State of the Union

THE STATE OF THE UNION The progress of market-oriented reform in the EU

CONTENTS Introduction The European Union Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom

1 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56

The Stockholm Network is the leading pan-European think tank and market oriented network. It is a one-stop shop for organisations seeking to work with Europe’s brightest policymakers and thinkers.Today, the Stockholm Network brings together more than 130 market-oriented think tanks from across Europe, giving us the capacity to deliver local messages and locallytailored global messages across the EU and beyond.

Combined, think tanks in our network publish thousands of op-eds in the high quality European press, produce many hundreds of publications, and hold a wide range of conferences, seminars and meetings. As such, the Stockholm Network and its members influence many millions of Europeans every year.

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© Stockholm Network 2008.The views expressed in this publication are those of the authors and do not necessarily represent the corporate view of the Stockholm Network or those of its member think tanks

ACKNOWLEDGEMENTS All credit and thanks go to the contributors to this publication – their fine work, dedication and support are much appreciated. I would particularly like to thank Helen Davison and Tamlin Vickers, who helped with every aspect of this project, and unquestioningly went the extra mile for me. My thanks and admiration to Sarah Hyndman, whose creativity and commitment never cease to amaze me. As ever, I am grateful to Helen Disney for her unwavering support, encouragement and expertise.

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Published by The Stockholm Network, 2008.

Introduction

Since the Stockholm Network last produced its State of the Union publication in early 2005, the EU, and indeed Europe as a whole, has undergone major shifts.

In many of the western European economic powerhouses, a new political guard has seized power. Whereas in 2005 a number of the key leaders were, at least to some extent, comfortably established, we now see politicians in Germany, France and the UK who are forced onto the cutting edge of policy. Whether attempting to manage a fragile coalition or, indeed, a sclerotic economy that will bring severe problems for future generations unless reformed, several western European nations have had to accept that they must adapt in order to survive.

The expansion of the Stockholm Network’s own work and the spread of its affiliated network of think tanks illustrates the rise of free market economics and liberal politics across the continent. Indeed, the tables in Europe have somewhat turned. New hope is now arising from many of the economies in Central and Eastern Europe. Their experiences since the fall of the Berlin Wall and their desire to move away from a top-down central state have led to them experiencing huge economic growth and new-found prosperity. Now they are in many cases leading the way for others to follow with brave, if not always popular efforts to tackle healthcare and pensions and the widespread adoption of the controversial flat tax.

But, while our leaders fight their national battles, they must continue to fulfil their European commitments, both financial and administrative. As demonstrated in the following chapters, the Maastricht criteria and the adoption of the euro have led to huge increases in the prosperity of many new accession countries and provided them with the necessary incentives for overhauling economic policy. As a result, these countries have introduced measures that have attracted investment, created jobs and brought about positive feelings towards the EU amongst their electorates.

Whereas 65% of Poles back EU

membership, that figure is only 53% in France.

By contrast, western European countries have largely hung on to regressive immigration, tax and labour market regulation laws. As a result, businesses have gone elsewhere, and eager, hard working and increasingly mobile workers from the new Europe have upped the competition for jobs at all levels. While the Western European electorate debates the minutiae of an EU treaty and worries about overloaded public services, our eastern European neighbours are visibly reaping the benefits of full EU membership – demonstrating that being part of the EU need not stand in the way of governments undertaking much-needed reform.

If there is debate over the treaty and the social benefits of integration, there can be little doubt about the benefits the EU has brought in terms of trade. The EU is currently the worlds’ biggest exporter and second largest importer of goods and attracted €9.05 billion in FDI in 2006 alone. The EU has also enjoyed an employment increase of 3 million in the last year, despite a moderate slowdown in the global economy. The whole, it seems, is greater than the sum of its parts, and we should focus on these huge successes.

Importantly, with increased migration and economic prosperity has come increased freedom, and this is what the EU should be most proud of. In the words of John Stuart Mill, “the only freedom which deserves the name is that of pursuing our own good, in our own way, so long as we do not attempt to deprive others of theirs, or impede their efforts to obtain it.”

Susie Squire March 2008

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The European Union

Helen Disney is Chief Executive and founder of the Stockholm Network.

What has happened overall to economic growth and market-oriented reform in Europe over the past three years?

The Stockholm Network last published its State of the Union report in early 2005, in the aftermath of the wave of eastward enlargement which took place in May 2004. Our aim was ambitious – to try to assess as concisely as possible what progress European nations were making towards market-oriented reform and economic growth.

Three years on, a great deal has happened, not least a rising influence of the new member states, with Slovenia being the first of the former Communist countries to assume an EU Presidency, in the first half of this year.

The addition of Romania and Bulgaria in January 2007 has increased the size and scope of the European Union once more, and hence also the remit of this publication, which looks at these two nations in their role as member states, rather than as accession states, for the first time.

More broadly, Europe’s continuing accession discussions for candidate countries including Croatia and Turkey amplify the question of what the EU bloc represents in the long-term.

Europe has to make a choice about how willing and flexible it is going to become to adapt to the vast economic and social changes that globalisation brings The intense political discussion surrounding the signing of the Lisbon Treaty in December 2007, which will continue until its proposed ratification by the member states in 2009, heightens the tensions between those who prefer a looser trading bloc approach and others who wish to extend and deepen the political aspects of union. But, leaving aside the thorny question of EU politics, are we safe to assume that the single market is automatically conferring economic benefits?

What do the official figures tell us? According to the European Commission’s own statistics,

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GDP growth in the EU area has risen slightly from 1.7% in 2005 to 2.7% in 2007.There has also been some progress in labour productivity, which has risen from 0.7% in 2005 to 1.3% in 2007. Meanwhile, unemployment has fallen by a percentage point from 8.6% in 2005 to 7.6% in 2007.

Things are not necessarily getting worse but nor are they progressing as quickly as might be required to compete on the global stage. If one compares growth rates in the EU area against NAFTA, for example, during NAFTA’s first thirteen years, GDP growth has been significant with the United States experiencing 50% growth, Canada, 54% and Mexico 46%, according to NAFTA data Moreover, looking at the EU average may give us something of a distorted picture in comparison to a grassroots analysis of the progress of individual member states – as a study of the rest of this publication makes clear.

While Nordic countries such as Finland and new member states like Slovenia are optimistic about their prospects, France, Belgium and Spain are gloomier about their ability to keep up economically.

The most recent 2007 edition of the Centre for Economic Reform’s ‘Lisbon scorecard’ largely backs this up, showing that some EU countries are well placed to benefit from globalisation, while others will lose out.The Nordic countries somehow manage to combine high employment rates with the most successful high-tech industries and the best social welfare system.

France, Germany and Italy are gradually feeling the pain of reform in labour markets, pensions and healthcare, although progress is not as fast as some would like and economic growth remains sluggish.The Mediterranean member states, like Greece, meanwhile, alongside some of the newcomers of 2004, remain the EU’s laggards.

More specifically, it is also instructive to consider what is happening in some of the most significant sectors of the European economy. In the public

despite its many practical pitfalls it is being considered as a model around the world, as a way of creating a quasi-market for carbon.Yet there remains a great deal of uncertainty over whether green policies will slow or boost growth, particularly for the economies of central and eastern Europe which will find adapting to regulation more costly.

Nevertheless, the ‘green economy’ also presents some potential opportunities for growth and development of new technologies, in which Europe can become a market leader.

sector, for example, has Europe made any progress towards shifting the burden of expensive health and welfare services from the taxpayer to the consumer? In the knowledge economy – be it telecommunications, creative industries, software, pharmaceuticals or biotechnology – is the balance between protecting IPRs and stimulating competition working and is this leading to greater innovation and growth? In energy, are environmental policies working to create a more vibrant energy market and will concerns over carbon emissions put a brake on the economy or be able to open up new markets?

The development of Europe’s economy away from traditional heavy industry and manufacturing into a modern, knowledge and service-based economy has opened up the prospect of new jobs, new industries and new growth – but the nature of this shift also poses problems for policymakers and business, not to mention the societal change it will engender.

Take healthcare, as one good example.

Healthcare has traditionally been national – organised and largely paid for by European governments and with each country in Europe having its own particular method of funding and arranging treatment. But what will happen as consumers become more demanding unwilling to accept waiting times or lack of access to care. A small but significant trend has begun of cross-border movement, with more patients willing to go abroad for private treatment and with some patients even willing to challenge the legality of their own national systems and receive care abroad yet paid for by their home government. In the first round

of debate over the Service Directive, health and social care was thrown out – considered too controversial for inclusion – but just a few years later and the European Health Commissioner, Markos Kyprianou is already on the verge of launching a new directive to specifically address the question of patient mobility.The prospects for a European healthcare market are opening up and, while controversial, may come to be seen as a positive development for both the economy and for patients.

As for other new opportunities, most of the burgeoning sectors of Europe’s economy now lie in the creation or dissemination of knowledge products. Intellectual property and its protection have therefore become much more central to Europe’s political and policy debates. Recent cases, be they the Microsoft case, or the recent stance towards Google, suggest that the European Commission is taking a more pro-active approach towards the expansion of competition policies, possibly at the expense of intellectual property rights.This poses challenges for the growth of knowledge sector in general, but also for policymakers in the years ahead as the issues become more complex and technical.The convergence of content and communications technologies is one example where regulation is becoming highly technical and where industry is innovating too quickly for politics to keep up.

If the knowledge sector is growing exponentially, so too is interest and concern over the economic impact of European energy policy. Europe’s Emission Trading Scheme has become an innovation in its own right –

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In all of these areas, Europe has to make a choice about how willing and flexible it is going to become to adapt to the vast economic and social changes that globalisation brings. If we want to harness the benefits of global growth, Europe will need more flexible labour markets, less onerous welfare entitlements, an attractive climate for innovative business and a speed of manoeuvre that outstrips its current performance. We still have much work to do.

The goals of the Lisbon agenda notwithstanding, Europa still needs to become more ‘bullish’ if its wants to continue to compete and be competitive on the global stage.

Austria

Kristian Niemietz is a research officer at the Stockholm Network.

Located amidst a number of countries that suffered from sluggish economic growth and chronically high unemployment,Austria to date seemed to be immune from the economic ills that plagued many of its neighbours. Growth rates were above 3% over the last two years, unemployment fell to below 5%, inflation to 2%, and the balance of trade has shown comfortable surpluses.

Austrian firms have successfully used the opportunities provided by EU enlargement, which has placed the alpine republic at the heart of the continent, and made Austrian business a top player in Central and Eastern Europe.

Much to the annoyance of German politicians, especially the finance minister, many companies and workers from Austria’s large northern neighbour decided to relocate to the other side of the border. Entrepreneurs felt attracted by, among other things, lower corporate tax and less red tape.The top rate has been cut from 34% to 25%, and the period required to start a business shortened to an average of 29 days.

The Austrian Business Agency toured the world with the advertising slogan ‘We are the better Germany!’. It also seemed that the grand coalition of Social Democrats (SPÖ) and Christian Democrats (ÖVP), which took office in January 2007, had no intention of challenging the relatively business-friendly course of the centreright government they superseded in office.

However, being slightly better than average can hardly be the ultimate goal of an economically advanced nation. While Austria has clearly circumnavigated the maelstrom of stagnation and structural crisis, it has come far short of the extraordinary growth experienced by countries such as the US, Ireland and some Nordic countries. Austria’s performance is solid, but not spectacular, and while there have been a number of policy improvements in recent years, there have also been backshifts and missed opportunities.

GROWING PAINS One of these neglected areas is productivity growth. This key figure, the main long-run determinant of a nation’s wealth, has run flat since the 1990s.This is surprising since globally we have seen revolutionary progress in information and communication technologies, and productivity growth in the US, Ireland and Scandinavia has indeed reflected this development. What prevents Austrians from benefiting from technological progress on the same level?

It is telling to break down the productivity growth figure. There has been notable growth – but it has been largely confined to the

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traditional manufacturing sectors, which have formed the backbone of the Austrian economy for decades. In the service industries productivity growth has been stagnant or even negative. Interestingly, these are also the sectors that are most regulated and shielded from competition, internal and domestic. Take, for example, the OECD indicator of product market regulation. While on the summary rating, Austria takes a middle-of-the-road position, there is intense regulation of and restricted access to the retail sector, the liberal professions, and parts of the transportation sector. A similar picture is obtained for the OECD indicator of regulatory restrictiveness of foreign investment. The Austrian service sector receives the second worst value of all the OECD countries in the sample, which results in depressed foreign investment rates.

With the new government showing protectionist leanings, the situation is unlikely to improve. Last year when a British private equity group attempted to take over the Austrian steelmaker Böhler-Uddeholm, Chancellor Alfred Gusenbauer called the move “a catastrophe” because the Böhler-Uddeholm was a “jewel of Austrian industry”. This was not an isolated statement but followed a series of blocked takeovers, which included stakes of VA Technologie, Telekom Austria and the postal service. Note that the bids did not come from the Chinese or the Saudi Arabian government, but from Swiss and German companies. Some ministers encouraged business leaders to set up an ‘Austro Fund’ that should block foreign takeovers. Mere sabre-rattling, or a harbinger for a new alpine-style protectionism?

Public spending is another area where all that glitters is not gold. On the one hand, the annual budget deficit is clearly below the Maastricht upper limit of 3%, and in 2007 the total debt ratio has fallen below the 60% of GDP agreed in the Maastricht treaty. Compared to ‘big spender’ nations like France, Italy and Germany, Austria appears fiscally prudent. But the target

it is striking that even in the second generation, skill levels and school performance of this group are substantially lower than for the native population. The education system appears unable to integrate immigrants.

Reforms aimed at school autonomy regarding their budgets, employment and curricula should be enacted, perhaps along the lines of the Swedish model of school competition.

With the development of a quasi-market in education, schools where there is a lack of German language skills in specific areas could use their budgets to address these deficits.

of a balanced budget has been postponed again to 2010, and the social insurance agencies are running large deficits of their own. If a balanced budget cannot be achieved in times when the economy grows by 3.4% and tax revenues are at a record high, it will not be achieved within the next two years, especially since growth is forecasted to slow down, and the government has already committed to higher social and environmental spending. Nota bene, the problems of Austria’s public finances are not caused by a lack of revenue. Even though a cut in the top corporate tax rate has aroused attention, this should not divert from the cold truth: Austria is a high-tax nation.The top income tax rate amounts to 50%, and the government’s share in the economy is about the same.

cross-level responsibilities, co-financing, tax transfers and tax sharing undermine transparency and weaken accountability.

Whether it is the health sector, education, family policy, environmental regulation or residential construction – everyone is responsible, which means that in the end no one is responsible. Some incremental improvements have been achieved in the latest reform. The states will now have greater spending autonomy, instead of merely following orders from Vienna.

But a disentanglement of responsibilities and revenue autonomy for the states and municipalities is missing. Austria should have looked to its western rather than its northern neighbour, i.e. looked to the paradigm of competitive federalism instead of the paradigm of equal living conditions.

If Austria revitalised the best of its intellectual traditions, it could indeed become the true heart of Europe, in more than a geographical sense

The Austrian labour market performance has found international acclaim. An annual unemployment rate of 4.7% is noteworthy because it coincides with a high proportion of those aged 15 to 65 willing to work, as the employment rate of 73% shows.This means that Austria does not simply tune up its statistics by pressing the unemployed into the passive sector, but owes its positive figures to actual job creation. However, behind these laudable averages, some worrying trends lie concealed. The specific employment rates of workers aged 55 to 64, as well as of unskilled workers, are amongst the lowest in the OECD. The former certainly has to do with the strong incentives that were historically offered to early retirees.

A recent reform of federalism, which was to rearrange responsibilities between the various levels of government, could have been an opportunity to improve public spending efficiency. Unfortunately, it has been shelved.

Despite its longstanding federal tradition, Austria is effectively a heavily centralised nation.The division of public expenditure between the national, the provincial and the municipal level roughly follows a ratio of 70:16:14, compared to 30:40:30 in federalist Switzerland. But even within their limited sphere, provinces and municipalities cannot autonomously decide on their own tasks or raise their own revenues. All the important taxes are shared between central and state governments, with the central government setting the rates. Even the communal tax rate, the most important revenue item at the subnational level, is set in Vienna. A myriad of

Over the past year, the government has reduced these incentives, which were incompatible with an ageing society. Early retirement is, of course, a legitimate decision.

But the deductions should be such that this decision is cost-neutral for the system as a whole, which is still not the case in Austria.

The government has done a disservice to unskilled workers by introducing a monthly minimum wage of €1000 YTD. To improve the take-home pay of the low-income earners, it should rather have lowered their income tax bracket and social security contributions. For some groups, the solutions must be still more far-reaching than that. The unemployment rate is particularly high among immigrants, and

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Austria has a lot to offer and richly deserves its successes. But it could scale even greater heights. Austria should permit its service sectors to become as competitive as its manufacturing sectors, by liberating them from excessive regulation, but also by exposing them to competition. In public spending, there are sizeable fat reserves. A clear assignment of responsibilities, with taxing and spending in one hand, would limber up the public sector.

This could clear the way for substantial tax cuts while simultaneously reducing the debt level. Austria should make sure that older and unskilled workers, too, enjoy the good employment opportunities of the rest of the population. It should equally ensure that fringe groups can catch up with the high skill level of the general labour force, by permitting a much more diversified education system.

And there are good examples close by. For a reform of federalism, Austrians could look to their western neighbour. For a tax reform, they could look to their north-eastern neighbour. For education reform, they could look far north.

But Austrians need not even look abroad for advice. It is, after all, the home country of Friedrich Hayek, Ludwig von Mises and Joseph Schumpeter. If Austria revitalised the best of its intellectual traditions, it could indeed become the true heart of Europe, in more than a geographical sense.

Belgium

Stephan Wyckaert is attorney-at-law at Janson Baugniet and an associate professor at the Université Libre de Bruxelles.

Writing on reform in Belgium today is an even harder task for me than it was in 2004, when I wrote my entry for the first State of the Union.The evolution of market reform is largely dependent on the reform of the Belgian state itself.

Belgians of the North and the South are indeed seeking a new identity, a new structure to organise their coexistence.The result of this quest will not only shape our political sphere, but also determine the evolution of market reforms.

In 2004, I began my article by reminding the reader that Belgium is characterised by an often uneasy equilibrium between the two main linguistic groups – Dutch and French – and a number of diverse regions with distinct cultural legacies. Within this amalgamated system, economic and political actors often fall short of mutual concord and understanding. After the regional elections of 2004, government coalitions in Flanders and Wallonia were composed differently at the level of the Federation. Political rivalry between the French-speaking socialist and liberal parties, both members of the federal government but rivals in the French-speaking region, exacerbated rising tensions; on the Flemish side there was growing support for the Christian Democrat/Flemish nationalist cartel CD&V/NV-A, which pledged far reaching reform of the state.

under way to reach a definitive coalition agreement. Indeed, according to plan, the interim Prime Minister Guy Verhofstadt would lay down his office on 20 March 2008 to be succeeded

by Yves Leterme, and by that time a ‘Council of Elders’ would have to set the outlines for state reform. It is not known at the time of writing which parties will be part of the coalition after March 23rd, but by the time this publication is launched, the answer will be known.

TIES THAT BIND

On 13 December 2006, Belgium’s Frenchspeaking public television network created a stir with a surprise 90 minute broadcast that began with a news flash that Flanders had declared independence and that the Belgian state was breaking apart. Although the broadcast was heavily criticised, it set the tone for an election campaign dominated by comminatory issues, and it became ever more obvious that politicians on both sides of the linguistic border were entrenching themselves behind the – true or false – interests of their own community.

Why is it so difficult for people in Belgium to agree when it comes to matters of state?

Certain media organisations present my country as a place where a rich, Dutch-speaking majority (living in Flanders) has grown tired of their poor, French-speaking countrymen and want to separate from them and to continue as an independent nation. All too often, Flemings are painted as a right-wing and separatist people who hate French-speakers. But in reality the Fleming is neither far-right, nor separatist, nor does he hate French-speakers. It may be true that, historically, Belgium was conceived by its founding fathers as a French-speaking country and was modelled after the July monarchy in France. During the nineteenth and early twentieth century, Flemings struggled hard for equality. The scars left by this struggle have mostly healed and, in general, members of the two major language groups get along well.

When, finally, the parliamentary elections took place on June 10th, it soon became obvious that the winners would have a hard time finding partners prepared to enter into a coalition.

The result was the longest political crisis in Belgian history: with the formation talks taking place between June 10th and November 3rd.

These talks were punctuated by unreasonable demands and acts from both (Flemish and Walloon) sides, as if each side feared losing face if they yielded even slightly to the other. When the Parliament finally confirmed the formation of an interim Government (on 23 December 2007), it had been 196 days since the Belgian people had voted out the previous coalition.

At the time of writing, negotiations are still

Many people in Flemish cities such as Ghent or Bruges will not lose sleep over what happens over the linguistic border and the same is true for inhabitants of, for example, Mons or Namur in Wallonia. It can, however, not be denied that certain differences clearly exist: Flemings tend to rely less on the welfare state, whereas Walloons expect more from the State and from public authorities. Many people in the South fear abandonment by the North.

A majority of Flemings, however, remain convinced that splitting up the country would not be a good idea, even if, as things stand, some drastic changes need to be made to the division of powers between the Federal State and the federated entities. For many Walloons,

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interest deduction for risk capital, better known as the notional interest deduction, will be maintained.The concept of this notional interest deduction was launched in July 2004 by the Finance Minister, Didier Reynders. The central idea behind the incentive is to let companies, which use their own equity for investments, deduct a (fictitious) interest from their tax base. Among other initiatives to look for additional means, a yearly tax of roughly €250 million will be imposed on the electricity production sector.

such changes are difficult to accept: shifting powers from one level to another is a step in the direction of confederalism, which they see as the last phase before a Flemish declaration of independence. The possible economic consequences of such a split – to a large extent, the economy of the South is dependant on that of the North – are seen as far too gruesome.

The political class in the North and South pursue their own political agendas, a fact aided by the absence of national political parties, the absence of a federal constituency and the lack of a national media The political class in the North and South pursue their own political agendas, a fact aided by the absence of national political parties, the absence of a federal constituency and the lack of a national media (an ever-decreasing number of Flemings watch French-speaking TV or read newspapers in French, and the same is true in the other direction). Several political parties are capitalising on this situation and act as if they were the only true defenders of their language group’s interest: the upshot is mutual distrust among politicians and the resulting difficulty in reaching consensus on important issues. Furthermore, the cohesion within the interim government currently running the country’s affairs is weak: to quote just one example, the Walloon liberals of the Mouvement Réformateur are very unhappy that they were forced into a coalition with their archrivals, the Parti Socialiste, which is more or less supported by the French Christian democrats who depend on the Parti Socialiste in the Walloon regional government.

On the Flemish side, many questions are asked about the cohesion within the Flemish cartel of Christian Democrats and Flemish Nationalists, where the former often tend to be more moderate about state reform than the latter.

BUDGET BLUES The outcome of government negotiations will be instructive in the economic direction the country will take. One such problem is the budget. According to the declarations of interim premier Verhofstadt when he took up office once more, the national purse is empty and there is insufficient money for new initiatives. Therefore, the first major economic problem for the government (albeit an interim government) was to decide on the budget. For 2008, the Federal budget has a deficit of roughly €3.5 billion, and the interim government hopes the federated entities (the Flemish and Walloon regions) will make a financial contribution to the Federal budget by injecting several hundreds of millions of Euros.

For some time, the Flemish minister-president Kris Peeters was reluctant to do so. On March 2 2008, the budget talks were suspended to allow the ‘Council of Elders’ (where the proposals for state reform are debated) to finish talks about a first set of power shifts, which also has to open the way to a definitive coalition agreement. And thus it becomes clear how much any sort of reform in any sector is dependent on increased political stability. When an agreement was reached on a first – limited – set of measures for state reform (not without criticism from the cartel partner of CD&V, which declared they would abstain from the vote), it was finally possible to conclude the budget talks.

The budget includes €340 million for new measures, such as a 2% rise in the lowest pensions, an income guarantee for elderly people and a rise in the income ceiling for retired people (so that, even if they are entitled to a pension, they can still earn an income from labour). The budget has been criticised because the interim government is unlikely to have reserved enough means to finance the cost of an ever-ageing population.

Measures introduced in the past, such as the

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As I conclude this article, talks are under way to form a definitive government. However, it is still evident that power games which are said to be inspired by the ‘interest of the community’ or the ‘common good’ (but seem to be more instructed by the self-interest of politicians) are still going on. Which government will rule Belgium after Easter remains unknown.

Depending on the combination of parties that will form the coalition after that date, we will know whether the economic programme will be mainly market-oriented or interventionist.

However, current developments and knowledge of the political context are not inspiring much optimism that market-oriented forces will prevail.

Bulgaria

Georgi Angelov is the senior economist at the Open Society Institute.

For a long time, Bulgaria has been a laggard in terms of economic reform and development.This ended in 1997 after a huge financial crisis and hyperinflation.

As a result, two consecutive governments have moved the economy in the direction of liberalisation, privatisation and deregulation, although this path has been turbulent.

However, in 2005 the Socialist Party won the elections, creating speculation that they would stop the reforms and bring about another economic crisis, as seen a decade earlier. Reform proposals by liberal economists (including the author of this article) to introduce a 10% flat rate for all direct taxes, to privatise social welfare, healthcare and government enterprises, seemed doomed.

These fears were not realised. 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.

RADICAL REFORMS = RADICAL OUTCOMES At the beginning of 2006, social security tax was cut by 6% – something that only the most liberal economists had supported a year earlier.

