UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 592-v

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

TRADE AND INDUSTRY COMMITTEE

EUROPE MOVES EAST

Tuesday 3 July 2007

MS KATINKA BARYSCH

Evidence heard in Public Questions 244 - 299

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Trade and Industry Committee

on Tuesday 3 July 2007

Members present

Peter Luff, in the Chair

Roger Berry

Mr Brian Binley

Mr Michael Clapham

Mr Lindsay Hoyle

Miss Julie Kirkbride

Mr Mike Weir

Mr Anthony Wright

________________

Witness: Ms Katinka Barysch, Chief Economist, Centre for European Reform, gave evidence.

Q244 Chairman: Welcome to what I think will prove to be the last evidence session of this Committee's inquiry into the consequences of Eastern European enlargement. We are very grateful to you for volunteering to come in and speak to us and tidy up some of the loose ends of our inquiry and give us the view of an economist. I wonder if I could just ask you to introduce yourself as I always do, and perhaps say a word about yourself and the organisation you come from because I do not think everyone is familiar with the Centre.

Ms Barysch: My name is Katinka Barysch. I am the Chief Economist at the Centre for European Reform and have been there for six years. The CER is an independent think tank which was set up ten years ago with two objectives: one was to improve the quality of the debate on Europe in the United Kingdom; and the other one was to be a very British pragmatic voice for policy improvements in Europe. Having failed miserably in the first objective it is now going to concentrate on the second! We have become an international organisation. We try to work across party as much as we can. Half of what we do, our events, our meetings, everything takes place outside the United Kingdom. We do not take any government funding; we survive on corporate donations. We describe ourselves as "pro European but not uncritical". In other words, in the context of the British debate we would be seen as pro-European; but if I go to Brussels or to Berlin they think I am a euro sceptic. We are not federalists. We do not advocate European integration for its own sake. Personally I have worked on eastward enlargement since 1997. I was in the European Commission when they first wrote the opinions on eastward enlargement. I then spent five years at The Economist and The Economist Intelligence Unit also mainly looking at Eastern Europe. For the last six years I have continued that focus to some extent at the CER.

Q245 Chairman: Your organisation would have a lot in common with a lobby group like Open Europe, for example?

Ms Barysch: No, we do not have an agenda as such. We certainly do not have an agenda that is targeted to the British debate. What we are doing is really trying to generate ideas for making Europe run better. We think that Europe does a lot of good things from a trade point but often does them badly. We would look at different areas - be it energy policy, be it defence procurement, be it transatlantic relations or how to deal with China; but we certainly do not target our activities to a domestic policy debate.

Q246 Miss Kirkbride: The evidence would suggest, and it would be interesting to see whether you agree, that whilst the EU with the new countries has been economically very successful, that in terms of their own opinion polls that has paid a price in terms of the popularity of the EU in the new European accession states. Do you think that is true? In which case do you have any reasons why that might be?

Ms Barysch: Economically certainly eastward enlargement, to my mind, was a huge success because it left the EU economy overall better prepared for globalisation, which is something I would like to come back to later if I may. In political terms also I would say it is a huge success because I have watched over more than the last ten years how these countries have changed, and have changed for the better. How they have gone from post-Communist upheaval to functioning democracies and open capitalist societies. I do believe that the accession objective was instrumental in achieving that change. If you want to compare Hungary with Serbia, or Poland with the Ukraine you will see what a powerful anchor the EU accession objectives can be. If you define success in the European context only as steps in internal integration then maybe it is problematic because it has slowed down the integration process; but since I believe that our big challenges in the future will lie outside the EU's borders or in our neighbourhood you can just see how, on the one hand, we have not only created a stable neighbourhood by taking these countries inside the European Union, but we have also vastly increased what we call our "soft power". Just look at the line up of countries that want to join now after they have seen how much the EU admission has benefited those countries.

Q247 Miss Kirkbride: Why do you think it is then that in many of these new countries the EU is quite unpopular when it has had what would seem to be very obvious benefits?

Ms Barysch: In the new Member States?

Q248 Miss Kirkbride: Yes.

