International Economic Conference Progress Foundation 1991

The Challenge of Freedom: Fostering Market Enterprise in the Developing Democracies

Proceedings

Hotel Diplomat Prague, Czechoslovakia September 24, 1991

ECONOMIC EDUCATION BULLETIN Published by AMERICAN INSTITUTE for ECONOMIC RESEARCH GREAT BARRINGTON, MASSACHUSETTS About Progress Foundation Founded in 1968, Progress Foundation is an independent, noncommer- cial organization that supports scientific research concerned with ascer- taining the beneficial and detrimental influences in the progress of civili- zation. The seat of Progress Foundation is: Residence Falcieu, CH-6914 Carona, Switzerland. Communications address: Postfach 562, CH-8027, Zurich, Switzerland. About A.I.E.R. American Institute for Economic Research, founded in 1933, is an independent scientific and educational organization. The Institute's re- search is planned to help individuals protect their personal interests and those of the Nation. The industrious and thrifty, those who pay most of the Nation's taxes, must be the principal guardians of American civilization. By publishing the results of scientific inquiry, carried on with diligence, independence, and integrity, American Institute for Economic Research hopes to help those citizens preserve the best of the Nation's heritage and choose wisely the policies that will determine the Nation's future. The Institute represents no fund, concentration of wealth, or other special interests. Advertising is not accepted in its publications. Financial support for the Institute is provided primarily by the small annual fees from several thousand sustaining members, by receipts from sales of its publications, by tax-deductible contributions, and by the earnings of its wholly owned investment advisory organization, American Investment Services, Inc. Experience suggests that information and advice on eco- nomic subjects are most useful when they come from a source that is independent of special interests, either commercial or political. The provisions of the charter and bylaws ensure that neither the Insti- tute itself nor members of its staff may derive profit from organizations or businesses that happen to benefit from the results of Institute research. Institute financial accounts are available for public inspection during normal working hours of the Institute.

ECONOMIC EDUCATION BULLETIN Vol. XXXH No. 5 May 1992

Economic Education Bulletin (ISSN 0424-2769) (USPS 167-360) is published once a month at Great Barrington, Massachusetts, by American Institute for Economic Research, a scientific and educational organization with no stockholders, chartered under Chapter 180 of the General Laws of Massachusetts. Second class postage paid at Great Barrington, Massachusetts. Printed in the United States of America. Subscription: $25 per year. POSTMASTER: Send address changes to Economic Education Bulletin, American Insti- tute for Economic Research, Great Barrington, Massachusetts 01230. The Challenge of Freedom: Fostering Market Enterprise in the Developing Democracies Contents

Foreword 3

About the Participants 5

Proceedings 7

DEMOCRACY AND MARKET-ORIENTED REFORM — A LOVE-HATE RELATIONSHIP? Some Thoughts About the Interdependence of Systems in the Transition Stage from a Controlled to a Competitive Economy by Dr. Gerhard Schwarz 13

THE TECHNOLOGY OF FREEDOM

by George Gilder 30

Questions and Answers 43

Conclusion 48 Foreword

An advisor to the Politburo of the now defunct Soviet Union is said to have remarked on the eve of its collapse that trying to fashion a capitalist market economy out of the socialist rubble would be akin to trying to "make a stallion out of a gelding." Without question, the obstacles con- fronting a transformation of the command economies of Central and Eastern Europe to market-based enterprise are daunting. At the time of the demise of the communist order, most Eastem-bloc countries lacked even the most elementary features of a market economy — i.e., a legal struc- ture with the authority to enforce property rights, free pricing, open mar- kets, or sound money and credit. These features evolved only over centu- ries in the Western democracies and their development involved numer- ous conflicts, among them the American revolution and Civil War. And nowhere has the process of delivering productive resources into private hands or perfecting institutional safeguards to market-based enterprise yet been completed. Western economists nevertheless have been quick to offer advice to the former Iron Curtain countries on a wide variety of policy matters, from contracts and currencies to pricing and pollution. Not surprisingly, their analyses sometimes have been extraordinarily varied, if not contradictory. The presentations in the pages that follow generally reflect the diversity of views with respect to a number of crucial issues, notably the relation of democracy itself— and human freedom — to the process of establishing market economies in the formerly socialist nations. Provocative in this regard is Dr. Gerhard Schwarz's observation that, insofar as their capacity to effect change is concerned, authoritarian re- gimes possess many advantages over democratic ones. He cites recent experience as evidence that authoritarian regimes have demonstrated marked success in promoting market-based economies, and suggests that some form of "authoritarian democracy" may be necessary to manage a rapid transition from controlled to competitive economies. Far more controversial is his view that "An authoritarian regime es- pousing a market-directed economy ... limits automatically the duration of its power due to its unstable structure." The view that rising incomes tend to diminish and eventually promote the dissolution of authoritarian regimes is well known. As with Lord Acton a century ago, however, one is hard put today to find historical instances where charismatic leaders, such as Dr. Schwarz describes, established governments whose primary goal was to put themselves out of business. Where some analysts have identified obstacles to market-based enter- 3 prise in the emerging democracies, others have identified opportunities. Supply-side scholar George Gilder suggests that, if their leaders permit human freedom full expression, the technology of the microchip may enable countries such as Czechoslovakia to compete quickly and effec- tively in the world marketplace. Unhindered by the inertia either of bu- reaucracy, which threatens to thwart the entrepreneurial spirit elsewhere, or of the antiquated copper-and-wire technologies in which so much capital has been invested in the developed countries, the emerging democ- racies may enjoy a unique opportunity to leap frog their more developed competitors in the age of quantum technologies. Contrary to the view that authoritarian approaches may provide useful direction in this economic transformation, Mr. Gilder maintains that the new technologies will em- power individuals in ways that make hierarchical arrangements of almost any type, including government, obsolete. The remarks of Robert Holman, one of the leading economic advisors to the Czech government, suggest that whatever turn political and other events may take, the most valuable assets available today in Czechoslova- kia and the other developing democracies may be their human ones. Indeed, the Prague economists with whom the conference participants met would seem to have a far more sophisticated understanding of markets than do many Western economists. Equally important, as Mr. Holman's comments also may suggest, they would appear to have the political will to translate that understanding into action. In contrast to our own politicians, who toady to every interest group within reach, at least so far they appear to have the resolve to say: "Your concern is not government's business." Whether these champions of the market will become victims of a disappointed mobocracy, as im- plied by Dr. Schwarz's analysis, or whether they will end up "on top,*' as suggested by George Gilder's remarks, remains to be seen. In the mean- time, established democracies such as our own have the chance to observe an attempt to fashion what appears to be a genuinely liberal market order from which we ourselves might take lessons. About the Participants

George Gilder, Senior Fellow of the Hudson Institute, is the author of the international best-seller Wealth and Poverty, which earned him worldwide recognition as one of the principal architects of the supply-side revolution in economics and provided the inspiration for the economic reforms, most notably the 1981 tax cuts, of the first Reagan Administration. A graduate of Harvard University, where he later taught as a fellow at the Kennedy Institute of Politics, Mr. Gilder was chairman of the Lehrman Institute's Economic Roundtable and Program Director of the Manhattan Institute. Currently he is a corporate Voting Member of the American Institute for Economic Research. He has written broadly on entrepreneurship and the promise of information technology and is a frequent contributor to a wide range of publications, including The Wall Street Journal, The Washington Post, and The National Review. Mr. Gilder is a leading critic of neo-liberal theories of "industrial policy" for high-tech industries. In this regard, two recent works, The Spirit of Enterprise and Microcosm: The Quantum Revolution in Economics and Technology, deal specifically with matters of vital concern to the emerging market economies of Central and Eastern Europe.

Ing. Robert Holman is Advisor to Vaclav Klaus, Minister of Finance of the Czecho-Slovak Federal Republic. He also serves as a Trustee of the Liberal Institute, Prague, where he is head of the Economics Section and Chairman of the F. A. Hayek Club. As a principal leader in the movement to liberalize the Czech economy, Mr. Holman has lectured and written widely on privatization. In June 1991, he was a featured speaker on "Economic Turnarounds — Privatization and the Welfare State" at the University of Zurich Conference held in Kristiansand, Norway. He is the author of a number of public policy and economic studies sponsored by the Liberal Institute, Prague, among them "Economic Thinking on its Road out of Serfdom," "Liberal Order— Liberty, Law, Prosperity," and (with D. Valenta) "On Credit Finance of the Small-Scale Privatization."

Dr. Gerhard Schwarz was born in 1951 in Vorarlberg (Austria). He studied economics at the Graduate School for Economics and Business Administration in St. Gall (Switzerland). After studies at the American Institute for Economic Research in Great Barrington (Massachusetts) and further studies in Colombia (South America) he was awarded his Ph.D. in economics from the same school in 1980. After 1 year of work in industry he joined the economic staff of Neue Zürcher Zeitung, the leading Swiss newspaper in the German language. From 1983 to 1986 he was an eco- nomic correspondent in Paris (France). Since 1987 he has been an eco- 5 nomic editor of Neue Zürcher Zeitung, responsible for the subjects "com- parative economic systems," "business cycles," "development econom- ics," and "general economic policy." Since 1989 he has also been a lecturer at the University of Zurich on "comparative economic systems." Dr. Schwarz has also written and edited various books and contributed articles to scholarly journals on subjects as varied as "foreign direct investment in the third world," "deregulation and privatization," "the social aspect of the market economy" and "the Swiss economic policy."

