On the home stretch

On the home stretch

The European Union’s events calendar has not been this full for a long time. Before the Copenhagen summit convenes on December 12-13, the EU aims to wrap up negotiations with, presumably, ten candidate countries. The target is to sign the accession treaties by April. Then, the potential entry date would be June 1, 2004, to leave time for the ratification process. The new EU states could subsequently participate, as intended, as full-fledged members in the elections to the European Parliament (EP).

Under the motto “From Copenhagen to Copenhagen” , the reunification of Europe would find its reflection also in (economic-)policy structures nine years after the EU detailed the accession criteria for new membership at the Copenhagen summit of 1993. However, the residual risks must not be underestimated. They range from controversial negotiation topics and political uncertainties, such as the Irish referendum on October 19, to the constantly raised question of whether the candidates vying for the first round are in fact ready for accession.

Critical negotiation issues

Over the past several months more chapters have been (provisionally) closed, and the negotiations have come to concentrate on a few unresolved issues. Besides the problem of transit between the Russian exclave Kaliningrad1 and Russia, which has to do with foreign policy, these issues mainly involve competition policy and, of course, the sensitive budget-relevant aspects of enlargement.

The chapter on competition policy, which Poland and Hungary have yet to close, focuses particularly on making tax aid compatible with EU practices. Some of the candidates have in the past set up special economic zones or granted foreign investors tax breaks and even tax exemptions which extend beyond the envisioned date of EU accession, putting them in violation of the relevant EU arrangements. A reasonable compromise ought to be found to settle this matter; foreign direct investment has played, and continues to play, an important role in the process of economic development in the Central and Eastern European countries (CEECs). However, due attention must be paid to the legitimate concerns of current EU members over tax-induced competitive distortions in the single European market. Uniform rules on competition and state aid are key prerequisites for a functioning internal market.

The package of proposals for the financing of enlargement remains the thorniest issue for negotiation (see page 3)2. The European Commission’s proposals on the common agricultural policy (CAP) have encountered varied criticism since they provide, among other things, for the (gradual) inclusion of the accession countries in the system of direct aid. While some of the candidates speak of a “two-class society” , especially the Union’s net contributors fear a further, significant increase in spending on agriculture. For this reason, some member states say they will only agree to this arrangement if, at the same time, the way is paved for a substantial reform of the CAP in an enlarged Union. While the desire of individual member states to stage an exit at long last from the centralist, inefficient, expensive CAP is understandable, it would still be problematical to link the two objectives.

The agreements reached on agriculture and regional policy will have a major effect on the payments position of the new members and will thus influence the arrangements of the financial and budgetary provisions chapter. Undue hardships may emerge for new members because prefinancing (in agricultural policy) and the time lag in the inflow of funds (in regional policy) will – unintentionally – put them in the position of net contributor in the first year of their membership. It goes without saying that the new members must meet their financial obligations in respect of the Union budget. However, a deterioratio n of the net budget position vis-à-vis the current situation can scarcely be justified. Therefore, the Commission has proposed to set up a EUR 800 m compensation fund. Equalisation payments of this type have been disbursed in earlier enlargement rounds; for example, Austria received close to ECU 800 m between 1995 and 1998. Moreover, given the structure of the EU budget it cannot be ruled out that especially the accession countries that have an only minor farm sector and are already far advanced economically might become net contributors permanently. Besides, all of the – economically weak – candidates will have to participate in the UK’s contribution rebate.

Political uncertainties

The accession of divided Cyprus remains a particularly sticky problem. Going by the number of chapters closed and economic strength, the country is one of the leading candidates. All hopes that UN intercession could help the opposing sides bridge the gap have been disappointed so far. With elections set for November 3, 2002 in Turkey it seems unlikely that a solution can be found in time before the accession negotiations end. But since Greece would block an enlargement round that excluded the Greek part of Cyprus, the divided island is probably certain to be included in the first round3. The Turkish part could be assigned the same type of status once held by the German Democratic Republic. That country became part of the EU immediately upon German unification due to the political concept of the ” common state” pursued by the Federal Republic of Germany. How relations with Nato partner and EU accession candidate Turkey will shape up in this regard – especially after the elections – is hard to predict, though.