Ms Barysch: There is not actually any clear evidence that you have a huge increase in euro scepticism in these countries. I expected it to be much worse, because usually countries are the most enthusiastic about Europe the further they are away; whereas what you saw in the new Member States, those countries that have always been broadly pro-Europeans such as Hungary, they are still very enthusiastic; and those that have always been a bit more sceptical, like some of the Baltic countries, they are still a little sceptical. I expected there to be a much bigger backlash against the European Union, because they have been told what to do for ten years and then they come inside and I expected them to get their own back - but they did not; they remain broadly supportive of the European Union. They are just finding their feet within the EU, so the backlash that I perceive is amongst the old Member States that have a certain nostalgia for the cosy club that the EU once was when it had six or 12 members; and they have not quite realised that this cosy club has gone anyway and that has very little to do with eastward enlargement. The fact is that the EU, even with 27 member countries, functions reasonably well. Policymaking has not ground to a halt. Obviously we now have the new amending treaty that should fix some of the institutional flaws, and hopefully make the institutions work even better with the larger number of Member States.

Q249 Chairman: Before I bring in Mike Weir, could I just ask you whether you think it is accession or the end of communism that was the determining event? In Hungary last week we were told very clearly that actually accession had been a relatively unimportant event from the point of view of the country; it was the end of communism that was the defining moment. They began a process of reform then which EU accession merely reinforced but did not actually contribute to that significantly.

Ms Barysch: Of course that was the really significant event - the fall of the Berlin Wall - because without that accession would not even have been conceivable. Once the Wall was gone, and once the Soviet domination was gone, this overwhelming sense of returning to Europe has provided a focus to the political system that, from anything I have ever seen in politics, was completely unprecedented. There was not a single mainstream party in any of the accession countries that even voiced any doubts about the fact that EU accession was the number one priority. For ten years there was the strongest conceivable cross-party consensus in these countries that that was the right thing to do; and whatever it took to get into the EU they were ready to do. I do believe that this kind of focus is really important in making the changes. The changes they had to make to get into the EU of course were good for the countries for their own sake - they might have done them without the EU objective - but the speed with which these were pushed through, and the fact that they were largely uncontroversial, I cannot imagine that would have happened in the absence of the EU accession anchor.

Q250 Mr Weir: Just following on from that, do you feel then that the main driving force for the EU membership is more political than economic - having come out of communism they wanted to anchor democracy by joining the EU - rather than the economic benefits of it?

Ms Barysch: I think it was certainly a mainly political objective to join the EU. The fact that the EU happens to be a rich nations' club and especially small open economies, like most of the Central and East European countries are, gain from the kind of trade integration and legal approximation that the EU single market is about, that obviously is an added benefit; but the initial drive to get into the EU was a security one. These countries thought at the time it would be ages, if ever, before they could join NATO, and there was a lingering fear that they might fall back under Soviet domination, or Russian domination. I think initially the drive to get into the EU was predominantly a security one; and then later on they realised there were all sorts of benefits, and one was obviously to have a seat at the table in Brussels where the policies are made that affect countries that are in the EU's neighbourhood.

Q251 Mr Weir: There has been in recent years a lot of political instability in some of these countries. How do you feel politics has changed since accession? For example, we were in Hungary and speaking to Hungarian politicians of allegedly Left and Right it seemed to be backwards/forwards almost, where the Conservatives were in favour of keeping things under State control and the Socialists wanted to privatise and we found that quite difficult to get our heads round in many ways?

