European Economic Integration 1The macroeconomic aspects of integration

Fabrizio Coricelli salle 117/D641 (S) (fabrizio.coricelli@gmail.com)

Presentation of the course The course will analyze the process of European Integration, discussing mainly the macroeconomic aspects and economic policies, monetary and fiscal. Emphasys will be placed on the specificty of the European experience that has lead to the creation of the European Monetary Union. The introductory lecture starts with the historical background of the European integration.

Topics of the lectures

Part 1 History1. History 2. Economic integration and Enlargements 3. Monetary and Fiscal rules 4. Implications for current crisis

Part 2: The road to EMU1. Whats behind the choice of an exchange rate regime? 2. A monetary History of Europe and the road to EMU 3. Is EMU an Optimal Currency Area? 4. The impact of EMU on trade and specialization

Part 3: Policies in EMU

Monetary and fiscal policy in EMU

Part 41. European integration and globalization 2. Capital flows, current account and growth 3. Boom and bust 4. Why several EU countries were hard hit by the crisis?

Reading listBaldwin R. and Ch. Wyplosz (2009): "The economics of European integration", McGraw-Hill, 3rd edition De Grauwe, P. (2007), Economics of Monetary Union, Oxford University Press, 7th Edition. Papers will be indicated during the course

Practical information Material for the course: EPI

Part 1History

Early Post War Period A Climate for Radical Change: Facts:Death toll The Economic Set-Back: Prewar year when GDP equalled that of 1945 1886 1924 1936 1938 1891 1908 1909 1912 1937 GDP grew during WWII GDP grew during WWII GDP grew during WWII

Austria Belgium Denmark Finland France Germany Italy Netherlands Norway Sweden Switzerland UK

525,000 82,750 4,250 79,000 505,750 6,363,000 355,500 250,000 10,250 0 0 325,000

The prime question in 1945 How can Europe avoid another war? What caused the war? 3 answers Blame the loser (as after WWI) Blame capitalism Blame destructive nationalism

These implied 3 post-war solutions Neuter (rural) Germany, Morgenthau Plan 1944 Adopt communism Pursue European integration

European integration ultimately prevailed, but this was far from clear in the late 1940s.

The origins of 3rd solution The natural effect of trade is to bring about peace. Two nations which trade together, render themselves reciprocally dependent; for if one has an interest in buying, the other has an interest in selling; and all unions are based upon mutual needs. Montesquieu, 1758. There will be no peace in Europe, if the states are reconstituted on a basis of national sovereignty, with all the prestige policies and economic protection involved, Jean Monnet, 1943. Preamble to the Paris Treaty of 1951 establishing the ECSC (European Coal and Steel Community): resolved to substitute for age-old rivalries the merging of their essential interest; to create, by establishing an economic community, the basis for a broader and deeper community among peoples long divided by bloody conflicts.

The War Trade relationship Is it true that more trade lead to less wars? Very debated issue in Pol. Sci. Economists: trade increases the opportunity costs of conflicts RTAs (regional trade agreements) offer a forum for resolving disputes BUT, decreases the opportunity costs of conflicts with 3rd countries.

In the European (and other RTAs) case, the two first effects have largely dominated.

Military Conflicts in Europe

The Greece-Turkey case

Determinants of wars

What next? Simulations for Turkey

Global trade does not affect probability of war

Emergence of a divided Europe Cold War begins on a clash between 2nd and 3rd solutions. USSR pushes communism in the East. UK, French and US zones merged by 1948 Moves towards creation of Germany & Berlin divided into 4 West German government. zones Berlin blockade, 1948.

Neuter Germany solution abandoned for strong West Germany + European integration.

East German Guard Towers

First Steps First Steps: the OEEC and EPU OEEC (Organization for European Economic Cooperation) and EPU (European Payments Union) set up in conjunction with Marshall Plan, 1948. OEEC coordinated aid distribution and prompted trade liberalisation, became OECD in 1961. EPU facilitated payments and fostered trade liberalisation (1950-58).

Note that it is the USA that insisted on a permanent centralized organization and internal trade liberalization.

