1979, the European Monetary System

¶ … 1979, the European Monetary System (EMS) was established to stabilize exchange rates between the participating European countries. After a decade, the Single European Act of 1987 was set to pave the way for a single European market and for a monetary union, known as European Monetary Union (EMU). The Maastricht Treaty, which was signed on February 7, 1992, and came into effect on November 1, 1993. Subsequently, European Union was established. Further, on January 1, 1994, the European monetary institute was established in Frankfurt to lay the groundwork and rules for the European Systems of Central Banks, which is responsible for the general oversight of the preparation of EMU. The European Union (EU) was established with the commitment of economic and monetary union under a single currency and central integration. The Euro, EU common currency, was set to start its circulation in January 1, 2002.

The analysis below will focus on how advances in European enlargement have been impacted by the current enlargement with a specific focus on how the growth environment has been affected. The underlying analysis will focus on how the tenets of enlargement can help to either minimize or increase the threats from a widespread economic the current enlargement that affects every sector of society.

2004 European Enlargement

The Maastricht Treaty set down the economic convergence criteria for participating in the union. A European country must meet the following five economic criteria to convert to the new currency. These criteria are as follows:

1. Price Stability: EU members must show an average rate of inflation not exceeding 1.5% of the three best-performing countries. (Previously was set at 2.6% in July 1996, meaning a country's inflation rate cannot exceed 4.1%).

2. Interest Rate Stability: Long-term rates observed over a period of one-year and should not be greater than 2% of the three best-performing countries.

3. Exchange Rate Stability: Countries should maintain their respective exchange rates within the normal fluctuation margins of the exchange rate mechanism of the EMS for at least two years and avoid devaluing their currency against EU member countries.

4. Public Debt Ratio: The ratio of public debt to gross domestic product (GDP) must not exceed 60% unless the ratio is approaching this value at a "satisfactory" pace.

5. Public Finance: The budget deficit (including central, regional, and local governments) should not exceed 3% of GDP.

There are 11 original EU members. They are Austria Belgium, France, Finland, Germany, Ireland, Italy, Luxembourg, Portugal, Spain, and the Netherlands. Greek failed to meet the convergence criteria because of weak economic performance. Britain voted not to join the EU because of its national reasons. There are additional 15 more countries looking to join the EU in the coming decades, which include the Eastern European nations that previously under Soviet Union's bloc.

In 2004 there was the largest single expansion of the EU with the accession of ten countries: Poland, Slovenia, Malta, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, and Slovakia. Majority of these countries were part of the eastern bloc and this paper will examine if accession to the European Union has increased growth and led to better economic conditions for these ten member states.

TENETS of EUROPEAN ENLARGEMENT & ECONOMIC GROWTH

Democracy promotes privatization and free market economic policies and rejects governmental involvement in the economy. EU and especially newly formed democratic states from former communist countries in Central and Eastern Europe are at the forefront of the democratic movement, as such there are many areas that have been significantly reformed. In the wake of democratic practices, there is major EU restructuring taking place. The major tenets of integration include:-

Stable currency

Balanced Budget

Free market capitalism

Free Trade

European enlargement provides an excellent platform to examine some unconventional effects of the current enlargement. Specific emphasis will be placed on the economic implications of the current enlargement and how this is affects the growth environment. Some examples will be briefly examined to provide an application to the theory being researched and examined and to get a better understanding of how the costs of enlargement weigh against the benefits.

European enlargement is one of the few specializations that can simultaneously analyze a complex issue such as the current enlargement and its economic and political implications of the EU. The analysis will provide some insight into the spatial geographic development within Europe as the issue is examined within the economic context.

McConnell and Brue (2005) argue that there are also some important trends that influence the EU and provide a base for how it is defined:

Economic enlargement/cooperation among nations creates larger markets and expands the demand prospects. With the promotion of free trade areas and formations, it is clear that the global market is becoming more intermingled, and economic implications from enlargements have to be examined differently. This makes it imperative that the growth environment adapt and embrace the economic trends, understand market trends and use this to broaden the customer base.

Growth and identification of competitive advantage means that emerging economies with lower wages and cost of production are effectively competing with traditional production and marketing centers. This has direct implications for economic trends in Europe's growth sector and is derived from neo-liberal policies.

There are various trends in the member states that posit to the fact that EU growth environment is affected by the current enlargement, irrespective of being in such a strong union. Therefore the exploration of EU trends and should be with an explicit application to the growth realm. The factors most commonly cited are:-

1) Shifts in demand characteristics: - Countries are becomingly increasingly dependent on international markets; this has created increased competition on a global scale and has made it clear, that many countries cannot depend solely on domestic demand to boost the economy. It is therefore imperative that EU growth objectives be explored to take this into consideration. This activity is identified as a necessary facet of EU growth environment and will be treated as such in this paper.

