In previous chapters, we discussed some of the features of the Argentine polity that limit the ability of politicians to enter into complex intertemporal transactions. In Chapter 3, for example, we showed that legislators lack basic incentives to develop professional careers, to invest in legislative capabilities, and to develop expertise that would allow them to control the bureaucracy. We claim that one of the features that limits legislators' incentives is the lack of judicial enforcement of policy agreements. In this chapter, we analyze the incentives and constraints facing Argentine justices that make it so that in equilibrium and on average the Court has not been a binding constraint on the workings of the Argentine executive.

The common wisdom on the Argentine judiciary is that the Court is too obliging, too connected to the other political powers to serve as an independent source of political enforcement (Ekmekdjian 1999). Nevertheless, the lonely voices of those who question whether the Court really lacks independence have found support in the results of two studies, which show that in the second half of the twentieth century the Argentine government lost cases in a proportion similar to that of the U.S. government. Hence, it is not obvious that the government's appointment powers are so overpowering as to void the implications of the division of power theory: that is, that an “aligned” Court will indulge the president and be unresponsive to changes in the political environment.

Legislatures are critical institutions in the effective functioning of a democratic system and in the policy-making process. In terms of the framework developed in Part I, Congress is the most natural arena for the institutionalized political exchanges necessary to sustain effective public policies. The ability of the congressional arena to play such a role varies substantially from country to country. At the more proactive and constructive end of the spectrum, the U.S. Congress is able to develop its own legislative proposals and has an active role in directing the policy agenda as well as in overseeing policy implementation. Congress itself is institutionalized in a manner that facilitates intertemporal exchanges and that leads to the accumulation of policy capabilities (Weingast and Marshall 1988; Krehbiel 1991). This, in turn, is associated with legislators having the right human capital characteristics to make them productive in those roles (Diermeier, Keane, and Merlo 2005).

The extensive literature on the U.S. Congress provides a detailed and relatively comprehensive understanding of this institution and a set of widely accepted truisms. Members of the U.S. Congress serve long terms in office. They specialize in the topics of committees on which they serve. They play an active role in the policy-making process. As an institution, the U.S. Congress engages in considerable oversight of the public bureaucracy, and it is at the center of policy making.

Argentina's sovereign debt default in December 2001 attracted the attention of scholars and policy makers around the world. A country that had a per capita income comparable to Canada's at the turn of the nineteenth century had become an economic disaster 100 years later, with 50 percent of the population living in poverty. Its inability to produce consistent public policies is, we contend, the cause of its economic misfortunes as well as a puzzle that requires explanation.

Argentina's policies have tended to shift dramatically over time. Its aggregate economic policy stance has moved from highly interventionist to extremely promarket and back. After many years of very high inflation and many unsuccessful stabilization attempts, the government introduced a rigid stabilization mechanism known as convertibility in 1991. This mechanism allowed for a reduction of inflation to international standards and resulted in a decade of relative macroeconomic prosperity. But the convertibility regime fell chaotically in early 2002 in the aftermath of the default, leading to one of the worst economic crises in recent world history. Argentine microeconomic policies have also been volatile. The geographical distribution of welfare payments changes as frequently as does the minister in charge of social welfare. Public utility policy moves from promoting private investment in infrastructure to asking foreign investors to leave. And, unlike some of its regional neighbors like Brazil or Chile, Argentina also seems unable to steer a well-defined course in its relations with the rest of the world.

The complexity of post-socialist transition was unprecedented. Initially, no one could accurately predict its pace or foresee how soon and to what extent it would be accomplished.

For example, when Solidarity's victory in the 1989 elections opened the “window of opportunity” for Polish reformers, it was impossible to assess the extent of Poland's problems and foresee the difficulties that would arise as the society and the economy adapted to market conditions. But today the stage of transformational recession, as well as the discussion about its causes and consequences, belongs to the past. Although major difficulties still have to be overcome, the economies of post-socialist countries largely display stable GDP growth and effective market mechanisms.

Transformational recession can be explained rather simply. The dismantling of the socialist economic structure revealed a sad circumstance: a substantial part of the economic activities carried out under socialism would never be needed in a market economy or democracy. The redistribution of resources concentrated in those activities cannot occur overnight. Processes that occurred at this stage of post-socialist recession were reminiscent of what Joseph Schumpeter (1950) described as “creative destruction,” but they occurred on a scale unprecedented for market economies. It is vital to understand that both post-socialist recession (the adaptive decrease in production) and the subsequent recovery are part and parcel of a single process, whose essence is the structural rebuilding of the economy.

