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Austria: Selected Issues

Author(s):
International Monetary Fund
Published Date:
August 2002
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III. The Effects of EU Enlargement for Austria14

A. Introduction and Summary

62. Austria is among the European Union’s member states likely to be most affected by the upcoming eastward EU enlargement. There are two main reasons. The first is geographic location: four of Austria’s neighbors (the Czech Republic, Hungary, the Slovak Republic, and Slovenia), covering about half of its borders, are among the leading accession candidates, expected to join the EU in 2004. The second reason is the strength of the economic ties that Austria has already developed with the Central and Eastern European countries (CEECs).

63. Austria’s links with the CEECs strengthened considerably over the 1990s. The opening up of the CEECs toward the West, combined with the Europe Agreements that eliminated most non-agricultural tariffs between the CEECs and the EU, set the stage for a dynamic expansion of trade flows, especially with Austria. The annual growth rate of Austrian exports to and imports from the CEEC5 (the four neighboring candidate countries plus Poland) averaged in the double digits over the 1990s. As a result, the share of the CEEC5 in Austrian exports and imports doubled (Figure III-1).

Figure III-1.Austria: Trade Links with the CEEC5

Source: IMF Direction of Trade Statistics.

64. Equally spectacular was the increase of these countries’ importance as a destination for Austria’s outward foreign direct investment (FDI). This reflected both the acquisition of privatized CEEC assets and greenfield investments by Austrian firms, as these sought to gain market share and take advantage of lower production costs via outsourcing. By the end of the 1990s, the CEECs accounted for over one third of outward Austrian FDI flows (Figure III-2), and Austria ranked as one of the top foreign investors in all of its CEEC neighbors (Table III-1).

Figure III-2.Austria: Regional Breakdown of Outward FDI

(In millions USD)

Source: OeNB.

Table III-1.Austria: Austria as a Foreign Direct Investor in CEECs
CountryTotal stock (billion USD)Ranking of AustriaAustria’s share (in percent)Date
Slovenia2.8145.62000 Dec
Croatia5.9129.22001 Sep
Slovak Republic4.3318.42001 Sep
Hungary10.4312.11999 Dec
Czech Republic17.6310.11999 Dec
Bulgaria4.356.52001 Sep
Romania4.875.22001 Sep
Ukraine3.9103.32000 Dec
Poland48.4112.52001 Jun
Source: OeNB, WIFO.
Source: OeNB, WIFO.

65. The experience so far has been positive for Austria. The opening up of the CEECs has increased Austria’s exports and growth, created jobs, and helped keep inflation low. Estimated growth effects are significant, adding close to ½ percent per year to annual Austrian GDP growth,15 while no major adjustment problems appear to have emerged in the factor markets or at the sectoral or regional level.

66. Increased exports and FDI to the CEECs were accompanied by job creation in Austrian manufacturing at home, disproving fears that jobs would go East in search of lower wages. Palme (1999) estimates the direct effects on manufacturing employment between 6,000 and 20,000 jobs. Taking into account indirect effects would approximately double these numbers.

67. The integration of the CEECs with Western Europe is likely to continue in the future. This Chapter reviews the extensive research on the channels through which EU enlargement, is likely to influence the Austrian economy.16 Although the integration process is multidimensional and EU accession has numerous important non-economic aspects in the candidate countries (such as policy coordination and convergence of institutions, norms and standards) that may in turn have economic repercussions for Austria, the Chapter focuses on direct economic linkages and does not consider other effects in detail.17 The horizon over which effects on the Austrian economy are examined is the medium term. Although after EU enlargement, the new member countries could possibly adopt the euro within this time frame, this further step in the integration process is not considered here.

68. The possible effects of EU enlargement on the Austrian economy can be grouped in three broad categories: budgetary, macroeconomic, and distributional. Budgetary effects comprise the direct costs of EU enlargement through changes in Austria’s net contribution to the EU budget. Macroeconomic effects show up as changes in the major economic aggregates (output, prices, exports and imports, cross-border movements of capital and labor). Finally, distributional effects generate “winners” and “losers” (at least in relative terms) for instance in the labor market, among various industries, or across regions.

69. The main channels for the direct budgetary effects of enlargement are the rules determining Austria’s gross payments to the EU budget and the EU policies on agricultural subsidies and structural funds. While the size of the contribution to the EU budget (1.27 percent of GDP) is not expected to change with enlargement, post-accession budgetary arrangements are still being negotiated, and the Common Agricultual Policy—a critical component from the point of view of net contributions—is under discussion. The size of the budgetary effects is hard to estimate, and is not undertaken here.18

70. The major channels for the macroeconomic effects of EU enlargement (discussed in detail in Section B) are trade, changes in firm size and market structure, and cross-border movements of capital and labor.19

