As an economist I have been paying a lot of attention to the process of transition in the framework of economic change in post-communist states in Central and Eastern Europe. There have been several success stories in this part of Europe. But shadows at Europe’s postulated area of economic transition are still persistent. A great amount of restraints remains as the opponent barrier to creating new opportunities. Privatization is still lacking behind the very much needed speed while entrepreneurs still suffer from high taxes, enormously explosive fiscal burden and insufficient protection of intellectual as well as of private property rights. And those three needed features are among the very first steps to demolish the repressive legacy of post-communist economic policy.
After nearly a decade of the collapse of communism, the entire picture of Eastern European economies is broadly different across those countries. Estonia, at the very beginning the economic slave, took a radical approach to economic policy. The country under the leadership of Europe’s most progressive reformist Mart Laar privatized more than 90 percent of all governmentally-owned enterprises. Inflation was dropped below 5 percent immediately after the Estonian government enacted monetary reform. The country opened itself to the rest of the world by eliminating tariffs and quotas on imports. The results were impressive. Perhaps the most striking surprise, criticized by many collectivists and falsified intellectuals from Western Europe, was the enactment of a single flat tax on both personal and corporate income. As a significant outcome of free-market reform a small tiger from the edge of Eastern Europe became the leading tiger in enacting economic reforms. On behalf of himself, Mart Laar emphasized that only free trade makes nations prosperous, not foreign aid. He told that, despite being a historian, he read only book from economics, namely Milton Friedman’s Free to Choose. This book, he said, gave him everything he needed to know to launch economic reforms that made Estonia an economic miracle among the sleeping lads in Central as well as Eastern Europe. Latvia and Lithuania quickly followed Estonia’s experiment and quickly graduated from the maturity of transitional reforming. Foreign investment started to grow greatly in those countries. Investors benefited from low taxation of corporate income. The protection of intellectual and property rights has been modest but definitely more sufficient than in other post-communist countries.
Czech Republic and Slovakia split-up in 1993. Slovakia came under the leadership of Vladimir Meciar, whose government ruled Slovakia with an iron fist, so that Madleine Albright remarked Slovakia as “a black hole in the heart of Europe”. Immediately after Mikulas Dzurinda and Ivan Miklos took the leadership of a structurally demolished country in their own hands, Slovakia became a part of success story. The reforms included the enactment of the flat tax, the removal of restrictions on foreign investors and a privatization at an accelerated speed. Economic growth boomed. Investors in automobile industry such as Peugeot and Volkswagen chose Slovakia for the location of production facilities partly because of the comparatively cheap labor force but primarily because of highly stimulating tax regime. KIA has recently chosen a small Slovakian town of Zilina where it will launch an automobile production facility and process. Slovakia already rates at the top according to produced cars per capita. IBM’s business report on global investment location placed Slovakia among the top five in the world according to the number of new investment projects brought to Slovakia. Hungary relatively successfully transformed its collectivist economy into a free-market oasis in the very central part of Europe. The primary reason why Hungary was poured by foreign investment has been the corporate tax rate of 16 percent which is the second lowest rate on corporate income in Europe.
But a bunch of structural problems remain high. Macroeconomic stability is very far from being mature. Hungary has prolonged its policy of constant annual budget deficit which temporarily equals 9 percent of the entire GDP. At the very beginning of the transition Hungarian central bank directly fixed the exchange rate after the inflation peaked at the rate over one hundred percent. But the vastness of problems, coming out as a result of an unreformed government remained broadly increased. Today, one quarter of the labor force is employed in the public administration. Despite its enormousness and explosive expansion, the administration does very little. The protection of private property rights, seen in the profile of the judicial maturity is still very weak and very far from being mature enough to be modestly satisfied with. Above all, the situation of public finance needs to be reformed because Hungary expects to enter the European Monetary Union in 2011. On the other side, the EU has loaded Hungary with seriously threatening impositions of tax harmonization. Thus, Hungarian policy-makers and inefficient decision-makers employed in the public sector responded immediately by raising and imposing new taxes. The corporate tax rate was lifted above the previous rate of 16 percent. On the other side, solidarity tax was imposed as well. And according to recently announced statistics, tax burden measured in the percentage of the GDP is growing also.
Government spending is rising while those outlays are primarily contributed to financing welfare-based programs such as social security and health-care schemes. In the survey explored by Tanzi, Schuknecht and Alfonso, the authors showed the Hungary, as well as Slovenia, suffers from a very low efficiency of government spending in health-care industry despite one of the highest rates of health-care spending. The level of Hungarian competitiveness is going deeply down after Hungarian socialist policy-makers decided not to impose very much needed reforms. There are some featured demographic problems persistent as well. The birth rate remains low and many youthful and enthusiastic Hungarians find new employment perspectives therein. And there’s an empirically verified fact that brain-drain effects coupled low capital formation could be the beginning of an economic and structural downturn. But Hungary is not the sole problem. There’s Poland as well whose structural performance is lagging strongly behind the very much-needed pace.