In first post-WWI years, EU nations were bankrupt, and trade often took the form of bilateral barter. EPU ended the need to have bilateral balanced trade + strong pressure to end quantitative restrictions. Intra-OEEC trade boomed + very rapid growth, which showed policy makers that trade and growth were not ennemies. Important trade surplus with USA which stabilized financial situation: possible to restore convertibility of currencies, and thus more private trade.

Need for deeper European integration As Cold War got more war-like, West Germany rearmament became necessary. 1949, Fedl Rep. of Germany established. But strong and independent Germany was a scary thought to many, including many Germans. Wide-spread feeling: best to embed an economically and militarily strong W. Germany in European superstructure. Problem: OEEC was too loose to avoid future war among Western European powers.

Two strands of European integration Federalism and intergovernmentalism Disagreement about depth of European integration / role of nation-states in wars. Federalism supranational institutions (favoured by most hit nations) Intergovernmentalism nations retain all sovereignty (favoured by relatively spared / neutral countries)

Intergovernmental initiatives OEEC (1948), Council of Europe (1949), EFTA (1960)

Federal initiative ECSC-European Coal and Steel Community (1951), EEC (European Economic Community) (1957 Treaty of Rome, EEC starts in January 1958)

ECSCs radical federalist move Two industries were viewed as the key inputs for economic growth and military capacity. Schuman Plan proposed that France and Germany place their coal and steel under the control of a supranational High Authority , ancester of todays European Commission. Designed to make war between the two materially impossible. Other European nations invited to join: Belgium, Luxemburg, Netherlands and Italy did. Group of the 6 that will remain the core of integration in Europe.

The road to EC Encouraged by the ECSC, Monnet pushed for two even more ambitious plans: European Defence Community (EDC) European Political Community (EPC)

French Parliament rejected EDC in 1954 (Gaullist opposition), EPC abandoned. The natural way forward was therefore to pursue economic integration.

The EEC Foreign ministers of the Six started in 1955 a process that ended with the signing of the Treaty of Rome in March 1957 (implemented January 1958). Customs Union (removing all trade barriers + common external tariff, ahead of schedule), Free labour and capital mobility, Range of common policies implemented by a supranational European Commission, Several other supranational institutions, such as European Parliament and Court of Justice.

The EFTA Formation of EEC changed trade liberalization conditions in Europe: OEEC was non-discriminatory EEC would go much further, but discriminatory

Other OEEC members, led by UK had fear of dealing with the new block on their own: 7 (out of 11) form their own block (EFTA) in 1960. Finland joined EFTA in 1961, Iceland in 1970 Greece and Turkey applied for associate EEC membership in the late 50s Spain signed a preferential trade agreement with EEC in 1970 and EFTA in 1979.

1960-1973, two non-overlapping circlesIS EFTA-7 NL D B L F N S I EEC-6 IR L UK P CH DK A FIN

E

West European Trade Arrangements in : 1960s The EFTA-7 and the EEC-6 form two GR non-overlapping circles.

Two unequal circles In 1958, Intra-EEC trade was 30% of EEC total trade, this share went to 45% in 1968. Meanwhile, EFTA countries share in EEC countries trade remained flat. A UK exporter on the French market suffers a relative disadvantage compared to German exporter. Converse is true, BUT EEC >> EFTA, in 1972: ECC = 727 bn USD EFTA = 306 bn USD

Evolution to Two Concentric Circles Preferential liberalisation in EEC and EFTA proceeded (EECs customs union and EFTAs FTAs completed by 1968)

Discriminatory effects emerge, leading to new political pressures for EFTAs to join EEC Trade diversion creates force for inclusion As EEC enlarges, force for inclusion strengthens

When UK decides to apply for EEC (1961), 3 other EFTAns also change their minds. De Gaulles non (twice)

Evolution to Two Concentric Circles First enlargement, 1973 UK, Denmark, Ireland & Norway admitted (Norwegians say no in referendum)

Enlargement of EEC reinforces force for inclusion on remaining EFTAs Remaining EFTAs sign FTA agreements with EEC-9 Why werent the FTAs signed before? Domino-like effect of lowering barriers 1st within EEC6 enlargement EEC-EFTA FTAs

Two concentric circlesWest Europe's Trade Arrangement in mid-1970s :IS FIN DK NL UK B D L F P N S EEC-9 A CH EFTA-7

IRL

I

E

GR

Euro-pessimism, 1975-1986 Political shocks: Luxembourg Compromise (1966, after crisis of the empty chair) + enlargement leads to decision-making jam (more unanimity needed).

