When the European Union took in 10 more countries in May 2004, many people across Europe feared that its enlargement would wreak havoc in the economy and bring EU decision-making to a halt.
One year on, it is clear that enlargement was a success. It has boosted growth in the new member states and spurred economic reform in the eurozone. Politically, however, the EU has not yet digested enlargement, and there are worrying signs of widening divisions between "old" and "new" Europe.
Most economists expected the accession to have little impact on growth in central and eastern Europe as trade integration between east and west was almost complete by the time the new members joined the EU. And foreign investors had already ploughed billions into eastern Europe in anticipation of accession.
spending boom
Nevertheless, the newcomers enjoyed something of an accession boom. In early 2004, east Europeans went on a shopping spree, fearing that tax rises related to EU entry would soon push up prices. Surging demand, in turn, prompted businesses to invest more. Foreign direct investment also remained strong, as west European companies continued relocating production into lower-cost countries such as Slovakia and Poland. Exports and imports between the new members and the eurozone grew at double-digit rates in 2004, spurred by the removal of the remaining trade barriers.
As a result, real GDP growth in the east European members averaged a healthy 5% in the accession year, a full percentage point more than in 2003. For 2005, forecasters expect only a mild slowdown: it seems that the boom has become self-sustaining. Strong economic growth has alleviated fears that the new members would fare badly in the EU. Even farmers – previously the most sceptical group in eastern Europe – now seem happy. The arrival of EU farm subsidies and surging EU demand for cheap east European food products boosted their incomes in 2004.
The boom has bolstered support for the EU. The very low turnout at the European Parliament elections in June 2004 appeared to indicate the new members were already disillusioned with the EU. But the most recent opinion polls from Eurobarometer shows growing support among the east Europeans.
Although almost 40% are still unsure whether being in the EU is good or bad, their views on membership are becoming increasingly positive. Public support has allowed governments to continue the economic reforms demanded by Brussels – despite the fact that all east European member countries went through some kind of government crisis over the past year.
Slovakia first
The Centre for European Reform's 2005 Lisbon scorecard classifies Estonia, Slovenia, Poland and other newcomers as "heroes" in reform areas ranging from innovation to market opening. The World Bank has singled out Slovakia as the fastest-reforming country in the world in 2004. Alongside Lithuania, Slovakia now ranks among the top 20 countries for the ease of doing business. France, Germany and Italy do not make the grade.
As expected, enlargement had much less of an impact on the "old" EU members – the east European economies are too small to directly influence growth in Germany or Italy. But accession may be delivering what years of anguished debate failed to achieve, namely faster reforms in the big eurozone countries. Nowhere is this more obvious than in the area of taxation.
tax reforms
Most east European countries lowered their corporate tax rates in the run-up to accession when they had to abolish investment tax breaks. Some countries, such as Slovakia and Lithuania, went further by introducing flat taxes on any kind of income. These tax reforms could trigger a chain reaction across the continent. Austria slashed its corporate tax rate to 25% from 34% in January. Germany announced a profit tax cut to 19% from 25% in March. It may only be a question of time before France and Italy follow suit.
Changes in labour markets could be even more important. Faced with the threat of their jobs moving eastwards, workers at Siemens, Volkswagen and scores of other German companies have agreed to wage freezes and longer working hours. France has loosened the rules of its 35-hour week. Both countries are trying to free up labour markets in response to heightened competition in the enlarged union.
Such reforms will be good for eurozone growth in the medium to long run. But in the short run, they have turned many west European voters against enlargement, and even against the EU generally. There are now as many people in Germany and Austria who think that EU membership is bad as there are in eurosceptic Sweden and Britain, according to Eurobarometer. A solid majority of Austrians, Germans and French are against any further enlargement, in particular if it includes Turkey.
With constitutional referenda and national elections coming up, politicians in these countries have started to exploit anti-enlargement sentiment. The new members are accused of "social dumping" – a politically charged word for low-wage competition. Notwithstanding the fact that Poland spends as high a share of its GDP on social security as Germany and that Czech and Slovak payroll taxes are higher than the EU average, many workers sense that competition in the enlarged EU has somehow become "unfair".
east-west divisions
In March thousands of people took to the streets of Brussels to demand the defence of "social Europe". The east Europeans, meanwhile, suspect that "old" Europe (perhaps with the exception of Britain, Ireland and some of the Nordic countries) is trying to prevent them from reaping the full benefits of membership.
East-west divisions are becoming apparent in some EU negotiations, in particular those about the services directives, the EU budget and tax policy.
If such divisions become entrenched, the EU will risk losing many of the benefits from eastward enlargement. In a divided Europe, "old" Europe could be slow-growing, reform-resistant and perhaps more protectionist. "New" Europe would be resentful, more eurosceptic and perhaps politically volatile. Politicians on both sides should remind their voters how much their countries have already gained from enlargement and continue to see it as an opportunity, not a threat.
Katinka Barysch is chief economist at the Centre for European Reform