The European Union, Economic Consequences

Introduction: Beginning
Introduction: (i)1951,European coal and steel community (ECSC) 6 countries (Belgium, France, W. Germany, Italy, Lux. Netherl.) signed the Treaty of Paris. (ii) 1957, Treaty of Rome European Economic Community (EEC) common market eliminated trade barriers (iii) 1967, European community (EC) and European parliament formed (iv) 1973 first enlargement of EC, Den UK Irel added=9 (v)1979 first election of European parliament, every 5 years since. (vi)1986 add Greece, Spain, Portugal= 12 (vii) 1992 European Union (EU) created. Treaty of Maastricht, further forms of coop in foreign and defense policies.(viii) 1995 Austria, Finland, Sweden join=15 (ix) 1999 New currency Euro launched, became unit of exchange for all EU except UK, Sweden and Denmark (x) 2002 citizens of 12 Euro area countries form European Monetary Union (UMU). (xi) 2004, 10 new countries join EU =25(xii) 2007 , Bulgaria, Romania join=27 (Euro Zone= 17)

Introduction: Performance
(i) Internally, the EU has abolished trade barriers, adopted a common currency, and is striving toward convergence of living standards. (ii) Internationally, the EU aims to bolster Europe's trade position and its political and economic weight. (iii) Because of the great differences in per capita income among member states (from $7,000 to $78,000) and in national attitudes toward issues like inflation, debt, and foreign trade, the EU faces difficulties in devising and enforcing common policies. (iv) Between 2004 and 2007, 12 states acceded to the EU that are, in general, less advanced economically than the other 15 member states. (v) Of the 12 most recent entrants, only Slovenia (1 January 2007), Cyprus and Malta (1 January 2008), Slovakia (1 January 2009), and Estonia (1 January 2011) have adopted the euro. (vi) Following the 2008-09 global economic crisis, the EU economy saw moderate GDP growth in 2010 and 2011, but a sovereign debt crisis in the euro zone intensified in 2011 and became the bloc's top economic and political priority. (vii) Despite EU/IMF adjustment programs in Greece, Ireland, and Portugal, and consolidation measures in many other EU member states, significant risks to growth remain, including high public debt loads, aging populations, onerous regulations, and fears of debt crisis contagion. (viii) In response, euro-zone leaders moved in 2011 to boost funding levels for the temporary European Financial Stability Facility (EFSF) to almost $600 billion, to make loan terms more favorable for crisis-hit countries, and to bring the permanent European Stabilization Mechanism (ESM) online in July 2012, a year earlier than originally planned. (ix) In addition, 25 of 27 EU member states (all except the UK and Czech Republic) have indicated their intent to enact a "fiscal compact" treaty to boost long-term budgetary discipline and coordination.

Introduction: Facts
Population: 503,824,373 (July 2010 est.) GDP $17.33 trillion (2011 est.) Growth rate: 1.6% (2011 est.) GDP per capita: $34,500 (2011 est.) Labor Force: 228.4 million (2011 est.) Unemployment: 9.5% (2011 est.) Distribution of family income- Gini Index: 30.4 (2010 est.) Inflation rate: 3% (2011 est.) Current Account Balance: -$32.72 billion (2011 est.)

I. Consumers/Producers Surplus
1.Consumer Surplus: (i) D curve shows the highest possible price at which some consumers willing to purchase each unit of the product. (ii) A consumer willing to pay a very higher price of 3600 for first unit. (2000 is market price) (iii) Consumers who would have been willing to buy at a higher price benefit from buying at the market price (v)The whole area under the D curve measures the total value to consumers from buying this quantity of output (c+t+u) (vi) But the consumers make payments equal to (t+u) only. (vii) The net gain to consumers is the difference between the value that consumers place on the product and the payments they must make to buy the product (viii) Thus, CS =(c+t+u) (t+u)= c, the area below D curve and above the price line (ix) If P increase1000-2000, CS increase to c+t+d (gain in Cs= t+d)

