EU Enlargements
– Status and Future

Borka Babic, International Relations

INTRODUCTION

On 1 January 2007, the EU was enlarged to include Bulgaria and Romania, bringing the number of member states to 27. This enlargement is the 6th in the 50-year history of the EU. It is also the 2nd enlargement of the EU to include eastern European member states. In 2004 the EU was enlarged to include 10 predominantly central and eastern European member states, cf. Chart 1.

With the enlargement to include Bulgaria and Romania, as well as the accession negotiations with Turkey and Croatia, enlargement of the EU is back in focus. EU enlargements were discussed by the heads of state or government on two occasions during 2006. The EU's future enlargement strategy is generally unchanged, but the requirements for compliance with existing conditions during the accession process have been tightened.  

This article describes recent years' economic development in Bulgaria and Romania. There has been high growth and inflation, and current-account deficits have increased. The two member states are compared particularly with the central and eastern European member states that joined the EU in 2004. Then an account is given of experience so far from the 2004 enlargement, which is assessed to be positive. The article concludes with a description of the EU's future enlargement strategy and the countries that are engaged in the accession process.

BULGARIA AND ROMANIA: NEW EU MEMBER STATES

The decision that Bulgaria and Romania would join the EU in 2007 was taken by the EU's heads of state or government in December 2004. The execution of this decision was, however, conditional on a positive assessment from the European Commission concerning the fulfilment of the conditions for EU membership. This positive assessment was presented in a report from the Commission in the autumn of 2006, cf. Box 1.^[1] On 1 January 2007 the population of the EU was thus increased by approximately 30 million – 8 million in Bulgaria and 22 million in Romania. This represents an addition by approximately 6 per cent, and the population of the EU now totals approximately 490 million.^[2]

In economic terms, the two new member states have a very small impact on the EU as their total output is only approximately 0.5 per cent of the total GDP of the EU. In structural terms, especially Romania differs from other EU member states^[3] in that its agricultural sector's share of total output, and especially employment, is very large, cf. Chart 2.^[4] This indicates especially low productivity for agriculture, and also that unemployment probably exceeds the official unemployment figure of approximately 8 per cent of the labour force at the end of 2006.

High growth from a low level
The level of income and prosperity is low, and GDP per capita in both Romania and Bulgaria is not just far below the EU average, but also considerably lower than in all the new member states from the 2004 enlargement, cf. Chart 3. Since the millennium rollover, however, the gap from the EU average has narrowed, in view of the high growth in Bulgaria and Romania in recent years, cf. Chart 4.

In 2006, GDP growth in both Bulgaria and Romania – as in most of the EU10 member states – was higher than in the preceding period. Year-on-year growth in the 3rd quarter was respectively 6.7 per cent and 8.3 per cent, cf. Chart 4. As in the preceding years, private consumption and investments were the principal factors driving growth in the two member states.

Macroeconomic stability
Bulgaria and Romania have both enjoyed macroeconomic stability in recent years. However, inflation is high and the deficit on the current account of the balance of payments has been rising. In December 2006, inflation in Bulgaria and Romania was respectively 6.5 per cent and 4.9 per cent on a year-on-year basis, cf. Chart 5. These are among the highest inflation rates in the EU.. In Bulgaria especially, the high inflation is partly attributable to temporary factors such as indirect tax increases, cf. Chart 5. The strong growth, together with the Balassa-Samuelson effect,^[5] has also contributed to high inflation in the two member states. In the coming years the tendency for lower growth in productivity in the service sectors than in the economy as a whole is expected to continue to exert upward pressure on prices and thereby impede compliance with the nominal convergence criteria, cf. Box 2.^[6]

During the period 2002-05 the banks' lending to the private sector in Bulgaria and Romania on average expanded by respectively 22 per cent and 28 per cent p.a. The two member states share the high growth in lending with other transition economies, and it should be viewed against the low starting level. The two member states' banking sectors are considered to be sound, and the growth in lending currently presents only a small risk to financial stability.^[7] However, the high growth rates are not sustainable in the longer term. The strong growth in lending can be assumed to stimulate demand, thereby contributing to the large current-account deficit, cf. Chart 6. In both member states the authorities have in recent years therefore sought to curtail the growth in lending.