2) International Trading Agreements: - Globalization and the free market concept have created an environment that causes economies to be linked. Many states now realize that having a comparative advantage in a sector means that there is a demand and market for that particular good or service, since protectionism is decreasing. Since there is now a market demand, the connection with supply has to be via strategies that can link suppliers and demanders and create equilibrium in specific sectors. This inevitably has serious implications in EU, where this trend is most prominent.

3) Increased Trade Activities: - Global trade activities have been used to leverage exports and imports and balance of trade/payments deficits by many states. Figure 1 below shows a seven-year time series of exports and imports activity for the world.

Figure 1: Percentage Change in Exports and Imports for the World

A similar analysis was presented by Basu and Eichengreen (1991) who argued that globalization promotes privatization and free market economic policies and rejects governmental involvement in the economy. Economies are at the forefront of the global movement, as such there are many areas that have been significantly reformed. In the wake of global practices, there is major international restructuring taking place and the enlargement has inevitably changed the structure of the growth environment for EU member states because of this.

The foreign exchange market prices currencies of one country in terms of another currency. Exchange rate markets can be fixed or flexible. Enlargement like that within the EU, embraces flexible exchange rate regimes, since the price of currencies are determined by market forces and will therefore efficiently allocate resources, (Basu, 1991: 23). The need for a stable exchange rate is also linked to the balance of payments, that is, the goods, services, and capital export and import activities. With linkages across currencies, it is clear that shifts in economic factors, such as limited resources from an enlargement causes wide-spread disequilibrium within EU member states growth markets.

How does the foreign exchange market within the EU relate to the growth environment and the enlargement? Globalization also encourages labor mobility, since labor will move across rapidly areas where there is an abundance of economic resources. One of the consequences of the enlargement and its link to the foreign exchange market has been a shift in the global demand for labor, (Eichengreen, 1991: 12). Labor mobility is an emerging facet of EU growth environment and is of increased importance especially in wake of the migration and changes in labor mobility trends. The movement of people predicates on the rapid acceleration of population movements across borders, which is an important aspect of development. The enlargement changes its dynamic from an economic issue to a social issue by embracing a framework that identifies that labor mobility as an important aspect of EU growth environment. The movement of people is still a very questionable aspect of EU development and its linkages with the foreign exchange market, since there are many questions in relation to what would be a realistic multilateral system for coordinating and managing migration. What kind of regional and international cooperation is needed to respond to emigration pressures in many low and medium income countries within EU? In addition to the existing EU standards on migration, what other measures could be taken at the national, regional, and international levels to better protect migrants? Answers to these questions inexplicitly have direct implications for the growth environment and have become more pressing issues as the enlargement continues.

A balanced budget exists when tax revenues equal government spending. Within the EU, economic policy dictates that efficiency is achieved when the amount of revenue collected by the government is what is spent in a given period. Hence budget deficits and/or surpluses represent a misallocation that can lead to macroeconomic stability within an economy. As the growth cycle within Europe continued and deepened in 2008/2009, it was clear that macroeconomic objectives for all member states became misaligned and inefficiencies in one country led to destabilization in other countries.

Krueger (1991) also mentions that an important ideal of the EU paradigm within the context of spatial diffusion is that many EU countries have now shifted the chain of command related to international issues downward to local governments and provincial levels. "Issues that were under the auspices of the central government such as border control, customs regulations, trade and investment, and infrastructural development have been embedded in local government policy," (Keech. 2114: 23). This is due to the fact that geographic boundaries are blurred in the wake of increased global policies, and local forces have a better understanding of their international economies, and as such can impose the appropriate policies within the region. As such, shifts in economic order such as is typical with enlargements will lead to concentrated strains across all countries that are members of the EU.

Economic policies within the EU, dictates that all aspects of prices should be controlled by demand and supply activity -- free market capitalism. There should not be any government intervention in the market, since markets and prices should act as a signal and allocating mechanism so that efficiency is attained. Overall, this is the major tenet that has affected the spatial diffusion within the EU as the enlargement has caused markets to no longer be efficient allocators of resources, even the signaling role of markets became skewed, which led to growth markets being somewhat disorganized.

Why do nations trade? What is the role of trade within the logic of EU growth environment? According to Barron "EU trade enables nations to specialize in production processes, enhance their resource productivity, and acquire goods and services" (Barro, 2000: 35). Free trade also identifies that the countries are endowed with different levels of natural, human, and capital resources, hence there has to be a process that allows countries to specialize in their relative strengths, while still being able to access gods and products that their relative endowment of economic resources did not allow them to produce. This process is accomplished via economic trade. As such it creates a necessary link of economies across geographic borders, which are a major aspect of the EU development movement within the EU. Expansions of GDP within the EU region have also been linked to the increased financial issues of the region, although these activities do come with a cost to society. Figure 2 below shows how this has had a cyclical effect on the growth environment. That is, there is evidence that the link with EU growth environment can lead to debt crisis, as shown in panel a, but there are negative effects that can lead to deficiencies and increased unemployment. This is represented graphically with the economic tool of production possibility frontiers, where growth in the realm of EU growth environment, refers to the expansion of the societies productive capacity; this however sometimes results in the spatial diffusion of the population which can lead to social issue surrounding poverty and unemployment.

