European Economics

Interactive Tests & Preparatory Material for Open Competitions

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 Content

I. Economic integration

II. Economic constitution of the EU

III. Integration and liberalisation

IV.Common Competition and Trade policy

V. Economic and Monetary Union

VI. Policy coordination, regulatory strategy

I. Economic integration

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 Economic integration

 Definition: elimination of economic frontiers between

two or more economies
 Significance: increase of actual and potential
competition
 Development of the Community was driven by market
integration and selective common economic policies
 Negative integration: removal of discrimination in
national economic rules and policies under joint
surveillance
 Positive integration: transfer to common institutions, or
the joint exercise of at least some powers
 Stages of economic integration
Stage Definition Characteristics
Free trade Tariffs and quotas abolished for Essence of GATT
area (FTA) imports from area members definition; no
area members retain national positive integration
tariffs against third countries
Customs Suppressing discrimination for Essence of GATT
Union (CU) CU members in product markets definition; no
Equalisation of tariffs in trade positive integration
with non-members (common
external tariff)
Common A CU which also abolishes Beyond GATT;
market (CM) restrictions on factor movements definition should
include services;
no pos. integrat.
 Stages of economic integration
Stage Definition Characteristics
Economic A CM with some degree of Positive
Union harmonisation of national integration
economic policies in order to introduced;
remove discrimination extremely vague
Total Unification of monetary, fiscal, Centralist; vision
economic social and counter cyclical of unitary state;
integration policies supranationality
Setting up a supranational only introduced
authority where decisions are here
binding for the Member States
II. Economic constitution of
the EU

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 Rome Treaty (EEC Treaty) 1957
 Economic aims:
• harmonious development of economic activities
• Continuous and balanced expansion
• Increase in (macro-economic) stability
• Accelerated raising of the standard of living
 Means:
• the common market (Customs Union, 4 economic
freedoms)
• approximation of economic policies (common
trade, agricultural, competition and transport
policy; approximation of economic regulation)
 Rome Treaty (EEC Treaty) 1957

Key principles:

 Community loyalty
 Non-discrimination as to nationality
 Widening of powers, only within the operation of
the common market
 ‘Rules, not money’ (the EEC is a regulatory
machinery, not a spending spree)
 Single European Act (1985)
 Economic aims, the common market, the four common
policies attached to ‘approximating economic policies’, the
key principles and the institutional framework is untouched
 5 additions:
• Far more qualified majority voting (QMV) on internal
market matters
• An explicit, unambiguous definition of the internal market
area without frontiers, freedoms ensured
• Mutual recognition as a regulatory principle
• Approximation of health and safety in the workplace
• Economic an social cohesion (Structural Funds)
 Single Act codified a number of existing policies, including
the European Monetary System (EMS), R & TD policy and
environment
 Maastricht Treaty (Treaty on EU) 1991

 Economic aims reformulated and extended:

• Harmonious & balanced development of economic
activities
• Sustainable & non-inflationary growth, respecting
the environment
• High degree of convergence of economic
performance
• High level of employment & of social protection
• Raising of the standard of living & the quality of life
• Economic & social cohesion & solidarity among
Member States
Maastricht Treaty (Treaty on EU) 1991
 Means:
• Common market (old)
• Common policies (formerly ‘approximation of
economic policies)
• Economic and Monetary Union (EMU)

 Key principles: two groups added:

• Stable prices, sound public finances and
monetary conditions, sustainable balance of
payments
• Subsidiarity, maintenance in full of the acquis
communautaire
 Amsterdam Treaty (1997)

 Very limited economic significance

 Economic aims reshuffled and one (equality of men
and women) added
 Social Protocol incorporated
 Employment strategy included
 Stability and growth Pact agreed
III. Integration and
liberalisation