  • As most tariffs have already been eliminated, additional trade creation upon EU enlargement would be modest and largely due to lower costs from eliminating border controls. However, “imponderables”, such as faster real and institutional convergence in the accession countries after their EU entry are also likely to broaden the scope for trade between the old and the new members.
  • Widening the single market is likely to increase the scope for economies of scale, thus raising productivity, and strengthen competition, thus putting a downward pressure on markups and input costs. Through these channels, EU enlargement could increase long-term growth and lower inflation in new and old member countries.
  • By reducing investment risk, EU accession is expected to stimulate FDI inflows to the new entrants. To the extent that this crowds out investment in Austria, as domestic and foreign investors divert some of their funds to the accession countries, slower capital accumulation would tend to lower economic growth.20
  • Labor flows are likely to remain limited following EU enlargement, as the 7-year transitional arrangement in the area of labor mobility will constrain migration. After that, Austria—like the rest of the current members of the EU—is likely to be a net recipient of labor. This would increase the economy’s resources and contribute positively to economic growth.

71. Studies quantifying these macroeconomic effects of EU enlargement on Austria estimate that the overall magnitude of the gains is modest but significant. Estimated cumulative growth effects over the medium term are in the 0.7 to 1.6 percentage point range (or 0.1-0.2 percentage points extra growth per year), while employment is slightly higher and inflation is slightly lower than in the no-enlargement counterfactual.

72. The two main channels for distributional effects from EU enlargement (discussed in Section C) are relative wage changes and shifting patterns of comparative advantage across industries or regions.

  • Relative wages may change due to the reallocation of resources. Increasing immigration or cross-border commuting to work after the liberalization of labor movements between Austria and the new EU members may change the relative supply of different skills on the labor market, leading to a change in relative wages. To the extent that foreign workers would be competing with lower- to medium-skilled Austrian workers, they would bid down relative wages in these skill categories. Moving capital and production to the CEECs would also influence relative wages through changes in labor demand.
  • The consequences of the relocation of economic activity are likely to be concentrated in specific industries and regions. For example, production intensive in low-skilled labor (such as textile production) may be relocated to the new EU members, or the CEECs may exploit better their comparative advantage in certain areas of agricultural production. Regions where such disadvantaged industries are overrepresented would be challenged to adjust to these shifting production patterns. The likely target areas for immigration and commuting, Vienna and the border regions, would experience a change in the size and skill composition of their labor force, which could, in turn, change their comparative advantage vis-à-vis other regions, necessitating structural adjustment.

73. Additional distributional effects triggered by EU enlargement are unlikely to be dramatic over the medium term. As Austria’s links with have CEECs been gradually tightening during the 1990s, production allocation decisions have already been changing, with attendant distributional effects. EU enlargement may speed up this process but is unlikely to cause drastic changes. In the area of labor markets, the transitional arrangements prevent disruptive changes in the size or composition of the labor force. Finally, there is no indication that Austria’s comparative advantages will shift overnight with EU enlargement. Rather, enlargement appears to pose just one more challenge for Austria in a globalizing world economy. Studies suggest that the Austrian economy is well-positioned to tackle this challenge while keeping costs to a minimum.

74. The remainder of the chapter reconsideres the channels and effects sketched above. Drawing on the literature on the effects of EU enlargement on old member states, in particular, on Austria, Section B discusses the various macroeconomic effects in detail. Section C follows with a detailed discussion of distribution effects.

B. Macroeconomic Effects of EU Enlargement

75. Regional studies indicate that EU enlargement would benefit economic growth in Austria. This is not surprising, as fuller integration of the CEECs with the rest of Europe would reduce distortions and contribute to the more efficient allocation of economic resources. However, growth benefits are estimated to be asymmetric. First, the payoff for new members would be substantially—perhaps by a factor of five to ten—larger than for old members.21 This is not surprising, given the relative size of the EU and the candidate countries.22 And second, some old EU members would benefit more than others. The distribution of benefits among the EU members is largely determined by two factors: the strength of their economic linkages with the CEECs; and the change in their net contributions to the EU budget. As the Austrian economy already has close ties with the CEECs, and Austria is not expected to be among the strongest competitors of the CEEC for EU structural funds, Austria stands to benefit more than the EU average.

76. Quantitative estimates of the macroeconomic effects of EU enlargement bear this out. While EU enlargement would on a cumulative basis add 0.1 to 0.7 percentage points to growth over the medium term in old members (or about 0.02 to 0.1 percentage points per year), the estimates for Austria are significanty larger, ranging from 0.7 to 1.6 percentage points, or about 0.1-0.2 percentage points extra growth per year (Table III-2).

Table III-2.Austria: Cumulative Growth Effects of EU Enlargement 1/
SourceGrowth effectCountryMethod
Gasiorek, Smith and Venables (1994)0.5-0.8EU12CGE model
Baldwin, Francois and Portes (1997)0.2EU15CGE model
Kohler (2000)0.1EU15CGE model
Neck, Haber and McKibbin (2000)0.0EU15CGE model
European Commission (2001)0.5-0.7EU15Growth model
Breuss (2001)0.3EU15Macro model
Lejour, de Mooij and Nahuis (2001)0.1EU15Macro model
Breuss and Schebek (1995) 2/1.6-1.7AustriaMacro model
Breuss and Schebek (1998)3/1.3AustriaMacro model
Keuschnigg and Kohler (1997) 4/1.4-1.5AustriaCGE model
Keuschnigg and Kohler (2001)2/1.1-1.3AustriaCGE model
Breuss (2001)0.7AustriaMacro model
Source: Fidrmuc et al (2002), p. 50, Table 1.

