THE EUROPEAN UNION

THE SPEC

•Elementary understanding of the institutional structure of the EU, notably the role of the European Commission and the European Central Bank. •Discuss main features of customs unions •Understand significant of the EU as a customs union – considered in relation to the Single European Market •Appreciation of potential impact on the UK economy of EU enlargement •Evaluate economic and monetary union and the single currency in the context of the debate over UK membership

EU KEY TERMS Key Term The Euro Single Market European Monetary Union Trade Deflection Rules of Origin Intra-area Trade Trade Creation Social Dumping Anglo-Saxon Neo-Liberalism FOREX Market Eurosclerosis

Definition

EU KEY TERMS Key Term

Definition

The Euro

The currency adopted by the members of the Economic and Monetary union (EMU)

Single Market

Removal of obstacles, such as customs checking, to allow the free movement of goods, services, capital and persons through the area

European Monetary Union

A group of countries that have adopted the euro and have their monetary policy controlled by the European Central Bank

Trade Deflection

Redirection of international trade due to the formation of a free trade area

Rules of Origin

Stipulation that a product must be manufactured from locally sourced components

Intra-area Trade

Trade between the members of a trading agreement

Trade Creation

An increase in international trade that results from the reduction in tariff barriers

Social Dumping

Where goods are produced by low wage labour usually without expense by employers on workers’ social benefits

Anglo-Saxon Neo-Liberalism

Economic reform aimed at boosting the dynamism of economies – in contrast to the ‘social model’ which stresses social objectives

FOREX Market

Abbreviation of the foreign exchange markets

Eurosclerosis

High unemployment and slow job creation despite economic growth

INTRODUCTION TO THE EU 

UK joined in 1973



Post WW2 the leaders of the main countries in Europe realised that a way had to be found to keep peace in Europe and increase the welfare of the populations

LO: To achieve an elementary understanding of the institutional structure of the EU, notably the role of the European Commission and the European Central Bank

THE INSTITUTIONAL STRUCTURE OF THE EU

THE COUNCIL OF MINISTERS 

Decides all major laws and policy changes



Made up of Ministers from each member state Main meeting room of the Council of Ministers

THE EUROPEAN PARLIAMENT 

626 members directly elected by the people in each member state



The number of seats each nation has reflects the size of the population



Has very little power to create new laws – this power lies with the Council of Ministers

1st Meeting Place: Strasbourg, France

THE EUROPEAN COURT OF JUSTICE (ECJ) The supreme court of justice  In Luxembourg 

THE COMMISSION Responsible for:  Proposing legislation  Implementing decisions  Upholding the union's treaties  General day-to-day running

Mentioned specifically in the Spec

THE EUROPEAN CENTRAL BANK    

Central bank for the Euro Established in 1998 HQ in Frankfurt, Germany Is independent of political intervention

Mentioned specifically in the Spec

THE EUROPEAN CENTRAL BANK

Mentioned specifically in the Spec

Main Role:  To maintain the Euro’s purchasing power and price stability – inflation target of 2% Other Roles:  To define and implement monetary policy  To support economic policies of the Eurozone members  To conduct foreign exchange operations  To issue bank notes  The smooth operation of the banking system

SARCOZY, FRENCH PRESIDENT 

Has criticised independence of ECB



Wants mandate to extend to growth and job creation, rather than primarily on inflation control



But others argue this would undermine the principle of independence

THE SINGLE MARKET Single Market: Removal of obstacles, such as customs checking, to allow the free movement of goods, services, capital and persons through the area The Treaty of Rome 1957 (the Treaty which led ultimately to the EU being established) set out 4 economic freedoms it wanted to create in Europe:  Free movement of goods  Free movement to provide services  Free movement of capital  Free movement of people The European Single Market came into operation in 1992 and removed barriers to trade

BENEFITS OF THE SINGLE MARKET Scope to exploit EOS and for Specialisation  480 million consumers in 27 countries  EOS + Specialisation = Productivity up  Free movement of factors of production therefore a more efficient allocation of resources Increased Dynamic Efficiency  As competition increases inefficient companies will suffer a loss of market share and may have to exit the market  Consumers benefit from cheaper products and more choice Emergence of Cheap Airlines  E.g. Easyjet and Ryanair Lower Electricity Costs for firms and consumers  In countries where the market has been opened up to competition Reduction in Export Bureaucracy  Open borders cut delivery times and reduce costs UK Citizen freedoms  UK Citizens have the right to work, study or retire in all member states

COSTS OF A SINGLE MARKET Increased Competition  Some UK firms may be unable to compete  Leading to decline of traditional markets  With a consequence of job losses Work in Progress  The single market is “work in progress”  Gaps still remain in the development of a single market for intellectual property rights, services, financial services, transport and energy Services Market Lagging  The market for services has opened up more slowly than the market for goods  This means competition has not increased to the extent originally envisaged

ACTIVITY P.222 1.

