The European Union (EU) is seen to be one of the most successful political and economic unions in history. Since the signing of the Treaty of Paris in 1951 by the EU’s six founding countries (Belgium, Germany, France, Italy, Luxembourg and Netherlands) which created the European Coal and Steel Community, the EU has enlarged on six different occasions. These expansions have resulted in membership increasing from the six countries mentioned prior to now 28; with the fifth wave of enlargement, commonly referred to as the eastern enlargement being the largest to date. The enlargement took place over two periods and was viewed as a qualitative step forward in the history of European integration (O’Brennan and Cox, 2009). The first group of countries joined the EU on the 1st May 2004 with the accession of ten states[1]
and concluded on the 1st January 2007 with Bulgaria and Romania joining the union. Not only was this enlargement the most significant transformation of the modern era, but it also correlated with significant improvements in the business environment for the joining countries, thus clarifying why businesses were advocating integration (Johnson and Turner, 2006).
The question of how and to what extent the EU has influenced change in Central and Eastern Europe (CEE) has been the focal point of extensive literature since the eastern enlargement concluded in 2007. The institutional changes that occurred as a result of EU membership gave the EU an unparalleled influence in the restructuring of the states (Schimmelfenning and Sedelmeier, 2004). A considerable amount of literature has accumulated about the impact of the fifth wave of enlargement on the respective countries. Broadly, the research falls into two categories: The first group of papers deal with the political aspects of integration such as the impact enlargement had on democratic consolidation and more recently on democratic backsliding (see Epstein, 2013; Levitz and Pop-Eleches, 2009). The second group of papers analyse the economic aspect of the enlargement such as its influence on privatisation, macroeconomic stabilisation, and its impact on foreign direct investment (FDI), as well as how joining the EU impacted the labour market (European Commission, 2009, 23). Despite the different focuses, there is considerable overlap among these papers as the areas of analysis are interconnected. Although the papers provide a critical review and background on the eastern enlargement, they do not analyse the impact the enlargement had on the business environment explicitly. Nevertheless, some scholars did attempt to focus on the change in the business environment as a result of enlargement, but their works leaves room for further development and analysis.
This dissertation aims to fill this gap in the literature by analysing the impact enlargement had on the business environment by mainly focusing on EU conditionality. Investigating the business environment is crucial, as a vast swathe of transformation have caused substantial changes to arise within the countries that joined the EU (Guay, 2014), and it is essential to know how much of this can be attributed to EU membership. A problem that occurs when analysing this topic is that there is no unanimity over the definition of the business environment. For example, Simon White (2004) describes it as all those factors external to the business, which either inhibit or favour the development of the firm. In regards to the business environment, this dissertation acknowledges that there are various aspects of said environment, but due to the limitations of word count, it will specifically focus on the macro-business environment in three specific areas: starting a business, contract enforcement and property rights. To provide an in-depth analysis, this dissertation will be concentrating on a handful of states. As the eastern enlargement was split over two years, Bulgaria and Romania have been chosen as they enlarged later in 2007, with the Czech Republic, Poland and Hungary being chosen due to them enlarging in 2004. Analysing nations from both enlargements will provide a more detailed understanding of the role EU membership played and thus enable correlations to be developed.
Similar to existing work within this field, this dissertation will adopt a qualitative approach to assess the correlation between enlargement and changes in the business environment. Through the use of secondary data, the ‘descriptive research’ tool will be utilised to assess the correlation between the eastern enlargement and improvement in the business environment. This is due to the difficulty in establishing causality.
This study will begin by providing a background on the general knowledge of the field. This will consist of analysing existing literature, providing an overview of the business environment before enlargement and then justifying the definition of the business environment that will be used. This is succeeded by the methodology in which the descriptive research tool is explained, with the analysis and concluding marks following thereafter.