Estimates without migration effects.

The lower and the higher values correspond to the accession of 5 and 10 CEECs, respectively.

Assumes the accession of 10 CEECs.

Assumes reforms of the EU budget.

Source: Fidrmuc et al (2002), p. 50, Table 1.

Estimates without migration effects.

The lower and the higher values correspond to the accession of 5 and 10 CEECs, respectively.

Assumes the accession of 10 CEECs.

Assumes reforms of the EU budget.

77. EU enlargement can also be beneficial for inflation and employment in old members, but these estimated effects tend to be small. Better resource allocation and stronger competition would tend to reduce costs and markups, which, in addition to possibly stimulating growth, would decrease inflation. For Austria, estimated cumulative inflation effects are in the 0.1 to 1.4 percent range over a 10-year horizon (Breuss (2002b)).

78. The estimated aggregate employment effects also tend to be small (Breuss (2002b) reports a cumulative increase in employment between 0.1 and 1 percent for Austria), and mostly reflect job creation from faster growth. Consistent with the transitional arrangements in the area of labor mobility, these estimates are based on the assumption of a small net labor inflow. Since the net economic effect of immigration is positive for recipient countries, larger net immigration into Austria would unambiguously raise growth and employment even more in the long run, but in the short run, a fast expansion of labor supply could temporarily increase unemployment. These macroeconomic benefits would be accompanied by distributional effects on the labor market (discussed in Section C), as competition between domestic workers and immigrants could bid down relative wages for certain skill levels and professions.

79. The main channels through which macroeconomic effects materialize are trade, changes in firm size and market structure, and cross-border movements of capital and labor. While trade creation provides a demand pull, increased productivity (from e.g., exploiting economies of scale), keener competition, and better allocation of the factors of production act predominantly on the supply side and raise the economy’s growth potential. Breuss (2002a) decomposes his estimates of the medium-term effects of EU enlargement for Austria’s economic growth (Figure III-3) and finds that supply factors account for most of the benefits. This conclusion, however, may be somewhat biased. To the extent that trade creation after EU enlargement is not fully attributable to the elimination of tariffs and border controls (see below), demand pull effects are probably somewhat underestimated. In addition, as the calculations assume cumulative net immigration flows of about 1 percent of Austria’s population over the medium term,23 the contribution of labor flows to growth is likely to be overstated.

Figure III-3.Austria: Contribution to Cumulative Effect on Real GDP Growth

(In percent)

80. After this bird’s-eye review of the macroeconomic effects of EU enlargement and their expected magnitude in Austria, the remainder of this section discusses in detail some of the channels through which enlargement can influence the major macroeconomic indicators.

Trade creation

81. Over the 1990s, the rapid redirection of trade of the CEECs led to fast growth in their exports to and imports from countries in the western part of Europe. As a result, the Austrian economy registered correspondingly fast growth in its exports to and imports from the region (Table III-3). The increase in trade flows between East and West was boosted by a reduction of tariffs between the CEECs and EU countries. In the framework of the Europe Agreements concluded with 10 CEECs, the EU eliminated most tariffs (with the exception of agricultural and sensitive products) on CEEC imports. The CEECs took a similar step in 2002.24

Table III-3.Austria: Growth of Manufacturing Exports(In percent)
To country:PeriodGrowth rate
Czech Republic93-009.7
Hungary89-0016.0
Poland89-009.3
Slovak Republic93-0010.2
Slovenia93-0011.0
CEEC593-0011.2
EU93-006.7
World93-007.9
Source: IMF Direction of Trade Statistics.
Source: IMF Direction of Trade Statistics.

82. What is the further scope for trade creation between Austria and the candidate countries, and how it would be influenced by EU enlargement? The magnitudes are uncertain, but studies indicate that trade flows are likely to increase further and more dynamically after EU enlargement. The CEECs’ share in Austrian exports and imports appears to have plateaud in recent years, reflecting that the transition-induced large shift in the geographical trade structure of the candidate countries has mostly been completed. However, as countries with more similar real income levels tend to trade more, the catching-up process in the CEECs is expected to create more trade. In addition, the intensity of trade relations between the EU countries and the CEECs still falls short of that observed between EU member countries even if real income differentials are taken into account. For example, based on a gravity model, Egger (1999) estimates that trade flows between Austria and the CEEC5 could increase more than threefold in nominal terms, should trade links become as tight as between current EU members.25 One channel through which EU enlargement could facilitate trade creation is the elimination of border controls.26

83. Although the potential for additional trade creation appears large, the extent and timing of the effects attributable to EU enlargement are highly uncertain. They would depend on such imponderables as the boost EU accession gives to real convergence in the CEECs or the change in the speed of institutional convergence between old and new EU members. However, some changes upon EU enlargement are more tangible. Breuss (2002a) and (2002b) considers the elimination of all remaining tariffs (assumed at 5 percent for CEEC imports from the EU) as well as border controls (assumed to cost 5 percent of trade flows). The elimination of these distortions and trade costs would benefit Austrian exports and growth, increase employment, and lower inflation. But the overall estimated effect is predictably small, amounting to some 0.2 percentage point of growth on a cumulative basis over the medium term.