The results proved more successful than expected: revenues from tax declined but by much less than expected and the tax cut cost the budget 4 times less than the government projected. More than 200,000 new jobs were created after the cut. In 2007, social security tax revenues continued to outperform expectations and the rate was cut again by 3%, effective from autumn of the same year. Social security tax reached less than 34% in 2007 as opposed to almost 43% in 2005. At the same time, the amount of social security tax that went into private pension funds increased. Almost a quarter of the obligatory pension contributions now go into private funds, a big rise compared to only one tenth 2 years earlier.

The next big move was the introduction of 10% corporate tax at the beginning of 2007.

It received cross-party support in the parliament (none supported it 3 years earlier when it was first proposed). This success was even more impressive than the social security tax: although the rate was only cut by a third, revenues from the tax increased by an astonishing 39%. Lower rates and more revenues made everyone happy, even the socialists in government who used the revenues to increase the average

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pension not by 8.5% as planned but by 21% within one year. At this point even some former enemies of low taxes changed their outlook and began to support tax cuts. Another previously unthinkable proposal became reality at the beginning of 2008 – a 10% flat income tax. Most of Bulgaria’s neighbours have already introduced a low flat tax, a fact that was well publicised by liberal economists. As a result of the flat tax, the top marginal rate of taxation decreased from 24% to 10%.

Bulgaria’s reforms were not confined to taxation.

In education, crippling inefficiency needed to be addressed. Empty schools started to be closed and school financing was connected to number of students in a voucher-like system (although private schools have not yet joined this system).

As expected, the strong teachers’ unions instigated a large-scale strike, the biggest in Bulgaria for a some years.

The upshot of these strikes was that the result was not slower reforms but just the opposite – faster educational reform and optimisation of the system in exchange for higher teacher salaries. In 2008 the autonomy of schools will be increased, power is now decentralised and management of school budgets is in the hands of individual schools themselves. External evaluation of schools’ and students’ achievements has been introduced and teacher salaries are now differentiated according to results.

2008 saw the creation of an electronic register for companies with the aim of increasing the speed of registration and cutting the number of procedures, as well as lowering fees and allowing internet registration. The system is working, but due to administrative problems it is still not running at peak efficiency in several big cities (several hundreds of companies must re-register with the new system and the staff of the new register seem underprepared). It seems that bureaucracy is still a huge obstacle to efficient reform.

In 2007 the army draft was revoked and a military career became voluntary. Also, the social system was changed, limiting the number of months a person can receive social benefits

to 18. In addition, child benefits are given to parents only if their child attends school regularly. This is expected to incentivise both increased work and education.

The results of the above reforms became evident quite rapidly. In 2006 and again in 2007 foreign direct investment reached record highs – almost 20% of GDP per year.

Economic growth is around 6% per year, and unemployment decreased to less than 7% at the end of 2007, which is the lowest level ever recorded. Employment is almost 63% of labour force and rising. Salaries are also growing fast.

Bulgarians want better results and faster growth than any government has been able to deliver The Government’s budget has had a surplus of about 3.5% of GDP for two consecutive years (in October – November 2007 it even reached 7% of GDP and the government decided to spend part of it by the end of the year). And all this happened in a country with no oil reserves! Government debt is at record low levels at less than 20% of GDP, and government fiscal reserve amounts to more than 10% of GDP. The foreign reserves of the Bulgarian central bank are at their highest ever level and the Bulgarian currency is fully backed by these reserves. On the top of this, Bulgaria was able to become a member of the

European Union in the beginning of 2007, having overcome many obstacles. Trade is increasingly free and competition is possible in formerly protected sectors such as the aviation and tobacco industries.

SOME WAY TO GO… Of course, not everything in Bulgaria’s garden is green and big challenges lie ahead. Bulgaria is still the poorest country in the European Union and the real rate of economic growth of 6% is good but still far away from the double-digit levels that other countries were able to achieve. Without faster growth the income gap between Bulgaria and Western Europe will not be overcome easily.

The business environment in Bulgaria, although improving, is not among the best in the new member states. The same goes for economic freedom and competitiveness. Many problems persist in spite of efforts to change: the biggest of all is the court system that remains slow and inefficient and the fact that the police force are having limited success in fighting corruption. In addition, the government still owns a number of companies and privatisation is not rapid enough.The public sector remains inefficient and reform has proved difficult.

Last, but not least, some special interest groups were able to limit market competition passing laws against the will of the government – for example, the ownership of pharmacies, where only pharmacists can own a pharmacy with no branches allowed (the law is approved by the Parliament but its execution was delayed).

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As with all previous governments, support for the coalition is slipping away. Bulgarians want better results and faster growth than any government has been able to deliver.

Interestingly, this time the government is ready for the challenge and recently approved a new programme for implementation between now and the elections in summer of 2009. Not lacking in ambition, it is planning to revoke the monopoly in the healthcare system, privatise hospitals, cut social security tax again, fire 12% of the public administration, revoke unneeded regulations and reform universities and the financing of scientific research. In addition, according to the Minister of Economy, these privatisations will be finished within a year (but this does not include energy, where the government is unwilling to sell).

The goal of the government is to improve the business environment radically in order to enter the top ten best EU countries in which to do business. The aim for economic growth is even higher. And as a result of this the coalition believes it can to rule for another four year term after the elections.

If they do not manage to fulfill the expectations of the people, another party is poised to take power. The biggest party in Bulgaria is the opposition centre-right Citizens for European Development of Bulgaria (GERB) party led by the mayor of Sofia. Their economic programme is already published and it is even more radical in the sphere of economic reform. For example, they propose an even lower flat tax, lower government expenditures and faster reforms in every sector. And so it would seem that, whoever wins the next election, market reforms in Bulgaria will surge on.

Cyprus

Tamlin Vickers was a researcher at the Stockholm Network and is now undertaking an internship at the European Commission.

These are busy times for the Cypriot economy. In the space of four years Cyprus has become an EU member and has joined the Eurozone, both of which have encouraged market-oriented activity.Yet the government is failing to push ahead with much needed reforms.

With a population of 800,000, Cyprus is the third smallest country in the EU, both in size and population.The years that followed British rule – independence was gained in 1960 – saw rapid and sustainable socio-economic development.The occupation of the northern part of Cyprus by Turkish forces in 1974 and the subsequent period of destabilisation hit the entire island’s economy hard. On both sides of the dividing line, economic development relied heavily on state expenditure, and marketoriented ideas made little headway.The heavy involvement of the state in economic and commercial affairs has been difficult to shrug off, but modern Cyprus has nevertheless taken impressive steps in recent years to embrace free market principles.

Broadly speaking the past decades have seen a steady movement towards a market-oriented economy; modern day Cyprus boasts sound macroeconomic policies, a dynamic and flexible business environment and a highly educated workforce.The economy has moved away from agriculture towards services; within the service sector, tourism has provided the main thrust, although this has waned in recent years as the island has struggled to compete with other Mediterranean destinations.

The island has all the ingredients to become a beacon of successful market-oriented governance The predominance and increasing importance of the services sector reflects the gradual restructuring of the Cypriot economy from an exporter of minerals and agricultural products in the period 1961– 73 and an exporter of manufactured goods in the latter part of the 1970s and the early part of the 80s, to an international tourist, business and services centre during the 1980s and 1990s.

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Despite joining the EU and signing up to the euro, the issue which dominates discussion about the island remains the division between the southern area controlled by the Cyprus Government and the northern Turkish Cypriotadministered area.The Turkish Cypriot economy has roughly one fifth the population and one third the GDP per capita of the south; as it is recognised only by Turkey it has had much difficulty arranging foreign financing and foreign firms have been hesitant to invest there.To compensate for the economy’s weakness Turkey provides direct and indirect aid to nearly every sector.

MONEY MATTERS The Cypriot economy has been buoyed in recent years by its accession to the EU and its adoption of the euro. Growth is predicted to be 4.1% of GDP in 2008, far higher than the Eurozone average. Moreover, the Government expects inflation to stay at a manageable 2.1%, despite worries that the economy is overheating due to high consumer credit and borrowing in the property construction sector.

Cyprus is an increasingly attractive destination for international businesses.There is a uniform corporate tax rate of 10% and in order to attract foreign investments and enhance economic prosperity, the Government has liberalised the Foreign Direct Investment (FDI) policy for both EU and non-EU nationals.

Administrative procedures have been simplified and no limitations apply in most sectors of the economy as to the minimum level of investment and foreigners´ participation percentage.

According to the Index of Economic Freedom (insert reference as a footnote), between 2004 and 2008 trade freedom edged up from 79.4 to 81 whilst investment freedom leapt from 50 to 70.

Since its accession to the EU on 1 May 2004, Cyprus has seen sizeable economic benefits.

Accession forced much-needed institutional reforms in the areas of state aid, regulation of the financial market, competition and international trade. Cypriot goods and services have benefited from access to the single market. Investment from other EU member states has grown year upon year. Cyprus has

can have a dramatic effect on tourism.There is also considerable concern about the resilience of the housing market, as a global economic slowdown would be sure to hit both foreign and local demand. Moreover, falling UK house prices would reduce the wealth of UK home owners and might therefore lead to a drop in demand for housing in Cyprus. As the island is now more integrated into international financial markets than ever before, an economic slowdown in Europe would clearly damage the Cypriot economy.

also received direct financial assistance from the EU.The process of globalisation driven by international trade and financial flows worldwide has played its part too in liberalising the Cypriot economy. Since 2002, the amount of international reserves has been steadily increasing and the rate of inflation has been consistently under 3%. Government deficit as a percentage of GDP (-6.5% in 2003) has been impressively turned around so that it stood at -1.2% on the eve of joining the euro. In recent years, the Central Bank has intensified its efforts to liberalise the financial sector. Capital controls have been abolished, which, combined with EU accession, has meant there is now full liberalisation of capital flows to and from Cyprus.

Thanks to a growth rate of 4.2% of GDP, Cyprus joined the Eurozone on 1 January with a 1.5% fiscal surplus. The Government has attributed this turnaround to an increased level of revenue obtained from the booming property market and also to its programme of improved income tax collection, which has helped to secure the island’s economic convergence with the single European currency.

The adoption of the euro has helped Cyprus to liberalise its economy because it has necessitated the liberalisation of financial flows and the abolition of fixed interest rates.

Foreign exchange controls have also been abolished and the institutional make up of the Central Bank has had to be modernised.The elimination of exchange rate risk is conducive to trade transactions and raised transparency in price comparison should produce a more competitive marketplace. The Cypriot government hopes that the adoption of the euro will reinforce the status and power of the Cypriot economy in terms of attracting foreign investment by enhancing growth prospects and safeguarding macroeconomic stability.

The European Commission has praised Cyprus for its smooth adoption of the euro.

However, despite Government pleas to companies to round down their prices when converting from the Cypriot pound to the euro, there is concern that retailers have used the changeover to round up their prices.

If this turns out to be the case, it would be unwelcome news for the Government at a

time of economic uncertainty – the authorities announced in December 2007 that year-on-year consumer price inflation rose from 3% in October to 3.5% in November. Healthcare and transport costs in particular have increased sharply. This upward pressure on prices forced the Central Bank to keep the main interest rate temporarily on hold at 4.5%, rather than bringing it into line with the European Central Bank rate of 4%.

Being an island, it is necessary for Cyprus to import the vast majority of what it consumes.

At a time when the price of many of these imported goods is rising fast, Cyprus stands to be affected more than other more selfsufficient countries. To deal with these inflationary pressures, the Government is sensibly focusing on operating a restrictive budgetary policy.

LURKING THREATS Despite considerable progress towards a market-oriented economy, there remain areas in dire need of liberal reform. The level of government expenditure is the primary weakness. In the last year, government spending equalled 43.6% of GDP. Moreover, privatisation has yet to occur in the key sectors of telecommunications and utilities.

According to the World Economic Freedom Global Competitiveness Report, Cyprus is ranked 55th overall, down from 49th in 2006; out of the 27 EU member states, only four rank lower. Although the Index of Economic Freedom puts Cyprus at a healthier 22nd, this position is down from previous years – in 2004 it ranked 15th. Between 2004 and 2008 the Index, which uses a scale of 100, deemed business freedom to have fallen from 85 to 70, fiscal freedom from 81.4 to 78.2, government size from 56.2 to 42.9, and freedom from corruption down from 70 to 56.

Although it is hoped that the adoption of the euro will help to shield the Cypriot economy from external shocks, reliance on tourism and foreign investment in construction leaves the country somewhat exposed. History has shown that political instability, on the island or off it, is capable of leading to significant drops in tourist numbers. Fluctuations in economic conditions in Western Europe too,

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In summary, whilst Cyprus has done an impressive amount to embrace free market policies in recent years, there remain many sectors which are still desperately in need of liberalisation. The island has all the ingredients to become a beacon of successful marketoriented governance; whether or not the administration utilises these ingredients to continue down the road of free market reform remains to be seen.

Czech Republic

Jiri Schwarz is President of the Liberalni Institute.

The Parliamentary election results of 2006 had a great influence on the course of Czech economic reform. The Social Democratic Party, hitherto leader of the government coalition from 2002 to 2006, had not been willing to start any real reform of public finance, and more specifically the ailing fiscal, healthcare, pension and education systems. Instead, the Social Democrats were merely maintaining the status quo in an attempt to win votes for the upcoming 2006 elections. In spite of this they lost, but the winning conservative-liberal Civic Democratic Party was not able to form a majority government coalition.The Czech Republic consequently remained under provisional governments for a further six months.

Subsequently, a new government composed of a coalition of three political parties – Civic Democratic Party, Christian Democratic Party and the Green Party – managed to get the narrowest of parliamentary majorities, due to the support of two social democratic MPs. This weak coalition gave rise to the inconsistent government stance on the coalition reform programme.

This reform programme represented a worrying development in public finance: it brought about a long-lasting public deficit caused by a rapid growth in government expenditure. Increasing indebtedness started to have a negative impact on other political aspirations (e.g. accession to the Eurozone). In 2007, planned government expenditures were 1,040 billion CZK (about €39.5 billion), whereas revenues only came to 949 billion CZK (€36 billion). When including other public sector expenditures, the predicted deficit for 2007 was 121 billion CZK (more than €4.5 billion) or 3.4 % of GDP.The share of mandatory expenditure as a percentage of total expenditures increased from 52.5 % in 2006 to 54.7 % in 2007.This steady rise has been the driving force behind persistent public finance deficits. In order to stop this negative economic development in its tracks, to consolidate the national budget and to decrease the deficit back below the 3% of GDP set by the Maastricht criteria necessary for joining the Eurozone, major public finance reform was necessary.

Differences in the electoral programmes of the coalition partners made it extremely difficult to get agreement on systematic public finance reform, based on a substantial cut in public expenditure, reduction of taxes and a simplification of the over-complicated Czech tax declaration form. The coalition parties have nevertheless agreed on some tax reform, on healthcare reform, and on the necessity of preparing a pension reform, as well as some fine-tuning of the social security system.

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PROGRESSIVE, REGRESSIVE, OR BOTH? Instead of cutting the growing budget expenditure, the coalition partners turned to revenue to enable their campaign promises.

Caught between the Maastricht criteria and the election promise of a 15% flat tax, the coalition government designed a system of 15% flat tax paid from the ‘super gross’ wage, complemented by a generous tax deduction. ‘Super gross’ can be defined as a current standard gross wage plus health and social insurance contributions paid by the employer. The employees will, therefore, pay a tax on another tax, as the compulsory insurance contribution is no different from a tax. The comparable tax rate, recalculated for the currently defined gross wage base, would be about 23%. Income tax has therefore been neither cut nor simplified; by the end of 2007 there were four tax brackets in the Czech Republic for personal income tax with rates ranging from 12% to 32%.

In a truly flat tax system, the corporate income tax rate should be equal to the personal one.

However, in the Czech Republic, starting from 1 January 2008, the CIT rate will be 21% (now 24%), and in the next two years should drop to 19%. The PIT rate is projected to be reduced to 12.5% (again from the ‘super gross’ wage) by 2009. This decrease is going to be compensated for by a corresponding cut in the general tax deduction, so that some taxpayers, especially the low-to average income earners, are going to pay more. Most of the changes are beneficial, particularly for high-income taxpayers and corporations. Unlike in Slovakia, however, there has not been any discussion around the goal of these tax reforms. There are repeated talks about the need for rapid budget deficit cuts, but the flat tax does not help to fulfil this objective.

Lower marginal tax rates, especially for high-income earners (entrepreneurs and

GDP), from 2006. On the other hand, public revenues increased only by 6.9% (to 39.8% of GDP). Looking at the predicted evolution of these two variables for 2008, only a slight change in trend – attributable to fiscal reform – is visible. Expenditure should fall to 42.4%

corporations) tend to boost the economy.

However, this was not presented as the ultimate goal, but rather as means of achieving another one: to bring in higher tax revenues in future. Another flat tax target, according to the Programme Declaration of the Government, is to decrease expenditures on tax administration as well as tax compliance costs on the taxpayers’ side. In other words, the tax reform objective is quite perverse – to make the tax system more efficient, and push tax revenues up, although the individual tax burden may go down. For this reason, the whole debate about the Czech tax system collapsed into discussion: whether the proposed set up of deductibles offsets the increase in tax rate for selected income groups, or provides some income groups with an advantage over others.

High-income taxpayers do indeed benefit from this tax reform, and not only due to the marginal tax rate decrease. The reduced VAT rate, which applies to socially-sensitive items such as food, housing and public transport, increases from 5% to 9% (the EU minimum is 5%), the standard rate stays at 19% (the EU minimum is 15%). The increase of the reduced rate will impact hard on low-income taxpayers, although its only purpose is to regain part of the revenues lost through the PIT rate decrease for high-income groups.

Moreover, the introduction of an ‘eco tax’ will increase coal and electricity prices. Such a tax is also expected to be regressive, i.e. to pose a bigger relative burden on low-income than on high-income taxpayers. Another significant change on the revenue side is the introduction of a ceiling on social insurance contributions, set at 48 times the average monthly wage.

FINE TUNING LEAVES MUCH UNDONE The most important argument for healthcare reform in the Czech Republic is to prevent wasted resources. For this reason any reform must be based on changing incentives to save, so that patients, medical doctors and health insurance companies make rational decisions according to market signals. The government should reduce its participation in the management of healthcare provision and

should focus on the supervision of health insurance. One goal of the reform is to strengthen the position of the patient, enabling them to go from a captive recipient to an empowered consumer. Reduction in waste of public resources will allow for higher quality service provision to patients in general.

However, the most discussed aspects of healthcare reform are the measures adopted during the first stage of the reform. To begin with, no sickness benefits are to be paid by the state health system for the first three days of sickness. The biggest change, though, is the introduction of regulatory fees per prescription, per day of in-patient care, and per visit to an emergency department in hospital. The fixed amount for these fees is more symbolic than cost-covering, and their main purpose is to create incentives for rational use of public health care and to achieve savings in the public health care system. Yet this measure is symbolic and emotive and has thus provoked a strong reaction from the political opposition.

The Czech government has approved an amendment to the Pension Insurance Act, the first phase of pension reform. The most important change is a gradual increase of the retirement age up to 65 years for men and for women with one or no children, and to 62– 64 years for women with more than one child. Another important component of the reform is the extension of the necessary period of compulsory insurance contributions to 35 years in order to qualify for a state pension.

The proposed public finance reform has focused heavily on budget revenues. However, too much emphasis has been put on reform neutrality at the level of tax-paying individuals.

That is why the reform is not likely to be successful in lessening various tax burdens and in simplifying the tax code.

The government’s expenditure cuts have, in fact, been slight. In addition to healthcare reform, there was mere fine-tuning of savings in social security provision, and the pension and education systems on the expenditure side of public finance. In 2007, public expenditure rose by 8.3 % (to 43.3 % of

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The outlook for the Czech Republic could be promising but only if it continues to face up to the need for long-term structural reform in exchange for higher levels of prosperity of GDP and revenues as a share of GDP are expected to stay roughly unchanged (39.5%).

But is the expected growth of 5% in 2008 attainable? The International Monetary Fund estimates Czech economic growth at about 4.5%. This expectation gap could lead to lower tax revenues and to serious problems with budget deficit. Due to a relatively high inflation rate of 5%, monetary policy is expected to tighten. This might also lead to lower GDP growth and the inability of the current tax system to obtain sufficient revenues. The outlook for the Czech Republic could be promising but only if it continues to face up to the need for long-term structural reform in exchange for higher levels of prosperity.

Denmark

Martin Ågerup is the CEO of the Center for Political Studies (CEPOS).

CEPOS (Center for Political Studies) is a Danish free market think tank that was founded in 2005. It focuses mainly on the domestic policy agenda and seeks reforms that will limit the scope and size of government and increase economic freedom. CEPOS has proposed a number of reforms in different areas, including labour market reform, pension reform, privatisation of state and municipal activities, outsourcing and cutting public spending. Its main objective, however, has been to push for tax reform.

In comparison to other countries, Denmark enjoys relative economic freedom. It has an open economy with low government regulation of labour and markets, financial services and industry, compared to the European average.

There are two exceptions to this: the size of government spending and the total tax burden are very high in international comparison. The marginal income tax rate of 63% is the third highest in the OECD and does serious harm to the Danish economy.

The current Danish government is a coalition government between the Conservative party (Konservative) and the classical liberal party (Venstre). Their coalition majority is also based on the nationalist Danish Peoples’ Party which advocates strict limits to immigration, a tough approach towards crime and a largely social democratic or ‘big government’ approach to economic policy. This coalition was first elected in 2001, re-elected in February 2005 and again in November 2007.

The undisputed political stability of this coalition comes with a high price from a free market perspective.The big coalition partner,Venstre, has dropped most of its classical liberal heritage and now embraces big government policies and rhetoric. Government consumption in the 2008 budget is set to increase three times as fast as originally planned by the previous social democratic government in their long term economic plan, dubbed the 2010-plan. This plan was adopted wholesale by the new coalition government when it took office and would have implied a moderate spending increase of 1% a year until 2006 and 0.5% a year from 2006 until 2010. Actual government spending goals have exceeded this goal every year. In the late summer of 2007 the government gave up the goals set out in the 2010-plan and launched a new long term economic plan running until the year 2015.

Some leading government ministers sound increasingly like socialists. The employment minister, Claus Hjort Frederiksen, has said

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that people ought to, “smile a bit more when they pay their taxes.” There has been a fairly substantial shift in public opinion towards the left on a number of issues in recent years – partially because no political parties now offer a small government vision.

However, from a free market perspective all is by no means lost. The government has introduced a couple of significant reforms. The 2006 welfare reform went about half of the way to solving the budgetary problems caused by the demographic shift facing most European countries whereby an increasingly ageing population becomes economically burdensome.

One of the most interesting features of the reform is that the future retirement age will be indexed to mean life expectancy.This effectively means that if life expectancy rises, the official retirement age will automatically increase by the same number of years.

THE BIG FREEZE The other significant policy reform introduced by the newly elected government in 2001 was the tax freeze. With this policy, the government pledged not to introduce any new taxes or to increase existing ones. The tax freeze is an interesting (if somewhat modest) policy. It has been popular with voters, who appreciate the fact that they can calculate with certainty their personal future tax burden. The opposition Social Democrats have responded by themselves endorsing the tax freeze. Most economists dislike it, however. They see it as an obstacle to introducing a tax reform that shifts taxation from income to other sources like property, which have less harmful effects on incentives. However, from a political economy perspective, the benefits of the tax freeze cannot be ignored.

It ties the hands of politicians in fiscal policy in the same way as the creation of an independent central bank ties their hands in monetary policy.

Unfortunately, relatively high economic growth and exceptionally high tax revenue from North Sea oil has to some extent limited the disciplinary effects of the tax freeze.

Its chief economist was the fourth most quoted economist in the Danish media in 2007.

CEPOS has pushed the intellectual debate in the right direction. For example,it has argued that the consensus estimate of the dynamic effects of tax cuts was too conservative. In October 2007 the government-financed (but independent) Economic Council adjusted their estimate of the degree to which top marginal tax cuts are self financing from 40–50% to 70 –80%.

Government revenue has increased enough to allow a relatively large expansion of the public sector, at least in the short term. A spending freeze would have been a more effective policy option than a tax freeze. The main argument against a tax freeze is that it makes it difficult to reform the tax system, since other taxes can not be increased to finance the lowering of income taxes. There is no reason why politicians should need to increase other taxes in order to lower taxes on income. Lowering the top marginal tax rate from 63% to 43% would result in a loss of revenue of approximately 29 billion DKK (€3.9 billion).That is approximately 3.4% of total tax revenue – less if the offsetting revenue increase from the expected dynamic effects of tax cuts is included. Thus, such a tax reform could be financed by spending cuts or even by freezing expenditure growth for approximately seven years.

The undisputed political stability of our coalition comes with a high price from a free market perspective A substantial tax reform could be financed by allocating a certain share of the revenue growth from our growing economy to tax cuts while still allowing for growth in public consumption. In fact, the Danish government lowered taxes in 2004 by approximately 16 billion DKK (€2.1 billion) and again in 2008 by approximately 4 billion DKK (€0.5 billion).

The tax freeze also implies a loss of revenue, partly because some taxes payable in fixed amounts are not raised with inflation. All in all the total tax cuts amount to approximately 37 billion DKK (€5 billion).That is 2.1% of GDP and constitutes a sizable tax cut by international standards.

