MS KATINKA BARYSCH

3 JULY 2007

  Q260  Roger Berry: To what extent are the tax regimes in the new Member States more competitive than in "old Europe" as it were? Is it a significant factor in determining whether or not new Member States have a competitive advantage?

  Ms Barysch: Again, taxes are not the main reason why a company goes to a country; but everything else being equal obviously they can make a difference. If you look at the overall tax intake in the Central and East European countries, it is a bit lower than in the EU15 but not very much. We are talking about the difference between, let us say, 35%-36% of GDP versus 40% of GDP as an EU15 average. The difference is not huge. A difference which is big is in headline corporation taxes. There obviously you have countries which go from 0% in Estonia to, let us say, 13% in Slovakia, up to over 30% in some of the other countries. If you compare that to what is happening in Germany, France and Italy, obviously the headline tax rates on corporate profits are much lower in Central and Eastern Europe. There is another difference because the tax base in these countries is much more coherent. Germany has a high headline tax rate, but it has so many exemptions and loopholes in its corporate tax system that most large German corporations do not pay corporate taxes. It is very difficult to calculate what the effective tax rate is. In Germany, for example, the effective rate could be only half the 38% headline rate, and the Commission and the OECD also publish figures where they look at the amount of money that governments collect in corporate taxes as a share of GDP. The last time I looked in Germany this was less than 1% of GDP. In Britain, mind you, it is more than 3% because you have a lower headline rate, but you have a move consistent tax base. In Estonia, which has a 0% tax rate on reinvested profits, Estonia collects more as a percentage of its GDP in corporate tax than Germany. The whole debate is seriously flawed when you then have politicians in Western Europe saying, "Oh, we shouldn't give these people structural fund money because they are competing unfairly"; then you have to ask yourself where these arguments come from. The other reason why Central and Eastern Europe is seen as a low tax paradise is obviously the flat taxes on income that some of these countries have adopted and for good reasons, because they are very ineffective tax systems, and tax evasion was so high that these taxes make sense in the context of transition economies. The main advantage that they have is not the level of the tax rates. As I said, payroll tax rates are very, very high; VAT can be high, so the overall tax take is not lower than, let us say, here but the big advantage is that many of these tax systems are quite simple. If you look at Slovakia, Slovakia has the most beautifully simple tax system in the world. It is a 13% tax rate on absolutely everything. 13% flat income tax rate, VAT, capital gains tax, no matter what. You can really do your entire tax declaration on the back of an envelope. Obviously the Germans look across the border and say, "Why can these guys do it and we can't?" I think that is the competitive advantage. Not so much the low tax rate, but they have really got it right in terms of the simplicity.

  Q261  Roger Berry: What are the implications of that for the debate on tax harmonisation?

  Ms Barysch: Certainly you cannot do that with the Central and East Europeans because they see very clearly the demands for tax harmonisation are basically a way of trying to force them to raise the headline rate. As I said, the European Commission called the bluff of the Germans and the French by saying, "Okay, if you want to go down the route of tax harmonisation it is good, but we have to start with the tax base". Companies are actually in favour of that, because the companies that operate across Europe would very much welcome more common rules for tax bases. Then what happens next? First, it becomes obvious that the whole debate is flawed; and, secondly, I think that the competition between tax rates would intensify; that is quite clear. The East Europeans certainly do not want any harmonisation in tax rates. They might or might not be willing to talk about the harmonisation of tax bases; but only if they can make quite sure that the outcome of this is not any large EU countries forcing them to raise their rates.

  Q262  Chairman: The implication of harmonisation of tax bases would be a British Chancellor of the Exchequer would not be able to offer certain reliefs that he currently enjoys offering? The loss of the ability of the Chancellor of the Exchequer, or any Member State equivalent finance minister, to offer specific reliefs to companies would disappear?

  Ms Barysch: You cannot do that anyway. Under EU law you are not allowed to. EU law is quite strict on how far you are allowed to give benefits to one company or another.

  Q263  Chairman: I am not talking about a company, but am thinking of things like research and development tax credits, for example?

  Ms Barysch: That would not necessarily be affected because we have common rules across the EU for that already.

  Q264  Chairman: There is a debate in political parties in the UK about research and development tax credit. My Party says we should abolish it and simplify the tax system; the Labour Party says no, we should keep it because it benefits R&D. A common tax base—that debate would disappear, would it not?

