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Understanding the European Union

1.1 The development of the European Community
1.2 Treaties establishing the European Union
1.3 The Community legal system
1.4 The Community finances
1.1 The development of the European Community
The history of modern European integration was launched in the late 1940s in the wake of the second
World War. Six years of conflict had left a demand for politic and economic reconstruction as a devastated
Western Europe sought ways to rebuild its economy and to prevent future wars. Much of Europe lay in ruins,
communications were broken, food and fuel were in short supply and industry was geared to the needs of war.
The continent also faced a future between the superpowers, a developing Cold War creating a dividing line
between Europes war-ravaged nations. It took the complete collapse of Europe and its political economic
decline to create the conditions for and give a new impetus to the idea of a new European order. The method of
construction chosen, namely the voluntary integration of different nations, had never before been tested in
human history. It involves (in its conception), by means of instruments voluntarily adapted by all, the gradual
creation of imperceptible, but innumerable, links between the nations taking part in the experiment.
In overall terms, moves towards unification in Europe since the Second World war have created a
confusing mixture of numerous and complex organizations that are difficult to keep track off. For example, the
Central and Eastern European countries and the Soviet Union (with Cuba, Mongolia, and Vietnam had been
integrated through the Council for Mutual Economic Assistance (CMEA, often called COMECON). This
was a markedly different form of economic integration from the other types of integration. The CMEA was
begun in 1949 to promote economic cooperation among the member countries as a Soviet counterpart to
the Marshall Plan. There are many other organizations appeared at that time, such as OECD (Organization for
Economic Cooperation and Development), WEU (Western European Union), NATO ( North Atlantic
Treaty Organization), the Council of Europe, the European Union (which started life as the European
Coal and Steel Community, the European Atomic Energy Community and European Community) coexist
without any real links between them. The number of member countries in these various organizations ranges
from 19 (WEU) to 40 (Council of Europe).
This variety of institutions only acquires a logical structure if we look at the specific aims of these
organizations, these can be divided into three main aims:

The Euro-Atlantic organizations

The Euro-Atlantic organizations came into being as a result of the alliance between the United States of
America and Europe after the Second World War. It was no coincidence that the first European organizations of
the post-war period, the OEEC (Organization for European Economic Cooperation), founded in 1948, was
created at the initiative of the United States. The US Secretary of State at the time, George Marshall, called on
the countries of Europe in 1947 to join forces in rebuilding their economies and promised American help. This
came in the form of the Marshall Plan, which provided the foundation for the rapid reconstruction of
Western Europe. At first, the main aim of the OEEC was to liberalize trade between countries. In 1960, when
the United States and Canada became members, a further objective was added, namely to promote economic
progress in the this World through development aid. The OEEC then became the OECD.
In 1949, NATO was founded as a military alliance with the United States and Canada. In 1954, the
Western European Union (WEU) was created to strengthen security cooperation between the countries of
Europe. It brought together the countries that had concluded the Brussels Treaty (United Kingdom, France,
Belgium, Luxembourg and the Netherlands) with the addition of the Federal Republic of Germany and Italy.
Portugal, Spain and Greece are now members of the WEU. The organization offers its members a platform for
close cooperation on security and defence, and thus serves both to strengthen Europes political weight in the
Atlantic alliance and to establish a European identity in security and defence policy.

The Council of Europe and OSCE

The future common to the second group of European organizations is that they are structured to enable
as many countries as possible to participate. At the same time, there was an awareness that these organizations
would not go beyond customary international cooperation.

These organizations include the Council of Europe, which was founded as a political institution on 5
May 1949. Its Statute does not make any reference to moves towards a federation or union, nor does it provide
for the transfer or merging of sovereign rights. Decisions on all important questions require unanimity, which
means that every country has a power of veto, the same set/up is to be found in the United Nations (UN)
Security Council. The Council of Europe is therefore designed only with international cooperation in mind.
Numerous conventions have been concluded by the Council in the fields of economics, culture, social policy and
law. The most important and best known of these is the Convention for the Protection of Human Rights and
Fundamental Freedoms (ECHR) of 4 November 1950. The Convention not only enabled a minimum standard for
the safeguarding of human rights to be laid down for the member countries, it also established a system of legal
protection which enables the bodies established in Strasbourg under the Convention under the Convention (the
European Commission on Human Rights and the European Court of Human Rights) to condemn violations of
human rights in the member countries.
This group also includes the Organization for Security and Cooperation in Europe (OSCE),
founded in 1994 at the Conference on Security and Cooperation in Europe. The OSCE is bound by the principles
and aims set out in the 1975 Helsinki Final Act and the 1990 Charter of Paris. Alongside measures to build up
trust between the countries of Europe, these aims also include the creation of a safety net to enable disputed to be
settled by peaceful means. As events of the recent past have shown, Europe, still has a long way to go in this
The European Union
The third group of European organizations comprises the European Union, which itself has grown out
of the European Coal and Steel Community, the European Atomic Energy Community and the European
The feature that is completely new in the EU and distinguishes it from the usual type of international
association of States is that the Member States have ceded some of their sovereign rights to the EC at the
center an have conferred on it powers to act independently. In exercising these powers, the EC is able to issue
sovereign acts which have the same force as laws in individual States.
The foundation stone of a European Community was laid by the French Foreign Minister, Robert
Schuman, in his declaration of 9 May 1950, in which he put forward the plan he had worked out with Jean
Monnet to pool Europes coal and steel industries. He made history by putting to the Federal Republic of
Germany, and to other European countries who so wished, the idea of creating a community of pacific interests.
In so doing he extended a hand to yesterdays enemies and erased the bitterness of war and the burden of the
past. In addition, he set completely new process in international relations by proposing to old nations together to
recover, by exercising jointly their sovereignty, the influence which each of them was incapable by exercising
Schuman, thus, opted for the functional method of European Integration, rather than for the
constitutional method, which would be based on the constitution of a federation. That meant that the European
States, which had just regained their national sovereignty following the Second World War, did not need to give
it up immediately and its entirety for the benefit of a federal European State. They merely needed to renounce
the dogma of the indivisibility of sovereignty and therefore certain parts of sovereignty in certain clearly defined
areas. In return they would gain the right of inspection of those affairs of their partners which were placed under
common management and would to that extent enlarge their own sovereignty.
It was therefore a question of progressively reducing the existing contradiction between European
integration and national independence.
In his declaration of 1950, Robert Schuman proposed the creation of a common market in two
important economic sectors which had until then been used for military purposes, namely the coal and steel
sectors; it would be a matter of integrating Germany economically and politically into a European Coal and Steel
Community with France an other willing countries. He advocated some transfer of sovereignty to an independent
High Authority which would exercise the powers previously held by the States in those sectors and the decisions
of which would bind those States. That was to say that the cooperation of the Member States in those sectors
should be completely different from that already existing within the traditional international organizations. The
choice of coal and steel was not fortuitous. The Strategy was to reconcile German economic recovery and French
national security, the plan was designed to overhaul the French economy, which had shown signs of serious
sickness well before the damage and dislocation of World War II. In the early 1950s those sectors were the basis
of a country's power. In addition to the economic benefits to be gained, the pooling of French and German
resources in coal was to mark Franco-German reconciliation. Beyond the coal and steel community, Robert
Schuman envisaged the creation of a common market for all products, on a scale comparable to that the United
States, in which the conditions would be fulfilled for rapid and regular economic expansion through economies
of scale, better division of labor and the improved use of new production techniques. Even beyond economic
integration he envisaged political integration, by means of the European countries, through the creation in stages

of a European Federation. But that was to be achieved gradually through concrete achievements or, to use the
building image, by means of brick upon brick to make up the community edifice.
Although the appeal from the French Minister for Foreign Affairs was addressed to all European
countries, only five Germany, Italy, Belgium, the Netherlands and Luxemburg gave a favorable reply.
Therefore, only six States signed the treaty establishing the European Coal and Steel Community (ECSC) in
Paris on 18 April 1951.
The Europe of six began its construction on 25 July 1952, the date of entry into force of the ECSC
Treaty. The United Kingdom, on the other hand, wanted a European free trade area, to be set up, which did not
involve and waiving of national sovereignty. Customs duties would, of course, be abolished between member
countries, but the latter would remain autonomous with regard to commercial policy vis--vis third countries.
Denmark, Norway, Iceland, Austria, Portugal and Switzerland supported that argument.
On 24 October 1950 the French Minister of Defense Rene Pleven, made a declaration to the National
Assembly similar to the by R. Schuman. Against a backcloth of the Korean War and worsening tension between
East and West, he proposed, as a solution to the problem of German rearmament, the creation of a European
army answerable to the political institutions of the united Europe. Surprising proposal was immediately accepted
by the Governments of the Six and led to the signing in Paris of the Treaty establishing the European Defense
Community. That undertaking was somewhat at variance with R. Schuman's idea of progressing little by little.
As defense, like foreign policy, was logically amongst the last aspects of the construction of Europe.
What would have become of that Community if the French National Assembly had not refused on 31
August 1954, to ratify the Treaty establishing it on the grounds that it regarded the abandonment of a national
army as a serious infringement of French sovereignty? Probably, that Community along with the European
Political Community, the draft of which was adopted on 10 March 1953 by the ad hoc Assembly set up by the
ECSC Member States, would have proved to be premature as long as the de facto solidarity which Robert
Schuman and his adviser Jean Monnet considered necessary for the advent of European political union was
On the other hand, the functioning of the common market in coal and steel showed that economic
integration was possible and worthwhile and that it should extend to all products. Thus, the Ministers for Foreign
Affairs of the Six, meeting in Messina from 1 to 3 June 1955, discussed the possibility of creating a common
market embracing all products and a separate Community for nuclear energy. They instructed a committee of
experts, chaired by the Belgian Minister for Foreign Affairs, Paul-Henri Spaak, to prepare a report on the matter.
The committee presented its report on 21 April 1956 and its conclusions were approved by the
Intergovernmental Conference in Venice on 29 May 1956. The Ministers for Foreign Affairs then decided to
initiate negotiations between the six countries with a view of creating a European Energy Community (EEC) and
a European Atomic Energy Community (EAEC). Only ten to sign the Treaties establishing the two new
British attempts at creating a vast European free trade area between the European Economic
Community and the other Member States of the OECD failed during the autumn of 1958 owing to intractable
differences of opinion between France and the United Kingdom. In 1959 it has been created European Free
Trade Association (EFTA), to which the United Kingdom, Norway, Sweden, Denmark, Austria, Portugal,
Iceland and Switzerland acceded, with Finland joining at a later date.
Having been impressed, however, by the early successes of the European Community, it was not long
before the British Government was rethinking its refusal to play an active role in the work of European
unification. It was aware that the United Kingdom could not maintain its political influence if it played a
preponderant role onto in the Commonwealth. Nor could EFTA, the objectives of which were economic - as
opposed to the European Community, which also had political aims, allow it to impose its influence. So in
August 1961m the United Kingdom submitted an initial official appreciation to become a full member of the
European Community. That example was followed by two other EFTA member countries, namely Denmark ad
Norway, and also by Ireland.
Accession of those countries initially met with the opposition of the President of the French Republic,
General de Gaulle who, being extremely distrustful of the United Kingdoms application for accession, declared,
right in the middle of the negotiations in 1963, that he wished to discontinue them. The second British
application for accession, in 1967, with Ireland, Denmark and Norway were yet again associated, was not
examined for much time owing to Frances misgivings. The issue of the accession of those countries could not be
resolved until following General de Gaulles resignation in April 1969. After laborious negotiations, the Treaties
of Association were finally signed on 22 January 1972. The accession on the United Kingdom, Ireland and
Denmark took effect on 1 January 1973, following favorable referendum (Ireland and Denmark) and ratification
by the national parliaments. Only Norways accession was prevented, after 53.49% of the Norways population
opposed accession to the European Community in a referendum.

Once democracy was restored in Greece, Portugal and Spain, those countries submitted applications for
accession to the European Community, in 1975 in Greeces case and in 1977 in the other two cases. Greece
acceded to the Community on 1 January 1981, and Spain and Portugal on 1 January 1986.
With the signature of the single European Act, in June 1987, the Twelve decided to complete their
internal market on 31 December 1992. One year before that date, in December 1991, they decided in Maastrict
to develop within the single market an economic and monetary union, a judicial and internal affairs policy and a
common foreign and security policy, thus transforming the European Economic Community into a European
Union (EU).
Since the 1st January 1995, the Europe of Twelve became the Europe of Fifteen, with the accession of
Austria, Finland and Sweden, the people of Norway having again voted against membership of the Union by a
majority of 52.8%.
The case of withdrawal of a Community Member State has never occurred and is difficult to imagine.
However, even though it is not specifically provided for in the Treaty it is certainly possible, under conditions to
be negotiated between the outgoing State and the others. The example of Greenland, although partial and special,
bears witness to that. Greenland had been integrated into the EC in 1973 by virtue of its links with Denmark. The
small population of Greenland was, however, most distrustful in particular of the Communitys fisheries policy,
as fishing was the islands main economic activity. Having voted by a small majority in a referendum to
withdraw from the Community, the Danish Government and the EC agreed, in February 1984, to allow
Greenland to leave the Community as from 1 February 1985 and to grant it the status of overseas territory
associated with the EC. A similar solution could be found, if a Member State of the European Union decided to
withdraw from it. It could, for example, find itself in the European Economic space, which brings together, since
the 1 January 1994, the Member States of the EFTA, minus Switzerland.
The European construction can and one day certainly will accommodate other European countries,
notably those of Central and Eastern Europe, which were separated from it until the end of the 80s by an
impassable wall, but which, following the demolition of the latter, see it as a strong, functional refuge. The
European Union has already declared its intention to welcome these countries and Cyprus, but, before it can do
so, it must solve its institutional problems, which become more and more acute after each new enlargement. It
has to be emphasized here that any State wishing to accede to the Community has to be prepared to adopt, and be
capable of adopting, during a given transition period, all the Community law which constitutes the various
policies examined in this work.

1.2 Treaty agreements establishing the European Union

In force


European Coal and Steal (ECSC) Treaty
(Treaty of Paris, 1951)
European Economic Community (EEC) Treaty
(Treaty of Rome, 1957)
European Atomic Energy Community (EAEC)
Treaty (Rome, 1957)
Treaty establishing a Single Council and a Single
Commission of the European Communities
(Merger Treaty, 1965)
European Elections Act (1976)


Single European Act (1986)



Treaty on the European Union (Maastricht Treaty,




Treaty of Amsterdam (1997)



Treaty of Nice




A sector-specific Treaty of limited application.
First of the founding Treaties
Concluded on the model of the ECSC Treaty
but with a broader range of objectives
A sector-specific Treaty of limited application


Created a single institutional framework

serving all three Communities


The basis for the first (1979) and subsequent

European Parliamentary elections
Amended and expanded the EEC Treaty.
Introduced measures for the completion of the
Internal Market and extended the scope of
qualified majority voting
Established the European Union, amended and
expanded the EEC Treaty, created the codecision procedure, codified the EC, CFSP
and JHA pillars
Amended the Maastricht and EEC Treaties.
Extended codecision, added new employment
title to Treaties and incorporated the Schengen
accord into the EEC Treaty
Not in force

The first European Treaty, the one establishing the European Coal and Steel Community (ECSC),
was signed in Paris in 18 April 1951 and entered into force on 25 July 1952. Its main objective was to eliminate
the various barriers to trade and to create a common market in which coal and steel products from the Member

States could move freely in order to meet the needs of all Community, inhabitants, without discrimination on
grounds of nationality. Capital and workers in both sectors should also circulate freely. In order that all this could
be achieved, the Treaty laid down certain rules on investment and financial aid on production and prices, on
agreements and concentrations of businesses ad on transport and Community institutions, including a High
Authority and a special Council of Ministers, the decisions of which would be binding on all Member States.
Ambitious despite its restricted scope, the ECSC Treaty introduced a European Assembly and a European Court
of Justice. The intentions of the founders of the ECSC were, indeed, that it should be an experiment, which could
gradually be extended to other economic spheres, culminating in a European Federation.
The ECSC Treaty was concluded for 50 years, when it will expire in the year 2002, the specific rules
covering these two sectors will be incorporated into the EEC Treaty.
The Treaty establishing the European Atomic Energy Community (EAEC, EUROATOM) was
signed in Rome on 25 March 1957 and came into force on 1 January 1958. Its aim was to create a common
market for nuclear materials and equipment, establish common nuclear legislation, introduce a common system
for suppliers of fissile materials, introduce a system for supervising the peaceful use of nuclear energy and
common standards for nuclear safety and for health and safety protection of the population and workers against
ionizing radiation. The key elements in this Treaty were, however, the coordination of the research programmes
of the Member States and a joint research programme, implemented in a Joint Research Centre, which was to
develop technology and stimulate nuclear production in Europe.
Signed at the same time as the Euroatom Treaty the European Economic Community (ECC) Treaty
signed in Rome on 25 March 1957, it provided detailed plans for the creation of a common market among its
signatories. That involved:
a) The achievement of a customs union entailing, on the other hand, the abolition of customs duties,
import quotas and other barriers to trade between Member States, on the other hand, the introduction of a
Common Customs Tariff (CTT) vis--vis third countries.
b) Implementation, harmonization of national policies of four basic freedoms: freedom of movement
of goods, of course, but also freedom of movement of salaried workers, freedom of establishment and freedom to
provide services by independent persons and companies and, finally, freedom of capital movement.
An important amendment to the Treaties establishing the European Communities took lace on 1 July
1987 with the coming into force of the Single European Act. Supplementing in particular the EEC Treaty, the
Single Act committed the Community to adapt measures with the aim of progressively establishing the internal
market over a period expiring on 31 December 1992. At the same time it consecrated the European Council,
European cooperation on foreign policy and social and economic cohesion, between Member States. Lastly, it
confirmed the Communitys competence in numerous fields: social, environmental, research and technology.
But it is the Treaty on European Union (TEU), signed in Maastricht on 7 January 1992 that marked a
new stage in the process of creating an ever-closer union among the peoples of Europe. The Union is founded on
the European Communities and supplemented by new policies, and forms of cooperation. According to Article B
of the Treaty, the Union sets itself the following objectives:
To promote economic and social progress which is balanced and sustainable, in particular through he
creation of an area without internal frontiers, through the strengthening of economic and social cohesion and
through the establishment of economic and monetary union, including ultimately a single currency.
to assert its identity on the international scene, in particular through the implementation of a common
foreign and security policy, including the eventual framing of a common defense policy, which might in time
lead to a common defense.
to strengthen the protection of the rights and interests of the nationals of its Member States through
the introduction of a citizenship of the Union.
to develop close cooperation on justice and home affairs.
to maintain in full the acquis communautaire and build on it with the aim of ensuring the
effectiveness of the mechanisms and the institutions of the Community.
The Treaty of the EU separates the European construction into three pillars or edifices, distinguished
mainly on the basis of the decision-making process:
The main pillar, which is the European Community (namely the ECSC, the European Atomic Energy
Community (EAEC) and the EEC);
The two other pillars remain largely intergovernmental, namely the second pillar dealing with Common
Foreign and Security Policy (CFSP) and the third pillar dealing with Co-operation in Justice and Home
Affaires. These other two pillars have lower institutional capacity. There is normally no majority voting, the
Commission plays a lesser role and the common positions or joint actions adopted do not constitute Community

First pillar:
- Single market and measures law
-Trade policy
-Democracy xenophobia
-Fighting terrorism
-Economic and monetary union
-Trans-European networks
-Research and environment
-Europes security framework
-External borders

Second pillar:

Third pillar:

-Foreign policy
-Cooperation between judicial
-Agricultural policy
- Police cooperation
-Aid to non-member countries
-Fighting drugs and the arms trade

-Customs union and

-Cooperation, common positions
authorities in civil and criminal
-Sectoral policy
-Human rights
-Combating racism and
-Fighting organized crime
Trafficking in human beings
-Education and culture concerning the
security of the EU
-Asylum policy


-Criminal acts against children,
-EU citizenship
-Drawing on the WEU: questions
-Consumer protection
-Financial aspects of defense
-Social policy
-Immigration policy

Even within the main edifice - the European Community - the TEU has brought about profound
changes, since it has renovated certain community policies and has instituted several others, such as education
and youth, culture, public health and consumer protection.
On June 1997 at Amsterdam, the Heads of State and Government of the fifteen countries of the EU
revised the Treaty on European Union.
The Treaty of Amsterdam establishes a more democratic Europe, emphasizing the respect of human
rights and of democratic principles by the Member States. It also makes clear progress on matters relating to the
free movement of its citizens, while enabling the war on organized crime to be waged more effectively.
The Treaty of Amsterdam has four main objectives:
To place employment and citizens rights at the heart of the Union. While confirming that the
Member States bear primary responsibility for employment, the new Treaty gives centre-stage to the need for
them to act together to find solutions to unemployment, which is the number one problem in Europe today.
The sweep away the last remaining obstacles to freedom of movement and to strengthen security, by
consolidating and communitarising the cooperation of the Member States in the field of Justice and Home
To give Europe a stronger voice in world affairs by making the European Council (heads of State or
government) responsible for defining common strategies to be implemented by the Union and the Member States
and by designating a High Representative for the CFSP (the Secretary General Council) and a Policy Planning
and Early Warning Unit under his responsibility;
To make the Unions institutional structure more efficient with a view to enlarging the Union,
particularly towards the eastern European countries which are knocking at the Unions door.
The Amsterdam Treaty has taken steps towards meeting this last objective, notably through the
extension of the co-decision (Parliament/ Council) procedure and of the majority voting in the Council, but a
new amendment of the TEU or a new Treaty would be necessary in order to complete the reform of the
institutions and make it possible for them to work in the context of more than twenty Member States.
Since the citizens have the rights and obligations deriving from the European Treaties, they can rightly
claim the transparency of these texts. The Unions basic Treaties are very difficult to read and understand, which
is hardly likely, to mobilize public opinion in their favour. The Treaty of Amsterdam, which includes
consolidated versions of the two main Treaties, the one on the European Union (TEU) and the one establishing
the European Community (TEC), with a new numbering of their articles, gives a beginning of the solution of
their problem.
The Treaty of Nice which was signed on 26 February, 2001 should mark the end of a prolonged phase
of adjustment for the EU. Concluding the Intergovernmental Conference held in 2000 at Nice, focusing on the
three issues left over from Amsterdam size and composition of the Commission, weighting of votes in the
Council and possible extension of qualified majority voting (QMV)- as well as other necessary amendments to
the Treaties arising as regards the European institutions in connection with the above issues and in implementing

the Treaty of Amsterdam. A generally accepted aim of re-weighting was to ensure that any winning coalition
under QMV will represent a reasonable majority of the population and that decisions cannot be blocked by too
small a minority. Yet the basic goal was achieved: the possible institutional obstacles to enlargement were
removed. There was an agreement to have one Commissioner per Member State as of 2005 and a reduction to an
unspecified number less than that of the Member States once there are 27 countries in the EU, a complex system
of reweighting of votes with a triple threshold for qualified majority a limited extension of qualified-majority
voting, and some relaxation of the conditions for enhanced cooperation. It is not possible to foresee exactly
how the new arrangements may work, and they may be modified before they come into force.

1.3 The Community legal system

In the image of the European construction, the cement is the will of the different nations to live
peacefully together, the building plans are the treaties and the bricks are the legal acts adopted by the Parliament
and the Council. These legal acts may be undertaken by the competent institutions with legal effect only if they
are empowered to do so by the European Treaties (principle of attribution of powers). Article 249 of the EC
Treaty provides for five forms of legal act, each with a different effect on the Member States legal systems: some
are directly applicable in place of national legislation, while others permit the progressive adjustment of that
legislation to Community provisions.
The Regulation has a general scope, is binding in all its elements and is directly applicable in each
Member State. Just like a national law, it gives rise to rights and obligations directly applicable to the citizens of
the European Union. Regulations enter into force on a date which they lay down or, where they do not set a date,
on the twentieth day following their publication in the Official Journal of the European Communities. The
regulation substitutes European law for national law and is therefore the most effective legal instrument
provided for by the EC Treaty. As European laws, Regulations must be complied with fully by those to
whom they addressed (individuals, Member States, European institutions).
The Directive binds any Member State to which it is addressed with regard to the result to be achieved,
while allowing the national authorities jurisdiction as to the form and methods used. It is a sort of Community
framework law and lends itself particularly well to the harmonization of laws. It defines the objective or
objectives to be attained and leaves it to the Member States to choose the forms and instruments necessary for
complying with it. Since the Member States are only bound by the objectives laid down in directives, they have
some discretion, in transposing them into national law, in taking into account of special national circumstances.
They must however, ensure fulfillment of the obligations arising out of the Treaty or resulting from action taken
by the institutions of the Community (Art. 10 ETC). Although they are generally published in the Official
Journal, Directives take effect by virtue of being notified to the Member States to which they are addressed. The
latter are obliged to adopt the national measures necessary for implementation of the Directive within time-limits
set by it, failing which they are infringing Community legislation.
The Decision id binding on the addressees it indicates, who may be one, several, or even all the
Member States or one or more natural or legal persons. This variety of potential addresses is coupled with a
variety in the scope of its contents, which may extend from a quasi regulation or a quasi directive to a specific
administrative decision. It takes effect on its communication to the addresses rather than on its publication in the
Official Journal. In any case, according to the Court of Justice, a decision can produce direct effects creating for
the individuals rights that national jurisdictions must safeguard 1.
In addition to these legal acts, the effects of which are binding on the Member States, the Community
institutions and, in many cases, the citizens of the Member States, the Council and the Commission can adopt
Recommendations suggesting a certain line of conduct and opinions assessing a current situation or certain
facts in the Community or the member States. These instruments enable the Community institutions to adopt
positions in a non-binding manner, i.e. without any legal obligations for the addressees- Member States and/or
citizens. Furthermore, the Council and the European Parliament adopt Resolutions, which are also not binding,
suggesting a political desire to act in a given area.
While Resolutions and opinions are published in the C series (communications) of the Official
Journal of the European Communities (OJ), binding acts and recommendations- as well as common
positions and joint actions of the common foreign and security policy and of justice and home affairs (Art.12,
13 and 31 of TEU) are published in the L series legislation of the OJ. It is the binding instruments that
constitute Community law, that is, the law adopted by the institutions in order to pursue the objectives of the
European Treaties, giving certain rights and obligations to the citizens and obliging the Member States to adapt
their legislation and/ or the administrative practices.
Community law is uniformly and entirely valid throughout the Community and cannot be invalidated by
the individual law of one Member State. It ensures from the Treaties and the constant decisions of the Court of
1. Judgement of 6 October 1970, case 9/70, Grad, ECR 1970, p.838

Justice that this law has precedence over national law, even the constitutional law, of the Member States,
whether it predates or postdates Community legislation. In fact, the Member State have definitively transferred
sovereign rights to the Community they created, and they cannot subsequently go back on that transfer through
unilateral measures which are incompatible with the concept of the Community.

1.4 The Community finances

The conventional international organizations such as the UN or the OECD are financed by contributions
from their member countries. In most instances their financial requirements amount to staff and operational
expenditure: if they are entrusted with operational tasks, their financing is generally provided on an a la carte
basis by those member countries, which decided on those tasks. It is virtually never a question, in such
organizations, of financial transfers or even of financial compensation. The European Community, on the other
hand, although it is not a federation, pursues certain federal objectives, and its expenditure in the main
corresponds to a transfer of resources from the national to the supranational level. Indeed, since 1970, the
Community controls its own resources.
The first European tax was introduced with the creation of the ECSC. Article 49 of the Treaty of Paris
stipulates that the High Authority (now the Commission) is empowered to procure the funds it requires to carry
out its tasks by imposing levies on the production of coal and steel. It may itself determine the mode of
assessment and the amount of that tax. The levies are assessed annually on the various ECSC products
according to their average value, the rate thereof shall not, however, exceed 1 percent. The system applied in
this connection by the Commission is similar to the VAT system. The levy is applied to undertakings in the steel
and coal sector. Since 1994, the Commission has gradually reduced the levy, thus leading to its total elimination
when the ECSC Treaty expires (23 July 2002)1. After the expiration of the Treaty, the assets of the ECSC in
liquidation should revert to the Communities revenue and be administered by the Commission2.
Provision had been made in the EEC Treaty (Article 201) for replacing the Member States initial
contributions (determined on a scale according to GNP shares or other criteria) by own resources after
establishment of the Common Customs Tariff (CCT). The transfer of customs revenue to the Community budget
by Decision of 21 April 1970 was the logical outcome of the attainment, provided for in the Treaty, of a genuine
customs union3. In such a union the country of import of goods from a third country is not always the country of
final destination of those goods. The revenue from customs duties is therefore often collected in a country other
than the country of destination or of consumption. Only the payment of that revenue to the customs union, in this
instance to the Community, makes it possible to neutralize that effect.
As customs duties are being progressively abolished or reduced under the General Agreement on Tariffs
and Trade (GATT) and the various tariff concessions granted to the least developed countries, for that reasons it
was decided, in 1970, to use a proportion of the value added tax (VAT) as an additional source of Community
financing. That tax, which has a uniform basis of assessment, affects all citizens of the European Union and
takes fairly accurate account of the economic capacity of the Member States, as it is levied at the consumption
level. The uniform base, which was adopted for calculating the proportions of the VAT yield which countries,
must pay to the EU, is made up of all taxable supplies of goods and provisions of services in the Union. It
therefore does not depend on the amount of the VAT itself, the rates of which vary from Member State to
Member State. Customs duties on products within the province of the ECSC Treaty now constitute Community
own resources. A new own resource was added to the others, grounded on an additional base representing the
sum of the member States GNPs at market prices. Each Member State contributes to this fourth resource (21.4%
of total revenue) in accordance with its wealth. A 1996 Regulation improved implementation of the own
resources collection system by making it more transparent and strengthening the provisions to combat fraud 4.
In order to give tangible form to the Maastricht commitments, particularly as regards economic and social
cohesion, the creation of an environment stimulating Europes competitiveness and development of Community
action on the external front, the Commission proposed the doubling of the financial allocation in 1997 compared
to its 1992 level (Delos package II). The European Council, meeting in Edinburgh on 11 and 12 December
1992, agreed to raise the ceiling on own resources from 1.20 % of the Communitys GNP in 1993 to 1.27% in
1999. A Council Decision of 31 October 1994 fixed the level of own (Community) resources available for the
period 1995-1999 and the structure of the Community financing system 1. In its Agenda 2000 outlook and
position document of 15 July 1997, the Santer Commission asserted that the financing system of the Community
had worked satisfactorily and did not need any adjustments to the Member States contributions. Accordingly, the
1.27 % GNP ceiling could suffice to finance, until 2006, the development of common policies, including the

Commission Decision 2983/94/ECSC, OJ L315, 08.12.1994

COM (97) 506, 8 October 1997
Council Decision 70/243, OJ L 94, 28.04.1970
Council Regulation 1552/89, OJ L 155, 07.06.1989

The Commission had taken account of a number of factors, in particular the economies obtainable under
the agricultural guideline, the effect of greater concentration of structural expenditure on the most needy regions,
the fruits of economic growth and the benefits of budgetary discipline in the context of economic growth and the
benefits of budgetary discipline in the context of economic and monetary union.
As far as Community expenditures are concerned, we should note that they have increased between
the early eighties and the early nineties from 1.7 to 2.4% of all public expenditure in the Member States. They
still represent, however, little more than one percent of the cumulative Gross Internal Product of the Member
States. More than 90% of the receipts of The European Union are redistributed to the Member States and serve
to finance the objectives of the various common and Community policies. Thus, out of a total of EUR 97 billion
(41.6%) were allocated to the common agricultural policy, EUR 39 billion (40.2%) to structural measures
including the Structural Funds, EUR 5.8 billion (6%) to other internal policies, roughly the same amount to
external action of the Union (6%), EUR 4.5 billion (4.6%) to administrative expenditure and the remaining
amount to reserves including guarantees 2. It is interesting to note that the guarantee of the Community budget
covers lenders when the Community floats an issue under one of its financial instruments, such as the balance of
payments facility or the financial assistance for certain non-member countries. A Guarantee Fund for external
actions is designated to reimburse the Communitys creditors in the event of default by the recipient of a loan
given or guaranteed by the Community in a non-member country3.
Table 1.2 The EU Budget for 2000


Council Decision 94/728, OJ L 293, 12.11.1994

Decision 1999/105, OJ L39, 12.02.1999
Council Regulation 2728/94, OJ L 293, 12.11.1994 and Council Regulation 1149/99, OJ L 139, 02.06.1999


The General Budget of the European Union

The EU is endowed with revenues, which it is empowered to discharge for certain specified functions,
including institutional administration and policy-related expenditure. These revenues (capped at a limit of 1.27
% of EU GNP) are generally referred to as the General Budget of the European Union. The pattern of the EUs
budgetary revenues and expenditures has changed over time. For the first decade expenditures were modestless than 0.1 % of EU GDP. It was roughly evenly distributed among administration, agriculture, research and
energy and aid for developing countries. The introduction of the Common Agricultural Policy in 1968,
whereby a guaranteed price system for farm products was established, transformed this situation. Not only
did total expenditure rise dramatically, the great bulk of that expenditure was absorbed by agricultural policy.
Today, the EU budget totals nearly 100 billion Euro with commitment appropriations of 96.93 billion Euro in
1999. This now represents 1.11% of EU GDP and about 2.5% of the total expenditure of the EU member states.
These budgetary funds (which are of the same order of magnitude as a large UK government
department) emanate from three sources. First, the duties that member states collect on imports into the EU
are paid centrally. These consist principally of general customs duties, agricultural tariffs and levies on sugar
imports. Second, a proportion of VAT receipts levied by member states is paid over to the EU. Between 1986
and 1994 this was equivalent to 1.4% of VAT revenues raised on 55% of GDP at market prices. Since 1995 (and
until 2002), the proportion of VAT receipts paid over has been reduced to 1.0% raised on a lower total of 50%
of GNP. Third, since 1988, the difference between what is raised from the first two revenue sources and what
is required to meet EU expenditure is raised from member states in proportion to their national income. In 1999
the projected proportions from these three resources were as follows: VAT, agricultural and sugar levies (38%),
customs duties (15,5%), and GNP resources (46.5%).
Since 1988 expenditure has been divided into six broad categories:
1. Agriculture;
2. Structural operations;
3. Internal policies (with multi-annual allocations);
4. External (or other policies);
5. Repayments and administration;
6. Monetary reserves.
The annual increases of expenditure on each category have to be contained within an agreed rate of increase.
Political priorities have been reflected in allowing the rates of increase to differ between categories. For
example, since 1988 Categories 2, 3 and 4 have been allowed to expand more rapidly than others. Nonetheless,
European Union expenditure is still dominated by agriculture and in particular, for price guarantee purposes.
While the amount spent on agriculture (including the Agricultural Guidance Fund) had been reduced to 45.6%
of total commitment appropriations by 1999, this is only approached by spending on structural operations
(excluding the EAGGF), which accounted for 34.8% of total spending in 1999. Key areas such as education
and the environment and other internal policies such as research claim only 5.9% of the budget, and external
policies (and action) a comparable 6.0%. Equally, while it is often argued that the EU is excessively


bureaucratic, it should be noted that only 4.5% of the EU budget is spent on administration, which is probably
not excessive for any organization of its size. Two-thirds of this expenditure goes to the European Commission.
In 1999, 1.2% of the EUs budget was directed towards category 6 (monetary reserves). These reserves are used
for a variety of purposes, including emergency aid.

General references on the EU and suggested readings:

DINAN Desmond, Ever Closer Union: an Introduction to European Integration, 2 nd ed., Macmillan,
Basingstoke, 1999, pag 1-3.
2. DEGRYSE Christophe, Dictionnaire de lunion Europeenne. Politiques, institutions, programmes, De
Boeck/Universite, Bruxelles, 1998.
3. PASCAL Fontaine, A new idea for Europe: The Schuman declaration 1950-2000, 2 nd ed., European
documentation, Luxembourg, 2000, pag 5-7;
4. MOUSSIS Nicholas, Guide to European Union policies, European Study Service, Brussels, 1999
5. PELKMANS Jacques, European Integration. Methods and economic analysis, Addison Wesley Longman,
Harlow, Essex, 1997.
6. EUROPEAN COMMISION, How does the European Union work? Office for official Publications of the
European Communities, Brussels, 1996.
7. Moussis Nicholas Access to European Union, European Study Service, 2001, pag 7-9; 12-16; 23-28;
8. EUROPEAN POLICY CENTRE, Making Sense of the Amsterdam treaty, Institute of European Affairs,
9. EUROPEAN COMMISSION, Treaty of Amsterdam: what has changed in Europe, Luxembourg, 1999
10. DRUESNE Gerard, Droit et Politiques de la Communaute et de lUnion europeenne 5e ed, PUF, Paris,
11. LAFFAN Brigid, The Finances of the European Union, Macmillan Press, Basindstoke, 1997.
12. Richard Welford, Kate Prescott, European Business, 4 th edition, , 2001, pag 69,86-87;
13.European Commission, LEurope des quinze: chiffres cles, 1996, pag 4;
14. European Parliament, Office for official publications of the European Communities, Luxembourg, March
2000, pag 12;
15. Edward Best, The Treaty of Nice: Not Beautiful but itll do, Eipascope (2001), pag 2-9;
16. Meunier, Sphie and Kalypso Nocolaidis, Trade Competence in the Nice Treaty, ECSA Review, Vol.14,
No.2, Spring 2001

Glossary of EU terminology
Full text legislative information


2. The structure and functions of European Institutions

2.1 The European Commission
2.2 The Council of the European Union
2.3 European Parliament
2.4 Court of Justice
2.5 Other EU Institutions (Economic and Social Committee, Committee of the Regions, the
European Investment Bank, the Court of Auditors)
2.6 Institutional reform: future challenges
Table 2.1 The Institutions of the EU
European Council
15 Heads of State
or Government and
the President of the

Committee of the
222 members

Council of the EU
15 ministers

European Court of
15 Judges

European Parliament
626 members

Economic and
Social Committee
222 members

Court of Auditors
15 members

European Commission
20 members

European Central Bank

United Kingdom

Votes in the
Council of

investment Bank
of total votes

Percentage of

Members of


Having considered a brief history of European integration and the role of integration theories in helping
us to understand pathways and progress, attention should now be turned to the organization of the EU and to the
institutional arrangements of the Community pillar. Much recent attention has been paid to the EU as a
governance system and an understanding of its basic elements is a fundamental requirement for European
businesses. Those firms hoping to influence the decision-making process (through lobbying) require a detailed
understanding of the openings for dialogue and of the centers of executive and legislative authority. Those firms
operational in the European business environment should at least understand how EU rules, regulations and
directives, many of which govern their activity and behavior, are issued and from which centers of power. In
order to understand the workings of the EU it is necessary to outline the role and activities of each of four
governing institutions with a role in the initiation, enactment, interpretation and application of Union law.

2.1 The European Commission

The Commissions role and function
The role and responsibilities of the European Commission place it firmly at the heart of the European
Union's policy-making process. Its three basic tasks are to initiate EU action, to act as guardian of the treaties
and to operate as manager and executor of the Unions policies and of international trade relationships.
As an institution it is headed by twenty civil servants representing the fifteen member states who are
chosen to represent the interests of the EU rather than individual countries. The Council and the European
Parliament need a proposal from the Commission before they can pass legislation. EU laws are mainly upheld by
Commission action, the integrity of the single market is preserved by Commission policing, agricultural and
regional development policies are sustained, managed and developed by the Commission as is development
cooperation with the countries of Central and Eastern Europe, Africa, the Caribbean and Pacific. Research and
technological development programmes, vital for the future of Europe, are orchestrated by the Commission.
The Commission, in close collaboration with the European Council, frequently provides the impulse
towards further integration at the crucial moments when it is needed. Decisive initiatives in recent years have
been launching the strategy which culminated in the completion of the single market in 1993, the Commission's
role in drawing up a blueprint for economic and monetary union and its drive to strengthen economic and social
cohesion between the regions of Europe.
Although not controlled by the member states, the Commission is at least appointed by them. Each
member state must be represented by at least one Commissioner, but no member state may have more then two
nationals. Prior to the next enlargement, the largest nations Germany, France, Italy, the UK and Spain send two
Commissioners and the smaller states one each. Commission members are appointed by common agreement of
the member states to serve a five year term, which is renewable. The President of Commission is appointed by
common agreement among the member heads of state and is subject to the approval of the European Parliament.
Prior to the recent appointment of Italian, Romano Prodi, the most recent was the former Prime Minister of
Luxembourg, Jacques Santer (1995-1999), whose predecessor was the former French Finance Minister, Jacques
Delors (1985-95).
At the start of 1999, the Commission was organized into twenty-four directorates-general (divisions) and
a number of specialist units and support services.
Table 2.2 Directorates-General, Services and Special Units of the European Commission

External Relations: Commercial policy and relations with North America, the Far East,
Australia and NZ
External Relations: Europe and New Independent States, CFSP and External Missions
External Relations: Southern Mediterranean, TOP and Near East, Latin America, South
and South East Asia and North-South Co-operation
Economic and Financial affairs
Employment, Industrial Relations and Social Affairs
Personal and Administration
Information, Communication, Culture and Audiovisual



Environment, Nuclear Safety and Civil Protection

Science, Research and Development
Telecommunications, Information Market and Exploitation of Research
Internal market and financial Services
Regional Policies and Cohesion
Credit and Investments
Financial Control
Customs and Indirect Taxation
Education, Training and Youth
Enterprise Policy, Distributive Trades and Tourism
Consumer Policy and Consumer Health Protection

Sevices and Special Units

Forward Studies Unit
Spokesmans Service
Statistical Office
Informatics Directorate
Humanitarian Office
Accession Task Force

Legal service
Conference Service
Translation Service
Publications Office
EAEC Agency

The Commission meets once a week to conduct its business, which may involve adopting proposals,
finalizing policy papers and discussing the evolution of its priority policies. Commissioners are expected to give
full support to all policies, even when they are adopted by a majority.
The Commission's democratic legitimacy is being increasingly strengthened by more determined and
thorough Parliamentary vetting of the President and his colleagues. The full Commission has to be approved by
the European Parliament before its members can take office. They can be required to resign / by a
parliamentary vote of censure a power that has never yet been used.
With its staff of 16 000, the Commission is the largest of the Union's institutions. The employment total,
however, is modest, given the wide range of its responsibilities and also bearing in mind that one-fifth work in the
translation and interpretation services. Their work is essential to the Commission which must be able to reach all
of the citizens of the Union in their own languages.
The Commission is not an all-powerful institution. Its proposals, actions and decisions are in various
ways scrutinized, checked and judged by all of the other institutions, with the exception of the European
Investment Bank. Nor does it take the main decisions on Union policies and priorities this is the prerogative of
the Council and, in some cases, of the European Parliament.

Legislative initiator
The legislative process begins with a Commission proposal Community law cannot be made without
one. In devising its proposals, the Commission has three constant objectives: to identify the European
interest, to consult as widely as is necessary and to respect the principle of subsidiary. The European interest
means that a legislative proposal reflects the Commission's judgment of what is best for the Union and its citizens
as a whole, rather than for sectoral interests or individual countries. Consultation is essential to the preparation of
a proposal, the Commission it listens to governments, industry, trade unions, special interest groups and technical
experts before completing its final draft.
Subsidiarity is enshrined in the Treaty on European Union and is applied by the Commission in such a
way as to ensure that the Union takes action only when it will be more effective than if left to individual Member
States. Once the Commission has formally sent a proposal for legislation to the Council and the Parliament, the
Union's law-making process is very dependent on effective cooperation between the three institutions.
The Commission does not have an exclusive right of initiative in the two areas of intergovernmental
cooperation covered by the Treaty on European Union common foreign and security policy and cooperation on
justice and home affairs. But it can submit proposals in the same way as national governments and it participates
in discussions at all levels.


Guardian of the Treaties

It is the Commission's job to ensure that Union legislation is applied correctly by the Member States. If
they breach their Treaty obligation, they will face Commission action, including legal proceedings at the Court of
Justice. In certain circumstances, the Commission can fine individuals, firms and organizations for infringing
Treaty law, subject to their right to appeal to the Court of Justice. Illegal price-fixing and market-rigging cartels
have been a constant object of its attention and the subject of very large fines in late 1994, one group of firms
were fined a record ECU 248 million. The Commission also maintains a close scrutiny over government subsidies
to industry and certain kinds of State aid must, by Treaty, receive its assent.

Manager and executor

The Commission manages the Union's annual budget (ECU 92.453 billion in 1999) which is dominated
by farm spending allocated by the European Agricultural Guidance and Guarantee Fund and by the Structural
Funds, designed to even out the economic disparities between the richer and poorer areas. Its executive
responsibilities are wide: it has delegated powers to make rules which fill the details of Council legislation; it can
introduce preventive measures for a limited period to protect the Community market from dumping by third
countries; it enforces the Treaty's competition rules and regulates mergers and acquisitions above a certain size.
The Union's effectiveness in the world is enhanced by the Commission's role as negotiator of trade and
cooperation agreements with other countries, or groups of countries. More than 100 have such agreements with
the Union including the developing countries of Africa, the Caribbean and Pacific which are covered by the Lome
Convention, and those of Central and Eastern Europe and the former Soviet Union which receive important technical assistance under the PHARE and TACIS programmes. The countries of the southern Mediterranean are also
benefiting from a European development aid effort.

2.2 The Council of the European Union

Table 2.3 Composition of the Council
One representative of each Member State at ministerial level,
With composition varying according to the subject discussed, for example:
General Affairs Council

Economic and Financial

Transport Council


(ECOFIN) Council

Permanent Representatives Committee

Coreper I and II

Special Committee for Agriculture

Working groups
General Secretariat (approximately 2 200 officials)

Drawing up

Coordination of
economic policy




Function and organization


The Council of the European Union, usually known as the Council of Ministers, has no equivalent
anywhere in the world. The Council of the European Union is the main decision-making institution of the
European Union. Here, the Member States legislate for the Union, set its political objectives, coordinate their
national policies and resolve differences between themselves and with other institutions. It has four main elements:
the Councils of Ministers themselves, the Permanent Representatives (COREPER), the Presidency and the
Secretariat General.
It is a body with the characteristics of both a supranational and intergovernmental organization, deciding
some matters by qualified majority voting, and others by unanimity. In its procedures, its customs and practices,
and even in its disputes, the Council depends on a degree of solidarity and trust, which is rare in relations between
Its democratic credentials should not be in doubt. Each meeting of the Council brings together Member
States' representatives, usually ministers, who are responsible to their national parliaments and public opinions.
Nowadays, there are regular sessions of more than 25 different types of Council meeting: General Affairs (Foreign
Affairs Ministers), Economy and Finance, and Agriculture meet monthly; others such as Transport, Environment
and Industry meet two to four times a year.
The Presidency of the Council rotates between the Member States every six months: January until June,
July until December. The Presidency's role has become increasingly important as the responsibilities of the Union
have broadened and deepened. It must:
1. Arrange and preside over all meetings;
2. Elaborate acceptable compromises and find pragmatic solutions to problems submitted to the
3. Seek to secure consistency and continuity in decision taking;
Decision-making in the Council
In the Community pillar of course, the main function of the Council of the European Union is to
formulate law. The Council receives legislative proposals from the Commission and may turn those proposals into
legal Acts. Once the Commission has proposed a new measure, it is considered and amended by the European
Parliament and the Council of the EU together, with the two bodies now acting (in most cases) as co-legislators. A
proposal can not become law without the approval of the Council. Depending on the subject matter of proposals,
decisions are taken either by unanimity or on the basis of majority voting. This is predetermined by treaty
Pillar One covers a wide range of Community policies (such as agriculture, transport, environment,
energy, research and development) designed and implemented according to a well-proven decision-making
process, which begins with a Commission proposal. Following a detailed examination by experts and at the
political level, the Council can adopt the Commission proposal, amend it or ignore it.
The Treaty on European Union increased the European Parliament's say through a co-decision procedure,
which means that a wide range of legislation (such as internal market, consumer affairs. trans-European networks,
education and health) is adopted both by the Parliament and the Council.
In the vast majority of cases (including agriculture, fisheries, internal market, environment and
transport), the Council decides by a qualified majority vote with Member States carrying the following
Table 2.4
Germany, France, Italy and the United Kingdom:
10 votes
8 votes
Belgium, Greece, the Netherlands and Portugal:
5 votes
Austria and Sweden:
4 votes
Ireland, Denmark and Finland:
3 votes
2 votes
87 votes
When a Commission proposal is involved, at least 62 votes must be cast in favour. In other cases, the
qualified majority is also 62 votes, but these must be cast by at least 10 Member States. In practice, the Council tries
to reach the widest possible consensus before taking a decision. Those policy areas in Pillar One which remain
subject to unanimity include taxation, industry, culture, regional and social funds and the framework
programme for research and technology development.
For the other two pillars created by the Treaty on European Union common foreign and security policy
(Pillar Two) and cooperation in the fields of justice and home affairs (Pillar Three), the Council is the decisionmaker as well as the promoter of initiatives. Unanimity is the rule in both pillars, except for the implementing of a


joint action which can be decided by qualified majority. The objectives of the common foreign and security policy
are to define and implement an external policy covering all foreign and security aspects.
Cooperation in justice and home affairs aims to achieve the free movement of persons inside the Union;
promote measures of common interest in the fields of external border control, asylum policy, immigration policy;
and fight against terrorism, drug trafficking and other serious forms of international crime.
The European Council
The European Council and the Council of Ministers are related but separate entities. The Council is composed
of one representative at ministerial level from each member state with several different councils operational
(councils for agriculture, transport and employment). By meeting on subject matter basis, or by policy area, it is
ensured that the appropriate ministers from the government of each member state address those policy proposals
that would naturally and necessarily come under their ministries consideration. Members of the European Council
may also constitute the Council of Ministers- after all, they are representatives of each member state at ministerial
level authorized to commit the government of that member state- but invariably they meet not to adopt formal legal
texts but to resolve otherwise intractable problems and to lead the Community at the highest political level.
Since 1974, Heads of State or Government have met at least twice a year in the form of the European
Council or 'European Summit'. The President of the European Parliament is invited to make a presentation at the
opening session. The European Council has become an increasingly important element of the Union, setting
priorities, giving political direction, providing impetus for its development and resolving contentious issues that
have proved too difficult for the Council of Ministers. The European Council also deals with current international
issues through the common foreign and security policy (CFSP), a mechanism devised to allow the Member States to
align their diplomatic positions and present a united front.
The European Council submits a report to the European Parliament after each of its meetings and an
annual written report on the progress achieved by the Union.
Each Member State has a national delegation in Brussels known as the Permanent Representation. These
delegations are headed by Permanent Representatives, who are normally very senior diplomats and whose
committee, called Coreper, prepares ministerial sessions. Coreper meets weekly and its main task is to ensure that
only the most difficult and sensitive issues are dealt with at ministerial level and shall be responsible for preparing
the work on the Council and for carrying out the tasks assigned by the Council. Coreper is also the destination of
reports from the many Council working groups of national experts. These groups make detailed examinations of
Commission proposals and indicate, among other things, areas of agreement and disagreement. Coreper itself sits in
two parts: Coreper Part 1, which is composed of the Deputy Permanent Representatives and examines technical
questions on the whole, and Coreper Part 2, which is composed of the Ambassadors themselves and deals with
political questions on the whole.
After examining an issue Coreper either submits a report to the Council, preparing the ground for its
discussions by drawing attention to the political aspects which warrant particular attention, or, if unanimous
agreement has been reached between the Parliament Representatives and the Commission representative,
recommends that the Councils work is much lighter owing to Corepers intervention.
The work of the Agriculture Council is prepared by senior Brussels-based representatives of Member
States meeting weekly in the Special Committee on Agriculture. The Secretariat-General provides the intellectual
and practical infrastructure of the Council at all levels. It is an element of continuity in the Council proceedings and
has the custody of Council acts and archives. Its Legal Service advises the Council and committees on legal matters.
The Secretary-General is appointed by the Council acting unanimously.
The Council is making strong efforts to make more of its work accessible to the citizen votes on legislative
matters, as well as the explanations of these votes, are now automatically made public.
The public has also been given some rights of access to Council documents and some Council discussions
are transmitted audiovisual. Other attempts to improve transparency include briefings for journalists and the
provision of background notes on subjects under discussion.
In addition, the Council's Press Service produces comprehensive press releases following Council
meetings which are available on demand and through databases.

2.3 The European Parliament

The European Parliament sees itself as the guardian of the European interest and the defender of
citizens rights, the largest multinational parliament in the world, representing the 370 million citizens of the
Union. Its primary objectives are like those of any parliamentto pass good laws and control the executive


power. Now more than ever before, it is in a much better position to do both because its respon sibilities have
been gradually widened and its powers strengthened first by the Single Act of 1987, then by the Treaty on
European Union of 1993, and, in 1997, by the Treaty of Amsterdam.
Naturally, the Parliament sees itself as the guardian of the European interest and the defender of the citizens'
rights. Individually, or as a group, European citizens have the right to petition the Parliament and can seek
redress of their grievances on matters that fall within the European Union's sphere of responsibility. The
Parliament has also appointed an ombudsman, Mr. Jacob Magnus Soderman, to investigate allegations of
misadministration brought by citizens.
The European Parliament attaches a high priority to maintaining links with national parliaments through
regular meetings between speakers and chairpersons and between parliamentary committees. These contacts are
further enlivened by discussions of Union policies in major conclaves known as 'parliamentary assizes'.
The most important powers of the European Parliament fall into three categories:
Legislative power;
Power over the budget;
Supervision of the executive.
Legislative power
Originally, the Treaty of Rome (1957) gave the Parliament only a consultative role, allowing the
Commission to propose and the Council of Ministers to decide legislation. Subsequent Treaties have extended
Parliament's influence to amending and even adopting legislation so that the Parliament and Council now share
the power of decision in a large number of areas.
The consultation procedure requires an opinion from the Parliament before a legislative proposal from
the Commission can be adopted by the Council. This applies, for example, to the agricultural price review.
The cooperation procedure allows Parliament to improve proposed legislation by amendment. It
involves two readings in Parliament, giving members ample opportunity to review and amend the Commission's
proposal and the Council's preliminary position on it. This procedure applies to a large number of areas including
the European Regional Development Fund, research, the environment and overseas cooperation and development.
The co-decision procedure shares decision-making power equally between the Parliament and the
Council. A conciliation committee made up of equal numbers of Members of Parliament and of the Council,
with the Commission present seeks a compromise on a text that the Council and Parliament can both
subsequently endorse. If there is no agreement. Parliament can reject the proposal outright. The co-decision
procedure applies to a wide range of issues such as the free movement of workers, consumer protection,
education, culture, health and trans-European networks. The Treaty of Amsterdam extends this procedure in
particular to employment, freedom of establishment, equal pay for men and women, etc.
Parliament's assent is required for important international agreements such as the accession of new
Member States, association agreements with third countries, the organization and objectives of the Structural and
Cohesion Funds 0 and the tasks and powers of the European Central Bank.
Budgetary powers
The European Parliament approves the Union's budget each year. The budgetary procedure allows
Parliament to propose modifications and amendments to the Commission's initial proposals and to the position
taken by the Member States in Council. On agricultural spending and costs arising from international agreements
the Council has the last word, but on other expenditure for example, education, social programmes, regional
funds, environmental and cultural projects Parliament decides in close cooperation with the Council. In
exceptional circumstances, the European Parliament has even voted to reject the budget when its wishes have not
been adequately respected. Indeed, it is the President of the Parliament who signs the budget into law.
Monitoring of expenditure is the continuous work of the Parliament's Committee on Budgetary Control
which seeks to make sure that money is spent for the purposes agreed and to improve the prevention and detection
of fraud. Parliament makes an annual assessment of the Commission's management of the budget before
approving the accounts and granting it a 'discharge' on the basis of the Annual Report of the Court of Auditors.
Supervision of the executive
The Parliament exercises overall political supervision of the way the Union's policies is conducted.
Executive power in the Union is shared between the Commission and the Council of Ministers and their
representatives appear regularly before Parliament.
Parliament has an important role every five years in appointing the President and members of the
Commission. It exercises detailed scrutiny through a close examination of the many monthly and annual reports


which the Commission is obliged to submit to the Parliament. Members may also put written and oral questions to
the Commission nearly 5 500 in 1997 and they regularly interrogate Commissioners at Question Time
during plenary sessions and at meetings of parliamentary committees. Parliament can, by a two-thirds majority of
its members, pass a motion of censure and thereby compel the Commission to resign as a body (Article 201 EC),
five motions of censure have so far been tabled (most recently in January 1999).
The President in office of the Council presents his or her programme at the beginning of a presidency
and gives an account of it to Parliament at the end of that period. He or she also reports on the results of each
European Council and on progress in the development of foreign and security policy. Ministers attend plenary
sessions and take part in Question Time and in important debates. They must also respond to written questions. At
the beginning of each meeting of the European Council, the President of Parliament presents the institution's main
positions on the topics to be discussed by the Heads of State or Government. This speech often sets the tone for
the important discussions of the day.

2.4 The Court of Justice

The Union, like the European Communities on which it is founded, is governed by the rule of law. Its
very existence is conditional on recognition by the Member States, by the institutions and by individuals of the
binding nature of its rules. The role of the Court is to provide the judicial safeguards necessary to ensure that the
law is observed in the interpretation and application of the Treaties and, generally in all of the activities of the
The success of Community law in embedding itself so thoroughly in the legal life of the Member States
is due to its having been perceived, interpreted and applied by the citizens, the administrative authorities and the
courts of all of the Member States as a uniform body of rules upon which individuals may rely in their national
courts. The decisions of the Court have made Community law a reality for the citizens of Europe and often have
important constitutional and economic consequences.
The Court may be called upon to decide cases brought by the Member States, by the Community
institutions and by individuals and companies. It ensures uniform interpretation of Community law throughout the
Community by close cooperation with national courts and tribunals through the preliminary ruling procedure. The
Court of Justice worked alone until 1 September 1989 when the Council attached to it a Court of First Instance in
order to improve the judicial protection of individual interests and to enable the Court of Justice to concentrate its
activities on its fundamental task of ensuring uniform interpretation of Community law. The Court of First
Instance now has jurisdiction to deal with all actions brought by individuals and companies against decisions of
the Community institutions and agencies. Its judgments may be subject to an appeal brought before the Court of
Justice but only on a point of law.
The Court of Justice is composed of 15 judges and 9 advocates general appointed by common accord of
the Member States for a renewable term of six years. Their independence must be beyond doubt and they must be
qualified for the highest judicial offices in their respective countries or be jurists of recognized competence. The
judges elect the President of the Court from among their number for a term of three years. The President directs
the work of the Court and presides at hearings and deliberations. The Court is assisted by the advocates general
whose task is to deliver independent and impartial opinions on cases brought before it.
Table 2.5 Composition of the European Court of Justice
Governments of the Member States
appoint the 15 Judges and 8 (9)
Advocates- General by common accord
for a term of six years
Types of proceeding
Actions for failure to fulfill
obligations under the Treaties:

under for annulment and actions
on grounds of failure to act

Commission of Member State

(Article 226)

brought by a Community institution or a

Member State in connection with an
illegal act or failure to act
(Article 230 and 232)

Cases referred from national

courts for preliminary
to clarify the meaning and scope of
of Community law (Article 234)

The Court of First Instance has 15 judges appointed by the Member States for the same renewable term
of office. This Court also elects its President, however there are no advocates general. The Court of Justice may


sit in plenary session or in chambers of three or five judges. It sits in plenary session when it so decides or if a
Member State or an EU institution which is a party to the proceedings so requests. For its part the Court of First
Instance sits in chambers of three or five judges. It may sit in plenary session for certain important cases.
Broadly speaking two types of cases may be brought before the Court of Justice:
either direct actions may be brought directly before the Court by the Commission, by other Community
institutions or a Member State. Cases brought by individuals or companies challenging the legality of a
Community act are brought directly before the Court of First Instance. If an appeal is lodged against a
decision of the Court of First Instance it is dealt with by the Court of Justice according to a procedure
similar to that of other direct actions;
or preliminary rulings may be requested by courts or tribunals in the Member States when they need a
decision on a question of Community law in order to be able to give a judgment. The Court of Justice is
not a court of appeal from the decisions of national courts and can only rule on matters of Community
law. Having given its decision the national court is bound to apply the principles of Community law as
laid down by the Court in deciding the case before it.
In a direct action the language of the case is chosen by the applicant whereas in prelimi nary rulings the Court of
Justice uses the same language as the national court, which referred the case. Thus any of the Community's
languages may be used. Written exchanges are an important part of the Court's procedures, both for pleadings and
for the submission of observations. After the end of the written phase, cases are argued orally in open court.
Following the hearing, the advocate general delivers an impartial and independent opinion in open court
on the arguments submitted and on the interpretation of the relevant rules before recommending a decision for
adoption by the Court. Although the advocate general's opinion is not binding upon the Court, his or her advice is
extremely persuasive and is most often followed by the Court.
The judges consider the case in closed deliberation and then deliver judgment in open court. The text of
the judgment includes the reasoning upon which it is based and copies of the text are available in all 11 official
languages. Since 1954 almost 10 000 cases have been brought before the Court of Justice which has delivered
some 4 507 judgments.

2.5 Other EU Institutions (Economic and Social Committee, Committee of the Regions,
the European Investment Bank, the Court of Auditors)
The economic and Social Committee
The role of the Economic and Social Committee, founded by the Treaty of Rome in 1958, is
consultative; its membership is drawn from a broad cross-section of society and the economy. Some represent
employers and workers (the 'social partners'), while the daily activities of others range from farming to commerce,
transport, the professions, cooperatives, mutual, small and medium-sized enterprises and environmental and
consumer protection. Members belong to one of three groups of roughly equal size; employers (Group I), workers
(Group II) and various interests (Group Members are leading representatives of civil society who carry out their
role with a conscious determination to bring the EU institutional machinery closer to the people.
The Treaty requires the Commission and the Council to refer draft legislation in specified policy areas to
the Committee and leaves them free to choose whether to do so on other matters. Since 1972, the Committee has
also had the right to issue opinions on its own initiative on any matter of Community interest. The most recent
amendment to the Treaty on European Union, adopted in Amsterdam, now allows the European Parliament to
consult the Economic and Social Committee too. No European law of any significance has been adopted without
the Committee's voice being heard. Since it was set up, the Committee has adopted more than 3 000 opinions, all
of which have been published in the Official Journal of the European Communities.
Draft opinions are drawn up by reporters and tripartite study groups, passed for discussion and
amendment to one of nine 'sections', bodies which resemble parliamentary committees, and then submitted to one
of the monthly meetings of the full Committee. Adoption is by a straight majority by requiring its members to
find common ground on each issue and to resolve conflicts of interest between economic and social groups, the
Committee makes a useful contribution to consensus building.
Given the involvement of its members in the Union's daily economic life, the Committee is well
qualified to contribute directly to the growth and development of the single market. At the request of the
European Parliament, the Commission and the Council, it keeps the single market under review and draws
attention to malfunctions. Twice a year, it holds a single market forum, which brings together correspondents
from the Member States to review developments. The forum enables the Committee to act as a permanent
monitoring unit. It points out things that have been left undone and draws attention to misinterpretations and footdragging likely to prevent the free circulation of goods, capital, services and people. It also recommends remedies
to Community decision-makers.
The Economic and Social Committee maintains good relations with its international, national and


regional counterparts. These are important channels for involving civil society in the construction of Europe, and
bringing Europe closer to the public. The Committee regularly stages wide-ranging symposia on the citizen's
Europe. It is also in regular contact with socioeconomic bodies in the African, Caribbean and Pacific States. More
occasionally, meetings are held with partners from, for instance, the Mediterranean regions and countries which
wish to join the EU.
Committee of the Regions
The Committee of the Regions is the European Union's youngest institution whose creation reflects
Member States' strong desire not only to respect regional and local identities and prerogatives but also to
involve them in the development and implementation of EU policies. For the first time in the history of the
European Union, there is now a legal obligation to consult the representatives of local and regional authorities on
a variety of matters that concern them directly.
Created as a consultative body by the Treaty on European Union, the Committee has emerged as a strong
guardian of the principle of subsidiarity since its first session in March 1994. Subsidiarity is enshrined in the
Treaty and means that decisions should be taken by those public authorities, which stand as close to the citizen as
possible. It is a principle, which resists unnecessarily remote, centralized decision taking. As regional presidents,
mayors of cities or chairpersons of city and county councils, the 222 members of the Committee are elected
officials from the levels of government closest to the citizen. This means that they have a very direct experience
of how the Union's policies and legislation affect the everyday life of their citizens. With such resources, the
Committee is able to bring powerful expertise and influence to bear on the Union's other institutions. It has many
opportunities to do so. The Treaty requires it to be consulted on matters relating to trans-European networks,
public health, education, youth, culture and economic and social cohesion. But the Committee can also take the
initiative and give its opinion on other policy matters that affect cities and regions, such as agriculture and
environmental protection.
The Committee's work is based on the following structure:
Commission 1: Regional policy. Structural Funds, economic and social cohesion,
Cross-border and inter-regional cooperation
Commission 2: Agriculture, rural development, fisheries
Commission 3: Trans-European networks, transport, information society
Commission 4: Spatial planning, urban issues, energy, the environment
Commission 5: Social policy, public health, consumer protection, research, tourism
Commission 6: Employment, economic policy, single market, industry, SMEs
Commission 7: Education, vocational training, culture, youth, sport, citizens' rights Commission on Institutional
Affairs: responsible for contributing to the debate on the reform of the EU institutions.
The Bureau, elected for a two-year term, organizes the work of the Committee of the Regions.
The European Court of Auditors
The European Court of Auditors is the taxpayers representative, responsible for checking that the
European Union spends its money according to its budgetary rules and regulations and for the purposes for which
it is intended. Some see the Court as the 'financial conscience' of the Union, others as a 'watchdog' over its money.
In either case, it is a guarantor that certain moral, administrative and accounting principles will be respected. The
Court's reports are a rich source of information on the management of the Union's finances, and a source of
pressure on the institutions and others with administrative responsibility to manage them soundly.
The Court's function, performed with complete independence, is a vital contribution to transparency in
the Union. Objective scrutiny reassures the taxpayer that the Union's money is being managed responsibly a
reassurance which is all the more necessary given the growth of expenditure in recent years over a widening
range of policies.
In 1997, the Union's budgetary operations reached ECU 120 billion, including borrowing and lending
activities. Every institution and body that has access to Union funds is subject to scrutiny and must provide the
Court of Auditors with the information and documents it requires. Not only the European institutions fall within
its scope; national, regional and local administrations which manage Community funds must satisfy the Court that
all is in order, as well as recipients of Community aid, inside and outside the Union.
The task of the Court and its auditors is to check that revenue and expenditure observe the legal
regulations and are in line with the Community's budgetary and accounting principles. At the same time, the Court
is also concerned to make sure that the Community is getting value for its money by checking whether and to


what extent financial management objectives have been achieved and at what price. The Court carries out on-thespot audits wherever necessary on the premises of European institutions, in Member States and outside. These
do not have to wait until the financial year is over, they can be made at the same time as the funds are being
Primary responsibility for preventing, detecting and investigating irregularities lies with those
responsible for managing and executing EU programmes. When the Court identifies errors, irregularities and
potential cases of fraud, it makes them known to the relevant administrations and other bodies for action to be
taken. It also points out any weaknesses in systems and procedures which may have enabled the particular
problems to occur.
The Court's observations on the management of Community finances are published in its Annual report
together with the replies from the institutions concerned. The Annual report highlights those areas in which
improvements are possible and desirable. Adopted every year in November, the report is examined by the
European Parliament on a recommendation of the Council when it is considering whether or not to give a
discharge to the Commission for its management of the budget.
The Court is not limited, however, to just this occasion if it wants to make its views felt. It can, at any
time. Issue special reports on specific areas of budget management. Like the Annual report, these reports are
published in the Official Journal. For their part, if the institutions feel they need guidance on some aspects of their
management of funds, they can ask the Court for an opinion and must do so before adopting documents relating
to financial regulations and own resources (EU budget revenues).
The Court also provides the European Parliament and the Council with a Statement of assurance. This
certifies the accounts as reliable and the operations they relate to as legal and regular. The Statement is the formal
declaration to taxpayers that their money has been spent in the places for which it was intended, and for the
purposes intended.
European Investment Bank
The European Investment Bank (EIB), the European Union's financing institution, provides long-term
loans for capital investment promoting the Union's balanced economic development and integration. The
EIB is a flexible and cost-effective source of finance whose ECU 26 billion volume of annual lending makes it
the largest of the international financing institutions in the world. In the European Union, EIB loans go to
projects, which fulfill one or more of the following objectives:
Strengthening economic progress in the less-favored regions;
Improving trans-European networks in transport, telecommunications and energy transfer;
Enhancing industry's international competitiveness and its integration at a European
level and supporting small and medium-sized enterprises;
Protecting the environment and quality of life, promoting urban development and safeguarding the EU's
architectural heritage;
Achieving secure energy supplies;
Extending and modernizing infrastructure in the health and education sectors as well as assisting urban renewal,
under the 'Amsterdam special action programme in support of growth and employment.
The Bank carries out a rigorous appraisal of each investment project, not only assessing its consistency
with EU policies but also vetting its economic and environmental justification as well as its financial and
technical viability.
The EIB is not a bank in which people deposit their money, but it is a bank, which pays a quality of life
dividend for millions of citizens. Underpinning regional development is the Bank's priority task and two thirds of
its total lending is advanced for productive investment in regions, which are lagging behind or facing industrial
The direct benefits of EIB lending activities to the citizens have included new companies, more jobs,
better communications and improved environmental protection. Loans are not allocated according to any system
of quotas. They are determined by policy priorities and the demands of economic operators.
The ElB's financing for regional development often goes hand in hand with grants from the EU's
Structural Funds and Cohesion Fund. Ensuring that loans and grants are complementary brings the Bank into
close collaboration with the Commission, and involves it in the preparation and implementation of structural
support programmes.
The Union is committed to a strategy for strengthening the economies of Member States, their
competitiveness and their capacities to create new jobs. In pursuit of these aims, the European Council at its
recent meetings called on the Bank to play a major role in the Union's economic integration in the run-up to
economic and monetary union (EMU).
To this end, the EIB channels a large amount of its financing towards less-favoured regions.
Complementing the efforts of the Member States and the EU to further a balanced economic development. The


EIB also focuses its lending on basic infrastructure sectors and trans-European networks (TENs) in transport,
telecommunications and energy transfer, paying particular attention to the linking of neighboring regions with the
European Union. Especially in Central and Eastern Europe. In 1997 the bank launched its three-year Amsterdam
special action programme (ASAP) aimed at investment in: health, education, environmental protection and urban
renewal; new venture capital facilities for high-growth innovative SMEs; and additional support for large
infrastructure schemes.
While the EU is the main focus of its activities, the EIB also helps to execute the financial aspects of the
Union's cooperation policies with non-member States. Currently, the Bank is operating in more than 100 of these
In support of economic development projects in the countries of Central and Eastern Europe preparing
for EU membership;
In fostering cross-border infrastructure and environmental projects, as well as developing the productive
private sector in Mediterranean non-member countries;
In contributing to the set-up of the Euro-Mediterranean partnership, launched at the Barcelona
Conference and assisting the Middle East peace process;
In the 70 African, Caribbean and Pacific signatories to the Lome Convention, longstanding beneficiaries
of EIB loans, and in the Republic of South Africa;
In financing projects of mutual interest in such areas as technology transfer, joint ventures and
environmental protection in Asian and Latin American countries which have signed cooperation
agreements with the ED.
Projects supported by EIB loans carry the lightest possible interest rate burden. The Bank obtains the bulk of
its resources on the capital markets where its top (AAA) credit rating enables it to borrow on the best terms
available and to pass on the benefit to project promoters.
As a major presence on the capital markets raising over ECU 23 billion in 21 curren cies in 1997 the EIB
plays an important part in their development, particularly for the emerging markets in the EU candidate countries
in Central and Eastern Europe. The Bank's borrowing policies also aim to help prepare the ground for a large and
liquid euro capital market, much as it did to support the ECU at the beginning of the 1980s, thus promoting the
financial market's confidence in the single currency.
References on the European institutions and suggested readings:
1. Burban Jean-Luis, Les institutions europeennes, Vuiber, Paris, 1997
2. Serving the European Union, Luxembourg: Office for Official Publications of the European
Communities, 1999, pag 5-7; 9-11; 17-20;
3. Simon Mercado, Richard Welford, European Business, Financial Times, 2001, pag 56-57;
4. The European Parliament, Office for official publications, Luxembourg, 2000, pag 14-15;
5. Marcel Scotto, Les institutions europeennes, la reforme inachevee, Le Monde, 1997,
6. Pascal Fontaine, European in ten points, European Documentation,1995, pag 9-13;
7. Dinan Dinan, Ever Closer Union?, Macmillan, London, 1999, p. 217-220;
8. Peterson John and Bomberg Elisabeth, Decision-making in the EU, Macmillan, Basingstoke, 1999
9. Klaus-Dieter Borchardt, The ABC of Community law, European Commission, 2001
10. Helen and William Wallace, Policy-Making in the European Union, Forth Edition, Oxford University
press, 1999, p. 10-20;
Web guide
Improving the functioning of the co-decision procedure, Discussion Document by the VicePresidents responsible for conciliation, European Parliament
Open Letter from civil society on the new code of access to documents of the EU Institutions, 2
May 2001.


