EU expansion. The joys of enlargement

Date: 10/04/04

What May Day will mean for European business

MORE than 70m people in central Europe will wake up on May 1st to find themselves citizens of the European Union. Eight countries in the region, along with the Mediterranean islands of Cyprus and Malta, will become the EU's newest members. European laws will take precedence over national ones, customs codes will be replaced by the rules of Europe's single market, and Brussels will have the last word on matters ranging from competition policy and value-added tax to sex discrimination in the work place.

Governments and firms have been hoping and planning for this moment since communism collapsed in 1989-91. With so much advance notice, big economic adjustments in the private sector have already taken place. Foreign direct investment has poured into central Europe in the past decade, drawn by a combination of low wages and guaranteed access to EU markets. A wave of new factory-building in the region may even have passed its peak, as the competition from China has grown stronger. Now the EU's new members must move up-market, to lure higher-paid, higher-skilled jobs in service industries such as scientific research and information technology.

They have a good chance of succeeding. By banning or limiting legal inflows of cheap workers from central Europe for two-to-seven years after enlargement, the governments of France, Germany and other rich EU countries are forcing their firms to go on pursuing cheap labour by investing abroad. Even for big companies, central Europe will retain some advantages over Bangalore or Beijing when viewed from the West: productivity is higher, tariff and border problems are disappearing, shipping costs are lower, and the business environment is more familiar. As for medium-sized firms in western Europe that want to cut costs but lack the resources to cope with exotic business environments, central Europe will offer a very reassuring option for investment and outsourcing once it is within the EU.

Most barriers to trade in goods between the EU and the new members have already fallen, leaving only a few to go in May. These last restrictions cover about 5% of current trade by value, mostly farm products. Alas for consumers, there is little prospect that their removal will flood western Europe with cheap food, as protectionists claim. Prices for many farm products in central Europe have risen close to EU levels; farm productivity remains low; the region's big dairy industry will be hobbled by EU milk quotas; and the EU's tough health standards will limit meat exports.

Multinational firms are fighting as fiercely for sales in the consumer-goods markets of central Europe as they are in those of western Europe, often more so. But though the EU's new members no longer count as emerging markets, they are not quite mature ones either. Prague and Warsaw may be full of smart supermarkets, but outside the big cities there are very few moneyed consumers. Average incomes in central Europe are barely one-fifth of those in the current EU, so full convergence of living standards is decades away at best. Given this, most multinationals plan to retain separate divisions and strategies for western and central Europe, despite enlargement. They are more likely to integrate operations across the EU later in the decade, as the central Europeans begin to adopt the euro, according to a survey conducted by the Economist Corporate Network, a sister firm of The Economist.

For firms of all kinds in central Europe, the main change on May 1st will come with the need to know and obey EU laws and regulations. But these are so extensive and complicated that few firms (and no governments) have mastered them fully. Some countries have not even finished translating them. It will take months and years for inexperienced courts, tax offices and other government agencies to gain experience in interpreting and implementing them. As long as differences between old national rules and new EU ones remain to be ironed out, firms may encounter inconsistencies between the two - for example, in the collection of value-added tax, where the EU establishes the over-riding principles but national governments decide the practical implementation. Companies caught in such conflicts should “follow the rule that suits them best, and hope”, says one tax consultant.

The accession countries already have national laws on competition and state aid, drawn up with EU entry in mind. But the rules here are likely to be implemented more rigorously after May 1st, when EU law takes effect directly and the final authority to enforce it passes to the European Commission, the EU's executive body. “If you have 40% of the market...then worry,” says Ann LaFrance, a competition lawyer with Squire, Sanders & Dempsey.

If the commission determines that a company has seriously breached competition law, it can impose a fine of up to 10% of its global turnover, as Microsoft found recently. Suppliers and customers in central Europe will have a few months' grace to make sure that their contracts contain no unfair pricing provisions or other restraints. Then the commission will be on the prowl, and may well be looking for some high-profile cases that will send clear messages to the market. State aid will also be policed more strictly: companies receiving illegal aid in cash or in kind may be forced to repay it all.

Business people in central Europe know that the problems of EU membership will not end with the many teething troubles of accession. Membership will mean a constantly evolving body of restrictive laws in areas such as environmental standards, health and safety, and corporate governance - quite a lot of them ill-adapted to the needs of poorer countries. Yet they are optimistic on balance. They expect such costs to be dwarfed by the benefits of better public administration and a stable, uniform and more open business environment. From May 1st, this optimism can be put to the test.

What EU enlargement in 2004 will mean for businesses in the new Member States, the existing Member States and multinationals.

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