Ms Barysch: The old Left/Right divisions never really applied in Central and Eastern Europe. It was the old guys, the Communists, which we would define as Left, but for them it is the Conservative force against the new guys, the Centre Right parties, which we would define as Conservatives. Yes, it is a bit muddled. You saw one really striking fact - in 2004, the year of accession, every single one of these Central East European accession countries, I think bar one, lost their government. You really saw quite a significant increase in political instability in these countries bang on the date of accession. Within one year all the governments tumbled - not in a big crisis, but prime ministers had to step down for all sorts of reasons. I put that down to the idea, as I already pointed out, that the EU accession objective acted like a kind of political glue that held the political spectrum together. Once you are inside the EU that glue dissolves. All of a sudden, after ten years of being told what to do and just keeping your eyes on the prize, you are allowed to have policy debates; and they enjoyed that. These are democracies, after all. You saw more antagonistic, more real policy debates. At the same time there was a certain amount of reform fatigue in the population. Populism gained a foothold in Central and Eastern Europe. Many of the things you need to do for the EU accessions - such as liberalising your banking system - are relatively easy compared to what they have to do now - such as reforming their social security systems. You put all these factors together and you just see this increase in populism and political instability pretty much across all the countries. You have been to Hungary where there were riots last year; the Czech Republic was without a government for seven months last year; Slovakia and Poland elected populists; now Bulgaria and Rumania have joined and you saw, bang on the date of accession, in Rumania a huge standoff between the government and president; coalition tensions in Bulgaria; so you see it across the region.

Q252 Mr Weir: Going to Hungary again, going through their austerity package in a moment, the reform of the health care system and social security, you mentioned the election of populism in Poland and some other areas - do you see that as leading to greater instability in the likes of Hungary? Do you think stability will reassert itself? How will that affect business decisions to invest in these countries if there is political instability?

Ms Barysch: It is almost impossible to foresee whether you will see even a greater drive towards populism. I observe two things: even in those countries that elected populist governments, such as Slovakia, the actions of those governments have been nowhere near as bad as their rhetoric. I also observe that in those countries where you had quite intense political instability, such as Poland and Rumania, you still had a record year last year for foreign direct investment. We did see a slow-down in reform which, as I said, I put down to reform fatigue, and the fact that many of the tasks that now have to be done are more difficult than the ones in the past; but reforms do continue across the region. One thing that is striking is, despite the fact that Central and Eastern Europeans basically never elect incumbent governments, that is a very strong fact across the region, no matter which government you had in power, no matter which country basically continued the same broadly liberal reform agenda, there have been slight setbacks but no big policy reversals; and investors do not seem to be too concerned about the increase in political stability, because foreign direct investment is flowing in like never before and these countries are growing faster than ever before. So far we seem to see that there is a decoupling between the political side and the economic success story that Central and Eastern Europe is today.

Q253 Mr Weir: The reform of the health service is always a difficult issue in countries in Eastern Europe where traditionally there has been very strong health service. People losing a lot of these benefits, is that likely to lead to greater instability? It is one thing to reform economically, but when you start reforming social services that is opening a whole new different can of worms, if you like. Is that not likely to lead to instability?

Ms Barysch: If income growth continues at the same time and people do not feel that they are losing out from the economic transition altogether then I do not see why reforms should not be possible. In some of these countries, for example, pension reforms have been much more daring and drastic than anything we have seen in the old EU countries. It is possible to reform the social security system and it is also necessary because, contrary to what most people think in Western Europe, they actually have quite extensive social security systems in Central and Eastern Europe, but they are badly targeted so they are expensive. If these countries do want to join the euro one day and they need to reduce their budget deficits that is where the work needs to be done.

Q254 Mr Hoyle: Just taking a point the Chairman raised, he mentioned they did not gain that much more once they joined the EU; but is it not fair to say that a lot of the companies invested very early on because they knew they were going to join the EU and the investment took place much earlier than everywhere else; and that is why they did not see the benefits in the end but they had had them at the very beginning?

Ms Barysch: Absolutely. Accession is not an event, it is a process. Whenever economists model the impact of accession on economies in both East and West they usually define it as a ten or 15 years process of economic input.

Q255 Mr Hoyle: Of course people would say part of the main reason for investments in Central and Eastern Europe is actually low wages. Would you agree with that?

