European Union: A Big Payoff From A Bigger EU

In May, 2004, the single-market European Union will expand from 15 countries to 25, incorporating 10 Central and Eastern European (CEE) nations, with full integration into the single currency likely three to six years later. Most studies have concluded that the net economic benefits to existing EU members will be positive, but very small. But the potential pluses may well be understated.

"The quantitative models aren't able to capture all of the integration effects," says Elga Bartsch in the London office of Morgan Stanley (MWD ). Most studies analyze only the impact of integrating the market for goods, while services, some 70% of the economy, are ignored. For example, the European Commission has estimated that a fully integrated single market for financial services alone could add 1.8 percentage points to growth in gross domestic product over the next decade. Also, most models fail to capture potential gains from technological change as competition and the larger market boost research and development, investment, and productivity.

Taking the Final Step
Perhaps most important, new competition from Eastern Europe's high-skilled, low-cost labor force will only make structural reform in the West more urgent. "It might not be such a surprise that we see major reforms coming through in Germany at the moment," says Bartsch. A recent International Monetary Fund study concluded that bold labor- and product-market reforms in the EU could add 8 percentage points to EU GDP growth over the long term.

EU expansion will produce both winners and losers. Most studies agree that Germany, Italy, Austria, Sweden, and Finland, who have close trade and investment ties with the East, will be gainers. France, Spain, Portugal, Greece, and Ireland are likely to be losers, given the sizable funding they receive from EU programs -- especially France's agricultural funds -- as the money gets stretched over 10 more countries.

Clearly, the CEE nations stand to gain the most, but the full benefits won't be felt until the new members adopt the euro, which requires them to align their budget deficits, interest rates, and currencies within the guidelines in the Maastricht Treaty.

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