Social coldness versus liberal public spirit?

Speech by Kaspar Villiger International Symposium for Liberalism

13th June 2015, Zurich,

 

I.

In 1992 Francis Fukuyama announced the end of history. He wanted to express that with the breakdown of real socialism in 1989, the principles of liberalism with democracy and market economy are finally established and will lead to permanent peace and prosperity. In the same year, Samuel Huntington held his famous lecture on the "Clash of Civilisations". Huntington, not Fukuyama, turned out to be right. The Arab Spring abruptly ended in chaos and violence. The financial and economic crisis shook many states and is interpreted as a market failure, for which the only remedy seems to be monetary easing and a tsunami of regulation. Authoritarian governments that adopted market economy, celebrate economic success, while proven democracies can't fight their way back from the debt crisis and record-high unemployment.

This environment is hard for liberals. An actual cultural clash broke out in democracies between the representatives of the liberal constitutional state and the representatives of the interventionist redistribution state. In line with the principles of the Noelle-Neumann "Spiral of silence" the defenders of freedom and market economy behave increasingly more subdued while the apologists of state feasibility who distribute fiscal income express themselves in an increasingly bold way. Although the facts clearly speak against them, because, very obviously, one cannot cure a patient by giving him more of the medicine which made him ill to begin with. Therefore it is time that the liberals regain their confidence and raise their voice clearly and unmistakably!

But first things first!

II.

The liberals and the ones that think market-economically are frequently accused that they only advocate for the wealthy and the corporations. That they embody social coldness and accept growing inequality for the sake of profit. Nothing is more wrong! For the real liberals, the goal are mature, self-responsible and free persons, who can develop according to their talents and inclinations. You can only be free, however, with sufficient prosperity. The state must therefore be designed to allow persons a free life in dignity. Market economy is not an end in itself. It is very simply by far the most efficient method in order to reach these objectives. And because people can only reach these objectives when they collaborate, social aspects are of greatest importance to the  liberals.

Because all that happens in politics and economics is the consequence of human action, we must first understand what influences those actions. How can it be achieved that the action of individuals overall lead to the results which facilitate a life in dignity and prosperity?

First of all, there are the individual persons themselves. We know from experience that every person is different. Character, talent and intelligence are unequally distributed. Furthermore persons often act completely irrationally. They are afflicted from cognitive distortions. The experience also shows again and again that outstanding personalities strongly influence matters for better or for worse.

However, the same persons act differently depending on the prevailing circumstances. They react – and this is also proven in modern behavioral economics – to incentives. Incentives basically stem from two sources: From the institutions and culture in the broadest sense.

Institutions so-to-speak are the hardware within which human activity can develop. Within the state these are the constitution, laws, regulations etc.; in the economy and in companies it's the legal framework, but also the articles of incorporation, the rules or the governance etc.. Star economist Daron Acemoglu of the MIT examined in his famous book "Why Nations fail" why countries develop so differently economically. He concluded, that the design of the institutions is the decisive factor. They provide the incentives that make people perform, which allows for a flourishing economy to develop, or otherwise makes them refrain from just that.

Unfortunately people often do not provide politicians the favor to behave like policy-makers imagine them to when they design legislation. Therefore, laws often have different outcomes than intended. I mention only a few examples:

The Swiss Law on Occupational Retirement demands a politically determined minimum interest rate and a politically defined conversion rate to translate the total savings capital into an annual pension in order to ensure pensions are as high as possible. Unfortunately, neither the markets nor the demographic developments do politicians the favor to play along. This drives many pension funds into existential difficulties. When Switzerland charged gold trading with a turnover tax some years ago, it disappeared irrevocably to London. Too much labor market regulation in terms of job protection and minimum wages above market wages increases unemployment and eventually damages those which are meant to be protected. More often than not, market forces prove to be stronger than defectively designed laws and continue to play via detours, and rarely like intended. As long as for example taxes are so high that citizens can't see a fair cost-benefit ratio, illegal work and tax evasion will never be eradicated.

Unlike Acemoglu, I think culture is just as important. Culture is so-to-speak the "software" of human society. It consists of unwritten, but lived norms and behavioural patterns. Institutions and democracies generally only function sufficiently, if they are supported by a values-based culture. Therefore the question of values is of vital importance also for the liberals. Otfried Höffe subsumed this into a useful formula: "Where civic virtues flourish, government authority can restrain itself".

III.

