11 The Economic Consequences of the European Union
Since its last expansion on January 1st of 1995, the European Union (EU) has consisted of 15 member states with a total population of 371 million persons. Its average gross national product (GNP) per head measured at current exchange rates
is a prosperous $20,500 (Table 11.1). Calculations based on the purchasing power of domestic currencies places it as a slightly more modest $18,000 (largely because of the high cost of food within the EU). The total GNP of the EU (the sum of the national GNPs) is about $7.5 trillion at current exchange rates making it a larger economic entity than the United States and, therefore, a global force to be reckoned with. Although economic growth in Europe was strong during the early days of the European Economic Union (EEC), the pace has slackened of late and the EU has been growing more slowly than North America, although recently it has turned in a better performance than slumping Japan. Few Europeans regard the growth rate of income per head of 2.1 percent per annum, exhibited between 1980 and 1999, as creditable, especially as slow growth in output has led to an increasing unemployment. The causes of this poor performance are much debated, but most observers place some blame on inflexible labor markets and a lag in the pace of technological innovation relative to other nations.
TABLE 11.1
Selected Macroeconomic Indicators for EU Members
Population / GNI per capita (2000) / GNI per capita PPP (2000) / GDP billions (1999) / Real GDP Growth % per annum (1990-1999) / Inflation % per annum (1991-2001)Germany / 82 / $25,050 / $25,010 / $2,112 / 1.00% / 2.0
United Kingdom / 60 / $24,500 / $23,550 / $1,442 / 2.10% / 3.4
France / 59 / $23,670 / $24,470 / $1,432 / 1.10% / 1.7
Italy / 58 / $20,010 / $23,370 / $1,171 / 1.20% / 4.1
Spain / 39 / $14,960 / $19,180 / $596 / 2.00% / 4.4
Netherlands / 16 / $25,140 / $26,170 / $394 / 2.10% / 2.4
Greece / 11 / $11,960 / $19,640 / $125 / 1.80% / 10.0
Belgium / 10 / $24,630 / $27,500 / $248 / 1.40% / 2.1
Portugal / 10 / $11,060 / $16,880 / $114 / 2.30% / 6.2
Sweden / 9 / $26,780 / $23,770 / $239 / 1.20% / 2.8
Austria / 8 / $25,220 / $26,310 / $208 / 1.40% / 2.1
Finland / 5 / $24,990 / $24,610 / $130 / 2.00% / 2.2
Denmark / 5 / $32,020 / $27,120 / $174 / 2.00% / 2.4
Ireland / 4 / $22,960 / $25,470 / $93 / 6.10% / 3.3
Luxembourg / 0.438 / $44,340 / $45,410 / $19 / 3.80% / 2.5
European Union / 376.438 / $23,819 / $25,231 / $8,497 / 2.10% / 3.0
SOURCE: World Development Report 2002, Human Development Report 2001.
The theory of the economic consequences of the creation of the EEC, and its successor the European Union, is well developed. The impact can be divided into static effects, which are examined formally next, and the longer-term dynamic effects, looked at in the following section.
Static Effects
The static effects of a common market, or customs union, are shown in Figure 11.1. Let us start with the assumption that the same good is produced in three countries, A (the domestic economy), B (its neighbor and ultimate partner in a customs union), and C (the lowest cost producer in the world). For simplicity we assume that Country C can supply effectively unlimited quantities of the good to CountryA, which is relatively small, at a constant price of Pc. Under these conditions all of A’s imports of the good (an amount shown by gh in the diagram) originate in C, and the balance of consumption Q1. B is by and large a lower cost producer than A, selling at at Pb, but it cannot compete with C’s price of Pc. Now let us consider the effect of a protective tariff of magnitude t. Because of the small country assumption, C’s output remains at the same price on world markets, but within A is increased by the full amount of the tariff. Therefore the price within A’s economy rises from Pc to Pt. The output of neighboring Country B is, in the presence of the tariff, priced at Pb 1 t, which is still above C’s price of Pc 1 t or Pt. Imports, therefore, come exclusively from the lowest cost producer country C, but they are now restricted by the tariff to a level of ab. The balance of domestic consumption is supplied A’s own protected producers, who are able to expand production behind protective barriers. Revenue from the tariff is the rectangle abji—that is, the volume of imports, ab, multiplied by the tariff, t. The welfare consequences of this tariff are a fall in consumers’ surplus of PchbPt, and the protection raises producers’ surplus by an amount PcgaPt. Total deadweight loss is given by the two triangles aig and bjh.