At the time of going to press, the biggest risk facing the enlargement process is a renewed rejection of the Treaty of Nice in the second Irish referendum. Current surveys again point to a close decision. In political terms, at least, the Treaty of Nice – with its institutional changes – is a prerequisite for enlargement. Its enactment hinges on ratification by all EU member countries though. If the ratification process were to be broken off because the Irish voted no for a second time, the EU would land in serious political difficulties. The accession of new members without institutional reform would be very difficult to justify to an already sceptical public. But it would be even more dubious to allow enlargement to be sunk by the votes of just a few hundred thousand people. Various options could enable the enlargement process to be continued as planned:

• The institutional accession conditions, which the Treaty of Nice formulates especially as regards voting rights and the distribution of seats, could be included in the accession treaties, as was the practice in previous enlargement rounds. The fact that some member states see Nice only as a ” package” (for example: majority decisionmaking only in combination with a change in the weighting of votes) could, however, cause problems.
• The decision-making rules set out in the Treaty of Amsterdam could be prolonged. Since accession treaties are primary EU law, this would also rescind the protocol annexed to the Treaty of Amsterdam, which says that the decision-making rules are only to apply as long as membership of the European Union does not exceed 204. However, if the old rules were to regain validity this would again raise the issue of credibility and, not least, of the Union’s (inadequate) ability to function.
• The new provisions being drafted within the framework of the EU Convention will scarcely take effect in time for this enlargement round – assuming that the EU adheres to its road map. However, a transitional arrangement could conceivably be put in place until the provisions come into force.

The Irish referendum will take place on October 19. If the outcome is ” no”, the EU will have to present solutions at the special summit on October 24 that will keep the timetable for e nlargement from becoming fully unrealistic and will avoid market disruptions.

Economic realities

The candidate countries undoubtedly still show considerable weaknesses in a multitude of areas. These include, above all, the development of functioning institutions. Without the latter, neither will the legal framework of the internal market be able to infuse its confidence-building effect into investors and consumers, nor will the accession countries be able to employ Union funds in efficient and target-oriented fashion. The Commission has discussed this subject at length in its regular reports on enlargement presented on October 9.

Nevertheless, the convergence process under way since 1998, reflected in DB Research’s convergence indicator, shows that the simplest solution in political terms – a ” Big Bang” – is justifiable in economic terms, too. The differences between the countries of the Luxembourg and the Helsinki groups were relatively pronounced at first. But the ” laggards” in the catch-up process gained momentum very rapidly, so the large field of candidates has generally become pretty homogeneous. For example, the gap between the leading country and the one with the lowest convergence level will fall from just over 15 percentage points (pp) in 1998 to about 10 pp in 2003. This narrowing of the differences becomes more apparent in a comparison of the average of the Luxembourg group with that of those Helsinki-group countries which in our baseline scenario (and meanwhile also in the eyes of the EU) will be part of the first accession round (Latvia, Lithuania and Slovakia): on average, the three countries still trailed the field by 9.4 pp in 1998, whereas next year the divide will narrow to only 3.5 pp. Besides stronger growth it is mainly the more rapid pace of institutional reform in Slovakia, Latvia and Lithuania that has helped them to shorten the distance so quickly. Looking at the Big Bang group as a whole: the five Luxembourg countries have a lead on the three Helsinki candidates as regards the real economic indicators and the external sector. By contrast, the Helsinki countries show greater growth dynamics and are on firmer ground in terms of monetary and fiscal policy.

Eastern enlargement: a new dimension?

As regards economic feasibility, it clearly makes sense to compare eastern enlargement of the Union with the generally successful integration of the two countries of the Iberian Peninsula. This holds especially for the issue of how strongly advanced convergence with the EU must be in order for candidates to cope with ” competitive pressure and market forces in the single market” 5. Comparing eastern enlargement with the accession of Spain and Portugal to the south in 1986 obviously has its shortcomings. The main reason is the much higher level of integration within the EU since the creation of the single market in 1992. Nevertheless, a comparison of the convergence level reached by Spain and Portugal at the time of their accession with the level which we expect the countries of Central and Eastern Europe to achieve for 2003 offers interesting results6. When Spain joined the EU it had a convergence level (related to the EU average at the time) of 76.2%, and Portugal’s reading came to around 74.4%. The average convergence level of the upcoming large accession round will be around 70%, which falls far short of the readings posted for the other two countries. The difference between Spain and Poland is particularly sizeable, exceeding 10 pp. But the picture is quite different for the leaders among the current candidates, i.e. Slovenia, the Czech Republic and Hungary. They will attain a level in 2003 approaching that recorded by the two Southern European countries, and may in fact surpass it.

