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Romanian Journal of European Affairs

Vol. 6, No. 1, May 2006

EUROPEAN INSTITUTE OF ROMANIA

Director Nicolae Idu Editor-in-Chief Oana Mocanu Associate Editors Irina Rmniceanu Gilda Truic Editorial Board Farhad Analoui Professor in International Development and Human Resource Management, the Center for International Development, University of Bradford, UK Daniel Dianu Professor, Academy of Economic Studies, Bucharest, former Minister of Finance Eugen Dijmrescu Vice Governor of the National Bank of Romania Nicolae Idu Director General of the European Institute of Romania Andras Inotai Professor, Director of the Institute for World Economics, Budapest Mugur Isrescu Governor of the National Bank of Romania Alan Mayhew Jean Monnet Professor, Sussex European Institute Costea Munteanu Professor, Academy of Economic Studies, Bucharest Jacques Pelkmans Jan Tinbergen Chair, Director of the Department of European Economic Studies, College of Europe Bruges Andrei Pleu Rector of New Europe College, Bucharest, former Minister of Foreign Affairs, former Minister of Culture Cristian Popa Vice Governor of the National Bank of Romania Tudorel Postolache Member of the Romanian Academy, Ambassador of Romania to the Grand Duchy of Luxembourg Helen Wallace Professor, Director of the Robert Schuman Centre for Advanced Studies, European University Institute, Florence

CONTENTS
IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET Gbor Hunya, Anna Iara INFLATION TARGETING IN EASTERN EUROPE Laurian Lungu, Juan Paez-Farrell TURKEY INTO THE EUROPEAN UNION: PAST CHALLENGES AND FUTURE PROSPECTS Murat Metin Hakki WHY LEGAL TRANSPLANTS INSTEAD OF MORE ADAPTATION WITHIN THE PROCESS OF LEGAL APPROXIMATION IN THE CENTRALEASTERN EUROPEAN MEMBER STATES OF THE EU AND THE CANDIDATE COUNTRIES? Mnika Jzon

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ROMANIAN JOURNAL OF EUROPEAN AFFAIRS

VOL. 6, NO. 1, 2006

IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET
GBOR HUNYA, ANNA IARA*
Abstract**. This paper explores the potential impact of Romanias accession to the European Union on Austria in three major fields: foreign trade, FDI and labour market. While conditions of doing business in Romania have improved in recent years, they are still more complicated than in old and new EU member states. Romania remains a rapidly growing market for investment goods, consumer goods and services alike providing good opportunities for Austrian companies. While the effect of Eastern European labour immigration to Austria can be expected to be marginal on total employment and wages, it may affect specific segments of the labour market. Overall, labour immigration from Romania will remain relatively unproblematic. INTRODUCTION Romania will become a member of the European Union in 2007 or 2008. This paper explores the potential impacts of this step on Austria in three major fields: foreign trade, FDI and labour market. Romania has been on a path of rapid economic growth since 2001. In 2005 private consumption provided the main stimulus to GDP expansion while also contributing to the widening of the foreign trade deficit and curtailing disinflation. Conditions of doing business in Romania have improved in recent years but they are still more complicated than in old and new EU member states. The medium-term prospects of the Romanian economy depend of two main factors: restructuring and improving international competitiveness, and the capacity to absorb EU funds after accession. If progress is slow in both respects, economic growth will be around 4% annually in the coming years, while under favourable conditions it may climb to 5-6%. Romania will

* Gbor Hunya is senior research economist at the Vienna Institute for International Economic Studies (WIIW). He is a specialist of economic transformation, privatization and foreign direct investment in Central and Eastern Europe. He has published articles and has conducted research projects on foreign direct investment and its effects on restructuring and competitiveness in this region. His interest in Romania and Bulgaria dates back to the 1980s. He published a post World War II economic history of Romania in 1990 (in Hungarian). In Vienna he regularly contributes the part on Romania to his institutes economic surveys and forecasts and also follows the economic development of Bulgaria. He also worked as short-term consultant to the World Bank, UNCTAD, OECD and the CASE Foundation. His recent publications include the article Restructuring through foreign direct investment in Romanian manufacturing published in Economic Systems in 2002 and another with the title Hungarian-Romanian cross-border economic co-operation published in Rgion et Dveloppement in 2003. Anna Iara is staff economist at the Vienna Institute of International Economic Studies (WIIW) since summer 2005. Prior to her present assignment, she had been a research fellow at the Center for European Integration Studies (ZEI), University of Bonn, since 2002. Her research topics cover labour markets and migration, regional economics, and applied econometrics, with an empirical focus on Central and Eastern Europe. In addition to economics (completed at the Central European University), she holds a masters degree in geography from the University of Bonn. ** This study was commissioned by the Romanian Embassy in Vienna, March 2006.

funds after accession. If progress is slow in both respects, economic growth will be around 4% annually in the coming years, while under favourable conditions it may climb to 5-6%. HUNYA, ANNA IARA GBOR will Romania remain a rapidly growing market for investment goods, consumer goods and services alike providing good opportunities for Austrian companies.

remain a rapidly growing market for and payments, then at a the volume In the Austrian-Romanian relations, a small rich country meets relatively large and but investment goods, consumer goods and structure of trade between Austria and much poorer country. By territory and population Romania is almost three times larger than services alike providing good Romania. In this relationship, Austria is Austria, but its per capita GDP at purchasing power parity is only one quarter. The income opportunities for Austrian companies. in a clear winner position, enjoying a gap the two countries isrelations, a stimulus for migration current to Austria, which will be slowly Inbetween the Austrian-Romanian significant account surplus with the expected economic catching-up of Romania. amitigated small by and rich country meets a Romania (Table 1; note that 2005 data relatively large but much poorer will be only available towards the end country. By and territory of April The bulk of that surplus 1. Payment trade and flows population between Austria and 2006). Romania Romania is almost three times larger is generated by trade in goods, but In this chapterbut we its firstper look at the GDP items at of the bilateral balance of payments, then at the than Austria, capita increasingly also by services and purchasing power parity only one volume and structure of tradeis between Austria incomes. and Romania. this relationship, Austria is The In term incomes represents quarter. The income gap enjoying between in a clear winner position, a the significant current account surplus with mainly the profits of Romania Austrian two countries is a stimulus for migration (Table 1; note that 2005 data will be only available towards the end of April 2006). The bulk companies. These profits are mostly reto Austria, which will be slowly invested in Romania and thus booked of that surplus is generated by trade in goods, but increasingly also by services and mitigated by the expected economic also FDIofoutflow Austria. The incomes. The incomes represents mainly the as profits Austrianfrom companies. These of term Romania. catching-up balance of transfers is the only negative profits are mostly re-invested in Romania and thus booked also as FDI outflow from 1. Payment and trade flows between position from the Austrian point of view. Austria. and The Romania balance of transfers is the only negative position from the Austrian point of Austria This category includes the remittances view. This category includes the remittances of amount that is not highhigh but workers,an an amount that is not In this chapter we first look at the of workers, rising over time. items of the bilateral balance of but rising over time.
Table 1

Austrias current account with Romania, EUR million


Credit Current account Goods Services Incomes Transfers Other 244 184 56 4 0 0.3 1995 Debit 129 94 31 3 1 0.5 Net 115 90 25 2 -1 -0.2 Credit 677 537 139 -1 2 0.2 2000 Debit 429 338 81 6 3 0.9 Net 248 199 57 -7 -2 -0.7 Credit 1309 1026 183 95 4 3.9 2003 Debit 697 575 105 10 7 1.9 Net 611 451 79 85 -3 2.1 Credit 1588 1237 263 91 -3 0.9 2004 Debit 901 685 192 14 10 3.5 Net 687 552 71 77 -13 -2.5

Source: OeNB (Austrian National Bank).

From the Romanian National Bank is the large size of profits made by From the Romanian National Bank we received the 2005 bilateral 1 balance of payments we received the 2005 bilateral balance Austrian companies. For Romania, migrants of payments (earlier years were not (earlier years were not available). This reveals a EUR 714 million deficit fortransfers Romania,are of an important source of revenues, available). This reveals a EUR 714 which EUR 454 million is in the exchange of goods and services, EUR 299 million is the million deficit for Romania, of which equivalent to 15% of total exports of EUR 454 million is in the exchange of goods and services; however, such goods and services, EUR 299 million is transfers from Austria are insignificant. the deficit on income. The main novelty In 2005 Romania received about EUR
1 The bilateral trade and payment flows reported by 2 the individual countries are usually not identical, thus we cannot extrapolate the Austrian data based on the Romanian mirror statistics.

IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

4 billion in current transfers from abroad, in which Austria had a minor share of 1.55%. If we take the latter figure as the share of Romanian workers in Austria in the total estimated number of one million Romanians working abroad, the number of those working in Austria would be about 15,500. In chapter 4 we shall provide also other approximation results. The most obvious characteristic of the trade flows between the two countries is its very small volume. In 2004 Romania ranked 16th regarding Austrian exports (EUR 1236) and 21st regarding imports (EUR 722 million) (customs statistics based on the Austrian Statistical Yearbook 2006). The share of Romania in Austrian exports was 1.38%, that in imports 0.8%. This is only one fourth of what Austria trades with the Czech Republic or Hungary. But it is also important to note that trade between Austria and Romania has been increasing rapidly in recent years. Between 2000 and 2003 exports to Romania doubled and in 2004 they rose by another 20%. Imports from Romania expanded less rapidly, but they also more than doubled between 2000 and 2004. The Austrian trade surplus amounted to more that 40% of exports. Increasing trade can be beneficial for economic growth in both countries. Romania provides a rapidly growing export market generating sales of Austrian companies which may have positive employment effects in Austria. Also, low cost sourcing can increase efficiency in Austrian companies and improve their overall competitiveness. Both of these impacts were confirmed by the survey of Austrian investors in Romania that is presented in section 3.4.

In addition, there is the benefit of the positive trade balance. Romania has much room to catch up in terms of economic development and international competitiveness which would generate even more trade with Austria in the future. Back in 1995 the volume and balance of AustrianHungarian trade, for example, was similar to those of Austrian-Romanian trade in 2004. If Romania follows the pattern of Hungary, the picture may change substantially within five years. The trade volume may increase 2-3 times and would become more balanced. To achieve such a development, Romanias export capacities should strengthen through rapid export-oriented industrial restructuring based on FDI. In this respect, however, Austrias recent large FDI projects in the Romanian banking and oil sectors may not have significant trade-promoting impacts as their activities are mostly confined to Romania. But several of the manufacturing FDI projects which started in the past two years will contribute to structural change in Romanian industry and exports (see Box 3 further below). For the time being, trade between Austria and Romania is complementary with little intraindustry trade. The commodity structure of bilateral trade bears the typical features of trade between developed and less developed countries. Austrias exports to Romania consist mainly of machinery, motor vehicles, chemicals (including medicines): these three industries represent 43% of the total (see Table 2). Imports are more diversified, with the first three industries making up only 33% (see Table 3). Crude petroleum and natural gas are the main 7

For the time being, trade between Austria and Romania is complementary with little intra-industry trade. The commodity structure of bilateral trade bears the typical features of trade between developed HUNYA, ANNA IARA and less developed countries. Austrias exports to Romania GBOR consist mainly of machinery, motor vehicles, chemicals (including medicines): these three industries represent 43% of the total (see Table 2). Imports are more diversified, with the first three industries making only 33% (seeinstruments Table 3). Crude petroleum natural gas commodities, followed by up chemicals, such as and anti-dumping, are the main commodities, followed by chemicals, communication equipment, motor communication equipment, motor antisubsidy and safeguard measures vehicles and machinery. The most important Romanian export commodities textiles, vehicles and machinery. The most are tools which may be used clothing, shoes andexport furniture show up modestly in Austrian imports. Theseinto goods are important Romanian commodities exclusively against imports the EU mainly exported the contractors in Italy and Germany and the latters 2 textiles, clothing,toshoes and furniture The originating in spread third under countries. labels through show up Europe. modestly in Austrian experience of the 2004 enlargement

imports. These goods are mainly suggests that becoming part of the exported to the contractors in Italy of and What will change in the conditions trade when European Union? singleRomania market joins can the boost foreign trade Germany and under the Romania willspread be integrated into thelatters single market and will be part of the EU-27. All issues especially among the new members. labels through related to the Europe. free movement of goods among the member states will be subject to the EU Both exports and imports of Romania What will change in the rules. conditions of defence instruments such as anti-dumping, market and competition Trade are expected to expand by twodigit trade when and Romania joins the anti-subsidy safeguard measures are tools which may be used exclusively against rates. As a novelty, trade may European Union? Romania in will be growth 2 The experience of the 2004 enlargement imports into the EU originating third countries. increase not only with the old EU integrated into the single market and suggests that becoming part of the single market can boost foreign trade especially among will be part of the EU-27. All issues members but even more rapidly with the new members. Both exports and imports of Romania are expected to expand by related to the free movement of goods Bulgaria. Trade with Austria will not two-digit growth rates. As a novelty, trade may increase not only with the old EU members among the member states will be benefit in a special way due to the but even more rapidly with Bulgaria. Trade with Austria will not benefit in a special way due subject to the EU market and single market regulation, but it may be to the single market regulation, but it may be boosted by increasing FDI. competition rules. Trade defence boosted by increasing FDI.
Table 2

Main Austrian export industries to Romania, NACE category in per cent of total, 2004
Export shares 18.2 14.8 10.1 5.8 4.9 4.7 4.3 4.1 4.0
2

Description Manufacture of machinery and equipment n.e.c. Manufacture of motor vehicles, trailers and semi-trailers Manufacture of chemicals and chemical products Manufacture of basic metals Manufacture of electrical machinery and apparatus n.e.c. Manufacture of other transport equipment Manufacture of radio, television and communication equipment Manufacture of food products and beverages Manufacture of fabricated metal products

3.7 3.5 3.3 3.2 3.1 3.0

For details see http://europa.eu.int/comm/competition/index_en.html.

Manufacture of medical, precision and optical instruments Manufacture of furniture; manufacturing n.e.c. Manufacture of rubber and plastic products Manufacture of pulp, paper and paper products Manufacture of wood and of products of wood Manufacture of other non-metallic mineral products

Source: Eurostat COMEXT Database.

For details see http://europa.eu.int/comm/competition/index_en.html.

Table 3

Main Austrian import industries from Romania, NACE category in per cent of total, 2004
Description Extraction of crude petroleum and natural gas Manufacture of chemicals and chemical products

Import shares 15.2 9.4

3.3 3.2 3.1

Manufacture of rubber and plastic products Manufacture of pulp, paper and paper products Manufacture of wood and of products of wood

3.0 Manufacture of other non-metallic mineral products ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET IMPACT OF ROMANIAS Source: Eurostat COMEXT Database.

Table 3

Main Austrian import industries from Romania, NACE category in per cent of total, 2004
Import shares 15.2 9.4 8.4 7.8 7.8 6.1 5.2 5.1 3.7 3.5 3.3 3.1 Description Extraction of crude petroleum and natural gas Manufacture of chemicals and chemical products Manufacture of radio, television and communication equipment Manufacture of motor vehicles, trailers and semi-trailers Manufacture of machinery and equipment n.e.c. Manufacture of other transport equipment Manufacture of basic metals Manufacture of electrical machinery and apparatus n.e.c. Manufacture of medical, precision and optical instruments Manufacture of furniture; manufacturing n.e.c. Manufacture of wearing apparel Manufacture of fabricated metal products

Source: Eurostat COMEXT Database.

billion from additional imports can One may expect further trade to be by transfers One may expect further trade to be created the EU budget. For the first be created by transfers from theRomania EU expected. A together well-founded presence three years of EU membership, and Bulgaria are eligible for of budget. For the first three of years EU potential Austrian suppliers in will Romania commitment appropriations EUR of 25.4 billion, of which about three quarters be membership, Romania and Bulgaria may increase the chance of receiving Romanias share. The main targets are grouped as agriculture, structural operations, together are eligible for commitment an important part of these contracts. internal policies, and administration. 75% of the amount available for structural operations appropriations of EUR 25.4 billion, of Our company survey confirms that most is still the remarkable sum of EUR 6.2 billion allotted to Romania in three years. Spending which about three quarters will be of the large Austrian construction firms such a sum on investments generate amounts of imports, and project- in Romanias share. The mainmay targets are significant have already established subsidiaries related finances will be available for contractors and suppliers from all EU countries. The grouped as agriculture, structural Romania and expect positive impacts example of earlier enlargements show and that in EU-15 cohesion countries, of the operations, internal policies, from the countrys EU 25-35% accession. value of structural policy was spent on imports (European Commission, administration. 75% of interventions the amount 2. AUSTRIAN FDI INother ROMANIA available for structural operations is still projects 2004). Although part of the EU-cofinanced may crowd out projects, the remarkable sum of EUR 6.2 EUR 1-2 billion additional imports canbillion be expected. A well-founded presence of potential 2.1 Amount of Austrian FDI in allotted Romania in three years. the chance Austrianto suppliers in Romania may increase of receiving an important part of Romania by different data sources Spending such a sum on investments these contracts. Our company survey confirms that most of the large Austrian construction Investing abroad is a risky business. may generate significant amounts of imports, and project-related finances will For an Austrian company undertaking be available for contractors and investment in a country with a less suppliers from all EU countries. The 5 familiar and less stable environment, example of earlier enlargements show decisions must be based on a careful that in EU-15 cohesion countries, 25- assessment of possible risks and 35% of the value of structural policy returns. Trust is needed before large interventions was spent on imports amounts of money are transferred (European Commission, 2004). Although abroad. The increasing flows of FDI part of the EU-cofinanced projects may into Romania confirm the presence of crowd out other projects, EUR 12 rising confidence that business will go 9

2.1 Amount of Austrian FDI in Romania by different data sources Investing abroad is a risky business. For an Austrian company undertaking investment in a HUNYA, ANNA IARA and less stable environment, decisions must be based on a GBOR country with a less familiar careful assessment of possible risks and returns. Trust is needed before large amounts of money are transferred abroad. The increasing flows of FDI into Romania confirm the well. Austrian companies from will other transition countries, Austrian presence of rising confidencebenefit that business go well. Austrian companies benefit from the advantage that they can rely on the advantage that they can rely on experience made in other, transition companies can more moreadvanced easily cope with experience made in other, countries. From the company surveymore we shallthe conclude that due to knowledge they difficulties in thethe Romanian advanced transition countries. From the gained in other transition countries, Austrian companies can more easily cope with the company survey we shall conclude that business environment than their less difficulties in the Romanianthey business environment than their less experienced competitors. due to the knowledge gained in experienced competitors.
Table 4

Austrian FDI outflows to Romania, EUR million


1997 FDI 47 1998 62 1999 36 2000 184 2001 97 2002 61 2003 85 2004 1713 1.1-30.6.2005 2005 estimate 137 400

Source: OeNB, balance of payments.

Austrian companies have been present in Romania since the beginning of transformation, Austrian companies have been the oil company Petrom through OMV. present in with Romania sinceamounts. the beginning In the was first negligible half of 2005, when no of major but initially very small The FDI outflow in the first half the of transformation, but initially with very privatization took place, EUR 137 million 1990s and only about EUR 50 million annually in the second half of the past decade small amounts. The FDI outflow was flew from Austria to Romania and about (Table 4). In the years 2000-2003 they increased to EUR 100 million on average. negligible in the first half of the 1990s EUR 400 million can be estimated for Compared to the EUR total amount of Austrian FDI outflows of EUR billion annually overto those and only about 50 million annually the year as a6 whole. According the years, share mere 1-2%. In 2004 outflows to Romania made big leap in the Romanias second half of was the a past decade provisional bilateral balance of a payments (Table In 2000-2003 they published by the Romanian National forward4). due tothe the years acquisition of the oil company Petrom through OMV. In the first half of increased to EUR 100 million on Bank, the FDI inflow from Austria 2005, when no major privatization took place, EUR 137 million flew from Austria to average. Compared to the total amount amounted to EUR 534 million in 2005. Romania and about EUR 400 million can be estimated for the year as a whole. According of Austrian FDI outflows of EUR 6 The huge acquisition by Erste Bank of to the provisional paymentsBanca published by the Romanian National billion annually bilateral over balance those of years, Commerciala Romana for Bank, some the FDI inflow from Austria amounted to EUR 534 million in 2005. The huge acquisition by Romanias share was a mere 1-2%. In EUR 2.2 billion does not show in the Erste Bank of Banca Commerciala Romana for some EUR 2.2 billion does not show in the 2004 outflows to Romania made a big statistics for 2005 because payments leap forward due to thepayments acquisition of be will onlyinbe made in 2006. statistics for 2005 because will only made 2006.
Table 5

Austrian FDI in Romania, year-end stock


2000 OeNB (Austrian National Bank) EUR mn. % of total National Bank of Romania, EUR mn % of total Trade Register of Romania, EUR mn % of total Source: Institutions listed in the table. 297 1.1 n.a. 310 4.5 2001 2002 568 1.4 n.a. 449 6,2 2003 555 1.25 633 6.2 474 5.8 2004 n.a. 2355 15.7 1384 13.1 2005 n.a. n.a. 1917 14.5

6 1.3

431 n.a. 615 6.8

The stock of Austrian outward investment to Romania was EUR 555 million (1.25% of the total) in 2003, which puts Romania in the 14th place among the target countries of Austrian investors. In the Romanian National Bank survey for 2003 Austria ranked 7th among the 10 inward investors with a stock of EUR 633 million, i.e. 6.2% of the total inward FDI stock. According to the 2004 survey, Austria advanced to 2nd place with EUR 2355 million of FDI

IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

The stock of Austrian outward investment to Romania was EUR 555 million (1.25% of the total) in 2003, which puts Romania in the 14th place among the target countries of Austrian investors. In the Romanian National Bank survey for 2003 Austria ranked 7th among the inward investors with a stock of EUR 633 million, i.e. 6.2% of the total inward FDI stock. According to the 2004 survey, Austria advanced to 2nd place with EUR 2355 million of FDI stock, 15.7% of the total. According to a third source, the Romanian National Trade Register Office, 3578 Austrian companies were registered in the country by the end of 2005, which is 3.2% of the total number of foreign ventures and puts Austria on rank 8. The amount of registered capital was EUR 1919 million, 14.5% of the total, the second largest amount after the Netherlands.3 Taking into account the impact of the Erste Bank investment, we estimate the 2006 yearend Austrian FDI stock in Romania at about EUR 6 billion. This amount is similar to those expected in the most prominent Central East European target countries the Czech Republic and Hungary and will constitute about 10% of the Austrian outward FDI stock. By that time, the difference between Romania and the earlier established target countries will not relate to the amount of FDI but to its sectoral structure. In those earlier target countries the concentration of FDI is much smaller, Austrian investors have more subsidiaries, they are more evenly spread among economic activities and a larger part of them is export-oriented. In Romania, local market-oriented, privatization-based

ventures dominate although as we shall see from the list of recently registered ventures (Box 3) exportoriented FDI projects have become more numerous recently. 2.2 Characteristics of Austrian subsidiaries in Romania in 2003 Austrias National Bank (Oesterreichische Nationalbank, OeNB) published the results of its 2003 survey on foreign investment enterprises in September 2005 (OeNB, 2005) (Table 5). This is the most up-to-date Austrian source concerning employment, profits and other indicators of Austrian affiliates in Romania. While the number of projects (58 subsidiaries) is only a fraction of what the Romanian Trade Register shows, the invested capital is higher. One of the reasons for the difference is that the OeNB survey does not cover ventures with less than EUR 72 thousand FDI whereas the Romanian Trade Register also covers smaller companies including one-person ventures as well. The number of employees working for Austrian subsidiaries (weighted by the equity share of the Austrian owner) reached 14,800 in 2003, two times more than three years earlier (Table 6). This is the sixth largest number among the target countries. Having taken over large numbers of employees in the newly acquired companies Petrom and BCR in 2004 and 2005, employment of Austrian subsidiaries must meanwhile have increased to a level of 50-60 thousand. The restructuring of the two firms will require the presence of Austrian or other foreign nationals while the Romanian staff will be reduced in order to increase efficiency.

3 National Bank of Romania (NBR) data and Trade Register data differ in methodology and coverage. NBR data are more complete, based on international methodology. The Trade Register includes only data on the statutory capital of the foreign investment enterprise but provides more up-to-date information concerning the country of origin and even names the investing companies.

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large numbers of employees in the newly acquired companies Petrom and BCR in 2004 and 2005, employment of Austrian subsidiaries must meanwhile have increased to a level of 50-60 thousand. The restructuring of the two firms will require the presence of Austrian HUNYA, ANNA IARA or GBOR other foreign nationals while the Romanian staff will be reduced in order to increase efficiency.
Table 6

Characteristics of Austrian subsidiaries in Romania


1997 Number of subsidiaries FDI stock, end-year, EUR million Number of employees Own Capital Profits minus losses Patents and Management fees Intra-company exports of goods and services Intra-company imports of goods and services
1)

1998 37 119 5607 108 -5 2 8 1

1999 43 174 4797 156 -1 2 20 5

2000 52 297 7302 264 -10 4 27 3

2001 53 431 10683 377 -6 3 18 4

2002 50 568 12074 507 10 5 24 5

2003 58 555 14799 475 66 6 39 14

19 42 2049 40 -1 0 15 0

Note: 1) Weighted by the share of the Austrian company in equity. Source: Survey of the OeNB.

Austrian FDI in Romania is highly did profits outpace losses (Table 6). profits in later years reflect labour-intensive. Austrian subsidiaries in The rising Austrian FDI in Romania is highly labour-intensive. Austrian subsidiaries in Romania the stock. increasing maturity with of businesses Romania employ one per EUR FDI employ one person per person EUR 37.5 thousand In the countries the highest and conditions of in doing 37.5 thousand FDI In is the Austrian employment the stock. latter figure nearly twiceimproving as high: EUR 58.1 thousand the countries with the highest Austrian business in Romania. In 2003 the Czech Republic and EUR 64.2 thousand in Hungary. Relatively low capital intensity but employment the latter figure is nearly picture improved substantially: profits high labour intensity is in line with the comparative advantages of 78 Romania. jobs to EUR millionLow-paid and losses twice as high: EUR 58.1 thousand in jumped in Romania not compete withEUR Austrian wages because the not re-export diminished tosubsidiaries EUR 12domillion. The the Czech do Republic and 64.2 number of profit-making companies thousand in Hungary. Relatively low modest much to Austria as confirmed by relatively intra-company trade data. In the years capital intensity but high labour intensity increased as well. Still, there were only is in line with the comparative 34 subsidiaries recoding profits and 24 advantages of Romania. Low-paid jobs subsidiaries running losses in 2003. 8 in Romania do not compete with Romanian data for 2005 indicate an Austrian wages because the increase in Austrian profits to EUR 300 subsidiaries do not reexport much to million, which would mean a new age Austria as confirmed by relatively of making profits in Romania. The expected changes for modest intra-company trade data. In the years 1999-2002 Austrian companies subsequent years may include even exported about EUR 20 million annually further increasing profits and the start to their Romanian subsidiaries while of profit repatriation from more mature they imported only in the value of EUR FDI projects. Austrian benefits will then 5 million p.a. (Table 6). Exports jumped be earned directly and can generate to EUR 39 million in 2003 and imports income in Austria; spending these to EUR 14 million and may have earning may also increase demand and perhaps generate workplaces. increased further in recent years. The small number of Austrian FDI In the early stages of an FDI project investors usually have to reckon with firms in the OeNB sample does not low or no profits. Up until 2001 Austrian allow for a detailed breakdown by investors aggregately reported net economic activity because it would losses, and only in the following year violate privacy rules. A broad 12

and the start of profit repatriation from more mature FDI projects. Austrian benefits will then be earned directly and can generate income in Austria; spending these earning may also increase demand and perhaps generate workplaces.
IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

The small number of Austrian FDI firms in the OeNB sample does not allow for a detailed breakdown by economic activity because it would violate privacy rules. A broad classification (Table reveals that 23 2000 andofbecame later due to reclassification (Table 7)7) reveals that 23 subsidiaries (40% the total lower number) were active in subsidiaries (40% of the total number) classification of activities. Similarly, agriculture and industry, but their invested capital amounted to only EUR 72 million, 13%the of were active in agriculture and industry, labour force employed by these the FDI stock in 2003. These companies employed 5543 persons, 37% of the total. Thus but their invested capital amounted to subsidiaries declined in 2001, we have lower average higher than average labour The intensity in only EUR 72 than million, 13% capital of theintensity FDI and recovering only in 2003. foodthe manufacturing subsidiaries. The number of such subsidiaries more or less stagnated in stock in 2003. These companies beverages-tobacco industry is the most 1998-2003,5543 while the invested capital a peak in 2000 and became later due employed persons, 37% of reached the significant investor and lower employer in total. Thus we have lower than average manufacturing, to re-classification of activities. Similarly, the labour force employed e.g. by theseBrau-Union. subsidiaries capital and higher Construction material production ranks declined intensity in 2001, recovering only in than 2003. The food-beverages-tobacco industry is the average labour intensity in the second, including e.g. the brick most significant investor and employer in manufacturing, e.g. Brau-Union. Construction manufacturing subsidiaries. The number producer Wienerberger. Chemicals and material production ranks second, including e.g. the brick producer Wienerberger. of such subsidiaries more or less machinery follow, examples are Henkel Chemicals and machinery follow, examples are Henkel and Siemens investing via Austrian stagnated in 1998-2003, while the and Siemens investing via Austrian headquarters. invested capital reached a peak in headquarters.
Table 7

Austrian subsidiaries in Romania by economic activity


Activity of subsidiary FDI, EUR mn Production ( NACE code A-F) Trade Finance Other services Altogether Production A-F Number of subsidiaries Trade Finance Other services Altogether Production A-F Trade Finance Other services Altogether 5607 4797 37 5001 394 43 3691 774 119 22 6 174 21 11 1998 91 11 1999 113 35 2000 142 105 35 16 297 21 15 10 6 52 4549 2239 363 150 7302 2001 54 239 117 22 431 21 15 11 6 53 3051 4072 3448 112 10683 2002 50 264 216 38 568 20 14 11 5 50 3357 3771 4799 147 12074 2003 72 283 152 48 555 23 17 12 6 58 5543 4119 4935 201 14799

Number of employees weighted by equity share

Source: Survey of the OeNB.

