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The European Union

Economic Integration & The European Union


INT 362 Osman Sabri KIRATLI

The European Union

Since the creation of the EU half a century ago, Europe has enjoyed the longest period of peace in its history.
EU enlargement has helped overcome the division of Europe contributing to peace, prosperity, and stability across the continent. A single market and a common currency conditions for companies and consumers.

The European Union


What is the European Union?

27

Member States

Shared values: liberty, democracy, respect for human rights and fundamental freedoms, and the rule of law. Largest economic body in the world A unique institution Member States voluntarily cede national sovereignty in many areas to carry out common policies and governance. Not a super-state to replace existing states, nor just an organization for international cooperation. Worlds largest & most open market for goods and commodities from developing countries.

Combined population of EU Member States

490
million

Percent of worlds population Percent of global GDP

30

55

Percent of combined worldwide Official Development Assistance

The European Union Stages of Regional Integration


Stage 1 Free Trade Area: the elimination of tariffs
for goods and services within region (NAFTA) Stage 2 Customs Union: Free Trade Area with a common external tariff (EEC)

Stage 3 Single Market/Economic Union:


eliminating all tariff and non-tariff barriers Freedom of goods, services, labor and capital Harmonization of regulation

May also have common currency (euro)


Stage 4 Political Union? Common Political Institutions/Constitution

The European Union

The European Union


1951:

European Coal and Steel Community

In the aftermath of World War II, the aim was to secure peace among Europes victorious and vanquished nations and bring them together as equals, cooperating within shared institutions. Based on a plan by French statesman Jean Monnet and Foreign Minister Robert Schuman (to German Chancellor Adenauer) Six founding countries Belgium, the Federal Republic of Germany, France, Italy, Luxembourg and the Netherlands signed a treaty to run heavy industries (coal and steel) under common management to make war not only unthinkable but materially impossible

Jean Monnet and other leaders with the first European ingot of steel

The European Union


1957:

Treaty of Rome
The six founding countries expanded cooperation to other economic sectors, creating the European Economic Community (EEC) or common market.
Signing of the Treaty of Rome

As a result, people, goods, services, and capital today move freely across the Union. Britain left out, formed EFTA instead EURATOM: shared nuclear energy research 1960s: Common Agricultural Policy

The European Union


Single European Act & Maastricht Treaty
Jacques Delors and the SEA (1986) Single Market by 1992

End of Cold War (1989-91) and Maastricht Treaty (1991/3) Three pillar structure (left): Euro & economic Policies, CFSP and Justice & Home Affairs Extension of Qualified Majority Voting, European citizenship

The European Union Lisbon Treaty


Reformulated version of the failed European Constitutional Treaty of 2004 The No of the popular referenda in the Netherlands & France dealt a significant blow to the Constitution and the future of the Union- which found itself in a reflection/crisis period after the Reform/Lisbon Treaty, ratified in 12/2009 (in 2nd attempt in Ireland) which takes in most aspects of the constitution (minus flag, anthem, constitutionwording, Minister) such as - Semi-permanent Council President (Herman Van Rompuy) - High Rep for Common Foreign Affairs & Security (Catherine Ashton) Policy (EU Foreign Minister) + Ext. Diplom. Service - Charter of Fundamental Rights (binding) - Qual. Majority Voting & Co-decision the rule - National Parliaments receive more time for review - 1 Million Citizens Initiative

The European Union Enlargement Waves


1967: ECSC, EEC, and EuroAtom merged to form the basis of the EC
1973: the United Kingdom, Denmark, and Ireland joined the EC 1981: Greece joined 1986: Spain and Portugal joined

1995: Finland, Sweden, and Austria joined


2004: Central Europe (eight countries), Cyprus and Malta joined 2007: Romania and Bulgaria joined

The European Union


Candidate Countries Croatia Former Yugoslav Republic of Macedonia Turkey Potential Candidate Countries Albania Bosnia & Herzegovina Montenegro

Serbia including Kosovo (under UN Security Council


Resolution 1244)

The European Union EU Institutions


The Institutional Triangle: The Commission, The Council of Ministers, The Parliament
The Other Two: The Court of Justice, The Central Bank

The European Union 1-European Commission


27 (College of) Commissioners, representing the European perspective, each responsible for a specific policy area.

Supported & represented by ~25,000 Eurocrats in Brussels & the world, divided into departments called Directorates-General
Reduction to 2/3 planned in 2014 The Commission is supposed to represent the interests of the EU, not the member states. Thus they arent supposed to receive instructions from their home country European Commission President Jos Manuel Barroso Does no directly control taxation, policy or armed forces Occasional problems with corruption: The EU parliament can force the entire Commission to resign through a vote of no confidence. Almost did in 1999 with Santer Commission, which, instead, resigned en masse.

