Enlargement, withdrawal and changes in the structure of the union

Overview

Enlargement create additional trade diversion for existing members, rules of origin and two-speed union.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What does the admission of new members do to the market facing firms in an existing member state?

   Model answer

   Enlargement adds the new members' consumers to the tariff-free market, so an existing member's firms can sell into them without customs duties or border checks, which raises potential output and the scope for economies of scale. It also adds the new members' producers as competitors in the existing member's home market, so domestic firms in overlapping industries face more competition and lower margins. Net gains are largest for firms with scale economies and a cost advantage, and losses are concentrated in industries where the new members are cheaper.

2. 2

   Why can enlargement to lower-wage economies shift the location of production within a bloc?

   Model answer

   Once barriers are removed, a firm can serve the whole bloc from any member, so it will locate where total unit cost is lowest. New members with lower wages, lower land costs and often generous investment incentives can offer a lower cost base, and single-market rules guarantee that goods produced there face no barrier in the richer members. Production of labour-intensive, standardised output therefore tends to relocate, while activities that depend on skills, clustering or proximity to customers tend to stay. This raises efficiency for the bloc as a whole but transfers employment from higher-cost to lower-cost members, which is why the effect on an existing member is a gain in consumer prices and a loss in particular industrial regions.

3. 3

   Analyse the effect of enlargement to lower-income economies on the labour market of a richer member state.

   Model answer

   Free movement means workers can move from the new members to the richer ones in search of higher wages, and the flow is usually largest immediately after accession and concentrated in sectors such as agriculture, construction, food processing, hospitality and health and social care. In the receiving economy the labour supply curve shifts right, which relieves shortages and moderates wage growth in those occupations while raising total output; workers who are close substitutes for the migrants experience the greatest downward wage pressure, and those who are complements, such as supervisors and skilled trades, may see their productivity and pay rise. Because migrants are concentrated in working ages, the fiscal effect is usually positive in the short run, though the local pressure on housing and public services can be sharp.

4. 4

   How does the admission of poorer members affect a common budget and the position of existing net contributors?

   Model answer

   Regional and agricultural spending is directed towards lower-income regions, so poorer new members become substantial net recipients. Unless the budget grows, spending must be redistributed away from existing recipients, and if it does grow, contributions from the richer members must rise. Existing net contributors therefore face either a larger contribution or a smaller receipt, which raises the direct fiscal cost of membership for them. Against that cost they gain a larger tariff-free market, lower-cost supply and investment opportunities in the new members, so the net effect depends on whether those trade and investment gains exceed the extra budget burden.

5. 5

   Why can enlargement create additional trade diversion for existing members?

   Model answer

   Enlargement extends tariff-free treatment to the new members while leaving the external tariff in place against everyone else. If a new member is a higher-cost producer of some good than a supplier outside the bloc, but is now the only one whose goods enter duty-free, buyers will switch to it. The switch lowers the price paid but shifts production to a less efficient producer and destroys the tariff revenue that was being collected on the outside supplier's goods, which is trade diversion. The risk is greatest where the new members' comparative advantage lies in the same goods as low-cost non-member exporters, such as agriculture and light manufacturing.

6. 6

   Why does trade between two countries fall when one of them leaves a customs union and single market, even if a zero-tariff agreement replaces membership?

   Model answer

   Tariffs are only one component of the cost of trading. Leaving reinstates customs declarations, rules-of-origin paperwork to prove goods qualify for the zero tariff, sanitary and safety checks, separate regulatory approvals and separate conformity testing, and it ends the automatic recognition of professional qualifications and of the right to supply services. These non-tariff costs raise the delivered price and, just as importantly, add delay and uncertainty, which is particularly damaging for perishable goods and for supply chains that cross the frontier repeatedly. Small firms often find the fixed compliance cost exceeds the value of their exports and withdraw from the market altogether, so the number of trading relationships falls as well as the value of each.

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