Beyond the Borders

STOCKHOLM NETWORK

Beyond the bordersMarket-oriented reform outside the EU-25

From glacial, liberal Iceland to arid, tempestuousIsrael, and from alpine, cosseted Switzerland tobarren, bellicose Russia, this disparate selectionof countries is as diverse politically as they aregeographically. Many are attempting to moveaway from legacies of communist rule andSoviet dominance. Others are seeking to affirmtheir place among global economic leaders.Some seek membership of the EU, while othersreject all the principles for which it stands.

Yet not all is well.The region also containspugnacious dictators and pseudo-democracies,irredentist and secessionist rebellions.Partitions are being erected as others arebrought down.These pose great challenges,but could yield to greater opportunities.

These developments have external significancetoo. Successful reform in these countries couldprovide a new role model for others seekingprecedents to follow. Countries which lack thefinancial resources of the big western Europeannations will need to concoct more ingeniousplans to stave off similar crises as demographicchange threatens long standing welfarearrangements.War-ravaged states whereunemployment grips half the population willneed to find new ways to generate investmentand work. Nations long governed by dictatorsand despots will find themselves pressured todemocratise, and compelled to find ways toachieve without succumbing to corruption ornationalist dogma. If they thrive, as well asproviding the EU and the rest of the worldwith valuable new trading partners, they mayalso provide it with new models for how toenact their own reform agendas.

Greater benefits, though, will inevitably bederived by those inside reforming countries,as their personal freedoms and living standardsincrease. Developments in some of the subjectcountries have given impetus to this process,particularly with the much-heralded ‘colouredrevolutions’ in Georgia and the Ukraine.Whilesailing has not always been smooth, especially in the latter instance, the ability of the public to admonish its revolutionary heroes in ademocratic manner represents progress in itself.They are advances which leave authoritarianand undemocratic nations shorter of friends,and in an isolation which optimists will look to to spur peaceful transition to reform.

Pessimists, though, would cite acquiescentpopulations’ unwillingness to challenge themost assertive oppressors of freedom, andtheir reluctance to be weaned away from

comparatively generous state support systems,as signs that the public spectacle of reformconceals a demonstrably unchanged mentality.

European Union membership presents afurther point of division. Switzerland andNorway have both unambiguously rejected the possibility of acceding in the near future.They are content to maintain their free-tradingrelationship with the EU, without seeing fundsslipping away to Brussels through contributions.Meanwhile, for countries such as Turkey andCroatia, prospective entry dominates thepolitical agenda as they attempt to coalescewith European laws and norms.

Some within these countries, however, expressconcern about whether EU entry, and themore stringent regulatory system this implies,will mean sacrificing what progress has beenmade by the reformist movements. Afterescaping years of economic constriction due to communism, the prospect of volunteeringfor the same fate from Brussels has causedsome disquiet.These concerns may bealleviated by the advantages granted by freeaccess to a much larger trading market, and thepotential economic boom this could generate.

What this collection of essays reveals morethan anything, is that despite the ostensibledifferences between the various participatingcountries, many of the challenges they face are similar. Quandaries of demography, ofoverwhelming public service costs, of politicalliberty apply across the board.The ways inwhich they are addressed, however, is indicativeof the great divergence of approaches to befound. A great deal is occurring beyond theborders of the EU. It should not be neglected.

Simon MooreEditorApril 2006

Introduction

BEYOND THE BORDERS PAGE 1

On a continent that has come to be so dominated politicallyby the EU, it is easy to forget that there are almost as manycountries beyond its borders as there are within.Yet in theseoft-overlooked nations, some of the most profound andmeaningful reform in Europe is occurring.

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0 2.5 3 3.5 4 4.5 5 5.5 6

3

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WORLD ECONOMIC FORUM GREATER

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AER

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Albania

Bosn

ia

Bulga

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atia

Icelan

d

Israe

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Maced

onia

Moldov

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Norway

Roman

ia

Switz

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Turke

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Ukraine

USA

Franc

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Chad

Slova

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Georgi

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Russi

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The table below combines data from two annual economic reports, the first assessingeconomic freedom, and the second assessing competitiveness. Produced by the HeritageFoundation/Wall Street Journal and the World Economic Forum respectively, the formerstudy reflects the efficiency of a state’s inner workings, while the latter examines its relativeperformance in global markets.While not being a scientific comparison, it provides a usefulat-a-glance view of the progress made by the countries of this report.

SourcesWorld Heritage Foundation/Wall Street Journal Index of Economic Freedom 2006 – http://www.heritage.org/research/features/indexWorld Economic Forum Comptitiveness Index rankings 2005http://www.weforum.org

Economic Freedom vs CompetitivenessIndex Scores

PAGE 2 THE STOCKHOLM NETWORK

1st125th 100th 75th 50th 25th

125th

100th

75th

50th

25th

1st

WORLD RANKING GREATER ECONOMIC FREEDOM

SSENE

VITI

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Albania

Bosn

ia

Bulga

ria

Croati

a

Georgi

a

Icelan

d

Israe

l

Maced

onia

Moldov

a

Norway

Roman

ia

Russi

a

Switz

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d

Turke

y

Ukraine

USA

Franc

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Chad

Slova

kia

The following shows data from the same organisations, but ordered by world rankingrather than absolute score

Belarus not assessed by the World Economic Forum. Index of Economic Freedom score 4.11, ranked 151stSerbia and Montenegro not assessed by Index of Economic Freedom.World Economic Forum score 3.38, ranked 80th.

Economic Freedom and Competitiveness:World comparison


ADRI NURELLARI is a founder anddirector of the Albanian Liberal [email protected]

The intellectuals who had opposed the oldregime had disappeared in prisons or inforced labour camps long before.The westernworld, together with the population’s desirefor rapid change, influenced the newgovernment to expedite an economic strategyaimed at swift economic growth based on theso-called ‘Washington Consensus’, whichcomprises a set of neoliberal policies that havebeen advised by the Western-basedinternational financial institutions.

In the early stages of post communisttransition, inflation in Albania was kept low and GDP increased at one of the highest rates in Eastern Europe. Despite thedisadvantageous external pressure that camefrom the traditionally unstable SoutheastEuropean area, Albania remained out of theconflicts during the 90s. Unlike the othercountries of the region, Albania has a veryethnically homogenous population, with only2% in minority groups. From 1996 Albania hasbeen holding irregular elections which createdhighly contentious governments and gave wayto great political polarisation. Such polarisation,combined with the appearance of financialpyramid schemes, caused a popular uprising inMarch 1997 that soon degenerated into chaosand a public-order vacuum.This situation wasresolved only after military intervention by agroup of European countries. Although Albaniadid not suffer ethnic war, she needed theinternational community to come to her aid(just as in the neighbouring countries), tomediate disputes between Albanians.

The elections organised in the midst of theturbulence of 1997 gave a landslide victory to the Socialist Party, which comprehensivelywon the local elections as well.The return to power of the socialists begat a return togoverning by former communists and the halt of the reforms that were initiated by theDemocratic Party.The socialist governmentcreated a system of nepotism and clientelismthroughout the country.The events of 1997

Albania


Albania was the last among Eastern and Central Europeancountries to undertake a shift from communism todemocracy. It was a transition ultimately precipitated by theperilous economic state of the country, and spillover fromthe breakdown of other former communist countries.

During the 1980s, the Albanian economy hadfallen into sustained economic crisis, triggeringfood shortages which subjected the populationto malnutrition and fuelled general populardiscontent. Because of information coming intothe country, particularly from Italian television,Albanians could compare their standard ofliving with the west.They thus became awarethat statements about the supremacy ofcommunism were false.They developed ageneral cognisance that their system was aneconomic failure.This discontent manifested inriots that became gradually more frequent andviolent, forcing the government to acceptchange to a pluralistic system with democraticelections.This occurred despite the absence ofan Albanian dissident movement. Albania didnot possess the internal anticommunist under-pinnings that were present in Poland or Hungary,where communism was seen as imposed fromabroad. On the contrary, the regime constructedcommunism in Albania in symbiosis withnationalism, creating a mixed ideology thatbutressed Albania’s lengthy isolation.

Due to the inexperience of opposition partiesand the lack of political discontent, thecommunist party in power (the Party ofLabour, which would later become theSocialist Party) won the first democraticelections. In 1991 and 1992, there waseconomic collapse accompanied by anarchy.Popular discontent reached an apogee. Onlyan Italian humanitarian mission, ‘OperationPelican’ saved the country from famine.Thissituation forced new elections, held in March1992. More than 62% of the population,having lost confidence in the old rulers, votedfor the Democratic Party headed by SaliBerisha.The Democratic Party created agovernment comprised mostly of universitylecturers, inexperienced in politics, many ofwhom a short time before had beencommunists. At that time, only communistsand those close to them could access highereducation in Albania and obtain such positions.

The elections organised inthe midst of the turbulenceof 1997 gave a landslidevictory to the Socialist Party

decreased the expectations of the Albanianpopulation, which became more concernedabout security and safety and less sensitiveabout economic growth and the progress inthe process of democratisation.

International actors became very muchconcerned about the stability of Albania ratherthan with the progress of democratisation and economic reforms.The instability ofAlbania in 1997 was followed by riotingamong the Albanian population in Macedoniaand the beginning of the armed rebellion ofethnic Albanians in Kosovo. In order to receiveinternational support and legitimacy thesocialist government subscribed fully to theapproach of the EU and NATO in Kosovo. Inthe beginning of the Kosovan crisis, Albaniadiscouraged and obstructed fighters from theKosovo Liberation Army (KLA) but later, whenthe NATO bombing started, Albania gave fulllogistical support to both NATO and the KLA.The readiness of the socialist government todo whatever necessary to placate NATO andEU demands, combined with severity of thecrisis in the Balkans, granted the socialists afree hand in domestic policies.

Reforms were not only halted, but facedreversal. Most high-ranking officials in thesocialist party had stakes in the economy. Forinstance the former finance minister owned themain oil importer in Albania, and the formerminister of agriculture owned the main seedand fertiliser merchant.The administrationdeveloped into some sort of comprador élitethat aligned their interests with those of theirforeign trade partners while ignoring the needsand pressures of the country. The socialistpoliticians had a clear interest in maintaininghigh rates of imports because they possessedthe main importing companies.They thereforediscouraged domestic investments and createdan economic system dominated by oligopolies.

The general elections of 2001 coincided againwith ethnic turmoil in the region. Afterwitnessing how embarrassed the EU has beenin the past by failures in Balkan regionalstability, it is perhaps understandable that itshould now dominate their policy concerns.Hence, Albanian influences in former Yugoslaviahave shaped the relationship between theRepublic of Albania and international actors.The EU has consistently supported Albanianpolitical actors that have discouraged the riseof Albanian nationalism in the neighbouringcountries regardless of the domestic supportthat these actors have within Albania. In fact,the main interest of the EU in Albania has notbeen the development of democracy in thiscountry but the maintenance of an anti-nationalist approach towards their regionalcompatriots. As a consequence of this policythe EU has offered open support for different‘reliable’ political parties at different times,trying to finagle Albanian public support for

these parties. Even more concerningly, the EUhas recognised fraudulent elections as long asthey granted power to political parties thathad acquiesced to EU instruction regarding ‘theAlbanian question’. Such actions have seriouslycontributed to the slowdown and reversal ofthe process of democratisation in the countryand have increased mistrust amongst Albaniancitizens on the liberal democratic system.Because of the civil war in Macedonia, theloyalty of the Albanian government towardsWestern policies once more became veryimportant. As a result, the results of thegeneral elections of 2001 were officiallyinternationally recognised, even though theywere highly fraudulent.

Consequently the socialist received a secondmandate, and carried on with the anti-freemarket approach. Besides damaging thefreedom of the economy the socialistgovernment developed a highly corruptedsystem of governance, through the eight yearsof their governance Albania plunged morethan twenty places in the TransparencyInternational ranking of corruption in theworld. Law enforcement statistics undersocialist rule were almost 50% worse than inthe last year of the Democratic Party. Albaniabecame a haven for the trafficking of drugs,weapons, and people, and a prominentinternational money laundry.

These were the circumstances Albania founditself in prior to the 2005 general elections.TheAlbanian Democratic Party identified the highlevel of corruption and the damage done tothe free market, and made their correction thetwo main priorities of the campaign and of theelectoral platform that this party put forward.The campaigns for the parliamentary electionsof 2005 were particularly imbalanced, as onone side there were the Socialist Partycandidates who spent a great amount ofmoney (it is estimated that about €60 millionwere spent in campaigning), had access to themedia and could commandeer state owned

facilities and logistics. On the other side wasthe Democratic Party with little funding andlimited access to the media.

Nevertheless, the Democratic Party won theelections and built a coalition government withother right wing parties.The new governmentof Sali Berisha was formed in accordance withthe classical liberal principles that werecampaigned before the elections.The newgovernment reduced the number of ministriesfrom 18 to 14, looking to create a smallergovernment. Continuing this approach, the newgovernment undertook a restructuring of thepublic administration and cut 30% of the sizeof the administration as well as 25% ofgovernmental operative expenditures.Twoweeks after it came to power, the newgovernment reduced taxes for small andmedium sized businesses by 50% and disclosedthe plans to minimise income and corporatetaxes within a year. Moreover, the newgovernment undertook an aggressivedevolution process to simplify and reduce theadministrative procedures concerning openingand running businesses. From a minimum of 40days that were required to be spent in thelabyrinths of state bureaucracy, a business cannow be registered in a maximum of 8 daysunder a ‘one stop shop’ format. Anotherpriority of the democratic government hasbeen the formalisation of the economy andcreating a legal legitimacy for the scores of‘informal’ buildings that have been constructedin Albania during the last decade. Furthermore,Berisha’s government started a policy of zerotolerance against crimes and monopolies, andhas been resolute in dismantling theconsolidated networks of crime and economicmonopolies. It is because of the progressachieved within such a short time, that Albaniajoined the EU in a Stabilisation and AssociationAgreement in February 2006.


SIMON MOORE is a researchofficer at the Stockholm [email protected]

accounts for more than 95% of industrialoutput. Furthermore, government has acquiredcontrol over pricing and management of‘private’ enterprise. Business regulations changeswiftly, with little coherent pattern to thealternations, and new laws are often appliedretroactively so that businessmen can be (andfrequently are) arrested for breaking laws thatdid not exist at the time. Indeed businessmenand factory owners are generally perceived asdisruptive, threatening to the state and thePresident, and often end up behind bars.

A similar fate awaits most of those politicianswho speak out against the president. InDecember 2004, politician Mikhail Marinichbecame the latest in a long string of arrestedopponents, ostensibly for ‘stealing officeequipment’. At the 2005 referenda andelections, scores of exit-pollsters were locked up in a move decried by oppositioncampaigners. All of Belarus’ judges areappointed by the President. Latterly, anotherlaw was passed hardening penalties for thosefound guilty of ‘inciting demonstration’ ordistributing information deemed harmful tonational interests or defamatory to thepresident.This arrived in anticipation of the2006 election.

What little output Belarus produces is mostlybought by Russia, the only nation with whichBelarus enjoys a friendly relationship.Lukashenko is highly loyal towards Russia, andin recent times is being increasingly rewardedfor this stance, as other former Russian alliessuch as the Ukraine and Georgia turn theirattention westward. Russia purchases goodsfrom Belarus despite their uncompetitiveprices, and rewards it with discounts onimported goods, particularly energy (duringthe gas crisis of January 2006 Belarus was theonly nation exempt from Russia raising energyprices by 25% or more). Indeed, in December1999 the two countries agreed to form a two-state union aiding greater political andeconomic integration, although as yet little

Belarus


Belarus is the last surviving dictatorship in Europe, a basket-case of a country with its dictator crushing what little is leftof personal liberty beneath his iron fist. Private enterprise isvirtually non-existent, and government interference iscommonplace. As a result, foreign investors have littleinterest in the country.

The aforementioned dictator, the‘democratically elected’ President AlexanderLukashenko came to power in the wake of thebreak up of the USSR. Having been elected in1994 with a sizable majority, he pushed throughreferenda that could be quaintly described as‘rigged’ to consolidate almost all power with thepresidency.The referendum that passed in 2004to remove the two-term limit on his power,described by international observers as “vastlyfraudulent,” accompanied a parliamentaryelection where Lukashenko’s party won everyseat. His ‘re-election’ in March 2006 was metwith what is becoming standard internationalcriticism, but any prospect of a repetition of the‘coloured revolutions’ seen in Georgia and theUkraine seemed little more than unrealisticoptimism on behalf on the west. In theaftermath of the vote, sanctions, including travelbans and asset freezing, were raised by the EUand the USA against members of theBelarusian government. Nevertheless, mostindependent observers also conceded that hadthe election been free, Lukashenko wouldprobably still have carried the popular vote.How much of this can be put down to thetight governmental controls on media andopposition activity in open to much dispute.

In 1995, Lukashenko launched a programmeof so-called ‘market socialism’.The purpose of the ‘market’ part of this term has yet tobecome clear ; indeed, at various points overthe last 10 years, the KGB has been used to‘impose order on the market’.This is about as far from laissez faire as it gets.The statecontrols over 80% of the economy, and

What little output Belarusproduces is mostly boughtby Russia, the only nationwith which Belarus enjoys a friendly relationship.

practical implementation has come of it.However, this may provide clues as to the finalresting place of Belarus, as reuniting with Russiawould make both political and economicsense. However, Lukashenko’s predictably fiercepatriotism leads him to believe they cancombine in a ‘union of equals’ – somethingMoscow would never countenance.

Other problems bedevil the nation, but all arederived from the poverty and repressioninstilled by its rulers. In 1997, PresidentLukashenko announced the revival of theSoviet tradition of ‘subbotniks,’ weekend unpaidmandatory labour. Since 1998 food has beenrationed, a catastrophic development in apeacetime Europe.

International agencies have taken anassortment of steps against the country. InNovember of 2004, the United Statesimposed sanctions on Belarus, condemningthe electoral malpractice.The Act, passedunanimously by Congress, forbids US federalagencies from sending money into Minsk andcalls for assistance of non-governmentalorganisations dedicated to the peacefuloverthrow of the present regime.The EU andits members have at various times withdrawnofficials in protest at an array of Belarusianactions, including the expulsion of inspectorsfrom the OSCE (Organisation for Securityand Cooperation in Europe).The EU has alsomaintained for a number of years acomprehensive travel ban on seniorgovernment figures.