2. Historical background/ General knowledge
2.1. Literature review
Although there is an abundant amount of literature on the business environment, there is limited analysis conducted on the role the EU had in altering the business environment. The lack of extensive development in this field is surprising due to the systematic transformation that has occurred within these states, most of which were a result of the adjustments required to meet EU membership (Witkowska, 2007). Much of the existing literature focuses instead on the impact the business environment had on economic growth. For instance, through the use of a theoretical framework Acemgolu, Johnson and Robinson (2004) showed how differences in financial institutions are fundamental causes of differences in economic development. Their analysis illustrated how aspects of a weak business environment such as poor property rights and a biased judiciary discourage investment. Furthermore, the work of the work Katinka Barysc illustrated how the accession process led to an export boom, as the removal of the trade barriers was one of the factors that enabled the business environment to resemble that of the West (Giddens et al., 2006). As a result, countries such as Poland, Slovakia, Hungary and the Czech Republic became more attractive to investors, which led to a massive influx of foreign direct investment (FDI). The work of these authors is essential as it demonstrates that improvements do arise through EU membership; however, the majority of the academics have overly focused on FDI and not given other aspects of the business environment in-depth analysis.
There exists some literature assessing the role the EU played in transforming the business environment in Central and Eastern Europe, such as the work Kučerová and Pošvář, who evaluated doing business in the Czech Republic before and after accession, with much of their analysis focusing on whether integration into the EU lived up to the expectation of the people, in particular, the managers. The conclusion drawn was that the new business environment exceeded the hope of many, as before enlargement, many of the managers were pessimistic about the effects of joining the EU (Kučerová and Pošvář, 2005). Although their work illustrated an improvement in the environment after enlargement, it nevertheless struggled to demonstrate the role the EU played on it. The reason for this can mainly be attributed to the methodology that was employed in their analysis. By using SWOT analysis Kučerová and Pošvář’s study focused more on the managers at the expense of assessing the driving force behind the changes. Litva (2017) on the other hand focused his analysis on the data from the World Bank and the Global Competitiveness Index. In doing so, he was able to illustrate the improvement that occurred within the business environment in Poland, the Czech Republic and Hungary and was able to specify how the improvements mainly occurred in taxes and starting a business (Litva, 2017). Although the data was able to determine the areas in which improvements occurred, it nevertheless struggled to assess the role of the EU. For example, it was unable to illustrate whether EU law, directive or conditionality brought about a specific change. For this reason, this dissertation will devote some attention on the criteria for accession and will attempt to illustrate the impact it had on the business environment in CEE.
2.2. What made the business environment in CEE less favourable?
Having an overview of the business environment in Central and Eastern Europe before enlargement is essential to understand the changes that occurred and what the causes of the changes were. As stated earlier, the business environment has no concrete definition, and it’s for this reason several scholars adopt an inclusive definition (White, 2004). The broad definitions mean that the business environment can consist of both endogenous as well as exogenous factors such as legal, ecological, technological and many more. When assessing this topic, many specifically focus on political, economic, social, technological and legal factors commonly referred to as SLEPT analysis.
Before enlargement, the countries in CEE were unable to develop their private business sector effectively which failed to create opportunities for entrepreneurs to build a stable business (Smallbone and Welter, 2001). The presence of the communist ideology was the cause of this, with policies rejecting private property, as ownership of private property was perceived as a “cornerstone of capitalist expropriation” (Demela and Mikula, 2015, 328). The lack of property rights created obstacles for businesses as it led to the “grabbing hand paradigm” (Shleifer and Frye, 1997) which emphasised the predatory nature of the state. Within this, large-scale expropriation occurred with the communist leaders often confiscating and becoming legal owners of the seized property. Although the degree of state ownership varied across the region, for instance in the 1980s, Poland and Hungary began to privatise, whereas 95% of the economy in the Czech Republic and Slovakia was still under the control of the sate (Guay, 2014). Nevertheless, expropriation was still persistent throughout the region. This highlights how the CEE countries lacked the necessary laws for protecting the interest of the people, as it failed to provide a reasonable expectation of the behaviour of the individuals and the state. The one-party authoritarian system that was present throughout the region was the causal factor for this. The system allowed parties to wield ultimate power via their tight control of organisation which extended to all levels of bureaucracies, trade unions and enterprise management (Johnson and Turner, 2006). The rigid planning and isolation from non-communist countries which was associated with communism meant that the business environment in CEE was unable to flourish, explaining the high number of uncompetitive enterprises. To make matters worse, as a result of the decades of central planning, the economic structure of CEE countries had become severely distorted, which led to a decline in economic activity and living standards (Hull, 2011). Consequently, the business climate within the region became unstable and discouraged investment(s) into businesses.
