Online Extra: Where Membership Has Its Disadvantages

Pushing hard to join the EU, Central Europe tightly linked its economies to those in the eurozone. That was a plus -- until the slump began

Many business leaders and politicians in Central and Eastern Europe are looking at their economies and growing worried -- for good reason. In the decade since they ditched communism, they have labored mightily to transform their countries into market-oriented democracies with growing ties to Germany and the European Union.

But just as they're reaching the final stages of a deal to enter the prosperous 15-nation club -- up to eight countries in the region are likely to join the EU on Jan. 1, 2005 -- they're feeling the effects of the slowdown gripping the Continent, especially Germany, the EU's largest economy. As a result, the jobless ranks are growing in Central Europe, and swelling alongside is anti-European sentiment. "The short-term outlook certainly doesn't look rosy," says Tomasz Koskucki, president of Hoga, a Web portal based in Katowice, Poland

Still, growth rates in the east are above depressed EU levels (see table below). And productivity is climbing at an impressive 6% annually. What's more, billions of dollars in foreign direct and portfolio investment continue to flood in. Poland, the Czech Republic, and Hungary are already all but wedded to the EU economy. More than 50% of their banking and insurance company assets are now owned by regional institutions, and over 70% of their exports go to the EU.

DRAGGED DOWN.

  But greater integration and dependence mean that they're badly hit by slumping demand from the eurozone, especially in Germany, which is teetering on the brink of recession. As growth slows, Central Europe's drive to catch up to with the West faces a setback. Certainly, none of them has hit the stellar growth pace that Ireland, Spain, and Greece achieved before and after they joined the EU.

Feeling the worst pinch is Poland, by far the region's largest economy and for years its star performer. Growth in Poland was a mere 1% last quarter, says Maciej Reluga, an economist with ING Barings in Warsaw. For the year as a whole, it will be lucky to muster growth of 3% -- well below the 4.5%-plus rates achieved during most of the past 10 years. Unemployment is hovering at 16%, and with tax receipts down and social spending up, the budget deficit is ballooning.

Jittery investors have been dumping Polish securities, the zloty is sinking, and the Warsaw stock exchange has fallen to four-year lows. "The German recession is hitting the region hard," Reluga says. "Integration with the EU has its drawbacks as well as its benefits."

The picture isn't as bleak in Hungary, the Czech Republic, or the region's other countries. But economists warn that they may soon follow Poland's lead. "With Germany doing so badly, it's hard to see us doing well," says Antonin Zvojski, who owns a small factory making garden furniture and equipment near the Czech city of Cheb. "More than 80% of my products are sold to Germans."

The irony is that the region is now focused almost exclusively on the EU at a time when the Russian economy has finally started growing strongly. "We've reoriented ourselves so successfully to the West that we hardly benefit from stronger growth to the East," notes Polish economist Wieslaw Rosynski.

STILL COMMITTED.

  Despite the worries about fallout from the eurozone slump, few policymakers and even fewer business executives doubt that joining the EU is critical for the region's long-term prosperity. They hope to wrap up negotiations for entry by the end of next year, with a view to becoming members at the beginning of 2005 at the latest. "All economic roads lead to the eurozone, especially to Germany," says Zvojski. "Membership of the EU will undoubtedly help our living standards catch up with German levels -- though it may take longer than we originally hoped."

But they no longer look at the EU through rose-tinted glasses. And there's widespread criticism of Europe's unwillingness to make the radical structural reforms that economists say are needed to get the EU economy moving. "We've made further-reaching structural reforms than they have in France or Germany," says one Hungarian banker. "Maybe it's time for them to take a leaf out of our book."

Central European Economies Have High Investment Ratios...

Data: International Monetary Fund, Goldman Sachs

...And Are Growing Faster Than the Eurozone

Data: Eurostat, national central banks

Likelihood of EU Enlargement

(percentage probabilities)

Data: Goldman Sachs

By David Fairlamb in Frankfurt.

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