Ms Barysch: It is one factor. There are actually surveys out there that ask companies why they go and invest in one location rather than another and wages come quite far down the list. What investors are after is political stability, macroeconomic stability, infrastructure and a good legislative framework. The things people think are so important, such as wages and taxes, actually come quite far down the list. If it comes from Central and Eastern Europe obviously there is a big wage gap. I looked up the figures recently in 2005, which is the last year for which we have comparable statistics from the European Commission, and you have an average wage level in the EU of about €20 per hour. In the Czech Republic, Hungary and Poland it is about €6 per hour; and in Bulgaria and Rumania it goes down to €1 to €2 per hour. The wage gap is big. You always have to bear in mind that, although wages there are lower, they are growing fast and these countries cannot and will not compete with wage levels in China. They need other advantages and these advantages are very clear. As I have said, the EU accession process is an anchor. As a foreign investor you are basically insured against policy reversals. You also see a business environment that, through the Acquis Communautaire, is very similar to what you are using at home, because the laws are basically the same for product standards or competition policy across the European Union. You also know that if you invest in a country that will join the European Union you have completely free access to a consumer market of almost half a billion people. It is very important to have these added benefits. Wages are important but they certainly are not the main reason why companies would go to one country rather than another.

Q256 Mr Hoyle: Just looking at that, what is the most important competitive advantage in ranking? If it is not wages what would you say - education?

Ms Barysch: Certainly wages are only one part of the equation. It is the wage:productivity ratio that counts. The education levels in Central and Eastern Europe are very high. On some indicators these countries score better than the old Member States, for example secondary school enrolment and drop-out rates, which are more numeric indicators. When you go and test the actual skill levels, let us say, through the OECD studies you find that all is not well in Central and Eastern Europe because their education systems still need a lot of reform; they tend to be quite rigid, very heavily focussed and they do not really give people the kind of generic skills of, let us say, management and problem-solving and foreign languages that people need in a market economy. Again, these things are improving but, for the time being, they have good technical skills which are still adequate for their current level of development, which is mainly in manufacturing; but if they want to move up the value chain they obviously need to fix their education systems.

Q257 Mr Hoyle: Looking at that, it would be fair to say to go up the value chain that low cost production is actually moving further east now?

Ms Barysch: It is, yes. For some sectors, when it comes to the mass manufacturing of electronic gadgets, these countries are already losing investments; but at the same time they are now attracting services, not only call centre outsourcing but all sorts of other things; they are moving up the value chain into higher value-added. Then you have the huge success story of the automotive sector. I understand there that other things rather than just wages levels are important, because wages actually only make up a very small proportion of the cost of producing a car.

Q258 Mr Hoyle: I visited the Ford plant in Czechoslovakia(?) and they made a major investment and what they said was it is not just about low wages but about the higher education standards they can achieve. The qualification levels really mattered to them and that is why they made that investment and moved from the UK, so other companies must be copying that model?

Ms Barysch: Yes, but the wages in these export-oriented manufacturing sectors tend to be rather high. The productivity there is almost as high as you would find in Western Europe, which is understandable give that Volkswagen or Ford go in and put in a brand new car plant so obviously it is the latest machinery, so the productivity would be on an equal level, or even higher than what they have at home. Plus you take the people who are highly skilled but, because they have high productivity, they can pay them rather large wages. If you look at the average wage levels across the region that is misleading because some people make very good money; but then you go into Eastern Poland or Eastern Slovakia and the wages are just a fraction of what people could get in industrial centres or urban areas.

Q259 Mr Clapham: Picking up from what you said about wages, yesterday we had the British Chamber of Commerce, and one of the things they made quite plain is the relocation of manufacturing is driven by the incentive of profit. The two factors there would be low wages and higher productivity. My question relates to the fact that not only the UK but the other 15, particularly the Germans and the French, also see relocation of their manufacturing bases being important, the relocation into the A10. Firstly, do you feel that as manufacturing relocates from the 15 that it is undermining, if you like, the domestic manufacturing base of the 15? Secondly, would you subscribe to the view that as manufacturing moves into the A10 what is happening in the EU15 is that they are nudging their economies to a higher value level?