3. Customs Union in the European Community

3.1 Concepts of regional integration, integration theory and economic analysis
3.2 Customs Union: economic and legal framework
3.3 Intra-community trade
Elimination of internal frontiers
Veterinary and plant health legislation
Administrative cooperation
3.4 Trade with non-member countries
The Common customs tariff
Economic tariff matters
General customs legislation,
Origins of goods,
Customs procedures with economic impact
1.2 Concept of regional integration, integration theory and economic analysis
The eagerness of countries to affiliate themselves to a regional economic grouping stems from the
various benefits offered by economic integration including opportunities for gaining economies of scale (in an
enlarged trading market) and the promotion of trade and welfare through increased specialization of production.
Although specific incentives may vary over time and by case - political and security dimensions may also be
relevant in the formation of regional economic groupings - REGs are expected to be at their most attractive when
the level of economic and commercial interdependency between members is at its greatest. This provides
conditions for net trade creation. The high level of trade conducted within the continental region between
European states makes trade with other parts of the world less significant than for countries in other regions. The
US relies on the north and South American region for just 35% of its exports and Japan sells only an equivalent
percentage of its exports in the Asia - Pacific area. In contras, since the 1960s, the average EC/EU member state
has relied on Community markets for over 50% of total export sales. Since 1995, the average share of intra-EU
trade has been somewhere between 63% and 69% of total foreign trade and the average share of regional trade
(taking account of other European market sales) in excess of 70%.
The study of economic integration is the study of arrangements between two or more sovereign states as
a result of which trade and economic transactions between them are conducted on a basis more favorable to them
than to states outside the agreement. Agreements on this kind can range from preferential tariff arrangements to
full economic union and different models involving an ascending order of degrees of integration can be
characterized on a five-point scale:
1. One of the most basic forms of integration or co-operation is that of a preferential agreement
wherein preferential tariffs are applied mutually or by one party on another. Preferences will be limited to a
particular good or range of goods. In the case of mutual preferences, participating countries agree to levy a lower
rate of taxation on imports from each other than that levied on countries outside the agreement. Such an
agreement is common among countries which have close political links, for example, between the UK and
members of the Commonwealth prior to the UKs EEC entry (1973).
2. A form of integration extends the preferential tariff to cover all imports between the countries
involved in the agreement. Commonly all imports from one country party to the agreement will be at a zero tariff
while comparable imports from countries outside the agreement will be subject to a tariff barrier. This sort of
arrangement is often referred to as a free trade area and characterizes the arrangement for industrial products
made between the countries of EFTA (the European Free Trade Association), NAFTA and ASEAN. Tariffs levied
on products imported from non-participating countries are levied at whatever rate the individual country
3. There is a type of arrangement known as a customs union. Here there is completely free trade in all
products between the members of the union and a common external tariff levied on imports from non-member
states. Tariff revenues become common property and are subsequently shared out according to some agreed set
of rules. Examples include the Central African Customs and Economic Union and the MERCOSUR grouping in
Latin America.
4. There is another level of integration which carries this process one step further and leads to the
creation of a single or common market. Free trade between member countries is ensured not only by the
elimination of tariffs but also by removal of all other obstacles (non-tariff barriers) to free trade in goods and
services. Thus licenses, foreign exchange controls, customs procedures, standards and indirect taxes other than
tariffs have to be harmonized or eliminated. An internal market also operated with respect to production as well


as exchange and therefore freedom of mobility for labour and capital is also required. The EC, at the end of
1992, provided an example of an integrated group of countries with common market policies and principles.
5. The ultimate level of economic integration is complete economic union. This implies a high degree
of co-operation between members of the union and will include the co-ordination of monetary and fiscal policies
and macroeconomic planning across all member countries. This would usually result in a single currency being
used. When this is achieved, while countries may remain individual political units, they cease to be independent
economic units. In time, many argue it is likely that their political independence will be reduced and political and
economic decisions will be made at the centre, although a degree of development to regions is likely. The USA is
a collection of separate states. And while a degree of political and legal sovereignty is maintained by each state,
they share a single monetary system and are subsequent to a federal government with control over most, though
not all, taxation and public expenditure. With the realization of the single currency in Europe (EURO) the EUR11 grouping of EMU participants (the Eurozone) exhibits many of these traits. The further extension of fiscal and
tax harmonization would go some way to realizing a full economic union amongst these economies.
3.1 Customs Union: economic and legal framework
A customs union is an economic area whose members agree, by treaty to refrain from imposing any
customs duties, charges having equivalent effect or quantitative restrictions on each other and to adopt an
external common customs tariff in their relations with third countries. The customs union introduced by the
EC countries in July 1968 is thus fundamentally different from a free-trade area such as the European Free
Trade Association (EFTA). Although a free-trade area also involves the reduction, between member countries, of
customs duties and charges having equivalent effect on the areas originating products, each state maintains its
own external tariff and customs policy with regards to third countries. Thus, only those goods made in the
territory of the free trade area can move freely, whereas freedom of movement is applicable in a customs union
regardless of the origin of goods.
The founders of the community had, from the start the goal not only of setting up a customs union, but
also a common market in which goods, services and capital could be trade freely. In economic integration, they
foresaw not only a formula offering economic advantages, but also the means to set up conditions for political
union in Europe.
The first operational article of the European Economic Community (EEC) Treaty (which, since the
entry into force of the Treaty on European Union in 1993, is now referred to as the EC Treaty), as originally
adopted in Rome in 1957, is Article 9, which provides in paragraph 1 that:
The Community shall be based upon a customs union which shall cover all trade in goods and which
shall involve the prohibition between Member States of customs duties on imports and exports and of all charges
having equivalent effect, and the adoption of a common customs tariff in their relations with third countries,
Customs union and free trade area, which inevitably entail an element of discrimination in favour of
certain trading partners and against others, are not new, and were recognized by the General Agreement on
Tariff and Trade (GATT) Treaty, Article XXIV 8 (a) of which contains the following definition:
A customs union shall be understood to mean the substitution of a single customs territory for two or
more customs territories, so that:
1. duties and other restrictive regulations of commerce are eliminated with respect to substantially all
the trade between the constituent territories of the union or at least with respect to substantially all the
trade in products originating in such territories, and
2. subsequently the same duties and other regulations of commerce are applied by each of the members
of the union to the trade of territories not included in the union.
Although the GATT Treaty refers to substantially all the trade, and can accept a limitation to trade in
products originating in such territories, as well as requiring substantially the same duties to be applied by
each of the members of the union to the trade of territories not included in the union, the founders of the EC
decided to create a maximalist customs union applying to all trade and harmonizing all duties, not only
substantially all trade and duties. Furthermore, for the purposes of free movement between member states, the
EC does not distinguish between goods on the basis of their origin: free circulation applies equally to goods
wholly obtained in the EC and goods imported into a member state from a third country and put into free
circulation by the payment of import duties and the completion of any other formalities applicable to those
goods, as provided for in Article 10 (1) of the EC Treaty.
This distinguishes the ECs customs union from the trade areas that the EC has established with the
European Free Trade Association (EFTA) countries (most of which have now acceded to the EU) and for a wide
range of products, with the Czech and Slovak Republics, Hungary and Poland, and more recently, in a similar
form, with Bulgaria, Romania, Slovenia and the three Baltic Republics, through the so-called Europe
Agreements; free trade with all these countries is subject to the fulfilment of origin criteria.


Rules that define the notion of an origination product are laid down both in general Community
provisions (non-preferential origin rules) and also in specific origin rules for certain products that are negotiated
in the framework of individual preferential trading arrangements (preferential origin rules).
A current activity of considerable importance to the EC and its preferential trading partners is the
development of rules for cumulation of origin, which enable products that have been transformed successively in
two or more countries that are party to a free trade agreement to enjoy a preference, even if no individual country
has been responsible for a substantial enough transformation to confer origin.
3.2 Intra Community trade (Tariff Union and free circulation)
Before the Community treaties came into free, every country protected its national production with
customs tariffs preventing the import of goods at prices lower than those of the national production and
quantitative restrictions preventing the import of certain products in quantities exceeding those which were
necessary to satisfy local demand not covered by national production. Thus, a country would import the
quantities and qualities not normally supplied by its internal production. As industry was well protected, it saw
no need to make large-scale efforts to modernise or reduce production costs. The European consumer, faced with
a limited choice and high prices for low quality goods, was the main victim of this situation. Customs union,
aimed at correcting such a situation, is the foundation of the ECSC, EAEC and the EEC.
In his historic declaration of 9 May, Robert Schuman said: the circulation of coal and steel within
acceding countries will immediately be freed of all customs dutiesIn fact, article 4a of the ECSC Treaty
prohibited import or export duties, charges having equivalent effect was problem-free and by 1954, had
yielded good results in terms of trade intensification. The steel, iron and coal markets have certainly faced
serious problems, first in the 60s and then in the 80s. These were, however, structural problems caused by
customs union. On the contrary, the later enabled the industries of \member |States to face together the coal crises
of the sixties and the steel crisis of the eighties and to allow for survival of the fittest regardless of national
As requested by article 93 of the EAEC Treaty (EUROATOM), the member states abolished between
themselves on 1 January 1959 (one year after the entry into force of the Treaty) all customs duties on imports
and exports or charges having equivalent effect, and all quantitative restrictions on the import and export of
goods and products which come under the provisions of the chapter on the nuclear common market. These
products were to circulate freely on the markets of new member states a year after their accession.
According to article 23 of the EC Treaty, the Community is based upon a customs union which covers
all trade in goods and which involves the prohibition between member States of customs duties on imports and
exports and of all charges having equivalent effect and the adoption of a common customs tariff in their relations
with third countries. The customs union of the EC covers all trade in goods. This means that products coming
from a third country can move freely within the Community if the import formalities have been complied with
and any customs duties or charges having equivalent effect which are payable have been levied in the importing
Member State (Art.24 TEC).
Article 13 and 14 of the Treaty of Rome provided that customs duties and charges having equivalent
effect to customs duties on imports were to be progressively abolished during the twelve-year transitional period
from 1 January 1958 to 31 December 1969. Although the Treaty gave the Member States the option of varying
the rate of reduction of customs duties according to product (should a sector have difficulties) the reduction was
constant and problem free. The rate of tariff dismantling was even accelerated by two Council decisions and
completed on 1 July 1968, 18 months ahead of schedule. This demonstrates that there were no major problems,
as any country objection would have prevented the change of schedule provided by the Treaty. The new member
States of the Community had a five-year transitional period to eliminate customs duties in inter-community
The accelerated accomplishment of the tariff union meant that, as of 1 July 1968, inter-Community
trade had been freed of customs duties and quantitative restrictions on imports and exports. However, other
trade obstacles, such as charges having equivalent effect to customs duties and measures having equivalent to
quantitative restrictions, were far from gone. A great number of those trade barriers were hidden in regulations,
such as consumer, or environment protection standards, which varied from one State to another. Their restrictive
effects were often more damaging than customs duties and quantitative restrictions. Indeed, while customs
barriers raised the price of imports or quantitatively limited them, various regulations could completely block the
import of product. Fortunately, such extreme cases were rather limited. However, as seen in the chapter on the
common market, the elimination of non-customs barriers to trade proved to be much more difficult and took
three times as long as did the elimination of customs barriers.
A great number of those trade barriers were hidden in regulations, such as consumer or environment
protection standards which varied from one State to another. Their restrictive effects were often more damaging


than customs duties and quantitative restrictions. Indeed, while customs barriers raised the price of imports or
quantitatively limited them, various regulations could completely block the import of a product. Fortunately,
such extreme cases were rather limited. The elimination of non-customs barriers to trade proved to be much
more difficult and took three times as long as did the elimination of customs barriers.
Despite this shortcoming of the customs union, the economic results of the free circulation of goods
achieved by it were indisputable. From 1958 to 1972, while trade between the six founding Member States and
the rest of the world had tripled, inter-Community trade had increased nine fold. Such exceptional trade, growth
was a key factor to economic development and the raising of the standard of living in all member countries of
the original EEC. Thanks to the fact that enterprises faced increased competition in their principal markets, the
simulative effect of a wider market created a felling of confidence, which resulted in investment growth.
Consumers emerged as the overall winners, supply was much more diverse and products cheaper than before
tariff dismantling.
In 1973, the Commission created an Advisory Committee on Customs Matters to advise and assist it in
the management of customs union. Due to the importance which indirect taxation has now acquired in the
smooth operation of the Single Market, the Commission has replaced it with an Advisory Committee on
Customs Matters and Indirect Taxation.
Elimination of internal frontiers
Theoretically, the Community having laid down the foundations of customs union and the common
customs tariff (CCT) having replaced national tariffs, a large part of border formalities should have been
eliminated since 1968. In reality, customs union and the common transit procedure have only had a limited effect
thanks to the inventiveness of national administrative departments, which replaced them with a plethora of
documents to be completed at borders. However, the good results of the customs union and the common market,
which were the goals of the Treaty of Rome, both suffered from the same problems and finally benefited from
the same remedies.
Since January 1, 1993, no customs formalities are required for trade within the Community. Hence, all
checks and all formalities in respect of goods moving within the Community have been eliminated 1. The
Community henceforth forms one single border-free area for the purposes of the movement of goods under
cover of the TIR (international road transport) and ATA (temporary admission of goods) carnets 2. This saves a
great deal of time for economic operators and thus helps cut the cost of transporting goods within the
Community. The absence of duties and formalities bolsters intra-EU trade of the Fifteen and up to 80% of the
total imports or exports of some countries of the Union.
In order to guarantee the free movement of persons provided for by Article 18 of the EC Treaty, a
Council Regulation of December 19, 1991 abolished with effect from January 1, 1993 controls and formalities
appertaining to cabin and hold baggage of persons taking an intra-Community flight and the baggage of persons
making an intra-Community sea crossing3. Although customs checks of persons have disappeared since the 1 st
January 1993, the non-suppression of identity checks has provoked much criticism on the part of citizens and the
European Parliament.
The abandonment of customs formalities, as of 1 st January 1993, has necessitated the establishment of a
system for collecting statistical information on exchanges of goods between Member States directly from
undertakings (INTRASTAT). The amendments to customs legislation following the completion of the internal
market have necessitated the updating of the regulations on the completion of statistics on the trading of goods
with non-member countries4.
Veterinary and plant health legislation
The veterinary and plant health legislation is important not only for intra-Community trade, but also for
the protection of the environment and of human health. It is in the interest of all member States to strengthen
their common legislation in these fields and, at the same time, not to upset intra-Community trade of foodstuffs.
To this scope, the Veterinary and Phytosanitary Inspections Office has been entrusted with the internal and
external organization and implementation of inspection measures, checks and monitoring in the veterinary
(including fishery products) and plant health fields in accordance with Community regulations, thus ensuring the
uniform application of these.


Council Regulation 717/91, OJ L78, 26.03.1991 repealed by Council Regulation 2913/92, OJ L302, 19.10.1992
Council Regulation 719,/91, OJ L 78, 26.03.1992 repealed by Council Regulation 2913/92, OJ L 302, 19.10.1992
Council Regulation 3925/91, IJ L374, 31.12.1991 and Commission Regulation 2454/93, OJ L 253, 11.10.1993
Council Regulation 1172/95, OJ L 118, 25.05.1995 and Council Regulation 374/98, OJ L48, 19.02.1998


The plant health arrangements which came into force on 1 June 1993 have made it possible to remove
all physical obstacles to trade of plants and plant products 1. These arrangements include the rules applicable to
the intra-Community trade of plants and plant products imported from third countries, the standards for the
protection of the environment and human health against harmful or undesirable organisms, the reduction in
number of plant health checks by setting up a Community inspectorate, and by initially moving the checks from
the border to the place of destination. The Community Plant Variety Office supervises the protection of plant
varieties in the Community2.
In the veterinary field, the efforts of the Community are mainly geared towards protecting the health
of animals and consequently human health, while allowing the smooth operation of the internal market. Since
January 1, 1992, veterinary checks at intra-Community frontiers have been abolished and are instead carried out
at the point of departure, while measures were taken to prevent outbreaks of food-borne infections and
intoxications. At the same time, the Community has switched from a system characterised by a policy of
systematic preventive vaccination against foot and mouth disease, which could act as an obstacle to the free
movement of animals and products, to a policy of non-vaccination and slaughter in the event of an infection
source appearing. Numerous problems have appeared, however, after the elimination of controls at internal
frontiers. In order to establish mutual trust, it is necessary to have a system of identification of animals traded in
the internal market.
The Food and Veterinary Office (FVO), established in Ireland, is responsible for consumer protection
and particularly for the monitoring of all slaughterhouses approved in the Member States for intra-Community
trade, as well as of all establishments manufacturing meat products. Veterinary checks on animal products
entering the territory of a Member State from third countries are organized at Community level. Veterinary
import procedures for animals and animal products from third countries have been computerised (Shift System),
thus ensuring smooth operation of the market.
Administrative cooperation
Since they collect customs duties, which must be paid in the Community budget and guard the external
frontiers against illicit trading, the customs officers of the Member States act in fact in the name of the
Community and must apply the Community law. The efficiency of a customs union depends as much on
homogeneous rules as on the quality of its operational structures. As essential elements of these structures, the
customs authorities of the Member States must be open to cooperation both among themselves and with the
Commission in the spirit of Article 10 of the EC Treaty. This is the objective of the Council Regulation on the
mutual assistance between the Member States administrations and on their collaboration with the Commission
to step up fraud prevention, ensure the proper application of customs and agricultural regulations. Article 29 of
the EU Treaty urges the Council to take measures in order to strengthen cooperation between customs authorities
and police forces, both directly and through the European Police Office (Europol). Modern administrative
management increasingly uses computerised methods. In this context, several computerized links have been
developed, updating of the Communitys integrated tariff multilingual database (Taric), which is managed
centrally by the Commission, are transmitted daily to the Member States by electronic data transfer (TARIC
interface) and to traders via the Internet.
A centralized system for automatic tariff quota management communicates electronically with national
administrative departments (Quotas). The electronic mail system known as Scent (system for a customs
enforcement network) is designed to pass urgent messages concerning cases of fraud.
3.3 Trade with non-member countries (CCT, economic tariffs matter, customs legislation and
origins of goods)
A true internal market, free of frontiers, presupposes that the external relations of the Member States be
regulated in the same way. For this purpose, the Community Customs Code groups together and presents all of
the provisions of customs legislation governing the Communitys trade with third countries in the light of its
undertakings within the World Trade Organization3.
By regrouping some 75 Regulations adopted between 1968 and 1992, it aims to improve the clarity of
Community customs regulations and move the risk of divergent interpretations or legal vagueness. The Code is
divided into three parts:
the basic rules of customs legislation: customs territory of the European Union, customs tariff, customs
value, origin of goods;
Council Directive 91/683, OJ L 376, 31.12.1991 and Council Directive 93/19, OJ L96, 22.04.1993
Council Regulation 2100/94, OJ L 227, 01.09.1994 and Council Regulation 2506/95, OJ L 258, 25.10.1995
3. Regulation 2913/92, OJ L 302, 19.10.1992 and Regulation 955/1999, OJ L 119, 07.05.1999


rules relative to customs destinations with economic impact: customs systems with economic impact
(free zones, temporary admission, processing under customs control), instances of goods redirection or
rules relating to customs debt and appeals against decisions taken in customs matters.

Apart from removing obstacles to intra-Community trade, a customs union includes the harmonization of
customs regulations on trade with non-member countries. The efforts aimed at implementing such regulations in
the European Union are taking shape in two directions. On the one hand, the Community has established, and
manages a Common Customs Tariff (CCT), on the othe hand, Community rules fit into an international context
of GATT and, henceforth, of the World Trade Organization must be transposed into Community law.
The common customs tariff
A customs union is identified by the existence of a single external tariff applied by all Member States to
imports coming from third countries. Such imports only have to clear customs once and can then move freely
within the common customs area. Reaching an agreement among European countries on a single external tariff,
however, required a complex striking of balances and compromises, given the different national interests,
stemming from the different products that each country wished to protect. The common customs tariff is
therefore a major achievement by the Community.
For the member countries, the CCT meant the loss of both customs revenue, which, since 1975, has
been a resource of the Community budget, and the option of carrying out an independent customs policy. No
member country can unilaterally decide on or negotiate tariff matters, all changes to the CCT are decided by
the Council following negotiation (if necessary) and proposal by the Commission. All bilateral (between the EU
and non-member countries) and multilateral (GATT/WTO) negotiations are carried out by the Commission.
Since 1995, the customs tariff of the EU takes account of the outcome of the GATT Uruguay Round of
negotiations negotiations. The Commission and the Member States cooperate to ensure the proper and uniform
application of the CCT 's nomenclature.
The customs instrument is very important, not only for the collection of customs duties, but also for a
number of Community spheres of activity, such as the preparation of foreign trade statistics and the proper
application of various measures regarding commercial, agricultural, fiscal or monetary policy. This activity takes
the form of the adoption of Commission regulations, the finalisation of explanatory notes or classification in the
customs nomenclature1. The Community uses the same nomenclature as its main trading partners, thus
facilitating trade negotiations; it is called the Combined Nomenclature (CN) because it meets the Communitys
tariff and statistical requirements simultaneously2.
In parallel with the introduction of the CN, the Integrated Community Tariff database was
established, in order to indicate, in relation to each CN code, the Community clauses applicable to the goods of
this code. It incorporates import provisions not included by the CN, such as tariff quotas and preferences, the
temporary suspension of autonomous CCT duties, anti-dumping duties and countervailing duties 3. Thus
Integrated Community Tariff spans all the Community measures applicable to trade and provides national
administrations with information on all Community measures relating to internal and external trade.
Before effecting any customs operation, it is first necessary to proceed to the customs classification
of the goods concerned. Classification has a determining effect on the proper functioning of agreements between
the Community and certain exporting countries on the trade of textile products. Economic operators can request
binding tariff information from the authorities in the Member States with responsibility for the classification of
goods under the customs nomenclature 4. This information indicates the tariff heading to be used for specific
goods in all of the Member States and it makes a vital contribution to the legal security of economic operators
and greatly facilitates imports and exports.


Council Regulation 2658/87, OJ L256, 07.09.1987 and Commisssion Regulation 2626/1999

Council Regulation 1715/90, OJ L160, 26.06.1990 and Council Regulation 2913/92, OJ L 302, 19.10.1992
Council Regulation 2658/87, OJ L 256, 07.09.1987 and Commission Regulation 2626/1999, OJ L 321, 14.12.1999
See OJ C 212, 23.07.1999, p. 1-31


Economic tariff matters

As of 1968, the Member States are not entitled to unilaterally carry out customs policy, suspend
duties or change CCT. Only the Council can waive the normal application of CCT by means of regulations
adopting various tariff measures. Such measures, whether required under agreements or introduced unilaterally,
involve reductions in customs duties or zero-rating in respect of some or all imports of given product. They take
the form of Community tariff quotas, tariff ceilings or total or partial suspension of duties.
The most important tariff concessions are granted by the Community in the context of the General
Agreement on Tariff and Trade (GATT). In the course of several international negotiations, namely: the
Dillon Round (1960-1962), the Kennedy Round (1964-67) and the Tokyo Round (1973-79), substantial
reductions of customs duties were made on most industrial products. The Uruguay Round, which was
launched on 20 September 1986 and was concluded on 15 December 1993, has achieved major tariff reductions
on the part of the 117 participating countries in the sectors of industry, agriculture and services. It has also
imposed new rules and disciplines to international trade.
The EU can raise customs duties on products whose protection has been bound consolidated under
GATT only if it offers its trading partners equivalent compensation. However, the Council may adopt unilateral
protective measures on imports when these present a serious risk to European production. Such measures may
not be directed at a single country or be limited to one or more member States. The EU can also protect itself
against unfair trading practices by applying the anti-dumping procedures included in GATT provisions. Pursuant
to these provisions, the EU can fix countervailing duties if goods are offered in the European market at a
substantially lower price than in the producing country.
As part of its development aid policy, the EU applies generalised tariff preferences to imports from
developing countries (LDCs). To the African, Caribbean and Pacific States (ACP), signatories of the Lome
Convention, the EU grants free access to the near-totality of their imports, with the exception of textile products
and of the agricultural products that are subject to common market organisations of the common agricultural
Following the accession to the EEC of the UK and Denmark, both former European Free Trade
Association (EFTA) members, free trade agreements were concluded between the Community and the EFTA
countries in order to avoid the erection of new obstacles to trade. As a result of these agreements, trade between
the two groups of countries tripled from 1974 to 1984. These bilateral agreements have been replaced, since 1 st
January 1994, by the Treaty on the European Economic Area (EEA), which, after the accession of Austria,
Sweden and Finland to the EU, brings together the Fifteen with Norway, Iceland and the Liechtenstein in a vast
economic zone guaranteeing, not only free trade, but also the fundamental freedoms of a common market. The
free trade arrangements are gradually being extended to the countries of Central and Eastern Europe in the
framework of Europe Agreements.
Several tariff quotas and ceilings are opened every year, under bilateral agreements with non-member
countries or on a unilateral basis in order to secure the Community supply situation for certain products. Tariffs
are also suspended on a number of agricultural and fishery products, to improve the supply of certain types of
food and honour preferential commitments entered into with certain non-member countries.
The legislation on preferential tariff measures resulting from agreements concluded between the EU and
States or groups of States with which contractual relations are maintained has been consolidated in a few main
multiannual Regulations. For the sake of simplification and efficiency, the publication of tariff suspensions in
separate Regulations with a specified date of validity has been replaced by publication in a comprehensive
multiannual form1.
The full application of CCT is thus limited to trade with North America, Japan, Australia and a few
other developed countries. Although CCT has become less important, customs union, supported by the
instruments of trade policy, which accompany it, ensures sufficient protection from the import of cheap industrial
goods. In the textile sector, customs duties are generally supplemented by agreements on voluntary restraint of
exports negotiated as part of the Multifibre Arrangement (MFA). In the steel sector, agreements on voluntary
restraint have also been concluded with the principal producing countries. As seen in the chapter on agriculture,
the agricultural market is protected by a special system, now based more and more on customs duties in
application of the GATT agreements.

Council Regulation 1255/96, OJ L158, 29, 06.1996 and Council Regulation 1381/1999, OJ L 165, 30.06.1999


General customs legislation

Customs union requires more than just having a common customs tariff, it must be applied according to
identical rules throughout all Member States. Failure to do this could result in different values for customs
purposes or different rules on the release of goods for circulation according to the importing Member State. The
Customs Code of the European Union, which groups together all the provisions of the Communitys customs
legislation, aims precisely at removing the risk of different interpretations of EU rules in trade between the
Member States and third countries1.
The customs territory of the Community is defined by a Council Regulation and now by the
Community Customs Code3. It states inter alia that the coastal Member States territorial sea is part of the
communitys customs territory. This is of particular importance to the fishing and offshore activities of Member
States. Another Regulation lays down provisions relating to the place of introduction to be taken into
consideration for the determination of value for customs purposes. Value for customs purposes can sometimes
have a greater impact on trade than customs duties. A Council Regulation specifies the method by which such
value is determined, the customs clearance criteria for goods finished or processed out of their country of origin,
and the conditions under which goods are temporarily exempt of import duties.
Transit systems (Community transit, common transit and TIR are at the heart of the customs union and
the common commercial policy, but these systems are subject to fraud.
A Regulation on checks for conformity of products imported from third counties with the rules of the
Community Directive on product safety, aims to ensure an efficient and coherent management of the common
external frontier and to equalize the conditions of competition between Community products and imports. It
enables the customs authorities of the Member States to temporarily suspend the customs clearance procedure in
cases where imported products present characteristics, which may constitute a direct health or safety hazard.
Agreements between the European Community and the United States and Canada provide effective market
access throughout the territories of the parties, since they authorize product testing and certification in the
exporting countries and no longer only in the countries of destination.
The Community Customs Code has harmonized the legislative, regulatory and administrative
provisions on: the customs treatment of goods entering the Communitys customs territory and on the temporary
storage of these goods, goods brought into the customs territory of the Community until such goods have
received a destination for customs purposes, returned goods in the customs territory of the Community,
admission to free circulation of goods, and relief from customs duties2.
The Community Customs Code now governs also the export procedures of Community goods, the
deferred payment of customs duties on imports or exports, the refund or remittance of these duties, and the postclearance collection of export duties not imposed on goods entered for a customs procedure3.
Of capital importance to the administration of customs union and to the legal security of individuals are
the common rules concerning the origin, liability and settlement of customs debt, those providing the definition
of persons liable for payment of a customs debt and those defining the conditions under which a person may
submit a customs declaration.
The close co-operation between national administrations, organized by the Commission, is needed to
prevent infringements of customs rules and other conditions for access to the Union market. Priority areas
include fraud prevention, protection of intellectual property rights-particularly trademarks, designs and
copyright-and measures to combat counterfeiting.
The action to combat fraud in trade with non-member countries is organized by a Council Regulation
on the mutual assistance of the administrative authorities of the Member States and on their collaboration with
the Commission to ensure the proper application of customs or agricultural rules. The Community, however,
lacks uniform penal provisions to prevent the infraction of customs legislation. Common protection against the
unfair trading practices of non-member countries is covered by a Council Regulation of 1 December 1986,
which lays down measures preventing imports and prohibiting the release for free circulation of counterfeit and
pirated goods infringing intellectual property rights including patents 4. The Community has signed agreements
on customs co-operation and mutual administrative assistance in customs matters, including fraud prevention,
with the Republic of Korea, Canada, Norway, and the United States. It is negotiating similar agreements with
China and the ASEAN member countries.
1.Council Regulation 2913/92, OJ L 302, 19.10.1992 and Commission Regulation 1427/97, OJ L 196, 24.07.97
2.Council Regulation 2151/84, OJ L 197, 27.07.1984 and Council Regulation 2913/92, OJ L 302, 19.10.1992
3.Council Regulation 2913/92, OJ L 302, 19.10.1992
4.Council Regulation 3295/94, OJ L 341, 30.12.1994 and Council Regulation 241/1999, OJ L 27, 02.02.1999


Origin of goods
The rules of origin determine to what extent products coming from third countries may be exempt of
duty by determining the degree of processing or transformation they have undergone. These rules, which are now
contained in the Community Customs Code, are important for the proper application of preference systems and
several provisions of the commercial policy of the European Union. In order to prevent fraud arising from
irregularities of origin, it is necessary to determine uniformly the origin of goods obtained in a country after
substantial transformation of raw materials and semi-products originating in other countries.

Thus, goods admitted under preference agreements must come entirely from the exporting country or, if
imported from a third country, have undergone substantial processing or finishing. The Community Customs
Code defines for purposes of non-preference traffic, the concept of the origin of goods 1. The rules on origin are
now incorporated in the agreement establishing the World Trade Organization 2.
The origin of several categories of products has also been determined autonomously by Council
regulations. Such definitions are used for non-preferential traffic. Other provisions determine the rules of origin
on a conventional basis within the framework of preference agreements between the Community and certain
countries, namely the ACP.
The action to combat fraud in the field of rules of origin is mainly concerned with textile products
imported from developing countries. For Community exports, the Commission adapted the model certificate of
origin to the overall frame recommended by the UN3.
Customs procedures with economic impact
Common customs regulations, uniformly applicable in the Communitys trade relations with other
countries, involve setting up various customs procedures with economic impact. Using Directives, the Council
harmonized the legislative, regulatory and administrative provisions relative to customs warehouses procedures,
free zones procedures and usual forms of handling, which can be undertaken in customs warehouses and free
zones4. The CCC also governs the processing of goods under customs control before their release for free
circulation in order to avoid, by use of tariff measures, the processing operations of certain imports, such as
certain petroleum products, taking place in third countries rather than in the Community. To facilitate the use of
containers in, for example, combined road/rail carriage, the Council defined on 13 July 1987 a regulatory system
for the temporary admission of containers is defined 5. Bearing the mark of their Member State, the containers are
deemed to meet the conditions of free circulation provided by articles 9 and 10 of the EEC Treaty (Art 23 and 24
Of particular interest are inward processing arrangements allowing for the temporary release for free
circulation of products coming from third countries processed in a member State and re-exported to a third
country. The Member states must properly apply these procedures especially when the inward processing deals
with agricultural products and when compensating products are released for free circulation in a Member State
other than where the processing took place. In an attempt to lighten the formalities for those involved a
Commission Regulation sets specific provisions applicable to certain inward processing arrangements or
processing under customs control carried out in a customs warehouse, free warehouse or free zone.
The reverse mechanism, outward processing arrangements, is of interest to many European
enterprises which, in the context of the international division of labour, export goods with a view to re-importing
them following processing, working or repairs. This alleviates the enterprises production costs and thus favours
production in the EU. Established in 1982 as part of the multifibre arrangement for textile and clothing products,
outward processing relief arrangements were expanded, in 1986, to standard exchange arrangements and, in
1988, to triangular traffic covering two Member States. The Member States can check the relevant documents
in order to ensure that the compensating products have been manufactured using goods temporarily exported.
The outward processing arrangements have been adapted to the internal market and cover tariff concessions for
the Central and Eastern European countries6.

Council Regulation 2913/92, OJ L 302, 19.10.1992 and Commission Regulation 1427/97, OJ L 196, 24.07.1997.
OJ L336, 23.12.1994
Commission Regulation 2454/93, OL L 253, 11.10.1993 and Commission Regulation 1662/1999, OJ L 197, 29.07.1999
Council Regulation 3036/94, OJ L 322, 15.12.1994
Council Regulation 3036/94, OJ L 322, 15.12.1994
Council Regulation 3036/94, OJ L 322, 15.12.1994


References on Customs Union and suggested readings:


Inama Stefano, Vermulst Edwin, Customs and Trade Laws of the European Community, Kluwer Law
International, The Hague- London-Boston, 1999
Trotignon Jerome, Economie europeenne. Integration et politiques communes,, Hachette, Paris, 1997
Free trade agreements and customs unions, experiences, challenges and constraints, co-published by the
European Institute of Public Administration, Maastricht, the Netherlands, 1997, pag 105-111;
Krueger, A.O.(1995), Free trade Agreements versus Customs Unions, NBER Working Paper, No. 5084
Nicholas Moussis, Access to European Union, European Study Service, 2001, pag 60-74;
Customs Union Agreement (Decision No 1/95 of the EC-Turkey Association Council) OJ 1996 L 35/1
The EU Market Access Database


4. The Single European Market

4.1 The internal market Programme. Single European Act
4.2 The removal of physical, technical and fiscal barriers.
4.3 The impact and effects of the Single European Market
4.4 Understanding the four freedoms: Free movement of goods, capital, labor and services
4.1 The Internal Market Programme. Single European Act
The creation of a single European economic area based on a common market was the fundamental
objective of the Treaty of ROME. Article 2 of that Treaty set out that objective as follows: The Community
shall have as its task, by establishing a common market and progressively approximating the economic policies
of Member States, to promote throughout the Community a harmonious development of economic activities, a
continuous and balanced expansion, an increase in stability, an accelerated raising of the standard of living and
closer relations between the States belonging to it.
The establishment of the common market first required the elimination of all import and
export duties in force between Member States before the foundation of the Community. We saw in the previous
chapter how the Member States effectively removed the customs barriers even before expiration of the period
laid down by the Treaty and how immediately after tariff dismantling, they began erecting other barriers between
them, in particular technical barriers which were even more difficult to cross than customs ones. In the first
section of this chapter, we shall look at how the Member States decided to take to eliminate technical obstacles
to trade and to open up their public contracts. Also we shall examine the measures aimed at the free movement of
goods, constitute the basic elements of the common market.
The common market, which was completed in 1992, is a very important stage in European integration.
Underlying in there is a range of basic freedoms: the free movement of goods, persons, services and capital.
Their implementation first and foremost makes it possible to allow the production factors of work and capital to
operate without hindrance. Businesses can manufacture and sell their products in accordance with a system of
free competition in the Member State in which conditions are most advantageous to them. They can set
themselves up wherever they wish in the common market and can call on a multitude of sources of capital,
which exist in every Member State. Consumers have a free choice of better quality and or lower price products,
manufactured in the Member States. Workers have free access to jobs wherever demand is strongest and thus
benefit from better working conditions and remuneration. They can establish themselves with their families in
any of the member countries and take up employment there. The key word for the common market is, as we can
see, freedom.
It is useful to define here the concepts of common market, single market, and internal market
which are used almost synonymously but which have significant nuances of meaning. The common market is a
stage in economic integration which, in the words of a Court of Justice ruling, aims to remove all the barriers to
intra-Community trade with a view to the merger of national markets into a single market giving rise to
conditions as close as possible to a genuine internal market. It is worth noting that the Treaty establishing the
European Community ignores the concept of the single market. It refers generally to the stage of the common
market and to the end result of it, the internal market, which according to its Article 14 comprises an area
without internal frontiers in which the free movement of goods, persons, services and capital is ensured in
accordance with the provisions of this Treaty.
At the Milan Council of June 1985, the member states finally and formally endorsed a concrete plan of
action proposed by the European Commission. This plan, presented in the form of a White Paper, Completing
the Internal Market (European Commission, 1985), was the end-point of five years of intensive Commission
study of the deficiencies of the Communitys trading order. Under the authorship of British Commissioner Lord
Cockfield, it outlined three different types of barrier to the completion of the internal market (physical, technical
and fiscal) and a deadline of 31 December 1992 for the implementation of a series of liberalizing measures.
Physical barriers were identified as those hindering the free movement of people, goods and capital, and
technical barriers as those extending from national standards, legal and administrative requirements across the
Community states. Fiscal barriers were described as a consequence of diverse fiscal arrangements in Community
territories, including divergent sales taxes, excise duties and varying payment collection systems.
The basis of the Milan agreement was quickly embodied in Community law by the Single European
Act (SEA). This was signed in February 1986 and entered into force on 1 July 1987. The SEA also introduced
changes in the Community legislative system (designed to encourage the adoption of internal market measures
by majority voting) and revised the terms of the third article of the Rome Treaty. By re-establishing majority
voting by the Council, it put the Community in a position to take decisions more efficiently and to act more
rapidly and more democratically. In addition it provided for the European Parliament to play a fuller part in the
decision-making process through the cooperation procedure. By making significant changes to the Community


decision making process (qualified majority voting in the Council acting in cooperation with the European
Parliament) the Single Act succeeded in removing the technical barriers to trade, thus creating the Single Market.
Yet the SEA had real potential for the Communitys rapid development. First, provision for qualified
majority voting could not only expedite the internal market but also encourage the Council of Ministers to be
more flexible in areas where unanimity remained the norm. Second, a successful single market program might
advance European integration in related economic and social sectors. Third, the SEAs endorsement of the White
Paper and formal extension of Community competence could strengthen the Commissions position. Fourth, the
introduction of a legislative cooperation procedures to coordinate foreign policy might enhance the
Communitys international standing. Within a short time, proponents and opponents of greater European
integration would know whether and how the SEAs potential would be realized.
4.2 The removal of physical, technical and fiscal barriers
As a point to check compliance with national rules on indirect taxation and as a method of monitoring
and controlling the movement of persons throughout the Community, internal customs posts frustrated
companies attempts to move goods and services across national boundaries with speed and efficiency. Practical
difficulties associated with these frontier controls (including paperwork and stoppages) were estimated to cost
EC industry the equivalent of 12 billion ECU per annum. Today fresh food can be collected from UK production
points and sold in French supermarkets within twelve hours and with little interference, such trading would then
have been impossible. UK producers of perishable products like any others faced costly delays as a consequence
of hold-ups at customs points accounting for up to one-third of total journey times. This frustrated the whole
exercise of cross-border trade adding substantial costs estimated at up to 2.0% of average consignment value and
providing a strong psychological barrier to cross-border business for many smaller firms.
A central aim of the White Paper was to ease these border formalities and to move inland tasks
relating to national customs, taxation, veterinary and phytosanitary controls. In the Commissions view, the
removal of a frontier-controlled VAT and excise system would significantly reduce waiting times at borders and
associated costs. The balance of customs-related administrative activities could be shifted to more efficient
points within the Community system and in the process, some 60 million tax forms abolished. Further, seventy
different administrative forms could initially be consolidated into a Single Administrative Document, the
requirement for which would pass with internal market completion. Checks arising from health protection, for
example of animals, foodstuffs and flora, could also be moved away from the border to the place either of
departure or destination. This would further alleviate the burden at border points and enable the introduction of a
tougher and more humane supervisory regime for livestock trade.
Elsewhere, passport checks for internal EC flights would be lifted (the Commission would seek their
removal with the co-operation of the member states) and residual capital controls would be terminated. Although
the process of ensuring free movement of persons would be complicated, capital would be allowed to move
freely out of national jurisdictions as a part of a basic deregulation under a new Capital Movements Directive.
Although countries including Germany, the UK and the Netherlands had removed controls or taxes on capital
movements, such restrictions endured in a number of southern EC member states, for example in Greece and
Portugal. One effect of this deregulation would be to facilitate the cross-border selling of financial products and
to assist processes of cross-border capital investment.
The removal of technical barriers
The importance of removing technical barriers was underlined for the Commission by the inhibited
nature of cross-border competition in several markets (goods and services) and by the dwindling international
competitiveness of European firms in strategic high-tech markets. In several sectors, Europes leading firms were
confronted with different national product regulations, national industry standards, national testing and
certification procedures, and other state laws and provisions that fragmented and segmented the EC market.
These barriers which had been adopted over several years-prevented European businesses from reaping the full
benefit of economies of scale in relation to production, research and development and imposed serious
restrictions in efforts at pan-European marketing of audio-visual equipment, cars and televisions, encouraged
many firms to produce their various products in plants based in end-user markets. This kind of duplication often
resulted in sub-optimal plants and supported company inefficiency. Equally, firms wishing to export their
products throughout the EC from a single production point and around a basic standard were heavily penalized.


Table 4.1 A typology of costs resulting from divergent standards and regulations
For companies

Duplication of product development

Loss of potential economies of manufacturing scale
Competitive weakness on world markets and vulnerability on European markets as companies operate
from a narrow national base

For public authorities

Duplication of certification and testing costs

Not getting value for money in public purchasing whose non-competitive nature is often
by national standards and certification


For consumers
Direct costs borne by companies and governments means higher prices
Direct and larger losses due to industrys competitive weakness and inefficiency structure
As with the physical barriers already discussed, the Internal Market paper proposed to tackle these
barriers by pursuing a strategy of convergence. Specifically, it proposed a three-tier approach based on:
o Mutual recognition,
o The select approximation of standards, and
o The strengthening of common reporting and notification procedures.
This approach, which is now firmly established, was to displace a traditional method of wholesale
(product-by-product) legislative harmonization. While holding out the attraction of uniform product regulations,
this approach had proven inefficient for two central reasons. First, the legislation was becoming highly technical
and extraordinarily complex as it looked to meet the individual requirements of each product category. Second,
the adoption of technical harmonization directives was based on unanimity in the Council.
Mutual recognition
In order to facilitate the right of firms to sell and market their goods across the Community, mutual
recognition of standards has been introduced. This means that, in principle, each member state must give access
to goods accepted as fit for sale in another EU market. In effect, this ruling reduces the need for the Commission
to make undertakings on an individual product basis.
Nevertheless, there remain two key issues, which mean that mutual recognition alone is insufficient to
eliminate all of Europes technical barriers:
1. Countries are still able to restrict access to those goods, which do not meet their essential requirements.
This means that products can be barred access on the grounds that they infringe local rules (essential
requirements) on health, safety, consumer and environmental protection.
2. Historically, standards have been different and goods are often required which are compatible with
existing equipment and systems.
Standardization of essential requirements
The Commission has undertaken to standardize the essential requirements rulings in a number of areas
where a close approximation of technical requirements is beneficial. In areas such as chemiodstuffs and
pharmaceuticals, a wide range of products and product risks may be sufficiently homogenous to allow for the
identification of common essential requirements. While this does not provide exacting standards for individual
products, this approach permits a degree of harmonization to be achieved at a relatively quick pace. The
technical specifications of products meeting essential requirements are laid down in harmonized standards
agreed by common professional organizations such as the European Standardization Committee (CEN) and the
European Electro technical Standardization Committee. The specifications being adopted by these organizations
for repeated or continues application are being transposed at national level by local standards authorities such as
AFNOR in France and DIN in Germany.


While these standards are not legally enforceable (they remain voluntary), products manufactured in
conformity with national standard which itself transposes a published harmonized standard benefit from a
presumption of conformity with essential requirements throughout and cross the EU. In this sense, there is now a
clear incentive for producer firms to adapt their products so as to comply with EU-wide standards.
Mutual information-notification procedures
Finally, the Commission has introduced mutual information-notification procedures, which require
national authorities to inform the Commission of any changes in regulations and standards. Although this chapter
will later highlight the continued failure of member states to do this, this is an important element of the new
approach to standards in the EU. The Commission is empowered to block changes in national regulations if they
are deemed to raise barriers to market entry and to competition.
Liberalizing public procurement
Under the category of technical barriers, the White Paper on the Internal Market also addressed the situation
in the European market for contracts concluded by public authorities and by public sector firms. This is generally
referred to as the public procurement market. The cost savings and the Commission promoted a number of
benefits including:
The static trade effect-which involves cost savings for buyers as they purchase from the cheapest
The dynamic trade effect-sometimes referred to as the competition effect- wherein there is a downward
pressure on prices as a result of competitive bidding by numerous firms for tendered contracts;
The restructuring effect-which, in the longer term, will allow economies of scale, particularly in specific
high-technology sectors such as computers telecommunications and aerospace;
The savings to be made by private sector buyers who benefit from the lowering of prices by firms
serving the public sector;
The greater innovation and investment of firms operating in a competitive environment.
These gains were of the clearest importance given estimations of the sheer size of the EC procurement market.
At the time of the White Paper, this was estimated somewhere between 10% and 15% of Community GDP
although subsequent analysis has estimated a current contribution to Union GDP of some11% (&500 billion).
The Commission evidenced that less than 5 % of contracts were awarded to companies from other EU countries
and highlighted closed bidding and exclusive trading in favour of national suppliers. Such practices- encouraged
by the social and political benefits of supporting local profit and employment worked against and spirit of EU
competition and fragmented the European market. National government purchasers were also paying the price of
staying local, by facing higher prices and limited choice.
After an initial upgrading of Community texts on public contracts and the extension of rules to formerly
excluded sectors, the various texts in this area were consolidated in 1993. Directives 93/36 for public supply,
93/37 for public works and 93/38 for the formerly excluded sectors (energy, transport, telecommunications and
water) tightened the obligations on member states and established the principle that equal opportunities shall
apply for national and non-national undertakings. This principle is implemented through the central requirement
that contracting authorities shall publish all contract notices no the basis of a model notice and a periodical
notice summarizing the most important information on the contracts planned for the twelve months ahead.
Publication must be in the Official Journal of the EU and requirements shall apply above the following minimum

Supplies and services (200,000 Euro),

Works (5 million Euro),
Telecommunications suppliers and services (600,000 Euro),
Suppliers and services of other public services (400,000 Euro).

However, although the opening up of public sector contracts to competitive bidding has been encouraged, certain
restrictions continue. EU public authorities can sometimes limit the bidding (restricted tender) to satisfy
conditions set by the purchaser (essential financial requirements) or may turn to negotiate procedures. These
involve a closed short-list of suppliers and may apply where tenders are not received under open tendering or
where exceptional circumstances apply. Purchasers can be forced to justify a decision to use negotiated
procedures to the European Commission. The use of this negotiated procedure is just one of a number of


problems with current legislation. Other weaknesses include excessively high thresholds, deficient transposition
into national law and flawed application of the rules by the contracting authorities.
The removal of fiscal barriers
The target of removing fiscal barriers related to the impact of divergent excise duties and indirect taxation
regimes on cross-border trade in the EC. In theory at least, fiscal harmonization is required to ensure a single
market. Although rates may not have to be completely equalized, research from the United States suggests that
contiguous states can maintain differentials in sales taxes of only up to 5 % without the tax leakage becoming
unbearable. The existence of differential sales taxes and excise duties between the units of an integrated
economy, and in income and corporation taxes can therefore provide major market distortions. Significant
variations in comparable tax rates interfere with the optimal allocation of resources and distort otherwise normal
trading relationships. In addressing this problem, the White Paper made several proposals, further elaborated by
the European Commission in 1987.
With respect to the harmonization of sales taxes, the European Commission proposed moving towards a
system which established two VAT rate bands. The lower or reduced rate was to be set at between 4 % and 9%
and the upper or standard rate set at between 14% and 20 %. The lower rate would cover foodstuffs, energy
products, water supplies, pharmaceuticals, books, newspapers, periodicals and passenger transport. This proposal
was rejected by the member states, who saw it as too constraining and was subsequently modified. From 1
January 1993 a more flexible approach was introduced involving an all-party pledge to keep standard VAT rates
at between 15% and 25%. Under the agreement of EU Finance Ministers, some scope is also provided for the
application of reduced and super-reduced rates and for the zero-rating of specific items. The White Paper on the
collection of VAT in the country of production or origin and the redistribution of revenues to the country where
the good or service would be consumed While a transitional VAT system was introduced in 1993, there has been
little progress towards a definitive origin based system despite successive Commission proposals.
On excise duties, as applying to mineral oils (petrol), alcoholic beverages and tobacco-based products,
the Commissions original proposal was for absolute harmonization. As example, its proposed harmonized rate
for cigarettes was calculated as an arithmetic average of national duty rates, at the time 53% of the tax-included
retail price. This plan was rejected by the member states because it implied too radical an attack on existing
excise discrepancies. In many cases, these discrepancies afforded a degree of protectionism for domestic
producers. Wine for example was not taxed in large-scale producer countries such as Greece, Italy, Portugal and
Spain, while extremely high rates applied in Denmark, Sweden and the UK. In the end, minimum excise duty
rates applied in Denmark, Sweden and the UK. In the end, minimum excise duty rates were established through
directives on cigarettes (92/79/EEC), on other tobacco products (92/80/EEC), on alcoholic products (92/84/EEC)
and on petrol. The minimum tax of Euro 0.3337 was required per liter of petrol.
Divergence with respect to excise duties (like sales tax) has narrowed as a consequence of the agreed
convergence measures but remains sufficient to maintain major price differentials between countries. One
consequence of this is a growing trend towards targeted cross-border shopping. For example, the booze cruise
phenomenon (familiar to British readers of this title) sees UK based consumers exploit the lower duties on beer
and wine in France and a sizeable duty-paid allowance for personal consumption. Analysts suggest that the
elimination of the duty-free internal market on 30 June 1999 will add further stimulus to such cross border
shopping, with travel companies encouraged to expand their presence in the duty-paid market.
The potential gains of Single Market completion, there would be immediate savings due to the removal of
barriers and savings spread over time due to the exploitation of economies of large-scale production. The net
welfare gain would be between 5% and &% of the ECs GDP, with benefits accruing fully with appropriate and
co-coordinated macroeconomic policies on the part of member states. Additional gains in terms of jobs, prices,
trade and budgetary balances were projected by use of a variety of methods. By removing non-tariff barriers,
Europe would benefit from greater competition in product markets and from reduced production costs. Falling
prices (coupled with reduced x-inefficiency) would act as a natural stimulus to demand and investment, which,
in turn, would contribute towards increased output, better resource exploitation and increasing economies of
4.3 The impact and effects of the SEM
It is clear that the Single European Market has realized dramatic and positive changes to the European
business environment. Technical and regulatory barriers have been reduced with the principle of mutual
recognition of standards meaning that manufacturers can sell their products all over the EU, eliminating
expensive re-testing and maximizing scale economies. Business can bid for public sector contracts outside their
home state and operate more freely in internal EU markets, many of which telecommunications and air transport
services) have been significantly liberalized. Most of the physical and administrative restrictions on goods


crossing borders within the EU have been removed, free movement of capital has stimulated cross-border
investments and there is now much greater freedom to provide many services across internal frontiers. Although
individuals can move freely (with residency rights attached) and with mutual recognition of their professional
and higher education qualifications in the vast majority of cases.
Macroeconomic effects
The abolition of customs and fiscal formalities and the gradual elimination of technical barriers have been a
catalyst for greater competition in Community markets, for increased cross-border trade and for improved
technological performance. The effect has been a stimulus to economic growth, to investment and to
employment creation. In the Commission reports, these include a number of measured results that would not
have been experienced without internal market completion. The following estimates have been provided for the
EU as a whole:
- A 1.1- 1.5 % hike to aggregate EU GDP (1987-1993)
- A 1% increase in internal investment,
- The creation of 900.000 extra jobs,
A reduction in EU average price inflation by at least 1%.
On trade, the SEM appears to have boosted both the EUs external trade performance and the volume of
intra-Community or internal Community trade. The percentage of total merchandise trade constituted by intraEU dispatches has accelerated from 61.2% in 1985 to 67.9% in 1998. In terms of external trade performance, the
EU has moved from an external trade deficit in 1992 to a 19.21 Euro billion-trade surplus in merchandise goods
in 1998 (Eurostat-Comext database). Internal as well as external trade in services has also expanded rapidly. The
EU-15 enjoyed an external trade surpluses in services of Euro 8.2 billion in 1998, benefiting from a general
pattern of sectoral change, deregulation and technical progress.
On investment, the period of the SEM has been associated with an increase in internal (intra-EU) and
external (inward) investment. With respect to intra-Community investment flows, gains have been most clearly
felt in the UK and Holland. During the period 1993-1997, these two member states sucked in about 30 % of all
intra-EU cross-border investments. With respect to inward investment, FDI assets held in the EU by foreign
investors have steadily increased since the first efforts to complete the Single Market. In 1998 alone, the EU
attracted 94.3 billion Euro of inward investment (mainly from North America), with the UK benefiting from 4.9
billion of this total. At the end of 1996, the EU countries hosted FDI liabilities worth an estimated 422 billion.
Much of this investment has been stimulated by concerns over future access to the EU market, although in recent
years fears of a fortress Europe, have greatly dissipated. Today, foreign investors are less concerned with EU
markets barriers and are more concerned with the advantages offered by the Single European Market. This
insider advantages can be said to include:
Closeness to the market- this involves not only geographic proximity which makes delivery easier but
also closeness in the sense of shortening the communication links between the market and the
manufacturer for the diffusion of information.
Better market information- related to the above point, gathering market information on which marketing
strategies are based is easier at first hand. In turn, this also helps firms adapt more quickly to changes in
market conditions (demand, consumer behavior, competition) and adapt products and strategies
Stimulating demand there is often assumed to be a presence effect in foreign investment where the
introduction of new competition into the market serves to raise overall levels of market demand.
Raises image and local identity one of the major problems for firms doing business abroad,
particularly in highly nationalistic countries, is their foreignness. This manifests itself in a lack of
understanding of the local culture and also the image of the country held by local customers. Firms with
a local manufacturing presence often come to be considered as local firms.
Access to public procurement similarly to the way that barriers to competition between the fifteen
member states within the EU made it difficult or impossible for non-indigenous firms to gain access to
public procurement, non EU firms may only win contracts if they have a local market presence.
The impact on market structures
The Internal Market Program has led to substantial restructuring of industry, facilitating deregulation
and market liberalization in many sectors, encouraging greater competition in a wide range of markets, and
accelerating market concentration. Benefits of the Single Market are seen as being particularly pertinent in the
sectors of telecommunications, automobiles, foodstuffs, energy, construction and building materials, financial
services, transport services, textiles, clothing and pharmaceuticals. Deregulation has dramatically affected a


number of these sectors and may yet be further realized under detailed timetables for specific industries.
Consequently, previously regulated and protected national markets have become more international in character,
with the establishment of new market entrants, lower prices and a greater level of competition.
The trend towards market concentration in Europe deserves particular comment. This is the process
wherein the market share of the largest N firms in a given industry is increased. Largely in anticipation of the
advent of the SEM, EU manufacturing and service sectors underwent a substantial amount of consolidation with
significant increases in the volume of domestic and cross-border mergers and acquisitions.
Benefits for the individual business

The removal of barriers to intra- EU trade has allowed firms to operate unhindered in a wider Europe of
some 376 million consumers. As they take up the opportunities of expanding their European coverage
and of increasing their output, they are better placed to raise the scale of their manufacturing units, to
reduce their costs and to gain from economies of scale.
The mutual recognition of standards means that manufacturers can, subject to few restrictions, sell their
products all over the EU. Given compliance with essential requirements, opportunities exist for the sale
of a standardized product across Europe.
By no longer having to adapt production and operations to national standards, firms may expect to
rationalize their production and operations
The Single Market has led to the scrapping of customs forms and paperwork associated with internal
frontier checks and with cross-border passage. This has led to shorter border waiting times, reduced
transport costs and simplified border formalities. Taking the UK as example, some 10 million customs
forms have been dispensed with, saving UK business around 135 million per year.
Lower transport costs combined with the free movement of goods have enabled companies to relocate
production from their domestic market to areas where production id cheaper or for other targeted
The internal market regime has also provided new incentives for innovation and to develop new
technologies as a way of sustaining long-term advantage.
The SEM has contributed to a reduction in input costs for many firms. Among other things, the four
freedoms of the SEM provide improved access to other member states for the purpose of acquiring
cheaper raw materials and component parts.
Closer market integration has provided freer access to ensure and financiers across the EUs economic
space. This has provided potential for reductions in costs of credit and insurance although advantages
here will only be maximized with the elimination of exchange rate risk exposure under EMU.
Collaborative arrangements are encouraged within the Single Market, permitting companies to gain
from an exchange of ideas and expertise, to burden share and/ or to penetrate new markets at lower risk
and shared cost.
Expansionary strategies are encouraged by several factors including new rights of establishment, market access
freedoms and the removal of restrictions on crossborder investments and capital movement.
Threats and challenges
Despite this gains, European businesses (large and small) have been forced to confront threats to their
operations and to respond to the challenges of enhanced competition. Underpinning the following concerns is an
assumption that powerful Asian and US companies will tend to produce/manufacture locally in order to take
advantage of SEM freedoms and to avoid paying import tariffs. This assumption has been validated by an
upward trend in inward investment since the advent of the SEM.

Increased competition in consequence of any EU firm being able to sell freely in any EU market may
imply reductions in market share for company X.
Profits and margins in established markets may be squeezed as a result of increased market entry.
Heightened competition will tend to encourage a downward movement prices.
With domestic protection from external competition largely removed, and with downward pressure on
prices, business closure rates will accelerate among least efficient firms and sectors.
State assistance of competitors from other member states (state aid) may threaten an ability to compete
in specific markets along with the potentially uneven enforcement of internal market rules and
Smaller operators will be more vulnerable to take-over as market integration stimulates domestic and
cross-border mergers and acquisitions.


Whatever the actual or perceived threat for individual businesses, the removal of barriers between the fifteen
member states of the EU has, in theory at least, raised the opportunity for European players to consider the
whole market as their domestic back yard. Although the balance sheet may be mixed, the SEM has created
opportunities previously denied to European firms to penetrate and to capture foreign markets and to realize
significant efficiency gains. In constructing appropriate and efficient strategies for Europe, firms will have to
weigh up several factors including company resources, product traits and life cycles, market conditions, cultural
and regulatory practices.
A key question of course is whether or not the completion of the Single Market has led to more or less
protection for indigenous firms. This issue is bound up with outsiders concerns that the creation of the Single
European Market might lead to a fortress Europe. Early action against many industrial imports, particularly
Japanese exports in high technology sectors, suggested that the new Europe was not going to welcome further
encroachment by competitive foreign imports. Added to this belief were reports emanating from member capitals
(and from Brussels) which seemed to suggest that, along with the new internal freedoms from competition across
the EU, external trade policies, in the short term at least, would be designed to protect the EU from external
pressures in an effort to allow firms and industries alike to strengthen their position in the new Europe.
As the SEM took its final shape in the early-mid-1990s, fears of fortress Europe began to dissipate. In
practice, the completion of the internal market undermined the ability of the member states to use national tools
of protection and it became clear that those countries that favoured protection (such as France) faced a
strengthened liberal coalition in the form of the Commissions external relations directorate (DG1) and a cluster
of liberal states (the UK, Denmark, Germany and the Netherlands). While the EU emphasized reciprocity on
market opening, very few national restrictions (quotas, voluntary export restraints etc) were replaced with EUlevel trade restrictions and the number of EU anti-dumping measures stabilized at around 150 a year. The
completion of the SEM also coincided with the completion of the Uruguay Round GATT trade talks, which
committed the EU to various market-opening measures even in its most sensitive sectors.
While EU trade defences remain significant, there is now a strong consensus that the formation of the
SEM has not led to an increase in European trade barriers or to a picture of aggressively competitive inwardlooking regional trade blocs. The WTOs Trade Policy Review Board has concluded that:
The deepening of European integration, with single market completion. Has not reduced the EUs
involvement in the multilateral system nor increased its levels of overall protection.(WTO PRESS/TPRB/66, 27
November 1997)
In a growing number of areas, the interface between the single market and the international trading system now
appears to be working together to the benefit of both the Union and its trading partners.

Understanding the four freedoms : Free movement of goods, persons, services and capital

Throughout the EU, the huge number of different technical standards has been massively reduced.
Nonetheless, significant problems remain and, with countries continuing to operate their own standards against
essential requirements prescribed in EU legislation, there remains much potential for argument and confusion.
Several operators have reported delayed acceptance of standards and expensive re-testing procedures for their
products. In addition, although procedures exist requiring member states to notify new technical regulations to
ensure that no new technical barriers to trade arise in the Single Market, member states are still putting in place
an increasing number of technical rules without proper notification and approval.
In short, the patchwork of national product standards, the vagaries of notification, and the ambiguities
of mutual recognition, continue to trouble intra-EU exporters-importers. In one recent case, French authorities
blocked the sale of imported disposable barbecues, rejecting the standard of the product on the grounds of
unacceptable fire risk. Despite product modifications by the exporting company and improvements to the
instructions for use, the Commission reports that French authorities continue to refuse sales authorization.
Technical barriers to trade result from national regulations obliging industrial products and
foodstuffs to satisfy certain criteria or to meet certain standards and technical specifications. This legislation is
necessary for various reasons: the rationalization of industrial production, guaranteeing the safety of workers,
protecting the health of consumers and preventing or reducing environmental pollution. The problem for the
common market was not the existence of national regulations, but the differences between them and also the fact
that those measures could be used to protect the national market from products from other Member States which
were subject to different standards.
The disparity that existed between countries in terms of technical requirements stemmed from
historical and economic considerations. A country in which a product was imported rather than manufactured
tended to impose stringent requirements on it and checks prior to its being placed on the market, without
concerning itself greatly about economic cost, which that represented. On the other hand a producer country of


an industrial product tended to take into consideration the economic implications of requirements and controls,
an excessive stringency of which would penalize its industry. In any case, the various technical regulations could
hinder trade even more than customs duties. Indeed, even a high customs tariff could be paid and a product
originating in one country could enter the market of another, whereas if a product did not comply with the
technical standards its entry to that countrys market was completely blocked.
The result was that the industrialist who whished to export to the other EEC member countries was
obliged to bear additional research, development and production costs in order to comply with all the national
standards which his products had to satisfy. Thus the disparity of the legislation within the Community
compelled producers to manufacture different components, increase their production lines, diversify their stocks
according to country of destination and to have specialized distribution and after-sales services for each country.
The free movement of persons
Another enduring problem, although not one emphasized in the stated survey, is the continued failure to
ensure the free movement of persons throughout the Community. Although customs formalities for the
movement of goods were simplified during the period 1985 92 and then abolished on 1 January 1993, border
controls on the movement of person remain. As a consequence of this and of factors tied to cultural diversity and
to restricted rights of residence, the free movement of people throughout the EU remains no more than an
aspiration. In fact, labour mobility between European nation-states is barely one-third the level found in the USA
and a Commission survey has found that more than 80% of French and German workers would never seek work
elsewhere in the EU.
The Schengen Agreement on frontier controls, now integrated into Community law, is supposed to
allow EU citizens to travel without a passport within EU countries, with non-EU citizens requiring only visa to
enter any EU state. Despite this, passport-free movement is a reality only for EU citizens moving between the
thirteen member states that have presently signed the accord the UK and Ireland have refused to do so or
within the Anglo-Irish common travel area. Even within the expanded circle of the Schengen Group, certain
restrictions on freedom of movement continue to exist. Despite the relaxation of internal border controls since
1995, Schengen nationals and nationals of other EU member states need a European identity card (or valid
passport) for the purpose of their identification when traveling throughout the Union.
Aside from this impediment to the free circulation of EU citizens, for the SEM to work properly, people
must also have the tight to live and work where they can find suitable employment and business must be allowed
to recruit and to post workers according to their requirements. According to Article 39 (ex Article 48) of the
Community Treaty, any European Union citizens has the right to enter the territory of any member state in order
to work or to look for a work.
Freedom to provide services
Article 49 (TEC) provides that restrictions on "freedom to provide services" within the Community shall be
"abolished in respect of nationals of Member States who are established in a State of the Community other" than
that of the person for whom the services are intended". Under Article 50 (TEC), services shall be considered as
such where they are normally provided for remuneration, in so far as they are not governed by the provisions
relating to freedom of movement for goods, capital and persons. This Article specifies, however, that the
provisions on the free movement of services cover all activities of an industrial or commercial character or of
craftsmen and the activities of the professions.
Services represent almost 60% of the value added of the Community economy and cover a vast spread
of economic activities, from banks and insurance to transport and tourism, not to mention data processing and
management consultancy. They therefore play an increasingly large part in the economy and employment and are
a linchpin for smooth operation of the EU's internal market.
Financial services - banks, insurance companies and stock exchanges - which are closely monitored by
the official authorities, are particularly important, as they constitute a vast market and are indispensable activities
for the proper functioning of the other economic sectors. The European Union has to reconcile two contradictory
requirements in these cases, viz. the need to maintain very stringent criteria for control and financial security and
the need to leave the branch concerned enough flexibility for it to be able to meet the new and ever-more
complex requirements of its customers throughout the European market, particularly with the introduction of the
euro. The EU financial services legislation, detailed below, needs to be enforced effectively, but does not need
radical surgery. However, more flexible methods are required to adapt the rules to evolving market conditions
and additional legislation is needed in a few targeted areas including pension funds and consumer redress 1.
In accordance with the principle of mutual recognition, if financial service is lawfully authorized in
one Member State it must be open to users in the other Member States without having to comply with every
detail of the legislation of the host country, except those concerning consumer protection. Control has to be


exercised by the Government in the territory of which the company providing the services is established, with
the authorities of the country in which the service is performed merely ensuring that certain basic rules relating
to commercial conduct are observed. This system applies both to the traditional fields of transport insurance and
banking and to the new fields of services, such as information technology, marketing and audio-visual services.
Harmonization of legislation is henceforth necessary only in very specific instances, to facilitate the exchange of
services. Thus, a Directive seeks to harmonize the legislation of Member States concerning measures to combat
illicit devices which allow unauthorized access to protected services, such as pay television, video or sound
recordings on demand, whose remuneration -and often viability -relies on "conditional access" techniques such
as encryption or electronic locking.
As regards banking, the Council, after abolishing restrictions on freedom of establishment and freedom
to provide services in respect of self-employed activities of banks and other financial institutions adopted, in
1977, a first Community Directive on the coordination of the laws, regulations and administrative provisions
relating to the taking up and pursuit of the business of credit institutions 1. A second Directive in this field,
adopted by the Council in 1989, permits the mutual recognition of supervision systems, i.e. application of the
principle of supervision of a credit institution by the Member State in which it has its head office, and the issue
of a "single bank licence" which is valid throughout the Community2. The single licence authorizes a bank
established in a Member State to open branches without any other formalities or to propose its services in the
partner countries. It also contains provisions relating to the reciprocity governing the opening in the Community
of subsidiaries of banks from non-member countries. In an interpretative communication concerning the second
banking Directive, the Commission clarifies, in the light of the case law of the Court of Justice, the exact scope
of the freedom to provide banking services. It also maps out the legal framework within which a Member State
may invoke the concept of "general good" in order to restrict the provision of services by a credit institution
benefiting from mutual recognition3.
A related area, of great interest to travelers in particular, is that of the use throughout the Community of
magnetic-stripe and microcircuit payment cards. These cards are increasingly used in the Member States for
obtaining cash from automatic cash dispensers or for paying for products or services directly and electronically
at sales-point terminals or even at home. Achievement of the internal market requires Community action to
ensure the interconnection of networks and the mutual opening-up of magnetic card systems, the liberalization of
electronic payments from all administrative constraints and an appropriate balance between the interests of the
various parties (industries, companies providing services, financial institutions, consumers and traders). So as to
encourage the interconnection of the networks, the Commission issued Recommendations: on consumer
protection in the field of the new payment systems, and in particular the relationship between cardholder and
card issuer; on the transparency of bank charges relating to cross-border transactions; and on transactions by
electronic payment instruments, including electronic money products, and in particular the relationship between
issuer and holder4.
In the field of insurance too, the Council, after adopting, in 1973, a first Directive on the coordination of
laws, regulations and administrative provisions relating to the taking-up and pursuit of the business of direct
insurance other than life insurance5, adopted, in 1988, a second Directive amending the first to facilitate the
effective exercise of freedom to provide insurance services 6. It provides in particular for very liberal
arrangements for covering major industrial and commercial risks, together with adequate protection for minor
consumers. The Council already, in 1987, adopted two Directives supplementing and clarifying the provisions of
the first coordinating Directive as regards credit insurance and suretyship insurance on the one hand and legal
expenses insurance on the other.
A third coordination Directive in the area of direct insurance other than life insurance provides for a
single authorization system enabling a company with its registered office in a Community Member State to
open branches and operate services in all the Member States without the need for authorization procedures in
each country6.
It is designed to ensure the free movement of insurance products within the Community and give
European citizens the opportunity to take out insurance with any Community insurer, thus finding the coverage
best suited to their needs at the lowest cost, while enjoying an adequate level of protection. An Insurance
Committee set up by a Council Directive has been given the brief of helping the Commission exercise the
implementation powers conferred on it by the Council in the field of direct insurance.