Economic shocks: Bretton Woods falls apart, 1971-1973. Failed monetary integration schemes (except within DM bloc).

1973 and 1979 oil shocks with stagflation. Failure of deeper trade integration: TBT rose muchfaster than standards harmonization using old approach

Growing cost of Common Agricultural Policy creates frictions over budget.

Bright spots Democracy in Spain, Portugal and Greece Greece joins in 1981 Spain and Portugal join in 1986 after long a difficult accession talks EMS set up in 1979 works well Budget Treaties 1979 Cassis de Dijon decision built on 1974 Dassonville ruling Challenged validity of national rules that introduce non-tariff barriers to trade. Mutual Recognition Principle introduced.

Deeper circles: single market programme Mutual recognition as threat to national regulatory control; race to bottom? How to put member govt back in charge? Delors launches completion of the internal market with Single European Act create "an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured".

Important institutional changes, especially move to majority voting on Single Market issues. Mutual recognition is disciplined by minimum harmonisation More efficient decision making procedures allow agreement on min. standards New Approach Directives.

Single Market Programme, EC92 Basic elements Goods Trade Liberalisation Streamlining or elimination of border formalities, Harmonisation of VAT rates within wide bands Liberalisation of government procurement Harmonisation and mutual recognition of technical standards in production, packaging and marketing

Factor Trade Liberalisation Removal of all capital controls (!!!), and deeper capital market integration Liberalisation of cross-border market-entry policies,

Domino effect, part II Deeper integration in EC-12 strengthened the force for inclusion in remaining EFTAns. End of Cold War loosened EFTAns resistance to EC membership. Result of force for inclusion EEA: initiative to extend single market to EFTAs. Membership applications by all EFTAns except Iceland.

Concentric circles, but both deeper.

Fourth enlargement 1995, Austria, Finland, Norway and Sweden admitted (Norwegians again vote no).1995

1973 2004 1958 2007Cyprus

1986

1981

Malta

Communisms creeping failure and spectacular collapse By the 1980s, Western European system clearly superior due to the creeping failure of planned economies. Up to 1980s, Soviets thwarted reform efforts (economic & military pressure). Changes in USSR due to inadequacy economic system. timid pro-market reforms (perestroika). openness (glasnost).

Velvet revolutions in CEECs June 1989 Polish labour movement Solidarity forced free parliamentary elections & communists lost Moscow accepted new Polish government.

Moscows hands-off approach to the Polish election triggered a chain of events. Reformist in Hungarian communist party pressed for democracy & Hungary opened its border with Austria, 1000s East Germans moved to West Germany via Hungary and Austria. Mass protests in East Germany; Wall falls 9th November 1989. End of 1989: democracy in Poland, Hungary, Czechoslovakia and East Germany (unification in 1990).

USSR collapses 1990, Estonia, Latvia and Lithuania declared their independence from the USSR. End of 1991, the Soviet Union itself breaks up. Cold War ends without a shot. Military division of Europe ended.

EU reacts The European Union reacted swiftly to this geopolitical earthquake by providing emergency aid and loans to the fledgling democracies. After initial hesitations, signing of Europe Agreements with newly free nations in Central and Eastern Europe These are free trade agreements with promises of deeper integration and some aid

From Copenhagen to Copenhagen EU says CEECs can join the EU (June 1993). Set out famous Copenhagen criteria for membership. stability of institutions guaranteeing democracy, the rule of law, human rights and respect for and, protection of minorities, the existence of a functioning market economy as well as the capacity to cope with competitive pressure and market forces within the Union.

Copenhagen summit December 2002 says 10 CEECs can join in 2004. 5th enlargement in May 2004

German unification and Maastricht Pending 1990 unification of Germany opens door to a grand bargain (Mitterrand, Kohl). Germany gives up DM for European Monetary Union & East Germany joins the EU without negotiation.

Jacques Delors proposes 2nd radical increase in European economic integration. the formation of a monetary union. Idea championed by French President Francois Mitterrand and German Chancellor Helmut Kohl.