Conference Coordinators Dr. Marcel Studer is Chairman of the Board of Trustees of Progress Foundation, Switzerland. Dr. Robert A. G¡lmour is President and Chief Executive Officer of Ameri- can Institute for Economic Research, Great Barrington, Massachusetts. Proceedings Dr. Studer: I regret to inform you that Minister of Finance of Czechoslo- vakia Vaclav Klaus has taken ill and must cancel his appearance. I am sure that you join me in sending him our best wishes for recovery. It is my pleasure to announce, however, that Mr. Robert Holman, his personal consultant, is prepared to read the manuscript of Dr. Klaus. The topic is the Czechoslovak transformation and lessons to be learned. Further, Dr. Gerhard Schwarz, economic editor of Neue Zürcher Zeitung, and member of the American Economic Association, is going to speak, and he is not going to hesitate to speak about the relationship of democracy to the market economy. Dr. Robert A. Gilmour, president of our sister organiza- tion in America, the American Institute for Economic Research will intro- duce our last speaker, the distinguished American economist and social philosopher, Mr. George Gilder. I would like to call upon you after Mr. Gilder's paper to ask questions. Can I ask Mr. Holman kindly to come up and take the floor? Mr. Holman (for Vaclav Klaus): Ladies and gentlemen, I have been asked to speak here on behalf of Minister Klaus who unfortunately is unable to participate at this conference because of illness. Permit me to take this opportunity to say a few words on the basic principle and main problems of economic transformation in Czechoslovakia. First, what are the basic principles of this transformation and what is the whole philoso- phy of the economic transformation? That is to say, of restructuring to market economy? We conceive of this transformation as a long-term and spontaneous process where the market institutions and markets cannot be established from above by some decision. All is subject to spontaneous process. In this sense, the economic transformation will take a long time — at least one decade for us to reach a real market economy as we know it from advanced Western countries. What is then the role of the state in the economic transformation? I would say that the role of the state is above all to get rid of obstacles — obstacles to the spontaneous development of markets and market institu- tions. And this is the essence and substance of our economic reform. This getting rid of obstacles and this action of market forces includes a role for the state primarily in creating the basic rules of the game — new rules of economic life, as it were. These are mainly the basic system changes which already are being accomplished in rough form: liberalization of the markets, introduction of the convertibility of the currency, and naturally, privatization. Another role of the state is to provide a certain macroeco- nomic environment in which the spontaneous development of market institutions would be possible, above all, to see to a sound currency. And this is the task to be ftilfílled by macroeconomic policy. However, when 7 speaking of creating basic rules for the functioning of a market economy, we mean by that complicated legislative reform. We are changing all our legislation and our government as well as our parliament and are over- whelmed by legislative tasks. Another role of the state in the transformation is limitation of the interference of the state. That means that the state should, above all, reduce all the redistribution processes by which our economy is burdened and which were characteristic of the past economic system. This goal has already been partially achieved by abolition of all subsidies for prices and of direct subsidies to enterprises. A further long-term task for the future is the limitation of the public sector in the national economy. But this process of limitation of the public sector must be a spontaneous one. The state cannot decrease taxes without decreasing expenditures. And the state will not decrease expenditures for public sectors as long as private ownership does not penetrate into those areas and services which have been a monopoly of the state. The problem, the issue in itself, is the so-called structural or industrial policy which is often discussed nowadays. It is discussed as to whether the government should be engaged in industrial policy and whether the latter should be a component part of our strategy. Always when there are some serious economic difficulties, which are concomitant, which exist together with economic transformation, there are stronger claims for the state to start some industrial policies. The essence of this industrial policy is that the state should consider and decide which industries are profitable and which are not—and that the state again should engage itself in different activities and redistribution processes which were characteristic of the past economic system. The supporters of economic policies think that they are more clever than the enterprises and consumers and that they would be able to run the economy better than the markets. Their arguments usually are that we find ourselves in a transitional period when the maricets don't woiic yet — they're in a vacuum that this industrial policy should fill. This argument is absurd because the industrial policy does not fill any vacuum and the only thing they will achieve is to block definitely the spontaneous development of market institutions that has been already initiated in this country. As soon as the state gets engaged in industrial policies, they will have to take care of agrarian policies, export policy, machine building policy, automo- tive policy, and so on. Let us see what are the consequences of the liberalization of markets in our economy. I would say that the economic transformation is a continual process, but we can cite here two of the more important stages. The first 8 was the liberalization of the markets, which was initiated at the beginning of this year; and the second is the privatization, I mean the big privatiza- tion, which is going to be started at the beginning of the next year. First I would like to consider the consequences of liberalization of markets in our economy. The fears and forecasts that liberalization of markets will disturb mac- roeconomic stability were not confirmed. The price level has increased by almost 50 percent, but it is also true that most of it, at least one-half, happened in January and then the increase in prices began to slow down. In June and July the price level was practically stable, which means that inflation is under control. There hasn't been any development of an infla- tion spiral. This is not going to occur provided the government does not change its up-to-now policy of demand restriction. Equally, the liberaliza- tion of foreign trade by the introduction of convertible currency has not violated the present-day stability and equilibrium of payment balance. There has been some decrease of the current account balance. This has been balanced by an influx of foreign capital. Thus the balance of pay- ments is, after all, not of concern. The consequences of the liberalization of markets became more mani- fest elsewhere, above all in the decrease of real wages. This is a direct consequence of the monopolistic structure of our economy, which proved to be a greater problem than expected. The monopoly structure of our economy cannot be destroyed by any administrative interference or deci- sion. We've got certain experience with that. For instance, in the building industry there was a division of big contractors' companies to a number of small but narrowly specialized contractors. But the monopoly structure has remained, has been kept, in this. The drop of real wages was due to the increase of prices, on the one hand, and, on the other hand, surprisingly slow increase of nominal wages, which compared with the same period of the past year have increased only by 6 percent. And their growth hasn't even achieved the development foreseen and allowed by the government. The increase of nominal wages hasn't been the result of any restriction, but result of the financial situation of enterprises that could not afford to increase these wages. Let us see now what is the character of economic decline. It proves that problem #1 is not inflation. It is the economic decline and there is a lot of discussion on the question as to the character of this decline and whether it wouldn't be possible to cope with it by a change of the policy of demand and expansion. In real terms, there has been a decrease of consumer demand. But this was due to the decrease of real wages and is also due to the monopoly 9 structure of our economy. "Demand management" probably would not solve the problem and would lead to further increases in prices. A great part of that economic decline can be accounted for by external influences, above all, a decrease in exports to the Soviet market and to the DDR market. The German market has become too hard for us and our products are not competitive. And the Soviet market has become insol- vent— they are unable to pay. This is responsible for the economic decline in our country. But, again, it is difficult to conceive that the situation could be solved by the policy of demand expansion and that it could be replaced by increased state expenditure. From the point of aggre- gate demand, it could be replaced, but it would deepen our foreign debt. There has been also a decrease of business investment, for which there are two interesting reasons. On the one hand, it is a fact that our enter- prises are living in a sort of pre-privatization condition where their status is not clear. The rules of the game are unknown to them. They are only guessing what will happen after the privatization and in such conditions they are not much inclined to invest. The main reason for the decline in investment activity is, however, the financial environment in which the enterprises must operate, above all, cautiousness of our commercial banks in giving loans. The behavior of our commercial banks contrasts surpris- ingly with that of Polish banks, which are quite willing to give loans to enterprises in Poland and whose propensity to lend indiscriminately needs to be curtailed. In our country the situation is reversed. The volume of credits that our commercial banks have created has not reached the limit of the central bank and we can therefore say that there is a money restriction in our country. This tight money situation is not due to the policy of the central bank, and it is not due to a high rate of interest. The real rate of interest is still negative. But it is due to the unwillingness of the commercial banks to give loans. And this is in connection with another serious problem of our economy and of our economic transformation. These are the financial problems: excessive bad debts and insolvency of our enterprises. Huge loans, which had been made by our banks, have the character of very bad, faulty, loans. The main source of the indebtedness and insolvency of our enterprises is an inappropriate structure of assets, where the enterprises have their assets in the form of excessive inventories or unrecoverable assets, and bad credit of their customers. What we observe in the past year could have been accounted for by inflationary expectations. Where they increased their inventories according to the inflationary expectation. The insolvency of our enterprises is growing this year, too, and this is very dangerous. In the first quarter of the year [1991-ed.] it was about 70 10 billion crowns [about $2.1 billion]. Now we are speaking about 120 billion crowns [about $3.6 billion]. What are the causes of this dangerous phenomena which alarms the economists so much? Evidently the reason is that there are certain foci of insolvency which are proliferating. And these foci are the enterprises which cannot sell their products. And instead of limiting production or stopping the production as it would be custom- ary in a market economy, they continue manufacturing for the stores and simply don't pay to their suppliers. A certain satisfaction may be seen in the fact that this is not a specific problem of Czechoslovakia. Insolvency in Hungary is even greater and this is probably a general problem of a transforming economy. At the present time we are trying to find possibilities of reducing the burden of debt and solving the problem created by the bad loans made by our banks. The banks don't want to exchange their bad loans for shares of enterprises. They demand state obligations. One solution, which has been recommended to us by the World Bank, is in the fact that the bad loans be exchanged for state obligations, which would be paid out of the state budget. But this would burden the state budget by 20 billion crowns yearly and would lead to deficits in the state budgets. The World Bank has given us no advice about how to avoid this trap, and the government refuses this solution. Recently another proposal/solution has been submitted; namely, that the bad loans of the banks would be exchanged not for government obligations but the obligations of a fund of national wealth, which will be funded from the privatization process by the sale of shares. The fund of national wealth, it is said, could provide obligations up to the amount of money that it will gain from the sale of state enterprises. But this wouldn't be enough for a general cancellation of debts. It is probable that our enterprises will be privatized and that they will have to solve their finan- cial problems by joining with foreign capital. I would also say a few words concerning foreign assistance. Foreign assistance can be distinguished in two kinds: financial aid and real aid. The financial assistance is when governments of advanced countries offer us money, or the financial means to purchase their goods. This assistance is not much help if it is not accompanied by real assistance, which consists in their willingness to open their markets and allow our goods access to these markets. We cannot accept new loans without being able to pay them back, and we cannot do that in any other way than by export. It is absurd if some countries offer us financial assistance, but handicap us by denying of our goods access to their markets. The failure of the first round of the debates of association agreements 11 in the European community on the one hand and Czechoslovakia, Hun- gary, and Poland on the other was a great disappointment for us. What France did, which practically precluded our association with the European community, was an especially great disappointment. It can be seen that great and beautiful words of some Western politicians disappear as soon as they are in conflict with some narrow interest groups. It is absurd if someone says that our association with the European Community is not in the interest of France, or any other country, if by interest we mean the interest of their consumers and not those of manufacturers of meat. We hope that in the future our attempts to gain entrance in Europe will not be like besieging some fortification, and that the nations of the European Community will give us not financial assistance but real assistance. Thank you very much for your attention.

Dr. Studer: Thank you very much, Mr. Holman. I am pleased now to introduce Dr. Gerhard Schwarz who will be our next speaker. [Dr. Schwarz delivered only an oral summary of his paper, which here is printed in its entirety - ed.]

12 DEMOCRACY AND MARKET-ORIENTED REFORM — A LOVE-HATE RELATIONSHIP? Some Thoughts About the Interdependence of Systems in the Transition Stage from a Controlled to a Competitive Economy By Dr. Gerhard Schwarz

