European Economic Relations

1. European Economic Relations Prof. Dr. Dirk Wentzel Jean Monnet Chair in European Economic Relations Summer Semester 2016

2. Agenda • Part 1: Foundations and Basics of European Integration • Introduction • Eight questions about Europe • Theories and Strategies of Economic Integration • Where does Europe come from?  - The historical perspective • Institutions and bodies of the European Union • Part 2: • Monetary Integration in Europe: The EMS • European Central Bank (ECB) • The Evolution of a Stability Culture in Europe

3. “Unitedin Diversity!”

4. Eight questions about EuropeA systematic economic introduction • What is Europe? • Europe is a Community of Values • Tolerance • Democracy (all countries must be democratic) • Rule of Law • Openness (open to new ideas, technology, culture…) • Non-discrimination (for example, women and minorities are not discriminated against)

5. What is Europe? b) Europe is an Economic Community • Europe is “economically a giant” (Henry Kissinger) • Biggest Common Market worldwide (over 500 million people) • Free trade elevates the prosperity and wealth of all participating nations (Adam Smith) • Trade relationships drive dependence and interdependence - “He who trades doesn’t shoot!” • Development of the European Union, starting with the European Coal and Steel Community in 1951, was primarily a result of similar economic interests (the Monnet Plan) • The realization of the Common Market was a decisive milestone for European integration

6. What is Europe? c) Europe as a Geographical Entity • Europe is surely a geographical entity“European Council” vs “Council of the European Union” ? • But: Some European countries (e.g., Russia, Turkey) are partially in Asia • North African countries (Morocco and Tunisia) want to become EU members • Israel is a part of Europe, at least in respect to sports and culture • Norway and Switzerland are a geographical part of Europe, but are not EU members

7. What is Europe? d) Europe is a Political Community • Europe is “politically a dwarf” (Henry Kissinger) • The basic consensus of democracy binds the nations • But: the political willingness to act is restricted (Balkan crisis, Kosovo conflict, currently Crimea crisis) • Real political unity requires political sovereignty to be centralized – is that the solution European countries want? • Example 1: the question of environmental protection • Example 2: conflict between “old and new Europe” in Iraqi war • Example 3: opting out regarding the adoption of the EURO?

8. What is Europe? e) Europe as a Religious and/or an Ethnic Community • Is Europe a “Christian community”? • Europe is based on specific Christian ideologies • EU is ruled by a clear separation of church and state • Basic tenets of religious freedom and tolerance • “Behind closed doors”: The political dimension of religion

9. What is Europe? f) Europe is a Cultural Entity • Europe is defined by its common cultural heritage (Greece, Turkey, Rome, Russia) • Important: what constitutes “European style” and “European culture”? • Cultural borders are not congruent with the present geographical borders of the European Union (e.g., Russia)

10. What is Europe? What is Europe? • Europe is much more of an open dynamic process in which the outcome is not clearly foreseeable

11. Eight questions about EuropeA systematic economic introduction • Who belongs to the European Union? • European Economic Community (EEC) in 1957 after the ratification of the Treaty of Rome, beginning with “the Six” • Precursor of the EEC: the European Coal and Steel Community (later merged as part of the European Community) • “The Six”: Germany, Belgium, the Netherlands, Luxembourg, France and Italy • In 1973, the EC 9 (+ Great Britain, Ireland and Denmark) • In 1981, the EC 10 (+ Greece), “Cradle of Democracy” • In 1986, the EC 12 (+ Portugal and Spain)

12. Who belongs to the European Union? • In 1990, the EC due to the German reunification the EU expanded • Treaty of Maastricht in 1992, EC became EU • On January 1, 1995, EU 15 (+ Austria, Finland and Sweden ) • Norway decided against EU membership in referenda in 1973 and 1995 • On May 1, 2004, EU 25 (+ Slovenia, the Czech Republic, Slovakia, Malta, Cyprus, Hungary, Estonia, Latvia, Lithuania and Poland ) • On January 1, 2007, EU 27 (+Romania and Bulgaria) (“Economies of shortage”) • January 1, 2010: Treaty of Lisbon • 2013: Acceptance of Croatia to EU 28 • 2014: The Banking Union (SSM + SRM)

13. Eight questions about EuropeA systematic economic introduction • How have the integration steps been implemented so far? • Differentiation between political and economic logic • Europe is characterized by political as well as economic considerations • “Common market” and “freedom of movement”, European economic integration in general has been extremely successful and improved further integration

