THE EUROPEAN UNION:

ECONOMY, SOCIETY, AND

POLITY

by
Andrés Rodríguez-Pose

London School of Economics

Oxford University Press

ISBN 0-19-874286-X
 Part I

ECONOMY
 Chapter 1

Competitiveness
 The stages of economic
integration
• Free trade areas:
– Free trade between members, different external tariffs
– Little or no institutional co-ordination
• Customs union:
– Free trade between members and common external trade restriction
– Common regulatory bodies
• Common (or single) markets:
– Removal of all barriers to free factor mobility
– Free mobility of goods, capital, labour, and services
– Greater level of regulation and strong institutions to monitor decisions
adopted by member states
 The stages of economic
integration (II)
• Economic union:
– Harmonisation of economic policies (generally monetary or
fiscal policy)
– Members give up powers. Strong central institutions which
dictate common economic policy
• Complete economic integration:
– All economic policy areas are harmonised
– The capacity of states to implement independent policies
disappears
– Central institutions become the centres of economic
decision-making
 The stages of economic
integration in the EU
Level of integration Main features Period

Free trade area Free trade among members From 1958 to the early
1960s
Customs union Free trade with a common In theory from 1958, in
external tariff reality from the early 1960s
until 1993
Common market Free mobility of factors across 1993-1999
member states
Economic union Harmonization of economic Early stages in 1993.
policy Partial economic union in
1999
Economic integration Completely unified economic Not yet achieved
policy
 Economic integration to
achieve competitiveness
• Why did a customs union (the EC) decide to
increase the pace of economic integration during
the 1980s and 1990s?
– Increasing globalisation of the world economy
(increased competition, especially from the US,
Japan, and the NICs)
– More sophisticated systems to dodge trade barriers
(multinational corporations)
– Belief that market fragmentation (nationally divided
markets) was reducing economies of scale
GDP per capita (2000) in
Europe, the US and Japan
Total GDP in % of the EU
Country 2000 (billions economy
of €)
Austria 205.5 2.42
Belgium 244.0 2.87
Denmark 174.2 2.05
Finland 131.2 1.54
France 1399.2 16.47
Germany 2036.0 23.97
Greece 120.7 1.42
Ireland 101.1 1.19
Italy 1152.3 13.57
Luxembourg 19.9 0.23
Netherlands 399.1 4.70
Portugal 112.3 1.32
Spain 605.7 7.13
Sweden 248.8 2.93
United kingdom 1543.0 18.17
European Union 8493.0 100.00
United States 10738.7 126.44
Japan 5163.2 60.79
 The limits of European
competitiveness
• The costs of the ‘non-Europe’ (Cecchini, 1991):
– Physical barriers: Intra-European stoppages,
controls at border checkpoints, red-tape,
different currencies…
– Technical barriers: Different national product
standards and technical regulations across
Member States
– Fiscal barriers: Lack of fiscal harmonisation
 Physical barriers
• Custom related costs:
– Customs controls, border stoppages
– Paperwork and red-tape
– Exchange of low-value added perishable goods suffered
as a result
• High administrative costs and regulatory
hassles:
– Higher cost of red-tape of SMEs (higher proportion of
their business volume, and lack of expertise and human
resources)
 Physical barriers (II)
• Protected markets (II):
– Fear of foreign dependence leads to protection of ‘national strategic
sectors’
– Many sectors fall under this umbrella: petrochemical industries,
shipbuilding, iron and steel, tobacco, car manufacturing,
telecommunications, air transport,...
– Formation of monopolies (BT, Deutsche Telekom, SIP, Air France,
Iberia,...) or oligopolies
– Cost of protection born by the consumer:
• Lack of competition and underperforming industries
– And companies:
• Higher prices for services than their competitors
 Physical barriers (III)
• Different currencies:
– Transaction costs of changing currencies
– Higher costs of holding higher international
reserves
– Costs associated to exchange rate volatility
– Higher interest rates in many countries
 Technical barriers
• Different product standards and technical
regulations:
– Problems and additional costs for consumers
– Cost for firms which had to adapt their products to different
national standards
– Cost premium for SMEs
• Protected public-sector procurement:
– Government supply and construction contrast restricted to
national firms
– Or technical regulations discriminating against foreign
bidders
 Fiscal barriers
• Different fiscal regimes:
– Different regimes for companies
– Different VAT rates
– Different national accounting standards:
• Duplication or multiplication of accounting
standards for multinational companies
• ‘Fiscal suspicion’ by national authorities in
order to prevent tax evasion
• Premium for SMEs
 The expected benefits of
economic integration
• Cecchini report (1988). Cost saving effects:
– ‘Static trade effect’: benefits reaped from allowing public authorities
to buy from the cheapest suppliers
– ‘Competition effect’: Downward pressure on prices as a result of
greater competition
– ‘Restructuring effect’: Reorganisation of industrial sectors and
individual companies as a result of greater competition
• Other possible benefits:
– Benefits on investment, innovation (rationalisation of R&D
expenditure) and growth
– Savings for the public sector (lower government subsidies for
inefficient firms
 The expected benefits of
economic integration (II)
• Combination of cost saving effects results in two
kinds of benefits:
– Direct benefits: from the eradication of economic borders
– Indirect benefits: from economic restructuring, increases
in trade and competition and greater economies of scale
• Result:
– The emergence of virtuous cycles of innovation and
competition
– Lowering of prices for consumers
– Greater job creation
 Estimation of benefits
• Cecchini (1988): 4 to 7% of Europe’s GDP
• Baldwin:
 The expected benefits of
monetary union
• For all Member States adopting the Euro:
– Price transparency across borders, inducing a greater
‘competition effect’
– Elimination of transaction costs of changing currencies
– Savings through holding lower international reserves
– Reduction of uncertainty caused by exchange rate volatility
• Specific benefits for peripheral economies:
– Image premium and credibility in international markets
– Monetary and macroeconomic stability (lower inflation, deficit,
debt, and interest rates)
 The possible impact of
monetary union
• Possible impact:
– Large benefits expected …
– But Commission reluctant to issue estimates (as
was the case of with the Single Market)
 The impact of economic
integration
• Is European economic integration delivering
the benefits predicted by its supporters?
• Has the EU experienced the increases in
trade, the more efficient allocation of
resources, and the greater growth and
welfare gains expected?
• Have European economies become more
competitive?
 Trade
• Sizeable increase in trade across the EU
– Greater expansion in absolute terms than in other
developed areas of the world
– But not in relative terms, where the US has
expanded more (but not Japan)
– This means that in a world context the evolution of
European trade has been rather disappointing,
especially in comparison with countries like
Canada or Mexico, which have undergone milder
processes of integration
 Exports of goods and
services as a share of GDP

