EUROPEAN ECONOMIC AND MONETARY

UNION

LECTURER ITIR BAGDADI

OVERVIEW

Economic Integration One of the most powerful dynamics of

this era in world politics Nations are increasingly driven to

unite their economies for greater efficiency and growth

Integrated markets do NOT necessarily mean integrated states

EUROPEAN UNION Began life in 1957 as the European Economic

Community (EEC) – often called the Common Market

1980s - “economic” element in group's name was eliminated – European Community (EC) created

1993 – name changed to the European Union (EU)

1999 – the Euro came into effect for 11 member states (currently 17 member states use the €)

2011 – move towards a fiscal union agreed to by all member states except the UK

Fundamental question: Are economics more important than politics? Do the individualistic motives of the market

matter more than the unifying social values of the nation-state?

20th Century in Europe

Most violent century in history 2 common enemies:

1.External threat of the USSR during the Cold War

2.Internal threat of a return to divisions and conflicts that created war and instability in Europe in the past

Europe has been able to achieve political cooperation and even unify by using economics as a political tool

21st Century Regionalism is a distinctive feature

of IPE in the 21st century IPE is pulled in 2 directions:

On the one hand security concerns make the state as important now as it has ever been.

At the same time, the forces of economic globalization are blurring the distinction between home and abroad. From an economic standpoint the world is defined by markets – and they are global.

Regionalism Refers to the process by which groups of nation-

states, usually in the same geographic region, agree to cooperate and share responsibility to achieve common goals.

Regional groups are “clubs” formed by nation-states to accomplish objectives that require coordinated or collective action

The goals may be narrow and specific (ex. Ecotourism) or very broad and ambigous (like the EU)

Regionalism takes many forms in IPE Regional environmental agreements, regional economic

development programs, regional scientific and health regimes, and regional security arrangements

Regionalism is not a new thing but what is new is its strength as an organizing force due to the increasing importance of economic integration and the rise of regional trade blocs

ECONOMIC INTEGRATION

The process by which a group of nation states agree to ignore their national boundaries for at least some economic purposes, creating a larger and more tightly connected system of markets

Several degrees of economic integration: Free Trade Area (FTA) Customs Union Economic Union

Free Trade Area Involves a relatively minimal degree

of integration Nations in FTA agree to eliminate

tariff barriers to trade for goods and services they produce themselves

However, each nation still retains the right to set its own tariff barriers with respect to products from outside the FTA

In essence, some goods are still subject to differential trade barriers while some goods are tariff-fee (for ex. Goods from other countries) – this leads to complications

North American Free Trade Area (NAFTA)

Example of an FTA Goods from the USA, Canada and

Mexico will be traded freely within NAFTA borders

Goods from other countries will be subject to differential trade barriers of these three countries (ex. Chile has negotiated three

separate bilateral trade agreements with each of the NAFTA members separately)

NAFTA

Trade bloc in North America created by the U.S.A, Canada and Mexico Came into effect January 1, 1994 Between 1993 – 2004 trade among NAFTA members increased 129.3%

Customs Union (example: Turkey - EU)

A group of nations agree both to tariff free trade within their collective borders and to a common set of external trade barriers

If NAFTA were to evolve into a customs union, the USA, Canada and Mexico would need to agree to a unified set of tariff barriers that would apply to products from other countries

The Treaty of Rome, which created the EEC, was based upon the idea of a customs union

The movement to a customs union is an important step in terms of economic and political integration

Customs Union (cont.) Nations involved give up some

degree of sovereignty or national political economy since they can no longer set their own trade barriers without consulting their economic partners

Nations gain a far greater degree of economic integration

Products flow more easily within a customs union without need for border inspections or customs fees because of the unified trade structure (however, member nations still retain right to impose some non-tariff barriers such as health and safety standards

Turkey – EU Customs Union

Came into effect on 31 December 1995

Does not cover essential economic areas like agriculture (bilateral trade concessions still apply) and services

Turkey applied for full EU membership in 1987

Helsinki Summit (December 1999) – Turkey given candidate country status

October 3, 2005 – European Council began accession negotiations with Turkey

Turkish Exports

Economic Union (example: EU)

