Will Recent European Economic Turmoil Negatively Affect EU Expansion?

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Includes: EU, FXE, IEV
by: Casey Breznick

Summary

There are currently 28 member states in the EU and six recognized candidate states.

Turmoil in the Eurozone and EU at-large might delay or put a halt on candidate state accessions.

If the EU’s expansion is delayed, what does that mean for member states and candidate states?

Background

Of the roughly 50 or so countries in Europe, 28 are members of the European Union (NYSEARCA:EU), a politico-economic union of sovereign European states. The EU is not to be confused with the eurozone, which is a monetary union of 19 European states all sharing the euro currency. States like the United Kingdom, Denmark, and Sweden are members of the EU but do not use the euro and are therefore not part of the eurozone.

Currently, there are six countries at various points in the application process to join the EU. They are known as the recognized candidate states, and include Albania, Iceland, Macedonia, Montenegro, Serbia, and Turkey. Of these, Montenegro, Serbia, and Turkey have initiated negotiations with the EU; Albania and Macedonia have candidate status but have not initiated negotiations; and Iceland suspended its application in mid-2013. Bulgaria, a EU member state that has yet to adopt the euro, recently resumed talks to ascend to the eurozone.

The only country to have joined the EU post-financial crisis (i.e. since 2007) has been Croatia, which joined in 2013. Several countries have adopted the euro since then--the most recent being Lithuania, which adopted the euro on the Jan. 1 of this year.

Joining the EU

Joining the EU is not a simple process, but the process can be described simply. The conditions to join are known as the Copenhagen Criteria and include "a free-market economy, a stable democracy and the rule of law, and the acceptance of all EU legislation, including of the euro." (See Why Join the EU? for why "Copenhagen Criteria" is an ironic name for these requirements.) Once candidate status is awarded, a state enters into negotiations with the EU concerning the "adoption of candidate's adoption, implementation and enforcement of all current EU rules" on 35 different policy fields.

Once a country joins the EU, it might still have several reforms or integration processes still in place. In particular, nine EU members have yet to adopt the euro. This is important to keep in mind.

Meet the Candidates

All data are 2013 estimates from CIA World Factbook. GDP is reported as purchasing power parity.

European Union candidates

Albania

  • GDP: $28.34 billion, GDP per capita: $10,700
  • Real GDP growth rate: 0.7%
  • Unemployment rate: 16.9%
  • Budget surplus/deficit: -6.1% of GDP
  • Public debt: 70.5% of GDP
  • Inflation rate: 1.7%
  • Net exporter or importer: Importer
  • Exchange rate: 109.2 leke per US dollar

Iceland

  • GDP: $13.11 billion, GDP per capita: $40,700
  • Real GDP growth rate: 1.9%
  • Unemployment rate: 4.5%
  • Budget surplus/deficit: -1.5% of GDP
  • Public debt: 130.5% of GDP
  • Inflation rate: 3.9%
  • Net exporter or importer: Exporter
  • Exchange rate: 123.7 kronur per US dollar
  • Suspended its accession in 2013 after parliamentary vote

Macedonia

  • GDP: $22.57 billion, GDP per capita: $10,800
  • Real GDP growth rate: 3.1%
  • Unemployment rate: 28.6%
  • Budget surplus/deficit: -4.1% of GDP
  • Public debt: 34.3% of GDP
  • Inflation rate: 2.8%
  • Net exporter or importer: Importer
  • Exchange rate: 46.398 denars per US dollar

Montenegro

  • GDP: $7.429 billion, GDP per capita: $11,900
  • Real GDP growth rate: 1.5%
  • Unemployment rate: 19.1%
  • Budget surplus/deficit: +2.2% of GDP
  • Public debt: 52.1% of GDP
  • Inflation rate: 4%
  • Net exporter or importer: Importer
  • Exchange rate: uses euro, 0.764 euros per US dollar

Serbia

  • GDP: $80.47 billion, GDP per capita: $11,100
  • Real GDP growth rate: 2%
  • Unemployment rate: 20.1%
  • Budget surplus/deficit: -4.9% of GDP
  • Public debt: 61.2% of GDP
  • Inflation rate: 2.2%
  • Net exporter or importer: Importer
  • Exchange rate: 85.67 Serbian dinars per US dollar

Turkey

  • GDP: $1.167 trillion, GDP per capita: $15,300
  • Real GDP growth rate: 3.8%
  • Unemployment rate: 9.3%
  • Budget surplus/deficit: -2.1% of GDP
  • Public debt: 36.6% of GDP
  • Inflation rate: 7.6%
  • Net exporter or importer: Importer
  • Exchange rate: 1.899 liras per US dollar

eurozone candidate

Bulgaria

  • GDP: $104.6 billion, GDP per capita: $14,400
  • Real GDP growth rate: 0.5%
  • Unemployment rate: 11.6%
  • Budget surplus/deficit: -2.4% of GDP
  • Public debt: 18.4% of GDP
  • Inflation rate: 1.5%
  • Net exporter or importer: Importer
  • Exchange rate: 1.478 leva per US dollar

European Union

  • GDP: $15.85 trillion, GDP per capita: $34,500
  • Real GDP growth rate: 0.1%
  • Unemployment rate: 10.5%
  • Budget surplus/deficit: N/A (Germany has 0.1% surplus, Greece has -4% deficit)
  • Public debt: N/A (German has 79.9%, Greece has 175%)
  • Inflation rate: 1.5%
  • Net exporter or importer: Importer
  • Exchange rate: 0.764 euros per US dollar

Why Join the EU?

