Does Market Economy require Democracy?

 Alone among development/transition banks the European Bank for Reconstruction and Development (EBRD) in its Art. 1 of the Agreement Establishing the Bank has a political mandate: “In contributing to economic progress and reconstruction, the purpose of the Bank shall be to foster the transition towards open market-oriented economies and to promote private and entrepreneurial initiative in the Central and Eastern European countries committed to and applying the principles of multiparty democracy, pluralism and market economics.”

When EBRD was founded – after the dissolution of the Soviet Union – in 1991, mainstream thinking aligned market economy with democracy as “virtuous twins”. Twenty years later it may be time to review the rationale behind this principle, which for EBRD has become harder and harder to implement. There are especially two reasons responsible for that:

–         For a number of years it seemed that multi-party pluralism was  the  only way to go and it was also the way most of the now 30 countries of operations of the EBRD were going.

–         There was at this time a strong presumption that market economies require multi-party pluralist democracies, in order to function.

While the Central and Southern European countries which in 2004 and 2007 joined the European Union today all have multi-party democracies where political power has changed hands several times, some countries further to the East, including Russia, Central Asian and Caucasian countries, seem to have halted or even reversed some of this early progress towards Western democracy models. In addition, especially the example of China shows that a successful market economy is also viable in an autocratic, one-party regime which has very few traits of liberal democracy.

It is especially three countries, Turkmenistan, Uzbekistan and Belarus which cause problems for the EBRD for not fully complying with the conditions of Art. 1. While conditions in these 3 countries are very diverse, and progress towards democracy on very different levels, it is quite clear that government still plays a very dominant role in these countries’ economies, incompatible with EBRD’s mission. In order to still be able to fulfil its mandate in these countries, EBRD has adopted a “calibrated” strategy to support only private sector projects and not sovereign operations, in order not to be seen as supporting these regimes. But in addition to these “obvious” non-complete democracies, observers point to a halt in democratic progress in quite a number of other countries of EBRD operations.

The crucial question, however, is whether the presumption of 1991 that market economies are only possible in multi-party democracies, i.e. the conceptual basis of Art.1, is still valid in the same way. A large number of academics and observers have long pointed to the empirical fact that market economies can thrive under very different models: the example of Chile after the elimination of Salvador Allende, of Vietnam after the withdrawal of the US forces, of Singapur’s autocratic regime, and of China during the last 20 years are the most glaring examples. Analysts have also pointed to the fact that also within the OECD countries (the 30 most advanced market-economy countries in the world) very different specifications exist with respect to parliamentary democracy –yet all OECD countries adhere to market economy principles.

This would point to the fact that the original idea of the founding mothers of EBRD in 1991: to model the formerly communist states after the example of the OECD countries, might have been too simple, too prescriptive, too ideological and maybe too naïve. It may have been the spirit of the time, carried forward by the proponents of “shock therapy” (personified in its major proponent J. Sachs) that the specific historical, cultural diversities of the ex-communist countries stood in the way of market economy and a uniform and desirable model of democracy. Cultural theory and political science in the meantime have pointed to the much more differentiated models which actually existing market economies may take. Azar Gat, in his wonderfully insightful book “Victorious and Vulnerable”, Hoover Institution, Stanford University, 2010) has pointed to the fact that the capitalist prowess of German Fascism was close to bringing down the rest of Europe and only eventually succumbed because of its too small size – when the US and the Soviet Union joined the war effort. He uses this example to show that the purported superiority of democracies plus market economy is tenuous at best, even though he acknowledges the great advancement in standards of living brought about by democratic market economies.

One of the operational effects of this “naïve” idea that a close and necessary correlation exists between market economy and democracy was that the role of the “state” – overwhelming, oppressive and stifling in the previous system – needed to be reduced towards close to that of a nightwatchman’s role – as the old libertarian dictum maintained. Forced and rapid privatization was the outcome. Today we know that this privatization “mania” led to rapacious accumulation of societies’ assets in the hands of the few and not to widespread popular ownership of assets, as the shock therapists had promised.

