CHAPTER 1 - THE HISTORY OF THE

EUROPEAN ECONOMIC AND

MONETARY UNION

➢ 1. European economic Integration since 1950:

the main steps.

➢ 2. Welfare and economic effects of Integration.

1. European economic Integration since 1950: the
main steps.

➢ 1.1 Aftermaths of WWII.

➢ 1.2 Levels of economic and political integration
➢ 1.2 The background of the Treaty of Rome.
➢ 1.3 The negotiation and outcome of the Treaty of Rome.
➢ 1.4 The Single European Act (SEA) (1986): The
implementation of the European Single Market for 1992.

2. Welfare and economic effects of integration

1. European economic integration since WWII:
the main steps.

➢ Before WWII:
❑ The modern idea of European integration goes back from the
philosophers of the 17th and 18th century to more recent
theorisations after end of WWI (e.g. 1929: proposal of European
Federation by French Foreign Minister Aristide Briand, 1930:
Churchill call for the creation of United States of Europe).

❑ But nothing concrete after WWII

➢ After WWII:
Death and destruction in the Second
World War

• The war killed about 8M people. Germans account for 3/4 of the total.
• Equivalent to two « 11 September » per day between 1938 and 1945
The prime question in 1945:
“How can Europe avoid another war?”

•What caused the war? 3 answers

• Blame the loser
• Capitalism
• Destructive nationalism

•These implied 3 post-war solutions

• ‘Neuter’ Germany , Morgenthau Plan, 1944
• Adopt communism
• Pursue European integration

•European integration ultimately prevailed, but

this was far from clear in the late 1940s.
 Europe is divided:

➢ West vs East
➢ Winners vs Losers of the war

➢ Germany: limitations to national sovereignty ->

naturally favorable to European integration
➢ Italy: strong communism opposition -> eager to
stay in the “Western side”
➢ UK starting strong relations with the US

Key factor: The cold war (started in 1947)

played a decisive role for the European
West-integration.
 Cold War begins.
• US,UK and USRR key players

USSR pushes communism

in the East (solution 2: blame
capitalism).

• UK, French and US zones

merged by 1948
• Moves towards creation of
West German government.
– Reaction: Berlin blockade, 1948.

• “Neuter Germany” solution

abandoned for strong West
Germany + European integration.
➢ The merger of the French, US and UK zones was a
turning point in Europe’s post-war history.
Different European interests
➢ The Franco-German integration as a way of counter-balancing US-UK
influence on the Continent while at the same time assuring that a
reindustialized Germany would become an economic partner rather than
a military adversary.

➢ UK starting strong relations with the US. Integration to counter the spread of
communism.

➢ Germany: embraced European integration as the surest route to re-

establishing Germany as a 'normal' nation (Germany was recognized as an
independent nation only in 1955).

➢ Italy: strong communism and fascist opposition -> eager to stay in the
“Western side”

➢ BENELUX to avoid another Franco-German war

First steps of integration by the US:

➢ Interest in an integrated and prosperous and stable

Europe to counter the Soviet threat.

First project?
 Marshall Plan and the Organization for
European Economic Cooperation and EPU

➢ From the perspective of European integration, the most important result

of the western European effort to resist communism was the so-called
Marshall Plan and the Organization for European Economic
Cooperation (OEEC), which became later the Organization for
Economic Cooperation and Development (OECD).

➢ George Marshall announced (1948) that the USA would give financial
assistance to all European nations 'west of the Urals', if they could agree
to a joint programme for economic reconstruction.

➢ 13 countries. 12 Billion dollars (half for France, UK and West Germany).

➢ OEEC mandated to reduce intra-European trade bareers and improve the

system of payments.

➢ Soviet bloc’s counterpart: Council of Mutual Economic Assistance

Marshall Plan

• 1949: new boost. US demanded more effort in terms of

intra-OEEC trade liberalization.

• Trade liberalization among west European nations went

hand-in-hand with spectacular growth; intra-European
imports and exports expanded even more rapidly than
output.

• European Payment Union: nations were bankrupt, trade

was made on the bases of bilateral agreements. The
EPU multilaterized bilateral “deals”: each month, EPU
members added up deficits and surpluses in their
accounts.
Marshall Plan and the Organization for
European Economic Cooperation (OEEC):
Western European GDP growth and
manufactures export growth, 1950- 58 (Baldin &
Wyploz,
Deeper integration

• It was a success, but was it enough to prevent another

war?

• As Cold War got more war-like, West Germany

rearmament became necessary.

– Problem: OEEC was too loose to avoid future war

among Western European powers

• Need of deeper integration, but they disagreed on the

level of integration and the form.
1. European economic Integration since 1950: the
main steps.

➢ 1.1 Aftermaths of WWII.

➢ 1.2 Levels of economic and political integration
➢ 1.2 The background of the Treaty of Rome.
➢ 1.3 The negotiation and outcome of the Treaty of Rome.
➢ 1.4 The Single European Act (SEA) (1986): The
implementation of the European Single Market for 1992.

2. Welfare and economic effects

Different degrees of Economic Integration.

➢ What does “economic integration” exactly mean?

➢ Bela Balassa, The Theory of Economic Integration

(1961), the term "economic integration" refers to both a
process and a state of affairs.

"measures designed to abolish discrimination between

economic units”.

➢ Different stages and definitions of integration. Balassa 5

stages.
 Stages or types of economic integration
between national states.

➢ Preferential Trade Agreement (PTA). It is an arrangement between

two or more countries in which goods produced within the union
are subject to lower trade barriers than the goods produced
outside the union.