The European Union 1-European Commission


EUs executive branch proposes legislation, manages Unions day-today business, budget, and enforces rules.
Negotiates trade agreements and manages Europes multilateral development cooperation. Proposes new laws

Implements them
Prepares EU Budget Acts with complete political independance Acts as guardian of treaties

Can take offending parties to court


Answerable to parliament

The European Union 2-Council of Ministers (+ EU Council)


EUs main decision-making body, comprised of (9 configurations of) ministers of 27 MS, representing their point of view After obtaining the draft law from the EC & input from EP, Council votes either by unanimity or QMV QMV: majority of member states+73.9 of votes (+62 percent of population) Council presidency rotates among MS every six months EU Council: regular meeting of Heads of Government Not the same as the Council of Europe which is a European organization located in Strasbourg, It was founded in 1949 to protect human rights and foster democracy. Made up of 36 nations Meetings held in secret, little media coverage

The European Union 2-Council of Ministers (+ EU Council)


Decides on foreign policy
Sets EU political goals Co-ordinatetes national policies Controls EU budget Makes key decisions:economic and political Heads of govt meet twice a year at EU summits

The European Union


3-European Parliament
Voice of Europeans (785/750) members elected across EU for 5-year terms (according to national population) Since 1979 directly elected, but low turnout Seats are, for the most part, shared proportionally according to size of member state These produce distortions: Germany has 99 seats, Malta has 5, but . . . European Parliament in session This means: Germany has 1 MEP per 800,000; Malta one MEP per 80,000 Oddity is that EU parliament cannot introduce laws nor raise revenue MEPs in the Parliament are currently organized into 8 different political groups

The European Union


3-European Parliament
With the Council, passes EU laws and adopts EU budgets (co-decision rights)
Approves/Supervises EU Commissioners. It has the power to dismiss the Commission by censure Debates new legislation Ammends/approves budget Advises council

The European Union 3-European Parliament:Political Parties


These European parties are themselves composed primarily of national parties For example, a member of the British Conservative (Tory) Party would be a member of the European Democrats) and include parties not currently elected or even currently outside the EU Hence, European Union parties are more fluid, with national or European parties easily able to switch between groups which often occurs after elections or an enlargement

The European Union


4-European Court of Justice
Highest EU judicial authority 27 judges (6yr terms) + Advocates General/Cof First Instance Ensures all EU laws are interpreted and applied correctly and uniformly (Preliminary rulings, direct actions against MS, EC) Located in Luxembourg Primary Law: Treaties & Constitutional Boundaries of MS Secondary Law: Rules & Regulations, Directives Power of Court seems to be growing; this reflected in tension between Court and member states On the other hand, Court of Justice has strengthened courts in member nations by giving it new jurisdiction Under new constitution, ECJ power would grow significantly

The European Union


4-European Court of Justice
Can act as an independent policy maker/over-rules national law
Determines if national laws are consistent with EU laws EU law takes precedence but only in areas of EU competence, that is, where the countries have given power to the EU Legislates laws, supervise Commission, controls budget allocation Deals with Claims by the EU Commission that a member state has not implemented a legal requirement Claims by a member state that the EU Commission has exceeded its authority

Responds to inquiries from national courts about the meaning or validity of a particular piece of EU law
General Court (Court of First Instance before 2009) screens issues before they come to Court of Justice

The European Union Other important EU bodies


The Economic and Social Committee (ESC) (advisory group on social/econ. issues), a forum for EU civil society, dominated by groups of employers, trade unions and agricultural organizations The Committee of the Regions (advisory opinion in regional issues) The Court of Auditors monitors the EU budget The Eur Ombudsman receives and investigates complaints by citizens The European Central Bank (ECB) formulates the EUs monetary policy (Frankfurt) European Investment Bank (EIB) supplies loans for European projects Specialized Agencies (across EU) COREPER: Committee of Permanent Representatives Powerful but often overlooked in understanding EU Acts as links between Brussels and member states Sets agenda for much of Councils business

The European Union Major Policies


Euro & Monetary Union: Euro removes transaction costs & is reserve currency CFSP: Foreign Minister, External Action Service; minimal budget: 170 million (2007) Common Agricultural Policy (CAP): farm subsidies keystone of integration, accounts for ~ 40% of EU budget Regional Policy: Structural & Social Funds JHA: Europol & -just; Counterterrorism & Internal Security; Asylum & Immigration laws, borderless Schengen agreement Trade, Transport & Competition: Single Market rules (4 freedoms of movement), subsidy control & mergers; External Trade Culture/Education: Exchange, sister cities Environmental Policy Foreign Aid: Cotonou Convention (77 countries)

The European Union Figures on Transatlantic Economy


EU and U.S. together account for 40% of total global trade (more than $1.5 billion in transatlantic trade every day). The $3 trillion EU-U.S. transatlantic economy employs 14 million workers on both sides of the Atlantic. In 2005, Europe accounted for roughly twothirds of total global investment flows into the U.S. by far the most significant source of foreign investment in the U.S. economy.

