Sunday, January 11, 2004
The threat from the new kids on the EU block
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

Just when you thought the question of euro entry had been kicked into the long grass, a couple of stories last week emerged to remind us that for some people it is still not dead.

One, in The Independent, said Tony Blair has his sights on 2007 entry and a referendum soon after the next election. That, however, would fall into the “over the chancellor’s dead body” problem and run against the government’s declared aim that entry will not occur until the economics are right.

Another story, based on comments from Carlos Ghosn, Nissan’s chief executive, suggested that, unless Britain joins, the new Almera may not be built in Sunderland. Some may see that as a sign the Japanese firm is looking for financial support from the government for the investment, as before, but it is also a reminder that euro entry remains an issue for some in business.

Why? Euroland, now having to cope with the burden of a rising euro, is struggling. The suspension of the stability and growth pact, forced by France and Germany, may face a legal challenge from the European Commission. The euro project is looking rather weary.

But could Europe be about to get a new injection of dynamism? In just a few months, at the beginning of May, the EU will gain another 75m people, almost equivalent to a country the size of Germany but from more rapidly growing economies. How will this latest enlargement, the biggest in the EU’s history in terms of the number of new members, affect Europe, and what will be the impact on Britain?

This enlargement — adding Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia — is big in terms of the number of countries but small in its immediate addition to the EU economy. The enlargement will increase the EU’s population by 20% but boost its economy by only 5%.

This is because the accession countries, by and large, have low per capita GDP levels and poor living standards. On a crude comparison, per capita incomes in some of the new members are only a fifth of those in Britain and the average of current EU members.

Even adjusted for relative prices — so-called purchasing power parity — average GDP of the new members is only 45% of the EU average. The two exceptions are Cyprus and Slovenia, which have higher per capita incomes, adjusted for prices, than Greece and Portugal.

What’s been happening to the economies of the new members? Some have been growing rapidly in the run-up to entry. The Baltic trio of Estonia, Latvia and Lithuania have achieved growth rates of 5%-7% for the past two years. Elsewhere, though, growth of 2%-4% is the norm. This is faster than euroland’s sluggish performance but hardly sets the world on fire, particularly as it has been achieved in the context of a large inflow of foreign investment, of which more below.

Most of the accession countries have also been experiencing population decline, partly because of migration to richer pastures in western Europe. This, indeed, is where much of the attention has focused on the consequences of enlargement.

Home Office estimates suggest Britain will gain 5,000 to 13,000 immigrants annually from the new members. Others, such as Migration Watch, forecast higher numbers, about 40,000 a year. One consequence, however, seems clear — the conversion of many illegal workers from eastern Europe, particularly Polish building workers, into legal immigrants.

The better the new EU countries do, the less the pull for their workers to migrate elsewhere in Europe. What prospects do they have? As many international companies have recognised, one key role for them will be as low-cost production locations. Their monthly wage cost in manufacturing averages 420, compared with 2,560 in Britain and 2,300 across the EU. They tend to have lower productivity but still have a huge cost advantage.

These lower costs were one worry raised by the EEF, the manufacturers’ body, in a comprehensive report, Manufacturing in the New Europe. Enlargement, it warned, would “intensify the competitive threat” faced by UK firms. “Even under pessimistic assumptions on labour costs and productivity, the new members will have a sizeable cost advantage for some time,” it said.

The EEF has a wider worry. While the government has welcomed EU enlargement, not least because it should widen rather than deepen Europe — easing the pressure for integration — British business has been slow on the uptake. The EEF points out that most of the foreign investment into the former communist countries has come from Germany, The Netherlands, Austria and America.

“UK companies appear to have overlooked eastern Europe as a destination for foreign investment,” it says. This means Britain will face the full competitive onslaught from lower-cost production, without reaping the benefits of having operations located there. This is a lesson, it warns, that British business should heed in the context of the next wave of enlargement, which will take in the likes of Bulgaria and Romania.

Will May’s enlargement give us a more dynamic EU? It would be nice to think so, but many would argue that acquiring all the red tape that Brussels considers necessary — as well as linking up with some pretty undynamic economies — will be an antidote to dynamism.

There is a risk too that the catch-up in wages and prices in the new economies will run ahead of overall productivity gains — a variant of what is known to economists as the Balassa-Samuelson effect. Against this, they could find themselves caught up in unnecessarily orthodox economic policies in preparation for the dubious benefits of joining the euro. All new members automatically enter the waiting room for membership. Some could join quite quickly.

Everybody should celebrate the fact that the former communist countries of eastern Europe, as well as others, have progressed far enough to be on the verge of joining the EU. It’s just a pity — particularly in the context of a euro rise that seems likely to condemn euroland to sub-2% growth and high unemployment for the foreseeable future — that the EU isn’t able to provide a warmer welcome.

PS: Catching a train the other day I thought I had been transported back to the 1970s. I am referring not to the standard of service — more like the 1870s — but to the fare rise. “They went up on January the 4th, haven’t you heard?”, I was told.

Sure enough, according to the Rail Passengers Council, the average rail fare has just gone up by 4.1%, with a 9% rise on some routes. Even that does not win the public-transport prize. Outer London bus fares went up from 70p to 1 on the same day, a 43% rise.

This seems to me to be bonkers on a number of levels. How are people expected to believe we are in a low-inflation environment, with a rate of just 1.3% on the new official measure and a 2% target, when highly visible administered prices are increasing so sharply? And how are people supposed to be encouraged to switch from cars to public transport when the price mechanism encourages them to go the other way?

Official figures show that since 1996 car prices have fallen 11% while fares on public transport have increased more than 25%. Petrol and car-maintenance costs have risen, but not enough to alter the fact that prices have been moving in favour of private transport. If this is joined-up government, you could have fooled me.

From The Sunday Times, January 11 2003

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