"The European Union and its Expanding Economy"

"The European Union and its Expanding Economy" Bernhard Zepter Ambassador and Head of Delegation Speech 2005/06/04

2 Dear Ladies and Gentlemen, I am delighted to have the opportunity today to talk to you on the European Union and its expanding economy. Let me first make some remarks on the recent referenda in France and the Netherlands. No doubt the rejection of the constitution in both referenda constitutes a very serious setback for both countries and for Europe and we are entering a period of uncertainty. But the European Union will continue to function on the basis of the existing Treaties. It is the future direction of the EU and its capability to act effectively, which are now the challenge. The coming summit of EU Heads of State and Government on 16/17 June in Brussels will review the situation and try to decide on a way forward. The Commission will, as the executive branch of the EU, actively assist in this process. Let me now turn to the enlargement process of the Union and in particular the very important step towards a larger Union on 1 May last year. Enlarging the Union has been part of the project of European integration for more than three decades. The 2004 enlargement, however, was the biggest one in terms of the number of countries joining the EU : eight countries from central and eastern Europe and the Mediterranean islands of Malta and Cyprus joined the Union, raising the number of members from 15 to 25 and boosting total population to over 450 million people - more than the combined population of the United States and Japan The political significance of this enlargement for Europe and its people is without any doubt momentous. Nevertheless, the new Member States had to wait impatiently for a couple of years. In the early nineties, they clearly lacked the necessary political, economic and legal structures that would have allowed them rapidly to join the Union. Preparations for accession, therefore, started with a sweeping transformation of the new Member States economies and societies : in order to qualify for membership, the applicant countries did not only have to prove that they were functioning democracies and market economies, but also had to adapt their legal framework to the rules of the European Union. Another challenge of the latest wave of enlargement is that it is not yet complete. Bulgaria and Romania should be able to accede on1 January 2007and the recent ballots on the Constitution can hardly change this agenda. Furthermore, the Council has proposed that under certain conditions accession negotiations with Croatia and Turkey shall be opened in the course of the current year. The issue of Turkey's accession is presently the subject of intense debate in Europe. Turkey's secular democracy, alongside its role as a NATO partner for over 50 years, but also its history, may make the country seem an obvious candidate for EU Membership.

3 Turkey applied for associate membership of the EEC in 1959 which led to the signature of the Ankara Agreement in 1963. Already at that time, Turkey was promised that after 25 years the EEC would look at the issue of membership again. Turkey officially applied therefore for full membership of the EC in 1987. The Commission recommended against this request in 1989 and proposed instead the establishment of a Customs Union which was set up in1995. The Customs Union was economically remarkably successful the EU currently accounts for 47.9% of Turkey's total external trade but it was not until the Helsinki European Council in 1999 that Turkey was officially acknowledged as a candidate country. EU leaders declared in December 2004 that Turkey sufficiently fulfils the Copenhagen political criteria and proposed once certain other conditions are fulfilled - the opening of negotiations on3 October 2005. Whatever happens, the negotiation process with a country like Turkey is likely to be a long one, with 2015 being mentioned as the earliest possible date for accession. Turkey is big almost 70 million people - and lags behind even the poorest of the new Member States, although the economy has largely stabilised after the financial crisis of 2001.The fact, however, is that each successive enlargement has brought benefits to Europe s citizens and new opportunities for its businesses. The impact of the 2004 enlargement on the EU s economy is indeed significant, as a bigger and more integrated market boosts economic growth both for newcomers and the old member states. The European Commission estimates that joining the Union adds up to one per cent extra growth each year for the newcomers during the first 10 years of membership. As the new Member States have successfully completed their transformation into functioning market economies, the overall yearly growth rates of these countries is estimated at around 4.5% over the next decade due not least to a stable investment climate and the need for consumption and infrastructure investment. The new Member States remain important clients for investment from the other EU countries as well as for their exports of capital and consumer goods. Some of these investments and exports will be used to improve the infrastructure of the new Member States. The combined injection of new technologies, know-how and financial investment has already boosted productivity as old industries restructure and new ones gain ground. The newcomers have benefited from a wave of investment by companies in particular in the automotive, retail, banking, energy and telecommunications sectors. For example, Volkswagen of Germany has taken over the Skoda vehicle group in the Czech Republic; France Telecom is a shareholder in the Polish operator TPSA; retail chains based mainly in France, Germany, the United Kingdom, Belgium and the Netherlands have set up supermarkets all across central and eastern Europe. Business in the enlarged EU also benefits from improvements in the legal and regulatory environment, as the new Member States had to adapt their laws and now apply inter alia a

