Managing diversity: the Swiss example
[04.06.2008, Victoria Curzon-Price, CONSERVATIVE LETTERS]

Conservative Letters

Depending on your point of view, Switzerland is either free-riding unfairly on the rest of Europe, or is an intriguing example of rugged - and rather successful - independence from the European Union. Let me address this question first, and then move on to what I believe is the real secret of Switzerland’s success: its sheer diversity.

The European Commission has spent the last ten years criticizing Switzerland’s tax system, accusing it first of being a tax haven, and now of unfair competition in attracting mobile productive resources via low taxes. The Swiss Federal Government has responded to these attacks by amending some tax laws, but will soon run out of political space to do much more, because fiscal sovereignty lies with the Cantons (26 of them in a country with a population of 7.2 million!), and they do not consider that their tax regimes are anyone’s business but their own.

The fact is that some Swiss Cantons practice a “slim, lean” approach to government, and enjoy low levels of personal and corporate taxation, while others are well up to European norms, with a “high tax, high spend” attitude. What is interesting is the sheer diversity of government-types that you find in Switzerland. But not only is there no movement to harmonize taxes within Switzerland, but it is a self-evident fact that this diversity of democratic outcomes has not prevented Switzerland from becoming prosperous. How strange! Because if one listens to Brussels, we hear that “harmonization” would make competition freer, fairer and more transparent at a European level, and is much to be desired!

However, before examining the question of harmonization versus diversity, let me quickly lay to rest the idea that Switzerland’s prosperity depends upon poaching people’s savings from other countries. For many, many years, Switzerland has run a substantial balance of trade surplus. This necessarily implies an equal and equivalent deficit on the capital account. In other words, Switzerland, on a net basis, is a substantial net supplier of capital to the rest of the world. This, incidentally, is the correct and proper role of an advanced, capital-intensive economy, where returns to capital are low by comparison with other countries.

No, Switzerland more than earns its way with several high-tech, high-productivity activities conducted by more than a few world-class corporations. In reality, it just specializes and trades according to its dynamic and constantly changing comparative advantage, since it has an open-market policy towards international trade, with the one exception of farm products.

Why has Switzerland never become protectionist? One possible hypothesis is that internal Swiss politics would not have allowed it. Each Canton eagerly competes to attract investment and economic activity generally, from other Cantons, and from the world at large, but trade protection at the Swiss level would inevitably favour some Cantons more than others, so would not be considered legitimate, and would not stick.

Constitutionally speaking, Swiss Cantons consider themselves to be sovereign states. They lie in relation to the Federal government as members of the EU do to the European Union: the true seat of sovereignty rests with them. The Swiss Federal Government does not even have the right to tax. This power is delegated to it by the Cantons, and is renewed every decade.

Because of this fierce attachment to sovereignty in what are, after all, very small political units (smallest, Appenzel, with 11’000 inhabitants, largest Zurich with 1.2 million) Switzerland respects the principle of subsidiarity quite naturally: only what really cannot be accomplished efficiently at Cantonal level is delegated to the Federal level. The Federal Government is responsible for no more than 30% of public expenditure, the rest being set by the Cantons and Communes (even smaller political entities). It turns out that rather few items need to be centralized and most matters are settled at Cantonal level, to everybody’s satisfaction. Remember that Switzerland embraces 4 linguistic and cultural entities, two major religions and successfully bridges the gap between Northern Germanic and Southern Latin Europe.

The inevitable corollary to this fact is Switzerland’s amazing diversity. It is not that people are unaware of the all the arguments in favour of harmonization at a federal level – simplification, transparency, lower transaction costs, economies of scale etc. – it is simply that they judge the benefits of harmonization and centralization to be much smaller than the costs.

The Swiss people do not go through complicated econometric analysis to reach this conclusion. They simply vote, not once every 4 or 5 years, but every two or three months. For yet another amazing characteristic of the Swiss is that they enjoy the benefits of direct democracy. The Swiss people are constantly voting at Federal, Cantonal and Communal level on all sorts of things. They are the collective “sovereign”, and elected representatives must obey their decisions. If the elected government, in a moment of absent-mindedness, misjudges the mood of the “sovereign”, a handful of citizens can launch a referendum, and if successful, force the government to change its policy. The natural outcome of all this is, once again, an extreme level of diversity from Canton to Canton. Never, in a thousand years, would the Swiss people vote to change this system. They prefer to live with the inconvenience of different laws, regulations, taxes, educational systems etc. rather than renounce their ancestral rights to self-determination. For they are indeed exceptional.

Now I am not saying that other countries should adopt this amazing form of democracy – that is obviously impossible. The ruling political class in a normal representative democracy would never permit such devolution of power to the people. What I am saying is that the diversity which the system produces has not made Switzerland a poor country. On the contrary.

I would argue that it has helped to make Switzerland rich. In particular, the Swiss constitutional setup forces each Canton to finely adjust its regulatory and tax environment to the reality of institutional competition between the Cantons. As a result, for an advanced industrial nation, Switzerland has one of the lowest tax regimes going and it has world-class public services as well. It is attractive to investors. And this is what is bothering the Germany, France, Italy and other members of the European Union, giving rise to the barrage of EU complaints about unfair tax competition.

Whatever the outcome of this dispute, the paradox of Switzerland should be kept in mind: whenever the EU suggests harmonization in the name of efficiency, transparency and economies of scale, remember that institutional competition trumps harmonization every time! And it’s more democratic, too…

Author serves as a Professor of Economics at the University of Geneva and former President of the Mont Pèlerin Society (2004-06).

Article was published in Slovak language in Conservative Letters 05/2008, a newsletter of the Conservative Institute.

Conservative Institute would like to invite you to another of the 2008 CEQLS lectures: Victoria Curzon-Price will be our guest on June 12, 2008 in Bratislava - more information is available here.

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