Postcards from Old Europe – New meets old

We are only about two weeks away from one of the most important things to hit Europe this year. I am of course talking about the upcoming enlargement of the EU. May 1st will see 10 countries enter the European Union. As a result, the EU will expand to 25 states and have a combined population of around 480 million people. Eight of the new EU members come from Central and Eastern Europe (Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic and Slovenia), the other two are Cyprus and Malta.

The entry into the EU does not mean that these countries are going to introduce the Euro. Most people are forecasting Eurozone entry to be around 2009 – 2012 for the biggest accession economies (Czech Rep., Hungary and Poland) and some time later for the others. Entry into the EU means that – at the most basic level – that the new members subscribe to the basic tenets of the club as described by the “Four Freedoms”

Free movement of goods (Articles 23 to 31 of the Treaty establishing the European Community)

Free movement of persons (Articles 39 to 48 of the Treaty establishing the European Community)

Freedom to provide services (Articles 49 to 55 of the Treaty establishing the European Community)

Free movement of capital (Articles 56 to 60 of the Treaty establishing the European Community)

If you view EU enlargement through the filter of economics you quickly start asking questions about the effects on growth, migration, the EU budget, employment and numerous other factors.

If we look at the aforementioned basic freedoms one by one we can easily see that most of the points are pretty uncontroversial. Free movement of goods and services or the freedom to invest somewhere isn’t something which gets Hans or Francois riled up. The reaction to the free movement of persons is much more hotly debated. It doesn’t only mean that tourism is easier, it also means that Zbigniew from Poland can now hop over the border and start work in Germany just as if he were German.

This does not sit well with the border countries such as Germany and Austria and they have secured the right to restrict free movement of labor for the next seven years. Most other countries have followed suit except for the UK and Ireland who have no restrictions at all (and are pretty far away anyway + have robust labor markets).

Why is there so much angst? Well most Old Europeans are afraid that the relatively high incomes in their countries will cause a wave of mass migration. Germany and Austria both pay very much for low skilled work as these incomes have a natural floor in form of (high) welfare entitlements. Classical theory of migration world run the numbers and find that the income differentials are so high making the decision to move from Poland to Austria a foregone conclusion.

But is this really the case? I don’t think so. Looking around Berlin (and most other parts of this country) shows me that most of those Eastern Europeans who want to work here are here already. The other factor to keep in mind is that history shows that living standards of countries entering the EU tend to rise rather quickly. Spain, Greece and Portugal saw average incomes rise at a very fast clip after joining the European Union – this led to a net migration of zero.

People often speak of the “United States of Europe” and draw comparisons to the US of A. In this case they say that Americans will pack up and move if there are jobs to be had in other states – so why shouldn’t Europeans react in the same way? I’m always suspicious of these kinds of oversimplifications. I argued last week that Europeans – and Germans in particular – are risk averse. This inertia extends to moving as well. Research has shown that

By contrast, OECD figures for 1987 showed that French and German workers were only a third as likely to move between departements and Länder as US citizens between States – let alone between France and Germany themselves!

From here

I’ll admit that there could be a higher incentive for workers from the new accession countries to move than there was for – say – Spaniards to migrate. The difference being the fact that average Spanish incomes were at around 70% of the EU average at the time they joined vs. 40% or so in the new members. But please keep in mind that there are very formidable obstacles in moving within the Union. Contrast the following with moving from New York to California

Clearly, some endemic obstacles to labour mobility exist in Europe which are almost – though not entirely – absent in the US: notably differences of language and culture. Other obstacles are the result of divergent action by public authorities: for example, the non-transferability of pension rights, restrictions on the right to social security, inflexibility in housing markets, nationality restrictions on recruitment in the public sector, non-recognition of qualifications, lack of information about jobs in other Member States, etc. Progress in removing these obstacles – as in implementing the “free movement of persons” principle in general – is proving extremely slow.

So why is everyone afraid? Is it simple xenophobia? Or are there other forces at work? I think general anti-immigration sentiment is strong in many European countries but I also think that the main reason people are against (im)migration is that they think there is only a fixed number of jobs to be had. This so-called “lump of labor” fallacy is also behind the idea that reducing the amount of hours worked will increase the number of employed people. There is actually no evidence I know that supports this. On the contrary: higher supply can create it’s own demand in the jobs market if labor markets are flexible.

I would wager that migration will not be necessary anyway – the jobs will move to where the people are. Foreign direct investment in the accession countries has been strong and will continue to get stronger as hindrances on the movement of capital are eliminated. This will lead to even more lower skilled jobs moving out of Old Europe into “New Europe” and see the establishment of a NAFTA-like production belt on the border. This could of course have bad consequences for the countries losing manufacturing jobs.

A look at the US shows that a large part of “lost” manufacturing jobs turned up as (lower paid) service jobs. The big difference is that in Western Europe many workers might consider two years of unemployment benefits at around 65 – 70% of last wages to be more attractive than a job in the service sector. Add in the fact that the service sector might not want to hire anyone as they will find it exceedingly difficult to get rid of their new workers in an economic downturn.

To sum it up: I don’t think that we’ll see a wave of mass migration rolling over Western Europe after EU enlargement. What we will see is more pressure being put on governments to reform the system of entitlements and to increase the flexibility in their labor markets. The source of this pressure is to be found in the free movement of goods and capital which will accelerate the movement of manufacturing jobs to countries with lower wages.

I wish you all a very nice weekend – if you don’t know what to do with the time on your hands I suggest that you visit my other home on the web: CurryBlog.