In May 2004, some 15 years after the fall of the Iron Curtain, eight Central and East European countries are set to join the European Union, alongside Cyprus and Malta. Although the European Commission still sees shortcomings in compliance with the accession criteria, it assumes that the countries concerned will be able to redress these ahead of their admission.

"The candidate countries have devoted enormous effort to fulfilling the entry criteria, and together with the Union they have pushed ahead negotiations on accession at breathtaking speed," according to Allianz Group economists in their latest report "Perspectives of EU Enlargement".

An expanded Union offers enormous opportunities, both for the accession countries and for the current member states. Michael Heise, Chief Economist of Allianz Group, is upbeat about the economic prospects: "The new EU member states will benefit in particular from the emerging recovery in the euro area."

To ensure that European integration remains a success story, existing obstacles need to be removed and potential blunders corrected early. Enlargement will not overstretch the EU financially, but it must be ensured that funds are deployed efficiently. More emphasis than to date should be placed on the subsidiarity principle. Should this not occur, the EU could reach the limits of its ability to absorb new members.

Already, a question mark hangs over the Community’s workability. So far, none of the reforms of Community treaties has succeeded in reorganizing EU institutions to equip them for the future. Certainly, the draft EU constitution does contain ambitious proposals on revamping Union institutions, which is a political step forward. However, there is no convincing concept of a European economic order.

The number of transitional arrangements accompanying this round of enlargement goes way beyond what was necessary. Even if transitional arrangements make sense and are needed on the labor market, say, the multiplicity of regulations conflicts with the idea of the single market and further increases opaqueness.

Originally there were only supposed to be transitional arrangements in valid individual cases. At the end of the day, however, the negotiating partners agreed on around 250 transitional arrangements, not least on the insistence of current EU members. The long transition periods of in some cases up to 12 years are particularly problematic.

The Europe of tomorrow will have regions with wide variations in the speed of integration. "In the past the process of European unification was driven by economic factors. In political terms, however, it has usually constituted nothing more than agreement on the smallest common denominator," notes Heise.

This stems from the considerable discrepancy in the EU members‘ willingness to integrate politically. It can be assumed that this discrepancy will be even more acute in an expanded Union. The idea of a united Europe in the political sense of the word will have to be set aside – but this need not necessarily be a bad thing. Not all members are equally willing or able to share in a deeper European Union.

Enlargement will give a boost to the accession countries on various fronts. Structural reform is likely to be pushed forward in the new member states, leading to enhanced competition and efficiency. It is essential to put public finances back in order, even if this will dampen growth in the short term.

Joining the EU will also help stabilize foreign direct investment (FDI) which in the 1990s played a key role behind economic growth in the accession countries. In recent years the sums reached were sufficient to plug the bulk of the current account deficits. In the coming years the privatization process will draw to a close. On its own, this will tend to lower inflows of direct investment. However, the accession countries themselves can help to keep FDI inflows high by further improving investment conditions.

Heise: "The high level of inflows seen in recent years is unlikely to be matched in future. Nonetheless, helped by EU accession, the region will remain attractive for direct investment."

Alongside direct investment, the export sector in Eastern Europe has been the second driver of growth. EU entry will provide a positive boost here, too. The present European Union is now the main sales market for products from Eastern Europe. On average, some 60 percent of the accession countries’ exports are destined for the EU. All told, export activity is set to rise further, but given the degree of market integration already reached an export boom in the Eastern European countries is not on the cards. However, manufacturing depth will increase, with the Eastern European countries gradually shaking off their role as contract processor.

In future, growth will need to stem more from the domestic side. In most of the accession countries that part of local industry geared mainly to the domestic economy is still clearly underdeveloped. The catch-up process will gather further momentum. EU structural policy will be pivotal in efforts to reduce such disparities in the economic structure. Potential inflows of EU funds will be in the order of up to 6 percent of respective GDP. This is a good basis but it needs to be ensured that the funds are channeled into those sectors which will provide the strongest boost to growth.

Together, annual inflows of EU financial aid and direct investment will amount to between 5 and 10 percent of GDP, depending on the country. If this money is funneled into investment, annual growth rates of around 4 percent real are feasible over the next 10 years. But harmonization of living standards will nonetheless still take a long time. According to the report, average per capita income in the new member states is likely to rise from 23 percent of the EU-15 level today to just under 29 percent in 2013.

The system change in the 1990s also heralded reform of the social welfare systems in the accession countries which in part could serve the present EU-15 as a model. Greater emphasis has been placed on funded provision. However, the expansion of private and occupational pension schemes is not yet complete. The importance of funded pension pillars will grow. To achieve a pension provision level equal to 70 percent of previous earnings, roughly 8.5 percent of annual income would need to be saved on the basis of a six percent return on investment and a time horizon of 30 years. Additional domestic savings will help reduce reliance on capital imports.

Enlargement will bring the prospect of introducing the euro in the accession countries closer. It will not undermine confidence in the euro. Fulfillment of the inflation and interest-rate criteria will not pose a problem, but budget deficits remain critical. Weak economic growth in Western Europe and ongoing structural change are weighing on Eastern European budgets. However painful budgetary consolidation might be, the accession countries would be well advised in their own interest to radically rein in their budget deficits. Without consolidation, strong economic growth is not feasible in the medium term.

Heise: "The Baltic states and Slovenia will join monetary union at the earliest possible date (beginning of 2007). The Czech and Slovak Republics, as well as Hungary and Poland, are likely to follow in 2009."

As with all content published on this site these statements are subject to our Forward Looking Statement disclaimer, provided on the right.