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European Affairs
Opinion
New Members Will Make the EU More Competitive
By Mart Laar
The enlargement of the European Union from 15 to 25 member countries next year will have a significant effect on U.S.-European relations and on developments in the rest of the world. It is not yet clear what the final consequences will be, but the admission of the ten new members, mostly in Central and Eastern Europe, will push the European Union in the direction of economic reform and encourage it to become a more open, competitive market.
The European Union will certainly be subject to big changes, not least because the 2004 enlargement will not be the end of the story. In the coming five years, at least a further five to seven countries are likely to join the European Union, meaning that at some point in the relatively near future there will be more new than old members.
It seems that some of the old member states did not initially understand what the practical implications of this enlargement are likely to be. It is now becoming clear, however, that the entry of the new members will subject the existing members to such strong competitive pressures that they will finally have to engage in real structural reform of their economies. In the new member states, even the most left-wing governments are significantly more free-market oriented than the most right-wing governments among the current member states.
It will not be possible to continue many current EU policies, such as the Common Agricultural Policy (CAP), in the new Europe, simply because there is not enough money to do so. Even though the first ten new members will only be included in the CAP step by step, it is clear that the money will run out. And that does not even take into account the inclusion of future members, such as Bulgaria and Romania, which have even bigger agricultural sectors that would have to be paid for by the CAP.
It is very clear that Europe has no alternative but to reform its farm policies, and that this was the only reason why the first steps have recently been taken toward agricultural reform. Of course, those steps are very small, and fall far short of what is needed. But they are at least, finally, first steps in the right direction.
Without the pressure of enlargement, these reforms would not have been adopted. In the past, neither negotiations in the World Trade Organization nor conflict with the United States have been enough to budge the European Union from its old ways. But now that the money is just running out, there is simply no other choice - and changes will have to be made not just in agriculture, but in a lot of other areas, too.
In my view, this was one reason why some countries wanted to hold the constitutional convention on the future of Europe that finished work in June. Of course, there were practical reasons why institutional changes had to be made. The current institutions would simply not be able to function in a European Union with 25 members, or 26 including Turkey.
From another point of view, however, it looks as if the first proposals made by France and Germany to the convention were at least in some way designed to avoid the effects of enlargement. There are some very clear examples, especially in economic policy.
One of the biggest battles that took place in the convention was over taxes, which, of course, are among the cornerstones of an economic system. In a Europe in which the rules of the single market provide for the free movement of goods, services, capital and people, the question of taxes will be fundamental in deciding the future direction of the entire European Union.
If taxation is unified, and individual countries no longer have the right to adopt their own tax policies, then there will be really important steps toward a United States of Europe. If each country is allowed to decide on its own taxes, and to dissent from any common tax policy, there will be competition between the member states, leading to a very different kind of Europe.
In this light, the conflict in the convention over this one small question, which was not much noticed, was actually the most crucial battle - because the idea was to introduce majority voting on taxation policy, ending the national right to a veto in this area.
Nobody, of course, was so naive as to think that the end result would be a general reduction in European taxes, with the majority voting to adopt the level of Estonia, where taxes are lowest. Everybody understood that Estonia and other countries would be required to move their taxes up to the levels of France and Germany.
This would, firstly, have effectively destroyed the economies, and the recent economic successes, of the new member states. Secondly, of course, it would have created a very different kind of Europe, in which the state would have enormous power to distribute wealth and welfare, and the people's liberties would be curtailed.
In my view, the biggest success of the convention was that this plan was thwarted. It was stopped, I think, forever, because in future it will be even harder to force such ideas through. An especially positive development was not only that the new member states united unanimously against the proposal, but that we also received significant support from so-called Old Europe as well. Among the 26 countries that participated in the convention, we built a bloc of 20 countries to resist the plan, a very clear majority.
That was a very good omen for the future of Europe and an indication of how different countries are looking to their own futures over the coming years. We can see that a very new kind of thinking is developing. Finland, for instance, has taken a clear decision to start cutting taxes in the coming year because of heavy competition from Estonia.
There are companies in Finland and elsewhere in Europe that are thinking of moving their headquarters to places like Estonia after EU enlargement to benefit from lower levels of taxation. These are very big companies, and even if only one-third of those considering a move actually put their plans into effect, there will be radical economic consequences.