Ms Barysch: I think that is pretty much inevitable. The basis of our wealth is not the share of GDP that is produced in factories rather than offices; it is how much value each worker can add. If we insisted on keeping all our old industries we would still all be making T-shirts and cigarette lighters. I am glad we are not because that makes us a wealthier society. A lot of the manufacturing that has gone into Central and Eastern Europe in the early days was either labour-intensive, because of the lower wages, or was capital-intensive. You had heavy industry, steel, maybe chemicals and so on. It is only now that they are also moving up the value chain because actually Central and Eastern Europe is in a slightly uncomfortable spot between high-tech Western Europe and very low-cost Asia and further Eastern Europe. They need to move ever faster just to stand still. If you want to look at the impact of the shift of production processes into Central and Eastern Europe I would argue that it has been good for the EU economy as a whole; because what we have not seen, for example, is a massive increase in unemployment in Europe during the time when this shift of production processes happened. You have seen, of course, friction which you would expect in economies that are not fully flexible. We have not seen a huge set-back for any of the countries that start outsourcing to the region. The key thing for me to bear in mind is that eastward enlargement happened at the same time as China and India started integrating into the world economy. Eastward enlargement and globalisation happened at the same time. What that means is that the increase in global pressure on, let us say, automotives, on pharmaceuticals, on these globalised sectors has really increased quite fiercely. What do the companies do in response to that? They do not have a choice between producing at home and producing abroad. Nokia does not face that choice because it has a choice between either cutting costs or going out of business and laying-off everybody in Finland anyway. The choice is, how do we make our production more effective? Just heaven sent, all of a sudden you have several hundred million low-cost, high-skilled workers right at your doorstep with a brilliant business environment, and of course you start shifting some of the production processes eastward. That has actually helped these companies - Volkswagen and so on - to stay competitive on a global scale. The alternative would not have been that all the production takes place in Germany; the alternative would have been that Volkswagen lay off workers anyway. I do see obviously production processes are moving but there are some very interesting surveys out there particularly with regard to Germany, because that has been the biggest foreign investment centre in East Europe. They asked these companies: "Have you shifted the jobs abroad?" Quite a few said, "Yes, we have". The chair of companies that said, "This relocation process has actually allowed me to create jobs at home, and create higher value- added jobs at home", is much, much larger.

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 every 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 breaks 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 is 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 separate. 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 this. 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, then 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 actually 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 close.

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 tank 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 to 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 settle 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, but even if there was 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.

Q280 Mr Weir: Finally on the effect on Eastern European countries, one of the things we were told in Lithuania and Hungary (perhaps not so much in Hungary but certainly in Lithuania) because so many people had left Lithuania and come to the EU15 they were now sucking in people from further east, from Belarus and Kazakhstan, and places like that. Is that happening in a lot of other Eastern European countries as well, are you aware? What effect is that having on their economies?

Ms Barysch: I think it is happening to some. Again, I have only heard anecdotal stories of Ukrainians going to work in Poland, and Rumanians going into Hungary as their own populations move further west. Again, I do not see a big problem with that. People should be able to go there where they can add the most value. It is difficult for those countries from outside the European Union because we have a visa regime and the new Member States want to join the Schengen areas, so they need to enforce these visa regimes quite rigorously. It is not actually that easy for Ukrainians and people from Belarus and Kazakhstan to come and work in what are now EU countries because we have quite strict rules about that.

Q281 Mr Weir: Possibly quite a lot of legal work going on?

Ms Barysch: Yes, but by definition we do not have numbers on that.

Q282 Mr Clapham: A little earlier you mentioned the German system where there are work permits and people are restricted to certain sectors, in comparison to the UK where there is a free labour market. Given that there is this freedom in the UK, does it not result in people moving from certain sectors that they came to work in, for example in agriculture, to work in construction, and consequently you then get a depression of wages in the construction industry; whereas in Germany there is much more control and, therefore, you would not get the sector wage depression? Would that be a correct analysis between the two?