1.Council Directive 77/780, OJ L 322, 17.12.1977 and Directive 98/33, OJ L 204, 21.07.1998
2. Council Directive 89/646, OJ L 386, 30.12.1989 and Directive 92/30, OJ L 110, 28.04.1992
3.OJ C209, 10.07.1997.
4. COM (97) 353
5. First Council Directive 73/239, OJ L228, 16.08.1973 and European Parliament and Council Directive 95/26, OJ L 168, 18.07.1995


6.Council Directive 88/357, OJ L 172, 04.07.1988 and Council Directive 92/49, OJ L228, 11.08.1992

Community law on stock exchanges and other securities markets is directed towards widening the range
of investments at Community level while protecting investors. A 1979 Directive coordinated the conditions for
the admission of securities to official stock exchange listing1. Two Council Directives, adopted in 1993,
established the single market in securities.
By virtue of the first of these Directives, investment services in the securities field can be freely conducted,
although monitored, throughout the EU financial area 2. An investment firm in any Member State can carry out its
activities anywhere in the European Union on the basis of a single authorization (called a "European passport)
issued by the Member State of origin. The conditions governing authorization and business activity have been
harmonized for this purpose. Prudential supervision, based on uniform rules, is carried out by the authorities of
the home Member State, but in cooperation with the authorities of the host Member State. Investment firms have
right of access to all the regulated markets in the EU. Minimum transparency rules designed to guarantee
investors a sufficient level of protection must be respected on regulated markets.
The equity capital of investment firms and credit institutions must be adequate to guarantee market
stability, guarantee an identical level of protection against bankruptcy to investors throughout the European
Union and to ensure fair competition between banks, subject to specific prudential provisions, and investment
societies on the securities market. In order to fulfill these objectives, the second 1993 Directive lays down
minimum initial capital requirements and sets the equity capital which must permanently be held in order to
cover position, settlement, exchange and interest rate risks 3. A Parliament and Council Directive on investor
compensation schemes provides for minimum compensation for investors in the event of the failure of an
investment firm, authorized to provide services throughout the Union under the condition that it can prove to be
able to honour its debts4. Another Directive is intended to reduce the systemic risk inherent in payment and
securities settlement systems and to limit the perturbations caused by the insolvency of a participant in such a
system. It stipulates that, in cases of insolvency, the collateral security provided in connection with participation
in payment and securities settlement systems will be realized first and foremost in order to satisfy the rights of
these systems vis-a-vis the insolvent party.
Freedom of capital movement is another essential element for the proper functioning of the large
European internal market. The liberalization of payment transactions is a vital complement to the free
movement of goods, persons and services. Borrowers - notably SMEs - must be able to obtain capital where it
is cheapest and best tailored to their needs, while investors and suppliers of capital must be able to offer their
resources on the market where there is the greatest interest. That is why it is important that the Member States
free capital movements and allow payments to be made in the currency of the Member State in which the
creditor or beneficiary is established.
A 1988 Directive ensures the full liberalization of capital movements. Under this Directive, all
restrictions on capital movements between persons (natural or legal) resident in
Member States were removed in the beginning of the nineties. Monetary and quasi-monetary operations
(financial loans and credits, operations in current and deposit accounts and operations in securities and other
instruments normally dealt in on the money market) in particular are liberalized. A specific safeguard clause
allows Member States to restore restrictions on short-term capital movements if their monetary or exchange rate
policies are disturbed. Such measures must, in all circumstances, be authorized by the Commission, but the
Member State may, on the grounds of urgency, adopt such measures itself as interim protective measures.
However, Articles 56 to 60 of the EC Treaty, which have replaced Articles 67 to 73 of the EEC Treaty,
go even further than the 1988 Directive in the liberalization of capital movements. The principle of the free
movement of capital and payments is now expressly laid down in the Treaty. Article 56 declares, in fact, that all
restrictions on the movement of capital between Member States and between Member States and third countries
are prohibited. The main change as compared to the previous situation is the extension in all but a few cases of
the obligation to liberalize capital movements to and from third countries. Nevertheless, Article 59
authorizes temporary safeguard measures to be taken where they are justified on serious political grounds or
where capital movements to and from third countries cause serious difficulties for the functioning of economic
and monetary union. In addition. Article 58 authorizes Member States to take all requisite measures to prevent
infringements of national law and regulations, in particular in the field of taxation and the prudential supervision
of financial institutions. According to the Court of Justice, the Treaty does not allow any restrictions to the free
movement of capital, but the export of important amounts of money may be subjected to a prior declaration, so
that the national authorities may exercise effective supervision in order to prevent infringements of their laws
and regulations.


Council Directive 79/279, OJ L66, 16.03.1979 and Council Directive 88/627, OJ L 348, 17.12.1988
Council Directive 93/22, OJ L 141, 11.06.1993 and Parliament and Council Directive 97/9, OJ L84, 23.03.1997
Council Directive 93/6, OJ L141, 11.06,1993 and Parliament and Council Directive 98/33, OJ L 204, 21.07.1998



Parliament and Council Directive 97/9, OJ L84, 26.03.1997

On the basis of these provisions and of those liberalizing banking, stock-exchange and insurance services,
the Community financial market has been completely liberalized since January 1,1993. European undertakings and individuals have access to the full range of options available in the Member States as regards
banking services, mortgage loans, securities and insurance. They are able to choose what is best suited to their
specific needs or requirements for their daily lives and for their occupational activities in the large market. The
Court has held that the free movement of capital and loans should not be restrained by national provisions which
are likely to deter the parties concerned from approaching banks established in another Member State. According
to the European Commission, it is also necessary for funded supplementary pension schemes to benefit from the
single market, the freedom of movement of workers and the euro. It, therefore, advocates better protection for
members of the schemes combined with more efficient fund investment.
The European financial area must not, however, be exploited for the purposes of laundering money
generated by criminal activities. With a view to nipping such practices in the bud, the Council adopted a
Directive on June 10,1991, applicable to credit establishments and financial institutions, including life
insurances. Under the terms of this Directive, the Member States must make provision for measures such as
identification of customers and economic beneficiaries, the conservation of supporting documents and
registrations of the transactions, the informing of the relevant authorities of suspected laundering operations and
the obligation for the institutions covered to set up training programmes for their employees and apply internal
checking procedures. The Member States must, furthermore, apply the appropriate measures to ensure that these
provisions are fully applied, thanks notably to the determination of applicable sanctions. A contact committee
will have the task of contributing to the harmonized implementation of national measures through regular con sultations between representatives of the Member States and of the Commission.
Bibliography on the Common Market and suggested readings


European Commission, How does the European Union work?, 1996, pag 5-6;
European Commission, Single European Market, 1997
Simon Mercado, Richard Welford, European Business, Prentice Hall, 2001, pag 89-96, 99-105;
Nicolas Moussis, Access to European Union, law, economics, policies, European Study Service,
2001, pag 104-109, 112-113;
European Commission, The EU Market Access Strategy, 2000
Desmond Dinan, Ever Closer Union, an Introduction to European Community, Macmillan, 1997, pag
Cen-Cenelec, The new approach. Legislation and Standards on the free movement of goods in Europe,
European Committee for Standardization, Brussels, 1997
European Commission, Technical Barriers to trade, the Single Market Review III:1, EUR-OP,
Luxembourg 1999;
Woolcock Stephen, European Trade Policy Global Pressures and Domestic Constraints, Oxford
University Press, 2001, fourth edition, pp/208-226



5. Economic and Monetary Union in Europe

5.1 The European Monetary System and the birth of the ERM
5.2 Launching EMU: Maastricht Treaty
5.3 Economic policy and convergence of national economic policies under EMS and beyond
5.4 EMU impacts
5.5 EMU and EU tax harmonization
5.1 The European Monetary System and the birth of the ERM
Economic and monetary union (EMU) is an advanced stage of economic integration involving a common
monetary policy and closely coordinated economic policies of the Member States. The EUs monetary integration
begins with the establishment, in the 1970s, of series of formal mechanisms designed to limit exchange rate volatility
in the then EEC markets. The advantages of stable exchange rates were identified by European leaders as early as the
1950s but for many years European leaders participated in the international post-war system of exchange rate
coordination known Breton Woods. This involved a system of cross-rate parities against the US dollar. It was only as
this system began to show terminal signs in the late 1960s that European leaders paid attention to the benefits of
regional European schemes of exchange rate co-ordination and to seriously explore the possibilities of monetary
union. There had been no mention of a unified monetary system within the original Rome Treaty but the idea had
long circulated among European leaders.
In March 1970 the Werner Plan which formalized a number of proposals concerning macroeconomic policy cooperation and a managed currency arrangement as apart of three-staged move to full EMU within ten years. In March
1971, the collapse of the Btretton Woods system and the decision of the US Government to float the dollar in August
1971 produced a wave of instability on foreign exchanges. This instability, coupled with internal Community
tensions, ended hopes of realizing monetary union according to the Werner Plan. This left in place only the agreed
mechanism for exchange rate co-ordination, which had originally been perceived as an experimental arrangement. In
its first incarnation (the snake of 1971) and then as the snake in the tunnel (1972-1976) a mechanism was provided
for the managed floating of EEC currencies (the snake) within narrow margins of fluctuation against the dollar (the
tunnel). Although these arrangements promised some exchange rate stability in a turbulent period, weak mutual
support mechanisms, continued dollar instability and a rolling oil crisis all contributed to system failures.
In 1977, Roy Jenkins, the President of the European Commission, once again raised the issue of macroeconic
policy integration with the EEC Council and called for a zone of monetary stability in Europe. The Commission
pushed through complex proposals for exchange rate co-operation based on four assumptions:
1. That currency movements had a destabilizing effect on the economies of member states and that exchange
rate volatility was inherently damaging.
2. That the linkage of exchange rates would be beneficial for business confidence and make trade between
countries more likely. This would fuel growth and ensure a high level of employment.
3. That a strictly European system was both feasible and preferable (recalling failed links with the US dollar).
4. That a European exchange rate mechanism and broader monetary system had independent merits and did
not depend on the ability or choice of the member states to move towards EMU, the idea of which was at
least revived.
Consequently, the EMS was set up with three main elements.
The ECU (a basket of all the member states currencies) was introduced as the denominator used for
fixing exchange rates and for operations within the system. It was to be revised from time to time in line with
underlying economic criteria on the consent of all the members. Although the ECU did not exist in note and coin
form, ECU bank accounts were available and the ECU could therefore be used as an instrument of settlement
between monetary authorities, institutions, firms and even individuals. Note that the market values of the ECU were
adopted as the basis of Euro values in 1999 under a simple one-for-one rule.
The Exchange Rate Mechanism
The central element of the EMS was to be the ERM. Within this system, each member states currency
enjoyed an exchange rate against the ECU, called the central rate. A complete grid of bilateral rates was calculated on
the basis of these central rates and fluctuations against these had to be contained within tight margins. Prior to

August 1993 (when bands were widened to +- 15%), the permitted limits of fluctuation were set up to +2.25% or at
+-6% for high inflation states such as Italy and Spain. Member states were committed to supporting their own
currencies within these bands and intervention points would be reached before currencies attained their maximum
permissible spreads. The system was thus fairly described as a semi-fixed exchange rate system. The Possibility of
fluctuations and of formal re-alignments meant that some exchange rate uncertainly remained.
Financial support mechanisms
The EMS also included short-and medium term credit or financial support mechanisms designed to assist
member states with balance of payments difficulties. For several years, the European monetary system contributed
powerfully it exchange rate stability in Europe. The ERM/EMS provided a framework whereby member states were
able to pursue counter-inflationary policies contributory to a sustained period of economic growth. Exchange rate
realignments were infrequent and, prior to 1989, inflationary pressures were cooled by the alignment of other
member states monetary policies on those of the Bundesbank (in itself committed to price stability). The ECU also
became established as a significant currency of denomination.
Despite this, the experiences of 1992 and 1993 when speculators ram raided one currency after another,
leading to an abandonment of ERM disciplines, have led to strong criticism of the operation of the ERM. For
example, when the system came under its greatest pressure, the assumption that co-coordinated efforts on the part of
all member states would be made in order to prevent the breaking of individual currencies proved false with exits for
the lira and sterling. In the realignments of 1992 and 1993 very little co-operation and co-ordination was evident.
Despite the countries of currencies under attack pushing up interest rates, speculators often pursued their relentless
attack on the chosen currency in the certain knowledge that realignment would follow and a large profit would be
It must be recognized, however, that these experiences cannot be separated from the recession of the early
1990s which affected different member states in different ways, leading to a period of divergence rather than
convergence of macroeconomic indicators. Above all else, we should not ignore the way in which the Deutchmark
and not the ECU had become the real core of the system, placing undue weight on domestic German monetary
policy decisions such as interest rate changes.
While this arrangement provided benefits to the other members in terms of exporting German monetary
virtues it did, of course, also have the risk that any German monetary troubles would be exported too. The massive
shocks to the German economy resulting from the unification of East and West Germany in 1990 were bound to
product shocks for the European economy as a whole. Specifically, the inflationary effects of German unification led
the bundesbank to raise German interest rates higher simultaneously making the DM a more attractive currency to
hold and forcing other European currencies linked through the EMS to maintain the value of their own currencies (at
enormous costs to official reserves).
Thus, during the second half of 1992, uncertainties surrounding the process of ratification of the Maastricht
Treaty, currency turmoil and doubts surrounding the outcome of the Uruguay Round placed the EMS exchange rate
mechanisms under severe strain. Injury 1993, more severe pressures developed within the exchange rate mechanism
with massive speculative attacks against the weaker currencies. Under these circumstances, the Ministers and central
bank governors of the Member States decided, on 2 August 1993, to widen temporarily the fluctuation margins
within the exchange-rate mechanism from 2.25 % to 15% either side of the bilateral central rates.
5.2 Launching EMU: Maastricht Treaty
The Treaty on European Union provides for the introduction of a single monetary policy based upon a single
currency managed by a single and independent central bank. The primary objective of the single monetary
policy and exchange rate policy shall be to maintain price stability and, without prejudice to this objective, to support
the general economic policies in the Community in accordance with the principle of an open market economy with
free competition. These activities of the Member States and the Community shall entail compliance with the
following guiding principles: stable prices, sound public finances and monetary conditions and a sustainable balance
of payments (Art. 4 TEC).
Although economic and monetary union has to be envisaged as a single process, there are, in fact, three
stages involved. The first stage, marking the beginning of the whole process, came with the entry into force of the
Directive on the complete liberalization of capital movements in July 1990. The central objectives of this stage were


greater convergence of economic policies and closer cooperation between central banks, incorporating greater
consistency between monetary practices in the framework of the EMS. A Monetary Committee with advisory status
was set up in order to promote coordination of the policies of Member States to the extent needed for the functioning
of the internal market. The Member States and the Commission each appoint two members of the Monetary
Committee (Art. 114 TEC).
As provided for in Article 118 of the EC Treaty, the composition of the basket of the ECU was "frozen" on 1
November 1993, the date of the entry into force of the Maastricht Treaty,
on the basis of the composition of the basket (in amounts of each national currency) defined on 21st September 1989
at the occasion of the entry into the basket of the peseta and the escudo. The European Council, meeting in Madrid
on 15 and 16 December 1995, decided that, as of the start of stage three, the name given to the European currency
should be the euro, a name that symbolizes Europe and must be the same in all the official languages of the
European Union, taking into account the existence of different alphabets.
The second stage of economic and monetary union began on 1st January 1994 and ended on 31 December
1998. During that stage, the Treaty on European Union compelled each Member State to endeavour to avoid
excessive public deficits and initiate steps leading to independence of its central bank, so that the future monetary
union encompassed only countries which were well managed economically. A Council Regulation laid down detailed
rules and definitions for the application of the excessive deficit procedure, including the definition of public debt, as
well as rules for the reporting of data by the Member States to the Commission 1. In the process leading to the
independence of central banks, the Treaty prohibited them from granting governments overdraft facilities or any
other type of credit facility and from purchasing public sector debt instruments directly from them (Art. 101 TEC). A
Council Regulation clarifies certain implications of this prohibition2.
Together with the prohibition on the direct monetary financing of public deficits and in order to submit public
borrowings to market discipline, the Treaty provided that public authorities should not have privileged access to
financial institutions, unless this was based on prudential considerations (Article 102 TEC). The Treaty sought, thus,
to institutionalize a sort of market-induced budgetary control. To this effect, a Council Regulation defined the
terms "privileged access", "financial institutions", "prudential considerations" and "public undertakings" 3.
Following the provisions of Article 109f (present Article 117 TEC), the Committee of Governors of central
banks and the European Fund of Monetary Cooperation were dissolved in January 1994. They were replaced by a
European Monetary Institute (EMI), with its seat in Frankfurt. Its task was to monitor the functioning of the
European Monetary System and facilitate the use of the single currency. It examined the technical issues connected
with the changeover to the single currency, carried out the preparatory work necessary to enable the European
Central Bank and Member States' central banks to apply a single monetary and exchange-rate policy based on the
euro from the start of the third stage, and monitored, in cooperation with the national central banks, the progress
made in the banking and financial spheres on preparations for the changeover to the single currency. The EMI also
prepared the Target (trans-European automated real-time gross settlement express transfer) system, which enables
domestic and cross-border payments to be executed in euro.
In preparation for the move to the third stage, the Treaty required the Commission and the European
Monetary Institute to report to the Council on national legislation linked to the achievement of economic and
monetary union and progress towards a high degree of convergence assessed by reference to four specific criteria, a
rate of inflation which is close to that of the three best performing Member States in terms of price stability; a
government budgetary position without a deficit that is excessive, meaning a government deficit not exceeding 3% of
GNP and total government debt not greater than 60% of GNP (subject to an appraisement by the Council deciding by
qualified majority); the durability of convergence achieved by the Member State being reflected in the long-term
interest rate levels; and the observance of the normal fluctuation margins provided for by the Exchange Rate
Mechanism of the European Monetary System, for at least two years (Art. 121 TEC and Protocol on the excessive
deficit procedure).
Indeed, on 1 May 1998, following the procedure and the timetable set out in the EC Treaty, the Council,
acting on a recommendation from the Commission under Article 109j (present Art. 121 TEC), concluded that
Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland
satisfied the necessary conditions for the adoption of the single currency. The conclusions of the Council were
endorsed by the European Parliament on 2 May 1998. On this basis, the Council, meeting at the level of Heads of
State or Government on 3 May 1998 decided that the 11 Member States referred to above satisfied the necessary
conditions for the adoption of the single currency on 1 January 1999,
1.Council Regulation 3605/93, OJ L332, 31.12.1993
2.Council Regulation 3603/93, OJ L332, 31.12.1993
3.Council Regulation 3604/93, OJ L 332, 31.12.1993


namely that: national legislation, including the statute of the national central bank, was compatible with the Treaty
and the Statute of the European System of Central Banks (ESCB); the average rate of inflation in the year ending
January 1998 was below the reference value; these countries were not subject to a Council decision on the existence
of an excessive government deficit; these countries had been members of the exchange rate mechanism (ERM) for
the last two years and their currencies had not been subject to severe tensions; in the year ending January 1998, the
long-term interest rates in these countries were below the reference value1.
The Council also stated that Greece and Sweden did not at that stage fulfill the necessary conditions for the
adoption of the single currency. It did not examine whether the United Kingdom and Denmark fulfilled the
conditions given that, in accordance with the relevant Treaty provisions, the United Kingdom notified the Council
that it did not intend to move to the third stage of EMU on 1 January 1999 and Denmark notified the Council that it
would not participate in the third stage of EMU. Member States not able to adopt the single currency from the
start were given a derogation implying that the provisions on monetary policy and on sanctions with respect to
excessive deficits do not apply to them (Art. 122 TEC). Countries benefiting from an "opt-out" and those, which do
not meet the criteria from the outset, will nevertheless participate in all the procedures (multilateral surveillance,
excessive deficit...) designed to facilitate their future participation. The Governors of their central banks will be
members of the ECB General Council.
From the start of the final stage of EMU, i.e., from 1 January 1999, the Community has a single monetary
policy and a single currency - the euro. They are which replaced the EMI and formed together with the monitored
by the European Central Bank (ECB), central banks of the Member States, the European System of Central
Banks (ESCB). Neither the ECB nor national central banks shall seek or take instructions from governments or
Community institutions (Art. 108 TEC). The total independence of the European Central Bank is the cornerstone of
the Community's new monetary policy. According to the German concept, which has shown its worth through the
independence of the Bundesbank, currency is something much too serious to leave in the hands of politicians who,
legitimately worried about unemployment, are tempted to manipulate the exchange rate or the interest rates to kickstart the economy without drawing on the lessons of the past. Democratic control can and must be exercised a
posteriori by the dismissal of the governors of national central banks, members of the ECB board, who are judged by
their governments to have failed in their task. The president, the vice-president and the other members of the
Executive Board of the ECB were appointed by decision taken by common accord of the governments of the eleven
Member States adopting the single currency, after their appointments were endorsed by the European Monetary
Institute and the European Parliament1.
All central banks, including those not participating in the single monetary policy, are members of the ESCB
from the start of the third stage. The primary objective of the ESCB is to maintain price stability. In addition, the
ESCB must support the general economic policies in the Community with a view to contributing to the achievement
of the objectives of the Community as laid down in Article 2 (TEC). The basic tasks to be carried out through the
ESCB are: to define and implement the monetary policy of the Community; to conduct foreign exchange operations
consistent with the provisions of Article 111 (TEC); to hold and manage the official foreign reserves of the Member
States; and to promote the smooth operation of payment systems (Art. 105 TEC). However, exchange policy with
regard to the currencies of third countries (US dollar, Japanese yen...) is determined by the Council after consultation
of the ECB (Article 111 TEC).
The ECB can adopt regulations and take decisions necessary for carrying out the tasks entrusted to the ESCB
(Art. 110 TEC). National authorities must consult the ECB regarding draft legislation within its field of competence 2.
The ECB has powers to: apply minimum reserves and specify the remuneration of such reserves; impose fines and
periodic penalty payments on firms for infringing its regulations or decisions; and collect statistical information in
order to carry out its tasks3. The ECB will have the exclusive right to authorize the issue of euro banknotes within
the Community. The ECB and the national central banks may issue such notes 4. Member States may issue euro coins
subject to approval by the ECB of the volume of the issue (Art. 106 TEC). The ECB will be consulted on any
proposed Community act and may submit opinions to Community institutions or to national authorities on matters
within its field of competence (Art. 105 TEC). A Council decision defines the scope and conditions of consultation of
the Bank by national authorities concerning draft legislation within its field of competence 5.

Council Recommendation 98/318, OJ L 139, 11.05.1998 and Decision 98/345, OJ L 154, 28.05.1998
Council Decision 98/415, OJ L 189, 03.07.1998
Council Regulation 2533/98, OJ L 318, 27.11.1998
Decision ECB/1998/6, OJ L8, 14.01.99
Council Decision 98/415, OJ L 189, 03.07.1998


The capital of the ECB (initially 5 billion euro) will be held by the national central banks in proportion to the
individual countries' demographic and economic weight 1. The external foreign reserves of the national central
banks will be pooled at the ECB within certain limits. The decision-making bodies of the ECB will be the
Governing Council and the Executive Board. The policy of the ECB aiming at ensuring price stability will be
formulated by the Governing Council, which will be composed of the fifteen Governors of the central banks of the
Member States and of the members of the executive Board. The executive Board, consisting of the President of the
ECB, the Vice-President and four other members, will implement the ECB monetary policy and will give the
necessary instructions to the national central banks.
At the start of the third stage, on 1 January 1999, the Monetary Committee was replaced by the Economic
and Financial Committee (EFC). The Member States, the Commission and the ECB may each appoint two
members to the Committee, which therefore has a total of 34 members. This has the following tasks: to deliver
opinions at the request of the Council or of the Commission, or on its own initiative for submission to those
institutions; to keep under review the economic and financial situation of the Member States and of the Community
and to report regularly thereon to the Council and to the Commission, in particular on financial relations with third
countries and international institutions; to contribute to the preparation of the work of the Council on EMU; to
examine, at least once a year, the situation regarding the movement of capital and the freedom of payments and to
report to the Commission and to the Council on the outcome of this examination (Art. 114 TEC). According to its
statutes, the EFC prepares the Council's reviews of the development of the exchange rate of the euro and provides the
framework for the dialogue between the Council and the European Central Bank.
At the starting date of the third stage, on 1 January 1999, the ECU was replaced by the euro and this became a
currency in its own right (Art. 123 TEC). The euro is, in fact, the currency of those Member States which participate
fully in the single monetary policy. As mentioned above, the exchange-rate mechanism (EMS II), which replaced
the European Monetary System (EMS), limits the fluctuations between the single currency of these Member States
and the currencies of the Member States with a derogation, i.e., Greece and Denmark. The voting rights of the latter
are suspended for all questions relating to the single currency. A Commission communication on the reinforced
convergence procedures and the new exchange-rate mechanism in the third stage of EMU is intended to clarify the
relationships between the Member States having adopted the euro and the other Member States so as to encourage
the latter to participate in the euro zone and to guarantee the monetary stability of the single market 1.
The Amsterdam European Council of 16 and 17 June 1997 adopted a Resolution laying down the firm
commitments of the Member States, the Commission and the Council regarding the implementation of the Stability
and Growth Pact. In this Pact Member States commit themselves: to respect the medium term budgetary objective
of "close to balance or in surplus" set out in their stability or convergence programmes, to correct excessive deficits
as quickly as possible after their Emergence, to make public, on their own initiative, recommendations made in
accordance with Article 104 (TEC); and not seek an exemption from the excessive deficit procedure unless they are
in severe recession characterized by a fall in real GDP of at least 0,75%.
The Amsterdam European Council also agreed two Regulations that form part of the Stability and Growth
Pact for ensuring budgetary discipline in the third stage of EMU. These Regulations set out a framework for
effective multilateral surveillance and give precision to the excessive deficit procedure. The first, which is based on
Article 308 (ex Article 235) of the EC Treaty, concerns the continuity of contracts, the replacement of references to
the ECU in legal instruments by references to the euro at a rate of one for one, the conversion rates and rounding
rules2. In addition to this Regulation, the Directive on consumer protection in the indication of prices of products
offered to consumers, mentioned in the section on consumer protection in the chapter on the EU and its citizens, sets
down requirements concerning conversion rates, rounding rules, and the clarity and legibility of price displays. On
top of this Directive, the Commission calls on trade organizations to reach agreement on good practices for dual
displays of the euro along the national currency. It also recommends that banks do not charge for the conversion of
incoming and outgoing payments, accounts and banknotes denominated in euro or national currency 3.
The second Regulation, which was formally adopted by the Council on 3 May 1998, concerns the
introduction of the euro and provides in particular for the conditions in which the currencies of the participating
Member States will be replaced by the euro from 1 January 1999 . It also provides that, as from 1 January 2002, the
European Central Bank and the central banks of the participating Member States will put into circulation banknotes
denominated in euros and that, from that date, the euro notes and coins will be legal tender. As from that date, the
participating Member States will issue coins denominated in euros or in cents.
1. COM (96) 498, 16 October 1996
2.Council Regulation 1103/97, OJ L 162, 19.06.1997
3.Parliament and Council Directive 98/6, OJ L 80, 18.03.1998


Banknotes and coins in the national currency unit will remain legal tender within their territorial limits up to six
months after the end of the transitional period at the latest. A Regulation on denominations and technical
specifications of euro coins intended for circulation provides that the first series of euro currency will consist of eight
coins (1 cent, 2 cent, 5 cent, 10 cent, 20 cent, 50 cent, 1 euro and 2 euro).
Stage three of EMU thus began on 1 January 1999 with the irrevocable fixing of conversion rates between
the currencies of the 11 participating countries and against the euro (Phase B). From that date, the euro is the
currency of the participating Member States, monetary policy and the foreign exchange rate policy are conducted in
euros, the use of the euro is encouraged in foreign exchange markets and new tradable public debt must be issued in
euros by the participating Member States. During a transitional period lasting until 1 January 2002, private economic
agents are free to use the euro, but they are not obliged to do so and are able to continue to use the national currency
It is quite remarkable that the transition to the third stage of economic and monetary union was achieved
smoothly in spite of turbulence on the world financial markets. This is the result of prudent economic policies in the
context of EMU. It is also the result of careful technical and legislative preparation. As seen in the preceding
paragraphs, all Community legislation necessary for the introduction of the euro were adopted before 1 January
1999. The introduction of the euro is a major event for the (international monetary system, whose cornerstone
is the International Monetary Fund (IMF). The EU sought pragmatic solutions for introducing a major international
currency into the system which did not require a change in the Articles of the IMF. Thus, the IMF Executive Board
agreed to grant the ECB an observer position at that board. The views of the EU/EMU are presented at the IMF
Board by the relevant member of the Executive Director's office of the Member State holding the Euro-zone
Presidency, assisted by a representative from the Commission. The President of the ECB attends meetings of the G7
Finance Ministers' and Governors' Group for the discussions which relate to EMU, e.g. multilateral surveillance or
exchange rate issues. At those meetings a Commission representative is a member of the Community delegation in
the capacity of providing assistance to the President of Ecofin/Euro group.
By 1 January 2002 at the latest, euro banknotes and coins will start to circulate alongside national notes
and coins, which will start to be withdrawn (Phase C). At most six months later, the national currencies will have lost
their legal tender status and will have been completely replaced by the euro in all participating Member States.
Thereafter, national banknotes and coins may still be exchanged at the national central banks. The continuity of
contracts initially denominated in a national currency or in ECU will be assured, but new contracts will have to be
denominated in euros. Any reference to a national currency unit in a legal instrument will have to be read as a
reference to the EURO2.
The European institutions are aware of the practical and psychological problems of an upheaval of this
magnitude and without precedent. On 8 November 1999 the Council stated that the cash changeover in the euro zone
is an unprecedented logistical challenge. According to the Council, Member States will make their best efforts to
ensure that the bulk of cash transactions can be made in euros by the end of a fortnight from 1 January 2002.
Member States consider that the period of dual circulation of the old and new notes and coins will last between four
weeks and two months. Member States may facilitate the exchange of old notes and coins after this period.
The Member States, which have moved to the third stage of EMU, have undoubtedly lost the autonomy of
their monetary policy, since they are no longer at liberty to use the two main levers of this policy, the exchange rate
and the interest rate (a freedom which they had already lost to a large extent, due to the interdependence of the
European economies). At the same time, however, they lost responsibility for the parity of their currency and the
equilibrium of their balance of payments, while enjoying shared responsibility for the parity of the euro against the
currencies of third countries and the equilibrium of the collective balance of payments of the countries entering the
third stage of EMU. The countries moving on to this stage have in fact already got their economies under control as
regards inflation, external debt and public sector deficit and can thus collectively share the advantages of belonging
to a strong currency zone, the euro zone.


COM (96) 499 and Council Regulation 974/98, OJ L 139, 11.05.1998

Council Regulation 974/98, OJ L139, 11.05.1998


5.3 Economic policy and Convergence of national economic policies under EMS and beyond
The Member States signatory to the Treaty of Rome were not prepared to abandon their sovereign powers
in economic or monetary matters in favour of the Community. Accordingly, the Treaty was confined to defining the
objectives to be pursued in national economic policies, including full employment, a stable level of prices and
currency and equilibrium of the balance of payments. Elaboration and implementation of economic policy as such,
however, remained exclusively within the jurisdiction of the Member States.
However, the Treaty of Rome had considered it desirable that the Member States regard their conjunctural
policies as a matter of common concern. Article 103 stipulated that they should consult each other and the
Commission on the measures to be taken in the light of the prevailing circumstances. Pursuant to that provision of
the Treaty, the Council set up an Economic Policy Committee for Short-term Economic and Financial Policies 1.
That Committee, which consists of one representative for each Member State and a Commission representative, has
the task of preparing the meetings of the Economic and Financial Affairs (ECOFIN) Council. It is also responsible
for the exchange, on a reciprocal and continuing basis, of information on decisions or measures envisaged by the
Member States which could have a considerable effect on the economies of the other Member States or on the
internal or external equilibrium of the Member State concerned or which could give rise to a considerable gap
between the development of the economy of a country and the jointly defined medium-term objectives.
The Community's economic policy did not really get off the ground until the Member States decided to
undertake the attainment of economic and monetary union. More than other Community policies, the economic
policy is indispensable to attainment of such union, as it constitutes one of its two aspects. The task assigned to it by
the Resolution of the Council and of the Representatives of the Governments of the Member States of 22 March
1971 on the attainment by stages of economic and monetary union was the convergence of the economies of the
Member States, which was an extremely difficult task considering the structural disparities between the economies
which were to participate in that major undertaking. In fact, the first attempt to create an economic and monetary
union failed. However, the experience acquired during this effort is precious for the second attempt based on the
Treaty on European Union.
This fresh endeavour, like the first, twenty years before, has started in an environment of economic and
monetary crisis.
The persistence of the crisis between 1991 and 1993 exacerbated an already difficult labour-market
situation.The need to face up to the crisis and to the deterioration in employment and working conditions led the
Commission to draw up a White Paper on the medium-term strategy for promotion of growth, competitiveness and
employment , which contained a clear presentation of the structural problems facing the Community and proposed
concrete solutions for addressing the issues raised . According to the Commission, the sustainable development of
the European economies and the increase of labour intensity require a strategy based on three inseparable
elements: (a) the creation and the maintenance of a macroeconomic framework which, instead of constraining
market forces, as has often happened in the past, supports them; (b) determined actions in the structural area aimed at
increasing the competitiveness of European industry, at removing the rigidities which are curbing its dynamism and
preventing it from reaping the full benefits of the internal market; (c) active policies and structural changes in the
labour market and in the regulations limiting the expansion of certain sectors (notably the service sector) making it
easier to employ people and increasing the employment component of growth.
Largely following the ideas of the Commission, the European Council, in December 1993, decided to
implement an action plan disposing of around ECU 20 billion per year which should, in particular, stimulate the
setting up of big equipment and communication networks, in order to improve the competitiveness of the economy
and the functioning of the internal market. Both, the White Paper and the action plan of the European Council were
vital elements in the EU's strategy for steering the economies of the Member States back onto a path of growth and
employment creation, as well as for allowing them to attain the objectives of economic and monetary union.
Economic convergence in the European Union
In contrast to monetary policy. Member States retain ultimate responsibility for economic policy within the
economic and monetary union provided for by the Treaty on European Union. They are, however, required to act in
such a way as to respect the principle of an open market economy where competition reigns, to regard their
economic policies as a matter of common concern and to conduct them with a view to contributing to the
achievement of the objectives of the Community (Art. 98 and 99 TEC). Herein lies the originality of the model for
European Economic and Monetary Union; a union of independent States with significantly different development
levels but which want to be partners in the pursuit of common goals.


Budgetary policy is perhaps the area in which differences between Member States are still at their strongest.
This stems from the fact that the budget is the most characteristic manifestation of national sovereignty in economic
terms. The budget is in fact the main instrument of orientation of the economy in general and of individual
government policies, such as regional, social, industrial policies, etc. Through its expenditure side the budget has a
direct influence on public investment and an indirect influence, through aids of all sorts, on private investment.
Through its revenue side the budget acts on savings and on the circulation of currency. A State's budgetary policy
may pursue short-term economic objectives (avoidance of a recession or stemming of inflation) or structural
improvement objectives pertaining to the national economy and implemented through productive investments.
Clearly, although it is difficult, coordination of budgetary policies is extremely important for economic convergence
sought by the Treaty on European Union and for participation of a Member State in the third stage of EMU.
Since the second stage of EMU, i.e. since the 1st January 1994, economic policies of the Member States are
coordinated at Community level. A Council Decision of 1990 is directed towards the attainment of progressive
convergence of economic performance of the Member States 1. To this effect the Council (ECOFIN), acting by a
qualified majority on a recommendation from the Commission, formulates, each year in the spring, a draft for the
broad guidelines of the economic policies of the Member States and of the Community, and reports its findings to
the European Council. This discusses a conclusion on the broad guidelines of the economic policies of the Member
States and of the Community. On this basis, the Commission recommends and the Council, acting on a qualified
majority endorses the broad guidelines of economic policy, which lay down the common objectives in terms of
inflation, public finance, exchange rate stability and employment (Art. 99 TEC) 2.
The Council, on the basis of reports submitted by the Commission, monitors economic developments in each
of the Member States and in the Community as well as the consistency of economic policies with the broad
guidelines (Art 121 TEC)3. This multilateral monitoring is based on convergence programmes presented by each
Member State which specifically aim at addressing the main sources of difficulty in terms on convergence (Art. 99/3
TEC). It also involves a review of budgetary policies, with particular reference to the size and financing of deficits, if
possible prior to the drafting of national budgets. The regular monitoring of economic and monetary policies of the
Member States by the European Monetary Institute, mentioned in the previous part of this chapter, is an integral part
of the general monitoring procedures.
Where it is established that the economic policies of a Member State are not consistent with these guidelines,
the Council may, acting by a qualified majority, make the necessary recommendations to the Member State
concerned. It may decide to make its recommendations public (Art. 99/4 TEC). The Council may, acting
unanimously on a proposal from the Commission, decide upon the measures appropriate to the economic situation, in
particular if severe difficulties arise in the supply of certain products. Where a Member State is in difficulties or is
seriously threatened with severe difficulties caused by exceptional occurrences beyond its control, the Council may,
acting unanimously on a proposal from the Commission, grant, under certain conditions. Community financial
assistance to the Member State concerned (Art. 100 TEC).
As the secondary legislation necessary for implementing the second stage of EMU was adopted in full in
1993, certain restrictions on financing public deficits came into force on 1 January 1994, including the bans on direct
financing of deficits by central banks (Art. 101 TEC) and on any form of privileged access by the public to financial
institutions (Art. 102 TEC)4. The Council recommendations designed to bring to an end the excessive deficits are
adopted by qualified majority in accordance with Article 104(6) of the EC Treaty.
The move to the third stage of economic and monetary union has linked the economies of the Member States
adopting the euro more closely together. They share a single monetary policy and a single exchange rate. Economic
policies and wage determination, however, remain a national responsibility, subject to the provisions of Article 104
(TEC) and the Stability and Growth Pact. Since national economic developments have an impact on inflation
prospects in the euro zone, they influence monetary conditions in that zone. It is for this reason that the introduction
of the single currency requires closer Community surveillance and coordination of economic policies among euro
zone Member States. Close coordination should, in addition, contribute to the achievement of the Community
objectives set out in Article 2 of the EC Treaty. In order to ensure further convergence and the smooth functioning of
the single market, non-participating Member States must be included in the coordination of economic policies.
1. Council Decision 90/141, OJ L78, 24.03.1990
2. Council Regulation on the broad economic policy guidelines for 1999 in OJ L 217, 17.08.1999
3. COM (97) 169, 23 April 1997
4. Council Regulation 3604/93, OJ L 332, 31.12.1999

This is particularly true for those Member States which participate in the new exchange rate mechanism.
The Luxembourg European Council of 12 and 13 December 1997 adopted a Resolution on economic policy
coordination in stage three of EMU in which it defined the arrangements for enhanced economic policy


coordination, both between Member States participating in the euro and between those Member States and the ones
not yet able to participate. It pointed out in particular that the ECOFIN Council was the central decision-making
body for such coordination, adding that the ministers of the Member States participating in the euro area would be
able to meet informally to discuss issues connected with their shared specific responsibilities for the single currency.
This "Euro Group" takes account of the special needs of coordination for Member States participating in the euro
From the third stage of EMU, which began on 1 January 1999, the budgetary policies of the Member States
are constrained by three rules: overdraft facilities or any other type of credit facility from the ECB or national central
banks to public authorities (Community, national or regional) are prohibited (Art. 101 TEC); any privileged access of
public authorities to the financial institutions are banned (Art. 102 TEC) 1; neither the Community nor any Member
State is liable for the commitments of public authorities, bodies or undertakings of a Member State (Art. 103 TEC).
Implementing the new arrangements for economic policy coordination, the Council looks closely into actual and
prospective developments in Member States' budgetary policies.
The Commission should monitor the development of the budgetary situation and the level of government debt
in the Member States with a view to identifying gross errors. In particular it should examine compliance with
budgetary discipline on the basis of the following two criteria: a) whether the ratio of the planned or actual
government deficit to Gross Domestic Product exceeds a reference value (3% of GDP), unless either the ratio has
declined substantially and continuously and reached a level that comes close to the reference value or, alternatively,
the excess over the reference value is exceptional and temporary and the ratio remains close to the reference value; b)
whether the ratio of government debt to gross domestic product exceeds a reference value (60% of GDP), unless the
ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace (Art. 104 TEC and
Protocol on the excessive deficit procedure).
If a Member State does not fulfill the requirements under one or both of these criteria, the Commission shall
prepare a report, taking into account all relevant factors, including the medium term economic and budgetary
position of the Member State. The Council shall, acting by a qualified majority on a recommendation from the
Commission, and having considered any observations which the Member State concerned may wish to make, decide
after an overall assessment whether an excessive deficit exists. Where the existence of an excessive deficit is
decided, the Council shall make recommendations to the Member State concerned with a view to bringing that
situation to an end within a given period. If there is no effective action in response to its recommendations within the
period laid down, the Council may make its recommendations public.
If a Member State persists in failing to put into practice the recommendations of the Council, the Council
may decide to give it notice to take, within a specified time limit, measures for the deficit reduction which is judged
necessary in order to remedy the situation. If the Member State fails to comply with the decision of the Council, the
latter may decide to apply or intensify one or more of the following measures: to require that the Member State
concerned publish additional information, to be specified by the Council, before issuing bonds and securities; to
invite the European Investment Bank to reconsider its lending policy towards the Member State concerned; to
require that the Member State concerned make a non-interest-bearing deposit of an appropriate size with the
Community until the excessive deficit has, in the view of the Council, been corrected; to impose fines of an
appropriate size (Art. 104 TEC).
The Stability and Growth Pact, mentioned under the heading of the monetary system of the EU, asserts that
it does not change the requirements for participation in stage three of EMU, either in the first group or at a later date,
and that Member States remain responsible for their national budgetary policies. It provides, however, both for
prevention and deterrence through two Regulations. The Regulation on the strengthening of the surveillance of
budgetary positions and the surveillance and coordination of economic policies requires Member States to submit
stability programmes (or convergence programmes in the case of the countries not participating in the single
currency) presenting the medium-term objective for a government budgetary position that is close to balance or
surplus1. It also provides for the establishment of an early warning system to monitor budgetary developments with a
view to detecting any significant divergences from the planned adjustment path. The purpose of the second
Regulation is to speed up and clarify the implementation of the excessive deficit procedure 2. It specifies more fully
how the relevant provisions of Article 104 of the EC Treaty will be applied in the third stage, in particular as regards
the sanctions to be imposed on Member States which fail to take appropriate measures to correct an excessive deficit,
and it lays down the deadlines which must be observed for the different stages of the procedure.
The Resolution of the Amsterdam European Council of 16 June 1997 on Growth and Employment aims to
strengthen the links between a successful and sustainable EMU, a well-functioning internal market and employment.
It asserts that social protection systems should be modernized so as to contribute to competitiveness, employment
and growth, establishing a durable basis for social cohesion. To this end, the close coordination of the Member


States' economic policies referred to in Arti-cles4, 98 and 99 (TEC) should be focused in particular on policies for
employment. In addition to various other measures, mentioned under the heading of "employment policy" in the
chapter on Social Progress, the Growth and Employment Resolution calls upon the European Investment Bank to:
examine the establishment of a facility for the financing of high-technology projects of small and medium-sized
enterprises in cooperation with the European Investment Fund; examine its scope of intervention in the areas of
education, health and environmental protection; step up its interventions in the area of large infrastructure networks
by granting very long-term loans 3.
On the basis of the Treaty and specially agreed instruments, economic policy coordination concentrates on
those national policies which have the potential to influence monetary and financial conditions throughout the euro
area, the exchange rate of the euro, the smooth functioning of the single market, as well as investment, employment
and growth conditions in the Community. Thus, economic policy coordination includes:
-the close monitoring of macroeconomic developments in Member States to ensure sustained convergence;
-the close monitoring of exchange rate developments of the euro and other EU currencies, seen as the
outcome of all other economic policies;
- the strengthened surveillance of budgetary positions and policies in accordance with the Treaty and the
Stability and Growth Pact;
- the monitoring of nominal and real wage developments with reference to the broad economic policy
- the close examination of national employment action plans (NAPs), dealing in particular with active labour
market policy in accordance with the employment policy guidelines;
- the monitoring of Member States' structural policies in labour, product and services markets, as well as of
cost and price trends, particularly insofar as they affect the chances of achieving sustained non-inflationary growth
and job-creation.
5.4 EMU impacts
The move towards EMU requires that national governments give up independent control of a separate
national currency, exchange rate and interest rate. In practice, each participating state takes a stake in the joint
exercise of monitory policy authority (including the fixing of a single interest rate) and adopts a common unit (the
Euro) as its official currency. Therefore, nations will lose much of what remains of their independence, including
important instruments of monetary policy making. Individual states will no longer be able to use competitive
devaluations as a way of enhancing national export performance or lower or raise their own interest rates as and
when local conditions require it. For example, when a national economy goes into a recession or inflationary boom
not shared by other countries in the EMU zone, its response will rest largely with various fiscal policy tools.
Although the single interest rate regime is managed within the European System of Central Banks in which the
member state has representation, this rate cannot and will not be set according to the specific demands or
requirements of any one member. Moreover, under the combined effects of EMU and the Stability and Growth Pact,
the independent Fiscal policy powers of individual EMU members will e much diminished. In particular, the stability
and growth Pact constrains fiscal policy freedoms by setting out fines for deficits in excess of 3 % of GDP. Without
such stability pact loose financial discipline in a single member state could force interest rates up for all other
These massive implications for economic policy management (and for economic sovereignty) are at the
very heart of continuing debate over EMU. However, any assessment of these implications must be considered in the
light of the main benefits associated with the move towards EMU and with the exercise of joint monetary authority.
It can be argued that common European monetary authority, and a single currency, will make a contribution to a
healthier economic environment that inspires greater confidence, growth and wealth creation. A common, sound and
independent monetary policy may also contribute to a stable low-inflation environment and facilitate the emergence
of conditions necessary for sustained non-inflationary growth throughout the EU. Clearly, the independent policy
records of individual member states have been less than impressive and, through EMU, disinflation benefits will be
felt in countries that hitherto have not enjoyed the benefits of price stability. A common interest rate regime
characterized by low rates of interest will, for many participants, also lead to significant reductions in the traditional
costs associated with credit-financing and debt-servicing in the domestic economy. Under the combined effects of
EMU and the Stability Pact, pressures are also exerted for fiscal responsibility on the part of member authorities. In
turn, progress towards sounder public finances should create scope for tax reductions and should stimulate
investment. Reducing government deficits by 1 percentage point in Europe releases an estimated 60 billion a year
for investment and consumption.


Foreign exchange
As a consequence of a common currency, Eurozone firms are able to avoid the risk that exchange rate
changes might reduce or wipe out the value of their future profits. Exchange rate movements do not necessarily
impose a penalty but volatility in exchange markets and/or the unpredictability of rates can play a disruptive and
costly role in multi-currency transactions. Many firms have opted to hedge these exchange risks for long-dated
transactions and/or have included a margin in their prices to cover adverse exchange rate movements. The costs of
hedging alone are estimated to be between 1% and 2% of the sales and purchases of small companies in Europe
(AMUE, 1998). Under a single-currency regime, foreign exchange transaction costs are also eliminated on all
internal (intra-Eurozone) dealings. Putting these 'gains' together, the suggested benefits are predicted at as much as
8% on the total price of industrial goods.
Bigger, more competitive markets
The Euro, by providing a common unit of account for commercial activities, ensures that companies will
face a more integrated European market. Cross-border trade and investment will be stimulated and, as such, the
forces of competition will be strengthened in many product markets. In particular, businesses who currently see
foreign exchange risk and transaction costs as major barriers to cross-border trade are more likely to move into new
markets once these 'barriers' are removed. New business start-ups may also be encouraged.
Transparent price differences
With the Euro it will be possible to directly compare prices for the same goods and services in different
EUR-11 countries and to spot the best prices. Despite the SEM, substantial price disparities persist as a result of
differential pricing policies, differences in tax rates, the costs of transporting products from factories, national market
structures, and perceived product values. For example, anyone shopping for an excavator in the EU can end up
paying 40% more, depending on where the product is sold (see Marsh, 1999). The ability of consumers to compare
prices more easily will tend to move prices towards the lowest market level and it will become harder for businesses
to maintain differential pricing policies by country and currency. 'The pressure will be greatest in border regions and
for high value goods which are easily transportable' (European Commission, 1997, pp. 20-1).
Lower borrowing costs
It is axiomatic that with a single currency and a single central bank that there will be a single interest rate
regime across the Community'. In turn, banks will be able to lend in Euros throughout the Community and
enterprises will be able to borrow from outside their home countries without incurring the risk of exchange rate
exposure. This may provide scope for a reduction in total borrowing costs. Cost savings may be greatest in countries
where Euro interest rates fall below previous rates. The introduction of the Euro should also favour the development
of new financing methods. Overall, firms should have more choice and flexibility in raising finance and, in many
cases, will face lower costs.
Wage transparency
It will now be easier for employees to calculate whether like workers in other countries are offered higher wages and
to compare wages with payments made to other employees in different countries but within the same company. This
is referred to as 'wage transparency', cutting out the need to convert currencies when comparing wages across
markets. Transparency of wage and salary differentials will probably bring salary convergence closer to reality and
should, in theory, result in increased labour mobility. However, just as intra-national variations in salary and
remuneration exist today, international variations are likely to persist. Although people will ask 'Why are they paid
that much over there when I'm paid this much here?', firms can usually demonstrate differences in taxation, benefits,
purchasing power etc. by country and currency. Fundamentally, organizations will need to consider how to set fair
and competitive remuneration packages in a Euro-denominated environment. Salary denomination issues will also
surface during the transition perod.
Treasury and finance


While the complexity of treasury and financial activities may be heightened during the period of transition, for many
European businesses the Euro will present opportunities for long-term savings. The Euro will alter balance sheets,
cash flow management, currency management and corporate finance. Among other things, businesses with units
operating in different corporate currencies (that is, those different national currencies used for book-keeping and
reporting) will eventually be able to record and to compare all accounting values, margins, costs, expenditures etc. in
one currency. Such transparency may greatly assist in processes of internal planning, accounting and benchmarking.
For many firms, the changeover to the Euro will provide significant opportunities in terms of procurement.
With the Euro it will be easier and cheaper to find and to work with new suppliers outside of the home market. This
raises the prospect of real business savings for those prepared to source on a pan-European basis.
Information technology systems
To be Euro compliant, several systems may need to be adjusted or upgraded. This includes electronic
payment systems, budgeting and costing systems, databases and other commercial software packages containing
references to financial information. While some systems will have multi-currency capabilities (facilitating the use of
two denominations during the transitional period), Euro functionality is unlikely without major changes. Systems and
software packages must also conform to EU rules on rounding, conversion and triangulation. IBM Europe has
reported changes to over 700 different software applications in its drive towards full Euro compliance (Vowie, 1999,
p. 50). This represents over half ($150 billion) of its total Euro conversion budget with over 80% of IT applications
affected. The BBC's Euro case study of electronics giant Siemens quotes the company's IT-IS conversion bill at
DM100 million ($60 million). With respect to SMEs in a country like Spain, Pardo has estimated that the costs
associated with the information systems challenge for firms may be between 0.25% and 1.25% of company turnover.
Extending our analysis here, we may separate the unit-level impact of the Euro into two broad categories.
The first such category refers to those effects which will impact on business and marketing environments and will
therefore raise a series of strategic questions. This directs attention to overarching management strategies and to key
business functions such as marketing and procurement. The second class is of those effects at organizational level
which raise more practical concerns and which impact upon internal business processes and/or technical systems.
Alternatively, this directs attention to the Euro's effects on business accounting procedures, contract and payroll
arrangements, IT and information systems etc. (see Connor, 1998; FEE, 1998; AMLJE, 1998). However, while it is
analytically convenient to think in terms of strategic versus practical issues, the effects of the Euro on major business
functions will be both strategic and operational in nature. In terms of business and functional strategies, a company
must prepare with internal and external focus in order to capitalize on new opportunities and to ensure support of
essential business processes. This point is clearly demonstrated in the subsequent focus on the marketing function
and on the implications of the Euro for commercial and marketing departments. This concentration should be
considered in light of the earlier statements made about the contribution of EMU to the stimulation of trade and
competition in many market sectors.
The UK perspective
It would appear from the preceding analysis that businesses outside of the Eurozone may face a series of
competitive disadvantages arising from relative exchange rate risk and higher costs of borrowing. Such concerns
have fuelled the debate in Britain about the merits and timing of UK participation, although this debate configures
around commercial, constitutional and political arguments. Address of the UK position allows for a clarification of
policy options in the United Kingdom and for a presentation of some of the main criticisms of EMU.
The present position of the UK government is that the conditions need to be right before the UK joins the
single currency but that the principle of future membership is established. This follows the UK's opt-out of first-wave
entry. Although Labour insiders and senior Cabinet figures have talked up EMU membership, a majority of the UK
cabinet have, to date, been persuaded that EMU represents a 'difficult sell' to a skeptical UK public. No single
public opinion poll has shown majority support for EMU entry (or anything like it) and the public may even be
growing more doubtful as to the merits of the Euro. A poll by Salomon Smith Barney Citibank and Mori in late 1999
showed that 58% of the British public remained opposed to EMU membership and that only 27% proclaimed support
for Euro adoption (Euro Quarterly Review, Financial Times, 10 September 1999). While the Government has been
encouraged to 'push' the Euro by many of the UK's leading firms, even the business community has evidenced
divisions on the currency issue.
The Blair administration has now set up the prerequisite of measured economic convergence through an
assessment of five economic tests. According to government officials, this represents clear support for EMU (and the


principle of UK entry) but reflects a reality of under preparation, divergent business cycles and untested EMU
The five economic tests which have to be met before Britain enters are as follows:
1. business cycles and economic structures in the UK and Euroland would have to be demonstrably compatible;
2. EMU would have to be likely to promote growth and jobs in the UK;
3. there must be evidence of sufficient flexibility in the operation of the stability pact and in Euro-markets to respond
to economic shocks;
4. EMU will have to create better conditions for companies to invest in the UK;
5. EMU will have to have a neutral or positive effect on the competitive position of the UK's financial services
industry, particularly the City's wholesale markets,
These five tests extend the limited usefulness of the Maastricht convergence criteria and highlight a number
of issues for interpretive analysis. The real task here rests with the demonstration of cyclical convergence and, within
this, of the capacity of the UK economy to live with Euro interest rates on a permanent basis. For a sustained period,
UK interest rates have been higher than long-term continental rates and the initial Euro rate of 3.0% (January 1999)
was less than half of that applying in the UK economy at the point of the Euro's launch.
The Blair Government has also made a pledge to hold a referendum on any decision to take Britain into a
single currency. Although the timing of any such referendum remains unclear, it is now unlikely to be held until after
the next general election which will take place at some point prior to May 2002. Whatever the outcome of that ballot
(should it occur), the context of any future referendum on the Euro will be one of deep political division. The official
opposition (the UK Conservative Party) has hardened its policy of keeping Britain out of the single currency, in sharp
contrast to that of the third force in British politics, the Liberal Democratic Party. The Liberal Democrats remain the
most enthusiastic of the British parties for the single currency but have evidenced little unity with the Labour
government on the currency question, accusing it of weak leadership. These tensions were exacerbated in early 2000,
when Britain's self-exclusion from the Euro (and the high rate of sterling) were cited by senior BMW executives as
foremost among their reasons for selling off the Rover car company, its ailing British subsidiary. Indeed, the fact that
the pound has been pushed to ever higher levels against the Euro has brought new problems for the UK government.
Not only has sterling's dramatic appreciation against the Euro made life difficult for British manufacturers and
exporters, fears have been raised that a future fixed conversion rate for sterling against the Euro would be
prohibitively high. Depreciation of the Euro against sterling - its value declined by 10% in 1999 from a starting rate
of 70.4 pence - also does damage to the assumption that the Euro will be a strong and stable currency. While the Euro
may well recover lost ground - in early 2000, it traded at a low-spot of just 60 pence - a falling currency is typically
perceived as a weak one.
Of course the focus of Britain's debate has shifted from the academic question of whether a future Euro
might replace the pound (like other EU currencies) to the question of whether the established Euro should replace the
pound. On this question, British business people, like the public as a whole, are deeply divided. So what are the
arguments articulated by the 'pros' and 'antis' and of the commentators and economists on whom they can draw?
The case for joining
The case for joining rests with the economic advantages of EMU and with the competitive and political
disadvantages that Britain may face as a consequence of 'staying out'. According to its advocates, the Eurozone, or
'Euroland' as it is sometimes called, will be a zone of economic stability, within which effective business planning
can take place and growth be enhanced. Internal price stability, a lower external (Euro) risk premium and lower real
interest rates as well as sustained economic growth are all conducive to business efficiency and to efficient business
planning. Fixed exchange rates also promise to put an end to the days of currency instability in Europe, eliminating
exchange rate risk on cross-border transactions in the EMU core. Were Britain to shun the Euro then it would miss
out on these advantages with the gain in competitiveness of the EMU group eroding our own ability to compete. For
example, as Eurozone rivals benefit from lower interest rates, taking on larger loans and investing in future
technology, borrowing costs for British firms will likely remain higher and their customers will be penalized by
higher relative mortgage repayments. Of course, there is no certainty that Euro rates will be lower in the long term
but, for the last twenty years, UK rates have averaged 3.5% more than those in Germany. This has put British firms
which borrow in sterling at an immediate competitive disadvantage (see Simon, 1997, pp. 7-8). With doubts over
Britain's long-term commitment to anti-inflationary disciplines outside of EMU and with the ECB's statutory
commitment to low inflation and price stability, Britain could for some time suffer an interest rate premium over
Eurozone rates.


Most of these points (greater stability for business planning, lower borrowing costs for businesses and
reduced exchange rate risk exposure) have received prior treatment in this chapter and can be grouped with the
following 'positive' aspects of Euro changeover raised in unit-level examination:
reduced transaction costs
better information on input costs and competitor prices (transparency)
deeper financial markets and new capital options
simplified book-keeping and treasury management
speedier (cross-border) transactions
scope for pan-Euro marketing, labelling and packaging
Elsewhere, a persuasive case for UK membership of EMU can be built on a number of broader arguments.
For example, if Britain stayed outside the Eurozone, seeking to profit from competitive devaluation, its partners
might retaliate with protection. If it stayed outside of the Eurozone burdened by an overvalued currency, its export
performance would probably suffer. The second of these concerns seems the more relevant at the time of writing
with a number of companies (including major foreign investors) warning that their position is being eroded by the
pound's strength. Already, 'a number of large multinationals have pulled out of the (North-East) region including
Siemens and Gilette; [and] Toyota has also threatened to pull out of the UK if the UK does not adopt the single
currency' (Floyd, 1999, p. 3). Note of the BMW case - with its sell-off and break-up of the Rover car group - has
already been made, although it is contestable that the exchange rate was a primary factor in the company's decision
to axe Rover.
Another economic concern is that, outside of the Eurozone, the position of the City of London as Europe's
premier financial capital might be undermined. Although this claim appears to be have been exaggerated (London
has a booming Eurobond market and is performing well outside of the Eurozone), it is to be emphasized that
international financial services in Britain employ around 150,000 people, generating approximately 15 billion in
annual invisible exports. Any threat to this industry arising from self-exclusion would have to be taken seriously.
Some commentators have also warned that, if Britain shuns the Euro, it will become marginalized from
economic policy decisions that will inevitably affect it.


5.5 EMU and EU tax harmonization

As is clear from the terms of 'the British Debate' one important question is the extent to which monetary
union will lead to tax harmonization in the EU. As considered, any collectivization of fiscal policy, which is the
balance of government revenue through taxation and government expenditure, implies a further strengthening of
political union and the possibility of higher (standardized) tax rates. At present, the EU has little control over tax
policies with national governments retaining broad control (subject to some harmonization) of sales taxes, excise
duties, income and corporation taxes. Such freedoms contribute to varying average tax levels - from 36% of GDP in
the UK to around 60% in Denmark and Sweden -and to a patchwork of tax measures and treatments.
With respect to taxation, it is possible to establish a solid argument that differentials in taxes (especially
those applying to sales and profits) provide the basis for internal 'tax competition'. Tax competition means competing
for a larger share of productivity, markets and investment by cutting tax rates. In a context of derestricted capital
movements, inward investment may be lured by lower taxes on corporate profits and, in the absence of agreed
minima, there may be a spiral down to ever-lower levels. Consequently, given that cross-border flows of capital are
more sensitive to differences in tax in the absence of exchange rate risks, EMU may be predicted to accentuate tax
competition in the Single Market. Already since 1996, the average corporate tax rate in the EU has been reduced by
about 3% to 36% (KPMG International, 1999). An apparent stimulus to EU initiatives on tax harmonization is
therefore unsurprising although it is probably erroneous to claim that the averaging out or banding of rates is an
inevitable consequence of a single currency. As Hawksworth and Cussons (1999, p. 9) contend this is not the case
either in theory or in practice:
From a theoretical perspective, complete tax harmonization across a group of countries would be inevitable
only if companies were completely mobile and there were no other differentiating factors between these
countries. In fact, it is costly to relocate existing companies and tax is only one of many factors influencing
investment location decisions. This view is confirmed by practical experience in countries with federal
structures such as the U.S., Canada, Switzerland and even Germany; this shows that there is still
considerable scope for state and local governments to vary corporate tax rates within a single currency zone.
Although evidence is unclear at time of writing, EU initiatives on tax harmonization do appear fairly active.
Currently being debated by EU finance ministers are measures to eliminate distortions in the taxation of capital
income, measures to eliminate withholding taxes on cross-border interest and royalty payments, and measures to
regulate the use of preferential tax regimes. It is worth stating here that the EU already operates a system of
harmonized VAT rates (see Chaper 3) and has three significant directives with important tax implications: the Mutual
Assistance Directive, the Parent/Subsidiary Directive and the Merger Directive (see Hawksworth and Cussons, 1999,
p. 10).
A number of other recent developments are also noteworthy. First, it is clear that the Commission remains
committed to setting up a definitive VAT system with standardized rates. The status of its VAT Committee was
upgraded in early 1998. Second, the EU states signed a code of conduct pledging action on harmful tax competition
in the ECOFIN Council in December 1997. This has led to the formation of a Code of Conduct Working Group on
harmful tax competition along with a number of EU subcommittees focused on various tax issues. The Code of
Conduct on Business Taxation requests member states to adopt certain principles and empowers them to 'discuss the
tax measures of other member states and to evaluate whether they are harmful'. Member states can then be asked to
amend taxes with a view to eliminating any harmful measures. The number of measures now being raised in the
Code of Conduct Working Group appears to be growing rapidly.
Third, the Commission appears to be using indirect methods of enforcing harmo-nization, such as the
application of articles of the Treaty on state aids, to bring about corporate tax convergence. This has already
happened with Ireland's special 10% tax (applying to manufacturers locating in designated enterprise zones) judged
in contravention of EU rules on state aids. Ireland has been forced to abandon this 10% rate (Ireland's top corporate
tax rate is 36%) and to apply, by 2003, a 12.5% corporation tax rate on almost all trading activity. A limited number
of projects specified on a list agreed with the Commission will be entitled to the 10% tax rate until the end of 2005 or
It is also clear that support of tax harmonization has been growing in certain member states. For example,
the Austrians and Germans stamped their six-month presidencies of the European Union (1998-99) with calls for
future EU tax harmonization. Although controversial German Finance Minister Oskar Lafontaine was ousted from
his post in early 1999, others in German and EU politics have taken up the cause of wider tax harmonization and
have championed the case of qualified majority voting on tax issues in the European Council.