  Ms Barysch: Not necessarily, no. It might affect it. The example you just gave shows how huge the challenge would be trying to harmonise such rules across 27 countries. I think what we are basically stuck with (and I think that is a good thing) is minimum rules that say, "You cannot subsidise your pet industries through whichever means". I do not foresee any big move towards a harmonised tax base. Companies would welcome more joined rules because it would make their lives easier.

  Q265  Mr Wright: We are seeing for ourselves the huge growth rates currently being experienced by the A8/A2 countries. Do you believe it is sustainable? How do you see them developing over the next ten years?

  Ms Barysch: In the short-term certainly the high growth rates do seem to be sustainable. A lot of that growth is from export-oriented sectors. These countries are small open economies so their growth rates to some extent depend on what happens in the euro zone, which is their major market. They have also managed to reorient some of their exports to fast growing Asia; but these are basically export-oriented economies. You see the large amounts of investment that are still going in these countries; new factories are being built because privatisation is basically over so the money that comes in now is really building new production facilities. From that perspective, over the short to medium term, it all looks good. Over the medium to long term, as I already pointed out, they need to move up the value chain. Their wage levels will rise. They cannot afford to compete or they will not be able to compete with China. They need to have high skill levels. That is a policy challenge that these countries are very well aware of. Then you have another issue in the medium to long term, which is demographics. In Central and Eastern Europe populations are aging even faster than some of the euro zone countries. In order to maintain output when your workforce is actually shrinking you desperately need higher productivity. They still have a lot of new resources to bring into the labour force. If you look at overall employment levels, the share of the workforce that is employed is actually much lower than in most of the West European countries. Some of these people are idle because they have the wrong skills; because they are in the wrong areas. That again is a big policy challenge, because it is not only about re-training, it is also about fixing the housing market; building new transport and housing infrastructure and so forth. There are big policy challenges over the medium to long-term if they want to sustain these very high growth rates they are seeing at the moment.

  Mr Wright: We have recently visited Hungary and Lithuania, two completely different countries in terms of the difficulties and obviously some of the issues they face in the future. In Lithuania, for instance, large numbers of the population have migrated abroad, mainly to Ireland. In Hungary they have not got a stable workforce. In those two countries obviously it is going to create difficulties. Do you see their aspirations to become high value-added economies being achieved?

  Q266  Chairman: I want to ask you in detail about migration impacts in a moment.

  Ms Barysch: I am not too familiar with what Lithuania is doing at the moment; but in the case of Hungary certainly if you look at the share of the exports that are already accounted for by high-tech industries you see how quickly the country is changing. It seems to be taking advantage of the situation in Europe, yes.

  Q267  Mr Wright: They see themselves as the hub really of Central Europe—do you accept that as a viewpoint? That is what their strength is for the future in terms of becoming a high value economy.

  Ms Barysch: They have a very good international image, the Hungarians. They were early reformers. They have an image of stability. They have a highly qualified workforce. The good thing in Central and Eastern Europe is that these countries are all very aware of the fact that they are competing against each other. It keeps them on their toes. From what you have just told me about Hungary they seem to be taking advantage of that.

  Q268  Chairman: Is that concept of hubs very useful in looking at the Central and Eastern European economies, or are they all individual markets, and can a British company say, "I can base myself in Slovakia, Hungary and use it as a hub"?

  Ms Barysch: It probably depends on which sector you are in. For Hungary to claim it is the automotive hub of Europe would not be plausible.

  Q269  Chairman: Slovakia could?

  Ms Barysch: Slovakia is probably closer to that, but I think it all depends on which sector you said. The term "hub" I would associate with transport, which is certainly not a sector that Hungary sees its future in.

  Q270  Mr Clapham: A little earlier you mentioned education in the A10 countries being a factor that does help in attracting relocation. Is it possible to say what the strengths and the weaknesses of the A10 education systems and workforce skills are compared, say, not just with the UK but with the other EU15?

  Ms Barysch: As I said, on many educational indicators these countries are doing great—better than, say, the euro zone average. If you look at countries such as the Czech Republic and Poland and you find that over 90% of the population have completed secondary education, it is much higher than the EU average; but then these skill levels are adequate for their current specialisation in manufacturing and basic services; but if they really want to become knowledge economies, if they want to become high tech economies they need to make their secondary education more flexible and they also urgently need to reform their tertiary education. The enrolment rates in tertiary education, universities, are still much lower than you would find in most West European countries. The curricula tend to be very rigid. There is a heavy specialisation early on, which is not very good because you need a flexible workforce. Money is only so much of a problem, but it would certainly help if the state budgets in these countries were not under so much strain at the moment. The countries are aware of the importance of educational reform for their future competitiveness.