Ms Barysch: It is difficult to compare the two systems because, unlike Britain, Germany does not have a general minimum wage. What you saw in Germany is that all wages, and all agreements that affect wage levels, working hours and so on are negotiated between the employers' federations and the labour unions. Some sectors have a minimum level of wages and others do not. What you saw in Germany, and what caused a lot of the controversy, is that people came in and they worked in the building trade and in slaughterhouses for as little as €1 an hour. They actually found women working in call centres for €0.50 an hour, and that obviously caused a lot of upheaval in an economy that is used to being a high wage economy. That is why now in Germany you see a debate about introducing a general minimum wage. Here the situation is fundamentally different because the Government made the decision that there should be a general minimum wage which applies to all sectors. This is a political decision; this society decided we do not have to wage depression below that level because we do not think that is human and that is a political issue. Obviously that is the minimum floor, and you might argue that illegal immigrants might put pressure on that but I do not know if that is then a matter of enforcement but not a political decision. Yes, you probably will not see wages rise much higher than the minimum wage, but you do have that floor.

Q283 Mr Clapham: Really what we ought to be doing is to ensuring that as we get people coming in from the A10 countries we should be directing them through the trade union route?

Ms Barysch: I am not sure that is necessary. I understand the minimum wage is binding whether you are a member of the trade union or not.

Q284 Mr Clapham: The minimum wage is but of course the rate of pay in a particular sector is not. The rate of pay in a sector like construction may well be negotiated by the trade unions, and well above the minimum wage. Whereas when you get the movement of labour from, say, agriculture into construction they can be relocated by virtue of gangmasters who pay a very low rate. One of the things we are told by the construction unions is that is what is occurring.

Ms Barysch: It is true that this is an issue quite a few of the European countries face at the moment. I do not know if you have heard of the Vaxholl case in Sweden where there was a Latvian construction company that built a school and then the Swedish trade union said, "This is unfair because, unlike everybody else, they have not closed a bilateral deal between the trade unions and the employers about the wage level on that particular construction site". The Latvians argued that they did not need to do that because they operated under the rules of their home country, not the country they happened to be in. That went to court and the Latvians had to go home. It then went to the European Court of Justice, and the European Court of Justice recently expressed a certain amount of sympathy with the point of view of the Swedish trade unions. I am quite sure that the trade union leaders in this country will be following very closely what comes out of that debate, because that might ultimately allow trade unions here also to go to the European Court and enforce what they see as their rights. I think because the differences between the various EU countries in setting wages levels (be it at the company level, the industry level or where the governments are involved or not involved) are so vast, you probably will not see a European solution to that. Not being a trade union specialist I do not really know what the outcome in this country will be.

Q285 Chairman: Would labour shortages and, in particular, certain skills in some accession state economies now mean that the viability of British inward investment to those economies is limited?

Ms Barysch: Yes. You do see companies that are complaining about skill shortages in and around Prague and some urban areas, which is why they now want to go further east where land is cheaper and labour is still more available. For that, you obviously need infrastructure investments which are happening in some of these countries, so I would not say that the potential of these countries is exhausted. You also need to put things into perspective, these countries got about $40 billion worth of foreign direct investment last year, the Central and Eastern Europeans together, but if you take that amount, that is only about 7% of what the EU got as a whole in foreign direct investment. The fact is that most of the investment that goes out of the UK still goes to other European countries and the US. The Central and Eastern Europeans are really just a tiny share of where British companies put their money abroad.

Q286 Chairman: Just a few other concluding questions from me and if there is anything else you need to say at the end, by all means, please do. First of all, the acquis, which is all signed up to by the accession states, obviously on paper they have done very well. What do you think about enforcement on the ground of those new sets of rules?

Ms Barysch: I can only say what the official figures show, which is that they have fewer infringement cases and less of what they call the "transposition gap" which is the share of EU law that you should have adopted but have not than many of the old Member States, so on paper it looks as if the new Member States are quite diligent when it comes to implementing the acquis. This might have to do with the fact that they joined relatively recently and as long as you are outside, you fear the European Commission because it has some real power because it gives you a school report every year; once you are inside the European Union you feel much freer to ignore the European Commission. My friends in the Commission tell me that there is a kind of lingering respect for the Commission that you do not see in other countries, so when Brussels says, "Can you please implement that law?", they are still more likely to do it than, let us say, some other countries.

Q287 Chairman: They are also smaller so there would be fewer cases, you would expect. Italy tops the league table I think, whatever measure you use.

Ms Barysch: Yes, France is also not very good in these statistics.

