Why Business Should Support a Risky Political Enterprise: Companies Need EU Enlargement in Order to Secure the Opportunities Which Have Flowed from Economic and Political Reforms in Eastern Europe. by Taking the Initiative Now They Can Be Good Corporate Citizens as Well as Wise Investors
Cecchini, Paolo, Jones, Erik, Lorentzen, Jochen, European Business Forum
For two compelling reasons, executives of international firms should take an active interest in how the European Union manages its Eastern enlargement. The first is that despite the marginal role East European economies still play in world trade and investment, at least some--and, in the long term, potentially all--of them belong to Europe's most dynamic growth areas. Thus, they represent business opportunities. The increasing integration between East and West over the past decade has brought economic benefits to firms and consumers alike. East European firms are participating in EU-centred production hubs and have joined global corporate networks. Compared to large parts of Asia, Africa, and Latin America, the countries currently striving to join the EU are among the more stable emerging markets, and foreign investors have used them successfully to increase their global competitiveness in many sectors. Along the way, they have helped advance industrial modernisation and technological upgrading in the transition economies. This is good news.
The second reason is that the enlargement of the European Union is not the same thing as the economic integration of West and East. Put another way, without the prospect of enlargement, economic integration is ultimately bound to fall short of its potential. This could be bad news. Why that is so, and what businesses can do about it, is the topic of this article.
The economic transformations underway in Eastern Europe have had effects that--while not unfamiliar in most advanced industrial societies--could destabilise fledgling democracies. Take the misery of poverty for example: the European Bank for Reconstruction and Development (EBRD) estimates that the number of poor people roughly quadrupled during the transition. For young political democracies and emerging market economies, the discontent that results from deprivation makes for a bad bedfellow. The problem is that economic reform and growth alone will not eradicate poverty; indeed, they may exacerbate it. The European Union's enlargement to the East and South is an attempt at countering this risk of destabilisation. Given the wide disparities in economic capacity between the candidate countries and existing member states, and the difficulty of stabilising political regimes through the process of developing market economies, the task at hand is enormous.
Risk is contagious
Enlargement creates political risks for the EU even as it works to alleviate such risks elsewhere. It will upset old bargains at the heart of the EU's system of transfer payments, especially in agricultural subsidies and regional convergence. The EU will have to find new compromises, unpalatable to many, over an institutional set-up that would allow an enlarged Union to continue to function. To be sure, under current arrangements a united Europe and a workable Europe are a contradiction. Finally, a more complex and more complicated Union could lead to a de facto reduction in co-operation among the member states and, ultimately, to a loss of purpose for the whole edifice of European integration. These risks are real, and they are serious, notably so for firms who have benefited from the completion of the internal market over the last decade and a half.
Nevertheless, a failure to act would be even more perilous. Economic integration takes place piecemeal through the activities of firms and individuals. By contrast, European enlargement is a structured, formal process. To be brought to fruition, the opportunities associated with the former need the assurance of the rules and procedures that come with the latter. This will be successful only if business elites prod political leaders on both sides of Europe to show the political courage and wisdom to insist on EU enlargement as the most desirable formula for guiding integration toward prosperity and stability in Europe. Not only the effectiveness and the legitimacy of the European Union but also the competitiveness of Europe-based firms are at stake.
In the West, European Heads of State and Government must press ahead with institutional reform that is essential for the success of enlargement. In addition, they must quickly improve the perception of enlargement in Western public opinion. In the East, governments must not only adopt but also apply the more than 80,000 pages of European Union legislation known as the acquis communautaire. Any attempts to bargain for opt-outs or to slow down the process of implementing these provisions will only encourage existing members of the Union to delay the date at which any treaty of accession can come into force. At the same time, however, many of the candidate countries have begun to attach considerable political importance to fixing the date of accession as soon as possible. This tension between unnecessary delay and peremptory action is detrimental. The quality of the negotiations is more important than the date by which they are completed. By implication, West and East must be committed to solving any problems prior to accession, but without drawing out the process. And governments on both sides, but especially in the East, must find ways to reconcile the gains to society at large with the losses imposed on vulnerable groups.
European firms have a stake in the success of the political project of EU enlargement. Successful enlargement will help to ensure successful integration. This is beneficial to American companies as well in that it will help the transition economies converge towards global standards in trade and investment.