Changes in market structure

84. EU enlargement will increase the size of the single market. This will have two implications for market structure. First, the larger market will provide more scope for exploiting economies of scale, increasing production while at the same time raising productivity. Second, the number of firms within the single market producing the same good or close substitutes will increase, strengthening competition and putting a downward pressure on markups. In addition, EU entry of Austria’s CEEC neighbors would facilitate breaking up production processes and locating some phases in the new members (outsourcing), thereby reducing costs via cheaper intermediate inputs.27 Through higher productivity, lower costs, and improved international competitiveness, EU enlargement would increase long-term growth and lower inflation in both old and new members.

85. Breuss (2002a) calibrates the likely increase in productivity and the decrease in the price level based on ex ante expectations of similar effects at the creation of the single market. As Austria is a small country that trades relatively extensively with the CEECs, the estimated effects are above the EU average, raising GDP growth by about 0.6 percent on a cumulative basis over the medium run.

FDI flows

86. During the 1990s, foreign direct investment played a significant role in the economic restructuring of CEECs. Further inflows are expected, as foreign firms will continue to seek to secure or increase their share in the fast-growing CEEC markets. In addition, the CEECs’ relatively cheap and highly-skilled labor force can provide cost advantages and thus attract foreign capital. EU accession is likely to stimulate this process by lowering risk premia required by foreign investors.

87. Increased FDI inflows to CEECs can affect the Austrian economy through two main channels. First, domestic and foreign investors may divert some of their funds that otherwise would have been available for investment in Austria—or in other old EU members—to the accession countries. This can increase the cost of capital, crowding out some investment and lowering capital accumulation in the old members. Second, jobs and production may migrate together with capital to the new members.

88. Given the CEECs’ small size, faster upgrading of their capital stock after EU enlargement is likely to have limited effects on capital availability in old members; all the more so as not all of their capital needs would be financed from within the EU. Correspondingly, changes in the cost of capital would remain small. For example, Breuss (2002a) assumes that short-term interest rates in the euro area could rise by five basis points after enlargement, and then by further 15 basis points over the medium term. The resulting lower investment in Austria would dampen growth by about ¼ percentage points on a cumulative basis over the medium term.

89. Regarding the other possible effects of higher FDI inflows to the new members after enlargement, Austria’s experience during the 1990s does not appear to support the argument that employment and production also relocated with capital. As a result of Austrian firms’ strong investment activity in the CEECs, the share of these countries in Austria’s FDI stock reached about 25 percent by the end of the decade. Meanwhile, cross-border intra-company trade consistently produced surpluses for Austrian firms with CEEC subsidiaries, and domestic employment by Austrian firms that made direct investments in the CEECs probably rose more dynamically than domestic employment by all Austrian firms with FDI.28 The fact that Austrian investors predominantly cite gaining market share as their motivation for investing in the CEECs (Table III-4) suggests that FDI and exports will remain complements in the years to come. As a result, increased FDI in the CEECs after EU enlargement would not crowd out domestic employment; rather, it would create jobs via higher exports. Were cost considerations to become more important, some production would shift to the East, with temporary negative growth and employment effects. However, over the long run, exploiting comparative advantages would raise welfare.

Table III-4.Austria: Motivation of Austrian Outward Direct Investors, End-1999
Labor costsTaxationMarket accessSupply securityOtherLabor costsTaxationMarket accessSupply securityOtherTotal investments
Share in the number of investments (in percent)Share in the value of investments (in percent)NumberIn millions euro
Germany027022501510483251,428
UK01663290123234968726
Hungary80684197069222404841
USA0477118013906074599
Czech Republic60741193061135257993
Switzerland 1/15664240932653137385
Netherlands016500340173404938246
Caribbean countries0331105604900509157
Sweden008601400100001429
Poland207412111079416105236
Other countries317621813525407413,621
Total3272320135054121729,261
EU-11127022502460515652,846
EU-15127022503405516643,841
Eastern Europe6073317417122310983,314
Source: OeNB, “Austrian Outward and Inward Direct Investment at the End of 1999” (Focus on Austria 2/2001), Table 10.1.

With Liechtenstein.

Source: OeNB, “Austrian Outward and Inward Direct Investment at the End of 1999” (Focus on Austria 2/2001), Table 10.1.

With Liechtenstein.

