2015 by the ECB, with the specific aim to raise the inflation rate.13 The initial impact of the QE was to cause a depreciation of the euro against foreign currencies, thus helping the economic recovery, but the inflation rate remained below the ECB target.14 Economic growth in the EZ has not taken full advantage of the easy monetary policy, both because of the structural problems of the credit system (with the burden, in some countries, of the “non-performing

13 The QE ended in December 2018, leading to a doubling in size of the ECB budget

(from 2000 to 4000 billion euros). It has been restarted in November 2019 (with monthly net purchases of bonds equal to 20 billion) thanks to the latest Draghi’s decision, also motivated by the deceleration of the euro area’s growth occurred in 2019. 14 The weaker link between monetary base (and other monetary aggregates) and inflation is a general phenomenon in developed countries and can be due to several factors, including the deflationary pressures in globalized markets (i.e. low costs/prices of goods exported from emerging countries like China) and the macroeconomic conditions (i.e. persisting low growth or stagnation with significant unemployment and output gaps). In addition, especially in some countries, a partial “liquidity trap” exists (also favoured by an excessive presence of non-performing-loans in the banking sector) and this makes less effective the monetary policy transmission to real economy.

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loans”) and the adverse expectations of private firms, that are often reluctant to invest. In any case, the new ECB President Lagarde declared its intention to substantially continue Draghi’s policies; in addition, she also launched a “strategic review” (the previous one was realised in 2003), to be completed in the year 2020, for assessing all the ECB instruments and their relative and joint effectiveness, also in order to define the best monetary policy mix according to the evolving economic and monetary conditions and, eventually, to design future “reforms”. Nevertheless, it should be remarked that monetary policy is not sufficient for stabilization purposes, as recognized by both Draghi (as early as in 2014: see ECB 2014) and Lagarde. It should be complemented by growth-friendly fiscal policies and suitable structural policies. As for the latter, structural reforms are repeatedly sponsored by international institutions for achieving higher economic growth. Of course, liberalisation or introducing more competition in some sectors (where it is insufficient) is advisable.15 However, in our opinion, in order to raise production and productivity on the supply side, structural reforms should be accompanied by a new industrial policy, innovations, R&D and more investments (see Cappellin et al. 2017). In any case, apart from the evidence that structural reforms have a positive impact on potential output in the long run, the empirical evidence is that output gaps have been negative for a long period in the Eurozone.16 This is a clear indication of a lack of aggregate demand that would require more expansionary policies also with the fiscal instrument. 15 In addition, structural reforms should not imply (as suggested in neoliberal approaches) large reductions in taxation, if this leads to a cut in fundamental social services, expenditures for health or education, incentives to research and development. Notice that such expenditures have already been heavily cut in the crisis period and in some countries are extremely low. Instead, the reduction of fiscal pressure should be realized by contrasting all forms of tax evasion and elusion. 16 In countries like Italy they have been negative over the whole decade since 2008. Moreover, the real output gaps are probably larger than the ones computed by the EU Commission (its methodology tends to underestimate the magnitude of the economic cycle by assuming pronounced hysteresis effects). This entails two wrong policy implications: (i) attaching too much importance to structural policies with respect to aggregate demand management; (ii) requiring an excessive budgetary adjustment, because of the (apparently) high structural public deficits.

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On the contrary, fiscal policies had several limits in the EZ. Not only have budget policies been restrained even in countries exhibiting a “fiscal space” (the German case mentioned before), but the fiscal rules became more restrictive after the adoption of the reinforced Stability and Growth Pact and the Fiscal Compact (see Marelli and Signorelli 2017a, Chapter 4). Because of the strict rules, public accounts—after the deterioration in the crisis period (2008–2012) with the ensuing operation of automatic stabilizers together with banks bailouts and fiscal packages in some countries—improved after 2012, with decreasing deficit/GDP ratios (Table 4). Notice that the United States had always a deficit/GDP ratio more than double the corresponding ratio in the EZ; the gap between the two monetary areas widened over time. This might (at least partly) explain the better performance of the US economy. The contained public deficits were in some EZ countries accompanied by primary surpluses, but it should be remembered that it is extremely difficult, on economic and social grounds, to increase primary balances during recessions or slow economic recoveries; at least the automatic stabilizers should be allowed to act. Moreover, the debt/GDP ratios continued to rise for some more years because of inertia; in the most recent period, despite a decreasing trend, they continued to persist at high levels in some countries (Table 5). The austerity approach was “self-defeating” (Krugman 2010), because it was partly successful in lowering public deficits, but determined a worsening in the dynamics of nominal GDP, i.e. the denominator of the debt/GDP ratios. In particular, the inflation close to zero (especially in the 2014– 2016 period) added to the negative or very small real GDP growth, thus making the fiscal adjustment more difficult. The EU institutions underestimated the negative impact of restrictive policies also because of the wrong assessments of fiscal multipliers. These multipliers, differently from prevailing opinion until 2010, are greater than one, especially during recessions, with zero interest rates and when many countries consolidate at the same time (see Blanchard and Leigh 2013). In any case, the typical Keynesian effects of restrictive fiscal policies emerged, contrary to the “non-Keynesian effects” and the so-called “expansionary austerity” assumed in neoliberal approaches. The fiscal rules in the EZ caused also a collapse in public investment, especially in the years 2010–2014. This behaviour, easily explainable on political grounds (it is easier to cut or postpone investment rather than current expenditure), aggravated the pro-cyclical effects of national fiscal

0.3 0.2 −6.7 2.0 −2.5 −1.5 −3.0 – −3.0 – −3.5 −2.1

2007

0.0 −7.0 −9.0 −4.4 −3.2 −2.7 −3.8 – −5.1 – −7.0 −1.9

2008

2010 −4.1 −30.4 −11.1 −9.4 −6.8 −4.2 −11.2 – −9.6 −6.4 −12.0 −8.3

2009 −3.0 −13.9 −15.2 −11.0 −7.2 −5.3 −9.8 – −10.8 – −12.7 −8.8

−0.9 −12.6 −10.1 −9.4 −5.1 −3.5 −7.4 −4.1 −7.6 −4.5 −10.6 −8.8

2011 0.1 −8.0 −8.6 −10.3 −4.9 −3.0 −5.5 −3.6 −8.3 −4.2 −8.9 −8.7

2012 0.1 −5.7 −12.2 −6.8 −4.1 −2.8 −4.9 −2.9 −5.8 −3.2 −5.6 −8.5

2013

Public deficit to GDP (2007–2019) in selected countries

Note Net lending (+) or net borrowing (−) general government; *Forecasts Source European Commission (European Economic Forecast, Autumn 2019)

Germany Ireland Greece Spain France Italy Portugal Eurozone U.K. EU-28 US Japan

Table 4

0.6 −3.6 −3.6 −6.0 −3.9 −3.0 −7.2 −2.5 −5.4 −2.9 −4.8 −5.4

2014 0.9 −1.9 −5.6 −5.2 −3.6 −2.6 −4.4 −2.0 −4.6 −2.4 −4.6 −3.6

2015 1.2 −0.7 0.5 −4.3 −3.5 −2.4 −1.9 −1.4 −3.4 −1.7 −5.4 −3.5

2016

1.2 −0.3 0.7 −3.0 −2.8 −2.4 −3.0 −0.9 −2.4 −1.0 −4.3 −3.0

2017

1.9 0.1 1.0 −2.5 −2.5 −2.2 −0.4 −0.5 −2.3 −0.7 −6.6 −3.0

2018

1.2 0.2 1.3 −2.3 −3.1 −2.2 −0.1 −0.8 −2.2 −0.9 −6.7 −2.8

2019*

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Table 5

Public debt to GDP (2007–2019) in selected countries 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019*

Germany 63.5 64.0 72.4 80.3 77.6 79.0 76.9 74.5 72.1 69.2 63.3 61.9 59.2 Ireland 24.0 42.8 62.2 87.4 111.1 121.7 123.3 104.1 76.7 73.9 67.8 63.6 59.0 Greece 103.1 109.8 126.8 146.0 171.3 158.9 174.9 178.9 175.9 178.5 176.2 181.2 175.2 Spain 35.5 39.4 52.7 60.1 60.2 84.4 92.1 100.4 99.3 99.2 98.6 97.6 96.7 France 64.2 67.8 78.8 81.5 85.0 89.2 92.2 94.9 95.6 98.0 98.4 98.4 98.9 Italy 99.7 102.3 112.5 115.3 116.4 122.2 127.9 131.8 135.3 134.8 134.1 134.8 136.2 Portugal 68.4 71.7 83.6 96.7 111.1 124.8 128.0 130.6 131.2 131.5 126.0 122.2 119.5 Eurozone 64.9 68.5 78.3 89.8 86.4 90.8 93.1 94.2 93.0 92.2 89.8 87.9 86.4 U.K. 43.6 51.6 65.9 76.4 81.9 85.8 87.2 87.0 86.9 86.8 86.2 85.9 58.2 EU-28 57.8 60.9 72.9 78.4 81.3 84.9 87.1 88.1 86.5 85.3 83.6 81.9 80.6 US 64.0 72.8 86.0 94.7 99.0 102.5 104.6 104.4 104.7 106.8 106.0 104.3 106.7 Japan 176.6 184.6 202.4 208.2 222.3 228.6 232.8 236.1 231.3 236.3 235.0 236.3 236.4 Note Gross debt general government; *Forecasts Source European Commission (European Economic Forecast, Autumn 2019)

Table 6 Public investment to GDP in per cent (2007–2019) in selected countries 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019* Germany Ireland Greece Spain France Italy Portugal Eurozone U.K. EU-28 US Japan

1.9 4.6 4.9 4.7 3.9 2.9 3.2 3.2 2.5 3.2 3.8 3.6

2.1 5.2 5.6 4.6 3.9 3.0 3.7 3.3 3.0 3.4 4.0 3.5

2.4 3.7 5.7 5.1 4.3 3.4 4.1 3.6 3.3 3.7 4.2 3.9

2.3 3.3 3.7 4.7 4.1 2.9 5.3 3.4 3.2 3.5 4.1 3.7

2.3 2.4 2.5 3.7 4.0 2.8 3.5 3.1 3.0 3.3 3.9 3.6

2.2 2.0 2.5 2.5 4.1 2.6 2.5 2.9 2.8 3.1 3.6 3.6

2.1 2.0 3.4 2.2 4.0 2.4 2.2 2.8 2.6 2.9 3.2 3.9

2.1 2.2 3.7 2.1 3.7 2.3 2.0 2.7 2.8 2.9 3.1 3.9

2.1 1.8 3.6 2.5 3.4 2.4 2.3 2.7 2.7 2.9 3.2 3.7

2.2 1.9 3.5 2.0 3.4 2.3 1.5 2.6 2.6 2.7 3.2 3.6

2.3 1.8 4.4 2.0 3.3 2.2 1.8 2.6 2.7 2.8 3.2 3.7

2.4 2.0 3.0 2.1 3.4 2.1 1.9 2.7 2.7 2.9 3.2 3.6

2.5 2.3 3.5 2.1 3.5 2.2 2.0 2.8 2.8 3.0 3.4 3.7

Note *Forecasts Source European Commission (European Economic Forecast, Autumn 2019)

policies. Table 6 shows that public investment significantly declined (over GDP) in the past decade in several EZ countries, especially those more hit by the long crisis: in some countries, the cut has been equal to one

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third or even one half the initial value.17 This reduction has been an upsetting policy mistake, also because public investment indirectly affects private investment (that also collapsed during the crises) and aggregate demand in general; moreover, public investment supports, in a long-run perspective, aggregate supply, potential output and productivity. Therefore, a first conclusion, so long as the monetary policy continues with its accommodative strand, is that more growth-friendly fiscal policies are needed, in order to favour a higher GDP growth, in particular through an increase of public investment, to be realized in different ways (two of them are mentioned in the next Section).

4

Reforms

Many economists and policymakers agree that, without significant reforms, the euro’s survival is not guaranteed in a long-run perspective.18 The primary objective would be to complete the monetary union, with a truly economic union (i.e. the second pillar of the construction started with the Maastricht Treaty). The EU institutions themselves, in particular the EU Commission and the EU Council, have proposed some reforms. See for example the 2012 “Four presidents’ report: Toward a Genuine Economic and Monetary Union” or the 2015 “Five presidents’ report: Completing Europe’s Economic and Monetary Union”. The objectives of the latter regard the economic union, future financial and fiscal unions as well as strengthened democratic accountability, legitimacy and institutions. However, such documents are too generic, imprecise on the time horizons of future integration and about the needed resources. More recently, the European Commission “White Paper on the Future of Europe” considered five different scenarios on how Europe could evolve by 2025: “Carrying on”, “Nothing but the single market”, “Those who want more do more”, “Doing less more efficiently”, “Doing much more together”. The last scenario is the only one that provides some

17 For the EZ as whole the public investment/GDP ratio declined from 3.3% in 2008 to 2.8% in 2019; in all countries there has been a reduction vs. the initial levels, except for Germany (where the incidence is however relatively small). 18 In the short-run the survival of the Eurozone is favoured by the high costs and risks (compared to advantages) of “exit”; on this assessment, an investigation, referred to the Italian case can be found in Marelli and Signorelli (2018).

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indications on how to improve the functioning of the Eurozone and its resilience to crises. In 2017 the European Commission prepared a “Reflection Paper”, on the “Deepening the Economic and Monetary Union, on the basis of the Five Presidents’ Report of June 2015”. For the first time, such paper includes some specific proposals to make the Eurozone more resilient to shocks, in particular two options for introducing a “stabilisation function”: the European Investment Protection Scheme and the European Unemployment Reinsurance.19 Many other reform proposals have been extensively discussed in the recent literature (see, among others, Bénassy-Quéré and Giavazzi 2017; Costa Cabral et al. 2017; Marelli and Signorelli 2017a; Minenna 2016). The first sensible reform is the introduction of an adequate Eurozone budget, that could be used for two main scopes: (i) for stabilization and crisis-management purposes, including a European unemployment insurance or re-insurance scheme; (ii) for sustaining real economic convergence across States.20 A sort of “Ministry of Finance of the Eurozone” or a “European Fiscal Institute” (that could be an evolution of the European Stability Mechanism, ESM) have also been proposed. We think however that these reforms would be helpful if two conditions are satisfied: the Eurozone budget should have an adequate size and the EU Finance Minister should not only supervise national public accounts but also have the power to dispose of sufficient resources. As a general rule, the principle of risk-reduction should be accompanied by that of risk-sharing. In future, this should include a progressive mutualisation of public debts, through the issue of Eurobonds in partial substitution of national bonds.21 Because this reform does not have, at present, the necessary political consensus, some intermediate proposals 19 However, the “sovereign bond-backed securities” proposed in the same document is, according to us, the second best solution compared to the Eurobonds proposal, for which the political consensus is still lacking. 20 The “Budgetary instrument for convergence and competitiveness” (Bicc), recently proposed in view of the multiannual financial framework 2021–2027, would be of the second type. It will finance packages of structural reforms and public investments in the euro area. It is a first attempt to introduce a specific budget (section) for the Eurozone, but it presents two great limits: it has a base of 17 billion euro (only!) and the resources will be collected from the EU overall budget. 21 A widely accepted (by experts) solution is a partial (up to 60% of GDP of each country) transformation of national debts into Eurobonds.

