The Role of the European Union in Eastern European Economies
The European Union plays important roles in diplomacy, trade, development aid and work with global organizations.
—European Union External Action
Historians, economists, and political scientists have described the transition process following the post-1989 collapse of communist regimes throughout the Central and Eastern European (CEE) states as a “return to Europe.”1 The task of “reconnecting” with Europe reflected a desire on the part of the elites and a significant portion of the public in these states to (re)claim a heritage or identity that, in political terms, entailed the creation of liberal democratic institutions and, in economic terms, a move toward the creation of market economies. Many believed this would be achieved gradually through participation in European integration and a single market. This chapter will provide the reader with information on the gradual integration of the CEE post-communist states into the European Union (EU), including how the process was influenced by, and how it in turn influenced, the political and economic transformations taking place in those states.
Accession, Negotiation, and the EU
By May 2007, most CEE states had become member states of the EU, leaving only the western Balkans and several former-Soviet Union states outside the EU. In outlining the process for EU accession, the Treaty on European Union states that any European country may apply for membership if it respects the democratic values of the EU and is committed to promoting them. The country must meet the key criteria for accession, as defined at the European Council in Copenhagen in 1993 and referred to as “Copenhagen criteria.”2 The criteria, in essence, state that countries need to possess (1) stable institutions guaranteeing democracy, the rule of law, human rights, and respect for and protection of minorities; (2) a functioning market economy and the capacity to cope with competition and market forces in the EU; and (3) the ability to take on and implement effectively the obligations of membership, including adherence to the aims of political, economic, and monetary union.3 The process for states proceeds in three steps:
When a country is ready, it becomes an official candidate for membership—but this does not necessarily mean that formal negotiations have been opened.
The candidate moves on to formal membership negotiations, a process that involves the adoption of established EU law, preparations to be in a position to properly apply and enforce it, and implementation of judicial, administrative, economic, and other reforms necessary for the country to meet the conditions for joining, known as accession criteria.
When the negotiations and accompanying reforms have been completed to the satisfaction of both sides, the country can join the EU.4
Some elements of the process of accession are subject to negotiation, such as financial arrangements—how much the new member is likely to pay into and receive from the EU budget (in the form of transfers) or transitional arrangements—sometimes certain rules are phased in gradually, to give the new or existing members time to adapt.5
The elements of this process are reflected in the series of transitions experienced by the EU in the 20th century. Historians of the EU mark the decade of the 1990s for Europe as one “without frontiers.”6 The signing of the Single European Act of 1986, which provided the basis for a six-year program aimed at liberalizing free trade across the EU borders in a single market, was completed with the adoption of the “four freedoms in 1993, the movement of goods, services, people, and money.” The formation of the single market was also complemented by the creation of the “Maastricht” Treaty on EU in 1993 and the Treaty of Amsterdam in 1999.
The Maastricht Treaty and the Euro
Europe’s core countries continued to grow closer in the transition and accession processes. In the early stages, exchange rate variability between member states was reduced through the European Exchange Rate Mechanism (ERM), which allowed currencies to fluctuate around parities within predefined bands. In 1990, exchange controls within the European Economic Community were abolished, allowing for the free flow of capital. Although there were crises under the ERM—for example, the United Kingdom was forced out in 1992 when the value of the pound sterling fell below ERM limits—realignments became less frequent over time as monetary policies and inflation rates converged.7
The idea of a common currency slowly gained traction, but it was not until the Maastricht Treaty of 1992 that the “Economic and Monetary Union,” and with it a common currency and monetary policy, truly began to take shape. While creation of a single currency was rooted in Europe’s integration and facilitating economic transactions within the EU, it also helped place the unified Germany that emerged at the end of the Cold War solidly within a common European institutional framework.8
The Maastricht Treaty established convergence criteria to ensure that countries joining the new common currency would be sufficiently similar, and it also gave market forces a significant role in disciplining member states, by establishing the “no bailout” clause.9 To dispel skepticism and preserve fiscal discipline after the common currency was introduced, member countries signed the Stability and Growth Pact in 1997, which was designed to tie policies to fiscal balance and debt targets.10
During the initial stages of CEE accession, external economic assistance came mainly from other countries and international institutions such as the International Monetary Fund (IMF), the World Bank, and the new European Bank for Reconstruction and Development. But as the process of accession gained steam, the EU became a critical force in developing institutions, guiding economic policy, and financing infrastructure for the transitioning states. The process culminated in EU accession for 11 countries (4 of them already euro area members), and candidate status for an additional 3 countries. Reza Moghadam and others argue that this achievement was “inconceivable” 25 years prior and brought tremendous benefits both to the transition countries and to the existing EU members through increased trade, capital, and labor flows.