Migration

90. The transitional arrangements in the area of labor mobility provide constrain migration after EU enlargement. However, as the immigration potential from the new members is highly uncertain, and labor movements can have significant distributional consequences, the issue remains an important topic in policy discussions. Especially so in Austria that – together with Germany – can expect to be a favored destination on account of its geographical proximity to the CEECs and its relatively large existing stock of CEEC immigrants.

91. Estimates of potential labor flows from the new to the old EU member countries vary widely. For Austria, they range from 10,000 to over 100,000 immigrants (or from 0.1 to 1¼ percent of the Austrian population) annually in the first few years after relaxing administrative constraints on labor mobility.29 Experience from previous EU enlargements, as well as from the German unification, indicates that flows above the high end of the range are unlikely to materialize.30 An immigration potential closer to the midpoint of the range, such as the estimates of Boeri and Brückner (2000) (Table III-5), would appear more consistent with previous experience.

Table III-5.Austria: Projections of Immigration from the CEEC

(in percent of baseline population) 1/

12351015202530
From the CEEC 10 2/
EU-150.090.080.070.070.040.020.010.000.00
Austria0.500.450.410.370.220.120.060.030.00
Germany0.270.240.220.200.120.070.040.010.00
From the CEEC8 3/
EU-150.050.050.040.040.020.010.010.000.00
Austria0.300.270.240.220.130.070.040.020.00
Germany0.160.140.130.120.070.040.020.010.00
Source: Boeri and Bruckner (2000), Tables 7.6 and 7.10, World Bank World Development Indicators, and staff calculations.

For Germany, immigration projections are from Boeri and Bruckner (2000). For the EU and Austria, immigration projections were obtained by scaling the projections for Germany based on the relative number of CEEC immigrants.

CEEC5, plus Bulgaria, Estonia, Latvia, Lithuania, and Romania.

CEEC5, plus Estonia, Latvia, and Lithuania.

Source: Boeri and Bruckner (2000), Tables 7.6 and 7.10, World Bank World Development Indicators, and staff calculations.

For Germany, immigration projections are from Boeri and Bruckner (2000). For the EU and Austria, immigration projections were obtained by scaling the projections for Germany based on the relative number of CEEC immigrants.

CEEC5, plus Bulgaria, Estonia, Latvia, Lithuania, and Romania.

CEEC5, plus Estonia, Latvia, and Lithuania.

92. However, the Boeri-Brückner estimates, which are based on historical immigration data, may not be appropriate for gauging the scope for labor flows from the CEECs. Blanchard (2001) has argued that in the past, labor tended predominantly to move either between countries that were similar in terms of income levels and culture (e.g., the Netherlands and Germany), or between countries that were dissimilar in both respects (e.g., Germany and Turkey). The CEECs and the EU present a third case, where different income levels combine with similar cultures. This is probably conducive to higher mobility. But, even in such a case, in which the scope for immigration was underestimated by, say, a factor of 2 to 3, labor inflows from the CEECs to Austria would still be comparable to those experienced in the early 1990s.

93. As a net recipient of labor, Austria would derive long-term benefits from future liberalization of labor movements between old and new EU members. Immigration would increase the economy’s resources and have a positive effect on economic growth. However, the adjustment of the economy to a larger labor supply would also have costs in the short term. These costs would mainly take the form of temporarily higher unemployment, and tensions emanating from distributional effects, and their duration would depend on labor market flexibility.

C. Distributional Effects of EU Enlargement

94. A purely macroeconomic perspective on the effects of EU enlargement misses distributional consequences that may be particularly important from a political economy point of view. While Austria stands to gain in the aggregate, the benefits are unlikely to be evenly distributed and may vary across segments of the labor market, industries, and regions.

95. Popular concerns remain strong regarding possible labor market disruption, in particular. After the liberalization of labor movements, distributional effects on the labor market could indeed be substantial. Although—as argued above—immigration is likely to remain contained even over the long run, Austria’s long borders with the new EU members combined with the proximity of major urban areas across the borders provide large scope for cross-border commuting. This would increase labor supply and amplify the extent of labor market effects from enlargement. The Austrian labor market has recent experience of labor inflows: in the early 1990s, the labor market demonstrated its flexibility by quickly absorbing a wave of immigrants without large frictions. However, depending on the composition of immigrants, certain groups of Austrian workers could be strongly affected even with moderate aggregate inflows.

96. Relative wages and unemployment rates may also vary by industry, reflecting varying output and employment effects of EU enlargement. As trade in manufactures has largely been liberalized, additional production and employment effects in most industries are expected to remain small, with the possible exception of industries that rely on lower-skilled labor and operate in a highly cost-competitive markets (e.g., textiles and leather, plastic products, production of construction materials). The situation is different in services, where liberalization has been slower. As a result of EU enlargement, service industries with a regional reach—construction, transportation, and retail trade—can come under increased competitive pressure. Consistently with the expected macroeconomic benefits from EU enlargement, Austria’s production structure is dominated by industries (both in services and manufacturing) that are either advantaged or neutral form in the process of economic integration with the CEEC.