A. The Tense Relationship between a Market-Directed Economy and Democracy a. The Thesis of Complementarity ... In the course of November 1989, Prague was the scene of recurrent protest demonstrations. Toward the end of the month, more than 200,000 people assembled on the Wencelas Square shouting a word which in Western Europe one hears usually only from the theater stage, whose high-sounding appeal therefore quite often merely arouses a condescend- ing smile: "Freedom!"1 On 28th November, the "Citizens' Forum" — the umbrella organization of all oppositional groups — submitted a 7-point program during a discussion with the then Prime Minister, Adamec, whose key demands aimed at the creation of a democratic state and simultaneous abolition of the centrally planned economy, to be replaced by a free- market system. However, not only in Prague, but also in Warsaw, East Berlin, Budapest, Sofia and Bucharest the objectives of the peaceful revolutions were identical: establishment of a political system based on freedom — which 3 years ago we would all have considered absolutely impossible — accompanied by the introduction of a liberal economic sys- tem. These phenomena seemed only to confirm once again the thesis up- holding the indivisibility of freedom, of "freedom as one whole,"2 as defined by Milton and Rose Friedman. The reform movements taking shape in the economic field since considerable time obviously could not be kept separated from the political sphere, and people behind the torn- down Iron Curtain did not either wish a more competitive market or more political rights, they wanted both. Market-directed economy and democ- racy — do they really amount to a love relation? The idea of a market economy belonging to democracy as one twin to the other is so firmly rooted in our minds that we often utter it in an unreflected and undifferentiated manner. This conviction is probably not least due to the fact that it satisfies our desire for harmony and thus is rather convenient to espouse by a confirmed Liberal. However, the fol- lowing considerations purposely are aimed to deviate from this beaten track, although it is quite clear that they will hardly meet with unanimous approval and applause. 13 At least within the German-speaking area, the thesis of the com- plementarity of a free-enterprise economy with democracy is scientifi- cally based mainly on the works of the ordoliberal school,3 i.e., above all on the writings of Walter Eucken, who in his turn could draw from thoughts already formulated at an earlier time by Schumpeter and Hermens.4 The key premise supporting this complementarity presupposes that the restraint of political power by universal suffrage and constitutionality based on the rule of law should be seconded by a corresponding restraint in the economic sector, ensuring unimpeded free competition. According to Eucken's opinion the existence of a unilateral dependence of society's other framework patterns on the economic system must be denied. In- stead, Eucken postulates their interdependence, which corresponds pre- cisely to his catchword of the interdependence of systems ("Interdependenz der Ordnungen") in a given society, now widely used in the theoretical literature on systemic questions of politics, economics and social matters. Consequently, the various frameworks of these systems should be devel- oped concurrently, in particular the organization of the economic and political systems. Starting from Eucken's teachings, his fellow advocates of neo-liberal- ism and his disciples never ceased to emphasize the interdependences between a competition-oriented economic system and a both liberal and democratic system of society and state.5 Statements similar to those of Eucken have consequently been made by many other authors, such as Alexander Rüstow, Alfred Müller-Armack or by the architect of the so far most important really successful experiment of remodeling a country's economic system known to history, i.e., the German economic and cur- rency reform achieved by Ludwig Erhard. b. ... and Antagonism as its Antithesis The question now arises: could the described "interdependence of sys- tems" pass an empirical test? Or is wishful thinking really the source of this concept? If this is so, the said "interdependence" might have to be interpreted as a normative rather than a descriptive term.6 As such a normative term, interdependence should certainly be endorsed, for which freedom-loving person who firmly believes in freedom would not strive after both economic and political freedom? But as a description relating to reality, the interdependence thesis is certainly subject to considerable doubts Anyhow, there are too many examples apparently disproving it. In this context, it is noteworthy that most OECD-countries can by no means boast of a long-standing democratic tradition. Actually, their rise to affluence and to a modern economic system started precisely in a thor- oughly authoritarian environment. Germany under Bismarck and Japan under the Meiji regime provide typical examples. And Chile's road toward 14 a market-directed as well as a growth-oriented economy, at present stand- ing out as Latin America's model case of economic development — has it not been paved by a brutal military dictatorship? Furthermore, is the thesis of the harmony existing between a market economy and democracy7 not drastically disproved in our days by the four tigers in Southeast Asia, i.e., Hong Kong, Singapore, South Korea and Taiwan? Given this background, the question as to whether a pure "thorough- bred" capitalistic system could at all be developed within a democracy most probably has to be answered in the negative. Conversely, the pro- vocative conclusion ensues that precisely the absence of democracy or at least of free elections might make a market economy possible or further it at least. At any rate, it is rather difficult to find examples of the introduc- tion of market-oriented economic systems in existing economies of a predominantly collective type, without the support of an authoritarian regime.8 Even Ludwig Erhard would hardly have enjoyed any chances of success without the support given by the Allied Powers to his reform and without the vast and almost dictatorial powers he was thus granted. Even from the ranks of his own Christian Democratic Party — let alone the Social-Democratic opposition — the resistance against his radical con- cept was so intense that normal parliamentary proceedings would assur- edly have prevented the German Economic Miracle.9 Therefore, it is hardly a coincidence that, in the time preceding the aborted putsch of August 19, 199110 in the Soviet Union, many intellectu- als openly confessed their thoroughly substantiated conjectures on the necessity of authoritarianism. Such thoughts were by no means harbored by the 'left-wing conservatives" only, i.e., by those people who after- wards cooperated at the putsch.11 In China, too, intense discussions were held on the "New Authoritarianism" between 1986 and 1989, especially among younger intellectuals.12 Finally, the discussions about special pow- ers to be granted to the Polish government in the fall of 1991 provided further evidence of the conspicuous difficulties to implement the reform process by truly democratic means. Market economy and democracy — do they amount to an irreconcilably hostile relationship?

B. Which Government? The discussion so far shows that the question as to which political regime would render possible the passage from a planned economy to a market economy — or would better be qualified to make it easier and more likely to last permanently — is not at all easy to answer. To be sure, we know the main pillars that make a transformation of the economic system, i.e., - free prices 15 - open markets - private property, and - sound money. However, which political system would allow setting up these pil- lars — that question is largely ignored by the relevant literature. At all events, the interdependence thesis provides no help in this context: Even if it were true that whoever questions the prevailing economic system also advocates the abolition of the coexisting political system, and vice- versa13 — which is not the case, as I have mentioned elsewhere14 — this is of no use for application to the special situation prevailing in the postcommunist countries. There, the former economic and political sys- tems are bankrupt and should be replaced by a market economy as well as by democracy. But what will happen, if democracy proves unsuitable to introduce a market economy, and if democracy cannot survive without a free-enterprise economy as well? That is precisely the dilemma to be overcome in this context.

1. In order to eliminate a frequently occurring misunderstanding right from the start, emphasis must be laid on the basic premise that the role of the State cannot be dispensed with when introducing a market economy. Liberalism (here always used in the classic European sense) is by no means tantamount to anarchy,15 and the State as a supervising and ordering authority has hardly ever been required as urgently as for the imminent transformation processes in post- communist countries. The reproach suggesting that in this way the constructivism of state planners is replaced by the constructivism of the reformers, does not therefore appear to me as justified. A market economy cannot be anything else than an organized by the state event.16 Of decisive importance is merely the kind of economic framework and its fine-tuning by the State. A liberal, freedom- oriented concept of government calls for a framework with few and not too detailed conditions, though clear-cut and strict ones. "Short- sighted regulations aiming merely at the elimination of single symp- toms"17 as well as continuous interventionist interferences in the economic processes are to be rejected. So matters boil down to the sole question as to what type of State or government is required for diving into the cold water of a market economy, whether one of a predominantly democratic nature or one with rather dictatorial fea- tures. 2. I am aware that "dictatorship" is an emotive and controversial term. It designates a regime capable of holding onto power without recur- rently needing the consent of the population's majority.18 Moreover, I would like to clarify immediately that a dictatorship may be either 16 authoritarian or totalitarian and that hereinafter the authoritarian dictatorships will be considered. The term "totalitarian" has been created by Mussolini and was not at all meant in a pejorative sense. By this concept, Mussolini wanted to define the objective of fas- cism: "Nothing against the State, nothing without the State, nothing outside the State." The delimitation against the authoritarian regime is above all due to Hannah Arendt's definition: Both authoritarian and totalitarian regimes suppress all political opposition, but the former — in contrast to totalitarianism — admit free individual de- velopments and activities outside the political sphere.19 Of course, this is a rather delicate distinction. There is a permanent danger of an authoritarian regime turning into a totalitarian one. From a classic liberal point of view as held by Hayek, an authoritarian dictatorship is to be feared in particular due to this tendency, as for Hayek totalitarianism represents the antithesis of freedom, whereas he con- siders an authoritarian regime as being the opposite of democracy, but not necessarily to be anti-liberal.20 3. This requires a second term to be more accurately defined: "democ- racy." The Western democracies are characterized by numerous fea- tures, comprising — among others — universal suffrage, a pluralis- tic system of values, constitutionality, i.e., rule of law as well as a multiparty system. However, there is a main leitmotif "continuing throughout the whole history of political ideas and doctrines..., namely the identification of "democracy" with political equality, sovereignty of the people and government by majorities of the elec- torate."21 Democracy should thus be interpreted as a system whereby the governed subjects at regular intervals elect those who rule them in general elections by majority vote,22 or — as expressed by Karl Popper — "a rule of law that enables us to get rid of the government without violence."23 It is precisely this aspect of democracy which creates problems on transition from a planned to a market economy. C. Advantages of an Authoritarian Dictatorship for a System Trans- formation But first of all we should enquire as to why the authoritarian regimes in the aforesaid examples were actually successful or even necessary, or — vice-versa — what are their peculiar characteristics which apparently make them practically indispensable for the introduction of market-directed economies in the postcommunist countries, too.24 In particular, four of these characteristics stand out, i.e., - ability to prevail over particularistic interests - long-term orientation 17 - consistency, and - stability. a. Ability to prevail The removal of the depressing heritage left by long years of Communist rule temporarily burdens a wide segment of the population with high costs in social terms. Whoever wants to leave behind the mismanagement of a rigidly controlled economic system with the goal of affluence in mind must first of all be prepared for a hard journey through an economic desert. As soon as the survival of a government seems jeopardized if it takes any unpopular measures, such measures are either not at all implemented, or then the economic crisis might develop into a political one. In this way, democracy assumes the rule of a drag hindering the introduction of a market economy. (A case in point is precisely demonstrated by the endeav- ors of the Hungarian government to raise the gasoline price drastically in October 1990: massive street protests and the danger of the coalition being split up compelled the Antall government to sound the retreat.25) In such situations, authoritarian regimes are better qualified to pre- vail.26 Manifest unemployment, the compulsion to retrain for a new pro- fession, inflation provoked by the correction of the former highly dis- torted price structure and newly arising inequalities after decades of an egalitarian ideology — all this will certainly provoke opposition. Many people will continue to long after the assured supply on a minimal level by the centrally planned economy or demand the establishment of a Western- type welfare state even before its economic foundations have actually been laid.27 A system corresponding to what Anthony de Jasay terms an "insensitive power."28 can prove to be of advantage in such a situation. To a certain degree, an authoritarian regime must be characterized by an indifference regarding the desires of the subjects it rules. In a transitional situation, this can precisely be a virtue. By contrast, within a framework of democratic decision-making pro- cesses, it is very difficult to find the necessary majorities approving of the indispensable shock therapy. Even if its necessity is realized, it may be difficult not to yield to the temptation of shifting the burden of adaptation to other segments of the population or to future generations, continuing instead to live on the cuff, at least for a while. The quagmire — typical of today's situation of countries such as the Soviet Union — gets only worse thereby, whereas the social expenditures one tries to avoid will amount to a far stiffer bill at a later stage. However, it is actually impossible to avoid paying that bill. b. Long-Term Orientation We owe insights on politicians' short-term manner of thinking in a 18 democracy to the Public Choice School (J. Buchanan). As a rule, authori- tarian regimes remain in the saddle longer than just 4 or 5 years, and they need not take any steps in order to improve their reelection prospects. They can afford to plan and think in a long-term perspective, which is one of their qualifications for a smooth transformation of economic systems. In a short-term perspective, the transition to a market economy will undoubtedly entail more social disadvantages than benefits, as already mentioned. By contrast, the fruits yielded by such a transformation pro- cess can only be harvested after many years.29 Consequently, the people have to show lots of patience. If this patience is lacking, a fundamental reform of the economic system is probably only possible when actually enforced by a powerful and firmly rooted authoritarian regime. c. Consistency An authoritarian regime is capable by its very nature of acting in a far more uncompromising and ruthless manner than a democracy, which virtually embodies a system of compromises.30 However, while a system transformation is ongoing, compromising in terms of political economy runs the permanent danger of ending up in a "Third Way," i.e., in a compromise between a planned and a market economy, which is doomed in advance. There is hardly a more concise verdict on this "Third Way" as defined above, than Vaclav Klaus's admonition of the "Third Way" lead- ing directly toward the Third World. Consequently, this alternative must be absolutely avoided, apart from the fact that during the transitional phase toward a new system, consistency and firm resolution are of the utmost importance. It is indeed the objective of economic policy "to fully comply with the logic of facts,"31 thereby implementing a strictly homoge- neous and consistent economic policy, as has always been requested by Walter Eucken. d. Stability Democracy is essentially characterized by the possibility of changing majorities, involving simultaneously a change of the political outlook, especially of the economic framework conditions. In a perspective of checking political power, this institutionalized change is certainly justi- fied. However, it also involves some disadvantages, such as a certain hectic pace and instability — and this to an increasing degree, the more basic prerequisites are exposed to change or abolition at any vote. (Even in a democracy with its periodic elections, stability may be largely en- sured in special circumstances, such as the following ones: in Japan, with its elections at regular intervals, 150 of 600 members of Parliament are the sons of MPs,32 whereas in Italy the government changes every year, but never the main government party, meaning that there is never any real political change.) However, investments — so fervently craved by 19 postcommunist countries — normally relate to a long-term period, thus requiring a certain long-range security and stability.33 Authoritarian re- gimes, at least the firmly rooted ones, precisely seem to guarantee such a stability. D. Alternatives to an Authoritarian Dictatorship Are we thus confronted with the rather unpleasant fact that, on the road leading from totalitarianism to democracy, we cannot avoid the intermedi- ate stage of an authoritarian dictatorship and that we need a powerful State in order to introduce a market economy? 1. Who is reluctant to answer this question in the affirmative because "a true freedom-lover may by no means call democracy in doubt/' should be reminded that — according to Friedrich August von Hayek and Herbert Spencer,34 just to mention two key advocates of liberal thinking — Liber- alism aims at the curtailment of a government's coercive power, irrespec- tive of whether or not such a government is provided with a democratic legitimization. Viewed in this way, any rule of a majority may assume distinctly totalitarian traits, for example when a majority consisting of "the poor" decides to introduce confiscatory taxes to be paid by a minority of "the rich." Conversely, an authoritarian regime might very well act according to libertarian principles. To the Liberal, the contents of the laws are of the foremost importance, whereas the democrat's chief concern centers on the manner in which they are developed and adopted. Conse- quently, a law approved by a majority may not necessarily be a liberal law. That's precisely a lesson which we as residents of the West have recur- rently been taught. 2. A second aspect has been recently examined by Peter Bernholz.35 He asks under which circumstances a free society might be allowed to resort to coercion or compulsion, arriving at the conclusion that this would only be legitimate toward people endeavoring to abolish freedom and constitutional rule of law or to impose an autonomous and authorita- tive supreme value of their own choice. As a free society is unthinkable without free economic activities — comprising protection of private prop- erty and free enterprise — this means that the use of compulsion in order to create a free market system cannot be dismissed right from the start. 3. Thirdly, it will be easier for us to examine the possibility of an authoritarian system paving the way to introduce a market-directed economy when fully realizing that a market economy, as a matter of fact, will gradually undermine even the toughest authoritarian regime.36 An authoritarian regime espousing a market-directed economy thus limits automatically the duration of its power due to its unstable structure. Supported by these arguments, we should however not fatalistically 20 submit to the conviction that an authoritarian regime is an almost inevi- table intermediate stage on the road leading to democracy and a market- directed economy. As in the real world the benevolent dictator hardly exists and as there is probably no stronger temptation than the one exer- cised by power,37 one may rather ask whether the results achievable by an authoritarian dictatorship might not be attained by another alternative. An analysis of those characteristics of a dictatorship which seemingly pro- mote under certain circumstances the success of a given transformation process evidences that only the said characteristics are relevant, not the exercise of power itself by dictatorial means. Therefore, should it be possible to create a suitable framework of basic conditions outside the rule of an authoritarian dictatorship, the above shown dilemma might possibly take care of itself by disappearing. This would dispense the advocates of a free market economy to call for the intervention of an "authoritarian dictatorship" as a necessary evil, but possibly only for an "authoritarian democracy" or — as one may call it — a "limited democracy." We now must examine which "quasi-dictatorial conditions" further the generation of the main favorable prerequisites of a dictatorship but avoid simultaneously the arbitrary and despotic rule of a totalitarian dictator- ship. Six such prerequisites are to be named first of all: - natural authority and charisma of a leader - legitimization of the State's leadership - people's trust in its leadership - far-reaching consensus of the population - small-scale political units - an "authoritarian constitution." a. Authority and Charisma The authority a certain government enjoys must not necessarily be based on military might and strong state-guaranteed power. Both "II Duce" and "Der Führer" provide extreme examples of the consequences ensuing from the misuse of power. However, if leadership and control is interpreted rather as "the provision of the public good of responsibility,"38 then an authoritarian regime might very well be partly replaced by the authority and the charisma of true natural leaders, such as Lech Walesa or Vaclav Havel. But in order to benefit the market-directed economy and thus freedom, these leaders must have a thorough knowledge of economics, or they must at least listen to a competent adviser, as was the case with the twosome Adenauer-Erhard. In such circumstances, personalities of this type may succeed in implementing the indispensable reforms quickly and thoroughly without provoking street demonstrations. With charisma and credibility, it is possible to have drastic measures accepted by a consenting population. Of course, the authority of such a charismatic personality 21 might further be strengthened by outside influences, namely by the inter- national recognition of a leader and of his politics. In this way, the West could probably better support reforms than by spending billions of dollars. b. Legitimization To the German philosopher Immanuel Kant we owe the thesis that the key requirement for an international order of peace would rather consist in the legitimacy of a regime than its being a democracy.39 In analogous manner, this applies also to the transformation processes. The demand for legitimization provides an obvious motive for an authoritarian regime not to base a new order on the privileged elite of the former "Nomenklatura." As a rule, legitimacy is associated rather with a democratic regime than with an authoritarian one.40 However, in certain situations, authoritarian regimes may enjoy a high degree of legitimization: when they replace a thoroughly bankrupt regime. Such a former government might have been an incompetent democracy having failed to ensure stability and the rule of law or a totalitarian dictatorship, conspicuously outshone by a merely authoritarian regime. c. Trust The residents of the postcommunist countries have undergone several disappointments during their lives. Any promises of reform were never truly concretized. Therefore, confidence in any new "gospels" — even the one preached by Adam Smith — is now imbued with a considerable dose of sound skepticism, not at all easy to overcome. But whoever has once won the people's confidence probably enjoys better prospects of success- fully carrying through painful and risky operations than would an authori- tarian dictator. Confidence is not least based on honesty. Therefore, it is important to tell people the plain truth when a planned economy is converted into a market-directed one. Who tells citizens that in the near future they will for some time be worse off than before and that only afterwards improve- ments will take place in minimal steps according to an approximate schedule — as did the Polish Minister of Finance Lescek Balcerowicz when disclosing his reform program on December 12, 198941 — will be able to get the population's backing without resorting to special powers, especially if he is lucky enough to see his promises come true at least partly. The announcement of "Blood, Sweat and Tears" has, moreover, a second advantage: it keeps expectations low and thus ensures that the system transformation's first slightly favorable results are felt as a true uplift instead of further frustrating the people.42 d. Consensus If there is a society whose members all want the same things, there is 22 no need of a State's coercive power in order to push through society's objectives. However, such a situation corresponds to a mere Utopian concept. Nevertheless, the more certain basic convictions are shared by a majority of the population, the easier it will be for a democratic govern- ment to pursue a consistent reform policy. But the countries once belong- ing to the Comecon hardly can afford — during the present transitional phase — to try and obtain this consensus. It must already preexist. This was indeed largely the case in Poland under the Mazowiecki Government. However, where such a consensus has first of all to be developed in a laborious democratic process, as in the case of Hungary, precisely that type of paralysis occurs, whose avoidance is part of an authoritarian regime's positive characteristics.

