How the Integration into the EU may Affect the Building of Free Market Societies in Post-Socialist Countries

“Integration into the EU is the only choice for post-socialist nations committed to democratic values and a free market,” – many would readily agree with this statement. Free-marketeers argue, however, that the values proclaimed by the EU are not tantamount to the tenets of a free market. They aim to scrutinise how this likely integration goes with the prospects of building free market societies in post-socialist countries. In order to be consistent, they contemplate alternatives, or how non-integration might affect the said prospects.
The wave of the future for post-socialist nations
First, let us look at the general prospects of implementing the principles of a free market. There is a fair chance that these principles will find a friendly environment in post-socialist nations. A free market is the only rightful alternative to socialism, in both economic and moral terms. Having tasted a whole variety of “blessings” bestowed by socialism, people seem to be sympathetic to free market ideas. They are beginning to realize that attempts to imitate systems of Western democracies with their ever-expanding governmental authority – systems which evolved as a counteraction to revolutionary socialism – will not change the East. Both theory and practice suggest that the most prosperous are those nations which are committed to reducing the state and leaving market forces to rule and to guide.
When transition started in 1990, Lithuania replaced a whole range of socialist-style prohibitions and regulations. Despite right-to-left-and-back-to-right shifts of political power, the country pursued consistent liberalisation. It became a matter of fashion to extol the merits of a free market. Yet, very few perceived its true nature. Somewhat ironically, the best time for advocating and adopting free market reforms was when people were still stuffed full of entrenched socialist beliefs. Under the new circumstances, they refrained from voicing leftist attitudes and sought to switch to new ideals. And quite a few of them did. Today, a free market is for some people a matter of principle and belief. For others, it is but the fashion. Still others may loathe the idea but need it to achieve the country’s well-being and prosperity.
The power of the common market
The EU integration is having a twofold influence on the building of a free market in post-socialist nations. The power of “free movement of people, capital, goods and services,” as proclaimed by the EU, is producing positive effects. Needless to say, this principle has had a profound impact on the evolving ideology and developments in the region, preventing reversion to socialist principles at times. International trade affords a good example. Talks with the World Trade Organisation (WTO) and integration in the EU offset the pressure from interest groups to increase trade tariffs. Stimulated by these two organisations, the Lithuanian government pursued consistent trade liberalisation.
Lifting the ban on foreign banks was another example of how the EU helped to remove barriers erected by protectionist thinking. Several years of severe criticism failed to eliminate the obstacles put in the way of foreign banks, but Brussels’ anxiety, coupled with the banking crisis in Lithuania, seem to have done the job. The spirit of the EU also proved to be the key to stamping out the dogma of prohibiting foreigners from owning land.
These developments point to the conclusion that leaning toward the EU and other multi-national organisations is a safeguard against reversion to the fallacies of the past. It acts as a check on adherence to the principle of free movement of people, capital, goods, and services. But… only as far as the borders of the EU extend.
The pitfalls of free trade limited
The fact that all the liberties exalted by the united Europe are of territorial character poses an array of concerns. The trade regime with non-EU nations is but one of them. Free trade does not simply end with the boundaries of the EU. It is required, as a rule, that protective measures be imposed on trade with non-member states. Protective measures instigate retaliatory protectionism. Consequently, joining the European club means that all the markets outside the EU will be more difficult to deal with. For Lithuania, markets in Russia, Newly Independent States, Asia and America are too significant to lose. However, no research has been done to assess likely implications for the trade and economy in general.
Paradoxically, the principle of free trade as perceived by the EU happens to be an obstacle to Lithuania’s membership of the World Trade Organisation, whose mission is to promote free trade among nations. Lithuania’s Agreement on Free Trade and Trade Related Matters with the EU entered into force on January 1, 1995. According to this agreement, Lithuania has to phase out custom tariffs on imported industrial products from member states. On the other hand, upon joining the EU, Lithuania will have to charge uniform EU tariffs on imports from non-member states. The existing tariffs applied by the EU to non-member states are higher than those imposed by Lithuania. Even as a result of the Uruguay Round, when the common trade tariffs will be lowered by an average of 37 per cent, the ultimate EU average for industrial products will constitute 3.6 per cent. It will still be higher than Lithuanian tariffs towards non-member states!
Today, Lithuania’s weighted average tariff for industrial products is two to three percent. Ninety seven percent of total foreign trade is with nations enjoying preferential or most favoured nation’s status. Obviously, if Lithuania is to become uniform with Europe, it will have to raise tariffs. But this is not in line with the WTO policies! In fact, negotiations with WTO already seem to have come to a deadlock because of these contradictions. Estonia, which has won the reputation of the most pro-free market nation in the former Eastern block, found itself even in a more perplexing situation. It has to go back to protective tariffs which only several years ago were abolished with such a great deal of resolution! Most likely, the EU will have to pay compensations to those WTO members who will lose due to aggravated terms of trade with Lithuania, Estonia and the like. But how, praytell, to compensate these countries for the isolation from the global division of labour?
It should be noted that some people think that the EU trade policy will ultimately lead to a global free trade. Yet, protectionism remains its major driving force and an impediment to the expansion of free exchange worldwide. Naturally, it makes Lithuanians question the merits and perils of free trade. Only few dare to voice that which is obvious: As long as unfettered trade is confined to Europe, the global market will have no chance to provide the largest benefits for all nations – whether in the first, second or third world.
Uniformity versus indigenousness and competition
Uniform currency represents another puzzle. As of 1994, Lithuania adheres to the currency board principles which require renunciation of monetary policy pursued by national authorities and shifting to a uniform monetary realm. A shift from the currency board to euro would thus be a minor change. One should keep in mind though that the monetary policy will not be forsaken but concentrated in the European Monetary Authority. Global monetary wars, which were somewhat alleviated by the great variety of European currencies, will then gain ground. A uniform currency, which would reflect not the verdict of the market but a multinational political will, may then become a major protectionist measure.
