What are the Economic Arguments for Further Enlargement of European Union - Essay Example

Policy Paper What are the Economic Arguments for further Enlargement of European Union of May2007 Table of Contents 1. Executive Summary 3 1.2 Policy 3 2 Introduction 3 3. Arguments for European Union Expansion: 4 3.1 Opportunities to both Old and New Member States: 4 3.1.1 More trade 4 3.1.2 Increased Foreign Direct Investment (FDI) 6 3.1.3 More Dynamic Financial System 7 3.2 Opportunities for New Member States: 7 3.2.1 Economic Growth: 7 3.2.2 Financial Aid from Old State Members 8 3.2.3 Agriculture success 9 3.2.4 Implementation of Economy Legislation 10 3.3 Opportunities for Old Member States: 11 3.3.1 Economic Growth 11 3.4 Reasons why these arguments were accepted 11 4. Arguments against European Union Expansion: 11 4.1 Fears of relocation of Activity and Job Losses 12 4.2 Limited migration 13 4.3 Unemployment and Human Resource Development 14 4.4 Reason why arguments were rejected 15 5. Conclusion 15 6. Bibliography 16 1. Executive Summary: This policy paper is for the attention of the European Union Economic and Monetary Affairs Commissioner, and is designed to explore whether the European Union should support further expansion of the European Union from the economic point of view. 1.2 Policy: This study advises the European Union (EU) Economic and Monetary Affairs Commissioner to support further expansion of the European Union on economic grounds. Further expansion of the EU will increase economic growth and productivity, reduce costs, increase trade and increase return on Foreign Direct Investment (FDI) for both old and new member states of the EU to better prepare for global competition. EU commission should take direct steps to (a) convince member states of the economic benefits from expansion of the EU (b) encourage capable member states to help candidate states meet the monetary and fiscal requirements to join the EU. 2. Introduction: After the collapse of the Soviet Union, Eastward extension of Europe offers Europeans their best chance in 500 years to unite in peace. It is now possible to achieve the dream of living and working anywhere in Europe using one currency under one rule. The EU was enlarged five times with the largest enlargement on May 1, 2004 to include ten new states. The accession mainly had a strategic dimension towards reunification of Europe. In order to join the European Union, a state must fulfill specific economic, fiscal and political conditions. Each member state must agree to accession of any enlargement. Economic gains from the expansion of the EU were surrounded by concerns from economic situation in new member states. Marginal economic gains were expected for old member states with newer states expected to have large economic growth to catch up with older states. The European commission gives advice to EU. The European commission includes the European Commissioner for economics and finance whose job is to maintain a strong European economy over the coming years. Her recent efforts range from removing trade barriers to public awareness of the benefits of single European market. The single market offers EU citizens to live, work, study and do business anywhere in the EU while enjoying a wide choice of competitively priced goods and services. The following sections present the arguments for and against the advice provided in this report. 3. Arguments for European Union Expansion: 3.1 Opportunities to both Old and New Member States: 3.1.1 More trade Accession to EU obligates joining member states to remove their trade barriers and open their market for free trade. A Free Trade Zone is established throughout EU member states. Lowering trade barriers leads to increased bilateral trade among member states. Old member states still run a large trade surplus with new member states. Comparative advantage specialize new member states in low- and medium technology using labour intensively, while trade of the older member states is more specialised in products requiring higher skill and capital intensity as shown in figure 1 and 2. Figure 1: Comparative Advantage of new member states1 Figure 2: Comparative Advantage of old member states2 New member states have been running large trade deficits. Foreign direct investment from older member states have helped decrease trade deficit to about 3% of GDP by 2005 (European Commission 2006c). 3.1.2 Increased Foreign Direct Investment (FDI) Since the 1990s, the presence of foreign firms in the new member states has grown rapidly. Foreign direct investment (FDI) has reached over 190 billion in 2004. Old Member States are the main investor. Germany is the top investor in the Czech Republic, Hungary, Poland and Slovakia while the Nordic countries are the main investors in the three Baltic States. The largest part of FDI (55%) is invested in services, followed by manufacturing (37%) (European Commission 2006c). FDI in new member states is shown in figure 3. Figure 3: FDI in new member states3 3.1.3 More Dynamic Financial System The banking crisis in the early 1990s, have lead new member states to develop a stable financial environment that is capable to withstand major financial turbulence. Although, most new member states maintain a small financial system compared to old member states. Recent surge in FDI have lead to rapid expansion in new member states financial systems. The one market enhanced competition within banking services will result in cheaper loans and interest rates closer to older states interest margins. Accession has offered old member states financial service providers' new opportunities for growth. Many banks from old member states invest their assets in other member states. 