A Marriage of Inconvenience

September 18, 2003 • Commentary
Tech Central Station on September 18, 2003.>

This week, the last of the invited Central and Eastern European countries decide whether to join the European Union. So far, all of the incoming states chose to join the EU and thus to benefit from reduced trade barriers, increased investment and, eventually, greater movement of labor.

However, despite wide margins in favor of joining, there was a lack of enthusiasm for the EU expansion, which is documented by the low voter turnouts throughout Central and Eastern Europe (CEE). In Hungary, for example, only 38 percent of the eligible voters supported the accession. Considering that the EU membership was relentlessly portrayed as a solution to economic problems in CEE, those low numbers are disappointing.

The trouble is — to make a medical analogy — that the doctor looks sicker than the patient. In 2002, for example, Slovakia’s economy grew by 4.4 percent. The German economy, on the other hand, grew at only 0.2 percent. Clearly, EU membership does not guarantee economic growth. A combination of market access and economic liberalization, on the other hand, is crucial.

Unlike Norway, Switzerland, and Iceland, the new EU members did not push for a free trade agreement with the EU. Having expressed their interest in full EU membership early on, the accession countries chose to sacrifice economic freedom for access to a highly regulated European common market.

Estonia, for example, abolished all of her import tariffs in the early 1990s. As a result of the accession, Estonia has had to adopt 10,794 European tariffs and other protectionist measures, such as quotas and subsidies. How ironic that to join the supposedly capitalist West, Estonia must adopt characteristics of the communist East.

Obsession over the EU in the former Soviet satellites was caused partly by misunderstanding and partly by greed. The post‐​communist governments saw the lavish aid that the EU disperses through structural and cohesion funds as a sure and easy way out of economic morass. Alas, by the time CEE became eligible for aid, the EU entered a recession and was forced to make cutbacks. After a decade of wishful thinking, the candidate nations realized there is no such thing as a free lunch.

But economic prosperity depends on liberal economic policies, not on aid. Regrettably, upon entering the EU, the accession countries will find their ability to spur economic growth through liberalization restricted. In the increasingly homogenized Europe, many of their comparative advantages will be legislated out of existence by more than 97,000 European rules and regulations.

The European Commission readily acknowledges the role it plays in fostering the economic problems in the CEE. The Commission’s Web site says, “each new member must implement and enforce EU law, which includes key areas of social policy such as limits on working time, minimum standards of safety in the workplace, gender equality and other measures to combat discrimination. Thus the risk of ‘social dumping’ will be avoided.”

Far from combating a social ill, what the EU really does is engage in old‐​fashioned protectionism. As Vaclav Klaus, president of the Czech Republic, warned: “Social rights are disguised… attempts to protect high‐​cost producers in highly regulated countries, with unsustainable welfare standards, against cheaper labor in more productive countries.”

Yet, there is still one path to prosperity open to the CEE. Due to the efforts of successive British governments, the accession countries will retain control over taxation. As Ireland has demonstrated, tax cuts can be used to offset the cost of increasing regulation of the economy. Thus, despite being bound by EU rules, Ireland managed to grow at an average rate of 7.65 percent between 1992 and 2001.

To lure investment, Ireland reduced its top marginal tax rate from 80 percent in 1975 to 44 percent in 2001. Similarly, the Irish government cut the basic tax rate from 35 percent in 1989 to 22 percent in 2001. Moreover, the Irish corporate tax rate was cut from 40 percent in 1996 to 24 percent in 2000. All in all, Ireland’s tax revenue in 1999 was 31 percent of the GDP. A comparable figure in the rest of the EU averaged 46 percent.

In the future, the accession countries must protect their tax autonomy and beware of moves toward greater European harmonization, which would further reduce their competitiveness. They should try to introduce economic dynamism to Europe by forging alliances with more economically liberal governments. They should work to prevent the adoption of costly welfare entitlements in the new EU constitution and to guard the national veto system. They should also work to abolish the protectionist Common Agricultural Policy, which harms them as well as the developing world.

Perhaps then they will truly benefit from their accession to the European Union.

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