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have been made, such as the “European safe bonds”.22 On the monetary policy side, some scholars have proposed a more complete mandate for the ECB, including also targets on real variables (employment and growth). Some others wish that the ECB formally disposes of all the instruments of other central banks, including the “lender of last resource” function to guarantee the Eurozone debt (beyond the indirect guarantee through the unconventional measures adopted in the recent years). In the meanwhile, further steps are needed to complete the banking union: in fact, the third pillar of the banking union—a common insurance scheme of bank deposits—is still missing.23 Besides the lack of political consensus in most EZ countries for many of the mentioned reforms, further integration will require a long time, also due to technical problems (e.g. the need to change the existing Treaties). In any case, even if a “small steps” approach is agreed (De Grauwe and Ji 2016), the entire process should be well defined and progressively implemented. In the meanwhile, current macroeconomic policies should be changed as soon as possible. A first target should be the increase of public investment, that—as we have seen before—has been curtailed in the last decade and it is crucial for the whole economy (including private investment). Public investment can be sustained in two ways.24 The first way is to increase public investment at the national level, by relaxing the existing rules on national budgets. Many experts support the introduction of a “Golden rule”, i.e. the exclusion of public investment from the count of deficits, relevant for the application of the excessive deficit procedure in the Stability and Growth Pact (a reform now backed by the European Fiscal Board itself). Empirical estimates attribute to public investments a multiplier of impact greater than current expenditure (Deleidi et al. 2019) and, therefore, a greater anti-cyclical function.25

22 These bonds are formed from the senior tranche of a diversified portfolio of euro area sovereign bonds, but do not imply any risk sharing; a common warranty only applies to the new bonds issued at the European level (see Brunnermeier et al. 2016). 23 Germany and other “core” countries ask all countries, especially in the periphery, to

reduce (in the first place) the non-performing loans and also the weight of domestic debt in the assets of private banks. 24 De Grauwe (2017), De Grauwe and Ji (2016), Micossi (2016), among others, also attribute a key role to public investment. 25 Nevertheless, it should be recognized that public spending in education (especially tertiary) and R&D can have a growth impact partly similar to public investments.

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An alternative possible reform is the adoption of a European large investment plan, possibly financed by Eurobonds (see Della Posta et al. 2019). Given the current favourable monetary conditions—zero interest rates (or around 1–2% interest rate on the long term sovereign debt of peripheral countries)—there certainly are many investment projects whose rate of return exceeds the cost of financing (see also Micossi 2016; De Grauwe 2017). They do not necessarily consist in huge infrastructure projects or public works (such as transports, communications, digital agenda), that may suffer because of various limitations.26 On the contrary, they could include a number of “micro-investments” spread over the territory, such as: environmental protection, safeguard of the territory, anti-seismic interventions, energy efficiency, social housing, hospitals and schools building and renovation, local transport, tourist infrastructures; specific investments in education and R&D could also be included (see Cappellin et al. 2017). The proposed plan is consistent with previous EU programmes,27 such as the Lisbon agenda and “Europe 2020”, where a smart, sustainable and inclusive growth was the key goal. The Juncker plan introduced in 2015 was an initial move in this direction, but it has been too timid as for the resources allocated and too slow in its implementation. Marelli and Signorelli (2017a) originally proposed a plan of new investments additional to the current national ones, worth about 500 billion euros, i.e. equivalent to 5% of Eurozone’s GDP, to be realized within three years. It could be financed either by Eurobonds28 or through a major involvement of the European Investment Bank that might issue bonds to be purchased either by the market or, on the secondary market, by the ECB itself (such purchases have been partially made within the QE programme). The direct involvement of the EU budget is at present not possible because of its limited size, although the principle has been accepted even by the European Commission.29 Thanks

26 For example, long planning and implementation times, budgets continuously revised upward, corruption episodes (at least in some countries). 27 Such programmes, however, did not provide specific resources at the European level

to reach the stated objectives, apart from the traditional “structural cohesion funds” (that are just equal to 0.5% of EU’s GDP). 28 For instance, Eurobonds at 10 years could be issued at a low interest rate (lower than 2%). 29 See the recent “InvestEU Programme” proposed for the 2021–2027 horizon: a newly created “InvestEU Fund” will mobilize private and public investment using guarantees

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to the multiplicative effects on the economy, the investment plan will be self-financed, through the increase of future incomes and tax receipts. The resources could be distributed to each Eurozone country in proportion to the national population (or GDP) and also the annual interest rate expenditure could be added to each national budget with the same distribution (i.e. proportionally to the population or GDP): this proviso is useful to favour the necessary political consensus on this proposal (e.g. from Germany and other “core” countries).30 Moreover, the investment projects will be monitored by euro area (or EU) countries at any stage: ex-ante, in itinere and ex-post. A specific external institution, centred on the European Commission, could supervise all market-financed investment operations. Della Posta et al. (2019) show another advantage of the European investment plan: thanks to the improved growth prospects and the interest rates reduction, the plan will relax the constraint on the primary surplus necessary to guarantee the public debt stability of individual countries, thanks to the reduction of the risk premium and the better sustainability of the national sovereign debts. In any case, to be clear, the proposed plan would not imply any direct commitment of the euro area (or EU) countries to rescue highly indebted countries. So the EZ “core” and Northern countries would realize that the plan would be a substantially costless way for continuing enjoying the gains realized through the monetary union (including the positive net exports), with significant reduction of the systemic (and collapse) risk for the whole Eurozone.

5

Conclusion

The European institutions appear conscious of the need to reform the Eurozone (see the previous Section), but the necessary political consensus in the Member states is still lacking. The problem is that a “status quo” scenario bears too many risks either because of the occurrence of new financial crises or for the unsustainability of the economic and social

from the EU budget (just 15.2 billion euro); thanks to a large leverage, a total of 650 bn. new investments is estimated. It will focus on four policy areas: sustainable infrastructure; research, innovation and digitisation; small businesses; social investment and skills. 30 The debt service could be limited, given the current low interest rates; we can assume it, in a precautionary way, to be around 2% on 20-years maturity bonds, equivalent to 10 billion euros for the whole Eurozone.

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system in an area that is not capable of growing and achieving a satisfactory cohesion. Without reforms, the long-run sustainability of the euro is not guaranteed (Stiglitz 2016) and the survival of the entire EU would be threatened. Notice that, in economic terms, the European Union’s weight in the world continuously declined in the past decades: now it is about half than in 1980 (still including the U.K.); EZ’s weight is even smaller (11.3% in 2018). Yet, as Table 7 shows, the weight of individual countries would be tiny (in comparison to the US, China, India and other emerging economies): even Germany’s weight in the world economy is about 3%. Therefore, it is especially urgent to change macroeconomic policies (as discussed in Sect. 3). First of all, they should aim to support aggregate demand, in particular public investments, that in turn stimulate also private investments. At the national level, public investment should be boost by the adoption of a “golden rule” within the Growth and Stability Pact. At the European level, a great European Investment Plan, to be possibly financed by the issue of Eurobonds, would be an effective solution (see Sect. 4). More investments stimulate in the short-run aggregate demand; in the long-run, they will increase potential output and reinforce economic growth. They will improve not only the economic situation but also the social conditions, thus reducing the opposition towards further Table 7

National (or “regional”) GDP to world GDP (in PPP)

Emerging and Developing Countries Developed Countries China European Union Eurozone-19 US India Japan Germany Russia Brazil France U.K. Italy Source IMF. *Eurostat

1980

1990

1999

2007

2018*

36.2 63.8 2.3 29.8

36.0 64.0 4.1 27.2

44.7 57.6 7.2 23.7

50.2 49.8 11.3 20.7

22.4 3.0 7.8 6.5 – 4.3 4.5 3.4 4.5

22.5 3.8 8.9 6.0 – 3.7 4.2 3.3 4.1

21.3 4.5 6.8 4.9 3.0 3.2 3.5 3.0 3.3

18.6 5.5 5.5 4.0 3.7 2.9 2.9 2.8 2.6

56.0 44.0 18.7 16.3 11.3 15.2 7.7 4.1 3.2 3.1 2.5 2.2 2.2 1.8

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steps in the European integration process,31 making more likely the adoption of the mentioned reforms in the governance of the European monetary union and thus enhancing the lasting success of the whole EU.

References Acocella, N. (2016). Signalling Imbalances in the EMU. In B. Dallago, G. Guri, & J. McGowan (Eds.), A Global Perspective on the European Economic Crisis. London: Routledge. Beker, V., & Moro, B. (Eds.). (2016). The European Crisis. Bristol: World Economic Association Books Conference Series. Bénassy-Quéré, A., & Giavazzi, F. (Eds.). (2017). Europe’s Political Spring: Fixing the Eurozone and Beyond. London: VoxEU eBook, CEPR Press. Blanchard, O. J., & Leigh, D. (2013). Growth Forecast Errors and Fiscal Multipliers. American Economic Review, 103(3), 117–120. Blyth, M. (2015). Austerity: The History of a Dangerous Idea. Oxford: Oxford University Press. Brezinski, H. (2019). The Euro—A German Perspective. Scientific Annals of Economics and Business, 66(SI2), 183–194. Brunnermeier, M. K., Langfield, S., Pagano, M., Rees, R., Van Nieuwerburgh, S., & Vayanos, D. (2016, September). ESBies: Safety in the Tranches (European Systemic Risk Board, Working Paper Series, 21). Cappellin, R., Baravelli, M., Bellandi, M., Ciciotti, E., & Marelli, E. (2017). The Role of Investment and Innovation in a Program of Economic Recovery in the EU and in Italy. In R. Cappellin, M. Baravelli, M. Bellandi, R. Camagni, S. Capasso, E. Ciccotti, & E. Marelli (Eds.), Investimenti, innovazione e nuove strategie d’impresa: Quale ruolo per la nuova politica industriale e regionale?. Milano: EGEA. Costa Cabral, N., Gonçalves, J. R., & Cunha Rodrigues, N. (Eds.). (2017). The Euro and the Crisis: Perspectives for the Eurozone as a Monetary and Budgetary Union. Switzerland: Springer Publishing International. De Grauwe, P. (2013). Design Failures in the Eurozone: Can They Be Fixed? (LSE ‘Europe in Question’ Discussion Paper Series, 57). De Grauwe, P. (2017). Making the Eurozone Sustainable. In A. Bénassy-Quéré & F. Giavazzi (Eds.), Europe’s Political Spring: Fixing the Eurozone and Beyond. London: CEPR Press, VoxEU eBook.

31 Some progresses towards a well-designed democratic “federal Europe” (a sort of “United States of Europe”) would be desirable to give the necessary political role to (a large part of) the “Old Continent” in the global context.

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De Grauwe, P., & Ji, Y. (2016). How to Reboot the Eurozone and Ensure Its Long-Term Survival. In R. Baldwin & F. Giavazzi (Eds.), How to Fix Europe’s Monetary Union: Views of Leading Economists. London: CEPR Press, VoxEU eBook. Deleidi, M., Iafrate, F., & Levrero, E. S. (2019). Public Investment Fiscal Multipliers: An Empirical Assessment for European Countries (Working Paper Series). UCL Institute for Innovation and Public Purpose. Della Posta, P., Marelli, E., & Signorelli, M. (2019). An Immediate Solution for the Euro Area Crisis: A Grand European Investment Plan. In L. Paganetto (Ed.), Yearning for Inclusive Growth and Development, Good Jobs and Sustainability. Cham: Springer. EU. (2012, June 26). Four Presidents’ Report: Toward a Genuine Economic and Monetary Union. Brussels. EU. (2015, June 22). Five Presidents’ Report: Completing Europe’s Economic and Monetary Union. Brussels. European Central Bank (ECB). (2014, August 22). Unemployment in the Euro Area. Speech by Mario Draghi, President of the ECB, Annual Central Bank Symposium in Jackson Hole. European Commission. (2017). White Paper on the Future of Europe: Reflections and Scenarios for the EU27 by 2025. Brussels. European Commission. (2017). Reflection Paper on the Deepening of the Economic and Monetary Union. Brussels. Fadda, S., & Tridico, P. (Eds.). (2017). Inequality and Uneven Development in the Post-Crisis World. Abingdon: Routledge. Holland, S. (2016). Beyond Austerity: Alternatives for a Democratic Europe. Spokesman: Nottingham. Krugman, P. (2010, July 7). Self-Defeating Austerity. In The New York Times, The Opinion Pages, The Conscience of a Liberal. Marelli, E., & Signorelli, M. (2017a). Europe and the Euro: Integration, Crisis and Policies. London and New York: Palgrave/Springer. Marelli, E., & Signorelli, M. (2017b). Young People in Crisis Times: Comparative Evidence and Policies. CESifo Forum, 18(2), 19–25. Marelli, E., & Signorelli, M. (2018). E se l’Italia tornasse alla lira? Vantaggi, costi e rischi. Padua. Libreriauniversitaria.it. Micossi, S. (2016). Balance-of-Payment Adjustment in the Eurozone. In R. Baldwin & F. Giavazzi (Eds.), How to Fix Europe’s Monetary Union: Views of Leading Economists. London: CEPR Press, VoxEU eBook. Minenna, M. (Ed.). (2016). The Incomplete Currency: The Future of the Euro and Solutions for the Eurozone. San Francisco: Wiley. Stiglitz, J. E. (2016). The Euro and Its Threat to the Future of Europe. London: Allen Lane.