Q288 Chairman: Structural and cohesion funds, we had some very interesting sessions in Hungary last week looking at the way the government is really being very diligent in the way they use those funds to make sure they bring maximum advantage to the Hungarian economy and that funds are appropriately used and not misappropriated, which is an issue in Hungary. How effective do you think the accession states are proving generally at using those funds?

Ms Barysch: I believe it is too early to tell because the rules, according to which these funds are spent, are very complex and complicated. You might criticise that, but that is just a flipside of the coin of the demands that we make on the European Union to spend the EU budget wisely and in a way that is transparent and safe. You cannot say, on the one hand, "We want maximum control and prevent wastage and corruption", and, on the other hand, say, "We want super-simple rules that allow for the expending of money", so these two things go together. Because these rules are complicated, it took the Central and Eastern Europeans a little while to identify projects that fit into that framework, to apply for the money and I understand that in many of the areas they are just now at the stage where the money starts flowing in. What has not happened is the scandals of money being stolen or wasted that we expected to come out of some of these countries, I have not seen any headlines claiming that this is the case. What is also interesting is it should get easier now because they are getting used to the bureaucratic process and also I think it was a British initiative, because it was under the British Presidency, under which the last budget was negotiated, they reduced the overall amount of the structural funds that will go to Central and Eastern Europeans, but in return offered an easier set of rules for these countries according to which they spent their money and they reduced the co-financing requirements in some areas. It should now get easier for these countries to spend the money and it is also encouraging that they are trying to learn from the old Member States what to do and what not to do. There was a lot of interest in how Ireland managed to spend EU money in a way that was so good for the country's long-term growth rate and also a lot of interest in the Greek case on how not to do it.

Q289 Chairman: The main purpose of this inquiry is to assess what the impact of these developments has been on the UK economy and we have not exploited our opportunity as we might. We have heard consistently quite a lot of criticism of the UK banking sector for not being sufficiently entrepreneurial in its approach to Central and Eastern European economies and the pretty well widespread absence of the major high street retail bank names from those economies. Do you think that is a matter of concern?

Ms Barysch: It is a very small market so ----

Q290 Chairman: They are saying that the British companies do not want to go and invest because they have not got the bank names they are familiar with to do business in these countries.

Ms Barysch: I cannot imagine that British businesses say, "Well, I can only do business with Barclay's but not with Deutsche Bank", that would surprise me - maybe that is the case - but since predominantly these banking sectors are in the hands of West European banks, not necessarily British ones but Germans, Italians, French, these are well-known names so you would not cite that as a major impediment for British businesses to go and do business there. As I said, these are small markets, so some of the most successful banking players in Central and Eastern European countries themselves come from small countries, such as Austria, because Austrian banks would not have the scale to roll out big foreign projects, let us say, in the German or British market, but they were quite successful niche players in Central and Eastern Europe and they still are.

Q291 Mr Binley: We got a different message from two of the accession countries I have been to and I think you got the same sort of message from Lithuania. What is missing is not the ability to cash cheques and shove credit cards into holes in the wall but real skill about public sector financing, big project financing, PPI-PPP stuff, the capital elements of investment that they really are crying out for that they reckon are skills best lodged in the City of London and they are saying, "Please come". That is the impression I got from the states we went to, so there is a slightly different story between the two of you there.

Ms Barysch: That is a very good point but, then again, if the demands are really there in Central and Eastern Europe, I would be highly surprised that the very crafty people we have in the City of London are not taking advantage of that. I believe if there is a real demand for the skills that are only available here, then I do believe that is -‑‑‑

Mr Binley: We were told that they were missing.

Q292 Chairman: We have had a fairly consistent complaint that the financial services sector has not been quite as entrepreneurial as it ought to be in these states.

Ms Barysch: That is a very good point.

Q293 Chairman: We seem to have got a pretty clear impression that Britain was behind the curve on taking advantage of opportunities in Central and Eastern Europe compared with other Member States, not just Germany but also countries like Spain, Italy and France. Do you think that general comment, that British business was a bit behind the mark, is fair?

