The role of economic analysis in the Commission's assessment of candidate countries

1. INTRODUCTION

On December 1997, the Luxembourg European Council took the historic decision to launch the enlargement process. In its conclusions the Council stated: "the tasks for the years ahead will be to prepare the applicants States for accession to the Union and to see that the Union is properly prepared for enlargement".
The challenge is clearly identified as a double one, for both parties must get ready for enlargement. The Commission set the context for the overall enlargement process in the Agenda 2000 communication. In Agenda 2000, the Commission presented: 1) its views on the future development of EU policies, notably agriculture and cohesion; 2) its Opinion on the readiness of candidate countries for EU membership and 3) its assessment of the EU's medium-term financial framework, from the year 2000 to 2006, taking into account enlargement needs.

This article¹ deals with the role that economic analysis has played, and will play, in the evaluation of candidate countries readiness for accession and the institutional context defining it. Candidate countries include the 10 central and eastern European countries (CEEC) which have applied for membership in the EU, Cyprus and Turkey. Malta, after having withdrawn its application in 1997, has reapplied and recently received a favourable opinion from the Commission. The European council will take a decision on its application in June 1999. However, this paper focus on the ten CEE transition countries as they present specific features based on their common past.

2. CRITERIA FOR ASSESSING READINESS FOR ACCESSION

The first issue was to decide on which basis to judge these countries' application for membership. This was done by the European Council held in Copenhagen in June 1993 which identified the economic and political requirements CEE countries will need to fulfil to join the EU. It also decided that Accession could take place as soon as they were capable of fulfilling them. The criteria are:

· Political: "membership requires that the candidate country has achieved stability of institutions guaranteeing democracy, the rule of law, human rights, and respect for and protection of minorities".
· Economic: "the existence of a functioning market economy as well as the capacity to cope with competitive pressure and market forces within the Union".
· Institutional: "the ability to take on the obligations of membership, including adherence to the aims of political, economic and monetary union" Based on these criteria, the Commission made an assessment, in its 1997 Opinions, on the readiness of the ten CEEC countries towards accession. The Commission reckoned that the following five: Czech Republic, Estonia, Hungary, Poland and Slovenia, could satisfy the criteria in the medium term perspective of accession if they were to keep up their preparation efforts. The Luxembourg Council endorsed this assessment² when it decided that accession negotiations could start with these five countries (plus Cyprus). They constitute the so called first group. However, this does not imply that negotiations will be finished earlier with the five countries of the first group. For in this regard, the Council set up a review procedure under which the Commission, starting in 1998, makes regular reports to the Council on the progress of the CEEC towards accession, together with any necessary recommendations for the opening of accession negotiations. Negotiations with the other five could the n start as soon as they made sufficient progress in preparations.

Nor does it mean that negotiations will need to finish with any group of countries at the same time. For the duration of negotiations will depend largely on the capacity of each country to adopt, implement and enforce the Community acquis.

In summary, what distinguishes countries in the first group is that formal negotiations have started with them but not with those in the second group. However this situation is reassessed annually, through the Regular Reports. Moreover, the Commission has developed a tailor-made reinforced pre-Accession strategy³ towards each country designed to ensure that no one is left out and every one participates in the Accession process, at is own speed.

The first Regular Reports were established at the end of 1998. They did not change the Opinion's conclusions although the Commission and the Council acknowledged the substantial progress achieved by Latvia and to a lesser extent by Lithuania - even if they lack track record. Bulgaria is catching-up although starting from lower levels. Romania continues to face serious economic difficulties. A second round of Regular Reports will be presented by the Commission to the Council at the end of 1999.

