Remarks by Dr. Robin Harris, October 16, 2009 in Split
Presentation on Repercussions of the Global Economic Crisis to the 19th Zagreb Stock Exchange Conference in Split, Friday 16th October 2009
It is a great privilege to speak to this distinguished business audience. I love Croatia – Sava, Drava, Danube, all of this beautiful country. But I know Dalmatia best, and I take the liberty of telling a cautionary tale with some lessons for today.
In 1571 the Dubrovnik Government decided that it would sharply raise the customs dues it levied on foreigners. The revenues increased but the protests were loud, particularly from the powerful and mobile Jewish community. Three years later a prominent Jewish merchant, Daniel Rodriguez, proposed that Venice open a free port at Split. The Venetians dithered. But finally, in 1590, they agreed. The tax regime and Split’s natural advantages gave it the edge. Soon the cellars of Diocletian’s Palace were bulging with Balkan merchandise. Good for Split – but a disaster for Dubrovnik – and probably more serious than the Great Earthquake in accounting for its decline.
Four centuries before Art Laffer invented the Laffer Curve, or Margaret Thatcher entered Downing Street, the truth was established: high taxes impoverish those who levy them. If you wish Croatia to be poor – levy high taxes.
The current crisis is not a crisis of capitalism. It is a crisis that has occurred in capitalist economies. But that is not the same thing. Capitalism by its nature, indeed by the human nature that explains its success, experiences boom and bust. No one will ever abolish the business cycle. At the micro-level the process of “creative destruction”, as Joseph Schumpeter termed it, is, indeed, the condition for new steps of economic advance.
Capitalism does not, contrary to Marxist analysis, experience “structural” crises. There is, as usual, an apposite Russian joke. The question is: name the four structural crises of Soviet agriculture. The answer is: spring, summer, autumn and winter.
Free enterprise capitalism is not like that. It is the highest social achievement in human history, for the simple reason that it delivers continuing economic progress without coercion.
There would have been a recession, probably a deep one. But it was overtaken by a banking crisis which hugely magnified its effects. The underlying causes of that crisis were excess money and credit, principally but not only in America, and – also in America – irresponsible lending for house purchase. These policies were pursued by central bankers and government agencies under political pressure and for political purposes. The globalised banking sector then added its own fatal complication, through the devising and trading of largely incomprehensible collateralized debt obligations (CDOs). The subsequent stages of the crisis are well known.
The point I am making here is that although the operation of markets – and the misjudgement of bankers and investors – magnified and transmitted the crisis, it was government failure, not market failure, that was at the heart of it. Consequently, while there are important lessons to be learned about the way in which banks are regulated and, just possibly, bankers remunerated, it would be foolish to assume that politicians and officials are likely to come up with all the right answers at once, if at all. Any measures should be taken case by case. The assumption that one international size fits all countries should be resisted. We should try to mitigate the effects of bank failure. But we should not fall into the trap of accepting that some banks are just too big to fail. That would guarantee those institutions pursuing imprudent policies. And, finally, no one should assume that the fertile brains of financiers will be slow to find ways round new rules – as they have previous ones.
There is one further point I want to make about the crisis itself. It may be obvious to members of the Zagreb stock exchange but not to all decision makers. A sound financial system is a necessary condition for a successful economy. But it is not a sufficient condition.
What drives an economy forward is human energy. Such energy has to be harnessed, but not suppressed or distorted. It demands confidence – confidence in the worth of a currency, in the solvency of financial institutions, in the availability of credit on reasonable terms, above all in the security of property rights. But this confidence must be a springboard not a hammock. If government steps in and makes decisions which properly pertain to individuals the result is inefficiency and less wealth creation – as well, of course, as less freedom.
Capitalism falters, but it does not fail; it also recovers. It would have done so without the fiscal and monetary measures that governments have taken. Would it have done so more slowly? Probably. Would it have emerged from the process healthier? Probably that too. The creative destruction’s creativity could have gone further.
We can say for sure that it will be a long time before external finance is available so easily and cheaply to fund consumption and investment. We can also say that governments and individuals will have to look much more closely at what they spend. These circumstances should induce a new atmosphere of realism – including realism in Croatia, which indeed shows early signs of breaking through.
Recently I was editing a new version of Margaret Thatcher’s memoirs. In doing so, I re-read the account of the economic problems she faced when she entered Downing Street, three decades ago this year. I was struck by the similarities between Britain’s situation back then and yours in Croatia now.
Croatia has an enormous amount to be proud of. I want to say – because it’s not said enough – how much we should admire the huge progress Croatia has made since the unjust war waged against it.
But, as I say, your difficulties now remind me of ours back then.
Our problems were a swollen, inefficient state sector, powerful unions that wanted to cling on to existing jobs not allow new ones, low productivity, a lack of new small businesses, very high personal taxes that discouraged effort and innovation and encouraged a brain drain, and a large burden of debt – so large, in fact, that two years earlier we had been bailed out by the IMF. Unlike you we also had high inflation.
Mrs Thatcher was told by nearly everyone that Britain was destined to decline – the decline just had to be managed.
She proved that analysis wrong. Britain by the time she left office was one of the most successful economies in Europe. Public spending was under control. The deficit had turned into a surplus. The country had built up overseas assets. Previously state owned loss makers had either been liquidated or slimmed down or were making healthy profits in the private sector. Crucially, productivity growth had been revolutionised. The number of days lost in strikes was lower than for decades. Living standards had risen for all groups – yes, I repeat, all groups.
The policies pursued were often unpopular – though please note that four elections were won on them. But anyway they worked – because they established the basis of successful free enterprise capitalism along classic lines. These lines apply everywhere and always, and to suggest otherwise is to be a flat-earther.
I have also been reading, in some detail, what well placed economic observers say about Croatia. Some of it is good. The Croatian National Bank, for instance, has been a model of intelligence and prudence. But much of the rest is not encouraging. I particularly commend to you the Heritage Foundation’s Index of Economic Freedom and the World Bank’s EU Convergence Report – the former for its analysis and the latter for its proposals.
Croatia is only going to succeed economically if it cuts public expenditure substantially – not just to fund the deficit but because public expenditure at nearly half of GDP is a burden you cannot afford. Croatia needs to stop subsidising out of date industries. It needs to cut its very high personal tax rates, which discourage effort and merely increase the black economy. It needs to make it easier to start a business and to downsize staff. It needs to remove perverse incentives for active people to stay out of the workforce.
One thing more Croatia needs. That is a long term view of how to become a rich country. This isn’t just about balancing the books. It’s about creating the conditions for much higher living standards for this generation of Croatians and much better opportunities for the next. It’s not a mystery. It can be done. And as a friend of Croatia, I think that it is time you got on with it.
Thank you for your attention.