Let me start by drawing you a picture of what a European country might look like five or ten years from now. Imagine a country where the tax system is very simple and transparent, and where all citizens and companies pay a 19% flat tax rate. Imagine a country without an overly regulated labour market and where the welfare system helps all those in need without removing the incentives for those who are able to work to find a job quickly. Imagine a country with universal health insurance coverage, but where healthcare costs are not ballooning, in spite of an ageing population, because people are provided with a system that motivates them to make the right choices about their healthcare and health providers are actually compelled to be efficient. Imagine a country where all citizens are ensured a decent, secure pension, because they are required to save a set amount from their salaries in their own private pension accounts, and so invest for their retirement.
Perhaps this is how some other countries in Europe could be five or ten years from now - but this is already a reality in Slovakia. Slovakia has acquired a fairly good reputation for introducing reform. Indeed, the World Bank has called us ‘the world’s leading reformer’, a reputation we have acquired thanks to a series of radical and far-reaching measures conducted over the past two years.
From a technical or economic point of view the reforms are nothing exceptional, with the exception perhaps of the health-care reforms. They are simply standard economic solutions being put into practice. When you ask an economist what the most efficient, and most economically fair, tax system is, he will tell you that you need a tax system that is simple, transparent and non-distorting.
So the solution is simple. I think the real question is: how do you put it into practice in Europe? How is it possible for a country to undertake all these reforms in such a very brief period of time? Why were these reforms possible in Slovakia and what does this mean for the rest of Europe?
Crucial to making these reforms possible was the fact that our country emerged after 50 years from a system that simply did not work; a system where public services were failing, where people were paying taxes but were not getting from the state the kind of services they expected. This is not the case in most western European countries. Problems with the healthcare and pension systems are not at present immediately apparent to the average citizen. These are, however, issues that, because of the ageing population, will become very serious in the coming decades.
In Slovakia, as in most of the other central and eastern European countries, these services were not being provided and the crisis was self-evident. This made it much easier to convince people that something needed to be done.
In the wider European context, the key issue politically is to explain to people that the systems are not working as well as they should be, and that it is certain that without additional reforms many of them will face serious problems in the future.
The second reason why there was radical reform in Slovakia was because we were going through a very long transition process. These reforms were not just introduced out of the blue, but were seen by most citizens as a continuation of the reforms that began some time in 1990 with the transition from a centrally planned to a market economy.
After fifteen years of a very difficult reform process, it is important to recognise the role that was played by the people of Slovakia, who were willing to accept these sometimes difficult changes. We did experience protests and strikes, but generally they were manageable rather than paralysing.
The third and perhaps most important factor was the political courage of particular individuals. Even now our deputy prime minister and prime minister are facing the spectre of serious social upheaval. The question was: should we actually go through with the reforms and face all these difficulties? Should we implement reform in the social welfare and pension systems, knowing that people would probably resent us for this, perhaps enough to ensure that the government was not re-elected? Or should we take the easy route? Should we just carry on doing things as usual?
The deputy Prime Minister, Ivan Mikloš, would probably tell you very frankly that he is a member of what at least in 2004 was the most unpopular government in the history of Slovakia. Yet if you look at the opinion polls in February 2005 – six months after most of these reforms came into force – they changed quite substantially. His government is not actually any less popular than many other governments in the region, in spite of the fact that it passed such far-reaching reforms. It seems likely that the popularity of the government is growing because the reforms are now starting to bear fruit. We have a very high growth rate - above 5%. This trend is expected to continue in the next few years. There are almost daily announcements by large international firms that they will be investing in Slovakia, creating new jobs. It is encouraging that investment is no longer concentrated solely in Bratislava but has been dispersed throughout the country. People have noticed that Slovakia is starting to change. The political decision to implement the reforms is no longer looking so suicidal - there is still over a year until the next elections, time for the benefits to filter down to the general population.
So what does this mean for the rest of the EU? Can Slovakia be used as an example to other member states?
There are several reasons for optimism. The first is simply the issue of competition. As an economist I have to believe that competition is a driving force leading to efficient solutions or outcomes that are a force for good. Competition is something that is visible and it is clear that competition is a factor here.
If you have a 19% flat tax rate and a 19% corporate tax rate in one country, and across the border you have another EU country with a 35% corporate tax rate, with the same kind of laws and regulations, this will influence where firms choose to invest. The business environment of many new member states is making companies sit up and take notice. It is also making existing member states consider their own framework of regulation and taxation. The other member states are facing competition and are under pressure to reform as well.
Another reason is peer pressure, or what might be called a change of collective spirit. For example, in ECOFIN meetings, instead of there being fifteen people around the table there are now 25, of whom a fairly large proportion represents countries that have carried out really dramatic, dynamic reforms. This really has changed the spirit around the table.
This leads me to the third factor: positive experience.
Competition from central and Eastern Europe is often portrayed in some of the Western countries as something negative - as part of a zero-sum game. I do not think this is the case. In fact, it is certainly not the case with new member states. We are definitely benefiting. We can see that there are new jobs coming in. There is growth and people are optimistic. If you look at the various indicators of public opinion, they are improving quite dramatically – at least in Slovakia.
We have had these really positive experiences. We have imposed a flat tax system and it was not a disaster - in fact we probably now have a much higher degree of tax compliance. We did not end up with a huge deficit. On the contrary, our revenues are higher than we expected, although our original expectations had to be fairly conservative for reasons of fiscal management.
As for pension reforms, personal accounts are a reality in many new member states where the system is working.
We have also transformed the social system and dramatically deregulated the labour market. The number of people who rely on social welfare, even though their eligibility has not changed in principle, has dropped significantly. If you want to receive a reasonably good income from the social system you have to be active, so this measure is also working. These are just some of the positive examples. There are also signs that we are having a positive impact on the old member states.
Look at Austria, for example. Partly in reaction to our flat tax rate, they have lowered their corporate tax rate to 25%. Nobody is complaining. In fact the only people who are complaining are the Bavarians, because a lot of companies are now starting to move to Austria.
Ultimately, the migration of jobs to new member states will free up the highly skilled labour forces of countries such as Germany and France to perform activities of higher economic value. Most of the investment in new member states is creating semi-skilled and low-skilled work, something that longer-standing, wealthier member states can afford to lose.
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Martin Bruncko is an economist specialising in financial and public economics. Currently, he is a chief economic adviser to the deputy prime minister and minister of finance of Slovakia, Ivan Mikloš. He has extensive experience as a consultant for both the private and public sectors. He has held a position in the OECD’s economics department, working on the implementation of Slovakia’s accession. Subsequently, as a consultant at the World Bank, his main responsibilities included advising the Slovak government on an optimal strategy for the utilisation
of the EU’s structural funds.
He holds a BA degree from Stanford University and an
advanced graduate degree from Harvard University. He has also studied at several distinguished French institutions of higher learning, including the Institut d’Etudes Politiques de Paris. Mr Bruncko has published numerous technical articles in journals and books and co-edited a volume on the implications of European integration for Slovakia.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
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