East-West Business Integration
In the global economy, Eastern Europe is a new kid on the block. The region is still struggling to regain its output level from prior to the transition. Only three countries--Hungary, Poland and Slovenia--have a higher national income than ten years ago. Eastern Europe is also a small player. In the late 1990s, its share in world trade was about two per cent--no more than Mexico's. And cumulative flows of foreign direct investment (FDI) 1989-98 amounted to $81bn. This is only half as much as Brazil's inward stock, about as much as Thailand's and Indonesia's taken together, and only slightly more than Africa's.
But new kids need to be judged not by their size: ambition and potential are what count. And here the picture looks distinctly different. Since the mid-1990s, a few East European economies had significantly higher growth rates than most EU countries. Growth in their trade noticeably outstripped the world average. And FDI inflows grew faster than those aimed at developing countries or advanced economies. With a share in world inward FDI stock of a quarter per cent in 1990, there was clearly a lot of catching up to do. For the whole region, the ratio of FDI to gross fixed capital formation is 9 per cent, compared to 6 per cent for the world and 8.5 per cent for developing countries. But in individual countries such as Poland and Hungary it reaches between 20 and 30 per cent. Hence, by many measures at least part of Eastern Europe has evolved from a rather closed to a truly internationalised economic space.
Since the opening of the East European economies a decade ago, East and West have integrated more and faster than seemed possible only a few years ago. And survey results confirm that firms on both sides have found ways to work together even when the trade provisions of the Association Agreements restricted their commercial ambitions. The change in the geographic composition of Eastern Europe's trade toward the EU was so fast and sizeable that the EU and the candidate countries now have a similar regional trade structure. The share of Estonia's exports to the EU is as high as that of Greece, and the share of Czech and Hungarian imports sourced in the EU is equivalent to France's. An increasing part of this trade is intra-industry which demonstrates the growing complexity and maturity of economic integration between the EU and the transition countries.
In fact, western firms have been busy setting up cross-border networks. In 1999, mergers and acquisitions involving international groups in the East totalled $17billion, almost twice the figure of 1998. Research by the World Bank shows that the EU has become a hub for the candidate countries in office equipment, automotive supplies, telecommunications and more traditional sectors such as furniture, textiles and footwear. Firms in Eastern Europe are both suppliers and assemblers in global value chains. Research sponsored by the European Commission demonstrates that foreign-owned firms are more efficient and profitable than local firms; they also export more. As a result, the Czech Republic, Hungary, Poland, Slovakia, and Slovenia now have an internationally competitive automotive supply industry, and Hungary and Estonia an emerging information technology industry. EBRD data show that the exports of these countries to the OECD are increasingly skill-intensive, meaning that at least some local firms have made good use of foreign know-how.
The consequences of these emerging networks for the competitors of firms based in Europe tend to be sector-specific. But in general, the opening of Eastern Europe has been good business for western firms. Two thirds of inward direct investment originate in the EU. Germany is the most important home country (19 per cent), with the US a close second (15 per cent). This concentration affords European companies and the subsidiaries of overseas firms with advantages in their home market other Triad firms do not enjoy. The networks also help them--through increased specialisation of plants, increased capacity utilisation, and improved inter-plant optimisation--compete outside Europe.
The European Round Table of Industrialists which includes 40 of Europe's best known multinational firms, is strongly in favour of enlargement. In the long run, it argues, economic opportunities must be accompanied by a common set of rules and regulations to guarantee a level playing field for foreign and domestic firms. And an efficient administration would facilitate long-term investments. Clearly, the more serious the EU is about enlargement, the more incentives East European authorities would have to strengthen their institutional framework.
So far, the activities of countless small and large firms, and not some grand political scheme, have brought the economies of East and West closer. But while businesses can do the necessary footwork, they cannot bring the process of integration to completion. Only political authorities can do that. Without enlargement, economic integration is fraught with risk.
The Nature of Political Risk in Eastern Europe
The transition from a planned to a market economy creates winners and losers. This is not surprising--in any society some groups find it easier than others to adjust to structural change. Some people have a strong enough motivation to try their luck even under difficult circumstances. Some have skills and qualifications that match new job profiles. Some can afford the flexibility at least temporarily to prioritise the demands of their workplace over any other social commitments. Some are willing and able to move or commute to emerging growth centres. What they have in common is the ability to exploit new economic opportunities. Czech and Slovak engineers in VW's assembly plants. Polish stockmarket whizzkids, Estonian software programmers under contract for multinational information technology groups, and Hungarian mathematicians in research labs owned by Nokia and Ericsson, belong to the fortunate group of winners. Transition is nothing but structural change writ large, a wholesale overhaul of the basic understanding behind and the rules of economic organisation. To some, it represents an insurmountable challenge because they lack the insights to understand the requirements of economic adjustment, or the means to invest in the improvement of their situation, or because they are too old (or much too young) to try.