97. Because labor market and sectoral effects will tend to be concentrated in certain geographic regions, distributional problems may become compounded: e.g., border regions with a disadvantaged industry structure may be particularly adversely affected by EU enlargement.

Relative wage changes

98. EU enlargement may speed up the reallocation of resources between old and new EU members: capital and labor flows may intensify, changing the size and composition of labor supply and demand. After the liberalization of labor movements, immigration and cross-border commuting is likely to change the relative supply of different skills on the labor market. While there are large uncertainties regarding the size of labor flows, both for immigration and for cross-border commuting (Table III-6), there is more consensus in the literature on the composition of the group of newcomers on the Austrian labor market. Foreign workers are expected to be predominantly prime-age males, with skill levels above those of immigrants from traditional “guest worker” countries.

Table III-6.Austria: Estimated Day Commuter Potential
ProvinceBaselineUpper variantLower variantBaselineUpper variantLower variant
in thousandsin percent of employees
Vienna30.368.222.73.98.93.0
Lower Austria23.252.217.44.510.23.4
Burgenland4.710.63.56.013.54.5
Styria8.519.16.42.04.51.5
Carinthia4.610.23.42.45.51.8
Upper Austria5.011.23.71.02.10.7
Salzburg0.00.00.00.00.00.0
Border regions total76.3171.557.12.86.32.1

99. The attendant changes in relative wages depend on who these workers compete with. Experience from the 1989-92 wave of immigration, which increased the Austrian population by some 300,000, indicates that newcomers tend to compete with lower- to medium-skilled, less mobile, workers many of whom are “old” immigrants themselves. For these groups, the risk of unemployment increases, and relative wages are bid down, increasing the differential between high- and low-wage earners. How large could these effects be? Hofer and Huber (2001) estimate that annual immigration of about 40,000 persons would decrease blue collar workers’ average annual wage growth by about 0.3 percent.

100. In contrast to distributional effects through changes in labor supply, moving capital and production to the CEECs could influence relative wages through changes in labor demand. For example, Palme (1999) identifies disadvantaged manufaturing industries as those with technologies requiring relatively little human capital. As such industries tend to use more low-skilled labor (e.g., textile production), their relocation to the new EU members would depress demand for low-skilled labor in Austria. These effects, however, would tend to be small.

101. In summary, although immigration and cross-boarder commuting are expected to have distributional effects on the Austrian labor market, their size will likely be small. Nevertheless, increasing further the flexibility of the labor market could strengthen Austria’s ability to adjust smoothly to these shocks.

Changes in the patterns of comparative advantage

102. The industry structure of the Austrian economy is adapting continuously, reflecting the changing competitive position of the individual industries both on domestic and international markets. The opening up of the CEECs in the 1990s influenced this process via two channels: by providing new markets, and by intensifying competition. As discussed before, Austria benefited from the trade creation effect. However, the comparative advantages of individual Austrian industries have changed as a result of the emergence of competition from the CEECs.

103. In general, manufacturing industries that relied on lower-skilled labor and participate in markets with strong cost-competition became disadvantaged. Examples include textile and leather, plastic products, construction materials, and wood products. Reflecting the adjustment taking place in response to the changes in comparative advantages, some—but not all—of these industries scaled down employment31 and are running trade deficits with the CEECs. However, employment losses were small, and the trade surpluses32 of some disadvantaged industries with the CEECs indicate that they may have improved their competitive position due to non-cost factors.

104. As trade in manufacturing is already largely liberalized, EU enlargement is unlikely to represent a trigger for abrupt, large-scale structural changes. While advantaged industries are expected to win and disadvantaged ones to lose from closer integration between Austria and the CEECs, the process—which in any event is already in motion—is likely to remain gradual and driven by established forces.

105. Among the service industries, those with international reach and high human capital intensity (e.g., financial services) can be considered advantaged. Disadvantaged service industries are likely to be those that rely on lower-skilled labor and operate on highly contested regional markets—for example, construction, transport, and retail trade. As liberalization in the area of services remained slow in 1990s, EU enlargement is likely to have stronger effects than in manufacturing. However, liberalization of trade in services will be gradual between Austria and the new EU members, as the EU allowed Austria and Germany to introduce measures in sensitive sectors where the cross-border provision of services could lead to serious disturbances.

106. The overall consequences of the relocation of economic activity are likely to be concentrated in regions where disadvantaged industries are overrepresented. These regions would be challenged to adjust to shifting production patterns. At the same time, Vienna and the border regions, the likely target areas for immigration and cross-border commuting, would over the long run experience a change in the size and skill composition of their labor force. Due to these regions’ proximity to the border, commuters are likely to be drawn to these destinations. Thus, the distributional effects of EU enlargement on the labor market may also be concentrated in a few geographic areas.

107. In some cases, disadvantaged production structures and exposed labor markets are both present in the same region. For example, disadvantaged service industries have a large share in the economies of Burgenland and Carinthia, two provinces bordering CEECs (Table III-7).