The Complexities of Accession for CEE States
The path to EU membership, however, was longer and more complex for the CEE states than many of those in neighboring regions (Southern Europe, for example).11 The CEE states varied significantly both in their preparedness for EU membership and with respect to the “political effort” they were willing to undertake to move closer to accession.12 EU accession was a broadly, not universally shared aspiration, as evidenced by the domestic political, social, and economic debates that emerged within the CEE states. Parties who feared themselves “transition losers” included workers in state-subsidized heavy industries, the public sector, small farmers, and individuals on fixed incomes. Social groups emerged with objections to accession on religious, cultural, or ideological grounds. Eager political entrepreneurs took advantage of potential social discord and momentary setbacks to consolidate and boost their own domestic political power. Some parties within the CEE states expressed concerns about the general transition to a market economy and the impact of globalization, political corruption, or bureaucratic incompetence, expressing fears that extended beyond accession. After the collapse of communism, CEE countries found themselves in a potential security vacuum and feared the possibility of returning to totalitarianism, secessionist movements, nationalist movements, or paralyzing political fragmentation that could jeopardize their potential future security, stability, and economic growth. This led to a push for “quick accession to the EU... to ensure this region remained on the path of growth.”13
With the opening of accession negotiations, public debate shifted; the public and political elites become more aware of possible consequences of accession and the debate moved from generalities to specifics.14 Further, the exclusion of the CEE states from the European integration process until their official membership in 2004 and 2007 and the long accession negotiation periods undermined the initially strong enthusiasm among the public.15 What began as a “euro enthusiastic” process of accession and the “return to Europe,” quickly transitioned to “euro scepticism,” and a realization of the complexity of reform measures that needed adoption.16 Cecile Leconte and others argue that in countries where such processes are lengthy and drawn-out, the “perception of a link between the processes can be eroded.”17
Nonetheless, the CEE countries adopted some form of economic liberalization, including changes to monetary policy, elimination of hyperinflation, independence of the central banks, and unification of exchange rates.18 The reforms and EU accession led to positive social, economic, and political benefits for most of the CEE states. Broadly speaking, the EU enlargement to include CEE states provided the “needed impetus for their political and economic modernization.”19 It united Europe in a common vision of democracy, stability, prosperity, and a growing internal market with over 500 million people. For this reason, the 2004 and 2007 enlargements were unique “due to the number of acceding countries, their size, their comparatively low levels of economic development, the predominance of their agrarian sector, and their post-communist past.”20
Security Considerations
The enlargement, in many ways, complemented the North Atlantic Treaty Organization (NATO) in “filling the security vacuum resulting from the dismantling of the Soviet empire.”21 Following the signing of the Balladue Pact in 1993, the EU could help diffuse threats posed by the collapse of communism or any border disputes. In the case of Poland and Romania, for example, “the EU could minimize the inflow of migrants, drugs, arms, and human trafficking,” which constituted important security concerns for both the countries in the post-communist transition period.22
Economic Considerations
CEE accession to the EU opened the way for people to freely travel across national boundaries, reconnect with friends and family in other states, and more easily relocate to other member states, if desired. With the support of the Erasmus Programme, students from CEE countries could complete their education at Western universities and the possibility of study abroad was viewed positively by nearly 84 percent of EU citizens.23 In the case of Romania, for example, university students and faculty received scholarships to study at Western EU member’s states to address a chronic shortage of investment in education and research in the Romania state.24 This was not an isolated case. According to a report produced by the European Commission in 2010, more than 15 million citizens have moved to other EU countries to work or enjoy retirement, benefitting from social benefit transferability and the enlargement of the Schengen Area.25
These positive social changes also illustrate the strength of the EU as an economic unit. The EU is one of the strongest and largest economic and free trade areas in the world. As noted previously, the Treaty of Rome of 1957 based Europe’s reconstruction on the gradual development of a borderless common market involving the free movement of goods, services, people, and capital between participating countries.26 This early vision evolved into the European Monetary System, a precursor to the economic and monetary union launched in 1979, and the 1992 Maastricht Treaty, establishing the European Central Bank.