More than half of the FDI capital is 2.3 The most important Austrian More than of the FDI27% capital invested in trade and 27% in financial services. FDI per invested inhalf trade and inisfinancial investors in Romania services. peris employed person is also in financial services it is higher than in employed FDI person the highest in trade; The Romanian National Trade the highest in With trade; inlarge financial manufacturing. the also recent projects, the share of banking and the oil industry Register publishes the top 40 services it is higher than in must have increased. investment projects each month and manufacturing. With the recent large projects, the share of banking and the provides more recent information than oil industry must have increased. the Austrian National Bank surveys. In
2.3 The most important Austrian investors in Romania The Romanian National Trade Register publishes the top 40 investment projects each 13 month and provides more recent information than the Austrian National Bank surveys. In 2003 and 2004 there were 30 new Austrian investment projects registered. In 2005 the number of such entries increased to 40, which confirms the upward trend of Austrian FDI.

2.3 The most important Austrian investors in Romania


GBOR HUNYA, ANNA IARA

The Romanian National Trade Register publishes the top 40 investment projects each month and provides more recent information than the Austrian National Bank surveys. In 2003 and 2004 2004there there were 30 Austrian new upward trendprojects of Austrian FDI. Eight of the 2003 and were 30 new investment registered. In 2005 the number investment of such entries increased to 40,In which confirms the upward trend of Austrian FDI. Austrian projects registered. Austrian companies were in the list of the Eight of the Austrian in the list the top 100 foreign affiliates in Romania 2005 the number companies of such were entries topof100 foreign affiliates in Romania at at the end of Table 8). increased to 2004 40, (see which confirms the the end of 2004 (see Table 8).
Table 8

Top Austrian investors and their field of activity in Romania: ranking by registered capital, end-2004
1. 8. 22. 24. 50. 68. 81. 87. PETROM SA; OMV AKTIENGESELLSCHAFT; Oil processing RAIFFEISEN BANK SA; RAIFFEISEN INTERNATIONAL BANK - HOLDING AG; Banking services BRAU-UNION ROMANIA SA; BRAU IMMOBILIEN AKTIENGESELLSCHAFT; Brewery OMV ROMANIA MINERALOEL SRL; OMV REFINING & MARKETING GMBH; Oil distribution BILLA INVEST CONSTRUCT SRL; EUROBILLA SA; Real estate developer HVB BANK ROMANIA SA; BANK AUSTRIA CREDITANSTALT AG; Banking services HENKEL ROMANIA SRL; HENKEL AUSTRIA GMBH; Wholesale trade with non-food products UNITA SA; WIENER STDTISCHE ALLGEMEINE VERSICHERUNG AKTIENGESELLSCHAFT; Insurance industry

Source : ARIS, the Romanian FDI development agency (http://www.arisinvest.ro/). Source : ARIS, the Romanian FDI development agency (http://www.arisinvest.ro/).

Many of the large Austrian investors countries, as well as other German are themselves subsidiaries of foreign subsidiaries such as Kromberg & investors in Austria, such as Henkel or 10 Schubert, and Mahle. Among the Brau-Union. Geographic proximity to the Austrian manufacturing companies Central and East European countries which are not foreign subsidiaries and knowledge of the business Schwarzmller, Baumit, Wienerberger environment there are important and Agrana stand out. The largest of advantages of Austria which attract the 2005 investment projects was multinational companies to establish conducted by HVB Bank through Bank regional headquarters. These Austria Creditanstalt, the second largest headquarter function generates highly qualified jobs in Austria. Large foreign- was the takeover of Forte Business owned Austrian investors in Romania Services which became a Siemens include Austria Tabak, owned by the subsidiary. A remarkable number of British multinational Gallaher, and new subsidiaries in Romania was Siemens Austria, which runs the established or expanded in the businesses of the German Siemens in manufacturing sector last year (see eight Central and East European Box 1).

14

IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

Box 1 New Austrian manufacturing sector investment projects in Romania announced in 2005
ADA: The furniture producer ADA established a subsidiary in Oradea close to the Hungarian border with EUR 1.8 million. Austria Tabak: The owner of Austria Tabak, the British company Gallaher Group, invested in Romania through the Austrian subsidiary in late 2004 and made a new EUR 4 million investment in April 2005. They have production and distribution with 86 employees based in Bucharest. Baumit: The Austrian company with world-wide presence for facade coatings opened production facilities in Teius in mid-2005, after its first investment in Romania in 2002. The Romanian subsidiary employs 120 people and produce not only for the local but also for Southeast European customers. Cascade Empire: The US wood trading company Cascade Empire invested EUR 5.2 million in Romania through Austria, in February 2005. Egger Romania SRL: EBRD announced that the Austrian company Egger Osteuropa Beteiligungs GmbH will use a EUR 110 million EBRD loan to build a new wood processing plant in Suceava County, in north-east Romania. The Bank is also paying EUR 17 million for a stake in the new company. The company was registered in November 2005 with a statutory capital of EUR 7 million. Holzindustrie Schweighofer: The company returned to the lumber business in 2003 by opening a production site in Sebes, Southern Transylvania. The investment uses local wood. The total value of the investment is EUR 64 million and 350 new jobs were created. The plan is to export products all over the world. ISOVOLTA AG: The wholly-owned subsidiary of Constantia-Iso AG has its headquarters in Wiener Neudorf, producing insulated wires and laminates. The company expanded world-wide by mergers and acquisitions in Europe, America, Japan and China. It had no subsidiaries in Central and Eastern Europe before establishing one in Romania. In 1998 they purchased ICME S.A. in Bucharest. In 2002 they bought Electroizolante SA in Bucharest, which was expanded in 2005. Kromberg & Schubert: The German cable and car component producing company entered Romania through its Austrian subsidiary in 2000 and established a new production site in Sibiu in 2005 with a statutory capital of EUR 2 million. MAHLE: In December 2005 the car component manufacturer MAHLE with headquarters in Germany invested in Timis County through its Austrian subsidiary. Schwarzmller: The trailer producing Austrian multinational Schwarzmller, present in most countries of Central and Eastern Europe, invested EUR 1.5 million in September 2005.

15

GBOR HUNYA, ANNA IARA

Siemens: The merger between Forte Business Services SRL and the former Siemens Business Services subsidiary in Romania became operational in October 2005. As a result of the merger, Forte is the owner of ten branches in the major cities and operates working points in every Romanian county. The registered capital is EUR 41 million. SW-Umwelttechnik: On 27 September 2005 the Austrian Group SW-Umwelttechnik AG opened, at Ortisoara (10 km from Timisoara), a EUR 2 million new plant, producing concrete prefabs (sewerage cannulars, hydrocarbs separators, trimming rings). Leader on the Austrian and Hungarian market, the SW-Umwelttechnik Group has 723 employees and operates six factories in Austria, six in Hungary and one plant in the Slovak Republic. Wienerberger: The brick producer Wienerberger established its presence on the Romanian market in 1998, operating initially as an importer and distributor of Wienerberger products imported from the production unit in Hungary. In 2003 they set up a production facility in Gura Ocnitei, where they invested some EUR 18 million. In 2005 they set up a second factory for EUR 20 million, located in the Sibiu industrial park.
Source: ARIS, the Romanian FDI development agency (http://www.arisinvest.ro/) and company home pages.

3. RESULTS OF A SURVEY INVESTIGATION AMONG AUSTRIAN COMPANIES WITH SUBSIDIARIES IN ROMANIA A questionnaire specially prepared for this study was sent to 45 companies in Austria, of which 21 returned the (at least partly) completed form during February 2006.4 From the list of the top eight Austrian investors in Romania, four answered the questionnaire. The other companies represented also large investors but the new manufacturing firms established in 2005 could not be covered. The companies were asked to answer 32 questions grouped under four headings: the size and activity of the firm and of the Romanian subsidiary, investment motivations and results in Romania, impact of the
4

business in Romania on other locations of the corporation, and future plans for the years following Romanias EU accession. Although the relatively small number of cases does not allow to treat the answers as a representative sample, they still provide interesting insights. Most of the responding companies are important international players with subsidiaries all over Central and Eastern Europe (CEE). They usually have at least five subsidiaries in other CEE countries established before entering the Romanian market. Unfortunately half of the respondents did not provide detailed data concerning the development of employment and sales, but they reported whether these had increased or declined in recent years. The documented cases reveal

The authors wish to thank the Romanian Embassy for sending out the questionnaires and collecting the answers. We are also grateful to the responding companies for their cooperation.

16

other CEE countries established before entering the Romanian market. Unfortunately half IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET of the respondents did not provide detailed data concerning the development of employment and sales, but they reported whether these had increased or declined in recent years. The documented cases reveal that the Austrian companies in our sample are that the Austrian companies in our fluctuated marginally, while new highly internationalized; their foreign employment exceeds the employment in Austria. sample are highly internationalized; their subsidiaries with more and more Over the past three year, their employment in Austria fluctuated marginally, while new foreign employment exceeds the employees added the NMS and subsidiaries with more andOver more employees added in were the NMS and in Romania. employment in Austria. the past were

three year, their employment in Austria


Table 9

in Romania.

Main motivation for investing in Romania: number of answers by type of investment


Manufacturer for exports Number of subsidiaries Access to Romania with imported products Access to Romanian market with locally produced goods Control Romanian market-segment Cheap sourcing of input Low cost of production Establish regional headquarter 1 4 1 5 Manufacturer for Romania 7 2 5 Construction and service company 9 3 2 3 Altogether 21 5 7 3 1 4 1

Eleven of the subsidiaries in companies active in trade, construction Eleven of are the subsidiaries in Romania are active manufacturing production, four in Romania active in manufacturing and in services, while manufacturing construction, three trade and two in financial services. The amount investments and production, four in in construction, three in companies have ofmore diverse trade and two financial services. The motivations. Seven ofthe them the number of in employees are higher in financial services than in othercould fields be of amount of Manufacturing investments and the number identified as employees, local market-oriented, activities. subsidiaries have just a few hundred only one has of employees are higherproduction in financial active employing mainly in 2000 the food industry. Five large-scale export-oriented in Romania persons. Based on services than in the other fields of companies are export-oriented, active in their activity, we arranged the companies into three groups: manufacturer for exports, activities. Manufacturing subsidiaries the manufacturing of car components, manufacturer thehundred Romanian market, and construction service companies active on have just a for few employees, wood andand paper products. The main the Romanian market (see export-oriented Table 9). only one has large-scale motivation of these companies to production in Romania employing 2000 establish an exporting subsidiary in persons. on their activity, we access Romania were localmarket raw materials and As to the Based main motivation of the investors, to the Romania is dominating. arranged the companies into three low labour cost. It seems that this type Fifteen companies mentioned selling on the Romanian market of either imported or locally groups: manufacturer for exports, of activity is still underdeveloped in produced products as their main activity in Romania. This is quite natural for companies manufacturer for the Romanian market, Romania. All the export-oriented active in trade, construction services, while manufacturing haveothers more and construction and serviceand companies investors but onlycompanies few of the diverse motivations. Seven of them could be identified as local market-oriented, active active on the Romanian market (see chose Romania after comparing this Table location other countries. mainly9).in the food industry. Five companies are with export-oriented, active in The the As to the of main motivation wood of the competition between Southeast manufacturing car components, and paper products. was The main motivation of these investors, access toan the Romania European countries and did not affect companies to establish exporting subsidiary in Romania were local raw materials and market is dominating. Fifteen companies the NMS. low labour cost. It seems that this type of activity is still underdeveloped in Romania. All the mentioned selling on the Romanian The impact of the Romanian export-oriented investors but only of the others chose on Romania comparing market of either imported or few locally subsidiary the after firms activity this in produced products as their main activity Austria is usually positive as the in Romania. This is quite natural for companys overall sales increased
13

17

location with other countries. The competition was between Southeast European countries GBOR HUNYA, ANNA IARA and did not affect the NMS.

following the penetration of the other hand, increasing sales in the companys overall sales increased following the penetration of the Romanian market. Romanian market. But looking at the Romania fostered the employment of But looking at the detailed results, we can see a variety of types (Table 10). Two of the detailed results, we can see a variety additional persons in four companies, export-oriented ventures replaced production in Austria, and employment in Austria of types (Table 10). Two of the exportdecreased in one company. On the other hand, increasing sales six, in Romania fostered and the and in another management oriented ventures replaced production in employment persons four companies, andemployment in another six,increased management services in and the Austria, andof additional employment in in Austria services employment increased in the Austrian headquarters. decreased in one company. On the Austrian headquarters.
Table 10

The impact of the Romanian subsidiary on the firms activity in Austria is usually positive as

Impact of the Romanian subsidiary on the mother company in Austria by type of investment
Manufacturer for exports Decreased output in Austria due to imports Increased employment in Austria in production activities Increased employment in Austria in management and business related services Decreased employment in Austria due to imports Increase of turnover No impact on production or employment 1 3 2 1 1 1 2 1 3 1 2 3 Manufacturer for Romania Construction and service company Altogether 2 4 6 1 4 4

We also asked about the impact of corruption suggests that the regulatory We also asked about the impact of the Romanian subsidiary NMS locations, but only the Romanian subsidiary on NMS environment ison the main problem, not six companies found the question relevant. This indicates that Austrian multinationals locations, but only six companies found the misuse of bureaucratic power. are In the question This way, indicates it seems that companies organized in a relevant. hub-and-spoke with few addition, links between the subsidiaries. Among are the that Austrian multinationals are able to master is the problems related to positive answers, three indicate that the Romanian subsidiary subordinated to a NMS organized in a hub-and-spoke way, with bureaucracy: only three of them found headquarter and two refer to a relocation of production to Romania. few links between the subsidiaries. their relationship with authorities Among the positive answers, three problematic, eight praised the A further partthe of the questionnaire investigated the problemswith investors in Romania. indicate that Romanian subsidiary is cooperation the faced authorities and The most important is bureaucracy: seven ten companies mentioned this that in the their first subordinated to a problem NMS headquarter companies replied and two refer a second relocation contacts the Romanian authorities place, a further fiveto in the place. of Corruption was with mentioned only by one company production to Romania. were irrelevant to their success. The in the first place and by two in the second. The difference between the scores given to A further part of the questionnaire second most important problem faced bureaucracy and corruption suggests that the regulatory environment is the main investigated the problems investors by investors is the under-developed problem, not the misuse of bureaucratic power. In addition, it seems that companies are faced in Romania. The most important transport infrastructure. In addition, able to master the problems related to bureaucracy: only three of them their problem is bureaucracy: ten companies some companies found that found production relationship this with authorities problematic, praised the cooperation with the authorities mentioned in the first place, eight a in Romania is not as cheap as they further fivecompanies in the replied second had with envisaged and that they were are and seven that place. their contacts the Romanian authorities Corruption was mentioned only by one negatively affected by the appreciation irrelevant to their success. The second most important problem faced by investors is the company in the first place and by two of the local currency. in the second. The difference between The confidence of investors the scores given to bureaucracy and concerning their activity in Romania is
14

18

under-developed transport infrastructure. In addition, some companies found that ROMANIAS ACCESSION EUROPEAN UNION ON envisaged THE AUSTRIANand TRADE, FDIthey AND LABOUR MARKET IMPACT OF in production Romania is not TO asTHE cheap as they had that are negatively affected by the appreciation of the local currency.

reflected in their future plans. For the negative impact in the form of The confidence of investors concerning their activity in Romania is reflected in their future majority of majority investors, Romanias labour costs. We also asked plans. For the of investors, Romaniasincreasing accession to the EU will not influence their accession to the plans, EU will whether the large pilot of future investment onlynot fourinfluence would increase investments due to thisinvestments reason. But all their future investment plans, only four OMV and Erste Bank had any positive respondents mention some advantage of accession to their activities, at least in the form of would increase investments due to this impact on the activity of other Austrian easier border crossing and more EU-financed projects (Table 11). Four expect a negative reason. But all respondents mention companies in Romania. Most of the impact in the form of increasing labour costs. We also asked whether the large pilot some advantage of accession to their respondents found those investments investments of OMV and Erste Bank had any positive impact on the activity of other activities, at least in the form of easier irrelevant but four intended to expand Austrian companies Romania. Most of the respondents found those border crossing and inmore EU-financed their activity following the investments two showirrelevant but four intended to expand their activity following the two show-cases. projects (Table 11). Four expect a cases.
Table 11

What will change for your company when Romania becomes an EU member? Multiple answers allowed; number of responses by type of investor
Manufacturer for exports No change expected Conditions of doing business will improve Sales in Romania will grow faster Labour cost will grow faster More government incentives will be available EU financed projects will encourage business 1 3 4 1 3 1 2 4 3 2 3 4 Manufacturer for Romania Construction and service company Altogether

3 8 4 5 5 6

The overall conclusion is that the confidence has increased. Following The overall conclusion is that the internationalization of activities brings about more internationalization of activities brings Romanias EU accession, some FDI benefits for employment in the home country (Austria) than job losses due to relocation to about more benefits for employment in location factors will improve while Romania, if exceptions of economic activities to Romania the home even country (Austria)exist. thanThe jobexpansion others may become more complicated supports the to development Austrian companies, and further investments are planned losses due relocation ofto Romania, in Romania. Based on the lessons of after Romanias accession theexpansion EU. even if exceptions exist. to The the 2004 enlargement (Hunya, 2004 of economic activities to Romania and 2005) we may expect the following supports the development of Austrian new features: companies, and further investments are 4. Impact of EU accession on FDI in Romania The decline in transaction costs (e.g. planned after Romanias accession to border crossing) benefithave all In the three years prior to the assumed accession in 2007, Austrianwill companies the EU. investors engaged in trade. become increasingly active in Romania. Two big privatization deals and a number of 4. IMPACT OF EU ACCESSION ON Increasing stability and transparency greenfield projects indicate that investors confidence has increased. Following Romanias FDI IN ROMANIA of the business environment will EU accession, some FDI location factors will improve while others may become more benefit in particular small and In the in three years prior to lessons the complicated Romania. Based on the of the 2004 enlargement (Hunya, 2004 and medium-size companies. assumed accession in 2007, Austrian 2005) we may expect the following new features: As a new member, Romania will companies have become increasingly have some cost of compliance with active in Romania. Two big privatization EU rules (e.g. environment) that may deals and a number of greenfield projects indicate that investors 15 increase the cost of investment. 19

GBOR HUNYA, ANNA IARA

EU-financed projects can boost investments in construction, services and environment-related activities. Labour cost advantages in comparison to the EU-25 will remain in place for quite some time and stimulate export-oriented FDI in Romania. Geographic segmentation of production can strengthen the competitive position of the multinational companies as a whole and thus stabilize workplaces in headquarters and subsidiaries alike.

FDI-related workplaces are expected to shift between the new EU members due to concentration and specialization of foreign subsidiaries. Some of the production capacities that have been established in each country one by one will be closed down, others will be enlarged and supply more than one country. Taking these changes into account, Austrian companies intend to increase their activities in Romania this is one of the results of the company survey presented in section 2.4.

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IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

REFERENCES:

ABA Austrian Business Agency (2004), Austria: The Ideal Hub for Central and Eastern Europe, ABA, 7 April (http://www.aba.gv.at/) Damijan J. and M. Rojec (2004), Foreign Direct Investment and the Catchingup Process in New EU Member States: Is There a Flying Geese Pattern?, wiiw Research Reports, No. 310, The Vienna Institute for International Economic Studies (wiiw), Vienna, October. EBRD (2005), Transition Report, European Bank for Reconstruction and Development, London. European Commission (2004), A new partnership for cohesion, Third report on economic and social cohesion, February. European Commission (2005a), 2004 pre-accession economic programmes of acceding and candidate countries: overview and assessment, Enlargement Papers, No 24, August. European Commission (2005b), Romania 2005 comprehensive monitoring report, Brussels, October. FIAS (2004), Assessment of the reform to remove administrative barriers from investment, http://www.minind.ro/DIMMA/actderul.htm. Gabanyi, A. U. (2005), Rumnien vor dem EU-Beitritt, SWP-Studie S31, Stiftung Wissenschaft und Politik, Deutsches Institut fr Internationale Politik und Sicherheit, Berlin, October. Havlik, P. (2005), Structural Change, Productivity and Employment in the New EU Member States, wiiw Research Reports, No. 313, The Vienna Institute for International Economic Studies (wiiw), Vienna, January. Hunya G. (2003), FDI-led Economic Growth in Romania?, in: M. Birsan and T. Paas (eds.), Competitiveness of National Economies and the Efficient Integration into the European Union, Editura Fundatiei pentru Studii Europene, Cluj-Napoca, pp. 167-184. Hunya, G. (2004), Manufacturing FDI in New EU Member States Foreign Penetration and Location Shifts between 1998 and 2002, wiiw Research Reports, No. 311, The Vienna Institute for International Economic Studies (wiiw), Vienna, November. 21

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Hunya, G. (2005), wiiw Database on Foreign Direct Investment in Central, East and Southeast Europe. Opportunities for Acquisition and Outsourcing, by G. Hunya (concept and analysis) and M. Schwarzhappel (database), The Vienna Institute for International Economic Studies (wiiw), Vienna, May. Hunya, G. and M. Sass (2005), Coming and Going: Gains and Losses from Relocations Affecting Hungary, wiiw Research Reports, No. 323, The Vienna Institute for International Economic Studies (wiiw), Vienna, November. Hunya, G. (2006), Romania: end of the upswing, in: L. Podkaminer, V. Gligorov et al. (2006), Strong Growth, Driven by Exports in the NMS and by Consumption in the Future EU Members, wiiw Research Reports, No. 325, The Vienna Institute for International Economic Studies (wiiw), Vienna, February, pp. 78-81. Isarescu, M. (2005), New and future member states: Romanias role in the EU27, Romanian Journal of European Affairs, Vol. 5, No. 3, October, pp. 9-12. Kramer, H. (2004), Editorial: Zur Erweiterung der EU, WIFO-Monatsberichte, No. 4, pp. 227-229. Lungu, L. (2005), Multi-Annual Budgeting and the Future of Fiscal Policy in Romania, Group of Applied Economics (GEA), Bucharest, March. National Trade Register Office (2005), Companies by foreign direct investment, Statistical Synthesis, No. 92, Bucharest, December. OeNB Oesterreichische Nationalbank (Austrian National Bank) (2005), Direktinvestitionen 2003. Sonderheft Statistiken, Vienna, September. Podkaminer, L., V. Gligorov et al. (2006), Strong Growth, Driven by Exports in the NMS and by Consumption in the Future EU Members, wiiw Research Reports, No. 325, The Vienna Institute for International Economic Studies (wiiw), Vienna, February. Romanian Academic Society (2006), Raport de analiza si prognoza anuala 2006, Bucharest, www.sar.org.ro. WIIW (2005), wiiw Handbook of Statistics 2005: Central, East and Southeast Europe, The Vienna Institute for International Economic Studies (wiiw), Vienna, November. World Bank (2006), Doing Business in 2006. Creating Jobs, a copublication by the World Bank and the International Finance Corporation, Washington DC.

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IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

IMPACT OF ROMANIAS ACCESSION TO THE EU ON THE AUSTRIAN LABOUR MARKET


ANNA IARA
unobserved illegal migration. Therefore, the constant number of Romanian citizens officially living in Austria does In previous parts of this study we citizens Before 1989, the presence of Romanian in Austria was but it not mean zero netnegligible, immigration inrose the looked at the indirect labour market effects 1990s. In the course of time, earlier substantially later. According census data, in 1981 Austria hosted some 1200 Romanian on Austria generated by FDItoin Romania. immigrants obtained Austrian citizenship citizens; this number around 15-fold until the next census in 1991. There was no In this chapter we increased discuss the potential and were replaced by new migrants. migration under migration regimes increase later on: free both the 1991 and 2001 censuses found around 18,500 Romanians in Naturalization in Austria is typically and under the specific conditions after Austria. In the latter year, Romanians made up 2.5% of the foreign of possible after tenpopulation years and of 3% lawful Romanias EU accession respectively, and residence. In 19922001, some 13,500 the foreigners from other countries than the EU-15. Thus the Romanian community came derive related conclusions as regards the Romanians were naturalized (Table 1), seventh in size after the foreigner Germany, Turkey, and four post-socialist direct labour market effects in groups Austriafrom implying a similar size of net legal countries. These census data do not reflect the total numberin ofthat foreign persons originating which appear from migration. immigration period. Before 1989, the presence of from Romania, due to naturalization and unobserved illegal number migration. the The annual of Therefore, naturalizations Romanian citizens in Austria increased constantly a zero peaknet of constant number of Romanian citizenswas officially living in Austria does up not to mean negligible, but it rose substantially later. 2800 in 2001, sizeably dropping immigration in the 1990s. In the course of time, earlier immigrants obtained Austrian According to census data, in 1981 thereafter to less than 1400 in 2004. citizenship and were replaced by new migrants. Naturalization is typically Austria hosted some 1200 Romanian Romanians share in in Austria all naturalizations citizens; this ten number around In increased possible after years increased of lawful residence. 1992-2001, to some 13,500 Romanians were nearly 11% in 2001 to 15-fold until the 1), next census in 1991. steadily drop to 3.3% in 2004. This naturalized (Table implying a similar size of net legal immigration in that period. There was no increase later on: both the fluctuation reflects the high number of 1991 and 2001 censuses found around immigrants in the early 1990s, people The annual number ofin naturalizations constantly upcitizenship to a peak of 2800 in 2001, 18,500 Romanians Austria. In increased the who obtained ten years later. sizeably dropping thereafter to less than 1400 in 2004. Romanians share all latter year, Romanians made up 2.5% of In the period 2002 to 2004,in net the foreign population and 3% of the immigration of Romanian citizens to naturalizations increased to nearly 11% in 2001 to steadily drop to 3.3% in 2004. This foreigners from other countries than the Austria amounted to around 7400 fluctuation reflects the high number of immigrants in the early 1990s, people who obtained EU-15. Thus the Romanian community persons (see below). In the same period, citizenship ten in years the period 2002 to 2004, net immigration of Romanian came seventh sizelater. after In the foreigner some 5200 received naturalization. Taken citizens from to Austria amounted to around 7400 together, persons (see below). the same groups Germany, Turkey, and four these data Inimply that period, during post-socialist countries. These census the 15 years from imply 1990 that to 2004, some 5200 received naturalization. Taken together, these data during total the data do not the2004, total total number of net immigration of Romanians to Austria 15 years fromreflect 1990 to net immigration of Romanians to Austria numbered foreign persons originating from numbered 39,000, of which around 39,000, of which around 18,700 persons were naturalized. Romania, due to naturalization and 18,700 persons were naturalized.
Table 1

1. IMMIGRATION AND NATURALIZATION OF ROMANIANS

Naturalization of Romanian citizens in Austria


1990 (1) (2) 294 3.20 1991 667 5.85 1992 547 4.59 1993 672 4.67 1994 904 5.56 1995 874 5.71 1996 692 4.26 1997 1098 6.75 1998 1501 8.19 1999 1639 6.55 2000 2684 10.89 2001 2818 8.78 2002 1779 4.89 2003 2098 4.65 2004 1376 3.26

(1) Number of naturalized persons. (2) Share of (1) in all naturalizations. Source: Statistics Austria.

Table 2

Romanian citizens with valid residence permits in Austria


1997 (1) 18735 1998 19084 1999 19550 2000 19742 2001 18479 2002 18516 2003 17807 2004 18442

23
2005 18408

1990 (1) (2) 294 3.20

1991 667 5.85

1992 547 4.59

1993 672 4.67

1994 904 5.56

1995 874 5.71

1996 692 4.26

1997 1098 6.75

1998 1501 8.19

1999 1639 6.55

2000 2684 10.89

2001 2818 8.78

2002 1779 4.89

2003 2098 4.65

2004 1376 3.26

GBOR HUNYA, ANNA IARA (1) Number of naturalized persons. (2) Share of (1) in all naturalizations.
Source: Statistics Austria.

Table 2

Romanian citizens with valid residence permits in Austria


1997 (1) (2) 18735 4.55 1998 19084 4.28 1999 19550 3.94 2000 19742 3.69 2001 18479 3.49 2002 18516 3.33 2003 17807 3.13 2004 18442 3.20 2005 18408 3.64

(1) - Number of valid residence permits as of 1 July. (2) Share in all valid residence permits. Source: Biffl (2005, p. 60), based on data from the Federal Ministry of Interior.

