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Radical measure

in Opinion

If the EU-15 and recent accession countries are to prosper, an extreme reformulation of policy in core countries is required

Now that the champagne corks have popped and the fireworks displays have fizzled, it’s time to reflect soberly on some of the economic problems posed by a 25-member European Union.

I have just returned from an economics conference at the University of Poznan where these matters were hotly debated (and not for the first time, one might add!). Will enlargement bring new dynamism to Europe’s economies, or on the contrary, will its budgetary cost slow us down? Will the 10 new members catch up like Spain and Portugal, or will the income gap between the rich and poor countries grow? Should the new countries join the euro immediately or should they be asked to adhere to an extended timetable of convergence?

The short answer is that we don’t know!

What the EU-15 gain from accession is reasonably clear: first, a pool of cheap, well-educated labor; and second, a collection of low-tax countries where EU firms can relocate without difficulty. However, the current round of accession is quite unlike those of 1995 (Austria, Finland, Sweden) or 1986 (Portugal, Spain). Broadly, the EU’s population has grown by 20 percent, but its combined gross domestic product (GDP) by only 9 percent. The combined economic weight of the 10 new members is equivalent to the Netherlands!

Moreover, the accession countries are poorer — their per-capita GDP is only half that of the EU-15. Accession will double Europe’s farm population; it is estimated that by 2013 Brussels will need to find an extra 5 billion euros ($6 billion/160 billion Kc) a year to subsidize agriculture in the new states — an effort that (it is hoped) may finally kill off the Common Agricultural Policy.

Although extra spending is foreseen on accession countries’ infrastructures, the amount falls far short of what is needed to achieve rapid modernization. Polish living standards will take nearly 60 years to catch up to the average of the EU-15, according to the rosiest forecasts prepared by The Economist Intelligence Unit in London. How long will it take the Baltic States to catch up, where living standards are only one-third of the EU-15 average?

Eight of the 10 accession states are from the former Eastern bloc, the so-called “new Europeans” first identified by U.S. Defense Secretary Donald Rumsfeld. Although there is much enthusiasm for joining, there is also much legitimate concern. After all, these countries were promised a glorious future upon abandoning “socialism” nearly 15 years ago. Instead, the transition to a market economy proved traumatic: Per-capita income fell and unemployment surged. Since 1995, the trend in most countries has sharply reversed. But it is only today that Poland, Hungary and the Czech Republic, the largest accession economies, are at last returning to their 1989 level of per-capita income.

Understandably, these countries do not want to be put under stringent tutelage in the style of the International Monetary Fund again. But that is what the Maastricht rules require. To join the eurozone, as all new entrants must, strict targets must be met with respect to each country’s budget deficit, level of indebtedness, level of inflation, exchange-rate regime and so on. Most recently, both Hungary and Poland have experienced serious pain in attempting to tighten their belts, and Poland is currently embroiled in a deep political crisis. This has led some economists, most prominently France’s Charles Wyplosz, to call for a change in the rules, lest the Central and Eastern European countries be forced into a new recession.

Czech particularism

At first sight, the Czech Republic appears on course for a painless economic entry to the rich-folks’ club of the EU-15. Since the economic crisis of 1997, the country has enjoyed relatively buoyant growth, high levels of foreign direct investment, favorable interest rates, low inflation and a strong EU trading relationship, particularly with Germany. Czech farmers may be unhappy that they will receive only 25 percent of the subsidy level enjoyed by their EU-15 counterparts, but the withdrawal of such featherbedding is probably a blessing.

This bright picture is spoiled by only two factors: unemployment and the government’s current deficit. Even with 3 percent growth during the past five years, unemployment has remained a steady 7-8 percent. More worrisome, the Czech government’s deficit has been growing and stands at 6 percent of GDP (2003 estimate), as mirrored by a growing external current account deficit.

Granted, optimists will argue that some wiggle room is available because public-sector borrowing is only 27 percent of GDP, but the point is that this borrowing is forecast to rise steadily. Fiscal reform has so far proved an intractable problem. Under these conditions, it appears inevitable that the commission will force major spending cuts on the Czech government and that these will fall largely on social support programs. Such cuts are deflationary and undermine growth and employment. Moreover, if growth falters under the Maastricht rules, the strong crown may be forced downward. The Central Bank, quite understandably, appears reluctant to join the euro too quickly.

The four Visegrad countries are already familiar with exchange-rate fluctuations. Fluctuations have proved greater that those experienced by core EU countries in the exchange-rate mechanism (ERM) of the 1990s. Within a few days of the May 1 entry date, Cyprus, Estonia, Lithuania and Slovenia announced plans to adopt the euro by late 2007. Brussels is not keen, arguing that only by spending several years, two at least, within the new ERM will countries converge sufficiently with the eurozone to qualify for membership. Is this a sensible argument?

It is not, according to professor Barry Eichengreen of the University of California at Berkeley. Prolonged membership in the ERM only increases the probability of a currency suffering a speculative attack of the sort that Britain experienced in 1992 at a cost of nearly $3 billion (78 billion Kc) in reserves.

A difficult road ahead

There is no guarantee that the accession states will find membership in the EU a magic potion to remedy all economic ills; indeed, the opposite seems more likely. While entry may prove a blessing for the more-advanced accession countries (including the Czech Republic), the poorer countries may fall even further behind the EU-15, according to projections recently published by the Centre Economique de l’Universite de Paris Nord.

Overly tight fiscal and monetary policies have nearly paralyzed the economies of Germany, France and Italy. Thus, EU generosity is in short supply. The Dutch finance minister’s opposition to sharing the 2004 EU budget surplus with the 10 new members is one example of the new miserliness of the rich. In addition, there’s an ominous possibility that the Maastricht budget deficit rules will be applied to the accession countries immediately.

In short, a radical reformulation of macro-policy in the core eurozone countries is urgently required if the EU-15 and the 10 accession countries are to prosper together.


The writer is a professor of economics at the Institute of Social Studies, The Hague.

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