1988 1991 1994 1997 Change % Change

1988-97
EU 26.80 26.26 27.79 31.73 4.93 18.40
US 8.99 10.37 10.54 12.09 3.10 34.48
Japan 10.02 10.19 9.27 11.11 1.09 10.88
OECD 17.31 17.89 17.92 21.02 3.71 21.43
 Trade at a national level
• Several countries have experienced significant
increases:
– Countries with relatively open economies: Ireland
– Countries which were relatively closed: Finland, Sweden, Spain,
or Italy
• The trend is far from universal:
– Germany, Greece, and Portugal have seen their exports as a share
of GDP decline
– Luxembourg, Greece, and Portugal have seen a decline in their
import share
– The lack of a clear pattern in the evolution of trade suggests that
no greater territorial specialization is evident
 Changes in trade patterns
• Increase in intra-industry trade…
• But, stability of inter-industry trade
– This has prevented a further concentration of capital
intensive industries in core countries to the detriment of the
periphery
– Former lagging countries such as Ireland and Spain have
profited from integration to expand trade and attract capital
intensive industries…
– Portugal and Greece have been less successful
• The level of intra-industry trade suggests that the
expected specialization may be starting to happen
 Foreign direct investment
• Early stages of integration seem to have had a lower impact on
FDI than on trade
– Net inflows of FDI oscillate with economic cycles
– Flows of FDI reached their peak around 1990
– After the implementation of the Single Market they followed a downward
trend
• In international comparisons the EU does not score favourably
– When compared to the US, net inflows of FDI into the EU have declined
with respect to the period before 1993.
– FDI flows among the member states have lost some importance...
– But, outflows to the rest of the world have increased.
 FDI net inflows
Country 1980 1985 1990 1994 1997
Austria 0.30 0.26 0.41 1.08 1.20
Belgium - - - - -
Denmark - 0.19 0.85 3.31 1.70
Finland 0.05 0.21 0.60 1.53 1.78
France 0.49 0.50 1.10 1.19 1.65
Germany - - - 0.09 -0.02
Greece 1.38 1.10 1.21 0.99 0.86*
Ireland 1.43 0.83 1.38 1.55 3.63
Italy 0.13 0.25 0.59 0.21 0.32
Luxembourg - - - - -
Netherlands 1.33 1.17 4.35 2.23 2.42
Portugal 0.55 1.16 3.78 1.44 1.68
Spain 0.70 1.19 2.84 1.94 1.04
Sweden 0.20 0.39 0.86 3.16 4.33
United Kingdom 1.88 1.20 3.33 0.90 2.96
EMU area 0.50 0.56 1.46 0.75 0.83
United States 0.62 0.49 0.86 0.66 1.19
Japan 0.03 0.05 0.06 0.02 0.08
* Data from 1996.
 Economies of scale
• Ex-ante reports highlighted that economic
integration was to bring about a more efficient
concentration of resources
• And a restructuring of companies
– Number of mergers and acquisitions has increased by
more than two and a half times between 1987 and 1998
– The bulk of this happened in anticipation of the Single
Market
– Transnational M&As have taken off after the Single
Market and in anticipation of EMU.
 Economies of scale (II)
• Three stages in the process:
– National M&As: started to take place during the late 1980s in
anticipation of the Single Market
– European M&As: the percentage of M&A involving at least one foreign
company almost doubled between 1990 and 1998.
– Trans-national M&As: Increasingly M&As are global. In 1998 one
third of all M&As involved at least one non-EU partner.
• During the 1990s there has been an important increase in the
volume of the deals.
– The total volume of deals has been multiplied by six between 1991 and
1998
– Greater expansion in outward M&As
 Mergers and acquisitions
(1987-98)

1987 1990 1993 1996 1998

Number 2775 7003 5740 6327 7600
% National 71.6 60.7 63.4 55.7 50.1
% EU 9.6 21.5 15.9 17.4 16.5
% International 18.8 17.8 20.7 26.9 33.4

Source: AMDATA in European Economy (1999).

