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The Enlargement of the European Union: The impact of joining the Single Market
By Raműnas Vilpiđauskas, Policy Analyst, LFMI
published in Indsigt , 2002 05 15
Indsigt is a newsletter of the Danish Industrialists Organisation
With accession negotiations between the EU and the Central and
Eastern European countries entering the final stages, increasingly
more attention is being given to the likely economic effects of
joining the Union. The wider public as well as economic and political
elites in the accession countries are debating the potential
impact of becoming part of the world’s largest market without
internal barriers. This article addresses the implications of joining
the Single Market for the accession economies. Most of the
examples provided here are based on the analysis undertaken in
Lithuania, but its insights can be generalized to other candidate
countries.
The approaching conclusion of the accession negotiations (by the
end of this year under the Danish presidency, as many hope) and
the accession itself (by 2004) is naturally creating interest in the
economic effects of the EU enlargement, this should not obscure
the fact, that the integration of the applicant countries and the
EU has been taking place for about a decade. This means, that
the accession itself is not likely to bring any sudden changes,
because the process of integration is a gradual one. It started with
the removal of barriers to trade in the beginning of the 1990s, and
it will continue after the EU enlargement with some transition
periods extended for some of the ”four freedoms” and with further
integration taking place inside the Union.
Still, even taking into account the gradual nature of economic
integration in Europe, the enlargement of the EU is likely to have
important implications for the economies of both the current and
future member states.
The dual challenge of competition and regulatory adjustment
The economic impact of EU accession for the economies of the candidate
countries could be characterized as a dual challenge of
increasing competition and adjusting to the higher regulatory
standards, which are in force in the EU Single market. The accession
into the EU could be seen as a process during which (1) the
barriers to exchange of goods, services and factors of production
between the EU and the candidate countries are removed and (2)
common policy principles and norms of behaviour are adopted (by
the candidate countries).
The removal of barriers to trade results in an increased access to
the new markets and therefore creates new opportunities for companies
to expand their activities beyond the national borders, provides
consumers with a wider range and a better quality of products
and services. It also creates conditions for the growth of
competition after the import duties, quantitative restrictions and
physical barriers to trade are removed. It is the increase of competition
which is going to bring the most significant benefits to the
economies of the candidate countries (and current member states)
by strengthening incentives to improve the productivity, exploit
the business opportunities by specialization and division of labour
in the Single Market. Although the parallel nature of economic
(transition) reforms in the candidate countries and the introduction
of integration measures complicates any quantitative estimates
of economic benefits of integration, there is a strong agreement
about the significance of these effects.
The other group of integration measures includes the adoption of
the norms and policy principles (the so called acquis communautaire)
by the candidate countries. The enlargement is based on the
more or less consistently applied rule which states that the candidate
countries have to transpose and enforce the norms and principles
which are applied in the EU. Taking into account that the
EU is much more than the free trade area, accession of Central
and Eastern European countries also include the alignment of
external trade regime (including the adoption of the EU common
external tariff), the adoption of product and process standards
(ranging from quality standards of toys, pharmaceuticals, electronic
equipment, etc. to safety at work and environmental norms),
and application of other EU common policies (common agricultural
policy, transport policy, regional policy, etc.). The effects of
adopting these measures on the economies of candidate countries
depend on the nature and degree of adjustments to the acquis as
well as the level of integration already achieved.
The impact of joining the Single market, thus, can be analyzed by
further detailing the effects of removing barriers to trade and
movement of factors of production on the one hand, and adoption
of common EU standards on the other hand. Of course, this distinction
is not always clear cut, since the removal of non-tariff
barriers to trade is often linked to the adoption of product standards
(for example, only those diary producers in candidate countries
which are certified on the basis of meeting EU norms can
export their products to the Union). But this distinction (which is
sometimes also referred to as negative and positive integration)
provides important insights into the nature and the impact of
integration in Europe.