Table III-7.Austria: Service Industries Potentially Affected by EU Enlargement
Industries with international markets 1/Industries with regional markets near border 1/Potentially affected industries 1/Index of advantaged industries 2/Index of disadvantaged industries 2/
Vienna31.568.5100.0138102
Lower Austria27.048.975.987112
Burgenland21.778.3100.082142
Styria26.352.378.689115
Carinthia28.671.4100.095130
Upper Austria28.633.562.19896
Salzburg38.40.038.48859
Austria total30.643.273.8100100
Source: Preparity project (2001), pp. 14-15.

Employment in percent of total service sector employment

100 = national average. A value over 100 indicates above-average representation.

Source: Preparity project (2001), pp. 14-15.

Employment in percent of total service sector employment

100 = national average. A value over 100 indicates above-average representation.

108. Nonetheless, such regions need not be net losers from enlargement over the long term. For example, Huber (2002) argues that immigration can actually help the border regions. While low-skill immigrants derive significant benefits from the agglomeration of similar workers in urban areas, these “peer benefits” may become lower as the skill level rises. As a result, low-skilled workers would tend to congregate in cities, while higher-skilled workers would choose the border regions. This hypothetical settlement pattern would increase the relative human capital endowment of border regions, and help modernize their industry structure. Border regions may also benefit from strengthening cross-border linkages of local economies. For example, Hanson (1996) found that relocating manufacturing to Mexican border cities increases the demand for goods and services produced by US border cities, contributing to the formation of binational regional production centers. This mechanism, however, is unlikely to be significant in rural regions.

109. Over the medium term, the pressure for adjustment generated by EU enlargement will undoubtedly vary by region. This, however, would largely represent the continuation of existing trends emanating from globalization rather than a brand-new phenomenon.

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APPENDIX Austria: The Time Dimension of Expenditure Policy33

110. The government budget balance is frequently used as a summary indicator of fiscal policy. However, when the objective is to assess the long-term sustainability of public finances, a disaggregated analysis of public expenditures can provide useful additional information. A simple example is decomposing expenditures into primary spending and interest expenditures. The relative dynamics of the two categories can be indicative of long-term sustainability. For instance, a constant expenditure to GDP ratio with an increasing share of interest expenditures calls long-run sustainability into question. Another example is decomposition of public expenditures into redistribution-related versus other spending. After some (high) threshold level, persistently increasing redistribution spending is likely to cause large distortions and increase the likelihood of unsustainable long-term developments in public finances.

111. One way of disaggregating public spending is to classify expenditures along their time dimension. Public spending items can be divided into three categories:

  • Past-related expenditures are determined by past political and legal commitments. Examples include interest payments on public debt and public pensions.
  • Present-related expenditures cover the cost of providing current public services and, more broadly, an economic, legal, and social framework for economic activity. Examples are public administration costs, spending on defense, as well as health care outlays and social transfers (other than pensions) that target maintaining the productive potential of the labor force.
  • Future-related expenditures are those that improve the future growth potential of the economy. These include education expenditures or spending on R&D and public infrastructure.

Austria: The Structure of Public Expenditures in 2000

Source: Eurostat

112. Due to different degrees of commitment, the flexibility of fiscal policy differs across these three expenditure categories. Typically, the evolution of past-related expenditures is taken as predetermined by the policymaker: significant changes (e.g., restructuring public debt or reducing public pensions) would require amending or repudiating existing legal obligations or, more generally, the “social contract,” and would thus entail high political and economic costs. The degree of commitment is smaller and the room for discretion is higher for the other two categories.

Public investment, in percent of GDP

Source: OECD

113. A very rough decomposition of Austria’s public expenditure along these lines shows that the bulk of spending is past- and present-related.34 While the numbers are highly tentative, a comparison with the 1995 shares indicates that the substantial (4.5 percent of GDP) decline in total expenditure between 1995 and 2000 was associated with broadly stable spending composition. In the case of past-related expenditures, the unchanged share was due to smaller interest payments. Data for other EU countries tell a similar story: decreasing interest payments helped keep the share of past-related expenditures in overall spending stable. This is consistent with the interpretation that, due to little policy flexibility in the past-related category, spending restraint tended to concentrate on areas of lesser resistance, such as for instance public investment or administration costs.

114. Under current policies, Austria’s past-related expenditures are set to increase over the long run. Assuming that the policy objective of balanced budget over the cycle is maintained in the coming years, the trend in interest payments will remain favorable for some time due to the declining public debt stock, but demographic changes will lead to an increasing public pension bill. Fiscal policy may react to this in three ways: passively, reactively, and preemptively.