Belarus has demonstrated reasonable growthnumbers over the past couple of yearsregistering 6.4 and 7.8% in 2004 and ’05,sustained principally by Russia importingmachinery from Belarus at prices well abovethe market rate. However, mammoth inflationrates (between 1995 and 2004 the averagerate was 27%) and cataclysmic trade deficitsnegate any possibility of positive economicdevelopment.The grand redistributive intent ofthe state has left the country with possibly themost equally distributed wealth in the world –rendering everybody equally impoverished.

Freedom House assigned Belarus its lowestrating (‘not free’) in its most recentassessment. It was particularly critical of thelevels of press freedom within Belarus, inaddition to the other problems alreadyoutlined.The state has persistently haranguedindependent media outlets, and ultimatelyclosed most of them down. In the meantimeit uses state-run newspapers and televisionchannels to broadcast pro-governmentpropaganda, especially, although by no meansexclusively, during ‘election’ and referendumcampaigns.

Worse still, the Heritage Foundation ranksBelarus 151st of 157 countries assessed givingit the ranking of ‘repressed’, placing it marginally

above such luminaries as North Korea, Iran,Burma, Zimbabwe, Libya and Venezuela.

Belarus also features on two more prestigiouslists. It is one of the ‘Committee to ProtectJournalists’ “10 worst places to be a journalist”.President Lukashenka, meanwhile, appears onthe ‘Reporters Without Borders’ organisation’slist of “predators of press freedom”, andstands accused of carrying out a “systematiccrackdown” on private press in the country.

One of the more worrying facets of thewhole situation is the remarkable degree ofpublic support for the Marxist goals of thepresident. Rural communities in particular arekeen to see the continuation of state-sponsored collective farming and other similarinitiatives. Although buttressed by the constantmedia propaganda, government foreign policyfinds much favour among a highly anti-Western population.

Prospects for the future look bleak.ThePresident’s tight grip on power and thewillingness with which he exercises force tosubdue any dissent make the prospects of anykind of popular revolution, as seen in regionalneighbours like the Ukraine and Georgia aremote possibility. His health is sound and heis still relatively young (he was born in 1954)so the likelihood of his withdrawal frompower, voluntary or otherwise is also slight.The more plausible future scenario is onewhere Belarus is absorbed back into the mass of Mother Russia. As the two tightenedtheir relations, the value of Belarusianindependence diminishes.WhetherLukashenko will sacrifice his premiership toMoscow, or his people to national bankruptcymay well become the final issue.


Jessica Hodin worked at the StockholmNetwork in early 2006, and is currentlycompleting a Bachelors Degree atDartmouth [email protected]

countries. And other issues also persist —GDP is lower than it was before the war, andthe private sector lacks vigour.

However, some key reforms have beenenacted. Peter Nicholl, Governor of theCentral Bank of Bosnia-Herzegovina (CBBH)from 1997-2004, helped guide Bosnia awayfrom crippling debt problems, whichapproached US$2 billion in 2004. He also ledefforts to reform the CBBH.The introductionin 1998 of the convertible Marka as the newcurrency to replace the BiH Dinar was one ofthe elements enacted to stabilise Bosnia-Herzegovina’s currency. Its shadowing of theDeutschmark, and later the Euro also helpedto maintain a low rate of inflation.This reformwas an early priority, having proven successfulin several other transition economies. Citizenshave trusted the foreign base currency morethan their own existing institutions andcurrencies, and the Euro has strengthenedtrade and economic links to Bosnia. UnderNicholl, Bosnia also helped consolidate itsbanking sector, with the number of bankshalving from 76 banks to 33. Indeed 8 bankshold 80% of the deposits in a country of 4million people.The bank has come to be seenas a beacon of stability in a country stillrecovering from conflict.

That said, those deposit values do not amountto much and the banks do not offer theproducts one might expect. Chequeingaccounts are unheard of, so transaction mustbe conducted in cash, or with very expensiveelectronic transfers. Even the internationalinstitutions such as the EU and NATO havebeen known to pay their employees ‘underthe table’, allowing those employees to decidefor themselves whether they want to declarethat income for taxation, as going through theofficial procedures are too costly to beefficient.

The Thessalonica summit meeting of theEuropean Council in 2003 resolved to

Bosnia and Herzegovina


Bosnia and Herzegovina emerged in 1995 from half adecade of conflict almost obliterated, but also independent.The cataclysmic breakup of Yugoslavia probably hit Bosniaworst of all. Its territory was bitterly fought over by all theparties involved in that war.The Dayton Peace Agreement,finalised in 1995, divided Bosnia-Herzegovina into twoexecutive power wielding entities, the Muslim-CroatFederation and the Serbian Republika Srpska. Now a federalrepublic, Bosnia is ruled by a tripartite Presidency of Ivo MiroJovic (Croat), Borislav Paravac (Serb), and Sulejman Tihic(Bosniak).

There is now growing international consensusthat an ethnically unified single governmentmust be built up in order to preserve Bosnia’sfuture. Former High Representative LordAshdown, and his successor ChristianSchwarz-Schilling, have slowly but surelyguided a process of limiting the powers of thetwo existing governments, in hope of turningBosnia into a fully fledged liberal democracy.However, some domestic observers recognisecertain inherent advantages of the presentfederal system, particularly as competitionbetween the federal units has maintainedpressure for lower taxation and betterbusiness incentives.

Furthermore, the Serbian district has provenitself willing to embrace reformist agendas.Theregional leader threw out nationalist membersof the executive with a vote of no confidence,and is now attempting to pass as muchreformist legislation as possible before thenext election in the winter of 2006,particularly intended to combat corruption,drugs trade, official misconduct, andexcessively complex business procedures.Thatthis is occurring at the state, not national, levelis indicative of the reasons the federaladvocates hedge their support for a moreunified national system of governance.

Post-war Bosnia is enjoying a period ofeconomic recovery. However, it remains at thetransition stage, and is only beginning toinstitute market-oriented reforms. Since thewar, attempts have been made to remodel thecountry’s infrastructure, and many refugeeshave returned home. However, unemploymentremains obstinately high, approaching the 50%mark, with a far worse situation in some ruralareas. In Sarajevo, it often seems as thoughevery employed local is working for foreignnon-profit organisations, or in restaurants andhotels that cater to visiting westerners.Thesituation in some border regions showsmodest signs of recovery, principally due tocross-border investment from the ‘parent’

integrate the Western Balkan states into theEU. It has been concluded that Bosnia-Herzegovina is “considered likely to join theEU between 2010 and 2015” depending on itsfulfilment of the admission criteria. First andforemost, Bosnia-Herzegovina must enact theentire contents of their Stabilisation andAssociation Agreement before officiallyapplying for EU status. Similarly, Bosnianconstitutional reform, which is running at avery slow pace, due to the unwillingness ofthe various ethnic groups and political partiesto reach tough compromises, is critical.Thethree-member presidency will be reduced toone single executive power, thereby relievingethnic factionalisation, but as anticipated thereare strong disagreements over how thisposition should be elected. At the moment, atwo stage process seems likely, with onenominated president and two vice-presidentsrepresenting the three states, but with theroles alternating on a rotating basis. In aneffort to create greater governmentalefficiency, the central government will bestrengthened, placing the rights of ethnicentities to vote on national legislation inquestion. However, a stronger centralgovernment is in Bosnia-Herzegovina’s bestinterest, if for no other reason than that it willmake EU accession more feasible and facilitatecommunication and negotiations betweenBosnia and the outside world.

A regional free trade agreement (FTA) isbeing developed among Bosnia-Herzegovinaand other Western Balkan countries at theinstigation of the European Union.This shouldserve to boost Bosnia-Herzegovina’s intra-regional trade by integrating the existingnetworks of bilateral FTAs in the Balkans intoa single regional FTA by mid-2006. Suspicionshave been raised, though, that these free-tradeagreements may be used in the future as anexcuse for the EU not to accept the WesternBalkan states for membership,The EU mustmake it clear that membership into the Unionis ultimately inevitable (even if only in the verylong term) if they expect Bosnia to trust theEuropean Commission’s mooted reforms.Toassist this process, financial contributions areexpected to come from the European Union.After all, it is, in the EU’s best interest tostabilise and develop Bosnia-Herzegovina.

Employment discrimination remains rife in theBosnian work force. In the aftermath of the

war, allegations were made against the AluminijAluminium Factory in Mostar for hiring onlyCroats. Another example comes from theLjubija iron-ore mines near Prijedor wherenon-Serb workers were fired from their jobswithout explanation and have still not beenable to get their jobs back. Displaced minoritymembers have a very difficult time findingemployment, and therefore are often receivingsocial care.This discrimination in employmentpoints to the deeply engrained sense offactionalism that still exists in Bosnian society.However, this problem pales into insignificancecompared with the numbers who simplycannot find work, or who have nowhere elseto turn but the state pension (equivalent toUS$200 per month) and cleaning westerners’houses to raise some extra cash.

Although Bosnia-Herzegovina has come a longway since Dayton, reform is still a necessity forthe country’s economy to approach EuropeanUnion standards. It is critical that the reformprocess continues at a faster rate thanhitherto. Privatisation, freeing trade andremoving barriers to foreign investment arethree of the main prerequisites for furthereconomic development. Retroactive measures,designed to redress some of the excesses ofthe privatisation programme to date havecaused quite a stir, though. Practices which,while ostensibly dubious, were alsocommonplace and apparently legal during thefirst round of privatisation, have come underconsiderable criticism since, and there hasbeen an inclination on the part of the currentrulers to try to ‘punish’ them.Therefore, theEuropean Commission will continue to helpexpand the region’s economy, making it morecompetitive, improving its administrativecapabilities, and helping it to conform to theUnion’s acquis communautaire (the body ofcommon EU law).

The Commission has also identified highunemployment rates and the remnants offactionalisation as major problems in need of

resolution.The Commission has acknowledgedprogress in the area of justice, freedom, andsecurity, as many actions to combat organisedcrime have been implemented or at leastagreed.The EU’s presence in peacekeepingmissions and conflict prevention gives it agreater ability to observe conditions withinBosnia than it may have in other prospectiveapplicants.

Despite the long journey Bosnia-Herzegovinamust travel to reach EU accession, itsachievements up to now cannot beoverlooked. In an attempt to encourageBosnia and other countries aspiring to EUstatus to persist in their reform, the EU shouldtry to match each positive step with a positiveresponse.


Despite the long journeyBosnia-Herzegovina must travel to reach EU accession, itsachievements up to nowcannot be overlooked.

GEORGI ANGELOV is senior economistat the Institute for Market Economics, afree market think tank in Sofia, andmember of the managing board of theBulgarian Macroeconomic [email protected]

hardship than necessary.At this point it wasevident that sweeping reforms were neededand, finally, they began.The crisis provoked hugeanti-government rallies and protests whichresulted in the government being ousted inearly 1997.After elections a new governmenttook its place with a substantial majority and aclear mandate for reform.

In subsequent years progress occurred moreswiftly.The old monetary policy was abolishedand a currency board system was introduced.Most prices were liberalised; foreign trade wasfacilitated by decreasing customs duties. Abouthalf of the state-owned enterprises were sold,including all banks, the state telecommunicationcompany, and many steelworks.The share ofthe private sector in the economy increased to79%. Critically, within several years the publicsector share of total employment decreasedfrom 70% to 30%.

Considerable advances were also achieved inother spheres. In 2000 pension reform began,wherein a small portion of the social securitytax was directed toward individual pensionaccounts in private pension funds.Thisproportion has increased over the years and,despite some delays in the stipulated timing, itreached 3% of the salary in 2005.The reformcould have occurred much faster and beenmore substantial – other countries in theregion are a testament to this. Nevertheless,it represents a substantial step in the directionof creating a fully-funded private pensionsystem. It is also important that the newcentre-left government has continued thatpolicy by increasing the portion directed intoprivate pension funds to 4% from 2006.

One of the boldest reforms enacted in recentyears is the dramatic reduction of directtaxation. In 1997 the corporate tax rate inBulgaria was 40.2%. After 8 years of reform,this rate is now 15%, almost three times lower.The top rate of the personal income tax was40% in 1997; it is 24% now.Thus by 2005-

Bulgaria


It is sixteen years since the beginning of the transition fromcommunism to markets and freedom, yet Bulgaria remainspoorer than almost all other European countries.The goodnews is that the economy is developing, growing much fasterthan most EU member states. Eventually, Bulgaria shouldbecome a wealthy nation. Nevertheless, the challenge issubstantial: depending on the pace and depth of reforms, thischange could take as few as ten years or as many as sixty.This disparity is too large to be left unexamined.

The transition began at the end of 1989 andearly reform focussed upon the politicalprocess and its institutions.The formercommunist party remained in power for mostof the following seven years and thesereforms were implemented very slowly. State-owned enterprises and banks dominated theeconomy, inflation was high, and taxes andregulations were punitive.The state companiessustained ever greater losses, yet because ofthe generous support of the government andits banks, not one of them went bankrupt.There was a huge fear of real change, soreform was prevented by any means. As aresult, the economy contracted; real economicgrowth averaged -5% per year.

These attempts to maintain the structure ofthe economy and to ‘save’ loss-making statecompanies incurred a high cost.Thegovernment assumed the non-performingdebt of state enterprises, which led only tolarger non-performing debts. Eventually most,if not all, state companies were technicallybankrupt, as were most of the state banks.The government was running a huge budgetdeficit (more than 10% of GDP), which theyfunded by printing yet more money. By 1996most state banks were closed, inflationreached 1000% and the economy was in adeep crisis.The government debt had reached120% of GDP.

The desire of the government to slow downreform in order to make it more ‘sociallybearable’ inevitably produced the opposite result- the public suffered a much higher burden of

One of the boldest reformsenacted in recent years isthe dramatic reduction ofdirect taxation.

2006 Bulgaria had some of the lowest profitand income tax rates in Europe.

However, at the same time the social securitytax has remained among the highest inEurope, accounting for more than 42% ofsalaries. Here, it has been difficult to achieveany progress over the last 6-7 years. However,following a two-year campaign by various thinktanks to introduce a 10% flat rate for all directtaxes - corporate tax, personal income taxand social security tax - some success hasbeen achieved in this area.The new centre-leftgovernment recently cut social security tax by6% in its 2006 budget.

Government debt has decreased substantiallyas a share of GDP since these farther-reachingreforms were enacted. From a level of morethan 120% of GDP in the mid 1990s it hasnow dropped to about 30% of GDP.This is aresult of increasing GDP while the debt wasmaintained at the same nominal level, andlater repaying a portion of it with proceedsfrom privatisation and budget surpluses.

The result of these reforms was stark andinstantaneous. Economic growth increased by9-10% per year – from an average of -5%before 1997 up to roughly 5% post-1997.Unemployment increased initially, and thendecreased as a result of economicdevelopment and subsequent job creation. It isclear that reform has yielded beneficial results.

However, it seems that recently themomentum for reform has started todisappear. Budget surpluses, positive economicgrowth and improved economic indicatorshave slowed the pressure for change.Government complacency has increased andthe spur for such rapid reform - the economiccrisis of 1996 - is now fading into the past. Asa result, some necessary improvements remainpolitically sidelined.

Despite positive developments in the area ofdirect taxation, the overall tax burden inBulgaria remains relatively high, bothcompared with the new EU member statesand comparable countries that areexperiencing higher economic growth. Effortmust be concentrated in that direction tochange things further.Yet a willingness topromote further reform in that area, sadly,seems lacking in the new coalitiongovernment. In the past few years the fiscalbudget is constantly in surplus, reaching almost5% of GDP in 2005.Yet still, the overall taxburden has not decreased visibly, though this isprincipally due to the insistence of theInternational Monetary Fund that Bulgariashould continue running budget surpluses.

In the long term education and healthcare arethe sectors most in need of improvement, sothat the increase in economic growth can besustained, while government expendituredecreases concurrently.The Ministry of

Finance recently released a paper on publiceducation spending which called for theintroduction of a ‘voucher system’ - wherebyspending is determined by the studentaccording to his or her priorities, rather thanby the school - and the decentralisation ofdecision making in order to increase incentiveswithin the system. Although, this wassupported by most political parties, strongopposition emerged from schoolteachers’unions.The Ministry of Education joined thatopposition and has now effectively precludedany reform in the foreseeable future. A newEducation Minister has thus continued theexisting policy, pouring ever more money intothe already bloated sector.

The healthcare system is also notorious forhigh spending without commensurateimprovements in the provision of services.Medicines are being procured at prices abovemarket levels, corruption is perceived to bewidespread and hospitals run deficits everyyear while asking for additional subsidies fromthe government. Despite these obviousfailings, little is being done in this field either.Although there is much talk of theprivatisation of hospitals nothing has beenachieved until now.There is some movetoward partial implementation of the ‘paymentfor activities principle’, which will change thepresent situation whereby hospitals receivemost of the healthcare funding irrespective ofthe actual amount of service they provide.Theprevious government promised to allowprivate alternatives to the state monopolyhealth fund, but failed to deliver on thatpromise.

Similar problems can be seen in the areas ofadministrative and regulatory reform. Eachnew government starts by cutting itsadministrative staff by 10%, but balancing thisout in subsequent years by increasing totalstaff numbers by 15-20%. Deregulation is alsoa favourite topic for politicians even thoughthey admit that, to paraphrase the Finance

Minister, for every regulation removed twonew ones are usually introduced.

Reform in other areas has been delayed andas a result Bulgaria is still lagging behind theleading reformers of Europe. For example,military service is still compulsory despitedefence expenditures being amongst thehighest in Europe, which serves only toremove manpower from the labour market.The loss-making state railways are subsidisedbecause no one has the will to implement aprogramme for reform, prepared years ago byformer government and World Bank experts.

Overall, the outlook is mixed. Significantreform has been enacted yet much more isstill needed.The pace of these reforms willdetermine how many years will be neededbefore Bulgaria can claim to enjoy the wealthof nations.