14. How have the integration steps been implemented so far? • But: Political implications: EC created a military counterweight against the Soviet Union and the Warsaw Pact; Parallelism between NATO and the EC • And: Sometimes trade-off between political and economic decisions • Neglecting the economic ratio – a great danger for Europe! • An example of the interplay of politics and economics: The Airbus A380

15. Eight questions about EuropeA systematic economic introduction • Which integrations steps were fundamental?

16. Which integrations steps were fundamental? • In 1946, Churchill challenged the establishment, calling for the United States of Europe (USE) during a speech in Zurich • With that he referred to continental Europe, viewing England as a long-time independent power outside of the old continent • In 1948, the Marshall Plan was implemented in Europe (European Recovery Program) (up until 1952) • NATO was established in Washington, DC • In 1950, French foreign minister Robert Schuman suggested the first step towards European integration (Schuman Declaration)

17. Which integrations steps were fundamental? • In 1951, the European Coal and Steel Community (ECSC) was founded to combine management of the most important resources at that time – coal and steel • In 1952,a proposal for a European Defense Community was put forth – failed in ratification in France in 1954 and was abandoned • Europeans favored membership in NATO because only in cooperation with the USA would a credible counterweight against the USSR be created

18. Which integrations steps were fundamental? • In 1957,Treaty of Rome led to the establishment of the European Economic Community (EEC) in 1958, considered the birth of the European Community. At the same day, the EURATOM-Treaty (European Atomic Energy Community) was passed • EEC: Created a common market • EURATOM: Cooperation in nuclear power; shared the Common Assembly and the Court of Justice of the ECSC, but not it’s executives. EURATOM is still a distinct legal personality, treaty remains in force after the Maastricht-Treaty created the EU

19. Which integrations steps were fundamental? • 1957: The founding of the European Free Trade Association EFTA (Austria and Northern Europe; today European Economic Area) – “second pillar of Europe” • Important: Austria was committed to neutrality and was not allowed to be a member of the EEC • 1963: First great conflict between France and England - De Gaulleused his veto against the admittance of Great Britain (regarding agriculture commodities market ) • This began France’s “empty chair” politics in the European Council

20. Which integrations steps were fundamental? • 1967: The Merger Treaty fused the 3 main institutions (EEC, Euratom, ECSC) to one council and a commission • 1971: The Werner Plan for the creation of a monetary union • 1973: Admission of Great Britain, Ireland and Denmark • 1974: Founding of the European Council (also referred to as European Summit) • 1976: First general European election • 1979: Through the initiative of Helmut Schmidt and Valéry Giscard d’Estaing, the European Monetary System was founded

21. Which integrations steps were fundamental? • 1981: Admittance of Greece • 1985: Adoption of the single market program • 1986: Acceptance of Portugal and Spain • 1986: The Single European Act (Einheitliche Europäische Akte), in a first step towards the creation of the union • April 12, 1989: The Delors report detailed plans for the Economic and Monetary Union (EMU) of the EU • November 9, 1989:  The fall of the Berlin wall led to a drastic structural change for the entire system of European integration

22. Which integrations steps were fundamental? • The complete liberalization of capital flows in Europe • 1992: The Maastricht Treaty established the European Union and the adoption of a common currency, Euro. Convergence criteria were defined to secure lasting monetary and fiscal discipline • 1992: Beginning of the first phase of the EMU • 1993: Beginning of the single European market • January 1, 1994: Beginning of the second phase of the EMU • 1995: Acceptance of Austria, Finland and Sweden • 1996: Customs union between the EU and Turkey • 1997: Treaty of Amsterdam

23. Which integrations steps were fundamental? 23

24. Which integrations steps were fundamental? • 1998: The eastern expansion of the EU was agreed • 1999: Start of the third phase of the EMU • March 15, 1999: The European Commission stepped down in the face of corruption charges • 2000: European Charter of Fundamental Rights • 2000: Denmark voted against the introduction of the Euro • 2001: Treaty of Nice, which sought reform of the EU Treaty, was deemed as a difficult political setback

25. Which integrations steps were fundamental? • January 1, 2002: Introduction of the Euro currency • 2002: In the Treaty of Copenhagen, the principles and criteria of the eastern expansion were defined • May 1, 2004: eastern enlargement (EU 15 + 10) • 2005: Beginning of accession negotiations with Turkey • 2005: Consent granted for Romania and Bulgaria to join in 2007 • 2007: Admittance of Romania and Bulgaria • January 2010: Lisbon Treaty • May 2010: Crash of the Greek economy • 2013: Acceptance of Croatia (No. 28) • November 2014: The Banking Union (SSM + SRM)

26. Eight questions about EuropeA systematic economic introduction • Is there an optimal integration depth? • How deep should we integrate? • Optimal integration depth is discussed from different ec. angles • Concept of “Economics of standardization” • Common standards: language, traffic rules (e.g., driving on the left or right side), or technology (e.g., computer standards) • Common standards reduce transaction costs, thus increasing economic efficiency: But how should the common standards be determined?