There has, however, been virtually no reduction of the most harmful of Danish taxes: the top marginal tax rate of 63% paid by 40% of full time employees. The main reason for this is probably that the

government (and specifically the liberal party) wants to avoid a debate about the distributional effects of such a tax reduction – fearing allegations of antisocial tax cuts for the wealthy. In a candid interview with a national newspaper the Prime Minister, Anders Fogh Rasmussen, admitted that he knew and acknowledged all the economic arguments for lowering the top marginal tax rate but that he would still not initiate such a reform because of the effects on economic inequality. This fear of increased inequality seems disproportionate to reality: Denmark is the most economically equal country in the world. That is, our country has the lowest income inequality in the world as measured by the gini coefficient. According to the OECD a tax reform that reduces the top marginal tax rate by 15 percentage points would only marginally increase income inequality and Denmark would still retain its crown of economic equality. A reduction of 20 percentage points would bring Denmark level with Sweden, the world’s number two.

Political pressure has also been mounting for a tax reform that tackles the high marginal tax rate. Some of that pressure comes from the new flat tax party, Ny Alliance founded in the spring of 2007 by Naser Khader, a Syrian born immigrant. Other proponents are from the Conservative coalition partner and also from classical liberal forces within Venstre.

This pressure has produced results. After the November 2007 election the new government programme states, “The aim is a significant reduction of income taxes to stimulate work and initiative, partly through lowering marginal taxation.” A tax commission has been established and will analyse the need for tax reform and make recommendations by February 2009. It seems likely that the commission proposals will result in a tax reform that significantly lowers the top marginal tax rate.

CEPOS cannot take the credit for this welcome development but it is certainly a goal that it has been aiming for in three main ways: CEPOS made an effort to keep tax reform high on the policy agenda. In 2007 it had more than 1800 print media citations of which approximately 55% were tax related.

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Through concrete policy proposals the think tank has shown how tax cuts could be funded. It has also calculated the benefits of tax cuts in terms of increased labour supply and higher economic growth.

If other governments have lessons to learn from the Danish reform experience, they would be to push through reforms by establishing reform commissions. This approach might irritate those of us who are keen to push through change at a swifter pace, but the welfare commission proved useful in priming the public debate and setting the stage for reform. There was very little opposition to the 2006 welfare reform, partly due to the long public debate that shaped the views of opinion leaders and the electorate before the reform proposals were announced.

Estonia

Kalev Kallemets is the vice chairman of the Estonian Free Society Institute.

Several blows for liberty were struck in Estonia in 2007. March 2007 saw a landslide victory for the liberal Reform Party, which collected 31 seats out of 101, ensuring the continuing rule of Prime Minister Andrus Ansip. Notably, the 2007 election marked a world first in that citizens were allowed to vote online – a significant milestone in Estonia’s embrace of technology as a symbol of progress and freedom.

Estonia’s political climate had been riddled with political tensions since 2005. A failed merger between the conservative Res Publica and the liberal Reform party led to a series of confrontations between the governing parties, leaving Estonia facing the prospect of an illogical left-right governing coalition that posed a threat to the continuation of key liberal social and economic policies. To this end, 2007’s most notable liberal triumph was the re-election of the avowedly free market Reform Party and the formation of a three party centre-right coalition, ensuring the continued preservation of the income tax system that has made Estonia an economic success.

The global economic slowdown could bring about the long overdue cooling process that the government could not The Reform Party’s most important election promise was to continue to reduce income tax.

As a result income tax has dropped from 26% in 2003 to 22% by 2007, with a promise to decrease this to 18% by 2011. Estonia has been something of a tax pioneer, adopting a 26% flat rate of income tax in 1994 and reforming its company tax regime along flat tax lines in 2000.

The Estonian Free Society Institute has worked hard to expose the positive effects of a decreased and simplified income tax; among them growth rates at twice the rate of eastern European nations with variable tax rates, and a tripling of foreign direct investment. Indeed, the country has come to represent an international flat tax success story; inspiring a host of other post-communist countries to follow suit, most surprisingly Russia, under the economic

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leadership of Andrei Illarianov, a former advisor to Vladimir Putin, who announced a single marginal rate of tax in 2001.

SLOWDOWN OR COOLDOWN? The effect of the global credit crunch is expected to have significant effects for the Baltic States. Yet, some amount of slowdown might just be what Estonia needs. The ‘super charged’ Baltic economies have been in danger of overheating for a while – and with currencies pegged to the Euro, governments have been constrained in their ability to respond to high inflation by raising interest rates. The global economic slowdown could bring about the long overdue cooling process that the government could not.

Despite falling economic growth (5.5% expected for 2008) and growing wage and pensions costs, it is expected that the 2008 budget will have a surplus of 2.8% of GDP, second only to oil-rich Norway.The fear is that if investment in Estonia falls back the economy will become increasingly vulnerable. FDI has been one of the principal drivers of growth in the Estonian economy, declining investor confidence could, in a worst case scenario, lead to recession. The Estonian government is therefore right to look at all available measures to reduce costs in order to be prepared for worsening economic conditions and to maintain its budget surplus. Since 2006 rapid wage increases have been introduced in response to labour shortages. The Bank of Estonia has warned that continued increases across the public and private sector could threaten sustainable economic development.

One area in which Estonia may yet find a way out of its economic woes is its commitment to a knowledge-based economy. The current Estonian government has vowed to increase state investment in R&D and support enterprise and innovation, especially among young people, as part of its 2007– 2011 governing programme. Moving towards a high-

allow Russia to re-assert itself politically in the Baltic region. Significant tensions therefore remain throughout Estonia that could hamper any possible positive developments in relations with Russia even after Dimitri Medvedev is inaugurated as president.

Foreign policy has sadly not been as high on the liberal agenda as one would expect.

Despite an economic focus, many liberals have failed to make the connection between international relations and actual freedom in countries. Liberals should vigorously oppose political exploitation of nationalism and scaremongering of any sort and advocate improved diplomacy, friendship and cooperation with all countries. tech, high-earning economy would put Estonia in line with close-by economies like Sweden and Finland.

Many of the current government’s aspirations put it at the forefront of the EU’s Lisbon Agenda goals. These include encouraging the development of small and medium-sized enterprises, undertaking labour market reform and reducing the overall regulatory burden on business.

MAKING THE CASE FOR LIBERAL VIEWS Despite some obvious liberal successes in Estonia, it lags behind in other key areas.

One of the areas ripe for fresh debate is the new round of privatisations.

The share of revenue generated from state owned enterprises (SOEs) in Estonia is 10% of GDP compared to the OECD average of 4%. Considering the internationalisation of capital markets, the opening of energy markets and the increasing ability of the Estonian population to invest in stocks and shares, there is a growing case for many of the state held companies to be listed on the Tallinn stock exchange. Both the CEO of the Tallinn exchange and the CEO of the largest SOE, Estonian Energy, have expressed willingness to list SOEs, but it will only, in all likelihood, move to the top of the policy agenda after the next parliamentary elections in 2011. The Estonian Free Society Institute plan to contribute to this debate with comprehensive research and will work to ensure that political parties make it one of the leading economic policy issues for the 2011 elections.

This topic is sensitive due to fears of an aggressive Russian takeover once there is even partial privatisation of certain sectors.

Hopefully a new Russian president will, over time, help relax these tensions somewhat and even bring moderate change to Russian economic and foreign policy.

The second pertinent issue relates to the financing of health care. Presently, 80% of health care costs are covered by a mandatory tax (13% tax on income) or state-operated insurance which provides no incentive to drive down costs or encourage healthy habits like correct nutrition and physical fitness. While the government has made lifestyle awareness a central part of its programme, policy needs to focus more on encouraging individual responsibility instead of state dependence and should look at more sustainable ways to finance the health system.

ESTONIA IN THE WORLD Estonia is a small country and is not a foreign policy shaper, even in Estonia-Russia relations.

Thus far its key foreign policy goals have been integration into NATO and the EU; achieved in 2002 and 2004 respectively.

With regard to neighbouring Russia, Estonia has had a particularly troubling time.The removal of the Bronze Soldier, a Soviet war memorial in central Tallinn, resulted in a wave of cyber-attacks in 2007. These were particularly troubling for Estonia; a country that has undergone a significant internet revolution with e-government and e-commerce now very much the norm. Presently, there are fears that the proposed Nord-Stream pipeline would

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It is fair to expect that if it elects a Democratic president, the US will begin pulling troops out of Iraq, allowing Estonians to pull out as well.

A more diplomatic and careful US foreign policy, akin to that advocated by Barack Obama, would have a significant impact on global development as well as on Estonian foreign policy.

So, a busy time ahead for Estonia if it is to become as free, prosperous and economically productive as it promises to be.

Finland

Martti Nyberg is an economist at the Finnish Business and Policy Forum (EVA).

Nearly all of the countries around the Baltic Sea have centre-right governments, and the same trend seems to sweep further west into Europe. In Finland, however, the relationship between the composition of the coalition government and the ideological content of economic policy is less straightforward. Finland has three big parties of equal size, two of which are consistently in power and one that is in opposition. In this multiparty framework, the ideological views of the parties are less ambitious than the ones in the two party systems, since the leading opposition party is likely to be in the next coalition government.

The largest parties are the Coalition Party, the Centre Party and the Social Democrats, who are in opposition at the moment.As a result of this structure, no major shift in economic policy towards liberalisation has been expected nor taken place under Prime Minister Vanhanen’s centre-right administration which was elected last year.

The Finnish economy is often described as belonging to the ‘Nordic model’, meaning it has a large welfare state and the large government spending associated with high levels of taxation.

And, like its neighbouring country Sweden, Finland is known for its high technology and high ratings in growth and competitiveness indexes as well as an outstanding education system, which comes top in the Pisa rankings (add reference/footnote if poss).

seen by any industrialised country since the Great Depression of the 1930s. Real GDP declined by over 10%. Factors that accelerated the crisis were a sudden drop in East European trade due to the collapse of the Soviet Union, a speculative bubble in the stock and real estate markets and the uncontrolled lending by the banking sector leading to an inevitable credit crunch which left households and firms in excessive debt.

LESSONS FROM HISTORY

The crisis triggered a process of creative destruction and many of the inefficient enterprises were swept from the market and replaced by new, more dynamic ones.

The recovery was fast and Finland experienced strong growth through the rest of the 1990s.

At the same time the structure of Finnish industry shifted from metal and paper manufacturing to knowledge-based industries, the real shining star being the ICT sector.

The driving force for economic growth moved from traditional areas of production to innovation and creativity. By the end of the century, R&D expenditure in relation to GDP was well above 3%, which was one of the highest in the world.

A brief look at history shows how a small, closed and fairly regulated country was transformed into an open market economy.

It is important to bear in mind that most of the reforms in Finland, as well as elsewhere, have taken place because of external shocks.

Globalisation and taxes, for example, create competition between countries which limits the possibilities of policy makers in each nation to act in their own self interest at the expense of the preferences of the vast majority of the population. This is exactly what has happened in Finland.

Financial market liberalisation, which had begun in the 1980s, was completed by removing the remaining restrictions on capital movements and domestic financial markets.

Foreign ownership of shares in Finland was fully deregulated in 1993, when Finland became a member of the European Economic Area (EEA) as a step towards membership of the European Union and European Monetary Union a few years later.

Following financial liberalisation, Finland experienced a major banking crisis and a collapse of its fixed exchange rate regime. The economy underwent the most serious recession

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Finnish financial markets were reorganised.

In the 1980s Finland still had a house bank structure, like the financial systems of Japan and Germany. By the end of the millennium that had changed.The stock market gained influence and debt played a smaller role in terms of financing investments. Restructuring the financial market was a key element in increasing the significance of the high-tech industries and R&D investment.

The role of the medium-sized firms was also seen as important for future economic growth.

Both of these changes created demand for foreign capital.

Ministry of Finance has recently promised more cuts in wage taxes for the current and following year. The explanation for the postponment of the 2007 cuts has been the peak of the economic cycle, which makes little sense, since all the tax cuts during the last decade have generated more revenue for the government.

The share of foreign ownership in the Helsinki Stock Exchange has increased dramatically since the early 1990s. By 2000 over 70% of Finnish market capitalisation was in foreign hands. As a result the Helsinki Stock Exchange became one of the most internationalised stock exchanges in the world and the level of foreign ownership has remained high. The model of corporate governance in Finland also underwent major changes. The traditional Continental European system (stakeholder framework) was replaced by the AngloAmerican system (shareholder framework).

This shift undoubtedly increased the efficiency of businesses.

HEALTHY,WEALTHY AND WISE One of the most important reforms, however, was made in the Finnish tax code as many laws were passed to increase the incentives for firms and their owners. The corporate tax rate was lowered and double taxation of dividends was removed. The corporate tax rate was cut by almost ten percentage points to 25% in 1993, with significant results. As a result, firms showed high profits and corporate tax revenues collected by the government increased ten-fold from 1993 to 2000 to a steady €5 billion per year. Another important consequence of removing the double taxation of dividends has been that a large number of owners were able to gain reasonable amounts of private wealth. And, as we so well know, wealth begets wealth.

Raising revenues from corporate tax made it possible to lower the personal income tax rates considerably for ten successive years which had the desired dynamic economic

effects on the government’s financial situation.

Although the tax wedge on labour was reduced by more than 5% in terms of GDP between 1995 and 2005, total tax revenues were not reduced. It is important to understand that without the extra tax revenue from corporate taxes the cuts in wage taxes could not have been implemented to the same degree. Even though the so-called ‘avoir fiscal’ (footnote this to explain what this fiscal credit means exactly) has been a tremendous success story in Finland, it came to an end in 2006 and the double taxation of dividends was partly re-established. However, large owners of corporations were compensated and wealth tax was removed in 2007. In addition, inheritance tax is currently under reform and taxes on vehicles were lowered earlier this year.

Most of the reforms in Finland have taken place because of external shocks Despite the positive effects of repeated cuts in wage tax on the Finnish economy they were not continued in 2007. Marginal tax rates among high income groups in Finland last year were 9% above the European average. The corresponding figure among the middle income groups is 6%.

This means that the incentives for making an additional Euro in Finland are much lower than in other European countries. The

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Even though government ownership has been reduced considerably in many firms during the last decade, and quite a few have been sold to private investors, the state remains a significant owner in some companies. It has become a top political issue over the past year because of dilapidated part state-owned paper mills and the laying off of workers. Even President Halonen has voiced her concerns on the subject. The Social Democrats want the government to use its influence to steer companies in a particular direction regardless of the pressures of market forces while governing centre-right parties correctly feel that it is inappropriate to intervene in the strategic decision making of listed companies.

Reforms in Finland are in most cases generated by external shocks and coalition governments ensure that high-risk economic experiments do not occur. This also means that it is difficult for governments to predict any clear economic policy targets. All the significant reforms would have been made regardless of what combination the coalition government took, and other necessary ones are left incomplete for the same reason.

France

Guillaume Vuillemey and Valentin Petkantchin are researchers at the Institut économique Molinari in Paris.

Nicolas Sarkozy was elected in May 2007 with the firm conviction that radical reforms were necessary in France, and that he was the man to implement them.

A few months later, a reality check is due: the only reforms that have been implemented (concerning the privileged pension regimes or the decrease of labour costs) were either superficial or too complex to result in a more market-friendly economy in France.We must accept that the opportunity to reform, greater in the months immediately following an election, has once again been wasted.

DOWNSIZING THE PUBLIC SECTOR Retirement of public servants is a great opportunity to reduce their overall number, as it is a politically expedient moment not to replace them and to reorganise public administrations instead. In spite of this, the government promised the replacement of every second retired public servant and in the end, it backed down even on that promise: one out of every three State employees, or some 22700 civil servants’ jobs will eventually not be replaced in 2008.

Such an opportunity was crucial: a new civil servant is a lifelong commitment for France’s taxpayers. Moreover, as every retired public servant continues to live off the government’s budget for his or her pension, one should actually expect expenditures on public servants as a whole to continue growing in the future.

The chance to reduce public spending in that regard was thus completely wasted by Sarkozy’s government, as was the opportunity to reduce public sector jobs in France.

Several public companies, including EDF, SNCF and RATP, have a privileged pension regime, working only 37.5 years instead of the usual 40 years expected in the private sector to get their full pension. In 2007, these regimes cost the taxpayer around €8.5 billion, according to Sauvegarde Retraites, an independent association promoting market-oriented solutions to our pension problems. There have, for some time, been calls to suppress those regimes in the name of equity and Sarkozy’s government appeared to be delivering the goods in this area. Despite large strikes last October, the government held firm and secured the 40 years contribution from the formerly privileged public sector employees.

However, one should be aware that this reform nevertheless maintains many privileges for public sector employees. Whereas private pensions are calculated by taking into account

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the last 25 years of work, public pensions are based on the best-paid 6 months before retirement. Also, the 40 years contribution will be effective only in 2012, whereas it is going to be implemented immediately in the private sector. More importantly, the reform did not touch upon the ‘pay as you go’ system in a country that dedicates the highest percentage of GDP to pension expenditures and where savings for retirement are the lowest, at less than 0.5% of GDP. With an anti-market tax environment, radical reform in France was the only thing that could stimulate market dynamism. Despite superficial measures, such a reform is nonexistent. Sarkozy’s government would do well to pay attention to the study by Ernst and Young concerning the state of the tax burden in France and the growth of its public spending which shows, in no uncertain terms, how much this burden hinders growth.

The implementation of tax free inheritance transfers between spouses and on children, the tax deductibility of loan interest for the purchase of a residential home and the fiscal shield at 50% of income are leaving more money in the hands of those who earn it. These improvements are, however, largely discounted by increases in capital gains tax and the free distribution of a company’s shares to its employees. One should also expect tax pressure to increase because of the emphasis put on the fight against global warming and environmental policies by the current government.

A drastic tax reform is thus absent from Sarkozy’s reform programme, whilst the latest available OECD data indicates a record high tax burden in France in 2006, at 44.5% of GDP. The ratio of French public spending to GDP was the second highest, at about 54% in 2007, above even those of Scandinavian countries like Denmark (at 50.8%) or Finland (50.5%), and behind only Sweden (55%). Not for long,

though. France is poised to become the most collectivist country in the western world, as Sweden seems committed to diminishing its own public spending and has already seen a 1.2% decrease in 2007.

According to Contribuables Associés, the leading French taxpayers’ association, it means that the French are about to become the nationality who work longest for the state (some 200 days per year).

WHAT CHANCE FOR WORKERS? The French labour market is legendary for its rigidity. Beyond the existence of a minimum wage – which contributes to the unemployment of non-qualified workers – and a legally established 35 hour working week, obstacles to layoffs are one of the main problems responsible for sluggishness in job creation. It was of utmost importance, if the unemployment rate was to be cut as Nicolas Sarkozy promised it would be, that

those rigidities be relaxed. Instead, even if some legislation moved toward greater flexibility, the opportunity to implement true market-oriented reforms was again missed. For example, the first reform the government should have made was to get rid of the socialist 35 hour law and to get away from defining a ‘legal’ working week.

Instead, a bill was enacted on 1 September 2007, which was limited to exempting extra-working hours from social and fiscal charges. This bill was intended to get around the 35 hour law and to give employees incentives to work more if needed. Even if some companies and employees find this new bill useful, its implementation will prove complex. According to a survey by the National Association of Human Resources Managers, more than two thirds of human resources directors find the bill a new source of problems.

Another example is the attempted removal of obstacles to layoffs. Heavy regulation pushes companies into relying on other, less restrictive arrangements such as temporary contracts or the use of interim agencies.

Moreover, in the context of international competition, companies can easily choose

to locate elsewhere. Heavy labour regulation in France thus results in chasing out those that hire. But instead of freeing the permanent contract model from the arbitrariness of the Labour Code, the government left unions and business lobby organisations to define a new mandatory permanent labour contract model, during a negotiation process labelled ‘Modernisation of the labour market’. Among other things, they proposed – in an agreement reached in January 2008 – a new opportunity to put an end to a permanent contract by mutual decision between an employee and an employer or a new temporary contract model. But the new regulation will come, if backed by the government, on top of all existing constraints of the labour code, which remains untouched.

union representatives’ positions, even if they are unpopular, inefficient or heavily politicised. Second, unions are heavily subsidised by the government. As a consequence, their financial health does not

Whilst this is a new option for some big companies, small enterprises who represent an important pool of new jobs, can hardly find benefit in it. Among other

depend on their members’ number or on their effectiveness. They have no incentive to negotiate, and limited incentives to serve their members. Giving legitimacy to the unions should have meant allowing free and competitive elections, and transparent private funding: unfortunately, no change has been made in that direction. The recent Attali report which aims to ‘release growth’ in France makes some interesting proposals in that area. However, neither Nicolas Sarkozy nor the five monopolistic unions are enthusiastic about implementing such reforms.

things, the cost of layoffs may remain as high as ever: any employee under a permanent contract could continue to require similar compensations after sacking as they did before. In spite of some statements in favour of union reform during his election campaign, Nicolas Sarkozy seems now to be reluctant to act on this pledge, which is the prerequisite to many other reforms in France. The current situation is paradoxical. While French unions represent only 5% of private workers and 15% in the public sector, they are the main discussion partner of the government and are decisive in labour matters, privileged pension reform and reduction of the number of civil servants. They have huge power over the economy, because a large section of their members are concentrated in public monopolies, such as the SNCF or La Poste.

Two areas seem particularly essential for reform. First, a monopoly over representativeness that protects five unions (CGT, FO, CFDT, CFTC, CFE-CGC) should be abolished. This monopoly means that they are the only ones that may run for

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With an anti-market tax environment, radical reform in France was the only thing that could stimulate market dynamism

Before his election, Sarkozy seemed determined to break the mould and to reform the French economy in order to become more market-friendly for entrepreneurs and workers alike.

Unfortunately, 7 months after his election – a potentially fertile period for reform – changes are superficial and results insignificant.

Perhaps more worrying is that Sarkozy’s enthusiasm for reform seems to have petered out. In his President’s New Year’s press conference, there was no more mention of market-oriented reforms, whether further liberalisation of the labour market, reducing tax pressure or cleaning up the unions. On the contrary: he announced new taxes on access to the Internet and on wireless telecommunications to finance public TV channels. Sadly, it seems to be ‘politics as usual’ in France.

Germany

Steffen Hentrich is a fellow at the Institute for Free Enterprise in Berlin.

Germany’s economic situation in recent years has been mixed. For many years German growth rates lagged behind the European average. Only in the last two years was it able to catch up. Germany’s labour market is still characterised by high and persistent unemployment. This puts major strain on the welfare system.

Even measures such as freezing pensions and increases in contributions to the health and long-term care system could not stop the chronic deficit in the social security system.

Germany’s export boom, induced by the global economic upswing, cannot hide the country’s economic problems.The drastic reduction of the vertical range of manufacturing is an indicator that a growing share of industrial production takes place in countries with lower labour costs – at the expense of employment in Germany.

Increasingly, it is the capital intensive, last stages of industrial production that take place in Germany. This outsourcing is the result of German companies trying to escape high factor costs, particularly labour costs. Until recently, Germany did not maximise the opportunities of globalisation due to a lack of wage flexibility, high welfare costs and excessive regulations, which led to high production costs.

OPPORTUNITIES MISSED This situation forced the German government to reduce public spending, reform parts of the health care system (2003), the labour market (Hartz I-IV) (until 2004) and the public pension system (2004). Meanwhile, the situation in the labour market improved, although it is unclear whether this improvement is related to the reforms, or whether it is just the result of export-driven growth. For the first time since the early 1990s unemployment dipped below 9%. The increase of people employed not only boosted the economy but allowed for more room to manoeuvre within the welfare system.

The reduction of debts and deficits of statutory health and long term care insurance, and the surplus of the public unemployment insurance system are good indicators for the stabilisation of the welfare system, at least for the time being.

Increased employment shows that the German economy is making better use of the available labour force. While, over the last few years the labour costs per unit were shrinking, a disproportionate rise in productivity will lead to rising wages. Additionally, the rising trade surplus shows that capital is increasingly flowing abroad and therefore not available for domestic expansion. This is illustrated by Germany’s very low level of net investment. In the late 1990s

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almost 7% of GDP was reinvested; by 2006 the rate dropped to 2%. Only in the last two years has net investment risen towards the 4% mark.

A higher return on capital also requires greater wage flexibility, a development that is not yet noticeable on the German labour market.

Germany’s economic upswing is by no means concrete or permanent. The grand coalition government has decided to reverse some of the recent reforms and to offer more public welfare.

The unemployment payment for older people has been extended to 24 months, reducing the incentive for unemployed people to look for jobs. At the same time, new subsidised employment schemes have been introduced e.g. ‘Kommunal Kombi’. While these schemes are good at hiding unemployment and ‘improving’ the official statistics, the people participating in these schemes rarely manage to find regular employment afterwards.

Success will require more than cosmetic changes The minimum wage debate is also raising serious concerns. Until now, apart from selected industries, there was no compulsory minimum wage, and many industries set wages by collective bargaining. In the late 1990s the construction industry became subject to the Arbeitnehmer-Entsendegesetz, which effectively introduced a minimum wage. This spread only to a few related industries, but in 2007 the discussion of a federal minimum wage started.

Its introduction would cause a serious threat to low skilled workers and young professionals as the wage-level is expected to be high. The recently introduced minimum wage for postal services caused a reduction of the workforce and of services offered by the competitor to the state-owned Deutsche Post AG. In the western part of Germany a loss of up to 3% of jobs is expected, and in the Eastern part up to 6%, both

tax surcharge and a decrease of the rates of income and corporate taxes would all be steps in the right direction.

in the low wage sector. The biggest hurdle on the way towards wage flexibility is welfare payments. The level of these payments functions as a de facto minimum wage. Jobs offering a payment below the welfare level hardly find any takers, a known problem that the previous ‘Hartz IV’ reforms could not resolve.

the country’s economic life. Despite a 6% decline in the government’s share of GDP, the state still absorbs 44% of GDP.Thanks to the moderate increase of welfare expenses and growing contributions towards the system, Germany experienced its first budget surplus since unification.