18
Table 3

Number of Romanian immigrants to Austria (annual flows, register data)


1998 Total net foreign immigration Romanian citizens immigration emigration net % of total net foreign immigration Source: Statistics Austria. 1543 1188 355 2.47 1866 1263 603 2.40 1921 1076 845 3.91 2393 1514 879 3.70 4320 1529 2791 5.19 5333 2689 2644 5.17 5501 3528 1973 3.3 14364 1999 25100 2000 21587 2001 23776 2002 53790 2003 51099 2004 60621

Table 2 shows the numbers of valid and some 7% were temporary Table 2 shows the numbers valid residence permitspermits held by(Aufenthaltserlaubnis Romanian citizens in residence residence permits held by ofRomanian ).5 Austria in to 2004. The number of The persons holding such permits by citizens in1997 Austria in 1997 to 2004. This shows that increased most slightly, Romanian 1000, to of reach around 19,700such in 2000 and then dropped to stabilize around in 18,400 in the number persons holding permits citizens who reside legally Austria do increased slightly, 1000, to reach so on a long-term basis. following years. The by share of Romanian nationals in the total number of foreigners with around 19,700 in 2000 and then outflow of Romanian valid residence permits is around 3.7%. In 2004, The 88% inflow of the and residence permits held by citizens to and from Austria can be dropped to stabilize around 18,400 in Romanians were permanent settlement permits (Niederlassungsbewilligung), and some the registration of the following years. The share of checked through 5 7% were temporary residence permits (Aufenthaltserlaubnis). This shows that most Romanian nationals in the total number residence. Registered immigration of Romanian citizenswith who reside in Austria Romanian do so on a long-term basis. 6 of foreigners valid legally residence nationals increased from permits is around 3.7%. In 2004, 88% 1500 in 1998 to 5500 in 2004, the year The the inflowresidence and outflow permits of Romanian citizens and from Austria canfigures be checked through of held by tofor which the latest are available 6 Romanians were permanentRegistered settlement (Table 3). Emigrationnationals increased as well, the registration of residence. immigration of Romanian increased permits ( Niederlassungsbewilligung ), in particular in 2003. The number of from 1500 in 1998 to 5500 in 2004, the year for which the latest figures are available
(Table 3). Emigration increased as well, in particular in 2003. The number of Romanians The above figures are based on Biffl (2005a, p. 60) and Austrian Federal Ministry of the Interior leaving pp. Austria reached in 2004. Net migration but permit below 1000 (2003, 12ff.). Up toaround 1997, 3500 there was a single type was of positive residence called Aufenthaltsbewilligung in Austria. The amendment of the Alien Law 1997 replaced this by the two persons annually until 2001. In the following two years, it rose to about 2700 persons and above-mentioned types of permit. Since 2003, a third settlement certificate thereafter to 2000. The share of Romanian nationals in total net immigration to (decreased Niederlassungsnachweis ) was introduced for longer-term permanent residents (see Biffl, 2005, p. 18). 6 Note that registration records include temporary stays in the country. Registration does not Austria was around 2.5% to 4% except in 2002 and 2003 when it rose to 5.2%. This may require proof of legal residence, therefore the figure may include illegal Romanian residents in be related to the extended possibilities of family relevant reunification for Austrian citizens, children given Austria. Registration of illegal residents is particularly for parents of school-aged because it is a precondition admission toIn schools. that naturalizations peakedfor in 2000/2001. 2004, Romanians accounted for 3.3% of total net legal immigration to Austria, ranking seventh among the source countries. As we shall see in section 4.4, the legal environment for migration will become slightly more attractive
5

24

The above figures are based on Biffl (2005a, p. 60) and Austrian Federal Ministry of the Interior (2003, pp. 12ff.). Up to

IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

Romanians leaving Austria reached around 3500 in 2004. Net migration was positive but below 1000 persons annually until 2001. In the following two years, it rose to about 2700 persons and decreased thereafter to 2000. The share of Romanian nationals in total net immigration to Austria was around 2.5% to 4% except in 2002 and 2003 when it rose to 5.2%. This may be related to the extended possibilities of family reunification for Austrian citizens, given that naturalizations peaked in 2000/2001. In 2004, Romanians accounted for 3.3% of total net legal immigration to Austria, ranking seventh among the source countries. As we shall see in section 4.4, the legal environment for migration will become slightly more attractive after Romanias EU accession, therefore we may expect a modest increase in the number of immigrants from Romania. So far, we have looked at Romanian nationals legally residing in Austria. On illegal immigrants no reliable information is available. According to recent data of labour inspectorates in Austria, Romanian nationals were not among the nationalities with higher shares among apprehended illegal workers (Jandl, 2004, p. 9).7 2.ROMANIAN CITIZENS ON THE AUSTRIAN LABOUR MARKET To take up employment, foreign residents in Austria typically need authorization. 8 Several types of permits exist. The work permit

(Beschftigungsbewilligung) is the most restrictive. It refers to a specific job in an industry with excess labour demand and is issued to the employer for one year. Authorizations for up to six months are granted within an established quota in specific industries (at present, agriculture and forestry, and tourism). After one year of employment with a work permit, a work entitlement (Arbeitserlaubnis) can be requested if a job offer exists. It is valid for two years for any job or employer, but it is restricted to a federal state. These authorizations can be renewed. With a five-year employment record within eight years in Austria, an exemption certificate (Befreiungsschein) can be obtained, which offers a labour market status equal to that of natives. The permanent settlement certificate (Niederlassungsnachweis) introduced in 2003 includes similar rights and is increasingly replacing the exemption certificate. This system of work permits with successively extended rights allows a successful foreign entrant to establish long-term residence and work in Austria step by step. For the admission of Romanian nationals to its labour market, Austria has neither bilateral agreements nor specific unilateral concessions.9 Work permits are granted within global quotas, i.e. there is no national quota for Romanians.

7 Reviewing existing methodologies and assessments of illegal migration in Europe, Jandl (2004) concludes that there is barely any serious information about the extent of the phenomenon. Hofbauer et al. (2005) survey illegal migration in Austria; they cannot provide any specific information on the role of Romanians either. 8 In a number of cases, such as being the spouse of an Austrian citizen, a foreign resident in Austria does not need a specific authorization for employment. For details, see http://www.ams.or.at/statistik/glossar.htm. 9 From the eight NMS to which labour mobility restrictions apply, bilateral labour market arrangements exist with Hungary only (since 1998), covering cross-border commuters and interns. An agreement has also been signed with the Czech Republic in 2001, but it is not yet effective.

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In 2004, about 5700 Romanian unemployed) accounted for 3% of the nationals were employed in Austria with total foreign labour force in Austria, or an authorization, and a similar number, 3.5% of the foreign labour force from of the European about 5300, worked without non-members authorization.10 The number of the Economic Area (EEA).11 We are lacking Romanian force of (without self- Economic information on (EEA). the 11 number selfforce from labour non-members the European Area We areof lacking employment i.e. employees and employed foreigners in Austria. information on the number of self-employed foreigners in Austria.
Table 4

Number of Romanian employees with employment authorization in Austria by type of permit


Type of authorization Work permit (Beschftigungsbewilligung) Work entitlement (Arbeitserlaubnis) Exemption certificate (Befreiungsschein) Settlement certificate (Niederlassungsnachweis) Other types Sum Source: Arbeitsmarktservice. 2000 698 464 6067 n/a n/a 7229 2001 931 439 5025 n/a n/a 6395 2002 1005 514 4128 n/a n/a 5647 2003 1242 478 3301 433 51 5505 2004 1366 361 2446 1462 104 5739 2005 1274 323 1807 2180 89 5673

Consistent with the fact that most from about 700 in 2000 to about 1370 Consistent with the factin that Austria most Romanian in Austria established long-term in 2004. Otherhave types, such as permits Romanian citizens have citizens residence, most authorized employment is based and permanent foron exemption workers certificates in key positions established long-term residence, most (Schlsselkrfte ) and(Table authorizations for authorized employment isprovide based settlement certificates, which full on access to the labour market 4). The share employees of Romanian firms active in exemption certificates and permanent of employment based on work entitlements (Arbeitserlaubnis) made up around 6% to 9% settlement certificates, which provide full the Austrian market (Entsendebesttigung) of total authorized employment of Romanians, with a peak in 2002/2003. In contrast, access to the labour market (Table 4). have played a marginal role. employment based on the short-term work permits expanded The unemployment rate from of The share of employment based and on most restrictive about 10% to about 23% in 2004/2005. ) In absolute figures, suchinemployment nearly Romanian nationals Austria rose from work entitlements (Arbeitserlaubnis doubled, from6% about 2000 to about 1370 in 2004. Other types,12 such as made up rising around to 700 9% inof total 9% in 2003 to 9.7% in 2005. In the authorized employment of Romanians, same period, the total unemployment permits for workers in key positions (Schlsselkrfte) and authorizations for employees of with a peak in 2002/2003. In Austrian contrast, rate(Entsendebesttigung in Austria increased from 7% to Romanian firms active in the market ) have played a employment based on the short-term 7.2%, unemployment among foreigners marginal role. and most restrictive work permits from 9.8% to 10.6%. There is a high expanded from about 10% to about variation across nationalities: in 2005 The unemployment Romanian nationalshigher in Austria rose from 9% inrates 2003 to 9.7% for in 23% in 2004/2005.rate In of absolute figures, unemployment than 12 2005.employment In the same period, the total rising unemployment rate in were Austriaobserved increased for from 7% to such nearly doubled, Romanians Turkish
unemployment among foreigners from 9.8% to 10.6%. There is a high variation that this must not be confused with illegal employment see footnote 8. across higher unemployment rates than for Romanians were 11 Based nationalities: on data from in the 2005 Federal Ministry for Economy and Labour. 12 observed for Turkish (14.1%), former (10.9%), and Polish (10.2%) nationals, Unemployment rates by citizenship are Yugoslav provided by the Main Association of Social Security Institutions. Note that they not conform with theCzech standard definition of unemployment, since while unemployment wasdo sizeably lower among and Slovak (7.3%) and Hungarian they disregard self-employed. The above data are available from the Austrian Federal Ministry for (5.2%) citizens. Hence, Economy and Labour (2006).while foreigners are more affected by unemployment than Austrians, Romanians are in a better position than foreign workers on average. 7.2%, 10 Note

26
11 12

Based on data from the Federal Ministry for Economy and Labour. Unemployment rates by citizenship are provided by the Main Association of Social Security Institutions. Note that they

IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

(14.1%), former Yugoslav (10.9%), and Polish (10.2%) nationals, while unemployment was sizeably lower among Czech and Slovak (7.3%) and Hungarian (5.2%) citizens. Hence, while foreigners are more affected by unemployment than Austrians, Romanians are in a better position than foreign workers on average. In 2004, average monthly earnings of Romanian employees amounted to 75.5% of Austrians earnings, i.e. less than those earnings of foreign employees from other Eastern European countries (77-81% of natives earnings).13 Available figures are neither adjusted for hours worked nor for other labour market characteristics. Still, the image emerges that immigrants from low-income Romania accept a lower pay than do citizens of more affluent countries. 3. POTENTIAL ROMANIAN MIGRATION INTO AUSTRIA Above we have shown that within the past 15 years, some 39,000 Romanian nationals emigrated to Austria. Future emigration will depend on the economic situation in Romania and the EU. As described in chapter 1 of this study, fairly rapid economic growth can be expected in Romania during the next few years, and the unemployment rate is moderate, 7% in 2005. These data suggest that Romanian citizens may expect improving living conditions in their home

country. However, with 58%, the employment rate is 5 percentage points below the EU-25 average, and GDP per capita in purchasing power parities is at one third of the EU-25 average (Podkaminer, Gligorov et al., 2006). This may motivate Romanian citizens to seek a better living in the incumbent EU member states. What will be the extent of Romanian emigration if restrictions on settlement and labour market access are abolished? This question has been at the centre of the discussion about potential labour market effects of EU enlargement. The answer is not straightforward because such migration could not be observed so far, thus data on past migration from Romania are unsuited for extrapolation. Methodologically, two options are available to assess the extent of the expected postenlargement migration flows under a liberalized migration regime: the econometric evaluation of data on past migration flows, including source countries from where migration to the host countries was unrestricted, and the analysis of survey information on the propensity to emigrate. In the following, we will present the findings of an influential study of each type. The pros and cons of these methodologies are summarized in Box 1 below.

13

Data source: Hauptverband der sterreichischen Sozialversicherungstrger.

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Box 1

Assessing post-enlargement East-West European migration: methodologies


Due to the complexity and idiosyncrasy of bilateral migration flows, forecasting the size of migration after the introduction of free movement is difficult and can only provide indicative results that should not be read as precise predictions. One option to obtain such results is to estimate a macroeconomic model of migration that explains stocks or flows of migrants with variables that account for economic push and pull factors of migration, such as per capita income differences and labour market conditions, as well as variables that reflect, e.g., cultural and spatial proximity and migration regimes. Future migration flows are then extrapolated based on assumptions on economic and labour market developments. This implies double extrapolation, in time and in space (see Fidrmuc et al., 2003). To enhance the validity of the results, it is important to capture the institutional characteristics of the bilateral flows concerned, such as guest worker schemes. A methodological problem is that migration patterns are strongly countryspecific. Technically, the inclusion of country-fixed effects into the estimation has a strong impact on the estimation and simulation results. To translate results for one set of countries (such as the Southern European sending countries) to another, the country-fixed effects for the latter need to be known. Alvarez-Plata et al. (2003) overcomes this problem by a secondary regression for the country-fixed effects that allows calculating them for the Eastern European countries as well. Even in a specification with institutional variables and country-fixed effects, the question remains whether the parameters estimated from sending countries with more or less unrestricted migration in the past are equally valid for postsocialist source countries where attitudes may be altogether different. The second option to assess the size of post-enlargement East to West European migration is to evaluate survey data of the willingness to migrate from the source countries. On the positive side, this methodology draws conclusions from studying the population of a specific country directly. Hence, it avoids the pitfall of translating results from one country to another. Such studies have their own shortcomings, however (see Alvarez-Plata et al., 2003, pp. 10f.). First, they focus on the supply side of migration, while demand conditions are left out of regard. Even on the former, they can provide only a snapshot that may be of limited validity under different conditions. Besides, they typically do not consider the intended length of stay abroad. Even if they did, the validity of such results would remain doubtful, since migrants tend to adjust their plans during the stay abroad. Therefore, survey results indicate the expected gross inflow of migrants into a set of host countries in a period of time, but they are not informative about the change in the stock of foreigners living in those countries at a point of time. However, they relate about the socio-economic characteristics and motivations of potential migrants.

The highly influential and thorough forecast of post-enlargement, postliberalization migration flows of AlvarezPlata et al. (2003) evaluates data on immigration to Germany from 19 source countries in 1967-2001 and provides 28

simulations for the EU-15. The strong points of the study are the consideration of country-fixed effects as described in Box 5, and of institutional variables. The study provides joint results for migration from Bulgaria and

IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

Romania into Germany and the EU-15. The simulation results on Germany imply that Romanian immigration to Austria could amount to some 43,500 persons in the first decade after the introduction of free labour mobility.14 The study also performs simulations for a high migration scenario, assuming slower income convergence, higher unemployment in Romania, and declining unemployment in the host countries. From these figures, we obtain a migration potential from Romania to Austria of some 55,500 persons within the first ten years with free labour mobility.15 Thus the average annual number of net immigrants from Romania would be, in normal circumstances, about 4300 persons and 5500 at maximum. The baseline number is 76% higher than the actual net immigration in 2002-2004 and the high number corresponds to 125% (see Table 4). Importantly, Alvarez-Plata et al. (2003) show that the postponement of free movement will not have a sizeable impact on the total number of immigrants over ten years, since migration is mainly driven by the income gap, which is slow to diminish. However, restrictions that are abolished gradually could mitigate a sudden shock. According to the simulations, at a sudden transition to the liberalized regime, around 30% of the above migration potential would materialize in

the first two years, and annual numbers would subside thereafter. In the baseline and high scenarios, in the first and second year after a sudden release of the present migration restrictions, a net immigration of 6500 and 8000 Romanian nationals p.a., respectively, is expected. Initial restrictions on labour mobility and their gradual fading out could smoothen the transition to the liberalized regime. As a survey-based assessment, Krieger (2004) evaluates information on the intentions to migrate to the EU-15 from the Candidate Countries Eurobarometer dataset of April 2002. It distinguishes three levels of intention to migrate to the EU: a general interest in living in the EU in the next five years, a basic intention as a choice between target areas for migration (local, regional, international), and a firm intention that is cross-checked with the willingness to live in a country with a foreign language. Results are provided for groups of countries only. The study finds that 5% of the Romanian and Bulgarian citizens have a general inclination to migrate to an EU country, while 3.2% show a basic intention, and again a considerably lower share, 2%, show a firm intention to do so. Remarkably, these migration intention rates are considerably higher than in the NMS (3.1%, 1.3%, and 0.8% respectively).

14 The study simulates the total expected immigration from Romania and Bulgaria to Germany. From the figures provided, we impute the above number using the 2001 ratios of Romanian and Bulgarian immigration to Austria and Germany respectively given in Alvarez-Plata et al. (2003, p. 4). 15 Adopting the model of Alvarez-Plata et al. (2003), Huber and Brcker (2003) provide forecasts of expected post-enlargement net immigration to Austria from both the eight NMS (ten NMS less Cyprus and Malta) and Romania and Bulgaria respectively. They expect a total inflow of around 14,000 Bulgarian and Romanian nationals to Austria in the first ten years upon free labour mobility. By the ratio of present immigration from these countries, 11,000 Romanians would come to Austria in that decade. We find this figure less convincing than the number obtained from Alvarez-Plata et al. (2003). Certainly, this is due to the fact that the Huber and Brcker (2003) simulation is based on a very short time period when immigration to Austria was relatively restricted.

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With Romanias population of 21.6 million in 2005 and an assumed share of Austria in Romanian migration to the EU of 8%16, a share of 2% with a firm intention to migrate to the EU within five years implies a migration potential of 34,560 persons from Romania to Austria. Note that part of this migration potential may relate to return migration so that the figures cannot be read as the total net increase of the stock of citizens from Romania within the five subsequent years upon the liberalization of labour mobility. A potential for more than five years cannot be obtained from the Krieger (2004) results by linear extrapolation. But results of AlvarezPlata et al. (2003) are available for the first five years. They imply a migration of 29,000 to 36,000 Romanian nationals to Austria under the two scenarios referred to above. Thus the two methodologies arrive at fairly similar results, an annual inflow of 6000 to 7000 on average in the first five years. Looking at the socio-economic characteristics of those with migration intentions, Krieger (2004) finds that the general inclination to move is highest among people aged 15-24 and is sharply decreasing in the older cohorts. For Romanians and Bulgarians, this pattern is even more pronounced than among NMS citizens. A share of 37% of the Romanians and Bulgarians with a general inclination to move possess secondary education, while another 14% have completed tertiary education, 31% are still studying, and 19% have only primary education. The latter figure is considerably higher than the percentage of the low-skilled would-be

migrants from the NMS, 5%. Among those with a firm intention to migrate, the better educated are more strongly represented than among those with a general inclination. Still, the difference between the NMS and the later accession countries in terms of skill levels of potential migrants remains, leading Krieger (2004) to conclude that the labour market integration of migrants from Romania and Bulgaria may be more difficult than of those from the NMS. Around one third of the Romanians and Bulgarians with a general inclination to move are employed (32%) and students (35%). Even though the share of students among those with firm migration intentions is much lower, this draws the attention to the potential risk of youth/brain drain. In addition, a particularly high number of the nonstudying inactive (13%) express their general interest to migrate to the EU. These could be discouraged unemployed who have temporarily withdrawn from the national labour market but would seek re-entry abroad. The Eurobarometer data also allow to distinguish between various motives for migration.17 From these results, Krieger (2004) finds that financial reasons are the predominant motive for 54% of the Romanians and Bulgarians with a general inclination to migrate. For the NMS, this share is considerably lower, at 24%; the importance of the economic motive thus decreases with increasing country wealth. Data on firm intentions to move suggest that a major part of the migrants are likely to be students and persons seeking escape

16 This assumption is based on the forecast results of Alvarez-Plata et al. (2003, p. 60) which in their turn are based on the distribution of Eastern European immigration across the EU-15 countries in the early 2000s. On this item, we have no other reliable information based on comparable data across Europe. 17 Namely: dissatisfaction with housing conditions, dissatisfaction with the local community, workrelated reasons, family and other private reasons, and financial reasons.

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from unemployment, and that the willingness to emigrate is motivated by bad economic conditions. 4. FREE MOVEMENT AND LABOUR MARKET ACCESS OF ROMANIAN CITIZENS AFTER EU ACCESSION In principle, new EU member states are fully assuming the rights and responsibilities of EU membership upon
Box 2

accession. However, the right of nationals from the new EU member states of May 2004 to assume employment in the EU-15 has been restricted by transitional arrangements. For Romania and Bulgaria, the EU Accession Treaty includes similar provisions, summarized in Box 2.

Free movement of labour from Romania upon accession: transitional arrangements 2+3+2 formula: Within the first two years upon EU accession of Romania, incumbent member states may apply national or bilaterally agreed measures to regulate the labour market access of Romanian nationals. These measures may be maintained up to three more years. In case of serious disturbances of the respective labour market or a threat thereof, they may be prolonged by another two years. Even if they do not resort to the above transitional restrictions, incumbent member states may suspend free labour mobility from Romania to certain regions or occupations, in case of a serious disturbances or a related threat. This is possible during the entire seven-year period. As of EU accession, Romanian nationals who have been legally employed for at least 12 months without interruption in an incumbent EU member state (prior to accession or thereafter) will obtain access to the labour market of the respective member state (but not of other EU members). Spouses and children up to the age of 21 of a Romanian national who qualifies for this right will equally obtain immediate access to the respective labour market if they have legally resided for 12 months in that state at the date of accession. If such family members have not legally resided in the respective member state with the worker at the date of accession, they obtain labour market access after 18 months of legal residence in that state. From the third year upon accession, this right to family members is granted without any requirement of prior residence. As concerns the trans-national provision of services, Germany and Austria specifically have the right to restrict such activity of Romanian companies in certain sectors. For Austria, these sectors are horticulture (NACE 0141), the carving of stone (0267), the manufacture of metal structures (2811), construction (451 to 454), security activities (7460), industrial cleaning (7470), home nursing (8514), and social work (8532). Standstill clause: transitional measures applied by the incumbent member states may not be worse than those in force at the date of accession. Community preference: Incumbent member states may not grant privileged labour market access to third country nationals as compared with the citizens of the new entrants. Romania has the right to maintain reciprocal restrictive measures towards workers from the incumbent EU member states respectively. If restrictive measures towards Romanian nationals are applied by at least one incumbent EU member, Romania may restrict the labour market access of Bulgarian nationals. Source: Annex VII of the Accession Treaty.

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Transitional arrangements allow the incumbent EU members to continue their present regulatory regimes. Sweden is the only pre-2004 EU member that allowed full access of the new EU citizens to its labour market, while the UK and Ireland have provided general access to employment but restrictions of welfare benefits. All other incumbent members resorted to maintaining restrictions (Traser et al., 2005). With the end of the first twoyear period approaching, the continuation of the restrictions is presently being debated.18 After EU enlargement in 2004, Austria has chosen to maintain the present regime towards the NMS. This implies that the employer of a new labour market entrant from the NMS needs to request a work permit. The adoption of a law that foresees the application of an analogous regime to Romania and Bulgaria upon accession is presently pending. The main mode for Romanian citizens to enter the Austrian labour market after Romanias EU accession will thus remain to be via work permits that are issued to employers in sectors with excess labour demand only. Changes in the present scheme of Romanian labour migration to Austria after accession can be expected from the following postaccession rights. First, those who would have moved from work permit (Beschftigungsbewilligung) to the next step, the work entitlement (Arbeitserlaubnis), will immediately profit from unlimited labour market access in Austria. Since new EU citizens will not need a
18

residence or settlement permit either, work permits, temporary residence permits and settlement certificates will be replaced by free movement certificates (Freizgigkeitsbesttigung).19 Second, EU accession will improve the labour market access of family members of Romanian immigrant workers in Austria. In particular, family reunification is immediately possible without authorization, due to the freedom to reside. Any right to labour market access to a new immigrant from Romania will imply labour market access of joining family members as well with delay, or immediately as of January 2009 or 2010. Other than at present, labour market access of the family member will not be bound to a specific job or industry. Third, Community preference will increase Romanian immigrant labour at the expense of immigrant workers from third countries. At present, resident foreigners are prioritized against new entrants from Romania to obtain work permits. Community preference is neutral with respect to the total number of immigrant workers. However, total labour supply of foreigners may nevertheless increase due to the family multiplier described above. Transitional arrangements will restrict Romanian citizens right to assume employment in the incumbent EU member states, but they will be able to exercise their right to reside, set up a business, work self-employed, or provide services (within the limits

Recently, Finland, Portugal and Spain have decided to abolish the restrictions on labour mobility for the new EU members as of 1 May 2006, while France is considering fading out the restrictions. 19 See Austrian Federal Ministry for Economy and Labour

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IMPACT OF ROMANIAS ACCESSION TO THE EUROPEAN UNION ON THE AUSTRIAN TRADE, FDI AND LABOUR MARKET

specific to Germany and Austria described above). A number of Romanian citizens may establish a living in Austria on these grounds. However, creating a new business or establishing self-employment is far from easy even for natives: in all likelihood, it will be those who are better equipped with physical and human capital as well as entrepreneurial spirit who will manage to do so. The Austrian law on the employment of foreigners applies to self-employment as well if its activities are similar to employees work (Huber and Brcker, 2003, p. 15). Experience with NMS nationals has shown cases of abuse of the right to self-employment in Austria. However, due to strict controls and the difficulty of effective exculpation, this is not a sustainable practice. Finally, the freedom to reside can be used to perform illegal work combined with lawful residence. Again, controls in the manufacturing and service sectors are likely to deter large-scale illegal employment. However, strict controls are hardly possible in the area of services to domestic households. Illegal employment of Romanian nationals for home maintenance, childcare and nursing may therefore increase after EU accession. 5. CONCLUSION: LABOUR MARKET EFFECTS OF ROMANIAN POST-ACCESSION IMMIGRATION Labour market adjustments to immigration and wealth effects thereof have been widely researched in the context of Eastern EU enlargement (for a more extensive review, see Drinkwater et al., 2003). Most studies conclude that East to West European migration will be far from massive, hence there are no grounds to expect

drastic total effects on domestic labour and wages (for a review see Fidrmuc et al., 2003). First assessments of the labour market effects of postenlargement migration from the NMS to Western Europe find that the experience confirms the predictions of relatively modest migration flows, and that the countries allowing labour mobility have benefited from NMS immigrants because those predominantly assumed hard-to-fill jobs (Traser et al., 2005; European Commission, 2006). In terms of the total expected effect of Romanian postaccession immigration to Austria specifically, similar conclusions may be drawn. In the first years, Romanian labour migration to Austria will be modest due to the transitional arrangements. In an unrestricted regime, it is most realistic to expect an immigration of about 43,500 Romanian nationals within the first decade. This is 1.3% of the total Austrian labour force of 2004, or 10.8% of its foreign labour force over a ten-year period. Part of the migration potential from Romania will cover children and non-working spouses. Even the high scenario of the Alvarez-Plata et al. (2003) simulation implies a migration of about 7900 Romanian nationals to the Austrian labour market in the first year upon labour market entry liberalization. This is 2% of the foreign labour force (without the self-employed) in Austria in 2004. Any potential negative impact of such immigration on wages or unemployment could be mitigated by a downward adjustment of the quota allocations for work permits that are granted for the employment of new entrants from third countries. While the effect of Eastern European labour immigration to Austria 33

GBOR HUNYA, ANNA IARA

can be expected to be marginal on total employment and wages, it may affect specific segments of the labour market, however. Existing research suggests that low-skilled domestic employees and blue-collar workers in particular may face retarded wage growth or even decreasing wages, or increased risk of unemployment. This may in particular affect foreign labour already residing in Austria, as well as female native employees. Eastern European immigration may increase the earnings gap between skilled and unskilled labour and add to the pressure on the unskilled arising from economic globalization (Huber and Brcker, 2003). Since foreign labour tends to cluster in specific sectors and regions, adverse

adjustment effects may arise even in the presence of low total immigration. Such effects could be aggravated by immigrant labour from Romania, especially in the light of the survey findings of a higher share of potential migrants with low education levels quoted above. But in fact, the largest potential challenge to the Austrian labour market arises from daily commuters from the border regions of the neighbouring NMS, who can afford to supply labour at lower wages due to lower cost of living in their home country, an option not available to Romanians. Thus labour immigration from Romania will remain relatively unproblematic.