With the aid of an AD/AS diagram indicate the benefits of the single market on the UK economy

2.

Prepare a brief to defend the view that the single market has created more advantages than disadvantages on the UK

QUESTION 1 Diagram AD up – free movement of goods, services, capital and labour is likely to lead to increased market opportunity SRAS up – Exploiting EOS will likely reduce costs and shift SRAS to the right

LRAS up – as opportunities for profit increase many firms will increase investment, increasing the productive capacity of the economy The Economic Consequences of the Single Market on the UK In the long term the consequence will be  Increased economic growth  Increased employment  Reduced inflation  Increased competitiveness

The short term impact on inflation depends on the relative size of the shifts in the AD and AS curves – AD outstripping AS in the short term will create inflationary pressure

JAN 2011 Extract D (lines 35-36) argues that ‘a more ambitious set of common macroeconomic policies would help speed recovery in the EU.’ Using the data and your economic knowledge, asses the impact on the UK economy of a recovery in the EU as a whole. (25 marks)

STARTER RECAP 1. 2. 3.

4.

List the 4 economic freedoms a single market aims to achieve What year did the European Single Market come into operation? The European single market is still relatively under developed in some respects, explain a few of these Explain the impact the European single market has on the following, including how/why: a.

b. c. d.

5.

UK ECONOMIC GROWTH UK INFLATION (think about what happens to the SRAS and LRAS and why) UK COMPETITIVENESS UK EMPLOYMENT

Explain 1 negative implication to the UK of their membership of the European single market

Customs Unions The Spec: LO: TO DISCUSS MAIN FEATURES OF CUSTOMS UNIONS TO UNDERSTAND THE SIGNIFICANCE OF THE EU AS A CUSTOMS UNION, CONSIDERED IN RELATION TO THE SINGLE EUROPEAN MARKET

FROM FREE TRADE TO ECONOMIC UNION Types of Integration: Performance Areas Countries agree to give a lower tarriff on certain trade

Free Trade Area

Customs Union

Common Market

Members eliminate barriers between themselves and other members but continue barriers against nonmembers than may vary

Members eliminate barriers between themselves and establish uniform barriers against non members with a common external tariff

A customs union that also enables the free movement of labour and capital across national boundaries

Increasing depth and commitment Nb. Tariffs are imposed by countries on imports, it is in-effect a tax

Economic Union A common market that also that also creates the unification of members general objectives in respect of economic growth and the harmonisation of monetary and fiscal policy

CUSTOMS UNIONS 

Members eliminate barriers between themselves

And 

Establish uniform barriers against non members with a common external tariff

TRADE CREATION An increase in international trade that results from the reduction in tariff barriers

Due to the removal/reduction in tariffs as the result of a Customs Union a country will perhaps now be able to import the goods cheaper than producing them themselves Price

Domestic Supply

F

H

W1 W

J

K

Price with Tariff

I

G

Customs Union Price Domestic Demand

0

E

B

A

C

Quantity

TRADE CREATION 

Before entry to the customs union the country imposed a tariff on the product, resulting in a price of W1



At W1 domestic demand is 0A and domestic supply is 0B, therefore imports are BA



Removal of the tariff results in price of W, where domestic demand is 0C, domestic supply is 0E and imports increase to EC



The difference between the original level of imports and the new level is the trade creation: EB+AC

TRADE DIVERSION Trade Diversion: this happens when as a result of joining a union a country has to buy goods from a high priced producer inside the union due to the operation of the common external tariff 

As a result a country may be forced to buy from less efficient producers

Price

Domestic Supply

F

H

W1 W

J

K

EU Price with Tariff

I

G

World Price Domestic Demand

0

E

B

A

C

Quantity

TRADE DIVERSION 

Demand in UK falls to 0A from 0C



Domestic output rises to 0B from 0E



Imports were EC



Imports are now BA as a result of the contraction in demand and the extension in supply

ECONOMIES OF SCALE 

 

A major reason for entry into the customs union is to exploit the economies of scale on offer The EU has 480 million inhabitants, compared to 60 million in the UK Since the single market began in 1992 many cross coutry mergers have taken place e.g. in 2000 German Conglomerate Mannesmann and the British Vodaphone AirTouch merged, creating the worlds largest mobile telephones group

COMPETITION 

Domestic industries will face greater intra-union competition



Competition will encourage dynamic efficiencies – R&D, innovation, new products, new processes, new techniques, reduced costs of production and prices



There is a danger that oligopolistic control will occur through crosscountry mergers, and thus collusion which will reduce any benefits of increased competition



The competition authorities must be vigilant

FINANCIAL CONTRIBUTIONS 

Membership of a union involves financial contributions which may not benefit the contributor

LABOUR MOBILITY CONCERNS 





Whereas the free movement of capital has been readily exploited by many countries Many countries are holding back regarding the free movement of labour This is due to concerns about unemployment levels and social dumping Social dumping: where goods are produced by low wage labour usually without expense by employers on workers’ social benefits

WORLDWIDE FREE TRADE? 