3.2 Opportunities for New Member States: In addition to the political and strategic stability provided by the accession to the EU, newcomers are offered the benefits of a large single market. Their market will adopt European competition rules and market regulations. The following economic gains are expected: 3.2.1 Economic Growth: During the period 1997-2005, economic growth has become faster in new Member States (3% per year) as shown in table 1. Faster economic growth has lowered national deficit to acceptable levels and increase average income in new member states has risen from 44% of the old member state in 1997 to 50% in 2005. Countries with the lowest per-capita incomes grow the fastest. Strong economic performance has stabilized the labour market after a long period of decline (European Commission 2006c). Table 1: Growth and GDP of EU-15 & EU-104 3.2.2 Financial Aid from Old State Members In the last 15 years, 28 billion (2% of old member state GDP in 2005) has been transferred to new member states for preparation for accession (European Commission 2006c). This reflects the commitment of older richer Member States to help their newer poorer states. Under the new financial framework 2007-2013, net transfers to the new Member States are expected to triple. EU payments to new member states are shown in figure 4. Figure 4: EU Payments to Recently Acceded Countries 3.2.3 Agriculture success The Common Agricultural Policy (CAP) plays a key role in EU budget. The enlargement process has increased the EU's agricultural area by (25%), production (10%) and number of farmers (50%). Agricultural productivity in the new Member States is considerably lower than in the EU-15 and the income gap correspondingly large. However, the situation in agriculture is quite heterogeneous in both the old and new Member States. Some of the new Member States have high agricultural employment shares associated with subsistence-like farming (19% in Poland in 2005, 16% in Lithuania and 12.5% in Latvia), a situation similar to that of Greece and Portugal at the beginning of the nineties. Countries such as Slovakia and the Czech Republic, on the other hand, have a rather low share of agricultural employment (about 4%), which is already similar to the average level in the old Member States. Flow of FDI and EU support have modernized agriculture and raised farmer's income by 70% on average between 1999/2003 and 2004/2005. During the period 1999-2004, agricultural trade doubled both within new member state and between old and new member states. Modernization in agriculture caused trade in processed products to increase during the same period. However, with annual income per work unit in new member states is 16% of income in old member states in 2004/2005, there is ample room for growth in the agriculture section of new member states. 3.2.4 Implementation of Economy Legislation Governments of new member states are obliged to reform politically and economically. Under reform, people of new member states would enjoy better democracy and respect for human rights and minorities. New Member States are expected to undertaken extensive reforms to modernise to create a more dynamic market. New member states are better than old member states at transposing EU law. New member states have reformed the way their economies are regulated. They adopted modern regulatory frameworks in the areas of finance, company law, intellectual property thus creating better environment for business to grow. Economic reforms are changing financial systems driving inflation and interest rates in the new Member States have come closer to those of the older member states reflecting credibility of economic policy. 3.3 Opportunities for Old Member States: 3.3.1 Economic Growth Newly added member states provide new opportunities for firms in the older member states, thus helping them stay competitive in the face of challenging global environment. Consumers across the EU would benefit from the wider choice of products. Adding several faster-growing countries to the single market should increase overall growth. 3.4 Reasons why these arguments were accepted The expected gains from expansion of the EU have been proved a success by economic evaluation of statistical economic data presented by (European Commission 2006c). Both old and new member states would benefit from the expansion of EU. 4. Arguments against European Union Expansion: Some old member states are unwilling to make the necessary changes to enlarge the EU. In difficult economic times many will oppose both the cuts in farm prices and the redistribution of regional aid proposed by the commission (Sobek 2002). Relative poverty of the Central and Eastern Europeans will impose unpopular extra demands on EU spending and the budget for regional aid. Consequences of accession of poorer member states such as migration flows, relocation of activity, downward pressure on wages in the old Member States and adjustment costs in the new Member States raised concerns to policy makers as described in the coming sections: 4.1 Fears of relocation of Activity and Job Losses FDI from old member states in the new Member States has raised concerns about relocation of activities and job losses in older states. Evidence indicates that new member states receive only a minor part of overall FDI outflows of older member states, in 2004 Outflows to new Member States was 4% against a 53% share for old member states and 12% share for the US. In addition, a large part of the FDI by old member states occurred in the privatization programs of new member states to capture fast-growing markets and does not involve the substitution of activities previously carried out in the home country (European Commission 2006c). Germany and Austria, the largest investors' old member states, such investment has lead over the past fifteen years to a lower employment creation of 0.3-0.7%, which is a very small percentage (European Commission 2006c). Moreover, outsourcing part of the production process to the new Member States has allowed firms in older member states to higher returns strengthening their competitive position leading to a net favourable impact on employment. Investment decisions depend significantly on the tax system, including labour taxation and the overall transparency and integration of the corporate tax system. Taxes paid by EU companies have been fairly stable in both old and new Member States. 