Economics: More pillars needed to build a united Europe

Eastern enlargement of the EU is a central pillar in Europe's post-Cold War architecture. Keeping the eastern countries out seriously endangers their economic transition, and economic failure in the east could threaten peace and prosperity in western Europe. The perceived economic costs and benefits will dictate the enlargement's timing.

In new research, we have examined the economics of EU enlargement as a solution to the increasing instability of the central and east European region and a means of ensuring its future prosperity. We have estimated the benefits for both east and west. Eastern enlargement will be an excellent bargain for all the incumbent EU15 members and enormously beneficial to the central and east European economies.

Less than a decade ago, millions of men and trillions of dollars' worth of equipment stood ready for combat in Europe. The demise of the political systems of eastern Europe and the Soviet Union defused that situation and the political "creative destruction" in the revolutions of 1989 offered great opportunities, but also great dangers. Success in CEE will lock in democracy and pro-market reforms. Moreover, 100 million eastern consumers with rising incomes will be a boon for west European businesses. Sustained economic success in the east will foster prosperity and peace.

But stagnant or falling incomes and the impoverishment of a large slice of the population of CEE could foster disillusion with market economics and democracy. This may occur while a power vacuum exists in central Europe. Geography and history make these continent-wide problems. Any serious unrest or conflict could harm western Europe via surging migration, increased defence expenditure and changes in investors' attitudes.

Stability and prosperity in CEE could come from incorporating the region into the EU. We examine the economics of this strategy. There are four parts - the costs and the benefits in the east and the costs and the benefits in the west. Discussion so far has been concerned with the costs to the EU budget of an eastern enlargement. We attempt to fill in two more parts of the calculus - the economic benefits for the east and the west. The final part - the cost of enlargement for the east - seems to defy calculation, especially the extent to which adoption of the EU's social and economic regulations (including rules relating to employment rights and social insurance) will stunt eastern growth and raise unemployment.

We believe - with supporting evidence from previous EU accessions (Portugal and Spain) - that joining the EU will make the region substantially less risky from the point of view of domestic and foreign investors. EU membership constrains arbitrary trade and indirect tax policy changes. It locks in well-defined property rights, competition policy and state-aids policy.

By securing open capital markets and rights of establishment, membership assures investors that they can put in and take out money. EU membership guarantees that regional products have access to the EU's 15 markets (accounting for almost 30 per cent of world income).

On the macro side, membership could put the region on an easy path to monetary union and thus provide a solid defence against inflation spurts. These two aspects of membership will be mutually reinforcing and will raise investor confidence.

We estimate the long-run economic benefits and budgetary costs of eastern enlargement. The benefits are calculated using a computable equilibrium model, with two scenarios envisaged. Our first "conservative" scenario views membership for the region as entailing only the standard elements (single market access and the common external tariff). The second takes on the argument above, that membership promotes regional investment by stabilising the economic and political climate.

Under both scenarios, the EU15 are projected to gain about Ecu10bn ($9bn) in real income. This gain is likely to be unevenly distributed: calculations suggest that Germany, France and the UK would get 70 per cent of the total. Under the conservative scenario, the CEE countries gain Ecu3bn (1.5 per cent of their GDP): including the stimulus to investment multiplies this tenfold: CEE would gain Ecu30bn, somewhat over 15 per cent of their base year GDP.

EU budget costs are estimated using two different approaches. The first is based on a survey of the literature estimating likely CAP and structural fund receipts and an approximation to the region's contributions to the EU budget. We arrive at a consensus estimate of the net budgetary cost for a Visegrad 5 enlargement in 2000 at Ecu17bn.

The second approach estimates a new power politics model of the EU budget (members' receipts are related to their voting power in the Council of Ministers and per capita national contributions are related to per capita income) and uses this to project the net budgetary cost of a Visegrad enlargement. The figure arrived at - Ecu15bn - is remarkably similar to the figure from the survey approach.

Putting together the economic gains and budgetary costs, eastern enlargement is beneficial for the incumbent EU15. Setting aside questions about the timing of the benefits and budget costs, and the list of countries in the first enlargement, the budgetary transfers, less the economic benefits, should be no more than between Ecu5bn and Ecu7bn - one-tenth of one per cent of the EU15's GDP. This is very favourable given the historical nature of the challenge. EU membership would be enormously beneficial in the long-run to CEE economies.

Richard Baldwin is professor of economics at the Graduate School of lnternational Studies in Geneva and a co-programme director in CEPR'S international macroeconomic programme. Richard Portes is a professor of economics at London Business School and director of the Centre for Economic Policy Research. Tel: 0171 878 2900.

q EU Enlargement: Small Costs for the West, Big Gains for the East, Economic Policy No. 24, published by Blackwell Publishers. Fax: 01865 381 381.