The unemployment rate s 15 percent and country’s competitive shift on the lower level continues to be strong. According to annually announced Index of Economic Freedom, Poland reaches the lowest score on competitiveness itself. Gradually determined approach to transition resulted in a series of crises. The inefficiency of the public administration remained unreformed. The education system is very far from giving youth a proper knowledge to create added value in the business sector and to solve the problems successfully. Financial sectors, one of the key determinants of economic prosperity in the future, have been continually weak and mostly deficient since banks were not able to offer enterprises a strong financial support to their business projects. But the reason for this drip is hidden somewhere else. After the beginning of transition many Polish enterprises remain structurally as well as technologically depressed. Political influence over the economy came out as a general problem of entrepreneurial future development. Because politically appointed managers practice bureaucratic administering rather than risk-taking, they were strongly irresponsible when seriously condemned problems came up. In the nature of protectionism, including unimaginably high tariffs and quotas on imports, Poland avoided making gains from international trade. Wage policies were done highly unmarketable. Public sector’s outcome remained low while new taxes and welfare-supported governmental programs started growing like mushrooms after the rainfall.
Slovenia was traditionally reputed as the most developed post-communist state. Country has indeed made some significant progress in the period of past ten years. In fact, Slovenia will be the very first post-communist country to enter the EMU and adopt Euro in 2007 but the whole story is not like goofy fairytale. Slovenian labor market is one of the worst problems. Significant institutional protection of trade unions made them behave not in compliance with market rules but in the seeking of governmental protection. Politicians never decided to gain very much needed power to beat the unions. Even worse, they promoted them as key-partners in the process of collective bargaining. Macroeconomic discipline varied strongly. Inflation-targeting has been predominantly unattained. Inflation was not reduced immediately but it took numerous years to put it below the required rate of Maastricht criteria. Gradualism has truly been the inhibitor of transition which is seen in the behavior of the central bank, its willingness to start creating new monetary aggregates postulated in higher rate of inflation. The problem of inflation is primarily connected with catastrophically attained trade policy. Central Bank, instead of focusing on inflation, put its attention to exchange rate configuration. Thus it controlled the value of Slovenian tolar and implicitly forged industrial policy since exporters were given a preferred position in the international trade of one of the smallest countries in Europe. Previously underpinned problems of the labor market reflected in a very deficient business environment with barriers and obstacles. Foreign investment participation remained very low, perhaps at the lowest rate in Central Europe. Even domestically unreformed industrial enterprises resulted in more than 25 percent of “dependent employment”.
Strong institutional status of trade unions colored with threats to businessmen and entrepreneurs prevented enterprises from being structurally sophisticatedly reformed. Thus, a quarter of the labor force was decidedly put in a risky position. Economically, the behavior of the labor force remained chained in the socialistically flavored culture of denying itself to reeducate and become competitive on the labor market. In 1999, only 5 percent of Slovenian exports were natured as high-technological. In Hungary, the rate of high-tech exports peaked at the rate above 10 percent. In Ireland, for example, 53 percent of exports were high-tech based. But the main core of the problem does not lie solely in the business sector. Slovenia is comparably very weak at producing innovations. Old-fashioned innovation structure established itself on the basic research. Slovenian state-based universities offer very poor knowledge as well as they, in cooperation with business sector, remain unwilling to remunerate the fruits of knowledge in applications and device mechanisms. Private sector has a minimal role in the structure of educational institution. In fact, there’s none Slovenian university among the top five-hundred in the world. Increasingly growing role of the government in education resulted in a very slow technological progress that could be accelerated if private sector took the leadership in technological innovations produced at the university. If Slovenia continued registering patents at international patent institutions at the current rate, then it would get in touch with the average European level of knowledge development in three hundred years (!).
According to Eurostat, there are only 65 percent of private activities in the structure of the GDP compared to 80 percent rate in Czech Republic. The role of the government is still very strong. Here we can open the chapter of privatization. When privatization was launched, the structure of the ownership remained very rigid and not perspective for the future development of products and services. Many government officials have been actively engaged in decision-making in big companies. KAD and SOD, the main para-governmental funds, have been insufficient owners and their role resulted in less effective and less productive decisions of the companies itself. The entire management of the biggest companies was occupied with government officials. Their intention was not to let the business and developments grow greatly but to control the development of enterprises. The role of those funds was strongly persistent in financial sector which limited the potentials of the private sector itself. Financial sector was largely uncompetitive due to non-dynamic behavior on the market. Venture capital funds rarely occurred and there were hardly found new products on the financial markets.
To demolish post-communism in Central and Eastern Europe, entrepreneurship, capital formation, productive behavior and reforms of the government are the only effective means to achieve that. Lower tax rates, on both personal and corporate income (flat tax), institutional transparency and efficiency, reduced government spending, accelerated privatization of public sector, health-care and social security, eliminating the restrictions on capital and financial markets, small but efficient administration, respectful protection of private and intellectual property rights, the abolishment of the minimum wage and further enactment of free-market institutions upon pro-growth orientation of economic policy are likely to be the most prosperous path to create new opportunities in Central and Eastern Europe and therefore let its economies grow. In fact, there is in a competitive society nobody who could posses only a fraction of power which a socialist planning board and explosive governmental role can exercise.
