THE CASE FOR REDISTRIBUTIVE LIBERALISM

James Stodder, Lally School of Management & Technology, Rensselaer at Hartford, stodder@rh.edu

(written December 9, 1997)

in the Journal Economic Systems, March 1998

Published by the Osteuropa Institut, University of Munich

Any policy mixing market liberalization with egalitarian redistribution may seem unbalanced, even self-contradictory. In fact, there is an important tradition of "redistributive liberalism" associated with the growth of capitalist relations, going back at least to the redistribution of lands in the English Civil War and French Revolution (Schmidt 1997).

In the mid-19^th century, John Stuart Mill, a founder of the Liberal Party in Britain, argued both for laissez-faire and against the institution of inheritance. His Principles of Political Economy (1848) was sympathetic to the egalitarian goals of socialism, and claimed that for the "beneficial operation" of the institution of private property:

Every full grown man or woman ... would be secured in the unfettered use and disposal of his or her bodily and mental faculties; and the instruments of production, the land and tools, would be divided fairly among them, so that all might start, in respect to outward appliances, on equal terms. (Book II, Chapter 1, "On Property")

So while the question of "the least growth inhibiting redistribution" posits a tradeoff between equality and growth, Mill, Bentham, and other liberals considered an egalitarian distribution of wealth important for justice and for growth in what we now call "human capital." (Mill did not argue, however, for the equalization of incomes ex post.) This theme is consistent throughout what became, for the English-speaking world, the standard economic textbook of the late 19^th century (Riley 1994, xviii).

The neoclassical model of the 20^th century pointed to a quite different policy, one of distributional indifference. Assuming (i) convex preferences and production, and (ii) perfect information, efficiency is unaffected by the initial distribution of wealth. In the absence of such nice assumptions, of course, efficiency may well be affected.

With imperfect information, financial assets usually determine one’s access to credit. In a new international data set compiled for the World Bank by Deininger and Squire (1996, 1997), an initial inequality of land holdings is found to be a major barrier to growth. Of the 15 developing countries with Gini coefficients on land in excess of 70 percent, the authors find that only two grew at an annual rate of more than 2.5 percent over the period from 1960 to 1992.

The "contradiction" between economic growth and redistribution, therefore, is often a conflict between political interests, not a self-contradictory economic logic. The forces for redistribution of land are usually hostile to free markets, as in the failed Mexican ejidos or Soviet kolkhozes. The elites favoring liberalization, on the other hand, can usually block any substantial redistribution of wealth, as in the tepid land reforms of the Philippines or Central America.

Postwar South Korea and Taiwan were in a position to escape this contradiction. The unusual combination of (i) a defeated "collaborationist" landlord class and (ii) US-backed competition with a communist "twin", allowed each regime to embrace (i) massive transfers of land and (ii) export-led growth. Major studies on the development of Korea (Adelman and Robinson 1978) and Taiwan (Kuo, Fei and Ranis 1981) emphasize that land reforms permitted a better matching of land and labor, faster growth of wages, a more diversified rural industrialization, as well as more income equality.

The transitional regimes in China and Vietnam adapted this redistributive market strategy to their own circumstances. Both countries undertook a "socialist privatization" that returned control of the land to the direct control of village authorities and individual peasant families. In Vietnam, these were known as the "new road" reforms, and in China, as the Town-Village Enterprises (TVE).

The success of these reforms is well-known: China has grown at a real rate of about 9% for nearly two decades, and Vietnam at a similar pace since 1989. Yet the Asian transition has been dismissed as basically irrelevant to Central and Eastern Europe (CEE) and the Former Soviet Union (FSU) by most prominent Western-trained economists; e.g., Sachs and Woo (1996). (For a survey of this debate, see Benziger, forthcoming.) These economists stress that it is far more difficult to redistribute ownership in an industrial economy with a huge state-owned sector than for one overwhelmingly based on peasant agriculture. While this is certainly true, the basic challenge posed by the Asian transition experience has still not been addressed.

