Europe and Economic Integration

1. Europe and Economic Integration Historical and Political Context, Bacic Concepts Europe in Global Economy

2. Single market • 1980s Europe stagnated, while US and Japan surged ahead (losing market share in cars, electronics…) - deeper integration seen as a receipt; • When status quo proved untenable – response was to push ahead with integration; • Governments such as FRA and UK were using the institutions of the EC to advance their nationalagendas – delegating to the Commission and the Court responsibility for implementing painful economic reforms; • Founding document – white paper by team of experts 1985 the Cockfield Report (UK civil servant) – summarized dissatisfaction with progress; • Reinvigorating growth and accelerating the integration – portrayed as synonymous; • Goal: market freenotjust of internal tariffs but also of regulatory barriers to the movement of goods and services (Common -> Single); • Intergovernmental conference 1986 -> Single European Act(SEA) – commitment to establish a single marketfree of barriers to the movement of goods and factors of production + greater use of qualified majority and cooperative procedure (first direct elections to parliament 1979); • SEA provided expansion of the structural Funds – program for funding of infrastructure investment in its poorer member states – side payment; • SEA emphasized the need for cooperation in the conduct of economic and monetary policies – progressive realization of monetary union;

4. Context of Maastrich Treaty • 1 January 1993 – singlemarketcomplete; • The share of intra-EC imports in consumption rose from 22,6% to 25% (1986-1992); EU attracted 45% US and 21% JAPFDI, intra-EU share from 31%-51%; • With the relaxation of controls, even discussion realignment of exchange rates was risky – no realignments after 1987 – necessary to replace separate national currencies with single currency; • Bundesbank set the tone for monetary policy – inflation in GER low, DMhad tendency to appreciate – othercentral bank were forced to follow to prevent excessive depreciation; • FRA perspective: unfairlybearing a disproportionateshare of the adjustment burden – EMS would create a collectivepolicyspace + more expansionary thrust for macroeconomic policies; • GER – skepticism of monetary union but advocating elimination of capital controls (monetary union as quid pro quo) + committed Europeanists saw foreign (FRA, ITA) criticism of Bundesbank as destructive to goal of FRA-GER partnership (H.Kohl); • Coalition of leading companies formed Association for Monetary Union in Europe – voicing support (exchange-rate risks and transparency) + financial institutions saw single currency as economy of scale opportunity;

5. Economic and monetary convergence • Delors report (1989) recomended empowering ECOFIN Council and Parliament to impose bindingceilings on fiscal deficits + proposed that record of sound fiscal policies should be a precondition for joining monetary union; • It was compromise between GERinsistence on priviledging stability (central bank independence) and operation of market forces and the more politicizedapproach of the French; • New ECB organized alongBundesbanklines – politicaly independent and price stability as its primary objective; • Presumption that only a small subset of member states with impeccably strong and stable policies would qualify for participation; • Set of macroeconomic preconditions – convergence criteria: • Inflation within 1.5 percent of three lowest; • Long term interest rates within 2 percent of three lowest; • National debt no more than 60 percent of GDP; • Budget deficit no more than 3 percent; • Exchange rate within 2.25 percent bands of the Exchange-Rate Mechanism; • Stages: independence of central banks + removing remaining capital controls 1990-1993; creation of European monetary Institute 1994; union itself no later than 1999;

7. Key Issues • Key tool mutual recognition– accepting the regulations and standards of other EU countries + activities lawful in one member to be pursued throughout the EC; • Government procurementtenders- reducing bias toward domestic producers -argument of efficiency of natural monopoly; • Mutual recognition of professional credentials; • Since 1990 control of mergers – restraining the tendency of states to grant legal monopolies (telecom, transport, post, gas, electricity); • Services was sticking point – (insurance, business services) states required foreign firms establishing subsidiaries to undergo lengthy and often discriminatory authorization; • 2005 services directive– granted companies the right to provide services in all member states so long as they followed the laws of their home states – opposition from high-income countries; • Financial services: after elimination of capital controls 1988 by EC directive –proceeded rapidly; • Frustratedindustrialpolicy ambitions – removed barriers for foreign banks to entry market - for 40 years governments has useddirectedcredit - to advance their industrial policies – now financial sector privatized and domestic bank competed with foreign; • Integration increasingly came to be identified with liberalization + Commission perceived itself as an agent of deregulation; • Increased mobility of tax base – pressure for reductions in rates of taxation – to limit the danger that high taxes would cause capital to migrate abroad – states with large public sectors pushed for tax harmonization – UK saw single market as a mechanism for forcing corporate and personal tax rates down resisted;

9. Economic integration – Basic Concepts • Concept used since 1942; • State of affairs or a process which involves the amalgamation of separateeconomiesintolargerfreetradingregions; • Sometimes used for - simply increasing economic interdependence between nations – now globalization; • Integration- regional integration: • Regional trading agreements(RTAs), preferential trading agreements(PTAs) – discriminatoryremoval of all tradeimpediments between participating nations and establishment of certain elements of cooperation and coordination between them;