A national consensus can be greatly favored by an ethnic homogeneity of the society concerned. Japan's economic success might be due, among other things, to the comparatively high homogeneity of that country. Even outside pressure may strengthen national unity. This is not meant in the sense of a country concentrating its forces to confront an external enemy, but rather presupposes that an assistance coupled with certain conditions or a steady pressure, for example exercised by the International Monetary Fund, might unify divergent currents in a population. Although it may sound cynical when voiced by a West European, even the pressure exer- cised by suffering may stimulate a national consensus.43 Where there is nothing to lose anymore, or in a dramatic crisis, the people might, even under democratic rule, show the degree of unanimity and resolution nec- essary to impose sacrifices on themselves. To be sure, all large-scale reforms of the social, economic and political framework known to history took place after wars and during crises — but certainly not under condi- tions of affluence.

e. Small-Scale Political Units As nationalistic tensions coupled with a large-sized country make it more difficult to unify the population in order to jointly face a system's transformation, small states present considerable advantages. Leopold Kohr, the "philosopher of smallness," published almost 50 years ago an article headlined "Disunion Now," running counter to the mental attitude prevailing then and now, as it supports the particularism of small states.44 Not only are small states more democratic, as the individual's sovereignty is less easily absorbed by an anonymous bureaucracy, but they also offer advantages in respect of the transition to another system. They further the country's stability, are less endangered by contrasting particularistic inter- ests and may be more responsive to swift and resolute decisions. If, in addition to a wide variety of social strata and professional segments, there is no further need to show regard for the most diverse geographic regions, 23 ethnic groups and religions, too, the experiment "market economy" is likely to be carried out faster and more thoroughly. At least viewed from this angle, the reawakening of nationalistic trends in Eastern and Southern Europe hardly deserves an exclusively negative rating. f. An "Authoritarian" Constitution When talking about authoritarian regimes, the meaning includes the authoritarian dictatorship as one extreme case, whereas the other extreme is simply embodied by a strong presidential government system, i.e., what can be called an authoritarian democracy. In tune with the latter definition, one may try — within a given democratic system, whereof many variants do actually exist — to curtail the properties detrimental to a system trans- formation, while strengthening the favorable aspects. Consequently, this may involve provisions of the constitution aimed at long-term govern- ment and stability. Suitable models are, for example, a French-type presi- dential democracy, a long term of office of the President or of the govern- ment, such as 7 years — in order to prevent all decisions being based, after only 2 years, exclusively on tactical motives inspired by future elections — or a stabilizing clause setting a 5 percent minimum vote allowing a party to sit in parliament.45 On the other hand, the State's area of authority to decide on specific subject matters — such as taxes — should actually be restricted.

E. An Authoritarian Democracy? Some of the above mentioned prerequisites reciprocally favor one another, others are complementary, and partly they are even interchange- able and/or substitutionable among themselves. Small-scale entities favor a consensus while legitimation and trust belong together. In countries with strong national cohesion, a government might get along even without a strong personality. But it is impossible to direct all conditions from above, i.e., by the State. They cannot be designed by political means, which certainly is a drawback. It does not amount to fatalism, but rather to realism, when we recognize that history cannot dispense with lucky breaks or even "windfalls" — a point to be driven home to diehard constructivists. The advent of a charismatic but not power-hungry politician, the population's trust in a purposeful and resolute government or a national consensus furthered by ethnic homogeneity and suffering — any lucky combination of all these alternatives can hardly be attributed to special merits of the country involved. Let me now summarize things: If a "benevolent authoritarianism," i.e., an authoritarian democracy has been praised in the context of a centrally planned economy being converted into a market-directed one, then this is neither due to the absence of a sense of political freedom, nor to the 24 rejection of the tenet of freedom as an indivisible whole. As in the long run a democracy based on universal suffrage and constitutionality by the rule of law may only be safely assured by freedom prevailing also in the economic sector, the introduction of a consistent market economy in Eastern Europe is naturally of key importance. Should it be impossible to apply democratic means to this introduction, then the democratic freedom has to undergo a short-term restriction in the long-term interest of political freedom. Economists are certainly well-acquainted with such a notion. The political "wave-trough" corresponds to the economic one, to be tra- versed on the road to greater affluence. And ordoliberalism did recognize and accept this (apparent) paradox a long time ago, because this school believes in a strong government being necessary to introduce as well as to maintain a market economy, the said government having to be an athletic and not a fat one.46 In final analysis: do market economy and democracy actually have a love-hate relationship? The answer may rather be that a real love relationship with its ups and downs — but without hatred — is involved, and certainly not the blinding infatuation which naive idealists confuse with an everlasting reality — and of which all of us dream now and then.

