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Free trade and tolerance The case of Switzerland

Victoria CURZON PRICE University of Geneva MPS Regional Meeting Iceland 21-24 August 2005

Small western states tend to be wealthy. The only major exception to this rule used to be Ireland, but the Irish have remedied this in a spectacular fashion in the short space of 20 years proof that sensible policies can work wonders. The main reason why small states tend to be wealthy is simply that they trade more than big ones. You could say that this is not a matter of choice, but of simple economic geography. But you would be wrong. Any state, large or small, must have a policy with regard to foreign trade, and protectionism can be found everywhere (see, for instance, New Zealand and Ireland before the 1980s). The set of small, wealthy states that exists today is a mere remnant of that which used to exist before the political consolidation of the United Kingdom, France, Germany and Italy. I would argue that only those small states managed to resist the loving embrace of their larger and more aggressively inclined neighbours, which were wealthy enough to defend themselves. Some, like Austria (after 1918), Belgium or Luxembourg, were often invaded and only survived as independent entities through sheer luck. But many, many nations disappeared during the 17th-20th centuries: Scotland, Wales, Bavaria, Saxony, Brittany, Normandy, Burgundy, Savoy, Catalonia, Sienna, Florence the list is endless. But Switzerland, the Netherlands and the Nordic countries actually survived. Perhaps geography helped, but they were also serious traders, rich enough to raise strong armies or navies in time of need. So free trade, it could be argued, was part of the story of their political survival.

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Switzerland is an even more curious case. It was briefly invaded by Napoleon (who was not?), but otherwise managed to keep itself independent from its much larger neighbours, for all the well known reasons, among them the fact that the great powers could not let any one of their members control the Alpine passes to the detriment of the others, so they agreed to recognize Switzerlands neutrality from an early date. But I would like to point to some interesting lessons to be drawn from this little country all the same. Un peu dhistoire Some time in the 12th century (no one knows the exact date)1 some tough mountain peasants threw a bridge across the deep Alpine gorge through which rushed the river Reuss, transforming a dead-end valley (known romantically as the Trou dUri) into a major trading route leading to the Saint Gothard pass. The inhabitants of the forgotten valley soon became wealthy, from the tolls charged on crossing the bridge, the nice hotels they built for weary travelers, and from becoming themselves traders between the North and the South of Europe. What did they do with their newfound wealth? They bought their freedoms. These were feudal times, so this meant offering the distant overall Emperor Frederic II a once-and-for-all cash indemnity (the actual amount is unknown), in order to escape from the local feudal overlord, one Rudolph of Habsbourg (whose descendants later became Emperors themselves) in exchange for the right to appoint their own judges, to run their own affairs and to answer to no one, except the Emperor himself. By the time Rudolphs successors had woken up to the fact that a small, wealthy and strategic group of mountain people had escaped their grasp, and had sent in armies to beat them into submission, the three original founding states of the Swiss Confederation possessed enough military strength, and love of freedom, to send the Habsbourg armies packing. Love of freedom is not enough This episode tells us something. In the 12-13th centuries, many towns and regions became wealthy enough to buy their freedom in this way, but very few managed to keep it: local gangsters soon conquered them again, because the Emperor was far away and engaged in other battles (mainly with the Pope). The Uranais had no monopoly on the love of freedom, but they were able to
1

The facts which follow are taken from the following excellent and very readable history of Switzerland: William MARTIN, Histoire de la Suisse: essai sur la formation dune confederation dtats , Payot, Lausanne, 1966.