27. Is there an optimal integration depth? • Danger: wrong standards can be applied or that the standards will need to be updated due to technological innovation, but path dependencies make modifications unlikely • The famous case of QWERTY • Integration of an economic area is practical if same standards are possible, trade barriers eliminated and trading intensity increased • Within EU: Strong tendency towards harmonization within the technical and institutional framework • But: Standardization leads to bureaucratic centralization

28. Is there an optimal integration depth? • Note: “Standardization” is always a restriction to competition and thus to a reduction of innovation potential • Standardization that follows the principle of subsidiarity: “Each problem that arises should be solved at the most local level possible.” • An “optimal” depth of integration is achieved when the advantages of the use of common standards and markets outweigh the disadvantages of standardization • Note: Competition and harmonization  (or centralization) are difficult areas of conflict for future European integration politics

29. Eight questions about EuropeA systematic economic introduction • Is there an ideal integration speed? • It requires in turn a considered decision • A very fast integration can lead to a step backwards in reform efforts, andbenefit domestic market by increasing the relevant market • A slow or even a delayed integration can lead to disappointment of accession countries, e.g., Turkey • It must be determined how to proceed with some of the former Soviet Republics and especially the Balkan States

30. Is there an idealintegration speed? • Politically, it may be argued that advantages of a faster expansion outweighs disadvantages of a bigger union • There are graduated integration forms (see “Trade Theory”), so integration is not an “either/or” decision • Important: the more humbly and realistically integration is conducted, the faster new accession countries can be admitted • Note: before every new integration step, it must be guaranteed that the union remains capable of acting!

31. Eight questions about EuropeA systematic economic introduction • How should Europe design its economic foreign relations? • In foreign relations, Europe is frequently considered protectionist, (e.g., to developing countries or at the WTO negotiations) • Europe has an economically successful domestic market • Europe partially follows a common trade policy – Its trade policy belongs to collective politics • But: Europe is in danger of risking its domestic integration advantages by imposing trade restrictions in foreign relations

32. How should Europe design its economic foreign relations? • “Fortress Europe” • Currently: in WTO negotiation, EU agricultural protectionism is the major bottleneck • EU promotes economic development in Africa, Asia and Latin America, but creates serious obstacles with the Common Agricultural policy (CAP) • “less aid for more trade” • Important: special relationship of the EU with Russia • Should Europe become an economic “counterweight” to the USA? • The idea of economic networks instead of economic poles

33. How should Europe design its economic foreign relations? • Economically speaking: It is impractical to only think in a few meaningful categories of polarized trade regions • Europe is characterized by relatively weak economic growth in comparison to other economic regions of the world economy – in large part “home-grown” and can be traced to failed regulatory policy • Continued isolation and formation of blocs will surely contribute to the further stagnation of economic growth

34. Eight questions about EuropeA systematic economic introduction • What freedoms does Europe need? • Economically speaking, Europe is built on the basic principle of political and economic freedom • The economic freedoms are manifested in the Single European Act, which was introduced in the summer of 1985 in Milan and signed on February 17, 1986

35. What freedoms does Europe need? Characteristics of the economic freedoms: • Free movement of goods • Freedom to provide services • Free movement of capital • Free movement of people • Cassis de Dijon Case (1979) • German beer and the “Reinheitsgebot” (purity law) • The Bosman case(1995) on European football

36. What freedoms does Europe need? Central feature: freedom of opinion, ideas and the press • Europe relies on the free exchange of ideas and opinions in a special way • The exchange is promoted through the mutual recognition of university degrees and ease of student exchange • Important: uncompromisingly guaranteed freedom of the press • The European Union has earned recognition for breaking up national broadcasting monopolies, especially in Germany • Long run: it must be ensured that no country reverts back to protectionism in international competition of ideas

