NATO AND THE EUROPEAN UNION: ECONOMIC CAPACITY OF NEW MEMBER COUNTRIES AND OPPORTUNITY COSTS

CRS Report for Congress
NATO and the European Union:
Economic Capacity of New Member Countries
and Opportunity Costs
April 23, 1998
John P. Hardt
Senior Specialist in Post-Soviet Economics
and
Milana I. Gorshkova
Intern
Economics Division

Congressional Research Service ˜ The Library of Congress

A^BSTRACT
Formal accession agreements with the Czech Republic, Hungary, and Poland joining the
North Atlantic Treaty Organization (NATO) are scheduled for spring 1999, with accession
to the European Union (EU) several years later. In tight budgets over the coming decade
these security requirements for assuring integration into NATO structures and force
modernization would have to compete with other incremental programs designed to further
economic transition and meet European Union (EU) accession requirements. How well the
likely new members to NATO and EU assess their opportunity costs in formulating their
budgets in the decade ahead may be of special interest to the U.S. Congress in discharging
its foreign and appropriations policy responsibilities.
This report will be updated as justified by events.

NATO and the European Union: Economic Capacity of New
Member Countries and Opportunity Costs
Summary
Formal entry of the Czech Republic, Hungary, and Poland into the North
Atlantic Treaty Organization (NATO) is scheduled for spring 1999, with accession
to the European Union (EU) several years later. In tight budgets over the coming
decade defense spending in these three nations, with or without NATO membership,
would have to compete with other incremental programs designed to further
economic transition and meet European Union (EU) accession requirements. The
cost of opportunities foregone by choice of one required program over another could
represent significant opportunity costs when all desired appropriations can not be fit
into tight budgets.
Providing adequate budgetary outlays for satisfying the full requirements of
security plans — with or without NATO accessions; full requirements for fulfilling
economic and political plans — with or without European Union accession will be
difficult for even the most successful transition economies in the region. Joining
NATO and the European Union may ease these tough decisions as both
organizations provide financial and technical support and offer integrative
advantages that would facilitate transitions in each acceding country. Tight budgets
and opportunity costs will make judicious decisions on budgetary inclusion a central
factor in the success of comprehensive transitions. Although the three candidate
countries are the success stories of transition to date and may well be the best
performing in the future their state budgets constrained by a tight cap on deficit
financing, will not have the capacity to simultaneously meet all the priority claimants
of both “guns and butter.” Each of the three new NATO members has more
incremental programs especially critical to economic transition than can be funded
in projected budgets, e.g., pension fund recapitalization, restructuring and retraining
costs for privatization efforts in critical sectors, contributions to construction of an
the EU-sponsored railroad/road network, increased debt servicing burdens, health,
education, and administrative reforms. These programs are the key requirements for
stabilization, liberalization, and privatization, which are all interlinked as they
determine economic growth, economic assistance, and investment from abroad.
Each of these programs and more are part of the EU accession requirements. The EU
assistance programs are now being tied to meeting these criteria. These are critical
programs in the decade 1999-2009 when both the NATO and the EU enlargement
costs are projected to be concentrated.
How well the likely new members to NATO assess their opportunity costs in
formulating their budgets in the decade ahead may be of special interest to the U.S.
Congress in discharging its foreign and appropriations policy responsibilities. These
first accessions may set precedents for successive accessions to both NATO and to
the EU. The rising opportunity costs in countries with less economic capacity may
affect how quickly the EU and/or NATO will decide to integrate new members. For
NATO and the EU, the timing and the conditions of subsequent accessions will pose
continuing questions.
This report will be updated as justified by events.

Contents
The Setting for Incremental Programs in a Decade of Tight Budgets..........1
Opportunity Costs and Tight Budgets..................................6
The United States Stake in Opportunity Cost Debates in Prospective NATO
and EU Countries ............................................12
Appendix .......................................................16
Country Profiles for Assessing Performance and Economic Capacity
to Meet Accession Requirements into the 21st Century...........16
Czech Republic..........................................16
Hungary ................................................18
Poland .................................................20
List of Tables
Table 1. Economic Indicators........................................5
Table 2. Accession to the EU and NATO..............................15

NATO and the European Union: Economic
Capacity of New Member Countries and
Opportunity Costs

The Setting for Incremental Programs in a Decade of
Tight Budgets¹
The North Atlantic Treaty Organization (NATO) has invited the Czech
Republic, Hungary, and Poland to join; the three are scheduled to join when they and
all current 16 members have completed their national processes of ratification and
submit their instruments to the United States government. A formal ceremony
welcoming the three new members is scheduled to take place in Washington in April
1999. By joining NATO, the new members gain the security and larger transitional
benefits from an organization with a new “community of values.”
Today, the members have moved beyond the collective defense commitment to
employ NATO’s strengths as a defense cooperation organization for additional
purposes. These purposes include creating political/military options for dealing
with crises and challenges to the interests of the member states, spreading
stability to Central and Eastern Europe, and encouraging cooperation with Russia²
and other countries.
The synergism of improved security is important to the success of economic
transition to market systems and political benefits from increased democratization
under a rule of law. The three countries seek membership in both NATO and the
European Union (EU) because of the complementary benefits of security
enhancement, economic growth, and the development of democratic systems.
While benefits are complementary, costs for necessary new programs in the
state budgets of the three candidate countries are not. Tight budgets constrained by
a limit of three percent or less deficit spending in the Gross Domestic Product
provide a procrustean bed for the incremental claimants in the decade ahead.
Increasing pressures for financing strongly supported programs by deficit financing
has been turned back by reformers’ desires to maintain a balanced budget, facilitating
reduction in the inflation rate and keeping a stable exchange rate regime. While the
EU enforces a three percent deficit-to-GDP cap, Poland is now projecting a zero
deficit for 1999.
In the decade 1999-2009 incremental budgetary outlays will be required to
enhance interoperability of new and old members in NATO and to modernize and
restructure forces of the new members. During the same decade incremental
budgetary outlays will be required to provide the bases for these advanced transition
economies to proceed toward a stage of sustained economic growth. Without
accession to NATO or to the EU, these requirements for effective transition would
be greater as integration into the NATO and EU systems provides benefits that are

¹Co-author Milana I. Gorshkova is in the graduate program of the Elliott School of
International Affairs at George Washington University; she has been an intern at CRS in

1997-1998.

²^{U.S. Library of Congress, C}^{ongressional Research Service,}^{NATO’s Evolvi}^{ng Role and}
^Mission^{, by Stanley Sloan wit}^h^t^h^e^a^{ssistance of J. Michelle Forrest, CRS Report No. 97-708 F,}
^{updated March 11, 1998.}

not funded by the new members.³ The funding dilemma, however, is not caused by
aspirations for NATO membership. The governments of all candidates for NATO
membership believe their defense expenditures, and therefore their spending
dilemmas, would be more challenging if they had to provide their defense as a non-
NATO member.
The three candidate countries demonstrated capability to support requirements
of their defense plans in the initial development period of NATO expansion through

1999 and rising requirements into the next decade:

The Czech Republic defense spending may rise from 1.7 percent of GDP
in 1997 to 2 percent in 2000 ($1.5 billion). The “National Defense
Concept 2005" program calls for 20 percent of the budget for
modernization, including purchase of Western fighter aircraft and
upgrading their main battle tanks. . . .
Hungary has increased their defense allocations to 1.5 percent of GDP and
projects 2.0 percent in 2000. “Force 2000" program calls for force
modernization to rise from 12 percent in 1997 to 25 percent of defense
spending in 2001. . . .
Poland supports the largest force and military budget in the prospective
candidates. Their defense budget at 2.4 percent of GDP in 1997 may rise
to 3 percent in 2000. Their fifteen-year (1998-2012) study projects
modernization of forces to grow at 3 percent and procurement to grow at
a 2 percent annual rate.⁴
The NATO Common Funds will be helpful in providing resources for required
military and security investment programs to meet collective needs in pipelines, road
transport, communications and military coordination activities. As the costs for the
some $1.7 billion program is allocated largely on the basis of GDP and population
the impact on new members’ budgets would be small and the benefits substantial.⁵
Each of the candidate countries with defense and NATO accession plans
currently project their security requirements as manageable. Indeed, the relatively
troubled Czech Republic is increasing its percent of GDP to defense in 1998-1999