From ”free trade” to ”four freedoms”
As mentioned the gradual process of economic integration between
the EU and the candidate countries started in the beginning of the
1990s, when the first agreements on liberalization of trade were
signed. For the Visegrad countries (Hungary, The Czech Republic, Slovakia and Poland) , these were the association
agreements and in particular the ”interim agreements” that removed
the barriers to trade in industrial products. The Baltic states
soon followed with the free trade agreements that were signed
with the EU in July 1994 and came into force in 1995. On the
basis of these agreements, the EU removed import duties from the
beginning of 1995, while each Baltic state had a different schedule
of liberalization with Estonia applying the tariff free regime,
Latvia having a four year transition period and Lithuania – a six
year period, during which the import duties were gradually removed.
These agreements were later incorporated into the association
agreements which were signed between the Baltic states and
the EU in June 1995 and came into force in February 1998.
The liberalization of trade with the EU together with general
external liberalization undertaken by the Central and Eastern
European countries in the beginning of the 1990s proved to be a
major factor in creating conditions for economic recovery and
growth. The trade flows between the applicant countries and the
EU have been rising throughout the decade. Even in the case of
the Lithuania, which was most affected by the Russian economic
crisis in 1998, and with national currency litas until February
2002 being pegged to the US dollar against which euro depreciated
in 1999-2000, the growth of trade with the EU has not reversed.
Growth rate of Lithuania’s exports to the EU, %
Source: Lithuanian Department of Statistics
It should be noted that the growth of Lithuania’s exports has
exceeded the growth of EU’s imports for all the years except 1997.
The share of foreign trade to the country’s GDP has increased significantly,
in particular during the first half of the 1990s. In 2000,
the foreign trade as a share of GDP equalled about 71 percent for
Latvia, about 82 percent for Lithuania and reached 179 percent
for Estonia. The Baltic states have soon become the most open
economies of all the candidate countries with Estonia applying no
import duties and Latvia and Lithuania having comparatively low
tariffs, in most cases lower than the ones applied by the EU.
The share of the EU-oriented exports has also been increasing in
the foreign trade turnover of the candidate countries.
The share of the EU-oriented exports in country’s total exports, %
|
1994 |
1995 |
1996 |
1997 |
1998 |
1999 |
2000 |
2001 |
Estonia |
47,9 |
54,7 |
51,0 |
48,6 |
55,1 |
62,8 |
68,5 |
n.a. |
Latvia |
39,3 |
44,2 |
44,1 |
48,8 |
56,6 |
62,6 |
64,6 |
n.a. |
Lithuania |
30,1 |
36,4 |
33,4 |
32,5 |
38,0 |
50,1 |
47,9 |
47,8 |
Source: World Bank, Lithuanian Department of Statistics
The economic trade links have been paralleled by the growing
foreign direct investment. Currently, more than 70 percent of FDI
in the Baltic states originates from the EU, in particular the
Scandinavian countries. Significant shares of foreign investment
were attracted through privatization, in particular in infrastructure
and financial services. Business networks have also been
developing through outsourcing and subcontracting which link
products of furniture, electronics and other producers in the
Scandinavian EU members and the Baltic applicant countries.
The proliferation of the free trade agreements between the EU,
Baltic States, the CEFTA and EFTA which were all driven directly
or indirectly by integration into the EU has contributed significantly
to the expansion of trade and business networks in the
Baltic Sea region.
However, the liberalization of trade between the EU and the candidate
countries has been both gradual and selective. The EU has
reserved the right to apply commercial protection instruments
which until now have been restricting trade with its partners. For
example, several Lithuanian producers have experienced the
negative effects of the antidumping duties imposed by the EU.
The agricultural trade is another area where trade liberalization
has been very slow. It is still restricted by customs duties and
non-tariff barriers which will probably be removed only upon the
accession into the EU.
Therefore, although the candidate countries are already considerably
integrated into the EU on both levels of informal economic
relations (business contracts) and political contacts (negotiations,
consultations, information sharing and monitoring of the membership
obligations), the additional benefits will accrue after joining
the Single market. These will include the removal of remaining
market protection measures and the physical barriers to
trade and movement, namely, the customs procedures. The latter
are in particular important for reducing the transaction costs of
businesses. According to some estimates, the costs of customs procedures
currently make up around 3 percent of the exports’ value.
The immediate benefits would result from the removal of the
remaining barriers to trade, while long term benefits to the accession
economies would come from increase in competition, removal
of barriers to the free movement of capital (restrictions to sales of
agricultural land) and labour (discriminatory employment regimes).