Despite the level of convergence already achieved, the structural differences within the EU will grow more strongly upon enlargement now – and especially later with the accession of Bulgaria and Romania – than was the case with southern enlargement in 1986. This holds all the more so since, naturally, the cohesion countries Spain, Portugal and Greece have lowered the EU average7. The differences separating the candidates from the more prosperous member states are very much larger. But in many respects, countries such as Slovenia, the Czech Republic and Hungary have no need to fear comparison with the EU cohesion countries. In certain fields their structures are even more modern than those of the larger EU members: take, for instance, the fully privatised banking market in the Czech Republic in contrast to Germany, where the public sector is strongly entrenched in the financial market, or even Poland, which boasts more extensive energy-market liberalisation than France. The challenges facing the EU as a result of enlargement thus lie not so much in their economic dimensions and heterogeneity as in the (misguided) orientation of both EU policies and institutions and the decision-making processes.

Negotiating schedule still on track?

The EU’s road map for enlargement has extremely tight time constraints, even assuming a positive outcome to the Irish referendum on the Treaty of Nice and hence a successful conclusion to the ratification process. By mid-October, all the items under negotiation except for the financing issues should have been settled. The latter have been held up because the elections in France and Germany prevented the EU from reaching agreement on a common position8. This must be redressed at the special summit to be convened at the end of October. With the elections over, Germany is likely to approve the compromise tabled by the European Commission. Given the sensitive nature of the matter and since time is running out – the negotiations are, after all, to be over by the date of the Copenhagen summit in early December – there is little leeway left for the individual candidates to further improve their positions. Despite the tight schedule, we see good chances of the EU keeping to its timetable. The EU has managed often enough to meet its self-imposed official targets for prominent projects (such as the single market launch, 1992; EMU, 1999), not least because its members have been all too aware of the potential political repercussions if they had been missed.  

How do things stand for the concrete entry date that the EU has to announce in December? The original vision of enlargement taking place at the start of 2004 has become unrealistic, as we had already assumed two years ago in our baseline scenario. If the accession treaties are finalised in January 2003 and subsequently meet the approval of the European Parliament, they could be signed in mid-April. The time remaining to year-end is too short for the ratification procedure. This means that the earliest conceivable accession date might be June 1, 2004, which would still fulfil the original target of allowing the accession countries to participate in the EP elections as members. This date, too, is still pretty ambitious and presupposes that the ratification process, also in the candidate countries, will encounter no major problems. Surprises must not be ruled out, not least in view of the referenda to be held in many countries9. Therefore, there is a significant probability that accession will not take place until 2005.

Even after the enlargement negotiations with the ten countries are wrapped up, much work remains for the EU – quite apart from the fact that the talks with Romania and Bulgaria will continue. Encouragingly, tentative signs of progress are emerging in the different project areas in the EU. With the reform proposals put forward in July as part of the mid-term review of the CAP, the European Commission has created more scope for economic logic (see p. 9). Despite criticism of individual elements it is to be hoped that the EU-15 will agree these reform steps as quickly as possible11. Moreover, the work of the European Convention, which has focused in minute detail on the institutions, policies and legal foundations of the EU since last spring, has now gained momentum. After the various working groups have presented their findings, a draft proposal on the new ” architecture” for the treaties is likely to be tabled in late autumn. If the final accession dates are subsequently set at Copenhagen, the reform process should receive a further boost12. Therefore, the European Union should use the year 2003, in which practically no elections will be held in the member states, to take courageous decisions in the interest of securing the future sustainability of an enlarged Union.

For more DB Research analyses see the

Deutsche Bank Research website.