³^{Report to the Congress on the Enlargem}^{ent of}^{NATO: Rationale, Be}ⁿ^e^{fits, Costs and}
^Im^{plications, February 1997. A report subm}^{itted to}^Congress^{pursuant to Section 1048 of the Fiscal}
^{Year 1997 Defense Authorization Act, that desc}^{ribes the rationale, benefits, costs and other}
^{considerations related to NATO’s enlargem}^ent.^{NATO Enlargem}^{ent, Cost Estim}^{ates Developed to}
^{Date are Notional, General Accounting Office repor}^{t to Com}^m^{ittee on International Relations, August}
^{1997. See: U.S. Library of Congress. Cong}^re^s^sⁱ^oⁿ^a^l^R^e^s^{earch Service. NATO Expansion: Cost}
^{Issues. By Carl Ek, CRS Rpt. No.}^97-668F.^July^2,^1997;^{NATO: July 1997 Madrid Summit}^Agenda^.
^{By Stanley R. Sloan. CRS Rpt. No.}^97-443^F.^U^{pdated June 5, 1997;}^NATO:^Congress^Addresses
^{Expansion of the Alliance. By}^Paul^Gallis.^IB^95076.^{Updated regularly; NATO Enlargem}^{ent: The}
^{Process and Allied Views. By Paul Ga}^{llis. CRS Rpt. No. 97-666F. July 1, 1997.}
⁴^NATO^{Prospective Members: Military Modernization}^{, by Christopher Bell, CRS Report}^98-
^{154 F, February 24, 1998..}
⁵^NATO^Com^m^on^{Fund Burden Sharing: Background}^{and Issues, by Carl Ek, CRS Report 98-}
^{239 F, March 11, 1998.}

while holding non-defense increases to zero. Likewise, as they proceed into specific
discussions on accession requirements with the European Union, they postulate that
meeting the accession requirements of the EU are manageable. Projections and
requirements for programs enhancing security, economic growth, or democratization
will need to be translated into budgeting outlays into annual budgets of these
candidate countries when programs needed for all transitional requirements increase.
The non-defense requirements alone will exceed the likely state budgets as these
economies move toward improving enterprise efficiency, repairing their social safety
nets, building modern infrastructures, providing effective debt management and other
mandatory programs. These substantial incremental economic programs may be
considered mandatory by judgments of the EU, foreign assistance providers, foreign
investors, reform leadership and the electorates. Whether actually mandatory or
discretionary, all these priority economic programs cannot be assured of full funding
within the tight budgets of the next decade.
In this oversubscribed budget context security programs will have strong
competition. No doubt the requirements for defense programs and NATO
enlargement costs will be strongly supported. However, the decision in each budget
year and throughout the decade ahead are likely to require difficult choices and
managing the shortfalls is likely to be complex.
All the countries in the region in transition will have difficulty meeting their
multiple requirements from their state budgets. Economic growth of GDP provides
a basis for generating increased tax revenue, attracting the foreign assistance and
investment necessary to fund programs without deficit financing. The candidate
countries must all limit deficit financing to fight inflation effectively and ensure a
stable exchange rate regime. These three candidate countries may have the greatest
economic capacity for absorbing incremental costs of accession. These three have
been and may continue to be the “success stories” of transition in the region, best
able to generate the economic capacity to bear the costs of enlargement (Table 1).
They have recovered early from post-revolutionary recession, have shown positive
growth, have attracted the most foreign investment, and are deemed most likely to
attain sustainable growth of about five percent per annum or better in the decade of
NATO and EU enlargement (1999-2009). Most investment advisory and risk
assessment agencies project Czech economic recovery to a sustainable growth rate⁶

comparable to that expected for Hungary and Poland.
⁶^{Appendix, Country Profiles,}^{op cit.}

^{Table 1. Economic Indicators}¹
¹²³⁴⁵⁶
^Population^O^{utput (GDP Growth)}^S^tab^ilization^L^{iberalization}^P^rivatization^I^ntegration
^(m^illions,¹⁹⁹⁰¹⁹⁹⁷¹⁹⁹⁷^{Inflation rate}^Dom^e^stic^Open^{(% of large,}^{FDI per}^T^{rade Turnover}
^m^e^dium
¹⁹⁹⁶⁾^{(annual %}⁽¹⁹⁸⁹⁼¹⁹⁹¹¹⁹⁹⁷^prices^econom^y^&^sm^all-scale^capita¹⁹⁹¹¹⁹⁹⁷
^change)¹⁰⁰⁾^{(annual % change)}⁽^1-4+)²^enterprises)^{US $}⁽^{billions US $)}
^10.3^-^1.2¹⁹⁰⁵²⁹³³⁷⁵¹²³²¹^52.9
⁴⁰²
¹^.5^-8.1⁷⁷⁶³⁰⁴¹²³³^-⁶⁷⁷¹⁸^6.8
^10.3^-^3.5³⁸⁹³²¹⁷³⁺³⁷⁸¹⁹⁵²¹^40.2
ⁱ^ki/CRS-98-
^g/w^38.5^-^11.6⁶¹¹⁰⁶⁰¹⁵³⁺³⁶⁵⁷¹^25.4^64.7
^s^.or²^-4.7⁴⁹⁹²⁴⁷⁹³⁺²⁵⁵⁹⁰⁸^17.5
^le^ak
^://wiki
^h^ttp
^8.4^-⁹^-⁷⁶³³³⁹⁵⁹²³²⁴⁶¹²^7.4⁹^.1
^2.5²^.9⁸⁵⁴²⁶²⁸³^3-⁵⁵⁹²^1.6⁴^.5
³^,7^-5¹⁰⁴⁴³⁴⁵¹⁰³²⁺⁶⁸⁴¹²^.2^9.1
^a^nia^22.7^-^5.6¹^.5⁸⁷²²³¹¹⁶²²⁵⁵⁹^10.1^19.6
^5.3^-^2.5⁵⁹⁴⁵⁸⁷³³⁷⁰³³^12.8²⁰
^{ent (EBRD) in Tr}^ansition^Report^{1997: Enterprise Perform}^{ance and Growth, Decem}^ber^1997;^{PlanEcon, Review and Outlook}
^{Europe, Decem}^{ber 1997 with selected country PlanEcon Re}^{ports; Nicholas Stern, The Transition in Eastern Europe and}^{the form}^{er Soviet Union: som}^e^{strategic lessons}
^{the experience of 25 countries over six years, EBRD W}^o^{rking Paper No. 18, April 1997.}
^Sc^o^rⁱ^{ng from}^{one to five as highest score in transition: Price}^{liberalization scores from}^{1 (m}^{ost prices form}^{ally controlled by}^{the governm}^e^{nt) to 4+ (com}^preheⁿ^sⁱ^v^e^p^rⁱ^c^e
^{of advanced industrial countries); 2 indicates that}^{state procurem}^{ent at non-m}^a^{rket prices rem}^a^{ins substantial,}^{and 3 stands for substantial price liberalization; Open}
^{y also ranges from}^{1 (lim}^{ited access to foreign m}^a^{rkets, no}^com^p^{etition legislation and institution) to 4+ (unrestricted}^entry^{to m}^o^s^t^m^a^rke^t^s^;^e^ffe^c^t^ive^enforcem^ent^of
^p^{etition policy), Transition, W}^o^{rld Bank Newsletter, Septem}^{ber 1997.}