10. GATT/WTO rules • Article 24 GATT allows the formation of RTAs -are discriminatory associations – may not pursue policies which increaselevel of their discrimination beyond what existedprior to their formation+ tarrifs and other trade restrictions are removed on substantialy all the trade among participants; • Drafters article 24: Economic integration do not contradict the basic principles WTO – trade liberalization on MFN basis (lowest tariff applicable to one member must be extended to all members), non-discrimination, transparency of instruments used to restrict trade (tariffication), reciprocity and promotion of growth and stability of world economy; • Serious arguments suggesting article 24 contradictsspiritWTO – however if nation decide to treat another as if part of single economy, nothing can be done to prevent; • Integration schemes like EU – strong impulse toward liberalization + WTO have no coercion power; • Argument against: nothing can be morediscriminatory than for a group of states to remove all tariffs on mutual trade while at the same time maintaining the initial levels against outsiders;

11. Integration ladder • Customunions (CUs) member nations must conduct and pursuecommonexternalcommercialrelations – common external tariffs (CETs) on imports form the nonparticipants (EU, CACM, CARICOM); • Common markets – CUs that also allow for free factor mobility across national members frontiers (capital, labor, technology, enterprises), EU; • Complete economic unions – CMs that ask for complete unification of monetary and fiscalpolicies, participants must introduce a centralauthority to exercise control over these matters – nation effectively become regions of the same nation (Eurozone close); • Complete political unions (PUs) – one nation – central authority needed in CMs paralleled by a common parliament and institutions needed to guarantee the sovereignty of one state (Germany 1990);

13. Gains from economic integration • In reality existing economic integration (especially EU) were formed for politicalreasons even though the arguments popularly put forward were expressed in terms of possible economicgains; • FTA and CU possible sources of economic gain: • Enhanced efficiency in production by increased specialization in accordance with the law of CA; • Increased productionlevel due to exploitation of economies of scale - increased size of market; • Improved international bargainingposition because larger size, potentially better termsof trade; • Changes in economicefficiency brought about by enhanced competition; • Changes affecting amount and quality of the factors of production arising from technologicaladvances; • BeyondCUlevel to the economic union level – further sources of gains: • Factormobility across the boarders of member nations; • Coordination of monetary and fiscal policies; • The goals of near fullemployment, higher rates of growth and better incomedistribution becoming unified targets…

14. Economy • Before the theory of second best was introduced; • accepted tradition that CU formation should be encouraged – since free trade maximize world welfare, CU formation was a move towards free trade, CUs increasewelfare (even though do not maximize it); • This rationale – GATT 24; • Viner 1950 challenged this proposition – CU formation is not equivalent to a move to free trade; • Combination of free trade and protectionism could result in tradecreationand/or trade diversion; • TC is replacement of expensivedomestic production bycheaperimports from partner; • TD is the replacement of cheaper initial imports form the outsideworld by more expensive imports form a partner; • TC is beneficial since it does not affect the rest of the world, TD is harmful – relativestrength of theseeffectsdetermines whether CU formation should be advocated; • Policy of unilateral tariff reduction is superior to custom union formation (Cooper-Massell criticism); • Johnson’s assumptions: • Government use tariffs to achieve certain non-economioc (political) objectives; • Actions taken by governments are aimed at offsetting differences between private an social costs – rational efforts; • Government policy is rational response to electorate; • Countries have a preference for industrial production...

18. Custom unions vs. free trade areas • FTA may result in deflection of trade, production and investment – deflection occurs when imports from RoW (cheapest source of supply) come to the highertariffpartnervia the member country with the lowertariff rate; • Deflection of production and investment – in commodities whose productionrequires quantity of raw materialsimported from RoW; • If deflection occur, then the FTA effectively becomes a CU with a CETequal to the lowesttariff – beneficial for the world; • FTAs adopting rules of origin – only those commodities which originate in a member state are exempt from tariff imposition.

19. Economic unions • Freefactormobility may enhanceefficiency – more rationalreallocation of resources; • Depressedareas – regional problems and imbalances; • Fiscal harmonization may improve efficiency by eliminatingNTBs and distortions and by equalizing their protective rates; • Coordination of monetary and fiscalpolicies – implied by monetaryintegration – easeunnecessarilysevereimbalances – promotion of the right atmosphere for stability; • Factormobility: • Lmove to those areas where it can obtain the highest possible reward – neednot necessarily lead to an increase in actualmobility – socio-political factors which normally result in peopleremaining near their birthplace – social proximity is a dominant consideration; • If the reward to K is not equalized will move until equalized; • K and L are neverperfectlyimmobile at the international level and MNCs have ways of transferring K; • K may move to areas with lowwages in Economic Union – if K moves predominantly in one direction – depressedarea – social costs and benefits need to be taken into consideration; • Particularly if the EcU deems it important that economies of H and P shouldbebalanced.

