Charlemagne: Dancing an Irish jig

Date: 17/04/04

EU newcomers will mimic the nimble Gaels - if they get the chance

EVEN by local standards, it will be a time of craic and conviviality to remember. At the beginning of May, ten newcomers to the European Union will mark their first day as members of the club by joining the 15 older ones for a hearty celebration - in Dublin. The venue could hardly be more appropriate. For anyone talking to politicians from the new member states will know the refrain: “We want to be like Ireland.”

The Irish-wannabes in central Europe are not thinking about the delights of smoke-free pubs or Celtic music. Ireland has become “Exhibit A” for those who believe that entering the Union can make you much richer. When Ireland “joined Europe” in 1973, its per-capita income was just 62% of the EU average; by 2002 it was 121%. Pat Cox, the Irish president of the European Parliament, says membership “turned us from a stagnant, backward, failed part of the British regional economy into a modern and prosperous European country.”

Yet EU membership does not automatically confer riches. Greece had a GDP-per-head of 64% of the EU average when it joined in 1981, and by 2002 the figure was only about 70%. Even in Ireland, the miracle took a while coming. In 1987 - almost 15 years after joining - the country was facing double-digit unemployment, mass emigration and a public debt of over 120% of GDP. But by slashing taxes and the state's share of the economy, the Irish were able to exploit their access to the EU market and encourage a torrent of foreign direct investment. By 1998 American multinationals accounted for 70% of Irish exports. The top corporate tax rate, once over 40%, now stands at 12.5%; the state's share of GDP, which hit 54% in the 1980s, is now down to 33%. Unemployment is less than 5%.

These lessons have been eagerly absorbed in the new member-states, where flat taxes and small government are now all the rage. Estonia led the way by introducing a flat corporate tax rate in the mid-1990s. Now Poland, Hungary and Latvia have all cut corporation tax to below 20%. Slovakia has introduced a 19% flat tax for both corporate and personal income. Combine low taxes with good basic education and relatively low wages - Slovakian workers' wages are around 20% of those in Austria - and you have a very attractive package for investors. Slovakia, whose population is just 5.4m, is fast becoming one of the car manufacturing centres of Europe: Volkswagen, Hyundai and Peugeot have all invested. Ivan Miklos, the Slovak finance minister who has masterminded his country's reforms, says confidently: “Foreign direct investment into Slovakia is going to be even higher soon, because investors will have the added economic and legal certainty of being part of the EU's internal market.”

Ireland had some advantages - an English-speaking population and close ties to the United States - that the new members of the EU cannot replicate. On the other hand, countries like Poland and Slovakia are nearer the big markets of western Europe than Ireland is. The economies of the new member-states grew by an average of 3.7% last year - a much healthier rate than the 0.4% average experienced in the euro-area. The central Europeans will have to keep up this pace for many years, if they are to achieve their ambition of becoming as rich as western Europe. The current wealth gap is so large that the Economist Intelligence Unit, our sister organisation, has estimated that - even if they grow at around 4% a year for the foreseeable future - it would take Slovakia almost 40 years to catch up and Poland almost 60 years.

Fear of high-fliers

Such rapid rates of growth, if they are achieved, would provide healthy new markets for west European companies. Yet there is now a distinct whiff of fear among the current members about competition from central Europe. When Ludwig Georg Braun, the head of the German chambers of commerce, recently advised his members to invest in central Europe rather than “wait for better policies” in Germany, he was denounced as unpatriotic by Gerhard Schroder, the German chancellor. Austria has announced that it will cut its corporation tax to 25% next year from the current 34%, citing the competition from neighbouring Slovakia. The Austrians say they welcome the competition. But not everybody in the EU is so sanguine. Guy Verhofstadt, the Belgian prime minister, has revived the idea of a minimum corporate tax rate for the whole of the EU - and added a nasty new twist, by suggesting that countries that refused to co-operate could be deprived of the EU's regional aid to poorer places.

Such tax harmonisation, however, would have to be agreed unanimously in the new EU - and it is hard to see why new members should agree to hobble themselves. The real threat to the Irish ambitions of central Europe may end up being home-grown rather than imported from Brussels. Economic reform in central Europe inevitably creates losers as well as winners. Workers in uncompetitive old industries or over-staffed state bureaucracies lose their jobs. The middle class may find that prices are rising, as indirect taxes go up to compensate for cuts in corporate and personal taxes.

The political fallout can be nasty. In Poland, the prime minister has just been forced out of office and Andrzej Lepper, a potato-throwing populist, is riding high in the polls. In Slovakia, Mr Miklos insists bravely that “deep structural reform is only possible with deep political will”. But while the finance minister's determination is unquestionable, ordinary Slovakians show signs of rebellion. In the first round of the recent presidential election, they gave first place to Vladimir Meciar, a backward-looking nationalist who is deeply suspect in the rest of the EU. If populists like Mr Lepper and Mr Meciar come to power in central European countries, investors are liable to take fright. For the Irish recipe was not just low taxes and small government. It also contained another vital ingredient investors need to be able to take for granted - political stability.

Commentary feature. Newcomers into the EU want to mimic the success of Ireland as they join.

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