Opportunity Costs and Tight Budgets
In the annual budgetary deliberations in the candidate countries for both NATO
and the EU the governments, parliaments and electorate will raise questions on the
opportunity costs of choosing among desirable programs with valid requirements.
An essential characteristic of budget formulation everywhere is the consideration of
the opportunities foregone by choosing one program over another. Opportunity costs
in tight budgets are a particular concern for countries in transition. Increasing
demands for funding programs that foster economic transition through stabilization,
liberalization, and privatization have crowded on to the state budgets. With strong
popular and leadership support for NATO accession, security programs will have
strong supporters. Each of the candidate countries to NATO will have to decide
where in their priority list for new programs the NATO enlargement and related
defense costs fit in competition with programs designed to further the transition to
a market economy and to meet the requirements of European Union (the EU).
The European Union and the European Bank for Reconstruction and
Development (EBRD) have made detailed, complementary appraisals of progress in
transition and requirements for accession to the EU and integration into the global
economy. Advanced countries such as Poland, Hungary, and the Czech Republic are
considered to be in their second stage of transition. In this advanced stage of
transition, more resource demands on the state budgets will be required for building
on first-stage success in macrostabilization, liberalization, and privatization.
Attention to institution building, enterprise reform, and improvements in quality of
life programs are to be needed to qualify for accession and make strides toward
transition to a well functioning market economy. Looking ahead, the EBRD notes
“large additional investments” would require major new programs in the respective

state budgets, along with increases in private domestic and foreign investment.⁷
Successful transition to date has created a favorable environment for foreign direct
investment (FDI) channeled into restructured productive assets which play a critical
role in generating increased productivity. This synergistic character of the programs
supporting transition and EU membership strengthens their claim on scarce budget
outlays. As each of the three have begun serious discussion on EU accession
requirements in March 1998, the leverage from current accession requirements
further strengthens the claims of non-defense programs.
With tight budgets going into the next decade, even with optimistic growth
projections and a promising climate for investment, the choices among meritorious
programs will be increasingly difficult. The projected requirements for the mature
capability development of NATO enlargement with increasing costs for the
candidate countries from 1999-2009 will be paralleled by a period of increasingly
expensive programs in the state budgets for fostering transition and meeting the EU
accession requirements. On the one hand, some programs for force modernization
to meet minimum security needs may have to be foregone or deferred to meet
economic transition requirements. On the other hand, effective restructuring of
industries and agriculture, addressing critical reform requirements in pensions,
health, and other reform programs may come to be considered hostages to meeting
some NATO commitments.
Each of the three countries has a similar list of major incremental claimants on
their future state budgets. The specific sectors, social programs, and debt obligations
vary, but are deemed by the EU/EBRD and reform governments to be critical to
transitional success and therefore priority claimants on the state budgets.
The European Union Agenda 2000 provides qualitative bases for assessing
progress for the Czech Republic, Hungary, and Poland. Critiques on economic
transition indicates specific changes requiring large investments through their state
budgets that will be needed to satisfy the EU accession requirements. Each of the
countries is judged to be “functioning market economies, but”:⁸
The CzechFurther progress will need to be made over the next few years
in Republic:strengthening corporate governance and the financial system.
The banking sector is dominated by a few, partly state-owned
banks and its competitive position is not strong. The country
should be able to cope with competitive pressure and market
forces within the Union in the medium term, provided that
change at the enterprise level (restructuring) is accelerated.
Hungary:The reform of pensions and social security needs to
advance rapidly. (Parliament approved in July 1997 the
new pension law, reforming the system). Hungary should
be well able to cope with competitive pressure and market

^{EBRD, Transition Report 1997, Enterprise Perform}^{ance and Growth, Decem}^{ber 1997.}
⁸ “The Commission’s Report Card” European EU views were supplemented by grades
based on ratings given by the Hungarian Economic Weekly (Budapest), while the grades for
compliance are all four or more on a scale of five, major changes are still needed. Transition
Newsletter of World Bank, August 1997.

forces within the Union in the medium term, provided the
macroeconomic conditions for strong investment growth
remain in place.
Poland:Pension and social security system need to be reformed.
Financial services are underdeveloped. The banking sector
needs further reform. Poland should be well able to cope with
competitive pressure and market forces within the Union in the
medium term. Agriculture needs to be modernized. Polish
industry is characterized by the existence of both a dynamic
competitive new private sector and large mostly state-owned
sectors that need restructuring.
Each of the three new prospective NATO members must consider programs
tailored for meeting accession requirements to the European Union. These programs
will be specific and are, in the main, reinforced by conditionality of the International
Monetary Fund, the World Bank family, and the Organization for Economic Co-
operation and Development (OECD). Conditionality of all these assisting
institutions means that aid funds are provided conditionally related to fulfillment of
performance criteria. The EU in 1997 made compliance with their accession criteria
a condition for providing financial and technical assistance, through their PHARE
and TACIS programs. The list of transition programs also are the same programs
that are important to the investment risk assessments of the three countries. When
investment risk ratings by Standard and Poor’s and Moody’s improved, foreign
direct investment to the three countries increased, with the reverse being true.
Foreign investment improves the financial position and facilitates transition in the
three enlargement countries.
Poland, the largest economy in the region with the largest share of NATO
enlargement and defense costs, is also considered to have the best capability for
absorbing accession costs because of current high growth rate and a projected surge
of foreign investment. Specific programs and estimates of costs provide substance⁹
to both NATO and EU accession requirements. These EU-related programs will be
especially large and difficult to squeeze into the future state budgets of Poland,
Hungary and the Czech Republic. The fall 1997 election in Poland a provided a
broad consensus supporting the Polish economic strategy. This provided a basis for
more reliable estimates on the budgetary implications of future economic programs.
Upcoming spring, 1998 elections in Hungary and the Czech Republic may provide
similar bases for more detailed budgetary projections. These incremental claimants
for inclusion in Poland’s budgets are expected to be similar by category to the
specific future programs of the two other new candidate countries.
!Debt service for external debt. Poland’s annual servicing requirements for
rescheduled debt from governments (the Paris Club agreement) comes back
with a vengeance in 2000 when a surge of maturities begins with servicing

⁹Polish Ministry of Finance, Medium-term Strategy for Poland, passed by Economic
Committee of Council of Ministers. Reported in News from Poland, Newsletter of Embassy
of Poland, April 1998.

and payment of about $40 billion in the next decade.¹⁰ Hungary continues to
service a substantial foreign debt through its state budget while the Czech
Republic has a negligible external debt service burden.
!Privatization of key sectors. Preparation of Polish coal mines for sale will
necessitate state assumption of state-owned mines’ interenterprise debts,
currently 11 billion zloty ($8.1 billion). Payment of arrears in wages and
other benefits for coal miners are substantial but estimates are not available.
Other sectors such as steel may be added with similar Polish state budget
implications. Interenterprise debt is a costly problem in Czech and Hungarian
privatization and restructuring, requiring increments to their state budgets for
resolution.
!Restructuring and recapitalization of pension funds for employees of
formerly state owned enterprises. In 1999-2001 and thereafter, the Polish
annual budgetary cost is estimated to be around 1.0-1.6 percent of GDP.
Czech and Hungarian transition have a similar requirement, as noted by the
EU Report Card, cited above. Pension funds are not the only welfare program
that will need funding in the next decade.
!Comprehensive health reform requires not only taking over from former
state enterprises health benefit obligations, but modernizing the health
care system. In Poland, from 2000 through the decade, an estimated 0.4 to
0.6 percent of the GDP per year has been ticketed for health reform.¹¹ The
majority Solidarity party negotiated a larger health reform budget, closer to¹²
one percent of GDP. While there is a common requirement for Czech
Republic and Hungary, budgetary priority of health reform programs are not
yet clear in those countries.
!Education reform with revamping the curriculum and modernizing
facilities. The scale of budgetary implications probably depends on costs for
constructing new facilities in all three countries.¹³
!Administrative reform involving decentralization of government. With
a major shift of economic and political governance to the localities,
substantial costs in new facilities may be incurred.¹⁴ A new tax code may also
be required.
!Infrastructure costs borne by state for trans-European rail and road
network contributions in each country. The overall program projected to
cost $395 billion is supported by the EU and EBRD with each country
expected to provide some public support. Four major highways are ticketed
for completion in Poland over the next decade. Although private toll road