Ms Barysch: It seems to be the case that other countries were quicker to invest in these markets and also put in larger amounts. I think partly that is just a case of geographical proximity, partly it is the case of necessity, because German businesses, for example, are under particular pressure due to re-unification and all sorts of other areas, and partly it is a question of the industrial structures. As I said, a lot of the foreign direct investment in the earlier years was in manufacturing. Since the continental European economies have more export‑orientated manufacturing sectors than Britain, the opportunities just presented themselves in a different way, because half of the FDR in the 1990s was manufacturing orientated and half was just basically acquiring existing businesses and building up telecoms companies and supermarkets. Some British businesses, such as Tesco, were at the forefront of this and others might have been a little slower, but I am not entirely sure why that would be the case.

Q294 Mr Hoyle: We keep bouncing this around, but I think the truth of the matter is that when the wall came down and it was opened up, we were too busy looking to the Pacific Rim countries and the ASEAN countries that we thought the East was where we ought to be. Germany went straight in and bought out the banks and the supermarket chains, Tesco was a late player even then coming into the market, most of it had all been bought up by German companies. When we looked at banking, by the time we got around to even considering it, all the banks had been bought out and there was nothing really left for us to pick up and Tesco had to buy chains off the Germans in order to get a foothold. Is that fair?

Ms Barysch: That might well be the case, but then I do not see any huge damage that might have done to the UK economy as a whole.

Mr Hoyle: The Government was expecting business to look to the East - when I say the "Far East", not Eastern Europe - but Germany was well placed and it took advantage.

Q295 Chairman: We got a complaint last week that the British Government back in the 1980s was steering, exactly as Lindsay said, British businesses towards the Pacific Rim and was not focusing their attention on the opportunities in Central and Eastern Europe that emerged but you are saying that has not damaged the British economy overall?

Ms Barysch: I do not see any evidence of this because, as far as I can see, the British economy is doing fairly well. You have to bear in mind that these markets are small. If you put together all the accession countries, the outcome is an economy the size of The Netherlands, so it is not as if you are missing out on a huge market, these are small, fast-growing markets but they are still relatively limited in size.

Q296 Chairman: You certainly think the Turkish market is a hugely important market, judging by a recent paper, and that there is a need to make sure that the accession process continues on a smooth path for Turkey.

Ms Barysch: I just observed what the accession anchor did to Central and Eastern Europe and I want some of that magic to rub off on Turkey, a country which I think is hugely strategically important and is going the right way at the moment. I would very much wish whatever we can do to help that country continue its transition, we shall do, rather than having a debate about the borders of Europe, which would be ultimately futile. I do believe that there are big opportunities. The accession, in the case of Turkey, will invariably be weaker for all sorts of reasons than it was in Central and Eastern Europe, but if we can help make Turkey more stable, open and prosperous, I think we should do that.

Q297 Chairman: Is there any other country outside the current European Union we could apply that logic to as well?

Ms Barysch: We cannot really. In the case of Turkey, the fact that Turkey is non‑negotiating was not a well-thought out, strategic decision, maybe it just so happened but it is good that it happened. If we now said to, let us say, Ukraine, "We will give you what we call a membership perspective as well", it just would not be credible, so we cannot and for the time being I do not think we are in a position to make any more promises of future membership to anybody else other than the countries that are already lined up in the queue, which are the Western Balkans and Turkey.

Mr Hoyle: But Turkey cannot join. It cannot resolve its Cyprus issue, it has also got France opposed to it, it has got The Netherlands opposed to it. The problem we have got is we have real problems out there. Austria just will not bend at all, and it is how do we overcome those major issues politically that are driving against Turkey completely. Turkey has got itself into a situation where it has even closed its ports to Cypriot ships, so instead of getting better, it is actually getting worse at the moment.

Q298 Chairman: This is a subject to which the Committee may well return, it is not part of this inquiry. It is an in-house message. Is there anything else you would like to add that you have not had a chance to say in answer to the questions?

Ms Barysch: No, thank you.

Q299 Chairman: We are enormously grateful to you, you have been an extremely informative witness, and we are ending this particular inquiry on a very high note. Thank you very much indeed.

Ms Barysch: Thank you.