So far, no one has spelled out the likely effects of the single monetary policy on different markets. Equally unclear is how these indigenous markets will adjust to its entrails. There is no doubt, however, that this policy will call for overall harmonisation.
Taxation, which has so far avoided the harmonisation mania, will be the first target. This may present a perverse impediment for those post-socialist nations which are contemplating sweeping tax reforms. Unlike most Western states, the Baltics are reforming their tax systems to eliminate, among other things, the evils of progressive, multi-level and differentiated taxes. Estonia has adopted a uniform 26-percent tax on both personal and corporate income. In Latvia, the tax rate is a flat 25 percent. Lithuania, which has a corporate income tax of 29 percent and a 33-percent personal income tax, is ready to follow its neighbours’ course and may go even further.
The abolition of corporate income tax has grown into a popular solution among influential political groups in Lithuania. It has even become a part of major electoral platforms. The tax has already been scheduled for removal, and all investment has been fully exempted from taxable corporate income as the first step of the reform. It is likely, however, that such changes may be halted because of EU integration. Presently, no harmonisation policies on direct income taxes exist. It is clear that they will come up one day. Yet, even without them, innovative solutions may be faced with the pressure not to go against the stream.
It should not be neglected that competition between governments acts as a safeguard against the expansion of governmental authority and, above all, against the power to tax and to spend. Harmonisation erodes competition between governments as to which of them will create more liberal conditions and encourage more economic activity. For Lithuania and other nations that lack indigenous capital and business traditions, imitating the fallacies of Western tax systems would lead to total economic stagnation.
Harmonisation: human or machine-driven
The process of unifying legislation is creating new concerns every day. Rather than recognising the pressing need to deregulate the economy and debureaucratise other spheres of life, the authorities are wrapped up in enforcing EU directives. In some cases, this translates into lifting over-regulation. In many others, however, it leads to creating new bureaucratic procedures on top of old, soviet-style regulations.
It is a disturbing reality that after many years of taking orders “from the centre” the authorities are inclined to adopt EU directives without testing them or even questioning their merits. As a rule, these directives are taken for granted. Standard rules and conditions at which the EU aims would be acceptable, and even welcome, if they all were based on free market principles. Otherwise, accepting them means adopting rules that will thwart the pursuit of free and prosperous societies.
Regulation of competition affords a good example. Even though it cannot boast of being a champion of limited government, the EU legislation does put a ban on providing aid to, or discriminating against, individual economic agents. But the rules of government interference in competition applicable in the EU differ immensely in magnitude and implications from those in Lithuania. That which is a restriction on government aid in the EU (support in excess of ECU 30,000) is its encouragement in Lithuania. In other words, the enforcement of non-involvement of the state as perceived by the EU is like giving the green light to government aid in Lithuania.
Privatisation of the Lithuanian Telecom and strengthening of its monopoly position has encountered much public resistance. The Lithuanian Telecom was granted a five-year monopoly by a new telecommunication law which was adopted, as the officialdom noted, “as the first step of demonopolisation and privatisation.” Critics charged that this would drive out market forces and therefore the sale was not privatisation. Yet, EU regulations allow the monopolies of telecoms to be preserved for the time being. The Lithuanian government thus justified itself by saying that its decision was in line with EU directives. All warnings of likely consequences of monopolies, which, among other things, will represent a drag on technological progress, were dismissed out of hand. The society was given to understand that if the EU backs the monopoly, we must hang on to it, too.
Especially notorious were newly adopted rules of money laundering prevention. Following an EU directive, Lithuanian authorities introduced a provision requiring that every company and its bank report in writing on any transaction over 12.5 thousand U.S. dollars worth. This is an illustration of how national authorities overdo it with being over-enthusiastic in fulfilling EU instructions. The newly introduced rule cannot prevent money laundering. It only augments operational costs of legitimate businesses. Yet, any criticism is refuted on the ground that the EU insists on fighting money laundering, and measures like this cannot even be called into question. This shows how senseless, futile bureaucracy is extending to both public and private domains.
Not only are the direct effects of yielding to all EU regulations dangerous. Sadly, it is also the mentality of state paternalism that remains as commanding and forceful as ever. By transforming the “know-how” of state interventionism and paternalism, the EU does not allow socialist ideas to recede. Rather, it gives them an impulse to revive.
The uneasy case for free market… and the EU
People oppose accession for different reasons, and everybody, not only free-marketeers, seem to find some faults with it. In most cases, however, membership of the EU is viewed as the only realistic option for nations like Lithuania. People say they cannot imagine one country standing alone among major political and trade blocks. They say, “Join in, speak for your ideals, change the EU.” It is somewhat unlikely though that these small nations will have a chance of doing so. On the other hand, it would be a challenging and uphill experience for one nation to be open and free in a protectionist and regulated surrounding. Even if the whole world closed behind walls, it would still pay to stand open.
Needless to say, if a nation is faced with a risk of slipping up and reverting to socialism and command economy, the EU plays a crucial role of safeguarding democracy and a market order. Some people even believe that the EU may grow over time into a fully-blown free market and do away with remaining socialist legacies. If, however, some nations show commitment to sweeping free-market reforms, the EU, as we know it today, becomes a drag on their ambitions. It appears to cripple motivations and erode competition between nations in creating the most friendly environment for people’s initiatives. More than that, being a strong political magnet, the EU demagnetises the otherwise overpowering attractiveness of a genuine free market.