¹⁰^{A. Slozewska, “}^Z^am^{iana Rezerw Dewizowych}^{na Papiery}^Sua^r^{bowe” (“}^{The Exchange of}
^{Hard Currency Reserves for Governm}^e^{nt S}^{ecurities”), Rzeczpospolita, Septem}^{ber 13, 1996.}
¹¹^Solidarityⁱⁿ^call^{to speed up reform}^{s, Christopher Bobinski,}^{Financial Times}^{, April 9, 1998.}
¹²^Prim^e^{Minister Jerzy Buzak term}^{ed health, education and adm}ⁱ^{nistrative reform}^{s “}^u^rgent^and
^im^{portant.” News from}^{Poland, newsletter}^{of Polish em}^{bassy, W}^a^{shington, DC, March 1998.}
¹³ ^Ibid.
¹⁴^Ibid.

financing is anticipated, Poland will have to budget at least $10 billion for
land right of way purchases and to provide credit guarantees for about 50
percent of the toll road indebtedness.¹⁵ Rail modernization under way will
also require public financing. Foreign investment requirements for
infrastructure sectors — transportation, energy and telecommunications —
would be between $15-$17 billion a year in Poland.¹⁶ The Czech Republic
and Hungary have similar claimants, that may be made clear after their
elections.
!Emergency funding. Natural disasters such as flooding and droughts seem
to be recurrent priority claimants on the state budgets of each country.
So when there is a step-up in defense claimants for resources in annual budgets
in 1999-2009, they will compete with increased economically necessary programs
as viewed by reformers, the EU, other international economic institutions, and credit
rating organizations, whether or not these countries join NATO. In this balanced
budget competition for appropriations, neither economic nor security programs will
consistently win out.
Success from transition programs generates growth, assistance from many
donors supporting transition and foreign investment that all generate revenue and
financial flows that may ease the pressure of tight budgets. Current unexpectedly
high Polish growth, seven percent increase in Gross Domestic Product (GDP) in
1997, generates more revenue, providing more funds for both transitional, EU
programs and support for NATO enlargement and defense. Slow growth in the
Czech economy, one percent in GDP, limits the choices among new programs.
However, high growth prospects in Poland is not an unmixed blessing for budgeters
as the high growth puts pressure on the exchange rates and price levels and account
for the lowering of the current deficit financing cap to 1.6 percent of GDP, with a
future prospect of a zero-deficit budget policy. High growth may thus lead to
inflation and exchange-rate problems requiring tighter deficit control.
The opportunity cost problems for defense costs are not just competition on the
margin with popular and critical economic and politically desirable programs but
from the overall synergism of economic programs required for transition and
attaining sustainable economic growth. These complementarities make it more
costly to postpone any one of the priority transition programs. Only by simultaneous
economic transitional progress would sustainable growth be attained. Enterprise
productivity and competition would be improved if there were better stabilization,
liberalization, and privatization and if the appropriate institutions were assuring
improved corporate governance and technological change. When looking at the
more detailed interrelationships of programs and performance as we do in the
appendix profiles, we are especially struck by this synergism of economic and
political transition programs. The degree of interdependency of transitional variables
as they affect economic performance is noteworthy. Still, military programs also
exhibit interdependencies, especially in the new definition of NATO roles and

¹⁵ ^{“Corridors prom}^{ise efficient transport, Brusse}^ls^{grand rail/road network for Eastern Europe}
^{is dogged by financial uncertainties,}^{” Financial Tim}^e^{s, July 1, 1997.}
¹⁶^From^{U.S.-EU Polish Action Com}^mⁱ^{ssion repor}^{t cited in News from}^{Poland, op. cit.}

missions.¹⁷ Infrastructure programs for pipelines, roads, communications in the
NATO Common Fund support both security and economic requirements.
Infrastructure development is important for both security and economic transitions.
This synergism of both security and economic transition programs raises the
complexity of opportunity cost deliberations. Although both programs for
facilitating transition and improved economic performance and programs designed
to meet defense needs are synergistic, they will not all be easily absorbed in future
budgets.
Once the opportunity costs are evident, they may become the subjects of
political debate. If a program for fostering economic transition is not supported
because funds are put in a needed security program, the central European
policymaker may find that less revenue is generated, less aid money is available,
foreign direct investment is reduced and the electorate is unhappy. The EU and IMF
may withhold assistance, and lower growth prospects may result in a lower
investment risk ratings. Finally, the electorate may vote against politicians favoring
defense costs over transition and EU accession programs. If a modern tank or fighter
aircraft were not purchased abroad to meet modernization requirements of NATO
enlargement a negative reaction might be expressed in Brussels. To be sure, offset
agreements and production of military equipment in the candidate countries may
soften a possible negative reaction to these hardware purchases. However, if aircraft
and tank-related purchases were perceived as budgetary outlays that squeezed out
funds for pension reform or training unemployed mine workers, the political reaction
in the new member countries might be quite vocal. Elected officials in the new
member states may consider many programs for supporting transition and EU
accession are “third rail” issues, i.e., too politically hot to touch. For this reason,
NATO has discouraged candidate countries from initially focusing on “big ticket”
modernization projects like new fighter aircraft and have emphasized lower-cost but
important improvements in communications interoperability, for example. U.S. and
European weapons manufacturers, also sensitive to budgeting limitations, are
packaging sales proposals with a variety of co-production and offset arrangements.

¹⁷Cf. Stanley Sloan, supra, p. 1.

The United States Stake in Opportunity Cost Debates in
Prospective NATO and EU Countries
When transition and enlargement requirements are made more explicit in the
upcoming decade and new member countries begin to factor them into their annual
budgetary deliberations the debates on opportunity costs may develop and become
contentious. Tight budgets, escalating demands for funding, and the opportunity
costs of programs for security, economic and political programs will require difficult
choices that U.S. policy makers may wish to reassess as our benefits and costs are
influenced by choices made in the new NATO and EU member countries among
competing programs.¹⁸ The United States benefits from the improvement in
European security that enlargement of NATO may be expected to produce. Security
improvements would be expected to facilitate democratic market development under
a rule of law. More regional security, in turn, facilitates developments of profitable
U.S. commerce with the region. Some sharing of the cost of NATO enlargement has
therefore been deemed justified in our national interests for improved security alone.
“For the American people, clearly, the costs will be far less in lives and money to
expand the bounds of democracy and security than it would be if we had to involve¹⁹
our people in another conflict in Europe.” The European Union criteria for their
part include both economic and political reform criteria in their accession
requirements, but not security requirements. The interrelationship of economic and
political reforms of importance to the EU may even be quantifiable according to a
World Bank study correlating economic liberalization and political freedom. The
Central European countries are adjudged to do especially well in transition because
they combine economic liberalization and political freedom. By matching country
rankings of the cumulative liberalization index to a comparative index of political
rights and civil liberties, it has been found that economic liberalization has been
typically associated with a similar degree of political change. The direction of
causality, it is further argued, is determined to be two-way, since economic
liberalization is an essential step in breaking the power of established structures,²⁰
especially line ministries that previously controlled industry and trade.
While the benefits from accession to the European Union and NATO are
complementary in enhancing security, political stabilization, and economic welfare
in the three candidate states, their costs are generally not. For this reason, some
former U.S. officials here suggested the NATO debate be recast to link NATO and
the EU expansion, to assess both the costs and the conflicts in serving multiple
objectives.²¹ They argue that the policy of cost sharing adopted for supporting NATO
enlargement may adversely affect economic and political reform, and thus some
security gains might adversely affect overall transition. With attention to opportunity