The risk is either that the winners will force adaptations that are unnecessary or detrimental to society as a whole or that the losers will block adaptations that are necessary and beneficial. The implications of this risk are both economic and political. In economic terms, the threat is that such groups will distort the functioning of the marketplace by skewing the distribution of resources away from considerations of efficiency and toward more explicitly self-interested criteria. In political terms, the threat is that they will subvert the democratic process by imposing their wishes on the government, by ring-fencing parts of the policy process from outside interference and accountability, and by delegitimating open and transparent procedures for representation. On both fronts, therefore, the danger is that markets will become less liberal and governments less democratic--effectively reversing the economic and political reforms the candidate countries have been pursuing over the past decade.
Such political risk exists in all countries and across Europe, East and West. Romanian farmers and Polish trade unions are not more powerful than their counterparts in France and Italy. And engineering firms in the Czech Republic or Hungary hold no more sway over their respective governments than, say, Germany's machine tool manufacturers or the City of London over theirs. Indeed, economic change is all around us, and so is the political risk that comes with it. The difference between East and West lies in the capacity of governments to accommodate such risk. In the EU, governments can use redistributive measures to silence noisy losers. They can also rally other groups to support market efficiency and representative politics against the opposition of those who seek to use force to protect their gains or to correct their losses. For example, consent to the completion of the European Union's internal market in the late 1980s and early 1990s was bought partly through cohesion funds and beefed-up regional transfers. More importantly, its success depended on a broad coalition across societies in favour of further integration and liberalisation.
In the East, governments must make do with empty coffers. Buying the support of losers is therefore not a feasible option for risk management. At best, adequate welfare provision is planned for better times. At worst, social safety nets are simply absent. Thus, government finances are more likely to represent an additional source of adjustment rather than a response to the inequitable distribution of adjustment costs. The ability of governments to mobilise broad support in favour of economic reform is also more circumscribed in the East than in the West. Well-established and broadly-based political parties with wide-ranging--as opposed to narrow--economic interests and a firm stake in the functioning of representative democracy are rare. Instead, political parties often lack financial resources, loyal activists, and organisational experience. Their material commitment to the system of representative democracy is narrower and their need to engage in fierce competition for floating voters is greater. On the whole, this makes for a more fractious political process. This, in turn, has the potential to undermine stability, including across borders.
So the EU's desire to respond to political risk in the East is easy to understand. Its long-term interests are straightforward: an open business environment, partners capable of negotiating issues of common concern, and societies committed to integrative as opposed to nationalist problem solutions. In the absence of political risk, all of this would be possible without enlargement. With political risk, nothing is. Thus for the EU accession is an exercise in risk control in which it underwrites economic and political reform in its neighbourhood through the invitation to join the club. For the candidate countries, the prospect of EU membership provides a focus for political activity in support of market efficiency and political openness. It represents the stake that mainstream political parties in the candidate countries have in supporting "the system" against those challengers that mobilise along single-issue campaigns. The prospect of membership can serve as a least common denominator for diverse coalitions of interest that separately support only part of the liberalisation and democratisation agendas. The prospect of membership also symbolises the benefits available to individuals and to firms in exchange for accepting the hardship of adjustment. And because the rules of accession include respect for human rights, this will help to eliminate discrimination against minority groups such as Russians in the Baltic states, Romany in the Czech Republic, and Hungarians in Slovakia or Romania. Such provisions will also support an improvement of the terrible condition of the 100,000 children in Romania's child care institutions. Thus, adaptation to EU membership is more likely to be beneficial to all of society than a general--and inevitable--adaptation to world markets alone.
This strategy is no free lunch for Western Europe. The downside is potentially enormous both for individual West European countries and for the Union as a whole. EU enlargement will necessarily force countries to forego cosy distributive arrangements for agriculture, fisheries, and regional development. A continuation of existing subsidies beyond enlargement would be prohibitively expensive. Prohibitively, because according to the European Commission's Eurobarometer survey, just three people out of ten believe that enlargement should be an EU priority. The cost to Europe as a whole centres on the effectiveness of the European Union as a political system. While the present institutional set-up of the EU could be more or less maintained in the absence of enlargement, the reverse is not true: enlargement can only happen if the current intergovernmental conference results in Treaty revisions that are capable of accommodating some ten new members. For this to happen, in turn, EU governments will have to strike compromises on majority voting and national representation that are hard to swallow and, therefore, difficult to negotiate. Yet more tinkering with reform will not do.