37. Theories and Strategies of Economic Integration • Global vs. regional integration Global Economic Integration • General rule: “to whom it may concern” • Global integration of markets addresses everyone and is based upon the common principle of nondiscrimination • Trade liberalization can be interpreted as a dynamic process (cause) as well as a final state (effect) • Cause of trade liberalization through removing trade barriers • Effect of the flow of trade under free trade conditions

38. Global vs. regional integration • Idea of free trade: promotion of international trade through imports and exports leads to increased wealth for all participants (theories of absolute and comparative advantage) • Consumers profit the most from free trade because they can consume better quality for lower prices

39. Global vs. regional integration • Protectionism: protection of ones own industry by discriminating against other countries and their industries • Tariffs: addition to foreign prices and defense of imports (Example: protectionism of the EU in the agricultural sector) • Tariffs in “infant industries” • Non-tariff trade barriers: Quotas • Neo-protectionist measures: With a rhetorical guise: social dumping, ecological dumping, tax dumping • So-called “strategic trade policy”

40. Global vs. regional integration Institutions of global integration World Trade Organization (WTO) (1995) General Agreement on Tariffs and Trade (GATT) General Agreement on Trade and Services (GATS) Trade Related Aspects of International Property Rights (TRIPS)

41. Global vs. regional integration Regional economic integration • Ex ante restricted to a limited number of nations • Empirical examples:  NAFTA, APEC, Mercosur, EFTA • A regional economic integration is regarded as a quasi- “club good” • “Economic Theory of Clubs” by James M. Buchanan • Participants voluntarily offer a “club good”, which has differing advantages for the participants • But: Clubs as we know them can have exclusion effects

42. Global vs. regional integration Regional economic integration • Static and dynamic effects • Trade creating effectsand trade diverting effects (Jakob Viner) • Pro-competition effects and economies-of-scale effects come about in the longer run by the impact of changes in economic structure • Dynamic effects come about in the longer run by the impact of changes in the economic structure of the Economic Union on the pattern and rate of economic growth

43. Global vs. regional integration • Question: from the viewpoint of the common economy, when does regional economic integration have advantages and when does it have disadvantages? • To scientifically discuss this question, you need to determine quantitative criteria • If trade creating effects outweigh trade diversion effects (tce > tde), then regional economic integration is compatible with WTO regulations of non-discrimination

44. Theories and Strategies of Economic Integration • Development scheme of regional integration Alternatives for regional integration • Functional integration (1st degree): free trade zone or customs/tariff union • A relative production maximum is reached in the best case without increasing factor mobility between the countries of the integration area. The Gap to an absolute maximization of production follows from the fact that marginal productivity of production factors can only be balanced between the participating countries (Because the production factor mobility is still missing in the integration area).

45. Development scheme of regional integration • Functional integration of the 2nd degree: common market with free production factor movement • Not only can products and services be traded on national market without restrictions, but also production factors are free to move amongcountries of common market. Discrimination in the economic exchange as well as competition tampering are forbidden • Institutional integration1st degree: incomplete economic union with coordinated economic policy • Institutional integration of the 2nd degree: economic and monetary union with common trade policy-making body in the shape of supranational administration

46. Options of regional integration

47. Development scheme of regional integration Free trade area • Reduction of tariffs and trade barriers within the tariff union • The participants of the tariff union cling to their autonomy against third countries • No common foreign tariff Customs Union • One or more trade areas are joined into a common tariff area • There is a common tariff applied to third countries  Differences: complete customs union vs. preference union

48. Development scheme of regional integration Common Market • Abolishment of all barriers concerning the production factor mobility • Right of freedom of travelers, students, employees, and money… • Attempt to coordinate and fit to the domestic economic policy like: • Harmonized economic and competition policy • Harmonized monetary policy or complete convertibility of currency • Harmonized tax and finance policy • Harmonized social policy

49. Development scheme of regional integration Economic Union and Monetary Union • Standard currency with a supranational central bank • Completely harmonized economic and competition policy • Supranational institutions • Assignment of national sovereignty rights in all fundamental areas of economic policy • Idea is the complete creation of an “exchange-, price- and payment-community” (Wilhelm Röpke)

50. Development scheme of regional integration Note: The last three integration forms are characterized by an internal dynamic that it can drive them to further integration • Increasing interdependence triggers externalities • States have to adopt cooperative policies to internalize these externalities • New supranational rules and institutions are needed • Externalities to non-member states may lead to a further integration of these states (enlargement)