Endnotes 1 A. Oplatka, "Prague's Call for Freedom," German-language editorial in Neue Zürcher Zeitung of 25 November 1989, p. 1. 2 M. and R. Friedman, Free to Choose, New York, 1980, p. 68. 3 In view of today's great changes in Europe the fact has to be particularly stressed that the German-speaking area owes to this school decades of in-depth research regarding the fundamental prerequisites of economic systems, a topic largely ignored by the United States, otherwise ranking foremost in economic sciences. Consequently, between 1985 and 1989, only 1.4 percent of the articles published by the American Economic Review concerned topics connected with "economic order" ("Wirtschaftsordnung"), as, e.g., against 13.5 percent dealing with industrial economics. The other side of the coin is that in the United States "ordoliberalism" was never given due attention and that — expressed in rather exaggerated terms — ordoliberalism had to be reinvented and given a new guise within the framework of the New Political Economy. 4 Reference is made to J. A. Schumpeter, Capitalism, Socialism, and Democracy, New York, 1942 and F. A. Hermens, Democracy or Anarchy?, Notre Dame, Indiana, 1941. Compare also W. Kaltefleiter, "Politische Ordnung und Wirtschaftsordnung," in: Trend- Thema, March 1990, p. 12. 5 To cite an example: Otto Schlecht — who later on as undersecretary in the FRG's Ministry of Economics acted as a kind of "ordering" conscience for the German economic policy — wrote in 1950 a graduation thesis at Freiburg University on "Die Vereinbarkeit von politischer und wirtschaftlicher Ordnung," i.e., The Compatibility of Political and Economic Frameworks (reprinting, Tubingen: J. C. B. Mohr, 1986). Cf. also Otto Schlecht, Grundlagen und Perspektiven der Sozialen Marktwirtschaft, Tubingen: J. C. B. Mohr, 1990, in particular p. 198 et seq. 6 It is hardly a coincidence that, in connection with Eucken's "Interdependenz," K. 25 Nimtz and G. Fels use the term "postulate." L·iformedia-Stiftung,i n loco citato, p. 8 (preface). 7 This example as well as further ones are also mentioned by G. White, "Democracy and Economic Reform in China," Institute of Development Studies, Discussion Paper No. 286, Aprill99l,p.2etseq. 8 Even Spain, a frequently quoted example, set out on the road toward a market economy while still ruled by Franco. 9 One should remember that Ludwig Erhard survived only by a one-vote majority in the "Bundestag" when the Social-Democrats asked for a vote of confidence. At that very moment and by one sole vote, the destiny not only of Germany but possibly also of Europe in its entirety was decided. Cf. the rather stimulating essay of R. Dahrendorf, Betrachtüngen über die Revolution in Europe, Stuttgart: DVA, 1990, p. 89. The essay is worth reading despite its annoying attack on Hayek, which might partly be due to Dahrendorf's insuffi- cient acquaintance with the latter's work or to his prejudices. 10 The word "Putsch" (in the meaning of "coup") actually surfaced in the uprisings in Switzerland in the 1830's and was subsequently integrated into High German. 11 As early as 1989, one of the most lively political scientists of the U.S.S.R., Andranik Migranyan, upheld the thesis that an authoritarian regime could ensure the peaceful transition from totalitarianism to democracy (in issue no. 33 of Literaturnaya Gazeta), a thesis he also repeated later on in an interview with Karl Popper, published in the Moscow News (1990, no. 46). Cf. also H. Brahm/R. Götz-Coenenberg/D. Heinzig/G. Simon. "Die Sowjetunion Anfang 1991: Zurück zur Diktatur?," Köln: Bundesinstitut für ost- wissenschaftliche und internationale Studien, January 1991, p. 31. "Such an authoritarian presidential regime might possibly be powerful enough in order to enforce the first steps in the direction of a market-directed economy. The present Gorbachev Government lacks both the authority and the strength required to this effect, and probably also the political will. A plebiscite-based authoritarian regime might seize power due to great social unrest, a situation likely to happen at any time in view of the disastrous economic situation." 12 These discussions were strongly influenced by the works of the American political scientist S. Huntington, in particular Political Order in Changing Societies, London: Yale University Press, 1968. Cf. G. White, in loco citato, p. 7. 13 Cf. W. Kaltefleiter, in loco citato, p. 13. 14 Cf. G. Schwarz, "Limitations to the Interdependence of Systems," in K. Dopfer/K. F. Raible (editors), The Evolution of Economic Systems, London: Macmillan, 1990, p. 32 et seq. 15 "The Liberals thus necessarily interpreted freedom as a freedom under the rule of law.... In this respect, liberalism is strictly to be distinguished from anarchism." F. A. von Hayek, Liberalismus, Lectures and Essays (in German) of the Walter Eucken Institute, Tubingen: J. C. B. Mohr, 1979, p. 22. 16 L. Miksch, Wettbewerb als Aufgabe, Grundsätze einer Wettbewerbsordnung, 2nd edi- tion, Godesberg, 1947, p. 12. Cf. also G. Schwarz, "Die ordnungspolitische Verwahrlosung der Schweiz," in: G. Radnitzky/H. Bouillon (editors), Ordnungstheorie und Ordnungspolitik, Berlin among others: Springer, 1991, p. 221 et seq., in particular p. 232 et seq. (English edition forthcoming.) 17 W. Stützel, "Sicherung der Sozialen Marktwirtschaft durch konsequente Ordnungspolitik," in: Stützel and others (editors), Grundtexíe zur Sozialen Marktwirtschaft. Zeugnisse aus zweihundert Jahren ordnungspolitischer Diskussion, Stuttgart, 1981, p. 354. 26 18 A. de Jasay, "Pour une tyrannie paresseuse," in: Commentaire, Vol. 10, No. 38, summer 1987, p. 324. 19 Cf. in this respect P. L. Berger, The Capitalist Revolution, Fifty Propositions about Prosperity, Equality, and Liberty, New York: Basic Books, 1986, p. 83 et seq. 20 Cf. F. A. von Hayek, Liberalismus, in loco citato, p. 35. 21 R. A. Dahl, Vorstufen zur Demokratie — Theorie, Tubingen: J. C. B. Mohr, 1976, p. 32 (original 1956). 22 This is also the definition of the classic economic work on the theory of democracy, i.e., A. Downs, Oekonomische Theorie der Politik, Tubingen: J. C. B. Mohr, 1968, p. 23 A similar definition of democracy is given by M. U. Rapold, Demokratie und Wirtschafìsordnung. EinBeitrag zur Soziahvissenschafìlichen Grundlagenforschung, Zurich: Polygraphischer Verlag, 1958, p. 62 et seq. 23 K. Popper, "The Open Society and its Enemies Revisited," in: The Economist, 23 April 1988, p. 25 et seq. 24 The question as to what kind of incentives induce "dictators" to commit their actions remains excluded in this context. Our reflections are rather based on the empirically observable characteristics and behavior patterns of authoritarian regimes. Of which type these incentives are, that question is above all important in order to determine why authoritarian regimes change into totalitarian ones. This is indeed a fascinating complex of problems, exceeding however the scope of this essay. 25 Cf. "Kompromiss im ungarischen Benzinstreit," in: Neue Zürcher Zeitung, 30 October 1990, no. 252, p. 9. 26 Similar arguments are used by Robert Wade in a new book on Taiwan and South Korea. In his opinion, an authoritarian regime is better able to withstand the pressure of particular- istic interests than a democratic one. R. Wade, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialisation, Princeton: Princeton Univer- sity Press, 1991. 27 Cf. W. Wilczynski, "Der Uebergang ost- und südosteuropäischer Lander von der Zentralverwaltungswirtschaft zur Marktwirtschaft am Beispiel Polens. Aufgaben, Dilem- mas, Hindernisse," in: Österreichische Osthefte, 32nd year, issue no. 3, 1991, p. 549. 28 A. de Jasay, in loco citato, p. 324. 29 The St. Gall Center for Futurology demonstrates, on the basis of a model computation, that even "Eastern Germany" — among all the postcommunist "countries" certainly the most favored one in many respects — would require a yearly productivity growth of 15% (= more than double Western Germany's growth in the heydays of the economic miracle) just to attain in 10 years the living standard of Germany's Western half in the year 1990. H. G. Graf/F. Kneschaurek/D. Mettler, "Konjunktur & Perspektiven 1992," St. Gall, June 1991, p. 70 et seq. 30 Cf. W. A. Jöhr, "Der Kompromiss als Problem der Gesellschafts-, Wirtschafts- und Staatsethik," in: same author, Der Aufirag der Nationalökonomie. Ausgewählte Schriften, Tubingen: Mohr, 1990, p. 145 et seq. (first publication in 1958). 31 W. Eucken, Grundsätze der Wirtschaftspolitik (edited by E. Eucken and K. P. Hensel), 6th edition, Tubingen: J. C. B. Mohr, 1990, p. 308. 32 As stated by Singapore's Prime Minister Lee Kuan Yew in an interview under the headline "A map up here, in the mind," given to The Economist, issue of 29 June 1991, p. 19. According to the Japanese Masao Kunihiro, even more than 40% of all members of parliament allegedly "inherited" their seat in parliament from their fathers or grandfathers. In addition, there is the fact that the Liberal Democrats are ruling since 1950 without any interruption. Cf. "Freedom and Prosperity," in: The Economist, 29 June 1991, p. 20. 27 33 In this respect, cf. W. Schrettl, 'Transition in Depression. Soviet Monetary Issues," Eastern European Institute Munich, Working Paper no. 140, Munich, October 1990. 34 "... as true Liberalism in the past disputed the assumption of a monarch's unlimited authority, so true Liberalism in the present will dispute the assumption of unlimited parliamentary authority." H. Spencer, "The Man versus the State," The Thinkers Library no. 78, London: Watts & Co., 1940, p. 18 (first publication 1884). Compare also F. A. von Hayek, Liberalismus, in loco citato, in particular p. 35 et seq., as well as W. Linder, "Demokratie und Marktwirtschaft — ein Kuppelprodukt? Eine Handvoll Bemerkungen zum Fall der VR China," in: Informedia-Stifiung, in loco citato, p. 107 et seq., in particular p. 109 et seq. 35 Cf. P. Bemholz, "Notwendige Bedingungen fur Totalitarismus: Höchste Werte, Macht und persönliche Interessen," in: G. Radnitzky/H. Bouillon (editors), in loco citato, p. 241 et seq., in particular p. 278. 36 Cf. G. Schwarz, "Limitations...," in loco citato, p. 39. 37 Cf. G. W. Nutter, Political Economy and Freedom. A Collection of Essays, Indianapolis: Liberty Press, 1983, p. 20. 38 C. P. Kindleberger, "Crashes, Crises and Moral Capital," an interview in Challenge, vol. 34, no. 4, July/August 1991, p. 25. 39 Cf. W. Kaltefleiter, in loco citato, p. 15. 40 Based on the tacit assumption that this will practically always be so and on a rather questionable empirical fact-finding research in Latin America, David Rostov has formu- lated his rather critical view of authoritarian regimes. Cf. D. E. Rostov, in loco citato, p. 9 et seq. 41 Cf. D. Bingen, "Vorgeschichte und Phasen des Systemwechsels in Polen 1989," Berichte des Bundesinstitutes für ostwissenschaftliche und Internationale Studien, no. 34, Cologne, 1990, p. 47 et seq. 42 Cf. A. Etzioni's article, which is strongly advocating a soft and gradual political proce- dure, "Eastern Europe: The Wealth of Lessons," in: Challenge, vol. 34, no. 4, July/August 1991, p. 10. 43 Germany's disastrous economic situation also helped Erhard to achieve his objectives. Cf. R. Dahrendorf, in loco citato, p. 92. 44 L. Kohr, "Disunion Now. A Plea for Society Based upon Small Autonomous Units," in: The Commonweal, 26 September 1941. In personal discussions, Kohr referred to this article as the stepping stone for his lifelong commitment to small political units. 45 Cf. also W. A. Jöhr/G. Schwarz, Wirtschaft und Politik, in: Handwörterbuch der Wirtschaftswissenschaft (HdWW), volume 9, Stuttgart/New York: Fischer and others, 1982, p. 31. 46 Cf. E. Dürr (editor), Soziale Marktwirtschaft in Entwicklungs- und Schwellenländern, Bern/Stuttgart, 1991, p. 25.

