Wall Street Journal
THE WALL STREET JOURNAL
East is Flat
July 23, 2007
It wasn't too long ago that Albania was joked about as the last Communist holdout, a kind of Marxist museum. Not anymore. The small Balkan country is about to halve its personal income-tax rate, starting August 1, to a flat 10%. The corporate rate is also slated to drop to 10% in early 2008.
Albania's flat tax is the latest sally in an intramural tax competition fueling growth in the former Communist bloc. The trend began with Estonia in 1994 -- then- Prime Minister Mart Laar had read Milton Friedman's "Free to Choose" -- and now extends to a dozen nations. The Czech government says its move to a flat 15% tax next year is "a certainty." And Montenegro plans to reduce both income and corporate taxes to a flat 9% by 2010.
The Adriatic Institute for Public Policy, a think tank based in Croatia, has found that governments that adopt flat-tax regimes see either steady or increased revenues within the first year. Macedonia expected increased revenue when it reduced both its 15% corporate tax and its 15-18-25% progressive income tax to a flat 12% at the beginning of the year. But it got more than it bargained for. Finance minister Trajko Slaveski recently told the Economist that "lower taxes did not just yield higher revenue -- they yielded 20% more than we projected."
For Western Europeans, their neighbors' low, flat taxes are both an opportunity and a lesson. In the first quarter of this year, the euro zone -- dominated by France, Germany and Italy -- for the first time sold more goods to the 11 new Central and Eastern European EU members than to the U.S. Old Europe has these new customers in large part because New Europe is getting its fiscal policy right. Both would be richer if the West followed the East's example.
THE WALL STREET JOURNAL
July 23, 2007
WSJ Opinion Europe
For a lesson in pro-growth tax policy, may we suggest gazing east, to Albania. This small Balkan country is about to halve its personal income-tax rate, starting August 1, to a flat 10%. The corporate rate is slated to drop to 10% in early 2008.
Albania's flat tax is the latest sally in the intramural tax competition fueling growth in the former communist bloc. It began with Estonia in 1994 -- then-Prime Minister Mart Laar had read Milton Friedman's "Free to Choose" -- and has since extended to a dozen nations.
Political leaders, such as Albanian Prime Minister Sali Berisha, are aware of the example they're setting. When Parliament approved the most recent tax cut -- made in response to lowered rates in neighboring Macedonia -- Mr. Berisha cheered that "the fiscal revolution" will proceed even "faster than forecasted."
Indeed it may: The Czech government has announced that a flat 15% tax next year is "a certainty." And Montenegro plans to reduce both income and corporate taxes to a flat 9% by 2010.
The Adriatic Institute for Public Policy, a think tank based in Croatia, has found that governments that adopt flat-tax regimes see either steady or increased revenues within the first year.
For Western Europeans, the success of their neighbors' low, flat taxes can be seen piled on their very own freight trains. In the first quarter of this year, the euro zone -- dominated by France, Germany and Italy -- for the first time sold more goods to the 11 new Central and Eastern European EU members than to the U.S. Old Europe has these new customers in large part because New Europe is getting its fiscal policy right. Both would be richer if the West took a good look at the flat tax, too.
Private debt overshadows Goldilocks scenario
By Eric Jansson, Financial Times
Published: Nov 12, 2007
Working papers from the International Monetary Fund usually make dry reading. But one such paper has caused a splash in Zagreb, as campaigning kicks off in advance of the country's November 25 parliamentary election.
The IMF paper titled "Vulnerabilities in Emerging South-eastern Europe - How Much Cause for Concern?" published last month, argued that south-east Europe had begun to show imbalances similar to those seen in East Asia before financial crisis struck a decade ago.
In a tone more prescriptive than accusatory, the authors refrained from criticising individual governments in the region, which has experienced some of Europe's swiftest economic growth in recent years. Nonetheless, they highlighted acute imbalances in Croatia, which has a higher debt level as a percentage of GDP, and a higher current account deficit, than the East Asian average before that region's 1997 crisis, despite achieving slower GDP growth, 4.8 per cent in 2006.
With the highest external-debt-to-GDP ratio of any non-EU country in Europe and the greatest exposure to foreign currency loans, Croatia faces a growing risk of financial hiccups, the authors wrote: "The probability of a sudden stop increased between 2000 and 2006, especially in Croatia and Serbia. The probabilities are driven by the rising degree of euro-isation and the extent to which tradable consumption is 'financed' from abroad."