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 Integration and liberalisation
 Common market for goods: in reality a customs
union entailing the obligation to eliminate all tariffs
and quotas in trade between MS and establish a
CET (Common external tariff)
 Elimination of trade restrictions exposed the fact that
internal market for goods and services remained
fragmented into national markets by regulatory
barriers
 New impetus to integration came in the eighties to
stem nationalistic and protectionist tide after the oil
shocks
Single European Act
 Integration and liberalisation
 Legislative programme (Cockfield’s White paper)
approved by European Council (June 1985) to achieve
internal market (IM) by 1992
 Single Act introduced the IM objective (and deadline)
in EC Treaty and QMV for IM measures (goods,
services, capital, but NOT fiscal measures and free
movement of persons)
 Basic goals: elimination of non-tariff barriers (physical,
technical, fiscal) and realisation of ‘four freedoms’
 Integration and liberalisation
 Negative integration, that is removing obstacles
through the principle of mutual recognition, rather
than harmonisation
 Harmonisation only for health, safety and consumer
protection (Directives set the ‘essential
requirements’)
 Reversing the burden of proof (national restriction
justified by the MS creating the barrier)
 Removing fiscal barriers: destination principle
 Mutual information directive (Directive 98/34/EC):
requires MSs to notify all their technical measures
affecting Internal Market
 Product market integration
Contains a mixture of liberalisation, approximated
national regulation and common policies:
1. Approximation: customs, regulations, indirect tax
• depend on political will to harmonise
• Problems: vested interests, inefficiency of the
decision making system
1. Liberalisation: must give ‘free movement’, right to
access, no tariffs and quotas, no regulatory barriers
• Lacking international precedents in removing
regulatory barriers
• Post-war period: significant intensification of
economic regulation
 Product market integration
3. Common policies
 Common trade policy: Going far beyond the CET (Common
external tariff) requirements in GATT, but exceptions:
• Agricultural Trade
• Quotas vis-à-vis third countries (trade deflection)
• Preferentialism in an era of decolonisation
 Competition policy: to prevent subsidies or restrictive business
conduct from replacing the removed tariffs
• Monopoly abuse prohibited
• Compromise clause on public enterprise
• State aids prohibited
 Supporting/flanking policies:
• Common transport policy = essential complement of the free
movement of goods
• Exchange rates: flexible rates after 1970
• Social policies: very weakly formulated
 Product market integration
Principles
 Harmonisation is limited to to essential requirements
 Only products fulfilling the essential requirements may
be placed on the market and put into service
 Harmonised standards transposed into national
standards which conform to the essential
requirements
 Application of harmonised standrds or other technical
specification remains voluntary, manufacturers are
free to chose any technical solution that provide
compliance with essential requirements
 Services market integration
 Definitions:
• temporary services = cross-border services (Art.
49-55 EC)
• permanent services = provided permanently in
another EU country (right of establishment) (Art 43-
48 EC)
 Method of establishing an internal market for services
• obligation to abolish restrictions on free movement
• standstill clause (= no new restrictive regulation)
• a programme approach : Council takes measures
with QMV
• non-discrimination clause for remaining restrictions
to all residents
 Services market integration

 To test if national regulations are compatible with

free movement of services:
• justification test = only public interest can justify
derogations
• home country control test = supervision and
verification in the home country must be taken
into account in the host country => no
unnecessary duplication of required conditions
• proportionality test = if restrictions are justified,
then only use the least restrictive means
 Services market integration

 Why regulate: market failures in services:

• Internalities: asymmetries of information (moral
hazard, adverse selection)
• Imperfect competition: entry/exit costs, market
power
• externalities
 Bolkestein directive on the Internal
Market for services
 harmonisation of legislation
 stronger mutual assistance between national authorities
 measures for promoting the quality of services
 encouraging codes of conduct

Freedom of establishment
 administrative simplification measures
 establishment of ‘single points of contact’
 principles for authorisation schemes
 prohibition of certain particularly restrictive legal requirements

Free movement of services

 country of origin principle
 right of recipients to use services from other Member Sates
 mechanism to provide assistance to recipients who use a service
provided by an operator established in another Member State
 Labour market integration
 Free movements of goods, services, capital, persons
(Art 3, EC). Labour nowhere in treaty
 Workers, in art. 39-42, EC: legal free movement;
national treatment
 However, unfree movement. Main economic reason:
social protectionism:
• Host country control (lower wages not negotiable
so no price competition)
• Local workers advantages: language, work habits,
networks…
• Other reasons: social security, tax, health
insurance, housing, etc.
 Labour market integration
 What has been achieved:
• Free movement
• Art 42. aggregation of social security between
countries
• National treatment
 What should be achieved:
• Approximation of national labour market regulation,
need for mutual recognition and minimum
standards
• Mutual recognition of qualifications of workers and
professionals
• Union-wide access to social security
• Supporting/flanking measures (on health insurance,
pensions, etc.)
 Labour market rigidities in EU
 wage bargaining (degree of unionisation and
coordination between employers and employees,
minimum wage)
 job protection and flexibility of working arrangements
(working times, type of contracts, health and safety
regulations)
 generosity of income replacement for unemployed

Results in:
 high labour costs
 capital intensive production
 rising structural unemployment rate
 Integration and liberalisation
Changing priorities after mid-90s
 Labour and product market flexibility
 Capital market integration
 Reduce taxation and tax distortions

Objectives (key areas):