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REFERENCES:

Alvarez-Plata, P., H. Brcker and B. Siliverstovs (2003), Potential migration from Central and Eastern Europe into the EU-15 An update, DIW Working Paper, German Institute for Economic Research, Berlin. Arbeitsmarktservice (2006), Bewilligungspflichtig beschftigte AuslnderInnen nach Nationalitt, http://www.ams.or.at/neu/ooe/1400.htm#Auslnderbeschftigung. Austrian Federal Ministry for Economy and Labour (2004), Informationen ber den Zugang von Staatsangehrigen der neuen EU-Mitgliedstaaten zur Beschftigung in sterreich ab 1. Mai 2004, Vienna. Austrian Federal Ministry for Economy and Labour (2006), AuslnderInnen am sterreichischen Arbeitsmarkt, http://www.dnet.at/elis/. Austrian Federal Ministry of the Interior (2003), Asyl- und Fremdenstatistik 2003, Vienna. Biffl, G. (2005), SOPEMI report on labour migration, WIFO Working Paper, Austrian Institute of Economic Research, Vienna. Biffl, G. (2005a), Zur Niederlassung von Auslnderinnen und Auslndern in sterreich, WIFO Working Paper, Austrian Institute of Economic Research, Vienna. Brcker, H. (2004), EU-Osterweiterung: Effekte der Migration, Wochenbericht des DIW, No. 17/04, German Institute for Economic Research, Berlin. Buch, C. and D. Piazolo (2000), Capital and trade flows in Europe and the impact of enlargement, Kiel Working Paper, No. 1001. Drinkwater, S., P. Levine, E. Lotti and J. Pearlman (2003), The economic impact of migration: A survey, FLOWENLA Discussion Paper, No. 8, Hamburg Institute of International Economics, Hamburg. Fidrmuc, J., S. Mundschenk, I. Traistaru and J. von Hagen (2002), European Union enlargement: Economic consequences and perspectives for the European Union, in: Andrew M. Warner (ed.), The European Competitiveness and Transition Report 20012002, Oxford University Press and World Economic Forum, Oxford and Geneva. Hauptverband der sterreichischen Sozialversicherungstrger (no year), Statistische Daten aus der Sozialversicherung. Verteilung der beitragspflichtigen Arbeitseinkommen nach Staatsbrgerschaft, Zusammenstellung, Berichtsjahr 2004, Vienna. 35

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Hofbauer, S. et al. (2005), Illegal Immigration in Austria, International Organisation for Migration, National Contact Point Austria within the European Migration Network, Vienna. Huber, P. and H. Brcker (2003), Auswirkungen und Ausnutzung von bergangsfristen fr die Freizgigkeit der Arbeitskrfte nach der EU-Erweiterung, WIFO Working Paper, Austrian Institute of Economic Research, Vienna. Jandl, M. (2004), The Estimation of Illegal Migration in Europe, Studi Emigrazione/Migration Studies, Vol. 41, No. 153, pp. 141-155. Krieger, H. (2004), Migration trends in an enlarged Europe, European Foundation for the Improvement of Living and Working Conditions, Dublin. Lopez-Carlos, A., M. Porter and K. Schwab (2005), The Global Competitiveness Report 2005-2006, Palgrave Macmillan. Podkaminer, L., V. Gligorov et al. (2006), Strong Growth, Driven by Exports in the NMS and by Consumption in the Future EU Members, wiiw Research Reports, No. 325, The Vienna Institute for International Economic Studies (wiiw), Vienna, February. Statistics Austria (1992), Volkszhlung 1991, Vienna. Statistics Austria (2002), Volkszhlung 2001 Hauptergebnisse I sterreich, Vienna. Statistics Austria (2002-2006), Statistisches Jahrbuch sterreichs, various issues, Vienna. Traser, J., M. Byrska and B. Napieralski (2005), Report on the Free Movement of Workers in the EU-25: Who s Afraid of EU Enlargement?, European Citizen Action Service working paper, mimeo. European Commission (2006), Report on the Functioning of the Transitional Arrangements set out in the 2003 Accession Treaty (period 1 May 2004-30 April 2006), Communication from the Commission to the Council, The European Parliament, the European Economic and Social Committee and the Committee of the Regions, Brussels. WIIW (2005), wiiw Handbook of Statistics 2005: Central, East and Southeast Europe, The Vienna Institute for International Economic Studies (wiiw), Vienna, November.

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ROMANIAN JOURNAL OF EUROPEAN AFFAIRS

VOL. 6, NO. 1, 2006

INFLATION TARGETING IN EASTERN EUROPE


LAURIAN LUNGU, JUAN PAEZ-FARRELL1
Abstract. This paper addresses the inflation targeting approach in three transition economies, namely Hungary, Poland and the Czech Republic with the use of Taylor rules as benchmarks. The three economies considered have been successful at achieving disinflation, but deviations of inflation from its target have been persistent in all cases. Except for the Czech Republic, deviations from the Taylor rule are large and persistent, with Hungary displaying the largest fluctuations. Polish interest rates have consistently exceeded those suggested by the Taylor rule and given the prevalence of high unemployment, these undershootings do not augur well for the stability of monetary policy. Finally, the behaviour of Czech interest rates can be remarkably captured by the simple Taylor rule proposed in this paper, suggesting that the Czech National Bank has been the most successful at stabilising inflation and output around their target levels. Over the last two decades a number of central banks around the world have adopted inflation targeting (IT) as a monetary policy regime2, and more recently, a number of Eastern European countries claim to have moved towards the implementation of an IT regime. One of the appealing features of IT is that the public understands more easily the monetary policy objectives, as stated by the central bank. The essential elements of the IT framework are the announcement of a numerical inflation target by the central bank together with a clear desire from the monetary and fiscal authorities to meet this target. The accomplishments of these criteria can be fairly easy monitored by the public, which can thus assess the central banks performance against its stated objectives and penalise its behaviour if necessary.
1

There is now a growing literature that deals with IT; see among others, Amato and Gerlach (2001), Bernanke et al. (1999), Mishkin (2000), Taylor (1999), Truman (2003). Under this monetary policy regime, the central bank uses its instruments with the direct goal of bringing inflation as close as possible to the target over the medium run. In this framework, controlling inflation becomes the overriding goal of monetary policy. All the other indicators (ie output, money stock growth, the exchange rate, etc) become auxiliary variables; the central bank will take them into account only if this information helps it to improve its inflation forecast. Given their post communist experience with high inflation it is not surprising that several central banks in Eastern Europe have become strong

Laurian Lungu (PhD) teaches Mathematical and Numerical Methods at Cardiff Business School. He is also a member of the Group of Applied Economics (GEA), based in Bucharest. More information about his research interests can be found at: www.laurianlungu.com Juan-Paez-Farrell (PhD) teaches Macroeconomic Theory at Cardiff Business School, UK. More information about him can be found at: http://www.caerdydd.ac.uk/carbs/econ/paez-farrellj/ 2 Pioneers were New Zealand (1990), Canada (1991), Chile (1991), Israel (1992), United Kingdom (1992), Australia (1993) and Sweden (1993).

37

LAURIAN LUNGU, JUAN PAEZ-FARRELL

adherents of IT. Following a period in which most of them pursued a monetary policy aimed at stabilising the exchange rate, they subsequently turned to IT. The first country to adopt IT in Eastern Europe (EE) was the Czech Republic in December 1997. Initially the Czech National Bank (CNB) chose to target a 5.5-6.5% band for core inflation, defined over a one-year time horizon. From December 2001 the CNB moved to target the consumer price index (CPI). Starting with January 2002 the CNB adopted a 4-year inflation forecast period in which targeted inflation was expected to fall gradually within a band from 3-5% to 24% by the end of December 2005. From January 2006 the CNB announced that it would target an inflation rate of 3% until the country joins the euro area. Poland followed suit in adopting an IT regime. Starting with June 1998 the National Bank of Poland (NBP) set a short-term inflation target within the 88.5% range. Subsequently different targets were set at the end of each year. It is worth noticing that the NBP was still maintaining an exchange rate band while targeting inflation. This was widened gradually before allowing the Polish zloty to float freely in April 2000. Since 2004 the NBP has been pursuing an inflation target of 2.5% within a +/-1% fluctuation band.
3

Following on the steps of the Czech Republic and Poland, Hungary launched inflation targeting in mid-2001. The first target band was +/-1% centred around a parity of 7%. For the end of 2005 the announced target band was 4% +/- 1% with the central parity target at the end 2006 falling by 0.5%. At the same time, the National Bank of Hungary (NBH) aims at maintaining the forint-euro exchange rate within a +/-15% band, which in effect emulates the ERM-II regime3. More recently, both Slovakia (2004) and Romania (2005) have also publicly announced inflation targets. Although the EE central banks which follow IT tend to stress the importance of pursuing this monetary policy framework in achieving low inflation this might not necessarily hold true. Clearly the recent low global inflation environment has made it easier for the EE countries to control domestic inflation. This argument aside, it is not clear what the results of implementing a different monetary policy framework would have been. The Baltic countries and Bulgaria, for instance, have also achieved low inflation, with the aid of a currency board. Moreover, there are a multitude of studies which show, in fact, that the benefits of IT are still to be proved in practice4. As the experience in the EE economies mentioned above has shown

Each country aiming to join the euro area must spend a minimum of two years in the exchange rate mechanism II (ERM-II). This implies defining a central parity and a +/-15% variation interval of the domestic currency against the euro with the scope of ensuring the stability of the exchange rate prior to the adoption of the euro. 4 Mishkin and Schmidt-Hebbel (2001) argue that IT reinforced accountability and credibility. Yet they point that, at the end of the process, inflation in IT countries is not lower than in non-IT countries. Along the same lines Ball and Sheridan (2004) show that, once corrected for the initial conditions, the differences between inflation targeters and non-targeters are minor. Other authors such as Friedman (2004) contend that IT, as practised in reality in the low inflation countries, actually obscures the communication of the central banks goals. Moreover, Friedman (2004) argues that this monetary policy framework is not as transparent as claimed by most IT advocates, casting doubts on the benefits brought about by the adoption of IT.

38

INFLATION TARGETING IN EASTERN EUROPE

so far, targeting inflation is not an easy task. The ongoing restructuring process in these economies makes the inflation forecasting process more difficult and introduces an additional source of uncertainty in the system. Moreover, these central banks claim that interest rate setting is conducted in a forward looking manner due to the perceived lags in the monetary transmission mechanism, so that reliable forecasts are essential. By unequivocally choosing inflation as a nominal anchor the central banks could face potential dilemmas if, for example, the exchange rate appreciated too much following capital inflows. The paramount policy issue in EE countries is then whether the central bank should pre-commit itself to a single nominal anchor namely inflation. This is clearly not the case in Hungary where the Central Bank Act of 2001 stipulates that both the government and the NBH mutually decide on the exchange rate policy. There are a range of challenges faced by the central banks in the EE countries which could jeopardise the inflation targets. Firstly, the central banks response to various shocks that hit the economy is made more difficult due to the effects caused by structural changes as broad economic reforms still continue in EE countries. This increases the uncertainty regarding the source of the shocks making the understanding of the monetary policy transmission mechanism more difficult to learn. Secondly, there is the issue of central bank independence and the objectives of monetary policy. Inflation
5

targeting was regarded as tool of anchoring low expectations of inflation during the early disinflationary process. However, now that low inflation has been achieved, and adding the fact that the inflation target has often been undershot for considerable periods of time in the Czech Republic and Poland has led to greater pressure on their central banks to pay greater attention to employment. In the case of Hungary, the lack of control over fiscal policy during election years suggests a weak institutional framework for guaranteeing actual central bank independence. In this respect, the upcoming Hungarian parliamentary elections in April of this year will provide a test of the continuing volatility in the budget deficit. Another potential unavoidable conflict caused by multiple objectives is between IT and ERM-II, as the Maastricht criteria of maintaining a stable exchange rate could be incompatible with the IT framework. The experience of the NBH is illustrative in this respect. In January 2003, in the aftermath of a speculative attack on the forint, the NBH was forced to shift the band the Hungarian forint was trading in at that time. The NBH moved in strongly to defend the exchange rate band, spending some euro 5.3 billion or the equivalent of 7% of GDP. Apart from the spillover effects such actions might have5, they are bound to affect the credibility of monetary authorities. Thirdly, fiscal policy considerations play an important role in the evolution of inflation in transition economies. Table 1 below shows that high fiscal deficits are a common characteristic

Foreign investors reacted to the NBH intervention in the foreign exchange markets by adopting different positions vis--vis other EE currencies. As a consequence, volatility of these currencies increased inducing more uncertainty. The movements in the Czech koruna against the euro provide a good example.

39

LAURIAN LUNGU, JUAN PAEZ-FARRELL

across the three economies considered. The pressure on budget deficits is likely to grow in the years to come as the EU accession costs will have to be

added to the costs of reforming social security systems. Such actions can affect the credibility of fiscal policies and raise inflation expectations.

Table 1. Selected Macroeconomic Indicators Czech Republic GDP (%) CPI (%) Gov. bal. GDP) 2003 2004 2005 2006 2007 3.2 4.4 4.1 3.8 3.8 0.1 2.8 1.6 2.8 3.0 -6.0 -4.0 -6.3 -5.8 -4.5 -6.2 -5.2 -4.0 -3.1 -3.0 3.4 4.0 3.4 3.6 3.3 4.7 6.8 4.0 3.6 3.7 C/A (% of GDP (%) Hungary CPI (%) Gov. bal. GDP) -7.2 -5.4 -6.1 -5.9 -5.9 -8.7 -8.9 -8.4 -8.7 -8.5 3.8 5.4 3.2 3.7 4.3 0.7 3.4 2.2 1.9 2.1 C/A (% of (%) Poland GDP CPI (%) Gov. bal. GDP) -5.9 -6.1 -3.4 -3.6 -3.3 -2.2 -4.3 -1.5 -0.9 -0.3 C/A (% of

(% of GDP)

(% of GDP)

(% of GDP)

Data Sources: IMF Country Reports and OECD Economic Outlook

20

15

10

99

00

01

02

03

04

05

06

P L In fl ati o n

P L In te re s t Ra te s

40

INFLATION TARGETING IN EASTERN EUROPE

20 15 10 5 0
-5

98

99

00

01

02

03

04

05

06

CZ Interes t Rate

CZ Infl ati on

14 12 10 8 6 4
2

2002

2003

2004

2005 RS T

2006

A N NUA L P I

Exchange Rates Against the Euro


120

110

100 90

80 Jan-99

Jan-00

Jan-01

Jan-02 Zloty

Jan-03 Koruna

Jan-04 Forint

Jan-05

Jan-06

41

LAURIAN LUNGU, JUAN PAEZ-FARRELL

Taylor Rules and Inflation Targeting flation Targeting nflation Targeting Taylor Rules and Inflation Targeting Most modern research on monetary policy rules focuses on Taylor rules (Taylor, 1993, 1999 h on monetary policy rules focuses on Taylor rules (Taylor, 1993, 1999), so ch on monetary policy rules focuses on Taylor rules (Taylor, 1993, 1999), so Taylor Rules and Inflation Targeting terms ofon a Taylor short term (Taylor, interest1993, rate 1999), that so Most modern research on monetary policy rules focuses that the monetary policy instrument is set in termsrules of a short term interest rate that respon Most modern research on monetary licy instrument in short rate responds to olicy instrumentis isset set interms termsof ofaa shortterm terminterest interest ratethat that responds to responds to deviations of inflation from to that the monetary policy instrument is set in terms of a short term interest rate that responds deviations of inflation policy rules focuses on Taylor from rulesa (possibly explicit) target and the output gap, such as: n from explicit) target and the output gap, such as: (possibly explicit) target on fromaa(possibly (possibly explicit) target and the output gap, such as: a deviations of inflation from a (possibly explicit) target and the output gap, such as: and the (Taylor, 1993, 1999), so that the monetary policy instrument is set in output gap, such as: Rt r  S t  P1 (S t  S T )  P 2 y t (1) 1 ! 0, 2 ! 0 TT S )  P y ! 0 , ! 0 (1) T ~ S )  P ! 0 , ! 0 (1) 22y t t 1 2 1 2 Rt r  S t  P1 (S t  S )  P 2 y t P1 ! 0, P 2 ! 0 (1)

T where r represents the real the interest the rate, exchange rate because of its direct where r represents real interest is the inflation t t denotes the inflation rate, S TT S S he denotes the inflation rate, is the inflation target effect on expected future inflation, but T S hereal realinterest interestrate, rate, denotes the inflation rate, is the inflation target rate, denotes the inflation rate, is the t S real interest rate, denotes the inflation rate, is the inflation target where t r represents the t this would not require an rule additional y t is is the gap. The underlying assumption behind this is that the central bank and ~ inflation target and the output output gap. gap. assumption behind this rule is that the central bank aims coefficient for the exchange rate (1). gap.The Theunderlying underlying assumption behind this rule is that the central bank aims The assumption behind this y t is the output gap. The underlying assumption behind this rule is that the centralin bank aims and underlying to stabilise inflation around its If target rate andthe the output gap around zero (so that actual o this were case, then the central rule is that the central bank aims to around rate and output zero actual output aroundits itstarget target rate andthe the outputgap gaparound around zero(so (sothat that actual output bank would be reacting exchange to stabilise inflation around its target rate and the output gap around zero (soto that actual outputthe central stabilise inflation around its target rate equals its potential value). Therefore, whenever inflation rises above the target, rate movements over and above their alue). Therefore, whenever inflation rises above the target, the central bank value). Therefore, whenever inflation rises above the target, the central bank and the output gap around zero (so equals its potential value).interest Therefore, whenever inflation rises above the target, the central bank impact on inflation and output. Taylor increases rates by more than the rise in the inflation rate, so as to raise real r thatthe actual output equals its so potential es by rise in the inflation rate, as to raise real rates, (2000, 2001) has argued that the ates by more more than than the rise in the inflation rate, so as to raise real rates, increases interest rates by more than the rise in the inflation rate, so as to raise real rates, stabilising economic activity. original Taylor rule did not include a value). Therefore, whenever inflation cactivity. activity. response to the exchange rate on because stabilising economic activity. rises above theMuch target, the central modern researchbank has extended Taylors analysis by focusing what coefficient value its inclusion worsened economic increases interest rates by more than ch Taylors analysis by focusing on what coefficient values are rchhas hasextended extended Taylors analysis by focusing on what coefficient values are Much modern research has extended Taylors analysis by focusing on what coefficient values are and by modifying rule to includewithin additional by a changing the ti the variables context or of the rise in the optimal inflation rate, so as to the performance 6 ifying the include additional variables or by changing the timing difying therule ruleto to include additional variables or by changing the timing . However, this multicountry model optimal and by modifying the rule to include additional variables or by changing the timing raise real rates, stabilising framework (e.g., economic by having theconclusion central bankwas react relevant to past values, rather than current ones, in the context having bank react to past values, rather than current ones, as in havingthe thecentral central bank react to past values, rather than current ones, as in activity. framework (e.g., by having the bank react to past rule values, rather than current ones, as inflation in of Taylor developed economies, so it is (1)). From thiscentral perspective, is compatible withthat a flexible targ Much modern research has the spective, rule is compatible with a flexible inflation targeting not clear whether the results also rspective,the theTaylor Taylor rule is compatible with a flexible inflation targeting (1)). From this perspective, the Taylor compatible with a flexible inflation targeting extended Taylors analysis 7 target, regime, that is,by the focusing central rule bankis uses its policy achieve the inflation Most but also attemp extend to to Central Europe. on what coefficient values are optimal ntral bank its policy to achieve the inflation target, but also attempts to entral bankuses uses its policy to achieve the inflation target, but also attempts to regime, is, the central bank uses its policy to achieve the inflation target, buteconomies also attempts importantly for the stabilise Applied Taylor rules generally include a lagged interest rate to on the right and by that modifying the output. rule to include considered here, given the uncertainty lied Taylor generally include a lagged interest rate on the right hand plied Taylorrules rules generally include a lagged interest rate on the right hand additional variables or by changing the stabilise output. side Applied Taylor rules generally include a lagged interest rate on the right hand of (1) on grounds that central banks also to smooth of interest surrounding the attempt independence theirrate movements timing framework (e.g., by the having the unds that banks also attempt to interest rate but ounds thatcentral central banks also attempt tosmooth smooth interest ratemovements, movements, but central banks and interest lack of rate knowledge on but side of bank (1) on the grounds that central banks also attempt to smooth movements, central react to past values, rather more important for our analysisthe is the possibility of including exchange correct model of the some economy, it rate measure i than current ones, as in (1)). From this ur analysis possibility of including some exchange rate measure in the our analysisis isthe the possibility of including some exchange rate measure in the more important policy for ourrule; analysis is the possibility of including some exchange rate measure in seems overambitious expect it is possible bank following a forward to looking Taylorthe rule to react t perspective, the Taylor rule for is a central ble for bank following a forward looking Taylor rule to react to the monetary policy to stabilise all four sible foraacentral central bank following a forward looking Taylor rule to react to the compatible a flexible inflation policy rule; itwith is exchange possible for a central bank following a forward looking Taylor rule to react to the rate because of its direct effect on(inflation, expected future this would not re variables the inflation, output but gap, targeting regime, that is, the central e on future inflation, but this not require seof ofits itsdirect directeffect effect onexpected expected future inflation, but thiswould would not require exchange rate because of its direct effect on expected future inflation, but this would not require rates the exchange rate). bank uses its an policy to coefficient achieve the additional for theinterest exchange rate and in (1). If this were the case, A then the central likely result of paying too much ent for rate in (1). If this were the case, then the central bank inflation target, but also attempts to cient forthe theexchange exchange rate in (1). If this were the case, then the central bank an additional coefficient for the exchange rate in (1). movements If this the case, then the central bankon inflation would be reacting to rules exchange rate over and above their impact attention to were exchange rate fluctuations stabilise output. Applied Taylor ooexchange movements over and above their impact on inflation and exchangerate rate movements over and above their impact on inflation and is that the publics understanding of the generally a rate has argued would be include reacting tolagged exchange rate movements over and their Taylor impact rule on inflation and a respon output. Taylorinterest (2000, 2001) that above the did not include objectives of original monetary policy will on that the right hand siderule of did (1) on the aa the original Taylor not include response to 0,2001) 2001)has hasargued argued that the original Taylor rule did not include response to output. Taylor (2000, 2001) argued thatits the original worsened Taylor rule did with not include a response become obfuscated the result of to the context grounds that central bankshas also attempt the exchange rate because inclusion economic performance within cause its worsened economic performance within the context of a greater uncertainty for inflation. ecause itsinclusion inclusion worsened economic performance within the context of a tothe smooth interest rate movements, but exchange rate because its inclusion worsened economic performance within the of a of devel multicountry model6is . However, this conclusion in context the context as was in relevant the case of more important for our analysis the ofFurthermore, conclusion was relevant in the context developed 6 l.6. However, However, this this conclusion was relevant in the context of developed multicountry . However, this conclusion was relevant in the context of developed Hungary, implementing a policy of a possibility of model including some exchange rate measure in the policy rule; it is fixed exchange rate and an inflation 6 target the presence of openness possible for a central following a others, Althoughbank Svensson (1999) among has in argued in favour of including the exchangeto rate in the policy rul 8 seems to ignore the 99) among others, has in favour of including the exchange rate in the policy rule. 6 argued 999) among others, has argued in favour of including the exchange rate in the policy rule. capital flows forward looking Taylor rule to react to Although Svensson (1999) among others, has argued in favour of including the exchange rate in the policy rule.

6 Although Svensson (1999) among others, has argued in favour of including the exchange rate 77 in the policy rule. 7 It should be noted that this response to the exchange rate pertains to normal fluctuations and not those caused by say, a financial crisis.

42

INFLATION TARGETING IN EASTERN EUROPE

monetary policy dilemma, whereby the As in the original formulation of the monetary authority can only focus on Taylor rule, the particular values in the rule will be calibrated, as the small two of the three objectives. To gain a better understanding of sample size would not make estimation 11 the actions of the three largest fruitful. countries that joined the EU in 2004, Hungary namely the Czech Republic, Hungary Starting with Hungary, Figure 1 plots and Poland, one can compare the the value of the actual short term behaviour of interest rates in recent interest rates and two variants of the years with alternative monetary policy basic Taylor rule during Hungarys rules by varying the basic Taylor rule in inflation targeting period, which began (1).9 To this end, the policy rule in June 2006. The general variants considered will be the basic interpretation of this type of analysis is Taylor rule with two alternative that if for a particular time period actual measures of the output gap commonly interest rates were lower than used in the literature on Central Europe suggested by the Taylor rule, monetary and an inflation-nutter rule, where the by the actual interest rates were lower than suggested Taylor rule, monetary policy was regarded policy was regarded as too loose, that monetary authority only responds to is, interest rates were lower than as too loose, that is, interest rates were lower10 than required by fundamentals. deviations of inflation from the target . required by fundamentals.
16 14 12 10 8 6 4 2002 Actual rates 2003 2004 2005 2006 Rule with real exchange rate Rule with industrial production

Fig. 1 Taylor rule for Hungary during inflation targeting period (2001:06-2006:01). The central bank reacts to deviations of inflation from its target, the output gap and smoothes interest rates: Rt (1  0.2) 2.5  S t  0.25 ygapt  0.8Sgapt  0.2 Rt 1 , where the output gap measure is either the

>

detrended real exchange rate or detrended industrial production (in both cases these have been detrended using the Hodrick-Prescott filter using O 14400 . Sgap represents the deviation of inflation from the announced end-of the year target. Source: Eurostat and Magyar Nemzeti Bank.

Although for Hungary the exchange rate band is a rather wide one. An alternative, related exercise is to estimate (1) to infer the central banks response to gradually reversed, so that from mid-2003 short term interest rates are above those suggested fundamentals. However, as by noted by Siklos and bel (2003), the very small samples considered here and the existence of large structural change would lay serious doubts to the results. by the Taylor rule for most of the period. An alternative view of Figure 1 is can be seen below, in 10 A similar exercise for Hungary which only considered the first two rules and covering only the 1990s (before IT was place), conducted Siklos (2003). Figure 2, which plotsinthe gaps was between actual by rates and and eachbel of the two rules above. Both 11 Examples of these for Hungary, Poland and the Czech Republic can be found in Mara-Dolores measures of the output gap yield similar conclusions: the gap has been rising gradually, (2005) and Leigh (2005), and Mohanty and Klau (2004), but one should be wary about the robustness of the results given2005, the small sample size and likelihood of structural change. remaining positive throughout the reason being that inflation remained below target for that
9

The sample begins with actual rates much lower than those suggested by both rules, but this is

year. Moreover, the relatively large discrepancy between the two rules for early 2005 arises from the fact that detrended industrial output was over 4% below trend, which called for an additional 43 reduction in interest rates.

LAURIAN LUNGU, JUAN PAEZ-FARRELL

The sample begins with actual rates much lower than those suggested by both rules, but this is gradually reversed, so that by from mid-2003 short term interest rates are above those suggested by the Taylor rule for most of the period. An alternative view of Figure 1 is can be seen below, in Figure 2, which plots the gaps between actual rates and each of the two rules above. Both measures of the output
4 2 0 -2 -4 -6

gap yield similar conclusions: the gap has been rising gradually, remaining positive throughout 2005, the reason being that inflation remained below target for that year. Moreover, the relatively large discrepancy between the two rules for early 2005 arises from the fact that detrended industrial output was over 4% below trend, which called for an additional reduction in interest rates.

2002

2003 Rule 1 gap

2004

2005

2006

Rule 2 gap

Figure 2: gap between actual interest rates and those proposed by the Taylor rule described in Figure 1 for Hungary. Rule one uses the detrended real exchange rate and rule 2 detrended industrial production.

Nevertheless, the main conclusions from both rules remain broadly the same, except for the fact the volatile main conclusions Czech thatNevertheless, the first rule is more than the second. In terms of Republic the actual size of the gaps between from both rules remain broadly the In the case of the Czech Republic, the rates suggested by the rules and actual interest rates, reaches a maximum of 4.6 at the same, except for the fact that the first the sample considered will begin in beginning of thevolatile sample, which compares favourably with the experience the UK reported by 1998, which is whenofinflation targeting rule is more than the second. was implemented. The Czech central In terms of the actual of rate thegap gaps McCallum (2000), with an size interest of approximately 13 percentage points. bank began a process of disinflation between the rates suggested by the targeting net inflation of 6%, culminating rules and actual interest rates, reaches Czech Republic in a target for headline inflation for 3% a maximum of 4.6 at the beginning of until accession to inthe euro area. In In the case of which the Czech Republic, the sample considered will begin 1998, which is when the sample, compares favourably contrast to the experiences of Hungary inflation was implemented. The Czech central bank began process of disinflation with the targeting experience of the UK reported and Poland, the a Czech process of by McCallum (2000), with an interest disinflation achieved gradually, targeting net inflation of 6%, culminating in a target for headlinewas inflation for 3% until accession rate gap of approximately 13 without interest rates steadily declining to the euro area. In contrast to the experiences of Hungary and Poland, the Czech process of throughout the inflation targeting period. percentage points. disinflation was achieved gradually, without interest rates steadily declining throughout the inflation targeting period. The results for the same two rules and parameter values are shown in 44 Figure 3. In this case, both rules track actual rates very closely throughout the inflation targeting period, especially from 1999 onwards. The magnitude of the gaps between the actual rates and

INFLATION TARGETING IN EASTERN EUROPE

The results for the same two rules and parameter values are shown in Figure 3. In this case, both rules track actual rates very closely throughout the inflation targeting period, especially from 1999 onwards. The magnitude of the gaps between the actual rates and
20

those suggested by the Taylor rule variants is far smaller than for Hungary; given the discussion above regarding the lack of central bank independence in Hungary and its commitment to an exchange rate target, this should not be surprising.

15

10

98

99

00

01

02

03

04

05

06

CZ A c tual rates

CZ Rul e 1

CZ Rul e 2

Fig. 3 Taylor rule for the Czech Republic during inflation targeting period (1998:01-2006:01). The central bank reacts to deviations of inflation from its target, the output gap and smoothes interest rates: Rt (1  0.2) 2.5  S t  0.25 ygapt  0.8Sgapt  0.2 Rt 1 , where the output gap measure is either the

>

detrended real exchange rate or detrended industrial production (in both cases these have been detrended using the Hodrick-Prescott filter using O 14400 . Sgap represents the deviation of inflation from the announced end-of the year target. Source: Eurostat and Czech National Bank.

Nevertheless, it is also worth pointing out that the although the gaps, which are very highly correlated, display a considerable amount of persistence, especially during the periods 1999:11 to 2002:08 and 2004:11 to 2005:12. The reason for this lies primarily in the fact that the deviations of inflation from the central banks target remain highly persistent, and in fact, inflation has been undershooting its target for most of the past four years.

45
11

LAURIAN LUNGU, JUAN PAEZ-FARRELL

Nevertheless, it is also worth pointing out that the although the gaps, which are very highly correlated, display a considerable amount of persistence, especially during the periods 1999:11 to 2002:08 and 2004:11 to 2005:12. The
1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 98 99 00 01 02 03 04

reason for this lies primarily in the fact that the deviations of inflation from the central banks target remain highly persistent, and in fact, inflation has been undershooting its target for most of the past four years.

05

06

CZ rule 1 gap

CZ rule 2 gap

Figure 4: gap between actual interest rates and those proposed by the Taylor rule described in Figure 1 for the Czech Republic. Rule one uses the detrended real exchange rate and rule 2 detrended industrial production.