28 Dr. Studer: Ladies and Gentlemen, I can see that Mr. George Gilder has arrived. I want to ask Dr. Gilmour kindly to give his introduction. Dr. Gilmour: It is my pleasure to introduce our next speaker, Mr. George Gilder. I think it's difficult to exaggerate the importance of Mr. Gilder's work in stimulating the economic revolution that has swept the United States and, indeed, the other Western economies during the last decade and a half. I think it wouldn't be wrong to say that he is one of the principal intellectual architects of the market revolution that has shaped many of the economic policies of the United States since the first Reagan Administration. As the author of the best-selling book, Wealth and Pov- erty, which has been termed both the bible of the supply-side revolution and a capitalist manifesto, as an economic consultant, and as a formal and informal advisor to businessmen and policymakers, Mr. Gilder's stamp is on many of the key achievements of the past two U.S. administrations. Among the most notable of those achievements have been the initiatives for lower tax rates and deregulation. This is all well known to Western economists, but it may not be so well known to you. And I think there is something more to Mr. Gilder's work that distinguishes him further from the "run-of-the-mill" market econo- mist, if there is such a thing. More than most, and more than any certainly that we have seen recently, he has resisted the intellectual temptation to reduce men and women, who are struggling under whatever regime to get along, to such terms as the "population," the "workers," the "middle class," or whatever. George Gilder is adept at describing why we try to do what we do in personal terms, in terms that make clear the importance of freedom in the economic equation, and it is my very great privilege now to introduce him to you. [Mr. Gilder gave an abbreviated oral presentation of his paper, which here is printed in its entirety - ed.]

29 THE TECHNOLOGY OF FREEDOM By George Gilder Every era achieves a cultural pinnacle. In the Middle Ages it was probably the giant cathedral, whether Gothic or Baroque. Wrought of rock and sand and glass, these cathedrals stand today as a cultural and religious epitome, a beacon of faith and aspiration reaching forth over the centu- ries — issuing a reproach to most of the architecture and art of the current epoch. Nonetheless, our own age, I believe, has summoned a monument of aspiration and faith, devotion, diligence, and art as formidable as the great cathedrals of the past. The cathedral of the twentieth century is the microchip, a tiny computer inscribed on a small piece of semiconductor material. Like the medieval cathedrals, the microchip is wrought of the commonest elements in the earth, being earth itself. But seen through a microscope, that semiconduc- tor shape emerges with the opalescent symmetry of a cathedral window. I would sum it up in a vision of sand and glass. The sand is the substance of microelectronics. It comes in the form of a silicon sliver the Size of a thumbnail that bears a pattern of wires and logic as complex as a street map of America, switching traffic in trillionths of seconds. At the heart of a microchip is the microswitch: the transistor. Twenty years ago transistors cost $7 apiece and were plugged into circuit boards one at a time by hand. Today far better, faster and more useful transistors cost a few ten thousandths of a cent. Current chips contain as many as 20 million transistors. Scores can be placed not on the head of a pin but on the point of a pin. Switched in trillionths of seconds, these devices transcend all the normal constraints of time and space. Their development is by far the most important event of the current era. The microchip of sand, however, joins with another amazing technol- ogy made of glass. The glass in the vision is so pure that if it were a window you could see through miles. But it comes in fiber optic threads the width of a human hair and as long as Czechoslovakia. It is fed by laser diodes the size of a grain of salt and as bright as the sun. Today these threads flash informa- tion between the East Coast of America and Chicago in the Midwest at a pace of 8.6 gigabits a second. A thousand bibles a second. This technology represents a vast leap ahead of the copper wires that transmit most phone calls around the globe. For example, the U.S. Con- 30 gress maintains a library holding all the publications of the Nation over the last 100 years. Using copper wires and 9600 baud modems, it would take 500 years to transmit the contents of the Library of Congress. Using fiber optic threads it would take just 8 hours. That's a 547-thousandfold advance. As this technology moves into homes and offices over the next decade, it will hugely enhance the powers of individuals to send and receive communications of all kinds, from movies and other digital video prod- ucts to whole libraries of data and text. In the process it will replace the dumb television terminal with a telecomputer that can not only receive but also shape and send digital data and images. It will endow what is cur- rently called a TV receiver with powers exceeding TV stations today. As fast as fiber optic technology is advancing, however, chip technol- ogy is improving still faster. Within the next 10 years, it will be possible to put as many as one billion transistors on a single sliver of silicon. One billion transistors is equivalent to the computing resources of 16 of the world's most powerful supercomputers, Cray YMP machines that cost some $20 million apiece. Within the next 10 years or so, this computer power will be inscribed on a single chip that will cost less than $100 to manufacture. Such an advance will mean approximately a millionfold rise in the cost effectiveness of supercomputing hardware in 10 years. Together these two technologies will create a global ganglion of com- puters and cables, a worldwide web of glass and light and sand that leaves all history in its wake. For good or ill, this technology will shape the future of all nations through the twenty-first century. The rise of these miraculous tools, I believe, both necessitates and enables a radical change in the economic structure of the formerly Commu- nist states. These microelectronic tools will allow Czechoslovakia to move toward capitalism without suffering the pains and setbacks that econo- mists often prescribe for you. You will not fall into Europe with the gravitational force of heavy industry; you can leap into Europe by provid- ing homes for the most powerful computer and telecommunications tech- nology in the world. However, the use of these new tools utterly requires the abandonment of all dreams of a centralized or protected economy. You can lead the world only by being open to it. Last year even Mikhail Gorbachev showed a recognition of this im- perative. He pointed to the most valuable resource of the age. He did not mention oil or gas or gold, missiles or nuclear power. Instead he decalred: "In the age of information sciences, the most valuable asset is knowledge, which is a creation of human imagination and creativity. We were among the last to comprehend this truth and we will be paying for this oversight for many years to come." 31 Gorbachev may be too pessimistic. Czechoslovakia in particular is full of the most valuable asset of the information age, full of well-trained and resourceful men and women. Czechoslovakia faces no inherently difficult problem of transition. You merely face the challenge of liberating your crucial resources of knowledge, now incarcerated in a million mazes of bureaucracy and still largely cloistered from the rest of the world. T.J. Rodgers of Cypress Semiconductor, one of the leading American microchip entrepreneurs, recently discovered how rich is Russia in the crucial resources of this new age. He visited the USSR this summer intent to license a graphics chip design. He expected to find the Soviet Union far behind the U.S. in semiconductors. In many ways he was right. In manu- facturing and selling chips, the Soviet Union is indeed in the Dark Ages. Compared to state of the art American chips, Soviet devices are big and slow. But in a crucial way, T.J. discovered that he had greatly underesti- mated the Soviets. Rodgers found that adversity breeds creativity. The Soviet failure to develop advanced hardware had induced great ingenuity in computer architecture and software. The absence of leading edge computer technol- ogy impelled Soviet engineers to an early mastery of the algorithms of parallel processing: using many low performance microprocessors in par- allel to emulate the most advanced single processors. Soviet computer architects and chip designers, Rodgers discovered, emerged from their crucible of privation as some of the best in the world. Some Americans making such a discovery would have hastened back to the Pentagon to report the terrible news of a new Soviet threat in microelectronics. Some American businessmen might have petitioned the government for new subsidies and supports to help keep pace with the Soviet designs. Even in America, many people see the world as a zero sum game, with every gain for one country — or company — a loss for some- one else. Prevailing through the centuries, this attitude — the view that the success of others is a threat rather than an opportunity — has blighted most of human history. The view that creators of wealth somehow oppress the poor is the most crippling prejudice of Marxism. T.J. Rodgers, how- ever, is imbued with a different spirit: the spirit of enterprise. Being an entrepreneur, T.J. on the spot decided to buy licenses to all the salable technologies he found. He bought licenses for nine chip designs. He launched a major computer project with a Soviet team. Entitled "Mir," it will be executed by a 50 man team in the USSR. Today some 15 leading Soviet engineers are working at Cypress in the U.S. T.J. was thrilled with the computer people he met. As an entrepreneur he could launch mutual projects with them almost immediately. Did he 32 exploit the Russian designers he dealt with? No. They all will gain hard currency royalties from any chips sold in the U.S. Most of their designs were too complex even to be manufactured in the Soviet Union. They will have their chips produced on the best semiconductor production lines in the world. They gain financially and they gain from the experience of having their ideas realized in hardware and sold widely to customers. In such deals, former communist states gain technologies that were previously unavailable to them and markets that were previously beyond their reach. Thus they will gain guidance about where to focus future efforts. The Soviet computer men who dealt with TJ. Rodgers came away as big winners. How about T.J.? He gained access to the most valuable resource of the information age: human creativity and imagination. He gained entrance to what will be a tremendous new market for high technology devices. He too was a big winner. That is the key secret of capitalism: win-win rivalry. Everybody wins; no one is exploited. Because every deal is voluntary, both sides gain; every transaction is a positive sum. If anyone feels unsatisfied with the terms, the deal cannot go through. Since each side improves its position through the transaction, the very process of free capitalist trading assures that national wealth increases with every exchange. Gross domestic product (GDP) rises even without the creation of any new product. The free market enhances the value of all the production of the nation by assuring that it will go to the people who want it most and can use it best. Until TJ. showed up in Zelenograd, most of the chip designs and computer architectures of the USSR were valueless because they could not find customers or manufacturers. His entrepreneurial vision lent value to intellectual properties that were valueless in a communist economy. In contrast to chip designs deemed worthless in the USSR, TJ. also visited a great center of wealth and power as judged by Soviet authorities. He visited the office of the man he said "has the worst job in Moscow." That is saying a lot. That man is the noted physicist name Yurij Pavlov. He does not sweep the streets or clean the public toilets. His job is "General Director of Moscow City Council Scientific Development Conglomerate for Automated Control Systems." He runs Moscow's governmental com- puter center. The wonders of central planning mean Yurij has to plan the movement of bread and milk. He tries to make the line shorter. He also keeps track of health care, drug prescriptions, retirement payments, water bills, apart- 33 ment rents and allocations and a long list of other services for nine million people of the city. Under communism, Yurij Pavlov was a man of great relative wealth and power. He commanded arrays of seemingly valuable computers. He helped rule the lives of millions. Unlike the chip designs deemed worth- less in the USSR, Pavlov's establishment was supremely valuable in the planned economy. In a market system, however, all Pavlov's panoply of powers and machines is less than worthless. The old IBM compatible computers he used could hardly be sold as scrap in the U.S. The work he does is irrelevant in an economy where economic planning is performed voluntar- ily by millions of individuals. It is often said that Eastern Europe cannot prosper without huge inflows of capital from the outside world. That is an absurd assumption. Eastern Europe is already glutted with capital: roads, factories, weapons, mines, tractors, schools. For decades, the communist world invested a hugely greater proportion of its wealth than the U.S. Communist systems are nearly always awash with useless capital. But without freedom, capital is blind and sterile. In a capitalist system, you do not need new capital to create wealth. Freedom in itself creates wealth just as T.J. created new wealth in Russia. By allowing the perpetuation of economic planning, outside capital may even reduce the real wealth of Eastern Europe. It may plunge the real capital of these nations — their creative citizens — into the darkness of production without free customers. Freedom means the right to fail. The key reason the U.S. economy is more successful than communist economies is that the U.S. allows more failure. U.S. scientists and engineers outproduce Soviet scientists and engineers not because they are more numerous or better trained or more talented. In fact, there are many times more highly trained scientists and engineers in Eastern Europe than in the U.S. and your students outperform American students on international tests. American students go to some of the worst socialist schools in the world, completely run by huge educational bureaucracies. Socialist bu- reaucracies in the U.S. may even be worse than socialist bureaucracies in Europe because U.S. bureaucrats can feed their mistakes from the pros- perity around them. Subsidized socialism is less productive even than penurious socialism. U.S. scientists and engineers create more value because they collabo- rate with millions in the marketplace around the world. Socialist scientists 34 and engineers collaborate only with each other and their political bosses. U.S. scientists and entrepreneurs can prevail because they can fail. Bankruptcies play the same role in economic progress that falsification plays in the progress of ideas. The eminent philosopher of science Karl Popper identifies a valid scientific proposition chiefly by whether it is stated in a form in which it could possibly be disproved or rejected. If a theory — such as that people born in August under the sign of Leo tend to be temperamental — is too general or flexible to be proven wrong, it is incapable of generating new knowledge. Similarly, if an economic plan cannot be rejected by the marketplace, it cannot generate new value. Every new business, however, provides an entrepreneurial test of a new idea. Unlike a national plan, a business plan is falsifíable. Because it can fail, it can also generate new knowledge. In fact, entrepreneurs often learn more from their failures than from their successes. By the very process of acquiring profits, they learn how to use them. By the very process of building businesses, they gain the discipline to avoid waste and the knowledge to see value. By the process of creating and responding to markets, they orient their lives toward the service of others. Entrepreneurs who hoard their wealth or seek governmental protection from rivals or revel in vain consumption or retreat to selfish isolation betray the very essence of their role and responsibility in the world. To that degree, they are no longer entrepreneurs or capitalists but relics of the feudal and static societies of the precapitalist era. Every capitalist investment has a dual yield: a financial profit and an epistemological profit. One without the other is barren. Economies progress when the process of investment is informed by the results of previous investment. Entrepreneurs like T.J. Rodgers spread wealth because they constantly accumulate new knowledge by risking failure. This new knowl- edge is the most crucial capital they wield. For many years, Marxists have believed that they could solve the knowledge problem of socialism through the creation of ever larger knowl- edge machines: computers. Giant computers could simulate markets and thus render freedom unnecessary and obsolete. I believe, however, that it is the computer that makes communism obsolete. The microchip may indeed offer the solution to the problem of socialist bureaucracy. But it is also the dissolution of socialism and all other centralized systems. The key problem of the planned economy is the explosion of complex- ity. In the planned economy only the bureaucrats can plan. But their plans inevitably break down in the nearly infinite complexities of a large economy. 35 In a free economy, all citizens and businesses can make plans. Because individual businesses face manageable complexities, they can actually carry out their plans. The paradox of the planned economy is that it prohibits all practical planning. This problem can be summed up as the law of complexity. It shows that complexity arises by the square of the number of entities to be orga- nized — whether phones in a network, chips on printed circuit boards, or prices and quantities in an urban economy. This law of complexity even confounds computations in physics, where the so-called many-body-prob- lem afflicts all analysis of relations between large numbers of entities. Amo Penzias, the Nobel laureate physicist, explains the problem in terms of the impact of an additional child arriving at a party. The noise level does not rise by the increment of one more child; it rises exponen- tially in proportion to the additional child and all the other children he may shout at and interact with. Another form of the many body — and vocal chord — problem. That's the law of the macrocosm — complexity arising by the square of the number of entities to be organized. The microcosm of silicon chips, however, a completely different law applies: the law of the microcosm. On silicon, not complexity, but effi- ciency rises by the square of the number of entities to be organized. The more transistors crammed on each microchip the cheaper, faster, cooler, more powerful and more valuable they are. This relationship is measured in the industry as the power-delay product, relating the power consump- tion (and heat) to the speed of operation of a microelectronic device.