20. Income effect • Balasa 1974: welfare gain from trade creation in manufactured 0,7bill. USD 1970; welfare gain 0,15% of GNP – surprisinglysmall amount; diversion in agriculture loss from diversion 0,3 bill. USD; • Most studies –welfare gain form liberalization quite small; • Trade accounts for small proportion of total output, tariffreduction resulting from integration small; • Intra-industry specialization – increasedchoice – potential EoS effects; • Increasedcompetition – if producers forced to cut prices – consumers will enjoy increase – dynamic effects of integration; • May be more important type of gains – reductions in unit costs resulting from greater plant specialization and increased competitionaffect the full range of products -not only traded; • Elimination of tariffs was irreversible reduction of the risk for producers and investors; • Owen 1983: firms are forced to rationalize their operations =large low cost plants– cost reduction resulting form intra EC trade creation – welfare gain for six EC members from dynamic effects 3-6% GNP; • Cecchini report 1988: gain from removingNTBs by estimating the cost to the EC of having NTBs – gains ECU 70-190 bill., 2,5-6,5% EC GDP: • Change in welfare as %of GDP: France 2,27; GER 2,47; Italy 2,22; UK 2,8;

21. Europe • Paris1951European Coal and SteelCommunity(ECSC); • Rome treaty 1957European Economic Community and European Atomic Energy Community; • 1965 – sensible to merge the three entities into European Communities (EC); • Accessions: Denmark, UK, Ireland1973; Greece1981, Portugal and Spain1986; East Germany 1990; Austria, Finland and Sweden1995; and 10 CEE countries 2004; Bulgaria and Romania2007; • Candidates: westernBalkan and Turkey (Copenhagen 2002 – candidate 36 years, Kurds, army, conflicts – Cyprus 1974, France 2005 membership conditional on referendum); • EU, Island, Lichtenstein, Norway – European economic Area (EEA) 1992 – virtual membership without having say in EU decisions + Switzerland; • Treaty on EU (Maastricht treaty – ratified and extended by Treaty of Amsterdam – transformed the ECinto the EU1994 – centralbank, singlecurrency (13 members), commonforeign and defensepolicy; • EFTA - 1960 Stockholm convention, free manu goods: AUT, DEN, NOR, POR, SWE, SWI, LIE, associate member FIN1961, ICE joining 1970; • Eastern Europe – CMEA1949 BUL, CS, DDR, HUN, POL, ROM, USSR + MNG, CUB, VIE– did not achieved much in the nature of economic integration; • 12 out of 15 former Soviet republics formed ComonwelathofIndependentstates (CIS); • CEFTA since 1993, Nordic community 1994;

22. Americas • NAFTA • 1988 CAN-US FTA, + MEX 1994 NAFTA ; • LATAM • LAFTA Latin American FT association 1960; • 1970 succeeded by Association for LATAM integration (ALADI); • 1969 Andean Pact – Cartagena agreement: Bolivia, Chile, Colombia, Equator, Peru, Venezuela; • Mexico NAFTA; • MERCOSUR (Mercado Comun del sur) Asuncion treaty 1991 – CU 1995, aimed to become CM – BOL and CHI associate members – BRA project SAFTA, 2005 associated COL and EQU, PER, VEN (full 2010)? • ALBA 2006 CUB, BOL, VEN – Bolivarian alternative for the Americas – to thwart the US plans for a FTAA;

23. Asia • ASEAN – Brunei, Cambodia, Indo, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam 1967 – 10 years of inactivity – security pact 1976; Singapore summit 1992 – ASEAN-FTA (AFTA) tariff reduction in phases implemented by 2008 – advanced to 2002; AFTA plus activities – NTBs; 2006 agreement on EU style association by 2015; • 2002 ASEAN – China PTA (trade and investment by 2010); • ASEAN + 3 PTA (China, Japan, SKOR) – goal East Asian Community; • SAACR – South Asian Association for Regional Cooperation (SAARC) Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, Sri Lanka 1985; • APEC 1989: ASEAN + Australia, Can, JAP, NZ, SK, US + China, Taiwan, H-K 1991 + Chile, Mexico, Guinea + Peru, Russia, Vie; 2010 AIC FTA + inv, 2020 DCs; non-binding commitments; • Middle East – Arab League – 22 nations; Gulf Cooperation Council 1981 – Bahrain, Kuwait, Oman, Qatar, SA, UAE – CU+single currency 2010;

24. Africa • Practicaly all countries – oldest two schemes Souther African Customs Union (SCAU), East African community (EAC); • ECOWAS – Economic Community for West African States (should be monetary union – it’s a mere CU 2003); • Arab Maghreb Union UMA (should be CM by 2000 – not mere FTA); • Unique characteristic – multiplicity and overlapping schemes; • Only west 33 schemes and 130 inter- governemntal economic organizations; • Rationalization recommended by UNECA – African Economic Community (AEC) 1991- African Union 2001 (endorses all existing schemes and call for more); • If a certain level of integration cannot be made to work, the reaction of policy makers has typically been to embark on something more elaborate, more advanced and more demanding in terms of administrative requirements and political commitment (Robson 1997);