The final stage of economic and political integration

Non-tariff barriers are eliminated along with tariff barriers creating an even more fully integrated market

Member nations also agree to four “freedoms” of movement: Goods Services People Capital

Economic Union (cont.) Four freedoms represent significant

limitations on national sovereignty but have significant effects on economic activity

Free Movement of Goods: Goes beyond the elimination of tariff

barriers Requires a variety of governmental

health, safety and other standards and regulations to be “harmonized” so that a product that can be sold somewhere in the economic union can be sold everywhere in it

Free Movement of Services: The service sector includes many

industries such as banking and finance traditionally subject to heavy regulation that varies considerably among nations

Economic Union (cont.) Free Movement of People:

Requires a unified immigration policy since a person free to enter and work in one member of the economic union would be able to live and work anywhere in the area

Free Movement of Capital: Individual nations give up their ability to

regulate investment inflows and outflows Many nations have traditionally imposed

capital controls to encourage domestic investment, promote financial stability or reduce foreign exchange variations

These controls are not eliminated in an economic union but must be “harmonized” so that national regulations are similar enough to not become a barrier to economic activity

Economic Union (cont.)

If we consider the different state in an alliance, then the US is the most successful economic union in the world

Economic integration is appealing because it is a way for nations to achieve greater efficieny in their use of scarce resources and higher rates of economic growth

Leads to both static efficiency gains and dynamic efficiency gains

Static Efficieny Gains With completely free trade within

the area, each member nation is able to specialize in producing the goods and services in which it is most efficient

Protective barriers that preserve inefficient industries and promote redundancy are eliminated

The creation of a large, integrated market promotes efficiency in certain industries where large scale production or long production runs are possible. These gains from “economies of scale” make products cheaper and more competitive

Dynamic Efficiency Gains

Promotion of economic growth A larger and more competitive

market is likely to be more innovative

As internal trade barriers are removed, previously protected firms are forced to compete with one another and this makes them more “efficient”

If economic integration is successful, economic growth rates tend to increase, which raises living standards

Trade Diversion Effect Regional Trade Blocs became important

and controversial in the 1990s because of the trade diversion effect of a FTA, customs union or economic union

By dropping internal barriers members create more trade between and among member nations Some of this is newly created trade but some

of it is trade that is lost from another non-member partner

Ex. With NAFTA, Mexican trade to the USA increased while other developing nations’ trade decreased

Trade Diversion Trade diversion is a two-fold problem:

It is an economic problem because it means that economic integration is not as efficient as it may seem. Trade blocs may be economically beneficial for the nations that form them but they create inefficiency and economic loss for other countries that suffer the loss.

It is also a political problem since as more and more countries enter into regional economic groups non members find themselves locked out and vulnerable. They have a strong motivation to gain membership in an existing bloc to get trade creation effects or to form their own bloc with other countries in the same boat.

The threat of trade diversion and of being left out has led to an expansion in size and number of trade blocs

Sovereignty at Risk: The Politics of

Integration There are many political implications that should be considered when looking at an economic union Trade-offs between economic benefits

and political costs Cooperation in economic sphere =

cooperation in political sphere Example: an economic union requires that a

nation negotiate a new immigration policy, safety standards, methods of financial regulation and adopt a harmonized system of investment controls

Political choices no longer influenced mainly by domestic voters and groups – now the wishes of groups in other member states must also be considered

Politics of Integration (cont.)

Fundamental problem: loss of sovereignty that occurs when nations form regional trade blocs

At some point each member state risks being forced to ignore national interests as a consequence of maintaing its international obligations

This tension between national interest and international obligations poses a severe dilemma for states which tend to value security and autonomy

Another school of thought that does not believe that economic integration weakens political power states that integration weakens the hold of national interest groups on political decisions – specific interest groups are less likely to benefit and resulting policies will reflect the public interest

Politics of Integration (cont.)

Another argument states that individual nations may actually gain political power, especially in relations with other nations, by being members of a powerful economic alliance. Example: Belgium – a more powerful

political presence as a leading nation of the EU than if it were simply a small but autonomous European nation

Basically, it is argued that smaller countries are far more powerful as members of a larger group than tney would be as separate, unaffiliated individual nations

European Economic Community (cont.)

