By Lili Bayer

Summary The European Union’s eastern members, who became members of the bloc in several rounds of expansion starting in 2004, are highly exposed to Western Europe economically. Countries like Poland, Hungary and the Baltic states need access to European labor markets to avoid unemployment crises at home. They also benefit from high levels of funding from the European Union, while investments and exports to Western Europe continue to drive the region’s economies. Economic stability and growth prospects in the EU’s eastern member states thus depend on both the fate of the European Union and the trajectory of Western European economies.

At Geopolitical Futures, we have discussed extensively the fragmentation of Europe, the exporters’ crisis impacting Germany and the troubles facing southern European economies. Last week, we outlined how Germany’s economic challenges could affect Central Europe. As Europe’s crises deepen, however, another element of the bloc’s economic challenges will come to the fore. The erosion of Europe’s free movement zone, Schengen, as well as the upcoming Brexit referendum threaten to undermine some of the bloc’s eastern members’ economic ties with the rest of the EU. Their economic and social stability depends heavily on continued access to European Union funding, investments, trade and labor markets. They are thus highly vulnerable to both economic changes in Western Europe and continued fragmentation of the bloc.

Impact of Free Movement on Employment

Access to European labor markets has helped the EU’s eastern members avoid large-scale employment crises. While unemployment in Greece stands at over 24 percent, the EU’s eastern members all enjoy very low unemployment, with the exception of Croatia. The Czech Republic, for example, boasts a 4.5 percent seasonally adjusted unemployment rate, according to Eurostat. Unemployment levels in the EU’s eastern states are low in large part because their workers have proven highly mobile and in some cases cheaper to hire, with millions moving to countries like the U.K. and Germany in search of jobs. According to Poland’s Central Statistical Office, 2.2 million Poles lived abroad for over three months in 2013. In 2014, Eurostat reported that over 740,000 Polish and over 160,000 Lithuanian citizens resided in the U.K. alone. Estimates vary, but there are also reportedly over 500,000 Hungarians abroad, with 300,000 of them in the U.K.

unemployment-rates

The movement of workers not only contributes to lower unemployment rates and domestic stability, but also brings wealth back to Eastern European countries through remittances. For example, in Lithuania, Hungary and Bulgaria, remittances contributed over 3 percent of GDP in 2014. As a point of comparison, in Greece and Italy, remittances constitute merely 0.3 percent of GDP.

remittances-as-share-GDP-2014

However, two emerging developments threaten to limit these benefits. The U.K.’s June 23 referendum on EU membership could jeopardize access to jobs in Britain, thus potentially raising unemployment levels and reducing the flow of remittances in the east. Similarly, any moves to significantly limit free movement across the bloc or change the composition of the Schengen zone could impact workers from the EU’s eastern member states. There have already been indications that some Western European countries, like the Netherlands, would prefer an arrangement where the bloc’s eastern and southern members were excluded from the free movement zone. At the same time, many EU members are already implementing ad-hoc border controls and have received temporary waivers from fully implementing their Schengen commitments. An intensification of this process could ultimately impact the movement of workers from east to west, thus affecting economic conditions in their home countries and potentially contributing to social instability in the bloc’s eastern members.

EU Funding and Western Investment

The EU’s eastern states are also highly dependent on funding and investment from the bloc. These countries all receive more funding from the EU budget than they contribute. The largest beneficiaries are Hungary, Lithuania, Poland and Romania, where EU budget spending exceeds 4 percent of Gross National Income (GNI) while national contributions to the EU budget remain less than 1 percent of GNI. This arrangement may shift after 2020 when the EU is scheduled to reassess member needs based on income levels, but based on current EU budget policies poorer countries like Romania and Bulgaria will likely continue to benefit from large budget transfers from Brussels.

eu-funding-country-contributions

At the same time, foreign direct investment (FDI) from the European Union’s western economies and exports to western markets are driving economic growth in the east. Western companies began opening offices and factories in the region and investing in local businesses in the early 1990s. Today, much of the FDI in the region comes from countries like Germany, the Netherlands and Austria. FDI levels are particularly significant in smaller economies, including Bulgaria, Hungary and Estonia, where FDI stocks represented over 70 percent of GDP in 2014, according to UNCTAD data.

fdi-stock

Moreover, as we discussed last week, some of the region’s economies are highly exposed to fluctuations in Western European economies, especially Germany, due to their role as exporters. The vast majority of the region’s exports go to Western Europe. For example, according to UN Comtrade data, over half of Polish exports go to Western European markets. Furthermore, the region forms an important part of Germany’s industrial supply chain, as goods imported from Eastern Europe are used to produce German exports. Economic growth in the EU’s east thus depends in large part on global demand for German exports, the unhindered movement of goods and access to Western European markets.

exports-of-goods-services

Conclusion

The EU’s eastern members are all highly dependent on Western Europe and the European Union, but their overall vulnerabilities vary. Hungary and Bulgaria, for example, are more exposed than Poland to economic and regulatory shifts in the rest of the EU. Bulgaria and Hungary are more dependent on exports and FDI, receive higher levels of EU budget funding as a percentage of national income and rely on proportionately more remittances. Nevertheless, Poland would also suffer acutely if demand for its exports to Western Europe declined or if access to European markets was constrained. Perhaps more important, Poland would likely experience a significant economic and political crisis if the country’s access to European labor markets was limited and 2 million unemployed Poles were forced to return home.

The European Union’s expansion eastward contributed to the intensification of complex economic interdependencies. For the bloc’s eastern members, the fate of Western European economies and decision-making in Brussels are both critical. There are opportunities in the long run for these countries to locate new export markets and attract FDI from outside Europe. But with Europe in crisis, Russia facing its own financial troubles and China’s economy slowing down, the EU’s eastern members will likely remain highly exposed to Western European markets in the short to medium term.