 Quality of regulatory environment, including the MSs
 Removing remaining obstacles: applying present
rules, closing gaps in legislation
 Improving performance of financial services
 Competition and liberalisation
 Taxation
IV. Common Competition and
Trade policy

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 Common Competition policy
Agreements
 Horizontal agreements (two competitors in the
same market level): market sharing, setting quotas,
fixing prices
 Vertical agreements (firms at different market
level): exclusive purchase or distribution or
franchising
 Art. 81 forbids restrictive agreements that may
affect intra-Community trade and may have as their
objective or effect the prevention, restriction or
distortion of competition
 Common Competition policy
Monopoly
 Art. 82 prohibits abuse of dominant position
 Four conditions: (1) firm be dominant (2) its actions have
affect on the common market (3) dominant firm abuses
its position (4) this abuse affects trade between MSs

Merger regulation Art. 23

 Access whether concentration (1) falls within
Commission competence (2) creates or strengthen
dominant position (3) is incompatible with the common
market
 Merger task Force: notification and information obligation
for mergers above thresholds. Fines for incorrect
 Common Competition policy
State aid policy Art. 87
 Subjects of regulations are member States
 State aid incompatible if it is specific to certain firms,
threatens to distort competition and affects trade within
IM
 Critical areas for state aid: regional policies, sectoral aid
(crisis management), horizontal aid for general
purposes
Services of general interest (public service)
 Art. 16: MS shall take care that such services operate
on the basis of conditions which enable them to fulfil
their mission
 Public authorities may lay down specific obligations for
the provision of these services (see also Art. 86)
 Common Trade policy
 Common trade policy is justified by negative
externalities, generated by disparate national trade
policies (subsidiarity)
 Principle governing EU trade policy: an open market
economy with free competition
 Objectives: the harmonious development of world trade
the progressive abolition of restrictions on international
trade and the lowering of customs barriers
 Instruments: tariffs, preferential tariffs, quotas, VERs,
anti-dumping duties, price undertakings, regulatory
barriers, export subsidies, domestic subsidies, licences
 Common Trade policy
 Tariff protection has became relatively unimportant in the
EC, except agriculture
 All EC tariffs are bound in GATT
 Generalised system of preferences (GSP): introduced for
developing countries in 1971, EU tariff reduced or
eliminated (agriculture excluded)
 Cotonou agreement (formerly Lomé Group): trade
preferences and development aid for 79 ACP countries;
most manufactured products have tariff-free entry to EU;
some preferences on agri products
 ‘Everything but arms’ initiative for 48 least developed
countries, EU suspended tariffs unilaterally
 Euro-Mediterranean Agreements with North African
 Common Trade policy
Pyramid of trade preferences

EFTA
Least Developed Countries
Euro-Mediterranean agreements
ACP countries
Europe Agreements

Generalised system of preferences

GATT/WTO ‘most favoured nation’

Others (i.e. Russia)
V. European Monetary Union

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 Bretton Woods Regime

 Fixed exchange rates

 all currencies defined in terms of gold
 margin of fluctuation fixed at +/- 1%
 Problems:
 asymmetry (n-1 problem = each country cannot
have independent exchange rate policy)
 Realignments
 speculative effects
 Towards monetary integration
 Werner Report (1970) envisaged monetary
integration in 3 steps to be completed until 1980
 Oil shocks in the 70s – not even the first stage
introduced
 1972 some countries agreed to limit the diameter of
the fluctuation band between their currencies to
2,25%
 Brussels resolution established the European
Monetary System (EMS), which came into operation
in 1979
 All countries of the EEC members of EMS, but
participation in Exchange Rate Mechanism (ERM) is
voluntary
 Avoid Bretton - Woods problems
To avoid Asymmetry problems, 2 rules
(1) The ECU (European Currency Unit) and not any
national currency would be the centrepiece of EMS
(2) Marginal interventions in the foreign exchange
market would be compulsory in the context of the
ERM
 ECU was defined as a basket of currencies of all MS
 ERM: bilateral parities of the currencies of the MSs
participating were fixed, maximum variation allowed
±2,25% (widened to ±15% in 1993) – ECU played no
role in setting up the ERM.
 Avoid Bretton - Woods problems

To avoid Realignments problems:

 on request of several participating countries, central
parities could be changed with the agreement of the
other countries

To avoid Speculative Attacks problems:

 Obligatory intervention by both central banks of the
MSs whose currencies have reached the margin of
the permissible band
 Financing arrangements between central banks
 European Monetary System