Movement toward a united Europe was founded upon two important ideas:(1)It is possible for nations to live in a state

of “perpetual peace” (attributed to Immanuel Kant) under a federal system of governance, where each yields some sovereignty and sacrifies some national interests in return for like actions by others. However, it was difficult to transform an environment of nearly perpetual war (Europe from 1914-1945) into one where Kant's vision of perpetual peace would take hold

(2)Economic cooperation and the gains therefrom would strengthen the cooperative ties that bind European nations together (attributed to David Ricardo)

European Economic Community (cont.)

More than perpetual internal peace was desired. Postwar Western leaders sought to create strong, democratic, capitalist nations to a firm wall of resistance to the spread of communism

Marshall Plan (1948): The first formal postwar step toward

building an integrated European economy

President Harry S. Truman's Secretary of State, General George Marshall called upon the nations of Europe to form a continentwide economic market like the USA

Marshall Plan aid was designed to hasten economic recovery by providing a resource base on which to build a European community

How different states viewed European

integration USA – saw European integration as a strong

anticommunist ally Many Europeans – supported it as a solution to

the “German problem” – the need to embed German political and economic power in supranational insitutions

Germany – wanted to be reintegrated into the international community after the disaster of Nazism

Great Britain – Winston Churchill saw the “United States of Europe” as a balance to US influence in the postwar era

France – President Charles de Gaulle imagined a “Europe of States” in which the structure of regionalism would enhance the sovereignty and status of all its members

European Economic Community (cont.)

An integrated Europe also needed European leadership

Jean Monnet, a French political economist, provided the intellectual guidance He proposed an alliance along

functional economic lines: a zone of free trade uniting the heavy industry regions that spanned the French-German border

This plan for the European Coal and Steel Community (ECSC) was implemented by Robert Schuman, a French statesman, in 1950

ECSC was a critical test for Europe and provided a model for futher integration in Western Europe

European Economic Community (cont.)

1957 – Treaty of Rome: Created the European Economic

Community (EEC, or the Common Market) – a customs union that brought together the markets of Italy, France, Belgium, Luxembourg, the Netherlands and West Germany

This union of “the six” was a great success because these nations were natural trading partners

Great Britain participated in the negotiations but decided against it for fear of losing political and economic autonomy and preferential trading relations with the Commonwealth nations and the USA

European Economic Community (cont.)

European Free Trade Area: Great Britain did not want to be isolated

from the rest of Europe and organized a weaker alliance of trading nations called the European Free Trade Area (EFTA)

EFTA brought together Denmark, Sweden, Austria, Switzerland, Portugal and the United Kingdom

An FTA, being more restricted than a customs union, could never offer these nations the benefit of a common market

Geographic separation, deep cultural divisions, huge economic gaps between rich and poor members contributed to limit trade and growth

EFTA members soon sought EEC membership

European Economic Community (cont.)

Trade among EEC members was never entirely free – non-tariff barriers to trade abounded and sometimes nations would simply refuse to accept imports of any items from another member, in violation of the Treaty of Rome because of domestic political or economic concerns

It was also necessary to create an elaborate system of agricultural subsidies across the EEC to defuse political opposition from powerful farm groups The Common Agricultural Policy (CAP)

provided for a complex pattern of payments to farmers in all EEC nations

European Economic Community (cont.)

Although a far cry from free trade and laissez-faire, CAP was the price of achieving greater liberalism and cooperation in other spheres of economic life.

The CAP eventually led to a budget crisis in the 1980s

The EEC changed its name to the European Community (EC) in 1967 signaling intention to move beyond purely economic issues

Common Agricultural Policy

One of the most controversial and divisive elements of economic and political integration in Europe

An EU-wide system of agricultural subsidies, financed through value-added-taxes imposed by EU member nations

Largest item of expenditure of the EU and has been a point of contention both within the EU and in its relations with other nations

Perfect example of the use of economic means to achieve political ends

Common Agricultural Policy

Common Agricultural Policy (cont.)

When the EEC was being formed, farm interests were a major political obstacle

Farmers feared a more comopetitive market would make them suffer to sell their own goods

Since farm groups could have potentially blocked the European integration the CAP was created

CAP created a unified system of farm subsidies that insulated farmers from many aspects of competitive market forces

CAP can be thought of as a system that collected some of the economic gains of European integration in the form of taxes that were then paid to farmers in exchange for their political support

Common Agricultural Policy (cont.)

