Varieties, Jobs and EU Enlargement

Abstract

Two key factors that have so far allowed fast growing economies of central and eastern Europe to cope with their external constraint have been I) the presence of relatively low unit labour costs and ii)the initial undervaluation of the exchange rate. The accession to the EU will inevitably reduce both sources of competitiveness of eastern European exports: real wages are likely to catch-up western European levels and current EU members are pushing these countries to enforce labour market and social regulations that will increase labour costs; moreover, stability of the exchange rate will be a precondition for the negotiations over the accession to proceed. Small open economies can grow faster than their neighbours without running into a balance of payment crises if they succeed in increasing the number of differentiated goods produced domestically. The multiplication of the number of varieties in these countries after trade liberalisation is an unambiguous sign that consumers coming from the empty shelves of the pre-transition era have a strong taste for varieties, and hence that new varieties can create their own demand. But the increase in the number of varieties will involve a furthering of the worker reallocation process as production is still largely concentrated in homogenous good and scale-intensive industries and enterprise density is significantly lower than in western Europe. This paper will start by reviewing the changing profile and orientation of trade in transitional economies of central and eastern Europe. Next, developments in enterprise density and the performance of greenfield vs. state and privatised firms will be reviewed in an attempt to assess barriers to the entry and growth of small business. Finally, numerical simulations of a model will be developed which enables to assess the likely impact on employment, unemployment and gross worker flows of reductions in start-up costs.