Piketty Thinks the EU Is Bad for Eastern Europe. He's Half Right.

Piketty Thinks the EU Is Bad for Eastern Europe. He's Half Right.

Wednesday, 14 February, 2018 - 14:15
Rockstar economist Thomas Piketty's view of eastern European countries as "owned" by their wealthier Western neighbors has helped nationalist parties in that part of the world make a case for economic decolonization. But Piketty's arguments as he frames them are rather easy to dismiss -- which is a problem: There are stronger ones to be made.

Last month, Piketty used his blog on the center-left French daily Le Monde's web page to argue that European Union membership may not have been net beneficial for countries such as Poland, Hungary, the Czech Republic and Slovakia. He compared these countries' net outflows of profits and incomes from property with the net transfers they have received from the EU and finds that the outflows have been higher. "Of course, one might reasonably argue that Western investment enabled the productivity of the economies concerned to increase and therefore everyone benefited," Piketty wrote. "But the East European leaders never miss an opportunity to recall that investors take advantage of their position of strength to keep wages low and maintain excessive margins."

This week, Hungarian economist Zsolt Darvas, writing for the Brussels-based think tank Bruegel, picked apart these claims, pointing out that EU convergence grants are conceptually different from foreign investment, on which investors are right to expect a return. Besides, the outflows aren't all to the rest of the EU: "What can be learned by comparing, for example, the EU transfers to Hungary with the profits that the Hungarian subsidiaries of the Japanese Suzuki or the South Korean Hankook Tires make?"

Darvas also pointed to the foreign investment's central role in driving growth in the region and cited abundant literature showing that, far from keeping wages low, foreign companies in eastern Europe largely pay more than local employers and enjoy a better record on workers' rights.

Both Piketty and Darvas are dancing around a real problem for the eastern European economies. Darvas points out, for example, that in the Czech Republic between 2000 and 2017, 39 of the 50 state aid receivers were foreign companies; for him, it's evidence that the Czech authorities recognize the value of foreign investment for economic development. But it could just as easily point to a policy blindness: What if dependence on foreign capital inflows is, at this point, hurting more than it's helping?

The large profit outflows mentioned in Piketty's post are in part explained by eastern European countries' tax policy. With just two exceptions -- Slovakia and the Czech Republic -- they rely less on corporate taxes for government revenue than industrialized nations, members of the Organization for Economic Cooperation and Development, do on average. And even Slovakia and the Czech Republic show a greater than average reliance on consumption taxes.

It doesn't matter, contrary to what Piketty implies, where corporate profits end up geographically after all the taxes paid. A billionaire owner of a private German company might stash them in an investment account in some offshore area or they could be reinvested in the Polish subsidiary that made them, pretty much from anywhere. What matters for a country is its ability to tax these profits adequately. In their race to be competitive foreign investment destinations, most eastern European countries don't overburden the corporations. And, given the prevalence of foreign companies -- as Piketty points out, they account for more than half of corporate assets in eastern Europe -- the foreigners end up contributing less to the construction of east European social safety nets and infrastructure than they do in their own countries. Instead, the local populations, who already earn less because relatively low wages are what attracts investment to the region, contribute more than people in wealthier countries in the form of consumption taxes.

The economic colonization of eastern European countries is a real problem, though not quite for the reasons Piketty mentions. The gap between the taxes western European companies would have paid at home and those that are levied in eastern Europe is what should be fairly compared with the EU convergence grants. It's harder to calculate than profit outflows, and it's likely to be smaller than the grants. But it's natural for eastern European nations to try to claw back some more foreign company profits, as the Hungarian government has done with special taxes for certain foreign-dominated industries. The Polish government, too, imposed an additional tax on the banking industry, which is mostly in foreign hands, and attempted to do the same with large retail chains (the EU blocked that move).

Eastern European countries can and should be more aggressive in taxing the foreign companies on which they've come to depend. Given the still substantial pay gaps between eastern and western Europe, these firms won't pull out their investment, anyway -- and perhaps they'll be tempted to invest more in higher-margin activities up the value chain from the majority of today's projects. If eastern Europe is to converge faster with the west in terms of pay and social benefits, it needs to stimulate investment, both domestic and foreign, in areas where the upside is higher. That requires gradual policy shifts that western neighbors may not like -- but, as Piketty has noted, they are benefiting from considerable profits flows from the region, and that should sweeten the pill.

(Bloomberg)

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