Over the last fifty years Europe has gone through a unique historical process of economic and political integration, sharply contrasting with the tragic first half of the twentieth century. The last fifteen years, in particular, have brought remarkable progress. The Single European Market and the common currency (euro) have significantly deepened the prior integration, which was limited to little more than trade. Meanwhile, the European Union (EU) has gone through subsequent enlargements. The latest and biggest enlargement of the EU in May 2004 expanded the number of member states from fifteen to twenty-five. As a consequence, the EU's economic and geopolitical importance has increased. Most of Europe's nations and population are now contained in the Union.

Several other countries are in various stages of EU accession (Bulgaria, Romania, Turkey, and Croatia) or would like to start this process in the not too distant future (western Balkans, Ukraine, and Moldova). The Rome Treaty established that all European countries have the right to apply for EU membership, signaling that future EU borders will move farther to the east and southeast.

Despite the obvious achievements of integration, the European economy and European institutions face serious challenges. This volume concentrates on five big ones. The first task for the EU is to find a new legal shape and adopt a European Constitution. The EU decision-making process is ineffective and lacks sufficient democratic legitimacy on the European level.

Introduction

Oligarchs have become one of the big political and economic issues after communism, and one of the biggest policy questions in both Russia and Ukraine is what to do with them. Russia has seen the lawless confiscation of its biggest oil company, Yukos, through taxation, while Ukraine has flirted with widespread re-privatization. The resolution of the problem of the oligarchs will greatly influence the future of the economic systems of these countries.

To design a suitable policy for the treatment of oligarchs, we need to examine what oligarchs actually are, the economic and legal reasons for their emergence, how they act politically, and why they provoke such popular outrage. Our endeavor is to discuss oligarchs as a social phenomenon rather than a moral matter.

Economically, oligarchs have proven highly useful. They are a natural product of large economies of scale and weak legal security, and very large enterprises can hardly develop without them. A major problem is that oligarchs spend inordinate amounts to assure their property rights. The best cure would be to guarantee private property rights to all people, including the oligarchs. If not even the property of the richest is safe, how can anybody trust his or her property rights? Such a guarantee of property rights marks the crossing of the threshold to mature capitalism. Oligarchs may become more palatable politically if they are charged additional taxes or induced to undertake large-scale charitable donations. What must be avoided is the redistribution of property and legal limbo.

Introduction

In March 2000, the EU established the ambitious goal of becoming the most dynamic and competitive economy in the world by 2010. A variety of measurable targets were set accordingly, from increases in employment to higher spending on research and development. Despite initial optimism, the first half of the decade has been dispiriting and the EU is unlikely to achieve the objectives of the Lisbon Strategy. Over the last five years output has moved in fits and starts, without embarking on a sustained expansion, at a time when other OECD economies, notably the United States, were enjoying a strong recovery from the post-bubble recession. In the labor market, high unemployment has persisted in a number of EU countries. Trend labor productivity growth has declined toward the lowest pace ever recorded during the post-war period. Many observers have concluded that governments have failed to implement much-needed policies required to achieve the Lisbon targets and that, without radical changes, the strategy will fail to deliver on its promises (IMF, 2004; Kok, 2004). While this has been true for a long time, the lack of structural reform has become all the more problematic following the May 2004 enlargement, which brought into the EU ten countries with a total of 4.8 million job seekers. As more countries with large numbers of unemployed workers are knocking on the door, Europe must accelerate the pace of reform if it is to rise to the challenge.

Introduction

The growth of total factor productivity has been declining for several decades in the largest member states of the European Union. The program, which the EU announced at the Lisbon Summit in 2000 to reverse this trend, has so far failed. The passage of the halfway mark in the Lisbon Agenda calendar in 2005 was the occasion for numerous critical assessments and calls for renewed efforts to stimulate EU productivity.

In the midst of this productivity crisis, Europe is also constructing itself. In May 2004, it added ten new members. One month later, Valery Giscard d'Estaing handed a draft “Treaty Establishing a Constitution for the European Union” to the leaders of the expanded Union at a summit meeting in Thessaloniki. On May 29 and June 1, 2005, the electorates of France and the Netherlands rejected the Treaty in referenda and its ratification came to a halt. Will the Union eventually adopt principles and rules of governance that will allow it to function efficiently as a body of twenty-five? Will expansion continue? How will those processes affect the prospects for productivity and growth?