While legal, economic and political factors are crucial for a healthy business environment, social factors are also perceived to be as equally important. These factors are related to the population or the market, included but not limited to the size of the population, health and education. The primary social factor that influenced the business environment before enlargement was education. The purpose of education pre-enlargement was to serve the goals of the party. Shimoniak (1970) developed this argument further by claiming the goal of education was to educate the workers of communism and thus enabling them to understand the plans of the party better (Owen-Jackson, 2015, 11). In the eyes of communism, education was perceived as the “ideological arm of the revolution” (Owen-Jackson, 2015, 11). As schooling did not intend to promote the development of the individual as it did in a liberal democracy, efficiency and the development of the business were undermined. As a result, there were more underperforming companies and innovative thinking and development was hampered. Therefore, this demonstrates that before enlargement the business environment was severely flawed, primarily due to the communist legacy.
2.3. What constitutes as a good business environment
To justify the definition of the business environment used in this dissertation, it is vital to understand what a good business environment is. There is a vast plethora of literature on the business environment, which is seen to be a subset of the large and growing institutional, economic research. Having a favourable business environment has become not only a central issue in the modern marketplace but also a principle one (Hamplová and Provazníková, 2014, 1225). For this reason, the European Union prioritised the creation of a friendly business environment in which entrepreneurs can flourish. This dissertation acknowledges various factors that are necessary for a favourable business environment, however, due to limitation, only three key aspects are analysed: Starting a business, contract enforcement and property rights. This section outlines what constitutes as a good business environment in these areas, and why it’s essential to analyse these areas within the analysis.
2.3.1. Starting a business
Costly entry regulations damage the business environment as it dissuades firms from entering the market, and fails to prevent the entry of corrupt firms which builds the case for fewer entry barriers. It is for this reason that there is much emphasis by the EU on streamlining the procedures and time required to start a business. Focusing on the ease of starting a business is an important indicator when assessing the change in the business environment in CEE, as procedures for starting a business was one of the main obstacles businesses faced. This was evident in the work of Djankov et al. (2001) who assessed the regulation of entry for start-up companies in 85 countries in 1999. Their results illustrated how there was a significant difference regarding the number of procedures to start a business in the acceding countries and the countries already in the EU.
Figure 1: Number of procedures to start a business
Country
Number of procedures
Bulgaria
10
Czech Republic
10
Hungary
8
Poland
11
Romania
16
Source: (Djankov et al., 2001)
Figure 1 illustrates the number of procedures to start a business in the acceding countries were high, especially when comparing them with the nations already in the EU such as the United Kingdom who only had five procedures to start a business (Djankov et al., 2001). One of the leading causes for the high number of procedures was due to an overly bureaucratic legislative process. For instance, in the case of the Czech Republic, the bureaucracy has “always been a challenge” (The New York Times, 2010) with it delaying the time to start a business as a result of decision making being split into various layers of jurisdiction. Due to the legacies of the old regimes, the issue was present throughout the countries in the region. Furthermore, data stretching back to 1995 emphasised the difficulty of starting a business before EU membership. For instance, Bulgaria was ranked 55 out of a possible 100 in its Business Freedom [2]
which was significantly lower than Germany which was ranked at 85 (Heritage.org, 2018). These are just some statistical data that illustrate the difficulty of starting a business in CEE countries.