  Q271  Mr Clapham: On the rigidity of the curriculum, is that leftover from the Communist period? For example, is Hungary or Poland introducing a more flexible curriculum?

  Ms Barysch: I think they are working on it. The curricula changed very slowly because they sort of evolve in line with what your country is good at. If you look at Germany, for example, the heavy focus on engineering skills was perfectly adequate for most of Germany's post-war period, but not they are becoming more service-oriented you see this huge super-tanker of an educational system being very slow to turn around. I suppose that is the same in Central and Eastern Europe where they were specialising in manufacturing and heavy industry during the Communist period, and it is very difficult to change the mindset of a whole education sector that was once very useful and is maybe now a little less useful. What we see very clearly across the region is that the private sector is stepping in where there are the most obvious failings. You have private business schools all across Central and Eastern Europe that are doing very good work. Skill shortages do exist in some sectors. If you ask companies they will always tell you they do not have IT skills and other technical skills, but that is not something that is specific to the Central East Europeans; you have that in most West European countries too.

  Q272  Mr Clapham: Given also that education has a civilising influence, are we seeing for example different attitude towards gender mix in both education as well as in work? Is that beginning to happen in the A10?

  Ms Barysch: They have traditionally been very egalitarian societies, simply because under Communism most women worked, and they still do. The participation of women in the labour force there is very high, although it has been declining a little bit because there was more choice; under Communism there was not choice. These are broadly egalitarian societies.

  Q273  Mr Binley: Can I just ask a supplementary about education because we were told in Hungary by a very articulate, senior manager that one of the strengths was in fact related to some of the discipline and rigidity within the educational system. Whilst he recognised that were more creative in terms of educational approach, there needed to be a mix of the two. That is slightly different from what you are telling me. Is he right, or have I misunderstood what you have said?

  Ms Barysch: I think the two statements might be compatible in the sense that I said for their current specialisation in manufacturing, engineering and electronics their education systems are adequate, because they do produce good engineers and technicians, and that is what these education systems seem to be good at. If they really want to go into creative industries and software engineering and so forth then maybe they need a bit more of that. I would not advocate that all the professional education they have at the moment becomes worthless; but you need a bit more of the more flexible kind as well, I guess.

  Q274  Mr Binley: Thank you. Can I move on to migration of labour, because we always see the figures from national perspective, not from localised geographic perspective; and we always see the movement on national basis and not on segmented population basis; when in fact migration is very much about localisation, local areas and it differs massively within national boundaries. Secondly, it is very much about specific levels of the population—for instance, Lithuania. Not only are we seeing many people coming from Lithuania, but they are mostly young, they are skilled, they are very energetic. We are seeing them come to specific areas within the UK. In fact in those specific localised areas the figure is very much higher, and the drain from Eastern European countries is very much more relevant to given, important age groups, and our figures are misleading in that respect. I want to ask you where you see the long-term impact in terms of taking the very brightest and the most energetic and the most skilled from Eastern European countries; and whether you see that there will be a shift back as people say, leaving a real skills problem in the UK, for instance?

  Ms Barysch: For the time being it is good for us, bad for them, I would say. You could also argue that since we are, as you rightly point out, getting the best and the brightest from Central and Eastern Europe—however initially they tend to work in rather low skilled jobs in our economies until they have gained a foothold—there is a net loss for the EU economy as a whole because we are under-using skills on quite a broad level; having said that I would not be unduly pessimistic. We do not have good numbers about these migration flows from Central and Eastern Europe, but there is anecdotal evidence that people come over here and quite a few of them are going back. In the meantime, they are making more money here than they could at home, otherwise they would not come, and they are sending that money home. They are spending some of it here but they are still sending some of it home. There are remittances that help some of these countries. They are obviously also picking up skills whilst travelling in terms of the jobs they do, but also language skills and the general way things are done around here. They might go back with new enthusiasm and new skills and set up their businesses. That would be the optimal scenario. The labour market opening I think is too recent to say whether that is the case or not. I think the UK has done a very good thing by opening up its labour market. Here the people come in and you leave it to the market for them to find the best way to apply their skills. If you look at the big euro zone countries that decided to keep restrictions on labour movements, they did not keep these restrictions to keep the East Europeans out, they just kept them to keep control over who comes in and for how long. For example, there are still more Polish people going to Germany than there are Polish people coming to the UK. In Germany they get work permits for six to 12 months so that they can work in agriculture or the building trade. At the end of the day the German economy probably gets less out of its immigrants than the UK, which has the courage of leaving those people to sort out where they can add the most value and achieve the highest earnings.

