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SPEECH/ 09/287

Joaquín Almunia

European Commissioner for Economic and Monetary Policy

20 years since the collapse of communism: Progress and priorities for Central and Eastern Europe

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Address at conference: " 20 years after the collapse of the socialist economy: transformation, economic growth and convergence in Poland and other Central and Eastern European countries"

Warsaw , 5 June 2009

Presidents, Governors, Ladies and Gentlemen,

It gives me enormous pleasure to be here to mark 20 years since the collapse of the communist system and the beginning of a new era for Poland and for the countries of Central and Eastern Europe. Indeed, a new era for Europe and the world.

And what better place to commemorate these historic events than here in Warsaw. The determination and courage of the Polish citizens and trade unions blazed a trail for opposition movements across Eastern Europe. Their election victory twenty years ago dealt a symbolic blow to the Iron Curtain. Months later, the Berlin wall was reduced to rubble and a continent was reconciled after more than four decades of division.

Today we are taking stock of the progress made by the countries and in particular the economies of central and Eastern Europe. After 40 years of dictatorship, the task that you faced in 1989 was considerable. The sweeping reforms needed were painful and difficult. So I congratulate those countries that in the space of 20 years have accomplished a remarkable economic transformation. It is a major achievement that today, notwithstanding the global crisis, most of these countries are politically stable and economically prospering.

The European Union has played a critical role in this process. The 20 th anniversary of the fall of the iron curtain coincides with the 5 th anniversary of European enlargement. The collapse of communism paved the way for the biggest expansion in the EU's history. And in turn, European integration has accelerated and reinforced the transition process of Central and Eastern European countries.

In the political sphere, enlargement provided an anchor for stability and peaceful democratic change. It helped consolidate individual freedom and the rule of law and reinforced the protection of human rights.

In the economic sphere, enlargement cemented the virtuous circle of institution building, foreign investment and economic development. I recently presented, on behalf of the Commission, a study on the economic impact of enlargement. The results were overwhelmingly positive.

Take, for example, the impressive increase in trade. Trade between new and old Member States grew almost threefold in less than 10 years. From €175 billion in 1999 to about €500 billion in 2007. Between the new members themselves, trade flows increased fivefold in the same period.

In parallel, the accession countries enjoyed a massive surge in foreign direct investment. Investment brought in new technologies and expertise as well as capital, fuelling the rapid modernisation of former communist economies.

Indeed, we have seen a clear shift towards services and knowledge intensive sectors. In 2006 high tech goods reached 14% of total exports in the new Member States – that's almost the same percentage as in the older Member States – an impressive achievement in such a short period of time.

All this helped the significant improvement in economic growth in Central and Eastern countries in the last years. New Member States of the EU expanded by an average of 5.5% in the period from 2004 to 2008, compared to 3.5% during the previous five year period.

Regarding labour markets, high levels of unemployment were a widespread problem during the transition process. Here too, we have seen considerable progress. Between 2003 and 2007 three million jobs were created in the EU12. In 2008, unemployment had been brought down to levels similar to the rest of the EU.

Poland is a prime example of the transformation that has taken place. This country's external competitiveness increased considerably in the last two decades. Thanks to higher growth and trade, Polish people have enjoyed higher living standards and Poland is seeing real convergence in this respect with mature economies. In the early 90s GDP per capita was below 40% of the EU average; today it is around 56%.

None of these improvements in the new Member States has come at the expense of the older members of the EU. Far from it. Growth in the EU-15 was unaffected. Job creation remained very strong during the last five years. And the opening of new economies in the East and their membership in the Union has presented huge new opportunities for investments and exports for the Western European countries. In Germany, for example, exports to new member states have more than tripled during the last 10 years.

A Europe of 27, with 500 million citizens, also means more political clout. The enlarged EU carries more weight when addressing issues of global importance. Whether climate change or the current financial crisis – today Europe is a major international player.

These are some of the key benefits of enlargement. Unfortunately I do not have the time today to elaborate on other crucial aspects of the European enlargement project.

However, we shouldn’t let the gains – impressive though they are - mask areas which need improvement.

In labour markets, for example, long-term unemployment remains a persistent problem for many Central and Eastern European Member States. Full income convergence is still to be achieved with the rest of Europe. Moreover, the financial crisis is exposing macro-financial imbalances and home grown vulnerabilities in Central and Eastern Member States that urgently need addressing.

In some of the new Member States, large capital inflows have led to high external deficits and overheating. The crisis is hitting these countries particularly hard, as their external imbalances and housing bubbles begin to unwind sharply.

Credit growth has dropped significantly, reflecting tighter liquidity conditions and higher risk awareness. As a result, balance sheets of households and the corporate sector are now looking fragile, especially in view of high foreign currency borrowing.

Moreover, a severe deterioration in external financing conditions means countries face the risk of a disruptive adjustment of capital flows. In some cases, difficulties in meeting external financing needs have required international assistance.

The currencies of those Member States with a flexible exchange rate system have experienced heightened volatility and, in some cases, depreciations. Those with fixed exchange rate systems are also facing testing times given the adverse financing conditions and sharp domestic adjustment.

The slowdown in export markets, which is affecting economies the world over, makes the adjustment process even more difficult. Even beyond current short-term liquidity risks, the region is also likely to face more difficult and volatile funding conditions in the period ahead.

Of course, these problems are not limited to New Member States. The crisis has hit every country in Europe and some are suffering more than others, depending on the exposure of their banking system, or their dependence on construction or exports.

