The Economics of European Integration PDF

Chapter 1 History The Economics of European Integration, Seventh Edition Early Post War Period, 1945-50: death, destruction and upheaval Europe has experienced horrifying wars and was in ruins after WWII: Millions of people died, enormous damage to infrastructure and economic capacity...

Chapter 1 History The Economics of European Integration, Seventh Edition Early Post War Period, 1945-50: death, destruction and upheaval Europe has experienced horrifying wars and was in ruins after WWII: Millions of people died, enormous damage to infrastructure and economic capacity Pictures show London in late 1940 (left) and Dresden in 1945 (right) McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 2 Early Post War Period, 1945-50: A climate for radical change and the prime question Prime concern: ‘How can Europe avoid another war?’ What caused the war? - Three schools of thought, implying three different solutions blame Germany → ‘Neuter’ Germany to avoid any future aggression; blame capitalism → adopt communism; blame nationalism → pursue European integration. → European integration ultimately prevailed, but this was far from clear in the late 1940s. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 3 Early Post War Period, 1945-50: The beginning of the cold war Wartime alliance among the US, UK and USSR rapidly unravelled. Germany was divided into the US, UK, French, and Soviet zones in 1945. Communism spread in Eastern Europa: in Estonia, Latvia, Lithunia during the war, in Albania, East Germany and Romania in 1945, Bulgaria in 1946, Poland in 1947, and Hungary and Czechoslovakia in 1948. America and Britain rejected the Soviet vision and this confrontation lead to the ‘Cold War’. The division ruled European realities for a half century. US suggests Marshall plan for economic recovery. 1948: US, UK and France merged its zones, plans for a new nation – West Germany – began to take shape. Moscow reacted by blocking land traffic to Berlin in June 1948, countered by the airbridge known as the Berlin Airlift. The Federal Republic of Germany and the German Democratic Republic were established in 1949. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 4 Early Post War Period, 1945-50: Marshall Plan Marshall Plan (1948) The USA offered financial assistance if countries agreed on a joint programme for economic reconstruction. Marshall Plan aid amounted to $12 billion, with half of this going to the UK, France and West Germany. The Organisation for European Economic Cooperation (OEEC) administered this aid and prompted trade liberalization: The OEEC (which in 1961 became the OECD) started in 1948 with 13 western members of today’s EU plus Norway, Iceland, Switzerland and Turkey. It advanced European integration, i.e. by removing quotas on intra-OEEC trade and establishing the European Payments Union. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 5 Make Europe not war: ECSC, EEC and EFTA, 1951-60 The German Question: The formation of West Germany was hoped to help with an economic recovery of post-war Europe...... but need to embed Germany in a European supranational structure European Coal and Steel Community (ECSC, 1951): Belgium, France, Germany, Italy, Netherlands, and Luxembourg (the ‘Six’) place their coal and steel sectors under the control of a supranational authority (Schuman Plan) Failed attempts to create the European Defence Community (EDC) and the European Political Community (EPC) European Economic Community (EEC, 1957): riding on the success of the ECSC, the ‘Six’ committed to form a customs union, promise free labour mobility, capital market integration, free trade in services, and a range of common policies EEC meant discrimination against non-EEC Europeans, including OEEC members like Britain McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 6 Make Europe not war: ECSC, EEC and EFTA, 1951-60 European Free Trade Association (EFTA, 1960): tariff reduction without harmonizing external tariffs – a free trade area (FTA) as opposed to EEC, a customs union (CU) Two non-overlapping circles by the late 1960s: McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 7  Make Europe not war: ECSC, EEC and EFTA, 1951-60 The Federalism vs intergovernmentalism schism EEC vs. EFTA - two concepts about the depth of European integration Intergovernmentalism: nations retain all sovereignty, (economic) cooperation only when necessary and agreed upon OEEC and EFTA, but also the Council of Europe (1949) and the Court of Human Rights (1950), unrelated to the European Union Federalism: embed nations in a supranational structure (EEC, EDC, EPC), embodied with some of the powers that had traditionally been exercised exclusively by nations European integration gains economic motivations New view: (trade) liberalization is pro-growth , pro-industrialization Confirmed by spectacular growth in manufacturing, exports and incomes, beginning in the 1950s („Wirtschaftswunder“, „Les Trente Glorieuses“) McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 8 Evolution to two concentric circles While the first years of European Integration had a lot to do with geo- strategic thinking after WWII, this changed with the formation of EEC and EFTA. Falling trade barriers within the EEC and within EFTA (but not between) led to discrimination. The GDP (i.e., potential market size) of the EEC was much larger than that of EFTA (and EEC incomes were growing twice as fast). Thus, the EEC club was far more attractive to exporters and this led to new political pressure for EFTA nations to join the EEC. The UK applied for membership in 1961 and Denmark, Ireland, and Norway also followed. Charles De Gaulle stopped UK membership twice. Denmark, Ireland, and the UK joined in 1973 while Norwegians said no in a referendum. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 9 Evolution to two concentric circles: First enlargement, EEC–EFTA FTAs and the domino effect I Firms based in the remaining EFTA states would suffer a disadvantage EFTA industries pushed their governments to address this situation; Resulted in a set of bilateral free trade agreements (FTAs) between each remaining EFTA nation and the EEC. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 10 Delayed trade integration, accelerated monetary integration: the 1970s Euro-pessimism 1.0: the 1970s Political shocks: ‘Luxembourg Compromise’ + enlargement = decision-making jam; unanimity was the typical rule in EEC decision-making procedures: the insistence on consensus radically reduced the EEC’s ability to make decisions. Economic shocks: Bretton Woods falls apart, 1971-1973; EEC failed to establish monetary union (Werner Plan was put on hold); 1973 and 1979 oil price shocks with stagflation; New trade frictions: ‘technical barriers to trade’ However, also some bright spots: democracy in Spain, Portugal and Greece lead to their accession; EMS set up in 1978 works well. Special role for the Bundesbank. Budget Treaties (1970 and 1975) and direct election of EU Parliament (1979). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 11 Deeper circles and the domino effect part II: the Single Market Programme The Single European Market (SMP) was a powerful boost to European economic integration: Jacques Delors launched completion of the internal market; The Single European Act (SEA, 1987) aimed to create ‘an area without internal frontiers in which the free movement of goods, persons, services, and capital is ensured’ (i.e., the four freedoms already promised by the Treaty of Rome); It also implemented important institutional changes: EEC was renamed the European Community (EC) and European Union (EU) after monetary union was agreed upon in the 1990s majority voting instead on unanimity on issues related to the Single European Market; This change in voting procedures unleashed a massive wave of TBT liberalization and gave a big boost to further trade integration; McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 12 Deeper circles and the domino effect part II: the Single Market Programme Basic elements of the Single Market Programme (SMP): Goods trade liberalization streamlining or elimination of border formalities; harmonization of VAT rates within wide bands; liberalization of government procurement; harmonization and mutual recognition of technical standards in production, packaging, and marketing. Factor trade liberalization removal of all capital controls (which ultimately led to the euro); liberalization of cross-border market-entry policies, including mutual recognition of approval by national regulatory agencies. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 13 Deeper circles and the domino effect part II: the Single Market Programme Dominos again: the EEA and the fourth enlargement ‘Investment diversion’ effect (on top ‘trade diversion’ effect already by customs union). Non-EU governments under pressure to react. The fourth enlargement (1995) adds Austria, Finland, Sweden, and leads to the EC15. Norway, Iceland and Liechtenstein: European Economic Area (EEA, 1989). Accept single market regulations in return for market access, retain sovereignty over non-Single Market issues („Norway Option“). Swiss solution: complicated set of bilateral, EEA-like treaties with the EU. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 14  Reuniting East and West Europe Communism’s creeping failure and spectacular collapse Division of Europe was cemented by the Berlin Wall (1961). By the 1980s, West’s economic system provided a far better way of life and living standards diverged. Up to 1980s, Soviets thwarted reform efforts but inadequacy of Soviet system forced changes in USSR, i.e. pro-market reforms (perestroika) and openness (glasnost). Pro-democracy forces in the central and eastern European countries (CEECs) had been repeatedly put down by military force hereto but found little resistance from Moscow in the late 1980s: June 1989: Polish labour movement ‘Solidarity’ forced free parliamentary elections and communists lost. Moscow accepted new Polish government. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 15 Reuniting East and West Europe Moscow’s hands-off approach to the Polish election triggered a chain of events: Hungary opened its border with Austria and many East Germans moved to West Germany via Hungary and Austria; mass protests in East Germany; Berlin Wall falls 9th November 1989; end of 1989: democracy in Poland, Hungary, Czechoslovakia; end of 1990: German re-unification. End of 1990: independence of Estonia, Latvia, and Lithuania. End of 1991, the USSR itself breaks up. Former Soviet Republics becoming independent nations or merging with Russia. The Cold War ended without a shot and with it, the military division of Europe ends. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 16 Reuniting East and West Europe First steps: the Europe Agreements CEEC announced that their goal was to join the EU At first, no promise of eventual membership was made. but ‘Europe Agreements’ were introduced: free trade agreements with promises of deeper integration and some aid. In 1993, the EU sets the Copenhagen criteria for accession of CEECs: political stability of institutions that guarantee democracy, the rule of law, human rights, and respect for and protection of minorities; a functioning market economy capable of dealing with the competitive pressure and market forces within the Union; acceptance of the Community ‘acquis’ (EU law in its entirety) and the ability to take on the obligations of membership. Copenhagen summit (2002): CEEC nations plus Cyprus and Malta join in 2004 (5th enlargement). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 17 Reuniting East and West Europe Preparing the EU for eastern enlargement Envisaged enlargement required EU to reform its institutions (designed for six members initially). New CEEC-members: Poorer, more agrarian, small populations per member state but in total 300 million more people. The process was politically painful for the existing EU members since almost every change helped some EU15 nations but hurt others. Basic dilemma: while there was a shared understanding of the institutional challenges, there was little agreement on the solutions. Four attempts at reform over a 16-year period: Amsterdam Treaty, 1997; Nice treaty, 2000; (rejected) Constitutional Treaty, 2004; Lisbon Treaty, 2007. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 18 Monetary Union German unification and renewed push for integration Political consensus: accompany German unification with increased European integration. Delors proposes 2nd radical increase in European economic integration: monetary union. Maastricht Treaty (‘Treaty on European Union’) signed 1992: monetary union by 1999, a single currency to put into circulation by 2002. Further elements: EU citizenship; strengthened EU cooperation in non-economic areas (justice, defense etc.); strengthened the power of the European Parliament; introduced the ‘Social Chapter’. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 19 Monetary Union From ratification difficulties to the introduction of the euro Ratification difficulties: Britain opted out of common currency; Danish voters rejected the Treaty and reversed their choice only once Denmark opted out of common currency. Maastricht convergence criteria as entry conditions to enter the monetary union. 4 January 1999: freezing of the exchange rates of 11 countries Establishment of the European System of Central Banks (ESCB) and the European Central Bank (ECB). January 2002: euro banknotes and coins. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 20 Global and Eurozone crises and institutional responses European economic integration during the 1990s and much of the 2000s: Great moderation: growth, low and stable inflation. 15 September 2008 Lehman Brothers, a major US bank, became insolvent, and the US authorities decided to not bail it out. Reconsideration of risk associated with lending to weaker nations in financial markets: interest rates started to diverge between nations like Greece and Germany. Eurozone Crises unfolds: Irish bail out of the Anglo Irish Bank in January 2009, anouncement of higher than thought government debt in Greece in October 2009. Financial markets: fears about nations solvency and the surivival of the euro zone. Several emergency loans and rescue packages by other EU nations and the International Monetary Fund (IMF) to stabilise Greece, Ireland, Portugal and Spain; followed by a massive institutional reform. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 21  Euroscepticism 2.0 Rise of populists’ anti-EU positions, push for more national sovereignty (more intergovernmentalism) from Marie Le Pen (France), Matteo Salvini (Italy), Geert Wilders (Netherlands) and others. Eurosceptic vote shares in national and EU elections, 1992 to 2020: On the other hand: High and rising positive image of the EU by a majority of EU citizens Probable explanations: Economically harsh conditions? Migration shock? McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 22  Brexit 23 June 2016: Should the United Kingdom remain a member of the European Union, or leave the European Union? Remain: 48% Leave: 52% Lack of a plan: how to leave the EU and about the future relationship between an independent UK and the EU and the Single Market. The long, difficult and messy Brexit negotiations Brexit began in 2015 by a political gamble by PM David Cameron, who won the general election but failed to win the promised Brexit-referendum. Theresa May (a remainer) took over as PM, started a 2-year exit clock, called for a general election and lost the conservative majority in Parliament. Key problem in Brexit negotiations: Avoiding a hard border between Northern Ireland and the Republic of Ireland, that is a member state of the EU and part of the Single Market. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 23  Brexit The three options for the Northern Ireland Protocol, none of them accepted by the EU, the UK and Northern Ireland. After many failed attempts to find a fourth option, a general election in 2019 and after Boris Johnson became Prime Minister, extended deadlines - the UK left the Single Market and EU Customs Union in January 2021. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 24  COVID19 pandemic & European Green Deal The COVID19 pandemic cost (and continues to cost) many lives and affected the health of many. The impact on economies worldwide were also enormous. The measures taken to contain the pandemic, which consisted in the beginning mainly of restricting physical contact, led to a recession and a resurgence of national unilateralism (not only) in Europe. But co-operation within the EU also played an important role, e.g. in vaccine procurement or through a recovery fund "NextGenerationEU", which for the first time is fundeded by borrowing by the EU itself. European Green Deal: Spending plan 2021-2027 shifts EU priorities toward climate change issues. Carbon neutrality by 2050 as a legally binding obligation, goal of 55 percent lower emissions in 2030. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition” 25 Chapter 2 Facts, law, institutions and the budget The Economics of European Integration, Seventh Edition Economic integration in the EU Treaty of Rome The Treaty of Rome was a far-reaching document: it laid out virtually every aspect of the economic integration implemented up to the 1992 Maastricht Treaty. Radical Thinking: Economic integration as the way to a politically unified Europa, an “Ever Closer Union” The Treaty of Rome was re-labelled as the “Treaty on the Functioning of the European Union (TFEU)” by the 2009 Lisbon Treaty. The Treaty’s intention was to create a unified economic area = an area where firms and consumers located anywhere in the area would have equal opportunities to sell or buy goods throughout the area, and where owners of labour and capital would be free to employ their resources in any economic activity anywhere in the area. Key element: 4 freedoms - free movement in goods, service, workers and capital McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 2 Main elements of the Treaty of Rome Free trade in goods: eliminate tariffs, quotas, and all other trade barriers (!) Common trade policy with the rest of the world: Customs Union and Common commercial policy to avoid trade deflection (‘tariff cheating’). Ensuring undistorted competition (to avoid ‘deals’ that offset trade barrier removal): state aids (subsidies) are mostly prohibited; anti-competitive behaviour regulated by Commission; approximation of laws (EU-jargon for harmonization of standards and regulations) – really started with the Single European Act 1986; taxes (weak restrictions but no explicit harmonization). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 3 Main elements of the Treaty of Rome Unrestricted trade in services: principle of freedom of movement of services, but implementation has been and still is hard. free movement of workers (Lisbon Treaty: of people); free movement of capital in principle = “Rights of Establishment” and no restrictions on financial capital flows. Very little capital- market liberalization until the 1980s. Exchange rate and macroeconomic coordination. Common policy in agriculture: because the competitiveness of the six farm sectors differed massively; set up in 1962, agriculture was much more important than it is today. However, still 1/3 of EU budget is devoted to agriculture. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 4 Omitted elements of the Treaty of Rome The Treaty of Rome was silent with respect to some important policy areas: Social and Tax policies. Social policy (wage policies, working hours, social benefits, …): harmonization is very difficult politically: nations have very different opinions on what types of social policies should be dictated by the government; Two schools of thought about whether there is a need to harmonize. like social policies, tax policy directly touches the lives of most citizens, and it is the outcome of a national political compromise. Thus, EU leaders have always found it difficult to harmonize taxes. