At present, the most ambitious economic integration

takes place in Europe. This section (1) outlines its origin

and evolution, (2) introduces its current structure, and
(3) discusses its challenges.
Origin and Evolution
Although European economic integration is often noted for its economic benefits, its
origin was political in nature. In an effort to stop the vicious cycle of hatred and vio-
lence, Belgium, France, (West) Germany, Italy, Luxem-bourg, and the Netherlands in
1951 signed the European Coal and Steel Community (ECSC) Treaty, which was the first
step toward what is now the EU. There was a good reason for the six founding members
and the two indus-tries to be involved. France and Germany were the main combatants in
both WWI and WWII (and major previous European wars), each having lost millions of
soldiers and civilians. Reflecting the public mood, statesmen in both countries realized
that such killing needed to stop. One of the best ways to prevent hostilities is to let France
and Germany economically embrace each other so tightly that neither could get an arm
free to punch the other. Italy al-ways had the misfortune of being dragged along and
deva-stated whenever France and Germany went to war. The three small coun-tries
known as Benelux (Belgium, the Nether-lands, and Luxembourg) had the unfortunate
geo-graphic location of being sandwiched between France and Germany, and were
usually wiped out when France and Germany slugged it out. Natu rally, Italy and Benelux
would be happy to do anything to stop France and Germany from fighting again. Also,
the industry focus on coal and steel was not an accident. These industries traditionally
supplied the raw materials for war. Integrating them might help prevent future hostilities
from breaking out.
In 1957, six member countries of ECSC signed the Treaty of Rome, which launched the
European Economic Community (EEC)—later known as the European Community (EC).
Starting as an FTA, the EEC/EC progressed to become a customs union and eventually a
common market. In 1991, 12 member coun-tries signed the Treaty on European Union in
Maastricht, the Netherlands (in short, the “Maastricht Treaty”) to complete the single
market and establish an economic union. The title the “European Union” (EU) was offi-
cially adopted in 1993 when the Maastricht Treaty went into effect. Recently, the Lisbon
Treaty, signed in 2007 and enacted in 2009, amended the Maastricht Treaty that served as
a constitutional basis for the EU.
The EU Today
Headquartered in Brussels, Belgium, today’s EU (see PengAtlas Map 9) has 28 member
countries, 500 mil-lion citizens, and $18 trillion GDP. Contributing about 26% of the
world’s GDP, the EU is the world’s largest economy, the largest exporter and importer of
goods and services, and the largest trading partner with ma-jor economies such as the
United States, China, and India. Here is how the EU describes itself in an official
publication:
The European Union is not a federation like the United States. Nor is it simply an
organization for cooperation between governments, like the United Nations. Neither is it
a state intended to replace existing states, but it is much more than any other
organization. The EU is, in fact, unique. Never before have countries volun tarily agreed
to set up common institutions to which they dele gate some of their sovereignty so that
decisions on spe-cific matters of joint interest can be made democratically at a higher, in
this case European, level. This pooling of sovereignty is called “European integration.”

The EU today is an economic union. Internal trade bar-riers have been mostly removed.
In aviation, the EU now has a single market, which means all European carriers compete
on equal terms across the EU (including domestic routes in a foreign country). US
airlines are not allowed to fly between pairs of cities within Germany. However, non-
German, EU airlines (such as Ireland’s Ryanair) can fly between any pair of cities within
Germany. On the ground, it used to take Spanish truck drivers 24 hours to cross the
border into France due to paperwork and checks. Since 1992, passport and customs
control within most (but not all) mem-ber countries of the EU has been disbanded, and
checkpoints at border crossings are no longer manned. The area covered by EU countries
became known as the Schengen passport-free travel zone, named after Schengen,
Luxembourg, where the agreement was signed in 1985. Now, Spanish trucks can move
from Spain to France nonstop, similar to how American trucks go from Texas to
Oklahoma. At present, 22 of the 28 EU member countries are in the Schengen zone. Six
other members are not yet in: Britain and Ireland chose to opt out, and four new members
—Bulgaria, Cyprus, Romania, and Slovenia—have yet to meet requirements.
(Interestingly, three non-EU member countries—Iceland, Norway, and Switzerland—are
also in the Schengen area.)

