From EEC to EU: The Ups and Downs of Economic Integration

Erik BuystCenter for Economic Studies

Structure

• European Economic Integration: Not a New Phenomenon

• The End of the First Global Economy

• The Late 1940s

• The Real Start of European Economic Integration

• EEC and Euratom

• The Setback of the 1970s

• New Initiatives in the mid-1980s

• The Maastricht Treaty (1992)

• Towards the sovereign debt crisis

3

1. Economic Integration: Not New

• Driving forces in the 19th centuryo Revolutionary changes in transportation and information

technologies: railways, steamships, telegraph,…• Sharp decline in transportation and transaction costs

o Drive towards free tradeo Monetary stability – gold standard

• Full convertibility of national currencies in gold

1. Economic Integration: Not New

• Results: o Rapidly increasing international trade flowso Rising factor mobility

• Labour: o Massive emigration from Europe to US and Latin

Americao Large migration flows within Europe

1. Economic Integration: Not New

• Capital:o Universal banks (retail + investment) search

continuously for highest returno First multinational enterprises: international composition

of board of directors

• “First global economy”o Economic convergence in last decades before WW I:

poor countries at ‘periphery’ of Europe grow faster than rich industrial leaders in NW Europe

2. The End of the First Global Economy

• World War I (1914-1918)o Economic warfare: blockadeso Government control over economy increases

dramaticallyo Extreme nationalism

• Incomplete recovery in the 1920so Mobility of labour remains restrictedo Tariffs go up substantiallyo Hyperinflation in Germany (1923)o Bad political relations between many European states

2. The End of the First Global Economy

• Result: Economic DISintegration of Europeo Trade within Europe never regains its 1913 levelo Production of consumer durables, e.g. cars, grows

slowly compared to USo Domestic markets in Europe too small to generate

sufficient economies of scale

• Great Depression of 1930s:o Trade wars (import quotas), capital controls, exchange

controls o Competitive devaluations

2. The End of the First Global Economy

• World War II:o More than 40 million people killed in Europeo European economy suffers substantial devastationso Third armed conflict between France and Germany in

less than a century

3. The late 1940s

• Reconstruction after WW II is painful processo 1947: acute shortage of US dollars to finance imports of

raw materials, machinery and foodo Causes massive strikes in France and Italy, cf. Cold War

• Marshall Plan (1947)o US provides help: free deliveries of goods

• Condition: receiving countries have to develop a common reconstruction plan

• Institutionalized in OEEC = Organization for European Economic Cooperation

3. The late 1940s

• Accomplishments of OEEC: o Import quotas are largely abolishedo Reduction of import dutieso Liberalization of intra-European payments = exchange

controls disappear (1958)o Capital controls remain in many countries

• But:o OEEC = US dominated: influence diminishes rapidly as

Marshall help dries upo Rather traditional intergovernmental organization

3. The late 1940s

• In 1961: US, Canada and Japan join OEEC, which is transformed into OECD = Organization for Economic Cooperation and Development

• Not only push from US, also initiatives from within western Europe: Beneluxo Established during WW II

• Customs union realized in late 1940s• Free flow of labour and capital in mid-1950s

4. The Real Start of Economic Integration

• European Coal and Steel Community (ECSC)o Why? Because of Cold War, US and UK want to rebuild

West-German heavy manufacturingo France and Benelux fear Germany:

• Demand control over German heavy industry• Free access to German coal• Germany disagrees

• Solution: Schuman Plan (Jean Monnet)o Free trade zone for coal and steelo Create supranational authorityo 1951: Six countries sign Treaty of Paris

4. The Real Start of Economic Integration

4. The Real Start of Economic Integration

• Institutions of ECSC:

o High Authority -> European Commission• Independent supranational institution• Own financial resources: levy on coal and steel production• Its decisions are binding on all member countries

o Special Council of Ministers -> Council of EU

o Common Assembly -> European Parliament• Composed of members of national parliaments

o Court of Justice

4. The Real Start of Economic Integration

• Economic: rather disappointingo Wants to boost coal production, but underestimates

rapidly growing competitiveness of oilo From late 1950s: overproduction = beginning of long

death struggle of coal mines

• Psychological: successo European cooperation is possibleo Institutional innovations work

• UK not interested: Commonwealth, US

5. EEC and Euratom

• 1957: Treaties of Rome (in operation 1958): same six countries as ECSC

• European Atomic Energy Community

• European Economic Communityo Customs uniono Common economic policy, e.g. concerning international

trade, agriculture and transportationo In the long run: move towards free movement of labour,

capital and serviceso “ever closer union”

5. EEC and Euratom

• Evaluation of EECo Realization of customs union went smoothly, operational

by late 1960so Common agricultural policy (CAP)o Transportation policyo Harmonization of economic policy much more difficult

• Fiscal policy: introduction of VAT• Intention to start free movement of labour and capital

5. EEC and Euratom

• Intermezzo: European Free Trade Association (EFTA)

o UK did not like supranational idea of EEC, therefore creation of another international organization (1960)• Free trade zone for manufacturing products only• Intergovernmental organization

o No success: EFTA too heterogeneous

o Already in early 1960s UK applies to join EEC, but French veto

6. Setback of the 1970s

• Success: extension of EECo 1973: UK, Ireland and Denmark joino 1981: Greece

• Failures:o Energy shock of 1973/74 causes severe recessiono Different policy responses

• Germany: anti-inflation• France, Italy, UK: expansionist

o Lead to large inflation differentials• Monetary instability within EEC, cf. breakdown of Bretton Woods• Threatens customs union, CAP, etc.