Nevertheless, the remarkable result Inflation exceeded 10% in 2000 and of applying a simple Taylor rule to the approached deflation in early 2003. of inflation Czech Republic is its ability toapplying track a Consequently, Nevertheless, the remarkable result of simple Taylor rule deviations to the Czech Republic is its actual rates so closely. Indeed, the from the target level have been highly ability to track actual so closely. Indeed,4the magnitude gaps in Figure compare persistentof the and worst of 4all for well the magnitude of the rates gaps in Figure purposes the integrity compare well by with those (2000) found with those found McCallum for by the US, Japan andof the maintaining UK, with the conclusion that McCallum (2000) for the US, Japan and and independence of the central bank, Taylor rules can be yield fruitful insights to the study of monetary policy in transition economies. the UK, with the conclusion that Taylor inflation undershot its target for most of rules can be yield fruitful insights to the 2001-2004. Given that over this period the unemployment rate averaged study Poland.of monetary policy in transition around 18%, reaching 20.4% in economies. For Poland the same Taylor rules are applied during the period However, 1998:10 to 2006:1 are shown 2002:09, this and was not Poland. achieved in a uniform manner and in in Figure 5. Inflation targeting in Poland, as in the other countries described above, was For Poland the same Taylor rules 2000 the inflation rate exceeded 10% successful in achieving low period inflation,1998:10 although this was then not a steady process. Inflation exceeded are applied during the and bordered near deflation in to 2006:1 and are shown in Figure 5. early 2003. 10% in 2000 and approached deflation in early 2003. Consequently, deviations of inflation from Inflation targeting in Poland, as in the As was the case with the Czech the target level have been highly persistent and worst of all for purposes of the other countries described above, was Republic, thethe deviations of maintaining inflation from 12 successful achievingof low inflation, its target have been large and integrity and in independence the central bank, inflation undershot its target for most of 2001although this was not a steady process. persistent. 2004. Given that over this period the unemployment rate averaged around 18%, reaching 20.4%
12

The BankHowever, of Poland focused onachieved a band in rather than a point, and but in the central point will rate be in 2002:09, this was not a uniform manner 2000 the inflation considered here for simplicity.

exceeded 10% and then bordered near deflation in early 2003.

46

As was the case with the Czech Republic, the deviations of inflation from its target12 have been
INFLATION TARGETING large and persistent. IN EASTERN EUROPE

25 20 15 10 5

99

00

01

02

03

04

05

06

PL A c tual Rate

P L Rule 1

P L Rule 2

Fig. 5 Taylor rule for the Poland. During inflation targeting period (1998:10-2006:01). The central bank reacts to deviations of inflation from its target, the output gap and smoothes interest rates: Rt (1  0.2) 2.5  S t  0.25 ygapt  0.8Sgapt  0.2 Rt 1 , where the output gap measure is either the

>

detrended real exchange rate or detrended industrial production (in both cases these have been detrended using the Hodrick-Prescott filter using O 14400 . Sgap represents the deviation of inflation from the announced end-of the year target. Source: Eurostat and Polish National Bank.

As shown in Figure 6, the gaps targeting, in the sense of maintaining a As shownby in Figure 6, the gaps implied by the two Taylor rules have been large and persistent, implied the two Taylor rules have low an stable inflation rate, has not been large and persistent, with no clear with no clear indication of an improvement overbeen time, suggesting that although disinflation in very successful; in effect Polish indication of an improvement over time, Poland has been success, inflation targeting, in the sense of maintaining low an stable policy has been aunnecessarily suggesting that aalthough disinflation in monetary Poland a been success, inflation has rate, been has not very inflation successful; restrictive. in effect Polish monetary policy has been
unnecessarily restrictive.
3 2 1 0
12 -1 Bank of Poland focused on a band rather than a point, but the central point will be considered here for The simplicity.

-2

99

00

01

02

03

04

05

06

13

P LRGA P 1

P LRGA P 2

Figure 6. Gaps between actual rates and rates implied by the Taylor rules described in Figure 2.

47

LAURIAN LUNGU, JUAN PAEZ-FARRELL

Issues Regarding the Output Gap. option given the short sample, so that One limitation of analysis conducted the cycle obtained could be largely above, and also applicable to much spurious. In this sense, when using current research on estimating monetary Taylor rules for normative analysis one policy rules for the transition economies should be cautious in the presence of concerns the measured of the output discrepancies arising from large gap. As described in the previous deviations in the measured output gap. Bulletin (Pez-Farrell, 2005), the For the current context this problem is Hodrick-Prescott yields cyclical output, alleviated by the fact that the output for a given definition of a business gap enters the Taylor rule with a very cycle, but not the output gap unless the small coefficient and that deviations in economy does not experience any real the measured output gap have not shocks. Given the prevalence of been excessively large.13 As an alternative to this, one could also theAs consequences of a Taylor ruleone without an an alternative to this, could ongoing structural change in consider the also consider the consequences of a economies described above this is output gap measure. Doing so, as shown below (third Taylor rule) for Poland, does not in this Taylor rule without an output gap highly implausible. Moreover, the filter case14 , alter the main conclusions the paper. will be sensitive to the end of points and measure. Doing so, as shown below in this regard it would normally be (third Taylor rule) for Poland, does not preferable to discard the first and last in this case14, alter the main two years of data, but this is not an conclusions of the paper.
20 16 12 8 4
0

99

00

01

02

03

04

05

06

P L Rul e 2

P L Rul e 3

Figure 7. Comparison of rule 2 and an inflation nutter rule, where the response coefficient to the output gap is zero, for Poland.

Conclusion This paper has analysed the inflation targeting approach in three transition economies, namely
13 14

Hungary, Poland and the Czech Republic with the use of Taylor rules as benchmarks. The three economies considered have been successful at achieving disinflation, but deviations of inflation from its target have been persistent in all cases. Except for the Czech Republic, deviations from 48 the Taylor rule are large and persistent, with Hungary displaying the largest fluctuations. The fact that Hungary is following an inflation targeting regime and a fixed exchange rate is probably part

This is also the reason the results remain largely robust to the two rules analyzed. The results are virtually identical for Hungary and the Czech Republic.

INFLATION TARGETING IN EASTERN EUROPE

CONCLUSION This paper has analysed the inflation targeting approach in three transition economies, namely Hungary, Poland and the Czech Republic with the use of Taylor rules as benchmarks. The three economies considered have been successful at achieving disinflation, but deviations of inflation from its target have been persistent in all cases. Except for the Czech Republic, deviations from the Taylor rule are large and persistent, with Hungary displaying the largest fluctuations. The fact that Hungary is following an inflation targeting regime and a fixed exchange

rate is probably part of the problem, a policy that is inconsistent with perfectly flexible capital markets. Polish interest rates have consistently exceeded those suggested by the Taylor rule and given the prevalence of high unemployment; these undershootings do not augur well for the stability of monetary policy. Finally, the behaviour of Czech interest rates can be remarkably captured by the simple Taylor rule proposed in this paper, suggesting that the Czech National Bank has been the most successful at stabilising inflation and output around their target levels.

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REFERENCES:

Amato, Jeffrey and Gerlach, Stefan (2001), Inflation Targeting in Emerging Market and Transition Economies: Lessons After a Decade, CEPR Discussion Paper 3074. Ball, Laurence and Sheridan, Niahm (2004) Does Inflation Targeting matter? in Ben S. Bernanke and Michael Woodford, eds., The Inflation Targeting Debate. Chicago: Chicago University Press (forthcoming) Bernanke, Ben S, Laubach, Thomas, Mishkin, Frederic, S. and Posen, Adam S., (1999) Inflation Targeting: Lessons from the International Experience, Princeton, NJ, Princeton University Press. Friedman, Benjamin, M. (2004), Why the Federal Reserve Should not Adopt Inflation Targeting. Paper presented at the 2004 AEE Conference in San Diego, January 2004. Leigh, D. (2005). Inflation Persistence and Monetary Policy, in Hungary: Selected Issues. International Monetary Fund, Washington D.C. McCallum, B. T. (2000). Alternative Monetary Policy Rules: A Comparison with Historical Settings for the United States, the United Kingdom and Japan. Federal Reserve Bank of Richmond Economic Quarterly, Winter, pp. 49-79. Maria-Dolores, R. (2005). Monetary Policy Rules in Accession Countries to the EU: Is the Taylor Rule a Pattern? Economics Bulletin, Vol. 5, no. 7 pp. 1-16. Mishkin, Frederic S (2000), Inflation Targeting in Emerging-Market Countries, American Economic Review 90, pg. 105-109. Mishkin, Frederic S., Schmidt-Hebbel, Klaus, 2001, One decade of inflation targeting in the world: what do we know and what do we need to know? NBER Working Paper 8397. Mohanty, M S and M. Klau. (2004). Monetary Policy Rules in Emerging Market Economies: Issues and Evidence. BIS Working paper 149. Siklos, P. L. and Abel, I. (2003). Is Hungary Ready for Inflation Targeting? Economic Systems 66, pp. 1-25. Taylor, J. B.(1999) ed., Monetary Policy Rules. University of Chicago Press Taylor, J. B. (2001). The Role of the Exchange Rate in Monetary Policy Rules, American Economic Review, AEA Papers and Proceedings 91, 263-267. Truman Edwin M., (2003), Inflation Targeting in the World Economy, Washington DC: Institute for International Economics.

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ROMANIAN JOURNAL OF EUROPEAN AFFAIRS

VOL. 6, NO. 1, 2006

TURKEY INTO THE EUROPEAN UNION: PAST CHALLENGES AND FUTURE PROSPECTS
MURAT METIN HAKKI*
Abstract. This paper aims to analyze the impact that the EU accession process has already had on Turkeys foreign policy since the acceptance of that countrys candidacy for EU membership in 1999. It also endeavors to highlight the potential challenges ahead for eventual membership, while commenting on the problems that Turkey may face in its future negotiations with the EU, with particular emphasis on the areas in which Turkish Foreign Policy (TFP) may need further adaptation. INTRODUCTION Turkeys relations with the European Economic Community (EEC) now the European Union (EU) date back to 1959 when Turkey applied for associate membership. On 3 October 2005, the accession negotiations finally began. Turkey was the second country to sign a European association agreement, normally seen as a prelude to membership, as long ago as 1963. Owing to various military coups, it could formally apply for membership only in 1987. The European Commission recommended against that application in 1989, but it remained on the table. Throughout the 1990s, even as they prepared to take in the eight excommunist countries that joined in 2004, European leaders trod gingerly around Turkish hopes, though in 1996 an EU-Turkey customs union was formed. In 1997, the Luxembourg Summit pointedly left the country off its list of candidates. A partial reversal of this decision occurred at the Helsinki Summit in 1999, which went on to recognize Turkeys candidacy for EU membership. In 2002, Europe refused
* 1

to take that to a further level and start the accession negotiations1. This paper aims to analyze the impact that the EU accession process has already had on Turkeys foreign policy since the acceptance of that countrys candidacy for EU membership in 1999. It also endeavors to highlight the potential challenges ahead for eventual membership, while commenting on the problems that Turkey may face in its future negotiations with the EU, with particular emphasis on the areas in which Turkish Foreign Policy (TFP) may need further adaptation. It is divided into three parts. In the first part, I analyze the effects of candidacy for EU membership on Turkeys foreign policy between 1999 and 2005. I conclude that democratization as taking place within the context of Turkeys Europeanization process and not the democratization process per se can explain some of the developments in Turkish foreign policy (TFP). In the second part, I examine the potential for problems relating to Cyprus and the Aegean, together with other
on:

LLB (Southampton), LLM (London School of Economics), LLM (Cornell), A.M. (Harvard). The Impossibility of Saying No, The Economist, 16 September 2004. Available www.economist.com/displaystory.cfm?story_id=3195754

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issues such as the so-called Armenian Genocide and the creation of an independent Kurdish state in todays Northern Iraq, to further complicate Turkeys negotiations with the EU. I also try to elaborate how in my opinion- the Turkish government may approach these issues to minimize the prospects of friction with the EU (and perhaps also with the US). In the cases of Cyprus and the Aegean, different negotiation tactics may need to be employed. As far as the Armenian and Kurdish problems are concerned, it is recommended that in the short term Turkey increase its political leverage over Armenia and Northern Iraq by bringing both entities within Turkeys sphere of economic influence. In the long term, Turkey may find it useful to begin land reform and develop strategies to complete the Southeastern

Anatolia Project to improve the living standards of its Kurdish citizens. It may also find it useful to commence a scheme that envisages a gradual devolution of political power to local authorities throughout the country. Such measures may minimize the separatist tendencies amongst Turkeys Kurds. In the remaining sections of Part 2, I comment on Turkeys chances of becoming a full member of the EU and highlight the reasons why some leading EU members like France are not very likely to give their final approval to Turkeys full membership in the Union. I also explain why such countries are more likely to push Turkey towards a privileged partnership status in the medium or long term. The third section contains some remarks for the future based on the uncertainties described in the previous sections.

PART I: TRANSFORMING TURKISH FOREIGN POLICY SINCE 1999 Democratization reforms through purely internal dynamics in Turkey have progressed very slowly. It was only recently, in the late 1990s, that democratization attempts increased in Turkey mainly due to Turkeys aspiration to become an EU member which is an external dynamics2. The so-called Copenhagen criterion laid down for countries intending to join the EU in the post-1993 period demands that applicants respect human rights, the rule of law and the free market during the accession process. Hence, the EU connection plays a very important role in Turkeys democratization.
2

To be able to comment on the democratization attempts carried out by Turkey and elaborate on their effects on Turkish foreign policy, one must consider two propositions. First of all, attention must be paid to analyzing whether the recorded changes are attributable to the democratization process per se or democratization as taking place within the context of Turkeys Europeanization process. The former proposition is based on the assumption that the policy changes are a natural result of the democratization process in Turkey. On the other hand, the second proposition defends the view that the policy changes are mostly attributable

Ahmet Sozen, Democratization in Turkey: Copenhagen Criteria for EU Membership and Reflections on Turkish Foreign Policy, (Paper prepared for presentation at the 2002 Annual Conference of the International Studies Association in New Orleans, Louisiana, March 24-27), p.2.

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TURKEY INTO THE EUROPEAN UNION: PAST CHALLENGES AND FUTURE PROSPECTS

to the political pressures coming from the EU. My observation is that the second explanation is more appropriate. In Turkey, the drive for westernization can be traced back to Ottoman reforms of the late eighteenth and nineteenth centuries. In the postWar period, and especially from the early 1960s onward, eventual membership in the EU has been interpreted as a necessary counterpart of the drive toward westernization and modernization, which itself has been proclaimed as official state ideology3. Four consecutive economic crises between 1994 and 2001 had the effect of making the Turkish economy very fragile. The business community also increasingly saw the EU anchor as a means to consolidate the kind of economic environment conducive to their long-term interests. The implicit fear has been that the economic reform process itself could easily be reversed in the absence of EU membership prospects4. The Treaty on the European Union (TEU) made the principles of democracy and human rights a fundamental part of the process of European integration. Before the end of the Cold War, the logic of security cooperation overwhelmed the logic of promoting democracy. So, when countries like Greece and Portugal joined the EU in the 1980s, a lower threshold was applied to them. In other words, priority was given to certain geostrategic calculations, and concerns regarding the economy or respect for

human rights were given far less attention. Article F of the TEU emphasizes the importance of governmental systems founded on principles of democracy, respect for fundamental rights, the protection of human rights, and fundamental freedoms. More recently, the Treaty of Amsterdam (ToA) amending Article O of the TEU provided for similar conditions5. The political picture discussed so far has made Turkey more vulnerable and responsive to EU demands in the period following its membership applicationespecially since 1999. Greece, a long-time enemy of Turkey, joined the European Economic Community in 1981. For nearly two decades following its accession, Greece appeared to be the main obstacle to its eastern neighbors EU membership aspirations. However, the situation changed in the 1990s. In the second half of the 1990s, the two countries came to the brink of war on three different occasions and were only stopped by Clintons skillful diplomacy. This prompted a change in the Greek stance regarding Turkish-EU relations. After the Helsinki Summit in December 1999, the Greeks lifted their veto on the recognition of Turkeys candidacy status. George Papandreu, the Foreign Minister between 1999 and 2004, appears to have reached the conclusion that only the incentive of eventual EU membership can make Turkey more liberal and hence less aggressive towards his country6.

3 Ziya Onis, Domestic Politics, International Norms and Challenges to the State: Turkey-EU Relations in the Post-Helsinki Era, Turkish Studies, Vol. 4, No.1 (2003), p.17 4 ibid, p.22 5 Harun Arikan, A Lost Opportunity? A Critique of the EUs Human Rights Policy Towards Turkey, Mediterranean Politics, Vol.7, No.1 (Spring 2002), pp.20-21 6 Ioannis N. Grigoriadis, The Changing Role of the EU Factor in Greek-Turkish Relations, (London School of Political Science, Hellenic Observatory, 1st PhD Symposium on Modern Greece: Current Social Science Research on Greece, London, 21st June 2003), p.3.

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It is true that there have been significant changes in TFP after Turkeys candidacy for the EU was approved officially at the Helsinki Summit. Let us examine the four main areas of contemporary TFP where relations with the EU had an impact: 1. Cyprus issue 2. Relations with Greece 3. European Security and Defense Policy 4. Forming a bridge between the West and Islam. The EU has identified several areas in which Turkey needs to undertake policy reform in order to make its standards converge with those of the EU. Of these, the role of the military in Turkish politics is the most important for our purposes. The military intervention of 1980 was the third in the republican era following those of 1960 and 1971. The Turkish army most recently carried out the velvet intervention of 1997 by issuing a warning to the Islamistdominated government and creating a chain of events that eventually toppled it7. Besides, the military-biased composition of the National Security Council (NSC) until recently- allowed it to be the most influential body of the state in the shaping of both domestic and foreign policy. Thus the reforms introduced to trim the political power of the military can account for many of the changes that will be observed below. Since the establishment of the Turkish Republic in 1923, the main democratizing agent has been the state
7

and the extent of the democratization process has been defined by the state, in a top-down manner, in accordance with the requirements of Kemalist ideology, named after Kemal Ataturk, the founder of modern Turkey8. Since the Ottoman Empire had come to an end owing to ethnic and religious fragmentation within the empire, the first job of the republican elites had been to establish secularism and homogenous nationalism as the guiding principles of the new state9. The military has been the main pillar of these Kemalist elites. However, most often it acted in concert with a large group of nationalist, and unelected, senior bureaucrats whose acts have often constrained the freedom of elected politicians to maneuver significantly. According to Tsakonas, the Turkish civil-military elite is divided into two main groups, the Conservative Kemalists and the Reformers10. The Conservatives adhere to a strict interpretation of Kemalism and reject any deviation from secularism and uniculturalism. They tend to interpret the countrys national interest in narrow security terms; they have difficulty recognizing any need for reform that will express new societal demands. Although their primary aim is the westernization of the country, they do not trust the western countries at all, believing that they are in a conspiracy to bring about the disintegration of Turkey if the right circumstances arise. The Reformers, on the other hand,

Ihsan Dagi, Human Rights and Democratization: Turkish Politics in the European Context, Southeast European and Black Sea Studies, Vol.1, No.3 (September 2001), p.52 8 Tarik Oguzlu, The Impact of Democratization in the Context of the EU Accession Process on Turkish Foreign Policy, Mediterranean Policy, Vol.9, No.1 (Spring 2004), p.98 9 ibid. 10 Panayotis J. Tsakonas, Turkeys Post-Helsinki Turbulence: Implications for Greece and the Cyprus Issue, Turkish Studies, Vol.2, No.2 (Autumn 2001), p.12

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recognize the limits of the Kemalist ideology and the need to give new content to some of its pillars. The Reformers are in favor of reducing the role of the military and changing both the Constitution and the current patriarchic and clientelistic party The majority of the system11. population, pressure groups, journalists and business associations like the TUSIAD and most members of Parliament share their views. The competition for influence between these wings can explain some of the zigzags noticeable in Turkish foreign relations in the last 10 years. The Conservative group has been reluctant to relinquish their sovereignty over key areas of policy that would directly undermine their privileged positions or interests12. The civic organizations were unable to become, as a force below, the prime agents for political reform. By the year 2000, hope for political reform had been largely displaced onto the EU or to President Sezer. In other words, Turkish civil society was no longer viewed as the prime agent for change; if change were to come, it would be either from outside or from above. Additionally, although there has been a consensus in Turkish society that things need to change, there has been no agreement as to how such change could take place13. Potential EU membership creates both conditions and incentives, constituting a powerful engine of democratization and economic transformation in candidate countries in the process. We can say that the
11 12 13 14 15

Customs Union created between Turkey and the EU in 1996 on its own failed to provide an appropriate mix of conditions and incentives to induce a major transformation in Turkeys domestic politics and economy14. More initiatives from Europe towards Turkey were needed to accelerate the transformation. Up until the Helsinki Summit in 1999, Turkey normally pursued policy lines disapproved by the EU. Turkish military operations in Iraq, the threat of force against Greece and Cyprus in the case of deployment of Russian made S-300 missiles on the latters soil as well as against Syria over the PKKs leader, are only some of examples observed between 1996-99. How can this be explained? I propose that there are two main reasons for this behavior: In December 1997, the EUs Luxembourg Summit excluded Turkey from the next group of countries that began the accession process. The ambiguous EU attitude towards Turkeys accession to the club strengthened the hand of the traditional civil-military elites in convincing a great part of Turkish society that further democratization without strong EU promises of membership would eventually create serious threats to Turkish security. So long as the EU appeared undecided about Turkeys membership while demanding that it democratize, these traditionalists could find a legitimate excuse to interpret democratization consistent with the EU accession process as a threat-generating exercise15. The EU hesitations about

ibid. Onis, p.11 Tsakonas, pp.16-17 Onis, p.9 Oguzlu, pp.100-101

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Turkish entry consequently prevented the EU from channeling strong support to the pro-democracy forces within the country16. The EU could not be a strong enough influence for democracy in the pre-1999 era. It is undoubtedly the case that the decision taken at the Helsinki Summit has accelerated the momentum of political and economic reforms in the subsequent era. It changed the mood of the public as well as official circles. The end of the armed conflict in the Kurdish areas during the early part of 1999 also strengthened the hands of the reformists. The Conservatives resistance gradually started eroding. This was paralleled by increasing courage on the part of government circles to propose measures in areas previously considered taboo. Still, the tri-partite coalition government that lasted between 1999 and 2002 and the political crises that crippled its working mechanism meant that many of the really innovative steps were to be reserved for the future. Important developments have occurred in Turkey-EU relations in the aftermath of the AKPs election victory in November 2002. Although the party had strong Islamic roots, it presented itself as a center-right conservative party with moderate leanings and a commitment to secularism. For example, the militarys representation in the NSC was diluted only after the Justice and Development Party (AKP) led by the former Islamist Recep Tayyip Erdogan came to power in the November 2002 elections with a landslide victory. One drawback of the
16 17 18

Helsinki decision was that it failed to disclose a timetable for the start of the accession negotiations. It also did not guarantee Turkeys eventual membership in the EU. This prompted various wings of the civil-military elite to continue asking what if the Europeans do not agree to Turkeys accession to the club even though Turkey has undertaken all the radical reforms on the way to a liberal-pluralist democracy, as part of the efforts to comply with the accession criteria? In the last 6 years, the struggle between the conservatives and the reformists has not been easy. As Tsakonas put it, Turkey entered a turbulent transition period in the aftermath of the Helsinki decision in 199917. During this period, there were occasions when elite and societal preferences became radicalized- typical of a nation that experiences problematic democratization- and the traditionally conservative groups, such as the military, perceived military adventures as a useful way to regain their political power and prestige18. Such reactions were especially acute as regards the political situation in Cyprus. 1.1. Cyprus It soon became clear that Turkeys eligibility for starting the accession talks after Helsinki depended on the resolution of two chronic and sensitive issues: its border conflict with Greece (Aegean Sea), and the Cyprus issue. Greece was an EU member and Cyprus was destined to join by 2003 or 2004. Adopting a good neighborhood policy towards current and prospective EU members appeared to be vital.

ibid. p.21 ibid.

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Attempts to continue to maintain the status quo could lead Turkey headlong towards a crisis in which the EU bid could be the main casualty. Cyprus is a nationalist issue par excellence for many segments of the Turkish civil-military elite since it touches upon deep nationalist sensitivities. Until recently, a strengthened nationalism on the one hand and Turkeys strategic importance for the West on the other have resulted in the rigid Turkish stance on Cyprus. Over the years, Cyprus has become the sole reason of pride for the Turkish Kemalist elite (especially the military), which promoted a modernization project that was a failure in some respects19. Some argue that the occupation of Northern Cyprus in 1974 is in fact the most vivid proof of Turkeys role as a regional power and the testing ground indicating what, how, and how much Turkey can do for Turks living outside Turkey. Whenever bilateral EU-Turkey relations turned sour, Turkey has not hesitated to stall inter-communal talks by encouraging the nationalist leader of North Cyprus (TRNC), Rauf Denktash, to sabotage them by withdrawing from the negotiating table. Turkey has also threatened the EU that it might annex the TRNC if the island were to join the EU before a resolution of the dispute20. These events coincided with times when the Euro-skeptic conservatives exploited tensions with the EU to gain the upper hand in their struggle for power with the reformers. Once it came to power the AKP, much more than any other political party of the previous era, demonstrated
19 20

a high degree of commitment to the goal of full EU membership. Hence, the party constituted a key component of Turkeys pro-EU coalition by the end of 2002. After a while it secured the full backing of the media, the leading pressure groups and business associations. This not only showed its readiness to accelerate the reform process that had already gained momentum during the course of that year, but also expressed its willingness to diverge from the official state line in resolving the Cyprus dispute, even before the UN Plan on Cyprus became public. The party was clearly willing to challenge the military-security establishment on the critical issue of Cyprus, something that political parties of the previous era, including the liberal Motherland Party (ANAP), were not able to do. The AKP clearly faced a number of challenges and certain factors explain why it found success in the EU accession field so crucial. First of all, the Islamists and the Kurds have been two of the major victims of the various military interventions between 1960 and 1997. The last military intervention in 1997 was solely aimed at removing Necmettin Erbakan, the then leader of the Prosperity Party (RP) from power. At the time, Tayyip Erdogan who belonged to the same party , was the mayor of Istanbul and not long after the velvet coup of 1997, he lost his position and was jailed on the grounds of inciting religious hatred among various factions of the Turkish public. Promoting further democratization in Turkey and curbing the militarys political power was essential to ensure

ibid. p.24 Oguzlu, p.108

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that at least some Islamist views could be expressed more easily in the society and that no more military interventions that could potentially remove Erdogan from power could take place. The EU was the only body that could provide the AKP with increased momentum for democratization in Turkey and enable it to outflank its military opponents. Secondly, the AKP can rightly be considered an unnatural conservativeliberal-nationalist coalition. Thus, it could easily start disintegrating in the case of another major political or economic instability in Turkey. As stated before, the EU integration process appears to be the main antidote for an economic instability that could have major repercussions in the political field as well. Given these facts, Erdogan adopted a much more compromising attitude towards issues that could sour Turkish relations with the EU. The key outcome of the EUs Copenhagen summit held in December 2002 involved the offer of a firm date (December 2004) for opening up accession negotiations with Turkey, provided it could satisfy all aspects of EU conditionality by then. This new perspective further shifted the balance of power in Turkish politics and society in favor of the pro-EU coalition. The constitutional powers of the military were rapidly trimmed thereafter. After the Copenhagen summit, Turkey dropped its threats to annex Cyprus. In February 2004, the Turkish government pressured the Turkish Cypriot side to accept the UN sponsored peace proposals that envisaged the withdrawal of Turkish troops and the unification of Cyprus. The referenda held on both sides of the island in April 2004 showed that 65% of Turkish Cypriots supported the plan. 58

Nevertheless, the rejection of the proposals by the Greek Cypriot community effectively killed the hopes for a solution in the near future. Despite this outcome, the Greek Cypriot administration managed to accede to the EU, being recognized as the sole representative of the whole of Cyprus. This anomaly can be attributed to various UN resolutions adopted in the late 1970s and 1980s, as well as parts of the Copenhagen Declaration issued in December 2002 that concerned the Cyprus conflict. Having said these, I will now begin considering the impact that the EU had on some other aspects of the TFP. 1.2. Relations with Greece Following the capture of Abdullah Ocalan in February 1999 that brought to light the relations between Greece on the one hand and Ocalan and his separatist Kurdish guerilla organization (the PKK) on the other, Greece initiated a sort of rapprochement with Turkey. This was reciprocated by Turkey and followed by the agreement by the Turkish and Greek governments to sign various cooperation protocols ranging from cooperation on fighting terrorism to cooperation on environmental issues and tourism. The formal recognition of Turkey as a candidate country for EU membership during the Helsinki Summit when Greece did not use its traditional veto against Turkey fostered the rapprochement between Turkey and Greece. However, the Greek veto was conditional on certain points which were included in the Presidency conclusion of the Helsinki Summit: The European Council stresses the principle of peaceful settlement of disputes in accordance with the United

TURKEY INTO THE EUROPEAN UNION: PAST CHALLENGES AND FUTURE PROSPECTS

Nations Charter and urges candidate States to make every effort to resolve any outstanding border disputes and other related issues. Failing this they should within a reasonable time bring the dispute to the International Court of Justice. The European Council will review the situation relating to any outstanding disputes, in particular concerning the repercussions on the accession process and in order to promote their settlement through the International Court of Justice, at the latest by the end of 2004. Moreover, the European Council recalls that compliance with the political criteria laid down at the Copenhagen European Council is a prerequisite for the opening of accession negotiations and that compliance with all the Copenhagen criteria is the basis for accession to the Union (paragraph 4). The European Council welcomes the launch of the talks aiming at a comprehensive settlement of the Cyprus problem on 3 December in New York and expresses its strong support for the UN Secretary-Generals efforts to bring the process to a successful conclusion (paragraph 9 (a)) 21. Therefore, the EU overcame the Greek veto by paragraphs 4 and 9 (a) where according to paragraph 4, the Greek Turkey disputes would be solved diplomatically and if that failed, be taken to the ICJ. The above paragraph targets the so-called Aegean Dispute to which more attention will be given below. Despite the expiry of the 2004 deadline, Greece has so far abstained from taking any action in that
21 22

regard. Since the Helsinki Summit, the relations between the two countries and the discourse used by the governments have been very positive compared to the previous years where the two sides never hesitated to use threatening words toward each other. At present, outside diplomats describe the relations between Turkey and Greece as confidence building measures between two democratic states with a good potential for normalized relations.22 1.3. European Security and Defense Policy (ESDP) The impact of democratization accompanying the EU accession process on the style, process, and outcome of Turkeys approach to the settlement of the ESDP dispute has been minimal, if not negative, in character23. The matter concerned the possibility of allowing the EU armed forces to make use of NATOs military capabilities in EU-led military operations. Traditional state elites have had a near monopoly on this issue. Due to the national issue character of the ESDP dispute and concerns about the quality of Turkey-EU relations, the Turkish security elite approached the matter from a nationalistic and unilateral perspective by adopting a bullying style24. There are arguably three reasons why the tone adopted has differed from the one adopted with respect to the disputes with Greece and Cyprus. To begin with, the ESDP disagreement mostly dominated the agenda in the late 1990s and early 2000s. Those

Sozen, p. 31 According to daily Milliyet (9 March 2002), a dialogue between the Turkish and Greek foreign ministries officers regarding the Aegean disputes started in Ankara on 12 March 2002. 23 Oguzlu, p.110 24 ibid.