By joining the EU a country is obligated to eventually adopt the euro (only Denmark and the UK are not obligated). Thus, countries like Bulgaria, Sweden, and Poland that are EU members but still use national currencies will eventually have to adopt the euro, exit the EU, or somehow finagle their way out of adopting the currency as Denmark and the UK did.

Even though I included "EU" in this article's title, I think the more important question to look at is whether these candidate states and other potential candidate states are or should be enthusiastic about and willing to join the eurozone and adopt the euro, and on the flip-side whether or not current eurozone states should want more countries joining. Arguably, adopting the euro and becoming beholden to ECB monetary policy are the biggest external economic changes that come with joining the eurozone.

While many opinions exist about the prospect of certain countries exiting the eurozone, and what the repercussions, positive and/or negative, of such occurrences would be, it is abundantly clear that the eurozone is currently facing immense economic turmoil.

The EU at-large is also embroiled in political and social turmoil due to the rise of far-left and far-right political parties and intense debate over the need for a fundamental re-assessment of the state of European immigration policy in light of the recent terrorist attacks in Paris. EU states are also at constant odds with politico-economic issues such as the centralization of decision-making authority by technocrats in the EU capital, Brussels, which erodes national sovereignty.

Once a country has reformed itself sufficiently well enough to join the EU and adopt the euro, it stands to benefit in several ways: free trade across the EU, greater access to liquidity and securities markets, adoption of a widely-used currency, etc. In taking a more cynical look, perhaps the greatest benefit in joining the EU and adopting the euro for poorer European countries is access to the largesse of fellow EU states' coffers (basically, Germany's). True, these countries must make significant institutional reforms in order to join, but they don't need to be rich or prosperous in order to join.

Looking at countries like Albania and Montenegro as possible EU additions isn't exactly confidence-inspiring, especially when average eurozone GDP growth and productivity are stagnant and unemployment is high. These countries have little to add to the EU's growth prospects, but offer much in the way Greece has to drag it down. In fact, it's now well-known Greece "cheated" in order to join the EU and certain criteria were specifically relaxed in order to allow the country's ascension, a fact that Germany Chancellor Angela Merkel has made light of before.

Another factor to consider in possible EU expansion over the next 5-10 years are the effects of the ECB's recently-announced trillion dollar bond purchasing program, to commence in March and last until September of next year.

According to Mario Draghi, only about 20% of the hundreds of billions in debt purchases would come directly from the ECB; the rest would come from national central banks. Additionally, the total amount of bond purchasing will come in proportion to the relative size of each EU country's economy, meaning that larger economics like Germany's will experience more than smaller economies.

All of this comes to the chagrin of Germany and to the happiness of lackluster southern European economies (they probably would like more of the monetary stimulus, but after all beggars can't be choosers). Germany doesn't need the extra liquidity or in-flow of capital, as evidenced by its ultra-low bond yields, but will receive the lion's share of it anyways. In fact, Greece doesn't really stand to directly benefit from this because the ECB already owns more than 33% of the country's bonds outstanding. The ECB cannot by its own rules purchase anymore unless it waits for some to mature or if it changes the rules for Greece (a re-occurring theme it seems).

This leads to the fundamental question: Do current EU states want more Greece-like states joining, and do Greece-like states even want to join the EU?

It's pretty clear that having fewer Greece-like states and more Germany-like states would be good for the eurozone's prospects for longevity. It's unclear whether the candidate states really should join the EU. While none of the states is positioned to join the EU in the next few years, it will take many years to become completely aware of the full repercussions of the ECB's new plan. What if, say, the ugly head of massive hyperinflation rears its head a few years down the line the same year a fledgling economy like that of Albania joins the eurozone? Another consideration is that after adopting the euro, countries are essentially no longer masters of their monetary fates; in other words, they can't inflate themselves out of debt binds, as Greece painfully learned several years ago.

In the unlikely scenario where the eurozone rebounds in the next few years, these states and perhaps others, like Bosnia-Herzegovina, will eagerly want to join the EU. They still, however, might be weary of adopting the euro if it appreciates versus other currencies, thus making their exports less competitive globally.

It's also important to keep in mind that even though these small, poor countries would like tons of money and low rates courtesy of the ECB, none is in a position to benefit from the current bond-purchasing program. Still, this is all a subject worthy of at least a moment's reflection.

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