The scope for fiscal harmonization in the EU is, however, limited by a number of factors.
First, businesses tend to like diversity, 'in that they can then pick the regimes that suit them' (see Cussons,
1999). Consequently, it is improbable that concerted pressure for harmonization of tax rates will extend from the
business community despite the fact that businesses may benefit from the elimination of discriminatory tax
Second, the EU involves the harmonization of developed countries with diverse and complicated tax and
fiscal systems. This complexity is growing and wide disparities exist in the effective rates of taxation in the member
states. These apply to both direct taxes such as corporation rates and to indirect taxes such as sales duties. For
example, although standard VAT rates only range from 15% in Luxembourg to 25% in Sweden (see Table 4.1), sales
tax rates for all goods actually vary from 1% to 38% when account is made of reduced and super-reduced rates
applying to specific items. Corporate tax rates also show a significant range with the UK having a much lower
headline rate than the likes of Germany and France (see Table 5.1).
Third, tax harmonization impacts on the very foundations of a government's control and management of its
economy. The harmonization procedure upsets the status quo and is likely to face serious political obstacles. This can
be demonstrated in the past rejection of Commission plans for VAT standardization and, more recently, in the
tortured progress of the so-called 'Savings Directive'. This proposes a minimum 20% withholding tax on gains made
by individuals in another EU member state and is being flatly opposed by the UK government.
Finally, and of huge significance here, tax harmonization measures continue to require the unanimous
approval of all member states. As Cussons (1999) puts it, 'Under the Treaty of Rome and the Maastricht Treaty (and
now Amsterdam), tax is one of the few remaining areas where one of the 15 member states can actually stop the
whole show by just saying "no, I won't agree to that measure"'. If, as some have argued, tax issues were able to be
decided under QMV then the prospect of far-reaching tax harmonization would be much greater.
Table 5.1 Tax rates in Euopean Union member states
United Kingdom

Standard sales tax rate (1 May 2000)


Corporate income tax rate (1 January 1999)

52.31 (retained profits) 43.60 (distributed profits)
35.00 (listed) 40.00 (limited liability)

Note: Corporation taxes are calculated taking account of standard corporate income taxes and effective municipal taxes. A simple comparison of
tax rates is of limited value given variations in the coverage of corporate taxation and in the nature of deductions and rate depreciations. The
relative tax burdens imposed by different governments range from 1.4% of GDP in Germany to 4.0% in Italy. EU states apply reduced and superreduced VAT rates on certain items. Source: European Commission; KPMG
Bibliography on EMU and suggested readings


Desmond Dinan, Ever Closer Union, 1997, p.418-429

Martin Ricketts, Economic and Monetary Union in Europe, Press Durope,
Mc Namara Katheleen R. and Meunier Sophie, Between National Sovereignity and International Power: What external Voice for the
EURO? Paper prepared for presentation at the European Community Studies Associations 7 th Biennial International Conference, May
31-June 2, 2001, Madison
Portes Richard, The role of the Euro in the world: past developments and future perspectives, Frankfurt, 2000
Simon Mercado, European Business, Financial Times, 2001, p. 122-124, 134-147
Nicholas Moussis Acess to European Union, 2001, p. 129-141
Orlowski, Lucian, Exchange rate policies in Central Europe and Monetary Union< Comparative Economic Studies, 1998.3 p. 58-78
Kopits, George, Implications of EMU for exchange rate policy in Central and Eastern Europe, Washington, IMF, 1999, p.41.
Boone, Laurence, Economic convergence of the CEECs with the EU, London, CEPR, 1998, p. 27
Bernard, Luc, What impact Will the Euro have on the Candidate Countries of Central and Eastern Europe?, Bruxelles, 1999, p. 87-126.
Issing Otmar, The European Monetary Union in a globalized world, Second Vienna Globalization Symposium, Institut fur Donauraum
und Mitteleuropa, 11 May 2001
Feldstein Martin, EMU and International Conflict, Foreign Affairs, Vol 76, N6, November/December, 1997, pp.60-73


6.Common policies of the European Union

6.1 Horizontal policies (Regional Development Policy, Social Policy, Taxation Policy, Competition Policy,
Environment Policy)
6.2 Sectoral Policy (Industrial and Enterprise Policy, Energy Policy, Common Transport Policy, Common
Agricultural Policy, Common Fisheries Policy)
6.1 Horizontal policies
Regional Development Policy
Every Member State, along with the European Union itself, presently has a regional policy aimed at
enhancing the development of less-favoured regions by means of transferring resources from prosperous regions.
The regional policy of the EU does not seek to supersede national regional policies, the Member States,
through their own regional policies, are the first ones who must solve the problems in their regions by promoting
infrastructure (includes means of transport, communication and telecommunication, housing, and any facilities
allowing for the creation or extension of towns) and financially supporting job-creation investments. However,
Community regional policy must coordinate national regional policies by formulating guidelines and establishing
certain principles in order to avoid competition for regional aid between Member States. It must also coordinate the
various policies and financial instruments of the EU to give them a regional dimension and thus more impact on
regions most in need of care.
The main objective of European regional policy is the reduction of existing disparities and the prevention of
further regional imbalances by transferring Community resources to problem regions using financial instruments
such as the European Regional Development Fund (ERDF). European regional policy has grown in importance since
the Treaty made it an essential instrument of economic and social cohesion, itself necessary for the progress of
economic and monetary union, implying the convergence of the Member States economies.
The Committee of Regions set up by the Treaty on European Union and consecrating the role of regional
authorities in the institutional system of the Union, should play an important role in the forecasting of regional
tendencies and in the management of structural interventions of the EU.
Of course, each Member State carries out its own regional policy, which generally aims at favoring the
development of the national territory's less prosperous regions by means of transferring resources from wealthier
regions. The means normally used by Member States to remedy regional problems are of two types: firstly,
improving the infrastructure and the social and cultural development of backward regions, and secondly, various
premiums, subsidies and tax incentives for attracting private investment in these regions. The general objective of
these measures is to create or re-establish a better distribution of economic activities and population over the national
territory. To do this, certain governments also try to discourage investments in highly developed regions. The
advantages of such measures are twofold: favoring the transfer of resources towards poor regions while halting the
disproportionate expansion of congested regions.
All the Member States of the European Union are experiencing variations in the levels of development and
living standards from one region to another and the gaps are wider still when measured across the Union as a whole.
At the beginning of the 1990s, some 52% of the total population of the Union lived in problem regions. The per
capita gross domestic product (GDP) in the ten poorest regions of the Union was only about one quarter of that in the
ten richest regions. Unemployment in the ten regions worst hit was up to seven times greater than in the ten most
fortunate regions. From one country to another the ratio of young people receiving vocational training was about 1 to
2, the ratio for basic infrastructure about I to 3 and the ratio for grants for research and technology about 1 to 7.
Since the beginning of the 21st century, the Community regional policy recognizes two main types of
"priority" regions and areas: regions whose development is lagging behind and areas facing structural difficulties.
The identification of the priority regions and areas at Community level is based on the common system of
classification of the regions, referred to as the "Nomenclature of Territorial Statistical Units (NUTS)" established by
the Statistical Office of the European Communities in cooperation with the national institutes for statistics. The
feature, which these regions have in common, is their excessive dependence on a limited range of traditional
economic activities that can no longer provide sufficient productivity, employment and income. The consequences
are common to all these regions, namely per capita GDP below the Community average, high and prolonged
unemployment and a continuous outward population flow.
Regions whose development is lagging behind, termed "Objective 1 regions" in Community jargon are
basically regions corresponding to level II of the Nomenclature of Territorial Statistical Units (NUTS level II) whose
per capita gross domestic product (GDP) is less than 75% of the Community average. The outermost regions (the
French overseas departments, the Azores, the Canary Islands and Madeira), which are all below the 75 % threshold,


and the areas with very low population density (less than 8 inhabitants per km2), which are, situated in the north and
east of Finland and the northern half of Sweden. The exact list of regions eligible under Objective 1 was drawn up by
the Commission and is valid for seven years from 1 January 2000 1. These regions are faced with a combination of
handicaps: insufficient or rundown infrastructure - transport, energy or telecommunications; weak or outdated
industrial structures whose production methods often fall short of the mark and whose products are ill-adapted to the
marketplace; agriculture where archaic structures prevail; population exodus combined with urban decay; and high
rates of unemployment particularly among young people and unqualified or poorly qualified workers.
The regions with structural problems whose socio-economic conversion is supported under Objective 2 of
the structural policy include in particular: areas undergoing socio-economic change in the industrial and service
sectors; declining rural areas; urban areas in difficulty; and depressed areas dependent on fisheries. According to the
Regulation laying down general provisions on the Structural Funds, these regions constitute about 10% of the
population of the Community in the case of the industrial areas, 5% in the case of the rural areas, 2% in the case of
the urban areas and 1% in the case of the fisheries areas. The total population of the Objective 2 regions must not
exceed 18% of the total population of the Community. Accordingly, the Commission laid down a population ceiling
for each Member State on the basis of certain criteria fixed by the Regulation2.
Economic and social cohesion
The objective of economic and social cohesion, implying the desire to reduce disparities between the various
regions of the Community, was introduced by the Single European Act 3. On this basis, the Commission requested the
doubling of the financial allotment of the structural Funds until 1993 in order to ensure the problem-free completion
of the single market.
The European Council of Brussels, in February 1988, agreed with the Commission by accepting the "Delors I
Package" on the reform of Common Agricultural Policy, Community financing and the reform of the structural
funds. The new Community regional policy thus took off on 1 January 1989 with an endowment of some ECU 64
billion for the 1989-1993 programming period; but its limits could already be seen in 1992. In pursuance of the new
objectives for economic and monetary union set by the Maastricht Treaty and closely following the proposals of the
Commission (Delors II Package), the Edinburgh European Council on 11 and 12 December 1992 agreed to devote a
cumulative amount of over 140 billion ECU (1992 prices) to structural actions in the period 1994-1999.
Of course, the achievement of economic and monetary union promises enhanced prospects for the
developed and the less favoured regions alike. The reduction of trans-frontier transaction costs and the elimination of
exchange rate risk may promote regional specialization and intra-Community trade in goods and services. The
weaker regions can benefit from this specialization by exploiting more fully their comparative advantages.
Furthermore, a general expansion of trade is likely to be beneficial for economic growth, which provides in turn
favorable conditions for lagging regions to catch up. Finally, increased capital mobility encouraged by fixed
exchange rates and the tendency towards quasi-uniform inflation rates may equalize interest rates for any given level
of risk, which should favour the less developed regions where capital is often relatively scarce and capital costs,
therefore, relatively high.
At the same time, however, Member States will lose certain fiscal and monetary policy options as well as
the ability to adjust the exchange rate. Exchange rate flexibility is important in that, in principle, it enables a country,
through devaluation, to offset a loss in international competitiveness in a relatively painless manner. As such, it
facilitates short-term adjustment to general, or country-specific economic shocks. The removal of the possibility of
exchange rate adjustment, therefore, represents a more important loss to the least developed countries of the Union,
which must carry out the most important structural changes. Those countries must invest most, while spending least
so as to conform with the Maastricht criteria.
In addition, those countries could lose the advantage of lower labour costs. As long as markets were
protected, salaries in certain countries were much lower than in others, compensating for the lower productivity of a
labour force that was not very qualified. But in a common market, and even more in an economic and monetary
union, freedom of movement for workers, better information on respective situations, and trade union demands tend
to align revenues towards the levels already attained in the more prosperous regions.
This may be a positive result from a social point of view but it is one, which engenders inflationist tendencies
and creates difficulties for businesses in areas where productivity is low. If these businesses have to shut down, the
workers lose their jobs and their revenue increase is merely an illusion.

Commission Decision 502/99, OJ L194, 27.07.1999

Commission Decision 503, OJ L194, 27.07.1999
OJ L 169, 29.06.1987


From both an economic and social point of view, neither the weakest member countries nor the European
Union can tolerate a substantial part of their patrimony being left to underdevelopment because of economic
integration. The prosperity of certain areas of the union cannot be paid for by the decline or stagnation of other areas.
Wide disparities are intolerable in a community, if the term is to have any meaning at all. Furthermore, disparities
do not just imply a poorer quality of life for the disadvantaged regions. But indicate a failure to take advantage of
economic opportunities that could benefit the Union as a whole.
With growing European integration, the Union increasingly shares responsibility with the Member States for
the maintenance of the European model of society. This model reflects the values of the social market economy,
which seeks to combine a system of economic organization based on market forces, freedom of opportunity and
enterprise with a commitment to the values of solidarity and access for all members of society to social protection
and services of general interest. Therefore, the policies of economic and social cohesion, which are linked with the
objectives of the European model of society, are considered to be a factor in strengthening the productivity of
European society and contributing to economic and social well being.
Taking into consideration these requirements, the Treaty on the European Union states in its Article 2 that the
strengthening of economic and social cohesion is a fundamental objective of the Union. Article 158 (TEC)
specifies that in order to promote its overall harmonious development, the Community shall develop and pursue its
actions leading to the strengthening of its economic and social cohesion, aiming, in particular, at reducing disparities
between the levels of development of the various regions and the backwardness of the least-favoured regions,
including rural areas. Although all Community policies can contribute to reinforcing economic and social cohesion,
as is stated in Article 159 (TEC), a major role is, certainly, played by the Structural Funds (Art. 161 TEC). In the
Community terminology "Structural Funds" or simply "Funds" mean the European Regional Development Fund
(ERDF), the European Social Fund (ESF), the European Agricultural Guidance and Guarantee Fund (EAGGF) Guidance Section, and the Financial Instrument for Fisheries Guidance (FIFG).
The situation in which certain Member States find themselves necessitates special efforts to promote
economic and social cohesion and thus enable them to comply with the convergence criteria required for the passage
to the third stage of Economic and Monetary Union. Indeed, among these criteria is, in particular, the one on curbing
public deficits. In order to satisfy this condition, the less wealthy countries must apply very strict budgetary
disciplines, whereas they need, at the same time, to pursue and even increase public investments in order to close the
prosperity gap with the other Member States.
To elude this contradiction. Article 161 (TEC) and a Protocol annexed to the Treaty of Maastricht have
provided for the creation of the Cohesion Fund. This must contribute financially to projects in the fields of the
environment and transport infrastructure for trans-European networks in Member States whose per capita GNP is
less than 90% of the Community average (Greece, Spain, Portugal and Ireland) and which are implementing a
programme aiming to fulfill the conditions of economic convergence announced in Article 104 of the EC Treaty. The
Regulation establishing the Cohesion Fund was amended in June 1999 along with the new reform of the Structural
Funds1. The basic principles of the Cohesion Fund laid down in 1994 continue to govern the Fund's activities until
In its communication of 15 July 1997, called "Agenda 2000" and dealing with the outlook of the European
Union in the beginning of the 21st century, the Commission set out three priorities for economic and social cohesion:
reducing regional disparities, supporting regions undergoing economic change, and developing human resources
throughout the Union. These priorities had to be reflected in three objectives instead of the present seven, thus
increasing the efficiency and visibility of the Community structural activities. The Commission also advocated
greater geographical concentration, reducing from over 50% to below 40% the population qualifying for structural
aid. This approach, coupled with the decision to maintain overall expenditure on cohesion to 1999 levels, would,
according to the Commission, make it possible to meet the structural needs both of the actual Member States and
those of the six countries which it designated in the same document as ready to join the EU after 2002. The Berlin
European Council on 25 March 1999 reached an overall agreement on Agenda 2000 based broadly on the guidelines
laid down by the Commission. It allocated a total of EUR 213 billion for structural and cohesion policies (EUR 195
billion for the Structural Funds and EUR 18 billion for the Cohesion Fund).
At the same time, the Structural Funds were again reformed and an Instrument for Structural Policies for Preaccession (ISPA) was established to contribute to the preparation for accession to the European Union of ten
applicant countries (Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and
Slovenia) in the area of economic and social cohesion, concerning, environmental measures and transport
To promote the goal of economic and social cohesion. Community regional policy seeks to coordinate
national regional policies by formulating guidelines and establishing certain principles in order to avoid distortion
of competition between Member States through their regional aid schemes. It must also coordinate the various
policies and financial instruments of the EU to give them a "regional dimension" and thus more impact on regions
most in need of care. These two wings of the Community regional policy are examined below.


Regional state-aid schemes and national-level authorities

The concentration of regional aid in the most disadvantaged areas forms a common objective of both the EUs
regional and competition policies. In effect, if an aid or package of measures:
Is a part of a coherent regional development strategy,
Is directed towards a region eligible for Community assistance according to defined EC rules, and
Is notified by the member state under Article 88 of the TEC (ex Article 93)
Then it may be exempt from the Communitys general restrictions on state assistance.
Member state also have a margin of room to direct aid payments to regions not eligible for Community
assistance ( or for EU structural funding) but where a region and state aid scheme falss one of the exemptions
provided in Article 87(3a) or Article 87 (3c). This establishes a complex relationship between regional policy and
competition law and highlights a lack of complete consistency between the EUs policy on regional state-aid
schemes and its regional policy. In this context, member states are themselves granting regional aid through national
and subnational authorities to regions eligible under the Structural Funds and/ or to regions eligible under Article
87(3) specify that the following may be considered to be compatible with the common market: "aid to promote the
economic development of areas where the standard of living is abnormally low or where there is serious
underemployment" and, more generally, "aid to facilitate the development of certain economic activities or of certain
economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common
interest". In monitoring regional aid, the Commission should seek on the basis of economic criteria to determine
which are the least-favored regions of the EU and establish for each of them the level of aid. Intensity so that the aid
be targeted at those areas of the Union which are really experiencing difficulties. The monitoring of State aid thus
makes a considerable contribution to the economic and social cohesion of the Union.
The successive enlargements of the Community have boosted its regional diversity and accentuated the need
for new instruments to control regional aid. This is why article 158 (TEC) gave fresh impetus to the aim of stronger
economic and social cohesiveness and stipulated that the Community should attempt to close the gap between its
regions and help the less-favored regions to catch up. In response to these requirements, the Commission decided, on
16 December 1997, to introduce new regional aid guidelines for the application of Article 87, paragraph 3 (a and c)
of the EC Treaty (ex Art. 92)1.
The guidelines, which will be applicable in the period 2000 to 2006, lay down the aid ceilings to be applied
according to the severity of regional problems and are based on four fundamental principles: (a) aid should be
concentrated on the poorest regions for maximum effectiveness; (b) the total amount of regional aid should be
reduced and better distributed between the "cohesion regions" (Spain, Greece, Portugal, Ireland) and the more
prosperous regions; (c) the real effect of aid on employment should be taken into account and, to that end,
consideration given to the possibility of granting aid not only on the basis of investment but also in the light of the
number of jobs created; and (d) there should be consistency between the regional aid maps and those used for the
Structural Funds . At the same time, the Commission decided to introduce a multicultural framework for regional
aid for large investment projects aimed at reducing the excessive volume of regional aid for highly capital-intensive
EU Policy and financing
While there are some inconsistencies between the regions which are supported under national regional
policies and those which are supported under Community instruments, the latter are designed to support and to
bolster national efforts in their most disadvantaged regions. The Communication from the Commission to the
member states on the links between regional and competition policy of the Treaty (98/c 90/03) stresses a broad if
imperfect consistency in the number and identity of regions covered under national and Community measures.
Community efforts provide broad support for national development measures by part-financing schemes and projects
designed and implemented at national or at regional level. Funding comes predominantly from three sources:
1. the European Investment Bank (which grants cheap loans for special projects),
2. the EU Cohesion Fund (supplying finance to environmental and infrastructure projects in Spain,
Greece, Portugal and Oreland), and


Commission communication, OJ C 212, 12.08.1998, p.2-5



the so-called Structural Funds (the European Regional Development Fund (ERDF), European Social
Fund (ESF), European Agricultural Guidance and Guarantee Fund(EAGGF).
The three Structural Funds (ERDF, ESF and EAGGF) have financed a number of European regional and social aid
projects drawn u\p by the member states and/ or the Brussels-based Commission. In the programming period 199499, fund assistance focused largely on specific types of problem regions identified by numbered objectives:
Objective 1. Regions whose development had been lagging behind as determined on the basis of relative
per capita incomes. Eligibility applies where average per capita income is below 75% of the EU average. In the
period 1994-99, regions of this nature included the West of Ireland and the Italian Mezzogornio. During this period,
financing of projects in objective 1 regions accounted for 67.6% of all spending under the Structural Funds.
Objective 2. Declining industrial areas, for example former coal and steel regions such as the Ruhr,
Piedmont and South Wales. In the period 1994-99, 11.1% of Structural Fund spending was channeled into these
Objective 5. Regions defined as vulnerable areas in law-income rural regions and not designated as
objective 1 areas (no region may receive assistance under more than one objective). Accounting for 4.9 % of the
Structural Fund budget between 1994 and 1999.
Objective 6. Areas defined as thinly populated such as those of the new member states, Finland and
Sweeden. Accounted for 0.5 % of the programming budget, 1994-99.
Taken together, the regions covered by objectives 1,2,5 and 6 accounted for just over 80 % of the
Communitys total ECU 154.5 billion assistance under the Structural Funds between 1994 and 1999. The remaining
money was targeted on a number of cross-regional issues such as:
long-term unemployment and the socio-economic integration of excluded groups (objective 3),
unemployment associated with industrial change (objective 4),
the structural adaptation of fisheries and agriculture (objective 5).
and on four broad Community Initiatives (Cis):
INTERREG (developing cross-border and inter-regional cooperation);
URBAN (revitalizing depressed urban areas);
LEADER (focused on rural development);
EQUAL ( combating inequalities in the labour market).
Most of the money paid out to objective 1 regions actually comes through the ERDF, which focuses on
infrustructure, human resources and productive investment. The ESF has had the principal aim of encouraging job
creation in area of high unemployment (objective 2 areas) and of providing assistance for the development of new
and appropriate skills. EEGGF money (Guidance section) has been spent on intervention and export subsidies in the
agricultural sector.
For the period 2000-2006, a new system of European regional and social aid has been introduced with
expenditure targeted on a streamlined list of three objective areas (Regulation 1260/99). An average of 26.2 billion
Euro (at 1999 prices) is to be spent per annum, as against 24.1 billion Euro over the period 1994-99. An agragate
total amount of 213 billion Euro is to be complemented by 46.80 billion Euro worth of regional spending in the
Candidate countries of Central and Eastern Europe.
European Regional Development Fund
The reform of the Structural Funds in 1988 clearly brought a need for revision of each of the individual funds,
including the European Regional Development Fund (ERDF). The new reform of the Structural Funds in June
1999 dictated a new Regulation on the ERDF1. This was the fourth major overhaul of the ERDF since its creation in
1975, demonstrating both the Community's growing commitment to regional development and its increased
experience on this matter.
The beginnings of the Regional Fund were relatively modest. Quite apart from its insufficient budget during
its first years of operation, the ERDF had a handicap which was unique among the Community's financial
instruments: the allocation to the Member States of quotas, which had to be respected in the sharing out of the
Fund's aid and which turned it into a financial instrument at the service of the regional policies of the Member States
rather than the Community's regional policy. The Commission had no qualms about putting its finger on this
weakness of the Regional Fund and fighting to adapt its means to its targets. The first unambitious reform of the
ERDF in February 1979 gave the Commission a "non quota" section for the financing of specifically Community
measures, designed to supplement or reinforce the application of other Community policies.
1. Council Regulation 1261/1999, OJ L 161, 26.06. 1999


When the ERDF was reformed for a second time, in June 1984, the system of national quotas was replaced by
a system of brackets which defined, for each Member State and for a period of three years, upper and lower limits of
aid which could be granted. This led to greater flexibility in the management of the Fund and therefore to higher
concentration of its operations in the less prosperous countries.
The third reform of the ERDF, in December 1988, an offshoot of the structural fund reform, abolished the
compulsory breakdown of ERDF resources, replacing it with an indicative
allocation decided upon by the Commission. This policy is pursued by the new reform of the Regional Fund in June
1999. The new ERDF Regulation is characterized by considerable flexibility at operational level. The Fund can make
use of all forms of financial operation, such as co-financing of regional operational programmes, regional aid
systems and major projects for infrastructures and productive investments, the granting of global subsidies and
support for technical assistance and for preparation and assessment measures.
The Regulation laying down general provisions on the Structural Funds provides that the main task of the
ERDF is to contribute to the attainment of Objectives 1 and 2 defined by that Regulation 1. As part of its tasks, the
ERDF contributes namely towards the financing of:
(a) productive investment to create and safeguard sustainable jobs;
(b) investment in infrastructure; and
(c) the development of endogenous potential by measures, which encourage and support local development
and employment initiatives and the activities of small and medium-sized enterprises, involving in particular:
assistance towards services for enterprises, in particular in the fields of management, market studies and
research and services common to several enterprises;
financing the transfer of technology, including in particular the collection and dissemination of
information, common organization between enterprises and research establishments and financing the
implementation of innovation in enterprises;
improvement of access by enterprises to finance and loans, by creating and developing appropriate
financing instruments;
direct aid to investment where no aid scheme exists;
the provision of infrastructure on a scale appropriate to local and employment development;
aid for structures providing neighborhood services to create new jobs but excluding measures financed by
the European Social Fund (ESF);
technical assistance measures.
In the regions designated under Objective 1, the ERDF may contribute towards the financing of investment
in education and health that is beneficial to the region's structural adjustment. It also contributes to the
implementation of the Community initiatives for cross-border, transnational and inter-regional cooperation
("Interreg") and for economic and social regeneration of cities and urban neighborhoods in crisis ("URBAN").
Finally, the ERDF contributes to the financing of innovative measures, notably studies, pilot projects and exchanges
of experience.
Social Policy
The Communitys social policy builds on a long history and a strong tradition of social legislation in the member
states. Only the UK, during nearly fifteen years of Conservative government, disputed the philosophical
underpinnings of Western Europes social policy agenda. Thus, the Brussels became the battleground for ideological,
political, and economic disputes over such issues as women s rights, workers rights and especially industrial
democracy- employee participation in company decision making. Because legislation on social issues potentially
affects the everybody existence of almost everybody in the Community, a progressive social policy is an invaluable
means by which Brussels can stress the relevance of European integration and, attempt to close the democratic
The Treaty of Rome contains a number of social policy provisions. The Community built the first phase of
its social policy in the 1960s almost entirely on Articles 48-52. Buoyed by the heads of governments endorsement of
an active social policy, in 1974 the Commission proposed and the Council accepted the Community s first Social
Action Program. The program included wide-ranging measures to achieve full employment, better living and
working conditions, worker participation in industrial decision making and equal treatment of men and women in the
work place. Apart from its legislative agenda, THE Community established two institutions-the European Foundation
for the Improvement of Living and Working Conditions and the European Center for the Development of Vocational
Training- to conduct research on social issues.

1. Council Regulation 1260/1999, OJ L 161, 26.06.1999


The infamous Vredeling draft directive of 1980 showed how politically out of touch the Commission had become,
not only the issue of worker participation but on social policy in general. Popularly known by the name of the thencommissioner for social affairs, the directive proposed to expand workers information and consultation rights in
multinational companies. The Vredeling directive went well beyond existing provisions at the national level by
requiring multinationals to give employees details of the companys entire operations, including those outside the
Community. Margaret Thatcher, who came to power in 1979, embodied prevailing political opinion about
government intervention in economic and social affairs. That helps to explain why the single market program
initially lacked a social dimension.
The 1985 White Paper touched on social policy only in relation to the free movement of people (workers and
professions). The SEA went farther, affirming in its preamble the need to improve the Communitys economic and
social situation by extending common policies and pursuing new objectives and by including a new title on
economic and social cohesion. Moreover the Single European Act introduced qualified majority voting for
legislation on the health and safety of workers Article 118a. Not only did the health and safety area produce the
largest and most important body of social policy legislation in the late 1980 and early 1990s, but also the majority
voting provision for health and safety legislation opened a loophole through which the Commission tried to enact
other social measures.
In an effort to ameliorate the possible adverse effects of economic liberalization and to counter criticism
that 1992 was for the benefit of businesspeople only, in 1998 Delors began a careful consideration of the single
markets social consequences. Delors explored the social dimensions of 1992, calling it one of the SEAs priorities
and a key to the success of the large market. With the obvious exception of Thatcher, most heads of government
enthusiastically supported Delors. They feared social dumping, the possibility that Community countries with
higher labor costs would lose market share to Community countries with lower labor costs or, worse, that firms
would relocate from the former to the latter.
Meeting in Hanover in June 1988, the heads of government stressed the social dimensions relevance for the 1992
program. The presidency conclusions noted that, as the internal market had to be conceived in such a manner as to
benefit all our people, it was necessary to improve working conditions, living standards, protection of health and
safety, access to vocational training and dialogue between the two sides of industry. In October in 1989 the
Commission produced a final draft, Community Charter of the Fundamental Social Rights of Workers. Despite
other pressing issues, such as EMU and the events in Eastern Europe, eleven of the twelve heads of government
adopted the Social Charter at the December 1989 Strasbourg summit (Thatcher was the lone dissenter).
The Charter listed twelve categories of workers fundamental social rights:
On 17 May 1989, the Commission produced a new document entitled 'Community Charter on the
Fundamental Social Rights of Workers'. This Charter set out a set of basic social rights (to be guaranteed under
Community law) and committed the Community to the improvement of living and working conditions within the
SEM. All of the Community governments except Britain proclaimed support for this Charter, with six governments
(including those in Bonn and Paris) immediately calling for the preparation of detailed legislation. At the Strasbourg
Council in December 1989, the UK was again isolated as the other EC governments adopted the draft Charter and
agreed to the principle of a new Social Action Programme. In its detail, the approved Social Charter listed fortyseven actions to be taken at Community level - about half of them needing legislation. These were to cover such
ground as freedom of movement, employment and remuneration, living and working conditions, equality of
treatment, information and consultation (on management decision-making), and health and safety in the workplace.
In all, the Charter specified twelve areas of entitlement (for workers and citizens) and encompassed a commitment to
translate agreed and guiding principles into concrete and legal measures. These twelve areas, and attaching
declarations, provided an echo of many of those essential principles enshrined in the European Social Charter of the
Council of Europe, which was signed at Turin on 18 October 1961.
An outline of the main themes (and principles) of the Social Charter is given below. It should be clear that it
was a wish to continue along the path laid down by the Social Charter (which itself did not have legal force) that
motivated eleven of the twelve member governments to attempt subsequently to import a 'Social Chapter' into the
Community Treaties. Although future analysis will be made of this attempt - and of the resulting compromise - the
following presentation reflects the extension of Community Charter principles into the Social Chapter and the
resulting 'Agreement on Social Policy' (as annexed to the Maastricht Treaty). Given British obstructionism on social
regulation ahead of and throughout the 1990-91 IGC, this agreement was concluded between the other eleven
member states so as to allow for further progress towards a strengthened social policy. As of 1999 and the final
ratification of the Amsterdam Treaty, this agreement has been fully incorporated into the main Community Treaty
(new Articles 136-145, TEC) bringing final coherence to the various provisions on social policy affecting the fifteen
member states.


Right of freedom of movement

According to the Social Charter, each citizen of the EC (now EU) should have the right to freedom of movement
throughout the territory of the EU and to 'establishment' for the purposes of work or training. This freedom established in the Rome Treaty itself - should only be subject to minor restriction, where justification might rest with
concerns over public security or public health. At an operational level, the right to freedom of movement must enable
any citizen to engage in any occupation or profession in the EU under the same terms as those applied to nationals of
the host country subject to the provision of Community Law (see also Chapter 3). This right implies entitlement to
equal treatment in all fields, including social and tax advantages, and the search for work. Furthermore, social
protection must be extended to all citizens of the EU engaged in gainful employment in a country other than their
country of origin on terms identical to those enjoyed by workers of the host country. Essentially, this means treating
workers moving in the EU much as one would treat workers moving from one part of a member state to another.
Discrimination in terms of low wage rates and a lack of social benefits, say against south Europeans working in
northern European states, is implicitly barred.
Employment and remuneration
In general, a key principle of the Social Charter (and of the Agreement on Social Policy) is to establish fair
remuneration for all employment in the EU. In effect, this means establishing an equitable wage defined as 'a wage
sufficient to enable a worker to have a decent standard of living'. This contrasts with the idea of a minimum wage
which is normally defined as a minimum level of remuneration guaranteed by law. As of 1999, legal national
minimum wages were in place in eight member states (Belgium, Greece, France, Luxembourg, the Netherlands,
Portugal, the UK and Spain). There has been no firm proposal for a uniform minimum wage across the EC/EU and
the UK's national minimum wage was only introduced in 1999.
Improvement of living and working conditions
Living and working conditions are not discrete entities. We all spend a large part of our lives at work. The quality of
the workplace, the work we do, the way we are treated and the extent of our own self-determination at work, all have
an effect on our general quality of life and of the efforts we make at work. It has long been recognized by the best
employers that it is not in their best interests to treat labour as a mere factor of production and that time spent on
considering employee utility in the workplace is often rewarded by higher productivity and lower absenteeism.
A general aim of the single European labour market is to lead to an improvement in the living and working
conditions of workers in the EU. The Social Charter provided significant prescription on the organization of work,
with an emphasis on flexible working time arrangements and on establishing a maximum duration of working time
per week. The later summary of legislative action demonstrates the significant attention of the Commission, social
partners and member states to improving conditions in all forms of employment including: contracts of fixed and
unfixed duration, full- and part-time work, and temporary work.
Right to social protection
Since the Social Charter agreement, the member states have been in agreement that social security arrangements
should be harmonized in their structure but not in their value across the EU. The payment of unemployment benefits
at the German level in Portugal, for example, would encourage people in Portugal never to work again. The principle
established is that all workers, whatever their status, shall enjoy social security cover proportional to length of
service, their pay and their financial contribution to the social protection system. Workers who are unemployed or
otherwise excluded from the labour market shall receive appropriate benefit. Where this is not unemployment benefit
and where such a person does not have adequate means of subsistence, they shall be able to receive a minimum
income and appropriate social assistance.
Right to freedom of association
One of the basic statements of the Social Charter was that every employer and every worker in the EU shall have the
right to belong freely to any professional or trade union organization of his/her choice. This right shall entail
recognition of the right to belong to a trade union. Therefore some governments and some firms which did not allow
trade union membership for certain occupations have been forced to reassess their restrictive practices as these
principles have acquired legal status. This general right to trade union membership also extends to the freedom to
negotiate and conclude collective agreements rather than to have conditions and pay awards imposed. It also relates
to the right to renounce the aforementioned rights without any personal or occupational damage being suffered by the


person concerned. In other words, it means that if workers refuse to join trade unions, then they have a right to do so.
This implies that closed shops may not be implemented. The establishment and utilization of procedures of
conciliation, mediation and arbitration for the settlement of industrial disputes are encouraged.
Right to vocational training
The intention in the Social Charter was that every European worker should have the opportunity to continue
vocational training during his/her working life. Public authorities, companies and trades unions are thus encouraged
to set up and operate continuing and permanent training systems, enabling every citizen to undergo training and
retraining throughout his/her working life. Moreover, leave for training purposes and for periodical training,
particularly as a result of technological developments, is to be encouraged. Every EU citizen shall have the right to
enrol for occupational training courses, including those at university level, on the same terms as those enjoyed by
nationals of the member states in the country in which the courses take place.
Right of men and women to equal treatment
As considered, equal opportunities for men and women have been a central platform of EC/EU social policy since its
very inception. The Social Charter reiterated the basic principles of Article 119 of the Rome Treaty (now Article 141,
TEC) and envisaged that action on remuneration, access to employment, social protection, education, vocational
training and career development would be intensified. However, as has been seen in the UK, despite having had
Equal Pay Acts for almost twenty years, the degree to which this is workable depends largely on the responses and
behaviour of employers. Many still choose to discriminate against women. When it comes to discrimination (either
active or passive) or through negligence, the scope for avoidance of legislation is enormous. This is a continuing
feature of the female employment experience in Europe, as discussed later in this chapter.
Right to information, consultation and participation of workers
Among those principles rejected by the UK Government pre-1997, the Social Charter states that 'information,
consultation and participation of workers must be developed along appropriate lines', taking account of the laws,
contractual agreements and practices in force in the member states. Although the issue of worker consultation was
not central to the Single Market programme, the Commission had long held the belief that a common market needed
generalized rules on information and consultation of the workforce (see the Vredeling Proposal of 1980).
The Internal Market strengthened the case for relevant EC legislation and the Commission's favour for new
provisions found support among several governments, especially those accustomed to works councils at national
level. Existing Community-wide provision was limited (and largely ineffective) with restriction to decade-old
directives on consultation vis-a-vis collective redundancies and on the safeguarding of workers' rights in conjunction
with the transfer of undertakings. With a view to the implementation of the Charter, the Commission's Second Action
Programme provided for an instrument on the increase in worker representation and consultation (on a works council
or parallel board) in 'European scale undertakings'. The succeeding account of legislative outcomes reveals the role
of the European Works Councils Directive in satisfying this particular aim. Both the ETUC and ECOSOC had
supported the specific targeting of European transnationals and, according to Hall (1992, p. 550), this was influential
in ensuring that all provisions not specifically connected to transnational circumstances were excluded. Following
agreement on European works councils, attention has shifted again to the establishment of procedures for
information, consultation and participation in national scale undertakings.
Since a basic aim of the EU is to stimulate growth and employment, the Commission has been happy to
promote the role and importance of participatory arrangements such as profit-sharing and share-ownership schemes.
Such ideas are also expressed in the Social Charter. Experiences of worker participation in a number of forms, and
from a number of sources, show that there are benefits associated with these arrangements (see Weitzman, 1984;
Cable, 1988). Not only does it seem to be in the interest of workers to have a share in profits and/or a role in
planning in their workplace, the evidence also shows that it is in the interests of businesses themselves. An involved
workforce is likely to judge atmosphere at work in a better light and, as such, is likely to work harder, be absent less
and be less likely to move to other firms, taking their skills with them. Surprisingly, perhaps, some trade unions have
been wary of co-operative arrangements, profit-related pay and worker share-ownership schemes which, ostensibly
at least, advance the principle of worker participation.
Protection of children and adolescents
According to the Social Charter, appropriate measures must be taken in the workplace with a view to providing basic
protection for children and adolescents with a minimum employment age to be fixed at no less than fifteen years.


One aim is to ensure that young people get a thorough preparation for employment via the provision of vocational
training. Another is that they should receive equitable remuneration (in accordance with national practice) when in
gainful employment.
Health protection and safety at the workplace
The Single European Act (1986) gave the EC new powers in the area of health and safety. The SEA states that there
should be greater effort to improve workers' health and safety and a harmonization of conditions across the member
states. These objectives were restated in the Social Charter, thereby encouraging the adoption of new minimum
requirement directives as a development of existing health and safety provisions.
Rights of the elderly
According to the Social Charter, every EU citizen in retirement shall be entitled to receive a minimum income giving
him/her a decent standard of living. This shall include citizens who, having reached retirement, are not entitled to a
pension (because they have never been part of the labour market) and those who have no other adequate means of
Rights of the disabled
The Charter also refers to the combating of social exclusion and to the fullest possible integration of the disabled into
working life. Objectives on disability include greater access to employment and training opportunities, improved
mobility for disabled persons, transport and housing.
The attempt to transform the Social Charter into legislation began quickly. Before the end of 1989, a Second
Action Programme had been submitted to the Council of Ministers and two General (or Framework) directives had
been concluded. First, the Council concluded a General Directive requiring all member states to recognize as
equivalent regulated professional qualifications obtained in any and all member states (Directive 89/48). Second, the
Council concluded agreement on a new framework for the protection of health and safety in the workplace (Directive
89/391). Fourteen new directives would extend from this particular agreement with progress enabled by the
groundbreaking provision for qualified majority voting (on health and safety issues) under the new Article 118a of
the SEA. In the aftermath of the Strasbourg Council, the Council also proceeded with discussions on main
contractual terms, protection of pregnant women's rights and benefits and maternity leave, signaling a breadth of
focus consistent with the solemn declarations of the Social Charter. However, just as prior to the SEA, difficulties in
converging national laws and in achieving unanimous political support for social measures, meant that many
proposals made by the Commission were not enacted. Despite this and indeed because of the EC's lack of legal
muscle in the field, the member states negotiated a new 'Social Chapter' for inclusion in the EC Treaty. By the point
of the Maastricht Council in December 1991, it was envisaged that this Chapter would:
bring amendments to Articles 117-122 of the 1957 Treaty,
give a Treaty basis to the objectives of the Social Charter,
extend EC/EU competence into new areas such as social security and the protection of employees (allowing for
unanimous decisions in the Council),
extend the scope of qualified majority voting (QMV) to several new areas, and
provide for greater consultation with the 'social partners' in the development of employment and social policies.
However, despite these limited ambitions and a number of exclusions - pay, rights of association and the
right to strike, were all left out - the UK government would refuse to endorse the draft Social Chapter. The UK's
central argument was that the costs of the Social Charter/Chapter were prohibitive and would cause the costs of
businesses to increase while suffocating them in over-regulation. Fears were also raised that the United Kingdom
could be outvoted on a wide range of damaging legislation which could be adopted by qualified majority voting ( see
Box 6.1).


Box 6.1 A social Europe - understanding the UK position

Until 1997, the UK's position remained largely unchanged from the influence of Thatcherism. Intervention in labour
markets and in the relationship between employers and employees was seen as unnecessary regulation, which would ultimately
impose increased costs on jobs leading both to uncompetitive industry and to higher unemployment. In this view, the social
dimension represented a continental approach to labour market management based on regulation and statutory obligation that
contrasted with a British approach based on low burdens on business, voluntarism and flexible working practices. Freedom from
Social Chapter constraints would boost the competitiveness of United Kingdom firms in world markets and increase their capacity
to create and to maintain jobs. Moreover, the 'social dimension' also threatened to revive and to extend the power of the unions
(e.g. through strengthened works councils) and would leave Brussels in control of new and important powers.
For Mrs Thatcher and her supporters, the idea of a social Europe (and of harmonized social and employment measures)
was entirely misguided and was symptomatic of the centralist and corporatist tendencies she associated with the Community. Her
infamous Bruges Speech in late 1988 berated a socialist, centralist agenda threatening to reverse the direction of domestic market
and trade union reforms and to steal further powers from the British Parliament. Even her successor John Major, determined to
place Britain 'at the heart of Europe', could not endorse the Social Chapter, with senior ministers condemning the plan as a 'jobdestroying machine'. Indeed, Major's erstwhile Trade Secretary, lan Lang, once described the Chapter as a 'socialist virus' and
accused its supporters of wishing to 'sign a blank cheque' {DTI press release 96/725 of 30 September 1996). Before his
government's eviction in the General Election of May 1997, Lang was to claim that the adoption of the parental leave directive in
maternity or adoption cases would have cost British companies 200 million if the Maastricht opt-out had not protected them. The
claim was also made that the imposed directive limiting working hours (the so-called Working Time Directive) would cost UK
industry over 2 billion (Daily Telegraph, 1 October 1996). The strategy devised to apply this measure to the UK (identifying it as
a health and safety measure and thereby bringing it under Article 118a of the modified Rome Treaty) was the source of an ill-fated
legal challenge and of wide condemnation within Conservative and industry ranks.
The direction of British policy was changed dramatically with the election of a Labour Government in May 1997. While
in opposition, the Labour Party had repeatedly attacked Conservative warnings as alarmist and had suggested that the
Commission was only offering improved standards of worker protection and the prospect of German-style worker participation.
The Labour party was also able to highlight that Article 2 of the Social Chapter provided assurances that legislation would avoid
imposing administrative, financial and legal constraints in a way which held back the creation and development of SMEs.
Immediately after their election victory, Britain opted in to the Social Chapter, committing itself to extend the rights and benefits
of the Chapter to the British people. In so doing, it established a more pragmatic approach to the issue encapsulated in the words
of a post-election press release by the Foreign and Commonwealth Office:
We do not accept that the British People should be second class citizens with less rights than employees on the
Continent. We want our people to enjoy the right to information ;
about their company and parental leave to be with their family, as good as those who work on the Continent, often for the same
companies ... partnership between innovative management and a committed workforce is the key to a competitive company. We
will test all future proposals under the Social Chapter by whether they promote competitiveness and help us to meet our goal of a
skilled, flexible workforce. (FCO press ' release of 4 May 1997)
The effect of this policy shift was to immediately extend a small number of measures (adopted f. under the Agreement
on Social Policy) and to smooth the way for the incorporation of the Social Chapter into the main body of the Community Treaty.
This process was completed at the Amsterdam European Council in June 1997. Measures now applying in the UK and previously
avoided under the Social Chapter opt-out concern the consultation of workers in European-scale undertakings, the burden of proof
in cases of sexual discrimination, the rights of part-time workers and the right to parental leave.

The result was a separate agreement, among the other member states, annexed to the main body of the
Treaty on European Union in the form of a special protocol, and re-affirming the commitment of the eleven to
develop the rights set out in the Social Charter. Significantly, this 'Agreement on Social Policy' established a second
route to binding social legislation at EU level with provision for qualified majority voting on working conditions, the
information and consultation of workers, equal treatment of men and women, and the integration of people excluded
from the labour market. In essence, where unanimous agreement could not be secured on a social proposal or where
decisions could not be reached by a qualified majority under the Treaties (as under Article 118a), discussions could
now bypass the United Kingdom. At this stage, the 'social partners' - the European Trade Union Confederation
(ETUC), the Union of Industries in the European Community (UNICE) and the European Centre of Public
Enterprises (CEEP) - would have to be consulted on all proposals under consideration, becoming co-actors within the
social area. These groups would enjoy the power to conclude independent collective agreements, which might later
be turned into EC law.
The first practical results of this evolving Euro-corporatism were the adoption of Framework Agreements on
parental leave and on part-time work. In both these cases, a succeeding Council Directive gives legal validity to the


terms of agreement without itself containing any further or substantive provisions in relation to individual rights. The
full text of the Framework Agreement is attached as an annex to the final Directive.
Taxation Policy
The EEC Treaty was very cautious as regards tax harmonizations. What it wanted above all was the
introduction and observance of the rule of fiscal neutrality in Community trade, equal tax treatment for domestic
production and imports from other member countries. The Treaty did not call for any harmonization or other
Community action with regard to direct taxes. The fiscal objectives of the Treaty were attained rapidly. Cumulative
multi-stage taxes, which did not guarantee fiscal neutrality, were replaced by a new turnover tax, value added tax,
and the structures of that tax were harmonized in all Community Member States. The principle of fiscal neutrality
was thus guaranteed, but at the price of maintaining tax barriers, which were necessary for the collection of VAT and
excise duties in the country of destination of goods.
In the single market goods must be able to move completely freely, and to achieve this, tax has to be imposed
on them in the country of origin or in that of destination. This led, at the end of the 1980s, to the alignment of VAT
and excise duties. At the same time the harmonization of direct taxes has begun, especially those on companies and
savings, in order to make the growth of companies and capital movement independent of tax considerations. The
approximation of the Member States tax systems can be completed only through the approximation of their
Having economic and social structures which differed in many ways, the States which were to form the
Community also had rather dissimilar tax systems, both as regards financial policy, that is to say in particular the
composition of the tax burden as between direct and indirect taxes and the technical organization of taxation. In the
short term there was no question of tackling those disparities themselves. It was a matter of little by little trying to
level out the underlying economic and social differences before aiming at the final objective of Community fiscal
policy, making a single fiscal territory of the European Community. But pending such unification, some urgent
measures in the taxation field were needed for the common market to work properly.
If the Member States of a common market has absolute freedom in the fiscal field, they could very quickly
replace the customs barriers to trade by tax barriers. They could in fact, while lowering their customs duties in
accordance with the timetable led down by the Treaty, raise their domestic taxes in such a way that the total burden
on imports remained unchanged. It was therefore necessary that indirect taxes, in particular turnover tax, have no
influence on intra-Community trade flows. In other words, fiscal neutrality between domestic production and
imports from the partner countries was needed. To secure fiscal neutrality in a common market the turnover tax of
the country of origin or of the country of destination would have to be imposed on all goods.
If the rule of the tax of the country of origin were adopted, there would be a danger of creating trade flows
based artificially on the difference were adopted, there would be a danger of creating trade flows based artificially on
the difference in the taxes rather than on the difference in comparative costs, but there would be pressure on the
Member States to approximate the rates of their taxes, and fiscal frontiers could be removed, as imported goods
would already have paid taxes at the rate of the country of origin. If, on the other hand, the system of the tax of the
country of destination were applied, production could be concentrated where the comparative economic advantages
were greatest rather than where taxation would be lower, as all products in competition on a market, whether of
domestic origin or imported, would be uniformly subject to the tax on consumption in force on that market.
However, under that system the tax barriers would have to be maintained in order to levy the taxes of the country of
destination on imported goods and the Member States would not be encouraged to approximate the rates on their
taxes. This was the price which the Founder Member States, in light of the low level of integration of their
economies, paid in opting for the system of taxation in the country of destination.
Even if the system of the tax of the country of destination were imposed uniformly, fiscal neutrality could
still not be ensured if some countries in the common market applied a system of cumulative multi-stage turnover
tax, which was the case in five of the original six Community countries. Under that system tax was levied on the
product for each transaction and therefore its total size was not only a function of its rate but also of the number of
transactions which had been carried out up to the stage of final distribution. A product was therefore taxed less
heavily if it was manufactured by a vertically integrated undertaking (firm, business) than where it was manufactured
and distributed by various small firms. It is immediately evident that such a system would distort competition in the
common market by favouring integrated large companies originating in certain member countries or third countries.
In addition, such a system would not make possible genuine fiscal neutrality in intra-Community trade, as it would
be very difficult to monitor each product at every stage of manufacture and distribution in order to ascertain the exact
amount of the tax it had borne.
Recognizing this difficulty, Article 97 (now repealed) of the EEC Treaty allowed Member States which levied
a turnover tax calculated on a cumulative multi-stage tax system to establish average rates for products or of


repayments allowed be they on exported products. But the Treaty did not provide any rule for establishing average
rates. It merely prohibited the application of such average rates from resulting in products imported from the other
Member States being liable to taxation in excess of that imposed on similar domestic products. (Art. 95 EEC, present
Art.90 TEC) and from resulting in the repayment of taxation on products exported to Member States at a rate that
exceeds the taxation actually imposed (Art. 96 EEC, present Art. 91 TEC). Those were at liberty to establish the
average rates of their multi-stage taxes.
In addition, there existed important specific taxes on consumption, known as excise duties, whose structures
and levels varied greatly in the countries of the Community. Those differences stemmed not only from historic
reasons, but also from economic and social ones. Given that the main reason of existence of excise duties was their
yield, States had a tendency to impose higher levels on certain products of major consumption, and those products
were not necessarily the same in every State. Some goods were regarded as luxury products in some States but not in
others. Moreover, if a Member State of the Single Market taxed heavily certain products which are dangerous to
health, such as alcoholic drinks, in order to restrain their consumption, whereas another country preferred to attack
other products, such as tobacco products, illegal traffics might develop between the two countries frustrating the
objectives of both. Be that as it may, the differences between Member States in excise duty structures could rise to
significant disturbances in conditions of competition, especially where products heavily taxed in one State mainly
came from the others. In such instance consumption naturally moved towards alternative products, as is the case with
wine and beer. In the interest of the proper functioning of the common market and the attainment of the Community
agricultural, energy and transport objectives, the structures of those taxes needed to be harmonized.
Taxation and conditions of competition
Just behind the harmonization of the structures of all indirect taxes came, of course, the harmonization of
their rates. It is obvious that in order to create completely impartial conditions of competition in the common market
a common system of taxes on consumption is needed, comprising not only the same structures, but also very
approximate rates or, indeed, the same rates wherever possible. In effect, the different rates of taxes could have a
different influence on the consumption of various products in the common market and could distort the conditions of
competition between the undertakings of the Member States. Where the tax burden on a product is lower in one
country than in another, if the other conditions of competition are identical in both countries, the undertakings which
manufacture the product in the first country are in a much more favourable competitive position than their
counterparts in the second country, as they can have increased demand and high profits in their principal market.
Moreover, there are grounds for questioning whether, in spite of the harmonization of tax structures and the
alignment of indirect taxation, fiscal neutrality exists, when some States have much more recourse than others to
direct taxes. It is true that such States tax the products of their partners less than do those which have more recourse
to indirect taxes, but the terms of trade and productivity offset to a large extent the fiscal disparities of Member
States' companies. Moreover, States clearly apply certain categories of tax on the basis of historic habit, sociological
structure and economic conditions. Some mainly apply indirect taxes, which are easily collected, whilst others have
greater recourse to direct taxation, which is fairer from the social viewpoint. The European Union States still need to
have sufficient autonomy in the tax field so as to have enough room for manoeuvre to act in the light of their
economic situations. Harmonization of direct taxes can therefore only be a long-term objective of European tax
However, some harmonization of direct taxation is necessary for several reasons. First, to ensure that
conditions of competition are not distorted in the European Union, production costs and the profitability of invested
capital must not be influenced too differently from country to country by taxation. Thus, lower company taxation in
one State than in the others is tantamount to a subsidy, which is incompatible with the common market. Capital
movements and the sitting of businesses can also be influenced by the disparate levels of direct taxation in the
countries of the EU and by the more or less strict application of the rule of deduction at source. Countries which have
high taxes on company revenue or which do not give favourable treatment to reinvested profits may, if there is no
monetary equalization, lose capital to countries in which company taxation is more favourable. Such capital
movements are undesirable, as they do not lead to optimum use of financial resources and production factors in the
Tax barriers, such as the taxation of an appreciation of assets in the event of a merger or double taxation in the event
of deduction at source, impede concentrations, which are necessary to enable Community small and medium-sized
undertakings to adapt to the dimensions of the common market and to make them competitive in the world market.
Disparities in direct taxes work to the advantage of multinational companies, as they are able to concentrate their
profits in the State which taxes them least. For that purpose they use holding companies, transfer prices within the
group and international debenture loans. The holding companies are established in countries with low taxation,
known as tax havens. They group, by various means, a large proportion of the profits of their subsidiaries established


in countries with normal taxation and reinvest them in the same or other companies. One means of concentrating
profits in low-taxation countries is the practice of transfer prices between units within the same group, which can
vary greatly from actual market prices.
It can be seen from the foregoing that the requirements for tax harmonization increase together with
progress in economic integration. Whilst fiscal neutrality in a customs union is ensured by the harmonization of the
structures of turnover and excise duties, in a common market and even more so in an economic and monetary
union gradual harmonization of levels of those taxes and even of direct taxation are also necessary, to ensure fair
competition throughout the single market. The long-term goal is to reach a taxation framework conducive to
enterprise, job creation and environment protection in the Union1.
Harmonization of indirect taxation
Indirect taxes are those on turnover, production or consumption of goods and services - regarded as
components of cost prices and selling prices - which are collected without regard to the realization of profits, or
indeed income, but which are deductible when determining profits. Customs duties are a form of indirect taxation.
That is why, following the removal of customs barriers in a common market. Member States could be tempted to
replace them with fiscal barriers, i.e. with internal taxes. That danger was foreseen in the EEC Treaty, Articles 95 to
98 of which contained provisions to obviate it, together with Article 99, which called upon the Commission to
consider how the legislation of the various Member States concerning turnover taxes, excise duties and other forms
of indirect taxation, including countervailing measures applicable to trade between Member States, could be
harmonized in the interest of the common market.
Indeed, the Commission assisted by two committees of experts, examined the harmonization of indirect
taxation and, particularly, of cumulative multi-stage taxes. That system, which was practiced by five of the six
countries of the original Community, had the specific characteristic of levying turnover tax on raw materials, semiprocessed products, component parts and finished products each time they were sold by one firm to another. The
result was that the taxes on the various stages of production of a product burdened its consumer price all the more
inasmuch as it had taken numerous transactions to manufacture and distribute it and, consequently, the system
burdened more the production of small and medium sized enterprises (SMEs). That is why, in the countries which
applied that system of indirect taxation, there was a tendency to integrate vertically every stage from the production
of the raw material up to and including the retail trade in a product. That was an incitement to an artificial concen tration of undertakings; as such a concentration was often sought not for its genuine economic merits, but for its tax
advantages. It goes without saying that the integrated undertaking, which enjoyed advantages under the tax system,
could oust its small competitors from the market.
Moreover, given the inherent complexity of cumulative taxes, the fixing of average levels for compensation
measures at frontiers in respect of such taxes did not rule out the unfavorable treatment of imports and the favourable
treatment of exports. As a result, the Commission was already convinced, at the beginning of the 1960s, that the only
radical solution to the problems arising from cumulative multi-stage taxes was the adoption by all Member
States of a system of turnover taxes which did not distort conditions of competition either within a country or
between Member States. Such a system was the tax on value added.
Value added tax
When it was adopted for the first time, in France in 1954, value added tax (VAT) was regarded as
merely another tax on turnover or on consumption and did not attract the attention of other countries. It was only
from 1962, with the publication of two reports ordered by the Commission recommending its adoption by all
Member States, that its interest for the Community was understood.
Acting on the basis of Commission proposals, the Council adopted on 11 April 1967 two Directives on the
harmonization of the legislation of Member States concerning turnover taxes 1. Those two Directives laid the
groundwork for the common value added tax system and a third one, adopted in 1969, introduced it in the tax
systems of the Member States2.
According to Article 2 of the first Directive of 1967, VAT is a general tax on consumption, i.e. a tax on all
expenditure on goods and services.
1. COM (96) 546, 22 October 1996
2.Council Directive 67/227, OJ 71, 14.04.1967 and Council Directive 77/388, OJ L145, 13.06.1977


The tax is levied at each stage of an economic activity on the value added at that stage. It is paid by all those
involved in the production and distribution of a product or service, but it is not an element in the costs of those
intermediaries and does not appear as an item of expenditure in their accounts, as it is not they who bear the tax, but
the end consumer.
The tax is proportional to the price of the products and services irrespective of the number of
transactions, which have taken place at the stages preceding that to which it is applied. At the time of each
transaction, the amount of VAT, calculated on the price of the good or service, is reduced by the amount of the taxes
previously paid on the cost of the various components of the cost price. The total sum which changes hands at each
stage in the production or distribution includes the VAT paid up to that point, but the amount of the tax is recovered
at each sale, except for the final sale to the final consumer, who purchases the product or service for his private use.
The tax is paid to the State by the vendor in each transaction. However, the latter does not bear the burden of the
VAT, as his purchaser has advanced the full amount of the VAT to him. Tax paid at previous stages, on deliveries
made or services rendered to the taxable person, and the tax paid on imports, is deductible from the turnover tax of
that taxable person. Given this deductibility of taxes already paid, VAT is neutral from the point of view of
domestic competition, i.e. it does not favour vertically integrated undertakings, as did the cumulative multistage
taxes. But VAT is also neutral from the point of view of international competition, since it cannot favour domestic
products. Calculation of the tax paid is easy, as it appears on all invoices and documents accompanying the product.
The replacement of cumulative multi-stage taxes by value added tax eliminated the main source of
discrimination within the meaning of Articles 95 and 96 of the EEC Treaty. But, as the two Directives of 11 April
1967 did not resolve all the structural problems of value added tax, they left in existence the possibility of many
significant differences as to the scope of the tax, particularly as regards taxable persons, taxable or exempt transactions, the methods of calculating basic taxable amounts and the special schemes. Article 19 of the second Directive
of 1967 merely stated that those differences should be progressively restricted or abolished.
It took some ten years plus a new Directive, the sixth on the harmonization of turnover taxes, to achieve that
goal. This Directive established a package of common rules making it possible to define the scope of the tax and the
method of determining tax liability, i.e. the territorial application of the tax, the taxable persons, the taxable
transactions, the place of applicability of such transactions, the chargeable event, the taxable amount, the detailed
procedures for applying rates of taxation, the exemptions and the special schemes. In Community jargon all these
rules are known as "the uniform basis of assessment of VAT", and that basis is particularly important in that VAT is
a basic source of revenue for the Community. The sixth Directive on the harmonization of the laws of the Member
States relating to turnover taxes, which was adopted on 17 May 1977, repealed the second Directive of 1967 and
filled the gaps it had left, notably in the fields of the provision of services, agricultural production, small
undertakings and exempt activities and operations1.
The sixth Directive firms up the definition of the provision of services and establishes the place in which
they are to be taxed: as a general rule this is the place where the person supplying the services has his principal place
of business or the permanent establishment from which the services are provided. As regards farmers, it confers on
the Member States the right to apply to them, in accordance with a common method of calculation, a flat-rate scheme
to offset the deductible tax on their purchases and the services supplied to them by third parties. With regard to small
undertakings, it lays down that the Member States may apply simplified schemes for charging and collecting tax. In
addition, the sixth Directive provides for a complete system of exemptions both for activities within the country and
for transactions linked with importation, exportation and international trade in goods, including the acquisition of
gold for investment purposes. An amendment to Directive 77/388 allows Member States wishing to do so to apply on
an experimental basis, for three years, a reduced rate of VAT on two or, in exceptional cases, three categories of
labour-intensive services, such as minor repair services, repairs to private dwellings, cleaning and hairdressing2.
However, with the implementation of the sixth Directive, the work on harmonizing the Member States' laws
on turnover tax structures was not at an end. A number of the provisions of the Directive still needed to be thrashed
out. Thus, the sixth Directive had laid down the principle that any taxpayer was entitled to the deduction or refund of
VAT in whichever country he incurred expenditure subject to tax. An eighth Directive on the matter, adopted by the
Council in 1979, lays down the common arrangements for the refund to taxable persons not established in the
territory of the country of VAT borne by them on imports or purchases of goods or services in a Member State 1.
The thirteenth Directive, adopted in 1986, does likewise for refunds to taxable persons not established in
Community territory3. The tenth Directive applies VAT to the hiring out of moveable tangible property4.
1.Council Directive 77/388, OJ L145, 13.06.1977 and Council Directive 1999/85, OJ L277, 28.10.1999
2.Council Directive 1999/85, OJ L277, 28.10.1999
3.Council Directive 86/560, OJ L326, 21.11 1986
4.Council Directive 84/386, OJ L 208, 03.08.1984


Since some non-Member countries do not impose VAT on telecommunications services, these services are
subject to VAT in the Community at the place of establishment of the recipient of the services, while services
rendered by Community operators to consumers in non-Member countries are not subject to VAT in the Community.
Community guidelines on electronic commerce and indirect taxation, proposed by the Commission and endorsed
by the Council on 6 July 1998, aim at ensuring the certainty, simplicity and neutrality of the Community VAT system
with regard to electronic commerce, with a view to promoting its growth. A transaction whereby a product is offered
to the customer in digital form through an electronic network must be considered for VAT purpo ses as an instance of
provision of services to be taxed at the place of consumption and no new or additional tax should be envisaged.
Electronic billing which does not require the use of paper must be authorized when establishing the amount of VAT
due in respect of transactions within the EU, provided that conditions exist for monitoring and preventing abuses.
One of the main challenges to the completion of the single market was in the tax field. Prior to 1992,
goods and services moving within a Member State were taxed differently from those that were exported. On
exportation the product benefited from full tax remission and was in return subject to the VAT of the country of
import at the crossing of borders. The tax was paid to the country in which the goods arrive at the final consumption
The protection, which that system afforded against tax evasion and avoidance, depended on the frontier
controls. Without a check at the border to ensure that the goods which were the subject of an application for the
reimbursement of tax had actually been exported, it would be all too easy for dishonest operators to invoice goods at
the zero rate for exportation and subsequently resell them on the internal market, either free of tax, which would
place their competitors in a disadvantageous position with regard to price, or by including the tax component in the
price, but keeping its amount for themselves. That would not only have constituted a loss of tax revenue for the
exporting State, but also a source of serious distortion of trade. For the authorities of the importing State, on the other
hand, frontier controls were used to tax imported goods at the rates prevalent in the country in question, so as to
collect the revenue due to them and, at the same time, make sure that these products did not unduly compete with
national products.
However, the export refunds and import taxes which accompanied intra-Community trade, and the resultant
controls, constituted the so-called "fiscal frontiers". To remove those frontiers, it was vital that cross-border trade be
treated in the same way as purchases and sales within a State. The Commission actually proposed that as from 1
January 1993 all sales of goods and services should be taxed at the rate of the country of origin 1. But the Council did
not follow the Commission's lead. In conclusions of 9 October 1989 adopted unanimously (necessary condition in
order to counter the proposal of the Commission), it considered that conditions could not be fulfilled for a system of
taxation in the country of origin and that it was therefore necessary to continue, for a limited period, to levy VAT and
excise duty in the State of consumption.
The Directive on the approximation of VAT rates completes the common VAT system, amending the
Directive of 17 May 1977 stipulates that, during the operational period of the transitional VAT arrangements (from 1
January 1993 to 31 December 1998), the Member States shall apply a standard VAT rate of at least 15% 2. In fact,
the standard VAT rate varies between 15 and 25% in the Member States. Thus, in 1997, it was 25% in Sweden and
Denmark, 22% in Finland, 21% in Belgium and Ireland, 20.6% in France, 20% in Austria, 19% in Italy, 18% in
Greece, 17.5% in the United Kingdom and the Netherlands, 17% in Portugal, 16% in Spain and 15% in Germany
and Luxembourg. All the higher VAT rates existing in several Member States have been abolished, leading to a
significant fall in consumer prices in some sectors, such as automobiles.
The Member States however enjoy the option of applying, alongside the normal rate, one (or two) reduced
rates, equal to or higher than 5%, applicable only to certain goods and services of a social or cultural nature.
Examples include foodstuffs, pharmaceuticals, passenger transport services, books, newspapers and periodicals,
entrance to shows, museums and the like, publications and copyright, subsidised housing, hotel accommodation,
social activities and medical care in hospitals. The preservation of the zero and extra-low rates (below 5%) is
authorized on a transitional basis, along with reduced rates on housing other than subsidized housing, catering and
children's clothes and shoes.
The sixth Directive on VAT was amended in 1991 to supplement the common system of VAT3. The
amendment establishes the basic rules for the transitional VAT system. The new scheme dispenses with customs
procedures. Intra-Community trade in goods between taxable bodies is subject to taxation of the goods acquisition in
the country of destination.

