The European Union’s first expansion to Eastern Europe last May — 10 countries with a total population of 74 million — seems to be working. Its second, due in 2007, to Bulgaria, Romania and Croatia, is too small (34 million) to cause major problems. However, its newly envisioned third expansion, to Turkey and Ukraine, may be much more problematic, because of the very large population involved (124 million), the two countries’ relative poverty and their recent and long term history.
Expanding the EU to poorer countries can work well, provided you give each expansion time for the new countries to catch up with existing EU members before expanding further. Indeed, expansion has already worked well in Ireland, Spain, Portugal and Greece, the success stories in which countries however took more than 20 years from Irish (1973) and Greek (1981) entry and well over a decade from the entry of Portugal and Spain (1986).
The besetting problem of the Western European countries of the EU is their high cost base, relative to their productivity. Not only are direct labor costs quite high, but social security costs, taxation of one kind or another, real estate costs and regulatory charges add enormously to the overall bill. Hence to compete internationally, European companies need to be making products or services (finance in London, for example) that are very high value added, preferably with a brand name or some other cachet to ensure that a premium price can successfully be charged for them in foreign markets. Nevertheless, once an international market has been established for such products and services, it is relatively price insensitive, so that a rise of the Euro against other currencies does not immediately devastate Western Europe’s trade balance.
Western Europeans not engaged in making premium products can then be supported in two ways; they can receive the relatively high European social security payments or, more attractively, they can be employed providing domestic products and services for their wealthy compatriots, generally behind a protectionist barrier that blunts the thrust of U.S. and Asian competition.
Expanding Europe to the East modifies this balance in a number of ways, but can potentially benefit it. First, since Western European products depend as much on brand name and salesmanship as on technology for their success, they can be manufactured by Eastern European labor, under appropriate Western European supervision, and an appropriate saving can be made. Second, Eastern Europeans can be allowed to migrate westwards, filling up the jobs that Western Europeans are unwilling to take, given the high local social security payments.
Either way, a modest expansion towards Eastern Europe is not a problem, although it does dilute the beneficial economic effect of Western Europe’s premium products. With the exception of a little wine and beer, Eastern European countries do not themselves produce products or services that will sell internationally at a premium price, and so cannot immediately add significantly to the portfolio of Western European products that are so successful internationally. In the long run, if integration is successful, Eastern Europeans will grow richer, develop additional premium products or services of their own and enlarge the circumference of Western Europe’s cozy, protected environment. How long this might take to happen depends on the Eastern European countries’ existing capabilities and standards of living, and their ability to adapt their political and economic systems to EU norms.
One sees immediately the attraction to Eastern European countries of joining the EU; it produces an almost automatic uplifting in their standard of living, whose benefits can potentially continue for a generation or more. Only in East Germany was EU entry not particularly beneficial to the local population; in that case the German government tried to give its new East German subjects West German standards of living immediately, without any transition during which West German and other EU companies could move to East Germany and raise the local capabilities. The result was enormous costs and very high unemployment, which will only decline gradually as a new generation appears in the eastern lander that has been taught in college and technische hochschulen the secrets of being a productive German workforce.
In other Eastern European countries, labor costs remain low, and the local education systems are mostly very capable. It is thus highly attractive for Western European companies to set up operations in Eastern Europe and gradually raise the local workforce’s capabilities and standards of living.
An additional factor that has made the absorption of the first round of expansion countries into the EU relatively easy has been their willingness and ability to adapt to EU regulatory norms. Since all the new EU members in Eastern Europe had become fully independent only 15 years ago, and had thrown off their previous governmental system at the time of independence, there was no great political pressure to maintain existing regulations and ways of operating, since these had mostly been imposed from outside and were known not to work. The imposition of the “acquis communautaire” of EU regulations, therefore, was a painstaking and difficult process, but raised no great questions of time-honored rights and privileges that it cut across in the domestic system, because the domestic regulatory framework was either new or, if left over from Communism, largely discredited.
Absorption of future countries into the EU will generally be a lot more difficult, for a number of reasons. Bulgaria and Croatia will be fairly easy; both have quite small populations, good education systems and have been lucky enough to have governments that wanted to move towards a free market system, and had a fair idea of what was required to do so. If they enter the EU in 2007, a very short period after the previous expansion, they will add to the burden of integrating the 2004 expansion, which will still be incomplete, but they present no difficulties of principle and their 14 million will add only modestly to the 74 million already being integrated.