As an economic union, one of the EU’s proudest accomplishments—but also one of its
most significant headaches—is the introduction of a common currency, the euro, initially
in 12 of the EU 15 countries. Since then, seven more countries have joined the euro zone.
Today, the 19-member euro zone accounts for 330 million people and 21% of world GDP
(relative to 24% for the United States). The euro was introduced in two phases.
First, it became available in 1999 as “virtual money” only used for financial transactions,
but not in circulation. Second, in 2002, the euro was introduced as banknotes and coins.

Adopting the euro has three great benefits (Exhibit 8.3). First, it reduces currency
conversion costs. Travelers and businesses no longer need to pay processing fees to
convert currencies for tourist activi-ties or hedging purposes (see Chapter 7). Second,
direct and transparent price comparison is now possible, thus channeling more resources
toward more competitive firms. Third, adopting the euro imposes strong macroeconomic
disci-pline. Prior to adopting the euro, different governments independently determined
exchange rates. Italy, for ex-ample, sharply devalued its lira in the 1990s. While Ita-lian
exports became cheaper and more competitive, other EU members (especially France)
were furious. But Italy can no longer devalue its currency, although it has been engulfed
in an economic crisis. Also, when confront-ing recessions, governments often printed
more currency and increased spending. Such actions cause inflation, which may spill over
to neighboring countries. By adopting the euro, euro zone countries agreed to abolish
monetary policy (such as manipulating exchange rates and printing more currency) as a
tool to solve macro-economic problems. These efforts in theory would provide
macroeconomic stability. Overall, the euro has boosted intra-EU trade by about 10%.
Commanding a quarter of global foreign currency reserves, the euro has quickly
established itself as the only credible rival to the dollar.

However, there are also significant costs involved. The first, noted above, is the loss of
ability to implement in-dependent monetary policy. Since 2008, economic life in many
EU countries without the option of devaluation is tough. The possibility of leaving the
euro zone has sur-faced in public discussion in some countries. The second cost is the
lack of flexibility in implementing fiscal policy in areas such as deficit spending. When a
country runs into fiscal difficulties, it may be faced with inflation, high interest rates, and
a run on its currency. When a number of countries share a common currency, the risks are
spread. But some countries can become “free riders,” be-cause they may not need to fix
their own fiscal problems other, more responsible members will have to shoulder the
burden.