The European Union

The uro

The euro Europe's new single currency - represents the consolidation and culmination of European economic integration. Its introduction on January 1, 1999, marked the final phase of Economic and Monetary Union (EMU), a three-stage process that was launched in 1990 as EU member states prepared for the 1992 single market. With German reunification 1990, EMU presents opportunity to tie a unified Germany to the EU/EC by creating common bandwidth of currency fluctuations & deciding which countries can take part (by 1998) (Stage 1) - single currency instead of common currency! Jan 1, 1999 =launch of currency at $ 1.18 and ECB creation (Stage 2)

Final money intro/circulation Jan 1,2002 (Stage 3)


Results: Reduces cost of business/transaction costs, reduces exchange rate risks, but also reduces national monetary flexibility

The European Union Economic Integration: Basics


Definition: The combination of several national economies into a larger territorial unit
It implies the elimination of economic boarders between countries. Economic borders: any obstacle which limits the mobility of goods services and factors of production between countries.

All processes of economic integration include two aspects:


Negative integration: the elimination of obstacles. Positive integration: harmonization, coordination of existing instruments.

The European Union Stages of Regional Integration


Stage 1 Free Trade Area: the elimination of tariffs
for goods and services within region (NAFTA) Stage 2 Customs Union: Free Trade Area with a common external tariff (EEC)

Stage 3 Single Market/Economic Union:


eliminating all tariff and non-tariff barriers Freedom of goods, services, labor and capital Harmonization of regulation

May also have common currency (euro)


Stage 4 Political Union? Common Political Institutions/Constitution

The European Union


Number of regional trade agreements, 1948-2002

The European Union

Egy pt

Sudan

Ethiopia

Uganda Keny a Zaire

Angola Zambia Namibia Zimbabwe Madagascar

COMESA

The European Union

My anmar

Viet Nam Lao PDR Thailand Philippines Cambodia

ASEAN

Malay sia

Malay sia

Indonesia Indonesia Indonesia

Indonesia

The European Union

Canada

United States

Mexico

Venezuela Colombia

Peru Brazil

RTAs in America
NAFTA CARICOM CACM ANDEAN MERCOSUR (3) (13) (5) (5) (4)

Bolivia

Arg entina

The European Union European Economic Integration


Establishing a common market (EEC treaty) with four freedoms:
Free movement of goods (Cassis-de-Dijon case, 1979). Free movement of persons Free movement of services Free movement of capital

The European Union European Economic Integration


1951 ECSC Membership 1957 1957 1967 1973 1981 1986 1990 1993 EURATOM EEC EC Membership Membership Membership Membership EU European Coal and Steel Community Belgium, France, Luxembourg, Netherlands, Italy & W. Germany European Atomic Energy Community European Economic Community European Communities; combining ECSC, EEC, and EURATOM + United Kingdom, Ireland, and Denmark + Greece + Spain and Portugal + East Germany (re-unification of West and East Germany) European Union

1995
1999

Membership
EMU

+ Finland, Austria, and Sweden


Economic and Monetary Union

The European Union Economics of Integration


Starting assumptions:
1. A country whose producers are favored, that is be subjected to preferential tariff treatment will gain economic advantages. 2. Third nations which are excluded from preferential treatment will lose. 3. Such discriminatory liberalization is both liberalization, which removes price barriers and tends to improve economic efficiency and Home welfare, and discrimination, which introduces new price barriers and thus tends to harm efficiency and welfare. (Trade creation vs. trade diversion)

The European Union Economics of Integration


Consumer surplus is the difference between the maximum price a consumer is willing to pay and the actual price they do pay.
Producer surplus is the difference between its cost and what it actually gets for the good

The European Union Economics of Integration


If the price falls:
Consumers obviously better off. Consumer surplus change quantifies this intuition. Consumer surplus rise, 2 parts:

Pay less for units consumed at old price; measure of this = area A.
A = Price drop times old consumption. Gain surplus on the new units consumed (those from c* to c); measure of this = area B. Total Consumer surplus: A+B

The European Union

If the price rises:


producers obviously better off. Producer surplus change quantifies this intuition. producer surplus rise, 2 parts:

Get more for units sold at old price; measure of this = area A.
A = Price rise times old production. Gain surplus on the new units sold (those from q* to q). Measure of this = area B. B= sum of all new gaps between marginal cost and price.