With free trade it is argued that the world economy can achieve a more efficient allocation of resources. Free trade it is stated also benefits countries through the EU transmission of ideas, that is, new processes can be developed and advanced by trade, which can have a positive 'spillover' effect on the economy. Enlargements however remove this noted transfer of ideas and resources and leads to continual disequilibrium which spills over into the growth environment via the production mechanism.

Cole and Kehoe (1996) show that information exchange is an integral aspect of EU growth environment, since it entails the knowledge, management techniques, and production transfer across geographic borders. This spread of knowledge and technology is usually linked to economic development. In fact the push to be more market oriented has created an enlargement of EU forces and players, due to the geographic enlargement of the regions. See figure 3 below to understand the shift.

* Source: Mobarak (2002): EU Development/Global Prospects

EU has the third highest present and projected percentage of population living in cities. EU also has the more increased use of global policies, and as such might have a connection between the variables.

Globalization and Growth Intertwined -- Analysing European Enlargement for NEW MEMBER STATES

Deaton and Miller (1995), argue that the enlargement has shaped the growth performance within the EU new member states. By 2025 it is estimated that, two-thirds of humanity will be living in cities and towns, since global policies seem to push opportunities to these areas.

The enlargement is also perpetuated by the affluent in cities surrounded by deprivation and poverty. This is so because the EU new member states growth environment and its trend towards market economies creates huge gaps between the income levels of individual within a society, which is perpetuated within an enlargement. Hence poverty is no longer restricted to isolated areas, but has become dominant in some of the most prominent cities. The EU new member states development of regions has become somewhat spatial, since there are no longer geographic boundaries to determine economic development in regions, since there has been a tremendous increase in the population due to the necessary adjustment of the economy to global policies.

Enlargement has often been revered as the cornerstone of modern economic development, due to the many benefits and positive aspects of the logic of global policies. Nevertheless, there exist many ideals, ideologies, and assumptions that underline the logic of the growth environment and its effect on EU new member states economic principles. Many theorists state that global polices lead to uneven economic resources, and as such cause a diffusion of economic expansions that are not beneficial to the region and is worsened during an enlargement. In addition, the gains from expansion and efficiency are not easily achieved by all parties or individuals in the EU new member states, since some areas have the capacity to readily utilize the gains from the processes, while others do not. Hence this creates a cycle of disproportionate development within certain regions -- again that an enlargement exacerbates. See figure 4 below for a flowchart analysis of the effects mentioned above.

FIGURE 4: OVERVIEW of EU new member states ENLARGEMENT and GROWTH RELATONSHIP

Figure 4 above shows the major aspects of EU new member states growth environment and its effect on the EU new member states development. The focus lies with both positive and negative aspects of the transition process and how institutions and development handle the enlargement implications.

An econometric model will be used to evaluate how the EU enlargement and economic growth are intertwined for the new member states. The focus will be to examine the traditional gross domestic product equation from an aggregate expenditure model and include a proxy for the countries accession within the EU. The idea is to examine how this enlargement has affected the primary measure of production and output relative to other domestic measures of consumption, investment, government spending, and net exports. The analysis will focus on a cross-sectional analysis in 2007 (three years after the enlargement). The cross section will be of the ten member states from Central and Eastern Europe: Cyprus, Czech, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia.

The econometric model is based on the literature with fundamental principle of how growth is affected by trade flows with the net export variable being the proxy for trade flows and openness of economies -- albeit integration.

The modeling will be based on a similar framework such as Roderick, where the GDP equation is measured with a variable for integration to analyze the necessary link between the variables. The overall GDP equation is measured to get a structure for measuring economic performance and then assessing the role or impact of integration in this setting.

The model to be estimated will be based on the theoretical structure of the GDP economic performance model with measures of consumption, investment, government spending, trade flows, and an integration variable explaining GDP in Europe. The modeling if based on the form:

Y = a + bx, with x ? Rn, a ? Rn, b ? Rn Equation 1

With dependent and independent variables as:

ln (GDP) = ?+?1ln (Consumption)+?2ln (Investment )+ ?3ln (Government Spending)+ ?4ln (Trade) +? Equation 2

The data was extracted from national statistics from the countries and a myriad of tables from the CIA world fact book and the OECD statistics page. The analysis of the regression was via ordinary least squares and all the data was measured in logs to be consistent with the literature estimation of the model. The measure of integration is proxied with the trade variable and all other variables are based on the dollar value of the variable. The regression output for the European GDP model to understand the link between integration and economic performance is presented below:

Dependent Variable: GDP

Method: Least Squares

Date: 04/26/10 Time: 21:38

Sample: 1 10