Central Europe’s economies: Cheap allure

Low labour costs matter more than low corporate taxes in central Europe

THE European Union's new members from central Europe are bristling at pressure from France and Germany to raise their corporate-tax rates or risk losing EU subsidies. The French and Germans fear that competition from the east will force them to cut their own tax rates, or lose jobs and investment. Nicolas Sarkozy, the French finance minister, has declared that, if the new members are “rich enough” to forgo high taxes, they can hardly ask the EU for development funds.

“Completely unacceptable,” retorts Tibor Draskovics, Hungary's finance minister, defending his country's right to set corporate tax at a flat 16%, just under half the French rate. In Poland and Slovakia, the corporate-tax rate is 19%, half the effective rate in Germany. Estonia levies no tax at all on reinvested profits. At least the central Europeans can relish one aspect of this row: more foreign investors have learnt about their low corporate taxes.

They are less keen to own that their other taxes are high - though this would be a good riposte to Mr Sarkozy. Hungary's 25% standard rate for VAT is nine points above Germany's. Poland's top 40% income-tax rate bites at €16,200 ($20,000) a year, whereas Britons earn more than twice as much before hitting the 40% band. Government shares of national income still tend to be large: public spending in Poland, Hungary and the Czech Republic takes 45-50% of GDP. Overall, indeed, the central Europeans tax more, not less, than most economists think they should.

They are also bad at balancing their books. Hungary has admitted that its budget deficit last year breached 6% of GDP; Poland is expecting a deficit of 6% this year. But higher corporate-tax rates would do little to close fiscal gaps. Nor, pace Mr Sarkozy, would they stop investment and jobs migrating from western to central Europe. For the big attraction of central Europe would remain: its low labour costs.

According to a report by Kevin Waddell of the Boston Consulting Group, presented at last month's Polish Economic Forum in Krynica, labour costs are between five and 12 times lower in central Europe than in Germany. Yet productivity in central European factories matches western Europe's at comparable levels of capital investment and technology. A maker of car parts in Germany could save 30% by moving production to Poland. One moving from Spain could save 24%. For many goods aimed at European markets, central Europe is a cheaper manufacturing base than China, thanks partly to lower shipping costs, says Mr Waddell.

The puzzle is why more foreign firms are not flocking in. One complaint is that small companies still feel uneasy about central Europe's business environment. They worry that governments and regulations change too often, and they find public agencies inefficient and unresponsive. Even big investors hit snags. Hyundai of South Korea recently delayed construction of a car plant in Slovakia, because the government had announced the deal before the site was acquired and local landowners were holding out for sky-high prices.

But if central Europeans can learn from such mistakes, they should prosper. The Boston Consulting Group figures suggest that many foreign companies, perhaps dazzled by China, have underestimated the merits of central Europe. Even if EU pressure led some countries to add a few points on corporate taxes, that would not reduce their fundamental appeal.

Low labour costs matter more than corporate taxes in central Europe.

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