Pursuing economic integration

Although the EU achieved a customs union by 1970, little progress was made toward becoming a common market until 1985. The hostile eco­nomic climate (stagflation) of the 1970s led EU members to shield their people from external forces rather than dismantle trade restrictions. By the 1980s, however, EU members were increas­ingly frustrated with barriers that hindered trans­actions within the community. European officials also feared that the EU's competitiveness was lag­ging behind that of Japan and the United States. In 1985, the EU announced a detailed pro­gram for attaining the common-market stage of economic integration. Plans called for the elim­ination of remaining nontariff trade barriers by 1992. Examples of these barriers included bor­der controls and customs red tape, divergent standards and technical regulations, conflicting business laws, and protectionist procurement policies of governments. The elimination of these barriers to intra-EU transactions would create a market of more than 325 million con­sumers. It would also turn the EU into the sec­ond largest economy in the world, almost as large as the U.S. economy.

The common market's completion was ex­pected to trigger a supply-side shock to the EU as a whole, leading to cost decreases. Prices would fall under the pressure of new rivals on previously protected markets. Falling prices would lead to increases in demand, thus allow­ing companies to expand output, use resources more efficiently, and become geared up for Eu­ropean and global competition. Four major benefits were expected from removing the re­maining nontariff barriers:

1. Cost reductions as a result of economies of scale in production and business organization.

2. Improved efficiency within companies and an environment where prices fall toward production costs under the pressure of more competitive markets.

3. Increased R&D and innovation fostered by the dynamics of an expanded internal market.

4. New patterns of competition in which comparative advantages determine the role of market success.

As previously noted, the advent of a larger European market would permit firms to take advantage of hitherto unexploited economies of scale, with resulting decreases in unit costs and expansion of output. The benefits from scale economies, however, were considered problematic. Significant economies of scale were expected to be concentrated in only a few European industries. The realization of scale economies would also imply that industries would consist of fewer but larger firms, which might conflict with the EU's objective of increased competition. Finally, econ­omies of scale, at least at the manufacturing-plant (technical) level, are often due to output standardization and long production runs. But output standardization, even at reduced prices, might increase consumer welfare less than would have occurred if a wider range of prod­ucts were available. This product-diversity ar­gument supported the view that national mar­kets would remain distinctive after completion of the common market because of factors such as language and cultural differences.

The supply-side shock would also ripple through the European economy at large. The elimination of trade barriers and resulting inten­sified competition would increase productivity and reduce costs, shifting the aggregate supply curve to the right. Moreover, savings on spend­ing as government procurement was opened up would decrease tax burdens and interest rates, the latter stimulating investment in productive capacity, further adding to the beneficial supply shift. The outcome would be increased output, reduced unemployment, and lower inflation.

While the EU was pursuing the common-market level of integration, its heads of state and government agreed to pursue much deeper levels of integration. At the Maastricht Sum­mit of 1991, EU officials agreed to implement economic and monetary union in 1999.

 

 

Answer the questions:

1. When was the progress in European Union made?

2. What benefits brought the elimination of barriers between the European countries?

3. How was the consumers’ number increased?

4. What changes happened in prices, demand and supply?

5. What are the fore major benefits in European community?

ECONOMIC AND MONETARY UNION

Travelers in the United States take for granted their ability to use the same dollar bills to pay for their meals, motels, taxis, and other goods and services throughout the nation, whether they are in Seattle, Miami, or anyplace in be­tween. In Europe, however, the situation was quite different. Even short trips often involve traveling through more than one country, and, each time a border is crossed, travelers had to use completely different currency and coins.

This situation changed as a result of the formation of Europe's Economic and Monetary Union (EMU) in 1999. Under the EMU, mem­ber countries replaced their individual currencies with a single currency, the euro, in 2002. As a result the old national currencies and coins were withdrawn from circulation that point, the euro becomes the single currency in circulation throughout the monetary union.