The European Union

The European Union


Neo-classical theory of economic integration
price
decrease producer surplus

demand

net gain increase consumer surplus decrease government revenue

supply

pC+t pB+t pC pB imports before customs union imports after customs union q0 q1 q3 q4

tariff tariff

quantity

The European Union


decrease producer surplus
price demand

-/-

net gain; possible loss increase consumer surplus decrease government revenue

supply

Trade diversion

pB+t pC+t pB pC imports before customs union imports after customs union q0 q1 q3 q4

tariff tariff

quantity

The European Union

The US is the most efficient producer (Pus)

Before the CU:


France imports ru from the US applying a tariff which leads to PF. T = ruhi CU: Germany faces no tariffs but the US does: France imports kn from Germ. Loss of tariff revenue and reduction of producer surplus: ruhi + PFrkPG (in favour of consumers) Trade creation: Consumption effect: umn Production effect: rkl Trade deviation: lmhi (what you dont import from the US multiplied by PAPUS)

Net welfare effect: rkl+umn-lmhi

The European Union Static Benefits of Customs Union


Trade Creation:
Replace domestic production by cheaper imports from another member of the customs union: Production effect: reduce inefficient local production and minimize the inefficient use of resources

Consumption effect: increase demand since price has fallen


Trade Diversion: Replace imports from cheaper 3rd countries by more expensive imports from members of the customs union.

The European Union Static Benefits of Customs Union


The customs union has a positive welfare effect if trade creation > trade diversion. This will tend to happen when:
The more inclusive the customs union (fewer 3rd countries) The higher the initial tariff eliminated by the creation of the customs union (PF-P G in the following figure)

The smaller the difference between the price which emerges from the customs union and the price which could be had from importing from the most efficient producer who by definition is a 3rd country.

The European Union


Indirect and Dynamic Effects of Customs Union
Dynamic Effects (longer term and more difficult to measure) Increases productivity and thus potential growth rates due to: 1- Improvement in the allocation and utilization of resources within members Factor mobility Free movement of K and L: More efficient allocation of resources Convergence of wages and capital incomes within the CM But:

K moves easier than L (transport and cultural costs). So not a full equalization
Factor mobility can also lead to depressed areas within the CU

The European Union


Indirect and Dynamic Effects of Customs Union
2-Economies of scale effects Provide conditions for optimum size production and opportunity for cost reductions Market is enlarged, and the avarage cost of production decreases

3-Specialization according to comparative advantage


Yet a danger: increasing returns can lead to dumping and monopolies. By that, integration can reinforce imperfect competition The application of an effective competition policy to ensure that firms do not exercise monopoly power or abuse their market power to the detriment of consumers and the efficient allocation of resources in general. 4- Increasing competition

The European Union


Indirect and Dynamic Effects of Customs Union
Minor effects: 5- Bargaining power 6- Insurance Small countries may want to join as an insurance for both political and economic events (such as future discrimination on trade economic- or further consolidation of politica regime political-)

The European Union Economic Integration: Final Remarks


National universal tariffs replaced by preferential tariff changes. This is only a second-best outcome (after universal tariff liberalization) and creates both trade creation and trade diversions.
RTAs in general increase welfare through trade creation, but the discriminatory nature of an RTA may make the net welfare effect negative. Net effect of CUs (trade creation-trade diversion) should be calculated. Different segments within the society gain or lose Increased popularity of Regionalism rather than Multilateralism may be bad for the world economy. EU is most succesful and powerful economic integration scheme; many CEE countries want to join; EUs political decision process needs to be revised.

The European Union Economic Integration: Final Remarks


This process causes externalities for non-members, which may seek to internalize them by closer cooperation or even participation in it. Hence: enlargement
Contradicts WTO regulation that countries should impose tariffs on a nondiscriminatory basis GATT loophole: FTAs and customs unions it was allowed because some early members wanted to preserve their preferential arrangements (British Commonwealth) So, GATT Treaty allows preferential liberalization for CUs and FTAs

The European Union European Single Market: History


Article 3, Treaty of Rome:
the elimination, as between member states, of customs duties and quantitative restrictions on the import and export of goods, and all other measures having equivalent effect; the abolition as between member states, of obstacles to freedom of movement for persons, services and capital Programme to create a Common Market (CM) initially proposed in 1969 Before: Free trade but restrictions to capital movements and mobility