Low skilled people and the long term unemployed have neither the chance, nor the incentive, to find a job. Other interventionist programmes have not produced positive results either. The so called ‘Ein-Euro-Jobs’ are jobs provided by public employers and subsidised by the labour agency. They are criticised for crowding out the private sector. It remains to be seen if these jobs help the long term unemployed back into the labour market.

Also, the payment of numerous rehabilitation grants and the revival of subsidised employment schemes also seem ineffective tools to integrate the above mentioned groups into the labour market. These schemes come with high administrative costs and are prone to become opportunities for windfall gains for employers.

FISCAL MATTERS

Despite these problems, there is no lack of ways to get out of this dilemma. While the ifoInstitut in Munich suggests an incentive driven welfare system, the German government’s council of economic advisors favours subsidised wages, and others see the solution in a negative income tax. All of these concepts share the goal of combining a basic income with incentives to take up work, particularly in the low wage sector, thereby increasing overall employment and reducing welfare costs. The German welfare state plays a decisive role in

The next important project will be the corporate tax reform. Germany has one of the world’s largest tax burdens on corporate profits. From 2008 the tax on corporate profits will be reduced to 30%, but the planned tax on income from investment of capital might cause discrimination of equity financing against debt financing assets. It remains to be seen whether the German government will further increase consumption and existing subsidies, or further reduce the tax burden. The elimination of the solidarity

Germany has reduced tax privileges, but in recent years the tax burden has been rising because of increasing VAT and cyclical additional revenues from taxes on earnings.

Notwithstanding a slight decrease in the burden of social welfare contributions, the share of taxes and social welfare contributions, as a percentage of GDP, is still growing. At present, consumers and firms are burdened with a redistributed 40% share of GDP. A visionary proposal of a simple income tax without tax privileges, along with lower tax rates, was talked down during the last election campaign and substituted by a tax reform, which remains complex despite the reduction of marginal tax rates for all stages of income.

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The German federal system has been a frequent barrier for necessary reforms.

Economic policy projects had to be passed by the Federal Council of Germany, which led to delayed decision making and opaque agreements. ‘Cooperative federalism’ curtails the financial autonomy of local authorities and federal states and impedes the potential for a federal system to deliver citizen-tailored public goods. The distributional effect of the financial equalisation scheme between the Federal Government and the Länder restrains federal competition and reduces political responsibility of the Länder. The recent federal reform made some steps to simplify the process but only made minor changes to financial federalism.

The Federal Government still supports projects of the Länder, but with no discernable cross-regional welfare effect. Without greater tax autonomy the Länder will not be able to act without an increase in public debt.

Neither the reform of public healthcare, nor the pension system, are enough to solve the problem of financing German social security.

The cost reduction measures may lessen future cost acceleration, but the welfare system feeds on personal incomes and acts like a tax on wages. Some experts suspect the design of the planned health care fund will distort competition between compulsory health insurance funds. Faced with an ageing society, the political decision to delay the pension start date to the age of 67 was a necessity to slow down accelerating pension costs and to secure labour force potential. Despite steps to assist private pension funds, the necessary decoupling of pension savings from wages is not an immediate prospect.

It will not be easy for Germany to remain a leading economic nation unless current and future political powers recognise the fundamental problems of the German welfare state. Dynamic industrial globalisation continues to show the fragility of the sclerotic labour market and huge incentive problems. Politicians try to hide this reality from voters, interest groups seek special treatment in a competitive environment, and voters are not open to change. Success will require more than cosmetic changes.

Greece

Anthony Livanios is the President of the Hellenic Leadership Institute.

In the national elections of September 2007, the New Democracy party led by prime minister Kostas Karamanlis won a second term and a mandate to continue with the economic reform plan introduced in 2004.

The Greek economy has proceeded with an economic reform programme to sustain a high growth rate and an increase in foreign investment and exports of goods, long after the successful 2004 Olympic Games and in spite of the steep rise in oil prices.The positive course of the Greek economy was marked by the reduction of public deficit (5.3% of GDP since 2004) and an increase in total investment in the country (up by 12.7% from 2005).

The Greek economy is a market economy, where the public sector accounts for 40% of GDP, and per capita GDP reaches €15,090.

Between 2003 and 2007, Greece exhibited a growth rate of nearly 4% per year – one of the highest growth rates in Europe – attributed to infrastructural investment for the 2004 Athens Olympic Games and increased credit availability, which resulted in increased consumer spending.

Unemployment, one of the first priorities of the Karamanlis administration and his Minister of National Economy, has been reduced substantially (approximately 3% in 4 years).

According to the 2007 Index of Economic Freedom (Heritage Foundation & Wall Street Journal, 2007), Greece scored well in areas of trade freedom, monetary freedom and fiscal freedom. Significant progress has been made in reducing corporate income tax from 35% to 25%. As a result of the new tax reforms, 3.3 million citizens will not pay tax, due to the increase of tax free income and 2.5 million tax payers with low to medium income will gradually pay (from 2007 to 2009) significantly less taxes.

The economy constitutes the most important political issue in Greece and, although the New Democracy government has had considerable success in improving economic growth and reducing the budget deficit, it is still facing high expectations and long-term challenges in its effort to continue with the economic reforms planned, especially social security reform and privatisation. These challenges include reduction of public debt and government spending, shrinking of the public sector and drastic reform of the labour and pension systems.

Implementation of these reforms has been somewhat slow, partly due to strong opposition from the country’s labour unions and the media, used to years of statist tradition.

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PRIVATISATION RULES A strong statist tradition has characterised Greece’s development for the last three decades. In analysing the progress of economic reforms in Greece, one should take into account the important psychological barriers, manifested by the strong opposition of labour unions and the media.

The key for Greece’s development is to continue and accelerate privatisation reforms Since 2004, a concerted effort toward privatisation has been planned and gradually implemented, with the most notable examples being the placement of shares of Hellenic Petroleum Group, National Bank of Greece, OPAP S.A. (Greek Organization of Football Prognostics S.A.), and OTE (Hellenic Telecommunications Group). The further privatisation of OTE, has been a long process. It started in 1996 when OTE was a state-owned monopoly, and was at the top of the Greek government’s agenda for 2007. Last year, the Greek State sold part of its residual shareholding in OTE, furthering the privatisation process of one of the largest state enterprises. A private equity fund is now the second-largest shareholder in OTE after the Greek state, with a stake of 18%, after its recent share purchases.

Today, the state owns 28% of OTE’s share capital, having repeatedly announced their plan for a long-term strategic investor in OTE, possibly in the form of another European telecoms operator.

The Greek energy sector is going through major structural changes, due to three major factors: EU policies to introduce competition in the energy market; government plans to implement privatisation of the energy industry; and, finally environmental policies of both the EU and the Greek state. The management of PPC (Public Power Corporation) plan to sign a memorandum of understanding with the German company RWE. The agreement includes

€5.19 billion for investment in Greece, Cyprus and southeastern Europe, having acquired stakes in several companies in Greece, with the one in telecommunications (OTE) being most well known. They have also acquired various companies in the sectors of food and beverages (Vivartia), health (Hygeia S.A), information technology (SingularLogic Information Systems and Applications S.A.), shipping (Attica Holdings S.A. and Cape Investment Corporation S.A.), hospitality and leisure (Hilton Hotel Cyprus; Anakon Investments S.A. and Theros International Gaming Inc (Casino Rio), and financial investments (Euroline S.A.; Interinvest S.A.).

the construction of two power plants and the acquisition of two secondhand gas turbines, as well as cooperation in the natural gas and renewable energy sectors.

The banking sector is following hot on the heels of the energy sector, with stakes in ATEbank and Post Savings Bank on the market, while recently, the plans for privatisation of a further state-owned bank, ATTICA, have been announced. The banking sector is one of the healthiest and more robust of the Greek economy, yielding substantial returns to investors.

Future steps include: • Developing of assets of the Tourism Development Co. • Listing of the Athens International Airport and the Public Gas Corporation • Turning over the management of state hospitals to private companies • Privatisation of Olympic Airways, the Greek national carrier: the case of Olympic Airways remains one of the most persistent challenges in the privatisation plan of the government. Public opinion research shows that the collective mentality is slowly changing and people are realising the necessity of market-oriented reforms.

Other reforms include the improvement and modernisation of public infrastructure, use of state-owned entities and the provision of services to citizens through PPPs (Public Private Partnerships), an innovation that complements the existing framework of concession projects. Discussions around the privatisation of the Port Authorities in Greece are well under way, as a result of the established regulatory framework for partnerships with private investors.

One of the top priorities of the Greek government is to diversify and strengthen its leading role in the Balkans by increasing its economic influence, namely via trade and investment. Particular efforts have been made in the energy sector with the signing of the Burgas-Alexandroupolis Oil Pipeline Agreement as well as that of the ‘Interconnector GreeceItaly (IGI)’ natural gas pipeline.

Regarding the Burgas-Alexandroupolis Pipeline, the agreement was signed in March 2007 between Russia, Bulgaria and Greece to build a pipeline for the transport of Russian oil to Alexandroupolis in Greece, via the Bulgarian port of Burgas – it is the successful culmination of a long series of discussions, as the initial idea was proposed almost 14 years ago. The pipeline will make possible the supply of tankers with oil in Greece, with the advantage of circumventing the Bosphorus and the Dardanelle Straits. The project entails a 280 kilometre pipeline with capacity of 35 million tonnes of oil annually and the potential of upgrading to 50 million tonnes.

Immediate economic benefits are anticipated, including the creation of new jobs during the construction of the pipeline and its operation.

The pipeline is expected to constitute a permanent source of growth for the region of Thrace.

Construction of the IGI natural gas pipeline is due to begin in June 2008, with completion expected in 2011. The Greek-Italian pipeline will be approximately 800 kilometres long, (600 of which will be built by Depa-Public Natural Gas Corporation in Greek territory), with a capacity of 8 – 8.8 billion cubic metres of natural gas per year. The EU has included the IGI Project in the five priority development axes for the trans-European energy system and will make a financial contribution to the technical-financial studies.

The total investment will exceed €1 billion, part of which will be funded under the EU’s 4th Community Support Framework (CSF).

The project is expected to strengthen the position of Greece in the energy market of the wider region. Furthermore, it will improve energy security and enhance the country’s role as a natural gas transit hub.

April 2007 marked the acquisition of one of the major Greek mobile phone companies TIM Hellas by Weather Investments, the Telecom holding company of Egyptian tycoon Naguib Sawiris, CEO of Orascom Telecom.

The deal, an investment of €3.5 billion, confirmed the steady increase of FDI in the country, and proved Greece’s appeal to freign investors. In 2007, private equity funds raised

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According to the Wall Street Journal, “Europe’s ‘sick man’ gets well – Greece cuts deficit and keeps robust growth; a lesson for others?”

Considerable progress has been made over the last few years and the government’s main aim is to continue with its efforts to balance the budget and reduce debt. The key for Greece’s development is to continue and accelerate privatisation reforms, placing strong emphasis on the reduction of the size of the public sector and increasing FDI. Reduction of procedures and time required for entrepreneurs to start a business, as well as easing regulation of professional services, both of which are under way, can and should be significantly improved in order to facilitate further investment. Reforms of the rather fragmented pension system specifically will be one of the main challenges for the Greek economy, and possibly a source of tension, in the years to come.

Hungary

Katharine Cornell Gorka is the director of the Institute for Transitional Democracy and International Security.

Hungary in 2007 was plagued by ongoing crises in both the political and economic spheres, crises which originated with events in 2006. Firstly, the results of the national elections of April 2006 were extremely close—the leftleaning Hungarian Socialist Party won a second term with 43.21%; while the right-leaning Fidesz came in just behind with 42.03%.This left a sense of deep divisiveness and bitterness in the country as accusations of voting fraud were leveled.Tensions were further exacerbated in June with the announcement of the Socialist government’s far-reaching economic reform package.While reforms were expected and indeed necessary given the rising government debt and inflation, the package was heavily criticised for placing too much emphasis on increased revenue through higher taxes, and not enough emphasis on lower government spending and greater fiscal responsibility. Subsequently, Standard & Poor’s downgraded Hungary’s long-term credit rating, with the 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.”

Several months after the elections, on September 18th 2006, tensions which had been building finally exploded when a tape recording was released on which Prime Minister Ferenc Gyurcsany was heard admitting to having lied to the country about the state of the economy in order to win the election and that his party had accomplished nothing in its previous term in office. “No country in Europe has screwed up as much as we have…” Gyurcsany can be heard to say. “We did not actually do anything for four years. Nothing.” In response to the tape, thousands of demonstrators took to the streets, and the country saw its worst political violence in 50 years. Demonstrations continued for several weeks, culminating in a clash between police and demonstrators on October 23rd, the 50th anniversary of the Revolution of 1956. This led to an independent civil investigation of human rights abuses by police and use of illegal policing tactics and weapons as well as condemnation of the government’s handling of events.

This was the tone in which 2007 began. Many minds were still focused on the police abuses during the October 2006 demonstrations and were anxiously waiting to see whether there would be further violence on March 15, the next big national holiday. But while March 15 passed without event, the government’s management of public security was further questioned as a series of scandals involving police and security services erupted in April and May. As a result of the scandals, in late May the Justice Minister resigned, and both

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the Budapest and the national police chiefs were fired. Government and police integrity were further questioned in September when the government was caught having used Schengen funds to purchase water cannons (traditional instruments of riot control), when the funds should have been used to strengthen security at the new borders.

While the integrity of the national police remained under question throughout the year, for many the primary issue remained the fact that the prime minister, who had himself admitted to lying and incompetence, was still in office. Neither demonstrations nor police violence resulted in the prime minister’s resignation. Constitutional means also proved unsuccessful in ousting him. So the opposition focused its efforts on a referendum. This strategy was first proposed in October 2006, and it remains their principle means for challenging the legitimacy of the government. The referendum (scheduled for 9 March 2008) will put to a popular vote specific aspects of the reform package—it will challenge the newly introduced doctors’ visit charges, hospital fees and higher education tuition fees.

On the one hand, the opposition now sees the referendum as the only legal means possible for the electorate to express its discontent with the government. Fidesz Spokesman Peter Szijjarto said the decision followed a ‘struggle’ lasting over a year, to “give people the right and opportunity to voice their opinions on the future of their country and themselves.” Yet the actual measures they are voting against are both insignificant (the

its neighbours.

Hungary is travelling down a well worn path.

It is virtually identical to Ireland in the 1980s: high government debt following years of expansionary fiscal policies, taxes increased to reduce the deficit, low growth and neighbours who were growing much faster. What forced Ireland to radically reduce state spending and state employment and thereby achieve its economic miracle was not an ideological commitment on the part of any one party to institute limited government, but rather the impending fiscal crisis. In the words of Prime Minister Charles Haughey, who had previously overseen a tax and spend government, the new reforms were “dictated by the sheer necessity of economic survival.” co-payment fee that the government introduced is about $1.50, or €1, an absurd amount by Western standards) and yet critical, as they mark baby steps in the very necessary process of reforming the state health care system after 17 years of inaction on this issue by both right and left. The small conservative party MDF has said that Fidesz is propagating ideas that are anti capitalist, anti free market and contrary to conservative principles. This is one of the key problems in Hungary today: there is no true advocate for free market reforms. 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.

Economic developments throughout 2007 were shaped almost entirely by the implementation of the reform package.

In 2006, corporate tax was raised from 16% to 20%. Income tax,VAT and social security contributions were all increased as well, coinciding with an increase of governmental resources to enforce compliance (50% of the population was claiming the minimum wage).

As a result, economic deceleration, which had already begun in the second half of 2006, became more pronounced in 2007, with GDP for the year reaching only 1.8%, according to the independent economics research institute Kopint-Telki. This rate was well below its neighbours (Slovakia, to cite just one example, had growth of 8.8% in 2007).

The rate of inflation in Hungary increased from 3.9% in 2006 to 7.6% in 2007, the highest rate in Central Europe. Hungary topped the price increase rankings in principle food products, according to Ecostat. Petrol prices also increased sharply during the year, with a 13% price rise.

The energy sector was also much in the news in 2007. In 2006, it was announced that Gazprom and MOL, Hungary’s energy giant,

formerly state owned and now private, were drafting a plan to extend the Blue Stream gas pipeline from Turkey to Austria in order to improve supplies of Russian gas to southeastern Europe. However, that plan seems to have fallen through, and now Hungary is fighting to defend MOL from a hostile takeover by Austrian energy company OMV, which is thought to have strong ties to Gazprom. Driving this issue is the fear of a loss of sovereignty in the energy sector (though as is stands, Hungary imports more than 80% of its gas, mostly from Russia).

While the governing coalition and the opposition are deeply divided on most issues, they came together to vote in the so-called MOL Law (337 in favour, only 4 against), a law that protects Hungarian companies which are considered to be strategic from foreign ownership.The EU is currently challenging the law.

LOOKING AHEAD 2007 was a low point for Hungary since the democratic transition began 18 years ago, not simply because it performed so poorly in comparison with other transitioning countries, but also because of the many signs indicating deep divisiveness and discontent among the population. The outlook for 2008 is little better. Promises of continued strikes by rail and bus workers as well as the upcoming referenda threaten to undermine the few meaningful structural reforms the government has undertaken. At the same time, the combination of high taxes and over-regulation make the Hungarian economy unattractive for foreign businesses and investors and difficult for local businesses and entrepreneurs. Some analysts are optimistic, suggesting that because the government will meet its target for debt reduction, the economy will recover. But to suggest that is to ignore the fact that Hungary is not alone in the international environment, and that the health of the Hungarian economy depends not only on domestic performance but also on its standing with regard to its neighbours who are by now well out in front in terms of economic performance. Short of sweeping tax cuts, more significant cuts to state spending, and a simplification of the reporting and regulatory environment, Hungary will not be able to catch up with

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Ireland has been cited by both the governing party in Hungary and by the opposition as the model they would like to follow. Yet they have both missed the point. Fidesz attributes Ireland’s success to state-sponsored initiatives to spur growth and innovation, failing to see that these initiatives started well after the transformation was under way. The government cites Ireland’s political unity as key to its

This is one of the key problems in Hungary today: there is no true advocate for free market reforms success and uses that argument to pressure the opposition to go along with its reforms.

But in fact it was a far-ranging series of reforms in which the Irish government withdrew its restraints from the economy and allowed the initiative of individuals and private companies, which drove growth and thereby salvaged Ireland’s economy. At this moment, Hungary’s reforms are nowhere near what Ireland implemented. Given the relatively insignificant reductions to the government’s spending, coupled with the many fiscal and regulatory restraints on the productive sector of the economy, Hungary’s moment of crisis may come sooner rather than later.

Ireland

Dr Constantin Gurdgiev is a Founder of the Open Republic Institute.

During the period of 2001–2006, rapid rises in house prices and the resulting explosive growth in the residential construction sector were the main factors driving economic growth in Ireland. However, in 2007 new and resale housing markets suffered between 15% and 25% decline and new construction start-ups have fallen by over 30%.The resulting drop in economic activity appears to be spreading across various sectors as the result of unfavourable policy and regulatory environments – the conditions that were previously masked by the booming construction and housing sectors.

Following years of slow reforms, Irish domestic economic policies hit the doldrums in 2006-2007 with no further liberalisations in state-controlled sectors. Most notably, the Government has failed to reform energy (where the state-owned ESB retains nearly 70% market power in electricity generation), air transport (with state-owned DAA controlling virtually all airports capacity in the country), and health insurance (where state-owned VHI holds a nearly 80% market share in health insurance).

No improvements in market access and competition took place in several other key sectors, such as education, rail and public transport, and health services.

Ireland has gone from being the dynamic Celtic Tiger of Europe to a slumbering Celtic Garfield of the western hemisphere This, together with reliance on centralised price setting in some sectors, such as taxis, banking, alcohol and tobacco, and high share of stateinduced indirect taxation, most notably in retail services, housing and local business charges, meant that Ireland experienced further widening of the gap between prices in statecontrolled sectors of the economy relative to privately supplied goods and services. In October, a Deloitte report on the Irish energy sector revealed that the direct cost of the ESB to Irish consumers and businesses is around €100 million per annum. The indirect cost of the state-ownership of energy sector may be some five times greater.

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STATE-FUELLED INFLATION AND SPENDING Driven by extensive state intervention, Irish prices rose consistently faster than in the rest of the Eurozone. Between 2004 and 2008 retail prices rose by just 4%, but the price increases in sectors influenced by Government were: Housing and Utilities – 61% rise Education – 24% rise Health – 21% rise Transport – 14% rise Between 1 January and 31 December 2007 Irish inflation was 0.4% in the private sectors and 4.5% in the state-controlled sectors.

Elections in May 2007 further exacerbated the problem. By Q3 2007, exchequer expenditure rose 17.5% year on year – more than three times the budgeted 5.5% rate of growth in revenue. At the same time, exchequer receipts were falling precipitously due to contraction in the housing markets, with Ireland Inc recording deficits of €1.62 billion by the end of 2007 (as opposed to a surplus of €2.27 billion a year earlier). The latest projections put Irish Exchequer in the red for 2008 to the tune of €4.8 billion.

In line with this excessive state spending, household savings in Ireland have fallen by almost 31% between 2005 and 2006 and are expected to fall by a further 25% in 2007.

Ireland’s Central Statistics Office attributes this worrying trend to “a considerably higher level of taxes being paid by Households... These taxes include a substantial increase in capital gains tax.” A combination of stalled institutional and market reforms and rising state-controlled prices are spelling disaster for Ireland’s competitiveness. In 2007, the World Economic Forum ranked Ireland at a miserly 22nd place for the third year in a row in terms of overall country competitiveness. The World Bank revealed that over the last 9 years, Ireland has

lost ground against our main competitors in terms of all institutional quality measures.

The 2007 World Bank study, Governance Matters VI: Aggregate and Individual Governance Indicators 1996–2006, covering 212 countries and measuring six dimensions of governance, showed that the most troublesome was our performance relative to our closest competitors – the small open economies around the world.

CONTROVERSY AND CONSEQUENCES The re-elected government (a coalition of Fianna Fail –with the Progressive Democrats coalition, enlarged to include the Green Party) presided over a series of controversies in the second half of 2007.

In October, following a quasi-independent review, the Government approved massive wage increases to senior public servants and politicians. The Taoiseach received a salary increase of €38,000 to €310,000 per annum – making him the highest paid head of state in the OECD. Senior ministers’ salaries went up by €25,000 per annum, and the average increases for senior civil servants were 7.3%.

State bodies’ senior officials and executives at state-owned enterprises were awarded 7.8% increases, while public health officials got 19.2%. Subsequently, the second Public Service Benchmarking Body (PSBB-II) report recommended that the pay increases to public sector employees should average just 0.3% across 109 grades of public service employment. The PSBB-II was only a marginal gain on the arbitrary and outrageously lavish raises of 8.9% recommended by the same body in 2002 (PSBB-I).

For the period of 1999–2006, when average private sector wages rose by 42%, public sector employees saw their earnings rise by 79% in regional bodies and local authorities, 67% in semi-state companies and 64% in administrative civil service positions.

Over the same period of time, the numbers employed in the public sector have risen by 160,000, or roughly 114%, while total public expenditure has increased from €13 billion to €25 billion – up 92%. Yet, the gross value added per hour of labour in all public sectorcontrolled corners of the economy has fallen:

• In Education, Health and Social Welfare – by 5.2% • In Public Administration, Defence and Social Security – by 6.7% • In state-dominated Electricity, Gas and Water Supply – by 2%.

Since 1999, value added per euro in wages has grown by 13.4% in the private economy.

Even after massive budget increases, in public administration it has actually fallen by 4%.

The PSBB-II report claimed that the public sector wages and risk-adjusted pensions yield only a 20–22% public-private pay gap. This is a gross underestimate. Taking into account defined benefit inflation-indexed pensions automatically awarded in the public sector, the overall risk-adjusted difference in lifetime earnings stands at 36-44% in favour of the public sector. Adding to this a more than 17–20% productivity gap, Irish public sector pay on average exceeds private sector wages by a whopping 42–53%.

The lack of productivity growth in the public sector is so pronounced that Ireland has been losing ground even in the areas that in the past were the basis for our international competitiveness. One example is education.

Using three main sources of international university rankings for 2007, the Irish university system (assessed in terms of its three top performing universities), achieves a low-average grade relative to its main competitors in the developed world. Based on 2007 data from Webometrics, The Times Higher Education Supplement and Shanghai Jiao Tong University, Business & Finance compared top three performing Irish universities to their counterparts in the OECD and middle-income states. Overall, Ireland’s top three universities rank 22nd out of 38 countries surveyed. Irish tertiary education only scores higher than Portugal, Poland, Mexico,Turkey, Iceland, Slovak Republic, Russia, India and Chile. When the best performing university (in the case of Ireland – Trinity College, Dublin) is removed from the rankings – allowing corrections for historical imbalances in university systems’ development – the Irish tertiary education system is ranked 33rd out of 38 countries.

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Ireland’s relatively poor academic performance has also translated into below average performance in research and development.

For example, according to data for the EU15 FP-5 programme for research funding, released last year, Ireland ranks seventh in per capita-adjusted terms in the number of international research projects that were coordinated from Ireland, ninth in terms overall per capita research financing obtained

by Irish institutions and ninth in the overall per capita number of research projects in which Irish institutions participated as collaborators with other EU institutions. Disregarding the five large EU states, Ireland came in as the third to last performer (ahead of only Portugal and Luxembourg) in overall levels of scientific research activities.

Declining cost competitiveness and quality of education and research meant that in 2007 Ireland failed to rank among the top 25 investment destinations for FDI (foreign direct investment) for the second time in a row.