BY NATASA SRDOC, MBA and JOELANAND SAMY, co-founders of theAdriatic Institute for Public Policy,Croatia’s first independent free marketthink tank advancing and advocatingmarket reforms based on the rule oflaw and protection of property [email protected]

a ‘one stop shop’ for registering a new businessthat still takes longer and costs more incomparison to the US, UK and other EU nations.A growing number of local entrepreneurs andbusiness leaders from abroad have come to callit a ‘one shop…and then stop’, having observedthe difficulties of starting, growing and sustainingprivate enterprises.

Worryingly, the myth that Croatian entry intothe European Union will automatically boosteconomic growth, increase employment andbring about a higher standard of living seemsto be gaining ground. A quick glance at Greeceor Portugal provides ample evidence that EUentrance is not an automatic guarantor ofeconomic vitalisation and prosperity

Croatia’s economic growth has slipped alongwith a significant slowdown in foreign directinvestment.The nation’s only saving grace hasbeen its flourishing tourist industry that bringsseveral million tourists to the Adriatic coastduring the brief summer period and providesan infusion of foreign currency into a cash-strapped economy.

The 2006 Index of Economic Freedompublished by The Heritage Foundation and The Wall Street Journal, ranks Croatia 55th of155 assessed countries, yet this leaves it behindAlbania and the majority of Eastern European’stransitional nations. Croatia is categorised as’mostly free’.The report rates the areas ofproperty rights and regulation with a score of 4 out of 5 and informal market 3.5 (five beingthe worst).The areas of foreign investment andfiscal burden receive a score of 3.

In October 2005,Transparency Internationalunveiled the annual Corruption PerceptionIndex (CPI) and Croatia’s ranking slipped from67 in 2004 to 70 in 2005 (The survey covered158 countries).The CPI score for Croatiadecreased from 3.5 in 2004 to 3.4 out of 10 in2005 (ten being ‘cleanest’). It is important tonote that the CPI report reveals that poorperformance in long-term EU states including

Croatia


The bloody and destructive war in the early 1990s gainedCroatia its independence, but at a heavy cost. Much of thenation’s infrastructure was destroyed. Populations shiftedfrom place to place as they sought refuge from the conflict.The medieval port of Dubrovnik just about survivedbombardment from the Yugoslav military, but other industrialcities, such as Vukovar, were not so fortunate.To this day, thewar torn areas in the eastern part of the country remain aneconomic wasteland with unemployment rates above 50%.

The nation’s first post-communist electionushered in President Franjo Tudjman and thenationalist Croatian Democratic Party (HDZ).As with many transitional countries in EasternEurope, President Tudjman’s ruling government(1991-1999) catered to cronyism andcorruption that further hampered the fledglingnation’s efforts to establish the rule of law.Rather than transitioning to a free marketeconomy, the fragile rule of law gave way tocriminal capitalism which created a privilegedgroup of instantly wealthy selected individuals,as former senior government officials wereinstalled in key management positions in largestate owned companies (SOEs).

After Tudjman’s death, the SocialistDemocratic Party (SDP) came to power in2000, but continued the HDZ’s failed policiesof central planning, leading to the governmentbailing out a number of troubled SOEs.Theweak coalition of SDP was punished by theelectorate when the Croatian DemocraticParty, led by Dr. Ivo Sanader, won the electionsin November 2003, promising market reformsbefore they took office a month later.

Two years later, the government has failed toimplement a single major initiative in favour offree market reforms. An absence of economicpolicies and pro-growth solutions has led toeconomic stagnation. Citizens, taxpayers andentrepreneurs were hoping for marketreforms that would lead to economic growth,increased employment and prosperity.

In the economic arena, the government haspeddled half-baked changes such as establishing

Croatia’s economic growthhas slipped along with asignificant slowdown inforeign direct investment.

Greece and Italy, as well as the new membersCzech Republic and Poland show little or nosign of improvement.The Report furtherstates, “This weakens the credibility of the EUin promoting anti-corruption in its newmember states and exporting anti-corruptionto countries proposed for accession in 2007.”

According to the World Bank’s annual report‘Ease of Doing Business – 2005’, Croatia onceagain performed poorly. Croatia was ranked118th out 155. Croatia’s leaders weresurprised to hear that neighbouring Serbiawas considered one of the top economicperformers in the world.The World Bank’sreport again ranked Albania ahead of Croatia.

During 2005, Croatia’s current governmentstalled the vital process of privatisation andeventually pushed through a seriously flawedprivatisation deal in the summer.This incidentled to an investigation which resulted in thefiring of the president and vice-president of theCroatian Privatisation Fund (CPF) overconcerns about corruption.The CPF has sharesand stock in 1035 companies and its portfolioincludes agricultural based companies, shipyards,aluminium and steel plants and hotels that areheavily subsidised.These poorly managed andloss-making state entities have significant debt.

According to The Wall Street Journal and TheHeritage Foundation’s 2006 Index ofEconomic Freedom, ‘Red tape presentsdifficulties to foreign and domestic investorsalike… Lack of transparency in governmentdecision-making often leads to allegations ofconflict of interest or bad decisions… Somelocal governments have occasionally beenopenly hostile to foreign investment.’Moreover, unrealistic preconditions set by theCPF, including requirements to retainunnecessarily high staffing levels orpredetermining the level of future investmentsimpede sales. A fair, transparent and ethicalprocess of privatisation has yet to be realised.

The Economist online reported on February 16,2006, “In Croatia, a widely admired justiceminister,Vesna Skare-Ozbolt, was sacked lastweek. She had pushed both judicial reforms(such as appointing independent senior judges)and an aggressively timetabled anti-corruptionprogramme.These delighted the outside world,but annoyed Croatia’s old guard, who preferthe old system of cronies and favours.”The lack of bold leadership in combatingcorruption dampens Croatia’s economicvitality. Much of the corruption is connectedwith the tremendous influence of governmentinvolvement in the economy. Skare-Ozboltadvanced anti-corruption strategies andpresented a comprehensive package thatwould have dealt a serious blow to corruption.

According to the 2006 Index of EconomicFreedom, “Huge case backlogs mean thatbusiness disputes can go unresolved for years;

some investors have chosen to insist thatcontract arbitration take place outside ofCroatia.The Government of Croatia hasmade a commitment to reinvigorate itsefforts to reform the judiciary, but muchremains to be done.”

It is important to note that a backlog of 1.4million unresolved cases burdens Croatia, anation with a population of just 4 millionpeople. Property restitution remains a majorroadblock as local governments impederestitution stating that they are protecting the‘local government’s interest’. A majority of thecases dealing with property have been tied upin the court systems for more than a decade.

Croatia’s huge bureaucracy, restrictive labourlaws and high taxation all create obstacles forthose working in the private sector. PrimeMinister Sanader’s government originallypledged to reduce taxation during its politicalcampaign. Croatia’s government expenditure,as a percentage of GDP, is over 52%, thehighest in Eastern Europe and above the EUaverage. Lack of fiscal discipline is worrisomeas Croatia’s debts increase amidst economicstagnation and lack of FDI. Its high debtremains a ticking time bomb.

The Organisation for Security and Cooperation(OSCE) Mission to Croatia reports, “Thegeneral climate for public debate in Croatiacontinues to improve. Croatian print media hasbecome more critical and has progressivelybegun reporting on sensitive issues such as warcrimes committed by members of the CroatianArmy and the return of refugees.”The reportstated that, “HTV has generally freed itself ofpolitical bias but retained a strong bias in termsof topics covered.” However, as progress ismade in strengthening free media, journalistsand media communications entities in Croatiahave experienced a number of setbacksincluding a plethora of lawsuits and journalistsfacing prison sentences. Over the course of2005 reporters and editors have felt pressure

from Croatia’s government leaders and severalinvestigations have been abandoned for fear ofthe state’s response.

The grassroots reform movement has justbegun in Croatia with a spirited debate on flattax rates, labour and pension reforms, rapidprivatisation, and education and health carereforms. Prime Minister Sanader has publiclycommented that he stands for reforms inCroatia.The minority HDZ government hasan opportunity to clearly articulate pro-growth solutions and advance practicaleconomic reform initiatives that will lead toeconomic growth.

Croatian taxpayers have noticed thatneighbouring countries are prospering,drawing foreign capital and creating jobs.Parliamentary elections are expected in 2007and the electorate showed in 2003 that theywill vote with their wallets in mind.The rulinggovernment should take heed and work oncreating a pro-reform economic team that willbegin the reform process in Croatia by fullyimplementing the ‘anti-corruption strategies’,tax reform, labour law flexibility andaddressing the privatisation process.

In 1998, former UK Prime Minister LadyThatcher, known for her bold leadership inadvancing free market reforms, visited Zagreb.Croatia’s leaders will do well by heeding toLady Thatcher’s profound message, that “thesystem of freedom and free enterprise is,above all, based on the rule of law — lawwhich must be fair, clear, and honestlyadministered, and to which government, andall those associated with it, are also subject likeeveryone else. Such is the political andeconomic system for which we should aim.Wherever it is tried it is successful.”

These words, delivered nearly a decade ago inCroatia, are still highly pertinent to today’sleaders and taxpayers.They outline a goal wellworth pursuing.


NINO GORGADZE is ExecutiveDirector of the New EconomicSchool, [email protected]

was low during previous regimes, this kind ofaggressive intrusion carried out byunaccountable bureaucrats only serves toscare away the investment needed toreconstruct the country.

The next step on the road to reform wasliberalisation of the tax system. A new taxcode was adopted in January 2005 thatreduced the overall tax burden, but, becauseof additional administrative costs to handle themore complex codes, may have made lifemore complicated for businesses.The numberof taxes has reduced, from 23 to just 7, as hasthe size of the tax burden. Income tax hasreduced, from a progressive system to a flattax which, at 12%, is among the lowest inEurope.VAT has gone from 20% to 18%, andsocial security taxes have dropped from 33%to 20%. However, corporate taxes still stand ata relatively high 20%, and a tax onreinvestment dampens enthusiasm for businessdevelopment.

Tax collectors have unlimited powers to takearrears, including the forcible mortgaging ofproperty, without recourse to the courts.Indeed, with only the authority of the head ofthe tax department, property can be seizedand sold. Money may be removed from bankaccounts and from cash stockpiles.Thesekinds of actions prevent entrepreneurialactivity and are hazardous to the safety of thewhole society.

The radical liberals, whose ideologicalbackground is based on the idea that in a freemarket, monopoly positions must not bepermitted, changed anti-monopoly legislationand created a new free trade and competitionlaw. Under the new regulations, only thegovernment can create monopolies, or givepermits for particular firms in ‘naturalmonopolies’.With these few exceptions, anystate activity which hinders competition isprohibited. State bodies may not impose any taxcuts, or other initiative, which may favour one

Georgia


In the aftermath of Georgia’s ‘Rose Revolution’ of late 2003,it did not take long for the incoming government to realisethat, without swift and radical economic reform, the collapseof the state would have been inevitable. Based on theirreform record to date, it is safe to say that the governmentbelieves liberal values and economic freedoms are the bestroutes to success and profit.

Georgia’s two main aspirations at present areeconomic liberalisation and EU accession.However, there seems to be a misconceptionof the benefits that EU membership will bring.While on the one hand, the boon in terms offree trade and movement of labour andcapital will be enormously beneficial, theadditional imposition of much moreoverbearing regulation and bureaucracy couldbe equally damaging.

The government was so committed to thereforms it even went so far as creating acabinet-level position – State Minister forReform Coordination – to manage the project.Sadly though, the vast scope and structuralirregularity of the existing systems has meantsome vital components in need of reform haveeluded his grasp, and he has also foundprogress thwarted on some occasions byinstitutional enemies of beneficial reform plans.

The first step to reform, taken directlyfollowing the revolution, was a sweepingprivatisation plan.The government sold offpretty much everything (“except itsconscience”, said Reform Minister KakhaBendukidze).The government, seeking themost lucrative short term revenue haul, soldall its ‘strategic assets’ such as ports, railways,and oil and gas pipelines.Yet in spite of this,privatisation is moving slowly. Political instabilityand uncertain property rights have madeforeign investors wary, resulting in revenues ofjust 330,000 GEL (US$183,300) fromprivatisation in 2005.

The government has also commenced asevere clampdown on tax avoidance.Thisgenerally involves sending financial police intofirms for ‘auditing’, closing them down forweeks at a time, resulting in profit losses,without any compensation. Most of this occursoutside of the court system, with injunctionsbeing set by the Office of Public Prosecutionsand cabinet officials, at a massive cost to thetaxpayers.While it is likely that tax compliance

firm over another, pose any kind of impedimentto entrepreneurial activity, grant special powerswhich deter competition, or influence decisionsto grant monopoly positions.

One result of this law was the so-called ‘third-party access’ provision.This states that ownersof specific types of property (e.g. pipelines, orrailway lines) are obliged to offer othereconomic agents free access to their gridsunder non-discriminative conditions.They mayonly refuse if the other party does not fulfilpredefined technical requirements. Equipmentfor the transmission of non-tradable goodscreated by private investments is free fromthis obligation.The shortcoming of this law isthat it delimits property-owners’ rights,although it does serve to open up markets,which in other countries are severely hinderedby access agreements (for example, Georgia’sopen pipelines give it among the mostcompetitive energy sectors in Europe).

In order to oversee the implementation ofthese objectives, the Free Trade andCompetition Agency was established.However, the precedents of governmentcorruption make it hard to be too optimisticabout how effectively this will operate.

The reform of the licensing and permit systemwas also radical.The number of licenses andpermits was reduced from 909 to 159.Additionally, the system was vastly simplified. A‘one-stop shop’ system was created to enableease of acquisition.The ‘silence equals consent’principle was introduced, whereby a wait oflonger than a certain length of time (usually30 days) equates to the automatic receipt ofthe license. Finally, the ‘one umbrella’ principleallows owners of generic permits to not needto acquire subordinate specific ones.Theregulatory burden was reduced thanks to thislaw, and the removal of many layers ofbureaucracy also removed much of theopportunity for corruption. However, its laxitymay also permit activity previously considered‘criminal’. Perhaps a more effective way tosolve problems in this area would be theadoption of an ‘insurance-like’ system, butgovernment is unwilling to completelyprivatise in this area.

The next direction reform went was theprivatisation of land ownership. All governmentowned land on which rent was collected, andthat was not within 5km of an internationalborder, has been or will be sold off.Unfortunately omitted from this, though, arepastures, forests, and some special historicalareas, meaning nobody in particular owns or isable to take care of them. Only Georgiancitizens, or institutions legally registered withinthe country could buy the land.

This reform will aid agricultural development,and allow market mechanisms to set landprices. However, more detailed property rights

are less easily determined. For example, thereis a distinct absence of clarity as to whetherresources found on private property belongsto the land owner or not. At the moment, thegovernment claims all such resources as thenation’s, and the land owner only has the rightto compete with other parties to produceresources found.This rule reduces the marketvalue of land, and may go some way toexplaining the apparent scarcity of resourcesin Georgia.

Reform in the banking sector is ongoing, butso far change has been modest. Sellingprocedures were tweaked to simplify collateralmechanisms.The minimum capital required toset up a bank was raised to 12 millionGeorgian Lari (about €5 million).This has nothelped make the sector more accessible forforeign banks, though, and governmentcontinues to meddle in this sector with anoverly visible hand.

Customs also stands in need of reform, as hightariff and quota restrictions engendercorruption among customs officials. Customstariffs need immediate revocation to supporteconomic growth by raising import levels andreducing prices, and increasing domesticcompetitiveness by exposing firms to newrivals.

Georgia needs rapid privatisation of its socialsecurity and healthcare systems. Now is theperfect time, as Georgia’s government isunable to take great responsibility in this areabecause of funding shortfalls. Georgia’s state

pension burden is so insignificant (€12 percitizen per month), that for the government toallow private assistance would seemappropriate. Georgia has no unemploymentbenefit, or any decent state healthcare system,but at the moment private alternatives existoutside the law. Legalising them would fosterbeneficial competition and reap betteroutcomes for the society.

It may be time for Georgia to look furtherafield for inspiration.The EU model may betoo state-heavy for such a small andunderdeveloped country. Other examples,such as new EU members like Estonia, or free-market trendsetters like New Zealand may hold better exemplars of the reformsGeorgia should be pursuing, alongside a morethoroughly developed rule of law which createsa safe harbour for individual activity. Hopefully,the Georgian government understands that,and a free-market rose may bloom in theflowerbed of the former USSR.


Reform in the bankingsector is ongoing, but so farchange has been modest.

HJÖRTUR J. GU MUNDSSON isDirector of Veritas, a conservativefree-market think tank in [email protected]

since 1974). Geir H. Haarde took over asForeign Minister in Oddsson’s place, havingpreviousy served as Finance Minister since1998. Haarde was then elected chairman ofthe IP at its biannual national congress inOctober. He has announced he will continuethe same economic policies.

The fact that the Independence Party hasbeen the ruling partner in government since1991 has led to a great political and economicstability and ensured steady progress in theright direction. Iceland has sustained animpressive GDP growth ever since 1995 with the sole exception of 2002. In 2004 thegrowth was 8.2% and it is forecast to havebeen around 5.5% in 2005. Purchasing powerhas grown every year and unemployment isvery low (1.6%). As a result Iceland has inrecent years scored very highly in internationalreports on countries’ socio-economic success.

Taxes have been lowered significantly inIceland since 1995. Corporate tax rates havebeen cut over that period from 33% to 18%,though this has actually raised government taxrevenues. Income taxes collected by the statehave also been lowered since 1995 from33.15% down to 24.75% and are scheduled tobe reduced again to 21.75% in 2007. Propertytaxes paid by individuals and companies willbe abolished this year (2006) and the samegoes for a special tax on high income earners.The value added tax is also up for review anda number of other smaller tax reforms havebeen scheduled.

Iceland


Today, Iceland is one of the wealthiest and most prosperouscountries in the world. However until the late 1980s,Icelandic society was deeply socialistic – there were manystate-owned enterprises, high tax rates and excessivegovernment interference in day-to-day business operations.However since the early 1990s, Iceland has been on a steadytrack toward sustained economic growth, achieved throughmarket-orientated reforms and liberalisation.

