“In 2004, everything turned out to be better than expected. But it’s not a one-way bet. Things have to keep moving forward,” admits Mr Ermisch.
In its latest Transition Report, the European Bank for Reconstruction and Development (EBRD) identifies “serious shortcomings in the business environment, including barriers to business expansion, market entry and exit, weak judicial and regulatory systems and widespread corruption”. It is also concerned that in “some central European and Baltic countries, public willingness to accept the immediate hardships of further reform may diminish now that EU membership has been achieved”.
Mr Djankov says: “Some central European countries were keen on implementing as many reforms as possible before EU accession because they believed that once they entered the EU, it would be more difficult to liberalise aggressively because of EU regulations and the power of certain influential lobby groups.”
Main priorities
Economists say that the main priority for the central European countries should be to streamline social expenditures, cut payroll taxes and improve the transparency and accountability of public administration. The new member states have trimmed their corporate taxes aggressively but they have not been as bold in cutting other taxes. According to the Organisation for Economic Co-operation and Development (OECD), the tax wedge – the share of labour costs that is attributable to income taxes and social security charges by employers and employees – in central Europe is one of the fattest in the OECD group of countries, ranging from 43% in Poland, the Czech Republic and Slovakia to a staggering 48% in Hungary, with nearly all of the wedge accounted for by social security contributions. “This is not a low-tax region,” notes Thomas Laursen, lead economist for central Europe and the Baltics at the World Bank’s office in Warsaw.
Marianne Kager, chief economist at Bank Austria Creditanstalt, says that although the central Europeans have shrewdly advertised their low business taxes, flat-rate taxes are not a panacea for increased FDI and brisk economic growth. “Successful reforms are not defined only by flat [rate] taxes. One has to look at these countries’ entire tax systems and how low corporate taxes are being financed given these countries’ high social expenditures,” she says.
Mr Laursen’s main concern is the quality of the region’s public administration. “This is the number one issue, particularly in Poland given the size of the country. This reform is crucial to absorb EU funds,” he says. He is also worried that the new EU member states are trying to replicate the policies of some of the southern European countries by focusing too much on narrowing regional income disparities. “This is understandable but there is a trade-off between internal and external convergence. The central Europeans, specifically Poland, should support market-driven growth poles, where rates of return are the highest. That is what Ireland did and it proved successful,” he says.
Yet, despite all the challenges, investors remain sanguine. “There was a window of opportunity in the early 1990s and we took the plunge. To us, this always made economic sense. Some other banks were more cautious and stayed away. But we now generate nearly 50% of our pre-tax profit in central and east Europe. It has changed the profile of Bank Austria. We’re one of the rare examples of a truly pan-European banking franchise,” says Mr Ermisch.