Provides Europe's farmers with high prices through a system of price supports – the EU purchases excess farm produce to keep prices from falling and farm incomes from declining – a system that benefits farmers at the expense of the tax-paying public

Over the years the CAP's guarantees have encouraged European farmers to over-produce

CAP is now a source of deep political disagreement

Common Agricultural Policy (cont.)

Problems of CAP:(1)As the EU expanded, the cost of maintaining

agricultural subsidies has grown. Rising costs have pitted nations that are net recipients of CAP funds against nations that are net payers of the taxes that fund the program

(2)The future of the EU's expansion into Central and Eastern Europe have created additional pressures. The countries that believe they unfairly pay the bills are worried that the bills will get larger. At the smae time, current EU members are fearful that more subsidies to new EU members will come at the expense of payments to their own farmers

(3)EU is under pressure from the US and other countries to reduce agricultural subsidies generally as part of the WTO's process of trade liberalization

- Plans are in the works to reduce agricultural subsidies

Common Agricultural

Policy

The European Community, 1973-1993

The second stage of development of the EU lasted from 1973-1993

Great Britain, Ireland and Denmark entered the EC in 1973

Greece entered in 1981, followed by Spain and Portugal in 1986 EC membership for these three

countries was in part a reward for the triumph of democratic institutions over authoritarian governments. Free trade and closer economic ties were intended to solidify democracy and protect it from communist influence

The European Community (cont.)

The entry of poorer nations of Ireland, Greece, Spain and Portugal magnified a variety of tensions within the EC Lower living standards limited the

extent of their trade with richer member states

Lower wage structures threatened some jobs in EC industries

The entry of four largely agricultural nations to the EC institutions, like the CAP, put severe fiscal strains on the other nations

The European Community (cont.)

These economic and political stresses caused a split in the EC.

Jacques Delors, the new president of the European Commission tried to find a way to reunite the EC and he produced a proposal for the creation of a single market by 1992 – the Single Market Act

Although it seemed as if the EC was already a single market, it was still far from its goal

The goals were the “four freedoms”: Free movement of goods Free movement of servies Free movment of capital Free movement of people

The European Community (cont.)

National sovereignty and economic growth were often in conflict For example: Germany wanted its

stringent environmental laws applied to the EC but Portugal and Greece objected because it was too costly

The four freedoms required sacrifice of some domestic freedoms, such as the right to self-determination of environmental and safety standards

Not all of the goals of the Single Market were achieved by 1/1/1993, the basic thrust of the program succeeded, however, Europe did not immediately experience economic growth

1995-2003 1995 –

Accession of Austria, Finland and Sweden to the EU Schengen Agreement (abolishing border controls)

implemented by Germany, France, Benelux states, Spain and Portugal

1997 - European Council agrees on the Treaty of Amsterdam strengthening EU institutions

1999 – The Euro goes into effect in 11 of the 15 EU member states

2000 – European Council agrees on the Treaty of Nice

2002 – Euro coins and banknotes enter circulation and replace national currencies

2003 – The Draft of a Constitution for Europe presented

EU-27

EU-27 2004:

10 new states (Czech Republic, Slovakia, Slovenia, Hungary, Poland, Cyprus, Malta, Lithuania, Latvia and Estonia) joined the Union

The European Council signs the treaty establishing a Constitution for Europe

2005 – The treaty for establishing a constitution is rejected in referanda in France and the Netherlands

2007: Bulgaria and Romania join 2009: The Lisbon Treaty goes into effect Today:

Croatia will join in 2013 Turkey and Iceland await future membership Serbia, Macedonia and Montenegro also awaiting

membership Major financial crisis starting in Greece, but also

involving all other member states

Political Institutions of the EU

The Treaty of Rome did more than commit six nations to economic integration – it also began the process of developing a set of political institutions to make policy, settle disputes and provide leadership for Europe

The most important political institutions in the EU today are: The European Commission (and its

President) The Council of Ministers The European Council The European Parliament The European Court of Justice

Political Institutions of the EU (cont.)