During the past two decades, the continuing development of the European Union has had an important liberalizing effect on its member states. The Single Market Act in 1986 and the implementation of the Economic and Monetary Union in 1999 have stimulated rationalization and restructuring. A single, anti-inflationary currency has slowly made competition in financial markets, and even competition in the market for corporate control, progressively more intense.

Introduction

Since their entry into the European Union in May 2004, the larger new member states (Czech Republic, Poland, Hungary, and Slovakia) have been subjected to the Excessive Deficit Procedure (EDP) of the Stability and Growth Pact (SGP) (Box 4.1). Subsequently, the EU has even declared Hungary in a state of excessive deficit. This pattern contrasts with the EU's prior experience. In the past, entry into the European Monetary Union (EMU) was a powerful mechanism to induce EU members, such as Italy, to adjust fiscal policies. In the last few years, however, the SGP has ceased to be an effective constraint on fiscal policy in EU countries.

The decision of the European Council of Economic Ministers (ECOFIN) to halt the EDP for France and Germany has weakened the credibility of EU fiscal rules. The reform of the SGP introduced in March 2005 further worsened the situation by expanding the list of circumstances that allows countries to breach the deficit ceiling of 3 percent of GDP. Countries are now excused not only for exceptional circumstances, such as a decline in output of 2 percent or more, but also for persistent economic slowdowns or for reforms, such as pension reform, that adversely affect the budget. The horizon for adjusting the budget deficit has been lengthened. The special treatment of France and Germany and the SGP reform have sharply increased the arbitrariness in the evaluation of fiscal policy and in the implementation of the SGP. The clear targets and constraints that acceptance to the Eurozone and the SGP once provided for the ten new member states (NMS) have become elusive and “flexible.”

Introduction

Once upon a time Europe was a small group of like-minded countries, determined to integrate politically and economically in order to eliminate war. After centuries of recurrent devastation, this was an ambitious project. It was built on Jean Monnet's prudent step-by-step strategy, now called neo-functionalism. Integration always progressed in fits and starts, but achieved amazing results. Not only is war all but ruled out, but also economic and political integration has deepened to a degree undreamt-of even by most Euro-enthusiasts. More amazing still, the project has spread. Nearly the entire continent is now part of the Union, and Turkey might join by the end of the decade. Two hundred million people share the same currency and enjoy borderless travel.

But success has its price. Twenty-five countries do not cooperate as six used to. Each enlargement gives the impression that the undertaking is being diluted, resulting in more weight given to national interests and less willingness to take the next integrative step. This perception is misguided. The EU-25 group is considerably more integrated than the original EU-6 ever was. Enlargement does not cause dilution, but it brings to the fore institutional failures that were present all along.

Now Europe needs to clean up its institutions and practices. Fifty years of negotiations have led to agreements both good and bad. Some of the old acquis communautaire is outdated. The European Constitutional Convention offered a unique opportunity to sort out this legacy, but this opportunity has been squandered.

Introduction

The accession of ten new member states to the European Union on May 1, 2004, brought deep changes to Europe's political economy, both toward the new member states and the EU's “new neighbors” to the east and south. To formulate a policy toward these “new neighbors,” the European Commission (EC) presented the European Neighbourhood Policy (ENP) strategy paper, setting out a new framework for relations and financial support for the neighborhood countries in May 2004 (EC, 2004a). The neighbors in question were Ukraine, Belarus, Moldova, Algeria, Egypt, Israel, Jordan, Lebanon, Libya, Morocco, Syria, Tunisia, and the Palestinian Authority, with the recommendation to also include Armenia, Azerbaijan, and Georgia. Russia was included as a privileged partner. Then European Commission President Romano Prodi described the goal of the ENP as seeking to create a “ring of friends” around the EU, by offering close cooperation on issues ranging from political dialogue to economic integration. This initiative was supposed to allow these neighbors to participate in major EU policies and programs, and ultimately in the EU's single market. ENP participants were expected to form a relationship with the EU similar to that of the European Economic Area (EEA) members, such as Norway, Iceland, and Liechtenstein.

This chapter describes the general framework of the EU's emerging relationship with its new neighbors and explores the potential economic impact of the ENP, both for the EU itself and for its neighbors in the Commonwealth of Independent States (CIS): Armenia, Azerbaijan, Belarus, Georgia, Moldova, Russia, and Ukraine.