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maintain it because they remained wealthy through trade, able to spend enough on mercenaries and military hardware to keep the aggressors at bay. Not only did these simple mountain people have a taste for freedom (otherwise, why spend good money buying it?), but the success of their venture meant that more and more people, from more and more adjacent valleys, wanted to join them. Love of freedom proved contagious and widespread. Switzerland dates its foundation from 1291, when three mountain communities (Uri, Schwyz and Unterwald) made a solemn and secret vow to stand together for ever against the Habsbourgs or whoever else aimed to take their freedoms away. This original pact between the three mountain communities snowballed into a broad military alliance, embracing ever more members and becoming ever stronger. Maintaining independence from the Habsbourgs occupied the following centuries, constant battles forging links between what became, over time, a curious collection of Northeners, Southeners, Germans, French, Italians, Romanches , Catholics, Protestants, mountain peasants and traders. This loose confederal structure of some twenty distinct and fully sovereign communites lasted until 1848. Every time internal conflict threatened to tear them apart, with Prussia, France and the Austro-Hungarian Empire waiting eagerly to pick up the pieces, in the end the desire to be free from foreign domination kept them together. Love of freedom was the common thread which transcended ethnic, linguistic, religious and geographic divides. A voluntary, contractual State Dare I say that Switzerland, along with the United States, is one of the few truly contractual states ever created? Most other states were created through conquest and submission. Switzerland was created by a set a voluntary treaties, entered into by small sovereign entities, not at a single sitting, as in Philadelphia, but progressively over something like 800 years. And it has survived, no mean feat, when surrounded by some of the most aggressive nationstates ever to have emerged in the course of history. It is therefore no surprise to me that Switzerland has not joined the EU, of which France and Germany (ancestral enemies, despite the linguistic and cultural affinities with different parts of the country) are founding members Direct democracy Another aspect of the free and voluntary nature of the Swiss state is its system of direct democracy. I dare say that Iceland may have something similar, because it, too, may have escaped the fate of conquered peoples. But the

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Swiss, as far as I know, are pretty unique. It is as nice an example of an institution which spreads because it contributes to the success of the people who adopt it as one could wish to find. The three original Cantons were no more than high mountain valleys, in which the tough climate and terrain imposed rigorous and forward-looking survival strategies. Among other things, it made no sense to graze cattle on private plots of land. Such land as there was had to be managed collectively, with no margin for mistakes. So all able bodied men took the relevant collective decisions together, and open air democracy was born. Curious! There was no feudal lord, because he was far away in Vienna or Aix-la-Chapelle, and no local gangster chief emerged, perhaps because these mountain herdsmen would have slit his throat in the night In any event, the news soon traveled, and as more and more Cantons joined the original three, their own people claimed the right to this extraordinary institution which, more than anything else, symbolized their escape from coercion under a feudal lord and gave their love of freedom tangible form. After all, the leaders could have decided otherwise they could have joined any number of neighbouring kings, dukes and princes, all eager to enlarge their domains. But they decided to join the curious Swiss Bund instead and found that direct democracy was often part of the bargain. By 1848, when the sovereign communities finally decided to pool their sovereignty and agreed to create a federal state (after a short civil war), direct democracy had spread to almost all the members of the Bund. After 1848, it was also extended to the federal state itself, which was subjected to referenda and intitiatives on the part of the people. Thus the pooling of sovereignty did not imply submission to a higher authority, since the people remained in charge. And this is no myth. To this day, the Swiss are constantly voting on all sorts of matters at Communal, Cantonal and Federal level. The votes often appear contradictory for instance, last spring, the Canton of Geneva voted (a) not to increase taxes, (b) not to reduce unemployment benefits and (c) to proceed to a balanced-budget constitutional amendment. It drives the politicians mad, because what the voters were really saying was reduce public sector employment. No surprise that there is a widespread movement among the political class, from both ends of the political spectrum, to limit the right to call for referenda, raise the number of signatures needed and reduce the time-frame within which to do so, all in the name of efficiency. So far, predictably and sensibly, the people have rejected such notions. Direct democracy and the EU

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Direct democracy is the principal institutional reason why Switzerland cannot join the EU: every EU directive would be submitted to a referendum, with very little chance of success. As it is, the bilateral treaties which Switzerland has painstakingly negotiated with its giant neighbour are constantly threatened with rejection. In a months time, on 25 September 2005, we shall be voting on whether or not to extend the free movement of workers to the new members of the EU. If we say no, all previously negotiated treaties become null and void and we shall return to the 1972 free trade area in industrial products. According to the polls, it will be a very close call either way. The political class is frantic. They want to join the EU and abolish direct democracy Size of State You might think that with such a break on the State, Switzerland would have a very small ratio of public to private expenditure. Not so. Switzerland is well up with the rest of the OECD, after a remarkable burst in the growth of social spending since the 1980s, which just goes to show that there is no law against economic suicide, and even the most democratic country in the world can still freely decide to destroy its economy. Actually, Switzerland is not quite there yet, and there is still hope that its tradition of tough self-reliance will gradually replace the woolly do-gooders, the apparently harmless soft socialists who just want the world to be a better, kinder place and to round out the hard edges of capitalism In other words, Switzerland has not escaped the general climate of the times, prevalent in Western Europe since 1945, and which is perhaps only now beginning to recede in the face of zero growth and high unemployment. Free trade Where Switzerland differs from many other European countries is that it has not turned its back on free trade. With the known exception of farming, which I shall return to in a moment, Switzerland does not protect its tradable goods sector, and has always appeared to me fairly open in most commercial service sectors, like legal services, banking and insurance. The reason is, I believe, quite easy to spot. In all other parliamentary democracies, as Buchanan and Tullock have taught us, political parties are always trying to buy support from marginal voters, by offering this or that group some protectionist privilege or other, while other voters remain in blissful rational ignorance. This simply does not work in Switzerland, where every proposal to raise taxes on this or that imported product, immediately divides the country along its numerous communitarian fractures: religious, ethnic, linguistic, professional, geographic etc. The winners and losers are immediately identified, the latter raising a

