Chapter 14

1. Chapter 14 The European Union: Many Markets into One

2. Learning Objectives • Narrate the chronology of Europe’s regional trade agreement, from free trade area to economic union. • Describe the major institutions and treaty agreements of the EU. • Distinguish EU widening from EU deepening. • Discuss the problems of regional integration agreements that occur even when all sides want to reach agreement.

3. Learning Objectives (cont.) • Explain at least two theories as to why the single currency moved forward so quickly. • Analyze the EU’s single currency program within the theoretical framework of an optimal currency area.

4. Introduction: The European Union • The European Union (EU) is an economic union of twenty-seven nations— It is the largest, oldest, and most integrated of regional agreements • In 1979 the nine members of what was then called the European Community (EC) linked their exchange rates in a system designed toeliminate wide fluctuations among currencies

5. Introduction: The European Union (cont.) • In 1987 EEC members signed the Single European Act (SEA) aimed at creating a single European identity and a single market • In 1992, the Treaty on European Union was signed, paving the way for A common currency, the euro (1999)

6. Introduction: The European Union (cont.) • The EU is the most ambitious integration agreement in the world today • In 1958 EU was a free-trade area only, European Economic Community (EEC); as it became more integrated, the name changed to European Community (EC) • In 1993, with the implementation of treaty agreements to form an economic union, the EC became the European Union (EU)

7. The Size of the European Market • The EU is the largest integrated market in the world • Few countries are able to grow and prosper without selling their goods in the European market • A powerful incentive to accept European leadership on international issues

8. TABLE 14.1 Population and Income in the European Union, 2011

9. TABLE 14.1 (continued) Population and Income in the European Union, 2011

10. TABLE 14.1 (continued) Population and Income in the European Union, 2011

11. The European Union and Its Predecessors • The EEC born March 25, 1957 with the signing of the Treaty of Rome by the original six members. The treaty went into effect January 1, 1958 • The treaty remains the fundamental agreement, the Single European Act and the Treaty on European Union, also called the Maastricht Treaty were passed as amendments to the original treaty

12. The Treaty of Rome • The European Coal and Steel Community (ECSC) Treaty was signed in 1951 • In 1955 the European Atomic Energy Community (EAEC or Euratom) was created • The goal of the former was to create a single, integrated market for goods, services, labor, and capital

13. Institutional Structure • The EU is based on subsidiarity: The relationship between national and EU areas of authority, and between national and EU institutions • EU tackles only issues better handled through international action than individual nations • EU’s responsibility includes trade, competition, environmental policies, regional development, research and technology development, economic and monetary union • Less clear areas of authority are the social safety net, health care, and labor market policy

14. Institutional Structure (cont.) • European Commission: An executive body; each country has one vote; guardian of the treaties • Council of the European Union: A legislative branch; enacts into law Commission’s proposals; composed of ministers from each EU nation; requires qualified majority • European Parliament: Representative of popular interests in the EU; three responsibilities- passing laws, supervising institutions, passing final EU budget -Provides democratic legitimacy to EU

15. TABLE 14.2 Votes in the Main EU Institutions

16. EU Institutions and Finance • The total budget of EU for 2012 was 147.2 billion Euros ($184 billion) • The EU institutions and programs are funded by: • Tariffs and goods entering the European Union • An EU share of national value added taxes • Payment from each member country based on size of its economy

17. EU Institutions and Finance(cont.) • The two largest EU expenditure categories are: – Agricultural support, both direct payments in subsidies and indirect payments – Cohesion funds, which are used to support less developed regions within the EU

18. Deepening and Widening the Community in the 1970’s and 1980’s • EU’s deepening came from increasing the level of cooperation between member countries • EU’s widening came from including new members in the union

19. Before the Euro • In 1979, EEC members linked their currencies to prevent radical fluctuation in currency values • EC wanted to prevent competitive devaluations, in which one country devalues in order to capture the export markets of another country • Competitive devaluations inevitably generate conflict and breakdown in cooperation; devaluing country is viewedas gaining exports and jobs at the expense of others.

20. Before the Euro (cont.) • In 1979 the European Monetary System (EMS) with an exchange rate mechanism (ERM) formed; served to prepare the way for the eventual introduction of a single currency • The European currency unit (ECU) was used as a unit of account but not as a means of payment

21. The Second Wave of Deepening: The Single European Act (SEA) • In the 1980s, Low growth rates and high unemployment caused the European economies to appear stagnant and incapable of new dynamism • The EC was reshaped by the Delors Report adopted as the Single European Act (SEA) in 1987 which came to be called informally, the Single Market Program (SMP)

22. The Second Wave of Deepening: The Single European Act (SEA) (cont.) • The date for implementation of the SMP was January 1, 1993 • SEA aimed at the “four freedoms” of movement; goods, services, capital, labor

23. The Second Wave of Deepening: The Single European Act (SEA) (cont.) • The steps taken to implement the SMP can be broadly divided into three areas: • the elimination of physical barriers; passport and customs controls at the borders between member countries • the elimination of technical barriers; differences in product and safety standards • the elimination of fiscal barriers; differences in taxes, subsidies, and public procurement