Brexit: The Lure of the Neoliberal Thought Collective Jens Hölscher and Peter Howard-Jones

On the 23 June 2016 a referendum conducted in the United Kingdom (UK) voted by a 52–48% majority to leave the European Union. The turnout was 79% of the voting population. The campaign was conducted within an environment of mild hysteria in which wild claim and counter claim were greeted with lurid headlines from the tabloid press, including accusations that the Supreme Court judges were “enemies of the people”. In this febrile atmosphere, the triumph of the populists was achieved by a combination of a nostalgic appeal to the glories of the British Empire, a malevolent view of immigration, and exaggerated claims of the economic and military importance of the UK’s role in the world. The paradox of both the approach and the decision is that the argument for leaving

This paper develops a theme in relation to the creation of the Euro as a neoliberal concept which is contained in Chick (2013) and expands the concept into the broader UK economy. J. Hölscher (B) · P. Howard-Jones Bournemouth University, Poole, UK e-mail: [email protected] P. Howard-Jones e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_9

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was deployed on the basis of a neoliberal ideology, which resulted in the exit from a single market and customs union built on the very principles espoused as the justification for departure. The claim is that the EU will be replaced by a neoliberal agenda, which will go further, ideologically, in the pursuit of free market goals, theoretically, to bring prosperity to the UK and trickle down to the population at large. Thus, the population of the UK will be subjected to an economic regime, which was the basis of their decision to vote to leave. In this context, it is important to understand the motivation of this ideological movement. The neoliberal paradigm that has held sway in both the UK and the United States since 1980, when the Thatcher led Conservative government in the United Kingdom and the Reagan led administration in the United States championed Hayekian economic policies in the interests of their perception of national welfare (Harvey 2007). This contention of state capture has its roots in the Hayekian and Friedman inspired school at the University of Chicago, which itself grew from the Mont Pèlerin Society founded in 1947. The founding members were Friedrich Hayek and Milton Friedman and, amongst others, Ludwig von Mises, James Buchanan and Karl Popper. This context is of interest since three of these economists were awarded the Nobel Memorial Prize in Economics. The Chicago School was pivotal in the creation of partisan economic think tanks like the Institute for Economic Affairs in London and the Heritage Foundation in Washington, DC (Mirowski and Plehwe 2015). Straying into the field of politics and sociology, there is a persuasive argument that the influence of neoliberalism, and its apparent dominance of economic thought and practice, is the result of a “thought collective” (“Denkkollektiv” in German). This was developed by Polish/Israeli physician, Ludwig Fleck, to explain how a cohort of researchers jointly develop and elaborate, from a shared framework of ontological and epistemological ideas, knowledge, experience, beliefs and cultural background, to produce a universal truth in relation to a particular concept (Harwood 1986). In relation to neoliberalism, the claim is that members of the Mont Pelerin Society, through Hayek and Friedman, became influential in both the Chicago School of Economics and the London School of Economics and both these establishments became thought leaders in the post war debate between Hayek and Keynes. The fact that the individuals purportedly leading this thought collective have continually denied its existence,

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is an argument that is unappealing to leading researchers on the subject. Mirowski (2014) claims that: [W]hat is noteworthy about the neoliberals is that they forged a unified doctrine and institutional structure to do just that: they can reassure themselves that no human being is capable of second-guessing the Truth of the Market, and therefore spreading ignorance about their own true motives is not duplicity, but rather, foaming the runway for the bearers of real civilization to land and take over. There is no better modern exemplar of the core of the Straussian political doctrine of the noble lie.

The evidence to support the claim that the five hundred members of the Mont Pelerin Society had a profound effect on economic outcomes and policy is addressed in a compendium of research edited by Mirowski and Plehwe (2015) and provides thoughtful insight on the subject. Marxists held the view that capitalism should be encouraged and supported to such a degree that an overly repressed proletariat would rise and support their political objectives (Mirowski 2014). However, the real evidence exists in the actual events and in the known members of the society who emerged since the transition from Keynesianism to neoliberalism in the early 1980s. Following the Pinochet coup in Chile, against the democratically elected socialist government of Allende, which chimed with the collapse of the Import Substitution programme that had successfully regenerated much of South America, the subsequent recession required an economic solution. It came in the shape of a cohort of United States educated economists who became known as the “Chicago Boys” due to their allegiance to the teaching of Milton Friedman. From the point of view of the Chilean economy, their successful introduction of what subsequently became known as the Washington Consensus (WC) programme, was the direct application of all they had been exposed to while studying at the Chicago School, and the shock tactics they implemented received Friedman’s full support (Silva 1991). Solow (2013) regarded Friedman as an ideologue, echoing his support of Reagan and Thatcher, and stating, “I think that Milton Friedmans’ are bad for economics and bad for society”. The most recent examples of the programme in action are found in Europe, although it is first necessary to contextualise the reference. Literature suggests that the EU has gone further than any other group of member states to embrace the principles of the WC and, while there is

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significant reference to the WC, what is “less widely recognised is that there really exists only one pure laboratory experiment implementing the Washington Consensus in the Western World: Europe. [It] ……. has gone very far in the internalisation of the Washington Consensus; in fact, it has devised constitutionally a form of government that has no choice but to implement it” (Fitoussi and Saraceno 2013, p. 1). It can be argued that, in so doing, Europe laid the foundation for the poor growth it is currently experiencing. There is also some evidence of convergence of IMF and EU funding policies, with the EU adhering to a much more orthodox monetary regime than the IMF (Lütz and Kranke 2014). For example, the new member states of the EU had no choice but to incorporate the Aquis Communitaire (accumulated body of EU law and protocols since 1958) into their legal and regulatory administrations. The accession states had no choice but to engage completely in the process; to have done otherwise would have led to denial of entry. Western Balkan countries, currently in the accession process, face the same dilemma in a one-sided negotiation, where the conditionality of membership is nonnegotiable (Lavigne 2000). This will result in the same systemic change as that enforced on the countries of Central and Eastern Europe. Following the Eurozone crisis, the internalisation of the WC can be epitomised in the formation of the Troika, consisting of the European Commission (EC), the European Central Bank (ECB) and the IMF, to bail out Portugal, Ireland, Italy, Greece and Spain (the PIIGS). The policy of austerity, demanded in return for money, is the very bedrock of the IMF’s strategy of external conditionality and serves to demonstrate the extent to which the EU has internalised the WC (Featherstone 2015). This view is further emphasised by the crises in Hungary, Latvia and Romania in 2008/09, when the EU and the IMF cooperated to provide a rescue package. It should be noted that the conditionality imposed by the EU was far stricter than recommended by the IMF (Lütz and Kranke 2014). There have been a multiplicity of interpretations of the WC policy, although the reality is that it is associated with orthodox macroeconomic policies established and pursued by international financial institutions, including the IMF and the EU. It was the EU however, which proved the most recalcitrant by pursuing an aggressive, contractionary and pro cyclical programme conditional on the award of loans to Hungary,

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Latvia, Romania, Greece, Ireland and Portugal (Marangos 2009; Lütz and Kranke 2014; Babb 2013). A particular example was its treatment of Romania, where severe austerity measures were demanded, including a 25% cut in public sector pay and a 15% cut in pensions, followed by further cuts in return for additional funds. In contrast, the IMF believed a far less austere regime could have been agreed. This demonstrates that, by internalising the WC programme, the EU’s adherence to the established paradigm necessitated a far stricter observation of economic orthodoxy (Lütz and Kranke 2014). This approach is identical to that pursued by the UK government since 2010, with similar consequences. The complete supremacy of the EU Commission is apparent in the control exerted at supranational level on trade, competition and, in the case of the Eurozone, through the monetary policy of the European Central Bank. Even in the area of fiscal policy, there are constraints established by the Stability and Growth pact. Essentially therefore, the neoliberal agenda is established with a reduction in the presence of government, insistence on a balanced budget, control of inflation and the increase of competition through market mechanisms (Fitoussi and Saraceno 2013). When the priviledges of the common market and the customs union are added then the transformation to an augmented WC programme is complete. In this context, the UK’s decision to leave the EU is perverse. Firstly, those who appear currently to be leading the campaign for a hard Brexit, are the very disciples of Hayek and Friedman and likely to supply the next leader of the Conservative party; by definition, the Prime Minister. Albeit at a supranational level, the EU already has in place the free trade agreements (FTA) which the UK would have to replace simply to retain what it currently enjoys. It has established laws, rules and regulations that encourage and support the principles and areas of operation that the Brexiteers claim they will introduce to the significant benefit of the UK. There is duty free access to the largest single market in the world, which includes the free movement of capital. There are free trade agreements, in which the UK participates, with in excess of 50 countries worldwide, including Canada and Japan. Some 43% of UK exports go into the EU, which rises to 63% when countries with an FTA with the EU are included. Furthermore, the EU also houses subsidiaries of multinational enterprises (MNE) accounting for 25% of global sales (see Fig. 1).

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UK Exports and MNE's Sales in EU 60 50

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Fig. 1 UK exports and MNE’s sales in EU (Source Authors from Theurer et al. 2018)

Over 50% of imported goods emanate from the EU, including manufacturing inputs which form part of global production networks (GPN); the life blood of globalisation. Globally, manufacturing MNEs are dependent on complex and sophisticated international supply chains. A perfect example is the UK automotive industry, almost entirely owned by Japanese, German and Indian companies, in which 60% of inputs are imported. Equally, subsidiaries of EU multinationals account for circa 40% of foreign company sales in the UK. The importance of GPNs to the UK economy cannot be underestimated. Figure 2 shows the breadth of EU inputs throughout the UK’s manufacturing and services sectors. By contrast, with the exception of financial services, UK inputs into UK businesses are comparatively modest. Production networks consist of the core manufacturing process, namely, the assembler of the finished good supplied by a complex international tiered supply chain providing raw material, assembled components and services. Core companies have invested heavily in greenfield sites in the UK to benefit from membership of the single market and the customs union. Tier 1 and tier 2 suppliers have been encouraged to invest in local companies to minimise distance and maintain the integrity of the just in time principle. Nevertheless, a significant quantity of inputs is imported

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UK Imports and MNE's Sales in UK 60 50 40 30 20 10 0 2008

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Fig. 2 UK imports from the EU and affiliate sales in the UK (Source Authors from Theurer et al. 2018)

%

Share of Inputs EU to UK and UK to EU 18 16 14 12 10 8 6 4 2 0

Axis Title EU Inputs

UK Inputs

Fig. 3 Share of EU inputs into UK and UK inputs into EU (Source Authors from Theurer et al. 2018)

(Djankov and Hoekman 2000; Meyer 2000). Reference to Fig. 3 indicates the level of dependence on EU imports of many UK businesses: the paucity of reciprocal volume should be noted. The significant volume of foreign inputs not only limits the opportunity of an export multiplier but reduces the potential for domestic firm spillovers limiting the probability

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Less

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Fig. 4 Product regulations (Source OECD)

to those in receipt of foreign investment. In this context it is difficult to envisage how creating obstacles, where none previously existed, removing the raison d’être for maintaining a UK manufacturing base, and risking the “just in time” nature of IPNs, is going to provide the UK with a competitive advantage. A hard Brexit could result in a double jeopardy; disrupting the just in time protocol and increasing prices as a consequence of a weaker pound, thus threatening competitiveness. As margins in the automotive industry are tight (3–4%), any disruption to the process would erode what little there is. Since exports would be cheaper, there would be some alleviation, although this could be negated by dearer foreign inputs which already depress the export multiplier. The overall effect could be disinvestment in the UK, threatening 1 million jobs. In addition to the threat to the UK’s membership of IPNs, there is the problem of the UK work force skill base. In this context, what is interesting is the paucity of skills caused, in part, by the application of neoliberalism in the eighties when whole industries were privatised, labour regulated and capital deregulated. This asymmetry led to the deindustrialisation and financialisation of the UK economy when reduction in taxation resulted in reductions in infrastructure spending in key areas such as education and training. Figure 4 shows education spending as a percentage of GDP. Notably, in a Keynesian environment, the percentage rose steadily from a base of 2.8% in 1953/54 and peaked at 5.9% in 1975/76, declining to a low of 4.3% under the neoliberal regime of a

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Conservative government. Under a further Keynesian orientated Labour government, it began to rise again back to a peak of 5.9%, before falling to 4.7% under another Conservative neoliberal regime (Statistics only Belfield et al. 2017). Studies have demonstrated that improvement in skill training and education improves productivity and the UK has shown little sign of growth since the financial crisis of 2007/08. Manufacturing, utilities, construction and financial services are claiming increased density of skill shortage vacancies, with the agriculture sector claiming a general lack of manpower. This problem will not be solved by relying on the indigenous population, therefore both skilled and unskilled immigrants will be required to fill the breach. Within the public services sector, particularly elderly care and the health service, there is an almost total reliance on immigrant workers and yet one of the overriding reasons for Brexit was opposition to the high level of immigration. In this context, curtailing the free movement of people within the EU, allied to an increasingly hostile environment within the UK, there is already a shortage of labour, with a lower percentage of immigrants and a higher percentage of emigrants who are EU citizens. The importance of absorptive capacity in relation to improving productivity is emphasised by Kneller (2005) and Girma (2005), both of whom find that the benefits obtained are influenced by the human resources available. Kneller (2005) finds that the shorter the distance between investor and investee the greater the effect, whilst Girma (2005) claims that a base level of absorptive capacity is required for a positive result. Both findings indicate that curtailing immigration from the EU will have a detrimental effect on manufacturing, construction, business and public services. Notably, EU immigrants are better educated and less likely to be unemployed than their indigenous peer group. Thus, they contribute to the economy, not only in relation to their work rate but also by paying taxes and increasing demand, which in turn creates more employment opportunities. Between 1995 and 2015, the number of EU immigrants tripled from 0.9 million to 3.3 million, yet the UK has record employment figures and the lowest levels of unemployment in decades, with no evidence of this group impacting rates of pay (Wadsworth et al. 2016). The bonfire of regulations predicted post Brexit is a further myth being promulgated by the Brexiteers. Reference to Figs. 4 and 5 shows that the UK is amongst the least regulated economies in the OECD and EU for both labour and products. Therefore, the potential upside for regulatory reduction is limited and there is little supply side benefit. Furthermore,

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OECD Employment Protecon Indicators 4 3.5 3 2.5 2 1.5 1 0.5 0 Canada

US

New Zealand

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Individual and Collecve Dismissals

