Why the Enlargement of EU is Beneficial for the Economy of the Member States and EU as a whole - Essay Example

Policy Paper: Why the Enlargement of EU is Beneficial for the Economy of the Member s and EU as a whole This policy paper is addressed to the European Commissioner. It sets out the economic arguments for the enlargement of the European Union. It recommends the European commission to support the enlargement of the EU in favour of better health of the economy of each member state and the EU as a whole. The background to enlargement is explained in the first section. The reasons for supporting this policy position are explained in the next section. The recommendations for the future course of action for the EC are given in the last section. 2. Background to European Union Enlargement 2.1 The European Union started as a six nation economic community in 1958. On January 01, 2007 in total membership of the bloc were 25 member states. The last two members to join were Bulgaria and Romania. These two are the poorest members of EU. They comprise less than 1% off its GDP while contributing 6% of the EU’s population. But these economies are growing fast, at about 5-7% per year. (BBC News) Croatia and the Former Yugoslav Republic of Macedonia have received “candidate” status as a precursor of membership. Turkey also started membership talks in October, 2005. Albania, Bosnia, Kosovo, Montenegro and Serbia are also expected to start discussions for membership. But these countries will have to face increasing opposition to enlargement of EU from some member states. The major opposition comes from five member states – Austrian, France, Germany, Luxembourg and United Kingdom. 2.2 There was serious opposition when the idea of a European union was first broached. The main arguments offered against enlargement were: it would lead to mass immigration from poorer countries to the richer nations, with the result that poor countries would take away jobs from the richer ones and companies also would relocate to countries which offer lower labour costs and lower social protection; the poor countries would require huge subsidies from the richer member states. But several arguments were also given in favour of the enlargement. Most of these arguments have been borne out by fact, giving support to the policy of enlargement. The main economic argument in favour of enlargement is that access to more countries would stimulate and boost long term dynamic economic growth in the relatively poor economies. There would be gains from trade and investment benefiting the EU member states, along with an expansion of the internal market by nearly 500 million consumers offering major growth opportunities in all the member states. It is estimated that there would be an increase in the economic growth to the tune of €60-80 billion and expansion of 300,000 new jobs as a result of enlargement. (“The Economic and Business Benefits of Enlargement,” 2001) 3. Factors of Growth 3.1 The economic gains are expected to be driven by four factors: 1. An increase in foreign direct investment and capital flows among the member states, due to a common political and regulatory framework and a level playing field for all 27 or more economies. 2. An increase in immigration would, contrary to expectations, drive economic growth, and the cheaper labour which will become available to the richer European nations would help in competing against low labour cost countries like India or China. The richer member states would be gaining more from being members of a single market than it costs them in transfers to the poorer countries. 3. An increase in business confidence across all the countries of the European Union would be helpful in rising trading and skills standards, improving productivity, technology transfers, modernizing plant and equipment and providing with better environment and social standards. 4. The European Union would increase confidence in the political and economic futures of its member states, and require legal and administrative reform, and stable laws, regulations and standards with better implementation. This enables companies to make long term decisions on strategy and investment. 5. There would be more international competitiveness in both new and old member states. 6. There would be an increase in cross border trade among the new and old member states with lowering of trade barriers among member states. (“The Economic and Business Benefits of Enlargement,” May 2001) 3.2 There are certain economic conditions, apart from other criteria for membership, which have to be met before member states are allowed into the European Union. They should have a functioning market economy, and the capacity to cope with competitive pressures in the Union’s single market. The inflation should be under control in all new member states before they can join. In accordance with the provisions of the Maastricht Treaty, all the members of the EU are eligible to join the Economic and Monetary Union (EMU) as well and the European single currency, the Euro. They have to meet a number of conditions before they can join the Euro. These conditions are: (a) Maastricht convergence criteria of fiscal stability; (b) Central bank independence; (c) Low inflation and interest rates; (d) Monetary stability of their currencies under the Exchange Rate Mechanism II (ERM II) for a minimum period of two years. (“Enlargement and the Euro,” 2004) 3.3 Till date, 12 countries have adopted the single common currency Euro. UK, Sweden and Denmark have decided to stay out of the Euro zone for the moment. 