➢ A Free Trade Area (FTA) is a PTA in which member countries do

not impose any trade barriers (zero tariffs) on goods produced
within the union. However, each country keeps its own tariff
barriers to trade with non-members.

➢ A Customs Union (CU) is an FTA in which member countries apply

a common external tariff on a good imported from outside countries.
 Stages or types of economic integration
between national states.

➢ A Common Market (CM) is a CU which further allows free

movement of labour and capital among member nations.
Besides this, to achieve this level of integration, it is necessary for
the member states to remove all trade barriers (including non-
tariff restrictions), as well as to have a certain level of
coordination of some of the economic policies.

➢ The Economic and monetary union (EMU). It establishes a

common exchange rate mechanism, which grows into a common
currency that functions on the common market. There is a
common monetary policy and coordination of macroeconomic
policies of the member- states.
Political integration: federalism vs
intergovernmentalism
➢Immediate disagreement about depth of political integration
• Federalism – supranational institutions
• Intergovernmentalism – nations retain all sovereignty

➢ Federalism popular among countries where state-nation failed the

population (FR, GER, IT, BEL, NL, LUX)

➢ Intergovernmentalism popular in countries less affected by wars (UK,

Denmark, Norway, Iceland + neutrals)

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

➢Federal initiative
• ECSC (1951), EEC (1958)
Source: https://transportgeography.org/contents/chapter7/globalization-international-
trade/economic-integration-levels/
Pillars of the early European integration

1- Plan Marshall: Economic integration

2- The Hague Congress: Political integration?

➢ Conference of all movements for European unification.
➢ Many different visions (federalist vision vs intergovermentalism vs
neofunctionalist)
➢ Failed to produce concrete results. Creates the Council of Europe, but it
will play a marginal role

3- Military integration: millitary alliance among a number of European

countries

INTERGOVERNALISM dominated in the post-war period → OEEC and the

council of Europe followed the intergovernalism tradition.
Until…
1. European economic Integration since 1950: the
main steps.

➢ 1.1 Aftermaths of WWII.

➢ 1.2 Levels of economic and political integration
➢ 1.2 The background of the Treaty of Rome.
➢ 1.3 The negotiation and outcome of the Treaty of Rome.
➢ 1.4 The Single European Act (SEA) (1986): The
implementation of the European Single Market for 1992.

2. Welfare and economic effects

You know him?
Jean Monnet and the Schuman declaration
➢ Jean Monnet born in Cognac in 1888, was a cognac merchant, joined
Charles de Gaulle's near the end of WWII

➢ responsible for the 'Monnet Plan', which is credited with helping

France's post-war industrialization.

➢ Led the “European movement” in the 1950s and 1960s.

Context:
➢ France is eager to foster its own economic and industrial recovery and
worried about Germany regaining too much power

➢ German coal resources are very important. The management of coal

resources had been one of the key elements of tension between France
and Germany in the past years.

➢ Plus France + Germany wanted to counter rest the power of UK and US

Jean Monnet and the Schuman declaration

➢ The 'father of European integration’, because he was the co-author

of the Schuman Declaration, a statement made by the French
foreign minister Robert Schuman on 9 May 1950 (which day it
is?).

➢ Aim: to place French and German production of coal and steel under
one common High Authority (the European Coal and Steel
Community ): FIRST FEDERALIST STEP

➢ Good for Germany -> regain partially control of these resources

➢ He pushes for the European Economic Community and the European

Atomic Energy Community (Euratom).
He died in 1979.
 The European Coal and Steel Community
➢ Soon, more countries join in – Belgium, Luxembourg, The Netherlands, and
Italy (not the UK): “the six”)

➢ The Treaty of Paris is eventually signed in 1951, establishing the European

Coal and Steel Community.

➢ The European Coal and Steel Community is based on a number of

institutions:
➢ The High Authority (most powerful institution): independent, supranational
executive whose task is to ensure the smooth functioning of the common
market of coal and steel.
➢ Supranational character: Member States agreed to cede part of their
sovereignty to a common institution that has the power to enforce its
decisions.
➢ Other institutions: the Council of Ministers, a Common Assembly with
delegates of the national Parliaments sit., the Court of Justice
The European Coal and Steel Community

➢Jean Monnet was the intellect behind the idea of the

European Coal and Steel Community and the first president
of its 'High Authority' (precursor of the European
Commission) from 1952 to 1955.

➢Huge political success, as it seems to have solved decades

of Franco-German rivalry

➢Also an economic success, because ‘The Six’ as a whole,

specially Germany continued to grow fast.

➢It cuts national sovereignty on resources that are key to

make war -> it has made war virtually impossible.
 Expanding federalist track
➢ In previous years, military cooperation start to develop. Initially, this is not
much more than a military alliance first among Western European
countries and then between them and the United States (NATO)

➢ Beginning of 1950: North Korea invades the South. Fear for Germany.

➢ Proposition to rearm West Germans under a European command, failed

when the French parliament rejected it in 1952.

➢ Counter-proposition: Prime Minister René Pleven proposes the creation of

a European Defence Community: a European army, in which the German
rearmament should be framed. The Treaty establishing the European
Defence Community will be signed by the Six members of the European
Coal and Steel Community in 1952.