The 2007 FDI Confidence Index compiled

by AT Kearney shows that the last time Ireland appeared in the top 25 list was in 2000, when Ireland was ranked 25th. Added to the lack of international investors’ confidence, domestic and multinational companies are downgrading their growth expectations for 2008. In the latest Manpower labour markets trends survey, Ireland achieved the lowest hiring outlook in the world. Employers in Ireland are forecasting the weakest hiring pace in four years and Ireland’s outlook for the first quarter of 2008 is pretty grim.

Lack of deeper structural reforms in key markets and falling house prices and construction activity (with property prices now expected to fall between 4.5% and 5.8% in Q4/2007–Q2/2008) are likely to continue plaguing the Irish economy well into 2008.

According to the survey of economic forecasters, ranging from the Exchequer budget estimates to the international and national institutional and professional analysts, mean growth rate in GNP in Ireland is expected to fall to 2.6–2.9% in 2008 (down from over 5% achieved in 2007). Employment growth is expected to fall to 1.2–1.27% in 2008 (down from 3.2% in 2007), while unemployment is expected to rise to 5.4–5.5% (from 4.5% in 2007). In the end, 2007 might prove to be the year when the Irish economy, plagued by the ‘socialist’ policies of rising taxation, rampant government spending and public sector inefficiencies, has turned from being the dynamic Celtic Tiger of Europe to a slumbering Celtic Garfield of the western hemisphere.

Italy

Alberto Mingardi is the General Director at the Istituto Bruno Leoni.

Italy has been a country ‘in transition’ ever since the early 1990s. The country saw a tremendous growth in public expenditure between the early 1970s and the late 1980s. The number of public employees skyrocketed from 7.7% of the Italian workforce in 1960, to 14.5% in 1980 and 16.2% in 1994. At the same time welfare-related benefits and entitlements were given away with extravagant generosity (for a short period of time, the law allowed access to retirement benefits for people who had worked 15 years, 6 months and one day, which, for some professions, included the years spent obtaining a degree as well).

Such exponential increases were brought about by a variety of factors.

For almost fifty years (1948-1993) Italy enjoyed a high degree of political stability: the majority coalition was always formed by some version of an agreement between the Christian Democrats and various smaller parties, and the Communists were always in opposition. The system was deadlocked; the fact that there had been 47 different cabinets between 1948 and 1994 led people to joke that, “you go to London to see the change of the guard; you go to Rome to see the change of the government”. As the Left could not compete effectively for power (first and foremost because of geopolitical reasons), perverse incentives developed on the part of those in power to maintain the deadlock, in spite of the poor performance of the governments they led.

The continual churning of government posts – the ‘change of government’ that could be better understood as a ‘change of ministerial appointments’ – was a way of keeping everybody in the coalition motivated and happy. Political patronage was widely misused, particularly in the South. Additionally, although the Communists sat in opposition in Parliament, ideological forces striving to lead the country in the opposite direction were not particularly active. The Christian Democrat-led government coalition continued to build, brick by brick, a more invasive welfare state. Public expenditure continually rose, and inflation was never properly controlled.

The status quo was to change as a result of a fortunate ‘perfect storm’: in the early 1990s the judiciary started to aggressively prosecute – and to jail – leaders of the Italian political class for corruption, and the country was keenly aware that it needed to meet the requirements of the Maastricht Treaty if it wanted to remain a full member in the European club. In the early 90s, transition began – and with it a process of privatisation of public agencies, a reduction of public spending, and the liberalisation of key markets that had been previously monopolised

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by state businesses. It is estimated that before the process started, roughly 70% of the Italian economy may have been within the public sphere.

Rolling back such an extensive state was not easy – particularly in the absence of a strong free market culture for which individual liberty and society’s autonomy from government were the bedrock.

Italy underwent a definite political willingness to curb public spending in order to enter the Eurozone; this period saw a few major privatisations (motorways and the telecoms industry) and some important partial privatisations (energy and natural gas), the beginning of a liberalisation process which, when properly executed, had a highly significant impact. The mobile phone market is a good example, with intense competition in tariff rates and a proliferation of mobile phone owners, to the extent that some analysts predict that in a few years the rate of ownership will reach three telefonini (mobile phone handsets) per capita.

DRIVING WITH THE HANDBRAKE ON Since 2003, however, the process of privatisation has stalled. The last one was the privatisation of the monopoly in the tobacco industry, which the Berlusconi-led government successfully sold to British American Tobacco. This privatisation may be one of the most successful divestments of public assets ever carried out in the country.

The privatisation of the two former state monopolists of energy (Eni and Enel) is yet to be completed. The sale to private hands of assets such as the state railways company (Ferrovie dello Stato), the postal service (Poste Italiane) or the national television station (Rai tv) has never been seriously considered.The state airline, Alitalia, though on the edge of bankruptcy for years, Z is only now being released back to the private sector. The process of privatisation has proved to be very difficult and painful. After the failure of

ITALY’S FUTURE: MORE OF THE SAME? As a result, the political landscape does not look promising for market reforms in the near future. With a general election scheduled for 13 April 2008, both the major parties (Partito Democratico, a new coalition on the left led

by Walter Veltroni; and Popolo della libertà, an alliance of the biggest parties on the right, built

by Mr. Berlusconi) seem neutral to economic freedom. Electoral platforms have been only partially unveiled as yet , but none of the contenders seem to be ready to call for a liberation of the Italian economy from statism.

a ‘beauty contest’, in which major international funds competed for ownership, the Treasury opened negotiations with Air France. The choice of a foreign buyer was not received well by sections of the Italian public, which came to question the procedures that had been used in the privatisation process and to resurrect the national obsession with keeping the ‘Italianness’ of Alitalia. Indeed, while national champions tend to be a financial burden for the state, they are always popular with the public.

Privatisation and deregulation are the obvious cure, for the Italian public’s morale as much as for Italy’s public finances The privatisation of Alitalia could be considered one of the very few positive legacies of the recent Prodi government. Encouragingly, the left-wing executive gave some momentum to the process of liberalisation. Although he started by targeting traditionally right-leaning groups and interests, the Minister for Economic Development, Pier Luigi Bersani, made genuine attempts to open up some markets for competition. In particular, as far as the so-called ‘liberal professions’ are concerned, Mr Bersani clearly implemented market principles. For lawyers and professionals, he legalised access to advertising, previously prohibited for alleged professional ethics reasons. He opened up the

distribution chain of non prescription drugs to shopping malls and supermarkets. He also tried to grant business a further degree of freedom by erasing the rather medieval rules requiring ‘minimal distances’ between similar shops to be regulated by local governments. Unfortunately, many of Mr Bersani’s measures did not come into effect, since implementation was left to local governments.

Overall, the Prodi government, in its two years in power, cannot be seen as a champion of market ideas. The same applies to Mr Bersani, who under the very same pretence of ‘liberalisation’, implemented new regulations eroding the freedom of contract (e.g. in the insurance business,) and simply assumed paternalism should be an inherent trait of regulators. One such example is when Bersani forced low cost airlines to advertise their full prices, inclusive of taxes. On a wider scale, Mr Prodi’s government will be remembered as one that increased public expenditure and taxation and failed to foster the process of deregulation and privatisation. Furthermore, apart from the partial deregulation of the labour market developed in the years of Silvio Berlusconi, Prodi has slowed down the rise of the retirement age that his predecessor put in place.

Admittedly, Berlusconi (who governed from 2001 to 2006) did very little for the cause of market freedom either. Although some of Berlusconi’s reforms were clearly beneficial (such as those mentioned above, plus the abolition of inheritance tax), he did not dare undertake the radical restructuring of the tax system he had promised to voters.

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In 2007, Istituto Bruno Leoni released its first ‘Indice delle liberalizzazioni’ (Index of Liberalisation), an attempt to measure economic freedom in eight key specific markets, ranging from electricity to postal services. According to our Index, the Italian economy is liberalised by a mere 52%. This happens to be consistent with the general understanding of our country by foreign observers. Italians have done a lot to move forward from the economic predicament that fifty years of aggressive statism bestowed upon them. Yet they have not done enough, largely because of a political class that refuses to contemplate releasing the economy from their control. Italians understandably continue to consider their country an “economia di relazioni”, an economy based upon personal relationships, where the fate of businessmen and workers alike depends more on personal links with the powerful political class than on good ideas and hard work. Public policies can seldom reinvigorate a country’s culture, a fact that can be considered as proof of the futility of the current situation in which state intervention continues to permeate Italian society.

Privatisation and deregulation are the obvious cure, for the Italian public’s morale as much as for Italy’s public finances. They are needed to give more oxygen to the vibrant entrepreneurship that continues to push Italy towards a better economic performance than we may anticipate given the poor conditions for business growth. Also, in a country which is ageing more rapidly than anywhere in Western Europe, welfare reform is urgent. But the rolling back of the welfare state can only begin when Italians find the courage to say goodbye to the state entrepreneur.

Latvia

Helen Davison is Senior Researcher at the Stockholm Network and has previously worked as a research assistant on a series of papers looking at reform of the civil services of the eastern European EU member states.

Latvia has undergone major structural, economic and political reform, culminating in acceptance into major international institutions such as the WTO and the EU. On 21 December 2007 Latvia experienced another historic milestone when it became one of nine new EU member states to join the Schengen Zone.

The Latvian economy has continued to grow at an astonishing rate, leading the EU with an average GDP growth rate of 8.1% from 20002006. Latvia’s economic growth can be linked to its situation close to large, rich markets.

However, good policies like the adoption of a flat tax in 1994 and a stable currency pegged to the euro have certainly helped to secure this outcome. The Latvian government has boosted economic growth by promoting a knowledge-based economy; making use of EU Structural Funds and providing funds from its own state budget to support innovation through investment into research and development infrastructure.

But, will Latvia’s recent political and economic woes slow this growth down?

The effect of running a huge current account deficit has begun to catch up with Latvia; widely referred to as ‘Europe’s most overheated economy’. Inflation rapidly accelerated throughout 2007, mainly due to high food and fuel prices and rising wage costs and now stands at the highest in Europe. Hence, the fight against inflation, a key characteristic of government policy since independence, continues. Last year, after the country suffered a domestic run on the currency, the government introduced an inflation busting package that, so far, seems to be producing results. However, the political turmoil that characterised 2007 may damage the country’s chances of a quick recovery and worryingly, has left Latvia increasingly vulnerable to the tightening global credit conditions.

TROUBLE IN THE RANKS Like many of the Central Eastern European states, Latvia has seen a rapid turnover of governments since gaining independence.

Although entering a period of relative stability after the 2004 elections, the country experienced its tenth change in government in 2007, with the resignation of Latvia’s longest serving Prime Minister; Aigars Kalvitis. The resignation came after allegations surrounding the attempted sacking of a key anti-corruption official. While the government maintained that his attempted removal was due to financial irregularities at the anti-corruption office, many

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believe that the campaign was motivated by ongoing investigations into the ruling People’s Party’s election campaign spending.

The centre-right Kalvitis government submitted its resignation early in December despite surviving a vote of no confidence. Ivars Godmanis, who led Latvia to independence as prime minister in the early 1990s, won parliament’s backing and assembled a cabinet virtually unchanged from that of the previous administration. The new government is not expected to make any major changes to economic policy due to the continuing need to stabilise the economy. Latvia continues to have the youngest cabinet of all the EU member states; with an average age of just 42.1 years in 2006.

It is generally accepted that the privatisation process is all but complete in Latvia. In 2006, Latvia saw the largest privatisation in its history with the total sale of the Latvian government’s 38.62% stake in Ventspils Nafta; an oil transit company. However, state owned assets do remain in the form of the country’s main energy company, Latvenergo. There had been plans to privatise the company, but the process stalled in 2000 after 23% of eligible Latvian citizens signed a petition calling for a referendum on the issue. The Government also still holds shares in Lattelcom, the country’s main telecom company and its wireless sister company Latvijas Mobilais Telefons (LMT).

In August 2007, Lattelcom’s shareholders and the company’s board chairman, Nils Melngailis, signed a protocol of intent on what should be done to prepare for the privatisation of Lattelcom, with the aim to complete the deal by the end of 2007. However, the Godmanis government is currently reviewing the process, including discussing the possibility of keeping a majority stake rather than the 8% proposed

by Lattelcom CEO, Nils Muiznieks.

HEALTHY COMPETITION? Reform of the healthcare system has focused more on decentralisation than funding, although differing payment mechanisms have been experimented with. Healthcare was extensively decentralised in the early 1990s, with a view to developing competition but this was followed by a period of recentralisation in the late 1990s

encourages labour force participation and incentivises later retirement. Furthermore, NDC’s can be seen as a useful first step towards a defined contribution pension system, although there are presently no plans to implement a pension system of this type.

in response to criticism that the system was too fragmented. 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

There is widespread optimism about the future of reform and continued economic prosperity in Latvia field.

Since the early 1990s governments have tried to address healthcare workers’ grievances about low pay rates with promises that once completed, healthcare reforms will improve funding, but these promises have not been followed up. In 2004 there was a wave of protests by various healthcare workers calling for major pay rises. The government had hoped to fund doctors’ pay rises by increasing patient contributions; a proposal that was rejected by both patients and medical workers. Existing patient contributions are already deemed too high – at present they are amongst the highest in any European country and so the issue remains unresolved.

Latvia adopted a ‘three pillar’ pension system largely to address the weak link between social contributions and pensions received in the pay as you go (PAYG) system and because Latvia

began to suffer the effects of a rapidly ageing society.The first pillar state provision is now run as a ‘notional defined contribution’ (NDC) scheme, based almost entirely on the Swedish system. Member contributions are recorded in individual accounts that return notional interest until retirement, while real contributions are used to meet the cost of current pension expenditure. At retirement, pensions are paid according to a formula that divides the notional value of contributions by assumed life expectancy in retirement. This is supplemented by a second pillar in the form of a mandatory fully funded plan financed by diverting a portion of the payroll tax. Since 2003, contributors to the second pillar have been able to switch provider once a year and can choose between five domestically registered asset managers who compete with each other for market share. The second pillar remains largely state-centred; contributions continue to be collected by the Ministry of Welfare and paid on to the selected second pillar manager, an example of the so-called ‘Montreal solution’ for second pillar premium distribution, which is being managed on an outdated, paper-based transaction system. As in Poland, this may result in delays between tax collection and final investment into second pillar funds. Ideally, the state should withdraw from this market completely, but no final date for this has been set. The third pillar is designed to stimulate voluntary retirement savings, through various tax advantages, with public involvement limited to oversight and regulation.

Such a system does bring benefits: the model is designed to ensure a much closer link between contributions and benefits which

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After joining ERM II in 2005, Latvia is hoping to adopt the Euro in 2008. Whether they will meet the strict Maastricht convergence criteria is another matter; at present the rate of inflation is well above EMU guidelines.

Keeping the budget deficit under the 3% threshold could also pose a serious threat to these plans. It has come seriously close to the reference value in recent years; standing at 2.7% in 2002. A recent Credit-Suisse report shows Latvia to be in a difficult position vis a vis Eurozone membership, even compared with its Baltic neighbours and estimates 2011 as a more realistic timetable for membership.

LOSING MOMENTUM? There is widespread optimism about the future of reform and continued economic prosperity in Latvia. This is despite the above EMU guideline inflation rate which could derail plans to adopt the Euro and the general waning of reform momentum throughout the region.

Politically, whilst disruptive, the protest and subsequent resignation of the Kalvitis government at least points to an increasing expectation of professionalism and transparency in the political classes.

Economically, sound policy looks set to continue. The Latvian National Development Plan for 2007-2013 focuses on developing a knowledge-based economy and on finding new ways to ensure an attractive business environment. It is actively promoting the development of small and medium-sized enterprises and seeks to increase export and entry into new markets while consolidating its strong position in current ones.

The inflation reduction plan has been assessed as ‘comprehensive and rigorous’ and indications are that a soft landing is the most likely outcome for Latvia’s economy. Indeed, Jan Liden, chief executive of Swedbank, the largest bank in Latvia is optimistic. He recently told journalists: “We believe this is an intermission in a long-term growth story”.

Lithuania

Remigijus Simasius is the President and Kaetana Leontjeva is a Policy Analyst at the Lithuanian Free Market Institute in Vilius.

Lithuania’s political and economic scene in 2007 was characterised by turbulent events in the economy yet stagnation in key sector reforms.The political parties have been gearing up for the 2008 Parliament elections, so 2007 has been abundant with populist initiatives, including progressive tax legislation. Meanwhile, crucial reforms in the healthcare, higher education and pension sectors were the objects of heated debates that produced barely any action or visible results.

One of the most significant topics in 2007 was the steep increase in consumer price index, which rose by 8.1% over the course of the year.

Although food became more expensive in many countries around the globe, Lithuanian politicians claimed that prices in the home market could not be rising due to international trends. Instead, statesmen were quick to blame the producers for having arranged cartel agreements, even though no evidence of such agreements and their influence on the price increase has been found. Meanwhile, private banks continued to increase their loan portfolios: loans to private individuals rose by 65.6% between mid-2006 and mid-2007, further fuelling the inflation.

High inflation and a budget deficit, coupled with inflationary problems in Estonia and Latvia induced rumours that all Baltic currencies, including the Lithuanian Litas, might be devalued in the near future. Compared to the other Baltic states, the Lithuanian case was the strongest against devaluation. The Law on Litas’ Credibility guarantees not only a fixed exchange rate, but also a 100% back up in foreign reserves of all the currency in circulation. The population awaited the worst case scenario. It took several months for central bankers, analysts and politicians to realise that devaluation would not resolve any of the country’s problems, but would only add new ones. By the end of 2007 the idea of Litas’ devaluation had faded away, although international analysts still worry about the future of Litas.

ALL EYES ON THE MONSTER The hottest topic of political and public life in 2007 in Lithuania was the creation of a ‘national investor’ – a merge of two state-owned energy companies and a private one in order to build a nuclear power plant. As agreed when Lithuania joined the European Union, the existing nuclear power plant in Ignalina will have to be shut down in 2009. This shut down would increase Lithuania’s energy dependency on foreign sources; thus, in 2007 the Parliament began exploring the idea of building a new nuclear power plant. The national investor, which the media and public have nicknamed the ‘three-

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headed monster’, would build the new power plant as well as set up connections to Sweden and Poland. However, the creation of the national investor lacked transparency, for there was no open competition for private investment within the new organisation, leading many to question why one specific firm was chosen by the Government. Currently, a triumvirate of the companies is still in the throes of a fiery debate on the conditions of the merge.

Despite continuous economic growth and an unprecedented increase in budget revenues, the Government has still been unable to form a budget without a deficit.The planned deficit appears particularly dangerous in the current period of sharply rising inflation and a forecasted economy slowdown. Finally a long-awaited and (some may say) somewhat overdue reform in state finances came with the Law on Fiscal Responsibility, which established a limit on the budget deficit. It is, however, questionable whether the limit will be adequate.

Fiscal responsibility is only part of the problem with Lithuanian state expenditure. Other problems, such as lack of transparency, effectiveness and clear-cut aims of the budget programmes, cannot be solved with the help of a single law. Programme-based financing replaced institutional budgets 5 years ago, yet the programmes’ goals and targets are often still tailored to suit the needs of a given institution. Deeper reforms are very much needed and one can only hope that the newly elected government will have the courage and political will to take up these challenges. Sticking to the schedule, Lithuanian personal income tax has been decreased twice in less than two years: from 33% to 27% in mid-2006, and since 2008 the rate was further cut to 24%. Lithuania’s international competitiveness is, however, still being hampered by this tax rate, since rates are considerably lower in many Central and Eastern European countries.

Perhaps the most alarming initiative in 2007 was the Prime Minister’s and Social Democrats’ determination to introduce progressive personal

income taxation.The bill was, however, not even proposed because it immediately encountered strong opposition within the Parliament and among prominent economists, as well as from Lithuanian President Valdas Adamkus.Yet it may be too early to celebrate, for the Social Democratic Party, which heads the minority government, has declared progressive taxation among its star attractions of the Parliamentary election’s programme.

Lithuania is one of the few countries that still collect contributions to the social insurance fund as a percentage of one’s personal income, however large it is. Many analysts have warned that the lack of a ‘ceiling’ up to which contributions should be made is hurting Lithuania’s job market and international competitiveness. Currently, many companies have located their headquarters and thus the highest-paid jobs in Latvia, where “ceilings” on social insurance contributions exist. Although the Ministry of Economy has proposed the introduction of such ‘ceilings’, the move was opposed by the Tripartite Council consisting of the Government, trade unions and employers’ organisations, as well as the Parliament.

HEALTH AND EDUCATION: THE WAY TO PEOPLE’S HEARTS? The public sphere in 2007 has been occupied by numerous discussions and debates on healthcare and higher education reforms.

The situation in both areas is very similar: it is agreed that reforms are vital, there is an appearance that something is being done, yet no visible results have been produced.

There is a widespread lack of understanding of the roots of the existing problems; it is still

thought that we should first increase the funding and improve the conditions of the employees and only afterwards look for ways to improve the quality of the system.

Hopefully, people will elect new leadership that will thaw the frozen reforms The higher education sector is plagued by lack of funding, followed by an ineffective use of funds, spread of pseudo-education and decrease in education’s prestige. In mid-2007 six out of nine parliamentary parties reached an agreement on the broad guidelines of higher education reform. Subsequently, the Ministry of Education and Science came up with a new Draft of the Law on Higher Education. Among the more important changes, the Bill proposes to bring in private funding into the student loan system and end state regulation of tuition fees, whereby each university would have the liberty to set its tuition fees. However, these proposals would only modestly alter the existing system without changing the distorted incentives within it. Pro reform stakeholders and analysts propose abolishing institutional funding in higher education and introducing funding individual students instead (like a school voucher system) as well as deregulating higher education fees.

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The Lithuanian healthcare sector is afflicted with numerous difficulties.The supply of healthcare ‘products’ does not meet the patients’ demands; thus, the quality of those products is low and under-the-counter payments to doctors are commonplace.

There is no competition among public healthcare providers, meaning the system itself is ineffective. The situation is worsened by the regulation of health services’ prices, and, consequently, low wages of healthcare sector employees and parallel shadow payments. The functioning of the private healthcare sector is burdened with overregulation, discriminatory tax treatment, large subsidies to the public sector, lack of clarity on what kind of services are financed with public money and provided by public institutions. The only glimpse of hope came with a reform-promising document entitled ‘Outline for Further Healthcare System Development in 2007-2015’ which was developed in the first half of 2007. It has, however, not yet been approved as an official strategy or a legal act.

Currently there are no conditions in Lithuania for private health insurance to come into being. Although this type of insurance is legally allowed, it is too risky for insurance companies to insure separate individuals; thus, additional private health insurance can only be purchased through the workplace. In the autumn of 2007 the Government’s Strategic Planning Committee approved the conception of voluntary supplementary health insurance through healthcare savings accounts. However, many questions still surround this model: even though it is called voluntary health insurance, it would be more accurate to call it a health savings account. When proposals of the model were made, discussions of the existing problems were mostly left out, meaning that attention was focused on ways to increase the overall funding of the healthcare sector.

Judging from the past, parliamentary elections will be accompanied with political intrigues as well as a multitude of empty promises and populist proposals. Hopefully, people will elect new leadership that will thaw the frozen reforms.

Luxembourg

Paul Healy works on a range of projects at the Stockholm Network.

With a strong and successful economic system, Luxembourg is the European Union’s ‘poster child’ state for highlighting what a small-sized country can do.

However, the EU’s insistence on regulating the Grand Duchy has meant that the possibility of a genuinely competitive tax system may have been lost.

The Grand Duchy of Luxembourg was formed in the peace resulting from the Napoleonic War at the Congress of Vienna. Home to approximately half a million people, the current constitutional monarch is Grand Duke Henri, whilst executive powers have been exercised by the government coalition, between the Christian Social Party (CSV) and the Socialist Workers’ Party of Luxembourg (LSAP), since July 31, 2004.

The head of the government is Jean-Claude Juncker, who has been prime minister since January 1995 and as such is the European Union’s longest serving political leader.

Politically revered, Juncker has failed to be intimidated by a tradition for strong prime ministers in Luxembourg and is potentially the most significant of them all.

Luxembourg’s economic stability is a result of steady growth, low inflation and low unemployment SUPER JUNCKER Juncker’s credentials extend back to his time as one of the principal architects of the Maastricht Treaty. On this treaty, his skills as a competent Finance Minister meant he was able to draft a substantial portion of the sections relating to Economic and Monetary Union (EMU). Having also successfully mediated negotiations between Germany and France on the Growth and Stability Pact at the Irish European Council, he was dubbed ‘the hero of Dublin’.

More recently, Juncker headed the Luxembourg presidency of the first half of 2005. During this period, he was able to secure an agreement at the March 2005 European Council on reforming the Growth and Stability Pact, as well as being able to revive the Lisbon Strategy, in a bid to reaffirm its social and environmental dimensions. In Brussels, he is rapidly developing experience that is differentiating him from other

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leaders on the continent. While many talk of Tony Blair’s intention to be the inaugural President of the European Union, most are backing Juncker. For Luxembourg, this would be a phenomenal development and one that would add another (perhaps defining) chapter to their noble European history.

The climax of Juncker’s political career in Brussels came in June 2005, when he reaffirmed his intention to stand down as PM if Luxembourg voted no on a referendum on the European Union’s Constitutional Treaty.

In a suitable endorsement of Juncker, 56.5% of the Luxembourg electorate voted yes despite the popular trend against the treaty, ignited by France and the Netherlands’ rejection by referendum in the months before. The referendum result in Luxembourg highlighted the respect that the country holds for Europe.

The European Union has long been a part of the history of Luxembourg, which was the birthplace of European luminaries such as Jacques Santer, Pierre Werner, Jacques Poos, Gaston Thorn and even the ‘Father of Europe’ Robert Schuman.