Prior to this recent period of reform, truecapitalism was widely considered an extremeeconomic model, and any step taken towardsliberalising the economy was seen as a gravepolitical risk. However, a new generation ofpoliticians took over the leadership of theconservative Independence Party (IP) in thebeginning of the 1990s and brought with thema new way of thinking.The IP began to put itsideas into practice; liberating the economy,introducing privatisation, lowering taxes and, asa direct consequence, limiting the powers ofpoliticians.Today libertarianism and economicreform directed toward a more liberalisedeconomy are considered to be mainstreampolitical ideology in Iceland.The two individualsmost responsible for this development areProfessor Hannes H. Gissurarson, theideologist of the movement, and DavíOddsson, who has been principally responsiblefor putting these ideas into practice.

Oddsson became Prime Minister of Iceland in1991 following his election as chairman of theIP. His first government was a coalition withthe Social Democratic Party (today a part ofthe Social Democratic Alliance), but since1995 the Independence Party has governedwith the centrist Progressive Party (the IP isthe only centre-right political party in Iceland,and won around 40% of the vote). Oddssonserved as Prime Minister for more than 13years, from May 1991 to September 2004,when the Chairman of the Progressive Partytook over as Prime Minister and Oddssonbecame Foreign Minister, in accordance with apact the two parties made after the generalelections in 2003.

On September 27th 2005 Oddsson leftpolitics in accordance with this earlier decisionand stepped down as Foreign Minister and asan MP and took over as president of theIcelandic Central Bank.The main reason forthis decision was the length of time he hadspent on the front line of Icelandic politics (anunbroken succession of prominent positions

From a cultural point ofview Icelanders areextremely open to allinnovations, new ways ofthinking, of doing things andparticularly new technology.

Serious discussions about the benefits of flattaxes have emerged in Iceland at the initiationof the Icelandic Chamber of Commerce. InFebruary 2005 a special report from the ICCon the issue recommended a 15% flat tax forthe income of individuals and companies andon consumption (taxes in Iceland are actuallyalready rather flat due to the absence ofthresholds).The fruits of these discussions arealready beginning to show - the IP hasaccepted into its tax policy a recommendationthat immediate work will start on collectinginformation about flat taxes and estimatingwhat impact the introduction of such a taxwould have on the state’s finances.

A special committee was thus appointed onOctober 20, just after the party’s nationalcongress, by the Minister of Finance, Árni M.Mathiesen, for the purpose of reviewing theIcelandic tax system in light of the possibleintroduction of a system of flat taxation.Thecommittee is mainly supposed to shed light onwhat makes the Icelandic economycompetitive and efficient, and also to look intodevelopment in tax reform and structures inother countries.They will be looking forinspiration not only from countries whichIceland traditionally compares itself to, but alsocountries which are not stuck in the westernway of thinking on the issue of taxation.

Halldór Ásgrímsson, the Icelandic PrimeMinister, also announced at the beginning ofOctober the government’s intention to launcha special campaign of deregulation in Iceland.He said the Icelandic administration was thethird most efficient in the world. Neverthelessthere were many things that could be better.The campaign is called ‘Simpler Iceland’ and isaimed at simplifying the legislation, decreasingbureaucracy and encouraging greater efficiency.

In Iceland there are few obstacles to reformtowards economic freedom. From a culturalpoint of view Icelanders are extremely opento all innovations, new ways of thinking, ofdoing things and particularly new technology.One of the reasons for this is the small size ofthe country – new, and better, ideas are ablespread quickly. However, when it comes to thehealthcare and educational systems and(especially) agriculture, many people are verysceptical about any mooted liberalisation.

One of the main reasons for this is the fact acenter-left majority has governed the city ofReykjavík since 1994 and it has been veryhostile towards trusting the private sector forprojects within the city related to educationand health services (about a third of theIcelandic population lives in the capital).Nevertheless, public trust in the privatesector’s ability to behave responsibly in healthand education is slowly growing.This shift inopinion may be acted upon if the IP are ableto form a majority following municipalityelections this spring.

Agricultural reform, however, remains stuck inthe mud.The level of producer support inIceland remains among the highest in theOECD. According to the OECD, state subsidiesaccount for 69% of the income of farmers inIceland. Sceptiscism about reform exists bothwithin the Independence Party and among theother parties, not the least its coalition partner,the Progressive Party, which has strong tieswith the countryside – it was formerly theAgrarian Party.Yet there are strong voices inIceland calling for the reform of agriculture,including possible international steps towardslowering tariffs, and liberating the internationaltrade with agricultural products.

The National Telephone Company(Landssíminn) was privatised in the summer of2005 and was sold for 67 billions Icelandickrónur (€954m). About half was paid in foreigncurrencies, euros and dollars, which was usedexclusively to pay off the foreign debts of theIcelandic state.The results of this is that sincethe beginning of 2006, the state has effectivelyno foreign debt.What remains of the windfallis intended to be used for several projects, butnot until 2007-2012, and then only if theeconomic conditions in the country remainsuitable. Until then the money will be kept,accruing interest, in the Icelandic Central Bank.

Many other state-owned companies havebeen privatised since 1991.This includes threebanks; the National Bank of Iceland(Landsbanki Íslands), Búna arbanki Íslands(now part of Kaupthing Bank) and FBA (nowpart of Glitnir).

The liberalisation of the economy in Icelandhas provided a strong foundation for the‘break-out’ of Icelandic companies to othercountries in recent years, especially toDenmark and the United Kingdom.This hastaken many people outside Iceland bysurprise, but there are several reasons for this.Economic reform has made it much easier forIcelandic companies to grow and become

stronger. Equally, the Icelandic market is smalland many Icelandic companies quickly reachthe limit of their growth in Iceland and havetherefore increasingly taken to looking abroadfor investment opportunities. Finally, Icelandiccompanies are, in general, very well run.

The Icelandic economy has recently comeunder some criticism from abroad, with someeconomic analysts warning that the economyis overheating and that recession lies ahead.Given the recent high exchange rate of theIcelandic króna, a correction had beenanticipated and prepared for. It is not, however,expected that this will lead to a depression,and GDP growth in Iceland is forecast toremain high in forthcoming years.

The single most important thing for Icelandto continue on the road towards increasingeconomic liberalisation is to retain its center-right government.The left-wing of Icelandicpolitics has fought hard against thegovernment’s policies and therefore it is quitecertain that if a center-left government wereto take power in Iceland that it would meandramatic changes in policies – in all thewrong directions.


CORINNE SAUER is the Director of theJerusalem Institute for Market [email protected]

Breaking with a long tradition of interventionisteconomic policies and a continuously growingpublic sector, Finance Minister BenjaminNetanyahu launched a series of reforms thathelped contain public expenditures and spureconomic growth. After much social unrest andloud demonstrations, the bankrupt welfaresystem was finally reformed along the lines ofthe welfare-to-work reforms adoptednationally in the United States in 1996. Beforethe new reforms, average welfare payments inIsrael exceeded the average wage that mostwelfare recipients would have received in thelabour market, leaving them with very littleincentive to look for work.The Israeli welfare-to-work plan was first implemented in thebeginning of 2005, and the immediate effectwas a reduction of transfer payments from7.3% of GDP in 2004 to 7% in 2005. At thesame time, unemployment decreased from10.4% to 9.1 % in the first and secondquarters of 2005, accompanied by an increasein the number of transitions from part time tofull time employment.

In addition, the long awaited privatisation ofpublic companies was launched in full force in2005.Workers employed in public-sectormonopolies were earning five times theaverage Israeli salary and were enjoyingexceedingly advantageous retirement plans.Thus, it is not at all surprising that theprivatisation plan was met with fierceopposition by public sector labour unions. Butin March 2005, after two months of strikesthat literally shut down the country, the Israelitaxpayer won a small victory against privilegedpublic sector employees. In a first steptowards privatising Israel’s seaports, thegovernment signed an agreement with theHistadrut (General Federation of Labour)resulting in the breaking up of the portauthority. Each port will be transformed into adifferent public company that will have tocompete in the market.These publiccompanies will then be privatised in the

Israel


In 2005, the Israeli economy started to show the first signs ofa long-awaited economic recovery.The overall economicgrowth rate exceeded 5%, and more significantly, the businesssector grew at an even more impressive rate of 6.4%.

The recent spurt of growth can be explainedby a number of factors. One is the relativeimprovement in the security situation, whichresulted in an immediate increase in thenumber of tourist arrivals and a recovery inthe tourism sector, which accounts for 4% ofGDP. However, Israeli experiencedemonstrates that a calm security situationdoes not ensure economic growth; soundeconomic policies and fiscal discipline aremuch more essential ingredients. BenjaminNetanyahu, the former Prime Minister andFinance Minister, clearly understood this andpushed for a more reasonable fiscal policyconsistent with deficit targets. A morefavourable environment for private businesseswas created through his economic policies.The privatisation of several public companiesand the cancellation of bank monopolieshelped create more competitive markets andlowered prices.The move towards a newwelfare system influenced by US welfare-to-work reform also led to necessary changes inthe labour market.

The recent recovery of the Israeli economy is,however, still fragile and strongly dependenton economic policies that will beimplemented after the elections in March2006.The Israeli economy continues to sufferfrom the vestiges of a heavily centralisedeconomy. The public sector in Israel currentlycontrols 51.5% of the economy, compared toan average of 41.6 % among OECD countries,and 34% in the United States. Note that largemilitary expenditures do not fully account forthis discrepancy.The government debt to GDPratio in Israel is also expected to reach101.5% in 2005. Netanyahu’s push to liberalisethe economy and reduce the weight of thepublic sector promises to help sustain andfurther accelerate economic growth. On theother hand, the fragility of the recent growthwill be quickly demonstrated if the statistprograms presented by all other candidates inthe election prevail.

future.The oil refineries are also planned to besplit into two competing public companiesthat will be privatised in a second stage. Asimilar initiative was partially introduced forIsrael Military Industries Ltd.

In 2005, Netanyahu also succeeded in slightlylowering individual income tax rates and theVAT without significantly increasing the budgetdeficit as a percentage of GDP. Tax bracketswere widened at all wage levels and thehighest marginal tax rate was lowered to 49%from 60% in 2003.The VAT was lowered by.5% from 17.5% to 17%.These fiscal changesincreased the disposable income of Israelis anddomestic demand, creating growth in thecommerce and service industries. In July 2005,the Knesset approved a tax reform bill that willgradually reduce the corporate income taxrate from 34% in 2006 to 25% in 2010. On aless upbeat note, capital gains taxes forindividuals will grow from 15% to 20% in 2006.

The above reforms were also accompanied bya much needed overhaul of the bankingsystem in which more competition wasintroduced. Israel’s banking system has beenhistorically dominated by two banks, BankHapoalim and Bank Leumi.These two bankscontrol almost half of all tradable assets.Thisduopoly received almost all national savingsand enjoyed exclusive powers in the lendingmarket because only banks can offer credit inIsrael.There are no other lending institutions.One of the results of this corrupted systemwas that 70% of all credit went to 1% ofborrowers (insiders). Unfortunately, the vastmajority of ‘outsiders’, other businesses andentrepreneurs, struggled to raise capital. Profitopportunities were stymied because of lack ofcompetition in the lending market.Thisdamaged economic growth.

The 2005 economic reforms have alreadyborne fruit.The high-tech industry had its bestyear in 2005 since the dotcom bust of 2000.The high-tech sector generates 40% of allIsraeli exports, amounting to $13 billion a year.Israel’s high-tech sector includes within its ranksIntel, the world’s largest chip maker. Intelalready has six production and design plantsacross Israel and is opening a new plant in thesouthern town of Kiryat Gat.This new plantwill add another 2000 jobs to Intel’s largeIsraeli workforce of 6000 men and women.

The Intel success story is accompanied by thenotable number of Israeli companies listed onNASDAQ (New York’s technology stockmarket). Israel has more listed companies onNASDAQ than any other country outside ofthe United States. Israel’s highly skilled and welleducated workforce bestows on the country acompetitive advantage that is attractive tohigh-tech businesses. A more competitivelending market will further foster the growthand creation of new high tech firms.

Overall, 2005 was the start of a new vision forthe Israeli economy, but last year’s economicrecovery is still very fragile and, at this time, itis not at all clear that the policies of fiscaldiscipline, privatisation and deregulation willcontinue in the future.The unions willundoubtedly fight every move towardsmodernisation that encourages economicgrowth, in a country that already loses moreworkdays to union-led strikes than any otherindustrialized nation. In fact, the national labourunion leader, Amir Peretz, has recently takenover the leadership of the Labour Party and isrunning for Prime Minister in 2006. Note thatPeretz has earned the nickname of Stalin, notjust because of his physical appearance, butbecause of his lifelong economic philosophy. Ifelected Prime Minister, Peretz has alreadypledged to cancel proposed cuts in education,health, and welfare and at the same time raisethe minimum wage by 30%. Economists haveassessed the costs of Peretz’s proposal to beover $2 billion.

The business community is correct in voicingserious concerns over the potential impact ofPeretz’s proposals.The Israel ManufacturersAssociation already warned that raising theminimum wage will lead to the firing ofthousands of workers, the shut down offactories and the transfer abroad ofproduction facilities. If Peretz’s plan was to beput into action, Israeli private businesses willonce again suffer from high taxes, excessivegovernment oversight, new tariffs, and endless

bureaucracy. Further signs of uncertainty havebeen introduced following the appointment ofEhud Olmert as Finance Minister, followingBenjamin Netanyahu’s resignation overSharon’s disengagement and expulsion ofsettlers from Gaza. Olmert, like Peretz, is alsoknown to believe in old-style economicinterventionism and statism that has proven tocripple economic growth in the past. Onlyhours after Peretz was elected as head of theLabour Party, Olmert announced a new planto combat poverty through public spending.

The Israeli economy has enormous potential.The possibility of a Hebrew Tiger is withinreach. However, the overwhelming majority ofIsraeli politicians remains short-sighted andunfortunately eschew policies consistent witheconomic freedom and economic growth.2006 will certainly be a critical year for thefuture of the Israeli economy.


The recent recovery of theIsraeli economy is, however,still fragile and stronglydependent on economicpolicies that will beimplemented after theelections in March 2006.

ZORAN JOLEVSKI is a professor atthe European University and ViceChair UN/ECE Trade [email protected]

the late 1980s, with more than 3,000employees. Gazela was one of the largestshareholders of Makedonska Bank and took asmall loan to pay for labels for shoe boxes.With such high interest rates, Gazela lost all itsshares, went into bankruptcy, and MakedonskaBank became the owner of the company.

Slow reforms and an inappropriate policy mixresulted in a long transition period. Real GDPdeclined from 1989 to 1995, finishing at a levelof less than 70% of its 1989 mark. Real wagesin the first four years dropped sharply. In 1992they were a little above 40% of their value in1989. Employment also declined, until 1997,when it was at only three quarters of its 1989level. After six years of recession, for the firsttime, Macedonia in 1996 recorded its firstGDP growth (a modest 1.2%). For the nextfour years Macedonia experienced growthwhich achieved healthy rates in 1999 and2000 of 4.3% and 4.5% respectively, in spite ofthe huge crisis in 1999 when it received over360,000 refugees from neighbouring Kosovo(equivalent to 18% of the population). Duringthis period the Macedonian government had ayoung finance minister, Nikola Gruevski, whowas a genuine reformist. During his term ofoffice he conducted rigorous policy reforms,including amongst other things, introducingVAT, transferring the payment system from thegovernment owned Social Accounting Agencyto the banking system, and a denationalisationact. Unfortunately, this growth was interruptedin 2001 by ethnic conflict, which wascontained and resolved by political means with the Ohrid Framework Agreement.

The government, aware that Macedonia was asmall market in the second half of the 1990s,began to negotiate bilateral trade agreements.Today, Macedonia is a leader in regional tradecooperation and has concluded free tradeagreements with all of the countries in theregion.Through the Stabilisation andAssociation Agreement it conducts free tradewith the EU trading bloc.The Republic of

Macedonia


The economic transition of the Republic of Macedonia wasunique. It combined a struggle for independence, a transitiontowards political democracy and free market economics,regional instability, UN sanctions being imposed on its mostimportant traditional foreign market – Serbia – and a bizarretransport embargo from its southern neighbour. If we add ina paucity of political will for swift and deep reform, it is clearwhy the economy suffered greatly.

Macedonia opted for a model of privatisationwhere managerial buy-outs were key. ’Theidea was that by encouraging management toacquire their companies, it would be in theirinterest to run them well. In practice, for themost part they opted to run the companiesbadly, decreasing the price they would have topay out. Prior to their privatisation, companiessuffered from investment shortfalls as theprospective new owners had little interest inmodernising equipment. In the process, manycompanies were driven to bankruptcy. In 1990the private sector share of GDP in Macedoniawas 15%, the same as the average in thetransition economies that recently acceded tothe EU, but by 1994 private sector share ofGDP in Macedonia was 35% whilst in the EUapplicants it had risen to 54%.That is asignificant indicator of the speed of reformstowards the free market economy.

Allied to this, the banking sector operated apolicy of extremely high interest rates whichcaused many further bankruptcies. Macedonia,in the beginning of its independence, hadinherited high interest rates, corresponding tohigh inflation. Its programme for monetarystabilisation immediately after the dissolutionof the former Yugoslavia brought inflation to asingle digit annual level, and the new currency,the Denar, was stable, being pegged to theDeutschmark. However, monthly interest ratesremained obstinately in double digits. Forcompanies that had loans, this was disastrous.The best example is Gazela, a shoe producerand one of Macedonia’s largest exporters in

Slow reforms and aninappropriate policy mix resulted in a longtransition period.

Macedonia has also concluded free tradeagreements with member countries of EFTA,Turkey and Ukraine. Furthermore, Macedoniarecently acceded to CEFTA.This ensuredpreferential access in the markets of 38countries with 647.5 million consumers.Theaim was to provide markets for productsoriginating in Macedonia and to attract foreigninvestors.The openness of the Macedonianeconomy is confirmed by comparative studiesprepared by several international institutionsand institutes. Namely, the Report onInternational Openness for 2003 from theItalian Academy of Inter-Disciplinary Studiesranked Macedonia on the 40th position out of141 countries. Only Slovenia, (ranked 19th),and Bulgaria (ranked 27th), are placed aheadof it among its neighbours.The policy was theright option but it was not followed up withmeasures for enhancing Macedonian exportsand attracting foreign investors, and as a resultthe trade deficit is very high (20.6% of theGDP in 2003), unemployment remains over39%, and a low inflow of FDI persists.The highpolitical risk level of the region and somesurprising legislative decisions made foreigninvestors wary, despite positive statementsfrom governmental officials.