4. Reasons for Supporting Enlargement: Literature Review 4.1 Many studies have been undertaken to seek out the effect of an enlargement of the European Union. Economists have studied the effect that EU has had on the economics of the member states since their joining the Union. A mass of literature has found reasons to further continue the process of enlargement of the Union, to all European states, despite apprehensions of a loss of welfare in the richer states due to a shift in trade and welfare funds to the poorer European states which join the union. Most of the apprehensions have been found to be false and contrary to fact. The Union has been found to be beneficial to all member states, whether rich or poor. The reasons for this scenario are explained as under. (a) An increase in FDI and capital flows among member states of the EU, leading to higher economic growth in all countries. A study by Michal Brzozowski in Nov. 2003, has analyzed the impact of a reduction in an exchange rate uncertainty, as a result of EMU accession, on the intensity of the FDI inflow into candidate countries. (Brzozowski, 2003) The author has found that nominal exchanges rate uncertainty and volatility hampers FDI inflows in accession countries, and the adoption of a single currency will exert a positive influence on FDI inflows in such countries. It has been found that FDI plays a very important role in the new European countries which are converting from the centrally planned economies of Central and Eastern Europe. It encourages technology transfer which is important and stimulating economic growth. He has found that the access channel into the EU raises the credit ratings of the accession countries and increases the attractiveness of the countries where FDI is concerned. The first condition of EU membership is the placing of monetary and fiscal policy constraints in the new member states. This reduces the exchange rate variability and hence the investment conditions in candidate countries after the EMU enlargement. (Brzozowski, 2003) The author conducted an econometric analysis of the influence of exchange rate volatility and exchange rate uncertainty on the FBI inflows in transition countries of Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia. He found that exchange rate volatility has a significant negative impact on FDI inflows in transition countries, but he also found that exchange rate uncertainty is the main barrier to FDI inflows in transition countries. His study provides firm evidence that the exchange rate uncertainty has a detrimental effect on the FDI inflows into the eight accession countries. The impact of exchange rate volatility was found to be negligible in both accession and transition countries. The adoption of Euro rules out exchange rate uncertainty and volatility, and hence, it brings about an intensification of FDI inflows originating in the EMU member states. The author explains that fixing of the exchange rate will directly affect and stimulate the FDI inflow into the accession countries. The indirect channel through which fixing of exchange rate encourages foreign investors is through the lowering of trade costs, and raising income and market size within EMU. (Brzozowski, 2003) He concluded that the exchange rate stability would enhance FDI, which will reinforce the positive impact of GDP expansion and overall risk reduction as a result of the accession into the EU. The author calculated that the highest FDI inflows would be into the host accession countries that receive the bulk of long term capital from the Euro area. His calculations are shown in the following table: The author’s calculations show that the stock of FDI originating from the EMU members account for three fourths of the total FDI stock in half of the eight accession countries. When exchange rate uncertainty is eliminated as a consequence of euro adoption then there is an intensification of FDI inflows originated in the EMU member states to the accession countries. The flow of FDI into the accession countries “reinforces the positive impact of GDP expansion overall risk reduction due to accession into the EU.” (Brzozowski, 2003) Jacques Pelkmans and Jean-Pierre Casey in a BEEP Briefing paper have explored the external economic implications of EU enlargement after the first two phases of enlargement in 1973 