Functioning of EMS
 Established a fixed exchange rate system between
participating countries with institutional rules for
realignments
 It functioned as it was supposed to: a fixed but
adjustable exchange rate regime
 From February 1987 it became extremely rigid
 Broke down in 1992 (because of Maastricht treaty
vote in DK – no, FR – expected no; and liberalisation
of capital flows in 1990)
 Transition to Monetary Union
 Delors report (1989): three stages – superseded by
Maastricht T.
 Maastricht Treaty: takes over three stages approach
Stage 1: coordination of national monetary policies
Stage 2: transition to Monetary Union (began on 1 Jan.
1994)
 Establishment of the European Monetary Institute (takes
the duties of the central banks)
 MSs shall endeavour to avoid excessive government
deficits
Stage 3: Monetary Union (starting on 1 January 1999)
 Criteria for membership

1. Government deficit may not exceed 3% of GDP at

market prices. If it does, the Commission evaluates
weather it has declined substantially and
continuously, or the excess is temporary in nature.

2. Government debt may not exceed 60% of GDP. If it

does, the Commission shall take into account
weather the ratio is diminishing sufficiently and
approaching the reference value at a satisfactory
speed.
 Criteria for membership
3. The inflation rate is sustained and over the year
preceding examination, does not exceed by more than
1,5% of, at most, the 3 best performing MS. The CPI
shall be used.

4. Long term interest rates shall not exceed over the year
preceding examination by more than 2% that of, at mos
the 3 best performing MS in terms of inflation rates.

5. The MS shall have participated in the ERM of the EMS

and respected the normal fluctuation margins without
severe tensions for at least 2 years before the
examination.
 European Monetary Union
 On the day stage 3 begins exchange rates between
Community currencies and between these currencies and
ECU irrevocably fixed
 ECU becomes a currency in its own right, name replaced to
Euro
 Exchange rate policy vis-à-vis third party currencies is the
responsibility of the Council (ECB must be consulted)
 Ensuring budgetary discipline in Stage 3: Stability and
Growth Pact
 Not in EMU: Denmark and UK excluded themselves,
Sweden excluded for not having belonged to ERM (that’s
what it wanted), Greece did not satisfy several conditions
(joined in 2001)
 European System of Central Banks
 European Central Bank (ECB) established. ECB and
national central banks organised into a European
System of Central Banks (ESCB)
 ESCB primary objective: to maintain price stability
 Subordinate objective: without prejudice to the primary
objective, to support the general economic policies in
the Community, with a view to contributing to the
achievement of the objectives of the Community
 ESCB basic tasks: define and implement monetary
policy, conduct foreign exchange operations, promote
smooth operation of payment systems, hold and
manage the official foreign exchange reserves of the
participating MSs
 Monetary Policy
 Price stability objective defined as: a year-on-year increase
in the Harmonised Index of Consumer Prices (HICP) for the
euro area below 2%
 Two pillar strategy to maintain price stability:
1. Monitor monetary and credit aggregates: prominent role
assigned to money (M3)
2. Watch overall output, demand and labour market
conditions: analysing demand and supply, and the resulting
cost pressures on pricing behaviour in the markets
 Operational instruments used by ESCB:
• Standing facilities
• Open market operations (main refinancing, longer term
refinancing, fine-tuning, structural operations)
• Minimum reserves
 Budgetary policy coordination
 EMU combines centralised monetary policy, with
decentralised budgetary policies and structural policies
 Need for budgetary coordination: effects of given
budgetary policy spill over to EMU partners through
 import channels
 Effects on area-wide interest rates
 Effect on common exchange rate
 Budgetary coordination is aimed at creating the conditions
for the proper working of budgetary automatic stabilisers
 Budgetary autonomy is important to be able to respond to
country specific demand developments
 Joint budgetary action is needed: (1) Risk of overheating,
(2) Severe common recessions, (3) Supply shocks
 EMU - benefits
Benefits of Monetary Union as irrevocable fixed
exchange rate + single currency:
 Avoid costs of exchange rate volatility and
uncertainty increase the quality of information
provided by the price mechanism
 Avoid transaction cost: cross-border payments
 More price transparency: weakening of “home bias”
in trade of goods and services
 Better functioning of the internal market
 Welfare gains from more efficient use of reserve
assets
 EMU - costs

 Loss of exchange rate policy as an instrument of

monetary policy
 The cost of joining the Union is dependent on the
value given to the short-term advantages of
exchange rate manipulation
 In the long run costs tend to zero
 Assessment of costs and gains from a single
currency is an eminently political question
 EMU - Optimum Currency Area
 The EU does not meet the criteria of an Optimum
Currency Area because of:
 insufficient labour mobility
 Insufficient wage/price flexibility
 Asymmetries in shocks and structures
 The sustainability of EMU depends on the long-term
steady state benefits from large, low inflation
currency area
VI. Policy coordination,
regulatory strategy

