Speakers:
Michaela Dodini, DG ECFIN, European Commission
Marco Fantini, Desk Officer for Russia, Moldova and Belarus, DG ECFIN, European Commission.

Michaela Dodini and Marco Fantini presented their new paper, “The European Neighbourhood Policy: Implications for Economic Growth and Stability” at a CEPS lunchtime meeting.  This paper considers the potential, long-term economic effects and risks associated with the EU’s new Neighbourhood Policy programme.  
In an effort to enhance EU relations with border countries to the south and east, the European Commission launched the European Neighbourhood Policy (ENP), also known as “Wider Europe”, in March 2003.  Addressing concerns that the EU was leaving behind some countries while expanding to include others, the ENP was devised as an initiative to accompany the recent enlargement.  The neighbour countries are diverse, with respect to the EU-25 as well as to themselves.  Most neighbour countries have income levels lower than in the EU, but each is in a different stage of development.
 
While promoting relationships between the EU and neighbour countries, an important principle of differentiation has been adopted.  Policies are to be tailored to meet country-specific needs and capacities.  This is evidenced in “Action Plans”, the most concrete instrument for ENP implementation.  The EU is currently drafting individual country reports.  These Action Plans must be approved by the EU this autumn and subsequently endorsed by individual countries.  Based on an underlying commitment to furthering shared values, Action Plans cover political, social, and economic policy issues. 
 
Focusing their presentation on the economic concerns of the integration of Europe with its neighbours, Ms. Dodini and Mr. Fantini argued that the most positive economic effects will be a result of enhanced trade preferences, increased financial assistance to neighbouring countries as of 2007, development of interconnected infrastructure (particularly energy and transportation), and, most importantly, the extension of the EU Internal Market to neighbouring countries.  Of course, the Internal Market has been extended to non-EU countries, such as Switzerland and Lichtenstein, before.  This is the first time, however, that the Internal Market would be extended to non-European countries that tend to have less infrastructure, lower per capita GDP, and to be in a different stage of economic development.  However, precisely because of these differences, there is considerable potential for economic gains, especially for the poorest neighbour countries.
 
The neighbour countries are generally lower-middle income countries, starting from a relatively strong macroeconomic position.  All countries experienced positive real GDP growth rates and most achieved moderate inflation and improved public finances in 2003.  On the external side, most have sound current account positions and high levels of foreign currency reserves.  High unemployment rates, however, present one persistent macroeconomic weakness.  Regarding structural reform, there is a significant gap between EU and neighbour countries and, thus, the potential for structural reform seems considerable. 
 
Extending the Internal Market to neighbour countries offers incentives to achieve macroeconomic stability and structural reform. The Internal Market is a well-tried framework, as countries with access to the Internal Market have seen economic benefits.  Other value-added include financial and technical assistance from the EU, monitoring (through progress reports), peer pressure effects (political pressure may be exerted by fellow neighbour countries if one country seems to be “falling behind”), and, of course, closer economic relations with the EU.  All of these “soft” incentives will encourage economic growth either directly or indirectly.  This, of course, is one of the ENP’s fundamental goals.
 
Ms. Dodini and Mr. Fantini argued that it is too early to quantify the economic implications of the ENP.  Thus, making a few key assumptions, they issued a qualitative assessment.  They assumed that the ENP would be “successful” in the long term, i.e. the process will break down or substantially reduce the existing tarrif- and non-tarrif barriers to trade and factor movements.  Thus, the ENP qualitatively is akin to the experience of accession countries’ economies during previous EU expansions.     
 
Based on past experiences, the authors project that the following should apply to the ENP.  First, neighbour countries will see an increase in their share of trade, i.e. exports plus imports as a percentage of GDP.  A decrease in the barriers that prevent the movement of capital and labour will result in an increase in factor movement between neighbour countries and the EU.  Trade specialisation will occur; countries will produce and export goods and services in which they possess a comparative advantage.  Consequently, production will become less diversified in neighbour countries.  The deepening of cyclical synchronisation is likely to happen as well.  The European economy will encourage growth in neighbour countries when it is in a business cycle upswing, but decelerate growth when Europe slows.  Finally, the so-called “policy anchor” will provide incentives for governments to adopt more responsible economic policies and, in turn, encourage economic growth.
 
These changes in the economic playing field are likely to impact the “four freedoms of markets”: freedom to trade goods, services, capital and labour.  Decreased trade barriers for industrial goods will have significant positive welfare gains for the eastern neighbour countries, while, in the Mediterranean countries, where they have enjoyed about 25 years of free trade access to EU markets, the gains will be less pronounced.  However, a decrease in non-tariff barriers, such as regulatory barriers, will benefit eastern and southern countries.  Regarding benefits from agricultural trade, the speakers admitted that one must take a longer-term view, as EU protection in this sector remains relatively high.  However, as the agricultural sector significantly contributes to most neighbour countries’ GDP, even a modest degree of opening to EU markets may lead to an increase in exports and, therefore, an increase in GDP. 
 
Trade in services also seems to be a promising source of economic growth, as services now make up approximately 50% of GDP for many small countries.  However, services are traditionally considered to be difficult to trade.  Yet as this is changing with technological advancement, over time the trade of services could offer growth potential.  One caveat is that the high value-added services, such as financial services, are notoriously difficult to trade due to significant industry regulations. 
 
The most risky of the four freedoms is openness to capital.  Appealing to economic theory as well as worries about macroeconomic stability, the authors argue against the premature opening of capital movements.  However, the gradual implementation of the ENP can significantly reduce the risk of market instability.  Finally, the prospects regarding labour mobility are unclear.  Increased long-term labour flexibility does yield positive implications with respect to labour market differences, immigration, and an ageing EU population.  However, the language in the Commission Communication is cautious.
 
Of course, integrating economies inherently involves the possibility of new risks.  For the ENP, these risks include: trade diversion (the NAFTA experience resulted in trade reorientation), supply-side specialisation (leaving economies more vulnerable to negative shocks), exporting and importing in different currencies (increased GDP volatility), “social risks” (such as inequitable growth).  The most important risks stem from the fact that no one knows which policies are essential and which are superfluous.  Overregulation would result in undue requirements on and bureaucratic procedures for neighbour countries.  On the other hand, underregulation could have negative implications for the EU, such as unsafe products in their markets or unfair advantages for neighbour countries. 
 
Finally, the ENP clearly has the potential to foster economic growth, both directly and indirectly.  In order to maximise this potential, policy-makers must pay special attention to the open policy issues.  How can effective implementation be assured?  What parts of the acquis communautaire are essential?  What is the appropriate macroeconomic framework in which to set the policy?  What should the sequencing of measures be?  Of course, for each neighbour country, there will be a different answer to these questions.  Thus, if there is one universal policy recommendation, it is to continue following the principle of differentiation.
 
See the slides of the presentation.