“The country stands out among its regional peers. It went for across-the-board reforms that have significantly improved the business climate,” notes Caralee McLiesh, a senior economist at the World Bank.
According to the World Bank’s 2005 survey of business regulations worldwide, Slovakia was the leading reformer, “introducing flexible working hours, easing the hiring of first-time workers, opening a private credit registry, cutting in half the time to start a business and, thanks to a new collateral law, reducing the time to recover debt by three-quarters,” the survey says. The country’s tax reform has spurred foreign investment and economic growth and, for the time being, has led to an increase in budgetary revenues.
The Baltic states have also reformed aggressively. In 1994, Estonia became the first country in Europe to introduce a flat-rate tax, prompting neighbouring Lithuania and Latvia to follow suit and encouraging other east European countries, including Russia and Ukraine, to do the same. All three Baltic economies have grown at a combined average rate of 7% during the past four years. The trio are renowned for their thrifty fiscal policies, are closely integrated with the Nordic countries and are expected to be the first post-communist candidates to adopt the euro, possibly by 2007. “The Baltics have quickly become poster children for EU convergence,” notes HSBC in a report.
Ms McLiesh says that the EU’s new members are eager to attract further FDI. “This is all about regulatory competition. They know that to catch up with the West, they need to have the best [business] climate possible,” she says. Her colleague, Mr Djankov, says that the central Europeans already have “more flexible labour regulations than in Germany or France”.
Mr Ermisch believes that “if things stay the same with regard to growth and improvements in the business environments, the long-term outlook [in central Europe] is very positive. At some stage, we could even see the [region’s] risk premium fall below some west European countries’. By being successful and by attracting more FDI, they are also changing the political dynamic [of reform] in the EU,” he says.
Competition pressure
The Franco-German opposition to the European Commission’s draft services directive – in particular the controversial “country of origin” principle, which would grant companies the right to provide services across the EU as long as they adhered to the regulations of their home state – is the latest example of the EU’s reluctance to embrace competition.
German chancellor Gerhard Schröder redrew the battle lines between liberal-minded member states, such as the UK and Ireland, and protectionist ones, like France and Belgium, when he castigated the central Europeans last year for slashing their corporate tax rates. In opposing the services directive in its current form, the French and German governments are again responding to growing fears of a “race to the bottom” across the EU that will erode the labour and welfare standards that define the EU’s cherished “social model”.
Germany has the most to fear from low-cost competition from central Europe, given its close proximity to the region. “The Germans had their own enlargement when they had to absorb the eastern half of the country. Now they are going through a similar thing again but on a much bigger scale,” says Mr Profumo. According to Mr Ermisch: “A lot of German companies have already shifted, or plan to shift, parts of the production to east Europe. Germany is feeling the pressure of competition the most.”
Defining moment
Merrill Lynch regards the enlargement process as a defining moment in Germany’s economic development. “Enlargement and a strong euro are providing Germany with the sort of big shocks that are often needed to [drive] economic reform. It is similar to Sweden’s budget crisis in the early 1990s or the UK’s ‘winter of discontent’ in 1978-1979,” the bank’s report says.
Reform is already under way in Germany. In March, Mr Schröder grudgingly jumped on Europe’s tax-cutting bandwagon by announcing a €6bn corporate tax cut, which will trim the nominal rate from 38.7% – Europe’s highest – to 32.7%. On the microeconomic level, changes are more profound. A number of large German companies, including Siemens and Bosch, have clinched groundbreaking labour agreements with their unions after warning that they were considering moving parts of their production to central Europe.
“Germany has bitten the bullet. Now the debate is all about reform,” says Alasdair Murray, deputy director of the Centre for European Reform.
Austria has been more eager to compete with the central Europeans. It has cut its nominal corporate tax rate from 34% to 25%, roughly on a par with the Czech Republic and Slovenia but still higher than Hungary (16%) and Poland (19%). “We almost certainly would not have done this without the pressure from central and east Europe,” says Mr Ermisch.
At a recent conference in Warsaw organised by the British-Polish Chamber of Commerce, Mark Platt, a senior policy adviser on European affairs at the Confederation of British Industry (CBI), said: “The central and east Europeans are important motors for keeping the old member states on their toes.”
Herbert Stepic, CEO of Raiffeisen International Bank, says: “The size of the new members’ economies belies the much greater influence they are exerting on the EU’s economic agenda. There is now a constant pressure on Brussels and the EU’s leaders to reform the rigid institutions of the past. When you look at someone like [Ivan] Miklos, you can only admire him. This young guy is not only talking about radical reform, he is implementing it without a social upheaval.”