Maastricht Treaty, signed 1992 a monetary union by 1999, single currency by 2002. Also, sets up EUs three pillar structure to reduce EUs competency creep;

Extremely difficult ratification process: Short French Yes / Danish No then Yes / UK opt-out / German constitutionality challenge.

Preparing for Eastern Enlargement Impending enlargement required EU to reform its institutions Four tries: Amsterdam Treaty, 1997 Nice treaty, 2000 draft Constitutional Treaty, 2003 Reconsidered by IGC 2003

Constitutional Treaty, June 2004.

Amsterdam Treaty Failed to reform main institutions Tidied up of the Maastricht Treaty More social policy, Parliament powers modestly boosted, flexible integration, closer cooperation introduced

Amsterdam leftovers voting rules in the Council of Ministers, number of Commissioners, Extension of issue covered by majority voting

Nice Treaty Reforms of main institutions agreed, but poorly done Council voting rules highly complex and reduce EUs ability to act with more members No important extension of majority voting Make shift solution for Commissioners No reform of decision making in ECB

Generally viewed as a failure Main changes re-visited in draft Constitutional Treaty, 2003

Constitutional Treaty New procedure: Instead of having talks begin at the IGC European Convention designed to prepare the IGC More representation (national gvt + national and European parliaments + Commission representatives )

Dec. 15th 2001: Laeken Declaration Contains list of questions to be treated Focused on reforming Nice decision rules Term constitution introduced

Constitutional Treaty Improved decision-making rules for Council of Ministers and slightly more majority voting. Inclusion of Charter of Fundamental Rights. Other things where CT not strictly required: Many gestures and tidying up. Moves towards more coherent foreign policy decision making. Many de facto points turned into de jure.

Constitutional Treatys Problems First draft rejected by dec. 2003 IGC out of Spanish opposition to fall in voting power. Finally accepted in June 2004. France and Netherlands reject the Constitutional Treaty in referendums in Summer 2005. EU leaders suspend the ratification deadline. Next steps uncertain as of late 2007: short treaty?

Lisbon Treaty Despite inadequacy of Amsterdam and Nice Treaties reforms were not abandoned Germany (presidencey in 2007) relaunched the process Constitutional Treaty dead, replaced by a Reform Treaty: The Lisbon Treaty Plan: include constitutional treaty reforms in the Lisbon Treaty

continued Especially the more symbolic elements of the Constitution Treaty were eliminated (flag, anthem, foreign minister) New Treaty signed in Lisbon in December 2007 Irish referendum stopped the process in July 2008 but in 2009 decision was reversed Treaty approved in Decemnber 2009

Main changes 1 move from required unanimity to double majority voting in several policy areas in the Council of Ministers more powerful European Parliament as its role of forming a bicameral legislature alongside the Council of Ministers becomes the ordinary procedure, a consolidated legal personality for the EU

Main changes 2 and the creation of a long-term President of the European Council a High Representative of the Union for Foreign Affairs and Security Policy. The Treaty also made the Union's bill of rights, the Charter of Fundamental Rights, legally binding.

Voting threshold 1. 2. Nice Treaty Council voting arrangements will apply until 31 October 2014. After that period, the following rules will be used; however, until 31 March 2017, any Member-State can request that the Nice rules are used for a particular vote. To pass: Majority of countries (55% or 72% when acting without the initiative of the European Commission) representing 65% of the population or condition to block not met To block: At least 4 countries against the proposal or in cases where, under the Treaties, not all members participate the minimum number of members representing more than 35% of the population of the participating Member States, plus one member are against the proposal The Constitution envisaged the "double majority" system for the QMV (qualified majority voting) which better reflects the true size of populations and at the same time acknowledges the smaller member states' fears of being overruled by the larger countries. The Treaty of Lisbon has adopted this method. The second condition of at least 4 countries against the proposal is to ensure that the most populous Member States cannot block decisions and is important in 10 different voting scenarios where legislation requiring QMV can be passed although the population requirement isn't fulfilled and all member states except Germany and France and one of UK, Italy, Spain or Poland Germany and UK and one of Italy, Spain or Poland Germany and Italy and one of Spain or Poland France and UK and Italy are for the proposal.