Would further extend the benefits of European free trade

CUSTOMS UNIONS

Good

Removal of tariffs with members and common external tariffs for non members

Bad

Trade Creation: countries now able to import goods cheaper than producing them themselves due to removal of tarriffs with other members

Trade Diversion: countries are now forces to but goods from less efficient (more expensive) producers as a result of the common external tariffs on countries they previously bought from

Economies of Scale: EU=480 million inhabitants, compared to UK=60 million

Financial contributions: are compulsory but may not benefit the contributor

Competition: greater dynamic efficiencies Resistance to free movement of labour: but risk of oligopoly forming and due to concerns for domestic collusion unemployment levels and social dumping European single market: Still not as efficient as worldwide free trade would be

TASK 

Using the table, Evaluate in your own words the impact membership to the EU customs union has had on the UK

Analyse 2 +s  Analyse 2 –s  An evaluative paragraph – link to current UK economy and the argument that the best way to get out of this double dip recession is to “export our way out of it” 

EU Enlargement THE SPEC:

APPRECIATION OF THE POTENTIAL IMPACT ON THE UK ECONOMY OF EU ENLARGEMENT

“EU10” 

May 1 2004



10 countries joined the European Union



This was the largest expansion in the history of the EU and brought significant changes to Europe

2004 New Entrants: Czech Republic Hungary Poland Slovakia Slovenia Latvia Lithuania Estonia Cyprus Malta

WHAT IMPACT DID THE “EU10” HAVE? 

EU population increased by 100 million



Added only 5% to EU GDP



Created fear in some members about an influx of cheap labour, the “Polish Plumber”



A migration of capital from Western Europe into the new entrants – Slovakia is now the car producer of Europe

“ENLARGEMENT HAS BEEN A PRINCIPAL FEATURE OF THE UNION'S POLITICAL LANDSCAPE”   

 

2007 saw the latest members, Bulgaria and Romania join the Union Croatia will become the 28th member of the EU on 1 July 2013 Iceland, Macedonia, Montenegro, Serbia and Turkey are all candidates There are at present no plans to cease enlargement Membership of the European Union is open to any European country that is a stable, free market liberal democracy that respects the rule of law and human rights

EU ENLARGEMENT New entrants to the EU are beneficial because: 

It increases the size of the freemarket



They are fellow free-market capitalist economies and so are natural allies



New members are seen by the UK as powerful counter-weights to the combined power of France and Germany within the EU

TASK 1. 2.

3.

4.

What and who are the “EU10?” What impact did the EU10 have on the EU and the UK in particular? Who are the potential new entrants t the EU moving forward? What are the arguments for these new entrants being allowed to join the EU?

ECON 4 SPECIMEN Extract D (lines 5-6) states that, in assessing UK macroeconomic performance, ‘the impact of EU enlargement itself may be difficult to isolate from other determinants of economic success.’ Using the data and your economic knowledge, evaluate the significance of EU enlargement to UK macroeconomic performance.

(25 marks) Planning frame

ECON 4 SPECIMEN Key Points from Extract: 

Impact of enlargement difficult to isolate from 

  

 

“tremendously powerful multiplier effects” Immigration:  



 

Export performance beyond EU Sound demand management policies Supply side reforms eg. Education/training, wel fare/tax reform

Eased pressure on labour market and reduced wage inflationary pressure But inflows of labour have been accompanied by unemployment rises

Increased competition – stimulate supply side reforms, productivity in UK economy 2% up Investment 5.5% up UK must be responsive

LO:

TO EVALUATE ECONOMIC AND MONETARY UNION AND THE SINGLE CURRENCY IN THE CONTEXT OF THE DEBATE OVER UK MEMBERSHIP

MONETARY UNION





The Euro was necessary for the EU to be able to move to common fiscal and monetary policies Full monetary union went ahead on 1 Jan 1999

Reminder: A Managed Float

S ER of €



Ceiling

ER1

The euro operates in the FOREX market as a managed float D



The ECB regulates monetary policy of euro zone members, including their interest rate

a Demand and supply of €

Floor

EUROZONE GROWTH AND STABILITY PACT 

Limits public sector borrowing of euro zone members to 3% of GDP to stop countries holding back monetary policy implemented by the ECB



Many economists considered the Stability and Growth Pact as being too restrictive in times of recession and Portugal, Italy, France and Germany have broached it



The pact was loosened by reforms in 2005 to allow for extra spending on areas which would improve aggregate supply and thus aid economic growth and inflation control

NEXT STEPS 1.