Commission proposal, OJ C 250, 19.09.1987, p.2

Council Directive 92/77, OJ L316, 31.10.1992
Council Directive 91/680, OJ L376, 31.12.1991 and OJ L 384, 30.12.1992


The case of sales between companies subject to VAT, i.e. the vast majority, the vendor exempts the deliveries made to
clients in other Member States. In his VAT return, he indicates, in a separate box, the total of his exempted intraCommunity sales. In another return (usually quarterly), he lists the VAT number of his customers in the other
Member States and the total amount of his sales to each of them during the period in question. The purchaser applies
VAT to his purchase in another Member State, termed an "acquisition". He must declare the total amount of these
acquisitions in a separate box in his normal VAT return and can request the deductibility of this VAT in the same
Individuals traveling from one Member State to another pay VAT there where they purchase the goods
and are no longer subject to any VAT-related taxation or any border formality when they cross from one Member
State to another. The system of travelers' allowances is thus abolished as far as intra-Community traveling is
concerned. Under certain conditions, the Member States will be able to authorize duty-free sales until July 1, 1999.
However, tax-free purchases in intra-Community travel are limited to ECU 90, whereas allowances for travelers
arriving at the Community from third countries can be as high as ECU 1751.
In the framework of the transitional system, the seventh VAT Directive has introduced certain special
systems. For remote sales (mail order) of an undertaking to individuals and other non-taxable bodies, VAT is
counted at the rate in force in its Member State, except when its sales in the Member State of destination are above a
certain limit (generally, ECU 100,000 per year) or if it prefers taxation in that State. New vehicles (cars, boats,
aircraft) which form part of the operating stock of the vendor and which do not have a mileage of more than 3,000
kilometers are taxed in the country of registration, i.e. in the purchaser's country of origin, whereas second-hand
vehicles are subject to the VAT rates practiced in the country of the vendor. Institutional non-taxable bodies
(government authorities) and exempted taxable bodies (banks, insurance companies...) are able to purchase goods
in other countries, paying the VAT applicable in the country of origin, provided that their purchases do not overstep a
certain threshold to be set by each Member State. For second-hand goods, works of art, collectors' items and
antiques, sales between individuals are free of VAT and those realized by second-hand dealers and tradesmen are
taxed in the Member State of destination on the dealer's profit margin and not on the total value of the goods 2.
On 1 January 1993, the new arrangements provided for in the transitional VAT regime came into force and,
as a result, the charging of VAT on imports within the Community and the associated customs-based formalities
ceased to exist. The transitional VAT arrangements are functioning satisfactorily overall. However, some mechanisms
of the transitional VAT arrangements have proved to be complicated, particularly for small and medium enterprises, and the deterrent effect of some of the rules remains an obstacle to the development of trade between Member
States. Likewise, the justification of the intra-Community nature of operations and the burden of identification and
declaration are real difficulties encountered by traders, demonstrating that enterprises and consumers still do not
enjoy all the expected advantages of the single market. This is why; the Commission recommended to the Member
States a simplification of the taxation on small and medium enterprises 3.
The abolition of frontier controls and the resultant fraud risk require cooperation between government
authorities in the area of indirect taxation. Such cooperation got off the ground in 1992. It revolves primarily around
regular exchanges of data between the relevant authorities of the Member States on intra-Community trade. The
backbone of the system is an on-line network linking the relevant administrations of the Member States ("SCENTtaxation"), enabling rapid and efficient information exchange designed to combat fraud in the VAT and excise-duties
The Fiscals programme seeks to ensure the effective and uniform application of Community indirect tax
legislation by exchanging information and helping officials working in this area to achieve a high common level of
understanding of this legislation and its implementation through effective initial and continuous training.
Noting the complex nature and cost of the present system of VAT and the fact that it is poorly suited to the
new economic challenges, the Commission suggests the creation of a genuine Community tax area through an
approach which is consistent with the policy objectives set in the context of economic and monetary union. Being
based on the principle of taxation at the place of origin, the new system should afford equal treatment to domestic
and intra-Community transactions, maintain a level of tax revenues commensurate with consumption within a
Member State, provide legal certainty for operators, effective monitoring of transactions, simple rules and uniform
application. The Commission has set out a step-by-step timetable for the formal proposals for the introduction of
such a system consistent with the programme for the introduction of the single currency.
1.Council Directive 94/4, OJ L60, 03.03.1994 and Council Directive 98/94, OJ L 358, 31.12.1998
2.Council Directive 94/5, OJ L60, 03.03.1994
3.Commission Recommendation 94/390, OJ L177, 09.07.1994


Excise duties
In a fiscally integrated Community a number of major special taxes on consumption (excise duties), i.e.
taxes on the consumption of certain products, yielding substantial revenue to the States, must be maintained
alongside VAT. Excise duties make it possible to impose a much larger tax burden on a small number of products
than that borne by the vast majority of goods which are only subject to VAT, which has very few, and fairly low,
rates. If the various excise duties in the Community States were abolished, the resultant losses of revenue would have
to be offset by increasing VAT rates, which would be certain to have an inflationary effect on their economies. Thus,
for example, manufactured tobacco products and mineral oils bear, without major drawbacks, very high taxes, which
on average yield more than 10% of the tax revenue of the EU States. To replace that revenue by other revenue would
entail not only fiscal, but also economic and social disturbance.
Moreover, within the overall context of a tax scheme, excise duties constitute flexible components, which
can easily be maneuvered if further tax revenue is needed. As they are separate taxes, excise duties can easily be
adapted to the various economic, social and structural requirements. Lastly, they can be levied specifically in order to
reduce consumption of certain products, such as tobacco products and alcoholic drinks, for public health reasons, and
petroleum products for reasons of energy savings and reduction of energy dependence.
But if some excise duties had to be maintained in the Community two conditions had to be met so as not to
disturb the common market. First their structures had to be harmonized so as to remove taxation indirectly
protecting national production or in excess of that imposed directly or indirectly on similar domestic products (Art.
95 EEC, present Art. 90 TEC). Then, as integration progressed, their rates had to be harmonized so as to eliminate,
in trade between Member States, taxation and tax refunds as well as frontier controls, which disturbed the free
movement of goods within the common market.
Article 99 of the EEC Treaty gave the Commission a brief to consider how the legislation of the Member
States concerning excise duties could be harmonized in the interest of the common market. In fact, the Commission
forwarded to the Council on 7 March 1972 five proposals for Directives on the harmonization of excise duties.
Examination by the Council of the Commission proposals revealed that the Member States were much less willing to
harmonies their specific taxes on consumption than they had been as regards their turnover taxes. Faced with that
situation, the Commission utilized the judicial process. In 1978 it brought five cases against various States under
Article 169 of the EEC Treaty for failure to fulfill their obligations under Article 95 in the field of alcoholic drinks.
In fact, alcoholic drinks belong to a single family, whether distilled like spirits or fermented like wine and beer. Was
it pure chance that excise duty in the United Kingdom was five times higher on wine than on beer or that brandy in
France enjoyed rates, which were at least 30% lower than those applied to whisky? On 27 February 1980, the Court
of Justice sided with the Commission to condemn such practices.
Despite the Commission's efforts and several fresh rulings against various Member States by the Court of
Justice/ a political compromise for excise harmonization only emerged in the early 1990s as part of the removal of
fiscal frontiers necessary for the achievement of the Single Market. The 92/12 Directive defines the general
arrangements for the holding and movement of products subject to excise duty from 1 January 1993 1. In contrast to
the harmonized VAT system, the general arrangements for excise are definitive.
The taxable event takes place at the stage of manufacture in the Community or of import into the
Community from a third country. The tax is payable when the product is put up for consumption and must be
acquitted in the country of actual consumption. The Member States have the option of introducing or maintaining
taxation on other products and services/ provided however that this taxation does not give rise to border crossing
formalities in trade between the Member States.
Excise duties are paid by the consignee in the country of destination and the appropriate provisions are
taken to this effect. For commercial operations, the Community system is similar to that applied within a State; the
movement of products subject to suspended excise duty is through interconnected bonded warehouses and is covered
by an accompanying document, which has been harmonized at Community level. The payment of the excise due in
the State of destination can be assumed by a fiscal representative established in this State and designated by the
consignor. The appropriate provisions are taken to enable the exchange of information between all the Member
States concerned by the movement of goods subject to excise with a view to ensuring effective fraud control. Individuals can purchase the products of their choice in other Member States, inclusive of tax, for their personal use.
Denmark, Finland and Sweden are, however, authorized by the Council to continue restricting the quantities of
certain alcoholic drinks and tobacco products which individuals purchase in other Member States and import for
their own consumption.
Directive 92/78 harmonizes the excise-duty structures on manufactured tobaccos in the Member States,
with the retail sales price taken as the calculation basis. Directive 92/79, on the approximation of excise-duty rates on
cigarettes, stipulates that total excise duty (specific duty plus proportional duty calculated on the basis of the
maximum retail sales price, before VAT) must constitute at least 57% of the sales price. Directive 92/80, on the


approximation of taxes on manufactured tobaccos other than cigarettes (cigars, cigarillos, tobacco for rolling
cigarettes and other tobaccos for smoking), sets minimum total excise duties for these products, but grants the
Member States the option of applying them either as specific excise duty per unit, or proportional excise duty
calculated on the basis of the maximum retail sales price, or a combination of the two 2. The Directive on taxes which
affect the consumption of manufactured tobacco was consolidated in 19953.
Directive 92/81, on the harmonization of excise-duty structures on mineral oils, generally makes them
subject to specific excise duty calculated per 1000 litres of the product (or, for heavy fuels, liquefied petroleum gas
and methane, per 1000 kilograms). Directive 92/82 stipulates minimum excise duties for mineral oils at the following
levels: 337 ECU per 1000 litres for leaded petrol; 287 ECU per 1000 litres for unleaded petrol; 245 ECU per 1000
litres for diesel and paraffin used as fuel; 18 ECU per 1000 litres for domestic oil, diesel and paraffin used for fixed
engines; 13 ECU per 1000 kilograms for heavy fuel; 100 ECU per 1000 kilograms for liquefied petroleum gas and
methane used as fuel; 36 ECU per 1000 kilograms for liquefied petroleum gas and methane used for fixed engines;
and 0 ECU for liquefied petroleum gas, methane and paraffin used for heating 4. The Member States are authorized to
apply to certain mineral oils, when used for specific purposes, reduced rates of excise duty or exemptions from
excise duty. A 1995 Directive establishes common rules for the tax marking of gas oil and kerosene which have not
borne duty at the full rate applicable to such oils when used as propellants.
Directive 92/83 covers the harmonization of excise-duty structures on spirits and alcoholic beverages.
Directive 92/84 sets minimum excise duties on spirits and alcoholic beverages at the following levels: 550 ECU per
hectoliter of pure alcohol; 45 ECU per hectoliter for intermediary products; 0 ECU for wine; 1.87 ECU per hectoliter
per degree of alcohol in the finished product for beer.
Other indirect taxation
Various indirect taxes whose harmonization is important for European construction also exist in addition to value
added tax and special taxes on consumption. Examples of these are taxes on insurance policies and taxes on motor
vehicles intended for the carriage of passengers, which vary greatly between Member States. The most significant
from the point of view of competition, however, are capital duty and stamp duty levied on shares in registered capital
(shares and securities), as their diversity can give rise to double taxation and distortions of competition and constitute
obstacles to the free movement of capital.
In order to prevent such problems, a 1969 Directive concerning indirect taxes on the raising of capital
provided for the harmonization of capital duties and the abolition of stamp duties, which were deemed to be
undesirable from the economic point of view1. However, when that Directive was applied it became clear that capital
duties could be set at too high a level, especially in certain company-restructuring operations. For that reason it was
amended to facilitate the contribution of risk capital to undertakings by reducing their fiscal burden 2.
Harmonization of direct taxation
Taxes on the revenue of undertakings and private individuals, which are not incorporated in cost prices or
selling prices and the rate of which is often progressive, may be regarded as direct taxes. The two important
categories of direct taxes are income tax and capital gains tax. Article 92 of the EC Treaty prohibits, as regards
such taxes, countervailing charges at frontiers, i.e. the application of remissions and repayments in respect of exports
to other Member States. Derogations may not be granted unless the measures contemplated have been previously
approved for a limited period by the Council. Apart from that provision the EC Treaty does not deal with direct taxes
and does not call for them to be harmonized.
Whilst the harmonization of indirect taxes was necessary from the outset to avoid obstacles to trade and to
free competition and later to make the removal of fiscal frontiers possible, the harmonization of direct taxes did not
appear indispensable in the common market. It gradually became clear that the free movement of capital and the
rational distribution of production factors in the Community required a minimum degree of harmonization of
direct taxes. If one wishes to approximate Member State's economic policies, one must also coordinate the fiscal
instruments used by them.
1. Council directive 92/12, OJ L 76, 23.03.1992
2. Council Directives 92/78, 92/79 and 92/80, OJ L 316, 31.10.1992
3. Council Directive 95/59, OJ L 291, 06.12.1995
4.Council Directives 92/81 and 92/82, OJ L316, 31.10.1992


Likewise if the wish is to facilitate the creation of internationally competitive industrial businesses, the
taxation of companies operating in several Member States must not place them at a disadvantage in relation to those
restricting their activities to the purely national level. The Commission tabled proposals in this connection as long
ago as 1969. The Council needed 21 years (!) of debate before it could approve these proposals, vital for
transnational cooperation and company mergers.
Business taxation
The first Directive adopted by the Council in July 1990 relates to the taxation system applicable to the
capital gains generated upon the merger, division, transfer of assets, contribution of assets or exchange of shares
between two companies operating in different Member States.

National regulations consider this type of operation as a total or partial liquidation of the company making
the contribution and subject it to capital gains tax, set in an artificial manner, since it compares the market value of
the good in question (the company itself, or a building, land, a share package) to the value entered in the balance
sheet, traditionally underestimated. Such a calculation is unjust insofar as no liquidation is taking place in effect;
rather two companies from different Member States are forming closer links. The Community solution consists of no
longer taxing the capital gain at the time when the merger or contribution of assets takes place but rather when it is
collected. This solution encourages the formation of "European companies", insofar as such companies usually result
from the merger of companies originally established in different Member States.
The second Council Directive of July 1990 relates to the common fiscal system applicable to parent
companies and subsidiaries situated in different Member States1. There can be little doubt that the decision by a
company to set up a subsidiary in another Member State of the Community is adversely affected by the fact that the
dividends of the latter would be subject to tax in the country where it has its domicile for tax purposes, to corporation
tax and, in the Member State where the subsidiary is domiciled, to a non-recoverable withholding tax. The Directive
abolishes withholding taxes on dividends distributed by a subsidiary to its parent company established in another
Member State.
In July 1990, representatives of the Member States also signed a Convention providing for the introduction
of an arbitration procedure in the event of disagreement between the tax authorities of the Member States relating
to a cross-border operation2. This ensures the avoidance of double taxation arising when an adjustment to the profits
of a company carried out by the tax authority of one Member State is not matched by a similar adjustment in the
Member State of the partner company. Such double taxation would penalize European transnational cooperation. A
time limit has been placed on the procedure, so that lengthy delays lasting for several years and generating additional
costs cannot develop. The company concerned by the measures in question becomes rapidly a party to the procedure
and consequently has an opportunity to put its viewpoint forward.
The guiding principle of Community policy in the field of direct taxation is to eliminate the double taxation
of cross-border activities whilst ensuring taxation at least once. Concrete measures, such as the proposed
Directives for interest and royalties, the offsetting of losses and the extension of the parent-subsidiary and merger
Directives have been tabled by the Commission. These measures enjoy the support of economic operators since they
would make a significant contribution to improving the tax environment in which cross-border activities are planned
and executed. However, adoption of these measures would only go part of the way towards resolving the problem of
double taxation. The guidelines laid down in the Commission communication to the Council and Parliament in
response to the Ridding report provides a detailed blueprint for further Community action in this field 3. This action
would take the form of either a general obligation to abolish all cross-border double taxation or a phased approach
the priorities for which would have been set by mutual agreement with the Member States.
In the "Schumacker" case, the Court of Justice found that, although direct taxation does not as such fall
within the competence of the Community, the powers retained by the Member States must nevertheless be exercised
consistently with Community law, and in particular with the rules governing the free movement of workers, which
require the abolition of any discrimination based on nationality 4. Thus, tax benefits granted only to residents of a
Member State can constitute indirect taxation by reason of nationality, but only where different rules were applied to
comparable situations or the same rule was applied to different situations.

2. SEC (92) 1118, 26 June 1992
3.SEC (92) 1118, 26 June 1992
4. Judgment of 14 February 1995, case C-279/93, p.I-0225


Where direct taxes are concerned, however, the Court found that the situations of residents and nonresidents are not, as a rule comparable and, therefore, a non-resident can be taxed by a Member State more heavily
on his income than a resident in the same employment.
On 1 December 1997, the Council agreed to a package of measures intended to tackle harmful tax
competition, which are necessary to reduce distortion in the single market, to prevent increasing losses in tax revenue
and to enable employment-friendly tax policies to be pursued.
The package included a Resolution on a code of conduct on business taxation comprising a political
commitment not to bring in any tax rules which constitute harmful tax competition and to phase out existing rules
including withholding taxes on interest and royalty payments between companies forming part of a group 1. The code
defined "harmful tax measures" and provided for the establishment of a Group within the framework of the Council
having as tasks to assess the tax measures that may fall within the scope of the code and to oversee the provision by
the Member States of information on those measures. The Resolution invited the Commission to draft a proposal for
a Directive on the taxation of income from savings, i.e. interest paid in one Member State to individuals who are
resident in another Member State. Responding to this invitation, the Commission proposed a "coexistence model",
whereby each Member State would have to apply either a withholding tax of at least 20% in the case of individuals
residing in other Member States or to provide information on such payments to the Member States in which the
beneficiaries are resident2.
Effort to combat tax avoidance
The most important and urgent problems for the Community in the area of direct taxation were posed by
international tax avoidance. In addition to the substantial budgetary losses for States and the fiscal injustice,
international tax avoidance generates abnormal capital movement and distortions of conditions of competition. The
particularly important aspects from the international point of view are: the concealment by some taxpayers of their
taxable activities beyond the borders of their States in countries in which the level of taxation is low or the risk of
discovery small;
The possibilities of avoidance open to multinational companies, especially through the manipulation of transfer
prices between undertakings in the same group; and the tax arrangements for holding companies, which is a problem
outside the European Union's remit, as a large number of those companies are established in tax havens outside the
In a 1975 Resolution the Council had already agreed to make correct assessments for taxes on income or
profits and to support prosecutions of persons guilty of tax avoidance 3. In order to implement this Resolution, the
Council adopted a Directive concerning mutual assistance by the competent authorities of the Member States in
the field of direct taxation. That Directive introduced a procedure for the systematic exchange of information
directed towards enabling them to effect a correct assessment of direct taxes in the Community. The exchange of
information may take place at the request of the Member State concerned, but it is also provided for where that State
has no grounds on which to base its request. Thus, the exchange of information without request may be automatic, in
certain cases decided upon by mutual agreement between the authorities concerned, or spontaneous, where one com petent authority feels that it has certain information likely to interest another Community tax authority, for example
where there are grounds for supposing that there are artificial transfers of profits within groups of enterprises. For
that purpose the Directive established a procedure for cooperation between the Member States and the Commission
which enables them to inform each other of their information and experiences notably in the field of transfer prices.
However, the liberalization of capital movements as from 1 July 1990, in accordance with the Directive of
24 June 1988 has increased the risk of tax evasion. In fact. Community residents can henceforth freely transfer
their savings to bank accounts in any Member State without the corresponding income necessarily being declared to
the tax authorities of the State of residence. Since, in several Member States, there is no "withholding tax" on bank
interest paid to non-residents, investment would tend towards those States, thus avoiding any taxation. Such capital
movements, motivated purely by tax considerations, would be at variance with the optimum allocation of resources,
which is the objective of establishing a Community financial area. Moreover, as in the global economy capital has
become very mobile, the States have a tendency to displace the tax burden towards less mobile bases, such as work.
Thus, between 1980 and 1993, the implicit tax burden on capital in the EU has decreased by more than one tenth
while the implicit tax burden on work has increased by one fifth 4. Any new increase on the tax burden on work could
drive economic activity towards the black market and/or aggravate the effects on the costs of labour and
1. Resolution, OJ C2, 06.01.1998, p. 2-5
2.COM (1998) 295, 20 May 1998
3. Council Resolution, OJ C 35, 14.02.1975, p.1-2
4.SEC (96) 487, 20 March 1996


It would therefore be necessary, to lessen the risk of tax distortion, evasion and avoidance, to intensify the
exchange of information between tax authorities on the basis of the Directive of 19 December 1977 and to remove
the encouragement to invest in a Member State which applies a more favorable tax scheme than the Member State of
the investor by introducing in all the Member States a relatively low withholding tax. That twin objective is aimed at
by the Council in its conclusions of 13 December 1993 on the taxation of savings. Interest received by Community
residents is to be subject either to withholding tax at a minimum rate of 15% or to notification of the tax authorities
of the country of residence. Despite UK misgivings, the Helsinki European Council (10-11 December 1999) has
agreed on the principle that all citizens resident in a Member State of the European Union should pay the tax due on
all their savings income. In addition Member States should act in concert to prevent tax evasion towards third
countries, which erodes their tax revenues and even their fiscal sovereignty.
A more radical proposal of the Commission is based on its Confidence Pact for Employment and on its tax
strategy presented in October 1996 and endorsed by the Dublin European Council 1. The Commission is, indeed,
proposing that the Community system of minimum rates, which is currently limited to mineral oils, be extended to
all energy products2. Agreeing with the Commission, the Vienna and Cologne European Councils (December 1998
and June 1999) emphasized the need to make tax systems in Europe more employment-friendly and urged the
Council to continue its work on the proposals for a directive on the taxation of savings and for the taxation of energy.
The question of greater harmonization of direct taxes will doubtless be placed on the EU's agenda after the
achievement of economic and monetary union. In the meanwhile, the regular meetings between the Directors
General of direct taxation represent a cooperation instrument, which could be used for the gradual coordination of
national fiscal policies.
EU competition policy: defending and facilitating the Single Market
There is little benefit in removing tariff and non-tariff barriers to internal trade if firms are then faced with
restrictive practices or with other anti-competitive activities permitted by the absence of effective anti-trust rules.
Accordingly, the EU has looked to tackle private and public barriers to competition through regulation and the
construction of a broad legal framework. It has established legally binding rules and obligations in order to:
Prevent firms from colluding by price-fixing, cartels and other collaborative strategies. This is in order to
stimulate competition and to prevent oligopolists from behaving in a quasi-monopolistic way.
Prevent firms from abusing positions of market dominance. That is, to control such actions as monopoly pricing,
discriminatory pricing and fidelity rebates, which can do damage to competition and to consumers.
Control the size to which firms grow through acquisition and merger. This is aimed at ensuring that acquisitions
do not seriously (and adversely) effect competition within defined markets and at preventing monopolies from
reaping supernormal profits.
Restrict state aid to indigenous firms. This is aimed at limiting the competitive advantages gained by 'supported'
firms over unsupported counterparts and at ensuring that firms are not shielded from the real competitive pressures
bearing on their markets.
In satisfying these aims, the EU (through its executive arm, the European Commission) can be said to have
'a double mandate'. On the one hand, it must work alongside national competition authorities in ensuring that
restrictive and anti-competitive practices are forbidden
and to prevent the formation of EU-wide or regional oligopolies that impede competition and penalize consumers.
On the other hand, its actions must reflect the realities of global competition and the need for Europe to possess
larger, cross-border undertakings in order to compete in global markets. This is just one of the challenges posed in
framing EU competition policy and requires a policy of sufficient flexibility (see Story, 1996, p. 277).
In legal terms, the basis of this policy rests with Articles 81-89 of the Community Treaty and with the
European Merger Control Regulation, no. 4064/89 (as modified by Regulation no. 1310/97). These instruments
forbid a number of measures and practices that impair competition within the Common Market and which distort
intra-Community trade. Anti-trust rules, associated primarily with Articles 81 and 82, have been in operation since
1962. These have provided Commission jurisdiction over national and international anti-trust concerns where there is
a distortion in competition in the Common (or Internal) Market. As considered, tasks encompass the policing and
regulation of concerted practices undertaken by commercial entities (Article 81) and the abuse of dominant trading
positions (Article 82). The EU's Merger Control Regulation has been in place since 1990. This provides an important
complement to Articles 81 and 82 and gives the Commission specific power to police mergers and the acquisition of
more market share by undertakings where there is evidence of a Community dimension. An undertaking is defined as
any entity engaged in commercial activity regardless of its legal form, ownership and the way in which it is financed.
Articles 87-89 constrain the flow of public capital to domestic industries. The Treaty assumes in Article 87 that any
aid granted by a state or through state resources in any form shall be incompatible with the Common Market if it
distorts or threatens to distort cross-border competition. This does not preclude all categories of state assistance to


indigenous firms - state aid granted for specific purposes may be compatible with the Common Market - but imposes
clear controls on the support of domestic industry by public authorities in each of the member states.
Competition, free markets and efficiency
Although it is tempting to move directly to these legal instruments, an examination of the EU's anti-trust
rules and performance is best oriented around an understanding of competition itself. Welfare economics suggests
that competition is 'good' and, in the neo-classical view, competition is seen to promote an optimal distribution of
resources in society. The existence of many buyers and sellers, efforts at profit maximization by independent firms
and the absence of barriers to the movement of goods or factors of production, are all assumed to make positive
contribution to the effective functioning of the market. The Austrian and Chicago Schools have taken a more tolerant
view of monopoly power (arising when there are serious imperfections in the market) but competition has remained
the prevailing ideal of Western society and economy. As Burke et al. put it (1991, p. 8): 'people in business usually
subscribe, both intellectually and financially, to an ideology of competition'.
Market structures
In actuality, economic theory distinguishes between four main types of market structure, suggesting how firms
behave differently under different competitive forces. These four market structures are:


perfect competition
monopolistic competition
Perfect competition
Perfect competition, as an ideal market structure, provides a yardstick against which to judge the nature and
efficiency of other market forms. Given that 'perfectly' competitive markets have (1) many buyers and sellers (who
cannot fix prices), (2) no entry or exit barriers, (3) a homogenous product, (4) complete information and (5) firms
acting independently of one another (and seeking to profit maximize), the satisfaction of its full condition is nigh
impossible. Only in a small number of markets, for example for commodity products such as eggs, rice or wheat, is
there any approximation of these conditions. These products will sell on a market based on their comparative costs
and are essentially undifferentiated. Prices are only distorted by variance in transport costs and by forms of
government intervention (e.g. in the form of price supports).
Monopolistic competition
Monopolistic competition is the name given by economists to that form of imperfect competition that takes place
between competitive companies supplying similar but differentiated (non-identical) products. Competition applies to
price, product quality, labeling, advertising and promotion. Here then, the concept of branding emerges as a core
feature of competition. Unlike perfect competition, each good is slightly different in composition and/or brand
image. Markets of this type are expected to consist of a large number of firms entering and exiting the market with a
good measure of freedom. A number of European markets for consumer and electrical goods are of this type.
Under oligopoly a smaller number of larger firms enjoy a greater degree of market power and where there is no
longer complete freedom of entry into the industry. Under these conditions, firms may be inclined to collude (e.g. to
fix prices or output) and may progress to do so, especially where public policy controls are weak or absent. Even in
the absence of such collusion, the predominant concerns of firms are with the actual and potential actions of others,
with the threat of new entrants, and with the risk of substitutes. Firms are interdependent in the sense that alterations
to output or pricing by one in the industry will induce a response from the others. Therefore, although price
leadership is possible, oligopolists tend to eschew aggressive price competition and rely heavily on product
innovation, differentiation, branding and advertising. The European automobile industry (dominated by a small
number of high-volume manufacturers) provides example of oligopolistic competition in Europe, as do the European
aerospace, paper and pulp industries.
Monopoly provides the opposite extreme to perfect competition. Only one firm (or a group acting as one) is
producing in the market, exercising substantial or total control over market supply. Entry barriers are high - causing
other firms to remain outside of the industry - and supernormal profits may exist to be exploited from a protected
position. Several monopolies have characterized the European business environment over the last twenty years,
although their number has been greatly reduced by processes of market deregulation and privatization. Most, like
Deutsche Telekom (prior to 1998), have encompassed governmental control of the business and protection by refusal
to grant licences to other potential suppliers, capital requirements, patent rights etc. According to welfare economics,
monopolies are 'bad' be they in the public or private sectors in that they result in a higher price charged and lower
output produced than under perfect competition. Monopolies also tend to be less efficient. With state-owned
examples in particular, X-ineffi-ciency can be significant, a factor prompting several European nations to embark on
wide-ranging privatization programmes in the 1980s and 1990s.
Dynamic and technical efficiency
The theoretical comparison of a firm facing no competition (a monopolist) and a firm operating in a
perfectly competitive market is shown in Figure 6.1. Perfect competition dictates that the price for the industry (and
thus for the firm) is determined by the intersection of the supply curve (which is also the marginal cost curve) and
demand (which equates with average revenue) and is shown as Pg in Figure 6.1. If, however, the industry were to be
taken over by a single firm (a monopolist) and costs and demand are initially unchanged, the marginal revenue curve


for the industry must lie within the original average revenue (demand curve). Thus the price charged by the profitmaximizing monopolist is P, higher than under perfect competition, and the output Q lower than under competitive
conditions. The monopolist therefore charges higher prices to the market and has no incentive to increase levels of
output. Equally, there is no incentive to reduce costs and promote internal efficiency to raise price/cost margins as the
firm is already earning supernormal profits. In reality, the price charged by the monopolist may or may not be higher
than under perfectly competitive conditions. Much depends on whether or not the monopolist benefits from
economies of scale. Where they do, the marginal cost curve moves to MC and the price charged would be lower than
under perfect competition.

Figure 6.1 Perfect competition versus pure monopoly

Within the EU, the only firms that could feasibly be considered as perfect monopolies are the enduring
nationalized industries. These firms, often regarded as political policy instruments, are renowned for their
inefficiency. Diseconomies of scale, bureaucratic systems and poor management by civil servants rather than trained
business people have all been cited as factors resulting in poor productivity, profits and overpriced goods and
services. Such X-inefficiency (the gap between actual costs and those theoretically attainable) is often postulated as a
problem specifically associated with large nationalized organizations. Overcoming these problems, however, is not
merely a question of privatization. Turning public monopolies into privately owned monopolies is likely to be more
detrimental than beneficial to the public good. Private monopolies unlike their public counterparts are not compelled
to provide goods and services which are unprofitable and without some form of compulsion by regulation, may fail
to do so.
Where the industry is characterized by a large number of small players, that is competition is imperfect
(monopolistic), firms face a downward-sloping demand curve (see Figure 6.2) as products are differentiated from
their competitors' and thus not complete substitutes. The small scale of firms also means limited scope for generating
scale economies in production. The industry demand curve reflects total demand for industry output at all prices
assuming all firms in the industry charge that price. An increase in the number of firms in the industry will shift the
demand curve for each firm to the left as market share falls. Thus, in the EU, as new entrants are encouraged to enter
markets and stimulate competition, demand for each individual firm will fall along with their corresponding level of
market share.

Figure 6.2 Imperfect competition versus new entry

In Figure 6.2, the firm's marginal revenue curve is shown as MR, its marginal cost curve MC and its demand curve D. As
the firm is a profit maximizer it will set MC equal to MR and produce output Qo at price Pp. With new competitors entering the
market (which is likely given the above-normal profits being earned by established companies), the firm's demand is reduced. The


demand curve moves to D), marginal revenue curve to MR^ and price falls to P, and output to Q,. Profit-maximizing firms under
these conditions are likely to reduce their costs and improve their internal technical efficiency as a way of preserving cost price
margins and thus levels of profitability. Quite unequivocally, the theoretical model of intensified competition predicts increased
Alternatively, in oligopolized markets decisions are made on the understanding that any change in strategy is likely to
meet competitor reaction. This raises the likelihood of firms colluding - several European examples will be established in this text
- completing explicit or implicit agreements with their competitors to actively avoid competition. Therefore, by co-operating on
levels of shared output oligopolists may behave as monopolists aggregating marginal costs and equating them with marginal
revenue for the whole industry. Collusion of this kind involves explicit agreement and a high degree of co-ordination, which, as
the number of players increases, is hard to sustain. Any increase in output by one player will immediately depress prices and
prevent the realization of optimized profits. More commonly, firms in oligopolized markets do not, as a matter of course, involve
themselves in aggressive price competition which can potentially lead to price wars and be damaging for all players. Instead,
oligopolized markets are characterized by competition based on differentiation rather than on prices. As collusion and cartels curb
the extent to which firms engage in price competition and promote heightened technical efficiency the Commission has
specifically targeted these practices as detrimental to competition and the achievement of a Single European Market. However,
because oligopolized firms are not exempt from competition they do not ignore efficiency altogether.
The stimulation of differentiation and new product development are also critical elements in the promotion of efficiency
through competition. Dynamic efficiency, which refers to the rapid development of new technologies and products, is essential for
firms to keep one step ahead of their rivals in highly competitive markets. Improvements in organizational form, production
techniques, management systems, products and services, and distribution systems, performed continuously, all contribute to
enhancing the competitive potential of firms to compete both in the EU and in other international markets. Whilst technical
efficiency involves establishing the most appropriate processes to facilitate best practices, dynamic efficiency concerns the
ongoing evolutionary development of the organization. Both are fostered through competition which means that firms who do not
continue to develop in line with other competitors will either be taken over or simply fail to survive.

EU competition law
It is to be recalled that the EU's rules on competition are in direct relation to:
concerted (or restrictive) practices,
abuse of dominant positions,
concentrations (by merger or acquisition), and
state aids.
In the terms of Wilks and McGowan (1995, p. 261), these operate as a form of 'economic constitution' guaranteeing the
maintenance of liberal order and ensuring that competition in the internal market is not distorted. The articles concerned (and
associated regulations) apply only in so far as the behaviour or practice at stake affects trade between member states. This is
intended to distinguish the scope of Community law from that of national law.

Concerted practices (Article 81, ex Article 85)

Article 81 (ex Article 85) bans cartels, price-fixing and other forms of collusion, where such has the effect of restricting
competition within the common market. It asserts that such practices are 'incompatible with the common market', forbidding all
agreements between undertakings which have as their object (or effect) 'the prevention, restriction or distortion of competition'.
Paragraph 1 of the Article explicitly prohibits those agreements and concerted practices which:
(a) directly or indirectly fix purchase or selling prices or any other trading conditions;
(b) limit or control production, markets, technical development or investment;
(c) share markets or sources of supply;
(d) apply dissimilar conditions to equivalent transactions with other trading parties;
(e) make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature
or according to commercial usage, have no connection with the subject of such contracts.
Paragraph 2 declares such agreements to be void unless exempt under the 'group' or 'block' exemptions set out in the Article's third
paragraph. Delimiting the effective coverage of Community controls, these exemptions can be seen to cover:
(a) Specialization agreements - horizontal production agreements which involve the participating firms each specializing in the
production of a particular product or product group. The justification for permitting this kind of activity is to allow small and
medium-size firms the potential to rationalize production efforts, improve their efficiency and strengthen their competitive
position vis-a-vis larger firms. Consequently the exemption only covers agreements between small and medium-sized firms based
on market share and turnover. Twenty per cent marketshare on specialized products and combined turnover of 500 million are
the current thresholds. Other stipulations dictate that agreements must be reciprocal and must only apply to the nature of products
and not to the volume of production or prices.
(b) Exclusive distribution agreements - where stipulations are made by the manufacturer on the permissible sales territory and
the sale of competitor products. These are sometimes considered beneficial as a result of their ability to promote efficiency in
distribution as well as facilitate unification. The concept of parallel imports is critical here, as traders other than exclusive
distributors who buy from third parties in other markets provide competition for the firm that has been granted exclusive rights.
Any attempts to hinder parallel importing therefore render the group exemption inapplicable. Equally, no restrictions may be
applied in respect of prices or customers, and agreements cannot be made between competing firms as this will lead to market
sharing, except where one or both parties have an annual turnover of less than 100 million. There has been some infringement of


these rules in the European motor vehicle industry, where a block exemption covering distribution and servicing agreements
continues to apply.
(c) Exclusive purchasing agreements, such as those for beer and petrol (EEC/194/EEC), involve the reseller agreeing to buy
exclusively from a specific manufacturer. These restrictions can make it difficult for competitors to penetrate the market and
consequently there are limitations on the duration of such obligations (five years) and on the nature of products covered (applying
only to those which are connected to each other).
(d)Patent licensing agreements, which may pose restrictions in terms of territorial rights and the exclusivity conferred on the
licensee, do provide access to technologies for those firms without the potential to innovate, and market access for small
innovating firms lacking the capacity to sell on a pan-European scale. Three main principles cover the group exemption in this
case: a degree of protection afforded to both the licensor and licensee to ensure continued R&D effort by the innovator and ensure
a favourable environment for technology transfer, assurance of effective competition and intra-EU trade for patented products and
legal security of the contract partners. Territorial restrictions cannot be enforced, although licensees may only sell in other
licensees' territories in response to unsolicited orders, they may not actively sell or manufacture. Regulations do not exempt
obligations for licensees to buy materials and components from the licensor (often undertaken to protect the invention) to pay a
minimum royalty, to observe technological secrecy and use the technology only in connection with production of the designated
(e) Research and development agreements, which have always been regarded favourably by the Commission, are permissible so
long as competition in the final consumer market is preserved. This means that controls are applied to competing firms who
jointly exploit technologies (limiting them to 20% joint market share for products which may be improved or replaced by the new
technology), and all parties are afforded right of access to results and freedom of distribution.
(f) Franchising agreements, which have become more prevalent in the EU in recent years, usually involve licences covering
industrial or intellectual property rights (trademarks, brandnames or know-how). They are regarded as having a generally positive
effect on competition allowing franchisors to develop a wide and uniform distribution network without major investment. This has
the potential to introduce new competition (particularly for small and medium-size firms), allows rapid expansion and extends
interbrand competition. This clearly benefits consumers as it offers them wider choice and the advantages which result from
standardized, efficient distribution. Franchise operations are seen as being very different from exclusive distribution and
purchasing agreements as a result of the advantages offered, although the block exemption applies only to distribution and service
franchises and not to those in the manufacturing sector.
(g) Know-how licensing, like patent licensing, benefits the economy by facilitating technology transfer and innovation although
territorial restrictions can stifle competition. As a result of the irreversible nature of knowledge transfer (once attained it cannot be
retracted), the Commission was keen to provide greater legal certainty for involved parties on how agreements fit into existing
competition policy. The policies which apply to patent licensing also apply here with provision being made for restrictions which
are not considered to be damaging to competition: obligations to maintain the secrecy of know-how by the licensee after
termination of the agreement; obligations that the licensee divulge any experience gained in exploiting the know-how and the
granting of non-exclusive licences to the licensor when improvements and new applications are revealed. By permitting such
arrangements the potential to maintain a degree of monopoly over know-how is designed to facilitate its licensing (and implicitly
its sharing).
Special exemptions may also be awarded where the harmful effects of restrictive agreements are more than compensated
for by particular benefits. Article 81 identifies four conditions for the granting of such exemptions:
1. where improvements are made in production, distribution or economic progress such as cost reductions or capacity increases;
2. where a fair share of the benefits accrues to consumers (be they final consumers or trading companies) such as lower prices or
the improved quality of goods and services;
3. only agreements which actively contribute to the additional benefits will be permitted;
4. a degree of competition must exist in a substantial part of the goods and services supplied.
As explained in the European Parliament's fact-sheet on EU competition rules:
(in aggregate) these exemptions are designed to simplify the Commission's administrative task so it does not have to deal
individually with too many concerted practice cases and make it easier for companies to fulfil their obligations by giving certain
types of action a general prior exemption. (European Parliament, 1999a)
With similar aim, and given the desire to promote co-operation amongst and between smaller enterprises, Article 81 also
excludes concerted practices (with a Community dimension) below agreed thresholds. Where the aggregate turnover of the
involved parties is less than 200 million, and where the goods or services covered by an agreement represent less than 5% of the
total market, Article 81 shall not apply and notification is unnecessary. This is the so-called 'de minimus' principle further detailed
in the Commission's 'Notice on Minor Agreements'. Also exempt are activities between parent companies and their subsidiaries or
between the subsidiaries themselves. As these activities involve one economic unit, they fall outside of the scope of Article 81
except where the subsidiary is deemed to have freedom to determine its own course of action.

Dominant positions (Article 82, ex Article 86)

Article 82 addresses a rather different problem: the abuse of a dominant trading position. Dominance itself is not
prohibited but abuse of it is, at least if it affects trade between member states. In the basket of EU competition rules, the place of
Article 82 is important in that there will always be a fear that large firms (enjoying a dominant market position) may make it hard
for smaller firms to compete. To guard against what might be termed 'abuse' of market advantage, the Article asserts:


Any abuse by one or more undertakings of a dominant position within the common market or in a substantial part of it shall be
prohibited as incompatible with the common market insofar as it may affect trade between Member States.
The Article gives examples of abusive practice, including:
low pricing with the object of eliminating a competitor
discriminatory pricing between or within member states
retaining customers by granting fidelity rebates
limiting production, markets or technical development to the prejudice of consumers
unjustified refusal to supply
imposing supplementary obligations which have no connection with the purpose of the contract
In recent practice, four principal criteria for establishing market dominance can be discerned from the decisions of the
Commission and the ECJ:
1. an undertaking's relative market share (greater than 40% implies dominance)
2. an undertaking's independence from its competitors
3. the ability to eliminate competition
4. dominant relationships with customers and suppliers
These criteria provide the acid test in assessment of cases and some flexibility in assessing a firm's impact on its market.

Applying Articles 81 and 82: the role of the Commission

The Commission is responsible for application of the rules under Articles 81 and 82. It investigates cases on application
by a third party (complainant) or on its own initiative. Despite notification procedures and the welter of exclusions considered
previously, there are numerous instances where such investigation is necessitated and where formal decisions are reached. As
regards complaints, the number received by the Commission in 1998 pursuant to Articles 81 and 82 was 192. Most of these were
of manifest Community relevance with only a small number of notified cases referred back to member state authorities. As
regards the number of cases instituted by the Commission on its own initiative, these numbered 101 in 1998, the same number as
in the previous year (European Commission, 1999a). Figure 5.3 locates these figures as part of a six-year trend towards increased
complaints, investigations and formal decisions.
A formal obligation to act is provided where a 'complaint' is made by a third party (say a company or trade association)
normally through a national competition authority. Only where the complaint relates to behaviour falling within the scope of
Community jurisdiction will the national authority pass the matter on to the European Commission. If the complainant has a
legitimate interest in the termination of the behaviour under question and can show why and how the alleged infringement
prevents fair competition, then the Commission is obliged to investigate the situation. Where investigations show that the
complainant has a legitimate claim, the Commission must take the necessary steps to put an end to the infringement. Where no
proof of infringement can be found, the Commission is obliged to inform the complainant of its decision and the reasoning behind
it and give him or her the chance to provide further information.

Figure 6.3 New EU anti-trust cases, 1993-98

Source: European Commission (1999a, p. 45)
The first stage of assessment normally involves the collection of information through either direct requests or formal
investigations. This involves not only firms suspected of infringing rules but also third parties who are in a position to clarify


certain information as a result of their proximity to the market. Investigation teams have complete freedom to enter company
premises and to consult company documents, taking copies of any records they consider pertinent to the case. Although
companies do not have to admit investigators, failure to do so will result in the Commission ordering the firm to comply by a
formal decision and a daily penalty of between 50 and 1,000 can be imposed in addition to a lump sum fine. Visits are usually
unannounced to prevent documents being destroyed in the interim. Where there is evidence of violation of Community rules,
hearings will be held with the companies for the purpose of subsequent assessment and to establish the facts of the case before
In reaching its decisions (and in determining its penalties), the Commission must weigh up the deliberate nature, gravity
and duration of any infringement where discovered. Guidelines authorise a 'starting point' for fines at 1 million but the
Commission is at liberty to impose fines of up to 1,000 million or 10% of the annual turnover of the parties concerned,
whichever is the larger. For very serious infringements, fines should start at no less than 20 million with the Commission taking
into account the different roles and resources of the undertakings concerned. Fines should be paid within three months although
they are subject to possible appeal. One case where Commission-imposed fines were successfully contested was in the case of the
European chemicals cartel. In April 1999, the European Court of First Instance cut fines for Elf Atochem (France), ICI (UK) and
Societe Artesienne de Vinyle (France) from a combined total of 6.1 billion to 4.29 billion, reducing individual levies by
between 33% and 66%. The original Commission fines, which followed exposure of a price-fixing cartel between twelve
European chemicals companies, were rejected on the grounds of 'flawed calculation of company market shares' (Financial Times,
21 April 1999). However, while these firms enjoyed success in their appeals, dangers in such action exist. Interest is added to the
value of the fine if any appeal is unsuccessful.
To encourage companies to co-operate more closely with the Commission when it is probing alleged breaches of ELJ
rules, the institution has now introduced a 'leniency' system under which firms involved in anti-competitive practices may have
their fines reduced by assisting with a Commission investigation. Such assistance - after an investigation has been started and
where a company does not substantially contest the facts on which the Commission bases its allegations - should encompass cooperating with officials and supplying them with information relevant to their investigations (European Voice, 5 July 1999).
Cartels, of course, are mostly secret agreements between companies, and without such co-operation it is difficult and time
consuming for the investigating unit to unravel and to expose the full extent of secret dealings.

Collusion and market-fixing - the application of Article 81

In the Commission's view, cartels keep the least efficient companies in the market, keep prices high, weaken the
production process and inflict considerable damage on the economy in general. Former EU Competition Commissioner, van Miert
has described them as 'pernicious arrangements'. Those engaged in this sort of behaviour, he claims, 'damage not only their
customers but also themselves by restricting efficiency and innovation'.
Although private cartels are by no means easy to uncover, offenders are often flagged by customers faced with continual
price rises from all producers and by rival firms being squeezed by the actions of large groups of market players. Therefore, while
the first responsibility of business managers with regard to competition policy is to ensure compliance, 'business managers must
be also alert to competitors acting in contravention of the policies' (El-Kahal, 1998, p. 50). Tip-offs in the building industry, for
example, have resulted in industry scrutiny and dawn raids on suspected firms, resulting in confiscation of documentation.
Thermal insulation, stainless steel and ready-mixed concrete all provide example of market sectors which have come under
scrutiny. Certain characteristics of the industry perhaps contribute to this tendency for collusion:
1. there is a relatively small number of suppliers in each national market, making it easier to negotiate co-operative market sharing
and price fixing;
2. material costs are a relatively small proportion of total development costs which means that customers are more concerned
about delivery schedules than price;
3. many of the materials are bulky, raising transportation costs, localizing competition and severely restricting cross-border trade;
4. customers are often able to hand on price rises to end-users and demand tends to be inelastic.
Evidence suggests that DG-IV (the Commission's Competition Directorate) has had increasing success in busting cartels tied to
the building industry with, in many cases, fines resulting of up to 10% of company turnover. For example, on 30 November 1994,
the European Commission imposed fines totalling ECU 248 million on thirty-three cement producers found to have participated
in secret arrangements to rig markets over a period of more than ten years. The decision affected suppliers in the then twelve EU
states as well as in Norway, Sweden and Switzerland. The largest fines were imposed on Italcementi (ECU 32.5 million), la
Societe de Ciments Francaise (ECU 24.7 million), Lafarge Coppee (ECU 22.8 million) and Blue Circle (ECU 15.8 million).
Another price-fixing agreement involving sixteen steel makers (including British Steel) was also broken around this time, leading
to total fines of 78 million. In this case, the parties were judged guilty of breaching competition rules over a ten-year period by
fixing prices of beams supplied to the building industry and sharing out the market among them. More recently, the European
Commission fined ten companies a total of ECU 92.21 million in 1998 for running an elaborate cartel in insulated heating pipes .
A wide variety of other industries have also faced the same kind of analysis -carton-boards, sugar and plastics to name
but a few - leading to further success for a now formalized Commission cartel unit. In July 1994, the Commission announced
fines totaling over 100 million on nineteen companies found to have fixed prices over several years in the market for cardboard
packaging. In 1998, the Commission also prohibited an agreement between four sugar producers who had developed a
collaborative strategy of higher pricing. Fines totalling ECU 50.2 million were imposed on the participating companies - British
Sugar, Tate & Lyie, Napier Brown and James Budgett. Further cases were concluded in the areas of stainless steel and of ferry
services in the Adriatic waters.


Abuse of a dominant position - the application of Article 82

Preceding analysis has made clear that while a dominant position is not, in itself, considered to be detrimental to the
economic health of the EU, abuse of that position, hindering the maintenance of effective competition by acting independently of
competitors and customers, runs contrary to EU objectives. Relating back to the basic ruling, it has to be proved that the firm is
abusing its dominant position in the product market or a major proportion of it.
Much as the Commission has acted to invoke Article 81, so it has acted to apply Article 82. In fact, the number of
formal cases pursuant to the Article has increased steadily over recent years. According to its XXVIIIth Report on Competition
Policy, the Commission concluded six cases under the Article in 1998 and launched a number of fresh investigations. The upward
trend in action has continued in 1999 with the Commission initiating a number of investigations focused on supplier-distributor
relationships and examining various concerns relating to telecommunication and Internet services. Internet infrastructure and
related services are of particular interest in that the Commission confronts substantial challenges with respect to market definition.
As in its management of AOL Europe's complaint against Deutsche Telekom - in early 1999 AOL accused the German giant of
predatory pricing and discriminatory practice through its own Internet subsidiary company - the Commission must ask which
aspects of Internet services constitute separate markets.
Of those recently concluded cases, two provide a quick illustration of the issues attaching to the application of Article
82. In the Amministrazione Aiitonoma del Monopoli dello Stato (AAMS) case, Italian cigarette producer and distributor AAMS
had a dominant position on the Italian market for the wholesale distribution of cigarettes. The Commission ruled that the company
was imposing restrictive distribution contracts on a series of foreign producers. The effect was to protect AAMS's own sales and
to limit the access of foreign cigarettes to the Italian market. In 1998, the Commission fined AAMS ECU 6 million and ordered it
to put an end to the infringement. In the British Airways case, the UK carrier was fined 6.8 million in early 1999 when found to
be creating an illegal barrier to airlines wishing to compete against it. BA was found to be in breach of Article 82 by offering extra
commission to travel agents that promoted its tickets over those of the airline's rivals. These included complainant Virgin Atlantic.
The Commission has warned that other airlines could face similar penalties where found to be operating anticompetitive loyalty
schemes with travel agents.

The role of the member states

Treaty articles in the anti-trust field apply only to an agreement or dominant position in so far as they
impede trade between member states. Hence, where an agreement has no perceptible effects on trade flows between
the member states then domestic competition law applies. Most member states have their own competition laws and
authorities, and these are important to anti-trust regulation inside individual EU countries. Although EU law is
binding on all member countries, national governments are free to operate their own national legislative frameworks
and to determine the nature and scope of domestic anti-trust rules. Indeed, while some member states have remodelled their domestic competition policies on the principles of EU law, significant differences in national rules on
competition persist (see Turner, 1995). For example, while Finnish competition law now relies almost entirely on EU
legislation, German competition rules (especially on market dominance) remain strongly influenced by preceding
domestic codes.
Thus, while domestic legislation can be closely aligned with the principles of supranational law, and while
there is close co-operation between national and supranational authorities, national competition bodies remain
independent and important authorities in their own right, governing those many competition infringements that lack a
Community dimension. To illustrate this point, the following examples of recent national action may be considered:
1. In 1997, the Finnish Competition Council imposed on Finland's major dairy products company Valio a
competition infringement fine of FIM5 million. This was for its abuse of a dominant position in the national liquid
dairy products markets.
2. In 1997, Germany's competition authority, the Bundeskartellamt, detected a cartel of power cable manufacturers in
the German market. Case investigation concluded in 1998 with fines totaling DM280 million.
3. In the summer of 1999, Volvo Car UK admitted supporting secret agreements to fix its car prices in the UK. This
admission followed an investigation by the United Kingdom's Office of Fair Trading (OFT) which uncovered
evidence of an agreement by Volvo dealers not to offer discounts beyond set levels. Volvo has given assurances that
it will not support price-fixing cartels operated by its dealers.
National courts and competition authorities also have a central role to play in support of the Commission's
activities at EU level. The power to apply the provisions of Articles 81 and 82 are vested simultaneously in the
Commission and the national courts (direct effect) and it is open for complainants to commence legal proceedings
with reference to Community articles in their national courts. Meanwhile, competition authorities in the member
states play a crucial rule in detecting breaches of Community competition rules within their own territory.
It is also clear that in the decentralization process envisaged by the Commission for the future execution of
anti-trust cases, national competition authorities are to be central players. Where national authorities are approved by
the Commission and where they can guarantee effective protection of individuals' Community competition rights,
they may in future receive and execute decentralized anti-trust complaints pursuant to Article 81 (see Davison and


Fitzpatrick, 1998). Although European competition authorities vary tremendously in terms of their experience,
reputation and sophistication, the Commission is having to consider such a 'decentralization' of powers in an attempt
to reduce and to focus its case burden. Articles 81 and 82 make no specific provision for the control of European
concentrations (acquisitions or mergers) which will often create or strengthen a dominant market position. In
December 1989, a European Merger Control Regulation (MCR) no. 4063/89 was agreed in order to fill this void and
to strengthen the Community's ability to regulate M&A activity. The rules under this regulation - as recently
amended by Regulation 1310/97 - allow prior investigation and thus prevent mergers that would give rise to an abuse
of a dominant position on the Community market before they happen. The Commission is empowered to declare a
concentration with a Community dimension (CCD), pulling it under its sole jurisdiction, and to assess its
compatibility with the common market. Incompatibility is established where that concentration creates or strengthens
a dominant market position so as to impede effective competition. Where a concentration lacks a Community
dimension it comes under national competition policy rather than EU regulation. Investigation applies to companies
in all economic sectors when they are proposing a concentration by means of merger, acquisition or the creation of a
joint company and where the concentration has a Community dimension. With effect from September 1990, this
dimension has obtained where:
the combined turnover of all parties is in excess of 5 billion;
the aggregate EU-wide turnover (of each of at least two of the undertakings) is in excess of 250 million;
each of the companies concerned generates no more than two-thirds of its aggregate Community-wide turnover in
one member state.
With many cross-frontier concentrations remaining below these thresholds, efforts have been made to
extend the scope of the MCR. Amendments made to Regulation 4064/89 by Regulation 1310/97 now ensure that
mergers will be considered as having a Community dimension, where they fall below the (original) 'global'
thresholds but satisfy the following requirements:
the merging parties must have a combined worldwide turnover of more than 2.5 billion;
in each of at least three member states, the combined turnover of all the companies concerned must exceed 100
in each of these three countries, the total turnover of at least two of the companies concerned must exceed 25
the aggregate Community-wide turnover of each of at least two of the undertakings concerned must exceed 100
The two-thirds rule also applies to this second category of Community mergers of which fourteen cases were notified
to the Commission in 1998 (amounting to 6% of all cases).
In effect, the Commission now has the competence to examine cases of a smaller scale and where multiple referral to the authorities of three or more member states
would otherwise take place. These cases will now benefit from the simplicity and legal security of Communitylevel control or 'a one stop shop' for merger approval. This change to EU merger controls emerged as an alternative
to a reduction in the global and Community thresholds set out in Regulation 4064/89. The French, Spanish, German
and British governments all rejected Commission proposals to lower the aggregate worldwide turnover threshold to
2 billion and the aggregate EU-wide threshold to 100 million.
Defining the market
Again, as in anti-trust investigations, the task force has to decide what constitutes the market. On the surface
this appears to be an easy task whereas in practice it can be highly complex. As discussed with reference to Articles
81 and 82, the Commission has traditionally taken a narrow view of what constitutes a market, building on the
concept of demand side substitutability. Indeed, the Commission's Notification of Acquisitions form provides the
following definition:
A relevant product market comprises all those products and/or services which are regarded as
interchangeable or substitutable by the consumer by reason of the products' characteristics, their prices and their
intended use.
Nevertheless, supply side factors have also been considered. The case of metal containers serves to highlight
this point. In the takeover of the British company Metal Box Packaging by the French concern Carnaud, the market
was, initially, taken to be metal containers. Conversely, in parallel mergers between USA metal packaging companies
the product market has been defined to encompass metal containers, glass bottles and plastic containers. The
Commission's argument for taking a narrower definition of the market centred on production switching difficulties in
the context of glass, plastic and metal packaging. Calculations of market share, highly dependent on the definition of
market boundaries, showed a wide disparity in the Metal Box case. Whereas the merged firm would have had a
combined turnover of 2 billion in a packaging market worth 35 billion, in the more narrowly denned metal
packaging market it would have had a dominant position and thus have been rejected under new legislation. Similar


claims were made by the Commission in the merger of Metallgesellshaft and Safic Alcan (1991), where the differing
production techniques of natural rubber and latex meant they were treated as separate products resulting in a narrow
definition of the market. Debates about identifying the 'relevant market' when undertaking an appraisal were also
central to the de Havilland case (1991) in which the Commission vetoed Aerospatiale's (France) and Alenia's (Italy)
attempts to take over Canadian aircraft maker de Havilland. In assessing the competition effects of the proposed
concentration, the Commission defined the product market ('regional turbo-prop commuter aircraft') and subdivided
the market into segments in such a way that gave the highest market share possible to the concerned parties. Its
decision to block the acquisition therefore rested, in large part, with its methodology of describing and analysing the
Questions of distinction also apply to services. In analysis of proposed concentrations in accountancy,
insurance, financial and Internet access services, the Commission has established (and employed) evidence of the
existence of separate and distinct markets, for example, statutory auditing (within accountancy services), credit
insurance (within commercial insurance) and 'universal connectivity' (within the realm of Internet services). Here,
and in more traditional sectors, if markets are defined too narrowly this can prevent mergers which do not distort
competition and which may actually increase efficiency. Alternatively, if markets are defined too broadly then they
will permit mergers to go ahead which act against the public interest by permitting a dominant market position to be
Of course, along with product market definitions, there are also geographic boundaries to be considered as
with cases pursuant to Articles 81 and 82. In seeking to assess the homogeneity of competition within a geographical
area, the Commission's decisions have taken into account several factors. Among others, we can count the
geographical distribution of market shares, transportation costs (which dictate the distance goods may be moved
economically), market entry barriers, cultural preferences (which suggest whether or not goods stand a chance of
penetrating foreign markets) and differing competitive conditions. Different cases have resulted in very different
geographic market definitions. In a number of concentrations tied to the automotive components sector (see DENSOMagneti Morelli and others) the relevant geographic market has been identified as that of the European Economic
Area (EEA). Such a definition has been based on the reasoning that:
transportation costs within the EEA are not significant
there are no obstacles to intra-EEA trade
prices are similar throughout Europe
suppliers tend to serve the entire EEA from only a few plants located within it
similar conditions of competition apply throughout the EEA
suppliers tend to treat the EEA as a distinct product market in planning their production, sales and marketing
In other cases and in certain sectors of activity marked by global competition, the Commission has carried
out competition analyses on markets that it deems to be 'worldwide'. With respect to transatlantic airline services
(e.g. the Boeing-McDonnell Douglas case), telecommunications alliances (e.g. Atlas-Global One) and other markets
such as steel and platinum, the Commission has identified 'world markets' in a number of recent cases. As is made
clear by EU officials (European Commission, 1999a, p. 44):
As globalisation of markets progresses, the Commission is increasingly Carrying out competition analysis
on markets which are not confined to Europe ... [and] even where the market is identified as 'European', the
Commission may take account of potential competition from other geographical areas when assessing a transaction.
Procedure and action
Companies involved in agreements or mergers or considering mergers which could affect competition
within the EU, and which could fall under the MCR, should notify the European Commission in advance. The first
imposition by the Commission of a financial penalty for a failure to do this was in 1998. The nature of the
applications procedure has been very clearly outlined, with further formalization of initial stage I proceedings.
Within a week of announcing the merger the firms involved must complete and return to the Commission a
notification form which comprises detailed questions covering a wide range of aspects including prices charged in
the EU and relative market shares. Although the detailed nature of the questions included on the form has caused a
certain amount of dissent among firms, the Commission asserts that it is necessary if they are to make a stage I
decision (within thirty days) once the prior notification requirement has been complied with. At this first stage, the
Commission may decide:
(a) That the notified concentration falls outside of the scope of the Regulation,
(b) That the notified concentration falls within the scope of the Regulation but does not raise serious concerns, or
(c) That the notified concentration falls within the scope of the Regulation and requires detailed consideration on the
grounds that there are serious doubts about the concentration's compatibility with the common market.


In the first example (a), supranational authorities are uninvolved in any subsequent appraisal. In the second
example (b), clearance is provided at stage I (perhaps subject to minor remedies). In the final example (c), unless the
notification is withdrawn, a detailed investigation is conducted in to whether or not the proposal creates or
strengthens a dominant position on the relevant market. There is a four-month time limit to such an investigation
(second stage proceedings) culminating in a formal Commission decision. The proposed merger cannot go ahead
until the Commission's final decision has been taken. At this stage, the parties are provided with fresh opportunity to
modify their concentration plans (so as to avoid their rejection) and many plans are actually withdrawn in order to
avoid an adverse final decision. For example, phase II investigation was already under way in 1998 when merger
plans were withdrawn between publishers Reed Elsevier and Wolters Kluwer. The Commission found grounds for
concern about the merger's impact on competition in the global markets for academic journals and books, for
professional books on law and taxation (in a number of EU member states) and for various kinds of dictionary and
business publications. Amid growing concerns that it would either block the merger or demand large-scale
divestments, the 17 billion merger plan was abandoned.
Although the Commission has formally vetoed only a handful of mergers under the MCR, it is clear then
that many planned tie-ups have been scrapped or abandoned (following EU investigation) before a formal decision
has been made necessary. It is also clear that several mergers (e.g. Nestle-Perrier and Zeneca-Astra) have been
authorized on strict conditions and subject to undertakings established at the point of stage I or stage II proceedings.
These points should be borne in mind when considering the bottom-line figures in Table 5.1. These highlight only a
small number of formal prohibitions - just ten up to and including September 1999 -including those made in the
cases of Bertelsmann-Kirch-Premiere and Deutsche Telekom-Beta Research. Both of these merger plans were linked
to the German digital pay-TV market and were blocked by the Commission in 1998. Since the end of the reference
period for Table 6.1 (September 1999), two further mergers have been formally blocked: an all-Swedish merger of
truck, bus and coach builders Scania and Volvo and a proposed merger between UK tour operators Airtours and First
The rules on state aid (Articles 87-89, ex Articles 92-94)
Although the EU has developed a role in the supporting of certain industries and regions by financial
assistance, the Commission has a further responsibility to prohibit state aids if they affect the EU in any way. Under
the terms of Articles 87-89, the Commission must ensure that national governments do not unfairly favour their own
national businesses over those of other EU countries through the use of direct payments, grants, soft loans, tax
concessions and other forms of aid (see Box 5.1). Such aid can frustrate free competition in the EU not only by
preventing the most efficient allocation of resources but also by giving a substantial competitive advantage to
domestic producers.
As a general rule, Article 87 determines that all state aid to business is illegal insofar as it affects trade between the
member states of the EU. However, paragraphs 2 and 3 of Article 87 list various categories of aid which are
permissible. This provides member states with some genuine scope for public intervention in support of regions
and/or national industry and to support such wider Community goals as 'economic and social cohesion'.
Under Article 87(2) the following types of aid are permissible:
(a) aid having a social character, provided that such aid is granted without discrimination related to the origin of the
products concerned;
(b)aid to make good the damage caused by natural disasters or exceptional occurrences;
(c) aid granted to the economy of certain areas of the Federal Republic of Germany affected by the division of
Germany, insofar as such aid is required in order to compensate for the economic disadvantages caused by that
Under Article 87(3), the following may also be considered to be compatible with the common market:
(a) aid to promote the economic development of areas where the standard of living is abnormally low or where there
is serious underemployment (a platform for many national regional-aid schemes);
(b)aid to promote the execution of an important project of common European interest or to remedy a serious
disruption in a national or regional economy;
(c)aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does
not adversely affect trading conditions to an extent contrary to the common interest;
(d)aid to promote culture and heritage conservation where such aid does not affect trading conditions and
competition in the Community to an extent that is contrary to the common interest;
(e) such other categories of aid as may be specified by decision of the Council acting by a qualified majority on a
proposal from the Commission.


Box 6.1
Types of aid instrument
Interest subsidies received directly by the recipient
Tax credits and other tax measures
Tax allowances, exemptions and rate relief
Reductions in social security contributions
Sale or rental of public land or property at prices below market value
Equity participation (including debt conversions)
Soft loans from public or private sources
Participatory loans from public or private sources

Hence, a wide range of national- and Union-level investment subsidies are available under specific
conditions and particular classes of aid (e.g. regional aid measures) are given clearance where in accordance with
Treaty terms. It should be clear, therefore, that state aid control at EU level is not about prohibition of aid but about
attenuating action that unduly distorts competition in the European Union. The central task rests with monitoring and
regulating 'assistance' and with defining (and amending) the conditions under which states may provide specific
forms of structural and/or regional assistance. Accordingly, the Commission has sole responsibility for checking that
national aid schemes, which must be notified by member states under Article 88(3) of the Treaty, are compatible with
the aims of the Treaty. In all circumstances, aid measures must conform to Treaty obligations and must be limited to
the minimum necessary to achieve the desired purpose. For example, any and all sectoral aid must, to be acceptable,
aim to restore long-term viability by resolving structural problems including, where necessary, the reduction of
capacity. State aids are quite capable of falling foul of these rules and the Commission will ban assistance that is not
compatible with the SEM or that is being misused. The most celebrated example here was the coming to blows of the
Commission with the German federal government (and the regional German government of Lower Saxony) in 1995.
At this time, the Commission blocked DM240 million of a proposed DM780 million in 'regional' subsidies for
Volkswagen to build two plants in the East German state of Saxony. The Commission ruled that the aid was illegal
because VW had first agreed to invest DM3.5 billion to assist East German development if it received clearance for
this sum. When the carmaker scaled down its total investment, improperly, it received the same sum of aid. In this
case, as in others, a Commission decision prompted an immediate legal challenge via the European Court of Justice.
Arguments surrounding subsidies
Economic theory has generally failed to advance a persuasive case in favour of state subsidies although there may be
specific cases where state aid is justified as a result of market imperfections. The first is where the social benefit may
be greater than the benefit derived by the individual firm, that is where there are externalities (spillover effects). For
example, it is argued that some research and development (R&D) initiatives result in greater social benefits than
returns to the individual organization. Second, in high technology sectors, which are consumptive of up-front capital
and R&D costs, there are high returns to scale which make it difficult for firms to compete with incumbents (the
infant industry argument). Third, there are instances where, as a result of imperfections in information in the capital
market, firms are more able to assess the risks of new projects and new investments than the credit institutions. This
results in lenders charging high interest rates making socially desirable investments unprofitable for the private firm
and providing a case for government-supported loans. Finally, there may be cases where (on social grounds) help is
needed to create jobs and to overcome barriers to future competitiveness.
However (and irrespective of the security of these claims), the bulk of such subsidies in Europe go not to
new industries with a future or to those generating positive externalities, but to ailing giants in industries such as
ship-building, coalmining and motor vehicles. As succinctly put by The Economist publication in a scathing attack on
European subsidies (The Economist, 1997, p. 75):
The benefits of competition between European airlines, car makers, energy firms, banks, chemical
companies and the rest have all, at various times, been dissipated by governments that have merrily bailed out losers.
Cost control and efficiency go out of the window when firms expect state support if things go wrong. Strained public
budgets are stretched further by the cost of subsidies.
This statement highlights just some of the reasons why subsidies may not work even in the circumstances
previously considered:
1. Governments tend to be less able to pick winners than the private sector because their decisions are often obscured
by social pressures and a lack of expertise.
2. Government-supported R&D may simply replace private sector R&D and may not add to a net overall increase in


3. Even if there appears to be an economic case for a subsidy, calculating the exact amount is difficult and can result
in too much subsidy being paid which can worsen the distortion.
4. Export subsidies paid to firms in one country are likely to be matched by governments in others, leading to a
subsidy war which acts as a drain on national resources.
5. The economic costs of subsidies can be high. As governments find money for subsidies, public budgets are
stretched and/or tax policies impact adversely on incentives to work.
6. Aid is often a way for governments to delay or prevent the demise of failing industries and/or non-viable
businesses with no long-term benefits as it simply puts off inevitable closures and redundancies.
Given such debate, and the financial and political investments associated with public aid decisions, it is relatively
unsurprising that state aids are such a sensitive area of ELJ activity. Indeed, the EU's determination to rein in the
granting of state aids (especially those given on an ad hoc basis) has come into sharp conflict with the determination
of many member governments to use aid, in one form or another, in order to protect domestic industries (see Case
Study 5.5). The scope for discretionary assistance under Article 87 and the matter of consistent (or inconsistent)
application of ED rules adds to this combustible mix. At the heart of present argument, the Commission continues to
warn that current aid levels are dangerously high. According to the findings of its seventh survey on state aid in the
European Union (European Commission, 1999b), state aid volumes to industry (manufacturing) have been fairly
consistent in recent years, at an average of 37.7 billion a year between 1995 and 1997 (see Table 5.2). The EU's
former Competition Commissioner, van Miert, has described this as a substantial problem resulting in serious market
distortions in many sectors. This position is well supported by the European Industrial Employers Federation
(UNICE) which says that companies damaged by unfair state handouts to competitors should be compensated.
Controlling state aids: future issues
The Commission is now looking at reform of notification procedures and to concentrate its vetting work on cases
involving large volumes of ad hoc aid. Some 60% of applications for state aid are approved after fairly brief
investigation and the Commission intends to use the device of block exemptions to limit and to concentrate its case
work. These should apply to small amounts of aid, to aid for SMEs, to the many aid forms designed to encourage
R&D and to measures in support of environmental protection. Brussels is also talking in terms of a more open policy
on state aid, looking to compile and to publish as much data as possible on aid volumes. DG-IV describes this as 'one
primary means by which the Commission is able to demonstrate that it is constantly keeping a close watch on public
interventions' (European Commission, 1999b, pp. 1-2). In addition, the EU is likely to take an increasingly tough
view of failures to notify aids and of attempts to abuse the principle of rescue aid. Many of its previous 'rescue'
clearances (e.g. of French aid to Air France and to Credit Lyonnaise) have provoked legal challenge on the grounds
that subsidies were without proper account of restructuring proposals or of previous subsidies. The Commission can
also be expected to continue its crackdown on preferential tax rates. As considered briefly in Chapter 4, the
Commission ruled in July 1998 that Ireland's 10% corporate tax rate for investing manufacturing companies
constituted a form of state aid. This suggests that predatory tax regimes are now a clear target.
Table 6.2 State aid to industry in current prices, 1993-97 (million Euro)


United Kingdom






Environment policy

Thanks to the
Treaty on European
environment has graduated to the status of
and falls into the
priority objectives of
constraints must be
integrated into the
Source: European Commission (1999b)
other EU policies. The
uniform application in all Member States of environmental standards is, in fact, indispensable not only for the
preservation of Europe's environment, but also for the good functioning of the internal market and for economic and
social cohesion.
It is very difficult to evaluate the specific results of the European measures in this area, first because the
quality of the environment is a highly subjective notion and therefore difficult to define, and secondly because the
policy to combat pollution is a Sisiphean task. The quality objectives that it lays down are incessantly thrust aside
by economic development and urbanisation. It is true that the annual reports of the Commission to the Parliament
and the Council on the implementation of the European Community's environment programme show a reduction of
ozone-depleting substances and improvements made in water quality and waste management. But, the state of the
environment overall remains a cause for concern, particularly in respect to monitoring of chemicals, waste
management, soil degradation and management of natural resources. In any case, a permanent vigilance is required
of citizens, who can lodge complaints with the Commission whenever they observe that European standards are not
being complied with by an undertaking or by public or private works in their country or a neighbouring country.
Likewise, mechanisms are needed for handling complaints and carrying out environmental investigations outside the
Moreover, the European Union cannot work in isolation in this field. Even if it were to succeed in
significantly reducing and preventing pollution in its territory, it would still be open to water and air pollution from
the other countries of Europe and the other regions of the world. For that reason the Union must play a leading role
in international negotiations and take more visible action in the framework of international organisations such as the
Council of Europe and the United Nations. It may thus summon others to comply to a greater extent with standards
agreed in international fora. Thus, the new economic departure of the East European countries, assisted by the
countries of the West, must go hand-in-hand with increased consideration of environmental constraints, which have
been tragically neglected in the past. The European Environment Agency, which is open to the other obvious as regards the second aspect of environment policy, namely that of the management of resources, in particular fauna and
flora. In this area it is the third world which faces some of the most threatening environmental problems and the most
serious at world level, viz.: desertification, excessive urbanisation, population explosion, extinction of wildlife and
destruction of the rainforests. The cooperation and development programmes of the European Union must lend
particular attention to these problems, notably that of rainforests, which constitute one of the planet's most important
natural resources.
In a European economy that undergoes structural change, the challenge facing those with responsibility for
environment policy is to develop instruments which will make it possible painlessly to achieve the objective of
growth which is compatible with the essential requirements of the environment. This involves foreseeing the
ecological problems of technological development and limiting them from the outset, for example by encouraging
the selection of new chemical products before they are launched on the market, the preparation of stringent safety
standards applicable to potentially dangerous manufacturing procedures, the disposal of waste without danger to the
environment or to human health and the systematic evaluation of the likely impact on the environment of any new
economic activity. Yet, there is no major conflict between economic growth and a healthy and clean environment.
On the other hand, the "environment industry" is probably in a position to help the European economies to
restructure themselves on new bases by directing them towards new activities that employ advanced technology and
a skilled workforce.
Promoting a sustainable economic growth in Europe entails the combination of more competitive industrial
production with less environmental degradation, more efficient use of energy and raw materials resources and higher


employment rates. Indeed, there can be a synergy between environmental policy and employment policy so as to
rectify the overuse of environmental resources and the underuse of human resources. However, this synergy is not
automatic, but has to be induced by certain measures, first and foremost being the restructuring of tax systems by
reducing non-wage labour costs and by incorporating environmental and resource costs into the market prices of
goods and services. In addition, environmental education and training coupled with financial incentives should
encourage public authorities, private and public companies and consumers to move towards cleaner, more environment friendly and more labour intensive production methods and products.