It is very likely that this type of privatization contributed (as “collateral damage”) in many countries of operation of EBRD to the recent stagnation or even reversal in the process towards multi-party democracy, because the new “private” owners of previously government-owned assets resist competition and governance rules and want to defend their assets from other predators. High levels of concentration, especially in commodities, lead to a concentration of political power and sometimes to destructive fights for market share and political influence. This is far from the dispersed-ownership model the proponents of shock therapy envisioned for these countries.

While crying over spilt milk does not help, it is important to re-evaluate the role of the state for the period coming after the present crisis. The crisis has shown, among other things, that weak states with badly remunerated civil servants are powerless in reigning in economic excesses. Privatized public utilities which charge non-affordable prices to impoverished households lead to widespread theft of power and water, and sometimes to citizen revolts. Lack of investment because of incomplete privatization contracts and lack of capacity to regulate and implement legal requirements by the state lead to lawlessness and corruption. Widespread corruption at the political top – especially, but not only in resource-rich countries, lead to justification by private citizens of “doing as they do”. In many countries, poor utility infrastructure, high prices and widespread corruption have halted or reversed the badly needed improvements in the standard of living. And: even more importantly, they have undermined the necessary trust relationship between government and citizens and business.

What could be the lessons for the future?

–         While the mandate of Art.1 is worth to be maintained, on the ground it needs to be interpreted widely, i.e. different  modes of democratic principles, some deviating from those in the “West”, need to be accepted as viable and as culturally and historically appropriate. If formal democracy is not necessary for establishing a viable market economy, it should be rather the content of “democracy” in the form of civil society participation in society and economy, than the “form” of governance which should govern EBRD involvement.

–         The role of the state, both as a regulator and as an owner of assets needs to be re-evaluated. A strong state with effective regulatory institutions both in the financial market sector and in competition policy is absolutely essential in raising living standards for the populations and preventing market abuses.

–         Where the federal state or municipalities own assets, EBRD should primarily make sure that these assets are being used according to market principles (“commercialization”), and only secondarily promote private ownership. Sequencing can be very important in this case. Tariff structures, investment and maintenance and universal, affordable access are the key words. Whether the assets are privatized, whether public-private partnerships introduced, whether they stay – well run – in public hands, should be secondary. This thinking should also enter the activities of EBRD.  

–         In the last decades the seemingly exclusive superiority of democracy in promoting economic and citizen welfare has come under severe “threat” by the rise of non-democratic capitalist China and others. For transition laggards there is more than one “role model”. In dealing with these countries’ march towards a functioning and sustainable market economy, EBRD needs to take this challenge into account. Operationally, this means that the more formal criteria of multi-party parliamentary democracy must be expanded or replaced by elements of good governance, citizen and civil society participation and sharing the fruits of progress and transition with the population as “make-or-break” triggers for EBRD involvement.

–         It is increasingly recognized that traditional liberal democracies with their emphasis on individualism have increasing problems with implementing collective public good activities, such as climate change mitigation and adaptation, collective security maintenance and other collective goods requiring solidarity and sacrifice. This makes less liberal governance models also attractive to “left”, egalitarian movements. Thus, liberal democracy may come under increasing pressure from both the left and the right. EBRD’s emphasis on project finance to some extent exempts its interventions from such considerations. Increasing emphasis on climate-related activities (clean energy, energy efficiency, environmental and social safeguards), however, also require fresh thinking by EBRD.

Erfordert Marktwirtschaft die liberale Demokratie?

EBRD ist die einzige Entwicklungsbank mit einem politischen Mandat. Dieses fordert die EBRD auf, nicht nur für den Übergang zu einer tragfähigen Marktwirtschaft zu sorgen, sondern dies nur unter Beachtung des Fortschritts des jeweiligen Landes zur pluralistischen Demokratie zu tun.

Diese Denkweise, Demokratie mit Marktwirtschaft quasi gleichzusetzen, war unmittelbar nach dem Zerfall der Sowjetunion und der Gründung der EBRD im Jahr 1991 verständlich. In der Zwischenzeit schleichen sich jedoch Zweifel ein: eine ganze Reihe von EBRD-Klienten hält auf dem Weg zur Demokratie inne oder schreitet sogar zurück, trotzdem geht der wirtschaftliche Aufholprozess zur Marktwirtschaft voran.