 Economies of scale (III)
• European companies have become more ambitious and aggressive:
– Probably in connection to the launch of the Euro
– But also as a result of the emergence of new TNCs in Europe resulting from
previous mergers
• New mergers increasingly involve companies from two different
European countries:
– Orange and Mannesman
– Vodafone and Mannesman
• And also truly global M&As:
– Daimler-Chriysler
– Terra Lycos
– Repsol-YPF
 Volume of cross-border
M&A's (Billion US$)
Inward
1991 1994 1997 1998 Multiplier
1991-98
EU 38.7 58.4 133.6 223.4 5.8
Rest of Europe 4.1 7.4 14.6 17.6 4.3
North America 26.1 62.9 76.3 218.1 8.4
Rest of the World 16.4 67.7 116.5 98.9 6.0
Total 85.3 196.4 341.0 558.0 6.5
Outward
1991 1994 1997 1998 Multiplier
1991-98
EU 50.5 75.3 127.5 330.6 6.5
Rest of Europe 3.4 18.2 42.1 14.4 4.2
North America 15.7 52.0 106.4 175.2 11.2
Rest of the World 15.7 50.9 65.0 37.8 2.4
Total 85.3 196.4 341.0 558.0 6.5
Source: KPMG Corporate Finance (1999).
 Volume of cross-border
M&A's (%)
Inward
1991 1994 1997 1998 Change
1991-98
EU 45.4 29.7 39.2 40.4 -5.4
Rest of Europe 4.8 3.8 4.4 3.1 -1.7
North America 30.6 32.0 22.4 39.1 8.5
Rest of the World 19.2 24.5 34.0 17.8 -1.4
Total 100.0 100.0 100.0 100.0 0.0
Outward
1991 1994 1997 1998 Change
1991-98
EU 59.3 38.4 37.4 59.3 0.0
Rest of Europe 3.9 9.3 12.4 2.5 -1.4
North America 18.4 26.5 31.9 31.4 13.0
Rest of the World 18.4 24.8 18.3 6.8 -11.6
Total 100.0 100.0 100.0 100.0 0.0
Source: KPMG Corporate Finance (1999).
 Economies of scale (IV)
• But have EU companies become the leading
actors in international M&As?
– Despite the increase in numbers and size, EU
companies have lagged behind the US...
– And during much of the 1990s also behind Japan and
the Asian Dragons
– Only the Asian crisis of 1997/98 changed the tide
• And a diminishing number of European
companies can be found among the top 50 in
the world
 Location of the world's
largest 50 corporations
United
States Europe Japan Other

1960 42 8 0 0
1970 32 14 4 0
1980 23 19 5 3
1990 17 21 10 2
2000 15 16 19 0

Source: Bergesen and Fernández (1995) and Fortune Global 500.

 Productivity
• European labour productivity has been reducing the gap
with the US in the post-war decades
• Convergence came to an end in the second half of the 1980s
– Increasing technology gap between the US and the EU
– Permanence of fragmented markets in Europe (monopolies which
prevented access to new technologies)
– Rigidity of European labour markets (which kept the young out of
work)
• Productivity has grown faster in the US in the 1990s
– Some encouraging signs for EU (advantage in mobiles)
1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991
Growth

1994

1997

2000
0
2
4
6
8

-4
-2
10
12

%
Labour Productivity

US
EU

Japan
Productivity in selected EU
countries
140

120

100
Change in productivity

France
80 Italy
US=100

Spain
60
UK
40 United States

20

0
1960

1970

1980

1995
1965

1975

1985

1990

Source: World Bank World Development Indicators (2000).

 Growth
• On average, the EU has had slightly greater growth
than the US and lower than Japan during the post-war
decades
• Precisely at the time of European economic
integration, the roles have been reversed
– Greater growth in the US (double that of the EMU area)
– Lower in Japan
– Strong internal divergence in growth patterns in the EU
• Extremely high growth in Ireland and Luxembourg
• Moderate in Austria, Denmark, the Netherlands and Portugal
• Low elsewhere in the EU
 Average growth in the EU,
US, and Japan (1960-2000)
14

12

10

6 EU
US
%

4 Japan
2

-2

-4
1966
1969
1972
1975
1978
1981
1984

1990
1993
1996
1960
1963

1987

1999
 Conclusion
• The impact of economic integration on the economic
performance of the EU has not been as spectacular
and immediate as predicted by ex-ante studies
• The gap between the EU and the US has increased in
many areas (growth, productivity, trade, M&As)
• Different economic cycles may have a lot to say about
diverging economic performances
• However, economic integration may be setting the
bases for a quicker adaptation by the EU in the future
to new economic challenges