6.2 Sectoral Policy (Industrial and Enterprise Policy, Energy Policy, Common Transport Policy, Common Agricultural
Policy, Common Fisheries Policy)
EU industrial policy
Our focus on EU regional policy measures was launched by questioning the very legality of regional state assistance in
the EU member states under the EU's competition rules. Moving us away from this field, but with no less importance to the
shaping of competition in Europe, is the issue of industrial policy-making in Europe. The EU's approaches to industry and
competition are hardly unified but competition and industrial policy are closely related. Competition policy aims to offset market
failures arising from scale economies and market power. Industrial policy (at least in part) is designed to offset other sources of
market failure which arise in the production process. Moreover, like competition policy itself, the European Commission regards
industrial policy not as an end in itself but as a means of facilitating and defending the Single Market.
With respect to industrial policy, the EU's role is largely restricted to coordination and to setting an overall framework
for industry to operate within. All member states of the EU have their own industrial policies and there has been little effort to
substitute these or to erode sovereign authority in this field. The Treaty on European Union describes the task as ensuring that 'the
conditions necessary for the competitiveness of European industry exist' and the detail of Treaty provision makes clear the need
for co-operation between EU, national and subnational authorities. With respect to the EU's own tasks, the Treaty defines four
central challenges:
speeding up industry's adjustment to structural changes;
encouraging an environment in which initiative can thrive and in which undertakings, particularly small and medium sized, can
encouraging an environment favourable to co-operation between undertakings;
fostering a better exploitation of the results of innovation and of research and technological development which are of potential
value to industry.
EU industrial policy originated with the sectoral concentration of the Paris Treaty (1951) which initiated a series of
interventions in the coal and steel industries. However, no mention was made of industrial policy in the Rome Treaty, and,
although pressures for the development of a coherent European approach intensified during the 1970s, national authorities tended
to look to domestic measures in support of their ailing industries (e.g. steel, textiles, coal and ship-building). The lack of a clear
mandate at Community level provided little scope for co-ordinated efforts towards reform and restructuring at a time when
protectionism and other forms of government paternalism were widely employed. Even as a tug-of-war developed between
supporters of more (e.g. France and Italy) and less (e.g. the UK and the Netherlands) interventionist policies, support for greater
Community competence failed to swell. For many member states, there were already important sectors, e.g. coal, steel and
agriculture, where national governments had ceded powers and where promotional activities to the advantage of Community
undertakings could be jointly pursued.
Despite this, in the build-up to the IMP, the Council of Ministers adopted a Transnational Plan' designed to improve the
competitiveness of European industry through technological and industrial innovation and through enhanced cooperative
arrangements. In the period after the completion of the single market, EU industrial policy gathered speed around such objectives
and found clearer direction. The 1993 White Paper on Growth, Competitiveness and Employment (European Commission, 1993)
identified a number of issues concerning European competitiveness including the need to capitalize on the Community's industrial
strengths, to develop industrial co-operation and strategic alliances, and to target measures to ensure the competitive functioning
of markets. Today, EU industrial policy appears to have consolidated around these established principles and the further objectives
of promoting the access of European enterprises to the global market and of achieving success in the new information markets.
Consequently, in seeking to address the challenges of global competition and in order to promote fair and liberal competition in
the major industrial sectors, the member states have distanced themselves from many of the principles of the 1970s, therein
rejecting insularity and blanket protectionism. While 'industrial planning' is far from a redundant concept, European authorities
now largely subscribe to a mix of non-interventionist and (strategic) interventionist measures. In principle, these are to be taken
within the context of an open and competitive Community market, and with the purpose of responding to inherent industrial
weakness and to new forms of competition.
To complete this overview, the EU's industrial policy is now strategically designed to help European business and
industry to compete in the global marketplace (not to shield it from global market pressures) and to maximize the potential
benefits of the SEM. Although a framework for an integrated industrial policy is really yet to emerge (such a project still runs the
serious risk of political defeat), revisions to the Treaties have established a reasonably clear and coherent mission for common
efforts. The amended Article 157 TEC (ex Article 130) highlights the need for policies to:
encourage an open and competitive industrial sector,
smooth adjustments to structural change,
promote small and medium-sized enterprises,
encourage co-operation in R&D, and
modernize the industrial role of public administrations.
Supplementation has followed in the form of successive communications by DG-III (the directorate responsible for EU industrial
policy). In 1999, these have stressed the further need to:
eliminate institutional and regulatory barriers to the development of venture capital, and
to reinforce intangible investment in research, skills and training.


Backing research
Perhaps top of the agenda for improved competitiveness is the continued promotion of research and technological
development (R&TD). Knowledge-based industries are now outstripping traditional sectors in growth, capitalization and
exportability and, throughout industry, innovation is the key. In information technology, for example, 78% of revenue comes from
products that did not exist two years ago (EUR-OP News, 1999).
Since the SEA, R&TD has enjoyed its own Treaty Title and EU policy has expressed the clear objective of
'strengthening the scientific and technological bases of Community industry' (Article 163 TEC, ex Article 130f). In present shape,
policy aims to encourage industrial competitiveness by the promotion of R&TD activities and to co-ordinate Community-wide
research efforts. EU action is designed to complement national policy (all EU governments provide clearance, tax rebates and
other incentives to firms prepared to engage in collaborative R&D) and to give momentum to EU-based research. The EU directly
undertakes its own research activities (through its Joint Research Centre) and promotes and finances shared-cost or contract
research between private companies, research institutes and public bodies throughout the EU. Since the early 1980s the
development, sponsorship, co-ordination and financing of such research - usually to about 50% of the total cost - has been
pursued through a series of Framework Programmes dating back to 1983. Several research development projects have also been in
place, such as RACE (telecommunications), BRITE (industrial technology) and ESPRIT (information technology).

The fourth framework programme (1994-98)

Under the fourth framework programme, ECU 13.1 billion was spent on research and technological development in
information and communications, industrial technologies, biotechnology, the environment, transport and energy. Elsewhere,
funding was attached to technological co-operation with non-EU countries (ECU 790 million); dissemination and application of
results to small and medium-sized enterprises (ECU 600 million), and to the training and mobility of researchers (ECU 785
million). The overriding aim was to make the Community activities more selective so as to increase the economic spin-offs from
Community research and to enable European industry (and subcontractors) to go back on the offensive in international
competition. As noted in Chapter 3, there has been some evidence of success in this regard with an increased total of some 34,600
European patent applications filed by EU countries, well up on previous years. If not all of this improved performance can be
attributed to the EU Framework Programmes, it is nonetheless noteworthy that, in 1998,6,200 new projects were launched under
the Community Framework, involving some 28,000 partners and creating more than 90,000 collaborative links (European
Commission, 1999c). According to the Commission's research and technology directorate, these figures confirm 'the central
position now occupied by [the EC] Framework Programmes in the landscape of European research' (European Commission,

The fifth framework programme (1998-2002)

The fifth framework programme (FP5) sets out the present priorities for the European Union's research, technological
development and demonstration (RTD) activities for the period 1998-2002. These priorities have been identified on the basis of a
set of common criteria reflecting the major concerns of increasing industrial competitiveness and the quality of life for European
citizens. Specifically, twenty-three key actions are to be resourced under a 14.96 billion budget (see Figure 5.4). The funding for
FP5 - up 4.5% in real terms on FP4 - is divided between what the Commission calls 'horizontal' and 'thematic' programmes.

2413 -Quality of life and management of living resources
3 600 - User-friendly information society
2 705- Competitive and sustainable growth
3104- Energy, environment and sustainable development
475- Confirming the international role of Community research
363- Promotion of innovation and encouragement of participation of SMEs
1280-Improving human research potential and the socio-economic knowledge base
1020-joint Research Centre
Figure 6.4 Fifth Framework Programme budget 1998-2002 (in million Euros)
Source: European Commission
The horizontal programmes attract a 3,138 million share of the FP5 budget. Focus is on:
expanding Europe's socio-economic knowledge base (one key action);


ensuring SME research promotion;

confirming the international role of Community research; and
developing the EU's own Joint Research Centre.
The thematic programmes attract a 11,822 million share of FP5 funding and encompass twenty-two of the twenty-three new 'key
actions' and the areas of research that they cover. Focus is on:
life science (six key actions);
the information society (four key actions);
sustainable industrial growth (four key actions); and
energy and the environment (eight key actions).
Within this framework, individual action areas include the acquisition of critical technologies for aeronautics
(aerodynamics, flight mechanics etc.) and the development of economical, efficient and clean technologies for road and rail
vehicles. These and other projects are significant in their promotion of innovation and adaptation in European commercial sectors
and directly involve a small community of innovative firms. In Starlab for example, fifty-six partners - thirteen of them industrial
companies - are working on six biotechnology projects involving lactic acid bacteria (micro-organisms that develop in milk) and
the improvement of food product qualities and safety. Participation in such projects may also sow the seeds for profitable
collaborations and/or for independent corporate growth. For example, thanks to the support of the ESPRIT programme and of two
German lens and glass companies, the Dutch company ASM Lithographies has become a global market force in the printing of the
integrated circuits found in microprocessors. In another case, Pirelli is now positioned to exploit new commercial advantages from
a steel cord-rubber adhesion technology developed with Rhone Poulenc Chimie and scientific partners in the BRITE-EURAM
Euro-tyre project. Pirelli claims that tests have demonstrated the superiority of the new wire-rubber adhesion system and that it
will be incorporated into its next generation of top-end car types.
Critics of the EU's technology policies have, however, made persuasive claim that, since the inception of Community
R&D activities, there has been lots of research and little development. For some, the EC has concentrated unduly on precompetitive research (lying between basic research and applied commercial development) and has been slow in moving R&D
close enough to the market. Of course the failure of high-profile projects such as High Definition Television (HDTV) has added
fuel to the critics' fire. Critics also point out that the EU's research budget continues to represent only about 5% of overall civil
R&D spending in Europe. Despite this, there is renewed optimism that Community R&TD efforts are now more commercially
driven and better targeted. The EU is encouraging European firms to take full advantage of collaborative research activities and, in
many cases, is putting up the money. Its insistence on transnationality promotes cross-border activity (at least two partners from
different EU countries must participate in a project) and proposals are evaluated on merit, not proportional to member state
Enterprise policy
The Commission has addressed many of its recent communications in the different policy fields towards the specific
needs of small and medium-sized enterprises (SMEs). The broad aim has been to initiate further expansion and to create the
optimal competitive environment for SME business success, growth and co-operation. The single clearest manifestation of this
has been the establishment of a separate Directorate-General (and Commissioner post) for Enterprise, thereby creating a technical
distinction between industrial policy and enterprise policy.
The first measure establishing Community enterprise policy was the organization in 1983, following a proposal from the
European Parliament, of the European Year of Small and Medium-Sized Enterprises and Craft Industry. At its meeting in
Luxembourg on 2 and 3 December 1985, the European Council decided to institute an assessment of the impact of Community
proposals on SMEs and the preparation of measures to simplify their administrative, tax and regulatory environments. A new
SME 'task force' was set up in June 1986 and a concerted programme was launched later that year with two overriding aims:
creating a favourable environment for SME activities and providing services to support growth and to maintain their flexibility.
On the first point, the Commission concerned itself with fostering entrepreneurship, improving the administrative, competitive
and regulatory environments of smaller businesses, and with modifying company law. On the second, training and information
initiatives figured large, particularly in relation to export procedures, company formation and growth, innovation and co-operative
agreements. The 1986 initiative was followed up in 1989 with a new Council Decision on the improvement of the business
environment and the promotion of enterprise, and the allocation of more resources to the policy. It was also at this stage that the
new Directorate-General XXIII for Enterprise was established. Since these foundations were put in place, enterprise policy
objectives have been pursued through three multi-annual programmes adopted between 1994 and 1996. The most recent of these
was adopted on 14 November 1996 to cover the period 1997-2000. This now provides the legal and budgetary basis (127
million) for the Community's SME policy actions with the following principal objectives (European Commission, 1996):
to simplify and improve the administrative and regulatory business environment;
to improve the financial environment for enterprises;
to help SMEs to Europeanize and internationalize their strategies;
to enhance SME competitiveness and improve access to research, innovation and training;
to promote entrepreneurship and support special target groups.
The different elements, services and initiatives here are comprehensively profiled by DG XXIII at the following URL
location address: dg23/guide_en/index2.htm. In the context of present analysis, and given earlier
commentary on SMEs in Europe, two elements of enterprise policy are considered subsequently.


Communication and SME co-operation

In achieving many of its enterprise policy aims, the Commission has taken it upon itself to co-ordinate information
provision to ensure that firms are fully aware of their rights and opportunities in the European marketplace and to put Europe's
SMEs in easier contact with one another. This has resulted in organizational contact schemes such as 'Europarternariat' and the
establishment of 275 European Business Information Centres (EICs) across the EU, often linked to existing organizations such as
chambers of commerce. The European Commission, which is anxious to exploit the potential of EICs for the maximum benefit to
SMEs, has appointed EICs as 'first-stop shops' providing a first port of call for expert service and advice. This implies that the
EICs will refer businesses to other specialized networks or organizations when very specific assistance is required. The
Europarternariat scheme is designed to encourage small and medium-sized businesses from all over the Community (and third
countries) to establish business relationships with their counterparts in less-favoured regions or those suffering from industrial
decline. Under the programme, biannual events are organized where heads of SMEs from external regions which meet the specific
criteria for participating in the scheme are brought into contact with those in the host region. On average, 30-40% of enterprises in
the host region conclude co-operation agreements as a result of a Europartenariat conference.
Co-operation initiatives have in fact been paid reasonable attention since the early days of EC enterprise policy with the
formation of the BRE correspondents network in 1983 and the BC-NET network of business counsellors in 1988. These initiatives
assist SMEs (of any kind) with defined free, part- and full-cost services in their search for financial, technical and commercial
partners across Community borders. BC-NET handles both confidential and non-confidential requests and takes the inexperienced
or building enterprise through a series of stages. Although varying from case to case, this typically encompasses the design of a
co-operation profile and the registration and circulation of various details via the BC-NET database.

Research and Development: Integrating SMEs

In the light of the preceding analysis, it is also noteworthy that the Commission has actively encouraged the inclusion of SMEs in
the Community R&TD programmes. Some theorists argue that research monies should be channelled into larger grants and
concentrated on fewer advantaged players. However, there is no proof that larger institutions are better placed than smaller ones to
develop or to profit from new technologies and this kind of thinking has been flatly rejected by the Commission. Brussels
Enterprise and Research staffs have published statistics claiming that Europe's SMEs are innovating twice as much (per
employee) as large companies. Indeed, the Commission has placed great emphasis on the record of involvement of over 12,000
SMEs in the R&TD activities in the first four framework programmes. Technology stimulation measures for SMEs were actually
introduced in twelve of the specific RTD programmes under FP4 and there is a specific SME unit within the Commission services
responsible for RTD. Under FP5, horizontal programme number two, 'Promotion of innovation and encouragement of
participation of SMEs', will also make better use of research results by smaller firms and create a single entry point for SMEs to
EU programmes (EUR-OP News, 1999).

Energy Policy
There is a general impression that Community energy policy is nonexistent or at best inefficient. This
impression arises chiefly from confusion between energy policy and oil supply policy. The latter is clearly of vital
importance and is still lacking. But it is only a part of energy policy. It cannot be denied that the common coal, oil
and nuclear energy markets have been largely achieved thanks to Community policy. But their exist ence tends to be
taken for granted and similarly significant achievements are expected in the area of supply, notably oil supply. The
fact that the EEC Treaty did not provide for such a policy is often forgotten. The Treaty rarely set objectives in areas
not viewed as vital for the completion of the common market and at the time oil did not swing the economic weight
which it acquired in the coming years. Another fact often overlooked is that in thel960's, all the Member States chose
to boost industrial growth through low energy prices rather than promoting indigenous energy production by high
prices. This preference for the industrial rather than energy sector culminated, at Community level, in a system
diametrically opposed to the one existing for agriculture. It was a political decision, the advantages of which cannot
be denied, even with hindsight of the post-1973 events.
It must also be acknowledged that the system of production licences for international oil companies lulled
everyone into the idea that energy supply security was not a problem as such, and despite the Commission's warnings
to the contrary, the threat of crisis passed unnoticed until 1973. But even after the illusion was shattered, at the end of
1973, the policies conducted by the Member States separately and by the Community as a whole were for many
years fragmented, reflecting different national energy situations. The Member States, and this is their main failing,
have proven unable to conduct a coherent policy towards their main oil suppliers.
Nonetheless, after 1974 supply security moved to the top of priorities in the Council's Resolutions on energy
policy and targets were set for the reduction of dependence on imported oil. The Community adopted mea sures to
give it a clearer insight into the oil market, tightened up compulsory storage provisions, set up mechanisms to defuse
crisis both before and after the horse had bolted, financed technological development projects to work the oil
resources in the North Sea and rationalised energy consumption. This policy has been a considerable success, with
the Community attaining its main objective of reducing to around 40% dependence on imported oil. As a
consequence, at the peak of the Gulf crisis in January 1991, the Community had at its disposal oil reserves


representing more than 100 days of consumption and therefore enjoyed a breathing space of several weeks before it
would have been obliged to take the binding measures provided for in the crisis mechanism of the International
Energy Agency. This fact helped to prevent any upsurge of panic in the Community.
Thanks to the increase of internal production - notably in the North Sea - and to the diversification of fuels
and suppliers, the Union is now in a much more comfortable situation than the one the Community has experienced
in the mid-1970's. However, despite these improvements, the problems have not gone away. Given the different
energy situations and energy policies of the Member States, a sharp shift away from the present favourable world
energy situation could have a catastrophic impact on the internal market and on the economies of the Union. This
is why a policy framework is needed in which Member States are working towards agreed common objectives,
notably the development of nuclear, renewable sources and clean technologies, assisted by Community financial and
fiscal measures. The 1998 energy framework programme is a good instrument for the development of a more focused
and integrated Community energy policy, closely coordinated with other Community policies, notably the
environment and enterprise policies.
Energy is certainly an important factor determining the economic performance of a country or of a group of
countries such as the EU. The absence of a single market in energy is a serious competitive disadvantage for the
businesses of the European Union as compared with those of its main trading partners. However, economic
performance is not measured only by industrial competitiveness, but also by the welfare of citizens taking account of
the employment situation and the state of the environment. The reduction of greenhouse gas emissions requires
common policies, such as a sustained commitment to energy efficiency and energy saving, a commitment to make
more systematic use of energy sources with low or no C02 emissions and a reduction in the impact of the use of
energy sources with high C02 emissions. Therefore, the Community's Fifth Action Programme for Sustainable
Development takes the view that the best and most efficient way of integrating environmental concerns would be the
intemalisation of external costs and benefits, which still charge the society at large with a large part of the cost of
polluting activities. The intemalisation of external costs could be achieved through fiscal measures such as the
C02/energy tax proposed by the Commission, but since such a tax would risk to penalize the European industry
alone, whereas all polluting industries of developed countries should be equally concerned, the EU should use its
international weight to persuade other major industrial competitors to follow suit.
The availability of secure, sustainable and competitive sources of energy is essential to economic growth,
prosperity and quality of life in the industrialized world. Economic progress in the developing world will lead to
major increases in global energy demand, with possible implications for fuel prices, and could increase the already
adverse effects of energy consumption on health and the environment of the planet. These problems can only be
mitigated through concerted international effort to develop promising technologies and new energy sources. In view
of the expected growth in demand for energy worldwide, it is probable that, in the foreseeable future, increasing use
will be made of all potential energy sources. It is also probable that the Community energy policy will be faced with
major challenges in the near future. It will certainly be called to make a greater contribution than it has done in the
past to the achievement of the main objective of the EU Treaty, the ever-closer union of the peoples of Europe.
Transport Policy
Until the end of the 1980s, the Community achievements in the transport sector did not correspond to the
energy invested in it or to the clear need for progress on a policy expressly mentioned in the Treaty of Rome as a
crucial cornerstone of the common market. It is true that in the first thirty years of its existence, the Community
policy succeeded in harmonising admission conditions to the profession of transport operator, in abolishing fare,
fiscal and other such discrimination, while harmonising to a certain extent competition conditions for inland
transport. Viewed from this angle. Community social regulations in the area of road transport represent considerable
progress, both as regards the alignment of competition conditions and as regards social policy and traffic safety, with
notably the introduction of compulsory maximum driving periods per day and per week.
However, the market for goods carriage by road remained boxed in by a quota system, the railways were
undermined by State intervention, transport infrastructure was not planned at Community level and sea and air
transport remained outside the Community's action scope. Thus at the beginning of the 1980s, transport policy did
not correspond to the evolution in the economic integration of Europe. This point was forcefully made by the
European Parliament's proceedings against the Council for failure to act. Its case was at least partially upheld by the
Court of Justice in its ruling of May 22,1985.
The Council's failure to act was chiefly due to an absence of political commitment to pushing economic
integration in this field. However, it must be admitted that this field was particularly rough. The diversity of
structures in the five modes of transport was further heightened by the variety of situations in which they operated in
each of the Member States. These difficulties were further complicated by the often very technical nature of the
questions discussed. As a consequence, national experts, who prepared the Council meetings, played a very
important role in examining the Commission's proposals. Since these proposals, by their very nature, were likely to


upset the apple cart in transport systems and the economic policy concepts of the Member States, very often there
was exaggerated defence of national interest and sectoral perception of the problems which did not make sufficient
allowance for the requirements of Community integration.
Whether under pressure from the European Parliament and public opinion or the need to integrate transport
into the post-1992 Single Market, transport policy stepped on the accelerator in the middle of the 1980s,
particularly in three fields: road haulage, maritime transport and air transport.
The greatest breakthrough for Community transport policy has undoubtedly been in the area of liberalizing
international road haulage services. At the beginning of the 1980s, no one would have dared hope that within the
next decade, all the quotas applicable to cross-border transport within the Community would be replaced by a system
of Community licenses issued on the basis of qualitative criteria. Following the completion of the internal market,
this is viewed as something totally normal, as are generally viewed by the public the successes of European
integration. In any case, liberalization and integration serve each other, since road transport is one of the essential
cogwheels of the Single Market. The fact that the liberalization introduced gradually since the early 1990s has had
little impact on the road haulage market, with the most efficient cabotage hauliers being the most active, a situation
which is not expected to change following the cabotage quotas in 1998, shows that the fears of some Member States
of the common transport market upsetting their national markets were exaggerated.
In the area of maritime transport, which is the carrier for 85% of the EEC's external trade, the Member
States undertook to apply the rules of free competition and the principle of free provision of services to this sector.
They also agreed to fight unfair tariff practices and unsafe seafaring methods, while guaranteeing free access to
ocean trades and progressively to cabotage.
As regards air transport, the liberalization measures completed in 1992 have had a major impact on
competition between air carriers. Additional routes have been opened, new companies created, new services
introduced and monopolies put under pressure. Despite the fall in fares, most companies have achieved considerable
productivity improvements, have created jobs and have seen a return to profitability. Nevertheless, basic fares are
still too high if compared to those in other regions of the world, especially the United States; the costs of air transport
remain high, largely because of heavy infrastructure charges and airport fees; access to the market is still too
difficult, mainly due to bilateral agreements between the Member States and third countries; airport runways
capacity is limited due to a substantial increase in air traffic. The main concern for the future is even greater
saturation of the Community's airports and air corridors. To meet this challenge, air safety should be enhanced
through the creation of a European aviation safety authority.
In general, the European Union must find the answer to several challenges in the field of transport. In
particular, it must face the problems caused by the saturation of existing networks, the uneven modal split and
increasing pollution caused by most means of transport. At the same time, transport liberalisation involving the
arrival of new entrants and greater competition between operators, engenders important structural changes, technical
innovations and new investments; all, certainly, good developments, but which need to be coordinated at Community
level. To answer these challenges the Community should adopt an overall approach combining: improvements to
infrastructure and means of transport and their more rational use; enhancing the safety of users; achieving more
equitable working conditions and better environmental protection.
In view of the Amsterdam Treaty obligation to integrate the sustaina-ble development and the protection of
the environment into all Community policies, environmental requirements should be integrated into the common
transport policy. Developments of this policy should, therefore, be expected soon concerning in particular transport
pricing and environmental costs, revitalisation of rail transport and promotion of inland waterways, maritime
transport and combined transport, the sustainable development of air transport and environmental considerations in
external transport relations. These developments should also tend to improve the accessibility of peripheral or
disadvantaged regions in the interest of the economic cohesion of the Union.
Common transport policy must, thus, adopt a global approach consisting of going beyond the internal
market and promoting an integrated transport system, which should be environmentally and socially acceptable
and should provide a high level of safety for users and transport workers. To give a fair chance of success to this new
approach, the external costs, which are now largely paid by society, should be internalised. This intemalisation of
external costs would ensure the development of an environment-friendly and therefore sustainable transport system.
On the external front, the Community should have competence to negotiate and act in areas which concern the
internal market, such as access to this market of third-country operators and rules applicable to international
transport, including safety and environmental protection.


Common Agricultural Policy

CAP foundations and reforms
The objectives of the common agricultural policy are specified in Article 33 of the EC Treaty (ex-Art. 39): higher
agricultural productivity; guarantee of a fair standard of living to farmers; market stabilisation; supply security and
reasonable prices for consumers. In order to attain these objectives. Article 40 of the EEC Treaty (actual Art. 34 TEC) called
for the common organisation of agricultural markets which, depending on the product, could take one of three forms:
common coordination rules, compulsory coordination of the various national market organisations or European market
organisation. It is interesting to note that it is always this last and most stringent concept that has been applied to the common
organisation of agricultural markets.
The Treaty was also prudent as regards the applicability of competition rules to the agricultural sector, a sector
where State intervention was rife. According to Article 42 (actual Art. 36 TEC), the applicability of the general Articles on
competition was subordinated to specific provisions of the common agricultural policy. As early as 1962, however, the
Council decided that the Treaty competition rules applicable to undertakings (Art. 85 to 91 EEC, Art. 81 to 86 TEC) should
also be applied to agricultural undertakings. Only cooperatives and farming associations could be granted a special regime; as
it turned out, certain common market organisations assigned specific functions to producers' groups, thus involving them in
the common policy1.
Competition rules for State intervention (Art. 92 to 94 EEC, Art. 87 to 89 TEC) became applicable to agricultural
markets as and when common market organisations were established. Many of the market organisations consequently
incorporate specific provisions on national or Community aid. The Member States became obliged to notify the Commission
of all aid granted to agriculture as early as 1962. Since this date, aid to agriculture has been treated by the Commission in the
same way as all other national aid.
The other Articles of the Treaty devoted to agriculture were chiefly transitional provi sions. Article 43 EEC (Art. 37
TEC), however, was of special importance. It stipulated that a conference of the Member States was to be called by the
Commission as soon as the Treaty had entered into force to enable the Member States to compare their agricultural policies
and consequently come to an agreement on an outline of the common agricultural policy. This conference was called by the
Commission in Stresa in July 1958. Agricultural officials from the six signatory States, despite their different points of view
and different situations as importers or exporters of agricultural produce, succeeded in reaching a general agreement on the
protection of the common agricultural market against distorted external competition, on the need for a structural policy and a
farm price policy and on the principle that farmers should be paid in a manner comparable to workers in other sectors. The
Stresa Conference clarified the agricultural objectives of the Treaty, stipulating that for European agriculture to be
internationally competitive, its structures should be overhauled, but that the family nature of European farms should be
preserved; that for common farm prices to offer a decent standard of living, they must be set above world prices but not at a
level encouraging over-production2.
The Commission's first drafts of the common agricultural policy, submitted to the Council at the end of 1959, and
its first proposals for common market organizations in June 1960 were built on the foundations laid at Stresa. The
Commission's proposals fired the starting gun for the hard-hitting negotiations in the Council, which became known as
"agricultural marathons".

Each of these negotiating rounds produced a common market organization for the various agricultural
products: at the beginning of 1962, those for cereals, pigmeat and poultry meat, eggs, fruit and vegetables and
wine were in place; they were followed at the end of 1963 by those for rice, beef and veal and dairy products.
Despite the difficulties encountered in satisfying all the varying interests, it was to the credit of the young
Community that by the end of 1963 a common market organization existed for almost 85% of the agricultural
output of the then six Member States.
Three years later, however, the CAP came upon its first and only serious crisis, which shook the whole
Community. Indeed, the completion of the common agricultural policy required the Community to take control
of the Member States' expenditure under the common market organizations. The Commission suggested in
March 1965 that the common agricultural market be completed on July 1,1968, thus coinciding with the customs
union for industrial products. However, the Council failed to meet its deadlines and the Community lived
through the most serious crisis in its history. In order to press its points of view France under de Gaulle practiced
for seven months an "empty chair" policy in the Council and thus blocked any new Community initiative.
Work on the common agricultural policy only got back on track after the Luxembourg compromise of
January 28,1966. It culminated, in May 1966, in a Council agreement on Commission proposals for the
financing of the agricultural policy1. This agreement under its belt, the Council was able to make fresh progress
on the common market organization for practically all-agricultural products. Thanks to these decisions, the
common agricultural market was able to be an integral part of the customs union created on July 1, 1968.
CAP reforms
With most of the major decisions on the common market organisation thus taken, the Commission
turned its attention to structures. In December 1968 it submitted to the Council a "Memorandum on the reform of
agriculture in the European Economic Community:
Agriculture 1980", otherwise known as the Mansholt Plan after the Commissioner who had inspired it. On this
basis, the Council, after many "marathon sessions", adopted in April 1972 the Directives of the first reform of

the CAP dealing respectively: with the modernisation of farms; measures to encourage the cessation of farming
and the reallocation of utilised agricultural area for the purposes of structural improvement and the provision of
socio-economic guidance for and the acquisition of occupational skills by persons engaged in agriculture1.
The other structural measures which were adopted later on covered mountain and hill farming and
farming in certain less-favoured areas, the processing and marketing of agricultural produce and producer groups
and associations thereof. But other problems also emerged, such as permanent surpluses of the main agricultural
products and continuing imbalances in the Community. To face these problems, the second CAP reform
recommended by the Commission was approved by the Brussels European Council on February 11-13, 1988,
which gave the green light to the "Delors package". This package covered, in addition to reform of the common
agricultural policy, the level of agricultural expenditure, budgetary discipline, the system of own resources and
the reform of the Structural Funds, including the EAGGF Guidance section. Acting on this European Council
agreement, the Council of Ministers adopted the measures necessary for a new reform of the common
agricultural policy, in April 19882: market related measures, such as the system of stabilisers (maximum
guaranteed quantities) and the co-responsibility levies; and structural measures in favour of afforestation, the
diversification of agriculture and incentives for the set-aside of farmland. But since the impact of this set of
measures proved to be too small, because technical progress allowed a large increase of agricultural output
despite the restrictions, the Commission, in 1991, proposed a much more radical reform of the market
After several agricultural "marathons", the Council, on May 21,1992, reached a political agreement on the
Commission's proposals for the third reform of the CAP. The Council upheld the three guidelines proposed by
the Commission: a substantial cut in the target prices of agricultural products in order to make them more
competitive on internal and external markets; full and sustained compensation of this drop in farmers' income by
use of means of production (set-aside of arable land, withdrawal of part of the land for major crops, limits on
livestock numbers per hectare of fodder area). At the same time, the Council decided to increase measures to
conserve the environment and landscapes, encourage the early retirement of certain categories of farmers with
the transfer of their land to other uses and facilitate the use of farmland for other purposes, such as afforestation
or leisure. Through this profound revision of its agricultural legislation, the Community, which is the world's
biggest trading entity, has made possible the liberalization of international trade through the GATT Uruguay
Round of negotiations.
However, the third reform of the CAP was not the last. In its outlook document of 15 July 1997 called
"Agenda 2000", the Commission considered it necessary to continue the 1992 reform of the CAP and press
ahead with the transition to world market prices, particularly through a substantial drop in the common support
prices for cereals and beef and veal offset by an increase in income premiums for Community farmers 1.
According to the Commission, this approach was justified for a variety of reasons: the danger of further market
imbalances, the prospect of a new round of trade negotiations within the WTO, the desire for a more
environment-friendly and quality-oriented agriculture, the prospect of enlargement to the countries of Central
and eastern Europe and, last but not least, the interest of the consumer for lower prices and safer food products.
The political agreement of the Berlin European Council on Agenda 2000 in March 1999, resulted in the
fourth reform of the CAP. The agricultural budget should be restricted to an average of EUR 38 billion
annually for market policy (including veterinary and plant health measures) and EUR 4.3 billion for rural
development measures. The reform package included a set of regulations that aimed to develop a more modem
and sustainable European agricultural sector, thus ensuring that agriculture can be maintained over the long term
at the heart of a living countryside. This means that the CAP is henceforth targeted not just at agricultural
producers but also at the wider rural population, consumers and society as a whole. Thus the new CAP seeks to
- an agricultural policy that establishes a clear connection between public support and the range of
- a competitive agricultural sector which is capable of exploiting the opportunities existing on world
markets without excessive subsidy, while at the same time ensuring a fair standard of living for the
agricultural community;
- an agricultural sector that is sustainable in environmental terms, contributing to the preservation of
natural resources and the natural and cultural heritage of the countryside;
- the maintenance of vibrant rural communities, capable of generating employment opportunities for the
rural population;
- production methods which are safe and capable of supplying quality products that meet consumer
demand and reflect the diversified and rich tradition of European food production;
- the integration of new Member States and the reinforcement of the European Union's position in the
future multilateral trade negotiations at the WTO.

Council Directives 72/159, 72/160 and 72/161, OJ L 96, 23.04.1972

Council Regulation 1094/88, OJ L106, 2.04 1988


CAP management and financing

The unity of the European Union's agricultural market requires common prices, common support
instruments for these prices, common external protection, joint financing and, in general, joint management, for
which the European Commission has responsibility. The Commission, as for other areas of Community activity,
is also invested with the power of initiative, i.e. the power to make proposals. The genesis of any agricultural
policy measure is a Commission proposal. Once a Commission proposal for a Regulation in the area of common
agricultural policy has been put before it, the Council entrusts the preparation of its proceedings to a committee
of senior officials known as the Special Committee on Agriculture (SCA). In the area of agriculture, the SCA
assumes the role normally fulfilled by the Committee of Permanent Representatives COREPER.
A vast number of experts are involved in drafting and implementing the common agricultural policy.
The Commission, acting in accordance with the Treaty, naturally consults the European Parliament and the
Economic and Social Committee. The ESC is made up of representatives of the various socio-professional
categories and farmers are therefore also in its midst. In addition, the Commission cooperates closely with
farmers professional bodies to ensure that allowance is made for their interests in the drafting of common
policy and the management of the common market organizations. This is why a large number of professional
farming bodies operate at European level, the most important of which are: the Committee of Agricultural
Organizations in the European Community (COPA), an umbrella body for farmers; the General Committee for
Agricultural Cooperation in the EEC (COGECA), which represents farm cooperatives; and the Commission of
the Agriculture and Food Industries (CIAA), representing these industrial sectors. The European Centre for
Promotion and Training in Agricultural and Rural Areas (CEPFAR) seeks to promote information and the basic
and advanced vocational training of agricultural experts.
However, consultation of these large general organizations tends to be on the mainstream policies of the
CAP. The Commission rapidly felt a need to be better informed on specific problems in each agricultural sector.
As a consequence, as part of the process of implementing the common market organizations, it has set up an
advisory committee for each product or product group falling under a common market organization. The
socio-economic interest groups represented in these committees are: agricultural producers, agricultural cooperatives, the agricultural and food-manufacturing industries, the agricultural products and foodstuffs trade,
farm workers and workers in the food industry, and consumers. The advisory committees give an opinion on the
proposals put before them during the drafting phase within the Commission. No vote is taken for the advisory
committee opinion, which is in no way binding for the Commission. However, the advisory committees enable
the Commission to learn the views of interested parties on the major sectors of farm policy (arable crops, animal
products, etc.) and they are often seen by their members as opportunities for dialogue and participation in
decision-making, a highly important factor for building a consensual policy in a sector involving very different
Scientific committees are advisory committees of a different type, since they give advice to the
Commission on the very important matters of consumer health and food safety. Eight committees meet about ten
times a year, and the Commission consults them whenever there is a legal requirement to do so, and whenever a
matter of special relevance to one of them arises. A Scientific Steering Committee (SSC) has a multidisciplinary
role. One of its tasks is to coordinate the work of the scientific committees to provide an overall view of
consumer health matters, and to deliver scientific advice on matters not covered by the mandates of the other
scientific committees, e.g. on transmissible spongiform encephalo-pathies. The operation of the scientific
committees and, in particular, of the SSC, is based on the three principles of excellence, independence and
After adoption of the basic regulations by the Council comes management of the common
organisations. Management is either the joint responsibility of the Commission and Council or that of the
Commission alone. For general policy decisions such as the annual setting of farm prices, undertaken in
application of the basic regulations, the full procedure is used: the Commission after consulting professional
organisations submits a proposal to the Council, which takes a decision after consultation with the European
Parliament and very often the Economic and Social Committee as well as the Committee of the Regions. For
long-application management provisions, such as adjustments of market mechanisms or of basic criteria, a
medium-length procedure is used: the Commission proposes measures to the Council, which takes a decision
without consulting either the European Parliament or the Economic and Social Committee.
The implementation provisions for basic regulations and management measures in the strict sense of the
term, which are applicable on average for a few weeks or a few months, are adopted by the Commission using a
procedure known as the "Management Committee" procedure, whereby the Commission acts after having
received the opinion of the relevant management committee. Management committees comprise representatives
of the Member States dealing with a specific sector. They give their opinion on the Commission's plans for the
management of agricultural markets. There is a management committee for each category of product: cereals,


milk products, beef and veal, wine, fruit and vegetables, etc. Very important management committees are
notably: the Committee of the EAGGF, which deals exclusively with matters relating to the guarantee section of
the European Agricultural Guidance and Guarantee Fund, such as regulations applicable to agricultural markets
or price and income support policy; and the Committee on agricultural structures and rural development (STAR),
which assists the Commission with the management of the EAGGF guidance section.
The committees vote by qualified majority. In cases where the Commission is empo wered by the
Council to take decisions after consultation of a management committee, it must submit a draft of the measures,
which it intends adopting, to the relevant committee in good time. If the committee issues a favourable opinion
or no opinion at all, the Commission can proceed with the adoption of the planned measures. Should a negative
opinion be given, the Commission can adopt the measures but must notify them to the Council, which has one
month to adopt a different decision by a qualified majority1.
Regulatory committees play a role similar to that of the management committees for decisions about
the regulations that apply in general areas such as food law, common veterinary or plant health standards, etc.
The composition and the voting arrangements are the same as for management committees. However, the
committee's opinion is binding on the Commission, which cannot adopt the measures unless the committee's
opinion is favourable. When the committee delivers an unfavourable opinion on the Commission's proposed
measures, or when no opinion is delivered, the Commission cannot take any decision, even a provisional one; it
must pass the proposal on to the Council immediately. The Council must act within a period laid down in each
instrument to be adopted by it, but this period may in no case exceed three months. It may adopt the proposal by
a qualified majority, or amend it by unanimity. If the Council has not acted by the end of the period, the
measures initially proposed are adopted by the Commission. If, within the time limit, the Council rejects the
proposed measures by a simple majority, the Commission may not take a decision; however, it may consult the
committee again, on the same proposal or different measures.
CAP financing
Article 40 of the Treaty of Rome (Art. 34 TEC) - devoted to the gradual development of the common
agricultural policy - declared that one or several agricultural guidance and guarantee funds should be created to
enable the common organisation of agricultural markets to fulfil its goals. On January 14, 1962 during the first
agricultural marathon, the Council opted for the creation of one single fund to finance all Community market and
structural expenditure in the various agricultural sectors: the European Agricultural Guidance and Guarantee
Fund (EAGGF). The Fund was set up in 1962, but the arrangements on the financing of the common
agricultural policy were finalized in 1970 .
The Fund's Guarantee Section finances, in particular, expenditure on the agricultural market
organisations, the rural development measures that accompany market support and rural measures in certain
regions. Indeed, the Regulation on the financing of the common agricultural policy provides for rural
development measures to be financed by either the Guarantee Section or the Guidance Section of the EAGGF,
according to the regional context . Thus, the Guarantee Section provides for co-financing of rural policy in rural
areas covered by the new Objective 2 and in rural areas outside Objectives 1 and 2 of the Structural Funds. The
Guarantee Section finances also specific veterinary and plant-health measures, as well as the dissemination of
information on the common agricultural policy.
The EAGGF Guidance Section co-finances the Community initiative for rural development, known as
LEADER and measures covered by Objective 1 programmes (excluding agri-environmental measures, early
retirement, forestry-related measures and the aid scheme for agriculture in less-favoured areas, which fall under
the EAGGF Guarantee Section).
EAGGF management falls to the Commission, which is assisted by the EAGGF Committee, made up
of representatives of the Member States and chaired by the Commission. The Committee is consulted on either
an obligatory or optional basis on all matters affecting the EAGGF in the framework of the "management
committee" procedure, described above. Although the Commission has sole responsibility for EAGGF
management, it nevertheless passes through the channel of state organisations or agencies in the Member States
for the payment of intervention expenditure on the Community's agricultural markets.
Management of expenditure in the EAGGF's Guarantee Section is anchored in a system of advance
payments to the Member States, with annual clearing of accounts. The Commission places at the disposal of
the Member States the funds necessary so that the agencies appointed by them can, in accordance with
Community rules, pay the expenditure required under the EAGGF Guarantee Section. These advance payments
take the form of a lump sum for each Member State and are paid into a special "EAGGF Guarantee" account
opened by each Member State with its Treasury or another financial institution. The paying agencies make
payments to beneficiaries in accordance with the Community rules. Only expenditure incurred by accredited
paying agencies may be the subject of Community financing. At the end of the financial year, the Member States
forward to the Commission their annual statement of expenditure together with an attestation regarding the


completeness, accuracy and veracity of the accounts transmitted. The Commission clears the accounts of the
paying agencies and presents a financial report on the administration of the Fund to the Council and Parliament.
Approximately half of the EU budget goes towards financing the CAP, or around 0.6% of Community
GDP. Given the size of the agricultural budget, it is essential for the credibility of the CAP that proper systems
are in place to ensure that these funds are spent correctly and to prevent fraud. Indeed, European taxpayers have
a right to expect that all public money is spent efficiently, whether this be under national or EU budgets. As seen
above, most of this expenditure is managed by the Member States, who therefore have the main
responsibility for administering payments and checks on payments.
However, it is clearly the Commission's responsibility - with the help of the EAGGF Committee
mentioned above - to make sure that efficient systems and procedures are set up at national level, that the
accounts presented by the Member States are correct and complete and that expenditure complies with specific
rules and regulations. Commission auditors verify that Member States' payment and audit systems are reliable
and that they meet Community standards. If the systems put into place by a Member State prove to be
unsatisfactory, the Commission must, under the clearance of accounts procedure, refuse to finance all or part of
the expenditure concerned. Recovery can be made for individual cases where irregularities have been found or
where systematic failures are revealed. The financial consequences of irregularities are, however, borne by the
Community, unless government departments of the Member States are responsible for the irregularities or
incorrect payment of sums.
Fraud often hits the headlines in the Member States and fuels the criticism of the CAP'S opponents. A
response to the problem has been given by a Council Regulation which requires the Member States to
themselves scrutinise the transactions forming part of the system of financing by the Guarantee Section of the
EAGGF. The 1992 reform of the CAP includes provisions for each Member State to set up an integrated
administration and control system (IACS) for direct payments. Under the IACS, Member States set up
computerised databases to enable electronic crosschecks and on-the-spot checks of holdings. However, the
Community co-finances action programmes by the Member States designed to improve their struc tures for
monitoring EAGGF Guarantee Section expenditure.
In this context, the Council established a control system using satellite pictures and air photographs
of agricultural land benefiting from EAGGF subsidies, it has reinforced physical checks at the export of
agricultural products having obtained a refund and provided for customs checks to be targeted on high-risk
sectors, notably export refunds. The Member States, in co-operation with the Commission, have introduced
advanced techniques to map land surfaces and verify land use. Once satellite images and aerial photographs are
placed on computer file, advanced software can be used to identify and measure individual parcels, to verify the
crops grown, and even to count olive trees. Computer analysis of the aerial or satellite photographs can check the
information in a beneficiary's claim form, and on-farm inspections can thus focus on land parcels where
discrepancies are detected. The knowledge that at any time a "spy in the sky" can check a claimant's fields acts
as a powerful disincentive to fraud and irregularity. The Council has also established a legal framework making
it possible to identify unreliable economic operators in the field of export refunds and of sales at reduced prices
of products held in public storage ("black list") and to make them known to the national authorities concerned.
In the case of livestock, the identification and registration system also facilitates veterinary health
surveillance. Bovine animals must be identified with a number shortly after birth or entry into the Community,
using tamper-proof ear-tags. Electronic animal identification may contribute greatly to the efficient traceability
of animals in the EU, facilitating both sanitary and veterinary checks with a view to protecting consumers and
run checks on the correctness of payments made to farmers. It may also make available data which is important
for the management of the meat market, the health of the livestock and hence the health of European consumers.
After the disastrous experience of the mad cow disease, there is no need to stress the importance of this last
The introduction of the euro, on 1 January 1999, led to a major reform and simplification of the
agrimonetary system. Agricultural conversion rates have been discontinued. Agricultural prices and aid in the
participating Member States is paid in euros; aid too is paid and collected in euros 1. Their conversion into the
national currency unit uses the irrevocable exchange rate fixed on 1 January 1999. In the case of the other
Member States, the euro exchange rate is used for the necessary conversions into their national currencies, unless
they decide to make payments in euro. For those Member States the value of a payment is determined by the
exchange rate on the date of the operative event (a price or an aid) and not on the date of actual payment. In the
case of compensation for a drop in prices or other aid, the EAGGF must cover half of the compensation actually
paid, matching the amount that the Member State actually contributes.
Thus, the euro ended the need for a system to dampen currency fluctuations in the agri-food sector. The
use of the euro benefits the CAP, not only by simplifying its procedures and reducing its budget costs through
the abolition of the green rates, but also through the simplification and transparency of aid schemes for farmers,
price stability and increased competitiveness in Community agriculture. Like their American counterparts, who
can use their national currency (the dollar) for export transactions, European enterprises now have the Euro and


are able to invoice their products in the currency in which their costs are also denominated, thereby avoiding an
exchange risk.
The common agricultural market is underpinned by common market organisations (CMOs) which
remove obstacles to intra-Community trade and create common protection at the external borders. At present,
almost all the Community's agricultural production is regulated by common organisations. Article 32 of the EC
Treaty (ex-Art. 38) defines agricultural products as products of the soil, livestock products and fishery products,
along with products of first-stage processing which are directly related to these products.
The market organization regulations, which came into force in 2000 as a result of the last reform of the CAP,
concern the arable crops, beef, milk and wine sectors, the new rural development framework, the horizontal rules
for direct support schemes and the financing of theCAP.
These regulations introduced gradual cuts in institutional prices - compensated by income support - with
the objective of bringing Europe's agricultural prices into closer touch with world market prices, thus helping
improve the competitiveness of agricultural products on domestic and world markets with positive impacts on
both internal demand and export levels. The CAP reform contains important elements of simplification in
various sectors. In the wine sector, for instance, there is now one regulation where previously there were twentythree. These changes of the common market organisation should also contribute to the progressive integration of
the candidate countries from Central and Eastern Europe. The reform takes full account of increased consumer
concerns over food quality and safety, environmental protection and animal welfare in farming. Both in
market support and in the new rural development policy, compliance with minimum standards in the fields of
environment, hygiene and animal welfare is a requirement.
The market organisation of each agricultural product uses different mechanisms defined by its basic
regulation and adopted by the Council using the full-blown procedure but all of them are underpinned by, on the
one hand, internal market measures, more often than not relating to price setting and support, and, on the other,
by a trade regime with third countries, which is in conformity with the Agreement on agriculture concluded in
the context of the GATT Uruguay Round.
The principles of the CAP
Three basic principles defined in 1962 characterize the common agricultural market and consequently
the common market organizations: market unity. Community preference and financial solidarity. Since the end of
the seventies, the principle of co-responsibility of producers has been added.
Market unity means that agricultural products move throughout the European Union under conditions
similar to those in an internal market, thanks to the abolition of quantitative restrictions to trade (quotas, import
monopolies,...) and the removal of duties, taxes and measures having equivalent effect. Market unity supposes
common agricultural prices throughout the EU. The Council, acting on a proposal from the Commission, thus,
early in each marketing year, sets common agricultural prices expressed formerly in ecu and, since 1999, in
euro1. In principle, the common agricultural prices should be attained through the free play of supply and
demand so that the only variations in the prices paid to farmers in all regions of the Union result from natural
production conditions and distance from main centres of consumption. But in reality, as will be seen below, the
common market organisations incorporate intervention measures, the force of which varies according to product,
in order to support the common prices should there be insufficient demand or external supply at lower prices.
Community preference, the second bulwark of the common agricultural market, signifies that products
of Community origin are bought in preference to imported products, in order to protect the common market
against low-price imports and fluctuations in world prices. This principle, spread throughout the world, is
enacted through import and export measures. The European Union tries to bring the prices of imports into the
EU at the prices practiced on the common market. The price gap between the world market and the minimum
guaranteed price in the EU was traditionally covered by import levies, which after the GATT Uruguay Round are
progressively replaced by customs duties. To the extent that external prices taxed with import duties are at the
same level as internal prices, it is not to the advantage of European traders to buy supplies from outside the EU
and they therefore give preference to Community products. But whereas this was practically always the case
with the import levies, it is much less certain with the customs duties, which are progressively replacing them.
The third basic principle of the common agricultural market is that of financial solidarity. It is
implemented through the intermediary of the European Agricultural Guidance and Guarantee Fund (EAGGF)
and signifies that the Member States are jointly liable as regards the financial consequences of the common
agricultural markets policy. Since the European Union organises agricultural markets and defines and applies the
intervention measures on them, it is logical that it is responsible for the financial consequences of these
measures. The EAGGF Guarantee Section therefore covers all the expenditure rendered necessary by the
common market organisations. The other side of the coin is that the customs duties (which have replaced levies)
collected at the Union's frontiers on imports from third countries do not go into the coffers of the Member States
but are a source of revenue for the Community budget.


The 1992 CAP reform, which made possible the 1993 GATT Agreement, has affected the fundamental
principles of the CAP, since it has supplemented the original price support with a direct income aid system. It
has, in fact, introduced a mixed system: price support was reduced, but the farmers' revenue was maintained at
its previous level by subsidies. In other words, the reduction of price support was compensated by the support of
the revenue of the farmers. This system was amplified by the 1999 reform. The new policy for rural development
seeks to establish a coherent and sustainable framework for the future of Europe's rural areas. It seeks to
complement the reforms introduced into the market sectors by promoting a competitive, multi-functional
agricultural sector in the context of a comprehensive, integrated strategy for rural development. The guiding
principles of the new policy are those of decentralisation of responsibilities - thus strengthening subsidiarity and
partnership - and flexibility of programming based on a "menu" of actions to be targeted and implemented
according to Member States' specific needs.
Agricultural prices and product quality
Prices are a central component of the common market policy and the terminology surrounding them
is very complicated. This is due to the various different roles which agricultural prices play and to the need for
them to be adapted to specific conditions on different markets. Generally speaking, prices play three roles in the
common agricultural market: they guide production, trigger intervention mechanisms and secure common
external protection. Each of these three functions will be analysed in turn.
The guide price (beef and veal, wine), which is also known as the target price (cereals, sugar) or the
norm price (tobacco), is the price that the common market organisation seeks to guarantee to producers. It is set
each year by the Council in accordance with evolution both of the cost of living and of supply and demand on
each market1. It therefore guides the production of each of the agricultural sectors for which such a price exists.
The intervention price (cereals, sugar, butter, beef and veal, tobacco) or the basic price (pigmeat),
which is a certain percentage lower than the guide price, is the price at which intervention organisations in each
Member State must buy products of Community origin which farmers put in for storage. For fruit and
vegetables, which cannot be stored, there are withdrawal prices below which producers' groups, in their role as
intervention organisations, stop selling and send surplus quantities for distillation, to charities or for destruction
until such time as more sluggish supply triggers a recovery of the market prices.
Intervention measures may be specific to a certain market organisation, in order to face particular
problems. Thus, in order to face the consequences of the mad cow disease (Bovine spongiform encephalopathy
-BSE), in addition to veterinary measures measures were taken in order to limit the negative consequences of
banning beef exports from the United Kingdom to third countries. As decided by the European Council in June
and by the Council in July 1996, the Community provided a total of ECU 850 million to help those farmers
affected by the crisis3. The Commission also adopted various supplementary market support measures,
concerning in particular aid for private storage of veal, public intervention purchases , part-financing exceptional
elimination measures involving incinerating certain meat in the United Kingdom 1 and laying down conditions for
the grant of various premiums. In November 1996, the Council introduced a higher ceiling on intervention
purchases and instituted a system of premiums for the processing and early marketing of calves 2. To increase
consumer protection by improving information on the origin of meat, the Council established a system for the
identification and registration of bovine animals, involving, in particular, the provision of a passport for each
animal, the creation of a computerised database in each Member State and the labelling of beef and veal and of
products derived from them.
The intervention arrangements are very often tied into a storage system, which varies according to the
product and helps attenuate the impact of cyclical production variations on prices and guarantee supply
continuity3. The stocks in the system are often necessary for normal regulation of the market.
It is only when stock levels remain abnormally high that structural surpluses and consequently serious imbalance
between supply and demand exist, which must in principle be corrected by lowering the intervention price. In the
context of various food aid programmes, large quantities of food from intervention stocks are supplied both to
designated organisations for distribution to the most deprived persons in the Community and to the
undernourished populations of numerous countries in the world.
Connected with the question of agricultural prices is the question of the quality of agricultural
products and foodstuffs. This question will gain in importance in an internal market characterised by the overabundance of most agricultural products. The quality and characteristics of these products are often linked to
their geographical origin. Two Council Regulations are designed to raise consumer awareness of the producers'
efforts to improve the quality of their products. The first establishes a Community system for the protection of
geographical indications and designations of origin for agricultural products and foodstuffs, supplemented by
lists of some 480 names of agricultural and food products drawn up by the Commission. It spells out with what
requirements a product or foodstuff should comply in order to qualify for a protected designation of origin
(PDO) or for a protected geographical indication (PGI). The other Regulation introduces an instrument for


registering the names of products, thus enabling producers who so wish to obtain certificates of the 'specific
character' of a traditional product (or foodstuff), the specific character being defined as the feature which
distinguishes the product or foodstuff clearly from other similar products or foodstuffs belonging to the same
category. Another Regulation concerns organic production of agricultural products and indications referring
thereto (labelling) on agricultural products and foodstuffs". A European Union symbol (logo), based on the 12
stars symbol of the EU, identifies agricultural products and foodstuffs whose names are registered under the
rules on the protection of geographical indications and designations of origin.
A new subject of concern for the common agricultural policy is biotechnology and genetically modified
organisms (GMOs). The Community is aware that the new technologies have great potential for reducing the
cost of feedingstuffs and even for improving the quality of foodstuffs, but it is also mindful of certain risks that
have to be carefully examined. It therefore follows the precautionary principle and defends it on the international
stage. This policy has already been denounced by external competitors as protectionist and will certainly lead to
fierce battles inside the World Trade Organisation. The Community claims that the precautionary policy is not
intended to protect the incomes of its farmers but the health of its citizens. Indeed, in recent years the
Community has constantly refined its standards in the areas of food safety, quality, and environmental and
animal protection. This has led to higher costs for European farmers and harmed their competitiveness. Rather
than protecting European farmers' interests, the precautionary principle seems, therefore, to be very demanding
on them as well as on their external competitors. After all, consumers have the right to decide whether they
should eat uncertain foodstuffs at lower prices or high quality products at higher prices.
Direct support schemes for farmers
A number of common market organisations provide for support to be granted to farmers in the form of
direct payments. In order to ensure that the Member States take account of environmental and employment
issues when granting direct aid to farmers under market organisations, a Regulation lays down horizontal rules,
applicable to various market organisations, notably: arable crops, cereals, olive oil, grain legumes, flax,
hemp, bananas, tobacco, seeds, rice, beef and veal, milk and milk products, sheepmeat and goatmeat.
With a view to better integrating environment protection into the common market organisations.
Member States must define appropriate environmental measures in view of the situation of the agricultural land
used or the production concerned, to be applied by farmers. However, Member States have three options at their
Support in return for agri-environmental commitments;
General mandatory environmental requirements;
Specific environmental requirements constituting a condition for direct payments.
Member States may also decide on appropriate and proportionate penalties for environmental
infringements involving, where appropriate, the reduction or even the cancellation of direct payments.
In order to stabilize the employment situation in agriculture and to take into account the overall
prosperity of holdings. Member States may decide the criteria and the rate of reducing the amounts of payments
which would be granted to farmers in respect of the calendar year concerned in cases where:
The labour force on their holdings falls short of limits (to be determined by Member States);
The overall prosperity of their holdings rises above limits (to be decided by Member States);
The total amount of payments granted under support schemes exceed limits (to be decided by Member
However, the reduction of support to a farmer resulting from the application of the above measures may
not exceed 20% of the total amount of payments granted to the farmer. In general, by applying environmental
and employment criteria, the Member States must ensure that farmers receive equal treatment and avoid market
and competition distortions. Amounts not paid to farmers because they fail to comply with the environmental
requirements and employment limits remain available to the Member States concerned for use as additional
Community support for rural development (early retirement, less-favoured areas and areas subject to
environmental constraints, agri-environmental measures, reafforestation) in accordance with the Regulation on
rural development.
The external wing of the common market organisations seeks to protect European agricultural prices
against low price imports. In the same way as intervention on the internal market attempts to prevent the market
prices falling too far below the intervention prices, intervention at the external borders tries to prevent low priced
imports from upsetting the European market. The threshold price (cereals, sugar, dairy products, olive oil) or
the sluice-gate price (pigmeat, eggs and poultry) is a minimum price above which imports from third countries
enjoy free access. For products for which a target price or guide price exists, the threshold price is determined in
such a manner that the sales price of the imported product, allowance made for transport costs, is on a par with
this price. For products for which there is no guide price (fruit and vegetables, table wine), the reference price is


the minimum price at which a third country product can be imported and a tax is collected if the reference price
is not respected.
The gap between the world price and the threshold price was originally bridged by an import levy.
Following the Blair House pre-agreement with the United States and the GATT agreements of December 1993,
this gap is now partially closed by customs duties. However, for certain product groups such as cereals, rice,
wine and fruit and vegetables, certain supplementary mechanisms that do not involve the collection of fixed
customs duties are introduced in the basic regulations of the CAP by a Regulation, which lays down the
adaptations and transitional measures required in order to implement the agreements concluded in the GATT
In the past, when internal prices were higher than world prices, exporters received subsidies, known as
"refunds", to offset the difference between their purchase price on the European market and their sales price on
world markets. As part of the Union's international commitments to the WTO, the subsidized exports of certain
groups of agricultural products are limited each year in terms of both volume and value . Export taxes may be
imposed on certain products, in exceptional circumstances, in order to avoid disturbance of the Community
market and safeguard supplies at reasonable prices for consumers in the European Union.
Aligning Community prices with those on the world market as a result of the 1999 CAP reform, should
make it possible to export without subsidies, and therefore without quantitative ceilings. As the second-largest
agricultural exporter and by far the largest processed food exporter, the EU certainly takes a keen interest in the
smooth functioning of world trade and believes that WTO negotiations are the ideal venue for creating stable
conditions and rules for fair international competition in agricultural trade.
It calls, in particular, for all export credits to be subject to compliance with agreed trade rules, as was already
agreed in principle in the Uruguay Round. The EU seeks, however, to ensure that in the next round of
negotiations greater attention is paid to the justified interests of consumers and that the WTO is not used as a
pretext for placing products on the market where there are legitimate concerns about their safety. It also
maintains that its new CAP addresses important non-trade issues that cannot be negotiated at world level, in
particular the need to strengthen the multifunctional role of agriculture as a means of ensuring the vitality of
rural areas, and animal and environmental protection.
The across-the-board tariff concessions which result from multilateral trade negotiations, such as those
of the GAIT and now the WTO, are only part of the commitments weighing upon the EU's agricultural
relationships. There are in addition preferential bilateral agreements with the majority of Mediterranean
countries, in the form of association agreements or cooperation agreements, which provide for concessions in the
agricultural sector. Similarly, the Lome Convention, concluded between the Community and 70 developing
countries, grants free access to the EU for the products of these countries. Tariff reductions have, finally, been
granted by the Community under the Generalised System of Preferences (GSP) to almost all the developing
countries notably in the framework of the United Nations Conference on Trade and Development (UNCTAD)
and in the framework of the Europe Agreements with the countries of Central and Eastern Europe. The
Community supplies the Russian Federation agricultural products free of charge from intervention stocks or
purchased on the EU market.
Structural policy and rural development
"Agricultural structures" are taken as meaning all production and work conditions in the sphere
of agriculture, i.e. the number or age spread of people working in agriculture, the number and size of farms, the
technical equipment on farms, the level of farmers' qualifications, producers' groups, marketing and processing
of agricultural products and so on. In December 1968, twelve years after the signature of the EEC Treaty, the
Commission stated in its Memorandum on the (first) reform of the CAP that in no other sector of the economy
had traditional production structures clung on so tenaciously as in agriculture.
As consequence, the socio-economic situation of people working in agriculture was lagging far behind
that of other economic groups. A Community socio-structural policy was required to rectify this situation. Since
the Community had initially turned all of its attention to establishing a common agricultural market, it had barely
given a thought to structural policy. It is true that, unlike market and pricing policy which, by its nature, required
uniform provisions and centralized management, socio-structural policy could remain more in the realm of the
Member States in that it had to be adjusted to the specificities of the different regions. But policy blueprinting
and supervision had to be brought under the wing of the Community to promote economic and social cohesion
and prevent uneven competition conditions for Community producers. Thus, a Regulation sets out a common
framework for introducing an integrated administration and control of direct aids under the reformed common
agricultural policy.
Measures designed to support the improvement of agricultural structures were introduced into the
common agricultural policy as early as 1972. For almost two decades, attempts have been made to integrate
agricultural structural policy into the wider economic and social context of rural areas. The 1992 policy reform


stressed the environmental dimension of agriculture as the largest land user, but rural policy was still carried out
through a range of complex instruments. The 1999 reform drove agriculture to adapt to new realities and further
changes in terms of market evolution, market policy and trade rules, consumer demand and preferences and the
Community's next enlargement. These changes affect not only agricultural markets but also local economies in
rural areas in general. Therefore, the rural development policy currently aims at restoring and enhancing the
competitiveness of rural areas, thus contributing to the maintenance and creation of employment in those areas.
The reformed rural development policy covers all rural areas in the Community through a single instrument
utilizing both sections of the EAGGF.
Agricultural structural policy requires exact information on farm income and on production parameters
of the agricultural economy in the Community. This is the task of the Farm accountancy data network (FADN) 1.
The FADN relies on the services of farm accountancy offices in the Member States and on the participation of
specially selected agricultural holdings to produce objective and practical data on the economic situation of the
various categories of agricultural holdings, including those upon which a close watch needs to be kept at
European level. Thanks to the use of individual data, the FADN can carry out detailed analyses which make
allowance for the variety of European agriculture. The FADN's conclusions form part of the prior study to any
major Commission proposal. Parallel to the FADN is the European forestry information and communication
system (EFICS).
EAGGF financing of rural development
The principle of partial financing of agricultural structures policy by Community funds won early
recognition. When the European Agricultural Guidance and Guarantee Fund (EAGGF) was set up in 1962, it was
stipulated that the "Guidance" Section would fund structures policy and should, in as much as this were
feasible, enjoy one-third of the Fund's available resources. In implementing the structural fund policy, dealt with
in the Chapter on Regional Development the financing of the EAGGF's Guidance Section falls into the general
framework of the Community's structural policy. Financing from the EAGGF Guidance Section, like that from
the other Structural Funds, is granted under the Community support frameworks (CSFs) and the single
programming documents (SPDs).
However, rural development and accompanying measures during the period 2000-06 are financed by the
EAGGF Guarantee Section or Guidance Section, depending on their regional context. Thus, Community support
for early retirement, less-favoured areas and areas with environmental restrictions, agri-environmental measures
and afforestation are financed by the EAGGF Guarantee Section throughout the Community. Community
support for other rural development measures is financed by the EAGGF Guidance Section in areas covered by
Objective 1 (integrated into the programmes) and Guarantee Section in areas outside Objective 1 The EAGGF
also covers measures for the development and structural adjustment of rural areas relating to the renovation and
development of villages, the protection and conservation of rural heritage, the diversification of farm activities
and the improvement of infrastructure relating to the development of farming which are not financed by the
European Regional Development Fund (ERDF) under Objectives 1 and 2 and in areas in transition. The
Commission has fixed an indicative allocation by Member State of the allocations under the EAGGF-Guarantee
Section for the rural development measures for the period 2000 to 2006.
Fisheries Policy
The Treaty of Rome did not provide for a fully-fledged fisheries policy, for it included fishery products
in the products to be covered by the Common Agricultural Policy. Little by little, however, the specific
characteristics of the fisheries sector pushed for a separate common policy. Towards the end of the sixties,
therefore, the Community began to turn its attention to the need to protect its resources in the Atlantic and the
North Sea, under serious threat from overfishing. Its concern was heightened by the creation of exclusive
economic zones, decided upon within the United Nations Conference on the law of the sea. A Community policy
to conserve fishery resources was necessary to protect the most threatened species in Community waters. Its
main manifestations have been the setting of total allowable catches (TACs), the allocation of catch quotas
between the Member States and technical management and surveillance measures. Through an external fisheries
policy, the Community has sought to guarantee its own fleet access to the waters of countries with surplus
resources and to restrict access to Community waters for foreign vessels, notably Soviet, Polish and Japanese
factory ships.
Curiously enough, third countries made no difficulties about accepting the Community as sole
negotiator for the EEC Member States, even if internal problems hindered these negotiations and held up
agreements. These internal problems took many years to iron out. The Community had declared equal access to
the fishery zones of the Member States (12 miles) when there were six states, which had begun to turn a jealous
eye towards the rich waters of applicant countries. The latter, unwilling to share the bounty, succeeded in writing


into their Act of Accession a ten-year derogation to the rule of equal access, which was to remain at the crux of
discussions on the common fisheries policy and brought the United Kingdom to blows with the other Member
States, particularly France. The United Kingdom wanted to exclude vessels from the other Member States within
a 12-mile zone around its coasts. France maintained that its fishermen had "historic rights" to fish in certain
British fishing grounds, even if these rights were relatively recent.
Six years of negotiations were required before, on January 25, 1983 the Community reached one of its
"historic compromises". On this date, a Community system of resource conservation, endeavoring to protect the
biological resources of the sea under severe threat from modem fishing methods, was added to the common
fisheries policy. This system introduced measures to restrict fishing and set conditions under which it could take
place, along with measures governing access to the waters of the Member States. Measures to conserve and
manage fishery resources thus came to join the "common organization of the market", which sets common
marketing standards for fisheries and aquaculture products, dividing them up into a freshness grading and
seeking to ensure that products which do not reach a satisfactory quality level are not marketed. It obliges the
Member States to carry out conformity control checks on these pro, ducts and to apply sanctions to any
infringements. This policy therefore helps protect consumer interests. Producers' interests are not neglected
either in the common fisheries policy. Structural policy, inaugurated in 1970, makes use of common measures to
restructure, modernize and develop the fishery sector, to develop aquaculture, encourage experimental fishing
and adapt Community fishing capacities to disposal possibilities.
This does not mean that the Community fisheries sector is riding on the crest of a wave. The depletion
of resources, due notably to the over-fishing of juveniles combined with fleet over-capacity, make the entire
European fisheries sector extremely vulnerable from the economic and social viewpoint. In order to redress this
situation, there must be more balanced and rational exploitation of resources and consequently a reduction in
both fishing and fishing capacity through more stringent regulation of access to resources and closer monitoring
of vessel movements in order to respect the general interest.
In light of the lasting nature of restrictions on authorized catches, fishery concerns should seek to raise
the qualitative value of their production, an objective that is consistent both with the common fisheries policy
and with consumer protection policy. Due to the fall in prices for the majority of species, to the imperatives of
freshness and hence of conservation and to operating constraints, many firms in the sector are, however, facing a
shortage of financial resources and a lack of profitability. This crisis situation is tending to become entrenched
because of the growing share of imports, upon which the Community market is already dependent for over 50%
of its supply.
To remedy the crisis, actions should be taken to improve resource management and restructure the
industry within the framework of the new structural rules. The aim of these actions should be to avoid the
collapse of fisheries by achieving a better match between resources and fishing capacities; but account should
also be taken of the development of regions dependent on fishing. If socio-economic upheaval in the fisheries
sector is to be minimized, social support measures must, indeed, be taken, combining Community means and
instruments in favour of the least developed regions and those most heavily dependent on the fishing industry.
Bibliography on Common Policies of the EU and suggested readings:

Desmond Dinan, Ever Closer Union, Macmillan, 1999, p. 325-335

Nicholas Moussis, Access to European Union, law, economics, policies, 2001, p.230, 282-294, 373-375, 469471, 502-520;
Simon Mercado European Business, 2001, p. 160-192
Balchip Paul, Bull Gregory, Sykora Ludek, Regional Policy and Planning in Europe, Routledge, London, 1999
How European Union Manage Agriculture and fisheries, European Commision, 1998, p16-23;
Proposed regulations governing the reform of the Structural Funds 2000-2006, Comparitive analysis, European
Commmission, 1998
Regional Policy and Cohesion, European Commission, 1998
The European Union: cohesion and disparities, European Commission, 1999 p. 12-17
European employment and social policy: a policy for people, European Commission, 2000
Frnacois Souty, Le droit de la concurrence, Montchrestien, 1997
Emonot Claude, Integration financiere europeenne et fiscalite des revenues du capital, Economica, Paris, 1998
Symansky Steven, Koptis George, Fiscal Policy Rules, International Monetary Fund, Washington, DC, 1998
Cini Michaelle, McGowan Lee, Competition Policy in the EU, Macmillan Press, Basingstoke Hampshire, 1998
Demmke Christoph, Schroder Birgit, European environmental policy: a handbook for civil cervents, Maastricht,


7. External Economic Relations of the European Union

7.1 Commercial Policy and the multilateral trading system (GATT- WTO)
7.2 External relations and the EUs hierarchy of trading preferences
7.3 European Union external trading relations: Japan and the US
7.4 The emergence of regional trade blocs and global Triad
7.1. Commercial Policy and the multilateral trading system (GATT-WTO)
The common commercial policy was founded on uniform principles, notably as regards tariff charges,
the conclusion of tariff and commercial agreements and the harmonization of liberalization measures export
policies and trade defence measures, including those to be taken in cases of dumping and subsidies. The
implementation of the common commercial policy therefore falls into the Communitys sphere of competence.
The European institutions draw up and adapt the common customs tariff, conclude customs and trade
agreements, harmonize measures to liberalized trade with third countries, specify export policy and take
protective measures, notably to nip unfair trading practices in the bud. If agreements have to be negotiated with
third countries, the Commission submits recommendation to the Council, which then authorizes it to open
negotiations. The Commission is the Communitys negotiator and consults a special committee appointed by the
Council to assist it in this task. It works within the framework of guidelines issued by the Council. In exercising
the powers granted to it by Article 133 (TEC), including the conclusion of agreements, the Council acts by a
qualified majority.
In international agreements, the Community as such, represented by the Commission, is more often
than not a party alongside the Member States, which means that it takes part in the negotiations, signs the
agreement and if necessary participates in their management a s a member of the organization in question. In
areas for which the Community has exclusive responsibility (agriculture, fisheries), the Member States are not at
the forefront, the Commission negotiates and manages the agreements on the basis of a negotiating brief
delivered by the Council (world commodity agreements, traditional trade agreements, preferential agreements,
association agreements)1. According to Article 307 (TEC), rights and obligations arising from agreements
concluded by the Member States before their accession to the Community are not affected by the provisions of
the EC Treaty, but to the extent that such agreements are not compatible with this Treaty, the Member States
concerned must take all appropriate steps to eliminate the incompatibilities established.
Given the complexity of international relations and of external policy instruments in the broad sense of
the term, the Community powers occasionally spill out the framework defined in Article 133 (TEC). In such
cases, the Community Institutions cannot act alone. They must draw in the Member States, a fact that
considerably complicates the negotiating process ant the conclusion of international agreements. However, the
Treaty of Amsterdam provides that the Council will be able, unanimously, to decide to extend the application of
Article 133 (commercial policy) to international negotiations and agreements on services and intellectual
property rights in addition to those already covered by this provision.
The Common Customs Tariff (CCT) is the key to the Communitys commercial policy. As seen in the
Chapter on customs union and as will be seen later in this Chapter, the blueprinting and evolution of the CCT
have taken place against the backdrop of the General Agreement on Tariffs and Trade (GATT). CCT tariffs were
low at the outset, responding to the central objective of liberalization of international trade. They have been cut
even further in the framework of successive GATT negotiations.
It should be borne in mind that the Commission, acting on a negotiating brief issued by the Council, and not the
Member States individually, is the Communitys negotiator in the GATT/WTO arena.
The EU, which is the worlds biggest exporter, is highly dependent on international trade and
therefore it is in its vital interests to keep trade open and free. Indeed, in 1997, the imports of the EU (fifteen)
accounted for around 10% of its GNP and for 16.6% of world imports. Its exports accounted for 17% of world
exports, compared with 15% for the United States and 9% for Japan. The level of protection in the Community
did not rise with the advent of the internal market . On the contrary, exporters from third countries, as the firms
of the Member States, need to comply with only one set of standards in order to market their products anywhere
in the Single Market. Instead of becoming a Fortress Europe when the single market was completed in 1992,
as feared by some of its trade partners, the Community made important concessions in order to allow the
conclusion of the GATT Uruguay Round in 1993.However, one of the central principles of GATT and WTO is
that of balance of mutual advantages (global reciprocity). This means, for the European Union , that it can tie
access for third country economic operators to the benefits of the Single Market with the existence of similar
opportunities for European undertakings (businesses, companies) in the country in question, or at least to the
absence of any discrimination. This implies a case-by-case approach for third countries, but a common approach
by the Member States. The Single Market obliges the latter to show a united face to third countries. At the same
time, the globalization of the economy is creating a state of interdependence and a growing realization that trade
problems need to be solved wherever possible in a multilateral framework.