On individual microchips the power-delay product improves exponen- tially with the increase in the number of transistors and thus the closeness they are packed together. As electrons moving in a transistor approach their mean free path — the distance they can travel without colliding with the structure of the silicon crystal — they move faster and more effi- ciently. It is as if a million more children arrived at the party and the noise level went down. These gains in efficiency, however, apply only on individual chips. You begin combining lots of chips together and the law of complexity takes hold again. The is why the Elbus strategy for saving socialism — the big computer dream — will inevitably fail. All computers will eventually become single chip systems, basically equal in power and cheap enough for anyone to buy. Any top down structure of organization — any hierarchy — will eventually collapse into a heterarchy, where equal processors, or individuals, communicate with one another on an essentially equal basis. 36 Once again, this is not an optional outcome; it is inherent in the very physics of computation. What is happening is the overthrow of the previ- ous relationship between the cost of wires and the cost of switches. Wires are the communications medium between chips and switches are the transistors that give the computer logical powers. When wires are cheap and switches expensive, it makes sense to cen- tralize. It pays to run a few more wires to an expensive central processing unit dominated by switches. This was the case at the beginning of the computer era when switches were fragile and expensive vacuum tubes. Today, however, switches are virtually free — infinitesimal transistors on a chip — while wires are relatively expensive. Under these conditions, it pays to distribute intelligence on single chips. The obsolescence of the big computer is already evident. For example, in 1977 nearly 100 percent of all the computer power in the world was commanded by large machines with dumb terminals attached. Just 13 years later, that figure had dropped to well under 1 percent. There are now over 100 million personal computers in the world and they command virtually all the globe's computer power. It is this change that dooms socialism. It is this change that permanently overthrows Marxism. Although Marx was wrong about many things, he did sense a. crucial fact about the past industrial order. In the past, ma- chines were hostile to human values. Factories worked best when indi- vidual workers adapted themselves to the machine. Industrial analysts would actually measure the movements of workers and attempt to adjust them to the requirements of the equipment they used. Even in free market economies, the factory or assembly line tended to be a top down hierar- chy, a master slave system. This system resulted in huge gains of human productivity. But whether in the East or West, it was deeply inimical to the nature of human beings. Human beings are far more like chips than like assembly lines. We have the most powerful processors in the world between our ears. Two human eyes, for example, can do more image processing than all the super- computers in the world put together. But as in the case of chips, our communications power is strictly limited. About 50 bits per second is the estimate of the experts. The chemist, Michael Polanyi, has explained the effects of this rela- tionship. It means that the bulk of human learning is tacit knowledge: it is literally incommunicable. For example, there is no way to explain how an individual reaches out and picks up a glass of water and brings it to his lips. Most of what we know about our jobs is this kind of tacit knowledge. 37 Although the industrial era hugely enhanced the productive power of human beings by raising their physical strength, this gain came at the cost of a holocaust of tacit knowledge. The nature of human beings means that an organization functions best when individuals can be coupled as closely as possible to specific prob- lems. Leaders can offer general goals and directions. But specific guid- ance and controls will cost far more in tacit learning than they will gain in efficiency. Workers must have common visions but not detailed supervi- sion. Top down bureaucracy, private or public, obliterates the crucial mental powers of human beings that elevate us above the apes and give us mastery of the world. The microchip is the first technology that accords fully with the nature of human beings as thinking creatures. Favoring heterarchy over hierar- chy, it overthrows all top down systems. As the chip reorganizes industry and commerce so also will it reorga- nize the powers of states and nations. The laws of the microcosm subvert any attempt to capture, intimidate, confine, or overwhelm the exertions of mind by the tyranny of matter. The mobility and ascendancy of mind among all the forms of capital deeply undermine the power of the state. Quantum technology devalues what the state is good at controlling — material resources, geographic ties, physical wealth. Quantum technology exalts the one domain the state can never finally reach or even read: mind. Thus the move from the industrial era to the quantum era takes the world from a technology of control to a technology of freedom. The most evident effect of the change is a sharp decline in the value of natural resources. The first industrial revolution vastly increased the value of materials. All the dirt, rock, and gunk that had been ignored for the centuries suddenly acquired worth in the age of mass manufacturing. The new industrial revolution is a revolution of mind over matter and it is rapidly returning what used to be called "precious natural resources" to their previous natural value as dirt, rocks, and gunk. The use of steel, coal, oil, and other materials is plummeting as a share of value added in the economy. As a symbol of the shift, consider two smelting processes. Smelting iron, you banish silicon in the slag as dirt; "smelting" silicon, you get rid of the iron as conductive waste. A silicon chip is less than 1 percent raw materials. A few pounds of fiber optic cable, also made essentially of sand, will soon carry as much information as a ton of copper. A single satellite now displaces many tons of copper wire. 38 This change has transformed the very foundations of geopolitics. Raw materials have long constituted a leading reason and reward for military aggression. In the past, ownership of particular regions imparted great political and economic power. The balance of power in Europe depended in part upon who controlled the coal and steel in the Ruhr Basin. The Ruhr Basin is now a European sink of government subsidies. We live in an epoch when desert bound Israel can use computerized farming to supply 80 percent of the cut flowers in some European markets and compete in selling avocados in Florida; when barren Japan can claim to be number one; and when tiny islands like Singapore and Hong Kong can far outproduce Argentina or Indonesia. To comprehend the change, consider a steel mill, the exemplary indus- try of the previous epoch: A huge manufacturing plant entrenched near iron and coal mines, anchored by a grid of railways and canals, served by an army of regimented workers, all attended by an urban infrastructure of physical systems and services. At every step the steel mill can be regu- lated, taxed, and controlled by government. Compare this massive array of measurable inputs and outputs to a man at a computer workstation, with access to databases around the world, designing microchips of a complexity exceeding the entire steel facility, to be manufactured from pattern generation tapes. Even the tape, the one physical manifestation of his product, has become optional. Without any fixed physical manifestation at all, the computer design can flow through the global ganglion of telecommunications into another computer at- tached to a production line anywhere in the world. The decline in the value of raw materials entails an equal decline in the value of geography. In an age when men can inscribe new worlds on grains of sand, particular territories are fast losing economic significance. Not only are the natural resources under the ground rapidly declining in value, but the companies and capital above the ground can rapidly leave. Commanding a worldwide network of transport and communications, the businessman sends wealth flashing down fiber optic cables and caroming off satellites at the speed of thought rather than of things. Capital is no longer manacled to machines and places, nations and jurisdictions. Capital markets are now global and on line 24 hours a day. People — scientists, workers, and entrepreneurs — can leave at the speed of a 747, or even a Concorde. Companies can move in weeks. Ambitious men need no longer stand still to be fleeced or exploited by bureaucrats. Geography has become economically trivial. The global microcosm has permanently shifted the world balance of 39 power in favor of the entrepreneurs. Using the planetary utility, they can avoid most of the exactions of the state. Without their fully voluntary cooperation a government cannot increase revenues, enhance military strength, provide for the public welfare, or gain economic clout. This good news for individuals and entrepreneurs, however, is bad news for socialism. The state can dig iron or pump oil, mobilize man- power and manipulate currencies, tax and spend. The state can expropriate the means of production. But the so-called means of production as defined by Marxists and even by many capitalists, are actually meaningless for real production. Geography hardly matters at all. For example, where is Cuba? Most people in America would answer that it is an island in the Caribbean 90 miles off the coast of Florida. But that is no longer true. Following good Marxist precepts still popular in American universities, Fidel Castro expropriated the means of production in Cuba. The result was that most of the men of production — the entrepreneurs — fled to America. As a result, in every meaningful sense, Cuba is no longer an island in the Caribbean. Cuban culture, Cuban enterprise, even Cuban cuisine have all moved to Florida and other parts of the U.S. The Cuban means of produc- tion are now in America. Indeed, the total gross national product of Cubans in the U.S. is at least six times the subsidized product of the Caribbean island. If communist expropriators took over the means of production in Sili- con Valley, the seat of the U.S. computer industry, they would find mostly sand. For the men of production, the entrepreneurs, run for the daylight of liberty. One way or another, most of the time, the entrepreneurs take their money with them or send it on ahead. But always they take their minds, and knowledge is their crucial power. Ideas are subjective events and always arise in individual minds and ultimately repose in them. The movement toward a quantum economy necessarily means a movement toward an economy of mind. Collective institutions will survive only to the extent that they can serve the individu- als and families who comprise them. This is the age of the individual and family. Governments cannot take power by taking control or raising taxes, by mobilizing men or heaping up trade surpluses, by seizing territory or stealing technology. By imperial- ism, protectionism, and mercantilism, nations eventually wither and weaken into third worldly stagnation. In the modern world, slaves are useless; they enslave their owners to systems of poverty and decline. The chief source of the new wealth of 40 nations is free immigrants; the nations of the baby dearth will compete for them to pay the pensions of their aging societies. Today nations have to earn power by attracting immigrants and by liberating their people, their workers and their entrepreneurs. The gains of the quantum era could yet be destroyed by some thug offering a final horrible holocaust to the Moloch of matter. But the logic of the technology, the logic of the microcosm, which is becoming the logic of history, runs the other way. History has capsized every prophecy of triumphant bureaucracy. Rather then a New Industrial State, this era will disclose the new impotence of the state. Rather than the Revolt of the Masses under the leadership of demagogues, this era will see the revolt of the venturers against all forms of tyranny. Systems of national command and control will wither away. Systems of global emancipation will carry the day. The dismal science of the economics of aggregates — capital, labor, and land — will give way to a microeconomics of liberty. The beggar thy neighbor strategies of mercantilism — of trade as weapon of state — will collapse before the strategies of global wealth creation under the leadership of entrepreneurs. The economics of scarcity and fear will surrender to the economics of hope and faith. The new technologies — themselves largely the creation of Promethean individuals — completely transform the balance of power between the entrepreneur and the state. Inventive individuals have burst every link in the chain of constraints that once bound the entrepreneur and made him a servant of parliaments and kings. He is no longer entangled in territory, no longer manacled to land, capital, or nationality. These developments are no special American monopoly. Indeed, much of the benefit will be lost if only the United States and a few Asian capitalist countries follow the crucial lessons of the new technology. For the central lesson is that information technology is not a zero sum game to be won by some governmentally supported monopolist. Information technology constantly redistributes its own powers as it is used. The final and most flexible source and vessel of these powers is the individual human mind. The power of information always ultimately gravitates to individuals. This is not a world in which the gain of one nation can only come at the expense of another. All the world will benefit from the increasing impo- tence of imperialism, mercantilism, and statism. In this new economy of freedom, Americans must hope for the prosperity and freedom of Rus- sians and Chinese. We must celebrate the successes of Koreans and Japa- nese. We must relish the increasing wealth and power of the Third World. 41 Most of all, we must hail the liberation of Eastern Europe — the inspiring new leadership in Prague. Depending on an altruistic spirit, the microcosm requires not only a technological renaissance but also a moral renewal. All Americans will cheer the success of Eastern Europe in its great adventure of reform. Within the spiraling gains of capitalism, impelled by the spread of infor- mation technology subverting all tyrannies, there is room at the top for all.

