Less than a decade ago, millions of men and trillions of dollars’ worth of equipment stood ready for combat in Europe. The demise of the political systems of Eastern Europe and the Soviet Union defused that situation, and the ‘creative destruction’ that followed opened the door to great opportunities. It also threatened potentially grave dangers.

On the bright side, continuing economic success in the East will foster prosperity and peace throughout the continent, locking in democracy and the full range of pro-market reforms. What’s more, a hundred million eastern consumers with rising incomes will be an enormous boon for West European businesses.

But on the darker side, stagnant or falling incomes and the impoverishment of a large slice of the eastern population could foster widespread disillusionment with market economics and democracy. Most worrying of all is that this may occur while a power vacuum exists in Central Europe.

Geography and history make these continent-wide problems. Any serious unrest or conflict – even if it were limited to the East – could bring considerable harm to Western Europe through surging migration, increased defence expenditure and calamitous changes in investors’ attitudes. In short, economic failure in the East could threaten peace and prosperity in the West.

Many have argued that the best way to promote stability and prosperity in the eastern region is to incorporate it swiftly into the European Union (EU). In a recent paper in Economic Policy, Richard Baldwin, Joseph Francois and Richard Portes examine the economics of this option. They argue that there are four parts to the calculus: the costs and benefits for the East and the costs and benefits for the West.

Baldwin and his co-authors note that most of the recent literature on this subject has focused on the costs of an eastern enlargement to the EU’s budget. They attempt to fill in two additional and important parts of the calculus: the economic benefits for both the East and the West. The final part, the cost of enlargement for the East, seems to defy quantitative assessment: here the main issue is the extent to which adoption of the EU’s ‘acquis’ will stunt eastern growth and raise regional rates of unemployment.

According to Baldwin et al, one of the most important effects of a successful eastern enlargement relates to foreign investment. They argue that joining the EU will make the region substantially less risky from the point of view of both domestic and foreign investors.

On the microeconomic side, EU membership greatly constrains arbitrary changes in trade policy and indirect taxation. It also locks in well-defined property rights and codifies policies on competition and state aids. And by securing open capital markets and rights of establishment, membership assures investors that they can bring in and take out their money with ease. Finally, EU membership guarantees that regional products have unparalleled access to the markets of the current EU-15, which represent almost 30% of world income.

On the macroeconomic side, EU membership could put the eastern region on the path to eventual monetary union. And that should provide a solid hedge against possible spurts in the rate of inflation. These two aspects of membership will be mutually reinforcing and are likely to have a related impact on investor confidence.

The researchers estimate the long-run economic benefits and budgetary costs of eastern enlargement. The former are calculated using a computable equilibrium model set up to estimate benefits under two different scenarios. The first scenario treats EU membership for the East as entailing only the standard elements: access to the single market and adoption of the common external tariff. The second assumes that in addition, membership promotes regional investment by stabilizing the economic and political climate – this in turn reduces the region’s country-risk premia.

The results suggest that under both scenarios, the EU-15 will gain about 10 billion ecus in real income. But this gain is likely to be very unevenly distributed among the current EU members: an extremely rough calculation indicates that Germany, France and the UK would together gain 70% of the total, while Germany alone would gain 40%.

For estimating the costs of eastern enlargement for the EU’s budget, Baldwin et al use two very different approaches. The first is based on recent literature that estimates the East’s likely receipts from the Common Agricultural Policy (CAP) and cohesion funds, plus a rough guess at the region’s likely contributions to the EU budget. This gives a consensus estimate of the cost of a Visegrád enlargement in the year 2000 of 17 billion ecus.

The second approach involves a ‘power-politics’ model of the EU budget, in which members’ receipts are related to their voting power in the Council of Ministers and their per-capita national contributions are related to their per-capita income. Using this model to project the budgetary cost of a Visegrád enlargement gives a figure of 15 billion ecus.

Putting the potential economic gains and budgetary costs together, the authors argue that eastern enlargement is a phenomenally good bargain for the incumbent EU-15. Leaving aside questions about the actual timing of costs and benefits (and the particular countries that would feature in the first enlargement), the costs outweigh the benefits by no more than 5 to 7 billion ecus.

This is something like one-tenth of 1% of the EU-15’s current GDP, an extraordinarily low cost given the historical nature of the challenge in Eastern Europe. At the same time, Baldwin and his colleagues estimate that in the long run, EU membership would be enormously beneficial to the economies of the eastern region.