Die damals verständliche negative Einstellung zum Staat hatte zur Folge, dass Staatseigentum massiv und rasch privatisiert wurde, da der Staat vollkommen desavouiert war. Folge war die Anhäufung früher gemeinwirtschaftlichen Reichtums in den Händen weniger. Diese bekamen damit auch grossen politischen Einfluss, den sie zur weiteren Bereicherung und Absicherung ihres Reichtums nutzten.

In der Zwischenzeit hat man erkannt, dass auch in den Transitionsländern ein starker Staat als Regulator notwendig ist, um die Rahmenbedingungen für das Funktionieren einer wettbewerblichen Marktwirtschaft durchzusetzen, sowohl im Finanzbereich, bei der Sicherung der Eigentumsrechte als auch bei der Durchsetzung von Wettbewerb und Arbeitsnormen. Die frühe Privatisierungs-“manie” hat oftmals Staatsmonopol durch Privatmonopol ersetzt und, vor allem im Bereich der öffentlichen Dienstleistungen zu exorbitanten Tarifen und wenig Investition geführt – und damit die Bürger zynisch werden lassen. Damit einhergehende Korruption durch politische und private Eliten hat ganze Gesellschaften mit Korruption durchseucht („wenn die da oben… dann dürfen auch wir“).

Eine realistischere Einstellung zum Staat als Eigentümer sollte Institutionen wie die EBRD dazu führen, der Kommerzialisierung von Versorgungsleistungen Priorität zu geben, damit allgemeiner leistbarer Zugang zu hochqualitativenLeistungen gesichert wird – und eventuell erst in weiterer Folge eine mögliche Privatisierung zu unterstützen – und nicht umgekehrt.

Der Aufstieg kapitalistischer nicht-demokratischer Staaten (historisch: Nazi-Deutschland, Italien, Chile; aktuell: China, Singapur) weckt Zweifel an der exklusiven Vorbildfunktion der OECD-Staaten für die Transitionsländer im Osten. Dazu kommt, dass die vielleicht naive Einheitsformel für Demokratie in Art. 1 der EBRD-Satzung zu wenig Rücksicht auf historische und kulturelle Eigenheiten vieler Staaten gelegt hat. Daher sollte Art. 1 in Zukunft stärker inhaltlich als formal interpretiert warden. Dabei geht es um Rechtsstaatlichkeit, Sicherung der Eigentumsrechte,  Teilhabe der Bürgerinnen und zivilgesellschaflticher Institutionen und um ökonomische Verteilungsfragen. Die zunehmende Schwierigkeit, in liberaldemokratischen Ländern Bereitschaft zur Durchsetzung von globalen Kollektivgütern, wie Klimaschonung, Krankheitsverhinderung, Terrorbekämpfung und anderen zu finden, macht auch von “linker” Seite stärker autokratische Systeme akzeptabel. Die liberale Demokratie kommt daher sowohl von rechts wie von links unter Druck (siehe dazu das hervorrragende Buch von Azar Gat. Victorious and Vulnerable. Hoover Studien, Standford University, Rowman and Littlefield, 2010).



Filed under Global Governance, Socio-Economic Development

4 responses to “Does Market Economy require Democracy?

  1. Pingback: Entwicklungszusammenarbeit: Auf dem Weg zu einer neuen Governance-Architektur? | Kurt Bayer's Commentary

  2. Your blog is so informative … ..I just bookmarked you….keep up the good work!!!!

  3. Werner Kiene

    This is an excellent and timely piece. I think your observation that there is a need to look at the functional aspects (rule of law, security, etc) more than just at the formal ones is pointing in the right direction and is gaining increasing acceptance. But do we have a good enough metric to decide what functional aspects are sufficient and where do both democracy and the market economy start to suffer?
    I am a bit troubled,though, by your allusion that a strong state and democracy must always be on opposite ends. or did I misread you at this late hour of my day… while you wrote that piece at an early hour of your day.

    • kurtbayer

      Werner, thank you: I do not think we need quantitative metrics to decide on functional democracy, qualitative assessments are adequate.
      On your last note: I just wanted to point out that especially with climate change (but also other public goods) individual liberal democracy is not very good at delivering remedies, since everybody protects his own turf – and long-term issues are very hard to get into public consciousness now. Thus I do not see a basic incompatibility of strong state with democracy, “just” with respect to the provision of some public goods.

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