Both Bulgaria and Romania have a high current-account deficit, which is not unusual for a country that is undergoing a catching-up process, cf. Chart 6. Among other things, a high current-account deficit reflects the need to build up the production capacity and the high expected returns on business investments. Especially in Bulgaria there is strong growth in investment, with Bulgaria's investment ratio rising from approximately 16 per cent of GDP in 2000 to 25 per cent in 2006. The development in both member states' government finances has partly offset the development in the private sector's savings deficit. Bulgaria thus has a budget surplus, while Romania has a moderate government deficit.^[8]

The course of the balance of payments should be viewed in the context of the development in foreign direct investment, FDI, which has both contributed to expanded demand for foreign goods and financed the deficits, cf. Chart 6. Like macroeconomic stability and sound growth prospects, the expectations of EU membership and privatisations have contributed to the very large inflow of FDI. Some of the contributing factors, especially privatisations, are temporary, and the high level of FDI can hardly be maintained in the long term.

The exchange-rate regime in Romania is a managed float. So far, the exchange rate has not been affected by the development in the current-account deficit. Bulgaria's fixed-exchange-rate regime has not been under pressure either. Bulgaria has a currency board^[9] that was introduced in 1997 when the country faced hyperinflation and was in the throes of a financial crisis. The change of regime in 1997, underpinned by a tight fiscal and income policy as well as structural reforms, has been of great importance to the stabilisation of the economy.

Catching-up to the EU level
EU membership is expected to have positive consequences for economic activity in Bulgaria and Romania. The scale of the effect is difficult to estimate since it is uncertain how far the stimulation from expanded trade and higher investments from the EU has already exerted an influence in the accession process. The two member states' trade with the EU has increased since the 1990s, and at respectively 65 per cent and 51 per cent of the two member states' total trade the EU is the most important trading partner of both Bulgaria and Romania.^[10] Financial support from the EU budget will also contribute positively to activity in both Bulgaria and Romania.

The growth prospects will also be dependent on whether the member states succeed in conducting a stability-oriented economic policy, ensuring a sound climate for investment and generally adapting to the developments in a globalised world. Growth is also determined by how effectively subsidies from the EU structural funds are used, as shown by the positive experience with Ireland in the 1990s.^[11] Ireland has also succeeded in maintaining high growth rates after its GDP per capita exceeded the EU average.^[12] Among the new EU member states, especially the Baltic states have succeeded in creating favourable conditions for growth, cf. the next section.

GDP per capita in Bulgaria and Romania is very low – also lower than in EU10 in 2004 – which indicates a long real convergence process even if the conditions for growth are favourable. A simple projection, in which it is assumed that the growth gap of approximately 4 per cent from the EU in the period 2000-05 is maintained, indicates that it will take around 30 years for the member states to achieve the EU's level of prosperity, cf. Chart 7.^[13]

EXPERIENCE SO FAR FROM THE EU ENLARGEMENT IN 2004

The 2004 enlargement with 10 central and eastern European member states had a special significance. The enlargement symbolised reunification between east and west, and its political importance is indisputable. Prior to the enlargement, academic studies pointed to an increase in growth by between 1 and 2 percentage points p.a. in the new member states.^[14] There was also scepticism from several quarters as to the success in enlarging the EU with so many countries with a relatively low level of prosperity, including whether the enlargement would lead to large-scale migration of labour from east to west, and the re-allocation of production from west to east, hereby pushing down western European wages.

Trade, investments and labour mobility
The period since the enlargement is too short to draw any firm conclusions regarding the economic consequences. In addition, it would also in many respects be misleading to consider only the past three years since the countries' integration into the EU in reality began in the 1990s. The free trade zone established at the start of the 1990s covered approximately 85 per cent of bilateral trade. Barriers to foreign direct investments and the free movement of capital were also lifted before the member states' accession to the EU.

