The recent enlargement of the European Union (EU) ushered in its largest-ever group of new member countries, some of which have relatively low per capita incomes. Raising incomes in the new members has therefore taken on increased importance within the overall goal of European integration. Indeed, the union of the capital-poor, generally low-employment new members and the higher-employment, capital-rich old members has set in motion forces driving labor migration from east to west and capital flows from west to east. To encourage better understanding of these trends and the policies that will influence how they play out, the Joint Vienna Institute (JVI), the IMF Institute, the IMF’s European Department, and the National Bank of Poland gathered academicians and policymakers for a conference at the National Bank in Warsaw on January 30–31.
The Warsaw conference on impacts of EU enlargement began with a review of large migration episodes and their effects on labor markets (papers by Tim Hatton, University of Essex and Australian National University; and George Borjas, Harvard University). It went on to a presentation of estimates of potential labor flows resulting from EU enlargement (Tito Boeri, Bocconi University) and a discussion of the public’s concerns (Christian Dustmann, University College London). It then turned to a description of the large foreign direct investment flows from old to new members (Philip Lane, Trinity College Dublin; and Gian Maria Milesi-Ferretti, Research Department, IMF) and the influence of tax rates on investment location decisions (Michael Devereaux, University of Warwick). Two presentations documented the extensive use of outsourcing and offshoring by German and Austrian firms (Claudia Buch, University of Tübingen; and Dalia Marin, University of Munich). These were followed by a survey of new theories of trade and factor flows (Elhanan Helpman, Harvard University) and an empirical study of possible complementarities between these flows (Poonam Gupta and Ashoka Mody, European Department, IMF). The dominant views on the principal topics—which were brought out clearly and underscored in the final panel session—are discussed in the following paragraphs.
Labor flows since enlargement have been much smaller than projected. Flows to the United Kingdom and Ireland have been larger than to other destination because of fewer restrictions, better labor market conditions, or more flexible institutions that allowed better utilization of labor inflows. Possibly because of restrictions, flows to the other countries in the EU-15 have so far been quite small, even in relation to standard estimates suggesting that migration might reach about 3 percent of new members’ (and about 1 percent of old members’) populations. Removing restrictions on inflows to other EU-15 members would probably elicit relatively small flows—especially those originating outside the EU.
An important basis for popular antagonism to labor inflows was a perception that migrants could overwhelm domestic welfare systems. Limitations on access to these welfare systems—along the lines of policies in the United Kingdom—therefore made sense.
Analysis of factor flows requires a global, rather than a purely European, perspective. In an outstanding survey of the new literature on trade, factor flows, and firm behavior, Helpman contributed to an important view that emerged from the discussions—namely that, given the huge amount of global trade and insourcing and outsourcing of intermediates, wage relativities were being established in global markets. Attempts by one country or cluster of countries to set high reservation wages, reduce wage dispersion, or introduce social policies aimed at achieving more egalitarian income distributions would likely be detrimental to growth, employment, competitiveness, and investment in human capital.
There was compelling evidence that German and Austrian firms had improved their competitiveness (particularly in the face of skill shortages) by using labor inputs from the new members. In this emerging “war for talent,” firms in the capital-rich old members were employing migrants domestically but also, to an even greater extent, outsourcing and offshoring intermediate inputs.
With respect to capital mobility, converging institutions and substantial differences in capital-labor ratios were bound to elicit huge flows into the new member countries. For the fixed exchange rate countries, this would mean substantial increases in liquidity, bank credit, external liabilities, current account deficits, and foreign exchange exposure—along with rapid growth. The sooner these countries could join the euro area, the smaller would be the window of currency-related vulnerabilities. For the flexible exchange rate countries, incipient inflows could force excessive currency appreciations, with dampening effects on competitiveness, profitability, and growth. A degree of vulnerability associated with substantial capital flows was intrinsic to the capital flow-driven convergence process, although some participants thought that capital account volatility would be mitigated insofar as flows were being driven predominantly by long-term investment decisions. In any event, the nature of vulnerabilities would be changed—from broad foreign currency exposure to individual credit risk—by early euro adoption; and, of course, sound macroeconomic policies would serve to lessen risks.
Tax policies could exert an influence on the amount and location of investment. There was, nevertheless, little enthusiasm for strict tax harmonization and some support for tax competition.
The conference was opened by Leszek Balcerowicz (President, National Bank of Poland) and Susan Schadler (Deputy Director, European Department, IMF); both talked about the principal questions to be examined and themes likely to emerge from the discussions.
Anne Krueger (First Deputy Managing Director, IMF) gave a dinner speech on the history of EU integration, the need to nurture trade creation and avoid trade diversion, and the importance of continuing this stance in the current environment.
The final panel, chaired by Leslie Lipschitz (Director, IMF Institute), included Marek Belka (former prime minister and finance minister of Poland), Lajos Bokros (former finance minister of Hungary), André Sapir (principal author of An Agenda for a Growing Europe, the “Sapir Report”), and Erik Berglöf (Chief Economist of the European Bank for Reconstruction and Development (EBRD)).
The conference program and papers are available on the JVI website at www.jvi.org/index.php?id=4447.