Consumers/Producers Surplus

National Mkt - no International Trade

2. Producers Surplus: (i) S curve shows the lowest possible price at which some producer is willing to supply each unit (ii) Some producer willing to supply first unit at $400 covering the extra cost of producing and selling this first unit , but sell at market price ($1000) (iii) ) Producers who would have been willing to supply at a lower price benefit from selling at the market price (iv) By adding up all S curves for each unit supplied, the whole area under S curve (z) is total cost of producing and selling this quantity of product. (v) But the total revenue (Q xP) received by producers is (area e+z). (vi) The net gain to producers is the difference between the total revenues received (e+z)) for units sold and the costs (z) that were incurred in producing the units of output (e+z)-(z) =e =PS(vii) PS is the area above the S curve and below the price line. (viii) If price incraese 1000-2000, Ps increase =e+w+v, Gain in PS= e+w+v(-)(e)=w+v 3. National Market with no International Trade: If no international trade then equilibrium at point A with a P=2000, QS=QD=4000 MBs. Both consumers and producers benefit as PS=h=32m and CS=c=32m

National Mkt No International trade

II. Welfare Effects of Free trade, tariffs, and Customs Union

II. Welfare Effects of Free trade, tariffs, and Customs Union

1. Welfare Effects of Free Trade. A=domestic economy, B=neighboring economy/ultimate partner in customs union, C=lowest cost producer in the world (ii) B is by and large a lower cost producer than A selling at Pb but it cannot compete with Cs price Pc. (iii) All of As imports of the good (gh) originate in C and the balance of consumption (Q1)is supplied by As domestic producers . So The free trade price in A=Pc and CS=pchx, and Ps=L. 2. Welfare Effects of a Tariff. (i)A imposes a protective tariff of magnitude t. (ii) Price within A is increased by the full amount of tariff from Pc to Pt. (iii) Price in neighboring country B is, in the presence of tariff, priced at pb+t which is still above Cs price of Pc+t or pt.

Welfare Effects of Free trade, tariffs, and Customs Union

(iv) As Imports therefore, come exclusively from the lowest cost producer C, but they are now restricted by the tariff to a level of ab (instead of gh). (v) The balance of domestic consumption is supplied by As own protected producers who are able to Expand production behind protective barriers.(vi) Revenue from tariff is rectangle abji volume of imports ab multiplied by the tariff t). (vii) The welfare effects of a tariff are = Fall in consumer surplus(pchbpt), increase in producer surplus,(pcgapt). Loss in CS>gain in PS. Total deadweight loss is 2 triangles aij and bhj.

Welfare Effects of Free trade, tariffs, and Customs Union

3. Welfare Effects of a Customs Union: (i) Now a customs union between country A and B Formed. (ii) All tariffs are removed between A and B but tariffs (t) are maintained with respect to ROW. (iii) Now tariff free goods from B are cheaper than the tarifed goods that originate from C. (iv) As a result M from C (ROW) eliminated and instead originate in B. Price established in A is Pb. (v) Total M =ef, part of this total cd(ab) replaces imports from C (called trade diversion effect of a customs union).(v) ec replaces part of domestic production called trade creation effect. ef increases in consumption brought about by decrease in price. (vi) Increase in CS= pbfbpt, decrease in PS=pbeapt, forgone tariff revenue abdc.

Welfare Effects of Free trade, tariffs, and Customs Union

(vi) the gain in CS is pbfbpt and is clearly greater than the sum of the loss of PS=pbeapt and (+) the forgone tariff revenue abdc. (vii) compared to the situation in which A imposes a tariff on imports from all sources, the customs union does represent a welfare gain. As consumers in A gain access to goods at a lower price (pb) than would be the case if tariff barriers were imposed on all imports. (viii) However these welfare gains are smaller than those that would result under free trade. (ix) the largest benefit from As entry into the market in this example goes to the producers and workers of B who gain access to As market. They see their production increase by an amount ef to meet the demand from A.

Welfare Effects of Free trade, tariffs, and Customs Union

(x) Compared to free trade As consumers are losers, and the only gainers are the producers of B. (xi) Consequently viewed, in a strictly static way, A would only join a customs union if it felt that in some industries it was in the position of lowest cost producer of the member nations. In reality this outcome does reflect the perceived benefits of joining the EU. (xii) The greater overall size of the market allows greater specialization and division of labor. Economies become more open and trade flows increase. Some domestic industries are likely to decline as imports from other member countries cut into the market, while the output of other industries increases.