Starting a business is not only time consuming but also includes bureaucratic and legal hurdles. There are various costs involved, ranging from registering property to obtaining electricity. In one of the earliest work within this area of study, North and Thomas (1973) argued that entry barriers hinder the development of firms. This topic has since been developed by Gassebner and Dreher who showed that the higher the number of procedures required to start a business, and the higher the minimum capital requirements are, the more negative the impact would be on the business environment (Gassebner and Dreher, 2013). They claim higher start-up costs discourages firm creation, and thus job creation suffers (Fonesca et al., 2001). When analysing businesses in Europe, Klapper (2011) found that costly regulations impact the establishment of new firms. He developed this topic by illustrating how reducing the cost, time and procedures of starting a business improves the business environment and thus leads to a higher number of firms (Klapper and Love, 2011). Therefore, this suggests that a good business environment in one in which businesses can be established quickly. To name just a few this involves reducing several layers of bureaucracy as well as reducing the procedures and time required to start a business.
2.3.2. Contract enforcement
Weak contract enforcement is damaging as it leads to the slowing down of the economy, as well as creating obstacles for innovation and entrepreneurship. The ability to enforce contracts and resolve disputes are necessary for the development of the firm. With regards to the eastern enlargement, it is important to assess this area when analysing the business environment due to the region’s history of weak contract enforcement. Not only was it poor under communism, but during the transition process in the early 1990s the legal and judicial system were seen be in their “embryonic stages” of development which resulted in court decisions being “non-transparent” and “highly uncertain” Cungu et al., 2008, 78). Therefore, contract enforcement was not only undermined as a result of the communist legacy but also because it was ineffective during the transition period due to the reforms that are of the institutions (Gow and Swinnen, 686). Furthermore, the issue of contract enforcement was especially evident in 1998, as due to weak enforcement, late payments became the single most obstacles affecting businesses in the Czech Republic, while it ranked 3rd out of a possible 12 in Hungary (Cungu et al., 2008, 4). Therefore, when assessing the improvement in the business environment, contract enforcement is a crucial aspect to consider.
The institutional framework and contract enforcement play a significant role in the establishment of a healthy business environment (Coase, 1960). The ability to enforce contracts and resolve disputes is fundamental as it enhances the predictability of commercial relationships and reduces uncertainty by assuring firms and individuals that their rights and contractual rights will be protected. However, for this to occur it is crucial to have legal institutions such as courts and an independent judiciary to ensure laws are appropriately implemented and enforced. Johnson illustrated this argument by using data from firms in Poland, Romania and Slovakia to assess how court quality affects business relationships. He found that the belief in the effectiveness of courts is associated with higher level of trust between firms and customers (Johnson et al., 2002). In the absence of trust, firms will rely more on the personalised relationship with suppliers or consumers to avoid risk, which reduces the capacity for new innovative firms to enter the markets. Furthermore, strong contract enforcement is also necessary for banks as in the absence of it; they are more conservative about their lending which leads to less investment for businesses (Ardagna and Lusardi, 2008). Therefore, a good business environment is one in which investors feel assured that their rights and contractual agreements are protected, as well as a climate in which the judicial system is efficient.
2.3.3. Property rights and protecting investors
Property rights are a necessary component of a healthy business environment. They are crucial for illustrating the institutions as being strong, which is key as it is able to demonstrate that investors will be able to reap the rewards from their investment. As stated earlier, a standard issue in the business environment of the enlarging countries was poor property right protection. Therefore, when assessing the improvement in the business environment for these countries, property right is an important indicator to evaluate.
Creating strong property rights requires credible constraints being imposed on the arbitrary decision making by the executive branch, as well as guaranteeing there is an independent and effective judicial system (Estrin and Mickiewicz, 2010). It is necessary as it ensures the status quo is upheld and is vital for the aspects related to “discovery, innovation and creation of new businesses” (Harper, 2003, 74). Moreover, the protection of minority shareholders is essential for a good business environment. The reason being is that ownership concentration among public companies is high in countries who have weak investor protection which indicates that smaller investors are reluctant to invest (La Porta et al., 1998). Therefore, signs of a good business environment are ones in which smaller investors are prepared to spend, and the arbitrary power of the state is limited.