The European Union European Single Market: History


1978: the Cassis de Dijon case

The ECJ ruled that Germany could not ban the importing of Cassis de Dijon on the grounds that it did not conform to German rules governing the sale of alcohol
It meant mutual recognition of each others rules and regulations 1979: the introduction of the European Monetary System (EMS): link currencies to prevent large fluctations among exchange rates early 1980s Lack of global competitiveness Lack of progress towards higher level of integration 1985 - The Commissions White Paper Completing the Internal Market contained the legislative blueprint for completing the single market by end 1992

The European Union European Single Market: History


1987
The Single European Act to create a Single Market within the European Community by 1992 Amended the Treaty of Rome to allow majority voting in issues of the Single Market

Article 13:
The internal market shall comprise an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provision of this Treaty

The European Union The Single European Act (SEA)


Programme towards a larger market without frontiers Economic and social cohesion Common policy on technological/scientific development EMS strengthening Coordinated environment protection

The elimination of cost increasing barriers between EC states:


Physical Barriers, associated with frontier inspections; Technical Barriers, causing legal and regulatory obstacles; Fiscal Barriers, (taxes and subsidies) New EC approach: approximation instead of standardization the removal of internal frontiers a binding timetable

The European Union Expected Benefits of Integration


Cecchini report (1988). Cost saving effects:
Static trade effect: benefits from allowing public authorities to buy from the cheapest suppliers Competition effect: Downward pressure on prices as a result of greater competition

Restructuring effect: Reorganisation of industrial sectors and individual companies as a result of greater competition

Integration may turn previously segmented markets in to a single integrated market

The European Union Expected Benefits of Integration


The emergence of virtuous cycles of innovation and competition
Lowering of prices for consumers Greater job creation Reduces firms monopoly power Inefficient firms exiting Allows for more products to be consumed Scale reduces costs of production

Still: Large variation in average prices: for consumer goods 15.2% around mean

The European Union Free Movements Revisited


Free Movement of Labour: Once labour barriers are reduced, labour will move from low to high wage countries. Wages in the former will tend to rise due to a reduced supply of labour, while in the latter they will tend to fall due to a rising labour supply, i.e. wage equalisation. But: cultural/language barriers in EU Free Movement of Capital: If the rate of return on investment is higher in one country than in another, investment funds will tend to move to the latter until the rate is equalised. But, the capital flows can be influenced by uncertainty and different fiscal policies.

The European Union Free Movements Revisited


Free Movement of Goods:
Before: Segmented markets, with prices independent across countries Eliminated (with limited success) policies that raise cost of entering specific market such as: Protectionist public procurement Different service regulation (banking; insurance) Capital controls Different legal frameworks

The European Union Allocation effects revisited


Real world
perfect competition vs. imperfect competition Fact: Intra-EU trade is 70-80% intra-industry, thus not driven by comparative advantage.

We need models with imperfect competition

The European Union SEM: Success or Failure?


_______________________________________________________ ECU (billion) as % of GDP of the EC _______________________________________________________ (a) (b) (a) (b) Barriers affecting 8 9 0.2 0.3 trade (customs) Barriers affecting production (subsidies) Barriers affecting the reaping of economies of scale (national procurement) 57 60 71 61 2.0 2.0 2.4 2.1

The European Union SEM: Success or Failure?


_______________________________________________________ ECU (billion) as % of GDP of the EC _______________________________________________________ (a) (b) (a) (b) Barriers which 46 46 1.6 1.6 prevent competition (subsidies, technical specifications) Total benefits 171 187 5.8 6.4

Note: (a) low estimate (b) high estimate based on Cecchini (1988) and Emerson (1988)

The European Union


SEM: Success or Failure?
GDP (%)
+ 4.5

Prices (%)
- 6.1

Employment
(millions) + 1.8

External Balance
(%) of GDP + 1.0

Time scale 6 + years from full implementation of programme (1.1.93) Estimates subject to a margin of error +/- 30%

The European Union SEM: Success or Failure?


Review by Commission in 2002
Effects of SEM between 1992-2002: GDP: 1.8% higher (164.5bn Euro higher) Employment: 1.46% higher (2.5 million extra jobs) FDI: intra-EU 15 times increase between 1995 and 2000 (from third countries 4 times higher) Downward price convergence (3.6%) Productivity immediately after 1992: up 2% Cross-border procurement: increase from 6% (1987) to 10% (1998) Export goods price convergence (50% of all in EU)

The European Union SEM: Success?


Improved supply-side of the EC economy:
higher aggregate demand by increasing real purchasing power increased investment improved competitiveness of EC relative to rest of the world Improvements in public sector budgets: reduction in cost of public procurement growth of GDP and tax revenue more public expenditure and reduced unemployment through restructuring

The European Union SEM: Failure?