The major hindrance to economicdevelopment in Macedonia is a lack of vision.Macedonia has traditionally faced two majorproblems – high unemployment and a tradedeficit.Therefore policies that promoteeconomic growth, enhance exports and createjobs are needed.The IT sector is seen to beone of the answers to this problem.

During his term of office, President BorisTrajkovski, who was elected in the autumn of1999, made it one of his top priorities toeducate both citizens and the government onthe need to become more IT savvy. Under hispatronage, he created the ‘E-Macedonia ForAll’ committee, which brought together thecountry’s top IT specialists to forge a policyfor the government to pursue.This committeecreated an environment for the developmentof an IT society, helping to raise awarenessamong government officials and the generalpublic.The committee also drafted a‘Declaration on IT’ which was subsequentlyadopted by the Macedonian Parliament.Thisdeclaration laid out a strategy, still beingpursued today, to encourage both thegovernment and the private sector toaggressively pursue ways of using IT to betterpeople’s lives.

Another top priority of President Trajkovskiwas to bring computers and IT education intothe nation’s schools.To accomplish this, heturned to experts on his ‘E-Macedonia For All’committee who helped lay out a strategy toprovide schools with computers and internetaccess.With this strategy, President Trajkovskirequested, and received, from the People’s

Republic of China, 2,000 computers in 2003for all of Macedonia’s 100 high schools. Undera project sponsored by the U.S. Agency forInternational Development, these schoolswere then linked via high-speed wirelesstechnology to each other and the world.Shortly after his untimely death in a planecrash over Bosnia-Herzegovina,Trajkovski’ssecond request to the Chinese governmentwas granted, resulting in an additional 3,000computers for the country’s primary schools.These schools will also be linked.

This resulted in another USAID projectwhich ambitiously aims to make Macedoniathe first wireless country in the world,providing wireless access to 95% of theterritory.Through Trajkovski’s foresight, thecitizens of Macedonia now have theopportunity to interact more closely andeffectively with the world.

The successful establishment and maintenanceof macroeconomic stability, the significantprogress in reforms achieved over the lastdecade, and EU candidacy status should havea positive impact on enhancing economicgrowth.The government needs, in the comingyears, to develop an integrated economicpolicy that will improve the competitiveness ofthe national economy in domestic andinternational markets.Transparency andpredictability for concluding business activitiesshould be ensured. It is therefore necessary toimprove the institutional and regulatoryframework, especially in the judicial sector,which is inefficient and one of the mainobstacles for a better business climate.Forming a flexible labour market anddecreasing employment expenses(contributions and taxes) are an importantelement for the creation of a more viableeconomy.The restructuring of privatecompanies, the strengthening of their technicalcapacity, and the enhancing of the quality ofmanagement as well as improving their accessto financial products that are available to their

competitors are important elements forimproving competitiveness. Attracting export-oriented labour-intensive foreign directinvestment is also key to strengthening theeconomy and growth of export and jobcreation. Further liberalisation of thetelecommunications market and furtherdevelopment of SMEs in the IT sector are alsoessential for innovation and economicexpansion.The educational system should bereformed in order to create a new and well-educated generation that will be able to workin the knowledge economy. Human capitalshould be the most important element foreconomic development.The next few yearswill be critical for Macedonia to engage inreforms in order to transform the countryinto a functional market economy.


IURIE BRINISTER is the Member ofthe Administrative Council of theNGO Telemedicina and consultant inareas of social protection, healthcareand SME [email protected]

ROMAN LADUS is the Chairman ofthe Center for Assistance to PublicAuthorities, a Moldovan think tank.He is also the Executive Director ofbrc.md, a business research [email protected]

Moldovan efforts to buildan efficient marketeconomy have beencommended by the Indexof Economic Freedom

calmed down, the funds became weaker andthe problem came up more obvious.Ultimately, the authorities decided to liquidatethe funds through the regulated repurchase ofshares from the population.

The land privatisation programme had its owndrawbacks. Moldova had more than onemillion landlords (around 30% of allpopulation), but the average size of the landplots barely exceeded 1.5 hectares of land.Obviously, this means land use is incrediblyinefficient, though a consolidation process isemerging, with land being bought by thosewho have the capacity to utilise it best.

Reforms in 1999 led to the development of anew Social Insurance Fund, separated from thestate budget.The system is pay-as-you-go,whereby the Fund collects social contributionsand distributes them as social insurancebenefits.The Democratic party-ledgovernment has also started to increase thepension age, from 55 to 60 for women andfrom 60 to 65 for men. Such reforms wereundertaken in order to improve the financialsustainability of the Social Insurance system.

By 2000, the social assistance system wasbased mostly on privileges given to certaincategories of the population, depending ontheir needs.Yet while few benefits took theform of cash payments, more than 30% of thepopulation benefited from the system.Thesame year, energy subsidy privileges werereplaced by nominal cash compensations andthe administration of child benefits changed.This reduced the number of beneficiaries toaround 10% of the population.

Financial constraints since independence quicklyled the healthcare sector to the brink ofbankruptcy. Despite a charitable response fromforeign aid donations, the overall capacity in thesystem was reduced, with particular problemsbeing found in hospital capacity.This gap hasnot been filled by a strong primary care systemor emergency provisions and thus the quantity

Moldova


During Soviet times Moldova was something of a testing-ground for new agricultural technologies, and most of itsindustry was oriented towards food production. Morerecently, Moldova has become a laboratory for a differentkind of experimentation, as economists and politiciansattempt to develop a flourishing economy in this formerSoviet backwater.

After gaining independence in 1991, Moldovaexperienced an economic shock from which itdid not recover from until 2000. GDPplummeted and poverty prevailed – aninauspicious start for the transition from acentrally planned to a market economy.

Unfortunately, the inherent problems oftransition have been exacerbated by the effortsof separatists to gain independence for asubstantial swathe of Moldova’s territory.Transdniester, the eastern part of Moldovawhich accounts for 10% of territory and around15% of population, declared itself independentin 1990, but has not been recognisedinternationally.The separatist regime wassupported – morally, at a minimum – by theRussian troops which remained there followingthe break-up of the Soviet Union, but were nowre-classified as ‘peacekeepers’. It is difficult forChisinau, the Moldovan capital, to exert much inthe way of political influence there, and crime isrampant.Transdniester’s self-declaredgovernment is also one of the last bastions ofSoviet-style rhetoric, and its internationalisolation massively restricts its economy’spotential – an economy which contains much ofterritorial Moldova’s industrial infrastructure.

Moldova began to build a market economy,based on the advice of internationalorganisations, by first privatising most publicproperty, including land holdings. However,privatisation based on property bonds,distributed proportionately to the populationaccording to their length of service to thestate, was not as efficient as expected. At thesame time several investment funds emerged.They exchanged their shares for privatisationbonds which they used than to purchaseenterprises. Unfortunately, gaps in theregulatory framework allowed speculation andfraud became rife. Having been reduced tocash cows for fund managers, many enterpriseseither went bankrupt or came perilously closeto it. As a result, the general population saw nobenefits from privatisation. As the process

and quality of healthcare has worsened. Since1998 the issue of health insurance has been apopular cause for reformists, the governmentmoved towards the introduction of the reformonly in 2004 due to the high transitional costs.Since 2000, the government has also specificallyfocussed on primary healthcare, but so faroverall improvements have been minor.

In 2001 the Moldovan people elected theCommunist Party into government, awarding it71 out of the 101 seats in Parliament. Someexpressed surprise that after a number of pro-democracy governments, the Communistswere able to gain such an enormous majority.However, the inefficient governance andcorruption of the Democrat regime resulted indeep poverty and uncertainty - thus spurringthe electorate to vote for radical change.

Until 2003, the policy of the country underthe Communist government focussed moreconcertedly on relations with theCommonwealth of Independent States (CIS),and Moldova remained economically andpolitically dependent on Russia. Moreover,relations with aid donors were neglectedwhich led to a considerable reduction ofinternational aid to Moldova, and to a periodof technical default. For around two years,Moldova did not receive any new fundingfrom multilateral donors and some previouslyagreed deals were held back.

Increased government awareness of its owninability to tackle these ever-growing problemsled to the rediscovery of the interim PovertyReduction Strategy which had been developedin 2000-2001. Since 2002, the government hasstarted to show more interest in itsrelationships with aid providers, and, since2004, in its relationship with the EU. Underpressure from external donors, the finalEconomic Growth and Poverty ReductionStrategy development process was conductedmore transparently, and as nationaldevelopment priorities were openly agreed,this enabled the development of mediumterm financing instruments.The MoldovanParliament approved the Strategy in 2004, andsuddenly, tiring of interference from Moscow,the Communists cooled their relationship withRussia and prioritised the EU. It was adangerous move considering their economicand political dependence on Russia, althoughthis has decreased of late. Following theRussian crisis of 1998, Moldova diversified itsexport market and so Russia’s share ofexports dropped from 58% in 1997 down to36% in 2004. At the same time EU countriesaccounted for increasing share rising from just13% up to 30%. Moldova has enjoyed aPartnership and Cooperation Agreement withthe EU since 1994, and in 2005 it signed anew EU-Moldova Action Plan.The issue of EUintegration was actively used by theCommunists during 2005 Parliamentary

elections.This helped them to keep themajority in the Parliament, although their sharewas trimmed by 15 seats compared with the2001 elections.

Labour emigration has greatly increased sinceindependence, reinforcing the degradation oflabour supply and the spread of povertythroughout the country. Despite assortedofficial declarations acknowledging this problem,the situation has not been improved. Accordingto official sources around 15% of thepopulation of working age is permanentlyabroad. Other sources provide even higherfigures. Remittances represent more than 25%of GDP and are now one of the cornerstonesof economic growth.They feed the importsector, driving its value up to double that of theexport sector. Obviously, sustaining economicdevelopment depends on the efficient use ofthose remittances and creating a favourablebusiness environment for their investment.

As part of the efforts made to secure aid andFDI, the Moldovan administration declared anew wave of reforms of the regulatoryframework to ensure the sustainableeconomic growth. Additionally, followingincreased GDP growth and improved taxcollection, the government undertook somequestionable and costly reforms in the socialsphere. It increased pension provisions forsome sections of the population, froze thepension age, and introduced a new healthinsurance scheme.

It is generally accepted that the economicgrowth since 2000 has been fuelled mainly bythe swelling stream of remittances, and therecently launched regulatory reform isconsidered to be an important tool toredirect remittance money away from pureconsumption and savings towards productiveinvestment. More broadly, regulatory reform isnow at the forefront of the reform agenda. Itbegan in 2003, but its efficacy improveddramatically in 2005 when the ‘guillotine’

approach was introduced to abandoninappropriate bureaucratic regulations.The‘guillotine’ system consisted of several stagesduring which central public authoritiessubmitted lists of their business-affectingactivities for review and revision. Around halfof all regulatory acts have been severed bythis ‘guillotine’.

Moldovan efforts to build an efficient marketeconomy have been commended by the Indexof Economic Freedom, reflected by its slightimprovement in the 2005 Index. Moreover ithas out-performed its neighbours for severalyears.When rated on an ‘ease of doing business’scale, Moldova ranks just below Romania andRussia, and is far ahead of the Ukraine.

It is important for Moldova to retainmomentum as its economy is highly sensitive.During Soviet times laws carried little poweror utility. They were very general, and thearbitrary orders of ministries and other publicauthorities usually took precedence.This mayhave been deemed an appropriate system ofcommand when public property dominated.However, this system should not have beenpermitted to continue for as long as it did.After the declaration of independence,Moldovan authorities continued to issue verygeneral laws which delegated much power tothe ministries. Although the system remainshighly bureaucratic, lacks transparency, iscorrupt, and is regularly flaunted, reforms topromote and implement principles of marketeconomics struggle through.

Further introduction of well thought-out andviable market-oriented reforms which can bothcontribute to the growth of the economy andto the social sphere are directly linked to theeffective enforcement of the rule of law.Obvious progress has been made, but questionsabout its sustainability are liable to linger.


DR PETAR IVANOVIC, Executivedirector, Institute for Strategic Studiesand Prognoses (ISSP)[email protected]

with the private sector considered a valuablepartner in drafting legislation. As a matter offact, Montenegrin private sector, representedby the private chamber of commerce (theMontenegro Business Alliance) managed toconvince the government to reduce corporatetax and contributions for wages.Thecorporate tax rate is now the lowest inEurope - 9%, while wage contributions werereduced by 10%. Still, taxation of personalincome is moderately progressive with therates of 15% and 23%. Introduction of a flattax rate remains a possible challenge for 2006.

Unsurprisingly, both the World Bank and theInternational Monetary Fund opposed the taxchanges.Their main concerns were to protectbudget revenues and to insure macro-economic stability. However, stability can beachieved at different levels: a level that causesstagnation or a level that fosters economicgrowth and development.The best proof thatfree marketeers were right in demanding taxcuts was the increase of budget revenues thatoccurred in Montenegro after the reductionof tax rates. Revenues from corporate tax andfrom personal income tax were higher in2005 than a year before, and total budgetrevenues increased from €379.3 million eurosin 2004 to €432.1 million in 2005.

Value added tax (VAT) is set at 17%, and theaverage customs tariff is 6%, which is stillhigher than in most of the EU and is nearlythree times higher than in the US. Only 68.2% of imports in 2004 and 67.7% in 2005 were covered by exports. Foreigninvestments rose and fell, but reached a peakin 2005, accounting for over €300 million or18% of GDP, mainly through the privatisationof state enterprises. A semi-independentagency for investment promotion was set up.Privatisation is approaching its end with fewer than 20 enterprises still state-owned.Telecommunications, the banking sector andthe capital market (including two stockexchanges, ten brokerages and six investment

Montenegro


In April 2006, the Republic of Montenegro plans to conducta referendum allowing its citizens to vote on completeindependence. Alongside representing the end of theprocess of break up of Former Yugoslavia, this process mightalso symbolise the ending of the era of politics’ dominationover the economy, at least in the smallest ex-Yugoslavrepublic. More importantly, this would be unique chance forMontenegro to strengthen the on-going creation of a freemarket and open society.

After a decade of destruction due to the warsin the surrounding countries, waves ofrefugees (that at one point reached 20% ofthe overall population), a brain drain triggeredby hyperinflation in 1993, political tensionsunder the Milosevic regime and NATO airstrikes in 1999. Montenegro ended up in aunique union, imposed by the EU, consisting oftwo republics - one ten times larger than theother and with completely different economicsystems. However, Montenegro is graduallymoving to the next stage of its development.

Under the Belgrade Agreement (signed bySerbia, Montenegro and EU representatives)Montenegro retained the right to proceedwith economic reforms through its ownParliament with the Euro as the only currency,while Serbia retained its Dinar. Over the lastfive years, the success of the economicreforms has been confirmed by the followingimproved macroeconomic indicators: theinflation rate reduced from 28.0% in 2001 to4.3% in 2004 while estimated inflation for2005 is 2%.

This country of 620,000 inhabitants increasedits GDP from €1 billion in 2000 to 1.53 billionin 2004. GDP per capita is €2,500 (2004).Real GDP growth was 3.7% in 2004 and 4.7% in 2005. In terms of the conditions forbusiness registration, Montenegro has beenrecognised by OECD as a champion with just€1 required as starting capital for a limitedliability company and just 4 days of requestedtime to confirm the registration in theCommercial Court. Montenegro has beenranked for the first time by the Fraser Institutein their indices of economic freedom. It isplaced 86th out of 127 nations with a scoreof 6 out of 10 (with 1 being the mosteconomically repressed). Standard and Poor’sawarded Montenegro a BB in 2004 and animproved BB+ in 2005.

The government has developed a morecorporatist approach to business relations,

funds) are now 100% privately owned. Byadopting the euro as its currency Montenegrocontributed to a valuable saving on transactioncosts, especially for European investors andimport/export firms.

A recent Montenegro Country Memorandumissued by the World Bank highlighted somenegative aspects of Montenegro’sdevelopment. However, The Institute forStrategic Studies and Prognoses identified over30 errors in this report and deduced that theWorld Bank experts had selected out-of-dateinformation to discredit progress made by theeconomic reforms, and only used new datawhen it aided their case.Thus, the value ofsuch an inaccurate report is questionable.

Although many positive changes haveoccurred at the state level that are improvingoverall environment for business development,three processes pose a significant threat toprogress: (i) public expenditure still accountsfor a large proportion of GDP; (ii) municipalbureaucracies are growing in power andinfluence (iii) the number of regulatoryagencies is expanding.

Budget expenditures (government spending,excluding state pension and health overheads)account for 25% and total public expendituresaccount for 45% of GDP. Budget expenditureshave increased from €259.3 mill in 2001 to€400.6 mill in 2004.While the main portion ofbudget expenditures are the fixed costs ofemployees’ salaries (constituting almost 40%),this boost is mainly due to the commitmentstoward the union with Serbia.

Numerous taxes and levies were created atthe municipal level, making them the largestsingle barrier to private sector development.The growth of such barriers developed underthe cover of two processes: decentralisationand democratisation, both imposed by foreigndonor support programmes.While suchprocesses make sense in large countries, it ishard to believe that they can really supportthe development of democracy in a countryof 620,000, with 21 municipalities, where overone third of the total population lives in thecapital city Podgorica. In fact, those processescreated monopolies at the municipal level,demonstrating that there is no single solutionfor all countries. Simply copying successfulprocesses from other countries toMontenegro has proven unhelpful due toMontenegro’s circumstances.

Additional danger comes from the regulatoryagencies. Such agencies already raise businesscosts.When regulators’ solutions fail initiallythey will persist in their attempts to restrictbusiness practice, and problems are alwaysblamed on the market.Therefore, theregulatory costs for a particular business arenot limited to those relating to equipment andemployees, but also incorporate the additional

legal and accounting work needed to complywith the rules, and these costs must be passedto consumers through higher prices.Theseregulatory costs have cut jobs and investmentsand there exists scant evidence of any benefit.