Germany

Spain

France

Temporary Contracts

Fig. 5 Labour regulations (Source OECD)

any reduction in labour regulations will inevitably have a detrimental effect on employees, many of whom are already disadvantaged as a result of the gig economy. As capital increases its hold on national wealth, there will be additional costs to the state when those same workers require working tax credits and state assistance within an increasingly unequal society. In the context of a low tax economy, this increased fiscal pressure will fuel the debt to GDP ratio, leading to a continuum of austerity and an inability to fund improvements to an aging infrastructure. An easing of product regulations will also do little for the economy. Firstly, without regulatory product alignment with the EU, it will be impossible to export to the world’s biggest market. Secondly, the adoption of multiple product specifications will increase unit costs making products more expensive and less competitive. Thus, firms will default to the regulations of their largest market which, in the case of the majority, is the EU. Furthermore, any relaxation of product regulation will expose the UK to substandard quality and potentially harmful and undesirable merchandise (e.g. chlorinated chicken and antibiotic treated meat from the United States and goats head meat from Australia). Allied to product standards and tariff protection, there is little doubt that the EU regulatory regime has the twin objectives of creating a level playing field for trade within the common market and customs union, whilst affording indigenous manufacturers a degree of protection from predatory pricing or even more efficient and cheaper states exercising a

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degree of comparative advantage. Thus, the Brexiteers suggest that by adopting WTO rules, or even abolishing import tariffs altogether, the UK will advance GDP and improve national welfare. In fact, they go so far as to adopt a General Equilibrium Model to advance the argument that there would be a 4% improvement in GDP: the fallacy being that they use a 70s trade model assuming perfect competition and goods of identical type and quality. The model assumes that trade will be enacted by buying from the cheapest producer. In this unilateral world, the UK would buy from the cheapest producers, thus reducing prices to benefit consumers. This would both increase demand and improve consumer welfare (Minford 2015, 2016). There are several fallacies to this argument, beyond the use of 70s econometric modelling and data that is over 14 years old. Firstly, the removal of protection from UK manufacturing companies would create significant damage to a sector already under competitive duress. The subsequent fallout, particularly in areas under economic pressure, would result in further erosion of the UK’s manufacturing base, thereby increasing unemployment and putting greater pressure on an already stretched benefits system. There is also an assumption that any price reduction would be passed on to consumers, whereas evidence suggests that an enhanced capitalist regime would hoard the gains with the consequent rise in inequality. Post Brexit, the devaluation of the pound would result in dearer imports negating any possible price reductions, and the resulting inflation would increase interest rates and the danger of short to medium term recession. Any advantage for exporters, particularly to the EU, would be negated by tariffs imposed under WTO rules: the service sector being particularly affected as the WTO has made little progress in comparison to the EU in terms of the liberalisation of services. FDI and international trade theories have existed since Adam Smith (1817) postulated that markets both created and dictated trade. David Ricardo (1817) claimed that countries should concentrate resources on products in which they have a comparative advantage. Heckscher and Ohlin (1991) espoused a factor proportion theory whereby countries would specialise by utilising their most abundant resources to maximise comparative advantage. More recently the discussion has become more nuanced when Hymer, in his posthumous Ph.D. thesis, argued that overseas investment was predicated on firm level advantage over internal competition and resources in the target country. In particular, he developed the notion that MNEs were the main drivers of FDI. Hitherto, portfolio capital flows were the main focus of international trade economists

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(Hymer 1973). This theory was further developed by Dunning who developed the eclectic paradigm of Ownership, Location, Internalisation (OLI) in which he proposed an approach that is encapsulated as; ownership, allowing an MNE to exploit firm specific advantages against competitors; location, that the firm has a choice of locale; internalisation, providing the operational capability of utilising assets to reduce costs in both the host and guest nation (Dunning and Rugman 1985). The gravity model relates international trade flows to the distance between the exporter and importer, implying that the shorter the distance, the greater propensity to trade. Additional variables can be used to enhance the model including size of the economy, language and common borders. An example is Germany, the near neighbour of the new member EU states of Eastern Europe, where there is evidence of increased business in relation to both FDI and trade, to a significantly greater degree than any other state within the EU15, albeit that trade grew strongly with the Euro area as a whole. This conforms to the gravity theory of trade (Bussière et al. 2005). The concept of free trade agreements with the economic heavyweights of the US, China and India is attractive, but does not stand detailed scrutiny. The UK already has a balance of trade surplus with the United States, which the latter is intent on reducing. It has product regulations, particularly in the agricultural and pharmaceutical sector, which the UK population may find unattractive, to say nothing of the prospect of the US healthcare industry penetrating the National Health Service. The Chinese market is appealing and, with an expanding consumer base, has potential for a myriad of UK goods. However, China is an autocratic state with subsidised industries which, in the case of steel, has already incurred the opprobrium of the Western world as a result of dumping its spare capacity cheaply on world markets. India has one of the most complex tariff arrangements in the world, with a lack of transparency that makes it difficult for exporters to price goods. Additionally, the issue of migration from the Indian sub-continent will be a mandatory topic in any trade negotiation. These three economic powerhouses have significant trade negotiation resources and experience, whereas the UK must build this expertise from scratch at a time when it has to replace all the other agreements with nations who already have free trade agreements with the EU. The concern is whether the UK can augment the trade it already enjoys with these countries at a level which replaces that which will be lost on leaving the EU. In relation to any international trade negotiation,

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it should be recognised that the UK economy is less than 20% of the size of the EU. Inevitably there will be a competitive edge to any transaction with the EU proving a more attractive export destination. The gravity model is equally relevant to the subject of investment. Bilateral FDI flows between states depend on a number of factors including market size, the potential for an export platform and the distance between them. Using the gravity model, there is evidence of the positive effect of EU membership on the quantum of FDI into any one of the member states. It is estimated that membership increases the stock of FDI from within the EU by 28%, and by 14% from states outside the EU (Dhingra et al. 2016). There is also evidence that EU membership leads to a 25% increase in trade with other EU members (Baier et al. 2008). It is a stylised fact that FDI raises productivity and therefore output, and theoretically income, although evidence suggests that income has stagnated throughout the Western world indicating the strength of capital and its ability to control the distribution of wealth by constraining labour costs. The UK has in excess of £1 trillion of FDI stock, of which in excess of 50% comes from other member states. Increases in trade costs with the EU, allied to issues relating to regulations and rules of origin and the diminution of the UK’s usefulness as an export platform, will reduce FDI over time. A conservative estimate is a reduction of 22%, causing a decline in real income of 3.4% or £2200 per household (Dhingra et al. 2016). The effect on the City of London may be particularly severe since it is the recipient of 45% of all FDI into the UK and the sector represents 8% of GDP and 12% of tax revenue (Tyler 2015). Currently, UK financial services have passporting rights throughout the EU allowing a free flow of services inside the single market. A loss of these rights could restrict UK firms and potentially lose trade to other financial centres, including the migration of indigenous firms out of the UK. The UK parliament has now voted to leave the EU on the 31 January 2020, whilst conforming to its rules and regulations during a transition period which ends at the end of the year and is negotiating an exit agreement to maintain a free trade environment, although there are a number of significant obstacles. The UK is insistent that it will leave the single market and the customs union, curtail freedom of movement, rescind the authority of the European Court of Justice and cease any contribution to the EU budget. The EU is wedded to the four fundamental freedoms: the free movement of goods, services, capital and people. To yield on any of these puts in peril the whole European project, which resonates

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strongly within clarion call of nationalists throughout the continent. In other words, the EU cannot allow the UK to exit without paying the price, and that price has to be high enough to deter others. In addition to trade, the UK has other political and fiscal issues to resolve. The vote to leave was carried primarily by those over the age of 50, particularly the population over 65. Whilst the motivation for the decision to vote leave is complex, there is little doubt that there was an element of nostalgia rooted in the UK’s imperial past, the industrial revolution and the period when “Britannia ruled the waves”. Paradoxically, this sentiment may well lead to the breakup of the very union on which the UK’s past successes were based. Both Scotland and Northern Ireland voted to remain, so the former may find solace in independence and the latter accept the embrace of Eire, with both opting to remain in the EU. From a fiscal perspective, the UK will save money when payments to the EU cease. In 2016 the gross payment to the EU was circa £12.6 billion and receipts £4.4 billion, making a net contribution of £8.2 billion (Office of National Statistics 2018). A breakdown of the receipts indicates that some £3.3 billion are expended on the agricultural community and regional development, and therefore it is not unreasonable to assume that, in the short to medium term, an identical sum will be required to prevent any deterioration in agricultural sector competitiveness and regional infrastructure. Thus, the savings are a far cry from the £19.2 billion promised to the National Health Service by the vote leave constituency. A generous estimate of the saving to the UK is £4.9 billion, circa 0.5% of UK GDP, a figure that the majority of economists claim would be dwarfed by the losses in trade alone. There are other obligations that may have fiscal implications that will have to be considered by a UK government. Membership of the European Medicines Agency and the European Aviation Safety Agency will lapse without an agreement and, whilst it is rational to assume that one will emerge, there could be a cost to the exchequer. The EU has also stated that membership of the Galileo project will lapse, resulting in the UK government promising to build an alternative solution at an estimated cost of between £3 and £5 billion. The conclusion to be drawn is that the economic case for leaving the EU has not been made. However, there is a recent and powerfully argued paper by Coutts et al. (2018) taking issue with the forecasts and suggesting that they have been derived as a result of an erroneous use of both the general equilibrium and gravity models. Firstly, the paper

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suggests that, following accession, the initial presumption of improved growth in the UK economy is erroneous as the 2.75% long term growth trend slowed post 1973. This is disingenuous since the 1970s were plagued by significant industrial strife, a three day week and an IMF bailout as the conflict between capital and labour took root. In the 1980s, the economic shock of oil price increases, deindustrialisation, deregulation of capital and the regulation of labour were more likely to have stalled growth than accession to the EU. An alternative study, using the Synthetic Counterfactual Method, evaluates the impact of an intervention by constructing a weighted combination of groups to be used as controls, which are then compared to the treatment subject on the assumption it had not received treatment (Imbens and Wooldridge 2009). They found that the UK benefitted substantially from membership (Campos et al. 2014). However, this evidence is discounted on the assertion that using Argentina and New Zealand as benchmarks adds little to any forecast relevant to the UK economy. The extensive use of augmented General Equilibrium and Gravity Models is criticised on the basis that their immediate post referendum forecasts have proved erroneous, and continuing work in this field is compounding the problem. The argument propagated is that the relationship between trade and productivity is exaggerated as that there is little evidence that trade growth in advanced economies is associated with increases in productivity, and therefore its inclusion in the model has a distorting effect. Coutts et al. (2018) also take issue with the trade diversion effects and the assumption that there would be no gain in trade to replace that lost from within the EU. Furthermore, there is criticism of the use of estimates based only on the mean for all EU member states, discounting the fact that circa 57% of UK exports are supplied to countries outside the EU. They make two further salient points, firstly, having controlled for the claimed distortions in models used by economists to date, they conclude that the negative effects of Brexit are exaggerated and, secondly, the consequent effect in the credibility of economic forecasting is damaged and undermines the profession’s potential contribution to the cause of national welfare (Coutts et al. 2018).1 There is little prospect of a meeting of minds on the effect of Brexit on the UK economy and the likelihood is that it could be a decade 1 Note that the authors Coutts, Gudgin and Buchanan are “remainers” and their paper is not politically or ideologically motivated.

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or more before the true effect can be measured. Equally, the outcome of the negotiations, the decisions made by the UK parliament and any fallout resulting in a further referendum or general election, are currently unknown. However, statements by the Prime Minister and the influence of the neoliberal wing of the Conservative party allows a prediction on the shape of the economy, at least until the general election of 2024. The UK will become a low tax economy, as the Prime Minister has promised the lowest corporation tax in the G7 group of countries. Regulatory control across a broad range of business sectors will be loosened, and labour regulations will be eased to maintain capital’s grip on both the economy and society at large. The causes of the failure of the banking system in 2008 remain unresolved, with the danger that any economic shock as a result of Brexit could have devastating effects. Austerity will continue as pressure is exerted on public services to a degree that influences national welfare, particularly amongst the poorest in society, with the greatest pressure on the deindustrialised regions of the UK. Brexit is a symptom of a deeper malaise within Western society, where the hegemony of the neoliberal agenda has polarised societies confronted by democratic choices at the more extreme boundaries of political and economic ideology. In consequence, the choices facing the UK electorate range from neoliberalism to left wing socialism. Empirical evidence already exists on the measurable effect of the increasing dominance of the neoliberal wing of the Conservative party, indicating the continuation of laissez faire, migration control, increasing inequality, a low tax low wage economy, stagnating income and deteriorating public services. The competing ideology will result in the nationalisation of the utilities and the railway system, the regulation of capital, necessitating some element of control to prevent flight, the deregulation of labour, increased taxation, particularly on corporations to repair the damage to infrastructure and public services, and provisions enacted to improve wealth distribution. Both these alternatives should be unappealing to the majority of the electorate. However, allied to the “first past the post” electoral system, in a post Brexit world, what has become the tribal nature of UK society will oscillate between two competing ideologies to the detriment of national welfare. The rationale for this phenomenon is little understood or accepted by the political elite. A plausible explanation is the cultural shift in progressive values towards a post-industrial, technological, socially inclusive, multicultural society, built on increasing opportunities for tertiary education,

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which has threatened the perceived superiority of privilege enjoyed by the older post war generation of primarily white men (Inglehart and Norris 2016). The spread of these progressive values, aided by increasing inequality and stagnant incomes, has created a feeling of marginalisation leading to a cultural backlash and the rise of populism. This is the challenge which the UK has to face and to create a more integrated society which is an essential antidote to the dangers posed.

References Babb, S. (2013). The Washington Consensus as transnational policy paradigm: Its origins, trajectory and likely successor. Review of International Political Economy‚ 20(2), 268–297. Baier, S. L., Bergstrand, J. H., Egger, P., & McLaughlin, P. A. (2008). Do Economic Integration Agreements Actually Work? Issues in Understanding the Causes and Consequences of the Growth of Regionalism. The World Economy, 31(4), 461–497. Belfield, C., Crawford, C., & Sibieta, L. (2017). Long-Run Comparisons of Spending per Pupil Across Different Stages of Education. IFS Reports (No. R126). Institute for Fiscal Studies. Bussière, M., Fidrmuc, J., & Schnatz, B. (2005). Trade Integration of Central and Eastern European Countries: Lessons from a Gravity Model (Working Paper Series No. 545/November 2005, European Central Bank, Frankfurt. Campos, N. F., Coricelli, F., & Moretti, L. (2014). Economic Growth and Political Integration: Estimating the Benefits from Membership in the European Union Using the Synthetic Counterfactuals Method (IZA DP No. 8162). Institute for the Study of Labor. Chick, V. (2013). (2014), The Euro as a Monetarist, Neoliberal Project. In J. Hölscher (Ed.), Poland in the Eurozone. London and New York: Palgrave Macmillan. Coutts, K., Gudgin, G., & Buchanan, J. (2018). How the Economics Profession Got It Wrong on Brexit (Working Paper No. 493). Centre for Business Research, University of Cambridge. Dhingra, S., Ottaviano, G. I., Sampson, T., & Reenen, J. V. (2016). The Consequences of Brexit for UK Trade and Living Standards. Paperbrexit02, London School of Economics and Political Science. Djankov, S., & Hoekman, B. (2000). Foreign Investment and Productivity Growth in Czech Enterprises. The World Bank Economic Review, 14(1), 49–64.

