The Internal Value of External Options

Most of the literature has treated EU enlargement and the transition of Central and Eastern Europe, two of the most memorable events in recent history, as separate events. We argue that such separation is not warranted; it obfuscates an important fact, namely that the reform process in many Central and East European countries has taken a sui generis turn precisely because of the external EU option. We offer a formal model that explains how and why the EU membership option drives regulation in applicant countries beyond their equilibrium level of regulatory quality. We derive a series of hypotheses from our model and test these hypotheses employing standard panel methods. Empirical results support our model and suggest that approximately 40% of the variance in regulatory quality among transition countries is explained by EU conditionality in the enlargement process.