Reforming the business environment in Central European countries

Roughly speaking, one can consider that the relative success of Central European countries depends mainly on small and medium-sized businesses and foreign direct investment. The policy of supporting foreign direct investment was initiated in Hungary as early as the late 1980s. Other countries in the region began to fully compete with Hungary for foreign investment after 1998.

Another success story concerns small and medium-sized businesses. The economic freedom gained after the fall of communism enabled the development of small and medium-sized businesses. When starting from scratch, the natural selection of entrepreneurial talent itself brings external benefits to post-communist countries. Small and medium-sized businesses are critically important for two spheres of activity: employment and political stability. Small and medium-sized enterprises – mainly those providing services and engaged in manufacturing – have provided very substantial assistance in absorbing the surplus of labor resources from the outdated state sector. Stability and democracy, among other things, are also based on the existence of small and medium-sized enterprises. Only a democracy with a large stratum of entrepreneurs and owners can be truly stable. There are countries with market economies that have efficient large companies and a small stratum of owners and therefore tend toward instability and rely on authoritarian regimes. Privatization and transformation of large enterprises are hardly a successful example. The performance results of such companies range between average indicators and bankruptcy. One study conducted in the Czech Republic since 1999 showed that companies with foreign direct investment perform far more successfully than those privatized through vouchers (privatization certificates) or sold to local business, as well as those remaining in state ownership.

Despite all attempts to improve management and corporate governance in privatized or still state-owned companies, successful experience is lacking. It turns out that the best results can be achieved by encouraging foreign direct investment and small and medium-sized businesses. However, the following questions prove very useful:

1. For whom will new companies produce goods and services? 2. Where will they produce them? 3. How will they produce them?

An excellent business environment is worth nothing if there is no market for selling products. This means that among companies with foreign direct investment, the best are those that serve external markets. Those that serve domestic markets usually improve product quality and productivity, but they also compete directly with domestic enterprises. Market competition is even tougher for small and medium-sized businesses. Successful rapid development of small and medium-sized businesses occurs in those regions where consumers are foreign tourists or foreigners in general. These are capitals and border areas that visitors from wealthier countries can easily reach. To attract such consumers, it is necessary to create the simplest possible visa regime for them (preferably visa-free), ensure easy access by all means of transport, provide many border crossing points (on the border between the Czech Republic and Germany, crossing points are arranged every fifteen kilometers), and last but not least, ensure the supply of hotels, guesthouses, etc.

Another important question is where to produce goods or services. Foreign companies prefer greenfield investments (when a new enterprise is established). The goal of countries should be investment in existing capacities, but this is a goal for the future. Companies prefer investment in new production capacities because they fear problems associated with inheriting existing assets and, most importantly, hidden liabilities. They can be of various types, but the most dangerous are environmental ones. To attract foreign direct investment under current tough global competition, it is necessary to provide the opportunity to buy land for the construction of new companies. Long-term lease (50 years, 99 years) can replace land ownership, but, of course, THIS IS A LESS ATTRACTIVE OPTION. Buying land from private owners to sell to foreign investors can be a complete nightmare. An example is the recent events in Slovakia, when the state bought land from private owners for an automobile manufacturing company. Nationalization of land by the state should be avoided where possible. Protection of private property is one of the basic principles of a market economy. Nationalization with compensation to the private owner can be used in the public interest (highway, railway), but in the case of transferring a land plot to another private owner (an automobile manufacturing company), doubts arise about the appropriateness of such a step. Overall, the country must provide foreign direct investment not only with land at an acceptable price but also with the necessary infrastructure, qualified labor resources, and some tax holidays (incentives). The latter raises many doubts due to the creation of unequal conditions for companies with foreign direct investment or large investors and the rest of the economy (as, for example, in the Czech Republic). An alternative option is so-called flat taxation – reducing the tax burden for all companies. The price of this approach is an increase in indirect taxation (VAT, excise taxes). For small and medium-sized businesses, the question of where to produce is even more acute. Here the experience of Central European countries has shown that the most effective way to obtain assets was restitution or voluntary resale to a more efficient owner (reprivatization). Former owners or their heirs received back restaurants, hotels, maintenance facilities, plots where production capacities were located, etc. A contribution to this was made by small privatization, which was used for small assets. Another source of acquiring ownership of capacities was the bankruptcy and liquidation of large companies. If there is a market for a company's products and the company has a place to produce them, attention must be paid to the conditions for conducting business. There are two areas where the state can take direct action: telecommunications and banking. Telephone communication, fax, and internet are the minimum conditions for conducting business. This can be achieved through the privatization of the telecommunications company to a strategic investor and/or the development of competition in this sphere. Banking is a more complex issue. All banks in the country must operate according to international standards, their development encouraged by competition, and thus resolve issues regarding the time required for money transfers and the time required to open an account.

Business licensing is a constant problem. There is no simple solution here. Some types of business activity must be subject to licensing, but licenses for many types of business activity undermine economic activity. A partial solution is the introduction of license types. Some types of commercial activity may not require a license, some may require moderate licensing, and others may require full licensing procedures. The purpose of such a step is to have as many types of activity as possible that do not require licensing, but how to classify types of business activity is already a matter for political debate.

Taxation is another important issue. Overall, taxation or the tax burden in Central European countries is sufficiently low. A matter for discussion is the relationship between direct taxes (in particular, so-called health and social insurance contributions or taxes levied on the payroll fund) and indirect taxes. The author is confident that a low level of direct taxation can stimulate economic growth. Slovakia was the first to apply such an approach, introducing a flat personal income tax rate of 19%. Other Central European countries are now also introducing such an approach with some delay. Particular problems in this area are the abuse of social assistance and temporary disability insurance. In 2004, Slovakia took decisive measures aimed at minimizing such assistance and increasing economic incentives to work. Even in the Czech Republic, which in recent years has followed a more cautious approach, such a trend has emerged. Sick leave payments have been reduced; this sphere is now regulated more strictly, and the authorities have even resorted to criminal investigations. There were companies whose only business was siphoning off such temporary disability insurance payments from the system. Another step is mandatory public works (eight hours a week) for the unemployed. This should encourage them to seek work so as not to fall out of the unemployment benefits system.