24. Forecasts of the Gains from the Single European Act • The two primary means economic gains expected to be realized: 1) increase in competition, 2) increase in economies of scale • SEA created gains in economic efficiency • Removal of customs and passport checks at internal national borders • Greater economies of scale • Increased competitiveness of European firms • Overall increase in GDP growth across Europe

25. FIGURE 14.1 GDP per Person (PPP) as a Percentage of the EC-12 Average

26. Problems in the Implementation of the SEA • Four issues hampered the achievements of the four freedoms: -The Effects of Restructuring -Harmonization of Technical Standards -Value-Added Taxes -Public Procurement

27. The Erasmus Program and Higher Education The objectives of these programs: • increase student mobility • foster language acquisition • increase the sophistication and international understanding of graduates • develop international networks among business people, intellectuals, government workers, and other educated labor

28. The Third Wave of Deepening: The Maastricht Treaty • In 1991, EC members reached the Maastricht Treaty, which aimed at: • Uniform labor laws and worked rights • Defines rights of all residents to vote regardless of nationality • Health, education, cultural, and consumer safety issues in hands of European Commission • Common defense and security policies • Creation of a monetary union and a common currency under control of a European Central Bank

29. Monetary Union and the Euro • There were three stages of the monetary union: • 1990 lifting of controls on the movement of financial capital within the EU • 1994 creation of the European Monetary Institute in Frankfurt • 1999 introduction of the common currency, the Euro, and the creation of the European Central Bank • To qualify, members had to meet convergence criteria: Monetary and fiscal requirements

30. TABLE 14.3 Convergence Criteria for Monetary Union

31. Costs and Benefits of Monetary Union • Benefits • Eliminates the costs of currency conversions • Reduces the effects of exchange rate uncertainty on trade and investment • Costs • A single currency does not allow individual nations to pursue an independent monetary policy • If labor is not fully mobile and business cycles synchronised between nations, the same monetary policy may not suit all nations

32. Costs and Benefits of Monetary Union (cont.) • Governments with large deficits in the wake of the financial crisis also unable to spend • Only option for increasing demand was through exports • Domestic prices made these countries’ goods uncompetitive in world markets, their only option is to create a decline in domestic prices. This is called an internal devaluation

33. The Political Economy of the Euro • Why did monetary union push ahead? • Potential gains large and potential costs would lessen as countries became more integrated • Excitement of an SMP caused leaders to push further integration • Anxiety over German reunification in some European capitals • Strategy to tie Germany ever more deeply into a pan-European project

34. The Political Economy of the Euro (cont.) • One of the most widely voiced explanations is the single currency became necessary after the removal of capital controls that took place under the SMP • The removal of these controls made it easier to speculate in foreign currency markets

35. The Financial Crisis of 2007-2009 and the Euro • The problem for the euro-crisis countries is straightforward • First, the collapse of a real estate bubble led to a banking crisis leading to a recession • The recession depressed tax revenues expanding social spending and increasing government budget deficits • Fiscal and monetary policies become expansionary in order to stimulate demand trying to restore growth

36. The Financial Crisis of 2007-2009 and the Euro (cont.) • Second, the politics and economics of the single currency • Governments have deficits that exceed the agreed limit of 3 percent of GDP • Economies so depressed bond markets are reluctant to lend except at relatively high interest rates, adding to the debt burden • In effect, fiscal policy unavailable creating the possibility of a sovereign default; when a government defaults on its debt

37. The Financial Crisis of 2007-2009 and the Euro (cont.) • Third, the European Central Bank (ECB) manages the euro and is the central bank for the euro zone • ECB is unable and unwilling to lend directly to sovereign governments beyond a limited amount, insufficient to stem the crisis • The ECB is unwilling to expand the money supply beyond a limited level, so monetary policy is not available

38. FIGURE 14.2 Average Budget Deficit as a Percent of GDP

39. FIGURE 14.3 Gross Debt as a Percentage of GDP

40. Widening the European Union • Ten countries joined the EU in 2004 and two more joined in 2007 • Membership requires a stable democratic government, market-based economies, and formal adoption of the EU’s body of laws and regulations, known as the acquis communautaire

41. Widening the European Union (cont.) • Members benefits • For prospective members, many gains from trade already realized since most countries have free trade agreements with the EU • Some, such as Iceland, already participate in the Schengen Agreement • Membership confers some additional benefits; a voice in EU governance, more secure set of property rights, additional investment and trade from the adoption of EU laws

42. Widening the European Union (cont.) • Issues to be resolved • First, the EU budget contains a shrinking but still extensive set of farm support programs • Direct payments to farmers were about 30 percent of the EU budget in 2011 with another 11 percent for rural development • Much of this amount is administered under the Common Agricultural Program (CAP) providing farmers about 23.5 percent of their revenue

43. Widening the European Union (cont.) • Second, EU governance structures were not designed for twenty-seven members • New members add pressure to change the voting system • Third, voting, democracy, and governance gap between the poorest and the richest members is wide • The original six EEC members were more-or-less equal in incomes, level of institutional development, security of property rights, and rule of law

44. The Demographic Challenge of the Future • A number of future challenges are visible for the EU: • It must continue to create convergence in income and living standards between its poorest and its most well- off members • It must prepare for further widening • It must adapt its economies and social support systems to prepare for a much older population

45. TABLE 14.4 Population Forecast, 2010–2040: Twenty-Seven Members of the European Union