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were the times when although TurkishEU relations were developing fast- there was still a respectable level of suspicion among the Turkish elites and the public regarding the EUs motives towards Turkey. In addition, in contrast to the cases of Cyprus and the Aegean, agreement concerning the ESDP did not appear to be amongst the preconditions for admission to the EU. Finally, a settlement of the dispute on the basis of French/Greek proposals would have left the door open to the possibility of using an independent European army against Turkey itself in Cyprus or the Aegean. There was no way that any Turkish politician would allow the EU to make use of NATOs military capabilities in EU-led military operations in the absence of satisfactory guarantees that Turkey would have a role in the decisionmaking processes of such operations. 1.4. Forming a bridge between the West and Islam. Beyond issues such as TurkeyGreece relations, the ESDP and Cyprus, Turkey is also preparing for a role to minimize the prospects of a clash between the Christian and Muslim civilizations. Many political observers believe that in order to decrease the likelihood of terror attacks against Europe and to use Turkey as a bridge between the East and the West, the Europeans felt somewhat

obliged to open their doors to the predominantly Moslem applicant. The former German Foreign Minister put it this way: letting Turkey in would be like a D-Day in the war on terror. By the same token, a No to Turkey would antagonize other Muslim countries, especially the Arab world, which would see it as a slap in the face delivered by the West against Islam25. There is no doubt that among the 57 Islamic countries of the Organization of Islamic Conference, none is more secular or modernized than Turkey26. The international community is in need of a dialogue and consensus between the West and the Islamic world especially after the 11 September attacks in the US. Prime Minister Erdogan made this proposal the cornerstone of his lobbying in order to get his country admitted to the EU. Whether the conditions are indeed ripe for Turkey to play such a role will be one of the many issues that will be discussed in the following part of this paper. In the preceding sections, I tried to demonstrate how relations with the EU actually led to changes in some aspects of the TFP. Now, it is time to move on to the second major issue: the challenges lying ahead and the areas where the TFP may need further adaptation.

In his article published on 24 September 2004, Ahmad Amrabi, a columnist for the Arabic Al Beyan Newspaper regarded EUs delaying games against Turkey as evidence of formers racist and biased attitude against Islam. 26 Bassam Tibi. Europe, Turkey and Islam in Flux. Changing Identities and the Quest for Euro-Islam. Available on: www.cianet.org.ezp1.harvard.edu/olj/tpq/vol3-1tib01.html

25

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PART II: CHALLENGES LYING AHEAD. There are various issues on which Turkey may be pressured to compromise later on. The Armenian question and the need for a political settlement in the disputes regarding Cyprus and the Aegean Sea have already been mentioned. In light of the negotiation framework approved on 3 October 2005, I would like to elaborate on these matters further. In addition, I would like to attract attention to one other potential issue that although not cited in the negotiation framework or the 17 December decision- could cause crises during the EU-Turkey accession talks: the disintegration of Iraq. 2.1.1. Cyprus Article 6 of the negotiation framework approved on 3 October 2005 begins with the following statement: The advancement of the negotiations will be guided by Turkeys progress in preparing for accession, within a framework of economic and social convergence and with reference to the Commissions reports in paragraph 2. This progress will be measured in particular against the following requirements: Amongst many other things, the aforementioned article incorporates the paragraph below: Turkeys continued support for efforts to achieve a comprehensive settlement of the Cyprus problem within the UN framework and in line with the principles on which the Union is founded, including steps to contribute to a favourable climate for a comprehensive settlement, and progress in the normalisation of bilateral relations
27

between Turkey and all EU Member States, including the Republic of Cyprus27. Given the fact that Greece and South Cyprus are both members of the EU, they are likely attempt to exploit this factor and thus threaten the accession process if Turkey fails to comply with certain Greek demands regarding the Cyprus dispute. This situation can allow them to have the upper hand during the future rounds of UN-sponsored peace talks and act intransigently. Should a political settlement of the Cyprus problem prove impossible over the next few years, the normalization of bilateral relations between Turkey and all EU Member States, including the Republic of Cyprus requirement can gradually force Turkey to extend both de facto and de jure recognition that the Greek Cypriot administration in Southern Cyprus demands, because it claims to be the only legitimate authority for the whole island, having usurped the title of Republic of Cyprus since the beginning of the civil war on the island in 1963. Pressures to withdraw the Turkish troops that have been stationed in Northern Cyprus since 1974 may follow the demands for recognition. This, coupled with the recognition of the Republic of Cyprus government, can effectively signify the neutralization of certain concessions that the previous Turkish governments managed to extract from Greece, the Greek Cypriot administration, and the United Nations (UN) in the past.

Adapted from: http://www.abhaber.com/haber_sayfasi.asp?id=7786

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During the peace talks that have been continuing for the past thirty eight years, the Greek side reluctantly accepted that such notions as federalism and bi-zonality (which will give substantial autonomy to both the Greek and Turkish zones) would be the key principles to govern the permanent settlement of the conflict in Cyprus. The UN has also endorsed this view in various resolutions. However, as no permanent peace treaty has been signed to date, the results of these compromises are not yet legally enforceable against the Greek side. The history of the civil war that lasted in Cyprus between 1963 and 1974 and public opinion polls may suggest that Turkish Cypriots and Turkish public opinion are highly unlikely to tolerate any dilution of the principles of bi-zonality and federalism that arguably formed the backbone of previous UN proposals. Mr Erdogan and his government may soon find themselves sandwiched between the EU/Greek/Greek Cypriot demands for the implicit restoration of the 1960 Constitutional order that envisaged a unitary system of government for Cyprus and the reaction of the Turkish and Turkish Cypriot public opinions against such suggestions. In the forthcoming months and years, US backing is crucial to pressure the Greek side against being intransigent at the UN sponsored peace talks. This objective must be achieved through improving the strategic dialogue between the U.S. and Turkey. Turkey may also evaluate the prospects of unilaterally implementing some provisions of the Annan Plan that was approved by 65% of Turkish Cypriots. Such measures may include the unilateral proclamation of the 62

autonomous Turkish Cypriot State envisaged in the Annan Plan. The proclamation of the Turkish Cypriot State may create a new legal situation in the island that may also enable the Turkish Cypriot side to bypass certain UN resolutions that expressly condemned and targeted the secessionist Turkish Republic of Northern Cyprus in 1983 and that have been the source of the isolationist measures applied by the international community in the fields of trade and sports since then. If the new political situation can somehow be recognized or acquiesced to by the US and some other Islamic countries, this could counter some of the bargaining power of the Greek side. Yet, the EU may not approve of such manoeuvres. It may also actively oppose them and try to block them. 2.1.2. The Aegean Dispute The Aegean Crisis is a term coined by Greek governments roughly from the beginning of the Cyprus dispute in the 1970s up to the present day and referring to a series of, for the most part, unresolved, highly controversial and delicate diplomatic issues with the state of Turkey regarding matters such as The presence or absence of grey zones in the Aegean Sea. Sovereignty problems over many islands of the Aegean Sea. Airspace violations and unauthorized naval exercises. The EU expects Turkeys unequivocal commitment to good neighbourly relations and its undertaking to resolve any outstanding border disputes with Greece in conformity with the principle of peaceful settlement of disputes in accordance with the United

TURKEY INTO THE EUROPEAN UNION: PAST CHALLENGES AND FUTURE PROSPECTS

Nations Charter, including, if necessary, jurisdiction of the International Court of Justice (Article 6, Negotiation Framework). Unlike Greece, Turkey prefers a negotiated settlement achieved by dialogue. Turkey prefers a negotiated settlement because it is afraid that a decision by an outside legal party (such as the ICJ) would not fully appreciate Turkish interests. Another large factor is that legally the facts support more Greek claims than Turkish claims and do not take into consideration the special and political circumstances of the situation. Furthermore, Turkey is afraid an outside party may be biased against it and is sure that more favorable terms can be obtained through trade-offs and negotiations28. Between 1912 and 1947 the Dodecaneses that were under Italian control had served as a sort of buffer zone between Greece and Turkey, and the Treaty of Paris upset the balance that this political situation brought about in the Aegean. These islands, with a large Greek population, were given to Greece in compensation for her suffering in World War II; Turkey, a neutral in the war, was in no position to obstruct the transfer even if it had wished to do so. Several UN Conventions on Law of the Sea (UNCLOS) were adopted in the second half of the 20th century, and their provisions are generally regarded as representing the contemporary customary international law. Many Greek islands in the Aegean are just a few kilometers away from the Turkish coast. In view of this, full adherence to UNCLOS terms may not only convert
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the Aegean into a de facto Greek lake, but may also distract and sometimes block- Turkish commercial shipping between Istanbul and Antalya and also interfere with air traffic and oil exploration in the region. In some cases, Turkish commercial shipping in the Aegean may come to depend on Greek permission. If Turkey one day becomes an EU member, many of the concerns highlighted above will be rendered meaningless. Still, this outcome is uncertain. So, to the extent possible, Turkey may need to continue to insist on a negotiated settlement. Before any dispute can be brought before the ICJ, Turkey may find it useful to seek some written guarantees to ensure that regardless of the outcome of the case, certain basic commercial interests would remain unaffected. The Treaty of Lausanne and Treaty of Montreux, as well as the Treaty of Paris and several other smaller treaties, established not only the sovereignty but also the demilitarized status of many of the Greek islands. Since the 1960s, many of these islands which are so close to Turkey have been re-militarized in violation of these agreements. Greece denies that this situation forms a part of the overall dispute. If such matters as the continental shelf and territorial sea are taken to a supranational body (like the ICJ), Turkey can demand that it settle this issue as well. In this way, some of the security concerns that may arise from Greek wins in the continental shelf and territorial sea matters may be alleviated.

Stephan Mann, The Greek-Turkish Dispute in the Aegean Sea: Its Ramifications for the NATO and the Prospects for Resolution, p. 56. (Thesis submitted to the Naval Postgraduate School, Monterey, California in March 2001.Adapted from: http://theses.nps.navy.mil/Thesis_01mar_Mann.pdf)

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2.1.3. The Armenian Question The international recognition of the so-called Armenian Genocide may have huge political and economic repercussions for Turkey. As in the case of Germany, it may be asked to pay huge sums of compensation perhaps measurable in billions of US Dollars. Moreover, as Ross Vartian, the president of the Armenian Assembly of America has said, Turkey may also be pressured to return to Armenia some of its northeastern territories- areas that were populated by Armenians before 191529. It has been more than a year since the December 15 resolution was passed by the European Parliament. But, for whatever reason, very few people paid attention to its details. It contains some striking proposals that can impact on Turkeys negotiations with the EU. The parts of the resolution concerning the so-called Armenian Genocide recently attracted some commentary. The relevant part reads as follows30: Take steps to achieve a breakthrough in Turkish-Armenian relations in view of the remarkable study by Turkish historian Halil Berktay on the Armenian genocide (Paragraph GG); It is well known that the resolutions of the European Parliament generally have the nature of recommendations. But according to columnist and Istanbul University professor Mithat Melen, the expression The EU Council notes the resolution of the European Parliament of December 15, 2005 in paragraph 21 of the Final Declaration of the
29 30 31

December 17 Summit means that the recommendatory resolution of the European Parliament becomes part of the resolution of the EU Council and thus the document dated December 15, 2004 and the conditions contained therein become primary law for Turkey and preconditions for the accession process31. However, I do not think that the word notes can create such broad legal effects. That would require a more clearly defined expression. The legal status of the 15 December 2004 resolution of the European Parliament asking for Turkish recognition of the Armenian Genocide is therefore uncertain. It is unknown whether the Armenian issue will be brought before Turkey during the negotiations. Yet, it is certain that the European Parliament must approve the admission of new members to the EU. Hence, it is possible that the recognition of the so-called genocide can be made a precondition at the very end of the accession talks. Given this, Turkey must start forming a strategy for the future. Increasing Turkish political leverage over Armenia by making that country economically dependent on Turkey may form the cornerstone of this strategy. Armenia is a landlocked country that has suffered badly due to the embargoes applied by neighboring Turkey and Azerbaijan since the early 1990s. The embargoes were put in place as retaliation for the invasion of Karabakh, an Azeri territory. Because of its geographical position, to be able to have a significant level of trade or contact with the West Armenia needs

Savas Suzal, Yenicag Newspaper, 17 March 2005 Yalin Dogan, Hrriyet, Dec. 25, 2004 Dunya Newspaper, 25 December 2004.

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Turkeys cooperation. It is much smaller than Turkey in size and population. Turkey can lift the embargoes unilaterally and thereby make Armenia economically dependent on it. Some major Turkish companies may also make investments there. If Armenia becomes dependent on Turkey, then Turkey can use its economic and diplomatic leverage on that country to ward off future genocide resolutions and EU pressures in this respect. If the eastern neighbor continues to cause trouble, then the embargoes can be reinitiated. This can be done in addition to such activities as organizing international conferences on the genocide issue whereby leading academics explain the Turkish views more clearly and more effectively by resorting to the Ottoman archives and other materials available in Turkey. Such moves can potentially disappoint the Azeri public and government officials. However, this situation can arguably be remedied by increasing Turkish investment and trade in Azerbaijan. Moreover, military cooperation can reach the maximum level possible under the circumstances. The tone of military cooperation should be adjusted to take into account Turkeys relations with the US, Russia, the EU, and Iran. Azerbaijan is crucially important for Turkey and potentially a stepping-stone to increase its influence in the Caucus and Central Asia in the future. 2.1.4. The disintegration of Iraq and the creation of an independent Kurdistan Another problematic factor is the likely disintegration of Iraq over the next few years and the emergence of an

independent Kurdistan. Such an event is likely to strain Turkish relations with the EU, and more importantly the USA. Such a development could threaten Turkeys territorial integrity. Seen in that light, many Turkish generals may consider it a strategic necessity to use or threaten to use force against a future Kurdistan. However, given the strength of the Kurdish diaspora in Europe, such a move is likely to be followed by the de jure recognition of Kurdistan by most EU members, as well as a threat to stop accession talks with Turkey in the event of the use of force. There is an issue that can prompt the US to devise strategies aimed at delaying the disintegration of Iraq in the short or medium term: the Iran factor. If an independent and radical Shia state emerges from Iraq alongside Kurdistan, it may come within Irans sphere of influence. Moreover, the Shia Al-Hasa region of Saudi Arabia that harbors 75% of that countrys oil reserves may also be destabilized. So, the most likely scenario is that the US will try to stop the disintegration of Iraq at least until Iran is dealt with. Yet, it is also possible that events will get out of Americas control and the disintegration will occur in spite of strategies to prevent it. In order to prevent a potential Kurdish state from tempting Turkeys Kurds and thus threatening Turkeys territorial integrity, it is crucial for Turkey to improve the living standards of its citizens living in East and Southeastern Anatolia. It is absolutely logical to expect that the Turkish economy will prosper as a result of the EU accession process. However, the standards of living in the Eastern and Southeastern provinces resemble those in the poorest African states. The yearly income is only about 65

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$400-$500 and the population totals about 20 million people. It will take many years before the standard of living can match that in western parts of Turkey now, let alone the rest of Europe. The Kurdish blocs ultimate aim is for Mosul and Kirkuk to be attached to the three provinces which are known by the international community as the Iraqi Kurdistan. An independent Kurdish state that controls the oil fields in Mosul and Kirkuk in Northern Iraq and is thus economically viable could attract the Kurds in Turkey, Iran and Syria like a magnet, threatening the territorial integrity if not the existence-of these three countries. The cities of Mosul and Kirkuk control about 40% of Iraqs oil reserves. This figure translates to about 5% of the total world reserves. Over the long term, these cities could generate more than a trillion US dollars in income and foreign investment. At present, the Iraqi constitution envisages that the oil revenues will go to the central government. Still, this safeguard may be meaningless if tensions increase or if the country eventually disintegrates. In Northern Iraq, the population in only 3-4 million people. Thus, the Kurds in Northern Iraq can have a better chance of obtaining economic prosperity than their cousins in Turkey living further north. Turkey may devise strategies attempting to prevent a chain of events that could jeopardize its relations with the EU, the US and threaten its territorial integrity. Together with countries like Saudi Arabia and Kuwait, crucial US allies, Turkey may attempt to determine a common position and apply pressure on the US regarding certain developments on Iraq. Turkey may find
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it useful to have a secret, very high level of dialogue with Iran regarding the future of Iraq. The Kurds are hopeful that Kirkuk may be made part of their region following a referendum that may take place in 2007. From the perspective of Turkey, the fall of these areas into Kurdish hands must be prevented. The Turcoman and the Sunni Arab tribes which form a substantial part of the population in these two cities may be armed for this purpose with weapons from countries outside the NATO. To prevent any diplomatic or military crisis with the US, Turkey may use some ultra-nationalist groups or underground organizations that are not officially linked to the Turkish army or the intelligence agency (MIT). Such a strategy was applied towards the Turkish Cypriots in the late 1950s and the Chechens in the 1990s32. Just like Armenia, the Kurdish region in Northern Iraq is also a landlocked territory that needs Turkeys cooperation to be able to have a significant level of trade or contact with the West. If Syria and Iran somehow disintegrate in the future, the Kurdish territories in these countries (North-Eastern parts of Syria and Mahabad province in Iran) as well as Arab speaking Khuzestan in Iran and Alawite western Syria may secede. This may allow an independent Kurdish state to have access to the sea (either the Mediterranean Sea or the Persian Gulf), bypassing Turkey. A disintegration scenario for Syria may materialize only if the current Baath regime is toppled as a result of an internal rebellion or external force. The Sunni fundamentalists who arguably have the support of the majority of the local population may

Adapted from: http://news.bbc.co.uk/2/hi/europe/1223398.stm

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seek to come to power following many years of brutal oppression by the Allawite minority. A civil war may then follow. There is some evidence to suggest that fearful of the consequences of military action against Iran, the U.S. may seek the ethnic destabilization of the country in order to bring the regime down33. Recently, the Pentagon commissioned Hicks and Associates, a defense contractor, to conduct research into Iranian ethnic groups to examine the depth and nature of grievances against the Islamic government34. What consequences such strategies may have is not known. Unlike in Syria, the sense of a common national identity in Iran is stronger and the ethnic fault lines may be more difficult to exploit. Unless a disintegration scenario for Iran, Syria or both materializes, the Kurds will remain desperate for Turkeys cooperation to be able to have a significant level of trade or contact with the West. In the short term, Turkey must make the Kurdish region more economically dependent on it. Some major Turkish companies may also make investments there. If Northern Iraq becomes dependent on Turkey, then Turkey can use its economic and diplomatic leverage in that area to influence the developments that might take place there. 2.1.4.1. Can GAP, land reform and devolution solve the Kurdish problem in Turkey? Most important of all, more concrete economic measures ought to be taken to alleviate the poverty and misery amongst Turkeys Kurds. The

Southeastern Anatolia Project (GAP) that was designed in the 1970s to change the economic fate of the region may need to be completed as soon as possible. Also, the land reform program that has been shelved since the Nihat Erim administration in the early 1970s could be revived and land belonging to the treasury may be distributed to the villagers. Finally, depending on the situation in its neighboring countries, Turkey may evaluate the prospects of undertaking some constitutional reforms and gradually devolving more and more power to local authorities throughout the country. The Kurdish regions may initially be divided into four or five administrative zones. Then some of these zones may be merged with neighboring regions that contain substantial Allawi and Sunni Turkish populations. In the long term, this may pave the way for a federation based on geography and not ethnicity. The US and Germany may serve as models in this respect. Such measures can serve as additional safeguards against Kurdish secessionism in eastern Turkey. 2.2. The Europeans Consented to Negotiations but will they let Turkey in? So far, I have been discussing the potential challenges that Turkey may face while negotiating with the EU with respect to four major issues. However, the biggest challenge lying ahead is whether Turkey will ever be admitted to the EU, and if so, in what form. This issue is so important that it merits separate analysis.
of Iran, see :

33 For some scenarios regarding the possible disintegration http://www.atimes.com/atimes/Middle_East/GD29Ak01.html 34 Adapted from: http://www.krsi.net/news/detail.asp?NewsID=1752

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The Europeans fought the Turks and tried to drive them away from Europe for about sixteen centuries. They almost achieved that goal with the 1912-13 Balkan Wars. However, circumstances brought Turkey to the gates of Brussels almost ninety years later, this time as a candidate for European Union (EU) membership. Turkey reached the most advanced stage in the process of accession with the EUs decision to start negotiations on October 3, 2005. The success of the AKP Government in bringing this about should be noted. It reached a point no Turkish cabinet has reached before. However, it is obvious that Turkey still faces an ambiguous future, with special conditions imposed upon it, and possible compromises that might be demanded. Let us first analyze the content of the EU decision, and then discuss the possible reasons for the EU policy towards Turkey. 2.2.1. EUs Bon Pour LOrient Negotiation Process for Turkey BON POUR LORIENT is a French term referring to the stamps affixed by the Western educational institutions on low-level diplomas which are not recognized in the West and which are valid only in Eastern countries35. This is the most suitable phrase that can describe the perspective presented to Turkey on December 17, 2004. The adopted document contains provisions stipulating that permanent restrictions can be placed on freedom of movement and imposes procedures that were never applied to any other EU candidates before Turkey. In this respect, it reflects a serious discrimination.
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In addition, the end-result of the negotiation process became ambiguous before that process even started, with the possibility of Turkey receiving special status put on record implicitly in the form of the expression anchoring in the EU without full accession. For the first time in the EUs history, this organization emphasized in writing that the ultimate nature of Turkeys integration within the EU structures will remain uncertain until the end of the negotiation process. It is more likely that Turkey may be directed via a special route towards special membership, especially when Merkel and Sarkozy famous for their explicitly anti Turkish stance- come to power by 2007. Angela Merkels Christian Democrats got the highest number of votes in elections held in Germany in September 2005, and Gerhard Schroeder has lost his seat. Even though Schroeders SPD has guaranteed that it will be an equal partner in the coalition, given that the Chancellorship will remain with the CDU, Germanys stance towards Turkey during the negotiations may be toughened in the short or medium term. In the words of British ex-Prime Minister Harold Wilson, [even] a week is a long time in politics. It is not possible to forecast exactly the results of the elections in France in 2007. However, the current situation is very clear: Jacques Chirac, who appears to be the other major (tacit) supporter of accession talks with Turkey, is likely to go. As of 2005, many think that Sarkozy is the French Rights best hope for the next presidential election in 2007. Polls often credit him with being one of

Ahmet V. Alp, H.O. Tercman Newspaper, Dec. 18, 2004

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Frances most popular politicians. In the past he said on many occasions that Turkey should never be made a fullmember of the EU. In his opinion, both culturally and geographically Turkey does not belong to Europe. Contrary to the common view, French political observer Julien Toldano actually predicts that Nicolas Sarkozy may be defeated by the socialist candidate in a second round showdown in the next presidential election to be held in 200736. Toldano asserts that Sarkozy has no economic programme at all and that most far-right National Front voters will swing to the left because of their leaders defiance of the classical right since the mid-1980s. The option of membership with special status for Turkey currently has no legal basis. But the EU Constitution provides options for establishing such a status. If adopted, the draft can support a different statuswithin the EU, which is not fully defined yet. Most people believe this amendment was made with countries like Turkey in mind37. The rejection of the constitution text at the referenda that took place in France and the Netherlands in May and June 2005 respectively is a significant development that can delay its implementation for a few years. Still, the fact that the proposed document has been ratified in 13 countries (out of 25) means there is a prospect for its revival over the next few years. In the meantime, the French government has passed a law that will ensure that Turkeys final accession treaty will be put before the French
36 37 38 39

people. What will France say after the negotiations for Turkeys membership in the EU are completed along with other formalities, and all obstacles are removed? The negotiation date for Croatias membership is the same per law to be enacted by the French Senate in March 2005, but its accession will not be subject to any referendum, unlike Turkeys membership. It seems inevitable that Austria, and even Belgium, will also follow the referendum procedure on Turkeys accession. It is very likely that fear of Islam and even racism will be on the rise in various E.U. countries over the next 10-15 years. Dutch Foreign Minister Bot stated that such referendums may significantly decrease the chance of Turkey gaining membership38. In the past, the EU proposed to all other previous candidates specific dates around which they could expect to join the union. Major deviations from this type of proposal have not been experienced till now. The Turkish case is again an exception. Since no exact date has been given for Turkeys accession, it is also possible that Turkeys membership might be postponed to well after 2014 by using the accession of Ukraine or some Balkan countries as a pretext. According to the first paragraph of the December 17 Declaration, the accession of the candidates is conditional not only on their performance during the negotiations, but also on the capacity of the EU to absorb new members39. If the Ukraine

Adapted from: www.politique-info.org Guneri Civaoglu, Milliyet Newspaper, 8 December 2004. Milliyet Newspaper, Dec. 20, 2004. The same condition has been repeated in the negotiation framework approved in late 2005.