Each of these institutions plays a specific role in setting the delicate balance between the national interests of member nations and the collective interest of the EU

President of the European

Commission Head of the state of the EU Leads the European

Commission Represents EU to other

nations Jose Manuel Barroso, the

former Prime Minister of Portugal, began his term in 2004, taking over from Romano Prodi, the former Prime Minister of Italy

The Vice-President (since 2010) is High Representative Baroness Catherine Ashton (of the UK)

European Commission

The executive branch of the EU serving much the same function as the cabinet in the USA or UK

Proposes legislation to the Council of Ministers

Administers EU programs Represents the EU in economic

relations with other countries or international organizations

Each commissioner has a special “portfolio” of responsibilities, such as competition or agriculture

Council of Ministers Main lawmaking body of the EU Composed of a single representative

from each member nation The Council can accept or reject

legislation proposed by the European Commission, but it cannot draft legislation itself

Intended to provide a balancing forum for more narrow national interests

The voting rules of the EU allow a minority of member states to block action in the European Commission when they believe their national interests are threatened

European Council Meetings of the EU heads of states

and governments are called the European Council

Meetings are held at least once every six months by the country holding the Presidency of the Council of Ministers

European Parliament The only body of the EU whose

members are directly elected by the citizens of its member states

European Parliament committees review legislation proposed by the European Commission and may propose amendments to the legislation before submitting it to the Council of Ministers

May veto a proposal after it reaches the Council of Ministers if it does not agree with the Council's position

Has 754 members as of 2009 President of the European Parliament

(elected in 2012): Martin Shulz (German Social Democrat)

European Parliament (cont.)

Organized along political party lines, not according to national citizenship For example: socialists from all EU

nations act together, as do conservatives and other groups

Provides a forum for debate and discussion from the perspective of political ideology, not national interest (Council of Ministers) or European interest (European Commission)

Not a legislative body but can have important influence over EU policies

European Parliament

European Parliament National apportionment of MEP

seats (2009)  Germany99 France72 Italy72 United Kingdom72 Spain50 Poland50 Romania33 Netherlands25 Belgium22 CzechRepublic22 Greece22 Hungary22 Portugal22 Sweden18 Austria17 Bulgaria17 Finland13 Denmark13 Slovakia13 Ireland12 Lithuania12 Latvia8 Slovenia7 Cyprus6 Estonia6 Luxembourg6 Malta6

Total: 737

European Court of Justice

“Supreme Court” of EU law Composed of 27 judges who are

appointed to six-year terms President: Vassilios Skouris (since

2003) Deals with disputes between

member governments and EU institutions and among EU institutions and with appeals against EC rulings or decisions

Made up of one representative from each of the EU member nations

European

Central Bank

EU's central bank Created after the decision to adopt the euro Executive board, appointed for eight-year terms,

and a governing board which includes the executive board and the heads of all EU member nation central banks

Currently responsible for the monetary policy of the 17 member states of the Eurozone (Austria, Belgium, Cyprus, Estonia, Finland, France,

Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia and Spain)

The 1990's The collapse of communism

eliminated the threat of Soviet domination but not the need for peaceful cooperation

The questions for Europe now are: Is Europe just a geographical unit that

lies north of Africa and west of Asia? Will it be united by money (its common

currency, the euro) alone? Will it become more – Europa – a

people with a common will? Will it remain intact after the current

financial crisis?

Post-Cold War Issues Confronting the EU

The EU was confronted with at least several issues at the end of the Cold War:1)The Ever-Wider Union:

✗ How to accommodate the new demands for membership in the EU without hopelessly alienating current EU members

✗ How to deal with rising membership applications at the end of the Cold War

✗ 12 countries filed formal membership applications:✗ Cyprus, the Czech Republic, Estonia, Hungary,

Poland and Slovenia were given top priority – joined in 2004

✗ Bulgaria, Latvia, Lithuania, Romania and Slovakia were given second priority – joined in 2004 (with the exception of Romania and Bulgaria which joined in 2007)

✗ Croatia awaits membership and Macedonia has received candidate status

✗ Turkey's application continues to be snubbed✗ New members were and will continue to be poorer

than current members causing tension between member states

✗ Like it or not, the EU opened its gates to these countries to ensure democracy persists