In accordance with the above, EU10's trade with EU15 had been rising since the early 1990s, and in 2004 accounted for approximately 62 per cent of EU10's total foreign trade, compared to 56 per cent in 1993. Since 2004 this share has by and large remained unchanged. The direct investments from EU15 to EU10 have also increased in a more long-term perspective, and have been of great significance to the EU10 member states. However, the increase in EU15's investments in the new member states is not only related to EU integration, but should also be viewed in the context of the general tendency to relocate production in countries where production costs are low. In 2004, investments to EU10 after all accounted for only around 4 per cent of EU15's total foreign direct investment.^[15]

Surveys show that investments in EU10 member states have had only a moderate effect on employment in the EU15 member states. During the last 15 years the aggregate negative impact on job creation in Germany and Austria, which are among the largest investors in EU10, has been around 0.3-0.7 per cent.^[16] At the same time, competition from the new member states has given incentives for efficiency increases in the old EU member states' business sectors, and cheaper goods for consumers.

The enlargement has not been of any great significance to labour mobility either. Migration from east to west rose after May 2004, but on a considerably smaller scale than expected, probably because the restrictions in most of the old EU member states were maintained for a transition period.^[17] In 2004 only the UK, Ireland and Sweden had removed the barriers to the free mobility of labour, and Ireland has seen the relatively largest inflow of job-seekers. According to the European Commission the influx of labour to the old EU member states has been limited to the sectors in which there was a shortage of labour. The migration has thus contributed to solving the labour shortage problems and to achieving better economic results in Europe.^[18]

Real and nominal convergence
The EU10 member states have been able to maintain high growth after their accession to the EU in 2004. The differences in GDP per capita in relation to the old EU member states have therefore narrowed. This is especially the case in the Baltic states, cf. Chart 3. In 2003 Slovenia's GDP per capita already exceeded Portugal's GDP, and in 2005 the prosperity of the Czech Republic exceeded that of the poorest of the old EU member states.^[19] Poland is at the other end of the scale and is relatively slow to catch up.

The member states with lower GDP per capita at the outset have generally achieved higher growth, cf. Charts 3 and 4. However, the economic-policy stance has also been significant to the narrowing of the growth gaps. The Baltic states, especially Estonia and Lithuania, have the most stable political conditions, a favourable business climate, exchange rates pegged to the euro and well-ordered government finances. These factors appeal to both domestic and foreign investors, and Estonia has the highest FDI per capita of all European countries.

The Baltic states' high GDP growth also has a less advantageous side, however. There are clear signs that the economies are overheating. Both the current-account deficit and inflation are very high, and due to their high inflation neither Estonia nor Lithuania comply with the convergence criteria and have therefore been obliged to postpone the adoption of the euro that was originally planned for January 2007. Several other new EU member states also face both high current-account deficits and high inflation. The oil price increases in recent years have been of relatively great significance to many eastern European countries due to their comparatively energy-intensive production set-ups. The harmonisation of indirect taxes to the EU level has likewise contributed to high inflation. Besides these temporary factors, the high growth in demand and the Balassa-Samuelson effect have also contributed to high inflation.

To be eligible to adopt the euro, the member states must, in addition to the criteria for inflation, interest rates and government finances presented in Table 1, also participate in ERM II for at least two years without severe tensions.^[20] Seven of the new member states participated in ERM II in 2006, and only Poland, Hungary and the Czech Republic have not yet joined ERM II. These member states especially are not likely to adopt the euro for some time. Hungary has a very large government deficit, amounting to 10 per cent of GDP in 2006. Since their budget deficits exceed the 3-per-cent limit, Poland, the Czech Republic and Slovakia are also subject to the excessive deficit procedure.^[21]

Comparison of the ECB's convergence reports from December 2006 and 2004 shows that fewer member states exceeded the convergence criteria in 2006. Furthermore, they generally exceeded the criteria by less than in 2004. In 2006, Slovenia was the first of the new EU member states to comply with all convergence criteria, and in January 2007 Slovenia became the 13th member state to adopt the euro.^[22]