3. INTERPRETATION OF THE ECONOMIC COPENHAGEN CRITERIA

Economic analysis and evaluation has played a key role as part of the Copenhagen criteria in deciding with which countries to start negotiations. In its reports, the Commission focuses on the analyses of the measures taken to satisfy these criteria. However, they cannot be reduced to a simple checklist, as it is the interplay, interaction and mutually reinforcing effects of all measures on the economy, that is pertinent. To have an impact, measures need to be adopted, implemented and enforced. This issue is referred to as "track-record" or "the irreversible, sustained and verifiable implementation of reforms and policies for a period long enough to allow for a permanent change in the expectations and behaviour of economic agents and for judging that achievements will be lasting".⁴

The first economic criterion identified by the Copenhagen European Council is the existence of a functioning market economy. This requires a number of conditions to be met which are analysed in each opinion, namely that:

· equilibrium between demand and supply is established by the free interplay of market forces; prices, as well as trade, are liberalised;
· significant barriers to market entry (establishment of new firms) and exit (bankruptcies) are absent;
· the legal system, including the regulation of property rights, is in place; laws and contracts can be enforced;
· macroeconomic stability has been achieved including adequate price stability and sustainable public finances and external accounts;
· broad consensus about the essentials of economic policy;
· the financial sector is sufficiently well-developed to channel savings towards productive investment.
The 1997 Opinions and 1998 Regular Report assess each applicant in the light of these conditions. The Commission found that five of them (the Czech Republic, Estonia, Hungary, Poland and Slovenia) can be considered functioning market economies, even if in all these cases some important features, such as capital markets, still need to mature and develop further. A sixth applicant (Slovakia) comes very close in terms of legislation and systemic features, but since it lacks transparency in implementation, it cannot yet be considered a market economy.
The second economic criterion is the capacity to withstand competitive pressure and market forces within the Union. This requires a minimum level of competitiveness in the main parts of the economies of candidate countries. The elements to be taken into account include:
· the existence of a functioning market economy, with a sufficient degree of macroeconomic stability for economic agents to make decisions in a climate of stability and predictability;
· a sufficient amount, at an appropriate cost, of human and physical capital, including infrastructure (energy supply, telecommunication, transport, etc.), education and research, and future developments in this field;
· the extent to which government policy and legislation influence competitiveness through trade policy, competition policy, state aids, support for SME, etc.;
· the degree and the pace of trade integration a country achieves with the Union before enlargement. This applies both to the volume and the nature of goods already traded with member states;
· the proportion of small firms, partly because small firms tend to benefit more from improved market access, and partly because a dominance of large firms could indicate a greater reluctance to adjust.
Assessing a country's capacity to withstand competitive pressures and market forces within the Union is a difficult task. The criterion is more complex. The judgement has to be made in a medium-term perspective, as it is clear that, at present or in the short term no country would fulfil it. Meeting this criterion depends in part on meeting the first. Even when the right policy measures are being taken, they take time to work their way through the economy and have their full impact on its ability to cope with competitive pressures.

While keeping in mind the difficulties inherent in such an assessment, the Commission found in its 1997 Opinions that two countries (Hungary and Poland) should be able to satisfy the second criterion in the medium term provided they stay on their current course. Three others (the Czech Republic, Slovakia and Slovenia) should be in the same position on condition that they strengthen their efforts and avoid policy reversals. Because Estonia has modernised and radically liberalised its economy, it comes close to this last group, but its large external imbalance is a cause for concern. Latvia, Lithuania and Romania have made great strides recently, but will require further consolidation of their efforts. Bulgaria is shedding the difficult legacy of the past; it has made considerable progress very recently and is on course to join the others during the next decade.
For the two economic criteria taken together, therefore, Hungary and Poland come closest to meeting them, while the Czech Republic and Slovenia are not far behind. Estonia meets the first criterion, but has some progress to make to meet the second criterion of capacity to withstand competitive pressure. Slovakia could meet the second criterion but cannot be fully regarded as a functioning market economy. In its 1998 Reports, the Commission confirmed its views but it remarked on the lack of progress in the Czech Republic and to a lesser extent in Slovenia and the deteriorating economic situation in Romania. At the current state of economic development and reforms, no candidate country fulfils today both Copenhagen economic criteria.
Finally, economic Copenhagen criteria aim at evaluating both macroeconomic stability and sustainability as well as the structural transformation of transition economies in a medium-term perspective. They should not be confused with Maastricht criteria whose fulfilment is required for adopting the euro in the Economic and Monetary Union (EMU). It would be inappropriate to examine the performance of the candidate countries with regard to the convergence criteria of Maastricht. Fulfilling the Maastricht criteria is not a requirement for EU membership. The economic policy efforts of candidate countries should be directed above all to ensure compliance with Copenhagen economic criteria. The Commission assessment of a country's capacity to join the EU is based exclusively on the Copenhagen criteria and not the Maastricht one.