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 5 EU architecture The organizational structure of the EU has undergone many changes, but is now pretty simple: Most economic-related policies and some of the judicial and police related policies are under the ‘supranational pillar’ (individual member states might be outvoted and must still implement the policy). Policies related to foreign and security policy are under an ‘intergovernmental pillar’ where each member must agree to a specific proposal if the EU is to take action. Supranationality arises in the EU in three ways: The commission proposes new laws that are then voted on by member states (in the Council of Ministers) and the European Parliament. If passed, they are binding for all member states. The commission has direct executive authority in a limited number of areas (i.e. competition) Rulings by the European Court of Justice can alter laws, rules and practices in member states (in some areas) McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 6 EU architecture: TEU and TFEU The EU as of the 2020s is based on two treaties (both updated and renamed versions of earlier treaties): Treaty on the Functioning of the EU (TFEU). Started life in 1958 as the Treaty of Rome, updated by the 1993 Maastricht Treaty and the Lisbon Treaty. Treaty on the European Union (TEU). Started life as the 1993 Maastricht Treaty. The Lisbon Treaty changed its content McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 7 EU law A unified economic area requires a legal system. Disputes over interpretation and conflicts among various laws are inevitable. By the standards of every other international organization in the world, the European legal system is extremely supranational, mainly because of the EU’s Court of Justice right to rule on matters concerning the interpretation of EU law. ‘deep supranationality’ does not apply to all areas, but the default is that applies to all areas except those that are explicitly excluded. The discussion about legal supremacy (also called legal primacy, or legal precedence) was a critical issue in the arguments made by pro-Brexit politicians in London, is a key part of why Switzerland has stayed out of the EU, and more recently it has hit the headlines when Poland’s constitutional court explicitly challenged the principle in October 2021. Since the EU lacks a constitution, the EU’s legal system is created via case law, based on rulings by the Court of Justice. Three principles of EU’s legal system: 1) ‘direct effect’ of EU law, 2) ‘Primacy of EU law’, and 3) ‘autonomy’ from national legal systems. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 8 EU law Main principles: direct effect: EU law can create rights which EU citizens can rely upon when they go before their domestic courts; primacy: Community law has the final say (e.g., highest French court can be overruled) so that it cannot be altered by national, regional or local laws in any member state; autonomy: system is independent of members’ legal orders. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 9 The ‘Big-5’ institutions There are many EU institutions, but the core ones are the ‘Big-5’. They have changed by each new treaty. Using the current names as defined in the Lisbon Treaty, these are: 1. European Council (heads of state and governments); 2. Council of the European Union (member nations’ ministers), [still often called by its old name, the Council of Ministers]; 3. European Commission (appointed eurocrats); 4. European Parliament (directly elected); 5. EU Court (appointed judges). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 10 The ‘Big-5’ institutions McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 11 The European Council The European Council is the highest political-level body in the EU: it provides political guidance at the highest level (i.e., it initiates the most important EU initiatives and policies). All EU major strategic choices are made by the European Council. It usually takes decisions by consensus, so its decisions have the implicit backing of every EU national leader. One peculiarity of the EU is that the most powerful body by far – the European Council – has no formal role in EU law-making. It consists of the leaders of each Member State, the President of the European Council and the President of the European Commission. To facilitate cooperation with other EU bodies, the President of the European Commission, and the High Representative of the Union for Foreign Affairs and Security Policy attend the meetings but do not vote. The Lisbon Treaty created the ‘President of the European Council’ who chairs the European Council for two and a half years and is selected by qualified-majority voting in the European Council. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 12 The Council of the European Union The Council of the EU is the EU’s main decision-making body. It was called the Council of Ministers for most of the EU’s history today is often just called ‘the Council’. Almost every piece of legislation is subject to its approval. It consists of one representative from each EU member authorized to commit its government to Council decisions, so Council members are the government ministers responsible for the relevant area. It uses different names according to the issue discussed: e.g., EcoFin for financial and budget issues, the Agriculture Council for CAP issues, General Affairs Council for foreign policy issues. The Council is where the Member States’ governments assert their influence directly. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 13  The Council of the European Union The Council is responsible for certain supranational areas; it has the following powers: to pass European laws (jointly with the European Parliament); to coordinate the general economic policies of the Member States in the context of the Economic and Monetary Union (EMU); to pass final judgment on international agreements between the EU and other countries or international organizations (a power it shares with the European Parliament); to approve the EU’s budget (jointly with the European Parliament). In addition to these tasks linked to economic integration, the Council takes the decisions related to Common Foreign and Security Policies. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 14 The Council of the European Union The Council has two main decision-making rules: unanimity: for most important issues (e.g., Treaty changes, accession of new members and setting the multi-year budget plan); ‘qualified majority voting’ (QMV): for most issues (about 80% of all Council decisions). The High Representative of the Union for Foreign Affairs and Security Policy is a new post created by the Lisbon Treaty. Previously, leadership and representation of EU policy on Common Foreign and Security Policy were divided between the Council of Ministers and the European Commission. Lisbon merged the two positions so that the new High Representative attends both Council and Commission meetings. The Lisbon Treaty also created the European External Action Service to assist the High Representative. This is a new organization; its roles and form are still evolving. Its most obvious manifestation is the EU Delegations (something like an embassy) in about 150 non-EU nations. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 15  The European Commission The European Commission is the executive branch of the EU. It enforces the Treaties and is driving forward European integration: it proposes legislation to the Council and Parliament; it administers and implements EU policies; it provides surveillance and enforcement of EU law in coordination with the EU Court. It represents the EU at some international negotiations (e.g., WTO). However, the Commission’s negotiating stances at such meetings are closely monitored by EU members. The Commission is made up of one Commissioner from each EU member (including the President and two Vice-Presidents). Commissioners are appointed all together and serve for five years. Commissioners are not supposed to act as national representatives. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 16  The European Commission executive branch of the EU + in charge of safeguarding the Treaties Three main roles: 1. To propose legislation to the Council and Parliament, usually based on general guidelines established by the Council of Ministers, the European Council, the Parliament or the Treaties 2. To administer and implement EU policies 3. To provide surveillance and enforcement of EU law in coordination with the EU Court. Commissioners are chosen by their own national governments and approved by the European Parliament. They are in charge of a specific area of EU policy, equivalent to a national ministry called Directorates-General (DGs). The Commission has a great deal of independence and often takes views that differ substantially from the Member States, the Council and the Parliament. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 17  The European Commission The Commission is the executive in all of the EU’s endeavours, but its power is most obvious in competition policy. One of the key responsibilities of the Commission is to manage the EU budget, subject to supervision by the EU Court of Auditors. The Commission decides, in principle, on the basis of a simple majority: almost all of its decision are on the basis of consensus. The reason for consensus is that the Commission usually has to get its actions approved by the Council and the Parliament: a decision that does not attract the support of a substantial majority of the Commissioners will almost surely fail in the Council and/or Parliament. However, it is ultimately answerable to the European Parliament since the Parliament can dismiss the Commission. The Commission as a whole, employs about 32,000 people (which is less than the administration of major cities like Vienna). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 18 The European Parliament The European Parliament has two main tasks: sharing legislative powers with the Council of Ministers and the Commission; overseeing EU institutions, especially the Commission. The Lisbon Treaty boosted the power of the European Parliament substantially, making it equal to the Council on most types of EU legislation (i.e., noteworthy are the Parliament’s new powers over the budget). Organization: about 705 members (MEPs) directly elected; number per nation varies with population but is less than proportional; MEPs physically sit left-to-right, not along national lines, organized in groups. Centre-left + Centre-right around 2/3 of all seats. Location(s): It is located in Strasbourg (owing to France’s insistence); Parliament’s secretariat is in Luxembourg; It also has offices in Brussels (this is where the various Parliamentary committees meet). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 19 Court of Justice of the European Union EU laws and decisions are open to interpretation that may lead to disputes that cannot be settled by negotiation. The role of the Court of Justice (often known by its pre-Lisbon Treaty name, the European Court of Justice, or the ‘EU Court’) is to settle these disputes (between member states, between the EU and member states, between EU institutions, and between individuals and the EU). Judges are appointed by common accord of the Member States’ governments. Organization: located in Luxembourg; one judge from each member appointed for six years; also, eight ‘advocates-general’ to help judges; Court reaches its decisions by majority voting. Court of First Instance set up in the 1980s to help with growing workload. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 20  Legislative processes The European Commission has a near-monopoly on initiating the EU law-making process: right of initiative allows the Commission a good deal of power over which new legislation gets considered. Once developed, the Commission’s proposal is sent to the Council for approval. Most EU legislations also require the European Parliament’s approval (exact procedure depends upon the issue). Procedures: ‘ordinary legislative procedure’: main one (but complex) and gives the Parliament and the Council equal power in terms of approval/rejection and amendment; ‘consultation procedure’: only Parliament gives opinion; ‘consent procedure’: Council adopts legislation (proposed by the Commission) after obtaining the consent (without amendments) of Parliament. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 21  The ordinary legislative procedure McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 22 Legislative processes: national parliaments and enhance cooperation National Parliaments: under the so-called ‘subsidiarity principle’, policy should be made at the level that is as close as practical to the people affected. ‘Yellow card’ procedure: national parliaments have the right to express concerns on subsidiarity directly to the institution that initiated the proposed legislation. ‘Orange card’ procedure: if a majority of national parliaments vote against a proposed law, the Commission must review it. Enhanced cooperation: under strict conditions, subgroups of EU members are allowed to cooperate on specific areas while still keeping the cooperation under the general framework of the EU. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 23 Some important facts: population and per capita income (PPS, 2019) McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 24 Size distribution of EU member countries The size distribution of European economies is very uneven, measuring economic size with total GDP. Just six nations, the ‘Big-5’ (Germany, France, Italy, Spain and - pre- Brexit, the UK) and the Netherlands, account for about 75 per cent of the GDP of the whole EU. ‘Small’ economies: account for between 1 and 3 per cent of the EU27’s output. This includes Sweden, Poland, Belgium, Austria, Ireland, Denmark, Finland, Portugal, the Czech Republic, Romania and Greece. ‘Tiny’ economies: account for less than 1 per cent of the total. These nations are Hungary, Slovakia, Luxembourg, Bulgaria, Croatia, Slovenia and Lithuania. ‘Minuscule’: ones that accounts for less than two-tenths of 1 per cent. The countries in this category are Latvia, Estonia, Malta, and Cyprus. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 25 The EU budget The budget is no longer just handing euros to farmers and poor regions New topics: fighting climate change, transition to a more digital economy, promoting resilience in anticipation of shocks 2021-2027 long-term budget + ‘Next Generation EU (NGEU)’. Increased budget and new spending priorities McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 26 The EU budget: EU spending plan by broad theme, 2021-27 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 27 The EU budget: EU spending by member and type, 2020 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 28 The EU budget: Revenue The EU’s budget must, by law, be balanced every year. All spending must be financed each year by revenues collected from EU members Each EU member pays a bit less than 1 per cent of their GDP Major revenue sources: 1) tariff revenue from the Common External Tariff, 2) Budget contribution as share of national income, 2019: McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 29 Chapter 3 Decision making The Economics of European Integration, Seventh Edition EU decision-making Two main questions: 1. Who should be in charge of what? That is, which decisions should be taken at the EU level and which should be taken at the national or subnational levels? Debates about subsidiarity and the appropriate division of powers is a constant issue since the late 1940s. Brexit, as it was essentially about ‘taking back control’ is a recent example In principle, this problem also exists within nations. 2. Is the EU-level decision-making procedure efficient and legitimate? McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 2 Task allocation and subsidiarity: EU practice and principles Task allocation = ‘competencies’ in EU jargon ‘exclusive competences’: EU decides alone; ‘shared competences’: responsibility shared between the EU and Member States; two types: members cannot pass legislation in areas where the EU already has; existence of EU legislation does not hinder members’ rights to make policy in the same area; ‘supporting, coordinating or complementary competence’: EU can pass laws that support action by members; ‘national competences’: national or sub-national governments alone decide. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 3  Task allocation: the ‘competences’ Support, coordinate Exclusive Shared or supplement Protection and improvement of Customs union Internal market human health Competition policy linked to the Social policy (as defined in the TFEU) Industry internal market Monetary policy for Eurozone Regional policy Culture countries Conservation of marine biological Agriculture and fisheries Tourism resources (common fisheries policy) Education, vocational training, Common commercial policy Environment youth, and sports Conclusion of international agreements (under certain Consumer protection Civil protection conditions) Transport Administrative cooperation Trans-European networks Energy Area of freedom, security and justice Research, technological development, space Development coop. & humanitarian aid McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 4 Task allocation: subsidiarity and proportionality ‘Principle of conferral’, that is, the default option is that competences remain with the members. The ‘burden of proof’ lies on the instigators of EU legislation: they must make the case that there is a real need for common rules and common action. National parliaments are ‘subsidiarity watchdogs’. The allocation of tasks is guided by two principles: Subsidiarity: keep decisions as close to the citizens as possible without jeopardizing win–win cooperation at the EU level (i.e., EU action is required only if it is more effective than action at national, regional, or local level). Proportionality: when EU action is necessary, the EU should undertake only the minimum necessary actions. Flexibility clause: there are situations when a new challenge – one not foreseen in the Treaties – arises that requires action at the EU level. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 5 Understanding the task allocation: the theory of fiscal federalism Optimal allocation of tasks depends on 5 trade-offs: (1) diversity and local informational advantages: if people have different preferences, centralized decisions create inefficiencies; A centrally chosen policy will typically be a compromise and therefore not the right policy for everybody. Local governments might find it easier to acquire all necessary information. (2) scale economies: cost savings from centralization; Per-person cost of a service might fall as more people use the service. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 6 Understanding the task allocation: the theory of fiscal federalism (3) spillovers: negative and positive externalities of local decisions argue for centralization (or, at least, cooperation); Spillover is an economic side-effect, known in economics jargon as an ‘externality’. Positive spillovers: a slightly higher level of a particular policy or public service in one region benefits citizens in other regions. Negative spillovers: when one region’s policy has a negative effect on other regions. The existence of significant spillovers suggests that decisions made locally may be suboptimal for the nation (or EU) as a whole. The pure existence of spillovers, however, does not force centralization: may take account of the spillovers via cooperation among lower-level governments; big differences in preferences. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 7 Understanding the task allocation: the theory of fiscal federalism (4) Democracy as a control mechanism that favours decentralization; If policy is in the hands of local officials and these are elected, then citizens’ votes have more precise control over what politicians do. High level elections are take-it-over-leave-it for many issues since only a handful of choices between ‘promise packages’ and many issues. This logic is important: it underpins the basic presumption that decisions should be made at the lowest practical level of government (i.e., as close to the voters as possible). (5) jurisdictional competition: ‘exit’ option is a way to influence governments. The fact that people can move (e.g., between regions) forces decision makers to pay closer attention to the wishes of the people. This favours decentralization because if all decisions are centralized, voters will not have the ‘exit’ option. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 8 Economic view of decision-making: QMV EU has several different decision-making procedures. But about 80% of EU legislation is passed under the ‘ordinary legislative procedure’: the Council adopts legislation by a ‘qualified majority voting’ (QMV). The QMV rules governing Council voting were set out in the Lisbon Treaty. They are based on the notion of a ‘double majority’: that is, to pass, a proposal must (1) pass a threshold in terms of the number of nations voting ‘yes’, and; (2) have the population share of the yes voters. The result is a double majority in the sense that a sufficiently large share of EU nations, who represent a sufficiently large share of EU citizens, must approve. The number-of-members threshold is 55 per cent; the share-of- population threshold is 65 per cent. The European Parliament, by contrast, adopts laws by a simple majority: the usual 50 per cent majority threshold with one vote per member of Parliament. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 9 Economic view of decision-making: voting weights Member‘s voting weight under the double majority QMV system: McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 10 Economic view of decision-making: EU ability to act and decision-making efficiency In economics, efficiency means an absence of waste. In EU decision- making, efficiency means ‘ability to act’. The perfect measure of efficiency would predict all possible issues to be voted; decide how members would form coalitions; and use this to develop an average measure of how easy it is to get things done in the EU. Such predictions, of course, are impossible! Instead, ‘passage probability’ measures how easy it is to find a majority under a given voting scheme (for a randomly selected issue): Passage probability = number of possible winning coalitions number of possible coalitions McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 11 Economic view of decision-making: Passage probability in a simple example (3 Countries) McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 12 The distribution of power among EU members No perfect measures available for distribution of power (i.e., influence) among EU members: Most direct and intuitive measure is national voting shares in the Council, but it has severe shortcomings: Suppose there are only three countries – A, B and C – and they have 40, 40 and 20 votes, respectively. Decisions are based on a simple majority rule (+50 per cent to win). If we used voting weights as a measure of power, we would say that countries A and B, each with their 40 votes, were twice as powerful as C with its 20 votes. → But this is wrong! Instead, all three nations are equally powerful in this toy Council. The point is that any winning coalition requires two nations, but any two nations will do. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 13 The distribution of power among EU members: The ‘Normalized Banzhaf Index’ (NBI) NBI = probability of making or breaking a winning coalition Example: Countries A, B and C – and they have 20, 5 and 5 votes, respectively (i.e., #2 from Table 3.2). Assume a 70 per cent majority threshold, so winning takes 21 votes. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 14 The distribution of power among EU members: Power shifts from Brexit When the UK leaves, the power shares of all remaining nations will change since both the population-shares and the member-shares will change for everyone. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 15 Legitimacy in EU decision-making The EU is a truly unique organization. Nowhere else in the world has so much national sovereignty been transferred to a supranational body. Thus, an important consideration is given to the democratic legitimacy of the EU’s decision-making process. Equal power per citizen is, thus, a natural legitimacy principle. But what constitutes a citizen - nations or people? NBI is a measure of ‘power per person’ and ‘power per nation’. ‘Power per nation’: each EU member should get 1/28th (1/27th) of the power. ‘Power per person’: each EU citizen has equal power regardless of nationality. Lisbon Treaty’s ‘double majority voting rules’ achieve a balance between the ‘union of states’ and ‘union of peoples’ perspective. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Sixth Edition" 16 Chapter 4 Essential microeconomic tools and tariff analysis The Economics of European Integration, Seventh Edition Essential microeconomic tools an tariff analysis Simplifying assumption 1: Simplifying assumption 2: Firms are assumed to behave There are no scale economies ‘perfectly competitive’ = per unit cost does NOT fall as = they take prices they observe as firms produce more units given = they believe they don‘t have an impact on prices = the believe they can sell as much as they want at market prices These assumptions will later on be relaxed... McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 2 Preliminaries I: supply and demand diagrams Demand curve It shows how much of a particular good consumers would buy at any particular price. It is based on optimization exercise: Would one more unit be worth (marginal utility) its price? marginal utility: the money value of consuming one more unit (happiness) Market demand is aggregated (horizontal sum) over all consumers’ demand curves. P* = c* Taken from Figure 4.1 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 3 Preliminaries I: supply and demand Supply curve It shows how much a typical firm would offer to the market at a given price. It is based on optimization exercise: Would selling one more unit increase profit? Marginal cost: extra cost involved in making one more unit of a good Market supply is aggregated (horizontal sum) over all firms’ supply curves. p* = q* Taken from Figure 4.1 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 4 Welfare analysis: consumer and producer surplus Since demand curve is based on marginal utility and supply curve is based on marginal cost, they can be used to show how consumers and firms are affected by price changes. Difference between marginal utility of a unit and price paid shows the surplus consumers obtain from being able to buy c* units at p*. If units are finely defined, consumer surplus is the triangle between demand curve and price paid. Difference between marginal cost of a unit and price received shows the surplus producers obtains from being able to sell c* units at p*. If units are finely defined, producer surplus is the triangle between marginal cost curve and price received. Notice that a price rise increases producer surplus and decreases consumer surplus. A price drop does the opposite. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 5 Welfare analysis: consumer and producer surplus McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 6 Preliminaries II: import demand curve Open-economy supply and demand diagram is essential for understanding the effects of European economic integration. Import demand curve MDH: can be derived from national demand and supply curves; it represents how much a nation would import for any given domestic price; it presumes imports and domestic production are perfect substitutes; imports equal the gap between domestic consumption and domestic production. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 7 Preliminaries II: import demand curve McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 8 Preliminaries II: import demand curve What happens if price increases from P′ to P′′? The previous graph shows that: consumer surplus decreases by A + B + C + D; producer surplus increases by A; country net loss is B + C + D = C + E. Notice that: area C is the border price effect = higher price for imported units; area E (= B + D) is the import volume effect = loss from drop in imports. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 9 Preliminaries II: export supply curve Export supply curve XSH (from perspective of foreign countries) = import supply curve MSH (both labels can be used). It represents how much foreign countries would export for any given domestic price. Is derived from foreign demand and supply curves. What happens if export price increases from P′ to P′′? The following graph shows that: consumer surplus decreases by A + B; producer surplus of foreign firms increases by A + B + C + D + E; foreign country net gain is C + D + E = D + F. Notice that: area D is the border price effect = higher price for exported units; area F (= C + E) is the trade volume effect = gain from increase in exports. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 10 Preliminaries II: export supply curve McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 11 Preliminaries II: The workhorse MD-MS diagram Import supply curve and import demand curve allow us to find equilibrium price and quantity of imports: free trade price PFT and volume of imports. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 12 MFN tariff analysis What is the effect of the introduction of a tariff of T euros per unit? Work out how the tariff changes the MD–MS diagram: introduction of tariff has no effect on MD; introduction of tariff shifts MS curve up by T: exporters would need a domestic price that is T higher to offer the same exports since they earn the domestic price minus T. New equilibrium: home price rises to P′; the border price (i.e., the price Home pays) falls to P′ – T; this also means that the price received by Foreigners falls to P′ – T; the Home import volume falls to M′. Moreover, the higher domestic price stimulates production and discourages consumption (not visible in this graph). Home production rises; Home consumption falls. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 13 MFN tariff analysis McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 14 Welfare effects of a tariff HOME +L -K FOREIGN -L -M WORLD LOSS McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 15  Welfare effects of a tariff The MFN tariff raises the Home price of the good (to P′) while lowering the border price (to P′ − T): Home consumers lose A + B + C + D; Home producers gain A; Home government gains tariff revenue C + E; net Home welfare effect is E − B − D, positive or negative depending upon the size of the tariff. Foreign country welfare effects: Foreign consumers gain F; Foreign firms lose F + G + H + I; net Foreign welfare effects is −G − H − I (negative regardless of the tariff size). A useful condensation (using the area labels in the center panel) Home’s welfare changes by +L − K; Foreign welfare changes by −L − M; World welfare falls by −K − M. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 16  Tariffs as a tax on foreigners A tariff might make the Home country better or worse off: there are two parts of Home’s net welfare impact, namely L − K; area L is the border price effect (i.e., gain from paying less for imports); area K is the trade volume effect (i.e., impact of lowering imports). In other words, area L represents Home’s gain from taxing foreigners while area K represents an efficiency loss from the tariff. If T raises Home welfare, the tariff allows the Home government to indirectly tax foreigners enough to offset the tariff’s inefficiency effects on the Home economy. Retaliation needs to be considered: if Home and Foreign were symmetric and both imposed tariffs, both would lose the efficiency triangle K and the gain to Home of L on imports would be lost to Home on its exports to Foreign; Home would also lose the deadweight triangle M on exports, so the net loss to each of the symmetric nations would be −K − M. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 17  Economic justice and efficiency The analysis above: overall gains for the economy (efficiency) and distribution of the gains and losses. No discussion of the impact of the tariff on economic justice, or inequality. Inequality rose substantially in many nations during the process of economic integration and liberalization. Income inequality has risen since 1980 in English-speaking nations but less so in Continental nations. Inequality is not an inevitable outcome of European economic integration McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 18  Analysis of Global Value Chains (GVCs) GVCs: supply chains that cross borders. Some parts of the final product are imported instead of being made locally. Formal analysis: assume that there is only one part, and we call it Y, and there is one final good, called Z (Y comes before Z); one unit of Y is required for each unit of Z; need to add the cost of the part, Y, to the cost of making Z from Y (MCZ). When no imports of parts are possible, the price of part will be where the supply and demand for Y meet, namely at PY. The supply curve for Z is the vertical sum of MCZ and the price of Y, so the supply curve for Z is SZ as shown in the right-hand diagram. If PWZ is the world market price of final goods: QZ (=QY) is home production of final goods (and part) and MZ are the imports. When parts can be imported: Suppose import price is PPY → marginal cost of making Z will fall (dashed line). S’Z is new supply curve: increase in production of final good and country may become an exporter of final good. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 19 Analysis of Global Value Chains (GVCs) McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 20 Types of protection A tariff allows the Home government to indirectly collect the ‘profit’: this is referred to as a ‘rent’. Different trade barriers lead to different rents. Several ways exist to categorize trade barriers. The following focus on trade rents: DCR (domestically captured rents) like tariffs, import licenses; FCR (foreign captured rents) like price undertakings, export taxes; frictional (no rents since barriers involve real costs of importing and exporting) like regulations and red-tape. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 21 Types of protection T: Tariff equivalent of a NTB Net Home welfare changes for: DCR = B − C; FCR = −A − C. Net Foreign welfare changes for: DCR = −B − D; FCR = A − D. Note: foreign may gain from FCR. Taken from Figure 4.9 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 22 Sources of competitiveness differences Comparative advantage analysis starts with a sector-by-sector comparison of the competitiveness of individual nations. Example of comparative advantage – price ratio as a measure of competitiveness 7 7 7 7 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 23 Sources of competitiveness differences McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 24 Intra-industry trade In previous examples, a country either exports the good or imports the good (inter-industry trade). This, however, is not the main type of trade in Europe; instead, intra- industry trade matters more: For example, Italy exports cars to France (Fiats) and France exports cars to Italy (Renaults). This back-and-forth trade is technically known as intra-industry trade. Goods traded are not identical (‘product differentiation’). → Previous diagrams are for very specific goods. Existence of economies of scale (precise effects will be considered in chapter 6: ‘Market size and scale effects’). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 25 Chapter 5 The essential economics of preferential liberalization The Economics of European Integration, Seventh Edition Analysis of unilateral discriminatory liberalization Preferential (discriminatory) liberalization is the heart and soul of European economic integration Simplest form: unilateral trade liberalization – one nation removes its tariff on imports from only one of its trading partner 3 basic elements needed to understand preferential liberalization or regional trade arrangement (RTA): ‘Smith’s certitude’ by Adam Smith: foreign firms gain (i.e., higher price and more exports) when tariffs against them are eliminated; ‘Haberler’s spillover’ by Gottfried Haberler: third nations – those excluded from the preferences – must lose; ‘Viner’s ambiguity’ by Jacob Viner: preferential liberalization might harm the preference-giving nation because discriminatory liberalization is both ‘liberalization’ – which removes some price wedges and thus tends to improve economic efficiency and Home welfare – and ‘discrimination’ – which introduces new price wedges and thus tends to harm efficiency and welfare. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 2 The RTA diagram McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 3 The RTA diagram Diagrams analyzing preferential liberalization are complex since they require at least 3 nations in the analysis (Home, Partner, and RoW). Extend workhorse MD–MS diagram to allow for 2 sources of imports: aggregate (i.e., horizontal sum) export supply curves of two sources (Partner and RoW); free trade equilibrium at intersection of MS and MD; level of imports from two sources read from each supplier’s graph. What happens when Home imposes a tariff T on all imports? MS curve shifts up by T and no change in MD; new intersection shows the post-tariff equilibrium domestic price for imports and new import level; with this border price, both import suppliers supply less. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 4 Discriminatory liberalization McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 5 Discriminatory liberalization What happens when Home removes tariff T only from Partner? MS curve shifts down but only halfway between MS (free trade) and MSMFN because liberalization affects only half imports; kinked MS curve with PTA, for low enough prices where only Partner country is exporting. New equilibrium: new domestic price is lower; Partner-based firms see border price rise, P′ – T to P′′; RoW firms see border price fall from P′ – T to P′′ – T; RoW exports fall, Partner exports rise more than RoW exports fall, so domestic imports rise (supply switching). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 6 Supply-switching effects of EEC customs union McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 7 Welfare effects What happens when Home removes tariff T only from Partner? Home’s welfare changes by (A + B – C), positive or negative (Viner’s ambiguity); Partner gains area D (Smith’s certitude); RoW loses area E (Haberler’s spillover). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 8 Excursus: Home welfare effects in more detail DCS = D + A1 + A2 + A3; DPS = -D; Dtariff revenue = B – A1 – C. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 9 Analysis of a customs union European integration involved a sequence of preferential liberalizations but all reciprocal = both Home and Partner eliminate T on each other’s exports. Assume that three goods are traded (goods 1, 2, and 3). Each country produces all three goods, but cost structures are such that each nation exports two of the three goods while importing the remaining one: McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 10 Analysis of a customs union McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 11 Analysis of a customs union Price and quantity effects: impact of Home’s discriminatory liberalization is as seen before; impact of Partner’s discriminatory liberalization of imports of good 2 from Home can also be seen using the same diagram but with change in perspective: → price of good 2 in Partner falls from P′ to P′′ but border price for Home exporters when they sell good 2 to Partner rises from P′ – T to P′′. No change to domestic prices in RoW since they did not liberalize, but RoW exporters face a lower border price for their exports to Partner. Welfare effects: a matter of adding up effects that have been illustrated before. On Home’s import side (i.e. in the market for good 1), Home gains the usual A + B − C. On Home’s export market (good 2), Home’s situation is shown in the left-hand panel, so it gains area D. The welfare effects on Partner are identical to this, as a result of the assumed symmetry of goods and nations. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 12 Analysis of a CU: welfare effects in detail The trade price loss associated with area C is here split into two parts, C1 and C2 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 13 Customs unions versus free trade agreements A free trade agreement (FTA) is like a customs union (CU) but without a common external tariff. This situation prompts ‘tariff cheats’: goods from RoW destined for Home market enter via Partner if Partner has lower external tariff = ‘trade deflection’. The solution is ‘rules of origin’ meant to establish where a good was made. However, such rules are difficult and expensive to administer, especially as world get more integrated. They often become a form of disguised protection. Still, almost all preferential trade arrangements in world are FTAs because CUs require some political integration. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 14 Frictional barriers: the Single Market Since the mid-1970s and especially since the 1986 Single European Act, most economic integration in Europe has involved the removal of ‘frictional’ barriers to trade. Still, frictional barriers can be conceptualized as tariffs where the tariff revenue is thrown away. For such barriers, Smith’s certitude and Haberler’s spillover still hold, but Viner’s ambiguity disappears. Reciprocal preferential frictional barrier liberalization leads to: lower Home’s domestic and border price; higher price received by Partner exporters and lower price received by RoW exporters. Thus, Home imports rise and Partner exports rise while RoW exports fall. Supply switching still occurs. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 15 Frictional barriers: price and quantity effects Reciprocal, preferential frictional barrier The quantity effects follow from the price liberalization: changes. Namely: Lowers Home’s domestic price from P′ to P″; Home imports rise from M′ to M″. lowers Home’s border price from P′ to P″; Partner exports rise from X P ′ to X P ″. raises the price received by Partner exporters from P″ – T RoW exports fall from X R ′ to X R ″. to P″; Combining the last two, we see that supply switching still lowers the price received by RoW exporters from P′ – T to occurs. P″ – T. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 16 Frictional barriers: welfare effects The overall welfare effect of the reciprocal, preferential frictional barrier liberalization FTA is +D + F + A for Home, and the same for Foreign by symmetry. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 17 ‘Deep’ trade arrangements EU external trade liberalization is proceeding by focusing on ‘beyond- tariff’ issues: Single Market reforms. Regional integration initiatives that go beyond mere tariff cutting are called ‘deep’ trade agreements. Large trade effects of the Euro. EU–Canada Comprehensive Economic and Trade Agreement, or CETA for short, is an example in which EU itself enters an deep trade arrangement. Empirically, for those arrangements, the trade creation effect is much larger than the trade diversion effect for most industrial goods. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 18 WTO rules A basic principle of the WTO/GATT is non-discrimination in application of tariffs. FTAs and CUs violate this principle. However, Article 24 permits FTAs and CUs subject to conditions: substantially all trade must be covered; intra-bloc tariffs must go to zero within reasonable period; in case of CU, the common external tariff must not on average be higher than the external tariffs of the CU members were before: in EEC, the CU meant that France and Italy lowered their tariffs, Benelux nations raised theirs while German tariffs were about at the average. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 19 Annex: Small Country Case McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 20  Annex: Small Country Case ‘Small country’ means ignoring the price effects on all foreign nations. Means that the import supply curve (MS) is horizontal, so the world price never changes. Country A producers are more efficient since they can offer the goods at a lower price. Suppose that Home initially imposes a tariff of T on imports from A and B. That is, importing from A costs Home consumers PA + T, while importing from B costs PB + T. All imports initially come from the cheaper supplier, namely, A. Next, we ask what would happen if the tariff were removed on a discriminatory basis: First case: the liberalization is applied to Home’s current trading partner (low- cost country) A: TS1 → TS3. Second case: preferential trade arrangement is signed with the high-cost country B: TS1 → TS2. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 21 Annex: Small Country Case First case: the liberalization is applied to Home’s current trading partner (low-cost country) A: TS1 → TS3 The price in the Home market of both imports and Home import-competing goods falls to PA. Home production falls from Q3 to Q1. Home consumption rises from Q4 to Q6. The import volume rises from the difference between Q3 and Q4 to the difference between Q1 and Q6. The border price (i.e. the price of imported goods before the imposition of the tax) remains unchanged at PA. Welfare: Consumer surplus rises by the sum of all areas, A through J. Producer surplus falls by the area A + E. Government revenue falls by C + H. Net effect is unambiguously positive and equal to (B + F + G) and (D + I + J). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 22 Annex: Small Country Case Second case: preferential trade arrangement is signed with the high-cost country B: TS1 → TS2 The preferential liberalization increases competition from imports and forces down the Home price of locally made and imported goods to PB. Consumption rises to Q5. Some high-cost Home production is replaced by lower-cost imports. This amount is equal to Q3 − Q2. The new Home production level is Q2. Imports from A are replaced by imports from B and the level of imports rises. The border price rises. Home now pays more for its imports (namely, PB) than it did before (namely, PA). Welfare: Home consumers gain the area A + B + C + D. Home producers lose area A. All tariff revenue is lost. This lowers Home welfare; the change being − C − H. The net effect is B + D − H. This may be positive or negative (Viner ambiguity). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 23 Annex: Small Country Case 1ST case liberalization: low cost country 2ND case PTA with high cost country McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 24 Chapter 6 Market size and scale effects The Economics of European Integration, Seventh Edition Introduction: Market size matters European leaders always viewed integration as compensating the small size of European nations. Implicit assumption: market size is good for economic performance. key economic rationale for European economic integration: achieve a market as large as that of the US or China Even within the single market, national markets are separated (tariffs, NTBs). Recent example: After Brexit, British industry felt the cost of NTBs that had been removed in the 1990s and 2000s (reduced imports and exports, loss of income and productivity). National champions (car industry...). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 2 Liberalization, defragmentation and industrial restructuring: the logic Tearing down intra-EU barriers brings a ‘pro-competitive effect’ which, in turn, puts pressure on profits and the market’s response is ‘merger mania’. That is, the pro-competitive effect squeezes the least efficient firms, prompting an industrial restructuring so that Europe is left with a more efficient industrial structure, with fewer, bigger, more efficient firms competing more effectively with each other. Schematically: liberalization → defragmentation → pro-competitive effect → industrial restructuring. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 3 Liberalization, defragmentation and industrial restructuring: empirical evidence French data on export prices: price discrimination across markets was reduced 40 per cent faster within the Single Market than in an appropriately defined control group of non-EU nations (Méjean and Schwellnus 2009). French manufacturing firms: implementation of the Single Market Programme and the introduction of the Euro lowered the price–cost ratio margin 4 to 5 percentage points (Bellone et al. 2008). More evidence on the pro- competitive effect of integration (other countries and sectors) in the literature. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 4 The BE–COMP diagram in a closed economy To study the impact of European integration on firm size and efficiency, the number of firms, prices, and output, it is useful to have a diagram in which all of these things are determined: BE-COMP diagram. We begin with the case of a closed economy: COMP curve: imperfectly competitive firms charge a price that exceeds their marginal cost; the COMP curve illustrates the relationship between mark-up (μ) and the number of firms; BE curve: the break-even curve illustrates that more firms will be able to survive if the price is far above marginal cost, i.e. if the mark-up (μ) is high. More details in the Annex. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 5 The BE–COMP diagram in a closed economy McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 6 The BE–COMP diagram in a closed economy From the equilibrium on the BE-COMP diagram, we can determine the equilibrium number of firms, mark-up, price, total consumption, and firm size all in one three-panel diagram. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 7 The impact of European liberalization European integration has involved a gradual reduction of trade barriers. The basic economic effects of this gradual reduction can, however, be illustrated more simply by considering a much more drastic liberalization – taking a completely closed economy and making it a completely open economy. To keep things simple, we suppose that there are only two nations, Home and Foreign, and that these nations are identical. The immediate impact of the no-trade-to-free-trade liberalization is to provide each firm with a second market of the same size and to double the number of competitors in each market. How does this change the outcome? To summarize: the no-trade-to-free-trade liberalization results in fewer, larger firms; the resulting scale economies lower average cost and thus, make these firms more efficient; extra competition ensures that these savings are passed on to lower prices. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 8 The impact of European liberalization McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 9 The impact of European liberalization → Integration implies that the BE curve shifts out. → It is useful to think of the integration as leading to two steps: Step 1. Short term: defragmentation and the pro-competitive effect (from E′ to A) initially, typical firm has 100% sales at home, 0% abroad; after integration, 50%-50% (can’t be seen in the diagram); equilibrium moves from E′ to A with firms losing money (below BE); mark-up falls and short-run price impact p′ to pA. Step 2. Long term: industrial restructuring and scale effects (from A to E″) from A to E′′, number of firms from 2n′ to n′′; firms enlarge market shares and output, and AC falls from p′ to p′′; mark-up rises and profitability is restored. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 10 The impact of European liberalization Welfare effects: The four-sided area marked by p′, p′′, E′, and E′′ corresponds to the gain in Home consumer surplus. The exact same gain occurs in the Foreign market (not shown). Examples for consolidation: Airline Industry (fewer flights, code sharing) Banking (mergers & acquisitions). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 11 Annex: COMP curve in more detail The monopoly case is easy because it avoids strategic interactions. Profit-maximizing strategy: marginal revenue = marginal cost. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 12 Annex: COMP curve in more detail McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 13 Annex: BE curve in more detail McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 14 Chapter 7 Growth effects and factor market integration The Economics of European Integration, Seventh Edition Growth effects and factor market integration: Introduction Shrinking output because of crisis (Financial crises 2008, Eurozone crisis 2010, Covid19) or the ups and downs of recessions and booms: NOT the topic of this chapter. Previous chapters 4-6: allocation effects. Integration leads to a single reallocation of resources. This chapter: Accumalation effects, i.e. a change of the rate of accumulation of factors of production, mainly capital Long-term perspective: ‘Europeans today are enormously better off than their grandparents were fifty years ago’ (Eichengreen). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 2 Historical phases of European growth By historical standards, continuous economic growth is a relatively recent phenomenon. Before the Industrial Revolution, which started in Great Britain in the late 1700s, European incomes had stagnated for a millennium and a half. ‘Golden Age of growth’ coincides with European Integration (European Steel and Coal Community 1950) but happened worldwide. General problem: distinguish between the causes and effects of integration and growth McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 3 Post-war convergence and slowdown Convergence: tendency that poor countries catch up with rich nations (in terms of income per capita). Based on higher growth rates of income. Slowdown: slowdown of income growth after 1973 (or so). Robert Gordon: This is a return to normal. 1870-1970: special century, several clusters of breakthrough inventions By 1970: room for recombinations of inventions exhausted EU’s average growth has been lower every decade since the 1970s. Since the same can be said of non-EU nations like Japan, Canada and the US, we should be careful not to confound causality with correlation when thinking about the growth effects of European integration. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 4 The facts of convergence and slowdown Average growth rates 1950-1973 vs 1973-2000. Countries with lower incomes grew faster (1950-1973), less so in the second period, where all growth rates (and their differences) were lower. EU: very different incomes in 1950, with UK leading. Higher growth rates for poorer nations catching up. UK ranked 11 out of 28 when it exited the EU. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 5 The logic of growth Economic growth means producing more and more every year. Per capita growth = annual rise in output per person Growth is based on more ‘tools’ for workers year after year, mainly ‘capital’ Physical capital (machines, etc.), human capital (skills, training, experience, etc.), and knowledge capital (technology). If European integration does affect growth, it will do so mainly by stimulating investment in those three types of capital McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 6 Two types of growth: medium-term and long-term Two categories of growth effects: Medium-term, like ‘induced physical capital formation’; Long-term, involving a permanent change in the rate of accumulation, and a permanent change in the rate of growth. Under medium-run growth effects, the rise in output per person eventually stops at a new, higher level. (‘diminishing returns’ ) Under long-run growth effects, the rate of growth is forever higher. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 7 Evidence from EU accessions Natural experiment: Accession = sudden and well-defined increase in economic integration. If integration raises a nation‘s capital stock, what would be the footprint in the data? Better investment climate and more investment from abroad: Stock market prices should increase The aggregate investment-to-GDP ratio should rise The net foreign direct investment figures should improve Examples: EU membership of Portugal and Spain (which joined in 1986), Latvia, Lithuania and Estonia (which joined in 2004), and Greece (which joined in 1981). McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 8 Evidence from EU accessions: Portugal and Spain France as control‘ Membership talks beginning in 1978 Membership 1986 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 9 Evidence from EU accessions: Baltics Mid 1990s: clear that the Baltics eventually would become EU members. Membership 2004 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 10 Evidence from EU accessions: Greece counter-example Membership 1981 McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 11 Brexit: evidence from Britain leaving the Single Market Brexit vote in June 2016 ended recovery of investment after the 2008/9 recession McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 12 Investment and output per worker For the analysis, we consider the whole EU as a single, closed economy with fully integrated capital and labour markets and the same technology everywhere. We study the link between growth and integration by focusing on the connection between GDP-per-worker and capital-per-worker: when a typical firm provides its workers with more and better equipment, output per worker rises; however, output per worker does not increase in proportion with equipment per worker: ‘diminishing returns’ – there is a positive return to using more equipment; the size of the returns diminish as the amount of equipment rises. Investment strategy of a typical firm: invest up to the point where the incremental cost of investing more exceeds the incremental benefit. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 13 Investment and output per worker McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 14 Determinants of long-run growth Continual technical progress introduces new products that spur more investment in equipment and skills. Technology also yields new production techniques that allow the same value of equipment and skills to produce more output. Both of these boost up the reward to investment and thus, keep firms investing. Technical progress raises the incremental gain in the value of output per worker for any given incremental increase in the value of equipment and skills per worker. As the incremental value rises, firms invest more. Technical progress raises the value of output per worker: Direct effect: for the current level of equipment and skills per worker, the value of the output is increased. Indirect effect comes from the output-boost impact of the extra investment that the technical progress induces. McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 15 Determinants of long-run growth McGraw-Hill Education | Baldwin & Wyplosz, "The Economics of European Integration, Seventh Edition" 16 What drives the big differences in labour productivity? 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