4 standard of patent and design protection of the Union, which are much more advanced and sophisticated than the previously existing laws and regulations. Last but not least, there is the financial support given to the newcomers. As these 10 countries are - often clearly - poorer than the EU average, they were and are entitled to receive important EU funds. To be honest, their integration was partly driven by access to EU programmes and financial assistance, as the Union s structural and regional resources are shared out in a way that gives priority to the most needy. Already in the framework of co-operation programmes, designed to prepare the ground for accession, 1.5 billion euro annually were channelled to the candidate countries. This figure has now significantly increased. During the accession negotiations the Union agreed to provide for the years 2004 to 2006 alone more than 20 billion for infrastructure investments in the new Member States alone. This type of structural policy to support regions in need will continue beyond the year 2006, if the European Council can endorse the new financial framework for the post 2006 period which is presently in the final stage of negotiation. Transitional measures have been agreed to deal with the possible negative effect on the economy of any Member State: countries that were already members before 2004 can, for a period of up to seven years, freely decide when workers from the new Member States can enter their job markets. Internal frontiers between the newcomers and other Union members will only be removed once external frontier protection is deemed to be adequate, based on a unanimous decision of the Member States. In the overall economic context, let me also refer to our common currency, the euro - one of the great success stories of the European Union. As you may know, the single currency was launched officially on1 January 1999, with the introduction of euro notes and coins being introduced on1 January 2002. We are very pleased to see that the euro has received such an international acceptance and interest. Not only have more than 50 countries pegged their currency to the euro, but the international bond market has also responded positively to the euro : the share of euro-denominated bonds in the total amount outstanding and excluding home currency issuance has risen from less than 20% up to 1998 to more than 30% in 2004. The membership terms agreed by the new Member States include a commitment to adopt the euro and accept the disciplines of Economic and Monetary Union. But the process of joining the euro is not automatic and no timetable was set. Before being able to adopt the single currency, new members will have to meet normal EMU requirements on budget deficits, debt, inflation, long-term interest rates and exchange rate stability. In order to facilitate the transition, the Accession Treaties allow for the ten new countries to peg their currency to the euro by entering the so-called European Exchange Rate Mechanism II ERM II. Membership in the ERM should last for at least two years in order to

5 enable the countries concerned to implement sound economic and monetary policies that foster price and exchange rate stability. On28 June 2004,Estonia,LithuaniaandSloveniaentered ERM II. Latvia, Cyprus and Malta joined the ERM II on2 May 2005. Should the convergence criteria be met, Estonia, Lithuania and Slovenia would be expected to join the euro in 2007 and Latvia, Cyprus and Malta could follow in 2008. For some new Member States it will, however, be advisable to wait a little longer before taking this irreversible step. New Member States need to catch up with the rest of the Union in terms of income levels and therefore need higher GDP growth levels - and possibly, temporarily, higher inflation rates - than in the existing Member States. All in all, the moment of entry and length of ERM II membership and the timing of the adoption of the euro should be determined according to what best serves the transition and macroeconomic needs of each individual country. Before I touch upon the opportunities for Japanese companies offered by enlargement, let me just make a few comments on the general state of the European economy. In my view, the EU economy is to a certain extent more stable and balanced than that of the US and Japan in spite of their recent GDP growth performances. It is true that at 2.4 % for the EU as a whole and 2.0% for the euro area, growth in 2004 was weaker than the growth rates observed in the US. The US has inter alia taken full advantage of its higher flexibility and the advanced structure of its economy. However, the US budget deficit has been rising extremely quickly after surpluses in the late 1990s and the current account is still at unsustainable levels and rising. Japan s economy is also growing at a higher pace now, after a prolonged economic slump. However, according to OECD statistics its public debt has now reached more than 160% of GDP, the highest level in any developed country. Japan s GDP growth is very welcome, but still appears to be driven more by strong growth in China and related business investment than by domestic demand. At the same time, many of the goals in terms of structural reform have not yet been attained. The situation in the EU appears steadier, with the current account broadly around equilibrium and the average nominal budget deficit still under 3% of GDP, in spite of the worrying transgression of certain individual Member States over the limits established by the Stability Pact. But compared to the budget deficits of the US(slightly above 4%) and of Japan(around 7%)Europe still looks better. Nevertheless, our GDP growth, which leapt ahead in the first years after the introduction of the euro, remains still disappointingly low. Obviously the EU needs higher and sustainable growth levels for the rest of this decade if it is to achieve its objectives. In a sense the challenges for the EU are the same as for Japan: structural reform is needed to maintain our positions as dynamic knowledge-based economies. When dynamic growth will resume in the EU, it will be on the basis of stable and balanced macro-economic conditions that will make growth more sustainable.

