Perils of enlargment

The entry of 10 new countries into the European Union (EU) from May 1 represents an opportunity as well as a potential threat to the economies of the old EU member states. This is more so for Greece, which still relies on EU structural funds to finance its growth, has a rather significant agricultural sector and more labor-intensive industries to care for. In addition, Greece will have to compete more directly with the new members to attract foreign direct investment (FDI) and protect its market share in merchandise exports in the old EU of 15 member states. It should be clear that Greece stands to lose more than gain from the EU’s eastward enlargement if it does not change course and improve its international competitiveness fast. The downward revision of last year’s GDP growth to 4.3 percent along with a more somber assessment of this year’s growth prospects, put at some 3.7 percent by the new government, have combined to fuel skepticism about the future of the Greek economy after the impetus from the 2004 Olympics fades. These concerns have been compounded by the inability to limit spending and control the budget deficit, expected now to surpass the 3.0 percent of GDP mark both this year and last. Whether this is just the outcome of an accounting exercise coupled with an attempt on the part of the new government to lower expectations remains to be seen. There is no doubt, though, that it sends a powerful message to the general public, the markets and the corporations that something is wrong and has to be fixed. There is little doubt that Cyprus’s accession to the EU and the above-mentioned economic developments have contributed to lack of debate on the potential impact of the EU’s enlargement on the local economy. Greek society’s propensity for ignoring important issues, such as the consequences of the EU enlargement, until they are actually felt has also contributed to that effect. The optimists like to look at the positive factors of enlargement and talk of a demand boost that the EU 15, including Greece, will experience as a result. Although the 10 new countries are already growing faster than the old EU 15 and are expected to continue to do so on average this year and next, they will add just 5 percent to the GDP of the old club. It is natural to expect that the 10 new members will seek to join the eurozone in the next few years. This is likely to lead to lower inflation and interest rates, further fueling economic growth and increasing demand for imports from the old members. This should have been good news for Greece, but it is not the whole story. A number of traditional local merchandise exports are price sensitive and therefore less competitive as Greek unit labor costs have been running faster than in the EU-15 average in the last few years. Moreover, the preferences of the consumers in these countries are becoming more and more westernized by all accounts, meaning they demand imports with greater quality content, effectively raising a barrier to a number of Greek product exports. Although a number of products exported by the new EU countries are competing against Greek ones in the markets of the old EU-15, one has to admit that a great deal of the adjustment has already occurred. According to studies, the volume of Greek exports to the EU 15 increased by 40 percent during the 1993-2000 period whereas in the case of some of new members, namely Poland, Slovenia and Estonia, export volume growth to the EU-15 markets surpassed the 100 percent mark in the same period. Still, much lower labor costs and the flexibility of allowing their currencies to slide against the euro ensure the advantage enjoyed by the exports of these countries over comparable Greek labor-intensive exports will get bigger and bigger, resulting in market share losses and ultimately jobs. Although labor productivity plays an important role in shaping unit labor costs, one should not ignore the fact that labor costs per hour are estimated at 10.40 euros in Greece versus 10.74 euros in Cyprus and 8.98 euros in Slovenia, the two most labor-expensive countries among the 10. Moreover, corporate tax rates are much lower in the 10 new countries than in the EU-15 club. The difference in statutory tax rates between the old club and the 10 new members is estimated at 14 percentage points, 33 percent to 19 percent. Not surprisingly, Greece, along with Spain and the Netherlands, commands the second highest tax rate at 35 percent, with Germany beating them at 38 percent. Although the 10 new countries receive low marks for transparency and economic efficiency, they have been able to attract huge amounts of foreign direct investment (FDI) over the past decade, banking on their inexpensive, educated labor force, flexible labor markets and low corporate tax rates. For Greece, a country in need of more FDI to compensate for the potential loss in significant amounts of EU structural funds, estimated at some 4.0 percent of GDP per annum, this is not good news either. Of course, these issues are not the only ones. The future of the Common Agricultural Policy, especially after 2013, and its impact on Greek farmers also remains to be seen. The same is true for the scale of immigration that the entry of the 10 new EU countries may unleash. So, setting aside any political considerations related to the entry of Cyprus into the EU, the Greek economy is not likely to benefit from the EU enlargement. This, of course, depends on the ability of the Greek government to turn things around and help improve the economy’s competitiveness as well as the ability of local businessmen to seize the opportunities existing in the new partners. It may be too early for judgment but things do not look particularly bright at this point.

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