With its capital city nominated to be European Capital of Culture in 2007 and with several EU institutions, including the European Court of Auditors, the European Investment Bank, the European Court of Justice and the European Investment Fund, based in Luxembourg, the European Union has been a defining aspect of Luxembourgish society, ever since they founded it with five other nations in 1957. Most recent Eurobarometer figures put Luxembourg support for the EU at 82%, the most encouraging in the whole Union. The economic proficiency of Prime Minister Juncker is not coincidental, it fits well with Luxembourg’s reputation for a strong and stable economic system. It is a country whose land area covers only 0.06% of the total of the European Union states and accounts for only 0.10% of the entire EU population, yet it has the highest gross domestic product per capita not just in the EU but in the entire world, with a growth rate of more than 6%.

Luxembourg’s economic stability is a result of steady growth, low inflation and low unemployment. It benefits greatly from large

lowest individual income tax rates on salaries within the EU. Add this favourable tax system to the fact that Luxembourg has the highest minimum wage in the EU (€1,503 per month) and it is easy to understand why unemployment is low.

amounts of foreign investment, particularly in the financial sector, which accounts for 28% of Luxembourg’s entire economy. In the 2008 Index of Economic Freedom, a study that ranks countries based on 10 specific freedoms such as trade freedom, business freedom, investment freedom and property rights, Luxembourg was placed 15th. In particular, the study noted the ease of starting, operating and closing a business, as well as the equal treatment of foreign and domestic businesses.

BIG VAT DEBATES A specific freedom that Luxembourg has exerted, which has caused conflict amongst other EU member states is Luxembourg’s imposition of a relatively low VAT level.

Luxembourg currently charges VAT at 15% – the lowest rate permitted by the European Union. It does so in order to maintain a competitive edge and to uphold an attractive image for global investors. Indeed, the policy has led to a large influx of inward investment, particularly in the e-commerce and telecommunications sectors.

On 1 July 2003, a new VAT regime for electronic services came into effect with the European Directive on E-commerce and VAT. In essence, the directive encouraged non-EU businesses to set themselves up in one EU member state and only charge VAT at the rate present in that country. Under the old system,VAT for these electronic services was charged at the VAT rate in the country of the purchaser. The result was that many e-commerce companies sought to establish their businesses in Luxembourg, with its 15% rate. AOL, eBay, Skype and iTunes are some

of the global companies and brands that took advantage of the new system, providing the Grand Duchy with a large increase in revenues.

These developments set Luxembourg up as the centre for e-commerce, a position that created tension within the European Union.

Countries with high VAT rates, whose residents provide the majority of the purchases of electronic services in Europe, argued that they were losing out and fought for a change to the regime. Predictably, the bigger states won and the EU sought to harmonise its tax systems upwards. On 5 December 2007, an agreement at the Eurofi Conference of EU finance ministers decided that the regime would be reversed, compelling each purchaser to pay at the VAT rate of the member state in which they reside. Luxembourg has come back saying that the new system costs them €270 million a year in lost revenues and argued for a system that allowed the VAT to be shared between two states. In the end, Luxembourg’s arguments were ignored and a concession was made, whereby the current system would be maintained until 2015, five years longer than previously agreed.

Due to globalisation, e-commerce and business have become increasingly interlinked.

Businesses see electronic services as a way of increasing efficiency, as well as a method for avoiding bureaucracy and, consequently, taxation. It is not just the VAT level that is low in Luxembourg. PriceWaterhouseCoopers estimates that for a married taxpayer, with an annual salary of €100,000 and with two children, the net salary after tax and social security contributions is €73,000. This is the

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At less than 60 years of age, Luxembourg has one of the lowest effective retirement ages of the entire Union, which would explain why at 14.9% it has the lowest percentage of 60– 64 year olds in active work in the entire region.

Officially Luxembourg residents are only entitled to social security pensions at the age of 65, however a number of loopholes have allowed workers to retire at a much younger age. In addition, pension replacement rates are high and in many cases reach 100% of net income for lower and average brackets.

This situation is exacerbated by the tripartite pensions negotiations or Rentendesch which took place in 2001 and raised basic pensions by 11.6%.The incentive to continue to work in Luxembourg is low and many people chose to retire as soon as they can. With an ageing demographic, the resulting need for more pension contributions and the likelihood of less pension contributors, one wonders if this current system is sustainable. In 2006, the OECD recommended that Luxembourg should index its retirement age to life expectancy, a move that would provide a more stable labour market by raising the average retirement age.

Luxembourg will look to the future with some trepidation as it aims to maintain its prosperity and economic stability. If it is able to contain escalating pension costs it will be wary of the loss of its competitive edge in telecommunications and e-commerce as a result of pressure applied by the EU. Regardless of this, it will still maintain its pro-European stance and will no doubt be at the frontline in promoting a more federalist European Union, whether as a member state or through the European president.

Malta

Babak Farrahi is an international relations graduate currently working at the Stockholm Network.

It took forty years following independence from Britain in 1964 before Malta joined the European Union.This was largely due to the antagonism shown towards integration by the Labour Party (MLP), during its administrations of 1971-87 and 1996-98. Malta did not apply for full EU membership until 1990 during a period of dominance for the Christian Democrat Nationalist Party (PN).

These negotiations were temporarily halted by the electoral triumph of the MLP in 1996, and serious negotiations did not continue until the return to power of the PN in 1998.

Given such a belaboured process, the assumption would have been that further integration would take a similarly slow path, but in the intervening four years there has been considerable change in the Maltese economy and a growing impetus toward further integration symbolised by Malta adopting the euro as its currency on 1 January 2008.The first government of Dr. Lawrence Gonzi (2004-2008) pursued an extensive reform agenda, earning both widespread acclaim from commentators at home and abroad. At the same time, it had consistently poor approval ratings and did not fare well at elections for the European Parliament and local councils.

independence, was largely reliant on tourism and manufacturing.This has, however, been changing. The percentage contribution of GDP from these two sectors fell between 2000-2005; with the tourism industry showing signs of decline in the face of greater competition.

Manufacturing’s contribution fell by over 5% and the decrease for tourism was close to 2%.The introduction of low-cost airlines has, however, seen record double-digit growth in tourism over the last two seasons. It has been the service sector which has increased its contribution to GDP by about 9%, and financial services have enjoyed a particularly robust improvement.

The increased official enthusiasm for Europe was so striking that European Commission President Jose Manuel Barroso presented Malta as an ‘inspiration’ following its approval of the Treaty of Lisbon. Malta was among the first three countries to ratify the treaty, all three happened to be the newest members of the Union, which was ‘particularly symbolic’ for Barroso.

Greater foreign direct investment has been one of the benefits of Malta’s European integration.

In 2006, the government sold its majority holdings in the telecommunications company Maltacom to a Dubai Holdings subsidiary. One of the leading flows of FDI into Malta has come from leading car manufacturers, such as BMW, Renault, PSA Peugeot Citroën and Volkswagen, who have moved the insurance branches of their operations to the island.This is both due to Malta’s membership status and also the attractive nature of the taxation system where income tax on dividends can be offset against corporate tax, which reduces the effective tax rate on dividends from 35% to 5%.

The Governor of the Maltese Central Bank, Michael Bonello, seemed conscious of the symbolism of joining the single currency when he said that, “since the eleventh century, when the Arabs were ejected, Malta has looked to the north.” Malta’s desire to join the euro was not one, however, based solely on symbolism; economic realities proved to be persuasive in their own right. During the official celebrations of the eurozone entry, Romano Prodi pointed out how symbolism and economic structures were welded together: the fact that all the Mediterranean member states are members of the eurozone may be economically important for the entire Mediterranean, north and south, as well as significant for the relative weighting of the currency in the region.

The legacy of colonial rule had been a healthcare system that is partly modelled on the British system, with a considerable public sector and welfare state.The economy, after

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AN ISLAND, BUT NOT ISOLATED

Accommodation and labour costs are also significantly lower in Malta than in other rival European financial centres such as Luxembourg and Dublin. Some 250 hedge funds, which hold €7.5 billion worth of assets, have now moved their operations to Malta. All this has contributed to an increase in inward investment, which according to the Maltese government is now at a level 25 times greater than a decade ago. Some now see Malta as a model for economic prosperity in a globalised world.

Overall GDP growth seems to be hovering in the 4% range which is a significant improvement on the pre-2004 rates. Economic growth

the Malta Energy Efficiency and Renewable Energies Association, 84% believed the government had not legislated enough in this area. Only 11% thought that current incentives to use renewables were sufficient, whilst 84% said that they thought stricter legislation would increase business opportunities in the field of renewable energy.

TROUBLE AT SEA

The new government led by Dr Gonzi has pledged to continue the economic policies followed in the previous legislature following membership came in contrast to the fiscal difficulties which had faced Malta 4 years earlier when public debt was close to 75% of GDP and the budget deficit was close to 5%.

Austerity measures were introduced to ameliorate these problems including reform of the taxation system, an increase in the rate of VAT and greater vigilance and prosecution of benefit fraud and tax evasion. Firms in the public sector which were operating at a loss were closed down, whilst government holdings in other businesses were sold.There was a broad introduction of cost-based pricing within public services. General government expenditure fell from around 48% to 43% of GDP in the 4 year period from 2003 and at the same time the share of public sector employment fell from 34% to 30%. Inflation over this timeframe has also been reduced.

The public debt to GDP ratio is down to 63% and the budget deficit is estimated at 1.6%.

Unemployment had been a longstanding structural problem for the Maltese economy in the years after independence and in the 1980s; low unemployment followed for much of the 1990s.The problem began to make itself felt at

the end of the decade, but fell to 6.2% by the end of 2007, the lowest level for 8 years according to the latest figures produced by the Central Bank of Malta.The government is seeking to provide more vocational training to cater for the industries migrating to the island, particularly airlines and computer companies.

This has been accomplished partly with changes to the unemployment benefit system, as payment has increasingly become contingent on a commitment to training.

Prime Minister Gonzi has claimed that the creation of 20,000 new jobs over the last four years is due to the effectiveness of austerity measures in promoting economic growth.

IN THE CLUB Membership of the euro has presented further means by which to enhance economic growth. According to the Central Bank, the eurozone was responsible for 54% of the merchandise imports and 35% of the merchandise exports of Malta; thus operating with a single currency will reduce costs and make the island even more attractive to foreign investment.The tourism industry also hopes to benefit from this change as it is expected that Malta will become a more attractive holiday destination to those in the euro area. Since joining the euro the Central Bank is less concerned about speculative attacks on the Maltese currency.

Sourcing renewable energy is an increasing concern in Malta, particularly in light of the increasing price of oil.The European Commission will oblige Malta to ensure that 10% of its energy comes from renewable sources by 2020. In a survey conducted by

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EU membership also, however, has down sides.

Since 2002, Malta has become a receptacle for illegal African migrants seeking entry to the EU. This is of growing concern to the Maltese people; their country may be the smallest in the EU, but it is also one of the most densely populated and thus an already struggling infrastructure has been put under further strain.The number of irregular immigrants landing in Malta since 2002 has averaged around 1500 per year. Despite an official detention policy for the first eighteen months, immigration has contributed to the emergence of a new far-right party in Malta, Azzjoni Nazzjonali (AN).

Governor Bonello still foresees many challenges ahead for Malta’s economy. In particular: fiscal consolidation, bridging the income gap with other members of the euro area and increasing incentives for R&D in the private sector. Malta has come a long way in a short space of time.The general election of 8 March 2008 saw the PN win a record third successive term, with 49.3% of the vote, although with a very slim majority of the votes cast. Its rival, the MLP, obtained 48.8%. Although 93% of the eligible population voted (slightly lower than the 96% that voted in 2003), the small parties did not fare well, with AN obtaining only 0.5% of the vote, and the Greens 1.3%.

The new government led by Dr Gonzi has pledged to continue the economic policies followed in the previous legislature, while enshrining the environment and sustainable development at their core. It is the government’s aim to achieve a budget surplus by 2010.

Netherlands

David Torstensson is a research fellow at the Stockholm Network.

Calm, consensual, and even corporatist in nature, the Dutch ‘poldermodel’ has come to epitomise a social and political system geared towards compromise, not confrontation. But the model, which some commentators trace to the communal spirit emanating from the country’s centuries long battle against flooding, has in recent years seemed to split at the seams. Indeed, during the 21st century Dutch politics have seemed more prone to convulsion and conflict than compromise.

Names such as Pim Fortuyn,Theo Van Gogh,Ayaan Hirsi Ali, Rita Verdonk and Geert Wilders and the conflict and violence associated with them are a growing part of Dutch politics. For policymaking this has had serious consequences.

PURPLE HAZE In 2002 the government of Wim Kok – the so-called Purple coalition – was voted out of power and the first in a series of governments under the leadership of Jan Peter Balkenende of the centre-right Christian Democrats (CDA ) was voted in. One cause of the Purple coalition’s electoral loss was the rise of the “Rotterdam Rottweiler” – Pim Fortuyn and his List Fortuyn party. In stark contrast to other contemporary mainstream political parties, Fortuyn’s personal style was abrasive and confrontational. The issues he chose to campaign on were deeply polarising: recent immigration, crime and the perceived ill effects of multiculturalism. While Pim Fortuyn never got the chance to compete in an election himself – he was shot and killed just before the 2002 contest – his party did become part of the short-lived centre-right coalition led by the CDA. The rise of the List Fortuyn marks an important juncture in Dutch politics and public policymaking. In effect, the Fortuyn phenomenon has opened up a can of political worms. Apart from the subsequent rise of various populist and nationalist political outfits like Geert Wilders and the PVV (Party for Freedom), this can of worms has also brought down a government and, with it, changed the public policy direction of the Netherlands as a whole.

CONFLICT The defection of the D66 – the traditional king and coalition maker in Dutch politics – from the second Balkenende government in June 2006 was precipitated by severe tensions between the then Minister for Integration and Immigration, Rita Verdonk, and Dutch MP Ayaan Hirsi Ali. While this was a long and very complex political stand-off, at heart of the conflict was how the issues of Dutch national identity and immigration should be treated

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within the political sphere.Verdonk had for some time campaigned and become identified with the politics of national identity – the Financial Times in 2006 even described her as the “chief heir to Fortuyn’s revolution”.

Whether or not this type of conflict and identity politics has fundamentally re-shaped the way Dutch politics and policymaking works – away from the compromising approach of the poldermodel – is debatable, but the immediate effect of this was a change of government.

During the period since the 2003 elections in which the D66 replaced the List Fortuyn in the CDA-led coalition, the centre-right government has moved away from a policy of welfare and health care reform to a sort of grand coalition stewardship between the CDA, the PvdA (Dutch Labour Party) and the ChristianUnion (a primarily religious party with a centre-left economic agenda). The 2003 coalition – what is called the Balkenende II government – began a process of liberal welfare and fiscal reform aimed at jumpstarting what had been a relatively flaccid economy.

Between 2000 and 2002 the Dutch economy plunged from a hefty 3.5% average growth per year to just over 1.5%. Certainly, a lot of this was due to the effects of the global downturn caused by the bursting of the dotcom bubble and 9/11, but the Dutch economy also suffered from some very serious structural faults. In particular, the proportion of people who were on disability benefit was a staggering 15% of the working-age population. This was a substantial bloc and certainly questioned the reliability of the official – and widely praised – low levels of unemployment. Balkenende II attempted to deal with these problems by cutting taxes, reducing the incentives for early retirement, reducing welfare benefits and reforming the provision of health care. Politically these reforms ended up being quite dangerous and the Prime Minister actually had to scale back his more

ambitious agenda in the face of widespread protests in 2004. But by the time of the most recent election, November 2006, Balkenende’s political fortunes had turned and he once again headed the biggest party and led the current fourth coalition.

As for the economy, the results of the Balkenende coalition’s reform programme have been mixed. According to the OECD’s most recent Economic Survey the Netherlands still suffers from a plethora of labour market overregulation and rigidness. Though the Balkenende governments have attempted to address some of these issues, such as the relative scarcity of workers over the age of 57 who remain active in the economy, reforms have been piecemeal and not farreaching enough.

For example, reforms to the taxation of a family’s second earner have also been slowly phased in to stimulate greater participation of women in the labour market. As the system works today, tax regulation provides families with the opportunity of transferring an annual €2000 tax credit from a nonearning family member to the primary earner.

While this would appear to be a fair policy, it has had the unintended consequence of discouraging a family’s second earner. This tax system also imposes a higher marginal tax rate for second earners through the reduction of housing and child benefits, consequently many people (often women) who wish to work fulltime are, in effect, discouraged to do so. The result is that the Netherlands has one of the highest rates of part-time employment in the world, yet the country’s average working time is one of the lowest in the OECD. One area in which some very big changes were introduced was in health care. Faced with a single-payer system that seemed not to be doing enough to limit medical inflation and deliver outstanding care, in January 2006 the Dutch Government completely revamped its existing system and a new, private insurance model was introduced. This model makes insurance mandatory for all citizens but also forces all insurance companies to offer insurance to all – not just the young and healthy. According to the Wall Street Journal, this new system has lowered the annual

increase in health care expenditure from 4.5% in 2006 to 3% for 2007. As for actual changes in the quality of health care, it is still too early to tell what effect the system has had. While critics have complained over the relative paucity in the number of insurers within this newly established market – questioning how much of a market it really is – these reforms are still a notable improvement in providing patients with more influence over their health care than what preceded them.

During the 21st century Dutch politics have seemed more prone to convulsion and conflict than compromise FRUSTRATING INCAPACITIES Despite the Balkenende government’s attempted cutbacks in social and welfare spending, incapacity benefit and long-term unemployment levels still remain relatively high. The reform package of the mid 2000s did not do enough to reduce the incentive for claiming disability benefits and deregulating the labour markets. Today, young people are able to easily claim disability benefits; compensation levels and duration for both unemployment and disability benefits are quite high; and it is very difficult and costly for employers to get rid of staff – a fact which works as a disincentive to hiring in the first place.

Overall the growth of the economy between 2002 and 2006 was very weak, at an annual rate of 1.4%. While growth has picked up in 2007, reaching 3.3% for the year, many analysts argue that this was a one-off and that from 2008 the economy will slow down markedly and again dip below an annual rate of 2%. If these predictions are borne out, what is the likelihood that the current Balkenende IV government will attempt to pass another reform package?

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In short, the chances are not high. As intimated above, the current coalition is an awkward embrace between the PvdA and the CDA, with the added flavour of a leftist Christian orthodox junior member. Both big parties were squeezed from the left and right in the 2006 elections – most notably the PvdA which lost a quarter of its seats and saw its rival Socialist Party become the country’s third largest. It will be very wary of attracting criticism from either of these flanks. At its formal inception in February last year, the new government made it quite clear it was easing restrictions on spending levels and increasing spending on social programmes as well as the environment. Much like Germany’s experience since 2005, the Netherlands are most likely entering a period of guarded stability in which few radical reforms will be embarked upon and a seemingly small political crisis could escalate and paralyse the government.

Apart from the economy, the most obvious political challenge Balkenende IV faces is the question of what to do with the EU Reform Treaty. The PvdA have made it clear that they are in favour of a national referendum, whereas both the CDA and ChristianUnion would prefer a parliamentary rubber stamp vote as a means of ratification. Whichever view prevails, it is clear that while Dutch politics may produce quite a lot of fireworks over the coming months and years, it is unlikely that government policy will be doing anything radically out of the ordinary. Further free market reform, it would seem, is currently off the cards.

Poland

/ Jaroslaw Górski is an economic expert at the Sobieski Institute in Warsaw.

Due to its rapid and determined implementation of political and economic reform after the collapse of the socialist regime in 1989, Poland soon became the unquestionable leader of the group of transitional countries in Central and Eastern Europe. Policy failures and derelictions in market reforms have resulted in a slowdown in the Polish economy which – combined with various political maelstroms – has led to the loss of development momentum. When proudly celebrating accession to the EU in May 2004, Poland was one of the least developed countries in Europe. A lot has changed in the past three years.

2007 brought Poland at least two meaningful events. Firstly, January was the last month of the 6 year period of Prof. Leszek Balcerowicz’s Presidency of the National Bank of Poland. It was Balcerowicz’s radical reforms which started the era of transition in Poland, resulting in the thorough modernisation of a socialist economy.

The end of Balcerowicz’s era is symbolic in that it highlights the struggles and controversies of transition. It is worth remembering that the need to transform the Polish national economy shaped the decisions made on Poland’s path to development.

Over 60% of Poles see a bright future for their country The second event had severe political ramifications. For the first time, people born after 1989 took part in national elections. So it is fair to say that from now on the political landscape will be decided by people who did not experience communist Poland. These young people have different political requirements and frames of reference, and this in turn could lead to a change of political class. The role of the young electorate was clearly visible in this year’s parliamentary elections, won by the liberal Civic Platform party (Platforma Obywatelska or PO) whose manifesto has an economic emphasis.

These two symbolic changes, with both political and economic significance, are summed up well

by Tomasz Teluk when he said that: “Poland is, after all, still waking up from the bad dream of socialism”.

THE POLISH ECONOMY – EXPANDING BUT LACKING REFORM Over the last year Poland’s GDP growth has reached almost 7%, exceeding even optimistic

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predictions. Unemployment has decreased to less than 10%, effectively cut in half from 2004. It is true that 10% is still too high, and there are other structural problems – as high unemployment among women, skill shortages in certain sectors and long term unemployment all come with serious consequences such as social exclusion.

The situation has improved but there remains a lot to be done. There is an obvious but unresolved lack of communication between the business and educational sectors which is crucial to harmonising the demand and supply side of the labour market. Moreover, there has been very limited progress toward creating a knowledge-based economy.

It was a good year for the workers, too: the average salary in Poland rose by over 8.6%.

Meanwhile, inflation did not exceed 2.5%.

Foreign direct investment during three quarters of 2007 came to a record €10.125 million (39% growth), while exports rose by 14% in the same time. Still, the trade deficit remains high. 2007 brought spectacular development of the Polish capital market, especially the stock exchange which has gained leadership in the region and attracts much investment from foreign markets. On the other hand, much needs addressing: though Polish domestic product rose by 6.7% (the average for the EU27 was 2.7%), Polish GDP per capita (in purchasing power parity) equals only 55% of the EU-27 average. Only the newcomers – Bulgaria and Romania – have lower GDP per capita. Although the Polish economy cannot compare to its developed EU neighbours, 2007 showed encouraging signs that it is robust and still dynamically growing, offering vast potential.

If supported with good economic policy, it can reach its long-term development goals.

ECONOMIC POLICY – primum non nocere When the Law and Justice Party (Prawo i SprawiedliwoÊç) won the 2005 elections, it did

integration with the EU and only 7% are against. This means that, since accession, the number of supporters has risen by 22%.

It is worth emphasising that Poland is one of very few countries that did not suffer post-accession shock, resulting in a reduction of support for membership.

not owe its success to any economic programme, but to promises of fighting corruption – in whatever form it existed.

Their economic programme was pushed into the background of a national debate on corruption, and thus many good economic ideas been lost in the turmoil of political infighting. It was the subsequent government, in fact, which did not reform public finance and only introduced minor tax changes. The issues most important to Polish businesses – high taxes, excessive labour costs and a lack of incentives for entrepreneurship and innovation – have simply been neglected.

The government’s strategy of “primum non nocere” (first, do no harm) masked a lack of interest in developing the competitiveness of Poland’s economy rather than from conscious choice. The economy’s successes can primarily be attributed to external macroeconomic factors and the microeconomic forces of Polish enterprises.

Despite the political challenges, 2007 was still a year of economic fulfillment, though the road was bumpy and the final results yet to be seen. The inability of Poland’s government to fulfill social expectations and the breakdown of the coalition with the SRP party (SelfDefence of the Republic of Poland or Samoobrona Rzeczpospolitej Polskiej and the League of Polish Families (LPR) led to early elections in October 2007. These were eventally won by Civic Platform (PO), who went on to construct a government with the Polish People’s Party (Polskie Stronnictwo Ludowe, or PSL). The elections were a manifestation of public expectations when it came to introducing stable, predictable and future-oriented politics.Very high voter turnout (54%) and the results of the election improved the social evaluation of democracy in Poland. The Polish people’s satisfaction with democracy in 2007 was the highest in history.

Moreover, the general social optimism at the beginning of 2008 was similar to the enthusiastic feelings at the beginning of the transition in Poland.

The 2007 elections were won by a party which promised its electorate an ‘economic miracle’. The Civic Platform’s key economic goals were thus: provide fast and sustainable

growth, decrease the rate of unemployment to the average EU level by 2012, cut taxes, further privatisation and to ensure the development of Poland’s infrastructure. Prime Minister Donald Tusk pointed to the ability of efficient and effective EU funds and attracting FDI as the core determinants in fulfilling those goals. Also pointing out the importance of a stable and peaceful political environment, he said: “In a market economy based on voluntary cooperation of citizens, trust is of first rank importance”. One cannot reliably say if all these promises are entirely feasible.

Particularly if that much-trumpeted trust is continuously disturbed by fierce strikes and wage-rise requests in the public sector (especially public health), which have not been handled well by the government.

EUROPEAN UNION – OUR UNION Poland’s entry to the Schengen zone which gives unrestricted access to travel across the EU was also very important to the Polish people. Further, the fact that Poland and Ukraine won the contest for hosting Euro 2012 was cause for huge celebration. It has become one of the most important issues of national debate as it not only gives spectacular chances of faster development and infrastructure improvement but also has become a source of anxiety – can our countries cope with this challenge? The balance of opportunities and threats is definitely positive, but the balance of our strenghts and weaknesses does not necessarily work out the same way – so far preparations have been sluggish.

