TCS Daily


Rolling Estonia

By Marian Tupy - April 7, 2006 12:00 AM

May 1, 2006, will mark two years since Estonia's accession to the European Union. As Estonians discovered, the effect of EU membership on their daily lives proved much less dramatic than the hype surrounding the pre-accession negotiations suggested. In an increasingly open world economy, access to Europe's single market is growing less important by the day. In contrast to the persistently higher growth rates in the United States, Europe is in relative decline. That trend will become more prominent as Europe's biggest economies grow more protectionist. Moreover, the primary vehicle for Estonia's defense and the guarantor of her independence remains the North Atlantic Treaty Organization (NATO) and not the defense-less EU. Estonian politicians would be well-advised to ensure that the moribund Euro-project does not drag their vibrant economy down with it.

In the early 1990s, political elites in post-communist Europe concluded that membership of the EU was the solution to the economic problems in the region. The allure of the single market and financial transfers from the West proved too strong to resist for the region's electorates, which seemed untroubled exchanging a rule by bureaucrats from one far-away capital, Moscow, for another, Brussels. As the accession date grew closer, however, the EU project started to look distinctly less appetizing. The flood of pricey regulations that Brussels insisted post-communist countries adopt without apparent regard for their economic development needs began to worry small businesses. Moreover, major Western European nations, France, Germany and Italy among them, entered a period of low growth and high unemployment. That meant that they would no longer be able to provide the kind of financial transfers that the post-communist countries hoped for.

Even the single market, as first envisaged by the Treaty of Rome 49 years ago, has not yet materialized. The Bolkestein Directive, which meant to liberalize trade in services, was radically watered down. The same goes for the "takeover" directive that was meant to facilitate free movement of capital. The labor market, as shown by the restrictions that many Western European nations imposed on workers from post-communist Europe, remains fragmented. Similarly, free movement of goods remains subject to arbitrary barriers. Between 1999 and 2002, for example, the French government maintained a ban on imports of British beef despite the EU's ruling that declared British beef safe for consumption. For three years, the case made its way through the EU courts. All the while, French farmers benefited from reduced competition.

In reality, EU membership means very little in economic terms. That will become even more obvious as the rest of the world economy becomes more liberalized. As global tariffs fall, so will the benefit of belonging to the EU. Even today, countries without EU membership, such as Iceland, are able to grow fast. Conversely, membership does not guarantee economic growth in EU member-states - just look at Germany. What really distinguishes fast growers from economic laggards is the economic policy pursued by their national governments. Estonia, of course, provides an excellent example of economic liberalization followed by fast economic growth and rising incomes.

Estonia began to liberalize at the end of 1992. The government eliminated import tariffs and instituted a flat income tax. Corporate taxes on reinvested profits fell to zero. To arrest inflation, the government established a currency board. State enterprises were privatized. As was the case with all former communist countries, initially the Estonian economy went into a recession as many inefficient firms folded. By 1995, however, the economy was growing again. According to the World Bank, between 1995 and 2003, Estonia's average annual GDP per capita grew at a rate of 6.6 percent. During that period, Estonian purchasing power adjusted per capita income rose by 78 percent. In contrast, the average annual economic growth rate in the pre-accession EU was 2.55 percent over that period and incomes rose by 26 percent. In 2004, the first year of Estonia's EU membership, Estonia's GDP per capita grew by 6.8 percent. Estonia's living standard, in other words, was set to go on converging with the EU's irrespective of membership in the bloc.

What has changed with EU membership, however, was Estonia's political economy and that could have a negative impact on the country's future. Courtesy of EU membership, Estonia had to give up its liberal trade relations with the rest of the world. As a part of the European customs union, Estonia was forced to impose some 10,794 tariffs on imports from abroad. As a result of the Common Agricultural Policy, which the British Ambassador to Poland Charles Crawford recently called "the most stupid, immoral state-subsidized policy in human history, give or take Communism," Estonia was forced to acquiesce to a creation of a heavily protected agricultural sector and, as a consequence, the emergence of a voting bloc reliant on government hand-outs for its survival. Moreover, the economy as a whole will be forced to carry the burden of Euro-regulations no matter how harmful those might be to Estonia's economic growth.

All in all, Estonia's membership of the EU is highly paradoxical. Many of the old EU members are determined to pursue statist policies that include heavy business and labor-market regulation, high spending and, consequently, high taxation. The new EU members, Estonia included, need to generate rapid economic growth and catch up with the West. That requires limited regulation of the economy and easy taxes. As more of the economic decision-making concentrates in Brussels, Estonia's economic needs may be ignored and her liberal voice silenced by more powerful and more protectionist members of the EU.

Of course, there are those who argue that Estonia's membership of the EU goes beyond economics. The EU membership is meant to protect Estonia from the ever-unpredictable Russia and her neo-imperialist tendencies. Those people have bought into the myth, peddled in the corridors of the European Commission, that the EU brought peace and stability to Europe. That is not true. Peace in Europe was guaranteed by the creation of NATO in 1949, which preceded the birth of the European Economic Community by full eight years. There is, of course, no guarantee that NATO will always be around or that the U.S. taxpayers will be willing to subsidize the cost of European defense forever. But that is an issue that is separate from the inescapable fact that the EU is not a military alliance and unlikely to become so.

Marian L. Tupy is assistant director of the Project on Global Economic Liberty at the Cato Institute.

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2 Comments

Then help us better it
Indeed, the EU has become a prime source for sclerosis, with it's willingness to overregulate any issue they handle. This is to a large extent driven by the old franco-german axis. Today Germany has Ms Merkel, and the EU has many more members that are more inclined to acknowledge the mechanisms of the market economy.
So it should be possible to change the EU into a freedom friendly club. To all you Estonians out there: we need you to help us redirect the EU, to undo the harmful legacy of Jaques Delors, and to set Europe for a period of growth and prosperity. Let's get to it!

a few small points

firstly Iceland is a member of the European Economic Area and therefore has access to the common market.

Furthermore as a small state (pop. 1.2 million ) Estonia can wield little real economic influence and as a result of it's geography Estonia must find itself within the orbit of either Russia and/or the EU.

Estonia decided not to become a Belarus nor a Ukraine where economic progress lies in the gift of Gazprom and it's owners. Estonia decided instead to side with the bureaucrats of Brussles, perhaps the lesser of the evils.

There is nothing intrinsicly deadly for an economy regarding EU membership; my country, Ireland, shows how states can prosper. Moreover Ireland shows that it is the member states themselves which hold the cure to their own malaise, much of the European directives of late have been dealing with reducing the hoops one must jump through in order to prosper in a given state.

Estonia should be wary of the Euro however, for Ireland it has been a mixed blessing as it has generated a credit bubble whereas Italy would prefer to devalue its currency due to its high relative costs on the export markets.

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