➢ This community will never see the light. But raises many questions: who
will be in control of the arms? How to fund it (common taxation)? In 1952
the 6 members of the European Coal and Steel Community asked the
Common Assembly to draft a European political statute (= the US, political
integration)
 Expanding federalist track
➢ But when they have to rectify the European Defence Community, change in
the international context: (i) republicans to power - more reluctant than his
predecessors to use the US budget for Europe’s defence, and (ii) Stalin’s
death

➢ Also high growth rates: more support for national governments

➢ German became an independent member of NATO→ Franco-German war

a possibility again!

➢ Having failed in their efforts to integrate West Germany directly into defence
and political communities, European leaders turned their minds to broader
economic integration: the European Economic Community (the EEC)
 Expanding federalist track

➢ Only successful institution left: European Coal and Steel Community. Jean
Monnet is convinced that this cooperation could be extended to other
sectors, and wanted also a separate community to cover nuclear power.

➢ Idea of a supranational Common Market was not new when Dutch

Foreign Minister Wim Beyen reissued his proposal in early 1955.

➢ Meeting in June 1955 in Messina started a process that created a

Committee of the Foreign Ministers of the six countries, chaired by Foreign
Minister Paul Henri Spaak (the Spaak Committee) to discuss further
European Integration.
1. European economic Integration since 1950: the
main steps.

➢ 1.1 Aftermaths of WWII.

➢ 1.2 Levels of economic and political integration
➢ 1.2 The background of the Treaty of Rome.
➢ 1.3 The negotiation and outcome of the Treaty of Rome.
➢ 1.4 The Single European Act (SEA) (1986): The
implementation of the European Single Market for 1992.

2. Welfare and economic effects

The negotiation and outcome of the Treaty of Rome

➢ Spaak’s committee in April 1955.

➢ Key decisions: what level of economic integration (Free trade area or also
common external tariff) ? Should there be supranational institutions or
intergovernmental ones?

➢ Final outcomes: European Economic Community (EEC) and European

Atomic Energy Community (Euratom)

➢ The Treaties of Rome as a twofold compromise;

The negotiation and outcome of the Treaty of
Rome: the French-German compromise.

➢ French government again put forward proposals for a

supranational organization accompanied by common sectoral
policies (e.g. on agriculture, transport) and a market protected
by high external tariffs.

➢ Germany: rejected the sectoral approach (too ‘dirigiste’) and

advocated the adoption at the European level of the principle of a
competitive, open, market economy.
Outcome of the Treaties of Rome

➢ Messina in June 1955 to start a process that led to the signing,

on 25 March 1957, of two treaties in Rome: the first created the
European Atomic Energy Community (Euratom); the second,
the most important, created the European Economic
Community (EEC).

➢ The members of these two communities are the founders of the

European Coal and Steel Community: France, Germany, Italy,
Belgium, Luxembourg and the Netherlands

➢ Main aims: first to form a common market by removing all

tariffs and quotas on intra-EEC trade and second adopting a
common tariff on imports from non-member nations (set at the
simple arithmetic average of the Six's pre·EEC tariffs).
 Outcome of the Treaties of Rome

➢ The European Economic Community is much more

comprehensive. It establishes a common market protected by a
common external tariff, it envisages the creation of a Common
Agricultural Policy, and it sets out rules for the free movement of
persons, goods and capital

➢ Several institutions are put in place. In an attempt to limit the

supranational character of this new Community, instead of a High
Authority, we now have a ‘Commission’, and most decision-making
powers are conferred to the Council of Ministers.

Deep economic integration (custom union), free mobility

of workers, capital market integration, free trade in
service, common policies, supranational institutions
 Evolution to two non-overlapping circles
➢Preferential liberalisation in EEC and EFTA proceeded
– (EEC’s customs union and EFTA’s FTAs completed by 1968)

➢Discriminatory effects emerge (see trade creation/diversion slides)

➢closer EEC integration diminished the relative competitiveness of non-EEC

firms in EEC markets, thereby harming their sales and profits.

➢The same happened to EEC firms in EFTA, but given the EEC's much
greater economic size, pressures on EFTA members to adjust were much
greater than those on EEC nations

➢This leads to new political pressures for EFTAs to join EEC

 Evolution to two non-overlapping circles
➢ Trade diversion creates force for inclusion
➢The EEC's share in its own trade rose from about 30% to almost 50%.
➢ As EEC enlarges, force for inclusion strengthens (domino effect)

UK decides to apply (1961) → 3 other EFTAs (Ireland, Denmark and Norway)

also change their minds (more dominos)

Germany was in favor of UK integration,

De Gaulle’s ‘non’ (twice): 1963 and 1967
Evolution to two concentring circles
➢ First enlargement, 1973 (after De Gaulle retired): UK,
Denmark, Ireland & Norway admitted, but Norwegians first say
no in referendum.

➢Enlargement of EEC reinforces ‘force for inclusion’ on

remaining EFTAs
➢Remaining EFTAs sign FTA agreements with EEC-9

➢Domino-like affect of lowering barriers

➢1st within EEC6 → enlargement → EEC-EFTA free-trade
agreements

➢Democracy in Spain, Portugal and Greece

➢ Greece joins in 1981
➢ Spain and Portugal join in 1986 after long a difficult accession
talks
1. European economic Integration since 1950: the
main steps.

➢ 1.1 Aftermaths of WWII.

➢ 1.2 Levels of economic and political integration
➢ 1.2 The background of the Treaty of Rome.
➢ 1.3 The negotiation and outcome of the Treaty of Rome.
➢ 1.4 The Single European Act (SEA) (1986): The
implementation of the European Single Market for 1992.

2. Welfare and economic effects

 Euro-pessimism

➢ Political crisis in the 70s: spectacular growth lead to citizens trust more
their countries, therefore more reticence for supranational institutions.