2007 also saw huge improvement in the labour market, partially due to a wide emigration flow of Polish workers to other EU countries, alongside the battle of fighting corruption and controversial strikes in the public sector.

Poland’s relations with the rest of the world, particularly with reference to the EU, are never far from the headlines. After 3 years of Polish membership of the EU, there is a high approval rating and even growing support for membership. About 86% of Poles define themselves as supporters of Polish

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The three year period after accession has strengthened the conviction that membership of the EU brings many economic benefits.

Being in the EU would always have considerable impact on Poland’s position in Europe. As years go by, more and more citizens regard Poland as a country of medium and not minor significance in the EU (now it is 60%).This opinion is surely a result of determined (sometimes uncompromising) Polish foreign policy.This approach proved sound during negotiations on the Lisbon reform treaty, which was finally signed on the 13 December 2007. Poland lobbied for adding a declaration of the Christian roots of Europe to the preamble of the Treaty and tried to engineer a preferential rule for decision making in the EU Council. Poland’s intransigent standpoint used to be sneered at in Brussels, nevertheless it showed Polish negotiating power.

Poles entered 2008 with plenty of optimism.

Half of us believe that this year will be better for us and our families than 2007. Over 60% of Poles see a bright future for our country.

Six months after accession many surveyed Poles said that people similar to them usually lose out during the process of integration to the EU, but currently twice as many Poles agree they have personally benefitted from accession than disagree. Since accession, Poland has built up self-confidence – and the Polish stereotype is now one that is EU positive.

Portugal

André Azevedo Alves is the Director of Causa Liberal.

Following José Manuel Durão Barroso’s resignation from the post of Portuguese Prime Minister in order to become the European Commission President in 2004 and a short lived government led by Pedro Santana Lopes, the legislative elections in early 2005 provided an absolute majority in Parliament for the Socialist Party, which had been in opposition since 2002.

The new government, led by Prime Minister José Sócrates, took office on 12 March 2005 and established as a key economic priority the reduction of the budget deficit.The seriousness of the public finances’ disequilibria was emphasised by the findings of a government appointed commission, led by the Governor of the Bank of Portugal, that projected a 2005 budget deficit of close to 7% of GDP. Even though these findings were somewhat controversial and accusations of partisanship were levied against the Commission, the seriousness of the fiscal imbalances was generally recognised and it was in this context that the new executive, backed by the parliamentarian majority of the Socialist Party, set out a plan to cut the deficit to 3% in three years.

Among the most significant measures announced was an increase in several taxes.The VAT rate was raised from 19% to 21%, substantial increases were imposed on tobacco and fuel taxes and a new top income tax rate of 42% came into effect for individuals earning more than €60,000 per year. In addition to the increase in tax rates, a programme of aggressive tax collection was implemented with measures ranging from wider disclosure obligations for the financial system to heavier penalties for violation of tax laws. However, the increased aggressiveness of the tax administration authorities has prompted claims that taxpayers’ legal protection and due process are in some instances being sacrificed to the government’s pressing need to increase revenues quickly.

Increased taxation and more aggressive tax collection have been quite successful in driving up government revenue since 2005 and can be identified as the main driver behind the successful reduction of the budget deficit by the Socialist government. In 2007 – a year earlier than planned – the official budget deficit was within the promised 3% of GDP, prompting praise by the EU Commissioner for Economic and Monetary Affairs, Joaquin Almunia. It should, however, be noted that although there was some recent (and praiseworthy) reduction in the public expenditure as a percentage of GDP, the bulk of the reduction of the budget deficit was

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achieved through increased fiscal pressure on the Portuguese economy and some extraordinary measures. Growth of expenditure on civil servants’ pay has been successfully limited in recent years but social expenditure has unfortunately not followed the same pattern. Additionally, since 2009 will be an election year, it is likely that the electoral cycle will induce further pressures to increase public spending across the board.

Social security has been one of the most disappointing areas in terms of reform Increased tax pressure on the economy coupled with insufficient structural reform in several key areas (summarised below) can probably be identified as the main factors behind the sluggish economic growth rates Portugal has experienced in recent years.Yearly GDP growth has been consistently under 2% and inferior both to the EU and Eurozone averages, a fact that is highly problematic for an economy in dire need of economic growth.The government has managed to introduce some order in the public finances but has so far failed to implement the structural reforms necessary to unleash the potential for faster economic growth.

POWERFUL INCENTIVES = POLITICAL ACTION As far as public administration is concerned, the reform scenario is somewhat mixed. Some efforts were made to end the priviledged status and benefits of specific groups and sectors within public administration, with the fiscal necessity of limiting expenditure serving as a powerful incentive for the government to curb some of these. A new system to evaluate the performance of civil service employees, public managers and departments (SIADAP – Sistema Integrado de Avaliação da Administração Pública) is being introduced but implementation has so far been relatively slow and cumbersome. In any case, it is too early to tell if the new performance assessment system will

the key weaknesses of the Portuguese economy with a large range of comparative indicators pointing to the extreme rigidity of the Portuguese labour market.The lack of flexibility discourages investment and employment and fosters the growth of informal and underground sectors of the economy.

The continuing restrictiveness of labour market regulation and sluggish economic growth are probably two of the key factors behind the continued rise in unemployment, now standing at around 8%, the highest rate in the last two decades for Portugal.

serve as a useful tool to promote efficiency and efficacy or merely add a new layer of unhelpful bureaucratic procedures to Portuguese public administration. Plans were also announced to rationalise ministries and departments and some cutbacks and reorganisation of structures have taken place, but the overall results have so far been insufficient to significantly reduce expenditure or promote wider efficiency gains for the economy as a whole. It is nevertheless worth mentioning that in terms of cutting the bureaucratic requirements imposed on the private sector some progress has been achieved through several reform initiatives.This is reflected, for example, in an improved position in the World Bank’s Doing Business overall ranking: from 42nd in 2007 to 37th in 2008.

The health sector has seen the continuation of reform efforts but structural problems of inefficiency and poor standards of service with the National Health Service (SNS – Serviço Nacional de Saúde) persist. An emblematic measure has been the closure of some health units and services, mostly in the interior of the country. Although defended by the government on grounds of promoting a more efficient use of existing resources and better standards of care, these measures faced stiff resistance from local populations and politicians and ultimately led to the resignation of the Minister of Health early in 2008. It remains to be seen what the future course of policy will be but it is highly unlikely that deeper reforms to introduce wider patient choice and promote a move towards a more market-oriented system will be implemented by the current government.

Additionally, very strong barriers to entry continue to prevent many prospective (and

highly needed) medical professionals (particularly doctors) from having access to a specialised education in that field, since the licensing process for new medical schools continues to be extremely restrictive. A similar situation can be seen with pharmacies, a sector that continues to be tightly controlled by incumbents and where freedom of entry is essentially denied by the government’s licensing process, despite some minor reforms.

In education, some reforms have been implemented to try to promote a more efficient management of public schools but basic mechanisms to allow parental choice continue to be absent. Given the stranglehold on the sector by teacher unions and bureaucrats at the Ministry of Education and the government’s ideological commitments it is unlikely that there will be scope for reform in the near future. At the University level, there are some ongoing institutional reforms and additional emphasis has been placed on the need for institutions to generate revenues; but tuition at public universities continues to be highly subsidised.

Social security has been one of the most disappointing areas in terms of reform.

Widely acknowledged financial problems and an ageing population provide a window of opportunity to enact significant reform on the existing pay-as-you-go system, but the strategy has been to make cuts in benefits (particularly future benefits) without allowing a greater degree of choice or mechanisms to opt out (not even partially) of the system.

Also disappointing has been the lack of significant labour market reform.This is one of

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The state-owned Caixa Geral de Depósitos (CGD) continues to play a prominent role in the financial system, as the country’s largest financial group and a very influential player in the economy through the allocation of credit and direct participations in other enterprises.

A recent crisis in Portugal’s largest private bank – Banco Comercial Português (BCP) – culminated with the CEO of CGD moving to become the new CEO of BCP, a move that prompted some of the opposition to criticise the Socialist government for further politicising the financial system.

In the media sector, the state also continues to play a significant role through heavily subsidised state-owned television and radio channels.

In 2005 a new regulatory body – Entidade Reguladora para a Comunicação Social (ERC) – was created with powers to supervise both public and private media; some of its interventions, particularly when dealing with newspapers, have generated accusations of undue restrictions to the freedom of the press.

Overall, in recent years, the reform efforts in Portugal can be characterised as mostly focused on the reduction of the budget deficit.

The government has made important progress towards this key objective, although this was achieved mainly through increased tax pressure.

The broader picture in terms of structural reforms is less encouraging, with limited breakthroughs despite positive measures in some areas. In the financial and media sectors there are continuing reasons for concern in relation to the influence of state institutions.

The recent Portuguese experience can perhaps best be summarised as one of trying at all costs to keep a burdensome social model while introducing only very limited structural reforms.

Romania

Horia Terpe is a PhD student at the National School of Political Studies and Public Administration and Executive Director of the Center for Institutional Analysis and Development.

After Romania’s EU accession on 1 January 2007, the country took a very intricate path and registered a rather mixed record of economic liberalisation and political reform. On the one side, seven previous years of continuous economic growth (averaging circa 5% annually), as well as corresponding quantitative and qualitative improvements in the consumption and information patterns of Romanians managed to improve the economic situation at a surprising pace.The population’s desire to catch up has boosted expectations and unleashed creative energies into expanding markets, producing significant advances in areas such as culture and lifestyle. On the other hand, the political and public administration systems, as well as the policies which they were pursuing, lagged behind.The reform process took an encouraging step at the beginning of the present electoral cycle (2004–2007), but slowed down in 2006 and 2007 and has now come to a complete stop.

The centre-right party’s coming to power in December 2004, combined with increased domestic and foreign pressures for reform (the latter largely arising from the EU accession conditions) gave market reforms momentum throughout 2005. Important reforms were made and the signs were positive, but there was also a failure to address several key problems.The core reform of introducing a flat tax was passed in the last few days of December 2004, and enacted at the beginning of January 2005.The overall impact of this reform has unfortunately been dampened by external factors, such as the shortcomings of the rest of the fiscal system – Romania has the second highest number of taxes in Europe.

Despite the promising start, just over a month after joining the European Union, Romania was already in the midst of a profound political crisis.

The plot reads like a political thriller: the Prime Minister, Calin Popescu Tariceanu, attempted to work his way out of a web of lies he had woven to protect his former business partner and employer, oil tycoon Dinu Patriciu, from the justice system. Patriciu’s troubles evolved out of an anti-corruption campaign thought up by the country’s president,Traian Basescu, who had signalled his intention to continue the reform process and the dismantling of the oligarchy.

Irrespective of his reasons, foremost of which was to maintain his electoral position, his determination to confront the oligarchy head on at the very moment when everybody expected a non-confrontational approach has produced a deep internal crisis.This turn of events has prompted a power struggle driven by the emergence of a coalition of political parties and oligarchs aimed at impeaching and removing President Basescu.

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After purging his adversaries from the National Liberal Party, the Prime Minister continued by excluding its coalition partner and former ally, the Democrat Party, from the cabinet, at the end of 2006. By doing this, the DA (‘YES’) Alliance – the winning coalition in 2004 – was abolished. In its place, the Prime Minister chose to rely upon an informal parliamentary majority.

This reliance brought the Cabinet vital political support from part of the Social-Democrat Party, the Democrat Union of Hungarians from Romania, the nationalist Great Romania Party and the Conservative Party, in return for political concessions to those parties.The change of majority was carried out without respect to due process; they avoided subjecting the new government to a parliamentary vote.

The Prime Minister’s strategy has become clear: to maximise the length of PNL’s time in power at all costs.

The Prime Minister’s strategy has become clear: to maximise the length of PNL’s time in power at all costs The collusion of these parties against President Basescu culminated with a successful vote of impeachment (322 MPs in favour of impeachment to 108 against), the procedure was only stopped in its final phase when subjected to a popular referendum (74% rejecting the impeachment).The antipresidential coalition took the vote lightly and tried to disguise and confuse its meaning;

the startling fact remains, however, that the parliamentary majority illegitimately tried to impose its will on the people.

Despite the vote, the political crisis deepened.

In this unprecedented situation, the ad hoc anti-presidential coalition could only resist by pillaging the budget to buy expansive political support from any willing supplier, increasing taxation by demanding sizable new contributions, whilst ignoring all accusations of corruption – in one case, the Minister of Agriculture resigned after being filmed receiving a bribe in a restaurant.

WAR RAGES ON As political war rages, reforms have been stalled and even reversed.Yet, the political battle has at least two important and positive effects.

The most immediate one is that it aids the painful process of political clarification. Its first result is the unification of the political right: the group of adversaries which PM Calin Popescu-Tariceanu excluded from the PNL in 2006, who later formed the Liberal-Democrat Party (scoring 8% at the European elections on May 13, an astounding result for a party which was only six months old), merged with the Democrat Party (also excluded from the government) and formed the new DemocratLiberal Party.The merger and the disastrous administration of the National Liberal Party has propelled it to being the clear favourite at the next elections, which will take place in November 2008.

Beyond political clarification, the second effect is surprising: the ongoing noisy political crisis reveals and exposes an underlying and much deeper institutional crisis – the Constitution.

Much of the legislation and the public system has been publicly exposed as being profoundly dysfunctional.

The political battles (several of them carried out in the Constitutional Court), demonstrated that most of the political crisis has in fact derived from the flaws, shortcomings and biases of the Constitutional text – reiterating a diagnosis made by the Center for Institutional Analysis and Development in June 2006.The split between parliamentarism and presidentialism, aggravated by the division of the executive power between the President and the Prime Minister, is a continuous source of conflict.

Two further instances of the institutional crisis should also be examined.The legislation and the administration present familiar symptoms.

Faced with structural problems and widespread corruption, the broken machinery reacts by inflating the number of laws.The growth of the state in terms of legislation is illustrated by the fact that 7,552 new laws were passed in 2006 and 4,816 in 2007.Their quality aside, a uniform and correct application of the total 71,529 Romanian laws is a fantasy. As one may expect, the effect of mushrooming low-quality regulation is general confusion, disrespect for the law and eventually non-compliance.

The administration is thus in a surprisigly deplorable state for an EU member. A general lack of transparency along with ambiguous, redundant and even illegitimate purposes annihilate the chances public institutions might have had to perform efficiently. Current budgetary policy enables public money to go from those who are economically productive to those who are sufficiently skilful at playing the welfare game.The public sector has increased in 2007 by 3.6% of GDP (from 32.8% in 2006 to 36.4% in 2007) although some analysts claim it could have increased by 12.4%, the total solicited by public institutions for 2007 being 45% of GDP. For 2008, the budgetary plan envisions an expenditure of 42% of GDP, an increase in public spending of 5.6%.

To sum up, Romania seems to be in a paradoxical situation. On the one hand, it has an apparently flourishing economy, and, on the other, it is experiencing a profound political and institutional crisis.That leads, in the end, to

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an increased gap between how people perceive the government’s competence and how the politicians and public administration actually behave.This is due to the incompatible directions in which the two evolved: with the people aspiring to prosperity and modernisation, and the political and institutional systems driving in the opposite direction.

Slovakia

Richard Durana is the Director of INESS – The Institute of Economic and Social Studies, Slovakia.

After almost 50 years of central planning, the Slovak economy turned into a market economy two decades ago.A multitude of pro-market reforms were accomplished. Living standards were rising, and fiery policy debates were cooled thanks to a reasonable pro-market approach. However, despite this excellent progress and empirical evidence showing the benefits of less state intervention, paternalism is once again thriving and recent history in Slovakia shows that pro-market ideology has not won the day.

In 2006, SMER (the Social Democrat political party) won national elections and formed a coalition with the Slovak Nationalist Party and Movement for Democratic Slovakia. Prime Minister Robert Fico, a leader of the Social Democrats, who is recognised for his leftist orientation, immediately announced the reversal of key reforms. Since Robert Fico is the leading ideological influence in SMER, one can ascribe the main steps in the deconstruction of the pillars of Slovak economic success to him.

Fortunately, the prospect of joining the Euro zone keeps government from larger spending and assures fiscal responsibility via fulfillment of the Maastricht criteria.

To illustrate Fico’s recent reversal of successful reforms, it is valuable to revisit the key reforms and the potential impact of the new government’s modifications. Despite many personal tensions in Mikulás Dzurinda’s governments between 1998 and 2006, his terms are acknowledged as making the most significant improvements in Slovakia’s recent political and economic situation. Many pro-market reforms were adopted by his cabinets, reforms that not only put Slovakia on the map for foreign investors and created the entrepreneurial environment and legal conditions which caused Slovakia to be dubbed the ‘central European tiger’, but reforms which also improved the everyday life of our citizens and diminished Slovakia’s biggest problem – unemployment.

Apart from stabilising the banks, Dzurinda’s government also privatised shares in strategic companies, which created the conditions for more efficient operations and increased investment. After being re-elected in 2002, the government continued in this vein.The introduction of a flat 19% tax rate and tax free dividends has attracted both foreign and local investment capital which capitalised on a cheap, skilled work force. Between 2002 and 2007 the average annual GDP growth was 6.4%, which resulted in Slovakia ranking top of the OECD countries. Unemployment fell from 18.5% in 2002 to 11.1% in 2007.The reformist

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government also consolidated its deficit and debt. A reform of the pension system, which introduced private pension funds and a structural reform of national health care provided solid ground for the control of growing implicit and explicit debts.

The measures approved by the Slovak government are undermining the driving forces of Slovak’s economic successes in recent years The pension reform represented a seismic change. Mandatory payments towards retirement savings are divided equally between the PAYGO pillar, which provides funds for the provision of current pensions, and the individuals’ accounts in pension management companies (private institutions under state supervision). Although the savers are not able to use these funds freely until they reach retirement age, such finances remain their property and can be inherited. Accumulation of funds in the pension accounts establishes a capital base that can then be invested in domestic and foreign capital and money markets.This reform was very well received by the general public and the number of entrants into the second pillar highly surpassed expectations. Almost one third of the whole population chose a pension management company to handle their money. Within three years 50 billion Slovak Crowns (€1.5 billion) had been transferred into private accounts.

In 2007, savings grew by 1.3% of GDP. The success of this reform was not convincing enough for Fico’s government, however. It attacked the principle of the reform and despite

were not completed and there still exist considerable drawbacks, such as a large portion of drug expenses on overall expenditures and 100% coverage from public funds.

the absence of real analysis or a viable alternative, it has changed the conditions for saving ,so that savers over the age of 45 are now forced to leave the second ‘capital’ pillar and bring their money back to the PAYGO system.This change was accompanied by a government campaign focused on discrediting private saving companies.

Changes in the Labour Code under the previous government brought about a significant improvement of the labour market’s flexibility.The changes provided for flexible work-time, flexible part-time contracts, simplified layoff conditions, and weakened the role and power of trade unions.

Despite a significant reduction in the unemployment rate and improvements in the labour market (the average real wage grew by 3% in the last two years), Fico’s government decided to make substantial changes in the labour code last year.The government deemed employees to be insufficiently protected and the labour code to be excessively liberal.

The decision was also a result of pre-election co-operation and the support of trade unions.

After a long legislation process accompanied by continuous input from employers’ unions and the general public, various changes were adopted that strengthened the trade unions’ position and limited employers’ rights.

The changes made for higher employer costs and reduced flexibility in the labour market.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.

A TAXING ISSUE Perhaps the most important of the recent pro-market reforms was the complex tax code reform. Apart from significant simplification of tax legislation, it also established the so-called ‘flat tax rate’ (despite its name, thanks to the deductible item the effective tax rate still remains a progressive one).VAT rates and income tax for individuals and corporations were set at 19 %.

An important part of the tax reform was the cancellation of the dividend tax, which eliminated double taxation of capital revenues.

This way, attractive conditions were created in Slovakia for capital-intensive production.

However, it has to be added that the general tax burden was not reduced, since in the first year after the ‘radical’ tax reform, tax revenues increased by 19%! Some direct tax rates were lowered, but indirect tax rates increased dramatically.

Nevertheless, prior to being elected, Fico announced a radical reversal of the changes to the tax code. He said rich people should pay more, as if they did not already.Tax payments from people with below-average wages made up 11% of total income tax revenues; an even more illustrative example: the richest 10% accounted for 50% of overall income tax revenues. Fortunately, despite his pre-election rhetoric, Fico’s government has not made substantial changes to the tax system. By reducing deductibles, it introduced the so-called millionaire taxation, which, in contrast to its name, will mainly affect the middle-class. A reduction of VAT from 19% to 10% for a handful of products such as books or medicines represents another flat tax system disturbance; however, this is a positive move since it decreases the tax burden.

The healthcare sector experienced important changes, too.The goal of the previous government was to introduce market-based legislation into this area.The former government successfully stopped the sector’s exponential debt growth, and introduced reform laws that redefined the healthcare system’s basic functions, together with the means of financing.The legal status of healthcare insurance companies changed from being public institutions to for-profit public companies with hard budgetary constraints, corporate governance, and solvency monitoring – which are not linked to public budgets. About a quarter of the hospitals were also transformed into corporations and allowed to make profits.The other substantial effect of the reform was the increased responsibility of the consumer for his own health via the introduction of user fees, higher co-payments on drugs, and co-payments for non compliance. Unfortunately, these reforms

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According to Fico’s pre-election rhetoric, healthcare reform was the most antisocial and unjust of all the reforms. Despite its unquestionable results in stopping debt creation, immediately after being elected in 2006 Fico abolished user fees. Further, he repeatedly attacked private health insurance companies for making profits out of mandatory healthcare contributions. However, no alternatives were introduced. In October 2007 parliament approved new legislation which nationalised the profits of health insurance companies (profit distribution to shareholders was prohibited).This step constituted a setback in the progress of Slovak healthcare, and was accompanied by massive protests from the general public (the largest ever healthcare petition), political opposition and unrest in the third sector. Recently, foreign investors in private health insurance companies announced their intention to sue the Slovak government for lost profits. Not only will this have a significant impact on the state budget, but it will also have a negative impact on future foreign investors’ decisions. Moreover, Slovak patients will not see better healthcare while Fico is in charge. A shortfall in capital, combined with perpetual attacks on private enterprises in healthcare, has shut the door on any substantial improvements.

Fico’s approach did not inspire optimism with regard to the economy last year.The measures approved by the Slovak leftist government are undermining the driving forces of Slovak’s economic successes in recent years.The effects of the government’s approach will only be fully felt in the coming years. We may only hope that experts, NGOs, the general public, and other European countries improving their business environment will generate enough pressure on the government to enable Slovakia to sustain its economic stability and further economic growth.

Slovenia

Mateja Jancar is the Director of Institut dr. Jozeta Pucnika.

In Slovenia’s short history as an EU member, the year 2007 has a special place.

The beginning was marked by an introduction of the euro and at the end of the year Slovenia (together with eight other new member states) became part of the Schengen area.The entire year was strongly marked by the preparations for 1 January 2008 when Slovenia took over the Presidency of the Council of the EU, the first among the new member states to do so.The centre-right coalition government led by the Prime Minister Janez Jan?a from the 2004 electionwinning Slovenian Democratic Party has embarked on a path of economic reform that will lead to a greater liberalisation and privatisation, limit public spending and enable greater competitiveness of the Slovenian economy which has been heavily burdened by taxes and social transfers.A number of reforms were carried through with considerable economic success. However, the end of 2007 brought high inflation rates (partly as a backlash against the introduction of the euro) which destabilised the government and brought to the surface considerable differences between the coalition partners, especially regarding, in the opinion of some government members, unnecessary privatisations of Slovenian Telekom and the largest Slovenian insurance company, the ownership of which is still largely in the hands of the state.

2007 – A VERY GOOD YEAR In spite of the politically turbulent end of the year, economic growth in 2007 remained strong.

GDP growth in the third quarter totalled 6.3%, slightly more than in the second quarter.The main factors of economic growth were still exports (export growth in the third quarter was one of the highest in the last ten years), and investment, although its contribution contracted somewhat.The growth of private and government consumption remained subdued despite a slight pick-up.

Investment remained the main driver of domestic consumption.The growth of private consumption increased gradually over 2007, but fell short of the 2006 figures. On the other hand, an improvement was shown in most shortterm indicators, which persisted at a significantly higher level than a year ago. Purchases of durable and semi-durable goods were on the rise, especially car sales.

The growth of value added stabilised at a high level. Favourable trends in market services continued, while the growth of value added in public services eased under the influence of developments in education and healthcare.

For the second year in a row, economic growth in Slovenia was approximately twice as high as the estimated growth in the euro area (2.6%).

The persistence of GDP growth at a high level in the third quarter and the preliminary data for the fourth quarter suggest that GDP growth in

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2007 will be higher than 5.8%.This is attributable to favourable export trends and higher than expected investment in construction. As trade with other EU countries accelerated, year-onyear growth of goods exports and goods imports picked up. Formal employment in 2007 was on the rise as well. Employment surged in construction and market services; it also increased substantially in manufacturing after declining for several years. Compared with November 2006, unemployment was down 13.3%.

Many positive achievements were damped by the fact that consumer prices increased by 5.6% in 2007.The inflation hike in 2007 that affected both Slovenia (from 2.8% to 5.6%) and other euro area countries (from 1.9% to 3.1%) was largely fuelled by higher prices of food and liquid fuels for transport and heating.The overall contribution of food price rises to inflation in Slovenia reached a high of 2.2% last year, compared with 0.7% in 2006. Liquid fuel prices contributed 0.9% to last year’s inflation (0.3% in 2006). In addition, the introduction of the euro at the beginning of 2007 is estimated to have added a further 0.3%.The fact that inflation was much higher in Slovenia than in other countries in the eurozone can, to a degree, be accounted for by lower competitiveness in the Slovenian market structure. High inflation gravely affected the lowest income section of the population and contributed greatly to the fall in popularity of the Government.

