It is a salutary thought that last year voters born in Eastern Europe after 1989 took part in national elections for the first time. Young men and women with no experience of life under communism were able to vote freely in countries which, until the collapse of the Soviet Union, had been inside the Warsaw Pact.
To those voters, who have known only democracy and the market economy, these things are entirely normal. The recent electoral success of the Polish Civic Platform Party (Platforma Obywatelska), with its liberal social and economic thrust, was in large measure the result of such voters’ views, in a country with a traditional conservative Catholic outlook.
That alone ought to give some perspective to any discussion of the changes effected in those countries since the fall of the Berlin Wall. The very fact that today we are able to talk of countries such as Estonia, Latvia and Lithuania deciding their own fates is remarkable enough; but when we then go on to examine the way a nation such as Poland has been transformed, it is little short of astonishing that so much has changed in so little time.
It is, of course, patronising – and wrong – to lump the former Warsaw Pact countries together. The political cultures of Bulgaria and Estonia, for instance, are very different, and the economies of Poland and Romania have little in common. Poland will soon be an economic powerhouse of the EU; Bulgaria still has a long way to go before it even has a properly functioning criminal justice system.
But there are, nonetheless, a number of important similarities in their subsequent paths. Most obviously, they are all, to a greater or lesser extent, now market economies. Some have gone further and more committedly down the road of privatisation and reform of public services, others have embraced flat taxes; some are unravelling the reforms introduced in the first flush of post-communism enthusiasm. But all now operate within a recognisable framework of Western, democratic, market-oriented economies. Indeed, EU membership – which, for all the institutional barriers the EU can impose, has happened in an astonishingly swift time frame – has entrenched not just democracy but fiscal discipline. This is, if anything, the greatest transformation of all. The need to adhere to the Maastricht criteria and the adoption of the euro have necessitated measures that have provided countries with the foundation for investment and employment. (And provided a contrast with Western European countries, which have not reformed their more rigid tax and labour laws.)
Poland’s success story
Take Poland, which has adapted to its new modus operandi with apparent ease. Given its place within the EU now, it is sometimes difficult to remember that less than 20 years ago Poland was under military communist rule. Indeed, 65% of Poles today back EU membership, compared with just 53% in France. When Poland joined the EU in the first wave of accessions in May 2004, it was not merely symbolic, it was of profound importance to the future prosperity of Poland. In 2007, Polish GDP grew at almost 7%, with unemployment standing at less than 10%. This despite a government that had occupied office with the less than inspiring strategy of Primum non nocere (First, do no harm). Economic reform had been on the back burner when the Law and Justice Party (Prawo i Sprawiedliwosc) won the 2005 elections. Rather, it had won power on a pledge to deal with corruption, a prevalent issue.
This theme is recurrent across the former Warsaw Pact countries, which is hardly surprising given the systemic corruption on which Soviet communism was built. In Bulgaria, corruption remains endemic, so that the business climate is far less promising than elsewhere. Worse, the courts are, even when honest, slow; and the police, even when attempting to deal with corruption rather than being on the receiving end of it, are largely ineffectual. The government has been slow to privatise and this, too, has kept alive opportunities for back-handers and corruption. Even Latvia, in so many areas a model, has suffered from the overhang of Soviet corruption. In 2007, Latvia’s longest-serving prime minister, Aigars Kalvits, who had been in office since 2004, was forced to resign over allegations about the attempted sacking of an anti-corruption official who was investigating the ruling People’s Party’s finances.
Successful structural reforms
Latvia is, however, a good example of how rapidly major structural reforms can not only be implemented, but also how they can have an immediate and clear positive impact. Latvia was one of the pioneers of reform, introducing a flat tax in 1994, privatising all but the most controversial state-owned industries, linking its currency to the euro and decentralising public services such as healthcare.
Between 2000 and 2006, the Latvian economy grew at an annual 8.1%. So quickly has the economy grown that it is now overheating, with accelerating inflation prompted by rising wages and fuel prices.But, as Jan Lidén, Chief Executive of Swedbank, the largest bank in Latvia, puts it: “This is an intermission in a long-term growth story.”
The Latvian experience over healthcare has been typical. The first initiatives in the 1990s focused on the delivery of services, followed by experiments with differing payment methods. But like Western European countries with long-standing welfare mechanisms, the Latvian governments lacked the courage of their convictions and began to retreat from the logic of their initial reforms. As Helen Davison of the Stockholm Network, an alliance of think-tanks, says in the network’s ‘State of the Union’ report: “In general, reform has been hampered by an overall lack of funding, which has hindered the satisfactory development of the sector and led to increasing dissatisfaction in both patients and those working in the field.”
Even where reforming governments have been voted out by electorates who want the brakes put on, there are strong factors that prevent a wholesale unravelling. Take Bulgaria again. One of the slowest to reform, a financial crisis and hyperinflation in 1997 forced the government to make changes, deregulating, privatising and managing the budget deficit. In 2005, the socialists won power by rejecting such liberalisation. The defeated government’s plans to introduce a 10% flat tax and privatise social security and healthcare seemed buried. And yet, as Georgi Angelov of the Open Society Institute in Sofia says: “Perhaps because they had to form a coalition with two other parties, or because they rightly feared another economic crisis, the socialists supported fiscal surpluses and, gradually, some quite radical reform proposals were approved.”
