Putting a united Europe in sync

Transition: The union's 10 new members are finally political equals, but by no means economic ones.

May 02, 2004|By THE ECONOMIST

Yesterday, the expansion of the European Union from 15 to 25 members finally took place, with eight former Soviet-bloc countries and two Mediterranean islands joining the club.

They will all be members of equal standing. But it will take several decades more for them to become members of equal means: Average GDP per head in the 10 new countries is only 46 percent of the other 15. Joining the union is one thing; economic convergence another.

The first, the theory goes, leads to the second. But when the raffish new members of the EU eventually catch up with the old money of Western Europe, they will do so largely through their own efforts - because of what they do for themselves, not what European Union does for them. It is what EU membership inspires - political stability, economic openness, fiscal rectitude - not what it provides that counts.

What Brussels provides will, in any case, be miserly. The 2000-2006 EU budget spares just 21.7 billion in euros in regional aid for the 10 new countries combined. Compare that with the 56.2 billion in euros that Spain is getting. But the EU's new citizens should not bemoan this tight-fistedness too much. The EU's "cohesion" funds are not terribly effective. Liberal handouts of aid are at best a poor substitute for liberal movements of goods, capital and labor.

Goods and capital will move freely in the expanded EU. But labor will not, at least not initially. Migration is an issue for old and new members. The rich west fears the arrival on its streets of huddled masses from the east; the poor east fears the draining of its best and brightest to the west. If both fears are confirmed, the eastern countries will have no one left, quips Willem Buiter, chief economist of the European Bank for Reconstruction and Development.

Strict immigration

They will not empty, but some will undoubtedly leave. The 15 older members of the EU already play host to up to 1 million immigrants from the new countries. If permitted, 2 million to 3 million more could eventually join them, arriving at the rate of 200,000-300,000 a year, according to some forecasts. But permission may not be forthcoming. Germany, Austria and the Netherlands have all imposed work permits; Britain may follow suit.

The real prize of EU membership remains guaranteed access to an enormous single market for goods and capital. But that prize may now be a little stale. The EU's markets have long since opened to the new members, which have received much EU investment. For example, Poland, Hungary, the Czech Republic and Slovakia have, between them, captured a tenth or more of the older members import market. Foreign direct investment into these four countries amounted to 5.9 percent of their GDP from 1998 to 2002, according to J.P. Morgan - some five times higher than the level Portugal, Spain and Ireland saw before their joining.

For the latest entrants, formal membership of the EU is just the icing on a cake they have been eating for some time.

The new members' appeal to investors and importers is of the obvious and vulgar kind: labor costs a fraction of the EU average, and lower taxes, too. Of course, as the new entrants gain ground on the older members, their wage rates and/or their exchange rates will rise, blunting their competitiveness. The Acquis communautaire, about 80,000 pages of EU rules, may also weigh heavily on the lightly regulated economies of Central and Eastern Europe. Some of their tax breaks for investors will now be banned by EU law, for instance. The costs of implementing the Acquis will also add to Central Europe's fiscal problems. Averaging 5.6 percent of GDP in 2004, the region's deficits may eventually crowd investment out and force taxes up.

Moving fears

Many now hope that the demands of entry to the single currency - unlikely as it is before 2009 - will reimpose some discipline on Central Europe's budget-makers. According to the euro's rules, budget deficits must not exceed 3 percent of GDP. The current euro members are likely to apply those rules more rigorously to new entrants than they do to themselves.

The EU's 15 incumbents fear convergence almost as much as the new entrants aspire to it. Will the enlarged EU lift its new members up, they ask, or drag its old members down? In the front-line countries, the movement of capital - the relocation, indeed, of entire industries - is proving as controversial as the movement of people. The Germans and Austrians claim to hear the "giant sucking sound" that Ross Perot, a former presidential candidate, warned of when Mexico joined the North American Free Trade Agreement.

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