Europe grows east

I spent much of today chatting and listening to ex-PM of Poland Marek Belka who visited La Trobe University and our Department of Economics and Finance. He had also worked in Iraq in the post-war reconstruction and is now Executive Secretary of the United Nations Economic Commission for Europe (UNECE). He is an astute and thoughtful person with a keen sense of humour. I enjoyed the day.

His seminar topic was 'The European Union After Enlargement'. What do Australians think of Europe these days? To exaggerate somewhat don't many of us see Europe as a sclerotic, over-regulated economy with high 'civilisation' standards as its main redeeming feature? Its an inaccurate picture, in terms of the economies, if only because what we need to define as Europe is changing so quickly. For one thing it is 'shifting east'.

Belka was drawing attention to those countries which have joined the European Union after breaking free from Communism. 8 of the 10 most recent newcomers to the EU are ex-communist states. This 'Eastern Enlargement' has changed the EU in important respects:

(i) Foreign policy. The enlargement has brought the borders of Europe close to those of Russia and the Ukraine and, it is to be expected, that problems and disputes will arise between the new neighbours and Europe. Russia now becomes more important. Also, new members are strongly pro-US (look at the map to understand why!) and hence will change Euro-Atlantic relations. For example, all these new members have sent troops to fight for the Coalition in Iraq. These countries will constrain Europe's ability to pursue a foreign policy that differs from that of the US and will moderate anti-Americanism.

(iii) Economic policy. The old EU has old market economies (France, Germany....) that some now see as having degenerated to become over-regulated welfare states. They certainly do differ from Anglo-Saxon capitalism of the US-type. But the 8 new members have all experienced recent market-oriented reforms that were , on balance, successful. Attitudes are ultra-liberal, pro-free-market and right-wing.

For example, flat-tax regimes have been introduced in Slovakia and the Baltic States and are being considered in Poland. Competition will make this become an issue for Europe generally. Also the new members have markedly low corporate tax rates from 18-20%. Again an issue for Europe in general. Finally, while liberalisation has occurred in banking, insurance and energy there are bold moves for it to be launched in services generally, such as construction. The implied challenge from low-tax, low-wage new EC entrants to established economies is obvious. Of course, sometimes reforms bite the new entrants as well - for example the ex-communist states probably cannot afford old Europe's environmental regulations but, as Belka was happy to admit, this is one battle few will mind losing! Who cares, after all, if you end up with clean water or quality roads, even if you do face transitional high costs!

The prospect of ex-communist countries challenging old European economies by promoting liberalisation is a stark one. The potential gains-from- trade that can be realised between such different economies are obviously great. But the social costs and the political squabbles should also be significant and fascinating to watch.