So were does Montenegro go? Today,Montenegro represents a melting pot ofvarious ethnic groups (Montenegrins, Serbs,Muslims, Albanians, Croats, Roma andBosnians), religious beliefs (Orthodox,Catholic, Islam), as well as of other types ofdifferences (for instance, between urban andrural population, or among the variousregions). It managed to avoid the ethnicconflicts and extreme polarisation betweenreligions, cultures and other identities ofindividuals and groups which so plagued itsneighbours.This creates an opportunity inMontenegro to develop a coherentMontenegrin identity that goes beyond thereligious or ethnic distinctions.

Still, some are raising the question of howmuch of a hindrance underdeveloped humancapabilities will become in Montenegro’sfuture development? It is vital that thesuccesses of those institutions operatingoutside of the formal state education systembe allowed to continue to expandMontenegro’s human capital.This will nurturea population which thrives on free thinking,free dissemination of ideas, and pure freedom.

There is no doubt that Montenegro is beingtransformed into a pluralist type of democracyand that with every day that goes by it is

becoming an increasingly open society.Thereforms of the past five years have beensuccessful. So long as Montenegro is allowedto adopt the policies most suited to itsdevelopment it has the potential to becomethe most successful economy to emerge fromthe Yugoslav ruins.


This will nurture apopulation which thrives onfree thinking, freedissemination of ideas, andpure freedom.

DAG EKELBERG is ManagingDirector of [email protected]

new right-wing protest party – the Progressiveparty – which today is the strongest non-socialist opposition party in parliament.

The renaissance for market oriented ideasreached Norway in the late 1970s and early1980s.The Conservative party won theparliamentary election in 1981, with promisesof deregulation and tax cuts.The hegemony ofthe Labour party was broken and a coalitionof non-socialist parties commenced a series oflong overdue reforms. Financial servicemarkets were deregulated, the state monopolyon broadcasting ended, and restrictions on thebuying and selling of private homes werelifted. Private healthcare was no longerforbidden and the first privately ownedhospitals were established.

When a more ‘moderate’ and pragmaticLabour party came back to power in the early1990s they did not reverse the reforms of the80s.Together with the Conservative party,their primary goal was to convince thepopulation of the need for EU membership. Inthe referendum in 1994, a majority (52percent) voted ‘no’.This was not an objectionto big government; on the contrary, it wassocialists and protectionist farmers who voted‘no’ to an EU which for them was a symbol ofinternational capitalism and, astoundingly, lowersubsidies. Since then the question of EU-membership has remained politically taboo.

After the parliamentary election in 2001, theConservative party formed a coalitiongovernment with the Christian Democrats andthe smaller Liberal party, with support inparliament from the Progressive party. Marketoriented reforms were supported on amunicipal level. Outsourcing, more competition,and the use of vouchers became central in themodernisation of the public sector.

The tax burden was reduced, both onbusinesses and on personal income, althoughnot as much as was initially promised. Norwaycontinues to have a relatively low formal tax

Norway


According to the UN’s Human Development Reports,Norway, the North European beacon of big government, isthe best country in the world to live. Needless to say, thisdoes not make for the most conducive environment inwhich to advocate market-oriented reforms.

Last year Norway celebrated its 100 years ofindependence from Sweden. Howeverindependent, Norway has both adopted anddeveloped further the welfare state ideologyof the Swedes. Since the early 1970s, thanksto enormous revenues from oil and gas, thecountry has steered clear of crisis which, inother countries with a more ‘normal’ economywould automatically trigger a debate on thecostliness of the welfare state.

Petroleum revenues have made a significantcontribution to the Norwegian economyduring the past few decades. Still, onshoreproduction constitutes about 80 per cent oftotal value added in Norway, a share that willgradually increase as a consequence of theforeseen decline of petroleum extraction.Ensuring mainland Norway’s capacity forgrowth is thus vital. It helps to be the mostproductive European country measured byGDP per capita (US$ 40,784 in 2005)

To sustain today’s public services and meetfuture pension obligations, the public sectormust deal with a gradually increasing financinggap. Compared to 2003, the gap is estimatedto increase to around 8 per cent of Norway’smainland GDP in 2060.)

The Labour party dominated Norwegianpolitics from the end of the Second World Waruntil the mid 1960s, after which came a periodwith alternating governments before a returnto Labour party dominance through much ofthe 1970s as well.The 1970s saw the birth of a

It was socialists andprotectionist farmers whovoted ‘no’ to an EU whichfor them was a symbol ofinternational capitalism and,astoundingly, lower subsidies

rate on corporate income, but a comparativelybroad tax base implies that the effective taxrate on company profits is in the middle rangeinternationally.The highest marginal tax rateon labour income has increased during thelast decade and is now relatively high (64.7per cent, including employers’ social securitycontributions). Due to Norway’s dual incomesystem, with a flat 28 percent tax rate oncapital income and a progressive taxation oflabour income, there is a need to bridge thegap between the taxation of individuals andthat of companies.

As every economic indicator was signallingsuccess, Norway’s voters decided that it wastime for a political experiment.The Labourparty, together with the Socialist party andthe agrarian and strongly protectionistCentre party, formed a majority coalitiongovernment after the election in September2005.The Conservatives experienced theirworst ever election result.The challengingsocialists succeeded in painting a rather grimpicture of the state of public social services.The centre-right government was accused ofdismantling the welfare state and giving taxcuts to the wealthy, rhetoric which thoughlargely unfounded, was never crediblyanswered.The election also saw a moreradical Labour party teaming up with labourunions and, for the very first time theSocialist party as well, in an effectivecampaign against market oriented reforms.

The leading Norwegian labour union (LO)has always played an important role for theLabour party.The labour union hastraditionally represented the interests ofNorwegian industrial workers in the privatesector.With a growing public sector anddecreasing industrial sector their focus hasshifted.The labour union has now becomethe leading force against market orientedreform in the public sector.They play a farmore active role today and have gainedstronger influence within the Labour party.The Labour union financed the partieselection campaign, and are now seeking areturn on that investment.

The private sector is losing ground and publicexpenditure is rising. One out of threeNorwegian workers is employed in the publicsector.With a population getting older and anincreasing demand for better services, it isquite obvious that market oriented reformsshould have been high on the agenda. But, onthe contrary, this government came to powerby promising “less market and moregovernment”.

A few months after the parliamentary electionit is quite clear for everyone that the majoritygovernment, which promised stability, is onunsteady ground, mainly due to a series ofblunders from the ministers from the once-popular Socialist party.The question is how

long the Socialist Party can afford to be a partof government.

So what are the hopes for market orientedreforms today? The answer is probably that anon-socialist coalition which includes theProgressive party will form in the election in2009. Meanwhile, in Oslo and in other citiesrun by centre-right politicians, reforms initiatedby the former government will to someextent continue.

Building a non-socialist coalition is crucial.TheProgressive party has gained popularity andfor the first time they represent a seriousthreat to the Conservative party’s historicalhegemony on the right side of politics.TheProgressive party is now by far the biggestnon-socialist party and no future coalition ispossible without their participation.That isquite remarkable, considering the Progressiveparty’s history of inconsistent politics; apeculiar mix of free market economics andsupport of increased government spendingand state ownership, combined withscepticism towards immigration.

However, the Progressive party and theConservatives agree on the need for marketoriented reforms.The challenge is to build analliance for change in 2009 and to work ondifferent levels and in many arenas to create abetter understanding for the need for reformthat includes the private sector and whichreduces government spending.


HORIA PAUL TERPE is a PhD studentat the National School of PoliticalStudies and Public AdministrationBucharest, and an Executive Directorof the Center for Institutional Analysisand [email protected]

rates to match the real one), thus enlarging thetaxation base in seeking to achieve the Lafferoptimum (the point at which taxation income isat its highest without disincentivisingproduction).The new government was swornin before the Parliament on December 28,2004, and the law implementing the flat tax wasfinalised the same evening and passed beforeJanuary 1st, so that it could enter into forcestarting in the 2006 fiscal year.

In addition to the corporate and income taxrates, various other taxes were also set at theuniform level of 16%. Some fiscal modificationssuch as the increases of the tax on stock marketgains (from 1 to 16%) and of the special tax formicro enterprises (raised from 1.5% to 3%)were postponed until 2007. Beyond the actualtax levels, tax collection was greatly simplified byabandoning highly complicated global incomeforms in favour of a direct 16% income tax,applied at source, for all persons having a singlesource of income (amounting to about 80% oftaxpayers).The simplified system has lowermaintenance costs and ensures a whole array ofadvantages, including more uniform taxcollection and a reduced probability of personalaccounting mistakes.

The practical implementation of the flat taxneeded to address a core problem: the time lagbetween the sudden decrease in budgetaryrevenues, resulting from the tax cut, and theirsubsequent increase, as a result of a larger baseand Laffer optimisation. Among the measuresemployed to address this, an ‘amnesty’ wasoffered to taxpayers for previous fiscal frauds;the bureaucracy was made more accessible byextending tax office opening hours andimproving staff training; and a retaliatory policyof tightened fiscal monitoring and sanctions wasput in place.The government has alsosubsequently operated on a much tighterbudget, refusing to increase public sectoremployment levels and not expandingresources for government departments.

Romania


Romania wasted the first 15 years of its independence.Following 1989 revolution, a vague, haphazard, and middle-of-the-road ‘gradualist’ reform programme was chosen as thesafest way to economic prosperity. In practice this only everamounted to a continuous series of ineffectual responses toever-expanding crises.

No progress had been made by 1996 whenthe former Communist party was finallyousted from power and replaced by a centristgovernment. Bedevilled by infighting however,the new government achieved little morethan its forebears. By 1999, having failed toachieve either economic liberalisation ormacroeconomic stability, growth wasrecorded at close to 0%.Thankfully, thismarked the end of the decline. In the periodfrom 2000-2005, the economy entered arecovery phase, marked by acceleratinggrowth. By 2004, the privatisation programmewas largely complete following some majorsales. Just as crucially, a long-discussedproperty rights regime finally became a reality.Furthermore, administrative decentralisationand other institutional improvements beganto produce promised efficiencies.

These small changes set the stage for asecond wave of reforms, which were put intomotion following the election of a centre-rightgovernment at the end of 2004, the ‘OrangeAlliance’ between the National Liberal Partyand the Democratic Party, and by theformation of a governing coalition around thisreconstituted political force.

The most significant feature of this secondwave was the creation of a system of flattaxation. Assuming a proposal previously madeby a group of NGOs in 2003, the Alliance set a16% flat tax as the policy cornerstone of itselectoral platform.The proposed measure wasbased upon a fairly detailed and soundmacroeconomic projection of the flat tax’simpact on the economy. The main argumentwas simple: previously, the nominal taxationlevel was 25% on corporate profits and rangedthrough five bands between 23% and 40% forpersonal income tax. However, due to themassive problem of tax evasion – estimated toaccount for as much as 40% of GDP - theeffective taxation rate was eventually set at just16 percent. Subsequently, the report concludedthat it was necessary to lower the nominal tax

The whole plan provoked heavy criticism fromthe IMF and other international actors whopredicted that increasing the budget deficitwould accelerate inflation.When revenuesstarted to increase, this dissent swiftlydissipated.This pressure did bring about anarray of contradictory announcements fromgovernment officials in the spring of 2005.Some promised tax increases, while otherpledged to maintain the status quo.Thesedeclarations created confusion and jeopardisedthe economy’s ability to adjust to the newmeasures. Deficient communications were alsoevident in the separate announcement ofsome increases to collateral taxes, which,though of little significance, led to a publicbelief that the tax burden was likely to rise.

While it is far too early to make a finalconclusion regarding the effects of the flat tax,the initial indicators are encouraging. Sixmonths after implementation, budgetaryrevenues increased by about 4.7% comparedwith the same period of the previous year. Acumulative 16% increase is estimated for 2005.100,000 new jobs were added to the economyin the first five months, and 140,000 in the firsteight (although some critics suggested that theywould have been created regardless of the flattax). Important economies of scale are beingderived from the reduction in bureaucraticwaste, as tax offices become easier to manageand tax forms are simpler to fill out. However,despite these achievements, criticism of theimplementation of the flat tax system becomemore vociferous

Another major achievement for the newgovernment, one which had been a prominentfeature of their electoral campaign, was theirfirst attempt at reforming the retirementsystem.The recalculation of all pensions beganwith a review of all retirement portfolios, whichstarted in January. Over the years, inflation, thegovernment’s persistent squandering of theretirement fund, and the fight for preferentialtreatment amongst and within occupationalcategories, caused unfair inequalities betweendifferent groups of retirees.This unfairness wasexacerbated as the ratio between contributorsand retired persons decreased. However, themeasure is of minor significance, and the systemis still a pay-as-you-go nightmare in whichcurrent generations’ contributions pay for theolder generation pensions.With dependencyrate estimations ranging between 0.7 and 1.1contributors per beneficiary, this recalculation ofall pensions must only be a necessarypreliminary step with more daring and drasticreform to follow.

Progress is also being made in reforming thejustice system, which needs to counterwidespread corruption both within the systemand society at large.Whilst low-levelcorruption is largely containable through theimprovement of incentives that will render it

economically inefficient (such as, for example,lower taxes), combating high level corruptionrequires vesting stronger investigative andpunitive powers in the justice system.

The appointment of Monica Macovei (aformer leader of a corruption-fighting NGO)as Minister of Justice was regarded as a meansof building confidence and ensuring suchreforms gets off the ground. Initially, a set oflegislative measures focussed on the justicesystem and property rights were codified, asthe previous lack of legal clarity in the areawas a bounteous source of corruption.However while this provoked a political crisisin the spring of 2005, and in spite of variousblockages, the continuation of the process andthe replacement of several high level justiceofficials constitute positive, if preliminarydevelopments.The progress Macovei’scampaign has made was evidenced by recentclashes between the Ministry of Justice andthe Parliament, which rejected two decisionsin the anti-corruption investigations. Duringthis spell of prominence, public support sidedmore strongly with Macovei’s team than theparliamentarians.

But much wider-reaching reform is stillneeded. Reforming the health system is anurgent priority - following appalling backlogsand shortages in 2005, the Health Ministerwas forced to resign.The system is, in itscurrent state, financially unsustainable.Education reform has also lagged behindschedule, though the recent resignation ofEducation Minister Mircea Miclea, coupledwith continued teachers’ protests, willhopefully help push reforms forward.

The civil service is also in poor shape. Underthe auspices of ‘depoliticising’ the administration,public officers have been granted immunityfrom being fired, making them rather difficult tomotivate.The selection of such public officersalso suffers heavily from corruption: preferentialtreatment is given to friends and contacts.

Consequently incompetent staff, and lack ofgeneral administrative capacity (as recognised inall EU Commission Reports on Romania’sprogress towards integration), are state-widephenomena.The quality of administrativeoutput (for example, laws and regulations, butalso reaction capability and general efficiency)has decreased steadily. Some progress has beenmade, though the results are currently unclear.

One reform that commands widespreadpublic support – roughly 80% in opinion polls- but which is yet to be addressed is that ofthe electoral system. More than 60% of thoseasked favoured abandoning closed party listsand replacing them with nominatedcandidates.The public have also demanded the creation of a more proportionallyrepresentative electoral system, combinedwith a reduction in the number of MPs.However, obtaining the necessary consensusof all the political parties will not be easy.

In Romania, as in so much of Eastern Europe,the picture is mixed. Fiscal and judicial reformsare encouraging, but without commensurateimprovements in education and healthcare,they are of little value and liable to be short-lived.That said, the pace of reform has pickedup through 2004-2005, and the public’sappetite for it is not diminishing.The progressof this year should be taken as evidence thatfurther improvements are possible.


The public have alsodemanded the creationof a more proportionallyrepresentative electoralsystem

SIMON MOORE is a researchofficer at the Stockholm [email protected]

journalists... and the drastic state of pressfreedom in Chechnya.” Even when the statemakes no overt interference, self-censorshipoccurs to such an extent that reporting,particularly on controversial subjects such asChechnya, or presidential elections, becomeswholly subservient to the Kremlin.

Political freedom barely exists. FreedomHouse assigned Russia their lowest possiblerating, ‘not free’, in their 2004 report (even the USSR was rated ‘partially free’ in its finalassessment in 1990). Russia was the onlycountry this time around to regress towardlower levels of freedom.The crackdown onofficial and unofficial opposition alike has beendramatic. Supporters and key members ofopposition parties face harassment andpersecution from the state, as political powerhas become more and more concentrated inthe presidency. In 2005, a new bill was draftedrequiring foreign NGOs to apply for permitsto operate in Russia.This seems to be partlyin response to the revolutions in neighbouringGeorgia and the Ukraine in recent years, inwhich foreign NGOs were seen as leading thedemocratic charge. Fearing ‘regime change’advocacy in Russia, the new laws grant thegovernment the ability to decide who maystay and operate and who can be forced out.And even when permits are granted, NGOswill be compelled to have a ‘council oftrustees’ composed of Russian nationals orpermanent foreign residents. Mercifully, this lawhas not yet been passed and remains open toamendment, but it would come as littlesurprise if Putin pushes this through.

Business freedom is also heavily encroachedupon by the state.The World Bank’s latestDoing Business report places Russia 79th of155 countries assessed, while the HeritageFoundation’s Index of Economic Freedomranks Russia 124th of 155, in the ‘mostlyunfree’ category.The latter report decried inparticular the Russian government’s doublingof income from property and industrial

Russia


Much like its forefather perestroika, reform in Russia hasalways occurred in a rather spasmodic fashion. Sweepingchanges are hinted at from time to time, but theirapplication scarcely runs as advertised. And, all too often, aperiod of reform is followed by a reassertion of theoppressive tendencies that the country so desperately needsto shed. In the short period of time since communism’s fall,this has never been more apparent than under thepremiership of President Vladimir Putin.

Between the economic collapse of 1998, whenthe Russian currency’s value was slashed by75%, and 2001, a period of vital growth (two ofthe three years, growth was in excess of 15%)generated a rare optimism about the economy.In a 2001 assessment, even the OECD wascomplimentary of Russia’s economic reformrecord and optimistic about its potential.Indeed, at that time the state had practicallywithdrawn from direct involvement in theeconomy, and with more than 90% of GNPproduced in the private sector, Russia was (bythat measure) the most capitalist country inEurope.Yet under Putin’s increasingly visiblehand, the economy has lurched back towardold practices, frightening away investors andharming prospects for the future.