Most Western economists concentrate on getting the domestic prices "right" and see distributional issues primarily as a political constraint, with a shadow price that should be minimized. In this, of course, they have consistently applied neoclassical theory. The Chinese and Vietnamese reformers, by contrast, had neither neoclassical nor Marxist theory to guide their transition. As Benziger (forthcoming) puts it, they were wise enough to realize that they did not know what they were doing. Even the dramatic Chinese agricultural reforms were not really a "big bang", but a series of piecemeal measures stretching out over nearly a decade. They were, in the Chinese phrase, "crossing the stream by reaching for the next stone."

It will be objected that the new governments of CEE-FSU did not have political of such a slow inductive approach, and it is true that the absence of a strong state has hurt the coherence of any transition. But it is those countries of CEE with the strongest democratic movements pre-1989 that have built the most coherent states post-1989, and this legacy could have been strengthened. The new governments of CEE-FSU were in a position to deny compensation to the old "owners" of land and capital, and thrown their economies open to the population’s enthusiastic, if naive, free market embrace. And like the post-communist regimes of China and Vietnam, they might have transmuted socialist egalitarian values into a new redistributive liberalism. The early 1990s talk of a "third way" in CEE-FSU showed that such hopes were common.

Instead, most of the new political leaders chose the quieter, more familiar, and more personally lucrative path of "insider" privatization, ceding assets to existing management and workers. Vaclav Klaus, the recently fallen Czech prime minister, stood virtually alone in his bold mix of redistribution with laissez-faire. Klaus’s stance recalled an earlier, heroic period of bourgeois virtue, one for which many, East and West, seemed nostalgic. His "capital reform", the mass distribution of equity through vouchers, was the closest approximation to the East Asian land reforms. Klaus (1995) explicitly justified this redistribution as creating mass support for privatization.

But the redistribution of equity is not so simple as the redistribution of land, and Klaus was not so austerely liberal as he seemed. State banks controlled the mutual funds in which most Czechs placed their newly minted vouchers, and these proved reluctant to liquidate "their" former state industries. An unsustainable current account deficit, insider-trading, and banking scandals were the result, and these finally brought down the Klaus government. Many analysts now blame Klaus’s debacle on his egalitarian distribution of Czech vouchers.

There is no doubt that a broader distribution of capital assets makes oversight and control more difficult. But this is an issue that is far from settled within the mature market economies, as is clear from debates around the power of institutional investors in the US, or the state support of banking in Japan. One cannot dismiss three years of strong growth, or the speed of economic reforms that made the Czech Republic the first country in CEE to be invited into the OECD, just because they failed to solve the riddle of corporate governance. That being said, however, one should note that some economic theories of "shareholder socialism" (Roemer 1994) do stress the oversight of funds by public banks. Those arguments must now be reexamined.

Any review of Czech voucherization must first of all acknowledge the impressive gains in political stability. Earle et. al. (1997) use a 1996 survey to show that the majority of Czech citizens who retained and reinvested their original voucher shares were far more likely to express "strong support" for the economic reforms, and overwhelmingly more likely to oppose price controls, than the minority who had sold their vouchers immediately for cash. One must question the direction of causality here, but the broad appeal of the Czech voucher scheme makes it unsuitable as a screening device for committed liberals. Over 80 percent of citizens were still holding some of their original vouchers by early 1996, and over 50 percent still held them all (Earle et. al. 1997, p. 44).

This broad political legitimacy, and what was the longest-surviving government in CEE until its recent fall, made the Czech Republic highly attractive for direct foreign investment. It received over 7.5 billion dollars of direct investment on a cumulative basis from 1989 to mid-1997, second only to Hungary in CEE (Done 1997). The current political uncertainty, however, will bring this strong inflow to at least a temporary halt.

But in addition to this remarkable support for reform, the Czech share redistribution has been accompanied by (i) admirable growth, (ii) low unemployment by OECD standards, and (iii) astonishingly low inequality.

Growth: GDP per capita growth rates adjusted for purchasing power are available from the CIA (1996) for 1993 through 1995. Czech growth averaged 3.7 percent in these years, with Romania and Poland growing at 6.1 and 6.6 percent respectively. All other CEE states did worse than the Czech Republic, however, while Russia and Ukraine were still in steep decline.