From this point we can consider the results if the neighboring countries A and B form a customs union. They agree to eliminate all tariff and quota restrictions between each other but maintain a common external tariff of size t with respect to the rest of the world. Now tariff-free goods from B are cheaper than the tariffed goods that originate in C. As a result, imports from the rest of world are eliminated, and instead they originate in B. The price of the good established in A is the production cost of B, (i.e., Pb). Total imports are of a magnitude ef. Part of this total, an amount cd (5 ab), replaces the imports from the C. This is called the trade diversion effect of a customs union. However, total imports are greater than before. An amount ec replaces a part of domestic production and is termed the trade creation effect. The amount ef is an increase in consumption brought about by lower prices and is termed the consumption effect.
Compared to the situation where A imposes a tariff on imports from all sources, the customs union does represent a welfare gain. Consumers in A have access to goods at a lower price, Pb, than would be the case if there were tariff barriers against all imports. The gain in consumers’ surplus is PbfbPt and is clearly greater than the sum of the loss of producers’ surplus PbaePt and the foregone tariff revenue abdc. However, these welfare gains are smaller than those that would result under free trade. The largest gainer from A’s entry into the market in this example are the producers, and workers, of B who gain access to A’s market; they see their production increase by an amount ef to meet the demand from A. Compared to free trade, A’s consumers are losers, and the only gainers are the producers of B.
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 does reflect the perceived benefits of joining the EU. The greater overall size of 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.
Dynamic Effects
While the static effects of a customs union are important, long-term dynamic considerations are probably more significant in providing a rationale for the creation of a common market than the static ones. Certainly from the inception of the EEC, one driving motivation was the beneficial effects of exposure of European firms to greater competition from its partners within the common market. A second was the ability to grasp economies of scale from the larger domestic market.
THE MAKEUP OF THE EUTHE WELFARE EFFECTS OF THE COMMON MARKET
Table 11.2 indicates some of the changes in trade volumes that occurred following the formation of the EEC and its successor the EU between the 1960s and 1990s. In terms of the openness of the whole Community as a bloc of economies, little has altered in this 30-year period. Between 1960 to 1967, about 8.8 percent of the GNP of the 12 nations, then part of the EEC, was traded. The comparable figure for the same group of countries between 1991 and 1994 was 8.9 percent. This stability is surprising since the average openness of most of the economies in the world increased sharply during this time, and the considered globally trade to GNP ratios rose rapidly. While trade with nations outside of the EU has only kept pace with the growth of output, trade within the EU has grown considerably more rapidly. On average the nations of the EU conducted 45 percent of their trade with other members in 1960; by 1991–1994 this had risen to 58.6 percent. The evidence therefore points to substantial trade creation and trade diversion effects
TABLE 11.2
Openness of EU Economies, 1960–1994 (average of imports and exports of goods
as a percentage of GDP; intra-EU trade is given as a percentage of total trade) 1960–1967 1991–1994
World Intra-EU World Intra-EU
Belgium and Luxembourg 37.5 64.8 53.3 70.0
Denmark 27.0 52.3 25.4 53.0
Germany 15.9 44.8 20.7 52.2
Greece 12.7 50.6 17.0 59.2
Spain 8.1 47.8 15.2 62.9
France 11.0 45.8 18.7 63.3
Ireland 33.6 72.2 50.3 68.8
Italy 11.7 42.9 15.9 56.4
Netherlands 37.7 62.7 43.9 65.9
Portugal 19.8 48.3 28.5 73.3
United Kingdom 16.0 26.7 20.2 52.1
EU-12 8.8 45.0 8.9 58.6
Austria — — 25.6 66.1
Finland — — 22.4 46.7
Sweden — — 23.6 54.9
Note: For the member states, these figures include intra-Union trade; for EU-12, intra-Union trade has been excluded.