Location of activities: Peripheral location and low productivity trap Difficult to face higher competition Income redistribution: Pressure on wages through competitionneed for extra social provisions Institutional setting: Need for policies on social issues - for even distribution of benefits Effects on outside world Positive growth versus protectionism New evaluation needed The distinction between what happened and what would be without Single Market Political changes: e.g. German unification Long term effects!?

The European Union The European Monetary Union


An overriding desire for exchange rate stability:
initially provided by the Bretton Woods system the US dollar as an anchor and the IMF as conductor Three attempts by the Europeans for monetary integration: Attempt 1: the Snake in the tunnel arrangement Attempt 2: the European Monetary System (EMS) Attempt 3: the Monetary Union

The European Union


The European Monetary Union: First Attempt
Monetary union in the European Community (EC) was proposed as long ago as 1970 in the Werner Report, which envisaged it being in place by 1980.
Adjustable fixed XR with US dollar in the centre and permitted margins for fluctuations Not supported by France However, two key developments in the international sphere derailed this first attempt: 1. The breakdown of the Bretton Woods system of fixed exchange rates in August 1971

2. The 1973 oil crisis

Upper limit

Lower limit

The European Union


The European Monetary Union: Second Attempt
The second attempt, the European Monetary System (EMS), created in 1979, proved more durable, although it too was accompanied by a number of major and minor crises. EMS = European Monetary System A EU arrangement: all EU members are part of it Main elements: Exchange Rate Mechanism (ERM) + ECU ERM = Exchange Rate Mechanism An agreement to fix the exchange rate The ECU: not a currency, just a unit of account took some life on private markets ERM jointly managed Changes in exchange rates agreed by all members Fluctuations between +/-2.25% and +/-15% Mutual support to correct exchange rates when needed Allows prompt realignments Deutschemark gradually emerged as the anchor

The European Union


The European Monetary Union: Second Attempt
ECU

The European Union


The European Monetary Union: Second Attempt
Full capital mobility established in 1990 as part of the Single Act ERM in contradiction with impossible trinity unless all monetary independence relinquished. Bad luck: German unification: a big shock that called for very tight monetary policy the Danish referendum on the Maastricht Treaty A wave of speculative attacks in 1992-3:

the Bundesbank sets limits to unlimited support


Way out of crisis: wide band of fluctuation (15%) a soft ERM on the way to monetary union

The European Union


The European Monetary Union: Third Attempt
The Maastricht Treaty did three things to further monetary integration in Europe:

1. It set out a timetable for the establishment of monetary union.


2. It laid down the criteria by which the fitness of countries to join in monetary union would be determined. 3. It established the institutional framework for the conduct of monetary policy under EMU. Stage One: 1990-1993 The complete elimination of capital controls among the Member States and increased cooperation between their central banks Stage Two: 1994-1998 The real beginning of the transition to EMU with the establishment of the European Monetary Institute (EMI). EMI = precursor of the European Central Bank, charged with co-ordinating monetary policy and preparation for the single currency Stage Three: January 1, 1999 Eleven countries fixed their exchange rates. The national currencies of the eleven were replaced by the euro. The ECB took over responsibility for monetary policy in the euro area.

The European Union


The European Monetary Union: Third Attempt
Denmark and the United Kingdom did not participate in the first round, having negotiated derogations, even though they satisfied most of the criteria. Likewise Sweden did not participate. The only country that wished to participate but failed to meet the convergence tests was Greece (joined in 2001) New member states need to meet euro acquis and Slovenia, Malta, Cyprus and Slovakia have now joined the EMU, too.

The European Union

The European Union

The European Union

Monetary Policy under EMU


EMU fundamentally changes the way in which monetary policy is conducted in the participating states.
Responsibility for monetary policy shifted from national central banks to the ECB on January 1, 1999. Monetary union implies a choice between exchange rate stability and monetary policy autonomy The impossible trinity: only 2 of the following possible simultaneously: Full capital mobility Autonomous monetary policy Fixed exchange rates

The European Union Optimum Currency Areas


Benefits:
No transaction costs, no exchange-rate uncertainty, efficiency of single currency as a unit of account and store of value Costs: Rising interdependence with other members of the union

Loss of monetary and exchange rate instruments

The European Union


Optimum Currency Areas: Benefits of Common Currency
The euro means big changes for business both within these countries and throughout Europe: 1.Cheaper transaction costs countries in the euro zone do not have to change currencies when doing business with each other. 2.Exchange rate certainty sharing a single currency means countries in the euro zone are no longer affected by currency fluctuations when trading with each other. 3.Transparent prices it is more obvious if different euro zone countries charge different prices for the same goods and services. 4.Increased cross-border competition: -Businesses who want to export into the euro zone may be at a disadvantage against competitors within the zone who share the same currency as the importer.