Despite the rises and falls of the transition period for most CEE states, the process of economic reform and accession led to strong convergence with the western side of Europe. Even before they achieved full member status, Poland, the Czech Republic, and Hungary experienced strong initial growth in gross domestic product (GDP).27 In Poland, between May and August 2007, economic growth was nearly 6.5 percent and unemployment declined from 20 (2003) to nearly 11.4 percent.28 In Hungary, imports from other new member states increased from €4 billion in 2003 to €13.7 billion in 2007.29 After EU accession, a wider financial market in Slovenia opened access to capital that stimulated import-export activity across small, medium, and large enterprises.30 Foreign direct investments sharply increased in Bulgaria, along with GDP—which grew from nearly 35 million BGN (Bulgarian Lev) in 2003 to nearly 57 million BGN in 2007.31 On average, income per capita rose from about 30 percent of EU15 levels in the mid-1990s to that of around 50 percent in 2014.32 That average, noted in 2014 IMF Report, does not include the difference between CEE countries, with some states, such as the Baltics, making huge advances; and others, such as Bosnia and Herzegovina, Moldova, and Ukraine, getting increasingly left behind. On the whole, however, price levels and wages have risen as part of the convergence process.
Political Considerations
In addition to incentives for growth and economic reform, accession to the EU required substantial political reforms in CEE countries. The EU standards imposed criteria for democratization that “aimed at minimizing the danger of a return to authoritarian regimes and centrally planned economies.”33 Following the guidelines of the Copenhagen Criteria and the adoption of the EU acquis, most CEE countries underwent extensive political reform between 1992 and 2002. Many adopted a parliamentary system of government similar to the states in Western Europe, as opposed to the presidential system favored by members of the former Soviet bloc.34 Since that time, most states consciously adopt reforms that bring their governing institutions in closer alignment with western liberal democracies. In Poland, for example, the state’s commitment to EU accession led to changes in the Polish constitution, which diminished the ability for an authoritarian regime to emerge. In Romania, the 1996 election of the Romanian Democratic Convention removed communists from power. This is not to say that politics and institutions are perfectly aligned in the CEE states, and this will be discussed in more detail in Chapter 8, “Political Risk in Eastern Europe.”
The Adoption of the Euro
Before the adoption of the euro and the post-communist transition, CEE states experienced price distortions, with prices detached from market forces. Trading took place primarily among Comecon members, with limited trade with the rest of the world. To integrate the post-communist economies into the international monetary and trading systems, several reforms were needed: liberalization of prices, establishment of currencies as units of exchange, and the establishment of functioning, autonomous, accountable central banks.
CEE states varied widely in their experiences with these reforms. For example, Poland’s new central bank law in 1989 established the independence of the governor, distributed previous commercial banking activities to nine commercial banks, and set a central goal of “strengthening of the Polish currency.” Czechoslovakia adopted similar reforms in 1990. Countries that were not able to adopt these types of reforms (i.e., Bulgaria, Romania, Russia, and Ukraine) were forced to undergo more than one round of stabilization.35
For CEE countries, multiple rounds of accession, negotiation, and reform also mark membership in the EU. The euro area includes those EU member states that have adopted the single currency. But the euro area is not static—under the Treaty, all EU member states have to join the euro area once the necessary conditions are fulfilled, except Denmark and the United Kingdom which have negotiated an “opt-out” clause that allows them to remain outside the euro area.36
CEE accession countries that plan to join the EU must align many aspects of its society—social, economic, and political—with those of other western EU member states. According to the European Commission, the purpose of this alignment is to ensure that an accession country can operate successfully within the EU’s single market for goods, services, capital, and labor—accession is a process of integration.
In this structure, adopting the euro and joining the euro area takes integration a step further, “it is a process of much closer economic integration with the other euro-area Member States.”37 Adopting the euro is an exhaustive process that requires even greater economic and legal convergence.