and 1986 and a further enlargement of candidates for membership after that. The authors have found that FDI flows were quite strong during the second half of the nineteen nineties. They refer to a study by Brenton and di Mauro (1999) which shows that the level of FDI in the more advanced candidates was greater than that signaled by the actual level of income, market size and relative proximity. (BEEP, 8) Bevan & Estrin (2000) have shown that an increase in FDI boosts credit ratings with a lag, and in turn it boosts FDI again. The expectation of good long run catch-up growth also acts as a major stimulus for FDI, which will serve as self fulfilling for that economic growth. They say that business attaches significance to actual, not possible, EU membership. (Pelkmans & Casey, 9) The businesses attach more credibility to the EU as an enforcer and stabilizer of the regime change. So, they wish to see the approval of EU. The authors explained that Spain and Portugal experienced an explosion in FDI inflows for four years after accession, before returning to the 1986 levels. This was mainly explained to have been due to the reason of productivity and low long term interest rates after entering the European Union. An additional argument was the stability of market access and of the currencies inside central Europe. They explain that FDI responds positively to such regional facilitation of market access. (Pelkmans & Casey, 9) According to the 2002 World Investment Report there was a fall of about 59% in world FDI flows to developed destinations in 2001, and that about 14% of the developing countries. But they found that the inflows to Central Europe remained stable at plus 2%, which may be due to the confidence of businesses in enlargement of the EU. A more concrete increase in FDI flows were predicted to be seen after 2004 enlargement. (b) The Industrial trade effects and Agricultural trade affects of enlargement are positive, leading to a positive impact on the economic growth of the accession countries. Enlargement is seen as a change from an industrial free trade area to a customs union. The entry of the candidates into the internal market produces additional potential benefits. Since there is not much difference in the tariff differentials in a free trade area and a low-external-Tariff customs union, so this will not produce large changes. The major changes will be produced by a deepening of specialization and vertical intra-industry trade stimulated by FDI and sub-contracting. This would be the main factors for the positive effects of enlargement for third countries. This is borne out by earlier experience. Kaminsky in 2001 found that up to 1994 there was a massive shift towards trade with the EU. Afterwards, the initial dominance of labour intensive final goods went down and the shadow of technology and skilled labour intensive products increased from 37% in 1993 to 50% in 1997. (Pelkmans & Casey, 5) Nielson 2001 also found quality of products at a high level of desegregation but it is still behind that of EU. It has found that their e trade dominated the east west industrial trade, where CEECs supplied the low unit cost goods. The import of capital goods by central Europe tripled between 1993 and 1998. This combined with an increase in FDI, points towards increasing restructuring and upgrading. Significant productivity increases in manufacturing were found by Landesmann (2003) between and 1993 and 2000 (at 5% and 15% annually, except for Bulgaria). (Pelkmans & Casey, 6) He also found much higher output growth rates in the medium-high tech sectors and an increase in the shadow of high-skill-intensive goods in the exports of all CEECs to the EU from 1995 to 2000. The candidates were expected to increase their exports to the EU by 13% -14%. The short run positive industrial effects resulted from a reduction in trade protection. In the case of Europe, trade diversion is not expected. The positive effect would be just from the improvement in market access for U.S. and Japan and the others. Enlargement would actually be trade creating in the case of the car industry. An econometric analysis by Pilar fajarnes and M. Thea Sinclair, has shown that “enlargement does not exert a negative pressure on the member countries’ trade with non preferred entities such as the Latin American countries.” (Fajarnes & Sinclair, 1997) They have examined Spain’s trade relations with the Latin American countries after the accession of Spain to the European Union. They arrived at the conclusion that trade was not adversely affected by enlargement. An exhaustive study has been conducted on the concerns for the negative economic impact of enlargement for the agricultural sector. It has been deduced that, contrary to expectations, the EU enlargement will not lead to a significant damage in the short to medium-run, in spite of the expansion of CAP eastwards. This has been concluded from the extreme inefficiency found in the farming sector