Does enlargement matter for the EU economy?

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV Media network.

Does enlargement matter for the EU economy?

The forthcoming enlargement round 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. In terms of economics, however, their accession will be of little consequence for most current EU members. First, economic integration between the EU and the Eastern European countries has already progressed to a degree that makes further big gains – and losses – unlikely. Second, the economies of the new memberstates are very small compared with the EU.

Nevertheless, many Western Europeans are worried that the accession of fast-growing, low-cost economies could create enormous economic pressure. In particular, they fear that cheap Polish or Czech exports could price local products out of the market; that financial flows to the new member-states could divert much-needed investment capital from Western European businesses; and that a massive influx of low-wage workers from the East could push unemployment in the EU even higher. These fears are largely groundless.

Trade integration is yesterday’s news

In terms of economics, eastward enlargement is largely yesterday’s news. Trade liberalisation was part and parcel of the early economic reforms in all Eastern European countries. As a result, trade with the EU took off even before the Europe Agreements opened the way for the gradual removal of trade barriers in the early to mid-1990s. Since then, bilateral trade has been growing at double-digit rates every year. By the end of the decade, the candidate countries were trading with the EU just as much as the EU members were trading with each other. On average, the wouldbe members are now sending two-thirds of their exports to the EU. These shares are unlikely to rise much further. Although there is scope for further integration with some EU countries, including France and the UK, future trade growth will largely depend on overall economic prospects in the two regions.

This rapid trade expansion has helped to boost catchup growth in most Central and Eastern European countries. But has it come at a cost for the EU? No. First, taken together imports from the candidate countries amount to no more than 1 per cent of EU GDP. Second, to the extent that these imports have intensified competition for EU producers, they have pushed down prices and benefited European consumers. And third, while the EU has increasingly thrown open its market to Eastern European goods, it has also exploited growing export opportunities in the accession countries. In fact, the EU sells much more to the accession countries than it buys in return. The result has been a large and rising trade surplus. According to estimates from the Osteuropainstitut, a German research institute, this trade surplus has created 114,000 jobs in the EU during the 1990s.

EU companies have not only sent their goods to the candidate countries, they have also bought up existing businesses there and built new ones. The Osteuropainstitut calculates that German foreign direct investment (FDI) alone has created almost 450,000 jobs in the Eastern European countries. But this does not mean that the same number of jobs has been destroyed in Germany or elsewhere in the EU. Most FDI in Eastern Europe has come in addition to, not instead of, EU investments. By investing abroad, EU companies sought to access new and fast-growing markets rather than to cut costs at home.

Foreign investment keeps EU companies competitive

Around half of EU investment in the candidate countries has gone into services, such as banks, supermarkets and hotels. A much smaller share has been invested in factories that produce for exports in sectors such as cars, clothing and chemicals. This share, however, is growing. First, much service-sector FDI came through the priva tisation of banks or telecoms, which are now drawing to a close. Second, with accession around the corner, the Eastern European economies are looking more and more like the EU. They now have the same trade policies, competition rules and product standards. As business environments become more alike, differences in wage costs will become more important when companies decide where to produce. Wages are much lower in the Czech Republic, Hungary and Poland than in France or Germany. But so is productivity. In other words: the average Western European worker produces two to three times more output in an hour of work than his Eastern European colleague.

Western investment itself will help to boost productivity in Eastern European industries. And Western European companies will continue to invest in the new member-states, in particular in labourintensive sectors, such as clothing or cars, as well as skill-intensive ones, such as electronics. These are industries that are coming under growing competitive pressure from low-cost producers in Asia and elsewhere. By transferring some labour-intensive production to Eastern Europe, EU companies make sure they stay competitive on a global scale and continue to expand in their home market. FDI in the East can therefore help to preserve jobs in places such Germany, France and the UK.

Poles and Czechs will prefer to stay at home

Once the Central and Eastern European countries are full members of the single European market, their citizens will have the right to settle and seek work in the other EU countries. But predictions that millions of Eastern Europeans will head westwards in search of comfort and prosperity are unlikely to materialise. Wages are lower in the East, but so are prices, with the result that most Eastern Europeans enjoy a reasonably good standard of living. Only very few will want to leave their homes, families and friends to look for new jobs in the West. High unemployment and slow growth in the EU as well as cultural and linguistic barriers will also put off potential migrants.