In June 2005, the OECD’s follow-up reportwas much more critical, pointing to theincreased concentration of power in thehands of the government, and an apparentinability to refrain from interfering in businessoperations and economic activity. Growthpredictions were down to 5.8% for 2005,signifying the downturn in reforming activityover that period.

Moreover, it could easily be argued that, since2001, there has been a regression in terms offreedom. For example, government nowexerts enormous influence over the media.Reporters Without Borders has expressedconcern at “mounting press freedomviolations” in Vladimir Putin’s Russia, including“the absence of pluralism in news andinformation, an intensifying crackdown against

Russia was the onlycountry this time aroundto regress toward lowerlevels of freedom

enterprises, and massive restrictions of foreigninvolvement in the aerospace, natural gas,insurance, electric power, defence, naturalresources, and large-scale construction sectors.Property rights are feebly protected, withbribery a common resort in the face of weakand incomprehensibly inconsistent judicialrulings. Inflation, however, is gradually beingbrought under control, trending downwardsfrom around the 20% mark in 2000 to around11% projected for 2005.

Following abysmally poor levels of taxcontribution during the 1990s, a period whenenforcement was negligible, and tax rates werehigh, (and in some cases also hopelessly unfair :a ‘turnover tax’ meant loss-making companieswere still taxed), a system of flat taxation wasintroduced under Putin. Personal income istaxed at 13%, while corporate taxes sit at 30%(with a +5% option available for municipalgovernments to add to this). Alongside this,and arguably more significant than the flat partof the new tax law, a much more effectivepayment enforcement regime was instituted,alongside other reforms including the abolitionof most deductions and exemptions, and thecreation of a new, regressive social securitypayments scheme where contributions varybetween 39.5% at the low-earnings end to just5% in the top band.The turnover taxes wererepealed completely.The outcome of thisswathe of reform was an increase in taxincome, but a slowing of growth rates (from anaverage of 10.6% over the six quarters beforethe law’s introduction to 4.6% for the sameperiod afterwards), although both the revenueincrease and the growth slowdown areattributable to other factors acting incombination with the tax reforms.

The new enforcement regime has comeunder severe criticism from business leadersbecause of its more stringent applicationagainst political enemies of President Putin.The case of Mikhail Khodorkovsky, one ofRussia’s wealthiest oligarchs and a keycontributor to Russia’s opposition parties, hasreceived the most publicity – many havecorrelated his conviction and 9-year sentencefor tax fraud with his erstwhile burgeoningpolitical aspirations. Other major businessleaders have become wary of using their vastwealth and influence in the political arena, lestthey suffer the same fate.

This antipathy represents one of the morestartling policy changes between Putin’sgovernment and his predecessor Boris Yeltsin.Yeltsin was highly supportive of the oligarchs,facilitating their accumulation of extraordinaryfortunes from privatising key state industries,while keeping them close to government askey advisors.This inevitably drew charges ofcronyism, which Putin, himself a onetimestooge to the oligarch power circle, has takendrastic steps to remedy.

Privatisation programmes in energy industriesin the early capitalist days were among themost radical and lucrative embarked uponever. Yet the scheme ultimately failed toproduce any kind of meaningful competition inthe sector, instead granting vast wealth andinfluence to a small cabal of energy magnateswhile failing to address the needs of theindustry or the nation. Russia has failed to takeadvantage of the increase in oil prices, seeinglittle change in government revenues orcorporate investment. Meanwhile, what cashdoes flow in is rather disproportionatelydistributed between Moscow, the Siberian oiland gas-producing regions, and the bankaccounts of the major companies. Most of theremainder of the Federation has developedlittle or not at all since the fall of the SovietUnion nearly 15 years ago. Infrastructuralconcerns outside Moscow, St. Petersburg, andthe oilfields makes what is left of the countrya poor destination for investment, whileminimum wage concerns put labour costsabove some competing ‘developing’economies, including many former allies inEastern Europe.

Another hindrance to Russia’s development isits continued state of quasi-war withseparatist rebels in the Caucasus province ofChechnya. Under Yeltsin, the conflictconsumed vast amounts of governmentresources, and yielded little in the way ofclear successes. Under Putin, though militaryengagements have been scaled back, theconflict has not been resolved. Hopes werehigh when a 2003 referendum was passedgranting greater autonomy to Grozny whilecementing Chechnya’s position as part of theFederation. Since then, however, terroristattacks have not abated, and Russianretaliatory attacks have been scaled up,including the assassination of the separatistgovernment President Aslan Maskhadov.Concerns abound, too, about other areas ofthe Federation. Russia’s territorial integrity

may be wholly in question, with up to eightregions exhibiting various degrees ofsecessionist yearnings.

More successful revolution attempts in otherneighbouring states have also prompted ire inMoscow.The ‘Rose’ Revolution in Georgia andthe ‘Orange’ Revolution in the Ukraine bothreplaced Moscow-aligned regimes with morewestward looking, pro-EU governments.This hasharmed Russia’s regional influence, and may alsoeventually harm Russia’s trade status, as many ofits neighbours in the former Soviet Unionpresently rely on Russia for large portions oftheir imports. Friendlier relations with the EUfor these countries could see the bulk of thatimport market transferred to EU members.

What the future holds is always difficult topredict, but Russia’s case is more difficult thanmost. Its history has been dogged withunderachievement and the squandering ofmajor advantages by political mismanagementand communist doctrine. Its sheer size (withthe natural resource benefits this provides)and traditional scientific expertise ought toconstitute a sound basis upon which todevelop productive niches in the globaleconomy. However, if these opportunities arewasted through corruption, governmentinterference and underinvestment ininfrastructure and development, Russia’seconomy may remain buried beneath aSiberian winter for many years to come.


MIROSLAV PROKOPIJEVIC isPresident of the Free Market Centre,a Belgrade based NGO, and isProfessor of Public Choice andPrincipal fellow of the Institute forEuropean Studies, Belgrade, [email protected]

Another example of this so-called reform is theanti-monopoly regulation passed in September2005, allegedly modelled on the EU system. Itdoes not, in fact, regulate state aid and actuallyexempts firms the government deems to be of‘special public interest’ from the application ofthe law.The government has the prerogative todeclare any firm a ‘special public interest’, apractice which has been common in Serbia fordecades, and which renders the entire law tobe little more than an illusion.

The current draft of a new law on traderequires all retailers with more than 5000m2

of sale space to obtain special permits, anotherunnecessary interference in market forces.Similarly, another draft law on foreign trade,which is currently circulating, restricts foreigntrade even when trade and current accountbalances are jeopardised, another decision leftto the discretion of the government. Draft bills on investment, pension and other fundseffectively prohibit shared investment, whereinstate bonds (approved, naturally, by the SerbianCentral Bank) are the only available investmentoption. And even if the Central Bank were toallow trade in foreign securities by reclassifyingthem as ‘safe’, another banking law currentlyprohibits their sale, rendering them utterlyfinancially inviable.

The position of the individual investor is evenless favourable because hard currency canonly be transferred outside the country for a restricted number of health and educationalservices. Regulation in this area is a holdoverfrom Tito’s rule, allowing money to easilyenter the country but only able to leave it in ‘extraordinary circumstances’. All the otherex-Yugoslav states have liberalised currentand capital transactions. Serbia remains theexception.

Following a pattern that runs contrary to bothinternal and international demands for reform,

Serbia


After 35 years of Tito’s rule, and a further 12 years underSlobodan Milosevic, Serbia became a democracy in October2000. Many expected a clean break from the past, and hopedfor a series of swift and wide-reaching reforms.They were tobe disappointed – all of Serbia’s subsequent leaders havebeen largely preoccupied with corrupt self-enrichment, andhave merely paid lip service to Western demands for reform.

The West’s guilt about their belated militaryintervention during the break-up of Yugoslaviaresulted in considerable foreign aid donationsand soft loans in exchange for Belgrade’scooperation on reform.Yet this influx of cash has only served to prop up the existingeconomic structure, further reducing theauthorities’ appetite for reform.Why riskcostly changes? After all,Western aid hasallowed them to sustain the illusion thatimprovements in living standards are possiblewithout reform.

Noting this reluctance to reform, the attitudeof Western countries and institutions beganto change in 2003. Aid is still provided, butmust now correspond to reforms mandatedby the World Bank, International MonetaryFund (IMF), and the European Bank forReconstruction and Development (EBRD).As a result, the Serbian authorities havepassed specific legislation at the behest of theinternational institutions, but significantly, theactual reforms have failed to wrest theeconomy free from the heavy hand of thestate and special interests

For example, the ‘Action Law’ regulatescompanies in which the government has aminority 2-50% stake following privatisation so that explicit government authorisation isrequired to act in any one of nine differentcapital areas of business policy.Thisrequirement fundamentally undermines privateproperty rights and is an open invitation forcorruption, as governmental approval simplycomes in exchange for ‘monetarycompensation’. Similarly, a new labour law was passed in June 2004 that replaced aprevious, more liberal law enacted earlier the same year. It reintroduced compulsorycollective bargaining, made the procedure for dismissing employees enormouslycomplicated and raised the minimum wagewell above the market equilibrium.

and to the recommendations of the EU’sFeasibility Study in April 2005, the Serbianauthorities continue to use any and everyopportunity to strengthen the role of the state,control voluntary exchange, suppress marketforces and extend opportunities for corruptionopportunities and the discretionary involvementof the state in individuals affairs. For that reasonSerbia belongs at the very bottom of the list ofEuropean transition countries in terms ofpersonal and economic freedom.

Serbia has never been ranked by the FraserInstitute in their indices of economic freedom,and it has not been ranked for two years bythe Heritage Foundation & Wall Street Journalbecause of a shortage of investor interest.Thelast time it was ranked, in 2003, it was placed149th place among 160 nations of the worldwith a score of 4.25 out of 5 (with 5 being themost economically repressed). In contrast to

private investors and independent researchers,who either do not rank Serbia at all or rank itat the bottom of their respective lists, the IMF,World Bank, EBRD and other non-marketfunds fluctuate between two extremes whenevaluating the Serbia’s performance. On someoccasions, Serbia is heralded as a champion ofreform; sometimes it is admonished forstruggling to implement any internationalrecommendations. Often, one institution willissue a very positive statement just as anotherprovides a very negative one. For example, theIMF threatened to withdraw its support if theSerbian government did not conduct minimalreforms – consisting of the selection of aprivatisation adviser for sale of two oilrefineries, a reduction of state pensions andmaking initial moves for the liquidation of somebankrupt firms. At the same time, the WorldBank ranks Serbia a relatively high 92nd among155 nations in the world in its Doing Business2006 report, and declares Serbia as one of thetwelve leading reformist nations in the world.This report also ranks Croatia the 118th bestnation in the world to start a business.This isseveral places behind Serbia, and all the otherremaining research suggests that this is wrong.(The list also ranks Belarus 106th and Iraq116th - mistakes that might be amusing if theywere not so misleading to potential investors).

So what are the basic facts about Serbia? A country of some 7.5 million inhabitants,

it produces an annual GDP of approximately€15bn - just 10% of Greece’s GDP or0.0015% of the EU25. Its average growth ratebetween 2000 and 2005 hovered around the3.5% mark, though GDP growth stagnated in2005. Inflation in 2003 and 2004 was 11% and13.7% respectively. It is currently around 17%per annum and is still on the rise despitealready being the highest in Europe.

The Serbian state is the most overbearing inEurope. State expenditure accounts for 55%of GDP, ahead of Sweden’s 52% and Belgium’s50%. However, the Serbian paradox is thatwhile state expenditure is proportionately thehighest in Europe, many important tax ratesare relatively low. Personal income is taxed ata flat rate of 10%, and corporate income taxat just 10%.Yet these two taxes do notcontribute significantly to governmentrevenues. Instead, numerous smaller taxescounter this shortfall.There are around 200different tax schemes, and some of them areprohibitive. In order to pay an employee €100of net salary, employers have to pay anadditional €73 in payroll tax. Sales tax is set at18%, and the average customs tariff is close to10%, three times higher than in the EU andnearly five times higher than in the US.Imports outweighed exports by 31% in 2004,and by 42% in 2005. Under thesecircumstances, investment amounts to 14% ofGDP, with just a half of that received by moresuccessful transition countries. FDI in 2004was around €700 million, just a third ofBulgaria’s FDI in the same year. Both figuresreflect a low level of economic freedom andthe weakness of the rule of law.

So what will become of Serbia? Thehoneymoon period that followed the October2000 elections – principally financed byWestern donations, soft loans and privatisationrevenues – is over. During the next two years,Serbia must reach final settlements with

Kosovo and Montenegro on issues ofterritorial and sovereignty. Both are likely togain greater autonomy, or even independence.To compensate for the loss of Kosovo, the EU will launch negotiations on the ‘Stabilisationand Association Agreement’, in order to boostpro-European sentiment and to suppressnationalistic forces. Unlike transition champions,such as the Baltic States or Slovakia, whichadapted to the conditions of EU membershiprelatively smoothly, it seems that Serbia may beless able to adapt. Democratic institutions,economic freedom and the rule of law inSerbia are all far weaker than in the EU.Theonly way to implement tough reform is withthe encouragement of the EU. But in order forSerbia to take this route, it needs to completelyreverse its current economic policies. Instead ofclinging on to the ways of the old regime, itneeds to break from them. Instead of servingthe old interest groups, the government needsto serve the public interest. Instead of closingthe country off, they must lower barriers withthe rest of the world. Instead of a heavyhanded state, economic reform is needed tofree market forces. Instead of cultivatingcorruption opportunities, the governmentpolicy should be to fight corruption. Only thepassage of time will show whether suchfundamental changes are possible and what thecost will be.


Another example of thisso-called reform is the anti-monopoly regulationpassed in September 2005

PIERRE BESSARD is political editorof L’Agefi, the Swiss financial dailynewspaper, and a founder of theInstitut Constant de Rebecque, thefree-market think [email protected]

along with Japan and others, exclusively defendfarmers’ interests with no consideration forconsumers. Swiss agriculture, a remnant ofWorld War II, still enjoys extraordinarypopular sympathy, which is aided by taxpayer-funded marketing campaigns and manicuredfields featuring the world’s most coquettedand expensive cows.This is all the more sordidsince Switzerland applies lower tariffs than theEU on industrial goods, and is otherwise a self-interested champion of free trade.

An equally pressing challenge is thedemography-related increase in welfarepayments. Mandated redistributive transfers,including healthcare, now make up 29.9% ofGDP, up from 19.7% in 1990, and 17.9% in1980. Just a little over half of those transfersare funded on a pay-as-you-go basis; the restare based on private insurance accounts andcapitalisation.The looming pension crisis istherefore less acute than in most countries,and Switzerland also benefits from the freestlabour market and the highest ratio ofworking people in old age in Europe. Amodest attempt to merely equalise men’s andwomen’s retirement age at 65 failed in 2004,and the government’s future steps are likely tobe even more restrained. At the same timevoters rejected a huge tax increase to financefuture pension liabilities, though ironically onthe same day as they also rejected tax cuts.Either the country will soon find itself at afiscal dead-end, or the Swiss government willneed to revise its confused strategy withoutbeing able to resort to its well-worn motto:‘We need to wait’.

In healthcare, the Swiss model of ‘managedcompetition’ is slowly reaching its limits.Insurance premiums have increased at tentimes the rate of inflation over the last tenyears. Compulsory basic insurance is drivingup costs because of consumption incentivesand overcapacities in subsidised hospitalfacilities, and the supposed competitionbetween insurance funds works far better on

Switzerland


Switzerland is often regarded as a model economy. It ranksamongst the world’s top ten nations in terms of itscompetitiveness, global integration and economic freedom.Referenda ensure that the public can influence tax increasesor reductions. Recent studies show the Swiss as being amongthe happiest people on Earth, with cities such as Zürich andGeneva leading international safety and quality of lifestandards. Beneath this glossy surface, however, the countryfaces similar challenges to the rest of Europe - governmentspending has increased by 65% in the last 15 years, and free-market reforms have stalled in many sectors.

Despite Switzerland’s apparent history of sloweconomic growth since the mid 1970s, it stillmanages to produce a remarkably high GDPper capita; a fact that explains economists’allusions to ‘the Swiss paradox’.The Swisseconomy divides itself into two very distinctsectors: a high-growth, high-value-added sectorof global corporations and innovative, export-oriented smaller firms, generating revenuefrom investments abroad; and a stagnant,overregulated internal sector, including anenlarged government sector.

Much criticism has recently been levied againstthe decentralised structure of Swiss politics,whereby most laws are modified andapproved at the canton, or ‘state’ level.This lackof centralisation is seen as one of the maincauses of the gridlock in internal reforms. In2004, attempts to introduce a federal packageof tax cuts – a potentially groundbreaking andadvantageous reform – was defeated by a left-wing minority accounting for just 25% of theparliamentary vote that, when joined with acoalition of cantons, was sufficient to defeatthe motion.

However, Switzerland’s decentralised politicalsystem and the Swiss citizens’ bottom-up vetopower have also prevented many costlypolitical mistakes.The evidence suggests that itis not so much the country’s institutionalframework, but rather its climate of opinion,that constitutes the main obstacle to reform(in other, more centralised countries with noreferenda, street protests just as often meanthe withdrawal of mooted reforms). Perhapsequally important is the creepingbureaucratisation that has entangled everylevel of government and which makesliberalisation a painstaking process.Theagricultural sector is a good example of thisshortcoming. Swiss farmers derive roughly80% of their income from protectionistmeasures – a system which makes the Sovietkolkhoz seem a liberal concept in comparison.At WTO negotiations, the Swiss government,

paper than in practice due to excessiveregulation. Although there are no complaintsabout the quality and accessibility of services,the cost spiral is increasing people’sdependency on government subsidies to payfor their premiums. It has also provoked avicious circle of ever increasing regulation thatthreatens to put Switzerland completely onthe path of socialised medicine. A free-marketinitiative drawn up by the Swiss People’sParty, the largest party, is likely to besubmitted to voters within the next couple ofyears, as is a left-wing initiative which will seekto remove the last vestiges of competition inthe system. In the meantime, a hesitantparliament has failed to advance plannedmarket-oriented reform.

