Enlargement and Implications for Growth

During the last decade a tremendous transformation and economic development has been observed in Poland, Russsia and the Baltic States. The EU accession process has been vital in the fast transition to market economy in the new member states.

Fastest growing economy
Over the past few years, the Baltic Sea region has been one of the fastest growing regions in the world. In the last decade the trade in the Baltic Sea region has boomed. Swedish trade with transition economies has quadrupled from the initial levels in the early 1990s. However, exports to Baltic States, Poland and Russia are relatively smaller than to Nordic countries.

Keeping growth going will require substantial investment. The capital stock needs to be upgraded before firms will be able to compete with developed countries. The income gap in opposition to EU member states is large with GDP per capita, therefore there is still plenty of room for these economies to grow. Labour productivity has been growing at a good pace of 4 percent in the Baltic States and 3 percent in Poland. Only productivity growth in Russia has been barely positive.

The supply of capital domestically for investment is limited due to countries suffering from large account deficits. Foreign Direct Investment (FDI) has boosted through Economic Zone arrangments but since these will no longer be allowed it is vital to keep the FDI on a high level.

EU will not better public finances
The structural funds are supposed to be matched with national public investment and this type of government spending may crowd out private investments, which leads to budgetary strain. New research indicates that the past 20 years of structural funds have had little if any impact on regional economic convergence. Therefore massive structural funds do not necessarily lead to sustained growth but sometimes just the opposite.

Reforms must continue
The domestic issues such as administrative barriers, corruption and the financial market are the most serious threat to economic growth and prosperity. There are several problems that must be sloved and instruments that should function.

Financial systems need to be further developed. There are still high spreads between lending and borrowing rates. Banking and finance in the accession countries is dominated by foreign players, which brought muscle and business knowledge but has not yet transformed into SME lending and financial integration

Growth of small firms must increase. Small and medium sized enterprises (SME) are not growing enough. There are difficulties in getting short and long-term loans so there exists a strong need to rely on internal funds. Poor support from state agencies is yet another problem especially in Russia, where the state rather tends to focus on most tax- profitable sectors such as fuels.

Institutional reform has slowed. The accession countries still lag behind the UE criteria such as rule of law, corruption, government effectiveness. So it is vital not to let the reforms weaken after the accession to UE. The level of institutional reform varies although Estonia is starting to approach OECD levels.

Baltic Sea Region bridges Russia to the West
Russian trade potential is huge. There is a commonly held view that the Baltic Sea region will be a "bridge to the west" but the evidence show it may appear just the opposite.

A general problem lay in the ability of implementation of the reforms. Russia suffers from an undeveloped SME sector, weaker domestic support for continues reforms. May lack of encouragement such as the UE membership was for the Baltic States and Poland may impede these processes in Russia? Joining the WTO would decrease russian ability to bureaucracy and would provide positive measures such as clear customs procedures, intellectual rights protection or less discrimination of foreign own companies. However the possible joining the WTO or formation of Common European Economic Space looks distant.

In recent years, exports from Russia to the Baltic Sea region have been growing more than imports which makes Russia a net exporter. Also an n increase of russian foreign investments in the EU and U.S. was noticed.

After the EU expansion eastwards a renewed debate about Russia's relations with Europe is expected.

FDI in East not detrimental for West
There is little evidence that the parent companies making investments in low cost countries cause reduction of employment in their home country. Research suggests that outward FDI may have a positive effect in this matter. Negative effects should be offset by positive ones such as vertical specialisation. For example, manufacturing industry in Poland or transport and communication of petrochemicals in Russia.

Getting the most out of enlargement.
The primary benefit of EU membership is removing trade barriers and reducing transaction costs. EU membership has still the capacity to encourage foreign investment. There is still room for substantial growth in investment and trade, but further improvements must come in the investment climate throughout the region and a new strategy must be found for cooperation with Russia.

Source: "EU Enlargement. Implications for trade, growth and investment in the Baltic Sea Region" - a report by the Stockholm Institute of Transition Economics (SITE)
The report is available at: www.hhs.se.