4.2 Limited migration Upon removal of barriers to trade, capital movements have been freed within the EU. Free movement of persons and workers is the most sensitive issues because of the fear of increased job and wage competition. Therefore, the 2003 Accession Treaty granted derogation from the principle of the free movement of workers, by allowing national restrictions on workers from new Member States. A three phases process was suggested to transition to free labor movements within the EU. During, the first phase, Ireland, Sweden and the UK decided not to apply restrictions. Other old member states maintained a work-permit regime combined with a quota system. On the other hand new member states opened their labour market to each other. During the second phase, some old member states have decided to lift restrictions on labour movements while others such as France, Italy, Belgium and the Netherlands decided to alleviate them. During the first phase of labour movement restrictions, migratory from new member states were minimal, even to countries with no restrictions. Migration from third countries is greater than intra-EU labor movements. In 2005, Austria and Germany, the two countries with the highest shares of non-nationals in the working population (10%), only a small share (1.5%) comes from new member states, while a larger share (7%) are non-EU nationals. Ireland holds the largest share of new member states workers (2%) against a total of (8%) of non-national workers (European Commission 2006c). Member States without restrictions for new member states (e.g. Ireland and the United Kingdom) experience better employment performance. Labour restrictions are not justified by economic theory as labour flows are determined by demand and supply. Labour movement restrictions may cause downward pressure on wages as immigrants accept work below their presumed qualification. 4.3 Unemployment and Human Resource Development During the 1990s, central and eastern European Member States experienced sharp declines in employment. Unemployment rate in older member states (13%) is currently higher than in older member states (5%) (European Commission 2006c). Even though, new member states are implementing new Labour market reforms, but major challenges exist in human resource development and implementation of reform such as minimum standards of labour law, health and safety at work, gender equality and anti-discrimination. Employment and Unemployment of new and old member states are shown in figure 5. Figure 5: Employment and Unemployment of EU-15 & EU-105 4.4 Reason why arguments were rejected Since accession to the EU, unemployment rates have been falling in almost all new member states. This diminishes the fear of labour movements to old member states and downward trends of wages (European Commission 2006c). 5. Conclusion By enhancing peace, stability, security, prosperity, democracy, human rights and the rule of law across Europe, further enlargement to EU would increase economic growth and productivity to better prepare the European community for global competition. The dream to unify Europe and to create a free market where one can live and work anywhere in Europe is finally possible with positive outlook on its outcome. The one European market ensures efficient allocation of resources, and ultimately leading to overall economic prosperity. Careful preparation and support for candidate countries to reform and strengthen their economies before joining the EU would diminish fears mainly arising from poor economies implications. References European Commission (2007). Economic Forecast: Spring 2007. Bureau of European Policy Advisers and the Directorate-General for Economic and Financial Affairs, Brussels. European Commission (2006a). Fourth report on the practical preparations for the future enlargement of the euro area. Bureau of European Policy Advisers and the Directorate-General for Economic and Financial Affairs. European Commission (2006b). EU Economy 2006 Review: Adjustment Dynamics in the Euro Area Experiences and Challenges. Commission of the European Communities Directorate General. Economic and Financial Affairs, Brussels. Retrieved on May, 12 2007 from http://ec.europa.eu/economy_finance/publications/european_economy/2006/ee606_en.pdf . European Commission (2006c). Enlargement, two years after: an economic evaluation. Bureau of European Policy Advisers and the Directorate-General for Economic and Financial Affairs, Brussels. Retrieved on May, 12 2007 from http://ec.europa.eu/economy_finance/index_en.htm Tupy, M (2003). EU Enlargement: Costs, Benefits, and Strategies for Central and Eastern European Countries. Cato Institute, Washington, D.C. Sobek, O (2002). Introduction of the Euro Completed. BIATEC, Volume X, 4/2002. TEAM Secretariat (2004). Eleven Arguments Against the EU Constitution. The European Parliament, TEAM Fact Sheet No. 4, 2004, Brussels, obtainted on May 14, 2007 from www.teameurope.info Read More