in the CEECs. The farms are found to be completely uncompetitive. The reasons are that they cannot benefit from scale economies because of the high extent of fragmentation; they cannot benefit from technological progress as well since they gets very little investment and are further being decapitalized; they also cannot benefit from technical efficiency gains because of the sedentary peasant farming and slow consolidation; lastly, the product quality is quite low leading to limited export opportunities. Any effort to increase competitiveness and efficiency would require a half decade or more. So, there is no need to fear the negative economic impact of the extension of CAP. The share of agriculture in GDP and employment and the population involved in agriculture, in the CEECs, are shown in Table 1. It can be seen in Table 1. that labour productivity in the agricultural sector is quite low. There is a large surplus of agricultural labour. This can be seen from a comparison of the percentage of labour force in agriculture and the percent of the return to GDP. It can be seen that only 10% to 20% of GDP is contributed by the agricultural sector while 15-30% of the labour force is employed in agriculture. Thus the productivity is very low. It is more a refuge of the unemployed. There is intense fragmentation of the farming sector. And there is an unwillingness to remove structural problems among the farmers of the accession countries’ peasants in response to economic change. (Pelkmans & Casey, 11) Owing to high protection distorting agricultural trade before accession, and as a result of lowering of the protection after accession to the EU, the trade balance in CEEC agriculture in contrast with EU is negative and deteriorating. All of this leads to the conclusion that the concerns about trade diversion in agriculture after accession are only relevant in the long run, in the short run. And this is due to the low efficiency of CEEC agricultural production, real exchange rate at the station and differences in competitive advantage. . The EU accession will help the growth prospects of the candidate countries and in turn increase the exhibit demand for imports, which in turn will help in mitigating the loss of market share through trade division. (Pelkmans & Casey, 16) The EU enlargement would be beneficial to both the EU members as well as the new candidate countries and for the third countries as well. Another article by “Agra Europe” in April, 2004, states that opportunities are more important than the threats from the enlargement of the European Union. A case has been made of Germany, whose exports have grown rapidly after accession of the ten new EU member states. The strong economic growth in some of these countries will also lead to an increased demand for higher added value goods, according to the German farmers union (DBV). The UK Farmers Union (NFU) has also seen a rising demand for premium products- poultry meat, cheese and luxury dairy products – due to growing prosperity of the new member states. ("Enlargement seen as opportunity, not threat,” 2004) (c) Migration of labour to the richer countries would help in increasing the economic growth of the European Union countries as a whole. In an article in Business Review (April, 2007), Nigel Watson has explained how the migration from the poorer East European countries could be beneficial for the EU member states. He says that it might be a good policy to encourage migration rather than restrict it. He gives five arguments in favour of migration for the British economy. 1. Migration would help in easing skills shortages. He says that skills shortages in a rapidly growing market could be a real problem for businesses. An example is that of the construction industry in Scotland. The industry itself is booming but according to the Scottish Chambers of Commerce,October 2006, there is a shortage of skilled construction workers. This is dampening the profitability of the construction industry and growth of the Scottish economy. He says that the Bolivian and Romanian migrants could help ease this shortage with the right skills just as migrants from Poland have already done. Another area which could potentially benefit from migration is that of clubs and bars. With the easing of licensing laws that is a shortage of Bar workers. Britons are not interested in working long hours in bars. Migrants from other countries could ease this shortage. This is not stealing of jobs, but rather an easing of skill shortages. He quotes CBI Director, Sir Digby Jones, in saying that every 1% increase in migration has brought about a 1.5% increase in national wealth. 2. Migration leads to lower wages and increased profits. Migration increases the supply of labour relative to the demand for labour. This reduces wage rates for the labour intensive industries and hence the wage bill. 3. Migration also helps in lowering interest rates. Lower wage rates ease the upward pressure on prices and hence reduce inflation. This helps lower the interest rates and makes firms internationally competitive, and stimulates the consumer boom through cheap borrowing. 