Press Release No. 06/28

Press Release: IMF, National Bank of Poland, and Joint Vienna Institute High-level Conference on Labor and Capital Flows in Europe Following EU Enlargement

February 8, 2006

A high-level conference on 'Labor and Capital Flows in Europe Following Enlargement' was jointly organized by the International Monetary Fund (IMF), the Joint Vienna Institute and the National Bank of Poland at the NBP on January 30-31, 2006. The conference program and papers are available at http://www.jvi.org/index.php?id=4447.

The conference brought together policy makers and academic experts to address three main questions. How large are labor and capital flows in the enlarged union likely to be? To the extent that labor mobility is limited, will capital flows be larger? How will labor and capital flows affect growth, wages, employment and economic structures in sending and receiving countries? What policies enhance benefits and mitigate costs of labor and capital flows?

Several important majority views emerged from the discussions.

Removing restrictions on migration within the enlarged EU would probably elicit relatively small labor movements—especially in relation to those originating outside the EU. About 3 percent of the population of new members (or less than 1 percent of the population of the old members) is likely to work at any one time in the old members once the adjustment is complete. Labor flows since enlargement have been much smaller than this. Emigration to the UK and Ireland has been larger than to other destinations—either because of the absence of restrictions, better labor market conditions, or more flexible institutions allowing better utilization of labor inflows.

An important basis for popular antagonism to labor inflows was a perception that migrants could overwhelm domestic welfare systems. Transitional arrangements that limited access to these systems instead of limiting migration therefore made sense.

The forces at play in European integration are a localized version of the broader forces of globalization. To be successful on the European or global stages, policies need to support competitiveness. In short, given the opportunities for global trade and as well as insourcing and outsourcing of intermediate production, sustainable wage relativities and rates of return on investments were being established in global markets. Attempts by one country or cluster of countries to set high reservation wages, reduce wage dispersion, or sustain labor-cost augmenting social policies would affect migration, investment in physical and human capital, competitiveness, and ultimately growth.

A "war for talent" is emerging within Europe as well as globally. Evidence suggests that German and Austrian firms had improved their competitiveness (particularly in the face of skill shortages) by using skilled labor inputs from the new members.

Converging institutions and substantial differences in capital-to-labor ratios were bound to elicit large capital inflows into the new member states. This would mean substantial increases in current account deficits, external liabilities, liquidity, bank credit, and foreign exchange exposure—alongside rapid growth. For the fixed exchange rate countries, the sooner they could join the Euro area the smaller would be the window of currency-related vulnerabilities. For the flexible exchange rate countries, incipient inflows could strengthen currencies, with dampening effects on competitiveness, profitability, and growth.

A number of participants thought that capital flows were unlikely to be volatile insofar as they were driven predominantly by long-term investment decisions. Vulnerabilities associated with substantial capital flows were nonetheless intrinsic in the situation; good policies—especially in conjunction with Euro adoption—could lessen them but not remove them entirely. Early euro adoption would relieve the currency-related vulnerabilities.

Finally, tax policies could exert an influence on the amount and location of investment. There was, nevertheless, little enthusiasm for strict tax harmonization and some support for tax competition.