Migration flows are fiendishly difficult to forecast. But many researchers think that between 100,000 and 400,000 Eastern Europeans will head West each year once restrictions on labour movements are lifted. Assuming that it will take a decade until most of those who want to move have actually done so, they predict that maybe 2-3 million people from the new memberstates will be living in the old EU countries by, say, 2015-2020. That may sound a lot, but it only amounts to 0.5-0.8 per cent of the EU’s current population (compared with 0.2 per cent at present).

The actual numbers will probably be lower still, since countries such as Germany and Austria have fought for the right to keep restrictions on labour flows for up to seven years after the accession date. These restrictions are understandable, but also shortsighted: some two-thirds of all Eastern European jobseekers coming to the EU are expected to settle in Germany. With unemployment already at 4.2 million, the German government wants to gain time to prepare its labour market and social security system for any future influx. In the medium to long-term, however, Germany will have to adopt a more welcoming attitude towards immigrants. With a low birth rate, a rapidly ageing population and a shrinking labour force, Germany may have to rely on foreign workers (and not only from Eastern Europe) to sustain its generous social standards and avert a looming pension crisis.

Overall impact: small but positive

On the whole, the impact of enlargement on the current EU will be negligible, simply because the economies of the acceding countries are so small: taken together, they amount to no more than 5 per cent of the current EU (if measured at current exchange rates; the share is closer to 10 per cent if income data are adjusted for exchange rate misalignments). In economic terms, therefore, eastward enlargeme nt is the equivalent of adding an economy the size of the Netherlands to an economic area with 380 million people and a GDP of S9 trillion. Small it may be, but most economists agree that the impact will be marginally positive for the EU. The European Commission, for example, estimates that EU enlargement (defined as a ten-year period of integration from 1995-2005) will push up EU GDP by a cumulative 0.5 per cent. Incidentally, the Commission assumes that half of the benefits would come from immigration, which – as explained above – will probably be delayed for some EU countries. Similarly, Germany’s Friedrich-Ebert Stiftung forecasts an increase in EU GDP of 0.1 to 0.4 per cent over several years. However, if the more dynamic economic processes, such as increased competition and higher investment, are taken into account, the gain could exceed 1 per cent of EU GDP.

And who pays?

These gains are obviously positive from an economic perspective. But since most Western Europeans will hardly notice this small and steady increase in their wealth, it will not help much in ‘selling’ EU enlargement to the public. While the benefits are longterm and amorphous, the economic ‘costs’ of enlargement are immediate and concentrated on a geographical and sectoral basis. Not only has the EU allowed some member-states to restrict immigration, it is also putting in place a number of ‘safeguards’, designed to protect Western European industries and the functioning of the single market after enlargement. Although these safeguards are unlikely to disrupt trade on a large scale, their existence shows that the old member-states are seriously concerned about increasing competition from the East.

As explained above, Eastern Europe has been most competitive in labour-intensive sectors such as clothing or food production, but also in some capitalintensive ones, such as the production of basic metals and chemicals. In these industries, the EU has seen steady job losses throughout the 1990s. But it would be wrong to attribute these entirely to the EU typically progress from labour- and resource-intensive manufacturing to capital- and knowledge-intensive production and services. For the richer EU countries, it makes no sense to cling to the production structures of the past. They should see EU enlargement as an opportunity for economic upgrading. Rather than protecting yesterday’s jobs in smokestack industries, they should invest heavily in building up the kind of human-capital intensive industries that will guarantee stable economic growth in the long term.

Similarly, Germany, Austria and others can only justify transition periods for the free movement of workers if they use the intervening years to reform their rigid labour markets. From an economic point of view, labour movements are unambiguously positive. But if labour markets are rigid and workers highly paid and protected, such movements can lead to temporary spikes in unemployment and put a heavy burden on public budgets. The natural instinct of a country like Germany – which already suffers from high unemployment – is therefore to shield its workers from low-cost competition. But this is not the way forward. Germany’s inability to deregulate its sclerotic labour market has already turned into a drag on the entire European economy. EU enlargement may well be the outside push that Germany needs to finally get serious about economic and labour-market reform.


Katinka Barysch is chief economist at the CER.

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