¹⁸ ^{Cf. Estim}^{ated Cost of NATO Enlargem}^{ent, A Contribution to the}^Debate,^prepared^by^Euro-
^{Atlantic Associates; provided by Em}^{bassy of Re}^{public of Poland, W}^a^{shington, DC, Decem}^{ber 12,}
^1997.
¹⁹^{Speech by Pre}^s^id^eⁿ^t^{Clinton, NATO sum}^m^{it in Madrid, July 8, 1997, Newsletter of the}
^Em^{bassy of the Czech Republic, July-August 1997.}
²⁰^{Martha de Melo, Cevdet Denizer, Alan Gelb, “P}^{lan to Market: Patterns of Transition,” Policy}
^{Research W}^o^{rking Paper, W}^o^{rld Bank, 1996.}
²¹^Howard^Baker,^Jr.,^Sam^{Nunn, Alan Gelb, “}^{NATO: A Debate Recast.” Op. Ed.}^{New York}
^Times^{, February 4, 1998.}

costs, we may conclude that a blend of programs needed for accession to each²²
organization may be deemed most cost effective.
This broader approach has other advocates. The Organization for Security and
Cooperation in Europe (OSCE) Parliamentary Assembly developed a model to
interconnect adverse economic developments to security considerations. They noted
in their Stockholm Declaration,
. . . security in the OSCE region as a whole and, more particularly, security in
Central and Eastern Europe and the CIS region can be substantially affected
negatively through economic, social and environmental developments that
undermine public support for democratic governments and exacerbate ethnic²³
rivalries and tensions.
This negative interconnection of security, economic and political aspects of
successful transition in the OSCE model broadens the resolution of the costs sharing
questions because it recognizes that economic, political and security objectives are
competitive and involve tradeoffs.
Not only security and economic programs are competitive, political and
economic costs are also in conflict. In bankruptcy procedures in restructuring loss
making enterprises in key sectors, political and human benefits of employment have
to be weighed against the benefits of fiscal discipline. Helmut Becker, Vice
President of the German Bundestag relating political stability to economic growth
noted,
No society can remain stable over the long term if its economy is unstable. Good
economic policies must walk a chalk line: if they make the economy dynamic,
then they will also set loose the forces of social tension as well. If they
emphasize maintenance of the status quo, then deficits and mismanagement will
cause political unrest. A functioning economy and a stable society are mutual
prerequisites. We will either be successful in achieving both or both will fail in
the long run. Increasing unemployment and social distress may seriously²⁴
jeopardize consolidation of the new democratic structure.
Substantially higher costs with stringent budget constraints on the new member
countries would tend to escalate opportunity costs and further elevate the concern
over costly tradeoffs. However, these popular choices for growth over security costs
are reinforced by specific European Union criteria for accession which in turn are
tied to availability of the EU aid through their financial and technical assistance

²² ^Chairm^an^Pete^V.^Dom^e^{nici of the Budget Com}^m^{ittee of the United States Senate posed}
^the^question:^“^D^o^{you believe the EU and NATO e}^xpansion^com^p^lem^e^nt^{each other or does one sap}
^{interests from}^{the other?}^{” Hearing on}^{“Europe’s}^{Monetary Union and its Potential Im}^{pact on the}
^{United States Econom}^{y.” October 21, 1997.}
²³^Stockholm^{Declaration of the OSCE Parli}^a^m^eⁿ^t^a^r^{y Assem}^b^{ly Toward a Com}^m^{on and}
^Com^p^{rehensive Security Model for Europe}^and^the^{Twenty-First Century. Stockholm}^,^{Sweden, July}
^{9, 1996.}
²⁴ ^{John P. Hardt, Jean F. Boone, Step}^h^e^{n B. Heintz and Aaron Presnall,}^{Parliamentary}
^{Responsibility for Economic Transiti}^{on i}ⁿ^C^eⁿ^t^r^a^l^{and Eastern Europe}^{, prepared by the Congressional}
^{Research Service with assistance from}^{the Institute of East-W}^{est Studies for the Com}^mⁱ^ssion^on^Security
^{and Cooperation in Europe (CSCE). GPO: W}^a^{shington, DC, July 30, 1996, p. 10.}

programs, PHARE and TACIS. This EU pressure may not fully consider the need
for security programs.
If the rationale on overall transition adopted and supported by the United States
requires more difficult tradeoffs than has been currently acknowledged, the question
of cost sharing by the new members may become a policy concern in the United
States. We may feel EU pressure leads to underrating the importance of security
programs to an extent requiring use of our influence for proper consideration of
defense requirements. At the same time, if we were to press for the inclusion of
some military expenditures in the budget of the new member countries that might be
seen as taking funds for recapitalizing workers’ pension funds or restructuring loss-
making enterprises of these new member countries, this decision may lead to
retardation of economic transition and a negative popular reaction within central
European countries and European members of NATO. The opportunity costs from
supporting programs related to either EU or NATO requirements might be
considered especially onerous in those cases where the candidate countries paid the
lion’s share of the costs.
The United States may be faced after accessions to both NATO and EU with
the broader consequences of judgments related to opportunity cost assessments.
How should the costs be shared if the new members cannot or should not afford a
greater share of costs and the other NATO members are unwilling to accept a larger
burden? Can we and should we leverage acceptance of more enlargement cost²⁵
sharing? If we have the leverage on Central Europe, would it be wise to use it
unless we are sure the net effect would be beneficial to the overall transition in the
region and in our broader interests? How should we differentiate among the three
countries in terms of judging the appropriate enlargement costs each should bear?
If one country is less capable of bearing the cost in the year 1999, should we favor
reducing their burden or deferring a heavy burden for later years, i.e., should new
members front-load or back-load their budgets with the required new programs?
As there are many countries lined up to join, precedents set now may be
considered in the context of future accession to NATO and the EU (Table 2). The
countries seeking future admission to NATO and the EU are likely to have less
economic capacity as judged by conventional success indicators (Table 1, page 3
above). Each of the future candidates in the region pose equal or greater problems
of opportunity costs for meeting requirements of NATO and EU enlargement. Those
who qualify would merit careful attention for appropriate blending of security,
economic, and political costs of transition in NATO and EU accessions.

²⁵Carl W. Ek, NATO Common Funds Burdensharing: Background and Current Issues,
CRS Report 98-239 F, March 11 1998.