Common rules for import

The new common rules for imports were established by Council Regulation of 22 December 1994 1.
They apply to imports of products originating in third countries, with the exception, on the one hand, of
textiles subject to specific import arrangements, discussed under the heading of sectoral measures of the
commercial policy, and on the other products originating from certain third countries, including Russia, North
Korea and the Peoples Republic of China, mentioned below. Apart from those exceptions, imports into the
Community are free and not subject to any quantitative restrictions. The regulation strives to establish a balance
between a Community market normally open to the world following the conclusion of the Uruguay Round and
more rapid and simplified procedures in case of a risk of serious injury caused by imports of a product to
Community producers.
The Regulation establishes a Community information and consultation procedure. When trends in
imports appear to call for surveillance or protective measures, the Commission must be informed of this fact by
the Member States. This information must contain all available evidence, drawn from certain specific criteria.
The Commission then passes on forthwith this information to all the Member States. Consultations may be held
either at the request of a Member State or on the initiative of the Commission. These consultations must take
place within eight working days of the Commission receiving the information. They take place within an
advisory committee consisting of representatives of each Member State and chaired by a representative of the
Commission. This consultations concern notably: a) the terms and conditions of import, import trends and the
various aspects of the economic and commercial situation as regards the product in question and b) the measures,
if any, to be taken.
When, after consultations have taken place, it is apparent to the Commission that there is sufficient
evidence, it initiates an investigation within one month of receipt of information from a Member State and
publishes a notice in the Official Journal of the European Communities, giving a summary of the information
received and asking for any relevant information, including the views of the interested parties. The Commission
seeks all information it deems to be necessary and, where it considers it appropriate, after consulting the
Committee, endeavours to check the information with importers, traders, agents, producers, trade associations
and organizations.
The examination of the trend of imports, of the conditions under which they take place and of serious
injury or threat of serious injury to Community producers resulting from such imports covers the following
factors in practice: a) the volume of imports, b) the price of imports, c) and the consequent impact on the
Community producers of similar or directly competitive products as indicated by trends in certain economic
factors such as production, capacity utilization, stocks, sales, market share, prices and so on.
Where the trend in imports of a product originating in a third country threatens to cause injury to
Community producers, import of that product may be subject, as appropriate, to prior or retrospective
Community surveillance. Products under prior Community surveillance may be put into free circulation only
on production of an import document endorsed by the competent authority designated by Member States and
valid throughout the EU, regardless of the Member State issue.
Trade protection
The Community can introduce surveillance and protection measures in the framework of the common
rules for imports when imports at prices viewed as normal are causing or risk causing serious injury to
Community producers. In cases where the export price is lower than the normal value of a like product
(dumping), the Community can take trade protection measures, notably through the application of antidumping
duties. Since 1979, Community rules in this area are broadly inspired by the provisions of the Anti-Dumping
Code and the Code on subsidies and Countrvailing Duties of the General Agreement on Tariffs and Trade
(GATT). Community rules being compatible with those of the GATT, economic operators must now comply with
only one set of rules. On the jurisdictional level, anti-dumping and anti-subsidy cases must be brought before the
Court if First Instance1.
According to the Regulation on protection against dumped imports from countries not members of
the EC, anti-dumping duty may be applied to any dumped product whose release for free circulation in the
Community causes injury2. A product is considered as having been dumped if its export price to the Community
is less than a comparable price for the like product, in the ordinary course of trade, as established for the
exporting country. The term like product means a product that is identical in all respects or has characteristics
closely resembling those of the product under consideration. In order to determine the dumping the normal price
and the dumped price must be defined and these two values must than be compared. It should be noted that these
definitions as well as the anti-dumping procedures are, after the Uruguay Round, similar in the EU and in other
GATT Member States.
Normal value is generally based on the prices paid or payable, in the ordinary course of trade, by
independent customers in the exporting country. Where there are no or insufficient sales of the like product in
the ordinary course of trade, or where such sales do not permit a proper comparison, the normal value of the like
is calculated on the basis of the cost of production in the country of origin plus a reasonable amount for selling,


general and administrative costs and for profits. In the case of imports from non-market economy countries,
normal value is determined on the basis of the price or constructed value in a market economy third country, or
the price from such a third country to others countries, including the Community, or where these are not possible,
or any other reasonable basis.
The export price is the price actually paid or payable for the product sold for export to the
Community.Where there is no export price or where it appears that the export price is unreliable because of
association or a compensatory arrangement between the exporter and the importer or a third party, the export
price is unreliable because of association or a compensatory arrangement between the exporter and the importer
or a third party, the export price may be constructed on the basis of the price at which the imported product is
first resold to an independent buyer or on any reasonable basis. In such cases, allowance must be made for all
costs incurred between import and resale (transport, insurance, general expenses), including duties and taxes, and
for a reasonable profit margin.
A fair comparison must then be made between the export price and the normal price. This comparison
must be made at the same level of trade and in respect of sales made at as nearly as possible the same time and
with due account taken of other differences which affect price comparability. Where the normal value and the
export price as established are not taken on such a comparable basis due allowance, in the form of adjustments,
must be made in each case for differences in factors which are claimed and demonstrated to affect prices and,
therefore, price comparability, notably: the physical characteristics of the product concerned, import charges and
indirect taxes, discounts, rebates and quantities, transport, insurance, handling and ancillary costs and the cost of
any credit granted.
The dumping margin is the amount by which the normal value exceeds the export price. Where
dumping margins vary, a weighted average margin may be established. The determination of the serious injury
caused to the Community industry or the threat of such injury must be based on positive evidence and involve an
objective examination of both a) the volume of the dumped imports and the effect of the dumped imports on
prices in the Community market for kike products, and b) the consequent impact of these imports on the
Community industry, the Community producers as a whole or as major proportion of the like products.
An investigation to determine the existence, degree and effect of any alleged dumping is initiated upon
a written complaint submitted to the Commission or to a Member State by any natural or legal person, or any
association acting on behalf of the Community industry. Where, in the absence of any complaint, a Member
State is in possession of sufficient evidence of dumping and of injury resulting there from for the Community
industry, it must immediately communicate such evidence to the Commission, after consultation with the
initiation of the proceedings. The final conclusions of the investigation must be adopted within a further six
months. The amount of the provisional anti-dumping duty must not exceed the margin of dumping as
provisionally established. Investigation may be terminated without the imposition of provisional or definitive
duties upon receipt of satisfactory voluntary undertakings from the exporter to revise his prices or to cease
exports to the area in question at dumped prices.
Where a provisional duty has been applied and the facts established show that there is dumping and
injury, the Council decides, irrespective of whether a definitive anti-dumping duty is to be imposed, what
proportion of the provisional duty is to be definitively collected. If the definitive anti-dumping duty is higher
than the provisional duty, the difference must not be collected. If the definitive duty is lower than the provisional
duty, the duty must be recalculated. Provisional or definitive anti-dumping duties must be imposed by
Regulation, and collected by Member States in the form, at the rate specified and according to the other criteria
laid down in the Regulation imposing such duties.
Another Regulation establishes the rules on protection against subsidized imports from countries not
members of the European Community1. Here again the Community legislation is compatible with GATT rules
and therefore, business must comply with only one set of rules. A countervailing duty may be imposed for the
purpose of offsetting any subsidy granted, directly or indirectly, for the manufacture, production, export or
transport of any product whose release for free circulation in the Community causes injury.
A subsidy is deemed to exist if: 1) there is a financial contribution by a government or by a private body
entrusted by it (directed transfer of funds, loan guarantees, fiscal incentives, provision of goods or services other
than general infrastructure, payments to a funding mechanism and 2) a benefit is thereby conferred.
Subsidies, which are not specific to an enterprise or industry or group of enterprises or industries,
cannot be subjected to countervailing measures. Even when they are specific, subsidies cannot be subjected to
countervailing duties, if they are given: for research activities, pursuant to a general framework of regional
development, to promote adaptation of existing facilities to new environmental requirements. The amount of
subsidies to be subjected to countervailing duties is calculated in terms of the benefit conferred to the recipient,
which is found to exist during the investigation period. Where all conditions are met, a provisional or definitive
countervailing duty is imposed following procedures similar to the ones described above concerning the
imposition of anti-dumping duties.


Reports on the Communitys anti-dumping and anti-subsidy activities supplied by the Commission
every year to the Council and Parliament suggest that less than 1% of Community imports are affected by such
activities. Of the 141 anti-subsidy measures in force at the end of 1997, 58 (41%) related to State-trading
countries, China according for 32 measures and Russia for 14.
In December 1994, the Council adopted a Regulation destined to improve Community procedures on
commercial defence and to ensure the exercise of the Communitys rights under international trade rules, in
particular those established under the auspices of the World Trade Organisation (WTO) 1. This Regulation allows
the Community to respond to obstacles to trade, to any trade practice adopted or maintained by a third country in
respect of which international trade rules establish a right of action. Thus, following the Community examination
procedures and after consultation with the Member States , the Commission may take any commercial policy
measures which are compatible with existing international obligations and procedures, notably:
a) suspension or withdrawal of any concession resulting from commercial policy negociations,
b) the raising of existing customs duties or the introduction of any other charge on imports,
c) the introduction of quantitative restrictions or any other measures modifying import or export conditions
or otherwise affecting trade with the third country concerned. The Commission has thus initiated procedures
concerning the US Anti-dumping Act of 1915 and US practices with regard to cross-border music licensing,
Japanese conditions governing imports of finished leather, and Brazilian practices in the area of import licensing
as applied to stainless steel flat products2.
Common export arrangements
By virtue of a Council Regulation of December 20,1969, Community exports to third countries are free
or, in other words, are not subject to quantitative restrictions, with the exception of a few products for certain
Member States and of petroleum oil and gases for all the Member States 3. However, when exceptional market
trends, which cause scarcity of an essential product, justify protective measures in the opinion of a Member
State, it can set in motion the Community information and consultation procedure. Consultations take place
within an Advisory Committee and cover notably the conditions and terms of exports and, if necessary, the
measures which should be adopted.
Should the Community market be in a critical situation due to a lack of essential products and should
the interests of the Community demand immediate action, the Commission, at the request of a Member State or
acting on its own initiative, can make exports subjects to the granting of an export authorization, issued if
certain provisions and restrictions defined by it, while waiting for a Council Decision, are satisfied. The Council
can uphold or invalidate the Commissions Decision, in light of the international commitments of the
Community or of all its Member States, notably as regards trade in primary products. Quantitative export
restrictions can be limited to specific destinations or to the exports of certain regions of the Community. They
must give due consideration to the volume of contracts concluded at normal terms, before bringing in a
protective measure. Export restrictions may depend on political or security reasons. Thus, exports as well as
imports of certain chemicals are subject to prior authorization by the relevant authorities in the Member
States1.Authorization must be refused if there are grounds for believing that the products in question could be
used to develop or manufacture chemical weapons or could be delivered directly or indirectly to belligerent
nations in area of high international tension.
Article 132 of the EC Treaty stipulates that the aid arrangements applied to exports by the Member
States should be gradually harmonized to ensure that there is a level competition playing field for the
Communitys exporting undertakings. As regards export credits, the Community has applied since 1983 the
arrangement concluded in the framework of the OECD and providing guidelines for officially supported export
credits2. These guidelines confine official support to the interest rates for export credits to certain countries.
Concerning export credit insurance for transactions with medium-and long- term cover, a Community Directive
aims to harmonies the various public systems for such insurance in order to prevent distortion of competition
among EU firms3. It lays down the common principles which must be observed by export credit insurers and
which concern the constituents of cover (general principles and definitions, scope of cover, causes of loss and
exclusions of liability and indemnification of claims), premiums, and country cover policy and notification

Council Regulation 3286/94, OJ L 349, 31.12.1994 and Council Regulation 356/95, OJ L 41, 23.02.1995
OJ C 197, 27.06.1997
Council Regulation 2603/69, OJ L324, 27.12.1969 and Council Regulation 3918/91, OJ L 372, 31.12.1991


The Commission contributes from the Community Budget to export promotion and notably to closer
cooperation at Community level and to research for joint action in favour of European exports (international
exhibitions, trade forums, conferences, seminars) in coordination with Community programmes and with
Member States export promotion programmes. The cooperation with trade federations and with national export
promotion organizations pursues two aims: first of all, to ensure that any activities on a particular market
strengthen the Community dimension and secondly, to focus activities on a number of target countries, the list of
which is topped by China, Japan, the countries of ASEAN (Association of South East Asian Nations) and the
countries of Central and Eastern Europe. In 1993 the programme was expanded to cover the Gulf countries,
which provide ready outlets for an extensive range of products and are close enough to Europe to attract small
and medium-sized enterprises from many Member States.
However, whereas customs tariffs diminish thanks to the Uruguay Round and the rules of the World
Trade Organisation impose in principle the freedom of international exchanges, European companies are still
faced with obstacles to trade and investment in a large number of countries. Thus, the Buy American clause
still excludes European firms from public works and supply contracts in the United States, and an environment
conductive to international exchanges and investments is still lacking in many Asian and South American
countries. The European Community has the necessary power to redress these situations, but its Member States
must lend a supporting hand in combating trade barriers by joining forces with the European Commission.
Having asked Member States and business circles to inform it on the most persistent trade and
investment barriers on the main export markets, the Commission established an ongoing inventory of tariff and
non-tariff barriers to trade in goods and services and the progress made towards removing them in the form of an
interactive electronic database accessible to businessmen via the Europe server on the Internet 1. A budget
heading covers the Commissions strategy to improve access for Community businesses to other to others
countries market, such as: identification and analysis of trade barriers in other countries, the establishment and
development of databases and the dissemination of information on trade barriers, studies concerning the
implementation by other countries of their obligations under international trade agreements and the production of
information packs on the legal and economic aspects of removing these barriers 2.
The General Agreement on Tariffs and Trade (GATT) came into being in 1947. Along with the
International Monetary Fund and the World Bank it was one of the institutions set up in the post-war period to
help regulate the international economy and prevent a recurrence of the disastrous policies undertaken between
the two World Wars. GATT was charged with overseeing international trade in goods and in particular, the
liberalization of this trade by means of a negotiated reduction in tariff barriers. The scope of GATT was,
therefore, somewhat limited initially, but the conclusion of the Uruguay Round negotiations enlarged its field of
activities and placed them under the auspices of the World Trade Organization. The Member States of the EC are
the contracting parties to the GATT, but, because of the common commercial policy, they participate as the
Community in the GATTs work. The Commission is the single negotiator and spokesman of the European
As stated in the Chapter on Customs Union, the EC Member States and other industrial countries made
major tariff concessions particularly in favour of the developing countries- during the successive negotiating
rounds between 1960 and 1979 under the aegis of the General Agreement on Tariff and Trade. Thanks to the
Dillon (1960-19620 AND Kennedy Rounds (1965-1967), the customs tariffs of the States participating in the
General Agreement were slashed by nearly 50% 3. Following the Tokyo Round (1973-1979), a fresh one-third
reduction in customs tariffs was agreed upon, to be implemented in eight stages the last of which was timed for
January 1, 19874. These tariff reductions made a considerable contribution to keeping the international trade
system open, despite the fact that in the first years of the eighties, the world economy went through the worst
period in its post-war history causing protectionist pressures to flare up. Since 1985, the Community committed
itself wholeheartedly to the process of launching a new cycle of multilateral trade negotiations under the GATT.
The Uruguay Round negotiations involved 117 countries from all over the world
and covered a large range of subjects. In addition to the issues traditionally covered by trade
talks, generally confined to tariff questions, the Uruguay Round encompassed the revision of
GATT rules and disciplines, plus the adoption of disciplines for new areas: the trade related
aspects of intellectual property rights, trade-related investment measures and international trade
in services. Also on the agenda were to devise an agreement for their gradual incorporations
into the GATT framework. Unprecedented in scope, the Uruguay Rounds main achievement,
obtained in December 1993, was to improve market access to a significant degree.

1.Council Regulation 2455/92, OJ L 251, 29.08.1992 and Commission Regulation 2247/98, OJ L 282, 220.10.1998
2.Council Decision 93/112, OJ L 44, 22.02.1993
3.Council Directive 98/29, OJ L 148, 19.05.1998


Market access for industrial products has been considerably improved by a reduction of one third or
more in the customs duties imposed by the industrialized countries and many developing countries on the
following sectors: building materials, agricultural machinery, medical equipment, steel, beer, spirits,
pharmaceutical products, paper, toys and furniture. The average level of tariffs for industrialized countries fell
from 5% to about 3.5%, whereas it stood at 40 % or more prior to the various rounds of GATT negotiations. In
total close to 40% of the EUs industrial imports are to be duty free. On their part, developing countries are to
apply substantial reductions of their customs duties on these products, whereas prior to the Uruguay Round they
had taken very few such commitments. The EU played a major role in pushing through the conclusion, in March
1997, of the Information Technology Agreement under which tariffs on information technology products of
countries accounting for 92% of world trade will be phased out completely by 1 January 20001.
Concerning agricultural products, the European Union succeeded, on the one hand, in achieving a
better balance between supply and demand on world agricultural markets and on the other, in ensuring that the
results of the Uruguay Round were compatible with the mechanisms of the reformed common agricultural
policy. The Agreements provides for the first time for the liberalization of trade in agricultural products and the
commitments cover market access, the gradual reduction of production support and also the observance of
export disciplines. The lowering of customs duties will be spread over a period of six years for industrialized
countries, including the European Union (36% reduction) and ten years fro the developing countries (24%
A first step was taken towards the liberalization of world trade in services. It should be noted that trade
is not limited to exchange of goods but also increasingly involves services, a sector which contributes nearly half
of the EUs GDP. The General Agreement on Trade in Services (GATS) includes general rules for trade in this
area, specific provisions for given service sectors and national schedules showing the services and activities
which each country agrees to open up to competition, with possible limitations 2. GATS establishes notably the
principles: of the most favoured nation provisions, the principle that all third countries must be treated equally, of
transparency on market access, and on national treatment, meaning that a company from a third country cannot
be placed at a competitive disadvantage in relation to a domestic country. The Agreement establishes for the first
time a multilateral framework based on satisfactory rules and compromising sufficient commitments to trigger
the liberalization process. The audiovisual sector was included in the GATS, which means that the rules relating
to transparency and of progressive liberalization apply to it. However, the EU has made no market access
commitment nor, as a result, any commitments on national treatment. It also took an exemption from the
principle of most favoured nation conditions and is, therefore, not bound to give equal treatment to all third
countries. Basic telecommunications services were covered by the fourth protocol to the GATS, in February
1997, in a balanced package of measures respecting the most-favoured nation principle 3. The fifth protocol to the
GATS, based likewise on the most favoured nation principle, provides better market access to financial services
covering more than 95 % of world trade in the banking, insurance and securities sectors 4.
The Uruguay Round negotiations included also the protection of trade-related intellectual
property (TRIPs)5. Intellectual property concerns an ever-increasing part of world trade, be it related to
pharmaceuticals, computer software, books and records. As trade has increased so too have cheating,
counterfeiting and copying. A further problem has been the appropriation of brand names and in the case of
wines and foodstuffs, certain geographical appellations.
The conclusions of the Uruguay Round have reinforced existing international conventions, for example
the Bern and Paris Conventions for the protection of literary and artistic works, by bringing them within the
ambit of the GATT dispute settlement procedures. In addition, there has been a strengthening of intellectual
property rights concerning the protection of trade marks, industrial designs, patents and geographical
appellations. A clear set of principles has been established for the enforcement thought the national courts of
intellectual property rights, any breaches being subject to sanctions under the dispute settlement procedure. The
Community has amended the Regulation on the Community trade mark, notably in order to comply with the
national treatment obligation established by the TRIPs Agreement. According to the Court of Justice, even
though questions relating to the TRIP s Agreement fall largely within the jurisdiction of the Member Stats, where
a provision of the agreement is to be applied to situations covered both by national and by Community law, it is
in the Community interest to avoid any differences of interpretation and national courts should apply the
Community trade mark law.
The Uruguay Round resulted also on an Agreement on trade-related investment measures (TRIMs)1.
An illustrative list of non-permissible measures is included in the agreement, covering such things as local
content rules, trade balancing and local sales requirements. Such measures must be phased out over a two-to
seven year period, depending upon whether the country is developed or developing. The TRIMs Agreemetn is
particularly important for the EU, which is responsible for 36% of direct investment in the world and receives
19% of such investments on its territory.
Very substantial results were achieved in the field of rules and disciplines thanks to the reform of the
provisions on safeguards, subsidies, anti-dumping measures, the balance of payments, the standards and
public procurement codes. The Agreement on Government Procurement, of which are part the EU, the
United States, Japan and a limited number of other countries on a reciprocal basis, is open to all and is largely
based on the Community rules on public procurement concerning, in particular, the procedures, the thresholds


which apply and the recourse mechanisms if firms believe that they have been denied equal treatment 2. Under
this Agreement which is founded on national treatment, in accordance with which foreign suppliers of goods and
services must be dealt with in the same way as national suppliers, public procurement contracts of over ECU 300
billion will be open to international competition for the first time. The Agreement includes, in principle, water,
ports, airports, electricity and urban transport, although not every country has made a commitment in each
The World Trade Organisation (WTO), established in 1995, has replaced GATT, taking all the
agreements concluded under its auspices, and settling trade disputes on a multilateral basis 3. In fact, the WTO
brings together under a single decision-making and administrative body the three agreements resulting from the
Uruguay Round: the General Agreement on Tariffs and Trade (GATT), the General Agreement on Trade in
Services (GATS) and the Agreement on trade-related aspects of intellectual property rights (TRIPS). The WTO
operates on the basis of a ministerial conference, which meet at least once every two years, and of a General
Council made up of representatives of all the member countries. The European Community as well as all its
Member States are members of WTO, a code of conduct defining the participation of the Community and its
Member States in areas of shared power.
Thus, the GATT continues to exist, while frozen its pre-Uruguay Round situation, for those countries
that are not in a position to accept the entire package of its conclusions.
On the contrary, the WTO is open to those who agree to abide by the entire Uruguay Round package of
rules. This increases the certainty of the world exchange system, since all the members of the WTO are perfectly
aware of their own rights and obligations and of those of their partners. The national law of each contracting
party must be in conformity with the rules of the WTO, thus precluding unilateral action.
The unique structure of the WTO allows an integrated system of dispute settlement. The parties must
refrain from making rulings themselves regarding violations and must abide completely by the provisions of the
dispute settlement procedure in dealing with all matters, including the determination of cross retaliation. The
Agreement establishes an appeals procedure providing for a review of the conclusions of the panels of first
instance. A Dispute Settlement Board (DSB) oversees the proceedings. Safeguard measures are authorized, but
their scope is limited both in terms of the measures taken and of their duration. A safeguards Committee
monitors all measures taken and ensures that they are in conformity with the agreement. One of the first
procedures initiated by the EU concerned the failure of the USA to repeal their Anti-dumping Act of 1916 1. on
their side, the USA are leading battles inside the WTO against EU legislation on the common organization of the
market in bananas2 and on meat produced with the aid of hormones 3. Between 1995 and 1998, the EU has lodged
40 complaints with the dispute-settlement body of the WTO, while 30 complaints have been lodged against it,
concerning chiefly issues to do with agricultural products.
Sectoral commercial policy measures
In the framework of the General Agreement on Tariffs and Trade, several agreements or arrangements
had been concluded in particularly sensitive sectors. The Agreements to which the Community and/or its
Member States were signatories sought to ensure the orderly growth of international trade in textiles, beef and
veal, dairy products and civil aircraft. The most important of these arrangements was that on international trade
in textiles, better known as the Multifibre Arrangement (MFA), signed in 1974, in the framework of the GATT
and owing its name to the fact that it covers most textile products, spanning artificial and synthetic fibres, cotton
and wool. Under the terms of the Arrangement, signatories had undertaken not to introduce new unilateral or
bilateral restrictions on trade in textiles and to regulate their trade relations by bilateral agreements. The
Community had based its textiles policy on this clause of the MFA, concluding with supplier countries bilateral
agreements revolving chiefly around the principle of voluntary restraint of export quantities by signatory
countries for a limited number of products, with gradual growth of the authorized quantities.
The Multifibre Arrangement was revised in order to progressively liberalize the international trade in
textiles as provided in the GATT Agreement of 15 December 1993. In fact, the WTO Agreement on Textiles
and Clothing (ATC) will govern trade between all Members of the WTO until such time as they have been
integrated into normal WTO rules and disciplines. This integration will be phased in three stages and will be
completed in January 2005. The Agreement provides in particular for the strengthening of the GATT rules and
disciplines, notably as regards market access, dumping, subsidies and counterfeiting. It contains a transitional
safeguard clause in order to prevent any serious market disturbance in the importing countries.
A Community Regulation modifying the common rules for imports of certain textile products from third
countries lays down a clear Community procedure for the selection of products to be integrated and notified to
the WTO at each stage, Another Regulation lays down common rules for imports of textile products from certain
third countries not covered by bilateral agreements, protocols or other agreements, notably the countries of the
Commonwealth of Independent States and the Peoples Republic of China. It eliminates the exceptions and
derogations resulting from the remaining national commercial policy measures and establishes quantitative
restrictions and surveillance measures applicable at Community level for a limited number of products
originating from these countries.


7.2 External relations and the EUs hierarchy of trading preferences

The EU enjoys trading relations with nearly 200 countries, including those like China who remain
outside of the structure of the WTO. A characteristic of these relationships is the extent to which the EU treats
certain trading partners preferentially and thereby deviates from the basic MFN principle of the WTO. In effect,
the EU countries have five types of trade relationship:
1. within the EU customs union itself, international trading relationships which are free from tariffs and from
other impediments;
2. with fellow WTO members (on the basis of mutual most-favoured nation treatment);
3. with fellow WTO members (on the basis of preferential terms and agreements);
4. with countries which are not party to the WTO (based on non-preferential agreements);
5. with countries which are not party to the WTO (based on preferential terms).
Discounting the first category of relationships which are not the subject of external EU trade, trade ties
with the US and Japan (among a small number of industrialized economies) come under the second category of
MFN treatment. Trade ties with other European economies and with most developing economies fall principally
into the third category of preferential conditions, although some of the developing markets that receive
preferential treatment from the EU remain outside of the WTO framework.
The meaning of this is that the vast majority of the Union's trading partners qualify for some form of
preferential treatment. As a consequence, the EU can be said to discriminate in favour of certain countries and to
operate a hierarchy of trading preferences. Concerning this hierarchy, it is clear that the EU has tended to group
countries under common agreements or to extend a rough equivalence of treatment through like bilateral
agreements. It is also clear that the EU does not always expect (or demand) reciprocal concessions from those
trading partners to which it extends trading privileges. For example, one-way (non-reciprocal) preferences are
extended to a number of developing economies and to former European colonies under the EU's Generalized
System of Preferences (GSP) and the EC-ACP Partnership (see subsequently).
The European Free Trade Associaton and European Economic Area
The European Free Trade Association (EFTA) was set up in 1959 on the initiative of the United
Kingdom, which thought that the Community was going too fast and too far along the path of European
integration. When the United Kingdom and Denmark switched allegiances from CEFTA to the EEC in 1973, the
scale of their commercial relations with other EFTA countries made it impossible to preserve customs barriers
between two groups of countries. As a consequence, free trade agreements were signed in 1972 and 1973
between the Community and EFTA countries. These agreements abolished customs duties and restrictions on
trade in industrial products. Furthermore, the Community agreed to certain compromises on the Common
Agricultural Policy, which was matched by reciprocal EFTA concessions in the agricultural field. EEC-EFTA
free trade has operated in a satisfactory manner and has brought about sustained growth in trade between the
two groups of countries. This trade, by the end of the eighties, represented 25% of total Community trade and
between 40% and 65% of that of the EFTA countries. In 1989, Jacques Delors, then President of the European
Commission, proposed and the European Council agreed to further strengthen the relations between the two
European trade blocks. The negotiations got underway in 1990 and were completed in October 1991 between the
Community and EFTA as a body on the basic, legal and institutional aspects of such a global agreement.
The Treaty on the European Economic Area (EEA) was signed in 1992 by the governments of twelve
EU countries and six EFTA countries. However, as a result of the negative Swiss referendum, on 6 December
1992, and the accession to the European Union since 1 January 1995 of Austria, Sweeden and Finland, the EEA
Treaty associates to the EU only Norway, Iceland, and Liechtenstein. The institutional framework of the EEA
comprises: the EEA Council, which is made up of members of the Council of the EU and the Commission plus
one member for each signatory EFTA government, and which provides political impetus for the implementation
of the Agreement and lays down general guidelines, the EEA Joint Committee and the EEA Consultative
Committee, which provides a forum for representatives of social partners. EEA EFTA countries participate in
the decision shaping process in the ambit of the Commission. The aim of the EEA Treaty is to establish a
dynamic and homogeneous integrated economic entity based on common rules and equal conditions of
competition. The EFTA States, minus Switzerland, undertook to take on board existing Community legislation
concerning the free movement of goods, persons, services and capital, subject to a few exceptions and
transitional periods in certain sectors. Apart from the implementation of the four freedoms of the common
market, the EEA Agreement also provides for relations between the Community and the EFTA countries to be
reinforced and extended in area which have an impact on business activity. These are the horizontal policies
which have an impact on business activity, notably social policy, consumer protection, environment, statistics
and company law, and the fields such as research and development, information, education, the audiovisual
sector, SMEs and tourism. Special arrangements on agriculture, fisheries and transport are provided in bilateral
Agreements which accompany the EEA Agreement. Other Agreements cover inland transport, air transport, free


movement of persons, agriculture, public procurement, mutual recognition of certificates of conformity, and
technological research and development. This contains provisions designed to iron out economic, social and
regional disparities under the cohesion principle. Therefore, the EEA countries contribute to the financing of the
Cohesion Fund in favour of Spain, Portugal, Greece and Ireland. Norway and Iceland are associated in the
implementation and development of the Shengen acquis under the Treaty of Amsterdam.
Not being a party to the EEA agreement, Switzerland has negotiated with the EU sectoral agreements
on the free movement of persons, air transport, the transport of goods and passengers by rail and by road,
scientific and technological cooperation, public procurement, trade in agricultural products, and mutual
recognition and conformity assessment.
The European Economic Area Agreement: Norway, Liechtenstein and Iceland
At the head of the EU's hierarchy of trading preferences are the three parties still outside of the EU that
are signatories to the European Economic Area (EEA) Agreement - Norway, Iceland and Liechtenstein. The EEA
Agreement was concluded in 1994 between the then EU-12 and six of the seven countries constituting the
membership of EFTA in 1994 (Norway, Iceland, Liechtenstein, Austria, Sweden and Finland). Alone amongst
the EFTA countries, Switzerland refused to ratify the EEA Agreement. In practical terms, the EEA establishes the
mutual application of the four freedoms of the Single European Market as laid down by the Treaty of Rome -the
freedom of movement of goods, services, persons and capital. As a consequence, and although special
arrangements are established for agriculture, fisheries and transport, the EEA is effectively an enlarged single
market and has added services to the industrial goods free trade area established by the 1972-73 free trade
agreements between the EC and EFTA. With the accession of new EU members from the ranks of the EEA
membership and with the refusal of Switzerland to join the EEA, there may be some doubt over the long-term
survival of the EEA as a distinctive economic area. Nonetheless, successive EEA Councils have concluded with
affirmation of the agreement's value and functionability. It appears that the EEA will continue to exist and to
govern relations with Norway and Iceland in particular.
Customs Union Agreements: Turkey, Malta and Cyprus
The countries of the Mediterranean are of considerable economic significance for the EU, constituting
as a group one of its largest trading partners and having close historic and cultural ties with some of its member
states. Relations between the Community and the Mediterranean countries have become ever closer in three
phases, during a period extending from the sixties to the eighties. A new phase of close cooperation began in
Acting on the conclusions of the Courfu European Council, the Commission in a communication of
October 1994 proposed the establishment of a Euro-Mediterranean partnership, chiefly with the Magreb and
Mashreq countries and Israel, whose process would begin with a gradual liberalization of trade, supported by a
substantial financial aid package, before moving on to closer political and economic cooperation and finally to
close association. In another communication the Commission proposed three areas of priority assistance: for
economic transition, for a better socio-economic balance and for regional integration. According to the
Commission, the EUs Mediterranean policy should become multi-faceted, encompassing all those areas where
interdependence exists, such as economic development and trade, immigration and the environment.
An Important Euro-Mediterranean ministerial conference took place on 27 and 28 November 1995 in
Barcelona between the EU and its twelve Mediterranean partners (Algeria, Cyprus, Egypt, Israel, Jordan,
Lebanon, Malta, Morocco, Syria, Tunisia, Turkey and the Palestinian Authority). At the end of the proceedings,
the ministers adopted a Declaration and a work programme instituting a regular political dialogue and enhanced
cooperation fostering peace, security, stability and prosperity in the region. The three key components of the
Euro-Mediterranean partnership are: a reinforced and regular political dialogue, an enhanced economic and
financial cooperation aiming at the creation of a free trade area, and a further strengthening of the social, cultural
and human dimensions. A Community budget heading called MEDA constitutes the single financial instrument
for the implementation of all cooperation activities with the countries concerned. It provides for support
measures in three areas: economic transition, economic and social development. And regional and cross-border
cooperation. The long-term objective is the creation of a Euro-Mediterranean economic area with more than 800
million inhabitants from some 40 countries.
The Mediterranean policy has not only been staggered in time but has differed from country to country.
The Community always took an open line towards the European Mediterranean countries, with a view to a
possible customs union or even accession. This policy has paid off, for it helped establish strong democracy in
three Mediterranean countries: Greece, Spain and Portugal, which are now fully-fledged members of the
European Community. Most other Mediterranean countries have close relations with it.
Malta has thus been associated to the Community since March 1971. Following the political choices of
successive governments it has applied for accession to the EU, freeze its application for some time and relented
the negotiations foe accession in 1998. An association agreement with Cyprus was concluded in May 1973.
Their Agreements provide for a customs union with the Community. In July 1990, the two republics applied for


Community membership. The pre-accession strategy for Cyprus took on added importance when the
Luxembourg European Council in December 1997 started the accession process for that country. The Union
believes that Cypruss accession to the EU should benefit all communities, including the Turkish Cypriot
community, and help to bring about civil peace and reconciliation on the island. It trusts, indeed, that progress
towards accession and towards a just and viable solution to the Cyprus problem will naturally reinforce each
The EU is in the process of developing customs union arrangements with three applicant countries Turkey, Malta and Cyprus. It is to be recalled that, under a customs union, tariffs and quotas are eliminated on
trade between members and that they apply a common external tariff on those imports covered under the terms
of the customs union agreement. Turkey and the EU formed a customs union on 1 January 1996. The agreement
covers industrial and processed agricultural goods. Textiles and agricultural trade are covered by special
protocols removing most quota restrictions on Turkish imports. As a part of this customs union, Turkey has
adopted the EU's Common External Tariff on most products. As a result, Turkey's tariffs for third countries have
generally been lowered. Cyprus and Malta have also made progress towards customs unions with the EU. A
customs union between Cyprus and the EU should be completed by the year 2003 and with Malta by 2004.
These unions will involve the elimination of all tariffs and quantitative restrictions on all manufactured goods
and on a number of agricultural products. Such steps are generally seen as a precursor to the full integration of
these countries into the EU.
European Association Agreements: Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania,
Poland, Romania, Slovakia and Slovenia
Ten European Association Agreements ('Europe Agreements') concluded by the EU member states and reforming
CEECs have served to create the beginnings of a free trade area joining the European Union to much of Central
and Eastern Europe. The core of these agreements - in commercial terms at least - is the creation of a series of
industrial free trade areas, all of which should be in place by the year 2004. Duty and quota free access to the EU
market is already in place for industrial items. Residual EU restrictions on steel, coal and textiles imports were
removed in 1999. The EAs also provide for some concessions on agricultural trade and for the progressive
elimination of barriers to commercial services trade.
Euro-Mediterranean Association Agreements: Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, Palestine,
Syria and Tunisia
Somewhat behind the development of the Europe Agreements (and more limited in scope), the EU is
making progress towards a series of new association agreements with nine economies in the Mediterranean
basin. For a number of years, the EU has extended a series of trading privileges to these states, which have
generally benefited from non-reciprocal free access to the EU market for most industrial products and for some
raw materials and agricultural products. In Israel's case, trade co-operation was enhanced by conclusion of a
special Co-operation Agreement in 1975. The effort now is to upgrade and (to some extent) to harmonize these
privileges as a part of a structured effort to create a more cohesive and open Euro-Mediterranean Economic Area
(EMEA). Bilateral Association Agreements are to be joined by a series of multilateral activities in the politicalsecurity, economic-financial and social-cultural fields. Each of these agreements will provide for a reciprocal
free trade area in industrial goods (by 2010) with special arrangements governing trade in agricultural products,
fisheries, textiles and clothing.
The Barcelona Declaration of November 1995 states that the association agreements concluded with the
Community should be followed by similar agreements on free trade and co-operation among the Mediterranean
countries themselves, including Turkey, Malta and Cyprus. The conclusion of such agreements between the
twelve 'Med' economies should result in a Euro-Mediterranean FTA of at least twenty-seven countries. The
creation of such a vast free trade area will be supported by multi-party efforts to promote private investment in
the Mediterranean basin, to develop the region's economic and social infrastructure and to establish suitable
regulatory systems. This forms a part of a wide-reaching Euro-Mediterranean Partnership based on political and
security dialogue, economic, financial and commercial co-operation, and partnership in cultural, social and
human affairs.
ACP-EC Partnership Agreement: seventy-one developing economies
The ACP-EC Partnership Agreement applies to seventy-one developing countries from Africa, the
Pacific and the Caribbean region. The Agreement provides non-reciprocal tariff-free access to almost all ACP
products on the EU market. For a number of agricultural products, border charges apply but at reductions on
standard MFN tariffs. The ACP-EC Agreement builds on the successive Lome Conventions which have
regulated trade between the ACP countries and the EU for nearly thirty years. While Lome I-IV have promoted
the economic growth of the ACP states, their present level of development requires the continuation of
preferential treatment.


The Generalized System of Preferences: 145 developing economies

The GSP scheme has long seen the EU grant, without any formal agreement and without any involved
reciprocity, a series of generalized duty reductions for imports originating from developing economies. The
granting of these reductions (renewed multi-annually) has been to the benefit of over 100 developing countries.
Under the present arrangements, tariff reductions vary depending on the type and sensitivity of the product. For
very sensitive products (such as textiles and certain agricultural products) the preferential duties are as much as
85% of the CCT duty normally applied. For semisensitive products, the modulated preferential duty will be 35%
of the CCT. Many imports are completely exempt from customs duty. In principle, all countries covered by the
scheme face the same tariff rate on each product line irrespective of their relative competitiveness or level of
development. However, special concessions apply to a small number the 'least advanced' of the developing
countries such as Bangladesh, Yemen and Nepal. These countries have complete exemption from duty for
industrial products and admission of a wide range of agricultural products under zero-duty rates. It should be
noted that when a GSP beneficiary's exports exceed 25% of EU imports in specified sectors, then its GSP
benefits will be withdrawn.
7.3 EU external trading relations: Japan and the US
It should be clear then that the EU has only a small number of purely MFN suppliers. However, the
largest share of imports by value into the EU enters under non-preferential conditions. This reflects the status of
countries such as the United States and Japan among the EU's most important trading partners. Relations with
these countries are amongst the most important of the EU's external ties. EU-US relations are currently
dominated by proposals for a New Transatlantic Marketplace (NTM). An outline of a plan is in place which
would see the elimination of mutual industrial tariffs by the year 2010 and the establishment of an EU-US free
trade area in services. The NTM plan is being realized under the auspices of a Transatlantic Economic
Partnership (TEP) agreed between the EU and US in London in May 1998. The NTM proposal has been
carefully designed to be compatible with all multilateral commitments such that the elimination of industrial
tariffs by 2010 must be multilateralized. The proposal for bilateral free trade in services is not dependent on
multilateral agreement to completely liberalize global services trade. Rather, the proposals are intended to
achieve a bilateral platform for free trade which would set an example for others. In the context of the WTO, the
EU and the US have also worked together to conclude the Information Technology Agreement, the Basic
Telecommunication Services Agreement and the Financial Services Agreement. These agreements build on the
GATS deal secured under the Uruguay Round and liberalize large portions of international trade in services.
Despite such co-operation, EU-US relations have always been characterized by dispute over trade questions. In
recent years, argument has surrounded the extraterritorial effects of US trade legislation (e.g. the Helms-Burton
Act on Cuba), aerospace subsidies, hormone-treated beef and genetically modified food products.
The relationship between Japan and the EU has historically been more difficult. An imbalance of trade
(in favour of Japan), EU controls on Japanese imports and innumerable obstacles faced by European firms
wishing to export to Japan have all been at the heart of longstanding tensions. Although market access remains a
thorny issue, bilateral co-operation has developed on multilateral trade issues and the EU and Japan have
strengthened a bilateral dialogue on trade and investment barriers. Subsequent sections add a statistical profile to
this trading relationship and that with the United States.
Member states trade
The importance of international trade from a European perspective cannot be overstated. The European
Commission estimates that between 10 and 12 million jobs depend directly on exports which, in turn, provide
9% of the Union's wealth. The European Union is itself the world's largest trade grouping. Even discounting
internal trade between the member states, it is responsible for approximately one-fifth of world trade in
merchandise goods (see Table 12.1) and over one-quarter of international services transactions.
The trade of member states is dominated (in value terms) by merchandise trade consisting of trade in
raw materials, energy and manufactured goods. In 1998, according to the Eurostat-Comext database, the EU's
export trade in merchandise goods (excluding intra-EU exports) totalled 731.58 billion. The EU's largest
(individual) export markets were the USA (22% share of EU total), Switzerland (7.8%), Japan (4.3%), Poland
(3.8%), Norway (3.4%), Turkey (3.0%), Russia (2.9%)) and China (2.4%). In the same year (1998), the EU
countries imported 712.37 billion worth of goods, establishing a merchandise trade surplus of just under 20
billion. The biggest exporters to the EU were the USA (21.3% of EU total), Japan (9.2%), Switzerland (6.9%),
China (5.9%), Norway (4.1%), Russia (3.2%), Taiwan (2.6%) and Poland (2.3%).
In recent years, the EU's external trade performance has steadily improved. A peak ECU 49 billion surplus in
1997 concluded five successive years of positive trade performance. Between 1988 and 1992, the EU recorded
major trade deficits, with a low of ECU 70.2 billion in 1991. This improvement in external trade performance
can be explained by a number of factors including the real depreciation of many EU currencies, relatively weak
domestic demand (causing exports to rise faster than imports), high-productivity growth and the opening up of


new export markets (e.g. Russia, China and the CEE markets). A narrowing in the EU's trade surplus in 1998
reflected the economic and financial crises that beset the Asian markets during this year.
Table 7.1 Leading exporters and importers in world merchandise trade (excluding intra-EU trade), 1998
World exports
Share (%)

Value ($bn) 1998

Source: World Trade Organization.

European Union
Hong Kong

World imports
Share (%)

Value ($bn) 1998




Table 7.2 disaggregates the merchandise trade performance of the EU states providing a ranking of
individual (national) exporters and incorporating intra-EU exports. The list includes seven of the EU-15 and
compares their individual (national) performance with other producer-exporters over the last twenty years. It is
interesting to note that the top six countries have not changed their ranking throughout this time and that newly
industrialized countries such as China, Singapore, Mexico and Malaysia have made dramatic trade gains.
Trade in services is of major importance to the EU economies. The EU is the world leader in this field
and a list of the world's top ten commercial services exporters features no less than seven EU states (see Table
12.3). Together, the EU states are responsible for 45% of all global services transactions, a figure which falls to
26% if intra-EU trade is stripped out. By comparison, and as can be seen in Table 12.3, the United States' share is
just 18% and Japan's just 4% (based on WTO estimates for 1998). The EU's capabilities in this field reflect the
maturity of its leading economies (each of which has a developed service sector) and the openness of EU
markets. Its domestic services market is one of the most integrated and lightly regulated in the world. It is
unsurprising, therefore, that the EU has been a driving force behind the efforts to realize an open global market
in services including computer and information activities, finance and insurance, transport and
telecommunications. Development on the General Agreement on Trade in Services (GATS), which established a
set of basic rules and obligations regarding world trade in services, is crucial to the long-term interests (and
growth) of many EU businesses. Accordingly, the EU has been a major influence in the conclusion of postUruguay agreements in the fields of telecommunications, information technologies and financial services. These
agreements mean that WTO rules will apply to over 90% of global trade in telecommunications, IT, banking and
insurance, with significant progress towards tariff reductions.
Table 7.2 Leading exporters in world merchandise trade 1979, 1989 and 1998



Source: World Trade Organization


1998 Value ($bn)

United Kingdom
Hong Kong




The EU's competitive advantage now rests heavily with a number of commercial services (transport
services, travel services, financial and business services especially) and with a number of high value added and
high-skill manufactures such as chemicals, aircraft, cars and machinery. In several commercial services,
machinery and transport equipment markets, chemicals, pharmaceuticals, food and beverages, the EU maintains
a healthy trade surplus. Each country holds a presence in most sectors but is relatively specialized. Among the
four large EU states, the UK is relatively specialized in financial services, telecommunications, fuels, chemicals,


printing and publishing. Germany's strengths rest with engineering, chemicals, plastics and metals, industrial and
transport equipment (including motor vehicle production). France's comparative advantage rests primarily with
the food and beverages sector, machinery and transportation equipment, chemicals and glass. It is also a major
exporter of wheat and dairy products. Italy specializes in cement and clay products, clothing and textiles,
production machinery, motor vehicles and food products. Each country retains a presence in most industrial
sectors but specializes in narrow product categories within each industry and with concentrations on high value
added segments. Elsewhere in the EU, other patterns of trade specialization include the Netherlands in electrical
machinery, refining and industrial chemicals, Belgium in iron and steel, Portugal in textiles, Spain in leather
goods, Ireland in food, and Sweden in wood products, paper and furniture. The EU runs a significant trade
deficit in raw materials, agricultural produce, energy, textiles and clothing.
Table 7.3 Leading exporters in commercial services, 1998
Share (%)
Value ($bn) 1998
Source: World Trade Organization

United Kingdom
Hong Kong

7.4 The emergence of regional trade blocs and the global Traid

The growth and consolidation of the EU as a regional trade grouping must be observed in terms of a
trend towards 'regionalized' economic unification in the new global economy. In this view, the EU bloc is seen as
just one (albeit perhaps the most important) of a number of regional economic groupings (REGs) including the
North American Free Trade Agreement (NAFTA), MERCOSUR and ASEAN. Various economic groupings and
the degree of economic integration pertaining to each group in 1999 are shown in Table 7.4. The levels and
forms of economic integration have been characterized in Chapter1. It may be recalled that a free trade area
(FTA) sees a group of countries agree to removal all trade barriers - tariffs, quotas and non-tariff barriers. Each
country retains discretion in establishing trade barriers with non-members. The next stage of integration is a
customs union in which as well as adhering to the removal of all trade barriers, members have a common
external policy on international trade with non-members. Common markets are those which, along with the
removal of trade barriers and the adoption of a common external policy, also feature additional provisions to
encourage trade and integration through the free mobility of factors of production. Finally, an economic union is
formed when the individual member countries agree to forgo unilateral control over economic-decision-making
and policy. Characteristically this involves a unified monetary system, a common fiscal and monetary policy, and
a unified international trade policy. With the realization of a single currency in Europe, the development of the
EU from a common market to an economic union has been brought much closer.
Table 7.4 Major regional economic groupings (REGs), 1999.

Customs union

of Free Trade Area
South East Asian
Nations (ASEAN)


Population (million)

GDP (PPP) $bn






Union Common Market

The Netherlands



American Free Trade Area
Note: GDP and population figures calculated from national statistical entries. Population figures, latest available estimate. GDP figures,
estimates for 1998. CDP dollar estimates for all countries are derived from purchasing power parity (PPP) calculations rather than from
conversions at official currency exchange rates. Source: CIA World Factbook 1999

Liberalization of trade between countries within these blocs promotes trade (trade creation) and supports efficient
patterns of specialization. Conversely, the expansion of trade within the bloc may potentially take place at the expense of
trade with non-member countries (trade diversion). The balance between these effects determines to what extent the creation
of a grouping is beneficial to its members and to world welfare. Many observers have concluded that, on balance, the creation
of the EU has had a beneficial effect on world welfare. Trade creation effects have been apparent within the EU but perhaps
more significantly, the creation of the single market has also catalyzed inward trade from non-EU members. Although a
degree of trade diversion has been apparent (for example, the adverse effects felt by the Caribbean sugar industry following
the UK's entry into the EEC in 1973) its extent has been limited by a lowering of tariffs (through GATT) and through
preferential trade deals with former colonies and non-EU member regions. Despite this, the enlargement of the Union and the
expansion of the EU's preferential network of free-trade agreements, which continues, is bound to give some concern to MFN
trading partners in relation to potential trade diversion.
The global Triad
The growing trend towards the development of economic unions is having a powerful effect on the shape of
international trade and investment. Ohmae (1985) argues that the economic world is now dominated by three major markets
-Japan, the US and EU - each of whom he saw as dominating a regional economic theatre. Ohmae labelled these markets 'the
Triad'. Any assessment of international trade and investment data would support this conclusion. Japan, the US and the EU
account for 47% of all world merchanise exports (excluding intra-EU trade flows) and for three-quarters of the world's
accumulated stock of FDI. In 1997, 50.5% of inward FDI flows went to the Triad economies who were responsible for 75.5%
of all outward FDI in the world economy (see Table 7.5).
Over 75% of production and sales in automotives, chemicals, petrochemicals, steel and other major industrial
sectors takes place inside the Triad. There is no doubt that these economies dominate the global economy and anchor
dynamic regional markets.
Table 7.5 Regional distribution of FDI flows, 1994-97 (percentage shares)

Inflows Outflows
Developed countries
Western Europe
European Union
Other Western Europe
United States
Developing countries
Latin America and the Caribbean
Developing Europe
West Asia
Central Asia
South, East and South-East Asia
The Pacific
Central and Eastern Europe
Source: World Investment Report 1999 (UNCTAD/WIR, 1999)







Considering the volumes of trade and investment now concentrated in the Triad it is unsurprising that
such concentration of economic activity is changing the strategic focus of many multinational enterprises. Most
MNEs focus attention on attaining a global balance in their business activities but interest in diverse international


portfolios must now be balanced with the 'need' for competitive positioning in the three Triad markets. Part of
the reasoning for this is gaining access to the largest industrial and consumer markets in the world as well as
benefiting from regionally initiated R&D programmes either internal to the firm or through government
initiatives. For smaller firms from the developed world, the challenges are no less significant. Concentration on
consolidating business or securing a broader position in the home region rather than attempting to expand on a
global scale may theoretically be the most attractive option. This permits exploitation of the advantages being
offered by greater integration in home regions and will generally entail less risk. Nevertheless, links with nonbloc members and the potential rewards of business in other markets may encourage many companies to look
outside of their regions. This reinforces the need for openness between the trading blocs.
A characteristic of the Triad is the high level of trade and investment conducted across and between the
members. Figure 12.2 gives some indication of the intra-Triad trade flows for 1998 (merchandise trade only).
The US shows a trade deficit with both the EU and Japan (which has led to much of the US's concerns over
access to European and Japanese markets). While the EU enjoys a small trade surplus with the US, it continues
to run a sizeable deficit with Japan.
Tables 7.6 and 7.7 highlight the direct investment stocks and flows linking the EU with Japan and the
US. The data highlight the scale of the investment relationships between these partners, cumulative stocks of
cross-investment and recent (annual) FDI flows. There are relatively few restrictions on inward investment in the
US and EU. Although investment barriers in Japan have long been a problem for many Western firms, Japan is
opening up to foreign investment and tackling many of the legal impediments to inward investment. Increasing
foreign investments is now evident in Japan's banking, manufacturing, and telecom industries.

Figure 7.2 Intra-Triad merchandise flows, 1998 (in billion Euros)

Source: EuroStat-Comext; UN-Comtrade

Table 7.6 EU foreign direct investment with the United States (billion Euros)
28,579 25,152
Share of EU total
Inward stocks
189,310 210,585
US share on total EU 51.3
inward stocks
Source: European Commission, 1999


Share of EU total
Outward stocks
US share on total EU
outward stocks










Table 7.7EU foreign direct investment with japan (billion Euros)

Share of EU total
Inward stocks Japan 28,160 31,915
share on total
EU inward stocks
Source: European Commission, 1999


Share of EU total
Outward stocks japan
share on total
EU outward stocks

The data in Table 7.6 highlight a stock of cross-investment between Europe and the US exceeding 500
billion. This is the world's largest investment relationship. The inward stock of US investment in the EU had


reached 210 billion by the end of 1996, a major share of all US FDI assets abroad (620 billion). The creation
of the Single Market clearly had a marked impact on levels of US business activity within the EU. For American
(and Canadian) firms, penetration of this vast and integrating market was increasingly seen as essential to a
company's competitive position in the European and global marketplace. As with Japan, fears that Europe would
become a 'fortress' following the establishment of the Single European Market were also a reason why American
investment increased in the region around the period of the IMP. A more recent stimulus has been provided by
the moves towards European Monetary Union. Present levels of US investment represent approximately one-half
of total EU inward investment stocks. Key investors include Ford, General Motors, IBM and Hewlett Packard.
Traditionally, much of the investment activity of these and other firms has been concentrated in a small number
of EU countries (France, Germany, the Netherlands and the UK).
European companies are the number one international investors in forty-one US states, and rank number
two in the remaining nine states ( EU investment in the US is valued at 298 billion
(1997) with the US garnering 45% of the EU's total outward investment in 1997. European Union statistics show
that annual outward investment flows into the US economy are rising dramatically.
Although Japanese investment in Europe remains relatively low compared with US levels (just 7% of
total EU inward investment stocks), levels have grown significantly since the 1970s. In the 1980s, external
restrictions imposed on Japanese exports encouraged many Japanese firms to invest inside the EU. Rather than
face external barriers, technology companies such as Sony and Hitachi decided to locate their production within
the EU and to bypass the barriers altogether. Increasingly, direct investment was seen as a means not only of
servicing local markets and of building global networks (a traditional view amongst pioneering investors) but of
avoiding European trade barriers. Europe's Internal Market Programme (and fear of exclusion from SEM
benefits) provided a further catalyst to Japanese investment in the late 1980s and early 1990s. Throughout this
period, the stock of Japanese investment in the EU increased dramatically as Japanese firms positioned
themselves to exploit insider advantages and as vertically integrated investment took off. By 1993 (and the
completion of the SEM), the inward stock of Japanese investment in the EU exceeded ECU 20 billion. Over a
ten-year period, the proportion of Japanese outward direct investment flows going to Europe had more than
doubled. By the end of 1996, the inward stock of Japanese investment in the EU market had reached 31.9
billion, a significant proportion of all Japanese FDI assets abroad (206 billion).
While Japanese investment has been controversial (raising fears over the plight of domestic
manufacturers), it has generally been welcomed. FDI creates new jobs, enhances the capital stock or production
capacity of host countries and offers a higher tax revenue for host governments. Throughout the EU, areas with
high unemployment and declining industries have been bolstered by major industrial investments by Japanese
firms. This is particular true of UK regions such as the North-East, Wales and the Midlands, all of which have
benefited from major investment projects. For example, the Nissan plant in the North-East of England and the
Toyota plant in the Midlands have provided direct and indirect employment opportunities (and altered status) for
two ailing UK regions. Add to this the contribution of Japanese exports to the UK's weak balance of trade
figures, and it is clear why Britain not only accepts Japanese investment but actively encourages it.
Bibliography on the External economic Relations of the EU and suggested readings:
1. Woolcock Stephen, European Trade Policy- Global Pressures and Domestic Constraints, Oxford
University Press, 2001, p. 373-399
2. Dinnan Dinnan, Ever Closer Union? Macmillan, London, 1999
3. White Brian, Understanding European Foreign Policy, Palgrave, Basingstone, 2001, pp. 27-46 (Chapter
2; making Sense of Europes Global Role)
4. European Commission, Illicit Trade and Organized Crime: New Threats to Economic Security, EUROP, Luxembourg, 1998
5. Nicholas Moussis, Access to European Union, 2001, p. 554-570
6. Shelton Joanna, Competition Policy: What Chance for International Rules? In Revue de droit des
affaires internationals, 1999, n.4, pp.457-470;
7. Simon Mercardo, European Business, Financial Times, 2001, p. 556-568
8. Coleman William, Regionalism and Global Economic Integration: Europe, Asia and the Americas,
London, 1998
9. Simon Mercado, Richard Welford, Kate Prescott, European Business, 2001, p.332-350
10. Steil Benn, Regional Financial Market Integration: Learning from the European Experience, Royal
Institute of International Affairs, London, 1998
11. Commission Europeenne, Lemarvhe Unique et lurope de demain, EUR-OP, Luxembourg, 1997
12. Colecchia, Alessandra, Ouverture, integration et specialization, impact sur la croissance en Europe,
Economie internationale, 1999, p. 37-50
14. Challenge Europe, on-line journal:
16.Commercial policy (http://



8.1. The Central and East Europeans
8.2. The nature of transition
8.3. Trade re-orientation and entry into the international economic community
8.4. Transition: progress and challenges
8.1 The Central and East Europeans
Despite historical reference to the 'Eastern bloc', Central and Eastern Europe is not a homogenous area.
The countries of the region differ widely with regard to ethnic compositions, languages, historical identities,
industrial structures and economies. The approach taken here is to distinguish between three main groups of
countries. Firstly, there are the countries of 'Central Europe', consisting of Poland, Hungary, the Czech
Republic, Slovakia and the former Yugoslav republics of Slovenia and Croatia. While separate reference is
sometimes made to the Baltic states (Lithuania, Estonia and Latvia) these are generally included with this
group. European Communities' reports and statistics on the Central European Candidate Countries (CECCs) also
aggregate Romania and Bulgaria with this group. This reflects their strong orientation towards economic
integration with the West (and with Central Europe) and their fellow status as prospective EU members. In other
respects, however, Romania and Bulgaria are more logically included with a range of countries in South-Eastern
Europe, typified by lower income levels, delayed structural reforms and relative instability. This group of
countries also includes Albania, Macedonia and the remaining Yugoslav republics, and is frequently referred to
as 'the Balkans', given the dominant geographic feature of the region. This practice is emulated in the present
study. A third group consisting of Russia, the Ukraine, Belarus and Moldova is referred to here as the 'European
NIS' (newly independent states). While the reader should be clear that the former Soviet Union encompassed
fifteen republics (including some in Central Asia), these four states constitute the remaining 'European' part of
the old USSR.
As can be seen from Table 8.1 the smaller countries of the region have populations similar to the size of
Belgium and the Netherlands (the smaller EU states). Despite this, population figures highlight the size and
importance of the Central and Eastern European countries when taken as a group. For example, the ten countries
that are 'candidate' EU members (hereafter the CECCs) have a combined population of some 105 million. Of this
total some 89 million persons are already linked through the Central European Free Trade Area (CEFTA)
providing for a degree of intra-regional trade and economic integration. Outside of this group, and taking into
account the majority of former Yugoslav and Soviet republics, another 236 million persons may be counted.
It is also clear that a small number of regional markets, notably Poland, Russia and the Ukraine, have
substantial domestic populations. Over time, as markets develop and as living standards increase, populations of
this scale will emerge as a serious variable in the investment equations of many international businesses. A
significant gap in real incomes between Western and former Communist Europe is matched by chasms in income
and welfare throughout Central and Eastern Europe itself. Most obvious here are the growing differentials
between the fast-reforming, west-oriented countries of Central Europe and the ailing economies of the Balkans
and former Soviet Union.
Several factors have combined to preserve and to accentuate these differences, for a start, CEECs have
embarked on the road of reform from different starting points. As noted by Stern (1998, p. 3), variations in initial
conditions concerned the length of period of central planning, past experiences of market economics, existing
levels of economic reform and private enterprise, levels of debt, economic structures, human and natural
resource endowments, and the state of macroeconomies.
Table 8.1 Population of Central and Eastern Europe, 1997 (mid-year)
EU Candidate Countries
Czech Republic


Bosnia & Herzegovina
Macedonia (FYR)
Source: UN/ECE Statistical Yearbook 1999
In this context, countries like the Czech Republic (with past experience of capitalism) and Hungary
(with its early engagement with market-style reforms) have generally had a huge advantage over the Balkan
economies and the European NIS. It is also fair to say that differences in the success and progress of reform
efforts have been influenced by a country's geographical proximity to Western markets with evidence of a broad
distance decay effect on both trade and investment flows between Western and CEE markets. Hungary especially
has benefited from its shared border with Austria (and by implication with the entire EU) and Poland and the
Czech Republic from their proximity to Germany and the core EU markets. Also relevant is the extent of social,
political and national fragmentation arising from the collapse of Communist authority. As Wolf (1999, p. 2)
insists: the dislocation involved in the fragmentation of the Soviet Union was greater than anything that
happened in Central and Eastern Europe, except in the former Yugoslavia. This is why the Baltic countries
suffered deep initial output losses, despite vigorous reforms.
Differences in reform efforts, and in the focus of transition policies, have also widened the gap between
Central and Eastern Europeans. In general, those transition economies that have pursued reform most vigorously
have recovered from the transformational recessions that characterized the region after 1989. Indeed, various
indices of reform progress evidence a strong correlation between faster growth in transition economies and the
pursuit of determined liberalization and structural reform. The importance of this factor - and on the strength of
political support for reforms - is demonstrated in the varying cases of Poland, the Czech Republic, Bulgaria and
Russia. As noted by Ellman (1997), similar economic packages were proposed and introduced at some stage
between 1989 and 1992 in all of these countries. Where conditions and determination allowed for full implementation (as in Poland and the Czech Republic) economic recovery and the growth of private sectors have been
impressive. In others (as in Bulgaria and Russia) failures in implementation have contributed, along with other
factors, to ongoing economic and financial crises.
The gap between the aspirations to Western living standards and the reality of what is being achieved
(and is likely to he achieved in the near future) is a source of popular discontent in CEE societies. For people
throughout the region, a decline in real incomes, higher prices and unemployment have been the most obvious
manifestations of the 'new Capitalism', outweighing the supposed gains of political and economic freedom. Since
most states began to liberalize their economies in the early 1990s, millions of jobs have been lost and inflation
has eroded savings and purchasing power, forcing millions into impoverishment. Today, according to the World
Bank, over 40% of the region's population live below the poverty line (Meth-Cohn, 1999, p. 14). This represents
a ten-fold increase since 1989 and hints at the emergence of massive inequalities of income in societies from
Prague to Kiev. Throughout the region, a gulf has opened up between entrepreneurs, property-owners and select
private sector workers (on the one hand) and a number of other social groups that have often seen little benefit
from the transition to capitalist democracy. Although social experiences have varied from country to country,
Ellman (1997) observes that: the losers have tended to include older (former) employees, those working in
agriculture, manufacturing, coal mining, and the state sector, the newly unemployed, ethnic minorities (e.g.
Romanians or Russians living outside Russia), children, large families, and the less educated.
Despite these tensions and disappointments, governments realize that they must continue with the
reform process and see it through to some sort of conclusion. In the Central European states, persistence with
reform has been key to a revitalization of output (and growth) following the transformational recessions of the
early 1990s. These recessions were marked by an extraordinary decline in industrial production, with falls across
the region amounting to average per annum declines of more than 10%. Indeed, despite adverse external
developments in 1998-99 - most notably the financial crisis in Russia and the conflict in Kosovo - most of the
Central European states have sustained their economic growth throughout the final years of the 1990s. Although
the crisis of the Czech Koruna in May 1997 has slowed down the Czech economy (see Table9.2), short-term
difficulties extending from poor bank management and insufficient industrial restructuring should not mask the
Czech Republic's strong macroeconomic performance since 1993.
For these countries, therefore, it is possible to talk of two 'developmental phases' in the post-Communist era.
What this highlights is an initial period of economic contraction (transformational recession) and a subsequent
period of reform-driven growth which has generally slowed towards the end of the decade.