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Mirowski, P. (2014). The Political Movement That Dared Not Speak Its Own Name: The Neoliberal Thought Collective Under Erasure (Working Paper No. 23). Institute of New Economic Thinking. Mirowski, P., & Plehwe, D. (Eds.). (2015). The Road from Mont Pèlerin: The Making of the Neoliberal Thought Collective, with a New Preface. Cambridge, MA: Harvard University Press. Ricardo, D. (1817). On the Principles of Political Economy and Taxation. London: John Murray. In P. Sraffa, Ed. (1951). The Works and Correspondence of David Ricardo (Vol. 1). Cambridge: Cambridge University Press. Silva, P. (1991). Technocrats and Politics in Chile: From the Chicago Boys to the CIEPLAN Monks. Journal of Latin American Studies, 23(2), 385–410. Smith, A. (1817). An Inquiry into the Nature and Causes of the Wealth of Nations (Vol. 2, W. Strahan and T. Cadell, Ed.). London. Solow, R. (2013). Why Is There No Milton Friedman Today? Econ Journal Watch, 10(2), 214. Theurer, C. F. P., Ruiz, J. L. L.‚ & Latorre, M. C. (2018). Multinationals’ effects: A nearly unexplored aspect of Brexit. Journal of International Trade Law and Policy. Tyler, G. (2015, February). Financial Services: Contribution to the UK Economy. In Economic Policy and Statistics Section, House of Commons Library, SN/EP/06193. Office of National Statistics. (2018). The UK contribution to the EU budget. Available: https://www.ons.gov.uk/economy/governmentpublicsectoran dtaxes/publicsectorfinance/articles/theukcontributiontotheeubudget/201710-31. Last accessed 9th October 2020. Wadsworth, J., Dhingra, S., Ottaviano, G., & Van Reenen, J. (2016), Brexit and the Impact of Immigration on the UK. Paperbrexit05. London School of Economics and Political Science.

The Limits of Europe: Lessons from Post-Communist Experience for the Post-Brexit Union László Csaba

1

From Pro-EU Over-Zeal to Freedom Fight

Joining the European Union has never been a matter of cost–benefit analysis for Hungary. Already from the late 80s but all across the first three democratically elected governments from 1990 to 2002 Euro-Atlantic integration has been a focal issue, a strategic consideration. Joining NATO enjoyed priority, as it was rightly understood that without any formal prescription, it has been a de facto security policy pre-condition for the EU entry for post-communist states. This was due to Western fears of the revival of the ethnical conflicts of the 30s and 40s that could well have been carried over to the Union, should not formal and treatybased reconciliation not have preceded enlargement. But also protection against open and covert Russian influence justified this circumstance. The parlance of the first 15 years on joining Euro-Atlantic structures rather than just the EU reflected this geopolitical reality.

L. Csaba (B) International Political Economy, Central European University, Vienna, Austria e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_10

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In the case of Hungary the strategy of Western orientation enjoyed consensus across all parties that could come close to governing positions. True style and justification differed, but commitment to the “return to Europe” had been axiomatic, by and large until 2013 (Balázs 2001; Palánkai 2004). This unusual consensus has been built on the historic consciousness and traditions, which implied—both for academe and the broader public opinion—that revival of the Central European identity— and co-operation in the form of CEFTA and Visegrád Four—has never meant to be a “third way” alternative between socialism and capitalism, or an alternative to Western orientation. On the contrary: this was a highlight of the cultural and historical, institutional and legal anchoring of the region in West European/Western Christian traditions, rather than accepting four decades of Communism as a formative element of the historical and institutional heritage (Cf. Halecki 1952, 2000; Sz˝ ucs 1983). The above mentioned interstate forms of co-operation embodied an old-new brand name used to dissociate participants from countries and not least of bloody conflicts and ethnical cleansings of the Balkans and “the East,” meaning the New Independent States, with no less complex (though less bloody) clashes and rearrangements. It is worth mentioning that the new label reflected accomplished realities. Reorientation of trade from Comecon to western markets took place already during the 1980s, largely out of pressure exerted by growing energy and consumer goods shortages in the Soviet Union coupled with the approaching Soviet insolvency, which turned this option imperative (Csaba 1990, Chapters 5, 8, and 11 and the literature cited therein). This fundamental change in terms had only in part been an outcome of policy decisions taken by the Communist reformers of the day. To a larger degree it resulted from the initiatives of large socialist firms. The latter used CMEA markets as a base where fixed costs and various outlays could be safely earned. Meanwhile innovation of products, obtaining new technologies, upgrading of products in terms of the value chains were and learning new forms of organization and sales all were oriented on western markets, evolved through co-operation with western strategic partners. The latter could be managed via the then popular East-West joint ventures, legalized by special legislation already in 1972, and by the much more lavish 1988 law on foreign investment. The latter—adopted in the framework of the three year liberalization program of the last two Communist governments—allowed 100% foreign ownership (an issue

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which is still an anathema to the regulators in the People’s Republic of China). Thus we may formulate with just a little overstatement that the reintegration of Hungary to Western trading and financial circulation has preceded to a considerable degree political transition to parliamentary democracy in 1990. Unlike in the Czech Republic or Russia it was a preliminary to, not a consequence of systemic change. In a way, trade re-orientation was a trigger, not a by-product of tectonic change. The Hungarian economy and society have therefore not been “thrown into ice-cold waters of capitalism,” as some ideologues and representatives of vested interest have never ceased to assert in the past three decades. Rather Hungary has left the byway imposed upon it by 45 years of Soviet conquest and returned to its natural path an environment.1 In short, many arrangements—from multi-party democracy to running firms in private hands, or applying legal standards, which happened to be oftentimes carbon copies of existing German stipulations to the point of the Constitutional Court,2 were already made readily available. Those operating them could rely on considerable expertise of both persons surviving from the pre-Communist times and newcomers who studied abroad or just implemented arrangements like the law on bankruptcy or mortgage lending. The system of commercial banks and the competition agency, both established in 1987–1988 may serve as cases in point. Unlike in most other transition countries legal and political change simply formalized what has already, to a large degree, been happening on the ground. It has been a hotly contested issue if the “unilateral turn to the West” has inflicted more wounds than it was really necessary or unavoidable, and if softer and better managed transitory options, including a clearing system, market protection, and wage subsidies could have mitigated the pains of radical change (as argued eloquently, but not convincingly by van Brabant 1998). Accepting the validity-academic plausibility—of these suggestions, we have to disagree also in hindsight. First: it is hard to deny that the core 1 It is a different story that the “natural environment” of West European capitalism has undergone perhaps its most fundamental change in the half century between 1940 and 1990 Stone (2015), thus there were no shortcut solutions available. 2 The function of the Court has darmatically changed in part by the adoption of the new, highly politicized Basic Law of 2011, as well as by the appointment of Party loyalists to the Court from 2010 on Sólyom (2015).

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EU followed its self-interest in opening up its markets, as cost and other comparative advantages, especially in the wage intensive sectors, are in the new EU members. Thus re-locating activities has been welfare enhancing. Second: by stabilizing Central Europe via economic ties it has also served its own security interest, with East–West migration kept at bay. Third, in strategic and political terms, the EU had not much successful cases other than post-communist change where the exportation of democracy would have worked, at least for quarter of a century. Last but not at all least, assisting transition to the market was a win-win option for all sides. The upgrading of Central Europeans and the convergence cited at the outset have been impressive. Imaging the counter-factual requires strong assumptions, especially on the benign aspects of Russian politics, which is hard to entertain even in abstractu following the annexation of Crimea in 2014. But also wherever we could observe slower, less radical change—say in Croatia or Ukraine—we do not see the superior outcomes. Once again: swiftness was basically triggered by history, not conscious calculation by the players. Being an extremely open economy, with exports and imports each reaching the value of GDP in the current millennium, Hungary has obviously benefitted considerably from open EU markets. Furthermore the country profited from the familiarity and additional credibility provided by the institutional transfer. Given that Hungary had to adopt the acquis communautaire in full, with derogations excluded already by the Amsterdam Treaty of 1997, this institutional upgrading has produced a better quality regulatory environment than the one autochthonous development could have produced. Being a participant in creating new legislation is not quantifiable still it has been an unquestionable plus for a country which usually is forced to adjust in a unilateral manner. The above assessment is by and large a lump sum, which may or may not cover individual misdeeds or mistakes. No question the overenthusiasm of the first phase has given ground to a backward move of the shuttle, culminating in the “freedom fight” of the Hungarian government of the post-2010 period (Csaba 2013). In the latter, especially in 2014–2019 antagonism to whatever the EU and its Commission does has become a red flag for the Hungarian government. The elections of 2018 were also won on a harsh anti-EU platform, a circumstance that could have been inconceivable, similarly to the poster campaign against JeanClaude Juncker, coming from the same party family as the Hungarian ruling party, Fidesz.

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Similarly, it would be difficult to deny, that a go-slow strategy has not proven fruitful in any way one cares to mention. The fact that Croatia joined the EU a decade later than the Ten, has not allowed the country to become better prepared for membership, or to run policies that would have yielded higher growth rates, as the argumentation by Jozef van Brabant (1998) has suggested. Eastward enlargement has been made in a snail’s pace if one considers any other accession, especially of the Nordic enlargement, which lasted exactly one third of the eastern counterpart. All in all, the major consideration has to be if a country is within the limes or not, as being outside has not offered a superior alternative in any walk of life. Backsliding in Turkey and also in Ukraine in terms of democratic values, stagnation of the market reform agenda in both cases is hard not to relate to the weakening, if not loss, of the European perspective that helped overcome partisan competition in Hungary, the Czech Republic or Slovakia (for a comparative overview cf Andreff 2007).

2

But…What Did the Romans Give to Us?

This quibble comes from the classical satirical film “The Life of Bryan” mocking i.e., narrow-minded behavior through the lenses of a story from Antiquity. Participant of the uprising in Judea are absorbed in fighting one another rather than the colonizers, but are good at lashing out against anything the Romans do. In their debate they do have to give into the fact, that money, water pipes, roads, etc., were all constructed by the oppressors. Likewise despite the achievements listed by us above, the overall feeling in much of the public in Hungary is that of being dominated by a mighty external power. This holds despite the fact that Hungary continues to be one of the largest beneficiaries of EU transfers in per capita terms, preceded only by Lithuania. However, it would be “poor economics” to borrow the expression by a book by this year’s Nobel winners in economics (Banerjee-Duflo 2011), to claim that advantages can or should be measured on the net balances of official transfers. What the MIT professors propose is to give up ideas that are widespread rather than testable on the ground. To apply their method to our subject: do we not have the experience of the Mezzogiorno in Italy, where 150 years of unilateral transfers failed to produce prosperity? Or could not we observe the replication of this bad example in the eastern German provinces, including the capital city and surrounding Brandenburg, faring quite poorly in the competition across the German Laendern,

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even after three decades of nurturing? If we invoke the familiar infant industry argument, 30 years is quite respectable an age for any infant, though the basic problems were raised early on (Brezinski and Fritsch 1995). In any empirically substantiated analysis one may have to set out from the fact, that EU transfers are macro-economically negligible magnitudes, unable to trigger major changes for the better. Were they properly used to bridge supply and institutional bottlenecks these could indeed be helpful, via the well-known multiplier and accelerator effects. Regretfully this is seldom the case. Recent overviews of the use of structural funds conducted in the European Investment Bank (Slacik 2019) have indicated rather regular and recurring mismatches in this respect. That means that the theoretically conceivable growth plus is unlikely to be significant in reality. Experts speaking on a recent conference on Hungary’s experience between 2004 and 2018 have found further difficulties (Weinhart 2018). These included corruption, lack of transparency, lack of competition and ensuing poor quality, “leakage” to private pockets (not peculiar, but quite visible in Hungary), overbureaucratized public procurements and nepotism in deciding over the winners. This translates into lacking productivity improvements in the EU funded projects, especially at small and medium sized enterprises (SMEs). If only a part of the above listed claims hold—and it has never been dispelled by the authorities—than the fact, that Hungary received over a decade more transfers than ceteris paribus the Marshall Plan injected to Western Europe, namely, 1–2% altogether (one-shot) in the latter and 4– 5% annually for Hungary in the past decade, it gives an entirely misleading overall impression. Then how has EU membership helped Hungary in improving her locational advantages? a The EU has assisted—already in the pre-accession period—improve Hungarian regulation and particularly institution-building. While individual options and compromises are always liable to criticism, what seems overwhelming is that in sum, a regulatory environment which is compatible to EU standards evolved, and it is testified by recurring Union level controls, thus it is credible. The EU had set it as an entry criterion and meticulously controlled implementation on the ground, especially during the acquis screening phase of 1998– 2003. Several Community organs, the Commission, the Eurostat, the Parliament, the European Audit Office, Olaf, the anti-corruption

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watchdog, and not least the European Court of Justice continuously monitor developments. The procedure launched by the Sargentini Report in 2018 on the state of the rule of law is but one of the examples that the EU is not a toothless lion. Owing to the regular co-operation of sectoral organs, including courts and independent agencies, following the logic of the single market, an increasingly uniform application of regulations and laws ensues. This holds to a great array of affairs, from trade policy to environmental issues. This has elevated the Hungarian institutional infrastructure to be qualitatively similar to the EU average, which is not world class in all areas, but improvement over past deeds. For any investor, be he from China, South Africa, or Argentina, it is clear and calculable, what kind of regulatory environment he may face, if he advances larger sums. And the nature of competition for investments among localities is such, that investors rarely bother themselves about the peculiarities of local arrangements. Rather they follow rules of thumb, thus being part of EU -27 is by definition superior to be one of the 218 members of the World Bank. b Both economic and legal analyses tend to under-rate the relevance of social learning . From our perspective it means that an economic or legal arrangement becomes operational and effective not upon its’ being promulgated. Rather what decides if it bites or not if and how it is being implemented on the ground. Transition has been an excellent laboratory on how societies learned and un-learned new and old rules. For instance it took time to realize that if somebody is bankrupted, it means—in most cases—exactly the opposite to the everyday meaning of this expression. The person in question is unlikely to have lost his property. What is more probably that he managed to secure it against his creditors. Travelling on discount airlines may confront us with the fact that the law of one price, a fundamental insight in micro-economics, may not hold in practice. Six of us sitting in the same row are likely to have paid six different compensation for the very same service we enjoy, depending on when and where we had bought our ticket. Without multiplying the examples we may advance the claim that the EU has provided a good