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and the Balkan countries become members of the EU, Turkeys membership might be delayed for good. When the Turkish delegation in Brussels consented to those conditions, even the Swedish Prime Minister Persson expressed his outrage at the situation by saying, If I were there, I would not accept it. The Turkish delegation were more concerned with certain short-term domestic or economic calculations than long-term certainty. 2.2.2. Problems of the Intergovernmental Conference Mechanism During the summit in Brussels, the proposals the EU Commission made in October 2004 were accepted and a decision was made to start the negotiations for Turkeys accession. According to Can Baydarol, the Chairman of the Turkey-EU Foundation, the acceptance of the kind of negotiation mechanism proposed in the October 6 Report issued by the EU Commission signifies the commencement of a negotiation process full of entrapments40. Negotiations with previous candidates were conducted addressing 31 topics, while that number was increased to 35 for Turkey and Croatia. Meeting the requirements of an intergovernmental conference, which requires a unanimous vote for opening and closing each negotiation chapter, would inevitably be seen in Turkey as a 70 concessions per member process. Requests for commercial or political concessions that might transform the agenda of Turkey into a new minefield will always be on everybodys minds. Theoretically, a veto that can be exercised arbitrarily should
40 41 42

not exist. However, what will prevent the exercise of veto powers frequently and over very insignificant details? The procedure for Turkeys accession to the EU should be the same as for other member states. Rather than having separate intergovernmental conferences for each file, an intergovernmental conference should be held only at the beginning of the negotiations; the remaining process should be conducted and finalized through the E.U. Commission, and the decision concerning full accession at the end of negotiations should be reached by votes of the individual members. The negotiations may appear to have been started, but they may lead Turkey to an unknown end and keep it in suspense for 10, 15 or 20 more years. Politicians such as Mesut Yilmaz41 and journalists like Oktay Eki have pointed this out42. Zafer aglayan, the Chairman of the Ankara Chamber of Commerce, points to another problematic and ambiguous issue in his speech on December 19, 2004: will the negotiation topics be discussed individually or in groups? Considering that discussing the issues of freedom of movement and agriculture may take up to 10 years each, the negotiation process for Turkey may not be completed by 2094, let alone 2014, if the topics are discussed individually. The negotiation framework published in October 2005 still leaves some questions in this respect. However, what it does make clear is that some of the most controversial chapters like the free movement of persons between

Referans Newspaper, Nov. 15, 2004. See the interviews with HABERTRK TV on Oct. 10, 2004, Dec. 19, 2004 Hrriyet Newspaper, Dec. 16, 2004

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EU member states will be among the first to be brought up for discussion. 2.2.3. Understanding the extent to which the EU needs Turkey In order to assess the EUs sincerity about admitting Turkey as a full member of the EU, we have to understand the extent to which the EU needs Turkey. Many strategists in Turkey argue that the EU has opened the door to Turkey for the following reasons: (1) Turkeys large market; (2) its ability to prevent the conflict between the civilizations; (3) Turkeys capacity to make the E.U. another superpower; (4) its young population; (5) using the Turkish model to promote democracy in the Middle East; (6) the Turkish army; and (7) the geo-strategic position of Turkey. My belief is that the last two reasons are the main ones for the EUs commencing of negotiations with Turkey. Full membership of Turkey in the EU is not essential for the Unions future and has the potential to upset political balances within the EU, so I am inclined to believe that Turkey will eventually be integrated as a country with inferior/special status within the European bodies. In the following section, I will try to elaborate on European motives for this outcome. In my opinion, the geo-strategic position of Turkey is the main reason why the EU is trying to anchor Turkey to Europe somehow. Turkey, which used to be a forward post of NATO against the Soviet Union during the Cold War, has now become a protective belt for the West against the lawless states of the Middle East. Turkey is situated on the passage to the Caucasus gas and oil, is in a position to affect the newly independent Turk republics, is the most effective

area to fight global drug trafficking, and has a key position in controlling immigration to Europe. As the U.S. has established hegemony over all Middle Eastern countries except Iran and Syria, and even neutralized Libya, it has become necessary for countries like France and Germany to gain influence over Turkey in order to maintain their presence in the Middle East. Besides, the Turkish Armed Forces is NATOs 2nd largest military power and has become even stronger after enduring the guerilla warfare of the PKK. If the EU without Turkeys full accession can utilize the Turkish Armed Forces, the EU may have more power to intervene in critical zones worldwide. It is worth noting that if Europe wants to have the military capability to reach many/all corners of the globe and thus be accepted as a great/super power, it must have an army significantly bigger than the current level of 60,000 troops. At the moment, with the exception of some armies like the French, most European armies are either very small or can be classified as medium sized armies at best. Hence, they do not have enough soldiers to contribute to such a project. Turkish troops can certainly be useful in this respect. None of the other possible reasons for the EU to accept Turkey as a full member seem viable. The EU has already gained control of the Turkish market through the Customs Union. Full accession of Turkey would not make the E.U. another superpower but would instead undermine the political unity of the EU and end the Federal United States of Europe project that some key European elites may have in their minds. And I do not think that the EU needs Turkey for its young population. 71

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The EU can attract young immigrants from many countries including Turkey if it develops flexible migration policies like Australia, where a points based immigration system allows government officials to select skilled workers. Like the US, Europe can attract workers from Russia, Ukraine, Belarus, China, India and Latin America and other parts of the globe if the appropriate legal or social opportunities are created. What Europe arguably needs now is some improvement in current labor markets and a change in ordinary peoples mentality. Before new workers may be welcomed on the continent, the current high level of unemployment in most countries must be brought down. Besides, ordinary Europeans must become more receptive to the idea of accepting immigrants from other places. The present situation is characterized by xenophobia more than anything else in most countries across the European continent. Currently, the U.S. attracts at least half a million immigrants from Mexico each year, yet it has never considered it necessary to integrate Mexico into the Union43. In addition, Turkey already acquired the right to freedom of movement in 1985 under the 1963 Ankara Treaty and the Annexed Protocol of 1970, but unfortunately this right is not exercised at the moment44. If this right that has been unilaterally ignored by many countries is exercised in the future, this problem of the need for immigrant workers will be solved. I also think that the EUs problem of low economic growth can be dealt with through certain structural reforms. For
43 44

instance, the social security systems of most European countries, which typically aim to sustain individuals from the cradle to the grave can be restructured and the economic burden can be reduced. Completing privatization can eliminate the principle of etatism which is still explicitly or implicitly in effect in many EU economies, and the production level can be increased by other serious reforms in E.U. wide employment laws to increase flexibility. The economic system of the U.S. can set an example for rest of the EU in several respects. To sum up, Turkeys full membership to the EU is not a requisite to save the economic future of the Union. The extent to which Turkeys democracy can serve as a model for Arab/other Muslim countries is also questionable. Most Muslim countries have been under foreign domination for long periods in history and gained independence relatively recently. In this case, it might be very difficult for a lot of them to adopt Western-type democracy, to achieve such political maturity in the near future, even in the medium term. Most institutions or traditions necessary for democracy building such as civic societies and an educated middle class are absent in the Middle East45. It must not be forgotten that it took nearly 500 years for the European states to reach the level they are at now. It took the US 100 years, if not more. Modern communication systems, like the Internet and mass media might help close this maturity gap more quickly. However, it might be

Adapted from: http://journalism.berkeley.edu/ngno/reports/newworld/immignumbers.html Yavuz Donat, Sabah Newspaper, 12 May 2005. 45 Bernard Lewis, Why Turkey is the only Muslim Democracy, The Middle East Quarterly, March 1994 (Vol.1, No.1). Available on: http://www.meforum.org/article/216

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unreasonable to expect it to close within the next few years. There is another obstacle to the democratization of the Middle East based on the Turkish model46. Nearly all borders of the Middle East are drawn in accordance with the 1916 Sykes-Picot Agreements, which do not correspond to the ethnic and historical realities of the region. Many states can rightly be labeled artificial states and national identity in many of them is not yet strong, Iran being an exception. With an imperial/state tradition dating back to the days of the Cyrus the Great of Persia, Iran has a relatively strong national identity and political maturity that increase its prospects for becoming a successful democracy in the region in the long run. Iran is the third country in the region (besides Turkey and Israel) to hold multi-party elections since the early 1980s and a large majority of the population openly/secretly admires basic western values. If these elections keep bringing anti-Western fundamentalists like Ahmedinejad to power, this is largely attributable to the policies of certain major Western powers that disappoint the population by applying embargoes to them and branding their country part of the so-called Axis of Evil47. Under many undemocratic regimes, territorial integrity has been achieved at the expense of human rights. If democracy spreads to them too prematurely and especially through external interference-, there is the risk that they might be drawn into civil wars and the current political system in the

Middle East can collapse, just like a house of cards. I doubt that the elections held in Iraq in late January of 2005 will bring democracy to that country. Iraq consists of three large ethnic groups, namely the Shiites, the Kurds, and the Sunnites, which do not trust each other and have conflicting goals. What kind of a consensus will they reach? In the event of a U.S. withdrawal, will the situation in Iraq be like that of Afghanistan after the Soviet occupation rather than a democratic country? Overall, the prospects for successfully spreading western style democracy over the next few decades are not good. Terror and the conflict between civilizations will continue to increase until the Palestine Question is solved and the U.S. changes its policies and stops bombing Muslim countries arbitrarily. If the U.S. attacks Iran in the short run, the division between the Sunnites and Shiites will become less sharp and this could potentially make the clash of civilizations scenario more likely. To sum up, it is doubtful whether Turkey can serve as a bridge between the Christian and Islamic civilizations and the role it can play to alleviate concerns of a clash of civilizations or spread democracy in the Middle East is minimal at best. 2.2.4. Do the USA and Europe play games with each other? 2.2.4.1. Full accession of Turkey is unacceptable for France. Turkeys full-membership in the EU may tilt the current balance of power

46 For further commentary on the issue see: Omer Taspinar, An Uneven Fit? The Turkish Model and the Arab World, The Brookings Project on US Policy Towards the Islamic World, Analysis Paper, Number 5, The Saban Center for Middle East Policy (August 2003). 47 For a constructive criticism of the US policy towards Iran see: Abbas Milani, U.S. Foreign Policy and the Future of Democracy in Iran, The Washington Quarterly (Summer 2005), at pp. 41-56

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within the transatlantic alliance towards America even more. This is another factor that may negatively affect its prospects for admission. It is beyond any doubt that the U.S. attaches high importance to Turkeys accession to the EU. We can understand American reasoning if we take a look at the book titled The Grand Chess Board by Brzezinski who was the U.S. National Security Advisor in the Carter administration and who continues to influence U.S. policies with his articles and studies. Brzezinski is in favor of accession of the Russian Federation and Turkey to the EU. He holds the view that through an enlarged EU the United States can expand its hegemony in Eurasia. In his opinion, the EU should be a beachhead for the U.S48. In other words, the U.S. may need to keep the political unity of the EU weak, to make it softer by means of the accession of Turkey, and even Russia, and thus to continue to hold control over Europe. The EU, under the leadership of Germany, may have the potential of becoming an important strategic rival for the United States. Global Trend 2015, the report drafted in 2000 by the NIC (National Intelligence Council) is just one of the studies disclosing that fact49. The European elite has a worldview animated by the belief that predominant powers should be counterbalanced and that a multi-polar world is more stable than a hegemonic or anarchical order50.
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Some of the important documents approved by the EU members since 1992 can be said to contain evidence for motives to make the Union a global power. Before its rejection by French and Dutch voters in the summer of 2005, the draft constitution for the EU envisaged such innovations as the creation of a legal personality, and the appointment by the European Commission of a single minister for foreign affairs with a view to achieving the progressive framing of a common Union defense policy. In Saving NATO from Europe, Jeffrey L. Cimbalo also warned that some provisions of the draft constitution concerning common defense had the potential for undermining the American role in Since the Europes defense51. disappointing results of the French and Dutch referenda, doubts have been cast upon the potential for further deepening political integration in Europe. However, if the current political crisis in Europe can be overcome in the medium-term there is a possibility that the aspirations for making the EU a global power may be revived. Today Turkeys population has reached 72 million, a figure larger than in any European state except Germany. According to the population estimates provided by the United Nations, within the next twenty years, Turkey will have the largest population in Europe about 89 million people52. The

Zbigniew Brzezinski, Buyuk Satranc Tahtasi, Turk Dunyasi Demokrasiyi Gelistirme Vakfi Publications, at p.64 49 Available on: www.cia.gov/cia/reports/globaltrends2015 50 David Shambaugh, The New Strategic Triangle: US and European Reactions to Chinas Rise, The Washington Quarterly, (Summer 2005), at p.8 51 Jeffrey L. Cimbalo, Saving NATO from Europe, Foreign Affairs (November-December 2004), at p.111 52 Katrin Bennhold, Will Turkey join the EU club?, International Herald Tribune, 13 September 2004.

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populations of Germany, France, and the United Kingdom within the same period will reach, respectively, 82, 64 and 63 million. That means that Turkey would be represented by 96 members in the European Parliament. As far as the Council of Ministers is concerned, the proposed Constitution stipulates a system of dual majority: in order for a resolution to be adopted, it must be supported by 55% of the states having 65% of the population. In that case, Turkey becomes a major player in the decision-making mechanism with a population share of 15-20%53. Some studies argue that Turkey, holding a key vote, will be able to block 76% of the decisions of the Council without the need for complicated alliances54. When Turkey draws the support of anti-federalist countries such as the United Kingdom and Denmark whose views on the EU perspective differ from those of France and Germany, it will be able to block any legislation and foreign policy initiatives that seek to deepen European integration. In the words of French ex-Minister of Justice Toubon, this may cause the break of the BerlinParis axis which is the most effective axis in the decision-making mechanism of the EU, and its replacement with the London-Ankara axis this is exactly what the U.S. would like to see55. Both the United Kingdom and Turkey have strong ties to the U.S. Both attach primary importance to the concept of national sovereignty and are likely to oppose the creation of a European
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super-state at the expense of their national sovereignty. Turkish-American relations have been strained since March 2003. Even if those relations come to a breaking point in the future, the accession of Turkey, which adopts a general approach similar to that of the United Kingdom, will dilute the political unity of the EU, and make it softer, and thus the United States will have achieved most of its goals. An E.U. with 30 or more members and a population of around 600 million is bound to remain politically impotent. Some may think that this scenario of a London-Ankara axis emerging in the future is unrealistic. But an alternative scenario of a Berlin-Ankara axis may not be acceptable for a country like France either. According to Newsweek magazine published in late summer of 2004, Turkey, upon becoming a member of the EU, could form an alliance with Germany and the driving axis of the EU could be Ankara-Berlin axis56. Turkey has had far more historical, political, economic, and cultural ties with Germany than France. The relationship has roots in the period of Kaiser Wilhelm II. During World War I Turkey sided with Germany; and during World War II Fevzi akmak, Chief of Staff, Numan Menemencioglu, Minister of Foreign Affairs, and many of their deputies supported Germany, though Turkey remained officially neutral57. The approximately 3 million Turks who migrated to Germany over the past 40

Le Figaro, Nov. 24, 2004 ABHABER, Dec. 14, 2004 55 Adapted from: http://www.abhaber.com/haber_sayfasi.asp?id=1976 56 2 August 2004 edition. 57 Saban alis, Pan-Turkism and Europeanism: a note on Turkeys pro-German neutrality during the Second World War, Central Asian Survey, Vol. 16 No. 1 (March 1997), at p. 103.

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years create another tie between the two countries. Germany is the largest trade partner of Turkey. In September 2002, Schroeder won the general elections only by 6,000 votes with the help of the Turkish population. These facts support the opinion that Turkey may prefer partnership with Germany rather than France. At the end of World War II, France was humiliated and lost most of its power. Charles de Gaulle made France believe that it could become a global player again by uniting her power with Germany and using other European countries to its advantage. The EU system has generally been based on the control of medium size states such as Italy, the United Kingdom, and Spain by the German-French axis and on the absorption of other 20 some smaller states. Would the accession of Turkey not disrupt that equilibrium and cause France itself to be transformed into a medium size state within the EU? The memories of the Cold War and communist oppression are still fresh in the minds of many Eastern Europeans and they still feel very grateful to the US for rescuing them from that situation. Over the next 10-15 years, such feelings will eventually fade away. Geographical, economic and historic factors may potentially cause Poland and other Eastern European countries to leave the US-UK orbit and eventually enter Germanys sphere of influence58. Will this not be a sufficient blow to the French position within the EU framework?
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2.2.4.2. Would accession of Turkey to the EU be advantageous for Germany? Germany has tried to control the Middle East and reach the Indian Ocean since the time of Bismarck. Wilhelm II considered Turkey an important bridge on that route, which should be kept under control. Some Germans thought that the Ottoman Empire should to be to Germany what India was to the British Empire. In the 1910s, they invested in the famous Baghdad and Hejaz Railway projects with such views in mind59. Until recently, the German Government appeared to be an enthusiastic supporter of Turkey in its bid to join the EU. It is obvious that Germany would not be adversely affected by the full accession of Turkey as much as France would. However, some political calculations cast a shadow on good intentions. German Foreign Minister Fischer was taped by some TV crew saying to his Danish counterpart Per Stig Moeller Dont worry, the Turks will never make it to the EU, we will lull them and then forget them at a cocktail party during the Copenhagen Summit60. The documentary Fogh behind the Scene was broadcast by Swedish DR1 TV channel, and became hot news61. With the end of the Cold War, Turkey had the potential to influence areas with from the Adriatic to the Great China Wall. But, Turkey has been unable to go beyond Edirne and Kars because of political and economic crises in the last 10 years. A strong

Janusz Bugajski and Ilona Teleki, Washingtons New European Allies: Durable or Conditional Partners?, The Washington Quarterly, Vol.28, No.2, (Spring 2005), at p.96 59 Akif Emre, Yenisafak Newspaper, 8 April 2004. 60 Zaman Newspaper, May 3, 2003 61 Here, the word Fogh refers to the middle name of Anders Fogh Rasmussen, the Danish Prime Minister, and should not be confused by fog.

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and wealthy Turkey with full member status in the EU may influence the Muslim Belt in the Balkans (Bosnia, Kosovo, Albania and Macedonia). Turkey is currently the 3rd largest foreign investor in Bulgaria and Romania despite the existing economic conditions. Arelik has established Eastern Europes largest durable consumer goods plant in Romania. Last year, The Ko Group almost bought Bulgarian Telecom that eventually was acquired by the U.S. Advent Group in a last minute deal. These two countries may gradually enter the zone of Turkeys influence. Germany attributes great importance to the Balkans. This country was the sponsor of the disintegration of Yugoslavia. It considers the Balkans to be its backyard and a way to gain access to the warm seas62. On the other hand, it is not easy for Germany to accept that Turkey would gradually acquire an influence equal to, or even greater than its own, in the EU. Germany, in order to protect its strong position in the world gold market attempted to foil gold production in Bergama by provoking the villagers through its secret services63. Germanys attitude in the gold production case can suggest that in the context of the EU as well it may never allow a Muslim country to have more influence than itself. In view of all these considerations, it is obvious that Turkeys full integration into the EU and its complete exclusion from the EU are against the interests of the Union. It is more likely that the EU plans to keep Turkey in suspense and take advantage of such a situation as long as possible, and then exclude it through referendums or, if there still is
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a need for Turkey, to integrate it into the EU as an outsider depending on the geo-strategic equilibrium of the time. There are some other motivations that the Europeans can derive from keeping Turkey in suspense. Some European politicians fear that if Turkey is not given the chance to begin accession talks, Iranian style fundamentalism may be on the rise in that country. Others also believe that an outright rejection might pave the way for Turkey to develop ever-closer ties with Russia. If the EU ever allows Turkey in, it would probably be done in a manner that firmly integrates Turkey into the EU camp and avoids U.S. plans for using Turkey as a Trojan horse. German exChancellors Helmut Kohl and Helmut Schmidt, who have been very influential figures in the last twenty years, have said that none of the EU leaders was sincere with Turkey; on the contrary they all had their own behind-thescenes plans. The EU leaders who will not be holding office in 15-20 years take comfort in that, saying, aprs moi, le deluge. Will the good cop Germany pit the bad cop Austria against Turkey over the next few years? Will France use the Armenian and Cyprus questions as an excuse to sabotage the negotiations? During the Paris Conference that took place in 1856, soon after the Crimean War, the major European powers admitted the then Ottoman Empire into the Council of Europe, promised to consider it a member of the family and furthermore undertook to guarantee its territorial integrity. None of these assurances were worth the paper they were written on and none were adhered to.

Mustafa Balbay, Cumhuriyet Newspaper, 30 June 2004. Necip Hablemitoglu, German Foundations and Bergama Case, Toplumsal Dnm Publications, 2003.

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PART III: FINAL REMARKS: Since the Helsinki Summit in 1999, one can see the influence of Turkish democratization reforms on TFP in such issues as Turkey-Greece relations, the ESDP and Cyprus negotiations. It is clear that Turkey is using peaceful political dialogue in solving its disputes with other democratic countries more often than before. However, it would not be correct to explain these developments by arguing that countries with strong democratic systems tend to employ more peaceful measures in trying to settle their disputes with other countries. In the domestic sphere, many reforms were carried out by politicians on the pretext that they improved the daily lives of Turkish citizens and contributed to the westernization of the country. Erdogan, the current Prime Minister, was previously convicted for thought crimes in expressing his Islamist opinions and he was anxious to avoid any repetition of that situation. However, it is doubtful that Turkeys democratization per se triggered a more compromising foreign policy attitude especially when dealing with other democratic countries. The problematic economy and the increasing desire to join the EU in order to introduce democratic reforms and to stabilize the economy made Turkey vulnerable to European demands and led to its more compromising attitude towards some issues. In other words, Turkish flexibility regarding Cyprus and other matters was as the result of political compulsion more than anything else. Seen in this light, democratization as taking place within the context of Turkeys Europeanization process and not the democratization process per se can explain some of the developments in the TFP that we touched upon. In the declaration issued by the Dutch Presidency last December, the 78 negotiation process for Turkey has for the first time in EU history- been classified as an open ended process whose outcome cannot be guaranteed beforehand. Hence the form of Turkish accession is still awaiting clarification. The so-called negotiating framework agreed upon on 3 October 2005 has actually made matters worse in this respect by placing an even stronger emphasis on the absorption capacity of the EU at the time when negotiations are finalized and Turkey fulfills all other obligations. It remains to be seen if the Europeans will ultimately try to exploit such uncertainties in their commitment in order to offer some form of privileged partnership to Turkey instead of full-membership. The future political developments that will take place within the EU structures are likely to have a big impact on the nature of Turkeys eventual integration with the Union. Attempts to deepen the political integration within the EU and to make the EU a global power suffered a big blow following the referenda that took place in France and the Netherlands in May/June 2005. The future direction of the Union cannot be predicted with certainty. Will European politicians be able to overcome their differences and revive the momentum for a deeper political integration? Will the EU become a two-tiered system where one group of states will pursue deeper political and military integration with each other while the rest refuse to follow their example? Will political fragmentation preclude the EUs evolution into anything more than a freetrade zone? So long as key political elites (especially those in France and Germany) continue their ambitions to make the EU evolve into a superpower, Turkeys prospects for full integration to the EU will not be high and integration

TURKEY INTO THE EUROPEAN UNION: PAST CHALLENGES AND FUTURE PROSPECTS

with a privileged partnership status will continue to remain the most likely scenario. I consider any fundamental changes in the senior European politicians ambitions in the short and medium term a distant possibility. The December 17 decision to commence the accession talks is an important opportunity for Turkey. A negative decision on December 17 would have demoralized the people, destabilized the economy, and the AKP an unnatural conservative-liberalnationalist coalition would have started disintegrating immediately like the late zals ANAP almost. As journalist Cengiz Candar put it, Copenhagen Criteria would be replaced by Mamak Criteria (meaning military) instead of Ankara Criteria64. Adopting 110,000 pages of EU acquis as its internal law would help Turkey turn into a modern country in every field even if it does not join the EU in the future. Turkey will need to come up with the tens of billions of Euros needed to adapt its industry and economy to the EU norms. The 9 billion euros likely to be offered by the E.U. until year 2013 may not be enough to enable Turkish governments to implement the environmental or structural reforms necessary to conform to the E.U. requirements during the accession talks. All of these issues are as important as accession to the EU itself. To ensure the continuation of the negotiation process in the most favorable manner for as long as possible, Turkey must continue its dialogue with, and seek even greater support of, countries like the United Kingdom. This uncertainty regarding the final outcome of the accession talks may
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affect Turkish willingness to compromise over contested disputes in the future involving the Cyprus, the Aegean Sea, Northern Iraq and claims based on the so-called Armenian Genocide. Also, this uncertainty, combined with painful economic reforms that may be demanded by the EU, might cause the Turkish public to turn away from the idea of EU membership. What impact, if any, changing Turkish public opinion can have on the attitudes of the ruling politicians or the Kemalists remains uncertain. However, many may perhaps correctly assume that the start of negotiations means that Turkey will firmly remain within the EUs orbit and that the political and economic costs of attempting to leave this orbit due to disagreements will be very high. Suffering from an 11% unemployment rate, chronic debt, and a big trade deficit problem, Turkey needs foreign investment to solve its economic and social problems and seeking EU membership is the key. Since the December 2004 decision, more and more international banks have started rating Turkey as a place where investments can yield good returns65. All these vulnerabilities can subsequently weaken Turkeys bargaining powers and resistance to certain EU demands. The December 17 decision will also arguably help the Turkish people feel psychologically more secure in the short term while the Middle East, the Caucasus and Central Asia continue to go through a period of turbulence. What the future will bring remains to be seen.

D.B. Tercman Newspaper, Dec. 18, 2004. Between December 2004-October 2005, the national stock exchange index rose by about 50%, the US $ exchange rate remained fairly stable and the government broke the previous years records by making privatizations that yielded about US $20 billion. On 6 October 2005, 3 days after the start of negotiations the Prince of Dubai announced his plans to invest US $ 5 billion in Istanbul.

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VOL. 6, NO. 1, 2006

WHY LEGAL TRANSPLANTS INSTEAD OF MORE ADAPTATION WITHIN THE PROCESS OF LEGAL APPROXIMATION IN THE CENTRAL-EASTERN EUROPEAN MEMBER STATES OF THE EU AND THE CANDIDATE COUNTRIES?
MNIKA JZON1
Abstract: The paper discusses the strategy of the EU in designing and implementing the legal approximation process in the candidate countries, on one hand, and the possibilities and constraints of the candidate countries in framing this process under their domestic conditions, within the European context. It questions, whether could have been feasible other alternative strategic solutions both for the EU and the candidates for achieving a less costly and more effective functional compatibility between the conditionalities of the candidates and the integration mechanisms of the EU? At the very heart of the problem there are the function of law, in general, and the function of legal approximation or other methods of legal unification of market regulations, in changing market conditions. In this context the analysis defends a strong case for the interdisciplinary research of the effectiveness of the legal-institutional approximation process highlighting the limits of market regulations in generating convergence of the market conditions and institutional culture. INTRODUCTION There are many unanswered questions concerning the effectiveness of the legal-institutional approximation process in the CEE candidate states, the Member States of today, although at the moment of their accession, the EU considered that there was functional compatibility at systemic level among the economies, legal systems and institutional frameworks of the candidate countries and the rest of Member States. Thus, we tend too much simplistically to consider that the legal approximation process as such has been completed, subject to the commitments undertaken in the accession treaties by the candidates to further improve effectiveness. The central question is whether the very same market regulations do produce in the new Member States the same market outcomes as in the western European Member States, in spite of the differences in market conditions, legal culture and institutional culture. One may ask the same question in many different ways, depending on from whose point of view the process is assessed, each defending its case according to its own methods and interests. The issue of effectiveness of legal approximation has therefore different meanings and values (i) for the Western European private sector, (ii) for the domestic

1 Dr. Mnika Jzon, LL.M is Junior Associate Professor at Sapientia-Hungarian University of Transylvania, lecturing EU business law and international trade law. She participated in various EU funded technical assistance projects aimed at justice reform in Romania. Her research expertise focuses on law & economics of EU enlargement. (jozonmonika@sapientia.siculorum.ro)

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undertakings of the new Member States, or (iii) for the other domestic social groups being affected by the approximation process, all tending to consider the consequences of legal approximation almost exclusively from point of view of micro-efficiency. The (iv) domestic political decision-makers, (v) regulators, (vi) and the judiciary view effectiveness from different political and social angles, more embedded in social-justice considerations and macroeconomic interests, (vii) whereas for the EU institutions the success of the process is assessed mainly in relation to its benefits for trans-national trade creation. The approaches and the results of the assessments can thus be very different, even conflicting, although the regulatory aims and purposes of the EU legislation that has been transposed into the domestic legal system of a Member State are clearly defined in the text of the Internal Market regulations and by the subsequent interpretations of the EU institutions and the European Court of Justice. However, EU laws are implemented in the Member States and are affected by the domestic environment, and therefore the issue of effectiveness of the Internal Market regulations manifests both intrinsically and extrinsically, at the level of legal compliance, implementation and enforcement. The Internal Market regulations have different functions at micro and macro-economic level than the domestic market regulations; they promote different market and nonmarket values and therefore they may give raise to conflicts between the transposed Internal Market regulation, the domestic legal framework and sectoral policies. Domestic and European regulatory policies are

continuously confronted by heterogeneous interests and preferences, from both domestic and European level. Such incompatibilities are thus not a typical Central-Eastern European problem, which appeared or became acute in the context of Eastern Enlargement. It is outstandingly important to clearly delimit in relation to the effectiveness of the pre-accession process and the costs of Eastern Enlargement, what the consequences of the conditionality of the new Member States and/or of their political and regulatory failures are. On the other hand, it should be also acknowledged the limits of the preaccession instruments of the EU and of the integration instruments, in general, in promoting economic, legal and institutional convergence at European level. Lawyers society finds itself inbetween these competing interests and diverging developments when trying to assess the regulatory values of the EU type market regulations at domestic and/or at a wider European level, according to legal criteria. The question of assessing effectiveness of harmonized domestic market regulations in the context of European integration and Enlargement becomes increasingly complex, because during the preaccession period the quality of legal approximation was assessed according to the accession conditionality; approximation was treated by the domestic policy makers as an external conditionality, and as a predominantly political question, rather than a complex economic-legal-social undertaking. The EU as well, measured the achievements of the candidate countries predominantly from a legislative and institutional point of view and less on the basis of a functional approach, 81

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although the concerns regarding the low effectiveness of implementation and enforcement of the approximated legislation was constantly present in the Regular Reports of the European Commission. However, the EU never provided the candidate countries with a clear set of criteria for assessing effectiveness because effectiveness of legal transposition, in terms of implementation and enforcement was not assessed in the Member States. There is no best practice in this regard concerning the Member States or instruments of monitoring, except the judicial review by the European Court of Justice in case of breach of community obligations by the Member States. The result of the pre-accession legal-institutional approximation processes is the creation and strengthening of a strong regulatory state, whereas the other forces, the private sector and non profit sector, which also shape the European regulatory policy and reception of regulations at national level, did not develop sufficiently and were not actively involved in the process of designing and implementing the legislative approximation strategy during the pre-accession period in the candidate countries. By accession the expectations of the European institutions suddenly have changed. The approximation process is assessed upon market values, that of transnational trade creation, and not from the point of view of the commitments or/and achievements undertaken by state authorities. The place of political instruments, which have been proven so efficient in pursuing legislative, administrative and judicial reform in the candidate countries, is now taken over by the community principles and legal 82

instruments that assure legal compliance by state authorities, undertakings and citizens of the Member States. From EUs viewpoint the effectiveness of the legislative approximation process is assessed in terms of economic efficiency considerations, namely whether the community law and the national law are being applied in such a way as to abolish the non-tariff entry barriers on the domestic markets of the new Member States. Effectiveness is measured in terms of regulatory costs that the market regulations, as applied by the implementing and judicial authorities, involve for the undertakings of other Member States under trade liberalization. There occurs, upon accession, a shift in qualifying the very same achievements of the pre-accession period from a political-legal-institutional approach onto an economic one, and from a formal assessment onto a more functionalist one, while the instruments of monitoring and sanctions change as well. Therefore, in the new Member States soon upon accession it should occur a paradigm shift concerning the regulatory values of pre-accession preparation process and the effects of the pre-accession strategy at domestic level. In this context there is a constant debate about the issue of legitimacy of the pre-accession strategy from the point of view of both the EU and the candidate countries. Integration theorists and the private sector in the former and new Member States often question in relation to the costs of approximation and its socio-economic consequences whether it was the right approach to simply transplant the EU laws into the domestic economic, legal and institutional environment of the

WHY LEGAL TRANSPLANTS INSTEAD OF MORE ADAPTATION WITHIN THE PROCESS OF LEGAL APPROXIMATION IN THE CENTRAL-EASTERN EUROPEAN MEMBER STATES OF THE EU AND THE CANDIDATE COUNTRIES?