➢ Unanimity voting rule in almost every EU institution: very difficult to make

decisions.

➢ Economic crisis in the 70s: US inflation due to Vietnam war translated to

Europe leading to breakdown of the global exchange rate system (ch 2)

➢ Oil crises in the Middle east

→ Failure of European Integration: By the end of the 1960s, a customs

union, with free trade in goods and a common external trade policy, plus a
common agricultural policy had been created. During the next fifteen
years, there was no more deepening of EU integration.
 Wind of change
➢ Spain, Portugal and Greece all adopted democratic governments, thus
rendering them eligible for EEC membership. Greece joins in 1981,
Spain & Portugal join in 1986

➢ European Monetary System (EMS) starts in 1978 and stabilizes intra-

EEC exchange rates

➢ Budget treaties (1970 & 1975) secure EEC financing

➢ First direct EU Parliament election in 1979

➢ In the 1980s US and European Central Banks decide to fight inflation.

Economic growth resumes in 1984

➢ Political attitudes change: Shift towards market economics (US and

Europe)
Background of the Single act

➢ By the early 1980s, EU countries were suffering of

"Euro-sclerosis“.

➢ The were no trade tariffs, but instead non-tariff

bareers.

➢ Favourable economic climate and arrival of

Jacques Delors → single market program (SMP)
 Jacques Delors

➢ Born in Paris, worked in the banking sector and for French

governments. Deeply engaged in the trade union movement.
➢ Finance Minister under French President Mitterrand in the early
1980s.
➢ Was chosen in 1985 to be President of the European
Commission, a post he held for two four-year terms.
➢ “Father” of the Single Market Programme and of the regional
policy (EU spending towards disadvantaged regions).
➢ In collaboration with President Mitterrand and German
Chancellor Kohl, he was also decisive in the adoption and
implementation of the Economic and Monetary Union (EMU)
(Treaty of Maastricht, 1992).

67
Background of the Single act

➢ The point was that, of all the economic integration promised

in the Treaty of Rome, only the tariff liberalization was fully
achieved

➢ Instead, the free movement of labour, capital and services -

were on the to-do list

➢ Delors called this new initiative the 'Single Market

Programme', to contrast it with the most common name used
at the time for the EEC - the Common Market
What is a non-tariff barrier?

➢ Many types of import barriers: The first phase of EU

integration, 1958-68, focused on tariff removal. Yet after
some 20 years of building the EU internal market, a huge
number of non-Tariffs barriers were still in place.

➢ A non-tariff barrier is any measure, other than a

customs tariff, that acts as a barrier to international
trade.

➢ Examples?
Non-Tariff Barriers
(https://corporatefinanceinstitute.com/resources/knowledge/econo
mics/non-
tariff-barriers/)

The first type of trade barrier remaining inside the EU: 'technical barriers
to trade' (TBTs) or non-tariff barriers. Some examples: restrictions
(quotas) and industrial standards (licences), embargos, that discriminate
against foreign goods. Most of them were forbidden by treaty of Rome.
Non-tariff barriers
➢ More important in the context of the EEC: the policies
designed to protect domestic companies, they do not
directly restrict trade with other countries, but they
implement actions that can restrict free trade with them.

➢ Examples of such barriers:

✓ custom formalities,
✓ packaging and labeling requirements,
✓ technical standards and environmental norms,
✓ sanitary standards, etc.

➢ One of the most famous examples of this comes from

the Court of Justice of the EU called “Cassis de Dijon”.
European Court of Justice's Cassis de
Dijon case-law: the principle of 'mutual
recognition' (1979).
➢ (Non-tariff) barriers concern often health and safety regulations
that have the side effect of hindering trade.
➢ German regulation forbade the importation of low- alcohol
spirits like liqueur (in this case, the French liqueur, Cassis de
Dijon, used to prepare “kir”), if the product sold as liqueur contains
less than 25% of alcohol (since weak spirits promote alcohol
tolerance ).
➢ Regulation challenged before the ECC's Court of Justice
as a barrier to trade.
➢ Ruling of the Court: this obstacle to trade should be removed+
basic principle known as 'mutual recognition’: goods that are
lawfully sold in one EU nation shall be presumed to be safe for sale
in all EU nations. Exceptions to this principle require explicit
motivation (mandatory requirements test).
71
 The Single European Act
➢ Intra-EC trade was hindered by numerous barriers: differing
technical standards, industrial regulations, capital controls,
preferential public procurement, administrative and border
formalities, VAT and excise tax disparities, and varying transport
regulations

➢ Free movement of service (guaranteed by the treaty of Rome)

was far from a reality due to requirement of local certification.

➢ In a white Paper published in 1985, the Commission identified

300 measures to be addressed in order to complete a single or
internal market.

➢ Adoption of the Single European Act in 1986, a treaty which set

a deadline of 31 December 1992 for the completion of a
single market.
 Single European Act
✓ Main aim was to complete the single market (the new name for the
common market) by removing all remaining non- tariff barriers to the
four economic freedoms : free circulation of goods, services,
labour, and capital within the European Union by December 31st
1992;

➢ Good and services trade liberalization:

✓ removed border controls (and the attendant delays) for goods

transported on land and water,

✓ liberalized the provision of services across borders (although the most

important measures came later with the so-called Services Directive in

2006),
✓ established the principle of mutual recognition of technical

standards, packaging, and marketing.