What are the potential benefits of a single currency?

2.

What are the potential costs of a single currency?

3.

What is the UK’s stance on the single currency?

POTENTIAL BENEFITS OF A SINGLE CURRENCY Reduced Transaction Costs  The cost of changing from one currency to another  The European Central Commission suggested that eliminating transaction costs could boost the GDP of countries by an average of 0.4% Reduced Exchange Rate Uncertainty  Exchange rate uncertainty eliminated for intra-union trade but remains as the euro floats against the rest of the world  Reduced uncertainty should lead to increased trade and increased investment  Increased investment should boost LRAS and create long term economic growth Lower Interest Rates Possible through commitment to Low Inflation  Less likelihood of government failure as interest rate changes will be made purely on economic rather than political grounds  The ECB is committed to achieving low inflation and this has allowed lower interest rates, one of the drivers of economic growth Increased Competition  Increased price transparency as consumers are able to easily and accurately compare prices from different countries  Puts pressure on firms to reduce prices and increase efficiency Increased FDI  Becomes cheaper (due to reduced transaction costs) for firms to set up factories in other euro zone member countries  Currency variations added uncertainty to profit forecasts, but this uncertainty is eliminated

POTENTIAL COSTS OF A SINGLE CURRENCY Loss of Independent Monetary Policy  Countries who adopt the euro pass control of monetary policy to the ECB  The ECB sets interest rates to achieve objectives for the single currency area as a whole rather for 1 particular country  This “1 size fits all” approach has several implications…. Monetary Policy Response  The ECB is unlikely to respond by adjusting monetary policy unless a significant number of euro zone countries are affected, it would not respond for the benefit of just one country Importance given to UK Employment Levels  It is unlikely that the ECB would attach the same level of importance to UK unemployment levels as the BoE does The Growth and Stability Pact  Limits government debt to 3% GDP, the country may be forced to resort to a fall in economic growth to restore its budget position Asymmetric Policy Sensitivity  A policy adopted by the ECB may affect some countries more than others. E.g. an increase in the interest rate would affect the UK more dramatically than countries such as Germany. The reason for this is that much more mortgage borrowing in the UK is variable rate than in other countries, meaning UK mortgage holders are more vulnerable to interest rate increase. House ownership is much more common in the UK than in other European countries too, where renting is more popular.  For these reasons AD in the UK would be much more sensitive to a tightening of monetary policy than that in other countries Too Deflationary  Many economists and politicians criticise the EBC 2% inflation target as being too low (i.e.. too deflationary). The result is higher than necessary unemployment and slower economic growth. Too much focus on Inflation Target 

Many economists and politicians also criticise the EBC of being too focused on inflation, making them much slower than the Bank of England at reacting to falling growth rates.

UK’S STANCE ON THE SINGLE CURRENCY The UK government has made no formal commitment to participate in the economic and monetary union Gordon Brown argued that the UK should join only when the EMU was proven successful A paper which accompanied Gordon Brown’s paper set out 5 economic tests that Britain would have to pass before joining the EMU: 1.

2.

3. 4. 5.

The degree of alignment of British and continental business cycles The flexibility of European markets to cope with economic shocks The effect of monetary union on investment in Britain The effect on the financial services industry The implications for British employment and growth

UK’S STANCE ON THE SINGLE CURRENCY: THE DEGREE OF ALIGNMENT OF BRITISH AND CONTINENTAL BUSINESS CYCLES



The biggest problem of the UK joining the Euro is the fact that our economic cycle is not aligned with Europe’s



There are fundamental differences between us and Europe causing this – the UK has more non-EU trade than other countries, more mortgages at variable rates and it is the only oil exporter



The UK can often be in recession whilst the Euro zone is in boom – one size does not fit all



Many economists argue that convergence should occur for many years before we join, whereas others argue that convergence will only occur as a result of monetary union (us adopting the €)



To achieve convergence the BofE would have to switch focus away from inflation control to achieving convergence which may have implications