In the field of tax policy, the main reform inprogress seeks to reduce the double taxationof dividend income, currently taxed at bothcorporate and investor levels. Unfortunately,the government plans fall short ofexpectations – so much so that the measurewill probably not have any future impact oneconomic growth. Parliament is likely tostrengthen it, but this runs the risk ofrejection by the cantons. At state level, anumber of competing cantons haveannounced, and many are alreadyimplementing, significant reductions in theircorporate tax rates; slashing them in somecases by up to two thirds of existing levelsand adopting regressive tax rates for higherincomes.Tax rates of holding companies,headquarters and administrative firms are alsolikely to remain attractively low, and criticismfrom abroad largely ignored. Furthermore,after having accepted in 2005 theintroduction of an anonymous withholding taxsystem on savings income for EU residents,Switzerland will adamantly refuse to furtherrelax its financial privacy laws for tax matters.

Despite the rejection of EEA entry in 1992,Switzerland has recently been able to deepenits already strong ties with the EU. In additionto the extensive 1972 free-trade agreement,both parties now benefit from additionalbilateral agreements in several fields, includingthe free movement of people, which hasinduced a large number of people fromGermany and France to immigrate intoSwitzerland. In 2005, voters approved with acomfortable majority the extension of thatfreedom to the citizens of the ten new EUmember states. However, there is no chanceof Switzerland joining the EU, as the Swissfinancial and business community is explicitlyagainst full membership. In 2001, 76.8% ofvoters turned down a proposal to open entrynegotiations, and the government in 2005downgraded membership from a frozen‘strategic goal’ to a ‘long-term option’. In truth,the advantages of staying out by far outweighthe perceived costs, and the political bias isclearly in favour of independence. But in

economic terms, too, Switzerland’sautonomous monetary, economic and taxpolicies avoid some of the pitfalls of the ‘one-size-fits-all’, overregulated EU approach.

The revitalisation of government following thegeneral election in 2003 has reinforced itsfree-market outlook, in particular with theinclusion of two renowned businesspersonalities, the industrialist ChristophBlocher and the renowned manager Hans-Rudolf Merz, in the seven-member cabinet.But despite their credentials, Switzerland’stradition of consensus politics, culture of civilsociety consultation prior to decision-makingand popular veto rights through referenda givethem little leverage to effectively implementthe necessary reforms. For free-marketalternatives to succeed, it is necessary toreverse previous governments’ mistakes, bethey in pensions, healthcare, tax policy oragriculture. However, history shows that inuncertain times voters are more likely to playit safe and support existing policies.This ispolitically hazardous terrain. If mostgovernment members are unable to persuadepopular majorities to implement the policychanges or, worse, are not fully convincedthemselves of the urgent need for suchchanges, Switzerland, like so many of itsneighbours, will slowly drift from its presentflawed model to an even less palatable future.


The revitalisation ofgovernment following thegeneral election in 2003 has reinforced its free-market outlook

Leda-Agapi Glyptis is a post-graduateresearcher at the London School [email protected]

situation was reversed. Economic policy wasno longer a matter of choice for Turkishgovernments; the path was carved and thegoals were set by a team of experts. One ofthem, Kemal Dervifl, noted that the primarygoal for Turkish economic restructuring in thenew millennium was first health, then wealth.Financial health – a healthy market, sustainablegrowth and economic stability – should be, forDervifl, the criterion to determine Turkey’s EUentry.This realisation enhanced thecommitment of both politicians and the publicto the post-2001 economic diet. It isimportant to note that, also in 2001, theNational Programme for the Adoption of theAcquis’ was adopted by parliament, making thepursuit of EU accession the top priority forTurkish politics and thus lending economicrestructuring even more urgency.

The combination of the two means that thepast five years have witnessed a concerted,well-orchestrated and conscientious effort tostabilise growth, increase productivity, minimisecorruption, streamline taxation andstandardise financial regulation. On paper,Turkey is doing well. In practice, institutions,directives and guidelines are gradually takingroot while the government is also learning tobe responsible, responsive and transparent inits financial dealings.Turkey has a long way togo. However, certain phenomena, such as thegrowth of the so-called Anatolian Tigers, giveTurkey’s supporters cause for satisfaction.

It is generally believed that Islam, with itsopposition to usury, interest and certain kinds

Turkey


In 2004, Ali Babacan –Finance Minister, and, since 2005, ChiefEU Negotiator – described the extensive market reformTurkey had undergone as a miracle rather than a mirage.Change was here to stay. Successive economic crises hadmade change expedient. Moreover, it has been recognisedthat large-scale restructuring represents Turkey’s ticket intothe EU. Membership is the single overriding nationalobjective as it will represent both the crowning glory ofTurkey’s Atatürkist modernisation drive and a vindication fornational pride after a saga that began in 1959. So, marketreform is at the forefront of government policy.

Turkish politicians and diplomats, as well asWestern supporters of the country’s EU bid,defend Turkey’s membership in economicterms.Turkey possesses a large, young labourforce that can sustain Europe’s agingpopulation; although that presupposes adegree of free movement for Turkish workerswhich many EU members are unhappy with.Turkey has long had stable economic relationswith the EU, incorporating a customs unionand established trade routes that couldbecome wider and busier following accession.Moreover,Turkey offers a large and growingmarket for European goods with better accesschannels to the Middle East, immense growthpotential as well as scope for industrialdevelopment. Productivity is high andoptimism is soaring.The question is, is theoptimism well-founded?

Turkey’s growth record has been extremelyvolatile in the past twenty years. In 1990 thegrowth rate of real GDP was nearing 10%. In1991 it was 1%.This roller-coaster – with realand painful day-to-day side effects for Turkey’scitizens – plummeted to almost -8% in 2001.At the end of December 2000, interest rateswere almost four times higher than at thebeginning of November.The intense financialcrisis, in the middle of an IMF-supportedstabilisation programme, soon translated into apolitical crisis as the exchange rate systemcollapsed and urgent assistance was needed.The remedy entailed a departure frompatchwork solutions and the adoption of astrict, IMF-endorsed economic programme forthe restructuring of the Turkish economy.

The aftermath of the 2000-2001 crisis put an end to the populist manipulation ofeconomics for short-term political gain byeffectively removing economics from thecontrol of governments.While, since the1980s, the economy was the core arena ofpublic activity and debate, following thelimitations on political deliberations imposedby the 1980 coup leaders, after 2001 the

Turkey’s growth record hasbeen extremely volatile inthe past twenty years.

of profit, is an obstacle to the growth ofcapitalism. As a result, it had been suggestedthat Turkey’s pious Anatolian population wasgoing to hinder its economic development,industrialisation and modernisation. And yet,according to the 2005 European StabilityInitiative Report, it is that very population -pious, socially conservative and yetentrepreneurial - that now represents themost rapidly growing segment of the Turkisheconomy. Manufacturing is flourishing inAnatolia and religion, rather than standing inthe way of economic growth, is actuallyhelping it benefit the community as Islamiccharity, practiced widely by the AnatolianTigers, translates into schools, universities andhospitals that further enhance modernisation.

However this image is not complete. SuchTigers do not exist in every corner ofAnatolia.Their appearance depends on myriadfactors, such as capital availability (often linkedto the degree of mechanisation of agriculturein the region) a large and specialised skill-base(as in the case of the Kayseri furniture-makers) that can be utilised and expandedand, of course, luck. Moreover, the Tigers, theirentrepreneurial skills and instinctsnotwithstanding, embrace modernityselectively. Markets are good, as is capitalism.But allowing their wives and daughters to joinin is a different matter.

The Anatolian Tigers are not alone here. A2005 opinion poll indicated that 12.8% ofTurkey’s population believe that womenshould definitely not work outside the homewhile a further 11.5% maintained womenshould only work in all-female offices. Suchattitudes are a severe obstacle to growth asthey effectively incapacitate almost half of thecountry’s labour force. ESI observers expresshope that such traditional attitudes willdissipate in the face of pressing demands forextra workers if Turkey is to maintain itsinternational trade share and remaincompetitive in both manufacturing andservices provision.Time will tell.

In the meantime, however, women are thechief ‘victims’ of one further problem ofTurkish economic practices, namely theinformal economy. A combination oftraditional male-dominated and family-centredattitudes combined with decades’ worth of laxfinancial regulation and control, paternalismand the relative success of clientelisticnetworks in delivering solutions to individualproblems, mean that Turkey now possesses ahuge and thriving informal economy.This isnot quite the underground economy thatmany former Soviet-bloc states labour under.Yet it remains unregulated and largely untaxed.Moreover, informal economy workers areuninsured and receive no formal remunerationand no pension upon retirement, while theirworkspace, usually a family-run shop,

workshop, or farm, rarely meets health andsafety standards.Turkey’s informal economy(which chiefly but not solely affects women)represents an obstacle to EU accession at alllevels of regulation and compliance. Successive‘Commission Communications’ have drawnthe government’s attention to the pressingproblem of regulating the informal economyand bringing its activities and workers into themainstream. It is not certain, however, whetherthe state can do much about this.

Turkey’s republican experience has alwaysbeen state-centred.The devlet-baba (father-state) wields considerable power and legislateson everything from industrial policy to lifestylechoices, although its ability to protect, controland provide for its people is circumscribed asa result of EU human rights concerns andinternational regulation capping stateeconomic activities.The state can and hasintroduced sweeping reforms in the economicsphere. Starting with Özal’s post-coupeconomic restructuring in the 1980s, throughto the AKP’s fiscal policy, the Turkish state hasused its powers to affect sweeping economicchange – always with an eye to Europe.

Dismantling the informal economy, however,may be beyond the abilities of the state. Inorder to ensure that seamstresses workingfrom their kitchen meet health and safetyregulations; that wives working in theirhusbands’ shops are properly insured and will,eventually, receive a pension and that cousinshelping with the harvest are not effectivelyevading tax, large-scale social change would benecessary. For Turkey to fully harmonise itspractices with EU regulations, social relationswould need to evolve in a manner that seemsunrealistic given the time frame in which it hasto be achieved. And it must be rememberedthat for many the change would also beundesirable. Even though family assistance infarming and small-scale businesses may fallbetween the cracks of the tax system, itconstitutes a tightly-knit nexus of kinship and

mutual assistance that, for many, engenders astronger and healthier society. Although theline between family-based exploitation offemale or teenage labour and ‘mutualassistance’ is blurred, there might be somemerit in this claim.What is certain, however, isthat if Turkey is to maximise its internationalmarket share and reach its full growthpotential, traditionalist attitudes that blockwomen’s access to the market will have to beradically revised so that the large numbers ofmarginally employed, unemployed orunderemployed women can gradually enterthe workforce and allow Turkey to live up toits promise of bringing Europe a large, youngand vibrant labour force.


ANNE K. JENSEN is project managerof the Stockholm Network’sintellectual property [email protected]

difficult than anticipated.The new governmenthas in fact had to struggle with its owncorruption scandals, leading presidentYushchenko to fire his entire government inSeptember 2005. Unfortunately, corruption isnot confined to the political sphere, but rathera characteristic of Ukrainian society as a whole.A poll developed by the Ukrainian Institute forSocial Research and the Social MonitoringCentre in conjunction with the United NationsDevelopment Program, revealed that about 44 percent of respondents had paid bribes ormade gifts in one form or another at leastonce in the last year.

Another legacy of the Soviet Union is auniversal yet poorly funded and ill-equippedwelfare state. In principle, every Ukrainian hasthe right to free health care. In reality, due to a chronic lack of resources, these services areboth underdeveloped and inefficient. Duringthe Soviet era the healthcare system inUkraine was under the strict control of thecentral government and the Ministry of Healthin Moscow. Control was exerted throughcentrally determined five-year plans, whichtook no account of local trends or needs.Thestate was the direct employer of health careworkers; it paid staff salaries and wasresponsible for equipping health care facilities,research institutes and educational institutions.

After independence in 1991 the Ukrainianstate continued to supervise the country’sformal health care system. Nevertheless, anincreasing amount of health care services arenow delivered in facilities owned and managedat regional or district levels. Although themarket has been opened up to private healthcare providers, these facilities continue to bepoorly developed.This is largely due to thehistory of state-run health care and thereforethe dominant position of state providers inthe market. Most importantly, the demand forprivate health care is low because mostUkrainians cannot afford it.

Ukraine


Ukraine has a long history of invasion and occupation byforeign forces.The Mongols, the Grand Duchy of Lithuaniaand the Polish-Lithuanian Commonwealth have all had theprivilege.The last country to exercise its powers overUkraine was its big neighbour to the East, the USSR. Finalindependence for Ukraine was achieved in 1991 with thecollapse of the Soviet Union, although the Kremlin continuesto play an influential role in Ukrainian politics.

The latest example of this took place in 2004when Russia’s President Putin came out instrong support of Ukraine’s rigged presidentialelection, which saw the re-election of theMoscow-friendly and corrupt ViktorYanukovych.The move, however, backfired asthousands of people took to the streets inprotest. Supported by foreign governments,the international media and a variety ofinternational organisations, Ukrainians forcedtheir tainted regime to submit to a secondround of elections, which resulted in theelection of a government led by the popularViktor Yushchenko. His government promiseda more transparent, prosperous andwestward- leaning Ukraine.Yet the following15 months have yielded few tangible results.

The Soviet Union left a legacy of endemiccorruption, poverty and state control.According to the International Monetary Fund(IMF), Ukraine has posted perhaps the mostdisappointing economic performance amongEastern European transition countriesemerging from planned economics.With itsfertile soil, diverse raw materials and heavyindustry Ukraine used to be the mostimportant ‘republic’ in the Soviet Union.Although a post-Soviet Union economicrecession was expected, the degree ofUkraine’s poor economic performance afterindependence is still surprising.

One explanation for Ukraine’s poor economyfollowing its independence has been theinability of the country’s leadership to build theinstitutions necessary to secure the rule of law,well-functioning markets and property rights.This again was due to a lack of consensusamong the ruling elite, for whom the links tothe former Soviet Union were still importantand whose main concern was to secureprivileges for themselves and their supporters.Many hoped that Yushchenko’s newgovernment would eradicate the culture ofgovernment corruption and privileges onceand for all, but it has proven to be more

Privatisation in other areas has also acceleratedover the last 10-15 years. A process oftransforming the country from a centrallyplanned economy to a market economy wasinitiated right after independence in 1992 and isstill going on.The aim of this transformation hasbeen to increase the private sector share ofindustry and to find strategic investors to speedup the development of industries andcompanies. Although the process startedmodestly, it has recently gained pace and 80%of the country’s industry is now privatised.Theremaining privatisation consists of the largeststate enterprises, mainly in electricitydistribution, telecommunications and metallurgy.The question of privatisation of welfare is stillhighly controversial, as in the rest of Europe.

Due to Ukraine’s history, most of its foreigntrade has been conducted with Russia andother neighbouring countries.The country hasalso had an important role linking Europe andAsia. In 2003 the country joined Russia,Belarus and Kazakhstan in creating a singleeconomic area (SEA) designed to coordinatethe countries’ trade regulations and reducetariffs. But the fact that it constitutes apreferential trade agreement may complicateUkraine’s ambitions to join the World TradeOrganisation (WTO). After Yushchenko cameinto power in 2004 however, the governmenthas made a conscious effort to become more independent of Russia and create closerlinks with the European Union. Adding to the Partnership Agreement originally set up between Ukraine and the EU in 1998,President Yushchenko travelled to Brussels inFebruary 2005 to negotiate an EU-UkraineAction Plan.While EU membership is not yet a viable proposition, the aim of the ActionPlan is to set out the main areas of reformUkraine needs to implement in order to meet EU standards.

By diversifying its economic partners andseeking alliances outside the former SovietUnion, Ukraine is aiming to become lessvulnerable to the politics of the Kremlin orindeed other external factors.The country stillhas a long way to go, as the gas crisis ofJanuary 2006 made evident. Russia, resortingto natural commercial interests, decided toquadruple the prices of gas in the middle ofthe coldest month of the year and leftUkraine, which is dependant on Russianimports for the bulk of its gas consumption,literally in the cold for days.

Interestingly, Ukraine’s vulnerability to externalfactors has not solely been a negative factorfor the country’s economy.The high growthrates the country experienced in 2000 afteryears of post-independence stagnation were infact mainly due to favourable external shocksincluding booming trade and metal prices. In2004 real growth in Ukraine reached theremarkable, (yet unsustainable) rate of 12%.It is however, important to keep in mind thatthis ascent began from a very low base. In2005 the growth had returned to a robust4%. Although this is a huge decrease from12%, it is still more than double the growthrate of the EU, which in 2005 was 1.7%.

Despite Ukraine’s enduring economicrecession, the country seems finally to bemoving in the right direction, albeit at amodest pace. However, disillusionment withthe manner President Yushchenko has handledhis Orange coalition led to his former ally andformer Prime Minister Yulia Tymoshenko takingthe largest portion of votes in parliamentaryelections in March 2006.While not a directrevocation of the principles of the Orangemovement, it does represent growingdisappointment with Yushchenko's inability todislodge endemic corruption or generate theeconomic growth he promised. It is doubtful, atthis point, whether the parliamentary shake-upwill have any long-term effect on Ukraine'sability to advance further. If a rapid turnaroundcannot be achieved, the momentum that therevolution gave to market advocates may ebbaway. Presently, it is hard to see a bright future,or indeed, an Orange one.


Despite Ukraine’senduring economicrecession the countryseems finally to be movingin the right direction

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Acknowledgments

Thanks must go primarily to the many authorswho contributed to this project, without whomit could not have happened.All gave their timeand expertise willingly to contribute. Secondly,praise is due to Anne K Jensen,Terry O’Dwyerand Jessica Hodin who aided the editingprocess valiantly. Gratitude must also beexpressed to Helen Disney, whose advice andassistance was always available. Sarah Hyndmanprovided us with another wonderful design.Finally, however, I would like to thank SachaKumaria, who inaugurated the project and whoprovided momentous encouragement andsupport for this book.

Beyond the Borders

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