Ivo Sanader, the prime minister, and his finance minister, Ivan Suker, quickly brushed the critique aside. "There is no financial crisis. Croatia is servicing its debts," Mr Sanader said.
But the paper's assertions provide fresh ammunition to Croatia's main opposition party, the Social Democratic Party (SDP), which has made similar concerns central to its election campaign. Economic mismanagement under Mr Sanader's Croatian Democratic Union (HDZ) has threatened economic stability, Social Democrats say.
Ljubo Jurcic, the SDP's prime ministerial candidate and chief economic strategist, argues that Croatia's economy has immense capacity for growth, but that it has been wrongly managed. Citizens have grown accustomed to an inflated standard of living "based on household debt", he says.
The dispute sets Croatia on course for an election focused closely on economic issues.
Mr Sanader's government has done much to bring Croatia more securely under the wing of the EU, with which the country began accession negotiations in 2005. He and his cabinet ministers describe their economic reform programme within the broad context of EU accession, emphasising a need to harmonise legislation with the acquis communautaire , the vast body of EU law. The HDZ portrays any challenge to this course as a potential risk to EU entry, which the Sanader government until recently promised could be achieved by 2009.
Yet the IMF paper warns against such approaches, asserting that the "EU halo effect" lowers perceived risk, sometimes unjustifiably.
The HDZ supports central bank measures aimed at limiting commercial credit growth. Its programme also includes paying down external debt, and the government has taken steps in this direction during the past year. Yet government claims that Croatia's external debt is shrinking exclude private-sector debt. Overall external debt rose from 30 per cent of GDP 10 years ago to 85 per cent last year. Central bankers predict it will rise to 86 per cent this year.
"External vulnerabilities have begun to appear and to create risks for stability," says Ljubinko Jankov, executive director of research and statistics at the Croatian National Bank, the central bank.
With financial markets experiencing a higher than usual degree of unpredictability amid a global "credit crunch", economists have begun focusing with new keenness on the price of borrowing, especially as Croatia has a growing share of short-term debts, which magnifies rollover risk.
"If there is a big global shock, it is for sure going to be a big problem for this whole region, including Croatia," Mr Jankov says.
Economists at Zagreb's European-owned banks continue to offer upbeat assessments, noting steady GDP growth, low inflation and the central bank's strict regulation of credit growth.
"Looking at credit default swap spreads there is no evidence of concern from investors and I, for a change, actually agree with Mr Suker that the current situation is stable," says Goran Saravanja, chief economist at Zagrebacka Banka, owned by Italy's UniCredit Group. Mr Saravanja says both the SDP-led coalition that governed from 2000 until 2003, and the current HDZ government, pursued credible courses of economic reform after a decade of authoritarian rule.
The current government showed a willingness to tackle sensitive economic issues when it re-indexed pensions. Recent reforms won praise from the World Bank, which called Croatia the world's second best reformer for last year in its Doing Business 2008 report. Next year ministers must tackle economic restructuring at the state-owned shipyards and elsewhere.
Croatia is now entering an "interesting" phase, says Mr Saravanja. "We have to see how post-2000 Croatian economic policy stands up to a downturn in the economic cycle, and we have not seen that yet."
Beneath the debate over financial risk, other economic fundamentals may be at issue in the upcoming election. Mr Jurcic, though representing the traditionally centre-left Social Democrats, sometimes casts these in terms of "free market competition". He speaks of "preparing the atmosphere for tax cuts", including a 50 per cent cut on health care contributions.
Mr Jurcic's message that small businesses should be able to operate on terms equal to those enjoyed by the country's big companies strikes a chord with citizens who still feel cheated by Croatia's "tycoonisation", the local term for corrupt privatisation in the early post-communist period.
The HDZ is vulnerable to criticism from this angle, says Joel Anand Samy of the Adriatic Institute, a free-market think tank. "In Croatia, crony capitalism is flourishing but not entrepreneurial capitalism, and it frustrates people," he says.
Damir Polancec, the deputy prime minister and HDZ candidate, suggests such criticism is overblown and that economic results speak for themselves, with GDP growth up to 6 per cent in the first half of this year. "A few years ago, one would become an entrepreneur because there was no alternative. Today, people are coming because of ideas, coming up with their own projects," he says.