Prosperity is generated by the individuals in the economy and only by them. I now want to elaborate on the question, which incentives government institutions must provide to make individuals want to be productive and how to empower them. If I combine recent economic findings with my own political, corporate and entrepreneurial experience, I come up with five simplified conditions:

Firstly: Only a market-driven economy produces broad-based prosperity. Only markets, not central planning, can bring supply and demand into balance and provide for the right number of goods at any given time in the right quality, of the right price, in the right place. That is made possible because markets aggregate millions of individual decisions. I can't imagine any economic system to be more democratic. In competitive markets, success is rewarded and failure punished. That incentivizes innovation and constantly high performance. However, markets can only fulfill their allocation function sufficiently, if the government grants them enough room to maneuver. Too many or wrongly designed government interventions could potentially choke off market economy.

Ever since the financial crisis we constantly hear that market economy has failed and that the world becomes increasingly unequal and poorer. Hence, the markets are supposedly in need for corrective measures by means of legislation. Of course, there are the real tragedies in the euro states because of political mismanagement, of course, there is a lot of poverty everywhere in this world, of course, there are countries with enormous, unsustainable social inequality. But at a closer look, enormous progress can be detected. Despite the world population having doubled in the second half of the twentieth century, the supply of calories per person increased by about 25 percent. Average life expectancy rose significantly everywhere, while at the same time, child mortality dropped. The share of the extremely poor in developing countries has more than halved despite the exploding population. Hundreds of millions were able to escape poverty and hunger. This was achieved by globalization and market economy, not by redistribution from north to south.

It is recently discussed whether the distributive effect of markets is ethically justifiable or needs political correction. Critics complain using glaring examples that market-based action incentivizes the violation of moral standards. However, they mostly can't answer the question which mechanisms for allocation would lead to morally better results. Would the allocation of jobs via networks for instance ("nepotism!") be fairer than via markets? I cannot go into these questions here. One may however agree with the economist Samuel Bowles, who finds that in countries with free societies, rule of law, social security and relatively equal distribution of prosperity, markets don't lead to a weakening of civic virtues. Because values in society are also important for liberals, this discovery is important.

Secondly the people must be allowed to keep the fruits of their own labor. This is very important! Only then will they work hard, save, invest, innovate, develop ideas and further educate themselves. This condition contains elements such as guarantee of ownership, loans secured by ownership of land, moderate taxes, stable value of money, patent rights and so forth.

Thirdly only constant reformation can secure prosperity in the long run. Therefore, what's obsolete must disappear so that the new can thrive. Any constraints to that end need to be lifted: Excessive job protection, obstacles to closing down companies, ostracism of new technologies, unnecessary preservation of structures. The people, however, will only accept this if a social safety net absorbs the worst consequences of structural change.

Thus I get to the forth condition: Behavioural economics supports that a society needs a certain balance of prosperity to be stable and for the political situation to be perceived as fair. The emotional discussion about manager salaries is an expression of that. Market economy, however, creates inequalities. The state must smooth these out moderately, otherwise the market economy loses its acceptance with the people, which would politically endanger the economy's necessary freedom. Therefore there needs to be a reasonable social balance. Nobody should have to suffer, and lose their dignity, without their own fault. Studies also point out that socially secure people are more willing to take risks, which is important for growth. Furthermore, structural adjustments can be implemented more easily if there is a social security net. However, social aid must be financed somehow. That is impossible without reasonable redistribution. Progressive income taxes and social aid structures based on solidarity are suitable instruments to balance prosperity. The liberals must (and do) accept these relationships. Liberalism is therefore all but antisocial.

The state, however, gets into a conflict of interest here: If it redistributes too much, the willingness to perform both of the contributors and the beneficiaries can be harmed, if it redistributes too little, the people perceive the system as unfair. Politically, this causes interventionism. The balance between these conflicting goals is a tightrope walk.

But redistribution is only possible if there is something that can be distributed. Therefore it is important to first maximize the overall income by means of market economy with as little harmful intervention as possible. Only in a second step the inequalities of the market can be smoothed out by moderate redistribution. That is the recipe for success of the so-called Scandinavian Flexicurity concept.

Fifthly: Modern sophisticated economies need a talent pool that draws on the entire population and not just an oligarchical or affluent minority. This is a question of education, advanced education, vocational training, equal opportunity (also for women or the poor) as well as free admission to labor markets and professional fields. It is also a question, however, of the necessary incentives to make the people willing to benefit from education. Additionally, Switzerland needs a foreign talent pool, because our economy is too big in relation to the size of the population to provide the sufficient amount of talent. That shows, which enormous risks Switzerland takes if it ceases to attract the best. This is one of the big issues of the mass immigration initiative which was accepted by the Swiss people by a very tight, accidental majority.