For most Central European countries, the second of these phases appears to have started at some point
between 1993 and 1994, although Poland's recovery - encouraged by a 'big bang' reform effort - can be traced
back to as early as 1992 (Carlin and Landesmann, 1997, p. 78).
In contrast to these Central European states, whose output levels have been restored to between 75%
and 120% of 1989 marks, Russia, the Ukraine and the Balkan states remain mired in recession. These countries
have been dependent on Western largesse in preventing acute economic and financial crises and (with the
exception of Romania) have failed to register any sustained positive economic growth since 1990. Output levels
remain depressed at between 45% and 50% of 1989 levels.
Table 8.2 Real CDP change (% change against previous year)





















Czech Republic -1.2


































































































































-2.0 0

EU Candidate Countries

8.2. The nature of transition

The concept of 'transition', therefore, as applying to Central and Eastern Europe, refers to the movement
away from a command to a market economy and to the creation of a new system for the generation and
allocation of resources. This process involves a range of policy reforms and institutional actions including
market deregulation, price liberalization, privatization, enterprise restructuring, and banking and financial sector
reforms. The introduction of new market-based systems also entails concerted policy action directed towards
macroeconomic stabilization and a massive reorientation of foreign trade and external economic relations
towards Western markets and institutions. In the following sections some of these features of transition are
examined with address of the form and progress of reform in a range of Central and Eastern European states. The
fundamental nature of these changes (coupled with the need for political reforms) makes the problem of
transformation in Central and Eastern Europe quite different from the development problem of raising per capita
incomes in poor market economies. Even in the more economically advanced countries of Central Europe, such
as Poland, Slovenia, Slovakia, Hungary and the Czech Republic, there is unfamiliarity with the mechanics and
institutions of market-based capitalism and a nest of challenges surrounding financial, legal and institutional
reform. Socio-cultural and political tensions, such as those arising from ideological, ethnic and national
divisions, can also weaken the cohesion of central governments and complicate the process of economic reform
(witness the case of Yugoslavia).
Market deregulation


Market deregulation (or liberalization) involves removing legal restrictions to the free play of markets and to the
establishment of private enterprises. It is a process common to all transitional economies although one that has
been managed variably and at different speeds. It should be recalled that before the collapse of Communism in
1989-90, governments in Eastern European countries exercised tight controls over prices and outputs (setting
both through state planning) and, with only minor exception in Poland, Hungary and Yugoslavia, precluded
private sector firms from operating in all sectors of the economy. Foreign economic activity was also limited to
the exchanges of COMECON (at least in substantial part) and foreign ownership of enterprises was strictly
prohibited. Consequently, structural measures aimed at creating private market economies have included
privatization, the introduction of competition policy (and the dismantling of state monopolies), foreign trade
liberalization (permitting enterprises to engage in foreign trade), reform of the banking and financial sectors, and
price liberalization (the release of previously fixed and unrealistic prices). These measures are central to the
establishment of market conditions and to the facilitation of enterprise restructuring.
Macroeconomic stabilization
Measures aimed at structural transformation have generally had to be launched within the context of (national)
macroeconomic stabilization programmes. Although varied in their forms, macroeconomic stabilization
programmes have usually consisted of measures designed to curb inflation and to balance government
expenditure. For example, in the early years of economic reform in Hungary, Poland and Czechoslovakia, efforts
were directed at controlling hyperinflation and at improving current account and fiscal balances. These included
increases in taxes, the introduction of convertible currencies fand their consequent devaluations), the reduction
of subsidies, and other cuts in government expenditure. In Poland, where huge inflationary pressures were
unleashed by quick moves to the market, restrictive monetary policies extended to the creation of positive real
interest rates and to the direct regulation of bank lending. Rigid incomes policies were also introduced during the
early stages of reform. While the implementation of many structural reforms (especially enterprise privatization)
can be realized over a number of years, stabilization measures have generally been required from the onset of
market-oriented reforms. This reflects both the initial impact of the movement away from central planning - e.g.
the inflationary consequences of price liberalization - and the contingency of much Western lending on tight
fiscal policies. It must also be recognized that stabilization measures were required regardless of the course and
patronage of reforms. For nearly all of the CEECs, the legacy of the Communist era included over-employment
(and high prospective welfare costs), repressed inflation, large budget and balance of payments deficits, and (in
certain cases) high levels of sovereign debt.
Most of the governments and central banks in Central and Eastern Europe began the implementation of
stabilization measures from the onset of market-based reforms. In Poland and Czechoslovakia, where a rapid
'shock therapy' model of transition was selected, stabilization measures were quickly introduced as new
enterprise laws, subsidy cuts, currency conversions, price and trade liberalization led to rising levels of inflation
and to an initial deterioration in current accounts and fiscal balances. In Hungary too, which had for many years
been taking gentle steps towards a prices for food, goods and services were artificially low when compared with
world prices. This established a margin for increase in consumer prices that contributed to early experiences of
hyper-inflation. The more complete the initial price liberalization, the bigger the initial price explosion' (Ellman,
1997). These underscore the severity of inflationary pressures experienced in the CEECs following the
abandonment of Communism, with peak (annual) rates reaching over 1,000% in specific cases.
A continuing disinflation process is being supported by the operation of tighter monetary policies
(partly through pressure from international bodies such as the IMF) and by the continued decline of input prices.
In the CECCs, continuing inflationary pressures relate primarily to the rapid growth of real wages. Inflationary
pressures also continue to emanate from further adjustments in administered prices and from indirect tax
measures, such as the introduction of VAT in Slovenia.
Among the structural measures necessary to establish market economy, we have already identified the
privatization of enterprises or the transfer of businesses from the state to the private sector. Privatization has been
seen to play an important role in improving state budgets (through sale proceeds and/or reduced subsidies), in
ownership change, and in the breaking-up of state monopolies. It has also been seen as central to the
restructuring of enterprises, in providing for efficient management of firms at the expense of former SOE
stakeholders, and to bringing in Western investment capital, expertise and technology. Privatization has also been
viewed among CEE governments as a means of reducing the state's administrative burden and of creating a
broad basis of support for market reforms through mass participation. Thus, the popular image of privatizations
in Western societies - essentially as a source of financial gain and competitive efficiency - has been promoted in
the CEECs alongside a number of wider benefits. In fact, it is only really in a number of states (in Hungary and
Estonia for example) that governments have concentrated on the outright sale of state assets to strategic
(Western) investors. Other countries have pursued populist 'give-away' voucher-type programmes and/or 'insider
privatization' to privatize swathes of industry, combining these methods with conventional capital-based


privatization. While such methods have sometimes facilitated speedy privatization, they have not always brought
great budgetary benefits or deep-level enterprise restructuring.
The evidence on privatization in the CEECs is that this is an aspect of structural reform that few
countries have found easy, that few have managed to complete and that has been marked by numerous and varied
methods. Indeed, the different routes to privatization in CEE states can be seen to include:
1. the restitution of enterprises to their former owners;
2. the transfer of small state assets such as shops and restaurants by sale or lease (generally with favour
to current employees);
3. the privatization of firms through employee or management buy-outs;
4. mass privatization by which 'free' vouchers transferable for shares in privatized firms or in
investment funds are distributed to all adult citizens;
5. capital privatization (sale at full or significant price to strategic investors -including foreign
6. insider privatization (selling firms or firm assets to enterprise insiders, often at reduced prices).
The privatization processes underway in Central and Eastern European economies, have evidenced a
mix of these methods. Indeed, when we examine the scale of operations and the spectrum of privatization
schemes across the region, it is clear that privatization has taken (and continues to take) a variety of forms both
within and between countries.
The Czech Republic
In the Czech Republic, restitutions to former owners and the auction of small-scale enterprises took place
quickly as a precursor to the privatization of large-scale enterprises. Following these auctions, centered largely
on small hotels, outlets and factories, a first wave of large-scale transfers (involving nearly 1,000 Czech
enterprises) was then completed in 1992 through a mass privatization programme. This programme was based on
the issue of voucher point books at a symbolic nominal price. Adult citizens (who were eligible to receive 1,000
voucher point books) were thus able to become individual investors in single enterprises or in investment funds
(IFs). These funds quickly attracted a large share of all voucher points and then bid for the shares on offer in the
privatization programme. Individual investors (and IFs) received confirmation of their share ownerships in the
middle of 1993 (see Potts, 1999). Foreign strategic investors were also able to buy large blocks of shares in
enterprises from the newly created National Property Fund (NPF). This fund retained significant stakes in nearly
all major companies. After some delay, resulting largely from the turbulence during the partition of
Czechoslovakia, a second wave of large-scale transfers was commenced in late 1993 involving nearly 700
companies. This privatization round proceeded on a similar basis. More recently, the Czech government has
embarked on the direct sale of stakes in strategic companies in the telecommunications, banking and
petrochemicals sectors and has developed plans to accelerate industrial privatization.
Several criticisms have applied both to the nature and scope of privatization efforts in the Czech
Republic. First, little restructuring of enterprises was undertaken before mass privatization. Second, it is only
fairly recently that the state has turned its attention to the privatization of banking and utilities. Third, although
there are plans to sell around a dozen large state companies over the next few years (from a variety of sectors),
many more will stay in state hands including firms such as Budvar (beer) and CEZ, the country's big power
producer (see Kapoor, 1999).
Fourth, although the voucher system has succeeded in enabling mass privatization in Czech Republic,
the nature of the approach has meant that there have been no major revenues for the state (and for enterprise
restructuring) as a consequence of the voucher privatization of nearly 2,000 enterprises. Finally, because IFs are
partly owned by leading state banks, this creates a situation in which banks are often lending money to
companies which they also 'own'. Significantly, the current shake-up of the Czech banking system is already
seeing the return of many unreconstructed companies to state control adding to the volume of Czech 'corporate
dross' that nobody wants to buy (see Kapoor, 1999).
By contrast, the focus of Hungarian (large-scale) privatization has consistently been the attraction of significant
foreign investment through auctions and direct sale. Privatization revenues have accounted for almost one-third
of FDI and have promoted considerable organizational restructuring in privatized Magyar enterprises. As early as
January 1990, the Hungarian government sold the state lighting company, Tungsram Tight, to General Electric
(of the US) and subsequent rounds of privatization have seen foreign investors establish majority or large
minority stakes in key enterprises in the electricity, gas and telecommunication sectors. In Hungary, privatization
has reached an advanced stage with movement into transport, banking and financial sectors. Indeed, although the
state retains 'golden shares' in strategic firms such as MOL (the main oil and gas importer-producer),
privatization is virtually complete. Compared with the Czech Republic, there are relatively few (inefficient)
enterprises left in state hands and a large section of control of important industries is now under foreign


In Poland, although small-scale privatization has been completed swiftly and successfully, 1998; Potts, 1999),
large-scale privatization has proceeded slowly. The overall rate of privatization, while encouraging, has been
slower than that of Hungary and the Czech Republic where almost 90% of state-owned enterprises have been
privatized (Schoenberg, 1998). In fact, there are still nearly 3,000 enterprises which are either state owned or in
which the Treasury is the sole or majority owner. Most of these companies have remained in poor financial shape
(Ziljstra, 1998). The country's 'mass' privatization programme - the National Investment Fund (NIP) Programme
- has accelerated the pace of privatization but, to date, this has had only limited coverage. In this scheme, over
500 state enterprises have been allocated to NIFs with each receiving a lead shareholding in a small number of
enterprises and a minority holding in an additional number managed by other NIFs. Privatization units
(vouchers) have been made available to all Poles at just over 10.00, with these units converted into shares in the
fifteen different NIFs. Each N1F is listed on the Warsaw stock exchange and each is characterized by powerful
outsider shareholders (see Potts, 1999). A total of 25 million Poles have involved themselves in this process. The
government now plans to sell stakes and to undertake partial flotations in key companies drawn from many
sectors including oil and energy, insurance and banking, chemicals, pharmaceuticals, transport and shipbuilding.
In late 1999, the Polish government seemed to be acting on this promise with, among several moves, a (partial)
flotation of leading refinery and petroleum company Polski Koncern Naftowy. This stock market flotation was
reported to have raised $515 million. During the final weeks of 1999, Swiss Air also became a strategic investor
in Poland's national airline Lot, buying a 10% stake for $180 million with plans to increase that to 38%. The
government is now also proceeding with the sale of a strategic stake in Tele-komunikacja Polska (TPSA) to
France Telecom, a deal expected to close early in 2000.
In Russia, privatization has also worked with a voucher scheme component (see Potts, 1999). In a first wave of
privatization (1992-93), approximately 6,000 medium to large-scale enterprises auctioned a proportion of their
shares for vouchers distributed to all adult citizens. A number of shares in these enterprises were retained by the
state or allocated to incumbent managers. As in other cases examined (e.g. the Czech Republic), vouchers could
be used to buy shares at auction in individual enterprises or could be entrusted to investment funds. Alternatively,
they could be sold to speculators set on investing in specific enterprises or in investment funds (Potts, 1999). The
Russian scheme gave particular preference to incumbent managers and employees. These 'stakeholders' would be
able to buy up controlling shares in their own enterprises (at reduced price) before public auction of the
remaining shares. This meant that a form of 'insider control' was created in newly privatized firms in Russia,
with managers often consolidating their control by progressing to buy shares from their employees. The
approach also created limited scope for restructuring of enterprises as it brought in little foreign investment (or
expertise) and exposed few companies to increased (external) performance pressures.
A second wave of privatization (which began in 1995) has included a controversial shares-for-loans
scheme. Under this scheme, a small but powerful group of bankers have secured lucrative shares in selected
natural resource companies at 'knock-down' prices (see Bush, 1999). These shares have been secured through the
conversion of special bonds issued by state authorities in exchange for much-needed loans and financing. The
Russian government now appears to be turning its attention to the auction-based sale of partial shares in highprofile companies such as Svyazinvest (the state-holding company in the telecommunications sector) and in
various energy-sector-related concerns. What is clear, however, is that the privatization process has been
bedeviled by the financial, political and economic instability of post-Soviet Russia and that there is much
domestic opposition to forms of privatization that surrender to the control of insidersReflections
These histories demonstrate that the need to privatize huge numbers of firms in quite difficult conditions has led
to a variety (and creativity) in privatization methods. The major methods of privatization in the Czech Republic,
Hungary, Poland and Russia have been discussed and have highlighted such variation as the weight of sales to
strategic investors (outsiders) in Hungary and the dominance of insider privatization to employees and managers
in Russia. While it is not possible here to consider other states at length, it should be registered that such
heterodoxy also characterizes privatization processes in and between other countries in the region. In tiny
Moldova, for example, privatization has taken place through mass privatization, national patrimonial bonds,
small-scale cash privatization and sale by tender. Lithuania's privatization efforts have combined spontaneous
privatizations of small-scale enterprises with the sale of company shares for vouchers and the sale of (larger)
assets for cash. In most cases, mass voucher-based programmes have had a natural attraction and, while the
analyst is struck by the variety of different methods in use, the dominance of voucher privatization can be easily
demonstrated. Direct sales through open auctions and public listings have the virtue of bringing in much needed
resources (capital, expertise etc.) but for large-scale privatization to be achieved through such methods there has


to be an attractive basis for sale and substantial capital resources. The problem, as noted by Potts (1999), has
been that limited western interest and domestic savings, combined with problems of valuation and the need to
create an effective stock market, reduce the possible speed, effectiveness and scope of such privatization at full
price'. Privatization by such methods has only been possible for a limited number of SOEs and, after a wave of
foreign buy-outs of potentially profitable firms, western interest has been limited.
Looking at the progress with privatization (both small scale and large scale), it is clear that some
CEECs have fared better than others. Privatization efforts in Hungary (especially), the Czech Republic, Poland
and Estonia are really quite advanced. Croatia, Latvia, Lithuania, Slovakia and Slovenia have also transferred a
large number of enterprises to private ownership. Outside of these countries, progress has really been quite
unimpressive. Having already discussed the limited achievements of successive Russian governments, it is also
the case that privatization programmes in Romania and Bulgaria have been extremely limited and that
privatization processes have barely begun in the Ukraine, Belarus and the wider CIS.
Enterprise restructuring
Successful enterprise restructuring depends not only on privatization but also on competition in the product
market and the imposition of financial constraints. This point is made emphatically by Cariin and Landesmann,
who write:
The role played by a credibly hard budget constraint, of bank reform, of the promotion of the private
sector, of privatization prospects, and of competition in the product market to the separation of good from bad
managers and to eliciting restructuring effort from good managers is clear...privatization per se is not a substitute
for the other elements of the policy package. (Carlin and Landesmann, 1997, p. 23)
In Central Europe at least, the introduction of privatization laws has been accompanied by the
introduction of anti-monopoly laws and by the promotion of the private sector. Support for liberal trade regimes
has also been quite high and increased competitive pressure from foreign (as well as from domestic firms) has
been central to the encouragement of enterprise restructuring (see Heinrich, 1995; Carlin and Landesmann,
1997). Repeatedly, international bodies such as the IMF and the EBRD have associated enhanced market
competition with the stimulation of enterprise reform. With respect to financial constraints (as imposed on
enterprises), the elimination of subsidies and reductions in 'soft finance' play an important part in bring ing about
changes in the structure of enterprises. Where cuts have been made in such financial support, enterprise
restructuring is accelerated. In Poland, for example, hard budget constraints on companies have forced many to
sell off assets and/or to engage in considerable labour-shedding. Changes in the law since 1992 have also
induced banks to renegotiate non-performing loans and to change their lending behaviour so as to weaken
support of unprofitable enterprises. Where strict bankruptcy laws have also applied (e.g. in Hungary) such
pressures have led to multiple closures or to operational restructuring. According to the EBRD, as a result of the
introduction of bankruptcy legislation in 1991, 9% of Hungarian industrial enterprises representing 24% of
industrial output and 35% of total exports had been registered as being in bankruptcy or liquidation within
twelve months. A shake-out of inefficient and bankrupt enterprises has continued since this time despite some
relaxation of the law. Effective bankruptcy regimes are an important component of transition and play a key role
in identifying firms with no future in a market environment and in increasing financial discipline. Arguably this
is one of the key failings of the Czech transition model where large-scale closures (at least in early transition)
were prevented by delayed introduction of a bankruptcy code and through the writing-off of much enterprise
debt. The Czech case, however, bears no comparison with Russia, where a largely unreconstituted enterprise
sector has faced rather soft-budgetary constraints. In Russia, only a small number of large and very large
enterprises are as yet subsidy-free (see Alfandari etal; 1996, cited in Carlin and Landesmann, 1997).
Small business development
The privatization of the large industrial units and their restructuring may be less sig nificant in the long run than
the development of small and medium-sized businesses. A significant small business sector not only carries an
immense potential for making an economy prosperous but also distributes that prosperity to a larger seg ment of a
country's population. Moreover, small business tends to be less environmentally damaging. The lack of
significant social benefits in Central and Eastern European countries is already driving people into enterprising
ways of generating incomes and an abundance of new small businesses is to be found in any large town. In
Poland, where transition has taken place at a rapid pace, the growth of the private sector has been fuelled by the
vast number of start-up companies and the economy now virtually relies on its small companies. These firms two-thirds of which are one-man or one-woman businesses - contribute significantly to an estimated total of 4-5
million small and medium-sized private sector enterprises in the CECCs. Eurostat estimates that 3.3 million such
enterprises were already registered in the CECCs by the end of 1995. While this rate of growth is not yet
matched in the NIS, large numbers of small private firms are emerging despite many obstacles to market entry.
Much can be learned from the development of small businesses in Europe and particularly from the
work of local authority development agencies in countries such as the UK and Italy. Again there is an apparent
contradiction between the creation of a market economy and the need for government (particularly local gov-


ernment) support and planning. In the EU local governments have been successful in creating and supporting
business parks, managed workspaces, small business advisers, co-operative support networks, grants and lowinterest loans. In many cases projects have built on local resources and skills and where appropriate have been
linked to such things as local tourism or the particular ethnic mix of a region. These types of developments are
being considered by governments in Central and Eastern Europe and, in some regions, are in their early stages of
development. However, there is limited availability of finance and venture capital for SMEs throughout Central
and Eastern Europe and most enterprise creation takes place with equity provided from savings, friends and
relatives. According to Pissarides (1998) this can be attributed to underdeveloped capital markets in the CEE
region in which access to credit is still easier for state and other large enterprises and in which SMEs continue to
face higher levels of nominal interest rates. While banks in alt societies generally consider the credit risks to
SMEs to be higher than those applying to larger enterprises, the average 2-5% that SMEs pay above what larger
enterprises pay for loan finance in the OECD economies is tiny compared with that extra premium paid by SMEs
in the CEECs. Therefore, for a significant development of new business to take place, local banking sectors must
be strengthened (and further commercialized) and incentives must be created for banks to lend to SMEs. Equity
and bond markets must also be developed so that the financing needs of SMEs can be served more efficiently
(see Pissarides, 1998, pp. 4-5).
Entrepreneurs find ways to profit for Dinu Patriciu, one of the wealthiest men in Romania, doing
business in the 1990s has been about getting in first. After the fall of Nicolae Ceausescu, the Romanian dictator,
Mr Patriciu was the first person to register a private company in the country - called Alpha, it was given the
registration number 00000001. An architect by profession, Mr Patriciu was also among the first to grasp the
value of property. Just before Bucharest land prices took off amid the high inflation of the early 1990s, he sold a
car and a video recorder and put the money into property. Simultaneously, he received a string of architectural contracts from others wanting to develop sites.
The boom later fizzled out and some of Mr Patriciu's projects were never built- But the fees were paid,
and Mr Patriciu was on his way to financial success. Today, aged forty-nine, he runs a business "" group that
includes property development, asset management and Rompetrol, one of Romania's largest oil companies with
its own refinery.
He has his problems, notably with a loss-making which are one-man or one-woman businesses contribute significantly to an estimated total of 4-5 million small and medium-sized private sector enterprises in
the CECCs. Eurostat estimates that 3.3 million such enterprises were already registered in the CECCs by the end
of 1995. While this rate of growth is not yet matched in the NIS, large numbers of small private firms are
emerging despite many obstacles to market entry.
Much can be learned from the development of small businesses in Europe and particularly from the
work of local authority development agencies in countries such as the UK and Italy. Again there is an apparent
contradiction between the creation of a market economy and the need for government (particularly local government) support and planning. In the EU local governments have been successful in creating and supporting
business parks, managed workspaces, small business advisers, co-operative support networks, grants and lowinterest loans. In many cases projects have built on local resources and skills and where appropriate have been
linked to such things as local tourism or the particular ethnic mix of a region. These types of developments are
being considered by governments in Central and Eastern Europe and, in some regions, are in their early stages of
development. However, there is limited availability of finance and venture capital for SMEs throughout Central
and Eastern Europe and most enterprise creation takes place with equity provided from savings, friends and
relatives. According to Pissarides (1998) this can be attributed to underdeveloped capital markets in the CEH
region in which access to credit is still easier for state and other large enterprises and in which SMEs continue to
face higher levels of nominal interest rates. While banks in all societies generally consider the credit risks to
SMEs to be higher than those applying to larger enterprises, the average 2-5% that SMEs pay above what larger
enterprises pay for loan finance in the OECD economies is tiny compared with that extra premium paid by SMEs
in the CEECs. Therefore, for a significant development of new business to take place, local banking sectors must
be strengthened (and further commercialized) and incentives must be created for banks to lend to SMEs. Equity
and bond markets must also be developed so that the financing needs of SMEs can be served more efficiently
(see Pissarides, 1998, pp. 4-5).
Financial sector reform and development
The development of an infrastructure for the market economy also necessitates a transformation of financial
institutions (and legislation) and the development of new capital markets. This is suggested in the preceding
observations on privatization, enterprise restructuring and small business development. Indeed, just as new legal
systems have had to be introduced to transform patterns of ownership and to create new property rights, so new
financial and banking systems (and capital markets) have had to be introduced so as to underpin and to
operationalize the new market systems. In this context, CER banks and other financial institutions have to be
modeled on Western equivalents (specifically EU forms) and must execute the role of these institutions. In short,
market-driven institutions need to be established to attract savings, to provide links between savers and
investors, to lend to creditworthy customers and to provide an efficient clearing and settlement system. With


respect to their practices, and as discussed with regard to the restructuring of enterprises, banks must also
enforce repayments and impose hard budget constraints on enterprises (EBRD Transition', Report, 1998, p. 15).
Banking and financing systems are still under development in the CEECs and the structural
impediments to banking sector reform and development are immense. Despite the privatization of some
commercial banks, several large commercial banks remain in state hands. Many of these banks are also debt
ridden and are plagued by non-performing loan problems. Combined with poor credit practices and inadequacies
in banking supervision, these factors have already led to severe sectoral crises in Latvia, Lithuania and Russia.
Even fast-reforming countries (notably the Czech Republic) have seen 'substantial disturbances in the form of
failures of medium-sized or large local banks' (see EBRD Transitions Report, 1998, p. 20). In addition, most
countries evidence a deep resistance to majority foreign control of domestic banking sectors and to downscaling
of banking sectors. Such weakness and the under-development of financial sectors throughout the region are a
genuine brake on growth in the CEECs. Banks continue to play only a modest role as providers of invest ment
finance and capital markets continue to lack maturity. Even where commercialization and privatization have
proceeded at greatest pace, banks continue to lack experience in private sector lending and other skills and
methods of work are as yet poorly developed. Bank reform struggles for pace few countries in central and east
Europe have been spared banking crises, as the region has made its painful transition to a market economy.
Governments have often been wary about surrendering control of state-owned banks and have been
reluctant to give up the powers of patronage and influence conferred on them by their seats on the bank boards.
Political leaders have had to learn the hard way, however, that financial reforms and healthy, financial
institutions lie at the heart of the transition process and are the foundation stones of a strong economy.
In fast-track reform countries such as Hungary, Estonia and Poland lessons were taken on board early. It
has been no coincidence that a fast pace of sustainable growth has been accompanied in most cases by
determined efforts to restructure the banking sector and to privatize state-owned banks, ii particular through the
sale of large stakes to foreign strategic investors.
However, the current spate of bank privatization deals across central and east Europe from Croatia to
Bulgaria and from Romania to the Czech Republic shows that a decade after the start of transition ever the worst
laggards are seeking to catch up with this pace set by the front-runners.
8.3. Trade re-orientation and entry into the international economic community
Central and Eastern European governments have also turned their attention to integrating themselves
more fully into the global financial and production systems. Aside from the construction of new relations with
the European Union (EU) and with other European institutions, this has encompassed membership of the World
Trade Organization (WTO) and significant efforts to gain access to international capital from such institutions as
the EBRD, the World Bank and the International Monetary Fund. Another feature of transition in Central and
Eastern Europe has been the establishment of new trading links with Western nations and the re-orientation of
foreign trade. The collapse of institutional trading relationships between the former members of the CMEA (a
primary cause of the collapse of industrial output in CEECs following 1989-90) has necessitated a substantial reorientation of trade towards Western Europe and the re-integration of the CEECs into the international trading
order. This in turn has contributed to the pressures for trade liberalization and to significant changes to the
commodity structure of exports with major changes required to the nature and type of products being sold.
Prior to 1988 EC trade flows with Central and Eastern Europe were relatively insignificant. Although
bilateral trading links between individual countries did exist, there was neither mutual recognition nor
contractual relations between the European Community and the Council for Mutual Economic Assistance.
Individual EU members were not supposed to enter into agreements without prior consultation with the
European Commission and state traders such as the Soviet Union, East Germany and Czechoslovakia, enjoyed
no group trading preferences with the European Community. Of the major CMEA economies, only Romania
received special trading concessions because it was categorized as a developing country. Eastern bloc exports to
the EC markets were also frustrated by quality problems. The quality and design of many products made in
Central and Eastern Europe were so inferior that these products were virtually unsaleable on Western markets.
Other serious obstacles included the inconvertibility of Eastern bloc currencies, the state monopoly of foreign
trade, red-tape and political-bureaucratic interference (see Lavigne, 1995, p. 84).
Geographic restructuring and the 'new' commercial relations
In Central Europe, there was a significant switch in trade patterns towards the EU and EFTA markets during the
early stages of transition. Indeed, between 1989 and 1993, regional exports to Western Europe increased by an
annual average of 12% (Faini and Fortes, 1995). Earnings arising from these exports helped to generate hard
currency inflows at a difficult time in the reform process, providing means for the importation of Western energy
and technology and for the servicing of sovereign debts. This geographical restructuring of trade has continued
in subsequent years despite the revitalization of intra-regional trade by the formation of CEFTA.
Indeed, while 14.0% of CEC exports go to other countries in the region, 59.1% of all CEC exports are
now destined for the EU market (see Table 7.6). For those countries dominating this trade - Hungary, Poland and


the Czech Republic - the EU is an even more significant trading partner accounting for nearly 70% of total
export trade. Trade flows are dominated on the EU side by Germany and Italy, which together represent almost
70% of EU trade with the group.
Contributing to the strengthening of trade links post-1989 (and to this broad re-orientation of foreign
trade) has been the progress of the Central European countries up the EU's hierarchy of trading preferences
Following the conclusion of 'first-generation' trade and co-operation agreements between 1988 and 1990, access
to EU markets has been regulated by the trade provisions of multi-issue association agreements with the EU. For
Poland, Hungary, Slovakia and the Czech Republic, the commercial provisions of these agreements - known as
Europe Agreements (EAs) - have been in place since March 1992. As at the Copenghagen Summit in June 1993,
these agreements have been occasionally revised so as to improve terms of trade and in order to address Central
European concerns over trade impediments and liberalization timetables. The basis of EAs, now also covering
Romania, Bulgaria, Latvia, Lithuania, Estonia and Slovenia, is the principle of reciprocal tree trade in nonagricultural products by the year 2004. Based around the principle of asymmetric liberalization, these
agreements also involve the guarantee of free EU market access for industrial exports by 1999. In this regard,
while the EU has stuck to its basic commitment, the member states have made full use of special conditions
applying to steel, coal, textiles, chemicals and other sensitive sectors so as to restrain import flows to 'acceptable
levels' prior to this date. These conditions, as established in a series of special annexes and protocols to each of
the Europe Agreements, have ensured tariff and/or quota restrictions in some of these sectors as late as 1998.
Although these restrictions have now been lifted, they have previously stymied exports in exactly those sectors
where the transition economies have enjoyed a comparative advantage (see Dyker, 1993; Faini and Fortes,
1995). The fear is now that the EU may compensate for their absence by subjecting its associates to antidumping actions and other contingent forms of protectionism. Since 1992, Brussels has taken a number of such
actions against its associates, shielding sensitive industries from competition and creating negative spillover
effects for other CECC exporters. Imports of ammonium nitrate from Lithuania and Bulgaria, of hematite pig
iron from Poland and of steel tube fittings from Slovakia have all, for example, been the focus of controversial
definitive anti-dumping duties.
Despite this, and short of final EU membership, the asymmetric liberalization of the Europe
Agreements establishes that the EU's trade concessions to Central Europe are now largely in place. In fact, the
terms of the EAs now commit the candidate countries themselves to demanding liberalization timetables and to
opening up their own markets to EU goods and services by 2004. This will establish new competitive pressures
for indigenous firms in Central Europe and create further export and investment opportunities for Western
businesses. Already, the balance of trade has tilted decidedly in the EU's favour with heavy demand for Western
products in transition markets. Reference to Figure 7.1 highlights a trade deficit with the EU (in 1997) of some
21.61 billion with the EU enjoying a significant surplus in machinery and transport equipment, road vehicles,
electrical machines and appliances. The main EU trade deficits with the region are apparent in products that are
not very capital intensive including clothing and textiles where EU imports marginally outstrip exports to
candidate countries. Indeed, the use of trade data to reveal comparative advantage suggests that the Central
European Candidate Countries are relatively efficient in the production of natural-resource-based and labourintensive products (see Brenton and Gros, 1997). The relative efficiency of a number of other sectors is forecast
to improve in the years ahead. These include paper, chemicals, metal products and mechanical engineering.
The Balkan economies and European NIS have also experienced a strong re-orientation of trade
towards Western markets. However, discounting its more favourable treatment of candidate countries Bulgaria
and Romania, the EU has stopped short of establishing preferential trading terms with these countries and has yet
to advance the idea of association. This has meant that East European states have been relatively disadvantaged
in commercial terms (at least compared with the Central European countries) and have had less success in
overcoming many of the trade barriers encountered when attempting to enter EU markets. Agreements range
from basic trade and economic co-operation agreements (as existing with Albania) to so-called Partnership and
Co-operation Agreements (PCAs) as concluded with the European NIS (Russia, the Ukraine, Belarus and
PCAs raise the possibility of an FTA between a signatory country and the EU (through future
negotiation), they do not establish a timetable for full liberalization or commit the EU to that result. Instead,
agreements consist of the limited extension of tariff concessions (most favoured nation treatment on goods), the
elimination of several quantitative restrictions (these were in place on over 300 commodities exported by Russia
as of October 1995), and an improvement in export opportunities in areas such as textiles and steel still to be
regulated by quota. The agreements also reduce substantially the scope of certain EU commercial instruments
such as anti-dumping procedures and safeguard actions, though these means of contingent protection are
provided for (e.g. Articles 17 and 18 of the EU-Russia PCA). Anti-dumping rules now apply in accordance with
GATT provisions and a consultation clause is granted. It is also to be noted that the PCAs extend MFN terms for
the cross border supply of a limited range of services (an innovation here) and provide conditions for freedom of
establishment of companies and of capital movements, although Russia can still apply restrictions on capital
While these terms have granted NIS products better treatment and access to the European market, they
clearly fall well short of those agreements concluded with the Central European countries and are essentially


'non-preferential'. Indeed, with respect to trade and commercial relations, the PCAs do little more than confirm
that the European NIS will be treated by the EU as if they were members of the WTO (a possible future
objective for these states). Significant trade concessions depend on further negotiation and the number of
sensitive sectors identified by the EU (and therefore subject to significant import restrictions). Inclusions such as
nuclear products and space launches suggest the EU's continuing ability to control Russian imports in strategic
areas. Nonetheless, these agreements are an important part of the process of commercial re-orientation in the
former Soviet states and in encouraging increased trade flows between these countries and EU markets. Figures
for the full set of newly independent states (but dominated by Russia and Ukraine) show that the European
Union is now the NIS' most important Western trading partner, taking more than 26 billion worth of imports
from the NIS in 1996 (or more than 33% of the NIS' total exports). Trade between the European Union, Russia
and the other NIS has been growing strongly since 1989 and the NIS as a group are now running a big trade
surplus with the European Union. The major part of Russian-NIS exports to the EU is fuel, energy and raw
materials. Exports of timber, chemicals and metals are on the rise and Russia (in the face of continuing
restrictions) is beginning to actively seek new export possibilities in relation to military aerospace production
and nuclear materials.

Figure 8.1 EU trade with the candidate countries in 1997 (in ECU million)
Source: European Commission, 1998
8.4. Transition: progress and challenges
The preceding analysis has highlighted a number of key points. First, while there has been no universal
agreement as to the best strategy for transition towards market capitalism in the CEE region, a number of
essential elements can be recognized as being central to the transition process. These include market
deregulation, price liberalization, privatization and enterprise restructuring, banking and financial sector reforms,
macroeconomic stabilization, and progressive integration into international financial and commercial systems.
Second, while a number of CEECs have opted for rapid transformation (or for 'shock therapy), most have taken a
slower path to reform. By and large, those economies that have adopted more rapid programmes of change have
seen an improvement in their economic fortunes and have succeeded in attracting the larger slice of international
capital investment (a point to be given more serious examination in the later stages of this chapter). In fact, it is
now possible to distinguish between those economies well down the road to successful market economies (e.g.
Poland, Hungary, the Czech Republic, Slovenia and Estonia) and those whose reform efforts have progressed at
a slower pace. Among this second set we find a varied mix of regional economies oscillating between progressive and revanchist measures. Here, divisions are now evident between the likes of Bulgaria (see Case Study
7.3), intensifying reform efforts after years of crisis, and economies such as that of the Ukraine marked by a
continued paralysis in economic decision-making. Third, throughout the CEECs there are outstanding tasks. As
seen in Figure 9.2 the EBRD's transition indicators (averaged out across countries) highlight restructuring
requirements in eight major categories.


Figure 8.2 Movements in EBRD Transition Indicators, 1994-1998 (average across the CEECs)
Source: EBRD Transition Report 1998
With a score of 1 representing little change from old regimes, it is clear that much progress is to be made in areas
such as enterprise restructuring and banking reform before scores are reached that signal Western standards (e.g.
scores of 4 or 4+). Of course such ratings mask the variations in national performance. But even in the betterperforming states, much remains to be done vis-a-vis financial sector reforms, corporate governance issues and
deep-level enterprise restructuring. In addition, efforts still have to be made in all societies to create a secure
basis for long-term competitiveness and to reduce state aids. These challenges sit alongside those tied to the
control of inflation and government spending, and to the tackling of unemployment and environmental
despoilment. It is to these two subjects (I) unemployment and labour market conditions; and (II) environmental
conditions and improvements, that analysis now turns.
For the past two years, Bulgaria has provided the economic success story the International Monetary
Fund has so lacked in other parts of the world, as emerging markets have lurched from one crisis to another.
When government ministers are asked about their commitment to the reform process, the reply is
invariably that the targets have to be met because they are stated in the agreement with the IMF, the programme
is open and transparent, and it is publicly available on the government Internet site, in both Bulgarian and
Certainly, the economic policies of the past two years have represented a clear break from Bulgaria's
recent chaotic past, which was marked by severe banking and foreign exchange crises, financial indiscipline,
mounting budget deficits, towering losses in state-owned enterprises, stalled privatization and, finally,
The progress has been remarkable. Helped crucially by the introduction of a currency board in the
summer of 1997 (which fixed the exchange rate of the Bulgarian lev to the D-Mark at 1,000 leva to 1DM and
provides full foreign currency backing for domestic money in circulation), the center-right government, led by
Prime Minister Ivan Kostov, has brought much-needed stability to the Bulgarian economy. (From 1 July in a
further reform, the lev will be redenominated to one new lev for 1,000 old leva).
Inflation as shown in the consumer price index had dropped to only 1% in December year-on-year from
578.5% a year earlier. The currency board system has brought stability to economic decision-making', says
Martin Zaimov, deputy governor of the Bulgarian National Bank. 'We can forecast far more. During the worst
times you could plan for a couple of weeks only. Now people can plan years ahead. Foreign exchange reserves
have been rebuilt with international support from a low of $400 million in January 1997 to more than $2.5
billion. The private sector now accounts for about 67 per cent of gross domestic product (GDP), up from 42%
two years ago.
Backed by the restrictive terms of the IMF agreement the government budget achieved a surplus
equivalent to 0.9% of GDP last year. The target is to achieve a broadly balanced budget in the medium term. The
government is forecasting a budget deficit of 2.8% of GDP for 1999 taking account of various steps to cushion
the blow of the tough structural reform measures that should be implemented this year. After the ravages of
recent years, the economy began to show some modest growth last year. The progress is real but still fragile. The
finance ministry currently estimates that GDP grew by 4.5% last year, albeit from a shrunken base. Gross
domestic product declined by 6.9% in 1997 and by 10.1% in 1996 in the final year of the previous socialist


government. According to figures from the European Bank for Reconstruction and Development, GDP in
Bulgaria last year was still only 66% of the 1989 level, ten years after the start of the transition from a com mand
to a market economy.
Despite the stabilization successes of the past two years, the daunting challenge still facing the
government is to put Bulgaria on a path of sustain-able growth at a time when the economy still faces tight
external limitations.
Under the three-year, $864 million IMF programme agreed last September, the government is targeting
growth of 4-5% a year, but Dimitar Radev, deputy minister of finance, accepts that that is unlikely to be achieved
in 1999, Against the background of the slowdown in the world economy, the finance ministry is currently
forecasting growth of 3.7%. The economy slowed sharply in the second half of last year. Industrial sales fell by
9.4% in 1998 owing to the fall in world prices for key exports, such as metals and chemicals. Exports fell by
12% in value last year.
Activity is seriously constrained by the lack of capital. The banks, burned by their experiences in the
recent years, remain very cautious lenders. They hold much of their assets as low-yielding deposits in, German
banks and in government securities, and new lending has been negligible. Privatization revenues should help to
finance the current account deficit during the next two years, with the government seeking strategic foreign
investors for assets such as the telecom utility, the leading state-owned banks, Bulgartabak (the tobacco
industry), the Neftochim oil refinery and Petrol (the state-owned service stations). Green-field site foreign
investment will be urgently needed as the receipts from privatization diminish, however, and it is crucial that the
government makes progress on infrastructure projects in areas such as power generation and distribution, and
municipal services, where foreign capital is also supposed to play a big role.
A key test of foreign investors' appetite for Bulgarian risk should come later this year with both the
Republic of Bulgaria and the capital city of Sofia planning to make their debut on the international bond market.
Acceptance of the bonds by international investors would provide a crucial vote of" confidence in the current
government's economic policies.
Stuart Eizenstat, US assistant secretary of state, warned on a recent visit to Sofia that the government
still had to take many 'courageous and painful economic decisions'. Privatization had been slow, bureaucratic and
had lacked transparency. Efforts to reform the state apparatus and to root out corruption and red tape had to be
intensified. 'Sustained, energetic reform' was critical, he said, but if it took place, 'in a few years we may be
describing Bulgaria as the Balkan Tiger.
Under the centrally planned system, the right to work was guaranteed and every worker had some rights
to choose his/her job. The latter part of this was subject to European countries had been Vietnamese, Cubans and
Angolans. In countries such as former East Germany it was common to find Poles and, in Hungary, Bulgarians
had often found jobs. In other words, there was a migration from the poorer East European countries to the more
wealthy. These people too have often been sent back to their countries of origin. Subsequently it was women
who were made redundant. In countries such as former East Germany 75% of women's jobs were traditionally
reserved for them. On reform, such rights to work were lost and female participation rates fell dramatically.
Increasingly, as financial constraints have been tightened on enterprises and as businesses have been liquidated,
large numbers of male jobs in both industry and agriculture have also been lost and totals for long-term male and
youth unemployment have escalated. The decline in male industrial employment especially reflects the scale of
industrial restructuring in the region and the high over-employment before transition. Eurostat estimates that,
between 1990 and 1997, employment in industrial sectors fell by more than 6 million people or by almost a
third. Employment fall-out in industrial sectors is further expected as slow-track reformers advance processes of
privatization and industrial restructuring,
Structurally, the private sector share of employment in the CEECs has been expanding rapidly. From a
level of less than 10% of total employment in 1990, the private sector's share reached almost 70% in Poland,
Latvia and Lithuania in 1998. Throughout the region, private sector shares of employment are now in excess of
50%. Equally, while agriculture continues to account for a substantial portion of total employment in all
countries except the Czech Republic, the transition years have been characterized by the growth of service sector
employment. Services now account for the largest share (and for growing shares) of total employment in most
Central European countries.
Average wages continue to lag well behind Western levels but, in most countries, are showing a steady
increase. While increased wage levels are helping to improve the welfare of many workers and their families,
one point of concern here (and one factor militating against larger declines in regional inflation) is the evidence
that the growth of real wages is continuing to outstrip increases in labour productivity. The consequent increases
in unit labour costs are a potential threat to CEEC competitiveness, especially in those labour-intensive
industries currently dominating exports.


Bibliography on Transition Economies: Central and Eastern Europe and suggested readings


Inottai Andras, The Czech Republic, Hungary, Poland, the Slovak Republic and Slovenia, Winners and
losers of EU Integration: Policy Issues for Central and Eastern Europe, World Bank, 2000
Mayhew, Alan; recreating Europe: the European Unions Policy Towards Central and Eastern Europe,
Cambridge University Press, 1998, p. 403
Maresceau, Marc, enlarging the European Union. Relations between the EU and Central and Eastern
Europe, Longman, London, 1997
Balwin, Richard, The costs and benefits of Eastern enlargement. The impact on the EU and Central
Europe, Economic Policy, 1997, p. 125-176
Simon Mercado, European Business, 2001, p. 258-285
Inotai, Andra, Political, economic and social arguments for and against EU Enlargement, Institute for
World Economics, Budapest, 1999, p.20




9.1 CEE development and integration with the European Union
9.2 The EU's pre-accession strategy
9.3 EU enlargement - costs and benefits
9.4 The financial consequences of enlargement
9.1 CEE development and integration with the European Union
As is clear from the preceding analysis, much of the transformation in CEE environments is marked by
attempts to adopt or to emulate West European practices and principles. If the issues are examined in greater
detail, it becomes clear that there are wide-ranging efforts directed at aligning domestic legislation with EU
legislation in a variety of fields. While the environment is an important area, harmonization with EU laws and
standards is also being pursued in such areas as competition law, financial services regulation and consumer
protection. These efforts reflect the determination of many CEE governments to enter their countries into the EU
and the EU's requirements for entry. A number of CEECs have made applications to join the EU - Hungary and
Poland (in 1994), Romania, Slovakia, Latvia, Estonia and Bulgaria (in 1995), and the Czech Republic and
Slovenia (in 1996). In March 1998, the EU opened formal entry talks with the Czech Republic, Estonia,
Hungary, Poland and Slovenia (along with another candidate country, Cyprus). For nearly two years, this placed
the remaining candidates into a second stream characterized by the absence of formal entry negotiations and a
more distant promise of future EU membership. At the Helsinki Summit in December 1999, the EU member
states finally agreed to open formal negotiations with these remaining countries -Bulgaria, Latvia, Lithuania,
Romania and Slovakia - also adding Malta and Turkey to their list. Thus ten CEECs (among a total of thirteen
candidate countries) are now engaged in EU entry talks and are continuing to make far-reaching economic, pol itical, social and legal adjustments with the target of future EU membership. The i existing member states have
remained vague about when the negotiations with the most advanced countries might conclude but the European
Commission has signalled that accession is unlikely before 2004 given both the expected length of future
negotiations (covering 80,000 pages of EU legislation) and the timetables attaching to ratification procedures.
Moreover, the EU has indicated that it will only open new 'chapters' or tracks of negotiations with an individual
candidate (there are thirty-one in total) where it is convinced that progress can be made. Few involved in the
process expect a first wave of entries before this date and it is clear that the finishing line, optimistically set at
2000 by former German Chancellor Helmut Kohl, keeps moving backwards.
While the prospect of future EU membership for Central and Eastern European countries was raised by
the very fall of Communism, it has only been since the Copenhagen Summit of 1993 that the EU has been
formally committed to eastward enlargement. At this summit, the EU took the important step of confirming that
present and future signatories to agreements of association ('Europe Agreements') were eligible for EU
membership. The EU also established an 'entry test' at Copenhagen, since referred to as the Copenhagen Criteria.
These include the essential requirements of a stable democracy and a fully functioning market economy.
Aspirant members must also demonstrate a good record on human rights (including the protection of minorities
and respect for the rule of law), the capacity to cope with competitive pressure and market forces within the
Union, and the ability to take on the obligations of membership (the acquis communautaire). In each of these
areas the applicant countries are subject to progress reports issued by the European Commission. When progress
reports were presented in October 1999, these showed that all the candidates still face a heavy workload in
preparing for accession. However, differences between the applicant states as regards compliance with the
eligibility criteria are such that it is possible to identify those moving at greatest speed towards the full
satisfaction of EU entry requirements. Hungary and Poland appear to have made greatest progress to date and are
thus likely to be among the first wave of CEE entrants. Slovenia has also made progress since 1997 but must
speed up its privatization efforts and further facilitate the restructuring of enterprises. All three of these front-line
applicants attract some criticism for the state of their administrative, political and judicial systems. Areas such as
state aid, environmental law and farm reform are also subject to some criticism.
9.2 The EU's pre-accession strategy
Discussion of the debate surrounding EU enlargement raises the various strands of 284 CEE development and
integration with the European Union EU assistance for Central and Eastern Europe already established. The EU
has operated a coherent pre-accession strategy since 1994, which now integrates:
1. formal association (or 'Europe') agreements,
2. bilateral accession partnerships, and
3. a multidimensional programme of financial aid and technical assistance.
The association agreements ('Europe Agreements')


In October 1991, Jacques Delors called on the EU to prepare for an EU of twenty-four, or even thirty,
members. His answer to the collapse of the economic system in Eastern Europe and the growing demand from
EFTA countries for EU membership was to devise a system of so-called concentric circles. This would see the
present EU membership at the centre, the EFTA countries in a second ring, and Central and Eastern Europe in an
outer ring. Circles were to be linked by their own internal agreements and would be built around the EU through
the device of external agreements. These ranged from agreement on the EEA between the EU and the EFTA
countries (see Chapter 3) to a bundle of fairly uniform association agreements with applicant countries from
Central and Eastern Europe.
Association agreements were initially negotiated between the EU and Poland, the former
Czechoslovakia and Hungary in 1991. These agreements built on bilateral trade and economic co-operation
agreements struck in the later 1980s. Succeeding agreements were later extended to Bulgaria and Romania (in
1993) and to Estonia, Latvia, Lithuania and Slovenia (in 1995). Replacement agreements for the Czech Republic
and Slovakia were also concluded in 1993 following the partition of Czechoslovakia. In all cases, these
agreements conferred the status of 'associate members' on the CEE signatories, set national paths for progressive
legislative convergence with the EU, and provided for far-reaching economic, political and financial cooperation. The EU's decision at Copenhagen (June 1993) to confirm the status of CEE associates as future EU
members brought an even higher status to these agreements and corrected what was for some, a glaring omission
in the original deals. Looking at the content of these agreements, apart from providing for free trade in industrial
goods and for the preferential treatment for exports of agricultural products (see previously), the EAs also
committed the new associates to introducing similar legislation to that of the Union in the areas of competition
rules, state aids, and intellectual, commercial and industrial property. The agreements also provided for national
treatment for establishment and operation of enterprises and for improved rights of movement for workers,
although not for free mobility between EU and CEE states. In the political sphere, a key feature of the
association agreements was the formalization of bilateral political dialogues between the EU institutions and the
applicant governments. These dialogues have been conducted primarily through so-called Association Councils
and have involved regular and systematic meetings at ministerial levels on most areas of Union policy. The EAs
also raised the possibility of the early participation of the transition economies: Central and Eastern Europe
associate countries in various Community programmes on cultural, technological and environmental questions,
the accession partnerships (APs) bilateral accession partnerships have been in place since early 1998 and are
central to what the European Commission now calls its enhanced pre-accession strategy. These partnerships
(established with all ten applicant countries) are aimed at guiding the applicants towards European Union
membership by supporting their preparations for membership. This builds on the EU's launch of the Agenda
2000 programme in 1997 which established a profile of all the internal and external measures needed to achieve
eastward enlargement. Under the APs, support is provided for the applicants' membership efforts by setting out
both the priority areas for further work and the financial assistance from the EU available to help tackle these
problems. Thus, unlike the earlier Europe Agreements, APs focus specifically on preparing the applicant CEECs
to meet specific membership criteria set by the Copenhagen European Council.
EU assistance to Central and Eastern Europe
Since the reforms in the Eastern bloc took place, the EU and its member states have increased the
amount of aid going to Central and Eastern Europe. In particular, specific EU programmes such as PHARE and
TACIS (which provides grant finance for the NIS) have been established to help with the transition process and
to channel large amounts of capital into specific development projects throughout the region. Public money from
the EU member states along with that from other OECD group economies has also been channelled into Central
and Eastern Europe through the European Bank for Reconstruction and Development. The EBRD is not actually
part of the EU but is jointly owned by fifty-eight governments, the European Union and European Investment
Bank. It is based in a member capital (London) and derives a majority of its capital from the EU and EIB. From
1991 to 1997, the EBRD had made available nearly 14 billion worth of financing. The bulk of approved EBRD
projects have been in the Czech Republic, Hungary, Poland and Russia. In capital terms, the largest recipient of
EBRD loans and investment since the launch of the bank in 1991 has been Russia, Financial institutions account
for the largest slice of the EBRD's disbursements (over 35%) but emphasis has fallen increasingly on transport
and energy projects and on manufacturing and environmental clean-up operations.
The EU's dedicated aid programme for the CEECs, PHARE, was set up in 1989. For ten years, it has
functioned as the world's largest grant assistance effort for Central and Eastern Europe, committing some 11.1
billion to programmes promoting private sector development, transport and telecommunications infrastructures, /
nuclear safety and environmental improvements. Between 1999 and 2006, the EU's pre-accession aid package
(worth 24 billion) will be administered under a relaunched PHARE programme - dubbed PHARE2 - and two
parallel instruments, ISPA and SAPARD. ISPA will finance projects in transport and the environment and
SAPARD will finance agricultural sector improvements. The future job of PHARE, which means 'beacon' in
French, is to focus solely on preparing the ten candidate countries for EU membership. Thus, between 1999 and
2006, around 30% of PHARE assistance will be channelled towards institution building, which includes the
strengthening of democratic institutions and public administrations. This is to ensure that public services are


ready to apply the acquis. The remaining 70% of PHARE financing will go towards more traditional investment
support, although with reduced emphasis on transport, agriculture and the environment (now covered by ISPA
and SAPARD).
The EU has resolved to only fund projects that tackle priorities set out in the Accession Partnership and
to ensure that more money is spent on development rather than on supervision and/or consultancy services. It has
also made clear that candidates are expected to show that proposals are cost-effective and that the necessary
technical and institutional arrangements are ready to deliver those projects. These insistences are welcome, along
with the broad re-organization of EU aid efforts, given some of the significant problems with EU aid
programmes prior to 1999. While these programmes have helped beneficiary countries bring about economic,
legislative and social progress, several problems have been noted. First, as highlighted by Echikson (1997),
nearly two-thirds of the aid money previously spent has gone to 'highly-paid Western consultants, including
wealthy multinational consulting and accounting groups'. Second, money approved by the EU's political leaders
under PHARE has often never been spent. The same problem has applied to the TACIS programme where, in
one notorious case, the EU Court of Auditors noted that only a third of $180 million allocated to improve
Ukrainian nuclear safety had been disbursed. Third, months have often been needed to get EU programmes up
and running and many projects have been outdated before tenders have been made and accepted. Fourth, failing
projects have been rarely terminated even where performance has been poor or where interim objectives have
been barely satisfied. Fifth, project proposals have often been poorly conceived or have simply not been ready
for implementation. Concerns have also been raised over the lack of transparency in programme administration
and the misappropriation of funds. The present re-orientation of PHARE should go some way to dealing with
some of these past difficulties but the EU must strengthen its oversight of pre-accession aid spending and
concentrate on fewer, strategically important projects.
Box 9.1
Since its creation in 1991, the EBRD has provided direct financing for private sector activities, restructuring and
privatization in transition economies and has provided funding for the infrastructure that supports these
activities. While its present reputation is good, this has not always been the case. In 1993 it emerged that the
EBRD had spent twice as much on its running costs and offices as on loans and investments to the east. Its then
President Jacques Attali was forced to resign. Since 1993, the EBRD has reestablished its reputation by emerging
as an effective 'pump primer' for economic and enterprise development in Central and Eastern Europe. The main
forms of its financing have been loans, equity investments (shares) and credit guarantees tied to sizeable
projects. It is only really through providing guarantees to other lenders, such as commercial banks, that the
EBRD involves itself in providing finance to smaller-scale projects and entrepreneurial schemes. In this respect
the EBRD-EU regional finance facility for the ten EU accession countries is an important step, providing term
loans and equity finance to financial intermediaries so as to facilitate the expansion of lending to small and
medium-sized enterprises (SMEs). By and large, the EBRD has exercised a conservative lending strategy and
has stuck largely to safe ventures with governments, blue-chip firms, banks and public agencies. For example,
the EBRD's ECU 102 million contribution to Volkswagen's ECU 3,490 million investment in Czech car
company, Skoda, was hardly risky or innovative and could easily have been served by a traditional commercial
bank- However, as private banking has developed in Central Europe and as privatization programmes have
edged towards completion, the EBRD has taken greater risk with larger investments in countries such as the
Ukraine, Bulgaria and Russia. Although concentration has continued to rest with larger (often complex) projects,
levels of risk have increased and substantial losses are being incurred as a consequence of the economic
instability in Russia. Despite this the Bank remains committed to Russia and the NIS. Many of its projects such
as the innovative Kamchatka energy project in Russia (for which it has provided a $100 million loan) are longterm projects at early stages of development and are set to have a substantial transition impact.
9.3 EU enlargement - costs and benefits
Of course the existence of a pre-accession strategy reflects the prospect of future EU enlargement to
Central and Eastern Europe, and some comment has already been made on the progress and scheduling of entry
talks. The admission of Central and Eastern European countries to the EU has a good number of supporters.
These supporters are able to point to both political and economic benefits. Politically, the re-integration of the
Central and Eastern European countries (or at least a number of CEECs) with the rest of Europe will promote
democracy and stability throughout the continent, cementing processes of democratisation and marketization
east of Berlin. A wider EU might also be assumed to carry greater weight and influence in international fora,
maximizing and harmonizing the 'European voice' in world affairs. Economically, (eastward) enlargement should
see the EU population rise by up to 30% with the possible integration of 100 million more consumers into the
Single Market. Enlargement should also provide a further stimulus to pan-European trade and investment and
accelerate the economic development of transition states. Deeper market integration holds a clear potential for
welfare gains on the part of all parties, arising in the form of traditional efficiency gains, increased exploitation


of economies of scale and a medium-long-run growth bonus. With specific regard to investment effects, there
would be manifold benefits for foreign investors extending from the further strengthening of the institutional,
commercial and legal linkages between the CEECs and the EU. Investors not only would have greater
confidence in the long-term security of the CEE region, but might also benefit from the ending of residual
restrictions on the transfer of employees, goods, services and capital.
However, the idea of extending EU membership into Central and Eastern Europe runs up against a number of
obstacles and cautions. For the applicant states, concerns surround the full exposure of indigenous industry to
Single Market freedoms (and competition). Fears are raised that SEM integration will lead to a 'wipe out' of
home-country firms in vulnerable sectors such as heavy engineering, steel and agriculture. Equally, although
applicant countries have maintained their bids for membership, the introduction of EU standards in various areas
has demanded much adaptation of national law (and much expenditure). Harmonization with EU laws and
standards in such areas as social and environmental protection may also pose a threat to the present competitive
advantage extending from present national standards. From the perspective of incumbent EU states, a number of
concerns are evident:
1. Fears that eastward enlargement of the EU could make the EU too cumbersome to function efficiently and
lead to an increase in conflict management difficulties.
2. Fears that eastward enlargement could lead to a weaker, multispeed EU marked by greater internal disparities
(between members) and the wider use of opt-outs.
3. Difficulties in 'funding' enlargement given the relative economic underdevelopment of applicant states and the
financial underpinnings of EU policies on agriculture and the regions (see below).
4. The belief that the EU should concentrate on deepening its integration rather than on admitting new members
5. Worries about a flood of cheap imports as a direct consequence of eastward enlargement. With Eastern Europe
strong in labour-intensive industries, enlargement is feared as likely to aggravate the slump in labour-intensive
industries in current member states.
6. Fears over a flood of economic migrants as the citizens of CEEC states secure the right to move freely across
the EU territories. This right is a notable omission from those provided under the Europe Agreements.
These fears have not prevented the establishment of a pre-accession strategy nor have they dissuaded the Council
of the European Union from backing the goal of eastward enlargement. What is clear, however, is that the
concerns listed above have contributed to the EU's internal arguments over enlargement and to the fragmentation
of pre-accession efforts. The condition of entry talks (which in most cases are little advanced) and the continued
absence of target entry dates also reflect the worries of incumbent EU members. Many of these concerns are now
being used to support calls for transitional arrangements at point of entry (e.g. initial restrictions on the
movement of CEE workers throughout the EU) and for full compliance with the Copenhagen criteria.
While a full evaluation of these arguments is beyond the scope of the present study, it is beneficial to provide
some further explanation of the specific concerns relating to the financial consequences of enlargement. These
concerns are central to the debate about the timing and format of EU extension and to the EU's internal review of
its own fiscal, policy and institutional arrangements.
9.4 The financial consequences of enlargement
On the EU's side, it is clear that enlargement will inevitably have consequences for certain common
policies and for the Community expenditure associated with them. This has also been the case with past
enlargements but, given the economic characteristics of the present applicants (relative underdevelopment and
large agricultural sectors), unparalleled concerns are raised over the future funding and operation of the EU's
agricultural and regional policies. Available estimates of combined fiscal costs range from 0.1% to 0.2% of EU15 GNP. Thus, as remarked on by Keuschnigg and Kohler (1999), 'given that the Union's own resources amount
to no more than 1.27% of national GNPs, approximately 10% of the Union budget is at stake'. At the policy
level, allowing for progressive cuts in farm spending and subsidies in the years ahead, conservative estimate
suggests that the costs to the CAP of CEEC membership may be around 10 billion. As eastern farm products
switch from the external protection regime of the CAP to its internal price and income support structures, CAP
expenditure will be inflated and tariff revenues will be lost. On the structural policies, eastward enlargement
could cost a similar sum at around 13 billion (Baldwin et al., 1997). While some calculations have virtually
doubled this cost, it should be recalled that, under current rules, EU structural funding has to be matched by
equal funding from state government. In this context, the European Commission has estimated that new
members would be unable to absorb more than 4% of their own GDP with absorption capacities varying from
case to case.
Whatever the precise costs, the budgetary consequences of eastward enlargement are clearly huge and
member states have been locked in repeated internal debate over their meaning and management. Specific states
such as Spain and Portugal, which receive significant monetary transfers under the EU's structural policies, have
been determined to secure assurances over future financial allocations and have argued for the EU to strengthen
its overall funding. Others, such as Holland and Finland, have been determined to hold EU spending to
acceptable levels and to look to policy reform so as to make enlargement achievable. The scope for such tensions


is considerable. Were the EU to stick to its present plan to hold spending to 1.27% of EU GNP, the financial
allocations received by some existing member states would inevitably be reduced as a consequence of EU
The reform issues surrounding these policies are complex but the EU's challenge is to preserve the
coherence and effectiveness of these policies (if not to improve them) while introducing new member states. On
agriculture, therefore, the Commission has proposed to continue the broad direction of reforms initiated under
the MacSharry Plan of 1992 (see Box 7.2). These involve progressive reductions in interventionist price supports
for commodities such as cereals, oilseeds and beef, as well as duty and export subsidy reductions agreed with
WTO partners under the Uruguay Round. Meanwhile, CEE farm sectors will have to undergo dramatic
restructuring before membership can even be considered. While some are modest in scale and do not raise
particular financial concerns (e.g. the Czech agricultural sector), others are large and encompass hundreds of
thousands of relatively inefficient smallholdings. According to Schoenberg (1998), for example, the average
farm size in Poland is approximately 8 hectares. In the UK, holdings under 10 hectares represent only a quarter
of all farms. Under current CAP rules, this pattern to agri-sector activity in Poland (which alone has 4 million
farmers) would equate with the eligibility of thousands of Polish farmers for a range of CAP subsidies,
compensatory payments and income supports.
On regional policy, the challenge is to find a structure that allows any new members to receive
manageable levels of aid and without creating uproar among the EU's present poorer members. Eighty-five of
the eighty-nine CECC regions (at NUTS II level) are at present eligible for objective 1 funding as their per capita
incomes are less than 75% of the EU average.
Box 9.2
The Common Agricultural Policy
For forty years, the Community's Common Agricultural Policy (CAP) has sought to increase agri cultural
productivity in Europe and to stabilize agricultural markets and farming incomes. As a consequence of its
operation, the EU experiences the free movement of agricultural products across and between the member
economies on the basis of common prices, common rules on competition and central administration by the EU.
The principle of Community Preference gives priority to the sale of EU produce via extensive regulation of
imports, levies and customs duties, price subsidization and other forms of domestic market support. Since
internal EU prices are higher than those on world markets, the CAP must protect domestic producers and the
internal market against cheap imports and fluctuations by the use of such means. Within this there is
considerable variation, Although common prices, external barriers and market interventions are used to control
agricultural production and to stabilize markets in general terms, external protection and intervention cover about
two-thirds of agricultural production in the EU and external protection without intervention covers about onethird. In the former cases, protection through levies and customs duties is combined with the formal maintenance
of EU prices above certain minimum levels. Specific agencies exist for key Community products such as cereals,
milk powder, beef and veal, which buy up supplies when at their highest so as to stabilize market prices.
This policy framework has undergone a number of significant changes in recent years inspired by internal
financial constraints, persistent agricultural surpluses and external demands for EU agri-market liberalization,
CAP reform in the 1990s - extending from the 1992 MacSharry Plan and the 1994 WTO Agreement on
Agriculture - has helped to reduce internal budgetary and supply pressures and to expose EU producers to
greater competition. Specifically, the EU has been looking to adopt:
A pricing policy geared more to the market, Interventionist price supports for commodities such as cereals,
oilseeds and beef are being drastically cut.
Full and on-going compensation for that reduction through compensatory payments (made on a hectarage or
headage basis).
Progressive implementation of measures to limit the use of factors of production such as the set-aside of arable
Reduced duties and export subsidies, the WTO Agreement demanding a tariffication of variable levies and
charges, and providing for duty and export subsidy reductions.
The priorities for the European Commission were to ensure that European agriculture would become more
competitive (on both the EU and global markets) and to facilitate satisfaction of international and tightening
environmental requirements. This had to be achieved without prejudice to CAP principles and with sensitivity to
the need to protect farmers' livelihoods. These priorities have been fully upheld in the latest package of measures
forming a part of the Commission's Agenda 2000 proposals.
Several actions have now been made the basis of Council agreement, including further reductions in price
supports, increases in (compensatory) direct payments, and a considerable simplification of policy rules. This
policy is again designed to improve the competitiveness of EU agriculture and to avoid future surpluses. The
Commission argues that lower prices will benefit consumers and leave more room for price differentiation in
favour of quality products. Greater market orientation will importantly prepare the way for the integration of
new member states. Additionally there will be increased emphasis in the new CAP on food safety and on
environmental concerns.


Foreign investment in Central and Eastern Europe

Up until the First World War, foreign investment was a very important feature of the economies of the
countries in Central and Eastern Europe. Foreign owner assets were an extensive part of the manufacturing
sector and over half of mining production. During the First and Second World Wars, the liberal regime that had
allowed this to happen was tightened and much foreign-owned property was placed under state control. Prior to
and during the Second World War, the majority of firms still under foreign control were expropriated and
assigned to German companies. Eventually, during the nationalization programme between 1944 and 1950,
control was placed in the hands of the Communist governments. In the 1960s the state control of production
remained binding but some Communist governments began to see that there might be certain advantages in
foreign investment and it began to be accepted that limited investment could help with some of the problems of
relative underdevelopment. Most of the inward investment centred around co-production activities, where
control was still held by the state. Towards the end of the 1970s it became clear that these types of arrangements
had not brought with them the hoped for technology transfer and associated benefits, and regulations were
loosened still further. Even this move did not bring with it significant new investment, because Western
companies were still reluctant to invest in countries which they perceived to be politically unstable.
There can be little doubt now that all countries in Central and Eastern Europe are in favour of attracting
foreign direct investment. This occurs when a firm invests overseas to produce and/or to market a product in a
foreign country, establishing both ownership and control over a company (or other foreign assets). Thus FDI
may take the form of an acquisition of an existing company in the local market, some form of equity investment
with local partners (involving part ownership and control of overseas facilities), or the establishment of new
overseas facilities. Thus an important distinction is raised between FDI and FPI (foreign portfolio investment)
which concerns passive investment in foreign firms (or investment funds) and which requires no management
effort by the investor. FPI does not generally involve an investor taking a significant equity stake in a single
foreign business entity.
Foreign direct investment into Central and Eastern Europe is likely to speed up the process of industrial
development and modernization. This belief is based on the expectation that inward capital inflows will augment
low domestic capital supplies and bring with them new technology and management methods. The experience to
date is that, in virtually all cases, the better organization introduced in factories belonging to foreign firms has
led to rapid increases in labour productivity. The technology transferred (although not always the most up to
date) has been more modern than those hitherto employed. The countries of Central and Eastern Europe are also
banking on foreign investment in helping them to access new markets (to strengthen their export potential) and
to improve their balance of payments problems. It is central, therefore, that foreign investment brings with it the
capability for export growth and import substitution. A further bonus of foreign investment is that it can help to
create greater market competition and to break down old state monopolies. This is especially the case where
investment is tied to privatization processes. Against this is the possibility that, in some instances, foreign
investment can actually reduce competition. This can happen when transnationals close off entry to markets,
where they secure exclusive supply rights, and suck up or kill off local companies to acquire local monopolies.
Indeed, the benefits brought by foreign investment should not obscure the fact that there are often less welcome
facets to this sort of activity. For instance, cross-border acquisitions can sometimes hamper trade. A study by the
UN's Economic Commission for Europe (RCE) found that big multinationals such as foreign automakers often
lobby for, and get, trade concessions from Central European governments such as quotas and tariffs on
competitors' imports. These concessions are often an effective precondition for investment (Papp, 1995, p. 9). In
other cases, investors have been able to secure tax concessions and favourable terms for profit repatriation. The
governments of all countries confront a key dilemma: if legislation is too restrictive and/or if investors' demands
are not treated sympathetically, foreign capital will go elsewhere; if legislation is too liberal and/or too many
concessions are made, revenue streams will be reduced and large slices of profit removed abroad. This reality
gives foreign firms some very strong bargaining power with which to play off different countries looking for
new investment.
We also see that foreign investment is concentrated in specific locations. To date, the overwhelming
proportion of inward FDI into Central and Eastern Europe has been located in Poland, Hungary, Russia and the
Czech Republic. Within these countries, foreign investors have also tended to target big urban areas with good
infrastructure and easy access to office space and production facilities (e.g. Praha in the Czech Republic and the
Mazowieckie, Slaskie and Wielkopolskie Voivodships in Poland). In this sense, the preference of foreign firms to
pay somewhat higher rents and wages in order to operate in the most developed and favourably situated
locations is, in itself, contributing to Central and Eastern Europe's own core and periphery problem. The benefits
of a border with the EU have been very clear. For example, Hungary has benefited significantly from its border
with Austria and Poland and the Czech Republic from their borders with Germany. On the other hand, Bulgaria,
located on the wrong side of the former Yugoslavia and at distance from the core EU market, has found it
relatively difficult to attract investors.


Table 9.1 Foreign direct investment flows, 1990-98


direct 1990





























Czech Republic














































































































Source: Business Central Europe Magazine Statistical Database (01.01.2000)

Bibliography on Enlargement of EU and suggested readings

Baldwin, Richard, Francois, Joseph, The costs and benefits of Eastern enlargement. The impact on the
EU and Central Europe, Economic Policy, 1997, P. 125-176
2. Bauer, Patricia, Eastward Enlargement- Benefits and Costs of EU Entry for the Transition Countries,
Intereconomics, 1998, p. 11-19
3. Dehousse, F The Enlargement of the European Union and institutional reforms, Stockholm, Swedish
Institute of International relations, 1998, p. 10
4. Lavigne, Marie, Conditions for accession to the EU, Comparative Economic Studies, 1998, p.38-57
5. Agenda 2000. Summary and conclusions of the opinions of the Commission concerning the Application
for Membership to the EU presented by the candidate countries.
6. Gelazis, Nida , The effects of EU Conditionality on Citezenship Policies and Protection of national
Minirities, EUI Working Paper, no.2000/69
7. Grabbe, Heather, A Partnership for Accession? The implications of EU Conditionallity for the Central
and East European Applicants, EUI Working Papers, no1999/12
8. Agenda 2000. Reinforcing the Pre-Accession Strategy
10. http://
11. The effect of Accession on the External Policies of the New Members: see