3. Methodology
This paper aims to analyse the business environment in CEE and establish correlations between the eastern enlargement and the improvement in the business environment. To examine the impact of the enlargement this research will be focusing on a handful of nations. Bulgaria and Romania have been chosen not only because they enlarged in 2007, but also because their business environment was much weaker as a result of the legacy of communism. Alongside these countries, the Czech Republic, Poland and Hungary will also be analysed as these countries were perceived to be the frontrunners during the enlargement process (EBRD, 1997), which enabled them to enlarge earlier in 2004. Through focusing on nations from both years, a more informed analysis can be conducted.
To effectively analyse the correlation between joining the EU and the improvement in the business environment this research has used a descriptive research methodology. Generally, to examine the business environment, methodology from business studies such as SWOT analysis is an example of one of the primary methods that are used. However, as illustrated in section 2, it is less useful for assessing the influence the EU had on the business environment. For this reason, the descriptive methodology is more suitable for this research as it can be used to identify if there is a correlation between the enlargement and improvement within the business environment. Typically, researchers use this method when attempting to “describe” a situation (Ehtridge, 2004, 24), which is what this dissertation is aiming to do due to the difficulty of establishing causality. Another reason why this method is ideal is because it will describe the research problem without influencing it, enabling a detailed analysis to be conducted. For this reason, the descriptive methodology will be used to determine if there is a correlation between joining the European Union and improvements within the business environment, particularly in the areas of starting a business, contract enforcement and property rights.
For the analysis of this dissertation, there will be an extensive range of secondary data to make inferences. This dissertation will be using data that provides an overview of the business environment within specific areas. Similar to Litva (2017), this study will be using data from the ‘Doing Business Reports’ of the World Bank to analyse the business environment. This dataset has been chosen due to the various components of the business environment it assesses For example, for starting a business the World Bank measures the number of procedures and the time required to start a business. To make inferences, qualitative data such as existing literature, surveys, reports and much more will be used to complete the analysis. In particular, this dissertation will primarily be focusing on literature on the accession process, as EU policy towards CEE was predominately a policy of conditionality. As a result of this, the CEECs have undergone a major process of external governance (Schimmelfenning and Sedelmeirer, 2004). Therefore, with the ontological approach of subjectivity and the epistemological stance of interpretivism, qualitative data will be used holistically to examine the relationship between the enlargement and the business environment.
Data source
The use of data is a necessary component for this research, as it will be used to assess the level of improvements in the business environment and enable inferences to be made. The ‘Doing Business’ data report (DBDR) by the World Bank is one of the most detailed indicators for assessing the quality of the business environment [3] in addition to it being the most consistent in terms of its methodology. As this dissertation is only focusing on specific aspects of the business environment only four of the components of the DBRD will be used (Doing Business, 2015)
Starting a business: this component analyses the time, speed and cost required to start a business
Enforcing contracts: Looks at the time and the cost required to enforce contracts through the courts.
Registering property
Protecting minority investors
Other components of the data have not been used as they are either irrelevant to the study, or there are gaps within the data. However, the limitation from using data from the world bank is that the data analysis/collection only began in 2003, which means when appropriate other data sources are used such as the Heritage Foundation.
4. Analysis
Despite the countries in Central and Eastern Europe being plagued with a weak business environment in the past, there has been a significant development in the sphere in which businesses have operated in over the past two decades. In this section, through focusing on EU conditionality, this section will draw correlations between the development that occurred in each area and EU membership, more specifically the adoption of the Copenhagen Criteria. In 1993, the EU member states adopted the Criteria which defined the political, economic and legal (acquis communautire) conditions for the accession into the EU (Sezen, 2013). Veebel claims that the Criteria was created due to the unique nature of the eastern enlargement as it encompassed more countries relative to the previous enlargement, in addition to incorporating nations with substantial differences (European Commission, 2009). The attractiveness of EU membership and its strict conditionality vested the Union with considerable transformative power in the applicant countries (Schimmelfenning and Scholtz, 2008). Therefore, analysing EU conditionality will enable this research to determine whether a correlation exists.
