Do we really want to be part of this?

Mitteleuropa: German Threat Resurgent
By Marian L. Tupy

The European enlargement was supposed to be wonderful. The Central and Eastern European countries (CEECs) were to join a happy European family and partake in its riches and political stability. No doubt, the bureaucrats who negotiated the EU expansion will go ahead with mutual backslapping. But there is no denying that the initial enthusiasm and naïve optimism that accompanied the enlargement negotiations in Central and Eastern Europe is petering out. Not only will the citizens of the new EU countries enjoy a second-class status by being kept out of the EU labor markets and exposed to unfair competition from over-subsidized French farmers, but they will also be subjected to blackmail from their traditional nemesis: Germany.

The trade-off at the heart of EU enlargement was simple enough. The CEECs would gain access to the EU markets and, in return, they would adopt 97,000 pages of European rules and regulations called the "aqui communautaire." Many of those rules were inappropriate and outright harmful. The EU Commission, for example, estimated the cost of Central and Eastern European compliance with environmental regulations alone at 120 billion euros. On the upside, the CEECs were promised financial help from the EU to meet the cost of accession. By the time the CEECs signed the accession treaty, however, the EU was experiencing an economic downturn and had to cut the size of financial transfers from west to east. Under the proposed EU budget for 2004, for example, the new members will net a total of only 1.8 billion euros, far too little to offset the cost of accession.

The bad news is that as long as the CEECs continue to receive EU financial aid, they will have to march to the German drummer, for it is the German taxpayer who bankrolls much of the EU spending. That fact was lost to the negotiators, but not to a skilled and unscrupulous German chancellor, Gerhard Schroeder, who last week explicitly tied continuation of EU aid to levels of taxation in the CEE. Again, the trade-off is simple. After decades of communism and the concomitant economic devastation, many accession countries continue to suffer from low productivity and high corruption. To compensate for their shortcomings, some CEECs have chosen to cut their taxes as a way of improving their investment environment. Slovakia, for example, has introduced a 19 percent corporate and income tax. Investments started pouring in and many European firms, including German ones, are considering moving there.

All that does not make Gerhard Schroeder happy. On his watch, the German economy slowed down and, last year, contracted. So did private investment, which declined 12.1 percent over the last three years. Most analysts agree that Germany is plagued by deep structural problems and business-killing taxation. Unfortunately, Schroeder can't do much to change that because he needs tax revenue to pay for a bloated welfare state, and welfare cuts are made virtually impossible by the size and strength of his domestic opposition. Schroeder could, of course, show political leadership and use his parliamentary majority to impose changes on his country in the way that Margaret Thatcher did in Great Britain. Instead, he has chosen to extend the German economic malaise on the accession countries as well.

As a matter of fact, the EU in general and Schroeder in particular have brought this state of affairs upon themselves. In a rapidly harmonizing EU, tax policy has emerged as the only effective means of competition among the member states. Tax-cutting policies, which are still a national prerogative, allow member states to offset the rising costs of European social legislation and "poach" investors from one another. Since the agreement on common taxation is unlikely to happen anytime soon, Schroeder opted to extort the European tax havens, like Slovakia, by warning them that low taxes are incompatible with continued financial transfers from the West.

As he explained, "In the future we have critically to discuss the issue [of low taxation] with the new members.... Tax policies of those countries are not sufficient to finance development of infrastructure and so they (CEECs) focus on co-financing from Brussels."

In other words, if the CEECs don't put up their taxes, they will not receive the structural and cohesion funds that were promised to them in the first place. The utter cynicism of Schroeder aside, the CEECs have to give serious consideration to their developmental policies. There is ample evidence to suggest that a welcoming business environment and low taxes are better at achieving economic growth than government-distributed financial aid. If it comes to that, therefore, the CEECs should be willing to jettison all EU aid, focus on keeping their taxes low and their vigilance high-for it is certain that the Schroeders of this world will search for new ways to undermine them.