Table 2. Accession to the EU and NATO
European Union¹NATO²
Countries Negotiations Expected Negotiations Expected
Accession Accession
Advanced
Czech RepublicMarch 19982002-2003Completed1999
³
EstoniaMarch 1998--
HungaryMarch 19982002-2003Completed1999
PolandMarch 19982002-2003Completed1999
⁴
SloveniaMarch 1998--
Less Advanced
⁴
BulgariaAnnual appraisal
³
Latvia---
³
Lithuania---
⁴
Romania---
⁴
Slovak Republic---
¹^{Agenda 2000. Address by}^{Jacques Santer, President of th}^{e European Commission, Strasbourg, France, 16 July}^1997.
^Cy^{prus is also proposed for the}^{first group to EU, but not to NATO.}²
^{Report to the Congress on Enlargement of NATO: Rationale,}^{Benefits, Costs and Implica}^{tions, August, 1997, op. cit.}³
^{President Clinton voiced support of NATO accession in W}^a^sh^{ington m}^{eeting with three Baltic nation presidents.}⁴
^{Some support in NATO for joining first three but not approved.}

Appendix
Country Profiles for Assessing Performance and Economic Capacity
to Meet Accession Requirements into the 21st Century²⁶
Sustained growth in the gross domestic product will be directly affected by further progress
in stabilization, liberalization, and privatization, with market friendly institutions building.
Integration, through opening to the external markets especially generating more foreign direct
investment, will stimulate growth and commerce. All these elements of a transition policy are
interactive with a multiplier effect on generating economic capacity that may support accession
programs by providing the economic capacity to support accession costs.
A more detailed examination of the transition profiles of the Czech Republic, Hungary, and
Poland will provide in-depth assessments of the ability and willingness of the new members
joining NATO under likely agreement terms to share NATO enlargement costs. The importance
of interrelationships of economic and political transition and overall economic growth and
support by the EU, other international aid providers, and investors, is illustrated. The synergy
in democratic market transition is important in assessing the economic capacity to
simultaneously support NATO enlargement, the EU accession, and transition programs.
Czech Republic.Policy Highlights. Even with a crisis in transition and scandals, the
Czech Republic is a leading performer in transition. Past success in transition of the Czech
Republic has been attributed to a social contract that combined political and economic reforms
and brought the Czech leadership and their electorate to a consensus on the need for an effective
economic transition strategy. Until recently the most stable of the new democracies of Central
and Eastern Europe, the Czech government is heading for elections in June 1998, caused by the
collapse of the center-right government. The Czech monetary and fiscal crisis led to a sharp
turndown in growth and significant government deficits. The caretaker prime minister, Joseph
Tosovsky, former central bank head, promised that with the elections adoption of new monetary
and fiscal policies would revive growth, strengthen the currency, reduce the deficit, and attract
more foreign investment. A new broad coalition supporting effective reform will be needed
from the upcoming elections in order to return the Czech Republic to its former position in the
front line of transition economies. With popular support for NATO less than that of the other
new members, the prospects of broad public support for Czech burden sharing of NATO
enlargement costs are not as bright as for Poland and Hungary. The Czech government will have
to make some tough budgetary choices in supporting financial, monetary, and enterprise policies
while discharging their commitment to support NATO enlargement costs. Consensus on this
issues would be important not just for successful economic transition, but also for attracting
more foreign investment, aid, and other means of financial support for facilitating accession to
both the EU and NATO.
Domestic Performance and Prospects. The Czech Republic came out of the transition-
induced recession from 1994 and sustained its economic growth at 4 per cent throughout 1996.
In 1995, the GDP expanded by 4.8 per cent compared to 1% in 1997. GDP was indexed at 90

²⁶^Prim^{ary Sources for these su}^{ccess indicators are the EBRD,}^{Transition Report 1997 Enterprise}
^{Performance and Growth}^{, Decem}^{ber 1997; Plan ECON,}^Review^{and Outlook for Eastern}^Europe^{, December 1997;}
^{Review and Outlook}^;^WE^F^A^{, N}^o^v^e^m^b^er^1997;^{Eurasia Economic Outlook}^{, W}^o^{rld Bank Newsletter,}^Transition^,
^Septem^ber-Decem^{ber 1997, and February 1998. See Table 1}^supra^{for sum}^m^a^{ry indicators.}

in 1997, with 1989 equal to 100. Post-Klaus policy is expected to return growth to 1995 level
by the year 2000. Slow growth and increased unemployment would make accession debates
more contentious. Investment ratings may be reduced, causing a slowdown in foreign
investment, weaken support of transition policy, making the EU and NATO accession processes
more difficult. The projected budget deficit is 1 percent of GDP in 1998, tighter than the 3
percent GDP cap set by the European Union requirements. A continuation of slow growth in
1998 would generate less revenues available to fund other critical programs, thus putting
pressure on the deficit financing cap. It is possible for the Czech government to partially offset
budget imbalances by selling assets or attracting more FDI. Funding of programs critical to
successful transition would be favored by the EU as they would tend to increase economic
growth and gain wider support from the public. The uncertain election outcome in Spring 1998
will be a key factor in projecting future economic performance. Only a strong government with
a broad support base can move the Czech economy back toward sustained growth and a low
investment risk rating needed to attract foreign capital. The government is trying to bring the
economy back into balance by trying to keep inflation at 8 per cent in 1998, with zero nominal
increase in public sector wages, no indexation of pensions and social benefits and a zero increase
in nominal government expenditure, except for defense. Their domestic state budget has been
further constrained by low collection of tax revenues and continued subsidies. The Czech
Republic would thus have to pay a high opportunity cost price to meet costs of NATO
enlargement by fitting costs into the new budget. Czechs need both austerity and growth.
NATO enlargement costs will not help either. Moreover, zero increase in government
expenditures in 1990 would hamper a transition toward a sustained growth and early accession
to the EU.
Stabilization. Full current account and partial capital account convertibility were
accomplished in 1995. The Czech Republic is adjudged to be a functioning market economy.
Despite tight fiscal policies, both trade and current account deficits grew in 1996. Koruna, the
national currency of the Czech Republic, was pegged to the German mark in 1997, and the
authorities were forced to devalue the koruna, ending several years of foreign exchange stability.
The Czech Central Bank spent more than $2.5 billion to support the currency in May 1997.
Liberalization. Price liberalization commenced in January 1991, and most of the prices
were freed. The only remaining significant controls pertain to utility charges, such as fuels and
energy, residential rents, public transport, postal service and telecommunication, health care, and
selected agricultural products. The Czech Republic has almost complete liberalization of
quantitative controls on imports and exports. They became a member of World Trade
Organization (WTO) in 1995 and maintain a very liberal trade regime, virtually free of non-tariff
barriers and export restrictions.
Privatization. Privatization of small and large enterprises in the Czech Republic was
carried out through a variety of methods, including the transfer of state property to
municipalities, restitution and the privatization and transformation of agricultural and other
cooperatives. The vaunted method of mass privatization through vouchers given to the
population to exchange for shares has had unhappy consequences. Ownership of many major
enterprises and banks were concentrated through investment funds in the hands of a very few
without adequate fiscal and monetary openness and accountability. A dramatic banking and
influence scandal brought this faulty reform to crisis and led to the demise of the Klaus
government. This oligarchy, or financial industrial group [FIG], control is a major cause of
Czech reform problems. In January 1998 the Czech lower house of parliament set up capital
market watchdogs to reduce the influence of banks over non-financial companies. The cabinet
has also agreed to the sale of the stakes in the four leading banks, opening the way to significant
foreign direct investment. It is important for the Czech Republic to reinforce the rule of contract