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Treaty principles of economic policies
 Art. 2: The Community shall have as its task … to
promote throughout the Community a harmonious,
balanced and sustainable development of
economic activities … and a high degree of
competitiveness
 Art. 3: (g) a system ensuring that competition in the
IM is not distorted and … (m) the strengthening of
the competitiveness of Community industry
 Art 4 states that this policy „shall be conducted in
accordance with the principles of an open market
economy”
Policy coordination in the economic union

 Maastricht Treaty: All EU countries have the

obligation to pursue price stability, sound public
finance and monetary conditions and all Member
States participate in treaty-base economic
coordination
 Article 99/1: “ Member states shall regard their
economic policies as a matter of common concern
and shall coordinate them.”
Broad Economic and Policy Guidelines

 BEPGs are the key element guiding the conduct of

the whole range of economic policies in the MSs
and the Community (Art. 99/2)
 Their objective is to ensure closer coordination of
economic policies and sustained convergence of the
economic performances of the MSs
 Member states shall regard their economic policies
as a matter of common concern and shall coordinate
them (Art. 99/1)
Broad Economic and Policy Guidelines

Convergence: Council monitoring the sustained

convergence of the economic performances of MSs

Stability and Growth Pact: surveillance of budgetary

positions and co-ordination of economic policies

Multilateral surveillance (Art. 99/3): monitoring

economic developments and policies in the MSs as
well as in the Community

Excessive Deficit Procedure (Art. 104): ensuring

budgetary discipline among MSs
Broad Economic and Policy Guidelines

Luxembourg Process: improved efficiency of labour

markets
Cardiff Process: improve the functioning of markets
through better multilateral surveillance and co-
ordination of structural reforms
Cologne Process (Macroeconomic dialogue: bring
together representatives of ECOFIN Council, Labour
and Social Affairs Council, Commission, ECB, social
partners
Economic policy coordination in EMU
 Single policy:
 Monetary policy
 Exchange rate policy
 Competition policy
 Close coordination:
 Budgetary policy (balances)
 Structural policies (Internal Market)
 Weak coordination:
 Policy mix
 Budegtary policy (quality of public finances)
 Wage development (Cologne process)
 Labour market policies (Luxembourg process)
 Product and capital market policies (Cardiff proc.)
 External representation and communication
 Subsidiarity
Any action taken by the Community must fulfil two conditions:
 In areas of shared competence, the Community must
demonstrate a need to act (existence f economies of scale
or cross-border externalities)
 Any action must be proportional to the desired objective

Subsidiarity test:
1. Identify weather a measure falls within the area of shared
competence
2. Apply the criteria (scale, externalities…) – ‘need to act’ test
3. Verify weather credible cooperation is feasible
4. If 1 and 2 are confirmed and 3 denied, then the assignment
is to the Union level
5. Define to what extent implementation, monitoring and
enforcement should also be assigned to the EC level
 EU regulatory strategy
Why regulate? Regulation is justified if:
 Market failures (market power, externalities, internalities, public
goods) are overcome
 the least-cost form of regulation is chosen
 The net benefit is positive
Regulate at what level?
 EC tier has rules shaping the internal market or substantiating
policy
 3 instances where MS can still regulate: domestic economic
activities, beyond EC rules as far as free movement is not
affected, where derogations from free movement are commonly
agreed
How to regulate?
 5 regulatory principles: free movement, no internal frontiers,
subsidiarity, minimum approximation, and mutual recognition
 Economic performance of the EU
 Much of the problems of the EU economy are
reflected in, and maybe determined by, the labour
market
 Employment rates – the ratio of the employed to
working age population – and participation rates –
the ratio of employed and unemployed to the
working age population – are considerably lower
than in the US
 Regulation is necessary for the protection of a host
of public interests, including the very functioning of
markets however, it may also introduce rigidities and
distortions in factor allocation, intentionally or not
Economic performance of the EU

 In the EU Internal Market harmonisation of national

regulations has perhaps mainly increased
competition between incumbents, leading to
concentration and labour shedding, less to new
players and innovation; e.g. public utilities
 Product market regulation has become more market
friendly, but progress uneven within EU, leading to
increased differentiation and market obstacles
Reasons of poor growth performance
 Too many protected markets (notably services)
 Insufficient wage and price flexibility; rigid labour
markets; as a consequence capital is also “sticky”
 Welfare and taxation systems that enhance rigidity
and discourage effort and investment
 Regulatory environment that does not encourage
enterprise and innovation
 Education and skills
 Demography
 Size and quality of the public sector