European Affairs

Summer 2005

 

The Effects of Enlargement

The EU Economy Will Have to Become More Flexible

By Franklin Vargo

 

EU enlargement will have a threefold effect on the rest of the world. There will be a traditional trade expansion and trade diversion effect; there may be an effect on the European Union's views on further liberalization of the global trade system, particularly in the Doha round; and there will be an effect on growth in the European Union. The third is by far the most significant consequence.

First, the traditional pattern of trade creation and diversion does not apply in this instance because of the association agreements that the new member states already had with the European Union before they joined. In fact, many American companies were disadvantaged because they faced generally higher tariffs in the Central and Eastern European countries, while the association agreements gave EU producers, including U.S. affiliates, preferential access.

So, when these countries actually joined the European Union, their tariffs mostly came down, and there should not be any negative effect on U.S. exports. The U.S. market share in Central and Eastern Europe has always been small, partly because so much of the demand for American brands is satisfied by U.S. production in Europe, but the share has continued to decline.

While the new members' tariffs overwhelmingly came down, however, some did go up. Under Article 24-6 of the GATT, which is embodied in the WTO, that should be grounds for trade compensation, in the U.S view. The European view has always been you have to look at the average change in tariffs, not individual movements, and we have often been through this when the European Union was enlarged in the past. We may or may not go through it again.

The second question is whether enlargement will alter the European Union's position on global trade rules in the negotiations on the Doha Development Agenda. There are two prevalent opinions. The predominant view is that enlargement will be good for the Doha round because it will compel the European Union to reform the Common Agricultural Policy, and this will lead to progress in the negotiations.

The other view is that such a change would be too rapid and the United States would want to resist it, believing there is no real need to liberalize the agricultural regime. That, of course, would have a very negative impact on the talks. I shall be optimistic and predict that the first alternative is more likely.

The third effect of enlargement, however, is by far the most predominant, and is going to be very beneficial. Now that the European Union has been enlarged, it will be obliged to do something it has not done in a long time - grow. There are two factors that stimulate economic growth. The first is demand, which is what really spurs production, and enlargement will bring new demand into the Union.

"The older member states are not used to change, but the new ones are"

As production increases in the ten new member states, the obvious market is the 15 older members. That will cause some angst and some dislocation, but it also will lead to rising incomes and demand in the new member states. How will this new demand be met? It will be met by the older member states, and that will trigger the kind of growth cycle that Europe has not experienced in years.

The second, and by far the more important, cause of economic growth is that the European Union will have to begin deregulating and becoming more flexible. Over-regulation and inflexible markets are the main reasons why Europe grows so slowly. That slow growth is a major cause of economic dislocation in the world. Japan is growing slowly, too, but the United States is growing very much faster. This has to change, and now there is an opportunity for it to do so.

Enlargement is the irresistible force that will bring about greater flexibility. It is not just that the 15 older members need greater economic flexibility so that they can increase productivity in order to compete with the rapid changes that are happening in the ten new member states. Another factor is that the older member countries are not accustomed to change - indeed, they have resisted it. The new members, on the other hand, have gone through enormous change. They have become much more flexible, and they will inevitably imbue the rest of the European Union with a greater appreciation of the need for more flexibility. We all know that Europe has to move in that direction.

It is obvious that the heavy load of regulation was designed in many cases to prevent change, and it has worked. My favorite was a regulation in Austria, which may still exist, which stipulated that if a new service establishment wanted to commence business, for instance a dry cleaner in Vienna, the owner would have to apply to the proper authorities and the authorities would go around and ask all other similar businesses whether they felt a need for a new establishment. The answer, of course, was almost invariably "No." All the regulations that are designed to prevent change will simply have to go.

Pressure from outside the European Union has not been enough to achieve these necessary reforms. Nor has the fact that many Europeans know that changes will have to be made sooner or later. Now, however, with the inclusion of ten more flexible states that are pretty hungry for change and for growth, Europe will finally have to bite the bullet.

We shall see a more rapid pace of deregulation, greater flexibility and, as a consequence, faster growth in Europe. This will expand Europe's imports and exports and have a salutary effect on world trade. When we look back ten years from now, we shall see that the major effect of EU enlargement was that it finally got Europe to move in the direction of deregulation, flexibility and growth.

Franklin Vargo is Vice President for International Economic Affairs, National Association of Manufacturers, and chief spokesperson on trade issues. During a 30-year career at the U.S. Department of Commerce, he served as Deputy Assistant Secretary for Europe, Deputy Assistant Secretary for Asia, and Deputy Assistant Secretary for WTO Affairs and Trade Compliance.