Even in the projected 2007 expansion, Romania is more of a problem. It is considerably larger than Bulgaria or Croatia (22 million population), its higher education system was deliberately destroyed by the regime of Nicolae Ceaucescu and has not yet been fully rebuilt because of lack of resources, and it has suffered for most of the period since 1990 under the neo-Communist regime of Ion Ilescu. The December 2004 election brought in a reformist government under former Bucharest mayor Traian Basescu, but in such matters as privatization of state industry (which was carried out in the 1990s in a way that siphoned off assets to the well connected and left most companies indirectly in state hands) the country is far from being ready to compete even in the gentlemanly and restricted free market of the EU.
If foreign investment does not come into Romania, private property is left at the whim of apparatchiks, and Romanian political life remains dominated by the anti-market left, no amount of EU regulation can save it. Romanian living standards will remain depressed, and instead of integrating into the EU economy, Romania will remain as a perpetual sink of costs to the EU budget and source of crime syndicates and unemployed economic refugees to other EU countries.
Turkey has now been accepted to begin negotiations for entry into the EU (only 41 years after it first applied) while the EU’s strong support for the election of the new reformist Ukrainian government has made it more or less impossible for the EU to leave Ukraine out in the long run, especially if Turkey is admitted. Both countries present considerably more difficult problems, as well as being a lot larger (Turkey will have about 78 million population in 2010, Ukraine about 44 million; Turkey’s population unlike the EU’s in general is still quite rapidly increasing.)
In the case of Ukraine, only now has the country got a government that may be committed to a free market and not impossibly corrupt; as in Romania, Ukrainian privatization was extremely murky and left many assets in state hands. Ukraine suffers from the additional problem that the impetus to Westernization is at best equivocal, because the old Soviet system was not imposed on it from outside, but to a large extent internally generated.
Thus there is and will probably continue to be much deep-seated opposition to Westernization in Eastern Ukraine, where Russia, if by Ukrainian standards economically successful, may prove an attractive alternative magnet to a distant Brussels. The combination of exceptionally low living standards, considerable political resistance and a hopelessly compromised corporate structure will make Ukraine significantly more difficult for the EU to absorb than any other candidate country, even Romania.
Turkey, finally, will also have great difficulties integrating into the EU, but of a different kind. Unlike the former Comecon countries, Turkey has a perfectly good more or less free market system of its own, with a centuries-long tradition backing many of its mores, and a highly successful and much respected modernization program under Kemal Ataturk in 1920-38. The “acquis communautaire” here is thus not writing on a clean slate, or on a slate whose previous contents are despised, but instead attempting to modify and disrupt legal and regulatory structures that have worked well and have considerable local support. Like the British public’s support for the shopkeeper who insisted on retaining Imperial weights and measures, Turkish resistance to Brussels’ sillier diktats may be spirited.
Further, Turkey is not potentially a “branch plant” economy for Western European companies, like the other new EU members, but has a successful and long standing corporate sector of its own, that has however competed internationally on a very different basis from those of Western Europe – primarily through low cost and, in the Middle East, through pan-Islamic connections. If Turkish integration into the EU doesn’t work, it will not relapse into destitution, refugee production and organized crime, like Romania or Ukraine, but instead will trend towards Islamism and hatred of its distant and haughty Western European trading partners. Whether you prefer an EU member suffering from religious hatred and terrorist activity, or one suffering from destitution and criminality is a matter of taste; both possibilities offer the likelihood of severe disruption of the EU’s future.
Integration of Turkey and Ukraine, on top of the other new EU members, can probably be done but it must make sense to wait a couple of decades before attempting it, so that the other new EU members can acquire Western standards of living and industrial/service capabilities, and contribute to pulling Turkey and Ukraine up towards them, rather than pulling Western Europe back.
Politically, however, it may prove impossible to wait more than a few years before Turkey and Ukraine are admitted to the EU. In that case, the risk is great. There must be a strong possibility that the weight of the new and imperfectly reformed members, combined with the economic deadweight of the EU bureaucracy and regulatory system, pulls Western Europe backwards rather than pulling Eastern Europe up. This would produce an EU that, however enlarged, was economically in retrograde, with very high unemployment in Western Europe, steadily declining export and productive potential, and a seething cauldron of discontent and low-level civil unrest in its new members.
The economic risks of rapid integration of further new EU members appear to be substantially greater than the potential rewards. Whatever the political imperatives, it would be best to proceed very carefully indeed.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.