In fact, few analysts expect significant policy changes after the elections, whoever wins. Mr Jurcic embraces some free market ideas, arguing that unproductive companies should have support withheld, and calling for a liberalised labour market. But he also praises former Yugoslav industrial performance and says that aggressive reforms are "politically impossible" in Croatia. Parts of the SDP's programme still carry a whiff of central planning, such as a plan to set up advisory "project teams" for industry.
Polls suggest voters are evenly split. Many have come to realise that with EU accession dominating the country's agenda, a new government led by either main party may struggle to leave an individualised mark on economic policy.
Bullets need biting in Croatia's shipyards
By Eric Jansson
Published by Financial Times, October 30, 2006
The Hoegh Delhi, a massive windowless box of raw steel plate, floats quietly in the Uljanik shipyard. Uniformed workers swarm over the enormous vessel, adding finishing touches to the largest floating garage ever built, big enough and powerful enough to haul 7,000 cars across an ocean.
Uljanik's world record-breaking shipbuilding job for Norway's Viking Car Carriers, owner of the Hoegh Delhi, will continue into next month. Even before completion, the boat has become a symbol for Uljanik's workers of the shipyard's successful transition from socialist management to streamlined global competitiveness.
"We may be small, but by our measure we now hold 10-20 per cent of the car carrier market worldwide," says Hrvoje Markulincic, the hard-hat-wearing lawyer who heads Uljanik's public relations.
The shipyard's switch from general shipbuilding to its specialisation in car carriers took 12 years, starting in 1987. The workforce fell from 20,000 to the current 2,000, but added 1,000 subcontractors
But Uljanik still depends on state subsidies to survive, and even with such help it made a loss last year. Croatia's four other large state-owned shipyards performed worse.
However, officials say the time has now come for restructuring and privatisation. A proposal is expected next month.
Free market purists - an embattled minority in Croatia - call for cuts across the board. Natasha Srdoc-Samy, president of the Adriatic Institute for Public Policy, a free market think-tank in the shipbuilding city of Rijeka, says the industry should be privatised immediately, as it is, with no restructuring financed by taxpayers' money.
"Shipyards for which there are no buyers should be closed," she says, adding that compensation paid to laid-off employees would cost less than "sustaining dying companies".
Damir Polancec, deputy prime minister in charge of economic policy, is more cautious. He predicts a "transitional period" during which the shipyards will be brought into line with European Union standards on state aid.
Analysts say a dose of privatisation along the way will be required to bring in foreign capital and industry expertise. "Any regulation without privatisation will fail," says Zarko Miljenovic, chief economist at Zagrebacka Bank.
European Commission pressure being applied to state-owned shipyards in Poland, an EU member since 2004, suggests what may lie ahead for Croatia if the government shirks reform.
The size of the heavily subsidised yards, and their importance to Poland's economy, has proved little defence against EU competition rules.
Croatia's shipyards have traditionally counted ongovernment officials, who were able to resist pressure from the International Monetary Fund to refuse heavy subsidies. But as Croatia's IMF's loan arrangement phases out and EU negotiations roll forward, government officials have begun hinting at changes ahead.
Mr Polancec says the government is obliged to "take into consideration all possible scenarios" including permanent closure. Vladimir Drobnjak, chief negotiator on European Union accession, echoes the hope for a way out: "I won't be exact, but the shipyards are located on prime real estate, in the heart of the Mediterranean. These are not back yards in the middle of nowhere."
Shipyard managers would prefer privatisation to closure, though they cringe at the prospect of either.
Mr Markulincic says Uljanik has no interest in being sold to a foreign investor, but acknowledges that no Croatian company is qualified to run the technologically advanced yard.
He says the state must keep "at least" 25 per cent of Uljanik, with shares being sold to workers and other companies in the shipbuilding sector.
Foreign buyers would be less likely to use Croatian suppliers along the chain of production, he argues.
In this way, sale to a foreign buyer would erase the "multiplier effect" held precious by the defenders of subsidisating the industry, who claim that for every dollar earned by the shipyards, $2.90 of economic activity is generated elsewhere in Croatia.
BBC Monitoring Article
International summit on economic growth ends in Croatia, November 7, 2004
How the East went flat and blossomed, by John Blundell, November 15, 2004
Croatia Business Report
Smarter Thinking for Croatia: An Interview with the Adriatic Institute
Adriatic Institute Proposals for Croatia's Economy