Poland is proving relatively resilient. This is partly because it is a larger economy, with a higher proportion of domestic demand which makes it less reliant on exports compared to other Central and Eastern European economies. On top of this, Poland is benefiting from the more prudent approach of its banks and financial supervision authority.

Nevertheless, it is absolutely vital that this crisis does not derail the convergence process that has made such incredible advances over the last 20 years – here in Poland – and throughout the region.

Solidarity between European partners is crucial here. This is why the EU has launched actions to stabilise the banking system and to coordinate a fiscal stimulus at the EU level.

So far, in the context of the recovery plan launched at the end of last year, national governments have announced measures amounting to 1.8% of GDP over 2009 and 2010 and these measures largely respect the guidelines set by the Commission: they are targeted to where action is most needed; they are temporary; and they are differentiated according to the budgetary room for manoeuvre of the different Member States.

A total of 17 EU governments have provided direct government support to the banking sector. Re-capitalisations of Western banks will ease pressure on their subsidiaries in Central and Eastern Europe.

For those economies most in need, the EU has launched concrete measures: balance of payments support to Hungary, Latvia and Romania worth up to almost €15 billion is helping to ease financing constraints and avoid contagion effects. We recently raised the ceiling of this payment facility to €50 billion.

Frontloading of cohesion and structural funds has released €7 billion to further the economic development of new Member States.

Meanwhile the European Investment Bank has increased its lending activities for new Member States by almost 40% this year to 11.5 billion euros.

At EU level we are doing everything possible to support crisis hit countries. But new Member States must also make efforts to safeguard their achievements.

This means implementing sound domestic policies to speed recovery from crisis and ensure sustained catching up. They would also pave the way for entry to the euro area, which is a crucial step for new Member States.

The single currency is key to further economic integration; it brings more trade and increases inward investment. But the euro is also a major asset because it provides an anchor of stability in times of economic and financial turmoil, as the current crisis is showing.

Today the Economic and Monetary Union is protecting its members from the risk of exchange rate turbulence and from speculative currency attacks. Spreads on sovereign debt would be higher in the euro area without the credibility brought by membership of the world's second currency.

For example, the countries which have recently adopted the euro have retained a better access to external financing than the member states which remain outside. In the months leading up to Slovakia's entry in the euro area in January 2009, the Koruna remained stable, protected by the prospect of the forthcoming euro adoption.

Four of the 12 new Member States have joined the single currency so far. The rest are committed to join once they fulfil the necessary conditions. This is not an easy task. Experience shows that success will depend on the vigorous pursuit of stability oriented domestic policies.

Rigorous implementation of the convergence criteria is absolutely necessary because they are more than simply a passport for entry. The criteria established in the Maastricht Treaty are designed to ensure that countries are fully prepared for successful participation in the euro area. That they are equipped to draw maximum benefit from the euro but also to manage the challenges that come with life in the euro area.

In essence, we are talking about sound and sustainable fiscal policies together with a targeted agenda for structural reforms.

Regarding , fiscal policy . The crisis is causing budget deficits and debts to mount across the EU. All member states will have to prepare concrete strategies for budget consolidation once growth returns in order to maintain sustainable public finances in the long term.

In this respect, the Stability and Growth Pact is instrumental to provide clear guidance in the current situation to help Member States find the right balance between stimulating jobs and growth in the short term while maintaining sound and sustainable fiscal policies in medium to long term.

The Pact should also guide Member States as they carry out fiscal consolidation in the next years. Principally, expenditure should be reallocated to more growth-enhancing areas. Performance-based budgeting can help identify those components of public spending which are not useful in stimulating growth or increasing the living standards. Expenditure-based consolidations can result in more durable deficit reduction, which helps anchor inflation and interest rates at levels necessary to enter the euro area.

Regarding structural reforms , productivity boosting measures are key to underpin a recovery and to promote integration and income convergence in the longer term. For new Member States, investment in infrastructure is particularly important. Further efforts to complete the single market, and to make labour, product and service markets more flexible and public administration more efficient would attract investment and boost growth and jobs.

Improving education and skills should remain a key priority. One useful lesson we have learned from the catching up process is that while physical capital can be upgraded relatively quickly, increasing human capital takes longer. Better education together with active labour market policies would also help address problems of long term unemployment. Moreover, investment in R&D and innovation should not be curtailed in the current situation.

As a final, more general point, the EU must enhance their country surveillance. If the crisis has taught us one lesson, it is to monitor more closely the build up of vulnerabilities and risk in our economic and financial systems and to act before it is too late. We need to use the framework of the Stability and Growth Pact and of the Lisbon Strategy to detect developments like the build up of macro-economic imbalances early and launch effective policies to address them.

Conclusion

Ladies and Gentlemen,

Let me conclude by recalling that this anniversary is above all a cause for celebration. Countries that suffered from 40 years under communism have undergone a remarkable transformation and are now thriving at the heart of the European Union. Their efforts to join the EU are now paying off.

The EU is playing a critical role, providing a safe harbour for the countries of Central and Eastern Europe to consolidate the achievements of transition.

Of course, EU membership does not solve all the persistent structural problems nor does it eliminate all the risks. The crisis shows us that we must pursue policies for stability and growth. It also shows the value of a truly united Europe. Acting together, Europe can overcome immense challenges. 20 years after Poland re-established the power of democratic elections, I hope this message inspires Europeans as they go to the polls this weekend.

Thank you for your attention and I wish you a fruitful conference.


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