  • “Passive” policy. There is no fiscal adjustment and the widening deficit of the public pension system is fully reflected in a larger general government deficit. Public debt is quickly accumulated, interest payments rise, and the debt dynamics may become unsustainable.
  • “Reactive” policy. Rising pension obligations are accommodated either by increasing taxes or compressing other, present- or future-related spending items. Given Austria’s already high tax burden, steep further increases in taxation are likely to produce a negative supply response either because of more severe distortions or because of lower competitiveness or the flight of internationally mobile factors of production. A vicious circle with a shrinking tax base and increasing tax rates may develop, endangering fiscal sustainability. Similarly, large cuts in present- and future-related spending may prove counterproductive (by e.g., reducing the rate of human capital accumulation, running down administrative and physical infrastructure, or weakening the social safety net). In addition, their feasibility may also be questioned, as some present-related spending items, such as non-pension benefit spending, also involve some political and legal commitment.
  • “Preemptive” policy. Preemptive steps encompass measures that change current policies in anticipation of the future increases in past-related spending. One option is to run sustained large surpluses in the coming 10-15 years and run down public debt in preparation for future borrowing to finance higher pension expenditures. This amounts to bringing “reactive” measures forward. The other option is to change the dynamics of past-related expenditures by modifying entitlement rules—that is, to introduce pension reforms. Because legal and political commitments imply that major retroactive changes to coverage or benefit levels are not possible, the dynamics of total pension spending can only change gradually. This underscores the need for early action.
Austria: Public Finances in 2001(In percent of GDP)
Revenues53.1
Tax revenue45.8
o/w pension contribution9.4
Nontax revenue7.3
Expenditure53.2
Benefits23.5
Pensions14.5
Other benefits9.0
Interest payments3.5
Discretionary expenditure26.1
Balance-0.1
Government debt62.9
Source: Statistik Austria.
Source: Statistik Austria.
14Prepared by Kornélia Krajnyák.
16The review draws strongly on the results of the “Preparity” cross-border research project that was launched in 1999 by seven Austrian provinces and the Federal Ministry of Economic Affairs and Labor, with the mandate to analyze the economic consequences of EU enlargement. Many of the cited papers can be accessed at the “Preparity” project’s website: http://www.preparity.wsr.ac.at/
17An example where a non-economic aspect of the CEECs’ integration may have economic consequences could be faster institutional convergence that encourages FDI activity.
18Existing studies based on hypothetical post-accession budgetary arrangements indicate small changes in Austria’s net contributions to the EU budget. Kohler and Keuschnigg (2000) estimate an increase of 0.1-0.2 percent of GDP, while Breuss and Lehner (2001) put the increase to 0.05-0.1 percent of GDP.
19This presentation follows Breuss (2002a) and (2002b).
20However, negative effects of lower growth on welfare would be offset by higher capital income from abroad and improved overall efficiency from the better allocation of resources.
21See for instance European Commission (2000) or Breuss (2002a).
22The combined GDP of the ten CEECs amounts to about 10 percent of the EU15’s GDP in PPP terms.
23This is based on the estimates of Boeri and Brückner (2000) that assume free mobility of labor immediately after enlargement.
24Kohler and Keuschnigg (2001) estimate that this eliminated an average tariff of about 6 percent on Austria’s CEEC imports. They estimate the average tariff on the CEECs Austrian exports at about 7 percent.
25If this were to occur in about 35 years, annual average trade growth between the old and new EU members would have to be about 3 percentage point higher than the baseline.
26If the new entrants joined the euro area at some later date—an option not considered here—transaction costs between the EU members and the CEECs could decline substantially, further stimulating trade.
27Kratena and Wüger (2001) estimate positive output effects from more extensive outsourcing, accompanied by slightly lower employment.
28Employment growth figures are hard to interpret because of the rapidly changing number of firms with FDI in the CEECs. For example, Stankovsky (1999) reports for the 1990-96 period cumulative employment growth rates of 170 percent and 9 percent, respectively, for firms with subsidiaries in Eastern Europe and for firms with foreign subsidiaries. Total private sector employment (without agriculture and forestry) grew by a cumulative 2.3 percent over the same period.
29See Huber (2002), Tables 1 and 2, for a summary of the estimates.
30The European Commission (2000) argues that the removal of barriers to labor mobility had only a minor impact on migration flows from Greece, Portugal and Spain into other EU countries. Currently, per capita GDP relative to Germany or Austria in the Czech Republic, Hungary, Poland, and Slovakia is about the same as Portugal’s relative per capita GDP at the time of its EU accession. Relative per capita GDP in Slovenia is higher, similar to that in Greece or Spain at the time of their respective EU accessions.
32Mayerhofer and Palme (2001a), Table 4, p.33.
33Prepared by Kornélia Krajnyák. This Appendix is based on A. Katterl (2002): “On the time dimension of budget policy”, mimeo, Ministry of Finance.
34This decomposition is based on Eurostat COFOG classification of public expenditures. Consistent data are available for Austria for the 1995-2000 period. Pension and interest expenditures were categorized as past-related spending; education, environmental protection, and housing and community amenities as future-related spending; and present-related spending was defined as the residual. This decomposition is likely to underestimate past and future-related spending, as all non-pension entitlements and some public investment show up in the present-related category.

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