✓ Harmonisation of VAT rates within wide bands
The Single European Act

➢ Factor trade liberalization:

• removed controls on financial capital movements,(!!)
• removed discriminatory rules on direct investment from other member
states,
• established freedom to reside and work in other member states.

➢ Improvement in the decision-making capacity of the Council of

Ministers : qualified majority voting replaced unanimity in
several existing areas of responsibility and new areas of
responsibility, such as the internal market, economic and social
cohesion, and environmental policy;

➢ Parliament’s powers were strengthened by Introducing a

procedure for cooperation with the Council, which gave Parliament
real, albeit limited, legislative powers;

77
The Single European Act: introduction of capital
mobility.
➢ The most novel aspect of the Single Market Programme was its
focus on capital mobility (completed in 1988); other features can be
viewed as deepening or extending integration initiatives already
agreed on.

➢ A key issue because the free movement of capital boosted

the introduction of the single currency: the euro because with
the free movement of capital, EU members states lost the
autonomy of their monetary policy (see Mundell triangle in
chapter 2).

➢ Once nations were no longer actively using monetary policy,

resistance to centralizing monetary policy decisions in a
European central bank and with a single currency was greatly
weakened.
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’

– Membership applications by all EFTAns, except Iceland.

• Concentric circles, but both deeper.

North/South divide
➢ This new heterogeneity + the free circulation of products lead to two
related issues already anticipated by Balassa in his discussion of Italy
in the early 1960s.

➢ The first was the fear by peripheral countries that their

nascent industrial activity would migrate from their
region to the EU core in order to benefit from
agglomeration economies.

➢ The second issue was the equal fear by Northern workers of

"social dumping" due to lower wages and social
conditions in the South and then in the East European countries
(revision of the posted workers directive in 2018).
To take away
➢ The single Act signed in 1986 aimed at removaing all
remaining Non-Tariff barriers to the free circulation of
goods, services, labour, and capital within the
European Union by December the end 1992

➢ Institutional reforms to ease and democratize the

decision making:
✓ Council of Ministers : qualified majority;
✓ Parliament’s powers were strengthened

Ultimately, there are still many barriers which make the

full integration of the Single Market challenging. These
are mainly associated with regulation, private law
issues, tax issues, logistics and other more nuanced
differences across EU member states. 81
CHAPTER 1 - THE HISTORY OF THE
EUROPEAN ECONOMIC AND
MONETARY UNION

➢ 1. European economic integration since 1950:

the main steps.

➢ 2. Welfare and economic effects of integration.

(chapters 5, 6 (6.4) , 7 and 10 )

What are the welfare and economic
effects of integration?

➢ Static effects
➢ Dynamic effects
➢ Localisation effects
2. The economics of the Treaty of Rome and
of the Single Market: welfare and economic
effects of Integration.

➢ The welfare analysis of integration originated with Viner (The

Custom Union issue, 1950), focused almost exclusively on the
static effects of trade integration.

➢ Balassa extended Viner's approach in two important directions :

gains due to economies of scale and increased competition,
impact of integration on the geographical location of income
and production within the area of integration.
 2.1 The Static analysis
➢ “Trade creation”: when with signing a trade agreement
between two countries trade is shifted from a higher cost
domestic producer to a lower cost producer inside the
customs union.

➢ “Trade diversion”: it occurs when trade is diverted from a

more efficient exporter towards a less efficient one by
the formation of trade agreement. In this case imports are
shifted from a lower price producer from a third
country, which is not a part of the trade agreement
(outsider), to a higher cost producer from a member-
state (insider) .

➢ Viner claims that trade creation increases a

country’s welfare while trade diversion reduces it.
 The MS-MD Diagram: The International Market
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p”” A axis
FT
horizontal
pp”
p’ Import
supply curve
MD
Import demand
Imports curve

mFT
m’ m”’ m”” m” imports
 The MS-MD Diagram: The International Market
euros

MS
pFT
Import
supply curve
MD
Import demand
Imports curve

mFT imports
Open Economy Supply & Demand Analysis: The Home
Market
The price pFT
euros Sdom indicates the price
When the price of imports is pFT as
This
At
Without trade barriers, the atimport
pFTis, the
Home which
supply foreign
consumers
curve
price
ofbuy
Home
a
fixes the Home
firms. It is
quantity ofupward
goods equal
slopedto since
C. firms
shown here, Home firms supply a market price; because when firms are
the importwilling
price is pto
wish to sell more when prices are
FT, the

quantity of goods equal to Z. total supply curve in the Home market is the kinked
high. supply imports.
line shown. The first Z units of supply are made by
Home firms. The rest is imported.
Demand and supply thus meet at point B.
The level of imports
equals the difference B
pFT
pFT between Home
This is the demand curve of Home
consumption and
consumers. It is downward sloped
Home production.
since consumers wish to buy more
when prices are low. Ddom

Imports

Z C quantity
Trade creation
➢ “Trade creation”: when with signing a trade
agreement between two countries trade is
shifted from a higher cost domestic
producer to a lower cost producer inside
the customs union.

➢ Increases welfare

➢ Switching from outside to inside suppliers

with the same costs only involves a
redistribution of tariff income from the
government to consumers..
Trade diversion

➢ Trade diversion”: it occurs when trade is

diverted from a more efficient exporter
towards a less efficient one by the
formation of trade agreement. In this case
imports are shifted from a lower price
producer from a third country, which is not a
part of the trade agreement (outsider), to a
higher cost producer from a member-state
(insider) .

➢ Ambiguous effect on welfare

Trade creation & diversion

➢ Trade creation & diversion is jargon that is often used.

