Struggling to join the euro

Barely 17 years after the collapse of communism in eastern Europe, Slovenia, on 1 January, secured entry into one of the most exclusive capitalist clubs on the planet - the eurozone.

And, like Bulgaria and Romania, which, on the same day became the 26th and 27th members of the EU, the timing could scarcely be better, at least from an economic perspective.

After flirting with stagflation through much of 2005, euro-area growth in 2006 should have surged to 2.6% according to the Commission’s autumn economic forecasts. This growth revival, even though it may slow to 2.1% in 2007, is proving a blessing to eastern European countries as they seek to profit from EU membership and catch up with their western neighbours’ living standards. Provided the global economic environment remains as benign as it is today, the EU12, the ten countries that joined in 2004 and this year’s two new members, should continue to grow rapidly.

"The strong recovery in German industry in particular is very positive for countries like Poland and the Czech Republic," says Lars Christensen of Danske Bank. "Their economic cycles are becoming increasingly German," he adds.

But improving economic performance and, in several cases, relatively low general inflation and interest rates, have fuelled worrying asset price inflationary booms, especially in some EU12 property markets.

Positive integrative economic forces are at play, too, in the Baltic region, Danske’s Christensen says. "The Baltic states are enjoying near Chinese rates of growth, 7-9%. [They] have adopted Anglo-Saxon economic models with a Scandinavian work ethic and they are being colonised by German and Scandinavian businesses." With the threat of an increasingly aggressive Russia on their eastern borders, they are more than happy to welcome foreign investors.

But, for most of the EU12, catching up with levels of prosperity in the West will be a long process. At the long run 4-5% growth rates which are expected for the region as a whole it could take 25-35 years, even if progress is relatively smooth. Some will make more rapid progress.

Slovenia, for example, has not become the first of the EU10 to join the euro area by accident. It has followed cautious economic policies for years, keeping its budget deficits and inflation down and maintaining stability in its international accounts. Even under communist rule it was more pros-perous than many of its neighbours. A small country with only around 2 million inhabitants, gross domestic product (GDP) is already a healthy €12,000 per capita. This compares with €3,500 for Romania, which has a population of 22m and €2,680 for Bulgaria, with a population of 7.5m. Germany’s GDP per capita is €22,000.

Romania and Bulgaria are already becoming more integrated into the EU economically, however, profiting not only from low labour costs but also from vigorous reform efforts. Romania, for example, is developing promising information technology supply businesses. But according to recent academic research at the Massachusetts Institute for Technology, it has a long way to go in raising the quality of its labour.

Managing the expectations of the EU12 will be a challenge, especially as they become more prosperous. Lithuania was bitterly disappointed at Brussels’ refusal last year to allow it into the single currency, a decision which some attribute mainly to a desire to maintain the entry barriers as high as possible.

One lesson from the launch of the single currency in 1999 is that the members took tough decisions when there was a danger of exclusion but once they were inside reform efforts slackened off, notably in Italy.

Avoiding a repetition with the new member states is a priority, not least because they are so far behind most of the existing Eurogroup members in terms of their economic development. The carrot of euro membership will have to be kept dangling tantalisingly in front of the new member states in order to foster economic and political reform and maintain popular support for the EU. But entry conditions will be applied rigorously, as Lithuania discovered.

Barely 17 years after the collapse of communism in eastern Europe, Slovenia, on 1 January, secured entry into one of the most exclusive capitalist clubs on the planet - the eurozone.