GDP UK Euro Zone

Time

Argument Against

UK’S STANCE ON THE SINGLE CURRENCY: FLEXIBILITY TO COPE WITH ECONOMIC SHOCKS

  

Requires labour flexibility UK labour markets are less regulated than Euro Lands’s In the UK:  

 





firms are freer to hire temporary and part time workers Can hire/fire a lot easier Trade union are less militant Workers are more occupationally/geographically mobile

This makes the UK better placed to cope with economic shocks than Euro Land However, once a eurozone member the UK’s flexibility will be more limited by the loss of control of monetary policy and Euroclerosis that still affects the eurozone

Euroclerosis: High unemployment and slow job creation despite economic growth

Argument Against

UK’S STANCE ON THE SINGLE CURRENCY: UK INVESTMENT



Over the last 2 decades the UK has had the greatest level of investment in the EU



The fear is that if the UK remains out of the Euro and the value of sterling increases firms in the UK will suffer as their exports become more expensive



For this reason firms will become more inclined to base themselves in Europe instead, having a detrimental effect on UK investment levels

Argument For

UK’S STANCE ON THE SINGLE CURRENCY: EFFECT ON UK FINANCIAL SERVICES INDUSTRY





UK specialisation London’s “square mile”



When the Uk did not join the euro in the first wave it was expected that much financial business would move out of London to Paris or Frankfurt



This situation did not materialise and the London market has grown



However, joining would mean reduced interest rates which would benefit traders as share prices would increase due to greater business investment and trader borrowing Argument For

UK’S STANCE ON THE SINGLE CURRENCY: EFFECT ON UK EMPLOYMENT AND GROWTH 

Joining the Euro would mean lower interest rates generally



This would lead to increased UK AD and particularly increased demand for houses in the UK as mortgages became cheaper



This would lead to demand pull inflation



With control of the UK Interest rate being given over to the ECB the UK government would have to use fiscal policy to reduce it



This would mean government spending cuts and tax increases



This would create a disincentive effect on both workers and entrepreneurs which would not bode well for either UK employment or growth

Argument Against

€ REAL WORLD AWARENESS KEY ISSUE: GREECE 

http://www.bbc.co.uk/news/business13798000

TASK Generic Pros

On your sheet of paper write in the middle “The Euro”

Generic Cons

Reduced transaction Costs for businesses Cost savings will be small and impact will be limited, despite claims it could boost GDP by 0.4%

Divide the page as shown opposite

€ UK Position

In each section write the pro/con information in one colour and then underneath it write an evaluative perspective on it

For

Against

JUNE 2010 Extract D (lines 32-33) concludes that ‘UK adoption of the euro at such an economically unstable time remains highly unlikely, whatever the potential benefits.’ Using the data and your economic knowledge, to what extent do you agree with the view that the UK economy would benefit if the euro were to be adopted by the UK at some point in the future? (25 marks) *need data extracts Have WAGOLL 21/25

STRUCTURE 

    

Date Response – use the data to help you!!!

Define Euro Explain background of UK in EU Analyse/evaluate 2 ways the UK would benefit Analyse/evaluate 2 ways the UK may suffer Synthesise/conclude  



Show awareness of Gordon Brown’s 5 Economic Tests Show awareness of current problems with Greece (“at such an economically unstable time remains highly unlikely, whatever the potential benefits”) Use current real world awareness to guide your judgement

TRADE DEFLECTION Trade Deflection: Redirection of international trade due to the formation of a free trade area Free Trade Area: Members eliminate barriers between themselves and other members but continue barriers against non-members Rules of Origin: Stipulation that a product must be manufactured from locally sourced components Intra-area Trade: Trade between the members of a trading agreement 

Prior to joining the EU the UK was a member of EFTA which created free trade between the members but allowed individual countries to negotiate tariffs with non-members



A free trade area leads to the problem of trade deflection where traders will try to import goods into the country with the lowest tariff (tax paid when goods come into a country) and then export them to other members



This means the traders avoid the higher tariffs and once the goods are imported into the free trade area, trade within the area is free



To avoid this rules of origin are required to govern intra-area trade which ensure that free trade refers only to partners own produce and not goods they have imported

TRADE DEFLECTION EXPLANATION  

  



Free trade areas create problems because import tariffs between the members vary This means that traders will always try and import to the country with the lowest tariff and then perhaps move the goods on elsewhere as once access has been gained trade is free Whenever trade is affected by a free trade area this is called trade deflection To solve this problem countries use roles of origin to control intraarea trade The rules of origin mean that free trade only applies to goods produced within the free trade area, as opposed to goods that have been imported in This problem happens because unlike with a customs union countries set their own import tariffs against other countries, resulting in variation and cheaper routes