6. Setback of the 1970s

• No consensus on remedies to fight monetary instabilityo “monetarists” (France): first exchange rate stability,

economic convergence will followo “economists” (Germany): first convergence towards

price stability and coordination of economic policies, then exchange stability

• Arrangements to limit exchange rate fluctuations = European Currency Snake, 1972-1978o No success, monetary DISintegrationo Capital controls become stricter

6. Setback of the 1970s

• CAP expenditures explode, but reform attempts fail

• European Monetary System (EMS), 1979-1998o Participants: Benelux, Denmark, France, Germany,

Ireland and Italyo Creation of ECU = basket currency: weights based on

share of member state in GDP and in EC external tradeo Parities are expressed in ECU (and not in USD)o 2,25 % limito Credit mechanism = compromiseo Realignment of parities is subject to mutual consent!

6. Setback of the 1970s

• Evaluation of EMS:o 1979-1983: many realignmentso Subsequent devaluations of some currencies against

German mark are perceived as painful eventso 1983: France drops expansionist policies (Mitterrand)

and adopts austerity measureso General move towards German model enhances

economic policy coordination

7. New Initiatives in mid-1980s

• Reduction in inflation differentials generates much more stability in EMS from 1983 onwards

• Early 1980s: European multinationals advocate a new integration effort to strengthen their position against American and Japanese rivals

• Europe 1992 Project (launched in 1985)o Free movement of goods, services and production

factors should be realized by the end of 1992• Weakening of national standardization requirements• Opening-up of national procurement procedures

7. New Initiatives in mid-1980so Free establishment of enterprises: no harmonization of

laws, but e.g. bank recognized in one member state can operate in rest of EC• = home country control and mutual recognition

• Single European Act (1986)o European Parliament gets more power

• Directly elected since 1979

o Regional development and policy becomes more important: structural funds• Portugal and Spain (1986)

7. New Initiatives in mid-1980s

• Evaluationo Europe 1992 project is a success

• Prospect of bigger market triggers merger and (foreign) investment boom

• Contributes together with inverse oil shock of 1986 to strong economic growth in the late 1980s

7. New Initiatives in mid-1980s

• Dominant position of DEM in EMS raises concerns in other member stateso France realizes that it only can regain influence if

monetary decision making is transferred to a supranational level = create monetary union

o More in general ‘Europe 1992 project’ causes a rapid increase in capital mobility• Creation of monetary union seems logical follow-up project

o German unification (1989-1990) speeds up the process• France accepts unification in return for monetary union

8. Maastricht Treaty (1992)

• Three stages towards EMU:o (1) All member states join EMS (end of 1993)o (2) 1/1/1994:

• Independence of national central banks has to be guaranteed: France versus Germany

• No monetary financing of budget deficits

o (3) 1/1/1999:• Member states that meet ‘convergence criteria’ start EMU• Irrevocably fixed conversion rates of the former national

currencies with the newly created euro are decided• Eurosystem (=ECB + NCB’s) becomes responsible for single

monetary policy

8. Maastricht Treaty (1992)

• EMU Convergence criteria:o National budget deficit of less than 3 % of GDPo Public debt ratio of maximum 60 % of GDPo Stable currencyo Low inflation rate and long-term interest rate

• Countries that do not meet these criteria cannot join EMU

• No bail-out clause

8. Maastricht Treaty (1992)

• 1992-1993 EMS crisiso No parity adjustments in EMS since 1987, but unit

labour costs continue to divergeo Undermines competitive position of southern Europe

and UKo Bundesbank pursues high interest rate policy to tackle

inflationary pressures related to German unificationo Leads to recession and growing budgetary deficits

• Provokes speculative attacks against EMSo GBP and ITL have to leave EMSo ESP and PTE have to devalue

8. Maastricht Treaty (1992)

• Many people believed that EMU project is dead, buto Countries in difficulties adopt austerity measures to

restore public finances and competitivenesso German interest rate policy normalizeso Kohl and Mitterrand continue to support EMU project

• Stability and Growth Pact (1997)o EMU members have to aim for balanced budgets over

economic cycleo 3 % public deficit is absolute maximumo In case of persistent excess deficits: fine of max. 0,5%

of GDP

9. Towards the sovereign debt crisis

• History shows that monetary unions without political union crash sooner or later, e.g. Latin Monetary Union.

• Nevertheless, after introduction of euro in 1999 little is done to deepen the EU, e.g.o Asymmetry: monetary policy is highly integrated, but

budgetary policy remains nationalo Monetary union provokes cross border banking

mergers, but no common prudential control o No support mechanism for EMU-members in difficultieso No exit mechanism

9. Towards the sovereign debt crisis

• Most attention goes to widening process: 2004 (EU25) and beyondo Old member states: little enthusiasm to accept new,

relatively poor member states• Agriculture• Textiles, steel

o Former communist countries have to go through a painful reconstruction process

9. Towards the sovereign debt crisis

• In 2000s divergent economic policies WITHIN EMU o Southern Europe: erosion of competitive positiono Large deficits on current accountso Speculative boom fuels economic growth

• These problems remains largely unnoticed until financial crisis of 2008

• Expensive rescue operations of banks draw attention to weak economic foundations in general and precarious public finances more specifically

Thank you for your attention!