Post-Cold War Issues Confronting the EU

(cont.)2) The Challenge of the Regions:

✗ What to do about demands for greater regional autonomy within the EU

✗ As nation-states secede power within the EU, regions have begun to assume more importance

✗ Sometimes the regional focus is rooted in culture, for ex.: Catalan region in Spain

✗ In other places the issue is money and the perceived need to be free of the shackles of national government, for ex.: Bavaria in Germany and Northern Italy

✗ The EU needs to find a way to address the desires of richer regions while trying to accommodate newer members

Post-Cold War Issues Confronting EU (cont.)

3) The Security Issue:✗ How to deal effectively with security

issues other than the Soviet threat✗ EU is surrounded by conflicts (the

Balkans, Middle East, North Africa) and threats (terrorists, environmental dangers, organized crime, illegal immigration)

✗ Europe needs a common defense policy, however, a collective policy would require a good deal more political unity than the EU has ever demonstrated in the past

Post-Cold War IssuesConfronting the EU

(cont.)4) The German Problem:

✗ How to make sure that Germany remains committed to a united Europe without dominating it

✗ The German problem was one of the original problems that the EC was meant to address

✗ Germany today, a decade and one half after unification of its Eastern and Western sections, finds itself bound by the EU to the rest of Europe but faced with very serious economic, social and political problems at home, both in the poorer Eastern provinces and in the rising tensions between East and West

✗ Germany has so many domestic problems that it would be natural for it to put domestic issues above those of European unity

✗ RISING NATIONALISM – a new problem??✗ The Economic Crisis? What will become of the EU

and and the Eurozone?

Post-Cold War IssuesConfronting the EU (cont.)

5. The Political Challenge of the Euro Once the Euro was launched in 2002 the

member nations faced a transformed political environment

Their ability to influence domestic economic conditions was much reduced and interest rates were now set by the ECB and not the policymakers of these states – this left national leaders in an awkward position.

One state’s economic problems also become problems of other member states (ex. Greek financial crisis)

Post-Cold War IssuesConfronting the EU (cont.)

6. The Constitutional Challenge In its movement towards an “ever

closer union” the EU is aiming at political union and an EU constitution – this raises issues of national sovereignty.

The draft of the Constitution was rejected in referanda in France and the Netherlands in 2005

Monetary Union Discussed in Maastricht in 1991 France proposed a single currency In theory, a monetary union was

supposed to address the four issues mentioned previously

A single currency would make European markets more efficient and Europe's economies more dynamic

It would provide economic gains to offset the costs of enlargement and boost the prospects of the regions; the German problem would be soved because Germany would be chained to the rest of Europe with money

Monetary Union (cont.) Finally, political cooperation would be

accomplished through an indirect mechanism – with a single currency EU nations would need to cooperate more on political issues

Germany did not have much interest in a common currency. It saw more to lose than to gain because of its strong deutschemark – however Germany wanted a political union

Monetary Union (cont.) A deal was struck – Germany would

gets its political union and France would get its monetary union (before Maastricht)

However, at the end of Maastricht, the monetary union had been adopted and the political union was not

The criteria for nations to be part of the single currency: Low government debt Low inflation rates Low interest rates

Greece initially failed to qualify on economic grounds and the UK and Sweden opted to remain outside the euro zone

Political Economy of the Euro

The euro is still a political issue The name euro was chosen because it

means nothing in any European language (ECU – European Currency Unit was considered but was rejected because France once had such a coin in medieval times)

Images on any euro currency look like what appears to be classic Europe but none of them are authentic because putting any real European scene could lead to disagreements

The euro symbol € means nothing

Political Economy of the Euro

Three levels of political issues that surround the euro:1)The monetary union has created a reason

for nations to unify in the absence of a common security threat. Being left out of the euro might mean being doomed to peripheral status.

2)Qualifying for membership in the monetary union has forced European nations to make very difficult political decisions like cutting government spending, increasing taxes and becoming more laissez-faire.

3)The single currency changes the domestic political environment – member nations will not longer be able to spend their way out of a recession or print money to pay for unemployment because fiscal autonomy is surrendered.