TCS Daily

Europe's Greatest Success

By Johnny Munkhammar - May 18, 2006 12:00 AM

Ten years ago I watched a TV film that was supposed to be a documentary from the future, showing how Europe had evolved during the first decades of the 21st century. It was, to put it mildly, pessimistic. Among other things, it predicted that a brick wall would be erected between Western and Eastern Europe. This new and bigger version of the Iron Curtain was intended to stop refugees from fleeing the enormously poor Eastern European countries to the promised land of Western Europe.

Ironically, the way things are going in the real world, people are more likely to move in the opposite direction. The former communist countries, according to a new report from the European Commission, are where the action is.

The difference between expectation and reality says a lot about how people once viewed countries in Eastern and Central Europe after their liberation from Communist oppression. Economists and political scientists painted them a bleak future. In Sweden, many commentators greeted the liberation of these countries with fear. This was said to be a dangerous process that would tilt the balance of power in Europe. For a country that had a so-called neutrality doctrine -- staying militarily neutral between the worlds of Communism and Capitalism -- this seemed risky.

But for millions of people this was a victory over a totalitarian system that produced poverty and isolation. The long-term question was how long the cheering would last. Many thought that these countries would, at best, become dependent on foreign aid from the West for decades. Others feared Yugoslavia-style civil wars.

Nobody dared to imagine then what we see now: how great the development has actually been for these countries. Eight of them are members of the EU and nine are members of NATO. They are not dependent on foreign aid -- on the contrary they have on average had twice the economic growth rate of Western Europe. Civil wars, severe as they were, were limited to the Balkans.

"Many doomsday scenarios preceded the Eastern enlargement, none of which has materialized," said Enlargement Commissioner Olli Rehn at a recent celebration marking the second anniversary of the most recent EU expansion.

A new study from the European Commission on economic development in the new member states shows just how dramatic their success has been. Trade in the ten new EU members, exports plus imports, represents 93 percent of their GDP on average, compared with an EU-15 (the old members) average of 55 percent. The EU-10 also attracted significant new foreign direct investment (FDI), reaching a total of €191 billion in 2004, or 40 percent of their total GDP; it was virtually non-existent ten years earlier. In the countries of the former Soviet Union and the countries of Eastern and Central Europe, the number of people living in poverty decreased by 40 million between 1998 and 2003. The GDP growth rates in the Baltic countries last year reached Chinese double-digit levels. Slovakia is the biggest car producer in the world, relative to the country's size.

These are truly amazing developments. But they didn't occur miraculously, out of the blue. Many of the pessimistic predictions could have come true if it hadn't been for the countries' willingness to undertake radical, market-oriented reforms. Privatization of state companies, tax cuts, deregulation, liberation of price controls, openness to foreign trade -- all these were part of the reform agendas. So far, eight countries in Eastern and Central Europe have followed the Estonian flat tax example.

The desire to do the opposite of what they had lived under before was a force behind the reforms. So, in time, was the institutional competition among the countries. But the possibility of EU membership was also a powerful motivator. Adapting to the demands of the EU concerning rule of law, the fight against corruption and a functioning market economy were important. Without the EU, the road map to reform and many incentives might not have been there.

These countries are now competing successfully with Western Europe. In a growing world economy, all can be winners at the same time, but there can also be net losers -- if they are not competitive. Most countries in Western Europe have serious economic problems and need to reform to be able to compete well. But reforming is also tough politically.

Politicians in Western Europe often choose what seems easier in the short term: getting rid of competitors -- either by pretending they are not there, or by trying to make them less competitive. This has led to resentment of the success of Eastern and Central Europe. When the EU enlarged in 2004, only three countries chose not to erect barriers to the free movement of labor from the new members: the UK, Ireland and Sweden. Several hundred thousand Eastern and Central Europeans soon moved to the UK and Ireland. Only a few thousand went to Sweden.

This was no accident. The free and reformed labor markets of Britain and Ireland easily absorbed these people and they found work. There was no rise in unemployment. Sweden, with its high taxes and regulated labor market, was less attractive and less able to offer many new jobs. Thus, Sweden did not benefit from an expanded new workforce.

This illustrates how easily Western Europe could benefit more from enlargement than it does now. Reforms not only increase competitiveness -- important in a globalized world -- but also increase attractiveness and the ability to benefit from labor mobility.

Most other countries in the old EU-15, by the way, still have restrictions in place preventing workers from coming from the new member states.

Eastern and Central Europe might be the world's best examples of what market-oriented reform can achieve. By promoting democracy and market economy in these countries, enlargement should be considered the EU's greatest success.

The author is Program Director of Timbro, a Free-Market Institute in Sweden.


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