The EU’s Challenges

Politically, the EU and its predecessors—the ECSC, the EEC, and the EC—have
delivered more than 60 years of peace and prosperity and have turned some Cold War
ene-mies into members. Although some people complain about the EU’s huge expenses
and bureaucratic meetings, they need to be reminded that one day spent on meetings is
one day member countries are not shooting at one another. Given that most European
countries, until WWII, had been involved in wars as their primary conflict resolution
mechanism, ne- gotiating to resolve differ-ences via EU platforms is not only cheaper but
also far more peaceful. For this extraordinary accom-plishment, the EU—in the middle of
a major eco-nomic crisis—received the Nobel Peace Prize in 2012.
Economically, the EU has launched a single cur-rency and has built a single market in
which people, goods, services, and capital can move freely—known as the “four
freedoms of movement”—within the core
Schengen area (although not throughout the entire EU). Although the accomplishments
are enviable in the eyes of other regional organizations, the EU has been engulfed in a
midlife crisis.7 Significant chal-lenges lie ahead, especially in terms of (1) enlargement
concerns, (2) internal divisions, and (3) existential crisis. The EU enlargement has caused
significant con- cerns. The EU’s largest expansion took place in2004, with ten new
members. Eight of them—the Czech Re-public, Estonia, Hungary, Latvia, Lithuania,
Poland, Slovakia, and Slovenia—were former eastern bloc Cen-tral and Eastern Europe
(CEE) countries. Three of these—Estonia, Latvia, and Lithuania—had previously been
part of the Soviet Union. Such expansion was a political triumph, but it was also an
economic burden. The ten new members constituted 20% of the overall population but
contributed only 9% to GDP and had an average GDP per capita that was 46% of the
average for the (pre-2004) EU 15. In 2007, Bulgaria and Romania joined and brought the
average down further. In 2013, Croatia joined. With low growth and high unemploy-ment
throughout the EU and severe economic crisis in the so-called PIGS (Portugal,
Ireland/Italy, Greece, and Spain) countries, many EU citizens are tired of taking on
additional burdens to absorb new members. Many EU 15 countries have re-stricted
immigration from new members. Another major debate re-garding enlargement is
Turkey, whose average income is even lower. In addition, its large Muslim population is
also a concern for apredominantly Christian EU. If
Turkey were to join, its population of 73 million would make it the second most
populous EU country behind only Germany, whose population is 83 million now (but is
declining). The weight of EU countries in voting is based (mostly) on population. Given
the high birth rates in Turkey and low birth rates in Germany and other EU countries, if
Turkey were to join the EU, by 2020 it would become the most populous and thus the
most powerful member by commanding
most significant voting power. Turkey’s combination of low incomes, high birth rates,
and Muslim majority visi- bly concern current member countries, especially given the
history of Christian–Muslim tensions in Europe. Turkey’s military coup in 2016 and the
government’s
crackdown in its aftermath have made Turkey’s prospects
to join the EU even dimmer.
Internally, there is a significant debate on whether the EU should be an economic and
political union, or just an economic union. One school of thought, led by France, argues
that an economic union should inevitably evolve toward a political union, through which
Eu-rope speaks as “one voice.” Its proponents frequently invoke the famous term
enshrined in the 1957 Treaty of Rome, “ever closer union.”8 Another school of thought,
led by Britain, views the EU
as primarily an economic union that should focus on free trade, pure and simple. The
profound frus-tration associated with the fear of losing national sover-eignty in the march
toward an “ever closer union” has directly contributed to Brexit (see Opening Case). The
2010–2012 bailouts to rescue Greece have intensified this debate. Although Germany
reluctantly agreed to lead bailout efforts, it demanded that the EU-wide “economic
governance” be strengthened and that insolvent countries lose some of their eco-nomic
sovereignty by having their budgets approved (or vetoed) by the EU. While this is viewed
as a step toward closer political union, Germany does not share France’s political
motivation for an “ever closer union.”
In fact, the German media has called for Germany to withdraw from the euro zone in
order to avoid the bur-den of paying for other countries’ problems. However, abandoning
the euro is not realistic for Germany. This is because a revived Deutsche Mark would
certainly appreciate and severely undermine Germany’s export competitiveness.
Germany ends up being a “reluctant hegemon.”9 Finally, since 2008, the EU’s challenges
have been magnified. Externally, in 2014, with Russia’s interven-tion in Ukraine, the EU
felt compelled to join the US-led sanctions on Russia, inflicting economic wounds on
itself by abandoning hard-won markets in Russia. Internally, a total of eight members
were engulfed in embarrassing financial crises that had to be bailed out by other members
(and the IMF): Hungary (2008), Latvia (2008), Romania (2009), Greece (2010, 2011,
2012), Ireland (2010), Portugal (2011), Cyprus (2011), and Spain (2012). Not
surprisingly, Germany and other relatively well-off EU countries, in the middle of their
own Great Recession, were reluctant to foot the bill to bail out other countries. Each
crisis was painful in its own ways, but the Greek crisis was particularly gut-wrenching,
resulting in calls for Greece to exit or to be expelled—a “Grexit” scenario.
Although Grexit has not materialized, Brexit—a newer word directly inspired by Grexit
—has been taking place (see Opening Case). Now that one country sets a precedent that it
is possible to leave the EU, certain politicians and groups frustrated with the EU’s
problems are now openly advocating Frexit (for France), Gexit (for Germany), and Nexit
(for the Netherlands) in addition to Grexit.
On top of all these political moves advocating exit, the migrant crisis, which began in
2015, has severely un-dermined EU solidarity. Basically, millions of refugees from
Muslim-majority countries such as Syria, Iraq, Afghanistan, and Libya have illegally but
desperately crossed the Mediterranean or traveled overland through Southeast Europe to
reach EU countries. Although such refugees typically arrive in a Southern European
country such as Greece and Italy first, their preferred destinations are often wealthy
Northern European countries, especially Germany. In response to the migrant crisis with
endless unauthorized crossings, border controls were reintroduced in seven Schengen
countries (Aus-tria, Denmark, France, Germany, Norway, Poland, and
Sweden). This has directly caused the collapse of Schen-gen—free movement of people,
one of the core “four freedoms of movement.” Overall, with the second largest economy
(Britain) leaving, with other countries threat-ening to leave, and with endless internal
crises and external threats, the EU is facing an existential crisis. This severe setback is
part of the recent backlash against glo-balization—and in the EU, against regional
integration.