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storm of protests and threats of multiple referenda. In Switzerland, voters are not rationally ignorant. If anything they are rationally ungovernable. It is like public choice theory in reverse: since any policy change inevitably involves some losers, they are immediately alerted and begin working the direct democracy levers. The mere threat is often enough to stop the proposal dead in its tracks. The downside to this is extreme conservatism. It takes a very long time to change anything, even when it is clear to almost all that something needs changing urgently. Although Switzerland is nominally a normal majoritarian federal democracy, with all the usual institutions (upper and lower houses at federal and often also at cantonal level), Swiss politicians know that they have to negotiate a very broad consensus if they are to avoid failure of their policies before the people. Both North2 and de Jasay3 argue convincingly that in normal parliamentary democracies, when economic change threatens the existing pattern of income distribution, upon which the State depends for the consent of the governed, those suffering a decline in their fortunes will claim, and often obtain, protection from the State, for the general reasons given by Buchanan and Tullock. As we have just seen, Switzerland is immune from this process because of its complex multicultural setup, and the institution of direct democracy. Free-riders, parasites and predators The free-riders in Switzerland and there are some have basically inherited a privileged position from some way back. This is true of farmers, who have benefited from a 60-year post-war thank you for having saved the country from starvation during the second World War. It is also true of many parasitic cartels which survive, rather anachronistically, in the non-traded goods sector, especially the building trades, personal services (especially medical) and retail distribution, contributing to the notoriously high price level. These privileges are gradually succumbing to competition in services imposed on Switzerland by WTO and/or the EU. Without the help of these two external pressures, Switzerland would be caught indefinitely in its web of conservative immobility but as it is, things are gradually changing. In fact, the strength of the agricultural lobby is waning as memories of the war years fade and as the
2

Douglass C. NORTH, Structure and Change in Economic History, Norton & co., New York etc. 1981, pp. 201-209, later fleshed out in greater detail in Institutions, Institutional Change and Economic Performance, Cambridge University Press, Cambridge, 1990. 3 Anthony de JASAY, The State, Liberty Fund, Indianapolis, 1998, especially pp. 205-249.

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population becomes more and more urbanized. Of true predators there are none: there are no big monopoly public service providers, no subsidized national champions (Swissair was allowed to go bankrupt); there is no industrial policy at all, and very little by way of inter-cantonal fiscal transfers. Fiscal federalism and tax competition There should be more fiscal competition between Cantons than there is4. The Cantons have basically succeeded in forging a tenuous fiscal cartel, and fiscal competition is the exception rather than the rule. However, this does not imply harmonization of Cantonal tax rates, which remain very different. Furthermore, politicians (and the public) at Cantonal level are anxious to preserve their discretionary power in this area the power to tax remains, after all, an important attribute of sovereignty. Rather, the different rates of Cantonal tax should be seen as reflecting an equilibrium, keeping the relative position of different Cantons, with very different fiscal potential, more or less stable. Rich and economically dynamic Cantons tend to have high tax rates, poor and agriculturally dominated Cantons tend to have low ones, and receive various federal subsidies as a result. The motor car and a decent road network may be disturbing this traditional equilibrium, as more and more people choose to live in one low-tax Canton and work in another, high-tax one, creating huge traffic jams on motorways at rush hours. Fiscal federalism extends all the way down to the Communes, of which there are over 3,000. Frontiers between one local tax jurisdiction and another are ever present and very close to each other. People are hyper-vigilant. They look out for fiscal spill-overs like hawks dont try leaving your garbage in another Communes bins If your Commune has no crche, too bad the neighbouring Commune will put you right at the bottom of the waiting list. It is said, but I have not seen any studies to support this hypothesis, that regulatory and fiscal competition is much more lively at the level of the Communes than at the level of the Cantons. If so, think about it: 3,000 autonomous decision-making units for a country with a population of 7.2 million, makes for an average unit size of only 2,400 inhabitants, of which probably only two thirds have voting rights (allowing for children and foreigners). Combined with direct democracy, this provides people with an amazing hold over their political destiny (average weight of a vote =1/1,800th, compared with 1/40 million in the UK, for instance) . And yet voter apathy
4

See my Fiscal Decentralisation : the Swiss Case , Journal des Economistes et des Etudes Humaines, Vol. XIII, No. 4, 2003, pp. 527-544.

