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How the European Union built stronger economies and better governments (even if Britain wants to leave)

- July 26, 2016
In this January 15, 1973 file photo, the First Ministerial Meeting of the Common Market gets underway at the Palais D’Egmont in Brussels. Between 1997 and 2015, 17 Eastern and Central European states joined what is now known as the European Union. (AP Photo)

When the United Kingdom voted in June to leave the European Union, there was much talk of whether European integration had ever contributed to the strengthening of the capacity of the British state to better position the British economy in global markets. Supporters of Brexit rejected the idea that the E.U. could have played any positive role in boosting state capacity in the world’s fifth-largest economy — and in a country that already had a robust system of laws and governance in place. But many argue that E.U. integration played a substantive role in shoring up the U.K.’s competition policy, a key element of economic governance in any state.

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A decade or two ago, the E.U. was adding member countries from Central and Eastern Europe. At the time, many of these might have been described as “weak” or “fragile” states — countries such as Bulgaria or Romania, which had weak economies and lacked stable governments. In the early 1990s, most of the countries of the former Soviet Union, including the Baltic States, had low levels of state capacity, which meant that they lacked the means to enforce law and order, uphold political freedoms and regulate economic activity.

Poverty, corruption and even terrorism are hallmarks of fragile states around the world — and we think that boosting state capacity is the way to address these severe problems. Our research takes a new slant and suggests that it is possible to increase state capacity through economic integration among countries at different levels of development. In particular, we show that deep economic integration can generate significant and substantial increases in state capacity.

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A free-trade area agreement is a form of shallow integration, involving only economic ties. Instead, we’re talking about the deep integration that comes from combined economic and political integration. An example of this would be a customs union, with encompassing regulatory harmonization — like the European Union. This level of integration entails the creation of transnational institutions to manage the common external tariff and, more importantly, the creation of supranational and domestic institutions that could guarantee enforcement and the administration of ensuing conflicts.

We looked closely at the 17 countries joining the E.U. in the 1997-2015 period.

Our research looked at the integration processes over the 1997-2015 period, when 17 Central and Eastern European countries were gearing up to join the E.U. We discovered two important things: (1) Deep economic integration did generate significant and substantial increases in state capacity, and (2) the sequence of how changes happened to market and state institutions mattered.

As to the explanation of our first finding: The potential gains from deep integration may generate strong incentives for state elites to initiate change in domestic institutions. Also, deep integration makes it more important for key players in the stronger economies to care about the quality of institutions in less-developed countries. But — and this is our second finding — it makes a difference how institutional change is sequenced.

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What do we mean, exactly? There are two opposing views on sequencing. One argument is that economic liberalization — the market — is the priority because it will ensure improvements in the quality of the bureaucracy and the rule of law. This view holds that countries need to focus first on economic reforms. The other viewpoint argues that core state institutions need to be addressed first. Without a functioning judiciary and an efficient public administration, this camp claims, economic liberalization will be inefficient and/or will increase income inequality.

The sequence of market and administrative reforms was important.

In practice, it’s not so simple. The relationship between the institutions of the market — the regulatory bodies that guarantee fair competition and consumer rights and that support freedom of movement of goods, capital, people and services — and the institutions of the state, the two central ones being public administration and the judiciary — is far more complex.

We compiled our new dataset based on the progress reports on all these issues for these 17 countries that formed the “Eastern enlargement” of the European Union. We quantified the monitoring reports that mapped institutional building that these countries needed to accede to full E.U. membership. Our research, based on this dataset, shows that this relationship is far from compact, homogeneous or unidirectional.

Based on our statistical analysis, we identified key sequences that contributed the most to increasing state capacity. We observe that neither approach — prioritizing the institutions of the state nor those of the market — yields sweeping institutional change on its own. For example, civil-service reform and the reform of the judiciary in Hungary or the Czech Republic might have improved the enforcement of economic competition. But we find evidence that changes that helped competition authorities be more independent were needed to boost the independence of state bureaucracy.

As several examples from this region have shown, introducing changes that strengthened the civil service and the courts did not on their own yield the desired effects in the mid-1990s, when powerful oligarchs, banks and investment funds dominated domestic economies. Increasing the independence of the authorities regulating markets changed this situation by enforcing public rules and by allowing entry in the domestic markets of new actors with strong stakes in the efficiency of the state. We also found that an increase in judiciary capacity would mean greater enforcement of antitrust regulation — and that would encourage new players to enter the market.

Free markets don’t strengthen state institutions on their own.

We found that mere furthering of free markets does not strengthen core state institutions on their own. The integration of Mexico by NAFTA, or the more recent attempt of the E.U. to integrate with Ukraine (within deep and comprehensive free-trade agreements), are examples showing that shallow integration is unlikely to substantially affect general state capacities and may even weaken them.

We discovered that in the accession countries, the alignment of domestic civil-service law with E.U. requirements and civil-servant training led to an increase in administrative capacity — and in turn furthered the independence of the bureaucracy. For the judiciary sector, we found that it was important to establish an independent constitutional court quickly. State elites may be tempted to ally with the strongest economic players and use the courts to stabilize their control over the economy and the state. Independent constitutional courts may reduce the danger of such predatory alliances. It is not by chance that both in Hungary and Poland, one of the first steps taken by illiberal governments was the abolition of the independence of constitutional courts. That gave nationalist governments a free hand to manipulate the economy and strengthen murky alliances between economic and political elites.

 A stronger legal system means stronger state capacity.

We also saw that changes that help streamline the workload of the courts led to increases in the capacity of the legal system, which in turn enhanced bureaucratic independence. Indeed, we identified this unique and mutually reinforcing relationship between judiciary capacity and bureaucratic independence as being at the heart of the state capacity-building experience in the Eastern enlargement.

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Deep economic integration offers a way to bring about large and long-lasting economic and political benefits in countries that need it the most. So changes that allow new players interested in demanding state reform to actually enter the market in a country — and that simultaneously boost the state institutions regulating market entry — are the types of changes that will yield more lasting institutional growth.

This has important implications for Europe and the rest of the world. After the Brexit vote, it’s not altogether clear what this might mean for a country that chooses to leave this type of deep economic integration. For the countries of Central and Eastern Europe, the deepening of economic integration can be shown to have contributed significantly to the building up of state capacity, which in turn has meant substantial declines in poverty and increased economic competitiveness.

For fragile states in general, there are important lessons from this experience. Deep integration can dramatically increase the demand for effective state institutions and more inclusive developmental alliances. The process of building up state capacity is, however, not unidirectional (that is, it involves trial and error). As the cases of reversals in Hungary or Poland show, there needs to be a broad distribution of the benefits of integration.

Laszlo Bruszt is professor of sociology at the Scuola Normale Superiore in Florence and at the Central European University in Budapest. Nauro Campos is professor of economics at Brunel University London, a research fellow at IZA-Bonn, and a research professor at ETH-Zürich. Follow him on Twitter @NauroCampos.