The euro’s architecture was built on the premise that market forces, combined with minimal coordination of policies, would sufficiently align economies, discipline fiscal policies, and allow countries to withstand idiosyncratic shocks. According to Susan Schadler and other scholars,
relinquishing monetary policy could lead to greater economic volatility unless adjustment to shocks that are asymmetric with respect to the euro area occurs efficiently through other channels— primarily fiscal policy and wage and price flexibility—or the incidence of such shocks is reduced owing to the discipline of the euro area macroeconomic policy framework and the elimination of variable emerging market risk premia.38
At the time of Schadler’s study, economists identified the Baltic states—Estonia, Latvia, and Lithuania—as having closer policy links with the euro area, while five other central European countries—the Czech Republic, Hungary, Poland, the Slovak Republic, and Slovenia— as requiring major changes in their macroeconomic policies and policy frameworks in their efforts toward adoption of the euro.39
In October 2004, the European Commission chose to assess the 10 countries joining the EU. Although the maximum 2-year period referred to by the Treaty had not yet elapsed for these countries in 2004, the obligatory reassessment of Sweden was taken as an opportunity to analyze also the state of convergence in the new member states. The report concluded that none of the 11 assessed countries at that stage fulfilled the necessary conditions for the adoption of the single currency.40
Since that time, multiple assessments of the CEE states have taken place. In 2013, the European Commission finally concluded that Latvia fulfilled all conditions for adopting the euro, and in 2014 they came to a similar conclusion regarding Lithuania. The next regular convergence assessment, covering all member states with derogation, is scheduled for June 2016.
Given the incredibly stringent rules and multiple layers of assessment, as well as the extended timetable for adoption, one might wonder what drives the CEE states (and other EU member states) to seek membership in the euro area. The European Commission sites the following benefits,
more choice and stable prices for consumers and citizens; greater security and more opportunities for businesses and markets; improved economic stability and growth; more integrated financial markets; a stronger presence for the EU in the global economy; a tangible sign of a European identity.41
Less optimistically, Ott Ummelas argues, “Euro membership proved that a country had the discipline to join one of the world’s most exclusive clubs.”42 On May 20, 2011, Poland’s central bank governor, Marek Belka, said his country and the region would not get the benefits they had anticipated from a quick adoption of the euro. As far back as December 2010, Czech Prime Minister Petr Necas said his country could refuse to adopt the single currency as long as it deems it beneficial to keep the koruna.43
Yet, other CEE states have expressed a strong desire to join the euro area, or are glad they already took steps to do so. Hungarian Foreign Minister János Martonyi said on June 22 that adoption remains a primary goal. Slovenia, already a member, has profited from being a member of such a large currency zone. Estonia, Latvia’s and Lithuania’s neighbor, endured many hardships to join.44 On balance, Harvard professor Jeffrey Frankel argues that monetary unions, such as the euro, facilitate trade. As trade patterns and cyclical correlations gradually shift toward Western Europe, the argument for euro adoption in the CEE states strengthens.45
1 For just a few examples of the use of “return to Europe,” see: Smith (2000); Bideleux and Jeffries (2007); Wolchik and Curry (2011); Jacoby (2004).
2 See the European Commission (1993).
3 European Commission (2015).
4 European Commission (2015a).
5 European Commission (2015).
6 European Commission (2015d).
7 BBC News: World Edition (2001).
8 Treaty of Maastricht on European Union (n.d.).
9 Treaty of Maastricht on European Union (n.d.).
10 Resolution of the European Council on the Stability and Growth Pact Amsterdam (1997).
11 Heinisch and Landsberger (n.d.).
12 Heinisch and Landsberger (n.d.).
13 deCrombruggle, Minton-Beddoes, and Sachs (1996, 3).
14 Whitefield and Rohrschneider (2006).
23 BIS: Department of Business, Innovation, and Skills (2010).
25 BIS: Department of Business, Innovation, and Skills (2010).
26 For more information, see: The European Union Explained: Economic and Monetary Union and the Euro (2014).
27 BIS: Department of Business, Innovation, and Skills (2010).
28 Karasinka-Fendler (2009, 122).
31 Krassimir and Kaloyan (2009, 29).
34 For more on this, see Beachain, Sheridan, and Stan (2012).
36 European Commission (2015a).
37 European Commission (2015b).
40 European Commission (2015b).