– It is imprecise, but widely used.
– Intuition for why it is so popular, despite its shortcomings.

➢ It captures ambiguity of welfare gains in two words.

➢ “Discriminatory liberalisation”.
– Liberalisation
= tends to improve welfare ~ trade creation
– Discrimination
= tends to diminish welfare ~ trade diversion
2.1 The Static analysis: 3 take-aways

1) Smith's certitude’ in The Wealth of Nations: Partner firms

enjoy a rise in sales to Home. Home consumers see lower
prices.

2) Harberler's spillover: The impact on excluded nations

(RoW) is always negative (remember domino effects!).

3) Viner’s amibuity: Not possible to know whether the sum of

the welfare effects for Home country (trade diversion + trade
creation) is + or -.

➢ In the EEC: Trade creation for manufactured goods,

trade diversion for agricultural products
(protectionism with high external tariff).
➢ Trade creation:
https://www.youtube.com/watch?v=qeNR93aW4ug

➢Trade diversion:
https://www.youtube.com/watch?v=irpERJXoKxs&t
=163s
2. The economics of the Treaty of Rome and of
the Single Market: welfare and economic
effects of Integration.

➢ 2.1 The Static analysis.

➢ 2.2 Dynamic effects.

Growth Effects

• European leaders have long emphasised a the pro-growth aspects of

European integration. How?

➢ Allowing market access to suppliers from other member states,

➢ Removing trade costs, thereby made suppliers from other

member states more competitive,

➢ it removed anti-competitive policies (like quotas), practices and rules in

many member states, in particular against suppliers from other member
states.

➢ EU integration promote knowledge capital: large research funding,

Erasmus exchanges

96
Market size and scale effects

• Defragmentation and pro-competitive effect (short-term effects):

• PRE liberalization: typical firm 100% sales at home, 0% abroad;
• POST: access to larger market .
• Pro-competitive effect = markup falls (price and profits go down).

• Industrial Restructuring:
• Some firms lose money (as price went down)
• number of firms decrease (lay-offs, mergers, buy-out, bankruptcies);
• firms enlarge market shares and output,
• More efficient firms,
• mark-up rises,
• profitability is restored.

• Result:
• bigger, fewer, more efficient firms facing more effective competition.

97
Competition & State aid (subsidies)

➢2 immediate questions
➢ “As the number of firms falls, isn’t there a tendency for the
remaining firms to collude in order to keep prices high?”
➢ “Since industrial restructuring can be politically painful, isn’t
there a danger that governments will try to keep money-losing
firms in business via subsidies and other policies?”

➢The answer to both questions is “Yes”. Need of new rules to

prevent anti-competitive behaviors.

➢Lead to the economics of subsidies and EU’s policy:

-EU regulates state aid
-EU regulates competition 98
 EU Competition Policy
➢To prevent anti-competitive behavior, EU policy focuses
on two main axes:

➢Antitrust and cartels. The Commission tries:

➢ to eliminate behaviours that restrict competition (e.g. price-
fixing arrangements and cartels),
➢ to eliminate abusive behaviour by firms that have a dominant
position (Firms that are lucky or possess excellent products
can establish very strong positions in their market.)

➢Merger control. The Commission seeks:

➢ to block mergers that would create firms that would dominate
the market.

99
Accumulation effects

• So far we focused on allocation effects

• Growth in income per worker requires more output per
worker.
• Nation's labour force can produce more goods and services
year after year only if they have more/better 'tools' year
after year.
• 'tools' means capital broadly defined:
• physical capital (machines, etc.),
• human capital (skills, training, experience, etc.) and
• knowledge capital (technology).
• Growth is linked to rate of physical, human and knowledge
capital accumulation.
• Most capital accumulation is intentional and it is called
investment.
• Thus: European integration affects growth mainly via its effect on
investment in human capital, physical capital and knowledge capital.
100
Verbal logic of growth: summary
• European integration (or any other policy) → allocation
effect → improved efficiency → better investment
climate → more investment in machines, skills and/or
technology (accumulation effect) → higher output per
person.

• Medium run effects eventually fade out (because of

diminishing returns to capital).
• Growth returns to its long-run rate.

• Long run effects raise long-run rate forever

(technological changes / knowledge capital/ investment
in R&D).
101
Some facts
Some facts
Table 7-1: European Growth Phases, 1890-1992

Period Real GDP Real GDP Real GDP per

per capita hour
1890-1913 2.6 1.7 1.6
Belle epoque
1913-1950 1.4 1.0 1.9
2nd 30 yr war
1950-1973 4.6 3.8 4.7
Golden era
1973-1992 2.0 1.7 2.7
Prod’ity slowdown
Whole Period
1890-1992 2.5 1.9 2.6
© Baldwin & Wyplosz 2006. The Economics of European
103
Integration, 2nd Edition
 The growth effect and the European
integration.
➢ Measurement of the dynamic effects of integration received very little
empirical attention during the early days of European integration because
during the period between 1945 and 1975 probably because economic
growth was not a matter of concern.

➢ The Cecchini Report (Commission of the European Communities

1988a) attempted to estimate the economic benefits of the single
market project but focused entirely on the static effects, viewing the
growth effects as impossible to measure.

➢ The general conclusion from these and other similar empirical studies
on the growth effect of European integration is they are not very
conclusive… results are very sensitive to a number of factors
➢ Counterfactual the real problem.