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is a problem. Abstentionism is on the rise. People are costly content, most of the time. Tolerance We now can explain how a culturally complex country like Switzerland can actually work. It works because federalism is pushed to the extreme. The principle of subsidiarity is elevated to virtually religious status. It turns out that in practice, public expenditure is split evenly 1/3+1/3+1/3 between the three different levels of government. Only the federal 1/3 requires intercommunitarian negotiations, the remainder being reduced to local, fairly homogenous social groups. So nobody is forcing the French or Italian speaking minorities to get along with the German speaking majority. They go their own ways most of the time. But thereby hangs a story. As part of the Congress of Vienna in 1815, the Canton of Bern acquired some new territory in the Jura mountains, on the frontier with France. The inhabitants of this new province were a mixture of French and German, of Catholics and Protestants. But the lines were blurred. For a long time the French and German Protestants so outnumbered the French and German Catholics that no separatist movement developed. But after World War II, the linguistic divide began to take precedence over the religious, and a Jura libre movement started. After a 20-year struggle5 and one violent death, a new French-speaking Jura Canton was created in 1975. This in itself is a remarkable fact, but even more remarkable is the level of decision-taking which was involved, and the fact that the process of creation was only started in 1975 it did not end for another twenty years. The jigsaw puzzle of communal sovereignty6 resulted in jagged and irregular cantonal boundaries and some enclaves (or exclaves, depending on how you look at things). Thus there are to this day small bits of Geneva in the Canton of Vaud, and several bits of Bern were left in the new Canton of Jura (and vice versa). The process of creating the Canton of Jura finally came to an end in 1995, when the enclaved commune of Vellerat (with 70 voters, the majority of whom were French speakers) chose to leave Bern and join Jura7. According to Steinberg (p.88), splitting political units in this way acts to reduce friction or, at least, to contain it in the smallest element of tolerable
5

The details of which will not retain us here, but which can be found nicely summarized in Jonathan STEINBERG, Why Switzerland?, Cambridge University Press, Cambridge, second edition 1996, pp. 89-98. 6 STEINBERG, op. cit. p. 88 7 idem p. 97

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dissatisfaction the system works because the parts are moveable. The parts are moveable if the sovereign says they are. Conclusion The story of Switzerland, from the Grtli pact of 1291 to the creation of the Canton of Jura in 1995, is one of people who have little in common save a notion of independence and love of freedom from outside interference. The counterpart to this is that they also have very little desire to get involved in running other peoples affairs. The Canton of Bern, once the French-speaking Jura minority made its feelings clear, had no imperialistic wish to run the affairs of a hostile minority. While the splitting of political units into tiny elements probably entails some cost in terms of lost economies of scale in the provision of some public goods (and even this is debatable), there is a huge gain in terms of the legitimacy of the State. Anthony de Jasay reminds us that a state obtains obedience in one of three ways: repression, bribery and consent8. Most modern democratic states end up using, and abusing, the second of these (with the political class bribing marginal voters to maintain power). The population becomes disheartened by the endless churning and redistribution of income, and rulers have to put up with an increasingly dissatisfied and sullen electorate. The art of democratic government is to obtain the willing consent of the governed by legitimacy. In such a case, scarce resources do not have to be wasted in repression, or misallocated in churning. They remain with civil society, whose members can pursue their objectives in peaceful prosperity. The story of Switzerland shows, furthermore, how misguided the European Union is when it strives to regulate as many matters as possible from the federal centre in the name of building Europe. At this stratospheric level of government, the EU enjoys no legitimacy whatsoever (how can it if detailed regulations have to apply equally to 25 nations?), and although it uses its entire budget to obtain obedience by bribery, this is clearly not working either (the budget is too small). So shall we be seeing, in due course, the EU facing a dire choice between using repression (impossible and unacceptable) or just turning a blind eye when EU directives are increasingly ignored?

de Jasay, op. cit. p. 76