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Optimum Currency Areas: Benefits of Common Currency
5. Cross-border mergers and other joint ventures: Increased competition might make mergers within the euro zone more likely, and sharing the single currency may also make them easier. 6. Raising finance: Firms may have more choice since bond and equity markets may be more attractive in euros. 7. Standardization and lowering of interest rates: Induces investment in a more stable market

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Six criteria for Optimum Currency Areas
Three economic criteria:
Labor Mobility Diversification Openness Three political criteria: Fiscal risk-sharing Homogeneity of preferences Solidarity

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Six criteria for Optimum Currency Areas
1. Labour mobility
2. Diversification: OCA is beneficial for countries whose production and exports are widely diversified and of similar structure. If production and exports are diversified and similar, there are few asymmetric shocks and each of them is likely to be of small concern. 3. Openness: Countries which are very open to trade and trade heavily with each other. If all goods are traded, domestic goods prices must be flexible and exchange rate does not matter for competitiveness.

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Six criteria for Optimum Currency Areas
4. Fiscal Transfers: Countries that agree to compensate each other for adverse shocks form an OCA. Transfers can act as an insurance that mitigates the costs of an asymmetric shock
5. Homogeneity of Preferences: Countries that share a wide consensus on the way to deal with shocks form an OCA Different interest groups enjoy political power in different countries 6. Solidarity: Countries that view themselves as sharing a common destiny better accept the costs of operating an OCA.

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Is EMU an optimal currency area?

Belgium/Luxembourg Slovakia Czech Republic Intra-EU trade and openness Netherlands Estonia Degree of asymmetry of shocks Hungary Slovenia A. Degree of Openness: Ireland Large differences in openness of EU countries with Lithuania Austria the rest of the Union Latvia For countries with a small degree of openness Denmark (UK and Greece), it is less clear that they belong Poland to an optimal currency area with the rest of the Germany EU Sweden Malta Cost-benefit analysis is likely to show net benefits of being in EMU for Benelux, and small Finland Portugal central European countries France Italy Spain United Kingdom Cyprus Greece

In order to answer to this question there are different parameters to evaluate:

66,7 58,9 54,1 51,1 45,6 43,7 37,3 34,7 30,1 28,1 24,6 23,1 23,1 22,0 21,2 21,0 19,1 16,6 13,7 12,2 12,0 9,8 6,1 4,0

The European Union Is EMU an optimal currency area?


B. Asymmetric shocks
Not all CE-countries may be part of an optimal currency area with the rest of the European Union Despite relatively large openness of the CE-countries vis a vis the EU, many are subjected to relatively large asymmetric shocks, so that it is not obvious that they would gain from entering EMU However, for some of these countries entering EMU might be the best possible way to import monetary and price stability

The European Union Is EMU an optimal currency area?


B. Asymmetric shocks If a country faces economic crisis, real exchange rate, EP/P*, must depreciate to restore competitiveness Either prices fall or nominal exchange rate depreciates. If not: overproduction and unemployment Symmetric: Same demand shock in two similar countries that share the same currency and, therefore, exchange rate: No problem. The same real XR adjustment as before. Asymmetric: Only one country is affected; countries share common currency: Problem! Country As (affected one) real exchange rate must depreciate both vis--vis ROW and Country B Country A wants a depreciation. Country B is unhappy: depreciation would lead to excess demand and inflationary pressure. Common central bank considers preferences of both countries and allows partial depreciation Both countries affected adversely when they share the same currency

The European Union The Maastricht Convergence Criteria


1. Inflation:

not to exceed by more than 1.5 per cent the average of the three lowest rates among EU countries.
2. Long-term interest rate: not to exceed by more than 2 per cent the average interest rate in the three lowest-inflation countries. 3. ERM membership: at least two years in ERM without being forced to devalue. 4. Budget deficit: deficit less than 3 per cent of GDP. 5. Public debt: debt less than 60 per cent of GDP (or diminishing and approaching 60% at satisfactory pace) Note: Fulfilment of criteria was observed on 1997 performance for decision in 1998. The convergence criteria give little regard to standard OCA arguments

Problem No. 1:
a few years of budgetary discipline do not guarantee long-term discipline excessive deficit procedure once in euro area

Problem No. 2: deficit and debt ceilings are arbitrary

The European Union How does the EMU work?


