Jan Frait

Luboš Komárek

English

Research Papers in Economics

371 Finance a úvûr – Czech Journal of Economics and Finance, 53, 2003, ã. 9-10
Joining the EU – The Experience of Selected
Current Members
In May 2004, ten countries will join the European Union. Most of them are small
post-socialist economies that have made huge progress in market reforms and eco-
nomic integration with industrially developed countries. Nevertheless, EU entry
will bring new challenges and clarify issues that have to be resolved for sustainable
convergence. In looking for solutions, the new members will have lessons at their
disposal from the current EU countries. In an attempt to extract these lessons we
have collected a few papers describing the experiences of selected small countries
that either opted for EU membership relatively recently or had less developed
economies when entering the EU. The selection has the potential to deliver lessons
that are particularly relevant for the countries of Central and Eastern Europe.
The first post-socialist country to join the EU was the former East Germany.
Although this particular accession was rather a unique event, it seems to have been
unjustifiably forgotten in the discussions on EU enlargement. East Germany’s cur-
rent state of progress with convergence may reveal problems that will have to be
resolved by other acceding countries some time after May 2004. Philipp Rother
and Ralph Süppel compare economic developments in the former East Germany
and the countries of Central Europe with the aim of highlighting the potential risks
associated with the excessive optimism generated by the benefits assigned to EU
membership. They warn that Central Europe could, on a smaller scale and in se-
lected aspects, repeat the East German experience. Unification with Western Ger-
many (and thus EU accession) proceeded swiftly and real incomes and investment
soared in the early 1990s thanks to generous public transfers. The boom ended
abruptly in 1995 with a downshift that has persisted to the present day, East Ger-
man per-capita disposable incomes have remained stuck at around 80 percent of
the western level. As productivity failed to catch up with wages and prices, unit
labour costs in East Germany rose strongly. The German economy had to go through
a painful contraction period to regain its competitiveness. This process seems to be
still far from complete.
Accession will provide the region with more ample funding, as it facilitates access
to global financial markets and unlocks sizeable public transfers. There may be
a temptation, similar to East Germany, to boost investment and incomes in the ac-
cession countries in order to “front-load” real spending convergence. Using an in-
tertemporal equilibrium model, the authors show that this front-loading would oc-
cur partly through an overshooting of the real external value of Central European
currencies. It may take a long time for the real external value of the currencies to
adjust back downward to equilibrium, leading to output losses and rising unem-
ployment in the meantime. This may entail a prolonged period of poor economic per-
formance. Averting this pitfall requires fiscal discipline, price and wage flexibility
and a continued focus of macroeconomic policy on competitiveness. Especially in
the field of fiscal policies, care must be taken not to fuel or accommodate the de-
mand pressures on the economy. With overall tax burdens already high, the neces-
sary public investment expenditure will need to be financed by expenditure restraint
in other areas.The paper on Ireland by Frank Barry reveals very important lessons for cur-
rent EU acceding countries, because it explains that success is by no means gua-
ranteed. Barry convincingly contrasts the poor economic performance of Ireland du-
ring the post-war decades with its dramatic growth in the 1990s. He warns that there
may be something in the political economy of poorer countries that makes their
macroeconomic stance vulnerable to general economic slowdowns. The fact that con-
vergence did not take place until almost two decades of EU membership had passed
highlights the importance of domestic policies with respect to development and con-
vergence. The analysis shows that fiscal balance can be viewed to a large extent as
a joint indicator for policymakers to address structural problems of the economy.
Ireland was able to jump on a “virtuous circle” of growth only after a decisive change
in fiscal strategy in the late 1980s. It is by no means surprising that fiscal deficits
are now viewed as one of the key problems of the acceding countries. One of the dan-
gers that can also be seen in some acceding economies is the creation of a “double-
-speed” economy. In the Irish case, this means the coexistence of a weak indigenous
sector and a strong foreign sector. Indigenous manufacturing firms are primarily lo-
cated in low-tech sectors, have a relatively low export-output ratio, are strongly de-
pendent on the UK market, and are highly exposed to sterling fluctuations. This
source of vulnerability creates rather a large challenge for policymakers. There is
one more important lesson, concerning the importance of EU regional aid pro-
grammes. These hardly constitute the key to convergence; their role is no more than
to prevent further divergence. On the contrary, if the acceding countries want to