4. ENLARGEMENT: ACCESSION AND EMU.

The Copenhagen Council concluded that membership requires that a "candidate country has the ability to take on the obligations of membership, including adherence to the aims of political, economic and monetary union". From January 1st 1999, the EU has entered EMU. In applying for membership, the CEEC accepted the objectives of the Treaty on European Union, including political, economic and monetary union. Within this context, no opt-outs from any treaty obligations can be granted to new Member States (MS). Only transitional arrangements in the form of transition measures or transition periods may be granted during negotiation, in duly justified cases, for those parts of the EMU acquis that candidate countries are obliged to apply upon accession but may be unable to. Accession to the EU means acceptance of the full EMU acquis and ultimately the adoption of the euro, when new MS have reached the necessary state of preparedness. Three distinct phases regarding the adoption of EMU acquis can be identified, name ly:

(1) pre-accesion phase, covering the period up to accession;
(2) accession phase, covering the period from accession to adoption of the single currency;
(3) final phase, with the adoption of the euro.
During the pre-accession phase, candidate countries carry out the economic reforms needed to fulfil the Copenhagen economic criteria on the existence of a functioning market economy and on the capacity to cope with competitive pressure and market forces within the Union, in the medium term. They will also adopt the required EMU related legislation. These are, notably:

· Completion of the orderly liberalisation of capital movements.
· Prohibition of any direct public sector financing by the central bank and of privileged access of the public sector to financial institutions.
· Alignment of the national central bank statutes with the Treaty, including the independence of the monetary authorities and the respect of the price stability goal.

Upon accession, CEEC will be part of the Single market and EMU but will not adopt the single currency. Their status will be like that of countries with a derogation and they have to comply with title VI of the EC Treaty. Namely:
· adherence to the aims of economic and monetary union;
· treatment of exchange rate policy as a matter of common interest and, possibly, participation in the exchange rate mechanism;
· treatment of economic policies as a matter of common concern and co-ordination of economic policies between the Member States through participation in Community procedures;
· avoidance of excessive government deficits and adherence to the relevant provisions of the stability and growth pact;
· further adaptation of the national central bank's statutes with a view to integration in the European System of Central Banks (ESCB)
· Progress towards the fulfilment of the Maastricht convergence criteria (on public finances, inflation, exchange rates and long term interest rates).

Their participation in the euro area will be decided on compliance with the conditions for the adoption of the single currency, following the examination of the achievement of a high degree of sustainable convergence. However, prior to accession, there is no institutional requirement to assess progress made on convergence criteria. The fulfilment of the Maastricht nominal convergence criteria will be the final key to open full participation in the euro-zone, just as it did for the euro-11.
The Opinions and Regular Reports have also assessed progress achieved on the obligations of the pre-accession phase. They found that for the Czech Republic, Estonia, Hungary, Poland and Slovenia participation in EMU, as a non-participant in the euro area, should pose no or few problems in the medium term, provided that the necessary measures specified in these reports were taken by each country. For all countries, it was still premature to judge when they would be ready to adopt the euro.
As the first stage of the negotiating process, the Commission has launched the screening process for the analytical examination of the community acquis in the area of EMU. The purpose of the screening is to familiarise candidate countries with EMU acquis as well to identify issues that could pose a problem during negotiations. At the end of 1998, the Commission held bilateral meetings with each of the countries in the first group and the screening reports have been established. On the basis of the screening results, the countries will shortly submit negotiating positions on the EMU chapter. Draft common positions will be presented to the Council during the Finnish presidency in the 2nd half of 1999 for adoption. It is expected that the area of the acquis that will likely present difficulties is liberalisation of capital movements .⁵

The commission will shortly start a screening exercise (mid-April 99) with countries of the second group. The screening will serve the same purpose as above, but it will obviously not lead to negotiations.

