Saturday, December 31, 2005
The EU's new boys are shaking up Europe
Posted by David Smith at 05:00 PM
Category: David Smith' s magazine articles

The European Union has had five enlargements in its history, which now stretches to nearly half a century (slightly more if you date it from the start of the European Coal and Steel Community). From a British perspective the most important was in 1973, when the UK, along with Ireland and Denmark, joined the original six of Germany, France, Italy, Belgium, the Netherlands and Luxembourg.

That 1973 enlargement had a profound effect on the EU, and continues to do so, probably much more than the three subsequent expansions that took in Greece (1981), Spain and Portugal (1986) and Austria, Finland and Sweden (1995).

It is doubtful, however, whether any of the EU’s enlargements have had as big an immediate effect as the one that occurred in May 2004. That was when what had become the 15 were joined by Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia.

Before this latest enlargement fears were expressed that the new members would impose a burden on the existing EU, through both the Common Agricultural Policy and the EU budget more generally. Some of the rich EU countries undoubtedly looked down on those joining the club. In fact, the impact has been almost wholly positive.

Not only does the new EU of 25 have a different dynamic than its smaller version (though this was of no help in the task of securing public backing for the Constitution) but the new members have been very influential in other respects.

In Britain, the most obvious impact of the latest enlargement has been on the labour market. Coming at a time when Britain’s job market was very tight and employers were complaining of serious skill shortages, the effect of the arrival of migrant workers from the new member states, particularly those in eastern Europe, was beneficial.

The Bank of England, in its latest inflation report, published in November, noted that new estimates suggested the working-age population was 136,000 higher than previously thought, and that much of the increase was to do with arrivals from the “new” Europe. Britain has had a more liberal attitude towards immigration from the new members than other EU countries and has particularly felt this effect. Direct migration from the 10 countries which joined the EU in May 2004 is officially estimated at 75,000.

Throughout this period the Bank’s regional agents have found in conversations with companies that business has been turning with enthusiasm to this new source of labour supply. The workers themselves appear enthusiastic to come to Britain, and with good reason. Not only has the government taken a liberal attitude to immigration but gross earnings in Britain are roughly six times those in Poland and Hungary.

Indeed, there is tentative evidence that employers prefer eastern European workers to the extent that some of the existing unemployed are being squeezed out. The Chartered Institute of Personnel and Development sees this year’s combination of rising employment and a steady increase in claimant unemployment as a reflection of this. Faced with competition from better qualified immigrants, some indigenous workers are missing out.

In the main, however, the effect is of benefit to Britain’s economy. According to the Bank: “Overall it seems likely that net migrant flows to the United Kingdom have acted to reduce inflationary pressure in the past. In the future, these flows might be expected to continue raising potential supply, and provide some further boost to demand.”

Low-cost labour among the new member states is, of course, having an impact even in those EU countries that have restricted migration. The threat of transferring jobs to eastern Europe has been a significant factor in allowing corporate Germany to push through changes in working practices.

Perhaps even more important than this for business, though, is the impact on taxation. Everybody by now knows of the flat tax revolution started by Estonia in 1994, with a flat tax on corporate and personal income, and followed by eight other countries, including not only Latvia and Lithuania but also Russia. Flat taxes have made governments and oppositions think again about the complexity of their tax systems. George Osborne, shadow chancellor at time of writing, has launched a tax commission to examine aspects of flat taxation that could be introduced in Britain.

The tax impact of the new member states goes beyond merely that of sparking a flat tax debate, however. For a start, the new members have lower tax burdens than existing EU countries. Lithuania and Latvia have tax burdens of 28.5 and 29 per cent of gross domestic product respectively. Most of the new members have burdens of less than 40% of GDP. This compares with almost 51 per cent in Sweden and typical burdens of 45 to 50 per cent in “old” Europe.

One possibility, clearly, is the new members will converge to the relatively high tax levels of longstanding EU countries. The signs are, however, that this is not occurring.

As far as corporate tax rates are concerned, the new members have long recognised that low rates are a surefire way of attracting inward investment. The average headline corporation tax rate in the 10 accession countries in 2000 was 27.4 per cent. Now it is 20.4 per cent. Driven by this tax competition on their doorstep the existing member states have respond. The average corporation tax rate in the old EU-15 has fallen over the same period from 30.5 to 30.1 per cent. The biggest cut has come in Germany, which is where it was probably needed most.

Some EU member states have been unhappy with this drive to lower tax rates. As Gaëlle Blanchard of Societe Generale in Paris points out: “The low-tax policies of the new states prompted some of old countries’ governments to call for an EU minimum company tax standard. Tax harmonisation appears however quite remote since the rejection of the European Constitution by France and the Netherlands.”

In place of harmonised corporate tax rates the Commission is pushing for a harmonised EU corporate tax base. Again, however, this appears quite remote, not just because of opposition from the new members but also from Britain and Ireland.

The new member states have, by and large, an economic philosophy built on low tax rates and flexible markets. The models they look to are those established by Britain (flexibility) and Ireland (low tax rates), rather than those of, say, France and Germany. Their impact is a breath of fresh air within the EU. Long may it continue.

From Business Voice, December 2005/January 2006 edition