➢ Is very difficult to separate the effects of European integration from the many
other factors affecting growth.
Integration-induced investement-led growth
 Synthetic analysis

➢ Control: « synthetic Britain » : weighted average of non-members such as the

evolution of GDP is similar before joining the UE

➢ Effect: +12%!!
Integration-induced investement-led growth

• To sum up:
• European integration: European economy more efficient → +
allocation effect → more investment → higher Y per capita / higher K
level

• European integration: investment less risky (reduced uncertainty

concerning the nation’s stability)→ more investment
2. The economics of the Treaty of Rome and of
the Single Market: welfare and economic
effects of Integration.

➢ 2.1 The Static analysis.

➢ 2.2 Dynamic effects.

➢ 2.3 Location effects.

Europe’s regions

• Concern for Europe’s disadvantaged regions has always

been part of EU priorities
• In Treaty of Rome preamble

• Pre-1986, most spending on regions was national

• Rural electrification, phones, roads, etc.

• Entry of Spain & Portugal created voting-bloc in Council

(with Ireland and Greece) that induced a major shift in
EU spending priorities, away from CAP towards poor-
regions

• “Structural spending” now about 1/3 EU budget

Europe’s Economic Geography: Facts
• Europe highly centralised Centrality of EU25
in terms of economic Regions
activity. Periphery
Intermediate
• western Germany, Benelux Core
nations, N.E. France and S.E.
England have 1/7th land, but
1/3rd of pop. & ½ GDP

• Periphery has lower

standard of living
• More unemployment
• Especially among youth
• More poverty

• Why is it a problem?
Social and political
considerations © Baldwin&Wyplosz The Economics of European Integration 110
Europe’s Economic Geography: Facts

Still, gaps among EU members have been steadily narrowing:

Europe’s Economic Geography: Facts

However, income inequality within each EU nation has been rising:

Geographic income inequality
• income distribution Index, EU-25 = 100

even more uneven at < 30

Canarias (E)

30 - 50
regional level. 50 - 75 Guadeloupe Martinique RÈ
union

75 - 100 (F) (F) (F)

100 - 125 Guyane (F)

>= 125
• Within nation
economic activity is AÁ
ores (P)

very unevenly Madeira

distributed (P)

• Income distribution has

become:
• More even in EU28
• Less even within EU28 Kypros

nations (by region) SIG16

GDP per head by region (PPS), 1998

Index, EUR-26 = 100 © Baldwin&Wyplosz The Economics of European Integration 114
Geographic income inequality
• Very uneven income Lux.
distribution, DK
Ireland
geographically NL
Austria
Belgium
• 1999 income/pop by German
Sweden
nation UK
Finland
• Luxembourg is 110% Italy
France
richer than average Spain
Cyprus
Portugal
• Bulgaria only 26% of Slovenia
Greece
average Czechia
Hungry
Slovakia
Poland
Estonia
• In 2016: Luxembourg Latvia
Lithuania
256%, Bulgaria 52% Romania
Bulgaria
0 50 100 150 200 250
EU26=100

115
Geographic income inequality
• French example
• Ile de France (Paris) has Outre-Mer
almost 1/3 of all
economic activity Mediterranee

• Per capita incomes (not Centre-Est GDP share

shown) are 158% of Pop share
EU15 average Sud-Ouest

• Mediterranee has 10% Ouest

of GDP, 12% of
Est
population
• GDP/pop only 86% of Nord - Pas-de-Calais
EU15 average
• Outre-Mer are former Bassin Parisien

French colonies (poor Ile de France

islands in Caribbean, 0.00 0.05 0.10 0.15 0.20 0.25 0.30
etc.)
© Baldwin&Wyplosz The Economics of European Integration 116
Europe’s Economic Geography: Facts
➢ Krugman specialization index: fraction of manufacturing that has
to change sector to make a nation’s sector-shares line up with
the sector-shares of average EU nations.

Most EU nations are becoming more specialized

Theory
➢2 major approaches linking economic integration to change in the
geographic location of economic activity

➢Comparative advantage suggests nations specialise in sectors in

which they have a comparative advantage

➢New Economic Geography suggests that integration tends to

concentrate economic activity spatially

➢General idea:
➢Use c.a. approach to explain cross-nation facts
➢Use NEG to explain within nation facts

118
Theory part I: Comparative Advantage and
Specialisation
Relative labour endowments in Europe:

What does the Hecksher-Ohlin framework predict?

Theory part I: Comparative Advantage and
Specialisation

• Comparative advantage suggests that nations specialize in sectors in

which they have a comparative advantage.

• Example:
- Germany abundant in high-skilled labour;
- Portugal abundant in low-skilled labour;
- with trade: Germany specializes in pharmaceuticals and trades them
for clothes from Portugal and the industrial structures of both
Portugal and Germany would become more specialized
 Theory part II: new economic geography

➢ New economic geography suggests that integration tends

to concentrate economic activity spatially.

➢ It is based on two pillars:

❖ Agglomeration forces encourage spatial concentration:

• demand linkages: big markets;

• cost linkages: availability of suppliers.

