Bridging the gap

This analysis looks at the impact of enlargement on the European single market, labour mobility and regional development.

The forthcoming round of enlargement is the EU’s biggest ever. Ten new members – eight central and eastern European countries plus Malta and Cyprus – are set to join the Union in May 2004. They will increase the EU population by one-quarter and its landmass by one-third. However, their combined gross domestic product will add only 4-5% to the existing EU economy. The figure is closer to 10% if GDP figures are adjusted for exchange rate misalignments, but this does not alter the striking conclusion that most of the new member states have small, rather poor economies.

According to European Commission figures, average GDP per head in the ten accession countries is less than 40% of the EU average. Within the eastern European group of candidates, the ratios go from as low as 30% in Latvia and Lithuania to almost 70% in Slovenia. Add to that the stark income gaps within some of the new member states and it becomes clear that eastward enlargement will burden the Union with unprecedented economic disparities.

Income disparities as such do not impede the functioning of the single European market. In fact, economic integration is more beneficial if the participating countries are very different. However, many in the current EU fear that the accession of these fast-growing, low-cost economies could create enormous economic pressure. In particular, they worry that cheap Polish or Czech exports could price western European products out of the market; that western European companies could divert much-needed investment to the East, where wages are much lower; or that a massive influx of low-wage workers could add to existing unemployment queues in countries such as Germany and France.

These fears are overdone. In terms of economics, eastward enlargement is largely yesterday’s news. Bilateral trade has been gradually liberalised since the signing of the Europe Agreements in the early to mid-1990s. By 2003, the accession countries were trading with the Union as much as (if not more than) the EU countries among themselves. On average, the eastern Europeans now send two-thirds of their exports to the Union and they receive a similar share of their imports from there. These shares are unlikely to rise much further.

The same does not hold true for the movement of workers. Most EU countries have retained strict limits on labour movements from eastern Europe. Western Europeans fear that once these restrictions are dropped, millions of eastern Europeans will pack up in search of higher wages and a more comfortable life in the West. Migration flows are fiendishly difficult to forecast. Economists have drawn up elaborate models to estimate how many eastern Europeans are likely to move. They have looked at past experiences, for example those of Spain, Greece and Portugal after accession. They have also conducted surveys in the accession countries to gauge the mood among eastern European workers.

Despite these different approaches, most studies come up with rather similar conclusions. They predict that between 100,000 and 400,000 workers will move from the East each year once restrictions on labour movements have been lifted. Assuming that it takes about a decade for all those willing to move to actually do so, economists assume that perhaps two to three million people from the new member states will be living in the ‘old’ EU by, say, 2015-2020. That may sound a lot. But it only amounts to 0.5 to 0.8% of the EU’s current population – and the share of eastern Europeans is already estimated at 0.2%. Some economists think that even these estimates are too high. They point to the fact eastern Europeans do not even like to move around within their own countries despite substantial regional differences in wages and unemployment rates. Moreover, it is highly skilled, well-paid workers who tend to have a higher propensity to relocate. This implies that East-West labour movements are more likely to take the form of a ‘brain drain’ than a deluge of unskilled labourers.

Nevertheless, some EU countries are so worried about the prospect of a large influx of workers that they insisted on the right to keep restrictions on labour movements for up to seven years after enlargement. This means the new member states may not enjoy a key element of the single market – the free movement of workers anywhere in the Union – until 2011. From a political point of view, these transition periods may be understandable. Germany – which is the destination of two-thirds of all labour migration from the East – is struggling with high and rising unemployment.

More than 4.6 million job-seekers are already stretching Germany’s cosy social safety net to bursting point. In neighbouring Austria, an above-average share of foreigners in the labour force has given a boost to right-wing and xenophobic political parties. Problems are particularly acute in regions which border on the accession states. Politicians therefore prefer to put off any possible adjustment pressures as far as possible.

From an economic perspective, however, these transition periods only make sense if EU countries use them to reform their labour markets. Historical experience with immigration shows that countries with flexible labour markets can easily absorb even large inflows of workers without having to accept permanently higher unemployment or lower wages. Countries such as Germany where wages are sticky and regulations onerous may find it much harder to adjust. Yet the adjustment appears inevitable, because even a seven-year transition period will not be enough to narrow the income gap between East and West to any significant degree.

Although the eastern European countries tend to grow faster than the current EU members, the income gap between the two groups of countries will narrow only slowly. Economists assume that on current trends, it would take the new members some 50 years to even it out.

But are current trends a good guide to the future? Pointing to the post-accession boom experienced by Portugal and Spain, some people expect eastern European growth to pick up strongly after 2004. The Commission, for example, predicts that GDP growth in the accession countries will rise from around 4% in the years leading up to accession to 6% thereafter. However, this projection does not fully take into account the costs of accession for the new members, in particular the burden of implementing thousands of pages of EU rules and regulations.

Some hope that Union money, in particular the structural funds for regional development, will fuel catch-up growth in eastern Europe. Under current EU rules, regions with a per capita GDP of less than 75% of the Union average automatically qualify for EU regional aid under the ‘Objective 1’ facility, which contains the largest share of money. This means that the eastern European countries will be eligible for EU aid almost in their entirety.

The Union has earmarked a total of €42.6 billion for the new members in its current 1999-2006 budget, of which more than half will be paid out through structural funds. But the money will be slow to come in. The Commission expects that in 2004, the new members will receive transfers amounting to only 1% of the combined GDP, going up to 1.5% by 2006. This looks paltry compared with what Greece, Portugal and Spain received in 2000, namely 3.6%, 1.9% and 1.8% respectively. The new members will get between €200 and €500 per head at the most in 2004-06, compared with €1,000-1,500 in Ireland, Greece and Spain during the last budget period.

For later years, the EU has capped regional aid flow to the new members at 4% of their respective GDPs. But some Brussels insiders think that this ceiling will not be reached any time soon.

First, the rules governing the use of structural fund money are so complicated that even the exis ting member states regularly fail to spend the full amounts that they have been allocated. The eastern Europeans, who have weak administrations and little experience in implementing regional policies, will find it even more difficult.

Second, the current main recipients of EU regional money, such as Greece, Portugal and Spain, will fight tooth and nail to keep their entitlements during the next budget period covering 2007-2013. At the same time, the net payers, such as Germany and the UK, are fiercely opposed to any increase in the overall structural funds budget.

Even if the new members get the sums they hope for, the money may not help them catch up quickly. Some of the main recipient countries, such as Ireland, have grown extremely fast in recent decades. Others, such as Greece, have continued to trundle along despite massive financial injections from Brussels.

Economic studies detect no direct correlation between Union aid and economic growth rates. Instead, what matters for growth is macro-economic stability which encourages investment; flexible supply-side policies which help economies adjust fast; sound institutions; and a well-educated, highly skilled labour force.

The accession countries have most of these ingredients in place. But they need to remember that EU structural fund money will only boost growth if they spend it wisely as part of a broader growth-oriented policy package.

Katinka Barysch is chief economist at the CER.

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