The latter two areas are the ones where some candidate countries
(though not the Baltic states) and some EU member states intend
to apply transition periods. The full membership in the Single
Market would most likely generate additional trade, foreign
investments and economic growth in the new member states, the
more exact estimates of which differ between 1.5 to 19 percent of
GDP depending on the reduction of risk premium and the effects
of removing barriers to trade.
It should be remembered, that joining the EU will imply the adoption
of the Union’s external trade policy which might have diverse
impact depending on the nature and degree of change. For example,
for Estonia with its liberal foreign trade policy the adoption of
EU common external tariff will increase the level of protectionism
and would probably result in some trade diversion. For Poland,
which has relatively more protectionist policy than the EU, the
alignment of import duties will produce economic benefits.
For Lithuania, which applies an average 2.5 percent of import
duties for industrial products which is lower than the EU average
of 4.5 percent, there will be some trade diversion. According to the
study done by the Lithuanian Ministry of Foreign Affairs, if the
EU import duties were adopted in 2000, the imports of industrial
goods would become more expensive by about 90 million litas ((Litas was pegged to the euro at a fixed exchange rate of 3,45 litas to 1 euro from
February 2002. Before that Litas was pegged to the US Dollar.),
while the lowering of import duties would bring a decrease of only
about 11 million litas. This means a general increase in protection,
although the total effects are likely to be insignificant since
about 70 percent of Lithuania’s trade already takes place on the
basis of free trade agreements. The import duties would affect
trade with Russia, USA, Belorussia and Japan most.
The effects of regulatory harmonization
Most of the attention in the candidate countries is currently directed
at transposition and enforcement of EU norms. Some of them,
for example health and safety at work are fully transposed into the
national law in most candidate countries. The adoption of others,
for example environmental, energy, agricultural norms, will extend
beyond the date of accession. Most of them will require companies
in the accession countries to adjust their practices to the new rules
of the game. Several observations could be suggested regarding the
effects of adjustment to the new rules of the game.
The companies which will be most affected by the need to invest
into the higher product and process standards are small and medium
sized enterprises which produce for the local market or import
from the CIS. These are the companies which will face the highest
adjustment costs and will have to accumulate additional investments.
This process is likely to be handled by initiating mergers
(as it has been the case in the diary or pharmaceuticals sector in
Lithuania in recent years) or inflows of foreign investments (or
the closure of the activities altogether). In this context, the regulatory
environment of starting new businesses and the ease of market
entry will be of particular importance in order to easy the
adjustment of small business to the new regulatory standards.
However, the investments into the new standards are likely to
translate into higher prices, which in some cases like in the pharmaceutical
sector are estimated to increase by up to 30 percent.
On the other hand, large companies from the accession countries
which already operate and sell in the EU market will have additional
benefits from the actual accession into the EU. In the case
of Lithuania, these include road haulage carriers, companies producing
furniture, fertilizers, electronics, textiles and diary products.
They will accumulate savings from removal of customs procedures
and setting up of certification centres in their domestic
markets, from removal of a threat of potential introduction of market
protection instruments by the EU, from uniform rules and economies
of scale. In such a way, the competitiveness of companies
in the candidate countries due to their natural advantages and
new opportunities in the Single market will be strengthened.
Moreover, investors from other EU member states and third countries
could take advantage of these new opportunities which would
also benefit accession economies.
Competitiveness through enlargement
The impact of EU accession on the candidate economies will depend
on the nature of concrete business and in particular on the
extent of their current internationalization. While the membership
in the Single Market is likely to generate additional economic
benefits for the candidate countries, it would from the candidate
countries point of view be rational to extend transition periods to
the adoption of EU acquis which requires significant investments.
It is important to notice that the progress in following the timetable
of the accession negotiations and the enlargement will become
the crucial test of EU’s credibility to making important strategic
decisions, to resist the pressure of narrow interest groups and to
create an additional stimulus to economic growth in the current
member states. Although the EU enlargement and the implementation
of the Lisbon goals (to make the EU the most competitive
economy in the world) are often discussed separately, it could be
stated that the successful handling of the enlargement would produce
a significant push for the achievement of Lisbon goals. The
Danish presidency of the second half of 2002 will have a major role
in this.
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