In 2007, social security tax was reduced to 34%, compared with 43% in 2005, and a quarter of the compulsory pension savings now go to private funds, compared with 10% in 2005. At the beginning of this year, even the 10% flat tax was introduced. The results are already clear: economic growth is at 6% per year, and unemployment is now less than 7%, the lowest level recorded. Indeed, there has been a budget surplus for the past two years of 3.5% of GDP.
Slovakia’s economic reversal
Slovakia has seen more of a push to reverse the tide. Between 1998 and 2006, Mikulá Dzurinda’s governments transformed Slovakia, leading it to be given the nickname of “central European tiger”, drawing in foreign investment and creating the foundations for prosperity and a reduction in unemployment. Between 2002 and 2007, the average annual GDP growth was 6.4%, and unemployment fell from 18.5% to 11.1%
As recently as 2004, Finance Minister Ivan Miklo introduced a major tax reform, with a flat tax of 19% (and full tax exemption for those earning less than half the average wage), and a switch of emphasis from direct to indirect taxes, not least because earlier labour market reforms had been so successful in increasing mobility that direct tax collection was becoming too complicated and itself harming competitiveness. But in 2006, the SMER (Social Democrats) won power in coalition with the Slovak Nationalist Party and Movement for a Democratic Slovakia. Robert Fico, the new Prime Minister, made clear his intention to reverse the reforms, arguing that employees were not sufficiently protected by an excessively liberal labour code. Richard Durana of the Institute of Economic and Social Studies in Slovakia says: “This will have a negative impact on the creation of new jobs and on the competitiveness of Slovak entrepreneurs in the global market. Nevertheless, Fico’s popularity among the working class has grown and he is treated as a champion of the workers, who are portrayed as fighting against exploitation by greedy capitalists.” But, just as in Bulgaria, the government’s key ambition of joining the euro, and thus the need for fiscal discipline, has put a brake on the reform reversal.
Estonia’s free economy
The story is not always “stop, go”, “go, stop”, or any other sequence. In some countries, such as Estonia, the population’s joy at freedom from Soviet oppression was matched by a continuing fervour for the freedom of markets. In March last year, for instance, the liberal Reform Party won an unprecedented 31 seats out of 101 – and with online voting, a world first and a symbol of Estonia’s technological advancement. The Index of Economic Freedom ranks Estonia as the world’s fourth freest economy.
Indeed, so free has Estonia been that, unlike other EU accession countries, membership actually dampened liberalism. Before joining, Estonia operated a unilateral free trade regime. Now the country has to comply with the Common Agricultural Policy, so membership of the EU led, for instance, to a 300% increase in the price of sugar. But some of the Estonian mindset remains vibrant: it refuses to take up its full allocation of EU structural funds, lest it loosen its fiscal discipline. Taxation is simple: a single flat rate for individuals and a flat corporation tax. The rate has fallen from 26% in 1994 to 22% last year, with a promise of 18% by 2011. And this with a budget surplus of 2.8% of GDP, second only to oil-rich Norway.
Hungary’s cautionary tale
At the other end of the scale sits Hungary. Traditionally the most Western-leaning of the Warsaw Pact countries, Hungary might have been expected to press on like Poland. But such reforms as have been introduced – not least by the socialists – have focused more on revenue raising through higher taxes than on reduced spending and fiscal discipline, leading Standard & Poor’s to downgrade Hungary’s long-term credit rating, with this comment: “The downgrade reflects the continued deterioration of Hungary’s public finances, as evidenced by very high general government deficits and quickly rising government debt figures.”
Hungary’s political culture exploded on 18 September 2006, when a tape recording was released on which Prime Minister Ferenc Gyurcsány was heard admitting to having lied to the country about the state of the economy in order to win that year’s election: “No country in Europe has screwed up as much as we have… We did not actually do anything for four years. Nothing.” Weeks of riots and demonstrations followed. The repercussions continue: last September, the government was found to have used Schengen funds to buy water cannons for riot control. The Prime Minister remains in office despite the scandals and despite a referendum defeat over doctors’ visit charges, hospital fees and higher education tuition fees.
As Katharine Cornell Gorka puts it in ‘State of the Union’: “The current government is doing the minimum possible to keep the country afloat, while having a limited grasp of economic mechanisms, notably failing to see that higher taxes will drive down growth. At the same time, the current government lacks the moral authority to ask sacrifices of an already burdened population. This one factor, as much as any other, helps explain why Hungary has fallen from its lead position in 1989 to virtually last place among the region’s economies.”
It is easy to get bogged down in the rises and falls of reform across the former Warsaw Pact counties, but sometimes the best approach is simply to stand back and remind oneself of the enormous growth in liberty that has occurred over the past 20 years.
Stephen Pollard is President of the Centre for the New Europe, a think tank