5. THE REINFORCED PRE-ACCESSION STRATEGY: ECONOMIC RELATIONS WITH CEE COUNTRIES

In the framework of European Agreements, a subcommittee on economic and monetary issues has been created between the Commission and each CEE country. This subcommittee meets at least once a year and provides a forum to exchange information and discuss economic policy issues of mutual interest. It has proven to be a useful means for open debates on the economic situation, economic performance and policies, policy stance and future prospects and co-operation. It reports to the Accession Committee.

The Commission adopted in March 1998 the Accession Partnership that defines for each CEEC the priorities for reforms. In the area of economic reform, they required the establishment of medium-term economic policy priorities and their joint assessment with the Commission. Accordingly, the Commission (DGII) is developing a series of joint assessments of economic policy priorities (JA) with each country. The main role of the JA is to ensure that, in the preparations for membership, adequate attention is paid to the importance of stability-oriented economic policy and to the completion of reforms. This should help applicants to make their preparations for accession in a coherent manner: the timing and sequencing of structural reforms can be planned within a consistent medium-term policy framework. The exercise consists of two major steps.
· Elaboration by the authorities, in co-ordination with the European Commission, of a medium-term economic strategy to prepare for accession. This should be a complete and detailed description of the necessary reforms and policies as well as of the timetable for their implementation.
· Agreement by the authorities and the European Commission on a joint assessment based on the above programme of a macroeconomic scenario consistent with the major structural reforms that are to be implemented. This is the actual Joint Assessment.

After agreeing on a JA with Hungary in June 1996 and one with Slovenia in November 1998, DGII has very recently finalised another joint assessment with Latvia. Work is proceeding smoothly to finalise the JA with other countries during 1999.

6. CONCLUSIONS

In the years ahead as candidates countries persist in their endeavours to transform their economies into efficient market economies capable of competing in the Union's markets, economic analysis will continue to play a key role in assessing the state of economic reforms. A proper assessment of economic progress is not only be crucial for starting accession negotiations with each country, but also for accession itself, as Copenhagen economic criteria needs to be fulfiled in the medium term horizon of joining the EU.

Many of the economic procedures now in place will be gradually transformed as we move closer to accession into the procedures used for the co-ordination of economic policy and multilateral surveillance in the UEM. The full range of EMU procedures will be apply when they finally adopt the euro.

In this framework, the Joint assessment of economic policy priorities is the forerunner of the future convergence programme and later stability programmes the CEEC will have to present when they join the EU. The economic analysis of the Regular Reports will grow and be transformed into the Annual Economic Report and other reports on the state of structural reforms. Finally, bilateral fora for discussion will give way to participation in the multilateral bodies, such as the Economic and Financial Committee, where member states, and not only the institutions of the Union, put peer pressure on each other and come to an understanding of common interest and joined actions. The preparations towards accession and EMU participation are well underway, the learning process has a long way to go while the economic efforts to be made by the CEEC are still considerable.

19-03-1999

alexandra.cas-granje@DG2.cec.be

1 Commission Européenne DG II D/1 "Affaires économiques des pays candidats à l'adhesion et questions connexes alexandra.cas-granje@DG2.cec.be. The paper draws on the Commission's 1997 Opinions, the 1998 Regular Reports and the economic analysis of Directorate General II. As such, it is the combined effort of officials in DG II unit D-1. Any errors are of course my own and the usual disclaimer applies.

2 Regarding the political criteria, the Luxembourg Council concluded that "Even though progress has still to be made in a number of applicant countries as regards actually practising democracy and protecting minorities, only one applicant State - Slovakia - does not satisfy the political conditions laid down by the European Council in Copenhagen". With respect to the institutional one, the Luxembourg Council concluded: "if current efforts are reinforced, Hungary, Poland and the Czech Republic should be able in the medium term to take on the major part of the acquis and to establish the administrative structure to apply it. Slovakia, Estonia, Latvia, Lithuania and Slovenia would be able to do so only if there is a considerable and sustained increase in their efforts". Bulgaria and Romania were not in a position to take on the obligations of membership in the medium term.

3 this strategy consists of the following elements: the Accession Partnership, further pre-accession aid and participation of CEEC in community programmes.

4 Composite Paper on the Commission's 1998 Regular Reports p.6

5 Even though capital movement is a separate chapter, it is also part of EMU acquis under the treaty.