EU companies have little to fear from eastwards expansion

Date: 28/01/1999

By Simon Taylor

FEARS that expanding the Union to take in the five leading applicants for membership from central and eastern Europe could pose a serious threat to investment in existing member states are unfounded, according to a new study on the likely impact of enlargement.

It concludes that expanding the EU to take in Hungary, Poland, the Czech Republic, Slovenia and Estonia would not result in a massive surge in imports from the region or a significant shift in investment from west to east.

According to the study by the Brussels-based think tank CEPS, trade between the EU and the five front-runners has already been almost fully liberalised, because the countries themselves have made major efforts to cut import tariffs.

The report's author Paul Brenton says this means full Union membership for the five will not significantly increase trade flows as most barriers will already have been removed. "There is no compelling evidence for large increases in trade with the central and east European countries [CEECs]," he told a recent conference.

His report points out that the remaining import tariffs on industrial goods are in the process of being abolished as part of the EU's association agreements with the five countries. This includes products where the price is highly dependent on the cost of labour - which is much lower in the CEEC countries - such as textiles, clothing and shoes. "Fears of a surge in imports of such products into the EU from the CEECs appear to be without substance," concludes Brenton.

However, some countries are likely to be hit harder by increased competition from the east than others, with Portugal expected to be the worst affected because of its reliance on exports of products such as textiles and shoes which the applicant countries also sell abroad in large quantities.

One key change which will occur in the run-up to enlargement is that accession countries will have to abolish a range of technical barriers to trade such as different product standards, certification requirements, inspections and border controls.

But the report says that it is difficult to assess the precise implications of these changes for trade flows, although it is clear "those that enter first will benefit at the expense of those left outside", as many of the countries in the region produce and export the same type of goods to the EU.

Brenton also rejects fears that enlargement will prompt companies to invest far more heavily in the applicant countries, at the expense of existing Union member states, to take advantage of wage costs which are 20-30% lower than EU levels.

He argues that foreign direct investment (FDI) in the five leading contenders is already very close to the usual levels seen in advanced market economies. This is because these countries have completed ambitious programmes of privatisation and market liberalisation, the main factors in attracting foreign funds.

"For the more advanced transition economies, there is no evidence that FDI inflows are comprehensively below their potential level," said Brenton, who argues that foreign investment will therefore not rise above current levels when they join the Union.

His study concludes that the main factor which will determine the inflow of foreign funds in future will be income levels in the applicant countries. In the case of Bulgaria and Romania, which are lagging well behind in making the transition to a market economy, the amount of capital being put into the country could increase if "suitable conditions for foreign investment are created".

The report also argues that the risk of companies investing in central and eastern Europe rather than at home are exaggerated. "Outward FDI to the CEECs has been less than one half of 1% of domestic investment for all the countries considered," it states. "This clearly suggests that the direct impact of overseas investment in the CEECs on domestic investment in Organisation for Economic Cooperation and Development countries must be very small."

But the study's findings have been challenged by other economists specialising in enlargement and investment issues.

"It is wrong to say the effect of enlargement on FDI flows would be insignificant," said Ros Lifton, eastern Europe specialist at HSBC research in London. "A Japanese or US firm may put a new office in Hungary rather than Germany because of lower wages and the regulatory environment."

She added that there would always be competition over tax regimes, pointing to the current debate among existing EU member states about eliminating predatory tax policies as evidence of this.

CEPS Internet site: http://www.ceps.be.