IV.

In theory, democracy is best to suitably fulfill my five prosperity conditions. We find, however, that authoritarian systems based on market economy suddenly become economically successful while established democracies are getting into trouble. That comes from false incentives that are inherent in democracies. I want to shortly outline four of them:

The first problem is the growth of the public sector. According to the so-called Wagner's law, the demand for public goods and services rises with prosperity and technological progress. Therefore, prosperity and state spending correlate positively in the first phases of development. It is, however, evident that with state spending at 100 percent, nobody generates prosperity and pays taxes anymore. Therefore the system collapses. Hence, there is a tipping point where prosperity and state spending start to correlate negatively. From this point on one must speak of a "crowding out" of the private sector that has to generate the taxes to finance the state. This point is reached in Europe. With the state intervening in more and more areas of life, citizens become accustomed to being taken care of. Their sense of personal responsibility disappears. The more the public sector grows, the more citizens become dependent on the state and the more state benefits go to people with direct interests. That increases the power of special interests. In this way democracy increasingly falls into the hands of organized special interest groups. They form a powerful lobby to protect vested rights and fight tooth and nails to combat reforms.

The structural incentives of the democracy to spend and make debt are a second problem. Politicians want to be re-elected. Therefore many of them think in legislative periods instead of generations. They try to give those who vote for them benefits at the expense of the general public. Because it is more popular to promise benefits than increases in taxation, there is an incentive to finance with debt. While in the private sector, debtors are liable and enterprises will be liquidated if they are overleveraged, politicians get to accumulate debts risk-free. It is the taxpayer of tomorrow who is asked to pay, when politicians currently in office have long since been replaced. Empirical studies of the IMF or from Rogoff and Reinhart show that from a debt quota of about 90 percent of GDP, growth is significantly compromised.

A third problem is what Nobel prize laureate Kahnemann calls the availability cascade. This is a public emotional process that begins with a media report about an insignificant, single event that has the potential to be scandalized. Other media join in, opinion leaders in politics and media constantly feed the escalation with small, but dramatized single events until the public develops a perception of a serious evil from which a political regulation machinery must be started. A dog bite produces the call for a national dog regulation, and twenty salaries perceived as immoderate among four million regular salaries cause substantial over-regulation in corporate law. This process resets the political priorities, and indeed not according to true necessities, but based on an artificially produced level of public indignation.

Wrong federal incentive structures are a fourth problem. The design of these structures has great effects on the behavior of states, member states and communities. Decentralized systems, in which the responsibility for a task is attributed to the lowest possible level according to the principle of subsidiarity, and in which – according to the fiscal equivalence principle – decisions on, funding, and usage of public service come from one source, are more efficient and more crisis-resilient than centralist systems. Indeed, public bodies will only act in a truly self-responsible way if they can also go bankrupt.

From what I said one realizes why false incentives hurt my five conditions for prosperity in many European countries. The growth of the public sector beyond an optimal size and the exploding and in part inefficiently designed regulation tie up the market economy. Increasingly, the fruits of hard work are stolen from the people by means of high taxes and eroding ownership rights which demotivates them. Rigid labor markets, over-regulation, bureaucracy and the braking force of organized interests inhibit reforms. The resulting weak growth and high unemployment intensify the problem of unequal distribution of income. The big unresolved problems of the EU thus have fundamental structural causes and are only to a small part caused by the current financial crisis and the flawed construction of the Euro.

V.