6 The growth potential of the enlarged EU constitutes an opportunity not only for the current EU Member States, but also for Japan. Japan benefits from the largest single market in the world and a simplified and enhanced access to the markets of the new Member States. More stability and prosperity in central and eastern Europe will mean more exports and business with these countries. EU enlargement has also extended the EU s trade policy regime to the new Member States. A single set of trade rules, a single tariff and a single set of administrative procedures applies. This has already greatly simplified the dealings that Japanese companies have within Europe. Moreover, enlargement has brought a range of immediate and tangible economic benefits to Japan, as all acceding countries will adopt the same open standard of treatment of third countries, applied in the EU. Negotiations on WTO adjustments, as requested by Japan, are in their final stage in Geneva. All major problems seem to have been solved. For trade in industrial goods, the new Member States also adopted the Common Customs Tariff upon accession. This means on average a significant decrease in the tariffs applied. The average weighted industrial tariffs of the acceding countries have decreased from around 9% on average to the 3.6 % average applied by the EU. Thus, third countries' business are benefiting from extensively lower tariffs in their trade with new Member States as a result of enlargement. In the case of services, third countries' service providers also benefit from the implementation of the single market in the new Member States. They get the same treatment there as in the rest of the EU. As regards technical regulations, the "one standard for all" principle of the single market is now extended to the new Member States. This has obvious advantages for Japan's exports. Under these favourable circumstances, it is not surprising that Japan s exports to the ten new member states have substantially increased from Yen 312.9 billion in 2002 to Yen 503.3 billion in 2004. Japanese companies were - and hopefully remain - also active as investors in the new Member States. Catch-up growth in the new Member States will continue to be a major stimulus for FDI for some time to come. With 75 million additional consumers, growth beyond the average level, and a stable legal and institutional framework, the new Member States are the most attractive emerging economies in the world to invest in. I am convinced that Japan has much to gain in further increasing its presence in this new market. I would like to encourage you therefore to be even more engaged in this dynamic region. All new EU Members do now fully participate in the useful co-ordination mechanisms provided by the EU-Japan Action Plan and the regular political high level meetings the Plan provides for. This will reinforce mutual knowledge and confidence. The Action Plan also provides for an excellent basis to broaden the field for our bilateral activities. I should recall that the leaders of Japan and the EU have repeatedly reiterated their commitment to initiate common

7 undertakings and to support international measures for the establishment of democracy, the rule of law, good governance and the promotion of economic perspectives in international relations. One of our objectives in our bilateral relations regularly discussed at the Summit meetings focuses on bringing together people and cultures. And in this regard we very much welcome that equipped with ten additional members, each bringing with them their distinctive culture, language and tradition we can this year celebrate the 2005 EU-Japan Year of People-to- People Exchanges. This constitutes a perfectly timed opportunity for Japanese people to explore a culturally more diverse and enriched European Union.