Accession tigers to punch above their economic weight
RICHARD CARTER
27.04.2004 @ 10:30 CET
EUOBSERVER / ENLARGEMENT - The President of the European Central Bank, Jean-Claude Trichet, is by no means a man given to issuing wild, optimistic statements.
His job is to express himself as neutrally as possible about economic events, giving nothing away that could startle the markets.
But he has surprised commentators by enthusiastically describing the accession of ten new countries on 1 May as an "absolutely fantastic" development in EU history, saying that the new member states would provide a "major contribution" to the EU economy and that "it is time to celebrate".
So, what has got the normally placid Mr Trichet so excited?
In a word, growth.
Tigers in the East
Although the combined economic weight of all ten accession countries is equivalent to a country the size of the Netherlands, the EU will soon inherit member states with growth rates that the sluggish EU 15 can only eye jealoulsy from the West.
Growth last year in the accession countries was over four times faster than the current EU 15. Whilst economic output increased in 'old Europe' by a sluggish 0.8 percent, the new member states stormed ahead by 3.6 percent.
And some new member states, especially the Baltic states, are already revelling in their reputation as "tigers", showing very fast growth. Estonia grew by 4.8 percent last year, Latvia by 7.5 percent and Lithuania by a staggering 8.9 percent.
Even the slower growing accession countries, such as the Czech Republic (2.9 percent) and Poland (3.7 percent) are relatively strong.
When comparing even these slower growth rates to Germany, the Netherlands or France - all of which have growth below zero or only just above - one can see why Mr Trichet seems to be rubbing his hands in anticipation.
Business drifting east
But aside from the impulse of higher growth from the new member states, what will the impact of enlargement be on business and the economy?
The main immediate effect should be to shake up the economies of 'old Europe' as it faces up to competition from more dynamic markets to the East and South.
Wages in accession countries tend to be much lower than in the current EU 15 - Poland's wage rate is approximately one tenth that of Germany. So companies will be more inclined to invest where they have to pay workers less.
Firms looking to invest in the EU will also take taxes into account. Currently, corporate tax levels in the accession countries are considerably lower than in the old EU 15.
According to a study by French bank Société Générale, there is a zero percent corporate tax burden in Estonia. Taxes in Lithuania and Cyprus amount to 15 percent and 19 percent in Latvia, Slovakia and Poland. In contrast, Germany levies 38.7 percent, France 35.4 percent, Spain 35 percent, Italy 34 percent and the UK 30 percent.
So old member states may find investment (and jobs) drift away from them, especially countries on the border, such as Germany.
In fact, this process has already started. In April, the German industrial giant Siemens announced it was relocating from Germany to Hungary where costs were 30 percent lower. And France is looking into ways it can persuade companies to stay on French soil.
Thus enlargement will have a double-edged impact on the economies of "old" and "new" Europe. The current EU 15 may suffer economic disadvantages in the short-term as companies profit from cheaper environments in the accession countries (which will of course benefit).
But in the long-run, economic giants such as France and Germany will be forced to take a long, hard look at their business environment and to raise their game due to the increased competition.
And this should be good news for everyone concerned.
Catching the US
The faster growing economies of the accession countries will undoubtedly provide a fillip for the EU's cherished goal of becoming "the most competitive, knowledge-based economy in the World by 2010".
This ambitious aim - known in Brussels jargon as the "Lisbon process" - is widely seen to be an abject failure as member states have broadly failed to live up to their promises to reform their economies.
But, according to a study by the World Economic Forum (WEF), the best accession countries are more competitive than the worst EU states and are likely to continue to improve. With the breath of fresh air provided by the newer member states, the Lisbon goals are still "acheivable", says the Chief Economist of the WEF, Augusto Lopez-Claros.
Race to the euro
Accession countries are clamouring for even closer economic integration with the EU by joining the single currency, the euro.
One of the quirkier consequences of enlargement is that overnight, there will be more EU members outisde the euro zone than inside.
But the race is on between the new member states to be the next entrants into the euro club.
All new member states are obliged by the accession treaty to join the single currency. There is no 'opt-out' such as that negotiated by the UK or Denmark. But before being able to join, they must pass certain economic criteria relating to their deficits, their inflation and their exchange rate.
The earliest possible date a country could in theory join is 2007 and here again, the Baltic states are ahead of the pack, along with Slovenia.
These countries all have deficits below the ceiling and will be first in line to join.
Long road to the euro
But the larger countries have some way to go.
Despite ambitious and optimistic targets for joining as soon as possible, countries such as Poland (with a deficit of 5.5 percent), the Czech Republic (5.5 percent) and Slovakia (3.9 percent) will have to take painful measures before they can join the eurozone club.
Both the International Monetary Fund (IMF) and the European Central Bank (ECB) have recently warned that joining the euro was dangerous if new member states have not prepared their economies properly.
But some of the Baltic tigers are heading full steam ahead towards economic union which will bring both dangers and opportunities.
Opportunities in that it should make trade between 'old Europe' and 'new Europe' even easier and dangers in that the new member states will lose control of setting their interest rates and that their joining will make the eurozone economies even more different than they already are.
Not all rosy
So, the new member states will provide faster growth, a boost to competitiveness, much-needed competition for the old economies and a more dynamic business environment. Is it all good news?
Unfortunately not, in fact there are several pitfalls and dangers lying in wait for the new member states and for the EU as a whole.
Firstly, although the growth issue is of course positive, it should be emphasised that these countries are coming from a very low starting point and that much work needs to be done to catch up with the rest of the EU.
The Chief Economist of the European Bank for Reconstruction and Development (EBRD), Willem Buiten, recently predicted that it would take 40 years for Poland to catch up with the EU average in terms of gross domestic product (GDP). The others would take between 15 and 30 years, said Mr Buiten.
So growth is one thing, but the EU should not lose sight of the fact that many of the accession countries are very poor with lower living standards and it will be a while until they are economically strong enough to make a real impact.
Rocky road to the euro
In their rush to join the euro - seen as a stable and strong currency in the accession countries - new member states will have to take painful measures to reduce their deficits.
In order to do this, they will have to either raise taxes or cut public spending. This should, in theory, result in lower growth and higher unemployment - already very high in some accession countries.
So, there will be some pain before any gain resulting from joining the euro zone.
And many citizens in the new member states are convinced that prices for goods will increase when their country joins the EU.
There is even anecdotal evidence that Estonians are hording salt and sugar worried that prices will rocket after 1 May. A kilogram of sugar, which costs around 0.4 euro cents now, will cost approximately 0.7-0.9 euro cents after enlargement after EU excise taxes are levied.
But when all is taken into account, the most important thing is that enlargement will create a single market of 450 million people. That means 450 million consumers spending in shops, 450 million potential workers driving forward economic growth and 450 million people indirectly working towards Europe's drive to be the best economy in the world.
And that is likely to be good news both for Mr Trichet and for finance ministers around the new enlarged EU.
