From Copenhagen to the euro

From Copenhagen to the euro

After ten years of hard work 8 countries from the formerly social part of Europe will be finally invited to join the EU. Together with the two Mediterranean islands, Malta and Cyprus, they will bring the number of EU members to 25 and increase its population by about 70 million. All the candidate countries are looking for prosperity after the decades of imposed socialist planning which left their economies in ruin. They have put all of their hopes for a recovery into their EU bid. In the end the success of enlargement will thus be measured by the economy.

What will be the economic implications of enlargement?

The first fact to keep in mind is that the GDP of all the ten (present) candidates combined mounts to only 5 % of that of the 15 incumbents. It is thus clear that the economy of the old EU-15 will not be much affected by enlargement, but that of the newcomers will be transformed.

A second key fact about enlargement to keep in mind is that to a large extent it has already happened. Tariffs and quotas for industrial goods are already gone and even in agriculture trades has been liberated somewhat. Moreover, the candidates have started de facto to apply a good part of the (in)famous ‘acquis communitaire’ even before formal membership starts. This is quite different from the Iberian enlargement, when Spain entered the (then) EC with still rather high tariff barriers, which were eliminated only 7 years later. Investors, especially those for the longer term have come to Central and Eastern Europe in ever larger numbers in the expectation that these countries will soon be full members of the EU. The perspective of EU membership has also been an immense help in international capital markets where the candidates for membership are no longer paying the exorbitant emerging market risk premia that have led other countries into crisis.

Much has been made of the fact that the prospective new member countries are much poorer than most of the EU-15. Does this mean they will benefit less? On the contrary. Economic theory suggests that integration is actually more beneficial the greater the differences in endowment. The differences in income should thus be regarded as source of potential economic benefits, rather than conflict.

The costs of enlargement, which have occupied such an important place in the discussions among the EU-15 are significant, but manageable, if looked at from the incumbents. An additional 0.25-.3 % of GDP will not bankrupt the EU. The difference in size (approximately 20:1) implies that what costs so little to the EU-15 can still be worth a lot to the candidates. Whatever the outcome of the last minute haggling over details at Copenhagen, the ultimate outcome will be that the new members will receive substantial transfers – at least 3-4 % of GDP. Measured as a percent of GDP these transfers will be much larger than those received initially by Spain or Portugal and they will make the Marshall Plan look modest.

But money is never the solution to deep-seated structural problems. The millions of small and unproductive Polish farmers will soon find out that direct transfers from Brussels might feel like manna from haven, but will not solve the problems of excessively small holdings, poor know-how and still underdeveloped phyto-sanitary systems. Structural funds will be useful, by financing lots of additional roads, sewage systems, etec.. But the experience in the EU has shown that they can be source of political corruption and will achieve little in the absence of regional labour market flexibility.

That so much has already been achieved to open the EU market and the economies of the candidates does not mean everything has been done. If the EU were a big NAFTA, the candidates would be at the end of the road. But the future members still have to prepare for a lot mor e, namely the full participation in the internal market and then the ultimate step in economic integration, namely membership in the euro area.

Experience has shown that it is in particular this last step that is most demanding. The deteriorating deficits in countries like Poland and Hungary show that the temptation is always there to distribute the fruits of reforms before they are ripe. Spain had a similar period during the mid-1990s when it let fiscal policy rip and was too slow to reform labour markets, with the result that unemployment soared to 20 %. Only the threat of exclusion from EMU forced a change in policy, whose results can still be seen today in fiscal accounts that are under control and improving labour markets. Poland, Hungary and some other countries are making similar mistakes today. Their labour market regulations have become tighter and budget deficit are ballooning as populist governments are distributing the benefits from EU membership before it has materialised.

The benefits from EU membership, and especially EMU membership, for the candidate countries are very substantial, even without the financial transfers. But to attain the real goal, rapid catch-up to EU levels of income per capita, will require more hard work especially in the area of labour markets and fiscal policy. These challenges will prove tricky as Spain found to its own cost when it stumbled during the mid-1990s. But the most likely outcome is still that the attraction of euro area membership will force sensible policies and then, if history is any guide, the new member states should be able to prosper once they have joined the largest market in the world.

For more analyses, visit the

CEPS webpage.