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service to its new member-states if and when it enforced its rule on transparency and of civilized market behavior in general. Enforcing these rules has remained a task for Community organs to the present day. Generalizing this insight we may even suggest, that especially in public administration, in municipalities, in law enforcement and environmental protection that is particularly in the non-tradable sectors one of the fundamental benefits of EU membership has been the type of learning we indicated above. Procedures and arrangements familiarized during applying for EU funds generate knowledge that improves performance in public procurements on the local markets as well. c In the past decade Hungarian economic policy-makers elevated discretionary, interventionist policies to the level of economic theory (György 2019). This revival of the line of the 1970s considers redistribution concerns to be the prime concern of policy-making against the established norms of the mainstream economic policy toolkit, which focuses on wealth creation and equal treatment of players, or rule of law. This approach, while reflecting the trend of illiberalism gathering momentum in many corners of the globe, is neither new nor is widely shared by major investors, who tend to appreciate calculability, transparency, and other conservative values. Providing market protection or subsidies on case by case assessment is though observable in many places, however there are good grounds of theory and public finance practice to be skeptical on them. One of the strongest policies that exist at the Community level is precisely competition policy, covering state aid which is not the case in the United States and Japan. If the above insights hold, supra-nationalism observable in EU legislation in this very area is not a drawback, but a factor enhancing competitiveness of the locality of new member-states. Investors acting under familiar rules and in a calculable environment are more likely to advance big sums even in areas where recoupment may be slow, as in the pharmaceutical or automobile industry. The more EU helps sustaining a rules-based policy environment, the more immediate has been its contribution to enhancing the quality of regulatory environment and in helping to lure good quality—rather than just a lot of—new investment in the new member-states NMS. Good

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quality investors are known to look for calculable environment, rather than individual favors (true they may not reject the latter). The more a country like the ones in Central Europe aim at and actually attain a climbing up on the ladder of value chains, the bigger is the advantage provided by the Community level law enforcement in case of disputes with the authorities. And by contrast: the more sophisticated is the product or service, the riskier it may be to enter a market with regulatory arbitrariness—a feature proudly promulgated by policy-makers cited above. We do not make the absurd proposition as if EU membership on its own could guarantee any outcome. Experience with countries of the Balkans, from Greece to Romania, has shown that it does not ensure high levels of inward foreign investment, or compliance with solid economic policy line, let alone overcoming the intertwining with mafia structures or overcoming systemic corruption. As a matter of fact one of the reasons for the large-scale innovations in EU policy surveillance, for shorthand Fiscal and banking Union since 2012 has been triggered by the experience of limited to non-compliance especially in cases where it would have been most required to avoid self-propelling crises. And if adherence to rules could not be attained even at the level of macroeconomic targets, even less could be realistically attained in changing state-business relationships and many other deeper going features of socio-economic systems. On the other hand we do sustain the claim, that being within the limes allows for an investment climate which is friendly to good quality inward FDI and improving the quality of economic activity in general. From the core EU we may cite the cases of Ireland, Spain, and Finland, all traditionally counting as periphery of the EU. From among the NMS Estonia, Slovakia, and Poland have definitely made good use of these new opportunities and also managed to climb up on the relative level of development. 2.1

The Real Dividing Line—the Rubicon—Within the EU Is Membership in the EMU or Lack of It

As the UK has experienced, even being a nuclear and maritime power is of little avail if you do not sit around the table when new rules and regulations are being hammered out, or when new initiatives are adopted, usually first in an informal fashion. Staying out—voluntarily or willy-nilly, alike—implies no more and no less than second class membership for any

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practical purposes. It is a world of difference to be formative to a new agenda or just being informed about the compromises struck by others. In theory one may imagine a situation when non-EMU members initiate and get their ideas through the rest, but we are unaware of such cases. The Council, in theory, could superimpose its will on bureaucracies. However it is not realistic to expect discussion of detail to take place at the policy-making level, i.e., in the Council. Thus what remains is “freedom fight,” vetoing majoritarian propositions as it has become quite frequent in justice and home affairs and in common foreign and security policy. However, these are not the fields where the EU would speak, as a rule, with a single voice, rather than opting for the open method of coordination. In issues of substance the rule, long established in the sociology of decisions, is to set up an inner circle of four to five who decide over agenda-setting and formulations. Thus, as we all know, the devil is in the detail, and the power is in the hand of the civil servant formulating the proposition, not in that of the President signing the final protocol. The more technical the issues are, as in finance and law, the more so. From among the thousands of pages four or five can only be decided at the top, but selection, screening, and substantive elements of formulation remain in the hands of civil service. Thus it is entirely unsurprising to observe that EU, for decades, has been evolving around the Franco-German axis, joined on occasion by the Italians, the Spaniards and until Brexit the UK (on matters of defense and foreign policy). As the Brits have abstained from the most important deliberative club, the Euro-group, they tended to be notified of rather than involved in hammering out joint decisions. The practice of the European Court of Justice, with its rulings becoming increasingly of immediate effect in national legislation and even in court practice, has remained completely alien to British traditions and practices. This has become a formative force in bringing about Brexit in the outcome of a series of decisions leading to largely unintended consequences (Bellamy and Castiglione 2019). 2.2

Joining in or not to EMU Has Thus Never Been a Simple Cost-Benefit Calculation but a Matter of Strategic Choice

Even for core members, like France, Italy, and Germany EMU is more than a bit of symbolism on the head of a fixed exchange rate regime. By contrast, the famous five points of Gordon Brown of 2003 had already

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indicated: one of the global centers of capital transaction is neither in the need nor is willing to merge its concerns with a supra-national player, the ECB in Frankfurt. Therefore it does not come as a surprise that at the time Hungary has matured for entry in the EMU, the think-tank for economic unorthodoxy, the National Bank has published a position paper (first in: Nagy and Virág 2017) warning against too early and too speedy accession, and re-stating basically similar conditions as the former Chancellor of the Exchequer. Like the latter, Hungarian bank managers do not consider joining EMU a political priority, expressing broader considerations and commitments to certain rules of behavior, but as a cost–benefit deal. For the latter they consider a weak currency and letting all options open in exchange rate management superior to the pegging needed to pre-qualify for EMU. If one turns the inherent logic of EMU to its head, one may claim: once real convergence (of per capita GDP) materializes, nominal convergence and common currency may follow suit. This is exactly their suggestion. One may easily subscribe to the above cited view: EMU, on its own, lacking other policy components, is by no means a panacea for accelerating rates of growth. The original claim has never been this. Rather it was suggested that “one money, one market” enhances consumer welfare at the micro level. Quite apart from the extensive debate on the uses and meaning of GDP it is quite clear: if we have four pairs of flights between Berlin and Budapest instead of the traditional one, and the price is about a third of what state monopolies used to charge 15–20 years ago, this is unlikely to enhance GDP, but will definitely improve well-being. Thus we are probably on a wrong track if we buy into the results of econometric analyses putting incremental growth at a mere 0.1–0.15% of GDP that is due to EMU. Furthermore, as we elaborated elsewhere (Csaba 2016), EMU nowadays is no longer about Maastricht, but about Banking and Fiscal Union and joint crisis management arsenal. Staying out implies additional vulnerability to an already extremely open and small economy without financial buffers of her own. 2.3

The Luxury of a National Currency

Herewith we have come to a pint which counts among the received wisdom in international finance. Keeping an independent currency is not just costly and renders the economy vulnerable. But in short: it is a true luxury for anyone not being a global financial center or major commodity

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exporter facing inelastic demand. If capital account convertibility holds, there is no way to stop owners of big sums from transferring their wealth by a push of a button via Internet. This has become a reality already from 2007 to 2009 in many countries. The solution required private–public joint bailouts as the Vienna Initiative of 2009. The dominant view in international finance is bipolar. Thus only extreme solutions, either pegging or free float are considered to be sustainable. Therefore the urge to join in currency blocs has only been strengthened by the experiences of the financial crisis. By contrast, the conventional view of the 70s and 80s which saw a weak currency as a good instrument for export promotion is no longer valid. The farther a country’s export is from prime commodities, the less so. What worked for East Asia in the 60s and 70s no longer works for diversified EU member-economies. One of the major troubles with the arguments of the central bankers cited above is that EMU has changed a lot. While annual EU spending is unlikely to be above the current levels of 130–135 bn Euros per year, roughly 1% of GNI, the unlimited supply of liquidity as well as targeted purchases of stocks and bonds by the ECB have changed fundamentally of what EMU is all about. By now it is primarily a huge counter-insurance structure against external shocks—but only for those being inside the Euro-zone. Capital markets are known to operate according to sharks’ rules. In short, one who may mobilize staggering sums, like ECB or Bank of England, is unlikely to experience a speculative attack. By contrast, weak economies can experience drying out of markets even if their fundamentals do not justify it, only because they are unlikely to be able to protect themselves. During the EMU crisis Cyprus, Portugal, Romania, Hungary, and the Baltics were cases in point (for a comparison cf. Gy˝ orffy 2018, pp. 113–190). This was a well-known potential analyzed already in the previous crisis, baptized by three eminent analysts (Reinhart et al. 2003) as sudden stops way before the Great Recession. Their claim is that one does not need weak fundamentals to become vulnerable. Sudden stops imply drying up of financial flows without any good reason, basically on grounds of perceived rather than experienced difficulties. The above cited paper has become a classic in its brand, showing the inherent limitations in our formalized models in terms of forecasting actual traumas. It may well be that a country with excellent fundamentals is shaken, as South Korea in

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1998, or conversely, even dismal indicators may not translate into imminent troubles, as in Italy between 2009 and 2012 (though much of the profession did expect that). This sketchy overview may illustrate our point. If a small open economy retains its national currency in order to “keep all options open” and particularly that of devaluations and policy improvisations, this choice is a momentous one. In a conceivable new storm the arrangement as such is an invitation to speculate against the currency, or pushing its rate of exchange to the doldrums, with costs born not only by those spending their holidays abroad.3 Certainly, an economy may withstand external financial shocks also without the buffer provided by the EMU, especially by the unlimited liquidity provision by the ECB, but… isn’t it safer to prepare for the worst? Under this angle the Hungarian central bank strategy (Virág 2020) of postponing EMU accession endlessly seems to be positively adventuresome. Given EU and OECD membership, capital controls cannot be re-instituted, thus accepting even more volatility of the exchange rate would run counter to the interest of the vast majority of economic agents, investors, and the general public alike. By contrast, EU accession would be a safer bet, and not least meeting a legal obligation taken upon us 15 years ago, when the accession protocol was taking effect. 2.4

Fiscal and Banking Union

Herewith we have come to the basic issue of peculiar national ways Sonderweg. The American literature terms jokingly as Sinatra’s Law the practice of opting for special arrangements even if standard options would do. As a matter of fact no informed analyst would these days suggest to country A to implement a carbon copy of arrangements in country B, only because these have worked in the original context. This “new thinking” has already infected even the international financial institutions and the policy advice provided by them, as Ilse Grabel documented in a critical monograph (Grabel 2017). This notwithstanding it is perhaps a platitude to claim after Brexit that the EU in general and EMU in particular has 3 Soós, K. A. (2019), p. 122 rightly draws attention to this eventuality,which happened in peacetime, without being confronted with crisis phenomena. The lasting decline of the Forint exchange rate is usually being de-emphasized by the triumphant official accounts of the past few years.

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yielded a set of institutions, rules, and procedures way beyond the free trade area plus a bit of declarative diplomacy approach cultivated by the United Kingdom. Since it is not primarily about the common spending items—farming, cohesion, or border protection—which are formative. Rather it is Schengen and what is called Fiscal and Banking Union and the new role of the ECB as a lender of last resort and an operator of the single supervisory mechanism that embody the new supra-nationalism—mostly outside the Treaty frameworks. a Far the most important issue for assessing the Hungarian ways if we consider chances of a new and major financial crisis realistic or not. The majority view in the literature on the EU—much less shared in broader global finance—is that the toolkit that was developed in the fire-fighting years of 2009–2014 is by and large sufficient to ward off any major external shock. But this claim holds only for those who live up to—and pay not only lip service to—rules of prudent behavior in peacetime. Hungary was reminded more than once by her peers in Ecofin that her fiscal stance is quite a long way from the trajectory that would follow from the jointly agreed path for the sunny years. Since fiscal correction was repeatedly rejected, the elbow room for counter-cyclical measures is likely to be narrow to nil. Negative real rates of interest do not allow room for maneuver in monetary policy, and options for quantitative easing were already used up in the previous good years by the National Bank. True, commercial banks do not need to be recapitalized, but their relative stability must have changed during the boom years of 2013–2019, not least owing to the government supported preferential credit programs. As the Budapest stock exchange is still dominated by four papers only, it is the benefit of backwardness which protects financial intermediation. But it is not a bulwark against a sudden stop, with the Forint being the few currencies left to speculate against, as the central bank does not care. b It would certainly diminish the dampening effect of Euro-sclerosis on the Hungarian growth rate should the country be able to realize its strategy of opening to the East and opening to the South, as promulgated in the years 2013–2016. Looking at the basic trends in the country’s foreign trade data can convince those in doubt that the

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attempt collapsed, for a variety of reasons. This includes lack of logistics, lack of organizational and financial power, lack of command of local languages (Russian and Portuguese, let alone Arabic) as well as a series of corruption-prone developments, civil servants working for private wealth (Rácz 2019). Oriental markets and policies are known to represent a special mixture of tales and realities. For instance at the height of the financial crisis in January 2012 the Hungarian government reported a billion dollar quotation of state bonds on the Chinese market, which was declared a mere declaration of intent by the Asian partner. Projects on updating the Budapest-Belgrade railway line are being aired for over four years, with the planning stage allegedly starting in the last weeks of 2019. Reconstruction of the nuclear power plant of Paks is about to be launched, while projects are being discussed at top level since 2007 and beginning may start in 2020 at best. In short markets in Central and Eastern Asia as well as in Africa tend to be anything but free and easy to conquer. Knowing the financial and logistic limitations of corporations working in Hungary and the strategies of multinationals aiming at EU markets, one may not be optimistic on this initiative. Divesting trading houses and learning to live with the traditional geographical pattern of trade comes hardly as a surprise. c One may obviously list a few countries who are highly successful in global competition who do not figure among the member-states of the EU. We may note Singapore, Chile, and Israel, or from among the European economies Norway and Switzerland. We have no time and space to expand the well-known observation: each of these nations has undergone a peculiar, non-replicable path of development in the past 50–70 years. If there is anything common across the varying national ways, this is a commitment to a by and large orthodox set of policies, including commitment to fiscal solidity and market orientation. None of them follows the unorthodox line advocated, and in part practiced, by the Hungarian government in the post-2010 period, expounded by the secretary of state cited above under footnote 15. For instance: in Chile public transport is run on a fully market base, and in Norway windfall from oil revenue is being invested in a fund to cover future pension outlays. This differs from

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the populist practices of the United States or Japan, but in quite different ways from the Hungarian option. d It is worth raising the question: what follows if the geographical pattern of Hungary must be taken as a given for the decade to come and longer. EU is much more than an area of specialized or sectoral governmental activity or a channel through which administration may spend to accelerate relatively slow growth. It is an area where Hungary is integrated in cultural, historical, political sense and also via family relations and increasingly also via labor market contacts, education, tourism and set of values, not only at the elite level. Does this chain of interwoven factors allow for a realistic alternative to what used to be the mainstream of thinking in Hungary, in economics, political science, sociology and law, even in the natural sciences? If not, the conclusion is that Hungary’s economic interest is not a retrogression of the European Union into a free trade zone, but the successful implementation of the Fiscal and Banking Union, complemented with the emerging Capital Market Union. In this line the Hungarian government should be supportive of the initiatives (inter alia of the Finnish Presidency) for regrouping EU expenditures to areas where Community gains are trivial, as border protection, management of migration, environmental protection and of course research and development. Initiatives to re-define expenditures along those lines and at the detriment of traditional priorities like farming and cohesion should therefore enjoy priority.

