Thursday, August 28, 2014

Is the European Union imploding?

The prospect of being accepted into the EU provided the nations of Eastern and Central Europe with a strong incentive to achieve fiscal balance - a process somewhat similar to what happened in Western Europe at the time the euro was launched. In both cases, however, after initial progress, countries have shown clear signs of political "fatigue": in the euro area, the Stability Pact has imploded; throughout Eastern Europe, budget deficits have started to rise.

In the Czech Republic last year, the budget deficit jumped to 13% of GDP, a threefold increase since 1999. Although this included a one-time charge for bank restructuring costs, this year the deficit will close above 6% of GDP. In Poland, the deficit is also moving close to 6% of GDP, up from 2.9% in 2001. In Hungary the budget deficit is widening again, after narrowing to 4% of GDP in 2001. Malta, too, has a deficit close to 10% of GDP, up four percentage points since 2001. Only the Baltic countries seem able to maintain sound fiscal policies.

In many ways, this is not surprising: once politicians no longer face annual EU progress reports - and the threat of exclusion - fiscal relaxation becomes much less costly. At the same time, the big euro area members (France and Germany) do not have a leg to stand on to criticize other countries' fiscal policies, so there are virtually no international constraints on EU countries' budget deficits. Indeed, these constraints have proven to be utterly useless after a country's EU entry, and it will be hard to impose them as an admission criterion for other potential entrants.

Perhaps more surprising is the apparent political backlash against the governments that have led countries into the EU. Once again the similarity with what happened in Western Europe at the time of the euro's implementation is striking. The government of Romano Prodi, having managed against all the odds to get Italy into Europe's monetary union, fell three months later. The Czech Republic, Poland, and Hungary have each endured a government crisis since EU accession.

Throughout Central and Eastern Europe, the EU is not as popular as it used to be. Voter turnout in the European Parliament elections in June was embarrassingly low in the new accession countries, ranging from just 17% in Slovakia to 38.5% in Hungary. Participating in their first-ever EU election, citizens in these countries turned out at a rate not only well below the European average (about 45%), but even below the UK average.

The reasons are twofold. Accession countries felt that they were asked to make major fiscal adjustments in order to be accepted into the EU. Regardless of whether such policies were in the long-term interest of these countries, in the short run they were politically costly.

This "adjustment fatigue," a term coined to describe the experience of Latin American countries to economic liberalization in the 1990's, is now coupled with the feeling that the EU is not such a great bargain after all. Perhaps most visible has been Western European countries' eagerness to protect their labor markets against migration from Central and Eastern Europe - a sticking point that always comes up in every meeting between politicians from the West and the East.

Little wonder, then, that voters in Central and Eastern Europe now feel that they got a poor bargain from the governments that brought them in: belt tightening, labor market restrictions, and the notorious barrage of EU regulation. The result has been a reaction against these governments and a lack of public interest in EU affairs.

So, after all the celebrations of European enlargement, we are left with a predictable set of problems: a "union" of countries with very different views on everything (from foreign policy to labor market policies) and different economic interests; widespread disillusionment among voters in the new member states; a constitutional process whose future is uncertain; and all the usual political wrangling in Brussels between countries seeking to get as much power as possible.

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