law to meet the obligations for the accession to the EU and in order to receive more foreign
assistance to encourage foreign investment. The programs for the FIG reform would have be
squeezed into a tight budget reinforced by a more restrictive deficit financing cap. Incremental
costs of NATO expansion would have to be within the tight Czech budget and at the expense of
some programs important to economic transition and the EU accession.
Market Institutions. Czech republic is a stable democracy, guaranteeing the rule of law
in human rights and respect for and protection of minorities. There are still some weaknesses
in laws governing freedom of press and discrimination problems that affect the population.
While the country has followed the European legal pattern harmonizing with the EU rules and
legal framework in the area of financial services and taxation, it is in this area that most radical
institutional changes are needed. Further progress in regulation is also required in agriculture,
environmental protection, and the energy sector. The European Union’s critique highlighted the
inefficiencies of the courts and the need to modernize and remove from politics the cumbersome
old regime bureaucracy. The EU also faulted them on their slowness in building a regional
government system. These shortcomings are related to the EU accession criteria and would
require programs in the budget to support resolution.
Integration. The Czech Republic should be able to cope with competitive pressure and
market forces within the Union in the medium term, provided restructuring on the enterprise
level is accelerated. The Czech Republic has a high economic transition grade from EBRD with
low investment risk and relatively high foreign direct investment (FDI) per capita. The
substantial foreign investment has had the effect of integrating Czech enterprises into the
European market for commerce and finance. The Czech Republic was the first in the region to
join the OECD. They do not have an external debt servicing burden. With the projected 2.5
percent of GDP growth for 1998, the Czech society would still have to face serious policy and
budgetary choices. If high rates of growth, high capital inflows, and low inflation are attained,
the Czech Republic would regain the benefits of a normal country on the road to full integration
into the global economy and financial markets. But for the first time since the “Velvet”
revolution, the Czech economic future is considered uncertain and sacrifices in real income and
quality of life may be necessary to get the Czech economy back on a successful transition track.
Hungary. Policy Highlights. The upcoming Hungarian elections in May 1998 will
reaffirm the Hungarian’s broad consensus on successful transition strategy. Even an optimistic
forecast on policy and performance may not allow Hungary to meet their obligations for
accession to both the EU and NATO. Hungary’s strategy of transition has been supported by
the current coalition of the Hungarian Socialist Party and the Free Democrats who are together
in their strongest position since 1994. The government recently won a referendum on NATO
membership with 85 per cent of voters in favor, although turnout was just under 50 per cent.
The booming economy is boosting the coalition’s prospects for the next election. The outcome
of the elections will depend on whether voters decide to punish the coalition parties for three
years of lower living standards and painful economic and social adjustments, or reward the
government for their transition strategy leading to the current high growth for Hungary.
Success of the coalition government would reinforce Hungarian commitments to the consensus
strategy of transition and policy of simultaneous accession to both the EU and NATO. The next
five years will be a period of decisive importance for Hungarian transition and integration
prospects into Western systems. The election outcome solidifying the consensus on transition
and integration into Europe may thus be pivotal.
Domestic Performance and Prospects. Hungary’s situation is the result of a remarkable
turnaround since early 1995 when it faced a Mexican-style debt crisis. It now approaches 1998

with some of the strongest economic fundamentals of any post-communist country in the region.
Their depression is over, and recovery is underway. Their projected level of real GDP in 1997
was 89 (1989=100). GDP growth increased from 1 per cent in 1996 to 3 per cent in 1997 and
is projected to accelerate to 4.4 per cent by the year 2000. Projected budget deficit is 3.6 percent
of GDP but should be lower to meet EU accession criteria. Critically needed pension reforms
would especially require funding in their already oversubscribed budget.
Stabilization. Hungary may be considered a functioning market economy. Still, inflation
has been slow to fall and is 17 per cent in 1997 compare to 32 per cent in 1991. The reduction
in inflation may speed up in the next two years. The Hungarian forint became convertible for
current account transactions in 1996. The exchange rate has been pegged to a basket of
currencies that consists of 30 per cent of US$ and 70 per cent Deutsche mark. The positive
interest rate imposed by the Central Bank encouraged domestic savings, tightened supervision,
and prevented excessive Czech-style currency appreciation by regular monthly crawling peg
devaluation of the forint. Servicing what has been the highest per capita external foreign debt
still burdens the balance of payments and state budget but is becoming more manageable.
Hungary’s accession to OECD in 1996 and compliance with the EU requirements reinforced the
Hungarian desire to join the West and be first among those integrating into the Western systems
of both the EU and NATO.
Liberalization. Liberalization in Hungary has been impressive. About 84 per cent of
consumer prices are free of administrative controls. Hungary is increasingly competitive in the
world market. Foreign trade was one of the brightest spots in the Hungarian economy in 1997;
exports were up 16.7 percent in the first seven months of the year, the best performance in
Central Europe.
Privatization. Hungary went further in its transition in the first stage of their reform than
many countries in the region to develop increased enterprise competitiveness, resulting from
their choice of privatization policies. The Hungarian government opted for a policy of rapid
privatization by the quickest and simplest method to obtain what it needed most—cash from
sales to strategic investors. Banks, industrial enterprises, power stations, water, sewerage and
other utilities including telecoms have been involved in this privatization process. Sales to
strategic investors brought new management and access to new technologies and foreign
markets, which resulted in increased productivity and increased standards of living for
Hungarians. The influx of fresh capital to replace obsolete capital assets, and the transformation
of formerly state-owned banks and enterprises from serious loss-makers into tax-payers, has
helped to raise tax revenues and employment, although servicing the foreign debt drew off a
share of the financial inflow. The banking system in particular benefitted from the influx of
foreign owners and managers who made possible the restructuring of many former state-owned
banks and industrial enterprises. Critics of Hungarian economic policy argue that the
government has concentrated too much on attracting foreign investment and not enough on
creating an environment for a Polish-style explosion of native entrepreneurial talent, especially
in small-scale private enterprises. However, the availability of competent Hungarian managers
and skilled labor is often cited by foreign investors as one of the attractions of investing in
Hungary. Hungarian deep enterprise and institutional reforms contrast sharply with the Czech
experience. A continued high level of foreign direct investment would strengthen the economic
conditions for strong growth, facilitating fulfillment of the accession criteria for both the EU and
NATO.
Market Institutions. EBRD has rated Hungary as a stable democracy with institutions
guaranteeing the rule of law, human rights and respect for and protection of minorities.
Hungary’s political institutions function well, but improvements are still needed in the operation

of the judicial system. The legislative foundation harmonized with the EU rules and directives
is almost complete in areas such as competition, public procurement, intellectual property, and
company and accounting law. Effective administrative reform is, however, still required. The
health system should be improved and the EU health and “safety at work” standards need to be
applied. By contrast, further efforts will be necessary to set up regulatory frameworks in
consumer protection and customs controls. Further monetary, financial, and competitive
institutions development would be significant for Hungarian accession to the EU and would
facilitate sharing the enlargement costs of NATO.
Integration. Hungary’s international position is comparatively stable, secure and hopeful.
Hungarian foreign, economic and security policies are dominated by the process of accession
to the EU. The EU accession opens opportunities for more financial and technical assistance for
Hungary and provides the basis for a greater surge of trade with Europe, especially with
Germany. Integration into the global market system would provide Hungary with improved
infrastructure, a favorable credit rating for future foreign financing at lower cost, further
expansion in commercial activities, reduced trade restrictions, ability to compete with market
forces within the European Union, increased FDI, and assured political stability. Hungary is
now highly rated by many credit-risk agencies, although their outlook is still not positive enough
for further upgrading. NATO accession is a popular issue in Hungary although without the
benefit of a public debate on opportunity costs of enlargement. By some estimates, Hungary
may expect an annual $50 million additional capital inflow from increasing military production
related to NATO accession. This new output would derive from being a NATO member and
would include various kinds of aid and long-term loans granted on better terms than usual under
international conditions. The future interactions between the budget and policy will depend on
opportunity costs and choices made by the government towards accession guidelines for both
NATO and the EU.
Poland. Policy Highlights. The outcome of parliamentary elections on September 21,
1997 reaffirmed Poland’s broad consensus on transition strategy and reinforced their accession
commitments to the EU and NATO. A strategy of transition has been broadly supported in spite
of differences on the tactics of stabilization, privatization, liberalization, and market friendly
institution building by eight successive governments from 1990-1997 and has been reinforced
by recent polls. The major shift in Polish attitude towards the EU came from a reversal of the
nationalistic, even xenophobic position of the Polish Roman Catholic Church. This changed
foreign policy demonstrated a readiness to join the EU on its economic, political, and social
merits. This also represented not only a willingness to follow the rules of the global market
place. This broader view on external affiliations adopted by the Polish church presumably
applies to NATO accession as well.
As paradoxical as Polish politics might often seem, once the election was held and the new
government was formed, the new right center coalition and the left were clearly both committed
to continue “Strategy for Poland.” That economic program contributed to accelerated growth,
increased investment and membership in the OECD. The OECD accession and detailed
compliance with IMF, World Bank, EBRD conditions reinforced the EU criteria and increased
Polish commitment to fulfill its obligations for accession to NATO. Accelerated structural
reforms, institutional reforms in banking and finance, and a more active role of the state are
going to be the main features of future economic policy. All these programs require substantial
funding and popular support. Public support in recent polls for both the EU and NATO has been
about 75 percent. However, NATO and the EU accession and acceptance of enlargement costs
are supported in principle but not in detail. There has to date not been public or parliamentary
budgetary debate on opportunity costs of NATO. Costs of enlargement was not included in