candidate countries, instead of a higher degree of adaptation of the regulatory solutions to the domestic conditionalities of these countries. Accusations for copying because of imposed external conditionality are often used by EUskeptics in criticizing the preaccession process. But would there have been feasible other alternative strategic solutions both for the EU and the candidates for achieving a less costly and more effective functional compatibility between the conditinalities of the candidates and the mechanisms of the EU? This paper discusses the strategy of the EU in designing and implementing the legal approximation process in the candidate countries, on one hand, and the possibilities and constraints of the candidate countries in framing this process under their domestic conditions and within the European context. At the very heart of the problem there are the function of law, in general, and the function of legal approximation or other methods of legal unification of market regulations, in changing market conditions. Thus, the process of legal approximation shouldnt be viewed as an aim in itself, but as an instrument, which has context related outcomes. Both the European law and the domestic legal systems of the Member States, as a consequence of its effects in framing the principles, concepts and institutions of the domestic legal institutions, through its formal and informal rules (soft laws), demand interdisciplinary assessments. The assimilative capacity of a legal culture is so much bound to the economic conditionality of market regulations, and economic integration is so embedded in the political culture of the Member States that comparative

legal studies are no long sufficient for legal framework assessments when effectiveness of a certain solution is at stake. The rules and principles of legal interpretation need reconsideration and openness for the solutions of European integration studies of economics, sociology and political sciences. Legislative techniques and strategies cannot be assessed exclusively through the spectacles of legal values or social justice either in the CEECs, because the Internal Market regulations and the wider EU law are the result of mostly micro-economic considerations and goals, unlike the traditional fields of private law in continental Europe. In such a context the debate on the positive and negative effects of transplant of foreign solutions into the legal system of another country and the issue of adaptation must go beyond the instruments and tools of comparative law, and should handle the issue of effectiveness from an interdisciplinary point of view, at least a legal-economic one. The reverse of the problem is true, as well. From the point of view of economic analysis, regulatory costs assessments should also go further than the classic assumptions of international economics, which states that enacting uniform laws would necessarily bring to less transaction costs, economies of scale, and significantly reduce asymmetric information and externalities. This is true from a micro-efficiency point of view, but not in general, and for all legal fields and for all Internal Market policies, and especially not if we consider that location decisions by undertakings are taken upon a complex assessment of the costs of regulations and together with the rest of 83

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competition factors of the specific market. The cost of regulations is only one component of market entry costs. Therefore, the effects of the very same EU type market regulations may be strengthened, weakened or even annihilated by the socio-economic and legal institutional environment in which they are implemented, regardless of the community instruments that assure uniform application of the community law. Accordingly, the cost of harmonized regulations will vary depending of the costs of legal compliance, market surveillance and legal enforcement of the specific market. Thus, effectiveness and EU compatibility are not inter-changeable, in debating the issue of transplant versus adaptation. Effectiveness of the EU law in the new Member States bears the consequences of the approximation process before accession. The consequences of the voluntary approximation and over-performance are irreversible not only for the new Member States, but also for the future of the regulatory policy of the Internal Market. The community instruments can hardly remedy regulatory or political failures from both sides. Therefore, this paper starts the debate on the issue of legal transplants by analyzing first, in Section 1, the specific nature of legal approximation in the candidate countries in comparison with the process of legal approximation in the EU, looking for reasons (legal technical and legal policy) in understanding the preaccession policy of the EU concerning the candidate countries. Section 2 debates the legislative technique of legal transplants from the point of view of comparative legal theory, and highlights the limits of legal 84

approximation in changing market conditions and legal cultures in the context of European economic and political integration, in general, and within the conditionalities of the CentralEastern European Member States, in particular. SECTION 1 The characteristics of the legalinstitutional approximation process in the CEE candidate countries As argued in the introductory part, from a comparative legal point of view, it is difficult to assess effectiveness, because the Internal Market regulations shouldnt be reduced to a pure legal point of view assessment, since they require a multidisciplinary approach, which needs to combine legal, economic and policy assessments, and because the assessment criteria of the EU cannot be viewed from a pure legal point of view either. The comparison of the regulatory strategy of the EU on legal approximation in the candidate countries should start with a review of the regulatory policy framework of the process from both the standpoint of the candidates and the EU. A closer look at the pre-accession strategies of the candidates and the EU regarding the legal-institutional approximation shows that in fact the approaches converge in their legal policy considerations. Both treated the legal-institutional reform from the point of view of strong political consideration and of political internalization, which had specific costs and benefits for both parties. The EU assessed the legislative activity mostly in terms of the formal compatibility of laws in comparison to what was the best practice in the EU Member states,

WHY LEGAL TRANSPLANTS INSTEAD OF MORE ADAPTATION WITHIN THE PROCESS OF LEGAL APPROXIMATION IN THE CENTRAL-EASTERN EUROPEAN MEMBER STATES OF THE EU AND THE CANDIDATE COUNTRIES?

and not in their market outcomes and social outcomes in the specific context of the candidate country. Effectiveness of institutional reform was limited to the setting up of such institutions which had similar competences as those implementing community policies and rules in the Member States. The regulatory policy commitments of the candidate countries governments prevailed and not the temporal effects of the legislative and institutional measures. The Copenhagen criteria of accession were assessed upon a piece meal basis, and not in their interaction. Although general in its wording, the criteria indeed aimed at pursuing the candidates towards a functional approach. However, this was mostly marginalized by the candidate countries. Thus the EU is not to be blamed for the regulatory failures of the candidate countries. The domestic political interests, driven by the domestic political and legal culture, which was more or less similar in the candidate countries, turned the process of voluntary approximation into a formal and not functional process, which was not the EUs approach. The Copenhagen criteria clearly mentioned the capacity of the candidate countries to cope with the competitive pressure coming form the Internal Market. However, it seems that for the candidate countries transplants proved to be less costly and more comfortable.
2 3

Gradual adaptation, in cases where it happened, caused more costly subsequent social and political compromises. When transmigration occurs and elements from different internal logics come together2, differences are as to structure, substance or culture.3 The political reputation of donor, the desire to belong to or to harmonize with a particular group, or ease of access are casual factors that seem to determine the pattern of transmigration of legal ideas and structures.4 This factor was the strongest in shaping the speed and context of the legal approximation strategy in the candidate countries. Evans says that force exerted by a foreign model on domestic policy can be two fold: push and pull and that in the context of relation between the Community and third states in Europe, the force seems to be of both kinds.5 The third state is pulled by its desire for closer relations with the Community and is pushed be its own traders who see voluntary harmonization as essential for easing their access to community market. 6 Legitimacy and acceptance of an un-adapted solution is easier to achieve if presented as an external conditionality than that of an adapted solution, which would have satisfied multiple or even contradicting domestic preferences. From the point of view of domestic acceptance of the approximation process and preferences

E. rc Internal Logic of Legal Cultures (1987) 7 Legal Studies, p. 310 E.rc, Law as Transposition, in International and Comparative Quarterly, vol. 51, April 2002, p. 212 4 F. Schauer, The Politics and Incentives of Legal Transplantations Law and Development Paper No2, CID Working Paper No 44, April 2000, Center for International Development at Harvard University, at 8-12, http://www.cid.harvard.edu/cidwp/044.htm 5 A. Evans, Voluntary Harmonization in Integration between the European Community and Eastern Europe, (1997) 22 El Rev, p. 202 6 Ibidem

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related to the legal reform process, this option definitely caused less political costs than adaptation. However, the cost of transplant for the private sector and non-profit sector were much higher than harmonization by more gradual adaptation. This is especially due to the short time-length, speed of approximation, and often the lack of adaptation period to for those regulated and those being affected by regulation to prepare. Unlike at EU level, where in case of directives, there use to be a periodical reassessment of the effects of the common regulatory solutions, and at a three dimensional basis (private sector, nonprofit sector and state administration), we can not find in the legislative approach of the candidate countries a correspondent approach. Even so, though, the high political costs of the legal and institutional reform in the former candidate countries in CEE shows that has been extremely low the capacity of governments to successfully transpose the accession conditionality into domestic micro and macro economic goals, in promoting those reform needs which regardless of EU accession would have been needed to be implemented. From the point of view of the candidates it seems that transplants without adaptation were the most feasible strategy from financial and political point of view. Not the legal, but political arguments prevailed in the approximation strategy, in defining the terms of sequences and timetable of transposing the acquis into the domestic legal system. The legal doctrine did not have time to develop before the entering into force of the transplanted EU laws and the implementing and enforcing authorities

did not have the time to develop the necessary skills. The effectiveness of the harmonized rules in the new Member States was also influenced by the transplant approach in other areas of legal reform, not affected by the acquis. The general legal reform in these countries evolved mostly along the traditional line with the main continental legal families, either the French law (as in the case of Romania) or German/Austrian law (in case of Slovenia, Hungary, Poland, Slovakia, Czech Republic) but there were borrowed legal solution from the best practices of the specific legal field, even from other legal families and some times from Common law. The legal institutions specific to business law in these countries were not generated and designed by the specific regulatory needs of their markets. However, the fact that the legal systems of these countries are no longer so purely embedded in the national legal culture has two-fold consequences on the effectiveness of harmonized rules and EU norms, if we consider implementation and enforcement. On one hand, these economic laws are not so homogenous, and thus it should be expected that they are more flexible to changes that economic and market developments require. However, it shouldnt be ignored that at the level of enforcement and administrative implementation there is a contrary trend because the development of administrative laws and procedural laws and practices in these countries are far behind the developments of substantive law, especially that of business law.7

7 M.Jozon, `Market Integration on the enlarged Internal Market: the costs of market entry and the level playing field in the Central Eastern European Member States Conference Paper presented at the International Conference The Wider Europe: Institutions and Transformations Kyoto University, November 24-26, 2005, p. 8

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On the other hand, the legal systems of the new Member States are less responsive to the economic and social regulatory needs than the legal systems of the Western European Member States, as the legal solutions are not always created by the domestic regulatory needs.8 Legislative approximation in the candidate countries was very different from the process of harmonization in the Member States. We may state that the paradox of legislative harmonization in the candidate countries is that it was deeper and at the same time more superficial than it is in the Member States of the EU. Harmonization was more extensive because of the sources of EU law, which have been transposed into the domestic legal system of the candidates and the field of application of the harmonized rules. The harmonization process in these countries include the provisions of primary law, directives and regulations, as well as the soft laws and even some of the definitions and principles developed by the case law of the Court of Justice and the doctrine on EU business law. The candidates transposed these rules as substitutes for domestic rules, and these rules are applied also for pure internal matters. This is the reason why harmonization in these countries may be considered more intensive as in the EU. Thus, as a result of the legislative harmonization with the acquis communautaire, the domestic legal systems of these countries are far more Europeanized than the laws of the rest of Member States. The impact of EU law on the regulatory reform of the new Member
8 9

States is without precedence in the history of the EU. 9 The effect of the transplant approach is strongly reflected also at the level of the preparation of the implementing authorities and courts for the EU-conform interpretation and application of the harmonized rules. The trainings as well could be characterized as transplants. The assessment criteria of the EU and preparation of the implementation authorities and courts mostly focused on the political criteria, strengthening independence and quality of the management. The main problem with the courts capacity in correcting regulatory failures and assuring the systemic compatibility of the EU laws with the rest of the domestic legal framework is that during the preaccession period the administrative authorities and courts were less trained for how to understand and interpret the acquis within the domestic legalinstitutional context. The context related training was missing from the technical assistance projects, although a high number of local experts were continuously involved in the process. Thus the skills required, in order to apply the EU law or the approximated national laws in such a way as to be compatible with the specific regulatory aim of the community regulation were not sufficiently developed. This can only partially be attributed to domestic regulatory failures, because even in the EU, in the case of former Member States, the process of developing uniform executive and enforcement practice was a long lasting process. Internalization of the transplanted rules will be a long lasting process also

Ibidem M.Jozon, The Enlarged EU and Mandatory Requirements, European Law Journal, Vol. 11, No.5, September 2005, p. 554

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in the new Member States, as it still is in many other Member States. However, the processes differ in many aspects, mainly because of the institutional culture inherited and because of the interaction between the state organization and market. It is questionable how far legal approximation and the community principles and mechanisms assuring uniform interpretation and application of the community laws and policies may change the state administration. Legal and institutional approximation didnt succeed even in the founding Member States of the European Economic Community to produce the same types of capitalism and market economies. Then it would be unrealistic to expect that this may happen or happened in the new Member States during 10-13 years of legal approximation. Market regulations have limited effects on state administration, hence the state administration is strongly culture embedded, and historically defined. Politics driven institutional, legal and economic issues can be changed easier by regulations and laws than those deeply culture embedded or strongly economic driven. The reduction of barriers, or different government interventions on the market, has highlighted the importance of the different socio-economic structures in which markets are rooted.10 However, in spite of the values and costs of transplants different legal solutions may converge intrinsically or/and extrinsically even inside different national legal systems, led mainly by three factors: a) market forces under trade liberalization may pursue
10

diverging national regulatory preferences in the same direction, b) court practice, c) political factors, external conditionality. However, the social forces (private sector and non profit sector) which contribute to the legislative and economic strategy making related to integration, work differently in the new Member States and candidate countries than at EU level or in the Member States. The private sector and nonprofit sector was not actively involved in the pre-accession strategy and is still weak to have a balancing role at domestic level or on the European scene to contribute in the depolitization of the legislative and integration related policy and legal process. These differences have two-fold effects on the future regulatory policy of the Internal Market, because they may restore the imbalance between market values and non market values/social justice which has been increased by the market creation considerations, promoted by the private sector, strongly represented in the European law making process. However, the risk for political decision failures and regulatory failures were much high than in the Member States of the EU and thus an adverse effects evolved. Last but not least, it is worth to mention in this context that as the legislative policy of the candidate countries focused strongly on the transplant of the EU laws, they little dealt with the developing and strengthening of the national capacity to successfully defend domestic regulatory solutions by invoking upon accession

C.G. Molyneux (1999) The Trade Barriers Regulation: The European Union as an Active Player in the Globalization Game , European Law Journal, Vol. 5, No.4, December 1999, p. 378

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the exemptions granted by the EC Treaty or those developed by the European Court of Justice. This also means that the strengthening of the capacity of the private sector to cope with the competitive pressure of the Internal Market supposes such a domestic regulatory approach, which fulfils four requirements. Domestic regulation should be compatible with at least one of the aims promoted by the Treaty and should stand the test of proportionality, and should be convertible into the regulatory values of the other Member State in order to be acceptable under the principle of mutual recognition.11 Different cultural and social values may generate different regulatory needs for the market as it has been argued above. In addition, the new Member States also have to learn to assess the market function of foreign legislation in order to avoid infringement of Article 28 EC by imposing double burden on the foreign product. This is a tremendous task not only for the legislative, but also and especially for the executive and judiciary.12 Over-performance and transpositions without constructive criticism and adaptation (even ignoring the room given for adaptation by the EU law) during pre-accession does not necessarily mean that the new Member States will act as promoters of further approximation in the EU, after the incentives of getting membership have disappeared by their accession. Legal compliance by the private sector and state institutions in the new Member State may thus be lower because the effects of the community legal instruments than was as a result of the
11 12

political conditionality and political instruments on which the relations between the candidates and the EU institutions were based during preaccession and which were effective in the given context. Transplants have costs for both the new comers and the former Member States, especially for the private sector. However, the costs of nontariff barriers which continue to exist on these markets, in spite of approximations, because of the difference in administration and enforcement practice, will be less significant for location decisions of foreign undertakings, if compared to the rest of competition factors of these markets, such as the competitive structure of the markets, labor costs, taxation. For the domestic private sector, however, the transplants imply much higher regulatory costs than for the foreign undertakings acting on their domestic markets. They will have costs, political and regulatory costs, also for the EU, because a functional approach in the political culture of those domestic regulators and political decision markers, which participate in the EUlevel law and policy-making process will evolve slowly. From the point of view of the EU, transplants were easier to control, and to assess in comparison with the best practice in the Member States and easier to impose as external conditionality. The EU opted in fact for a customary legislative policy approach, based on the specific dynamism of laws and the social reality they regulated. In some instances governments and supranational organizations intervene in the functioning of the market by

M.Jozon, The Enlarged EU and Mandatory Requirements, p. 564 Ibidem

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adapting rules to the specific regulatory needs, whereas in other instances the laws are enacted to precede and promote certain market developments. Given the sharp differences between the state of market economy development and the state of business law reform in the CEECs, at the moment, when the legal-institutional approximation has started, first under the umbrella of the Association Agreements, and later under the Copenhagen criteria, transplants were the most efficient solutions for deregulation and depolitization of the economy. The question remains: whose information asymmetry affects more the transplant approach, of the insiders or of the new comers? There are no losers and no winners in this process, because harmonization itself generates a different type of legal-institutional diversity that is new for both the western European and Eastern European Member States. The costs of the harmonized laws and of the EU laws having direct effect and direct applicability definitely will stay for a period as non-tariff market entry barriers. The very same Internal Market rules generate different market outcomes, and a different type of level plying field on the Central Eastern European markets. Differences are the result of the institutional culture, which laws cannot change, and of the assimilative capacity of the economies of the new Member States. Legal

harmonization by legal transposition or legal transplants may be viewed also as a natural monopoly in the EU.13 There are also such views in the legal-economic literature on EU enlargement, which question whether an approximation of law is necessary for making enlargement profitable for the EU? They argue that there are neither necessary nor sufficient conditions for It has making enlargement work.14 been also argued by this line of thoughts that though would also reap benefits from an approximation of law without immediate enlargement, these benefits might be smaller than those from allowing countries to become new members, even if they not perfectly adopted the acquis.15 SECTION 2 The standpoints of comparative legal theory on legal transplants Legal borrowing is not the exclusive domain of legal approximation in the context of EU Enlargement. A closer look at the legislative developments of the 19th and 20th century both in the continental and oversee countries shows that most of the national legal solutions were developed in other legal systems, or even completely different legal families. The EU law itself has borrowed legal institutions from the American law, the most successful undertakings in this regard being competition law and products liability. Legal systems, including the CentralEastern ones have thus

13 On legal culture as legal monopoly see A. Ogus, Legal Culture as ( natural?) Monopoly, in The Economics of Harmonizing European Law, Eds. Alain Marciano, Jean-Michel Josselin, Edward Elgar Publishing, 2002, pp. 77-84. 14 D. Schmidtchen, A. Neuzig, H.J. Schmidt-Tenz, Enlargement of the European Union and the Approximation of Law: lessons from an economic theory of optimal legal areas, in The Economics of Harmonizing European Law, Eds. A. Marciano, J-M. Josselin, pp. 235-236 15 D. Schmidtchen, p. 235

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developed their culture specific assimilative capacity, which only to limited extent may be influenced by external conditionality. It is worth to consider in this context how far the EU law has succeeded to become internalized by the legal culture even in the founding Member States; or whether integration requires such internalization, whereas the EU law is not a substitute of the domestic legal system but coexists with the domestic laws and institutions. Legal culture is defined as those historically conditioned, deeply rooted attitudes about the nature of law and about the proper structure and operation of a legal system that are at large in the society.16 It is true that under certain conditions, a dominant legal culture may properly be regarded as a natural monopoly. That, of course suggests that while its existence may be tolerated, its adverse effects should be controlled.17 Legrand defines legal culture as the framework of intangibles within which an interpretative community operates, which has normative force for this community and which, over the longue duree, determines the identity of a community as a community18 When applying this definition for the context of the effects of EU law on domestic legal culture, we should observe first that the EU law does not define the European citizens or the business sector acting on the Internal Market as a community. There is no

such community because there is no EU identity. Thus, the very essence of the relationship between the domestic legal culture in the new Member States or in the candidate states and the acquis that has been transposed into their legal system is not a typical Central-Eastern European problem, but a Europe-wide phenomenon that manifests more or less similarly in every Member State. In spite that a certain legal solution is borrowed without any change, it should not be ignored that law does indeed move, connect, disconnect, change and contribute to change.19 Therefore, the problem of adaptability should not be overdimensioned as it happened in the context of Eastern Enlargements, either because of legal policy and political considerations, or from point of view of legal theory. Legal theory, especially in the CEECs, provides us only half answers for how to achieve better quality regulations and laws, and how to deal with the issue of effectiveness, because legal theory reasoning views the regulatory value of a certain legal provision outside of its socio-economic context and on the basis of the traditional private law approaches, which focus on those regulated, and not on the effects of a specific legal institution on those affected by the specific legal solution. It will be a tremendous task for domestic regulatory decision makers to marry the political and social-justice arguments with the

16 J.H Merryman, D. C. Clark, Comparative Law: Western European and Latin American Legal Systems (1978), p. 29 17 A. Ogus, p. 71 18 P. Legrand, Fragments on Laws as Culture (1999), cited by Ogus in Legal Culture as (natural?) Monopoly, p. 75 19 E. rc, Law as Transposition, in International and Comparative Quarterly, vol. 51, April 2002, p. 205

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pure economic efficiency regulatory aims of the EU laws in developing effective administrative and court practice at domestic level, as well. The arguments of comparative legal theory as well oscillate between extreme views, which are suggestively manifest at the level of the terminology. We find in the legal literature on legal culture and legal transposition terms as legal irritants, implantation, infusions, contaminants, and legal transplantation.20 The debates either defend the values of transplants, or marginalize them. In the context of globalization and European integration, the choice of borrowing and that of how borrowing is no longer a pure legal policy matter. If, in relation to the legal reform measures the risks of regulatory and political market failures are high, if the market dysfunctions have high externalities, the sources of which is rather political than of economic nature, then borrowing legal solutions and exploiting external conditionality in favor of transplants by avoiding domestic pressures and preferences, may drive to a higher quality regulation. All this is true if the borrowed market regulations have an adequate economic policy background. The economic policy reform in the candidate countries has evolved much slower and more exposed to the pressure of political and social interest groups, and, therefore, it worked in many cases as counterforce for legislation. Typical example is the case of state aids regulations, because of industrial, fiscal, and social policies of the candidate states were not on line with the regulatory aim of the EC competition policy and EU law on state
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aids. In other cases, as well, the cause of weak implementation and enforcement is to be found not in the legislative technique and the suitability of legal transplants to achieve the same regulatory outcomes as have been settled by the regulatory needs and legal policy preferences of the system which has developed the legal solution, but in the economic policy and political environment of the recipient legal system. Nevertheless, the comparative legal theorists, besides this political conditioning should not ignore that the dynamism of market development generates multiple regulatory needs and legal solutions, regardless of externally imposed regulatory policy developments, as the result of the nature of economic influences that shape the market and the domestic economy under trade liberalization. The informal rules brought into the domestic legal-institutional culture by the foreign market actors acting onto the domestic market, may also have strong influences on the domestic legal compliance culture. Thus, law in context, whether as transplanted or adapted legal solution, will manifest differently, also as a consequence of the informal rules which govern business culture and which determine state institutions to develop surveillance and control mechanisms suitable to achieve the best result in implementation and enforcement of formal rules. Artificial transplants are followed by a natural assimilation of the laws, which first are modeled in their effects by the business culture, and then by institutional culture. Both change and evolve along the

E.rc, Law as Transposition, p. 207

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requirements of the new substantive legal solution. Even in cases when the legal institution, which has borrowed from another legal system has also a set of institutional and procedural provisions among the substantive ones, it may still not be able to generate the same administrative and court practice, even if the same types of institutions with same competences are set up, because of the different institutional culture of the recipient legal system is the result of the ways in which state and market interacts. The case of internalization of EU law in the new Member States differs form the case of former enlargements, although in both cases it is mostly a post-accession process, because the other acceding countries had their market economies closer to the level of development of the insiders regarding the institutional structures of the economy, and well-settled business and market regulations. The role of the market actors and other social forces in shaping EU integration strategy was different; their pre-accession strategies were more market led than in the case of the CEECs. In these countries, unlike the CEE candidate states, the internalization started much earlier and during the accession period, because of the more active participation of the domestic private sector in the development of trade liberalization. Internalization of legislation, which defines effectiveness also strongly depends on how difficult it is and how much time it will take to compensate the costs of approximation for the private sector and the society as a whole. The issue of internalization,
21

however, should not be overdimensioned either. Uniform application and interpretation of European law is assured by the community instruments and not because of the internalization of community laws in the domestic legal system. The high number of cases at the European Court of Justice shows that both private entities and state authorities continue to stay bound to domestic legal and institutional solutions. In fact domestic and EU law coexist and subsist. However, the situation in the CEE differs because many EU rules were transposed as substitutes for missing domestic rules, but without being internalized. This can be misleading. This type of internalization, however, is an artificial one that ignores that the community law has a different regulatory function that of abolishing the regulatory costs caused by different national rules under trade liberalization and does not necessarily perform the functions that the same legal institution it has in a domestic economy. National legal solutions, even in the case of market regulations, focus much more on the non-market values in balance with market values. The EU market regulations market values are related to trans-national trade creation, which do not necessarily correspond even to the domestic micro or macro economic regulatory needs. Therefore, we cannot call this internalization. Internalization supposes assimilation of the rule, at the level of its regulatory and socioeconomic goals, which is not the case in such situation when EU laws substitute the lacking domestic legal solutions.21

For more on this topic see: M. Jozon, Enlargement and Mandatory Requirements, European Law Journal, Vol. 11, No.5, September 2005, pp. 549-565

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Law as market integration instrument has its boundaries, which cannot be overruled either by political will or economic developments. In the CentralEastern European new Member States, but also at the level of EU institutions, the expectations are unrealistic concerning the laws power to change legal culture and economic conditions. We experience a so-called optimistic normativism causing high regulatory and political costs. Considering that the regulatory aims of legal approximation are the reduction of transaction costs, which may be caused by the differences in market regulations and administrative practices of the Member States, the central issue regarding effectiveness from the EU standpoint is whether transplants will generate more divergence instead convergence or new divergences. The transfer will always be confronted with the idiosyncrasies of the new legal culture and face resistance external to law, that is variety of social expectations of highly diverse social environment.22 Nevertheless, the effects of the transplant policy and the existing systemic incompatibilities may be diminished, on one hand, by the spill over effects of micro-efficiency gains from the western part of the EU onto the Central- Eastern part, and vice versa, and by the natural convergence of the national regulators that will evolve as the result of trade liberalization. Therefore, after a period of increasing divergence in the first years of enlargement, one may expect an evolving convergence in the CentralEastern European area.
22 23

Therefore, the issue of effectiveness should not be treated from unilateral approaches of legal or economic assessments, which oscillate between either over dimensioning the risks and costs of diversity and differences for the functioning of the Enlarged Internal Market, by handling the costs of regulation outside the socio-economic context in which these regulations, together with the market forces, define the competitive landscape in the new Member States, or by marginalizing the effects of existing differences, by attributing absolute value to market rules in changing market conditions. If legal relationships are seen within the framework of reciprocal influences, that is a series of cross currents rather than as one way movements of contaminants or irritants than on the reverse seepage the legal world at large may benefit and be enhanced by the divergences created in different soils.23 In order for this to happen there are needed pro-active systems which suppose the shift of the Member States from the voluntarily undertaken follower status during the pre-accession period into that of active player, which means searching for and contributing in the development of new common solutions and regulatory approaches, which equally take into consideration the emerging new regulatory needs generated in the reunified Europe by the scale effects of diversity brought into the EU by the new comers and the diverging conditionalities and preferences.

Tuebner, p. 12 E.rc, p. 211

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REFERENCES
A. Evans, Voluntary Harmonization in Integration between the European Community and Eastern Europe, (1997) 22 EL Rev M. Jozon, The Enlarged EU and Mandatory Requirements, European Law Journal, Vol.11, No.5, September 2005 M. Jozon, Market Integration on the Enlarged Internal Market: the costs of market entry and the level playing field in the Central-Eastern European Member States, Conference Paper C.G. Molyneux, The Trade Barrier Regulation: The European Union as an Active Player in the Globalization Game, European Law Journal, Vol. 5m No.4, December 1999 A. Ogus, Legal Culture as (natural?) Monopoly, in The Economics of Harmonizing European Law, Eds. A. Marciano, J.M. Josselin, Edward Elgar Publishing, 2002, pp. 77-84 E. rc, Internal Logic of Legal Cultures, (1987) Legal Studies E. ruc, Law as Transposition, International and Comparative Law Quarterly, vol. 51, April 2002 F. Schauer, The Politics and Incentives of Legal Transposition, Law and Development Paper no. 2, CID Working Paper No. 44, Center for International Development at Harvard University, http://www.cid.harvard.edu/cidwp/044.htm D. Schmidtchen, A. Neuzig, H.J. Schmidt-Tenz, Enlargement of the European Union and the Approximation of Law: lessons from an economic theory of optimal legal areas, in The Economics of harmonizing European Law, Eds. A.Marciano, J.M. Josselin, Edward Elgar Publishing, 2002, pp. 224-240 G. Teubner, Legal Irritants. Good Faith in British Law, on How Unifying Law Ends Up in New Divergences, (1998) 61 MLR

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ROMANIAN JOURNAL OF EUROPEAN AFFAIRS is the first Romanian publication to focus exclusively on the European integration debate and on Romanias role in an enlarged European Union. The publishers warmly welcome submissions of papers. The RJEA comprises mainly articles. We also intend to develop a section of book reviews. The Romanian Journal of European Affairs may include articles that go beyond the scope of European integration topics, but are, nevertheless, intrinsically connected to them. The ideal length of an article (written in English or French) is from 4 000 to 8 000 words, including a 200-word abstract in English or French and a very brief autobiographical note. Book reviews will be no longer than 2 000 words. RJEA is published on a quarterly basis, therefore contributors should consider notifying us of their intention to submit articles as soon as possible (specifying title of the article, name of the author, abstract and a brief autobiographical note). Please send your articles or book reviews before February 1st, May 1st, August 1st and November 1st respectively, so that your contribution may be considered for publication in the upcoming issue. Authors should send notifications, as well as the final and revised version of their articles or reviews in electronic form to ier@ier.ro.

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