The euro could prove a strong alternative to the U.S. dollar. Financial markets will con-duct transactions in euros, and central bank will want to hold some of their reserves in this currency. Both transactions will reduce the number of dollars held, but it is unclear by how much. How quickly the shift will occur is un-certain. If the euro takes off as a strong currency, it may affect the dollar's role as a reserve (key) currency for the rest of the world. The European Union represents a big market. It is likely that the world will want to hold more euros and fewer dollars for international trans­actions. If fewer countries hold dollars, then it will be a loss for the U.S. Treasury because for­eign holdings of U.S. dollars are interest-free loans to the United States from the rest of the world. But if the euro is unstable, then the dollar is likely to be seen as a safe haven and inter­national holdings of dollars will grow.

The EMU also resulted in the creation of a new European Central Bank in 1999 to take control of monetary policy and exchange rate policy for the member countries. The European Central Bank alone controls the supply of eu­ros, sets the short-term euro interest rate, and maintains permanently fixed exchange rates for the member countries.

There are several possible advantages of the EMU. One benefit is low inflation, as­sured by a central bank that is among the world's most independent. Also, the euro should create more certainty for trans-European busi­ness and mean lower costs, perhaps worth 0.5 percent of the union's gross domestic product (GDP), a tidy sum. Moreover, the euro may promote growth and attract foreign investment, partly by guaranteeing low inflation and partly by cementing in place Europe's single market.

 

TABLE 9.4 / Potential Macroeconomic Consequences for the EU of Forming a Common Market
	Removal of Customs formalities	Opening of Public Procurement	Liberalization of financial Services	Supply- Side Effects*
Change in GDP (%)	0.4	0.5	1.5	2.1
Change in consumer prices (%)	-1.0	-1.4	-1.4	-2.3
Change in employment in thousands
* Supply-side effects are the reduction in production costs due to the removal of trade restrictions Source: Paolo Cecchini, The European Challenge: 1992 (Brookfield, Vt.: Cover, 1988), p. 98.

 

On the downside, a lack of exchange-rate flexibility and loss of national monetary policy may prolong regional economic downturns. A country cannot lower interest rates when it goes into a recession unless all the other coun­tries agree that this is a good policy, perhaps prolonging a localized recession. For example, the fact that Texas could not lower interest rates when a collapse in oil prices sent its econ­omy into recession in 1986 may have extended Texas' recession.

When the Maastricht Treaty was signed in 1991, economic conditions in the various EU members differed substantially. The treaty specified that to be considered ready for mone­tary union, a country's economic performance would have to be similar to the performance of other members. To provide a basis for assessing the readiness of countries to participate in EMU, the Maastricht Treaty established con­vergence criteria in the areas of inflation, pub­lic finances, interest rates, and exchange rates. The specific convergence criteria are as follows:

· Price stability. Inflation in each prospec­tive member is supposed to be no more than 1.5 percentage points above the aver­ age of the inflation rates in the three countries with lowest inflation rates.

· Low long-term interest rates. Long-term interest rates are to be no more than 2 percent above the average interest rate in those countries.

· Stable exchange rates. The exchange rate is supposed to have been kept within the target bands of the European Monetary System with no devaluations for at least two years prior to joining the monetary union.

· Sound public finances. One fiscal crite­rion is that the budget deficit in a pro­spective member should be at most 3 percent of GDP; he other is that the outstanding amount of government debt should be no more than 60 percent of a year's GDP.

The economic rationale for the fiscal criteria is that such limits are needed to ensure the sup-port and commitment of all monetary union members to the goal of low inflation enshrined in the Maastricht Treaty. Historically, govern­ments have sometimes used inflation as a way of raising revenue to maintain spending on po­litically popular programs. Once monetary union is achieved, inflation could not be con­fined to one member but would necessarily in­volve the entire membership. A single member wishing to pursue an inflationary policy might exert pressure on the European Central Bank to raise inflation throughout the union. Alter­natively, if a member government with large debts had financial difficulty, the European Central Bank might feel obliged to bail it out to avoid a financial crisis, at the cost of compro­mising its low-inflation goal.

The fiscal criteria were intended to ensure that only governments with sound finances would be able to enter the union. Moreover, to guard against future problems the members of the EU agreed to set limits on deficits even af­ter monetary union is achieved: members are to be fined if they consistently violate the 3 per­cent limit on budget deficits.