SOURCE: Eurostat. [Loukas Tsoukalis, The New European Economy Revisited, 182.]
THE TRADE OF THE EU
Developed Nations
After the end of World War II, the United States directed its energy into creating a nonpreferential system of world trade predicated on the most favored nation principle of the General Agreement on Tariffs and Trade (GATT). The creation of customs unions like the European Community (EC) was facilitated by a special clause in the GATT (Article XXIV), which allowed the establishment of formal free trade areas. The United States allowed and even encouraged this development because it felt a strong Europe was essential to contain an expansionist Soviet Union. Nevertheless there has always been ambivalence in the American view and a recurrent fear that Europe might choose to close itself behind high tariff or walls.
Fortunately, the trade policy of the EU has been in line with GATT policy. The fears of Fortress Europe have been soothed by successive reduction in the common external tariff (CET). The EU has also sought to extend the free trade area beyond its core membership. The first extension was the creation of a free trade area linking the EC and the European Free Trade Area (EFTA) called the European Economic Area (EEA). Subsequently the central and east European economies in transition have been afforded special status through the signing of economic agreements (EAs) committing the parties to move toward a zero tariff status over a 10-year period. After U.S. pressure, and in partial compensation for the stalling over its full membership, Turkey has been admitted into the customs union without participating in the other aspects of the EU.
Trade Wars.Despite overall conformity with the rules of the GATT, the EU has used nontariff barriers to protect sensitive industry. This has led to frequent disputes, especially between the EU and the United States with respect to farming. These problems are often related to agricultural products, which is not surprising given that agriculture lay beyond the purview of the GATT and the highly protectionist postures of both Europe and the United States. One outburst in 1997 was over new European Union rules requiring that exporting countries comply with the EU’s food hygiene standards. The EU blocked the import of American chickens and turkeys, and the Clinton administration responded by promising to block $300million worth of meat imports annually. Like other disputes before it, it was resolved; but an undercurrent of mutual suspicion endures.
Policy toward Developing Nations.The EU’s relationships with the “developing” world are governed by the Lomé agreements; the latest of these (Lomé IV) was signed in 1989 and subsequently modified in 1995. The Lomé pact is between the 15 nations of the EU and some 70 third-world countries known as the African, Caribbean, and Pacific (ACP) nations, many of which have historic colonial ties to members of the EU. The agreements allow virtually tariff-free access into the EU for most exports of the ACP nations without any reciprocal obligation. Furthermore, the Lomé arrangements were backed by the stabilization of prices of agricultural exports (Stabex) and mineral exports (Sysmin). In addition, the European Development Fund disburses about 6 percent of European Union revenue in aid to the ACP nations.
However, despite their apparent generosity, the Lomé agreements have done little to assist either development in, or exports from, the ACP group. In fact, EU imports from the ACP countries fell sharply between 1970 to 1994, from over 8 percent of total non-EU imports to about 3 percent. While the pure transfer element of the grants-in-aid and the stabilization schemes is still important, the trade concessions have become less valuable over time as the size of the common external tariff has fallen.
THE EXTERNAL TRADE POLICY OF THE EU
The biggest recent change in the European Union is the adoption of a single currency. This must surely be ranked one of the most important events of the late 20th century, both for its ramifications for the global system of finance and for its impact on the policies of the member countries of the EU. The single currency remains, however, a controversial issue. While on balance most studies have found economic gains from the creation of a single currency, there are attendant costs that must be balanced against them.