3

Conclusions: It Is not the Economy, Stupid!

In various sections of this chapter we argued that Hungarian and European interests tend to overlap. The closer we get to business and economic policy, the material sphere, the more so. We argued about the past and potential future uses of being within the fences, even if those fences are not necessarily waterproof, and even if one can always advance arguments for better quality Community regulations in many areas. Still, as a rule, common rules and procedures yielded more transparent, more efficient arrangements than the purely local ones, in all walks of life, from monetary policy to environmental protection. Most community policies tend to be more forward-looking and more evidence-based than local ones lacking this point of orientation.

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What explains then the freedom fight conducted by the Hungarian government in the entire past decade since 2010, with a large degree of coherence and consistency? We may not enter into, but invoke, the broad and largely novel insights from political science which operationalized the original claim: 2010 was a watershed, more than a simple change of the government. The new pattern of legitimacy (Illés et al. 2019; Bozóki and Heged˝ us 2018; Körösényi 2019), of organizing support to a régime operated by a single leader positively required ongoing antagonism against what is perceived as the bulwark of the liberal and multinational ancient régime, that is the EU. While pragmatic considerations of the economy, law, institutionbuilding, and efficiency would have called for more co-operative behavior, the “primacy of politics” as Lenin once used to term it, required exactly the opposite. Staying within the realm of economics it is hard to marshal evidence to support a claim that an antagonistic line, playing in the coalition of the nasty, that is those opposing any deepening and any transparency, would be in the interest of the nation. Hereby we come to the old insight: there is no axiomatically given “interest” without the intellectual and interpretative framework of understanding reality. A jihadist is usually convinced of the value of his deeds as good and even superior to the norms of the godless. Likewise populist policies, based on the dichotomy of “us” and “them,” require an enemy to fight. Thus the debate on Hungary’s conflict with the EU organs, to a large degree, remains the dialogue of the deaf. While any international agency is bound to follow ideological neutrality and thus advance technocratic arguments even if it is to pursue ideational causes—as in human rights or environmental protection—these arguments are likely to fall on deaf ears if the commonality of visions between both parties is no longer given. While in the first two decades the common vision and shared perspectives were by and large given, this has ceased by 2010. In the post-2010 period, first burdened by imminent crisis management, later by adjusting to the new realities of Fiscal and Banking Union and the turning of the ECB into a lender of last resort and a provider of unlimited amounts of liquidity. Those modifications implied vastly enhanced redistribution effects over and above the joint Multiannual Financial Framework. Thus reflection about the nature of EMU has become a major component in defining and re-defining national interest. It has become formative

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for national politics in several EU member-states, Germany and France included.4 Hungarian leadership has used this window of opportunity to construct something brand new in terms of a political regime, a strongly majoritarian system replacing one previously dominated by a variety of partycoalitions. Economic arguments thus have turned completely instrumental in bringing about this novel reality. Only time will tell how far the country may go, and if and when the economic and social consequences are to become superior to more traditional options. Brexit has proven to be a single event. Contrary to widespread speculation, primarily, though by no means exclusively, in the media, it has not been followed by Frexit, Grexit, or Huxit. Commitment to and interest in the continuation and deepening of European integration prevailed over Euro-skepticism and populist criticism. Thus what we observe in Hungary is likely to be a case to be generalized: more rather than less skepticism, but all that within the fences. No question: Hungary’s conflicts and relapses are part and parcel of global processes that have unmasked the clear limits of EU’s normative power that are much more definitive than many of us tended to think about, bot to the South and to the East (Önis and Kutlay 2017). While EU organs, especially the Commission and the Parliament tended to stretch their mandates to the limits to reverse or at least slow down the above sketched change, outcomes were meagre if any. The government has observed some basics of macro-economics and was stepping back from some extreme measures. But on balance, the limits to a largely intergovernmentalist EU have become palpable. A lesson pointing well beyond the single case we presented here.

References Andreff, W. (2007). Économie de la transition. Rosny-sous-Bois: Éditions Bréal. Balàzs, P. (2001). The EU’s Enlargement and Mediterranean Strategies: A Comparative Analysis. London: Palgrave.

4 The unprecedented electoral support of anti-EU/EMU parties, like Alternative für Deutschland in Germany and Rassamblement Nationale in France are cases in point. It is a different story, if and to what degree electoral systems give way to representing those ideas, but in both countries 13% of voters supported them last time.

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Barenjee, A., & Duflo, E. (2011). Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty. London: Penguin Books. Bellamy, R., & Castiglione, D. (Eds.). (2019). From Maastricht to Brexit. London: ECP Press. Bozoki, A., & Hegedüs, D. (2018). An Externally Constrained Hybrid Régime: Hungary in the European Union. Democratization, 25(7), 173–189. Brezinski, H., & Fritsch, M. (1995). Transformation: The Shocking German Way. Most, 5(4), 1–25. Csaba, L. (1990). Eastern Europe in the World Economy. Cambridge, NY: Cambridge University Press. Csaba, L. (2013). Growth, Crisis Management and the EU: The Hungarian Trilemma. Südosteuropa Mitteilungen, 53(3–4), 153–168. Csaba, L. (2016). Fiscal and Banking Union: A Solution or a Trap? In A. B. Atkinson. et al. (Ed.), Nationalstaat und Europaeische Union: eine Bestandaufnahme (pp. 109–122). Baden-Baden: Nomos Verlag. Grabel, I. (2017). When Things Don’t Fall Apart. Cambridge, MA and New York, NY: The MIT Press. Györffy, D. (2018). Trust and Crisis Management in the European Union. London: Palgrave. György, L. (2019). Creating Balance—the Mission of Economic Policy. Budapest: Századvég Publishing House. Halecki, O. (1952) [2000]. Borderlands of Western Civilization: A History of East-Central Europe (2nd ed.). Safety Harbor, FL: Simon Publications. Illés, G., Körösényi, A., & Metz, R. (2019). Broadening the Limits of Reconstructive Leadership: Constructivist Elements in Viktor Orbán’s RegimeBuilding Politics. British Journal of Politics and International Relations, 20(4), 790–808. Körösényi, A. (2019). The Theory and Practice of Plebiscitary Leadership: Weber and the Orbán Régime. East European Politics and Societies, 33(2), 280–301. Nagy, M., & Viràg, B. (2017, October, 26). Felzárkózás az eurozónában— csakis megfelel˝ o felkészültséggel teljesíthet˝ o[Catching up in the EMU: Only if properly prepared]. Portfolio.hu. Retrieved June 14, 2019. Önis, Z., & Kultay, M. (2017). Global Shifts and the Limits of EU’s Transformative Power in the Periphery: Perspectives from Hungary and Turkey. Government and Opposition, 53(3), 1–28. Palànkai, T. (2004). Economics of Enlarging European Union. Budapest: Akadémiai Kiadó. Papi, L., Starvrev, E., & Tulin, V. (2018). Central, Eastern and Southeast European Countries’ Convergence: A Look at the Past and Considerations for the Future. Comparative Economic Studies, 60(2), 271–290. Ràcz, A. 2019. Füstbe ment terv: a magyar keleti nyitás külpolitikája[A Collapsing Plan: Hungary’s Opening to the East]. In J. Gyurgyàk (Ed.),

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Magyarország az Európai Unióban[Hungary in the EU] (pp. 69–78). Budapest: Osiris Kiadó. Reinhart, C., Rogoff, K., & Sevastiano, M. (2003). Debt Intolerance. Brookings Papers on Economic Activity, 34(1), 1–62. Slacik, T. (2019.) Mind the Gap: How Does the Flow of EU Funds Match Investment Gaps in CESEE? In E. Nowotny et al. (Eds.), How to Finance Cohesion in Europe? (pp. 135–160). Cheltenham: Edward Elgar. Soos, K. A. (2019). Önellen˝ orzés[Self-Check]. Külgazdaság, 63(9–10), 116– 123. Solyom, L. (2015). The Rise and Decline of Constitutional Culture in Hungary. In A. von Bogdàndy & P. Sonnenveld (Eds.), Constitutional Crisis in the European Constitutional Area: Theory, Law and Politics in Hungary and Romania (pp. 5–31). Oxford, UK: Hart Publishing. Stone, D. (Ed.). (2015). The Oxford Handbook of Postwar European History. Oxford and New York, NY: Oxford University Press. Szücs, J. (1983). The Three Historical Regions of Europe—An Outline. Acta Historica, 29(1–2), 131–184. van Brabant, J. M. (1998). The Political Economy of Transition: Coming to Grips with History and Methodology. London and New York, NY: Routledge. Viràg, B. (Ed) 2020. Fenntartható felzárkózás euróval [A Sustainable Catch-Up Strategy-With Euro]. Budapest: National Bank of Hungary Weinhart, A. (2018, October, 14). Ránk ömlött a sok EU pénz, de hova szivárgott el? [Lots of EU money flew on us, but where has it been leaking?] Portfolio.hu. Retrieved November 20, 2019.

Eurozone Membership and Foreign Direct Investment Randolph Luca Bruno and Saul Estrin

1

Introduction

Policy expectations about the effects of greater economic integration have been interested in both trade (Anderson and van Wincoop 2003) and foreign direct investment (FDI henceforth) (Blomstrom and Kokko 2003; Bevan and Estrin 2004; Bruno et al. 2020). However, while the

This paper builds from a project with Nauro Campos about the effects of Brexit on foreign direct investment (see Bruno et al. 2017). We gratefully acknowledge previous collaboration with Nauro Campos and excellent research assistance from R¯uta Kazlauskaite. ˙ R. L. Bruno (B) University College London, School of Slavonic and East European Studies, London, UK e-mail: [email protected] IZA, Institute of Labor, Bonn, Germany Rodolfo DeBenedetti Foundation, Milan, Italy S. Estrin Department of Management, London School of Economics, London, UK e-mail: [email protected] © The Author(s) 2021 W. Andreff (ed.), Comparative Economic Studies in Europe, Studies in Economic Transition, https://doi.org/10.1007/978-3-030-48295-4_11

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determinants and effects of FDI are well established in the economics literature (Helpman et al. 2004), there is less formal analysis of how FDI inflows have been affected by international integration experience, including the creation of the Economic and Monetary Union (EMU). The question of whether the EMU is improving trade (De Sousa and Lochard 2011; De Sousa 2012) and investment between member countries has reinvigorated the debate over the impact of exchange rate volatility (Flam and Nordström 2006; Belke and Spies 2008). The potential benefits from the EMU are especially important for the new EU member states and for the old members who have not yet adopted the euro (Faruqee 2004; Berger and Nitsch 2008). Researchers commonly argue that elimination of exchange rate risk stimulates trade and investment (Micco et al. 2003; Baldwin et al. 2005; Tenreyro 2007). This effect is argued to be particularly important for countries with underdeveloped forward foreign exchange markets and with no markets for hedging (Klein and Shambaugh 2006; Cieslik et al. 2012). Moreover, the reduction of transaction costs that are related to the exchange rate risk is perceived to be an important factor for countries that mostly trade with one country or group of countries that have a single currency (Cieslik et al. 2012). However, the effects of a common currency go beyond the elimination of exchange rate risk; it is a credible commitment to a stable exchange rate and has the benefit of eliminating transaction costs as well as enhancing competition, which may lead to greater investment as well as trade flows. Our aim in this chapter is to use contemporary methods to estimate the effects of EMU membership on FDI. In line with developments in the literature (e.g. Baier and Bergstrand 2004, 2007; Egger and Pfaffermayr 2004; Baier et al. 2014), we place emphasis on the use of contemporary estimation methods. Our analysis draws on the gravity equation, which has been successfully applied to explain most forms of bilateral cross-border flows, including trade, migration, and foreign direct investment in terms of the relative size and distance between countries (Head and Mayer 2014). The gravity model therefore highlights the potential for trade or FDI between relatively large economies; a country’s economic size is expected to have a positive effect on bilateral flows while distance is expected to have a (nonlinear) negative effect. Distance may be measured geographically but can also reflect transactional and frictional costs associated with differences in regulations, tariff and non-tariff barriers. The last two decades have witnessed enormous research progress in the empirical application of

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gravity models including Anderson and van Wincoop (2003), Santos Silva and Tenreyro (2006), and Bergstrand and Egger (2007). The resulting new structural gravity approach (Blonigen and Piger 2014) provides the necessary theoretical underpinnings as well as strong empirical support for the econometric estimation of the gravity model which we employ. We use this framework to derive results about the effects of EMU membership using data for 34 OECD countries between 1985 and 2013 for bilateral FDI flows, bilateral distance, GDP and GDP per capita (for sender and target countries). Our data represent more than 70% of global FDI flows and, because the countries are all OECD members, they are collected in a homogenous manner and are of uniform and high quality. We use a variety of econometric techniques and sensitivity analyses to ensure the robustness of our findings, including stock as well as flow measures of FDI, and addressing selection issues. Our estimates of the impact of EMU underline the role of FDI as a channel for benefits from deep economic integration between countries. The effect of EMU membership on FDI is estimated to be around 133% above the EU premium. The remainder of this chapter is organized as follows. Section 2 provides a survey of the relevant literature about gravity effects, monetary union and FDI. Section 3 describes the empirical methodology and the dataset. Section 4 reports our main results, while Sect. 5 concludes.

