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February 03, 2020

Is firms’ productivity affected by accession to the EU?

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The inclusion of the 11 transitional economies of Hungary, Poland, the Czech Republic, the Slovak Republic, Slovenia, Latvia, Estonia, Lithuania (2004), Romania, Bulgaria (2007), and Croatia (2013) in the EU brought both economic opportunity and national sovereignty issues. 

Accession into the EU resulted in a significant increase in vertical foreign direct investment (FDI) into the new member states. This has increased firm-level productivity but at the cost of states adjusting subsidies, tax regimes, and infrastructure spending to benefit these foreign entities to the detriment of domestic firms. This has resulted in asymmetric government expenditure focused on satisfying multinational enterprises at the expense of, for example, developing national innovation capacity through the medium of education. Furthermore, the motivation for the vertical nature of FDI was to incorporate the new member states into the global supply chain and, with over an average of 80% of production inputs being imported into the host countries, little value added was gained, resulting in a failure to achieve an export multiplier (the ratio of the increase in a country’s national income to the increase in the demand for the country's exports that brought it about). 

There is evidence that domestic firms are disadvantaged, not only as a result of increased competition from the common market but also from a lack of liquidity and access to finance. Information asymmetries—where one party has more or better information than another—amongst the primarily Western-owned banks indicate that there is a lack of available credit for all but “bankable” propositions. This is compounded by the imposition of Western European credit scoring techniques and the requirement for collateral. In relation to access to finance this is the source of market inefficiency and failure in transitional countries. 

Following the collapse of the Soviet Union, the 28 former Soviet states, including satellites, were encouraged to pursue a “one-size-fits-all” prescription enshrined in Western neoliberal ideology, which emphasizes the value of free market competition. The results were mixed, ranging from democracy to bloody conflict in the Balkans. However, the new member states were subject to the full force of neoliberal ideology through their acceptance of the Acquis Communautaire, the body of universal rights and obligations common to all the EU member states. Additionally, these countries were obliged to accept a trading regime designed to benefit EU15 competitiveness and reduce any dangers of an enlarged market to the original bloc. The neoliberal regimes established throughout the new member states exerted pressure on newly formed social democratic parties which were attempting to introduce free market reforms whilst sustaining distributive programs to improve national welfare. A combination of a surfeit of vertical FDI and the market failure of a reformed banking system led to limited economic growth and fiscal constraints on both governments and local firms. This unsustainable economic paradigm provided fertile ground for nationalist parties to appeal to the electorate, and for state capture by illiberal elites motivated by the twin ambitions of power and wealth.

Overall, EU membership benefits firms; however, certain aspects of the way the Aquis Communautaire was implemented, particularly the lack of control of FDI flows, the underdevelopment of financial intermediation, and the exploitation of host country comparative advantage, have negatively affected national welfare and the productivity of domestic firms in new EU member countries.

© Jens Hölscher and Peter Howard-Jones

Read Jens Hölscher and Peter Howard-Jones's IZA World of Labor article “Does accession to the EU affect firms’ productivity?

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