To remain in poverty is not a destiny that cannot be changed. The claim for courageous, quick and drastic market economic reforms is not a product of coldhearted liberal technocrats, but an empirically justifiable imperative. France with its apparently ineradicable belief in state feasibility and its reform resistance is today an alarming case in Europe. Italy with its labor unions blocking every reform has destroyed a quarter of the industrial production since 2008 and increased youth unemployment from 21 to 43 percent. While in Greece nothing has been moving for years, Turkey, which was just as poor 12 years ago, produced an industrial miracle thanks to rigorous spending cuts, forced privatizations, consistent restructuring of the banking industry, central bank independence from politics and the implementation of 19 structural reform laws. A strong fiscal agent program, vigorous reforms and flexible salary and price adaptations in Estonia in 2009 led to a dramatic slump of GDP of about 15 percent, but 18 months later the economy of the country recovered significantly. The industry grew around three quarters since then, and youth unemployment fell from 27 to 15 percent. Similarly Poland after the cold war, Sweden some years ago and Ireland just recently have proven what initially painful reforms can achieve. Germany as well, thanks to the not even very courageous Schröder reforms, rose from being a problematic case in Europe to become a role model in just 10 years. That the grand coalition, apparently blinded from success, inserts the reverse gear in terms of political reform and risks this long-term achievement, is one of the hardly understandable irrationalities of politics. The European Central Bank wants to provide the heavily indebted countries of the Eurozone with time by means of their negligently low interest rates, to solve their structural problems without too much pain. But it is the tragedy of Europe that it is exactly this which eases reform pressure, with unpredictable consequences.

That successful liberal economic policy leads to unfair results and rapidly opens the income scissor is one of those legends that many media and left wingers repeat until they seep into the public opinion as certainties. Irrespective of the chosen statistical method, inequality in Germany and Switzerland have stayed relatively stable. The share of the middle class in proportion to the total population and the share of their total income was quite constant for many years, even though political forces keep on claiming the opposite. The difference between the incomes of the richest 20 percent of the population and the poorest 20 percent is especially great in countries, where rigid labor markets create real-economic destruction. In Switzerland and in Germany this relation is about 4.5, in Spain, Greece, Portugal and Italy between 5.6 and 6.8. It is evident that strong over-regulated labor markets not only cause higher unemployment, but also increase the slope between poor and rich. From these numbers one can conclude that the poor did not become poorer in the economically successful countries, that low unemployment and high employment produce the most harmonious income distribution and that an intact, a flexible labor market is the most effective protection from social descent and the best way to strengthen the middle class. There is however big uncertainty amongst experts, whether the fast technological development accelerates the distribution problem or whether the opposite is true. This important question must keep us liberals occupied.

VI.

And Switzerland?

Up to now our political culture with a balanced mixture of desire for freedom, personal responsibility and national solidarity, with direct democracy and healthy competition between cantons and communities with high autonomy, fulfilled my conditions for prosperity quite well. Switzerland highly corresponds to the economically successful model of a liberally designed constitutional state. The counter example would be an egalitarian welfare state with centralistic steering, high redistribution, high costs and high density of regulation, an idea which seems to become more popular even with us. This counter example only inadequately fulfills the prosperity conditions. Therefore a cultural clash happens in Switzerland between the two state models, and the second model gained ground. Direct democracy (which I defend without any constraints), long guarantor of the reliability and rationality of our general economic conditions, seems to become a risk factor, despite the occasionally encouraging decisions by the people. Regulation density increases almost daily and complicates making business increasingly. One gets the impression that many politicians and representatives of the administration would like to dictate mandatory recipes how companies are to be managed. That would certainly go wrong.

The decreasing predictability and quality of Switzerland as a business location increasingly alienates investors. The uncertainty concerning the bilateral treaties as a consequence of the acceptance of the mass immigration initiative is the most current example.

Our debt ceiling indeed eased the problem of spending incentives inherent to democracies, however the impotence to sustainably secure our social security systems shows that the inclination to make debt is not conquered yet.

The economy itself is not innocent at the distrust towards market economy. That trust was harmed by slips and excessiveness of a few business leaders. Therefore the arguments of the business side were increasingly met by a lack of understanding in the general public. Because there are also external challenges massively complicating our economic situation, it is all the more important that we intensely work on the factors that we can influence to improve the quality of our business location.

VII.

At the beginning I referred to the creation of sufficient prosperity and social security as a necessary condition for a life in dignity and freedom. Even interventionists and socialists would probably agree with that. However, the facts show that those who ascribe all evil to capitalism and put through an immense number of state interventions, protective measures and confiscatory redistribution in the name of morality and justice, won't reach these objectives. I don't want to doubt their good intentions. But if the well-meant causes bad things, it won't be morally superior. Whoever misuses the social security system in the name of fraternity at the expense of future generations, who strangles growth in the name of justice through overregulation and poisoning national finances and who creates unemployment and equally distributed poverty on behalf of equality through exorbitant redistribution, does not have any right to morally discredit those who support general economic conditions that favor the creation of broad-based prosperity.

What is to be done now?

I would like to give just some concluding keywords. I would like to mention six points.