  Q275  Mr Binley: How in the long-run does this impact upon Britain a) when people go back; b) with the fact that they have got real skill shortages in the UK; and c) that we have got a growing number of young people not in education, employment or training? There seem to me to be some very dangerous factors coming together which could impact very detrimentally upon Britain in five or ten years' time. Is that a fear we ought to take seriously?

  Ms Barysch: I do not think you can solve the problems of the British education system or skill shortages through immigration alone. I would not go down that route. What certainly has happened is through the rather sudden and sizeable influx of Central and East Europeans that has put pressure on other lower skilled professions in this country. You see a bit of wage pressure, and you have seen people who have not had quite high skill levels and motivation being pushed out by these young, energetic people who have come in. Personally I think competition is good but there might be additional demand for state intervention, helping these people to retrain and succeed in the labour market. There will be a big loss for the UK economy if a large number of the Central and East Europeans go back home. I do not know, whether they will, but even if they do, there is nothing we can do about it. The only thing we can do is make Britain open and attractive and keep the labour market flexible so that people feel at home and welcome here. Apart from that there is nothing we can do. What we should not do is actively recruit in areas that have shortages across the European Union; I am particularly talking about the medical professions here, because there are some countries, including those that have restrictions such as the Netherlands, that are actively going to Central and Eastern Europe and recruiting for doctors and nurses. Since there is already such a shortage in the Central and East Europe health care systems that is not something I would support.

  Chairman: I thought Mr Binley was going to ask about the impact of migration on the accession states and Mr Weir was going to ask about the impact on the UK, but it seems to have gone the other way round!

  Q276  Mr Weir: It was interesting what you were saying about the energetic young people coming from Eastern Europe. One of the things we have been told by someone is that the immigrants and migrant workers have a greater work ethic than many in the UK. Do you think that is true?

  Ms Barysch: I honestly do not know.

  Q277  Mr Weir: People coming from countries that have just come out of Communism, low wage economies, are they more likely to work harder than somewhere where they are being paid a lot more money. Is that the driving force behind them, do you think?

  Ms Barysch: I guess it always depends on what your alternative is. If you grow up in Eastern Poland and your local job opportunities are very severely limited and you get this one crack at going abroad and making a living and setting up a career saving enough money so you can start something new you are probably quite motivated. We do not only see that with the Central and East Europeans; we clearly also see that, for example, with Asian immigrants that come into the United States that are said to be working much harder than the local population. Then again, why would Europeans work so much harder if they do not have to? This is a wealthy society and one of the great achievements of that society is that people do not have to work 16 hours a day any more. Since this is not necessary I do not see why people should.

  Q278  Mr Weir: People who are coming to work in the UK, for example, remitting money back to Eastern Europe, is there evidence they are acquiring entrepreneurial skills in the UK and going back home to start businesses in Eastern Europe? Is it a benefit to Eastern Europe as well? We hear about losing the brightest to the UK, but is it a cross-fertilisation backwards, helping business in these countries?

  Ms Barysch: I can only say that I hope that this is the case, but I have not seen any evidence because these migration flows are probably too recent and we do not seem to have the statistics—or at least I have not seen them—to say whether that is happening on a large scale.

  Q279  Mr Weir: That is interesting because we had the statistician from the Department of Work and Pensions. One of the discussions we had was about the true number of immigrants and it seems nobody really knows how many immigrants there are from the accession states within the UK. My experience, representing an area with a lot of agriculture and food processing, is that we get a lot of temporary migrant workers; perhaps students who work for a while, earn money to help with their studies and return to their home countries. As far as you are aware there are no figures as to how many actually settle as opposed to those who are temporary workers?

  Ms Barysch: I have not seen any figures. I know we count those who come in but not those who go back. I am not aware that the countries themselves produce such figures of how many come back, but it would certainly be an interesting area of study.