2 2.1

Literature Review Theoretical Literature

The gravity equation (Anderson 1979) has been widely used in analysing the determinants of international trade and to a lesser extent, investment flows (Baldwin and Taglioni 2007; Cieslik 2009). Early work assumed that the volume of trade between two countries is proportional to their economic size and inversely proportional to the distance between them (Rose 2000) but in later studies, the gravity equation was specified in a more general form (Cieslik 2009). The gravity equation has been very successful in explaining international trade and investment flows; it provides ‘some of the clearest and most robust empirical findings in economics’ (Leamer and Levinsonhn 1995, p. 1384). The gravity model has for many years had strong theoretical underpinnings and convincing empirical tests (Rose 2000). When considering

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the theoretical basis of the gravity model in trade, note that the gravity equation can only be derived from a formal model when the homogeneity assumption for the production function, which is typical to the early neoclassical trade literature, was relaxed (Cieslik 2009). Clear microfoundations for the gravity equation were provided by Anderson (1979), who exploited the Armington (1969) assumption1 to derive the gravity equation using the properties of Cobb–Douglas expenditure function (Baldwin and Taglioni 2007; Cieslik 2009). More generally, in the late 1970s and early 1980s the emergence of the new trade theory has led to a variety of theoretical foundations for a trade gravity equation (Baldwin and Taglioni 2007).2 Baldwin (2006) and Baldwin and Taglioni (2007) analysed the gravity model from the expenditure equation lens. Their work provides important insights for the application of the model in the empirical analysis. They derived the basic gravity equation from the expenditure equation as follows: 1−elastisit y

Bilateral trade = G (Y1 Y2 /(dist12 )elasticit y−1 ); G ≡ 1/(Ωo Pd

) (1)

where the Y s (s = 1, 2) are the origin and destination nations’ GDP. It is assumed that bilateral trade costs depend only on distance and most importantly G is a variable that includes all the bilateral trade costs between the two nations (o—origin and d—destination), so it will vary for each pair of trading partners. Exchange rate volatility generates exchange rate risk and has implications for trade and investment flows (Ozturk 2006). In the early theoretical partial equilibrium literature, models were constructed to support the belief that greater exchange rate variability leads to a decrease in the amount of foreign trade (Sercu and Uppal 2000; Ozturk 2006). 1 This postulates that internationally traded products are differentiated by the country of origin. 2 For example, Helpman (1987) and Helpman and Krugman (1985) argued that the gravity model could be derived from trade models with increasing returns to scale and product differentiation. Within this framework, the number of varieties produced in each country grows with its size and so the number of goods imported from each country is proportional to its GDP. Furthermore, standard in these models is the assumption that trade and investment barriers (as transportation and other transaction costs) increase the relative price of imported goods, and thus reduce trade (Micco et al. 2003).

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These papers (e.g. Clark 1973; Baron 1976; Hooper and Kohlhagen 1978; Broll 1994) argued that greater exchange rate risk decreases the risk-adjusted expected revenue from exports and thus lowers the incentive to trade (Sercu and Uppal 2000; Ozturk 2006). However, this conclusion rests on a few simplified assumptions. The majority of papers belonging to this literature assume that exchange rate uncertainty is the only source of risk in the decision-maker’s portfolio and either does not take into account the option to hedge (forward contracts, or nonlinear hedges as options and portfolios of options) or takes the prices of the hedge instruments as given (Sercu and Uppal 2000).3 Furthermore, these models also ignore the possibility for firms to alter their production in response to the exchange rate. One reason why international trade might be negatively affected by exchange rate variability arises from the fact that firms cannot adjust factor inputs in the short run. When this assumption is relaxed, greater volatility can lead to profit opportunities (Canzoneri et al. 1984; De Grauwe 1992). Hence, there is no consensus about the relationship between exchange rate volatility and trade and investment flows. A general equilibrium framework, where other major macroeconomic variables interact with each other, provides a fuller understanding of the exchange rate variability and trade/FDI nexus. For example, Bacchetta and Van Wincoop (2000) develop a two-country, general equilibrium model in which uncertainty arises from fiscal, monetary and technology shocks, and by contrasting trade and welfare for fixed and floating exchange rates, conclude that there is no clear link between foreign trade and different types of exchange rate arrangements. Obstfeld and Rogoff (1998) provide an illustrative example whereby lowering exchange rate volatility to zero by fixing the exchange rate could lead to a welfare gain of up to 1% of GDP in the medium run. One must also consider the role of sunk costs, since foreign trade often comprises differentiatedmanufactured goods that require sunk investment (Clark et al. 2004; Ozturk 2006). This is likely to make companies less responsive to shortrun exchange rate volatility, as they may choose a ‘wait and see’ tactics and remain in the export market until they can recoup their variable costs and the exchange rate turns around. Hence, the hypothesis that exchange rate variability negatively affects trade relies on numerous specific assumptions 3 For developed countries, which have well-functioning forward markets, specific transactions can be easily hedged, but such markets are largely non-existent for the currencies of most developing countries (Clark et al. 2004; Cieslik et al. 2012).

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and is ultimately an empirical question (Sercu and Uppal 2000; Clark et al. 2004; Ozturk 2006). When we turn to a common currency, this might affect foreign trade and FDI through a variety of channels. Firstly, a currency union eliminates bilateral exchange rate variability, and hence for the reasons above may lower the uncertainty and risk involved in trade and FDI (Frankel and Rose 2002; Micco et al. 2003). Moreover, a single currency might lower transaction costs and thus foster foreign trade and openness (Mundell 1961). Frankel and Rose (1998) argue that economies would move closer to matching the Optimal Currency Area criteria when they have a single currency, suggesting several transmission mechanisms in addition to the trade cost reduction including greater price transparency which fosters competition (Flam and Nordström 2006; Belke and Spies 2008). Therefore, joining a Currency Union such as EMU can have effects on trade and FDI in addition to lowering exchange rate variability; it represents a credible commitment to a stable exchange rate, and implicitly lower inflation, enhances competition and reduces transaction costs (“distance”) (see Bevan and Estrin 2004; Bruno et al. 2020). 2.2

Empirical Findings in the Literature

Stable exchange rates are usually regarded as important in encouraging trade. This view was based mostly on the correlation between increasing trade and investment flows and adherence to the Gold Standard (Baldwin 2006). However, economists could not find a robust, evidence-based relationship between exchange rate variability and trade. Some researchers found that the relationship is negative, others claimed that it is positive, but most concluded that there is no statistically significant relationship between the two (Sercu and Uppal 2000; Ozturk 2006; Baldwin 2006). However, Rose (2000) found that a common currency boosts bilateral trade by 200% and exchange rate volatility has a large negative impact on trade and investment flows.4 Glick and Rose (2002) also concluded that a Currency Union has a large effect on trade and investment flows—‘a pair of countries that starts to use a common currency experiences a near doubling in bilateral trade’ (p. 1243). Moreover, Frankel and Rose (2002) 4 Subsequent work, including by Rose himself, found these results were biased (Baldwin 2006). Rose and van Wincoop (2001) addressed the model misspecification and found that common currency increased bilateral trade by 91%.

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extended the analysis by including a variable for currency board arrangements and confirmed that ‘important beneficial effects of Currency Union come through the promotion of trade’ (p. 437). Thus, in the pre-Euro literature, the effect of Currency Union membership on trade was found to be large and significant. There is a substantial empirical literature analysing the trade effects of membership in the Eurozone, which started with the influential paper by Micco et al. (2003). They analysed the early effects of Eurozone membership on trade, using gravity approach and panel data for 22 developed countries from 1992 to 2002, and found a large positive effect on bilateral trade flows of around 25%. Barr et al. (2003) focused on the trade creation between EMU member countries and found the trade effect of the EMU to be positive and significant, around 29%. Faruqee (2004) investigated the effect of EMU on trade within the Eurozone, using a panel data for 22 industrialized countries over the period 1992–2002 and found a positive impact of approximately 10%.5 Flam and Nordström (2006) avoided all the common empirical shortcomings present in some papers of the trade literature and estimated the trade effects of the creation of the EMU using the gravity model. Flam and Nordström (2006) found that the EMU increased trade between Eurozone member states in 1998–2002 compared to 1989–1997 by 15% and trade with outside countries by 8%; they also highlighted that the effect is increasing over time.6 Hence, most of the previous literature on the trade effects of Eurozone membership confirm a positive effect on trade (De Sousa 2012). There is little work yet on the effects of EMU membership on FDI (but see Petroulas 2007; De Sousa and Lochard 2011; Sanso-Navarro 2010); an issue we address in the remainder of the chapter.

3

Methodology and Data

Our modelling strategy follows the structural gravity approach: a similar specification is used for example by Baier and Bergstrand (2007). The empirical gravity equation model for FDI parallels the specification for

5 Other papers, e.g. Bun and Klaasen (2002), De Nardis and Vicarelli (2003), De Sousa (2012), De Sousa and Lochard (2011) and Baldwin et al. (2005), reported similar results. 6 However, Berger and Nitsch (2008) found that the impact of euro on trade disappears if one controls for the positive trend in institutional integration.

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Eq. (1) above in the literature for trade (e.g. Bergstrand and Egger 2007):   E Bilateral f low o f F D Io,d,t |X = ex p(α0 + α1ln X o,t + α2 ln X d,t + It + ηo,d + u o,d,t ) (2) where the dependent variable is the unidirectional FDI flow (or stock) and the X o,t is a vector of characteristics of the origin country, o, in year t. Similarly, X d,t is a vector of destination nations’ characteristics in year t. As for trade equations, these include measures of the size of the economy (GDP) of the countries as well as indicators of time-varying economic distance. We also include a full set of time dummies to control for global macroeconomic shocks, It . However, many of the key host and home economy variables in a gravity equation, including almost all potential indicators of distance (transportation costs, cultural affinity, geography, etc.), common borders, landlocked countries, ocean harbours, lack of mountains, customs, different language/money, regulation and legal origin, are either invariant or do not change greatly over time for each pair (dyad) of countries. For these reasons, we instead include an unordered 7 dyadic fixed effect (ηo,d ) as a dummy variable for each pair of countries. In fact, the use of bilateral fixed effects/dyads helps to minimize the consequences of the exclusion of many of the usual suspects in explaining FDI flows. They control for country pair unobserved time-invariant heterogeneity and hence, implicitly, for factors such as cultural distance, bilateral regulatory agreements, etc. Concerns regarding omitted variable bias is mitigated in this way in these types of models. Year fixed effects, It , are also important in that they reflect the macro phenomena that are common across all country-pairs. The coefficient of interest, on the variable indicating EMU membership, is identified from the impact of changes in the relationships over time on the change in FDI flows over time. Being a member of the EMU will be one of the time-varying observable characteristics of a country that enters the X o,t and X d,t vectors (EMU origin and EMU destination, respectively) of characteristics specific to a country and will include things like time-varying pair proxy for trade/investment costs and time-varying regulatory cultural distance. The u o,d,t is the idiosyncratic error term. The

7 The use of ordered dyadic dummies would account for asymmetric ‘distances’. Following the literature, we use unordered ones.

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standard errors are clustered by dyadic pair to allow for serial correlation of the errors. Summing up, in our FDI equations, we estimate a Poisson model (Santos Silva and Tenreyro 2006) controlling for dyadic fixed effects and time dummies. In the FDI equations, we undertake robustness checks, notably using stock as well as flow measures. Our data are derived from the OECD and cover 34 countries between 1985 and 2013. The dataset includes bilateral FDI flows and stocks and GDP as well as GDP per capita for all sender (origin) and target (destination) countries.

4

Empirical Results

We report results from the Poisson Pseudo-Maximum Likelihood (PPML) model which—as noted—represents the current stage in the evolution of modelling gravity equations (Santos Silva and Tenreyro 2006). We therefore do not need to exclude from the data bilateral flows observations of zero because the PPML estimator can deal well with the resulting highly right-skewed nature of the distribution of flows. We report in Table 1 estimates of the gravity equation (2) with the dependent variable being bilateral FDI flows (column 1) and stocks (column 2). Inflow data is more commonly used as the measure of FDI, but it can be highly volatile from year to year, especially in the bilateral data, which points to the use of stocks. However, there are also issues with stock data, because it may indicate the length as well as the level of the bilateral FDI relationship. Hence, we report both; effects are typically more pronounced on flow than stock data. The independent variables of our gravity equation are GDP of the sender and the recipient economy receiving the foreign direct investment. It is also common in cross country studies to include the sender and recipient GDP per capita to control for levels of development (see Bevan and Estrin 2004; Bruno et al. 2017). We specify the impact of EU membership by a dummy variable, denoted EU and since both sender and recipient economies of FDI may or may not be EU members, we distinguish between them. Furthermore, we distinguish in each case between EU members that are members of the EMU (EU&Euro(destination) and EU&Euro(origin)) and those that are not (EU -NOT Euro(destination) and EU -NOT Euro(origin)). The impact of membership of the EMU for the recipient economy (destination) of FDI—the coefficient of interest in this study—is indicated by the incremental effect of being in the euro

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Table 1

Estimation of the gravity equation

Variables EU&Euro(destination) EU-NOT Euro(destination) EU&Euro(origin) EU-NOT Euro(origin) logGDP(destination) logGDP(origin) logGDPercapita(destination) logGDPercapita(origin)con Constant Observations R2

(1) FDI inflows

(2) FDI in stock

1.355*** (0.248) 0.507*** (0.163) 1.829*** (0.218) 1.056*** (0.196) 5.568*** (1.353) 5.670*** (1.380) – 3.849*** (1.387) – 3.476** (1.482) – 88.36*** (15.73) 30,535 0.450

0.958*** (0.126) 0.508*** (0.104) 1.630*** (0.181) 0.986*** (0.179) 2.599*** (0.804) 2.490*** (0.791) – 1.161 (0.843) 0.918 (0.865) – 69.10*** (10.78) 30,399 0.847

* p-value