4.1. Contract enforcement
During the mid-1990s and early 2000s, there was a profound change in the institutional framework of the countries of Central and Eastern Europe (Geršl, 2006). As stated earlier, one of the main flaws in the business environment was that the procedures for enforcing contracts were too bureaucratic and cumbersome. It was problematic as it prevented contractual disputes from being resolved in a timely and cost-effective manner. The Agenda 2000 reports emphasised this as before enlargement a consistent issue that was present throughout all the countries was an overloaded judicial system, which resulted in the average time for resolving cases to be high. For example, in Czech Republic (one of the ‘frontrunner’ countries) the legal proceedings for commercial law exceeded three years (European Commission, 1997). It was not ideal for businesses as it illustrated how the courts were unable to serve enterprises effectively, and thus discouraged investors (World Bank, 2004). However, over the past two decades, there has been an improvement within this area. The World Bank (2018) illustrated how the number of days to enforce contracts has fallen. For example, for Poland the number of days to enforce a contract fell from 1000 days in 2003 to 685 by 2016; both of which were significant improvements compared to the late 1990s where delays took up to four years (European Commission, 1997B). This was a similar theme that was present throughout all the countries that were being examined, apart from Bulgaria whose figures remained constant (see figure 2 in the appendix).
When analysing the change in contract enforcement, it would have been ideal to use the ‘Number of Procedures To Enforce A Contract’ indicator by the World Bank. However, an issue with this indicator is that due to a revision in the methodology, valid comparisons cannot be made as the World Bank introduced different components within its calculations (see appendix). Therefore, when assessing the change in contract enforcement, the analysis will be conducted through looking at formal contract institutions (the judiciary), and in particular, the rule of law indicator, as this indicator can be used to illustrate the level of enforcement within the country (Trauner, 2009). Figure 3 shows how the rule of law has improved in most of the countries that are being analysed, demonstrating that the nations are moving to a more stable and healthier business environment in which there is a greater assurance in the legal system. Having a strong rule of law is a necessity as it ensures stability and security to enforce contracts. The rule of law indicator used in figure 3 is constructed by the World Bank and ranges from -2.5 (weak rule of law) to 2.5 (strong rule of law). Although no country is close to 2.5, the data nevertheless illustrates how improvements have been made.
Figure 3: Rule Of Law. Source: TheGlobalEconomy.com
The improvement in the rule of law can largely be attributed to reforms in the judiciary, which has resulted in governments being held accountable and thus preventing issues such as expropriation. According to a World Bank study, there was little or no reform in the judicial system during the transition period (Anderson et al., 2005, 27). It suggests that the improvement occurred after the transition, which coincided with the enlargement period, during which the Commission points out that reform in the judiciary was required in all of the countries (Trauner, 2009). Although there was no acquis which directly addressed judicial reform, the Copenhagen Criteria required states to guarantee the rule of law (Mendelski, 2012).
Figure 3 demonstrates that the rule of law has always been weaker in Bulgaria and Romania, which can be used to explain why FDI flows are generally lower within these countries (The World Bank, 2016). However, since 2000 there has been a consistent rise in the rule of law in both countries. The statistics illustrate how the improvements came into effect after 2002, which coincides with the decision of the European Council to exclude Romania and Bulgaria from acceding into the EU on the basis of unsatisfactory reform in the administration and judiciary. The delayed accession was intended to motivate the countries to speed up their efforts in meeting the Copenhagen Criteria, as the European Council illustrated to the countries that the promise of membership was actually credible. The council promised entry into the EU by 2007, which incentivised the countries to reform (Noutcheva and Bechev, 2008). As a result of the lack of development, the EU were more committed in bringing about judicial and administrative reform within these countries, in particular the EU wanted to make the judiciary more independent in Romania and more accountable in Bulgaria (Noutcheva and Bechev, 2008). One of the ways in which the EU did this was through institutional capacity building. This consisted of providing financial and technical assistance, in addition to offering advice in an attempt to build a necessary judicial capaci