III. Economics/Costs-Benefits of a Single Currency

The Economics of a Single Currency 1.The Benefits of a Single Currency: (i)Elimination of currency conversions releasing substantial resources in the banking sector (ii) End of exchange rate uncertainty, which should encourage trade and allow more efficient allocation of resources within the EU through specialization and economies of scale (iii)Participating nations can largely eliminate their holdings of international currency and bullion reserves. The combined reserves of the members of EU in 1990 was about ECU 200B, while USA with an economy similar in size had reserves of only about ECU 40B. (iv) The creation of a common European unit will increase the importance of European currency in world markets. More of the worlds reserves will be held in Euros (v) EU will be able to benefit from seigniorage (difference between costs of production of a currency note and its value).

Economics/Costs-Benefits of a Single Currency

2. The Costs of Single Currency: (i)Non-availability of exchange rate policy as a means of accommodating shocks and balancing the external accounts. (ii) If all parts of the Union are hit similarly by an economic shock, it can be accommodated by coordinated union wide monetary and possibly fiscal policy. (iii) The more a country resembles union wide average the less harmful is the loss of an exchange rate flexibility. (iv) The greater the similarity between the structures of all the member countries the more likely is it that it comprises optimum currency area. 3. The degree of mobility factor also affects the desirability of a currency union. Highly mobile labor or capital help adjustment to a negative shock by moving quickly from the impacted region to areas where they are in higher demand. (vi) But, labor mobility between nations in EU is much lower than the interstate mobility in USA. Language and cultural factors as well as generous UE assistance tend to keep people at home.

IV. Labor Markets in EU

Characteristics of Labor Markets in EU. 1.High Social Protection Costs Cause High Unemployment: (i) EU committed to idea of substantial degree of social protection, guaranteeing incomes and services for those out of work , and the principle of equal pay for equal work (ii) public expenditure on social protection average 22% of GDP in EU15, 35% in some North European countries, but only 15% in USA and only 12% in Japan. (iii) These objectives tend to lessen labor market flexibility and increase unemployment. (iv) High level of income protection means a loss of urgency on the part of the job seeker and leads to high unemployment and a less flexible labor market. (v) A case can be made for the economic efficiency of more protracted periods of unemployment, because a longer period of search should ultimately ensure better match between the requirements of the vacancy and the skills of the applicant

2. The System of Collective Bargaining: (i) In Western Europe most workers are covered by national wage agreements, negotiated at the industry level, as opposed to being subject to more flexible plant or enterprise agreements more common in the USA context. (ii) Individual employers therefore have remarkably little control over what they pay their workers, a source of labor market inflexibility contributing to joblessness. (iii) The rising unemployment rates in EU countries favor the trend toward decentralization, and national and industry wide bargaining are now losing ground.

3. High Reservation Wages and Replacement Rates Cause High Unemployment: : (i) Reservation wage is defined as the lowest wage that will induce an unemployed person to accept a job. (ii) The replacement rate is the percentage of take home pay that continues to be received after loss of employment. (iii) The generous income support for the unemployed means that a job search tends to be less pressured . (iii) This degree of support leads to workers adopting high reservation wages. (v) In France, for example, a married person with 2 children receives 88% take home pay when first unemployed. (vi) Even by the 60th month of unemployment , a French worker would still receive 83% of initial in-work take home pay.

4. Non-wage Costs: (i) Transfers to the unemployed, the disabled, and the elderly are generally financed by heavy pay roll taxes , shared by the employers and the workers, (ii)The policies institute a vicious cycle; rising UE pushes up the total cost of social protection, causing an increase in the pay roll taxes. (iii) Because payroll taxes are levied on a shrinking work force and must support more dependents, the tax rates must rise, discouraging employment. (vi) Combined pay roll tax on the lowest paid and least skilled workers was about 62% with employers paying social security contributions of about 40% of gross wages and the employees contributing an additional 22%. (vii) Thus, although increases in wages themselves were moderating real cost for unskilled labor in France were about 40% higher than in USA.

5. Fragmented Labor Markets: (i) Although the European Union constitutes a single economic space , its labor market is highly fragmented. (ii) Regional, national, cultural, and linguistic differences cause pockets of high unemployment to coexist with area of tight labor demand. (iii) This fragmentation occurs within a single member country. Eg. UE in Northern Italys Alto Adige region is 3.4% whereas in Campania and Calabria in the south the rate is more than 25%. (iv) Within the EU as a whole even larger differences exist . Luxembourg has a jobless rate of 3.2% while Andalucia a poor region of South Spain, experiences 32% of unemployment. These are unusually profound differences in the absence of legal barriers to the movement of labor.