Most importantly, even a reformed institutional arrangement does not guarantee the success of the EU. The most contentious moments of European integration occurred when French farmers, British beef producers, Spanish fishermen, or German regional banks succeeded in lobbying their national governments for policies that went against the grain of economic integration. The vulnerability of the EU to such concerns is evident also in the fact that seemingly irrelevant issues such as the consumption of snuff in Sweden, the alcohol content of Cassis de Dijon, the purchase of Danish holiday homes and the comparison between Belgian and British chocolate can be elevated to continental significance. The EU's already manifest weakness when confronted with such well-organised groups means that it ultimately depends on the goodwill of its member states. When the countries that comprise the Union are willing and able to co-operate, the institutions of Europe can work effectively no matter how they are formally constituted. When the member states are unwilling or unable to work together, the effectiveness of the Union suffers. This simple relationship was as apparent when the EU consisted of only six member states as it is today and as it will be once enlargement takes place.
What will change is the likelihood that disenchanted losers or unreasonable winners from transition will hold Europe's member states hostage to their particular interests. If enlargement brings in a host of new members before these countries have completed the processes of political and economic reform, the effectiveness of the EU as a whole will suffer. And since superior effectiveness provides much of the legitimacy for European integration, this could translate into an outright loss of purpose.
The Social Costs of Adjustment
Since 1989, almost everywhere in Eastern Europe, the number of people who live below a poverty threshold of purchasing power-adjusted $4 a day has gone up. By the latest count, this affects some 25 million people. Twenty per cent of the population has experienced significant drops in income. Households with many children, single-parent households and social welfare recipients are the primary victims. In part, their predicament is due to a decline of average real incomes resulting from the double-digit recessions that accompanied transition in its earlier phase. More dramatically, a rise in inequality is responsible for making parts of the population relatively and absolutely worse off. In Romania, earnings inequality almost tripled in the 1990s, and even in more organised societies like Poland or Slovenia it rose by around 40 per cent.
Of course, causes for the persistence of misery are often internal. When cronies are allowed to strip assets and transfer the proceeds abroad as under ex-prime minister Meciar in Slovakia, national income is reduced. When privatisation agencies sell housing stock not to tenants but to outsiders, they affect not just current but also future wealth distribution. By skewing the initial distribution of real property, they make it more difficult for individuals to borrow against their assets in order to invest in their own human capital or to afford decent schools for their children. When governments, as in Poland, are slow in removing regulatory and bureaucratic obstacles to the creation of new firms, they make it more difficult for employees of bankrupt state enterprises to move into the private sector. Indeed any deficit in the provision of high-quality governance, including social safety nets, is inimical to poverty reduction. Fortunately, international organisations such as the EBRD have begun to pay more attention to the institutional framework necessary for successful economic reform. Even where governance is less of a problem, the social and economic costs of transition are high because building a new economic system is awfully difficult. Technological and organisational changes affect what kind of skills are in demand, and unless education systems manage to provide the new qualifications, too many low-skilled or wrongly skilled workers raise inequality because unequal wage distribution drives overall inequality.
There is no magic formula for good governance. What is clear, however, is that good governance starts with good rules. Inequality will not go away as the transition countries mature. What will go away, with time, are the differences in average per capita income between East and West, much like they have fallen between Ireland and the EU's southern periphery on the one hand and its northern members on the other, or between China and the rest of the world. But inter-country comparisons are statistical abstractions that say nothing about how well, or badly, people are doing. Poor people are more sensitive to shifts in relative international prices. When economies liberalise, they are doubly affected. This is what is behind the recent increase in global inequality and--despite structural and cohesion funds--inequality in Europe, East and West. In other words, income, resources, and wealth tend to concentrate among people, firms, and regions.
The simple lesson here is that the process of economic integration is no substitute for the development of good market rules--either by intention or by effect. When western firms invest in Eastern Europe, they ultimately promote growth and catch-up. They also, seemingly paradoxically, exacerbate differences between dynamic and declining regions, between people with the right and those with the wrong skills, between places with good infrastructure and lucky geography and those with hardly any means to communicate and stuck in the middle of nowhere. It would be wrong to blame western investors for this. But executives would be well advised to pay close attention to the problem. For while more balanced regional growth and a convergence of income levels do not belong to the remit of firms, they help create stability. And a stable environment is necessary for long-term investment decisions and, thus, the corporate bottom line. Ultimately it is political authorities that must take care of such political-economy concerns because, unless addressed, they translate into political risk. Inequality is a fact of life, and EU membership will not eradicate it in the candidate countries. But the process of enlargement will provide a framework for developing rules that can help reduce unnecessary inequality. And it will make dealing with the challenges posed by economic integration more manageable.