Firstly, even the liberals occasionally seem to doubt the markets. Even they often garnish their statements for the benefit of the markets cautiously and with various kinds of excuses and doubts as a consequence of the spirit of our time. They must learn to show their true colors again clearly and explicitly and to defend the market economy unconditionally.

Secondly: The growth of the public sector must be stopped. It is the only way to stop the erosion of the market economy and the further incapacitation of the citizens. However, I would not have dedicated the most important years of my professional life to the state if I was not convinced of the necessity of a strong, healthy, stable and credible state for a flourishing economy. Market economy cannot be imagined without the  regulative function of the state or without the necessary public services and government spending. But the state spending in most European countries, even maybe in Switzerland, has exceeded the mentioned tipping point from which the effects of growing state activity begin to strangle economic growth. We need to reflect with which instruments and in which areas the growth of the public sector can be slowed down.

Thirdly it is a question not only of the big regulatory interventions, but also of small scale regulations. The sum of many individual, possibly justifiable, measures change the quality of the whole system. I would also say that overregulation weakens responsibility and the morally correct behavior because the players in the economy are convinced to have fulfilled their duty by checking off the various points on their regulation checklists.

Fourthly: The commitment for open markets is paramount! In Switzerland, much is already happening. The retention of the first bilateral treaties with the EU has absolute priority. A free trade agreement with the USA should be striven for again. Different regional free trade agreements are indeed less favorable than multilateral ones, but better than nothing.

Fifthly, the players in the economy must make their contribution: They must again and again prove through correct and flawless moral behavior, that the freedom they are given in a market economy is used with responsibility.

Because not only does the state have to respect the necessary freedom of the market economy, but businesses also need to respect the regulatory function of the democratic state. Actors in the economy must support the credibility of the state institutions and enable employees to participate in the democratic process. And the bosses themselves must again expose themselves and maintain a dialogue with the citizens. They should participate as far as possible in the democratic process themselves. The call for a culture of public spirit is valid for them as well.

Sixth: The social security system must finally be consolidated given the demographic and economic changes. That is one of the very most important tasks. The proposals currently discussed in Switzerland do not suffice in order to solve the issue sustainably.

Our ratings with respect to our business location are still excellent. Because an economy sluggishly reacts to changes of general conditions, however, one often feels deteriorations when it is already too late. That is a type of Titanic effect: Once the iceberg can be seen, it's too late, the steamer cannot be stopped in time. Therefore people must act early. Maybe the shock of the appreciation of the Swiss franc activates the awareness for that. First encouraging signals into the right direction are perceptible in politics.

If we analyze the global economic development, we find that the tectonic plates of the world economy move. Asia is disciplined, prosperity-hungry and performance-oriented. Most Asian countries except for Japan after the Asian crisis conducted a more stability-oriented fiscal policy than many classic industrialized countries did. They will generate considerable growth on a long-term basis. America is younger than Europe, risk-friendlier, more market oriented, and now the dear God gave the Americans low-priced energy on a massive scale. All signs indicate that they will recover soon.

Europe on the other hand, in its saturation of freedom, its equality delusion, its inflexible social costs and its market skepticism, makes the impression of a maturing and risk-averse continent, that can't come to peace with the new realities. Of course a recovery is not to be excluded as we experienced it in some countries. But they will probably lag behind Asia and America for a long time. That will keep on compromising also Europe's political influence. That is a pity, because Europe could offer a lot if it could become economically fit. To make this possible we need the liberals. Who, if not them could raise their voice if the Treaties of Maastricht or the non-assistance stipulation of Lisbon would be broken? Who, if not them could call 'Halt' if the ECB conducts forbidden state financing? Who, if not them could vouch for tax competition to the protection of the citizens from fiscal exploitation and against tax cartels? Who, if not them would have to insist on the principle of the personal responsibility and counter-act the reregulation and harmonization delusion? That would not be EU hostile politics, even if that's how it is tried to be discredited. That would not be anything other than a contribution to the strengthening of Europe on the basis of historical European strengths such as diversity and competition. In such a Europe there would also be a place for an independent dynamic Switzerland which contributes to the strength of Europe through their own economic strength, through the exchange of goods, services and ideas. It is time to rise to the barricades again for freedom, self-responsibility and market economy even if the spirit of the time is opposed to that. Otherwise we Europeans will not be able to stand against the Asians and Americas in the long-term. That is the reason why we do not need "more of the same", but a liberal counter-revolution!

Top of page