Actors: National Central Banks (NCBs) continue operating but with no monetary policy function. A new central bank at the centre: the European Central Bank (ECB). The European System of Central Banks (ESCB): the ECB and all EU NCBs (N=27). The Eurosystem: the ECB and the NCBs of euro area member countries (N=16) Objectives: fighting inflation close to 2% is the absolute priority supporting growth and employment comes next Means: Control the very short-term interest rate: European Over Night Index Average (EONIA)

The European Union EMU: Success or Failure?

The European Union EU Competition Policy


Why? Competition and open markets put companies under continual pressure to innovate, improve quality and keep prices low. Driven by Treaty of Rome (art.3) ..ensuring that competition in a common market is not distorted Aims: Wider consumer choice Technological innovation Effective price competition These are only possible in an environment where: Companies compete rather than collude Dominant companies do not abuse their market power (by restricting entry) Efficiencies are passed on to the final consumers in the form of lower prices and better products

The European Union EU Competition Policy


Main Components of EU Competition Policy:
Antitrust and Cartels Merger Control Market Liberalization State Aid Control Implemented through rules Anti-competitive behaviour & abuse of monopoly power (Articles 81 & 82 in Amsterdam Treaty) Merger Policy

The European Union EU Competition Policy


EU is given exclusive competency; why? Spillovers (negative effects of one Members subsidies on other Members industry) Need belief in fair play if integration is to maintain its political support Note: recent protectionist tendency of Member States to prevent foreign takeovers

Free market v correction of market failure arguments


Commission controls competition policy. It can investigate, declare restrictive agreements by companies or governments void, order parties to terminate them and impose fines and penalties up to 10 percent of the firms worldwide turnover ECJ has the power to confirm, cancel, reduce or increase fines and penalties or to annul Commission decisions Policy not consistently applied

The European Union


Article 101: Anti-Competitive Agreements
Prohibites collusion: intra firm agreements that distort intra EU trade and prevent, restrict or distort competition as they are incompatible with the common market
covers horizontal agreements between the firms in the same industry and vertical agreements between companies along the supply chain Horizontal vs vertical co-operation Explicit prohibitions include price fixing output fixing market sharing agreements (eg sugar cartel 1970s) tied contracts

The European Union


Article 101: Anti-Competitive Agreements
Anti-Cartel instrument dangers of collusion and chance of cartels rise as the number of firms falls If Commission find against agreement firms usually agree to end or modify agreement Com. Issue formal decision fines upto 10% turnover of each firm particularly heavy for cartels Covers foreign firms if intra-EU trade affected Not all inter-company arrangements are illegal, and the Commission may create block exemptions: e.g. exclusive relationship between carmakers and their official distributors.

If Articles 101 and 102 are violated, a firm may end up paying fines amounting up to 10% of its annual turnover. The Commission imposed fines for anticompetitive behavior totaling almost $2 billion

But: Co-operation may be beneficial in some areas such as R&D

The European Union


Article 102: Monopolies, Abuse of Dominance
Anti-monopoly instrument Prohibits abuse of a dominant market position by one or more firms Abuses may take the form of restricting output, price discrimination, unfair pricing and using dominant position in market to limit competition in another market (e.g. Microsoft bundling Windows with Media Player ) Relatively few cases (compared to Article 101)

The European Union Merger Regulations


A firm may reach a dominant position by acquiring a competitor and this may benefit consumers in the form of lower prices, better products etc. (especially when economies of scale effects lead to cost reductions).
But the Commission may block mergers if mergers impede effective competition. Commission wants to ensure SEM gains not eroded by defensive mergers Firms need to get Commission approval before merging. This regulation applies to all transactions with a Community dimension, which in practice typically means those where the combine turnover of the companies exceeds 2.5 billion Euros. Large companies outside the EU but generating at least 100 million euros in terms of annual business in the Community are also subject to the EU merger regulation. Merger Regulation in force only in 1990 Critisims: State intervention, eg national security

The European Union


Article 106: Public Procurement
No anti-competitive behaviour in assigning public supply contracts
Little done until late 1970s Reforms aimed at: financial transparency no discrimination in public procurement allocations Harmonization of standards SEM: Com. intensified policy in energy, telecommunications, transport Difficult to implement resistance from States

The European Union Article 107: State Aid


No trade-distorting aid
to ensure that such measures do not distort competition in the Single Market (e.g. the prohibition of a state grant designed to keep a loss-making firm in business,) Exceptions include key sectors like steel

Aid must be notified by states and authorised by the Comission


Tougher stance since SEM More difficult to investigate State aid for steel producers, the coal industry, farming and aviation-all of which are facing long-term structural problems and an uncertain future.