latest questionnaires in public opinion polls. Poland may well await clarification of rationale and
full costs of the NATO enlargement in more detail before debate and approval in the Polish
parliament. Opportunity costs for NATO enlargement may be perceived as too high for Poland,
slowing down Polish economic growth, resulting in less FDI flows into Poland, and impairing
accession to the EU.
Domestic Performance and Prospects. The first stage of economic transition at the
macroeconomic level included success in stabilization, liberalization, and privatization. Macro
stabilization improvement was facilitated by a stabilization fund and restructuring of foreign
debt mainly initiated by the substantial international aid programs with the significant U.S.²⁷
Congressional support. Recovery of Polish economy began in 1992 in gross domestic product,
exports and incomes, with accelerated progress in stabilization, liberalization, privatization and
market institution building throughout the 1994-1997 period. Poland weathered the transitional
storms of emerging economies well: its level of GDP for 1997 was 110 (with 1989 equal to 100),
with a seven percent GDP growth. Poland is projected for 5.5 per cent growth in 1998 and just
under five percent to 2000. The projected budget deficit of 1.6 percent of GDP is to facilitate
a further reduction in inflation and curb trade deficit growth. Due to inflow of investment a zero
deficit cap is the new goal to keep the zloty from appreciating too much. Poland has promising
growth prospects but would face difficult choices due to substantial opportunity costs.
Stabilization. Poland may be considered a functioning market economy. Hyperinflation
has been brought down from 1,000 per cent in 1990 to 38 per cent in 1993, and to 15 per cent
in 1997. Inflation should continue to decline to around 10 per cent in 1998 and is likely to reach
the single-digit level on the eve of Poland’s anticipated accession to the European Union. Due
to macroeconomic reforms and the openness of the Polish economy, the national currency—the
zloty—became convertible in 1994. The encouraging results of the September parliamentary
elections and the creation of a strong reform supporting coalition boosted the confidence of
foreign investors in the zloty and the zloty was heavily traded in world financial markets in
September and October 1997. Problems in generating tax revenues, trade imbalances, balance
of payments deficits would all make transition slower, growth lower, inflow of foreign
investment smaller, and Polish ability to fulfill the EU criteria less likely. There is broadly
shared optimism on improved Polish performance across the board. Still, NATO enlargement
would require substantial defense expenditures and could dry up budget funds by competing
with funding of programs critical to successful transition. Transition and the EU-related
programs are likely to rise in the same 1999-2009 period when NATO enlargement costs peak.
Liberalization. Even though prices are substantially freed, state procurement at non-
market prices still exists, and prices for district heating, electricity, gas, domestically produced
medicines, rents in local authority housing still remain centrally administered. Coal, steel,
agriculture, and other state-owned industries are protected in foreign, trade and the failure to
adopt a clear strategy to restructure those enterprises would delay further price liberalization and
might slow Poland’s EU membership drive. Restructuring costs in these critical loss-making
sectors will have priority in the budget.
Privatization. Polish industry is characterized by the existence of both a dynamic
competitive new small- and medium-scale private sector and a large, mostly state-owned sector
that needs restructuring. Small-scale privatization has been the engine of Poland’s steady

²⁷^{“The Congres}^sⁱ^oⁿ^a^{l Role in United States Assist}^{ance Policy in Central-East European Econom}^{ies in}
^Traⁿ^s^{ition,” W}^illiam^{F. Schuerch,}^E^a^st^-^C^en^t^r^{al Europe in Transition}^{, Joint Econom}^{ic Com}^m^{ittee, Novem}^b^{er, 1994,}
^{pp. 336ff.}

economic growth and rising living standards: the average real income has risen 80 per cent over
the past four years. The first phase of reforms ended state ownership in two-thirds of the
enterprises but did not proceed toward restructuring and corporatization of many large
enterprises. Poland has been engaged in more extensive corporate reforms in small private
enterprises, resulting in lower labor costs, increased productivity, and decreased unemployment.
The Polish government may still have to support some of the giant, still state-owned, shipyards
and coal mines that cannot survive without huge subsidies for some years. The qualitative
change in privatization in the second stage will require accelerated mass large-scale privatization
and corporatizing with foreign participation in key sectors such as in telecommunication,
insurance, banking, mining, agriculture, and defense. There are a number of controversial
tactical issues still being debated with regards to what sectors to privatize first, how fast the
process should be, and the extent of foreign participation in privatization process in many
sensitive sectors. Poland has privatized five of the nine original state-owned commercial banks.
Of the four state-owned specialized banks, only Bank Handlowe has been privatized. However,
the pace of bank privatization has been slow and strengthening of the banking system remains
a priority. Mass privatization in Poland is currently projected to involve foreign assistance and
auctions open to foreign bidders and bankruptcy when appropriate. Selling off state assets,
especially through auctions involving foreign participation, is a major future source of income
for the budget with some of the foreign sales income dedicated to pension reform. The “third
rail issues” such as welfare reform, pension funds, education, health benefits, and administrative
reform, are at the center of Poland’s budgetary debate as they endanger survival of elected
politicians and are calculated in the opportunity costs relevant to NATO enlargement and EU
accession.
Market Institutions. EBRD has rated Poland as a country that is close to the highest in
development of market-supporting institutions. Poland is already a stable democracy, with
institutions guaranteeing the rule of law, human rights, and respect for and protection of
minorities. However, there is still a necessity to set up regulatory institutions to improve the
operation of the judicial system; intensify the fight against corruption; apply the EU norms in
agriculture, environment, and transport; liberalize capital movements; open up public
procurement; reform pensions, social security; modernize the agricultural and defense sectors.
The costs of these institutional developments necessary for effective transition and the EU
accession would likely be weighed against NATO enlargement costs.
Integration. Accession would provide more Polish access to the EU, especially the
German market, technological facilitation, restructuring and corporatization, financing, and
technical assistance to Polish enterprises. By opening up its economy further, Poland will be
able to finance infrastructure such as the road and railroads network in Europe and integration
into the world economy. Through favorable credit ratings Poland will receive greater access to
global financial markets for more funds at lower costs. Acceptance of World Trade
Organization norms and mechanisms will open trade prospects for Poland and will make foreign
and domestic investment more attractive in the future. However, Poland will be pressured to
restructure non competitive industries and make a larger share of their economy more open to
foreign competition. Poland would like the EU to open itself to labor movement from Poland
and more access to EU agricultural markets. These are among many issues under negotiation.
Accession to NATO may facilitate an increase in growth through assuring the country’s political
stability and security, but will also compete with claimants keyed to economic transition.