49.13% share to a strategic owner.The state sold its 49% share in the NKBM bank in November 2007 via an Initial Public Offer.

The withdrawal of the two parastatal funds – KAD (capital fund) and SOD (restitution fund) – from firm ownership is taking place gradually.

The number of companies listed on the two funds’ balance sheets decreased in 2004–2006 from 265 to 123 in the KAD and from 179 to 84 in the SOD. The sale of ownership shares should be carried out in an active and transparent manner but, as already mentioned, this has recently been a reason for much controversy within the Government coalition.

ECONOMIC REFORM ACCELERATES The favourable indicators were no doubt the result of the reform programme for achieving the Lisbon Strategy goals, which aim at an open internal market and competitiveness of the economy. By 30 April 2007, 17 of the 1,628 EU directives had still not been implemented and Slovenia’s transposition deficit totalled 1%. Slovenia has thus already achieved the new objective adopted at the Brussels European Council in March 2007.The country now ranks sixth in the EU together with Germany, Estonia, Cyprus, and Malta.

In spite of the politically turbulent end of the year, economic growth in 2007 remained strong Last year saw an expansion of the consumer protection network.The non-governmental European Consumer Centre was established in 2006. Slovenia has thus become part of a network of 25 European Consumer Centres operating in EU member states.The European Consumer Centres primarily offer assistance to consumers in asserting consumer rights vis-à-vis the providers of goods or services from other EU countries and provide general information about buying goods and services in the internal market to make the market more accessible to consumers.

It is evident from the main development documents that Slovenia is aware of the need to enhance the competitiveness of its industry.

The National Research and Development Programme 2006–2010 and the Programme of Measures to Promote Entrepreneurship and Competitiveness 2007–2013 both point to the areas that hold particularly high potential for Slovenia: (i) information and communication technologies; (ii) advanced (new) synthetic metal and non-metal materials and nanotechnologies; (iii) complex systems and innovative technologies; (iv) technologies for a sustainable economy and (v) health and life

sciences. However, the research activities at the universities and institutes in many cases still lack applicability and do not serve the needs of the economy; they are consequently largely dependent on state funding.

The internationalisation of the Slovenian economy is mostly accomplished through external trade flows and less through foreign direct investment (FDI). Compared with other EU countries, Slovenia has a higher import-export intensity and a lower intensity of inward and outward FDI. In 2000–2005, its inward and outward FDI as a share of GDP lagged behind the EU 25 average by more than 10 and more than 30 percentage points, respectively.

In 2005 the Government adopted the Programme for Stimulating the Internationalisation of Companies and for the Promotion of Foreign Direct Investment in 2005–2009.The measures and activities focused in particular on: (i) improving the supply of building land and industrial zones; (ii) systematically removing administrative barriers to investment (iii) reducing initial costs of a start-up investment to enable businesses to advance to high/medium technology and the creation of high-quality jobs and (iv) launching an assertive marketing campaign demonstrating Slovenia as a suitable FDI location.

Financial incentives for foreign investment allocated on the basis of public tenders reduce the initial costs of a start-up investment. Activities in the area of assertive marketing of Slovenia as a suitable FDI location were focused on attracting high-tech projects, after-sale services for multinational corporations and regional management centres of multinational corporations.

Advisory panels were appointed for four leading Slovenian companies (Telekom, Triglav Insurance Company, the NLB bank, and the NKBM bank) to prepare privatisation programmes for these firms. One of the most important transactions was the sale of the state-owned share in the Slovenian Steel Group in 2007.The shares of the Telekom were listed on the stock exchange in 2006 for the first time. At the end of August 2007, a public tender was issued for the sale of a

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Reforms in other fields have also been started and carried out to a greater or lesser degree since 2004 (e.g. tax reform, reform of higher education and of the public health system).

But as 2008 is an election year and reforms are not always enthusiastically accepted by the Slovenian public – indeed, they are often accompanied by a hostile media campaign professing the end of the welfare state – many of the planned reforms may not see the light of day in 2008 even though they might provide a much needed impetus to Slovenian social and economic life.

Spain

Fernando F. Navarrete Rojas is Director of Economics and Public Policy at FAES Foundation.

To talk about economic reform in Spain means, to a large extent, to talk about Europe.Well before Spain’s accession to the European Economic Community (EEC) in 1986, Europe had already acted as a catalyst for the great reforms considered as milestones in Spanish economic policy.When Spain was still outside the EEC, policies which aided the opening up of the economy were adopted.The signing of a Preferential Trade Agreement by Spain and the EEC in 1970 was the first step in cementing relations with a Europe that represented for Spaniards progress, freedom and improved economic welfare.What began as an opening of trade later turned into reforms of greater significance which affected Spain’s whole economic structure, thus making the dream of Spanish incorporation into the EEC a reality. In preparation for the accession and in the years that followed it, considerable effort was made to adopt the Community Acquis and the regulations of the Single European Market.

Reform in Spain accelerated greatly with the adoption of the single currency. Previously, economic reforms had been strongly reactive to processes already in operation, which had been accepted by Spain without its government fully or effectively taking part in their design and orientation. Now the euro challenge would mean that Spanish society and its leaders were going to adopt a very different attitude toward reforms.

The countries of the European Union were at a crossroads; the choice was whether or not to begin the necessary reforms in order to meet the convergence criteria established for the incorporation into Economic and Monetary Union.The starting point of the different countries was highly heterogeneous and in 1996 Spain was not one of the best positioned countries. In fact, opinion among Spaniards as well as foreigners, whether specialists or not, was that the task of meeting the eurozone criteria by 1998 was virtually impossible for Spain.

THE DRIVING FORCE OF REFORMS: 1996–2004 José María Aznar’s administration not only considered it possible, but essential, and went about convincing the Spanish public that the challenge was in fact within reach of their dynamic society, so long as they were willing to face it.The administration confidently carried out the necessary economic reforms to adjust the Spanish economy to meet the entry requirements. Most importantly, it managed to gather popular support in what came to be perceived as a great collective mission.This ambitious goal can be considered to be the most significant challenge since Spain’s transition to democracy. Indeed, it generated a wave of radical reforms that powered economic growth.

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The programme of reform sought to demonstrate that a different economic policy was possible.The increase of public expenditure was curbed, its allocation was rationalised, the sustainability of the pension system was ensured, public debt was reduced, privatisation processes of public companies were steadily continued, and market competition levels were significantly increased by means of liberalisation policies.

The adoption of the euro was followed by a long period of stability, prosperity and growth On 1 May 1998 in Brussels, Spain’s successful compliance with the single currency entry criteria was confirmed and many Spanish citizens were overjoyed at their collective success. In contrast, that very same day 100 years before, Spain had witnessed the collapse of its empire with the defeat of its fleet by the US Navy at the Battle of Manila Bay in the Philippines, which generated a collective loss of confidence and feeling of disappointment.

Thanks to the effort of Spanish society and strong leadership, Spain managed, for the first time, to initiate a new phase of the European project as a first-line founder member of the euro.The adoption of the euro was followed by a long period of stability, prosperity and growth.

The guarantee of macroeconomic stability provided by joining the eurozone created a more favourable and predictable economic

which is – relative to GDP – the highest among developed countries, in an international credit crisis.The worst thing is that the Spaniards have lost faith in their government’s economic policy which has increased unemployment and generated a relative loss of welfare compared to the rest of the member states as the latest Eurostat data shows.

setting in which doing business became more attractive and profitable. But the increase of macroeconomic stability and the structural reforms which were implemented can not by themselves fully explain the sudden emergence of companies, the unprecedented rate of employment creation, the attraction of immigration and, in short, the long phase of growth and welfare experienced in Spain after joining the euro.The additional explanation lies in the fact that the Spaniards recovered confidence in their capabilities to reach great collective goals.Together they were able to reach what very few people in 1996 believed feasible.

After adopting the euro the Spanish government continued to implement strong reformist economic policies, which provides an explanation for Spain’s higher rate of success in overcoming the international economic crisis caused by the bursting of the technology bubble, in contrast with those countries which proved they had a lower degree of commitment to the structural reform agenda.

This enabled the Spanish economy to maintain the rapid process of convergence towards the wealth levels of the richest countries of Europe. Spain enjoyed thereafter a more prominent role in the European policy making process, helping to create and implement subsequent European reform policies, such as the Lisbon Agenda.

The rise to power of Rodríguez Zapatero’s socialist government at the elections which took place three days after the terrorist train bombings of 11 March radically changed the reform scene in Spain.The 2004–2007 period witnessed the highest growth of the world economy and international trade in decades.

The economic legacy which the socialist government received was defined by an accelerating economy, strong rates of employment creation, decreasing unemployment rates, and balanced public accounts. In short, this economic legacy far outshone the ones received by previous governments. Had the socialist government continued with the reforms of the previous period, the Spanish economy would have been able to make good use of the ‘favourable winds’ of the world economy to make the final jump to the levels of per capita income of the richest

members of the EU. However, as with other policies – like foreign policy or counterterrorist policy – the socialist government decided to undertake a systematic ‘deconstruction’ of the previous programme of reforms and thereby squandered the legacy received.

In the economic sector, proactive reforms either fizzled out into inaction or were replaced with policies designed to reverse the changes made.The collective and integrating force which had been woken to achieve great national goals was replaced by inequality, privilege and market fragmentation. Many Spaniards looked once more with distrust to their fellow citizens in other regions as, for example, they were denied access to surplus water from the rivers.The previous decrease in taxes turned into burdensome tax pressure, exceeding 2.5% of GDP in the last four years.

Public expenditure spiralled, surpassing an average increase of 8% per year, and a strong assumption of budgetary commitments in the medium and long term were made.

The ‘deconstruction’ process of economic policy made its most dramatic turn with the rampant public interventionism carried out by the Economic Bureau of the President which, as if it were a sort of consulting company specialised in mergers and acquisitions, interfered with the activities of private economic agents.The arbitrary nature of this interventionism, which has generated a severe perception of legal uncertainty, has also caused deep suspicion, both nationally and internationally, towards the Spanish market and antitrust regulators.The takeover bid of the electric company Endesa has ended with a procedure against the Spanish Government for alleged infringement of EU law, not before the embarrassment of hearing the president of the antitrust Court advising the government to ignore the report officially approved by the institution presided by himself.

It is therefore not really surprising that with this evolution of economic policies, international investors have lost confidence in the Spanish economy, as can be seen by the recent decline in FDI.This has rendered the Spanish economy increasingly vulnerable when faced with having to finance an external deficit,

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As at other times in the past, the European Union offers the government winning the general elections on March 9 a powerful tool to recommence the reforms through the transposition of Directive 2006/123/EC on Services in the Internal Market.The full use of the potential offered by this Directive for the elimination of administrative barriers is a unique opportunity to relaunch market-oriented policies and re-establish market unity in a sector which amounts to 60% of Spanish GDP. If Rodriguez Zapatero, with the expression “bringing Spain close to the heart of Europe”, meant infecting Spain with the ‘eurosclerosis’ France and Germany are now painstakingly trying to get rid of by means of reform policies, we must unfortunately admit that, after four years in power, he has succeeded.

Sweden

Johnny Munkhammar is an entrepreneur in ideas. He is affiliated with several institutes and is the author of The Guide to Reform.

Sweden has developed rather well economically and socially during the past decade, due to waves of free-market reform.The current centre-right government is now launching further reforms, which focus mainly on the labour market.

In recent years, the ‘Swedish model’ has been internationally discussed as something to emulate.The definition of that term is unclear and tends to vary over time. In the 1960s, it sometimes referred to female liberation, and at other times to the rapid growth of the public sector. Lately, in an economic and political sense, it denotes the Swedish success story and attempts to explain why it happened. Like all countries, Sweden has legislation that works and legislation that doesn’t, and it is essential for other countries to emulate the policies that lead to success rather than the policies that create problems.

A brief look at history shows that from 1890 to 1950 Sweden had one of the world’s highest growth rates. During that long period of exceptional economic expansion, Sweden went from being one of Europe’s poorest nations to one of its wealthiest.This was largely a consequence of economic liberalisations in the 1850s and 1860s led by finance minister Johan August Gripenstedt.Total Swedish tax pressure – total tax revenues as a share of GDP – increased from below 10% of GDP in 1890 to only 20% of GDP in 1950 – lower than in the United States. In the early 20th century, Sweden was a country of innovators and entrepreneurs, like Alfred Nobel and Lars Magnus Ericsson.

The significance of that period is underlined by the fact that of the 50 largest Swedish companies today, only one has been founded after 1970 and most are about a century old. In the 1970s, Sweden began to experience serious economic problems.These were partly triggered by the oil crisis but had deeper roots and, by the end of that decade total tax pressure as a share of GDP had reached almost 50% of GDP. After 1968, there was a wave of new state intervention in the economy, with more market regulation, payment of subsidies to old companies and nationalisation of others. Inflation and unemployment soared and growth plummeted.

Then, from the late 1980s to mid-1990s there was a period of reform, first by the Social Democratic governments led by Ingvar Carlsson and then, in particular, by the centreright government of Carl Bildt. In the late 1980s, several product markets were deregulated, as were financial markets. A tax reform introduced

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broader tax bases and a top marginal tax rate of 50%, down from 80%. During the Bildt government of 1991 to 1994, state-owned companies were sold, inflation kept low, school choice introduced, product markets further deregulated, subsidies to housing cut, tax rates decreased and Swedish EU membership negotiated. In the mid-1990s, the Central Bank was granted independence and a fiscal framework for sound public finances was introduced. Growth levels picked up and have for ten years now been above the EU average.

Sweden became a centre for IT and telecoms business following deregulation of these industries, foreign trade almost doubled as a share of GDP and inflation remained low and public debt dropped.

FOUR HEADS BETTER THAN ONE? During the past decade, very little has happened in terms of reform. However, 2006 saw the election of a new four-party, centre-right coalition.This was remarkable since the parties were elected on the promise of change despite a growing economy.The key to their success lay in their emphasis on the one main area where serious problems persist – the labour market.

Though the official Eurostat figure of unemployment in 2006, 7.1%, did not seem too much of a cause for concern, many people who were unemployed were in fact hidden in other parts of the vast Swedish welfare system, labelled as early retired, on sick leave, or similar.

McKinsey Global Institute estimated Sweden’s real total unemployment rate to be between 15% and 17%.

During the past decade, very little has happened in terms of reform The four-party coalition government that took power in 2006 became the first government with a majority in Parliament for a quarter of a century. Previous governments always had to rely on support from smaller parties that were not in government.Their message in the election campaign was one of change, but modest change indeed – they promised to

preserve many features of the current economic and social model. Although the government had a somewhat bumpy start due to political scandals, they wasted no time in launching labour market reforms.They cut income taxes, with a focus on groups with low incomes, and cut payroll taxes. Unemployment benefits were made less generous, with additional decreases over time. Benefits in several other public social insurance systems like early retirement were also cut. Regulations for entrepreneurs are being simplified, but hiring and firing regulations are kept in place.

Analyses estimate that employment has risen by at least 100,000 persons so far, as a consequence of these reforms.

The four-party government – known as the Alliance – has also initiated reforms in a number of other areas. Seven state-owned companies are set to be sold to private owners, including famous brands like Absolut Vodka.The value of the state’s total ownership in 57 companies was estimated at some €80 billion in May 2007. In the health-care sector, a so-called ‘stop-law’, which prohibited public hospitals from receiving patients paying with private health care insurance, has been abolished.

Entrepreneurship is encouraged in health care, not least by directing capital to separate units within current public structures. Several large hospitals are under consideration to be sold to private owners. Public funding to welfare services has increased. Schools are undergoing a number of changes, and knowledge is to be the main aim in primary education.The tax pressure – still the highest in the EU – is being brought down, from 50% in 2006 to 48% this year and an estimated 47% in 2009.The surplus in the state’s budget beat all previous records in 2007, decreasing public debt sharply.

The government has also raised the Swedish profile in foreign and EU affairs.The nation’s foreign policy has become activist and aims to contribute to peace, liberty and reconciliation.

Foreign Minister Carl Bildt has a high profile internationally and Sweden has reinforced the transatlantic ties.The aim of its EU policy is to make Sweden a part of the core of the EU and contribute to further enlargement, free trade, completing the single market and improving the environment.

Sweden will be EU President in the second half of 2009, bringing to the fore key issues to Swedish voters. Immigration is being simplified.

The government does not intend to hold a referendum on the new EU Treaty.

A discussion about joining the euro is slowly being initiated – a majority voted ‘no’ in the 2003 referendum.

COULD DO BETTER… Economic freedom is closely related to prosperity – the higher degree of economic freedom, the higher GDP per capita. Before the period of massive state interventions 1965–1985, Sweden was mostly economically free, and subsequent reforms during the periods described during the past decades has again led to increasing economic freedom.

According to the 2008 Index of Economic Freedom, Sweden is number 27 in the world.

13 European countries have higher rankings than Sweden, including Germany and Belgium, showing that there is still work to be done.

Several of the ongoing reforms will lead to further improvements in economic freedom, which are bound to have further effects in terms of increased growth, employment and living standards.The steps are, however, quite limited, and the vast amount of labour market regulations will be left intact. Public spending is decreasing, but very slowly – and further decreasing it is not a stated aim of the government.

The Swedish government has received poor results in opinion polls. But the opposition, though currently riding high in those same polls, is in a poor state.The Social Democrats elected a new leader, Mona Sahlin, after the much-disliked Göran Persson.They lost the election in an economic upswing, yet they

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have not renewed their policies but continue to promise higher taxes and higher public benefits – policies of yesterday.They will not even consider a formal coalition with the two other leftist parties, the Left and the Greens, which means that the opposition alternative to the government is largely unknown. In fact, the current government has a great opportunity to reform and get re-elected in the next general election in 2010. Most reformist governments in the OECD have been re-elected, and this government looks to be following a similar path.They could probably do better with more substantial reforms and improved communication, but even as things stand, the election is theirs to lose.

United Kingdom

Susie Squire is Network Development Manager at the Stockholm Network.

Britain experienced a political sea change in 2007. Before last autumn, the New Labour government seemed to have won the day, with high approval ratings, generous spending on public services and a prosperous economy.Voters were feeling broadly satisfied, making it difficult for any opposition to be seriously considered. Britain’s GDP had grown by 2.8% in 2006, the Bank of England had been given its independence immediately after 1997’s election and, according to the Heritage Foundation’s Index of Economic Freedom, Britain ranked 3rd out of 41 countries in the European region for overall economic freedom.

That has quickly changed.The retirement from public office of Tony Blair has left the country unsure where Britain is heading. Although it may be argued that voters were ready for a change of leadership, some are now missing his charisma, and the security of an administration characterised by successful economic policy and popular ‘third way’ policies which appealed to middle-class voters. Meanwhile, some of his weak points appear to have tarnished his successor, including the Iraq war legacy and party funding scandals. Gordon Brown, the new Labour leader and Blair’s former chancellor, enjoyed a brief honeymoon period on entering office but, after threatening and then failing to call a snap election in October 2007, public opinion and the media have become more sceptical, opening the way for accusations of indecisiveness and opportunism from David Cameron’s Conservatives.

SENSE AND SENSIBILITIES One of the main battlegrounds for public approval has been tax. Direct taxes on income currently stand at 40%. In addition, further taxes include council tax (variable on area of residence but highest in London), capital gains tax (18%), inheritance tax (40%), and VAT (17.5%).

According to an Ernst and Young report, the overall tax burden is estimated to be 37.8% of GDP, rising to 38% by the year 2010.This is high, but not as high as countries such as Sweden, where people are broadly happy with their tax contributions. Why, then, are most Britons so aggravated by the amount of tax they pay? The key to the problem is the failure to improve public services, allied to the increase in tax and the general cost of living.Voters are finding it tough to accept paying more when they still have trouble getting a doctor’s appointment when they need to, when rubbish collections have been reduced to once a fortnight instead of once a week and when their pension doesn’t meet the cost of their heating bills.

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Britain’s public services have been struggling to cope for years, and, with the NHS (Britain’s taxfunded health care system) turning 60 this year, it was time for reflection.The British public have long lost sight of the fact that the NHS was originally founded as a source of primary care only, not intended for the type of ‘cradle to grave’ dependence to which most of the population have now come to feel entitled.

As a result of this expectation gap, and despite the Labour government pouring ever more money into the service, the last three years have been marked by increased rates of hospital infections and increased dissatisfaction on the part of both patients and professionals.The fact that the NHS is no longer ‘fit for purpose’ has been for many Britons akin to being told the truth about Santa Claus; not altogether a surprise, but difficult to accept all the same.

Gordon Brown recently announced that the government would support the increased use of polyclinics – doing away with the one GP per surgery approach.This specialised approach to healthcare may be more effective but yet another re-organisation will come at a practical as well as a financial price.This comes as an even greater surprise when one considers that, whilst chancellor, Brown was said to perceive the Labour government’s huge investments in the NHS as wasteful and ineffective.

The Conservatives, by contrast, have offered little in the way of encouragement towards use of the private sector for healthcare provision; launching the ‘NH Yes’ campaign to encourage voters to ‘Stop Brown’s NHS cuts’. David Cameron has repeatedly pledged his support for the NHS – wise politically but a vow he might come to regret should he inherit an exhausted public service with deficits of £3.1 billion (€3.9 billion) come the next election.

Meanwhile, the public seems to be ignoring the rhetoric and, frustrated with long waiting times or lack of access to the latest medicines and treatment, they are turning to the private sector in ever greater numbers. Non-NHS health care

spending topped £5 billion (6.3 billion) in 2006 and a recent paper by the British think tank Reform reported that the average family is spending £1,200 on private healthcare on top of the £3,850 contributed annually to the NHS via tax.

As for pensions, in a recent study by Aon consultancy, UK pensioners were shown to be among the worst off in Europe in relative terms, receiving, on average, a state pension equivalent to only 30.8% of the average wage.

This figure is 39.9% in Germany, 51.2% in France, and a whopping 95.7% in Greece. But Britain faces the same demographic challenges as much of Europe with an ageing population that cannot continue to be supported out of public coffers. Britons could be getting a much better return on monies invested if the right incentives were provided to save for the future.

In the absence of Government support for the pensions system – both public and private, Britons are taking the initiative, investing either in property or tax-free savings accounts to provide income in their dotage. If the state pension is to be curtailed to prevent public budgets cracking under the strain of an elderly population, something must replace or, at least, supplement it. Greater incentives need to be provided to encourage everyone to save for their old age – including their long-term care.

THE BUSINESS OF BUSINESS… If healthcare and pensions are not functioning effectively, at least Britain’s business credentials may give the population something to smile about. Since Gordon Brown introduced tapering tax relief and other legislation designed to promote entrepreneurship, London has boomed as a financial hub – providing all the benefits of a European base, without the heavy tax burden and long lunch breaks. But the cost of living in the capital has risen by an average of 4.4%, the highest jump in 15 years, and many people have begun to feel all this financial success is not translating into tangible benefits for them. Many professionals are able to live in the Britain but claim ‘non domicile’ status, meaning they pay little or no tax to UK coffers, and yet enjoy all the benefits of residence.This has been changed, but the legislation remains messy and, in many cases, has succeeded only in pushing away highly skilled professionals to other, tax free destinations.

In reality, a large proportion of Britain’s revenue comes from the City of London – it constitutes almost a tenth of the economy and 30% of overall GDP growth.The fuel that is partly powering economic expansion, both in the City and across the UK, is the unprecedented levels of immigration, although the truth about immigrants is that they are hard to count and even the Government appears unable to say exactly how many are living in Britain.

Back in September 2007 the Home Office made the embarrassing mistake of saying that 800,000 migrants had entered the UK since 1997 when the national statistics body counted much closer to 1.5 million.This has been used

by certain factions of the British media to engender xenophobia – using incidents such as the bomb threat in London’s West End in February 2007 to stir up insecurity.The public pressure of such concerns has led the government to swing towards social conservatism; with Gordon Brown talking of ‘British jobs for British workers’.

and, symbolically, precipitating the first run on a high street bank since Victorian times.The Bank of England failed to act decisively enough, only guaranteeing all deposits after a damaging amount of time had elapsed.The Opposition jumped in and accused both the Prime Minister and his chancellor Alistair Darling of dithering and showing a weakness that almost led to a crisis of confidence in the UK banking sector as a whole.

Politicians and financial advisors alike will have to work very hard to ensure that when America sneezes, Britain doesn’t catch the flu

The example is instructive not just for the current state of the global economy but also because it shows how the UK has become accustomed to financial prosperity and economic stability. But as the credit crunch starts to bite in the US, Britain is beginning to feel the squeeze.The depleted availability of cheap credit, rising inflation and falling house prices will mean that politicians and financial advisors alike will have to work very hard to ensure that when America sneezes, Britain doesn’t catch the flu.

But many British workers could not be less interested in most British jobs. Large sectors of the economy that are powered by both skilled and unskilled labour are now occupied almost exclusively by immigrants from new EU accession countries such as Poland and Romania, and, in early 2007 the Treasury released information estimating that immigrants contribute up to 15% of overall economic growth. With the government revising its growth predictions in the latest budget down to under 2%, one would have thought the government would be encouraging all the growth drivers it can lay its hands on.

Until recently, UK economic growth has also been aided by sensible economic policies such as the granting of independence to the Bank of England. As the government played a less hands-on role in economic matters, the economy boomed.

Enter Northern Rock, however. Northern Rock was Britain’s third largest mortgage lender –it sold £3.3 billion in mortgages in the first half of 2007 alone. A fragile business model, dependent on the availability of funding from the wholesale money market led to the bank experiencing financial difficulties, panicking shareholders, investors and customers alike

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