42 Questions and Answers

43 Q (from audience): I have one question about computer intelligence and language translation. Will computers be able to translate different lan- guages? Mr. Gilder: I actually don't think language translation is ever going to be achieved very successfully. For all the powers of the new technology, they will not succeed in readily translating between different languages. A lot of people predict this, and I think this is one of the false predictions that people make about technologies. Language is an extraordinarily subtle and com- plicated arena that can't be simulated by a computer. The more you study computers, the more you respect the human mind. Two human eyes, for example, can do more image processing than all the super computers in the world put together. It gives you a sense of humility as a computer architect to contemplate the human mind. And language is one of its greatest powers and it's not going to yield it to the computer. The computer amplifies human capabilities — it doesn't usurp them, it amplifies them. It enlarges human powers, it doesn't usurp human powers. It's the most humanistic technol- ogy ever developed, because it amplifies the most human of our powers, which is our mind. Previous technologies amplified our muscles or our other physical capabilities in which humans are not exceptional, but our mental powers are exceptional and we use the computer to enlarge them. Dr. Gilmour: George, I have a question for you. It seems that the broader implication of the technological revolution is perhaps that middlemen of all sorts are going to become obsolete as there is more opportunity for direct communications between individuals and those who want to supply them with the things they want. As you suggest, the biggest middleman of them all, the state, may be increasingly impotent in the face of technologi- cal change. Mr. Gilder: Bob Gilmour's point is that the computer age may make middlemen obsolete, because individuals can communicate and transact directly with one another, so that you don't need middlemen to manage the transactions. I think his implication is correct. The power of these technologies will erode the state, will erode the powers of the state, will undermine the possibility of socialism. I'd like to make one related point. As I said in my earlier remarks, there are many people in Eastern Europe and the Soviet Union who have great powers in software. This is true, because the absence of a market has made it impossible to create the kind of hardware production facilities that have emerged in the West. You know, silicon chip production has not succeeded anywhere in communist countries, but software one person can do by themselves. Great capabilities have emerged. And, as I said, I believe the key to it is opening to Western companies. India has a very powerful 44 software industry that began doing contract work for Western computer companies, but now is breaking off into lots of independent software producers. I think the key to it is being willing to collaborate with Western companies and not create obstacles to collaboration. The problem is that the bureaucrats, the middlemen, get in the way and often prevent these investments and collaborations, because they have to be intimate. A software project is an intimate collaboration. You have to work very closely and you have to fully understand the problem that's to be solved. If there's some middleman in there expecting a bribe, then these agreements never happen. That's the great obstacle today. When T. J. Rogers went to Russia, he thought he was a kid in a candy store. He expected to find a vast wasteland in Russia, but instead he found all these wonderful chip designers with designs that couldn't be manufac- tured. And so he signed up nine chip designs and launched two projects. Just a month in the Soviet Union, or less, he had some 15 substantial projects underway. Unfortunately, all these projects were thwarted by the Soviet govern- ment — everyone of them. All these agreements that Rogers made in the Soviet Union were followed by calls from higher level bureaucrats who wanted to participate and through whom all the communications had to pass. It was impossible to do the projects through these bureaucratic structures. T.J. still hopes that some of them will work out, but so far they've been prohibited, unnecessarily. It was all set when he left, but after he left the publicity led the higher-ups to try to get part of these deals. That's what can't be allowed to happen. It has to be direct, open communications. The United States isn't so great in some of this, too. The United States has its bureaucracies that restrict the transfer of technology to communist countries. I've always opposed most of these restrictions. I mean, when it applies to actual military hardware it makes some sense, but when it applies to computers these restrictions are worthless and obstructive to- day. I strongly oppose them in the United States and I'm making some progress. But these bureaucracies do get in the way, there's no question. Q (from audience): You were speaking about the symbol of achievement in the Middle Ages, the Gothic cathedrals. In this age we have this factor, that's the microchip, yes? Can you predict, or can you tell us something about your ideas for the future? What will be the next such dominant factor in the future? Mr. Gilder: The question is, I've presented these exciting technologies of the microchip and fiber optics, and what comes next? Well, I think that the era of the microchip and fiber optics is just beginning. They are just 45 converging now, and moving from industrial technologies to personal technologies. I think that immense movement has a long way to go. So I think that is the most powerful force today. However, in Pharmaceuticals, bio-engineering is going to be very im- portant. In 20 years, bio-engineering products of various kinds will prob- ably be of comparable importance in many ways. I see still the technolo- gies of information as peculiarly relevant to economics, because the mar- ket is an information system and that's why it works. So when you have these technologies that are directly applicable to information distribution, they have an enormous impact on economics, and politics for that matter, which is also an information phenomenon. So I think that these are the most important technologies now. But the biological sciences will yield very important medicines and will make agriculture extraordinarily more productive. We don't face any inherent limits on food production, for example. I don't think the Earth is threatened by overpopulation. I think that these new technologies amply provide for our future, assuming that we emancipate our individual pro- ducers. Thank you very much, I'm really delighted to have been provided the opportunity to speak to you. Dr. Studer: Thank you very much, George Gilder. I'm sure you have questions also for our other speakers. As we have interpreters, you can speak, of course, in Czech. Q (from audience): Yes, I have a question for Mr. Holman now, and that question concerns the privatization plans of companies who have a lot of debt. What should be in the plans of the companies with debt, what they should do with the debt when they're being privatized, according to the plans that are due on October 15th? Mr. Holman: The companies will be sold, including their debts. We will not engage in any global bailouts. There is nothing which will do it. We distinguish two kinds of privatization, or a double method. The standard ones and the nonstandard ones. As far as the standard ones are concerned, the companies will be sold to the national wealth and out of the outcome or profits of this sale the debts will be sold. As far as the nonstandard method, which is the voucher method, the companies will be privatized in such a way that their stock, their shares, will be exchanged for vouchers. The latter will be distributed to the population, to people interested. Hence, also these companies will be privatized including their debts. They will not be bailed out. I don't know if this is your question or if you're happy with my answer. 46 Q (directed to Mr. Holman): Won't the policy that you say the govern- ment will follow lead to the bankruptcy and collapse of businesses that are now troubled with debt? Mr. Holman: Naturally, the risk of bankruptcy does exist for each com- pany, in keeping with the bankrupt act, which exists in our legislation. Only such enterprises, which are overindebted, will be liquidated. The companies which are unable to make payment, which are insolvent but not overindebted, have sort of 1 year's delay. In other words, within 1 year of the validity of the act they can solve their insolvency and this kind of company should seek partnership with foreign capital. Q (directed to Mr. Holman): If the banks extend more credit to overin- debted businesses, which you seem to imply they should, won't that simply make the overall financial situation worse, since enterprises then would be burdened with even more debt and the banks would have even more bad loans? Mr. Holman: I didn't mean to say that our banks should give more credit. It depends on their complete situation. It depends on the extent of their bad loans. All I wished to say was, I wanted to illustrate one of the serious economic problems we are facing — excessive indebtedness and insolvency of companies that is at the core of the problem. The banks behave in a logical way. We cannot expect our banks to be happy to make loans to enterprises which are unable to pay back. At the same time, the expectations that the indebted companies will be bailed out are based on false hopes and the banks' notions that their bad assets should be ex- changed for state obligations, and that the latter should be paid out from the state budget, is impossible to accept at the present time. Again, as I have said, most of our companies and probably also banks will have to seek the solution of the situation by partnership with foreign capital. They cannot expect any global bailouts that would have to be paid out of the budget of the state.

47 Conclusion

Dr. Studer: Permit me a few words in conclusion, ladies and gentlemen. The Progress Foundation makes it its goal to exchange views on those conditions that promote human liberty and ideas on the market economy. We are happy to be able to pursue this goal by organizing conferences such as this one now. After today, we feel confirmed in our opinion that such meetings are useful. Allow me to thank the speakers for excellent presentations, and I would like to use this opportunity to thank the Liberal Institute in Prague, which has assisted us in organizing today's confer- ence, our best thanks. And a special thanks is directed to our lady and gentlemen interpreters and to you, ladies and gentlemen, thank you for coming and paying attention to what we are doing.

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