Indeed the policy transfer at the heart of the enlargement process may (and should) work both ways. What is often overlooked is that in some areas of social policy, the EU may actually be able to learn from some of the achievements of the candidate countries. Income inequality in the Czech Republic, Slovakia, and Slovenia is below the EU average. And despite their significantly lower per-capita incomes, the child mortality rates in the candidate countries--with the exception of Bulgaria, Latvia, and Romania--are not that much out of line with those prevailing in EU countries. Indeed, in Slovenia child mortality is lower than in, say, the UK or Belgium. And 14-year old Czechs famously beat all their EU peers in the Third International Maths and Science Study, while Hungarian and Bulgarian students were better than students from most EU member states. European enlargement is a formula for sharing the risks of transition. It is also a mechanism for sharing the benefits.
The Role for International Firms
Eastern Europe is to European firms what Mexico is to US firms and Southeast Asia to Japanese firms. But compared to its relative recent appearance on the global economic map, some firms located in Eastern Europe--be they foreign-owned or genuinely domestic--have made faster progress in shifting their competitive advantages from primarily low-wage activities to more knowledge-intensive production. This increases the scope and the depth of regional value chains. In numerous sectors, this has helped West European firms succeed in an increasingly competitive global environment. Truly footloose firms may be able to replicate this success in other emerging markets. But most firms are not footloose. They choose a specific location because of the relatively unique availability of a bundle of assets. Could Volkswagen/Audi produce its fancy convertibles outside Slovakia and Hungary? Would Ericsson be able to recruit a replacement for its Croatian software specialists? Or could Italy's small and medium-sized fashion footwear manufacturers find alternative sources for leather parts sourced in Romania and Albania? Would GE hold its position in the European lighting industry without the Tungsram plant in Hungary? Maybe. But the cost advantages would not be the same, and profitability would suffer. For Europe-based firms, Eastern Europe is not just another emerging market. It is an opportunity that is difficult to come by elsewhere.
This essay has argued that firms need enlargement in order to secure the business opportunities afforded through the economic and political reforms in Eastern Europe in the long run. What stands in the way of this is the lack of courage with which Europe's political leadership has behaved at the Nice Summit. "Think Small" is not an appropriate political motto in times of momentous change. Business leaders should not let governments and the European Commission get away with this. European competitiveness received a boost through the completion of the Single Market and through the introduction of EMU. It also benefited from East-West integration. Participation in the former two is for members only. This is not to exclude others--arguably US firms have been very successful in the Common Market, But the same logic that requires political co-ordination for the depth of economic integration inside the EU applies to East-West integration in Europe. This is why accession is important.
Even if governments were more courageous in dealing with enlargement, it is out of the question that they would master by themselves the expertise or the resources to deal with all the problems mentioned here. Nor, of course, would international firms. But corporations active in Eastern Europe are uniquely placed to help address problems of exclusion, poverty and inequality at the local level. With the right local partners they can use their clout to sponsor self-help initiatives and examples of good governance. That would not just make them good corporate citizens. It would also make them wise investors. Only decisive action can help stop the waste of human capital that stands in the way of securing prosperity for a large part of this continent.
Paolo Cecchini was formerly of the European Commission and author of the "Cecchini Report" whose estimates of the costs of 'non Europe' famously boosted the EU's internal market programme in the late 1980s.
Erik Jones is Jean Monnet senior lecturer in European politics at the University of Nottingham.
Jochen Lorentzen is Associate professor of international Business at Copenhagen Business School which is a CEMS member school.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Why Business Should Support a Risky Political Enterprise: Companies Need EU Enlargement in Order to Secure the Opportunities Which Have Flowed from Economic and Political Reforms in Eastern Europe. by Taking the Initiative Now They Can Be Good Corporate Citizens as Well as Wise Investors. Contributors: Cecchini, Paolo - Author, Jones, Erik - Author, Lorentzen, Jochen - Author. Magazine title: European Business Forum. Issue: 5 Publication date: Spring 2001. Page number: 51+. © 2008 Caspian Publishing Ltd. COPYRIGHT 2001 Gale Group.
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