Unemployment: The projected unemployment of the Czech Republic from 1993 through 1998 averages 3.6 percent, among the lowest in the OECD (1997). Hungary’s unemployment over this period is also impressive, at 4.3 percent. Unemployment in Poland and the European Union were at 12.8 and 11.2 percent respectively over the same period.

Inequality: The World Bank inequality data of Deininger and Squiles (1996) show the Czech Republic with one of the lowest Gini coefficients in the world, and the lowest of all CEE countries for every year from 1989 to 1994. Those countries are: Bulgaria, Czech Republic, Estonia, the Former Soviet Union, Hungary, Latvia, Lithuania, Poland, Romania, and Ukraine. Russia is not included in these data, but by 1995 it had a Gini coefficient of 46 percent (Commander et.al. 1997), one of the highest in the world.

Ranking income distributions simply in terms of Gini coefficients cannot be justified in terms of any concave welfare function, as is well-known (Atkinson 1970). Nevertheless, the relatively slow rise of the Czech Gini, when combined with its steady economic growth, means that the overwhelming majority in the Czech Republic have probably gained from since 1992. Inequality in all CEE-FSU countries has risen, but the relatively small increase in Czech inequality is striking. The latest Gini coefficient for the Czech Republic was 28.3 in 1994, still below that of relatively egalitarian distributions such as Sweden or the Netherlands (Deininger and Squiles 1996).

Although Czech growth is likely to fall in 1998, the performance of the past four years is impressive. Whether this momentum can be regained is now very much in question. But in any case, the goals of Czech macroeconomic policy -- restructuring without the demand shock of mass unemployment – are probably impossible without their corollary, the massive redistribution of assets.

Why should macroeconomic success be linked to redistribution? In addition to the broader access to credit made possible by broadly distributed financial assets, as in developing country land reform, there are other issues specific to "capital reform." The problems of oversight have been mentioned, but there are also efficiency gains from diversification and liquidity. Capital markets need the risk-reduction and liquidity that can only be achieved by portfolios that are both diversified and widely held, as opposed to holdings that are highly concentrated and limited to a few insider owners.

While failing enterprises were propped up for too long in the Czech Republic, a well-designed redistribution of capital should actually improve the mobility of labor. Since many state firms still need liquidating, the risks of ownership should not rest solely on employees or local governments. Their employment risks are already concentrated enough. Firm-specific knowledge may make it more efficient for some firms to be closely held, and employees who wish to purchase their own firm should therefore be given favorable (but not concessionary) terms. In most cases, however, as with the Investment Privatization Funds (IPFs) in the Czech Republic, or mutual and pension funds in the West, people will choose to diversify their holdings. Growing financial diversification in the West has probably strengthened the population’s tolerance for risk and restructuring, and there is no reason why it cannot do so in the East.

Russia, Poland, and Hungary have had recent elections that raise the prospect of a return to power by anti-liberal communist-nationalist forces. One cannot be as sanguine about liberal redistribution as at the time of the first voucher schemes proposed for Russia (Feige 1990) or Poland (Frydman, Rapaczynski, et. al. 1993). If privatization can be attacked by the authoritarian left, however, it is still possible that the emerging distribution of that private wealth can be affected by the liberal left.

That market imperfections determine the most efficient distribution of rights and liabilities is the starting point for the microeconomic analysis of property rights. The Law and Economics school has seen the common law as "an attempt to increase the value of [a] resource by assigning property rights to those parties ... in whose hands the rights are most valuable" when transactions costs preclude their efficient transfer (Posner 1972, pp. 17-18). A similar research program has, until recently, not been directed at the most fundamental fact of property, the distribution of wealth itself. If financial markets are assumed to have no serious transaction costs, then the question of an efficient distribution of wealth never arises.

Classic liberals like Jeremy Bentham and John Stuart Mill knew better: distribution matters. Real markets "care" about the distribution of assets, risks, and information. In the laboratory of capitalism’s most recent revolutions, Mill’s proposition is being tested: for liberal property relations to flourish, property is best distributed liberally.

References

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Atkinson, Anthony B., "On the Measurement of Inequality", Journal of Economic Theory, 2, 3, September, 1970.

Benziger, Vincent, "Can China’s Gradualist Reform Strategy Be Applied in Eastern Europe?", Journal of Asia Pacific Economy, forthcoming 

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