❖ Dispersion forces favour the geographic dispersion of economic

activity (e.g., higher rent and land prices, high cost of non-
traded services, competition with other firms);
Agglomeration Forces
• Agglomeration forces promote the spatial concentration
of economic activity

• Many agglomeration forces

• Technological spillovers (e.g. silicon valley)
• Labour market pooling (e.g. City of London)
• Demand linkages (a.k.a backward linkages)
• Supply linkages (a.k.a foreward linkages)

• NEG forces on demand & supply links since they are

clearly affected by economic integration (lower trade
costs)

122
 Circular Causality & Demand Linkages

1. If some industry moves to big region

4. Production
Shifting,
Due to trade costs, firms prefer to locate in big market. 2. Expenditure Shifting,
More industry moves to big region workers spend incomes in big region
instead of in small region

3. Market Size Effects:

big market gets bigger, small market gets smaller
123
 Circular Causality & Supply Linkages
1. If some industry moves to big region

4. Production
Shifting
Some more firms move from small market to big 2. Production Shifting,
market, attracted by lower costs Migrated firms’ output now
cheaper in big region & dearer in
small region (trade costs)

3. Cost Shifting,
Availability of wider range of locally available intermediate goods
makes big region cheaper place to produce

124
Dispersion Forces

• Dispersion forces promote the spatial dispersion of economic

activity

• Many forces lead to a tendency of firms to avoid

agglomerations of economic activity
• Rents and land prices
• High cost of other non-traded services
• Competition with other firms

• The NEG focuses on the last one “local competition” since it is

clearly related to trade costs
• As trade costs fall, distance provides less protection from distant
competitors

125
Location effects
➢ Outcome of economic integration on the location of
economic activity within the integrated area, two
competing effects :
✓ agglomeration linked to scale economies;
✓ and trickle-down [ruissellement] towards the less
developed regions with cheaper labour endowments.
➢ "new economic geography" literature (Krugman,
Venables) emphasises the role of clustering forces in
generating an uneven distribution of economic activity
and income across space.
➢ For some models, liberalization has a U-shaped effect
: first concentration of activities at the center (size
confers cost advantages with increasing returns to
scale), then production may return to the periphery with
lower wages.
Location effects in Europe

➢ Prior to the southern enlargement and the start of

the SMP, convergence among EU countries: causal
relationship between trade liberalization and income
convergence inside the European Union (factor price
equalization theorem).

➢ During the 80s: southern enlargement and deepening

of the process of integration with the launching of the
Single Market Programme.

➢ Convergence of incomes of the South would remain

relatively poor and, if so, whether this would generate
large flows of labour from the South to the North ?
Location effects in the European Union
➢ Income convergence after Greece, Portugal, and Spain
joined the European Union: Through trade
liberalization or thanks to the massive assistance
(regional policy) they received from the EU budget?

➢ As far as location is concerned, Krugman (1991) :

creation of an integrated single market likely to
increase specialization in the European Union
(increasing returns to scale).

➢ Empirically: only modest increases in country

specialization and geographical concentration of
industrial production since the start of the SMP.
EU Regional Policy

. . the Community shall aim at reducing disparities

between the levels of development of the various
regions and the backwardness of the least favoured
regions or islands, including rural areas. Treaty
establishing the European Community, 1957
EU Regional Policy
• Concern for Europe’s disadvantaged regions has always been
part of EU priorities (i.e., part of Treaty of Rome preamble).

• Still, major EU funding for less-favoured regions was introduced

only when the first ‘poor’ member, Ireland, joined in 1973: the
European Regional Development Fund (ERDF) was set up to
redistribute money to the poorest regions, but its budget was
minor.

• The situation changed in the 1980s when Greece, Spain and

Portugal joined: these nations were substantially poorer and did
not benefit from CAP funding. The voting power of Greece,
Spain, Portugal produced a major realignment of EU spending
priorities.
EU Regional Policy
• EU always had poor regions (Mezzogiorno, etc.)
• much spending on poor EU regions, but very little by EU (pre 1986)
• 1973, Ireland (poor at the time joined); 1981, Greece joined but
no major reorientation of EU spending priorities.
• In 1986, Iberian enlargement shifted power in Council and
spending priorities changed
Impact of 2004 Enlargement

• New members are much poorer than EU15

• Difficulties
• Cost of structural spending could rise substantially
• 10 new poor nations make some poor regions in EU15 look relatively
rich
• Pushes them above 75% of EU25 average

• Political power in Council likely to shift spending priorites

131
5 Objectives (2021-2027)

1. A more competitive and smarter Europe

2. A greener, low carbon transitioning towards a net zero

carbon economy and resilient Europe access to, and use and
quality of information and communication technologies
(ICT)

3. A more connected Europe

4. A more social and inclusive Europe

5. A Europe closer to citizens 132

4 funds

• The European Regional Development Fund (ERDF), to invest in the

social and economic development of all EU regions and cities.

• The Cohesion Fund (CF), to invest in environment and transport in

the less prosperous EU countries.

• The European Social Fund Plus (ESF+), to support jobs and create a
fair and socially inclusive society in EU countries.

• The Just Transition Fund (JTF) to support the regions most affected
by the transition towards climate neutrality.

• Funds from the ERDF and ESF+ are allocated in three categories of
regions (less developed, more developed, in transition), some
countries benefit from the Cohesion Fund, some regions with
specific needs receive dedicated funding (outermost
regions and sparsely populated), and all countries benefit from
the Just Transition Fund.
Empirical evidence

• Pienkowski and Berkowitz (2015) review the available existence on

the effects of regional policies on regional growth:

❖Positive but small effect of structural funds on regional growth

(concentrated in poor regions)
 To take away/A retenir.
Three kinds of economic integration’
effects.
➢ Static:
✓ Trade creation versus trade diversion and their welfare
effects;

➢ Dynamic effects:
✓ Allocation effects: bigger, more efficient firms
✓ Accumulation effects: investment in physical, human capital
✓ Economic integration between countries will raise the long- run
rate of growth because it increases the extent of the market.

➢ Location effects:
✓ Dispersion versus agglomeration effects linked to increasing
returns to scale.