COMING EU ENLARGEMENTS

The next enlargements of the EU and its enlargement strategy were discussed by the heads of state or government at the meetings of the European Council in both June and December 2006. The discussion in December was based on a report from the European Commission on the EU's enlargement strategy and the progress in recent years in the individual candidate and potential candidate countries.^[23]

EU enlargement strategy
A revision of the EU's enlargement strategy was adopted at the end of 2006.^[24] The heads of state or government emphasised that the pace of the EU accession process must depend on the results of the reforms in the individual countries, and the EU will refrain from setting target dates for accession until the negotiations are close to completion. The difficult issues such as administrative reforms, judicial reforms and the fight against corruption must in future be addressed at an early stage of the accession process. The pace of enlargement must also take into account the capacity of the EU to absorb new members while also continuing and deepening its own development.^[25]

Candidate countries and potential candidate countries
The three candidate countries Croatia, Turkey and the Former Yugoslav Republic of Macedonia (FYROM) are at various stages of the accession process. The accession negotiations with Croatia and Turkey were opened in October 2005, while the date for the opening of accession negotiations with Macedonia, which achieved the status of candidate country in December 2005, has not yet been fixed.^[26] In view of the progress of its negotiations Croatia is expected to become the 28th EU member state, but this is not likely to occur before the EU's institutional reforms are in place, i.e. in 2009.^[27] In terms of prosperity the countries are also at different levels, and their macroeconomic situations vary considerably, cf. Table 2.

The accession negotiations with Turkey have received a lot of attention, most recently due to Turkey's failure to meet its obligations in accordance with the Ankara protocol.^[28] According to the protocol, Turkey is obliged to eliminate the barriers to the free movement of goods vis-à-vis the EU member states, including restrictions to means of transport. Nonetheless, Turkey refuses to give the Cypriots access to Turkish ports and airports. The EU has therefore decided not to open eight out of 35 chapters in the accession negotiations before Turkey has met its obligations.^[29] In addition, negotiations in other areas cannot be concluded until Turkey fulfils the requirements.

Turkey's condition for its compliance with the protocol is the EU's discontinuation of the economic isolation of the Turkish section of Cyprus. When the UN plan for the reunification of the island was accepted by Turkish Cypriots and rejected by Greek Cypriots the EU undertook to lift the embargo on the Turkish section of Cyprus. However, since Cyprus has a right of veto, the embargo has not yet been lifted.

The western Balkan countries, Albania, Bosnia-Herzegovina, Montenegro and Serbia are the potential candidate countries.^[30] They are in the stabilisation and association process that the EU commenced with these countries in 2000 in order to promote peace, stability and economic development.^[31] The EU heads of state or government emphasised once again at their meeting in December 2006 that the future of these countries lies in the EU.

SUMMARY AND CONCLUSION

The EU was enlarged for the 6th time on 1 January 2007, on this occasion by two relatively poor Balkan countries, Bulgaria and Romania. Both economies are growing rapidly. This is also reflected in their high inflation rates and substantial current-account deficits, which they have in common with many of the central and eastern European member states that joined the EU in 2004. GDP per capita in Bulgaria and Romania is very low, and is also lower than for EU10 in 2004, which indicates that it can take several decades for the new member states to reach the EU's level of prosperity, even if conditions for growth are favourable.  

Experience so far from the 2004 enlargement is positive. Viewed over a longer period foreign trade and investments have increased significantly and experience with the mobility of labour is generally also positive. However, in many of the member states the nominal convergence is slower than expected, and several of the member states have had to postpone the planned date of introduction of the euro.

In 2006 the European heads of state or government decided to tighten the conditions for compliance with the requirements during the accession process and also emphasised that account would be taken of the EU's capacity to integrate new member states. The future of the Balkan countries within the EU has been confirmed, but there are currently no concrete plans to enlarge the EU with other countries than Croatia, Turkey and the Former Yugoslav Republic of Macedonia (FYROM).