For the moment there are simple reasons why such companies are investing in Estonia and other prospective new EU member countries. Estonia's tax system is very good. At the same time, after EU entry, we shall be able to benefit from the kind of indirect security that comes from participation in the European single market - the rule of law, and the same regulations and legal protection enjoyed by the rest of the European Union. If these features of the single market are combined with the liberal economic policies and low taxes of the Central and Eastern European countries, the European economy will quickly start to move from West to East.
Ten years ago, everyone thought the Estonian Prime Minister had gone totally crazy in proposing a flat rate of income tax. The idea, which was then considered radical and unrealistic, is now becoming part of mainstream thinking in Central and Eastern Europe.
Initially, people said that Estonia was such a small country that it could do a lot of crazy things, including adopting a flat rate of income tax. Then Latvia and Lithuania followed. They are a little bit bigger, but they are still small countries - so things did not change too much.
Now, Russia has introduced a 13 percent flat rate for personal income tax, which has proved to be the most successful economic reform since Russia emerged from the former Soviet Union. Russia is not a small country. And now, starting on January 1, 2004, Ukraine will follow suit. So will Slovakia, becoming the first country that is really in the middle of Europe to adopt a flat rate.
In the Czech Republic, more and more political parties and political leaders, including President Vaclav Klaus, are strongly supporting the flat tax. That was the main campaign promise made by Mr. Klaus's party in the last parliamentary elections. His party did not win, but the voting results and the level of support for the idea suggests that the flat tax will clearly come.
Even Poland, where an ex-communist, Leszek Miller, is prime minister, is seriously considering a flat rate tax, as a result of the pressure from other countries. But the biggest surprise was the recent proposal from a leading Finnish economic analyst that Finland should adopt a flat rate of income tax - a revolutionary idea for a Nordic country - that was welcomed by the government as not a bad idea.
Only a year ago, it would have been totally astonishing if a serious Finnish economist had proposed a flat tax and the government had not rejected it out of hand as totally unrealistic and impossible.
Now we can see why such developments are under way. At a recent conference Jorma Ollila, President of the Nokia Group, described high taxes as the biggest problem for European competitiveness and suggested that business leaders pay a visit to Estonia next year. If such statements are being made by the leader of such an outstanding Finnish company as Nokia, it is understandable why the Finns are reacting in such a way.
At a recent conference in Germany, German politicians looked completely shocked when a Polish expert discussed the possibility of Poland moving to a flat rate tax. But this is the reality. I believe that in five years nearly all the countries in the center of Eastern Europe will move to a flat rate of personal income tax.
This will put huge pressure on the European Union's old member states, and if one of them follows suit, then the idea will immediately spread to the rest of the Union. The result will be to make the European Union a very competitive region, in this and other economic areas.
The new member states have kept their independence of decision making on a lot of other difficult economic questions, including social policy.
So, nobody will be able to force us to follow the unwise policies that have been adopted by some of the existing member states. We shall be able to keep our free labor markets, which means we shall keep them working, and not make the costly mistakes that have been made in Western Europe, where every attempt at reform is met with strikes and other disturbances.
In all these aspects, the new member states will be very competitive, and some old member states are beginning to pay attention and look for ways of taking advantage of this new competitiveness. In the area around the Baltic Sea, for instance, countries like Finland and Sweden are looking for new forms of cooperation at the same time as they are coming under pressure to change their policies, which will be very healthy for their economies.
So this is the picture we shall see in Europe in the coming years. I think there will be considerable upheaval. The situation will sometimes be tense; there will be a lot of discussion and conflict. But Europe will move in a better direction, and become more competitive. The new member states will bring with them a new way of thinking, and a better understanding of the modern world, which will help to renew the whole of Europe.
This article draws on remarks made at the Heritage Foundation in June 2003.
Mart Laar is a Member of the Parliament of Estonia. He previously served as Prime Minister from 1999 to 2002, having held the position also from 1992 to 1994. During his political career, he has served as a Member of the Constitutional Assembly, Member of the Committee of Estonia (a people's movement for the continuity of an independent Estonian state), Member of the Congress of Estonia, and at the Ministry of Culture.