replicate thehigh-tech route, they need to achieve astrong R&D environment, ahigh
level of industrial sophistication and an abundance of human capital.
João Amador focuses on macroeconomic developments in Portugal, which
40 years ago was a fairly closed economy and also a closed society. Since entry to
the European Free Trade Association in 1960, significant structural changes have
occurred, the economic integration process has deepened and the economy has
achieved substantial nominal and real convergence to EU levels. Nevertheless,
the process has been complicated and painful. Portugal was hit by several negative
supply shocks and, as a consequence, serious macroeconomic imbalances mounted
and the economy entered a phase of macroeconomic turbulence with “stop-and-go”
policies. This lasted until 1985, when the accession treaty was signed.
The motivations for accession were threefold – political, strategic and economic.
On economic grounds, membership implied a higher degree of openness, generating
higher gains from trade. In addition, the European structural funds made it possib-
le for the economy to maintain private and public investment at higher levels with-
out incurring unsustainable foreign account imbalances. And what is most impor-
tant, membership induced the adoption of macroeconomic, structural and financial
reforms that might otherwise have taken longer to occur. Up until 1997 the fulfil-
ment of the public finance criteria required by EMU accession was the priority. How-
ever, the consolidation process, relying on interest savings and higher revenues, did
not deliver long-run results. Consequently, macroeconomic imbalances emerged con-
sisting of high financing needs in the private sector, relatively high general gov-
ernment deficits and, consequently, high foreign account deficits. In addition, de-
creasing interest rates and prospects of higher income led Portuguese households
to increase their consumption and investment, mostly in housing. The significant
investment in housing was financed by domestic bank credit, which in turn relied
on external borrowing. The investment in housing contributed to a boom in the con-
struction sector and to a rise in real estate prices. The expectations of higher pro-
ductivity and higher income did not materialize and private agents needed to read-
just their balance sheets. After reaching a general government deficit of 4.2 percent
of GDP in 2001, clearly above the 3 per cent reference value established by the Sta-
bility and Growth Pact, fiscal policy must definitively turn to a contracting stance.
372 Finance a úvûr – Czech Journal of Economics and Finance, 53, 2003, ã. 9-10Currently, the Portuguese economy is experiencing an adjustment process, which is
expected to continue in the years ahead. There is a very clear lesson for the coun-
tries of Central and Eastern Europe. Sustained output growth must rely on supply-
-side policies that increase total factor productivity. Otherwise, macroeconomic im-
balances eventually emerge and a protracted period of low growth is then required
to correct them.
One of the key policy determinants in EU countries during the last decade was
the run-up to monetary union. The paper by Tapio Korhonen focuses on the salient
aspects of Finland’s monetary and exchange rate policies during that period. He
explains the changes in policies that were pursued after an economic and banking
crisis in the early 1990s. Finland’s financial system nonetheless developed rapidly.
Even though almost all varieties of policy were tried, it was the strategy of a float-
ing exchange rate regime combined with inflation targeting that was successful. 
Using that strategy, euro adoption was accomplished without serious problems at
the start of 1999. This is a very valuable experience for acceding countries using
the same policies now.
Finland is also an example of fast and successful liberalization of the financial
market. A legacy of the decades-long regulation era was a large number of national
features of the financial markets, which were highly bank-centred. Surprisingly, one
of the consequences of the economic crisis of the early 1990s was balance in areas
of the economy that had traditionally given rise to problems and adaptation of the fi-
nancial system to the new situation. Despite the initial severity and huge costs of
the crisis, the financial system developed favourably and became increasingly globa-
lized. Despite this concentration of banking business, competition between thebanks
has increased. Similar developments can also be seen in some of the countries of
Central and Eastern Europe. 
We hope that this monothematic volume of Finance a úvûr – Czech Journal
of Economics and Finance will help our colleagues in the economic profession in
the countries of Central and Eastern Europe and beyond to understand better
the challenges, risks and opportunities that will arise from the arrival of the ten
new members in the European Union next year.
Jan FRAIT – Lubo‰ KOMÁREK
373 Finance a úvûr – Czech Journal of Economics and Finance, 53, 2003, ã. 9-10

Joining the EU - The Experience of Selected Current Members (in English)

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Joining the EU - The Experience of Selected Current Members (in English)

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