4. Migration would also help in increasing taxation revenue. Contrary to the expectations that migrants would leech the welfare benefits, it has been found that majority of migrants to the UK pay taxes. A negligible number claimed welfare benefits. The taxes paid increase the income of the government to spend on public services and increases the quality of life in the host countries. 5. Migration enhances marketing opportunities. Migration creates new gaps for products and services. This has been witnessed in case of 300,000 Poles living in UK, who have created an opportunity for sale of polish beers in its pubs. 6. Migration helps in creating a diverse workforce. This diversity helps in creating a dynamic organization, with the result that a more flexible and adaptable organization is created, and conservatives are challenged. (Watson, 2007) In an article in Newsweek International in September 2006, Foroohar, Glain, and Theil have contended that the economies of the Euro zone have experienced the strongest growth in six years in 2005. The euro zone grew at 1% last quarter and outperformed the United States, Britain and Japan. It is expected to grow by 2.5% in 2006. France and Germany, in particular, are creating jobs faster than United States. This is the first time that European consumers are fuelling growth, apart from industry. (Foroohar, Glain & Theil, 2006) 5. Conclusion 5.1 The enlargement of the European Union will be definitely beneficial for all the member states and other third countries as well. As can be seen from the above arguments, enlargement of the European Union leads to a better stability in exchange rates and prices, which in turn stimulates FDI inflows into the member states stimulating growth and investment. A higher specialization and up gradation can be seen in the new member states after the accession to EU. The industrial and agricultural trade effects are positive for the countries after accession. The migration of labour from the poorer to the richer countries also helps in fuelling consumer demand, mitigating skills shortages, increasing revenue through taxation, and building a dynamic workforce. 6. Recommendations 1. The European Commission should make increasing efforts to enlarge the European Union area and the economic and monetary union among the EU members. 2. Migration should not be restricted. Instead there should be increased efforts to facilitate and help migrants to achieve skills and work in other member states. 3. There should be an increased effort to bring about agricultural reforms in the farming sector in the new member states and candidates for membership. The industrial sector should also be reformed to provide an equitable playing field for all countries of the EU. 4. Cross border trade should be encouraged through better tariffs and rules and regulations. 5. Most important there should be an effort to reduce the unfounded concerns of the public arising from EU’s enlargement. References Watson, Nigel. "The business implications of migration: Nigel Watson examines the consequences for UK firms of increased migration resulting from the enlargement of the European Union.(External Influences)." Business Review (UK) 13.4 (April 2007): 20(3). British Council Journals Database. Thomson Gale. Fajarnes, Pilar, and M. Thea Sinclair. "Trade effects of European Union Enlargement: an ex post model of trade between Spain and Latin America." International Review of Applied Economics 11.n1 (Jan 1997): 65(25). British Council Journals Database. Thomson Gale. "Enlargement seen as opportunity, not threat.(Germany/UK)." Agra Europe 2103 (April 30, 2004): N/1(1). British Council Journals Database. Thomson Gale. Foroohar, Rana, Stephen Glain, and Stefan Theil. "A Reason To Smile; In a minor miracle, the euro zone is growing faster and creating more jobs than America." Newsweek International (Sept 4, 2006): NA. British Council Journals Database. Thomson Gale. Pelkmans, Jacques and Casey, Jean-Pierre. “EU Enlargement: External Economic Implications.” BEEP briefing no. 4. April 2003 Brzozowski, Michał. “Exchange Rate Variability and Foreign Direct Investment – Consequences of EMU Enlargement.” Studies & Analyses. CASE – Center for Social and Economic Research, Warsaw 2003. “The Economic and Business Benefits of Enlargement.” Extract from position paper and analysis of the European Round Table, May 2001. “Enlargement and the Euro.” 17 September 2004. www.euractive.com. [Online] Egger, Philippe. "Decent work and competitiveness: labour dimensions of accession to the European Union." International Labour Review 142.1 (Spring 2003): 5(24). British Council Journals Database. Thomson Gale. BBC News. “Q&A: EU Enlargement.” [Online]http://newsvote.bbc.co.uk/mpapps/pagetools/print/news.bbc.co.uk/2/hi/europe/2266385.stm] Read More